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Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over Nancy Paxton, Senior Director of Investor Relations. Please go ahead, ma'am. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and thanks to everyone for joining us today. Speaking first is Apple's CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. +Please note that some of the information you'll hear during our discussion will consist of forward-looking statements, including without limitation, those regarding revenue, growth margins, operating expenses, other income and expense, taxes, future business outlook, and plans for capital return and debt issuance. Actual results or trends could differ materially from our forecast. +For more information, please refer to the risk factors discussed in Apples Form 10-K for 2015, the Form 10-Q for the first quarter of FY16, and the Form 8-K filed with the SEC today, along with the Associated Press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective date. +In addition, today's comments will refer to a metric we describe as the purchase value of services tied to our installed base. This is a non-GAAP measure, and a reconciliation to the corresponding GAAP measure can be found on our investor relations website at Apple.com/investor. I'd now like to turn the call over to Tim for introductory remarks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Nancy, and good afternoon, everyone, and thank you for joining us. Today, we're reporting the results of a very busy and challenging quarter, and we're also announcing an update to our capital return program. +Revenue for the quarter was $50.6 billion, which was within our guidance range. Despite the pause in our growth, our results reflect excellent execution by our team in the face of ongoing macroeconomic headwinds in much of the world, and difficult year-over-year comparisons. +We saw continued currency weakness in the vast majority of our international markets. In constant currency, our revenue declined by 9% from last year, 400 basis points less than the reported decline of 13%. For the first half of the fiscal year, our revenue in constant currency was up 1% year-on-year. +Despite challenges, there were a number of encouraging signs during the quarter. Our installed base of over 1 billion active devices continued to grow strongly. We added a huge number of Android switchers and new-to-Mac customers, and we generated very strong growth from services. +We sold 51.2 million iPhones in the quarter, consistent with the range of our own expectations, but lower than the exceptional year-ago quarter, when we saw an acceleration in iPhone upgrades, and 40% iPhone sales growth over the previous year. To provide some additional color, iPhone sales come from three sources: Customers who upgrade from previous iPhone models, customers who switch from Android and other operating systems, and customers who purchase a smart phone for the first time. +As we look at each of these three sources of iPhone sales, we see a business that is healthy and strong. First, from an upgrade perspective, during the first half of this year, the upgrade rate for the iPhone 6s cycle has been slightly higher than what we experienced in the iPhone 5s cycle two years ago, but it is lower than the accelerated upgrade rate we saw with iPhone 6, which as you know, was a big contributor to our phenomenal revenue growth a year ago. Most importantly, our customers are incredibly loyal. A recent Kantar survey of US smart phone purchasers indicated a 95% iPhone loyalty rate, the highest ever measured for any smart phone. +Second, we continued to see a very high level of customers switching to iPhone from Android and other operating systems. In fact, we added more switchers from Android and other platforms in the first half of this year than any other six-month period ever. +And third, with only 42% smart phone penetration of the global handset market today, iPhone is still attracting millions of first-time smart phone buyers each quarter, especially from emerging markets. For example, in India, our iPhone sales were up 56% from a year ago. +Next, I'd like to talk about services, which was our second-largest revenue generating category during the quarter. Setting aside the amount we received from a patent settlement in the December quarter, the March quarter services revenue was our highest ever. Services revenue jumped 20% to $6 billion. App Store revenue was up 35% to beat last quarter's all-time record, and Apple Music continues to grow in popularity with over 13 million paying subscribers today. We feel really great about the early success of Apple's first subscription business, and our Music revenue has now hit an inflection point after many quarters of decline. +The services business is powered by our huge installed base of active device, which crossed 1 billion units earlier this year. As we discussed on this call in January, those 1 billion-plus active devices are a source of recurring revenue that is growing independent of the unit shipments we report every three months. In fact, the purchase value of services tied to our installed base was a record $9.9 billion in the March quarter, up 27% over last year, accelerating from the 24% growth rate we reported in the December quarter. +The reach of Apple Pay also continues to expand, following a very successful launch in China in the March quarter, and last week's roll-out in Singapore. Apple Pay is growing at a tremendous rate, with more than 5 times the transaction volume of a year ago, and 1 million new users per week. There are more than 10 million contactless ready locations in the countries where Apple Pay has launched today, including over 2.5 million locations now accepting Apple Pay in the United States, and more expansion of Apple Pay is coming soon. +Turning to the Mac, we met our sell-in expectations, in addition to reducing channel inventory by about 100,000 unites. Overall, the Mac continues to attract a large percentage of new customers. In our latest survey of major markets, over half of buyers were new to the Mac, and in some countries, the percentage is extremely high, like in China, where over 80% of customers were purchasing a Mac for the first time. We're confident in our Mac business, and our ability to continue to innovate and gain share in that area. +Turning to the Apple Watch, unit sales met our expectations in the quarter. For some color on how we think about Apple Watch sales, we expected seasonality to be similar to the historical seasonality of iPod, which typically generated 40% or more of its annual unit sell-through in the December quarter. +We started shipping Apple Watch just one year ago, and it has quickly become the best-selling and most loved smart watch in the world. In fact, unit sales of Apple Watch during its first year exceeded sales of iPhone in its first year. Last month, we refreshed the lineup for the spring with new bands and a new starting price point, and the response from customers has been great. +Apple Watch is an increasingly essential part of user's lives, from responding to messages, managing calendars and navigating with maps, to helping them be more fit. And in some cases, the heart rate sensor has even helped save lives. We're really excited about the first year with Apple Watch. We have learned a lot, and we believe it has an exciting future ahead. +We announced some fantastic new products during the March quarter. iPhone SE became available on March 31, so none of its sales were reflected in our second-quarter results, but so far this quarter, we're seeing terrific customer response. iPhone SE is the most powerful four-inch phone ever, and it's a great option for customers all over the world who want a compact phone with advanced features, and a great price, without compromising performance. Demand has been very strong, and exceeds supply at this point, but we're working hard to get the iPhone SE into the hands of every customer who wants one, as quickly as possible. The addition of the iPhone SE in the iPhone lineup places us in a better strategic position to attract even more customers into our ecosystem. +We also unveiled the stunning 9.7 inch iPad Pro, with cutting-edge performance and our most advanced display yet. The reviews of our new iPad Pros have been great, and we are hearing from customers of the features and capabilities in the new Pros make them both the ultimate upgrade for iPad owners, and a great PC replacement. +In the June quarter, we expect to see our best iPad revenue compare in over two years. iPad is the best-selling, best-reviewed and most used tablet on the market. Customers tell us that they love iPad for its unique mix of portability, capability, and versatility, with over 1 million iPad apps in the App Store to help them work, play, learn, and create. +We also announced Care Kit, a new software framework that developers can use to help people take a more active role in their health, by keeping track of their care plans, monitoring their symptoms and medication, and delivering the insights they need to make smart decisions about their health. We're very excited about the ways iPhone and Apple Watch are helping people lead healthier lives. We believe there's great promise here for the future, and we are very interested in where this can take us. +As always, we are contributing to society beyond our products, promoting the use of renewable energy across our facilities and inside our supply chain, and developing cutting-edge technologies to revolutionize recycling in the materials we use. We are unwavering in our commitment to protect the security and privacy of our customers and their data, and we are actively promoting inclusion and equality across our business. +As we continue through the June quarter, I'd like to remind you that we measure the health of customer demand based on sell-through. Despite ending Q2 within our channel inventory targets, in light of the macroeconomic environment we plan to lower our channel inventories in the June quarter. This will impact our reported revenue in Q3. Luca will provide more details on this in his commentary. +But before turning over the call to him, I will summarize by saying that the future of Apple is very bright. Our product pipeline has amazing innovations in store. We are very excited about bringing together developers for our four major platforms at our worldwide developers conference in June. +We are forging ahead with important investments in research and development, in our infrastructure, and in our supply chain. We've made 15 acquisitions in the last four quarters to accelerate our product and services roadmaps, and we are always on the lookout for companies with great technology, talent, and strategic fit. +Creating value for shareholders by developing great products and services that enrich people's lives will always be our top priority, and the key factor driving our investments and capital allocation decisions. As our business continues to generate high levels of free cash flow, we are in the fortunate position to expand our capital return program again this year, as we have done each year since we started the program four years ago. +Today, we are announcing an extension of the timeframe of the program by four quarters through March of 2018, and we are expanding the total program size from $200 billion to $250 billion. Luca has more details on this announcement and our results for the March quarter. Luca? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good afternoon, everyone. Let me start with the March quarter results. Revenue for the quarter landed within our guidance range at $50.6 billion, compared to $58 billion in the year-ago quarter, a decline of 13%. +As we had expected, our comparisons to last year were influenced by the continued strength of the US dollar against foreign currencies. That being said, in constant currency, our revenue declined by 9%. On a geographic basis, in Asia, our revenue grew strongly in Japan, but it declined in greater China and the rest of Asia-Pacific. +However our business in these two regions is faring better than the numbers might suggest. We had significant channel inventory reductions and currency weakness, which affected our reported revenue for both of these segments. In mainland China, revenue was down 11%, and the decline was 7% in constant currency terms. Keep in mind that we were up against an extremely difficult year-ago compare, when our mainland China revenue grew 81%. We remain very optimistic about the China market over the long-term, and we are committed to investing there for the long run. +Gross margin was 39.4%, near the high-end of our guidance range, thanks to strong cost performance. Operating margin was 27.7% of revenue, and net income was $10.5 billion. Diluted earnings per share were $1.90, and cash flow from operations was strong, at $11.6 billion. +For details by product, I start with iPhone. We sold 51.2 million iPhones in the quarter, compared to 61.2 million in the year-ago quarter, a decline of 16%. It was a particularly challenging comparison to the record quarter a year ago, when iPhone 6 grew 40% as we entered last March quarter, and supply demand imbalance, which was recovered during the quarter. +Also, this year we reduced channel inventory by 450,000 units, while we increased inventory by 1 million units a year ago. We have exited the quarter with in our five to seven-week target range for channel inventory. iPhone ASV was $642 compared to $659 in the year ago quarter, with weak international currencies and very popular mid-tier and entry offerings contributing to the difference year-over-year. +iPhone's momentum in business markets continues to be very impressive. A recent survey by 451 Research, formerly known as ChangeWave, found that among US corporate buyers planning to purchase smart phones in the June quarter, 78% planned to purchase iPhones. That's the highest June quarter iPhone purchase intent ever measured by the survey and 5 points higher than a year ago. +Turning to services, we generated $6 billion in revenue, an increase of 20% over the March quarter last year, thanks primarily to the continued strong performance of the App Store, with revenue growing 35% to a new all-time high. According to App Annie, the App Store generated 90% more global revenue than Google Play in the March quarter, up from a 75% lead in 2015. Among our customers who purchased apps and content from our iTunes Stores, the average amount spent per customer reached a new all-time record in the March quarter. +Next, I'd like to talk about the Mac. We sold 4 million Macs compared to 4.6 million last year, a decline of 12%. It was a challenging quarter for personal computer sales across the industry, but we believe we gained market share. Despite the overall market slowdown, we generated double-digit market growth in a number of markets, including Russia, Korea, Singapore, Taiwan, and the UAE. +Just last week, we updated the MacBook, our thinnest and lightest Mac, with the latest processors, faster graphics, fastest flash storage, and longer battery life. We think our customers are going to love this update. We ended the quarter within our four to five-week target range for Mac channel inventory. +Turning to iPad, we sold 10.3 million compared to 12.6 million in the year ago quarter. We also reduced channel inventory by about 200,000 units, and we exited the quarter within our five to seven-week target range. In the same segments of the public market where we compete, we continue to be highly successful. Recent data from NPD indicates that iPad had 78% share of the US market for tablets priced above $200. And the latest data published by ABC indicates that iPad accounts for 72% of the US commercial tablet market, comprising business, government, and education. +iPad customer metrics are also extremely positive. In February, 451 Research measured a 97% consumer satisfaction rate for iPad Air 2, and among consumers planning to purchase a tablet within the next six months, 59% planned to purchase an iPad, more than 3 times the purchase intention rate of the next highest brand measured. Corporate buyers reported a 94% satisfaction rate for iPad, and a June quarter purchase intent of 71%. +Revenue from other products grew 30% over the last year, thanks to Apple Watch. We have expanded distribution to 60 countries, and introduced bands in beautiful new colors for spring, so customers can personalize their watches in more ways, with a range of colors, styles, and materials. Our customers are very happy with Apple Watch, with 451 Research measuring 94% customer satisfaction. +We're also making great progress with our enterprise initiatives. IBM now has engagements for more than 200 deployments of native iOS apps for large enterprise customers to accelerate mobile transformation. Our mobility partner program also continues to grow, with 108 partners across 20 countries. +We see continued broad industry adoption of native iOS apps to transform how professionals do their work and serve their customers. For example, retail bankers are using iOS apps on iPads to greet and onboard customers, reduce queue times, and improve the customer experience. And in hospitals, using doctors and nurses are using iOS Apps on iPhone and iPad to share and communicate more effectively, so that they can spend more time with patients, and less time on administrative tasks. +Let me now turn to our cash positions. We ended the quarter with $232.9 billion in cash plus marketable securities, a sequential increase of $17.2 billion. $208.9 billion of this cash, or 90% of the total, was outside the United States. +We issued $15.5 billion in US dollar denominated notes during the quarter, including our first green bond tranche to fund initiatives such as renewable energy and environmental design projects. We exited the March quarter with $72 billion in term debt. We returned $10 billion to investors during the quarter, including $2.9 billion in dividends and equivalents, and $7 billion on purchases of 71.8 million Apple shares, to open market transactions. +We have now completed over $163 billion of the current $200 billion capital return program, including $117 billion in share repurchases. As Tim mentioned, today we are announcing the latest update to our program, which we are increasing to a total of $250 billion. Once again, we are allocating the majority of the expansion of the program to share repurchases, given our strong confidence in Apple's future, and the value we see in our stock. The Board has increased the share repurchase authorization by $35 billion, raising it from the current $140 billion level to $175 billion. We will also continue to net share settle, less the employee restricted stock units. +We also know that the dividend is very important to many of our investors who value income, and we are raising it for the fourth time in less than four years. The quarterly dividend will grow from $0.52 per share to $0.57 per share, an increase of about 10%. This is effective with our next dividend, which the Board has declared today is payable on May 12, 2016, to shareholders of record as of May 9, 2016. +We continue to plan for annual dividend increases going forward. With $12 billion in annual dividend payments, we are proud to be one of the largest dividend payers in the world. In total, with this updated program, during the next eight quarters, we expect to return $87 billion to our investors, which represents about 15% of our market cap at the current stock price. +As in the past, we expect to fund our capital return program with US cash, future US cash flow generation and borrowing from both domestic and international debt markets. We will continue to review capital allocation regularly, and solicit input on our program from a broad base of shareholders. This allows us to be thoughtful about the size, the mix, and the face of the program. +As we move ahead into the June quarter, I'd like to review our outlook, which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We expect revenue to be between $41 billion and $43 billion. The revenue guidance implies a year-over-year decline, as we lap an incredibly strong June quarter last year, when revenue grew 33%, due in part to accelerated iPhone upgrade purchases. This tough compare is compounded by the continued weak macro environment this year, and the strong US dollar, which affects our revenue growth in international markets. +Embedded in this guidance is a planned channel inventory reduction worth over $2 billion, as we have elected to be prudent about our channel inventory position, given the current macro environment. The guidance also reflects a range of possible scenarios related to how quickly we can get into supply-demand balance for iPhone SE. Due to these factors, our expected demand is greater than the revenue range implies. +Sequentially, our guidance implies a revenue decline of 15% to 19%, which is comparable to the 17% sequential decline that we've averaged from the March to June quarter for the last three years, despite the anticipated channel inventory adjustments I just described. We expect seasonal sequential declines in iPhone and iPad sales, and a sequential increase in Mac sales. We also expect iPhone ASPs to decline sequentially as we get further from the launch of iPhone 6s and 6s Plus, and as iPhone SE enters the mix. +We know that our revenue guidance falls short of market estimates for the third quarter. We believe the difference counts primarily from three areas: First, the $2 billion plus channel inventory reduction I just mentioned. Second, the effect of the channel inventory reduction, and the launch of iPhone SE on iPhone ASPs, as well as the current constrained supply of iPhone SE. Third, different estimates for Mac, which we expect to grow sequentially at the rate similar to what we have experienced in the past June quarters. +We expect gross margins to be between 37.5% and 38%. We expect continued cost improvements to be more than offset by the sequential loss of leverage from lower revenue, and a differing mix of products. We expect OpEx to be between $6 billion and $6.1 billion. +We expect OI&E to be about $300 million. And we expect the tax rate to be about 25.5%. With that, I'd like to open the call to questions. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Luca. +(Caller Instructions) +Operator, may we have the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +First, we hear from Simona Jankowski with Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + My first question was actually just a clarification, in terms of putting in context that $2 billion in channel inventory reduction. What was that last year, just to help us make the comparison on a year-over-year basis? The bigger question, Tim was, with the smart phone market now reaching a pretty mature growth base, how does Apple think of itself going forward? Is it a growth company, or is it a more mature tech company? And if it's still the former, how does that change how you think about M&A especially given the position you're in with your balance sheet strategically? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Simona, let me give you the data point on the sell through and then I'll let Tim answer the strategic question. We had a channel inventory reduction that was worth a bit less than $800 million a year ago. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [4] +-------------------------------------------------------------------------------- + + Simona, this is Tim. In terms of do I think the smart phone market is mature? I think that the market, as you know, is currently not growing. However, my view of that is that's an overhang of the macroeconomic environment in many different places in the world. We're very optimistic that this too shall pass, and that the market and particularly us will grow again. +The reason that we're optimistic is we look at sort of the three places that iPhone sales come from, and from an upgrade point of view, as I mentioned in my comments, we compare favorably, slightly better than the upgrade cycle that we saw on the iPhone 5s. We are lower than the iPhone 6, but I think all of us know that was an extraordinary cycle, that accelerated upgrades from 2016 into 2015, and so that comparable will be tough for this year, but that's a transitory thing. +As we look at switchers, we're extremely excited that for the first half we have set a record from switchers from other platforms. The largest we've ever seen in any six month period before, so we've got traction there. And then on emerging markets, if you take a look at India, we grew by 56%, and we're placing increasing emphasis in these areas, where it's clear there will be disproportionate growth versus the more developed areas. +The next thing is with the iPhone SE, we have seen our ability to attract even more customers into the platform, with incredible product that is at a new price point for us, with the latest technology. And so we're optimistic about attracting even more customers with that. We also look at our pipeline, and were very excited about what's in our pipeline. All of those things make me optimistic. +Your other question was on M&A, and regardless of the first, we're always looking in the market about things that could complement things that we do today, become features in something we to, or allow us to accelerate entry into a category that we are excited about. As I have said before, our test is not on the size. We would definitely buy something larger than we have bought thus far. It's more about the strategic fit, and whether it's a great technology and great people. We continue to look, and we stay very active in the M&A market. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [5] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [6] +-------------------------------------------------------------------------------- + + Thank you. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + From Piper Jaffray, we'll hear from Gene Munster. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [8] +-------------------------------------------------------------------------------- + + Good afternoon. Tim, can you talk a little bit about the iPhone ASP trends, and specifically you mentioned that the SE is going to impact, but how are you thinking about the aspirational market share that's out there, and your actual market share, and using price to close that gap? Is it just the SE or could there be other iPhone models that will be discounted, to try to be more aggressive in emerging markets? +And one for Luca. Can you talk a little bit about the services segment, in terms of what piece of the services is driving growth, and maybe a little bit about the profitability on a net basis versus the growth basis that you have referred to in the past. Thanks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [9] +-------------------------------------------------------------------------------- + + I think the SE is attracting two types of customers. One is customers that wanted the latest technology, but wanted it in a more compact package. And we clearly see even more people than we thought in that category. +Secondly, it's attracting people aspire to own an iPhone, but couldn't quite stretch to the entry price of the iPhone, and we've established a new entry. I think both of these markets are very, very important to us, and we are really excited about where it can take us. I do think that we will be really happy with the new to iPhone customers that we see from here, because of the early returns we've had. We are currently supply constrained, but we'll be able to work our way out of this at some point. But it's great to see the overwhelming demand for it. I will let Luca comment on the ASPs. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [10] +-------------------------------------------------------------------------------- + + On the ASPs, Gene we mentioned that we were going to be down sequentially, and this is really the combination of two factors. So when we go from the March quarter to the June quarter, is the fact that we are having the SE entering the mix, and that obviously is going to have a downward pressure on ASP, and also this channel inventory reduction that we have talked about, obviously the channel inventory reduction will come from higher-end models, and that is also affecting the sequential trend on ASPs. +The question on services, when we look at our services business, obviously growing very well across the board. The biggest element, and the part of the services business that is growing very well, we mentioned 35%, is the App Store. It's interesting for us that our music business, which had been declining for a number of quarters, now that we have both a download model and a streaming model, we have now hit an inflection point, and we believe that this would be the bottom, and we can start growing from there over time. +We have many other services businesses that are doing very well, we have an iCloud business that is growing very quickly. Faster than the App Store, from a much lower base but I think it's important for us as we continue to develop these businesses. Tim have talked about Apple Pay. It doesn't provide a meaningful financial contribution at this point, but as we look at the amount of transactions that go into Apple Pay right now, and we think ahead for the long-term, that could be an interesting business for us, as well. +From a profitability standpoint, we have mentioned last time that when you look at it on a gross basis, so in terms of purchase value of these services, the profitability of the business is similar to Company average. Of course, when you met out the amount that is paid to developers, and you look at it, in terms of what is reported in our P&L, obviously that business has a profitability that is higher than Company average. We don't get into the specifics of specific products or services, but it is very clear it is significantly higher than Company average. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [12] +-------------------------------------------------------------------------------- + + Thanks, Gene. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Yes, thank you. First for Luca. This is the worst gross margin guide in a year and a half or so, and over the last couple of quarters, you have talked about number of tailwinds including component cost, the lower accounting deferrals that went into effect in September. You just mentioned the services margins are above corporate average. So the question is, are some of those tailwinds winding down? Or is a significant guide down in gross margin for the June quarter entirely related to volume and the 5 SE? And then I have a follow-up for Tim. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [15] +-------------------------------------------------------------------------------- + + Katy, clearly the commodity environment remains quite favorable, and we continue to expect cost improvements. The other dynamics that you have mentioned are still there, obviously what is different, and particularly as we look at it on a sequential basis coming out of the March quarter, we would have loss of leverage, and that obviously is going to have a negative impact on margins. The other factor that's important to keep in mind is this different mix of products. +Particularly when you look at iPhone, what I was mentioning to Gene earlier, I think we've got a couple of things that are affecting not only ASPs, but obviously, they also affects margins. And it's the fact that we have a channel inventory reduction at the top end of the range, and we've got the introduction of the iPhone SE at the entry level of the range. And so when you take into account those factors, those are the big elements that drive our guidance range right now. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. Thank you. And that a question for Tim, appreciate the optimism around longer-term iPhone unit growth, but with developed market penetration in anywhere from 60% to 80%, the growth is going to have to come from new markets. You talked about India. Could you just spend a little bit more time on that market? What are some of the hurdles you have to overcome, for that to be a larger part of the business? When we expect Apple to have more distribution, and specifically your own stores in that country? Thanks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [17] +-------------------------------------------------------------------------------- + + Katy, in the short term, let me just make a couple of comments on the developed markets, just to make sure this is clear. If you look at our installed base of iPhone today versus two years ago, it's increased by 80%. When you think about upgrade cycles, upgrade cycles would have varying rates on it. As I talked about on the comments, the iPhone 6s rate, upgrade rate is slightly higher than the iPhone 5s, but lower than the iPhone 6. +But the other multiplier in that equation is obviously the size of the installed base. The net of the idea is that I think there's still really, really good business in the developed markets, so I wouldn't want to write those off. It's our job to come up with great products that people desire, and also to continue to attract over Android switchers. With our worldwide share there's still quite a bit of room in the developed markets, as well. +From an India point of view, if you look at India, and each country has a different story a bit, but the things that have held not only us back, perhaps, but some others as well, is that the LTE rollout with India just really begins this year. So we will begin to see some really good networks coming on in India. That will unleash the power and capability of the iPhone, in a way that an older network, 2.5G or even some 3G networks, would not do. The infrastructure is one key one, and the second one is building the channel out. +Unlike the US as an example, where the carriers in the US sell the vast majority of phones that are sold in the United States, in India, the carriers in general sell virtually no phones, and it is out in retail, and retail is many, many different small shops. We've been in the process. It's not something we just started in the last few weeks. +We've been working in India now for a couple of years or more, but we've been working with great energy over the last 18 months or so, and I am encouraged by the results that we're beginning to see there, and believe there's a lot, lot more there. It is already the third largest smart phone market in the world, but because the smart phones that are working there are low-end, primarily because of the network and the economics, the market potential has not been as great there. I view India as where China was maybe 7 to 10 years ago from that point of view. I think there's a really great opportunity there. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [18] +-------------------------------------------------------------------------------- + + Thank you, Katy. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + We will go to Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [20] +-------------------------------------------------------------------------------- + + I have one, and then a follow-up, as well. My sense is that you talked about adjusting for the changes in channel inventory, that you are guiding for relatively normal sequential growth. And I think if you do the math it's probably the same or perhaps a touch worse in terms of iPhone unit growth sequentially, relative to normal seasonality between fiscal Q2 and Q3. I guess the question is, given that you should be entering new markets and you should see pronounced elasticity from the SE device, why wouldn't we be seeing something that was dramatically above normal seasonal, in terms of iPhone revenues and units for this quarter? +Maybe you could push back on me, but I can't help thinking that when Apple introduced the iPad Mini in a similar move, to move down market, there was great growth for one quarter, and the iPad never grew again and margins and ASPs went down. It looks like you are introducing the SE, and at least on a sequential basis, you not calling for any uplift, even adjusting for channel inventory, and ASPs I presume will go down and certainly it's impacting gross margins as you've guided to. Could you respond to, A, why you're not seeing the elasticity, and B, is the analogy with the iPad mini completely misplaced? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [21] +-------------------------------------------------------------------------------- + + Toni, it's Tim. Let me see if I can address your question. The channel inventory reduction that Luca referred to, the vast, vast majority of that is in iPhone. That would affect the unit compare that you maybe thinking about. The iPhone SE, we are thrilled with the response that we've seen on it. +It is clear that there is a demand there, even much beyond what we thought, and so that is really why we have the constraint that we have. Do I think it will be like the iPad Mini? No, I don't think so. I don't see that. +I think the tablet market in general, one of the challenges with the tablet market is that the replacement cycle is materially different than in the smart phone market. As you probably know, we haven't had an issue in customer satisfaction on the iPad. It is incredibly high, and we haven't had an issue with usage of the iPad. The usage is incredibly high. +But the consumer behavior there is you tend to hold on for very long period of time, before an upgrade. We continue to be very optimistic on the iPad business, and as I have said in my remarks, we believe we are going to have the best compare for iPad revenue this quarter that we have quite some time. We will report back in July on that one, but I think iPhone has a particularly different kind of cycle to it than the tablet market. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [22] +-------------------------------------------------------------------------------- + + Okay, and if I could follow-up, Tim. You alluded to replacement cycles and differences between the iPad and the iPhone. My sense was, when you were going through the iPhone 6 cycle, was that you had commented that the upgrade cycle was not materially different. I think your characterization was that it accelerated a bit in the US, but international had grown to be a bigger part of your business, and replacement cycles there were typically a little bit longer. I'm wondering if it was only a modest difference between the 5s and the 6, how big a difference are we really seeing in terms of replacement cycles across the last three generations, and maybe you could help us, if the replacement cycle was flat this year relative to what you saw last year, how different would your results have been this quarter in the first half? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [23] +-------------------------------------------------------------------------------- + + There's a lot there. Let me just say I don't recall saying the things that you said I said about the upgrade cycle, so let me get that out of the way. Now let me describe without the specific numbers, the iPhone 6s upgrade cycle that we have measured for the first half of this year, so the first six months of our fiscal year to be precise, is slightly better than the rate that we saw with the iPhone 5s two years ago, but it's lower than the iPhone 6. I don't mean just a hair lower, it's a lot lower. +Without giving you exact numbers, if we would have the same rate on 6s that we did 6, there would -- it will be time for a huge party. It would be a huge difference. The great news from my point of view is, I think we are strategically positioned very well, because we have announced the SE, we are attracting customers that we previously didn't attract. That's really great, and this tough compare eventually isn't the benchmark. The install base is up 80% over the last two years, and so all of those I think bode well, and the switcher comments I made earlier, I wouldn't underestimate that, because that's very important for us in every geography. Thanks for the question. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [24] +-------------------------------------------------------------------------------- + + Thanks, Toni. Can we have the next question please? + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + From Cross Research Group, we'll hear from Shannon Cross. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [26] +-------------------------------------------------------------------------------- + + I have a couple of questions. One, Tim, can you talk a bit about what's going on in China? The greater China revenue I think was down 26%. You did talk about mainland China, but if you could talk about some of the trends you're seeing there, and how you think it's playing out, and maybe your thoughts on SE adoption within China as well. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [27] +-------------------------------------------------------------------------------- + + Shannon, thanks for the question. If you take greater China, we include Taiwan, Hong Kong, and mainland China in the greater China segment that you see reported on your data sheet. The vast majority of the weakness in the greater China region sits in Hong Kong, and our perspective on that is, it's a combination of the Hong Kong dollar being pegged to the US dollar, and therefore it carries the burden of the strength of the US dollar, and that has driven tourism, international shopping and trading down significantly compared to what it was in the year ago. +If you look at mainland China, which is one that I am personally very focused on, we are down 11% in mainland China, on a reported basis. On a constant currency basis, we are only down 7%, and the way that we really look at the health or underlying demand is look at sell-through, and if you look at there, we were down 5%. Keep in mind that is down 5% on comp a year ago that was up 81%. +As I back up from this and look at the larger picture, I think China is not weak, as has been talked about. I see China as -- may not have the wind at our backs that we once did, but it's a lot more stable than what I think is the common view of it. We remain really optimistic on China. We opened seven stores there during the quarter. +We are now at 35. We will open 5 more this quarter to achieve 40, which we had talked about before. And the LTE adoption continues to rise there, but it's got a long way ahead of it. And so we continue to be really optimistic about it, and just would ask folks to look underneath the numbers at the details in them before concluding anything. Thanks for the question. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks. My second question is with regard to OpEx leverage, or thinking about when I look at the revenue, your revenue is below our expectations but OpEx is pretty much in line. So how are you thinking about potential for leverage, cost containment, maybe when macro is bad and revenue is under pressure, and how are you juggling that versus the required investment you need to go forward? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [29] +-------------------------------------------------------------------------------- + + It is Luca. Of course, we think about it. We think about it a lot, and so when you look at our results, for example, our OpEx for the quarter, for the March quarter was up 10%, which is the lowest rate that you have seen in years. And when you look within OpEx, you actually see two different dynamics. You see continued significant investments in research and development, because we really believe that's the future of the Company. +We continue to invest in initiatives and projects ahead of revenue. We had a much broader portfolio that we used to have. We do much more in-house technology development than we used to do a few years ago, which we think is a great investment for us to make. And so that parts we didn't need to protect, and we want to continue to invest in the business, right? +And then when you look at our SG&A portion of OpEx for the March quarter, it was actually down slightly. So obviously we think about it, and of course we look at our revenue trends, and we take measures accordingly. When you look at the guidance that we provided for the June quarter, that 10% year-over-year increase that I mentioned to you for the March quarter goes down to a range of 7% to 9% up, and again, the focus is on making investments in Road and continuing to run SG&A extremely tightly, and in a very disciplined way. +As you know, our E2R, expense to revenue ratio, is around 10%. It's something that we are very proud of, it's a number that is incredibly competitive in our industry, and we want to continue to keep it that way. At the same time, we don't want to under-invest in the business. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [30] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [31] +-------------------------------------------------------------------------------- + + Thank you, Shannon. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + From UBS we hear from Steve Milunovich. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [33] +-------------------------------------------------------------------------------- + + Tim, I first wanted to ask you about services and how do you view services? You've obviously highlighted it the last two quarters. Do you view it going forward as a primary driver of earnings, or do you view it, and you mentioned platforms in terms of your operating systems, which I would agree with. In that scenario I would argue it's more a supporter of the ecosystem, and a supporter of the hardware margins over time, and therefore somewhat subservient to hardware. It's great that it's growing, but longer-term, I would view its role as more creating an ecosystem that supports the high margins on the hardware, as opposed to independently driving earnings. How do you think about it? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [34] +-------------------------------------------------------------------------------- + + The most important thing for us, Steve, is that we want to have a great customer experience, so overwhelmingly, the thing that drives us are to embark on services that help that, and become a part of the ecosystem. The reality is that in doing so, we have developed a very large and profitable business in the services area, and so we felt last quarter and working up to that, that we should pull back the curtain so that people could -- our investors could see the services business, both in terms of the scale of it, and the growth of it. As we said earlier, the purchase value of the installed base services grew by 27% during the quarter, which was an acceleration over the previous quarter, and the value of it hit -- was just shy of $10 billion. It's huge, and we felt it was important to spell that out. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [35] +-------------------------------------------------------------------------------- + + Okay, and then going back to the upgrades of the installed base, you have clearly mentioned that you've pulled forward some demand, which makes sense, but there does seem to be a lengthening of the upgrade cycle, particularly in the US. AT&T and Verizon have talked about that. Investors I think perceive that maybe the marginal improvements on the phone might be less currently, and could be less going forward. At the same time, I think you just announced that you can get the upgrade program online, which I guess potentially could shorten it. Do you believe that upgrade cycles are currently lengthening, and can continue to do so? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [36] +-------------------------------------------------------------------------------- + + What we've seen is that it depends on what you compare it to. If you compare to the 5s, what we are seeing is the upgrade rate today is slightly higher, or that there are more people upgrading, if you will, in a similar time period, in terms of a rate, than the 5s. But if you compare to 6, you would clearly arrive at the opposite conclusion. I think it depends on people's reference points, and we thought it very important in this call to be very clear and transparent about what we're seeing. I think in retrospect, you could look at it and say, maybe the appropriate measure is more to the 5s, and I think everybody intuitively thought that the upgrades were accelerated with the 6, and in retrospect, when you look at the periods, they clearly were. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [37] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [38] +-------------------------------------------------------------------------------- + + Thanks, Steve. Could we have our next question, please? + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + We will go to Rod Hall with JPMorgan. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [40] +-------------------------------------------------------------------------------- + + Yes, thanks for fitting me in. I wanted to start with a general, more general question. I guess, Tim, this one is aimed at you. As you think about where you thought things were going to head last quarter, when you reported to us, and how it's changed this quarter, obviously it's kind of a disappointing demand environment. Can you just help us understand what maybe the top two or three things are that have changed? And so as we walk away from this, we understand what the differences are, and what the direction of change is? Then I have a follow-up. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [41] +-------------------------------------------------------------------------------- + + I think you're probably indirectly asking about our trough comment, if you will, from last quarter. And when we made that, we did not contemplate or comprehend that we were going to make a $2 billion-plus reduction in channel inventory during this quarter. So if you factor that in and look at true customer demand, which is the way that we look at internally, I think you'll find a much more reasonable comparison. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. And then for my follow-up, I wanted to ask you about the tax situation a little bit. Treasury obviously has made some rule changes, and I wonder, maybe if Luca, you could comment on what the impact to Apple from those is, if anything? and Tim, maybe more broadly how you see the tax situation for Apple looking forward? Thanks. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [43] +-------------------------------------------------------------------------------- + + Yes, Rod, these are new regulations, and we are in the processing of assessing them. Frankly from first read, we don't anticipate that they are going to have any material impact on our tax situation. Some of them relate to inversion transactions, obviously that's not an issue for us. Some of them are around internal debt financing, which is not something that we use, so we don't expect any issue there. +As you know, we are the largest US taxpayer by a wide margin, and we already pay full US tax on all the profits from the sales that we make in the United States, so we don't expect them to have any impact on us on tax reform. I will let Tim continue to provide more color, but we've been strong advocates for comprehensive corporate tax reform in this country. We continue to do that. We think a reform of the tax code would have significant benefits for the entire US economy, and we remain optimistic that we are going to get to a point where we can see that tax reform enacted. At that point in time, of course, we would have much more flexibility around optimizing our capital structure, and around providing more return of capital to our investors. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [44] +-------------------------------------------------------------------------------- + + The only thing I would add, Rod, is I think there are a growing number of people in both parties that would like to see comprehensive reform, and so I'm optimistic that it will occur. It's just a matter of when and that's difficult to say. But I think most people do recognize that it is in the US's interest to do this. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [45] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [46] +-------------------------------------------------------------------------------- + + Thank you, Rod. A replay of today's call will be available for two weeks as a podcast on the iTunes Store, as webcast on Apple.com/investor and via telephone. And the numbers for the telephone replay are 888-203-1112, or 719-457-0820, and please enter confirmation code 7495552. These replays will be available by approximately 5:00 PM Pacific time today. +Members of the press with additional questions can contact Kristin Huguet at 408-974-2414, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570, and I am at 408-974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2016-Jan-26-AAPL.txt b/Transcripts/AAPL/2016-Jan-26-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..d90d6417cca762da574707bdf5a4fa4abd6921e0 --- /dev/null +++ b/Transcripts/AAPL/2016-Jan-26-AAPL.txt @@ -0,0 +1,760 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q1 2016 Apple Inc Earnings Call +JANUARY 26, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO + * Tim Cook + Apple Inc. - CEO + * Nancy Paxton + Apple Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Jim Suva + Citigroup - Analyst + * Katy Huberty + Morgan Stanley - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Mark Moskowitz + JPMorgan - Analyst + * Kulbinder Garcha + Credit Suisse - Analyst + * Shannon Cross + Cross Research - Analyst + * Toni Sacconaghi + Bernstein - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + * Brian White + Drexel Hamilton - Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 1Q16 revenue of $75.9b, net income of $18.4b and diluted EPS of $3.28. Expects 2Q16 revenue to be $50-53b. + + + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 1Q16 revenue = $75.9b. + 2. 1Q16 net income = $18.4b. + 3. 1Q16 diluted EPS = $3.28. + 4. 1Q16 YoverY revenue growth = 2%. + 5. 1Q16 GM = 40.1%. + 6. 2Q16 revenue guidance = $50-53b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 1Q16 Business Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. All-time record quarterly revenue $75.9b in Dec. qtr. + 1. In line with expectations. + 2. Up 2% over last year's blockbuster results. + 3. In constant currency, growth rate would have been 8%. + 2. Record revenue and continued strong operating performance led to all-time record quarterly net income of $18.4b. + 3. Sold 74.8m iPhones in Dec. qtr. + 1. All-time high. + 2. Avg. of over 34,000 iPhones an hour, 24 hours a day, seven days a week for 13 straight weeks. + 3. Almost 50% more than 1Q volumes just two years ago. + 4. More than four times volume five years ago. + 5. 74.8m iPhones is incredible number. + 4. Results are particularly impressive, given challenging global macroeconomic environment. + 5. Seeing extreme conditions, unlike anything Co. has experienced before, just about everywhere it looks. + 6. Major markets, including Brazil, Russia, Japan, Canada, Southeast Asia, Australia, Turkey and Eurozone, have been impacted by: + 1. Slowing economic growth. + 2. Falling commodity prices. + 3. Weakening currencies. + 7. Since FY14-end. + 1. Euro and British pound down double-digits. + 2. Major currencies like Canadian dollar, Australian dollar, Mexican peso, and Turkish lira declined 20% or more. + 3. Brazilian real down more than 40%. + 4. Russian ruble declined more than 50%. + 8. Two-thirds of Co.'s revenue is now generated outside US. + 1. Foreign currency fluctuations have meaningful impact on results. + 2. $100 of Co.'s non-US dollar revenue in 4Q14 translated to only $85 last qtr., due to weakening currencies in international markets. + 1. Movement has been dramatic. + 3. Last qtr. alone, currency impact has been large. + 9. 8% growth rate translates to $80.8b in constant currency revenue. + 1. $5b more than reported revenue. + 1. Difference is about size of annual revenue of Fortune 500 co. + 2. China: + 1. Last summer, while many companies experiencing weakness in their China-based results, seeing just opposite with incredible momentum for: + 1. iPhone. + 2. Mac. + 3. App Store. + 2. In Dec. qtr., despite turbulent environment, produced best results ever in Greater China. + 1. Revenue grew: + 1. 14% YoverY. + 2. 47% sequentially. + 3. 17% YoverY in constant currency. + 2. Great results were fueled by highest ever quarterly iPhone sales and record App Store performance. + 3. Notwithstanding these record results, began to see some signs of economic softness in Greater China earlier this month, most notably in Hong Kong. + 4. Beyond short-term volatility, remains confident about long-term potential of China market and large opportunities ahead. + 1. Maintaining investment plans. + 5. Despite economic challenges all over world, remains incredibly strong. + 1. Has satisfied and loyal customer base. + 2. Saw greater number of switchers from Android to iPhone than ever in 1Q. + 3. Committed to making best products in world and expanding Co.'s experience to change customers' lives in better and more meaningful ways. + 6. Invested through economic uncertainty in past. + 1. Has always come out stronger on other side. + 2. Some of most important breakthrough products in AAPL's history were born due to investing to downturn. + 7. Seeing these times as opportunities to invest in new markets. + 3. Accomplishments: + 1. Shipped amazing new iPad Pro. + 1. Well received by customers along with new smart keyboard and revolutionary Apple Pencil. + 2. Launched all-new Apple TV with its own app store laying foundation for future television. + 1. Had best qtr. by far for Apple TV sales. + 2. Number of apps developed for Apple TV is growing rapidly. + 3. Today, there are over 3,600 apps delivering everything from games to entertainment to educational programing. + 3. Expanded distribution of Apple Watch almost 12,000 locations in 48 countries. + 1. As expected, sets new quarterly record for Apple Watch sales with especially strong sales in Dec. + 4. Released OS X El Capitan, refining experience in improving performance for Mac customers. + 5. Updated entire iMac family with stunning new retina displays and introduced a new lineup of wireless accessories. + 6. Launched Apple Pay in Canada, Australia with American Express. + 1. Announced plans to bring this amazingly convenient, private and secured mobile payment experience to China, Hong Kong, Spain and Singapore in coming year. + 2. Consumers have spent billions of dollars with Apple Pay. + 3. In 2H15, saw significant acceleration in usage with growth rate 10 times higher than in 1H of year. + 4. There are now over 5m contactless payment ready locations in countries where Apple Pay is live today. + 5. It seemed to be accepted thousands of Exxon and Mobil branded stations across US, via their Speedpass plus app. + 7. Shared Apple Music experience with even more listeners with over 10m paying subscribers, less than four months since customers begin paying for service. + 8. Financial position has never been stronger. + 1. Has mother of all balance sheets with almost $216b in cash, which translates to nearly $39 per diluted share of AAPL stock. + 2. Investing confidently in future. + 3. Returning capital to shareholders at a rapid pace. + 9. During a period of economic uncertainty, believes it is important to appreciate significant portion of Co.'s revenue [recurse] over time. + 10. Customer satisfaction and retention rates are second to none; provides with long-lasting foundation. + 1. Recent consumer surveys by 451 Research, formally known as ChangeWave measured an incredible 99% customer satisfaction rate for iPhone 6S and 6S plus and equally impressive 97% rate for the iPad era 2. + 2. iPhone royalty rate is almost twice as strong as next highest brand. + 3. Growing portion of revenue is directly driven by existing installed base. + 4. Because of enduring value of device, replacing is likely higher to be given or sold to someone who will love in use it after. + 11. Installed base has been growing fast. + 1. Recently reached major milestone crossing 1b active devices for first time. + 1. This is an unbelievable asset. + 2. Installed base is growing quickly. + 3. Seen acceleration in growth of services business; another large and important source of recurring revenues. + +-------------------------------------------------------------------------------- +II. 1Q16 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Results: + 1. Vast majority of services provided to customers, apps, movies and TV shows, are tied to installed base of devices rather than to current qtr. sales. + 2. For some of these services like content, recognizes revenue based on transaction value. + 1. For App Store, shares a portion of value of each transaction with app developer, and only recognized revenue on portion that Co. keeps. + 3. When aggregating purchase value of services tied to installed base during FY15, adds up to more than $31b. + 1. Increased 23% over FY14. + 4. In recent Dec. qtr., purchases of installed base services reached $8.9b. + 1. Grew 24% YoverY. + 5. Installed base services, quite profitable. + 1. GM on purchase value basis, similar to Co. avg. + 6. Active device is one that has been engaged with services within past 90 days. + 1. Active installed base recently passed 1b devices; YoverY growth more than 25%. + 7. Has built huge installed base around four platforms: + 1. iOS. + 2. Mac OS. + 3. watchOS. + 4. tvOS. + 8. Tremendously satisfied loyal customers who are engaged with services at fast growing rate. + 9. All aforementioned provides with unparalleled foundation for future of business. + 2. Highlights: + 1. Revenue $75.9b. + 1. Increased $1.3b or 2% YoverY. + 2. Growth was driven by: + 1. All-time record iPhone sales. + 2. All-time record revenue from services. + 3. Expanded availability of Apple Watch. + 4. Successful launch of new Apple TV. + 3. Achieved this record revenue performance despite large negative impact from weakness of foreign currency. + 4. In constant currency, revenue growth rate was 8%. + 2. Achieved impressive results in Greater China. + 1. Revenue grew 14% YoverY and 47% sequentially to an all-time record of $18.4b. + 2. Emerging markets performance was strong overall, up 11% YoverY, and representing 34% of total Co. revenue. + 3. GM 40.1%. + 1. Up sequentially and better-than-expectations, mainly due to: + 1. Favorable commodity cost. + 2. Product mix. + 4. Operating margin 31.9% of revenue. + 5. Net income $18.4b; all-time record. + 6. Diluted EPS $3.28. + 1. Increased 7% YoverY over previous all-time record. + 7. Cash flow from operations $27.5b; strong. + 3. iPhone: + 1. Sold 74.8m iPhones. + 1. Increase of 300,000 vs. last Dec. qtr. + 2. Sales grew 76% in India and more than 45% in: + 1. Korea. + 2. Middle East. + 3. Africa. + 3. Sales up 20% or more in many Western European countries. + 1. Grew 18% in Mainland China. + 4. ASP $691 vs. $687 in 1Q15 despite of unfavorable FX impact. + 5. Seeing strong interest in iPhone with consumers and business users. + 1. Among corporate buyers planning to purchase smartphones in March qtr., 451 Research found 79% planned to purchase iPhones. + 1. That is highest iPhone purchase intent in eight-year history of survey. + 6. Started qtr. below channel inventory target range. + 1. Due to extremely successful manufacturing ramp, able to exit qtr. slightly [above] low-end of target range of 5-7 weeks of iPhone channel inventory. + 4. Mac: + 1. Sold 5.3m Macs vs. 5.5m last year. + 1. Declined 4%. + 2. Continued long-running trend of PC market share gains based on IDC's latest estimate of 11% global market contraction. + 1. YoverY sales growth in Mainland China 27%. + 3. Ended qtr. within 4-5 week target range for Mac channel inventory. + 5. iPad: + 1. Sold 16.1m vs. 1Q15's 21.4m. + 1. Exited qtr. within 5-7 week target range of iPad channel inventory. + 2. Tablet market: + 1. Highly successful. + 2. Recent data from NPD indicates that iPad has 85% share of US market for tablets priced above $200. + 3. Latest data published by ITC indicates that iPad accounts for 67% of US commercial tablet market, comprising: + 1. Enterprise. + 2. Government. + 3. Education. + 4. In Nov., 451 Research measured 97% consumer satisfaction rate for iPad Air 2. + 1. Among consumers planning to purchase a tablet within next six months, 65% planned to purchase an iPad. + 2. Corporate buyers reported 95% satisfaction rate; March qtr. purchase intent, 73%. + 6. Enterprise: + 1. Initiatives expanding. + 2. IBM released 48 new IBM MobileFirst for iOS apps in Dec. qtr. + 1. There are now over 100 apps in IBM MobileFirst for iOS catalog for iPhone, iPad and Apple Watch. + 3. Partnership with Cisco gained significant momentum, since announced it at Aug.-end. + 4. Continuing to grow mobility partner program. + 1. Added more than 25 partners in Dec. qtr., bringing total to over 90. + 7. Services: + 1. Revenue almost $6.1b, including $548m received from patent infringement dispute. + 1. Excluding that amount, revenue was $5.5b. + 1. New all-time record and increase of 15% over last year due in large part to strong growth from apps. + 2. Revenue from App Store increased 27%. + 1. Number of transacting customers grew 18%; all-time record. + 3. Among customers who purchase apps and content from iTunes Stores, avg. amount spent for customer reached an all-time high in Dec. qtr. + 8. Other Details: + 1. Revenue from other products grew strongly. + 1. Up 62% YoverY due to: + 1. Growing contribution from Apple Watch. + 2. Successful launch of new Apple TV. + 2. Both aforementioned established new all-time quarterly records. + 2. Expanded Apple Watch distribution significantly over course of qtr. + 1. Experienced especially strong results during holiday buying season. + 9. Cash Position: + 1. 1Q16-end [$215.7b] in cash plus marketable securities. + 1. Increased $10.1b sequentially. + 2. $200b of this cash or 93% of total was outside US. + 2. Returned over $9b to investors. + 3. Paid $3b in dividends and equivalents. + 4. Spent $3b to repurchase 26m AAPL shares through open market transactions. + 5. Launched sixth share repurchase program, spending $3b and receiving an initial delivery of [20.4m shares]. + 6. Now completed over $153b of our $200b program, including $110b in share purchases. + 7. Plans to provide update on capital return program during 2Q results in April. + 1. Plans to be active in US and international debt markets in 2016 in order to fund capital return activities. + 2. On 01/26/16, Board of Directors declared cash dividend of $0.52 per share of common stock payable on 02/11/16 to shareholders of record as of 02/08/16. + 10. 2Q16 Guidance: + 1. Revenue $50-53b. + 1. Providing wider range for revenue than usual for 2Q because of volatility seeing in economy and financial and currency markets. + 2. GM 39.0-39.5%. + 1. Believes these are extremely strong margins in light of headwinds faced from FX and sequential loss of leverage. + 3. OpEx $6.0-6.1b. + 4. OI&E about $325m. + 5. Tax rate about 25.5%. + 6. Does not provide guidance beyond current qtr. + 1. Difficult to forecast economic and FX factors. + 2. At this point, believes March qtr. faces most difficult YoverY compare relative to rest of year. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question will come from Simona Jankowski with Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Hello. Thank you very much. Just in terms of your March quarter guidance, it does imply a double digit decline at the midpoint. Maybe if you can just clarify, first of all, what FX headwind is embedded in that? +And then just going to the fundamental underpinning reasons for that, how much of it do you think has to do with international markets in terms of weakening demand and how much of that do you think is comps versus any other factors you might identify, such as a response to higher prices for the iPhone in certain overseas markets? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Simona. Let me take this one. In constant currency, when you look at it for the March quarter, revenue would be down between 5% and 10%. So we are looking at a 400 basis point impact from foreign exchange for the March quarter. +You talked about a number of issues that are, in fact, included in this guidance. In addition to lapping, of course, a very strong year ago quarter -- just remind you that revenue growth a year ago was up 27% -- there's a number of things that we're facing. The macroeconomic environment is weakening. When you think about all the -- particularly all the commodity-driven economies, Brazil and Russia and emerging markets, but also Canada, Australia in developed markets -- clearly, the economy is significantly weaker than a year ago. We talked about the unfavorable FX, which again is 400 basis points. +One of the things that we've done to respond to the foreign exchange situation has been to increase the price of some of our products in certain international markets. That has had the effect of protecting our margins, which you've seen have been very strong, both in the December quarter and in the guidance that we provide for the March quarter. +But inevitably over time, higher prices affect demand and so we are capturing that in our guidance. So I would say these are the major reasons and the drivers for the guidance on revenue. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Simona. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + And next from Piper Jaffray, we'll hear from Gene Munster. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [7] +-------------------------------------------------------------------------------- + + Good afternoon. Tim, could you talk a little bit about the iPhone upgrade program and the theme of iPhone as a subscription? In particular, do you believe that this could have a measurable impact on the December quarter once we anniversary this? And then any thoughts on rolled outside the US when that program would. +And my follow-up question would be, I know you can't talk about new products, but any high level thoughts on the virtual reality theme. Do you think this is more of a geeky niche or something that could go mainstream? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [8] +-------------------------------------------------------------------------------- + + On your first question about iPhone, I think the most important thing, Gene, as you know for us, will always be the product and the experience. And so that's first and foremost. Secondly, I would say we were blown away by the level of Android switchers that we had last quarter. It was the highest ever by far. And so we see that as a huge opportunity. +Thirdly, the markets, sort of the emerging markets broader than BRIC, but including all of emerging, when I look at our share in these markets and the LTE penetration, I see huge opportunities. +In terms of the upgrade program itself, I think over time, it will be meaningful as customers get into a different pattern. How much of that plays out in the Q1 of 2017 range is difficult to say. My own sense would be that the other items I've mentioned are probably more important, but I am optimistic about the upgrade program, as well. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [9] +-------------------------------------------------------------------------------- + + And then virtual reality? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [10] +-------------------------------------------------------------------------------- + + In terms of virtual reality, no, I don't think it's a niche. I think it can be -- it's really cool and has some interesting applications. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [11] +-------------------------------------------------------------------------------- + + Thank you, Gene. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [12] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [13] +-------------------------------------------------------------------------------- + + Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + From Morgan Stanley, Katy Huberty. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Yes, thanks. I appreciate the macro comments as it relates to guidance, but can you talk a little bit about how you're thinking consumers might react from an ASP perspective? Do you expect consumers to move down the product line, given the macro environment? +And then also, how is channel inventory influencing guidance? Do you feel like channel inventory needs to come down, given the demand trends? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Couple of points here, Katy. Our iPhone ASP was $691 during the December quarter. We couldn't be happier with the level of ASP that we generated in the December quarter. +Keep in mind that the foreign exchange impact on that number was $49. So obviously, the mix of products was very strong. We had great reception for the new iPhones that we launched at the end of September. +Of course, we have a very strong mid tier this year in the portfolio, with 6 and 6 Plus. But overall, when you look at the outcome during the December quarter, it was very, very strong. So we feel very good about that and we feel that we have a very, very strong portfolio for iPhone. +On the question around channel inventory, we entered the quarter, the December quarter -- and we mentioned it back in October -- below our target range of five to seven weeks. We have built a bit of inventory during the course of the December quarter. But we have exited at the low end of the five to seven weeks, so we feel that we are in good shape there. And we've exited the quarter also on iPad and Mac well within the ranges that we want to have. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + And then as a follow-up, back in October you guided FY16 CapEx up over 30%. What's driving that growth? Can you rank it between equipment purchases, data center and real estate? And given the slowdown that you started to see in December, are you still comfortable with that level of investment growth? Thanks. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [18] +-------------------------------------------------------------------------------- + + Yes. So that is kind of the ranking, Katy. It starts always for us with our tooling and manufacturing process equipment, and that is up a bit year-over-year. +Then we've got data centers. And data centers is a growing expenditure for us, because, as we mentioned in our prepared remarks, our installed base of customers ands devices is growing, and is growing very significantly. And the data center capacity that we put in place is to provide the services that are tied to the installed base. So that type of expenditure goes together with the installed base. +And then around facilities, you probably know that we are nearing completion of our new campus here in Cupertino, and so this is the year where we've got our peak requirements in terms of capital. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [19] +-------------------------------------------------------------------------------- + + Thank you, Katy. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + From Bernstein, we'll hear from Toni Sacconaghi. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [21] +-------------------------------------------------------------------------------- + + Yes. Thank you. I have a question, a follow-up, please. To start, just on iPhones, it looks like your guidance implies about a 15% to 20% unit decline in iPhones for fiscal Q2, which I think, unless you really see a change in demand profile in the second half, suggests that iPhone units will decline year-over-year for FY16. +And I'd like you to address that question, because the obvious follow-up questions are is that because you believe the smartphone market won't grow or because Apple may be reaching saturation in the market? Is that because Apple's replacement cycle accelerated last year and is decelerating this year and that's why we'll see a decline in units? +Or is there something about Apple's ability to gain share in a market where the market is moving to much lower price points? But I'm wondering, and Tim, maybe you're best to answer it, if you can address what appears likely to be a decline in iPhone units and how we put that in the context of how we should think about that, given some healthy data around switchers that you highlighted. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [22] +-------------------------------------------------------------------------------- + + Toni, we do think that iPhone units will decline in the quarter. We don't think that they will decline to the levels that you're talking about. We aren't projecting beyond the quarter, as Luca mentioned earlier; but at this point in time, we see that Q2 is the toughest compare. +We believe it's the toughest compare because of the year ago quarter also had catch up in it from Q1. If you recall, we were heavily supply constrained throughout the whole of Q1, and so some of that demand moved into Q2. Plus, we are in an environment now that is dramatically different from a macroeconomic point of view than last Q2, from a currency point of view, from the level of which we've had to adjust pricing in several of these markets, and the overall melees in virtually every country in the world. And so it's really all of those factors that play in there and it's difficult to sort out how much is due to which one. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [23] +-------------------------------------------------------------------------------- + + Right. Can you speak to any of the points around your expectation for the smartphone market or whether you think your replacement cycle has changed or whether your ability to gain share has changed? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [24] +-------------------------------------------------------------------------------- + + The market itself, we don't spend a lot of time on predicting. Our view has always been that if we do -- if we make a great product and have a great experience, that we ought to be able to convince enough people to move over. And so as I look at maybe your broader umbrella point about a question on saturation, the metrics I see would strongly suggest otherwise. +For example, almost half of the iPhones that we sold in China last quarter were to people who were buying their first iPhone. And certainly if you go outside of China into the other emerging markets, our share is much lower and the LTE penetration is so low -- in some cases, it's zero -- that it indicates to me that there's still a lot of people, a tremendous number of people in the world, that will buy smartphones and we ought to be able to win over our fair share of those. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. And I just have clarifications, I don't really have a follow-up question. Luca, you had talked about channel inventory increasing. It was 18.4 million for iPhone last quarter. Can you tell us how many more units you had this quarter? +And then I'm not sure if I misheard you, but I think you said your total installed base grew 25% year-over-year. Can you confirm that? Because if Services grew at 13% and your installed base grew at 25%, it almost implies your penetration of your installed base, in terms of your ability to sell services, is going down. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [26] +-------------------------------------------------------------------------------- + + Maybe I'm going to start with Services, Toni. The reason why we added this -- I think it's page 3 of our supplemental material -- is to try and explain that a couple of steps. The first one is that of the services that we report, there's a portion, about 85% of all of the services that we report is directly tied to the installed base. There is a smaller portion of our services business that is not related to installed base and more related to when we sell a device. A perfect example would be an Apple Care agreement that you purchase at the time of the sale of the device. +And then we are showing that on that portion of installed base-driven services business, there is a part that is related to -- where we recognize revenue in terms of the full transaction value. And then there are transactions, like for example, App Store sales, where a portion of the transaction does not get recognized by Apple, but it goes to the developer. +So when you look at it from a purchase value standpoint, actually in the December quarter, we grew 24%, and for the FY15, we grew at 23%. So we are growing at very, very healthy levels. And to reconfirm the growth of the installed base, yes, it was over 25%. +To the question around the channel inventory for iPhone, we grew channel inventory by 3.3 million units during the course of the December quarter. Keep in mind, we started in acquisition where we were below our targeted range. We were significantly short at the beginning of the quarter. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [28] +-------------------------------------------------------------------------------- + + Thank you, Toni. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + From Cross Research, Shannon Cross. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [30] +-------------------------------------------------------------------------------- + + Thank you very much. I had a question about gross margin. Luca, you got gross margins of 39% to 39.5% in your guidance, and that includes hedging. So I'm curious about the puts or takes in there. +And then can you clarify if within the gross margin this quarter, that had the IP licensing contribution, as well? Any color you can give, both on this quarter's gross margin puts and takes, and then also the March quarter. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [31] +-------------------------------------------------------------------------------- + + Yes. So Shannon, let me start with Q1. I think when you say IP licensing, you mean this patent dispute that was resolved. Yes, it was included in the gross margins. And it was worth 40 basis points in the 40.1% that we reported for Q1. +For the second quarter, the puts and takes are actually quite simple. From an FX standpoint, the negative impact on a sequential basis from the December quarter is 50 basis points. +Then of course, I would say by far the largest impact on margins for the quarter is the loss of leverage, because that's part of our seasonal pattern, which gets offset by a favorable commodity environment that we've seen for a number of quarters now. And in a way, it's the other side of the coin of the foreign exchange situation. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [32] +-------------------------------------------------------------------------------- + + Okay. Thanks. And then Tim, can you talk a bit about -- and I apologize, I sort of lost my voice here -- can you talk a bit about leverage within the model? I know you said you want to invest while there's great opportunity in China and all of that. But given some of the pressures you're seeing, how do you think about where you spend that incremental SG&A dollar and that R&D dollar, and how should we think about it, given you're running $6 billion a quarter? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [33] +-------------------------------------------------------------------------------- + + Yes, on the R&D, Shannon, we're continuing to invest without pause. We have some great things in the pipeline and we very much believe strongly in investing through downturns, such as the one that everyone is going through. +In terms of SG&A, we obviously seek to throttle expenditures in SG&A to the business level, with the exception of where we're investing in new stores and, for example, our expansion plans in China have not changed. We are maintaining our investment profile and plans there. We are also continuing to invest in markets where we believe they are great places for Apple for the long term, like India, as an example of that one. +And finally, even in the markets where today, grantedly, it looks fairly bleak, from Russia and Brazil and some of the other economies that are very much tied to our oil-based economies. We do believe that this, too, shall pass and that these countries will be great places and we want to serve customers in there, and so we're not retrenching. That's not -- we don't believe in that. We are fortunately strong enough to continue investing, and we think it's in Apple's best long-term interest to do so. +Obviously, from a cost point of view, the downside of economic stress is that some asset prices get cheaper, commodity prices get cheaper, and that sort of thing. And so I think this is exactly the period that you want to invest and do so confidently. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [34] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [35] +-------------------------------------------------------------------------------- + + Thank you, Shannon. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + We'll hear from Steve Milunovich with UBS. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [37] +-------------------------------------------------------------------------------- + + Steve, are you there? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [38] +-------------------------------------------------------------------------------- + + Steve? + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [39] +-------------------------------------------------------------------------------- + + Let's go on to the next question, please. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + And we'll hear from Brian White with Drexel. + +-------------------------------------------------------------------------------- +Brian White, Drexel Hamilton - Analyst [41] +-------------------------------------------------------------------------------- + + Tim, could you talk a little bit about the next leg of growth in China? Obviously, Apple's done a phenomenal job there. But where do we see the next leg coming from? +And also, you mentioned investing in India. Where do you see that over the next two to three years? I think there's 1 billion mobile subscribers there, almost the size of China. Thank you. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [42] +-------------------------------------------------------------------------------- + + Brian, good question. In terms of China, the LTE penetration as of the end of last October, which is the last data I've got, was in the mid 20s. And so there's an enormous upgrade cycle there for people that are still running on 3G handsets. +Also, I've talked about this before, but I think it's worth mentioning again, because it's easy to lose perspective with some of the things you read every day, is that the middle class in China was less than 50 million people in 2010, and by 2020, it's projected to be about half a billion. And so there's just an enormous number of people moving into the middle class. And we think this provides us a great opportunity to win over some of those customers into the Apple ecosystem. +And so I think the demographics are great. We're continuing to invest in retail stores. Angela and her team have been on this very aggressive rollout plan. We now have 28 stores in Greater China and we are on target to have 40 in the summertime of this year. And so we're continuing on distribution. +Obviously, we've got product things in mind and are crafting our products and services with China heavily in mind. We remain very bullish on China and don't subscribe to the doom and gloom kind of predictions, frankly. +In India, India is also incredibly exciting. India's growth, as you know, is very good. It's quickly becoming the fastest growing BRIC country. It's the third largest smartphone market in the world, behind China and the United States. +The population of India is incredibly young. The median age there is 27. I think of the China age being young, at 36, 37. And so 27 is unbelievable. Almost half the people in India are below 25. And so I see the demographics there also being incredibly great for a consumer brand and for people that really want the best products. +And as you know, we've been putting increasingly more energy in India. India revenue for us in Q1 was up 38%. We also had currency issues in India, as everybody else did. Constant currency growth was 48%. And so it's a very rapidly expanding country. And I think the government there is very interested economic reforms and so forth that I think all speak to a really good business environment for the future. + +-------------------------------------------------------------------------------- +Brian White, Drexel Hamilton - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [44] +-------------------------------------------------------------------------------- + + Thank you, Brian. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + We'll hear from Kulbinder Garcha with Credit Suisse. + +-------------------------------------------------------------------------------- +Kulbinder Garcha, Credit Suisse - Analyst [46] +-------------------------------------------------------------------------------- + + Thank you. My question's for Tim on the iPhone business. You talk a lot about the macroeconomic weakness weighing on units, but is some of the issue just that last year replacement got accelerated and this year it's kind of normalizing, and that's kind of a one-time headwind in terms of the unit growth that you see in that business. Is any of that going on, or is that not material, in your view? +And the other follow-up I had was that you've mentioned in recent calls, helpfully, the percent of the base, prior to when the 6 came out, that were now on the larger screen phones. Can you give us an update on what that number is? I think the last time it was in the low 30s. Thanks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [47] +-------------------------------------------------------------------------------- + + Last question first. The number of people who had an iPhone prior to the iPhone 6 and 6 Plus announcements -- and so this was in September of 2014 -- that have not yet upgraded to a 6, 6 Plus or 6s or 6s Plus is now 60%. So another way to think about that is 40% have, 60% have not. +In terms of your initial question about is there some of the compare issue that are people that ran out quickly to buy a 6 and 6 Plus and sort of accelerated? There is no doubt that we had an unbelievable year last year, and the Q2 was particularly really, really strong because of the pent-up demand that left from Q1 in addition to Q2. And so there's no doubt about that. +However, I think you can tell from the numbers that Luca is talking about just on the currency side, and that's before thinking through the affect that price increases can sometimes have on the business over a period of time, it's clear that the economic piece is large. + +-------------------------------------------------------------------------------- +Kulbinder Garcha, Credit Suisse - Analyst [48] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [49] +-------------------------------------------------------------------------------- + + Thank you, Kulbinder. Could we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + And next we'll hear from Steve Milunovich with UBS. Mr. Milunovich, you may want to check your mute button. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [51] +-------------------------------------------------------------------------------- + + Steve, are you there? + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [52] +-------------------------------------------------------------------------------- + + Okay. Let's try the next question, please. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + And we'll hear from Mark Moskowitz with Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowitz, JPMorgan - Analyst [54] +-------------------------------------------------------------------------------- + + Yes. Thank you. Good afternoon. A question and a follow-up. As far as the question, Tim, I wanted to get a better sense from you in terms of what is the overarching message of introducing a little more details here around services. Is this really to just reinforce the power of the franchise or the platform at Apple in terms of to really navigate tougher macro times in terms of the higher level recurring revenue, or is it a stepping stone to much more in terms of Apple service, i.e. I think of all the stuff you do on the data center side. Could we eventually have seen, with the help of IBM and Cisco, that you eventually move more into the cloud services for the enterprise? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [55] +-------------------------------------------------------------------------------- + + So good question. We started breaking out Services, as you know, in the beginning of FY15. And as that business has grown and as it became clear to us that the investors and analysts wanted more visibility into that business, we've now elected to break it out and show the full size, scope, growth, and make comments on the profitability of it from a transparency point of view. +I do think that the assets that we have in this area are huge, and I do think that it's probably something that the investment community would want to and should focus more on. In terms of our future plans, I wouldn't want to comment about any particular thing, but obviously, with breaking this out, we wouldn't be breaking it out if it wasn't an area that was very important to us in the future. + +-------------------------------------------------------------------------------- +Mark Moskowitz, JPMorgan - Analyst [56] +-------------------------------------------------------------------------------- + + Okay. Thank you. And I wanted to follow-up on the upgrade advance program dynamics. Can you talk a little more about what you're seeing in terms of in-store at the Apple Stores? Are you seeing any sort of dislocation in terms of folks who are moving to the upgrade or finance program, are they moving more toward Apple versus maybe the in-store percentage that used to be related to the carriers? In other words, are folks just going with Apple now, instead of the carriers, when they buy their phone, as part of these upgrade programs? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [57] +-------------------------------------------------------------------------------- + + Honestly, this has nothing to do with wanting to move customers from one person to another. This has to do with wanting to provide customers a very simple way to upgrade. Because we serve a significant number of customers in the Apple Store who want the iPhone when it's new and when it comes out, and so we've designed a program that made it simple and easy to do that. I have no idea over time how the percentage of the sales will vary between carriers and the Apple retail store, but that's not our overriding objective. + +-------------------------------------------------------------------------------- +Mark Moskowitz, JPMorgan - Analyst [58] +-------------------------------------------------------------------------------- + + Okay. Thank you. Good afternoon. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [59] +-------------------------------------------------------------------------------- + + Thank you, Mark. We have time for one more question. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + And your final question will come from Jim Suva with Citi. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [61] +-------------------------------------------------------------------------------- + + Thank you very much. A question for Tim and then a detail follow-up for Luca. Tim, with the macro situation changing, a lot of CEOs view that and their strategy is very different go-to-market strategy. Some change the way they go to market. Some change their products. +In the past, Apple's been very known in always having a premium product. With the slowdown in the macro FX and also GDP revision, is Apple's strategy go-to-market still always at premium product, or is there a need to go to more also a middle market or lower price point to attract more customers? Just because it seems like growing that installed base and services, as you pointed out, really economically could really help out Apple in the long term. +And then the financial question for Luca is on that patent litigation, Luca, when you gave guidance three months ago, did you have a view that that was coming in? And if so, was that included in the guidance or not, or was that post the quarter guidance? And I assume it's all one-time this quarter you recorded it, it's all gross margin, and we don't cause that to reoccur again going forward. Thank you very much. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [62] +-------------------------------------------------------------------------------- + + Our strategy is always to make the best products. And that, for the smartphone market, that we are able to provide, though, several different price points for our customers. We have the premium part of our line is the 6s and the 6s Plus. We also have a mid price point, with the iPhone 6 and the iPhone 6 Plus. And we continue to offer the iPhone 5s in the market and it continues to do quite well. And so we offer all of those, and I don't see us deviating from that approach. +We always want to offer somebody the -- we don't design to a certain price point. We design a great product and we make it priced at a great value. And today, we're able to offer all three of those different iPhone options. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [63] +-------------------------------------------------------------------------------- + + And Jim, on the patent question, yes, obviously this is a one-off item that affected the December quarter. As I said earlier, it's worth 40 basis points. So without it, our gross margin would have been 39.7%. It will not repeat going forward. +To your question around was it included in the guidance, yes, the probability of receiving the amount was incorporated in the development of the guidance range. If you remember, we guided to 39% to 40%, and that number was included within the range. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [64] +-------------------------------------------------------------------------------- + + Thank you very much, gentlemen. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [65] +-------------------------------------------------------------------------------- + + Thank you, Jim. A replay of today's call will be available for two weeks, podcast on the iTunes store, webcast on Apple.com/Investor, and via telephone. And the numbers for the telephone replay are 888-203-1112 or 719-457-0820 and please enter confirmation code 7349088. These replays will be available by approximately 5:00 PM Pacific Time today. And members of the press with additional questions can contact Kristin Huget at 408-974-2414. Financial analysts can contact Joan Hooper or me with additional questions. Joan is at 408-974-4570, and I'm at 408-974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2016-Jul-26-AAPL.txt b/Transcripts/AAPL/2016-Jul-26-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..02c8d188b874e7a1647a7ba652c21b2227e2ca3d --- /dev/null +++ b/Transcripts/AAPL/2016-Jul-26-AAPL.txt @@ -0,0 +1,636 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q3 2016 Apple Inc Earnings Call +JULY 26, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Computer, Inc. - CFO + * Tim Cook + Apple Computer, Inc. - CEO + * Nancy Paxton + Apple Computer, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Katy Huberty + Morgan Stanley - Analyst + * Gene Munster + Barclays Capital - Analyst + * Mark Moskowitz + Barclays Capital - Analyst + * Kulbinder Garcha + Credit Suisse - Analyst + * Shannon Cross + Cross Research - Analyst + * Toni Sacconaghi + Bernstein - Analyst + * Steve Milunovich + UBS - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 3Q16 revenues of $42.4b, net income of $7.8b and diluted EPS of $1.42. Expects 4Q16 revenues to be $45.5-47.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 3Q16 revenue = $42.4b. + 2. 3Q16 net income = $7.8b. + 3. 3Q16 diluted EPS = $1.42. + 4. 3Q16 GM = 38%. + 5. 3Q16 CapEx = $4.2b. + 6. 3Q16-end cash plus marketable securities = $231.5b. + 7. 3Q16 share repurchases = 41.2m for $4b. + 8. 4Q16 revenue guidance = $45.5-47.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. Annotation (N.P) +-------------------------------------------------------------------------------- + + 1. Detail: + 1. Installed-base related purchases metric is non-GAAP measure. + +-------------------------------------------------------------------------------- +II. 3Q16 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Overview: + 1. Results reflect stronger customer demand and business performance than anticipated 90 days ago and includes several encouraging signs. + 2. Revenue $42.4b, near high-end of guidance range. + 3. GM 38%, at top of guidance range. + 1. Achieved these results while reducing channel inventory by about $3.6b, significantly more than $2b inventory reduction expected. + 2. Sell-through was markedly greater than sell-in. + 3. iPhone accounted for vast majority of channel inventory reduction. + 4. iPhone units sell-through down 8% YonY, greater YoverY improvement than predicted. + 1. Expects Sept. qtr. sell-through comparison to improve further. + 5. Believes channel inventory levels position Co. well for months ahead. + 6. Had successful global launch of iPhone SE and demand outstripped supply throughout qtr. + 1. Brought on additional capacity and able to achieve supply demand balance as Co. entered Sept. qtr. + 2. At its launch, stated that addition of iPhone SE to iPhone lineup placed Co. in better position to meet needs of customers through love of four-inch phone and to attract even more customers into its ecosystem. + 1. In both cases, this strategy is working. + 3. Initial sales data shows iPhone SE is popular in developed and emerging markets. + 4. Percentage of iPhone SE sales going to customers who are new to iPhone is greater than seen in first weeks of availability for other iPhones launched in last several years. + 7. Overall, added millions of first time smartphone buyers in June qtr. and switchers accounted for highest percentage of quarterly iPhone sales ever measured. + 1. YTD iPhone sales to switchers are greatest seen in any nine-month period. + 2. Co.'s active installed base of iPhones up strong double digits YoverY. + 2. Services: + 1. Businesses grew 19% to June qtr. record at $6b. + 1. Broad based growth with App Store revenue up 37% to a new all-time high in addition to strong increases in: + 1. Music. + 2. iCloud. + 3. AppleCare. + 2. In last 12 months, revenue grew almost $4b YonY to $23.1b. + 1. Expects it to be size of Fortune 100 co. next year. + 3. Most of Co.'s terrific services performance was fueled by active installed-base of devices with installed-base related purchases of $10.3b accelerating to 29% growth YonY. + 1. Had best iPad compare in 10 quarters, with revenue growing 7% due to roll out of 9.7-inch iPad Pro. + 2. Surveys show that about half of iPad Pro purchases are buying them for work. + 3. iPad Pro is ultimate upgrade for existing iPad users and ultimate replacement device for customers switching from PC notebooks. + 3. Apple Watch: + 1. Continues to be best-selling smart watch in the world. + 1. Just this month, J.D. Power ranked it highest in customer satisfaction among all smart watches. + 2. watchOS 3 coming this fall. + 3. Getting started with Apple Watch. + 4. Growth Prospects: + 1. Encouraged about growth prospects in China and India. + 2. Remains optimistic about long-term opportunities in Greater China; investing there. + 1. Opened 41st Greater China retail store during qtr. + 1. Made $1b investment in Didi Chuxing. + 2. Switchers and first-time smartphone buyers represented lion's share of iPhone sales. + 3. Installed-base of iPhones in China grown 34% YoverY. + 4. According to China Mobile, there are more iPhones on their network than any other brand with iPhone users ranking 1st regarding: + 1. Customer loyalty. + 2. Data usage. + 3. ARPU. + 5. By far, largest portion of global channel inventory reduction was in Greater China. + 1. Underlying business is stronger than results imply. + 6. Faced some challenges in Greater China as economic environment slowed down since beginning of the year. + 1. Reflected in consumer confidence and regional spending. + 7. Chinese yuan depreciated by 7% relative to US dollar since Aug. 2015. + 8. Hong Kong's tourism and retail businesses continue to be significantly impacted by stronger Hong Kong dollar relative to other Asian currencies. + 1. Combining this backdrop with tough comparison to last year when revenue grew 112% and channel inventory reduction this year, reporting a decline in revenue in 3Q16. + 9. In first three quarters of FY16, total revenue from Greater China was almost $40b. + 1. Up 55% from same time frame two years ago, while iPhone units grew 47%. + 3. India is now one of Co.'s fastest growing markets. + 1. In first three quarters of FY16, iPhone sales grew 51% YonY. + 2. Announced a first of its kind design and development accelerator to support Indian developers creating innovative applications for iOS. + 1. Opened a new office in Hyderabad to accelerate Maps development. + 3. Looking forward to opening retail stores in India down the road. + 1. Sees huge potential. + 5. New Products: + 1. Looking forward to the fall, thrilled by customers' response to software and services previewed at Worldwide Developers Conference last month; biggest WWDC ever. + 1. For first time, has four innovative Apple platforms for developers' apps: + 1. iOS. + 2. macOS. + 3. watchOS. + 4. tvOS. + 2. iOS 10 will be biggest release ever for iOS. + 2. There is a major update with macOS Sierra, with new features like Siri and Apple Pay that make Mac smarter more helpful than ever and even a stronger continuity features across all Apple devices. + 6. Artificial Intelligence: + 1. Focused Co.'s AI efforts on features that best enhance customer experience. + 1. Machine learning enables Siri to understand words and intent behind them. + 1. To make Siri an even smarter assistant, opening service to developers. + 2. This fall, Siri will be available across Co.'s entire product line. + 2. Using machine learning in many other ways across products and services. + 1. Machine learning is improving facial and image recognition at photos, predicting word choice while typing in messages and mail and providing context awareness in maps for better directions. + 3. Most of AI processing takes place on device rather than being sent to cloud. + 2. Starting this fall, will be using sophisticated technology called differential privacy. + 3. This fall, will bring Apple Pay to Safari. + 1. Tens of millions of users worldwide are enjoying Apple Pay today at stores and in app, with estimated monthly active users up more than 450% YonY last month. + 4. Leading financial partners tell that three out of four contactless payments in US are made with Apple Pay. + 1. There are more than 11m contactless ready locations in countries where Apple Pay is available today, including 3m locations now accepting Apple Pay in US. + 2. With launch of France, Switzerland and Hong Kong this month, Apple Pay is now live in nine markets, including six of Top 10. + 3. Adoption outside US has been explosive, with over half of transaction volume now coming from non-US markets. + 5. With latest OS releases, unparalleled continuity across Apple devices will become even more powerful. + +-------------------------------------------------------------------------------- +III. 3Q16 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Results: + 1. Revenue $42.4b, near high-end of guidance range vs. 3Q15's $49.6b. + 1. Customer demand for products and services were stronger than anticipated at beginning of qtr. + 2. Reduced overall channel inventories by roughly $3.6b. + 3. Geographically, revenue grew strongly in Japan to a new June qtr. record. + 4. Experienced healthy growth in a number of other important markets, including: + 1. Russia. + 2. Brazil. + 3. Turkey. + 4. India. + 5. Canada. + 2. GM 38%, at top of guidance range. + 3. Operating margin 23.9% of revenue. + 4. Net income $7.8b. + 5. Diluted EPS $1.42. + 6. Cash flow from operations $10.6b. + 2. iPhone: + 1. Sold 40.4m iPhones. + 2. Reduced channel inventory by over 4m units vs. about 0.5m units a year ago. + 1. Sell-through down 8%. + 2. Exited qtr. near low-end of 5-7 week target range for channel inventory. + 3. Roll-out of new entry level iPhone SE concurrent with channel reduction of more than 4m higher-end iPhones resulted in lower-than-usual iPhone ASP of $595. + 1. Expects ASPs to improve this qtr. + 4. Experienced strong iPhone growth in many markets, with sales in Russia more than doubling YoverY and double-digit growth in many other key countries including: + 1. Japan. + 2. Turkey. + 3. Brazil. + 4. India. + 5. Canada. + 6. Sweden. + 5. Showing great momentum in business markets. + 1. Recent survey by 451 Research, founded among US corporate buyers planning to purchase smartphones in Sept. qtr. 75% planned to purchase iPhones. + 1. Highest corporate purchase intent ever measured by survey for Sept. qtr. + 3. Services: + 1. Revenue $6b. + 1. Up 19% YoverY. + 2. Sets new record for customers transacting on iTunes Stores and among customers who purchased apps and content, avg. amount spent per customer was highest that Co. ever measured. + 2. App Store's growth rate accelerated for four consecutive quarters, reaching 37% in 3Q. + 1. According to App Annie, generated 100% more global revenue than Google Play in June qtr., widening lead from March qtr. + 2. Because of this continued growth for first nine months of FY16, services increased from 8% of total revenue a year ago to 11% this year. + 1. Represents an even higher percentage of profitability. + 4. Mac: + 1. Sold 4.3m Macs vs. 4.8m last year. + 1. Challenging qtr. for personal computer sales across industry with IDC estimating 4% global contraction. + 2. In addition to overall market slowdown, faced difficult YoverY when Co. introduced a new MacBook Pro and a new iMac. + 3. Despite these challenges, Mac gaining high percentage of new customers. + 4. Mac installed base grown to new all-time high at June qtr.-end. + 1. Ended qtr. below 4-5 week target range for Mac channel inventory. + 5. iPad: + 1. Revenue grew 7%. + 2. ASP $490 vs. 3Q15's $415, with increase driven by iPad Pro. + 3. Sold 10m iPads vs. 3Q15's 10.9m. + 1. Reduced channel inventory by about 500,000 units. + 2. Exited qtr. within 5-7 week target range. + 4. In segments of tablet market, where Co. competes, continues to be highly successful regarding market share and customer metrics. + 1. Recent data from NPD indicates iPad gained share in overall US tablet market in June qtr. and has 84% share of tablets priced above $200. + 2. In May, 451 Research measured 96% consumer satisfaction rate for iPad mini and 95% rate for iPad Air. + 3. Among US consumers planning to purchase a tablet within next six months, 63% plan to purchase an iPad, almost four times purchase intention rate of next highest brand measured, with iPad Pro top choice for planned purchases. + 4. Corporate buyers reported 94% satisfaction rate for iPad in purchase intent of 71% for Sept. qtr. + 1. One recent example of iPad business adoption is Sberbank, Russia's largest bank, which is adding 22,000 iPads to more than 10,000 purchased last year to deploy corporate mobility solutions across organization and enable its consultants to serve customers in more engaging and more efficient way. + 2. Making great progress with enterprise initiatives. + 3. Sees strong growth opportunities ahead. + 5. In May, announced a global strategic partnership with SAP to reimagine business processes with native iOS apps. + 1. SAP is the world's largest enterprise software provider with more than 130m potential users among its 300,000 global customers. + 2. Estimated 76% of global business transactions [touch on] SAP system. + 3. Partnership will deliver [NSDK to fast-track] iOS projects for SAP environments and iOS academy to enable 2.5m SAP developers worldwide to build great native iOS apps and portfolio of industry-specific apps to accelerate mobile transformation in enterprise. + 6. Last month, announced first three solutions from Cisco partnership. + 1. Dramatically improved network performance of iOS traffic running on Cisco networks and one that will bring desk phone to 21st century by integrating iPhone Wi-Fi calling into Cisco Spark. + 6. Cash Position: + 1. 3Q16-end cash plus marketable securities $231.5b. + 1. Sequentially decreased $1.4b. + 2. $214.8b of this cash or 93% of total was outside US. + 2. Issued $2.4b of debt in Taiwan and Australia, while retiring $2.5b in US debt, leaving Co. with $72b in term debt at qtr.-end, essentially unchanged from last qtr. + 3. Returned over $13b to investors. + 1. Paid $3.2b in dividends and equivalent. + 2. Spent $4b on repurchases of 41.2m Co. shares through open market transactions. + 3. Launched a new $6b ASR, resulting in initial delivery and retirement of 48.2m shares. + 1. Completed six accelerated share repurchase program, retiring additional in 8.7m shares. + 4. Completed almost $177b of current $250b capital return program including $127b in share purchases. + 5. Spent $1b on minority investment in Didi Chuxing in China. + 1. Completed three acquisitions. + 2. Incurred $4.2b in CapEx. + 7. 4Q16 Outlook: + 1. Revenue $45.5-47.5b. + 2. GM 37.5-38.0%. + 3. OpEx $6.05-6.15b. + 4. OI&E about $350m. + 5. Tax rate about 25.5%. + 6. On 07/26/16, Board of Directors declared cash dividend of $0.57 per share of common stock payable on 08/11/16 to shareholders of record as of 08/08/16. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Your first question comes from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [2] +-------------------------------------------------------------------------------- +Thank you very much for the question. Tim, can you talk a little bit about your thoughts on investments? You made the Didi investment this quarter. +Obviously you continue to make acquisitions over time. We just saw -- you invested in buying some of the carpool karaoke. I'm just curious as to how you're thinking about where you're putting your investment dollars for more of an acquisition or a potential equity stake standpoint as you look at overall capital allocation? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Shannon, we obviously invest a ton of capital in our business itself to support research and development and the production of our products and that's the main source of our capital. However, we're constantly looking on the outside for great talent and great intellectual property, and we have been buying companies on average every three to four weeks or so. We continue to do that, and we think we've made some really great choices there. +In terms of the investment in Didi, it was a unusual investment in that as you know, we don't have a long history of doing a lot of these. But, we have done some before. We invested in ARM in the early days. +We invested in Akamai and a few other companies so it wasn't the first. From a Didi point of view, we see that as one, a great financial investment. Two, we think that there's some strategic things that the Companies can do together over time. +And, three, we think that we'll learn a lot about the business in the Chinese market even beyond what we currently know, and Didi has an incredible team there. That's the rationale for why we did that. Would we do more investments? +Yes, but it's not something that you'll see a whole string of from us, but we will constantly look for things that are smart to do. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [4] +-------------------------------------------------------------------------------- +Great, thank you. And then, just as a follow-up for Luca. If you could talk a little bit about the gross margin puts and takes for guidance at 37% to 38%. How are we thinking about commodity pricing and mix of the new products and that just as you look to how you guided gross margin? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [5] +-------------------------------------------------------------------------------- +Yes, Shannon. Let me correct you, but it's 37.5% to 38%. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [6] +-------------------------------------------------------------------------------- +Oh, sorry. I had that written down, but I said the wrong thing. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [7] +-------------------------------------------------------------------------------- +For the September quarter. So, it's essentially, we are guiding GM flat to slightly down sequentially. +On the positive side, we are going to have leverage because we are guiding to a sequential increase in revenue, and we expect to have positive mix as we get into the September quarter. This positive is being offset more or less by what we call product transition costs which are typical of this time of the year for us. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [8] +-------------------------------------------------------------------------------- +Shannon, on the commodity side and for the September quarter, we see NAND being pretty much in balance while DRAM and LCDs and other major commodities remain in an oversupply situation. And so, overall commodity prices we expect to decline at, at least historical rates + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [9] +-------------------------------------------------------------------------------- +Thank you Shannon. Next question, please? + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +From UBS, we'll hear from Steve Milunovich. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [11] +-------------------------------------------------------------------------------- +Great. Thank you very much. +Regarding your revenue guidance for September, it's up about 10% sequentially which is clearly at the high end historically. So, what can you tell us about the timing of the new iPhone model? Is that affecting this? You mentioned the 451 is finding business interest in phones, but their survey on consumers actually finds the lowest level of expectation for purchases in the next three months since 2008. +You've seen the upgrade numbers from the carriers are quite low so it seems like it's still a very tough demand environment. So, where is the strength coming from in the September quarter? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [12] +-------------------------------------------------------------------------------- +Steve, we aren't going to get into products or product transitions. However, we've taken what we've learned from last quarter, and we did see a number of encouraging signs. Luca talked about the number of countries that we saw double-digit growth in during the quarter from Japan to Brazil to India. +Some even stronger numbers than that in Russia. So, there's a number of countries that we saw strong signals from that perspective. We also are very happy with the switcher rate that we saw. +Our highest ever recorded, and the number of switchers through the nine months or the highest absolute numbers that we've ever had. And so, when we look at that and then we look at the things going on in our other products and services, and we think services will continue to grow very briskly. We've made our best estimate of where we think we'll come in, and that's $45.5 billion to $47.5 billion. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [13] +-------------------------------------------------------------------------------- +Okay, fair enough. As a follow-up, I wanted to ask you about your platform strategy. You talk about the four operating systems essentially as platforms which I agree with. And, it's just interesting to me because Apple has such control over the vertical integration of your products, and yet you've somehow been able to grasp the openness that's required for platforms. +And, I think that's reflected in WWDC as you pointed out. Opening up APIs and so forth on messaging, and you made the case there for Apps versus messaging and the anti-bot argument. +Just curious is that the way -- am I characterizing this roughly correctly in term of how you think about the business? And, how are you managing that internally in terms of having this vertically integrated somewhat closed view of the hardware and yet this pretty open platform where the value is created externally? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [14] +-------------------------------------------------------------------------------- +Well, we think to have a great platform you have to have a really healthy ecosystem, and so we're really proud of the developer community and the fact that developers are earning a lot more money in writing for iOS than other apps. We think that the best experience for users include apps, and so we want to do everything that we can do to continue building that. +We now have over 2 million apps in the app store and are more focused these days on discovery and other things to bring more great apps to the service because there's so many out there. So, that's what we're doing. The TV and the -- you didn't mention CarPlay, but these are trying to provide our users a seamless experience across all of the different things that they do in their lives. +And so, that's the rationale for CarPlay. It's the rationale for why we're putting huge investment in the home. Making -- really bringing home automation to life for people in a very simple and elegant way. +It's the reason for Apple TV and what we are doing in the living room. All these things together are all about user experience and making people's daily lives better. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [15] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [16] +-------------------------------------------------------------------------------- +Thank you, Steve. Next question, please? + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +We'll go to Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- +Thank you. Luca, as it relates to gross margin, the guidance today is very similar to what you've provided over the last five years in terms of gross margin guidance in September versus June. And, the variances that you walked through in response to Shannon's questions are very similar to the dynamics that you see in any September quarter, but there's an added factor this time around which is you don't have the $4 million of high ASP, high margin inventory drain in September like you did in the June quarter. +So, I guess I'd just pushback and ask why gross margin guidance wouldn't be even better? Is it the more balanced NAND environment that Tim spoke to? Or, is there something else impacting the guidance? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [19] +-------------------------------------------------------------------------------- +Well, Katy, I've talked about these elements at a broad level. Of course, there are degrees of positive impact, right. We, for example, on the mix front every cycle is slightly different on our product mix, and so that clearly has an impact on gross margin. +The other thing that we need to keep in mind as we step back for a second and now we have gone through a couple of cycles where the US dollar has strengthened. As you know, we work with our hedging program where we get protection from FX fluctuations in the short term, when these hedges roll off over time, we end up replacing them with new hedging contracts at the spot rate. +And so, versus September of 2014, for example, the US dollar is now strengthened on average against international currencies by about 15%. I think we need to accept and now we are living in this stronger US dollar environment. We've taken a lot of actions on the cost side, on the pricing side, and obviously with hedges. But, we need to deal with the situation, and that's where we are right now. +We feel that 37.5% to 38% given the new FX environment, I think, says a lot about all the work that we've done on the cost side to get there. Just to give you a sense on a year-over-year basis when I look at foreign exchange, that has an impact of almost 300 basis points on our margins. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- +Okay. Thank you. Tim, can you speak to how you envision the upgrade rate of the iPhone installed base to play out over the next quarter or the next year? +Somebody mentioned that US carriers have reported really weak upgrade rates, not necessarily for iPhone but across their installed base. The press is discussing only modest technology upgrades in your next iPhone cycle. +So, those data points would lead investors to believe that the upgrade rate will be low. But, curious if you have a different view? Thank you. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [21] +-------------------------------------------------------------------------------- +I don't want to talk about new phones that aren't announced. And so that aside, what we have seen in the past tense or current tense on the upgrade rate is that the iPhone upgrade rate for the 6s is very similar to the 5s. And, I guess in retrospect maybe that was a predictable thing although we didn't predict it at the beginning. +It took a little time to realize that. The iPhone 6 was significantly higher than that, and so it likely accelerated upgrades that would have been in the current year ahead of those. And so, what the future holds we'll see, but I'm very optimistic about the future because I see so many signs that are positive. +I see an installed base that has gotten incredibly large. I see a switcher rate that is the highest ever. I see the Smartphone itself, lead by iPhone, becoming even more instrumental and important to peoples lives. +It's becoming essential, and all of the things that are coming both in the fall. The things that we've announced that you can see with iOS 10 hopefully you're running by now with the beta and other things make it even more instrumental and AI even makes it more and more. As the phone becomes more and more your assistant, it's one of those that you aren't going to leave without it. +And so, I see all of those things as vectors that are incredibly positive. I also really like what I've seen with the iPhone SE, and the fact that it's opening the door to customers that we weren't reaching before and likely convincing some people to upgrade that wanted a smaller form factor but wanted to stay with iPhone. And so, they were waiting for the iPhone SE. +I see lots of positive things so that's how I look at it. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [22] +-------------------------------------------------------------------------------- +Thank you, Katy. Next question please? + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +We'll go to Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [24] +-------------------------------------------------------------------------------- +Yes, thank you. You commented about the significant inventory drawdown in the quarter -- $3.6 billion on the revenue side. So, sell-through was $46 billion effectively. Over 4 million iPhones, suggesting that sell-through iPhone sales were $45 million. +When I look to your guidance for Q4, I actually have the opposite question of a previous question which is in light of the true sell-through rate which seems to reflect better than normal seasonality in Q3. Likely some contribution and elasticity from the SE. When I look at Q4, it looks like you're guiding for iPhone unit on a sell-through basis to be flat or potentially down? +And, for total Company revenues to be only fractionally up and below the kind of seasonality we see in Q4. So, I guess my question is are you expecting any drawdowns in channel inventory in fiscal Q4? Or, are my inferences around sell-through rate incorrect? +Or, given the business momentum that you spoke about in response to an earlier question and the hopefulness that you expressed in your prepared remarks, Tim. I'm actually surprised the guidance isn't a bit stronger on the top line. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [25] +-------------------------------------------------------------------------------- +Toni, let me take it. Starting with your comments on the June quarter, just want to point out that when we talk about a $3.6 billion channel inventory reduction, that is not entirely related to iPhone. IPhone is the vast majority of that, but we did reduce channel inventory on all other products as well. So, that probably leads you to different conclusions to the math that you just expressed. +On the September quarter when I look at the sequential increase for iPhone units that we are expecting, I would say that it is even with the sell-through adjustment that you've talked about, it's still pretty much in line with what we've seen in the past. As you know, we do not provide guidance for channel inventory, but I would say in general, it's important to keep in mind that if we look around the world, we do see a lot of positive signs. +But, we also know that the macroeconomic environment is slowing down in a number of places around the world, and that needs to be taken into account in our guidance. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [26] +-------------------------------------------------------------------------------- +Luca, I did understand the $3.6 billion, but you said over 4 million iPhones were drawn down. I added that to the $40.4 million so that would suggest close to $45 million on a sell-through basis, so that was the basis for my observation. I was wondering if we could, if I could direct one at Tim. +You talked about the upgrade cycle and how it is elongated relative to the iPhone 6, and that it's similar to what you saw with the 5s. My belief is that one of the bigger longer term concerns for Apple is that the replacement cycle could just structurally elongate over time particularly as your installed base of customers becomes less affluent and more international. So, I guess my question is you have a mechanism which is the Apple upgrade program which takes replacement cycle out of the equation and puts people on buying the phone as a service. +I'd welcome any comments on how that program is doing? And then, just more broadly, is Apple thinking about ways to sell not only the iPhone, but more of its products on a monthly-type subscription basis perhaps in a more bundled fashion so that you can add more predictability to what is now largely a transactional revenue model? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [27] +-------------------------------------------------------------------------------- +The iPhone demand is made up, as you know, of upgraders, switchers, and new to Smartphone. And so, if you take it in the reverse order for a minute and look at the new to Smartphone, the penetration around -- Smartphone penetration right now around the world at the end of December was 42%. So, there is quite a bit of room there. +It is true that a lot of those are in emerging markets, but we have done -- we've had reasonable business success in several emerging markets. So, we don't enter into those with no experience although we will enter into them humbly. +On the switcher side, we really like what we're seeing, and we think that from a user point of view, as the Smartphone itself becomes more and more essential to people's daily lives which is a part of what I had talked about before. A part of bringing it into the home in a bigger way and in the car and at work and so forth. +We think people will put more and more focus on what they're buying, and the thing that Apple does best which is provide this killer experience. A killer user experience that's integrated across their lives, I think, becomes more important, and I think that really plays to our advantage. +I also think that the deployment of AI technology is something that we will excel at because of our focus on user experience and so I like that. From an upgrade point of view, there are pluses and minuses as I see it. A plus is that more and more people have already joined upgrade programs. +Some of these programs like the one that you referenced that we've done replaces the iPhone every year. There are also carriers that have similar kind of plans where they also replace or change out the iPhone every year. Others have an 18-month clock. +Some have a 24-month clock, and there are even some that have a 30-month clock So, there's various time schedules there. As of today, there are obviously a lot more people on those programs than ever before because they just started and really got underway in a big way last year, in a smaller way two years ago. We'll see more of those this coming fall. +The minus side is that the bifurcation of the Smartphone from the service itself has a plus and a minus into it. The subsidy, the lack of that -- and this is more of a US phenomenon than the rest of the world. Some of that can be a shock for people that we're used to paying $199 for their Smartphone and they come back in and pay less for the service but they pay more for their Smartphone. +There's lots of pluses and minuses on this. But, overall, as I look at this for Apple -- and this is not a statement on the industry itself -- but for Apple, I'm very optimistic. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [28] +-------------------------------------------------------------------------------- +Thank you, Toni. Next question please? + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +From Goldman Sachs, Simona Jankowski. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- +Thank you. Tim, as you mentioned, you traveled to China during the quarter. While you certainly sound encouraged on China and highlighted the Didi investment, there are some of the key services for Apple like iBooks and iTunes, movies that are still banned, and some of the local vendors appear to be gaining share. +So, can you just give us your perspective on the market? Your expectations around getting those services back up and also regaining share? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [31] +-------------------------------------------------------------------------------- +Yes, for books and movies, we currently have those stores off as you mentioned. To put this in some context, those two stores for the months that we have been operational, which is several months, the revenue was less than $1 million. And so, it's not a revenue-related issue. +From our point of view, this is a service we want to provide our customers. So, we are working very closely with the appropriate government agencies, and we hope to make books and movies available again to our customers there. We'll see how that goes, but we're optimistic there. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [32] +-------------------------------------------------------------------------------- +And, in terms of just regaining share in the market more broadly? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [33] +-------------------------------------------------------------------------------- +I think we've always had a -- if you look at our share over time, our share in China tends to peak during launch windows. There's a higher high and a lower low there. There's a bigger difference between those two. +What we have to do and what we are doing is innovating like crazy and delivering the best Smartphone to our customers there. And, if we do a really great job of that, which we will, then I'm confident that we'll do well. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [34] +-------------------------------------------------------------------------------- +Thank you. Next question, please? + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Gene Munster with Piper Jaffrey. + +-------------------------------------------------------------------------------- +Gene Munster, Barclays Capital - Analyst [36] +-------------------------------------------------------------------------------- +Good afternoon, Tim, you gave some nice data points around Apple Pay. Can you remind us is this a business that ultimately impacts the services line in any measurable way? Or, is Apple Pay generally about selling iPhones? +And, separately is that, when you just take a step back and look at the proof point that augmented reality theme has had with this whole Pokemon phenomenon. How does it impact how you think about the future? I assume you think about it. +I'm curious what goes on in your mind when you see all of that? Thanks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [37] +-------------------------------------------------------------------------------- +Yes, on the Apple pay side, the revenues from Apple pay are in the services line. The growth is astronomical, but the base is very small. So, for today, Apple pay is very much about a great feature for our customers so that they can pay in a very simple, private, and secure way. +In terms of AR and the Pokemon phenomenon, it's incredible what has happened there. I think it's a testament to what happens with innovative Apps and the whole ecosystem and the power of being a developer being able to press a button, so to speak, and offer their product around the world. This certain developer has elected not to go worldwide yet because of the pressure on their servers, et cetera, because of the demand. +But, I'm sure that they will over time. It also does show, as you point out, that AR can be really great, and we have been and continue to invest a lot in this. We are high on AR for the long run. +We think there's great things for customers and a great commercial opportunity, and so we're investing and the number one thing is to make sure our products work well with other developers' kind of products like Pokemon. That's the reason you see so many of the iPhones out in the wild right now chasing Pokemon. + +-------------------------------------------------------------------------------- +Gene Munster, Barclays Capital - Analyst [38] +-------------------------------------------------------------------------------- +Would you say there's going to be a computing shift to AR longer term? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [39] +-------------------------------------------------------------------------------- +I know there's people that want to call it a new computer platform, and we will see. There's a tendency in this industry to call everything new the next computer platform. However, that said, I think AR can be huge. So, we'll see whether it's the next platform, but regardless, it will be huge. + +-------------------------------------------------------------------------------- +Gene Munster, Barclays Capital - Analyst [40] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [41] +-------------------------------------------------------------------------------- +Thanks, Gene. Next question, please? + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +We'll go to Mark Moskowitz with Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays Capital - Analyst [43] +-------------------------------------------------------------------------------- +Yes, thank you. Good afternoon. Just want to follow-up, Tim, if I could related to the R&D pace of growth. +Clearly, a lot of momentum there over the last couple of years, but we're just trying to figure out how much of that is dedicated to existing products and services versus what's next? And, can you give us a sense in terms of when investors should think about the ROI coming back to them from the R&D perspective? And, corollary to that, does that -- is it really restricted just to products and services currently? +Or, can we see more of a cloud services apparatus evolve over time where you do more and more in the Enterprise just given the core chips with SAP and Cisco and IBM? And then, my follow-up for Luca is around ASPs for the iPhone. +We keep getting a lot of questions around SE in terms of how cannibalistic could it be to the core iPhone franchise? Are you seeing any moderation in terms of the ASP pressures there? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [44] +-------------------------------------------------------------------------------- +On the R&D growth, we do continue to invest significantly in R&D. The growth rates are still large on a year-over-year basis and Luca can share the exact ones, but I think the recent quarter was in the [mid-20s] for R&D. The balance of the Company, we're managing more flattish from a year-over-year point of view. +The products that are in R&D -- there is quite a bit of investment in there for products and services that are not currently shipping or derivations of what is currently shipping. And so, I don't want to talk about the exact split of it, but you can look at the growth rate and conclude that there's a lot of stuff that we're doing beyond the current products. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [45] +-------------------------------------------------------------------------------- +Mark, on the ASP question. Talked about $595 in Q3. It's down $65 on a year-over-year basis. +Keep in mind about $20 of that $65 is foreign exchange. So, during the quarter, we had this combination of starting with no SE units in channel inventory so we had to do at least a partial channel [sale] that obviously had an impact on ASPs. And then, the other element was the fact that we've reduced more than 4 million units of channel inventory on the high end. +So, the combination of these two things, obviously, had an impact on ASPs. But, I think as I said or Tim said during the prepared remarks, we do expect iPhone ASP to improve sequentially as we move into the September quarter because these two factors that I just mentioned. I'm not going to repeat. +On cannibalization, of course, we've got limited experience because the phone has been in the market just for a few weeks. But, when we look at our survey data on iPhone SE, as Tim was saying, we believe that the SE is doing exactly what it was intended which is we are seeing a higher rate of new-to-iPhone customers which is obviously very important to us as we bring new people into the iOS ecosystem. And, we see a higher rate of previous iPhone owners that really prefer the four-inch phone factor. +We have not seen clear evidence of cannibalization from iPhone 6s or 6s plus. Of course, there's always going to be some level of cannibalization, but really to us what is much more relevant is the much bigger opportunity to bring more people into the iOS ecosystem. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [46] +-------------------------------------------------------------------------------- +Thanks, Mark. Next question, please? + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +From Credit Suisse, we'll hear from Kulbinder Garcha. + +-------------------------------------------------------------------------------- +Kulbinder Garcha, Credit Suisse - Analyst [48] +-------------------------------------------------------------------------------- +Thanks. Just a couple of questions. Luca, I want to clarify that last point on ASPs and iPhone? +In the last quarter, it seemed that you were quite clear that was a negative driver to the gross margin of the Company. So, I understand there is other drivers going into the September quarter, but just to be clear, the 4 million or so units that you didn't sell-through that were depleted out of channel inventory, those are relatively high gross margin as well. That's just a clarification. +And then, for Tim, on the services side. As Apple has spoken more and more loudly I guess over the last three or four quarters, I just think about some of the comments you've made about the TV market and how its still been in the '60s and '70s and the experience hasn't changed. I understand you have the Apple TV box out, but in terms of driving actual video-on-demand services, is that something that Apple wants to do themselves? +Do you want to partner? Could you even build content? How do you think about that as an actual business opportunity as opposed to here is an Apple box and we sell some units, but it's not that meaningful to the overall Company in terms of size. I'm just curious given the installed base and users you have? Many thanks. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Computer, Inc. - CFO [49] +-------------------------------------------------------------------------------- +On your question on iPhone ASP, I'm not sure if I understood it correctly. But clearly, the iPhone SE has a downward impact on iPhone ASP, of course, because it comes at the low end of the range. From a gross margin perspective, it is slightly dilutive to Company margins, but the impact is not particularly large. + +-------------------------------------------------------------------------------- +Kulbinder Garcha, Credit Suisse - Analyst [50] +-------------------------------------------------------------------------------- +Okay. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [51] +-------------------------------------------------------------------------------- +On the Apple TV question. The introduction of Apple TV and TV OS in last October and the subsequent OS releases and what's coming out this fall -- think of that as building the foundation for what we believe can be a broader business over time. +So, I don't want to be more precise than that, but you shouldn't look at what's there today and think we've done what we want to do. We've built a foundation that we can do something bigger off of. + +-------------------------------------------------------------------------------- +Kulbinder Garcha, Credit Suisse - Analyst [52] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Computer, Inc. - CEO [53] +-------------------------------------------------------------------------------- +Thank you for the question. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Computer, Inc. - Senior Director of IR [54] +-------------------------------------------------------------------------------- +Thank you, Kulbinder. A replay of today's call will be available for two weeks as a podcast on the iTunes store, the Webcast on www.Apple.com/investor, and via telephone. The numbers for the telephone replay are 888-203-1112 or 719-457-0820. Please enter confirmation code 4944387. +These replays will be available by approximately 5.00 PM Pacific Time today, and members of the press with additional questions can contact Kristin Huguet at 408-974-2414. Financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570, and I'm at 408-974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +Ladies and gentlemen, that does conclude today's presentation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2016-Oct-25-AAPL.txt b/Transcripts/AAPL/2016-Oct-25-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..d93aae24950136b61b305884355c226f9d4ec251 --- /dev/null +++ b/Transcripts/AAPL/2016-Oct-25-AAPL.txt @@ -0,0 +1,648 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q4 2016 Apple Inc Earnings Call +OCTOBER 25, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO + * Tim Cook + Apple Inc. - CEO + * Nancy Paxton + Apple Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Wamsi Mohan + BofA Merrill Lynch - Analyst + * Jim Suva + Citigroup - Analyst + * Katy Huberty + Morgan Stanley - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Rod Hall + JPMorgan - Analyst + * Shannon Cross + Cross Research - Analyst + * Toni Sacconaghi + Sanford C. Bernstein & Co. - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + * Steve Milunovich + UBS - Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 4Q16 revenue of $46.9b, net income of $9b and diluted EPS of $1.67. Expects 1Q17 revenue to be $76-78b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 4Q16 revenue = $46.9b. + 2. 4Q16 net income = $9b. + 3. 4Q16 diluted EPS = $1.67. + 4. 4Q16 GM = 38%. + 5. 2016 CapEx = $12.8b. + 6. 4Q16 CapEx = $3.6b. + 7. 4Q16-end cash plus marketable securities = $237.6b. + 8. 4Q16 share repurchase = 28.6m AAPL shares for $3b. + 9. 1Q17 revenue guidance = $76-78b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 4Q16 Business Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Results for Sept. qtr. were strong. + 2. Revenue $46.9b. + 1. Towards high end of guidance. + 3. GM 38%. + 1. At the very top of range. + 4. Sold 45.5m iPhones, reflecting continued improvement in YoverY performance vs. last two quarters as forecasted in Jan. + 1. iPhone sales up YoverY in 33 of Top 40 markets. + 5. FY16 saw more customers switch from Android to iPhone than ever before. + 1. This is due to superior customer experience Co. delivers with its products and it's something no other co. can match. + 2. Services: + 1. Record-setting qtr. for services. + 1. Revenue $6.3b. + 1. Growth accelerated to 24%. + 2. App Store revenue continues to skyrocket. + 3. Music revenue grew 22% due to growing popularity of Apple Music. + 4. J.D. Power recently announced that Apple Music enjoys highest customer satisfaction rating in streaming music market. + 2. In Japan, Apple Pay went live on 10/24/16. + 1. Expects strong response and rapid adoption of Apple Pay. + 3. Around the world, seeing strong growth in transaction volume through Apple Pay, which also launched in Russia and New Zealand, this month. + 1. Coming to Spain in next few months. + 4. Apple Pay transactions up nearly 500% YonY for Sept. qtr. + 1. Completed more transactions in Sept. than Co. did across all of FY15. + 2. With Apple Pay support now built into Safari, hundreds of thousands of websites are bringing Apple Pay to their customers. + 3. Co.'s major partners state that Apple Pay shows highest conversion rate of any digital wallet. + 5. Remains confident about future of services business given unmatched level of engagement, satisfaction and loyalty of growing installed base. + 6. Almost doubled the size of services revenue in last four years. + 1. As stated before, expected to be the size of a Fortune 100 co. in FY17. + 7. Thrilled with customer response to iPhone 7 and iPhone 7 Plus. + 1. These are the best phones Co. has ever made with breakthrough camera systems, immersive stereo speakers and best iPhone performance and battery life ever due to custom-designed Apple A10 Fusion chip. + 2. Demand continues to outstrip supply. + 1. Working hard to get them into customers' hands as quickly as possible. + 8. Off to a great start with Apple Watch Series 2, next generation of world's most popular smart watch packed with new features including built-in GPS, water resistance, dramatically brighter display and a powerful dual-core processor. + 1. Individuals and businesses alike are recognizing potential of Apple Watch to help people stay healthy, motivated and connected. + 2. Aetna has announced a new initiative to revolutionize its members' healthy experience by subsidizing Apple Watch for individual customers and select large employers. + 3. Aetna is providing Apple Watch to nearly 50,000 of its own employees to encourage them to live a healthier day. + 3. Key Details: + 1. Just rolled out new versions of iOS, macOS and watchOS. + 1. New features including Siri on Mac, enhanced health and fitness capabilities for Apple Watch and new way to experience photos on iOS with a feature called Memories. + 2. Has made massive advances in messages, making them more expressive and fun than ever with powerful animations, invisible ink and hand written notes. + 3. Seeing great offerings from developers in all-new App Store for messages. + 1. There has been a marked increase in monthly active users. + 2. One of the great new features of iOS 10 is Home app, which is making home automation easy to set up and intuitive to use. + 1. Customers can easily setup and securely control all their HomeKit accessories from lights and cameras to garage doors and air conditioners, all from their favorite iOS devices. + 2. Expects over 100 HomeKit compatible products to be on market by end of this year, all reviewed and approved by AAPL to help ensure customer security when using them. + 3. With latest operating systems, machine learning is making products and services smarter, more intuitive and even more personal. + 1. Has been using these technologies for years to create better user experiences. + 2. Has been invested heavily through R&D and acquisitions. + 3. Today, machine learning drives improvements in countless features across products. + 1. It enables proactive features in iOS 10 which offers suggestions on which app one might want to use or which context one might want to include in an email. + 4. Camera and photo software uses advanced face recognition to help one take better pictures and object and scene recognition to make them easier to sort and find. + 5. Machine learning makes fitness features of Apple Watch more accurate; even helps extend battery life across products. + 6. Machine learning continually help Siri get even smarter in areas like understanding natural language. + 1. Extended Siri to work in many new ways by opening it to developers and most recently by making Siri available to Mac users in Mac OS Sierra. + 7. Already seeing great momentum in just first few weeks from developers leveraging Siri and Speech APIs. + 4. Looking ahead, seeing some exciting developments in India. + 1. Reliance Jio is rolling out a first of its kind all-IP network in India with 4G coverage in 18,000 cities and 200,000 villages across the country. + 1. They're offering a free year of service to purchasers of new iPhones; partnering with them to ensure great iPhone performance on their network. + 5. iPhone sales in India up over 50% in FY16 vs. prior year. + 1. Believes Co. is just beginning to scratch service of this large and growing market opportunity. + 6. Progress of enterprise market initiatives continue to expand. + 1. Just last month, announced a partnership with Deloitte to help companies quickly and easily transform the way they work by maximizing power, ease of use and security of iOS platform. + 2. Deloitte is creating a unique [AAPL practice] with over 5,000 strategic advisors focused on helping businesses transform work in functions across the enterprise. + 3. Collaborating on development of Enterprise Next, new Deloitte consulting service designed to help clients across more than 20 industries takes full advantage of iOS ecosystem and quickly develop custom solutions through rapid prototyping. + +-------------------------------------------------------------------------------- +II. 4Q16 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $46.9b. + 1. Towards high end of guidance. + 2. Revenue grew strongly in many emerging markets including Russia, Turkey, Middle East, Thailand and Vietnam. + 3. Continues to see solid growth in Japan and in Latin America. + 2. GM 38%. + 1. At the top of guidance due to favorable cost performance. + 3. Operating margin 25.1% of revenue. + 4. Net income $9b. + 5. Diluted EPS $1.67. + 6. Cash flow from operations $16.1b. + 1. New record for Sept. qtr. + 2. iPhone: + 1. Sold 45.5m iPhones due to successful launch of iPhone 7 and iPhone 7 Plus and continued strong demand for other iPhones, including 2.7m iPhones that were in transit at qtr.-end. + 2. Increased channel inventory by [2.5m units]. + 1. Exited qtr. well below 5-7 week target range of channel inventory. + 3. Experienced strong iPhone from growth in many markets around the world, including Canada, Latin America, Western Europe, Central and Eastern Europe, Middle East, India and South Asia. + 4. Sales in Greater China declined. + 1. Initial customer response to iPhone 7 and 7 plus gives confidence that Dec. qtr. performance in China will be significantly better on a YoverY basis than Sept. qtr. results even as Co. laps all-time record period from a year ago. + 5. Worldwide demand for iPhone 7 and 7 Plus significantly outpaced supply, particularly on iPhone 7 Plus. + 1. Working hard to get new iPhones into hands of customers as quickly as possible. + 6. ASP increased to $619 in Sept. qtr. + 1. Above expectations. + 2. Up from $595 in June qtr. when Co. launched iPhone SE and it had a significant channel inventory reduction. + 3. Expects iPhone ASP to increase markedly on a sequential basis to a level similar to ASP in Dec. qtr. last year. + 7. Customer interest and satisfaction with iPhone remains extremely strong. + 1. In US, latest survey fielded by 451 Research found that among consumers planning to purchase a smartphone within 90 days, 65% plan to purchase iPhone with current iPhone owners reporting a 97% customer satisfaction rate. + 8. Among corporate smartphone buyers, latest survey measures 95% iPhone customer satisfaction rating and found that of those planning to purchase phones in Dec. qtr. 79% plan to purchase iPhone. + 3. Services: + 1. Revenue $6.3b. + 1. All-time record. + 2. Up 24% YoverY. + 2. App Store growth rate has now accelerated for five consecutive quarters reaching 43% in Sept. qtr. + 1. App Store remains preferred destination for customers and developers. + 2. App Annie, it generated 100% more global revenue than Google Play in Sept. qtr. + 3. In addition to great performance from apps, saw strong double-digit revenue growth in several other service categories. + 1. Apple Pay transaction volume has grown dramatically as Tim stated. + 4. Mac: + 1. Sold 4.9m, facing a difficult YoverY compare, given launch of new Macs in spring 2015. + 1. Despite this, Mac installed base reached a new all-time high at end of Sept. qtr. + 2. Ended the qtr. below 4-5 week target range for Mac channel inventory. + 5. iPad: + 1. Flat revenue YoverY. + 2. ASP $459. + 1. $26 higher YoverY with increase driven by new iPad Pro line. + 3. Sold 9.3m iPads. + 4. Reduced channel inventory by about 80,000 units, exiting qtr. below 5-7 week target. + 5. Continues to be highly successful in terms of market share and customer metrics in segments of tablet market, where Co. competes. + 6. Recent data from NPD indicates that iPad gained share in US tablet market in Sept. qtr. + 1. Had 82% share of tablets priced above $200. + 7. In Aug., 451 Research measured 96% consumer satisfaction rate for iPad Mini, 95% rate for iPad Air and 93% rate for iPad Pro. + 8. Among US consumers planning to purchase a tablet within the next six months, 73% plan to purchase an iPad. + 1. More than eight times purchase intention rate of next highest brand measured, with iPad Pro once again the top choice for planned purchases. + 9. Corporate buyers reported 94% satisfaction rate for iPad. + 1. Purchase intent 68% for Dec. qtr. + 10. In enterprise market, seeing some great examples of iPad and Mac deployment. + 11. Mobility partner program continues to grow stronger with over 120 partners around the world, offering tailored solutions to businesses of all sizes. + 12. Revel Systems, a leading iPad point of sale solution partner, recently announced a global agreement which Shell Retail to implement Revel's iPad-based POS system services at 34,000 Shell locations worldwide including support for Apple Pay in countries where Apple Pay is available. + 13. IBM has just released new data on great results of its Mac roll out. + 14. With more employees choosing Mac than ever before, there are now more than 90,000 Macs across the organization in addition to 48,000 iPads and 81,000 iPhones. + 15. IBM reports PCs are three times cost to manage, drive twice the number of support calls and are five times more likely to require a follow-up appointment to resolve an issues than Macs. + 1. Due to much lower support cost and significantly higher residual value, co. saving as much as $535 per computer when comparing the total cost of Mac ownership to a PC over a full year life cycle. + 6. Cash Position: + 1. 4Q16-end cash plus marketable securities $237.6b, sequential increase of $6.1b. + 1. $216b of this flow or 91% of the total was outside the US. + 2. Issued $7b of debt in July, leading Co. with $79b in term debt at qtr.-end. + 3. Returned over $9b to investors during the Sept. qtr. + 1. Paid $3.1b in dividends and equivalents. + 2. Spent $3b on repurchases of 28.6m AAPL shares through open market transactions. + 3. Launched new $3b ASR, resulting in initial delivery and retirement of 22.5m shares. + 4. Completed seventh accelerate share repurchase program, retiring additional 12.3m shares. + 1. Total buyback activity reduced share count by 1.5%. + 5. Has now completed $186b of current $250b capital return, including $133b share repurchases. + 7. Key Details: + 1. During Sept. qtr., completed four acquisitions and incurred $3.6b in CapEx. + 1. Total CapEx for year $12.8b. + 2. Effective tax rate 26%. + 1. Slightly higher than 25.5% guided to because of a different geographic mix of earnings relative to original expectations. + 3. Tax rate for full FY 25.6%. + 8. Dec. Qtr. Outlook: + 1. Revenue $76-78b. + 1. This represents a return to growth over all-time revenue record set in Dec. qtr. a year ago. + 2. GM 38.0-38.5%. + 3. OpEx $6.9-7.0b. + 4. OI&E about $400m. + 5. Tax rate about 26%. + 9. Other Details: + 1. On 10/25/16, Board of Directors has declared cash dividend of $0.57 per share of common stock, payable on 11/10/16 to shareholders of record as of 11/07/16. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +First we'll hear from Gene Munster with Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [2] +-------------------------------------------------------------------------------- +Good afternoon and congratulations. Tim, now that we're a month in the iPhone 7, are you seeing anything measurable in terms of the growing trend of annual upgrades? Second is, historically in terms of new product categories, you have always looked for you unique advantage before getting into a segment. And, I'm curious about the car. There are a lot of rumors out there and would like your perspective on how you think about an advantage that Apple could add in the auto space? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [3] +-------------------------------------------------------------------------------- +In terms of iPhone 7, Gene, the carriers that had upgrade plans, the information that we have from them is that the demand is very robust. But, from a worldwide point of view, the truth is that demand is outstripping supply in the vast majority of places, particularly on the iPhone 7 Plus. And so, it's -- we're in a situation at the moment, it's difficult in the early weeks to be able to differentiate. But, on an anecdotal basis, it's clear the upgrade programs are a win. +I can't speak about rumors, but as you know, we look for ways that we can improve the experience and the customers' experience on different sets of products, and we're always looking at new things. The car space, in general, is an area that it's clear that there's a lot of technologies that will either become available or will be able to revolutionize the car experience. So, it's interesting from that point of view, but certainly nothing to announce today. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [4] +-------------------------------------------------------------------------------- +Just one quick follow-up in terms of the supply. Do you think we'll be at equilibrium by the end of the quarter, for iPhone supply? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [5] +-------------------------------------------------------------------------------- +It's hard to say. I believe that on iPhone 7, we will. On iPhone 7 Plus, I'm not sure. I wouldn't say yes at this point because the underlying demand looks extremely strong on both products, but particularly on the iPhone 7 Plus versus our forecast going into the product launch. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [6] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [7] +-------------------------------------------------------------------------------- +Thanks, Gene. Can we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Thanks. Good afternoon. Luca, can you help us understand what's embedded in revenue guidance for the extra week as well as any rebuilding of channel inventory, given all the major products are running below target. Just trying to get at whether you see revenue, and in particular, iPhone growth year on year on more of a sell-out basis when you adjust for those two factors. And then, I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure. Let me say a few things on the 14th week and revenue outlook for the December quarter. Keep in mind that the December quarter a year ago for us was an all-time quarterly revenue record. +We think we can grow this year. As Tim said, the interest from customers on iPhone 7 and 7 Plus is very strong. The strength of our services business, you've seen we've grown 24% in September. We think we can continue to grow very well into the December quarter. +You mentioned the 14th week and the few extra days do help us this quarter, but I think it's important to keep in mind that there are other factors that go and offset these extra few days. As you know, the launch timing of the new iPhone is different this year. We had the first nine days of sales this year hit Q4. There were only two days last year. So, the cadence has moved more towards Q4 this year versus Q1 last year. As you know, we increased iPhone channel inventory by 3.3 million units in the first quarter of 2016. +As Tim said, we are very supply-constrained on iPhone 7 Plus this year. We are simply more supply-constrained this year than we were a year ago. And then, keep in mind there were a couple of things that affected compare as well, which is the fact that a year ago we had an award for a patent infringement of $548 million which is obviously a one-off item that is not going to repeat this year. And, also, the foreign exchange environment remains difficult, and we expect FX to be about $650 million headwind on a year-over-year basis into the December quarter. +So, I hope that gives you a bit of a sense that when you take into account all these factors, we believe that this is a good guidance for the December quarter. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [11] +-------------------------------------------------------------------------------- +That's great color. Thank you for that. Follow-up for Tim. What should we read into the fact that R&D has more than doubled over the past three years, while sales growth was one-fifth of that. Are R&D investments just less efficient than they were in the Company's history? Or, should we think about that as incremental spend for products that haven't yet come to market? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [12] +-------------------------------------------------------------------------------- +There's clearly some amount of R&D that are on products that today are in the development phase that have not reached the market. And so, that's a part of it. +We feel really great about the things that we've got. We've also put a lot of emphasis on our services business as well and on making the ecosystem even better. And so, we're very much -- we're confidently investing in the future, and that's the reason you see the R&D spend increasing. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [14] +-------------------------------------------------------------------------------- +Thank you, Katy. Could we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +From Cross Research, Shannon Cross. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [16] +-------------------------------------------------------------------------------- +Thank you very much. A couple of questions. The first, Tim, can you talk a bit more about China? Just how you're thinking about it? Where you're seeing pressure? I know you mentioned that you expect to see a significant rebound during the first quarter. But, what are your customers telling you about the demand in China? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [17] +-------------------------------------------------------------------------------- +It's a good question, Shannon. So, to back up from our results for the quarter, the 90-day clock and look at the full year of 2016. We were down 17% compared to the FY15 which was up 84% from the previous year. So, if you look at 2014 to 2016, the revenue grew 52%, and the CAGR was 23% which really are pretty good results. +Also, as you probably know, the FY16 performance was hurt by the devaluation of the currency which affected it about 3%. So, the underlying business performance was 14% down. And so, why was it down? There's lots of reasons, but the largest one in our view is that when you look at what happened in 2015 in China, we had a surge of upgraders that came into the market for the iPhone 6 or iPhone 6 Plus, and the upgrade rate increased relatively more in Greater China than elsewhere around the world. +And so, when that upgrade rate in FY16 returned to a more normal upgrade rate, which would be akin to what we saw with the iPhone 5S [as a point], it had further to fall. So, that's the main reason in our view that you see a difference. +Now, that spun or created another issue for us because we didn't forecast that accurately. So, in Q1 of last year, we put in too much channel inventory and had been resetting the channel inventory over the few quarters that came beyond it or came after it. So, those two issues, which really the main one is really the first one and the second one was a symptom of it, are in our views the main issue. +Now, looking forward, the response to the iPhone 7 and 7 Plus has been very positive. It's very hard to gauge demand, as you know, when you're selling everything you're making. And so, we'll find out more through the quarter, but we're confident enough to give you guidance that we're returning to growth this quarter which obviously feels very good for us. +And, from a longer term point of view, out of the 90-day clocks and so forth, we are very bullish on China. We continue to see a middle class that is booming there. There might be some sort of a new normal in the economy, but a new normal there is still a good growth rate. And so, with the number of middle class -- people growing into the middle class and the LTE adoption rate being still fairly low, around 45%, 50% or so, then I think we continue to have a really good opportunity there. And so, we continue to focus significantly in China. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [18] +-------------------------------------------------------------------------------- +Great. Thank you. And then, can you talk a bit about acquisitions. I don't mean like the smaller ones that you've done at a normal cadence, but there was clearly a fairly large one announced at least this week in the content world. And, especially if you find a way to have [cash] repatriation of some of the cash at a low tax rate possibly with the next administration. So, just if you can give an overall view of how you think about acquisitions that might be a little bit larger than normal? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [19] +-------------------------------------------------------------------------------- +We're open to acquisitions of any size that are of strategic value where we can deliver better products to our customers and innovate more. And so, we look at a whole variety of companies, and based on that, we choose whether to move forward or not. But, we're definitely open, and we definitely look. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [20] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [21] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [22] +-------------------------------------------------------------------------------- +Thank you, Shannon. Could we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +We'll go to Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Sanford C. Bernstein & Co. - Analyst [24] +-------------------------------------------------------------------------------- +Yes, thank you. I have a question and a follow-up, please. I guess a cynic could say Apple is benefiting from an extra week this quarter and is benefiting from Samsung being in complete disarray. And yet, from your guidance, it's unclear that iPhone unit growth will be up or certainly not up more than low single digits implied from your guidance. And, I appreciate some of the issues around channel inventory build and the timing of the launch. +But, if I just stand back from that and say you have terrific new products. Your major competitor is laying down. You have an enormous -- you have a significant contribution from an extra week, arguably, 7% or 8%, and yet the iPhone growth is sort of flattish. What does that really say about how investors should think about iPhone on a sustained basis growing forward? And, is it reasonable to think that this is an ongoing, growing business for the Company? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [25] +-------------------------------------------------------------------------------- +Toni, let me take this one. I think you mentioned a number of the things that are affecting us in the December quarter, and I went through them with Katy just a few minutes ago. +You're right. We've got an extra few days. You know very well the launch timing is different. You know that we increased iPhone channel inventory by 3.3 million units a year ago. I mentioned two issues that affect us, the one-timer from a year ago that you obviously need to exclude from the compare and the FX that is the reality of our business right now. +But, maybe the most important element of this is the fact that we are supply-constrained on 7 and 7 Plus. And so, when you talk about other competitors, it's not particularly relevant to us right now because we are selling everything that we can produce. And so, when we look at all these things in its totality, we think that for the total Company, of course, we believe that revenue is going to grow. You know that we don't get into specific product from a unit standpoint giving guidance. And so, we feel very confident about the trajectory for the Company and for iPhone going forward. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Sanford C. Bernstein & Co. - Analyst [26] +-------------------------------------------------------------------------------- +Tim, if I could ask you one, please. You've talked in the past about television being an area of intense interest. I was wondering if you could reaffirm that statement? Is that still the case? +And then, additionally, given what's happening with acquisitions, how broadly you think about the role of content? Apple has started creating on a very limited scale some of its own content, and whether you think content creation and ownership is important to Apple? Or, whether Apple ultimately sees its place in the value chain as being more around ecosystem and distribution? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [27] +-------------------------------------------------------------------------------- +I would confirm that television has intense interest with me and many other people here. In terms of owning content and creating content, we have started with focusing on some original content as you point out. We've got a few things going there that we talked about. And, I think it's a great opportunity for us, both from a creation point of view and an ownership point of view. And so, it is an area that we're focused on. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [28] +-------------------------------------------------------------------------------- +Thank you, Toni. Could we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +From Goldman Sachs, Simona Jankowski. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- +Thank you. I have a question for Luca, and then one for Tim as well. Luca, I wanted to dig into the services business a bit more. As you pointed out, it accelerated again to 24%. How does that compare to the pace of growth of the installed base, just to help us decouple how much of it is consumption-driven on a per-user basis versus the base as a whole? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [31] +-------------------------------------------------------------------------------- +Simona, the installed base number is something that we talk about periodically. Last time we talked about it was in the January call. It is growing. Our installed base is growing very well which is very important for us. It's growing on all major products, and it's growing, of course, in total. +When you look at our services revenue, the growth of the services revenues has been accelerating during the course of the year. During a period when, as you know, our revenue came down slightly. So, what that means in practice is that what we are seeing with our customers that consume our services is that the people that are actually taking advantage of our services, over time, they tend to spend more and more on our services. +We've got customers who are very engaged with our products. They're very loyal, and so you see this upward trajectory of our services business. It's not only with the App store but several categories that are growing very well for us. Tim mentioned Apple Music, but we've got other parts of the business that continue to do well. Even as I said, during a period of time when our sales have come down a bit. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [32] +-------------------------------------------------------------------------------- +Thank you. And then, Tim, we've seen an increasing focus on artificial intelligence both in smartphones like the new Pixel from Google, but also in some of the home assistants like the Amazon Echo. And, you have obviously had Siri for a while as well. But, I just am curious how you think about balancing AI with your focus on privacy. Also, how important it is to have a dedicated home assistant versus just having the phone as the home assistant? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [33] +-------------------------------------------------------------------------------- +I think that, to answer your second question first, I think that most people would like an assistant with them all the time. And, we live in a mobile society. People are constantly moving from home to work and to other things that they may be doing. And so, the advantage of having an assistant on your phone is it's with you all the time. That doesn't say that there's not a nice market for a home one. I'm not making that point. +I'm just saying on a balanced point of view I think the usage of one on the phone will likely be much greater. In fact, you can just look at Siri today, and this is now accelerating with iOS 10 and the Mac. But, we've been getting 2 billion requests a week for Siri. +And so, it's very large, and to the best of our knowledge, we've shipped more assisted, enabled devices than probably anyone out there. Our focus is on this worldwide. And so, it's not only a US focus, but we want to deliver a great experience around the world and deliver globally. So, we've put a lot of the energy into doing that. +In terms of the balance between privacy and AI, this is a long conversation. But, at a high level, I think it's a false tradeoff that people would like you to believe that you have to give up privacy in order to have AI do something for you. We don't buy that. It may take a different kind of work. It might take more thinking. But, I don't think we should throw our privacy away. +It's like the age-old argument about privacy versus security. We should have both. It shouldn't be making a choice. And so, that at a high level is how we see it. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [34] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [35] +-------------------------------------------------------------------------------- +Thank you, Simona. Could we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +We'll go to Steve Milunovich with UBS. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [37] +-------------------------------------------------------------------------------- +Thank you very much. Luca, I wanted to ask you about the total deferred revenue, which was down about $1.3 billion in June, and down I think another $400 million in September. Those are rather large declines even given the fact that your units are coming down, and you had the accounting change back in September. Could you talk about some of the drivers of that, and what you might expect going forward? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [38] +-------------------------------------------------------------------------------- +Steve, you mentioned by far the largest driver. The largest driver is the fact that we made the change, an accounting change to our ESPs exactly a year ago. So, we are lapping the year where you see the effect. I think you're not going to see the same thing going forward. +And then, we tend to defer some revenue on some other categories like, for example, gift cards or some AppleCare. But, in general, by far the largest element is the change in ESPs. I don't think you're going to see the same impact going forward. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [39] +-------------------------------------------------------------------------------- +Okay. Thank you. And then Tim, some investors are antsy that Apple has not acquired new profit pools or introduced a financially material new product in recent years. The question is, A, does Apple today have a grand strategy for what you want to do? I know you won't tell us what it is. But, do you know what you want to do over the next three to maybe five years? Or, is it more a read the market and quickly react? +B, do you have any sense, we're kind of in a gap period where the technology and arguably what we've called the next job to be done haven't yet aligned? So, maybe in a couple years, we will see this flurry of new products, and it will sort of match what people want to do but it's not quite here yet? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [40] +-------------------------------------------------------------------------------- +We have the strongest pipeline that we've ever had, and we're really confident about the things in it. But, as usual, we're not going to talk about what's in it. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [41] +-------------------------------------------------------------------------------- +But, in terms of your approach, I guess, to new products. Do you have a strong sense of where technology is going? Where you're going to play? Or, is it still enough up in the air that you're willing to react fairly quickly which arguably your organization allows you to do for the size of the Company you are. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [42] +-------------------------------------------------------------------------------- +We have a strong sense of where things go, and we're very agile to shift as we need to. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [43] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [44] +-------------------------------------------------------------------------------- +Thanks, Steve. Can we are have the next question, please. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +From Bank of America, Wamsi Mohan. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch - Analyst [46] +-------------------------------------------------------------------------------- +Thank you. So, Tim and Luca, you saw that you could raise the ASP on the iPhone 7 Plus by $20, and you're completely sold out. So, clearly this device plays a central role in our lives, so much that owners probably look at that incremental cost as a great tradeoff to get the best device out there. +As you see more and more features being added into iPhones, do you conceptually expect that you're anywhere close to the point where raising ASPs further would be net-disruptive to demand? Or, do you see more room to raise ASPs over time as you add incremental features. And, I have a follow-up. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [47] +-------------------------------------------------------------------------------- +With the iPhone 7 Plus, we've put an incredible amount of innovation into the camera and the overall photo experience, and customers are obviously using that and have discovered that they love it. So, we're getting an incredible amount of feedback there. We also get incredible feedback on the iPhone 7. +But, the mix that we projected on an iPhone 7 Plus is short of what the reality is. So, we are chasing supply there. In terms of the ASP, the way we think about it is we want to charge a fair price. And so, we don't want to charge more than that, and we think it's worth being fair. And so, that's how we look at it. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [48] +-------------------------------------------------------------------------------- +If I can add, Wamsi, keep in mind that in a lot of countries around the world the reality is that our customers have seen some significant price increases because of the FX situation, right. And, that's something that we need to keep in mind as well. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch - Analyst [49] +-------------------------------------------------------------------------------- +Great. Thanks for the clarification. And, Tim, this year, we saw carrier incentives come back to force, post the launch of the iPhone 7, 7 Plus. Two years ago, there was a giant upgrade cycle from the iPhone 6, 6 Plus. +Do you think every couple of years we are likely to see carrier incentives come back into play given worries around customer churn? Thereby, making the phone even more affordable? Thanks. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [50] +-------------------------------------------------------------------------------- +We clearly saw that this year. There's a lot of competition for customers in the US which I think is the market that you're talking about. Whether that will happen every two years, I don't know. But, I suspect that any time there are large numbers of customers that have a phone that's in that two-year kind of range that it tends to be a sweet spot, and I think you probably will see a lot of people trying to recruit those customers. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch - Analyst [51] +-------------------------------------------------------------------------------- +Thanks, Tim. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [52] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [53] +-------------------------------------------------------------------------------- +Thank you. Can we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- +Jim Suva with Citi. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [55] +-------------------------------------------------------------------------------- +Thank you very much. A strategy question for Tim and then more of a financial question for Luca. Tim, you had mentioned in your prepared comments a little bit about India, and we've been doing a lot of work talking about the opportunities in India. And, we get a lot of pushback talking about disposable income metrics and lots of things like that, yet the population being so large. +Can you talk a little about, do you see that India could at some point be as [big] of an opportunity as China, and it appears that the legal rules have prevented you from going in a lot. But, it looks like that's changing. Can you give us a little more clarity on India? +And then, Tim, for the clarification questions. Is it fair to say that the OpEx has a disproportionate more expense side with the 14th week that we should think of maybe as we go forward, that we shouldn't expect the OpEx to be chugging along at that high rate? Or, is it just kind of the rate of investing that you're going? Thank you very much, gentlemen. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [56] +-------------------------------------------------------------------------------- +Thanks for the question. I'll let Luca talk about the OpEx piece of it. On India, I think it's important to look not only at per-capita income, which may be what you're looking at, but sort of look at the number of people that are or will move into the middle class over the next decade. And, the age of the population, if you look at India, almost 50% of the population is under 25. So, you have a very, very young population. The smartphone has not done as well in India in general. +However, one of the key reasons for that is the infrastructure hasn't been there. But, this year, or this year and next year, there are enormous investments going in on 4G, and we couldn't be more excited about that because it really takes a great network working with iPhones to produce that great experience for people. +And so, I see a lot of the factors moving in the right direction there. I also think the government is much more focused on the infrastructure and on creating jobs, which is fantastic, because you really need the infrastructure and the technology to do that. +Will it be as big as China? I think it's clear that the population of India will exceed China sometime in the -- probably the next decade or so, maybe less than that. I think it will take longer for the GDP to rival it. +But, that's not critical for us to have a great success there. The truth is, there's going to be a lot of people there and a lot of people in the middle class that will really want a smartphone. And, I think we can compete well for some percentage of those. And, given our starting point, even though we've been growing a lot, there's a lot of headroom there in our mind. And so, we're working very hard to realize that opportunity. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [57] +-------------------------------------------------------------------------------- +And, Jim, on OpEx, our approach to OpEx is quite clear and quite simple. We want to continue to invest in the business in all the areas where we think it's critical for us to invest. +So, you see that we make significant investments in R&D. You've seen the growth rates over the last couple of years. We are making important investments in data centers because we want to support our services business. We continue to open retail stores around the world. We continue to invest in marketing and advertising. +At the same time, we want to continue to be efficient and lean. It's something that we've done very well over the years. We want to continue to do that. So, what you've seen, for example, in FY16, you've seen investments in R&D growing at 25% and then our SG&A expenses to be about flat. This is kind of the approach that we want to take and continue to take going forward. +If you step back for a second and you look at our implied guidance for the December quarter, we've got an expense-to-revenue ratio of 9%. This is extremely competitive in our industry, and I would I say in general. So, we want to continue to have this balance. Make the right investments and remain efficient. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [58] +-------------------------------------------------------------------------------- +Thank you and congratulations, and thanks for the details, gentlemen. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [59] +-------------------------------------------------------------------------------- +Thank you, Jim. Can we have the next question, please. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +We'll go to Rod Hall with JPMorgan. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [61] +-------------------------------------------------------------------------------- +Hi. Thanks for the question. I had one for Luca and then a follow-up for Tim. So, Luca, I wanted to ask about the gross margin guidance? I think that the Street and we were expecting something a little bit higher, and I guess that's about 50 basis points lower. The Street -- it was 70 basis points lower. I'm just curious, do you think that people are mis-modeling that? Or, is there something going on with pricing or mix there that you could provide us more color on? That's my first question. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [62] +-------------------------------------------------------------------------------- +Rod, let me give you some details both on a sequential basis, and I'll give you also something on a year-over-year basis because maybe that's where the disconnect comes from looking at last year's gross margins in the December quarter. +On a sequential basis, we're essentially guiding to some improvement in gross margins. We had 38% both in the June quarter and in the September quarter. We're guiding slightly higher for the December quarter because on the positive we're going to have, of course, better leverage and the mix in the December quarter tends to be better. But, we need to keep into account the fact that these positives are going to be partially offset by the cost structures of the new products that we are launching now, and we launched already a few during the September quarter and that will have an impact on our December-quarter results. +On a year-over-year basis, keep in mind that last year we did in Q1 we did 40%, around 40%, 41%. But, there's a couple of things that I think need to be considered before doing a year-over-year compare. And, it's a fact that last year we had this award for a patent infringement of $548 million that is at the gross margin level is 40 Bps. +And then, we've got the FX situation which I mentioned before which is worth another 60, 70 Bps. And so, you're left with less than 100 basis points deterioration on a year-over-year basis where, again, we have the reality of new cost structures into our products. +It is very, very important, I think, for investors to understand that what's happened during the last two years. During the last two years the US dollar has appreciated by 15% over the basket of currencies where we do business. And, we are a Company that generates two-thirds of our revenues outside the United States. 15% appreciation of the US dollar. So, on a year-over-year basis, just 2016 over 2015, was 340 Bps impact from foreign exchange. +This is something that we have offset almost entirely through a number of initiatives going from pricing actions to cost initiatives to our hedging program. But, at some point, the strong dollar becomes the new normal, and we need to work with that. And, I think over the years, we have made very good tradeoffs, and our gross margins have been quite stable over time. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [63] +-------------------------------------------------------------------------------- +Okay. Great. Thanks, Luca. And then, Tim, I wanted to ask you, this question comes up once in a while. But, I just wanted to ask you if you could talk to us a little bit about the arguments on both sides of the dividend question. +Apple seems to be perpetually undervalued. It's a very large Company. It is getting harder and harder to grow. Your payout ratio is significantly below the S&P 500. I know you can't tell us what your intentions are here, but if you could help us understand how that thinking around the dividend works it would be great. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [64] +-------------------------------------------------------------------------------- +We review the capital return annually, and we've established a cadence now to announce our thinking on that every April. So, we have a robust discussion around the dividend and the buyback. +We very much believe that Apple is very undervalued, and so we're investing with confidence in the Company that we know really well. And so, that thinking has I think proven out over time, and I think been very good for our shareholders. And, in addition to that, we know that some shareholders really like a dividend and some ongoing income, and so we provided an amount that we think is a good amount and have a good track record of raising it annually. And so, we'll be able to say more on that I'm sure in April of next year. + +-------------------------------------------------------------------------------- +Rod Hall, JPMorgan - Analyst [65] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [66] +-------------------------------------------------------------------------------- +A replay of today's call will be available for two weeks as a podcast on the iTunes store, as a webcast on www.apple.com/investor, and by telephone. The numbers for the telephone replay are 888-203-1112 or 719-457-0820. Use our confirmation code 2017273. These replays will be available by approximately 5 PM Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at 408-974-2414, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570, and I'm at 408-974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- +That does conclude today's presentation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2017-Aug-01-AAPL.txt b/Transcripts/AAPL/2017-Aug-01-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..b042723eef20dabe47b9b7effb00c30c1f7235ba --- /dev/null +++ b/Transcripts/AAPL/2017-Aug-01-AAPL.txt @@ -0,0 +1,504 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q3 2017 Apple Inc Earnings Call +AUGUST 01, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - Senior VP & CFO + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Amit Jawaharlaz Daryanani + RBC Capital Markets, LLC, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal and Analyst + * Kulbinder S. Garcha + Crédit Suisse AG, Research Division - MD + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Brian John White + Drexel Hamilton, LLC, Research Division - Global Head of Technology Hardware and Software, and Senior Equity Research Analyst + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD and Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 3Q17 revenue of $45.4b, net income of $8.7b and diluted EPS of $1.67. Expects 4Q17 revenues to be $49-52b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 3Q17 revenue = $45.4b. + 2. 3Q17 net income = $8.7b. + 3. 3Q17 diluted EPS = $1.67. + 4. 3Q17 YoverY revenue growth = 7%. + 5. 3Q17 GM = 38.5%. + 6. 3Q17-end cash plus marketable securities = $261.5b. + 7. 3Q17 share repurchase = 30.4m AAPL shares for $4.5b. + 8. 4Q17 revenue guidance = $49-52b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 3Q17 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Unit and revenue grew in all product categories. + 2. June Worldwide Developers Conference (WWDC) was biggest and best ever. + 3. Total revenue $45.4b. + 1. At high-end of guidance range. + 2. Up 7% YoverY. + 3. Growth rate has accelerated in three successive quarters this FY. + 4. GM was at high-end of guidance. + 5. EPS grew 17%. + 2. iPhone: + 1. Results were impressive with especially strong demand at high-end of lineup. + 2. iPhone 7 was most popular iPhone. + 3. iPhone 7 Plus sales up dramatically vs. 6s Plus in 3Q16. + 4. Combined iPhone 7 and 7 Plus family was up strong double digits YoverY. + 5. One decade after initial iPhone launch, now surpassed 1.2b cumulative iPhones sold. + 3. Services: + 1. Revenue $7.3b; all-time quarterly record. + 1. Grew 22% YoverY. + 2. Seeing great performance worldwide, with double-digit growth in each geographic segments. + 3. Over last 12 months, Services business has become the size of a Fortune 100 co. + 1. Milestone Co. has reached even sooner than expected. + 4. iPad: + 1. Has positive results with broad-based growth in units, revenue and market share. + 2. Sales up 15% YoverY and grew across all geographic segments. + 3. Achieved highest global market share in over four years, based on IDC's latest estimate of tablet market results for June qtr. + 4. In markets like China and Japan, over half of iPads sold were to people buying their first iPad. + 5. Product lineup is stronger than ever. + 6. Launched new iPad in March. + 7. All-new 10.5-inch iPad Pro launched in June features world's most advanced display with ProMotion technology and is more powerful than most PC desktops. + 8. Perfect tool for teaching new and compelling ways. + 1. iPad results were especially strong in US education market, where sales up 32% YoverY to over 1m units. + 2. Over 1.2m students of all ages are now using iPad and Swift Playgrounds to learn fundamentals of coding and over 1,000 K-12 Schools across US plan to use Co.'s Everyone Can Code in their curricula this fall. + 3. For high school and community college students, who want to pursue careers in fast-growing app economy, Co. announced App Development with Swift, innovative full-year curriculum designed by AAPL engineers and educators, and provided free to schools to teach students to code and design fully functional apps, gaining critical job skills in software development and IT. + 5. Mac: + 1. Gained global unit market share. + 2. Reached new June qtr. unit sales records in mainland China and Japan. + 3. Revenue grew 7% YoverY, driven by strength of MacBook Pro and iMac, despite IDC's latest estimate of 4% unit contraction in global PC market. + 4. With refresh of almost Co.'s entire Mac lineup in June, off to great start for back-to-school season. + 6. Apple Watch: + 1. Sales up over 50%. + 2. Number 1 selling smartwatch in the world by a wide margin. + 3. With features like built-in GPS and waterproofing, Apple Watch Series 2 is perfect companion for hiking, running and swimming. + 7. AirPods: + 1. Customer satisfaction based on Creative Strategies survey, 98%. + 2. Increased production capacity and working hard to get them to customers as quickly as Co. can. + 1. Still not able to meet strong level of demand. + 8. Recent Announcements: + 1. Launched new investment in future through Advanced Manufacturing Fund. + 1. Earmarked at least $1b for this program, aimed at helping manufacturing partners develop innovative production capabilities and create high school jobs in US. + 1. Believes this can lay foundation for new era of technology-driven manufacturing in US. + 2. First $200m from the fund has been committed to Corning to support R&D, capital equipment needs and state-of-the-art glass processing. + 2. In fall, has advances in iOS 11, Mac OS High Sierra and watchOS 4. + 1. iOS 11 will make iPhone better-than-ever with Apple Pay peer-to-peer payments and even more intelligent and natural Siri, new expressive messages with full screen effects, richer and more powerful maps, enhanced live photos, memories and portrait mode effects, and much more. + 2. iOS 11 will take iPad experience to a whole new level, with features like customizable dock, multi-touch drag and drop, powerful new multitasking, more efficient QuickType, great new markup and scanning capabilities. + 3. In WWDC, introduced ARKit. + 1. New set of tools for developers to create augmented reality apps. + 2. With hundreds of millions of people actively using iPhone and iPad today, iOS will become the world's biggest augmented reality probe platform as soon as iOS 11 ships. + 4. With iOS 11, bringing power of machine learning to all Co. developers with Core ML, enabling capabilities like face detection, object tracking and natural language interpretation. + 1. Core ML lets developers incorporate machine learning technologies into their apps with all processing done on device, so it respects customers' data and privacy. + 5. Mac: + 1. Provided a peek at immersive gaming 3D and virtual reality experiences made possible with upcoming release of macOS High Sierra and powerful new iMac Pro. + 6. Apple Watch: + 1. Will become more intelligent than ever this fall with watchOS 4 featuring proactive Siri watch face, personalize activity coaching and entirely new music experience. + 2. WatchOS 4 introduces GymKit, groundbreaking technology platform to connect workouts with cardio equipment. + 7. HomePod: + 1. Previewed breakthrough wireless speaker for home that delivers amazing audio quality and uses spatial awareness to sense its location in the room and adjust audio automatically. + 2. Designed to work with Apple Music subscriptions. + 3. Intelligent home assistant. + 4. Great way to send messages, set timer, get updates on news, sports and weather, or control [smart HomeKit devices by simply asking Siri to turn on lights, close shades or activate a theme]. + +-------------------------------------------------------------------------------- +II. 3Q17 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $45.4b. + 1. Up 7% YoverY; acceleration to growth rate Co. reported during 1H17. + 2. Achieved this result despite 200 BP negative impact from FX YoverY, as currency movements, especially in Europe and China, affected reported results. + 3. Performance was strong across Board, with growth in all product categories and almost every market globally. + 4. Achieved double-digit revenue growth in many developed markets, including US, Canada, Germany, Spain, Australia and Korea, and emerging markets outside of Greater China grew 19% YoverY. + 2. GM 38.5%. + 1. At high-end of guidance range. + 3. Operating margin 23.7% of revenue. + 4. Net income $8.7b. + 5. Diluted EPS $1.67. + 1. Up 17% YoverY. + 6. Cash flow from operations $8.4b. + 2. iPhone: + 1. Sold 41m. + 1. Reduced iPhone channel inventory by 3.3m units, leaving Co. with lowest level of channel inventory in 2.5 years and well within 5-7 week target inventory range. + 2. Sales up YoverY in most markets Co. tracks, with many markets in Asia, Latin America and Middle East growing unit sales by more than 25%. + 3. Pleased with iPhone results, especially considering tough comparison to 3Q16 when Co. launched iPhone SE. + 2. ASP $606. + 1. Up from 3Q16's $595, due to strong demand for iPhone 7 Plus, which represented higher percentage of iPhone mix vs. Plus model a year ago. + 2. Impact of stronger mix on ASP was partially offset by negative FX YoverY and reduction in channel inventory, which took place entirely at high-end of portfolio. + 3. Customer interest and satisfaction with iPhone are strong with consumers and business users. + 1. In US, latest data from 451 Research on consumers indicates 95% customer satisfaction rating for iPhone 7 and 99% for iPhone 7 Plus. + 1. Among consumers planning to buy a smartphone, purchase intention for iPhone was nearly three times the rate of closest competitor. + 2. Among corporate smartphone buyers, iOS customer satisfaction was 94%. + 1. Of those planning to purchase smartphones in Sept. qtr., 78% plan to purchase iPhone. + 3. Services: + 1. Set all-time quarterly record of $7.3b. + 1. Up 22% YoverY. + 2. App Store was major driver of this performance. + 3. According to App Annie's latest report, it continues to be by a wide margin, preferred destination for customer purchases, generating nearly twice the revenue of Google Play. + 2. Revenue from Apple Music streaming service and from iCloud storage grew strongly. + 3. Across all Services offerings, number of paid subscriptions reached over 185m; up almost 20m in last 90 days alone. + 4. Apple Pay: + 1. Reach, usage and functionality of Apple Pay continue to grow. + 2. Launched in Italy in May. + 3. UAE, Denmark, Finland and Sweden are scheduled to go live before this calendar year end. + 4. By far the Number 1 NFC payment service on mobile devices, with nearly 90% of all transactions globally. + 1. Momentum is strongest in international markets, where infrastructure for mobile payments has developed faster than in US. + 2. Three out of four Apple Pay transactions happen outside US. + 5. With launch of iOS 11 this fall, users in US will be able to make and receive person-to-person payments quickly, easily and securely. + 4. Mac: + 1. Due to great performance from new MacBook Pro, generated 7% revenue growth YoverY and gained share in global PC market based on latest data from IDC. + 2. Customer satisfaction is strong at 97% in most recent survey from 451 Research. + 3. Active installed base has grown double digits YoverY. + 4. Ended 3Q17 within 4-5 week target range for channel inventory. + 5. Has great lineup of Macs for customers heading into busy back-to-school season. + 5. iPad: + 1. Sold 11.4m units. + 1. Up 15% YoverY. + 2. Grew in each geographic segment, with strong double-digit increases in key markets like US, Japan, Germany, France and Greater China. + 3. Exited 3Q17 within 5-7 week target range for channel inventory. + 4. NPD indicates that iPad had 55% share of US tablet market in June, including eight of 10 best-selling tablets. + 1. Up from 46% share a year ago. + 2. Among tablets priced over $200, iPad's share was 89%. + 5. Most recent survey from 451 Research measured business and consumer satisfaction rates ranging 95-99% across iPad models. + 1. Among those planning to buy tablets, purchase intent for iPad was over 70%. + 6. Enterprise business continues to expand. + 1. Customers are transforming the way work gets done with iOS and iPad. + 2. Walmart will be deploying more than 19,000 iPads for employee training across 50 states with projections of over 225,000 associates trained on iPad by year-end. + 7. Initial response from businesses to iOS 11 and new iPad Pro has been amazing. + 1. Companies, including Bank of America, Medtronic and Panera, will be rolling out 10.5-inch iPad Pro throughout key areas of their organizations. + 8. Seeing real traction with enterprise partners. + 1. Last month, unveiled next set of technology enhancements in partnership with Cisco. + 2. New way adds whole new category of security features designed to help enterprises and employees defend growing cyber threats. + 3. Believes this investment in joint security solutions for iOS will make cyber insurance even more attainable for businesses. + 9. SAP is making great strides since launching SAP cloud platform SDK for iOS in March with pipeline of hundreds of global opportunities. + 1. SAP released SuccessFactors mobile, its first native iOS app for human resources, which will support 47m iPhone and iPad users worldwide across multiple industries. + 10. Partnership with Deloitte has recently expanded to several more European countries. + 1. Helping clients transform their businesses with iOS. + 2. Jointly develops programs like Connected Store, pop up version of retail environment, demonstrating iOS tools for sales and demand generation, and tailored apps for sales associates, store management and customers. + 11. iPad in education up 32% YoverY. + 1. Following launch of new iPad in March and update to Classroom app, and continued enhancements to iOS, make managing iPads in classroom even easier. + 2. Saint Paul Public School District in Minnesota is renewing its One to One program by deploying over 40,000 iPads across every student and teacher in the district. + 3. Shawnee Mission School District outside Kansas City recently purchased 19,000 iPads, extending its One to One program started in 2014 due to iPad's intuitive interface, superior reliability and expansive ecosystem of iOS tools for education. + 6. Retail & Online Stores: + 1. Collectively welcomed over 300m visitors. + 2. Opened first stores in Singapore and Taiwan. + 1. Expanded total store footprint to 497 stores. + 3. In May, kicked off Today at Apple. + 1. Stores collectively hosted 87,000 sessions during qtr. + 4. Entered new chapter in retail with unique and rewarding experience for customers and some stunning new stores coming in near future. + 7. Cash: + 1. 3Q17-end cash plus marketable securities $261.5b. + 1. Increased $4.7b sequentially. + 2. $246b of this cash, 94% of total, was outside US. + 2. Retired $3.5b of debt. + 1. Issued equivalent of $10.8b in new euro and US dollar denominated debt, including second green bond. + 1. Term debt $96.4b. + 2. Commercial paper outstanding $12b. + 3. Returned $11.7b to investors. + 4. Paid $3.4b in dividends and equivalents. + 5. Spent $4.5b on repurchases of 30.4m Co. shares through open market transactions. + 6. Launched new $3b ASR program, resulting in initial delivery and retirement of 15.6m shares. + 1. Retired 3.4m shares upon completion of 10th ASR. + 7. Now completed $222.9b of $300b capital return program, including $158.5b in share repurchases. + 8. 4Q17 Outlook: + 1. Revenue $49-52b. + 2. GM 37.5-38.0%. + 3. OpEx $6.7-6.8b. + 4. OI&E about $500m. + 5. Tax rate about 25.5%. + 9. Dividends: + 1. On 08/01/17, Board of Directors declared cash dividend of $0.63 per share of common stock payable on 08/17/17 to shareholders of record as of 08/14/17. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + And that question will come from Katy Huberty of Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + Luca, first question for you. Gross margin guidance is strong, but it did tick down from your June quarter guidance. And you also narrowed the range to 50 basis points. I wonder if you could just address, what is the driver of the sequential downtick, and what gives you confidence that you have more visibility than you did 3 months ago? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Katy, sequentially from 38.5% that we just reported, typically, we have product transition costs during the September quarter. That's the primary driver. This happens fairly regularly for us. We also have a more difficult memory pricing environment this year than a year ago. And we think that we're going to be able to partially offset this with a positive leverage. As you've seen, we've guided up sequentially in revenue. So those are the major puts and takes. In terms of the range that we use for gross margins, we have a fairly good understanding on where we are with our hedging program, and that allows us to mitigate some of the volatility there. So we felt we could guide to a slightly narrowed range, which we've done occasionally in the past. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- + + And maybe a question for both Tim and Luca. As you outlined on this call and at the developer conference in June, there is an unprecedented number of products that either ramped to volume or launched in the back half of this year. So appreciating you only formally guide a quarter out, I wonder if there's any qualitative commentary you can provide to help us think about the back half of this calendar year and how all those new products that come into the model could impact either revenue seasonality versus past years or could impact just the costs associated with ramping that many products all at once. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + Katy, as Luca mentioned, we did assume some transitional costs in our guidance for the quarter as is typically the case. And we're looking very much forward to the product rollouts. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + We'll go to Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [7] +-------------------------------------------------------------------------------- + + Tim, could you talk a bit about what you're seeing in China? I think obviously, there's -- continues to be strong demand for smartphones but perhaps mix shift, I think you brought back the iPhone 6 this quarter to be a bit more price aggressive. And then can you just talk a bit about how you see that market developing with the growth of WeChat and some of the other developments that are happening there? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + Yes. Thanks, Shannon. We were very encouraged by the results this quarter. We improved, as we thought we would, from the previous quarters a little more than I thought we would. If you look underneath the numbers, Mainland China was actually flat year-over-year during Q3. And in constant-currency terms, we were actually up 6% in Mainland China. And so we're very encouraged by that. iPad grew dramatically more than the market. The Mac grew much more than the market. iPhone was relatively flat year-on-year as the same sort of -- similar as the market was. And so we see all of those as very encouraging signs. On top of that, Services grew extremely strongly during the quarter. The -- Hong Kong continued to drag down the total Greater China segment. And -- but on a sequential basis, we're probably sort of at the trough of that, which is nice. With the peg to the dollar there, from a currency point of view and tourism being what it is, I don't really know when that market will come back. But what I -- what we see in the mainland is definitely much more encouraging. It's interesting to note that upgraders through -- both for the quarter and actually for the full fiscal year to date was our highest ever. And so that we felt very good about. In terms of WeChat, the way that I look at this is because our share -- because iOS share is not nearly a majority of the market in China, the fact that a lot of people use that, it makes the switching opportunity even greater. And I think that's more the case than the risk that a lot of folks have pointed out. And so I see Tencent as one of our biggest and best developers. They've done a great job of implementing a lot of iOS features in their apps. And we're looking forward to working with them even more to build even greater experiences for our mutual users in China. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [9] +-------------------------------------------------------------------------------- + + Great. And then can you talk a bit about the composition of the installed base of iPhones at this point as obviously, we're getting close to a refresh? Just you brought in the iPhone SE. You've obviously had strength at the high end. I'm just trying to think about like what percent do you think have upgraded in the prior generation? Any color you can give us on that? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- + + The -- from an absolute quantity point of view, the upgrades for this fiscal year are the highest that we've seen and so we feel good about that. However, if you look at it from an upgrade rate point of view instead of the absolute number, the rate is similar to what we saw with the previous iPhones, except for iPhone 6, which as we've called out in the past, had an abnormally high upgrade rate. We do think that based on the amount of rumors and the volume of them, that there's some pause in our current numbers. And so where that affects us in the short term, even though we had great results, it probably bodes well later on. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Steve Milunovich of UBS. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [12] +-------------------------------------------------------------------------------- + + I wonder if you wanted to make any comments about switching this quarter. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [13] +-------------------------------------------------------------------------------- + + Sure. Switching outside of China was up year-on-year and so we're happy with that. We continue to see people moving over to iOS, and it helped with us making the results that Luca announced earlier, including the channel inventory reduction. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And then a government question. First of all, the President suggested that you may build 3 big beautiful plants. I wonder if you'd comment on if that's a possibility, either directly or indirectly. And then in China, I think we all understand that you have to work within the regulations, but maybe you could comment a bit on how you feel your working relationship is with the government and if there's certain lines that you can't cross. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + Sure. Starting with the U.S. -- and let me just take this question from what are we doing to increase jobs, which I think is probably where it's rooted. There's -- we've created 2 million jobs in the U.S. and we're incredibly proud of that. We do view that we have a responsibility in the U.S. to increase economic activity, including increasing jobs because Apple could have only been created here. And so as we look at that 2 million, there are 3 main categories of that, and we have actions going on in each of them to further build on that momentum. The first category is app development, about 3/4 of the 2 million are app developers. And we're doing an enormous amount of things to deliver curriculum to both K-12 with Swift Playgrounds and the K-6 area; other curriculum, as you proceed beyond Grade 6, under the Everyone Can Code area. And just a couple of months ago, we announced a new curriculum that's focused on community schools and community colleges, junior colleges, technical colleges for kids that did not have coding in their elementary and high school years. And so we're excited about that because we think it could increase the diversity of the developer community and the quantity. And I think this area, in general and all the things we do for the developer community, will be the largest contribution that Apple can make because this is the fastest-growing job segment in the country, and I think will be for quite some time. If you look at the second area, it's -- we have purchased or we purchased last year about $50 billion worth of goods and services from U.S.-based suppliers. Some significant portion of those are manufacturing-related, and so we've asked ourselves, what can we do to increase this? And you may have seen that at the beginning of the quarter, sometime in April, I believe, we announced a fund, an advanced manufacturing fund that we're initially placing $1 billion in. And we've already deployed $200 million of that. And the first recipient is Corning in Kentucky and they'll be using that money to expand the plant to make very innovative glass. And we purchase that glass and essentially export it to the world with iPhones and iPads. We think there's more of these that we can do. I think there's probably several plants that can benefit from having some investment to grow or expand or even maybe set up shop in the U.S. for the first time. So we're very excited about that. And then the third area is we have about 2/3 or so of our total employee base is in the U.S. despite only 1/3 of our revenues being here. And we'll have some things that we'll say about that later in the year. And so that's what we're doing from a job growth point of view and we're very, very proud of that. If you -- now turning to China. Let me sort of comment on what I assumed is at the root of your question about this VPN kind of issue. Let me just address that head on. The central government in China, back in 2015, started tightening the regulations associated with VPN apps. And we have a number of those on our store. The -- essentially, as a requirement to -- for someone to operate a VPN, they have to have a license from the government there. Earlier this year, they began a renewed effort to enforce that policy, and we were required by the government to remove some of the VPN apps from the App Store that don't meet these new regulations. We understand that those same requirements are on other app stores, and as we checked through that, that is the case. Today, there's actually still hundreds of VPN apps on the App Store, including hundreds by developers that are outside China. And so there continues to be VPN apps available. We would obviously rather not remove the apps, but we -- like we do in other countries, we follow the law wherever we do business. And we strongly believe that participating in markets and bringing benefits to customers is in the best interest of the folks there and in other countries as well. And so we believe in engaging with governments even when we disagree. And in this particular case, now back to commenting on this one, we're hopeful that over time, the restrictions that we're seeing are loosened because innovation really requires freedom to collaborate and communicate. And I know that, that is a major focus there. And so that's sort of what we're seeing from that point of view. Some folks have tried to link it to the U.S. situation last year and they're very different. In the case of the U.S., the law in the U.S. supported us. It was very clear. In the case of China, the law is also very clear there. And like we would if the U.S. changed the law here, we'd have to abide by them in both cases. That doesn't mean that we don't state our point of view in the appropriate way; we always do that. And so hopefully, that's a little bit probably more than you wanted to know but I wanted to tell you. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + We'll hear from Kulbinder Garcha with Credit Suisse. + +-------------------------------------------------------------------------------- +Kulbinder S. Garcha, Crédit Suisse AG, Research Division - MD [17] +-------------------------------------------------------------------------------- + + A question for Tim maybe on the iPhone installed base. At various points in the past, you've told us the rate at which that was growing. At the end of the first half, what is that up year-on-year? What rate is it growing? Could you give us some sense of that? And on upgrade rates over the longer term, there's lots of moving parts and I get that there's, I guess, geographic mix shift on your base. There's any new phones that you may or may not bring out and how carriers promote your products. But do you think this rate of upgrade is sustainable? Do you think it gets faster over time? How should we think about the major drivers as you foresee see for it? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [18] +-------------------------------------------------------------------------------- + + I think the upgrade rate is a function of many, many different things, from the size of the installed base, the age of the installed base, the product that is new at the time, the regional distribution, the upgrade plans that are in various markets around the world. And so I think there's many, many factors in that it's not a simple thing that you can apply a set formula to -- or one variable or a couple of variable formula, in my opinion. And -- but I think in general, because our installed base is -- was up strong double digit once again, there's a lot of factors that are very positive for us. And between the upgraders and the switchers that we see and still -- the first-time buyer category is still out here, too, in several countries, including some that you may not think there is, there is still sizable base in some. Between those 3 areas, I think we have a lot of opportunity. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + I have one for Luca and one for Tim, please. Luca, typically, in the fiscal Q4, Apple builds considerable iPhone channel inventory like 2 million or 3 million units. You're starting from a very low point at the end of fiscal Q3 as you mentioned on the call with the drawdown. As we think about what's embedded in your guidance for fiscal Q4 for channel inventory for iPhone, should we be expecting a sort of normal seasonal build? Or is it likely to be significantly higher, given the very low starting point? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + As you know, Toni, we do not guide on channel inventory. We've never done that. We are providing a fairly wide range from a revenue standpoint, so obviously, that also has an impact on potential channel inventory levels. One thing that I would tell you is that we feel very good about the performance of the business right now. We think that our Services business will continue to grow well. We've got a lot of momentum on iPad and Mac because we refreshed the lineups of those products. Watch and AirPods are doing incredibly well. We're getting a lot of positive customer feedback. And I think in general, even the performance in China, Tim has mentioned it, we think that the performance will continue to improve. So those are the drivers of our guidance range for the quarter. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Tim, I was wondering if you could maybe talk a little bit about 2 things that you mentioned in public before. One is television, which you have described as an area of intense interest. But I don't even think there was an update on Apple TV on this call, so perhaps you can talk to us about how you're thinking about content. I know you're doing some original content creation and how that area is evolving and your thinking. And then recently, you talked about how Apple is focusing on autonomous systems for automobiles. And there's been press reports that Apple's been testing autonomous vehicles for potentially up to a year. I was wondering if you could talk a little bit more about Apple's interest in autonomous vehicles and whether self-driving is really likely to be Apple's principal focus in the near to medium term. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [23] +-------------------------------------------------------------------------------- + + On the first part of your question about original content, we have done some original content. It's focused on Apple Music. Currently, we have some more that's launching in a week or so that will be made available on Apple Music. The objective of this is really twofold. The one is for our own learning, given that we're new in the video space in terms of creation; and two is to give the Apple Music subscribers some exclusive content and hopefully grow our subscriber base. And we've recently hired 2 great folks with lots of experience in creating content like Breaking Bad and The Crown and some really top-notch content. And so we'll see how this area goes, but it's still an area of great interest. In terms of autonomous systems, what we've said is that we are very focused on autonomous systems from a core technology point of view. We do have a large project going and are making a big investment in this. From our point of view, autonomy is sort of the mother of all AI projects. And the autonomous systems can be used in a variety of ways, and a vehicle is only one, but there are many different areas of it. And I don't want to go any further with that. But thank you for the question. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + That comes from Mike Olson with Piper Jaffray. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [25] +-------------------------------------------------------------------------------- + + I just have one question for Tim. This may be a hard question to answer in a condensed way, but how would you describe what you expect the most near-term applications will be for developers to target using ARKit? Will it be consumer iPhone and iPad applications, enterprise applications or I guess some combination of the 2? And basically, how does this come to market in the most significant way in the next few quarters as Apple becomes the largest global platform for AR as you talked about? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [26] +-------------------------------------------------------------------------------- + + Mike, that is a great question. Since we -- and I could not be more excited about AR and what we're seeing with ARKit and the early going. And to answer a question about what category it starts in, just take a look at what's already on the web in terms of what people are doing and it is all over the place. From entertainment to gaming, I've seen what I would call more small business solutions. I've seen consumer solutions. I've seen enterprise solutions. I think AR is big and profound. And this is one of those huge things that we'll look back at and marvel on the start of it. So I think that customers are going to see it in a variety of ways. Enterprise, it takes a little longer sometimes to get going, but I can already tell you, there's lots of excitement in there, and I think we'll start to see some applications there as well. And it feels great to get this thing going at a level that can sort of get all of the developers behind it. So I couldn't be more excited about it. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + We'll go to Amit Daryanani. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [28] +-------------------------------------------------------------------------------- + + I guess to start off with, on your Services segment, your revenues actually, I think, accelerated by [400] basis points to worse than what you guys had in the first half this year. Could you just help us understand what's driving this? Is there a way to think about ARPU in the traditional manner within that Services business versus the installed base growing? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + Amit, Luca. Our Services business is very broad. We got multiple categories in the Services business, so it's difficult to talk about ARPU in general. It doesn't make a lot of sense. The reason for the acceleration also here is multiple factors. One that is very, very important for us is the fact that the App Store, which is the largest of our Services categories, is seeing an increasingly larger amount of paying accounts. On a year-over-year basis, the number of accounts that are actually transacting and paying on the App Store is growing very, very well. It is happening for a variety of reasons. One of them, for example, is the fact that we are making it easier for customers to pay on the App Store. Outside the United States, in many markets, not every form of payment is accepted. We're making it easier all the time. We launched on Alipay, for example, in China during the December quarter. That has obviously helped a lot with the growth in the number of paid accounts. And we continue to bring more and more forms of payment in the App Store around the world. That's a big reason for that. The other reason why the number of paying accounts is growing is the fact that the quality and the quantity of content continues to improve, and so there's many more ways of experiencing games and entertainment and other apps on the store. We have other businesses like the Apple Music streaming service, which is growing very fast because we just started it a couple of years ago, so we are getting a lot of new subscribers there. Our iCloud storage business continues to grow very, very fast. So it's multiple services. The number of people transacting on our stores continues to grow. In terms of ARPU, and maybe I can make a comment on ARPU specifically related to the App Store. What we're seeing and we've seen over a long period of time as we keep track of these cohorts of customers, we see that as customers get on the App Store and start spending on it, we see this profile, spending profile is very similar across generations of customers. People tend to spend more over time. Obviously, you have different spending profiles in different geographies around the world, but in general, you see that trend across the board. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [30] +-------------------------------------------------------------------------------- + + Got it, that's really helpful. And if I could just follow up. On the iPhone side, there's been a large amount of discussion, I guess, in blogs and among your component suppliers that the timing this time may be somewhat different and delayed versus past. Your guide almost seems you're more excited about this iPhone launch versus historically if the sequential growth is better. So I guess beyond the fact we probably shouldn't read every blog and believe every blog, what do you think is different with this product launch or product availability through the cycle versus what you've seen historically? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [31] +-------------------------------------------------------------------------------- + + We have no comment on anything that's unannounced. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + That'll come from Brian White with Drexel. + +-------------------------------------------------------------------------------- +Brian John White, Drexel Hamilton, LLC, Research Division - Global Head of Technology Hardware and Software, and Senior Equity Research Analyst [33] +-------------------------------------------------------------------------------- + + Tim, growth in the smartphone market is now crawling along at about a low single-digit percentage. I know iPhone grew about 2% year-over-year this quarter, and it looks like you had about a mid-teens market share in units in 2016. So as we look forward, maybe 3 to 4 years, do you think Apple can expand its unit market share? And if so, what will the drivers be? And my second question is just about India, general thoughts around India in the quarter. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [34] +-------------------------------------------------------------------------------- + + The answer to your first question is yes, I do think that we can grow both in units and market share. We don't predict those things. But yes, if you ask me what I think, that's what I think. And so what are the drivers? The installed base is growing. It's still growing very strongly. That will generate more upgrades over time. I feel good about our ability to convince people to switch. And where the developed markets, the first-time buyer rates are down other than places like Japan perhaps. The emerging markets, we haven't even got started yet really. And from a revenue point of view, we had very strong growth there on emerging markets ex China, we're up like 18% year-on-year. It was a record for us. So we see a lot of opportunity in these markets. We are investing in India. As you mentioned in your second point, we've already launched an app accelerator center, that's on top of working with the channel and looking at expanding our go-to-market in general. And we've began to produce the iPhone SE there during the quarter, and we're really happy with how that's going, and so we're bringing all of our energies to bear there. I see a lot of similarities where China was several years ago. And so I'm very, very bullish and very, very optimistic about India. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [35] +-------------------------------------------------------------------------------- + + Thanks very much, Brian. A replay of today's call will be available for 2 weeks as a podcast on the iTunes Store, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 6376964. And these replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at (408) 974-4570 and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2017-Jan-31-AAPL.txt b/Transcripts/AAPL/2017-Jan-31-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..c568c6519f1c1eee664a0aed63edc10020c143de --- /dev/null +++ b/Transcripts/AAPL/2017-Jan-31-AAPL.txt @@ -0,0 +1,543 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q1 2017 Apple Inc Earnings Call +JANUARY 31, 2017 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO + * Nancy Paxton + Apple Inc. - Senior Director of IR + * Tim Cook + Apple Inc. - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Amit Daryanani + RBC Capital Markets - Analyst + * Shannon Cross + Cross Research - Analyst + * Katy Huberty + Morgan Stanley - Analyst + * Brian White + Drexel Hamilton - Analyst + * Steve Milunovich + UBS - Analyst + * Toni Sacconaghi + Bernstein - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 1Q17 revenues of $78.4b, net income of $17.9b and diluted EPS of $3.36. Expects 2Q17 revenues to be $51.5-53.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 1Q17 revenue = $78.4b. + 2. 1Q17 net income = $17.9b. + 3. 1Q17 diluted EPS = $3.36. + 4. 1Q17 GM = 38.5%. + 5. 1Q17-end cash plus marketable securities = $246.1b. + 6. 1Q17 share repurchase = 44.3m AAPL shares for $5b. + 7. 2Q17 revenue guidance = $51.5-53.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 1Q17 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Overview: + 1. Generated highest quarterly revenue in Co.'s history, along with all-time: + 1. Unit and revenue records for iPhone and Apple Watch. + 2. Revenue records for Services and Mac. + 3. Revenue records for four out of five geographic segments. + 2. Strong business performance produced all-time record EPS. + 3. Revenue $78.4b. + 1. Above top of guidance range. + 2. iPhone: + 1. Had tremendous qtr. due to exceptional demand that beat Co.'s own internal expectations. + 2. While iPhone 7 is Co.'s most popular model, saw especially strong demand for iPhone 7 Plus, which was a higher portion of new product mix than Co. has ever seen with Plus models in past. + 3. iPhone 7 Plus: + 1. Demand exceeded supply throughout qtr. + 1. Came into supply-demand balance in Jan. + 2. Earned rave reviews for its advanced new features, especially dual camera system. + 1. This is uniquely AAPL feature. + 4. iPhone 7 and iPhone 7 Plus are empowering customers to be more productive, more engaged and more expressive than ever by integrating hardware, software and services to create experiences that only Co. can deliver. + 3. Services: + 1. Best qtr. ever. + 2. Revenue almost $7.2b. + 3. App Store customers broke all-time records, including $3b in purchases in Dec. alone making it the App Store's single best month ever. + 4. Innovative and vibrant developer community has created over 2.2m apps. + 1. Co.'s developer community has now earned over $60b, including over $20b in 2016 alone. + 5. Music business revenue grew for third qtr. in a row. + 6. AppleCare and iCloud storage services had all-time record results. + 7. Apple Pay continued its strong momentum, with number of users more than tripling over past year, and hundreds of millions of transactions and billions of dollars in purchases in Dec. qtr. alone. + 1. Transaction volume up over 500% YoverY as Co. expanded to four new countries including Japan, Russia, New Zealand and Spain, bringing AAPL into a total of 13 markets. + 8. Apple Pay on web is delivering partners great results. + 1. Nearly 2m small businesses are accepting invoice payments with Apple Pay through Intuit QuickBooks Online, FreshBooks and other billing partners. + 2. Beginning this qtr., Comcast customers can pay their monthly bill in single touch with Apple Pay. + 9. Services are becoming a larger part of business. + 1. Expects revenues to be the size of Fortune 100 co. this year. + 10. Services offerings are now driving over 150m paid customer subscriptions. + 1. Includes Co.'s own services and third-party content AAPL offers on stores. + 11. Goal is to double the size of Services business in next four years. + 4. Mac: + 1. Returned to growth. + 2. Generated its highest quarterly revenue ever. + 3. Latest data shows that most Mac customers are buying their first Mac with vast majority of them coming from Windows PC. + 4. New MacBook Touch with Touch Bar is an example of innovation made possible by integrating world-class hardware and software. + 5. Co. was supply constraint for new MacBook Pro throughout Dec. qtr. and just now coming into supply-demand balance. + 5. Others: + 1. Best qtr. ever for Apple Watch, units and revenues, with holiday demand so strong that Co. couldn't make enough. + 1. Apple Watch is best-selling smartwatch in the world and most loved with highest customer satisfaction in its category by a wide margin. + 2. Apple Watch is ultimate device for healthy life and it's gold standard for smartwatches. + 2. Thrilled with response to AirPod. + 1. They are far ahead of anything else on market today. + 2. Working hard to catch up with incredible demand. + 3. Ecosystem is broadening to more areas where people spend their time; at gym, on the go, in home and on job. + 1. Every major automaker is committed to supporting CarPlay with over 200 different models announced, including five of top 10 selling models in US. + 1. There are well over 1m people using CarPlay now and this continues to grow rapidly. + 2. Leading the industry by being first to integrate home automation into a major platform with iOS 10. + 1. With Siri and new Home app in iOS 10, everywhere one goes, one can easily and securely control all home accessories with iPhone, iPad or Apple Watch. + 2. Number of home kit compatible accessories continues to grow rapidly with many solutions announced this month, including video cameras, motion detectors and sensors for doors, windows and water leaks. + 3. Co. is unmatched when it comes to securing home with HomeKit enabled door locks, garage doors and alarm systems. + 4. Making great progress in enterprise market alongside major partners. + 1. Combination of iOS and Cisco technology is giving companies everywhere the opportunity to vastly improve user experience for their mobile employees. + 2. With enhanced networking performance up to eight times faster roaming, better reliability for apps and native voice experience, excited about how much more productive the workforce will be with these great capabilities. + 3. Total number of joint customer opportunities has grown over 70% since last qtr. + 4. Enterprises are using IBM's new Mobile at Scale design and development model to deploying multiple iOS apps with speed and efficiency. + 5. Finnair is transforming aircraft maintenance and [FIMIX] is revamping activities from attracting new client to invoicing to after sales support. + 6. Later this spring, SAP will be rolling out its SDK for iOS providing its community of more than 2.5m developers the tools to build powerful native iOS apps that leverage SAP HANA Cloud Platform. + 7. These partnerships are making it even easier for enterprise customers to transform how work gets done with iOS. + +-------------------------------------------------------------------------------- +II. 1Q17 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $78.4b. + 1. Highest quarterly revenue in Co.'s history. + 2. Above guidance range. + 2. Strength of results was broad based as Co. set new revenue records for iPhone, Services, Mac and Apple Watch. + 3. Established new all-time revenue records in most developed and emerging markets with strong growth rates in many countries, including US, Japan, Canada, France, Australia, Brazil, India, Turkey and Russia. + 1. Accomplished all this despite challenging FX environment due to continued strength of US dollar. + 4. As expected, YoverY performance in Greater China improved significantly relative to Sept. qtr. + 1. Total Greater China segment revenue down 12%, but revenue from mainland China was even with all-time record results from a year ago and grew in constant-currency terms. + 5. In all other geographic segments, generated all-time quarterly record results. + 6. Has benefit of 14th week, but this was offset by four factors. + 1. This year, grew channel inventory significantly less than a year ago. + 2. iPhone 7 launched earlier in Sept. qtr. vs. iPhone 6s launch the previous year, creating more difficult comparison for Dec. qtr. this year. + 3. Stronger US dollar affected total revenue growth this year by 100 BP. + 4. Year ago revenue included benefit of one-off $548m patent infringement payment. + 7. Strong customer interest left Co. in supply-demand imbalance for several products throughout qtr. this year. + 8. GM 38.5%. + 1. At high-end of guidance range. + 9. Operating margin 29.8% of revenue. + 10. Net income $17.9b. + 11. Diluted EPS $3.36. + 1. New all-time record. + 12. Cash flow from operations $27.1b. + 2. iPhone: + 1. Sold 78.3m units. + 1. New all-time record. + 2. Up 5% YoverY. + 2. Customer demand was even higher than reported results, as iPhone unit sell-through up 8%. + 3. Saw double-digit iPhone growth in US, Canada, Western Europe, Japan and Australia, and even stronger growth in many emerging markets, including Brazil, Turkey, Russia, Central and Eastern Europe, and Vietnam. + 4. ASP increased to $695 in Dec. qtr. from $619 in Sept. qtr., driven by strong product mix and success of iPhone 7 Plus. + 5. Despite stronger demand than last year, added 1.2m units of iPhone channel inventory across the qtr. + 1. Significantly less than increase of 3.3m units a year ago. + 2. Exited qtr. near low-end of 5-7 week target channel inventory range. + 6. Customer interest and satisfaction with iPhone are exceptional with consumers and business users. + 1. In US, latest data from 451 Research on consumers indicates 97% customer satisfaction rating among all iPhone owners and 99% satisfaction rating for owners of iPhone 7 Plus. + 2. Among corporate smartphone buyers, iPhone customer satisfaction rating was 94% and of those planning to purchase smartphones in March qtr., 78% plan to purchase iPhone. + 3. Services: + 1. Revenue $7.2b; all-time record. + 1. Up 18% YoverY. + 2. Run rate growth was actually higher when taking into account two discrete items. + 1. 14th week added to services revenue this Dec. qtr. + 2. That benefit was more than offset by comparison to one-off $548m patent infringement payment included in Services revenue a year ago. + 3. App Store: + 1. Continued its impressive run, breaking all previous revenue records. + 2. YoverY revenue growth was 43% through first 13 weeks of qtr. + 3. Avg. revenue per paying account and number of paying accounts grew strongly. + 4. According to (inaudible) latest report, App Store revenue continues to outpace industry overall with more than double the revenue of Google Play in calendar 2016. + 4. Mac: + 1. Sold 5.4m Macs. + 1. Generated highest-ever quarterly Mac revenue. + 2. Reported double-digit unit growth in several countries, including Japan, mainland China, India, The Netherlands and Sweden, and in US education market. + 3. Ended qtr. at low-end of 4-5 week target range for Mac channel inventory. + 5. iPad: + 1. Sold 13.1m units. + 1. Ahead of expectations. + 2. Posted double-digit growth in mainland China and India as Co. has expanded distribution channels in those countries and continues to attract high percentage of first-time tablet buyers. + 2. Reduced channel inventory by about 700,000 units as opposed to an increase of 900,000 units last year. + 1. Exited qtr. near low-end of 5-7 week target range. + 3. iPad is incredibly successful in segments of tablet market where Co. competes, in terms of market share and customer metrics. + 4. Recent data from NPD indicates that iPad had 85% share of US market for tablets priced above $200. + 5. In Nov., 451 Research measured 94% consumer satisfaction rate for iPad mini and 97% rate for iPad Air and 96% for iPad Pro. + 6. Among US consumers planning to purchase a tablet within next six months, purchase intention for iPad is more than four times higher than any other brand measured with iPad Pro once again top choice for planned purchases. + 7. Corporate buyers reported 96% satisfaction rate and purchase intent of 66% for March qtr. + 8. Businesses of all sizes are choosing iPad and iPhone to help them reimagining their everyday activities. + 9. Seeing strong momentum in sectors like retail, where iOS solutions are being deployed for everything from product development to logistics to mobile point-of-sale. + 10. Companies like Toys "R" Us, Coach and Kate Spade are using iOS and Co.'s Mobility Partner solutions to dramatically transform customer and employee experiences. + 11. Retail stores experienced strong double-digit growth in visitors and revenue. + 1. Expanding global presence with plans to open first store in Singapore and second store in Dubai soon. + 2. Continually updating stores and adding new exciting outreach programs to educate kids on Co.'s products, entertain community with fresh light music, teach future Swift developers to code and empower entrepreneurs to start, grow and evolve their businesses. + 6. Cash Position: + 1. 1Q17-end cash plus marketable securities $246.1b, sequential increase of $8.5b. + 1. $230.2b of this cash or 94% of total was outside US. + 2. Had $77.1b in term debt and $10.5b in commercial paper outstanding at qtr.-end. + 3. Returned almost $15b to investors for capital return activities. + 1. Paid $3.1b in dividends and equivalents. + 2. Spent $5b on repurchases of 44.3m AAPL shares through open market transactions. + 3. Launched new $6b ASR, resulting in initial delivery and retirement of 44.8m shares. + 4. Completed eighth accelerated share repurchase program, retiring additional 4.4m shares. + 5. This led to net diluted share count reduction of 65.3m shares. + 4. Now completed $201b of current $250b capital return program, including $144b in share repurchases. + 5. Effective tax rate 26%, as expected. + 7. March Qtr. Outlook: + 1. Revenue $51.5-53.5b. + 1. Includes $1.2b YoverY headwind from FX. + 2. GM 38-39%. + 1. Includes 80 BP sequential headwind from FX. + 3. OpEx $6.5-6.6b. + 4. OI&E about $400m. + 5. Tax rate about 26%. + 8. Others: + 1. On 01/31/17, Board of Directors has declared cash dividend of $0.57 per share of common stock, payable on 02/16/17 to shareholders of record as of 02/13/17. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Katy Huberty, Morgan Stanley. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Yes, thank you. First, Luca, what are the factors that caused you to widen the gross margin guidance for the March quarter, and what are the one or two factors that put you at the low end versus the tailwinds that might put you at the high end of that range? Then I have a follow-up, thank you. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Sure, Katy, well if you look back at our history, 100 basis points range for gross margin is not unusual. Clearly during a period when foreign exchange is very volatile we think it's more prudent to broaden the range, to broaden the range a bit. I've mentioned that we expect, assuming that rates don't move too much, we expect foreign exchange to be a major negative as we move from the December to the March quarter. You know that the dollar appreciated significantly towards the end of the December quarter, and so we got 80 basis points of sequential headwind from foreign exchange. +We also have the sequential loss of leverage which is typical of our seasonality, but we expect to offset these two impacts with cost efficiencies and also with our mix of products and services. So obviously if the dollar is a little less strong than it is today, we could do a bit better on gross margins. Obviously we continue to work very hard on our cost efficiency, so we'll see where we land. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Thank you. And Tim, there's a reasonable probability that you may get access to the $200 billion plus of cash that's been locked overseas. So I think it would be helpful to just get an update on your views around potentially larger M&A and some of the areas of interest that you've noted in the past, like owning more original content to penetrate more of the TV opportunity that the company has long talked about addressing. Thank you. + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [5] +-------------------------------------------------------------------------------- + + Yes, Katy, I am optimistic given what I'm hearing that there would likely be some sort of tax reform this year, and it does seem like there's people in both parties that would favor a repatriation as a part of that. So I think that's very good for the country and good for Apple. What we would do with it, let's wait and see exactly what it is, but as I've said before we are always looking at acquisitions. We acquired 15-20 companies per year for the last four years, and we look for companies of all sizes, and there's not a size that we would not do based on just the size of it. It's more about the strategic value of it. +In terms of original content, we put our toe in the water, we have put our toe in the water with doing some original content for Apple Music, and that will be rolling out through the year. We are learning from that and we'll go from there. The way that we participate in the sort of the changes that are going on in the media industry that I fully expect to accelerate from sort of the cable bundle beginning to break down is one, we started the new Apple TV a year ago, and we're pleased with how that platform has come along. We had more things planned for but it's come a long way in a year and it gives us a clear platform to build off of. +Two, embedded in the 150 million paid subscriptions that I mentioned in my opening comments, there are a number of third party services that are a part of that where we participate economically in some of that by offering our platform and selling and distributing. And then thirdly, we are obviously with our toe in the water we're learning a lot about the original content business and thinking about ways that we could play in that. Thanks for the question. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [6] +-------------------------------------------------------------------------------- + + Thanks, Katy. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Amit Daryanani, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks a lot, good afternoon, guys. First question, really appreciate the information you guys are providing around your Services business which was up 18% year-over-year. Could you just talk about how much of that do you think is growth in your install base versus increased monetization on a per iOS [device] spaces? It's weird to think about those in two separate terms. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [9] +-------------------------------------------------------------------------------- + + I think you're absolutely right, Amit. We look at it, those are the two key elements for us. And what is particularly interesting to us is to see that the number of people that are transacting on our stores is increasing strong double digits, and we're also seeing that the ARPU per paying customer is increasing double digits, right? So it's a combination of the two, obviously the quality and the quantity of content that we make available in our Services improves all the time. And we also see that as people getting to the platform and start transacting on the platform, and we keep track of their behavior over time, we actually see that they tend to spend more and more over time. And that's why we are excited about the future of the Services business and that's why as Tim said, we have a goal that it's already become a very large business. It's going to be a Fortune 100 company this year, but we have a goal to double it over the next four years. + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [10] +-------------------------------------------------------------------------------- + + Perfect. If I could just switch gears on a follow-up. There's been a fair amount of discussions around your market share in China and what's happening over there. Your numbers actually look fairly impressive in Greater China, China specifically. So could you talk about what are the demand trends you're seeing there on the ground, and how do you see that transpire through the year? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [11] +-------------------------------------------------------------------------------- + + I'll take this one. If you look at how we did in the quarter, as I think Luca shared, our Greater China revenue was down 12% and about four points of that was currency related. So it's an eight-point decline in constant currency. And then within Greater China if you look at the PRC, our revenue was flat year-over-year, and that was against the all-time record quarter. And if you look at that on a constant currency basis it was actually up six. So it's a significantly better performance on sort of every way you look at it, versus what we had experienced the prior three quarters. +Underneath that, what we've seen is that iPhone 7 was the best selling smartphone in China during the quarter, according to Kantar. Singles Day which is a huge day in China as you know, we were the most popular US brand on Alibaba. We set a new record for Services in China as the company did. And Mac revenue was up double digit year-over-year. iPad units were also up double digit in Mainland China which was obviously different than the trend that we saw in the balance of the world. We also saw 50% of our iPhone sales in China were to switchers and first time buyers, which is a very high number that we're pleased with. And then obviously our total install base continues to grow there in the strong double digits. +That said, the challenges that are there, one, the currency has devalued 6% year-over-year, and two, Hong Kong remains a very, very difficult market. And so I look at it and I'm encouraged with the significant improvement, but we're not without challenges there and I wouldn't want to imply that, although I do like many, many things that I've seen and how broad-based the pluses were across our product line. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [12] +-------------------------------------------------------------------------------- + + Thank you, Amit. Can we have the next question please? + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Shannon Cross, Cross Research. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [14] +-------------------------------------------------------------------------------- + + Thank you very much for taking my question. Can you talk a bit more about the Services business? And what I'm trying to figure out is I think the number was you're going to be doubling within the next four years, or at least that's your expectation. So what gets you there? Maybe if you talk about geographies and how penetrated you are in certain geographies? And then as you grow your Services business, is there anything we should keep in mind from a margin perspective? Would these be lower-margin services or similar, just so we can think about the trajectory and the contribution to bottom line? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [15] +-------------------------------------------------------------------------------- + + Yes, Shannon, I'll take it. Obviously within the Services business we have a number of categories. The App Store is the one that is driving significant growth right now. I said in my opening comments that we grew 43%, 13 weeks, over 13 weeks we grew own more for the quarter, right? And what we like about the App Store is that it's truly a global platform, so we are seeing significant growth not only in the developed markets where you expect to see a lot of transaction volume, but we see great growth in places like China for example. +And we know that there are parts of the world where we can do better. We can grow, for example, our developer community in a number of emerging markets. And so as we look, as I was explaining earlier, as we look at the number of people that transact growing double digits, we see the amount spent per paid account growing so well, we think that the App Store is going to be a significant driver of growth. +On the music front, we are the market leader in digital music and obviously now by having the combination of the download business with the streaming service, which we didn't have until recently, we've been able to bring our music business back to growth, we've grown over the last three quarters, and we feel very good about that. +Tim has talked about original content. We've had very good success with exclusives, so we know that it's another business that we can grow. Our iCloud storage business is growing very quickly, and so that is a business that also at the geographic level we can continue to grow significantly. Our AppleCare business is growing very well. +A lot of it comes from the fact that our install base of devices around the world continues to grow very well, from double digits and as we've explained in the past, the vast majority of the service that we provide is not driven by what we sell during the last 90 days. It's much more driven by the install base and that gives us a tail wind. +We're also opening up several new markets because we're accepting new forms of payment and therefore it's easier for, particularly for international customers to take advantage of our services. +You were asking about the margin profile. We said it many times, in aggregate, our Services business tends to have margins that are above company averages. They are accretive so they help us quite a bit from a margin standpoint. Within the Services business, we have very different margin profiles also because as you know we account for some of these services in different ways. In some cases we transact on a buy-sell basis, in other cases we perform as agents, for example, to our developers, right? And that drives different margin percentages. + +-------------------------------------------------------------------------------- +Shannon Cross, Cross Research - Analyst [16] +-------------------------------------------------------------------------------- + + Thank you. And then my follow-up is in terms of elasticity of demand and some of the moves from a currency perspective. I think in the past there was some concern in some of the emerging markets that you were basically not able to -- you weren't getting the volumes because you had to raise ASPs given currency, but you talked a lot about the emerging markets actually doing pretty well this quarter. So I'm just curious, you raised the price on the iPhone 7 Plus, and what are you seeing and what are your customers saying in terms of willingness to pay up? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [17] +-------------------------------------------------------------------------------- + + Well Shannon, I was looking back since June of 2014, so we're talking about two and a half years ago, the dollar has strengthened 25% against the basket of currencies where we do business. And so obviously it is a difficult situation for us. I mentioned that foreign exchange is a significant headwind for us, both at the revenue level and at the gross margin level. +In emerging markets, it's incredible. The level of interest for our products continues to be phenomenal. The brand continues to be very aspirational. There's more and more people that can afford our products around the world. The middle class is growing in places like China, India, Brazil, but certainly strong dollar doesn't help us and therefore when we make pricing decisions, we need to be very careful. We always want to find the optimal balance between units, revenue, and margin, and it becomes more difficult as the dollar appreciates. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [18] +-------------------------------------------------------------------------------- + + Thank you, Shannon. Could we have the next question please? + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Brian White, Drexel. + +-------------------------------------------------------------------------------- +Brian White, Drexel Hamilton - Analyst [20] +-------------------------------------------------------------------------------- + + Yes, Luca, I'm wondering if you could talk a little bit about gross margins. Sales obviously beat the high end of your revenue range, it looks like gross margins was dead down the middle. Can you talk about the puts and takes in gross margins in the quarter please? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [21] +-------------------------------------------------------------------------------- + + Sure. We were actually at the high end of the range for gross margins. We had guided 38 to 38.5, and we came in at 38.5 exactly. And really, the slight improvement over the mid point of the guidance range was due to the fact that our revenue was ahead of our expectations. And so we got a bit more leverage out of the increased revenue levels. We feel very good about the gross margins for the quarter. Again keep in mind the strong dollar that doesn't help us on that front. + +-------------------------------------------------------------------------------- +Brian White, Drexel Hamilton - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. And Tim, I didn't hear much mention about India. How did India perform with the iPhone, and how should we think about it for 2017 especially with the 4G network going up? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [23] +-------------------------------------------------------------------------------- + + That's a really good question. Despite the demonetization move in India that created lots of economic pressure there last quarter, despite that, we had all-time record revenue results. And so we were very happy about that. The demonetization impact has not worked its way through yet. It's still definitely having some overhang, but I think in the longer term it's a great move and I feel really good about how we're doing there. We are in discussions on a number of things including retail stores, and fully intend to invest significantly in the country and believe it's a great place to be. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [24] +-------------------------------------------------------------------------------- + + Thank you, Brian. Could we have the next question please?\ + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Simona Jankowski, Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [26] +-------------------------------------------------------------------------------- + + Hi, thank you. I wanted to dig in a little bit more into the iPhone upside in the quarter, with record revenues in every region except for Greater China. I think it touched on the percent of switchers in China, but can you give a little more color on the split of upgrades and switchers in some of the other regions, and overall as well? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [27] +-------------------------------------------------------------------------------- + + Yes, Simona, it's Tim. We did have an exceptional quarter with iPhone, and that was with the back drop of not predicting the demand very well in the iPhone 7 Plus and therefore being in constraint on it through the quarter. If you look at the absolute number of upgraders, it was the highest that we've seen in any quarter. And if you look at the switcher number, it's the highest that we've seen in any quarter. If you look at the upgrade rate, it's similar to last year. However, I think the big asterisk, and I share all this with you for transparency's sake, but I would tell you that the way we look at this is, in a quarter where you have a supply constraint, it's difficult to draw too many conclusions from it, but I wanted to share that with you anyway so you have the back drop. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [28] +-------------------------------------------------------------------------------- + + Thank you. And then just one follow-up on China specifically. As your comps get easier this year, I was curious if you think you're going to be returning to growth in that region? And then just to give us the context I know you talked about the 6% constant currency increase in revenue in Mainland China, but curious if you strip out the double digit increase in iPad and MacBook and potentially the mix shift to the 7 Plus, curious what underlying iPhone units did in Mainland China? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [29] +-------------------------------------------------------------------------------- + + That's a big question. I don't have the answer in front of me. If you look at 7 Plus, it was the most popular Plus model that we've ever had. It set a unit record, so that I can share. In terms of how are we going to do, we don't provide guidance at the segment level, but sitting here today for Q2 I wouldn't expect the year-over-year performance to be dramatically different than the year-over-year performance in Q1. The real comp really begins in the following quarter to a more significant degree, and we'll have to see how that plays out as we get closer to it. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [30] +-------------------------------------------------------------------------------- + + Thank you, Simona. Can we have the next question please? + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Toni Sacconaghi, Bernstein. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [32] +-------------------------------------------------------------------------------- + + Yes, thank you. I just wanted to better understand the upgrade rate dynamics. So I think iPhone units on a sell-through basis were up about 8%. You had an extra week which gave you about 8%. I understand there were differences of the timing of the launch. So making all those adjustments it looks like iPhone units were probably up low single digits. But Luca, you alluded to the fact your install base is growing double digits. So that would suggest to me that the upgrade rate, the upgrade percentage is actually declining. And more specifically, I'd just like your broader perspective on how investors should think about upgrade rates. It looked like they peaked in the iPhone 6 cycle, and it looks like they've been extending, going lower, replacement cycles have been extending over the last couple of years. I think some of the US carriers alluded to that as well. +So I'm wondering if you could step back and just talk a little bit more broadly about how investors should think about -- or what the trajectory's been over the last two years, and how investors should think going forward? Do you believe there are opportunities for that upgrade rate to improve, or replacement cycles to accelerate going forward? And what are some of the considerations we should think about? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Well it's a good question. A number of points that I want to make, starting with the growth in the install base of iPhones. Yes, it's growing strong double digits and that's very good for us for a number of reasons, including the fact that it's a big driver for our Services business. +When we look at it geographically, I think we see different developments. For example, we felt very, very good about the unit growth that we had in many markets around the world. You've been quoting an overall total company growth rate, but when we look at it on a country specific level, there were a lot of countries, I would say the majority of the countries, where iPhone units grew strong double digits, starting here in the United States where, for example, the fact that annual upgrade programs are becoming more and more popular is proving to be a positive for us. +Same happened in a number of countries around the world starting with Canada and Australia, but also many places in Western Europe as well. Japan grew double digits in terms of units. So I think geographically, we are seeing very, very good performance, and the point that I think I need to make when you think about upgrade rates, clearly this issue of the strong dollar doesn't help us. Could we sell significantly more or significantly faster from an upgrade cycle standpoint in places outside the United States where we've had, we've been forced to increase prices by up to 20%, 30%, 40% in certain countries? When you think about the impact that this is having on local demand, obviously, that doesn't help us. But overall, I would say as Tim said, when we look at the upgrade rate for -- and we look at it from the standpoint of the new phones, the new generation of phones, the upgrade rate, the percentage of people that have upgraded to the new phone has been very similar to what we've seen last year. The 6 cycle was certainly a phenomenal cycle. There was pent-up demand for the larger screen phones. And certainly as we look ahead, we have a role to play. The more we're able to innovate with new generations of products, clearly that plays a role in the upgrade rate. + +-------------------------------------------------------------------------------- +Toni Sacconaghi, Bernstein - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, thank you. Tim, I have a question for you. Back in April 2012, you said on one of these earnings calls that, I've always hated litigation and I continue to hate it, and I highly prefer to settle versus battle. Yet you recently decided to initiate a lawsuit against Qualcomm. I'm wondering if you can comment on the ostensible change or departure from this viewpoint, and what would be a successful end result of this litigation, and whether you can confirm whether there's any potential gross margin risk in the future as a result of this litigation? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [35] +-------------------------------------------------------------------------------- + + I feel the same way I did in April of 2012. I don't like litigation and view it as a last resort. And so you should take from our filing that we viewed it as we didn't see another way forward. They were insisting on charging royalties for technologies that they had nothing to do with. And so we were in a situation where the more we innovated with unique features like Touch ID or advanced displays or cameras, just to name a few, the more money Qualcomm would collect for no reason, and the more expensive it would be therefore for us to innovate. And so it's somewhat like buying a sofa, and you charge somebody a different price depending upon the price of the house that it goes into. From our point of view, this doesn't make sense and we don't believe it will pass muster in the courts. +In addition to that, as a part of their increasingly radical steps they were taking to try to hold up that model, they withheld a billion dollars in payments that they owed us. And so we felt like we had no choice was the net of it. In terms of where it goes, we'll see. I don't like litigation and so if there's another way, then that would be great. But at this point, I don't see it. I fully expect at this point in time that it will take some time, but in the end, I think common sense will prevail and the courts will see it for what it is. And so that's the way I see it. Thanks for your question. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [36] +-------------------------------------------------------------------------------- + + Thank you, Toni. Can we have the next question please? + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Steve Milunovich, UBS. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [38] +-------------------------------------------------------------------------------- + + Thank you. First I wanted to ask about the iPad. It looked like it was about to turn possibly even positive, and you said it was above your plan, but I think it was pretty well below the street's expectations. And the ASP deteriorated pretty significantly, I don't know if it's a mix shift. But maybe you can talk about the iPad and what you see going forward? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [39] +-------------------------------------------------------------------------------- + + The iPad, Steve, we had a 1.6 million unit swing on channel inventory between the years. In the year ago quarter, we increased by 900. In this quarter we decreased by 700. On top of that, and from an ASP point of view, in the year ago quarter we launched the iPad Pro 13 Edge. That would be the iPad with obviously the highest price on it. We would have done the channel fill plus the launch of the product, and so that would have bolstered the ASPs in that particular quarter. In addition to all of that, we did under call the number of iPads that would be in demand for the quarter, and that compounded a shortage issue that we had with one of our suppliers. And so all in all, there was quite a few things going on there. +If I sort of zoom out of the 90 day clock and look at it, we've got some exciting things coming on iPad. I still feel very optimistic about where we can take the product. When we look at the number of people buying iPads for the first time, which is a good thing to look at from a point of view of whether things are reaching penetration point or not, the numbers indicate that it's not close to that kind of thing. The customer sat numbers are through the roof. Literally the customer sat for the iPad Pro is 99%. It's stunning. And so I see a lot of good things and hope for better results, but we are still currently in this shortage issue now, and I'm not projecting to get out of that totally during the quarter. And so it will damper this quarter somewhat. But again, beyond the 90 day clock, I'm very bullish on iPad. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, that's great, thank you. And then, Tim, investors tend to think of the iPhone as mature and technology improvement is incremental, yet I believe you think there's plenty of runway left in terms of appealing new features. Do you think there are future enhancements coming that will be viewed by material by users, and particularly changes beyond foreign factor, beyond the way the phone looks? Are there functional things coming over time that you think could surprise people? + +-------------------------------------------------------------------------------- +Tim Cook, Apple Inc. - CEO [41] +-------------------------------------------------------------------------------- + + I think the smartphone is still in the early innings of the game. I think there's lots more to do. I think its become -- every year it becomes more important to people's lives, and there's more things people are doing with it. I talked a little bit about home automation, but I could have talked about health, I could have talked more about CarPlay, the use of it in the enterprise is growing significantly. And so when I look at all of these things, usage going up, app developers still innovating, we've got some exciting things in the pipeline, I feel really, really good about it. So this is one -- we think different about a bunch of things, so maybe this is just one more. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR [42] +-------------------------------------------------------------------------------- + + Thank you, Steve. A replay of today's call will be available for two weeks as a podcast on the iTunes Store, the webcast on Apple.com/investor, and via telephone. The numbers for the telephone replay are 888-203-1112 or 719-457-0820. Please enter confirmation code 3378275. And these replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at 408-974-2414 and financial analysts can contact Joan Hoover or me with additional questions. Joan is at 408-974-4570, and I'm at 408-974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2017-May-02-AAPL.txt b/Transcripts/AAPL/2017-May-02-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..290195a9ba68fd47a28dfcefc95d24611d147d9e --- /dev/null +++ b/Transcripts/AAPL/2017-May-02-AAPL.txt @@ -0,0 +1,528 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q2 2017 Apple Inc Earnings Call +MAY 02, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO and SVP + * Timothy D. Cook + Apple Inc. - CEO and Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Simona Kiritsov Jankowski + Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal and Analyst + * Roderick B. Hall + JPMorgan Chase & Co, Research Division - VP and Senior Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 2Q17 revenue of $52.9b, net income of $11b and diluted EPS of $2.10. Expects 3Q17 revenue to be $43.5-45.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 2Q17 revenue = $52.9b. + 2. 2Q17 net income = $11b. + 3. 2Q17 diluted EPS = $2.10. + 4. 2Q17 GM = 38.9%. + 5. 2Q17-end cash plus marketable securities = $256.8b. + 6. 2Q17 share repurchases = 31.1m AAPL shares for $4b. + 7. 3Q17 revenue guidance = $43.5-45.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 2Q17 Business Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Reported strong results, with accelerating revenue growth and EPS up 10% YoverY. + 2. Revenue $52.9b. + 1. Near high-end of guidance range. + 2. Global revenue up 5% YonY. + 1. Growth accelerated from Dec. qtr. performance, despite $1b YoverY revenue headwind from FX in March qtr. and larger iPhone channel inventory reduction this year vs. last year. + 3. iPhone sales were in line with expectations. + 1. Active installed base of iPhones grew by double digits YoverY. + 2. Based on latest data from IDC, gained market share in nearly every country Co. tracks. + 3. Late in qtr., released a stunning (PRODUCT)RED Special Edition versions of iPhone 7 and 7 Plus in recognition of 10 years of partnership with RED. + 2. Services: + 1. For second qtr. in a row, revenue topped $7b. + 1. Well on the way to being size of Fortune 100 co. + 2. App Store momentum is terrific. + 1. Revenue grew 40% YoverY to all-time quarterly record. + 2. Number of developers offering apps for sale on store up 26% over last year. + 3. Saw double-digit revenue growth from Apple Music subscriptions and iCloud storage. + 1. Overall, strong growth in total number of paid subscriptions for own services and third-party content Co. offers on stores. + 4. Paid subscriptions now exceed 165m. + 5. Apple Pay is experiencing phenomenal traction. + 1. With launch of Taiwan and Ireland in March qtr., Apple Pay is now live in 15 markets with more than 20m contactless ready locations, including more than 4.5m locations accepting Apple Pay in US alone. + 2. Seeing strong growing usage, as points of acceptance expand, with transaction volume up 450% over the last 12 months. + 1. In UK, points of acceptance have grown by 44% in last year, while monthly Apple Pay transactions have grown by nearly 300%. + 2. In Japan, where Apple Pay launched last Oct., more than 0.5m transit users are completing 20m Apple Pay transactions per month. + 6. Seeing great momentum from powerful advances in Messages. + 1. During Super Bowl in Feb., customers were sending 380,000 messages per second, more than double the previous year. + 7. A few weeks ago, introduced Clips. + 3. Mac: + 1. Revenue grew 14% to new March qtr. record. + 2. Gained market share due to strong demand for new MacBook Pros. + 3. Generated over $25b in revenue over past four quarters. + 4. Updated most popular sized iPad with brighter Retina display and best-in-class performance at most affordable price ever. + 1. iPad results were ahead of expectation. + 2. Believes Co. gained share during March qtr. in a number of major markets including: + 1. US. + 2. Japan. + 3. Australia. + 4. Apple Watch: + 1. Building on momentum from holiday qtr., sales nearly doubled YoverY. + 2. Seeing great response to AirPods, with 98% customer satisfaction rating based on recent Creative Strategies survey. + 1. Demand for AirPods significantly exceeds supply. + 3. Growth in Beats products has been strong. + 4. When Co. combines Apple Watch, AirPods and Beats headphones, revenue from wearable products in last four quarters was size of Fortune 500 co. + 5. Greater China: + 1. Saw strong double-digit revenue growth from: + 1. Mac. + 2. Services. + 2. Had great results from retail stores in Mainland China, with total store revenue up 27% YoverY and comp store revenue up 7%. + 1. These results contributed to improving performance in Greater China. + 3. Through first two quarters of FY17, YoverY comparisons improved significantly over last two quarters of FY16. + 4. 1H revenue down 13% YoverY. + 1. About a third of which was attributable to FX. + 2. Revenue declined 32% in 2H of last year. + 5. March qtr. results were in line with expectations. + 1. Similar to YoverY performance experienced in Dec. qtr. + 6. India: + 1. Set a new March qtr. record. + 2. Revenue grew by strong double digits. + 3. Continues to strengthen local presence across entire ecosystem. + 7. Other Details: + 1. With opening of newest store in Dubai this past weekend, now has 495 retail locations worldwide. + 1. New [Apple] Dubai Mall is a truly international store, with employees who collectively speak 45 languages. + 2. Capital return program: + 1. Given strong confidence in future, increasing program size by $50b, bringing total to $300b. + 2. Extending time frame through March 2019. + 3. Adding to share repurchase authorization and increasing dividend for fifth time in less than five years. + 3. Upcoming conference: + 1. Worldwide Developers Conference taking place in San Jose next month. + 4. Recently released 10th annual environmental responsibility report, reflecting amazing progress. + 5. In 2016, 96% of electricity used at Co.'s global facilities came from renewable sources of energy, reducing carbon emissions by nearly 585,000 metric tons. + 1. Co. is now 100% renewable in 24 countries, including all of Co.'s data centers. + 6. Moving into new corporate headquarters, Apple Park, new center for innovation. + 1. Main building on Apple Park is designed to house 13,000 employees under one roof in an environment that fosters even greater collaboration among incredibly talented teams. + 7. Through innovative products and success of business, incredibly proud to support more than 2m jobs in all 50 states and Co. expects to create even more. + 8. Last FY, spent more than $50b in United States with American suppliers, developers and partners. + +-------------------------------------------------------------------------------- +II. 2Q17 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $52.9b. + 1. Achieved double-digit growth in: + 1. US. + 2. Canada. + 3. Australia. + 4. Germany. + 5. Netherlands. + 6. Turkey. + 7. Russia. + 8. Mexico. + 2. Growth rates were even higher, over 20%, in many other markets, including: + 1. Brazil. + 2. Scandinavia. + 3. Middle East. + 4. Central and Eastern Europe. + 5. India. + 6. Korea. + 7. Thailand. + 2. GM 38.9%. + 1. At high-end of guidance range. + 2. Increased sequentially from 38.5% in Dec. quarter, which is particularly impressive, given seasonal loss of leverage, sequential FX headwinds of 100 BP and cost pressures on certain commodities. + 3. Operating margin 26.7% of revenue. + 4. Net income $11b. + 5. Diluted EPS $2.10. + 1. Increased 10% YoverY. + 6. Cash flow from operations $12.5b; strong. + 2. iPhone: + 1. Sold 50.8m. + 2. Reduced iPhone channel inventory by 1.2m units vs. reduction of about 450,000 a year ago. + 1. Performance was slightly better than last year on a sell-through basis. + 3. Had solid iPhone growth in four of five operating segments. + 1. Experienced especially strong results in Western Europe, the Middle East and rest of Asia Pacific segment, all areas of the world where iPhone sales were up double digits. + 4. ASP $655. + 1. Up from $642 a year ago due to strong mix of iPhone 7 Plus, despite unfavorable FX rates. + 5. Exited March qtr. within 5-7 week target channel inventory range. + 6. In US, latest data from 451 Research on consumers indicates 96% customer satisfaction rating among iPhone 7 owners and 98% for iPhone 7 Plus. + 7. Among corporate smartphone buyers, iPhone customer satisfaction was 95%. + 1. Of those planning to purchase smartphones in June quarter, 79% plan to purchase iPhone. + 3. Services: + 1. Revenue $7b. + 1. Up 18% YoverY. + 2. Best results ever for a [13-week] qtr. + 3. Saw strong level of growth, especially given tough compare to last year as busy week between Christmas and New Year's fell within March qtr. a year ago but was included in Dec. qtr. this year. + 2. Goal is to double the size of business by 2020. + 3. App Store established new all-time revenue record. + 1. Grew 40% YoverY. + 2. Continues to see growth in avg. revenue per paying account and number of paying accounts across content stores during qtr. + 1. Quarterly increase in number of paying accounts was the largest that Co. has ever experienced. + 3. According to App Annie's latest report, App Store continues to be the preferred destination for customer purchases, generating twice the revenue of Google Play during March qtr. + 4. Mac: + 1. Revenue up 14% YoverY. + 1. New March qtr. record. + 2. Sold 4.2m Macs. + 1. Up 4% YoverY vs. zero growth in PC market, according to IDC's latest forecast. + 3. Demand for MacBook Pro was strong, helping to drive overall portables growth of 10%, twice the growth of portables margin. + 4. Ended qtr. at low-end of 4-5 week target range for Mac channel inventory. + 5. iPad: + 1. Sold 8.9m units. + 1. Ahead of expectations, despite supply constraints throughout qtr. + 2. Saw growth in US and revenue growth worldwide for 9.7-inch and larger iPads over last four quarters. + 3. Channel inventory was essentially flat from beginning to end of qtr. + 1. Exited just below 5-7 week target range. + 4. Successful in segment of tablet market where Co. competes. + 5. Recent data from NPD indicates that iPad had 81% share of US market for tablets priced above $200. + 6. In February, 451 Research measured consumer satisfaction rates for iPad that ranged from 95% for 9.7-inch iPad Pro to 100% for the 12.9-inch version. + 7. Among US consumers planning to purchase a tablet within next six months, purchase intention for iPad was 69%. + 1. Corporate buyers reported 96% satisfaction rate and a purchase intent of 68% for June qtr. + 8. All products continue to be popular and drive mobile transformation in enterprise market. + 1. Set a new enterprise revenue record for March qtr. + 1. Expects this momentum to continue for remainder of the year. + 6. Other Details: + 1. Recently, Volkswagen selected iPhone as their corporate standard smartphone. + 1. 620,000 employees around the world had the opportunity to enjoy best-in-class mobile experience that iPhone offers. + 2. Capital One has reimagined customer banking experience by empowering their associates with Mac and Apple Watch and over 40 native iOS applications now running on nearly 30,000 iPhones and iPads. + 3. Seeing strong momentum with enterprise partners who are helping deliver long-lasting innovation and differentiation for iOS vs. competing platforms. + 4. Deloitte partnership is off to great start, with more than 115 customer opportunities in pipeline across 15 different industries. + 5. SAP released SAP cloud platform, SDK for iOS at March-end, and over 3m SAP developers now have an even better means to develop powerful iOS native apps for enterprise. + 6. Partnership with Cisco enables optimized performance of iOS devices over their networks and is generating a large and growing pipeline of sales opportunities across multiple verticals, including health care and financial services. + 7. Partnership with IBM continues to drive greater productivity and innovation with IBM MobileFirst for iOS apps now in more than 3,300 client engagements. + 1. With its Mobile at Scale offering, IBM recently closed an agreement to deploy 11,000 iOS devices at Santander Bank to drive digital transformation. + 7. Retail & Online Stores: + 1. Produced great results, with strong revenue growth in all geographic segments and 18% growth overall. + 2. Visitors to retail and online stores up 16% YoverY. + 3. Added four new stores during March qtr. + 4. With opening of store in Dubai last week, Co. is now at 495 stores in 18 countries. + 8. Cash: + 1. 2Q17-end cash plus marketable securities $256.8b. + 1. Increased $10.8b sequentially. + 2. $239.6b of this cash, or 93% of total was outside US. + 2. Issued $11b in debt. + 1. Term debt $88.5b. + 2. Commercial paper outstanding [$10b]. + 3. Returned over $10b to investors during the qtr. + 1. Paid $3b in dividends and equivalents. + 2. Spent $4b on repurchases of 31.1m Co. shares through open market transactions. + 4. Launched a new $3b ASR, resulting in initial delivery and retirement of 17.5m shares. + 1. Retired 6.3m shares upon the completion of ninth accelerated share repurchase program in February. + 5. All aforementioned activities contributed to net diluted share count reduction of 66.3m shares. + 6. Now completed $211.2b of $250b capital return program, including $151b in share repurchases. + 9. Program Update: + 1. Extending by four quarters through March 2019 and increasing size to total of $300b. + 2. Given strong confidence in Co.'s future and value it sees in its stock, allocating majority of program expansion to share repurchases. + 1. Board has increased share repurchase authorization by $35b, raising it from current $175b level to $210b. + 2. Will continue to [net share settle vesting employees'] restricted stock units. + 3. Raising dividend for fifth time in less than five years. + 1. Quarterly dividend will grow from $0.57 per share to $0.63 per share. + 1. Up 10.5%. + 2. This is effective with next dividend, which the Board has declared on [05/02/17], payable on 05/18/17 to shareholders of record as of 05/15/17. + 2. With over $12b in annual dividend payments, proud to be one of the largest dividend payers in the world. + 1. Continues to plan for annual dividend increases going forward. + 4. With this updated program, during next eight quarters, expects to return $89b to investors. + 1. Represents about 12% of market cap at current stock price. + 2. Expects to continue to fund capital return program with current US cash, future US cash generation and borrowing from domestic and international debt markets. + 5. Will continue to review capital allocation regularly, taking into account the needs of business, investment opportunities and financial outlook. + 10. 3Q17 Outlook: + 1. Revenue $43.5-45.5b. + 2. GM 37.5-38.5%. + 3. OpEx $6.6-6.7b. + 4. OI&E about $450m. + 5. Tax rate about 25.5%. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) First, we'll hear from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + My first question is for Luca around gross margin. How were you able to expand gross margin sequentially and guide rather seasonally for the June quarter in light of what's going on in the memory market? And maybe if you can comment, in particular, whether the holdback of payments to Qualcomm is benefiting you at all on gross margins year-on-year, and also whether your contracts around commodity prices is likely to hit gross margins by more in the back half of this calendar year. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Thank you, Katy, a lot of questions. Let me take one by one. Let me start with our performance for the March quarter, which we were very happy with. As you said, we were up 40 basis points sequentially, and this is in spite of the fact, as you know, that we lose leverage as we go from the December quarter to the March quarter. The foreign exchange headwind on a sequential basis was 100 basis points. Obviously, that was also a negative. And as you said, we started to experience some level of cost pressure on the memory side, particularly on NAND and DRAM. To offset that and actually do better than that, we had very good cost performance on other commodities. And the fact that our Services mix increases as we go through the year, that is, of course, also helping given the profile of our gross margin for Services. So that answers the question around Q2. +As we move into the June quarter, as you know, we tend to have some level of gross margin compression as we go from the March quarter to the June quarter. Again, the majority of that comes from the sequential loss of leverage. We also have a different mix of products as we move into the June quarter. And the cost pressures on memory will remain. We expect to offset partially these impacts with other cost efficiencies and again, with a mix shift towards Services. Yet, the impact on NAND and DRAM will continue to be there, and we expect it to be there. You know we don't guide past the June quarter, but we expect it to be there for the time being. +On Qualcomm, I just want to make it very, very clear that we are accruing. We do not expect to be paying more than what we are accruing right now. So we didn't get any benefit in our P&L, in our margins during the March quarter, and we're not getting any benefit during the June quarter either. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- + + And just a follow-up for Tim. As you noted in your remarks, the iPhone 7 Plus demand it's selling incredibly well, and this is a product that was pretty severely supply constrained in the December quarter. And I just wonder whether there are any lessons learned as you go forward into future product launches around how you manage the timing of announcing a product when there's supply constraints and how you might work with the supply chain differently around ramping some of these components that have particular difficulties around the yields early on. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- + + Yes. Katy, one of the things that we did not get right was the mix between the iPhone 7 and the iPhone 7 Plus. There was -- wound up the demand was much stronger to the 7 Plus than we had predicted. And so it took us a little while to adjust all the way back through the supply chain and to bring iPhone 7 Plus into balance, which occurred in this early -- this past quarter. What did we learn from it? Every time we go through a launch, we learn something. And you can bet that we're brushing up our models, and we'll apply everything we learned to the next time. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + We'll go to Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [7] +-------------------------------------------------------------------------------- + + Tim, can you talk a bit about what's going on in China and give us some more color, especially as you're going through the year? And then obviously, you won't talk about the next product launch. But just are there any shifts in demand with Greater China down 14%? Was it all iPhone or mix? Anything you can provide, and then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [8] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question, Shannon. We saw in Q2 the -- a performance that, combined with Q1 and that formed the first half of the year, was much better than what we experienced in the second half of last year. And if you look at what was driving that, iPhone 7 Plus, we sold the highest number of Plus models in the first half than ever before compared to 6s Plus or compared to the 6 Plus. We -- also the Mac business did extremely well. The Mac revenue growth was up 20% in China, and we had extremely strong Services growth during the quarter in China. As I've mentioned in the -- in my comments, our retail and online stores did well overall, and in China they grew by 21%, which is an acceleration from what we had seen in the previous quarter. +And traffic, which, for us, is incredibly important in the retail stores because we do a lot more than sell, traffic was up 27% year-on-year. And now 7 of our top 10 highest traffic stores in the world are in Greater China. And so that's the set of things that sort of went in our direction, so to speak. +On the flip side, currency devalued by 5%, and so that's not an insignificant headwind. And our performance continued to be weak in Hong Kong, which has been hit a bit harder as the tourism market continues to slump. Also where the iPhone 7 Plus did well, we didn't perform as well on some of the previous generation iPhones. And so that's sort of the set of things on the plus and minus side. We did perform about where I thought we would. In fact, I thought it would be similar to the previous quarter and it was. What I now believe is that we'll improve a bit more during this current quarter, not back to growth but improve -- but make more progress. And we continue to believe that there's an enormous opportunity there. And in the scheme of things, our business is pretty large there. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [9] +-------------------------------------------------------------------------------- + + And then just -- I don't know if Luca wants to take this or -- but thoughts on cash usage, you increased your program, but you still have, I think, $160 billion of net cash and obviously continue to generate cash. So I'm curious as to -- given some of the commentary that's come out of the administration, which I think most companies were expecting some sort of return, how do you generally think about what you need to run the business from a cash perspective, how you think about the balance sheet from a, I don't know, strength perspective, just as we look forward to what hopefully will come through? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO and SVP [10] +-------------------------------------------------------------------------------- + + Well, Shannon, you know how we run our capital return program. We've been pretty consistent during the last 5 years. Essentially for the last 5 years, the way we've run the company is essentially to return our free cash flow to our investors. That's what we've done with the program until now, and the expansion of the program that we've announced today goes in the same direction, right? We know how much we need to invest in the business. We will never under-invest in the business. We're in a very fortunate position that we generate cash beyond the needs that we have. And given the current capital structure that we have, we decided that until now we return about 100% of the free cash flow to investors. It's difficult for us to speculate about what might or might not happen. The program that we're announcing today reflects the current tax legislation in this country. And there's a lot that still needs to happen there, and we'll see. Obviously, we will reassess our situation if things change. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + From JPMorgan, Rod Hall. + +-------------------------------------------------------------------------------- +Roderick B. Hall, JPMorgan Chase & Co, Research Division - VP and Senior Analyst [12] +-------------------------------------------------------------------------------- + + I wanted to start off just going back to the 165 million subscriptions and ask Tim or Luca if you could comment on the unique number of users there. And I think you had made a comment, Tim, in your prepared remarks that the average revenue per user is up, or maybe that was you, Luca. But if you guys could just talk about any more color around that average revenue per user, it would be interesting to us. And then I have one follow-up to that. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO and SVP [13] +-------------------------------------------------------------------------------- + + Yes. I'll take it, Rod. We don't disclose into this number of subscriptions. Of course, we're just giving you the total count of subscriptions that are out there. Of course, there are several customers that subscribe to more than one of our services. There is some level of overlap, but the total number of subscribers is very, very large, obviously less than 165 million. But it's very good for us to see the breadth of subscriptions that we offer and that customers are interested in. It's a large number. +And if you remember, we quoted the same number a quarter ago, and we talked about 150 million. So when you think about a sequential increase of 15 million subscriptions from the December quarter to the March quarter, it really gives you a sense for the momentum that we have on our content stores, right? It's quite impressive to add 15 million subscriptions in 90 days. On -- as we look at the dynamics that are happening on our content stores and particularly on the App Store, which is the largest, we see fairly consistently 2 things. We see that the number of paying accounts is growing a lot. And I mentioned the increase in number of paying accounts that we've had during these last 90 days is the largest that we've ever had. So there's a very large number of people coming into the ecosystem, experiencing the ecosystem, which is obviously improving all the time in quality and quantity, and then start paying and transacting on the -- on our stores. And that number is growing very, very strongly, strong double digits. +What we're also seeing, as we look at the people that start paying on our stores, we see a pretty common trend over time, and we keep track of that across cohorts of customers, that as people come into the ecosystem and start paying on the ecosystem, we see a spending profile that is very similar around the world. People start at a certain level, and then they tend to spend more over time. And so obviously, the combination of people spending more over time and adding more people that are now actually spending on the stores contributes to this 40% growth that Tim mentioned for the App Store on a year-over-year basis. + +-------------------------------------------------------------------------------- +Roderick B. Hall, JPMorgan Chase & Co, Research Division - VP and Senior Analyst [14] +-------------------------------------------------------------------------------- + + And then I had a follow-up for Tim. Tim, I wanted to just ask -- the Services revenue keeps growing, and of course, the profit contribution from that is growing. And we've also, at the same time, I think, seen you maybe a little more aggressive than Apple has been historically in pricing certain key technologies, let's call them, that maybe you want to penetrate the market with. And I just wonder if you could just comment a little bit on your strategy there in terms of the usage of that extra profit contribution from that Services business, how you intend to apply it to the rest of the business. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [15] +-------------------------------------------------------------------------------- + + Rod, the way that we think about pricing is we come up with a price that we think is a good value for the product that we're delivering, and we do that on the hardware side as well as on the Services side. And so that's how we think about it. We're really not thinking about taking profits from one to subsidize the other or vice versa. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + From UBS, Steve Milunovich. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [17] +-------------------------------------------------------------------------------- + + Tim, could you comment on the opportunity in wearables? The Watch, some people consider disappointing. It had what seems to be a very good quarter, and ironically, the competition almost seems to be fading in that part of the market right now. The AirPods, of course, are doing well. Do you see wearables, a, expanding over time into a broader product line; and b, increasingly being independent of the iPhone longer term? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [18] +-------------------------------------------------------------------------------- + + Thanks for the question. We have seen the Watch as a really key product category for us since before we launched it. And we took our time to get it right, and we've made it even better with the Series 2 offering. And we're really proud of the growth of the business. The Watch units more than doubled in 6 of our top 10 markets, which is phenomenal growth, particularly in a non-holiday quarter. And so we couldn't be more satisfied with it. When -- as some people are doing, when you begin to combine that -- combine the Watch revenues with the revenues for AirPods, this was the first -- as you know, this is the first full quarter of shipments for AirPods, but it's still very much in the ramping mode. And we're not coming close to satisfying the demand. +And then add the Beats products that our -- a group of our customers really enjoy as well and look on the trailing 12 months. So this is not a forecast. That business was well into the Fortune 500. And so as I look at that, that's pretty fast to come that far. The Watch hasn't been out very long, and AirPods have been out there for 3, 4 months. And so we feel really great about it. +Where does it go? I wouldn't want to comment on that, but we do have a really great pipeline here. And I think in terms of competition falling out and so forth, it's -- the watch area is really hard. It, in essence, from an engineering point of view, is similar to a phone in terms of the intricacies and so forth. And so it's not -- I'm not very surprised that some people are falling out of it. But we're very committed to it and believe that -- it's already a big business and believe over time it will be even larger. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [19] +-------------------------------------------------------------------------------- + + And then there was a -- you mentioned a 451 Research survey. They did have a couple of findings that were kind of interesting. One is a 9-year low in iPhone purchase intent, and that might just be where you are in the cycle. And the other was a declining retention rate in the U.S. toward 80%. Any comment on either of those and whether you're concerned? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [20] +-------------------------------------------------------------------------------- + + I only glanced at it, and so I haven't had time to study it. But in general, what we are seeing, we're seeing what we believe to be a pause in purchases on iPhone, which we believe are due to the earlier and much more frequent reports about future iPhones. And so that part is clearly going on, and it could be what's behind the data. I don't know, but we are seeing that in full transparency. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + From Bernstein, we'll go to Toni Sacconaghi. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + I have 2 as well. First, Tim, I'm wondering if you can comment on your recent decision and the rationale for withholding royalty payments to Qualcomm. And really specifically, I wonder what you believe is the risk that Qualcomm could have a detrimental response such as withholding modem chip sales or potentially even getting an injunction on iPhones in select geographies around the world. And I'd like to understand your perspective on whether either of those are real risks to any degree and why would Apple potentially take on those risks just in advance of what will arguably be your most significant and largest product launch in history. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [23] +-------------------------------------------------------------------------------- + + The -- anyone that has a standards-essential patent has a responsibility to offer it to everyone that would like it under what is -- are called FRAND terms. FRAND stands for fair, reasonable and nondiscriminatory terms. That's both the price and the business terms. Qualcomm has not made such an offer to Apple, and so I don't believe that a -- I don't believe anyone's going to decide to enjoin the iPhone based on that. I think that there's plenty of case law around that subject. But we shall see. +In terms of why we're withholding royalties, you can't pay something when there's a dispute about the amount. You don't know how much to pay. And so they think we owe some amount. We think we owe a different amount. And there hasn't been a meeting of the minds there, and so at this point, we need the courts to decide that unless we are able to, over time, settle between us on some amount. But right now we're depending upon the courts to do that, and so that is the thinking. +The reason that we're pursuing this is that Qualcomm's trying to charge Apple a percentage of the total iPhone value, and they do some really great work around standards-essential patents, but it's one small part of what an iPhone is. It's not -- it has nothing to do with the display or the Touch ID or a gazillion other innovations that Apple has done. And so we don't think that's right. And so we're taking a principled stand on it, and we strongly believe we're in the right. And I'm sure they believe that they are, and that's what courts are for. And we'll let it go with that. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + I was wondering if you -- if I could just follow up a little bit on iPhone demand. If I try and adjust for the drawdown in inventory and the extra week last quarter, I think sequentially, iPhones declined about 27% if I make those adjustments. And that's actually quite a bit lower than the normal seasonality we would see from Q1 to Q2, which is typically closer to 20%. I understand your comments around China, but your comparison was 40 points easier this quarter relative to last quarter, and the growth rate improved only marginally, I think, when you adjust for the extra week. +So -- and then you made a final comment around a pause on iPhones. So I'm wondering if you could maybe elaborate on was the below sequential, at least by my calculation, growth rate in Q2 attributable to a pause. And can you characterize what you think upgrade rates are doing, perhaps broadly by geography, to help us better understand what might be happening or whether there are competitive dynamics that also are at play here that, again, might be contributing to that pause and that sequential decline that I referenced? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [25] +-------------------------------------------------------------------------------- + + A lot of questions there. Let me give you some color as I see it. In this quarter, we reduced channel inventory by 1.2 million units. And so if you look on a year-over-year basis, which is primarily what we look at from a unit point of view because it would have the seasonality embedded in that, we grew sell-through on a year-over-year basis. Last quarter, I'm sure other folks remember, was a 14-week quarter, and so you sort of have to adjust the rates last quarter to get at what the underlying sell-through growth was. And so I think that when you do that, you're going to find that, actually, the year-over-year performance is similar between the quarters. +In terms of upgraders, we saw the largest absolute number of upgraders ever in any 6-month period in the first half of this year, first half of this fiscal year to be precise. And we saw the largest absolute number of switchers outside of Greater China in the same period that we've ever seen. And so in 4 of the 5 operating segments, as I think Luca mentioned in his comments, we had very good growth, and it was really propelled by the demand for iPhone 7 Plus, which is growing incredibly fast around the world. And so that's kind of the color I would add there, and hopefully, some of that are -- is useful for you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + We'll go to Simona Jankowski with Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Kiritsov Jankowski, Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst [27] +-------------------------------------------------------------------------------- + + Had a question for Luca first. Last year, you had a 4-million-unit channel inventory reduction for the iPhone in the June quarter. So just curious what you're expecting for this year just so we have an apple-to-apple comparison as we think about your guidance. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO and SVP [28] +-------------------------------------------------------------------------------- + + As you know, Simona, we do not provide guidance around units and around channel inventory reduction, but our goal is always to have the right amount of weeks of inventory in the channel. And if you look at our history over the last several years, we have fairly consistently reduced channel inventory in the June quarter, so I think it's a fair expectation to have. + +-------------------------------------------------------------------------------- +Simona Kiritsov Jankowski, Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- + + And then just for Tim. Tim, you've been excited about the India market for some time and have made strides in establishing a retail, manufacturing and R&D presence there. So just curious as you look at that market and the rollout of 4G there, is it reasonable for us to assume that Apple can sell something on the order of 10 million to 20 million iPhones there next year and then grow from there? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [30] +-------------------------------------------------------------------------------- + + We make it a point not to forecast by geo. We just provide a current quarter forecast. But as hopefully you've seen, as we began to give you more information about India, we've been investing quite a bit. We have a ton of energy going into the country on a number of fronts. And it is the third-largest smartphone market in the world today behind the -- China and the United States. And so we believe, particularly now that a -- the 4G infrastructure is going in the country and it's continuing to be expanded, there is a huge opportunity for Apple there. And so that's -- that and the demographics of the country is why we're putting so much energy there. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Jim Suva with Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [32] +-------------------------------------------------------------------------------- + + Congratulations on returning to growth consistently. That's great. I believe, Tim, in your prepared comments, you mentioned India was growing double digit, which is great. But I believe if we look at geographic information, India is really underpenetrated from an Apple reception perceptive, but yet they have LTE. You have the iPhone SE, your lower-priced iPhone. Do you think that, say, this next 12, 18 months is going to be a turning point? Or is it more you need to work with the government to have Apple-owned stores or production there? Or what's it really going to take to get India going along because we think it's just truly a great opportunity? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO and Director [33] +-------------------------------------------------------------------------------- + + Well, we think it's a great opportunity too, and so we're bringing all the things that we've brought to bear in other markets that we've eventually done well in. And that's from channel to stores to our ecosystem and so forth. Phil was just over there opening a developer center last quarter. And so there's a -- there are a ton of things going on there. And we agree that we are underpenetrated there. Our growth rates are good, really good in -- by most people's expectations. Maybe not mine as much. And so we're putting a lot of energy in it, just like we have in other geos that eventually wound up producing more and more. And so I'm very excited about it. The 4G network investment really began rolling in, in a significant way toward the last quarter of last year, as you know, and -- but they are moving fast. They're moving at a speed that I have not seen in any other country in the world once they were started. And it is truly impressive. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [34] +-------------------------------------------------------------------------------- + + A replay of today's call will be available for 2 weeks as a podcast on the iTunes Store, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 3540172. And these replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at (408) 974-4570, and I'm at (408) 974-5420. And thank you again for joining us. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2017-Nov-02-AAPL.txt b/Transcripts/AAPL/2017-Nov-02-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..5314b27048bda67663b9d32e7e0f793735d35468 --- /dev/null +++ b/Transcripts/AAPL/2017-Nov-02-AAPL.txt @@ -0,0 +1,486 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q4 2017 Apple Inc Earnings Call +NOVEMBER 02, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - Senior VP & CFO + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Amit Jawaharlaz Daryanani + RBC Capital Markets, LLC, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal and Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Brian John White + Drexel Hamilton, LLC, Research Division - Global Head of Technology Hardware and Software, and Senior Equity Research Analyst + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD and Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +AAPL reported 4Q17 revenues of $52.6b and net income of $10.7b or $2.07 per diluted share. Expects 1Q18 revenue to be $84-87b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 4Q17 revenue = $52.6b. + 2. 4Q17 net income = $10.7b. + 3. 4Q17 diluted EPS = $2.07. + 4. 4Q17 YoverY revenue growth = 12%. + 5. 4Q17 GM = 37.9%. + 6. 4Q17-end cash plus marketable securities = $268.9b. + 7. 4Q17 share repurchase = 29.1m shares for $4.5b. + 8. 1Q18 revenue guidance = $84-87b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 4Q17 Review (T.C.) + + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Biggest year ever in most parts of world, with all-time record revenue in: + 1. US. + 2. Western Europe. + 3. Japan. + 4. Korea. + 5. Middle East. + 6. Africa. + 7. Central and Eastern Europe. + 8. Asia. + 2. Had particularly strong finish this year. + 1. Generated highest Sept. qtr. revenue ever as YoverY growth accelerated for fourth consecutive qtr. + 3. Revenue $52.6b. + 1. Above high-end of guidance range. + 2. Up 12% YoverY. + 3. Generated revenue growth across all product categories. + 1. Showed all-time record results for Services business. + 4. As expected, returned to growth in Greater China with unit growth and market share gains for iPhone, iPad and Mac. + 1. All-time record qtr. for Mac sales in mainland China and all-time high for Services revenue. + 5. Revenue from emerging markets outside of Greater China was up 40% with great momentum in India, where revenue doubled YoverY. + 6. Had great results in enterprise and education with double-digit growth in worldwide customer purchases of iPad and Mac in both markets. + 7. GM in Sept. qtr. was at high-end of guidance range. + 8. Record EPS, $2.07. + 1. Up 24% YoverY. + 2. IPhone: + 1. Sales exceeded expectations. + 2. In last week and a half of Sept., Co. began shipping iPhone 8 and iPhone 8 Plus to customers in more than 50 countries. + 1. They instantly became Co.'s two most popular iPhone models and have been every week since then. + 3. Launch of iPhone 10 is now underway as stores open across Australia and Asia. + 1. iPhone is 10 packed with innovative new technologies that chart Co.'s path for next decades. + 2. Orders have already been very strong. + 1. Working to get iPhone 10 into customers' hands as quickly as possible. + 3. Services: + 1. Revenue reached an all-time quarterly record of $8.5b in Sept. qtr. + 1. Few quarters ago, Co. established a goal of doubling FY16 revenue of $24b by 2020. + 1. Well on way to meeting that goal. + 2. In FY17, reached $30b, making Services business already the size of a Fortune 100 co. + 4. iPad: + 1. Second consecutive qtr. of double-digit unit growth. + 1. Customers responded positively to new iPad lineup. + 5. iOS: + 1. Launch of iOS 11 made iOS world's largest platform for augmented reality (AR). + 1. Believes AR is going to change the way one uses technology forever. + 2. iOS 11 is allowing developers to integrate machine learning models into apps with Core ML. + 6. Mac: + 1. Had best year ever with highest annual Mac revenue in Co. history. + 1. Best Sept. qtr. ever with 25% Mac revenue growth, driven by notebook refreshes Co. launched in June and a strong back-to-school season. + 2. Mac experience has become even better since Sept. launch of Mac OS High Sierra with new technologies to make Mac more reliable, capable and responsive and lay foundation for future innovation. + 7. Apple Watch: + 1. Unit growth over 50% for third consecutive qtr. + 1. Continues to be best-selling and most loved smart watch in world. + 2. Began shipping Apple Watch Series 3 just six weeks ago. + 1. Customers love new freedom of cellular. + 3. Excited about upcoming Apple Heart Study, which will use data from Apple Watch to identify irregular heart rhythms and notify users when unusual patterns are detected. + 4. Earlier this week, introduced watchOS 4.1, bringing 40m songs through Apple Music. + 1. Thrilled with the momentum of these products. + 5. Entire wearables business was up 75% YoverY in 4Q. + 1. In FY17, already generated annual revenue of a Fortune 400 co. + 8. Apple TV: + 1. Late in Sept. qtr., launched Apple TV 4K, delivering a stunning cinematic experience at home. + 9. Other Details: + 1. Apple Michigan Avenue: + 1. Opened two weeks ago on Chicago's Riverfront. + 2. First store that brings together Co.'s complete vision for future of Apple retail, providing a welcoming place for everyone to experience products, services and inspiring educational programs right in heart of their city. + 3. In addition to popular Today at Apple programing, which is available in all Apple Stores around world, Apple Michigan Avenue is partnering with local non-profits and creative organizations to make an ongoing positive impact in that community. + 2. Swift Curriculum: + 1. Expanded free app development with Swift curriculum to more than 30 community colleges across country. + 2. Excited about this initiative and thrilled by momentum Co. is seeing. + 1. Schools Co. launched with summer are just beginning. + 3. As Co. approaches holiday season, expects it to be Co.'s biggest qtr. ever. + +-------------------------------------------------------------------------------- +II. 4Q17 Financials (L.M.) + + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Sept. qtr. revenue $52.6b; record. + 1. Up 12% YoverY. + 2. Growth rate accelerated in every qtr. of FY17. + 1. Terrific qtr. performance was broad based with: + 1. Revenue growth in all product categories for second qtr. in a row. + 2. New Sept. qtr. revenue records in Americas, Europe and the Rest of Asia Pacific segments. + 2. Grew double-digits in US, Canada, Germany, France, Italy, Spain, Korea and several other developed markets. + 3. Returned to growth in Greater China. + 1. Revenue up 12% YoverY. + 4. With momentum in India, revenue doubled YoverY. + 5. Grew more than 30% in Mexico, Middle East, Turkey and Central and Eastern Europe. + 3. Aforementioned results helped to fuel overall growth of over 20% from emerging markets. + 4. GM 37.9%, at high-end of guidance range. + 5. Operating margin, 25% of revenue. + 6. Net income $10.7b. + 7. Diluted EPS $2.07; new Sept. qtr. record. + 1. Up 24% YoverY. + 8. Cash flow from operations $15.7b; strong. + 2. iPhones: + 1. Sold 46.7m, up 3% YoverY. + 2. Saw double-digit iPhone growth in many emerging markets including mainland China, Middle East, Central and Europe, India and Mexico. + 1. Gained shares also in Canada, Germany, France, Italy, Spain, Sweden and Singapore based on latest estimates from IDC. + 3. Channel inventory increased 1.3m units sequentially to support launch of iPhone 8 and 8 Plus, significantly less than increase in Sept. qtr. year ago. + 4. In US, latest data from 451 Research on consumers indicates a customer satisfaction rating of 97% or higher across all iPhone models. + 1. Among consumers planning to buy a smartphone in next 90 days, purchase intension for iPhone was 69%, more than five times rate of closest competitor with a loyalty rate for current iPhone owners of 95% vs. 53% for next highest brand. + 2. For corporate smartphone buyers, iOS customer satisfaction was 95% and of those planning to purchase smartphones in Dec. qtr., 80% plan to purchase iPhone; highest score for iPhone in history of survey. + 3. Services: + 1. Set all-time quarterly record of $8.5b, up 34% YoverY. + 2. Results included favorable one-time revenue adjustment of $640m. + 1. On run-rate basis, excluding adjustments, services growth of 24% was terrific and highest that Co. has experienced this year. + 3. App Store set a new all-time record. + 1. According to App Annie's latest report, it continues to be preferred destination for customer purchases by a wide and growing margin, generating nearly twice the revenue of Google Play. + 2. Getting great response to App Store's new design in iOS 11 from customers and developers. + 1. Seeing increases in frequency of customer visits, amount of time they spend in store and number of apps they download. + 4. Success of Apple Music continues to build. + 1. Seeing highest conversion rates from customers trying the service. + 2. Revenue grew strongly in Sept. qtr. + 3. Number of paid subscribers was up over 75% YoverY. + 5. Saw great performance from iCloud business, with strong double-digit growth in monthly avg. users and revenue. + 6. Across all services offerings, number of paid subscriptions reached over 210m at end of Sept. qtr., an increase of 25m in last 90 days. + 7. Apple Pay: + 1. Expanded to Denmark, Finland, Sweden and UAE last month. + 1. Continues to grow rapidly. + 2. Over past year, active users have more than doubled and annual transactions are up 330%. + 3. In US, 70% of leading grocery chains are now accepting Apple Pay with recent launch of Safeway. + 1. Over 5m US merchant locations will be Apple Pay enabled by end of this year. + 4. Mac: + 1. Set a new all-time revenue record of $25.8b in FY17. + 2. Sold 5.4m Macs during Sept. qtr., up 10% YoverY. + 3. Gained significant market share as global market contracted 1% based on IDC's latest estimate. + 1. Performance was fueled primarily by greater demand for MacBook Pro. + 4. Revenue grew 25% to new Sept. qtr. record. + 5. Had outstanding results all around the world with each geographic segment growing Mac revenue by 20% or more. + 6. Happy with success of Mac in education market. + 1. Customer purchases grew double digits YoverY. + 5. iPad: + 1. Sold 10.3m units. + 1. Up 11% YoverY with strong demand for iPad and iPad Pro. + 2. Revenue grew 14%. + 3. Saw iPad unit and revenue growth in all geographic segments and strong results in emerging markets, including Greater China, where iPad unit sales were up 25% YoverY and India, which grew 39%. + 4. NPD indicates iPad had 54% share of US tablet market in Sept. qtr., including 7 of 10 best-selling tablets. + 1. Up from 47% share a year ago. + 5. Most recent surveys from 451 Research measured customer satisfaction rates of 97% across iPad models and among people planning to buy tablets purchase intent for iPad was over 70% for consumers and businesses. + 6. Enterprise Market: + 1. Seeing great momentum with enterprise initiatives. + 2. During Sept. qtr., announced new partnership with Accenture, who is creating a dedicated iOS practice in select locations around world. + 1. Experts from Co. are collocating with this team. + 1. Together they will be launching new tools and services that have enterprise clients transform how they engage with customers using iPhone and iPad. + 3. Last month, announced a partnership with GE to reinvent the way industrial companies work by bringing GE's industrial IoT platform to iOS. + 1. Prefix SDK for IOS will enable developers to build native apps to drive industrial operations with more efficiency and speed than ever before. + 2. GE is also standardizing on iPhone and iPad for its global workforce of more than 330,000 employees. + 1. Working with Co., GE is developing iOS apps for internal and external audiences to bring predictive data and analytics to workers across broad range of industries. + 4. Seeing great traction for Mac in enterprise market with all-time record customer purchases in FY17. + 7. Stores: + 1. Sept. qtr. was strong for retail and online stores, which welcomed 418m visitors. + 1. Traffic was particularly heavy during week of new product announcements, up 19% over last year. + 2. Retail ran a successful back-to-school promotion in Americas, Europe, China and Singapore with sales of Mac and iPad Pro up strong double-digits vs. last year's program. + 1. Around the world, stores conducted over 200,000 Today at Apple sessions during qtr. + 8. Cash Position: + 1. 4Q17-end cash plus marketable securities, $268.9b. + 1. Up $7.4b sequentially. + 2. $252.3 of cash, 94% for total, was outside US. + 2. Issued $7b in new Canadian and US dollar denominated debt during qtr., bringing Co. to $104b in term debt and $12b in commercial paper outstanding. + 3. Returned $11b to investors during qtr. + 1. Paid $3.3b in dividends and equivalents and spent $4.5b on repurchases of 29.1m shares through open market transactions. + 2. Launched new $3b ASR program, resulting in initial delivery and retirement of 15.1m shares. + 1. Retired 4.5m shares upon completion of 11th ASR during qtr. + 3. Completed almost $234b of $300b capital return program, including $166b in share repurchases. + 9. Dec. Qtr. Outlook: + 1. Dec. qtr. in FY17 spanned 14 weeks. + 1. Dec. qtr. this year will include usual 15 weeks. + 2. Revenue $84-87b. + 3. GM 38.0-38.5%. + 4. OpEx 7.65-7.75b. + 5. OI&E about 600m. + 6. Tax rate about 25.5%. + 10. Others: + 1. On 11/02/17, Board of Directors declared cash dividend of $0.63 per share of common stock, payable on 11/16/17 to shareholders of record as of 11/15/17. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) First, we'll hear from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- +Luca, when do you expect to catch up with iPhone X demand? And given it's likely to be not in the December quarter, should we think about March as a better-than-seasonal revenue quarter because of that iPhone X ramp? And then, I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- +I'll take that, Katy. It's Tim. The ramp for iPhone X is going well, especially considering that iPhone X is the most advanced iPhone we've ever created and it has lots of new technologies in it. And so we're really happy that we're able to increase week-by-week what we're outputting, and we're going to get as many of them as possible to the customers as soon as possible. And so it's -- I can't predict at this point when that balance will happen. We -- and on -- in terms of March, we obviously don't give -- we don't give guidance beyond the current quarter. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- +Okay. And in China, growth returned to strong double digits, 12% up. You've talked historically about that region being more sensitive than others to form factor changes and the new iPhone X form factor was not available in September. And so, should we assume that growth in that region only accelerates from here as that new product gets pushed into the market? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- +Let me talk a little bit about Q4 in China to give you a little bit of color on the results. The -- we increased market share for iPhone, Mac and iPad during the quarter. We hit all-time revenue records for services and for Mac in the -- for the PRC during the quarter. We had very strong iPad revenue growth. We had double-digit unit growth in iPhone, and both the upgraders and Android switchers were both up on a year-over-year basis during the quarter. And so, the results were broad based. They were pretty much across the board, as I indicated. The other thing that happened is that the decline that we've been experiencing in Hong Kong moderated. And so it's still down year-over-year, but less so than it was. And part of that is the compare is an easier compare. And then, finally, in terms of another headwind that is a little less than it was, currency has been affecting us more significantly last quarter in China. It affected us 1 percentage point. And so the sum of all that, I feel great about the results. We don't obviously provide geographic-specific guidance, but you can see from our overall guidance, we think we're going to have a really strong quarter. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +From Piper Jaffray, Mike Olson. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [7] +-------------------------------------------------------------------------------- +Is there any information you can provide on how iPhone X preorders compare to what you saw with iPhone 8 preorders? And then, I have a follow-up as well. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- +Michael, we never go through mix. But I would share with you that the iPhone X orders are very strong for both direct customers and for our channel partners, which as you know, are lots of carrier throughout the world. And we couldn't be more excited to get underway. And I think as of a few minutes ago, the first sales started in Australia. And I'm told we had several hundred people waiting at the store in Sydney and I'm getting similar reports from across that region. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [9] +-------------------------------------------------------------------------------- +And we're excited about augmented reality. And from your perspective and maybe from our perspective on the outside looking in, how do we gauge the success of AR? And what are some of the applications of the technology that you're most excited about today? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- +Yes, it's a great question. The reason I'm so excited about AR is I view that it amplifies human performance instead of isolates humans. And so, as you know, it's the mix of the virtual and the physical world. And so it should be a help for humanity, not an isolation kind of thing for humanity. As I go through different countries, as I've been traveling lately and looking at things, some things in the market, other things that are coming, the very cool thing is they're all over the place. I see things that the consumer's going to love because it's going to change shopping. I see things that consumers will love on the gaming side and the entertainment side. I see business-related AR apps as well that are going to be great for productivity and between small and large business. And I see apps that makes me want to go back to K-12 again and repeat my schooling because I think it changes the game in the classroom a lot. And so the real beauty here is that it's mainstream. And of course, Apple is the only company that could have brought this, because it requires both hardware and software integration and it requires sort of making a lot of -- or giving the operating system update to many people at once. And we -- and the software team worked really hard to make that go back several versions of iPhone so that we sort of have hundreds of millions of enabled devices overnight. And so there's 1,000-plus in the App Store right now. I think this is very much like in 2008, when we fired the gun in the overall App Store. And so, that's what it feels like to me, and I think it will just get bigger from here. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +From Cross Research, Shannon Cross. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [12] +-------------------------------------------------------------------------------- +A couple questions. The first, Tim, can you talk a bit about how you're thinking in terms of the lineup? You go from $340 -- and this is for iPhone. You go from $349 to above $1,000, and it appears that you probably sold a fair amount of the lower end, perhaps that was just some of the switchers in China and maybe drove some of the growth in China in terms of market share. But how are you sort of thinking about what went into the guidance for the December quarter? Are you seeing really strong demand at the low end? And obviously, expected benefit from the X at the high-end. I'm just trying to understand, because you have such a broader lineup than you've had in prior years. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [13] +-------------------------------------------------------------------------------- +Yes, in terms of what we saw in Q4, you can probably tell from the ASP, we had good success, I would say, through the different iPhones. And we've tried hard to have an iPhone that is as affordable as possible for people that really want an iPhone that may have a more limited budget, and we've got some iPhones that are really great for that market. And then, we've got 3 new iPhones, and people will look at these and decide which one they want. And so we -- this is the first time we've ever been in the position that we've had 3 new iPhones at once like this at the top end of the line. And it's the first time we've had a staggered launch. And so, we're going to see what happens. But we've put our absolutely best thinking that we have here in the guidance that Luca presented. And you can tell from that, that we're bullish. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal and Analyst [14] +-------------------------------------------------------------------------------- +Great. And then, in terms of services, $8.5 billion, up 34%. Can you talk about some of the portions of that, that outperformed? How sustainable? You mentioned China in terms of significant growth in services. But I'm just curious, it's a pretty remarkable number, so I'm curious what the drivers were. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- +Yes, Shannon, it's Luca. As I mentioned in the prepared remarks, there was a $640 million adjustment. There was a one-off change. And it's important to call it out because, of course, it's a one-off. And so, the underlying growth rate for services in the quarter was fantastic, was 24%, the highest growth rate that we've had for services during fiscal '17. So the business is going incredibly well. I would highlight maybe 3 of these businesses within services. The App Store set a new all-time record. It's growing incredibly well. The number of paying accounts continues to grow very strongly, and that's very, very important to us for the App Store business. Apple Music was up -- subscriptions were up 75% year-over-year. We're getting the highest conversion rates that we've had since the launch of the service. And so we turned the corner in music. You remember that a few years ago, we were actually declining in music; now with the streaming service in addition to the download business, the business is growing again. And that really helps the growth rate for the entire Services business. iCloud is a service that continues to grow very strong double digits, and that's also helping. So we already become the size of a Fortune 100 company. We set a goal for ourselves to double what we did in fiscal '16 and the trajectory is actually quite positive. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Steve Milunovich with UBS. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [17] +-------------------------------------------------------------------------------- +I wanted to try to push a little bit more on the mix. Could you comment whether the 8 Plus outsold the 8 in the quarter? There seems to be some data that suggests that. And the 451 Research survey that you're alluding to also finds that over the next 90 days, those buying an iPhone, 43% are planning on buying the X. Could you comment upon your expectations in terms of the mix going forward? And if you won't do that, perhaps you could comment a bit about you're thinking in terms of pushing price elasticity. I think a couple of years ago, no one would have imagined selling a phone at this price. And obviously, you're pretty confident that you can do it. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [18] +-------------------------------------------------------------------------------- +Obviously, I'm not going to talk about mix. It's not something that we've done in the past. If you look at the 8 and 8 Plus, when we launched them, they instantly became our top 2 selling products. If you look at 8 Plus in particular, to provide a little color there, 8 Plus for that -- for the period of time that we can measure to date, has gotten off to the fastest start of any Plus model. That, for us, was a bit of a surprise, and it's a positive surprise, obviously. And so we'll see what happens next. As I've mentioned before, we've never had 3 products, and it's only today that the first customers can certainly look at all 3 of those. And I'm sure there's been some people that wanted to do that before deciding even which one. And so we'll see what happens there. But in terms of price elasticity, I think it's important to remember that a large number of people pay for the phone by month. And so if you were to go out on the -- just the U.S., since that tends to be more the focus of this call. If you look at the U.S. carriers, I think you would find -- you could buy an iPhone X for $33 a month. And so if you think about that, that's a few coffees a week. It's less than a coffee a day at one of these nice coffee places. The other thing to keep in mind is that many people are now trading in their current iPhone on the next iPhone. And the residual value for iPhone tends to be the highest in the industry and many people pick up $300, $350 or so for their iPhone. And so that even reduces the monthly payment less. And then, obviously some carriers also have promotional things going on. And so I do think it's important to try to place it in that context. In terms of the way we price, we price to the sort of the value that we're providing. We're not trying to charge the highest price we could get or anything like that. We're just trying to price it for what we're delivering. And iPhone X has a lot of great new technologies in there that are leading the industry, and it is a fabulous product and we can't wait for people to start getting it in their hands. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [19] +-------------------------------------------------------------------------------- +And then, I wanted to ask. The Street historically has been a little skeptical about continued innovation, and you suggested there is more to grow. Historically, you weren't first to large screens. You weren't first to OLED. Now, though, you're leading in AR. You're leading with Face ID, which [the all-in a year ago, as some of your guys had suggested, was kind of very reminiscent of the aggressive Apple. Is it possible going forward that you could accelerate share gains from Android because you're now in a stronger competitive position? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- +I think, Steve, we've been in a competitive position. And so, I probably -- maybe have a different view than you do or the folks that you're quoting. There's always doubting Thomases out there. I've been hearing those for the 20 years I've been here and suspect I'll hear about them until I retire. And so, I don't really listen to that too much. There's lots of fantastic people here and they're doing unbelievable things. And yes, I view AR as profound. Not today, not the apps that you'll see on the App Store today, but what it will be, what it can be, I think its profound and I think Apple is in a really unique position to lead in this area. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +We'll go to Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- +Just following up a little bit on that question, Tim. You talked a bit about providing a lot of value and that Apple sets its prices according to value. And I think, given the uniqueness of the product you have with the iPhone X in particular, that makes a lot of sense. I guess, the question is, given the uniqueness of the value that you have in the marketplace, why shouldn't we -- should we or why shouldn't we expect gross margins to improve this cycle versus previous ones? And perhaps, you can talk a little bit about how you think about pricing in the context of gross margin. And I have a follow-up, please. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- +Toni, I'll take that one. When -- you said, we price our products for the value that we deliver. We also said that every time we launch new products, the cost structures of the new products tend to be higher than the products that they replace. It's inevitable. We are adding new technologies, new features. And therefore, the cost structures go up. We have a very good track record of taking those cost structures and, over the life cycle of the product, we are able to bring them down. There are a lot of elements in the gross margin line that we have good control over and we -- there are also elements that we don't control. Take for example, foreign exchange, which has been a significant headwind for the company for the last 3 years now. Also, the mix of products that we sell into the market tends to change over time. And that also has an impact on the overall gross margin for the company. There are situations where the commodities markets are in good shape. There are situations where commodity markets can be a bit out of balance. We have a case right now around memory pricing, which is a headwind for the time being. So there's many puts and takes. The fact that our Services business is growing should be a positive because our services margins tend to be accretive to company margin. So there's many puts and takes that we tend to think about maximizing gross margin dollars. And -- because we think that's the most important thing for investors at the end of the day. When we look at our track record over years, I think we found a good balance between unit growth and gross margins and revenue, and we will continue to do that as we go forward. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- +Okay. And then, I wanted to revisit this notion of supply and demand. And I realize it's very early and you can't make predictions. I think, a common investor question is the iPhone X was made available for sale; it quickly had pushed out availability levels to unprecedented levels versus history. And so I think the really significant question is, is that initial pushout really a function of uniquely strong demand versus history? Or is that pushout in availability really a function of much weaker supply versus history? So it would be really helpful. You have in the past commented on first 24-hour orders for which there were 4 million-plus for the iPhone 6 and 6 Plus. You have, very often on this call, talked about targeting when you think you could reach supply-demand balance. So it'd be really helpful if you could provide some context in terms of what you know either about initial orders or about the supplies versus history that can help investors try and better understand the little data points that they're seeing in terms of availability of the device. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [25] +-------------------------------------------------------------------------------- +That truth is, we don't know. We've put our best estimate into the guidance. And you can see from the guidance that we're very bullish. And so, we feel really great about our -- about the product lineup. We're -- just sold the first units minutes ago. And so we'll see how things go. Until you get all of them out there, where customers have the ability to demo and so forth, I think it's -- I think any kind of mix discussion is very much estimating. And so we put our best estimates in but granted, we've never done this before. So there's no comparison here, with either the 3 iPhones nor the staggered launch. And so, we're going to learn something. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +We go to Jim Suva with Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [27] +-------------------------------------------------------------------------------- +And I'll ask my original question and follow-up at the same time because they're slightly different topics. But you had mentioned great success in India, I believe, Tim. In your prepared comments, you mentioned, I think, India had doubled year-over-year. Based upon market analysis, it looks like Apple is still just a relatively small sliver of the pie there. So Tim, what would it take to be even more successful in India? Is it a manufacturing footprint there with your partners? Is it more physical stores? Is it lower price points? Is it the bandwidth that has now caught up to many other countries? Or how should we think about that? And then, the follow-up question is on the AR/VR, when will it really show up in your income statement? Are you hoping more for hardware sales or services to the apps or where the excitement will then be monetized within Apple? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- +In terms of India, many of the things that you mentioned are correct. Growing a market like India is a result of all of those things and doing them all well. And so, it's analogous to the many years that we put into China. It's building stores. It's building channels. It's building markets. It's building the developer ecosystem. It's having the right product lineup for the market. And I feel like we're making good progress there and are gaining understanding of the market, but we still have a long way to go. I don't -- which I sort of see as an opportunity instead of a problem. And I do feel great about the growth rate. And so, that's India. I think it's all of those things. As you know, we -- as I've said, I think we talked about before, we started manufacturing the iPhone SE there 6, 9 months ago. So -- and the majority of iPhone SEs that we sold in the domestic market last quarter were manufactured there. And so we also have that going and are hoping that, that winds up saving some amount of money over time and avoiding some of the compounding of taxes, et cetera. The bandwidth issue has also been an issue, but as you point out, it is being addressed. And between the large carriers there with Bharti and now Jio investing the way they are, the service in India is materially better than it was just 12 months ago. So there's been a sea change there in a short period of time. So I feel good about all that, but we have a long way to go. In terms of the monetization question on AR/VR, we tend to focus first and foremost on customer experience. And so we're all about making sure the experience is great. And we think that if we get the experience right, that revenues and profits will be a result of getting that right. And so we're much -- we're very much focused on the experience right now. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +That will come from Amit Daryanani with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [30] +-------------------------------------------------------------------------------- +I have 2 as well. I guess, maybe to start with on gross margins. Luca, year-over-year, revenues are going to be up high single-digits at the midpoint, gross margins will be down a little. Could you just talk about what other puts and takes on that. And are yield and efficiencies broadly much more severe this time versus what you've seen historically? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- +Yes, Amit. So we're guiding 38% to 38.5%. That's up 35 bps sequentially. Obviously, we're getting the leverage from the larger volumes. As I mentioned, I think, to Toni, we have higher cost structures every time we launch new products. So that is going to be the offset. And I mentioned, particularly the impact from the memory pricing environment, which is a headwind at this point. Just to size it for you, the impact of memory on our gross margin is 40 bps sequentially and 110 bps on a year-over-year basis. So they are meaningful impacts. And I think that is what, I think, probably you're referring to. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [32] +-------------------------------------------------------------------------------- +Got it. That's really helpful. And I guess, if I could just follow up on the services line. You just talked about it a fair amount earlier, but even if I exclude the onetime gain, it looks like the back half of '17 accelerated by 500 basis points in fiscal '17 versus the first half of '17. Qualitatively or quantitatively, is there a way to think about how much of this is from expanding the installed base, which is 1 of the 3 things you mentioned, I think, versus more dollar per iOS device that you're seeing? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- +Yes, I think it's both. As I mentioned, particularly on the App Store, which is very important to us, the number of paying accounts has grown a lot. It's grown a lot because, as you said, the installed base has grown, but also because we have made a number of changes that have made it easier for our customers around the world to participate on the App Store and be able to transact on the Apps Store. We are accepting, for example, more forms of payment today than we were 12 months ago or even 6 months ago. So that's been very important. We also see that there is a typical spending curve for our customers when they start transacting on the store. They start at a certain level and they tend, over time, to get more familiar with the store and they start to spend more. We're also now very recently made some changes, as you probably have seen, to the design of the App Store. And I was mentioning during the prepared remarks that these changes have been received very favorably. And so, people now are spending more time on the store, they download more apps and then, over time, translates into monetization. But we also have other businesses that are growing very, very fast and actually accelerating. I mentioned Music; I mentioned iCloud. And so it all adds up. And as you correctly point out, our growth rate is accelerating. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +From Drexel, we'll hear from Brian White. + +-------------------------------------------------------------------------------- +Brian John White, Drexel Hamilton, LLC, Research Division - Global Head of Technology Hardware and Software, and Senior Equity Research Analyst [35] +-------------------------------------------------------------------------------- +Yes, Tim, wondering if we take a look at mainland China and we think about iPhone 8 and iPhone 8 Plus, they've been on sale for a while now. What has been the -- just general response to those 2 new iPhones? And also, preorders around the iPhone X in mainland China. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [36] +-------------------------------------------------------------------------------- +Brian, I hate to repeat this, but we don't really disclose mix. We view it as competitive information that we want to hold tightly ourselves. In terms of the way the preorder process works in China in the channel, so not in our direct channel, but in the broader carrier channel and channel, they generally take indications of interest versus something that I would label a preorder. And so, I would hesitate to even quote a number for fear it could be misconstrued. And we'll find out what the demand and where the supply and demand meets sometime in the future. I don't know when yet. But we're really excited to get going to find out. + +-------------------------------------------------------------------------------- +Brian John White, Drexel Hamilton, LLC, Research Division - Global Head of Technology Hardware and Software, and Senior Equity Research Analyst [37] +-------------------------------------------------------------------------------- +And Tim, it's interesting that sales grew 16% sequentially. If you look at the past 5 years, sales were up 7% in the September quarter. So that's an average. Yet you didn't have all your iPhones in the market. So if you had to -- what would you attribute that to? It's a pretty big disconnect, 16% versus an average of 7%. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [38] +-------------------------------------------------------------------------------- +Our emerging market performance during the quarter was very strong. Not -- and if you take China out, it's even stronger. But you can see the -- that China rebounded. And as I've indicated before, the China rebound was broad-based across the products. And so we just had a phenomenal quarter on iPad, on the Mac, on Services, on Apple Watch, on iPhone. I mean, we're literally, we're firing on all cylinders. And so that's what -- that and our new products give us great confidence headed into this holiday season that this is going to be the best holiday season yet. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [39] +-------------------------------------------------------------------------------- +Thank you, Brian. A replay of today's call will be available for 2 weeks on Apple podcast as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820, and please enter confirmation code 2484260. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Joan Hoover or me with additional questions. Joan is at (408) 974-4570 and I'm at (408) 974-5420. Thank you again for joining us. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2018-Feb-01-AAPL.txt b/Transcripts/AAPL/2018-Feb-01-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..7494d57339becf046edce3e1d836066ed1d29abe --- /dev/null +++ b/Transcripts/AAPL/2018-Feb-01-AAPL.txt @@ -0,0 +1,554 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q1 2018 Apple Inc Earnings Call +FEBRUARY 01, 2018 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Laura Anne Martin + Needham & Company, LLC, Research Division - Senior Analyst + * Steven Mark Milunovich + UBS Investment Bank, Research Division - Former MD and IT Hardware & EMS Analyst + * Amit Jawaharlaz Daryanani + RBC Capital Markets, LLC, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 1Q18 revenue of $88.3b, net income of $20.1b and diluted EPS of $3.89. Expects 2Q18 revenue to be $60-62b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 1Q18 revenue = $88.3b. + 2. 1Q18 net income =$20.1b. + 3. 1Q18 diluted EPS = $3.89. + 4. 1Q18 YoverY revenue growth = 13%. + 5. 1Q18 GM = 38.4%. + 6. 1Q18-end cash plus marketable securities = $285.1b. + 7. 1Q18 share repurchase = spent $5.1b on repurchases of 30.2m Co. shares through open market transactions. + 8. 2Q18 revenue guidance = $60-62b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. Annotation (N.P.) + +-------------------------------------------------------------------------------- + + 1. Note: + 1. 1Q18 included 13 weeks. + 2. 1Q17 included 14 weeks. + +-------------------------------------------------------------------------------- +II. 1Q18 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Active installed base reached 1.3b devices in Jan. + 1. All-time high for all major products. + 2. Represents 30% growth in just two years. + 3. Fueling tremendous growth in Services business. + 2. Biggest qtr. ever. + 1. Set new all-time records in revenue and earnings. + 3. Revenue $88.3b. + 1. Above high-end of guidance range. + 2. Up almost $10b or 13% over previous all-time record Co. set a year ago. + 3. Fifth consecutive qtr. of accelerating revenue growth with double-digit growth in each geographic segment worldwide. + 4. 1Q18 13 weeks long. + 1. 1Q17 14 weeks. + 5. Avg. revenue per week vs. last year, 21% growth. + 2. iPhone: + 1. Growth was broad-based. + 1. Key driver was iPhone, which generated highest revenue ever. + 2. iPhone X bestselling smartphone in world according to Canalys. + 1. Has been top selling phone every week since launch. + 3. iPhone 8 and iPhone 8 Plus rounded out Top 3 iPhones. + 1. Revenue for newly launched iPhones was highest of any line up in history, driving total Co. revenue about guidance range. + 3. Services: + 1. Revenue $8.5b. + 1. Up 18% YoverY. + 2. On pace to achieve goal of doubling 2016 revenue by 2020. + 2. Number of paid subscriptions across Services offerings passed 240m by 1Q18 end. + 1. Increased 30m in last 90 days. + 2. Largest quarterly growth ever. + 3. All-time record qtr. for App Store with best holiday season ever. + 1. Customers now enjoying over 2,000 ARKit-enabled apps spanning every category in App Store. + 2. In Dec. when Pokemon GO released new augmented reality features built with ARKit, it jumped to top of App Store charts. + 4. Four months after ARKit launched to public, Co. has released ARKit 1.5 in beta to developers around world. + 1. Tremendous response. + 5. Several other services had biggest qtr. ever including Apple Music, iCloud and Apple Pay, all of which saw growth in active users and revenue. + 1. Apple Pay reached important milestone in US. + 1. Due to 50% YoverY growth in merchant adoption, now accepted at more than half of all American retail locations which includes more than two-thirds of country's Top 100 retailers. + 2. Now available in 20 markets, global Apple Pay purchase volume more than tripled YoverY. + 3. Expanding to Brazil in coming months. + 4. In US, launched Apple Pay Cash in Dec. and off to terrific start; millions of people already using it. + 4. Apple Watch: + 1. Best qtr. ever. + 2. Over 50% growth in revenue and units for fourth qtr. in a row and strong double-digit growth in every geographic segment. + 3. Sales of Apple Watch Series 3 models more than twice the volume of Series 2 a year ago. + 4. Most popular smartwatch in world. + 5. Gained market share based on latest estimates from IDC. + 5. iPad: + 1. Third consecutive qtr. of growth for iPad revenue, due to strength of iPad and iPad Pro. + 2. Based on latest data from IDC, Co. gained share in nearly every market Co. tracks with strong outperformance in emerging markets. + 3. Worldwide, almost half of iPad sales were first time tablet buyers or those switching to AAPL. + 1. True in some of Co.'s most developed markets including Japan and France. + 2. In China, new and switching users made up over 70% of all iPad sales. + 6. Mac: + 1. Launched all new iMac Pro in mid-Dec. + 1. Fastest and most powerful Mac ever, delivering incredible computational power. + 2. Worldwide, 60% of Mac sales were first time buyers and switchers. + 1. In China, almost 90%. + 3. Looking forward to getting HomePod in customers' hands beginning next week. + 7. New Initiatives: + 1. Strengthened commitment and investment into initiatives like Everyone Can Code. + 1. App Development with Swift curriculum which is available free on iBooks has been downloaded more than 1.2m times worldwide. + 1. Almost half of those came from US. + 2. Announced that program was expanding to more than 70 colleges and universities in Europe. + 1. Millions of students around world will have opportunity to add Swift to their coding vocabulary. + +-------------------------------------------------------------------------------- +III. 1Q18 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Results: + 1. Set new all-time records for revenue, operating income, net income and EPS. + 2. Revenue $88.3b; all-time record. + 1. Up nearly $10b or 13% over prior record set last year. + 2. Fifth consecutive qtr. of accelerating revenue growth. + 3. Dec. qtr. year ago spanned 14 weeks vs. 13 weeks this year. + 1. Looking at avg. revenue per week, growth rate even higher at 21% with growth across all product categories for third consecutive qtr. + 3. Double-digit revenue growth in all geographic segments and all-time quarterly record in vast majority of markets Co. tracks including US, Western Europe, Japan, Canada, Australia, Korea, Mainland China, Latin America, Middle East, Central and Eastern Europe and India. + 1. In Greater China, generated double-digit revenue growth for second qtr. in a row. + 2. In emerging markets outside of Greater China, saw 25% YoverY growth. + 4. GM 38.4%. + 1. High-end of guidance range. + 5. Operating margin 29.8% of revenue. + 6. Net income $20.1b; all-time record. + 1. Up $2.2b over last year. + 7. Diluted EPS $3.89. + 1. All-time record. + 8. Cash flow operations $28.3b; strong. + 2. iPhone: + 1. Sold 77.3m iPhones. + 1. Highest number ever for 13-week qtr. + 2. Avg. weekly iPhone sales up 6% YoverY, with growth in every region of world, despite staggered launch of iPhone X. + 2. Established all-time iPhone revenue records in nearly every market Co. tracks with double-digit growth in all geographic segments. + 3. iPhone ASP increased to $796 from $695 year ago, driven primarily by launch of iPhone X and success of iPhone 8 and 8 Plus. + 4. Exited Dec. qtr. towards lower-end of target range of 5-7 weeks of iPhone channel inventory with less than 1m more iPhones in channel YoverY. + 1. In line with growth in avg. weekly unit sales. + 5. Customer interest and satisfaction with iPhone strong for consumers and business users. + 1. Latest data from 451 Research indicates US customer satisfaction ratings of 96% or higher across iPhone models. + 2. Combining iPhone 8, iPhone 8 Plus and iPhone X, consumers reported 99% satisfaction rating. + 3. Among business customers planning to purchase smartphones in next qtr., 77% plan to purchase iPhone. + 4. Kantar's latest US research reflected 96% iPhone loyalty rate, highest ever measured. + 3. Services: + 1. Revenue $8.5b. + 1. Up 18% YoverY. + 2. Up 27% in terms of avg. revenue per week, acceleration to 24% growth run rate that Co. experienced in Sept. qtr. + 2. App Store set new all-time revenue record. + 1. Store's all new design is off to fantastic start, with quarterly store visitors, transacting accounts and paying accounts reaching new all-time highs. + 2. During week beginning Dec. 24, record number of customers made purchase or downloaded apps from App Store spending over $890m in seven-day period, followed by $300m in purchases on New Year's Day. + 3. According to App Annie's latest report, App Store continues to build preferred destination for customer purchases by wide margin, generating nearly twice revenue of Google Play. + 3. Across all Services offerings, paid subscriptions reached 240m, with growth of 58% over last year. + 1. Major contributor to overall strong growth in revenue. + 4. Apple Watch: + 1. Best qtr. ever. + 2. Adding results from Beats and AirPods, total revenue from wearables up almost 70% YoverY. + 3. Wearables second largest contributor to revenue growth after iPhone. + 1. Started only three years ago. + 4. In total, other products category set new all-time record with quarterly revenue exceeding $5b for first time. + 5. Mac: + 1. Sold 5.1m Macs. + 1. Translates to 2% YoverY increase in avg. sales per week. + 2. Performance particularly strong in emerging markets with unit sales up 13% YoverY and with all-time records in Latin America, India, Turkey and Central and Eastern Europe. + 3. Worldwide, active installed base of Macs up double digits YoverY to new record. + 6. iPad: + 1. Growth qtr. + 2. Sold 13.2m units. + 1. Avg. iPad sales per week [up 8%] over last year's Dec. qtr. + 3. Sales grew strong double digits in many emerging markets including Latin America, Middle East, Central and Eastern Europe and India, and developed markets including Japan, Australia and Korea. + 4. Active installed base of iPad has grown every qtr. since launch in 2010. + 1. Reached new all-time high in Dec. due to high customer loyalty and large numbers of first time iPad users. + 5. NPD indicates that iPad had 46% share of US tablet market in Dec. qtr. + 1. Up from 36% share year ago. + 6. Most recent survey from 451 Research found that among customers planning to purchase tablets within 90 days, 72% of consumers and 68% of business users plan to purchase iPad. + 7. Customer satisfaction high with businesses reporting 99% satisfaction rating. + 7. Enterprise: + 1. Seeing great traction, as businesses across industries and around world standardize on iOS. + 2. Intesa Sanpaolo has chosen iOS as mobile standard for its entire 70,000 employee base in Italy. + 3. LensCrafters will be using over 7,000 iPad Pros to enable digital eye exams and digital optical measurements in personalized and interactive experience. + 4. Rolling out new initiative called Apple at Work to help businesses implement employee choice programs more easily and offer AAPL products co.-wide. + 1. Resources from AAPL and channel partners will enable enterprise IT and procurement teams to buy or lease Co. products more efficiently, streamline set up of iPhone, iPad and Mac and deliver seamless onboarding experience for employees. + 2. Launched program with CDW in US last week. + 3. Will be expanding to more channels and regions later this year. + 8. Stores: + 1. Busy qtr. for retail and online stores, which welcomed 538m visitors. + 2. Strong traffic during four weeks following launch of iPhone X, up 46% YoverY. + 3. Across qtr., stores conducted over 200,000 Today at Apple sessions. + 4. Last weekend, opened first store in [Seoul, Korea]. + 1. Looking forward to opening first store in Austria in a few weeks. + 2. Newest openings will mark expansion of retail store presence to 21 countries. + 9. Cash Position: + 1. 1Q18-end cash plus marketable securities $285.1b. + 1. Sequential increase of $16.2b. + 2. $269b of this cash or 94% of total was outside US. + 2. Issued $7b in debt, bringing Co. to $110b in term debt and $12b in commercial paper outstanding. + 1. 1Q18-end total net cash position $163b. + 3. Returned $14.5b to investors. + 1. Paid $3.3b in dividends and equivalents. + 2. Spent $5.1b on repurchases of 30.2m Co. shares through open market transactions. + 4. Launched new $5b ASR program, resulting in initial delivery and retirement of 23.6m shares. + 1. Retired 3.8m shares upon completion of 12th ASR. + 2. Has now completed over $248b of $300b capital return program including $176b in share repurchases against announced $210b buyback program with $34b remaining under current authorization. + 10. Taxes: + 1. Due to recently enacted legislation in US, estimates making corporate income tax payment of approx. $38b to US government on [cumulative passed foreign earnings]. + 1. This amount is similar to what Co. has been accruing on those earnings in financial results through FY17. + 2. Including $38b payment, Co. will have paid over $110b of corporate income tax on total domestic and foreign earnings during last 10 years for cash tax rate of about 26%. + 2. Tax rate 25.8%. + 1. Close to guidance of 25.5% as lower US statutory rate from new legislation was effectively offset by remeasurement of deferred tax balances. + 11. 2Q18 Outlook: + 1. Revenue $60-62b. + 2. GM 38.0-38.5%. + 3. OpEx $7.6-7.7b. + 4. OI&E about $300m. + 5. Tax rate about 15%. + 6. Tax reform will allow Co. to pursue more optimal capital structure for Co. + 1. Current net cash position is $163b. + 2. Given increased financial and operational flexibility from access to foreign cash, Co. is targeting to become approx. net cash neutral over time. + 7. On 02/01/18, Board of Directors declared cash dividend of $0.63 per share of common stock, payable on 02/15/18 to shareholders of record as of 02/12/18. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [2] +-------------------------------------------------------------------------------- + + Luca, wanted to talk a little bit about -- more about your comments on capital structure. I realize you don't want to give us any specifics about what you're actually going to return and the timing, but just maybe if you can talk about how much cash you -- I guess, you think you need to have to run the business. And then in terms of ongoing cash flow, since the overseas cash will no longer be encumbered, does that change sort of your thought process in general? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [3] +-------------------------------------------------------------------------------- + + Sure, Shannon. Of course, we've been talking about the importance of tax reform over the years because we believe it's really beneficial to the U.S. economy. What it means to us as a company, of course, is that we have additional flexibility right now from the access to the foreign cash. And in the past, we've been addressing this issue by having to raise debt as the cash was overseas, the majority of the cash was overseas. And so we are now in a position where we have $285 billion of cash. We've got $122 billion of debt for a net cash of $163 billion. And we have now the flexibility to deploy this capital. We will do that over time because the amount is very large. As I said earlier, we will be discussing capital allocation plans when we review our March quarter results. And when you look at our track record of what we've done over the last several years, you've seen that effectively, we were returning to our investors essentially about 100% of our free cash flow. And so that is the approach that we're going to be taking. We're going to be very thoughtful and deliberate about it. Obviously, we want to make the right decisions in the best interest of our long-term shareholders. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [4] +-------------------------------------------------------------------------------- + + Great. And then Tim, maybe could you talk a little bit more about what you're hearing from customers in terms of the iPhone demand? How you're thinking about the potential decay rate, for a lack of a better term, with the high-end phones and the over $1,000 phones versus balancing that with now your ability to [shift] phones down below $400 because you'd expanded the product line so much when you launched your phones in 2017? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + Yes, thank you, Shannon, for the question. The revenue growth from iPhone across all the geographic segments was in the double digits. And I think as Luca said earlier, when you change that to an average weekly sales basis, it's actually 22%, and so it was a stellar quarter for iPhone. The iPhone X was the most popular, and that's particularly noteworthy, given that we didn't start shipping until early November and were constrained for a while. The team did a great job of getting into supply-demand balance there in December. And -- but since the launch of iPhone X, it has been the most popular iPhone every week, every week since. And that is even through today -- actually, through January. And so we feel fantastic about the results. The most important thing for us isn't really the numbers though. It's customer satisfaction, and customer satisfaction is literally off the charts on iPhone X. You think about the advances in technology that were a part of the iPhone X from -- we went from Touch ID to Face ID. Face ID has been incredibly well received. The wireless charging, the edge-to-edge Super Retina display and totally new gestures, the user experience is different. And so it's great to get that kind of feedback. Now if you look at the sort of the overall iPhone line, which gets to the essence of the question I think, I looked -- I reviewed the top mini markets. I'll talk briefly about the top 4. In urban China and the U.S., the top 5 smartphones last quarter were all iPhones. And in Japan and the U.K., 6 of the top 7 were iPhones. And so in a market that is as large as the smartphone market is, people want some level of choice, and they're deciding which ones to buy. But we feel fantastic particularly as it pertains to iPhone X. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Next, we'll go to Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [7] +-------------------------------------------------------------------------------- + + Growing double digits off such a large revenue base is impressive in itself, but if I look at March quarter guidance, it does assume a slower average weekly growth in total revenue as well as, I think, on my math, iPhone shipments when you compare it to the December quarter. So just how should we read into a modest slowdown in average weekly growth as it relates to the last question around the decay of demand around the higher-priced products? Or any impact that you might be seeing from the lower-priced battery replacements or anything else in the market? Then I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [8] +-------------------------------------------------------------------------------- + + Katy, I'll take the question. We are guiding to $60 billion to $62 billion. It's strong double-digit growth, 13% to 17%. In context, it's $7 billion to $9 billion above last year. So when you put things in perspective and you add the $10 billion of growth that we had in the first quarter and the $7 billion to $9 billion that we're guiding to for the second quarter, you're talking about $17 billion to $19 billion of growth in 6 months. This is at the macro level. We typically don't go into this level of detail but I think it's important this quarter to give you additional color. And maybe the 2 most important messages are that we believe iPhone revenue will grow double digits as compared to last year during the March quarter, and also and importantly, that iPhone sell-through growth on a year-over-year basis will be actually accelerating during the March quarter as compared to the December quarter. Let me explain the factors that we took into consideration as we came up with our iPhone units and ASP that are embedded in our guidance. Historically, because of the channel fill and the holiday season, our sell-in volume during the December quarter is generally higher than sell-through. This year, the difference was further magnified because we shipped iPhone X in November rather than the September quarter. We had a very successful product ramp. We were able to reach supply-demand balance in December, which placed the entirety of our channel fill for iPhone X in Q1. And this will have an effect on both units and ASP in Q2. Now for units, there is a second point to consider. We typically reduce channel inventory for our newest iPhones in Q2 because they enjoy very large demand in the initial weeks of sales, which are compounded by the holiday season in Q1. So we anticipate doing that in Q2 this year as well. For ASPs, there's also another element that we need to consider. As you know, our newest products this year have higher ASPs than they had in the past. And so as a result, as we reduce inventories of these newest products, the overall ASPs for iPhone in Q2 will naturally decline sequentially by a higher percentage than we have experienced historically. So in summary, our guidance for iPhone, we got double-digit year-over-year growth and acceleration of sell-through growth on a year-over-year basis. For the balance of the company, in the aggregate, we expect to grow strong double digits year-over-year and particularly very strong performance in service and in wearables like we've seen during the December quarter. I hope this helps. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [9] +-------------------------------------------------------------------------------- + + Yes, that's great color. Just a follow-up on gross margin. Guidance for flat gross margin in March is pretty seasonal, but you do have the tailwind from currency. And so if you can just comment on how you think that flows into the model over the next couple of quarters, the weaker dollar, and what your outlook might be around component costs in the near future. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [10] +-------------------------------------------------------------------------------- + + Yes, let me walk you through the sequential first. So we're guiding about flat sequentially in spite of the loss of leverage, right? That is the largest element that we need to take into account because of our typical seasonality. And we expect to offset the seasonality impact with cost improvements and with mix. FX, on a sequential basis, is fairly muted because as you know, we got a hedging program that protects us from the volatility of currencies in the short term. Certainly, weaker dollar in the long term, if it holds, will be a positive, but it's not something that you're going to be seeing translate into gross margin tailwind quickly. And so I think we need to keep that in mind. We also need to keep in mind that we continue to experience a difficult memory pricing environment, which we think is going to start improving as we move into the second half of our fiscal year, but it still has a negative impact in the March quarter. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Mike Olson from Piper Jaffray has our next question. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + I know you don't talk about future products, which is often a preface to questions about future products, and I'll give it a shot. When you think conceptually about the path for iPhone X style devices going forward, is there any reason the road map wouldn't consist of multiple devices as we've seen with past iPhone upgrades? In other words, the X was unique amongst recent iPhone launches because it's a singular device, potentially limiting the shots on goal for upgrades given limited options. How do you think about that going forward? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [13] +-------------------------------------------------------------------------------- + + Mike, you did a good job of answering your question, I think, at the beginning that we don't really comment on future products. But I would tell you that we're thrilled with the reception of iPhone X. And as we said when we launched it, we were setting up the next decade. And that is how we look at it, and so that's the reason it's chock-full of incredible innovation. And so you can bet that we're pulling that string. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [14] +-------------------------------------------------------------------------------- + + All right. And then how do you think about AR beyond iPhone? You've created the world's largest AR platform. You got developers generating a wide variety of apps. I realize it's still early days, but do you see Apple as a provider of a larger ecosystem of AR-enabled device beyond iPhone and iPad in the coming years? Or should investors focus on the opportunity within your existing device portfolio for at least the foreseeable future? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + I see AR as being profound. I think it's -- AR has the ability to amplify human performance instead of isolating humans. And so I am a huge, huge believer in AR. We put a lot of energy on AR. We're moving very fast. We've gone from ARKit 1.0 to 1.5 in just a matter of months. I couldn't be happier with the rate and pace of the developer community, how fast they're developing new things. And I don't want to say what we may do, but I could not be happier with how things are going right now. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And next, we'll go to Toni Sacconaghi from Bernstein. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + I have a question and a follow-up. You commented on how your installed base over the last couple of years has grown 30%. And iPhone is clearly the largest component of that. And so iPhone installed base is probably growing close to that number, perhaps less, call it 20% or 25%. Yet if we look at iPhone unit growth for fiscal '18, sort of what's implied with your guidance, fiscal '17 and fiscal '16, it's been relatively flat. So you have an installed base that's 20-plus percent higher and a unit growth that's relatively flat, which would suggest that your upgrade rate is going down or your replacement cycle is elongating. And I'm wondering whether you agree with that and whether investors should be worried about that. And maybe if I could just add one other wrinkle to potentially get your response on is given consumers' heightened awareness of their ability to replace batteries going forward as opposed to upgrade, isn't that also something that investors should potentially be concerned about in terms of its impact on upgrade rate going forward? And then, believe it or not, I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [18] +-------------------------------------------------------------------------------- + + I think it's up to investors as to what things they would like to focus on, so I don't want to put myself in a position of that. The way that I look at this, and I -- the numbers you quoted, I have a different view of them. But generally, what we see with iPhone is the reliability of iPhone is fantastic. The second -- or the previously owned market has expanded in units over the years. And you see, in many cases, carriers and retailers having very vibrant programs around trading an iPhone in. And because iPhone has the largest residual rate on it. It acts as a buffer for the customer to buy a new one, and it winds up with another customer somewhere else that is perfectly fine with having a previously owned iPhone. And so I view all of that to be incredibly positive. It's more people on iPhones, the better. I would like to point out that the -- every major product hit a high on the active installed base. And so that's iPads, it's Mac, and those are huge numbers as well. And so as we've always said, there's a large part of the -- or the vast majority of the services kind of are mapped to the installed base instead of the quarterly sales. And there's -- this quarter is no different on that. Toni -- on the battery, Toni, we did not consider in any way, shape or form what it would do to upgrade rates. We did it because we thought it was the right thing to do for our customers. And I -- sitting here today, I don't know what effect it will have. And again, it's not -- was not in our thought process of deciding to do what we've done. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- + + Okay. And just a follow-up, maybe I could clarify 2 little things. One, Luca, on tax rate, you've talked about 15% for Q2. Is that how we should think about the tax rate on an ongoing basis? And then just back to you on your response, Tim. I guess, maybe you could just comment on whether you believe the upgrade rate has decreased over the last couple of years. Because again, just sort of mechanically, installed base is growing 20% and units are relatively flat over that period. Isn't that telling me the installed base is -- excuse me, upgrade rate is going down? Or am I not thinking about other considerations? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [20] +-------------------------------------------------------------------------------- + + Toni, on the tax rate, I will make 2 comments. First of all, the new tax law in the United States is complex. And I think we, as many other companies, are really trying to absorb what this all means. And I think we're going to be receiving, over the next few months, implementation guidance. So we've taken some provisional estimates in coming up with our tax entries for the quarter. And we will have to do that as we go forward here during the year. So it may be a bit bumpy in the short term as we understand the law in full and it actually gets explained in full. But I would say that for the current fiscal year, the guidance that we provided for Q2 should be approximately what you should be seeing. As we get into a new fiscal year, so many things change, and we need to take that into account, the geographic mix of our products and so on. So -- but I would say for the remainder of the year, it's what we're guiding to. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [21] +-------------------------------------------------------------------------------- + + I think on the replacement cycle, Toni, the answers probably look different by geography. In those geographies that had -- in the early days of the smartphone market, had very traditional subsidies where you paid the $199 out the door, $99 or whatever, I think it's accurate to say those types of markets, the replacement cycle is likely longer. Where that isn't the case, I'm not nearly as sure on that. I would point out that, that happened some time ago, and so it's very difficult currently to ever get a real-time handle on replacement rate because you're obviously not -- you don't know the replacement rate for the products you're currently selling. You only know that in a historical sense. So it's not something that we overly fixate on. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + That question comes from Laura Martin from Needham. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + I love the 1.3 billion devices you gave us, updating from 2 years ago. And I love the on-ramp as you spread out the pricing. Do you get the sense that we have more unique users in that 1.3 billion than we had unique users back there in 2016? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [24] +-------------------------------------------------------------------------------- + + Laura, I'm sorry. I missed the first part of that. You broke up on the phone. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + Okay. So we have 1.3 billion (inaudible) billion (inaudible) unique users are getting fewer products so we have a higher percent of unique [users] in the 1.3 billion devices than more in the +[Audio Gap] +billion devices. Is it a +Audio Gap +Are they +Audio Gap + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [26] +-------------------------------------------------------------------------------- + + Laura, you're cutting in and out, but I'm going to take a swing at what I think you're asking. I think you're asking, are there more active users today than there were 2 years ago when we had 1 billion active devices? And the answer is absolutely. There are many, many, many more. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Yes, I was asking as a percent, the ownership. It used to be 1.4 devices owned per person. Do you think it's now 1.2 or 1.6? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- + + Well, that 1.4, I don't know where that came from. It did not come from Apple. And so that's one of those things that kind of flowed out there, and I want to divorce Apple from that number. We're not releasing a user number because we think that the proper way to look at it is to look at active devices. It's also the one that is the most accurate for us to measure. And so that's our thinking behind that. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + Okay. Switchers in the quarter? You often give us switchers. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [30] +-------------------------------------------------------------------------------- + + It is so early on this product cycle, particularly with the iPhone X only starting in November that we do not feel we have data at this point that would be very meaningful to share. And so I'll punt that question until next time around. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Next, we'll go to Steve Milunovich from UBS. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - Former MD and IT Hardware & EMS Analyst [32] +-------------------------------------------------------------------------------- + + Tim, you said you don't want to tell investors what to do, but the first point you made was talking about the size of the installed base. Later, you talked about the importance of customer satisfaction. Given that this doesn't look like a super cycle in terms of unit growth, are you nudging us to focus on the size of the installed base, the annuity opportunity here? And do you have confidence that you can monetize that installed base through additional hardware and services? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [33] +-------------------------------------------------------------------------------- + + What I said on the investor part is I think every investor has to look at their own situation and conclude the things that they think are important. What I think is important, I think the active devices are hugely important. And that's the reason that we released the number 2 years ago and the reason that we're releasing that again today. That number speaks to the strength of the product, the loyalty of the customer, the strength of the ecosystem. And so I -- we do put a lot of weight behind that, and it obviously also fuels the services business. So I have long believed that a 90-day clock on unit sales is a very surface way to view Apple. I think that the far bigger thing is to look over a longer period of time. And customer satisfaction and engagement and number of active devices are all a part of that. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - Former MD and IT Hardware & EMS Analyst [34] +-------------------------------------------------------------------------------- + + And could you address the positioning of HomePod? What category is it in? Is it a music speaker? Is it a home assistance? Since people seem to be trying to position it versus Amazon and Google's offerings. And is the target market primarily Apple Music users? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [35] +-------------------------------------------------------------------------------- + + HomePod is an incredible product that gives an unbelievable audio experience in a very small form factor with a super assistant -- digital assistant in Siri that knows an enormous amount about music but also can handle requests to -- like home automation to close your garage door, open your door, turn the light on, turn the fireplace on, change the thermostat, all of the things that you would like to do on home automation, that takes it further because you can do it right from the Home app and set up scenes. So you can say, "Hey, Siri. I'm reading." And your room will change to the things you would like happening in that particular room for when you read. Maybe it's a particular light, maybe it's a type of light, maybe it's the fireplace, so on and so forth. It also -- obviously, you can also do things with HomePod like use it as a speakerphone. And so if you're talking to your parents or they're talking to their grandkids, it's unbelievable audio quality for speakerphone. You can also have Siri call for you. You can have -- you can send messages, you can get an Uber car or a Lyft car. And so there's just a whole variety of things. And so I think the use cases on this, much like our phones, will be broad-based. Some people will use it significantly for music and others may use it significantly for -- as a digital assistant. And I think the majority of people will likely use all of it and use all of the functionality of it. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question will come from Amit Daryanani from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [37] +-------------------------------------------------------------------------------- + + I have 2 questions as well. I guess, first one, could you just touch on what you're seeing in China in terms of underlying trends right now? I think growth was up double-digit year-over-year but essentially in line with what you saw in September. I would have thought it would have accelerated a little bit with iPhone X. Just the puts and takes in China will be great. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [38] +-------------------------------------------------------------------------------- + + Yes, Amit, it's Tim. It's a good question. Keep in mind that this year had 13 weeks, last year had 14 weeks. And so even though we're recording a similar year-over-year growth for Greater China, if you change that reporting to an average weekly sales, which is probably a much better way to look at it, there was actually a really nice acceleration. And specifically, the numbers this quarter, as reported, are 11% increase for Greater China year-over-year. But on an average weekly revenue basis, it was -- we were up 19%. Also mainland China, we had an all-time record for revenue in mainland China. And of course, a key part of that was iPhone. And as I've mentioned before, Kantar reported that the top 5 selling smartphones in urban China were all iPhones. And so we could not be more pleased with how we're doing. And if you look at the other -- we obviously grew share on -- for iPhone in the quarter, but we also grew share in iPad and Mac during the quarter. And our -- and wearables were extremely strong there in the quarter. And so everywhere I look, I feel really good about how we're doing in China. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [39] +-------------------------------------------------------------------------------- + + Got it. That's really helpful. I guess, Luca, maybe a question for you. When you talk about reducing your Apple's net cash levels to 0 effectively over time, I think that implies the number goes from $163 billion today to something like 0. I guess, what does "over time" mean for Apple? Is that 1 year, 3 years, 10 years? Just how do you define "over time"? And does this change your thoughts around M&A at all? And is that one reason, you get that number from $163 billion to 0? Does it change your M&A thought process? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [40] +-------------------------------------------------------------------------------- + + Let me answer, Amit, starting with M&A. Our thought process around M&A has always been the same, and it really doesn't change. We've been acquiring companies over the years. During -- in calendar 2017, we've acquired 19 companies. And the thought process is always to acquire something that allows us to either accelerate our product road maps, filling a gap in our portfolio, providing a new experience to customers. So it's always the customer experience in mind, right, that we make acquisitions. We look at all sizes, and we will continue to do so. We have plenty of financial flexibility, of course. We had that even prior to tax reform. And as I said, we will talk about capital allocation plans when we report the March quarter, and that will include talking about time frames and pace and so on. And as I said, we'll try to be very thoughtful. As you said, $163 billion is a large amount, and there are even practical considerations around it. So we'll see. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [41] +-------------------------------------------------------------------------------- + + Just for clarity, let me add one thing. What Luca is saying is not cash equals 0. He's saying there's an equal amount of cash and debt, and that they balance to 0, just for clarity. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [42] +-------------------------------------------------------------------------------- + + Thank you, Amit. A replay of today's call will be available for 2 weeks on Apple podcast, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. And please enter confirmation code 4783460. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. And thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2018-Jul-31-AAPL.txt b/Transcripts/AAPL/2018-Jul-31-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..d8093b5cbeffffc77eda88c2a1ada2c23e3e45f5 --- /dev/null +++ b/Transcripts/AAPL/2018-Jul-31-AAPL.txt @@ -0,0 +1,513 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q3 2018 Apple Inc Earnings Call +JULY 31, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Laura Anne Martin + Needham & Company, LLC, Research Division - Senior Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Brian John White + Monness, Crespi, Hardt & Co., Inc., Research Division - Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 3Q18 revenues of $53.3b, net income of $11.5b and diluted EPS of $2.34. Expects 4Q18 revenue to be $60-62b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 3Q18 revenues = $53.3b. + 2. 3Q18 net income = $11.5b. + 3. 3Q18 diluted EPS = $2.34. + 4. 3Q18 YoverY revenues growth = 17%. + 5. 3Q18 GM = 38.3%. + 6. 3Q18-end cash plus marketable securities = $243.7b. + 7. 3Q18-end term debt = $102.6b. + 8. 3Q18 share repurchase = 112.8m shares for $20b. + 9. 4Q18 revenue guidance = $60-62b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 3Q18 Review (T.C.) + + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Best June qtr. revenue and earnings ever, due to strong performance of iPhone Services and Wearables. + 2. Revenue $53.3b; new 3Q record. + 1. Up 17% YoverY. + 2. Seventh consecutive qtr. of accelerating growth. + 3. Fourth consecutive qtr. of double-digit growth. + 4. Strongest rate of growth in past 11 quarters. + 3. EPS $2.34; record. + 1. Up 40% YoverY. + 2. iPhone: + 1. Revenue up 20% YoverY. + 2. Active installed base grew by double-digits, driven by switchers, first-time smartphone buyers, and existing customers. + 3. iPhone 10 was most popular iPhone once again. + 1. Customer satisfaction score 98%, according to 451 Research. + 4. Based on latest data from IDC, iPhone grew faster than global smartphone market, gaining share in many markets including: + 1. US. + 2. Greater China. + 3. Canada. + 4. Germany. + 5. Australia. + 6. Russia. + 7. Mexico. + 8. Middle East and Africa. + 3. Services: + 1. Had stellar qtr. + 2. Revenue $9.5b; all-time record. + 1. Fueled in part by double-digit growth in overall active installed base. + 2. On target to reach goal of doubling FY16 Services revenue by 2020. + 3. Paid subscriptions from Co. and third parties have now surpassed 300m. + 1. Up more than 60% in past year alone. + 4. Revenue from subscriptions accounts for significant and increasing percentage of overall Services business. + 5. Number of apps offering subscriptions continued to grow. + 1. There are almost 30,000 available in App Store today. + 6. App Store: + 1. Turned 10 years old this month. + 2. Set new June qtr. revenue record. + 3. Exceeded wireless expectations, igniting cultural and economic phenomenon that has changed people work, learn and play. + 4. Based on third-party research estimates, App Store generated nearly twice revenue of Google Play so far in 2018. + 5. App economy is thriving. + 1. App Store is generating jobs for tens of millions of people worldwide. + 2. Developers have earned over $100b from App Store since its launch. + 6. Experienced rapid growth in App Store's [Search Ads service]. + 1. As announced earlier this month, expanding geographic coverage to Japan, South Korea, France, Germany, Italy and Spain. + 4. Other Products: + 1. Seeing strong growth in many of other services as well. + 2. Apple Music grew over 50% YoverY. + 3. AppleCare revenue grew at its highest rate in 18 quarters, partly due to expanded distribution initiative. + 4. Cloud Services revenue up over 50% YoverY. + 5. Communications Services experiencing record usage. + 1. Hit all-time highs for number of monthly active users of messages and number of face time calls made, with growth accelerating from March to June quarters. + 6. Siri request have already exceeded 100b so far this FY. + 7. Number of articles read on Apple News more than doubled YoverY. + 8. Apple Pay continues to expand with well over 1b transactions last qtr.; tripled amount from just year ago, with growth accelerating from March qtr. + 1. This past qtr. completed more total transactions than great companies like Square and more mobile transactions than PayPal. + 2. Apple Pay is now live in 24 markets worldwide with over 4,900 bank partners. + 1. Looks forward to adding Germany later this year. + 3. In US, eBay is beginning to enable its sellers to accept Apple Pay. + 4. CVS Pharmacy and 7-Eleven will roll-out Apple Pay acceptance and locations nationwide this fall. + 9. Transit is another important area of growth and Apple Pay can be used with iPhone and Apple Watch to quickly and conveniently ride public transit in 12 metropolitan areas. + 10. Apple Pay Cash (peer-to-peer payment service) is already serving millions of customers across US less than eight months following its launch. + 5. Wearables: + 1. Outstanding qtr. + 2. Comprises Apple Watch, AirPods and Beats. + 1. Up over 60% YoverY with growth accelerating from March qtr. + 3. Revenue exceeded $10b over last four quarters. + 1. Truly remarkable accomplishment for set of products that has only been on market for few years. + 4. Apple Watch delivered record June qtr. performance with growth in mid-40% range. + 5. Thrilled to see so many customers enjoying AirPods. + 6. HomePod: + 1. Expanded distribution of HomePod [through] additional markets. + 1. Added new immersive listening features with support for HomePod stereo pairs and new multi-room audio system. + 2. In June, hosted extremely successful developers' conference that previewed many major advances coming this fall through four operating systems. + 1. iOS. + 2. macOS. + 3. watchOS. + 4. tvOS. + 3. Has over 4m users participating in new OS beta programs. + 7. iOS 12: + 1. Starting with iOS 12, Siri will take major step forward with Siri Shortcuts, which delivers new much faster way to get things done and allow any app to work with Siri. + 1. Believes this will make Siri even more useful and significantly expand its adoption. + 2. Designed performance improvements across iOS 12 to make everyday tasks faster and more responsive. + 1. Camera launches up to 70% faster, keyboard appears up to 50% faster and abscond launch up to twice as fast. + 3. Adding tools to iOS 12 to help customers understand and take control of time they and their family spend interacting with their iOS devices. + 1. Activity reports will provide information on amount and nature of time spent on iPhones and iPads and screen time will enable parents to monitor and limit their children's activity from their own iOS devices, using Family Sharing in iCloud. + 4. Developers will be able to build even more intelligent apps with just few lines of code, using power of machine-learning with Core ML 2 and create ML. + 5. Included third release of ARKit in only one year. + 1. With ARKit 2, iOS 12 will provide even more powerful platform to make dynamic AR apps, integrating shared and persistent AR experiences, object detection and image tracking. + 2. Believes AR can enable profound experiences. + 1. Co. is uniquely positioned to provide best AR experience because of seamless integration of hardware and software. + 3. New capabilities of ARKit 2 will build on potential of thousands of AR apps already available in App Store that are changing way iPhone an iPad users see and experience world. + 8. Mac: + 1. Though iOS and macOS are different, they've shared common foundations from beginning. + 1. Taken key frameworks from iOS and adapted them to specific Mac behaviors like using mouse or track pad, resizing windows, copy and paste and drag and drop. + 2. Started with some own apps. + 1. So this fall, News, Stocks, Voice Memos and Home will be available on Mac for first time with macOS Mojave. + 2. Will be bringing these great new tools to developers next year. + 2. This fall, Mac App Store is getting full redesign with rich editorial content to help customers discover great Mac apps from developers. + 9. Additional Details: + 1. Believes privacy is one of most important issues of 21st century. + 1. Always working to make products more private and more secure for users. + 2. As Co. announced at WWDC beginning this fall, so far it will prevent share buttons and comment widgets on web pages from tracking users without their permission. + 3. Apple Watch: + 1. Users will see significant expansion of features and functionality in watchOS 5. + 2. Will become even stronger companion for fitness, communication and quick access to information with features including new workouts, activity sharing competitions, other workout detection, advanced running features, walkie talkie podcast and third-party apps on Siri watch face. + 3. Apple TV: + 4. Seen major growth in sales since introduction of Apple TV 4K last fall as video providers worldwide choose Apple TV 4K to deliver their subscription services. + 5. Later this year, Charter Communications will begin offering Apple TV 4K to its customers in nearly 50m US households, providing access to live channels and tens of thousands of on-demand programs via Spectrum TV app on Apple TV 4K, iPhone and iPad. + 6. tvOS will take cinematic experience of Apple TV 4K to next level this fall with support for Dolby Atmos audio and new features to easily find popular shows and movies. + 1. Apple TV 4K already offers customers largest collection of 4K HDR movies. + 2. This fall, iTunes will be home to largest collection of Dolby Atmos supported movies anywhere. + 4. As part of commitment to address climate change and increased use of renewable energy in supply chain, recently announced first of its kind investment fund in China. + 1. Initially 10 suppliers will join Co. in investing nearly $300m over next four years into China clean energy fund. + 1. Fund will invest in and develop clean energy projects, totaling more than 1-gigawatt of renewable energy in China; equivalent of powering nearly 1m homes. + 5. Seeing great momentum in Everyone Can Code and Everyone Can Create initiatives. + 1. More than 5,000 schools and community colleges are now teaching Everyone Can Code. + 2. More than 350 schools have committed to incorporating Everyone Can Create into their curricular for upcoming school year. + 3. Teaming up with leading educators for blind and deaf communities across US, who will start teaching Everyone Can Code this fall. + 10. Summary: + 1. Working with key partners and enterprise to change way work gets done with iOS and Mac. + 2. Expanding reach into emerging markets and seeing strong-double digit growth and revenue. + 3. Making great progress toward goal of significantly expanding Services business. + +-------------------------------------------------------------------------------- +II. 3Q18 Financials (L.M.) + + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Best June qtr. ever. + 2. As Co. has been in every qtr. this FY, set new quarterly records for revenue and EPS with: + 1. Revenue up 17% YoverY and EPS up 40%. + 3. Revenue $53.3b. + 1. YoverY growth in all geographic segments. + 2. New June qtr. records in Americas, Europe, Japan and Rest of Asia Pacific. + 3. Grew in each of top 15 markets with especially strong performance in US, Hong Kong, Russia, Mexico, Middle East and Africa. + 1. All places, revenue was up more than 20%. + 4. GM 38.3%. + 1. Flat sequentially as cost improvements and FX offset seasonal loss of leverage. + 5. Net income $11.5b. + 1. Up $2.8b or 32% YoverY; new June qtr. record. + 6. Diluted EPS $2.34. + 1. Up 40%; new record for June qtr. + 7. Cash flow from operations $14.5b; strong. + 2. iPhone: + 1. Revenue grew 20% YoverY. + 2. ASP increased to $724 from $606 a year ago, driven by strong performance of iPhone 10, iPhone 8, iPhone 8 Plus worldwide. + 3. Sold 41.3m iPhones with double-digit unit growth in several markets, including US, Canada, Germany, Switzerland, Mexico, Hong Kong, Russia, Middle East and Africa. + 4. Performance from customer demand standpoint was stronger than reported results as Co. reduced iPhone channel inventory by 3.5m units. + 5. Exited June qtr. towards lower-end of target range of 5-7 weeks of iPhone channel inventory. + 6. Customer satisfaction continues to be outstanding and is highest in industry. + 1. Latest survey of US consumers from 451 Research indicates that across all this iPhone models, customer satisfaction was 96%. + 1. Combining iPhone 8, 8 Plus and iPhone 10, it was even higher at 98%. + 7. Among business buyers, who plan to purchase smartphones in Sept. qtr., 81% plan to purchase iPhones. + 1. Up 3 points from last survey. + 3. Services: + 1. Revenue $9.5b; all-time record. + 1. Included favorable $236m one-time item in connection with final resolution of various lawsuits. + 1. Excluding this amount, revenue was still all-time record and underlying growth rate of Services business was terrific 28% YoverY. + 2. Generated double-digit Services growth in all geographic segments. + 3. App Store, AppleCare, Apple Music, Cloud Services and Apply Pay all set new June qtr. records. + 4. Other Products: + 1. Category set new record for June qtr. + 2. Revenue $3.7b. + 1. Up 37% YoverY with great states momentum for Apple Watch and AirPods. + 3. Apple Watch continues to be best-selling smartwatch by wide margin. + 1. Units and revenue grew dramatically. + 4. AirPods continue to be runaway success. + 1. Co. has been selling them as fast as, since their launch 1.5 years ago. + 5. Mac: + 1. Saw double-digit YoverY growth in active installed base to new all-time high with nearly 60% of purchases coming from customers who are new to Mac. + 1. YoverY sales performance was impacted by different timing of MacBook Pro launch, which did not occur until early 4Q this year as opposed to June last year with subsequent channel [sale] during June qtr. + 2. Even with difficult launch comparison, saw great momentum in many emerging markets with growth well into double-digits. + 1. Established new June qtr. records for Mac sales in India, Turkey, Chile and Central and Eastern Europe. + 6. iPad: + 1. Unit sales grew for fifth consecutive qtr. + 2. Gained significant share of global tablet market based on latest estimates from IDC. + 3. Recorded double-digit unit growth old in Greater China and Rest of Asia Pacific segments with new June qtr. record for iPad sales in mainland China. + 1. Almost half of iPad purchases were about customers new to iPad. + 2. Active installed base of iPads reached new all-time high. + 4. Overall YoverY performance was impacted by introduction of new iPad Pro models in June of last year, which resulted in different mix with higher ASPs and [channel sale] a year ago. + 5. NPD indicates that iPad has 60% share of US tablet market in June qtr. + 1. Up from 51% share year ago. + 2. Most recent consumer survey from 451 Research measured iPad customer satisfaction ratings of 94%. + 3. Among business customers, who plan to purchase tablets in Sept. qtr. 75% plan to purchase iPads. + 7. Enterprise: + 1. Continues to make great strides with enterprise customers across multiple industries. + 1. Financial services institutions are increasingly using iPads to deploy digital signature solutions for customer consent, compliance requirements, new account openings and services transactions. + 2. In railway industry businesses worldwide, are using iPhone and iPads to support operations, training, passenger engagement and maintenance activities. + 3. Leading global automotive companies are deploying iPads in dealerships for sales enablement and end-to-end customer service management and are choosing iPhone as standard mobile device for their employees worldwide. + 4. Enterprises including Salesforce and Capital One are deploying Macs based on employee preference. + 1. Salesforce, majority of their 35,000 employees are using Macs. + 2. Seeing great interest in Business Chat; powerful new way for organizations to connect with customers. + 1. Business Chat lets customers get answers to questions, resolve issues and complete transactions directly from within messages by starting conversation on their iPhone or iPad and even continue their conversation on their Mac or Apple Watch. + 2. Citizens Bank Park, home of Philadelphia Phillies, (inaudible) Business Chat with Aramark to handle beverage orders during games. + 8. Stores: + 1. Retail and online stores had great qtr., due to strong growth from iPhone, AirPods, and Apple Watch and expansion of HomePod to Canada, France and Germany. + 2. Stores hosted more than 250,000 of successful Today at Apple sessions. + 1. Continues to add content across all Today at Apple topics, including popular new sessions, music and photography. + 3. Opened 50th retail store in Greater China. + 1. Just opened new store in Milan line this month, bringing number of stores located outside US to 46% of total. + 9. Cash Position: + 1. 3Q18-end: + 1. Cash plus marketable securities, $243.7b. + 2. Retired $6b of debt, leaving $102.6b in term debt. + 3. Commercial paper outstanding $12b for net cash position of $129.1b. + 1. As stated in Feb., plans to reach net cash neutral position over time. + 2. Returned almost $25b to investors. + 1. Including $3.7b in dividends and equivalents. + 2. Repurchased $20b worth of Co. shares, of which $10b related to completion of previous $210b buyback program and $10b to beginning of the new $100b authorization announced three months ago. + 1. For total of 112.8m shares repurchased through open market transactions. + 10. 4Q18 Outlook: + 1. Revenue $60-62b. + 1. Sept. qtr. results last year included one-time favorable adjustment of $640m to Services revenue. + 1. Taking that adjustment into account, revenue guidance implies YoverY growth of about 16-19%. + 2. GM 38.0-38.5%. + 3. OpEx $7.95-8.05b. + 4. OI&E about $300m. + 5. Tax rate about 15% before discrete items. + 11. Dividend: + 1. On 07/31/18, Board of Directors declared cash dividend of $0.73 per share of common stock, payable on 08/16/18 to shareholders of record as of 08/13/18. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + I'll ask both my questions upfront. First, for Tim, you're on track to hit your Services revenue target even earlier than planned. So how are you thinking about the next legs of Services growth as you move into the next 3 to 5 years? And then for you Luca, NAND prices are falling this year. Services mix is rising. Those should both positively influence gross margins. And yet, we're seeing gross margin sort of hang out here at 38%. What are the offsetting headwinds? And is it possible that we could see the tailwinds start to overpower those headwinds in the next couple of quarters and see gross margins drift higher? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes, Katy, thanks for your questions, it's Tim. On the Services side, we're thrilled with the results. They were very broad-based. We had double-digit Services growth in all of the geographic segments. And the App Store, AppleCare, Apple Music, cloud services, Apple Pay all set new June quarter records. And then, of course, subscriptions have now passed 300 million as I've mentioned before. And so we're -- we couldn't be happier with how things are going. In terms of the next leg of this, we're -- given the momentum that we're seeing across the board, we feel great about our current services. But obviously, we're also thrilled about our pipeline that have some new services in it as well. And so with the combination of these, we feel great about hitting our objectives and maybe even doing a little better. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [4] +-------------------------------------------------------------------------------- + + Katy, for margins, let me tell you about the puts and takes for the June quarter, then I'll talk about the guidance for Q4 and make some general observations for the future. Starting with the June quarter, typically, we see a decline in gross margin going from the March quarter to the June quarter. Last year, we were down 40 bps, 2 years ago, we were down 140 bps. This year, we were able to keep GM flat sequentially. During the quarter, we always have some loss of leverage because of our typical seasonality. This year, we were able to offset that with some cost improvements, and also we had some favorability in foreign exchange on a sequential basis. Unfortunately, as you know, the U.S. dollar has already appreciated again recently, so we do not expect to see that favorability to repeat during the September quarter. But those are the puts and takes for June, and we're very happy to see gross margin sequentially flat for June. For September, we're also guiding about flat sequentially at the midpoint. As you know, we typically have what we call product transition costs during the September quarter. And this year, we also have about 30 bps of headwind from foreign exchange, again because the dollar has appreciated recently. We expect those 2 factors to be offset by positive leverage because we've seen the revenue guidance that we provided and the mix to Services that you've actually mentioned during your question. So we feel pretty good about most of the guidance for the fourth quarter. Looking forward, you know we don't provide guidance beyond the current quarter, but I think we have a pretty good record over the last several years to make good business decisions, balancing units, revenue and margins. As you know, foreign exchange has been a very significant headwind over the last 3-plus years, but we've been able to manage that. On the memory front, it is true that prices have started to decline. It has been a significant headwind for the last 12 to 18 months and still in the June quarter was negative. We believe that we're going to start seeing some improvement from here on. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [6] +-------------------------------------------------------------------------------- + + Tim, can you talk a bit about trends within your iPhone sales? ASPs were above expectations. And now that you've had -- and that was clearly better than some of the comments from some of your competitors. Now that you've had about 9 months of experience with the high-end fully featured phone, can you talk a bit about what you think customers want, what the elasticity of demand is and how you're sort of thinking about your competitive position? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [7] +-------------------------------------------------------------------------------- + + Yes. Shannon, we feel great about the results on iPhone, up 20%. And if you look for the cycle -- by the cycle, I mean Q1, Q2 and Q3, we've had, on an average weekly basis, growth in units of sort of mid-single-digit and ASP growth of double-digit. And so if you -- and look at iPhone X in particular, it's the most innovative smartphone on the market. We priced it at a level that represented the value of it, and we're really -- we could not be happier that it has been the top-selling iPhone since the launch, and so we feel terrific about iPhone X. If you look at the -- sort of the top of our line together, and by that I mean the iPhone X, the 8 and the 8 Plus, they are growing very nicely as you can probably tell from looking at the ASP, and we couldn't be happier with how that's gone. And so I think in this cycle, we've learned that customers want innovative products. And we sort of already knew that in other cycles and other points in times, but it just puts an exclamation point by that, I believe, with looking at the results. On the -- at the unit level, the iPhone SE had a difficult comp to the year-ago quarter, and so -- when we changed some of the configurations -- the memory configurations in the year-ago quarter. If you look at it on a geographic basis, the top 3 selling phones in urban China were iPhone, where iPhone X was #1 and has been for a couple of quarters. And iPhones make up 3 of the top 5 smartphones in the U.S., U.K. and Japan. And so it's difficult sometimes to get a read over exactly what's happening in the market. But given the industry numbers that we've seen, it's clear that we picked up global market share and picked up market share in several countries, not only iPhone but iPad as well. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [8] +-------------------------------------------------------------------------------- + + Great. And then can you talk a bit about China, up 19% -- Greater China, up 19% year-over-year during the quarter, I believe? Obviously, iPhone doing well, but -- there was some concern that maybe some of what's going on in the trade world might have impacted, it doesn't seem like that. So I'm just curious as to what you're seeing in China and how you're thinking about it as you look forward. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [9] +-------------------------------------------------------------------------------- + + Yes, it's a good question. Thank you. This is the fourth consecutive quarter that we've had double-digit growth in Greater China. I mentioned how iPhone X and sort of the iPhones were selling. We did pick up share in iPhone and iPad. But if you look more holistically at our complete line, we had a double-digit growth from Services to iPad to iPhone and to our other product category, which the Watch did extremely well. And so there are lots of good things happening there. In terms of the tariffs themselves, maybe I could sort of take a step back because I'm sure that a lot -- some people have questions on this. And our view on tariffs is that they show up as a tax on the consumer and wind up resulting in lower economic growth and -- sometimes can bring about significant risk of unintended consequences. That said, the trade relationships and agreements that the U.S. has between -- between the U.S. and other major economies are very complex, and it's clear that several are in need of modernizing. But we think that in the vast majority of situations that tariffs are not the approach to doing that, and so we're sort of encouraging dialogue and so forth. In terms of the tariffs that have been imposed or have exited the comment period, I think that there's one that's exiting today, there have been 3 of those. And maybe I could walk through those briefly just to make sure everybody's on the same page. The first was the U.S. imposed a tariff on steel and aluminum that was -- many, many different countries, that started, I believe, at the beginning of June. There have been 2 other tariffs that have totaled about $50 billion of goods from China that have either been implemented or are exiting the comment period in this month. I think the latest one is today. If you look at those 3 tariffs, none of our products were directly affected by the tariffs. There is a fourth tariff, which includes goods valued at $200 billion, also focused on goods that are imported from China. That one is out for public comment. Probably like everyone else, we're evaluating that one, and we'll be sharing our views of it with the administration and so forth before the comment period for that one ends. It's actually a tedious process in going through it because you not only have to analyze the revenue products, which are a bit more straightforward to analyze, but you also have to analyze the purchases that you're making through other companies that are not related to revenue. Maybe they're related to data centers and this sort of thing. And so we're going through that now, and we'll be sharing our results later on those and feeding back from the comment. Of course, the risk associated with more of a macroeconomic issue, such as an economic slowdown in one or more countries or currency fluctuations that are related to tariffs is very difficult to quantify. And so that -- and we're not even trying to quantify that, to be clear about it. All of this said, we're optimistic, as I've been the whole time, that this will get sorted out because there's an inescapable mutuality with -- between the U.S. and China that sort of serves as a magnet to bring both countries together. Each country can only prosper if the other does. And of course, the world needs both U.S. and China to prosper, for the world to do well. That said, I can't predict the future, but I am optimistic that the countries will get through this. And we are hoping that calm heads prevail. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And that will come from Brian White with Monness, Crespi. + +-------------------------------------------------------------------------------- +Brian John White, Monness, Crespi, Hardt & Co., Inc., Research Division - Research Analyst [11] +-------------------------------------------------------------------------------- + + Yes. Tim, I'm wondering if you could talk a little bit about the multiyear partnership with Oprah Winfrey and what that says about your original content strategy. And also Apple Music, if you can give us a little more color, sort of an update maybe around paid subscribers or total subscribers around Apple Music and how you feel that's rolled out. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [12] +-------------------------------------------------------------------------------- + + Yes, sure, Brian. Thanks for the question. We're very excited to work with Oprah. We think that her incomparable ability and talent to connect with audiences around the world are -- there's no match. And we think that we can do some great original content together, and so we could not be happier in working with Oprah. As you know, we hired 2 highly respected television executives last year, and they have been here now for several months and have been working on a project that we're not really ready to share the -- all the details about it yet. But I couldn't be more excited about what's going on there. And we've got great talent in the area that we've sourced from different places and feel really good about -- felt really good about what we will eventually offer. In terms of the sort of the key catalysts and the changes -- the cord-cutting, in our view, is only going to accelerate and probably accelerate at a much faster rate than is widely thought. We're seeing the things that we have on the periphery of this like Apple TV units and revenue grew by very strong double digits, very, very strong double digits in Q3. As I mentioned in my opening comments, we're seeing different providers pick up the Apple TV and use it as their box to go to market with their subscription service. There are -- within the 300 million-plus paid subscriptions, some of these are third-party video subscriptions, and we see the growth that is going on there. It's like 100% year-over-year. And so all the things from a -- all the forcing functions here from the outside all point to dramatic changes speeding up in the content industry. And so we're really happy to be working on something but just not ready to talk about it in, in depth today. In terms of Apple Music, we're well over 50 million listeners now when you add the -- our paid subscribers and the folks in the trial. And so we're moving along at a very, very good rate. It appears to us and what we've been told is that we took the leadership position in North America during the quarter, and we had leadership position in Japan. And so in some of the markets that we've been in for a long period of time, we're doing quite well. But really, the key thing in Music is not the competition between companies that are providing music, it's the -- the real challenge is to grow the market because if you add everyone up that's providing subscription music today or streaming music, it's -- outside of China, it's less than 200 million probably around the world. And so it does seem to me, there's an extraordinary opportunity in that business to grow the market well. And I think if we put our emphasis there, which we're doing, that -- we'll be a beneficiary of that as other people will as well. But I like where we are. Our revenues on Apple Music grew over 50%, as I'd mentioned earlier, during the quarter. And so it's really, really strong, strong results. Thanks for the question. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Toni Sacconaghi with Bernstein has our next question. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + I have one for Luca and one for Tim, please. Luca, I'm wondering, as we think about modeling Q4, iPhone ASPs are typically up sequentially about 2% to 4%, sort of low single digits. Perhaps you can help us think through how we should be thinking about Q4. I know you provided some commentary last quarter on how we should be thinking about Q3 ASPs. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [15] +-------------------------------------------------------------------------------- + + Toni, as you know, we do not provide guidance for either units or ASPs for any product category. But of course, we provide a guidance on revenue. And the guidance range implies growth of 16% to 19%. We expect the growth to come from strong growth from iPhone, from Services and from Wearables, which has been a bit of our pattern during the course of the year. On iPhone ASP, the only thing that I would point out is that, obviously, we're exiting the June quarter at a significantly higher level than in the past. And so that, I think it's important to keep in mind -- as we move into the September quarter, it's important to keep in mind the type of revenue growth that we've implied in our guidance. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + Okay. Tim, I was wondering if you could just comment a little bit about the health of the smartphone market. Apple's smartphone iPhone units have been relatively flat for 4 years. And I think you've probably been a share gainer during the period, which would suggest, at least at the high end of the market, that is perhaps flat to down. And I'm wondering if you can comment on, a, whether you believe that and what you think might be happening with replacement cycles and specifically also what impact, if any, you've seen from wider availability and less expensive replacement batteries for iPhones. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [17] +-------------------------------------------------------------------------------- + + I think the smartphone market is very healthy. I think it's actually the best market in the world to be in for someone that is in the business that we're in. So it's an enormous-sized market and whether it grows -- from our point of view, whether it grows 1% or 2% or 5% or 6% or 10% or shrinks 1% or 2%, it's a great market because it's just huge. And so that's kind of the way that I view that. iPhone revenues are up 20% for the quarter over last year. We're really pleased with that. And if you look at the sort of this cycle, which I'll define as Q1, Q2, Q3 for ease, you'll see that we've grown like mid-single digits and -- on an average weekly sales point of view and, of course, double-digit on ASP. And so I think it's really healthy. In terms of replacement cycles, as I've mentioned I think on a previous call, some replacement cycles are lengthening. I think that the major catalyst for that was probably the subsidy plans becoming a much smaller percentage of total sales around the world than they were at one time. And so I think that some are lengthening and -- but I think for us, the thing that we always have to do is come out with a really great innovative product. And I think that iPhone X shows that when you deliver great innovative product, there's enough people there that would like that, and it can be a really good business. And so that's how I look at that. In terms of the -- our installed base, which is something very important for us as it is one of the key drivers of Services, our active installed base on iPhone grew double digits over last year during the quarter. And so we're thrilled with that. And you can see that carrying through to the Services line, in the -- and the growth that we have there. In terms of batteries, we have never done an analysis internally about how many people decided to get a lower-priced battery than buy another phone because it was never about that for us. It was always about doing something great for the user. And I think if you treat the users and customers well, then you have a good business over time, and so that's how we look at that. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Next, we'll take a question from Laura Martin from Needham. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- + + Yes, can you hear me okay? + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [20] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [21] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + Great, okay. Super. I'd like to focus on product road map and strategy. There is a war going on for the home, the connected home, over the Internet of Things. And with 2 products, the HomePod and Apple TV in the home, my question is, strategically, how do you feel about the importance of being in the home and whether it threatens your dominance outside the home, with your core business in the mobile devices, if you sort of lose that battle? I'm just trying to figure out strategically, when you think about where the puck's going, how important is it for you to have a beachhead in the home as well as out of home? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [23] +-------------------------------------------------------------------------------- + + I think the home business, Laura, is bigger than the HomePod and Apple TV. They're both important products clearly. But everybody has their iPhone at home as well and everybody has their Mac at home and everyone has their iPad at home. And so in terms of the -- Siri access points, there -- as you can tell from the 100 billion number I quoted in the script, there's an extraordinary amount of usage of these products that are used to perform home-related functions. I do that every day with controlling all my home automation and so on and so forth. Part of that is on HomePod, but part of it is with the Apple Watch and the iPhone and the iPad. And so I think home is important. Home is important. Work is important. The movement between the 2 are important. Health is important. So the smartphone has become the repository that goes across the whole of your life, not something that is just meant for a portion of it. And so I think all of those are important, and we're focused on all of them. Thanks for your question. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + That's helpful actually. Yes, sort of. I mean, I'll watch your product road map and be able to tell what the answer is. The other thing, the thing I get in fights with investors about the most is this, and I'd love your insight on this. I love the expansion of the new products. The question I have is, are they actually on-ramped into the Apple ecosystem, the Beats, the Watch, the AirPods, subscriptions? Are they on-ramped into the ecosystem? Or is the on-ramp to the ecosystem the iPhone, and then these new products add revenue per member once you get somebody into the ecosystem via the iPhone? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [25] +-------------------------------------------------------------------------------- + + The -- a lot of people that buy Apple products buy for the whole ecosystem even though they might not currently use all the different products. And so the way that I think about those products are they're products within the ecosystem itself. And there's a -- the AirPods have really gone through the roof, and the Apple Watch has hit an air pocket and has gone to a whole different level, as I had mentioned earlier, with our overall Wearables revenue. And so in my view, this is a part of the -- they are a core part of the ecosystem. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + And so they attract a new person to the ecosystem. Or does the person have to have an iPhone first? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + It is -- well, but on your point though, it is clear from communications that I've had with users that some of them were attracted to iPhone because of the Apple Watch. And so the Apple Watch led them to the iPhone. The reverse of that is also true is that somebody got the iPhone and then decided, "I really want something to coach me in fitness and to curate some of the communications and so forth like the Watch does so well." And so it's not always a linear path. I see these things as being somewhat fluid and different for each user. + +-------------------------------------------------------------------------------- +Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + So they're complementary and self-reinforcing. Okay, that makes sense. All right. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [29] +-------------------------------------------------------------------------------- + + Exactly right. Thank you for the questions. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [30] +-------------------------------------------------------------------------------- + + Thank you, Laura. A replay of today's call will be available for 2 weeks on Apple podcast, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 5838188. And these replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Josh Rosenstock at (408) 862-1142. And financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2018-May-01-AAPL.txt b/Transcripts/AAPL/2018-May-01-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..d0cf0b91218c9af59ecb364828ee2b5adda63dbc --- /dev/null +++ b/Transcripts/AAPL/2018-May-01-AAPL.txt @@ -0,0 +1,511 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q2 2018 Apple Inc Earnings Call +MAY 01, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Amit Jawaharlaz Daryanani + RBC Capital Markets, LLC, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * Brian John White + Monness, Crespi, Hardt & Co., Inc., Research Division - Research Analyst + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD and Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 2Q18 revenues of $61.1b, net income of $13.8b and diluted EPS of $2.73. Expects 3Q18 revenues to be $51.5-53.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 2Q18 revenues = $61.1b. + 2. 2Q18 net income = $13.8b. + 3. 2Q18 diluted EPS = $2.73. + 4. 2Q18 YoverY revenues growth = 16%. + 5. 2Q18 GM = 38.3%. + 6. 2Q18-end cash plus marketable securities = $267.2b. + 7. 2Q18-end net cash = $145b. + 8. 2Q18-end term debt = $110b. + 9. 2Q18 share repurchase = 137m shares for $23.5b. + 10. 3Q18 revenue guidance = $51.5-53.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 2Q18 Review (T.C.) + + +-------------------------------------------------------------------------------- + + 1. Results: + 1. New March qtr. records for: + 1. Revenue. + 2. Earnings. + 2. Revenues: + 1. 2Q18, $61.1b. + 1. Up 16% YoverY. + 2. Sixth consecutive qtr. of accelerating revenue growth. + 2. Broad-based performance with: + 1. iPhone up 14%. + 2. Services up 31%. + 3. Wearables up almost 50%. + 3. Grew in each geographic segment. + 1. In Greater China and Japan, revenue up more than 20%. + 4. iPhone's performance capped tremendous fiscal 1H, with $100b in iPhone revenue. + 1. Up $12b over last year, setting new 1H record. + 2. Highest 1H growth rate in three years. + 5. iPhone gained share based on IDC's latest estimates for global smartphone market. + 1. Customers chose iPhone X more than any other iPhone each week in March qtr., just as they did following its launch in Dec. qtr. + 2. Since Co. split line with launch of iPhone 6 and 6 Plus in 2014, this is first cycle in which top-of-the-line iPhone model has been the most popular. + 6. 2Q was best qtr. ever for services. + 1. Momentum continues to be strong. + 7. Revenue topped $9b for first time; up more $2b over last year's March qtr. + 8. Had all-time record revenue from App Store, Apple Music, iCloud, Apple Pay and more. + 3. Across all services, paid subscription surpassed 270m; up over 100m from year ago and up 30m in last 90 days alone, contributing to overall increase in services revenue. + 4. Apple Pay continues strong growth, with active users more than doubling and transactions tripling YoverY. + 1. Believes availability of Apple Pay at major transit systems have been key driver of adoption among commuters. + 2. In March, launched Express Transit with Apple Pay in Beijing and Shanghai, second and third largest transit systems in the world. + 3. Apple Pay is already the most successful mobile transit payment system in Tokyo, which has busiest transit system of all. + 4. With launch of Brazil in April, Apple Pay is now available in 21 markets. + 1. Expects Norway, Poland and Ukraine to launch in next several months. + 5. Outstanding qtr. for wearables business, which includes Apple Watch, Beats and AirPods, with combined revenue of almost 50% YoverY. + 1. Looking at revenue over last four quarters, wearables business is now the size of a Fortune 300 co. + 2. Apple Watch had another great qtr., with revenue growing by strong double digits YoverY to new March qtr. record. + 1. Millions of customers are using Apple Watch to help them stay active help in connected and they have made it top-selling watch in the world. + 3. Launched carrier support for Series 3 with cellular in mainland China, Hong Kong and Thailand, with more markets on the way. + 4. With watchOS 4.2, there are more features than ever before. + 5. AirPods: + 1. Working hard to meet incredible demand. + 6. Started shipping HomePod in Feb. + 1. It's widely recognized as having the best audio quality for its size and class. + 2. Currently available in US, UK and Australia. + 3. Looking forward to adding new features to HomePod and introducing it to more markets globally soon. + 7. In March, announced new products for education community, including updating most popular iPad with support for Apple Pencil. + 1. In addition to successful Everyone Can Code initiative, launched Everyone Can Create. + 8. In March, released iOS 11.3, a major update offering new immersive augmented reality experiences, access to personal health records in Health app and more. + 1. Update to ARkit came just six months after Co. launched the world's largest AR platform. + 2. In iOS 11.3, patients in nearly 40 health systems, representing hundreds of hospitals and clinics can now consolidate their medical records from multiple sources and view them all in one place right from their iPhone. + 1. Consistent with long-term focus, privacy is key element of aforementioned initiatives for education and personal health. + 9. Environmental initiatives recently passed important milestone, all of Co.'s global facilities across 43 countries are powered with 100% clean energy. + 1. Works with communities worldwide to build clean power sources. + 2. Has 25 renewable energy projects operational and 15 more under construction. + 10. Driving supply chain to use clean energy. + 1. As of last month, 23 of suppliers are committed to operating on 100% renewable energy. + 11. Now halfway through FY18, with nearly $150b in revenue and double-digit growth in all geographic segments. + 1. Generated almost $34b in earnings in six month; bullish on Co.'s future. + 12. Has best pipeline of products and services Co. ever had. + 1. Has huge installed base of active devices that is growing across all products. + 1. Has highest customer loyalty and satisfaction in industry. + 13. Services business is growing dramatically. + 14. Balance sheet and cash flow generation are strong. + 1. Allows Co. to invest significantly in product roadmap and still return meaningful amount of capital to shareholders. + 15. Recent corporate tax reform enables Co. to deploy global cash more efficiently. + 1. In US, expects direct investment in economy to exceed $350b over next five years, including $30b in CapEx and Co. expects to create over 20,000 US jobs at AAPL over that time frame. + 16. Narrowing site selection for new US campus. + 2. Capital Return Program: + 1. Tax reform makes it possible for Co. to execute program more efficiently through share repurchases and payment of dividend to tens of millions of investors, who own AAPL stock either directly or indirectly from large pension funds to individuals with retirement account. + 2. Given strong confidence in Co.'s future, announcing significant update to capital return program. + 1. Board of Directors approved a new $100b share repurchase authorization and 16% increase in quarterly dividend, effective with next dividend payable later this month. + +-------------------------------------------------------------------------------- +II. 2Q18 Financials (L.M.) + + +-------------------------------------------------------------------------------- + + 1. Results: + 1. Record financial results, with: + 1. 16% revenue growth. + 2. EPS up 30%. + 2. Revenue $61.1b. + 1. Highest ever for March qtr. + 2. Revenue grew in all geographic segments, setting new 2Q records in most countries Co. tracks. + 3. Performance was strong in emerging markets where revenue was up 20%. + 1. Saw 21% YoverY growth in Greater China; strongest growth rate from that segment in 10 quarters. + 4. Set 2Q revenue records in: + 1. Americas. + 2. Europe. + 3. Japan. + 3. GM 38.3%. + 1. Essentially flat sequentially as Co. offsets seasonal loss of leverage with cost improvement and shifting mix towards services. + 4. Operating margin, 26% of revenue. + 5. Net income $13.8b. + 1. Up $2.8b YoverY. + 2. March qtr. record. + 6. Diluted EPS $2.73. + 1. Up 30%. + 2. New record for 2Q. + 7. Cash flow from operations, strong at $15.1b. + 8. iPhone revenue grew 14% YoverY, with iPhone ASP increasing to $728 from $655 a year ago, driven primarily by performance of iPhone X, iPhone 8 and iPhone 8 Plus. + 1. Sold 52.2m iPhones. + 1. Up 3% YoverY. + 2. Grew iPhone units by double digits in several markets, including Japan, Canada, Switzerland, Turkey, Central and Eastern Europe, Mexico and Vietnam. + 2. Performance from customer demand standpoint was even stronger than reported results as Co. reduced iPhone channel inventory by 1.8m units; 600,000 units more than March qtr. reduction last year. + 3. Exited March qtr. within target range of 5-7 weeks of iPhone channel inventory. + 4. Latest survey of US consumers from 451 Research indicates that across all iPhone models, customer satisfaction rating was 95%, and combining iPhone 8, 8 Plus and iPhone X, customer satisfaction was even higher at 99%. + 9. Among business buyers, who plan to purchase smartphones in June qtr., 78% plan to purchase iPhones. + 2. Services: + 1. Sensational qtr., with all-time record revenue of $9.2b; up more than $2b from last year; up 31% and double services revenue Co. generated in March qtr. just four years ago. + 2. Growing at fast pace all around the world, with revenue up more than 25% YoverY in each of Co.'s five graphic segments. + 3. App Store set new all-time revenue record. + 4. Apple Music reached new record for revenue and paid subscribers, which have passed 40m. + 5. iCloud storage revenue up over 50% YoverY to new all time. + 6. AppleCare revenue grew at highest rate in five quarters, setting new March qtr. record. + 3. Other Products: + 1. Category set new record, with revenue of almost $4b. + 2. Began shipping HomePod in Feb. + 3. Unit sales of Apple Watch and AirPods reached new high for March qtr. + 1. When combining all wearables and home products, they accounted for over 90% of total growth in other products category. + 4. Mac: + 1. Set new March qtr. revenue record, including new records in Americas and Greater China. + 2. Sold 4.1m Macs, generating YoverY growth in many emerging markets, including Latin America, Middle East and Africa, Central and Eastern Europe and India. + 3. Saw double-digit growth in active installed base to new all-time high, with almost 60% of March qtr. purchases coming from customers who are new to Mac. + 5. iPad: + 1. Grew units and revenue for fourth consecutive qtr. + 2. Sold 9.1m iPads. + 1. About half of purchases were by customers new to iPad. + 3. Growth was particularly strong in Japan, Latin America, Middle East and Africa, and Central and Eastern Europe. + 1. All markets were iPad sales up double digits vs. year ago. + 4. Gained share of global tablet market based on latest estimates from IDC. + 1. Active installed base of iPads reached all-time high. + 5. NPD indicates that iPad has 53% of US tablet market in March qtr.; up from 40% share a year ago. + 1. Most recent customer survey from 451 Research measured iPad customer satisfaction ratings of 95%. + 1. Among business customers who plan to purchase tablets in June qtr., 73% plan to purchase iPads. + 6. Other Details: + 1. Makes great strides in enterprise market. + 1. In Feb., announced new cyber risk management solution for businesses with Cisco, Aon and Allianz. + 1. Combined approach is industry-first that integrates most secure technology from AAPL and Cisco, cyber resilience evaluation services from Aon and options for enhanced cyber insurance coverage from Allianz. + 2. Able to better manage and protect from cyber risks associated with ransomware and other malware-related threats. + 2. Insurance industry leaders recognize AAPL products provide superior security. + 3. In March, announced two new services with IBM to bring more dynamic and intelligent insights into apps. + 1. IBM Watson services for Core ML and IBM Cloud Developer Console for AAPL will enable developers to more easily build native iOS apps that bring together machine-learning with artificial intelligence and cloud services. + 7. Healthcare: + 1. iPhones are being used across leading health systems, including Cedars-Sinai, Mayo Clinic and HCA Healthcare with iOS apps to support clinical workflows, communications and care delivery. + 1. HCA Healthcare recently announced they plan to deploy 100,000 iPhones across their hospital site within next three years. + 8. Retail & Online Stores: + 1. Produced highest March qtr. revenue ever. + 1. YoverY growth was led by: + 1. iPhone. + 2. Strong performance from AirPods. + 3. Introduction of HomePod. + 2. Stores hosted more than 250,000 of popular Today at Apple sessions, with particular emphasis on coding and app design. + 1. During qtr., opened beautiful new stores in South Korea and in Austria, Co.'s first in both countries. + 1. Three weeks ago, opened newest store in Tokyo, bringing Co. to 502 stores across world today. + 9. Cash Position: + 1. 2Q18-end: + 1. Cash plus marketable securities, $267.2b. + 2. Term debt, $110b. + 3. Commercial paper outstanding, $12b. + 4. Net cash position $145b. + 2. Returned nearly $27b to investors. + 1. Paid $3.2b in dividends and equivalents. + 2. Spent $23.5b on repurchases of 137m AAPL shares through open market transactions. + 3. Retired 5.7m shares upon completion of 13 ASR during qtr. + 3. Completed over $275b of current $300b capital return program, including $200b in share repurchases against cumulative $210b buyback program. + 1. Will complete $210b program during June qtr., three full qtr. sooner than initially planned. + 4. Biggest priorities for cash have not changed over the years. + 1. Wants to maintain cash Co. needs to fund day-to-day operations, to invest in future, and to provide flexibility, so that it can respond effectively to strategic opportunities AAPL encounters along the way. + 2. As mentioned 90 days ago, new tax legislation enacted in Dec. gives Co. increased financial and operational flexibility from the access to its global cash. + 1. Allows Co. to invest for growth in US more efficiently. + 2. Provides opportunity to towards more optimal capital structure. + 3. As mentioned in Feb., goal is to become approx. net cash neutral over time. + 5. Board has authorized new $100b share repurchase program, which Co. will start executing during June qtr. + 1. Considering unprecedented size of this new authorization, Co. wants to be particularly thoughtful and flexible in approach for repurchasing shares. + 1. Intention is to execute Co.'s program efficiently and at a fast pace. + 6. Raising dividend for sixth time in less than six years. + 1. Quarterly dividend will grow from $0.63 to $0.73 per share. + 1. Up 16%. + 2. Effective with next dividend, which Board declared on 05/01/18, payable on 05/17/18 to shareholders of record as of 05/14/18. + 2. With over $13b in annual dividend payments, proud to be among the largest dividend payers in the world. + 1. Continues to plan for annual dividend increases going forward. + 3. Expects to provide new update to capital allocation plans approx. 12 months from now. + 10. 3Q18 Outlook: + 1. Revenue, $51.5-53.5b. + 2. GM, 38.0-38.5%. + 3. OpEx, $7.7-7.8b. + 4. OI&E, about $400m. + 5. Tax rate, about 14.5%. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Your first question will come from Shannon Cross of Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [2] +-------------------------------------------------------------------------------- +I wanted to ask about your thoughts on sort of iPhone and positioning. Now that we're a couple of quarters out from the launch of the iPhone X, given the $1,000 price point, it's clearly selling, but there's been a lot of questions in the market about sustainability of that price point and how you're thinking about it as you go look out sort of holistically across your lineup. So if you could talk a bit about what you're hearing from your customers on that and then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- +Sure. Shannon, it's Tim. As Luca mentioned earlier, our revenues are up 14% year-over-year on iPhone, and that's a combination of single-digit unit growth and ASP growth that is mainly driven by iPhone X. I think that our iPhone line shows that there's a variety of different customers in a market that is as large as the smartphone market, and so we're going to continue to provide different iPhones to -- for folks to meet their needs. On iPhone X specifically, I think it's important to maybe emphasize again one of the things I mentioned in my opening comments that customers chose iPhone X more than any other iPhone each and every week in the March quarter just as they did following the -- following its launch in the December quarter. Also, since we split the line with the launch of iPhone 6 and 6 Plus back in 2014, this is the first cycle that we've ever had where the top of the line iPhone model has also been the most popular. And so with the customer sat that Luca referenced as well, the 99%, the iPhone X is a beloved product, and so it's -- I think that it's one of those things where like a team wins the Super Bowl. Maybe you want them to win by a few more points, but it's a Super Bowl winner. And that's how we feel about it. I could not be prouder of the product. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [4] +-------------------------------------------------------------------------------- +And then, Luca, can you talk about working capital, specifically inventory, which went up pretty significantly quarter-over-quarter? What's driving that? And how are you thinking about -- I mean, it's one of the uses of cash obviously. So how are you thinking about inventory and maybe working capital in general as you're going forward? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [5] +-------------------------------------------------------------------------------- +Yes. Shannon, you know that we've always generated a significant amount of cash through working capital. We've got a negative cash conversion cycle, and we plan to continue to have that. Our inventory level has gone up. It's just a temporary event. We have decided to make some purchasing decision given current market conditions, and that should unwind over time. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [6] +-------------------------------------------------------------------------------- +So that was essentially component purchases? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [7] +-------------------------------------------------------------------------------- +Correct. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +From Morgan Stanley, Katy Huberty. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [9] +-------------------------------------------------------------------------------- +The Services growth acceleration is really the highlight this quarter in my mind. Can you talk about what the biggest driver is, whether it be products or regions that drove the acceleration? And do you think that we can continue to see growth north of 30%? Then, I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- +It's Tim. The -- Services grew 31%. We hit an all-time record at $9.2 billion, first time we cleared $9 billion. The great news about it is it's not a single geo or a single service. If you look at it, each of the geos, the minimum was at 25%. So each of the geos were -- had -- did extremely well, and we set records from the App Store to the Apple Music, to iCloud, to Apple Pay and more. And underneath that, if you look at the subscriptions, the number of subscriptions, I think I mentioned this in my comments, paid subscriptions have moved up over 100 million on a year-over-year basis to over 270 million by the end of the quarter. And so it's very broad based in terms of type of service and geographic region. It's sort of exactly what we would like to see. In terms of forecasting moving forward, we've obviously made assumption for our guidance that Luca provided earlier, and in terms of longer term, we're on target to our 2020 goal of doubling the Services revenue of '16 as we had talked about previously. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [11] +-------------------------------------------------------------------------------- +And it doesn't look like the threat of a trade war with China slowed down that business. In fact, growth accelerated. But anything anecdotally that you see in the business in recent weeks that would suggest that, that is having an impact on demand? And any actions that Apple is taking as a company to preempt any risk of tariffs going forward? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [12] +-------------------------------------------------------------------------------- +Yes. I think my own view is that China and the U.S. have this unavoidable mutuality where China only wins if the U.S. wins and the U.S. only wins if China wins, and the world only wins if China and the U.S. win. And so I think there's lots of things that bind the countries together. And I'm actually very optimistic. I think history shows us that countries that embrace openness and diversity do much, much better than the ones that are closed. And so I'm a big believer that the 2 countries together can both win and grow the pie, not just allocate it differently. And so that's our focus, and I'm optimistic that -- I don't know every play by play that will happen, but over time, I think that view will prevail. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +The next question will come from Mike Olson with Piper Jaffray. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [14] +-------------------------------------------------------------------------------- +Just following on the Services question. I'd be curious what the next drivers of Services revenue are? Will it be continued penetration of Music and Pay that you see as kind of the largest future categories of incremental growth? Or maybe when could augmented reality become a material part of Services? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- +Well, Mike, it's Tim. The -- again, the great thing about Services is there are several services that make up the total that are growing nicely. And I think the other good news is that because our active installed base has -- is at such a level at -- last quarter, we said that we had exceeded $1.3 billion. This year, we're -- we're not going to release this number every quarter, but we've obviously grown again. And it's growing at a double-digit number on a year-over-year basis. And so with that kind of change in the installed base and with the services that we have now and others that we are working on, I think that this is just a huge opportunity for us and feel very good about the track that we're on. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [16] +-------------------------------------------------------------------------------- +And then any potential tariff issues aside, what's working for Apple in China right now? You talked about it being the strongest year-over-year growth in 10 quarters. I guess, what's driving that? Is it iPhone X specifically or something else that's behind that improvement? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [17] +-------------------------------------------------------------------------------- +A good question. IPhone X was the most popular smartphone in all of China last quarter. And so iPhone X has done well there. In order to hit a number like 21% on the growth that you see on your data sheet there, there has to be several things working well. And the things that have huge growth rates there are the other products category, which is our Wearables business in China and the Services business, which you and I just spoke about. The iPhone obviously had to do extremely well to get a 21% number, and we gained share in the market for the Mac as well. And so there's actually several vectors there that are working well for us. We also -- more broadly on the iPhone, the iPhone was the top 3 selling phones in China. And so it's iPhone X was #1, but we had several in the top. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +From RBC Capital Markets, Amit Daryanani. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [19] +-------------------------------------------------------------------------------- +Two questions from me as well. I guess, first one, just touching on the gross margin dynamics. If I look at the guidance for June on a year-over-year basis, I think sales are up double digit, but gross margins are still flat at the high end, maybe down 20 basis points at the midpoint. Can you just talk about what's driving the lack of leverage on the gross margin basis on a year-over-year basis for June? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [20] +-------------------------------------------------------------------------------- +Yes. Amit, it's Luca. We tend to look at the -- our gross margin dynamics on a sequential basis, and essentially, we're guiding to about flat on a sequential basis. On a year-over-year basis, it's less relevant for our business, but in general, I would say that this year we are seeing a more difficult cost environment. Particularly, we're still dealing with about 70 basis points of the impact from the memory pricing environment that we're working through. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [21] +-------------------------------------------------------------------------------- +Got it. And if I could just follow up, Tim, you've been fairly vocal, I think, talking about the need for better privacy protection and well-crafted regulation over time. Could you just maybe help us understand how does Apple protect consumer data? And how does this ongoing debate around data protection translate into a positive for Apple over time? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [22] +-------------------------------------------------------------------------------- +We protect it by encrypting it, and we keep the bulk of information or a significant amount of information on the device so that the user is in control of it. We also collect much less overall than others do because our -- if you look at our model, if we can convince you to buy an iPhone or an iPad, we'll make a little bit of money. You're not our product, and so that's how we look at that. In terms of benefit, we don't really view it like that. We view that privacy is a fundamental human right and that it's an extremely complex situation if you're a user to understand a lot of the user agreements and so forth. And we've always viewed that part of our role was to sort of make things as simple as possible for the user and provide them a level of privacy and security. And so that's how we'd look at it. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +We'll go to Steve Milunovich with UBS. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [24] +-------------------------------------------------------------------------------- +Luca, could you talk a bit more about the capital allocation? The dividend increase of 16% was relatively low relative to what you could have done. So are you really thinking the stock price is attractive here? And you said you would execute the buyback at a fast pace. Can you give us any time frame of that $100 billion? And how much debt do you think about in terms of net cash 0? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [25] +-------------------------------------------------------------------------------- +Yes. Let's start with the dividend. We're increasing it by 16%. This is the largest increase that we've done since we've reintroduced the dividend back in August of 2012. So we think it's a very meaningful increase for all the investors that value income. Obviously, when we come down to capital allocation decisions, we obviously also keep in mind that -- the opportunity for us to do some M&A activities, which we do in an ongoing basis. But when it comes down between dividends and buyback, our view is that for a variety of reasons, the -- we see a lot of value in the stock. We believe the stock is undervalued, and so we have a bias towards the buyback. So the dividend is a very large component of capital return because we're going to be returning more than $13 billion a year to investors through dividends. But we believe that given where we are with the valuation of the stock, we think that we continue to do the buyback primarily. We are not giving an end date to the program this time because the amount is very, very large. And so we will -- we would try to execute it. As you've seen from our track record during the last 5 years, we will do that at a very fast pace. But we also want to do it efficiently. We want to make sure that we buy back the stock at the right time. And so with that in mind, we have done $23.5 billion of repurchases during the March quarter. We will give you an update to our activities at the end of every quarter. And then 12 months from now we will actually talk about an update to the entire program. So you will be able to keep track of our progress every 90 days. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [26] +-------------------------------------------------------------------------------- +And Tim, could you talk a bit about your health care opportunity? Is it merely selling watches over time? Or do you think more broadly about? Is there a services play? You're doing some things for your employees. Could that potentially broaden out? How do you think about the opportunity there? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- +We think about it very broadly, and you can tell that a bit by some of the things that we've had going with ResearchKit and CareKit and most recently, the health records that I had referenced in my initial comments. And those all came out of getting significantly engaged in the Apple Watch and sort of pulling the strings so to speak. And we also have a Heart Study that is going on currently. And so I don't want to give too much away, but it's an area of great interest where we think we can make a big difference. And so it's a major strategic thrust of ours. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +We'll go to Brian White with Monness, Crespi. + +-------------------------------------------------------------------------------- +Brian John White, Monness, Crespi, Hardt & Co., Inc., Research Division - Research Analyst [29] +-------------------------------------------------------------------------------- +Yes. Tim, I think there's -- China numbers were actually phenomenal in the quarter and third consecutive quarter of growth. I think there's been a lot of concerns, just Apple in China and maybe misinformation out there. But what do you see as the drivers for Apple in both Mainland China and Greater China over the next few years? And also, if you could just give us an update on what you're seeing in India. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [30] +-------------------------------------------------------------------------------- +Yes, good question. Let me start with India, and then I'll talk more about China. India, we set a new first half record. So we continue to put great energy there and try to -- our objective over time is to go in there with all of our different initiatives from retail and everything else. And so we're working toward those things. It's a huge market, and it's clear that many people will be moving into the middle class over time as we've seen in other countries. China, I continue to believe is a phenomenal country with lots of opportunity from a market point of view but also lots of opportunity from an app developer point of view. We have almost 2 million application developers in China that are writing apps for iOS and the App Store, and they're doing unbelievably creative work and innovative work. And so we sort of -- we look at China holistically, not only as a market. On the market side, we've seen iPhone X, as I had mentioned before, as being the top-selling smartphone during the quarter. We gained share during the quarter. And I read some notes here and there about the market itself not being good. I think on -- in any kind of -- on a 90-day clock, lots of different things can happen, but my own personal view of China is that it's a great market. And I would -- I'm -- we are certainly looking far beyond 90 days and feel very bullish on the opportunity and the environment there. I would say that the market for us is more than iPhone. The Mac gained share there as well. The Watch is getting some traction there. Services is doing extremely well. And so it has several catalysts, and I'm very pleased with the results that we were able to show during the quarter. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Next we'll hear from Wamsi Mohan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [32] +-------------------------------------------------------------------------------- +Tim, can you comment on the price elasticity of demand at the high end for iPhones, if that was in line with your expectations? Do you have a preference for unit growth versus ASP growth when it comes to maximizing the gross profit dollar growth? And I have a follow-up for Luca, please. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [33] +-------------------------------------------------------------------------------- +We price for the value that we're delivering. And iPhone X is the most innovative product on the market, and as I've said a few times, we have -- they're sort of jam-packed with technologies that really set up the smartphone for the next decade. And so that's how we priced it. We were surprised somewhat that through all of this period of time that the iPhone X winds up at the most selling -- most popular for every week of the time since the launch, and so that's, I think, a powerful point. And it's #1 in China, which is another powerful point. And so obviously, at some point, if those technologies move to lower price points and that -- there's probably more unit demand. But the way we think about it is trying to price a reasonable price for the value that we deliver, and I feel that we did that. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [34] +-------------------------------------------------------------------------------- +And Luca, your gross margins have been very robust despite the headwinds that you absorbed on commodities, which you quantified, and frankly, also from the FX hedges that are limiting some of the FX upside that a lot of other companies are seeing. So as you -- one, when do you expect these to turn into tailwinds? And when they do turn into tailwinds, do you -- would you consider reinvesting some of those into pricing? Or would you -- like should we think about you flowing those through to the bottom line? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [35] +-------------------------------------------------------------------------------- +Well, Wamsi, I think let me start with where we are right now. I think you're right. I think we've been able to navigate a difficult foreign exchange environment for a number of years. And now as you know, because we have this hedging program, as the dollar has weakened a bit in recent months, although during the last week, it actually started to turn the other way again, we've got the hedging program that works both ways. And also on the memory front, we feel that for NAND, we're going to be turning the corner very soon. For DRAM, we also think that we are near the peak, possibly at the end of this year. And so that should provide some level of stability. As I said earlier this year, I think we are experiencing in total a more difficult cost environment. And so hopefully, that can turn into a positive for us. At the same time, it's very difficult for me to give you an indication of what is going to happen in the future because every product cycle is different, and as you know, we don't provide guidance past the current quarter. There are some elements that we understand quite well and we tend to manage well over the course of the cycle, for example, our cost structures that we are able to manage during -- throughout the year. But there are also elements that are not entirely under our control like foreign exchange. And the mix of products and services that we sell to our customers also has an impact on the overall gross margin. Our primary consideration is always around maximizing gross margin dollars, and that is the approach that we take around, for example, pricing decisions. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +From Citi, we'll hear from Jim Suva. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [37] +-------------------------------------------------------------------------------- +And I'll ask actually both my questions at the same time, one for Tim and one for Luca. Tim, strategically, when we talk to investors, they often say, "Oh, iPhone market is saturated. There's not much room for growth." Yet when we do our analysis, we kind of still see emerging markets like India and all those still a growth. When you think about India and those markets, do you kind of believe that some of those markets could get to much higher or a more normalized market share that you have in some of the developing countries over time? And can you talk a little bit about some of those efforts you may be doing? And then, Luca, the question for you is about the gross margin. When we think about if component prices start to stabilize, seeing how Apple Services have been so successful and accretive to margins, should we start to look for some potential margin -- gross margin upside, again, should components stabilize? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [38] +-------------------------------------------------------------------------------- +Yes. Jim, thanks for the question. In terms of the -- let me address the smartphone market a bit, and then I'll mention iPhone. In terms of the market in general, if you look at last year, which was the last data point we have on the full market, was -- there were still 0.5 billion feature phones sold in the world. Now many of those were sold into emerging markets, not all of them but many of them, and we still believe that, over time, every phone sold will be a smartphone. And so it seems to us that with that many feature phones being sold, that's a pretty big opportunity. In terms of the iPhone itself, even though we sell quite a few phones across the course of a year, our market share globally is low compared to the -- our sales are low compared to the full market of smartphones. And so the -- our task is to convince people that currently -- or have another type of phone to switch while really taking care of people that have an iPhone so that they choose, when they elect to buy another phone, that they buy another iPhone. And so we spend quite a bit of time on that as you might guess. I do think that India -- India is the third largest smartphone market in the world. There's obviously huge opportunities there for us, and we have extremely large share in that market overall. And so we're putting a lot of energy there and working with the carriers in that market. And they're investing enormously on the LTE networks, and the infrastructure has come quite a way since we began to put a lot of energy in there because of their leadership and so forth. And so I do think -- I don't buy the view that the market's saturated. I don't see that from a market point of view or -- and certainly not from an iPhone point of view. I think the smartphone market is sort of like the best market for a consumer product company in the history of the world. And so that's how I feel about it. It's a terrific market, and we're very happy to be a part of it. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [39] +-------------------------------------------------------------------------------- +Jim, on the gross margin side, I think I'll repeat what I said earlier, but we -- you're right. Our Services business, and I've said it in the past, is accretive to company margins, and so as we're able to grow the Services business, that should provide a positive, a tailwind. At the same time, within the Services portfolio that we have, we have services that have different levels of profitability, so we also need to take into account the mix of services that we're going to be selling. At a macro level, because about 2/3 of our company is outside the United States, a weak dollar is a positive for our gross margins. A strong dollar, as it's been during the last 4 years, has been a bit of a headwind for the company. We try to make it more stable through the hedging program. And in general, when we look at our process to innovate our products, typically, when we launch a new product, that product tends to have a higher cost structure than the product it replaces. And so that is something that we need to work through every time we launch a new product, and we have a pretty good track record and history of taking those cost structures down over time. So we need to balance all these different elements. I think we've done a pretty remarkable job during the last several years at managing all these different variables and coming up with a level of gross margins that we think is really good for investors. And certainly, it is our plan to continue to manage them that way, but it's very difficult for me to give you a prediction of where gross margins are going to be 6 months or 12 months from now. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [40] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [41] +-------------------------------------------------------------------------------- +A replay of today's call will be available for 2 weeks on Apple podcast as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820, and please enter confirmation code 5253762. These replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414. Financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation, and you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2018-Nov-01-AAPL.txt b/Transcripts/AAPL/2018-Nov-01-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fbcc1532c76d93d06c8703706ac492aa0bef6d --- /dev/null +++ b/Transcripts/AAPL/2018-Nov-01-AAPL.txt @@ -0,0 +1,352 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Apple Inc Earnings Call +NOVEMBER 01, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, and welcome to the Apple Inc. Fourth Quarter Fiscal Year 2018 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Nancy Paxton, Senior Director of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and thanks to everyone for joining us. Speaking first today is Apple's CEO, Tim Cook; and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. +Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook. Actual results or trends could differ materially from our forecast. +For more information, please refer to the risk factors discussed in Apple's most recently filed periodic reports on Form 10-K and Form 10-Q and the Form 8-K filed with the SEC today, along with the associated press release. Apple assumes no obligation to update any forward-looking statements or information which speak as of their respective dates. +I'd now like to turn the call over to Tim for introductory remarks. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Nancy. Good afternoon, everyone, and thanks for joining us. I just got back from Brooklyn, where we marked our fourth major launch at the end of the year. In addition to being a great time, it put an exclamation point at the end of a remarkable fiscal 2018. +This year, we shipped our 2 billionth iOS device, celebrated the 10th anniversary of the App Store and achieved the strongest revenue and earnings in Apple's history. In fiscal year '18, our revenue grew by $36.4 billion. That's the equivalent of a Fortune 100 company in a single year. And we're capping all that off with our best September quarter ever. +Revenue was $62.9 billion, ahead of our expectations. That's an increase of 20% over last year and our highest growth rate in 3 years. We also generated record Q4 earnings with 41% year-over-year growth in EPS. Record results from iPhone, Services and Wearables drove our momentum, and we produced strong double-digit revenue growth in all of our geographic segments. +It was a big year and a big quarter for iPhone. Q4 revenue was up 29% over last year, an increase of over $8 billion to a new September quarter record, fueled by continued momentum for iPhone 8, 8 Plus and X and the very successful launch of iPhone Xs and iPhone Xs Max. These latest devices are our most advanced iPhones ever with the industry's first 7-nanometer A12 Bionic chip with an Apple-designed 8-core Neural Engine capable of executing an astounding 5 trillion operations per second. +The A12 Bionic is many years in the making and a huge technological leap forward. It sets the iPhone experience far apart from the competition using real-time machine learning to transform the way we experience photo, gaming, augmented reality and more. It makes full use of the dual-camera system that shoots portrait mode photos with Smart HDR and dynamic depth of field, and Face ID is even faster. +The response has been powerful. As one reviewer put it, "iPhone Xs and Xs Max are the perfect blend of design and craftsmanship as well as seamlessly intuitive user experience." We're not done yet. Just last week, we began shipping iPhone XR, bringing the latest iPhone breakthroughs to even more users. With an all-screen glass and aluminum design and the most advanced LCD in a smartphone, the product reviews had been overwhelmingly positive. +iOS 12 has gotten off to an incredible start. It's been installed on more systems in its first month than any version of iOS ever. iOS 12 is delivering system-wide performance enhancements, Siri Shortcuts and new tools to help people reduce interruption and manage screen time for themselves and their kids. +Siri Shortcuts, in particular, is already deeply integrated with some of the most popular apps out there. Whether you're tracking your workouts or rushing to catch a flight, you can be sure all of your most relevant apps are working together with Siri in the driver seat. +iOS 12 also features ARKit 2, a major upgrade to our augmented reality engine. ARKit 2 makes possible simultaneous multi-user experiences and real-world object incorporation. Our developer community is really running with this technology. From gaming to shopping, we're seeing great new use cases emerge. iOS devices deliver the best AR experiences of any products in the market today, and with the announcement of our new iPad Pro this week, we've made that gap even wider. +More powerful than the vast majority of PC laptops, the new iPad Pro is unrivaled in its versatility and performance. And paired with the beautifully refined Apple Pencil and a new streamlined full-size smart keyboard, iPad Pro will extend its lead as the ultimate creativity and productivity device. And finally, just this week, we delivered the hotly anticipated group FaceTime functionality to all FaceTime-enabled devices. +For Services, it was our best quarter ever with revenue at $10 billion. Excluding the impact of a favorable onetime accounting adjustment of $640 million a year ago, our Services growth was 27%. +We set new Q4 records in all of our geographic segments and new all-time revenue records for the App Store, cloud services, AppleCare, Apple Music and Apple Pay. We also continued to see strong growth in paid subscriptions, reaching over 330 million in our ecosystem. +I want to spotlight the exceptional performance of Apple Pay, which is, by far, the #1 mobile contactless payment service worldwide. Transaction volume tripled year-over-year, and to put that into perspective, Apple Pay generated significantly more transactions than even PayPal mobile with over 4x the growth rate. +As a testament to accelerating U.S. growth, Costco completed the rollout of Apple Pay to over 500 U.S. warehouses last quarter, while Neiman Marcus is now accepting Apple Pay at over 40 stores across the country. With these additions, 71 of the top 100 merchants and 60% of all U.S. retail locations support Apple Pay. +We continue to invest in our strategy to replace the wallet with the recent launch of student ID passes at several major U.S. universities. And 10 months following its launch, Apple Pay Cash is the highest-rated mobile peer-to-peer service by Consumer Reports based on exceptional payment authentication and data privacy. +We set an all-time quarterly record for Mac revenue, thanks to strong performance in MacBook Pro and the impact of the back-to-school season. In September, we delivered macOS Mojave, bringing powerful new features to Mac like dark mode, stack and a completely redesigned Mac App Store. Considered alongside the release of iOS 12, watchOS 5 and a new tvOS, macOS Mojave tells a powerful story of the seamless integration of world-class hardware, software and services that define the Apple ecosystem. +As I mentioned at the beginning of the call, earlier this week, we announced exciting updates to the Mac lineup. The all-new MacBook Air brings a stunning Retina display, Touch ID, the latest processors and an even more portable design to the world's most beloved notebook. We also unveiled the biggest update ever to Mac mini, the small yet muscular desktop that powers everything from the music and sound effects of Broadway shows to the developers who build some of the most popular apps in the App Store. The new Mac mini boasts an amazing 5x faster performance than before. +With revenue growth over 50%, it was another record quarter for Wearables, which includes Apple Watch, AirPods and Beats products. With the highest customer satisfaction in the industry, Apple Watch has become an essential part of people's lives. The customer response to the Apple Watch Series 4 has been overwhelmingly positive, driven by its all-new design, larger display, faster performance, fall detection, enhanced cellular reception and electrical heart sensor. +Later this year, the ECG app will be available to Apple Watch Series 4 customers in the U.S., giving them the ability to take an electrocardiogram anytime right from their wrists. And for U.S. customers with Apple Watch Series 1 and later, watchOS will soon enable periodic checks for irregular heart rhythms that may be suggestive of AFib. These are unprecedented and potentially life changing features, showing how Apple Watch is not only an indispensable communication and fitness companion but also an intelligent guardian for your health. More broadly, we see this as just one further example of the kind of contribution we can make in the health space, and we look forward to making more in the future. +We are proud to bring HomePod to new customers. I was in Spain last week as HomePod became available there and in Mexico. HomePod delivers the highest fidelity audio quality, working together with an Apple Music subscription to stream over 50 million songs into any room in your home. +Our retail team posted record Q4 results to conclude their biggest year ever. They are transforming our stores into places where customers come to connect, learn and be inspired together with people from their community. Our Today at Apple sessions are a terrific example of what that looks like in practice. We hosted over 250,000 Today at Apple sessions this quarter, connecting aspiring creators with local photographers, illustrators and other experts who can help them get the most out of their devices. Apple Stores also hosted 74,000 kids at Apple Camp. +The relationship Apple has with our customers is about more than just making a purchase. With the recent addition of beautiful new stores in Italy, Japan, China and in just a few weeks, Thailand, we will have 506 stores where we can further those relationships, almost half of which are outside United States. +Before I turn the call over to Luca, I'd like to touch on 2 items that may not show up in our financial statement but are just as integral to Apple's mission and our commitment to making the world a better place. +First, education. More than 5,000 schools, community colleges and technical colleges worldwide are now using Everyone Can Code, our free coding curriculum. Ideas, creativity and passion for technology's potential aren't limited by ZIP code or country, and we don't think opportunity should be either. We're also excited that educators in more than 350 schools around the world have started working with Everyone Can Create, the free collection of tools and project guides we introduced this spring designed to help unleash kids' creativity throughout their school day with the help of iPad. +Next is the environment. This was a milestone year for Apple's commitment to our planet. In April, we announced that 100% of our global operations are powered by renewable energy. We also made progress in doing the same in our supply chain. And just this week, we announced that the enclosures of new products like MacBook Air and iPad Pro will be made from 100% recycled aluminum, a strong, durable and beautiful new alloy designed by Apple. +This is a great example of how a commitment to do right on the issues that matter can drive once unimaginable innovation, new ways of approaching old problems and beautiful solutions that set us apart. I'd like to thank all of our employees, customers, developers and business partners for helping us deliver outstanding results across our fiscal 2018. We are headed into the holidays with our strongest product lineup ever, and we could not be more bullish about Apple's future. +And now Luca has more details to share with you on the September quarter. Luca? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [4] +-------------------------------------------------------------------------------- + + Thank you, Tim. Good afternoon, everyone. We are extremely pleased to report record results for our September quarter, which capped a tremendously successful fiscal 2018, a year in which we saw double-digit revenue growth in every geographic segment and established new revenue and earnings records in every single quarter. +Revenue in the fourth quarter was $62.9 billion, up 20% and more than $10 billion over last year with strong double-digit growth in each of our geographic segments and record Q4 revenue in the Americas, in Europe, Japan and rest of Asia Pacific. In fact, we set new revenue records in almost every market we track with especially strong growth in Germany, Italy, Sweden, Switzerland, Japan and Korea, all major markets where revenue growth was 25% or higher. We also set new fourth quarter revenue records for iPhone and Wearables and new all-time records for Services and Mac. +Gross margin was 38.3%, flat sequentially in line with our expectations as leverage from higher revenue offset seasonal transition costs. We set new September quarter records for net income, EPS and cash flow from operations. Net income was $14.1 billion, up $3.4 billion or 32% over last year. Diluted earnings per share were $2.91, up 41%. Cash flow from operations was $19.5 billion, up $3.8 billion from a year ago. +iPhone revenue grew 29% with growth of more than 20% in every geographic segment. iPhone ASP was $793 compared to $618 a year ago, driven by strong performance of iPhone X, 8 and 8 Plus as well as the successful launch of iPhone Xs and Xs Max in the September quarter this year, while we launched iPhone X in the December quarter last year. +We sold 46.9 million iPhones during the quarter with growth of 20% or more in several markets, including Japan, Australia, New Zealand, Sweden, Norway, Chile and Vietnam. Customer satisfaction with iPhone continues to be outstanding and is the highest in the industry. The latest survey of U.S. consumers from 451 Research indicates customer satisfaction of 98% for iPhone X, 8 and 8 Plus combined. And among business buyers who plan to purchase smartphones in the December quarter, 80% plan to purchase iPhones. +Turning to Services. It was our best quarter ever in total and virtually in every market around the world with revenue of $10 billion. A year ago, we had a onetime $640 million favorable impact to Services revenue due to an accounting adjustment, and taking that into account, our Services growth in Q4 this year was 27%. As Tim mentioned, we reached new all-time quarterly revenue records for many Services categories, and we are well on our way to achieve our goal to double our fiscal 2016 Services revenue by 2020. +We now have over 330 million paid subscriptions on our platform, an increase of over 50% versus a year ago. We are very pleased not only with the growth but also with the breadth of our subscription business. In fact, 30,000 third-party subscription apps are available in the App Store today, and the largest of them all represents less than 0.3% of our total Services revenue. +Next, I'd like to talk about the Mac. We saw great response to our new MacBook Pro models that we launched in July with strong double-digit revenue growth driving an all-time quarterly record for Mac revenue. We were especially pleased with Mac momentum in emerging markets with strong growth in Latin America, in India, the Middle East and Africa and Central and Eastern Europe. At over 100 million units, our active installed base of Macs is at an all-time high, and the majority of customer purchasing Macs in the September quarter were new to Mac. +We sold 9.7 million iPads during the quarter, gaining share in nearly every market we track based on the latest estimates from IDC. We generated iPad growth in a number of key regions around the world, including Latin America, Europe, Japan, India and South Asia. Among customers around the world purchasing iPads during the quarter, nearly half were new to iPad, and our active installed base of iPads reached a new all-time high. +NPD indicates that iPad had 58% share of the U.S. tablet market in the September quarter, up from 54% share a year ago. And the most recent consumer survey from 451 Research measured iPad customer satisfaction ratings of 96% for both iPad and iPad Pro. And among business customers who plan to purchase tablets in the December quarter, 74% plan to purchase iPads. +Other products revenue grew 31% to a new September quarter record with an increase of over $1 billion compared to a year ago, thanks to Wearables growth of over 50% and the strong performance of Apple TV in addition to the introduction of HomePod earlier this year. +As we look back across fiscal 2018, we have made great progress in the enterprise market, where iOS is transforming how business gets done across multiple industries. In fact, over 450 airlines and 47 of the top 50 around the world have adopted iOS to help pilots fly safer, more efficient flights. And many airlines are also using iOS to support better customer experiences and improve maintenance operations. +We're also making great strides in the retail sector, where 9 of the top 10 global retailers use iOS devices to transform their customer and employee experiences. We are seeing industry-wide adoption of iOS at thousands of retailers from neighborhood boutiques to many of the best-known retailers in the world. Deployment of iOS devices is growing steadily as retailers replace their traditional point-of-sale systems and use custom iOS apps on iPhones and iPads to provide highly personalized shopping experiences. +Our success in enterprise is supported by our key partnerships. Since launching our first strategic partnership with IBM, 240 large customers have signed MobileFirst for iOS deals. Additionally, earlier in the year, we introduced 2 new technology offerings: IBM Watson services for Core ML and the IBM Cloud Developer Console for Apple that are enabling businesses to combine machine learning and cloud for a new generation of dynamic smart apps made for iOS. Over 60 new signings across numerous industries have been added since launching these new tools. +In our new partnership with Salesforce, we're excited to bring together the #1 customer relationship management platform and iOS. Together with Apple, Salesforce is redesigning its apps to embrace the native mobile platform with exclusive new features on iOS. The company can also provide tools and resources for millions of Salesforce developers to build their own native apps with a new Salesforce Mobile SDK for iOS. +And finally, we recently announced Apple business manager, a new way for IT teams to deploy Apple devices at scale. The response from companies around the world has been tremendous with over 40,000 companies currently enrolled. +Let me now turn to our cash position. We ended the quarter with $237.1 billion in cash plus marketable securities. We also had $102.5 billion in term debt and $12 billion in commercial paper outstanding for a net cash position of $122.6 billion. As explained earlier this year, it is our plan to reach a net cash neutral position over time. As part of this plan, we returned over $23 billion to investors during the quarter. We repurchased 92.5 million Apple shares for $19.4 billion through open market transactions, and we paid $3.5 billion in dividends and equivalents. +For our fiscal year 2018, revenue grew over $36 billion to $265.6 billion, an all-time record. Every geographic segment grew double digits with new records in the Americas, Europe, Japan and rest of Asia Pacific. We also set new all-time records for net income, up 23% versus last year and EPS, up 29%. And we returned a total of almost $90 billion to our investors during the year, including almost $14 billion in dividends and equivalents and over $73 billion in share repurchases. +Before we discuss our December quarter outlook, I'd like to describe a number of changes in our financial reporting that we're implementing as we enter our new fiscal year. First, given the increasing importance of our Services business and in order to provide additional transparency to our financial results, we will start reporting revenue as well as cost of sales for both total products and total services beginning this December quarter. +Second, also beginning this December quarter, we're adopting the FASB's new standard for revenue recognition. This will not result in any change to our total revenue, but it will impact the way we report the classification of revenue between products and services. In particular, the revenue corresponding to the amortization of the deferred value of bundled services such as Maps, Siri and free iCloud services was previously reported in product revenue. After adopting the new standards, this revenue will now be reported in Services revenue. +The change in classification between products and services will also apply to the costs that are associated with the delivery of such bundled services. After we file our 10-K, we will post a schedule to our Investor Relations website showing the reclassification of fiscal 2018 revenue from products to services in connection with the adoption of the new standard. +The size of this reclassification amounts to less than 1% of total company revenues. And for clarity, this reclassification was not contemplated in our previously stated goal of doubling our fiscal '16 Services revenue by 2020. That goal remains unchanged and excludes the revenue that is now shifting from products to services over that time frame. +Third, starting with the December quarter, we will no longer be providing unit sales data for iPhone, iPad and Mac. As we have stated many times, our objective is to make great products and services that enrich people's lives and to provide an unparalleled customer experience so that our users are highly satisfied, loyal and engaged. As we accomplish these objectives, strong financial results follow. +As demonstrated by our financial performance in recent years, the number of units sold in any 90-day period is not necessarily representative of the underlying strength of our business. Furthermore, our unit of sale is less relevant for us today than it was in the past given the breadth of our portfolio and the wider sales price dispersion within any given product line. +Fourth, starting with the December quarter, we will be renaming the other products category to wearables, home and accessories to provide a more accurate description of the items that are included in this product category. +As we move ahead to the December quarter, I'd like to review our outlook, which includes the types of forward-looking information that Nancy referred to at the beginning of the call. We have the strongest lineup ever as we enter the holiday season, and we expect revenue to be between $89 billion and $93 billion, a new all-time record. This range reflects a number of factors to be considered: First, we consider the effect on Q4 and Q1 of the launch timing of our new iPhones this year versus last year; Second, we expect almost $2 billion of foreign exchange headwinds; Third, we had an unprecedented number of products ramping, and while our ramps are going fairly well, we have uncertainty around supply and demand balance; and fourth, we also face some macroeconomic uncertainty, particularly in emerging markets. +We expect gross margin to be between 38% and 38.5%. We expect OpEx to be between $8.7 billion and $8.8 billion. We expect OI&E to be about $300 million. And we expect the tax rate to be about 16.5% before discrete items. Also, today, our Board of Directors has declared a cash dividend of $0.73 per share of common stock payable on November 15, 2018, to shareholders of record as of November 12, 2018. +With that, I'd like to open the call to questions. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [5] +-------------------------------------------------------------------------------- + + Thank you, Luca. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question will come from Wamsi Mohan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Tim, there has been some real deceleration in some of these emerging markets, partly driven by some concerns around some of the rules the administration is contemplating and partly driven by things that are more specific to China, for instance, like some of the regulations around gaming. So can you talk about how you see the trajectory there for the business and what you think of the initiatives of some companies like Netflix and Fortnite trying to bypass the App Store around subscriptions? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure. Great question. Starting with emerging markets. The emerging markets that we're seeing pressure in are markets like Turkey, India, Brazil, Russia, these are markets where currencies have weakened over the recent period. In some cases, that resulted in us raising prices, and those markets are not growing the way we would like to see. To give you a perspective in -- at some detail, our business at India in Q4 was flat. Obviously, we would like to see that be a huge growth. Brazil was down somewhat compared to the previous year. And so I think -- or at least the way that I see these is each one of the emerging markets has a bit of a different story. And I don't see it as some sort of issue that is common between those for the most part. In relation to China specifically, I would not put China in that category. Our business in China was very strong last quarter. We grew 16%, which we're very happy with. iPhone, in particular, was very strong double-digit growth there. Our other products category was also stronger, in fact, a bit stronger than even the company -- overall company number. The App Store in China, we have seen a slowdown or a moratorium to be more accurate on new game approvals. There is a new regulatory setup in China, and there's -- things are not moving the way they were moving previously. We did see a few games approved recently, but it's very far below the historic pace. And as you're probably seeing, some of the larger companies there that are public have talked about this as they've announced their earnings as well. We don't know exactly when this will -- the approvals will sort of return to a normal pace. So I would not want to predict that. I do not view, just to try -- for avoidance of doubt here, I don't view that, that issue has anything to do with the trade-related discussions between the countries. I think that is strictly a domestic issue in China. In terms of larger developers, if you sort of step back and look at the value proposition for people from the App Store, there are 2 key constituencies in that equation. There's the user, and there's the developer. If you start with the user, what the App Store provides people is sort of the best and safest place for users to get apps. And we put a -- we have a tremendous process and infrastructure around achieving that. And where it is not perfect, we wind up reviewing 100,000 -- over 100,000 apps a week between new apps and updates for existing apps and then work with developers quickly to fix the issues. And we also provide the user a one-payment model for purchasing apps and subscriptions and in-app purchases, et cetera, so that they are not in a position that they have to share their private information across many companies. And so that's sort of the proposition for the user. For the developer, we obviously provide developers a tremendous amount of developer tools, programs, compilers, languages, of course, the operating system APIs, SDKs and have a huge developer relations team. And we do a tremendous amount of marketing for developers, including the new Today editorial that we just started in the past few months, personal recommendations search, tools and so on and so forth. And so if -- there will be -- there's no doubt, in my mind, there have already been some large developers that concluded that they could do something on their own. We're fine with that. I think Luca mentioned in his comments that the largest -- if I look at the largest developer, they make up less than 0.3% of the Services revenue. So it's probably good to think about that in that context, and there are millions of apps on the store obviously and 30,000 or so subscription apps. And so the subscription business itself is nearly as broad as the App Store itself is. And so that's the value proposition, I think, that the vast majority of people are very happy with it and including the most important people of all, which is the user. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [4] +-------------------------------------------------------------------------------- + + Appreciate that response. If I could just ask you really quick on Apple's role in health care. It's been growing significantly since the early introduction on the Watch and then the various kits for developers, including HealthKit, CareKit, et cetera. And when you combine that with your very staunch advocacy for privacy, I see Apple could become a really large disintermediating force in all the friction in the health care industry today in the way medical information is shared and distributed. Is this the way that you see the future for Apple in health care? And do you see a means to also grow your Services business through the health care offerings that could become subscriptions to your customers? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + I think Apple has a huge opportunity in the -- in health. And you can see from the -- our past several years that we have an intense interest in the space and are adding products and services, non-monetized services so far to that. And I don't want to talk about the future because I don't want to give away what we're doing. But this is an area of major interest to us. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Shannon Cross from Cross Research has the next question. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [7] +-------------------------------------------------------------------------------- + + Given the $4 billion range in revenue that you're giving for the quarter and all of the -- all the things that are going on in the world right now, can you maybe give a little detail about the variables that you took into account when you were coming up with this, geopolitical trade, macro component costs, I don't know, if you can just give it some ideas as -- on what the puts and takes were? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [8] +-------------------------------------------------------------------------------- + + Yes. Shannon, I'll take this one. And at the revenue level, we started from the fact that we are very, very excited about the lineup of products and services that we have getting into the holiday season. It's the strongest lineup that we've ever had. And our guidance range, by the way, represents a new all-time quarterly revenue record, right? As I explained in my prepared remarks, there are a number of things that need to be considered as part of this guidance range, right? The first one is the fact that the launch timing of the new iPhones this year is essentially in reverse order versus last year. And that has had an effect on Q1 -- on Q4 and will have an effect on Q1. Last year, we launched the top end of our iPhone lineup, which was iPhone X during Q1, and placed the entirety of the channel fill for iPhone X in Q1. This year, we launched the top end of the lineup, which is the Xs and the Xs Max during Q4. Obviously, this resulted in a more pronounced ASP growth in Q4 of '18 and obviously a tougher compare for Q1. So I think it's important to keep that in mind as you look at the revenue guidance that we provided. The second point that needs to be kept in mind, it is a fact of life and we've dealt with it for a number of years now, is the fact that when I look at currencies around the world, virtually every foreign currency has depreciated against the U.S. dollar in the last 12 months. And when we look at the impact of foreign exchange on our revenue for the December quarter, we're looking at 200 basis points of headwinds, which translate, given our -- the size of our business, to almost $2 billion of headwind to our revenue. The third point that I think is important to keep in mind, and Tim has talked about this, we are launching -- in the last 6 weeks, we've launched an unprecedented number of new products. They're all ramping right now. The ramps are going fairly well, but obviously, we have some uncertainty around supply-demand balance for some of these products. And then finally, the last point that we've taken into account is what Tim's talked about in terms of some level of uncertainty at the macroeconomic level in some emerging markets, where, clearly, consumer confidence is not as high as it was 12 months ago. So take that into account, and that's how we got to the range. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [9] +-------------------------------------------------------------------------------- + + Okay. And then I just want to talk a little bit about the pullback in terms of guidance from a unit perspective. I understand you don't want to give guidance because 90 days is a short period of time and can be -- fluctuate. But what kind of qualitative commentary do you think you'll be able to provide? Because it's -- obviously, investors have spent the last however many years going P times Q. So how should we think about what we can expect? And sort of how are you going to manage this process as we go through? I know it's all our job to forecast but... + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [10] +-------------------------------------------------------------------------------- + + Yes, let me walk you through the rationale that we've used, and then I'll talk about this qualitative commentary that you were mentioning. As I said, right, our objective is to make great products, provide the best customer experience and get our customers satisfied, engaged and loyal to our ecosystem. When you look at our financial performance in recent years, take the last 3 years, for example, the number of units sold during any quarter has not been necessarily representative of the underlying strength of our business. If you look at our revenue during the last 3 years, if you look at our net income during the last 3 years, if you look at our spot price during the last 3 years, there's no correlation to the units sold in any given period. As you know very well, in addition, our product ranges for all the major product categories have become wider over time, and therefore, a unit of sale is less relevant for us at this point compared to the past because we got this much wider sales price dispersion. So unit of sale per se becomes less relevant. As I know you're aware, by the way, our top competitors in smartphones, in tablets, in computers do not provide quarterly unit sales information either. But of course, we understand that this is something of interest. And when we believe that providing qualitative commentary on unit sales offers additional relevant information to investors, we will do so. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [11] +-------------------------------------------------------------------------------- + + Let me make one additional point there just for clarity, is that, Shannon, our intention is to continue to give revenue guidance at the company level and gross margin guidance in the other categories that we've been providing. And so the -- our guidance isn't changing. It's the actual report that changes. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Mike Olson with Piper Jaffray. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + With the staggered iPhone launch, were you able to discern any impact on the Xs and Xs Max from buyers potentially waiting for the XR? And what, if anything, can we take away from the December quarter guidance related to what you're seeing for early demand on the XR? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [14] +-------------------------------------------------------------------------------- + + Mike, it's Tim. The Xs and Xs Max got off to a really great start, and we've only been selling for a few weeks. The XR, we've only got out there for, I guess, 5 -- 5 days or so at this point and so that it's -- we have very, very little data there. Usually, there is some amount of wait until a product shows -- another product shows up in look, but in -- that -- in looking at the data, on the sales data for Xs and Xs Max, there's not obvious evidence of that in the data as I see it. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [15] +-------------------------------------------------------------------------------- + + Got it. And you mentioned record levels for various components of the Services business. As we look forward, if growth of Services is to maintain something close to the recent pace, what are the components of Services that you're particularly excited about that could drive that and be the strongest drivers? And maybe an offshoot to that, it seems like the news flow around augmented reality slowed a little bit in recent months. Is that potentially materially contributor to services in the near future? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [16] +-------------------------------------------------------------------------------- + + Like as we said, during the September quarter, we set new records for many, many Services categories, right, from Apple Music to cloud services to the App Store to AppleCare and Apple Pay really has an exponential trajectory right now. When we look at our Services business, we think about the fact that we have a very large and growing installed base. The installed base of all our major product categories is at an all-time high and has been growing over the last several quarters. So the opportunity for us to monetize our Services business continues to grow over time. Of course, we are also improving the quality of the services that we provide, and if you look back during the last 3 years, we've added new services to our portfolio. We added Apple Pay. We added Apple Music. We added this advertising business on our App Store. And clearly, we will want to continue to offer new services over time. So there are a number of vectors that allow us to continue to grow the business over time. We have stated that we want to double the size of the Services business from the level that we had in fiscal '16 by 2020. We are well on pace to achieve that, and we feel very, very confident about the future of -- and the opportunities that we have in the Services space. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [17] +-------------------------------------------------------------------------------- + + Mike, in terms of your question on AR, I have a different view than you do on this one. We -- just a year ago -- practically, a year ago, we came out with ARKit 1. 6 months or so after that, we came out with 1.5. We then recently came out with ARKit 2. The number of things that you can do are growing significantly. The number of developers that either have done something or even more the case that are working on things that I've seen are growing tremendously. There's a lot of interest out there. And the number of categories that I'm seeing from gaming to shopping to -- I was in China a few weeks ago and saw AR in the -- in an art sense, an art exhibit. I was in Berlin last week and saw it being used in a historical educational kind of sense. I'm seeing it sort of everywhere I go now. And so I think we are in the early days, and it'll keep getting better and better. But I'm really happy with where things are at the moment. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Next, we'll go to Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [19] +-------------------------------------------------------------------------------- + + Tim, given the current trade negotiations and broader geopolitical risk, do you have any plans to consider diversifying the supply chain? And if you were to do that, either on your own or sort of forced, do you think it would have significant impact on the business or profitability? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + Katy, if you look at the products that we've created and are manufacturing, they're really manufactured everywhere. We have significant content from the U.S. market. We have content from Japan to Korea to many countries, and we have great content from China as well. And so there are many hands in the products. The vast majority or almost all of the R&D is in the United States as well as a lot of the support organization. And I -- so as -- I think that, that basic model where you look around the world and find the best in different areas, I don't expect that model to go out of style so to speak. I think there's a reason why things have developed in that way, and I think it's great for all countries and citizens of countries that are involved in that. And I'm still of the mindset that I feel very optimistic and positive that the discussions that are going will be fruitful. The -- these relationships, these trade relationships are big and complex, and they clearly do need a level of focus and a level of updating and modernization. And so I'm optimistic of -- that the countries, the U.S. and China and the U.S. and Europe and so forth can work these things out and work for the benefit of everyone. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [21] +-------------------------------------------------------------------------------- + + That's helpful color. And Luca, as a follow-up, NAND prices fell significantly during the September quarter. Why aren't we seeing that flow through to margin expansion to the overall company? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [22] +-------------------------------------------------------------------------------- + + You're referring to the guidance that we provided for Q1, I imagine. And let me give you the puts and takes, Katy. You're correct, we are going to be getting some benefits from commodities in general and memory in particular. Memory, on a sequential basis, it's about 30 basis points favorable for us going into the December quarter. And obviously, we're going to be benefiting from the leverage, which is typical of our seasonality in the December quarter. On the other hand, as I mentioned before, currencies have weakened against the U.S. dollar. And the impact that we expect at the gross margin level from foreign exchange is a 90 basis points headwind sequentially. And of course, at this point in the cycle, we also have higher cost structures because, as I said, we've launched so many new products in the last 6 weeks. So those are the puts and takes, leverage and commodity savings on one side and FX and the new products on the other side. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Next, we'll go to Jim Suva with Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [24] +-------------------------------------------------------------------------------- + + A question for Tim and a question for Luca, and I'll ask them at the same time, so you can decide to answer the first or second. But operationally, Tim, I think your company is at a disadvantage relative to others in India giving where items are produced versus shipped versus taxed versus installed as well as ability to own stores. So can you help us address that? Is India going to potentially be a big area as I think you've got about only 1% market share, but it sounded like things may be softened there? And then for Luca, there'd probably be a lot of pushback about not giving iPhone unit data. It sounds like you're still going to give revenue data if I heard that correctly. But some people may fear that this now means that the iPhone units are going to start going negative year-over-year because it's easy to talk about great things and not show the details of things that aren't so great. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [25] +-------------------------------------------------------------------------------- + + Okay. I'll start with India. We've had really great productive discussions with the Indian government, and I fully expect that, at some point, they will agree to allow us to bring our stores into the country. We've been in discussions with them, and the discussions are going quite well. There is -- as you point out, there are import duties in some or most of the product categories that we're in. In some cases, they compound. And this is an area that we're giving lots of feedback on. We do manufacture some of the entry iPhones in India, and that project has gone well. I am a big believer in India. I am very bullish on the country and the people and our ability to do well there. The currency weakness has been part of our challenge there as you can tell from just looking at the currency trend. But I sort of view these as speed bumps along a very long journey, though, in that the long term is -- I think is very, very strong there. There's a huge number of people that will move into the middle class. The government has really focused on reform in a major way and made some very bold moves, and I applaud them for doing that and sort of can't wait for the future there. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [26] +-------------------------------------------------------------------------------- + + And Jim, let me take the question on units. First of all, as Tim said, our approach to guidance -- providing guidance doesn't change at all, and we continue to provide the same metrics that we were providing before. In terms of reporting results, one of the things that we are doing, and it's new and it's an addition to the information that we provide to investors because we've heard some significant level of interest around this, is starting with the December quarter, for the first time, we're going to be providing information on revenue and cost of sales and therefore, gross margins for both products and services. And this will be the first time that we're going to provide gross margin information for our Services business, which we believe it is an important metric for our investors to follow. Given the rationale on why we do not believe that providing unit sales is particularly relevant for our company at this point, I can reassure you that it is our objective to grow unit sales for every product category that we have. But as I said earlier, a unit of sale is less relevant today than it was in the past. To give you an example, the unit sales of iPhone at the top end of the line have been very strong during the September quarter. And that's very important because we are attracting customers to the most recent technologies and features and innovation that we bring into the lineup, but you don't necessarily see that in the number that is reported. And so therefore, we will -- as I said, we'll provide the qualitative commentary when it is important and relevant, but at the end of the day, we make our decisions to -- from a financial standpoint, to try and optimize our revenue and our gross margin dollars. And that, we think, is the focus that is in the best interest of our investors. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + Jim, let me just add a couple things to that for color. Our installed base is growing at double digit, and so there's no -- and that's probably a much more significant metric for us from an ecosystem point of view and customer loyalty, et cetera. The second thing is this is a little bit like if you go to the market and you push your cart up to the cashier and she says or he says, "How many units you have in there?", it sort of -- it doesn't matter a lot how many units there are in there in terms of the overall value of what's in the cart. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [28] +-------------------------------------------------------------------------------- + + A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820, and please enter confirmation code 3699080. These replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2019-Apr-30-AAPL.txt b/Transcripts/AAPL/2019-Apr-30-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..f04576a9a92bcf07fea8bbfa5385cb62590cfd94 --- /dev/null +++ b/Transcripts/AAPL/2019-Apr-30-AAPL.txt @@ -0,0 +1,614 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q2 2019 Apple Inc Earnings Call +APRIL 30, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Louis Rocco Miscioscia + Daiwa Securities Co. Ltd., Research Division - Research Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 2Q19 revenue of $58b, net income of $11.6b and diluted EPS of $2.46. Expects 3Q19 revenue to be $52.5-54.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 2Q19 revenue = $58b. + 2. 2Q19 net income = $11.6b. + 3. 2Q19 diluted EPS = $2.46. + 4. 2Q19 YoverY revenue decline = 5%. + 5. 2Q19 GM = 37.6%. + 6. 2Q19-end cash plus marketable securities = $225b. + 7. 2Q19-end term debt = $101b. + 8. 2Q19 share repurchase = 71.7m AAPL shares for $12b through open market transactions. + 9. 3Q19 revenue guidance = $52.5-54.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 2Q19 Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $58b, toward high-end of guidance range. + 1. Sees this result as positive outcome in light of ongoing headwinds from weaker foreign currencies relative to US dollar. + 2. In constant-currency, YoverY revenue performance would have been 200 BP better than reported results indicate. + 2. Had great results in a number of areas across business. + 1. Best qtr. ever for Services. + 1. Revenue $11.5b. + 2. iPad revenue up 22% YoverY. + 1. Highest iPad revenue growth rate in six years. + 3. Wearables growth near 50%. + 1. This business is now about the size of Fortune 200 co., amazing statistic considering it's only been four years since Co. delivered very first Apple Watch. + 3. Grew YoverY in developed markets. + 1. Record March qtr. results in a number of major markets, including US, Canada, UK and Japan. + 2. Experienced revenue decline in emerging markets. + 1. Feels positive about trajectory. + 2. YoverY revenue performance in Greater China improved relative to Dec. qtr. + 3. Seen positive customer response to pricing actions taken in aforementioned market, trading and financing programs in retail stores, effects of government measures to stimulate economy and improved trade dialogue between US and China. + 4. App Store results are reflecting impact of slowdown in regulatory approval and gaming apps in China, but Co. is encouraged by recent increase in pace of approvals. + 5. Believes strongly in long-term opportunity in China due to robust ecosystem, talented developer community and country's growing population of tech savvy consumers who value best products and services. + 2. iPhone: + 1. Worldwide revenue down 17% YoverY. + 1. Declines were significantly smaller in final weeks. + 2. Looking back at past five months, Nov. and Dec. were most challenging. + 1. This is encouraging trend. + 3. Likes direction Co. is headed with iPhone. + 1. Goal is to pick up the pace. + 4. Active installed base of devices continues to grow in each geographic segment and set new all-time record for all major product categories. + 1. Growing installed base is a reflection of satisfaction and loyalty of customers. + 1. Driving Services business to new heights. + 3. Services: + 1. Had best qtr. ever for App Store, Apple Music, Cloud Services and App Store Search Ad business. + 1. Set new March qtr. revenue records for AppleCare and Apple Pay. + 2. Apple Pay: + 1. Transaction volume more than doubled YoverY. + 1. On track to reach 10b transactions this calendar year. + 2. Available in 30 markets. + 1. Expects to be live in 40 markets by year-end. + 3. More and more transit systems are accepting Apple Pay. + 1. New York's MTA system will begin rollout in early summer. + 4. As seen in places like London, Tokyo and Shanghai, contactless entry into transit systems helps to spur broader Apple Pay adoption. + 1. Believes this will get even more people using Apple Pay in US. + 5. Ticketmaster announced that they will be accepting Apple Pay for ticket purchases on web and through Ticketmaster app. + 1. Over 50 of their entertainment and sporting venues are launching contactless tickets this year, including vast majority of NFL stadiums. + 3. Subscriptions are powerful driver of Services business. + 1. Reached new high of over 390m paid subscriptions at March-end, up 30m in last qtr. alone. + 4. Incredibly important qtr. for Services moving forward. + 1. In March, previewed game-changing array of new services, each of them rooted in principles that are fundamentally AAPL. + 1. They're easy to use. + 2. They feature unmatched attention to detail. + 3. They put premium on user privacy and security. + 4. They are expertly curated, personalized and ready to be shared by everyone in family. + 5. These features are nice to have and help to eliminate boundary between hardware, software and service, creating singularly exceptional experience for users. + 5. Apple News+: + 1. Building on great momentum of Apple News, which is already Number 1 news app in US and UK, launched Apple News+. + 2. Will bring together over 30 popular magazines, leading newspapers and digital publishers into beautiful, convenient and curated experience within Apple News app. + 3. Builds on Co.'s commitment to supporting quality journalism from trusted sources, while providing best magazine and news reading experience ever for mobile devices. + 6. Apple Card: + 1. Advancing vision to replace Wallet, announced Apple Card, built on principles Co. stands for like: + 1. Transparency. + 2. Simplicity. + 3. Privacy. + 2. Integrated into Wallet app. + 3. Delivers all new experiences that only Co. can provide, integrating hardware, software and services in elegant solution that places customer at the center. + 4. First card to encourage to pay less interest, eliminate fees and give daily cash on all purchases. + 1. Customer interest to-date has been terrific. + 7. Apple Arcade: + 1. Previewed Apple Arcade, world's first game subscription service for: + 1. Mobile. + 2. Desktop. + 3. Living room. + 2. With over 100 new games, all with no ads or ad tracking, no additional purchases and respect for user privacy, created service for players of all ages, kids to teens to adults and one that families can enjoy together. + 3. App Store is already world's biggest gaming platform. + 1. Thinks Apple Arcade is a great way to unleash creativity of game developer community with collection of new games not available on any other mobile platform or in any other subscription service. + 8. Apple TV: + 1. Beginning in mid-May, all new Apple TV app will bring together different ways to discover and watch shows, movies, sports news and more in one app across: + 1. iPhone. + 2. iPad. + 3. Apple TV. + 4. Mac. + 5. Smart TVs. + 6. Streaming devices. + 2. Users can subscribe to and watch new Apple TV channels like HBO, Showtime and Stars, paying for services they want, all on-demand available online and offline. + 3. Coming this fall, Apple TV+ will be new home for world's most creative story tellers, featuring exclusive: + 1. Original shows. + 2. Movies. + 3. Documentaries. + 4. Several Major Product Introductions: + 1. iMac: + 1. Launched new more powerful iMac with dramatic increases in compute and graphics performance, making it great update for consumers and pros alike. + 2. For Mac business overall, faced some processor constraints, leading to 5% revenue decline vs. last year. + 1. Believes that Mac revenue would have been up vs. last year without those constraints. + 2. Does not believe this challenge will have significant impact on 3Q results. + 2. iPad: + 1. Returned to growth in Greater China. + 1. Generated strong double-digit growth in each of Co.'s other geographic segments. + 2. Great iPad results were driven primarily by strong customer response to iPad Pro. + 3. Late in qtr., launched all-new iPad Air with ultra-thin design, Apple Pencil support and high-end performance powered by A12 Bionic chip. + 4. Introduced new iPad Mini, major upgrade for iPad fans who love ultra-portable design. + 1. Like new iPad Air, it delivers power of A12 Bionic and support for Apple Pencil. + 3. AirPods: + 1. Last month, introduced new AirPods. + 1. Second generation of world's most popular wireless headphones. + 2. Demand has been incredible. + 2. With new Co.-designed H1 chip, new AirPods deliver faster connect times, more talk time and convenience of hands-free Hey Siri. + 4. Retail and online stores continue to be key point of innovation. + 1. As Co. mentioned in Jan., has been working on initiative to make it simple to trade in phone in Co.'s store, finance purchase over time and get help transferring data from old phone to new phone. + 2. As part of aforementioned initiative, rolled out new trade-in and financing programs in: + 1. US. + 2. China. + 3. UK. + 4. Spain. + 5. Italy. + 6. Australia. + 3. Results have been striking. + 4. Across Co.'s stores, had all-time record response to trade-in programs and with more than four times trade-in volume of March qtr. a year ago. + 5. With each passing qtr., more inspired by impact products are having on people's fitness and health. + 1. Brought ECG app on Apple Watch Series 4 to Hong Kong and 19 European countries, including: + 1. France. + 2. Germany. + 3. Italy. + 4. Spain. + 5. UK. + 2. Believes Co. is just beginning to tap into what it can do to help users actively manage their health and wellbeing. + 1. Last month, Stanford Medicine reported results of Apple Heart Study, the largest study ever of its kind, which enrolled over 400,000 participants from all 50 states in a span of eight months. + 2. Hundreds of institutions are supporting health records on iPhone with recent additions, including Michigan Medicine and UT Health Austin. + 3. In Feb., announced that Co. is working with US Department of Veterans Affairs to make health records on iPhone available to veterans. + 4. Aforementioned will be first record sharing platform of its kind available to VA, which is largest medical system in US providing service to more than 9m veterans across more than 1,200 facilities. + 6. Innovation extends beyond impact Co. has in lives of customers to impact it leaves on world around it. + 1. Recently marked Earth Day with several major announcements about Co.'s efforts to leave the world better than it founded. + 2. Completed allocation of $2.5b green bond proceeds across 40 environmental initiatives worldwide to projects ranging from solar power generation to water conservation to development of custom alloys for Co.'s products made from 100% recycled aluminum. + 3. Announced major expansion of recycling programs, including quadrupling number of locations where US customers can send their iPhones to be disassembled by Daisy, Co.'s recycling robot. + 1. Each Daisy can now disassemble 1.2m devices per year, allowing recovered materials to be recycled into manufacturing process. + 4. Partnered with a record number of suppliers to follow Co.'s lead in transition to 100% clean energy. + 1. With help of these 44 suppliers, will exceed goal of bringing four gigawatts of renewable energy into Co.'s supply chain by 2020 with over one additional gigawatt projected within that time frame. + 2. In last calendar year alone, partners that have joined this effort have generated enough clean energy to power over 600,000 homes in US. + 3. Hopes Co.'s actions will inspire other businesses to do what they can to protect world that it shares. + 7. Looking forward to sharing more information about future of four software platforms at Worldwide Developers Conference less than five weeks from now. + 5. Capital Return Program: + 1. In position of generating more cash than Co. needs to run business and invest confidently in future. + 1. On 04/30/19, announced latest update to capital return program, including increase to: + 1. Share repurchase authorization. + 2. Quarterly dividend. + +-------------------------------------------------------------------------------- +II. 2Q19 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $58b. + 1. Near high-end of guidance range provided 90 days ago. + 2. Down 5% YoverY. + 1. Decline reflects 200 BP of negative FX due to strength of US dollar. + 2. Overall Products revenue declined 9%, driven primarily by iPhone. + 1. Services revenue grew 16% to new all-time record. + 3. Set new March qtr. record for Wearables, Home and Accessories. + 1. Recorded best iPad growth rate in six years. + 4. GM: + 1. 37.6%, in line with guidance. + 2. Products 31.2%, down about 310 BP sequentially due to: + 1. Seasonal loss of leverage. + 2. FX headwinds. + 3. Services 63.8%, up 100 BP sequentially due to: + 1. Different mix. + 2. Leverage from higher revenue. + 5. Net income $11.6b. + 6. Diluted EPS $2.46. + 7. Operating cash flow $11.2b. + 2. iPhone: + 1. Revenue $31.1b. + 2. Seeing positive customer response to recent pricing actions in certain emerging markets and enhancements to trade-in and financing programs. + 3. YoverY performance improved relative to Dec. qtr. results in: + 1. Greater China. + 2. Americas. + 3. Japan. + 4. Active installed base reached new all-time high at March-end. + 1. Growing installed base reflects industry-leading satisfaction and loyalty of customers. + 2. Latest survey of US consumers from 451 Research indicates customer satisfaction of 99% for iPhone XR, XS and XS Max combined. + 3. Among business buyers who plan to purchase smartphones in June qtr., 81% plan to purchase iPhones. + 3. Services: + 1. Revenue $11.5b, up 16% YoverY. + 1. Best qtr. ever. + 2. Double-digit revenue growth across: + 1. App Store. + 2. Apple Music. + 3. Cloud Services. + 4. AppleCare. + 5. Apple Pay. + 6. App Store Search Ads business. + 3. Set all-time Services revenue records in four of five geographic segments. + 4. Services accounted for: + 1. 20% of March qtr. revenue. + 2. About one-third of gross profit dollars. + 5. Customer engagement in ecosystem continues to grow. + 1. Number of transacting accounts on digital content stores reached another new all-time high with number of paid accounts setting new all-time record and growing by strong double-digits over last year. + 6. Has over 390m paid subscriptions across Services portfolio. + 1. Up 120m vs. 12 months ago. + 2. All subscription categories are growing strong double-digits. + 3. Expects number of paid subscriptions to surpass 0.5b during 2020. + 7. On App Store, subscription business is extremely diversified. + 1. Growing strongly worldwide. + 2. Number of paid third-party subscriptions increased over 40% YoverY in each geographic segment. + 3. Across all third-party subscription apps, largest accounted for 0.3% of total Services revenue. + 4. Mac: + 1. Revenue $5.5b vs. 2Q18's $5.8b. + 1. Decline driven primarily by processor constraints on certain popular models. + 1. Despite this challenge, generated double-digit revenue growth in Japan and Korea, setting new all-time revenue records in both markets. + 2. Globally, nearly half of customers purchasing Macs were new to Mac. + 1. Active installed base of Macs reached new all-time high. + 5. iPad: + 1. Revenue $4.9b. + 1. Growth accelerating from Dec. qtr. to 22%. + 2. Revenue grew in all five of geographic segments. + 1. Return to growth in Greater China. + 2. Strong double-digit growth in all other segments. + 3. Best March qtr. ever for iPad in Japan. + 1. Especially pleased by performance in Korea, Thailand and Mexico, where revenue more than doubled YoverY. + 4. In total, over half of customers purchasing iPads during 2Q19 were new to iPad. + 1. iPad active installed base reached new all-time high. + 5. Revenue growth has been fueled primarily by great customer response to new iPad Pro. + 1. This completely redesigned iPads with full screen Liquid Retina displays, Face ID, powerful A12X Bionic chip with Neural Engine and support for new Apple Pencil and Smart Keyboard make iPad Pro perfect PC laptop replacement for consumers and professionals. + 2. Most recent surveys from 451 Research measured 93% customer satisfaction rating for iPad overall. + 3. Among customers who plan to purchase tablets, 77% of consumers and 75% of businesses plan to purchase iPads. + 6. Wearables, Home & Accessories: + 1. Set new March qtr. revenue record of $5.1b, fueled primarily by strong performance of Wearables business, which grew close to 50%. + 2. Apple Watch is best-selling and most loved smartwatch in the world. + 1. Produced best results ever for non-holiday qtr. + 2. Reaching many new customers with 75% of purchases going to customers who have never owned Apple Watch before. + 3. Interest in AirPods has been off the charts. + 1. Working hard to catch up with incredible customer demand. + 7. Retail & Online Stores: + 1. Strong double-digit revenue growth from Apple Watch and iPad. + 2. Announced 50 new Today at Apple sessions in three new and expanded formats, Skills, Walks and Labs, free at Co.'s stores worldwide. + 3. Making important progress in enterprise market, helping transform major industries. + 4. Building on Co.'s leading position in key functional areas to expand reach and share within large accounts. + 1. Aviation is strong example of this strategy at work. + 1. Across 450 airlines, iPad is overwhelmingly preferred solutions for pilots' electronic flight bag. + 2. Making great progress expanding Co.'s footprint beyond cockpit into cabin. + 3. More than half of Top 50 airlines have implemented iOS to enhance guest experience and enable new use case with mobile point of sale. + 4. Seeing traction with other mission critical airline functions in ground operations and flight maintenance. + 5. One of the largest airlines in the world tells Co. that adoption of iPad has kept maintenance delays in half. + 6. AAPL Services are making their way on board, including growing adoption of Apple Pay for food and beverage purchases and in-flight access to Apple Music. + 5. Seeing significant iOS traction with large enterprise platforms, which are face of complex back-end systems to tens of millions of employees worldwide. + 1. End-user employee experience is vital to engagement and productivity. + 1. With increase in mobility of today's modern workforce, those experiences are best on native iOS applications. + 2. Sees great momentum through growing number of iOS SDKs being delivered by world's largest enterprise platforms. + 1. SAP's SDK for iOS continues to gain strong traction with their customers growing by more than 40% in last six months. + 2. Salesforce released its SDK, enabling developers to build native iOS applications directly on top of Salesforce platform. + 6. Enterprise channels continue to build momentum. + 1. In Feb., Apple at Work initiative was launched with AT&T. + 1. Extension to ongoing collaboration with AT&T will make it easy for more customers to choose best AAPL products for their needs in enterprise and modernize their business. + 2. AT&T will enable business services for AAPL products to [other] companies with their IT strategy, including device management, security, productivity and collaboration. + 8. Cash Position: + 1. 2Q19-end: + 1. Cash plus marketable securities $225b. + 2. Term debt $101b. + 3. Commercial paper outstanding $12b. + 4. Net cash position almost $113b. + 2. In strong position that allows Co. to invest confidently in all business areas, while continuing to return value to shareholders. + 1. Last year, announced commitment to contribute more than $350b to US economy over next five years, including creation of 20,000 jobs. + 2. More recently, announced major expansion in Austin, Texas and in other cities across the country. + 1. All these efforts are essential investments to make sure that Co. is incorporating innovative ideas and top talent wherever they emerge. + 3. As Co. executes aforementioned initiatives, returned over $27b to investors. + 4. Began $12b accelerated share repurchase program in Feb., resulting in initial delivery and retirement of 55.1m shares. + 5. Repurchased 71.7m AAPL shares for $12b through open market transactions. + 6. Paid $3.4b in dividends and equivalents. + 3. Cash priorities have not changed over the years. + 1. Always wants to maintain cash Co. needs to: + 1. Run business. + 2. Maintain strategic flexibility. + 3. Invest in future. + 2. Well on way towards meeting investment projections laid out early last year. + 3. Wants to work towards more optimal capital structure. + 1. It is Co.'s plan to reach net cash neutral position over time. + 4. Given confidence in AAPL's future and value Co. sees in stock, Board authorized additional $75b for share repurchases. + 5. Because Co. knows many of its investors' value income, raising quarterly dividend for seventh time in less than seven years to $0.77, up about 5% from previous amount. + 6. Paid over $14b in dividends and equivalents over last four quarters alone, making Co. one of the largest dividend payers in the world. + 1. Going forward, continues to plan for annual increases in dividends per share. + 9. 3Q19 Outlook: + 1. Revenue $52.5-54.5b. + 1. Range comprehends 300 BP of negative FX impact YoverY. + 2. In 3Q18, Services revenue included favorable $236m one-time item in connection with final resolution of various lawsuits. + 2. GM 37-38%. + 3. OpEx $8.7-8.8b. + 4. OI&E about $250m. + 5. Tax rate about 16.5%. + 6. Reflecting approved increase, on 04/30/19 Board of Directors declared cash dividend of $0.77 per share of common stock payable on 05/16/19 to shareholders of record as of 05/15/19. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Certainly. Our first question will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [2] +-------------------------------------------------------------------------------- + + Tim, can you talk a bit more about what you're seeing in China? Clearly, it looks like things are improving sequentially. You also mentioned that last few weeks of the quarter were stabilizing in emerging markets, I believe. So what are customers saying there? What are your partners saying in China? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question, Shannon. We're seeing -- in the iPhone space, we saw a better year-over-year performance in the last weeks of the quarter as compared to the full quarter or November and December, which was sort of a -- appears to be the trough. I think there's a set of reasons for this. One, we made some price adjustments, essentially backing out the weaker currency effect and then some. The -- there's stimulus programs that the government has executed, including, and this happened in early April, VAT being reduced from 16% to 13%, so they've been aggressive in the stimulus side. Three, our trade-in and financing programs that we implemented in our retail stores have been very well received there, and I'm happy with the results to date there. And then four, the -- there's an improved trade dialogue between the U.S. and China. And from our point of view, this has affected consumer confidence on the ground there in a positive way. And so I think it's a set of all of these things, and we certainly feel a lot better than we did 90 days ago. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [4] +-------------------------------------------------------------------------------- + + And then I'm sure you're probably expecting a question on Qualcomm settlement. So what would you like to say on the settlement? How are you thinking about your component providers going forward? And how should we think about this with regard to, I don't know, your development plans in the future? Because I'm sure you're not going to talk about when you're going to do 5G but clearly, it helps that path. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + Yes. Thank you, Shannon. We're glad to put the litigation behind us, and all the litigation around the world have been dismissed and settled. We're very happy to have a multi-year supply agreement. And we're happy that we have a direct license arrangement with Qualcomm, which was, I know, important for both companies, and so we feel good about the resolution. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question will come from Samik Chatterjee with JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [7] +-------------------------------------------------------------------------------- + + Tim, you talked about China responding well to the pricing actions that you've taken in that market. Do any of those learnings kind of carry through into how you decide pricing in the remaining emerging markets like India, et cetera, as you get ready for the next product cycle? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + We have made some adjustments in India, and we've seen preliminarily some better results there. Everything that we do does advise everything we do in the future, so we try to learn the best we can and fold that into our thinking. And we'll obviously do that with this as well. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [9] +-------------------------------------------------------------------------------- + + I just had a quick follow-up for Luca on the Services side. Luca, we see that you're guiding to higher operating expenses quarter-on-quarter. How much of that incremental is going in to support the new services that you're planning to launch later in the year? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [10] +-------------------------------------------------------------------------------- + + Yes. Of course, we are supporting both our products and Services business, and you can see the trajectory of our OpEx over the different quarters. Clearly, as we add new services, we will need to make the necessary investments to support them. Our Services business is -- has multiple streams. In total, it is accretive to company gross margins. You've seen the latest -- we're running services margins at over 60%. So it's a very important business for us in many ways for our ecosystem and for our ability to monetize it. And so clearly, we will make all the necessary investments to ensure that the new services are successful. And we're really encouraged by the level of customer response that we received so far in anticipation for the launch of these services. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question will come from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [12] +-------------------------------------------------------------------------------- + + Luca, if I look back over the past 5 years, June quarter revenue typically declines about 15% from the March quarter. You're guiding to an 8% drop this year. So can you just talk about which regions or product segments you think can outperform that typical seasonality? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [13] +-------------------------------------------------------------------------------- + + Yes, Katy. And keep in mind, by the way, we are reporting this guidance including a 300 basis point negative impact from foreign exchange, so actually, in constant currency, the numbers would be even stronger. At the product category level, we expect that we continue to have strong revenue growth from the non-iPhone categories as we've had for the first half of our fiscal year. We're also expecting a relative improvement in our iPhone performance on a year-over-year basis in Q3 versus the first half. As Tim said, March was the strongest month of the quarter on a year-over-year basis, and so this has given the confidence to provide the guidance that you've seen. Geographically, of course, as you've seen from our results for the March quarter, China is the geo where we found some challenges, but we believe the trajectory should improve over time. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [14] +-------------------------------------------------------------------------------- + + And then just as a follow-up, Shannon said you're not going to talk specifics around the timing of the 5G phone, but Tim, maybe you can talk about how the company approaches a new technology like this given the higher cost but also potentially significant benefit, how you think about the right timing for coming to market with a product with those characteristics and then just, generally, how meaningful, you think, 5G is as a demand driver for upgrades in your iPhone installed base. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + Katy, this is one that I'm going to largely punt on as you would probably guess. We look at a lot of things on the different technologies and try to look at the -- and select the right time that things come together and get those into products as soon as we can. And the -- certainly, from a cost point of view, there has been -- the technologies have had cost pressure over the last couple of years or so. On the flip side of that, there's a number of things in the commodity markets going in the other direction at the moment like DRAM and NAND. And so it's difficult to project what happens next, but it's the aggregate of all of it that really matters from a price point of view. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Jim Suva from Citi has our next question. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [17] +-------------------------------------------------------------------------------- + + A topic that's probably split or shared by both Tim and Luca on a response but I'll ask the question and you can decide how to divide it up. In your opening remarks, Tim, you'd mentioned about pricing adjustments that you made in some of the markets, and then Luca talked also about the strength of the trade-in program or maybe it was Tim also. Can you help us understand about what type of lessons or elasticity you've learned about pricing and the trade-in programs of how it impacts like revenues and COGS and margins and things? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [18] +-------------------------------------------------------------------------------- + + Yes. Jim, the -- in the opening remarks, I was really talking about China specifically. And I mentioned 4 things that I believe are responsible for the better year-over-year performance in the Q2 relative to Q1 and also the final weeks of March being better than the Q2 average. And those 4 are the price reductions but that's 1 of them. But there are 3 others, and 1 of the others is the trade-in and financing programs that we instituted in our retail stores. Clearly, what we've learned here and it's not a surprise really is that the -- many, many people do want to trade in their current phone. It does -- from a customer user point of view, the trade-in looks like a subsidy, and so it is a way to offset the device cost itself. And many people in literally every market that we've tried this in, there is a reasonable number of people that want to take and pay for something on installments instead of all at once. And so it's a little different in each market in terms of what the elasticity is, but you can bet that we're learning quickly on all of those. +The other 2 items that are not insignificant in China that I don't want to lose here is that the stimulus programs, I believe, are having an effect on the consumer. And the 1 that I got much visibility in -- that happened in early April was the VAT reduction from 16% to 13%, so it's a very aggressive move. But there are other stimulus programs as well that likely have an effect to the consumer level. And then finally, and this is not to be underweighted either, I think the improved trade dialogue between the countries affects consumer confidence in a positive way. And so I think it's sort of the sum of all of those things. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [19] +-------------------------------------------------------------------------------- + + And Jim, if I may add on the gross margin level, as we look at pricing actions, of course, anytime you do a pricing action, it is gross margin percentage diluted. But what really matters to us and what we look at when we look at the elasticity of these programs is to see the impact on our gross margin dollars. And what -- the experience that we've had in a few of these emerging markets has been positive in that respect, and so that's what we think matters the most really. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + The next question will come from Wamsi Mohan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [21] +-------------------------------------------------------------------------------- + + Tim, you shared a lot of color around trade-ins, but I was also hoping maybe you can characterize what sort of dynamics you're seeing across your installed base on these trade-ins. What type of devices are being traded in? Is the profile of someone who has a really old iPhone? Or are you seeing folks that have newer iPhones trading in? And what sort of incentives are you providing beyond sort of the financing to drive that? And do you see this as something that can accelerate replacement cycles here over the next year or so? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [22] +-------------------------------------------------------------------------------- + + We're -- actually, the product that's being traded in is all over the place, to be honest. It's 6, 6 Plus, 6s, 6s Plus, 7, 7 Plus and then fewer 8 and 8 Plus. But there's some of each of those, and so you get customers that are on the 2-year cycle and customers -- some customers on the 1-year cycle and then customers as well on the 3- and 4-year cycles. And so it's really all over the place. In terms of the incentives, we're offering currently in our retail stores a trade-in value that has -- that is more than the sort of the blue book of the device, if you will, for lack of a better description. And so we have topped those up to provide an extra benefit to the user. +The installments are different in each geography. I would say that, at the moment, the geography that is doing the best in installments would be China. And we have a bit of a unique offering there, I think, versus the -- versus what you can get in the regular market, and so that probably further helps there. And so you can bet that we're learning on each of these, finding the parts that the user likes the most. +I think the key is we're trying to build a -- build something into the consumer mindset that it's good for the environment and good for them to trade in their current device on a new device. And we do our best of getting the current device to someone else that can use that or, in some cases, if the product is at an end of life, we are recycling the parts on it to make sure that it can carry on in another form. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [23] +-------------------------------------------------------------------------------- + + And as my follow-up, Luca, can you just clarify if the settlement with Qualcomm is creating either a headwind or a tailwind to your gross margins in the near term? And does your guidance contemplate incremental pricing actions that could be creating some gross margin headwinds? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [24] +-------------------------------------------------------------------------------- + + As Tim has explained, we've reach this comprehensive agreement with Qualcomm. As part of this, we have agreed that we're not going to share the financial terms of the agreement, so we plan to honor that. What you see in our gross margin guidance for the June quarter, we guided 37% to 38%, fully comprehends the outcome of the agreement with Qualcomm. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Mike Olson from Piper Jaffray has our next question. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + So you have more than 1.4 billion active devices, and at your event, you announced services that leverage that installed base. And you have obviously a remarkable position with kind of this Trojan horse of devices out in so many households. So I guess the question is -- and I know some of these services aren't even live yet, but should we expect a continuation of the building out of new services categories like what we saw at the March event? Is there a pipeline of new services in the works? Or have we kind of seen what we're likely to see on that front for the near to intermediate term? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + Yes, I wouldn't want to get into announcing things on the call, but obviously, we're always working on new things. And -- but we're -- right now, we're really focused on getting these 4 out there. We have the News+ in the market today. We'll have the Apple Arcade and the Apple TV+ products in the market in the fall, and Apple Card will go out in the summer timeframe. And so we've got lots in front of us, and we're very excited about getting these out there. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [28] +-------------------------------------------------------------------------------- + + Right. And then you mentioned the App Store search ad business a couple of times in the prepared remarks. Is that reaching a point where it's become material and maybe moving the needle for overall Services revenue? Or is there anything you can quantify related to that? I also imagine that this is a high-margin business, at least maybe higher than the overall Services margin but wondering if you can confirm if that's the case or not. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [29] +-------------------------------------------------------------------------------- + + It's growing very, very fast, Mike. I think it was up around 70% over the previous year. We're expanding into new geographies as well, and we still have more geographies out there that we think can move the dial further. So it is a -- it's definitely a business that is big and getting bigger. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Lou Miscioscia with Daiwa Capital Markets. + +-------------------------------------------------------------------------------- +Louis Rocco Miscioscia, Daiwa Securities Co. Ltd., Research Division - Research Analyst [31] +-------------------------------------------------------------------------------- + + Tim, when you look at the 4 things that you have announced, and I realize they have different dates when they're coming out, but which ones would you say, over the next 12 months, has the most potential to help your Services line? And then maybe which one has the best long-term potential? And then I have a quick follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [32] +-------------------------------------------------------------------------------- + + We're going to wait until we get these things out. And what I can tell you right now is that the -- we're taking sort of consumer interest on the Apple Card, and there's been a significant level of interest on that and we're excited. As you know, the -- gaming is the top category on the App Store. And so the Apple Arcade will serve some of that market, and it serves it with a different kind of game, which we think will be great for developers and great for users. +The TV+ product plays in a market where it's -- there's a huge move from the cable bundle to over the top. We think that most users are going to get multiple over-the-top products, and we're going to do our best to convince them that the Apple TV+ product should be one of them. And then we're working very hard to get everyone to give Apple News+ a look because we think it's a very unique product. And I love magazines, and we have really wanted to support the publishers. And so we're working very hard to -- at the -- but at the very beginning of the ramp there. We wouldn't do a service that we didn't think could be meaningful, so that's sort of the way I look at it. Yes, these aren't hobbies. + +-------------------------------------------------------------------------------- +Louis Rocco Miscioscia, Daiwa Securities Co. Ltd., Research Division - Research Analyst [33] +-------------------------------------------------------------------------------- + + Okay. A quick follow-up on India. Obviously, market share there is well, well below China. I believe you're looking to start manufacturing there. But what's the -- obviously, the potential could be huge, but the market already seems to be pretty dominated on the Android side. So maybe if you could just talk about trying to really aggressively ramp up share there. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [34] +-------------------------------------------------------------------------------- + + I think India is a very important market in the long term. It's a challenging market in the short term, but we're learning a lot. We have started manufacturing there, which is very important to be able to serve the market in a reasonable way, and we're growing that capability there. And we would like to place retail stores there, and we're working with the government to seek approval to do that. And so we plan on going in there with sort of all of our might. We've opened a developer accelerator there, which we're very happy with some of the things coming out of there. It's a long-term play. It's not something that's going to be on overnight huge business, but I think the growth potential is phenomenal. It doesn't bother me that it's primarily Android business at the moment because that just means there's a lot of opportunity there. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [35] +-------------------------------------------------------------------------------- + + A replay of today's call will be available for 2 weeks on Apple Podcasts as a webcast on Apple.com/investor and via telephone. And the numbers to the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 7060604. And these replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2019-Jan-29-AAPL.txt b/Transcripts/AAPL/2019-Jan-29-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..d95211e411c7d9636a3d2c2d92251eadeb70cbb4 --- /dev/null +++ b/Transcripts/AAPL/2019-Jan-29-AAPL.txt @@ -0,0 +1,513 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q1 2019 Apple Inc Earnings Call +JANUARY 29, 2019 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Senior Director of IR and Treasury + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Mark Milunovich + Wolfe Research, LLC - MD of Equity Research + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Walter Paul Piecyk + BTIG, LLC, Research Division - Co-Head of Research and MD + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 1Q19 revenues of $84.3b, net income of $20b and diluted EPS of $4.18. Expects 2019 revenues to be $55-59b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 1Q19 revenues = $84.3b. + 2. 1Q19 net income = $20b. + 3. 1Q19 diluted EPS = $4.18. + 4. 1Q19 YoverY revenues decline = 5%. + 5. 1Q19 GM = 38%. + 6. 1Q19-end cash plus marketable securities = $245b. + 7. 1Q19-end term debt = $102.8b. + 8. 1Q19 share repurchase = 38m shares for $8.2b through open market transactions. + 9. 2019 revenue guidance =$55-59b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 1Q19 Business Review (T.C.) + + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Dec. qtr. revenue, $84.3b. + 1. Below original expectations. + 2. Down 5% YoverY, or 3% adjusting for FX. + 2. Noted four factors that would impact results when Co. provided guidance in Nov.: + 1. Different iPhone launch timing from a year ago. + 2. FX headwinds. + 3. Supply constraints on certain products. + 4. Macroeconomic conditions in emerging markets. + 3. Weak macro conditions in some emerging markets were significantly more severe than Co. originally foresaw, especially in Greater China. + 1. Compounded by quarterly iPhone upgrades that were lower than anticipated. + 2. Greater China revenue down $4.8b YoverY, with declines across: + 1. iPhone. + 2. Mac. + 3. iPad. + 3. Most shortfalls relative to regional guidance, and over 100% of worldwide YoverY revenue decline was driven by performance in Greater China. + 4. Despite iPhone upgrades being lower than anticipated, Co.'s business grew outside of China, including new records in: + 1. Americas. + 2. Western Europe. + 3. Central and Eastern Europe. + 4. Rest of Asia Pacific. + 5. Had record performance in large markets, including: + 1. US. + 2. Canada. + 3. Mexico. + 4. Germany. + 5. Italy. + 6. Spain. + 7. Korea. + 6. In the letter shared earlier this month, Co. said it is proud to participate in Chinese marketplace and that it believes AAPL's business has a bright future there over time. + 7. Generated record Dec. qtr. Services revenue in Greater China, fueled by an amazing ecosystem with over 2.5m registered iOS developers. + 1. Saw strong results from wearables business, there with revenues up over 50%. + 8. Continued to grow total active installed base by adding new customers. + 1. More than two-thirds of all customers in China who bought a Mac or an iPad during Dec. qtr. were purchasing that product for first time. + 9. Despite challenging Dec. qtr., revenue from China grew slightly for full calendar year. + 1. Macroeconomic factors will come and go. + 2. Sees great upside and continuing to focus on things that Co. can control. + 2. iPhone: + 1. iPhone XR, iPhone Xs and iPhone Xs Max are by far the best iPhones Co. has ever shipped. + 1. They share advanced technologies, including A12 Bionic, the most powerful chip ever in a smartphone with Co.'s next generation Neural Engine capable of 5t operations per second. + 2. Proud of iPhone lineup, and Co.'s industry-leading customer satisfaction. + 1. Wouldn't change position for anyone. + 3. Customers are holding on to their older iPhones a bit longer than in past. + 1. Pairing this with a macroeconomic factor, particularly in emerging markets, it resulted in iPhone revenue down 15% from last year. + 4. Results accounted for significantly more than entire YoverY revenue decline. + 1. Outside of iPhone, business grew strongly, by 19%. + 5. From a customer perspective, Co. believes [aforementioned] is the sum of several factors. + 1. FX: + 1. Relative strength of US dollar has made Co.'s products more expensive in many parts of world. + 2. In Turkey, lira depreciated by 33% over course of calendar 2018 and in Dec. qtr., revenue there was down by almost $700m from previous year. + 2. Subsidy: + 1. For various reasons, iPhone subsidies are becoming increasingly less common. + 2. In Japan, iPhone purchases were traditionally subsidized by carriers and bundled with service contract. + 3. Competitive promotional activity frequently increased amount of subsidy during key period. + 4. Today, local regulations have significantly restricted those subsidies and related competition. + 5. Thereby, Co. estimates that less than half of iPhone sold in Japan in 1Q19 were subsidized vs. about three-quarters a year ago and that total value of those subsidies had come down. + 3. Battery replacement program: + 1. For millions of customers, Co. made it inexpensive and efficient to replace battery and hold on to their existing iPhones a bit longer. + 2. Some people suggested that Co. shouldn't have done this because of potential impact on upgrades, but Co. strongly believes, it was right thing to do for customers. + 4. Despite aforementioned factors, total active installed base of devices has grown from 1.3b at Jan.-end 2018 to 1.4b by end of Dec., reaching a new all-time high for each of main product categories and for all five geographic segments. + 3. Services: + 1. Large and growing installed base is a powerful testament to satisfaction and loyalty of customers, but it's also fueling fast growing Services business. + 2. Services revenue set an all-time record, at $10.9b in Dec. qtr., growing 19%. + 1. Had all-time records across multiple categories of services including App Store, Apple Pay, Cloud services and App Store Search Ads business. + 1. Had Dec. qtr. record for AppleCare. + 3. Nearly 16 years after launching iTunes Store, Co. generated highest quarterly music revenue ever due to popularity of Apple Music, now with over 50m paid subscribers. + 4. App Store wrapped up its best year ever, with record holiday period results propelled by biggest Christmas Day and Christmas week ever. + 1. Customers spent over $322m on New Year's Day alone, setting a new single day record for number of customers and purchase volume. + 5. Great holiday season for Apple Pay with over 1.8b transactions; well over twice the volume of 1Q18. + 1. Merchant adoption continues to reach new milestone. + 2. Customers can now use Apple Pay with iPhone and Apple Watch at nearly 3,000 Speedway locations. + 3. While all Target, Taco Bell and Jack in the Box stores will be accepting Apple Pay soon. + 4. Launched in three new countries in Dec. qtr.: + 1. Germany. + 2. Belgium. + 3. Kazakhstan. + 5. Live in 27 markets around the world. + 1. Rollout in Germany has been a huge success with Deutsche Bank reporting more activations for Apple Pay in one week than for Android in an entire year. + 6. Revenue from Cloud Services continues to grow rapidly with YoverY revenue up over 40% in Dec. qtr. + 1. Readership of Apple News set a new record with over 85m monthly active users in three countries where Co. has launched: + 1. US. + 2. UK. + 3. Australia. + 2. In US, latest data from comScore shows that Apple News has largest audience of all news apps. + 3. International audience will continue to grow with Co.'s first ever bilingual launch in Canada, available to customers later this qtr. + 7. Happy with growth and breadth of Services portfolio. + 1. Revenue from Services has grown from less than $8b in calendar 2010 to over $41b in calendar 2018. + 2. Largest category represents less than 30% of total Services revenue and new services launched in last few years are all experiencing tremendous growth. + 4. Others: + 1. Mac: + 1. Best qtr. ever. + 2. Revenue up 9%, fueled by new MacBook Air and Mac Mini, introduced in Oct. + 2. iPad: + 1. Revenue up 17%. + 2. Highest growth rate in almost six years, powered by new iPad Pro released in Nov. + 3. Wearables, Home and Accessories: + 1. Had best qtr. ever with 33% growth in total, and almost 50% growth from wearables due to strong sales of Apple Watch and AirPods. + 4. Co. doesn't measure success in 90 day increments; manages Co. for long-term. + 1. When considering keys to success over time, there are three that stand out: + 1. Highly satisfied and loyal customers. + 2. Large and growing active installed base. + 3. Deeply ingrained culture of innovation. + 5. Has an amazingly talented team, creating hardware, software and services, optimizing each of them to create an unparalleled user experience. + 1. Apple Watch is a powerful example of this. + 1. Believes Co. is just beginning to see impact it can make to improving health and is deeply inspired by possibility. + 2. Has embedded machine learning directly into silicon with A12 Bionic chip. + 1. Custom Neural Engine provides power efficiency and incredible performance in a small package, but it enables processing of data and transactions directly on device. + 2. iPhone can recognize pattern, make prediction and learn from experience, all while keeping personal information private. + 6. Undertaking and accelerating a number of initiatives to improve results. + 1. Making it simple to trade in an iPhone in stores and raising awareness of this opportunity. + 1. Because of quality and durability of iPhone, they maintain significant residual value, making trade-ins a great opportunity. + 2. It's not only great for environment, it's great for customer as their existing phone acts as a subsidy for their new phone, and it's great for developers as phone that has traded in and redistributed can help grow Co.'s active installed base. + 2. Beginning last week, Co. started making it easier for people to pay for their phones over time with installment payments. + 1. Working on rolling out this program to more geographies as soon as Co. can. + 5. Summary: + 1. Confident in fundamental strength of Co.'s business. + 2. Has a strong pipeline of products and services with some exciting announcements coming later this year. + 3. Will continue to invest through near-term headwinds, and will emerge stronger as a result. + +-------------------------------------------------------------------------------- +II. 1Q19 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Dec. qtr. revenue, $84.3b. + 1. Below expectations. + 2. Set new all-time revenue records in: + 1. US. + 2. Canada. + 3. Latin America. + 4. Western Europe. + 5. Central and Eastern Europe. + 6. Korea. + 3. Results were especially strong in US where revenue was up by more than $1.5b vs. a year ago. + 4. In several markets, revenue grew by double-digits, including among others: + 1. Germany. + 2. Spain. + 3. Poland. + 4. Mexico. + 5. Malaysia. + 6. Vietnam. + 5. iPhone revenue declined 15% YoverY. + 1. Revenue from rest of business grew 19% towards an all-time record, including best results ever for Services, for Wearables and for Mac. + 6. GM, 38%. + 1. Co. is now reporting on a quarterly basis GM for products in aggregate and for Services in aggregate. + 1. Products GM 34.3%. + 2. Services GM 62.8%. + 2. On sequential basis, products GM increased 60 BP due to positive leverage from holiday qtr., partially offset by higher cost structures as Co. launched several new products and by headwinds from FX. + 3. Services GM increased 170 BP sequentially due to favorable mix and leverage, partially offset by FX. + 4. Products and services GMs improved sequentially, total Co. GM was down 30 BP due to a different mix between products and services. + 7. Net income $20b. + 1. About flat to last year. + 2. Diluted EPS $4.18; all-time record. + 1. Up 7.5% YoverY. + 8. Operating cash flow $26.7b; strong. + 2. iPhone: + 1. Revenue $52b. + 2. On geographic basis, most of YoverY decline came from Greater China and other emerging markets with difficult macro and FX conditions affected Co.'s results. + 1. Believes reduction of carrier subsidies and battery replacement program had an impact in number of countries around world. + 2. Had a lower number of upgrades than anticipated at beginning of qtr. + 3. Global active installed base of iPhones continues to grow. + 1. Reached all-time high at Dec.-end. + 2. Surpassed 900m devices, up YoverY in each of five geographic segments and growing almost 75m in last 12 months alone. + 3. Plans to provide information on iPhone installed base and total installed base on a periodic basis. + 4. Customer satisfaction and loyalty for iPhone continue to be outstanding, and are highest in industry. + 1. Latest survey of US consumers from 451 Research indicates customer satisfaction of 99% for iPhone XR, iPhone Xs and Xs Max combined. + 2. Among business buyers who plan to purchase smartphones in March qtr., 81% plans to purchase iPhones. + 3. Based on latest information from Kantar, iPhone experience had 90% customer loyalty rating for iPhone customers in US, 23 points above next highest brand measured. + 3. Services: + 1. Best qtr. ever. + 2. Revenue $10.9b, up 19% YoverY. + 1. New Dec. qtr. record in all five geographic segments. + 2. Many Services categories set new all-time revenue records. + 3. On track to achieve goal of doubling FY16 services revenue by 2020. + 1. 2020 goal remains unchanged. + 1. Excludes impact of revenue reclassification between products and services Co. recorded in connection with ASC 606, new revenue recognition accounting standard it adopted at beginning of FY19. + 4. Level of engagement of customers in Co.'s ecosystem continues to grow. + 1. Number of transacting accounts on digital stores reached a new all-time high during qtr. with number of paid accounts, growing by strong double-digits over last year. + 2. Now has over 360m paid subscriptions across Services portfolio, up 120m YoverY. + 1. Given continued strength and momentum in this part of business, expects a number of paid subscriptions to surpass 0.5b during 2020. + 3. Subscription business has become large and diversified, covering many different categories from entertainment, to health and fitness, to lifestyle. + 4. More than 30,000 third-party subscription apps are available today on App Store, and largest of them accounts for only 0.3% of total Services revenue. + 4. Mac: + 1. Saw great response to new MacBook Air and Mac Mini introduced in Oct., which drove 9% increase in Mac revenue over last year to a new all-time record. + 2. Revenue was up in vast majority of countries Co. tracks with double-digit growth in many large markets like: + 1. US. + 2. Western Europe. + 3. Central and Eastern Europe. + 4. Japan. + 5. Korea. + 6. South Asia. + 3. Active installed base of Mac produced a new all-time high. + 1. Half of all customers purchasing Macs in Dec. qtr. were new to Mac. + 5. iPad: + 1. Revenue up 17% YoverY. + 2. Strong performance of iPad and iPad Pro. + 3. Generated double-digit growth in four of five geographic segments. + 4. Similar to Mac, installed base of iPads reached a new all-time high. + 1. Among customers purchasing iPad during qtr., half were new to iPad. + 5. Most recent consumer survey from 451 Research measured 94% customer satisfaction rating for iPad overall, with iPad Pro models scoring as high as 100%. + 1. Among business customers who plan to purchase tablets in March qtr., 68% plan to purchase iPads. + 6. Wearables, Home and Accessories: + 1. Revenue grew 33% to new all-time record in each geographic segments. + 2. Revenue up over $1.8b YoverY, due to amazing popularity of Apple Watch and AirPods, both of which were supply constrained as Co. exited qtr. + 3. Based on revenue over past four quarters, Wearables business is approaching size of a Fortune 200 co. + 4. Retail and online stores generated strong results from Mac and iPad, and all-time record performance from Services and from Wearables. + 1. Following launch of new iPhone trading campaign, Co.'s stores more than doubled volume of iPhones traded in vs. last year, reaching an all-time high in 1Q. + 5. Added Thailand to Co.'s footprint with a beautiful store in Bangkok. + 1. Opened a stunning new store in Champs-Elysees in Paris, exiting qtr. with 506 physical stores in 22 countries. + 7. Others: + 1. Enterprise: + 1. Across multiple industries, Co.'s technology continues to enable businesses to do their best work. + 2. Healthcare: + 1. iPhones and iOS apps continue to streamline and support clinical workflows, communications and care delivery across leading health systems, including: + 1. Johns Hopkins Medicine. + 2. Massachusetts General Hospital. + 3. Stanford Healthcare. + 4. St. Jude Children's Research Hospital. + 3. Manufacturing: + 1. SKF, world's largest producers of bearings and seals have transformed their manufacturing processes on iOS and iPhone with incredible success. + 1. With custom iOS apps available to production operators across worldwide locations, SKF reduced production errors from 20% to 0%, while saving 70% in system-related time. + 2. AAPL technology has made possible a simplified user experience, integrating SAP Cloud Platform, yielding better accuracy, efficiency and employee experiences across the board. + 4. Construction: + 1. Seeing great innovation with iPad and new third-party apps made for iOS. + 8. Cash Position: + 1. 1Q19-end: + 1. Cash plus marketable securities, $245b. + 2. Term debt, $102.8b. + 3. Commercial paper outstanding, $12b. + 4. Net cash position, $130b. + 1. Plans to reach a net cash neutral position over time. + 2. Returned over $15b to investors during Dec. qtr. + 1. Repurchased 38m shares for $8.2b through open market transactions. + 2. Paid $3.6b in dividends and equivalence. + 3. Consistent with historical cadence, Co. plans to provide an update on overall capital return program when Co. reports March qtr. results. + 9. 2019 Outlook: + 1. Revenue, $55-59b. + 1. Reflects negative YoverY impact of $1.3b from FX, which represents about 210 BP of last year's revenue and a more uncertain macroeconomic environment than a year ago, especially in emerging markets. + 2. GM, 37-38%. + 1. Sequentially, reflects seasonal loss of leverage and 60 BP unfavorable impact for FX, partially offset by commodity cost savings. + 3. OpEx, $8.5-8.6b. + 4. OI&E, about $300m. + 5. Tax rate, about 17%. + 6. On 01/29/19, Board of Directors declared a cash dividend of $0.73 per share of common stock payable on 02/14/19 to shareholders of record as of 02/11/19. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question will come from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + Services growth did decelerate from the growth rates in recent quarters. So can you talk about the factors that played into that slower growth? And then appreciate the new disclosure around paid subscribers. But if you compare what you added in 2018 versus what you expect to add over the next 2 years, that implies a slowdown in annual net new subscribers. So should we be thinking about Services as a lower growth segment than what you experienced in 2018? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [3] +-------------------------------------------------------------------------------- + + Yes, Katy, let me take that one. First of all, when we talk about the Services business, it's very important to start from the momentum that we have. As you know, we have set an ambitious target for ourselves to double the size of our business from fiscal '16 to 2020, which implied, at the time, a 19% CAGR. So far, we've been able to grow about 20%. In fiscal '18, we grew 22%, so we are on track to achieve our objective. And it's important to understand what is driving the growth of the business. First of all, it's our installed base. As we just told you, the installed base continues to grow very nicely. It has reached 1.4 billion active devices at the end of December, and really, very little of our Services revenue is driven by what we sell in the last 90 days. The second factor for the growth of the Services business is that, within this installed base, the percentage of users who are paying for at least 1 service is growing very strongly. This is due to several factors. First of all, we're offering more and more services. During the last few years, as you know, we launched Apple Music, Apple Pay and advertising service for our developers on the App Store. All these businesses are growing very strongly. Second, we are making it easier for our customers to transact on our digital stores. We accept many more payment methods today, which are very common in certain countries around the world. We've also increased the distribution coverage for many of these services. We're bringing AppleCare to more points of sale around the world. We are launching Apple Pay in more and more markets and so on. Thirdly, as you mentioned, our subscriptions are becoming a very large portion of our business, and they're growing very well above Services average. And the fact that we are saying that we will surpass 0.5 billion during 2020, we're not putting a specific date during 2020, but I think you've seen over recent quarters that we've been adding about 120 million on a year-over-year basis for a number of quarters now. And this is an incredible staggering number, right, when you think about it. We're also broadening the scope of many of these services. You should take Apple Pay as an example. It started off as the most convenient, most private and most secure way to make a payment in a store or in an app. Then, we took Apple Pay to Safari. Then, we started a peer-to-peer service, and we're launching it in new markets across the world every quarter. So we are broadening that scope. And of course, similar to what we've done in the past in the last 3 years we launched several new services, we're also looking to launch new services going forward that we believe will provide great value to our users. And we're really very excited about the opportunities that we see in front of us. I think you're referring to the deceleration in the growth rate that we've seen in the December quarter, and I think you're referring back to the growth that we reported in September. I think an important point I need to make and I think it's helpful that you asked the question is that a portion of this deceleration is truly just a reclassification of the amortization of free services that we've made in connection with the adoption of the new revenue recognition standard. And as we explained 90 days ago, this amortization of free services in the past was reported under products and now gets reported under services. The reclassification is actually dilutive to our growth rate because the amortization of free services is a relatively stable number, which gets applied to our growing base. So this reclassification reduces our growth rate versus the previous classification. This factor, by itself, represents roughly 1/3 of the deceleration that you've seen. We talked about 27% growth in the September quarter. With the reclassification, that growth rate was about 24.5%. So that explains about 1/3 of that deceleration. There are, I would say, 3 factors that explain this difference between the 24.5% to the 19%. The first one is that foreign exchange plays a role. Roughly 60% of our Services business is outside the United States; and as you know, the U.S. dollar has appreciated in recent months. And in general, we tend not to reprice our services for foreign exchange on a very frequent basis. The second factor is a well-known issue around the App Store in China. The App Store in China is a large business for us. We believe this issue around the approval of new game titles is temporary in nature but clearly is affecting our business right now. And then thirdly, we are seeing some level of deceleration in AppleCare, which has had very, very strong growth during fiscal '18, where we're starting to lap some of the increase in distribution coverage that we put in place recently and the channel fill of Apple components that happened when we increased the distribution coverage. But in general, we are very, very pleased with 19% growth, and we think that the business will continue to grow nicely going forward. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- + + Just a quick follow-up, Luca. Share repurchases in the December quarter were well below the run rate from the June and September quarters. How much did the weaker quarter play into your ability to carry out the buyback at the same level? And what should we think about as the right run rate going forward? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [5] +-------------------------------------------------------------------------------- + + Well, Katy, we've always said that we're very committed to executing our program. We have done almost $250 billion of repurchases from the beginning of the program. But we've also said that we want to execute the program in an efficient, effective, I will say, disciplined manner. And that takes into account also overall market conditions. So that's what we did during the course of the December quarter. We -- our fundamental view remains the same. We are optimistic about our future, and we think there is great value in our stock. And so we will continue to execute the program. We will continue to report at the end of every quarter. And by the way, when we report our March quarter results, we will also talk about the next step in our capital return program, which is something that we do traditionally in the spring. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question will come from Steve Milunovich with Wolfe Research. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, Wolfe Research, LLC - MD of Equity Research [7] +-------------------------------------------------------------------------------- + + Some have the perception that you priced the new products, the new iPhones too high. What have you learned about price elasticity? And do you feel that perhaps you pushed the envelope a little bit too far and might have to bring that down in the future? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + Steve, it's Tim. If you look at what we did this past year, we priced the iPhone XS in the U.S. the same as we priced the iPhone X the year ago. The iPhone XS Max, which was new, was $100 more than the XS. And then we priced the XR right in the middle of where the entry iPhone 8 and entry iPhone 8 Plus have been priced. So it's actually a pretty small difference in the United States compared to last year. However, the foreign exchange issue that Luca spoke of in the call and -- made that difference or amplified that difference in international markets, in particular, the emerging markets, which tended to move much more significantly versus the dollar. And so what we have done in January and in some locations and some products is essentially absorb part or all of the foreign currency move as compared to last year and therefore, get close or perhaps right on the local price from a year ago. So yes, I do think that price is a factor. I think part of it is that, the FX piece. And then secondly, in some markets as I had talked about in my prepared remarks, the subsidy is probably the bigger of the issues in the developed markets. I had mentioned Japan; but also even in this country, even though the subsidy has gone away for a period of time, if you're a customer that your last purchase was a 6s or 6 or in some cases, even a 7, you may have paid $199 for it -- and now in an unbundled world, it's obviously much more than that. And so we are working through those, and we've got a number of actions to address that, including the trade-in and the installment payments, which I had mentioned as well. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, Wolfe Research, LLC - MD of Equity Research [9] +-------------------------------------------------------------------------------- + + I know that you're not giving units going forward, but you said you might make qualitative comments. I was wondering if you have a comment particularly on the ASP on a year-over-year basis. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [10] +-------------------------------------------------------------------------------- + + Well, Steve, we did mention on the call last quarter that the different timing of our phone launches would affect the year-over-year compares. If you remember, our top models, the XS and XS Max shipped during the September quarter, which plays the channel fill and the initial sales in that quarter. While last year, the iPhone X shipped in Q1 in the December quarter but is in the channel fill and the initial sales in the December quarter. So we knew that this would create a difficult compare for Q1 of '19, and this is essentially what happened. It was pretty much in line with our expectations. To give you more color, I would say that the XR is our most popular model, and it's followed by XS Max and then the XS. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question will come from Toni Sacconaghi with Bernstein. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + I have one for Luca and one for Tim. Luca, looks like the midpoint of your Q2 revenue guidance implies the steepest Q1 to Q2 sequential decline in iPhone revenues in history. It also implies a year-over-year deceleration in iPhone revenues. And I'm wondering if you can comment about whether that's conservatism, whether you're entering the quarter with a high level of channel inventory, and maybe you can comment explicitly on that, or whether you actually think the macroeconomic conditions are getting worse. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [13] +-------------------------------------------------------------------------------- + + Yes. I mean, 3 questions there. The first one is a question around conservatism. As we always do, when we provide a range, it's a range that we believe we're going to fall within. We've done pretty well with that up until the December quarter, right? I mean, we've been -- we didn't miss in years and years. So that's the idea. It's -- there is that specific level of conservatism. We believe that this is the range where we're going to fall within. On channel inventory, as you know, our historical pattern for iPhone channel inventory is that, typically, we increase inventory in Q1 and we decrease in Q2. And we think this year will be similar, and we've exited the December quarter with levels of inventory that we are comfortable with. So that leaves us with the reality that our iPhone performance in Q1, from a revenue standpoint, was minus 15%. And we expect that the key factors that Tim mentioned during the call affecting iPhone performance in Q1 will also have an effect on Q2 starting with the strong U.S. dollar environment. On a year-over-year basis, the negative impact from currency is going to be about $1.3 billion, so that's about -- a bit more than 2 points versus last year's revenue. And so that obviously plays a role. And the macroeconomic environment, particularly in emerging markets, will continue to be there. On the positive side, we expect that we will continue to grow revenue nicely from the rest of the business, which is not iPhone. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Tim, at your September event, Lisa Jackson, an Apple VP, stated the company needed to "design products to last as long as possible." And Apple's clearly doing that by helping with the battery replacement program, iOS working on an older range of products, et cetera. But I guess, the question is why doesn't that mean that replacement or upgrade cycles for iPhones should continue to extend going forward, in part, because that's almost one of your objectives. And maybe to that end, maybe you can help us understand what iPhone's average replacement cycle might be today and how that may have changed over the last 3 to 5 years. And again, why wouldn't you expect it to elongate over time given some of the aforementioned things? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + We do design our products to last as long as possible. Some people hold onto those for the life of the product, and some people trade them in. And then that phone is then redistributed to someone else. And so it doesn't necessarily follow that one leads to the other. The cycles -- the average cycle has extended. There's no doubt about that. We've said several times, I think, on this call and before that the upgrades for the quarter were less than we anticipated due to the -- all the reasons that we had mentioned. So where it goes in the future, I don't know, but I'm convinced that making a great product that is high quality, that is the best thing for the customer and we work for the user. And so that's the way that we look at it. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Next question will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [17] +-------------------------------------------------------------------------------- + + I wanted to ask about the trajectory of Services gross margin, up about 500 basis points, it appears, year-over-year. You talked a little bit about sequential. But what's driving the improvement? Or will it be volatile as we go through the year depending on quarters and mix? Just whatever color you can give us as we start to forecast this. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [18] +-------------------------------------------------------------------------------- + + Yes, Shannon. I think you've seen that Services gross margins increased on a year-over-year basis by a significant amount. Let me start with sequential because I think it's probably most relevant for us. Sequentially, we increased 170 basis points. It's a business that is growing nicely, so we get good support from our scale. Some of these services are scaling quickly, and so we tend to expand gross margins there. And also, we had favorable mix. As you probably know, we have a very broad portfolio of services. Some of them tend to be accretive to the average gross margin for Services also because of the way we account for them. For example, you know that on the App Store, we book revenue on a net basis, and therefore, the gross margins tend to be accretive. But we also have services that are very successful that are below the average for the Services business. And so depending on how these separate businesses do in the marketplace, we're going to be seeing some level of movement going forward on Services margins. But you've seen that, for the last 12 months, they've gone up nicely, 450 basis points, and sequentially, they've gone up 170 basis points. But I wouldn't draw necessarily a conclusion on how this Services gross margin is going to move over time. We will report, of course, at the end of every quarter. But important to keep in mind, it's a broad portfolio with very different gross margin profiles within the portfolio. It is important for us to grow gross margin dollars. And if at times we grow services that are at a level of gross margins, which is below average, as long as this is good for the customer and as long as we generate gross margin dollars, we're going to be very pleased. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [19] +-------------------------------------------------------------------------------- + + And then, Tim, can you talk a bit about video? You've signed a myriad of deals. There was announcement about their TV app directly on Samsung. So perhaps when this comes out, you'll be multiplatform. I'm just curious how you view the opportunity in video. And I guess, assuming you can just leverage the costs that you've made already, it should be accretive to margin, I would think. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + Yes. Shannon, we see huge changes in customer behavior taking place now, and we think that it will accelerate as the year goes by to sort of the breakdown of the cable bundle that's been talked about for years. And I think that it'll likely take place at a much faster pace this year. And so we're going to participate in that in a variety of ways. One of those is through Apple TV, and you're well familiar with that product. The second way is the -- is AirPlay 2, which we have -- as you just pointed out, we have support on a number of different third-party TVs. And we're excited about that. It makes the experience in the living room with people using our products even better. We think that people are really going to like that. Another way is, of course, the -- all the third-party video subscriptions that are on the store. We're participating in this today. And I would guess that, that's going to accelerate into the future as the bundle breaks down and people begin to buy likely multiple services in place of their current cable bundle. And then finally, original content, where -- we will participate in the original content world. We have signed a multiyear partnership with Oprah. But today, I'm not really ready to extend that conversation beyond that point. We've hired some great people that I have a super amount of confidence in, and they're working really hard. And we'll have something to say more on that later. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + The next question will come from Walter Piecyk with BTIG. + +-------------------------------------------------------------------------------- +Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [22] +-------------------------------------------------------------------------------- + + I just have a question on the free services. Can you just describe how the math works on that? Is it that the free services are noncash revenue that's getting booked in the services revenue with no cost and the costs come out of products? Can you just run us through what the current state is versus how you were accounting for that before? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [23] +-------------------------------------------------------------------------------- + + Yes. In essence, when we sell a product at a certain price, we make an assumption. We estimate the value that can be associated to providing free service. In our case, it's providing Maps services, providing Siri and providing free iCloud to all the customers that purchase our product. And so we calculate an estimated value. That value gets deferred and gets amortized over the estimated period of time that we deliver the free services. In the past, that deferral and the subsequent amortization was reported under products. Now in connection with the new revenue recognition standard, we are reclassifying essentially that amortization from products revenue to services revenue. So total revenue has not changed. We just report that estimated value under the services category. We also reclassify the cost that we need to incur to provide those services. So the gross margin rate of each services is clearly significantly dilutive to the overall Services margin. I hope I've answered that. + +-------------------------------------------------------------------------------- +Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [24] +-------------------------------------------------------------------------------- + + Yes, you're right. So it's in mixed services gross margin. Got it. And then my other -- my second question is just when you think about growth in Services, you have selling more to existing paid subscription customers or it's the 300 million going to 0.5 billion. If you can just talk, at a high level, as far as when you look at growth going forward, is it about -- what is the mix in terms of selling more to existing users, getting new users or -- and maybe some of the individual services that you see the biggest growth opportunity? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [25] +-------------------------------------------------------------------------------- + + Yes. I mean, as I said, I mean, essentially, what -- the services -- I said services too is our installed base. So the first driver is growing the installed base. Installed base has grown nicely over the last several years. We've added 100 million in the last 12 months alone. So that's the first step. Then within that installed base, of course, we want to make sure that there are more people that are so interested in our services that, in addition to transacting on those services on a free basis, they also are interested in paying for those services. And I mentioned that the percentage of paid accounts has increased strong double digits. So we want to continue to do that. We want to make it easier for our customers to actually use our services, and so we are accepting more and more payment methods around the world. And clearly, as you said, the idea of adding new services is very important to us. During the last 3 years, we've added Apple Pay, which has been incredibly successful and is a wonderful customer experience. We've added Apple Music, where we now have more than 50 million paid subscribers and continues to grow very nicely. And we've added a very useful service to our developers. We provide an advertising service for developers on the App Store. The way we've added these services in the past, obviously, we're also very interested in adding new services that can provide great value to our customers in the future. And we don't want to get into product announcements here, but obviously, that is part of our strategy. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Senior Director of IR and Treasury [26] +-------------------------------------------------------------------------------- + + Thank you all. A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. And the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 2358120. These replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414. Financial analysts can contact Matt Blake or me with additional questions. Matt is at (408) 974-7406, and I'm at (408) 974-5420. And thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2019-Jul-30-AAPL.txt b/Transcripts/AAPL/2019-Jul-30-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..e58b3ba23f26c0a64bb86e2d566d6ea8ccd6c073 --- /dev/null +++ b/Transcripts/AAPL/2019-Jul-30-AAPL.txt @@ -0,0 +1,614 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q3 2019 Apple Inc Earnings Call +JULY 30, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Director-IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 3Q19 revenue of $53.8b, net income of $10b and diluted EPS of $2.18. Expects 4Q19 revenues to be $61-64b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 3Q19 revenue = $53.8b. + 2. 3Q19 net income = $10b. + 3. 3Q19 diluted EPS = $2.18. + 4. 3Q19 YoverY revenue growth = 1%. + 5. 3Q19 GM = 37.6%. + 6. 3Q19-end cash plus marketable securities = almost $211b. + 7. 3Q19-end total debt = $108b. + 8. 3Q19 share repurchase = almost 88m AAPL shares for $17b through open market repurchases. + 9. 4Q19 revenue guidance = $61-64b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 3Q19 Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Overview: + 1. Returned to growth and new June qtr. revenue record of $53.8b. + 2. Saw significant improvement in YoverY iPhone performance vs. 2Q19. + 3. Strong performances for Mac and iPad. + 4. Blowout qtr. for Wearables, where Co. had accelerating growth of well over 50%. + 5. New high watermark for Services, where Co. set all-time revenue record of $11.5b. + 6. Stepping back and considering Wearables and Services together, two areas where Co. has strategically invested in last several years, they approaches size of Fortune 50 co. + 7. Geographically: + 1. Happy with performance across the board, including return to growth in Mainland China. + 8. Accomplished aforementioned results despite strong headwinds from FX, which impacted topline growth rate by 300 BP vs. 3Q18. + 1. Equivalent to about $1.5b of revenue. + 9. In constant-currency, revenue grew in all five geographic segments. + 2. iPhone: + 1. Revenue $26b. + 1. Down 12% YoverY. + 1. Significant improvement to 17% YoverY decline in 2Q. + 2. Encouraged by results Co. is seeing from initiatives it spoke about in Jan., including strong customer response to in-store trade-in and financing programs. + 2. iPhone in retail and online stores returned to growth YoverY in June. + 3. Active installed base of iPhone reached new all-time high. + 1. Up YoverY in each of Co.'s Top 20 markets, underscoring quality of products and satisfaction and loyalty of iPhone customers worldwide. + 4. Revenue, excluding iPhone, up 17% YoverY, with growth across all categories. + 3. Services: + 1. Revenue $11.5b; all-time record. + 1. Up 13% YoverY. + 2. Excluding $236m favorable one-time item from 3Q18, growth was 15% or 18% in constant-currency. + 1. Consistent with 2Q performance. + 2. Strong performance was broad-based. + 1. Set new all-time records for AppleCare, Music, Cloud Services and App Store Search Ad business. + 2. Achieved new 3Q revenue record for App Store. + 3. Double-digit Services revenue growth in all five geographic segments. + 4. Surpassed 420m paid subscriptions to Services across platform. + 1. Remains on track to double FY16 Services revenue in 2020. + 5. In May, launched all-new Apple TV app in over 100 countries, bringing together all the ways to watch TV in single app across iPhone, iPad, Apple TV and select smart TVs. + 1. Monthly viewers in Apple TV app in US are up over 40% YoverY. + 2. Seen Co.'s success being driven here by several factors. + 1. The fact that Co. has been able to integrate content from over 150 leading content providers all in one place. + 2. Same ease-of-use and unmatched user interface that sets Co. apart in other categories sets it apart in TV. + 3. Benefiting from broader secular move to over-the-top services. + 6. Engaging with aforementioned third trend in five ways. + 1. Apple TV hardware. + 2. Apple TV channels, where customers can choose to pay only for channels they want. + 3. Massive library of over 100,000 iTunes, movies and TV shows. + 4. App Store, where users can find their favorite streaming services. + 5. Later this year, Co.'s original programing service, Apple TV+. + 7. Apple Pay: + 1. Completing nearly 1b transactions per month, more than twice volume YoverY. + 2. Launched in 17 countries, completing Co.'s coverage in EU and bringing it with total of 47 markets currently. + 3. Based on 3Q19 performance, Apple Pay is adding more new users than PayPal. + 1. Monthly transaction volume is growing four times as fast. + 4. In US, in addition to successful integration into Portland's transit system in May, Co. is beginning rollout of New York City transit. + 1. Will launch in Chicago later this year. + 5. In China, Apple Pay launched payment card for DD, world's largest ride hailing provider. + 6. Transit integration is major driver of broader digital wallet adoption. + 1. Going to keep up this push to help users leave their wallet at home in more and more instances. + 7. Thousands of Co. employees are using Apple Card every day in beta test. + 1. Plans to begin rollout of Apple Card in Aug. + 4. Wearables: + 1. Growth accelerated to well over 50%. + 2. Apple Watch set new June qtr. revenue record. + 1. Reaching millions of new users. + 2. Over 75% of customers buying Apple Watch in June qtr. were buying their first Apple Watch. + 3. Seeing phenomenal demand for AirPods. + 4. Tallying up last four quarters, Wearables business is bigger than 60% of companies in Fortune 500. + 5. iPad: + 1. Revenue over $5b. + 1. Growth driven by iPad Pro and by strong customer response to new iPad Mini and iPad Air. + 2. Third consecutive qtr. of growth. + 1. With revenue up 15% YTD, feels great about where Co. is headed with iPad. + 2. With current lineup of iPad, iPad Mini, iPad Air and iPad Pro, got perfect device for everyone from young learners to professionals. + 6. Mac: + 1. Double-digit revenue growth, fueled by strong performance of MacBook Air and MacBook Pro. + 2. Looking forward, there is enormous amount to be excited about for Mac. + 1. On heels of Mac Mini and iMac updates earlier in FY, brought significant updates to bulk of notebook lineup in last couple of months. + 2. Has $999 MacBook Air that is killer for college students. + 3. For Pro users, who pushed limits of what Mac can do, Co. unveiled most powerful Mac ever, new Mac Pro in all-new Pro display XDR, which will be available this fall. + 1. Designed for maximum performance, expansion and configurability and at breakthrough pricing. + 2. Most powerful tool Co. has ever put in hands of Pro customers. + 3. Mac ecosystem as a whole is about to get a big boost. + 1. At Co.'s recent Worldwide Developers Conference, announced game-changing tool to help developers easily adapt their iOS and iPadOS apps for Mac. + 7. Greater China: + 1. Saw significant improvement vs. 1H19. + 1. Returned to growth in constant-currency. + 2. Experienced noticeably better YoverY comparisons for iPhone business than Co. saw in last two quarters. + 1. Had sequential improvement in performance of every category. + 3. Combined effect of government stimulus, consumer response to trade-in programs, financing offers and other sales initiatives and growing engagement with broader Co. ecosystem had positive effect. + 4. Double-digit increase in Services, driven by strong growth from App Store in China. + 8. Future: + 1. Last week, announced agreement with Intel to acquire majority of its smartphone modem business. + 1. Second largest acquisition by dollars. + 2. Largest-ever in terms of staff. + 3. Sees this as great opportunity to: + 1. Grow Co.'s portfolio of wireless technology patents to over 17,000. + 2. Expedite development of future products. + 3. Further Co.'s long-term strategy of owning and controlling primary technologies behind products that it may. + 2. Had best WWDC ever last month, packed with announcements of great new features coming this fall across four software platforms, making them more: + 1. Powerful. + 2. Personal. + 3. Private. + 3. For iPhone users, iOS 13 will take on dramatic new look with dark mode, while delivering major updates to apps one uses every day, including photos, camera and maps. + 1. iOS 13 offers great new ways to help manage privacy and security, including Sign on with Apple, which uses face ID or touch ID to quickly sign into apps and websites without sharing personal information. + 2. Improvements across entire system will make iPhone even faster and more delightful to use than ever before. + 9. iPad: + 1. For first time, iPad is getting its own version of iOS called iPadOS, strategic step forward that takes iPad experience to whole new level. + 1. Redesigned home screen, powerful new multitasking tools, and deeper integration with Apple Pencil take productivity and creativity further, including using iPad as extended and interactive second monitor for Mac. + 10. Apple TV: + 1. tvOS 13 will make big screen experience even more personal. + 2. With redesigned home screen and multiuser support, everyone in the family can get more engaging and tailored experience with their favorite TV shows, movies, sports and news along with Apple Music, photos and videos in iCloud and App Store with thousands of great games and apps. + 11. Apple Watch: + 1. watchOS 6 is major step forward in helping Apple Watch users stay: + 1. Healthy. + 2. Active. + 3. Connected. + 2. Dedicated App Store that users can access directly from device. + 1. New watch faces, Siri enhancements and music and audio features make Apple Watch more useful than ever. + 3. Innovating on Apple Watch's promise to be intelligent guardian for health. + 1. watchOS 6 includes powerful new features like notifications that warn about high decibel noise to protect hearing and cycle tracking to aid in women's healthcare decision. + 4. Expanded availability of ECG app and irregular rhythm notifications to five additional European countries. + 1. Added Canada and Singapore last week, making them available in 31 countries and regions worldwide with more to come later this year. + 12. macOS Catalina: + 1. Believes macOS Catalina will be breakthrough in Mac ecosystem. + 2. New tool included in macOS Catalina called Mac Catalyst gives developers major head start in bringing their iOS apps to Mac. + 1. Thousands of developers are using it to bring their apps to Mac ecosystem. + 1. Expects to see wave of popular apps arriving for Mac as early as this fall. + 13. Other Highlights: + 1. Aforementioned updates are latest steps in broader strategic effort to make user experience across iOS, macOS, iPadOS, watchOS and tvOS more effortless and more intuitive. + 1. Co. is alone in offering this kind of value and ecosystem to its customers. + 1. Aforementioned devices and their platforms are unmatched in their ease of use, their seamlessness and their privacy and security. + 2. While providing aforementioned things, created dynamic environment where developers benefit greatly from creating for and distributing on these platforms. + 3. Customers benefit greatly from access to all creativity and innovation. + 2. Unveiled other exciting technologies to make it easier and faster for developers to create powerful new apps. + 1. SwiftUI provides intuitive new framework for building sophisticated user interfaces across software platforms using simple easy-to-use code. + 2. Core ML 3 supports acceleration of more types of advanced real-time machine learning models and (inaudible) developers build machine learning models without writing code. + 3. Has world's largest augmented reality-enabled platform. + 1. Thousands of ARKit-enabled applications in App Store. + 2. Building on strategy and momentum in this area, introduced three new AR-based technologies. + 1. ARKit 3 uses on-device real-time machine learning to recognize human form and integrates people seamlessly into AR experiences. + 3. RealityKit is new developer framework built from ground up to provide all tools and technologies required to make AR objects virtually life-like. + 4. Reality Composer brings AR content creation to tens of millions of developers who had no 3D experience. + 1. Developers are running with these new technologies. + 4. On so many fronts, there is enormous amount to look forward to over next few months, including launch of new services like: + 1. Apple Arcade. + 2. Apple TV+. + 3. Apple Card. + +-------------------------------------------------------------------------------- +II. 3Q19 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Revenue $53.8b; record. + 1. Up 1% YoverY. + 2. Returned to growth despite difficult FX environment worldwide, which impacted YoverY growth rate by 300 BP. + 3. Set June qtr. revenue records in Americas, Japan, and Rest of Asia Pacific. + 1. All geographic segments grew in constant-currency. + 4. Overall products revenue $42.4b, down 2% YoverY. + 1. Significantly better than 8% decline in product revenue experienced during 1H19. + 5. Product categories outside of iPhone grew 20%, with strong results in: + 1. Wearables. + 2. Mac. + 3. iPad. + 6. Services $11.5b; new all-time record. + 1. Grew 13%. + 2. Excluding one-time item Co. highlighted a year ago in connection with final resolution of various lawsuits, Services revenue growth was 15% and 18% in constant-currency terms. + 7. Geographically: + 1. Saw marked improvement in YoverY comparisons from emerging markets relative to 1H19, particularly in BRIC countries, where YoverY performance went from 25% revenue decline in 1H to 3% growth in 3Q19. + 2. Set June qtr. revenue records in several major developed markets, including: + 1. US. + 2. Canada. + 3. Germany. + 4. France. + 5. Japan. + 6. Australia. + 7. Korea. + 3. In emerging markets: + 1. Returned to growth in Mainland China. + 2. Grew strong double-digits in India and Brazil. + 3. Set new 3Q records in Thailand, Vietnam and Philippines. + 8. GM 37.6%, flat sequentially and in line with guidance. + 1. Products GM 30.4%, down about 80 BP sequentially due to seasonal loss of leverage and product mix, partially offset by favorable costs. + 2. Services GM 64.1%, up 30 BP sequentially, primarily due to favorable mix. + 9. Net income $10b. + 10. Diluted EPS $2.18. + 11. Operating cash flow $11.6b. + 2. iPhone: + 1. Revenue $26b, down 12% YoverY. + 1. Significantly better YoverY performance than [2Q19] 17% decline with sequential improvement in YoverY comparisons in 15 of Top 20 markets. + 2. Active installed base of iPhone continued to grow to new all-time high in each of geographic segments. + 1. In US, latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 99% for iPhone XR, iPhone Xs and Xs Max combined. + 2. Among business buyers, who plan to purchase smartphones in Sept. qtr., 83% plan to purchase iPhones. + 3. Services: + 1. Reached all-time revenue record despite FX headwinds, with: + 1. Double-digit growth from: + 1. App Store. + 2. Apple Music. + 3. Cloud Services. + 4. AppleCare. + 2. Triple-digit growth from: + 1. Apple Pay. + 2. App Store Search Ad business. + 2. All geographic segments had double-digit growth in Services revenue. + 1. Set new June qtr. records with all-time records in Americas and Rest of Asia Pacific. + 3. Accounted for 21% of Co. revenue and 36% of GM dollars. + 4. Customer engagement in Co.'s ecosystem continues to grow. + 1. Number of transacting accounts on digital content stores reached new all-time high. + 2. Number of paid accounts grew strong double-digits vs. last year. + 3. Has over 420m paid subscriptions across Services on platforms. + 1. Well on way to Co.'s goal of surpassing 500m mark during 2020. + 5. On App Store, growth accelerated sequentially. + 1. Subscription business continues to grow strongly. + 1. Extremely diversified across many categories like entertainment, lifestyle, photo and video and music. + 2. Third-party subscription revenue grew over 40%. + 3. Across all third-party subscription apps, largest accounted for 0.25% of total Services revenue. + 6. Among many Services records, it was best qtr. ever for AppleCare. + 1. Seeing increase in service contract attach rates. + 1. Expanding distribution of AppleCare through partners. + 2. Recently expanded authorized service provider network. + 1. Nearly 1,000 Best Buy stores across US are offering expert service and repairs for Apple products. + 2. This expansion provides customers with even more convenient access to repairs using parts certified for safety, quality and reliability. + 3. In addition to AAPL retail stores, there are over 1,800 third-party Co.-authorized service providers in US; three times as many locations as three years ago. + 4. Mac: + 1. Revenue $5.8b, up 11% YoverY. + 1. Grew in four of five geographic segments. + 2. Set June qtr. records in US, Europe and Japan as Co.'s overall market performance significantly outpaced global PC industry. + 2. Nearly half of customers purchasing Macs were new to Mac, with revenue growing in developed and emerging markets. + 1. Active installed base of Macs reached new all-time high. + 5. iPad: + 1. Revenue $5b, up 8%. + 1. Revenue grew in all five geographic segments with: + 1. 3Q revenue record in Mainland China. + 2. Double-digit growth in emerging markets. + 2. In total, over half of customers purchasing iPads during June qtr. were new to iPad. + 3. iPad active installed base reached new all-time high. + 4. Most recent surveys from 451 Research measured 94% customer satisfaction rating for iPad from consumers. + 1. Among business customers, who plan to purchase tablets in Sept. qtr., 75% plan to purchase iPads. + 6. Wearables, Home & Accessories: + 1. Revenue accelerated across all geographic segments. + 1. Grew 48% to over $5.5b; June qtr. record. + 2. Growth was fueled primarily by strong performance of Wearables business, which was up well over 50% and has become size of Fortune 200 co. over last 12 months. + 3. Generated double-digit revenue growth from Apple TV and accessories. + 7. Retail & Online Stores: + 1. Produced best June qtr. revenue ever with double-digit revenue growth across: + 1. Apple Watch. + 2. iPad. + 3. Mac. + 4. Accessories. + 2. Trade-in program is showing great momentum with more than five times the number of iPhones traded in vs. year ago. + 3. Opened new stores in Carnegie Library in Washington DC and Xinyi district in Taipei, and new location in Dallas Galleria. + 1. Ended qtr. with 506 physical stores in 22 countries, alongside online store presence in 35 countries. + 8. Enterprise: + 1. Gaining traction with strategy of transforming major industries by expanding leading positions in key functional areas to grow Co.'s reach and modernize customer and employee experiences. + 2. In financial services industry, 90 of largest 100 banks by asset size are deploying AAPL products to improve efficiency and effectiveness across their organizations. + 1. iPhone and iPad are overwhelmingly preferred mobile devices for bankers on the go. + 1. 60% of biggest banks are supporting iPads for wealth managers. + 3. In retail banking, two-thirds of top banks are deploying iPad for branch transformation and modernizing legacy interfaces with unified iPad experience. + 1. One of the world's largest banks created iPad suite that reduced customer onboarding time from more than an hour to just 12 minutes. + 2. Bank branch employees are using Apple Watch for communication and notifications and Apple TV for customer presentations from iPads using AirPlay. + 4. Financial institutions tell Co. that they receive positive feedback from leveraging AAPL solutions for direct customer engagement. + 1. American Express, Credit Suisse, Discover and TD Ameritrade launched Apple Business Chat as dynamic way to support and interact with customers. + 5. Intuitive interface of messages on iOS enables rich communication between customers and contact center staff. + 1. TD Ameritrade has become first brokerage in world to enable immediate funding of accounts using Apple Pay, eliminating 2-3 business days it used to take to fund accounts by wire transfer. + 9. Cash Position: + 1. 3Q19-end: + 1. Cash plus marketable securities, almost $211b. + 2. Retired $3b of term debt. + 3. Reduced commercial paper by $2b. + 4. Total debt $108b. + 5. Net cash $102b. + 1. Continues on path to reaching net cash neutral position over time. + 2. Returned over $21b to shareholders, including $17b through open market repurchases of almost 88m AAPL shares and $3.6b in dividends and equivalents. + 10. 4Q19 Outlook: + 1. Revenue $61-64b. + 1. Guidance includes almost $1b of YoverY negative impact from FX. + 2. GM 37.5-38.5%. + 3. OpEx $8.7-8.8b. + 4. OI&E [about] $200m. + 5. Tax rate about 16.5%. + 6. Board of Directors declared cash dividend of $0.77 per share of common stock, payable on 08/15/19 to shareholders of record as of 08/12/19. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + The first question will come from Amit Daryanani from Evercore. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess 2 from me. First off, could you just talk about, when I think about the September quarter guide, it's implied, I think, up 16% or so sequentially. Historically, at least in that guide has been in the 10% low double-digit kind of range. Just maybe help us understand what gives you the confidence for a better-than-seasonal guide in September either from a geo or product basis would be helpful. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [3] +-------------------------------------------------------------------------------- + + Amit, it's Luca. Of course, this is our best estimate of where we think we will land. Clearly, we expect to have continued strong growth from the non-iPhone categories. We have great momentum in Wearables. We mentioned that we were up almost 50% in the June quarter or actually over 50% in the June quarter. Our Services business, we set an all-time record in June. And so these 2 categories have become really important and really large for us. And so as we continue to grow quickly, that is going to help us as we go through the year. Keep in mind that the guidance includes an estimated almost $1 billion of foreign exchange headwind for the quarter. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [4] +-------------------------------------------------------------------------------- + + Fair enough. That's really helpful. And I guess if I just follow up on China, impressed to see the continued recovery you guys are seeing despite all the headlines that are out there. Just curious what are the few things that are driving the success in China? And how sustainable do you think those changes are for Apple as you go forward? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + Yes, Amit. It's Tim. I apologize for my voice. I'm suffering from an allergy. But what happened last quarter in China was -- it's a confluence of things. The government stimulus just came in terms of a VAT reduction, a very bold one. We took some pricing action. We instituted our trade-in and financing programs in our retail stores and worked with certain channel partners on that as well. And we're seeing a growing engagement with the broader Apple ecosystem during the quarter. +And so when you look at it, each of our categories, iPhone, iPad, Mac, Wearables, Services, everything improved sequentially. So we couldn't be happier with the results or the progress, I should say. I would point out, as I think I had mentioned in my comments, that we actually grew in constant currency for Greater China, and we grew in Mainland China on a reported basis. So there's several things going on there that are quite positive. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [7] +-------------------------------------------------------------------------------- + + Can you talk a bit about what's going on within Services, some of the puts and takes? I know Luca, you gave us some color in terms of the growth rates in that. But I'm just curious as -- and I know you won't talk about future products, but as you think about the opportunities, you think about what you've got now and in the future and then some of the -- what's been going on with China in that, is there something that could reaccelerate or again the 18% on a constant currency basis is obviously quite strong. But how are you thinking about it? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [8] +-------------------------------------------------------------------------------- + + Yes. I think it's important to start with that 18% in constant currencies, Shannon. Our reported results are on a normalized basis, removing the onetime item from last year, was 15%. Clearly, FX plays a role around the world, 300 basis points of FX impact during the June quarter. In spite of that, it was an all-time record revenue. Our installed base continues to grow. It's growing in every geography and it's growing across all our major product categories, and that is very, very important for the Services -- for the Services business. +I would say -- I'll give you a bit more color around 2 offsetting factors around this performance during the June quarter. On one side, the App Store, I mentioned in my prepared remarks that growth accelerated sequentially. We had double-digit growth on the App Store in every geography. In China, we saw significant acceleration. As you know, we tend to monetize in China on the App Store through game titles, and the government has approved a few key game titles during the quarter that has helped our performance there. +On the other side, AppleCare. I mentioned AppleCare was an all-time record in June so a really strong performance. But our growth has decelerated in AppleCare due to factors that we fully expected because we are comping this expansion of our coverage for AppleCare that we've had, we've had significant success during the last 18 to 24 months in really broadening our coverage of AppleCare around the world with some key partners, carriers and resellers. And obviously, as we go through the year, those comps become a bit more difficult. +Having said all that, you know that we've given ourselves a couple of targets and we feel very confident about reaching those targets. The first one is that we wanted to double the size of the Services business from our fiscal '16 to 2020. We are on our way there. Paid subscriptions is another target. It's important to us. It's an important way for us to monetize our ecosystem. We set a target of surpassing 0.5 billion paid subscriptions on the ecosystem during 2020. We're already at 420 million now. So we feel confident there. +And of course, as you mentioned, we're very excited about the fact that we're going to be launching new services soon. As Tim said, we're starting the rollout of Apple Card in August. And there's 2 more very important services that we're going to be adding to our portfolio during the fall. One is Apple Arcade, which is our gaming subscription service, and of course, Apple TV+, which is our video streaming service. So obviously, these services will help us carry on with the momentum that we have in Services. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [9] +-------------------------------------------------------------------------------- + + Great. And this is probably for you too as well, Luca. Can you talk about gross margin? The guidance was pretty solid. Obviously, there are various things that are at play here. I know you mentioned the $1 billion worth of top line impact, I think, from currency next quarter. But maybe if you can kind of talk about what went into your gross margin guidance? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [10] +-------------------------------------------------------------------------------- + + Yes. So of course, Shannon, as you've seen, our guidance for margin is 50 basis points higher than the guidance that we had given for June. I would say on the positive, we expect to benefit from leverage, as you've seen from our revenue guidance, and from cost savings because, as you know, the commodity environment is fairly favorable right now. On the negative side, the headwind on gross margins on a year-over-year basis from foreign exchange is about 100 basis points. And so we need to keep that in mind, but we feel pretty good about the guidance we provided. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question will come from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [12] +-------------------------------------------------------------------------------- + + I'd like to go back to the discussion around strength in China in the quarter and understand what linearity looked like. I asked because there was some industry data around the smartphone market in China that seemed to deteriorate in the month of June, the App Store data deteriorated a little bit in June. And just curious if that's something you saw in the business, and if it at all informs your outlook around the pace of the China business as you go into September. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [13] +-------------------------------------------------------------------------------- + + Katy, it's Tim. We obviously took into account all of the information that we had and coming out with the guidance, including linearity across last quarter and how this quarter has started. And so we've obviously looked at that in quite much detail. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [14] +-------------------------------------------------------------------------------- + + And then just on the App Store, appreciate there's not a lot of detail out around exact timing and even some pricing of the new services. But how should we think about the new services that launched in March impacting the overall Services growth? Does that start to benefit the model in the back half of this calendar year? Or will the impact be more longer term in nature and really show up in 2020? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [15] +-------------------------------------------------------------------------------- + + Katy, let me just talk about the new services that we've announced in March and then also about the timing of how we get to revenue, right? We've announced Apple News+, and this is the service that is available for consumers right now. We've announced our channel service, which has also become available a few weeks ago. The other 3 services, the Card is launching in August, the gaming service and the video service are starting in the fall. Keep in mind for all these services, there's a trial period upfront. There's going to be different trial periods, we'll see what they look like. So the road to monetization takes some time. Obviously, all of them will add to our base and will help us with growth rates as we get into next year. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + That question will come from Krish Sankar with Cowen and Company. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + I have 2 of them. First one, on the iPhone trade-in program, how effective was it and what percentage of iPhone sales came from the trade-ins? And are there any other geographies where you're left to roll it out? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [18] +-------------------------------------------------------------------------------- + + It's Tim. In retail, it was quite successful. We got going in a larger way during that quarter. We were pretty much just ramping in the previous quarter. And trade-in, as a percentage of their total sales, is significant and financing is a key element of it. Those 2 things in the aggregate led retail -- the combination of retail and online, we -- to short form that as retail, are Apple Store, led to growth in June. And so we feel very, very good about our trajectory. We are obviously taking those programs and advocating those more widely. And that is at different levels of implementation throughout different geographies because we're working with our carrier partners on those and retail partners. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Got it, got it. That's very helpful, Tim. And then a follow-up for you, a much longer-term question. I understand we're in the very early innings of the Services growth story. Is there a way to think about it down the road that 3 or 5 years down the road, would the Services growth be focused or will it still be tethered to the hardware of the iPhone? Or do you think at some point down the road, Services would be independent by itself and not really tied to your hardware installed base? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + Well, there are elements today that are not necessarily tethered to iPhone, right? We have other products where people are both purchasing things, they're watching Apple TV. We offer Apple Music on Android, and so there's a series of things that are outside of that. And so we'll see what we do in the future. I don't want to really get into that. +But more broadly, to answer your question about growth as we go forward, the way I see it is we have the strongest hardware portfolio ever. We've got new products on the way. The pipeline is full of great new stuff, both on the product and services side. We're very fortunate and work very hard to have loyal customers and to continue attracting an impressive number of switchers. The installed base is growing, hit a new record. That's obviously good. And it hit a new record across all geographies and across all categories. And so this is a really good thing. +And we've got the Wearables area that is doing extremely well. We stuck with that when others perhaps didn't and really put a lot of energy into this and a lot of R&D and are in a very good position today to keep playing out the what's next there. +At the same time, on the market side, we have emerging markets where we have low penetration. And in -- during the quarter, tactically, emerging markets had a bit of a rebound. In fact, on a constant currency basis, we actually grew slightly in emerging markets. We still declined on a reported basis. India bounced back. During the quarter, we returned to growth there. We're very happy with that. We grew in Brazil as well. +We're also continuing to focus on the enterprise market. Luca mentioned some of this in his comments, and we think that continues to be a big opportunity for us. And then we've got lots of what I would call core technology kinds of things like augmented reality, where we're placing big bets, and I think we have a big future in addition to the health kinds of things that may fall out of the Watch. And so hopefully, that kind of this gives you a view over the total. And so we're focusing on products and services and there will be some services that aren't hooked and some that are hooked not on current period sales are mostly -- very much services are rarely connected on that today or at least not a high percentage by any means. They're more correlated to the installed base, the active installed base and also the level of transacting customers that are there and the amount per customer, which relates also to the offering that we have. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Next, we'll go to Wamsi Mohan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [22] +-------------------------------------------------------------------------------- + + Tim, the China trade situation remains sort of fluid over here and recently -- more recently, you asked for some tariff exemptions. We're not granted those. How are you thinking about the longer-term footprint for manufacturing? And can you talk about any potential alternatives that you've looked at and considered in moving parts of production potentially out of China? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [23] +-------------------------------------------------------------------------------- + + Yes. I know there's been a lot of speculation around the topic of different moves and so forth. I wouldn't put a lot of stock into those, if I were you. The way that I view this is the vast majority of our products are kind of made everywhere. There's a significant level of content from the United States and a lot from Japan to Korea to China and the European Union also contributes a fair amount. And so that's the nature of a global supply chain. I think -- largely, I think that will carry the day in the future as well. In terms of the exclusions, we've been making the Mac Pro in the U.S. We want to continue to doing that. And so we're working and investing currently in capacity to do so because we want to continue to be here. And so that's what's behind the exclusions. And so we're explaining that and hope for a positive outcome. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [24] +-------------------------------------------------------------------------------- + + And there's -- Luca, maybe for you, there's been some significant destocking of inventory in the first calendar half of this year in iPhone. Can you comment about the broader channel inventory levels, where you are in your typical ranges, especially given the comment around June iPhone sales being quite strong? And do you expect anything atypical in channel inventory dynamics in the September quarter? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [25] +-------------------------------------------------------------------------------- + + Yes, Wamsi. As you know, we're not getting into this topic very much, but I think I can give you some color here. You know that in general, we decreased our inventory during the March quarter and the June quarter. That has been traditionally what we've done. This year, we reduced channel inventory for iPhone slightly more than last year. And that is true in total, and it's true for Greater China as well. So we feel very good about our channel inventory ranges as we get into the September quarter. I hope that helps you with that. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Jim Suva with Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [27] +-------------------------------------------------------------------------------- + + The first question is probably for Tim and the second one for Luca, and I'll ask them at the same time so you can pick and choose whichever one you want to answer, first and second. But the first question, Tim. Regarding the installed base comment you've made, which is quite encouraging, but yet when you look at the iPhone revenue year-over-year, the past several quarters has been down. Can you help us bridge the gap of how is the installed base growing? +Is it mostly because like secondary users are the new ones coming into the system as people are holding their phones longer? And what does that user typically bring in with them or something unique relative to what we historically know? And then for Luca, you've been investing a lot, a lot, lot, lot and a lot of these services are now coming to pass, whether it be AppleCare, Apple cloud, all these Wearables, and soon Apple Pay and Arcade. Are we at a point where now, a lot of harvesting is going to happen? Or do you kind of continue these relatively same investments that you've been doing for the future strategy? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- + + Okay. Jim, it's Tim. I'll start with your installed base question. Installed base is a function of upgrades and the time between those. It's a function of the number of switchers coming into the iOS, macOS and so forth tents. It's a function of the robustness of the secondary market, which we think overwhelmingly hits incremental customer. And it's a function still in the emerging markets and somewhat developed markets, to a lesser degree, of people new that -- they're buying their first smartphone. There are still quite a few people in the world in that category. +And so the reason that the installed base doesn't correlate to the 90-day clock is that what's happening underneath the numbers is switchers are still a very key piece of what's going on. The secondary market is very key, and we're doing programs, et cetera, to try to increase that because we think we'd wind up hitting a customer that we don't hit in another way. And the upgrades, where people are holding on to their device a bit longer than they were, they're staying in the ecosystem. And then you have the people in the new category as well. And so that's sort of the equation. I don't want to go into the specific numbers, but I think you can see readily, mathematically, how the installed base is growing in an environment where the iPhone revenue is declining within a 90-day kind of window. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [29] +-------------------------------------------------------------------------------- + + And Jim, on OpEx, obviously, it's very important for us to continue to invest in the business, particularly on the R&D side because we always want to bring more innovation into the market. We want to improve the user experience and differentiate our products and services in the marketplace. So we will continue to do that. +There are some types of investments, of course, that are very strategic for us and they will have long-term implications. You've seen the announcement that we made around the Intel acquisition. Very important strategically for us. It requires upfront investment, of course. As you've seen from this quarter and also from the past, we will continue to run our SG&A portion of OpEx tightly. We will -- of course, we'll continue to invest in marketing and advertising. We talked about a lot of new services that we are launching during the fall and Apple Card the next month. Obviously, they will require the appropriate level of marketing and advertising as we launch them to the general public. +When you look in total at where we are in terms of our expense-to-revenue ratio for operating expenses, you know quite well that we are extremely competitive relative to other tech companies. So we want to continue to be competitive and at the same time, we will not under invest in the business. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + The next question will come from Samik Chatterjee with JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [31] +-------------------------------------------------------------------------------- + + I just wanted to start off with the announcement of the WWDC around the independent App Stores for the Watch and the iPads. What level of interest have you seen from developers and how are they thinking about the ability to monetize services independently on those App Stores? And how does it help you position Wearables more formally into the health and fitness category? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [32] +-------------------------------------------------------------------------------- + + We're seeing good interest across virtually everything that we announced at WWDC. I couldn't be happier with the developer tools around ARKit and AR in general that I went through earlier. Lots of interest there. Lots of interest from the watch App Store to the Catalyst that will be released with macOS Catalina, which allows developers quickly to port a iOS app to the Mac. We think this is huge and so great for the user experience. And so you look at all of these and all of the things that I talked about earlier and I couldn't be happier with the reception that we're getting and the work that is going on behind the scenes right now to ready -- for the developers readying their apps for the fall. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [33] +-------------------------------------------------------------------------------- + + Got it. If I can just follow up on the China market. One of the things that we're looking at is with these -- going into the new year into 2020, there'll be a lot of 5G phones launching in that market from the Android players. How you're thinking about the competitive landscape there as you enter next year? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [34] +-------------------------------------------------------------------------------- + + We don't comment on future products. With respect to 5G, it's -- I think most people would tell you it's -- we're in sort of the extremely early, early innings of it and even more so on a global basis. So we couldn't be more proud of what our lineup is and we're excited about the great pipeline of both hardware and software, and we won't trade our position for anyone's. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Director-IR [35] +-------------------------------------------------------------------------------- + + Thank you, Samik. A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone and the numbers to the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 3057347. These replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414 and financial analysts can contact Tejas Gala or me with additional questions. Tejas is at (669) 227-2402, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + That does conclude our conference for today. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2019-Oct-30-AAPL.txt b/Transcripts/AAPL/2019-Oct-30-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..038d06716955ef14802c22fa766ec64ed7a82d65 --- /dev/null +++ b/Transcripts/AAPL/2019-Oct-30-AAPL.txt @@ -0,0 +1,584 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q4 2019 Apple Inc Earnings Call +OCTOBER 30, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + * Nancy Paxton + Apple Inc. - Director-IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * A.M. Sacconaghi + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Michael Joseph Olson + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 4Q19 revenues of $64b, net income of $13.7b and diluted EPS of $3.03. Expects 1Q20 revenues to be $85.5-89.5b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 4Q19 revenue = $64b. + 2. 4Q19 net income = $13.7b. + 3. 4Q19 diluted EPS = $3.03. + 4. 4Q19 YoverY revenue growth = 2%. + 5. 4Q19 GM = 38%. + 6. 4Q19-end cash plus marketable securities = almost $260b. + 7. 4Q19-end total debt = $108b. + 8. 4Q19 share repurchase = 86m AAPL shares for almost $18b through open market repurchases. + 9. 1Q20 revenue guidance = $85.5-89.5b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 4Q19 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Overview: + 1. This was Co.'s highest revenue in Sept. qtr. ever. + 2. Revenue $64b. + 1. At high end of expectations, even despite predicted FX drag of almost $1b. + 3. Geographically, set new 4Q revenue records in Americas and Rest of Asia Pacific, and saw further improvement in revenue trends in Greater China. + 4. iPhone: + 1. Customers have only begun to get their hands on iPhone 11 and iPhone 11 Pro models. + 2. YoverY performance continued to improve. + 5. Outside of iPhone, revenue up 17%. + 1. Reached new all-time high for Services with growth accelerating to 18%. + 2. Generated well over 50% revenue growth from Wearables. + 1. Set 4Q records for Wearables in each and every market Co. tracks. + 2. iPhone: + 1. Revenue $33b. + 1. 9% decline YoverY is significant improvement over 15% decline Co. saw across first three quarters. + 2. Significant upswing in demand in final part of qtr. is mirrored in positive reviews, customer feedback and in-store response Co. has seen for new generation of devices and best photos from a smartphone. + 2. iPhone 11 features Co.-designed A13 Bionic, fastest, most powerful chip ever in smartphone plus all new dual-camera system and even longer all-day battery life, all wrapped in six new colors. + 1. Since its launch, iPhone 11 has quickly become Co.'s best-selling iPhone. + 3. iPhone 11 Pro and iPhone 11 Pro Max deliver even more advanced performance. + 1. New Super Retina XDR display is brightest ever in iPhone. + 2. New triple camera system provides pro-level photography experience with ultra-wide, wide and telephoto camera. + 4. All three of new iPhones feature Night mode, delivering huge improvements to photo capture in low-light environments, either indoors or outdoors. + 1. They produce highest-quality video in smartphone, supporting 4K video with extended dynamic range for more highlight detail and cinematic video stabilization. + 5. iOS 13 is driving user experience forward across iPhone family with: + 1. Bold new look in Dark Mode. + 2. Major updates to apps customers use every day, like photos and maps. + 3. New ways to help protect their privacy with Sign in with Apple. + 4. Performance improvements across entire system. + 3. Services: + 1. Revenue $12.5b. + 1. Up 18% YoverY. + 2. Beats previous record set in June qtr. by more than $1b. + 3. Saw double-digit Services revenue growth and all-time records in all five geographic segments. + 4. Established new all-time highs for multiple Services categories, including App Store, AppleCare, Music, cloud services and App Store Search Ad business. + 5. Well on way to accomplishing goal of doubling FY16 Services revenue during 2020. + 2. Had all-time record revenues from payment services. + 1. For Apple Pay, revenue and transactions more than doubled YoverY with over 3b transactions, exceeding PayPal's number of transactions and growing four times as fast. + 2. Apple Pay is now live in 49 markets globally with over 6,000 issuers on platform. + 3. Believes Apple Pay offers best possible mobile payment experience and safest, most secure solution on market. + 3. Apple Card launched in US in Aug. + 1. Seen positive reception. + 2. Users can apply for Apple Card through Wallet app on iPhone in minutes and start using it right away in stores, in apps and on websites. + 3. Apple Card has absolutely no fees. + 4. Major apps and retailers like Uber, Uber Eats, Walgreens, Duane Reade and T-Mobile have already joined to offer 3% daily cash back on Apple Card transactions. + 5. On 10/30/19, announced that later this year Co. is adding another feature to Apple Card. + 1. Customers will be able to purchase their new iPhone and pay for it over 24 months with zero interest. + 2. They will continue to enjoy all benefits of Apple Card, including 3% cash back on total cost of their new iPhone with no fees and ability to manage their payments right in Apple Wallet app on iPhone. + 3. Believes aforementioned features appeal broadly to all iPhone customers. + 6. Believes this has been most successful launch of credit card in US ever. + 4. Last month, launched Apple Arcade, groundbreaking game subscription service, offering all new way for whole family to enjoy games online or offline. + 1. Apple Arcade subscribers get unlimited access to curated selection of games from many of the most innovative developers in the world with almost 100 new titles playable across iPhone, iPad, iPod touch, Mac and Apple TV today and more are being added all the time. + 2. Customer feedback to date has been positive. + 5. Working with Oprah Winfrey to bring Oprah's Book Club to Apple Books. + 6. Expanded reach of Apple News+ beyond US and Canada to readers in Australia and UK, bringing together popular publications, like The Times of London, The Australian and Hello Magazine, in addition to major publications like The Wall Street Journal, The L.A. Times, The New Yorker, People, GQ and much more. + 7. On 11/01/19, launching Apple TV+ in over 100 countries and regions. + 1. First all-original video subscription service. + 2. Premiered shows like See and The Morning Show in L.A. and New York over past couple of weeks, and stage is set for exciting debut. + 3. Customers who have purchased qualifying Co.'s devices starting Sept. 10 can opt into 12 free months of Apple TV+. + 4. Wearables: + 1. Had amazing results due to phenomenal popularity of Apple Watch, AirPods and Beats products. + 2. Set 4Q revenue records for Wearables in every single market that Co. tracks globally. + 3. In Sept., launched Apple Watch Series 5 with Always-On Retina display. + 1. New location features help users better navigate their day while international emergency calling allows them to call emergency services directly from Apple Watch in over 150 countries even without an iPhone nearby. + 2. Combined with power of watchOS 6, users are empowered to take charge of their health and fitness with new features like Cycle Tracking, Noise app, Activity Trends. + 3. ECG app now available in 32 markets, including India, has become widely celebrated illustration of Co.'s commitment to one's health, giving users the ability to document and monitor functioning of their heart and provide critical data to their doctors. + 4. Deepening commitment to medical research. + 1. Announced new Research app paired with three unprecedented medical studies spanning hearing, heart and movement, and women's health. + 2. Collaborating with leading health institutions to reach more participants than has ever been possible, enabling them to contribute to potential medical discoveries and help create next-generation of innovative health products. + 5. iPad: + 1. Generated 17% growth driven by iPad Pro and ongoing momentum of wider lineup. + 2. In Sept., introduced seventh-generation iPad, bringing more screen area and support for full-sized Smart Keyboard to most popular and most affordable iPad. + 3. For first time, released iPadOS built on same foundation as iOS but with powerful apps designed for iPads large multi-touch display, letting users multitask with intuitive gestures, and drag and drop a file with fingertip. + 6. Mac: + 1. Revenue $7b. + 1. Had tough comparison to 4Q18 when Co. updated both models of MacBook Pro. + 2. For FY19 overall, generated highest annual revenue ever from Mac business. + 2. In July, updated Mac portables with great pricing for students and MacBook Air, in particular, has been hit in back-to-school season. + 3. Earlier this month, released macOS Catalina with all new entertainment apps, innovative Sidecar feature that uses iPad to expand Mac workspace and new accessibility tools that enable users to control their Mac entirely with their voice. + 1. Catalina brings Apple Arcade experience to Mac. + 1. Already seeing some third-party developers bring their iPad apps to Mac App Store with Mac Catalyst, including Twitter, Post-it and more. + 4. Launching newly redesigned Mac Pro this fall, which Co. is manufacturing in Austin, Texas. + 7. Others: + 1. In FY19, crossed $100b in revenue in US for first time. + 2. Introduce new services from Apple Card to Apple TV+ and generated over $46b in total Services revenue, setting new yearly Services records in all five geographic segments and driving Services business to size of Fortune 70 co. + 3. Delivered new hardware in all device categories. + 4. Wearables business showed explosive growth and generated more annual revenue than two-thirds of companies in Fortune 500. + 5. Set yearly revenue record for Mac. + 6. Outside of iPhone, revenue grew by $17b to almost $118b. + 7. Overall success was achieved widely across markets with annual revenue records in US, Canada, Brazil, UK, Germany, France, Italy, Poland, Korea, Malaysia, Philippines and Vietnam. + 8. Believes that Co. leads in innovation because AAPL leads with its values. + 9. At time of urgency and action on climate change, continues to drive breakthroughs in clean power, sustainable materials and device recycling. + 1. By running 100% of global operations on renewable energy and challenging entire network of suppliers do the same, Co. is driving virtuous cycle of demand for clean sources of power. + 2. Sees award Co. recently received from United Nation's Global Climate Action program as mandate to deepen this vital work. + 10. Continues to invent and improves on cutting-edge renewable materials, including 100% recycled aluminum alloy found in many of Co.'s products. + 1. Added rare earth elements to list of recycled materials with introduction of iPhone 11. + 2. Disassembling, recycling or refurbishing millions of devices every year with help of Daisy, recycling robot, and pushing entire global supply chain toward recycled or renewable materials. + 11. Driving access to critical coding skills development to educators and students through programs like teaching coding academies and free Everyone Can Code curriculum. + 12. Continues to put user privacy at center of everything that Co. does. + +-------------------------------------------------------------------------------- +II. 4Q19 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Revenue: + 1. 4Q19 $64b. + 1. Up 2% YoverY. + 2. New Sept. qtr. record. + 3. As predicted, FX negatively impacted revenue by close to $1b. + 4. Constant currency growth, 3%. + 2. Products $51.5b. + 1. Down 1% YoverY, mainly due to iPhone but largely offset by strong performance from Wearables and iPad. + 3. Services $12.5b. + 1. Grew 18%. + 2. Up over $1.9b YoverY and almost $1.1b sequentially to new all-time record with broad-based growth globally and across portfolio. + 4. Geographically: + 1. Set new 4Q revenue records in Americas and Rest of Asia Pacific segments. + 2. Saw continuous improvement in Greater China where YoverY revenue comparisons became more favorable each qtr. of FY19 from 27% decline in 1Q to 2% decline in 4Q. + 3. Established new 4Q records in many major developed and emerging markets, including US, Canada, Germany, France, Korea, Singapore, Brazil, India, Thailand, Malaysia and Vietnam. + 2. GM: + 1. 4Q19 38%. + 1. Up 40 BP sequentially, driven by leverage from higher revenue. + 2. Products 31.6%. + 1. Up 120 BP sequentially, due to leverage and favorable mix. + 3. Services 64.1%. + 1. Even with June qtr. + 3. Results: + 1. Net income $13.7b. + 2. Diluted EPS $3.03. + 1. 4Q record. + 2. Up 4% YoverY. + 3. Operating cash flow $19.9b. + 1. 4Q record. + 2. Up almost $400m from previous record Co. set last year. + 4. iPhone: + 1. Revenue $33.4b. + 1. 9% YoverY decline; meaningful improvement to 12% decline in 3Q19 and 16% decline in 1H19. + 2. Saw great customer response to launch of iPhone 11, 11 Pro and 11 Pro Max at qtr.-end. + 3. Active installed base continue to grow to new all-time high in each geographic segments. + 4. In US, latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 99% for iPhone XR, XS and XS Max combined. + 5. Among business buyers who plan to purchase smartphones in Dec. qtr., 83% plan to purchase iPhones. + 5. Services: + 1. Had strong qtr. with all-time record performance and growth accelerating from June qtr. + 2. All five geographic segments set new all-time Services revenue records and all grew double digits. + 3. Established new all-time records for App Store, Apple Care, Music, cloud services, payment services and App Store Search Ad business. + 4. Accounted for: + 1. 20% of revenue mix. + 2. 33% of GM mix. + 5. Customer engagement in Co.'s ecosystem continues to grow. + 1. Number of transacting and paid accounts on digital content stores reached new all-time high with double-digit growth in paid accounts in all geographic segments. + 1. Now has 450m paid subscriptions across services on platform vs. over 330m a year ago. + 2. Well on way to goal of surpassing 500m mark during 2020. + 6. App Store revenue grew strong double digits due to robust customer demand for in-app purchases and subscriptions. + 7. Third-party subscription business grew across multiple categories and increased almost 40% YoverY. + 1. There are now more than 35,000 subscription apps on platform, with largest accounting for less than 0.25% of total Services revenue. + 8. Best qtr. ever for AppleCare due to strong service agreement attach rates and expanded distribution. + 1. To better meet customers' needs, announced new iPhone repair program, making it easier for independent providers across US to tap into same resources as Apple Authorized Service Provider network and offering customers additional options for most common out-of-warranty iPhone repairs. + 2. New program complements Co.'s continued investment in growing global network of over 5,000 Apple Authorized Service Providers that lead industry for customer satisfaction and help millions of people with in- and out-of-warranty service for all products. + 6. Mac: + 1. Revenue $7b. + 1. Down 5% YoverY due to different mix of products, given strength of MacBook Air lineup and difficult comparison to last year's launch of MacBook Pro models. + 2. Despite tough compare, generated all-time revenue record in US and India, and 4Q revenue record in Japan. + 2. More than half of customers purchasing Macs during qtr. were new to Mac. + 3. Active installed base reached new all-time high. + 7. iPad: + 1. Revenue $4.7b. + 1. Up 17% YoverY. + 2. Revenue grew in all five geographic segments with 4Q revenue record in Japan. + 3. Over half of customers purchasing iPads during Sept. qtr. were new to iPad. + 4. Active installed base reached new all-time high. + 5. Most recent surveys from 451 Research measured 95% customer satisfaction rating for iPad from consumers and 97% from businesses. + 6. Among consumers and businesses who plan to purchase tablets in Dec. qtr., more than 80% plan to purchase iPads. + 8. Wearables, Home & Accessories: + 1. Revenue $6.5b; new 4Q record. + 1. Up 54% YoverY with growth accelerating from 3Q across all five geographic segments. + 2. Performance was driven by growth across Apple Watch, AirPods, Beats products and accessories. + 2. Set 4Q records for Wearables category in every single market Co. tracks globally. + 9. Retail & Online Stores: + 1. Generated record Sept. qtr. revenue in all five geographic segments, and strong double-digit growth across iPhone, iPad, Apple Watch and accessories. + 2. Continued to see great results from trade-in program with more than five times the iPhone trade-in volume Co. had a year ago. + 3. Last month, reopened Apple Fifth Avenue store in New York with even more welcoming layout beneath landmark glass cube, providing nearly twice the space of original store. + 1. This store is open seven days a week, 24 hours a day, and provides even better environment for customers to experience latest products, meet with Geniuses, creative pros and specialists, and attend free daily Today at Apple session. + 4. Opened newest and largest store in Japan, and fifth store in Tokyo in Marunouchi business district across from historic Tokyo Station. + 5. Opened new store in heart of Mexico City's vibrant Polanco district. + 10. Enterprise: + 1. Seeing strong demand for products in enterprise market, with growth significantly ahead of Co.'s business overall, and has great momentum transforming major industries. + 2. 80 of 100 largest retailers in the world are choosing Co. to modernize their customers and employee experiences across all functions of their business. + 1. Retailers are using iPhone, iPad and Mac to optimize their back of house operations, modernize point of sale, and deliver differentiated customer and employee experiences. + 2. Customer engagement and assisted selling have been areas of particular focus. + 1. Seeing great results for brands like Burberry, Ralph Lauren, Sephora USA, Gap Inc., and many others. + 3. Helping government agencies globally, use technologies to improve effectiveness and efficiency of the way they deliver critical services to public. + 1. US Census Bureau is making fundamental changes to the design and implementation of next year's census with goal of producing quality results, while reducing costs by leveraging mobility, user experience and privacy of iOS. + 2. Hundreds of thousands of Co.'s devices will be deployed this FY to support innovative new model for collection and management of census data. + 3. CDW, Co.'s partner in this initiative, will utilize Apple Financial Services, AAPL's enterprise financing platform, to help minimize cost to public by taking advantage of uniquely strong residual value of Co.'s devices. + 11. Cash Position: + 1. 4Q19-end cash plus marketable securities almost $260b. + 2. Issued $7b of new term debt, retired $3b of maturing debt and reduced commercial paper by $4b, leaving Co. with total debt of $108b. + 3. 4Q19-end net cash $98b. + 1. Continues on path to reaching net cash neutral position over time. + 4. Returned over $21b to shareholders, including almost $18b through open market repurchases of 86m Co.'s shares, and $3.5b in dividends and equivalents. + 5. Retired additional 7m shares in final settlement of 14th ASR. + 12. 1Q20 Outlook: + 1. Revenue $85.5-89.5b. + 1. Includes negative impact from FX of over $1b. + 2. GM 37.5-38.5%. + 3. OpEx $9.6-9.8b. + 4. OI&E about $200m. + 5. Tax rate about 16.5%. + 13. Others: + 1. On 10/30/19, Board of Directors declared cash dividend of $0.77 per share of common stock payable on 11/14/19 to shareholders of record as of 11/11/19. + 2. Nancy Paxton, Head of IR, has decided to retire at Dec.-end. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Today, that will come from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + Congratulations on the quarter. iPhone revenue trajectory did improve, but it still declined 9%. So can you talk about the drivers that will allow you to get that category back to growth and if you think that's something that's realistic to expect in fiscal '20? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Katy, it's Tim. We're very thrilled with what we're seeing in the early going on iPhone 11 and iPhone 11 Pro and Pro Max. It's early, but the trends look very good, so I don't want to make a long-range forecast here. We've put our current thinking in the guidance, and you can tell that from the guidance, we are bullish. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- + + Great. And Luca, on margins, guidance is consistent with September, but there's a lot going on under the covers. Tariffs could expand in mid-December. There's some impact from the TV+ bundle. You have some big currency and commodity price moves. So can you just talk about the gives and takes that land you at the December quarter gross margin guidance? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [5] +-------------------------------------------------------------------------------- + + Yes. Katy, of course. As you said, I mean, at the midpoint of the range, we are essentially flat sequentially. On one side, we expect -- on the positive side, we expect leverage from higher revenue. On the other side, foreign exchange for us continues to be probably the biggest headwind that we got right now. It's going to be negative 70 basis points on a sequential basis. Also, keep in mind that during the holiday season, we have a higher mix of products revenue than we have in other quarters. And that obviously is dilutive to the company margin. On a year-over-year basis, we're also about flat. And on one side, we've got better commodity pricing. The environment is better than it was a year ago, but foreign exchange is a negative impact of 120 basis points on a year-over-year basis. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question will be from Mike Olson with Piper Jaffray. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + So Wearables category has been strong, and it's hard to believe it's now essentially the same size as Mac. But related to Apple's initiatives in health care, do you think health-related features are a primary driver of Wearables growth? And maybe conversely, how important is the rising installed base of Wearables and the data that's associated with that to the ongoing innovation within Apple Health? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + Yes. Michael, it's Tim. The Wearables have done extremely well. It was an acceleration further from the previous quarters, so we're thrilled with the results. As to what's driving it, it's the totality that's driving it. For some people, it's about fitness. For some people, it's about health. For some other people, it's about communication, and for some people, it's all of the above. And I think the new feature of always-on on Series 5 is a game-changer for many of our users. +And in terms of other health-related things that we have going, we will be continuing to build out our health records connection into the Health app, really democratizes the information about people's health, and so they can easily go from doctor to doctor. We've got the research going that I've mentioned earlier. There will be more of those through time. And obviously, we've got things that we're not going to talk about just yet that we're working on. But as I've said before, my view is there will be a day in the future that we look back and Apple's greatest contribution will be to people's health. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + And then with the strong slate of content in Apple TV+, can you just talk about the strategy behind giving it away to those that are buying an applicable device versus charging for it? And my congrats to Nancy and thank you. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- + + Yes. It's a gift to our users. And from a business point of view, we'd like to -- we're really proud of the content. We'd like as many people as possible to view it. And so this allows us to focus on maximizing subscribers, particularly in the early going. And so we're -- we feel great about doing that. I think it's a bold move. And the price also for those people that are not buying a device in the period of time that we offer this, the price is very aggressive as well. You think about the quality of content that you get for $4.99, and it's amazing. It is amazing. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + That will come from Evercore's Amit Daryanani. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [12] +-------------------------------------------------------------------------------- + + I guess 2 questions from me as well. First one, Tim, if you think about the Services business, you're less than $2 billion away from the targets you had laid out a few years back. But I'm wondering if you think about the growth rates you've had in the business over the last several years, the high teens average, I think, how much of that do you think was driven by the installed base growing versus incremental monetization of the installed base? And do you see that ratio essentially flipping or changing as you go forward? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [13] +-------------------------------------------------------------------------------- + + I think we have opportunities, Amit, in both the growth of the installed base. As Luca mentioned in his comments, we continue to grow across every category, hit new highs in the last quarter. And we hit new highs in all of our top 20 markets. And so the installed base is clearly a piece of it. Getting the trade-in program going and the secondary market moving has been helpful in that as well. And of course, the -- ultimately, the thing that builds the installed base is to make customers happy. And that's our -- always our top objective is to have satisfied customers. +The other thing that is obviously happening is in many areas, the ARPU is increasing. And so as there's more offers out there, I mean, the one that is today getting the attention is on the streaming side. But if you look at the number of services that have been added over the years, it's significant. And people love them. And so it's really both of those. And obviously, finally, getting more people that are enjoying things for free to elect to pay for some of the premium services. So it's sort of all 3 of those. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [14] +-------------------------------------------------------------------------------- + + Got it. And then if I could just kind of go back to the Wearables discussion, I mean, and especially if you think about Apple Watch and AirPods. Is there a sense or a way to think about what's the attach rate today to iOS devices for Apple Watch or AirPods? I guess I'm just trying to understand, if I think about 900 million-plus iPhone installed base, what kind of penetration do you have at Wearables and how long could this one may be as you go forward? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + Well, we're not releasing the precise numbers of our Wearables, but it is a really nice try in getting me to say that. The -- what we're seeing in terms of new ads on the watch, I think Luca may have mentioned this in his comments, is about 3/4 of the Apple Watch buyers are new to Apple Watch. And so we are still and significantly in the build mode there. And so don't think of the penetration as anywhere near a sort of a mature penetration. We got a lot left there. +And the AirPods just keep hitting new highs. And I anticipate that will carry over to this quarter too, and we're really proud to add another product up there for people wanting noise-canceling with the AirPods Pro beginning to sell today. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + That will come from Shannon Cross with Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [17] +-------------------------------------------------------------------------------- + + First, Nancy, just want to send you our best wishes. We'll definitely miss you. I'm sure, I agree with Luca, you've been very instrumental over the years. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Director-IR [18] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [19] +-------------------------------------------------------------------------------- + + My questions though with regards to China. And I don't know, Tim, if you can talk more about what you're seeing in China, the trends during the quarter, the reception specifically there to the iPhone. Any thoughts on Hong Kong used to be a big market. There's obviously some turmoil there. So if can you just provide some more in China that will be helpful. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + Yes. We had a very good September, Shannon, and the lead of that is sort of the reception of iPhone 11 and 11 Pro and 11 Pro Max. And so we feel really good about how we've gotten started there. As you can tell from the numbers, we've significantly improved since the beginning of the year. We've gone from minus well into the 20s to minus 2% last quarter. And if you looked at that in constant currency, we actually grew 1%. And so there's a very slight growth there. We obviously want that to be better. But we feel good about how we're doing. +I think it's a combination of things that are -- that have turned things around. On a macro basis, I think the trade tension is less, and that clearly looks positive right now with the comments that we've been reading in the press. Secondly, the products have been extremely well-received there. Third, the things that we've done from a pricing and monthly payments point of view, and trade-in, getting the trade-in program up and running, all of these things have moved the dial. And so it's sort of a -- the sum of all of that. +I would also say it's not all about iPhone in China. The Services area grew double digit. We began to see more gaming approvals in the quarter or I should say some key gaming approvals. It's not all about quantity but about which ones. We saw that. Also, Wearables, where Wearables are doing so great at a company level, they're doing even better in China. And so lots of positives there. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [21] +-------------------------------------------------------------------------------- + + And then I'm curious, Luca, maybe you can talk a bit about how you think about operating expense growth. It continues to grow significantly faster than revenue. So I'm just curious as to where you're targeting the incremental spend. And then is there a point at which we might just see some leverage? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [22] +-------------------------------------------------------------------------------- + + Well, Shannon, we've gone through different cycles. In some cases, our revenue growth exceeds our OpEx growth. In other cases, like fiscal '19, it was the other way around. But our approach frankly is not changing over time. We want to invest in the business. Our primary investments during the last few years have been in the R&D space because obviously we want to continue to innovate, improve the user experience, differentiate our products. +We continue to run SG&A tightly. Obviously, if you look at what we've launched during the last few quarters and few years, we launched a lot of new products, and now we're launching a lot of new services. And when we do that, we need to make the adequate investments in marketing and advertising to raise the awareness of the new products and new services. And that is what you're seeing, for example, in the guidance that we provided for the first quarter as we're launching new services right now. And so we're making investments both in engineering and in advertising to support the new launches. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + That will come from Bernstein's Toni Sacconaghi. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + I think this is for Luca, and then I have a follow-up as well. If I look at your guidance, the midpoint of your guidance for revenues on a sequential basis, it's up about 36.5%. Historically, fiscal Q4 to Q1 was up 50% or more. And even last year, given that iPhone is a slower-growing product, you guided for revenues to be up 45% sequentially. So given the enthusiasm about the iPhone 11 launch and the new Wearables products and the new Services, I guess the question is why is your guidance not stronger for Q1 on the top line? And is that sort of a reflection of conservatism, given that there's a lot of uncertainty in the world and we certainly saw that last year? Or are there other forces at work that we should be considering? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [25] +-------------------------------------------------------------------------------- + + Toni, thanks for the question. The guidance that we are providing, if you look at it at the midpoint, implies an acceleration of growth from the performance that we've seen during the course of fiscal '19. As I said earlier, foreign exchange is clearly a headwind for us right now. There's about $1.1 billion of negative foreign exchange on a year-over-year basis. So that is something to keep in mind. +We feel very good, as Tim said, about the iPhone, the way the new cycle has started. And we do expect an improvement in our year-over-year growth rate on iPhone. Wearables has very, very strong momentum. The portfolio of Services also has incredible momentum. One thing to keep in mind as we look at this guidance range is the fact that we also contemplated the comparison to the launch of the iPad Pro a year ago for iPad as well as the new MacBook Air that was launched during the December quarter last year. So for the iPad and Mac categories, you need to keep in mind that our launch timing is different on a year-over-year basis. + +-------------------------------------------------------------------------------- +A.M. Sacconaghi, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + Okay. And then if I could follow up. Just on the bundling of Apple TV+. I guess for you, Tim, this is really the first time we've seen a significant bundling of services offering and a hardware offering. And I'm wondering if you view this as kind of a strategic advantage of Apple and whether we might see more hardware plus services offerings -- bundled offerings. And ultimately, to you, do you ever believe that your hardware itself might be offered as a bundled service? And maybe while we're on that, either you or Luca could give us the 30-second tutorial on how we should think about the deferred revenue accounting, approximately how much of the $60 are you going to be deferring and what's your expectation for attach rate on that? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [27] +-------------------------------------------------------------------------------- + + Let me cover that accounting issue first. Obviously, we need to make some assumptions around the take rate of our customers on the -- on Apple TV+, right? And we don't want to get into the details of that because we view those assumptions as confidential and competitively sensitive. +But you need to keep in mind that we contemplate a number of factors, including the fact that we have family sharing as part of the service, the fact that there are multiple device purchases, the geographic availability around the world, the availability of local content at the beginning of the service, how many people do we have with payment methods on file. So we use all these things to make assumptions around what the take rate is going to be. Obviously, those assumptions will possibly change over time as we get more information on how the customers behave. We haven't launched the service yet. We're going to start serving our customers tomorrow, so we'll see how it goes, but we take into account all these different factors. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- + + On the bundled question, Toni, we look at each service and decide what's best to do for it. And on the TV+, we concluded that a great way to get more people to see the content would be to do this, and it would be a good gift for our users, and so that's what we're doing. You can also see that on the other services, we're not doing that. So it's not part of a broader pattern or -- although I wouldn't want to rule out for the future that we might not see another opportunity at some point in time. +In terms of hardware as a service or as a bundle, if you will, there are customers today that essentially view the hardware like that because they're on upgrade plans and so forth. And so to some degree, that exists today. My perspective is that will grow in the future to larger numbers that will grow disproportionately. And one of the things we're doing is trying to make it simpler and simpler for people to get on these sort of monthly financing kind of things that's a part of what we announced with the Apple Card earlier in the call. And so we're cognizant that there are lots of users out there that want sort of a recurring payment like that and the receipt of new products on some sort of standard kind of basis. And we're committed to make that easier to do than perhaps it is today. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + That will be from Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [30] +-------------------------------------------------------------------------------- + + And Nancy, our congratulations to you, too, and we're going to miss you. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Director-IR [31] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [32] +-------------------------------------------------------------------------------- + + My first question is about pricing and the effect of some of the lower price points for iPhone 11 as compared to last year. And it looked like margins and the revenues did well on that. And it also followed some price adjustments you made in emerging markets last year. And obviously, we've seen some improvement in China as well. So if you could talk about maybe what that tells us about pricing strategy in general and perhaps that you're willing to take a little more flexible approach to drive some elasticity if you think that's going to have a positive effect. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [33] +-------------------------------------------------------------------------------- + + Yes. Chris, I think that the price moves we've made have been smart and well-received and do show a level of elasticity. But the most important thing by far is the product. And I think we've got the best lineup we've ever had, and the customer response to the product, what the product does for them is really incredible. And the photos I'm getting from many users around the world are just incredible that people are taking. And so I think it's product first and then price sort of falls out of that. And we did decide to be more aggressive. And looking at the results in the early going, I think it was the right call. +In terms of emerging markets, we picked sort of locally relevant prices. And in some cases where the dollar had become stronger, we took an exchange rate that would've reflected a while back instead of the current exchange rate. And in other words, we tried to stay as close as we could to a local price point that we knew was effective for that particular market. And those, in addition to the U.S. price that have gotten more of a discussion, have been extremely well-received. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + As a follow-on, perhaps you could talk about the potential for some of the tariffs that are upcoming. What -- do you have a view of what potential impact that could have going forward and how Apple is looking to address it? Will you need to adjust your own pricing if, in fact, the tariffs are imposed? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [35] +-------------------------------------------------------------------------------- + + We're paying some tariffs today, as you know, some that went into effect pre-September and some others that went into effect in September. So we are paying some. That's been comprehended. But in general, my view is very positive in terms of how things are going. And that positive view is obviously factored in our guidance as well, and just the tone, I think, has changed significantly. And I have long thought that it was in both countries' best interest to get to an agreement that maybe initially doesn't solve everything but solves some things that each party may want and get to a better place than where we're at. And I'm hopeful that that's where we're headed. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + That will be from Samik Chatterjee with JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [37] +-------------------------------------------------------------------------------- + + I just wanted to start off with one of -- new Services, Apple Arcade and if you have any insights in terms of what you're seeing for engagement or retention of customers beyond the initial trial period. Also, how are your partnerships with developers progressing there? How does the pipeline look like? And any early projections of what that business longer term might look like? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [38] +-------------------------------------------------------------------------------- + + We're not going to give out projections on it, but I would tell you that we were really pleased with the number of people that entered the trial period. People are just coming out of the 30-day trial period in the last few days or a week or so, and so it's really too early to tell what the conversion rate will be. But I feel like we're off to a good start, and the -- most important of everything, the customer feedback to date has really been incredible, and we're very excited for the future of the service. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [39] +-------------------------------------------------------------------------------- + + Great. Another follow-up, if I can try and attack the Wearables question with another angle. What are you seeing in terms of typical -- consumer behavior in upgrading Wearables like Apple Watch or AirPods? And how are you thinking about your ability to accelerate some of that replacement cycle by driving innovation? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [40] +-------------------------------------------------------------------------------- + + I think we -- because the Watch is relatively young, we haven't seen enough upgrade cycles to really establish a pattern as yet. And as I've mentioned before, 3 out of 4 customers buying an Apple Watch currently or last quarter, I should say, were buying an Apple Watch for the first time. And so there's still a very, very large new to Apple Watch in this regard. I do think the upgrade market will get larger over time but just don't have a current view as to how often and so forth. +On the AirPods, we're anxious to see the customers for the new AirPods Pro. But I would guess that one, particularly in the early going, will be people that have AirPods today and want to have a -- also have a pair for the times that they need noise cancellation. + +-------------------------------------------------------------------------------- +Nancy Paxton, Apple Inc. - Director-IR [41] +-------------------------------------------------------------------------------- + + Thank you, Samik. +A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone, and the numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 4331479. These replays will be available by approximately 5 p.m. Pacific Time today. +Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414, and financial analysts can contact Tejas Gala or me with additional questions. Tejas is at (669) 227-2402, and I'm at (408) 974-5420. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And that will conclude today's conference. Again, thank you all for joining us today. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2020-Apr-30-AAPL.txt b/Transcripts/AAPL/2020-Apr-30-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..e47480ebb184617b26d4dcabdd0920228733772a --- /dev/null +++ b/Transcripts/AAPL/2020-Apr-30-AAPL.txt @@ -0,0 +1,553 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q2 2020 Apple Inc Earnings Call +APRIL 30, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tejas Gala + Apple Inc. - IR Contact + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kanghui Ong + Deutsche Bank AG, Research Division - Research Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 2Q20 revenue of $58.3b, net income of $11.2b and EPS of $2.55. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 2Q20 revenue = $58.3b. + 2. 2Q20 net income = $11.2b. + 3. 2Q20 EPS = $2.55. + 4. 2Q20 YoverY revenue growth = 1%. + 5. 2Q20 GM = 38.4%. + 6. 2Q20-end net cash = $83b. + 7. 2Q20-end total debt = $110b. + 8. 2Q20 share repurchase = 64.7m AAPL shares for $18.5b through open market repurchases. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 2Q20 Review (T.C.) + +-------------------------------------------------------------------------------- + + 1. Overview: + 1. Revenue $58.3b. + 1. All-time record for Services. + 2. Quarterly record for Wearables, Home and Accessories. + 3. Quarterly revenue record for Retail, powered by growth in online store. + 2. Amid the most challenging global environment in which Co. has ever operated its business, AAPL grew during qtr. + 2. COVID-19 Response: + 1. Contending with COVID-19 since Jan. + 2. Before COVID-19 was on the horizon, Co. anticipated that 2Q20 was going to be prolific and energetic period for AAPL. + 1. When pandemic did strike, teams succeeded in growing the business in introducing powerful new products and in meeting customers' needs, and they rose to the occasion in terms of meeting broader obligations to communities. + 3. At the same time that they were leaving no stone unturned to get Co.'s latest generation of devices manufactured and into customers' hands, worldwide network of supply chain partners, logistics and operations folks in every part of AAPL were also sourcing more than 30m masks for frontline medical workers, ensuring they're donated to places of greatest need in every region worldwide. + 4. While product teams were preparing to launch new iPad Pro, Magic Keyboard, MacBook Air and new iPhone SE, they were also working with suppliers to design, test, manufacture and distribute more than 7.5m face shields. + 1. Continues to ship more than 1m of these every week to doctors, nurses and medical personnel on frontlines. + 5. In a qtr. where Services teams achieved strong growth, which speaks to real durability of Services strategy, these teams were also putting COVID-19 front and center. + 1. As Apple News reached 125m monthly active users, Co. elevated trusted information from reliable sources through special COVID-19 vertical. + 2. Let customers skip payments without incurring interests on Apple Card for March and April in light of financial hardship for many families. + 3. Worked with everyone from Oprah to Lady Gaga, to inform, entertain and give back through Apple TV. + 4. Services like FaceTime and Messages set new all-time records for daily volume as users relied on their devices to stay connected in new reality. + 6. In software, at the same time that teams work with great creativity and excitement as Co. prepares to deliver first-ever all-online Worldwide Developers Conference later this qtr., they also worked with same creativity and speed to put together COVID-19 symptom checking website and app in partnership with CDC. + 1. As of 04/30/20, app has been installed nearly 2m times and web tool has received over 3m unique visits. + 2. This month, to accelerate contact tracing, launching joint effort with Google to enable to use of Bluetooth technology to help governments and health agencies reduce the spread of virus with user privacy and security central to design. + 7. Paired aforementioned programmatic efforts with broader strategy to give back where it's needed most. + 1. Made major corporate donations to response efforts worldwide to support global citizen, and new fund for Americans experiencing food and security due to crisis. + 1. When tallying these things up and considering ongoing two-to-one match for employee donations, Co.'s contributions to global response are significant, diverse and great source of pride for whole team. + 2. Doing what Co. can to help employees, their families, and by extension, their communities, stay safe and well by modifying its operations where appropriate. + 1. This extends to retail employees; they're Co.'s face to customers and instrumental part of business, and AAPL is compensating them normally despite store closures. + 8. During a qtr. where circumstances evolved by the hour, Co. has been gratified by resilience and adaptability of global supply chain. + 1. While Co. felt some temporary supply constraints in Feb., operations team, suppliers and manufacturing partners have been safely returning to work and production was back at typical levels toward March-end. + 9. At this time of social distance, of shuttered schools and gathering places, of delayed plans and new ways of socializing, Co. has seen significant evidence that AAPL's products have taken renewed importance for customers. + 1. Teachers and students worldwide are relying on Co.'s technology to teach, learn and stay connected with each other. + 2. Co. is in process of deploying major orders of iPads to school systems working to keep learning going strong at a distance, including: + 1. Tens of thousands in Ontario, Canada, Glasgow, Scotland, and Puerto Rico. + 2. 100,000 to city of Los Angeles. + 3. 350,000 to New York City. + 3. Aforementioned is Co.'s largest educational iPad deployment ever. + 4. Since early March, seen unprecedented demand for Pro Apps from students, enthusiasts and creative professionals. + 1. Made Final Cut Pro X and Logic Pro X available for free for 90 days for everyone. + 2. Reaction has been overwhelming, driving software downloads and usage to record levels. + 10. Doctors and medical professionals are making even greater use of Apple Watch and other health features to communicate with patients and to treat them safely from distance when necessary. + 1. With new FDA guidance on non-invasive remote patient monitoring, ECG app on Apple Watch is increasingly being used to facilitate remote ECG measurements and recordings for telemedicine usage, reducing patient and healthcare provider contact and exposure. + 2. Many hospitals like Geisinger Health System, NYU Langone Health and Stanford Health Care are using apps on iPad and iPhone to support communication and video conferences between hospitalized patients and their care teams. + 1. This enables care teams to keep close watch on patients without entering isolation rooms, which helps to minimize exposure and reduces some of the need for personal protective equipment. + 3. Key Metrics: + 1. Revenue $58.3b. + 1. Product revenue $45b. + 2. Performance of product business had three very different phases. + 1. Based on Co.'s performance during first five weeks of qtr., AAPL was confident it was headed toward record 2Q at the very high end of expectations. + 2. In next five weeks of qtr., as COVID-19 started impacting China, iPhone supply was temporarily affected, and demand for products within China. + 1. This caused Co. to withdraw revenue guidance in Feb. + 2. At that point, demand for products outside of China was still strong and in line with expectations. + 3. During last three weeks of qtr., as virus spread globally and social distancing measures were put in place worldwide, including closure of all Co.'s retail stores outside of Greater China on March 13 and many channel partner points of sales worldwide, saw downward pressure on demand, particularly for iPhone and Wearables. + 3. Given lack of visibility and certainty in near term, will not be issuing guidance for coming qtr. + 1. Over long term, has high degree of confidence in enduring strength of business. + 2. Global supply chain is profoundly durable and resilient. + 1. Shown consistent ability to meet and manage temporary supply challenges like those caused by COVID-19. + 4. Continued to deliver innovative new products across multiple categories that appeal to a broad cross section of customers, including all-new iPhone SE. + 1. Teams worldwide have tackled complexities of this moment with unmatched creativity, good humor and dedication to customers. + 5. Long running investment in Services strategy is succeeding. + 1. This business is growing, and is a reflection of Co.'s enduring large and growing installed base. + 2. Expects to meet longstanding goal of doubling FY16 Services revenue in 2020. + 6. Always run Co. for long term. + 1. Entered this period with unmatched financial strength, robust cash position and best product pipeline ever. + 7. Major investments, including five-year commitment to contribute $350b to economy in US are moving forward at full speed ahead. + 8. Always managed through difficult moments by doubling down and investing in next-generation of innovation, and that's Co.'s strategy today. + +-------------------------------------------------------------------------------- +II. 2Q20 Financials (L.M.) + +-------------------------------------------------------------------------------- + + 1. Overview: + 1. Different qtr. than what Co. was expecting at Jan.-end. + 2. Revenue: + 1. 2Q20 $58.3b. + 1. Up 1% YoverY, despite extreme circumstances from impact of COVID-19 and headwind of 100 BP from FX. + 2. Products $45b. + 1. Down 3%. + 2. After strong Jan., performance was impacted, particularly during last three weeks of qtr., when lockdowns and point-of-sale closures increased due to COVID-19 spreading worldwide and affected Co.'s product sales. + 3. On demand basis, performance was stronger than reported results as Co. reduced iPhone channel inventory more than it did a year ago. + 4. Installed base of active devices reached all-time high in all of Co.'s geographic segments and all major product categories. + 3. Services: + 1. Followed different trend. + 2. YoverY growth 17%; strong. + 3. Revenue $13.3b; new all-time record. + 1. Set all-time records in many Services categories and in most countries Co. tracks. + 3. GM: + 1. 2Q20 38.4%. + 1. Flat sequentially, with cost savings and mix shift towards Services offset by seasonal loss of leverage. + 2. Products 30.3%. + 1. Down 380 BP sequentially, due to loss of leverage and unfavorable mix. + 1. Drop was more pronounced than under normal circumstances due to COVID-19 impact. + 3. Services 65.4%. + 1. Up 100 BP sequentially, driven by favorable mix. + 4. Results: + 1. Reported tax rate 14.4%. + 1. Lower than 16.5% guidance due to one-time discrete items. + 2. Net income $11.2b. + 3. EPS $2.55. + 1. Up 4%. + 4. Operating cash flow $13.3b; very strong. + 1. Improved $2.2b YoverY. + 5. iPhone: + 1. Revenue $29b. + 1. Down 7% YoverY, as iPhone supply and demand were affected by impact of COVID-19 at some point during qtr. + 2. Suffered from some temporary supply shortages during Feb. + 1. Operations team and manufacturing partners put forth extraordinary effort to restore production quickly. + 2. Co. exited qtr. in good supply position for most product lines. + 3. After strong first five weeks, saw impact of COVID-19 affect demand in China for next five weeks and then more broadly worldwide for last three weeks of qtr. when lockdowns and point-of-sale closures became more widespread in many countries. + 4. While Co. saw slight elongation in replacement cycle towards qtr.-end, which Co. attributes to widespread point-of-sale closures, active installed base of iPhones has reached all-time high. + 1. This speaks to quality of products and strength of ecosystem. + 5. In US, latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 99% for iPhone 11, 11 Pro and 11 Pro Max combined. + 6. Services: + 1. Revenue $13.3b; all-time record. + 2. Had strong performance across the board with all-time revenue records in: + 1. App Store. + 2. Apple Music. + 3. Video. + 4. Cloud services. + 5. App Store search ad business. + 3. Set March qtr. record for Apple Care. + 4. New services, Apple TV+, Apple Arcade, Apple News+ and Apple Card, continued to add users, content and features while contributing to overall Services growth. + 5. Well on way to accomplishing goal of doubling FY16 Services revenue during 2020. + 6. App Store revenue grew by strong double digits, due to robust customer demand for in-app purchases and subscriptions. + 1. Third-party subscription business grew across multiple categories and increased over 30% YoverY, reaching new all-time high. + 2. First-party subscription services continued to perform well. + 7. Apple Music and cloud services both set all-time revenue records. + 8. Apple Care set March qtr. record. + 9. Paid subscriptions for all three aforementioned services were up strong double digits. + 10. Customer engagement in Co.'s ecosystem continues to grow strongly. + 1. Number of transacting and paid accounts on digital content stores reached new all-time high. + 1. Number of paid accounts increased double digits in all of Co.'s geographic segments. + 2. Now has over 515m paid subscriptions across services on platform, up 125m YoverY. + 3. Sequentially, paid subscriptions grew by over 35m; highest sequential growth ever. + 4. With this momentum, believes Co. will reach increased target of 600m paid subscriptions before the end of calendar 2020. + 7. Wearables, Home & Accessories: + 1. Established new March qtr. record. + 2. Revenue $6.3b. + 1. Up 23% YoverY, with strong double-digit performance across all five geographic segments. + 3. Wearables business is now the size of Fortune 140 co. + 1. Apple Watch continues to extend its reach as over 75% of customers purchasing Apple Watch worldwide during qtr. were new to the product. + 8. Mac & iPad: + 1. Revenue: + 1. Mac $5.4b. + 2. iPad $4.4b. + 2. Towards qtr.-end, launched brand-new iPad Pro that includes first-in-class LiDAR scanner with some augmented reality applications, and MacBook Air, with significantly improved performance at lower price. + 3. Around half of the customers purchasing Macs and iPads worldwide were new to that product. + 4. Active installed base for Mac and iPad reached new all-time high. + 5. Most recent surveys of consumers from 451 Research measured customer satisfaction at 95% for iPad and 96% for Mac. + 9. Others: + 1. In enterprise market, businesses everywhere have been making transition to working remotely. + 1. Created content to assist customers in this transition, including on-demand video learning series focused on topics like remote deployments of iPads and Macs and security. + 2. Realigned Co.'s own retail business and enterprise teams to provide timely and relevant support to customers as they navigate new work environments. + 3. Some of Co.'s largest customers offering Mac to employees, like IBM and SAP, have been able to pivot quickly to allow employees to easily set up and secure their devices from home, benefiting from Apple Business Manager and zero-touch deployment. + 4. Peloton worked with New York teams to deploy entire fleet of Macs overnight so their team could work remotely. + 2. In essential sectors like grocery and financial services, Co. is seeing organizations adopt its technology to better serve their customers safely. + 1. Leading grocers worldwide like Trader Joe's, Woolworths, Lawsons, Sainsbury's, Lidl and Carrefour offer Apple Pay so customers can use contactless payments. + 2. As stores shift to become fulfillment centers for online orders, organizations are leveraging apps for remote shoppers and food delivery to reduce foot traffic. + 3. In banking, where safety and security is a top priority, one way to protect co. and client information is by providing corporate iOS devices to employees who use mobile phones daily as part of their jobs. + 1. Bank of America is purchasing tens of thousands of additional iOS devices for their workforce. + 10. Cash Position: + 1. Liquidity has not been an issue for Co. during these highly unusual financial market conditions. + 2. Has extraordinarily strong balance sheet, deep access to capital markets and unmatched free cash flow generation. + 3. 2Q20-end: + 1. Cash plus marketable securities $193b. + 2. Total debt $110b. + 3. Net cash $83b. + 4. Returned $22b to shareholders. + 1. $18.5b through open market repurchases of 64.7m AAPL shares. + 2. $3.4b in dividends and equivalents. + 11. 2Q20 Outlook: + 1. Note: + 1. Given lack of visibility and certainty in near term, will not be issuing guidance for coming qtr. + 2. Guidance is based on what Co. has seen in April and how it thinks things might play out. + 2. From FX standpoint, US dollar has appreciated recently against most currencies worldwide. + 1. Thereby, expects revenue to be negatively impacted by more than $1.5b YoverY. + 3. Global supply chain is back up and running. + 1. Co. is in typical supply position, including Co.'s usual ramp associated with new products recently launched. + 1. These newly launched products, iPad Pro, MacBook Air and iPhone SE, have all received outstanding customer response even during these extreme circumstances. + 2. On iPhone and Wearables, expects YoverY revenue performance to worsen in June qtr. relative to March qtr. + 3. On iPad and Mac, expects YoverY revenue performance to improve in June qtr. + 4. On Services, seeing two distinct trends. + 1. Customers are actively engaging with Co.'s ecosystem and digital services. + 1. Believes strong recent performance in App Store, video, Music and cloud services will continue throughout June qtr. + 2. Due to overall reduced level of economic activity due to lockdowns worldwide, services like Apple Care and advertising have been impacted. + 1. Apple Care is comprised of product repair business and warranty agreements with customers, both of which have been affected by store closures and reduced level of customer traffic. + 2. Advertising, which is comprised of third-party agreements, App Store search ads and Apple News ads, has been impacted by overall economic weakness and uncertainty on when businesses will reopen. + 5. For GM, sequential headwinds include FX, mix within products and seasonal loss of leverage on Co.'s product business. + 1. FX will have 70 BP impact sequentially and 130 BP impact YoverY. + 6. Regarding product mix, keep in mind commentary provided at revenue level. + 1. Sequential tailwinds include cost savings and mix shift towards Services. + 7. With regard to capital allocation, approach remains unchanged. + 1. Continues to invest confidently in future while returning value to shareholders. + 12. Others: + 1. Co. is in midst of developing most exciting pipeline of products and services ever, while contributing over $350b to US economy and expanding footprint in many cities around the country over five-year period. + 2. Continues to believe that there is great value in Co.'s stock. + 1. Maintaining target of reaching net cash neutral position over time. + 3. Board has authorized $50b for share repurchases in addition to over $40b authorization remaining under current share repurchase plan. + 4. Board authorized 6% increase in quarterly dividend. + 1. On 04/30/20, declared cash dividend of $0.82 per share of common stock payable on 05/14/20 to shareholders of record as of 05/11/20. + 5. Managing Co. for long term. + 1. During uncertain times historically, continued to invest in business, and this remains Co.'s philosophy. + 2. Will continue to stay focused on what Co. does best, investing in product and service pipeline, managing business wisely and taking care of teams, and believes AAPL will come out from this stronger. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Yes. That will come from Shannon Cross, Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [2] +-------------------------------------------------------------------------------- + + I hope everyone is well. Tim, you talked about seeing some improvement in the second half of April. So I was wondering if you could just talk maybe a bit more on the segment and geographic basis what you're seeing in the various regions that you're selling in and what you're hearing from your customers. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure, Shannon. If you look at -- I'll start with China. If you look at what happened in China, we were having a really good January. The lockdown started there toward the end of January as you know. February, we saw a steep decline in demand. We closed our stores in February. As the lockdown completed in mid-February toward the second half of February, we began to open stores. We opened them on a staggered basis. That took about 30 days until mid-March. And from a demand point of view, we saw an improvement in March over February. And if you look at kind of where we are today, we've seen further improvement in April as compared to March. And so that's China. +If you look at the rest of the world, we were doing great in January, the first 5 weeks of the quarter. And we do believe that we were headed toward the sort of the top end of our expectations that we had talked to you about on the last call, that the next 5 weeks were spent sort of reacting and getting the supply chain back up in full force and working through the sharp decline in China that I already talked about. +The real thing for the rest of the world happened in March when the shelter-in-place orders went in and the work from home began. For those 2-, 3-week period, at the end of the quarter, we saw a sharp decline in demand. If you now step out into April and look at that, early April started like the end of March, but in the second half of April, we've seen an uptick across -- really across the board. It's not just related to a certain geo or a certain product. We think, by looking at it, a part of it is due to just our new products. A part of it is due to the stimulus programs taking effect in April, and then a part of it is probably the consumer behavior of knowing this is going to go on for a little while longer and getting some devices and so forth lined up to work at home more. +In particular for, as I think Luca shared, we believe that iPad and Mac are going to improve on a year-over-year basis during this quarter. And that's customers that are either taking online education or working remotely. And so complex answer to your question but that's what we're seeing. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [4] +-------------------------------------------------------------------------------- + + That was helpful. Luca, unless I missed it, you talked about various puts and takes in the quarter but didn't really discuss operating expenses. I know you mentioned some cost savings on the COGS line. I'm curious how you're thinking about your spending in OpEx given some of the macro challenges that you may be facing. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [5] +-------------------------------------------------------------------------------- + + Yes. Well, Shannon, as we said, we manage the company for the long term, right? So we know that the core of the business, the core of the company is innovation and product and services development, so we will continue to invest in our pipeline. We're very excited about what we have in store, and so we will continue to invest there. Obviously, we are aware of the environment, and so we will manage the SG&A portion of the company tightly. We are making new investments in the new services that we launched recently. We -- as you know, we purchased the baseband activities from Intel, and obviously, we want to develop that technology because we consider it's a core technology for us. And so we will try to balance the need to continue to invest during difficult circumstances and the fact that we like to manage the business wisely. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + That will be from Wamsi Mohan with Bank of America. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [7] +-------------------------------------------------------------------------------- + + Tim, I think I speak for everyone on the call that we're all very appreciative of Apple's contribution during this pandemic. We all appreciate it. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + Thank you very much for that. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + No, it's been great. Tim, in past downturns, we have not really seen Apple pull back from investing, and you as a company have largely maintained the product introduction cadence. But given these are unprecedented times and there are a lot of challenges associated with product development during a time when you have a global footprint for such activities and unable to really do a lot of things in person, how should we think about the product development and introduction cadence as we go over the next several quarters? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- + + Well, we're continuing to operate. And so as you can tell, along with everything else going on, we were able to launch and ship the iPhone SE, the iPad Pro with the Magic Keyboard and the MacBook Air. And so business continues and the new products are our lifeblood. And so we're continuing to work. Everybody is getting used to the work at home. In some areas of the company, people may be even more productive. In some other areas, they're not as productive, and so it's mixed depending upon what the roles are. But as you can tell from what we did this quarter, despite the environment, we have our head down, are working because we know that our customers want the products that we've got. They are even more important in these times. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [11] +-------------------------------------------------------------------------------- + + As a follow-up, I know you're doing a lot with both the Apple Card and financing plan for iPhones to get your products in the hands of customers. But I was wondering, would you consider using the strength of your balance sheet maybe a little differently structured, maybe deferred payments or things like that? And -- or do you think that there could be other steps like bundling that you will consider versus what you already currently do? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [12] +-------------------------------------------------------------------------------- + + Well, as you know, we launched the payment plan earlier on Apple Card for iPhone. We're working on doing that for other products as well, and you'll see something on that shortly. So we're very focused on the affordability point. The trade-in programs also are fairly wide across the board and act as both something great for the environment, also something great from a way to get that entry price down. +In terms of deferred payments, nothing to announce today. But as you know, having access to the Card, at least in the United States, gives us more degrees of freedom, and that is not using our balance sheet. It's -- but we play a key role in deciding what kind of programs go with the Card. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + That will come from Morgan Stanley's Katy Huberty. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [14] +-------------------------------------------------------------------------------- + + I hope the whole team is staying healthy and safe. Tim, I want to start on a longer-term question. Where do you see structural changes on the back of this health crisis that might present opportunities for new revenue streams at Apple? And I'm particularly thinking about your past comments on health and augmented reality, but I'm sure there's even more areas of inspiration and creativity coming out of the company. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + I think there are things from just a great reminder of how important our products are and -- for remote work. And it's pretty clear to me that where things will get a lot closer to normal than they are today, obviously, I think many people are finding that they can learn remotely, and so I suspect that trend will accelerate some. I think that's probably also true about working remotely on -- in some areas and in some jobs. And so I think we have significant solutions and products for those -- for all of those groups. +On the health area, I gave some examples in my opening comments about the ECG being used on the Watch. You can bet that we're looking at other areas in this. We were already doing that because we've viewed that, that area was a huge opportunity for the company and a way for us to help a lot of people. And so you will see us continue on that. I wouldn't say that the health door opened wider. I would say it was already opened fairly wide. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [16] +-------------------------------------------------------------------------------- + + Okay. And then as a follow-up, the $50 billion share repurchase authorization is impressive in absolute terms, but it is a bit lower than the last couple of years. So just any context around the thought process of landing on $50 billion? And then related to that, you have one of the strongest balance sheets in the world. Does the current environment change your thinking at all around M&A opportunities? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [17] +-------------------------------------------------------------------------------- + + Well, let me answer that, Katy. First of all, on the buyback, as I said, in general, our approach to capital allocation has remained the same for the last several years, and it's not changing now. Keep in mind here, we're talking about just the authorization, right? And when you look at our actual results at the end of every quarter, you see how much we actually do in terms of share repurchases. The $50 billion is in addition to over $40 billion that is still remaining from the past authorization that we've received from our Board, right? So it's the total available or outstanding in terms of authorization is over $90 billion. +And as you look at our run rate during the last several years, you know that, that is a very adequate amount. And as you know, we will provide an additional update a year from now. So nothing really has changed there. +And nothing has changed on our approach for M&A. We've been quite active over the last several years. We purchase companies on a very regular basis. We're always looking for ways to accelerate our product road maps or fill gaps in our portfolio, both on the hardware side, on the software side, on the Services side. So we will continue to do that. And so also on the M&A front, nothing has changed. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + That will come from Amit Daryanani with Evercore. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [19] +-------------------------------------------------------------------------------- + + I have 2 as well. I guess, first off, on the channel inventory, I was hoping if you could talk about how did channel inventory look like in the March quarter because it sounds like it may be below the historical ranges. And then the discussion you had for June quarter performance of iPhones, what are you embedding from a channel building back inventory levels in that expectation? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + Amit, it's Tim. If you look at the iPhone channel inventory during Q2, the reduction of it was more than the reduction from the previous year. It's not unusual that we reduce in Q2, and in fact, if you look back on -- generally speaking, in the first half of the calendar year, we reduce channel inventories. During the second half of the calendar year, we generally raise channel inventories. That's a seasonal thing. And I believe -- sitting here today, I believe that will happen this year as well. So hopefully, that answers your question. And by the way, we ended in a comfortable position, so you could conclude from that, that we were within a target range. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [21] +-------------------------------------------------------------------------------- + + That's really helpful. And could I just follow up? Tim, I was hoping you could maybe talk a little bit about how do you think about Apple's manufacturing strategy and perhaps need for some diversity, especially given everything the company and everyone has gone through over the last 12 months. How do you think about that? And do you feel comfortable that the supply chain and the manufacturing base is well situated today to launch the traditional fall products that they used to get from Apple? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [22] +-------------------------------------------------------------------------------- + + Yes. As you know, our supply chain is global and so our products are truly made everywhere. And I would focus on that versus focus on one element of the manufacturing process, which tends to get more visibility, which is the final assembly. We have some final assembly in the United States. We have final assembly in China as well. I think you'd have to conclude or at least I conclude that if you look at the shock to the supply chain that took place this quarter, for it to come back up so quickly really demonstrates that it's durable and resilient. And so I feel good about where we are. That said, we're always looking at tweaks, and it's just not something we talk about because we view it as confidential and competitive information. And so we will look at the -- as we get out of this totally, we will look to see what we learned and what we should change. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + We'll hear from Jeriel Ong with Deutsche Bank. + +-------------------------------------------------------------------------------- +Kanghui Ong, Deutsche Bank AG, Research Division - Research Analyst [24] +-------------------------------------------------------------------------------- + + So I want to focus the question on Services. The segment was solid in the quarter in spite overall macro weakness. I can kind of see launch behind it being strong despite product weakness overall. As you kind of look at the rest of the year, do you think that's sustained? Or at some point, does the macro impacts worldwide impact the Services line? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [25] +-------------------------------------------------------------------------------- + + Jeriel, let me take that one. We typically don't give a lot of specifics about our categories. But I've said, as we look into the June quarter, we see 2 distinct trends in our Services business overall. Our ecosystem is very strong. Our customers are very engaged. We are continuing to grow double digits the number of transacting accounts and paid accounts. And so we expect our digital services to continue at the same level of performance that we have seen during the March quarter. And that includes the App Store, of course, our video business, our Music business, cloud services, so we expect all these businesses to continue to grow very strongly. +Given the overall economic environment, the level of demand right now, there are 2 businesses that we believe are going to be impacted during the June quarter. One of them is Apple Care. Apple Care is essentially comprised of our product repair business and the warranty agreements that we signed with our customers when they purchased our devices. Both these businesses have been affected obviously by the store closures, not only our retail stores but also our partners' points of sale. And obviously, they reduced level of customer traffic because of the social distancing measures, right? And we do expect Apple Care to be affected during the June quarter. +The other business which we think is going to be impacted by the overall economic weakness and the uncertainty on when businesses will reopen is advertising, which is the sum of our advertising business on the App Store, on Apple News and the third-party agreements that we have on the advertising front. So these are 2 things that, during the June quarter, will create a headwind for the Services business. + +-------------------------------------------------------------------------------- +Kanghui Ong, Deutsche Bank AG, Research Division - Research Analyst [26] +-------------------------------------------------------------------------------- + + Got it. Appreciate that. My second question comes about the overall purchasing decisions consumers are making. So far through April, have you seen increased perhaps downticks across your product line? So for example, somebody might have a shift maybe towards the lower end of the storage mix of certain products. And do you expect that going forward as unemployment uptick and macro impacts kind of layer on through rest of '20? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + I haven't seen what you're asking, no. I have seen a strong customer response to iPhone SE, which is our most affordable iPhone. But it appears that those customers are primarily coming from wanting a smaller form factor with the latest technology or coming over from Android. And so those are the 2 principal kind of segments versus somebody buying down as you're talking about it. We've also seen -- we launched the iPad Pro in the midst of all of this, and the reception there has also been incredibly good. And that's obviously our top-of-the-line iPad. And so I'm not seeing what you're alluding to at least at this point. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + That will be from JPMorgan's Samik Chatterjee. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [29] +-------------------------------------------------------------------------------- + + So if I can just start with a question on kind of what you're seeing in China, you mentioned kind of the pickup in activity. But is that driven by more kind of footfall in the stores or what you're seeing relative to online activity and how much of this recovery is driven online? Any thoughts on that, please? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [30] +-------------------------------------------------------------------------------- + + Yes. What we saw in China for the full quarter, and I'll speak about Mainland China because I think that's the source of your question, we saw strong results in iPad and in Wearables and in Services. And if you look up underneath the full quarter, we saw a strong January and then a significantly reduced demand in February as the shelter-in-place orders and the lockdowns went into effect in China and the stores closed. And then in March, as stores reopened, we -- the recovery began, and then we've seen further recovery in April. Where that goes, we will see, but that's kind of what we've seen so far there. +To your question about store traffic, store traffic is obviously up from where it was in February, but it is not back to where it was pre the lockdown. There has been, however, more move to online. And as I'd mentioned earlier in my remarks, the -- it's pretty phenomenal actually. Retail had a quarterly record for us during the quarter, and that's despite stores being closed for the 3-week period around the world ex China and then China was closed prior to that 3 weeks. And that's partly because the online store had such a phenomenal quarter, and that included in China but it was also other regions as well. So there is definitely a move. And whether that's a permanent shift, I would hesitate to go that far as I think people like to be out and about. They just know that now is not the time to do that. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [31] +-------------------------------------------------------------------------------- + + Got it. And if I can just follow up on your previous comment about the strong demand you're seeing for iPhone SE, just given the price point, I'm wondering if you're expecting any change in terms of the geographic mix of where the demand comes from relative to typically what you see for other iPhones in the lineup just given the lower price point. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [32] +-------------------------------------------------------------------------------- + + I think it plays in every geo, but I would expect to see it doing even better in areas where the median incomes are less. And so we'll see how that plays out. And I expect some fair number of people switching over to iOS. And so it's an unbelievable offer. It's, if you will, the engine of our top phones in a very affordable package. And I think -- and it's faster than the fastest Android phones, and so it's an exceptional value. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our last question today will be from Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + I wanted to follow up with another question on iPhone SE and the decision to bring it back and where it sits within the total iPhone strategy. And I guess coupled with the fact that iPhone 11, you made the decision to bring that at a lower price point, what does that tell us with respect to your approach to iPhone pricing and flexibility? Is this helping to add users and kind of bring people into the ecosystem? And if so, what does that imply for gross margins? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [35] +-------------------------------------------------------------------------------- + + Chris, we've always been about delivering the best product at a good price, and that fundamental strategy has not changed at all. As you know, we did have an SE for a while. It's great to bring it back. It was a beloved product, and so I wouldn't read anything into that other than we want to give people the best deal that we can while making the best product. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [36] +-------------------------------------------------------------------------------- + + Okay. As a follow-up, the follow-up question is on commodity pricing, and I think you had expected to see some commodity price declines through the March quarter. If you could talk about what you expect as you go through the year perhaps in this new environment and again, whether that turned into a tailwind or a headwind for gross margins as you go into the second half. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [37] +-------------------------------------------------------------------------------- + + Yes. For March, Chris, we saw NAND pricing increase slightly, while DRAM and displays and the other commodities declined. For the June quarter, we would expect NAND and DRAM pricing to remain at this historically low level, while displays and most other commodity prices, we expect to decline. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [38] +-------------------------------------------------------------------------------- + + Thank you, Chris. A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. The numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 3229513. These replays will be available by approximately 5:00 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414. Financial analysts can contact me with additional questions at (669) 227-2402. Thank you again for joining us. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + And that does conclude today's conference. Thank you all for joining us today. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2020-Jan-28-AAPL.txt b/Transcripts/AAPL/2020-Jan-28-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0da8ca9c0b992cf6daf972e5f3917830a88c46c --- /dev/null +++ b/Transcripts/AAPL/2020-Jan-28-AAPL.txt @@ -0,0 +1,574 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q1 2020 Apple Inc Earnings Call +JANUARY 28, 2020 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tejas Gala + Apple Inc. - IR Contact + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Kyle P. McNealy + Jefferies LLC, Research Division - Equity Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Thomas Ferris Forte + D.A. Davidson & Co., Research Division - MD & Senior Research Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Michael Joseph Olson + Piper Sandler & Co., Research Division - MD & Senior Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 1Q20 revenue of $91.8b, net income of $22.2b and diluted EPS of $4.99. Expects 2Q20 revenue to be $63-67b. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 1Q20 revenue = $91.8b. + 2. 1Q20 net income = $22.2b. + 3. 1Q20 diluted EPS = $4.99. + 4. 1Q20 YoverY revenue growth = 9%. + 5. 1Q20 GM = 38.4%. + 6. 1Q20-end net cash = $99b. + 7. 1Q20-end total debt = $108b. + 8. 1Q20 share repurchase = 40m AAPL shares for $10b through open market transactions. + 9. 2Q20 revenue guidance = $63-67b. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 1Q20 Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Thrilled to report Co.'s biggest qtr. ever, which set new all-time records in: + 1. Revenue. + 2. Earnings. + 2. Revenue $91.8b. + 1. Above high end of guidance range. + 2. Revenue growth accelerated for third consecutive qtr. + 3. Geographically, set all-time records in Americas, Europe and Rest of Asia Pacific. + 1. Greater China returned to growth. + 4. Record performance was fueled by iPhone, where Dec. qtr. revenue was up 8% YoverY and by fifth consecutive qtr. of double-digit growth outside of iPhone, including new all-time record for Services and another blowout qtr. for Wearables. + 5. Active installed base of devices now surpassed 1.5b, up over 100m in last 12 months alone, reaching new all-time high for each main product categories and geographic segments. + 1. Not only is large and growing installed base of powerful testament to satisfaction engagement and loyalty of customers, but it's fueling growth across the Board, particularly in Services. + 2. iPhone: + 1. [Dec. qtr. revenue $56b]. + 1. Up 8% YoverY. + 2. Exceptional demand for iPhone 11, iPhone 11 Pro and iPhone 11 Pro Max. + 1. iPhone 11 was top selling model every week during Dec. qtr., and three new models were Co.'s three most popular iPhones. + 3. Had double-digit growth in many developed markets, including US, UK, France and Singapore. + 1. Grew double-digits in emerging markets, led by strong performances in Brazil, Mainland China, India, Thailand and Turkey. + 2. These new models are by far the best iPhone's Co. ever shipped with advanced technologies and unprecedented leap in battery life to easily get through the day and best-in-class camera experience. + 3. Has been wild with photos customers shared in all-new Night Mode photo challenge this month. + 3. Services: + 1. Revenue reached $12.7b. + 1. All-time record. + 2. Grew 17% over last year. + 2. Saw double-digit growth in all five geographic segments. + 1. Established new all-time records for multiple categories, including cloud services, music, payment services and App Store search ad business, and setting a Dec. qtr. record for App Store and Apple Care. + 3. 2019 was historic year for Services business. + 1. For App Store, 2020 started off strong with customers spending a new single day record $386m on New Year's Day alone, 20% increase over last year. + 2. Apple Arcade, new game subscription service, has been fast off blocks with catalog of over 100 new and exclusive games which can't be found anywhere else, all playable across Apple devices with new games and expansions added every month. + 3. Apple TV+ is off to rousing start. + 1. Continued to focus on telling stories that matter like Little America, which recently premiered to widespread critical acclaim with much more great content still to come. + 4. Apple News now draws over 100m monthly active users in US, UK, Australia and Canada and provides curated and personalized experience using on-device intelligence to recommend stories. + 5. Apple News+ continues to add new titles, offering subscribers seamless access to world's top publications across all of their devices. + 6. For Apple Pay, revenue and transactions more than doubled YoverY with run-rate exceeding 15b transactions a year. + 1. Apple Pay transit support expanded with customers paying for journeys on Transport for London more easily with Apple Pay Express Transit. + 7. In spring of 2020, iPhone and Apple Watch customers will be able to simply tap to ride trains and buses in even more cities, including Shenzhen and Guangzhou. + 8. Thrilled with continued growth of Apple Card. + 1. Last month, customers began using Apple Card monthly instalments at AAPL retail and online to purchase new iPhones and pay for them over 24 months. + 4. Wearables: + 1. Had another incredible qtr., setting all-time record in virtually every market Co. tracks worldwide. + 1. This product category is now size of Fortune 150 co. + 2. Demand for AirPods continues to be phenomenal, particularly for recently launched AirPods Pro, new addition to AirPods family that features active noise cancellation. + 3. Apple Watch had great start to FY20, setting all-time revenue record during qtr. + 1. It continues to have profound impact on customers' lives and continues to further its reach as over 75% of customers purchasing Apple Watch during qtr. were new to Apple Watch. + 2. AirPods and Apple Watch were must have holiday gifts helping drive unprecedented results for category even as Co. faces supply constraints for Apple Watch Series 3 and AirPods Pro. + 4. Mac and iPad generated $7.2b and $6b in revenue, respectively. + 1. High level of customer satisfaction and loyalty for both products drove active installed base of Mac and iPad to new records in all geographic segments. + 5. iPad: + 1. Saw growth in key emerging markets like Mexico, India, Turkey, Poland, Thailand, Malaysia, the Philippines and Vietnam. + 1. With current lineup of iPad Pro, iPad Air, iPad mini and iPad, along with new iPad OS, gives customers unparalleled tablet experience, integrating hardware, software and services in a way that only AAPL can. + 6. Mac: + 1. Exciting qtr. for Mac, as Co. launched most powerful notebook ever. + 1. 16-inch MacBook Pro, and Mac Pro and Pro Display XDR, the most powerful tools Co. has ever put in hands of pros. + 7. Other Details: + 1. This qtr., opened a beautiful new store in Kawasaki, Japan. + 1. Retail and online stores set an all-time record and delivered strong double-digit growth in iPhone. + 2. Began 2020 with greatest product lineup ever. + 3. In Nov., released a completely redesigned Everyone Can Code curriculum to help introduce more elementary and middle school students to the world of coding. + 1. The new curriculum includes even more resources for teachers, a brand new guide for students and updated Swift Coding Club materials. + 2. Nov. saw launch of new Research app, latest in ongoing effort to put future of health in hands of every user. + 1. Customers in US can enroll on three landmark multiyear health studies that Co. is undertaking with leading academic and research institutions, the Apple Women's Health Study, the Apple Heart and Movement Study and the Apple Hearing Study. + 2. Built user privacy into Research app from ground-up. + 4. This qtr., announced $2.5b plan to help address housing availability and affording crisis in home state of California. + 5. As Co. closes books on record-breaking Dec. qtr., already well underway on some new and exciting developments for future. + +-------------------------------------------------------------------------------- +II. 1Q20 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. Business and financial performance in Dec. qtr. were exceptional. + 1. [Set new] all-time records for revenue, net income and EPS. + 2. Revenue $91.8b. + 1. Up $7.5b or 9% YoverY, in spite of $1b headwind from FX. + 3. Geographically, established all-time revenue records in many major developed and emerging markets, including among others, US, Canada, Mexico, Brazil, UK, Germany, France, Italy, Spain, Poland, Thailand, Malaysia and Vietnam. + 4. Products revenue $79.1b. + 1. Up 8%, as iPhone returned to growth. + 2. Had incredibly strong results in Wearables, where Co. set all-time records for Apple Watch and AirPods. + 5. Services revenue grew 17% to new all-time record $12.7b with double-digit growth in every geographic segment, a new all-time records across portfolio. + 2. GM: + 1. 1Q20 38.4%. + 1. Up 40 BP sequentially, driven by leverage from higher revenue, in spite of negative 60 BP impact from FX. + 2. Products 34.2%. + 1. Up 260 BP sequentially. + 3. Services 64.4%. + 1. Up 30 BP sequentially, driven by favorable mix. + 3. Results: + 1. Reported tax rate 14.2%. + 1. Before discrete items, rate was 16.5%, exactly in line with guidance. + 2. Favorable one-time item impacted rate by 230 BP. + 2. Net income was all-time record at $22.2b, up $2.3b or 11% over last year. + 3. Diluted EPS was all-time record at $4.99, up 19%. + 4. Operating cash flow was strong $30.5b, improvement of $3.8b over a year ago. + 4. iPhone: + 1. Revenue $56b. + 1. Grew 8% YoverY, as Co. saw great customer response to launch of newest iPhones. + 2. Set all-time revenue records in several countries, including US, Mexico, UK, France, Spain, Poland, Thailand, Malaysia and Vietnam. + 2. Active installed base reached all-time high and is growing in each geographic segments. + 1. In US, latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 98% for iPhone 11, 11 Pro and 11 Pro Max combined. + 2. Among business buyers planning to purchase smartphones in next qtr., 84% plan to purchase iPhones. + 5. Services: + 1. Set all-time revenue record of $12.7b, with double-digit growth in all five geographic segments. + 1. Established new all-time records for Apple Music, cloud services, payment services and App Store search ad business, and Dec. qtr. records for App Store and Apple Care. + 2. Well on way to accomplishing goal of doubling [FY16] Services revenue during 2020. + 1. Already reached that goal on run rate basis with results of Dec. qtr. + 2. Customer engagement in ecosystem continues to grow. + 1. Number of transacting and paid accounts on digital content stores reached new all-time high with paid accounts growing double-digits in all geographic segments. + 1. Now has over 418m paid subscriptions across services on platform, up 120m from a year ago. + 2. At this point, expects to hit goal of surpassing 500m mark already during March qtr. + 3. Given tremendous momentum Co. is experiencing across Services offerings, increasing target for paid subscriptions and aims to reach 600m before end of calendar 2020. + 4. App Store revenue grew strong double-digits. + 1. Robust customer demand for in-app purchases and subscriptions. + 2. Third-party subscription business grew across multiple categories, and increased almost 40% YoverY. + 5. First-party subscription services continued to perform extremely well. + 6. Apple Music set all-time revenue record, offering a catalog of over 60m songs to customers. + 7. iCloud generated all-time revenue record, growing strong double-digits, while offering customers safe, secure and seamless experience across all their devices. + 8. It was Dec. qtr. record for Apple Care. + 6. Mac & iPad: + 1. Mac revenue was $7.2b and iPad revenue was $6b. + 1. Both products had difficult YoverY comparison due to launches of MacBook Air, Mac mini and iPad Pro during Dec. qtr. a year ago and subsequent channel field. + 2. Despite tough compare on demand basis, performance for Mac and iPad was around even to last year. + 3. Around half of customers purchasing Macs and iPads around the world, during the qtr. were new to that product. + 4. Active installed base for Mac and iPad reached new all-time high. + 5. Most recent surveys from 451 Research measured 93% customer satisfaction rating for iPad from consumers and 92% from businesses. + 1. Among consumers and businesses, planning to purchase tablets in March qtr., 78% plan to purchase iPads. + 7. Wearables, Home & Accessories: + 1. Established new all-time record with revenue of $10b, up 37% YoverY with strong double-digit performance across all five geographic segments and growth across Wearables, Accessories and Home. + 2. Set all-time records for Wearables in virtually every market Co. tracks, even as it experienced some product shortages due to strong customer demand for Apple Watch and AirPods during the qtr. + 3. Continued to see strong demand for products in enterprise market, as technology solutions enabled businesses to do their best work. + 1. 100% of Fortune 500 companies in healthcare sector use AAPL technology in areas like patient experience, clinical communications and nursing workflows. + 2. Seeing smaller companies in this sector drive innovation with technology and apps. + 1. One example is Gauss Surgical, which uses Core ML in iOS to more accurately estimate blood loss during childbirth and surgery. + 2. This helps clinicians have more complete and timely information on whether a patient needs an intervention, which can impact both clinical outcomes and costs. + 3. Another example is Butterfly Network, a medical imaging co., which makes handheld ultrasound device that connects to iPhone or iPad to enable clinicians to take an ultrasound anywhere at a cost that is dramatically lower than other solutions on market today. + 8. Cash Position: + 1. 1Q20-end cash plus marketable securities, [$207b]. + 2. Issued [EUR2b] denominated green bond, retired $1b of maturing debt and reduced commercial paper by $1b during qtr., leaving Co. with total debt $108b. + 3. 1Q20-end net cash $99b. + 1. Maintains target of reaching a net cash neutral position over time. + 4. Returned nearly $25b to shareholders during Dec. qtr. + 1. Began $10b accelerated share repurchase program in Nov., resulting in initial delivery and retirement of 30.4m shares. + 5. Repurchased 40m AAPL shares for $10b through open market transactions. + 1. Paid $3.5b in dividends and equivalents. + 9. 2Q20 Outlook: + 1. Revenue $63-67b. + 1. Wider than usual revenue range comprehends uncertainty related to recently unfolding public health situation in China. + 2. GM 38-39%. + 3. OpEx $9.6-9.7b. + 4. OI&E about $250m. + 5. Tax rate about 16.5%. + 10. Others: + 1. On 01/28/20, Board of Directors declared cash dividend of $0.77 per share of common stock, payable on 02/13/20 to shareholders of record as of 02/10/20. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Yes. That will be from Amit Daryanani with Evercore. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [2] +-------------------------------------------------------------------------------- +I guess first one for me. On Wearables, fairly impressive to see it's already a $10 billion business for you guys. Can you just touch on the growth that you see on the Wearables side? How much of the growth do you think is coming from first-time buyers of AirPods or Apple Watch versus folks that seem to be just upgrading the products that they have? Because it looks to us adoption rates are fairly low in your installed base so there should be a long runway, but love to just understand how you see the growth divided between those 2 buckets. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- +Yes. Amit, it's Tim. If you look at the Apple -- or the Wearables as a category within the Wearables, Home and Accessories revenue, Wearables grew 44%, so it was very strong, as you say. The -- both Apple Watch and AirPods did very well in terms of collecting new customers. Apple Watch, in particular, 75% of the customers are new to the Apple Watch, and so it's still very much selling to new customers at this point. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [4] +-------------------------------------------------------------------------------- +Perfect. And I guess, Luca, if you could just touch on gross margins. The March quarter guide, I think, implies gross margins are flat to actually up 10, 15 basis points. It's rare for you guys to actually guide gross margins up in March, I think, because you have a fairly high seasonal sales deleverage happening. So what are the offsets that's enabling what looks like a better-than-seasonal guide for gross margins? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [5] +-------------------------------------------------------------------------------- +Yes, that's right, Amit. It's about flat sequentially and, by the way, significantly higher on a year-over-year basis. But on a sequential basis, you're right. On one side, we got the loss of leverage from the usual seasonality, but we expect that, that loss of leverage will be offset by better mix and cost savings. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [6] +-------------------------------------------------------------------------------- +Thank you, Amit. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +That will come from Tom Forte with D.A. Davidson. + +-------------------------------------------------------------------------------- +Thomas Ferris Forte, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [8] +-------------------------------------------------------------------------------- +Great. So congrats on the launch of Apple TV+. I wanted to know internally how you are gauging success. Is it purely on critical acclaim? Is it on number of consumers that are using the service, contribution of service revenue, et cetera, et cetera? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [9] +-------------------------------------------------------------------------------- +Tom, it's Tim. We are primarily measuring ourselves on the number of subscribers. As you can tell from the way that we launched the product, we started with a very aggressive price at $4.99. And in addition to that, we have our bundle, where if you buy pretty much any device, you're getting a year for free, and so we're very focused on subscribers. That said, our -- the product itself is about storytelling. And we think if we do that well, then we'll find that there will be some number of those that will also be critically acclaimed and we're seeing that with The Morning Show. We're seeing that with Little America and others. + +-------------------------------------------------------------------------------- +Thomas Ferris Forte, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [10] +-------------------------------------------------------------------------------- +Great. And then my second question is, I think you indicated that last month, you started offering consumers the ability to use their Apple Card to buy an iPhone on an installment basis. Can you talk about how that's had an impact on your unit sales for iPhones? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [11] +-------------------------------------------------------------------------------- +The retail stores did fantastic on iPhone, very strong double-digit growth in iPhone from a year-over-year point of view. And one of the factors that enabled that was the -- getting to monthly payments on the Apple Card to make it very simple. Of course, that's U.S.-only at this point, but the U.S. is a very key market for us. And so it was an important part of it. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [12] +-------------------------------------------------------------------------------- +Thank you, Tom. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +That will come from Shannon Cross, Cross Research. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [14] +-------------------------------------------------------------------------------- +I wanted to go back to revisit China. Tim, can you talk about what you're seeing in the region -- what you were seeing in the region prior to the health crisis? And then can you also update us a bit in terms of your manufacturing strategy, dual sourcing, geographic diversification even within the region just so we have some idea of how this will be managed? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- +Yes. Thanks, Shannon. In terms of China, the results from last quarter and then I'll get into the coronavirus second. For the results from last quarter, we had double-digit growth for iPhone in Mainland China, so that was an important change from where we had been running. We also had double-digit growth in Services in Mainland China, and we had extremely strong double-digit on Wearables. And so really, there were a number of different factors. +In terms of the things that customers are responding to, iPhone 11 is doing particularly well there. The product has been very well received with its battery life, and the camera is unbelievable. We also, as you probably know, have certain trade-in programs going and financing programs. These have also been well-received. And so it's sort of the sum of all of this, and we're attracting quite a large percentage of new customers on products like the Mac. 3/4 of the customers buying a Mac in China are new, and nearly 2/3 of the customers buying iPad are new. And so it was a terrific quarter. We had 3 of the top 4 selling smartphones in urban China according to Kantar. +In terms of the coronavirus, as I mentioned earlier, first and foremost, our thoughts are with all of those that are affected across the region. And as I've mentioned, we're donating to groups that are working to contain the outbreak. We're also working very closely with our team and our partners in the affected areas, and we have limited travel to business-critical situations as of last week. The situation is emerging, and we're still gathering lots of data points and monitoring it very closely. As Luca had mentioned, we have a wider-than-usual revenue range for the second quarter due to the greater uncertainty. +I'll talk about supply chain and customer demand some to give you some color. With respect to the supply chain, we do have some suppliers in the Wuhan area. All of these suppliers, there are alternate sources, and we're obviously working on mitigation plans to make up any expected production loss. We factored our best thinking in the guidance that we provided you. +With respect to supply sources that are outside the Wuhan area, the impact is less clear at this time. The reopening of those factories after Chinese New Year has been moved from the end of this month to February 10, depending upon the supplier location. And we've attempted to account for this delayed start-up through our larger range of outcomes that Luca mentioned earlier. +With respect to customer demand and sales, we've currently closed 1 of our retail stores, and a number of channel partners have also closed their storefronts. Many of the stores that remain open have also reduced operating hours. We're taking additional precautions and frequently deep cleaning our stores as well as conducting temperature checks for employees. While our sales within the Wuhan area itself are small, retail traffic has also been impacted outside of this area across the country in the last few days. And again, we have attempted to account for this in our guidance range that we've provided you. I hope that gives you some color. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [16] +-------------------------------------------------------------------------------- +Yes, that was really helpful. Luca, maybe if you could just touch on, from a gross margin perspective, the commodity pricing environment and availability. Obviously, there's been some movement on DRAM and NAND. So if you can talk about how you're thinking about inventory levels and managing that going forward. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [17] +-------------------------------------------------------------------------------- +Yes. As I said earlier to the question around the gross margin guidance for the March quarter, we are seeing a benign commodity environment. Most commodities have been declining during the December quarter, and we expect the same to happen in the March quarter. As always and as you probably know, we look at the way these prices move. And at times when we feel it's appropriate, we buy certain commodities in advance. And so we will continue that practice as we go through the year. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [18] +-------------------------------------------------------------------------------- +Thank you, Shannon. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +That will come from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [20] +-------------------------------------------------------------------------------- +Luca, can you address the modest slowdown in Services growth this quarter, 17% versus 18% in September? Which Services categories accelerated versus where did you see some deceleration in the growth? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [21] +-------------------------------------------------------------------------------- +Katy, let me make a couple of comments here. The 17% during the December quarter, we look at it against our fiscal year '19 growth rate, which was 16%, so we feel very good about the results for the December quarter. As Tim and I mentioned during our prepared remarks, it was a very broad-based growth because we grew double digits in Services across all the 5 geographies. We set all-time records for many, many categories, music, cloud, search ads, payment services, December records for the App Store and AppleCare. +If you remember, we had set 2 goals for ourselves in the Services segment. First, we set a goal to double our fiscal '16 revenue during 2020, and when we look at it on a run rate basis, we've already achieved that goal with the results for the December quarter. We also set a goal to pass 500 million paid subscriptions during 2020. And given that we are already at 480 million at the end of December, we expect to pass that mark during the March quarter. And so now we are setting a new target for ourselves for paid subscriptions. And so we are now aiming to reach 600 million before the end of calendar 2020. +So we feel that the Services business is growing incredibly well. Of course, we have launched new services very recently. For example, Apple TV+ just launched in November. And so while these services did not have a material impact in our December quarter results, we expect that over time, these are contributing to the growth of the Services business. But we feel very happy with the 17%. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [22] +-------------------------------------------------------------------------------- +Tim, as a follow-up, at some point in the future, Apple will launch a 5G iPhone. How big of a demand driver do you view 5G capability in a handset? And what's your view as to what the killer app will be from a consumer perspective? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [23] +-------------------------------------------------------------------------------- +We don't comment on future products, and so I'll try to sidestep a bit. With respect to 5G, I think it's -- and we're in the early innings of its deployment on a global basis. We obviously couldn't be prouder of our lineup and is -- and are very excited about our pipeline as well and wouldn't trade our position for anybody. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +We'll hear from Kyle McNealy with Jefferies. + +-------------------------------------------------------------------------------- +Kyle P. McNealy, Jefferies LLC, Research Division - Equity Analyst [25] +-------------------------------------------------------------------------------- +So we're seeing some signs of new spectrum being deployed for 5G deployments and even additional 4G capacity, and it's already having a positive impact for handset upgrades to use that new capacity. Do you get the sense that wireless carriers are getting more incentivized to upgrade handsets to get leverage out of these new network investments? How much might this be helping? And do you think it will continue to accelerate? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [26] +-------------------------------------------------------------------------------- +I think that we've had some great partners not only in the U.S. but also around the world that were really helpful this quarter as partners. And so I think that probably a part of that is the level of investments they have, and then a part of it is probably making sure that those customers stick with them in an environment where there's a lot of trading back and forth. So I'm optimistic that it will continue. + +-------------------------------------------------------------------------------- +Kyle P. McNealy, Jefferies LLC, Research Division - Equity Analyst [27] +-------------------------------------------------------------------------------- +Okay, great. And then the comment that you made about capacity in your Wearables division with AirPods Pro and Apple Watch 3, what should we think about the time line of when those capacity constraints might be alleviated? And will they come from capacity additions or the natural workout of kind of unit shipments and something on the demand side? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- +I'm hopeful that the Series 3 will come into balance during this quarter. On AirPods Pro, I don't have an estimate for that for you. I just can't predict when at this point where -- we seem to be fairly substantially off there, and we're working very hard to put in additional capacity. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [29] +-------------------------------------------------------------------------------- +Thanks, Kyle. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Yes. Wamsi Mohan, Bank of America. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [31] +-------------------------------------------------------------------------------- +Tim, Apple has a very valuable installed base of users. Can you see a future where Apple can become larger in the advertising market as you build out TV+, given you could have the unique position and ability to drive targeted ads to users without compromising on privacy? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [32] +-------------------------------------------------------------------------------- +I think it's -- I think it is possible to have advertising in a straightforward manner that doesn't encroach on people's privacy. I wouldn't want to conjecture about us in that business. I think for the TV+ business, we feel strongly that what that customer wants is an ad-free product, and so that's not our aversion to ads, it's what we believe that the customer wants. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [33] +-------------------------------------------------------------------------------- +Okay. And Luca, can you just clarify if the Services revenue this quarter had any impact of deferrals associated with TV+ at all? And how can you help us maybe size the impact of the amortization of the content cost associated with TV+ as we think about the next couple of years? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [34] +-------------------------------------------------------------------------------- +Yes. So yes, of course, we launched the service, and so there was a very small contribution to revenue from the deferral. And there was also a contribution to revenue from the people, the subscribers that are actually paying for the service. When you think about what goes into the Apple TV+ revenue, at this point, there are 2 components: the paid subscribers, these are the customers that pay for the service and we recognize revenue over the subscription period; and then we've got the what we call the Apple TV+ bundle subscribers, these are the customers that buy an eligible hardware device and redeem the offer for a free year of TV+ services. We defer revenue for this offer based on 3 items. The first one is the value of the service that is being provided, the 1-year of Apple TV+. The second one is the number of customers that are eligible for the offer, and the third one is our estimate of the expected number of customers that will redeem the offer. So you need to keep in mind that from our total eligible device sales, you need to make a number of reductions for family sharing, for multiple device purchases and for geographic availability. Also the take rate can also be impacted by the availability of local content, and we also require a payment method on file. So this estimate is reviewed quarterly and gets updated based on actual trends of the offer. +And so these inputs provide us with the amount of revenue that we defer for each device sale that then gets recognized over the 1-year period that the TV+ service is provided. And so when you take the combination of pay subscribers and bundled subscribers, you get the Apple TV+ revenue. Of course, because we launched the service very recently, the amount of revenue that we recognized during the quarter was immaterial to our results. +With regard to the cost of the service, of developing the content, we -- essentially, as we incur these costs, we put them on the balance sheet, and then we amortize them over a certain period of time depending on the type of content that we produce. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +We'll hear from Cowen and Company's Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [36] +-------------------------------------------------------------------------------- +Congrats on the great results. I had 2 questions. First one, Tim, I just wanted to pick your brain a little bit on the overall smartphone market. There's a general view that when 5G phones come out, they're going to be more expensive due to higher component costs. But at the same time, it looks like you guys have proven that there is a market for low-cost geographies with phones like iPhone SE. So how do you see these 2 different segments within the smartphone market evolving over the next 1 to 3 years? And then I have a follow-up for Luca. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [37] +-------------------------------------------------------------------------------- +Again, I want to stay away from commenting about future products. But generally, I think it's important when you think about 5G is to look around the world at the different deployment schedules. And some of those look very different perhaps than what you might be seeing here. And so that's very important. In terms of the price, I wouldn't want to comment on the price of handsets that aren't announced. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [38] +-------------------------------------------------------------------------------- +Got it. No worries, Tim. And then a follow-up for Luca. OpEx as a percentage of sales for March looks like about 15% higher than in your prior quarters. Kind of curious, how much of that, as part of it, is driven by some of your Intel modem asset purchases or TV+ in the OpEx? Or how do we think about it on a go-forward basis? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [39] +-------------------------------------------------------------------------------- +Yes. I think we felt good about our OpEx results because they were at the low end of our guidance range. But clearly, we want to make all the necessary investments in the business. And from -- in terms of the new services, not only for TV+ but all the new services that we launched during 2019, this is a period where we're making the necessary investments in advertising and marketing, and that level of investment is reflected in our OpEx results. +And also, as you correctly stated, we completed the acquisition of the Intel baseband business during the December quarter. And so we had -- we reflected the run rate of the expenses related to that business partially during the quarter after the completion of the transaction. And we -- that is a very important core technology for the company, so we will continue to make all the necessary investments also there. There is a third category of expenses that affected the December quarter and is the fact that our revenue was very strong, and we have certain variable expenses, for example, credit card fees that are associated with higher volume and, of course, impacted our OpEx results. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [40] +-------------------------------------------------------------------------------- +Thanks, Krish. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +That will be from Mike Olson with Piper Sandler. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [42] +-------------------------------------------------------------------------------- +So a slightly different take on an earlier question on Wearables, and that is, what impact do you think Wearables is having on driving people into the Apple ecosystem? You mentioned 75% of watch buyers are new to the Apple Watch, but are many of them new to Apple overall? I'm sure a lot of existing iPhone, iPad or Mac users are going to be Wearables customers, but do you think Wearables bring people into the ecosystem to buy other devices in a material way? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [43] +-------------------------------------------------------------------------------- +I think that -- Michael, it's Tim. With each Apple product that a customer buys, I think they get tighter into the ecosystem because they like -- that's the reason that they're buying into it, is they like the experience, the customer experience. And so from that point of view, I think each of our products can drive another product. I would think in that case, it's more likely that the iPhone comes first, but there's no doubt in my mind that there's some people that came into the ecosystem for the Watch. + +-------------------------------------------------------------------------------- +Michael Joseph Olson, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [44] +-------------------------------------------------------------------------------- +Yes. And then I think you recently mentioned that augmented reality will pervade our entire lives. And I'm wondering if you could share your thoughts about how you think it starts to impact our lives most significantly. For example, will the inflection point in AR come from gaming or industrial usage or some other category? In other words, where will the average person kind of first feel the impact of AR on their lives in a significant way? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [45] +-------------------------------------------------------------------------------- +I think when you look at AR today, you would see that there are consumer applications, there are enterprise applications. This is the reason I'm so excited about it, is you rarely have a new technology where business and consumer are both -- most see it as key to them. And so I think it's -- the answer is that that's the reason that I think it's going to pervade your life, is because it's going to go across both business and your home life. And I think these things will happen in parallel. There are already companies that are deep into the enterprise business that are working on applications for the enterprise. And of course, you can see -- you can go on the store and see thousands of apps that are ARKit-enabled at this time and with even more coming. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [46] +-------------------------------------------------------------------------------- +Thank you, Mike. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +That will come from Raymond James' Chris Caso. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [48] +-------------------------------------------------------------------------------- +I guess the first question is on gross margins, and you spoke about the favorable mix. Wondering if you could expand on that a little bit. And clearly, iPhone is doing well within the overall mix, growing year-on-year. But if you could talk about what's happening to the mix within iPhone. Is that improving as well and also helping margins? And is there anything else you would point to with regard to the overall mix in margins? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [49] +-------------------------------------------------------------------------------- +Yes. I think that the mix helped us both in Q1, and it's helping us with the guidance for Q2. And as you said, some of it is mix of iPhones. The customer response for iPhone 11, 11 Pro and 11 Pro Max has been exceptional, and that clearly has helped our mix. iPhone 11 was our top-selling model throughout the quarter, every single week of the quarter. And so certainly, better mix within iPhone. +The other point that I'd like to point out is that as we move from Q1 to Q2, the proportion of revenue coming from Services increases versus the holiday quarter. And given the fact that Services are accretive to gross margin for the company, we end up getting a better mix from Services as well. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [50] +-------------------------------------------------------------------------------- +Okay. And I guess a follow-on question with regard to OpEx, and it has been growing at a faster rate than revenue for, I guess, largely over the last 3 years or so. Can you set us some expectation with regard to when you get a return on that investment? I understand there are new investments that are happening now. But how should we think about potential leverage going forward? Is there a point in time where the OpEx spending tend to level off and you get some return on that? Or is it just a function of faster revenue growth in the future? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [51] +-------------------------------------------------------------------------------- +Well, I would start by saying that our expense to revenue ratio is incredibly competitive relative to other companies in our sector. There are years when our OpEx grows faster than our revenue, but we've also had years in the recent past where the opposite has happened. We continue to believe that we have a lot of great opportunities in front of us. And just if you look at this past year, we launched many new initiatives, for example, on the Services front, which we want to support with the appropriate level of investment, not only marketing and advertising but also in R&D. +As I mentioned earlier, we closed the acquisition of the Intel baseband business because we think it's a very important strategic core technology for the company going forward. And I think from the results that you've seen during this quarter and the guidance that we provided during -- for the March quarter, I think we're doing a pretty good job at balancing the level of investments that we are making on the expense front with the level of returns that we get, both in terms of revenue and in terms of profitability that we're getting. Our net income, for example, was up 11% during the December quarter. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [52] +-------------------------------------------------------------------------------- +Thank you. Can we have the next question, please? + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +That will come from Samik Chatterjee with JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [54] +-------------------------------------------------------------------------------- +Just wanted to kind of ask on the iPhone revenue growth and definitely good to see it return to growth. Based on the velocity or momentum you're seeing for the products exiting the quarter, how comfortable are you feeling about sustaining growth in iPhone revenues through the year? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [55] +-------------------------------------------------------------------------------- +We have a practice of forecasting the current quarter, and so we've given you the range that we expect for the current quarter and really don't give a range beyond that. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [56] +-------------------------------------------------------------------------------- +Okay. So if I can just maybe then follow up in terms of, obviously, you've returned to growth in most of the regions you report. One of the regions that are declining is Japan, so if you can share your thoughts on what actions you need to take there to return that segment -- that geography to growth. And what are the product trends there? What's probably the headwind that's kind of limiting growth there? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [57] +-------------------------------------------------------------------------------- +Yes. So Japan was down 10% during the December quarter, was primarily due to iPhone performance, which was challenged because there were some regulatory changes that took effect on the 1st of October, where essentially, the regulators decoupled the mobile phone pricing from the 2-year contracts and are capping the maximum amount of carrier discounts that can be made. At the same time, I would say, within a more difficult macro environment, iPhone did incredibly well during the quarter. 6 of the top 7 selling smartphone models in Japan during the December quarter were iPhones. So it was a very strong performance by iPhone in a difficult environment. +Also, in Japan, we had very strong double-digit growth from Services, stronger than company average, and very strong double-digit growth in Wearables, also stronger than company average. So we feel very good. Japan is a country where it's starting to -- we've had great success. The customers are very loyal and very engaged, and we have a very strong position there, and we feel we have a very good momentum. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [58] +-------------------------------------------------------------------------------- +Thank you, Samik. A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. The numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 6826206. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414. Financial analysts can contact me with additional questions at (669) 227-2402. Thank you again for joining us. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Again, that will conclude today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AAPL/2020-Jul-30-AAPL.txt b/Transcripts/AAPL/2020-Jul-30-AAPL.txt new file mode 100644 index 0000000000000000000000000000000000000000..b00e1e24c1563d4de343e10033a696c4e3562f37 --- /dev/null +++ b/Transcripts/AAPL/2020-Jul-30-AAPL.txt @@ -0,0 +1,603 @@ + + +Thomson Reuters StreetEvents Event Brief +E D I T E D V E R S I O N + +Q3 2020 Apple Inc Earnings Call +JULY 30, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tejas Gala + Apple Inc. - IR Contact + * Luca Maestri + Apple Inc. - CFO & Senior VP + * Timothy D. Cook + Apple Inc. - CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Benjamin James Bollin + Cleveland Research Company - Senior Research Analyst + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Kyle P. McNealy + Jefferies LLC, Research Division - Equity Analyst + * Shannon Siemsen Cross + Cross Research LLC - Co-Founder, Principal & Analyst + * Wamsi Mohan + BofA Merrill Lynch, Research Division - Director + * Kanghui Ong + Deutsche Bank AG, Research Division - Research Analyst + * Kathryn Lynn Huberty + Morgan Stanley, Research Division - MD and Research Analyst + * Jim Suva + Citigroup Inc., Research Division - MD & Research Analyst + +================================================================================ +OVERVIEW +================================================================================ +Co. reported 3Q20 revenue of $59.7b, net income of $11.3b, and EPS of $2.58. + +================================================================================ +FINANCIAL DATA +================================================================================ + + 1. 3Q20 revenue = $59.7b. + 2. 3Q20 net income = $11.3b. + 3. 3Q20 EPS = $2.58. + 4. 3Q20 YoverY revenue growth = 11%. + 5. 3Q20 Co. GM = 38%. + 6. 3Q20-end net cash = $81b. + 7. 3Q20-end cash plus marketable securities = almost $194b. + 8. 3Q20-end total debt = $113b. + 9. 3Q20 share repurchase = $10b through open market repurchases of 31.3m AAPL shares. + +================================================================================ +PRESENTATION SUMMARY +================================================================================ + +-------------------------------------------------------------------------------- +I. 3Q20 Review (T.C.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. In uncertain environment, saw qtr. of historic results, demonstrating important role Co.'s products play in customers' lives. + 2. Revenue $59.7b; June qtr. record. + 1. Up 11% YoverY. + 2. Products and Services set June qtr. records and grew double-digits. + 3. Revenue grew in each geographic segment, reflecting broad base of success. + 3. Committed $100m to launch Co.'s Racial Equity and Justice Initiative and new and renewed internal efforts to foster diversity and inclusion at all levels of Co. + 4. As COVID-19 continues to represent great risk for individuals and great uncertainty for communities, care and adaptability are defining how Co. conducts work wherever it works. + 1. In some places that has met responsibly reopening operations and retail stores with enhanced health and safety precautions. + 2. In others, where virus has reemerged, it's met taking challenging, but necessary step of re-closing stores. + 5. Due to uncertain and ongoing impacts of COVID-19, did not provide typical guidance when Co. reported results last qtr. + 1. Provided some color on how Co. expected June qtr. to play out. + 2. Product Categories: + 1. iPhone revenue grew 2%. + 1. In April, expected YoverY performance to worsen. + 2. Saw better-than-expected demand in May and June. + 1. Attributes increase in demand to several interactive causes, including strong iPhone SE launch, continued economic stimulus, and potentially some benefit from shelter-in-place restrictions lifting worldwide. + 2. Expected iPad and Mac growth to accelerate. + 1. Saw strong double-digit growth for these devices. + 1. This remarkable performance came despite supply constraints on both products. + 2. Working hard to get more iPads and Macs into customers' hands as quickly as possible, recognizing how integral they have become to working and learning from home, providing entertainment, and staying connected with loved ones. + 3. Wearables growth decelerated as expected, but grew by strong double-digits. + 1. Set revenue record for non-holiday qtr. + 2. Building on powerful new features built into watchOS 7 and AirPods Pro announced this qtr., excited about many opportunities in front of Co. for this product category. + 1. Strong results helped drive installed base of active devices to new all-time records across each product category. + 4. Reflecting deep integration of hardware, software and services, Services generated June qtr. record of $13.2b, up 15% YoverY. + 1. There were two distinct trends Co. was seeing and they played out as it thought. + 1. Results for advertising and Apple Care were impacted by reduced level of economic activity and store closures to a degree that was in line with expectations. + 2. Strong performance in digital services with all-time revenue records in App Store, Apple Music, video and cloud services and elevated engagement on iMessage, Siri, and FaceTime. + 2. Customers are loving new offerings across Co.'s Services like: + 1. Apple News Today, new daily audio briefing. + 2. Greyhound, new summer blockbuster starring Tom Hanks. + 3. Apple TV+ hit history making 95 awards nominations and 25 wins and accolades. + 4. Based on aforementioned results and performance over last four quarters, achieved goal of doubling FY16 Services revenue six months ahead of schedule. + 3. Other Highlights: + 1. Conscious of the fact that these results stand in stark relief during time of real economic adversity for businesses, large and small, and certainly for families. + 1. Does not have zero-sum approach to prosperity. + 2. Especially in times like this, focused on growing the pie, making sure Co.'s success isn't just its success and that everything it makes, builds, or does is geared toward creating opportunities for others. + 3. App Store is a great example. + 1. This qtr., new study by independent economists at Analysis Group found that App Store facilitated more than 0.5t in commerce globally in 2019 alone. + 2. Especially in a time of COVID-19, one can measure economic resilience in the ways in which App Store supports remote ordering for restaurants, digital commerce for small businesses, and enduring entrepreneurial opportunity for creators and visionaries. + 2. Keeping learning vibrant and impactful in the time of COVID-19 is priority everyone shares. + 1. Earlier this month, announced significant enhancements to Develop in Swift and Everyone Can Code curricula. + 1. Launched new professional learning course available exclusively to educators. + 2. Two weeks ago, Community Education Initiative added 10 more historically black college and university regional coding centers to roster, bringing total to 24 locations nationwide. + 1. 12 of which are HBCUs. + 2. 21 of which serve majority black and brown student populations. + 3. In Co.'s backyard, announced that it is allocating $400m of multi-year $2.5b affordable housing commitment to new housing construction, homebuyer assistance programs, and support for those at greatest risk of experiencing homelessness across Silicon Valley. + 4. Results are possible due to people and their ongoing ingenuity, flexibility, resilience, and determination during these ever-changing times. + 1. Apple Care and retail teams paired exceptional service during time of intense demand with great adaptability during qtr. where stores have reopened in some places and re-closed in others. + 2. Team of specialists and experts has shoulder the task of caring for well-being of teams and communities store by store, location by location, with evidence-driven granularity and agility that is unrivaled anywhere. + 5. Innovation from adversity certainly define this year's Worldwide Developers Conference. + 1. Event where traditionally Co.'s worldwide community of developers gathers together to share, celebrate, and do big things together. + 2. Though could not be together in person, Co. set new standard for what online events can achieve with celebrated all virtual event. + 3. More than 22m viewers tuned in across all of Co.'s streams. + 4. For developers, distributed more than 72 hours of video content; three full days of video. + 5. Week saw more than 200 direct-to-video engineering and design sessions and about 4,500 person-to-person appointments with developers across 227 virtual labs. + 6. This year's announcements: + 1. iOS 14, which boasts radical redesign to home screen, powerful updates to messages, streamlined and effortless app clips and even greater privacy transparency and controls. + 2. Major updates to Apple Pencil, Siri [and calling] iPadOS 14. + 3. Much anticipated sleep tracking, new fitness and wellness features and unprecedented customization in watchOS 7. + 4. New macOS Big Sur, boasting biggest redesign upgrade to macOS since OS X. + 7. No less important for Co.'s innovation road map is transition to AAPL silicon for Mac. + 1. This two-year effort will achieve unprecedented performance for Mac and common architecture across all AAPL products. + 4. Outlook: + 1. Profoundly optimistic about future. + 2. Recognizes that with this success comes some real responsibility to lead with values because those values help make that success possible in the first place. + 3. Will be fully carbon-neutral by 2030 across entire supply chain and including energy use of every device Co. makes as it is of any hardware innovation. + 4. Committed to standing with those marching for lives and dignity through new $100m commitment to Co.'s Racial Equity and Justice Initiative. + 1. Deepening diversity and inclusion efforts internally. + 1. Future as a business is inextricably linked with future of communities. + +-------------------------------------------------------------------------------- +II. 3Q20 Financials (L.M.) +-------------------------------------------------------------------------------- + + 1. Highlights: + 1. June qtr. was a testament to Co.'s ability to innovate and execute during challenging times. + 2. Results speak to resilience of business and relevance of products and services in customers' lives. + 3. Total revenue $59.7b, new June qtr. record, up 11% YoverY, despite 300 BP headwind from FX. + 4. Performance was strong across entire portfolio, as Co.: + 1. Grew revenue in each product category. + 2. Set June qtr. records for Mac, Wearables, and services. + 5. Strong results worldwide, with: + 1. Growth in all geographic segments. + 2. New June qtr. records in: + 1. Americas. + 2. Europe. + 3. Japan. + 4. Rest of Asia-Pacific. + 6. Products revenue $46.5b, up 10% and June qtr. record. + 1. iPhone returned to growth. + 2. Saw strong double-digit growth from: + 1. iPad. + 2. Mac. + 3. Wearables. + 3. Lockdowns and point of sale closures were widespread during April and impacted performance. + 1. Saw demand for all products improve significantly in May and June. + 4. Due to strong performance and unmatched loyalty of customers, installed base of active devices reached all-time high in all geographic segments and all major product categories. + 7. Services continued to grow strongly, up 15% YoverY. + 1. Reached June qtr. record of $13.2b. + 2. Set all-time records in many Services categories and June qtr. records in each geographic segment. + 2. GM: + 1. Co. GM 38%. + 1. Down 40 BP sequentially due to unfavorable FX of 90 BP and different mix of products, partially offset by cost savings and services mix. + 2. Products GM 29.7%, decreasing 60 BP sequentially due to FX and different mix, partially offset by cost savings. + 3. Services GM 67.2%, up 180 BP sequentially, mainly due to mix. + 4. Net income $11.3b. + 5. EPS $2.58, up 18% and June qtr. record. + 6. Operating cash flow was June qtr. record at $16.3b. + 1. $4.6b improvement YoverY. + 3. iPhone: + 1. Revenue grew 2% to $26.4b, with customer demand improving as qtr. progressed. + 2. COVID-19 was most impactful during first three weeks of April when lockdowns and point of sale closures became more widespread in many countries. + 1. Saw marked improvement around the world in May and June, which Co. attributes to improved level of customer demand, helped by successful launch of iPhone SE and economic stimulus packages. + 3. Active installed base of iPhones reached an all-time high due to loyalty of customer base and strength of ecosystem. + 1. In US, latest survey of consumers from 451 Research indicates iPhone customer satisfaction of 98% for iPhone 11, 11 Pro and 11 Pro Max combined. + 4. Services: + 1. Revenue $13.4b; June qtr. record. + 2. Had all-time record performance and strong double-digit growth in: + 1. App Store. + 2. Apple Music. + 3. Video. + 4. Cloud services. + 3. New services, Apple TV+, Apple Arcade, Apple News+ and Apple Card are contributing to overall Services growth and continue to add users, content, and features. + 4. Customer engagement in ecosystem continues to grow at a fast pace. + 1. Number of transacting and paid accounts on digital content stores reached new all-time high with paid accounts increasing double-digits in each geographic segment. + 5. In aggregate, paid subscriptions grew more than 35m sequentially. + 1. Has over 550m paid subscriptions across services on platform, up 130m from a year ago. + 2. With this momentum, remains confident to reach increased target of 600m paid subscriptions before calendar 2020-end. + 5. Wearables, Home & Accessories: + 1. Revenue $6.5b; new June qtr. record. + 1. Up 17% YoverY. + 2. Wearables business is now the size of a Fortune 140 co. + 1. Set June qtr. records in majority of markets Co. tracks. + 2. Apple Watch continues to extend its reach, with over 75% of customers purchasing Apple Watch during 3Q20 new to product. + 6. Mac & iPad: + 1. Mac: + 1. Revenue $7.1b; June qtr. record. + 1. Up 22% YoverY. + 2. Grew double-digits in each geographic segment. + 3. Set all-time revenue records in Japan and rest of Asia-Pacific and June qtr. records in Americas and Europe. + 2. Customer response to new MacBook Air and MacBook Pro launches has been strong. + 2. iPad: + 1. Revenue $6.6b, up 31%. + 1. Highest June qtr. revenue in eight years. + 2. Demand was strong worldwide, with double-digit growth in each geographic segment, including June qtr. record in Greater China. + 3. Launch of new iPad Pro has been received incredibly well in every region of the world. + 3. Mac and iPad are extremely relevant products in new working and learning environments. + 1. Most recent surveys of consumers from 451 Research measured customer satisfaction of 96% for Mac and 97% for iPad. + 2. Around half of customers purchasing Mac and iPad during 3Q20 were new to that product. + 1. Active installed base for products reached new all-time high. + 7. Others: + 1. Retail business had record June qtr. revenue due to performance of online store. + 1. Set records in all geographic segments and grew across all major product categories. + 2. In June, launched Apple Card Monthly Installments for more products in US stores, allowing customers to pay for their devices overtime with 0% interest. + 1. Pleased with level of customer interest this new offering has generated. + 2. In enterprise market, continues to see companies leverage Apple products and offerings to successfully navigate their businesses through COVID-19. + 3. In healthcare, seeing rapid acceleration of telehealth to support more flexible model of patient care. + 1. Many hospitals like UVA Health, Rush University Medical Center and UC San Diego Health are using apps on iPad and iPhone to have triage, monitor and care for patients who are at home. + 1. This helps free up hospital capacity to support patients who need inpatient care, while enabling continued care for patients who do not require in-person visits. + 4. Since many call center employees are currently working remotely, Apple Business Chat has proven invaluable tool for staying connected with customers. + 1. HSBC deployed Apple Business Chat in its US and UK contact centers. + 2. Apple Business Chat provides flexible and secured channel for digital banking assistance through native AAPL experience, improving efficiency and experience for customers and agents. + 3. Seeing similar adoption by hundreds of other organizations. + 8. Cash Position: + 1. 3Q20-end cash plus marketable securities, almost $194b. + 2. Issued $8.5b of new term debt, retired $7.4b of term debt and increased short-term borrowing facilities by $1.1b, leaving Co. with total debt of $113b. + 3. 3Q20-end net cash $81b. + 1. Continues on path to reaching net cash neutral position over time. + 4. Returned over $21b to shareholders, including: + 1. $3.7b in dividends and equivalents. + 2. $10b through open market repurchases of 31.3m AAPL shares. + 5. Began $6b accelerated share repurchase program in May, resulting in initial delivery and retirement of 15.2m shares. + 6. Retired additional [4.8m] shares in final settlement of 15th ASR. + 9. 4Q20 Outlook: + 1. Similar to last qtr., given uncertainty worldwide in near term, will not be issuing revenue and margin guidance. + 1. Will provide some additional insight on expectations for product categories. + 2. iPhone: + 1. Expects to see recent performance continue for current product lineup, including strong customer response for iPhone SE. + 2. Last year, started selling new iPhones in late Sept. + 1. This year, projects supply to be available few weeks later. + 3. Expects rest of product categories to have strong YoverY performance. + 3. Services: + 1. Expects to have same trends observed during June qtr. except for Apple Care, where during Sept. qtr. year ago Co. expanded distribution significantly. + 1. Expects difficult comp for Apple Care, considering COVID-related point of sale closures this year. + 4. GM: + 1. Will have different mix than in prior years. + 5. OpEx $9.8-9.9b. + 6. Tax rate about 16.5%. + 7. OI&E $50m. + 8. Board of Directors declared cash dividend of $0.82 per share of common stock, payable on 08/15/20 to shareholders of record as of 08/10/20. + 9. On 07/30/20, announcing four-for-one split of AAPL common stock to make stock more accessible to broader base of investors. + 1. Each shareholder of record at close of business on 08/24/20 will receive three additional shares for every outstanding share held on record date and trading will begin on split-adjusted basis on 08/31/20. + + +================================================================================ +QUESTIONS AND ANSWERS +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Yes. That will be from Katy Huberty with Morgan Stanley. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [2] +-------------------------------------------------------------------------------- + + Tim, in light of the economic adversity that you talked about in the prepared remarks, can you just walk us through how Apple's leveraging finance and trade-in programs to make technology more affordable and accessible during this period while also addressing the opportunity to recycle and reuse products and maybe also extend that to how these programs might expand over time? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + As Luca mentioned, in June, we actually rolled out to the overwhelming balance of our other products the ability to do interest rate -- interest-free financing in our stores with payments. And that's in addition to trade-in, which is becoming a more common trend now, which I think is terrific because it is great for the environment and it acts as a subsidy, if you will, against the price of a new phone. And so when you compound these 2 things with the financing and the trade-in, it makes the product super affordable. And we're really happy with what we're seeing in that regard. + +-------------------------------------------------------------------------------- +Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [4] +-------------------------------------------------------------------------------- + + And then as a follow-up, just specifically to iPhone, the category returned to growth. As you pointed out, the installed base is larger today. Our math would suggest that replacement cycles, in some cases, are elongated. And then you have the affordability element that you just discussed. Does all of that combine to build confidence that we're entering a longer period of iPhone revenue growth after what's been 6 quarters of decline? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [5] +-------------------------------------------------------------------------------- + + We're very pleased with how we did on iPhone. It was better than we thought largely because, as we pointed out in the prepared remarks, May and June were much better. If you look at iPhone in totality, the things that get me very optimistic is the size of the active installed base. The fact that if you look in the major geographies like the U.S., we had the top 2 selling smartphones. In the U.K., we had 3 of the top 4. In Australia, we had 5 of the top 6. And in Japan, we had the top 4. Urban China, we were -- iPhone 11 was the top-selling smartphone in the country. And so these are some very different geographies with very different competitive situations and we're doing fairly well. +The iPhone SE, it's also clear that from the early data, we're seeing a higher switcher number than we did in the previous year, which we feel very good about. And it also seemed to appeal to some people that were holding onto the device a little longer because they wanted a smaller form factor phone. And so the combination of the smaller form factor and an incredibly affordable price made the iPhone SE very popular. iPhone 11 is still the most popular smartphone, but iPhone SE definitely helped our results. And as we -- as Lucas said in his outlook, we do see that continuing into this quarter currently. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + That will be from Krish Sankar with Cowen and Company. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + I have 2 of them. First one, Tim, when you look at the Services business and in terms of your TV+ content production, have the movement restrictions impacted the content production efforts? And along the same path, 4 years ago, your premonition on Services being a $50 billion business in 2020 came sooner than expected. I don't know if you want to make any such forecast 4 years out on how you think Services revenue is going to be. Then I had a follow-up for Luca. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [8] +-------------------------------------------------------------------------------- + + I'm sorry. I missed that second question because the audio didn't come through. But I think I got to -- just to the first, and that is production has been affected for Apple TV+, as I think it has for most people. We are working to get restarted. I don't have a precise date yet when we will get restarted, but there will be some impact because we shut down in the March time frame and are yet to really restart in a significant way particularly for those that are shot in the L.A. area given the current status of the virus in this -- and I'm sorry, I missed your -- the second part of your question. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + Well, Tim, I was trying to see. 4 years ago, you made a great prediction that Services is going to be $50 billion by 2020. I wanted to see if you have any update to the prediction 4 years down the road. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- + + We're not updating today. We feel good. We want to take the moment and feel good about achieving the doubling 6 months early. And we do have, still hanging out there, as you know, the subscription number that we're shooting for later in the year at 600 million. So we do have that objective out there. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [11] +-------------------------------------------------------------------------------- + + Okay. If I could just squeeze in one for Luca. With the strong sales in Mac given the shelter in place, do you think the back-to-school season got pulled in by a quarter? Or do you expect the momentum to still continue? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [12] +-------------------------------------------------------------------------------- + + As I said when I was talking about providing some commentary for the September quarter, we expect all the non-iPhone product categories to have a very strong year-over-year performance. So we definitely -- I mean the back-to-school season is clearly this one. And we're very excited not only for the Mac but also for the iPad. We got a fantastic lineup of products, and we know that these products are incredibly relevant especially given the current circumstances. So we expect the performance that we've seen for Mac in the June quarter to continue. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + From Cross Research, we'll hear from Shannon Cross. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [14] +-------------------------------------------------------------------------------- + + Tim, can you talk a bit about what you're seeing in China? I know the revenue was up 2%, and I think Luca talked about record iPad. But just curious as to -- given their 5G is a bit ahead, how you're seeing the market play out. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [15] +-------------------------------------------------------------------------------- + + Yes. Shannon, the growth that -- we did see growth in Greater China for the quarter of 2%. Currency affected China a bit more than in other places. It affected 400 basis points, and so in constant currency, we would have grown at 6%. As I'd mentioned before, the iPhone 11 has been our best-selling phone and has been #1 in Urban China, and so we're very, very proud of that. iPad was helped in the June quarter there by the work-from-home and distance learning as it was in other geographies, and the Mac also grew strong double digit during the quarter. And Services set a new June quarter record there. We also continue to see extremely high new customer rates on Mac and iPad there. To give you a perspective, about 3 out of 4 customers that are buying the Mac are new in China, and about 2 out of 3 that are buying the iPad are new. And so these are numbers that we're super proud of. + +-------------------------------------------------------------------------------- +Shannon Siemsen Cross, Cross Research LLC - Co-Founder, Principal & Analyst [16] +-------------------------------------------------------------------------------- + + Great. And then can you talk a little bit more about the decision to bring Mac silicon in-house and the benefits that you expect to see or you've seen from vertical integration of acquisitions like the Intel modem business? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [17] +-------------------------------------------------------------------------------- + + Yes. I mean what we wound up -- what we'll wind up with is a common architecture across all of our products, which gives us some interesting things that we can do in products that are -- that it sort of unleashes another round of innovation. And so I don't want to say a lot about it other than we're extremely excited about it. It's something that we've worked on quite a while to get to this point, and we're looking forward to shipping the first Mac with Apple silicon later in the year. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + That will come from Amit Daryanani with Evercore. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [19] +-------------------------------------------------------------------------------- + + I have one and a follow-up as well. So first one, I guess, Tim, if I think about the strength you're seeing with iPhones right now, do you have a sense in terms of where is this trend coming from? Is it more replacement cycles getting shorter? Or are we just getting new customers into the iOS ecosystem? Because clearly, these growth rates seem fairly impressive in the context of a pandemic and the upcoming refresh cycle that we have. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + I think, Amit, it's a combination of a strong launch with iPhone SE and in some -- probably some pickup because of the economic stimulus that hit different countries at different points in time and probably some of the reopening that took place across the quarter, particularly in May and June, as stores started to reopen. And so it's a combination of all of those. And as you know, we've been having a strong cycle with the iPhone 11 and the 11 Pro. And so when you combine the -- a strong cycle plus an iPhone SE launch plus the reopening of the stores, et cetera, I think there were a lot of things that were going in the right direction there. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [21] +-------------------------------------------------------------------------------- + + Perfect. That's helpful. And I guess, Luca, if I could just follow up with you. I'd love to get your perspective on how do we think about the overall 38% gross margins. What do you think are the levers to improve this as you go forward, not really September quarter but over the next 1 or 2 years? And in that context, do you see a point where the product gross margins start to stabilize because they have been trending somewhat lower for the last couple of quarters now? + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [22] +-------------------------------------------------------------------------------- + + Yes. Let me start with what we've seen during the June quarter. We were -- at 38%, we were down slightly sequentially but up the same amount on a year-over-year basis. And really, the big negative impact that we felt for several quarters now has been the strength of the U.S. dollar. So the foreign exchange impact on a sequential basis was 90 basis points, on a year-over-year basis was 130 basis points. So obviously, that is something to keep in mind. And then the other aspect, I think it's always important to keep in mind, Amit, is that we sell many different products. They have different margin profiles. And so sometimes, a different mix can have an impact on the aggregate level of products' gross margins. And we're very pleased to see the performance of Mac, iPad and wearables, but obviously, it's a different mix. +Going forward, the variables are always the same. It's -- the foreign exchange will continue to play an impact. The mix of products that we're going to be selling will have an impact as well. The commodities market has been relatively benign, and we'll see how that plays out over time. As you know now for several years, we've been managing gross margin, I would say, fairly well in spite of some difficult situations like the one with the strength of the dollar, and we plan to continue to make good trade-off decisions between revenue and units and margins. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + That will come from Kyle McNealy with Jefferies. + +-------------------------------------------------------------------------------- +Kyle P. McNealy, Jefferies LLC, Research Division - Equity Analyst [24] +-------------------------------------------------------------------------------- + + Our team in Asia, recently, we did some survey work on smartphones in China. It showed that there's still a high proportion of the installed bases on 6, 7 and 8 devices. I know you talked about the trade-in programs and promotions that you've been doing there. I wonder if you can tell us whether there's anything else that you're doing to get these customers into your latest technology. What might those customers be looking for? And how should we think about when an upgrade cycle might come on more strongly there in China? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [25] +-------------------------------------------------------------------------------- + + Customers upgrade at different -- at a different pace, and I don't have in front of me the exact installed base data from China. But I mean much like in other geographies, the upgrades have extended some. It extended some during the depths, if you will, of the pandemic in China and the rest of the world and probably, to some degree, is happening still at this point. The key things that we can do is keep innovating, deliver a product that people can't imagine going through life without and obviously keep rolling out these programs that make the front-end purchase be much less. And this is things like the financing and the trade-in programs that you mentioned. And I do feel like those are going quite good in a number of geographies. + +-------------------------------------------------------------------------------- +Kyle P. McNealy, Jefferies LLC, Research Division - Equity Analyst [26] +-------------------------------------------------------------------------------- + + Okay. Great. And one more, if I may. Congrats again on the strong iPad and Mac results. That's really impressive. I guess the obvious question is, should we ever think about how much of that might be pulled forward and what might it do to future upgrades in the next 2 years? Anything else you can share on how you think about growth from here or whether there's a hangover period maybe after the back-to-school season or holiday season, that would be helpful. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + The installed base is growing, and the new customer numbers that Luca went over in the aggregate are still very high in the -- close to 50% kind of range. And so that, to me, makes the -- bodes well for the future. There's clearly -- as we had indicated, there's some amount of work from home and remote learning that do affect the results of Mac and iPad positively. They probably affect wearables and iPhone the other direction and -- but on Mac and iPad, these are productivity tools that people are using to stay engaged with their work or stay engaged with their school work. And we believe we're going to have a strong back-to-school season. Sitting here today, it certainly looks like that. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + That will come from Cleveland Research's Ben Bollin. + +-------------------------------------------------------------------------------- +Benjamin James Bollin, Cleveland Research Company - Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + Tim, I was hoping you could share a little bit about where you think channel inventory is. You talked about the tightness you saw exiting the June quarter for Mac and iPad. Interested where you think inventory is across major product categories. And then I had a follow-up for Luca. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [30] +-------------------------------------------------------------------------------- + + We -- usually, we've gotten away from talking about channel inventories. But to give you a perspective, sitting here, looking at it, on iPhone, the inventory is slightly less than it was a year ago. And that's -- I'm saying that at a quarter end point, so at the end of Q3. And obviously, iPad and Mac are constrained, and so both of those are less than they were in the year-ago quarter. + +-------------------------------------------------------------------------------- +Benjamin James Bollin, Cleveland Research Company - Senior Research Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And then, Luca, I'm interested. Any color you could share about the impact COVID had on OpEx in the quarter, be it work-from-home stipends, less travel, other employee support costs? And also, how the company is thinking about the longer-term opportunity of employees working remotely maybe more permanently and any considerations on how that could influence future OpEx. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [32] +-------------------------------------------------------------------------------- + + Well, on the OpEx front, there have been obviously certain things that have been affected in terms of cost reductions. Obviously, travel is a perfect example. The number of meetings that we had internally, some of those costs have been reduced. We've also invested heavily in initiatives. For example, we're really trying to help during very difficult circumstances. For example, we have had a program, for example, where we match our employee donations. We made donations directly as a company around the world to many institutions and governments. On a net basis, I would say probably, the costs have outweighed the savings both during the March and the June quarter, but we think it's absolutely the right thing to do. +From an employee perspective, what we said so far is that here in the United States, most -- the majority of our population will continue to work from home until the end of the year. And then we'll see. I mean we've taken an approach that we try to understand how the virus is evolving over time. We've taken a very cautious approach both with our corporate facilities and with our retail stores. I think what you've seen with retail stores is that we have reopened in a number of geographies around the world. We've reopened here in the United States. We've had to reclose some of the stores here in the United States as the number of cases has gone up, and we will continue to track how the virus is doing. And hopefully, at some point, we're going to get to a point where there is a vaccine or there is a cure. And so we'll make those decisions as we get more information. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + That will be from Jeriel Ong with Deutsche Bank. + +-------------------------------------------------------------------------------- +Kanghui Ong, Deutsche Bank AG, Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + I have 2 questions as well. I'd like to focus on the gross margin expansion within the Services line, all-time record for the quarter. I'm just curious whether you think that will sustain. I understand within Services, there's a pretty wide range of gross margins by business, and I'm wondering if that should continue to improve. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [35] +-------------------------------------------------------------------------------- + + Well, as you've seen, obviously, we've had a sequential expansion in gross margin for Services, and that was driven primarily by mix, as you said, right? We have a very broad portfolio. And depending on which one of the services does better, then we have an impact on Services gross margins. We like the Services business because it's a recurring type of revenue and the margins are accretive to company margin. We did over 67% this quarter. But we want to offer very competitive services across the board, and the same -- I think I'm going to make the same comments that I made on products. What matters to us is to be successful with everything that we do and provide great products and services to our customers. So the relative success of our products and services in the marketplace will drive, to a certain extent, what our margins are. That's -- the margins are a by-product of our success in the marketplace. + +-------------------------------------------------------------------------------- +Kanghui Ong, Deutsche Bank AG, Research Division - Research Analyst [36] +-------------------------------------------------------------------------------- + + Got it. I really appreciate that. And I wanted to ask a question on the wearables segment. It seems to me that you're categorizing the wearables business as maybe being a little bit impacted by pandemic similar to the iPhones. And it's the first time that wearables hasn't materially upsided in at least a while in recent memory. I guess the drivers of wearables being Watch and -- predominantly Watch and AirPods, what are your thoughts going forward on whether there's a little bit of pent-up demand perhaps that might resume as we get back to a more normalized environment? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [37] +-------------------------------------------------------------------------------- + + I think on the Watch, in particular, is like the iPhone, more affected by store closures because people -- some people want to try on the Watch and see what it looks like, look at different band choices and those sorts of things. So I think as stores closed, it puts more pressure on that. I was -- we did come out sort of the way we told you last quarter. We were going to come out from a -- from the color that we gave you. So we knew things would decelerate because of the closures. So we wound up being very pleased with how we did, but the store closures definitely affect the wearables and the iPhone. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + That will come from Jim Suva with Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc., Research Division - MD & Research Analyst [39] +-------------------------------------------------------------------------------- + + And I have 2 questions. I'll ask them at the same time, and it's one for Tim and one for Luca. Tim, the coronavirus -- your company has done a fantastic job at overcoming the hurdle. So congratulations to you. As you look forward, say, to the Christmas holiday shopping season and given the economic challenges around the world of where is coronavirus and your product launches and things like that, can you give any commentary maybe how this Christmas, you're looking forward to see maybe some past cycles of Christmas of a line-up? Because it just seems like it's a little bit different, but Apple is really showing a lot more strength coming into this Christmas than maybe some of the past years. +And then for Luca. I think today, a quick comment, Luca, that -- you mentioned something about a few weeks later. Was that for like iPhone, iPhone chips or product launches? Or maybe expound upon that. I know things are more difficult but I didn't quite get the commentary. It was in your prepared comments, Luca, about a few weeks later. Let's just do a quick little blurb. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [40] +-------------------------------------------------------------------------------- + + Yes, we're -- we take it one quarter at a time, and so we'll give you a color on the December quarter in October. Generally speaking, I think we need to see a vaccine or therapeutic or both, and there's some optimism around that in that particular time frame. And so we'll see. I don't have any information that isn't publicly available there, but I think that would boost consumer confidence quite a bit if it began to happen. And I think that any kind of consumer stock company would benefit from that. + +-------------------------------------------------------------------------------- +Luca Maestri, Apple Inc. - CFO & Senior VP [41] +-------------------------------------------------------------------------------- + + And Jim, on the iPhone, I said in my remarks that we launched -- a year ago, we launched the new iPhone in late September. So I was referring to the new product. And I said that this year, the supply of the new product will be a few weeks later than that. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc., Research Division - MD & Research Analyst [42] +-------------------------------------------------------------------------------- + + Congratulations to you and your entire organization and teams. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + That will come from Wamsi Mohan with Bank of America. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [44] +-------------------------------------------------------------------------------- + + I was wondering if you can maybe comment on the penetration of Apple Card users in the iOS installed base. And have you seen any change in the buying behavior of Apple Card users in terms of accelerating spend on more Apple products and services? And I have a follow-up. + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [45] +-------------------------------------------------------------------------------- + + We saw changes in consumer spending as the shutdowns occurred and as the store closures occurred. We could see that across the Card. It affected the categories that you would guess the most, like travel and entertainment, et cetera. But overall, if you sort of pull the lens out on the Apple Card, we're very happy with the number of people that have the Apple Card. We believe, based on what we've heard, that it's the fastest rollout in the history of credit cards, and so we feel very good about that. + +-------------------------------------------------------------------------------- +Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [46] +-------------------------------------------------------------------------------- + + Okay, Tim. And as a follow-up, now that Apple has Apple silicon for Macs, would you ever consider monetizing this as a merchant silicon vendor? Or is this going to be forever for Apple use? + +-------------------------------------------------------------------------------- +Timothy D. Cook, Apple Inc. - CEO & Director [47] +-------------------------------------------------------------------------------- + + Well, I don't want to make a forever comment but there are -- we're a product company and we love making the whole thing and -- because we can own the user experience in that way and with the goal of delighting the user. And that's the reason that we're doing the Apple silicon is because we can envision some products that we can achieve with Apple silicon that we couldn't achieve otherwise. And so that's how we look at it. + +-------------------------------------------------------------------------------- +Tejas Gala, Apple Inc. - IR Contact [48] +-------------------------------------------------------------------------------- + + Thank you, Wamsi. A replay of today's call will be available for 2 weeks on Apple Podcasts, as a webcast on apple.com/investor, and via telephone. The numbers for the telephone replay are (888) 203-1112 or (719) 457-0820. Please enter confirmation code 2630782. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Kristin Huguet at (408) 974-2414. Financial analysts can contact me with additional questions at (669) 227-2402. Thank you again for joining us. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + And again, that will conclude today's conference. + + + + + + + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2016-Apr-21-AMD.txt b/Transcripts/AMD/2016-Apr-21-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..4f139b6a99642e47f8d7bf28ff78f43da3f7e0ee --- /dev/null +++ b/Transcripts/AMD/2016-Apr-21-AMD.txt @@ -0,0 +1,880 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Advanced Micro Devices Inc Earnings Call +APRIL 21, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Lisa Su + AMD - President and CEO + * Devinder Kumar + AMD - SVP, CFO, and Treasurer + * Ruth Cotter + AMD - SVP Human Resources, Corporate Communications, and IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Lipacis + Jefferies LLC - Analyst + * Sidney Ho + Deutsche Bank - Analyst + * Shankar Iyer + BofA Merrill Lynch - Analyst + * John Pitzer + Credit Suisse - Analyst + * Jaguar Bajwa + Arete Research - Analyst + * Suji Desilva + Topeka Capital Markets - Analyst + * Bill Peterson + JPMorgan - Analyst + * Hans Mosesmann + Raymond James & Associates, Inc. - Analyst + * Stacy Rasgon + Bernstein - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Vijay Rakesh + Mizuho Securities USA - Analyst + * Ian Ing + MKM Partners - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Deepon Nag + Macquarie Research - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices first-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, this is being recorded. +It is now my pleasure to introduce your host Ruth Cotter, Senior Vice President, Human Resources, Corporate Communications, and Investor Relations. Please go ahead, Ms. Cotter. + +-------------------------------------------------------------------------------- +Ruth Cotter, AMD - SVP Human Resources, Corporate Communications, and IR [2] +-------------------------------------------------------------------------------- + + Thank you and welcome to AMD's first-quarter conference call. By now, you should have had the opportunity to review a copy of our earnings release and the CFO commentary in slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. +Participants on today's conference call are Lisa Su, our President and Chief Executive Officer, and Devinder Kumar, our Senior Vice President, Chief Financial Officer, and Treasurer. This is a live call and will be replayed via webcast on amd.com. +I would like to highlight a few dates for you. Devinder Kumar will present at the JPMorgan Global Technology, Media, and Telecom Conference on May 24 in Boston. And our second-quarter quiet time will begin at the close of business on Friday, June 17, 2016. +Before we begin, let me remind everyone that first-quarter 2016 was a 13-week quarter for AMD and we expect to record our extra week in the fourth quarter of 2016. Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions, and expectations, speak only as of the current date, and as such involve risks and uncertainties that could cause actual results to differ materially from our current expectation. +Please note that we will be referring to non-GAAP figures during this call, except for revenue, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measures in the press release and CFO commentary posted on our website at quarterlyearnings.amd.com. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You will also find detailed discussions about our risk factors and our filings with the SEC, and in particular AMD's annual report on Form 10-K for the year ended December 26, 2015. +Now with that, I would like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Ruth, and good afternoon to all those listening in today. Our strategy to improve our business by gaining share in the graphics and PC markets, growing our semi-custom business, and expanding into the data center market is progressing as planned. First-quarter revenue decreased in line with expectations to $832 million, driven largely by an anticipated reduction in semi-custom shipments. +Looking at our computing and graphics segment, against the backdrop of one of the largest sequential Q4-to-Q1 declines in the PC industry and ongoing softness in the Chinese PC market, we continue to execute our multi-quarter plan to improve the financial performance of this part of our business. +Revenue decreased 2% sequentially, as improved notebook processor, desktop GPU, and professional graphics sales offset declines for our other PC products. We reduced our operating loss from the prior quarter, outperformed the PC market, and believe we regained processor and GPU share. Importantly, we accomplished this while maintaining our disciplined approach to managing inventory in the quarter, as our inventories with M&Cs and downstream channel partners were flat to slightly down sequentially. +We had our second straight quarter of double-digit sequential percentage growth in mobile APU sales. We began shipping our seventh-generation Bristol Ridge APUs in March, and have secured new design wins that continue our expansion into more premium notebook offerings, including HP's new Envy x360 convertible notebook. Compared to our previous-generation 15-watt APU mobile offering, Bristol Ridge delivered a 20% improvement in our already industry-leading graphics performance and up to 20% CPU performance uplift. +In graphics, we delivered a strong sequential double-digit percentage increase in desktop discrete unit shipments, largely driven by increased sales of our Radeon 300 series GPUs in the channel. Our investments in graphics and our focus on creating industry-leading drivers and software are starting to pay off. We have delivered seven new graphics drivers releases in the first quarter alone, not only improving the performance and user experience of our GPUs, but also adding support for new AAA game titles and features like our innovative XConnect external GPU technology. +We expect to grow our investment in graphics throughout the year as we further update our graphics software and extend our leadership in Direct X12 gaming and VR. We believe VR will be a key long-term demand driver for AMD across both our consumer and professional graphics offerings, especially as content creators require more powerful GPUs to create fully immersive VR experiences. +To capitalize on this trend, I am proud to share that we plan to launch the industry's most powerful platform for VR creation and consumption at the end of this month, when we introduce the $1,500 Radeon Pro Duo. +We remain on track to introduce our new 14 nanometer FinFET-based Polaris GPUs midyear. Polaris delivers double the performance per watt of our current mainstream offerings, which we believe provides us with significant opportunities to gain share. +Now, turning to our enterprise embedded and semi-custom segment. Revenue declined 24% sequentially due to lower semi-custom sales. Based on our current visibility, we expect semi-custom unit shipments and revenue to grow on an annual basis based on strong demand for game consoles and the ramp of our previously announced new business in the second half of the year. +In embedded, we secured new designs across our target markets. Highlights from the quarter include our first significant CPU design win with one of the leading network infrastructure providers. +I am also pleased to share that we are making excellent progress on our strategy to reestablish our presence in the data center market as we successfully passed several key milestones related to our next-generation Zen-based server processor. The Zen silicon running in our bring-up labs is meeting our expectations, and priority customer sampling is on track to begin this quarter in advance of data center system availability in 2017. +Our EESC results in the quarter also benefited from the latest step in our strategic IP monetization efforts. As we've disclosed earlier today, we have licensed high-performance microprocessor technologies to a newly created JV we formed with THATIC. The JV will develop SoCs tailored to the Chinese server market. The $293 million licensing agreement is a great example of how our IP monetization efforts can accelerate the adoption of AMD technologies in key markets while also strengthening our balance sheet and financial results. +Today's announcement is a key part of our overall strategy to reenter the data center market, with the JV providing AMD with a differentiated approach to gain share in the fastest-growing regional server market. +In closing, we are making steady progress on the clear strategy we have developed to return AMD to growth and profitability through delivering great products. We are executing well to our product and technology roadmaps, including the introduction of our seventh-generation APUs, our midyear launch of new Polaris GPUs, and our future Zen-based processors. +As we enter into the second quarter, we see strong demand for our semi-custom and graphics products, which we believe will lead to stronger-than-seasonal sequential revenue growth. For the full year, we are confident that our product portfolio and business execution can further strengthen our financial results and enable us to grow annual revenue and return to non-GAAP operating profitability in the second half of the year. +Longer term, we expect the strong customer interest in AMD's data center offerings will result in new design wins that can deliver profitable revenue growth in 2017 and beyond. +Now, I would like to turn the call over to Devinder to provide some additional color on our first-quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, and Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. From a financial perspective, the first quarter came in as expected. We continued funding our roadmap products and also made progress on our IP monetization strategy with the execution of a licensing agreement that is expected to generate $293 million of cash before tax, contingent upon achieving certain milestones. +Let me review the results for the first quarter. As a reminder, our first fiscal quarter was a 13-week quarter. Revenue was $832 million, down 13% sequentially, driven primarily by lower sales of semi-custom SoCs. The year-over-year decline was 19% due primarily to lower sales of semi-custom SoCs and client notebook processors. +Gross margin was 32%, a 2 percentage point improvement from the prior quarter due primarily to a more favorable product mix and a mix of revenue between the business segments. Operating expenses were $332 million, up $9 million from the prior quarter, primarily due to increased R&D expenses related to new products, partially offset by lower SG&A expenses. Operating expenses were $12 million higher than guided, primarily due to the timing of mass and hardware for our new products and some incremental investments in graphics. +Operating loss was $55 million and net loss was $96 million, with loss per share of $0.12, calculated using 793 million shares. We recognized a $7 million licensing gain associated with our IP monetization efforts in the quarter. +Net interest, other expense, and taxes were $41 million in the quarter, down from $53 million in the prior quarter, primarily due to a $13 million tax settlement in Q4 2015, which was included in the GAAP results. Adjusted EBITDA was negative $22 million compared to negative $5 million in the prior quarter. +Now turning to the business segments. Computing and graphics revenue was $460 million, down 2% from the prior quarter, primarily due to lower desktop processor sales. Computing and graphics segment operating loss was $70 million compared to $99 million the prior quarter, primarily due to decreased operating expenses. +Enterprise, embedded, and semi-custom revenue was $372 million, down 24% from the prior quarter, primarily due to lower sales of our semi-custom SoCs. The operating income of this segment was $16 million, down from $59 million the prior quarter, driven primarily by lower revenue and higher R&D expenses, partially offset by the IP licensing gains. +Turning to the balance sheet, our cash and cash equivalents totaled $716 million at the end of the quarter, down $69 million from the end of the prior quarter, primarily due to lower sales and higher debt interest payments of $69 million in Q1. Additionally, our Q1 results include $52 million net of taxes received from our IP licensing agreement. Inventory was $675 million, down $3 million from the end of the prior quarter. +Total wafer purchases from GLOBALFOUNDRIES in the first quarter were $183 million, including $155 million related to the 2015 WSA amendment taken in Q1 2016. Debt as of the end of the quarter was $2.24 billion, flat from the end of the prior quarter, including total borrowings of $230 million on our secured revolving line of credit, unchanged from the prior quarter. Free cash flow in the first quarter was negative $68 million compared to a positive $27 million in the fourth quarter of 2015. +Before providing our outlook for the second quarter, let me provide an update on our ATMP joint venture with Nantong Fujitsu Microelectronics. Earlier this month, NFME's shareholders approved the transaction and we are currently in the final stages of obtaining regulatory approvals and expect to close the transaction this quarter. +Now turning to our outlook, which is based on a 13-fiscal-week quarter. For the second quarter of 2016, we expect revenue to increase 15% sequentially, plus or minus 3%, driven by a strong demand for our semi-custom and graphics products.; non-GAAP gross margin to be approximately 31%; non-GAAP operating expenses to be approximately $335 million; IP monetization licensing gain to be approximately $25 million; non-GAAP interest expense, taxes, and other to be approximately $45 million, including approximately $3 million of taxes related to the IP licensing game; cash and cash equivalents to be approximately $950 million, including approximately $320 million related to our ATMP joint venture; inventory to be up slightly from first-quarter levels. +For the full-year 2016, we continue to expect revenue to grow year over year, to be non-GAAP operating profitable in the second half of 2016, and to generate positive free cash flow from operations for 2016. Also, we now expect non-GAAP operating expenses to be between $330 million and $350 million per quarter; IP monetization licensing gain of approximately $52 million, with $7 million already recognized in Q1 2016; and capital expenditures of approximately $80 million. For the rest the full-year 2016 outlook, please refer to the written CFO commentary document posted on amd.com. +In closing, we continue to strengthen AMD's core business while leveraging our IP and technology. As we look to the rest of the year, we are focused on introducing compelling new products, regaining market share, and improving our financial performance. +With that, I will turn it back to Ruth. Ruth? + +-------------------------------------------------------------------------------- +Ruth Cotter, AMD - SVP Human Resources, Corporate Communications, and IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we would be very happy for you to poll the audience for questions, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking my question. I guess this is one of the most exciting developments that we've heard about in awhile, the license agreement. And I was hoping that you could maybe provide some more color on that. +Could you help us understand, maybe just go back in time and just explain the cross-license agreement that you have with Intel? What should investors understand about that and assessing any kind of a risk associated with this IP agreement? Do you need to get -- do you check in -- do you tell Intel that this is going on, did you get clearance from them, or is this something that you just kind of run with? +And when do you -- do you have to wait for like regulatory approval to get this through? Or -- how should we think about timing and milestones? That is a lot of questions. I will stop there. Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [3] +-------------------------------------------------------------------------------- + + Okay, Mark. This is Lisa. Thank you for your question. Regarding the JV that we just announced, yes, we are very excited about it, partnering with THATIC, and really focusing on the Chinese market for server processors. +What we are licensing in this agreement is microprocessor technologies and system-on-chip technologies, all of the technologies, licensed our AMD technologies. So there are no encumbrances from that standpoint. +We have closed on the deal and we are starting execution of the deal. So we've talked about, from a financial standpoint, there is a $293 million licensing payment over a number of years. What we expect is the first payment we received in the first quarter of $50 million-ish, and we expect that over the first two years that about half of the licensing payments would be paid upon completion of some development milestones. +So overall for us, I've talked about IP monetization in a very broad sense. For us, that includes patents as well as technology licensing. This one is very positive for us, not just from the standpoint that it leverages our IP, but it also gives us a very key partner in the Chinese market, which we all believe is going to be very, very important for data center growth going forward. So hopefully I addressed your questions there. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Yes, and if I may, just one quick follow-up. Are you of the view that you just can go and hit the ground running? I guess you do, because you are expecting a $50 million payment right away. But do you feel that -- is there any risk in the regulatory front on this deal? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [5] +-------------------------------------------------------------------------------- + + We don't expect any risk on the regulatory front. We believe that the technologies that we are licensing are compliant with all of the regulations -- the US regulatory issues. And I would also say that the joint venture is starting and we do believe that we will execute quickly. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [8] +-------------------------------------------------------------------------------- + + Could you give us some idea? You called out your sequential growth guidance was in part due to graphics. Are you able to give us any feel for what sequential growth in graphics your guidance assumes? +And what products are driving the sequential growth? Does this come from Polaris? Or do Polaris revenues start after the June quarter? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [9] +-------------------------------------------------------------------------------- + + Yes. So David, our sequential guidance, as we mentioned, is due to both semi-custom and graphics. I would say it is more heavily weighted on semi-custom. +But if you look at our graphics progression over the last couple of quarters, even though Q1 is normally a weaker market than Q4, we grew units overall in the desktop graphics business. So we believe that was on some of the strength of some of our new software work and our work with the ecosystem. +So going into the second quarter, again, we believe that we have an opportunity in graphics to drive some volume. Polaris is on track to launch in the middle of the year and we will expect that will drive -- further strengthen the second half. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, great. And just a clarification. You mentioned $53 million license gain, but if I understand correctly, your guidance is for $25 million in the second quarter. Is that part of that $53 million? Or is that something different? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, and Treasurer [11] +-------------------------------------------------------------------------------- + + David, I can take that. So the total proceeds in the Q1 time frame are $57 million, but there are some taxes related to that. So the net cash [will result] $52 million. We recognized $7 million in Q1 of 2016. We are recognizing $25 million in Q2, and then the rest of it will be over the second half of 2016, which is the balance, $20 million. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [12] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Hans Mosesmann, Raymond James. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates, Inc. - Analyst [14] +-------------------------------------------------------------------------------- + + Can you give us a sense on Zen, based on you're hitting all your performance milestones, what part of the server market are you addressing? What's the size of the opportunity? And I am assuming that you can go after both enterprise and data center because it is an x86. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [15] +-------------------------------------------------------------------------------- + + Yes. We are pleased with the progress on Zen. Obviously, there are lots of engineering milestones to pass, but a key one is that we are on track to sample to our priority customers in the second quarter. +In terms of the markets that we can address, yes, we do believe that Zen has broad applicability across enterprise and data center. And we will continue to work with both OEMs and ODMs to ensure that they have the right boards and platforms for our products. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates, Inc. - Analyst [16] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + I wonder if you could talk a little bit about how the JV is going to be set up over time. Will you compete with them with standard products within China, or is there some kind of dividing of the market? And will they be manufacturing the products through their own foundry relationships or will you be delivering them manufactured product? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [19] +-------------------------------------------------------------------------------- + + Okay, so the way to think about it is the JV roadmap will be a complementary roadmap to our own server roadmap, so we think there will be enough differentiation. But taken as a whole, it will be a compelling roadmap. +In terms of foundries, I think we are not ready to talk about foundries. But we will update more about the products as we get further into the execution. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. And will the monetization of this over time -- I mean, you mentioned that there is a royalty component as well. Will most of the monetization come from the licensing? Or do you think the royalty portion could be of similar size down the road? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [21] +-------------------------------------------------------------------------------- + + I would say that it is probably a bit early to call that. The licensing payment is well understood. The royalties will come over time, depending on the strength of the products and the number of products that are being done. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Ian Ing, MKM Partners. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [24] +-------------------------------------------------------------------------------- + + First question on the server JV. Your products are going to go up against [decent incumbency] in the China server market, so how advantaged do you think this JV will be in terms of perhaps being a locally sourced product? Are there other advantages that this JV would bring to the table to address the incumbency? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [25] +-------------------------------------------------------------------------------- + + I think we believe that there is a large opportunity in the data center market across the board. That is why we are investing so much in Zen and its follow ons. As it relates to the China JV that we are doing with THATIC, I think there is a -- certainly a benefit to having someone local that has experience in the market and knowledge of the market. And THATIC is an investment consortium that is partially led by the Chinese Academy of Sciences. +So we think that both from a technical and a commercial standpoint, they will be a value-added partner in this joint venture. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [26] +-------------------------------------------------------------------------------- + + Thanks. And for my follow-up, for your June guidance, you are getting some strength in from this new semi-custom ramp. How sustained should we think that ramp to be? And is it a seasonal ramp? Does it come back every year? Any granularity would help. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [27] +-------------------------------------------------------------------------------- + + As it relates to our guidance for the second quarter and then the full year, if you think about the semi-custom business in the last few years, the third quarter is always the peak. And it will be the peak this year as well. We are starting some of the ramp in the second quarter as we build up to the stronger third quarter. +But overall, I think we feel good about the semi-custom business. The business overall will grow year on year as a result of the product momentum we have. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [28] +-------------------------------------------------------------------------------- + + Okay, thanks. I will re-queue. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Vivek Arya, Bank of America. + +-------------------------------------------------------------------------------- +Shankar Iyer, BofA Merrill Lynch - Analyst [30] +-------------------------------------------------------------------------------- + + This is Shankar on behalf of Vivek. I have a question on the gross margins. Given the strong growth in Q2, why isn't the gross margin growing? And longer term, what are the levers behind the gross margin? Can it grow from 32% to 35%, 40%, and what do you have to do get there? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, and Treasurer [31] +-------------------------------------------------------------------------------- + + I think if you look at the business in particular, as I said even in my prepared remarks, you have gross margin levers. But one of the things that obviously comes into play is the mix of business between the semi-custom business or the EESC business, and then the CG business. So that obviously comes in play, as Lisa said. +We have the growth with our guidance for revenue in Q2, and it is weighted towards the semi-custom business in addition to the growth that we are seeing in graphics. And that is primarily what is driving the guidance at 31% as compared to where we came in in Q1 at the 32% level. +And then as far as the levels going on from there, I think it partly is a mix of the business overall from a viewpoint of the semi-custom business and other businesses. But also the continuing investment we are making in the roadmaps, as you see from our OpEx guidance for the rest of the year, as we want to go ahead and invest in products, in graphics, and other areas that will help us improve the gross margin. And then getting into later on when the Zen product is introduced, having even higher gross margin compared to where we are today. + +-------------------------------------------------------------------------------- +Shankar Iyer, BofA Merrill Lynch - Analyst [32] +-------------------------------------------------------------------------------- + + Got it, thanks. As a follow-up on the semi-custom side, the -- didn't some embedded revenue will likely come in in the second half? Like you guided before -- $1 billion of total revenue spread over, I think, three years. How much of the second-half growth in semi-custom comes from embedded versus semi-custom? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [33] +-------------------------------------------------------------------------------- + + So maybe let me give you some explanation on that. So the semi-custom, if you -- just to recap on what we've said about the semi-custom designs in the past, we have a total of three design wins that have a lifetime revenue of about -- let's call it $1.5 billion or greater. And that will come across over the next three to four years. In addition, we have our current game console business as well. +So when you look at the aggregate of that, we do expect to start ramping that new business in the second half of the year. But we also expect the seasonal uplift of our traditional game console business. So that is adding to what we expect will be a strong year for semi-custom overall. + +-------------------------------------------------------------------------------- +Shankar Iyer, BofA Merrill Lynch - Analyst [34] +-------------------------------------------------------------------------------- + + If I can just slip in, the $1.5 billion you said, is that evenly split over the next three to four years or is it ramps towards the end of 2018 or so? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [35] +-------------------------------------------------------------------------------- + + No, it is definitely -- I mean, it takes some time to ramp. So this year will be lower since it is half a year and it is not all the designs. And as we go into the next few years, it will ramp to a steady-state. + +-------------------------------------------------------------------------------- +Shankar Iyer, BofA Merrill Lynch - Analyst [36] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [38] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. First, on the licensing agreement, can you be a little more specific on exactly what you are licensing? You said it was like high-performance CPUs and SoCs. Is this x86? Is it ARM? Is it both? What are the other pieces besides CPUs, potentially, that you are licensing? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [39] +-------------------------------------------------------------------------------- + + The -- what we are licensing is microprocessor technology and system-on-chip technology. So they are technologies, not products. The technologies are applicable to both x86 and ARM. But as you know, most of our investments are in x86. +And then in terms of other aspects, there are other aspects that are needed to put together system-on-chip. So they include things like fabrics and other IP. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [40] +-------------------------------------------------------------------------------- + + So let me ask the question a different way. Will the JV be able to manufacture and sell x86-based server chips into China? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [41] +-------------------------------------------------------------------------------- + + Yes. The JV will be able to manufacture and sell x86 server chips. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you, thank you. I have one more question for you on IP. Is this JV exclusive? Or will you be free to sign other server-based JVs with other parties, both either inside China or outside of China? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [43] +-------------------------------------------------------------------------------- + + It is not an exclusive deal. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [44] +-------------------------------------------------------------------------------- + + Okay. And one more, if I could. Just on your -- sorry, in your current quarter, you launched Bristol Ridge in March. So maybe that led to some of the incremental better-than-market-unit growth. But why were ASPs overall down, given the product refresh that started? And what do you expect for pricing into Q2? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [45] +-------------------------------------------------------------------------------- + + Yes, so, if you talk about the Bristol Ridge launch, we did start the launch in March, including -- on the mobile side. And that did contribute to some of the mobile units up. If you look at the overall ASPs, actually mobile ASPs were up. Desktop ASPs were down, and that is why we said overall down. But it was quite modest. So if you look overall, I think the ASP trends are about what we would expect. +Going into the second quarter in general, it depends on the mix and the mix of the product. We are certainly trying to sell further up the stack. But we will have to see how the exact mix comes out. But there is not a dramatic change in ASPs, if that is what you're asking. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [46] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [48] +-------------------------------------------------------------------------------- + + This is Bill Peterson calling in for Harlan. Thanks for taking the question. A clarification on an earlier question. You said most of the growth is coming from semi-custom and some from graphics. +How much -- is there any channel fill or related Polaris revenue in the second quarter or planned in the second quarter? Or is it really a second-half story? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [49] +-------------------------------------------------------------------------------- + + Again, not being specific, because we have not actually announced our launch date, but I would say the majority of Polaris is a second-half story. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [50] +-------------------------------------------------------------------------------- + + Okay, thanks. And then more of a broader question related to PCs obviously becoming less important. But what is AMD's view on the PC market in terms of unit shipments this year? And what is the expectation in terms of AMD's growth in that segment if we think about the full year? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [51] +-------------------------------------------------------------------------------- + + Yes. So again, on the PC market, I think our view of the PC market is very consistent with what's out there, probably down, let's call it, high-single digits. Certainly the first quarter started off a bit weaker than any of us would have liked. +I would say, though, that in that environment, we still believe that we can gain share in both the client compute and the graphics side. Really, as we are transitioning to a new product portfolio on the graphics side, so I think that is a strong driver for us. +And then on the client compute side, between our product refresh and also our partnership with OEMs. I think in general, OEMs are getting more comfortable using us higher up in the stack, and our A8s, our A10s, our commercial-based processors. So we are continuing to work with OEMs to ensure that we get into the right priority platforms. So that would be our focus, even in a down market. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [52] +-------------------------------------------------------------------------------- + + Okay. Thanks for that. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Suji Desilva, Topeka Capital Markets. + +-------------------------------------------------------------------------------- +Suji Desilva, Topeka Capital Markets - Analyst [54] +-------------------------------------------------------------------------------- + + On the arrangement with THATIC, can you talk about what end markets the server product would be specifically targeting? Is it going after government business there, research institutions, or maybe the China Internet companies? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [55] +-------------------------------------------------------------------------------- + + I think it's fair to say that the market range for the joint venture will be across China, so across all of the markets that you mentioned. + +-------------------------------------------------------------------------------- +Suji Desilva, Topeka Capital Markets - Analyst [56] +-------------------------------------------------------------------------------- + + Can you talk about the pipeline for the licensing business you instituted I guess -- announced a couple of quarters ago? You already have a success here. I'm wondering how robust the pipeline might be for further licensing opportunity. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [57] +-------------------------------------------------------------------------------- + + Look, we are thinking about our IP monetization strategy as really a broad strategy that is going to unfold over the next number of years. So I wouldn't say that these things are all going to be immediate. +The IP monetization includes patent licensing. It includes sales of certain parts of our patent portfolio that are no longer core to our business, as well as the strategic technology licensing. +We have a good, solid pipeline. I would say it's -- there are lots of opportunities out there. We are looking for ones that are very additive to our product portfolio and to our roadmap objectives. And I think we will look for the right partners to enable that. + +-------------------------------------------------------------------------------- +Suji Desilva, Topeka Capital Markets - Analyst [58] +-------------------------------------------------------------------------------- + + One last quick question; would you be -- would it be possible to tell us how long you had been in discussions with this licensing agreement to understand how long lead times are for them to close? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [59] +-------------------------------------------------------------------------------- + + It is fair to say that any one of these deals takes awhile. So they are fairly involved to go through. But I think we have a good set of conversations and we certainly believe that there is a lot of value in this IP portfolio that we will continue to leverage. + +-------------------------------------------------------------------------------- +Suji Desilva, Topeka Capital Markets - Analyst [60] +-------------------------------------------------------------------------------- + + (inaudible) by all means. Thank you. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [62] +-------------------------------------------------------------------------------- + + This is Sidney Ho calling on behalf of Ross. Thanks for taking my question. So first question is you talked about EESC revenue will be up annually, and I think you talk about the different components. +Just to be clear, do you expect to game console revenue specifically to be up? And kind of related to that, do you expect the C&G revenue to be up this year as well? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [63] +-------------------------------------------------------------------------------- + + Again, I would like to keep it at the segment level. And at the segment level, we expect both segments to be up -- to contribute to our overall guidance of revenue being up. As it relates to our EESC business, the majority of the EESC business is semi-custom, so semi-custom would have to be up year over year. And then I think that is about as specific as I would like to get. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [64] +-------------------------------------------------------------------------------- + + Okay, great. And my follow-up question is on the discrete GPU market. Your competitor has grown very nicely by, what, 35% in the last two years. Clearly, some of that is coming from share gains. +What do you think -- I mean, you guys have also gained share in Q1, seems like. What do you think the graphics market itself is growing on a normalized basis? And it wasn't that long ago you guys were like 50% share in discrete graphics. +But with the traction you are seeing right now and with Polaris right around the corner, how quickly do you think you can regain share? And which segment do you think has the biggest opportunities? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [65] +-------------------------------------------------------------------------------- + + I think the graphics business is very strategic to us, and I think it is not just a unit story. It is really also the mix going to higher-end graphics, driven by VR and driven by AAA gaming, and all the things going on there. +As it relates our share, I will say that we certainly have aspirations to regain shares to our historic levels. It will take us some period of time, so it will happen over multiple number of quarters. We are optimistic about the second half of the year and we think Polaris is positioned well. We are particularly positioning in some of the mainstream segments that are higher volume, so would drive share growth faster. And we will have to see how that plays out in the second half of the year. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [66] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Christopher Danely, Citigroup. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [68] +-------------------------------------------------------------------------------- + + This is Marco speaking on behalf of Chris Danely. In light of your IP licensing agreement with THATIC, can you just kind of talk about your expectations for the China server market in 2016/2017? And if are there any longer-term milestones? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [69] +-------------------------------------------------------------------------------- + + Yes, so with regard to our China JV with THATIC, we are -- we're starting the development phase in 2016, so I would say that we view this as a longer-term opportunity for us. But overall, I think all of the trends in the data center market are certainly positive. We believe we can participant in those trends with both the AMD products as well as the JV products. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [70] +-------------------------------------------------------------------------------- + + Thank you. And then my follow-up -- regarding your days of inventory, it looks like this quarter is about 110 days. Why is it so high? And if you -- if there's any worries. + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, and Treasurer [71] +-------------------------------------------------------------------------------- + + I think if you look at it from a days standpoint, essentially we have managed the inventory pretty well. It is up slightly in Q1, but we also guided the revenue up pretty significantly from where we ended in Q1. And we have also said the second half of the year, we are expecting strength over first half, and obviously that leads to higher inventory. +So Q1 to Q2, up slightly; revenues up. And then we expect second half to be stronger than the first half. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [72] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Kevin Cassidy, Stifel. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [74] +-------------------------------------------------------------------------------- + + Thank you for taking my question. On the licensing and JV, are there opportunities -- would you consider the mobile market or the desktop market? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [75] +-------------------------------------------------------------------------------- + + When you say the -- you mean mobile PCs or mobile other? + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [76] +-------------------------------------------------------------------------------- + + Yes, notebook -- just mobile PCs. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [77] +-------------------------------------------------------------------------------- + + I see. Look, I think as it relates to the overall licensing strategy, I think we are open to licensing that makes sense. And so strategically placed with the right market, with the right market drivers, I don't think we have anything that is necessarily off-limits. +I will say that it does need to be strategic and additive to our product business. Our first priority is the product business, and the IP monetization efforts is an overlay on top of that. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [78] +-------------------------------------------------------------------------------- + + Okay? And what is the time frame for the JV? I guess does this license go on through the life of the patent? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [79] +-------------------------------------------------------------------------------- + + It is for a number of years through the product development and sales cycle. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [80] +-------------------------------------------------------------------------------- + + Okay, nothing specific right now? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [81] +-------------------------------------------------------------------------------- + + Nothing specific right now. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [82] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + Vijay Rakesh, Mizuho Securities. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [84] +-------------------------------------------------------------------------------- + + Just on this licensing agreement, obviously when you license it to China, do you think they have the manufacturing or process experience to go into production with this? And what is the timeline to get commercial products in the market with this licensing agreement? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [85] +-------------------------------------------------------------------------------- + + We are not talking about sort of the details of the product timelines just yet. We would like to really get the JV off and running before we disclose those details. And those will be disposed as part of the joint venture. +As it relates to manufacturing, I think there might be interest in manufacturing in China, although that is certainly not a condition of the deal. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [86] +-------------------------------------------------------------------------------- + + Got it. And as you look at this semi-custom ramp, the 15% to 18%, very encouraging. How do you split it up between gaming and the new VR strategy, VR market? Obviously, VR seems to be a huge market as you look out. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [87] +-------------------------------------------------------------------------------- + + Yes, I think the way to think about it is for the near term, I think the semi-custom business and gaming is probably the larger driver. We believe VR is a strategic area where you will see more pickup over the next number of quarters and over the next years. But it is not the near-term driver. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [88] +-------------------------------------------------------------------------------- + + Got it, thanks. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [90] +-------------------------------------------------------------------------------- + + Lisa, I guess my first question -- when you look at your full-year guide for revenue to grow, I am kind of curious to what extent is that based upon sort of market forecast versus market share gains. +I know you don't want to get into division by division, but maybe at a high level, as you look at your year-over-year growth, how do you differentiate between what the market is doing and kind of the market share gains that you need to get to that year-over-year growth? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [91] +-------------------------------------------------------------------------------- + + Yes, that is a fair question. So let me break it up into the two segments. When you look at the EESC segment and especially semi-custom, that is less about a general market and more about what we see in terms of the customer forecasts, and what they are seeing the market to be. So I think those are, let's call it, fairly well understood by us, and we are very interlocked with our customers. +When you talk about the computing and graphics market, I think that is where you get a little bit more of how much uncertainty is there with the PC market trends. There is no question that the PC market is weaker than any of us would like. +I think from our standpoint, though, if you remember the last few quarters and how many times we've talked about inventory normalization and ensuring that we got ourselves into a healthy position relative to our OEM and channel customers, I think we feel that we've done a good job there. And we are now in a place where the consumption is more in line with the selling. +So we believe that even in this market, there is enough opportunity for us to gain share, and obviously we have to prove that out over the next couple of quarters. But just given where our business is, where we see the products, and where we see the design wins, that is how we see the market right now. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [92] +-------------------------------------------------------------------------------- + + And then Lisa, I apologize if you addressed this, but just going back to the JV in China, I am just kind of curious. The IP licensing gains you expected this year, are there any milestones that you need to hit to get that? And as we think about 2017, if you hit the milestones in 2017, would we expect licensing to grow year over year from the JV? +And then lastly on the JV, just given that you guys have the opportunity to go into China today and sell your own product, I am just curious how we should think about $100 of server product in the JV and what that means to you from an economic standpoint versus you just going into China today and selling $100 worth of server product as AMD. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [93] +-------------------------------------------------------------------------------- + + Yes, no, good question. So look, on the JV licensing payments, we will expect about half of the licensing revenue to come over the next two years, so over 2016 and 2017. Our current forecast for 2016 was that $50-ish million that Devinder mentioned, and it is contingent on several milestones that we believe are on track. +To your broader question about why do a JV versus just selling right into servers? We are very cognizant of where our share is in servers. So I believe we have the technology to get there and we will continue to make progress. +But given the importance of China and the fact that having a partner who is very much familiar with both the Chinese market from a customer as well as just a technology standpoint I think can only be additive. And there is more than enough server market to go after, given where we are. So I think it's an additive deal to our baseline strategy. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [94] +-------------------------------------------------------------------------------- + + Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [95] +-------------------------------------------------------------------------------- + + Deepon Nag, Macquarie. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Research - Analyst [96] +-------------------------------------------------------------------------------- + + Lisa, for the semi-custom wins that you are going to get in the back half of the year, are those going to be purely incremental to existing products? Or is there any risk of cannibalization to existing products? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [97] +-------------------------------------------------------------------------------- + + I don't believe that we have gone through any detail about what those wins are, so I would prefer to let that come out as our customers are ready to launch. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Research - Analyst [98] +-------------------------------------------------------------------------------- + + Okay, thanks for that. And then on the game console side, so clearly VR is going to be a pretty big deal in Q4 with so many PS4 VR. And there has been some chatter about obviously maybe a thatcher refresh for some of the game consuls. +Because the value of graphics is becoming higher in these game consoles, is there any potential for you to get higher content, and more specifically higher margins in future console refreshes? And is there also any ability to renegotiate terms if -- because of the value of your IP is getting more valuable inside these consoles? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [99] +-------------------------------------------------------------------------------- + + Let me take that in several pieces. Relative to our current game consoles, those deals were well negotiated at the beginning, and I don't think we will be renegotiating. I think the ASPs and all that stuff are also well understood. +Relative to what VR brings -- and again, not being specific to any particular customer because there is just a lot of speculation out there in the industry -- I will say that VR is very exciting, not just for game consoles, but for PC gaming, for the headset guys, for the ecosystem. So yes, we believe that graphics becomes much more valuable in this framework, and we will be looking for how to leverage and monetize that across both our semi-custom business as well as our discrete graphics and APU businesses. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Research - Analyst [100] +-------------------------------------------------------------------------------- + + Just one quick clarification, if I could squeeze it in. So if -- for any future console refreshes, though, you do have the ability to reset ASP trends? Or is it already pre-negotiated in your initial contracts? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [101] +-------------------------------------------------------------------------------- + + I think if anybody were to do a different console or a new console, then that would be a new negotiation. But for the current generation consoles, those terms are locked. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Research - Analyst [102] +-------------------------------------------------------------------------------- + + Okay, great. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [103] +-------------------------------------------------------------------------------- + + Jaguar Bajwa, Arete Research. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [104] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Just on the Polaris launch in midyear, you talked about attacking the mainstream segment of the GPU market. I just wonder when you look at potential share gains in the second half, do you expect that to come more from the discrete desktop side in the AIB channel or the notebook space where you have a relatively higher share, market share? +And given your ASPs in that space, roughly in the discrete desktop spaces, I think you've got about a third of the ASP of your competitor. Just wondering on the trend of that and how you see that over the second half of the year. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [105] +-------------------------------------------------------------------------------- + + Yes, so we believe that we have a share gain opportunity in both mobile and desktop/AIB as we look at Polaris and how it will launch in the second half of the year. Relative to the ASP trends, I think that depends a bit on the mix of the business. So I think I will defer that to how things look. +But from a macro standpoint, we believe we can get a larger share -- a larger revenue share in discrete graphics. But we will certainly have to look at how the individual quarters shape up. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [106] +-------------------------------------------------------------------------------- + + Okay. And then also, on the -- given your IP licensing deal in China, I am just wondering on the acceleration side for GPU, do you see opportunity there potentially with that deal? +And also just in a more general sense, we hear a lot about acceleration with GPU. Can you just talk about how you're approaching that acceleration in general? Will Polaris be suited to that? Or will we have to wait for Vega to come out later in the year? And how do you differentiate versus your competitors? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President and CEO [107] +-------------------------------------------------------------------------------- + + In terms of your first question on GPU acceleration, so the JV that we announced with THATIC is focused on microprocessor technologies only, so it does not cover graphics. +And then to your comment about graphics acceleration or just in general becoming more important and a growth driver, we would agree with that. I think going forward, you will see a bit more focus from us in that area. We have launched some new professional graphics products recently. +We will -- we've also introduced this new software initiative called GPUOpen that really focuses on building an open ecosystem around the graphics area, both in compute and gaming. So we do believe it is a good opportunity and it'll be an area that we will invest more. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [108] +-------------------------------------------------------------------------------- + + Great, thanks very much. + +-------------------------------------------------------------------------------- +Ruth Cotter, AMD - SVP Human Resources, Corporate Communications, and IR [109] +-------------------------------------------------------------------------------- + + Operator, that concludes today's call. If you would like to wrap it up, please. Thank you. + +-------------------------------------------------------------------------------- +Operator [110] +-------------------------------------------------------------------------------- + + That concludes today's teleconference. You may disconnect your line at this time and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2016-Jan-19-AMD.txt b/Transcripts/AMD/2016-Jan-19-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..62c165c6c511d2fb148658e7ae8c24a1a2f9efe9 --- /dev/null +++ b/Transcripts/AMD/2016-Jan-19-AMD.txt @@ -0,0 +1,691 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Advanced Micro Devices Inc Earnings Call +JANUARY 19, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Lisa Su + AMD - President, CEO + * Devinder Kumar + AMD - SVP, CFO, Treasurer + * Liz Morali + AMD - Director, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Stacy Rasgon + Bernstein - Analyst + * Hans Mosesmann + Raymond James & Associates, Inc. - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Srini Pajjuri + CLSA Limited - Analyst + * Steven Chin + UBS - Analyst + * Ian Ing + MKM Partners - Analyst + * Sanjay Chaurasia + Nomura Securities Intl (America) - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Chris Rolland + FBR & Co. - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and thank you for your patience. You have joined AMD's fourth-quarter and year-end earnings conference call. (Operator Instructions) As a reminder, this conference may be recorded. +I would now like to turn the call over to your host, Director of Investor Relations, Ms. Liz Morali. + +-------------------------------------------------------------------------------- +Liz Morali, AMD - Director, IR [2] +-------------------------------------------------------------------------------- + + (technical difficulty) fourth-quarter and year-end conference call. By now, you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. +Participants on today's conference call are Lisa Su, our President and Chief Executive Officer, and Devinder Kumar, our Senior Vice President, Chief Financial Officer, and Treasurer. This is a live call and will be replayed via webcast on amd.com. +I would like to highlight a few dates for you. Mark Papermaster, Senior Vice President and CTO, will present at the Morgan Stanley Technology, Media, and Telecom conference on March 3 in San Francisco. And our first-quarter quiet time will begin at the close of business on Friday, March 11, 2016. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions, and expectations, speak only as of the current date, and as such involve risks and uncertainties that could cause actual results to differ materially from our current expectation. +Additionally, please note that we will be referring to non-GAAP figures during this call, except for revenue, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary posted on our website at quarterlyearnings.amd.com. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and in particular AMD's quarterly report on Form 10-Q for the quarter ended September 26, 2015. +With that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Liz, and good afternoon to all those listening in today. While 2015 was a challenging year from a financial perspective, the dedicated commitment of our employees, combined with our long-term technology investments and sharpened focus, have created a strong foundation for future growth. +In the fourth quarter, revenue decreased 10% sequentially to $958 million, as seasonally lower semi-custom SoC shipments were partially offset by the second straight quarter of double-digit percentage revenue growth in our computing and graphics business. +Looking at our computing and graphics segment, revenue increased 11% sequentially as we continued to improve the performance of our PC business. We had strong double-digit sequential percentage growth in mobile APU sales, driven largely by increased Carrizo shipments and good sellthrough of AMD-based PCs on Black Friday. +In the channel, we delivered our third straight quarter of sequential revenue growth and further reduced downstream product inventories based on improved demand for FX CPUs and A-Series APUs. We also made progress diversifying our client computing revenue as we further expand into the commercial PC market. +Second-half 2015 commercial APU unit shipments increased more than 15% from the first half of the year. We believe we can continue to grow our commercial shipments based on the high-volume wins we are securing both across large enterprises and the public sector. +Now shifting to graphics, GPU revenue increased sequentially for the second straight quarter, driven by improved AIB channel sales of our Radeon 300 series across the enthusiast performance and mainstream segments and growth in professional graphics sales. The PC gaming market strength helped fuel a richer GPU mix and improved demand for our high-end Radeon R9 series in the quarter. We expect this momentum to continue throughout 2016 as Oculus and HTC begin shipping consumer-ready VR headsets. +The buzz and interest in VR is an exciting trend that is focusing the software industry's attention and some of its brightest minds back on the PC platform. While the initial wave of VR will be focused on gaming, an increasing number of developers see VR as the most significant advancement in how we interact with technology since the introduction of the mouse and graphical user interface. Most importantly, these breakthrough software experiences will only be enabled with high performance energy efficient GPUs. +Overall, we made good progress further stabilizing our PC business in the fourth quarter. And we believe we are well positioned to navigate the seasonally weaker first half of the year and ongoing challenges in the China PC market due to macro conditions. +Turning to our enterprise embedded and semi-custom segment, revenue declined 23% sequentially, in line with our expectations as semi-custom sales decreased from their third-quarter seasonal peak. We had record annual semi-custom unit shipments in 2015 and have shipped more than 50 million semi-custom APUs as a critical and trusted partner to Sony and Microsoft. +Demand for game consoles looks strong for 2016 and we remain on track to generate additional revenue from new semi-custom business in the second half of 2016. We also began production shipments of our first 64-bit data-center-class ARM SoC and expect additional system introductions from our partners throughout 2016 as the ARM 64 infrastructure ecosystem further develops. +Now turning to the year ahead. We remain focused on completing our strategic work around three key growth pillars. First, in PCs, even in a declining overall market, we believe we can regain client compute and discrete graphics share for the year, driven by gaming, VR, commercial, and our most competitive product roadmap in more than a decade. +We have clear opportunities to regain GPU share in 2016 based on the performance per watt of our new GPUs and software leadership. Earlier this quarter at CES, we announced our new Polaris GPU architecture, which we expect to begin shipping in the middle of 2016. +Polaris combines significant design enhancements as well as 14-nanometer FinFET process technology to deliver double the performance per watt of our current GPU offerings. Customer response has been excellent, particularly in the notebook space, where for the first time ever there will be a GPU architecture capable of bringing high-end gaming and VR experiences to thin and light notebooks. +In client computing, our opportunities to regain share in 2016 will be driven by our design win momentum, continued progress expanding into the commercial market, and reentering the high-performance desktop market late in the year with our Zen-based Summit Ridge CPU. +Our second growth pillar is in the $15-billion-plus data center and infrastructure markets, driven by our FirePro GPUs and next-generation server CPUs. +Our Zen-based GPU development is on track to achieve greater than 40% IPC uplift from our previous generation and we're on schedule to sample later this year. We have secured several key design wins with global OEMs for our Zen-based server CPU and believe we can rapidly reestablish our presence in the data center when we bring our new products to market in 2017. +With FirePro, we plan to leverage our upcoming Polaris architecture and suite of new software tools designed to dramatically simplify GPU computing to accelerate the adoption of FirePro in the HPC and data center markets. +Our third growth pillar is focused on further expanding the TAM for our products and technologies through ramping our previously communicated semi-custom wins, converting additional semi-custom pipeline opportunities, and gaining share in targeted embedded markets. +We also have near-term opportunities to strategically monetize our valuable IP in 2016 through licensing and partnerships that are complementary to our product development efforts. I look forward to sharing the initial results of our IP monetization strategy in the coming quarters. +While we expect revenue to be lower in the first half of 2016 compared to the second half based on the seasonality of the PC and game console businesses, we remain focused on successfully executing our product and technology roadmaps and plan to return AMD to non-GAAP operating profitability in the second half of 2016 and generate positive cash flow from operations for the year. +Now I'd like to turn the call over to Devinder to provide some additional color on our fourth-quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. In 2015, notwithstanding a difficult PC market and financial losses, we continued our multiyear effort to transition our business model by diversifying revenue and establishing a foundation for improved financial performance. +We made progress in stabilizing the computing and graphics segment and achieved strong double-digit percentage revenue growth in the second half of 2015. We also reduced overall channel inventory significantly from the prior year. In our EESC segment, we had record shipments of our semi-custom SoCs powering the Playstation 4 and Xbox One game consoles. +In total, against a backdrop of a 28% revenue decline from 2014, we reduced our cost profile with a 14% decrease in OpEx, managed our inventory down, and maintained our cash well within our target range of $600 million to $1 billion. +Now let me provide the specifics of the fourth quarter. Revenue was $958 million, down 10% sequentially, driven primarily by seasonally lower sales of semi-custom SoCs, partially offset by higher computing and graphics segment sales. The year-over-year decline was 23% due primarily to lower client processor and chipset sales and lower game console royalties. +Gross margin was 30%, a 7 percentage point improvement from the prior quarter, with 6 percentage points resulting from the impact of a $65 million inventory write-down in Q3. And the remainder primarily from improved product mix in the computing and graphics segment. +Operating expenses were $323 million, down $13 million from the prior quarter, primarily due to lower headcount and ongoing expense control. Operating loss was $39 million and net loss was $79 million, with loss per share of $0.10, calculated using 791 million shares. +Net interest, other expense, and taxes were $40 million in the quarter compared to $39 million in the prior quarter. The GAAP results include a $13 million tax settlement in a foreign jurisdiction. Adjusted EBITDA was negative $5 million, improving from negative $55 million in the prior quarter. +Now turning to the business segments. Computing and graphics revenue was $470 million, up 11% sequentially, primarily due to higher notebook processor sales. This is the second consecutive quarter of double-digit percentage revenue growth for this segment as we increased sales on both our client compute and graphics processors in Q4. Computing and graphics segment operating loss was $99 million, improving from $181 million the prior quarter, primarily due to higher sales and the absence of a third-quarter 2015 inventory write-down. +Enterprise embedded and semi-custom revenue was $488 million, down 23% from the prior quarter, primarily due to seasonally lower sales of our semi-custom SoCs. The operating income of this segment was $59 million, down from $84 million in the prior quarter, driven primarily by lower semi-custom product sales. +Turning to the balance sheet, our cash and cash equivalents totaled $785 million at the end of the quarter, up $30 million from the end of the prior quarter. Inventory was $678 million, down $83 million or 11% from the end of the prior quarter, primarily due to reduced levels of semi-custom SoC inventory. +We have concluded our wafer reprofiling discussions related to the 2015 WSA amendment with GLOBALFOUNDRIES and will be moving approximately $60 million of wafer purchases from that amendment to later in 2016. To date, total wafer purchases under the 2015 WSA amendment are approximately $1 billion, including approximately $150 million of wafer purchases which were not taken until early in our fiscal first quarter 2016. We are currently negotiating the 2016 WSA amendment. +Debt as of the end of the quarter was $2.26 billion, flat on the end of the prior quarter, including total borrowings of $230 million on our secured revolving line of credit, unchanged from the prior quarter. Free cash flow in the fourth quarter was a positive $21 million, an improvement of $105 million from the third quarter of 2015. +Turning to our outlook for the first quarter of 2016, which is based on a 13-week quarter, AMD expects revenue to decrease 14% sequentially, plus or minus 3%, driven by game console seasonality and a cautious macro environment in China. Gross margin is expected to be approximately 32%. +Non-GAAP operating expenses are expected to be approximately $320 million. Interest expense, taxes, and other to be approximately $42 million. Cash and cash equivalent balances to be down approximately $100 million from the end of the fourth quarter, including $70 million of cash interest payments. +This cash balance does not include any cash proceeds related to the ATMP JV with Nantong Fujitsu Microelectronics. We expect to close that transaction in the first half of 2016 pending regulatory and other approvals and expect cash flow proceeds of approximately $320 million net of taxes and other expenses upon closure. Inventory is expected to be approximately flat from fourth-quarter levels. +Our fiscal year 2016 is based on 53 weeks and we plan to take the extra week in our fiscal fourth quarter. For the full year 2016, we expect revenue to grow year over year. Non-GAAP operating expenses between $320 million and $340 million per quarter as we continue to invest in leadership products and in line with our expected revenue profile. +Interest expense, taxes, and other will be approximately $45 million per quarter. Cash and cash equivalent balances to be in the optimal zone of $600 million to $1 billion. Capital expenditures of approximately $70 million. Inventory to be down year over year, and to return to non-GAAP operating profitability in the second half of 2016 and generate positive free cash flow from operations for the year. +In closing, as we begin the new year, we remain focused on financial and operational execution and look forward to building on our second-half 2015 product and roadmap momentum throughout 2016 across the three areas that Lisa outlined: high-performance PCs, the data center, and TAM expansion through semi-custom and embedded opportunities. +With that, I'll turn it back to Liz. Liz? + +-------------------------------------------------------------------------------- +Liz Morali, AMD - Director, IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, can you please poll the audience for questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks very much. Looking at your guidance for growth, year-over-year growth in revenue in 2016, you are ending with the last quarter your game console revenues down year over year. Do you expect game console revenues to grow in 2016 as a whole? And what other things will drive overall growth for 2016? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [3] +-------------------------------------------------------------------------------- + + David, thanks for the question. So let me give you a bit of color through the guidance and how we view 2016. So if you look at overall 2016, we do expect to grow revenues. And if you look at our business, we see certainly the second-half revenue will be stronger than the first half because of both of our businesses. +Game consoles -- we see units going up 2016 to 2015. We've also said in the enterprise embedded and semi-custom segment that we will be ramping some new design revenue in the second half of 2016. So we see that as a positive growth driver. +And then if you look overall at our computing and graphics business, we do believe even in a down PC market that we have the opportunity to gain share as a growth vector in computing and graphics. So those are the overall drivers for the 2016 comments. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Great. And just a quick follow-up. I understand that you don't breakout all the details, but can you give us some feeling as to whether your discrete GPU business is showing year-over-year growth at the moment, either in the December quarter or expected for the March quarter? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [5] +-------------------------------------------------------------------------------- + + Yes. So as you say, we don't go into that level of detail. I think what we have said is that we did see growth in our discrete graphics business sequentially in both Q3 and Q4. As we look into 2016 with our discrete graphics business, we have a strong product portfolio. And particularly the ramp and introduction of our new FinFET products -- codenamed Polaris -- will happen in the middle of 2016, so that will be a 2016 growth driver. +So certainly we've seen some sequential improvement in the second half of 2015 and we look forward to those product releases in 2016. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Ian Ing, MKM Partners. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks. Could you talk more about the channel business in light of your cautious comments on macro in China. Are you seeing weakness potentially in the ODM business or the white box market? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [8] +-------------------------------------------------------------------------------- + + Yes. So Ian, I think overall if you look at the channel business in the second half of the year for us -- second half 2015 relative to first half 2015 -- we have made quite a bit of progress in the channel in terms of just overall inventory levels. We saw a good quarter in the fourth quarter in both North America and Europe. +We did see a degradation in China towards the end of the fourth quarter. And I think there are cautious comments throughout the industry about sort of the early 2016 start for China. So I think overall what I would say is I'm pleased with the progress we've made in the channel. I think in both the desktop channel as well as the AIB channel we've made some progress in the second half of the year. +I think China is a factor as we go into the first quarter, but I think overall we still view the channel as a positive business for AMD and one in which we believe we can grow share. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [9] +-------------------------------------------------------------------------------- + + Okay. Great. And then Devinder, your OpEx guidance range: $320 million to $340 million in the coming quarters. Can you give us a sense of the timing of some of the upcoming mask costs, given you've got Zen-based cores and Polaris coming up? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [10] +-------------------------------------------------------------------------------- + + I would say I think you've hit the nail on the head. There are new products coming out and there's some [mask to the] cost. I think that's more weighted towards later in the year. From a Q1 time frame, we have given the guidance on the OpEx at the $320 million level compared to where we ended up in Q4 of 2015. +So yes, we do have support for the investments in the products we need and in particular the technology and product transitions that we have coming out in 2016. And that's why you see a range in OpEx of between $320 million and $340 million. +And then a last factor that obviously affects the OpEx is obviously the revenue profile, because Lisa said earlier it's stronger in the second half of the year than the first half of the year. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [11] +-------------------------------------------------------------------------------- + + Okay. And my last question. You're talking now about some GPU share gains in 2016. I mean, does a lot of that come from the Polaris launch starting midyear or is that sort of sustained business from the R9 Series? Or a combination? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [12] +-------------------------------------------------------------------------------- + + Yes. So we have made some progress in with the R9 Series, particularly as in the fourth quarter. I think as we go forward, it's a combination of things. If you look at our investments in graphics, they really include both hardware and software. +So the Polaris family is excellent from a hardware standpoint in terms of the performance per watt that we get. But we have a number of software initiatives that we've started over the past couple months and will continue. And we see all of those contributing to graphics momentum. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Sanjay Chaurasia, Nomura. + +-------------------------------------------------------------------------------- +Sanjay Chaurasia, Nomura Securities Intl (America) - Analyst [14] +-------------------------------------------------------------------------------- + + One question on gross margin. I noticed that you are not providing gross margin guidance for 2016 and I was wondering if you have clarity that your revenue would be up year on year. What are some of the puts and takes here that's making you hold gross margin guidance? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [15] +-------------------------------------------------------------------------------- + + I think the key is if you look back over the last few quarters, we have made progress on the gross margin front, ending Q4 2015 at a 30% level. And the guidance specifically for Q1 of 2016 is 32%. +You're right -- I haven't given guidance for the year. But some of the puts and takes are really the mix of product as we get more into 2016. And then obviously the mix of business between our computing and graphics segment and the EESC segment. +In computing and graphics, we have introduced some new products in the second half of 2015 and even going into 2016 and you have some of the commercial success we've had. And that obviously has gross margin, but at the same time, we want to see how the year unfolds, in particular on the PC side of the house, given some of the comments we made about caution in China in particular. +So for the year, I'm not giving guidance today. This is kind of a first-quarter guidance at a 32% for gross margin and we'll get through the year as we get into the next one or two quarters. + +-------------------------------------------------------------------------------- +Sanjay Chaurasia, Nomura Securities Intl (America) - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. And then a follow-up, Lisa, a question on servers. You indicated you are shipping your Seattle, but at the same time in your guidance, you didn't mention anything about ARM contributing in 2016. And my question is, is ARM servers a meaningful share for you in 2017 and 2018? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [17] +-------------------------------------------------------------------------------- + + So Sanjay, the ARM server did start shipments and we have shipped our first production unit. I think we have some design wins with it and I would call it a modest revenue contributor in 2016. +We still see ARM strategically as a interesting market for the infrastructure markets, but it is certainly developing a bit slower than expected. So I think overall I think it's an important proof point in terms of enterprise class server architectures with ARM, but it's a modest revenue contribution in 2016. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Vivek Arya, BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [19] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Lisa, just to follow-up on the last one, on ARM servers. The comment about progress being somewhat slower -- do you think that's an AMD-specific trend or does that apply to all the ARM server vendors? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [20] +-------------------------------------------------------------------------------- + + I think it's more of a market statement, Vivek, than an AMD-specific statement. I think the overall commentary -- maybe if I just expand a little bit -- is the data center market is really, really interesting. And I think we all agree with that. I think x86 has a lot of momentum and that's one of the reasons that we've put quite a bit more emphasis on our x86 data center and infrastructure play. +Now that being said, I think ARM does have a lot of specific areas where it can contribute and it has done so. But I would say in servers in particular perhaps slower than originally expected, but still something to watch for the medium term. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [21] +-------------------------------------------------------------------------------- + + Got it. And as I follow up perhaps a longer-term question, which is what is the strategy to actually get to a meaningful earnings and cash flow growth? I understand the macro environment is a little tough right now, but the way I see it, a lot of the progress you guys are making on your embedded products is being offset by the declines in your legacy businesses. +And as the mix is shifting to your embedded products, gross margins are sort of holding around that 30% level, but you're not really able to reduce cost. So sales are finding it tough to grow with that offset; gross margins are not moving up that much and you are now going to hold OpEx steady also. So I'm just trying to understand what are we missing here that can help AMD be a more sustainably profitable company? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [22] +-------------------------------------------------------------------------------- + + Sure, Vivek. So let me try and then Devinder can add if he has some comments. So I think what you have to do is take a step back and look at overall, the progress in year 2015 from a foundation standpoint and then what we hope to accomplish in 2016 and forward. +I think the most important message around sustainable profitability for AMD is around our product and technology roadmap and ensuring that we grow share in our target markets. So that is certainly the goal. I think if you look at some of the progress that we made in the second half of 2015, we have seen some stabilization in our computing and graphics business and actually a return to some sequential growth. +As we go forward into 2016, we certainly have to continue that momentum in both our client, compute, as well as our graphics business in terms of gaining profitable unit market share. And then as we go forward, we have our data center strategy as well as our semi-custom and new markets that will bring additional opportunities. +So from a product standpoint, it is about getting our technology out there and I think we will enter 2016 with the strongest product portfolio we've had in a long time. And we need to continue to work with our customers on design opportunities and moving the platforms into production as we go through the year 2016. + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [23] +-------------------------------------------------------------------------------- + + If I can add, Lisa, I think the other thing I would add is if you look at a couple of areas that Lisa mentioned -- data center in particular, but also the embedded space. As we talked about in our financial analyst day in May, those are businesses that command higher gross margins. +So, Vivek, to your point about the gross margins, I think longer term with that business kicking in in 2017, we believe that we can get closer to the longer-term model. 2016 we've guided to operating -- free cash flow positive from an operation standpoint. And as we continue to manage the cost, as you said, especially on the OpEx side of the house, improving the gross margin in and of itself obviously benefits the bottom line. And that's kind of heading toward the longer-term model we outlined at the analyst day that we had in May of 2015. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. One last quick clarification: what PC unit declines, Lisa, are you assuming for 2016? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [25] +-------------------------------------------------------------------------------- + + So if you look at the current market projections, it's somewhere in the low single digits. I think if you were to talk to the customer set, it might go from low single digit to mid single digit. So that's the environment that we are forecasting unit share growth. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. Thank you. Good luck. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. First, I was wondering if you could elaborate a little more on how you plan to gain share on PCs for the year? Especially since it looks like Zen isn't really launching until the tail end of the year and it looks like you're starting Q1 already in the hole if I compare your guidance versus Intel. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [29] +-------------------------------------------------------------------------------- + + Okay, Stacy, why don't I start and again Devinder can add. So overall if you look at PCs, I think we'll have to wait until the numbers come out, but we believe we have gained a bit of share in Q4. +I think if you look at the driving factors behind that, Stacy, there were a couple factors. In 2015, I think we did a concerted effort to clean up some of our channel inventory, both on the OEM side as well as in the DIY channel. So that factor will be gone in 2015 relative to 2016. +I think if you look at the product roadmap, I think the product roadmap is stronger. I think if you look at our commercial business, that is also stronger. So it's leading to a stronger product mix, so those are the key factors. +Relative to the Q1 guidance -- I'll make a comment about Q1 guidance overall. Our Q1 guidance includes obviously both the computing and graphics and the enterprise embedded and semi-custom business. The semi-custom business is historically significantly lower in the first quarter of the year. If you look at the past couple of years it's been the case because they are coming off of a strong holiday season. So I would say that has to be factored into the guidance. +And then if you look at the computing and graphics business, I think what we're seeing is very consistent with what's out there in the market. And we believe in that market -- that set of market conditions we can gain share. + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [30] +-------------------------------------------------------------------------------- + + The only thing I would add, Stacy, is I think too early to tell from a viewpoint of your thinking in terms of the guidance for Q1, that just based on the guidance, we lose share in Q1 in the PC space. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + Well, if I just looked, you're down 14% and Intel down what they are, there is a differential there. + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [32] +-------------------------------------------------------------------------------- + + I think the key is to look at the guidance that we gave and trying to parse out where the decline is. And it's kind of more weighted towards the EESC segment than the computing and graphics segment. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [33] +-------------------------------------------------------------------------------- + + Got it. Okay. Thanks. For my follow-up -- + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [34] +-------------------------------------------------------------------------------- + + The other thing -- just one last clarification. I think the thing to bear in mind -- I think I said in my prepared remarks in our quarter this year, actually both from a viewpoint of the quarter and the year, we have a 53-week year and we have a 13-week quarter in Q1. As opposed to what the competitors and you are doing, I think it's more on the 14 weeks as opposed to 13 weeks. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [35] +-------------------------------------------------------------------------------- + + Well, even if you correct for that, but okay. In terms of my follow-up, just very briefly, does your guidance for positive free cash flow for the year include the proceeds from the backend sale? And does your guidance for a 32% gross margin for next quarter contemplate you selling any of the inventory that you wrote down in Q3? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [36] +-------------------------------------------------------------------------------- + + So the first one is no, it does not. The free cash flow from operations being positive for the year does not include the proceeds from the joint venture for the backend facilities. And then the guidance for the margin at 32% Q1 does not contemplate any sale of previous [sales] of inventory. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [37] +-------------------------------------------------------------------------------- + + Got it. And that free cash flow -- that's not operating cash flow guidance, that's free cash flow guidance? (multiple speakers) + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [38] +-------------------------------------------------------------------------------- + + No, that's free cash flow. I think the way we defined it is operating cash flow less CapEx. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [39] +-------------------------------------------------------------------------------- + + Got it. Okay. Thank you, guys. Good luck. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Matt Ramsay, Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [41] +-------------------------------------------------------------------------------- + + Thank you very much. Good afternoon. I think there's some -- my observation looking at the product roadmap is there's some pretty big hurdles past: getting Polaris on FinFET, getting Zen on FinFET over the next few quarters. +I guess relative to some lower operating spending that you guys are doing as a Company, maybe Lisa, you could lay out some priorities for how you are going to roll out these products? I guess particularly I'm looking at how you balance semi-custom versus discrete GPU? How you balance enterprise GPUs versus APUs when you roll out Zen. It seems like quite a bit to take on, given the lower spending levels of the business at a whole and I just wonder how you are prioritizing that versus the guidance for the year? Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [42] +-------------------------------------------------------------------------------- + + Sure. So Matt, I think maybe a couple comments. I will say that I am pleased with the execution on engineering that we have accomplished over the last 12 months. I think we have passed some significant hurdles. The transition to FinFET for us was very, very critical across our businesses and I feel good about the state of the progress there. +As it reflects on 2016 spending, I think Devinder commented earlier, but I would say that's why we're giving ourselves a range in the OpEx from $320 million to $340 million. And we are being prudent in where we spend. However, clearly there is a significant focus on discrete graphics and what we can do in that space. +I think we're very excited about the momentum around virtual reality and the momentum in gaming. And we think that that's a very good market for us. +I think relative to our CPU competitiveness and retaining competitiveness there, that is a very key priority as well. So Zen across both our client computing as well as our server markets are a priority. +Relative -- the good thing about our semi-custom business is it does rely on customer investment to customize the roadmap. So I think the combination of those things gives us a reasonable envelope to execute the go-to-market around the product portfolio. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [43] +-------------------------------------------------------------------------------- + + All right. Thank you. Thank you for that. And I guess as my follow-up, I think I took away as an impression at least from CES a refocusing of investment on developers, particularly in the GPU space. So Lisa, maybe you could speak to that little bit and how you guys are trying to I guess balance the priorities of the semi-custom business in consoles and gaming with sort of rekindling the brand and maybe rekindling mindshare with developers in the PC gaming community? Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [44] +-------------------------------------------------------------------------------- + + I think the Radeon Technologies Group has added a lot of focus to our graphics activities. And I think as you said, it's both a hardware and software statement. So the work we've done around our drivers and trying to ensure that we have a good customer experience as well as a good development experience is certainly there. I think the main takeaway is: we know how to do this. It's really a matter of getting the focus and getting it done. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [45] +-------------------------------------------------------------------------------- + + All right. Thanks. Good luck. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Srini Pajjuri, CLSA Securities. + +-------------------------------------------------------------------------------- +Srini Pajjuri, CLSA Limited - Analyst [47] +-------------------------------------------------------------------------------- + + Thank you. Lisa, just going back to your annual guidance for growth. If I start from down 14%, I think, you have to model double-digit for the next three quarters, which is well above seasonal for you. So I'm trying to understand where the growth is coming from. +Obviously you said you expect to gain share, but can you talk about the semi-custom win that's supposed to ramp in the second half, how big that opportunity is, and when exactly you expect those ramps to come in? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [48] +-------------------------------------------------------------------------------- + + Let me try to frame it in this way. So if you look overall at our business -- yes, we are projecting full-year revenue growth 2016 compared to 2015 and so we would have to have some significant growth as we go into the second half of the year. +Independent of any new designs, the semi-custom business naturally is significantly higher in the second half than in the first half; especially third quarter. It's kind of a peak for the business as we go into the holiday season and we continue to see that phenomenon as our customers are giving us their forecast. +We expect the base semi-custom business or the base game consoles to continue unit growth in 2016 versus 2015. There will be some modest ASP decline with that, and then we expect to layer over it some new semi-custom revenue starting in the second half of the year. +So from what we see, obviously a lot of things have to happen, but the semi-custom business is one that we've been able to predict pretty well, given the customer long-term forecasts. And then we have to continue the conversation around the computing and graphics business as we see how the market sorts itself out in the first half of the year going into the stronger second half for the PC business. + +-------------------------------------------------------------------------------- +Srini Pajjuri, CLSA Limited - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. Then as a follow-up, I think, Lisa, it was last quarter you told us that you were looking to monetize some of the IP properties that you have. Can you give us an update as to -- based on your discussions how you see that opportunity short term and long term? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [50] +-------------------------------------------------------------------------------- + + Yes. So on the IP monetization strategy, we will continue to update that quarterly as we go through the process. I think we have had really a good discussion around where to go there. I think there are several different avenues that we believe our IP will be valuable. +I think on the straight patent side, we've said before we have 10,000 patents that are over a substantive number of technical areas, including graphics and microprocessors and other semiconductor patents. Those can certainly be licensed or in some cases there may be sales. +However, another area that we think has a lot of potential is the area of technology licensing, where we can help partners accomplish their objectives with both patents and know-how. So we will update the results on that as we go through 2016, but we do believe it's a significant area for us going forward. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [52] +-------------------------------------------------------------------------------- + + Thanks for letting me ask a question. Lisa, one for you on I guess what you'd call now the base enterprise embedded and semi-custom business. You talked about the gaming SoC business being up on a unit basis, but in 2015, that whole segment was down about 8% year over year. +So I guess my question is I know new things are coming in in the back half of this year, but what gives you confidence that today's core business can actually remain anywhere close to flat considering that it fell in 2015? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [53] +-------------------------------------------------------------------------------- + + Yes, Ross. So let me give you some more color on the compare, which might help. So on the base EESC business, if you were to look at product revenues of semi-custom game console SoCs, they were actually up a bit. So overall, units were up double-digit percentage. ASP declined, but less than that. So product revenue was up. +What you saw as segment decline was actually legacy revenue from server and embedded. And if you remember, we have some legacy revenue based on some of the older updrawn products that we continue to sell. And that has seen a drop off as well as our DCSS or C Micro business was there in 2014 that we exited in 2015. So that was the year-on-year decline that was there. +And then I think as you go forward to 2016 -- I'm not being that specific about the base business, but I will say I think units will be up. And we will have to see exactly how much up and as the markets go, but we certainly don't see it substantially down, if that's what you're implying. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [54] +-------------------------------------------------------------------------------- + + That's very helpful. And I guess piggybacking off that to an earlier question -- this time for Devinder on the gross margin side. Correct me if from wrong here, but what I heard as to the answer to the earlier question as to why you're not guiding for the full-year gross margin was partially because the unknown mix dynamic in revenues. +To the extent that's true, does that imply that the gross margin delta between the computing and graphics group and the EESC group, even with the new ramps in semi-custom, is likely to remain as wide as it has in the last year or so? + +-------------------------------------------------------------------------------- +Devinder Kumar, AMD - SVP, CFO, Treasurer [55] +-------------------------------------------------------------------------------- + + I think we have to see how the year unfolds, to be honest. I think Q1, like I said, the guidance at 32%. We need to see mix of product. We have new products being introduced in both the businesses with the new design wins in the second half on the semi-custom side. And then obviously on the CG side, you've heard us talk about graphics and computing new products kicking in. +So from my standpoint, I want to see how it unfolds in terms of the mix of product, mix of the business before getting into the gross margin. But fair to say, as you know, the semi-custom business -- just the way the model works on an NRE standpoint has lower gross margin than the computing and graphics side of the business, so that's a fair statement. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Chris Rolland, FBR & Co. + +-------------------------------------------------------------------------------- +Chris Rolland, FBR & Co. - Analyst [57] +-------------------------------------------------------------------------------- + + Thanks for the question. On the semi-custom business, I'm sure you guys have looked at prior console platform price cuts for customers and their effect on sellthrough. So I'd love to know how you are kind of thinking about that and the potential re-acceleration if that were to happen. Do you have any prior metrics you can share with us? +And then also, I think I know the answer, but if there was a platform price cut, should we still expect to slow in linear reduction in your ASPs or might there be something a little bit more aggressive, like a one-time step down? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [58] +-------------------------------------------------------------------------------- + + Yes. Okay. So Chris, if you look at the semi-custom cycle -- and again, these cycles are hard to predict -- through this year, through the end of 2015, the game console units are far ahead of the previous cycle. So on the order of 20 million units ahead of the previous cycle. +When you look at the significant price points, I would say there are sub-$300 price points that start accelerating demand. And you saw some of that this holiday season, so that had some impact. +Your question overall in terms of acceleration -- I think, again, the game console guys know how to do this cost reduction and they've done it very well. Our price or ASP reductions are not step-function reductions. They end up being pre-negotiated and in line with cost reductions that we have agreed to with our partners. + +-------------------------------------------------------------------------------- +Chris Rolland, FBR & Co. - Analyst [59] +-------------------------------------------------------------------------------- + + Okay. Very helpful. Also, perhaps you can talk about ASPs in 2016, how do you see them trending with Summit Ridge and server products. And how big a driver is that for top line and for profitability? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [60] +-------------------------------------------------------------------------------- + + I think it is very important that we see an improvement in our product mix. And that's something that we've certainly been striving for in both our mobile products and as we introduce higher-performance desktop and server products we should see that reflected in the ASPs. +So the mix of business, focusing on commercial versus sort of the low-end consumer, will help all those things. But when the vendor talks about some of the pluses and minuses on gross margin, it really is our ability to increase and improve that mix in our overall business going forward. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Hans Mosesmann, Raymond James. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates, Inc. - Analyst [62] +-------------------------------------------------------------------------------- + + Lisa, a clarification on Zen. You said that you have some design wins already on the server side of that roadmap. Can you give us a sense on what kinds of server wins and what kind of an opportunity you see in terms of market share over the next several years as you come back to the market? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [63] +-------------------------------------------------------------------------------- + + Yes. So Hans, overall on the Zen design wins, we have been engaged very early on with large OEM and cloud providers on the Zen design point and the platforms that would be useful for Zen. So we have closed our first design wins. We are working very closely with these OEM partners to make sure that they bring up their platforms concurrently with our own design validation and testing. +I think the main message is we are on track with the schedule that we previously discussed in terms of sampling this year. We will introduce first in desktop and so we are having conversations with some of the PC OEMs about getting their platforms ready for desktop. And then we will go into enterprise server first full year in 2017. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates, Inc. - Analyst [64] +-------------------------------------------------------------------------------- + + Okay. And then as a follow-up, what kind of performance point should we look at your initial Zen in the server space? Is this kind of Xeon E3 Class-type products or E5s? Or maybe you can help with some granularity there if you can? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [65] +-------------------------------------------------------------------------------- + + So we believe that we will be able to address, let's call it, 80% of the server CPU market with our Zen class of products. So that's a very high end, but really the meat of the market. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [67] +-------------------------------------------------------------------------------- + + Great. Thank you. I wonder if you can talk about the discrete GPU market business. You were first to market with high-bandwidth memory and saw the benefit of that. Did you see the benefit that you had hoped for? And with your competitor ramping HBM at some point presumably this year, does that blunt the momentum that you've seen in the GPU side? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [68] +-------------------------------------------------------------------------------- + + Yes. I would say HBM was a very good technology. I think we got the performance benefit that we expected. It is still at the high end of the cost point range and so that's why we've introduced it just at the high end. +I think HBM and all this 2.5D packaging technology is going to be really important over the next three years -- three to five years -- but definitely over the next three years. So I think being first to market, we've gotten a lot of experience on the technology. We will continue to use high-bandwidth memory in our portfolio. And as the cost goes down, it will give us an opportunity to use it in a broader set of segments. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [69] +-------------------------------------------------------------------------------- + + Great. Thank you. And then as my follow-up, have you talked about potentially semi-custom products in virtual reality? And to the extent that you have or can, is that going to have the same type of GPU requirement that we've seen on the PC platform or is it possibly scaled down from that level of performance requirement? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [70] +-------------------------------------------------------------------------------- + + So I think there are opportunities to do custom implementations of GPU for virtual reality. I think the amount of graphics horsepower that's required and perhaps some of the form factors that you want to go into being smaller and more portable would enable you to do that. +I think it's early to talk specifics, but I think that the general idea that VR has a lot of requirements and doing something custom might be helpful I think is absolutely on the mark. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Steven Chin, UBS. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [72] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. Lisa, if I could on the graphics roadmap side, with the upcoming Polaris architecture later this year, that's going to come out about four to five quarters after Fiji was released, which is a pretty good improvement in terms of timing or cadence compared to the previous generation. +So I guess my question is is this sort of one-year-plus cadence for your GPU roadmap, is this something that can be assumed going forward? And how does that compare relative to the OpEx run rate that Devinder guided for for this year -- is that the right quarterly run rate for [that consisting] that type of graphics roadmap, first of all? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [73] +-------------------------------------------------------------------------------- + + Yes. So I think the overall answer is we do believe the cadence of graphics requires annual refreshes, and we're going to invest to enable that. And I think the Polaris launch is significant because it's also a change of process technology, which sometimes can run into other issues. But I think we feel very good about where we are there and you should expect that cadence to continue. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [74] +-------------------------------------------------------------------------------- + + Perfect. And as my follow-up, just given some of the product announcements on the professional commercial graphics side and some of the design wins you were talking about with Dell, for example, I was wondering if you could help provide any color from your customers in terms of qualitative or even quantitative, potentially, in terms of the opportunity for AMD this year, especially given the macro backdrop -- is there going to be some large step-function up this year from those design wins? Or it pulls the macro potentially play somewhat of a modest headwind for that new opportunity? + +-------------------------------------------------------------------------------- +Lisa Su, AMD - President, CEO [75] +-------------------------------------------------------------------------------- + + So I really view the macro has more of a headwind for the overall PC market. When you talk about professional graphics, I think it's such a specialized market that it is more about the product you offer and is competitive and differentiated enough. +I think it's fair to say that most of our customers would say the products are actually very good. So the overall product capability and performance is good. Our issue has really been are we investing enough in the software resources to help customers use some of our products. +So I think on the professional graphics base, we do believe it's a growth opportunity. I think we're going to continue to invest in some of the software around professional graphics and continue to make steady progress into 2016. + +-------------------------------------------------------------------------------- +Liz Morali, AMD - Director, IR [76] +-------------------------------------------------------------------------------- + + Thank you. That concludes our call for today. We'd like to thank everyone for participating. Operator, you may close the call now. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- + + Okay. Ladies and gentlemen, this does conclude your conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2016-Jul-21-AMD.txt b/Transcripts/AMD/2016-Jul-21-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..d89bf0ffc15df30a62fd5518ea1aa0546d347d8c --- /dev/null +++ b/Transcripts/AMD/2016-Jul-21-AMD.txt @@ -0,0 +1,642 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Advanced Micro Devices Inc Earnings Call +JULY 21, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Lisa Su + Advanced Micro Devices, Inc. - President and CEO + * Devinder Kumar + Advanced Micro Devices, Inc. - SVP, CFO and Treasurer + * Ruth Cotter + Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Jaguar Bajwa + Arete Research - Analyst + * Gabriel Ho + BMO Capital Markets - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Stacy Rasgon + Bernstein Research - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Marco Chan + Citigroup - Analyst + * Ian Ing + MKM Partners - Analyst + * Sidney Ho + Deutsche Bank - Analyst + * Joe Moore + Morgan Stanley - Analyst + * John Pitzer + Credit Suisse Group - Analyst + +================================================================================ +Presentation +================================================================================s +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Greetings, and welcome to the Advanced Micro Devices' second-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. +I would now like to turn the conference over to your host, Ruth Cotter, Chief Human Resources Officer, and Senior Vice President of Corporate Communications and Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [2] +-------------------------------------------------------------------------------- +Thank you and welcome to AMD's second-quarter conference call. By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you've not reviewed these documents, they can be found on AMD's website at IOR.AMD.com. +Participants on today's conference call are Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on AMD.com. +I'd like to take the opportunity to highlight a few dates for you. Lisa Su will present at the Pacific Crest Global Technology Leadership Forum on the 9th of August in Colorado. Raja Koduri, Senior Vice President and Chief Architect, Radeon Technologies Group, will attend the Jefferies Semiconductor Hardware and Communications Infrastructure Summit in Chicago on August 30. +Mark Papermaster, Senior Vice President and Chief Technology Officer, will present at the Deutsche Bank's Technology Conference on September 13 in Las Vegas. And our third-quarter quiet time will begin at the close of business on Friday, September 16, 2016. Before we begin, let me remind everyone that second quarter -- that the second-quarter 2016 was a 13-week quarter, and we expect to record our extra week in the fourth quarter of 2016. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date, and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note we will be referring to non-GAAP figures during this call except for revenue, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary that we've posted on our website at quarterlyearnings.AMD.com. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You will also find detailed discussions about our risk factors in our filings with the SEC, and in particular, AMD's Quarterly Report on Form 10-Q for the quarter ended March 26, 2016. +Now with that, I'd like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- +Thank you, Ruth. And good afternoon to all those listening in today. Our ongoing focus on diversifying our business model and delivering great products is creating solid market and financial momentum. Looking at the second-quarter specifically, strong semicustom demand and better-than-seasonal graphic sales drove a 23% sequential revenue increase and our return to non-GAAP operating profitability. +We also recorded our first full quarter licensing gain from our China server JV, THATIC, and improved our balance sheet with cash proceeds from the formation of our ATMP joint venture, with NFME. Looking at our Computing and Graphic segment, revenue decreased 5% sequentially, as stronger-than-seasonal GPU sales were offset by a decline in desktop processor sales. +First-half 2016 GPU sales increased by a double-digit percentage from a year ago, as the investments we have been making to develop leadership graphics hardware, software and drivers, combined with new marketing campaigns, are paying off. +Our strong second-quarter graphics performance was capped by the launch of our new Polaris based RX 480 GPUs at the end of June, which helped contribute to our highest desktop channel GPU shipments since the fourth quarter of 2014. The Radeon RX family resets expectations around the experiences and features gamers now want in a mainstream GPU. +We are pleased with the Polaris launch, initial channel sales, and OEM design wins. We expect this strong demand to continue and help drive revenue growth in the third quarter with the launch of the RX 470 and RX 460 desk top GPUs, and Polaris based notebooks from our OEM customers. We also delivered our third straight quarter of sequential professionals graphics revenue growth and believe we gained share driven by increased adoption of FirePro graphics by OEMs as well as several cloud data center GPU compute wins. +In client, mobile APUs sales increased for the third straight quarter, partially offsetting decreased desktop processor sales led by channel softness in China. Shipments of our recently launched seventh generation APUs are ramping well and outpacing sales of our six-generation APUs at this point in their lifecycle. +More than 25 new seventh generation APU systems, including several premium designs, are expected to be widely available in the coming months from Acer, Asus, Dell, HP, and Lenovo, providing us with confidence in this part of our business as we enter the seasonally stronger second half of the year. +Turning to our enterprise embedded and semicustom segment, our 59% sequential revenue increase is the largest since our first full quarter of semicustom products shipments in 2013. As in the previous two years, we expect semicustom shipments to peak for the year in the third quarter, as both Microsoft and Sony prepare for the holidays. Based on strong demand, we believe semicustom unit shipments and revenue will grow on an annual basis. +Last quarter at E3, Microsoft announced two new members of the Xbox One family powered by AMD. The Xbox One S is the slimmest Xbox console ever, and the first to support HDR. The system is expected to go on sale in the coming weeks. Microsoft also announced their next-generation game console, code-named Project Scorpio, for the 2017 holidays. +Project Scorpios is designed to be fully compatible with existing Xbox One software, while leveraging AMD's leadership gaming technologies to create more immersive 4K and VR gaming experiences. Project Scorpio is one of the semicustom design wins we communicated previously. +Our next generation Zen processor products passed several key milestones in the quarter as well. I'm excited to report that, in addition to conducting the first public demonstration of our next generation Zen-based processor at Computex in June, priority server customer sampling began in the quarter, and dual socket server platforms are now running at both our labs and our customers' labs. +We are pleased with the performance we are seeing with Zen hardware, which is helping to expand our customer engagements and accelerating design win momentum across multiple OEMs and ODMs. We remain on track for volume shipments of our Zen server CPU in the first half of 2017. +In closing, over the last 18 months, we have been diligently executing our strategic plan to improve our financial performance by delivering great products, strengthening our customer relationships, and simplifying our business. In the past six months alone, we released our game-changing Polaris architecture, completed our ATMP JV transaction, announced a JV and IP licensing transaction with THATIC, and returned to non-GAAP operating profitability. +While we recognize we have more work to do, we believe that, based on the ongoing ramps of our semicustom SoCs, Polaris GPUs, and seventh generation APUs, we can deliver full-year revenue growth in 2016 and non-GAAP operating profitability in the second half of the year. We also remain focused on delivering our road map of high performance products and technologies, including Zen and our next generation Vega GPU architecture that can drive long-term growth. +Now I'd like to turn the call over to Devinder to provide some additional color on our second-quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [4] +-------------------------------------------------------------------------------- +Thank you, Lisa, and good afternoon, everyone. The second quarter was a strong quarter, punctuated by better-than-expected financial performance, driven by demand for our semicustom SoCs and the closure of our ATMP joint venture transaction with Nantong Fujitsu Microelectronics, which bolstered our cash position. +Second-quarter revenue was $1.027 billion, up 23% sequentially, driven by higher sales of semicustom SoCs. The year-over-year revenue increase was 9% with higher sales in both reportable segments. Gross margin was 31%, down 1 percentage point from the prior quarter, primarily due to a higher mix of semicustom SoCs sales. +Operating expenses were $342 million, up $10 million from the prior quarter, primarily due to increased marketing investments. We also recognized a $26 million licensing gain associated with our JV with THATIC, and restructuring credits of $7 million, primarily related to facilities. We are pleased to report operating income of $3 million this quarter. +Net loss was $40 million with loss per share of $0.05, calculated using 794 million basic shares in the quarter. We recorded a pretax gain of $150 million related to the ATMP JV transaction, an equity loss of $3 million based on our 15% ownership stake, and taxes of $27 million related to the JV transaction. Adjusted EBITDA was a positive $36 million compared to negative $22 million in the prior quarter. +Now turning to the business segments -- Computing and Graphics revenue was $435 million, down 5% from the prior quarter, primarily due to decreased sales of client desktop processors and chipsets. Revenue was up 15% year-over-year, largely driven by higher client notebook Processor and Graphics sales. +Computing and Graphics segment operating loss was $81 million compared to $70 million in the prior quarter, primarily due to lower revenue. Enterprise, embedded and semicustom revenue was $592 million, up 59% from the prior quarter and 5% higher than the prior year, driven by higher semicustom SoC sales. Operating income of this segment was $84 million, up from [$16 million] in the prior quarter, driven by higher revenue and a $26 million IP licensing gain compared to a licensing gain of $7 million in the first quarter. +Turning to the balance sheet, our cash and cash equivalents totaled $957 million at the end of the quarter, up $241 million from the end of the prior quarter, primarily due to net cash proceeds from the ATMP JV transaction, offset by working capital needs in the quarter. Inventory was $743 million, up $68 million or 10% from the prior quarter, and higher than guided, in support of expected higher semicustom sales in the third quarter. +In the second quarter, we recorded a $62 million investment on our balance sheet related to our 15% ownership stake in the ATMP JV. Total wafer purchases from GlobalFoundries in the second quarter were 75 million and year-to-date, we have purchased 259 million. +Debt as of the end of the quarter was $2.24 billion, flat from the end of the prior quarter, and includes total borrowings of $226 million on our secured revolving line of credit. Free cash flow in the second quarter was negative $106 million compared to a negative $68 million in the first quarter of 2016, primarily due to the inventory build in support of strong second-half revenue. +Now turning to the outlook, which is based on a 13-week fiscal quarter. For the third quarter of 2016, we expect revenue to increase 18% sequentially, plus or minus 3%, primarily driven by our graphics and semicustom products, including the ramp of new semicustom business; non-GAAP gross margin to be approximately 31%; non-GAAP operating expenses to be approximately $350 million, due to an increase in R&D investments; IP monetization licensing gain to be approximately $22 million to maintain non-GAAP operating profitability; non-GAAP interest expense, taxes or other -- and other to be approximately $45 million; cash and cash equivalents to be approximately flat; and inventory to be approximately $700 million. And lastly, for the full-year 2016, we expect low-single digit revenue growth year-over-year. +In closing, we are pleased with the progress we've made this quarter. We launched exciting new products in the second quarter, with more expected to come to help drive strong revenue growth and improved financial performance in the third quarter. We recognize there's a lot more work to be done to return AMD to sustainable profitability and free cash flow generation, and look forward to continuing our progress over the coming quarters. +With that, I'll turn it back to Ruth. Ruth? + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [5] +-------------------------------------------------------------------------------- +Thank you, Devinder. Operator, if you could poll the audience please for a question-and-answer session? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [2] +-------------------------------------------------------------------------------- +My first question -- can you give us any detail on the ramp in dollar terms of revenues from new semicustom products in the September/December quarters, and what the seasonal pattern of these products might be? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- +Sure, David. This is Lisa. Let me start with that. So, our semicustom business overall, we see as strong for the year. I think the predominant business is the current generation game consoles, and as they ramp into the second half and the stronger holiday season. +We expect the seasonality of semicustoms to be similar to prior years. We'll see a peak in the third quarter and a decline in the fourth quarter, and we will see the new business layer in starting in the third quarter. But I don't expect that to change the seasonality pattern. So, we are building up for a strong holiday season overall. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [4] +-------------------------------------------------------------------------------- +Okay. Great. Thanks, Lisa. And since the launch of your Radeon 480 graphics product end of last month, have you been able to supply to demand for the cards? Or if not, when do you expect demand will rise to match supply? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [5] +-------------------------------------------------------------------------------- +Yes. So, David, we're very pleased with the launch of the Radeon RX 480. We had good supply at major retailers on launch day. Since then, the demand has continued to be strong and so some of the retailers are out of supply. We do see that the 14 LPP yields are good and we're ramping up production steeply. +So we expect that will equalize as we go through the quarter. We're also very soon going to launch the rest of the Radeon RX family. And so you'll see three products in the third quarter in terms of overall product momentum. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [6] +-------------------------------------------------------------------------------- +Great. Thanks very much. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [7] +-------------------------------------------------------------------------------- +Thanks, David. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking my question. First one -- Lisa, maybe for you -- the China licensing deal was -- I thought it was creative and fascinating. Can you characterize kind of the pipeline of IP deals that you have or the technology deals? Is this it? Or do you have more in the pipe? Can you talk about timing or the types of deals you might be working on? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [10] +-------------------------------------------------------------------------------- +Sure, Mark. So the China JV, as you said, we announced it last quarter and it's now in operation. It's actually going well, so we're on track for some of the important milestone deliveries that we had. +In terms of the overall pipeline, I would say we have a nice set of interesting opportunities. They're -- very much, as you know, they take a while for them to come to fruition, but we feel good about the model which is partnering with folks that need high-performance technology. And we'll continue to work those deals as we go through the next couple of quarters. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [11] +-------------------------------------------------------------------------------- +Okay. Great. And I'll follow-up if I may. I was hoping that you could just help me with the accounting of the semicustom design wins. So if I remember properly, there was two that you expect in the back half of this year, and then one -- I thought it was the first half of next year. +So Scorpio is one of those three? But that's next year; so that's the one for next year? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [12] +-------------------------------------------------------------------------------- +Yes, let me help you out with the accounting -- I know that we've had several different pieces of information on the semicustom new design wins. So what we said is we'll have a total of three semicustom new design wins that will account for about -- let's call it $1.5 billion of revenue approximately over the next three to four years. +We are starting the ramp of new business this coming quarter, this third quarter, and that will be one of the semicustom design wins. Scorpio is also a design win, and that, as our customer said, will be in 2017. And we'll give you more information about the third one as we have more visibility. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [13] +-------------------------------------------------------------------------------- +And do you have more design wins that you just haven't announced or mentioned timing of? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [14] +-------------------------------------------------------------------------------- +Well, we're trying to get out a little bit of the counting game, but I think overall, we're pleased with the semicustom pipeline. I think some of the questions that we've been asked are, do we believe we have design wins outside of game consoles, and the answer is yes. We have design wins outside of game consoles. I think we view the pipeline as good, and it's a business model that works well with our high-performance technology plans and our SoC capabilities. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [15] +-------------------------------------------------------------------------------- +Thank you. That's very helpful. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [16] +-------------------------------------------------------------------------------- +Thanks, Mark. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [18] +-------------------------------------------------------------------------------- +Thanks for taking my questions. Lisa, I have a couple of questions on Zen. You gave some color in your prepared remarks about server opportunities for Zen starting in the first half of next year. Maybe you could give us a little color on potentially what markets you are going after there, where you see the opportunities? +It seems to me that a lot of different moving parts in the cloud market with open power and ARM, and then custom CPUs from Intel, but a pretty big enterprise space that's x86 captive for you guys to go after. So I would just be interested to see what the strategy is going forward there and where the design wins might come from? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [19] +-------------------------------------------------------------------------------- +Sure, Matt. So, yes, let me give you a little bit of color how we see it. First of all, look, Zen is a brand-new CPU design and we had very ambitious goals for it. And given where we are today, it's actually coming up very well. +We've demoed both desktop systems, and now we have server systems working in both our labs and our customers' labs. I would say as the progress of Zen is -- goes along in terms of validation, the customer interest has increased. And so, while we did close a number of design wins in the second quarter and we have a number more in the pipeline, as we go into the third quarter and more widespread availability. +Our view is, Zen is a general-purpose server architecture that can play in many different places. So you mentioned the cloud. I think that's certainly one target market given the growth there. We also see there are workloads that would be particularly -- fit well for sort of the performance areas that we're targeting. I think enterprise is also again very much a target area for Zen. +What we are looking for again is ensuring that we have a very high quality launch, and so we're working very closely with customers to make sure that we run their workloads and demonstrate the performance improvement that we expect. But as I said overall, it's going well, and we continue to work with customers to ensure that they see the benefits of Zen and working with AMD. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [20] +-------------------------------------------------------------------------------- +Thank you for the color and it's good to hear. I guess another question on Zen more in the PC market -- because I think your prepared remarks focused a bit more on server -- but maybe you could give us a little bit of an update in the timing of desktop and notebook potential launches. +It just seems to me going into the holiday season that it's still a little unclear as to where Zen is going to land relative to holiday ramps in the Western market and to Chinese New Year. So any color around that would be really helpful. Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [21] +-------------------------------------------------------------------------------- +Yes. No, that's a fair question, Matt. So we have been very focused on the server launch for first half of 2017. Desktop should launch before that. In terms of true volume availability, I believe it will be in the first quarter of 2017. We may ship some limited volume towards the end of the fourth quarter, based on how bring-up goes and the customer readiness. +But again, if I look overall at what we are trying to do, I think the desktop product is very well-positioned for that high-end desktop segment, that enthusiast segment, in both channel and OEM, which is very much a segment that AMD knows well. And so that's where we would focus -- on desktop. +You should expect a notebook version of Zen with integrated graphics in 2017, and that development is going on as well. And so I think it's just a time of a lot of activity around the Zen and the different Zen product families. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [22] +-------------------------------------------------------------------------------- +Thank you very much. Congratulations on the return to profitability. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [23] +-------------------------------------------------------------------------------- +Thanks, Matt. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [24] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [26] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I was looking at the implied guidance for Q4. You said the -- I guess for the full year, up low single digits. So, I mean, call it 3%. But it would imply Q4 down 16%/17% sequentially, and actually down on an absolute basis, lower than I would've thought. I think Q4 also has an extra week in it. +I was wondering if you could give us, I guess, some color on how you see the drivers, I guess, for seasonality going from Q3 to Q4 across both of the businesses, given that, I guess, the trajectory of the different product launches that we have in the back half? Like, how do you come to that number? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [27] +-------------------------------------------------------------------------------- +Sure. Stacy, maybe I'll start and see if Devinder would like to add to it. So, look, our -- when we started the year, our expectation is that we would grow revenue in 2016 versus 2015, but we were coming off of a very low base in the first quarter. So we've been pleased with how it played out certainly in our second-quarter revenue and the third quarter revenue guidance. +Overall, the businesses are performing well, so we do expect both Computing and Graphics and EEFC to both grow for the year. I think the semicustom business is the large driver of the fourth quarter in terms of just how we see the overall business playing out. But the Computing and Graphics business is playing out as you might expect. +So the second half should be seasonally higher, certainly with Polaris, and as we launch broader availability across the product line, as well as the seventh generation APUs as they go into back-to-school and holiday. So that's the way we should think about it. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [28] +-------------------------------------------------------------------------------- +Okay. Thank you. For my follow-up, I just wanted to take a look at your notebook shipments in the quarter. So they were up again sequentially -- I think they were up double digits in Q1; I think they were up in Q4 as well. So three quarters in a row of sequential increase. Obviously off a low base as well. +But how confident are you -- like what's driving that? Is this -- is it actually sort of a sell-out that's actually driving the demand? Or is this sell-in into the channel? And how should we think about that potentially normalizing? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [29] +-------------------------------------------------------------------------------- +Yes, so if you're talking about the notebook computing business, actually we are kind of pleased with how it performed. So if you look at it, overall, the -- our OEM customers have adopted our technologies, so we see that across both notebook and desktop, but presumably notebook. +We are also making progress in commercial, and that was a very important initiative over the past five or six quarters. And so that's been nice to stabilize the business. And again, I don't believe it's a sell-in phenomenon. Actually it's consumption share that we see increasing. And I think we have a reasonable opportunity to add to that in the second half of the year. But it's really around our products in the platforms that we're putting together with the OEMs. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [30] +-------------------------------------------------------------------------------- +Got it. If I could ask one more really quick. I was just a little bit surprised at how much your wafer purchases at GlobalFoundries came down quarter-over-quarter, given the increase in notebooks as well as the timing of the Polaris launch. Any -- what -- should we read anything into that? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [31] +-------------------------------------------------------------------------------- +I think basically the purchases of the wafers are in line with product demand and mix of business. And as I said in the prepared remarks, the other day we purchased about [$260 million] of wafers, and we are getting into the back half of the year, which as you can see, with our revenue guidance in Q3, is pretty strong. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [32] +-------------------------------------------------------------------------------- +Thank you, guys. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group - Analyst [34] +-------------------------------------------------------------------------------- +Thanks for letting me ask the question and congratulations on orchestrating the turnaround. I guess, Lisa, my first question, I would kind of like to get your view on the news earlier this week around Softbank and ARM. You are sort of in a unique position because you are both kind of a partner with ARM as an ARM licensee. But if you look at your custom silicon business, especially on the x86 architecture, you could make the argument that you're a little bit of a competitor as well. +So I'm kind of curious to know how you see kind of the reaction to that from a customer perspective? And does that change your view of how you might be able to monetize your own IP in the future? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [35] +-------------------------------------------------------------------------------- +John, thanks for the question. Look, I think it's a very interesting deal -- the ARM SoftBank deal. I think we have a lot of respect for ARM; they are a close partner. I'm not sure we would call them a competitor. Overall, they are a partner. +As it relates to how we think about our IP, we really believe that our IP, particularly the high performance element of it on the microprocessor and the graphic side, is very unique, and in some sense, there are very few places in the industry where you have access to it. I think the applications that need it, whether you are talking about consumer applications or enterprise cloud applications, are growing. And so it's an opportunity for us to look for larger markets to monetize beyond just our own products. +And that's, in general, the way we think about IP monetization. We have a set of products that is very important to our business model, but our IP can go further than our products themselves. And so we would continue to look for opportunities to monetize our IP. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group - Analyst [36] +-------------------------------------------------------------------------------- +And again, I apologize if I missed this -- you commented on sort of your expectations for GPUs going into Q3 and for semicustom. How do you view the PC outlook within your total outlook above ATM? And I've got a quick follow-on. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [37] +-------------------------------------------------------------------------------- +Sure. So let me talk about the PC market overall. I think our view of the PC market is pretty similar to others in the industry. We would say, overall for 2016, high-single digit decline. We have seen some positive signals, and we saw some positive data points from IDC earlier the last week. And then we saw a little bit of pickup in consumption in June from our OEM customers. But again, that was compared to -- let's call it a soft April/May. +Our view is OEM business looks okay. The channel for us is still weaker than we would like, and that's our view of the PC business. Even in that framework, we believe we can grow our Computing and Graphics business on the strength of the products. The Graphics products, we've talked about, as they ramp in the second half of the year. And on the Computing side as well, I think we have a number of new platforms, and back-to-school and holiday are important for us. So that's the way would characterize PCs. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group - Analyst [38] +-------------------------------------------------------------------------------- +So, Lisa, not to put words in your mouth, but for Q3, PC's up but perhaps not up as much as seasonal? Is that the best way to think about it within your guide? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [39] +-------------------------------------------------------------------------------- +I would say roughly seasonal -- roughly seasonal. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group - Analyst [40] +-------------------------------------------------------------------------------- +That's helpful. And then lastly, guys, I apologize, but Devinder, now that you've got revenue growth behind you and you've got some momentum here, how do we think about the gross margin progression from here and kind of the puts and takes? And I know there's lot of different dynamics there, including the mix of semicustom. But from these levels, how should we think about gross margin progression over the next, call it, two to four quarters? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [41] +-------------------------------------------------------------------------------- +Yes, John, I think the way you think about it is, it is the mix of business, so that's a good observation. But also you see us making continuing investments in our roadmap in graphics and in other areas, and we believe that will help us improve the gross margin. And then as you look out longer-term, as you observe -- get beyond a couple of quarters and get into 2017, we do have the Zen product introduction coming up. We also have a product in the pro graphics area, and that should drive even higher gross margins compared to where we are today, given the mix will get better with those products. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse Group - Analyst [42] +-------------------------------------------------------------------------------- +Thanks. Well, thanks, guys. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [43] +-------------------------------------------------------------------------------- +Thanks, John. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [45] +-------------------------------------------------------------------------------- +Thanks for taking my question. This is Sidney Ho asking -- calling in for Ross. Just follow up to -- with the last question by focusing on third quarter, you guided third-quarter gross margin to be flat, but the profile seem -- of revenue growth seems to be -- would suggest gross margin should decline on a mix adjusted basis. +How should we think about gross margin by segment in Q3? What are some of the moving parts? And maybe follow-up to that, do you expect the gross margin of the new custom design wins ramping this quarter to have better or worse margins than your game console business? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [46] +-------------------------------------------------------------------------------- +Yes, I think that's well-put. I mean if you look overall when we have a higher mix of semicustom business, typically the gross margin is lower since the business model on the semicustom side has for the lower margin just the way the model is constructed. So keeping it flat at 31% with the guide in Q3 was variable in Q2. We were pretty pleased with that. And I think you're seeing some of the strength underlying the non-semicustom business is allowing us to keep it flat quarter-on-quarter. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [47] +-------------------------------------------------------------------------------- +Okay. Great. And then my follow-up question is -- you guys talked about the Zen products at Computex and it's on track for launching in the first half of 2017. Can you talk about the impact on R&D expense and maybe on gross margin on the preparation of this launch over the next few quarters? And if you hit your revenue plan that you have thought about, at what point do you need to start increasing OpEx from the $330 million to $350 million level? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [48] +-------------------------------------------------------------------------------- +The OpEx side of it, if I look at it from that standpoint, you have seen our OpEx actually go up; in Q3, we are guiding at the $350 million level with specific targeted investments we are making in key R&D areas and products, in particular the high performance roadmap that we have laid out. But we are also making some specific investments in the marketing area, given the new products that are coming out on the PC side as well as the GPU side, trying to attract end-users back to the AMD brand. +And I think you'll continue to see us do that. And that helps obviously with this new product underlying the better margins that you get with the fresh cycle, in particular with the new technology areas that we are putting our products in. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [49] +-------------------------------------------------------------------------------- +Great. Maybe just one quick follow-up. For Q4 with an extra week in the fiscal quarter, should we expect OpEx to be at the high end of levels, that that will be enough -- that $350 million? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [50] +-------------------------------------------------------------------------------- +I'm not prepared -- you know, one of the things about OpEx as I always say even if you look at Q3, the OpEx is up on a guided basis at $350 million, but very much as I always say, we manage the OpEx pretty tightly. We've done that over the last several years, and obviously it gets modulated somewhat by revenue. Q3, our revenue is up 18%, OpEx is at $350 million and we'll talk about Q4 when we gather here in about 90 days. + +-------------------------------------------------------------------------------- +Sidney Ho, Deutsche Bank - Analyst [51] +-------------------------------------------------------------------------------- +Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- +I was also curious about GlobalFoundries being so low in Q2. And I guess have you guys finalized the 2016 wafer supply agreement? And can you talk more generally about which products -- how you are deciding which products are allocated to Global and TSMC? And is there anything that's exclusive to one or the other? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [54] +-------------------------------------------------------------------------------- +Yes, several parts to it. I mean the working relationship, as Lisa said, with GlobalFoundries is very good. We continue to work through the 2016 WSA and that's not finalized; we're in the process of negotiating that. In the meantime, we continue to get delivery of wafers for the products that we need in line with the product demand and mix of business. And relative to your -- which products from which foundry, we typically do not share the source of foundry for any of our wafers or products. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [55] +-------------------------------------------------------------------------------- +Okay. That's fair. And then with regards to kind of thinking about next year's OpEx, when you look at the importance of a CPU that can attack the server market and can attack the high end of the sort of enthusiast CPU market, I guess I don't want you to necessarily be constrained by the R&D requirements of the last couple of years. +I mean, so how do you think about that? If you start to show some revenue traction, I mean, can you -- how much flexibility do you think there is on spending? I'm not asking for a number, but just qualitatively, how are you thinking about profitability versus investing in these opportunities next year? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [56] +-------------------------------------------------------------------------------- +Joe, I would say my engineers would be very happy to hear you say that. So look, I appreciate the question. I think you've seen -- and Devinder said this -- we're going to be disciplined in OpEx. And as this quarter was an important turning point for us, to return to operating profitability, I think we have a nice sort of a view into Q3. +We will look for opportunities to ensure that we are strategically placing the big bets in R&D, and both on the CPU and the GPU side. For example, this year, we have ramped up our investments on the graphics side with the formation of the Radeon Technologies Group, and what we're doing in both hardware and software -- very significant investments. +And similarly on the CPU side as well. So, I think we take very seriously our commitments in terms of profitability, but we will invest in the future and we'll continue to look for opportunities to balance those in the right way. +I don't know, Devinder, if you want to add --? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [57] +-------------------------------------------------------------------------------- +No, I think that's well-said. In 2017, obviously, as we get to the back half of the year, Q3 we have guided, we're getting to that -- get through Q3 and get into Q4. And at that point, we'll start thinking about where we want to place our bets as these are put in terms of the longer-term investments in 2017. Right now we're really focused on getting -- we got to non-GAAP operating profitability this quarter. We want to maintain that in Q3 and then we'll see what happens from there. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [58] +-------------------------------------------------------------------------------- +Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Christopher Danely, Citigroup. + +-------------------------------------------------------------------------------- +Marco Chan, Citigroup - Analyst [60] +-------------------------------------------------------------------------------- +This is Marco Chan calling on behalf of Chris Danely. Thanks for letting me ask the question. My first question is, could you please update us on your expectations on the THATIC x86 server JV in China? Are there any potential legal risks with it, potentially Intel? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [61] +-------------------------------------------------------------------------------- +Yes. So relative to the server JV that we have with THATIC, as we stated before, we believe that our joint venture is operational. I think it's well underway. The technology that we're licensing is AMD technology, and so we don't have any issues relative to licensing. I think -- + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [62] +-------------------------------------------------------------------------------- +Yes. If I may add, I mean, one thing on the update, I guess, if you look at the prepared remarks and the commentary for Q3 is, we now expect, based on technology transfer milestone completion, to recognize $22 million to authorize a gain in Q3 and approximately $75 million for the year, which is higher than what we had said previously when we said it was $52 million for the year. So you can see it's incremental and therefore, as Lisa said, things are operationally on track and we continue to meet our technology transfer milestones from a date standpoint. + +-------------------------------------------------------------------------------- +Marco Chan, Citigroup - Analyst [63] +-------------------------------------------------------------------------------- +That's very helpful. Thank you. And then my follow-up -- I know you guys mentioned PCs and Graphics segment should be up year-over-year. Could you guys get into more detail, maybe talk about each segment individually, your trends for PCs versus GPUs? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [64] +-------------------------------------------------------------------------------- +Yes, we don't usually go into granularity about the subsegments of the business. I think it's fair to say that our PC business has stabilized. And what we're seeing now is the opportunity, as we go into the seasonally stronger half of the year on both the PC side and graphics side, on top of that with some new product launches, we believe that we will end up growing year-over-year. But again, we don't usually guide to the details within the segment. + +-------------------------------------------------------------------------------- +Marco Chan, Citigroup - Analyst [65] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [67] +-------------------------------------------------------------------------------- +This is Gabriel Ho calling in for Ambrish. Thanks for taking my question. I have a follow-up on your Project Scorpio comment. I think it's going to be launched in 2017. And I think you had significantly higher performance and support 4K and V. So how should we think about the pricing on ASP that compares to what you have indicated on the current generation game console platform? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [68] +-------------------------------------------------------------------------------- +Yes. So, again we don't -- we wouldn't disclose anything that's incrementally more than what our customer has disclosed. So I think Microsoft has talked about their goals with Project Scorpio. I think we are in support of those goals. Given the performance level, you would imagine that there's more capability on chip, but I wouldn't want to go more than that. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [69] +-------------------------------------------------------------------------------- +Okay. As a follow-up -- I think your competitor has launched a comparable mainstream product -- I think GeForce 10 6P, so given the absence of your maybe higher performance part launching maybe in the second half, so how should we think about the rest of the year on the demand on your graphics side? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [70] +-------------------------------------------------------------------------------- +Yes, we are feeling very good about our Polaris launch. This was our strategy from the beginning. I mean we laid out a strategy where we were going after the mainstream, and growth rate, really a new experience in terms of both capability and price point. And I think we've done that. +We've also been very focused on DX 12 and our performance -- on new APIs like Vulcan. So we are happy with our competitiveness. I think it's played out as we thought it would do. Certainly our aspirations in GPU are to certainly have very competitive products across the entire product line. And so I've talked about working on Vega, which is the next generation high-end architecture. +But in terms of our competitiveness, you know, we -- again, we've executed what we thought we were going to execute. And it seems like, from both customer reviews and analyst reviews, that it's pretty well-received by the market. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [71] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [72] +-------------------------------------------------------------------------------- +Operator, we'll take two more callers, please. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [74] +-------------------------------------------------------------------------------- +Yes, thank you for fitting me in. So EESC -- looks like you achieved operating income same level as third quarter of last year but with $45 million lower revenue. So just wondering how you got more profitable in this segment, given these are both strong game console quarters and also you've got annual price declines in game consoles, I assume. Thanks. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [75] +-------------------------------------------------------------------------------- +I think if you look at the profitability, you've got to remember that in the EESC segment, we also have other businesses embedded for one, and also the investment we are making for the enterprise side of it, for the data center product that's coming out in 2017. So the profitability -- you're right about the observation, but profitability depends upon obviously -- the largest business we have in there right now is the semicustom business, but also the investments on the OpEx standpoint that we make year-on-year. And we talked about the targeted investments we are making in some of the product areas. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [76] +-------------------------------------------------------------------------------- +Okay. Great. But these are relatively older products that are embedded into enterprise products at the moment then, it sounds like. Okay, great. And then my follow-on is -- you are at a one-year cadence for GPUs now. Could you talk about expectations on how last year's R9300 series winds down and how that plays out? It looks like in Q2, it was really just a lack of a pause ahead of a known refresh. And do you expect sort of a sharp wind-down at some point? Or is it more gradual? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [77] +-------------------------------------------------------------------------------- +Actually, Ian, that's a good observation. The 390 series or the 300 series overall actually did do okay in the second quarter. We were also wondering whether there would be a pause prior to a new generation. I think we see it as a very orderly transition; it's actually one of our better product transitions as we go from the 300 series over to the 400 series. +So again, nothing very spectacular to report other than the sellthrough has continued -- the sellthrough was good in the second quarter. And we believe that it's an orderly transition of the inventory. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [78] +-------------------------------------------------------------------------------- +Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [79] +-------------------------------------------------------------------------------- +Thanks, Ian. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- +Thank you. Our final question today is coming from Jaguar Bajwa from Arete Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [81] +-------------------------------------------------------------------------------- +Thanks for taking my question. Just a question on Q3. Could you just lay out which would be the fastest-growing sequential segment in Q3? Will that be the GPU business, CPU or semicustom? Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [82] +-------------------------------------------------------------------------------- +Jaguar, I think what we would say is that our Q3 guidance is both semicustom and graphics will be the drivers of the sequential revenue growth. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [83] +-------------------------------------------------------------------------------- +Okay. Thanks. And then could you just give a bit more clarity around Vega timing? And also what do you expect to be your differentiation here versus what Nvidia has done with Pascal? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [84] +-------------------------------------------------------------------------------- +Again, I think we'll talk more about the details of the Vega architecture in time, but certainly Vega is a high-performance GPU that will use high-bandwidth memory as part of it. So, I would leave the details for a more -- as we go -- get closer to the Vega launch date. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [85] +-------------------------------------------------------------------------------- +Okay. Well, maybe just one final one then. When we get into the server CPU cycle with Zen, should we expect any kind of contribution from an APU format with CPU plus Vega? Because we're seeing a lot of acceleration now in the data center. Do you think that could be a key product for you guys which maybe your competitors may not have, bringing an APU to the server market for high-performance servers? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [86] +-------------------------------------------------------------------------------- +Yes, I think it's fair to say that we do believe we can combine high-performance CPU with the high-performance GPU. As we look at our GPU compute in general, sort of our both professionals graphics and server markets for GPU, I think that will increasingly become an area of focus for us as we continue to grow the graphics business. +So I think the answer is yes. I mean, obviously, it will come in time, but it's an area where combining the two technologies makes a lot of sense. + +-------------------------------------------------------------------------------- +Jaguar Bajwa, Arete Research - Analyst [87] +-------------------------------------------------------------------------------- +Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [88] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [89] +-------------------------------------------------------------------------------- +Operator, that concludes the question-and-answer session. If you wouldn't mind wrapping up the call, please? + +-------------------------------------------------------------------------------- +Operator [90] +-------------------------------------------------------------------------------- +Certainly. That concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2016-Oct-20-AMD.txt b/Transcripts/AMD/2016-Oct-20-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..ab95ef6f43f373897df03ac59a2038019bcb633f --- /dev/null +++ b/Transcripts/AMD/2016-Oct-20-AMD.txt @@ -0,0 +1,478 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Advanced Micro Devices Inc Earnings Call +OCTOBER 20, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ruth Cotter + Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR + * Devinder Kumar + Advanced Micro Devices, Inc. - SVP, CFO and Treasurer + * Lisa Su + Advanced Micro Devices, Inc. - President and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Stacy Rasgon + Sanford C. Bernstein & Co. - Analyst + * John Pitzer + Credit Suisse - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Ambrish Srivastava + BMO Capital Markets - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Chris Rolland + Susquehanna Financial Group - Analyst + * Chris Hemmelgarn + Barclays Capital - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + Greetings and welcome to the Advanced Micro Devices third-quarter 2016 earnings conference call. +(Operator Instructions) +As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ruth Cotter, Chief Human Resources Officer, for Advanced Micro Devices. Ms. Cotter, you may begin. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [2] +-------------------------------------------------------------------------------- +Thank you, and welcome to AMD's third-quarter conference call. By now, you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at IR.AMD.com. +Participants on today's conference call are Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer, and Treasurer. This is a live call, and will be replayed via webcast on AMD.com. +I'd like to highlight a few dates for you this afternoon. Lisa Su will present at the Credit Suisse PMT conference on November 30 in Arizona. I will present at the NASDAQ investor program on November 30 in the UK. Devinder Kumar will present at the Barclays Global Technology Media and Telecommunications Conference in December in San Francisco. And our fourth quarter quiet time will begin at the close of business on Friday, December 16, 2016. +Before we begin, let me remind everyone that third-quarter 2016 was a 14-week quarter, and we expect to record our extra week in the fourth quarter of 2016. Today's discussion contains forward-looking statements, based on the environment as we currently see it. Those statements are based on current beliefs, assumptions, and expectations, speak only as of the current date, and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note that we will be referring to non-GAAP figures during the call, except for revenue, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measures in the press release and CFO commentary, posted on our website at QuarterlyEarnings.AMD.com. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors and our filings with the SEC, and in particular, AMD's quarterly report on Form 10-Q for the quarter ended June 25, 2016. With that, I would like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- +Thank you, Ruth, and good afternoon to all those listening in today. Our strong third-quarter results highlight the progress we have made across AMD this past year, as we improved our financial performance by delivering great products. Third-quarter revenue of $1.3 billion increased 27% sequentially and 23% from the year-ago period, driven by upside demand for our graphics products, and record semi custom sales. +In addition to the significant revenue growth, we also achieved several financial and operational milestones in the quarter. We strengthened our balance sheet and improved our P&L through a series of capital markets transactions that reprofiled and reduced our debt. We also signed a strategic amendment to our Wafer Supply Agreement with GLOBALFOUNDRIES that provides sourcing flexibility and financial predictability. Most importantly, we delivered non-GAAP net income in the quarter, based on strong execution of our product road map, and growing momentum across our business. +Looking at our Computing and Graphics segment, we had solid growth in the quarter. Revenue increased 9% sequentially, and 11% from the year-ago period, driven by improved sales of mobile APUs and discrete GPUs. Mobile processor revenue and unit shipments increased for the fourth straight quarter, as 7th-generation APU shipments continued ramping, highlighted by the launch of our new PRO Series APUs earlier this month with HP. +Customer and partner excitement for our Zen-based desktop product, Summit Ridge, is growing as we successfully passed several key engineering and design win milestones in the quarter. We provided our first competitive performance preview of Summit Ridge in the quarter, and believe we will have a very competitive offering for the $4 billion high performance desktop processor market. We are working closely with our infrastructure partners and customers, in preparation for the launch in early 2017. +In graphics, we had a very strong quarter, with discrete GPU revenue and unit shipments growing by double-digit percentages sequentially and year-over-year. The launch of our expanded family of Polaris desktop GPUs, and our first full quarter of RX 480 sales drove our highest quarterly channel GPU revenue and ASP since early 2014. Radeon RX GPUs now account for more than 50% of our channel GPU revenue. +Polaris GPUs continued to gain traction based on their leadership performance in VR and on the rapidly expanding number of software titles that feature the latest generation of APIs, like DirectX 12 and Vulkan. Our progress in the quarter was punctuated by Oculus, announcing a limited edition Oculus-ready PC, powered by an AMD FX processor, and Radeon RX 470 GPU that brings the cost of entry for a VR-ready system down to $500 for the first time. This is a meaningful milestone for consumers, and I am excited that AMD is enabling the ecosystem, and driving broader adoption of VR, by making premium experiences available at such an attractive price point. +We also delivered our fourth straight quarter of sequential revenue growth for our professional graphics products. In addition to solid workstation sales growth, we expanded our presence in the server GPU market, as HP announced availability of multiple Radeon options across their traditional and blade server offerings. And just last week, we announced the collaboration with Alibaba Cloud, China's largest cloud provider, to deploy Radeon PRO server GPUs across their datacenters to expand the scale and services of their global cloud offering. +We now have material server GPU engagement with multiple cloud datacenter providers, demonstrating that our strategy to grow our presence in this profitable market by delivering superior performance with Radeon PRO hardware, in conjunction with industry-standard programming tools and APIs, is beginning to pay off. Now, turning to our enterprise embedded and semi-custom segment. +Revenue increased 41% sequentially, and 31% from the year-ago period, driven by record semi- custom sales, which included the ramp of three new FinFET-based products powering the Xbox One S, updated PlayStation 4, and our new design win in the Sony PlayStation 4 Pro. We are on track to grow semi-custom unit shipments and revenue for the third straight year, demonstrating our leadership in high-performance gaming technologies for the very successful game console market. We expect fourth-quarter revenue to be down seasonally, as we transition from our annual semi custom sales peak in the third quarter. +Our embedded product sales grew sequentially, as our newer design wins reached production. In server, our Zen-based high-performance processor remains on track for introduction in the first half of 2017. We successfully passed several silicon and platform technical milestones in the quarter, and have secured multiple new design wins across OEM, enterprise, and cloud providers. +In closing, as I complete my second year as CEO of AMD, I am pleased with the solid progress we have made across the Company on multiple operational, product, and financial fronts. We are executing our long-term strategy, and a set of near term priorities that I believe provide AMD with significant opportunities over the next 18 to 24 months, to drive top line revenue growth, operating margin expansion, and free cash flow generation. +We have strengthened the core of the Company, by clearly defining the markets where we have technology and expertise to win; bringing a laser focus to our product execution around our graphics and microprocessor road map; creating deeper, more lasting relationships with strategic customers; monetizing our assets and valuable IP with two joint ventures in China; and reengineering our balance sheet to increase our cash balance and reduce debt. I want to thank the thousands of AMDers whose determination this past year has allowed us to put in place the financial and operational foundation to drive growth and profitability. +In 2017, with Zen and Vega, we are focused on delivering our strongest product portfolio in over a decade, capable of unlocking multiple growth pillars for our business across the data center, gaming, and high performance graphics and PC markets. I am proud of what we have accomplished, and I believe that the best is yet to come. Now, I'd like to turn the call over to Devinder, to provide some additional color on our third-quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [4] +-------------------------------------------------------------------------------- +Thank you, Lisa, and a very good afternoon to everyone. In the third quarter, we achieved another milestone in our progress as we return to non-GAAP net income profitability. The third-quarter financial performance was driven by strong demand for our semi custom SoCs, higher graphics revenue, and positive free cash flow. +We executed a series of capital markets transactions that have significantly improved our balance sheet, and turned that profile, and will reduce interest expense beginning in Q4. We also finalized a long-term strategic Wafer Supply Agreement with GLOBALFOUNDRIES. +Third-quarter revenue was $1.3 billion, up 27% sequentially, driven by higher sales of our record semi custom SoCs and higher graphics processor sales. The year-over-year revenue increased 23%, driven by higher sales of our semi custom SoCs, client mobile processors, and graphics processors. +Non-GAAP gross margin was 31%, flat from the prior quarter, driven by a richer mix of PC and graphics products, offsetting lower margin semi custom product. Non-GAAP operating expenses were $353 million, up $11 million from the prior quarter, due to increased R&D investment. We recognized $24 million of net licensing gains, associated with our server JV with THATI. Non-GAAP operating income was $20 million this quarter, up $67 million from the prior quarter. +Third-quarter other net expense was $63 million, mostly consisting of a $61 million loss related to debt retirement. The equity loss in the ATMP JV was $5 million based on our 15% JV ownership stake. Non-GAAP net income was $27 million, with earnings per share of $0.03. +Non-GAAP EPS was calculated using 865 million diluted shares of common stock, which includes 12 million shares associated with the equity offering that closed late in the third quarter. Included in our GAAP operating loss and GAAP net loss is a $340 million charge associated with our fixed amendment to the WSA with GLOBALFOUNDRIES. Adjusted EBITDA was $103 million, compared to $36 million in the prior quarter. +Now, turning to the business segments. Computing and Graphics revenue was $472 million, up 9% from the prior quarter, and up 11% year-over-year, primarily due to increased sales of GPUs and client mobile APUs. Computing and Graphics segment operating loss was $66 million, compared to $81 million the prior quarter, primarily due to higher revenue. +Enterprise embedded and semi custom revenue was $835 million, up 41% from the prior quarter, and 31% higher year-over-year, driven by higher semi custom SoC sales. Operating income of this segment was $136 million, up from $84 million in the prior quarter, primarily driven by higher revenue. +Turning to the balance sheet, our cash and cash equivalents totaled $1.3 billion at the end of the quarter, up $301 million from the end of the prior quarter, including $274 million remaining from the proceeds of our capital market transaction. Excluding this amount, the cash was $984 million, as compared to $957 million last quarter. Free cash flow was a positive $20 million in the third quarter. +Inventory was $772 million, up $29 million or 4% from the end of the prior quarter, in support of holiday season GPU and semi custom product sales expectations in the first part of the fourth quarter. Total wafer purchases from GLOBALFOUNDRIES in third quarter were $168 million, and we continue to expect overall wafer purchases of approximately $650 million in 2016, including $155 million purchased in early 2016, as part of the fixed amendment to the WSA. +Debt as of the end of the quarter was $1.6 billion, down from the prior quarter, due to our significant debt reduction effort. During the third quarter, we raised approximately $1.4 billion in cash, as a result of issuing $690 million of common stock, which includes the exercise of an underwriter's option to purchase 15% or $90 million of additional common stock, and the issuance of $700 million in 2 1/8% convertible notes due in 2026. We used the majority of these funds to redeem outstanding term debt through cash tender offers, and we paid off the outstanding ABL balance of $226 million. +In addition, early in the fourth quarter, another $105 million of convertible notes were issued as part of the exercise of an underwriter's option, bringing the total principal amount of the 2026 convertible notes to $805 million. We also redeemed the remaining principal debt balance of $208 million of the 2020 senior note, which was our most expensive debt. This debt has now been fully paid off. +The debt reductions and issuance of the new convertible notes due 2026 that occur in the third quarter and early in the fourth quarter will result in approximately $55 million of annualized cash interest savings, beginning in the fourth quarter. Please refer to today's CFO written commentary for further details of the capital markets transactions and debt on the balance sheet. Free cash flow in the third quarter was a positive $20 million, compared to a negative $106 million in the second quarter of 2016, primarily due to increased revenue, improvement in working capital, and a reduction in capital expenditures. +Now turning to our fourth quarter 2016 outlook, a 14 fiscal week quarter, as it has an extra week. We expect revenue to decrease 18% sequentially, plus or minus 3%, primarily driven by a seasonal decline in our semi custom business, and an improvement in our CG business. Revenue at the midpoint of guidance would be up 12% year-over-year. Non-GAAP gross margin to be approximately 32%. +Non-GAAP operating expenses to be approximately $350 million. IP monetization licensing gain to be approximately $25 million. To maintain non-GAAP operating profitability, non-GAAP interest expense, taxes and other to be approximately $32 million. Cash and cash equivalents to be up, in line with our guidance of ending 2016 with positive free cash flow, excluding cash from capital market transactions, and the net proceeds from the ATMP JV. +Inventory to be down to approximately $660 million. Basic share count to be approximately 930 million, including 115 million shares related to the third-quarter equity issuance. And we now expect full-year revenue growth to be up approximately 6% from 2015, based on the midpoint of fourth quarter revenue guidance. +In closing, we are very pleased with the progress we have made in the third quarter. With focused execution we continue to build a solid financial foundation for the Company. In just the last three months alone, we achieved non-GAAP net income profitability, amended the WSA with GLOBALFOUNDRIES across multiple years, and deleveraged and derisked the balance sheet with our capital markets transaction, such that over the next five years, there is less than $200 million of term debt due. +We look forward to continued execution, and further improving our financial performance. With that, I'll turn it back to Ruth. Ruth? + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [5] +-------------------------------------------------------------------------------- +Thank you, Devinder. Operator, we would be pleased to poll the audience for questions, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question today is coming from Matt Ramsay from Canaccord Genuity. Please proceed with your question. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [2] +-------------------------------------------------------------------------------- +Thank you very much. Good afternoon. Obviously a lot has gone on in the last quarter. I figured I would ask a couple things about Zen, since that's been one of the things that's most topical, in my conversations with investors. +Lisa, you talked about in your prepared remarks, there are multiple OEM engagements and design wins for desktop, and also the same on server. Maybe you could do a little bit to expand upon those? The timing of launch of each, and in particular in the server market, the focus, whether that be enterprise, or whether that be cloud-based. Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- +Absolutely, Matt. Thanks for your question, and as you said, it's been a very busy quarter for us. As it relates to Zen, we are on track to launch in the first half of the year, for both our desktops and our servers. The desktop launch will go first, and it is on track for the first quarter, and then the server launch will go in the second quarter. +We've had a wide amount of sampling that's gone on in the third quarter. We have multiple customers on both the PC side, as well as the server side, who have working hardware now in their labs. They're bringing up their platforms and software, and we're very pleased with how smoothly it's coming up, actually. +So you asked specifically about the server side. Our focus on servers is really across the OEM business, including enterprise, as well as the cloud data centers. And I think the key for us is we're getting a lot of interest from our partners, and we continue to work with them to bring up their systems. But I think we are optimistic about where we are in the Zen bring-up, and the Zen launch cycle. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [4] +-------------------------------------------------------------------------------- +Thank you for that. That's helpful. I guess as a follow-up there, in the server market, I think obviously your GPU primary competitor has had some very stellar traction with server acceleration around GPUs, and you highlighted in the prepared remarks some wins and engagements that you had on Polaris, and I assume on Vega for server acceleration. +Maybe you could expand on that commentary a bit, what you're investing there, how the GPUOpen, or the OpenCL Environment is developing relative to the CUDA environment in server acceleration, and just what proportion of your GPU business could be driven by that server opportunity in the long term? Any commentary there would be great. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [5] +-------------------------------------------------------------------------------- +Yes. So let's talk overall about our graphics business. So when you look at our graphics business, certainly we're very pleased with the progress that we've made on the consumer side, with Polaris. But we've also mentioned that we've made good progress on the professional graphics side, including both workstations, as well as server GPUs. +I think the market is certainly very receptive to growth in the server GPU area. I was just at the Alibaba Cloud computing conference last week, where we announced our collaboration with them. They're actually using parts that are pre-Polaris and pre-Vega. We were demoing a GPU-based cloud server based on some of our FirePro technology, using hardware-based virtualization. +I think the main feedback that we've gotten from them, as well as multiple other cloud engagements, is the hardware looks very good. We're working with them on the overall infrastructure and software to bring that up, and we believe that the products are very competitive in this market. And the market is nice because it's certainly margin accretive, to the consumer side of the business. +So we do expect as we bring out Vega in the first half of 2017, that will certainly strengthen the product portfolio. But there's a lot of interest in the cloud space around what we're doing with Radeon PRO and on the server GPU side. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [6] +-------------------------------------------------------------------------------- +Thank you very much. I'll get back in queue. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Thank you. Our next question today is coming from Ross Seymore from Deutsche Bank. Please proceed with your question. +(Operator Instructions) + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [8] +-------------------------------------------------------------------------------- +We can go to the next caller, operator. Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Certainly. Our next question is coming from Mark Lipacis from Jefferies. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [10] +-------------------------------------------------------------------------------- +I had two questions. First one, on the Alibaba deal, so this is not a new set of products you're developing, it's products you already have. And can you talk about, to the extent this is a cloud services offering versus deep learning applications, that they might be doing with your products? And I guess when I think about the architecture, I normally think about having an X86 processor sitting next to the GPU. I was wondering is it logical to assume that Zen is the natural X86 pairing with your GPUs in the Ali deployments? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [11] +-------------------------------------------------------------------------------- +Sure, Mark. So again, I think on the Alibaba deployment, it is the beginning of what we expect to be a long-term collaboration. So the work today is being done on a pre-Polaris base, but we do expect that will upgrade as we go forward. +I think the key is, there are many, many applications, but what we're starting from is a GPU base cloud server application, so in virtualized environments, you can imagine cloud gaming or remote workstation-type environments which need a lot of graphics horsepower, as well as virtual desktop environments. And I think as we go forward, certainly, we view the opportunity to expand that into a broader set of workloads, as well as obviously on the CPU side as well. We think the cloud is a very important market for us to focus on, on both the GPU and the CPU side, and we're ramping up our efforts there. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [12] +-------------------------------------------------------------------------------- +Great. A follow-up if I may. Last night Tesla announced that it was using NVIDIA for their self-driving car, but on the conference call Elon Musk, I think the expression he used, was that it was a tight decision between NVIDIA and AMD, which suggests that you're further along in solutions for deep learning and neural networking than most, including myself, thought. +And so I was wondering, can you talk about your efforts in deep learning and artificial intelligence, how big is that business now? Do you have anything in that business now? And how do you grow that, going forward? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [13] +-------------------------------------------------------------------------------- +Sure, Mark. So look, there is a lot of interest in the deep learning space overall, and certainly our GPUs are very applicable to that space. So when we look at competitiveness and all that stuff, we think we can be very competitive there. +We will be talking more about our strategy in the coming quarters, so maybe let me refer to that, Mark. But I think suffice it to say, I think we looked at GPUs as overall secular growth, whether you're talking about consumer, professional workstations, server GPUs, or any of this machine learning area. So we're going to continue to invest and lean in, in those areas. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [14] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Thank you. Our next question today is coming from John Pitzer from Credit Suisse. Please proceed with your question. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [16] +-------------------------------------------------------------------------------- +Lisa, Devinder, nice job on the quarter. I guess, Devinder first. Just going to the December quarter guidance, you're characterizing it as seasonal. +I know the trappings of talking about normal seasonal, because there's so much variance around it, but it does seem like in prior quarters, where you had a 14th week, that extra week actually did help revenue a little bit. I'm just kind of curious within the context of the December quarter guidance, how you're thinking about that extra week, both on the revenue line and on expenses. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [17] +-------------------------------------------------------------------------------- +I think if you look at a 14-week quarter, I think, John, you're right, it depends upon many factors. Our 14-week quarter is in the Q4 time frame, which is this quarter we are in. On the revenue side, I would say looking at it overall, there's not much of an impact, as the extra week falls during the holiday season, when a large portion of our operations and our customers are in shutdown mode. There is an impact on the expense side, but that's already contemplated within the guidance of OpEx that I gave, the $350 million due to the extra week. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [18] +-------------------------------------------------------------------------------- +That's helpful. And then Lisa, a little bit longer term. Over the last several quarters, you've been somewhat forced to try to manage profitability levels to that breakeven line, given the lack of revenue growth. +But now that you're on this path of more sustainable revenue growth, I'm just curious as you think about R&D specifically, how should we think about your desire to want to invest in higher rates, as revenue begins to grow from these levels? Because clearly, as Mark talked about on the last question, you've got a lot of potential new areas and opportunities to go after. Can you give us a sense as to what -- to what degree you think you've been under-investing in R&D and how we should think about R&D investments over the next several quarters, as revenue growth resumes? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [19] +-------------------------------------------------------------------------------- +Absolutely, John. I think it's fair to say that we've been very prudent in how we've invested overall. If you look at our operating expenses, 2016 to 2015, although we've been relatively flat overall, we've actually increased R&D, relative to other elements of the P&L. +But as we see revenue growth and as we've seen progress over the last couple of quarters, I think you've also seen us increase our R&D spend. I think there are several areas that we see as very large opportunities, and we talked about some of the graphics areas in the previous question with Mark. I also think in the data center, there's a large opportunity for us on the CPU side, as Zen fully comes to market. +So I think we have an opportunity to invest a bit more in R&D as our revenue grows, but we're still going to be very prudent with how we do that. I think the key metric there in terms of being net income profitable this quarter, ensuring that we get free cash flow positive from operations for the full year, those are all important metrics for us, and we're going to continue to manage very diligently. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [20] +-------------------------------------------------------------------------------- +That's helpful. Thank you. Congratulations. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Thank you. Our next question today is coming from David Wong from Wells Fargo. Please proceed with your question. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [22] +-------------------------------------------------------------------------------- +Do you expect GPU sales will grow sequentially in the December quarter, and what about computing revenues? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [23] +-------------------------------------------------------------------------------- +Yes, so David, I think we would expect overall that the CG business or the Computing and Graphics business will grow in Q4. The EESC business will be down. And then within the Computing and Graphics business, I would expect growth on both the graphics, as well as the computing side. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [24] +-------------------------------------------------------------------------------- +Great. And do you have any new semi custom wins you can tell us about, or at least give us some idea of what the momentum is in the pipeline? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [25] +-------------------------------------------------------------------------------- +Yes, I think on the semi custom side, David, I will say that we previously announced three, and that's the number that we'll talk about today. Two of them are now known, and they're both in the game console area, one is outside of game console. I will say that we have some very good active discussions on future products and applications, and we'll update more as we get further along. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [26] +-------------------------------------------------------------------------------- +Great. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [27] +-------------------------------------------------------------------------------- +Thanks, David. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Thank you. Our next question is coming from Blayne Curtis from Barclays. Please proceed with your question. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [29] +-------------------------------------------------------------------------------- +This is Chris Hemmelgarn on for Blaine. With Summit Ridge launching in Q1 of 2017, how would you expect the channel to ramp that? Do you see it ramping pretty fully in the first couple quarters of the year, or are you looking for more normal PC seasonality? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [30] +-------------------------------------------------------------------------------- +I would expect that there will be a relatively good initial demand for Summit Ridge, that may be not quite at the seasonal patterns. From where we see, Summit Ridge is playing in a space in the high end desktop, that we currently aren't offering a product. So we believe we'll be competitive certainly with Core I5 as well as Core I7, and we will be launching in those areas. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [31] +-------------------------------------------------------------------------------- +Thanks very much. Then looking at the GPU side of things, you saw some pretty nice share gains in the first half of this year with the legacy portfolio. Any metrics you can give to help frame how the business did in the first full quarter with Polaris? And any further color you can provide on how you see the share situation progressing into the year-end. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [32] +-------------------------------------------------------------------------------- +We're very happy with how Polaris ramped in Q3. The customer demand across all geographies was very strong. Q3 was primarily a channel-based quarter. With our board partners, and as some of you noted, in the early part of Q3, we actually had some supply constraints, given the customer demand. We did catch up towards the end of the quarter. +So very pleased with how that's ramped. I think it's a very competitive market. We've leaned into VR, and we've leaned into our work with CX12 and I think you can see in some of the benchmarks that we're doing very well there. As we go into Q4, in addition to the channel partners continuing to ramp, you should expect some OEMs launching in Q4 more broadly. And so Polaris is off to a very strong start. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [33] +-------------------------------------------------------------------------------- +Thanks very much, Lisa, and congrats on the strong quarter. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Thank you. Our next question is coming from Stacy Rasgon from Bernstein Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [35] +-------------------------------------------------------------------------------- +I first wanted to ask about the second sourcing ability embedded in the new Wafer Supply Agreement. So you've said that you're going to be doing some second sourcing, starting in 2017. I wonder, did that push to actually seek out that supply diversification come from you, or was it from specific requests from your customers? And given that, how do you make the decision on which products to manufacture at GLOBALFOUNDRIES versus manufacture somewhere else? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [36] +-------------------------------------------------------------------------------- +Sure, Stacy. Let me start with that. I think, relative to our second sourcing or our supply sourcing flexibility, I think we make it on a product-by-product basis, based on where we are in the business. So we will have multiple products in 14-nanometer and 16-nanometer that will be sourced across foundries, and similarly when we talked about the Wafer Supply Agreement, we mentioned 7-nanometer as being a key target node for that. +Relative to how we make the decisions, I think it's a combination of factors. It includes the complexity of the product. It includes the timing, customers, all kinds of things. So I think that's part of our product planning process. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [37] +-------------------------------------------------------------------------------- +Got it. But did the customers themselves have a hand in driving you to make that push to second source? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [38] +-------------------------------------------------------------------------------- +I think that's one element, but frankly, I think what's more important to me is, I need to commit a strong, five-year product road map to the customers, and so we want to make sure that we have all the flexibility to ensure nothing happens. I'll give you just a little bit of context, Stacy, because I think you know our business well. +In this past six months, we've ramped five new FinFET products. It's the fastest transition we have ever made in a process node, and it's gone really, really well. And I think what's helped us with that is the fact that we've had two sources ramping at the same time. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [39] +-------------------------------------------------------------------------------- +Got it. For my follow-up, I just want to get some clarification on the timing of the Summit Ridge and Zen launches. You said Summit Ridge launches obviously in Q1 2017. You had said before that you were going to be shipping at least some product in Q4 of this year. Is that still true? And around the server launch in Q2, does that mean the volume is actually in Q3? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [40] +-------------------------------------------------------------------------------- +So I think our expectation is, we may ship some production samples in Q4, but the volume launch for desktop will be in Q1, and that's consistent with everything that we've planned into the business. And as it relates to server, I think it's a little early to tell. I think we'll go through our process, and our customers' processes, and we'll have more color on that, as we get into next year. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [41] +-------------------------------------------------------------------------------- +Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Thank you. Our next question today is coming from Ambrish Srivastava from BMO Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [43] +-------------------------------------------------------------------------------- +In your prepared remarks, you mentioned semi custom's decline and computing graphics to be up. Implies you'll have a pretty rich mix for Q4. Why is GM guided up only 1% given the really strong mix for 4Q? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [44] +-------------------------------------------------------------------------------- +If you look at it from an overall standpoint, let's talk about Q2 to Q3, first of all. Q2 to Q3, we had a significant ramp in the semi custom space, which led to significant revenue in the EESC side, and we were able to manage the margin flat quarter on quarter, which we are pleased with. Going to Q4, essentially with the Computing and Graphics business, that's what Lisa said ramping, and then EESC business, in particular semi custom coming down. The gross margin is up a percentage point, primarily due to the mix in revenue between the two segments. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [45] +-------------------------------------------------------------------------------- +Okay. And for a follow-up, a question on the cash balance. Looked like you're guiding cash to be up in 4Q, and looks like you have some excess cash after the transactions you've done in the quarter, and looks like you might be up over your $1 billion target balance. How do you plan on using the excess cash, or where would you reinvest that cash? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO and Treasurer [46] +-------------------------------------------------------------------------------- +I think right now, as you observe, it's through the end of Q3 we did have some remaining net proceeds from the capital market transactions. After completing what we did in the early part of Q4, we have about $162 million of remaining net proceeds. +What we plan to do with it, I think from a long-term strategy, that hasn't changed. Our plan is to continue to delever the balance sheet, reduce debt towards our longer-term targets getting to the net debt cash neutral that I talked about previously, and getting the leverage ratio down to about 2 times from a longer term standpoint. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [47] +-------------------------------------------------------------------------------- +Operator, we'll take two more questions, please. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Certainly. Our next question today is coming from Joe Moore from Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [49] +-------------------------------------------------------------------------------- +Lisa, you talked about a $4 billion performance desktop opportunity. What's your thinking in terms of what you can eventually attain of that, just how are you thinking about your potential for market share? And can you give us some sense for, when you have a chip like this, that you have enthusiasm about, how quickly it can ramp into that segment? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [50] +-------------------------------------------------------------------------------- +Yes. So I think if you look at our PC market share, as it's published by Mercury, we're talking about somewhere around 10%, plus or minus. I think we view that historically we've been higher than that in the PC market, and certainly the desktop market, especially the desktop channel market. We're fairly well-known by that customer set. +So we're enthusiastic about Summit. We think the performance is right on the mark with what we wanted to achieve. And we're hopeful that as we launch into the first quarter, that there will be a good, solid ramp in that business. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [51] +-------------------------------------------------------------------------------- +Okay. Great. And then, how are you thinking about as you think about bringing that chip to market, when will you make it available for third party benchmarks and sort of get a broader marketing program beyond the launch you've done? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [52] +-------------------------------------------------------------------------------- +I would expect certainly there are a lot of confidential benchmarks at the moment, but in terms of third party benchmarks, you would expect that in the first quarter. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- +Thank you. Our final question today is coming from Chris Rolland from Susquehanna Financial Group. Please proceed with your question. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [55] +-------------------------------------------------------------------------------- +Congrats on a great quarter, and nice to see it all coming together. We don't have September sell-through data yet. It's hard to predict holiday season, what it's going to look like for consoles. Perhaps the past two quarters' growth in EESC might be outpacing expectations for consoles. +So my question is, first of all, is that right? Is there something that's helping your guy's units here, like initial channel stocking for the PS4 Slim or the PS4 Pro? And how should we think about the size of the benefit that you're going to get from initial channel stocking there? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [56] +-------------------------------------------------------------------------------- +So, Chris, I think the game console shouldn't be really looked at on a quarterly level, when you're looking at sell-in and sell-out. It's so different from the other markets. I would say on an annual basis, everything trues up. The thought process is, in Q2 and Q3, there is a bit of build ahead as the customers are really building for the holiday season. And the customers do so much of their business in the last six weeks of the year. That's when all of the inventory is drained. +My view is that if you look on an annual basis, the game console business is doing quite well. We expect units to be up. We expect revenue for the business to be up for us, and the quarterly transitions are less important. It's more, we want to ensure that we're meeting our customers' build cycles, so that they get to build everything that they want, and get it into their channels. But from my standpoint, I think it's a very well-managed system. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [57] +-------------------------------------------------------------------------------- +Great. Congrats on a great quarter. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - Chief Human Resources Officer and SVP of Corporate Communications and IR [58] +-------------------------------------------------------------------------------- +Operator, that concludes today's call. If you could wrap it up, please, that would be great. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Certainly. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We do thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2017-Jan-31-AMD.txt b/Transcripts/AMD/2017-Jan-31-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..d8cecf9ce12df0ba0a4e4ee0c8e58943fb8dc76b --- /dev/null +++ b/Transcripts/AMD/2017-Jan-31-AMD.txt @@ -0,0 +1,642 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Advanced Micro Devices Inc Earnings Call +JANUARY 31, 2017 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + Advanced Micro Devices, Inc. - Corporate Vice President, IR + * Lisa Su + Advanced Micro Devices, Inc. - President and CEO + * Devinder Kumar + Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Stacy Rasgon + Bernstein - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Vijay Rakesh + Mizuho Securities USA - Analyst + * Ambrish Srivastava + BMO Capital Markets - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Chris Rolland + Susquehanna Financial Group / SIG - Analyst + * John Pitzer + Credit Suisse - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Chris Hemmelgarn + Barclays Capital - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings and welcome to the Advanced Micro Devices Q4 and full-year 2016 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Laura Graves, Corporate Vice President of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Laura Graves, Advanced Micro Devices, Inc. - Corporate Vice President, IR [2] +-------------------------------------------------------------------------------- + + Thank you and welcome to AMD's fourth-quarter and fiscal year-end conference call. This is Laura Graves. I recently joined the AMD IR team as Corporate Vice President of Investor Relations and I'm pleased to join you on today's call. +By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. +Participants on today's conference call are Lisa Su, our President and Chief Executive Officer, and Devinder Kumar, our Senior Vice President, Chief Financial Officer, and Treasurer. This is a live call and will be replayed via webcast on amd.com. +Before we begin today's call, I would like to share with you that first-quarter quiet time will begin at the close of business on Friday, March 17, 2017. And that we will host out financial analyst day on Tuesday, May 16 in California. Lastly, let me remind everyone that the fourth quarter of 2016 was a 14-week quarter and that first-quarter 2017 will be a 13-week quarter. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions, and expectations, speak only as of the current date, and as such involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note that we will be referring to non-GAAP figures during this call, except for revenue and segment operating income or loss, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measures in the press release and CFO commentary, which is posted on our website at quarterlyearnings.amd.com. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and in particular AMD's quarterly report on Form 10-Q for the quarter ended September 24, 2016. +With that, I'd like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. In 2016, we made meaningful progress across the Company, strengthening our product offerings, regaining share in key markets, and creating a solid foundation for sustainable growth. +Fourth-quarter revenue of $1.11 billion grew 15% from the year-ago period based on a substantial increase in computing and graphics segment revenue. Revenue decreased 15% sequentially based on seasonally lower semi-custom SoC shipments, while we achieved our second straight quarter of computing and graphics segment revenue growth. For the full year, growth across both of our business segments resulted in a 7% increase in annual revenue, non-GAAP gross margin expansion, and positive free cash flow. +Looking at our computing and graphics segment, on a full-year basis, CG annual revenue grew for the first time since 2011 as our focus on strengthening this key part of our business gained momentum. Fourth-quarter revenue increased 28% from the year-ago period based on strong GPU and mobile APU sales growth. Our CG quarterly revenue was the highest in 2 years, our client revenue was the highest in seven quarters, and we delivered our highest graphics processor revenue in 11 quarters. +Mobile APU shipments and revenue growth accelerated, as strong adoption of our seventh generation notebook APUs drove notebook share gains in the quarter. Desktop processor sales increased sequentially and declined from a year ago in advance of our Ryzen desktop processor launch this quarter. +At CES, we highlighted broad design win and ecosystem momentum for Ryzen. 17 different system integrators unveiled Ryzen-based gaming and enthusiast systems. And multiple ecosystem partners announced plans to offer a broad range of premium Ryzen motherboards. +We have also secured a number of high-end design wins for Ryzen with our global OEMs. We remain on track to launch Ryzen in early March, with widespread system and channel availability expected on day one. +In graphics, strong sales increases across all of our product lines drove a double-digit increase in GPU processor revenue from a year ago. Desktop GPU shipments and revenue increased by double-digit percentages from a year ago based on growing OEM and channel adoption of Polaris GPU's. Polaris processor sales were particularly strong in the performance and enthusiast portions of the market, resulting in our highest channel GPU sales in more than two years. +Mobile GPU sales growth outpaced desktop in the quarter, and we believe we gained further share in this part of the market as the first Polaris-based notebooks launched. We also launched Radeon Pro 400 mobile GPUs in the quarter. These ultrathin performance GPUs are ideal for mobile content creators and are powering Apple's latest premium MacBook Pro notebooks. +And in professional graphics, we finished off a record year with record quarterly revenue and unit shipments. Traditional workstation GPU sales grew in the quarter, as HP, Dell, and others began offering systems powered by our recently launched Radeon Pro WX GPUs. +We also continued to make progress in the server GPU market, with sales increasing significantly to support new mega data center deployments. As a part of our strategy to drive Radeon GPUs into the data center, we announced our Radeon Instinct family of machine intelligence accelerators and detailed our plans to expand the market for machine learning based on AMD's unique combination of high-performance GPUs, CPUs, and open source software. +Turning to our enterprise embedded and semi-custom segment, revenue increased 4% from a year ago, driven by growing embedded processor sales and ongoing demand for AMD-powered Microsoft and Sony game consoles. As we expected, revenue declined sequentially following the annual sales peak in the third quarter. 2016 game console sales aligned with our expectations, resulting in new records for semi-custom annual unit shipments and sales. +Embedded processor sales grew by double-digit percentages sequentially and from the year-ago period based on adoption across our targeted vertical markets. And development of our next-generation server CPU, ""Naples"", is on track as we continue to expand the breadth of our customer and partner engagements to enable broad platform, ecosystem, and software validation work in advance of launch. +""Naples"" is meeting our performance targets, and customer response to our competitiveness and differentiated feature set continues to be overwhelmingly positive. As a result, we expanded our design win momentum in both traditional and cloud servers as well as in the embedded infrastructure and communications markets. +As we look back on 2016, we successfully accomplished our key priorities, including growing discrete graphic share led by Polaris GPU adoption; regaining client compute share led by our seventh generation APUs; growing in adjacent markets with record annual semi-custom game console revenue and professional graphics; and strengthening the financial foundation of the Company by achieving annual non-GAAP operating profitability, reducing debt, and increasing cash. +All of our work the past two years has been designed to strengthen the technical, operational, and financial foundation of the Company. We enter 2017 with strong revenue growth and margin expansion opportunities as we prepare to launch our "Zen"-based CPUs and Vega GPUs that can return AMD to the high-performance markets where we have not materially participated in recent years. +The production ramp, customer adoption, and ecosystem support for our Zen-based desktop processor Ryzen are all mapping to our plans. We also remain on track to expand "Zen" into the data center market in the second quarter, followed by the embedded and notebook markets in the second half of the year. +Our Vega GPU development is also progressing to plan. Vega is designed to scale beyond the limitations of current GPUs to enable PC gaming, professional design, and machine intelligence experiences that traditional GPU architectures have not been able to effectively address. +We provided our first performance preview of Vega GPUs earlier in the quarter in advance of the launch planned for the second quarter of this year. Bringing all this together, based on our current market expectations and the strength of our upcoming products, we are confident we can grow annual revenue, expand gross margin, and deliver non-GAAP net income in 2017. +Now I would like to turn the call over to Devinder to provide some additional color on our fourth-quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. 2016 was a good year for AMD as we grew revenue, improved our financial performance, and strengthened the financial foundation of the Company. +AMD annual revenue grew 7% year-over-year with growth in both business segments. We expanded gross margin, maintained essentially flat operating expenses, achieved operating profitability, and reduced net losses significantly. +In addition, we improved our balance sheet with strategic capital market transactions that reduced and re-profiled debt, and lowered interest expense. Finally, we generated positive free cash flow and ended the year with cash and cash equivalents of $1.26 billion. +Now let me provide the specifics of the fourth quarter of 2016 together with quarterly year-over-year comparisons. Revenue was $1.1 billion, increasing 15% year over year due primarily to higher GPU processor sales, and declining 15% sequentially, driven primarily by seasonally lower sales of our semi-custom SoCs, partially offset by higher sales in the computing and graphics segment. Gross margin was 32%, up 2 percentage points year over year and up 1 percentage point from the prior quarter due to higher computing and graphics segment revenue. +Operating expenses were $357 million compared to $323 million a year ago and $353 million in the prior quarter. Both increases were due to ongoing targeted investments in R&D to support our new products. Net licensing gain associated with our server JV with THATIC was $31 million, up from $24 million in the prior quarter. +Operating income was $26 million in the fourth quarter of 2016 compared to an operating loss of $39 million a year ago and operating income of $70 million in the prior quarter. Operating income is down from the prior quarter due to lower revenue. +Fourth-quarter net interest expense, taxes, and other was $34 million, down from $40 million a year ago and $43 million in Q3 2016, primarily due to reduced interest expense. Net loss was $8 million or loss per share of $0.01, calculated using 931 million shares of common stock. This compares to a net loss of $79 million or $0.10 a year ago and net income of $27 million or $0.03 in the prior quarter. +Adjusted EBITDA was $60 million compared to adjusted EBITDA of minus $5 million a year ago and adjusted EBITDA of $103 million in the third quarter of 2016. +Now turning to the business segments. Computing and graphics revenue was $600 million, up 28% year over year and up 27% sequentially, primarily due to higher GPU and client processor sales. Computing and Graphics business segment operating loss was $21 million, improving significantly from a loss of $99 million from a year ago and a loss of $66 million in the prior quarter, primarily through higher sales in the fourth quarter of 2016. +Enterprise embedded and semi-custom revenue was $506 million, up 4% year over year and down 39% from the prior quarter, primarily due to lower sales of our semi-custom SoCs. Operating income was $47 million, down from $59 million a year ago and down from $136 million in the prior quarter. The year-over-year decrease was primarily driven by higher R&D investments in Q4 2016, partially offset by an IP monetization licensing gain. +Turning to the balance sheet, our cash and cash equivalents total $1.26 billion at the end of the quarter compared to $785 million a year ago and $1.26 billion in the prior quarter. Inventory was $751 million compared to $678 million a year ago and $772 million in the prior quarter. Inventory levels were higher from one year ago in support of product transitions and higher revenue in the first half of 2017. Total wafer purchases from global foundries in 2016 were $665 million and $239 million in the fourth quarter. +Long-term debt on the balance sheet as of the end of the quarter was $1.44 billion, down from $1.63 billion in the prior quarter, primarily due to debt redemptions. The principal debt amount of $1.77 billion, down from $1.93 billion as of the end of the third quarter of 2016, is reflected on the balance sheet as the carrying value of debt after netting the unamortized discount of our convertible debt and issuance costs. +During the fourth quarter of 2016, we redeemed $268 million principal amount of debt. In addition, we issued $105 million principal amount of 2 1/8% convertible notes due 2026. As a result of the underwriters exercising the option to purchase an additional 15% of the original issuance, bringing the total principal balance of the convertible notes to $805 million. Free cash flow in the fourth quarter was $167 million, a significant improvement from $27 million one year ago and $20 million in the third quarter of 2016. +Turning to our outlook for the first quarter of 2017, which is a 13-week quarter, we expect revenue to decrease 11% sequentially plus or minus 3%. The midpoint of guidance would result in Q1 2017 revenue increasing approximately 18% year-over year; [non-GAAP] gross margin(added by company after the call) to be approximately 33%; non-GAAP operating expenses to be approximately $360 million; [non-GAAP] interest expense, (added by company after the call) taxes, and other to be approximately $30 million; inventory to be approximately flat sequentially. We look forward to sharing additional 2017 and long-term guidance parameters at our financial analyst day in May. +In closing, we are pleased with the progress we made in 2016. As we begin 2017, we look forward to introducing several new leadership products and remain focused on further improving our financial and operational performance. +With that, I will turn it back to Laura. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, Advanced Micro Devices, Inc. - Corporate Vice President, IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, with that, we are ready for our first question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Lisa, I'm hoping that you can help me understand the dynamic of desktop microprocessors ramping down in front of the Ryzen ramp. My understanding was that Ryzen was the higher-end SKU that comped against the Core i5 or Core i7, which is above where the existing microprocessors competed in the stack. +So I'm wondering if we should think about Ryzen either cannibalizing the existing desktop microprocessors at a higher ASP or are you kind of ramping down the lower end? Or should we think about Ryzen layering on top of the existing lower-end desktop microprocessors? Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [3] +-------------------------------------------------------------------------------- + + Yes, absolutely, Mark. Thanks for the question. So look, you are absolutely right. Ryzen is really a high-end desktop product. And I think the comment was really around our overall channel inventories in desktop, so we wanted to ensure a very smooth transition. +No question that Ryzen will layer on top, competing well in the Core i7, Core i5 range. But we also will eventually see a full lineup of Ryzen throughout the desktop portfolio. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Thank you. And a follow-up, if I may. Is it fair to assume that as Ryzen ramps into the enthusiast stack that you would expect to see attach rates of AMD graphics cards also -- I guess I would expect to see higher attach rate of AMD GPUs with the Ryzen. Is that fair? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [5] +-------------------------------------------------------------------------------- + + Yes, if you look at our product lineup in the first half of the year, I think we have Ryzen launching in early March, and then we will have Vega, our enthusiast GPU, launching in the second quarter. And so as we go through the year, I think we are quite pleased with the performance that we are seeing on both of those products. +And so we should see Ryzen doing very well in the high end as well as Vega. And by nature, since both of those high-end markets are markets that we don't have significant presence today, there will be an opportunity to both gain share as well as increase attach rates in those markets. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [6] +-------------------------------------------------------------------------------- + + All right. Very helpful, thank you very much. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Matt Ramsay, Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [8] +-------------------------------------------------------------------------------- + + Lisa, since we understand that Ryzen launching here in March is going to lead into relatively the same core that these -- the server microprocessor that launches in the second quarter, maybe you can give us a little bit of update on timing to the specifics that you can on the server launch. And specific, what segments of that market, maybe in terms of, I don't know, application segments or percentage of the server TAM, that you might be going after in the first several quarters after you launch the server product. Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [9] +-------------------------------------------------------------------------------- + + Sure, absolutely, Matt. So as you stated, Ryzen and "Naples" share the same core, the same CPU core, which is our Zen core. Our performance on that core has done very well. We've actually met or exceeded our expectations. +So Ryzen will launch in early March. "Naples" will launch in the second quarter. We have made very good progress, actually, in the last few months with customers really testing the performance capability on their own software and their own application workload, so we feel good about where the product is positioned. +We expect that the key workload - ""Naples"" is really has broad applicability in the server market, but we are especially targeting workloads that will benefit from more threads, higher memory, as well as I/O bound applications. So we expect cloud, Big Data applications, as well as traditional enterprise. And our focus is both with OEMs as well as ODMs to ensure that we have a strong ecosystem ready for that launch. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [10] +-------------------------------------------------------------------------------- + + Great, thank you. And then a couple follow-ups for Devinder, if I could. I noticed that quite a big ramp year over year in growth in the computing and graphics segment, but it's still a slight operating loss on the P&L. +Maybe you could talk through maybe as the new product launches and the GPU and CPU segments of the year, how do you think about gross margin in that computing and graphics segments and getting that back to profitability. And then quickly, I think you guys guided to $50 million in THATIC IP revenue. Any help about how that is distributed through the year would be really helpful. Thank you. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer [11] +-------------------------------------------------------------------------------- + + Yes, let me cover the second one first on the THATIC IP licensing gain. You know, we had $88 million of that in 2016. As you observed, we guided $50 million in 2017. It is really dependent upon milestone deliveries, but I can share with you that based on tracking to those milestones, where we expect to recognize approximately half of that, call it $25 million, in Q1 of 2017. +And then as far as the second question, on the segment, Computing and Graphics: yes, very good progress I think year over year and quarter over quarter. We are very pleased with that. The segment loss has gone down significantly from Q4 2015, where we were about $100 million, so about $20 million. +And with the new products that are coming up, in particular, the Ryzen product we just talked about, with better gross margins and other products in the graphics space, we expect to continue to make progress in that segment, and reduce the losses and get back to profitability. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [12] +-------------------------------------------------------------------------------- + + Yes, Matt, and if I can just add to that. I think the key for the computing and graphics segment is our participation at the higher end of the market for both CPUs and GPUs. And as we do that, the margin expansion as well as the revenue growth opportunity are critical to get that business to profitability. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [13] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Vivek Arya, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Good job on the execution. My first question, Lisa, is on the gaming cycle. Because it seems like we have had a number of good years. So what is your sense of where we are in that cycle? +And just near term, what is your perspective on GPU channel inventory? And how you are making sure the channel is not overstocked as you go into your next-generation product cycle? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [16] +-------------------------------------------------------------------------------- + + Yes, absolutely Vivek. So on the console market, I think you are right. I think the last few years have been very good from a console cycle standpoint. We finished 2016 with both units and revenue up. +As we going to 2017, this is going to be the fifth year of the cycle. So normally, if you look at historicals, it would say that hardware sales might be down. This cycle is a bit different with both the PlayStation 4 Pro that launched a couple quarters ago and then the Scorpio -- Microsoft Scorpio that will launch later this year. +So we will need to see how they do through the year. But I think from our standpoint, the console business has been a strong business performer for us and we are pleased with that. +Relative to the GPU market, we were very pleased with the performance in Q4 and actually throughout 2016. We got both nice desktop channel as well as notebook acceleration as we went through the year. +In terms of channel inventory levels, actually they looked quite normal. I would say we drained a little bit of inventory in Q4. We would expect a seasonal slowdown as we go into Q1 ahead of our product launches, but nothing unusual in the channel inventory on the GPU side. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [17] +-------------------------------------------------------------------------------- + + Got it. Very helpful. And as my follow-up, if you compare AMD versus your top two competitors, Intel and Nvidia, what are the biggest gaps? Because it seems like you are making good progress on the hardware side with a number of new product launches. What about software? How soon do you think you can close the gap there? Thank you. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [18] +-------------------------------------------------------------------------------- + + Yes. So in terms of our strategy, I think on both the CPU and the GPU side, we have been on a fairly deliberate path to ensure that we got to a very competitive roadmap. So on the CPU side with Ryzen and "Naples", we believe we will be quite competitive. On the GPU side, as we launch Vega, we will have a full stack top to bottom with new hardware. +We continue to invest in software, and our approach to software is really around open source and using the ecosystem and using the community and focused on the new APIs. So in gaming, we are very focused on DX12 and Vulcan. +And on the professional graphics and on the GPU server side, really using our GPUOpen. So we will continue to invest in software; no question that that is really critical for the graphics market. But we feel we are making good progress. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [19] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. First on the gross margins, I was a little surprised, given the fairly powerful mix shift between computing and EESC that you had, that they weren't higher. In fact, they came in about 20 basis points below guidance. Could you elaborate on the drivers in the quarter and the drivers going forward into next quarter which we will -- what we should expect. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer [22] +-------------------------------------------------------------------------------- + + I think Stacy -- good question. It is basically the product mix of it in the quarter. Q4 -- if you look at Q4 in particular, we were at 31% gross margin. Q2 and Q3 and Q4, it stepped up to 32%. In Q1, we are guiding at 33%, but really it's a function of the product mix. +And you can recall that if you are talking about Q4, this is ahead of launching the products we just talked about in terms of Ryzen, which we expect to be shipping in the early March time frame. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [23] +-------------------------------------------------------------------------------- + + Got it, thanks. For my follow-up, I know you talked about EESC being seasonally down and we are expecting it to be down, but how did it stack up actually versus your expectations overall? Why was there such a big deceleration year over year versus Q3, where you went from kind of up 31% year over year to up 4%? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [24] +-------------------------------------------------------------------------------- + + Yes, actually, Stacy, it was very much in line with our expectations. If you look at our Q3, our Q3 was actually very strong, and that was the quarter where there were significant builds ahead of the holiday launches. +So when you look at the console cycle in general, they tend to build really for holiday. And so July, August, September, October are big build months, November is like half a month, and then it decelerates in December. So it was not unexpected and actually performed in line with our expectations. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [25] +-------------------------------------------------------------------------------- + + So why was the build so strong in Q3 than relative? Was that - year-over-year. Was that just like the PlayStation Pro or was there something else going on in Q3 that took it up so much year over year versus Q4? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [26] +-------------------------------------------------------------------------------- + + Yes, it was new product. And if you looked, in addition to the PS4 Pro, they also -- both console manufactures had new systems that they launched in that time frame as well. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [27] +-------------------------------------------------------------------------------- + + Got it. Thank you, guys. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [29] +-------------------------------------------------------------------------------- + + Thanks for letting me ask a question. Lisa, one for you or Devinder. For the first quarter, and then perhaps more importantly for the full year, can you just talk a little bit about the dynamics between your two segments? +You guide down 11% for the first quarter, which is above or below that number. And then how does mix change throughout the year, as you have a bunch of new products launching on one side of the equation, but perhaps not as many on the EESC side. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [30] +-------------------------------------------------------------------------------- + + Yes, sure, Ross. So for Q1, I think if you look at the -- overall, the guidance sequentially down 11%, you would expect that the semi-custom business should be down more than that. And you have seen that in our numbers the past couple of years, so it is behaving as it normally would. +Sequentially, you would expect that the Computing and Graphics segment would be better than seasonal, given that we will have one month of Ryzen in the market. On a year-over-year basis, I would say the computing graphics business is where you are seeing the majority of the growth as we go into Q1 with both GPU as well as Ryzen driving that growth. +As we go forward in the year, I think the expectations are that the product launches tend to be faster in the CG segment. In other words, from launch to revenue ramp is faster because it's more consumer-based. So as we launch Ryzen in first quarter and Vega in second quarter, but then the notebook and embedded in the second half, you would expect to see that reflected. +On the EESC side of the business, we do have our Microsoft Scorpio design win that will ramp in the year. That's an important one from the semi-custom side. And we will see "Naples" ramp as well, albeit server will tend to be a little bit slower from design win to revenue ramp. We would expect some contribution in the second half of the year. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [31] +-------------------------------------------------------------------------------- + + Great, thanks. And then for my follow-up one, perhaps for either of you again, how do we think about the OpEx side of things as we go through the year? And I know you purposely didn't guide to it in your 2017 as a whole, but conceptually when you are launching a bunch of new products, is it fair to assume that the SG&A side of things to support those launches increases? Any sort of color you can give about your philosophy on OpEx will be helpful. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer [32] +-------------------------------------------------------------------------------- + + Yes, I think our philosophy, first of all, is to be very disciplined about managing the OpEx. We did that, as you saw, in the 2014/2015 time frame. In 2016, we made some very targeted investments to products, which is -- with the launches that are happening in 2017, I would say they are going to pay off in terms of all the products we have on track to launch in 2017. +We have invested in software. We have got obviously some go-to-market expenses as we get into 2017. But I would say that you see our guidance for Q1 2017 at $360 million. So you will see a trend of continuing investment in product roadmap, new product launches, software. +R&D, if you look at it on a year-on-year basis, is up actually close to $50 million. And SG&A was down, even though we were essentially flat on OpEx 2015 to 2016. And I think as you look at 2017, we will continue to stay lean in SG&A and prioritize investments in R&D for the go-forward execution of our plans going into future years. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [33] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Chris Rolland, Susquehanna International Group. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group / SIG - Analyst [35] +-------------------------------------------------------------------------------- + + On the server side, you guys talked about "Naples". And Lisa, you mentioned more threads, higher memory, and I/O. With these products, do you anticipate taking more share in the cloud? Or how do you think you are going to fare versus enterprise storage comms, high performance? Is it going to be a lot more cloud-centric? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [36] +-------------------------------------------------------------------------------- + + Chris, the great thing about "Naples" is it really is a general-purpose product, so we will play in all of those segments. I think the cloud tends to move a bit faster in terms of just, again, from design win to revenue. So we certainly are very focused in the cloud, but I'm also quite enthusiastic about our opportunities in traditional enterprise as well as some of the storage and networking spaces. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group / SIG - Analyst [37] +-------------------------------------------------------------------------------- + + Okay, great. And then with, let's say, Summit Ridge and Vega and "Naples" all coming online here, can you guys talk about where these products -- the gross margins are versus either your corporate average or a comparable product now? And if things ramp the way you expect them to, when might you hit the low end of your long-term gross margin range? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [38] +-------------------------------------------------------------------------------- + + So maybe, Chris, I will start and Devinder can add. Clearly you mentioned some of the key products that are margin drivers for us. So Ryzen in high-end desktop, our server CPUs, server GPUs, professional graphics are all north of the corporate average. We still have game consoles, which will be a significant piece of our business that will be less than corporate average. +So our expectation is that we will make progress with margins as we ramp these products. Relative to when we will hit the long-term guidance, I think we will defer that perhaps to our analyst day and note that the target is still to be within the 36% to 40% range on a long-term model. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group / SIG - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks so much and great quarter. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Blayne Curtis, Barclays. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [41] +-------------------------------------------------------------------------------- + + This is Chris Hemmelgarn on for Blayne. Thanks for very much for letting us on to ask a question, and congrats on the good quarter and guidance. +I guess first of all, a number of questions have touched on this, but with Ryzen launching and then Vega in Q2, you presumably see some pretty big channel fill in Q1 and into Q2. Could you just talk about how you see that impacting seasonality through the rest of the year. Q3, Q4 are normally bigger quarters for PC sales, but you got big product launches in the first half. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [42] +-------------------------------------------------------------------------------- + + Yes, we're certainly looking forward to those product launches. And the way we view it is yes, there's some bit of channel fill, but I think there's also some pent-up demand for really great products in the gaming space. Both Ryzen and Vega are targeted at those enthusiast gamers. So certainly we do expect -- normal seasonality would say that the second half would be stronger. +Note that on Ryzen, we are starting first in the channel and with system integrators, and then OEMs will launch shortly thereafter. So you would expect a stage launch of our partners. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [43] +-------------------------------------------------------------------------------- + + That's very helpful, Lisa, thanks. And then just as a follow-up, so you have announced your first non-game console semi-custom win launching this year. As that business has matured, can you talk how you see further opportunities to grow outside of the core game console market there? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [44] +-------------------------------------------------------------------------------- + + Yes, so we have talked about three design wins and those are in progress now. In terms of ongoing engagements, we have a nice pipeline. We continue to view semi-custom as a strategic way for us to utilize our IP in our design capability. And so we will continue to view that is one of our go-to-markets for the IP that we are developing. And we will talk more about the semi-custom opportunities as we go forward. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [46] +-------------------------------------------------------------------------------- + + Good afternoon, guys. Lisa, congratulations on the strong results for 2016. I guess I wanted to go back with my first question to the OpEx line. If you just look at total dollars spent, you are spending well below your two main competitors. +And I'm just kind of curious. As revenue growth starts to reemerge in the model, how should you think about -- or how should we think about OpEx growth relative to revenue growth? Is there a target that you can give us that you'd like OpEx to grow half as fast as revenue? +Or are you at a point now where you see a lot of incremental investments that are worth doing that might have OpEx growth that are growing faster than that? Any guidance there would be helpful. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [47] +-------------------------------------------------------------------------------- + + Yes, certainly, John. Look, I think we have shown that we can be very disciplined with OpEx, and I think we will ensure that -- OpEx will certainly not grow faster than revenue. So that won't happen. +I think the opportunity for leverage does exist longer term in our model, but in the short term, I am very focused on ensuring that we execute our product roadmap really, really well. And so this year, it is about our product launches, making sure that we have the right software investments and go-to-market. +We are going to see improvement in the financial performance as a result of the margin expansion. And we'll look to find leverage on the OpEx line I think in the longer term as we continue to make progress. But again, we will be very disciplined on the OpEx line. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [48] +-------------------------------------------------------------------------------- + + That's helpful, Lisa. And then I guess as my second question, just going back on the gross margin for Ryzen and Vega. I guess can you help me understand, just given where in the stack those two parts will compete, why they shouldn't have gross margins that are more comparable to your two closest peers. Is that kind of the internal target or is that how we should be thinking about it? Or any guidance there would be helpful. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [49] +-------------------------------------------------------------------------------- + + Yes, so I think for the high-end parts, both Ryzen and Vega, and "Naples", frankly, we should expect that they are well above our corporate average in terms of margin. As it relates to our competitors, I think that's a harder question, but our goal is to make sure that we have very competitive product on a pure performance basis. And so that has been the goal, and that is certainly how we are viewing it. +But we will also have some opportunity for price-performance leverage as we gain share in the market. So I think where we are positioning the products is the right place and the right balance between revenue growth and margin. And we will certainly look for every opportunity to improve our margins over time. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [50] +-------------------------------------------------------------------------------- + + Thank you, guys. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [52] +-------------------------------------------------------------------------------- + + I guess the question I get most frequently is Zen looks pretty exciting in 2017, but you are competing with Intel, who has got 10-nanometer product coming. How do we think about this on a multiyear basis, Zen as a springboard to compete with them? And anything you can share in terms of the product roadmap and the longer-term competitiveness of these products you are introducing now? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [53] +-------------------------------------------------------------------------------- + + Sure, Joe. So look, we do think Zen is very, very competitive for where we are. In terms of our longer-term roadmap, I think, as with anything for top OEM customers, especially server data center customers, they are investing in a roadmap. So they are not just buying a point product. And we have a multigenerational roadmap that we are working on, including the Zen 2 and the Zen 3 follow-on. +From our standpoint, process technology, we ramped 16-nanometer and 14-nanometer really well last year and into this year. We are actually in the process of developing now in 7-nanometer and we think the 7-nanometer foundry roadmaps are available, are very competitive, and will ensure that we have a strong multigenerational roadmap. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [54] +-------------------------------------------------------------------------------- + + Great, thank you very much. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Vijay Rakesh, Mizuho and Company. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks, guys. Sorry to beat upon this, but when you look at the Radeon Instinct GPUs and the Vega architecture in 2Q 2017 and first half 2017 here, are the gross margins more in the 40% to 60% range as they go into data center versus what your existing margins are? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [57] +-------------------------------------------------------------------------------- + + No, Vijay, I think it's fair to say that both professional graphics and our Radeon Instinct line are higher than normal the GPU products -- the consumer GPU products in terms of margin. And now, we view the data center GPUs as a great growth opportunity for us. And so it's a key area of focus. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [58] +-------------------------------------------------------------------------------- + + Got it. And you mentioned GPUs seeing traction in multi-threaded applications. And so with that strength, there especially with [deplaning exit], what are your expectations for growth in that market if you were to -- obviously you are going from zero. But incrementally, what should that drive for -- in revenues for AMD? Thanks. + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [59] +-------------------------------------------------------------------------------- + + Yes. So again, we view GPU servers as a very good growth opportunity for us. We are starting from a small base, but we have had some really good engagement with cloud customers. And we had some meaningful revenue in the second half of 2016, and we expect it to be a growth driver for us into 2017 and beyond. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Kevin Cassidy, Stifel. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [61] +-------------------------------------------------------------------------------- + + Thanks for taking my question. On your Zen product lineup, you will have an APU in the second half of the year. And what kind of GPU does that have on it? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [62] +-------------------------------------------------------------------------------- + + Yes, Kevin, we will have an APU, we call it Raven Ridge, in the second half of the year off of the Zen processor core. And we haven't announced details of the graphics just yet. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [63] +-------------------------------------------------------------------------------- + + Okay. Will that be targeted for both desktop and notebook? + +-------------------------------------------------------------------------------- +Lisa Su, Advanced Micro Devices, Inc. - President and CEO [64] +-------------------------------------------------------------------------------- + + Yes, it will be. But it's a very strong notebook part when you think about the high-end notebooks, two-in-ones and those types of things. But yes, it can also be used in desktop. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [65] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Ambrish Srivastava, BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [67] +-------------------------------------------------------------------------------- + + I had a question on inventory, Devinder. You did give us the reason for why the inventory is higher. But what I'm trying to understand is why the delta between the guidance that you had given, which was supposed to be in the $660 million amount, which you guided to. +Was there a change in what you were expecting for the roadmap? Where there uncertainties that you had guided to $660 million, and now you came up to the number that you reported on the fourth quarter? Thank you. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - SVP, CFO, and Treasurer [68] +-------------------------------------------------------------------------------- + + Yes, I think it's fair to say that from the time I gave the guidance, $660 million coming into $750 million, that there were some changes, but let me explain. +First of all, it was higher than anticipated due to product ramps, product mix, and also our higher expected revenue in the first half of 2017. We also had an opportunity to purchase some inventory in a tight PC supply environment at commercially favorable terms. And we took the opportunity to go ahead and purchase the inventory, given what we see from a revenue standpoint for the first half of 2017. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [69] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Thank you. We've reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura Graves, Advanced Micro Devices, Inc. - Corporate Vice President, IR [71] +-------------------------------------------------------------------------------- + + Lisa, anyone? Thank you very much. Thank you, operator. Thank you, everyone, for joining us on our call today. We look forward to speaking with you throughout the quarter. Thank you. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2017-Jul-25-AMD.txt b/Transcripts/AMD/2017-Jul-25-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..0c39953c5cc81133f4ab49c5fd3b0fdc26cfa478 --- /dev/null +++ b/Transcripts/AMD/2017-Jul-25-AMD.txt @@ -0,0 +1,571 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Advanced Micro Devices Inc Earnings Call +JULY 25, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + - + * Devinder Kumar + Advanced Micro Devices, Inc. - CFO, SVP and Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Canaccord Genuity Limited, Research Division - Principal and Senior Analyst + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to Advanced Micro Devices Second Quarter 2017 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Laura Graves, Vice President of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Laura Graves, - [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Second Quarter Conference Call. By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. +Participants on today's call are: Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on amd.com. +I would like to highlight a few key dates for you. Mark Papermaster, Senior Vice President and Chief Technology Officer will present at the Canaccord Genuity Global Growth Conference on August 9; Raja Koduri, Senior Vice President and Chief Architect of Radeon Technologies Group, will present at the Jefferies Semiconductor, Hardware and Communications Infrastructure Summit on August 30; Forrest Norrod, Senior Vice President and General Manager of our Enterprise, Embedded and Semi-Custom Business group, will present at the Deutsche Bank Technology Conference on September 12. And our third quarter quiet time will begin at the close of business on Friday, September 15, 2017. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note that we will be referring to non-GAAP financials during this call except for revenue and segment operating income or loss, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary posted on our website at quarterlyearnings.amd.com. +Please refer to the cautionary statement in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors in our filings with the SEC and in particular, AMD's quarterly report on Form 10-Q for the quarter ended April 1, 2017. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. Q2 was a strong quarter for us as we continued to ramp our high-performance product portfolio. Second quarter revenue increased 19% to $1.22 billion, and gross margin improved year-over-year. Importantly, we returned to non-GAAP net income profitability in the quarter, driven by strong growth in our Computing and Graphics segment. +Looking at our Computing and Graphics segment, we made excellent progress in the quarter and reported operating profitability for the first time in 3 years based on our leadership Ryzen processor and GPU product offerings. The expansion and growing adoption of our Ryzen CPUs, combined with our sixth consecutive quarter of double-digit year-over-year graphics revenue growth, resulted in a 51% increase in Computing and Graphics segment sales year-over-year. +Client computing revenue increased by strong double-digit percentage from a year ago, driven by a significant ramp and strong sell-through of our Ryzen CPUs in the first full quarter of sales. Our Ryzen family of processors drove a richer mix of shipments, and client ASPs improved significantly from a year ago. All major PC OEMs have announced premium Ryzen-based desktop systems with widespread availability expected for the back-to-school and holiday seasons. +As we move into the second half of 2017, we are on track to complete the full family of Ryzen processors, including Ryzen 3 processors targeting the mainstream and value market segments with on-shelf availability later this week; Ryzen ThreadRipper products for the high-end desktop markets with global component channel availability in early August; Ryzen PRO-based offerings targeting the commercial client segment with availability in Q3; and Ryzen Mobile APUs, which will be available for the consumer market later this year. +In graphics, GPU revenue increased by a strong double-digit percentage from a year ago with higher unit shipments and ASPs driving growth across our desktop and mobile GPU products. Demand for Radeon RX GPUs was strong in the quarter driven by gaming and cryptocurrency mining. +In June, we began the introduction of our Vega GPU architecture with the launch of the Radeon Vega Frontier Edition, delivering a powerful professional workstation graphics card designed to tackle demanding design, rendering and machine intelligence workloads. Apple announced that our Radeon Pro Vega product will power the new iMac Pro, a workstation-class product line designed for creators running the most demanding workflows. In addition, Apple also announced expanded iMac offerings, which are powered by the Radeon Pro 500 series. +We will launch additional Radeon Vega products at Siggraph next week, expanding further into premium portions of the consumer and professional GPU markets. +Our investments in GPU compute and Radeon Instinct are continuing to build momentum. We introduced our first Vega-based Radeon Instinct data center products in June. These new GPU accelerators will significantly increase performance, efficiency and ease of implementation for machine learning and high-performance computing workloads. +We also showcased a server powered by AMD's EPYC SoC and 4 Radeon Instinct MI25 accelerators, working together to deliver groundbreaking performance of 100 teraflops. Interest and excitement are high as we recently started shipments of our Radeon Instinct MI25 accelerators to strategic data center customers. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue declined 5% year-over-year and increased 44% sequentially. The sequential revenue gains were primarily based on higher semi-custom product shipments due to seasonality. In addition, we reached an important milestone in the quarter, delivering initial EPYC server revenue. +In our semi-custom business, unit shipments were up sequentially and down year-over-year as we enter the fifth year of the current game console sales cycle. This console cycle continues to outpace previous cycles as Sony recently passed a milestone of 60 million PlayStation 4 consoles shipped. Last month, Microsoft announced the new Xbox One X with availability in November. This system will be Microsoft's smallest and most powerful Xbox ever made and will be based on the combination of high-performance CPU and GPU IP that only AMD can provide. +As we look at the remainder of the year and given the maturity of the current game console cycle, we expect semi-custom revenue to be down for the full year. +In our server business, last month, we launched our EPYC family of high-performance data center processors, reentering the incredibly important $16 billion data center market and setting several new industry performance records. With up to 32 high-performance "Zen" cores and an unparalleled feature set, our EPYC family of processors deliver greater competitive performance at every price point across a full range of integer, floating point, memory bandwidth and I/O benchmarks and workloads. Our 2-socket and 1-socket EPYC CPUs are designed to deliver industry-leading performance on critical enterprise, cloud and machine intelligence workloads and provide a substantial TCO advantage. +At our EPYC launch event, we were joined by more than 20 leading server manufacturers and global ecosystem partners who showcased optimized support and EPYC-optimized platforms. We received compelling endorsements from OEM, cloud providers and mega data center operators, including HP Enterprise, Dell, Baidu, and Microsoft Azure with more than 20 EPYC-based platforms announced at launch. And we expect an additional 20 EPYC platforms to be available in the second half of 2017. With the strong global ecosystem and customer interest we have built around our EPYC processor family, we are on track to reenter the data center market in a major way. +In closing, we are very pleased with the trend of our quarterly results and how our products are positioned heading into the back half of the year. Our business foundation and growth opportunities are strong based on our high-performance product portfolio and our expanding customer traction. Given our first half 2017 performance and our visibility into the third quarter, we are happy to report we are progressing ahead of our annual revenue guidance, and we look forward to a strong year overall. +Now I'd like to turn the call over to Devinder to provide some additional color on our second quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. For the second quarter of 2017, AMD revenue grew 19% and gross margin expanded on a year-over-year basis, driven by a 51% year-over-year revenue increase in our Computing and Graphics segment. We achieved non-GAAP profitability on both an operating and net basis with net income of $19 million and diluted earnings per share of $0.02. Let me provide more specifics for the quarter. +Gross margin was 33%, up 2 percentage points year-over-year due to a richer product mix and a higher percentage of revenue from our Computing and Graphics segment, driven by the first full quarter of Ryzen processor sales. Operating expenses were $381 million compared to $342 million a year ago. The increase was due primarily to higher graphics and data center R&D-related investments. +Net licensing gain from our server JV with THATIC was $25 million compared to $26 million a year ago, and we have recognized a total of approximately $140 million of net licensing gain to date. The remaining payments are related to production milestones, and I expect it to occur in 2018 and beyond. +Operating income was $49 million in the second quarter of 2017, a significant improvement from an operating income of $3 million a year ago. +Second quarter net interest expense, taxes and other was $30 million, down from $43 million a year ago, primarily due to a lower overall interest rate and a lower debt balance. Net income was $19 million or diluted earnings per share of $0.02 as compared to a net loss of $40 million or loss per share of $0.05 a year ago. Adjusted EBITDA was $84 million compared to $36 million a year ago and $28 million in the prior quarter. +Now turning to the business segments. Computing and Graphics segment revenue was $659 million, up 51% year-over-year and up 11% sequentially. The year-over-year increase was driven by demand for our Ryzen desktop processors and graphics processors. +Computing and Graphics segment operating income was $7 million, the first quarterly operating profit in 3 years, compared to a loss of $81 million a year ago. The significant improvement was primarily due to higher revenue and an improved product mix. +Enterprise, Embedded and Semi-Custom revenue was $563 million, down 5% year-over-year, primarily due to lower semi-custom SoC sales. Revenue was up 44% sequentially due to the seasonal semi-custom ramp. Additionally in the quarter, we reached an important milestone and recognized initial revenue from EPYC data center processor shipments. Operating income was $42 million, down from $84 million a year ago due primarily to lower revenue and higher data center-related R&D investments. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities total $844 million at the end of the quarter compared to $943 million at the end of the prior quarter due primarily to changes in working capital, largely driven by wafer purchases in anticipation of stronger revenue growth in the third quarter. Inventory at the end of the quarter was $833 million, down slightly from the prior quarter of $839 million. Long-term debt on the balance sheet was $1.38 billion. Total principal debt, including our secured revolving line of credit, was $1.74 billion. +In Q2, we repurchased $40 million of term debt, utilizing our lower-cost secured revolving line of credit. Free cash flow was negative $94 million due primarily to changes in working capital largely driven by wafer purchases. +Turning to our outlook for the third quarter of 2017, which is a 13-week quarter. We expect revenue to increase approximately 23% sequentially, plus or minus 3%. At the midpoint, this equates to revenue growth of approximately 15% year-over-year. We now expect annual 2017 revenue to increase a mid- to high-teens percentage year-over-year compared to our prior guidance of low double-digit growth, non-GAAP gross margin to be approximately 34%, non-GAAP operating expenses to be approximately $400 million, non-GAAP interest expense, taxes and other to be approximately $28 million and inventory to be down sequentially. +Third quarter diluted share count for modeling non-GAAP EPS is expected to be approximately 1.14 billion. This includes shares related to our 2026 convertible senior notes and the warrant held by a Mubadala entity. Additional information regarding diluted share count calculation can be found in the CFO commentary. +In closing, Q2 was a strong quarter, and our financial performance continues to improve. As Lisa shared in her remarks, our business continues to strengthen as we ramp new high-performance products and expand our presence in premium markets. We are pleased with the strong growth in revenue coupled with improving gross margin on the back of focused execution, financial discipline and ongoing strategic investments in the business. +With that, I'll turn it back to Laura. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, - [5] +-------------------------------------------------------------------------------- + + Thank you. Thank you, Devinder, and operator, we're ready for our first question to begin Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + The question is on EPYC, and I'm hoping that you can provide us some more color about how the reception is going, how we should think about milestones going forward. And I'm wondering if you can tell us about the number of different trials or where you're seeing the most traction and when you would expect this to ship into production environment in the Super 7 cloud guys. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure, Mark. Thanks for your question. So we are very pleased with the reception to EPYC. The launch that we did in June was very well received. We had a number of customers as well as partners, OEM providers, ODM guys as well as cloud providers who participated in that. The general reception has been very positive. I would say that interest level is very high. In fact, we're adding additional customer support to really ensure that we help customers get their platforms up and running. In terms of what to expect in the revenue ramp, we started shipping early volume in the second half of June. We would expect that we'd continue to ramp that revenue in the second half of the year. We would expect some additional customer announcements in the second half of the year, and then, as we stated with both cloud and enterprise accounts, depending on their qualification cycles, it can take anywhere up to 4 quarters to qualify the parts. But so far, so good. I think very good traction, and we continue to lean in hard on the data center opportunities. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + That's very helpful. And a follow-up if I may. You mentioned crypto as helping the GPU side. That can be a dual-edged sword, and I was wondering if you can help perhaps quantify like what that did to the upside. And is there any way to manage the risk of the minors breaking down their systems and putting it into the secondary market when the currency comes back down? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Sure, Mark. So certainly, the overall quarter for graphics was strong. Q2 tends to be seasonally down, and we were up in the quarter. So it was better than seasonal. I would say the better performance was due to 2 things. First of all, we did launch our RX 580 and 570 gaming cards in April, and those cards are very, very well positioned in the market. So they're doing well with gamers. Relative to cryptocurrency, we have seen some elevated demand. If you look at GPUs across the world, the inventory in the channel is actually quite lean, and so we're working on replenishing that inventory. Our priority though really is on our core market, which is the gaming market. And so couple of things that we are certainly doing are we're prioritizing supply towards the gaming market, so you'll see system integrators as well as on some of the major e-tailers, we have bundles with Ryzen and Radeon. And then some of our partners are also offering mining-specific cards that have a different feature set such that we're really segmenting the market between gaming and mining. But it's important to say we didn't have cryptocurrency in our forecast, and we're not looking at it as a long-term growth driver. But we'll certainly continue to watch the developments around the block chain technologies as they go forward. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question today is coming from Matt Ramsay from Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [7] +-------------------------------------------------------------------------------- + + Lisa, I wanted to ask a little bit about the longer-term road map in your businesses across the CPU and GPU side. It occurs to me, and through some of the conversations we've had, particularly in the enterprise markets of high-end desktop and server, that some of the purchasing decisions made by your customers might be sort of dictated by how confident they are in the long-term road map that you guys are putting together as you move to 7-nanometer versus just the products that you've launched so far. So maybe you could talk a little bit about the road maps, how they're developing and the progress that the team is seeing on the 7-nanometer front. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Sure, Matt. So look, I think the overall road map execution has been very good, very solid. I think our customers see that the Ryzen performance, the EPYC performance on the CPU side and then certainly the Vega performance on the GPU side have met our commitments. And the important thing, particularly in the enterprise market as well as the commercial market, having a road map, a strong road map with multiple generations is important. We stated at our Financial Analyst Day that we're already investing heavily in 7-nanometer. The 7-nanometer will be key for us on both the CPU and the GPU side, and I would say that development is progressing well. We're working with multiple foundries on that. We have multiple design teams that are working, and we expect that, that would give us a strong competitive road map for the next several generations. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [9] +-------------------------------------------------------------------------------- + + And a couple questions, quickly, for Devinder. The -- I guess, the first one is on share count. There was obviously some movement higher in the share count, either the -- in the in-the-money converts. Maybe you could talk us through, if you were modeling maybe your business on a long term, from an earnings power perspective, how would you think about modeling that share count? And then secondly, on the operating expense line, there's plenty to invest in here. But how should we think about that as we move through the year and into next year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [10] +-------------------------------------------------------------------------------- + + Yes. Thank you, Matt. I think on the share count, basically, beyond the basic shares, the dilutive impact come from 3 components. You have the employee equity grants. You have the 75 million share warrant that we issued to Mubadala in 2016. And you have the 101 million shares underlying our $805 million convertible note. The good news is that you start making money and you get beyond inflection point. All of that gets included in dilute share count. So I think given what we have laid out as guidance, in particularly in the Financial Analyst Day, the assumption should be, as you model profitability in the company, those shares get included. We have provided color in the commentary, and for Q3, we are estimating that the total share count is about $1.14 billion (sic) [1.14 billion]. As far as the OpEx is concerned, we are obviously, with the strength in the business, performing stronger. We are making targeted investments, particularly in R&D. We have included and invested in targeted R&D areas. And also, in 2017, I think there are some employee-related performance incentives that are included in our current guidance given the fact that the business is performing stronger than anticipated. Lisa, anything you want to add? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [11] +-------------------------------------------------------------------------------- + + Yes. No, I think you covered it, Devinder. On the investment front, Matt, just to give you a little bit more color on that, I think we see tremendous opportunity in the data center around both CPU and GPU compute, and so we're taking the opportunity with some of the strength in the business to make sure we lean in to those resources and fully pay off the product investments. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [13] +-------------------------------------------------------------------------------- + + Lisa, one for you first on the client ASPs. I know the Ryzen side, the mix had to go up, and those carry much better ASPs. But the client category as a whole, the ASPs went down. So if you just think about going forward, when do the size of the buckets work, that the Ryzen contribution will be big enough to offset whatever was the headwind against that in the second quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [14] +-------------------------------------------------------------------------------- + + Yes. Good question, Ross. When you take a look at our client business, think of it as desktop and mobile, and then within the desktop segment, it's channel and OEM. So Ryzen performed very well. I think the ASP contribution is very evident on the desktop line item. But when we look at where we are in the progression of the Ryzen rollout, we're still in the early innings. So we had our first full quarter of Ryzen desktop in the channel. The OEMs launched their desktop products in about mid-June, and so they just started selling at the end of June. And that will flow through into the second half of the year. And the mobile products are still our legacy products. So you saw the mobile ASPs were down slightly as we went from Q1 to Q2, and that was just a mix on some of the legacy business. But the desktop ASPs were quite strong, and we should expect that, as we go into the second half of the year and we have Ryzen really take off in the OEM sectors as well as once we introduce Ryzen Mobile towards the second half of the year, is when you'll see sort of more of the full portfolio over to Ryzen. Does that help? + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [15] +-------------------------------------------------------------------------------- + + It does. And a related follow-up on that is just transitioning those ASP and mix commentaries over to the actual gross margin. The full year revenue guidance is increased again. Just recently, you guys did it at the Analyst Meeting. Now you're doing it again, so that's clearly a positive. It seems like the C&G side of things is what's driving that given your commentary on the game console side being down. So given everything you just said about the mix improving in the back half of the year and the revenues now being higher, I'm a little surprised the gross margin guidance didn't change for the year. So if we translate everything you just said, Lisa, to a gross margin dynamic, can you help us kind of make all of that make sense as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [16] +-------------------------------------------------------------------------------- + + Yes. So I think you summarized the revenue guidance well. I think we see the Computing and Graphics business accelerating on the strength of the new products. We do have a bit of a year-over-year headwind when we compare game consoles. When you look at our Q3 margin guidance, we are certainly up year-over-year 3 points, and so I think that's the strength of the product portfolio. I think as we get into the Q4 guidance, we'll talk more about the margin progression, but the -- what we expected in terms of margin expansion with the premium products is certainly playing out, and that's helping the Q3 guide. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question today is coming from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [18] +-------------------------------------------------------------------------------- + + Can you give us some idea of whether your September guidance assumes any meaningful contribution from Vega sales for gaming in the September quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [19] +-------------------------------------------------------------------------------- + + Yes, David. We will be launching Vega actually in a week at Siggraph, and yes, there will be -- Vega will be shipping into gaming, into professional workstations as well as into the GPU compute segment in the third quarter. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [20] +-------------------------------------------------------------------------------- + + And can you update us on your expectations for launch timing of Ryzen notebook chips and if you expect there to be revenues from Ryzen notebook in December? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Yes. So Ryzen notebook is on track to launch for the holiday platform sales, and so you should see OEMs launching Ryzen Mobile for the holiday period. So yes, we will see revenue in the second half of the year. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ambrish Srivastava from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + My question, first one was on free cash flow. It's negative again, and for the first half, minus $420 million if my math is right. So Devinder, when does free cash flow turn positive? And then I had a follow-up, please. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [24] +-------------------------------------------------------------------------------- + + Yes. I think 2016, if you go back and look at the full year, because of the seasonality of our business, we were positive. From a viewpoint of midpoint of 2017, we do see strength of the business. You're right. Cash is down with the changes in working capital, and it's largely driven by wafer purchases in support of the stronger second half and in particular, the stronger business that we are seeing. We expect cash to be up for the quarter -- this quarter and to be free cash flow positive for the year. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst [25] +-------------------------------------------------------------------------------- + + Okay. And then my follow-up is, Lisa, on the crypto question that Mark had asked earlier. I'm not sure you gave an answer to -- or maybe Mark didn't ask that. Are you seeing follow-on strength from that in the current quarter? And then why -- and we realize it's not a core part of your business. But why or why not this is not similar to what happened in '14? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [26] +-------------------------------------------------------------------------------- + + Sure, Ambrish. So I think, from an overall standpoint, we see strong demand in graphics for the third quarter. I think that's a mix of a couple things. That's a mix of gaming being seasonally stronger in the third quarter. That's a mix of inventories being very low in the channel, and there is a crypto -- probably a cryptocurrency component as well relative to overall demand. When we look at it as a whole though, we think that the growth in the business is really on the strength of the products and how the design wins, both OEM and -- as well as system integrators, are improving. Now how is it different than sort of a couple of years ago? I think we understand the market much better from the standpoint of the products are significantly stronger. And so if you look at the product portfolio, not just the current sort of Polaris or RX 5-series products but the Vega product coming in, really opens up a larger TAM for us. And we are working with our add-in-board partners to segment the markets in terms of the feature set that go into the cards as well as prioritizing some of the gamer ecosystems, so in terms of system integrator supply as well as bundling and OEM supply. So I think we are doing quite a bit to make sure that we protect against any downside as it relates to cryptocurrency, but overall, I would view it as GPUs are strong. And we see GPUs continuing to be strong, and so it's a great market to be in. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question today is coming from Kevin Cassidy from Stifel. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [28] +-------------------------------------------------------------------------------- + + Maybe just as a follow-up to that. Inventories being down going into this quarter and with all your new product ramps, is that -- is it down mainly just because of GPUs? Or is there something else? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [29] +-------------------------------------------------------------------------------- + + I think it's -- if you look at the inventory, in fact, if you look at it from my standpoint and the strength of the business, there's revenue growth, we are obviously buying wafers in support of the stronger revenue. Some of the ramp in new products does have an impact on the inventory and obviously, we want to support all of new product ramps. It's down marginally in the quarter, but I expect that in Q3 it will go down. And then we have previously guided down year-over-year, so I expect, when we end the year, it will be down in 2017 compared to 2016 while fully supporting the needs of the business. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [30] +-------------------------------------------------------------------------------- + + Okay. And is -- I guess for the server side, how do you -- how are you building inventory for that? Or is that a longer design cycle so that you don't really start building inventory? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [31] +-------------------------------------------------------------------------------- + + I think the server side is -- yes. It's a smaller portion. I mean, the ramp in EPYC, as you probably heard us say, is slower than in other businesses. So from -- if you look at a total inventory, the server portion of inventory is not that huge. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question today is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [33] +-------------------------------------------------------------------------------- + + Lisa, for my first question, if I go back in history, at one point, AMD had a 20%-plus share in server CPUs, and I appreciate we are far off from that point right now. But I just want to know conceptually what are you doing or can do to recreate those conditions? Or do you think the environment is very different this time around? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [34] +-------------------------------------------------------------------------------- + + Yes. Vivek, I think we are actually very pleased with sort of the conditions around the server market for us. I mean, it all starts with a good product or a great product, and so I think the EPYC product performance is very important. But I think the other conditions that are different and perhaps even more favorable than in the past is the fact that the cloud data center guys are making up such a large piece of the market, and they tend to move faster in their qualification cycles given the fact that they have sort of more control of their own software environment. So I think our differentiation is strong. I think we have -- we put out a product that is not only strong on basic CPU performance but also offers much more flexibility in terms of what you can do with memory and I/O. I think that value proposition is recognized by the customer set, so we certainly are looking to ramp the revenue as fast as possible. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [35] +-------------------------------------------------------------------------------- + + Got it. And for my follow-up, as you're starting to become more competitive against Intel and NVIDIA, are you seeing any competitive response from them in terms of pricing or features or go-to-market strategy that you might need to respond to? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Obviously, we continue to watch the competitive market. It's been an exciting market. Some would say that, from a product standpoint, there has been a bit of back-and-forth already. We feel good about how our products are positioned not just today but how they will be positioned over the next 18 to 24 months. And so we're going to be very focused on ensuring that we lead with the product message. Of course, there's a go-to-market element and all of that around that, but I think the competitive environment right now is very focused on product competitiveness. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [37] +-------------------------------------------------------------------------------- + + And maybe a quick follow-up on that, Lisa, if I might. When Ryzen initially rolled out, I think some of the benchmarks and -- were not up to par. Have you seen an improvement in that? And as you -- especially as you roll out EPYC, are you seeing the ecosystem come and work around your products, so those benchmarks are not going to be an issue this time around? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [38] +-------------------------------------------------------------------------------- + + Yes. So I think, Vivek, you're referring to when we initially launched Ryzen 7, there were some games, particularly in 1080p resolution, that were not as good as some of the higher resolution. And I believe we worked around a lot of that. We've seen game developers, content developers really sort of support the Ryzen ecosystem. I've actually been very happy with how they've jumped on the support of it. We have been continuing to improve the ecosystem. So if you look at the motherboards and if you look at the memory capability, they've significantly improved just in the last 3 or 4 months. I think you'll see, as we go through ThreadRipper launch, which is coming up very shortly, that the Ryzen ecosystem is strong. And as it relates to EPYC, I think the -- very similar comments. I think the ecosystem has been very supportive of the EPYC processor family, and so I don't see that as an issue. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [40] +-------------------------------------------------------------------------------- + + Wonder if you could talk a little bit about -- as we think about EPYC for next year, how do you think we should frame that opportunity? Is it mostly a cloud -- sort of top-tier cloud customer that's going to drive that revenue? Is it sort of next level down of cloud customer going to drive significant revenue and then enterprise next year? I mean, how would you sort of bucket those 3 things in terms of where the EPYC potential lies? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [41] +-------------------------------------------------------------------------------- + + Yes. I would say, Joe, we have a broad set of customers that we're engaging with. So definitely, we see top-tier cloud guys very engaged with EPYC and talking about a number of different instances. Microsoft Azure was at our launch event, and Baidu was at our launch event. And we're working with a number of other cloud vendors as well. But we also have a very strong OEM support base as well. So with HPE and Dell putting out a number of platforms with EPYC, I think that will ramp enterprise customers in 2018 as well. So I view it as really both sides of the equation are important for 2018. I think we will see cloud be a little lumpier. So certainly, they tend to buy in stages, so they may be a little bit lumpier. But I think, overall, we are very focused on both cloud and enterprise accounts. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [42] +-------------------------------------------------------------------------------- + + And then circling back quickly to the inventory issue that you talked about in graphics. It seems like they're quite lean and in some cases, in shortage. Is that completely a function of demand? Were there any supply issues in the quarter? And how quickly if -- do you foresee that as an issue? And if so, like how quickly do you fix it? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [43] +-------------------------------------------------------------------------------- + + Yes. Joe, it was completely a function of demand and demand within lead time. I think from a supply standpoint, we've had a very strong supply chain across-the-board, across both CPU and GPUs. We are, as I said, in the process of catching up to demand, and so we're certainly increasing some of the production. And that was Devinder's comment about some of the working capital and some of the inventory comments. Overall though, I think we're going into a stronger second half of the year. So it's not unexpected for us to ramp up production. It's just demand was quite strong. Particularly in the April-May time frame is when we saw a spike and take some time to react to those signals. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Our next question today is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + Lisa, can you give us a sense of how EPYC is doing in virtualized environments because there might be some issues regarding compatibility with the other x86 suppliers and how you would go through that process over the next several quarters? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [46] +-------------------------------------------------------------------------------- + + Yes. Again, Hans, I think we have been working closely with a number of different customers, including in virtualized environments. We see no particular issues other than just getting their platforms up and running. And so I think we continue to believe EPYC will do very well in those environments. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [47] +-------------------------------------------------------------------------------- + + Okay. And then as a follow-up, can you give us a sense, now that EPYC is out, what the feedback is from your customers, cloud or OEM, regarding your packaging approach in terms of using a multi-chip module type approach versus a monolithic silicon approach? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [48] +-------------------------------------------------------------------------------- + + Yes. Hans, actually, the feedback has been actually quite good, and I think the -- what we're able to do -- obviously, it's a decision to make, right? We could have built one big monolithic chip or -- we decided very strategically to build a modular approach because it just gives us so much flexibility when we talk about the combination of CPU cores and I/O. So, so far, so good. I think there is some work to do to make sure that the latencies are appropriately taken care of, and the customers are working with us on that. I think the flexibility is really, really appreciated, particularly when you look at what we can do with single-socket servers as well. So we feel very good about where EPYC is positioned. I think the customer feedback continues to be very strong, and our goal is to get as many platforms out as possible with EPYC this year. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Our next question today is coming from John Pitzer from Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [50] +-------------------------------------------------------------------------------- + + Lisa, notwithstanding the possibility that you guys beat your revised guidance you just gave today, if you just go by the revised guidance, it's kind of implying calendar fourth quarter revenue down about 10% sequentially, which is about in line with seasonal. Just kind of curious, just given where you are in the product cycle for Ryzen and EPYC, why a seasonal quarter wouldn't be something that you could beat? And I guess, equally important, are you planning to stay profitable in the calendar fourth quarter if it is down seasonal just given the trajectory of OpEx? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [51] +-------------------------------------------------------------------------------- + + Yes. So yes, John, let me answer that. When you look at our typical seasonality, as you said, we tend to be down in Q4. Semi-custom is still a large, large piece of our business and semi-custom will peak in Q3. And it will come down in Q4. I also think that we want to be cognizant of the fact that some of the graphics demand that we see might be temporal, so we're not counting on that staying through the full year. We'll see what happens. Frankly, I think we'll see what happens with the whole mining stuff. But I think when you look overall, I think that it shows that the business is strengthening. And so we like the growth very much. Ryzen will continue to grow through the second half. EPYC will continue to grow through the second half. Vega and our GPU business will continue to grow through the second half, and the only headwind that we have is through the game console business just as part of normal seasonality. And then relative to the profit statement... + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [52] +-------------------------------------------------------------------------------- + + I think it's hard to predict that right now, John. I think if you look at our guidance, as we said, revenue, mid- to high teens, which, from our standpoint, is 16, 17-ish increase. And we'll get to Q4 when we get there. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [53] +-------------------------------------------------------------------------------- + + That's helpful. And then, Lisa, for my follow-up, R&D ticking up, which is absolutely the right thing to do for the longer-term health of the business, but I'm just kind of curious if you could help me understand your sort of R&D priorities. To what extent is this uptick in R&D really to help bolster your position in existing markets versus sort of R&D dollars to go after new markets, whether that be acceleration, machine learning or autonomous driving? How should I think about that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [54] +-------------------------------------------------------------------------------- + + Yes. So I think there are a couple points, John, that I want to make sure that we're clear about. Although OpEx is going up and R&D is going up, we're doing it in a very thoughtful fashion. And so staying within the confines of the business model is really important. And as Devinder said earlier, our model that we laid out at Financial Analyst Day for 2017 has us, let's call it, at approximately 31% ER, and we're going to stay within that model for sure. Now relative to priorities in R&D, it is very much focused on sort of the new growth areas for us, very much focused on data center and very much focused on GPU computes around machine learning and sort of the entire compute space on the GPU side. It is fairly incremental in terms of adding things like customer support, field application engineering, software support given that we're familiarizing people with our architecture. So I think it's good. We're happy that the business affords us the ability to increase R&D in this time frame, and we're using it to accelerate our growth in these high-margin markets. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question is coming from Vijay Rakesh from Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [56] +-------------------------------------------------------------------------------- + + Perhaps, Lisa, when you look at the EPYC, I know you said 20 customers already and then 20 more in the second half. Do you think that gets to 5% of your revenues, just the EPYC side of your revenues as you look at the third quarter? And should we assume pretty incrementally [about --] not the 50% margins on your EPYC product, especially as it goes in the data center side? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [57] +-------------------------------------------------------------------------------- + + So Vijay, without getting too granular about percentage of EPYC revenue, I think what we've said is our target for EPYC, we sort of have -- the midterm target is to get back to double-digit market share, so over 10%. We think that we have a product and a customer set in an environment that does support that. It will take longer than this year to get there. So I think this is a multiple-quarter ramp for us. But in terms of how we've laid out the business model, I mean, that's all contemplated sort of in our overall growth model for 2017. As it relates to margins, again, without being very specific, I would say the EPYC margins are highly accretive even at our current sort of pricing, which offers, I would say, significant value to the customer. I think it also gives us significant credit for the capability of the product. And so the margins are accretive to our business model. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [58] +-------------------------------------------------------------------------------- + + Got it. Very helpful. Just on the Radeon Instinct side, too, can you give us some similar commentary on how you see in terms of customer adoption and what the response has been similar to EPYC? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [59] +-------------------------------------------------------------------------------- + + Yes, yes. The Radeon Instinct similarly has a lot of interest from the marketplace, a number of different applications. We started shipping actually in July to some strategic data center customers. We see that interest continue to ramp. There, I think it is -- this is definitely a lumpy business. And so it goes, as a cloud guy puts on a new instance, you would see a larger buy, and that's the way it would work. But again, very good market. I think we're in the very early part of the growth trajectory for AMD in these markets, and we'll continue to invest and work closely with customers to ramp those platforms. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Our final question today is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [61] +-------------------------------------------------------------------------------- + + Lisa, I just want to follow up on the -- your comments on the cryptocurrency market. Just curious what's your visibility into whether someone -- obviously, they buy a dedicated card. It would be easy to track. Just your visibility on the back end as to where the strength in the overall GPU market is coming from. You mentioned it as a third factor, I think, in September, but then mentioned it may impact December and if you can just talk about in that full year guide, are you factoring in any contribution in December? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [62] +-------------------------------------------------------------------------------- + + We're being conservative in our estimates for what will happen as we get into the fourth quarter. I think the visibility is not -- it's anyone's guess at this moment. However, I think what we are doing very clearly is prioritizing sort of the core customer set so that we're segmenting the market. You can never segment it perfectly, but I think we are segmenting it well. And we continue to be very closely in tune with our partners and how this develops. And my expectation is that there will be a leveling off of the demand at some point. And as we fill the channel, that will become clear in what the level-off point is. But right now as we said, the channel inventories are very low, and so it's hard to call the absolute demand. And we're ensuring that we're not overcalling the demand. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [63] +-------------------------------------------------------------------------------- + + And then just a question for Devinder. The OpEx step-up in September, it's hard to tell from the full year guide, 31% can round a bunch of different ways. Just curious if you expect any follow-through in that increase in R&D into the December quarter? And then if you could just mention also timing of the JV payment. Obviously, you're not getting any in the back half of this year. Maybe you could talk about the milestones into next year and when those should come back as offsets. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [64] +-------------------------------------------------------------------------------- + + Yes. Let me take the JV one first. I mean, as we said in the commentary in my prepared remarks, $140 million licensing gained on the THATIC server JV to date. We got $52 million this year, and there's nothing more this year. The remaining payments are based on some production-related milestones, and those are in 2018 and beyond. And we'll update that as we get closer. As far as the OpEx is concerned, I think we've said a lot, and we stand by what we said. We'll manage within our guidance of expense-to-revenue ratio of approximately 31% for the year. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further closing comments. + +-------------------------------------------------------------------------------- +Laura Graves, - [66] +-------------------------------------------------------------------------------- + + Great. Thank you very much, operator. We appreciate everyone being with us today. We look forward to spending more time with you in the coming quarter, and thank you for your time. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2017-May-01-AMD.txt b/Transcripts/AMD/2017-May-01-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..002a9dea5a1ca0092c80ac3431c8a065968df4fe --- /dev/null +++ b/Transcripts/AMD/2017-May-01-AMD.txt @@ -0,0 +1,607 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Advanced Micro Devices Inc Earnings Call +MAY 01, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + - + * Devinder Kumar + Advanced Micro Devices, Inc. - CFO, SVP and Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher Adam Jackson Rolland + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * David M. Wong + Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Technology and Services Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst + * Matthew D. Ramsay + Canaccord Genuity Limited, Research Division - Principal and Senior Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to turn the conference over to Laura Graves, Corporate Vice President of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Laura Graves, - [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's First Quarter 2017 Conference Call. By now, you should've had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. Participants on today's conference call are: Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on amd.com. +Before we begin, I'd like to highlight a few dates for you. We will host our Financial Analyst Day on Tuesday, May 16, at our headquarters in Sunnyvale, California. Lisa Su will present at the J.P. Morgan Global Technology Media & Telecom Conference on May 22. Jim Anderson, our Senior Vice President and General Manager of Computing and Graphics, will present at the Stifel Nicolaus Conference on June 5. Mark Papermaster, Chief Technology Officer, will present at the BofA Merrill Lynch Global Technology Conference on June 6. And our second quarter quiet time will begin at the close of business on Friday, June 16, 2017. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date, and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note that we will be referring to non-GAAP financials during this call, except for revenue and segment operating income or loss, which is on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measures in the press release and CFO commentary posted on our website at quarterlyearnings.amd.com. Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors in our filings with the SEC and in particular, AMD's annual report on Form 10-K for the year ended December 31, 2016. +Now with that, I'll hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all of those listening in today. First quarter revenue increased 18% from a year ago to $984 million based on growth across both of our business segments. Gross margin also improved, driven largely by the success of our recently launched Ryzen CPUs. I am pleased with our first quarter product execution and improved year-over-year financial results, which demonstrate the revenue growth and gross margin expansion potential with our strong set of new products. +Looking at our Computing and Graphics segment. We delivered our fourth straight quarter of double-digit percentage year-on-year revenue growth. Strong demand for Ryzen CPUs and improved GPU sales resulted in CG revenue increasing 29% from the year-ago period. CG revenue declined 1% sequentially, which was better-than-normal seasonality as significant growth in desktop processor sales, driven by the first month of Ryzen CPU sales, largely offset seasonal declines in GPU and notebook APU sales. +Solid demand for our family of premium Ryzen 7 processors, including our flagship Ryzen 7 1800X offering, which is the industry's highest performance 8-core CPU, drove our highest desktop processor revenue in more than 2 years. Ryzen CPUs have been consistently ranked among the top-selling processors at global e-tailers and retailers. And press reviews and end-user sentiment have highlighted the strong performance and value proposition. +In early April, we launched our enthusiast-class Ryzen 5 processors and received overwhelmingly positive reviews that demonstrate our multi-threaded leadership and unmatched value proposition. +The Ryzen CPU partner ecosystem also continues to strengthen. We have seated more than 300 software developers to support their work optimizing for Ryzen CPUs and have already seen double-digit performance gains across a number of top-tier gaming titles. Last week, the first Ryzen-based OEM gaming desktops were announced, and we continue the rapid rollout of Ryzen-powered systems with additional launches planned for major OEMs later this quarter. +In Graphics, GPU sales increased by a strong double-digit percentage from a year ago based on growth across all of our product lines. The ramp of Polaris-based notebook design wins drove increased mobile GPU sales while our desktop growth was led by improved channel sales. +In early Q2, we launched 4 new Radeon RX 500 GPUs, featuring our Polaris architecture that deliver improved performance. These new mainstream GPUs provide a compelling solution for the millions of gamers looking to upgrade their PCs to support advanced display technologies and deliver optimal gaming experiences. +We also saw higher professional graphics revenue from a year ago, driven by expanding channel sales and growing data center wins, as we continue to increase our GPU-compute footprint with leading cloud service providers. +We remain on track to launch the first products from our next-generation Radeon Vega family later this quarter. Vega is a forward-looking architecture that combines a revolutionary memory subsystem, next-generation compute engine, advanced pixel engine and new geometry pipeline to dramatically improve performance and energy efficiency for the next generation of GPU workloads. Customer excitement is building as we focus on bringing significant competition to the high-end GPU space across the PC gaming, professional design and GPU compute markets. +Turning to our Enterprise, Embedded and Semi-Custom segment, revenue increased 5% from a year ago, driven by the latest game console offerings from Sony and Microsoft and our third straight quarter delivering year-on-year embedded revenue growth. We see solid demand for our latest FinFET-based semi-custom offerings in 2017, including the planned holiday launch of Microsoft's 4K-focused Project Scorpio console featuring a new AMD SoC. +On the data center front, in March, we demonstrated that our upcoming Naples server CPU would offer more cores, I/O and memory bandwidth when compared to the highest-end dual socket x86 server CPUs currently available, resulting in better performance across multiple workloads. +Naples platform development work continued to accelerate in the quarter. We are in the final stages of preparation in advance of launch and are very pleased with the status of our silicon and customer engagements. We have now seated thousands of Naples processors across an extensive set of OEMs, end users and partners, and remain on track for our first Naples products to launch this quarter. +In closing, we started 2017 delivering significant year-on-year revenue growth and margin expansion based on solid product execution and strong market and customer reception to our new leadership products. Our focus in 2017 remains on launching our Naples server CPU with broad customer, partner and ecosystem support. Naples is the first step in our long-term plan to deliver a leadership data center product road map. +Complementing the success of our mainstream Polaris-based GPUs with our high-end Vega GPUs, extending our Zen core into the mainstream desktop and premium notebook markets with the launches of our Ryzen 3 CPUs and Ryzen mobile APUs in the second half of the year, and expanding our participation in the fast-growing market for GPU compute with the launch of Radeon Instinct accelerators midyear. +2017 is an important year for AMD, and we are well positioned for solid revenue growth and margin expansion based on bringing performance, choice and innovation to an expanding set of markets. I look forward to discussing more about our long-term strategy at our Financial Analyst Day later this month. +Now I'd like to turn the call over to Devinder to provide some additional color on our first quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. We had a good start to 2017 as we expanded gross margin, increased revenue 18% year-over-year to $984 million and reduced losses year-over-year. +Computing and Graphics segment revenue increased 29% year-over-year, driven by the launch of our high-performance Ryzen desktop processors and our strengthened GPU product portfolio. Our Enterprise, Embedded and Semi-Custom segment revenue increased 5% from a year ago. +Let me provide some specifics for the first quarter of 2017. Gross margin was 34%, up 2 percentage points year-over-year, driven by a higher overall mix of revenue from our Computing and Graphics segment and a richer product mix within that segment, due to Ryzen desktop processor sales. +Operating expenses were $364 million compared to $332 million a year ago. The increase is due primarily to R&D investments in Graphics and our server business. Net licensing gain from our server JV with THATIC was $27 million compared to $7 million a year ago. Operating loss was $6 million in the first quarter of 2017, a significant improvement from a $55 million loss a year ago. +First quarter net interest expense, taxes and other was $32 million, down from $41 million year-over-year, primarily due to a lower overall interest rate and a lower debt balance. Net loss was $38 million, or loss per share of $0.04 calculated using 939 million shares of common stock as compared to a net loss of $96 million or $0.12 a year ago. Adjusted EBITDA was $28 million, compared to adjusted EBITDA of negative $22 million from a year ago. +Now turning to the business segments. Computing and Graphics revenue was $593 million, up 29% year-over-year and down 1% sequentially. The year-over-year increase was primarily due to higher Ryzen desktop, CPU and graphics processor sales. The better-than-seasonal quarter-over-quarter decrease was due to lower mobile and graphics processor sales, largely offset by Ryzen desktop processor sales. +Computing and Graphics business segment operating loss was $15 million, a significant improvement from a loss of $70 million year-over-year, primarily due to higher revenue. +Enterprise, Embedded and Semi-Custom revenue was $391 million, up 5% year-over-year, primarily due to higher semi-custom SoC sales. Operating income was $9 million, down from $16 million a year ago, due primarily to higher server-related R&D investments, largely offset by an increase in the THATIC JV licensing gain. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $943 million at the end of the quarter compared to $1.26 billion at the end of 2016. The sequential decrease was driven primarily by the timing of sales and cash collections, debt interest payments and increased inventory. +Inventory ended at $839 million compared to $751 million at year-end in support of the ramp of new products and increased semi-custom SoC sales in the second quarter. +Long-term debt on the balance sheet was $1.41 billion, down from $1.44 billion at year-end, primarily due to debt reduction activities. The principal debt amount was $1.73 billion, down $34 million from the prior quarter as a result of debt reduction actions. +Turning to our outlook for the second quarter of 2017, which is a 13-week quarter. We expect revenue to increase 17% sequentially plus or minus 3%, non-GAAP gross margin to be approximately 33%, non-GAAP operating expenses to be approximately $370 million, licensing gain associated with our server JV to be approximately $20 million, non-GAAP interest expense, taxes and other to be approximately $30 million, and inventory to be down sequentially. +For 2017, we now expect revenue to increase low double-digit percentage from a year-over-year basis and CapEx to be approximately $140 million, including the capitalization of production mask sets beginning in Q1 2017. Additional 2017 guidance can be found in the CFO commentary document. +In closing, we remain focused on continuing to improve our financial performance on the strength of new product introductions, continued financial discipline and ongoing strategic investments in the business. I look forward to sharing further details on our longer-term prospects at our upcoming Financial Analyst Day on May 16. +With that, I'll turn it back to Laura. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, - [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready to begin the Q&A portion of our call. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Matt Ramsay from Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [2] +-------------------------------------------------------------------------------- + + Lisa, I wonder if you could spend a little bit more time talking about the Ryzen desktop launch, how you would characterize that it's gone so far? Maybe any kind of quantification you can give on revenue for the 1 month you had in the first quarter and then for the second quarter guidance? And then anything that might have limited sales in the quarter. We heard things about, shortages of motherboards from the SKU suppliers, et cetera. So any kind of additional commentary around the Ryzen launch would be really helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes, sure, absolutely, Matt. So, look, we're very pleased with how the Ryzen launch well -- went. It was a big launch for us. We did Ryzen 7 first in early March and then Ryzen 5 here in the middle of April. All of the feedback that we've gotten so far from both our customers and from end users has been very strong. I think the value proposition is very strong at both the Ryzen 7 8-core devices as well as the Ryzen 5 4- and 6-core devices. Relative to how it performed in the quarter, actually it performed as we expected. So with the global launch, we were reaching many distributors and many channel partners, and I think that's going well. We did see some early shortages in terms of motherboards, and that was our motherboard partners ramping their supply in line with our CPU supply. But that was really dissipated after the first couple of weeks. So nothing out of the ordinary there. So we feel really good about where it is. I think the important thing is as we go into the second quarter, we not only have the channel sales, but we also have the major OEMs that will be launching their systems in the second quarter. So I think that's the next piece of the Ryzen launch for us. But overall, I would say it went quite well. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - Principal and Senior Analyst [4] +-------------------------------------------------------------------------------- + + And just as my follow-up question, wanted to ask a little bit about gross margin. Lisa, you talked in your prepared remarks about as the new product roll out across the different parts of the company through the year that margins should expand. Yet your -- with a full quarter of Ryzen, you're guiding gross margin down slightly sequentially. I know the new gaming console business starts to ramp for the upcoming season in that quarter as well. So any kind of puts and takes around that gross margin? Because for some reaction I got from investors tonight that sequentially down gross margin surprised a couple of folks. So any clarification there would be helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. Absolutely, Matt. So if you look at our gross margin progression, given the mix of our business, clearly we made actually very nice progress year-over-year. So if you look at Q1 2017 compared to Q1 2016, we expanded margin by 2 points and that was really on the strength of Ryzen. When you look sequentially, because of the mix of our business, game consoles were at the lowest point in the first quarter, and there will be a ramp of game consoles going into the second quarter. So the relative mix of the business sees more game consoles in the second quarter relative to the first quarter. So that's the reason for the sequential guidance. But again, if you look year-on-year, Q2 '17 to Q2 '16, you see again a nice margin expansion as a result of the strength of the products. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [7] +-------------------------------------------------------------------------------- + + Wanted to follow up on the Ryzen launch, not only in the quarter, but also in the guide, and specifically, any color you could provide on the channel inventory, how that exited the quarter and what your plans are for adding or boiling down some of that inventory in Q2? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Yes, So, sure, Ross. So as we go into the second quarter, we certainly are adding both the Ryzen 5 in addition to the Ryzen 7. So if we look at the forward guidance, up 17% quarter-on-quarter, that is driven by additional Ryzen as well as the semi-custom ramp that I just talked about. We are early in the ramp. Everything that we see is -- we're getting a positive reception throughout the ecosystem and we're going to continue with go-to-market activities and, as I mentioned, the OEM components of that will kick in, in the second quarter. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [9] +-------------------------------------------------------------------------------- + + And I guess as my follow-up, 2 quick ones for Devinder. The inventory went up sequentially by about 11%, 12%. And you had an explanation for that, but if I recall right, you thought it'd be flat. So I'm just wondering what changed there? And then with the share count, I think as you approach breakeven, the share count might change. So any color you could give us on the share count going forward would be helpful as well. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [10] +-------------------------------------------------------------------------------- + + Why sure. And you're right about the inventory. The ramp of new products and especially the ramp of the semi-custom product revenue that Lisa just talked about was the main reason for the high inventory. We also had the opportunity in the quarter to put [those wafers] in Q1 ahead of Q2 sales and took advantage of the opportunity leading to the inventory at the $839 million. On the share count, you're right. As we go ahead and look at the share count on a basic share basis, we have 939 million, but there are 2 parts to it. If we were profitable, the warrants that we issued to Mubadala last year as part of the WSA, those get converted depending on the stock price, and that would be in there depending on profitability. And then the second thing is a convertible, obviously, as you know, how that works, is, if converted, then obviously those will be included in the share count, otherwise it will depend upon dilution or not, depending on the EPS. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [12] +-------------------------------------------------------------------------------- + + Perhaps a question for Lisa and one for Devinder. Lisa, can you talk about whether or not you're getting the right capacity and expected yields from your foundry as Ryzen launches? And for Devinder, as your customers take higher ASP processors in the game console business, I seem to remember when you originally launched, I thought that the -- maybe the initial yields or maybe the initial margins were not as good but the margins improved over time. And I'm wondering if, assuming I remembered properly, if that's something also we should be thinking about as your customers take the higher ASP game console processors? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Sure, Mark. So on your first question, relative to the margins and how those look, I think they are -- the yields are as expected, so both the 16-nanometer and the 14-nanometer have done really well. And so in terms of the new product ramp, the yields are as expected and per our margin structure. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [14] +-------------------------------------------------------------------------------- + + Yes, on the semi-custom, Mark, as far as the margins are concerned, you are referring to the operating margins, I think we're pretty pleased where we are. And it's a mix for us in terms of transition to some of the products, for example, the Sony PlayStation Pro that we launched sometime last year and obviously, the older game console that we launched in 2013. The ASPs do come down over time, although we are able to manage the cost down, too, and therefore, offsetting the ASP decline. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Yes, and, Mark, maybe just to finish off the comment. I think -- to your question, I think we feel pretty good about our cost structure. We're always going to continue to try to reduce the cost structure over time. But in terms of the margin expansion story as we go through the year, it's going to be about the mix of business. And as we get into the higher ASP, stronger product portfolio and that ramps to a larger piece of the business, that will be the margin expansion story. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question today is coming from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David M. Wong, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Technology and Services Analyst [17] +-------------------------------------------------------------------------------- + + Can you give us some idea of where Vega sits? Does it focus on the price points above Polaris? Or does it provide a refresh also within the lower price points where currently you have Polaris? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Yes, absolutely, David. So Vega is really a new architecture, so it is focused on the price point above Polaris. We expect Vega to be a broad product for us that will go across the gaming segment, the professional workstation segment as well as GPUs in the data center, and we will be launching products across all of those segments with the Vega architecture in the next couple of months. So the Polaris refresh for us is the RX 500 series that we launched just a couple weeks ago. And that is what we would use in sort of those mainstream price points in 2017. + +-------------------------------------------------------------------------------- +David M. Wong, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Technology and Services Analyst [19] +-------------------------------------------------------------------------------- + + Great. And could you give us any specifics on when in the second half you expect to launch notebook and desktop processors [within cores] and integrated graphics? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [20] +-------------------------------------------------------------------------------- + + Yes, so we are on track to launch the rest of the Ryzen portfolio in PCs. We'll launched Ryzen 3 sort of earlier in the second half, and then we will launch our Ryzen mobile towards the holiday cycle for the second half. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question today is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + For the first one, I'm a little surprised on the [CSG] business, you said -- I mean, sales were roughly flat, sequentially, give or take. You said Ryzen sales made up for seasonally lower GPUs in notebooks we have -- should have materially lower margins. I'm just amazed -- I'm just very surprised that the loss in the business barely got any better. Can you give us some indication for where Ryzen margins are today versus the product that they're replacing? And give us a little bit of color on why the CPU margins didn't actually get much better just given the ramp? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Yes, Stacy, maybe let me start and see if Devinder has some comments to add. I think certainly the rise in gross margins are substantially better than the legacy portfolio. So I think that is true. I think when you look at the sequential, there was 1% sequential decline, and there was a $7 million or $8 million sequential improvement in operating loss. There was also some additional R&D in that segment as we're ramping up both product expenses as well as some sales and marketing and go-to-market expenses in the quarter. Yes, so overall, it was as we expected. Maybe, Devinder, do you want to add to that? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [24] +-------------------------------------------------------------------------------- + + Yes, I think the other thing I would add, Stacy, is on the Ryzen piece of it. The ASPs are better, the margins are better. And as you can see from a segment standpoint, we made some pretty good progress year-over-year from a viewpoint of the operating loss getting better or the results getting better year-over-year from a segment standpoint. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + Got it. For my follow-up, I guess maybe it hints at the OpEx a little bit, but it looks like you're capitalizing your masks now. You took your CapEx side up by $60 million for the year. You went from $80 million to $140 million. Is that all the mask? And if so, were those mask costs actually in OpEx before? And if that's the case, have you actually taken your OpEx guide effectively up by $60 million for the year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [26] +-------------------------------------------------------------------------------- + + I think, 2 parts to it. First of all, on the mask piece, okay, you're right. The mask costs, as our product development becomes profitable, I think the mass costs have gone up. Especially with the latest technology, we went ahead and decided to capitalize the production mask set cost. From a geographic standpoint, the mask costs, but as they would have been an R&D previously, would be sitting in the COGS side of the P&L, and therefore, amortized in the COGS side related to the production of the unit. And the difference in the CapEx guidance, $80 million to $100 million, and $40 million is primarily the max costs. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Got it. So what does that mean for, I guess, how you guys are tackling gross margin now if they would have been directly in the COGS before, and now they're being capitalized over time? Is that a margin -- I guess, effective margin boost even though it's not anything on the cash side? And if so, I guess, the same question then, why are margins down this quarter? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [28] +-------------------------------------------------------------------------------- + + Well, I think margins, as Lisa said earlier, year-on-year, we're pretty pleased with the progress, 2 percentage points up. Q2 is a mix of the business, and then as we get to the end of -- to the second of the year, we'll see the full impact of, not just the Ryzen product, but also both Naples product that's coming up at the tail end of Q2, and then maybe into the second half of 2017. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [29] +-------------------------------------------------------------------------------- + + Yes, Stacy, maybe I just want to clarify because I want to make sure that we were clear. So the masks were in OpEx and now they're going to be capitalized as they go into production. So they weren't in COGS before. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + So you have effectively taken your OpEx up then, because it doesn't look like your OpEx is coming down by the same amount. So you're spending more? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [31] +-------------------------------------------------------------------------------- + + Yes, I think it really is a full year statement, and I think it's a recognition of, as we transition from 14-nanometer to 7-nanometer, 7-nanometer masks are substantially more expensive than 14-nanometer. So I don't think you can exactly put it the way you put it. But I think -- overall, I think what we're trying to do is basically, as the masks sets becomes more sizable on the production level to capitalize them. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ambrish Srivastava from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst [33] +-------------------------------------------------------------------------------- + + Yes, I actually wanted to just continue with the discussion on margins. So would the margin profile then as we exit the year, should we expect margins -- gross margins to trend up for the second half versus what you reported, i.e., or what you're guiding to, i.e., would that be the lowest point for the year? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [34] +-------------------------------------------------------------------------------- + + Yes, Ambrish, I think you should expect that we will expand margins as we go through the year. We do have this mix effect between semi-custom and new product revenue. But certainly, our exit velocity as we ended the year, we should see -- when you compare year-on-year sort of Q4 '17 to Q4 '16, you should see the margin expansion. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research and Senior Research Analyst [35] +-------------------------------------------------------------------------------- + + Okay, and then for my follow-up, in your full year guide, on the top line, now you're giving a -- you're quantifying it versus what you had before. I just wanted to get a little bit more clarity or to the extent you guys can share on the assumptions that you have baked in there for the various segments. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Yes, so the full year guide is low double-digit revenue growth, '17 to '16. I think, given our product portfolio being very much influenced by the PC -- the Ryzen in PCs, Vega for GPUs as well as Naples from a server standpoint, we expect that the Computing and Graphics segment will be -- will grow more so than the EESC segment overall on a year-over-year basis, just given some of the consumer markets move faster than some of the data center and server markets. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question today is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [38] +-------------------------------------------------------------------------------- + + Lisa, can you give us a sense of the introduction of Naples into the second half and next year? Is that going to reflect or be similar to what you're doing with the Ryzen 7 and then 5 and then 3? And I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [39] +-------------------------------------------------------------------------------- + + Sure. So look, we're really pleased with where we are with the Naples program right now. Overall, from a performance standpoint of the product and the customer engagements, it's going as we would expect. We will launch here in the second quarter. So we'll start some low-volume of revenue shipments here in the second quarter that will ramp gradually into the second half of the year. And so overall, I think that is how the server outlook will be. I think I have said before, and I did still say, that the server market has a longer design win to revenue conversion cycle. And so we would expect it to take a couple quarters for us to ramp the Naples product over time. And you should see a number of customers announcing with AMD platforms over the next couple quarters. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [40] +-------------------------------------------------------------------------------- + + Great. And then as a follow-up on the server side, what's the strategy in terms of positioning of the product? I mean, traditionally, in most cases, it's been more of, like, a me-too product at the low end of the market. What's the strategy here? If you can share that with us. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [41] +-------------------------------------------------------------------------------- + + Yes. So we believe we're highly differentiated with Naples in the sense that we have more cores, we have more memory bandwidth, we have more I/O than our competition. So for certain workloads, I think Naples is going to do very, very well, certainly, in the cloud as well as in certain HPC workloads and big data workloads that can use all of that memory and I/O bandwidth. We will be talking more about the positioning of Naples and the key workloads as we go through the next couple of months prior to launch. But certainly, we feel that it's, again, like Ryzen, on the strength of the Zen core, we have a very, very strong foundational product. And now it's about making sure that we help our customers get to market. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question today is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [43] +-------------------------------------------------------------------------------- + + Yes, guys, can you hear me? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Yes, John. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [45] +-------------------------------------------------------------------------------- + + Lisa, can you hear me? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [46] +-------------------------------------------------------------------------------- + + Yes, go ahead. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [47] +-------------------------------------------------------------------------------- + + Yes. Just quickly, Lisa, given that mix is now becoming quite important in trying to understand gross margin, I'd be kind of curious, what percent of your compute business in the March quarter was based on Ryzen? And I guess, if you assume that all of it transitions to Ryzen eventually, had that occurred in the March quarter, can you give us an understanding of how much better gross margins would have been? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [48] +-------------------------------------------------------------------------------- + + All right, John, that might be hard for me to answer very specifically. But let me give you the high-level view. So, look, we started selling Ryzen on March 2, and a good piece of it was basically for us positioning into the distributors. We take revenue on a sellout model, and so you should think about -- although we shipped a number of Ryzens, we didn't necessarily revenue them all in the quarter, just given that we're on a sellout model for our revenue recognition. In terms of where we are in the transition, Ryzen, non-Ryzen, we still have a long ways to go. I mean, the way you should think about it is Ryzen 7 was at the very high end. We're going to -- Ryzen 5 has started, we have Ryzen 3 that will come next and then we have the entire mobile portfolio as well. So it will take us through this year to really transition the majority of the product over to Ryzen. I think everything that we've seen, the ASP uplifts are definitely very beneficial. And so we're pleased with sort of the pricing that we're commanding for the product and the reception for the product. So I think it's just that it will take us a couple quarters to transition the overall portfolio over to Ryzen. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [49] +-------------------------------------------------------------------------------- + + Well, Lisa, as a follow-up to that, I know you guys are coming up with an Analyst Day next month and some of these targets might change. But to the extent that your old gross margin target was sort of 36% to 40%, I'm just kind of curious to what extent can you get to that sort of 38% midpoint just by moving your current market share mix towards Ryzen? And to what extent does getting to 38% or above imply either market share gains in the compute business on the desktop notebook side or on the server side? How do I think about that dynamic? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [50] +-------------------------------------------------------------------------------- + + So the long-term guidance at 36% to 40%, I think we have multiple ways of getting there. Certainly, on the PC side, it is not anticipating that we gain a significant amount of share over our historical numbers. So I think the idea on the PC side is, again, I think 2017, a large percentage of the margin story is around PCs. I think as you go into 2018, you'll see a larger percentage of that be in servers. But to the fundamental question, I think we feel good that the mix dynamics are there, the product is strong enough to command the right ASPs that we can get to the long-term margin target several different ways. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question today is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [52] +-------------------------------------------------------------------------------- + + Lisa, for my first one, back to Ryzen. When I look at your Q2 outlook, it's going up about $170 million or so sequentially. And when I look at the last few years, generally Q1 to Q2, just the console side, has gone up over $100 million or so. So is it fair to assume that Ryzen perhaps is contributing something in that $50 million, $60 million, $70 million? And if that is the case, how does that compare to your original expectations? Did they change throughout the quarter because of whatever pricing action [people] might have taken? Just that this $50 million, $60 million, $70 million, if this is right, is this a run rate number for Ryzen? Or how should we put this in the context of what Ryzen can be as it becomes a bigger part of your portfolio? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [53] +-------------------------------------------------------------------------------- + + Sure. So without commenting on the exact numbers between semi-custom and Ryzen, I think it's fair to say that the semi-custom business will have a reasonable ramp in the second quarter as will Ryzen. In terms of relative to our expectations, it's actually very close to our expectations of what we expected the ramp rate to be as we're going into this new segment. As I think I mentioned on one of the previous questions, we don't expect to be at peak run rate in the second quarter. I think we will be continuing to ramp Zen-based product in the PC business throughout the year as we bring more and more SKUs online. And so I think the second quarter is -- will certainly be higher than the first quarter, and I would expect the second half to be higher than what we're seeing in the second quarter, as we ramp more and more SKUs, as more OEM platforms come online. As you guys know, the PC business is -- it tends to be a very back-half loaded business. So as we get into back to school, the retail segments and holiday, you would expect that both channel and OEM PC sales to benefit from the stronger product portfolio. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [54] +-------------------------------------------------------------------------------- + + Got it. And as my follow-up, how do you feel about the PC gaming market for this year? I know just near term, there have been some concerns about excess-GPU inventory in China. Have you -- are those concerns based on fact? Or are they just perception? And have you seen anything abnormal in the demand or supply for PC-GPU product, in any region or any customer segment? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [55] +-------------------------------------------------------------------------------- + + Yes, on the GPU side, we actually haven't seen anything abnormal. We normally see the seasonality going from the Q4 to Q1, that sales go down. We saw something very normal to that. From an inventory standpoint, we think it's normal to maybe even slightly lean because we were going through a transition from our 400 series to 500 series. So we see the gaming segment as healthy. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [56] +-------------------------------------------------------------------------------- + + And any comment for the full year? Last year -- last, actually, couple of years have been quite strong in PC gaming. I know you probably may not quantify it, but just how do you feel about the overall PC gaming market? Do you think the trend persists in terms of both unit and pricing expansion this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [57] +-------------------------------------------------------------------------------- + + Yes. From what we see, I think we feel good about the gaming segment overall. Graphics continues to be a strong segment. For, us it's not just a channel business, but it's the ramp of our OEM business. So we have a number of new OEM systems that are also ramping here in the first half of the year. As it relates to ASPs, we are excited with the launch of Vega that will see a significant improvement in our ASPs, just given our current presence in the high-end segment of the GPU market. So yes, overall, I think we feel good about the market. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our next question today is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [59] +-------------------------------------------------------------------------------- + + Actually 2 related ones. Just wanted to go back to the OpEx in terms of, not only is it up sequentially but then you're getting extra from the move of the mask sets. Can you just talk about where that OpEx dollars are going? And if it's, in fact, servers, can you just talk about the spend required to get at the market? And then just I wanted to clarify on the expense, it should hit gross margin, but can you just talk about 7-nanometer as a whole and timing as those would come through? Is it a back -- is the CapEx back-end loaded when you're doing the $140 million? And then just talk about the impact to the gross margin with the higher 7-nanometer spend now hitting gross margin. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [60] +-------------------------------------------------------------------------------- + + Yes. Maybe let me start on the OpEx and then have Devinder comment on the second piece of the question. So on the OpEx, we are making targeted investments in several different areas. The key areas are in GPUs and server. And it's both on the R&D side as well as on some go to market. So from our standpoint, these are very strong products. We want to make sure that we have enough customer resources to help our customers ramp into production. So I think they're targeted investments, but as we've been in the past, we'll be very prudent with where the OpEx goes. And then relative to the... + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [61] +-------------------------------------------------------------------------------- + + I think the CapEx, you asked about the front end -- back end. I think it's pretty balanced. Maybe it's about $40 million, $60 million, first half, second half to $140 million, but it's pretty balanced. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [62] +-------------------------------------------------------------------------------- + + Then just in terms of the impact to the gross margin as the mask sets roll through? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - CFO, SVP and Treasurer [63] +-------------------------------------------------------------------------------- + + They're all contemplated. I think we've had a lot of discussion on the gross margin improvement year-over-year and sequentially. And Lisa has referenced about improving gross margins as we go through the year and the move of the other expenses from the OpEx side related to the mask costs capitalization to the COGS side of it, which impacts gross margin, is all contemplated in that gross margin improvement. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Our next question is coming from Joseph Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [65] +-------------------------------------------------------------------------------- + + I wonder if you could talk about what the CPU mix looks like over the course of the year. And you've talked a lot about the Ryzen ramp, but what's happening to the older products? Do you see a long tail on that? Or is there a coexistence between the 2 product portfolios? Or are you sort of rotating everything to Ryzen on a faster basis? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [66] +-------------------------------------------------------------------------------- + + Yes. So, Joe, the way to think about that is for the Ryzen 7 and a good portion of the Ryzen 5, we really didn't have a competing product in that segment, so it's really additive. I mean, we've actually added [SAM] to our CPU market coverage. The legacy products will continue in the market. They would certainly continue through this year, and that's all contemplated in the model. So we feel that they're very complementary products. And different geographies move at different rates. We have still a significant installed base of motherboards out there from our previous generation, so we'll keep supporting both products. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [67] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. And then as you've talked about getting better Ryzen penetration over the course of the year, how do you think about Intel's new products in the back half? And you know, they've talked about sort of a 15% performance per clock improvement on their new 14-nanometer product. Is that contemplated in your guidance? And how are you thinking about the Ryzen products stacking up against that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [68] +-------------------------------------------------------------------------------- + + Yes. So we're very pleased with where the Ryzen product is positioned now. We think, from a value proposition standpoint, performance, performance per dollar, it's very strong. We obviously have -- other products are -- we're going to be launching throughout the year to ensure that we have strong product positioning throughout the year. And I think the more important thing, Joe, and we'll talk more about this at our Financial Analyst Day, is we have a long-term road map, whether you're talking about PCs or GPUs or servers, to ensure that we continue to refresh our product plans and our product road maps over time. So I think we feel good about where we are positioned today and we're going to ensure that we continue to roll out products to strengthen that positioning over time. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Our final question today is coming from Chris Rolland from Susquehanna. + +-------------------------------------------------------------------------------- +Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [70] +-------------------------------------------------------------------------------- + + I wanted to ask about the staggered launch to the major PC OEMs. Was that like just a modest supply constraint on the rollout? Or if not, then why not just launch to the enthusiast and the major PC OEM market together? And do you plan to do the same on Ryzen 5 and 3? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - CEO, President and Non-Independent Director [71] +-------------------------------------------------------------------------------- + + Yes, Chris. So there was no particular supply constraint. I think it's more of the ebb and flow of the market. When you think about the channel market or the DIY market, you can basically introduce your product any time during the year. The OEMs have a very set cycle. They typically launch new products in Q2 for the back-to-school season, and so that was just the timing of when the OEM platforms were ready. And then again, when you're launching so many different SKUs, I think launching Ryzen 7 first, then Ryzen 5, then Ryzen 3 was absolutely our plan to make sure that we hit all of the logistics and stuff on plan. But overall, like I said, nothing different than what we expected. I think we're pleased with where -- the overall launches, and we'll be rolling out many more products over the coming quarters. + +-------------------------------------------------------------------------------- +Laura Graves, - [72] +-------------------------------------------------------------------------------- + + Thank you, Lisa. Thanks, everybody. And thank you to everyone on the call who joined us today. We look forward to speaking with you again. As a reminder, our Financial Analyst Day will be Tuesday, May 16, at our corporate headquarters in Sunnyvale. We look forward to speaking with you again. Thank you. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Thank you. That does concludes today's teleconference. You may disconnect your line at this time, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2017-Oct-24-AMD.txt b/Transcripts/AMD/2017-Oct-24-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..74dcd1712abf0b710881d3c379b6d8c8f8f8b184 --- /dev/null +++ b/Transcripts/AMD/2017-Oct-24-AMD.txt @@ -0,0 +1,586 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Advanced Micro Devices Inc Earnings Call +OCTOBER 24, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + - + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Tristan Gerra + Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Wayne Loeb + - + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Kulin Patel + BMO Capital Markets Equity Research - Associate + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Matthew D. Ramsay + Canaccord Genuity Limited, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to Advanced Micro Devices Third Quarter 2017 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Laura Graves. Please go ahead. + +-------------------------------------------------------------------------------- +Laura Graves, - [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Third Quarter 2017 Conference Call. By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. +Participants on today's call are: Dr. Lisa Su, President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on amd.com. +I would like to highlight a couple of important dates for you. Lisa Su will present at the Crédit Suisse 21st Annual Technology, Media and Telecom Conference on Tuesday, November 28, and our fourth quarter quiet time will begin at the close of business on Friday, December 15, 2017. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date, and as such, involve risks and uncertainties that could cause actual results to differ materially from our expectations. +Additionally, please note that we will be referring to non-GAAP financials during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary posted on our website at quarterlyearnings.amd.com. Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors in our filings with the SEC and in particular, AMD's quarterly report on Form 10-Q for the quarter ended July 1, 2017. +With that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. Q3 was a strong quarter for us, demonstrating the significant growth potential of AMD, driven by our high-performance products, leadership IP and long-term strategy. +Revenue increased 26% from a year ago to $1.64 billion. Gross margin also improved significantly year-over-year as we achieved profitability and generated positive free cash flow in the quarter. +Looking at our Computing and Graphics segment, we made excellent progress in Q3 as the continued success of our Ryzen family of CPUs, combined with significant graphics growth, resulted in a 74% increase in Computing and Graphics segment revenue year-over-year. +Client computing revenue increased by a strong double-digit percentage from a year ago as we expanded our Ryzen processor family and saw increased demand in the desktop market. Ryzen 5 and Ryzen 7 processors have ramped well in the desktop channel market, reaching 40% to 50% desktop market share at strategic e-tailers worldwide. In addition, OEM adoption is accelerating as customers ramp shipments in advance of the holiday sales cycle. +In the quarter, we launched additional Ryzen CPUs, including Ryzen 3, expanding our reach in the mainstream and value market segments; Ryzen Threadripper processors, returning AMD to the high-end desktop market; and Ryzen PRO-based offerings, which have been adopted by all major commercial PC providers, including Dell, Lenovo and HP, expanding our presence in the commercial space. +Also in the quarter, we qualified and began early shipments of our Ryzen Mobile processors, combining our Zen CPU cores and Vega GPU cores in a high-performance APU designed to power ultra-thin and 2-in-1 notebooks. Acer, HP and Lenovo plan to launch their initial Ryzen Mobile-based systems in the coming weeks, and we expect an expanded assortment of premium notebooks to launch in Q1 2018. +In graphics, we achieved record GPU revenue in the quarter based on significantly improved ASPs and higher unit shipments from a year ago. These financial improvements were driven by the launch of our Vega-based GPUs and its strong demand for our Polaris products across both gaming and blockchain markets. In the quarter, we expanded further into premium portions of the graphics market with new consumer and professional GPU solutions. Our Radeon RX Vega family of GPUs launched in the channel, targeted at the enthusiast class gaming segment. Revenue from initial shipments of these products is significantly outpacing previous premium Radeon GPUs. +Radeon Instinct MI25, our GPU compute solution, also began shipping in volume to mega cloud data center customers, and Radeon Pro WX 9100 professional graphics cards, targeting the high-end professional content creation market, started shipping late in the quarter. In addition, we saw expanded AMD Radeon adoption with cloud customers in the quarter, driven by our investments in GPU compute. Amazon Web Services announced that they have deployed AMD Radeon Pro technology to power Amazon AppStream 2.0, driving GPU-accelerated cloud delivery of virtual applications. We also announced a collaboration with Baidu to build more flexible and powerful AI computing platforms based on the deployment of our Radeon Instinct GPUs in their data centers. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue was approximately flat year-over-year and increased 46% sequentially. Sequential growth was based on a seasonal increase in semi-custom revenue as well as growth in server revenue from our EPYC data center processors. Our semi-custom business continues to perform as expected for the year, and we anticipate seasonal demand to remain healthy as our customers enter the holiday sales cycle with Sony's PlayStation 4 Pro and Microsoft's Xbox One X. +In our server business, the server revenue increased from a year ago as we began ramping sales of our EPYC data center processors to key cloud and OEM customers. Customer engagement with our EPYC processors is growing as the true performance and features of the new platform are tested and implemented, with Tencent and JD.com joining the list of data center customers planning to deploy EPYC processors. +In a short period, 3 of the Super 7 mega data center providers have publicly announced plans to deploy EPYC-based products into their Hyperscale environments, including Baidu, Microsoft Azure and Tencent, and we have strong engagements with other major cloud providers. In addition, HP Enterprise and Dell are in the process of bringing their first EPYC-based platforms to market in Q4, and we are actively engaged with them to accelerate testing and validation of EPYC-based systems in data centers across a broad number of large and medium enterprise customers. We remain confident and focused on the steady expansion of our data center presence over the coming quarters based on the high performance and rich feature set of the EPYC product. +In addition, as a part of our ongoing strategy to monetize our differentiated IP, we successfully closed a patent licensing transaction in the quarter. +In closing, we are very pleased with our third quarter results. Throughout 2017, we have delivered significant year-on-year revenue growth and margin expansion as we achieved multiple major product, customer and market milestones. As we head into the final quarter of the year, we look forward to continuing to accelerate our business. 2017 annual revenue growth is now tracking above our previous estimates, and we remain confident in our ability to make AMD one of the premier long-term growth companies in the tech industry. +Now I'd like to turn the call over to Devinder to provide some additional color on our third quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. I'm pleased with our performance for the third quarter of 2017. We increased revenue 26% year-over-year, expanded gross margin and achieved both operating and net income, with net income of $110 million and diluted earnings of $0.10 per share. We are executing well with our strongest portfolio of products in many years, including our Ryzen, EPYC and Radeon Vega offerings. Let me provide some specifics for the third quarter. +Revenue of $1.64 billion grew 26% year-over-year and 34% sequentially. This is our highest quarterly revenue since the fourth quarter of 2011. Year-over-year growth was primarily due to our Computing and Graphics segment, while sequential growth was driven by the Enterprise, Embedded and Semi-Custom segment revenue seasonality as well as higher Computing and Graphics segment revenue. We also took another step in our IP monetization efforts by closing a patent licensing agreement that had a positive impact on both our segments. +Gross margin was 35%, up 4 percentage points year-over-year, primarily driven by the benefit of IP-related revenue and a richer mix from the Computing and Graphics segment, which were partially offset by cost associated with our GLOBALFOUNDRIES Wafer Supply Agreement for wafers purchased at another foundry. We continue to make good progress on the ramp of our new high-performance products, which had a positive impact on our gross margins. +Operating expenses were $419 million compared to $353 million a year ago. The increase was primarily due to higher R&D-related investments and expenses related to annual employee incentive programs driven by our better financial performance. Operating income was $155 million in the third quarter of 2017, a solid improvement from $70 million a year ago. Third quarter net interest expense, taxes and other was $45 million, up slightly from $43 million a year ago. Lower interest expense from a year ago was largely offset by withholding taxes for licensing revenue. +Net income was $110 million or diluted earnings of $0.10 per share as compared to $27 million or $0.03 per share a year ago. The diluted earnings per share calculations for the third quarter of 2017 was based on 1.143 billion shares, which includes 100.6 million shares related to our 2026 convertible notes. Adjusted EBITDA was $191 million, compared to $103 million a year ago. +Now turning to the business segments. Computing and Graphics segment revenue was $819 million, up 74% year-over-year, primarily due to strong sales of our Radeon graphics and Ryzen desktop processors. Computing and Graphics segment operating income was $70 million compared to a loss of $66 million a year ago. The solid improvement was primarily due to higher revenue. +Enterprise, Embedded and Semi-Custom revenue was $824 million, approximately flat year-over-year due to lower semi-custom SoC sales partially offset by IP-related revenue. Additionally, server revenue increased from a year ago driven by the increased sales of EPYC products. As you heard earlier from Lisa, customer interest and deployment plans are strong. Operating income was $84 million, down $52 million from $136 million a year ago, primarily due to higher costs. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $879 million at the end of the quarter, up from $844 million in the prior quarter, primarily due to higher revenue. Inventory at the end of the quarter was $794 million, down 5% from $833 million in the prior quarter. +Long-term debt on the balance sheet was $1.36 billion. Total principal debt, including our secured revolving line of credit, was $1.74 billion. In the third quarter, we used $28 million from our lower interest secured revolving line of credit to pay down long-term debt, which has a higher interest rate. Free cash flow was $32 million compared to $20 million in the year-ago period. +Before turning to our outlook for the fourth quarter of 2017, which is a 13-week quarter, let me remind you for comparative purposes that the fourth quarter of 2016 was a 14-week quarter. For the fourth quarter of 2017, we expect revenue to decrease approximately 15% sequentially, plus or minus 3%. At the midpoint, this equates to revenue growth of approximately 26% year-over-year; non-GAAP gross margin to be approximately 35%; non-GAAP operating expenses to be approximately $410 million; non-GAAP interest expense, taxes and other to be approximately $30 million; and inventory to be down sequentially. We now expect 2017 annual revenue to increase by greater than 20% over 2016 compared to the prior guidance of mid- to high-teens percentage growth. We do not anticipate significant changes to the diluted share count in the fourth quarter, and you can find additional information regarding the share count in the CFO commentary, which is posted online. +In closing, the third quarter was a strong quarter, and we are pleased with the momentum of our new premium products. We are making solid progress towards our growth and margin expansion objectives, and as our financial performance improves, we remain committed to investing in our multi-generational road maps and achieving our long-term financial targets. +With that, I'll turn it back to Laura for the Q&A session. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, - [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + For the first one, I was wondering if you could help quantify the benefit of your IP license in the 2 different segments. And is this a one-off? Or do you see ongoing benefits in Q4 and beyond? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure, Vivek. Hey, thanks for the question. We did close a IP-related transaction. It was a patent licensing transaction. The revenue and benefit was spread over both segments. When we look at it going forward, we have a pipeline of IP deals, and we're constantly looking at them. And from our standpoint, we're working several deals in progress. So we believe that IP-related revenue will be a factor as we go forward, but our primary focus is on the product-related revenue and the product-related growth. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + So Vivek, just to remind you, I mean, in line, you've heard us talk about our IP monetization efforts, and this is very much in line with that. And as Lisa said, the benefit is spread over both segments. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [5] +-------------------------------------------------------------------------------- + + Got it. And then for my follow-up, Lisa, when I look at your Q4 outlook, it's sort of in line with seasonality, perhaps somewhat better. Can you give us some more color around the adoption of your -- the new Ryzen Mobile portfolio, but more importantly, your EPYC products? When will we start to see a more tangible contribution from your EPYC product sales? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [6] +-------------------------------------------------------------------------------- + + Yes, absolutely, Vivek. So look, we are very pleased with how the revenue ramp is going in general on our new products. When you look at the Q4 guidance, year-over-year, we'll be up 26%, so we're really accelerating the business as we go into the second half of the year. As you know, our business is typically seasonal. And so Q3 is the peak, and then we're down seasonally from Q3 to Q4 due to some of the semi-custom revenue. But what we see going into the fourth quarter is we see a strong ramp of new products. We see Ryzen continuing to ramp. We will ship volume of Ryzen Mobile in Q4 and then more in the first half of the year. We will see a ramp of EPYC, and we will also see an OEM ramp of Vega. In terms of the headwinds, we have the semi-custom seasonality, and we're also predicting that there will be some leveling off of some of the cryptocurrency demand. As we look at it, it continues to be a factor, but we've seen restocking in the channels and stuff like that. So we're being a little bit conservative on the cryptocurrency side of the equation. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Next question is coming from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [8] +-------------------------------------------------------------------------------- + + Can you give us some idea of whether you have any semi-custom wins that might bring in new revenue streams in 2018? And specifically, are you in any discussions with potential customers for semi-custom designs in autonomous driving or data center processor and accelerator applications? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [9] +-------------------------------------------------------------------------------- + + Yes, sure, David. So look, the semi-custom business continues to be a business that's performing well for us. So we are -- as we go into 2018, we are expanding the customer set beyond our traditional Sony and Microsoft game consoles. Actually, this past quarter, we announced that Atari will be adopting a customized processor for their next generation. We also have a number of new opportunities that we continue to work, and they are in markets outside of game console, including some of the markets that you mentioned. So overall, we do expect there will be some puts and takes in the semi-custom business as we go into 2018 and there will be some product revenue that will ramp, particularly in the second half of 2018. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [11] +-------------------------------------------------------------------------------- + + First one on the gross margin outlook for Q4, it looks like it's flattish versus Q3, and I guess I might have expected the -- a sequential increase given that you will likely have a better mix. So I'm hoping you can reconcile that. I'm wondering if licensing had an impact on that or it's just fixed cost absorption. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [12] +-------------------------------------------------------------------------------- + + Yes. Let me start, Mark, and then maybe Devinder will add. So look, we have multiple puts and takes in the business as we look at gross margin. When we look at gross margin in Q3, we were pleased with the gross margin progress, and that came from both the richer mix of our Computing and Graphics revenue year-over-year as well as some benefit from the IP-related transaction. As we go into Q4, we have new products continuing to ramp, so you'll see Ryzen, Vega and EPYC ramp. And the primary driver for the Q4 gross margin is the product revenue, and we do have sort of the headwind of not having the benefit of the IP revenue in Q3. So those are the puts and takes. But the main point is the new product revenue is ramping and the gross margins are accretive, and that's contributing to our Q4 gross margin outlook. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [13] +-------------------------------------------------------------------------------- + + Yes. Mark, if you can -- if I can just add, if you look at the margin trend compared to 2016, 2016, we had 31% gross margin and we expect to be at 34% this year, and that's primarily based on the strength of the new products that Lisa referenced. And from a long-term model standpoint, we are on track with what we laid out in the Financial Analyst Day of going from 31% to 34% and then expecting to be greater than 36% in 2018 on the strength of the new premium products that are ramping into 2018. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [14] +-------------------------------------------------------------------------------- + + And a follow-up, if I may, on the EPYC server side. Can you help us understand to what extent you're shipping to customers who are going through testing right now versus shipping into customers who are actually deploying EPYC in live data center applications? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Yes, absolutely, Mark. So look, we're pleased with how things are going with the EPYC ramp overall. So we have been shipping to both cloud as well as non-cloud customers in Q3, mostly early platform type testing. In Q4, we will -- we expect to see some level of deployment, again, both in cloud and non-cloud applications. With the new platforms coming in from HP Enterprise and Dell, what we're seeing is actually a ramp of new seeding opportunities, particularly in medium and large enterprise customers. So overall, the EPYC ramp is going well, and we expect more deployments as we go into Q4 and into next year. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is coming from Ambrish Srivastava from BMO. + +-------------------------------------------------------------------------------- +Kulin Patel, BMO Capital Markets Equity Research - Associate [17] +-------------------------------------------------------------------------------- + + This is Kulin Patel calling in for Ambrish. You highlighted in your PR that you had a GM headwind related to buying wafers at another foundry. Do you expect any meaningful external purchases in Q4 or going forward into 2018 that could be a headwind to gross margins? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [18] +-------------------------------------------------------------------------------- + + I think the way I look at that is, if you look at Q3 from a volume standpoint and the volume is pretty high, and that's why it's highlighted from a viewpoint of the cost, the way you want to look at it going forward, Q4 and beyond, is all of the costs are related with the WSA that's referenced in the script. So it's contemplated within our guidance and our long-term models. + +-------------------------------------------------------------------------------- +Kulin Patel, BMO Capital Markets Equity Research - Associate [19] +-------------------------------------------------------------------------------- + + And I had a question on -- you launched the Radeon Instinct MI25 [maybe] last quarter. Can you discuss the traction you're seeing in that product? Are you seeing any meaningful revenues in 3Q and in your 4Q outlook? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [20] +-------------------------------------------------------------------------------- + + Yes. So the Radeon Instinct MI25 is Vega for the cloud data centers. We did actually start shipping volume in Q3 to multiple customers. We do see very high interest in the product portfolio, and so we expect that to continue to ramp into Q4. And there's a lot of focus on increasing the software usability and software flexibility, and so we continue to invest in those areas. But overall, I'm actually very pleased with the interest in MI25, and it's coming from multiple customers in a number of markets. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [22] +-------------------------------------------------------------------------------- + + I was interested in your comments that the sequential growth in the Computing and Graphics business was driven primarily by graphics. How literally should we take that? And I guess, if graphics is up close to $150 million sequentially, is that business now on par with the CPU business? Can you just give us a general sense of the size of the 2 businesses there? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Yes. So overall, the growth in Computing and Graphics, when you look over the past few quarters, has been very strong. And we've seen growth both on the Ryzen side, particularly in the desktop side of the business, as well as on the graphics side. So in terms of size of the business, again, I think we stated in the prepared remarks that the GPU business had a record quarter for us, and we're seeing very strong growth. We're seeing strong growth as a result of the new product launches. So the Vega product actually did very well for us in the quarter as well as overall Polaris in both gaming and blockchain markets. But yes, we're pleased with the graphics performance. But I'll also say, Ryzen did very well in the quarter. We look at the progress that we're making in the desktop channel when you look across retailers and e-tailers across the world and in the sort of Ryzen 5 and Ryzen 7 segment, we're seeing significant share gain in those parts of the business. So I think both parts of the Computing and Graphics business are doing well, and we continue to expect growth as we go forward. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [24] +-------------------------------------------------------------------------------- + + And is it possible to size the blockchain portion of that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + I think the blockchain tends to be -- again, it's hard to separate because it goes through some of the same channels as gaming does. I will say that blockchain sort of behaved as we expected in Q3, so we didn't see anything that we didn't expect. We did see some benefit of channel restocking, so if you look at the -- our channel inventories today compared to July, we have healthier channel inventory levels. And we expect that consumer blockchain will level off a bit as we go into Q4, but there's also a commercial blockchain component that we believe is interesting and likely to continue into the medium term. As we look into Q4 though, we also see growth from just the OEM side of the GPU business as we start ramping Vega into OEMs. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [27] +-------------------------------------------------------------------------------- + + Lisa, apologize, I'm kind of juggling a couple calls like everyone else. I apologize if this is a repeat. But I'm just wondering, just given the qualitative success of Ryzen and the accretive ASPs and gross margins, I'm wondering if you could just help us understand, on a more quantitative basis, how much of your PC unit business is now Ryzen. And I guess, more importantly, how do we think about that progressing over the next several quarters? And kind of where's the tipping point where you think we'll start to see some significant leverage relative to the accretive ASPs and the accretive gross margins? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [28] +-------------------------------------------------------------------------------- + + Yes, absolutely, John. So look, we are really pleased with how Ryzen is performing competitively and -- in the market. It's fair to say, though, that we're still at the early stages of the Ryzen ramp, so primarily in Q2 and Q3, Ryzen has been a desktop channel phenomenon. So most of the sales have been in the desktop channel. We have started ramping OEMs in the desktop space, and we will continue ramping OEMs as we go into Q4. But it's nowhere near the majority of the client revenue. You should expect that Ryzen will continue to ramp for us through the first half of next year because we're adding more and more platforms as we speak, both on the consumer and also on the commercial front. And -- so we see -- again, it's ramping well. The ASPs are good, so actually, we saw some ASP increase in Ryzen as we went from Q2 to Q3, and we launched the high-end desktop version as well as Ryzen 3. And we'll continue to ramp into Q4 and first half of next year. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [29] +-------------------------------------------------------------------------------- + + And then, Lisa, just as my follow-on, kind of a similar question around EPYC, and just I know you guys have kind of talked about potentially exiting the end of next year at about a 2% share. I'm just kind of curious how you think about the ramp of EPYC. And if you can differentiate between sort of your Hyperscale customers who might take it a little bit sooner versus more the -- the more traditional OEM channel, how should we be thinking about that on EPYC? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- + + Yes. So John, I'm not sure we ever said 2% by the end of next year, but what I would say is that we expect EPYC to be a sizable portion of our revenue in 2018. So the second half of this year, we're doing early pilots and we're doing some early deployments. The Hyperscale guys are aggressive, and they are first. We will start seeing some enterprise revenue here in Q4 as the early platforms launch, but I expect more of the enterprise to fill in as we go into 2018. And I think the important point is, as we look at the product, as we look at the competition and where we're positioned, the product positioning is strong, and so the customer engagements are growing. And we're seeing significant interest from enterprise customers ramp now as some of the OEM platforms are becoming available and starting their seeding. So overall, EPYC will continue to ramp into 2018 and should be a sizable -- we expect it to be a sizable portion of our revenue in 2018. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [32] +-------------------------------------------------------------------------------- + + I want to go back to the mix of the business and specifically in the Computing and Graphics segment. The client ASPs were down sequentially, and you highlighted that being because of mobile. Somewhat similar to John's question, Lisa, when do you expect to see the ASPs in that segment of your business start to turn to be a positive driver as opposed to a bit of a headwind? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [33] +-------------------------------------------------------------------------------- + + Yes. So definitely, desktop ASPs are up. Mobile ASPs are down. I think we will see -- again, there will be an initial ramp of Ryzen Mobile in Q4, but I think in the first half of the year, you should see a significant amount of the volume that we ship into notebook be with Ryzen Mobile. So when I look at sort of the rate and pace of the ramp, I think it's going as we expect with desktop channel first, then desktop OEMs and then commercial desktop and then, same, consumer notebook starting in Q4, ramping into Q1, and then we'll see commercial platforms in the first half of '18 as well. So I think there should be a steady ramp of ASPs as we go forward. We're also taking some opportunity, as you can imagine, to clean up some excess inventory as we transition to the new product, and so that's part of what we're doing to just ensure that we have a strong launch as we go into the new product portfolio. But overall, behaving as we expected and in some sense, we're very pleased with how we're positioned competitively with the product. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [34] +-------------------------------------------------------------------------------- + + And I guess, as my follow-up, switching to one for Devinder on the OpEx side of things. OpEx was a little bit higher in the third quarter. It's dropping sequentially into the fourth quarter. You've talked in the past about a 31% OpEx to revenue guide range for this year. You're probably not going to guide for '18 by that much -- with that much precision tonight. But is there any sort of puts and takes we can think of as far as how you guys are considering your investment philosophy as we move into 2018? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [35] +-------------------------------------------------------------------------------- + + No. I think the first thing I'll say is we do want to invest in the business, especially with the growth of opportunities we have and primarily targeting the OpEx investments towards R&D. They are -- in the current moment, there's a lot of products ramping just in the last few months. You heard about the Ryzen ramp. You heard about EPYC. We talk about Vega, and obviously, their go-to-market costs will ramp up new products. But as far as our 2017 guidance is concerned, I have said previously 31% has potential of revenue, but I think right now where the numbers are coming out, especially with the strength of the revenue side of the equation, we think we end up at about 30% on an expense-to-revenue ratio in 2017, of which you -- as you probably recall, is at the upper end of what we are setting of a long-term target model, which is 26% to 30%. So actually, I'm pretty pleased because, if all else, if everything works out in the Q4 guidance that we gave and in 2016 would have been a 32% of revenue, in 2017, approximately 30%, and then obviously, we'll see where we get into 2018 but very pleased from a viewpoint of being able to make the investments in the business to support the product road map, the go-to-market cost for the ramp of new products and at the same time, bring down the percentage of OpEx over revenue. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question is coming from Matt Ramsay from Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - MD [37] +-------------------------------------------------------------------------------- + + Lisa, I wanted to ask a little bit about the forward road map, particularly in the processor group. I know that you guys have talked quite a bit about taking the road map down to 7-nanometer next year, and I think Mark gave some public comments about doing some stuff on 12-nanometer with GF. So I think it'd be helpful if you could talk to the extent that you can about some of the feature road map and things that might be follow-on to the products that are ramping currently. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [38] +-------------------------------------------------------------------------------- + + Yes, absolutely, Matt. So 7-nanometer, we've talked about, is a very important node for us, and it's an important node for the industry. It's a major node, so we have a lot of engineering resources on that. And you should expect that, that will be across all of our businesses, and we're actively working on those products now. We do see an opportunity with 12-nanometer. 12-nanometer is a relatively small engineering lift, and I would view it as a performance enhancement to our current road map. And so we are working, taking some of our products -- I would say, a subset of our products into 12-nanometer in 2018 to augment the performance of our client and graphics road map. But I think the significant resources are on 7, and that's progressing well. We're overall pleased with how the performance on that is looking, and then we will opportunistically look at some products to go into 12-nanometer as it makes sense for the road map. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - MD [39] +-------------------------------------------------------------------------------- + + And Devinder, I wanted to press a little bit harder on the gross margin impacts of a few things that you called out, particularly -- I mean, is there any way that you can quantify for us at all the impact of the IP revenue on gross margins either in the third quarter or comparatively into Q4? And second, I think a lot of us are aware of the forward charges you'll get for using wafers from other foundries, but I assume that, that applies also to the gaming console business that comes out of TSMC currently. If you could clarify those 2 things, that'd be great. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [40] +-------------------------------------------------------------------------------- + + Yes. I think if you look at it from an overall standpoint, if you look at the cost impact, it's all within our guidance. I think if you look at IP from that standpoint, we have several IP deals in the pipeline. For Q3 specifically, we thought it was likely that we would be able to close an IP-related deal in the quarter, and that's how it turned out. And you see the benefit across both the segments. And from a go-forward standpoint, despite the costs being there, we look at it overall from a viewpoint of the trend of the margin. Major provider of the gross margin uplift is the premium new products that we are launching. And then, obviously, there's opportunities from an IP standpoint to benefit the P&L, we go ahead and put that in the equation. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [42] +-------------------------------------------------------------------------------- + + I just want to better understand the December guidance a bit, maybe if you can talk about it between the 2 segments. The Embedded business last year was down 40%. It's been tracking down slightly year-over-year. So is that the right way to think about that segment this December? And then maybe you can talk about on the graphics side. I just want to understand the commentary. You said that crypto or blockchain was kind of flattening out and that you were kind of getting some restocking. Just to kind of understand, when you look at growth in that segment, what are the moving pieces? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [43] +-------------------------------------------------------------------------------- + + Yes. So Blayne, let me answer that question. So overall, I think our business does have the seasonal pattern where the Q3 is a peak, and we're down in Q4 primarily due to the semi-custom business. I believe those dynamics are the same. I've -- we've looked at sort of how the business will perform on a year-over-year basis. We believe that semi-custom revenue will be down a little bit on a year-over-year basis, and that's expected. We're in the fifth year of the cycle, and you would expect that units to be down, although we have some positive mix because of the new launch of the Microsoft Xbox One X console, which is a higher ASP product for us. When you look at the graphics business, again, overall, we see the business as quite strong. We see Vega ramping as we go into Q4. We see that from an OEM ramp standpoint. We see that from a GPU compute standpoint, and that's offset with a little bit of leveling off of the blockchain demand. But overall, I think we see sort of Computing and Graphics continuing to grow as we go into Q4. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + And then just maybe a second question following up on some of the questions on process node. You had high reuse with the server product this time. When you see -- how do you think about the R&D cost in terms of if you were doing a core at TSMC versus doing one at GLOFO, a dual track? As you look into '18, how should you think about the OpEx required to do that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [45] +-------------------------------------------------------------------------------- + + Yes. So it's part of our engineering model. So we've -- we sort of engineered a model where we can use our IP at multiple foundries, and that will continue as we go into 7-nanometer. So if you look at this year, we have multiple products in 16-nanometer and 14-nanometer. As we go into 2018 and beyond, it's the same thing. So there are no additional costs related to our dual-sourcing strategy. I think from an overall R&D standpoint, as Devinder said, we will look to ramp our spending in line with revenue, and primarily, it's around continuing to invest in our new market opportunities, continuing to invest on the GPU side and what we're doing in the compute markets, continuing to strengthen our sales and marketing as we go to market with these broad new products. But it's -- there's no particular OpEx impact of using multiple foundries. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Our next question today is coming from Hans Mosesmann from Rosenblatt Security. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [47] +-------------------------------------------------------------------------------- + + Lisa, can you give us, in terms of timing, 7-nanometer for next year? And what products would be the focus initially for that node? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [48] +-------------------------------------------------------------------------------- + + Sure, Hans. So I'm not going to comment directly on timing of products because, obviously, there's a lot of R&D yet to be done. But I would say that our product portfolio, in general, will take advantage of 7-nanometer. You should expect our server portfolio, our graphics portfolio and our client portfolio to all take advantage of 7-nanometer at some point in time. And we like the performance as well as the power and the density strength that we get from it. And so again, we think it'll really help to improve our competitive positioning as we look forward. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [49] +-------------------------------------------------------------------------------- + + All right. And then as a follow-up, if you can answer this, and maybe it was already answered, so forgive me. The -- on the IP front in Q3, did you indicate what end market or what type of application or what geographic location the IP relationship is all about? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [50] +-------------------------------------------------------------------------------- + + Yes. So we did say that the IP transaction was a patent licensing-related transaction, so that's different from the technology licensing, for example, that we did with THATIC. This was a straight patent licensing. And the great thing about our patent portfolio is, beyond sort of our core markets, it's -- it has applicability across a broad range of markets, and so this was a patent transaction and not a technology licensing transaction. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question today is coming from Vijay Rakesh from Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [52] +-------------------------------------------------------------------------------- + + So I was just wondering on the data center side, when you look at -- you mentioned EPYC was strong. I was wondering if your breakout [comments] (inaudible) EPYC and what -- how it grew sequentially. And (inaudible) [have you seen it going] into the December quarter at all? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [53] +-------------------------------------------------------------------------------- + + Okay, yes. You broke up a little bit there, Vijay. But I think I got the question. So the question was sort of the strength of EPYC and where do we see it -- how do -- where do we see it going in Q4. Look, I think EPYC had a good quarter. Obviously, it's growing off of a small base since we had a small base for the server revenue, but we certainly saw growth in unit shipments and revenue into Q3. We will see more growth or we expect to see more growth into Q4, especially as some of these trial runs turn into more deployment activity. And as more OEMs ramp our platforms, the platforms will be more available in the industry, and we're seeing growing interest from a number of enterprise customers as well. So -- but we should think about EPYC as a long-term growth driver. So yes, we will see growth into Q4, but it will be a sizable portion of our revenue as we go into 2018. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [54] +-------------------------------------------------------------------------------- + + Got it. (inaudible) and then you start breaking out that enterprise [data center] out of the semi-custom like your peers are doing as you grow that market? Lastly, just wondering how channel inventory in graphics side GPUs are. + +-------------------------------------------------------------------------------- +Laura Graves, - [55] +-------------------------------------------------------------------------------- + + I think the question was whether we would begin breaking out enterprise separately as a segment, and I don't know that we've made any decision to do that. And then second question was very hard to hear, Vijay. We'll ask you to repeat it, please. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [56] +-------------------------------------------------------------------------------- + + Yes. Just channel inventory in GPUs. How do you see channel inventory on the GPU side? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + Yes. Okay, so for your first question, I think, as Laura said, we haven't made any determinations about a different segment reporting. But we will give you markers on how the business is growing, and I think it will be clear just given the accretive nature of EPYC. As we start ramping that product, you'll see more impact of the product-related revenue. The second question is as it relates to channel inventory in graphics. I believe that channel inventory is healthier in graphics here in October than it was in July. We've certainly restocked some of the channel both for Polaris as well as the Vega products. I would still say that channel inventory might be a little bit light. It's not fully restocked yet, but it's certainly healthier than it was in the July time frame. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our next question is coming from Chris Danely from Citigroup. + +-------------------------------------------------------------------------------- +Wayne Loeb, - [59] +-------------------------------------------------------------------------------- + + This is Wayne Loeb for Chris Danely. Can I ask you how you feel you did share wise in CPU and GPU in Q3? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [60] +-------------------------------------------------------------------------------- + + Yes. So we will have to wait until, obviously, the share results come in. I think when we look at the CPU side of the business, we feel really good about how Ryzen is doing in the desktop channel, so we think we definitely made progress there. As you look, overall, we have to see how the overall results come in. And on the GPU side, again, we shipped a significant volume. It was a record quarter for us, and we saw strength across our new products as well as our current products, and we saw significant ASP growth, which is important for us. But again, I would wait until the overall results come out in a few weeks. + +-------------------------------------------------------------------------------- +Wayne Loeb, - [61] +-------------------------------------------------------------------------------- + + Could you also give your view on the overall PC industry? Was it better, worse, the same as expected? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [62] +-------------------------------------------------------------------------------- + + I think that's a good question. I think the overall PC industry is about what we expected, maybe a tad bit better, but I would say about what we expected. We see good geographical -- sort of the geographies are doing well, particularly North America and Europe. There's a little bit of softness in China, particularly at the low end of the market, and I think there's some change in dynamics in China. But overall, I think the PC market was about what is expected, and that's a good thing. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Our final question today is coming from Tristan Gerra from Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [64] +-------------------------------------------------------------------------------- + + You've announced some design wins for EPYC. Have you seen the number of design wins increase in the quarter? And is what you have enough to reach that longer-term target of 10% market share? Or do you need to line up more design wins to get there? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [65] +-------------------------------------------------------------------------------- + + Yes. That's a very good question. So we have seen design wins and customer engagements increase in the quarter. We've seen customers who started with one platform now looking at multiple platforms with EPYC. And then in terms of design win coverage, we believe we have design win and platform coverage to meet or exceed our share goal targets. So it's not a design win statement. It's really a conversion of design wins to revenue as we help our customers ramp in the coming quarters. So very happy with the customer progress, very happy with the number of platforms that we have, and we continue to expand those platforms and the customer base over time. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [66] +-------------------------------------------------------------------------------- + + Okay. And then my quick follow-up will be, how do you see the opportunities of fitting EPYC and Vega in notably in enterprise platforms? Is that a fitting factor? Do customers value this as a system solution versus just one architecture? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [67] +-------------------------------------------------------------------------------- + + Yes, we have seen good interest from both OEMs as well as end customers on looking at EPYC and our MI25 product together. We actually have a working machine, the P47 petaflop machine that we announced at SIGGRAPH, and we have actually a number of customers using that to trial their software and their application. And so yes, I do think it's a selling point. I do believe that customers do want some integrated system solutions. But as we always say, the products operate very well standalone, and they work with other products as well. But we will continue to work on those system-level solutions for customers. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura Graves, - [69] +-------------------------------------------------------------------------------- + + Thank you. Thank you, operator, and thank you, ladies and gentlemen, everyone, for joining us today. We appreciate you joining our call. We're proud of these results and appreciate your support of AMD. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2018-Apr-25-AMD.txt b/Transcripts/AMD/2018-Apr-25-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..c179e999d14e908ce9d7e3a5b82a887b2e16291d --- /dev/null +++ b/Transcripts/AMD/2018-Apr-25-AMD.txt @@ -0,0 +1,626 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Advanced Micro Devices Inc Earnings Call +APRIL 25, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + - + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Auguste Philip Richard + Northland Capital Markets, Research Division - MD & Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices First Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Laura Graves. Laura, please go ahead. + +-------------------------------------------------------------------------------- +Laura Graves, - [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's First Quarter 2018 Conference Call. By now, you should have had an opportunity to review a copy of our earnings release and slide presentation. If you have not reviewed these documents, they can be found on the Investors Relations page of AMD's website at www.amd.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight a couple of important dates for you. Dr. Lisa Su, President and Chief Executive Officer, will present at the 46th Annual J.P. Morgan Global Technology Media and Communications Conference on May 15. Mark Papermaster, Senior Vice President and Chief Technology Officer, will present at the Cowan 46th Annual TMT Conference on May 30. And our 2018 second quarter quiet time will begin at the close of business on Friday, June 15, 2018. +During our call today, we will focus discussion on key metrics and year-over-year trends in our business, as we believe this is the most meaningful way for analysts and investors to evaluate our growth trajectory. We have expanded the slide content and eliminated the written CFO commentary document. For those of you on social media, we will be sharing key messages from this call on our Twitter feed, @AMDNews, at the conclusion of this call. +Please be reminded that AMD adopted revenue recognition standard ASC 606 effective 2018, using the full retrospective method as of Q1 2018. All prior period results have been adjusted to adopt this new standard, and our comments on today's call reflect these adjustments. For more information and historical financial statements, please refer to our 8-K filing on February 27, 2018. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that cause actual results to differ materially from our current expectations. We will refer primarily to non-GAAP financial metrics during this call, except for revenue, gross margin and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release posted on our website. Please refer to the cautionary statements in today's press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and, in particular, AMD's annual report on Form 10-K for the year ended December 30, 2017. +Now, with all of that out of the way, I'm happy to turn the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura. And good afternoon to all of those listening in today. We started 2018 with excellent financial results as we delivered our third straight quarter of double-digit year-over-year revenue growth. First quarter revenue of $1.65 billion grew 40% year-over-year. Gross margin improved 4 percentage points, and earnings per share increased significantly based on very strong operating and net income growth. +Our strong first quarter financial results demonstrate that our long-term strategy is paying off. We are executing consistently on our product roadmap. Our customers are increasingly adopting our new products, and we are strengthening the foundation of AMD with the right long-term investments. +Looking at our Computing and Graphics segment in the quarter. Excellent momentum for our premium product portfolio drove double-digit year-over-year and sequential revenue growth. Client processor sales were significantly better than seasonality, as Ryzen processor shipments grew year-over-year and sequentially. Ryzen processors accounted for 60% of our overall client processor revenue, up from the low 40%s in Q4, with desktop and notebook client processor ASPs increasing. Product execution was strong in the quarter as we expanded our Ryzen processor portfolio with new high-performance products. We launched the first AMD Ryzen desktop APUs, combining the power of our Zen CPU and Vega GPU on a single chip, delivering the world's most powerful graphics on a desktop processor, with the Ryzen desktop 2400G. Initial sales were strong in the component channel, which contributed of the significant Ryzen processor sales increase in the quarter. Additionally, we began shipments of our second-generation Ryzen desktop CPUs based on our 12-nanometer Zen Plus architecture, delivering outstanding gaming performance and best-in-class multiprocessing leadership for gamers, creators and hardware enthusiasts. Ryzen mobile unit shipments also ramped in the quarter ahead of OEM system launches planned for Q2, driving double-digit increases in our mobile processor unit shipments, both year-over-year and sequentially. Initial Acer, HP and Lenovo platforms had strong sales in the quarter, and Dell released new notebooks and 2-in-1s in early April that further expanded our Ryzen portfolio. Additionally, our first Ryzen PRO commercial notebooks are expected to launch in Q2. Dell, HP and Lenovo are all planning to offer AMD-based commercial notebooks based on the excellent performance and features of this new APU. +Overall, the number of Ryzen-based systems from OEMs continues to grow. In Q2 alone, we expect 25 new Ryzen-based consumer and commercial notebooks to launch, and our customers remain on track to bring a total of 60 Ryzen-based systems to market by the end of the year. +In Graphics, we delivered strong year-over-year revenue growth as ASP and unit shipments increased significantly. On a sequential basis, revenue increased and we outperformed seasonality with strong Radeon Vega and 500 series channel sales, driven by both gaming and blockchain demand. Gaming continues to be a top priority for us, with growth being driven by the expanding number of PC gamers and increasing demand for graphics performance to deliver more immersive experiences. Demand for our Radeon series of graphics products remained strong as new AAA game titles, such as Far Cry 5, were released. We continued our investments in gaming software and released our Radeon e-sports experience, providing a performance uplift on popular e-sports games such as Fortnite, PUBG, Dota 2 and Overwatch. We continue to see a significant demand for our Radeon Vega graphics family, as customers accelerate their RAMs based on increasing availability of our high-performing GPUs, with more supply coming to market. +In professional graphics, HP and Dell both expanded their AMD Radeon Pro workstation portfolio offerings in the quarter, including HP's launch of new Zbook thin and light mobile workstations powered by the AMD Radeon Pro WX 3100. +Our machine learning strategy continues to gain momentum. Mega data center partners are validating and testing our Radeon Instinct MI25 for deep learning applications, and we introduced our Radeon Open Compute ecosystem, ROCm 1.7, a top-to-bottom open solution software stack for machine learning. I'm also happy to report that our next-generation 7-nanometer Radeon Instinct product, optimized for machine learning workloads, is running in our labs, and we remain on track to provide samples to customers later this year. +Turning to our Enterprise, Embedded and Semi-Custom segment. Q1 revenue decreased year-over-year, due to lower semi-custom revenue, as expected, based on a maturity of the current game console cycle, and increased sequentially. In the quarter, Microsoft announced support for our industry-leading Radeon FreeSync technology in their Xbox One S and Xbox One X consoles, delivering stutter free gaming experiences. Server revenue increased double-digit percentage sequentially across mega data center, OEM and channel customers. EPYC processor unit shipments nearly doubled from the previous quarter. We continue to grow our data center momentum with dozens of new design wins across key workloads, including HPC, storage, virtualization and cloud applications. Dell EMC launched 3 of their newest PowerEdge platforms, powering virtualized storage area networks, hybrid cloud applications, dense virtualization and big data analytics with EPYC 7,000 series processors. Recently, supercomputing leader, Cray, announced that it added EPYC processors to its Cray CS500 line of HPC offerings. The Cray announcement pops off a very active quarter in HPC and big data, building on workload momentum in automotive simulations, university clusters and health care. And multiple mega data center customers passed key production milestones as they look to expand their deployments of EPYC-powered instances this year. +To date, there are more than 40 EPYC-based platforms in market, and we are actively working with OEMs, system integrators and channel partners to increase deployment to end customers. We remain focused on achieving mid-single-digit server unit share by the end of 2018. +Our Embedded business delivered increased revenue, unit shipments and ASPs, year-over-year and sequentially, as we introduced 2 new product families: the EPYC Embedded 3000 and the Ryzen Embedded V1000 processors, to enable a new class of thin clients, IoT and other Embedded solutions. +In closing, we are extremely pleased with our first quarter financial results and strong product execution. We believe 2018 is shaping up to be an excellent year for AMD with continued revenue growth and margin expansion driven by significant demand for our high-performance Ryzen, Radeon and EPYC products. Looking forward, we are confident that we have the right long-term strategy to deliver sustained revenue and profitability growth. The market TAM in high-performance computing will grow to over $75 billion over the next few years, including high-growth segments, like gaming, data center, machine learning and artificial intelligence. We have built a strong execution engine, and we will continue to make significant investments in hardware and software to deliver an even more compelling roadmap for our customers in 2019 and beyond. +Now I'd like to turn the call over to Devinder, to provide some additional color on our first quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa. Good afternoon, everyone. The first quarter was a strong quarter for AMD. Year-over-year, we grew revenue 40%, expended gross margin by more than 400 basis points, significantly improved net income and earnings per share, and achieved GAAP and non-GAAP net profitability. +Total revenue of $1.65 billion was driven by strong demand for our new products, with Ryzen and Radeon products growing double-digit percentage year-on-year, Ryzen sales coming in higher-than-expected, and EPYC server processors ramping. +Gross margin was 36%, up 420 basis points year-on-year, driven by a higher proportion of revenue from new products. Operating expenses were $446 million compared to $371 million a year ago. Operating expenses were 27% of revenue, lower than our prior guidance of 28%, and down 4 percentage points from 31% a year ago, as we continue to make strategic R&D investments, launch new products and invest in our multi-generation product roadmaps. +Operating income was $152 million, up sharply from $34 million a year ago, and operating margin was 9%, up from 3% a year ago. +Net income was $121 million, or diluted earnings of $0.11 per share as compared to a net income of $2 million a year ago. Adjusted EBITDA was $196 million compared to $68 million a year ago and, on a trailing 12-month basis, adjusted EBITDA was $496 million. +Now turning to the first quarter business segment results. Computing and Graphics segment revenue was $1.12 billion, up 95% year-over-year due to strong sales of both Radeon and Ryzen products. Our Ryzen offerings outperformed our expectations in Q1, accounting for approximately 60% of client processor revenue and contributed to strong sequential double-digit percentage growth in client revenue. The strength in Radeon products was driven by both gaming and blockchain demand. We believe blockchain was approximately 10% of AMD revenue in Q1 2018. +Computing and Graphics segment operating income was $138 million compared to a loss of $21 million a year ago. This significant turnaround was due to strong revenue growth and improved operating expense leverage. +Enterprise, Embedded and Semi-Custom revenue was $532 million, down 12% year-over-year, with lower Semi-Custom revenue partially offset by higher Server and Embedded revenue. As a reminder, revenue in both Q1 2018 and Q1 2017 includes Semi-Custom revenue related to quarter-end inventory, associated with noncancelable purchase orders as required under the ASC 606 revenue accounting standard. EESC operating income was $14 million, down from $55 million a year ago, primarily due to a licensing gain in Q1 2017 as well as increased operating expense investments in our data center business. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $1.04 billion at the end of the quarter, down from $1.18 billion in Q4, and up from $943 million in the year-ago quarter. Free cash flow was negative $132 million in the first quarter. Inventory was $715 million, up slightly from the prior quarter. Total principal debt, including our secured revolving line of credit, was $1.7 billion. We deployed cash to repurchase $14 million of debt in the first quarter as we continue to reduce term debt and interest expense. +Now turning to our financial outlook. For the second quarter of 2018, AMD expects revenue to be approximately $1.725 billion, plus or minus $50 million. This is an increase of 50% year-over-year, driven by the growth of Ryzen, Radeon, EPYC and Semi-Custom revenue. On a sequential basis, we expect Q2 revenue to benefit from continued strength in our Ryzen and EPYC product families and a seasonal increase in Semi-Custom revenue partially offset by a modest decline in graphics due to blockchain. +As a reminder, for comparative purposes, Q2 2017 revenue was $1.15 billion under the ASC 606 revenue accounting standard. In addition, for Q2 2018, we expect non-GAAP gross margin to be approximately 37%. Non-GAAP operating expenses to be approximately $460 million or 27% of revenue. Non-GAAP interest expense, taxes and other, to be approximately $35 million. And inventory to be up slightly on a sequential basis in support of higher revenue. +Our financial progress in the first quarter is attributable to the ongoing strength of Radeon and Ryzen products as well as continued early contributions from our EPYC products. Our business is strong, and we look forward to continued revenue growth, margin expansion and increased profitability year-over-year. +Based on the strength of our business momentum for the full year 2018, we now expect revenue to increase by mid-20% over 2017, driven by the ramp of our new products. Blockchain revenue to be mid- to high-single-digit percentage of revenue for 2018. Non-GAAP gross margin to be greater than 37%. +In summary, the first quarter was excellent. We are pleased with the momentum within our business execution and strong financial results, which we believe lay the foundation for a strong 2018. We are focused on delivering our long-term target financial model as we execute our monthly generational roadmaps and introduce and ramp high-performance computing products. +With that, I'll turn it back to Laura for the Q&A session. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, - [5] +-------------------------------------------------------------------------------- + + Thank you very much. Appreciate that, Devinder. +Operator, we're ready to go. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Congratulations on the strong results, especially on getting to the double-digit top margins in your Computing and Graphics segment, it's been a while since we saw that. For my first question, Lisa, on EPYC server sales, you mentioned they doubled sequentially. If you could give us some sense of what the magnitude is, so we at least have some ballpark sense on where you are right now? But importantly, what are the remaining pushbacks from customers in terms of what they would like to see before they adopt EPYC in a more meaningful way? Is it just a matter of time? Is it a performance or a pricing gap? Or what else do you need to deliver on to get EPYC to a more meaningful level? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes, absolutely, Vivek. Thanks for the questions. So look, on EPYC, we did make a very nice progress in the quarter. I think when you look at it from a revenue standpoint, it's a strong double-digit percentage. There is -- we certainly view that the units increasing is also very positive thing. The traction actually is across all areas. So we saw traction in Enterprise sort of end-user deployments. We saw some channel and system integrator deployments as well as hyperscale deployments. And our goal is to get to mid-single-digit share by the end of this year. I think we are making good progress towards that. What we're working with customers now is just going through their various stages of qualifications. So they go from proof of concept to initial deployment then to large volume deployment. And we're in that initial deployment phase. And so I think we're making good progress, and it is -- there are no real pushbacks other than just time going through the classification process and working with them in their environments to make sure that we get fully qualified. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [4] +-------------------------------------------------------------------------------- + + Got it. And as a follow-up, if I look at your server ASPs in the past, they were sort of in the $300 to $400 range, well below what your competitor had. As you look a lot of these engagements that you are participating in now, how should we think about pricing trends that you're seeing in that market? Are you able to sell in a higher-value segment than you were able to do in the past? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. So Vivek, I think the very strong part of our roadmap right now is we're really playing across the entire portfolio. So from, let's call it, the low end of the server market, the entry level, all the way through the high-end 2-piece SKUs. So the pricing on -- that we're seeing in the market is very reasonable. From our standpoint, they are -- we're providing value to the customer, but they're also very accretive to the margins of our own overall business. So yes, the pricing environment is good. + +-------------------------------------------------------------------------------- +Laura Graves, - [6] +-------------------------------------------------------------------------------- + + Thanks, Lisa. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [7] +-------------------------------------------------------------------------------- + + Thanks, Vivek. + +-------------------------------------------------------------------------------- +Laura Graves, - [8] +-------------------------------------------------------------------------------- + + Next question, please. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [10] +-------------------------------------------------------------------------------- + + First question on the rise in notebook effort. It sounds like's it's really starting to hit its stride. I was hoping you could give us a little bit more color, which segments does it seem to resonate with? To what extent is it a commercial versus a consumer product? And do you think that the Ryzen notebook opportunity, is it bigger than the desktop opportunity ultimately in your minds? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [11] +-------------------------------------------------------------------------------- + + Yes, Mark. So look, we -- we're making very good progress on Ryzen. I think we're very pleased with the Q1 results and then what we see going into Q2 in the second half. It is true that up until this quarter, much of our progress has been in the channel and in the desktop portion of the business. We saw a nice increase this quarter in notebooks and what it is, is many of the OEMs are actually launching systems in Q2. And with that, we had -- they're basically building up their production for the second quarter launches. What you're going to see in the second quarter is a number of impressive premium consumer designs, thin and light designs that, I think, are representative of the strength of the product. And we will also see the first launch of the commercial systems from the top OEMs. And the expectation is that the commercial notebooks will kick in, in the second half of the year. Q2 is more of a consumer cycle. But overall, I think we're seeing that the notebook OEM opportunity is a good one. We have strong design wins. The customers are working closely with us. We're doing a lot of work with retailers and the overall go-to-market to ensure that the notebook opportunity is important. And notebook is larger than desktop overall. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [12] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. And a follow-up, if I may. On EPYC, the product has been in the market for a while. I understand that you have to go through the testing phase and then pilot programs and initial deployments and then, hopefully, larger scale deployments. What -- how do you think -- or how should we think about the cadence of updates on this product? Is this a similar cadence that you would see on the desktop or a notebook side? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Sure, Mark. So on the service side, the cadence of deployments does tend to be longer. I think we're well into the cadence, and so I think the EPYC work with the OEMs, you saw the culmination of that with HPE announcing in December, and then Dell announcing in the first quarter. That will now move over into Enterprise customers, who are then taking their systems into their labs and doing their initial deployments. So I think the cadence is over a number of quarters. I will say, for the first-generation EPYC, we're seeing really nice customer interest, and it's quite broad. And so it is across Enterprise as well as the hyperscale customers. And we view this as a multigenerational play, so we're very excited about what EPYC can do over the next couple of quarters. But we also believe that this is the right investment to make with the customer set as we bring out the second generation of EPYC and the third generation of EPYC, obviously, it would go a little bit faster because the customer set is familiar with our system. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [15] +-------------------------------------------------------------------------------- + + Devinder, impressive year-over-year gross margin growth in the March quarter of 400 basis points. I'm just kind of curious, clearly, Ryzen has had a positive impact. Can help break down the 400 basis points year-on-year growth between kind of new products and the fact that Semi-Custom sort of declined as a percent of the mix pretty significantly from '17 to '18? And then how do we think about the incremental margin leverage as EPYC comes in and perhaps Ryzen, too? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [16] +-------------------------------------------------------------------------------- + + Yes, a good question, John. Actually, if you look at it from a margin standpoint year-over-year, the Semi-Custom revenue was actually down, so that was helpful. But beyond that, if you look at the new products, fundamentally, the new products is what's driving the margin. Ryzen, EPYC, GPU compute retail all higher than corporate average, those are driving the increase in the margin. As we get to the rest of the year, as you observed, the momentum and the products are there for the new products. They're going to go ahead and contribute to the margin increase and that's why from prior guidance, we just updated our margin to say maybe greater than 36% the last time, we updated it to say greater than 37% this time for the year, and that's fundamentally all with the momentum that we have for the new products. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [17] +-------------------------------------------------------------------------------- + + That's helpful, Devinder. And Lisa, for my follow-up. I appreciate kind of quantifying blockchain for both the first quarter and for last year, and also, your commentary about it being -- it looks like down sequentially, at least embedded in your June guidance. I'm just kind of curious, just given how hard it is the track where these GPUs are really going, how do you get a sense of what's a blockchain application versus something else, one? And two, do you see this as a viable long-term market, or do you believe that as this market develops, it's going to have to move from proof of work to proof of stake, which might just negate mining altogether and if that scenario were to play out, how worried are you about sort of secondary cards coming back to the market and kind of hurting pricing either the second half of this year or into 2019? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Sure, John. So look, on the blockchain, there is a lot of discussion about this. From our standpoint, we stay very, very close to the customer set with -- in the graphic space. And so we spend time with the commercial miners as well as spending time with our partners. And the way we look at this, our first priority when we look at allocation of graphics cards is to gamers. And so that's through OEMs, that's through system integrators that's also working with key e-tailers to make sure that they are prioritizing the gamers segment, and we're going to continue to do that. And so that's one piece that we know well. We also work directly with the commercial miners. And so we see kind of what their forecasts are and they work with us. And so that's -- that we have good visibility on. There is a piece that go through retail that it's hard to tell whether that's gaming or mining, but we believe we have a good sense of what that is. So it is an approximation, but we think it's a good approximation of where we are. And then to your longer-term question, I do think the blockchain infrastructure is here to stay. I think there are numerous currencies, there are numerous applications that are using the blockchain technology. We don't see a significant risk of GPU -- secondhand GPUs coming into the market. I think what you find is that, one, there are number of different currencies; and two, a lot of these users that are buying GPUs these days are actually buying them for multiple use cases, both commercial and consumer. So they're not necessarily buying just for mining. And I think for that reason, we do think this is a different cycle. That being the case, we do see a bit of volatility in it and that's why we are putting into our forecast for the second quarter and the second half, a little bit lower blockchain demand but that's more than made up for by the other new products and the way the new products are ramping in the business. + +-------------------------------------------------------------------------------- +Laura Graves, - [19] +-------------------------------------------------------------------------------- + + Operator, next question. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question is coming from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [21] +-------------------------------------------------------------------------------- + + Can you give us some idea of what your June guidance assumes in terms of sequential microprocessor sales growth compared to discrete graphics growth? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [22] +-------------------------------------------------------------------------------- + + Sure, David. So in our second quarter guidance, we're actually assuming that Ryzen and EPYC are up, and Semi-Custom is also up seasonally, and we expect graphics to be down modestly based on some of the blockchain demand. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [23] +-------------------------------------------------------------------------------- + + Excellent. Can you give us an update on what new products you plan to launch through the rest of this year and next year? And when these are scheduled to come out? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [24] +-------------------------------------------------------------------------------- + + Sure. That's a lot, David, but let me say a couple things. I think relative to our CPU business, and we are launching additional Ryzen-based products in the second half of the year, we just launched the second-generation Ryzen desktop in 12-nanometer. And that launch has gone really well. I mean, we're very happy with the positioning and how customers are reacting to that. In the second half, we'll have some commercial systems and some other updates to our Ryzen lineup that we will launch. We have a 7-nanometer GPU based on Vega that we'll sample later this year. We have a 7-nanometer server, a CPU that we'll sample later this year. And then obviously, we have a number of products that are planned for 2019 as well. So it's a very, very busy product season for us, but we're pleased with the sort of the execution on the product roadmap. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + First around OpEx, are you still looking for a 28% of revenue for the full year on a higher revenue base? And given that -- if that's your -- what areas are kind of key for investment then as we get through the rest of the year and going forward? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [27] +-------------------------------------------------------------------------------- + + Yes, let me take that, and then Lisa can add. So yes, we are targeting 28%. As you see, Stacy, we have a long-term target model of 26% to 30%. The year has started out well, we came in at 27% in Q1, and targeting around the same for Q2. But we do -- we are still in investment mode, and obviously, investing in R&D and the product roadmap. And Lisa can maybe add some of the details in terms of where we're investing in terms of OpEx. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [28] +-------------------------------------------------------------------------------- + + Yes, sure, Stacy. So I think from the investment side, certainly we're investing in R&D on the CPU and the GPU side, but a key focus for us is in software, and particularly, machine learning software. I think there's a high demand of people wanting to use our GPUs in the compute space, and so we're increasing our investments in software around machine learning. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + Got it. For my follow-up, I had a question on the ASC 606. I know last quarter, you kind of gave some historicals for how that was a headwind versus a tailwind versus what would have been normal seasonality, particularly in Semi-Custom. Is the ASC 606 into Q2, is that a headwind or tailwind on the guide? And how should we think about that as we go through the second half as well versus what we would have seen without the accounting change? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [30] +-------------------------------------------------------------------------------- + + Fundamentally, ASC 606, from a revenue standpoint, what happens is the seasonality and the profile of the Semi-Custom revenue changes. Some of the revenue that we used to get in the second half moved to the first half, so I would say, it's a little bit more balanced between the first half and the second half, as opposed to the peak revenue we used to see in Q3. So that is the primary effect on the profile of the revenue, not necessarily the annual revenue. ASC 606 has started earning a significant impact on our annual revenue, it's more of the profile of the revenue within the quarters. As far as impact is concerned, if you're comparing year-over-year, for example, in Q1 of 2018, Semi-Custom was down because we had more revenue in Q1 of 2017. And then Q2, it is slightly up but very balanced from where we see it from an overall standpoint. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + So last year in Q2, it was like -- I forget how much, like a $75 million headwind versus what would have been otherwise? Is it a similar amount of headwind this time in Q2? Or is it less? Or is it a tailwind? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [32] +-------------------------------------------------------------------------------- + + I wouldn't -- I would say that it was a headwind last year. This year, from an overall standpoint, if I compare year-over-year, it is up slightly from where we were in Q2 of 2018. So if you're comparing Q2 '17 to Q2 '18, it's a benefit the revenue in Q2 of 2018 in our guide. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question today is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [34] +-------------------------------------------------------------------------------- + + I had 2. I'm curious about your comments just now on blockchain, and I'm a little surprised to hear that you think that there would be limited risk that, that product would come back into the market. Can you, again, go over why you think that is? Because you're selling more of a general SKU, right? And then I guess, also, how you handicap the potential for there to be some ASP effect on that too? I know you've captured some of the rising ASPs in the channel, so how do you handicap that looking out throughout the rest of the year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + Yes, absolutely, Tim. So look, when you look at -- I think most people are comparing this sort of -- this blockchain time period to the last one, which is a couple of years ago. And I think there are a couple of important differences. I think the first one is that there are multiple currencies and multiple applications that are being used. And what we've seen is that people who are mining do go from one currency to another depending on what's happening. We're also seeing that many users on both the commercial and consumer side are actually buying GPUs for multiple use cases. And from that standpoint, again, we see that there is good demand for, not just blockchain, but for gaming, for the cloud and for those things as well. And so I think it's a balanced assessment of where we are. I think the breadth of the blockchain applications and also the breadth of the customer base give us that belief. Now as you go forward, there's also a -- when we look at the Graphics business go forward minus blockchain, we actually see a very good environment. We see a good environment for gaming growing, we see a good environment for GPU compute growing. And frankly, on the gaming side, some of those users have not been able to get access to GPUs and so, again, that's -- those are all positives as we go forward. And then you had a second question, Tim? + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [36] +-------------------------------------------------------------------------------- + + I did, yes. I think you said the 7-nanometer product is in the lab, and it's going to launch later this year? That's the product at TSMC, correct? And I guess, I'm just wondering on that front, do you feel comfortable that you can get capacity from that vendor? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- + + So our foundry strategy is to use both TSMC and GLOBALFOUNDRIES on the first 7-nanometer product. We are using TSMC for that product, and we have a very strong relationship with them. And so we do see a good momentum on it from what we see, and I'm not concerned about capacity. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question today is coming from Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- + + Just a follow-up on the Semi-Custom business. On the June quarter guide, you mentioned sequential growth in Semi-Custom. But if I look at your ASC 606 reconciliations for last year, it looks like the Semi-Custom business was actually down double-digits percentage point sequentially going from Q1 to Q2? So like-for-like on their 606, why are there different shipment profiles this year, Q1 to Q2? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [40] +-------------------------------------------------------------------------------- + + Yes, I can explain that. So in Q1 of '17, there was a strategic buy of wafers that we did in Q1 '17, so it had a bigger impact in Q1 '17 and then the effect caught up in Q2. So the impact Q1 to Q2 was significant. This year, it's more balanced. And from that standpoint, when you compare year-over-year, Q1 to Q1, it's down, but Q2 to Q2, it's up. So there was a different profile in Q1 '17 just based on the way the wafers were purchased in '17 versus the way in '18, where it's a little bit more balanced. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + Great. Question for Lisa. Embedded solutions contributed to the year-over-year and quarter-over-quarter growth in EESC, I think that this is kind of an often overlooked part of the business because Embedded is nice because it gives you guys exposure to kind of a diverse set of their market applications. Can you just help us understand where the team is seeing good demand traction in Embedded? And maybe give us a rough idea on kind of overall revenue contribution to EESC? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [42] +-------------------------------------------------------------------------------- + + Yes, Harlan. So Embedded is a nice segment, you're absolutely right. I think it's a margin-accretive segment to us. The end markets that we ship into, there are thin clients, they are places where you need graphics for displays, so there's some Embedded displays that we ship into there. It's still a small business for us, but we actually believe, in addition to the goodness around Ryzen and EPYC, when we launch those products, Ryzen and EPYC Embedded, we actually saw very strong interest from customers. And so we think as the product strength in our PC and our server business increased, they will also help that Embedded solutions business overall. So I would think it's still a small piece of the business, but we believe it will be a nice growing margin accretive portion of the business over the next couple of years. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question is coming from Srini Pajjuri from Macquarie. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [44] +-------------------------------------------------------------------------------- + + Lisa, question on the ASPs. I think you said the ASPs went up because of the Ryzen mix improving. Can you give us some more color as to where Ryzen is, in terms of the mix? And then with Ryzen 2, do you expect that to be accretive to ASPs and margins? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [45] +-------------------------------------------------------------------------------- + + Yes. So in terms of the client business, we saw units up overall. We saw ASPs up overall, and they were up in both desktop and mobile. And when you look underneath that, I think, what -- the main thing is we're seeing a larger mix of the business become Ryzen. So in the fourth quarter, we had stated that the Ryzen mix of the client business was kind of in the low 40s. And so we had in notebook a lot of legacy product that we're still shipping, and in desktop, we had some legacy product that we're still shipping. As we move over to the first quarter, the notebook mix has mixed nicely into Ryzen, and the desktop is now mixed very nicely into Ryzen as well. So overall, that's what led to the ASP increase. I think the second generation Ryzen is a very, very good product. I think it's -- it actually -- when you look at the first generation Ryzen, we were very good on multithreaded performance, but there were some detractors around single threaded and gaming performance. I think the second generation Ryzen is actually much more competitive on gaming performance. So we do see an opportunity for that to help us increase share in the desktop business, and certainly, that would be accretive to margin. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [46] +-------------------------------------------------------------------------------- + + Great. And then one question on the server business. I guess, your target is to get to a mid-single-digit share by end of this year, which is a fairly gradual ramp. I'm just curious as to when you expect the 7-nanometer part to be available in the market? And when that happens, do you see an inflection to your share gains or do you continue you expect gradual share gains? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + Yes. So all of the sales this year will be around of the current generation of Ryzen, and so that gets us to the mid-single-digit share. 7-nanometer Zen 2-based product we'll sample later this year to customers and that will be in production in 2019, and we do believe that the adoption rate of the second generation could potentially be higher than the adoption rate of the first generation, mostly because customers will be more familiar with our systems and our products. And so we'll see how it goes, but we certainly -- our overall goals are ambitious in the server space. And so this year, its first generation Ryzen, next year, we'll mix in the 7-nanometer, second-generation -- I'm sorry, first generation EPYC. And next year, we'll mix in the second generation of the EPYC products. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Our next question today is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [49] +-------------------------------------------------------------------------------- + + My first question's on the competitive landscape in the AI space. I was just wondering how you're thinking about your positioning relative not only on your biggest competitor there, NVIDIA, but also new entrants that potentially can be working on custom solutions? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [50] +-------------------------------------------------------------------------------- + + Sure. So the AI market is certainly growing very, very fast. Relative to the competitive landscape, we are a new entrant. I think our GPU compute hardware is very good. I think we have a strong roadmap that we are -- we're putting in place for that. I think on the software side, we have more work to do, and we're making significant investments in some of the machine learning frameworks, such as Tensor Flow and Caffe, and some of these key frameworks, to ensure that we make it easier to adopt our solutions. But we see this is a multiyear, really, opportunity for us. So GPU compute will continue to be a focus area for us. We think we can be very competitive and we're going to continue to invest in this area. As it relates to, let's call it, non-GPU solutions, I think there will -- the landscape says there will be some ASIC solutions in the marketplace, but I view that as complementary to the GPU solutions and, from that standpoint, I think we have the CPUs, we have GPUs, and then we have the ability to connect heterogeneously to these other elements. So yes, from our standpoint again, we see this as a market that very much fits our capability, and we will continue to invest in it. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [51] +-------------------------------------------------------------------------------- + + Got it. And then my follow-up's on the upcoming shareholder meeting. And then one of the proposals is to increase the authorized share authorization by about 700 million shares. Obviously, my understanding is that, that wouldn't be dilutive initially, but just wondering how you're thinking about potential uses of those -- that share is? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [52] +-------------------------------------------------------------------------------- + + Yes. So you're correct. There is a proposal in the -- at the shareholder meeting. It is not going to be dilutive to begin with, and it's really good housekeeping. We don't have any particular plans at this point. + +-------------------------------------------------------------------------------- +Laura Graves, - [53] +-------------------------------------------------------------------------------- + + Thank you. Next question. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Our next question is coming from Ambrish Srivastava from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [55] +-------------------------------------------------------------------------------- + + I have 2 questions. One was just a follow-up to what, Lisa, you were talking about on the machine learning side. When do we see -- or so just give us an update of where you are in traction and should we expect any meaningful revenues on that front from AMD in this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [56] +-------------------------------------------------------------------------------- + + Yes. So I think last year, we announced a partnership with Baidu to do software optimizations of -- for machine learning. And we have several other partnerships with others in this area. So there's a lot of interest. I think the time for meaningful revenue, we will see some revenue in the second half of the year and that's part of the growth in the margin expansion story. And I think into 2019 and 2020, this will be continue an area of growth for us. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [57] +-------------------------------------------------------------------------------- + + Okay. And then for my follow-up, just getting back to the discrete graphics in the quarter reported. The channel was really dry heading into the first quarter. So where are we on the channel inventory? And is there any way for you to help us understand how much of the growth was driven by the buildup in the channel in the March quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [58] +-------------------------------------------------------------------------------- + + Yes, so the channel inventory did -- the channel inventory was at very, very low levels going into the quarter, and frankly, it was hard to get the GPU -- it was hard to get GPUs. I think if you look now on typical retailer/e-tailer sites, the channel inventory is good. And I think there was an element of channel replenishment, but from what we see of inventory levels today, they're, I would say, normal. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [59] +-------------------------------------------------------------------------------- + + And what is the normal level, Lisa, in terms of weeks? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [60] +-------------------------------------------------------------------------------- + + Maybe somewhere between 4 and 5 weeks. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Our next question today is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [62] +-------------------------------------------------------------------------------- + + Lisa, a couple questions. Can you comment qualitatively about the competitive dynamic that you're seeing in microprocessors? And as a second question, can you give us an update on Spectre, in terms of the impact it's had on the business going forward? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- + + Sure, Hans. So on the microprocessor side, I think, with the competitive landscape, as we see it, Ryzen and EPYC are very competitive. And we've seen that in head-to-head design opportunities. I think from a CPU standpoint, we're very pleased with that. I think second generation Ryzen in 12-nanometer actually improves the overall performance, and so we like how that positions us on the PC side. I think as we look forward, and I think this is important, we believe that the 7-nanometer capability of The Foundry ecosystem is very good, and that puts us in a good competitive spot from a manufacturing standpoint. And then on the design side, obviously, we have things that we're planning. And so I see the competitive environment as one that is as good, and we're going to work very hard to make sure that it gets better over time. Obviously, we take the competition very seriously. Oh, yes, and the second question -- sorry, about that, Hans -- on Spectre. We have spent a good amount of time with our customer set to make sure that they're fully protected on Spectre. We've actually released a number of software mitigations already to our OEM customers and to our partners. They're in the process of deploying. So I think it took a lot of energy, certainly, we spent a lot of time on it and our customer set spent time on it. But we don't see any long-term effects. It's more that we want to make sure to get the work done quickly, and that's been our focus. + +-------------------------------------------------------------------------------- +Laura Graves, - [64] +-------------------------------------------------------------------------------- + + Thanks, Lisa. Thanks, Hans. Operator, we have time for 2 more questions, please. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Our next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [66] +-------------------------------------------------------------------------------- + + I wanted to ask you, I think you mentioned double-digit sequential growth in the CT business. I was just kind of curious what stage you're on in terms of channel fill for Ryzen Mobile business? And then I have one more follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [67] +-------------------------------------------------------------------------------- + + Yes. So we did, and as I mentioned, have some mobile product shipped ahead of OEM system launches in the second quarter. But we see this really as the beginning of the Ryzen ramp. So my expectation is that the client or the Ryzen portion of our business will be up in the second quarter and it will be up in the second half. And so it's the beginning of the notebook ramp. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [68] +-------------------------------------------------------------------------------- + + And I wanted to ask just on the OpEx side, Devinder. Just in terms of licensing gains that have been OpEx offset, do you expect any of those gains this year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [69] +-------------------------------------------------------------------------------- + + I think there could be, but it's hard to tell because it's kind of dependent upon the milestone that come into play. There was the OpEx offset last year that got reversed, but we'll see it when it happens from a milestone standpoint. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [70] +-------------------------------------------------------------------------------- + + I think, Blayne, just as a point of clarification on this point. From an IP standpoint, we're not forecasting IP either here in the second quarter or into the second half. I think as Devinder said, we do have some IP arrangements that we're working on, and depending on when those milestones complete, we will then sort of forecast it into the business. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Our final question today is coming from Gus Richard from Northland. + +-------------------------------------------------------------------------------- +Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [72] +-------------------------------------------------------------------------------- + + Real, real quickly, can you just tell me if the 12-nanometer is a die shrink or just performance improvement? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [73] +-------------------------------------------------------------------------------- + + It is -- yes, Gus, it is primarily performance improvement, and it is some design improvements. So you see some of the latency improvements and so on. It is not a die shrink. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura Graves, - [75] +-------------------------------------------------------------------------------- + + That's it for our call for today. We thank you very much for joining us. Look forward to seeing you at the Morgan Stanley conference and at the Cowan conference. And as always, we thank you for your support of AMD. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Thank you, ladies and gentlemen. That does conclude tonight's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2018-Jan-30-AMD.txt b/Transcripts/AMD/2018-Jan-30-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..3d24678d73d86340ea72301f27efdd480ddff2f0 --- /dev/null +++ b/Transcripts/AMD/2018-Jan-30-AMD.txt @@ -0,0 +1,606 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Advanced Micro Devices Inc Earnings Call +JANUARY 30, 2018 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Laura Graves + - + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Tristan Gerra + Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Brett William Simpson + Arete Research Services LLP - Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices Fourth Quarter 2017 Conference Call. (Operator Instructions) It is now my pleasure to introduce your host, Laura Graves. Please go ahead, Laura. + +-------------------------------------------------------------------------------- +Laura Graves, - [2] +-------------------------------------------------------------------------------- + + Thank you very much, and welcome to AMD's Fourth Quarter and Fiscal Year 2017 Conference Call. By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, www.amd.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight a couple of important dates for you. Dr. Lisa Su will present at the Morgan Stanley Technology Media and Telecom Conference on February 26, and our first quarter quiet time will begin at the close of business on Friday, March 16, 2018. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs +(technical difficulty) +assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +Additionally, please note that we will be referring to non-GAAP financials during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary, again, both posted on our website. +Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors in our filings with the SEC and in particular, AMD's quarterly report on Form 10-Q for the quarter ended September 30, 2017. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. Three years ago, we set out a strategic plan to reshape AMD to become a high-performance computing leader through great products, deep customer relationships and a simplified and focused business strategy. 2017 marked a key product and financial inflection point for AMD. Our newest wave of high-performance products and consistent execution created significant momentum for our business over the last year. Fourth quarter revenue of $1.48 billion grew 34% from the year-ago period, and we significantly expanded our gross margin and improved profitability. For the full year, we increased annual revenue by over $1 billion, resulting in 25% annual revenue growth. We expanded gross margin and achieved full year profitability. +Looking at our Computing and Graphics segment in the quarter, we delivered very strong Q4 results as we continued the ramp of our Ryzen CPU and Radeon Vega GPU products. Computing and Graphics segment revenue increased 60%, and we significantly improved operating income from a year ago. +Client computing revenue increased both year-over-year and sequentially. We outperformed seasonality in Q4, driving strong double-digit sequential revenue and unit growth based on very strong sellout of Ryzen processors throughout the holiday season. We expanded our Ryzen CPU family further into the consumer market with the introduction of the AMD Ryzen Mobile processor with Radeon Vega graphics, combining the power of our Zen CPU and Vega GPU architectures into the fastest processor in the industry for ultra-thin notebooks. Ryzen Mobile-based notebooks are currently available from Acer, HP and Lenovo with multiple new systems expected from all top 5 PC manufacturers in the first half of this year. +In graphics, we delivered our second straight quarter of record GPU revenue with significantly improved ASP and increased unit sales from a year ago, driven by strength across our entire graphics product portfolio. We saw strong demand for our Polaris products across both the gaming and blockchain markets, and Radeon Vega GPU revenue more than doubled from the prior quarter driven by strong gaming demand in the add-in-board channel as well as strength with strategic OEMs. +Apple launched the new iMac Pro, the most powerful Mac ever made, featuring AMD's Radeon Pro Vega product in the quarter. We also began shipments of a new semi-custom GPU that is integrated into an Intel multi-chip processor package. This semi-custom product opens up a complementary market for our high-performance graphics products and expands the power of Radeon graphics to more gamers and premium PC buyers. +Our professional graphics business had its best quarter ever based on growing data center sales highlighted by strong Radeon Instinct MI25 sales to a major cloud provider. For the full year, Computing and Graphics segment revenue increased 54% over the prior year as we launched more than 40 new high-performance CPUs and GPUs. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue increased 3% from a year ago driven by the ramp of our EPYC processors. Q4 server revenue and unit shipments increased sequentially and from a year ago as the market continues to qualify and deploy our family of high-performance EPYC processors. We closed dozens of new server deals in the quarter, securing key design wins with education, financial services and hosting companies. +We also had several key announcements in the quarter as we continued to see a steady drumbeat of adoption. Microsoft Azure became the first public cloud instance powered by AMD with their L-series of virtual machines for storage-optimized workloads. Hewlett-Packard Enterprise began volume shipments of the EPYC-based ProLiant DL385 Gen10 server, which recently set world records for floating point performance. Baidu deployed AMD FX single-socket platforms into their data centers to power AI, Big Data and cloud computing services. And Dell EMC has completed the qualification phase for their EPYC-based systems and will be sharing more on launch plans shortly. +Our reentry into the server market remains on track with a steady ramp of new platforms and deployments across our OEM and hyperscale data center customers. Our semi-custom business performed as expected in the quarter as unit shipments declined from a year ago as we completed the fifth year of the current game console cycle. +Before I close, I'd like to address the recent important security issues facing our industry. Security is and always has been a fundamental focus for AMD across all our products. We are vigilant about security in both our product design and throughout the product life cycle. As new exploits arise like we have seen with Spectre and Meltdown, we are dedicated to responding with speed and focus to keep our customers and partners informed and protected. As a reminder, we believe Meltdown is not apropos to AMD processors. +For Spectre variant 1, we continue actively working with our ecosystem partners on mitigations, including operating system patches that have begun to roll out. We continue to believe that variant 2 of Spectre is difficult to exploit on AMD processors. However, we are deploying CPU microcode patches that, in combination with OS updates, provide additional mitigation steps. +Longer term, we have included changes in our future processor cores starting with our Zen 2 design to further address potential Spectre-like exploits. We continue to collaborate closely with the industry on these vulnerabilities and are committed to protecting AMD users from these and other security threats as they arise. +In summary, we are very pleased with our quarterly and full year results. We made significant progress in 2017 as we completely reshaped AMD's product portfolio and launched a highly competitive set of new products. In 2018, we expect to increase our momentum with the next wave of premium products and expanded go-to-market activities to increase our market penetration. +In the client market, we will expand our Ryzen portfolio with new product launches, including: AMD Ryzen desktop processor with Radeon Vega graphics, which is expected to deliver the industry's highest performance graphics engine in a desktop processor; our second-generation Ryzen desktop CPU based on our higher-performance 12-nanometer Zen Plus architecture; and for business notebooks, our AMD Ryzen PRO Mobile processors with Radeon Vega graphics. +We are also expanding our go-to-market activities with our OEM and retail partners, and we expect to launch more than 60 new Ryzen OEM systems throughout 2018. In graphics, the launch of Radeon Vega Mobile products will expand our Radeon Vega lineup into high-end notebooks. Later this year, we plan to sample our first 7-nanometer Vega GPU optimized for machine learning. In addition, we will continue increasing our software investments around machine learning to address the growing demand for an open ecosystem in the GPU compute space. +In the server market, we will continue to work closely with major cloud vendors and OEMs to ramp their first-generation EPYC-based systems while also completing key development milestones on our next-generation Zen 2-based server platforms. Our Zen 2 design is now complete, and we will be sampling to our customers later this year. +2018 is clearly a defining year for the ramp of our server business, and we remain focused on our goal of achieving double-digit market share in this important market segment. 2017 laid a solid foundation with strong financial results and significant progress towards achieving our long-term goals. I am even more excited about 2018 as we continue our journey to position AMD as one of the premier long-term growth companies in the tech industry. +Now I'd like to turn the call over to Devinder to provide some additional color on our fourth quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. 2017 was a pivotal year for AMD. We grew annual revenue 25% over 2016 with revenue growth increasing every quarter on a year-over-year basis, culminating in growth of 34% in the fourth quarter of 2017. In addition, we expanded gross margin by 3 percentage points and achieved GAAP profitability for the year. +Computing and Graphics annual revenue grew 54% in 2017, while Enterprise, Embedded and Semi-custom annual revenue was flat. Both segments posted operating profits for the year, and it is particularly noteworthy that the Computing and Graphics segment was profitable for the first time in 6 years. Based on the overall strength of the business and our new high-performance products, we have set a strong foundation for achieving our long-term financial model. +Now let me turn to our results for the fourth quarter of 2017. Total revenue of $1.48 billion grew 34% year-over-year, driven by strong Radeon and Ryzen product demand. On a sequential basis, revenue declined 10%, better than expected, driven by seasonally lower semi-custom sales and partially offset by strong demand for new CPU and GPU products. Gross margin was 35%, expanding 3 percentage points year-over-year, primarily due to a larger portion of revenue coming from Computing and Graphics, driven by our new high-performance products. +Operating expenses were $412 million compared to $357 million a year ago. The increase was driven primarily by R&D and new product go-to-market investments, partially offset by an R&D credit related to a technology development agreement. Operating income was $103 million, up significantly from $26 million a year ago, and operating margin was 7%, up from 2% a year ago. +AMD received a onetime tax credit of $18 million as a result of U.S. corporate tax reform, which resulted in a net tax benefit of $8 million in the quarter. Net income was $88 million, or diluted earnings per share of $0.08, as compared to a net loss of $8 million or $0.01 per share in the year-ago period. Adjusted EBITDA was $142 million compared to $60 million a year ago, and adjusted EBITDA for 2017 was $445 million. +Now turning to fourth quarter business segment results. Computing and Graphics segment revenue was $958 million, up 60% year-over-year due to strong sales of our Radeon graphics and Ryzen desktop processors. Computing and Graphics segment operating income was $85 million compared to a loss of $21 million a year ago. The strong improvement was due to higher revenue. +Enterprise, Embedded and Semi-Custom revenue was $522 million, up 3% year-over-year, driven by server revenue. Operating income was $19 million, down from $47 million a year ago, primarily due to the absence of a licensing gain and ongoing R&D investments, partially offset by the benefit from a richer product mix. +Turning to the balance sheet. Our cash and cash equivalents totaled $1.18 billion at the end of the quarter, up from $879 million in Q3 due to significantly higher cash flow from operations. Inventory was $739 million, down slightly from the prior year and down 7% from the prior quarter. Total principal debt, including our secured revolving line of credit, was $1.7 billion. +In the fourth quarter, we deployed cash to repurchase $38 million of long-term principal debt resulting in a total reduction of long-term debt of $138 million in 2017. Our gross leverage ratio has improvement from 10x in 2016 to 3.8x at the end of 2017. +Free cash flow was $339 million, up sharply from $32 million in the prior quarter. Q4 is typically our strongest cash flow quarter, and for the year, free cash flow was $45 million negative due to increased working capital in support of higher revenue. +Before we turn to guidance, I want to highlight that we are adopting the new revenue recognition accounting standard effective 2018. We are adopting this standard under the full retrospective method, which we believe is most helpful to our investors. For the full year 2017, the impact of the accounting change to revenue was immaterial, and we expect the impact to be immaterial on 2018 annual revenue. +For the first quarter 2018, AMD expects revenue to be approximately $1.55 billion, plus or minus $50 million, an increase of 32% year-over-year, primarily driven by the strength of the ramp of Ryzen GPU and EPYC products. For comparative purposes, under the new accounting method, Q1 '17 restated revenue was $1.18 billion and Q4 2017 restated revenue was $1.34 billion. In addition, for Q1 2018, we expect non-GAAP gross margin to be approximately 36%; non-GAAP operating expenses to be approximately $435 million or approximately 28% of revenue; non-GAAP interest expense, taxes and other to be approximately $30 million; and inventory to be up sequentially in support of higher revenue. +For 2018, we expect double-digit percentage growth in annual revenue, greater than 36% non-GAAP gross margin, non-GAAP operating expenses to be approximately 28% of revenue. In addition, we expect a tax rate of approximately 10% of pretax income for 2018. +In summary, we made significant progress in 2017. We are pleased with the momentum in our business and delivered outstanding top line revenue growth, margin expansion and achieved profitability for the year. We continue to make strong progress towards our long-term target financial model, and our goal in 2018 is to deliver significant revenue growth and increase profitability as we continue to invest in our multi-generational high-performance product road maps. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura Graves, - [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [2] +-------------------------------------------------------------------------------- + + Can you please give us the puts and takes for the Q1 guide? There are lots of moving parts, and so I think that would be helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes, absolutely, Hans. Thanks for the question. So our Q1 revenue guidance was up 32% year-on-year, and if you take a look at that, it's actually significantly better than our typical seasonality. Primarily, that's due to the new product strength. So we see GPUs, Ryzen and EPYC, all up in Q1, and that's contributing to the strong guidance. We do expect that the semi-custom business will be down in Q1 relative to the first quarter of 2017 just due to the fact that we're in the sixth year of the cycle. So if you actually take the new product strength, the guidance is actually over 32% year-on-year. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then the seasonality of semi-custom will continue to be weaker on a year-over-year basis for the rest of the year. Is that the way to model that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. So what you should be -- expect with semi-custom is, on a full year basis, the revenue will be likely down compared to 2017 just due to where we are in the cycle, and units will be down. There will be a bit of an adjustment to the seasonality as we move over to the new accounting regulations with 606, and so we'll see, let's call it, a bit more revenue in the first half and a bit less revenue in the second half. So for the year, it is very similar, and then we'll see a little bit of shift in the quarterly profile. But again, back to the -- your question -- your initial question on the Q1 revenue guidance, it is really driven by new product strength. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question is coming from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [7] +-------------------------------------------------------------------------------- + + Following on from your answer to Hans' question, Lisa, can you give us some feel for the revenue, the new product momentum in terms of sales in the fourth quarter '17? And in particular, any numbers on Ryzen, EPYC or Vega? Absolute sales dollars or sequential growth in Q4 would be helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Yes, absolutely, David. So we had a very strong Q4. If you look at the overall business, it was up 34% year-on-year. If you look underneath that, the Computing and Graphics business was very strong. So we saw 17% sequential growth, significantly better than seasonality. That was up on client, particularly Ryzen desktop, had a very strong holiday. We also started initial shipments on Ryzen Mobile. And then on the graphics side, we saw strength in all product lines, so we saw strength in the channel for both gaming as well as blockchain. We saw strength in OEMs as we ramped Apple with our Vega processors. We also saw strength in professional graphics as we launched some GPU compute into the data center. So overall, those were the puts and takes. Semi-custom was down sequentially, and again, that's as expected given the typical seasonality of the semi-custom business. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [9] +-------------------------------------------------------------------------------- + + And Devinder, it might have been nested in what you -- your prepared remarks. But do you expect your net debt will grow in the seasonally weak first half of 2018? And if so, how much might net debt go up? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [10] +-------------------------------------------------------------------------------- + + Net debt, when you say net debt, just explain that, David. What do you mean by that? + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [11] +-------------------------------------------------------------------------------- + + Well, debt minus cash. Presumably, well, do your cash balances fall during the first half of the year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [12] +-------------------------------------------------------------------------------- + + The debt levels came down in 2017 because we did repurchase some of the long-term principal debt to the tune of $134 million. And in the guidance we provided, we said that 2018 would be free cash flow positive. So if anything, I guess, the net debt, as you look at it, would come down as we get to the second half of 2018. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [13] +-------------------------------------------------------------------------------- + + But any help in the first half? What happens to the net debt in the first half? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [14] +-------------------------------------------------------------------------------- + + Typically, we invest in the business. As you saw in the guidance, I expect inventory to be up in Q1. And obviously, with the strength of the business momentum that Lisa just talked about, we're prepared to go ahead and purchase product, a way for us to go ahead and fund the business. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [16] +-------------------------------------------------------------------------------- + + Lisa, I was hoping you could give us a little more color on EPYC. Are we starting to get past pilot programs now and getting deployed into production environments? And can you give us a sense of the take of EPYC in the cloud versus enterprise? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [17] +-------------------------------------------------------------------------------- + + Yes, absolutely, Mark. So well, we are pleased with where we are with EPYC. We think we've made a very nice progress as in the fourth quarter. We announced that the large OEMs are now qualified and starting to ship to end customers. And so we have seen some very nice design wins in sales at some marquee end customers. If you look across education, financial services and the hosting business, those are looking good. On the cloud side, we have publicly talked about Microsoft Azure as well as Baidu adopting EPYC in their cloud of environments. We are working with a number of the other cloud players to adopt EPYC, and we're working on some of the optimizations required there. So overall, we're very pleased with the momentum. I think we always knew that there was a qualification cycle to go through, but we've gotten through some of the major qualifications here in the fourth quarter and especially as we looked in December, we actually closed a number of new deals with the platforms being available for sale. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [18] +-------------------------------------------------------------------------------- + + That's helpful. And then on the C&G side, very impressive growth. Can you give us a sense of to what extent that growth was driven by Ryzen products versus Radeon? And then on the Radeon side, can you give us a sense of what blockchain was to the contribution and how you're viewing the sustainability of that? It seems like it's getting consistently strong. So appreciate any updates on your view on that segment. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [19] +-------------------------------------------------------------------------------- + + Yes, absolutely, Mark. So look, on the Computing and Graphics segment, we grew about $140 million sequentially, and if I look at that growth, it was across Ryzen and Radeon. If you look at blockchain in particular, our estimates are that it was about 1/3 of the growth, 1/3 of the $140 million, and then the rest of the 2/3 are around the GPUs -- the other segments of GPUs and Ryzen. When I look going forward, clearly, blockchain is a little bit of a fluid and dynamic market. We did see some strength as we went into December. We see strength as we're going into the first quarter. I'm sure many of you have seen that the graphics channel is very low, and we're certainly working to replenish that channel environment. So we think that graphics in general is going to be strong into the first half, and that's some of what's contributing to our strong Q1 guidance. But overall, my comments are we're seeing nice momentum across Ryzen and all of the GPU segments, which is important for us as we go into 2018. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [21] +-------------------------------------------------------------------------------- + + My first is on gross margin. Can you give us a feeling -- do you expect Q1 to be the trough for gross margins through the year given you're guiding in line to maybe a little above for the year, where you're guiding Q1? And can you give us some feeling on the puts and takes of gross margins as we go through the year, particularly around things like business mix, lower seasonality and lower growth on semi-custom versus some of the new products for example? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [22] +-------------------------------------------------------------------------------- + + Yes. Stacy, I can take that, and then Lisa maybe can add. As we start the year, as Lisa said, we do see momentum from the new products, the Ryzen, the GPUs and EPYC, and the margin is up on a sequential basis. We're starting off the year at 36%. We previously said that, for 2018, we expect margin to be greater than 36%, so it is a good start to the year, starting off well with a 36% guide. Obviously, the new products are having benefit then. And then the one thing I will add from what Lisa said earlier, in particular with the semi-custom business timing, is there is some incremental semi-custom revenue that gets recognized in Q1 as compared to the past from a timing in the year standpoint. But overall, I think the 36% is where we are starting off in Q1 and very pleased with that. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Yes. Stacy, the only... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + So you do believe Q... + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + Sorry, go ahead. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + I was just saying, so you do believe Q1 is probably a trough in terms of gross margins? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [27] +-------------------------------------------------------------------------------- + + Clearly, Stacy, the first half of the year is usually the weaker half of our business because we are a consumer-led business. So as we -- starting off with 36% margin in Q1 is a good start. And we do expect that the new products will continue to ramp as we go through 2018. So I think that's how we view the puts and takes going forward. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + For my follow-up, I know your competitors saw some unusual strength in the enterprise market and enterprise spending in Q4. I understand your exposure at this point to those enterprise wins is certainly less. But what are you seeing in terms of enterprise ramp? Are you seeing anything unusual or more or less sustainable in terms of strength versus what you'd ordinarily expect to see this time of the year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [29] +-------------------------------------------------------------------------------- + + Yes, Stacy. I think your question is about the market, and our market share is still relatively low. So our exposure with EPYC is there's a lot of activity, so there's a significant amount of activity with customers, both in all segments, cloud and enterprise. Although I wouldn't say that, that's necessarily a market trend. I would say that's sort of where we are with our EPYC qualifications and ramp. And so we don't see -- for example, we don't see that Q4 was especially strong, and there will be a drop-off in Q1. In fact, we expect that EPYC should grow as we go through Q1 and the rest of 2018. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [31] +-------------------------------------------------------------------------------- + + For my first one, just a clarification. I know it's been off a few times. But what would your Q1 sales and gross margin outlook have been under the older accounting methodology? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [32] +-------------------------------------------------------------------------------- + + Vivek, we're adopting the new revenue accounting standard under what is the full retrospective method because we believe this is most helpful to the investors, and for good measure, we have provided the Q1 '17 and Q4 '17 on a restated -- we restated the revenue and obviously, the Q1 2018 guidance under 606. We will publish the restated numbers as part of our 10-K. And from a Q1 2018 standpoint, if you look at the numbers, let's say, you compare to Q4 '17 on a seasonal -- on a sequential basis, the revenue is up quarter-on-quarter, and largely that's the strength of the new products in Q1 2018. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [33] +-------------------------------------------------------------------------------- + + All right. I ask that -- you're starting the year at a very strong 30%-plus base, and you're saying double-digit growth for the year. And double digit is a very, very wide range. So Lisa, could you help us at least get some level set of what double-digit growth means for the year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [34] +-------------------------------------------------------------------------------- + + Yes. So we are starting the year strong, Vivek. I think maybe to give you a little bit more color on your question as it relates to the Q1 guidance. We are -- as Devinder said, we are giving all guidance and forward-looking comments on 606. However, the largest impact, particularly as it relates to revenue, is really sort of the semi-custom business. As you know, our custom business is a little bit unique because it's a singular customer, and so under the new revenue recognition rules, we would actually take revenue with non-cancelable POs. So that impact in the first quarter sort of guidance would have been about, let's call it, $100 million or about thereabouts. And so that might help you calibrate where we are. I think the -- any way you look at it, the new product strength is the most important factor, but we also want to be clear on what the accounting rule impact would be. Does that help you, Vivek? + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [35] +-------------------------------------------------------------------------------- + + Yes, Lisa, very helpful. And for my follow-up, traditionally, there has been a very large price delta between in your and Intel product, sometimes 50%, 60% plus on PCs and servers. As you look ahead with the new products, are you starting to see some of that price conversion? Like, are you being positioned in segments where you had not been previously, so you can get the benefit of much better ASPs than you've had historically? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Yes, Vivek, absolutely. So if we look at 2017 full year and look at our ASPs in the client business, the graphics business and the server business, albeit it's early, we are definitely seeing a significant ASP expansion as a result of the fact that our products are now covering the higher end of the market. So we're competing very well in the higher end of the market. I expect that there's still a delta, but that delta is converging given our product coverage. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [38] +-------------------------------------------------------------------------------- + + Lisa, while the year-over-year gross margin improvement has been strong both in the calendar sort of third quarter, fourth quarter and now on the guide in the first quarter, the sequential gross margin leverage is perhaps a little bit less than I would have thought, especially as you move into Q4 and Q1 and semi-custom comes down. Now I know there's been sort of a lag effect as Ryzen grows as a percent of the mix, but maybe you can help me understand where we are as far as Ryzen as a percent of the mix being a positive influence on gross margin. And then just relative to your long-term gross margin target of 40% to 44%, how far does Ryzen get you before you become more dependent on EPYC ramps later this year into 2019 and beyond? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- + + Sure. So a lot of different questions there, John. Let me try to unpack it there. So let's talk about sort of Ryzen and sort of the margin both Q4 and Q1. On the Ryzen -- to give you sort of a flavor of where we are in terms of the new product ramp, Ryzen Q4 was probably in the high 40s percentage of our overall client business, and we expect that, that will be over 50% starting in the first quarter of 2018. And so that ramp definitely helps, and it's part of our sequential 100 basis point improvement from Q4 to Q1. I think in terms of overall new product revenues, if you take Ryzen, EPYC and then our new graphics products in totality, in Q4, they were about 33% of our revenue, and we expect that to ramp nicely as we go into 2018. So I think we are getting the margin leverage. The margin leverage certainly from Q4 to Q1 is due to the fact that we have strong products. And the thing that's a little bit different this quarter is because we are guiding under 606, and as a result of that, semi-custom, which is typically seasonally down Q4 to Q1, in this case, is actually up a little bit Q4 to Q1. And so that's a headwind on the margin, but overall, we're still up 100 basis points. Does that kind of get to the gist of your question? + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [40] +-------------------------------------------------------------------------------- + + No, that's helpful, Lisa. And then maybe a second question just on the OpEx. Revenue for the calendar first quarter, significantly above where the Street was expecting but so was OpEx. And I'm curious, is there any sort of unusual expenses around Spectre or Meltdown that's going on? And then to continue that, for the full year, you're guiding OpEx about in line with your long-term target. So is there opportunity that your long-term target can come down and maybe 28% of revenue on OpEx comes down over time? Or how should we think about that leverage? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [41] +-------------------------------------------------------------------------------- + + Yes. So look, so relative to OpEx, I think our long-term guidance was 26% to 30%. Calendar year 2017, we were roughly approximately 30% if you look at it for the full year basis. We're guiding 2018 to approximately 28%, so we're starting to see some of that leverage granted we're starting off in Q1, which is usually a low quarter for us. And then as we go forward, we're certainly looking at more leverage in the model, but we are investing in sort of the key new products. We are investing in software, and I think that's absolutely the right thing for us to do. As it relates to any unusual expenses with Spectre and Meltdown, there are no particular unusual expenses related to that. I think what we are doing is we're investing in the business. We believe strongly in the product road map that we have, and given the significant revenue growth, we believe we can afford to invest in the business. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [43] +-------------------------------------------------------------------------------- + + I'm wondering if you could talk a little bit about the product that you announced with Intel over the course of Q4, the semi-custom graphics product. I guess, interesting to see a few companies working together. Can you put that product into context for us? Are there things that you could do going forward? And then just is that going to be in the semi-custom part of revenues or in the compute part? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Sure, Joe. So the product that we announced with Intel was a semi-custom graphics product. So what we're doing is we're selling silicon to them. And then they're packaging it in a multi-strip module, and they're marketing it and selling to end customers. From my standpoint, this is an excellent way to get more Radeon GPUs in as many applications as possible. And so our strategy is we'll build our own standard products. We will build custom products for customers and then look for how do we get Radeon in as many places as possible. For this graphics revenue, because it's very similar to discrete graphics, we're actually reporting it in the Computing and Graphics segment, and we did see some initial revenue from that in Q4. But it is -- as I said, it's a semi-custom chip that is sold to them with their -- to be packaged with their products. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [46] +-------------------------------------------------------------------------------- + + Lisa, one for you back on the crypto side of things. It was great to see the incremental color that you gave. But is there any way you could give an absolute dollar amount, whether it be in the fourth quarter or just full year '17 and how much you believe crypto contributed to your revenues? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + Yes, absolutely, Ross. So it is hard to estimate. I think we said before it's hard to estimate just given some of the crypto -- sort of GPUs are sold through the same channels as our gaming channel. I previously said we thought it was about mid-single digits percentage of our annual revenue. It may be a little bit higher than that. Let's call it 1 point or so, but it's really a lot of our growth is outside of the blockchain market. What we see in the market though is, because I know there's a lot of conversation about this out in the market, it is an important market. I mean, we're now seeing it from the standpoint of there is a lot of dynamic movement in the market, but it is consuming a lot of GPUs. It's a good part of our business, and we intend to sort of work with the large players to better forecast that business going forward. But I don't want that to take away from the fact that we had significant growth in the GPU business outside of blockchain as we really ramped the Vega product line, as we ramped our GPU compute product line, as we ramped our Apple. And so those are all important pieces of our GPU story. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [48] +-------------------------------------------------------------------------------- + + Perfect, that's helpful. As my follow-up, I wanted to go back to a statement you said in answering a prior question about the semi-custom business being up sequentially and then saying it was about $100 million benefit. Is that up sequentially you're talking about relative to the fourth quarter pre or post the ASC adjustment? Just trying to tie this altogether and kind of get the moving parts behind your guidance because it is much higher than, I think, where many of us expected it to be. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- + + Yes. So let me try, and Devinder may keep me -- make sure that we're clear here. So the $100 million that I referenced was relative to the Q1 '17 adjustment, which was approximately $200 million or so. If you look at it on a sequential basis, it won't be up $100 million. It'll be up somewhat less than that, but typically, we're quite -- we're down quite a bit in semi-custom. And so it is a different seasonal pattern than we would normally see. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our next question is coming from Brett Simpson from Arete Research. + +-------------------------------------------------------------------------------- +Brett William Simpson, Arete Research Services LLP - Senior Analyst [51] +-------------------------------------------------------------------------------- + + I just had a question on crypto. I mean, if I look at the amount of hash compute being added to Ethereum in January, I mean, it's more than the whole of Q4. So we've seen a big start to the Q1. So I'm just wondering, what's the balance or the sort of mix in your C&G division between GPU and CPU sort of looking at Q4 and how it changes at Q1? And is there any sort of acute shortages here? I mean, can your foundry partners -- do they have the capacity to support you with the ramp of GPUs at the moment? And is there enough HBM2 DRAM to source as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [52] +-------------------------------------------------------------------------------- + + Yes, right. So in relation to your question about client and graphics, look, both the client business and the graphics business grew sequentially in Q4. So both of them were strong businesses for us, and as I said, there are -- crypto was one driver, but there were numerous other drivers as well. Relative to just where we are in the market today, for sure, the GPU channel is lower than we would like it to be. So we are ramping up production. At this point, we're not limited by silicon per se, so our foundry partners are supplying us. There are shortages in memory, and I think that is true across-the-board, whether you're talking about GDDR5 or you're talking about high-bandwidth memory. We continue to work through that with our memory partners, and that will be certainly one of the key factors as we go through 2018. + +-------------------------------------------------------------------------------- +Brett William Simpson, Arete Research Services LLP - Senior Analyst [53] +-------------------------------------------------------------------------------- + + And just a follow-up on 7-nanometer. I mean, a lot being talked about at 7 with the TSMC ramping fairly shortly and also Intel being perhaps a little delayed on 10-nanometer. Can you talk about what your plans are for 7-nanometer in 2018? Can you ship a CPU platform based on 7-nanometer in -- this year? Or is there -- are you also seeing some delays in 7 with your foundry partners? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [54] +-------------------------------------------------------------------------------- + + So relative to 7, 7 is a very important node for us. We're doing very active development to the 7 across our GPU and our CPU portfolio. Relative to shipment dates, I'll wait until we get closer to production before we talk about that. But what we have said is that we will sample a GPU here in 2018 targeted at machine learning, and that will be in 7-nanometer technology. And we are also actively working on CPU products in the 7-nanometer technology as well. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question is coming from Tristan Gerra from Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [56] +-------------------------------------------------------------------------------- + + You've mentioned that you expect very strong demand from blockchain in the first half. How aggressive are you in terms of embedding that type of trend in your Q1 guidance? Just trying to get a sense of the contribution from that segment in your Q1 guidance. And also, is the margin profile any different than the rest of your GPU business? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + So I think as we said on the Q1 guidance, it is really strength across our new products, so it's not just the blockchain or crypto conversation. That's one factor, but we do see strength across the rest of our GPU business as well as our CPU business with Ryzen and EPYC. So of course, we take into account what we believe the demand will be here in the first quarter, and we think we're fairly balanced with that. And overall, given the current lead times, I think we have good visibility into what the order pattern is and so on and so forth. So I think the key point is crypto is strong right now but we do believe that it is a very dynamic environment, and so we have to watch that step very closely. And there are numerous other product drivers in our Q1 guidance, including the CPU business, which is an important driver. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [58] +-------------------------------------------------------------------------------- + + Okay. And as a quick follow-up, in terms of the ramp of EPYC, should we look at a linear ramp throughout this year? Or is there more of an inflection point at any given time that you would expect or any given quarter that you would expect this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [59] +-------------------------------------------------------------------------------- + + I do expect a steady ramp of EPYC as we go through the year. Our target is to be at mid-single-digit unit share by the end of 2018, and so there would be significant revenue from EPYC as we are in the second half of '18. But certainly, I would expect a steady ramp throughout the year. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Our next question is coming from Srini Pajjuri from Macquarie. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [61] +-------------------------------------------------------------------------------- + + Just a couple of clarifications. First, I guess, Devinder, the accounting change, you kind of gave us an explanation how the seasonality works for Q1. I'm just curious as to how your seasonality changes as we go into Q2, Q3 and Q4 because, historically, you were down in Q1 and kind of flattish in Q2 and then up in Q3 and Q4. So just trying to understand how the accounting change impacts that seasonality. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [62] +-------------------------------------------------------------------------------- + + Yes. I think the more significant change is from our semi-custom business. So we're going to see acceleration of revenue in the first half as opposed to where it used to be weighted towards the second half of the year. And that's just a timing issue within the year. Annually, there's not much impact. It's pretty immaterial from that standpoint. But timing-wise, you will see recognition of revenue earlier in Q1 and Q2, and then, obviously, we still have it in Q3 and Q4. So seasonality for the semi-custom business changes. As Lisa stated earlier, typically, Q4 to Q1 is down, and now Q4 to Q1 is up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- + + Yes. But I would add, though, just for that seasonality question. I think what you'll see is perhaps a little bit of a flatter profile. We used to have a very high peak in Q3, and now I think you'll see a little bit of a flatter profile with sort of second quarter still being higher than first quarter, third quarter or higher than second quarter, and then fourth quarter, we would expect to be down. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [64] +-------------------------------------------------------------------------------- + + Great. And then, Lisa, just another clarification on Ryzen. Obviously, you're seeing very strong ramps. I would have expected you to see a little bit of ASP benefit in Q4, but it looks like ASPs came in flattish. I'm just curious as to why they're only flat, not up sequentially. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [65] +-------------------------------------------------------------------------------- + + Yes, sure. So I think when you look at the ASPs, it's very dependent on the actual mix. And so underneath the client ASPs, we actually saw desktop a little bit lower, and that's because the desktop sales in the holiday season were a little bit more weighted to Ryzen 3, which has a lower ASP than some of the Ryzen 5 and Ryzen 7. But we actually saw mobile ASPs up because we saw the beginning of the shipments of Ryzen Mobile, which pulled ASPs up. So it's just a -- the detailed mix of the business. But overall, I think we saw very strong growth. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Our final question today is coming from Ambrish Srivastava from BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [67] +-------------------------------------------------------------------------------- + + Devinder, I just had a question on free cash flow since I pester you so much on it. Good to see a solid quarter on that front. But my question really is how should we -- you've guided for an increase in free cash flow for next year. Should we expect the same kind of dynamic that you've had this year, seasonality in Q4? And then also, you had to build up working capital and inventory specifically because of the dynamics on memory and the tightness earlier on the year. So what are some of the puts and takes there if you could please help us with that? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [68] +-------------------------------------------------------------------------------- + + Yes. I think as you rightly observed, I mean, our strong quarter from an overall standpoint where cash is concerned, and cash from operations are very strong in Q4 and free cash flow was $339 million, ending at the $1.18 million, there is typically pressure on cash in the first half of the year just given the fact that the revenue is there, and we buy the wafers to support the business. And then it gets better in the second of the year. As far as working capital is concerned, it's a little bit early to tell. I think it depends upon how the revenue unfolds. Obviously, we have managed it pretty well, but supporting the higher revenue from the strength of the business is going to be the key from that standpoint. But to your point, I do feel very good as to where the cash ended up. I do feel very good with how we have done from managing the balance sheet for working capital and the debt levels. And 2018, we are guiding to free cash flow being positive for the year. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [69] +-------------------------------------------------------------------------------- + + Okay. And a quick follow-up for you, Lisa. If we look at the double-digit growth for this year, what are the absolute dollar drivers in terms of which product categories do you expect within EPYC GPUs for machine learning or for Ryzen if you were to rank order those in terms of absolute dollar impact this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [70] +-------------------------------------------------------------------------------- + + Yes. So if I were to rank order those, I would say that both EPYC and Ryzen, as we deploy Ryzen more into the notebook form factor, which is very significantly ramped, are very key for that. I think GPUs in machine learning are also a strong growth driver for us. But just given sort of where we are from the base that we're starting with, I think the other 2 are just more significant. + +-------------------------------------------------------------------------------- +Laura Graves, - [71] +-------------------------------------------------------------------------------- + + Thank you, Lisa. Thank you, Devinder, and to everyone who joined our call today. We appreciate you joining the fourth quarter conference call. We look forward to speaking with you again soon. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2018-Jul-25-AMD.txt b/Transcripts/AMD/2018-Jul-25-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef43d00d46a9dd98a925b0adc98e099f0e8a32b0 --- /dev/null +++ b/Transcripts/AMD/2018-Jul-25-AMD.txt @@ -0,0 +1,647 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Advanced Micro Devices Inc Earnings Call +JULY 25, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Wayne A. Loeb + Citigroup Inc, Research Division - VP + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Second Quarter 2018 Conference Call. By now, you should have had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, www.AMD.com. +Participants on today's conference call are: Dr. Lisa Su, President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. +This is a live call and will be replayed via webcast on our website. I would like to highlight a couple of important dates for you. Jim Anderson, Senior Vice President and General Manager of Computing and Graphics, and Ruth Cotter, Senior Vice President of HR, Worldwide Marketing and Investor Relations, will attend the Jefferies 2018 Semiconductor, Hardware and Communications Infrastructure Summit on August 28. Also, Devinder Kumar, Senior Vice President and Chief Financial Officer, will present at the Deutsche Bank Technology Conference on September 12. And our 2018 third quarter quiet time will begin at the close of business on Friday, September 14, 2018. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and, as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +We will refer primarily to non-GAAP financial metrics during this call, except for revenue, gross margin and segment operational results, which are reported on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in the press release posted on our website. Please refer to cautionary statements in today's press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC, and, in particular, AMD's quarterly report on Form 10-Q for the quarter ended March 31, 2018. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [2] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. We ended the first half of 2018 strong, delivering our fourth consecutive quarter of double-digit year-over-year revenue growth, driven by increased demand for our high-performance products. +Second quarter revenue of $1.76 billion grew 53% year-over-year, and gross margin improved more than 3 percentage points, resulting in our highest quarterly net income in 7 years. We are very pleased with the year-over-year financial performance across both of our business segments as we continue to gain share driven by strong customer adoption of our new products in the PC, gaming and data center markets. +Looking at our Computing and Graphics segment, second quarter CG segment revenue increased 64% year-over-year, driven by strong demand for our Radeon GPUs and a significant ramp of our Ryzen mobile processors. Ryzen unit shipments grew strong double-digit sequentially, as Ryzen mobile processor shipments more than doubled in the quarter. Acer, Asus, Dell, HP, Huawei, Lenovo and Samsung launched dozens of Ryzen processor-based notebooks, which position us well to continue growing Ryzen mobile sales heading into the back-to-school and holiday seasons. +In the commercial PC market, we launched our Ryzen PRO commercial mobile APUs in the quarter. For the first time in our history, all 3 major commercial OEMs: Dell, HP and Lenovo, now offer enterprise-class notebooks and desktops powered by AMD, and we are seeing strong initial interest as customers evaluate these new systems. +Continuing our strong roadmap execution, we launched our second generation Ryzen desktop CPU to very positive reviews in April, just 13 months after the first Ryzen desktop processors were released. Additionally, in June, we delivered the first public demonstration of our second generation AMD Ryzen Threadripper processors with the industry's first 32-core PC processor designed for the high-end desktop market. We are on track to launch our second generation Threadripper processor in August, with leadership performance for the enthusiast and content creation markets. +Overall, we are very pleased with the market adoption of our Ryzen processors. 44 consumer and commercial Ryzen-based desktops and notebooks have been launched this year, and our customers remain on track to bring a total of 60 Ryzen-based systems to market in 2018. +In Graphics, strong channel and data center demand drove significant year-over-year increases in revenue and ASPs. Sequentially, graphics revenue was down, primarily driven by lower blockchain-related sales, partially offset by stronger data center sales. Sales into the high-end enthusiast and performance portions of the gaming market grew substantially year-over-year based on the adoption of our latest Radeon RX 500 and Vega series GPUs. We continue to execute our software strategy to provide the best gaming experience in the industry with new AMD Radeon GPU drivers published for every major game launched in the quarter, and expanded partnerships with Ubisoft, Capcom and Rebellion to optimize their next generation of games on Radeon graphics. +On the hardware side, we continued to expand the adoption of our Radeon Vega architecture with the introduction of new OEM systems and AIB cards in smaller and more mobile form factors. Samsung also announced they added our FreeSync technology to many of their high-end TVs, giving PC and console gamers the ultimate big screen gaming experience. The AMD FreeSync ecosystem is the broadest in the industry, with more than 400 FreeSync-enabled monitors and TVs in market to date. +Data center GPU revenue increased significantly in the quarter, driven by Vega-based Radeon Instinct MI25 shipments. Our GPU engagements with large cloud customers continued to expand as we increased our investments in hardware and open software solutions in this important space. At COMPUTEX this year, we showed the first public demonstration of our next-generation 7-nanometer Radeon Vega GPU, which includes new features optimized for the artificial intelligence and machine learning markets. We started sampling of this product in the second quarter and we are on track to launch this next-generation product, the world's first 7-nanometer GPU, later this year. +Turning to our Enterprise, Embedded and Semi-Custom segment. Second quarter segment revenue increased 37% year-over-year, primarily driven by strong semi-custom sales and growing adoption of our EPYC data center processors. +Starting with our server business, we celebrated our 1-year anniversary of the launch of our EPYC server processors with an increase of greater than 50% in both revenue and unit shipments sequentially. We have over 50 customer platforms now in market, including Cisco, who announced their highest density server offering ever powered by EPYC processors; and HP Enterprise who launched their first EPYC-based single-socket ProLiant server, which delivers significantly lower cost per virtual machine than the leading dual socket competitor. +We also saw strong progress with our mega data center partners, as Tencent Cloud announced immediate availability of their SA1 Cloud service, delivering 30% lower cost per VM with outstanding performance across key workloads. Shipments for mega data center customers more than doubled in the quarter as we made significant progress towards qualification of production instances at multiple cloud providers in anticipation of deployments planned in the second half of this year. We're also seeing momentum from Tier 2 next wave cloud service providers that have the ability to ramp quickly with a noted preference for the value and capability that our EPYC single-socket offering brings. +Turning to large enterprise customers. We added dozens of new end customers in the quarter. Our value proposition continues to be strong in segments like HPC, data analytics and in general-purpose virtualized enterprise environments. We are extremely focused on accelerating EPYC processor adoption in these targeted segments in the second half of the year. +Finally, I'm very pleased with our execution against our long-term roadmap. We received first silicon of our next-generation 7-nanometer EPYC processor with Zen 2, codename Rome, in the second quarter, and the silicon quality and bring up has gone very well. I am happy to report that we recently started sampling Rome to select partners for early validation, and we are on track to launch in 2019, strengthening our already outstanding competitive position in the market. We remain focused on our near-term milestone of achieving mid-single-digit server unit share by the end of 2018 on the path to our midterm goal of double-digit market share. +Moving on to our Semi-Custom and Embedded businesses. Semi-custom revenue increased year-over-year and sequentially in support of Sony and Microsoft game consoles. We are proud that Microsoft and Sony have collectively shipped well over 100 million AMD-powered game consoles in the current cycle. The game console market continues to be an important segment for us in the long term and we are well-positioned based on our strong partnerships and differentiated IT and design capabilities. Embedded sales increased by double-digit percentage year-over-year, driven by growth across the embedded gaming, industrial and medical imaging markets. We also saw strong initial design wins for our new EPYC and Ryzen Embedded product families following their launch last quarter. +In closing, we are very pleased with our second quarter financial results. We delivered strong revenue growth, and margin expansion as demand for our new high-performance products continued to accelerate. Most importantly, we believe our long-term technology bets position us very well for the future. Several years ago, we made important decisions around our CPU and GPU roadmaps to drive leadership at the 7-nanometer node. We now have line of sight to those products coming to market and we see incredible opportunities ahead based on the competitive positioning and customer interest in our upcoming 7-nanometer products. We are confident that with continued execution, we are on an excellent trajectory to drive market share gains and growth in revenue and profitability. We are focused on that continued execution as we make significant investments in our hardware and software roadmaps to deliver even more compelling products to our customers in the 2019 and 2020 timeframe. +Now I'd like to turn the call over to Devinder, to provide some additional color on our second quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [3] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. +Q2 was another strong quarter for AMD. Year-over-year, we grew revenue 53% and expanded gross margins 37%, while significantly growing operating margin and earnings per share. Quarterly revenue of $1.76 billion was higher year-over-year, driven by strength across all product lines. Gross margin was up 360 basis points year-over-year, driven by the ramp of new products. +Operating expenses were $467 million or 27% of revenue, down as a percentage of revenue from 34% a year ago. We are delivering operating leverage while launching new products and making strategic R&D investments to support our multi-generation -- multigenerational product roadmaps. R&D investments in the first half of 2018 increased 25% as compared to the first half of 2017 in support of our future product roadmaps. +Operating income grew to $186 million from $23 million a year ago. Operating margin was 11% and both our business segments reported double-digit operating margin percentage. Adjusted EBITDA was $228 million compared to $58 million a year ago, and, on a trailing 12-month basis, adjusted EBITDA has grown considerably to $666 million, resulting in gross debt leverage of 2.5x. +Net income was $156 million, a significant improvement compared to a loss of $7 million 1 year ago. This is our highest quarterly net income since 2011. Non-GAAP diluted earnings per share was $0.14 using a diluted share count of 1,147 million, compared to a loss of $0.01 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $1.1 billion, up 64% year-over-year, led by strong sales of both Radeon and Ryzen products. Ryzen products accounted for approximately 60% of client revenue, and we saw a particular strength in Ryzen Mobile processors in the second quarter as new notebook products continued to ramp. +Strong channel and data center demand drove year-over-year graphics revenue increases. Sequentially, graphics revenue was down, primarily driven by lower blockchain sales, partially offset by stronger data center sales. We believe blockchain-related revenue declined from approximately 10% of our revenue in the first quarter to approximately 6% of our overall revenue in the second quarter. +Computing and Graphics segment operating income was $117 million or 11% of segment revenue compared to operating income of $7 million 1 year ago. The significant increase was due to strong revenue growth coupled with improved operating expense leverage. +Enterprise, Embedded and Semi-Custom revenue was $670 million, up 37% year-over-year, driven primarily by semi-custom and EPYC processor sales. These results include higher-than-anticipated semi-custom revenue in Q2 due to higher inventory, with noncancelable purchase orders in accordance with ASC 606. EPYC processor units revenue grew greater than 50% quarter-over-quarter, primarily driven by mega data center sales. EESC operating income was $69 million or 10% of segment revenue, up from an operating income of $16 million a year ago on higher revenue. Q2 2017 operating income for EESC also included a licensing gain of $25 million. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $983 million at the end of the quarter. Free cash flow was negative $88 million in the second quarter due to working capital requirements in support of recent revenue growth. Inventory was $750 million, up slightly from the prior quarter. Total principal debt, including our secured revolving line of credit, was $1.7 billion. +Now turning to our financial outlook. For the third quarter 2018, AMD expects revenue to be approximately $1.7 billion plus or minus $50 million. This would be an increase of approximately 7% year-over-year, primarily driven by higher sales of Ryzen and EPYC products, partially offset by lower sales of GPU products in the blockchain market. Sequentially, this would be a decrease of approximately 3%, with higher Ryzen and EPYC processor revenue offset by lower GPU revenue. +In addition, we now expect semi-custom revenue to be lower sequentially in Q3 following higher-than-expected Q2 revenue. As a reminder, for comparative purposes, Q3 2017 revenue was $1.58 billion adjusted for ASC 606 revenue accounting standards. +In addition, for Q3, we expect non-GAAP gross margin to be approximately 38%, up from 36% in the prior year, driven by the ramp of Ryzen and EPYC product sales; non-GAAP operating expenses to be approximately $470 million or 28% of revenue; non-GAAP interest expense, taxes and other to be approximately $35 million; and free cash flow to be positive. +For the full year 2018, we continue to expect revenue growth of mid-20s percent, gross margin in excess of 37% and to be free cash flow positive. +In closing, Q2 was an excellent quarter, and 2018 is expected to be a solid year. I am pleased with our business execution and financial results, driven by the strength of our high-performance product portfolio. We remain focused on executing our long-term financial model for revenue growth, margin expansion and improved profitability. +Now with that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [4] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question here in the room. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + Lisa, for you. On the -- it seems Intel seems to have pushed their 10-nanometer volume ramp out into 2019, and I think a lot of people view your foundry 7-nanometer kind of the same ZIP code as their 10-nanometer. So I'm wondering if you could give us some context and/or color on what does this mean? Does -- is it -- if you're at parity with Intel -- has AMD ever been at parity before with Intel? And does that change the conversation with your customers in terms of their interest in your products? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes, Mark. So look, in terms of our roadmaps, both on the CPU and GPU side, we made some important technology decisions a couple of years ago and we bet heavily on 7-nanometer. We thought 7-nanometer would be a big node for the industry and it would be important for us to be early in the adoption of 7-nanometer. So when you look at where we are today, especially on the CPU side, we have first silicon of our Rome product. It looks very good. We also have a good number of architectural improvements and enhancements in Zen 2 that will come with 7-nanometer technology. So we're very pleased with where we are and where the competitive positioning is. And I would say, to your question about how is it perceived, I think customers are very interested in where we are. I mean, clearly, we have to execute. But with our current generation Naples, customers have certainly gotten to understand our architecture with the improvements that we have going into 7-nanometer with Rome. I think there is enhanced interest and from a competitive positioning standpoint, we do believe we have an excellent competitive position going into 2019. So we are very, very excited about that. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + A follow-up, if I may. As we look at the double-digit bogey for next year on servers, is that -- do you need EPYC 2 to get to that? And what are the risks on bringing that to market? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. So Mark, we view the double-digit share goal as an important share goal. I think it certainly will come with the second generation of EPYC, so the Zen 2 product. But I view that as a journey, right? I mean, we have now sort of 3 generations that we have: we have Zen 1 that's in the market today, we have Zen 2 that's well into the productization phase and then we have a very strong roadmap around Zen 3 as well. So we feel good about our competitive position and the path to double-digit market share. I think this is all about rate and pace and we're working very, very closely with our customers to accelerate that ramp. And actually, I was very pleased. I mentioned in the prepared remarks earlier that in the second quarter, we saw some nice acceleration of the mega data center customers so we saw units there more than double, and that's an indication that were getting the right level of engagement and progress with our large customers. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [7] +-------------------------------------------------------------------------------- + + Lisa, I wonder if you could just give us a little bit more detail into the foundry strategy at 7-nanometers. And kind of how much flexibility do you have between your 2 foundry partners? And to what extent if one of them is having trouble on the 7, does the Wafer Supply Agreement kind of give you the ability to move capacity without having to pay for wafers? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Yes, sure, John. So a couple of years ago, we did amend the Wafer Supply Agreement. It was a very strategic agreement for us as we look over the long term. So at 7-nanometer, we are engaged with both TSMC and GLOBALFOUNDRIES. I would say that we do have, on a product-by-product basis, the choice between the foundries and we make those decisions on a product-by-product basis. But in terms of our long-term roadmap and how we feel about it, both on the GPU and CPU side, the main message is, we don't believe process technology is going to be a gate for us. We have a lot of architectural work, a lot of architectural improvements, but we don't believe process technology is a gate for our roadmap. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [9] +-------------------------------------------------------------------------------- + + And then Lisa as my second question, can you help me better understand, because one of the things I know you've been working on aggressively with the launch of EPYC 2 is your ability to cover a broader swath of workloads and just increase kind of the server TAM you can go after. So can you help quantify to me kind of as you go from EPYC 1 to EPYC 2 what that growth in workload coverage looks like? And importantly, as you continue to broaden out, how do we think about the R&D burden from here? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- + + Yes, sure, John. So when we go from the first generation of EPYC to the second generation of EPYC, I do think that there are some improvements that we'll make in the architecture that will expand the TAM. But from a TAM standpoint, we are not limited. I mean, I view our coverage today as 80% of the TAM. And yes, some workloads are really clean kills, and other workloads are closer, but we are servicing a large portion of the TAM. I think the value proposition increases with some of the architectural improvements that we've made in the second generation of EPYC, but from the standpoint of TAM, I think we feel good about it. From an R&D standpoint, and Devinder made the comment on our prepared remarks, that we did increase R&D by 25% year-on-year, but I think we've done it in a very responsible way. So we have revenue growth. We're seeing margin expansion, which is a very, very key piece of our business model. And then we will increase R&D and go-to-market resources effectively. But I don't believe that we will ever increase our OpEx ahead of revenue. I think it's a balance between each of those lines. So we have these -- I think, we have a strong roadmap at this point, and we'll look for opportunities to increase R&D, particularly on the software side, actually. I think we have a lot of opportunity on the software side across CPUs and GPUs to accelerate some of our machine learning work. And so that's where incremental R&D would go. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [11] +-------------------------------------------------------------------------------- + + And then if I could sneak one last one in, Lisa, just on the GPU side, I think this is the second or third quarter in a row that you've highlighted incremental gains inside of the data center. Can you help size what that represents as a percent of revenue today? And I guess, more importantly, as you bring to market the 7-nanometer GPU part, how you're think about exploiting that in the data center and kind of the TAM expectations, the revenue expectations we should have over the next kind of 4 to 8 quarters? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [12] +-------------------------------------------------------------------------------- + + Yes. So on the GPU side, there's no question that the demand for GPUs in the data center are growing very quickly, even faster than on the CPU side, for sure. And our data center engagements -- our focus on the GPU side is very cloud-centric. So large customers, places where are GPU capability can be well targeted. I would say the size of the business is still small, so we are growing, but it is still small. But there's lots of interest in our current generation MI25. And there's even more interest in our 7-nanometer Vega GPU that's coming to market later this year. So we expect an opportunity to grow that segment over the next 4 to 8 quarters. And as you can see in the market, overall, the GPU segment is growing quite a bit in data centers. And so we'll continue to invest heavily in this area. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [14] +-------------------------------------------------------------------------------- + + I wanted to just start with a clarification and then I have a follow-up. What's the assumption for blockchain revenue in Q3 and for the full year? And just if you have an updated view of overall 2018 sales growth? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Yes, sure, Vivek. So let me take that, and then Devinder can add as necessary. So for Q2, we were approximately 6% of revenue for blockchain. For Q3, we're planning very little blockchain, so we expected it to be down in the second half, but we're planning very little in Q3. And so if you update that on a full year basis, for 2018, blockchain will be lower than what we had previously discussed in the last earnings call. So I would say, previously, we said mid- to high-single digits, I think this will be a more on the mid-single digit side. And we'll continue to watch the market develop over the next couple of quarters. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [16] +-------------------------------------------------------------------------------- + + All right. And then, Lisa, have you seen any competitive response from Intel so far in either PCs or servers? For example, some of your desktop parts saw some ASP decline. Was it just mix or price competition? Or anything else that we should keep in mind? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [17] +-------------------------------------------------------------------------------- + + Yes, sure, Vivek. So let me take each of the segments separately. So if you look at the PC segment, what we have seen is basically a ramping of our product portfolio. Certainly, in desktop, we had some mix here in the second quarter where we increased the percentage of the APUs that were being sold into the desktop channel segment, and so you saw a little bit of a mix to -- a bit softer desktop ASPs. But overall, when I look overall, I would say that the competitive situation is about what I would expect. There's product competition, and we see that. We do ensure that there is good transition of products. So when we moved from our first generation Ryzen to our second generation Ryzen, we had some channel programs to make sure that we manage channel inventory on the first generation. But we've seen nothing that I would call unusual. And on the notebook side, actually, I'm pretty pleased, because we're really seeing the notebook side of the business pick up and so mobile ASPs were up. The percentage of Ryzen units in mobile were up and we see that continuing into the second half of the year. And then on the EPYC side, again, I would say that the competition is really product based and for us, there's some workload optimization that we do with customers, but I haven't seen anything that's unusual relative to the pricing environment and, in fact, as EPYC ramps, our ASPs are going up. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [18] +-------------------------------------------------------------------------------- + + All right. And one last quick one, if I may. When should we expect to see the breakout quarter for EPYC, Lisa? Will that be Q3, Q4? What's the visibility around that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [19] +-------------------------------------------------------------------------------- + + I think we are very focused on ensuring we deliver that mid-single-digit unit share at the end of 2018. I think as we go into the second half of the year, I would still see it as fourth quarter would be a real important quarter for us. I think we'll see ramps into third quarter. And the key is, as you know, with some of these cloud partners, their -- it's actually important when they actually ramp these larger instances. And so lots of visibility into work being done and the exact timing will depend on our customers' ramps. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [21] +-------------------------------------------------------------------------------- + + Lisa, a couple questions on the server business, and then I'll follow-up on a couple of PC things. In server, you guys have sort of laid out this mid-singles unit share number by the end of this year. And maybe you can walk us through that with a little bit of granularity, like how do you balance the what seems to be really high demand within the cloud customer base for Rome versus pushing volumes in the near-term of Naples? And I think some folks had asked a couple of questions around process nodes and you're obviously sampling already with Rome, so maybe you could be explicit about where you're manufacturing that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [22] +-------------------------------------------------------------------------------- + + Yes, sure. So a couple of different questions here, Matt. On the EPYC, your question is Naples versus Rome and how we manage that. Look, our focus from sales and go-to-market standpoint right now is on Naples. First generation EPYC, we have a lot of platforms in market, over 50 platforms in market. There are a lot of customers that have systems in their labs going through various stages of qualification, and we're very focused on supporting that and ensuring that we see that ramp into the second half of the year. Rome is really a 2019 story. I think the good part about it is I expect that customers perhaps took a little bit longer in their initial qualification and sort of work around Naples, and our hope is that, as we go into Rome, you'll see those qualification timelines tighten up a little bit. But no question that for 2018, it's a Naples story, and there's a lot of customer interest around Rome, and we will manage that. But we want to make sure that we also do as much of the validation work on our side before we sample too broadly. I think the good news is there's a lot of interest and it's really just on us to execute cleanly through the next couple of quarters. And Matt, you had some other questions or... + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [23] +-------------------------------------------------------------------------------- + + Yes, I mean, the last on there on server was about manufacturing for Rome, and then I'll just -- talk about some -- one thing on the PC side, particularly notebooks, one of the questions I'm getting most often from investors is as the product portfolio from AMD improves dramatically, and I think will again as you guys go to 7-nanometer, it seems like winning sell-in share with OEMs is something that you guys have a bit of control of. But I wanted to ask a little bit about sell-through and consumer adoption and sort of mindshare around your client products. Intel has wound down a little bit some of the Intel Inside marketing program, and I know you maybe have some opportunities there. Maybe you could talk about some of the steps that your marketing team is making to sort of maybe change and refresh some of the consumer perception of the products relative to how quickly they have improved fundamentally? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [24] +-------------------------------------------------------------------------------- + + Yes, absolutely. So Matt, on your first question relative to the manufacturing of the second generation of EPYC. So as I said earlier, we are working with both TSMC and GLOBALFOUNDRIES in 7-nanometer. As for the 7-nanometer Rome that we're currently sampling, that's being manufactured at the TSMC. And then your second question about where we are in that PS -- PC market, sell-in versus sellout share -- actually, it's a great question. It's a great question. And when I look at the PC market, we have great relationships with the OEMs. I mean, you can see it from the number of platforms that we have out there. But there's no question that there's opportunity for us to get the consumer perception and the commercial enterprise perception up. And so we've been very focused on that and that comes with additional investment in go-to-market expenses. So getting the Ryzen brand out there, getting the Radeon brand out there, it includes additional training at some key retailers to ensure that they know how to sell Ryzen and they know what the value proposition is. And what we see is some clear signs of early momentum in sellout. So as our platforms launched here in the month of June, we actually saw on quite a few of the outlets that they've actually sold out of our product and we've had to restock that here quickly. And as we go into the second half of the year, I think you'll see, in both back-to-school and in holidays globally, that we have a larger presence of assortment than we have had in the past. So that's a clear focus for us in the PC market. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + First, I wanted to ask about Ryzen share. I thought I heard you say that Ryzen was 60% of your CPU revenues in the quarter. I thought that's what you said it was last quarter as well. So how do I reconcile that with the other color around the sequential growth of Ryzen into Q2? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [27] +-------------------------------------------------------------------------------- + + Yes. So Stacy, it was approximately 60%. And when you look at it on a quarter-on-quarter basis, we had more units overall in desktop and notebook. Particularly in notebook, we saw an acceleration of Ryzen mobile units in the notebooks. So it's an approximate number, it's not an exact number, but it's approximately 60%. We also saw some legacy business increase, and that's why you see that. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + Okay. So basically, it's maybe like a little below 60% before, and like a little above 60% now but kind of around 60%? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [29] +-------------------------------------------------------------------------------- + + In that range, exactly. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + Okay. For my second question, you said you had EPYC up more than 50% sequentially. I think it doubled last quarter, it's up 50% this quarter. But I think you're still running, call it, 1%, maybe little kind of in that ballpark of share. So if you're going to get 5% [x] in the year, I mean you've got to probably triple or more the current run rate by Q4. And I know you had mentioned earlier that Q4 was going to be kind of like an important quarter. Is that the kind of, I guess, ramp rate or run rate you're actually thinking about this EPYC business into the back half of the year in order to meet your targets? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [31] +-------------------------------------------------------------------------------- + + Yes, Stacy. I mean, I think, we view an acceleration as we go into the second half of the year, particularly as some of these guys go into larger production. But yes, there are a significant number of more units. I think we just see a pipeline that can accomplish that. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Got it. One quick housekeeping, just why did the accounts receivable go up so much? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [33] +-------------------------------------------------------------------------------- + + Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [34] +-------------------------------------------------------------------------------- + + Sorry, I didn't get the question, Stacy? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + Accounts receivable. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + Sorry. Accounts receivable, why did they go up so much? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [37] +-------------------------------------------------------------------------------- + + Yes. It went up, primarily, it's higher revenue and timing of collections. So that's the main reason. In addition, there was an increase in this associated unbilled AR for semi-custom revenue, which, as you know, is recognized under ASC 606. That -- those parts have not shipped, but they get recognized as revenue, and that's it says, unbilled AR under the AR line. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [39] +-------------------------------------------------------------------------------- + + Maybe if you could talk a little bit about the Chinese JV and the product that's being developed there that you've licensed? Can you talk about when you expect to see that product emerge? And how do you think about that sort of AMD proper competing with the JV within those Chinese customers? Are you agnostic to who wins or just how should we think about that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [40] +-------------------------------------------------------------------------------- + + Sure, Joe. So we did start this Chinese JV a couple of years ago and the whole idea was to get more share in the domestic China market. The partnership has gone well, the product development is going well. We view the product as complementary to our current portfolio. So I think from that standpoint, we will continue to sell sort of AMD EPYC into the China market. And then for a certain domestic China applications, I think the China JV product will be available. They have not yet announced the exact timing of that, so I'll wait until the official announcement of it. But so far, it's gone as expected and I think the product development has gone quite well. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [41] +-------------------------------------------------------------------------------- + + Next question? + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + Lisa, a couple of questions. The timing of the Ryzen version of 7-nanometer after EPYC, when will that happen in 2019? Is that a quarter after or 6 months, just the timing? And the second question is, how many of the mega data center guys are you actually engaged with at the moment? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Yes, okay. So Hans, on the timing of the 7-nanometer Ryzen, I would just keep it as it's after the 7-nanometer EPYC. So we'll launch 7-nanometer EPYC first. I wouldn't say it's very far out, but I would say it's after. And then in terms of mega data centers, we are engaged with all of them in some way, shape or form across CPU and GPU. On the CPU standpoint, I would say we are heavily engaged with 5. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Kevin Cassidy with Stifel. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [46] +-------------------------------------------------------------------------------- + + Question. Just again on EPYC, you are very clear that it was going to be about 4 quarters in qualification before your customers would start deployment. With EPYC 2, are there any programs in place or can we expect there to be a shorter amount of time before that could be deployed? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + Yes, Kevin. So I believe -- and, of course, we'll have to see how this plays out. But I think with EPYC, there were some customers who waited for us to completely qualify before they started, let's call it, their own evals, and that's to be understood because we were sort of returning to the market. I think with the second generation of EPYC, one would expect that there would be some customers who would do, let's call it, parallel qualifications with our own qualifications. And so I think there is an opportunity to sort of overlap some of that work, and certainly, that's part of the reason that we've started early sampling as early as we have to try to parallelize some of that activity. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [48] +-------------------------------------------------------------------------------- + + Okay, great. And on the GPU traction you're getting in the data center, is there a high attach rate with your EPYC processors? Or is that just an independent traction? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- + + I would say, at the moment, sort of for 2018-type revenue, they are independent engagements at the moment. I think, as we move into the 7-nanometer node with both EPYC and our Vega 7-nanometer, there will be more of an attach rate, and there is more interest, frankly, in that attach. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [51] +-------------------------------------------------------------------------------- + + How should we think about OpEx growth over the next several quarters? It seems like you've been growing OpEx kind of in the 20%-plus range? Should that moderate going forward or should we expect that to stay relatively stable? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [52] +-------------------------------------------------------------------------------- + + I think, the first thing is if you look at our model that we've laid out, we've said the long-term target model to stay within the range of 26% to 30%. This year, with the revenue guide at the Q in the mid-20s, we're guiding to about 28% OpEx to revenue. Year-over-year basis, you're right, we have increased it, and largely, those increases have been in R&D. If you look on the first half of 2017 to the first half of 2018, OpEx is up, but it's largely weighted towards the R&D side. We are pleased with the operating leverage that we are getting from a company standpoint with the increase in revenue, but at the same time, targeted investments very heavily in the product roadmaps, and some of the things that you heard Lisa just talked about from the products and all of the multiple levers that we have to increase revenue, we are definitely investing in those areas. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [53] +-------------------------------------------------------------------------------- + + Great. And as a follow-up, Lisa, it's been a little bit over a year since you laid out your long-term financial model. I realize crypto has been sort of a tailwind since then. But is it fair to say that you guys are on track to hit the $0.75 and above EPS number ex crypto? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [54] +-------------------------------------------------------------------------------- + + Yes. I think, Toshi, if you look at the long-term financial model and put aside sort of temporal things, and we feel that we are on track towards that long-term financial model. In some places, we are ahead; in some places, we are on track; but overall, I think we feel good about where we are towards the long-term financial model. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Chris Danely with Citigroup. + +-------------------------------------------------------------------------------- +Wayne A. Loeb, Citigroup Inc, Research Division - VP [56] +-------------------------------------------------------------------------------- + + This is Wayne Loeb for Chris Danely. What kind of performance improvement will 7-nanometer EPYC have over the current one? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + Yes, Wayne, I think we are -- we're not yet getting into details of what the performance improvement is of the 7-nanometer EPYC. So I think we'll have more details on the architecture and where we are in performance later this year. + +-------------------------------------------------------------------------------- +Wayne A. Loeb, Citigroup Inc, Research Division - VP [58] +-------------------------------------------------------------------------------- + + As a follow-up, you talked about your goal of mid-single-digit share for EPYC by end of the year. At end of the year, what do you think your share would be in desktops and notebooks? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [59] +-------------------------------------------------------------------------------- + + I think we'll continue to make progress in desktops and notebooks. In particular, I think, we expect that the notebook share will increase as we go into the second half of the year. Obviously, the PC market overall is doing a little bit better than most people expected and so we'll have to see how the market does. But from our standpoint, we don't have a specific share target out there for end of this year. We believe we'll continue to gain share based on what we see in design wins at this point. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava with BMO Capital. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [61] +-------------------------------------------------------------------------------- + + I'm sorry, if you addressed it earlier on the call. What is the timing for the 7-nanometer GPU? And then my related question on GPU is, could you just update us on what's the progress on the software ecosystem, and specifically, in competition with the mode -- seemingly, huge mode that Nvidia has built with CUDA. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [62] +-------------------------------------------------------------------------------- + + Sure, Ambrish. So our 7-nanometer GPU is -- started sampling here in the second quarter, and we will launch it later this year. So it will launch -- we expect it to launch in 2018. As it relates to the software ecosystem, we're making good progress. We're making incremental progress each quarter. And the important thing and the reason -- our strategy right now in GPUs in the data center is to engage with sort of large cloud guys who have the ability to work with us and, in some sense, we're focusing our software efforts on their needs first. And that allows us to kind of do this sort of vertical by vertical. So I think we're making good progress. It's a multiyear effort, and we are very clear that it's a multiyear effort, but we have seen some initial positive momentum and we're going to continue to invest in this space. So it's the #1 investment priority for us. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [63] +-------------------------------------------------------------------------------- + + So in data center, Lisa, sorry, just a quick follow-up. What areas have you been able to gain traction in within the -- and it's a pretty large area, but within machine learning, where specifically have you been able to wedge yourself in? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [64] +-------------------------------------------------------------------------------- + + Yes, again, we're working with several cloud vendors on sort of key applications in their data center. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [65] +-------------------------------------------------------------------------------- + + Thanks, Ambrish. Operator, we have time for 2 more questions, please? + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + No problem. Our next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [67] +-------------------------------------------------------------------------------- + + I just -- I apologize to continue to go back to EPYC, but just curious, as we think about the ramp, you've mentioned that you have over 50 platforms now in the market. I'm just curious if you were asked to characterize how many of those were shipping in volume, and what your expectation would be through the course of the remainder of this year in terms of those turning into true meaningful volumes? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [68] +-------------------------------------------------------------------------------- + + Yes, so I'm thinking about that. I would say a number of those platforms -- a large majority of those platforms are shipping to multiple customers. So volume, of course, is all relative. But -- and the way we count platforms are, obviously, platforms from the OEMs as well as platforms from ODMs and a number of the cloud guys are doing their own platforms or specific platforms. So I would say a large number of those, the majority of those would have -- are shipping to multiple customers. And production -- sort of the scale of the production is what -- is customer dependent. So some of them are in hundreds of units, some of them are in thousands of units, some of them are in tens of thousands of units and -- different scale of numbers. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [69] +-------------------------------------------------------------------------------- + + Okay, fair enough. And then as a quick follow-up, as we think about the ramp of some of your new platforms going forward and we kind of tie that to your long-term gross margin target of, I think it was 40% to 44%, can you just remind us again of how we can think about the mix in terms of the margin profile of some of the new businesses ramping? And how quickly maybe we should consider that 40-plus percent target of gross margin? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [70] +-------------------------------------------------------------------------------- + + Well, we're guiding the third quarter to 38% gross margin. That's largely on the strength of the new product portfolio. I think what we said before, which still holds, is our Ryzen, our EPYC, our Radeon data center products are all, in aggregate, over 50% from a gross margin standpoint. They're well above the corporate average. I think we're starting to see the mix and that margin accretion of the new products, and so we'll continue to do that over the next couple of quarters. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [71] +-------------------------------------------------------------------------------- + + So, I guess, it's fair to -- yes, I guess I'm just trying to -- I guess given the commentary around the fourth quarter and EPYC, really that being an important quarter, could we assume that gross margin from here continues to trend higher? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [72] +-------------------------------------------------------------------------------- + + Well, I think it's fair to say that, as we go into the second half of the year, our new products will be a larger percentage of our overall product revenue. And that is positive from a margin standpoint. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Tim Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [74] +-------------------------------------------------------------------------------- + + I had 2. I guess, when I look at the stock there's not -- I'm not sure that there's a lot of doubt about the share gain targets this year. But maybe there is some question about the ability to sustain those targets next year and the year after. So I guess the question -- first question is, what are you doing differently this time that was not done in the Opteron cycle? Are you giving customers more visibility to your roadmap? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [75] +-------------------------------------------------------------------------------- + + Tim, I think the major thing that we're doing differently as a company and certainly around EPYC, is we are doing what we said we were going to do. We laid out a 5-year roadmap to what we wanted to do in servers. We told them what first generation EPYC would look like. It came out a little bit better than they expected. We told them when to expect second generation EPYC and what we were trying to do with that. And I'm really pleased to say that we're exactly on track to what we said we were going to do. And we have a third generation behind that. So our focus is to execute really, really well and provide the customers the differentiation in the value proposition to consider us as a long-term partner. We are not after what happens over the next 2 quarters. I mean, this is extraordinarily -- it's a journey for us with EPYC, and I think we feel good about what we've done and the entire team is focused on delivering what we said we were going to do. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [76] +-------------------------------------------------------------------------------- + + Got it, Lisa. And I guess, just the last question is really around the strategic foundry roadmap beyond 7-nanometer. Clearly, you have a lead now that -- because Intel is going to really, I think, functionally skip over 10-nanometer, which is great, and maybe it was -- it's a little bit unexpected given when you began development of these parts. But how do you think strategically beyond 7-nanometer as you move to 5-nanometer with your partner? And where Intel will be at that time? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [77] +-------------------------------------------------------------------------------- + + What we see in the foundry roadmap is actually a very nice cadence of technologies. So we do believe 7-nanometer will be a large node. There will be derivatives of 7-nanometer: 7-nanometer, 7-nanometer plus. We have seen the first view of 5-nanometer, and we think 5-nanometer is very competitive as well. So again, our goal is to use the best that process technology can offer in the foundry market, and then differentiate on architecture and sort of product positioning and those kinds of things. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes our question-and-answer session. And I would like to turn the call back to Laura Graves for closing remarks. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [79] +-------------------------------------------------------------------------------- + + Thank you, operator. And to everyone who joined our call today through Q&A, thank you very much. Appreciate your time and we'll speak to you again soon. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2018-Oct-24-AMD.txt b/Transcripts/AMD/2018-Oct-24-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..eeec1db083c8ae6ec7fe3ba78d5798ad5af69c90 --- /dev/null +++ b/Transcripts/AMD/2018-Oct-24-AMD.txt @@ -0,0 +1,648 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Advanced Micro Devices Inc Earnings Call +OCTOBER 24, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the AMD Third Quarter 2018 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to turn the call over to Laura Graves. Please go ahead, Laura. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and, yes, welcome to AMD's Third Quarter 2018 Conference Call. By now, you should have had an opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, www.amd.com. +Participants on today's conference call are: Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight some important dates for you. AMD's next Horizon event is scheduled for Tuesday, November 6, 2018, where we will discuss innovation of AMD's products and technology specifically designed for the data center on industry-leading 7-nanometer process technology. Dr. Lisa Su, President and Chief Executive Officer will present at the Crédit Suisse 22nd Annual Technology, Media and Teleconference on Tuesday, November 27; and our 2018 fourth quarter quiet time will begin at the close of business on Friday, December 14. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and, as such, involve risks and uncertainties that could cause actual results to differ materially from our expectations. +We will refer primarily to non-GAAP financial measures during this call except for revenue, gross margin and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced today are reconciled to their most directly comparable GAAP financial measure in today's press release posted on our website. Please refer to the cautionary statements in our press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and, in particular, AMD's quarterly report on Form 10-Q for the quarter ended June 30, 2018. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. We executed well on the third quarter. We continued to build momentum for our new products as strong sales of our Ryzen and EPYC processors offset soft GPU channel sales and drove our fifth consecutive quarter of year-on-year revenue growth, increased profitability and margin expansion. Third quarter revenue was $1.65 billion, an increase of 4% from a year ago. +Looking at our Computing and Graphics segment, third quarter CG segment revenue increased 12% year-on-year, driven by significant growth in both client processor and OEM GPU sales that offset a larger-than-expected decline in channel GPU sales. Ryzen processor sales increased to more than 70% of our total client revenue in the quarter. We delivered our highest processor unit shipments in nearly 4 years and believe we gained desktop and notebook client processor unit share in the quarter, driven by growth with both OEMs and in the channel. +In desktop, we had strong demand for our higher-end Ryzen 7, Ryzen 5 and Ryzen Threadripper processors, helping to drive a double-digit percentage year-over-year and sequential improvement in client processor ASP. We expanded our desktop offerings in the quarter, bringing our Zen processor core and Vega graphics to the entry-level part of the market with the Athlon APU and launching our flagship 32-core Threadripper 2 processor. With these new introductions, we now have a top to bottom lineup of client processors based on our high-performance Zen architecture. +In notebooks, Ryzen Mobile processor unit shipments doubled sequentially for the second straight quarter as OEMs ramped production of their latest AMD-based notebooks. 54 of the 60 Ryzen processor-based notebooks planned for 2008 (sic) [2018] have launched, with the final notebooks expected to go on sale this quarter. Based on the success of first-generation Ryzen Mobile notebooks, the expanded breadth of our customer engagements and our design win momentum, we are on track for an even larger assortment of AMD-powered notebooks in 2019. +In graphics, the year-over-year revenue decrease was primarily driven by significantly lower channel GPU sales, partially offset by improved OEM and data center GPU sales. Channel GPU sales came in lower than expected based on excess channel inventory levels caused by the decline in blockchain-related demand that was so strong earlier in the year. OEM GPU sales in the third quarter increased by a strong double-digit percentage year-over-year as new design wins began to ramp, including first shipments of our mobile Vega GPUs to support new premium notebooks launching this quarter. +In professional graphics, revenue increased by a double-digit percentage from a year ago, driven by data center GPU sales as we continued to gain traction in this important part of the market. We launched the Radeon Pro WX 8200 GPU for workstations in the quarter, delivering the world's best workstation graphics performance under $1,000 on real-time visualization, VR and photorealistic editing workloads. We remain on track to launch the industry's first 7-nanometer data center GPU this quarter. Customer interest in the product is strong based on its performance and differentiated feature set, and we have already secured multiple data center wins with shipments expected to begin in the fourth quarter. We continued to increase investments in GPU hardware and software to deliver industry-leading products that we believe will drive growth in the gaming, professional and data center markets. +Turning to our Enterprise, Embedded and Semi-Custom segment. Third quarter revenue decreased 5% year-on-year primarily based on semi-custom sales declining, as expected, as current generation consoles entered their sixth year. +In server, we delivered our third straight quarter of strong double-digit percentage sequential revenue and unit shipment growth. We are seeing the largest demand for our top of the stack 24- and 32-core EPYC processors, which combine industry-leading core count and I/O to deliver performance advantages across cloud, virtualization and HPC workloads. We continued to accelerate engagements with our cloud service providers, highlighted by yesterday's announcement that Oracle launched new AMD-powered emphasis that offer significant TCO and performance advantages on general-purpose cloud workloads and Oracle applications. We expect additional Tier 1 cloud service providers to announce availability of new EPYC processor deployment this quarter. We secured multiple new customer wins on the HPC front, including Microsoft's announcement they would offer an EPYC processor-based supercomputing instance, and that Haas Racing has chosen Cray to build an EPYC-powered supercomputer to improve their computational fluid dynamics modeling for future cars. +Turning to enterprise adoption. We continue to build a strong pipeline and accelerate the ongoing ramps of EPYC-based offerings from the major OEMs, including Cisco, Dell and HP Enterprise. In the third quarter, we added dozens of new end customers across oil and gas, health care, aerospace, banking and other industries based on the superior performance of EPYC processors in both data analytics and general-purpose virtualized workloads. We began sampling our next-generation Rome server chip broadly across our customer base in the third quarter, and the feedback on this leadership product is very strong. As a result, cloud and OEM customers are engaging earlier, deeper and more collaboratively with us on both Rome and our long-term data center road map. We remain on track to exit the year with mid-single-digit server unit market share based on cloud customer adoption. And based on our strong competitive position and broad customer engagements, we believe we can achieve double-digit server unit share with Rome. +In closing, 2018 remains an inflection point for AMD as we expect to exit the year with well over 50% of our revenue coming from new products, driving significant margin expansion. The foundational changes we have made across the business to strengthen our execution, and the investments we have made to deliver a leadership Computing and Graphics road map are paying off. Our current generations of high-performance CPUs and GPUs are doing very well in market, putting us on track to increase profitability, grow revenue and expand margin for the second straight year. We see significant opportunities to build on this momentum as we transition to our next generations of high-performance products and launch the industry's first 7-nanometer x86 CPUs and discrete GPUs over the coming quarters. Demand for our high-performance computing offerings remains strong, and our product portfolio and competitive positioning are getting stronger. We remain focused on executing our strategy and delivering our leadership product road map. +Now I would like to turn the call over to Devinder to provide some additional color on our third quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa. Good afternoon, everyone. Q3 was a good quarter for AMD as revenue, operating margin and earnings per share grew year-over-year. Gross margin was 40%, highlighted by the continuing ramp of our new Ryzen and EPYC products. We strengthened the balance sheet, reduced long-term debt by $97 million and further improved our gross leverage. Quarterly revenue of $1.65 billion was up 4% year-over-year, driven by higher Computing and Graphics segment revenue with higher client revenue more than offsetting global graphics revenue; third quarter revenue including IP-related revenue, of which $86 million was related to our THATIC joint venture. +Gross margin was 40%, up 390 basis points year-over-year, primarily driven by the ramp of new products, including Ryzen and EPYC processors. On a sequential basis, gross margin was up 280 basis points primarily driven by IP-related revenue and the ramp of new products. Excluding IP-related revenue and memory and inventory-related adjustments, third quarter gross margin would have been 2 percentage points lower. Operating expenses grew 12% year-over-year to $476 million, driven by R&D investments in our product road maps and incremental go-to-market investments. Operating income grew to $186 million from $148 million a year ago. Operating margin was 11%, and both business segments recorded double-digit operating margin percentage. Net income was $150 million compared to $100 million a year ago. Non-GAAP diluted earnings per share, using a diluted share count of 1,177,000,000, was $0.13 compared to $0.09 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $938 million, up 12% year-over-year. Revenue growth was driven primarily by strong Ryzen product sales as we expanded our client compute offerings in the quarter. Ryzen products accounted for more than 70% of client revenue, up from approximately 60% last quarter as we saw strength in both desktop and notebook offerings across OEM and channel partners. In graphics, channel GPU sales were down year-over-year, partially offset by strong Radeon data center and OEM GPU demand. For comparative purposes, third quarter 2017 blockchain-related GPU sales were approximately high single-digit percent of overall AMD revenue, while blockchain revenue in the third quarter of this year was negligible. Computing and Graphics segment operating income was $100 million or 11% of segment revenues compared to operating income of $73 million a year ago. The increase was primarily driven by a richer client product mix and IP-related revenue, partially offset by lower graphics revenue. +Enterprise, Embedded and Semi-Custom revenue was $715 million, down 5% year-over-year. The year-over-year revenue decrease was driven primarily by lower semi-custom product and IP-related revenue, partially offset by higher server sales. For the third quarter in a row, EPYC processor units and revenue grew by strong double-digit percentages quarter-over-quarter. EESC operating income was $86 million or 12% of segment revenue. This is up from operating income of $74 million a year ago primarily due to a richer server and semi-custom product mix. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $1.06 billion at the end of the quarter, and we generated free cash flow of $62 million. Inventory was down sequentially from $750 million to $738 million. Total principal debt was $1.6 billion as we reduced our long-term debt by $97 million in the quarter. Term debt due in March 2019 is down to $66 million, and beyond that, there are no term debt maturities until 2022. Adjusted EBITDA was $227 million compared to $184 million a year ago, and on a trailing 12-month basis, adjusted EBITDA was $709 million, resulting in gross debt leverage of 2.2x. +Now turning to our financial outlook. For the fourth quarter 2018, AMD expects revenue to be approximately $1.45 billion, plus or minus $50 million. This would be an increase of approximately 8% year-over-year driven by sales growth of Ryzen, EPYC and data center GPU products. For comparative purposes, Q4 2017 revenue was $1.34 billion adjusted for the ASC 606 revenue accounting standard and included blockchain-related GPU sales of approximately low double-digit percent of overall AMD revenue. Sequentially, the midpoint of fourth quarter revenue outlook would be a decrease of approximately 12%, driven primarily by lower semi-custom sales. In addition, for Q4 2018, we expect non-GAAP gross margin to be approximately 41%, up from 34% in the prior year driven by the ramp of Ryzen, EPYC and data center GPU processor sales; non-GAAP operating expenses to be approximately $465 million; non-GAAP interest expense, taxes and other to be approximately $30 million; and free cash flow to be positive. For the full year 2018, we continue to expect annual revenue growth of mid-20s percent and to be free cash flow positive, and we now expect non-GAAP gross margin in excess of 38%. +In closing, the third quarter was a good quarter as we continue to ramp our new products. This momentum is driving improvement in our financial results against a backdrop of expanding customer demand as we prepare to ship and launch our first 7-nanometer GPU products before the end of the year. We are executing on our strategy and investment and financial priorities as we continue making excellent progress towards our long-term target financial model. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + First question, if I may, Lisa, as you look into the fourth quarter and maybe discuss also the third quarter, can you just review the important puts and takes on the revenues, on the microprocessor and GPU side separately? And I know you don't like to discuss the competition, but I think there are some unique things going on in the competitive environment. I think there's a view that Intel is capacity-constrained in -- with NVIDIA's new product launches, how is that impacting how we should be thinking about the revenues? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes. Mark, thanks for the question. So let me take those in order here. So if we just look at the third quarter revenue, I would say that we did see a shift in our revenue mix as we went through the third quarter. Looking at the individual product lines, we had expected that the client business would be strong as we were ramping quite a few new notebook OEM systems as well as we have strong desktop product portfolio. And we saw the client business was strong. It was actually up probably a bit stronger than we expected. The server business also performed quite well. In the graphics business, we had our OEM and data center compute business performing well, but we did see the softness in the channel that was larger than we expected, and that was due to some of the channel inventory comments that I made earlier. +Now as you shift into the fourth quarter, I think what we see is that our fourth quarter revenue mix really mixes towards the new products. And so what you see in the product lines are -- you'd see the client business continue to grow, and client is usually seasonally down into the fourth quarter. So we're doing better than seasonality with the client business. We expect the server business to grow as well as we get more traction with our EPYC products, especially in the cloud. And then we would expect, with our graphics business, that, that will also grow sequentially primarily on the strength of new products around our data center GPUs and the semi-custom business actually will decline sequentially. Semi-custom business always declines in fourth quarter. I would say this fourth quarter is a bit more pronounced. It gets a bit more pronounced as we get later in the cycle as well as the fact that the 606 accounting regulations tended to pull some of the revenue earlier in the year. But hopefully, that gives you a view of sort of the puts and takes around revenue. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + That's very helpful, and if I follow up if I may. I think I heard Devinder say that you're expecting to ship EPYC 2 before the end of this year. And if I think back to a dozen years ago when you had the second-generation server product, that kind of signaled an opportunity for an inflection in the revenues. How should we think about EPYC 2 as we go into early next year? And what does EPYC 2 bring to your customers that EPYC did not? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. So Mark, maybe just a correction. So I think Devinder's comment was that our 7-nanometer GPU would ship here in the fourth quarter, and we're on track to launch that here shortly. The second-generation of EPYC, our 7-nanometer CPU, will ship in 2019. We are broadly sampling it now. I think from what we see, the performance is very competitive. And also, many of our customers have had a chance to really spend time with the first generation of EPYC, get to learn our architecture and do much of the platform bring-up. So we're excited about what the second generation of EPYC can do for us. We're -- and we're going to talk a little bit more about that in a couple weeks at our data center event, but we believe that our competitive position gets stronger as we get into 2019. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question today is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + Lisa, can you give us the puts and takes -- or Devinder or both, on the gross margin dynamic in Q3? And also, in Q4? Is there an IP component in Q4? And I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Sure. Let me -- maybe let me start and then Devinder can add. So on the gross margin for the third quarter, I think we were up 4% year-on-year. We did have an IP component in this year as we had an IP component in the third quarter of last year. The majority of the improvement though was due to the positive product mix, sort of the client and server business really growing year-on-year and with that, improving the product mix. As we go into the fourth quarter, there is no IP-related revenue that's planned right now. So with the guide at 41% margin, we really are at the -- let's call it, the low end of our long-term guidance. And again, that's on the strength of the product mix. It's a very positive product mix for us. The processor business, as we've always said, the new products are accretive to margin. And so the client business is expected to grow. The server business is expected to grow. The data center GPUs are expected to grow. And then there is a portion of that, that is the semi-custom business declining sequentially, but I would say that's the smaller portion. It's really the positive product mix that's going into the Q4 guide. And maybe, Devinder, is there anything you wanted to add? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [9] +-------------------------------------------------------------------------------- + + No, I think you covered it, Lisa. Thank you. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [10] +-------------------------------------------------------------------------------- + + Great. And then a follow-up. If you don't mind as a follow-up. As we look into early 2019, what can we expect in terms of seasonality for the semi-custom part of the business and on the PC side just because there are some constraints out there that -- from Intel and so on? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [11] +-------------------------------------------------------------------------------- + + Yes. So look, if you -- Hans, our typical seasonality is the second half of the year is stronger than the first half of the year. As we go into 2019, you would expect that the semi-custom business will be down relative to this year and then you would expect that we're still going to need a bit of time to work through some of this graphics channel inventory that we have. But on the positive side, we do see strength in our processor business in both the client and the server side. As it relates to the current supply environment, we did see some pockets of constraints in the supply chain around PCs. We saw that towards the end of the third quarter. We are increasing our production such that we can satisfy some of that demand. And I think that's a short-term statement, but I think on a midterm statement, it's an environment where we're partnering very closely with our OEMs to make sure their requirements are met. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question is coming from Matt Ramsay from Cowen and Company. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [13] +-------------------------------------------------------------------------------- + + Lisa, I wanted to follow up a little bit on the last, I guess, couple of sentences in your prior answer there. There's a lot of things moving in the model near term, but as we think about how you're positioning the company in the client business over the next, I don't know, 24 months or so, with some supply constraints at Intel and some changes in their marketing support for OEMs for some of those programs and their spending, how do you think about how you're positioned with the key top 5 or 6 OEMs in terms of both PC and, I guess, desktop and notebook over the next 24 months? And sort of what are the puts and takes of how much you're really willing to lean into that business in order to gain unit share? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [14] +-------------------------------------------------------------------------------- + + Yes. Matt, thanks for the question. So on the PC business particularly around client processors, I am bullish on that business. It's a good business for us. Our products are very well positioned when you look at both the desktop and notebook segment. It was important for us to get these new platforms out into the market, and so we have 54 new notebook platforms that are out in the market with a few more to go as we enter -- finish up here the fourth quarter. I think the traction that we see in terms of unit shipments, the metric around Ryzen being 70% of our client business -- over 70%, and we expect that to continue to accelerate. So we're bullish on the client business as a good business for us to grow over the next 12 to 24 months. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [15] +-------------------------------------------------------------------------------- + + Got it. That's helpful. And just as a follow-up, I understand in a couple of weeks, you'll probably be talking a bit more about the data center GPU portfolio. But I guess there's been a lot of movement in software ecosystem as you've been working, and the team has, to develop the MIOpen product in terms of software. Maybe you could give us a little bit of an update on how you feel that's positioned for Caffe and Tensor, which, I guess, are the 2 key development environments for AI. And what do you think the long-term prospects for that business are over the next couple of years? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [16] +-------------------------------------------------------------------------------- + + Yes. So on the data center GPU business, this will continue to be an area of investment for us. I think we've made very nice progress this year. I think as we finish up the year, we expected to again make good progress. We have invested in -- on both the hardware and the software side. So I think the 7-nanometer GPU starting shipments here in the fourth quarter is important for us. And on the software side, yes, we will also be updating the status of our software environment. I think the nice thing is, as we say, the data center is just an enormous opportunity, whether you're talking about CPUs or GPUs, and we're engaging deeply with cloud customers who are spending the time and the resources to optimize to our architecture. So again, I think it's -- data center tends to take longer from design win to revenue, but we're starting to see some nice signals there. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question today is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [18] +-------------------------------------------------------------------------------- + + I had 2 of them really quick. So first is actually on the CPU side, the server side. So is there any reason why a 10-nanometer chip wouldn't be able to outperform your 7-nanometer product given that you've already been able to do some of the testing on the server side? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [19] +-------------------------------------------------------------------------------- + + Maybe I would answer the question this way. When we look at our 7-nanometer product and its positioning in 2019 across the server landscape, we feel very good about the positioning. I think it's not just 7-nanometer. 7-nanometer is important, but we've also made some significant changes to the architecture as well as how -- sort of the system. So I think overall, we feel, with the design and process capabilities, that our 7-nanometer products will be quite competitive. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [20] +-------------------------------------------------------------------------------- + + Got it. And then secondly from me, in terms of production, I know you guys have kind of given the mid-singles and kind of double-digit market share opportunity in the server side. So is that due to capacity constraint at TSMC? Or is that just due to your own estimates of what type of share you think you can get? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Well, we have a great relationship with TSMC. I think they're very supportive of our road map in 7-nanometer. So it's not due to any supply constraint. It's just due to the time that we believe that we'll take for vendors to really qualify new systems. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [22] +-------------------------------------------------------------------------------- + + Got it. Just -- and just one last really small one from me. The graphics business, the highest blockchain or cryptocurrency quarter was Q1 of '18. Is that correct? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + The highest -- it was between Q4 and Q1. They were pretty close. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [25] +-------------------------------------------------------------------------------- + + For the first one, Lisa, can you help us kind of quantify how much of a headwind was that excess -- the graphics inventory in Q3 and maybe also in Q4 so we can reconcile some of the differences between what you are reporting and guiding versus some of the consensus expectations out there? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [26] +-------------------------------------------------------------------------------- + + Yes, sure, Vivek. So the best thing I can say is when we look at the CG segment, that's a segment -- we're down about $150 million here in the third quarter. We had expected the segment to be down, but we probably expected it to be down about $50 million or so. And if you look at that difference from when we started the quarter, that's entirely the GPU channel. We had some other puts and takes in there, but it's basically the GPU channel. As we go into the fourth quarter, we do expect graphics to be up, and that's primarily on the strength of the data center GPU business, and we're modeling the channel as, let's call it, roughly flattish. It's seasonally about flattish, but given some of the inventory in the channel, that's how we're modeling. Does that help? + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [27] +-------------------------------------------------------------------------------- + + Yes. So basically, you're saying this problem kind of goes away in Q4 or you're done with it by now. Or can it continue to be a headwind in Q4? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [28] +-------------------------------------------------------------------------------- + + Well, we are expecting that it might take a couple of quarters to completely get back to, let's call it, a normal channel. However, it is factored into our Q4 guidance. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [29] +-------------------------------------------------------------------------------- + + All right. And then the second one, Lisa, is on the server business. So you outlined the target to get to mid-single digit exiting this year. Is the next 5% share easier or tougher to get? How do you think your competitor will respond? And how important is it to ramp your 7-nanometer product next year to get towards that -- to make that jump from the 5% to the next target of 10% share? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- + + Yes. So I -- the way I look at it, Vivek, is it's really a continuum. And the continuum is we have a number of customers that are very actively working with EPYC. I think the first 5% does include some cloud customers ramping, and that's important. And then as we go beyond that, we would expect that they're more used to our architecture. Our architecture is socket-compatible between the first and second generation. We're sampling it now. And so I think the idea is we would like to see some acceleration in that as we bring in the 7-nanometer product, but we'll certainly have to go through that process. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + First, I wanted to ask about graphics trajectory in the next year. I mean, given my math -- I know you talked about maybe $100 million light versus your expectation, but my math suggests that might have fallen as much as $250 million sequentially if you're going to get it at least to the level that it was last year. Now if I look at what that trajectory means going further and if I ask you whether or not you thought graphics revenues to be down 20% year-over-year in 2019, like how would you feel about that? What's your response to that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [33] +-------------------------------------------------------------------------------- + + Yes. Stacy, let me make sure I clarify the first comment and then I'll certainly answer the comment. My comment was at the segment level. So at the segment level, I said we were about $100 million light, and I also said that client performed a little bit better than expected. So I think you can say that it was probably -- if you -- that should help quantify sort of Q3. When I look at it going forward, I would not expect that type of decline on a year-on-year basis. I think what you'll see is some funky seasonality, right. So the first half of the year was very strong for graphics. I think the first half of '19 will not be very strong for graphics, but we have a number of product launches coming up, and we're pretty excited about some of those product launches. And so I would view that -- we need to work off some of this channel inventory that's in place and then go back to sort of a more typical seasonality, which would see the second half stronger than the first. Does that help? + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- + + Okay. That does help. For my follow-up, I want to ask about the data center GPU. So you've been talking a lot about that. You've actually been calling it out as driving, like, some of the growth in the current quarter and going forward. How big is that today? I mean, you're calling it out, but like can you give us an order of magnitude? I mean, is it more than $20 million in the quarter at this point? Where do you see that going into Q4? And like what are your expectations as you ramp the 7-nanometer product in the next year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + You always have a way of asking the most granular questions. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + I don't think it's that granular. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- + + It is more than $20 million. We do see it as a driver. We do see it as more of a driver as we go into 7-nanometer. And this is one of those cases where typically, the data center products ramp slowly, but as you know, the deployments can sometimes be lumpy and there's good traction on some early design wins. And so we expect it to be a meaningful contribution in Q4. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [38] +-------------------------------------------------------------------------------- + + Got it. And just one more really quickly. How do you feel about your $0.75 in 2020? You're still holding to that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- + + There are no changes to our long-term financial model at this point. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [40] +-------------------------------------------------------------------------------- + + Yes, not today. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + Not today, okay. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [43] +-------------------------------------------------------------------------------- + + I just want to go back to the IP side of things. You gave some color about the fact that it's not contributing anything in the fourth quarter, and that's helpful on the gross margin side. But one other detail, Devinder or Lisa, is I think the $86 million you talked about, you said that was a portion of the IP and then you had some other inventory-related changes. Can you just give us a little bit more color on the size of those different buckets? How big was IP overall? Anything there would be helpful. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [44] +-------------------------------------------------------------------------------- + + Yes. On the IP, I think as we talked about, this $86 million is associated with our THATIC joint venture. There were some other IP, call it, about -- approximately about $35 million in the quarter, and that is why we talked about it in 2 parts. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [45] +-------------------------------------------------------------------------------- + + And then as my follow-up. As I'm looking at the GPU side of things, not to kind of beat the dead horse there too much more, but the ASP side of that equation or pricing side, is the channel inventory clearing dynamic something that also manifests itself on pricing pressure? Or is it just a matter of time to absorb that inventory, which, Lisa, I think you said, was going to be a flat dynamic in the fourth quarter but it sounded like it was going to be returning to a headwind in the first half of next year. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [46] +-------------------------------------------------------------------------------- + + Yes -- no. If that's how it sounded, that's not what I meant. So I would say that the GPU -- let's call it, the weakness in the GPU channel or primarily in the sell-in is, let's call it, for the -- we might see that for the next quarter or 2. But as you look through the overall business, I think -- gamers are still buying GPUs. And so this is really a matter of just absorbing some of the first half, let's call it, oversupply as it relates to GPUs and that's translating into a bit weaker sell-in. But we are still tracking the sellout and the sell-through, through the -- to the end customers. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [47] +-------------------------------------------------------------------------------- + + And if I could sneak in one quick one. Just OpEx intensity, I know you're not going to guide for OpEx for 2019, but the 26% to 29%, how do we think about where you are in the investment stage where, whether it's the EPYC or the other new products -- EPYC 2, I should say, or the other new products where you kind of get over the hump and you don't need to invest as much? Is that a framework we should think about? Or do you believe the opportunities are big enough and the competitors are spending enough that, that OpEx intensity in that range is likely to persist? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [48] +-------------------------------------------------------------------------------- + + Well, I think, Ross, if you look on an annual basis for 2008 (sic) [2018] , we'll be approximately 28% of OpEx to revenue. And I think what we've said in the past is we will grow OpEx but we will grow it slower than revenue growth on an annual basis. And that's still our philosophy. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [50] +-------------------------------------------------------------------------------- + + Great. If you said this, I may have missed it, but can you talk about how much servers grew sequentially in Q3? I guess you were fairly specific on that point in Q2. I think you said double digits this quarter. Do you expect to be sort of -- as you talk about it, mid-single digit next quarter, are you kind of half way to that target this quarter? Just help us calibrate where server is. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [51] +-------------------------------------------------------------------------------- + + Yes. I think, Joe, it'd be fair to say that we have strong double digits this quarter and we'd just say we're about half way. I mean, I think that's reasonable, plus or minus. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [52] +-------------------------------------------------------------------------------- + + Okay, great. And then with regards to the 7-nanometer, I know you're going to talk more about this at the product launch, but can you talk about what 7-nanometer itself gives you? Is it -- do you expect there to be a higher sort of clock speed on the microprocessors in the GPUs? Is it a better transistor budget? Is it better cost per transistor? Just what are -- obviously, there's a lot riding on you guys being early in both segments on 7. Can you just talk about the benefit to that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [53] +-------------------------------------------------------------------------------- + + Yes. And we will go this -- go through this in a lot more detail on November 6, but at a high level, I think 7-nanometer gives us better density. So for a given system, we can put more cores on it. It gives us better power. So that gives us total cost of ownership, and it does give us better performance as well. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [55] +-------------------------------------------------------------------------------- + + Lisa, congratulations on the strong gross margin results. I just wanted some clarification. The calendar fourth quarter guidance, does that include IP revenue in the gross margin? And clearly, gross margin is being helped in December by the growth in new products, but it's probably also being helped by the sharp falloff in semi-customs. Should we think about kind of the gross margin level in December as being the new floor off of which you can continue to grow sequentially even as semi-custom comes back seasonally? Or how do I think about that? Then I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [56] +-------------------------------------------------------------------------------- + + Yes. So on the gross margin, you know, that was Q4 guidance, there is no assumed IP-related revenue. So that's all product. We do have, as I said earlier, a very positive product mix related to processor side of the business, so the client, the server as well as the data center GPUs. We are helped somewhat by the fact that semi-custom is down, but I would say the much larger piece of that is the product-related growth in new products. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [57] +-------------------------------------------------------------------------------- + + So is this the new floor, Lisa? Or is it too hard to tell? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [58] +-------------------------------------------------------------------------------- + + I don't know if I would say it's the new floor. I would say that we're very pleased that we're at the lower end of our long-term guidance. And certainly, we'll see what the puts and takes are as we go from a quarterly standpoint into 2019. But on a full year basis in 2018, I think Devinder mentioned this in his prepared remarks, we're now over 38%, and we've really grown margins every quarter over the last number of quarters. And we're happy with that. I think that's the strength of the model. We've always said that the strength of the model is improving the product mix, and I think that's what we see here today. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [59] +-------------------------------------------------------------------------------- + + And then Lisa, I apologize if I missed it, but just relative to your Q4 guidance, given some of the capacity issues that your competitor is having, is there any share gain -- incremental share gain assumptions based upon shortage of CPUs? Is that something that should be a tailwind in Q4? Or does that take longer, it might be something we don't see in sort of calendar first quarter? Any commentary around that would be helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [60] +-------------------------------------------------------------------------------- + + Yes. So we do see some pockets of shortages. We are ramping up production. I do believe we see some incremental benefit here in the fourth quarter, but I don't want to take away from the fact that we have a strong portfolio and we have a lot of platforms ramping. So the client business was always going to be up for us in Q4. And are we benefiting a bit from, let's call it, some of the pockets of shortages? Perhaps. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Our next question today is coming from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [62] +-------------------------------------------------------------------------------- + + I have 2 as well, if I can. I wanted to go into the semi-custom segment, and we've talked about kind of an elongated or near the end of the life from some of these gaming platforms. I'm just kind of curious as how you guys think about that piece of the business as we start to look into 2019? And is there a point in time where we can start to kind of think about product cycles as driving reacceleration of growth in that segment? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- + + Yes, sure. So again, without commenting on any specific design wins, what I would say is in 2019, we will be in the seventh year of the game console cycle. And so we do expect it to be down. And if you look at the cycles, you'll see that it's very consistent with previous cycles. When we look forward, when I look at what happens beyond 2019, I like our semi-custom business. I think it's a good business for us. I think it continues to be a place where we differentiate ourselves because of our ability to customize for various customers. And I do see it growing again beyond 2019, and it will continue to be an important part of our business. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [64] +-------------------------------------------------------------------------------- + + Okay. And then on the channel inventory dynamic, there's a lot of kind of moving parts right now in the market. And we've seen, obviously, with the U.S.-China tariff situation, there's then some questions around demand pull-forward or any kind of element around the tariff situation that's impacted demand. I'm just curious, have you seen anything from your customers that have suggested that there's any -- been any kind of sort of demand pull-forward and any effects on your business as it relates to U.S.-China especially as we start to look into next year, the potential for increased tariffs further? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [65] +-------------------------------------------------------------------------------- + + Yes. So we're monitoring the tariff situation very closely. There's a lot of activity around that. I would say from what we see today, we don't see anything material as it relates to the tariffs, whether it's pull-ins or just the overall impact of tariffs. But we are doing quite a bit to adjust our supply chain, as I'm sure many others are. So we already had a supply chain that was highly multi-sourced, and so that's very helpful. And we're adjusting our supply chain to ensure that we have further options such that the tariffs are not a significant impact on our business. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Our next question is coming from Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [67] +-------------------------------------------------------------------------------- + + On the weakness in the channel-based GPUs, I'm just wondering if some of the weakness is due to the gaming bans in China. It looks like China is hindering the introduction of new games, but I'm not sure if it's impacting actual GPU sales and sort of the enthusiast gamers' motivation to kind of move up the stack? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [68] +-------------------------------------------------------------------------------- + + I don't think we see that specifically, Harlan. I think what we're seeing is more -- just we had very strong demand in the first half of this year. And as the supply chain build up, we're just seeing some excess inventory that needs to be worked through right now. We're not seeing anything specific relative to that China issue you mentioned. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [69] +-------------------------------------------------------------------------------- + + Great. Thanks for the insight there. And then on the Wafer Supply Agreement with GLOBALFOUNDRIES, now that they're not going to be supporting 7-nanometer, you'll be moving, I think, most of your 7-nanometer client products to TSMC, and as of right now, I think you guys still need to pay them a fee for every 7-nanometer product you produce at TSMC, can you just give us an update on the new Wafer Supply Agreement that doesn't include 7-nanometers? Obviously, this should be beneficial for your gross margins. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [70] +-------------------------------------------------------------------------------- + + Yes. So look, GLOBALFOUNDRIES is a good partner. They continue to be a very important partner for us. We are in discussions with them about how to update our agreement post their strategy updates. And we're making good progress on that. So we'll give you more detail as we get closer. But overall, they -- GLOBALFOUNDRIES continues to be an important partner for us. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Our next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [72] +-------------------------------------------------------------------------------- + + Just a question to follow up on that THATIC, the $86 million. My understanding is you had original agreement, you were getting an OpEx off that, and then eventually, if there was product revenue, you'd recognize that revenue with your portion of your ownership on those wafers. So I'm just kind of curious, what's this $86 million? Is it additional IP? And any color on as to what it's for, if possible. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [73] +-------------------------------------------------------------------------------- + + Yes, Blayne. So it is related to some additional IP with THATIC. And we've completed some technology milestones in this past quarter, and so that's what that was. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [74] +-------------------------------------------------------------------------------- + + Got you. And then I want to ask you -- it's well known that there is graphics inventory. You mentioned that graphics pricing was down. I'm just kind of curious of your expectation for that discounting as we get into the end of the year here. What have you seen and what are you expecting as you look into December? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [75] +-------------------------------------------------------------------------------- + + Yes. We're not expecting any significant changes from an ASP standpoint if that's what you're asking. I think what we see is the inventory just has to be worked through, and it's working through the system. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Our final question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [77] +-------------------------------------------------------------------------------- + + I did join a little bit late. So I do apologize if you addressed this. Lisa, I just had a question on the client CPU business and how you think about market share versus profitability going forward. Given some of the shortages near term, I'm sure you have the opportunity to pick up share if you wanted to but perhaps at a lower gross margin. So as you think about the client business over the next year or 2, how do you balance market share versus profitability? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [78] +-------------------------------------------------------------------------------- + + Sure, so the client business is a good business for us from a margin standpoint. And as we look forward, we look at it as an end-to-end portfolio. So -- and we really do have an end-to-end portfolio across notebook and desktop. And our goal is continue to improve the profitability of that business. +As it relates to unit share, I think unit share is certainly important. We look at revenue growth overall as important for that business, but I believe we'll be able to do that at good margins and continue on our margin path. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [80] +-------------------------------------------------------------------------------- + + Thank you very much for joining our conference call today, everyone. This does conclude our call. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2019-Apr-30-AMD.txt b/Transcripts/AMD/2019-Apr-30-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..a0245be0964173fc679a172d6a574ee027d7433e --- /dev/null +++ b/Transcripts/AMD/2019-Apr-30-AMD.txt @@ -0,0 +1,570 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Advanced Micro Devices Inc Earnings Call +APRIL 30, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings and welcome to the Advanced Micro Devices First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Laura Graves. Please go ahead. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's First Quarter 2019 Conference Call. By now, you should've had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, amd.com. Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight some important dates for you. In celebration of AMD's 50th anniversary on May 1, 2019, Dr. Lisa Su and members of AMD's executive leadership team will host a panel discussion reflecting on 50 years of innovation by AMD. This will be held at the NASDAQ MarketSite in New York City. Dr. Lisa Su, President and Chief Executive Officer, will also be delivering a keynote address at COMPUTEX in Taiwan on Monday, May 27; Ruth Cotter, Senior Vice President of Worldwide Marketing, HR and Investor Relations will present at the Bank of America Global Technology Conference on Tuesday, June 4; and our 2019 second quarter quiet time will begin at the close of business on Friday, June 14, 2019. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. We will refer primarily to non-GAAP financial measures during this call except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced on this call are reconciled to their most directly comparable GAAP financial measure in today's press release, which is posted on our website. Please refer to the cautionary statements in our press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and, in particular, AMD's annual report on Form 10-K for the fiscal year ended December 29, 2018. +Now with that, I would like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. We had a solid first quarter. Revenue was in line with our expectations at $1.27 billion, down 23% year-over-year. Ryzen and EPYC Processor and Data Center GPU revenue more than doubled year-over-year, helping expand gross margin by 5 percentage points and partially offsetting graphics channel softness and lower Semi-Custom revenue. +Looking at our Computing and Graphics segment, revenue declined year-over-year as higher Client Processor sales were offset by lower Graphics sales to the channel. Client Processor sales increased by a strong double-digit percentage from the year ago period as unit shipments increased significantly and our new products drove a higher client ASP. As a result, we believe we gained unit market share for the sixth straight quarter. +In the desktop channel, demand for our highest end Ryzen 7 and Ryzen 5 CPUs was strong, with sales increasing sequentially and outperforming seasonality. Ryzen Mobile Processor adoption continues to accelerate. Acer, Asus, Dell, HP, Lenovo and other OEMs have launched more than a dozen new Ryzen mobile notebooks so far in 2019, helping us deliver our fifth straight quarter of year-over-year Mobile Processor growth. Our customers are on track to increase the number of Ryzen Notebook models by more than 50% from 2018. The majority of these new systems are planned to launch in the second quarter in advance of the seasonally stronger second half of the year. +In Graphics, revenue decreased year-over-year driven largely by lower channel sales partially offset by a significant increase in Data Center GPU sales. Radeon Vega GPU shipments grew by a strong double-digit percentage both year-over-year and sequentially based on increased adoption across OEM, gaming and data center customers. Apple introduced 2 new iMac systems featuring upgraded Radeon Pro Vega GPUs that deliver up to 80% faster graphics performance than the previous generation. We believe we made good progress improving channel inventory levels. Sell-through accelerated sequentially driven by sales of both our mainstream Radeon RX GPUs and new high-end Radeon VII gaming GPUs. We are well-positioned to grow GPU revenue in the second quarter and through the second half of the year as we expect to introduce our first 7-nanometer Navi gaming GPUs in the third quarter. We delivered another quarter of strong data center GPU sales based on increased adoption across large customers. Our progress was highlighted by Google's announcement that they selected high-performance Radeon GPUs and AMD's software development tools to power their upcoming Stadia game streaming platform. Stadia is a great example of how we are expanding the depth and breadth of our data center customer engagements. We are seeing growing customer interest in our differentiated platforms for game streaming, machine learning and HPC workloads that combine our high-performance GPUs with open source software tools. +Turning to our Enterprise, Embedded and Semi-custom segment. Revenue decreased from a year ago as expected due to lower Semi-Custom revenue as we enter the seventh year of the current game console cycle. Our Semi-Custom business model continues to play an important role in our long-term growth as our strong IP portfolio enables the industry's biggest brands to create differentiated solutions. The latest example is Sony. We are honored that Sony has selected a custom AMD SoC based on our Zen 2 CPU and Navi GPU architectures to power its next-generation PlayStation console. Our Server CPU revenue grew significantly from the year ago period, as EPYC processor adoption across cloud, HPC and Enterprise customers continued to grow. Overall in the data center, our CPU and GPU sales accounted for a mid-teens percentage of quarterly revenue. Our work with cloud leader, Amazon, continues to expand as they rolled out AMD-based offerings to additional regions and launched 3 new EPYC processor-powered EC2 instance families, including the first T3 Series instance. Growing HPC and regional cloud service provider deployments resulted in EPYC processor channel sales increasing sequentially. In the Enterprise, we added dozens of new customers across the aerospace, health care, automotive and telecom industries based on the superior performance of EPYC processors in big data and general-purpose virtualized workloads. +Turning to our next-generation Rome processor. We made excellent progress in the quarter, achieving key production milestones with our largest OEM and cloud customers. We are very excited about the performance of Rome, which is on track to deliver 4x the floating-point performance and double the compute performance per socket compared to our current generation EPYC processors. We are on track to begin Rome production shipments in the second quarter to support a third quarter launch. +In summary, I am pleased with our first quarter financial results based on the strong execution engine we have built across the company. +Tomorrow is an important day in AMD's history, as we celebrate our 50th anniversary. This is a significant milestone for any company, but especially significant for a technology company. 2019 is arguably the most important year in our history as the $75 billion market for our high-performance Computing and Graphics products has never been larger. And our product portfolio has never been stronger. We are right where we planned to be with our multiyear road map, including our upcoming 7-nanometer Ryzen, Radeon and EPYC processors that can drive our next wave of revenue growth and share gains. We remain confident in our ability to continue delivering on our ambitious leadership road map for the PC, gaming and data center markets. +Now I'd like to turn the call over to Devinder, to provide some additional color on our first quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. The first quarter of 2019 was a good start to the new year. Revenue was $1.27 billion and gross margin of 41% was up almost 5 points from the prior year. This was the eighth consecutive quarter of year-over-year gross margin expansion driven by the ramp of our strong portfolio of high-performance products. Quarterly revenue was down 23% from a year ago. Strong sales of Ryzen and EPYC processors and data center GPUs were more than offset by lower graphics channel sales and lower Semi-Custom revenue. Gross margin was 41%, up 470 basis points from a year ago, primarily driven by Ryzen, EPYC -- Ryzen and EPYC processor sales as well as data center GPU sales. Operating expenses grew 12% year-over-year to $498 million, primarily driven by go-to-market activities and investments in our product road map. Operating income was $84 million, down from $152 million a year ago, primarily due to lower revenue and higher operating expenses, partially offset by a $60 million licensing gain from the joint venture with THATIC. Operating margin was 7%, down from 9% last year. Net income was $62 million, compared to $121 million a year ago, and diluted earnings per share was $0.06 per share compared to $0.11 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $831 million, down 26% year-over-year, as strong Client Processor and Data Center GPU sales were more than offset by lower Graphics channel sales. Ryzen Products continued to ramp driven by strong growth across both desktop and mobile processors. +In Graphics, sales were down year-over-year due to lower Graphics channel sales and negligible blockchain-related revenue in the quarter, partially offset by strong Radeon Data Center GPU sales. +Computing and Graphics segment operating income was $16 million compared to $138 million a year ago. The decrease was due primarily to lower revenue and higher OpEx. +In the Enterprise, Embedded and Semi-Custom segment, revenue was $441 million, down 17% from the prior year. Server revenue growth was more than offset by anticipated lower Semi-Custom revenue. EESC segment operating profit was $68 million compared to $14 million a year ago. The improvement was largely due to an IP licensing gain of $60 million associated with the joint venture with THATIC. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $1.2 billion at the end of the quarter. During the quarter, we received $448 million of cash related to Mubadala's warrant exercise. We used $64 million of cash to fully extinguish the 2019 term debt and $100 million of cash to retire other term debt. The principal debt balance as of the end of the quarter was $1.4 billion as compared to $1.7 billion a year ago, and we have no long-term debt maturities until 2022. Free cash flow was negative $275 million in the quarter primarily due to higher inventory and the timing of collections. We expect to be free cash flow positive for the full year. Inventory was $955 million, up $110 million sequentially, primarily due to an increase in inventory of new products in anticipation of higher revenue. Adjusted EBITDA was $130 million compared to $196 million a year ago due to lower quarterly earnings and, on a trailing 12 month basis, adjusted EBITDA was $737 million. Gross leverage at the end of the quarter was 1.8x. +Turning to the outlook for the second quarter of 2019. We expect revenue to be approximately $1.52 billion, plus or minus $50 million, an increase of approximately 19% sequentially and a decrease of approximately 13% year-over-year. Sequentially, the increase is expected to be driven by growth across all businesses. The year-over-year decrease is expected to be primarily driven by lower Graphics channel space -- sales, negligible blockchain-related GPU revenue and lower Semi-Custom revenue. In addition, for Q2 2019, we expect non-GAAP gross margin to be approximately 41%, non-GAAP operating expenses to be approximately $510 million, as we invest in our new products and upcoming product launches, non-GAAP interest expense, taxes and other to be approximately $25 million. +For the full year 2019, AMD continues to expect high single-digit percentage revenue growth and non-GAAP gross margin to be greater than 41%. +In closing, the first quarter was a good start to the year. We remain focused on executing our plans for the remainder of the year and look forward to unveiling a strong portfolio of next-generation products to drive financial growth and customer momentum throughout 2019. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first conference -- for our first call? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Matt Ramsay from Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [2] +-------------------------------------------------------------------------------- + + Congratulations, Lisa, to you and your team on the 50th anniversary. I guess, the first question from me is, it was encouraging to see you guys reiterate the full year growth expectation. Obviously, one of your large server competitors had a bit of a hiccup on some of the outlook and talked about maybe a bit of a softer server market for the full year. Maybe you could give an update on what you guys are seeing for the servo macro environment and the confidence that you might have in the product's ramping? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure, Matt. Thank you for the question. So yes, as it relates to how the year is developing, it's developing largely as we expected when we started the year. So relative to our Q2 guidance, we are guiding up 19% sequentially and every business is growing. That's coming from, if you look across the businesses, our client business is growing due to new platforms that are launching. Our Graphics business, the channel inventory has improved since we started the year, and we have our Server business which is really starting some early shipments of Rome in the second quarter going to the second half of the year. As it relates to the full year guidance and how we look at it, again, it's largely as we expected as we're laying out the year. There certainly is some discussion with our customers about some inventory in the Data Center especially here in the first half. When we developed them, our plan, our Data Center business was always more second half weighted, and continues to be so, because much of that is dependent on platforms that are launching around our Rome product portfolio. So we're going to continue to watch the Data Center overall environment, but at this point, we're focused on our products and our customers continue to have a very strong pull. There's a lot of interest in Rome. We're doing well on our qualifications and so we feel good about how that's developing. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [4] +-------------------------------------------------------------------------------- + + Got it. And as a follow-up, you mentioned the 19% sequential guidance for Q2. It seems like a bit of a transitional quarter for the company with a lot of things going on towards product launches that will happen to feed the back half of the year. So maybe you could talk a little bit more granularly about the drivers of Q2, just given that it's a bit of a transition for a whole new portfolio rolling out, and if there's any kind of color on contributions from older or newer products in the second quarter guidance, that would be helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Sure, Matt. So, yes. As we look at Q2, it is a bit of a transition in the product portfolio. It's an important quarter for us as we are preparing to launch our 7-nanometer products. In terms of the overall business, as I stated earlier, each of the businesses is growing for different reasons. I think starting with Server, again, it's the greatest percentage of growth, and it really is the start of some shipments of Rome. We expect that Rome will launch here in the third quarter and there's some preparations that need to be done for that. As we look at the Graphics business, again, the channel inventory situation has improved and so that we expect that the channel will be up here in the second quarter and then into the second half as we launch Navi. And in the Client business, we have a large number of platforms with our OEM customers that are launching here in the second quarter around our second-generation Ryzen mobile processors, and we're also in preparations for our third-generation Ryzen desktop as well. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question comes from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [7] +-------------------------------------------------------------------------------- + + I guess, first question, and I do have a quick follow-up, is when you kind of lay out Rome and the expectation of a ramp going forward, can you just remind us of how you currently see the setup with regard to market share opportunities or market share gains that you would expect? And where do you think you fell off this last quarter in terms of market share in the overall server space? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Sure, Aaron. Look, as we look at the server market, we know very well that the data center market takes time to ramp with any new product. And so that's the way we have sort of built our plans. What we have previously stated is that, from, let's call it, at the beginning of this year, we'd expect that over the next 4 to 6 quarters, we would continue to ramp our server market share with a goal of getting to double-digit percentage share. As it relates to the Q1 quarter, again, we'll have to wait to see how the numbers come out. The Data Center business, for us, on the CPU side behaved as expected in Q1. But we did see some product mix shift, so Q4 was a large quarter for us in the Cloud business for our EPYC processors. And Q1, the mix shift did more to Enterprise and channel. And from that, the ASPs were higher, the units were lower and so again, largely as we would've expected. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [9] +-------------------------------------------------------------------------------- + + Okay. And then as a quick follow-up, congratulations on the announcement with Sony. I'm just curious, I think last quarter, you had suggested that you expected that Semi-Custom business to decline by 20%-plus this year. Assuming that, that's still the case, number 1. Number 2, how do we now start to think about the growth profile of that looking into next year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- + + Yes. Sure. So yes, we are very pleased with our partnership and expanding our partnership with Sony on their next-generation consoles. As we see the Semi-Custom business at this point, we still believe that it's going to be down substantially in 2019. Let's call it approximately 20% plus. And then as we go into 2020, without talking about any specific customer, we believe that Semi-Custom will return to a growth business for us in 2020 and beyond. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [12] +-------------------------------------------------------------------------------- + + Lisa, we continue to hear about the CPU shortage, which is obviously primarily caused by your competitor. I'm curious, are you seeing any impact on your business in the near term? And more importantly, as we go into the second half and they ramp capacity, are you concerned at all that, that could disrupt your business, whether it be market share swings or pricing pressure? And I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Sure. So as it relates to CPU shortages in the market, look, we see a little bit of that. I would say there are pockets of shortage, mostly at the low-end of the market, frankly. So from our standpoint, I don't believe it's a huge contributor to our business. As we look at the PC business, both in the first half and the second half of the year, we believe that the PC business can be a growth business for us. From a market environment standpoint, we believe the market is not too bad. We call it flat to slightly down. When we look at our product portfolio in the notebook space with our second-generation Ryzen platforms, I would believe we have much stronger platforms that are ramping through this year. And then in the desktop space, we believe we'll be very competitive as we've launched the third generation of Ryzen desktops. So I view the PC business as an important growth driver for us in 2019 and we see it as a good market for us. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [14] +-------------------------------------------------------------------------------- + + And then on the follow-up, in your prepared remarks, you mentioned that Data Center CPUs and GPUs accounted for about mid-teens percentage of your revenue in the quarter. Like last quarter, can you give us a rough split between the 2 and related to that, I was hoping you could help us size the game streaming opportunity long-term. Obviously, you're involved with Google today. How does that business with them evolve over the next 12 to 18 months? And what's your opportunity elsewhere in terms of broadening your customer base? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Sure. So, as we stated, that the Data Center CPU and GPU business was about mid-teens percentage of revenue for us. Both businesses were down, as expected, in Q1 and much of that was the strength of the Q4 quarter, especially around the cloud. We mentioned in Q4 that the split between CPUs and GPUs was close. So they were close. As we look longer term for Data Center GPUs, and your question about the cloud streaming opportunity, we're very pleased with our partnership with Google. It's a result of several years of effort, where we were optimizing both hardware and software together. And so we think it's an important vertical for us. We are working with other customers in the cloud streaming area as well. So again, I think it's an interesting and important market over the next couple of years. We also have a number of other workloads that we feel good about as it relates to data center GPU, including HPC, especially when you combine our CPU and GPU portfolio together. We think HPC is a great workload for us and -- as well as machine learning. And we're working with, in machine learning, with a couple of leading cloud customers to, again, optimize our software to their needs. So again, the data center GPU market will continue to be an important driver for us over the next couple of years. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + I have a question on your gross margin guidance. I'm a little confused why it's flat sequentially into Q2 on a pretty meaningful revenue lift. You talked about all business is growing and you mentioned a number of them, but you didn't mention Semi-Custom. I mean, is this just a matter of mix? Is Semi-Custom driving a lot of the growth or is there something else going around -- on about your intra-business mix or pricing or something? Like what's going on with the gross margins? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Yes, Stacy, let me start and I'll let Devinder comment. I should have mention Semi-Custom in that list as well. So Semi-Custom is going through a seasonal build. So although it will be down substantially year-over-year, it's still a seasonal build for us as we go from Q2 -- from Q1 into Q2. Devinder, maybe you want to comment as well? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [19] +-------------------------------------------------------------------------------- + + Yes, so... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + By the quarter, maybe? Like with the growth by business? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Can I rank order the growth by business? That's probably a bit more granular than I would like to get, but I think it's fair to say that all businesses have to grow a decent amount to get to 19% sequential growth. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [22] +-------------------------------------------------------------------------------- + + That's right, Lisa. So fundamentally, Stacy, it's the product mix in the quarter that's driving the flat gross margin. Add the 41% guide. It is an improvement of 4 points year-on-year. Now, as you know very well, we have businesses that are higher than corporate average gross margin and lower than corporate average and the mix of the businesses, with Semi-Custom that we just talked about lower than corporate average, is driving the 41% guide for Q2. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + You would also -- I'm sorry, Stacy, I would just add. You would also expect Graphics is also a bit lower than corporate average on the consumer side. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + Okay, so it's fair to say that a good amount of the growth is coming from Graphics and Semi-Custom as it is as well with the other stuff? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + Yes, it's really across all of the businesses. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + For my follow-up I had a question on OpEx. You're guiding 29% for the year-on-year, $510 million in Q2, and obviously, high single-digits for the full revenue. So if I had revenue of 8% for the full year, that would imply OpEx in Q3 and Q4 of $510 million of flat to Q2 levels. Do you think that's realistic? Does OpEx actually stay flat for the rest of the year from Q2 levels? Or does it need to go higher and if it goes higher, does that imply that the revenue growth embedded in your guidance for the year has to be about 8%? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [27] +-------------------------------------------------------------------------------- + + Yes, I think, Stacy, the way you want to look at it is the first half of 2019, we do have incremental R&D and go-to-market activities in the first quarter and even in the second. As you know, we are preparing for a strong series of significant 7-nanometer product launches this year and also share gains as we get to the back half of the year. And that's obviously driving the OpEx. Overall for the year, we are comfortable in the 29% for the year of overall revenue from an OpEx standpoint. And as you have seen us in the past, we do have a way of modulating the OpEx as needed, but right now, we are investing in the road maps, we're embarking on product launches and the go-to-market activities and very focused to make sure that we are well positioned in the first half going into the second half where we see the revenue lift compared to the first half of 2019. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + Does that apply OpEx -- do see OpEx going up from current levels for the rest of the year then? Or does it go down or does it stay flat? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [29] +-------------------------------------------------------------------------------- + + $510 million is the guide for Q2, and 29% for the year is the layout all through the model. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is coming from David Wong from Nomura Instinet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [31] +-------------------------------------------------------------------------------- + + Devinder, can you give us an idea of what gross margins are currently running at for the client to data center processors and what direction these gross margins are moving in? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [32] +-------------------------------------------------------------------------------- + + The client and data center businesses are higher than corporate average and the Semi-Custom business and Graphics, as we just said on the last question, are lower than corporate average especially on the Graphics Consumer side and the Data Center GPU side obviously is better. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [33] +-------------------------------------------------------------------------------- + + Great. And are gross margins rising for your Microprocessor businesses at the moment? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [34] +-------------------------------------------------------------------------------- + + I think early in the year in the second quarter, we are getting the second quarter [at our] 41% guide and our guidance for the year is greater than 41% on an annual basis, is what we have stated so far. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [35] +-------------------------------------------------------------------------------- + + Okay, great. And Lisa, my last question, in 2020, do you expect meaningful Semi-Custom revenues outside the game console space and if so, what types of applications will these Semi-Custom chips be used in? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Yes, David, so as it relates to the Semi-Custom business, as we go out in time, we do expect additional applications other than consoles, but consoles are a large piece of the business, and so you would expect that they would continue to be a large piece of the business. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question today is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [38] +-------------------------------------------------------------------------------- + + Just 1 quick historic one. I've got 2, but the first on the historical side, for March of '18, did you guys provide a rough breakout of how much your revenue was server-related? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- + + No. We wouldn't have done that. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [40] +-------------------------------------------------------------------------------- + + No, we haven't done that. Not that specific. I think server is, if you're referring to the CPU side, it's within the EESC segment. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [41] +-------------------------------------------------------------------------------- + + Okay. And then if I look at the second half of the year, you guys are trying to talk to like around 41%, 42% kind of gross margin rough level. So is it safe to assume that we should see a pretty big step function in September quarter on the gross margin? Or is that, I guess, is that incorrect or is that aggressive? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [42] +-------------------------------------------------------------------------------- + + I think you've got to look at it from a viewpoint of the product mix. I said we are shipping, like Lisa said, Rome in preparation of our launch in Q3. We have a couple of other new products that will start shipping in Q3 and we'll see how the margin comes out when we come in and talk about Q3 about 90 days from now. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [44] +-------------------------------------------------------------------------------- + + I'm wondering if you can talk about gross margins in the Console segment. Obviously, that's been pretty low historically. You also have customers funding the R&D but as you look to the next generation of consoles, do you see opportunity to improve the gross margin in that space? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [45] +-------------------------------------------------------------------------------- + + Yes, Joe. I think it's a bit early to talk about margins for the next generation. As you stated, the gross margins of the Console business are below corporate average. The operating margins are quite good because the customers are paying the engineering expenses for it. But I think the gross margins are below corporate average. We would expect, though, and I think you would expect this, as the company continues to grow, the percentage of the company that is Semi-Custom is lower than it has historically been. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [46] +-------------------------------------------------------------------------------- + + Yes, that makes sense. And then if you look at the GPU Data Center opportunities, the gross margin there, how does that compare to, say, the discrete Graphics portion of your business and how does it compare to corporate average, things like that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + The GPU Data Center business would be above corporate average and above our Consumer Graphics business. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [49] +-------------------------------------------------------------------------------- + + I had a couple of questions on the Server strategy longer term. Can help us understand ultimately what percentage of the workloads in the cloud do you expect to target? And -- that's the first part of the question. The second part of the question is, I was hoping you could provide some color on the customization strategy? I think Intel might argue that they are embedding IP blocks for their customers. Is that something that you do or you think about doing? Or to what extent does your customization strategy fall under your Semi-Custom model? And I was wondering are your customers on the server side asking you for like an APU-kind-of-a product where the -- you have microprocessor and graphics processor capabilities integrated together. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [50] +-------------------------------------------------------------------------------- + + Yes, absolutely, Mark. So look, when we think about our Server strategy and maybe our -- let me generalize it to our Data Center strategy overall. It is a multiyear, multigenerational road map. In terms of the workloads that we plan to address, we are -- in addition to the workloads that we do very, very well on, like, big data, data analytics and virtualization, high-performance computing, cloud workloads, I think we do quite well with general-purpose workloads too, as we move generations. So as we look at, for example, the Rome generation, the second generation of EPYC, we would expect address well 80%-plus of the workloads. As it relates to customization for server CPUs, there are varying degrees of customization that customers want, especially as you go through a number of the different cloud workloads that are out there. There are specific requirements that are there. We're very comfortable doing that. I think the customers have been deeply engaged with us since the first generation of EPYC. There is both software customization as well as some hardware customization that we go through. So -- and we feel very comfortable with our ability to address that across the Cloud and the Enterprise businesses. And then, as we go forward, I think we are also very excited about what we can do when we put our CPU and GPU portfolio together and really do system-level optimization for the Data Center. So we view that as a early opportunity for us but one where there is a lot of opportunity to help customers really optimize for very high-performance computing applications. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question today is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [52] +-------------------------------------------------------------------------------- + + Congratulations on the strong results and the pipeline. These are 2 questions from me as well. First, you have Naples now and Rome server shipping soon. Intel has Cascade Lake with Optane. What are you hearing from customers on the pricing versus feature comparison? And where I'm going with that is, how well is AMD prepared if your competitor decides to perhaps become a little more aggressive on the pricing side? At what point does pricing matter, and at what point does your feature list matter more? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [53] +-------------------------------------------------------------------------------- + + Yes, so Vivek, look, we understand that it's a very competitive market out there. It's always been very competitive and we are prepared for it to get even more competitive. When you look at our road map, I think we feel very comfortable with sort of our positioning. And the way I think about it, when it comes to the data center market, the price is only 1 factor and it's probably not the most important factor when people are choosing their next-generation products. The most important factor is really total cost of ownership, and the advantages that we have with our chiplet architecture and their 7-nanometer sort of process capabilities really have a great sort of power performance benefit. So we are -- as you say, we're prepared for a competitive environment, but we also feel that our product, from a performance standpoint and a positioning standpoint will be positioned quite well in the marketplace. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [54] +-------------------------------------------------------------------------------- + + Got it. And as a follow up, Lisa, you mentioned your goal of getting to double-digit market shares in Servers over the next 4 to 6 quarters. I assume that will require a greater contribution from Enterprise customers, and that is right. What pushbacks are you seeing from them now? Is it just a matter of time that you increase your Enterprise attraction? In general, what -- do you need to do anything extra to attract Enterprise customers? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [55] +-------------------------------------------------------------------------------- + + Yes. No, it's a great point. We certainly have deep engagements with both cloud and the OEMs. On the Enterprise customers, we sell through our OEM partners. The pushback that we get, I don't know if I would call it pushback. I would just say that Enterprise tends to move a bit more slowly than cloud. There are longer qualification cycles because there're qualification cycles on both the OEM side as well as the end customer side. We are continuing to build out our direct sales force as it relates to facing the Fortune 1000 customers and CIOs in that area. And I believe we will make progress in Enterprise. Certainly, as we go forward from the Naples generation into Rome, we'll have more platform coverage with our OEMs, and I think there will be more familiarity with our architecture as well as more software optimized to our architecture. So yes, we're very committed to the Enterprise market and expect that we will make progress with time. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Our next question today is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [57] +-------------------------------------------------------------------------------- + + Lisa, was just curious on the Server product, you mentioned Enterprise was the bigger contributor in Q1. Just trying to think about the life cycle of EPYC 1. Enterprise takes longer to call, so I'm just kind of curious where you are in terms of rollout of that product. Obviously, Rome's going to come in at the end of the year. I'm just kind of curious how you see the tail on EPYC 1 throughout the year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [58] +-------------------------------------------------------------------------------- + + Yes, so Blayne, I think, as I stated a little earlier, I think the Data Center business does tend to move slowly. So we would expect that there will be a good amount of time where we will have both Naples and Rome in market at the same point in time, and that just depends on qualification cycles, platform needs and some platforms are being refreshed right away. Some platforms are going to take a little bit longer to be refreshed. And so, from my standpoint, I think that Naples will continue to be important for us in 2019, even as we ramp Rome with our launch in the second half of the year. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [59] +-------------------------------------------------------------------------------- + + Got you. And then if I could just ask on the Data Center GPU product you had, the Google ramp, I think it started in Q4. Just kind of curious, your pipeline for that product and how you think about the slope of that business and the lumpiness of -- given that large customer? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [60] +-------------------------------------------------------------------------------- + + Yes, so we do expect the Data Center GPU business to be a bit lumpy. We do have several sort of large customers that are ramping product with us, and there'll be some ebb and flow as we go on a quarterly basis. But on an annual basis, I think 2019 will certainly be -- we expect it to be significantly up from 2018. And the pipeline is good. So when we look at the pipeline, as I mentioned, cloud streaming is a good workload for us. Google is one customer, but we're working with other customers as well, and we also see HPC and machine learning as additional workloads that will be good for us in that business. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [61] +-------------------------------------------------------------------------------- + + Operator, we have time for 2 more questions, please? + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Certainly. Our question is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [63] +-------------------------------------------------------------------------------- + + Lisa, regarding Navi, if you can comment on it. What is the positioning of that particular product relative to the -- your current 7-nanometer GPU? And regarding Navi, can you tell us if it's going to include ray tracing? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [64] +-------------------------------------------------------------------------------- + + Yes, so Hans, we are excited about Navi. Navi is a new architecture for us in gaming. It has a lot of new features across the Navi architecture. Things are progressing well. We expect it to launch in the third quarter. From a positioning standpoint, I probably won't go through it in great detail right now other than to say that it is 7-nanometer Navi, but it will be positioned below where, for example, our Radeon VII is positioned today from a price point standpoint. And then in terms of ray tracing, again, we will talk more about our overall Navi road map as we get closer to the launch. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Our final question today is coming from Kevin Cassidy from Stifel. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [66] +-------------------------------------------------------------------------------- + + Congratulations. As you're introducing the new generations of Ryzen, should we assume that ASPs will continue to go up or are some of these purpose built for lower price points? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [67] +-------------------------------------------------------------------------------- + + Yes, Kevin. So as we look at the new generations of Ryzen, our goal is certainly to improve the mix of the products, and so we think, as we improve the performance of the product, that we can improve that mix. Now the actual mix will vary, of course, depending on a number of things as we go through quarter by quarter, but certainly, as -- our goal is to continue to improve our penetration at the higher end of the PC processors. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [68] +-------------------------------------------------------------------------------- + + Thank you, Kevin. Thank you, everyone, for joining us today. This concludes our call. We appreciate your time and attention to this earnings call, and certainly your support of our company. Have a nice evening. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2019-Jan-29-AMD.txt b/Transcripts/AMD/2019-Jan-29-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..de90dd26d5556bdec3091bbebf2b99622a3863bb --- /dev/null +++ b/Transcripts/AMD/2019-Jan-29-AMD.txt @@ -0,0 +1,587 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Advanced Micro Devices Inc Earnings Call +JANUARY 29, 2019 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to Advanced Micro Devices' Fourth Quarter and Full Year 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to turn the call over to Laura Graves. Please go ahead. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Fourth Quarter and Fiscal Year 2018 Conference Call. By now, you should have had the opportunities to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, www.amd.com. +Participants on today's conference call are: Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. +This is a live call and will be replayed via webcast on our website. +I would like to highlight some important dates for you. Dr. Lisa Su will present at the Goldman Sachs Technology and Internet Conference on Tuesday, February 12. Also, Ruth Cotter, Senior Vice President of HR Worldwide Marketing and Investor Relations will present at the Susquehanna Annual Technology Conference on Tuesday, March 12; and our 2019 first quarter quiet time will begin at the close of business on Friday, March 15, 2019. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and, as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. We will refer primarily to non-GAAP financial measures during this call except for revenue, gross margin and segment operational results, which are reported on a GAAP basis. The non-GAAP financial measures referenced herein are reconciled to their most directly comparable GAAP financial measure in today's press release, which is posted on our website. +Please refer to the cautionary statements in our press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and, in particular, AMD's quarterly report on Form 10-Q for the quarter ended September 29, 2018. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. 2018 marked another year of strong financial performance, driven by our expanded high-performance product portfolio despite near-term graphics weakness. We grew annual revenue by 23%, with Ryzen, EPYC and data center GPU product revenue growing by more than $1.2 billion for the year. Our new products gained share and significantly expanded gross margin, leading to our most profitable year since 2011. +Looking at the fourth quarter, revenue of $1.42 billion increased 6% from a year ago, with approximately 65% of sales coming from our new products. We reached an important milestone in our business in the quarter as our high-margin data center CPUs and GPUs accounted for a mid-teens percentage of overall revenue. While we expect our data center revenue to be lumpy, the ramp of our data center business is beginning to contribute meaningfully to our financial results. +Looking at our Computing and Graphics segment, we delivered our eighth straight quarter of year-over-year segment revenue growth. Sales of Ryzen desktop and notebook processors and data center GPUs offset lower GPU sales as the channel continued working through elevated levels of graphics inventory. Client processor unit shipments grew by more than 50% from the year-ago period. We had our highest client computing revenue in more than 4 years, and we believe we gained client CPU unit share for the fifth straight quarter. +At CES, Acer, Asus, Dell, HP, Huawei, Lenovo and Samsung, all launched notebooks powered by our new second-generation Ryzen mobile processor with Radeon Vega graphics. The second-gen Ryzen mobile processor delivers more performance, enhanced features and longer battery life than any mobile processor we have ever built and is the fastest processor available for ultrathin notebooks. +The industry's first AMD-based Chromebooks launched earlier this quarter from Acer and HP. We expect additional AMD-based Chromebooks to launch later this year as we expand our participation in this growing portion of the PC market. +Based on the competitive positioning of our Ryzen processors, we expect the number of Ryzen systems that we'll launch in 2019 to increase by more than 30% from 2018, with a number of Ryzen notebook systems planned to launch increasing by more than 50%. +In graphics, GPU revenue decreased year-over-year, driven largely by lower channel GPU and memory sales, partially offset by a significant increase in data center GPU sales. We saw an improvement in channel GPU sellouts throughout the quarter as our partners continue to drain their inventory. There is still more work to do, but we remain confident we're taking the right actions to further reduce channel inventory. +We set a record for professional GPU revenue in the quarter, driven by multiple high-volume wins for our Vega-based data center GPUs. We started shipping our new 7-nanometer Radeon Instinct accelerators in the quarter and introduced a major set of enhancements to our data center GPU software that make it easier for customers to deploy Radeon GPUs for AI and machine learning workloads. +At CES, we highlighted the significant gaming momentum we are generating for Radeon across consoles, PCs and the cloud. For gamers and creators, we announced our return to the high-end GPU market with the new Radeon VII GPU. Powered by our second-generation Vega graphics core and featuring 16 gigabytes of second-generation high-bandwidth memory, our new 7-nanometer Radeon VII GPU delivers leadership performance in content creation and compute workloads, and is very competitively positioned when running the most demanding AAA games at 4K resolution. In cloud gaming, we announced that Google selected Radeon Pro GPUs to power their game streaming initiative, Project Stream. The performance and differentiated virtualization features of our Radeon Pro GPUs enabled Google to deliver an uncompromised high definition gaming experience on virtually any PC. +Turning to our Enterprise, Embedded and Semi-Custom segments, revenue was flat from a year ago as a double-digit percentage decrease in semi-custom revenue was offset by strong growth in EPYC processor sales. As expected, semi-custom sales were down from a year ago based on where we are in the current console cycle. This console generation remains one of the most successful ever as Microsoft and Sony combined have now shipped well in excess of 120 million AMD-powered consoles. Fourth quarter server unit shipments more than doubled sequentially based on growing demand for our highest-end 32-core EPYC processors with cloud, HPC and virtualized enterprise customers. As a result, we believe we achieved our goal of mid-single-digit server unit share exiting 2018. +We had another strong quarter of cloud adoption, highlighted by industry-leader Amazon announcing new versions of their most popular EC2 computing instances powered by EPYC processors. Businesses can easily migrate their AWS instances to AMD and save 10% or more based on the technology advantages of our platform. +Microsoft Azure also announced general availability of their AMD-based storage instance in the quarter as well as a new HPC instance, powered by EPYC processors that is 33% faster than competitive x86 offerings. We secured multiple HPC wins in the quarter, including Procter & Gamble, the U.S. Department of Energy and one of Europe's largest supercomputers at the University of Stuttgart's High-Performance Computing Center. Lawrence Livermore labs also announced a new supercomputer featuring both EPYC processors and Radeon Instinct accelerators that will be used for machine learning and big data analytics workloads. +Customer interest in our next-generation Rome server processor remains very high. Rome is expected to deliver 4x the floating-point performance and double the compute performance per socket compared to our current-generation EPYC processors. We publicly demonstrated a single 64-core next-generation EPYC processor outperforming 2 of our competitors' highest-end server processors in multiple workloads. Rome development is proceeding very well, and we are on track to start shipments midyear. +I am also pleased to report that we concluded discussions with GLOBALFOUNDRIES on the seventh amendment to our Wafer Supply Agreement. The amendment affirms the strategic partnership with GF for products built at 12-nanometers and above and provides AMD with full sourcing flexibility at the 7-nanometer and below nodes. GF continues to be a critical supplier of AMD's current-generation products and will play a key role in our next-generation Ryzen and EPYC products with our triplet strategy. +In summary, 2018 was another strong year for AMD. Increased adoption of our high-performance products drove a second straight year of double-digit annual revenue growth, expanded gross margins and improved profitability. I would like to thank the more than 10,000 AMD employees whose dedication to building great products have made these results possible. +While headwinds remain in the graphics channel and macro uncertainties are causing some caution in the first half of 2019, we believe we are well positioned to gain share throughout the year and accelerate growth as we ramp our next-generation 7-nanometer products. +As we enter 2019, we are preparing to launch our strongest product portfolio ever. In gaming, we will launch our high-end Radeon VII GPU in February, followed by our next-generation Navi GPUs later in the year. In client computing, we started the year with our second-generation Ryzen mobile processors, and we are on track to launch our third-generation Ryzen desktop processors in the middle of the year. And in the server market, we expect to deliver a significant step function performance increase with the launch of our next-generation Rome processors in the middle of the year. +I am very proud of what we accomplished in 2018 and even more excited about how our long-term investments are set to pay off in 2019. +Now I'd like to turn the call over to Devinder to provide some additional color on our fourth quarter and full year financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. 2018 was a strong year for AMD. New product introductions wrought the highest annual revenue since 2011 and a significant improvement in gross margin year-over-year. Earnings per share increased from $0.10 per share in 2017 to $0.46 per share in 2018. Full year 2018 revenue was $6.48 billion, up 23% year-on-year, driven by strong performance in the Computing and Graphics segment with significant growth in Ryzen processor sales. Although there was weakness in the graphics channel in the second half of the year, we saw strength in data center CPUs and GPUs. Gross margin was 39%, up 440 basis points from the prior year. Gross margin improvements are primarily driven by our new Ryzen, EPYC and Radeon products. Operating expenses were 29% of revenue, an improvement of 2 percentage points from the prior year. For the full year, operating income was $633 million, up $409 million from $224 million in the prior year. Net income was $514 million, up $411 million, compared to net income of $103 million in the prior year. On the balance sheet, we reduced principal debt by $171 million and improved gross leverage significantly from 4.6x a year ago to 1.9x at the end of 2018. +Let me turn to the details of the fourth quarter results. Fourth quarter revenue gross margin, operating margin and earnings per share all improved year-on-year. Quarterly revenue of $1.42 billion was up 6% from a year ago. Strong sales of Ryzen and EPYC processors and data center GPUs more than offset lower channel GPU and semi-custom sales during the quarter. Fourth quarter 2018 revenue did not include any IP-related revenue, and blockchain-related GPU revenue was negligible. +Gross margin was 41%, up 740 basis points from 34% a year ago. Year-on-year gross margin improvement was driven primarily by the ramp of Ryzen and EPYC processor sales. Gross margin has increased year-over-year for 7 consecutive quarters, driven by a higher percentage of revenue from new products. Fourth quarter 2018 gross margin excludes a $45 million write-down of all the technology licenses that are no longer being used. Operating expenses grew 9% year-over-year to $474 million and remained approximately flat as a percentage of revenue from the year-ago period. We continue to invest in our product road map and go-to-market activities as we gain market share in important markets. +Operating income was $109 million, up $90 million from $19 million a year ago. Operating margin was 8%, up from less than 2% last year. Net income was $87 million compared to $8 million a year ago. Q4 2018 net income excludes a withholding tax refund plus interest of $43 million related to an IP litigation settlement from 2010. Diluted earnings per share using a diluted share count of 1,180,000,000 was $0.08 per share compared to $0.01 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $986 million, up 9% year-over-year. Revenue growth was driven primarily by continued strong Ryzen desktop product sales and the adoption of second-generation Ryzen mobile processors, largely offset by lower channel GPU and memory sales compared to the prior year. Ryzen products continued to ramp and were greater than 80% of total client revenue, driven by OEM and channel momentum. In graphics, sales were down year-over-year due to negligible blockchain-related revenue in the fourth quarter of 2018 as well as elevated levels of [tropics] inventory in the channel. Total graphics revenue grew sequentially, driven by strong Radeon data center GPU sales. +Computing and Graphics operating segment income was $115 million compared to $33 million a year ago. The increase was driven primarily by strength in Ryzen product sales and significantly higher ASPs in both desktop and notebook compared to a year ago. +Enterprise, Embedded and Semi-Custom revenue was $433 million, flat from the prior year. Server revenue growth was offset by lower semi-custom revenue. EPYC processor units more than doubled sequentially, driving significant growth in data center revenue in the quarter. EESC segment operating loss was $6 million compared to a loss of $13 million a year ago. The improvement due to higher EPYC processor revenue was partially offset by lower semi-custom revenue and continued engineering and go-to-market investments in the server business. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $1.16 billion at the end of the quarter. We generated free cash flow of $79 million in the quarter. Free cash flow was a negative $129 million for the full year primarily due to growth in inventory related to new products and the timing of collections. Inventory was $845 million, up $107 million sequentially, primarily due to the ramp of new products. Total principal debt was $1.5 billion as we further reduced term debt by $60 million during the [fourth] quarter, resulting in total debt reduction of $171 million during 2018. We expect to pay off the remaining $66 million of 2019 term debt in March 2019, and beyond that, there are no long-term debt maturities until 2022. +Adjusted EBITDA was $152 million compared to $58 million a year ago, and on a trailing 12-month basis, adjusted EBITDA was $803 million, more than doubling year-over-year. Gross leverage was 1.9x as we ended 2018, and we are pleased to have achieved our long-term gross leverage target of less than 2x. +Before turning to our financial outlook, let me discuss our Wafer Supply Agreement with GLOBALFOUNDRIES. Today, the seventh amendment of the WSA spans from January 2019 through March 2024. It establishes purchase commitments and pricing at 12-nanometer and above for the years 2019 through 2021. The amendment also provides AMD full sourcing flexibility at 7-nanometer and beyond without any onetime payments or royalties for products purchased from other foundries. +Turning to the outlook for the first quarter of 2019. We expect revenue to be approximately $1.25 billion plus or minus $50 million, a decrease of approximately 12% sequentially and 24% year-over-year. Sequentially, the decrease is expected to be primarily driven by continued softness in the graphics channel and seasonality across the business. The year-over-year decrease is expected to be primarily driven by lower graphics sales due to excess channel inventory, the absence of blockchain-related GPU revenue and lower memory sales. In addition, semi-custom revenue is expected to be lower year-over-year while Ryzen, EPYC and Radeon data center GPU product sales are expected to increase. In addition, for Q1 2019, we expect non-GAAP gross margin to be approximately 41%, non-GAAP operating expenses to be approximately $480 million, non-GAAP interest expense taxes and other to be approximately $25 million, and we also expect to record a $60 million IP licensing gain associated with the THATIC JV in the first quarter of 2019, which will be a benefit to operating income and recorded on the licensing gain line of the P&L. +For the full year 2019, despite near-term weakness in the graphics channel and a cautious macro environment, we expect high single-digit percentage revenue growth driven by Ryzen, EPYC and Radeon data center GPU product sales and as we ramp our 7-nanometer products throughout the year. We expect non-GAAP gross margin to be greater than 41%, non-GAAP operating expenses to be approximately 29% of revenue and a non-GAAP tax rate of approximately 4% of pretax income. +In closing, we made excellent progress in 2018. We grew the top line by more than $1.2 billion, expanded gross margin and significantly improved profitability. We continue to execute our long-term financial model, driven by our new high-performance computing products that gained solid momentum last year. We are pleased to enter 2019 with a strengthened balance sheet and a strong portfolio of next-generation products capable of driving continued financial growth. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + Lisa, I had a question on your full year 2019 outlook. You guys are guiding revenue growth kind of in the high single-digit range. Embedded in that outlook, what kind of growth rates are you assuming for your core businesses, computing, graphics, semi-custom and server CPUs? And then on the gross margin side, 41% or greater, is the improvement year-over-year primarily a function of revenue growth and mix? Or is the amendment in the WSA playing a role there as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure. Thank you for the questions. So relative to the full year guidance of up high single digits, the primary growth drivers are Ryzen and EPYC, are the 2 largest growth drivers. With data center GPU also, we're expecting that to be up. And then we would expect that semi-custom will be down. If you look at the life cycle, semi-custom will be in the seventh year of the console cycle, and so we expect semi-custom to be down approximately 20% and then we would expect consumer graphics to also be down, let's call it, double digits as we really burn off some of the channel inventory that we see in the first half of the year. So Ryzen and EPYC are the large drivers of the growth. And that's as we launch our 7-nanometer products throughout the year. And then your second question, Toshi, was? + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [4] +-------------------------------------------------------------------------------- + + Yes, in gross margins, 41% or greater, that's 2 percentage point or greater improvement year-over-year. Is that primarily a function of revenue growth and improvement in mix, given Ryzen and EPYC? Or is the WSA amendment providing a tailwind as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes, it's primarily due to mix. So the mix of the higher-margin new products, Ryzen, EPYC, and the data center GPUs. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [6] +-------------------------------------------------------------------------------- + + Next question, please? + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question is coming from Matt Ramsay from Cowen and Company. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [8] +-------------------------------------------------------------------------------- + + Lisa, I guess, I wanted to attack Toshi's question on the full year a little bit differently and maybe just talk about a little bit what share gain assumptions you guys are embedding for your 7-nanometer road map versus maybe some pragmatism or conservatism on the market just given the macro. I mean, Intel talked about a flat PC TAM in terms of units. And obviously, it's only, I guess, guided us to mid-single-digit growth for their sort of expansive server business for the year, and you guys are starting off down maybe 25% year-over-year in revenue for the first quarter given what's going on in the graphics business. So maybe you could just walk us through a little bit what you're thinking about the TAM growth of your 2 main growth markets for the year versus share gains you're embedding. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [9] +-------------------------------------------------------------------------------- + + Yes, absolutely, Matt. Look, I think, as it relates to the market, I don't think we would have a very different view of the market as others may have stated. Our story really is a share gain story. And when you take a look at sort of the progress that we'd made in 2018 and the design wins that we had in 2018, as we go over to 2019, when we look at both Rome as well as Ryzen, we look at sort of the breadth of OEM platforms that we have, the customer engagements by workload and sort of how we see that progressing. We feel very good about the opportunity to gain share as we go through the year, particularly given how competitive the products set is. Similarly, on the PC side, we've made nice progress over the last 4, 5 quarters. On Ryzen, we started strong on desktop, and then the last couple of quarters, we've made good progress on notebook. We see a broader portfolio with our OEMs as we go into 2019, and we also see a more competitive desktop product line as well as notebook product line. So that's how we're thinking about the year. To your point about starting a little bit with lower guidance in Q1, I think that's true. When we look at Q1, particularly on a year-on-year basis, there are a lot of moving pieces. But it's primarily due to the graphics channel. And that's both the reduced demand as well as the absence in blockchain revenue on a year-over-year basis as well as the semi-custom business. But as we move forward, as we go into Q2 and beyond, we see a significant opportunity with the ramp of our new products, and that's how we see the year. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [10] +-------------------------------------------------------------------------------- + + Got it, that's helpful. Devinder, maybe just a couple of little things in terms of licensing gains and IP revenue, just I got asked a few times, and I just want to clarify here that the gross margin outlook for the first quarter does not include any IP or licensing gains. And then, for the full year, are you including any IP revenue in the revenue outlook, and are we -- how should we think about the rest of the THATIC licensing gains applied to sort of timing for when those might get recognized? I know there's a lot there. But lots of questions on just the moving pieces there tonight. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [11] +-------------------------------------------------------------------------------- + + Yes, I can take that. License gain essentially does not impact gross margin. That sits on a separate line altogether on the licensing gain line in the P&L. So the gross margin is not impacted by that. As far as IP revenue is concerned in Q1, there's no contemplated IP revenue, so the gross margin at 41% guide is based on the products that we have. And for the year, at this point, outside of the THATIC JV IP licensing gain that we are expecting or recording in Q1, while there might be opportunities from an IP standpoint, but nothing substantial contemplated at this point. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question is coming from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [13] +-------------------------------------------------------------------------------- + + Lisa, I'm curious as you look back at 2019 and the success you had with EPYC -- the initial success with EPYC. What was the mix of cloud versus enterprise? And then how do you think it trends in 2019 because of all the concerns around slowdown in cloud CapEx and so forth? And as part of that, if you could share with us what your market share assumptions are as we exit the year on EPYC. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [14] +-------------------------------------------------------------------------------- + + Yes, sure, Vivek. As we look through 2018, we were pretty pleased with our progress on EPYC, and coming off of the fourth quarter, actually, it was a fairly strong fourth quarter for us and the fact that we doubled the number of units for our server business. And when you look at that mix, it is more cloud-weighted. So we had some large deployments that went online here in the fourth quarter, and that was positive for us. That being said though, we're making nice progress in the Enterprise and HPC side of the business too. We've had a number of wins in the quarter as well as going into 2019. So as we look into 2019, I would expect that the early Rome deployments will also be cloud-based. We'll be the first ones, but we have a strong set of enterprise platforms, and as I mentioned earlier, it's the breadth of the OEM platforms that gives us good confidence that we're going to a broader set of workloads and having broader coverage in the market. In terms of share assumptions, we'll have to see how the market and the year play out, but I think what we've said before is that, after reaching the mid-single digit market share in the fourth quarter 2018, we would expect it would take another 4 to 6 quarters to reach 10% market share. And I think we're still in that range. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [15] +-------------------------------------------------------------------------------- + + Got it. And for my follow-up, there were 2 things that came out on your competitors' last few public discussions, which is, one, this concept of CPU shortages, and I'm wondering if that has had any positive or negative effect on your strategy or positioning. And then Intel has also mentioned being a little more tactical when it comes to pricing, and I'm wondering how that figures into your full year outlook? So both the impact of CPU shortages and pricing, any color would be very helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [16] +-------------------------------------------------------------------------------- + + Sure, Vivek. So look, on the CPU shortages, my comment is that there are some pockets of shortage, particularly at the low end. However, our focus has really been on ramping Ryzen. And if you look at the Ryzen percentage of our overall business, Ryzen, Devinder mentioned, was 80% of our client business. So we are really actually improving our mix in the client business. I think that, again, from my view, the shortages are temporary. But we look at it as really getting consistent share gain. And as we've gone through each quarter in 2018, we've seen consistent share gain, and we believe we gained share in the fourth quarter as well. So I think we're well positioned with the portfolio, and we'll certainly drive that into 2019. And then, the other? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [17] +-------------------------------------------------------------------------------- + + Pricing. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Oh, pricing, yes. Relative to pricing, look, when we think about pricing and when we put together our long-term model, we have factored in that pricing and competition will be aggressive. I think we know that to be the case. What we've seen in the market is consistent with that, but we also believe that particularly as you go into the data center, the single largest factor from a buying decision standpoint is the performance and the total cost of ownership of the product, and we believe that Rome will be very, very well positioned in 2019. And so we are cognizant of the competitive environment but feel good that we have the right set of assumptions. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [20] +-------------------------------------------------------------------------------- + + Great to hit that mid-single digit milestone exiting the year. Lisa, as you start -- I just wanted to confirm, you expect to ship -- start shipping Rome midyear. And as you do, what's the biggest risk for Rome? Is it execution on delivering the product? Or is it the sales the process, convincing customers to take EPYC 2 in volume? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Yes, so I think the -- with Rome, our biggest opportunity/risk is adoption rate. I think, from a competitive standpoint, the product is very solid. Everything going through our development labs looks very good as well as our customer engagement. And so this is just about getting customers to production as fast as possible. We do expect though that the adoption rate for Rome will be faster than the adoption rate for Naples. And the reason for that is we are in a socket-compatible infrastructure. And so customers who don't necessarily need the newest features of the platform can actually use the same motherboard and system that they currently have with Naples and drop in Rome. And so I think that will help us accelerate some of the adoption, but right now, it's about helping customers in their environment. We are widely sampling Rome, and there is a lot of work to be done. But we feel good about the trajectory. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [22] +-------------------------------------------------------------------------------- + + Great. And a follow-up, if I may, for Devinder. So inventories, it looks like they were up about $100 million, going into a pretty healthy seasonal quarter that's declining. What should -- how should we read that, Devinder? And was there just some opportunity to get some wafers more cheaply? Or is there -- are you trying to stockpile product in front of launches, or -- and when can we expect the inventory to be a source of cash on the cash flow statement? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [23] +-------------------------------------------------------------------------------- + + Yes, Matt (sic) [Mark]. So the inventory growth is primarily driven by our new products and in preparation for our 7-nanometer next-generation product launches later this year, as you just mentioned. We overall expect to manage the inventory in line with revenue but also in support of the new products that will be launching and ramping throughout the year. Lisa mentioned a few of the launches at CES and also in the script, and we prepared to support that from an inventory standpoint. And we'll see how the year progresses and then manage it from there. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [24] +-------------------------------------------------------------------------------- + + Thank you, Mark. Next question please, operator? + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + Around the Q1 guide, obviously, you mentioned the GPU weakness, but you also mentioned seasonality across the businesses. Is my assumption correct that, that means everything is basically down sequentially, CPUs, GPUs, servers? Can you tell us, is that true? And if so, can you give us an idea of the magnitude, like at least what is down, I guess, most versus least, sequentially, Ryzen versus GPU versus EPYC? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [27] +-------------------------------------------------------------------------------- + + Sure, Stacy. So the largest driver, as I've said, is the GPU channel situation on a year-over-year basis. On a sequential basis, typical seasonality for, let's call it, PCs and GPUs and data center is probably around 10% or so. We are forecasting -- or we believe that that will be a little bit -- down a little bit more than that. And in terms of the ranking, I would say GPUs are down a bit more than the other 2 segments. That's the way we currently see it. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + Got it. And for my follow-up, I had a question just on, general, EESC. So its revenues are flat year-over-year. The server revenues are up a bunch and it's still losing money. And I get it, there's some incremental investments and everything, but I guess, how do we think about the profitability of that segment? How big does EPYC or Rome with the server business need be to get before it's sustainably profitable, especially as semi-custom is going to continue to decline, you said, 20% in 2019? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [29] +-------------------------------------------------------------------------------- + + Yes, I think the key, Stacy, is going to be ramping the server business in 2019. You are right that year-over-year we look at it, it's lost little bit of money. But fundamentally, it's investing in the go-to-market programs and launching the new products, investing in the ongoing engineering work that's needed to make sure the customers bring out the product on time. And semi-custom, given the fact that it's in the seventh year of the cycle, we expect it to be down from 2018 to 2019. But we do expect to go ahead and ramp our server business, and that will definitely benefit the EESC profitability in 2019. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + Do you think it's profitable for the full year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [31] +-------------------------------------------------------------------------------- + + Too early to tell. I won't -- I don't want to predict profitability at the segment level, but we'll see how it evolves over the year. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [33] +-------------------------------------------------------------------------------- + + Lisa, a potentially different way to ask the same question on the full year 2019 guide. Late last year, at a few different events, you talked about the server business being second-half-weighted. If I go through the remainder of this year, it seems like you have to grow the better part of 20% plus sequentially in each quarter to get there. I know it's not going to be perfectly linear like that. But I guess, my overall question is, if the server side of the business is back-half-weighted, what sorts of businesses are helping the middle portion of the year? Is there some snapback on the GPU side? Is there something going on in the Ryzen side? Just trying to get somewhat of the shape of the year off of a base that's admittedly pretty low as your first quarter starting point. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [34] +-------------------------------------------------------------------------------- + + Sure, Ross. So yes, I think it is fair to say that our quarterly progression will have a lot to do with our product launches. So you would expect that server will be more second-half-weighted than the first half. In general, our business is more second-half-weighted, though, if you think about the consumer portions of our business. But think about it as we would expect sequential growth in PCs. We would certainly expect sequential growth in data center, although stronger in the second half. We would -- we're also -- as we see the GPU business right now, we see the first quarter as the low point in the business, with the channels getting -- improving as we go into the second quarter. And we have additional product launches there as well. So that's the way we would see the portfolio. And semi-custom, although it's lower on a year-over-year basis, we would expect it to also increase as we go from second quarter into third quarter as well. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [35] +-------------------------------------------------------------------------------- + + Perfect. And a question on the GPU side, your big competitor in that market obviously is having some current issues and mentioned that the new product at the high end wasn't selling through. Are you at all concerned that the competitive landscape in that market, whether it's because China demand being weaker, as they cited, or them having to be a little bit more aggressive on pricing would do anything to your ability to penetrate the market with either existing or new GPU products as the year progresses? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Yes, so, look, when we look at the GPU market, and let's separate sort of gaming and data center, I think, on the gaming side, from what we are seeing, we did see sellout increase in Q4 versus Q3. So gamers are still buying GPUs. They may be more discerning about price points, and so I can imagine that there might be a bit more softness at the high end versus in the mid-range. But we believe that we have a good understanding of what's happening in the gaming side of the business. And it will be driven -- our gaming growth will be driven by new products. And we would see that as we go through this year with our Radeon VII launch as well as our Navi launches on the gaming side. On the data center side, we're making good progress in GPU data center, obviously from a low base, but the GPUs in the data center are very workload-dependent. There are some workloads that actually we do very well in things like cloud gaming and virtualization, and we have some early HPC wins. And so we see this as sort of customer acquisition redeployment. And so those are the sources of growth on the PC side for us. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question today is coming from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [38] +-------------------------------------------------------------------------------- + + Just 2 questions, if I can, building on that last one. In your prepared remarks, you noted that you've reached the milestone of which GPUs as well as data center CPUs reached a mid-teens percentage of your total revenue. I'm curious as you kind of contemplated your full year guidance, where do you think that mix of business can go? And is there a point in time where we actually -- you foresee us kind of getting granularity on how big the data center GPU business is trending? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- + + Yes, Aaron. So I think the mid-teens percentage revenue for us in Q4 was -- was a good milestone. I mean, I think that's a meaningful percentage of our revenue. And it was a contributor to our gross margin as we exited 2018. I think, as we go into 2019, again, we will continue to give you visibility into where the data center growth is. To be fair, my expectation is that the CPU side of the data center business will grow faster than the GPU side, just given what we see in terms of overall deployments. But I think both businesses will be meaningful for us and our key part of the growth story for us in 2019, and we'll continue to give color on how they develop as the year develops. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [40] +-------------------------------------------------------------------------------- + + Okay, that's very helpful. And just real quickly on the semi-custom side. As you kind of contemplated the guidance as well through the course this year and that 20% decline for the full year, is your assumption that Q1 kind of marks the bottom and we can grow seasonally off of that level? Or should we think about something differently from a progression through the quarters in '19? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [41] +-------------------------------------------------------------------------------- + + Yes. Aaron, yes, that's the correct way to think about it. So Q1 will be a low, Q2 will be higher, Q3 will be higher, and then Q4 will come down again. That should be the seasonality of semi-custom. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [43] +-------------------------------------------------------------------------------- + + Lisa, notwithstanding that the macro is extremely uncertain, making any predictions difficult. I'm just kind of curious, going back to Ross' question, how do you see sort of the cadence of growth sequentially throughout the year? Because as he pointed out, if you kind of divided it up equally by quarter, you're growing north of 20% in Q2, Q3, Q4, half-on-half growth, it would be somewhere around 50%. If you assume more seasonal, and seasonal is a little bit difficult to get to because of the change of accounting, I think you can get half-on-half growth as high as 75%. So as you think about the full year growth, is this something that's more like 50% half-on-half or 75% half-on-half? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Yes, thanks for the question, John. It might be a little bit early for us to go there. But what I would say is the following. When we look at the year-on-year compares from 2019 to 2018, Q2 2018 was still a very strong quarter for us because we still had a significant amount of blockchain sales in Q2 2018. So I expect that we will grow sequentially into Q2, but I think that will still be, let's call it, a tougher year-on-year compare. But then when we get into the second half of the year, we expect to be fully ramped on the entire 7-nanometer portfolio. And so we would see a heavier weighting in the second half. So we see sequential growth into second quarter but more heavily weighted into the second half. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [45] +-------------------------------------------------------------------------------- + + That's really helpful. And then, Devinder, on the profitability front, if you kind of run the numbers from Q1 guidance to kind of what you need to be exiting Q4 at to hit the full year number, you could see revenue up well over $1 billion, Q1 to Q4. I'm a little bit surprised that despite that, the gross margin guidance isn't a little bit better. I know you guided the full year to greater than 41% with Q1 at 41%, but I'm kind of curious, if you look at a Q4 run rate that's north of $1 billion higher than the Q1 run rate, how should we think about gross margin and operating margin exiting the year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [46] +-------------------------------------------------------------------------------- + + I think, John, if you look back the last many quarters, I think 7 quarters year-on-year, we've improved gross margin on the strength of the newer products. We ended the year quite well in 2018 and achieved gross margin in the fourth quarter that was nice. And now we start the year with 41%, and as we start the year, it's early guiding greater than 41%. I think you should expect that as the products ramp, in particular with the 7-nanometer product that Lisa referenced, our margins will continue to improve, and we'll see where we end up at by the end of the year. But we do expect that, year-on-year, margin goes up from where we ended in 2018 at 39% and greater than 41% for 2019. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Our next question is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [48] +-------------------------------------------------------------------------------- + + I have 2, quickly. First, on the C&G side, I realized that there's going to be a lot of kind of sequential difficulties there, but when I think about the long-term growth rate, I know you guys have kind of talked to kind of high singles to double-digit growth. Is that still essentially where you think that business can grow at long term? And then secondly, in terms of the next EPYC 2, is there any reason why it would underperform an Intel 10-nanometer in a testing environment? And if so, why would that be? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- + + Let me take the second question, and then maybe, Devinder, you can take the first question. So as it relates to our Rome product, when Rome was originally planned, we had planned that it would be competing against a 10-nanometer product. So that was the -- that was our expectation when we started. I think we've shown some of the generational performance advantages in terms of double the performance on a socket basis, 4x performance on a floating-point basis. And the other thing I would say is that, with our second-generation Rome, the customer set is now more used to our architecture, and so some of the architectural and software improvements that we've also spent quite a bit of time on over the last 4 to 6 quarters are coming into play. So I think we feel very good about the competitive positioning of Rome. And the other thing to keep in mind is we are deep in development of our next-generation beyond Rome. So the Zen 3 product portfolio is deep in development as well. So that's -- our goal is to ensure that we have a consistent cadence of very competitive products. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [50] +-------------------------------------------------------------------------------- + + Yes, and then as far as your question on the segment growth is concerned, relative to high-single-digits growth on a company level, in both of the segments, there are some factors that come into play. In Computing and Graphics, obviously, we feel good about the data center side of GPU. But on a compare basis, when you look at 2018 to 2019, we do have the impact of the blockchain and some memory sales from 2018 that don't happen in 2019 from a standpoint of where the market is. And then on the EESC side, semi-custom being down obviously is a factor when you compare year-on-year per segment. But good growth on the data center piece of it, in particular, but with the 7-nanometer Rome product launching in the back half -- I mean, ramping in the back half of 2019. And that's the way you kind of look at it. It is still early in the year from an overall standpoint. And where we ended up in 2018, we're projecting high single-digit growth at the company level for 2019 over 2018. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [52] +-------------------------------------------------------------------------------- + + Lisa, I just want to ask here, you laid it out a little bit, but in terms of EPYC 2, same socket, but -- and you have sampled it early. But in terms of getting over the finish line and getting these shipped, I guess, the customer still has to wait for production silicon. And then -- and typically, people talk about 6 to 12 months so they can kind of test it and make sure it does everything with the production silicon. So can you just walk us through the timeline because, obviously, you're baking in a pretty steep ramp in the second half? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [53] +-------------------------------------------------------------------------------- + + Yes, so we started sampling EPYC actually last year, so the second half of last year, to some of the top cloud vendors as well as our OEM partners. We've had a significant amount of development with our ODM partners as well. So I think there is a good amount of overlap between the customer development cycle and our development cycle. Now as you said, production silicon is very key, and ensuring that the final specifications are locked in is work that we still have to do here in the first half of this year. But I think we feel good about it. We feel good about the platforms, the customer engagements, the current progress of development and so that is very much our plan from an execution standpoint. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [54] +-------------------------------------------------------------------------------- + + I just want to ask on the GPU side. It looks like your ASP was up substantially with the data center. I was just kind of curious, as you think about the mix of data center, do you think -- how do you think about the trajectory of that business? I mean, is it -- is that portion lumpy as well? Or is this kind of the go-forward kind of level after that pretty sharp initial shipment in December? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [55] +-------------------------------------------------------------------------------- + + Yes, so on the data center side, we do expect that the data center GPU business will be a growth driver for us in 2019. It will be a little bit lumpy so I wouldn't say it's a straight line. But I would say, on a year-over-year basis, it's a important growth driver for us. And as it relates to the overall data center GPU ASPs affecting overall ASPs, I think that's true because the gaming ASPs are -- I'm sorry, the gaming business was lower than expected given the channel inventory situation. So I think it's also just weighted in terms of the units. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [56] +-------------------------------------------------------------------------------- + + Thank you, Blayne. Operator, we have time for 2 more questions, please. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [58] +-------------------------------------------------------------------------------- + + It seems like the GPU data center business is doing pretty well. Can you give us some color, if you look at mid-teens exposure overall between the 2 data center businesses, CPU and GPU, can you give us some qualitative sense for how much of that is GPU at this point and what are the main applications? Is it mostly virtualization? What other applications are you seeing there? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [59] +-------------------------------------------------------------------------------- + + Sure, Joe. So for the mid-teens percentage of revenue in Q4, between CPU and GPU, it's actually roughly similar. And then in terms of the workloads, the GPU data center side, we do very well in cloud gaming, we do very well with our virtualization solutions, and we have some early traction in HPC. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [60] +-------------------------------------------------------------------------------- + + Great. That's helpful. And I guess, just in terms of the business segmentation, I think you alluded to this earlier, but it seems like the conversation typically is around microprocessor, graphics and semi-custom as sort of 3 different opportunities. Have you thought about moving the segmentation to more align with that? And I realize that's easy to talk about and hard to implement, but what's your thought in terms of, over time, sort of migrating that more in line with the way you guys talk about the business? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [61] +-------------------------------------------------------------------------------- + + Yes, so we look at the business in all different cuts. As you can imagine, we look at it by segment, our CG and EESC. CG is very much a PC-driven segment and EESC with enterprise and semi-custom. And we are also, based on some of the feedback, trying to be a little bit more granular in terms of how the various businesses fall underneath that. So I think as the data center business becomes a larger piece of our business, we'll continue to look for how do we get -- give you guys more color and more transparency in how that is doing. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Our next question is coming from Vijay Rakesh from Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [63] +-------------------------------------------------------------------------------- + + Just in terms of the GPU gaming side, you mentioned higher inventory levels. I was wondering if you can give us some number on where normal inventory GPU levels are and where are they running currently. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [64] +-------------------------------------------------------------------------------- + + Yes, so when we look at the GPU channel inventory, we do believe our channel partners reduced inventory in Q4, and they will reduce inventories in Q1. We still think that Q1 levels are elevated, and there will be some spillover into Q2 where we will see some elevated inventory levels. We'll have to see how the sell-through really plays out. But my expectation is that, in Q2, we'll have sort of improved channel inventory levels and we will return to a sequential growth in the gaming side of our business. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [65] +-------------------------------------------------------------------------------- + + Got it. And on the 7-nanometer side, is the 7-nanometer GPU and CPU, as those ramp in the back half, are they accretive to this 41% gross margin levels? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [66] +-------------------------------------------------------------------------------- + + Yes, so the 7-nanometer GPUs on the data center side started ramping in Q4 so that was part of the data center GPU revenue that we talked about. The 7-nanometer CPU will ramp middle of the year, and the 7-nanometer CPU and GPU are both above corporate average margins so you would expect that they're above the 41 points and would be sort of accretive to margin as that mix improves. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + We've reached the end of our question-and-answer session. I'd like to turn the floor back to over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [68] +-------------------------------------------------------------------------------- + + Thank you very much, operator. We appreciate everyone joining us here today. We're quite proud of the accomplishment in 2018 and look forward to seeing you all on the road in 2019. Have a great afternoon. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2019-Jul-30-AMD.txt b/Transcripts/AMD/2019-Jul-30-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..dfd00bc7db07771e832bb3f432e9e9d705cde2b1 --- /dev/null +++ b/Transcripts/AMD/2019-Jul-30-AMD.txt @@ -0,0 +1,696 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Advanced Micro Devices Inc Earnings Call +JULY 30, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Laura Graves. Please go ahead. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Second Quarter 2019 Conference Call. By now you should have had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, AMD.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +Before we begin, I would like to highlight some important dates for you. AMD will officially launch our second-generation EPYC data center CPU on Wednesday, August 7. On Tuesday, August 27, Forrest Norrod, Senior Vice President and General Manager of our Datacenter and Embedded Solutions Group will present at the Jefferies 2019 Semiconductor, Hardware and Communications Infrastructure Summit in Chicago. On Tuesday, September 10, Devinder Kumar, Senior Vice President and Chief Financial Officer and Treasurer will present at the Deutsche Bank Technology Conference in Las Vegas. And on Friday, September 13, 2019, our third quarter quiet time is expected to begin at the close of business. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. +We will refer primarily to non-GAAP financial measures during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced today are reconciled to their most directly comparable GAAP financial measure in today's press release, which is posted on our website. +Please refer to the cautionary statements in our press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and, in particular, AMD's quarterly report on Form 10-Q for the quarter ended March 30, 2019. +Now with that, I'd like to hand the call over to Lisa. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. We made history in the second quarter, both as the first company to simultaneously launch high-performance CPUs and GPUs and the first to ramp 7-nanometer high-performance processors across PCs, gaming and the data center. I'm extremely pleased with our execution in the quarter as we ramped production on Ryzen 3000 CPUs, Radeon 300 GPUs and early volumes of our second-generation EPYC processors, in advance of their third quarter launch. +Looking at the second quarter, revenue of $1.53 billion increased 20% sequentially driven by growth across both of our business segments. Revenue declined 13% year-over-year in line with our expectations as client and server processor revenue increases were offset by lower graphics channel and semi-custom revenue. +Turning to our Computing and Graphics segment. Revenue declined 13% year-over-year as significantly higher client processor sales were offset by lower graphics channel sales. Mobile client processor revenue increased by a double-digit percentage year-over-year and sequentially driven by our highest quarterly unit shipments in 5 years. In desktop, we launched our industry-leading Ryzen 3000 processors featuring our new Zen 2 core to overwhelmingly positive customer response. Numerous third-party reviews highlighted the superior performance of our 7-nanometer Ryzen CPUs in both multi-threaded and single-threaded applications while consuming less power than competitive offerings. Ryzen 3000 processor customer demand has been very strong, with sales at global e-tailers and retailers outpacing our previous generations of Ryzen by more than 3x at the same point following their respective launches. +Based on the market response to our latest mobile and desktop processors and the growing number of AMD-powered commercial and consumer PCs, we expect to gain share in the high volume back-to-school and holiday periods. +In Graphics, revenue decreased year-over-year driven largely by lower channel sales partially offset by a significant increase in data center GPU sales. GPU revenue increased by a double-digit percentage sequentially driven by increased channel sales of our RX 500 series GPUs and the launch of our Radeon 5700 family. The Radeon 5700 series with our new RDNA architecture, delivers up to 1.5x more performance per watt compared to our previous generation. Initial demand for our new GPUs has been strong as third-party reviewers have highlighted our leadership gaming performance at relevant price points. We are well positioned for growth in the second half of the year as we continue to ramp our Radeon 5000 GPU family. +We had another quarter of strong year-over-year data center GPU sales growth driven largely by HPC and cloud wins. We continue making progress expanding this margin-accretive part of our business based on our strategy to focus on working closely with marquee customers. +We also announced a strategic partnership in the quarter with Samsung to bring Radeon graphics to their future smartphone and mobile SoCs. The partnership showcases our strategy to engage with industry leaders across the ecosystem to drive Radeon everywhere. We now have deep partnerships across the PC, game console, cloud and mobile markets that contribute to a growing developer ecosystem and installed base for our Radeon graphics architecture. +Turning to Enterprise, Embedded and Semi-Custom segment. Revenue decreased 12% from a year ago due to lower semi-custom revenue. In semi-custom, we have extended our game console leadership as both Microsoft and Sony have now both announced they will use custom AMD SoCs to power their next-generation game consoles. We are very proud to power back-to-back generations of the world's highest performing game consoles. +As we look into the second half of the year, we are seeing additional softness in game console demand, which is now reflected in our full year guidance. +In server, CPU revenue grew significantly year-over-year and sequentially driven by initial shipments of our next-generation Rome processors to lead cloud and OEM customers. First-generation EPYC processor-based cloud deployments continued to increase in the quarter. Amazon expanded availability of its EPYC processor-powered instances to the more than 15 regions and dozens of new configurations. And Microsoft launched general availability of its Azure HB supercomputing virtual machine that, for the first time ever, enabled customers to run demanding HPC workloads in the cloud. +Turning to our next-generation Rome server processor, Rome is on-time and exceed expectations, delivering leadership performance and TCO across a significantly expanded number of cloud and enterprise workloads. Customer excitement continues to grow. Compared to our first-generation EPYC processors, we have more than twice the number of platforms in development with a larger set of partners. We also have 4x more enterprise and cloud customers actively engaged on deployments prior to launch. As a result, Rome is on track to ramp significantly faster than our first-generation EPYC processor. +We are seeing particular strength in HPC, where we offer leadership compute density and I/O. We had multiple supercomputing wins in the quarter, including public announcements from Indiana University and Norway's National Research Network. Our supercomputing momentum was highlighted by the U.S. Department of Energy and Oak Ridge National Laboratory, selecting both EPYC CPUs and Radeon Instinct GPUs to power their next-generation Frontier exascale supercomputer built by Cray. Frontier is expected to be the world's fastest computer when it launches in 2021. We look forward to providing more details on Rome at our launch event in August 7. +In summary, as we complete the first half of 2019, we have reached a significant inflection point for the company as we enter our next phase of growth with the most competitive product portfolio in our history. We have seen some uncertainties across our supply chain driven by tariffs, trade concerns and the U.S. entities list. In the second quarter, we stopped shipping to customers added to the U.S. entities list. While we remained cautious given the fluidity of the situation, the impact to date has been limited and offset by growing momentum in other parts of our business. +We are executing well to our plans and see a path to significant market share gains for our product portfolio across the PC, gaming and data center markets in the coming quarters. +Now I'd like to turn the call over to Devinder to provide some additional color on our second quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa and good afternoon, everyone. We are pleased with the financial results for the first half of 2019, which provide a solid foundation for the second half of the year. Second quarter revenue of $1.53 billion grew 20% over the first quarter. Gross margin of 41% increased 4 percentage points from the prior year driven by the ramp of our strong portfolio of high-performance products. +Quarterly revenue was down 13% from a year ago. Strong sales of Ryzen and EPYC processors and our new Radeon RX 5700 GPUs were more than offset by lower semi-custom sales and lower graphics channeled sales associated with blockchain. Operating expenses grew 10% year-over-year to $512 million driven primarily by go-to-market activities and new product introductions. Operating income was $111 million, down from $186 million a year ago, primarily due to lower revenue and higher operating expenses. Operating margin was 7%, down from 11% a year ago. Net income was $92 million compared to $156 million a year ago. And diluted earnings per share was $0.08 per share compared to $0.14 per share a year ago. +Now turning to the business segment result. Computing and Graphics segment revenue was $940 million, down 13% year-over-year as strong client processor sales were more than offset by lower overall graphic sales due to negligible blockchain-related revenue in the second quarter of 2019. Computing and Graphics segment operating income was $22 million compared to $117 million a year ago, primarily due to lower revenue. +In the Enterprise, Embedded and Semi-Custom segment, revenue was $591 million, down 12% from the prior year. Semi-Custom revenue was lower and partially offset by significant growth in data center CPU revenue. EESC segment operating income was $89 million compared to $69 million a year ago. The improvement was largely due to growth in data center CPU revenue. +Turning to the balance sheet. Our cash, cash equivalents and marketable securities totaled $1.1 billion at the end of the quarter. Year-over-year, we have reduced gross debt by $392 million, and in the second quarter, we also replaced our asset-backed loan facility with a $500 million secured revolving line of credit. +Free cash flow was negative $28 million in the quarter, while cash flow from operations was $30 million. Inventory was $1 billion, up $60 million sequentially, primarily due to increased inventory of our new 7-nanometer products in anticipation of accelerating product sales in the back half of the year. Adjusted EBITDA was $163 million compared to $228 million a year ago due to lower quarterly earnings. On a trailing 12-month basis, adjusted EBITDA was $672 million, and gross leverage at the end of the quarter was 1.9x. +Turning to the outlook for the third quarter of 2019. We expect revenue to be approximately $1.8 billion plus or minus $50 million, an increase of approximately 9% year-over-year and 18% sequentially. The sequential and year-over-year increases are expected to be driven by Ryzen, EPYC and Radeon product sales, partially offset by lower-than-expected semi-custom sales. +In addition, for Q3 2019, we expect non-GAAP gross margin to be approximately 43%; non-GAAP operating expenses to be approximately $525 million; non-GAAP interest expense, taxes and other to be approximately $30 million; and third quarter diluted share count is expected to be approximately 1.21 billion shares. +For the full year, we now believe revenue will increase mid-single-digit percent over 2018 driven by significant sales growth of our new Ryzen, EPYC and Radeon processors, partially offset by lower-than-expected semi-custom revenue. Revenue, excluding semi-custom, is expected to increase approximately 20% year-over-year. Full year non-GAAP gross margin is expected to be approximately 42%. +In closing, we had a strong first half of 2019. We remain focused on executing to our plans for the remainder of the year and look forward to ramping our new Ryzen and Radeon products as well as the upcoming launch of Rome. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready for our first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [2] +-------------------------------------------------------------------------------- + + So my question is really just twofold. Number one, first on the gross margin side. So you guys have talked about semi-custom coming down pretty materially, and that's kind of the entire reason for the, I guess the mid-single-digit growth number. So why, I guess, aren't the gross margins expanding a little more if you're seeing more traction on the server side? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [3] +-------------------------------------------------------------------------------- + + I think, if we look at it from an overall standpoint, in Q2, we did 41%. In the third quarter in a row, 41% gross margin. And in Q3, you're right that the decline in semi-custom, there is benefit to the margin. And the margin guide for Q3, that's approximately 43%. I can tell you that the richer product mix, especially with the new products ramping in Q3, are going to drive the gross margin. Although there is a benefit from the decline of semi-custom also, the margin benefit is more weighted towards the non-semi-custom business, and that's where we end up with the 43% in Q3. We've also updated our guidance for 2019 and now are projecting 42% for the year 2019. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [4] +-------------------------------------------------------------------------------- + + Yes. So I guess, just a follow-up on that. So the assumption is that by the end of '19, you guys have more share on the server side. So I guess just high level, if I assume that 2020 gross margins are going to start going up as well if you keep gaining share in server. Is that a fair assumption for the next year or so? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [5] +-------------------------------------------------------------------------------- + + I think what I would say is we're very pleased with the progress we have made on the margin in 2019. The product mix continues to get richer, and we'll see as we get closer to 2020 in terms of the specifics. But you're right, the product mix does get better. And even in the other businesses, including the client business, the product mix being richer benefits the margin. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question is coming from Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [7] +-------------------------------------------------------------------------------- + + Good to see the traction in the new products. Lisa, for my first question, I was wondering if you could give us some more color around the traction you're seeing in Rome, both from if you're able to quantify it somewhat, but importantly, the traction you're seeing with customers, whether there is any pricing pressure from your main competitor. And I think in the past, you have outlined targets to reach certain market share. Just now that the product is out in front of customers, how are you seeing that traction with both the cloud and the enterprise side? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Absolutely, Vivek. Thanks for the question. So look, we are very pleased with how Rome is coming up. We did ship initial shipments this past quarter in the second quarter to both cloud and enterprise customers. The feedback that we're getting from customers is that the performance is very compelling both from a performance standpoint as well as a total cost of ownership standpoint. We've gotten a number of wins on both the cloud and the enterprise side as well as HPC. From our standpoint, next week is a big week for us. Obviously, we're going to officially launch Rome on August 7. But from a customer pull standpoint, we see good customer pull. +Your question specifically about the pricing environment, the pricing environment is always competitive. We expect it to be competitive. That being the case, in servers, price is not the first variable in terms of a buying decision. And so we believe the value proposition that we have for Rome from an overall standpoint is very strong, and we see a good pricing environment for that. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + And as my follow-up, on the quantification side, I think in the last quarter, you had given us some color around data centers, CPU and GPU kind of around that mid-teens as a percentage of sales. I was hoping you could give us some sense of what it was in Q2 and just what the outlook is for 2019 or the second half of the year. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- + + Yes. So in the second quarter, the percentages are similar to the past few quarters in terms of percentage of our business. We were more heavily weighted towards CPU versus GPU in the second quarter, so we saw data center GPU sequentially decline as expected. The CPUs grew as expected. As we go into the second half of the year, you should expect that the percentage of our revenue through the data center will increase as we ramp room. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [12] +-------------------------------------------------------------------------------- + + Lisa, obviously, it seems like you're making a lot of progress with Rome or at least the initial feedback continues to be very positive. That said, the overall hyperscale environment seems pretty slow based on commentary from your peers and your customers, I guess. Could that impact the ramp into the second half? Is that a concern for you going forward? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Sure. So look, we certainly have heard the same conversation, especially around the cloud environment in the first half of the year. Our plan was always very heavily second half weighted. And from our standpoint, we have seen significant customer engagement and pull for the Rome product, and we see a number of new installations that will come online over the next couple of quarters. So I believe that there is some cloud digestion that's happening out there. I also believe that given where we are from the product cycle standpoint, we are well positioned to grow. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [14] +-------------------------------------------------------------------------------- + + Got it. And then as a follow-up, I was hoping to learn a little bit more about the partnership with Samsung, the IP win in the quarter and also Frontier on the HPC side. Just from a modeling perspective, how should we think about those 2 deals, if you will, over the next couple of years and the accretion to the P&L? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Sure. So look, we're very pleased with both. They're both very significant announcements for us. On the Samsung side, it's a multiyear, multigenerational deal that we have across our graphics portfolio for mobile. In terms of 2019, the revenue is approximately $100 million that would be added. This was not originally in our guidance, and it offsets some of the headwinds that we talked about in semi-custom and in China. As it -- it's not pure IP, though, so the way you should think about it is there is some specific development expenses that are being -- that are part of that deal. And so those will be part of the COGS portion of that. As it relates to Frontier, Frontier again, very significant deal for us. It is NRE for the next couple of years to really get the software and infrastructure. I would say, that's not material. And it's a relatively smaller number. And then, the actual deployment will be in 2021. So the bulk of the CPU and the GPU revenue will be in 2021, with a small portion of that perhaps in the second half of 2020. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question or is coming from Matt Ramsey from Cowen and Company. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [17] +-------------------------------------------------------------------------------- + + Lisa, I think we'll be hearing plenty about Rome next week. I wanted to ask some questions about your PC business going into the back half of the year. The desktop momentum seems there. The notebook space, Intel is obviously going on to 10-nanometer for a portion of that portfolio. And it seems the 7-nanometer refresh on your side is a little bit later, yet the SKU coverage you've talked about, I think, is 50% higher than it was last year for back-to-school and holidays. So maybe you could talk a little bit about the momentum in the PC business into the back half and the differences between what you might see in desktop and notebook. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Yes, sure, Matt. So we're pleased with the progress of our PC business. In the second quarter, we had notebook perform very well. We saw a ramp of our second-generation mobile product, and that is due to some of the additional platforms that we mentioned. Going into the second half of the year, on the desktop side, our third-generation Ryzen products are very well positioned. We expect to ramp significant production here in the third quarter. And we expect that to lead to share gains. And we're also feeling quite good about the mobile products into the second half of the year. We made progress on both consumer and commercial. We had always been strong in consumer, but on the commercial side, we have a number of new platforms as well, and those are ramping here into the second half of the year. So overall, I think the PC business continues to be a good opportunity for us to gain share through the second half of the year. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [19] +-------------------------------------------------------------------------------- + + Got it. And as a follow-up for me, a couple things for Devinder. I wonder if you might talk about the margin or gross margin differential between some of the new 7-nanometer products that you're rolling out versus some of the predecessor products that were either on 12 or 14, just so we can get an understanding on magnitude. And before you take that, just congrats on cash positive for the company overall, even in some of the verticals. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [20] +-------------------------------------------------------------------------------- + + Okay. Yes. So on the margin side, the new products, as we have said previously, in aggregate are greater than 50% margin. And so as we launch the new products, in particular on the 7-nanometer node, those are accretive. And that's why you see us updating the guidance in terms of the margin not just for the quarter in Q3 but also for the year. And from that standpoint, as the product mix gets richer with more 7-nanometer products ramping, that should benefit the gross margin. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question is coming from Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [22] +-------------------------------------------------------------------------------- + + Congrats on the execution with the 7-nanometer. Lisa, are you guys constrained in terms of 7-nanometer at TSM? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Hans, yes. So we do have a number of products ramping at TSMC in 7-nanometer and we are not constrained per se. I will say that cycle times of 7-nanometer are longer, and so it just takes more time to ramp up, but we are not constrained. TSMC has supported us quite well. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + Great. And can you give us a sense, if you can, on 7-nanometer high-end Navi and mobile 7-nanometer CPUs, if you can? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + Hans, you asked the good product questions. I would say, they are coming. You should expect that our execution on those are on track, and we have a rich 7-nanometer portfolio beyond the products that we have currently announced in the upcoming quarters. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [27] +-------------------------------------------------------------------------------- + + Lisa, you have a lot of things working for you. You've got Rome, Ryzen, the GPU portfolio. Where are you seeing the biggest upside surprise on the feedback that you're getting relative to your original expectations? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [28] +-------------------------------------------------------------------------------- + + Yes. So look, Mark, I think all products have really performed quite well. I think the third-generation Ryzen desktop, both in terms of the reviews -- third-party reviews as well as just the customer interest, what we see is obviously it's only been in market for 3 weeks, and so we watch the data points very carefully. But across the globe, we're seeing sort of significant uptick in our share in the desktop market. I think Navi has come out positioned very well. We're very pleased with our RDNA architecture. Navi is the first step, and we have a couple more steps going. And then we'll talk much more about EPYC next week. I think the key thing is the products have been on schedule and at or above the performance. So our goal is of course to turn that into revenue growth in the second half of the year. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- + + Yes, that's great color. And a follow-up if I may, you mentioned the gen 5 game console wins at Microsoft and Sony. Can you give us a sense, when do these start to ramp? When they ramp, do you book the revenues as you build inventory as you did in the previous generation? And is there going to be -- should we think about anything differently on the gross margin profile? Is it going to be similar to what you've had in the past on these things? So just some color on the gen 5 game consoles. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- + + Sure. So Mark, we're proud of the wins at Sony and Microsoft. Those are big wins for us and, as you know, over many years. We can't comment on specific customers and their ramp profiles. The only thing I will say is, you can expect that in general, consumer ramps are second half weighted, especially weighted towards the holiday season. And you would expect that. And then as it relates to the gross margin profiles, with our semi-custom business model, I think the margins will be under the corporate average. However, our business model is actually quite different. If you look forward to our business model, the growth that we see across all of our other products, Ryzen, EPYC, Radeon is actually quite significant. And so the percentage of semi-custom as a percent of the overall business will be lower than, for example, in the last few years. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + For my first one, I want to follow up on that second half gross margin question again. I want to put some numbers behind it. So you're guiding 43% for Q3. Your implied guidance for Q4 is 43% and maybe a little under. It's only up about 150 bps year-over-year and flat sequentially, but you're guiding Q4 revenues of over 50% year-over-year. And consoles have to be falling like 40% to 50% sequentially, so the mix has to be massively switching over to the new products that, in aggregate, have gross over 50%. Why are gross margins only being guided up like 160 bps year-over-year in Q4 given that kind of a revenue trajectory? And why is it only flat sequentially even with revenues growing over 20% quarter-on-quarter into Q4? I don't understand. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [33] +-------------------------------------------------------------------------------- + + Yes. Stacy, let me start, and then maybe Devinder can add to it. So we guide approximately to full margin points. What you should expect as we go from Q3 to Q4 is that the product mix will get better, so we will expect more new products. And from the standpoint of semi-custom, semi-custom will be down sequentially Q3 to Q4. And so you should expect that we are not implying that the margin will be down in Q4, and we'll get to the Q4 guide as we get through the next 90 days. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- + + Okay. For my follow-up, the $100 million from Samsung, did your 20% year-over-year growth excluding the semi-custom include that $100 million that wasn't in the prior guidance? And what is the impact on the gross margins of that Samsung revenue as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + Yes. So the Samsung additional revenue is included as part of the 20% year-on-year, and it offset some weakness that we have in China due to the entities list. As to the gross margin profile for that, you can expect that to be somewhat above corporate average. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + So somewhat over low-40s? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- + + Somewhat above corporate average. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question is coming from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [39] +-------------------------------------------------------------------------------- + + I have one question and a follow-up as well. Just building on that last kind of question, I think the last couple of quarters, you've talked about your semi-custom business being down somewhere in the 20% plus range. It looks like by my math, your assumption now is that, that business declines maybe as much as 40-plus percent. And so when you parse through that, you kind of factor in the Samsung relationship and the incremental $100 million revenue, has your estimate at all changed ex those items? Meaning, revenue ex the semi-custom decline and then also ex the $100 million Samsung? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [40] +-------------------------------------------------------------------------------- + + Yes. So let me try to help you, Aaron, with that math. So look, originally, when we started the year, we thought semi-custom would be down, let's call it, approximately 20%. In the first half of the year it was down more than that. And based on what we see today, we would expect the full year now to be down, let's call it, mid-30s year-on-year. If you talk about now the rest of the business, I think the rest of the business is close to where we thought it would be, close plus or minus a couple percent. And if you think about all of the moving pieces, we do have some customers that were not shipping to -- in China. That is offset by the Samsung upside and with the new products and how they're coming in. So I think we are pretty close plus or minus to where we thought we would be ex those factors. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [41] +-------------------------------------------------------------------------------- + + Okay. That's very helpful. And then just looking at your product segmentation, I'm curious as how you think about the trajectory of the data center GPU business going forward. Obviously, I can appreciate that could be lumpy, but I'm just trying to understand how you see that. Is there a point in time when we can actually get some better visibility into that incremental growth driver or revenue stream going forward? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [42] +-------------------------------------------------------------------------------- + + Yes. I think that's a fair comment. It is a little bit lumpy because of its size and it's fairly concentrated in a couple of customers. I will say that we're going to see very nice year-over-year growth this year, and we see good customer momentum across both cloud as well as HPC. On the cloud side, it is both, let's call it cloud streaming/gaming as well as machine learning. And on the HPC side, the Frontier win is a public win, but we have a number of others that we're working as well. So I think we give more color as we go forward, but it continues to be a business that we feel will be a good growth driver over the next few years. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question today is coming from David Wong from Instinet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [44] +-------------------------------------------------------------------------------- + + One small clarification and then a second question. The clarification, the Samsung $100 million, does that come in under income statement to the revenue or is it on another line, a special item or something? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [45] +-------------------------------------------------------------------------------- + + It's revenue. So it's revenue, and then offset by some specific development costs and also in COGS. And like Lisa said earlier, the margin, when you take the revenue and the COGS offset, is somewhat above corporate average. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [46] +-------------------------------------------------------------------------------- + + Okay. Excellent. And can you give us any numbers in terms of for the June quarter, your sequential unit growth in desktop and notebook processing units and the sales growth PC GPUs? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + Let's see, David. So in the -- your questions is about the second quarter? + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [48] +-------------------------------------------------------------------------------- + + That's correct. Yes. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- + + Yes. So the second quarter we saw a sequentially mobile units up, and we saw desktop units down. And the desktop units down is somewhat due to the seasonality in the second quarter as well as the fact that we were going through a product transition as we were preparing for the third-generation launch, which happened at the very end of the quarter. In terms of graphics, we were up double digits sequentially, and that's both units and revenue statement as it relates to -- and that was driven primarily by the graphics channel. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our next question today is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [51] +-------------------------------------------------------------------------------- + + So your full quarter -- your full year guidance, mid-single digit. If I sort of project 5%, you need to get to a $2.2 billion number for the December quarter. I guess how literally should I take that? Is there anything -- I understand there's a lot of product momentum. That still seems like a big number. Is there anything we should understand in terms of seasonality or things that would kind of give you confidence in mid-single digit for the full year still? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [52] +-------------------------------------------------------------------------------- + + Yes, I think, Joe, our view is that we have significant amount of product launches to happen. So as we go through the third quarter and the fourth quarter, both on the PC side, the GPU side as well as on the server side. So, yes. It is significant growth, and I think we feel good about sort of the drivers there. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question today is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [54] +-------------------------------------------------------------------------------- + + Congratulations on these solid results. I apologies if I missed this, Lisa. Just going back to the Samsung revenue. Is that $100 million all coming into the calendar fourth quarter? Or will there be some in the September quarter as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [55] +-------------------------------------------------------------------------------- + + Yes, John. So that $100 million -- approximately $100 million for the year. There was a little bit in Q2, and then the rest will be in Q3 and Q4. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [56] +-------------------------------------------------------------------------------- + + Is there linearity you can talk about on that? Or can we just kind of evenly split it between Q3 and Q4? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + I think that's close. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [58] +-------------------------------------------------------------------------------- + + Okay. And then just a similar question on bridging sort of the gap between your Q3 guide and your full year guide as it pertains to OpEx. If you look at kind of the full year guide you're given in OpEx, it could imply that OpEx dollars are actually flat to down sequentially in Q4 on pretty meaningful revenue growth, which is great leverage and understandable on the SG&A line. But I'm just kind of curious, how we should be thinking or how you're thinking about the R&D spend as you start to see revenue begin to accelerate again. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [59] +-------------------------------------------------------------------------------- + + Look, I think you should expect that OpEx should be flattish as we go through the rest of the year. And we have increased OpEx. Obviously, the first half of the year was higher OpEx as a percentage of revenue. We are investing in the right places, and I think the product execution shows up. We will evaluate obviously in 2020 as we look through the overall revenue growth picture and what we'll do with OpEx. But I think we've made the right investments and we'll continue to do so. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [60] +-------------------------------------------------------------------------------- + + And John, if you're looking at additional data since you are doing the math, we expect OpEx to be approximately 30% for 2019, if you take Q3 and Q4 into consideration. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Our next question is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [62] +-------------------------------------------------------------------------------- + + Lisa, maybe this something you'll address next week in the Rome launch. But in aggregate, now that we're this much closer to the launch in the second half ramp, which you sound very confident on, a year ago you talked about the market share goals. I think it was double-digit market share, 4 to 6 quarters after you hit the 5% market share. Any sort of update on the timing and/or comfort around hitting that target? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- + + Yes. So I think, Ross, we feel good about that being the right target. I'm not ready to update that yet. I think we want to get through. There's a lot of platforms to launch here in the third quarter and in the fourth quarter. We'd like to get through some of that. But we feel that the target is the right target. The product is certainly performing well. And now it's about helping our customers get their platforms to market as soon as possible. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [64] +-------------------------------------------------------------------------------- + + Got it. A quick follow-up. It was part of a prior question that I don't think I heard the answer to. But is the accounting for the semi-custom ramp, whenever it may occur next year, the same in so far as when you build it, you recognize the revenue? So even if the customer tends to ramp in consumer in the half year, you guys obviously have to build and get the inventory stage, et cetera, much earlier than that, and therefore that would be revenue? Or did something change accounting-wise that that's no longer true? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [65] +-------------------------------------------------------------------------------- + + Yes. That was asked earlier, and I don't think I responded to it. The accounting is the same, so I don't think the accounting changes. The only difference, though, is we tend -- we would not ramp a product prior to qualification. So there are some -- when you're doing a brand-new product, there is a more involved qualification cycle. And so I think there would be -- it would be more commensurate with the actual product shipments. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [66] +-------------------------------------------------------------------------------- + + So 2 things would happen more simultaneously, is what you're saying? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [67] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Our next question today is coming from Ambrish Srivastava from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [69] +-------------------------------------------------------------------------------- + + I also had a clarification, Lisa. I'm not sure I quite understood. In the delta for revenues, you talked about semi-custom, and then you also said that China is having an impact. What specific product areas are those? And is that -- THATIC is also part of that? And then I have a follow-up for Devinder. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [70] +-------------------------------------------------------------------------------- + + Yes. So we did have a small impact due to China. We have several customers that are now on the U.S. entities list, and we stopped shipping to those customers in the second quarter. And so it's a small impact, but there is impact that is offset by some of the positives in the rest of the business. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [71] +-------------------------------------------------------------------------------- + + So I'm assuming that's CPUs, desktop and/or server, both, right? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [72] +-------------------------------------------------------------------------------- + + There is some PC business and there's some server business. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [73] +-------------------------------------------------------------------------------- + + And then Devinder, my follow-up is on free cash flow. The gap between free cash flow per share and earnings per share is massive. If I look at the first 2 quarters, roughly $300 million, negative free cash flow, but you're guiding for positive -- for the full year. Can you put some numbers around that? Is that tens of millions? Or what's the right way to think about that? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [74] +-------------------------------------------------------------------------------- + + I think, so if you asked in Q3, we expect to be free cash flow positive and free cash flow positive for the year. It won't be tens of millions from a year's standpoint. I think it's triple digit, but I'm not going to give you a specific number. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Our next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [76] +-------------------------------------------------------------------------------- + + I'm just curious on the notebook market. Intel talked about some pull-ins, but also ensuring the market. You're ramping products. Just wondering if you can parse those items out because notebook was pretty strong for you in June. Just curious if that impacts any seasonality at the end of the year. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [77] +-------------------------------------------------------------------------------- + + Sure, Blayne. From our standpoint, our notebook ramps were due to platform breadth. We ramped a number of second-generation platforms as well as some new Chrome platforms. I can't say that I can point to any particular pull-ins, per se. I think we're still expecting that we have -- we see a seasonal uplift in the second half of the year. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [78] +-------------------------------------------------------------------------------- + + And then maybe just a follow-on to that. In your September guidance, if you look between the Computing and Graphics segment, I'm wondering, between the 3 segments, if you can just highlight which one you expect to be the strongest? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [79] +-------------------------------------------------------------------------------- + + So, let's see. I think what I would say is that, amongst the product lines and where they are in their ramp cycle, you would expect perhaps PCs to be the strongest and then graphics and server next. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Our final question today is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [81] +-------------------------------------------------------------------------------- + + Lisa, so for my first question, I just wanted to ask how you think about semi-custom sort of over the longer term? And talk maybe about cloud gaming and sort of how you think about its long-term effect on you. Because on one hand you've done quite well with some of these big launches coming up, but you're also exposed to some potential cannibalization on the semi-custom side. So I'm wondering how you think about those 2 factors? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [82] +-------------------------------------------------------------------------------- + + Yes, so look, I think we like sort of gaming overall. So if you think about gaming overall, there's PC gaming, there's cloud gaming and then there's console gaming. We believe a rich ecosystem is important. We want to have our Radeon graphics architecture across all those 3 segments. +I've been asked about the cannibalization question, I think it's too early to talk about that. Maybe in a few years. I mean we think cloud gaming is going to be important, but it's too early to say whether it's really a cannibalization thing, or is it an additive, getting access to more users overall. So our goal is to make sure that our architecture is very friendly to all segments of gaming. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [83] +-------------------------------------------------------------------------------- + + Great. And then I just wanted to go back to the question that Ross just asked about, the server share target. So it's not that you're not reiterating that target here. It's more that you're going to update us on the target when you launch Rome. Is that the right way to think about it? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [84] +-------------------------------------------------------------------------------- + + No. Let me say it this way. I think we do stand by the target, so the target being double-digit, sort of 4 to 6 quarters after the initial 5%. I think we feel good about that target. I'm not being more specific than that until we get through more of the ramp. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- + + Thank you. We reached the end of our question-and-answer session, I'd like to turn the floor back over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [86] +-------------------------------------------------------------------------------- + + We're good. That was a good call. Thank you, everyone, for joining us for AMD's second quarter call today. We look forward to speaking with you from San Francisco on August the 7th, and we appreciate your support of our company. Thank you. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2019-Oct-29-AMD.txt b/Transcripts/AMD/2019-Oct-29-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..6bf0eedf3ab13a53f79e1623013af202153606e4 --- /dev/null +++ b/Transcripts/AMD/2019-Oct-29-AMD.txt @@ -0,0 +1,546 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Advanced Micro Devices Inc Earnings Call +OCTOBER 29, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Harsh V. Kumar + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Advanced Micro Devices Third Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It's now my pleasure to introduce your host, Laura Graves. Please go ahead. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Third Quarter 2019 Financial Results Conference Call. By now, you should have had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these items, they can be found on the Investor Relations page of AMD's website, amd.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight some important dates for you. On Wednesday, November 6, Mark Papermaster, Executive Vice President and Chief Technology Officer, will present at that Bernstein Technology Summit in New York City. On Monday, December 9, Ruth Cotter, Senior Vice President of Worldwide Marketing, Human Resources and Investor Relations, will present at the UBS Global Technology Conference, also in New York City. On Thursday, December 12, Forrest Norrod, Senior Vice President and General Manager of the Data Center and Embedded Solutions group will present at the Barclays Technology Conference in San Francisco. And our Fourth Quarter 2019 quiet time is expected to begin at the close of business on Friday, December 13. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. We will refer primarily to non-GAAP financial metrics during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced today are reconciled on their most -- to their most directly comparable GAAP financial measure in today's press release, which is posted on our website. Please refer to the cautionary statement in our press release for more information. You will also find detailed discussions about our risk factors in our filings with the SEC and in particular, AMD's quarterly report on Form 10-Q for the quarter ended June 30, 2019. +Now with that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. I am pleased with our strong third quarter execution and results. We delivered our highest quarterly revenue since 2005, our highest quarterly gross margin since 2012 and increased net income significantly, all driven by our first full quarter of 7-nanometer Ryzen, Radeon and EPYC processor sales. Third quarter revenue of $1.8 billion increased 9% year-over-year and 18% sequentially, and we expanded gross margin by 3 percentage points year-over-year. +Turning to our Computing and Graphics segment. Revenue increased 36% year-over-year and sequentially. Demand for Ryzen desktop and notebook processors drove a significant increase in unit shipments and ASP, resulting in our highest client processor quarterly revenue since 2011. We saw particularly strong demand for our top-end Ryzen processors, and believe we gained client processor unit share for the eighth straight quarter. In desktops, we are seeing strong demand for our Ryzen 3000 and previous generation Ryzen 2000 processors. Both product families are consistently among the top sellers at leading e-tailers and retailers globally. In commercial, HP and Lenovo announced new desktop PCs powered by our Ryzen PRO 3000 series processors in the third quarter. We are continuing to expand our presence in the commercial market as more financial, retail, education and health care customers purchase AMD-based PCs and Chromebooks to power their businesses. We are on track to expand our desktop product offerings in November with the launches of the industry's first 16-core mainstream desktop processor as well as our third-generation Ryzen Threadripper processor family. These products will offer unmatched combinations of core counts, performance and energy efficiency for the most demanding high-end desktop and content creation applications. +In mobile, we had another quarter of strong double-digit percentage notebook processor revenue growth driven by our virtual product mix and increased unit shipments. The number of AMD-powered laptops from major OEMs has increased by 50% this year, including multiple premium notebooks like the first ever AMD-powered Microsoft Surface laptop. We collaborated closely with Microsoft over several years to develop the AMD-exclusive 15-inch consumer Surface laptop 3, which includes a custom Ryzen Microsoft Surface edition processor and multiple operating system and software optimizations that will benefit all AMD-powered Windows systems. We are very pleased with our momentum in the client business this year and expect client processor revenue to grow sequentially in the fourth quarter as we head into the seasonally strong holiday season. +In graphics, revenue increased year-over-year driven largely by higher channel GPU sales. Shipments of our Radeon 5000 GPU family, featuring our RDNA architecture, increased sequentially and we are seeing solid demand for the new products based on their competitive performance and features. For mainstream gamers, we began shipping the Radeon RX 5500 GPU in the third quarter. Acer, HP, Lenovo and MSI announced plans to offer the new GPU in their upcoming PCs and multiple AIB partners plan to launch RX 5500 cards during the fourth quarter. +Data center GPU sales were down sequentially and roughly flat year-over-year. We added multiple cloud and HPC wins in the quarter, highlighted by Microsoft's announcement of a new remote desktop offering for graphics-intensive workloads powered by EPYC CPUs and Radeon Instinct GPUs. We are making good progress growing this margin accretive part of our business as we continue expanding our footprint with marquee customers and targeted data center workloads. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue decreased 27% from a year ago, as significantly higher server processor revenue was offset by lower semi-custom sales. We expect semi-custom demand to further soften in the fourth quarter now that both Microsoft and Sony have announced new AMD-powered consoles for holiday 2020. +In server, we had our highest quarterly CPU revenue since 2006 as strong second-generation EPYC processor demand drove a greater than 50% sequential increase in unit shipments and revenue. Second-gen EPYC processors are the highest performance server CPUs in the industry and have set more than 100 world records. Our newest EPYC processors feature up to 64 cores and deliver a 25% to 50% TCO advantage versus competitive offerings. As a result of our clear performance leadership and differentiated feature set, we are building momentum with cloud, enterprise and HPC customers. +In cloud, Amazon AWS, IBM Cloud, Microsoft Azure, OVHcloud, Twitter and Tencent all announced plans to deploy EPYC processors in their data centers. At our launch event, Google became the latest mega data center provider to adopt EPYC processors as they announced second-generation EPYC processors have been deployed across their internal infrastructure production data center environment and will also be used to power the Google Cloud platform. +In enterprise, Dell, HPE and Lenovo more than doubled their AMD-powered server portfolio as they launched new platforms featuring second-gen EPYC processors, helping us add dozens of new telecom, healthcare, financial services, manufacturing and energy customers in the quarter. We also secured multiple new HPC wins in the quarter, including 3 separate U.S. Department of Defense supercomputers and what is expected to be the fastest scientific computer in the U.K. We expect server revenue to grow sequentially by a strong double-digit percentage in the fourth quarter as we continue ramping our second-generation EPYC processors. We remain on track to achieve our near-term goal of double-digit server CPU share by mid-next year. +In summary, we are right where we want to be on our long-term strategic plan. We have the strongest product portfolio in our history. We executed our product launches and production ramps very well in the third quarter as our new products grow higher revenue, margin expansion and increase profitability. We're on track to exit 2019 with another quarter of significant growth driven by the ramp of our 7-nanometer products and believe we are well positioned to build our momentum in 2020 and beyond as we deliver an even stronger set of leadership products that can drive sustained growth and increase share of the $75 billion market for high-performance Computing and Graphics technologies. +Now I'd like to turn the call over to Devinder to provide some additional color on our third quarter financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. We are pleased with our strong third quarter financial results with revenue of $1.8 billion, up 18% quarter-over-quarter and our highest quarterly revenue since the fourth quarter of 2005. The third quarter showcases our financial momentum and the strength of our business model with operating income and net income growing significantly year-over-year. Quarterly revenue was up 9% from a year ago as strong sales of Ryzen and EPYC processors and Radeon gaming GPUs more than offset lower semi-custom sales. Gross margin of 43% was up 320 basis points from a year ago, our tenth consecutive quarter of year-over-year expansion. Operating expenses grew 13% year-over-year to $539 million primarily driven by increased R&D investments and support for our new product introductions. Operating income was $240 million, up $54 million or 29% from a year ago due to increased revenue from new higher margin products. Operating margin was 13%, up 210 basis points from a year ago. Net income was $219 million, up $69 million or 46% from a year ago. And diluted earnings per share was $0.18 per share compared to $0.13 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $1.28 billion, up 36% year-over-year driven by strong client processor and gaming GPU sales. Computing and Graphics segment operating income was $179 million compared to $100 million a year ago driven by higher Ryzen processor sales. Enterprise, Embedded and Semi-custom segment revenue was $525 million, down from $715 million the prior year. As anticipated, semi-custom revenue was lower in the third quarter as the market awaits next-generation AMD-powered game consoles from Sony and Microsoft. EPYC data center CPU revenue grew by over 50% sequentially driven by shipments of our second-generation product in the quarter. EESC segment operating income was $61 million compared to $86 million a year ago due to lower revenue and higher operating expenses. +Turning to the balance sheet. I'm very pleased with the continuing improvement of our balance sheet. Cash, cash equivalents and marketable securities totaled $1.2 billion at the end of the quarter, higher than the gross debt of $1.1 billion resulting in AMD being net cash positive. During the quarter, we retired $206 million of debt, which resulted in a loss of $40 million recorded on our GAAP income statement. The reduction in debt included $126 million of convertible senior notes in exchange for 16 million shares. Year-to-date, we have reduced gross debt by $441 million. Free cash flow was positive $179 million in the third quarter and cash flow from operations was $234 million. Inventory was $1 billion, up slightly from the prior quarter in anticipation of higher revenue in the fourth quarter. Adjusted EBITDA was $300 million compared to $227 million a year ago driven by higher quarterly earnings. On a trailing 12-month basis, adjusted EBITDA was $745 million and gross leverage at the end of the quarter was 1.5x. +Now turning to the outlook for the fourth quarter of 2019. We expect revenue to be approximately $2.1 billion plus or minus $50 million, an increase of approximately 48% year-over-year and 17% sequentially. The sequential and year-over-year increases are expected to be driven by growth in Ryzen, EPYC and Radeon processor sales offset by a further softening of semi-custom processor revenue. In addition, for Q4 2019, we expect non-GAAP gross margin to be approximately 44%; non-GAAP operating expenses to be approximately $535 million; non-GAAP interest expense, taxes and other to be approximately $22 million; and fourth quarter diluted share count is expected to be approximately 1.21 billion shares. +In closing, we had an excellent third quarter and remain focused on ramping our leadership portfolio of high-performance products to deliver strong revenue growth and gross margin expansion in the fourth quarter. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. Operator, we're ready to go ahead and poll for our first question, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + First one for Lisa. You had mention the total cost of ownership in your prepared comments, and I wonder -- I guess, I could imagine that the total cost of ownership over a lifetime of a 7-nanometer server chip might be greater than the price of a server chip when compared to a 14-nanometer server chip. And so I'm wondering if you could maybe just clarify the comments you made on total cost of ownership and quantify, if that is the case, how you see it. And how many -- what percentage of your data center customers actually look at total cost of ownership in evaluating the products? Is it -- does everybody do that? Or do some just look at the price? And I'm wondering, like, what do you think that has -- impact that might have on the competitive pricing environment? That's the first question. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure. Thanks for the question, Mark. So -- I mean maybe let me give some context on sort of the data center business for us, and then I'll answer your question. Look, I think from what we see, there is a very strong value proposition for Rome. When you look at just what we're able to do from just the amount of performance, the power consumption and then how that plays into total cost of ownership. We see it across all workloads, so whether you're talking about a virtualized environment or you're talking about high-performance computing or you're talking about the Enterprise sort of workloads, we see a strong performance as well as strong total cost of ownership. To your exact question, I think, server purchases -- or server purchasers are very, I would say, sophisticated. And so in most cases, total cost of ownership is definitely in the conversation. And it's not just about performance but performance at a given power level and also in terms of a given density. And that has played out in a number of our customer engagements. And so the overall point of -- we think that Rome is very well positioned. Price in and of itself is one factor, but I would say it's not the primary factor. I think the performance, power, total cost of ownership are all important buying factors, and we've seen very, very strong engagement from customers across-the-board, across all workloads for these drivers. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + And a follow-up, if I may, on the -- when you think about your share gain -- your potential to gain share as you look into 2020, can you talk about what you view as the biggest potential gating factors in that and like how you're managing those potential factors? And I'm hoping you can talk to your view on availability of 7-nanometer wafers or -- and engineering support for your customers who are trying to put together solutions. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. Sure, Mark. So a couple different questions there. Let me try to get through it. I will say, since our launch of Rome in August, we've had a very strong start. Now we had a full quarter of revenue here in the third quarter, and we saw that in sort of the ramp of units and revenue. What we are seeing is that the qualifications are going faster with the second-generation of EPYC than with the first generation, so customers are familiar with our platforms. In some cases, customers are doing drop-in platforms, and so they can take virtually the same or a very similar platform that they had for first-gen and drop-in the second-gen. They're familiar with our architecture. And so I think, from a market share standpoint, we feel good about the transition from Naples to Rome. I think the platform readiness across our OEMs and number of platforms that we have across the major OEMs is also very strong, and we're pleased with the set that are -- that have both new and existing platforms there. And so from the standpoint of where we are going in the fourth quarter into 2020, I think we feel very, very good about where we are with the data center customers. +As it relates to customer support and all that stuff, like I said, customers are much, much more familiar with the architecture in the second-generation compared to the first generation. And that is good for the ramp of Rome. As it relates to -- I think you asked about the 7-nanometer ramp and the availability there, we had a very large ramp here in the third quarter with 7-nanometer. We essentially ramped 3 full product families, Ryzen, EPYC as well as our Radeon gaming product families, in the third quarter. And it went very well. We're very pleased with it. It's the fastest ramp that we have done certainly in recent memory. And going into the fourth quarter and into 2020, I think we feel very good about the availability of Rome as well as the rest of our products. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question today is coming from David Wong from Instanet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [7] +-------------------------------------------------------------------------------- + + Can you give us an idea of what your revenues were from 7-nanometer products in the September quarter and what you reckon they'll be in the December quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + I think what I can say, David, and I'll start. Maybe Devinder has some additional comments. The ramp for 7-nanometer has gone very quickly in -- here in the third quarter. When we look at overall new product revenue, certainly in the third quarter, we had a significant piece of that be 7-nanometer. That will increase again as we go into the fourth quarter as well. And so the way to think about it is, for our major product lines, we're transitioning very fast from 14 to 7. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [9] +-------------------------------------------------------------------------------- + + Okay, great. And within your Computing and Graphics segment, that 36% sequential growth, could you give us an idea of how -- what client CPU sales grew sequentially and separately, what the PC GPU sales sequential growth was? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- + + Yes. So if you look at the CG segment from a sequential standpoint, we saw the client CPUs increase the most, and those were certainly the driver being both desktop and mobile. Desktop was higher than mobile, but both grew very nicely. If you look at GPUs overall, they actually declined a bit sequentially, and that decline was primarily driven by data center GPUs, which declined just due to some of the buying cycles in the cloud. Overall, gaming did well. And we continue to expect that, as we go into the fourth quarter, you'll see that the data center GPUs will increase as well, as I mentioned in the prepared remarks, that client and graphics would also increase. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question is coming from Matt Ramsay from Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [12] +-------------------------------------------------------------------------------- + + Before I jump into questions, just congrats to Devinder on being cash positive. The -- Lisa, a couple questions on Rome. We've been tracking some of the strength at Google, Microsoft and Amazon, but I wonder if you might comment a little bit about the server business in China given some disruptions there, just overall CapEx and also, the OEM business that you're now ramping with Dell, HP, and Lenovo, and how you expect those things to trend over the next couple of quarters. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Yes. So Matt, as we look -- so let me answer the first question as it relates to the cloud customers. I think we are very pleased with the cloud adoption. We are engaged across all major Tier 1 and many of the Tier 2 service providers, and I think we're making good progress there. As it relates specifically to China, we are well engaged there in both cloud and enterprise. Obviously, there is a little bit of disruption due to some of the China customers that are on the entities list and we follow that closely. But as it relates -- overall, I think we're -- we believe that there is strong pull for Rome both across cloud as well as Enterprise. On the enterprise side, what I will say is that the HPC market has been really good for us. And so we have won quite a few of the bids and they tend to be early adopters of the technology. And so that's one indication of the strong value proposition. As we go into more general Enterprise, the launch of HPE, Dell and Lenovo as well as Supermicro and the other ODM platforms is broader than our -- the first generation of EPYC, and we're seeing that in the pipeline that we see. So a lot of activity going on right now, and we feel really good about how that's going to develop over the next couple of quarters in terms of Enterprise wins. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [14] +-------------------------------------------------------------------------------- + + Just as a follow-up from me on the client business. Obviously, a lot of progress that's been made with the results that you've just put up. And I kind of go back to some comments made by your primary competitor on their call, I think, talking about tightness in their own 14-nanometer supply and also that they've maybe not addressed some of the lower tiers of the market, yet your ASPs are up quite strongly. I wonder how much some of the supply tightness from your competitor might have led to these gains versus sort of the merits of your own product. If there's anything you could talk about that, Lisa, that would be really helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Yes. Sure, Matt. Well, the client business has really had a very strong year, I mean, if you look at how it's played out over the last couple of quarters. I'll say that, in our desktop portfolio, the third-gen Ryzen has done very, very well. It's extremely well positioned. And where we're seeing the highest demand is at the highest tier sort of in the Ryzen 9 and the Ryzen 7. And so that's why you see the ASP strength in the business. Mobile is also ramping very nicely and what we're seeing, again, in mobile is the mix of Ryzen is now a predominant mix of the business. And we're seeing actually very nice momentum in commercial as well as our traditional consumer market, so we also see good sequential growth in ASPs there. There is some noise in the system as it relates to some supply constraints and all that stuff. I would view that as mostly -- again, it's pockets at the low end. I don't think it's a significant driver of our business. Our business is driven primarily by our new platforms, the fact that we are in a number of premium platforms on both the notebook side as well as just the strength that we're having in the DIY channel is there. And that's contributing to the positive mix as well as the unit growth in the client business. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is coming from Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [17] +-------------------------------------------------------------------------------- + + Congratulations on the strong growth and execution. I had 2 questions as well. Lisa, first, on the data center business. I know you mentioned the target is still to be on track for double-digit kind of unit share sometime in the middle of next year. Could you help us level set as to where the share is in Q3 and what the target is in Q4 and if you have seen your competitor react to your server share gains in any way through pricing or other means? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [18] +-------------------------------------------------------------------------------- + + Yes. So Vivek, as you know, we don't necessarily want to get ahead of ourselves in terms of server share. But what we will say is our -- the Q3 quarter was our highest units sort of with EPYC. And so we are seeing good strength and predominantly a very fast transition to Rome. We expect that to continue to grow as we go into Q4 and into the first half of next year. So this is about more platforms ramping and multiple platforms within a given customer. And you should see -- we saw a number of announcements around our launches here in Q3, and you should see additional announcements as we go into the fourth quarter as well as the first half of next year. +Your question about do we see any unusual activity from a competition standpoint. Look, our view is that the competition is aggressive, will always be aggressive and we're counting on that. It's a very competitive market out there. That being the case, I think we are feeling very good about how our product is positioned and also the readiness of the product. So the question earlier about are the platforms ready, how's the customer support, I think it's very strong. And I think our OEM and ODM partners have done a phenomenal job with the breadth of platforms, and that will help us continue to grow overall. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [19] +-------------------------------------------------------------------------------- + + Got it. And for my follow-up, Lisa, I had kind of a longer-term conceptual question, which is it's good to see growth margins improving and the cost discipline, but do you think this is the time to actually increase OpEx a lot and really go after maximizing footprint, right, adding more resources, more systems rather than trying to optimize profitability? I'm just curious to hear how you are looking at the puts and takes around whether you should be maximizing footprint rather than profitability at this level. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [20] +-------------------------------------------------------------------------------- + + Yes. Well, it's a good question, Vivek. I get asked it from time to time. But what you will see is I think we're very cognizant of where we're going. So in other words, the roadmap -- and I mean the long term sort of financial roadmap, I think we understand pretty well. We want to show leverage on both top and bottom line, and that's certainly our goal. We did spend a little bit more this year than we originally planned, and that was frankly because the opportunities are very strong. And most of the additional spend is targeted at R&D, with the notion of platform investments, software investments to ensure that we capture the opportunities that we have. I think we have the right balance, Vivek. And certainly, as we go into 2020, we'll continue to look at that balance. But I think we are very well balanced between top line and bottom line growth. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [22] +-------------------------------------------------------------------------------- + + Congratulations, guys. Lisa, I guess, my first question is, can you help me understand a little bit about the traction you're getting in the Enterprise market on both Ryzen and in EPYC? And kind of what milestones should we be looking at relative to that sort of vertical? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Yes. So the -- we're very excited about the opportunities for us in the commercial space. And I will tell you, when we look at our go-to-market investments, we are putting a lot of feet on the street as well as just general go-to-market around commercial. Starting with Ryzen, I think you have seen and you should have seen that the number of commercial platforms that we have continues to get stronger, and it's not just the number of platforms but the quality of the platforms. Certainly, Lenovo ThinkPad is a premium brand that is very key. We have very strong HP commercial offerings. We have additional desktops coming out as well. What we are seeing is good traction in the commercial space, and that is the stronger part of the PC market. And we'll continue to talk about that. +As it relates to new platforms, certainly as we refresh our mobile platform going into next year, I think you'll see even stronger commercial offerings there. We're investing heavily in security and manageability and all of those other aspects that are important in the commercial space. As it relates to EPYC in the Enterprise, I'm actually very encouraged with what we see in the Enterprise. We had originally said that we thought we would be more cloud -- sort of cloud would go first and then Enterprise would take longer. I think what we currently see is cloud is certainly a big driver of our business. But our Enterprise business is coming along very nicely. And I really would say that the key metrics there are more top tier brands adopting EPYC and talking about that publicly. We have had a number of engagements, and I mentioned earlier that the pipeline that we see in Enterprise across our top OEMs has increased very significantly just in the last sort of 2 months since we launched. So the awareness around EPYC as well as the awareness around these new platforms, I think, is strong, and we'll continue to build that out as we go forward. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [24] +-------------------------------------------------------------------------------- + + That's helpful, Lisa. Then maybe for my follow-up. As we, the analyst community, look out to modeling 2020, the GPU/CPU is relatively straightforward relative to market share expectations we might have. I'm just kind of curious if you can give us some help on the semi-custom business, if it's impacted by ASC 60? And also, we've got a new gaming cycle next year. I know you don't want to preannounce customer product, but how should we think about the semi-custom business trending throughout 2020 in broad strokes? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + Yes. So I think it's a good question, and we will certainly give you more guidance as we get into 2020. But the way to think about it at a high level is we are going through a product transition with semi-custom now. And in 2019, for example, we've had the unusual cycle, where the second half of 2019 is pretty soft for semi-custom compared to the first half. And what you should expect in 2020 is that, that would flip strongly. So I think both of our large customers have said that they're planning a holiday 2020 launch. That would mean that the semi-custom business would be quite heavily weighted in the second half, so you should expect that revenue in the first half will be, again, quite soft with a strong recovery in the second half of the year. And the way I look at it is, the gaming business, the console business is a strong business for us. And so it will be one of the growth drivers as we go into 2020 and beyond. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + First, I wanted to ask about gross margins. I mean, I guess, I'm glad to see them up. But given what's going on with the mix, I mean, I think you said GPUs were down sequentially. We've got data center up more than 50%. Ryzen is growing. You have the Samsung IP in there. I guess, I'm just surprised not to see them up more both in the quarter as well as into Q4. I was wondering if you could give us a little bit more color about what's driving that margin evolution given the positive drivers of mix that I think should be there. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [28] +-------------------------------------------------------------------------------- + + I think if you look at it from a quarter-to-quarter standpoint, if you're talking about Q2 to Q3, you're right about the mix of the product, in particular, with the ramp of the 7-nanometer products. And the margins are up. Last quarter, we had, call it 41%. And this time, it's slightly above 43%. And that is fundamentally due to the new products that are ramping and obviously some benefit from the semi-custom business, it's been down slightly in Q3 compared to Q2. So that's that. And then as you get into the Q4 timeframe, in the guide at 44%, it's driven by the new legacy products, demand for the high end of product -- of our product stack is driving a richer mix, and obviously, there's little bit of benefit as Lisa said earlier with the softer semi-custom revenue. So I think overall... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + I thought all those new products were supposed to have gross margins in aggregate of over 50% and they're driving like a massive mix shift, and yet, you've only got gross margins up a couple of points. What am I getting wrong? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [30] +-------------------------------------------------------------------------------- + + I think the numbers are coming out to be a couple of hundred basis points up on a quarterly basis with the ramp of the 7-nanometer product. I don't think you get anything wrong. You have to look at the mix of the product relative to the total revenue of the company at the $1.8 billion, and I think that's how it comes out, Stacy. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [31] +-------------------------------------------------------------------------------- + + I think, Stacy, maybe if this will help. In each of the product lines, we are certainly mixing up, and that's why you see some of the ASP goodness. But you also have some legacy product, right? And we continue to sell some legacy product as well. And so that's the -- that's perhaps the other piece. But I think, as Devinder said, look, we're very happy with the way that the gross margin has progressed. I think if you look at our long-term model, we had said 40 to 44 points, and we'll be exiting the year at 44, and I think very well -- positions us well as we go into 2020 and turn over more of the product portfolio to the new products. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Okay. For my follow-up, I wanted to ask about the EPYC server ramp into next quarter. So you were up, you said, more than 50% this quarter. So that might be, what, $80 million to $100 million maybe sequentially, which is, I guess, good. Your competitor added almost $1.5 billion sequentially in data center this quarter. So when you say next quarter that you're -- I guess, you did gain share. You're up about 50%, their units were up 20% but even so. So when you're saying, next quarter, you're going to grow it by strong double digits on EPYC, do you think that that's like better than the trend that we saw in Q3 as more stuff ramps? I mean, if we were up 50% sequentially in Q3, do you think we can be better than that in Q4? Is that was strong double-digit means? Or do you have a different meaning in mind? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [33] +-------------------------------------------------------------------------------- + + Well, I think we have in mind strong double digits. So I would say -- and Stacy, I'm not being facetious, but again, there are all kinds of puts and takes. What I will say, though, is put in context that the product has basically been in markets since early August. And if you put that in context, and we're saying that the transition is going quickly, and we have a number of new platforms that are -- literally, they've been in market 4 to 8 weeks. With the way the server cycle goes, I'm actually pretty happy with how it's ramping. And I expect, as I said, that Q4 will be another strong quarter for us, and it's just a matter of continuing to diligently ramp the platforms. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question is coming from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [35] +-------------------------------------------------------------------------------- + + I have a question and a follow-up as well. Sticking to the server, the EPYC ramp. I'm just curious, out of the gate, what kind of mix have you seen maybe skew towards the 48 and 64 core solutions? And what I'm really getting at is how do we think about the blended ASP trend on EPYC as Rome fully ramps? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [36] +-------------------------------------------------------------------------------- + + Yes. So Aaron, it's fair to say that initially, out of the chute, we are seeing a higher mix to the higher end. So more 48 and 64 cores as a mix. I think those are very, very attractive products and really take the full advantage of the EPYC product line. We are seeing, as you might expect with that mix, that the Rome ASPs are showing lift versus the previous first-generation EPYC. As we go forward, you would expect that to build out a little bit more. So we have a full product portfolio for the server parts, but then, you also expect that you'll get more Enterprise in that, and Enterprise tends to have a higher ASP. So the net of all that is, I can say, in the server market, we feel very good about where we're positioned from an ASP standpoint. And from a sort of unit share to revenue share, I think they're actually quite close. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [37] +-------------------------------------------------------------------------------- + + Okay. And then as just as a quick follow-up, maybe more of a model question. I think last quarter, you talked about the semi-custom business being down in the mid-30% range. You also talked about Samsung contributions being around $100 million for the full year. I'm just curious, is that still where we stand? And what was kind of the Samsung contribution this last quarter? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [38] +-------------------------------------------------------------------------------- + + So I think on the Samsung base, if you look at the second half, it's approximately $100 million. Slightly about half was taken in Q3, and the other half will come in Q4. So that's absolutely right. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- + + And then on the -- yes, on the semi-custom side, we had said last quarter that it would be down, let's call it, mid-30s. It's probably, when you look at it in aggregate for the second half of the year, it will be down a bit more than mid-30s. Let's call it high-30s. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Our next question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [41] +-------------------------------------------------------------------------------- + + Lisa, I had a follow-up question on your server CPU business. And I guess the question is, when you think about pricing and sort of the margin profile that you're seeing in that business today, how does that compare with what you had planned for 6 or 9 months ago? Is this pricing and margin coming in pretty much in line with expectations or are they coming in a little bit better? And then as you think about the margin profile for that business going into 2020, given 7-nanometer potentially maturing into next year, given the mix and given the change in customer mix from cloud to Enterprise, should those 2 dynamics serve as tailwinds for your margin in that business? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [42] +-------------------------------------------------------------------------------- + + Yes. So I would say that the margin mix, as we look here in the beginning of the ramp, is about what we expected. It's about what we expected. So the only thing I would say, and I said it earlier, is the product mix is perhaps a little bit higher in the early part of the ramp. But overall, the margins are pretty close to what we expected. The pricing environment is pretty close to what we expected. And as we go into 2020, I think the other piece of it is that the business scale will increase as we grow the business. And so that actually helps to absorb some of the fixed costs as well. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [43] +-------------------------------------------------------------------------------- + + Okay. And as a quick follow-up, your nearest competitor talked about pull-ins in their data center business, particularly in China, was there anything in the quarter that you thought was kind of abnormal from a customer activity standpoint on the client side or the server side? And if so, how big was that? And how should we think about kind of the implications into Q4 and potentially the early part of 2020? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Yes. When we look at both the client and the server business, I wouldn't say that we saw any significant pull-ins due to tariffs or other reasons. We monitor sort of certainly very closely the sell-in and sell-through trend. And we believe that what we're seeing in terms of the growth of the business is actually just new platforms running -- ramping. And given where we are in the product cycle, that makes sense. And so I wouldn't say that we saw any significance of pull-ins in the quarter. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question is coming from Mitch Steves from RBC. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [46] +-------------------------------------------------------------------------------- + + I just had 2. I guess first for Devinder. I realize you don't want to provide any kind of 2020 numbers, but you were already asked this 100 different ways, so I may as well save you guys some time. So if I look at the first half of '20, is there any reason why the gross margins won't be higher than they are in December quarter? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [47] +-------------------------------------------------------------------------------- + + We don't even want to get into 2020. There are several product transitions in play this year, as you've heard in the prior questions. OEM, the semi-custom business, that's in transition. We have obviously the rest of the business in transition with the ramp in 7 nanometers. Lisa reported some of the legacy products. So there's a lot of puts and takes and I think we want to talk about 2020 once we get past 2019 and put it to bed, and we can come back and talk about 2020 in about 90 days from now. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. Got you. And then secondly, just for Lisa here. There's been a lot of articles just in terms of some firmware issues, there's some software bugs and things out there. Can you maybe just help us address all of them at once and just kind of talk about what you guys did to fix them? Because we're still seeing kind of articles pop up here and there, and I just want to make sure that there are no issues in terms of the software. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- + + Let me make sure I understand what you mean, Mitch. Which product line are you referring to? Or what are you exactly referring to? + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [50] +-------------------------------------------------------------------------------- + + So there have been specific articles with Ryzen, right, saying that there's issues with the bios and things like that and performance metrics are a little bit lower. But then you guys kind of relate -- noted that you've improved them or fixed them, but we're still kind of seeing them in the market even today, for example. So I just wanted to know in terms of what happened? And then secondly, if everything's been resolved? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [51] +-------------------------------------------------------------------------------- + + Yes. So your question was relative to the third generation of Ryzen. Look, I think, overall, when you look at the third-generation of Ryzen and the platforms that we've put out, we're very, very pleased with how that ramp has gone. And when we look at the sales from a sell-through standpoint, we're very pleased with where it is. There have been some platform sort of optimizations that we've done through working with our ODM partners and the motherboard partners to try to sort of improve the optimization of the maximum boost frequency, which is, I think, what you're referring to. And that has largely been addressed over the last couple of weeks. But I would consider that more of an optimization versus any type of major update. And we're going to continue to improve the platform. So you're going to see that as is normal with a new platform, that we'll continue to improve the platforms over time. But I will say that we're very pleased with how third-gen Ryzen has done in the marketplace. And we're excited with the launch of the 16-core 3950X as well as the Threadripper family in the next couple of weeks as well. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [52] +-------------------------------------------------------------------------------- + + Operator, we have time for about 2 more questions, please. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question is coming from Harsh Kumar from Piper Jaffray. + +-------------------------------------------------------------------------------- +Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [54] +-------------------------------------------------------------------------------- + + Just a quick one. As you look at your leverages for gross margins, what would you consider as your greatest leverage? Is it just sales growth as you take share? Or is it more products going to 7-nanometer? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [55] +-------------------------------------------------------------------------------- + + I think, if you look at the products, definitely, the new products in the 7-nanometers are very good tailwinds for the gross margin. But also, the mix of the business comes into play. The more data center revenue we capture in terms of market share obviously helps the gross margin. The high end of the stack, in particular, in the client PC business, that helps the gross margin. So it's basically those are the things that help the gross margin as we go forward from 2019. + +-------------------------------------------------------------------------------- +Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [56] +-------------------------------------------------------------------------------- + + And as you look out, where do you think margins can go? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [57] +-------------------------------------------------------------------------------- + + Well, we think that, as Lisa said earlier, when we painted our long-term target model, we painted 40% to 44% in the 2017 time frame. That's what we said. We -- exiting, we had 44%, and we'll come back and update that sometime in 2020. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our final question today is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [59] +-------------------------------------------------------------------------------- + + I think in the past, you've given the percentage of total revenue that was data center CPU and GPU combined. Can you give us that number? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [60] +-------------------------------------------------------------------------------- + + Yes. I mean, as a percentage of revenue, it's similar to what it has been the past few quarters, although the server portion was significantly higher as we saw -- as we said early, greater than 50% sequential increase and so was CPU revenue -- unit shipments and revenue, so that definitely helps. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [61] +-------------------------------------------------------------------------------- + + Yes, got it. Okay. And then, I guess, just a bigger picture question. In terms of the kind of competitive edge you have, some of it relates to process technology, but of course, your competitor could just go to TSMC to build CPUs as well. But I guess, there's other parts that relate to your fundamental architecture, which is the chiplet, the memory density and your IPC advantage. So I guess can kind of break down -- Lisa, can you break down how much of the advantage really is process related versus how much is actually architecture related? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [62] +-------------------------------------------------------------------------------- + + Yes. So Timothy, the way I would answer that question is, look, we made a set of choices, and the set of choices include process technology, they include architecture, our chiplet architecture. They include sort of our overall system architecture. And I think we've made a set of good choices. Going forward, we are not relying on process technology as the main driver. We think process technology is necessary. It's necessary to be sort of at the leading edge of process technology. And so today, 7-nanometer is our great node, and we're getting a lot of benefit from it. We will transition to the 5-nanometer node at the appropriate time and get great benefit from that as well. But we're doing a lot in architecture. And I would say that the architecture is where we believe the highest leverage is for our product portfolio going forward. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + We've reached the end of our question-and-answer session. I'd like to turn the floor back over for any further and closing comments. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [64] +-------------------------------------------------------------------------------- + + Thank you very much, operator. And thank you, everyone, for joining us on the call today. We do have a number of events planned here in the fourth quarter, and we look forward to seeing you all soon. Have a great evening. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2020-Apr-28-AMD.txt b/Transcripts/AMD/2020-Apr-28-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..6bfd10ebb96264898731dac2a78c90e68beffa4e --- /dev/null +++ b/Transcripts/AMD/2020-Apr-28-AMD.txt @@ -0,0 +1,598 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Advanced Micro Devices Inc Earnings Call +APRIL 28, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + * Ruth Cotter + Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Mark John Lipacis + Jefferies LLC, Research Division - MD & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the AMD first quarter financial results conference call. (Operator Instructions) As a reminder, this conference is being recorded. +It's now my pleasure to introduce Ruth Cotter, Senior Vice President, Worldwide Market, Human Resources and Investor Relations. Ruth, please go ahead. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's First Quarter 2020 Financial Results Conference Call. By now, you should have had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website amd.com. +Participants on today's call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +Before we begin today, please note that our annual shareholder meeting will be held on Thursday, the 7th of May, as a virtual event accessible from amd.com. We will also be attending several virtual Wall Street events during the second quarter, including the Bernstein Strategic Decisions Conference on Thursday, May 28. And our second quarter 2020 quiet time is expected to begin at the close of business on Friday, the 12th of June. +Today's discussions contain forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such involve risks and uncertainties that could cause actual results to differ materially from our current expectations. We will refer primarily to non-GAAP financial metrics during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measures in today's press release posted on amd.com. +Please refer to the cautionary statement in our press release for more information on risks related to any forward-looking statements that we may make. You will also find detailed discussions about our risk factors in our filings with the SEC, and in particular, AMD's annual report on Form 10-K for the year ended December 28, 2019. +Now with that, I'd like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Ruth, and good afternoon to all those listening in today. Before covering our quarterly results, I wanted to provide some comments addressing our response to COVID-19. First, I want to recognize the toll the pandemic has taken on the world. The breadth and speed at which COVID-19 has changed the world since our last earnings call has been staggering. I want to thank the countless healthcare professionals and essential workers serving on the front lines every day. +At AMD, our first priority has been to protect the health and safety of our employees. We have transitioned the vast majority of our more than 12,000 employees worldwide to working from home, while ensuring we maintain focus on reliably supplying our customers with the products and services their businesses depend on. +We are also supporting the communities we call home through financial and personal protective equipment donations and providing our technology to accelerate medical research. More than ever, the pandemic has placed technology at the forefront of how we work, learn, shop and connect. And we are proud to be providing many of the components powering these essential technologies. Against that backdrop, we performed well in the first quarter. +Revenue increased 40% year-over-year to $1.79 billion as demand for 7-nanometer Ryzen, Radeon and EPYC processors drove record first quarter revenue and our highest gross margin in 8 years. I'm pleased with our execution in the quarter, as we quickly adopted our global operations to navigate pockets of supply chain disruption and addressed geographic and market demand shifts caused by COVID-19. +Turning to our Computing and Graphics segment. First quarter segment revenue increased 73% year-over-year to $1.44 billion, driven by increased Ryzen and Radeon processor adoption. We saw some softness based on the COVID-19 situation in China that impacted PC related sales in the first quarter. While both component and system demand were relatively strong at online vendors, off-line channel sales were weaker-than-expected as many retail locations across China were closed for much of the quarter. +PC demand in the rest of the world was strong, offsetting the softness in China. Client processor revenue grew significantly year-over-year as strong Ryzen processor demand resulted in significant double-digit percentage increases in unit shipments and ASP. As a result, we believe we gained client unit market share for the 10th straight quarter. +In desktop, overall demand for our latest Ryzen 3000 and prior generation Ryzen 2000 processor families was strong, both of which continue to top retailer best seller lists and have more than 50% share of premium processor sales at many top global e-tailers. +In mobile, unit shipments increased by a strong double-digit percentage year-over-year. We set a record for quarterly notebook processor revenue driven by sustained demand for our previous generation offerings and the ramp of the first Ryzen Mobile 4000 design wins. Initial consumer notebooks featuring our new Ryzen 4000 processors launched to strong demand based on reviews that demonstrated their performance and battery life leadership for ultrathin and gaming notebooks. We also gained momentum in the commercial market, winning multiple large-scale deployments as Lenovo announced new ThinkPads and HP launched commercial class ProBooks powered by our latest Ryzen 4000 mobile processors. We are on track to accelerate our mobile growth this year as Acer, ASUS, Dell, HP, Lenovo and other OEMs are expected to launch more than 135 new Ryzen-powered consumer and commercial notebooks over the coming quarters. +In graphics, first quarter unit shipments and revenue both grew by a double-digit percentage year-over-year, driven largely by sales of our Radeon RX 5000 series, desktop and notebook GPUs. Desktop channel sales increased based on solid demand for both 7-nanometer RDNA graphics cards and previous-generation Radeon RX 500 series GPUs. +In mobile, demand for notebooks powered by our Radeon 5000M mobile GPUs, including the latest Apple MacBook Pro and other gaming notebooks, drove a richer mix as customers transition their platforms to our new RDNA mobile offerings. +Development of our RDNA 2 GPUs continues to progress well. We are on track to launch our next-generation gaming GPUs later this year with a 50% performance per watt increase compared to our current offerings. In the data center, Microsoft Azure introduced new virtual machines optimized for visualization workloads powered by our Radeon Instinct MI25 GPUs. +Microsoft is using our differentiated virtualization technology to partition a GPU for the first time in the same way they partition multi-core CPUs, allowing customers to tailor the GPU capability to meet the needs of their specific workload. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue of $348 million decreased 21% year-over-year as lower semi-custom revenue more than offset a significant increase in server revenue. As expected, semi-custom product revenue was negligible in the quarter, as Sony and Microsoft both reduced inventory in advance of next-generation console launches. +We expect semi-custom revenue to increase in the second quarter and be heavily weighted towards the second half of the year as we ramp production to support the holiday launches of the new PlayStation 5 and Xbox Series X consoles. +In server, unit shipments grew by a double-digit percentage sequentially and more than tripled year-over-year as we continue gaining momentum across cloud, enterprise and HPC customers. We saw particular strength with cloud providers introducing new instances and accelerating current deployments. Microsoft Azure, Google and IBM, all announced new offerings powered by second generation EPYC processors, highlighted by Google launching multiple general purpose VMs and Microsoft rolling out an all-AMD virtual desktop offering that also includes Radeon Instinct GPUs. +Several cloud providers accelerated their infrastructure deployments to address rising demand from the growing number of users working and schooling from home. For instance, one of our large cloud customers was able to deploy 10,000 2nd Gen EPYC servers in less than 10 days to support the surge in demand for their collaboration services. +In the enterprise, we expanded our 2nd Gen EPYC processor portfolio with new high-frequency processors that expand our performance leadership to advanced modeling, database and hyperconverged workloads. With these new offerings, our 2nd Gen EPYC processor family now includes both the highest performance per core and performance per socket processors in the industry. We continue winning in HPC, highlighted by Lawrence Livermore National Laboratories, announcing they selected next-generation AMD EPYC CPUs and Radeon Instinct GPUs to power their El Capitan supercomputer, which is expected to deliver more than 2 exaFLOPS of computing performance when it is deployed in early 2023. We are incredibly proud that 2 of the 3 publicly announced U.S. exascale supercomputing systems will exclusively use AMD CPUs and GPUs, clearly positioning AMD as the exascale computing leader based on our high-performance computing and graphics technologies and software capabilities. +In closing, our long-term strategy and growth drivers remain unchanged. Although there are some near-term uncertainties in the demand environment, we are well positioned to navigate through this situation. We have a solid financial foundation, and our product portfolio is very well positioned across the PC, gaming and data center markets. While demand indicators across commercial, education and data center infrastructure markets are strong, we expect some softness in consumer demand in the second half of the year, depending on how overall macroeconomic conditions evolve. We remain on track to launch our next-generation Zen 3 CPUs and RDNA 2 GPUs in late 2020 and believe we can deliver another year of strong revenue growth and margin expansion based on the strength of our product portfolio and the diversity of markets we serve. +Now I'd like to turn the call over to Devinder to provide some additional color on our first quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. We performed well in the first quarter as we navigated a challenging environment as a result of the ongoing impact of COVID-19. First quarter revenue was $1.79 billion, up 40% from a year ago and down 16% from the prior quarter. Year-over-year growth was driven by strong sales of Ryzen and EPYC processors and Radeon products, partially offset by lower semi-custom sales. +Gross margin was 46%, up 490 basis points from a year ago, driven by Ryzen and EPYC processor sales. Operating expenses were $584 million compared to [$498] (corrected by the company after the call) million a year ago, primarily due to increased investments in R&D and go-to-market activities. +Operating income was $236 million, up $152 million from a year ago, driven by revenue growth and a greater percentage of Ryzen and EPYC processor sales, while operating margin increased to 13% as compared to 7% a year ago. +Net income was $222 million, up from $62 million a year ago, and diluted earnings per share was $0.18 per share compared to $0.06 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $1.44 billion, up 73% year-over-year, driven by Ryzen processor and Radeon product channel sales growth. Computing and Graphics segment operating income was $262 million or 18% of revenue compared to $16 million a year ago, driven by significantly higher revenue. Enterprise, Embedded and Semi-Custom segment revenue was $348 million, down 21% from $441 million in the prior year due to the expected decline in semi-custom sales, partially offset by strong data center growth. +EESC segment had a loss of $26 million compared to operating income of $68 million a year ago, which included the benefit of a $60 million licensing gain. +Turning to the balance sheet. Cash, cash equivalents and marketable securities totaled $1.4 billion. In addition, in early April, we took the precautionary step to draw down $200 million from our $500 million revolving line of credit. Inventory was $1.1 billion, up 8% from the prior quarter. +On a trailing 12-month basis, adjusted EBITDA was $1.2 billion, resulting in gross leverage of 0.5x. Free cash flow was negative $120 million in the first quarter, an improvement of $155 million from the prior year. Cash flow from operations was negative $65 million, an improvement of $148 million from a year ago. +Let me turn to the outlook for the second quarter of 2020. Today's outlook is based on current expectations and contemplates the current COVID-19 environment and customer demand signals. We expect revenue to be approximately $1.85 billion, plus or minus $100 million, an increase of approximately 21% year-over-year and an increase of approximately 4% sequentially. The year-over-year increase is expected to be driven by strong growth in Ryzen and EPYC processor sales. The sequential increase is driven primarily by EPYC processor and semi-custom sales. +In addition, for Q2 2020, we expect non-GAAP gross margin to be approximately 44% due to higher semi-custom revenue. Non-GAAP operating expenses to be approximately $600 million; non-GAAP interest expense, taxes and other to be approximately $20 million, and the diluted share count in the second quarter is expected to be approximately 1.23 billion shares. +For the full year 2020, despite expectations of weaker COVID-19-related consumer demand in the second half of the year, we expect annual revenue growth of approximately 25%, plus or minus 5 percentage points. In addition, we expect non-GAAP gross margin to be approximately 45%, unchanged from prior guidance and non-GAAP operating expenses to be approximately 29% on revenue. +In closing, while the market environment has become more challenging given the impact of COVID-19, our first quarter results demonstrate the strength of our business model. Notwithstanding some near-term demand uncertainties, our long-term strategy is unchanged, and we are well positioned with our competitive products and the strength of our balance sheet to navigate today's environment. +As I finish, I would also like to take this opportunity to thank all our employees for their dedication, flexibility and focus in these extraordinary times. +With that, I'll turn it back to Ruth for the question-and-answer session. Ruth? + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [5] +-------------------------------------------------------------------------------- + + Thank you, Devinder. And operator, if you could poll the audience for questions, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Matt Ramsey from Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [2] +-------------------------------------------------------------------------------- + + And I hope everyone at AMD is doing well considering the interesting times there have been. Lisa, I wanted to start with a couple of questions on the server business. I guess, one of which is, how do you -- the EESC results in the quarter that you just printed were a bit below, at least where I had modeled them. So maybe you could talk a bit about how you feel the EPYC business is tracking toward that sort of 10% target you guys had set for the second quarter. And I notice in Devinder's comments on the June quarter guidance, most -- some of the upside is going to be driven -- I guess, upside sequentially is going to be driven by EPYC. So how are you tracking against that? And then the last little piece is, I keep getting more and more questions still about the timing of Milan. And I know you guys reiterated that would be this year at the Analyst Day. And if that's still the case, just let us know. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes. Absolutely, Matt. Thank you, and I appreciate the question. So look, we are very pleased with the progress in our server business. I think if you look at sort of the progress we've made, there were a number of key things that we wanted to see happen. What we saw in the quarter that we just finished, in the first quarter, we actually saw a very nice acceleration of the cloud business as we went through the quarter. I think as we go into the second quarter, there's an additional significant ramp of the server business. And so we expect to continue to gain share as we go through these next couple of quarters. I think what we're seeing from the current COVID-19 environment, obviously, there's a lot of puts and takes. But as it relates to data center, it's positive for the data center market. Certainly, we've seen some of our largest customers ask us to accelerate some of our deployments. And we look forward to continuing to ramp our server business. I think you asked about Milan, and yes, we are expecting to be launching that at the end of this year. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [4] +-------------------------------------------------------------------------------- + + Got it. Just wanted to switch quickly into the PC business. One of the things that stood out to me from your commentary in the prepared script was the contrast between strength in the PC business globally versus the weakness in China. I imagine that weakness in China was both on the PC side and on the AIB graphics business. If there's any way that you help quantify that? And we've heard some commentary about the economy restarting in China. Have you seen some of those trends start to improve into the second quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Sure. So the PC business has actually held up pretty well. So if we look at the PC business in the first quarter, we saw the rest of the world PC business actually get some benefit from some of the acceleration in demand sort of towards the end of the quarter. We did see some weakness in China as China was shut down in the months of February and early March. We saw that primarily in the channel business, so in offline channels. Now we have seen that pick up as we've gone through the month of April. And what we're seeing in general in the PC business is the first quarter and the second quarter is actually relatively strong with accelerated notebook demand and desktops sequentially lower just based on sort of the preference around notebook versus desktop in this framework. So those are the key dynamics for the PC business. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [7] +-------------------------------------------------------------------------------- + + You guys are one of the few companies kind of giving a full year guidance. And I just wonder if you could talk us through how you're thinking about the second half? Obviously, you guys have OEM visibility into a bunch of new sockets and new designs, but your customers don't seem to have visibility. So just a little bit more color maybe on how you are thinking about forecasting beyond the visibility that you have in Q2? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Yes. Sure, Joe. So look, we understand that there's a lot of questions about visibility as we go into the second half of the year. The way we look at our business is, we have sort of a lot of positives in terms of just market drivers that we do have good visibility too. I think our progress in the data center market is a positive. We see that with a number of platforms ramping and the number of customers that we have coming on board. So we see that as a positive for us as we go through this year. +Console gaming is a positive for us. There's lots of anticipation around the consoles. It's one of the largest launches, I think, of the year. And from that standpoint, there's no change in our view as it relates to COVID-19, just given what we see today. Now as you look at the range, we have increased the range of our guide. And sort of the biggest sort of question mark in my mind is kind of the shape of the PC market this year. As I mentioned earlier, the first half actually looks a little bit stronger than expected, particularly on the notebook side. We are potentially expecting some weakness in the second half due to consumer spending. You sort of have the 2 -- the 2 forces are there. I mean, one is, there is a pull with the strong work-from-home trends, but then there's also the view that, from a macro standpoint, will be weaker in the second half of the year. So that's -- the primary variance in our model is what happens to the PC market. I will say, though, that underneath the market trends, we're very pleased with our portfolio. I mean, the notebook portfolio that we have in PCs is the strongest we've ever had. And we believe we have a good opportunity to gain share throughout the year, even as the market may be a little bit weaker than originally expected. So that's the reason for the guidance to try to give the puts and takes. And of course, we'll see how the year plays out. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [9] +-------------------------------------------------------------------------------- + + That's helpful. And then in terms of data center GPU, I know you talked a lot about the Analyst Day about the newer products and penetration of new workloads in the second half. Can you talk about the workloads that you've been addressing so far, cloud gaming and whatnot? And how is that business progressing before we get to the CDNA launch? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- + + Yes. So the data center GPU business is an important strategic business. In terms of size, it's still relatively small compared to the data center CPU business. We are making progress, good overall progress in a number of workloads. Cloud gaming is one that has been a good one for us, and we continue to see opportunity in that as we go through this year, with the current product set. We also just launched the VDI instance with Microsoft Azure, which we feel will be a good workload for us. And then we have a number of the HPC wins that we've talked about that are going to be based on the CDNA architecture, which is an important strategic area for us as well as continued focus on improving our machine learning and overall machine learning frameworks and capabilities. So those are the key workloads that we're going after. And I do think it's an important business for us as we go forward. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question is coming from Vivek Arya from Bank of America Securities. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [12] +-------------------------------------------------------------------------------- + + Lisa, for my first one, I just wanted to go back to your EPYC server business. So very strong units in Q1, but it appears that the mix was very kind of cloud-heavy. So perhaps ASPs were lower than we are used to seeing. I was wondering if you could just give us some sense of how we should think about server ASPs going forward. And importantly, if you think of server sales for you for this year versus what you thought 90 days ago, how is that looking like? Because I think your competitors said that they expected some kind of digestion of cloud capacity in the back half. So I was just hoping to get some more color around ASP and just what you thought of your overall server business for this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [13] +-------------------------------------------------------------------------------- + + Sure, Vivek. Yes. So that is correct. There was a mix shift towards cloud in the first quarter, and that did have an impact with ASPs lower. That being the case, the ASPs are very healthy. So I think from the standpoint of how our business evolves, it's within the plus or minus of the business model. In terms of where we believe demand will be versus 90 days ago, it's pretty similar. And the way I would say it is, we see cloud being strong. What we see is not just putting on more capacity, but really the ramping of new platforms. And so we view that as a positive. We have strong enterprise adoption as well. When we look at our pipeline in enterprise, it's continued to grow, and continued to grow in the first quarter and continued to grow in sort of the first month here of the second quarter. We do expect, perhaps at the transactional business, sort of the SMB type of business may be more impacted by COVID-19, but that was never a large piece of our business to begin with. So we feel good about the server business. And it continues to be a very strategic focus for us. I think the relationships with our partners and our customers are getting closer as we go through sort of the process of ramping volumes. And so we continue to view it as a strong growth driver for us on a year-over-year basis. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [14] +-------------------------------------------------------------------------------- + + Very helpful. And then maybe a follow-up for Devinder on gross margins. So first half, kind of tracking towards your 45-ish percent target for the year, but Q2 is 44%. And I recall, I think either Lisa or Devinder, you said that second half will be more semi-custom weighted, but that suggests some more pressure on gross margins. So I was just hoping you could walk us through how we should think about gross margins in the back half, given all the puts and takes of mix that you are expecting? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [15] +-------------------------------------------------------------------------------- + + Yes. Thanks, Vivek. I think the key puts and takes, as you said, continued ramp for the semi-custom, which has margins, as you observed lower than corporate average, but they are offset by the strength in the data center revenue. So semi-custom ramped the back half, and that does impact the gross margin being lower than corporate average. But data center strength, as Lisa just referenced, that we are pleased with the ramp in the data center business. In data center business, the margins are significantly higher than corporate average, and has the offset to help us deliver as we guided for 2020, the 45% gross margin for 2020. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [16] +-------------------------------------------------------------------------------- + + Yes. Maybe, Vivek, I can just add to that. So in addition to the data center mix that Devinder mentioned, we also expect to see the console gross margins improve as we go through the year. And that's the reason for the full year guide at 45%. So usually, what happens is in the very -- second quarter is our very first quarter of ramp for the consoles, and so the margin starts a little bit lower and continues to ramp as we go through the year. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + The next question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [18] +-------------------------------------------------------------------------------- + + On the -- first question on the client side. I guess, AMD has historically had a good presence on the consumer side, but it sounds like you're making great progress on the commercial side with the HP and ThinkPad design wins. Can you give us a sense roughly like what is the split between consumer and commercial on the notebook side? And like how does that play going forward? Does commercial just continue to grow faster than the consumer side? And is there an impact on the gross margin between -- if commercial does grow faster? That's the first question. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [19] +-------------------------------------------------------------------------------- + + Yes, Mark. So our PC business does tend to be much more consumer weighted. I mean, we've made progress in commercial. Commercial has grown nicely, but it's still consumer weighted. We expect to continue to gain commercial share as we go through this year. As that happens, I think there's 2 things in the PC margins that affect PC gross margins. Heavier weight of commercial is certainly positive for the overall gross margins. I think the other pieces, we should expect that education will be strong and that tends to be lower in the mix. And so there are lots of mix dynamics. But overall, I think our confidence level in notebooks being a strong growth driver for us as we go through this year is good. And we continue to work on the commercial versus consumer mix. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [20] +-------------------------------------------------------------------------------- + + Great. That's helpful. And then on the server side, if you look at cloud instances versus cloud internal versus enterprise versus HPC, can you give us a sense of the split today, if not by percentage and like a rank order? And what you would expect to drive going forward? Our own field work had indicated that your instances were growing nicely on EPYC 2. I wondered to what extent is that being deployed internally on the cloud guys also? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Sure, Mark. So when you look at our cloud instances, I would say that our cloud -- some of the cloud acceleration I referred to was acceleration of internal workloads at some of our top cloud customers. So I think that's an area actually where we get more visibility. Cloud instances in terms of numbers for external usage has grown. We announced the GCP platform. We announced the IBM platform as well as additional Microsoft platforms. You will see more cloud instances rollout over the next quarter or so. But much of the growth that we've seen has been around internal deployment of the cloud companies. And then as it relates to enterprise, it is more heavily weighted towards HPC. We've done very, very well in HPC. We're pretty excited about our new high-frequency SKUs that were just launched here in April. They're actually very well suited for large enterprise applications and financial sector as well as some of the technology sectors, and so that's a key focus for us in terms of growing those other pieces of the enterprise business. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question today is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + First, harp a little bit again on the server business. I guess I don't quite understand why a big shift toward cloud mix will drive ASPs down sequentially. I mean, your mix has been mostly cloud all along. So why all of a sudden is that driving ASPs down? And I know you said units were up double digits. I guess, in that context, what did revenues do sequentially? And maybe what were data center revenues, CPU plus GPU, as a percentage of total in the quarter? Like, if you could give any color on any of that, that would be really helpful. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [24] +-------------------------------------------------------------------------------- + + Sure. So we did have a positive cloud mix, but I would say that the Q4 to Q1 mix had significant improvement in cloud or significant growth in cloud. So that was the ASP sort of shift that we talked about. As it relates to data center overall, we were in the high teens this quarter. And you had one other question, Stacy? + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + I said, what did revenues do sequentially? Units were up, like, double digits. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [26] +-------------------------------------------------------------------------------- + + Yes. The revenues were also up sequentially. Not as much as units, but revenues were sequentially -- yes. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Got it. So my follow-up. Again, I want to talk a little bit about the share target. So I know you'd said 10% share, give or take, by the middle of this year. If I even just take your entire EESC revenue and I take Intel's data center revenue this quarter, you'd be about 5% revenue share. And I know you're guiding for growth next quarter, but I mean, just given the magnitude, it doesn't feel like that's going to double in the quarter. So just how are you feeling about that 10% guide for the middle of this year? Is that getting pushed out? Are we defining it wrong? Like how should we be thinking about that? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [28] +-------------------------------------------------------------------------------- + + Yes. So the way we define the share target, and it very much is sort of the view of -- we expect about 20 million units a year in terms of single-socket and dual-socket servers. That's about 5 million units a quarter. So 10% share is about 0.5 million units. From where we look today, we look to be on track to that. Q2 is actually... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + That's about Q2? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- + + Yes. Yes. Q2 is actually our strongest backlog quarter that we've seen. So I think that's our current visibility today. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + Is that 20 million an appropriate number, though, given you're now playing in comm whereas maybe when you gave that target before you weren't playing in comm? Isn't the total target at -- total market is more like 30 million or even more, right? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [32] +-------------------------------------------------------------------------------- + + Well, again, I think not to go back on how we define the target. I think I've given you how we define the target. And I think that's an appropriate way to define the target. I think our comms exposure is very, very early. And I would say, is not a significant part of the revenue at this point. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + The next question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [34] +-------------------------------------------------------------------------------- + + Lisa, I wanted to go back to your full year guide. I appreciate there's a wide range of outcomes here, and you did put up an updated number. But if we take the midpoint of your updated guidance and we compare and contrast that with your old guidance, you are lowering the midpoint of your revenue outlook by about $250 million, maybe a little bit more. In response to Joe's question, I think you focused very much on the notebook business. Is that sort of the primary part of your business where you're lowering numbers? Or is it a little bit more broad-based across GPU and perhaps the game console business as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + Yes. So I would say from the full year standpoint, the biggest variable is the PC business in its entirety. So that's notebook and desktop. And like I said, it's a variable, if I -- you can model various scenarios as to what it can be. And I think from our standpoint, when we started the year, we had the expectation of a pretty normal PC environment. I think we would all say that the environment is different than when we started. And given the size of that market, we have given ourselves a wide range. As it relates to what we thought before, it's priority PCs. And when you look at the other markets, game consoles, data center were about what we expected, and the signals continued to be positive in those areas. And by the way, I should -- I'm sorry, if I can just finish off. On PCs , I would say though that, I think we're all waiting to see some of the data as we go through the second half of the year. So I want to say that, like I said, there's those 2 competing forces. One is, there's a strong pull for work-from-home trends and the other is just what is the impact on macro going to be for discretionary consumer spend. And so I think that's a place where we lack full visibility. And we continue to talk to customers. And I think we're all trying to make sure that we are well prepared for any of the scenarios as they come about. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [36] +-------------------------------------------------------------------------------- + + Appreciate that. And then as a quick follow-up, Lisa, I wanted to ask about the competitive landscape. Your nearest competitor continues to grow wafer capacity, as you know, and they talked quite a bit about accelerating the RAM for 10 last week on their call. Are you seeing any changes in how they compete in the marketplace, either from a pricing perspective or from a marketing dollar perspective relative to how you saw the market 90 days ago? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- + + No. It's -- the PC market is always a competitive market. And from that standpoint, I don't think the environment has changed substantially from a -- either a capacity standpoint or a marketing dollar standpoint. From our view, it's all about ensuring that the platforms that we launch actually ramp into production smoothly. And so we've been working on that. And we feel very good about that. I think we mentioned that we have a significant number of platforms, over 135 mobile platforms that are coming to market here in 2020. And they're very, very competitive. They are some of our best platforms from just overall performance and capability standpoint. So we're bullish on our ability to turn that into revenue growth. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + The next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [39] +-------------------------------------------------------------------------------- + + So let me ask you a question. Lisa, not to kind of go back to the same well as everybody else, but I wanted to hit on the EPYC side of things. I guess the good news is you guys are growing very rapidly and taking share, and you reiterated that 10% market share goal for the June quarter. But overall, it seems like the number has not really upsided anybody's expectations over the last few quarters, despite the market accelerating from a demand perspective, your primary competitor upsiding their data center group or even their cloud segment within that for 3 to 4 quarters in a row. So I just wanted to get your feeling on, is there something that is capping the growth there? Is it the ASP is going down because of who the customers are? I'm just wondering why if the market is as strong as it seemed to be for the last 3 or 4 quarters, you're doing really well, but not actually upsiding our expectation? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [40] +-------------------------------------------------------------------------------- + + Yes. Ross, the way I look at it, and I mean, this was very, very similar to the ramp that we saw in PC business. The ramp in server is something like steady as she goes. And each quarter, we add platforms; each quarter, more platforms are qualified; each quarter, they ramp. It's a little bit different from a pure market phenomenon. And again, I mean, I understand that there are market phenomena, and then there are growth expectations based on platform launches as well as software being qualified and so on and so forth. So as it relates to our expectations, it's actually going quite well. As it relates to the acceleration of cloud, and we're pleased with it. We're not ready to upside numbers at this point. I think we want -- we already had very aggressive growth assumptions in what we went through. I think you'll see us a little bit less market-specific and a little bit more AMD specific as it relates to our customers and their qualification plans. So I think we are confident that our data center business is doing well, and we need to continue to demonstrate that over a number of quarters. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [41] +-------------------------------------------------------------------------------- + + Just for my follow-up, one that switch gears over to the computing and graphics side. Could you just give a little bit of color on what you expect for that in the second quarter? And then as you look into the second half, I know you mentioned that's the area of greatest uncertainty for many logical reasons. But any sort of difference between the computing and the graphics side, both in your second quarter expectations and then the puts and takes in the back half of the year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [42] +-------------------------------------------------------------------------------- + + Yes. So we are expecting that the computing and graphics business will be down sequentially. So it's offsetting some of the growth on the EPYC and semi-custom side. Within the computing and graphics business, we see notebooks up strongly, as a result of the launch of our new Ryzen 4000 platforms and some of the other trends that we've talked about. We see desktop down sequentially, and we see graphics down sequentially. Q2 is normally a sequentially down quarter for the channel business for us. So that's not unusual. And we -- that's -- those are the dynamics in the second quarter. And as we go through the second half of the year, as I mentioned, we'll have to see how consumer spending holds up against the other demand environments. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question today is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [44] +-------------------------------------------------------------------------------- + + Lisa, just my first question. I wonder if you could just help me kind of better understand in this current environment of shelter-in-place, how does that impact sort of new customer, new workload engagements? And I guess, to better kind of underscore that, just given that you're expecting pretty good share gains in the back half of the year, given your second half guidance, notwithstanding the gaming cycle. Are most of those wins already in your back pocket, and so you've got high visibility? Or how do I think about that dynamic? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [45] +-------------------------------------------------------------------------------- + + Yes. So I think there are many that are already in progress. And that would be our -- sort of our typical view of how long it takes to ramp a customer from beginning of engagement to actual ramp, can it be anywhere from 6 to 9 months if that's a good number. As it relates to what we see with the, as you call it, shelter-in-place, look, we see pretty strong activity. I mean, the activity level continues to be high on both the cloud as well as the enterprise side. +The only place where perhaps we see a little bit of a slowdown is, as I said, on some of the transactional business, which we had plan to grow as we go through this year, and that might grow more slowly just as people aren't focused on new infrastructure right now. But in terms of cloud and large enterprise, there continues to be good activity on both current already one design platforms as well as new pipeline engagements. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [46] +-------------------------------------------------------------------------------- + + That's helpful, Lisa. And as my follow-up, as you guys are painfully aware, one of the metrics that we probably focus probably too much on is just gross margin and gross margin progression. And given the gaming sort of ramp coming, it sort of convoluted the issue. So I was kind of hoping maybe you would quantify both in your Q2 guide and your full year guide, what impact the gaming console business is having on gross margins, i.e., what would gross margins be trending to right now ex gaming for both June and the full year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- + + I think, John -- go ahead. Go ahead, Devinder. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [48] +-------------------------------------------------------------------------------- + + So if you look at Q2, if you're asking the specific Q1 to Q2. Q2, we came in at the 46%, Q2 is down, and fundamentally primarily is due to the ramp in the game console revenue. As Lisa said earlier, we mentioned that the margins in the initial ramp of semi-custom revenue are typically lower and they do improve over time for semi-custom. But also from a company standpoint, when you look at the corporate average gross margin, it's lower. And therefore, it is having an impact in terms of sequentially the margin is going down from Q1 to Q2. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [49] +-------------------------------------------------------------------------------- + + But I guess, Devinder, my question is, is the non-gaming gross margins continuing to move higher sequentially every quarter this year, i.e., is it more than 100 basis point impact from gaming in the June quarter? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [50] +-------------------------------------------------------------------------------- + + I think... + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [51] +-------------------------------------------------------------------------------- + + Go ahead. Go ahead, Lisa. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [52] +-------------------------------------------------------------------------------- + + Sorry, we're -- Devinder and I are not in the same room. So the answer is yes, John. The impact of the sequential decline of 2 points is semi-custom. If you take semi-custom out, the rest of the portfolio would be -- what you would see in the rest of the portfolio is you would see server up and you would see desktop offset some of that. But the sequential decline is all semi-custom. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Your next question is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [54] +-------------------------------------------------------------------------------- + + I had two. I guess the first question, Devinder, I think you said that data center was high teens of revenue, so that would put it sort of in the low to mid 3s for March. Can you break out how much was CPU versus GPU? And I guess on the GPU side, that can be pretty lumpy. So anything to call out that's assumed for June? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [55] +-------------------------------------------------------------------------------- + + Yes. It's weighted towards the CPUs. If you take the data center CPUs and GPUs together, the revenue in Q1 is high teens of revenue in Q1, but primarily weighted towards the CPUs because that's the area of growth from a server CPU business standpoint. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [56] +-------------------------------------------------------------------------------- + + Okay. And then I guess bigger picture question. So Lisa, I think there's some new regulations in China that come into effect on June 1 around additional cybersecurity review for critical information infrastructure. And I would think that maybe you could fall under that. So any thought on how that could impact demand for you? And maybe if you could sort of tell us how much of your revenue on a consumption basis, do you think right now is in China? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + Yes. So we're looking at that new regulation. So I don't have any specifics at this point in time. We'll continue to look at that new regulation. As it relates overall, I would say, the majority of our business in China is consumer or, let's call it, consumer-related cloud. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [58] +-------------------------------------------------------------------------------- + + Operator, we'll take two more questions, please. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Our next question is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [60] +-------------------------------------------------------------------------------- + + I've got one and a follow-up. But the first one just kind of on the bookings you guys are saying. So I'm less worried about kind of the near-term revenue number you guys put up for server. But if you're sitting here today and you compare that to a quarter ago, what do the bookings look like or backlog? Has that changed at all? Is that improving? Is it getting better or is it pretty much in line with what you guys expected in terms of the overall backlog? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [61] +-------------------------------------------------------------------------------- + + Yes. I think it's -- I think I said earlier, but Mitch, it is certainly better. So we have better visibility a month into the quarter versus 90 days ago. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [62] +-------------------------------------------------------------------------------- + + Okay. And then the second one I had is just more broad. It's on China, actually. So one thing we're picking up is that a lot of the Chinese companies supposedly buying a lot of semiconductor chips ahead just in case they get banned from the U.S. and China relationship deterioration. So since you guys are not really involved in that, you're more exposed to the hyperscale. Do you guys have any comments on what you guys think is actually happening there, if people are actually trying to build up -- I guess, build up an inventory level for semiconductor chips they think may get banned? Or do you think that's kind of just noise, and it's not really occurring right now in that geography? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- + + Yes. Mitch, it's a little bit hard for me to generalize. I would say, from what we see and we track both selling and consumption pretty closely, it looks like it's normal patterns. But we don't have exposure to some of the markets you're talking about. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Your next question is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [65] +-------------------------------------------------------------------------------- + + Maybe, Lisa, just looking at the fiscal guide, I'm kind of curious, if you look at first half versus second half, it seems like you still would require growth in computer graphics. I want to just make sure that was right. And then I'm just kind of curious how you think of the server, obviously, your share gainer. I think cloud and enterprise get intermingled together, particularly with this work-from-home. So I'm just kind of curious as you look at that business, first half and second half, do you -- I think Intel was talking about some weakness in enterprise and government. It's not a big exposure for you, but just kind of curious how you're thinking about, is there any headwind as that work-from-home spend holds off with server as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [66] +-------------------------------------------------------------------------------- + + Yes. So as it relates to first half, second half, I mean, as we said, there's -- the $8.4 billion plus or minus 5% is a wider than normal range for us. I think you can see outcomes within that range that would have computing and graphics up as well as you can see outcomes with it more flattish. So that being the case, so I think the trends that I talked about are likely the right trends, which is the consumer spending, perhaps a little softer, enterprise and commercial, a positive for us; notebook share gain, a positive for us; and we want to see how sort of the desktop channel behaves as we go into the second half of the year. And then your second question? + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [67] +-------------------------------------------------------------------------------- + + Just kind of -- as you look at the server business, first half, second half, you had seen some -- you saw some strength in cloud in March and June. I'm kind of curious, are you thinking about -- is there any work-from-home benefits within that, that would then turn into a headwind in the second half? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [68] +-------------------------------------------------------------------------------- + + Yes. Look, I think from what we see, we see mostly platforms ramping. And so that's how we're thinking about the data center business. Of course, we're in this COVID-19 environment and so we'll have to actually play out the next couple of quarters. But within the ranges that we see, we see an opportunity to continue growing in the second half of the year, given the visibility that we have with customers, the platforms that are ramping. And I still feel very much like we're in the early stages of our 2nd Gen EPYC ramp. And I know it's been a couple of quarters, but that's just the way servers ramp. So we're in the early stages of the ramp, lots of customer activity, significant pull from the customers to get up and running as soon as possible. And as you said, we don't have as much exposure to some of the other end markets, which may have more volatility in the second half of the year. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further closing comments. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [70] +-------------------------------------------------------------------------------- + + Thank you, Kevin. That concludes today's call. We appreciate everybody participating, and stay safe, stay well. And we look forward to engaging with you throughout the quarter. Thank you. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2020-Jan-28-AMD.txt b/Transcripts/AMD/2020-Jan-28-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..b24945fb31603d3341c4a251ad3a7b6347e62fe8 --- /dev/null +++ b/Transcripts/AMD/2020-Jan-28-AMD.txt @@ -0,0 +1,626 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Advanced Micro Devices Inc Earnings Call +JANUARY 28, 2020 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Laura A. Graves + Advanced Micro Devices, Inc. - Corporate VP of IR + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Srinivas Reddy Pajjuri + SMBC Nikko Securities America, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Mark John Lipacis + Jefferies LLC, Research Division - MD & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the AMD Fourth Quarter and Fiscal Year 2019 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Laura Graves, Corporate Vice President, Investor Relations for AMD. Please go ahead, Laura. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to AMD's Fourth Quarter and Year-end 2019 Financial Results Conference Call. By now, you should have had the opportunity to review a copy of our earnings release and slides. If you have not reviewed these documents, they can be found on the Investor Relations page of AMD's website, amd.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. +I would like to highlight some important dates for you. On the afternoon of Thursday, March 5, we will hold our Financial Analyst Day at our headquarters in Santa Clara, California; and our first quarter 2020 quiet time is expected to begin at the close of business on Friday, March 13. +Today's discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date and as such, involve risks and uncertainties that could cause actual results to differ materially from our expectations. We will refer primarily to non-GAAP financial measures during this call, except for revenue and segment operational results, which are on a GAAP basis. The non-GAAP financial measures referenced herein are reconciled to their most directly comparable GAAP financial measure in today's press release posted on our website. Please refer to the cautionary statement in our press release for more information on risks related to any forward-looking statements that we may make. You will also find detailed discussions about our risk factors in our filings with the SEC, and, in particular, AMD's quarterly report on Form 10-Q for the quarter ended September 28, 2019. +With that, I will hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Laura, and good afternoon to all those listening in today. 2019 marked another major milestone in our multiyear journey. We delivered record annual revenue of $6.73 billion, and significantly increased both gross margin and net income as we successfully introduced and ramped the strongest product portfolio in our 50-year history. We grew clients and server processor annual revenue by $1.5 billion in 2019, driven largely by the strong demand for our 7-nanometer Ryzen and EPYC processors, powered by our Zen 2 processor core. +Looking at the fourth quarter, we ended the year very strong with quarterly revenue increasing 50% year-over-year to a record $2.13 billion, while also significantly increasing net income. +Turning to our Computing and Graphics segment. Fourth quarter revenue increased 69% year-over-year to $1.66 billion. Ryzen processor adoption accelerated sharply in 2019, helping to drive significant double-digit percentage increases in client processor annual unit shipments, ASPs and revenue. We ended 2019 with our highest quarterly client processor unit shipments in more than 6 years based on strong demand for Ryzen desktop and mobile processors. +In desktop, we had a very strong holiday season as our second- and third-generation Ryzen processors consistently held top sales spots at the largest global e-tailers and retailers. We launched our Ryzen 3950X processor and the 24- and 32-core versions of our third generation Ryzen Threadripper processors in November. Our 16-core Ryzen 3950X processor is the world's fastest mainstream desktop processor, while our latest Threadripper CPUs offer unmatched performance for the high-end desktop market. +In January, we expanded our leadership position in the HEDT market with the launch our flagship 64-core Ryzen Threadripper processor, which is the world's highest performance desktop processor. +In mobile, we had our eighth straight quarter of strong double-digit percentage year-over-year revenue growth as we expanded the number of AMD-powered laptops available for major OEMs. We began shipping our Ryzen 4000 mobile processors powered by our Zen 2 core at the end of the fourth quarter. These new processors double the performance per watt of our prior generation and deliver leadership single-threaded, multi-threaded and graphics performance for thin and light notebooks while enabling the industry's first ultrathin laptops with 8 cores. Initial systems featuring the Ryzen 4000 processors are expected to launch later this quarter, and more than 100 AMD-based consumer and commercial laptops are planned for 2020, from Acer, ASUS, Dell, HP, Lenovo and other major OEMs. +In Graphics, fourth quarter unit shipments grew by a strong double-digit percentage year-over-year, driven by sales of our Radeon RX 5000 series GPUs, featuring our new RDNA architecture. We further expanded our portfolio of RDNA GPUs with the introductions of the 5500 XT and 5600 XT desktop graphics cards, highlighted by strong third-party reviews that clearly establish 5600 XT as the most powerful gaming GPU available for under $300. +We launched our Radeon 5000M mobile GPUs in the quarter as well, and we are seeing solid design win momentum based on their strong performance and power efficiency. The first laptops powered by the new GPUs are available now, including the recently updated Apple MacBook Pro, and we expect many more notebooks featuring our Radeon 5000M GPUs to launch throughout 2020. +Data center GPU revenue increased sequentially, driven by cloud, VDI and game streaming deployments. We announced a major update to our open-source GPU computing software stack in the fourth quarter, featuring performance optimizations, expanded development tools and support for the most popular machine learning frameworks. We continue making strategic software investments to make it easier for developers to tap into the full capabilities of our Radeon Instinct accelerators for HPC and AI applications. +For the year, data center GPU revenue grew by a strong double-digit percentage as we continue to make progress growing our presence in this important part of the market. +Turning to our Enterprise, Embedded and Semi-Custom segment. Revenue of $465 million increased 7% year-over-year, as EPYC processor revenue growth offset declines in semi-custom revenue. Semi-custom sales continued to soften in the quarter in advance of the next-generation console launches from Sony and Microsoft planned this year. For 2020, we expect first quarter semi-custom revenue to be negligible, and the ramp of next-generation semi-custom products to start in the second quarter, with revenue to be heavily weighted towards the second half of the year. +In server, revenue grew by a strong double-digit percentage as unit shipments and ASPs increased sequentially, driven by demand for our second-gen EPYC processors. Our second-gen EPYC processors are ramping significantly faster than the first generation as we see particular strength for our higher core count models where our performance and TCO advantages are the most significant. +Cloud adoption with the largest providers continues to accelerate, driven by the expanding use of EPYC processors to power their critical internal workloads as well as a significant increase in the number of AMD-powered instances publicly available. Shipments to cloud providers increased sequentially by a significant double-digit percentage to support expanding build-outs at Amazon, Google, Microsoft, Oracle and Tencent. Microsoft announced the availability of 4 new virtual machines, and AWS announced 2 new EC2 instances powered by second-gen EPYC processors. +In the Enterprise, Dell began shipping their full portfolio of servers powered by our latest EPYC processors. We have doubled the number of EPYC processor platforms in market to more than 100 offerings in the quarter. These new platforms are driving increased enterprise customer engagements, broadening our sales pipeline considerably. +In HPC, we secured multiple large wins in the quarter based on our unmatched performance and scalability, highlighted by French, German and U.K. national supercomputing center deployments as well as the San Diego Supercomputing Center. +We are pleased with the significant traction and momentum in our server business and remain on track to achieve our goal of double-digit percentage unit share by midyear based on the growing demand for our second-gen EPYC processors. +I am very proud of our 2019 accomplishments as the successful ramps of our latest Ryzen, Radeon and EPYC processors resulted in record annual revenue and substantial increases in gross margin and net income. +I want to take a moment to recognize the more than 11,000 AMDers around the world, whose focus and determination enabled us to achieve these results. We entered 2020 well positioned to continue gaining share across the PC, gaming and server markets based on having an unmatched portfolio of leadership products, spanning from desktops to laptops, data centers and game consoles. With more than 27-nanometer designs in production or development, we are very excited about our next wave of products that can accelerate our growth in 2020 and beyond. +We are still in the early stages of our journey and remain focused on meeting our commitments as we establish AMD as the high-performance computing and graphics leader. +Now I'd like to turn the call over to Devinder to provide some additional color on our fourth quarter and full year financial performance. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- + + Thank you, Lisa, and good afternoon, everyone. 2019 was an outstanding year for AMD. Our competitive product portfolio and market share gains drove the highest annual and highest quarterly revenue in AMD's history. We achieved our highest annual gross margin percentage and annual free cash flow since 2011, and we improved non-GAAP earnings per share by 39% year-over-year. In short, we are very pleased with our financial performance. +Fourth quarter revenue was $2.13 billion, up 50% from a year ago and up 18% from the prior quarter, driven by strong sales of Ryzen and EPYC processors and Radeon GPUs, partially offset by softer semi-custom sales. Gross margin was 45%, up 360 basis points from a year ago, driven primarily by sales of our leadership 7-nanometer products. +Operating expenses were $545 million, with increased investments in go-to-market activities and R&D, compared to $474 million a year ago. Operating income was $405 million, up $296 million from a year ago, driven by revenue growth and higher gross margin. Operating margin was 19% as compared to 8% a year ago. Net income was $383 million, up $296 million from a year ago, and diluted earnings per share was $0.32 per share compared to $0.08 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $1.66 billion, up 69% year-over-year, driven by Ryzen processor and Radeon gaming GPU sales growth. Computing and Graphics segment operating income was $360 million or 22% of revenue compared to $115 million a year ago, driven by higher revenue. +Enterprise, Embedded and Semi-Custom segment revenue was $465 million, up 7% from $433 million the prior year. The continued growth of EPYC processor sales was partially offset by softer semi-custom revenue. EPYC processor revenue grew by a strong double-digit percentage sequentially, driven by robust shipments of our second-generation EPYC processors. EESC segment operating income was $45 million or 10% of revenue, driven by EPYC processor sales, compared to an operating loss of $6 million a year ago. +During the quarter, we reduced gross debt by $524 million, which resulted in a GAAP loss of $128 million. These debt reductions result in an annualized interest expense savings of approximately $16 million. +Free cash flow was positive $400 million in the fourth quarter, and cash flow from operations was $442 million. Inventory was $1 billion, down 6% from the prior quarter. +Fourth quarter adjusted EBITDA was $469 million compared to $152 million a year ago, driven by higher quarterly earnings. +Now let me cover the full year results. 2019 revenue was $6.73 billion, up 4% year-on-year, driven by strong growth in Computing and Graphics segment and sales of second-generation EPYC processors, partially offset by a decline in semi-custom sales. Excluding semi-custom, revenue was up more than 20% year-over-year. Gross margin of 43% was up 420 basis points from the prior year, driven by our current generation of Ryzen and EPYC products. Operating expenses were 31% of revenue as we increase go-to-market activities and investments in R&D. 2019 operating income was up 33% from a year ago to $840 million or 12% of revenue. Net income was $756 million, up 46 -- 47% from the prior year. +Turning to the balance sheet. I am extremely pleased with our progress on the strengthening balance sheet. Cash, cash equivalents and marketable securities totaled $1.5 billion at year-end, while gross debt was $563 million. This represents our highest net cash position since the third quarter of 2006. Full year free cash flow was $276 million. +We reduced principal debt by almost $1 billion in 2019, and ended the year with less than $600 million of gross debt. +On a trailing 12-month basis, adjusted EBITDA was $1.1 billion, resulting in gross leverage of 0.5x, down from 1.9x at the end of 2018. +Now turning to the outlook for the first quarter of 2020. We expect revenue to be approximately $1.8 billion, plus or minus $50 million, an increase of approximately 42% year-over-year and a decrease of approximately 15% sequentially. The year-over-year increase is expected to be driven by strong growth in Ryzen, EPYC and Radeon product sales. The sequential decrease is driven primarily by negligible semi-custom revenue, which continues to soften in advance of the ramp of next-generation products in addition to seasonality. +In addition, for Q1 2020, we expect non-GAAP gross margin to be approximately 46%; non-GAAP operating expenses to be approximately $580 million; non-GAAP interest expense, taxes and other to be approximately $18 million; and the first quarter diluted share count is expected to be approximately 1.22 billion shares. +For the full year 2020, we expect revenue growth of approximately 28% to 30%, driven by strength across all businesses. We expect non-GAAP gross margin to be approximately 45%, non-GAAP operating expenses to be approximately 28% of revenue and a non-GAAP tax rate of approximately 3% of pretax income. +In closing, we had an excellent fourth quarter and an excellent 2019. Our full year financial results highlight the strength of our business model. I look forward to what we have in store for 2020 as we expect to further expand and ramp our leadership portfolio of high-performance products to drive revenue growth, gross margin expansion, market share gains and financial momentum. +With that, I'll turn it back to Laura for the question-and-answer session. Laura? + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [5] +-------------------------------------------------------------------------------- + + Thank you very much, Devinder. Operator, we're ready to begin polling for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question today is coming from Vivek Arya from Bank of America Securities. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Congratulations on the strong growth and execution. Lisa, for my first one, you mentioned the goal to get to kind of this double-digit market share in servers by the middle of the year. I'm just wondering how the visibility is around in achieving this target. What's driving it? Is it just more instances at existing cloud customers? And as part of that, do you also have a share target for exiting this year? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Yes, Vivek, thank you for the questions. So, look, we are very pleased with how Rome is ramping. We've been in market now 4 to 5 months, and the visibility that we have is -- with the cloud guys, we have visibility to the public-facing instances as well as what they're doing in terms of internal workloads. And what we see is just the breadth of the overall workloads that are -- that they're using Rome with is expanding. And then on the enterprise side, with the full portfolio of our partners, HPE, Dell, Lenovo and the ODM partners, we see just a significantly -- significant increase in the overall enterprise pipeline that we have for Rome. So we're very focused on continuing to grow share in the data center market, and we feel good about our mid-year market share targets. +In terms of our market share targets, Vivek, I think we'll talk a little bit more at our Financial Analyst Day about some of the longer-term targets. But certainly, for 2020, we're very focused on growing our overall data center share. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [4] +-------------------------------------------------------------------------------- + + And for my follow-up, Lisa. How should we interpret the impact of capacity shortages at your main competitor? Have you seen any benefit from that? If not, why not? +And then kind of part B is, Intel did say that they plan to expand capacity later this year and will focus it more on the PC client side and try to reclaim market share. What effect will that have on the pricing in the market? And does your full year outlook kind of bake any potential impact of that competition? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- + + Yes. So when we look at the PC market, we finished 2019 very strong in the overall PC market, both mobile and desktop. I think that's primarily on the strength of the product portfolio and the expanding customer platforms that we have. There are some discussions about, let's call it, pockets of shortages. But as I said before, I don't believe -- we've been on this steady increase in market share now for the last 8 quarters, and we believe we gained share in Q4 as well. So I think what we see is just the portfolio getting a lot stronger. +As we go into 2020, I think we are, again, enthusiastic about our products. In addition to the Zen 2-based desktop products, we've added Zen 2 now in the notebook portfolio, and we'll have that for the full year of 2020. So I think our outlook expects growth in all businesses, including the PC business. And we remain very focused on expanding our market presence in both consumer as well as commercial PCs. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question is coming from Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [7] +-------------------------------------------------------------------------------- + + Lisa, this may overlap a little bit with Vivek's question, but I was hoping to better understand some of the key assumptions behind your full year guidance. For both your PC business as well as the server business, can you talk to some of the TAM assumptions that you're making and the market share assumptions for the full year? And then I've got a quick follow-up. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- + + Sure, sure. So let me talk first about the market, and then talk a little bit about how we're seeing the full year. So if you look at the PC market, I think, the discussion so far has been, let's call it, 2020, flat to maybe down slightly. There has been some concern raised about the second half of '20 perhaps be weakened -- weaker than normal seasonality just due to some of the enterprise refresh cycles that are strong in the first half. We're viewing it as flat -- flattish, maybe down very slightly. +That being the case, back to the comment I made with Vivek, I think we feel very good about our product portfolio, and especially when we look at sort of our notebook share and our relative opportunity to gain market share. The strength of our Ryzen 4000 series products is significantly stronger than previous generations, and the platforms are also significantly broader. So we feel good about that. +In the data center market, again, I would say that the growth of computing continues. From our standpoint, we see it as a good market environment for data center in both cloud as well as enterprise. When we look at our full year revenue guide of approximately 28% to 30% for the year, the highest growth from a percentage standpoint will obviously be server, just given the expectations in that market. But we expect all of our businesses to grow nicely in 2020. And that's just, again, based on where we are in the product cycle and the visibility that we have with customer design wins as well as just overall competitiveness. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [9] +-------------------------------------------------------------------------------- + + Great. And then I had a quick follow-up on gross margins, one probably for Devinder. You guys are guiding Q1 gross margins to 46% and then 45% for the full year. I appreciate your semi-custom business is at a low point in Q1 and the ramp in Q2 and more so in the second half is probably dilutive to corporate margins. But if you can kind of walk through some of the puts and takes from a gross margin perspective for the year, that would be helpful. +And then related to that, if you can compare and contrast the gross margin profile of your semi-custom business going into the next cycle versus the past cycle, product cycle, that would be helpful. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [10] +-------------------------------------------------------------------------------- + + Yes, let me start, and then Lisa can chime in. Overall, from a margin standpoint, you got it right. We are guiding to the 46% in the Q1 quarter. +And then the semi-custom business, as we've said, typically, is lower than corporate average. So as that product ramps in the second half, obviously, will have an impact on gross margin. The guide for the year is at 45%. So we feel good about that having ended 2019 at the 43% level. +And from a puts and takes standpoint, it's certainly product mix. And Lisa talked about the business is ramping and growing in 2020, with a 28% to 30% growth in revenue. Data center, as we've said before, is above corporate average. The client gross margin is around corporate average. And some graphics and then the semi-custom business has below corporate average gross margins. And that mix of revenue, as it ramps throughout the year, will obviously have an impact on a quarterly basis. From an annual standpoint, we feel pretty good with the guide at 45%, in particular with the 7-nanometer products ramping as we get to the year. And that obviously benefits the gross margin. +Semi-custom business, Lisa, you want to chime in on the difference between generation to generation? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [11] +-------------------------------------------------------------------------------- + + Yes. No, I think -- I just said, Devinder, the semi-custom margins tend to be below corporate average on a gross margin basis. Although, on an operating margin basis, given the contribution from our customers for the R&D, is actually quite good. As it relates generation to generation, the way to think about it is, in the first year of a console ramp, you would expect the margins to be on the lower side. And that's true no matter what, just because you're just starting the product ramp. And you should expect that the margins will get better as that ramp continues over time. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question is coming from Matt Ramsay from Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [13] +-------------------------------------------------------------------------------- + + Lisa, I wanted to just start with a question about the, I guess, comparing and contrasting a little bit, maybe a little weaker than we had -- some of us had modeled and, I guess, due to the console stuff for Q1 in the guidance versus a really strong, so 28% to 30% growth for the year. Maybe if you could just sort of lay out the year a little bit at a high level and just how you guys are sort of thinking about it coming together from the point of Q1. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [14] +-------------------------------------------------------------------------------- + + Sure. So look, Matt, we're pretty excited about 2020. It's a strong year for us, certainly, with the expectations of being around 28% to 30% revenue growth. We do expect all of our businesses to grow. I think relative to the Q1 guide, if you look at Q1 as an absolute number, it is up over 40% year-on-year, even with semi-custom revenues very low in Q1. And so that should give you an idea of the strength of the rest of the business. +From a sequential basis, Q4 to Q1, it's what we said on the call. There is some bit of normal seasonality, just as we are consumer-focused in our PC portfolio. So you expect that, that would go down from Q4 to Q1. And then we do have the factor that the semi-custom profile when we're doing a product transition has the revenue very low in Q1. It starts ramp in Q2, but it's very heavily weighted in the second half of the year. So you should think about semi-custom for this year, again, it's a ramp year, so it's a little bit different, that over 80% of the revenue for semi-custom will be in the second half of the year compared to the first half of the year. So overall, we think a very strong year. A little bit of reprofiling of revenue, particularly as it relates to semi-custom. And we look forward to executing it. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [15] +-------------------------------------------------------------------------------- + + As a follow-up, I guess, for both of you, but maybe for Devinder. Just a couple of little pieces. For me, it looks like, on the operating expense side, you're going to be up in the neighborhood of mid-20s for the full year in the annual guidance that you outlined. Maybe you could talk a little bit about the focus of that. Is it branding and marketing in the PC and server spaces as you grow? Or is it in other areas in R&D? +And then, secondly, I think you guys had disclosed the data center revenue mix. So GPU plus server in prior quarters. And if you have that number handy, that would be really helpful. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [16] +-------------------------------------------------------------------------------- + + Yes, let me take the second one first. Data center, it's, as we said in the past, mid-teens of revenue. In this quarter, it is around the same, mid-teens of the total revenue. And I'll point out that it is record revenue in the quarter, so that's pretty good. And we feel pretty good about that, having mid-teens revenue in the data center, combined server and data center GPU, on revenue of $2.1 billion. +As far as OpEx is concerned, our guide for the year is about 28% of the revenue guide that we provided. And you are right, fundamentally, the investments are R&D and go-to-market. And obviously, the business is growing. So obviously, there's investments needed to go ahead and grow the business from an absolute standpoint. But we feel we can manage it to about 28% of our revenue overall for the year. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [17] +-------------------------------------------------------------------------------- + + Matt, the only thing I'll add to that is for the data center revenue, particularly in Q4, it was very heavily weighted towards server CPU, just given some of the lumpiness of the data center GPU revenue. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [19] +-------------------------------------------------------------------------------- + + Great. I had one for Devinder and one for Lisa. For Devinder, the -- I think it's impressive that the cash that you generated 10 years ago, you were at $4 billion of net debt, now you're net cash positive. I didn't think back then we'd expect you to be here. But how should we think about capital structure going forward? And the -- and for the $400 million -- $440 million in cash flow from operations, could -- I had a challenge reconciling it. Can you share the biggest 2 or 3 sources of cash? +And then for Lisa, the last time AMD had a product cycle in servers, I think you were gaining -- once you hit 5% share, you started to gain share at 2% or 3% or 4%, 400 basis point clip per quarter. How should -- what is the right kind of cadence or pace of share gains in servers this cycle? And maybe you could just talk about, structurally, what gates your ability to -- or the pace of your ability to gain share? Is it capacity from your suppliers? Is it your own engineering support infrastructure? Or is it your customers testing and importing workloads? If you could give us a framework to think about that, I think that would be helpful. + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [20] +-------------------------------------------------------------------------------- + + Yes, let me get started, Mark. You do have a long memory, and so do I. I do remember the days when we had the challenge on the balance sheet. And one thing we feel good as we end 2019 is the strength of the balance sheet, and in particular, the net cash position we haven't been in many, many years, as we pointed out in the prepared remarks. +From a capital structure standpoint, another priority is investing in the business. The revenue is growing significantly in 2020 is what we're projecting at 28% to 30% over 2019. And also, we want to invest in the road map, the go-to-market and everything that's needed when the revenue ramps as significantly as it is going from year-over-year. So that's really the allocation priorities. +From a viewpoint of where the $440 million comes from, higher revenue, especially when you look at the revenue in Q3 and Q4 of 2019 compared to the first half of the year, we did go ahead and buy the inventory to go ahead and support the higher revenue. And as you know, when you sell that revenue, in particular, when it ramps up as it did on better margins, it generates the cash. And that's why you have the $440 million-plus operating cash flow from an overall standpoint. Lisa, over to you. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [21] +-------------------------------------------------------------------------------- + + Yes. So Mark, as it relates to just server rate and pace, I think the most important thing for us is when we look at from time of announcement or time of shipment to how customers actually deploy and trying to shorten that cycle. So when I look at the difference between, let's call it, Rome and Naples, we've seen that time to deploy actually significantly shortened with Rome. And so in terms of rate and pace of server share gain, it is primarily for cloud customers. It is having them deployed, not just sort of a set of instances, but ensuring that they get fully built out across all regions in the world, and also adding additional workloads. So it's just time is what I would say. +And then as it relates to Enterprise customers, I think the platform coverage that we have with Rome is significantly broader than it was with Naples. And so I'm quite encouraged, actually, by the strength of the pipeline that we see, the number of customers that are engaged, and then just how they're deploying. So I think we're going at a good pace, and we'll continue to accelerate that as we go through 2020. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + I had a -- first, a question on gross margin, especially into Q1. You said consoles are negligible. Gross margins are 46%, so that suggests that, that 46% is basically indicative of the business as it stands without consoles. So does that represent kind of the peak of the business on the current mix? I'm a little surprised it's not higher, given all the new products in aggregate, we're supposed to have gross margins in excess of 50%, and most of the mix today should be new products. So I guess, how do we think about the Q1 gross margins in the context of that? And what are the drivers that take it higher from here? Is it basically just server mix? Or is there something else that can help with that? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [24] +-------------------------------------------------------------------------------- + + Let me get started, and Lisa can add. But Stacy, as we talked about product transitions, the 46% guide in Q1, we recently introduced the next-generation notebook products. And as product transitions go, you still have legacy product that you sell before you get converted over to the new technology and the new generation products. The desktop products were ahead of that from that standpoint, and that did benefit our margin in the 2019 time frame. And you are right, the console being negligible revenue in Q1 of 2020, it does benefit, and the margin is 46%. +And from an overall standpoint for the year, it is 45%, and that's because the semi-custom business, which is lower than corporate average, does come back. And as Lisa said earlier, we're expecting 80% of that in the back half of the year. But by that time, also, the new generation products and the other businesses including data center and client reramping all on 7 nanometers, and that should help the gross margin to offset some of the impact that we have on the semi-custom business. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- + + No, that's good, Stacy. I was just going to add to what Devinder said. So we don't expect the client notebook mix to fully cut over to the new 7-nanometer products until later in the year. And in terms of opportunities to improve margins, it is definitely product mix. So higher mix of server as well as higher mix of, let's call it, Ryzen 7s and Ryzen 5s versus some of the legacy products. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + Got it. For my follow-up, if I sort of squint at the second half, it seems to me you're probably guiding it implicitly, call it, $800 million to $1 billion over the second half of 2019. How much of that do you think is consoles versus nonconsoles? Because it's not hard to get a console number, especially in the beginning of a ramp that's not that far off that number, which doesn't leave all that much room to ramp the rest of the business. So is this just conservatism? Or what else are you expecting here? How much of that second half do you think is consoles versus nonconsoles? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [27] +-------------------------------------------------------------------------------- + + Well, I think, as I perhaps answered to one of the earlier questions, when I look at the full year at 28% to 30% sort of revenue growth, expect server to be significantly above that. And then the rest of the businesses are all going to grow nicely. And so you would expect significant double-digit growth in the client business as well as in the semi-custom business. And overall, we see the aggregate of it to be a very strong year. So it is not all console-weighted, if that's what you're asking. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + Okay. Wouldn't you get that just from the nature of the ramp that we saw in 2019, we'd be doing the compare already? I guess I'm trying -- that's why I'm trying to sort of normalize second half to second half. You think you get strong double digits in second half versus second half growth across all the businesses? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [29] +-------------------------------------------------------------------------------- + + I would say, in aggregate, you will see -- so let me help you with this way. So what we said in 2019 is, 2019, overall, we grew 4% on an annual basis, but excluding semi-custom, we grew over 20% through all the rest of the businesses. If I do that same type of calculation, excluding semi-custom for 2020, we would still say the rest of the businesses would grow greater than 20%. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is coming from David Wong from Instinet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [31] +-------------------------------------------------------------------------------- + + Devinder, you said the sequential decrease in the March 2020 quarter is driven primarily by the drop in game console chips. Does that mean that you expect your microprocessor and graphics revenues will be flattish sequentially? Or if not, roughly, what does your guidance assume in terms of percentage sequential drop for, say, PC processors and GPUs? Do you get server processors sales rising sequentially? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [32] +-------------------------------------------------------------------------------- + + I don't think I said specifically that Q4 to Q1 is all due to semi-custom. That obviously helps the margin. But there is a product mix underneath that, that helps, especially with the notebook products that we talked about, that are moving to 7 nanometers. +And then I think your second question about sequential from Q1 outwards, is that right, David? + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [33] +-------------------------------------------------------------------------------- + + No, no. I was talking about revenues from December into Q1, the sequential drop. Can you give us some idea of -- I mean there's a big chunk that's game consoles, right? But I mean, what about the nongame console part of it? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [34] +-------------------------------------------------------------------------------- + + It's seasonality, seasonality in the business. We have the consumer weight from a revenue standpoint in our CG segment, and we go from Q4 to Q1, and you do have the seasonality coming into play. And typical seasonality is what's driving the other portion of the decline in revenue from Q4 to Q1. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [35] +-------------------------------------------------------------------------------- + + Yes. David, I think what you're asking is we would expect that the Computing and Graphics segment would be down sequentially due to seasonality, and we would expect that server CPUs should be up because we're continuing to ramp those processors sequentially. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [36] +-------------------------------------------------------------------------------- + + Okay, great. And Lisa, can you give us some idea of what new GPUs you're expecting to launch through the rest of 2020 for PCs and for data center? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- + + Yes. So in 2019, we launched our new architecture in GPUs, it's the RDNA architecture, and that was the Navi-based products. You should expect that those will be refreshed in 2020, and we'll have next-generation RDNA architecture that will be part of our 2020 lineup. So we're pretty excited about that, and we'll talk more about that at our Financial Analyst Day. +And on the data center GPU side, you should also expect that we'll have some new products in the second half of this year. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [39] +-------------------------------------------------------------------------------- + + Great. Devinder, you had talked about consumer graphics as being below corporate gross margin. I guess I was thinking that -- I know you've historically had a high cost structure because of high bandwidth memory. But as the product portfolio increasingly doesn't use high bandwidth memory, is there the prospect to improve that for consumer GPU to be closer to where your competitors' gross margins are? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [40] +-------------------------------------------------------------------------------- + + I don't think I specifically said that. I said some of our graphics products are below corporate average from a gross margin standpoint, in addition to the semi-custom being below average. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [41] +-------------------------------------------------------------------------------- + + And I think, Joe, maybe just to answer your question in terms of what we expect in consumer graphics. I think -- look, we're investing in consumer graphics. We think gaming is a very important segment, whether we're talking about consoles or discrete graphics. And the work that we're doing around the RDNA architecture and the future generations of RDNA architecture we believe will continue to improve our offerings for both consumer graphics as well as data center graphics. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [42] +-------------------------------------------------------------------------------- + + Okay, great. And then with the new console builds, you mentioned that, that starts in Q2, but it's mostly in the back half of the year. I guess as you think about that opportunity from a unit standpoint, is it the right way to look at it sort of a similar number of units to what we had in the first year of the current console cycle? +Or is there -- does the compatibility that you bring when you have an x86 CPU still and there's probably a little bit more similarity between the consoles, could that point us to a sort of a better console unit market in 2020 than we saw 6 years ago? Like how are you thinking about it, just to size that opportunity? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [43] +-------------------------------------------------------------------------------- + + Yes. So we do think there's some pent-up demand for the next generation of consoles. Without forecasting what our customers are planning, I would say they're both -- we're planning for a strong first year, and we'll have to see how things develop as we go through the ramp. But the overall sentiment is that there has been, let's call it, a lull in console sales in the second half of 2019 going into in 2020, sort of -- for some of this anticipation of the next generation. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Our next question today is coming from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + Maybe just following up on Joe. I just want to make sure I heard you right. I thought you said the semi-custom as well we grew at double digits, I just want to confirm that. +And then just following on, I don't know what the units are going to be, but is there a content or ASP story to layer on top of that equation as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [46] +-------------------------------------------------------------------------------- + + Yes. So I did say that semi-custom should grow double-digit as well. And again, it's a strong year for us. And then as it relates to content, again, it's fair to say that there is additional content in this generation versus previous generation. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [47] +-------------------------------------------------------------------------------- + + Got you. And then maybe just on the gross margin equation. Is there a way to talk about the mix of 7-nanometer? That's a big tailwind. Still seems early days, at least, across a couple of your products. Is there a way to kind of think about the whole company and what the mix of 7 is? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [48] +-------------------------------------------------------------------------------- + + Yes. So we just completed the fourth quarter, and it was a very strong quarter for us, record revenue for the company. And I would say about half of that revenue was 7-nanometer-based, and the other half, not yet. And so there is still a significant ramp as we go into 2020. But we're pleased with how quickly we ramped in 2019. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Our next question is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [50] +-------------------------------------------------------------------------------- + + Yes. Congratulations on solid results. I just want to go back to the gross margin bridge from Q1 to the full year. I just want to make sure I understand. The drop from Q1 to the full year, is that 100% being driven just by gaming coming back more aggressively in the back half of the year? Or have you baked in anything for either pricing competition from the #1 guy out there or some share shifts? How do I think about that? Is it all about gaming? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [51] +-------------------------------------------------------------------------------- + + I think if you -- maybe Devinder, you... + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [52] +-------------------------------------------------------------------------------- + + No, go ahead. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [53] +-------------------------------------------------------------------------------- + + All right. So I think if you look at it, the predominant factor, if you're talking about Q1 guide at 46% versus full year at 45%, it's just as we wrap those consoles, there are some -- yes, there's some impact of that. As it relates to the pricing environment and what we're expecting, we're expecting a competitive pricing environment, and that's the way we built our model. So we've always expected that the competition will be very aggressive on both the CPU as well as the GPU side. And that is part of the inherent model for the company. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [54] +-------------------------------------------------------------------------------- + + That's helpful, Lisa. And then you guys have a ton of goodness on your immediate plate on the server side and the data center side, just with the workloads you're going after. But I'm kind of curious, you answered an earlier question saying expect more GPUs for the data center. And I don't want you to preannounce product, but how should I think about your positioning for AIs and workload and acceleration? +And just given some of the heavy lifting that NVIDIA had to do around CUDA, how do I think about the investment there? Is this an area that you think you have some unique IP you can bring to? Or how do I think about that over the next couple of years? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [55] +-------------------------------------------------------------------------------- + + Yes. So I think that's actually a good way of talking about the opportunity, John. I think the CPU opportunity is very immediate and in front of us as we look at the opportunities with Rome and the expanding opportunities. I think the data center GPU market continues to be an important growth vector for us, and now I call that over the several-year horizon. So when you look at the opportunities that we have, when we combine our CPU and GPU IP together, they're very, very strong. I mean, for example, this is the reason that we won the Oak Ridge National Lab Supercomputer with Frontier, which were actually both a CPU and a GPU win, and some of the optimization that we've done with that overall system. We think that there are additional opportunities like that as well as machine learning and AI opportunities. Our focus there has been to work with large cloud providers to optimize the machine learning frameworks. And we had some key milestones that we completed in the fourth quarter that will continue to be a focus for us in 2020 and beyond. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [56] +-------------------------------------------------------------------------------- + + Is it fair to say some of the GPU data center announcements this year go beyond just the cloud gaming market? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [57] +-------------------------------------------------------------------------------- + + Yes. I think you should expect that we will have additional sort of customer announcements outside of cloud gaming. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our next question is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [59] +-------------------------------------------------------------------------------- + + I guess I had another question, just -- well, that's really on gross margin. (inaudible) of the year's revenue in the semi-custom would be in the back half, but how does that break out between September and December? I guess I asked that because I'm just trying to see what the gross margin will be exiting this year if you strip out semi-custom. Could it be 50% exiting the year? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [60] +-------------------------------------------------------------------------------- + + I think it's hard to break it down that way. We are in the initial stages of planning for the ramp, and you're asking about Q3, Q4. We are projecting about 80% of the semi-custom revenue growing double digits year-over-year in Q3 and Q4. And typically, when we have this new game launches, our peak quarter from a revenue standpoint in semi-custom will be Q3. But Q4, when you talk about the ramp of the product, especially in the first year of the ramp, it's hard to project how much it will be and then what the impact would be exiting 2020 from a gross margin, excluding semi-custom. Maybe as we get closer to that, I'm talking about 3 to 6 months, we can probably give you a better idea of that. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [61] +-------------------------------------------------------------------------------- + + I got it, okay. And then can you just talk about what your share targets are for the year in PC? I think you're 17, 18 in notebook and you're maybe 14 in desktop. Can you just talk about how much share you think that you can gain this year given all the moving parts with the shortages and whatnot? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [62] +-------------------------------------------------------------------------------- + + Yes. So I'm not sure I'm going to forecast a share target for 2020. I will say though, if you take a look back at the last 8 quarters, we've been on a fairly steady share gain in PCs, somewhere between -- depending on the quarter, let's call it, 50 to 100 basis points per quarter, and that changes between desktop and notebook. I think we grew somewhere on the order of 4 points a share. So we believe that we still have additional opportunities, and particularly, our focus is going to be both notebook as well as commercial. And those are good opportunities for us and play well to our new Ryzen 4000 mobile processors. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Our next question is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [64] +-------------------------------------------------------------------------------- + + Most of my questions been answered, and it kind of lines up with the model we got here, but I just want to make sure I got a couple of quick questions. And so, basically, for Q4, it looks like semi-custom is probably down 50% sequentially or somewhere around that range. Is that -- am I at least in the ballpark? +And then, secondly, from a server perspective, I'm not expecting you to give numbers on this, but maybe qualitatively, how much of your revenue is going to be cloud versus enterprise? And I think that's one of the bigger debates, and I don't expect specifics, but anything you could to help us understand what should be the mix between cloud and enterprise for calendar '20. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [65] +-------------------------------------------------------------------------------- + + Yes, sure, Mitch. So look, I think you're right. When you look at the semi-custom business in the fourth quarter, it is -- it was a bit softer than originally anticipated. So we had originally said last quarter that we thought the second half of the year would be down high-30s, and we were actually down more than that for the second half of the year and for Q4. And as it relates to mix of cloud versus enterprise for 2020, I mean, it will move around from quarter-to-quarter. But I think the best guess at this point is, let's call it, roughly even between the two. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Our final question today is coming from Srini Pajjuri from SMBC. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [67] +-------------------------------------------------------------------------------- + + Lisa, maybe on the supply side, you're guiding for a pretty strong growth here. I'm just curious, have you already logged in the supply for 7-nanometer? +And as we go into second half of the year, especially as you ramp the game consoles, I believe that those die sizes tend to be very large. I'm just curious if you were to get upside, how are you feeling about your supply situation? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [68] +-------------------------------------------------------------------------------- + + Yes. So TSMC has supported us very well through the first couple of quarters of our 7-nanometer ramp here in 2019. I think, as we go into 2020, there will certainly be a significant growth for us in 7-nanometer. Our current visibility supports the revenue guide that we gave you. It is fair to say that wafer supply is tight, and so it's really important for us to be planning well with our customers, and that's what we're working on. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + We reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments. + +-------------------------------------------------------------------------------- +Laura A. Graves, Advanced Micro Devices, Inc. - Corporate VP of IR [70] +-------------------------------------------------------------------------------- + + Thank you very much, everyone, for joining us today. We do look forward to having you join us on Thursday, the 5th of March, for our Financial Analyst Day, which will also be broadcast from our website. +Thank you very much. Have a great day, and we'll talk with you again soon. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMD/2020-Jul-28-AMD.txt b/Transcripts/AMD/2020-Jul-28-AMD.txt new file mode 100644 index 0000000000000000000000000000000000000000..ae143ae175093fc95489cce785a53abe673c801b --- /dev/null +++ b/Transcripts/AMD/2020-Jul-28-AMD.txt @@ -0,0 +1,511 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Advanced Micro Devices Inc Earnings Call +JULY 28, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Devinder Kumar + Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer + * Lisa T. Su + Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director + * Ruth Cotter + Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JPMorgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - MD & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Hello, and welcome to the AMD Second Quarter 2020 Conference Call. (Operator Instructions) A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. +It's now my pleasure to turn the call over to Ruth Cotter, Senior Vice President, Marketing, Human Resources and Investor Relations for AMD. Ms. Cotter, please go ahead. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [2] +-------------------------------------------------------------------------------- +Thank you, and welcome to AMD's Second Quarter 2020 Financial Results Conference Call. +By now, you should have had the opportunity to review a copy of our earnings release and slides. If you've not reviewed these documents, they can be found on the Investor Relations page of AMD's website, amd.com. +Participants on today's conference call are Dr. Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President, Chief Financial Officer and Treasurer. +This is a live call and will be replayed via webcast on our website. +Before we begin today, please note that AMD is scheduled to participate in several Wall Street events during the third quarter. On Tuesday, the 1st of September, Mark Papermaster, Chief Technology Officer and Executive Vice President, Technology and Engineering, will participate in the Jefferies Virtual Semiconductor IT Hardware and Communications Infrastructure Summit. On Tuesday, September 15, Forrest Norrod, Senior Vice President and General Manager, Data Center and Embedded Business Solutions Group, will participate virtually in the Deutsche Bank Technology Conference. +In addition, our third quarter 2020 quiet time is expected to begin at the close of business on Friday, the 11th of September. +Today's discussion contains forward-looking statements based on current beliefs, assumptions and expectations speak only as of the current date and, as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statement in our press release for more information on the risks related to any forward-looking statements that we may make. +We will refer primarily to non-GAAP financial metrics during this call, the non-GAAP financial measures referenced are reconciled to their most directly comparable GAAP financial measure in today's press release and slides posted on our website, amd.com. +Now with that, I'd like to hand the call over to Lisa. Lisa? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- +Thank you, Ruth, and good afternoon to all those listening in today. +For the last 5 years, we have built the technical, operational and financial foundation required to drive our long-term growth strategy. We consistently executed on our product road maps, established deep partnerships with an expanded set of customers, ramped multiple products in leading-edge manufacturing technologies and significantly strengthened our balance sheet. Our strong second quarter results and increased full year revenue guidance demonstrate how we are successfully scaling our business through our consistent execution. +Looking at the second quarter, revenue grew 26% year-over-year to $1.93 billion, driven by strong demand for our leadership server and client processors. We accelerated our server and mobile processor businesses significantly in the quarter, resulting in Ryzen and EPYC processor revenue more than doubling year-over-year. Importantly, we met our double-digit server processor market share goal as data center products accounted for more than 20% of our second quarter revenue. +Turning to our Computing and Graphics segment, second quarter revenue increased 45% year-over-year to $1.37 billion as growth in Ryzen processor sales more than offset lower graphic sales. We delivered our highest client processor revenue in more than 12 years. Increased working and schooling from home due to COVID-19 resulted in a strong PC market in the quarter. Although we believe our growth was largely driven by our 11th straight quarter of market share gains. +Desktop processor sales decreased sequentially as anticipated, while revenue and ASP increased year-over-year as demand for our higher-end Ryzen processors drove a richer mix. In mobile, we had record quarterly notebook processor unit shipments and revenue. Sales of our latest Ryzen 4000 Series processors grew significantly in the quarter, resulting in mobile revenue growing by a strong double-digit percentage sequentially and more than doubling from a year ago as both unit shipments and ASP increased significantly. +Multiple third-party reviewers have consistently highlighted that our latest notebook processors deliver superior performance and longer battery life compared to the competition. As a result of this strong performance, I'm pleased to report that Ryzen 4000 processor revenue has ramped faster than any mobile processor in our history. There are now 54 Ryzen 4000-powered notebooks in the market. +We expect to continue accelerating our mobile processor business in the second half of the year as HP and Lenovo ramp their first commercial notebooks powered by Ryzen Pro 4000 Series processors and a second wave of more than 30 ultrathin premium and gaming consumer notebooks launch from multiple OEMs. +In Graphics, second quarter revenue declined year-over-year. A strong double-digit increase in mobile GPU sales was more than offset by lower desktop channel sales. While desktop GPU shipments were lower year-over-year, channel sell-out accelerated in the quarter. Mobile GPU revenue growth was driven by adoption of our RD&A GPUs, highlighted by the launches of new Apple Professional and Dell Gaming notebooks featuring our Radeon 5000M Series mobile GPUs. Data center GPU revenue decreased year-over-year. +We expect revenue to increase in the second half of the year as additional cloud-based visual computing wins ramp and we launch our new CDNA data center GPU architecture optimized for next-generation exascale and machine learning workloads. +Turning to our Enterprise, Embedded and Semi-Custom segment, revenue of $565 million decreased 4% year-over-year due to lower semi-custom sales. Sequentially, revenue increased 62%, driven by record quarterly server processor sales and increased semi-custom product revenue. In semi-custom, we passed an important milestone in the second quarter as we began initial production and shipments of our next-generation game console SOCs. We expect strong second half semi-custom growth as we ramp production to support the holiday launches of the new PlayStation 5 and Xbox Series X consoles. +Turning to Server. Our focus since launching our EPYC processors has been on building a solid foundation to drive long-term growth. Our strategy is grounded in driving broad, high-volume adoption with widespread support from industry-leading cloud and hardware providers. We passed a significant milestone in the quarter as we achieved our double-digit server processor unit share goal based on broad adoption across cloud, enterprise and HPC customers. +In cloud, multiple hyperscale customers ramped second-generation EPYC processors into high-volume production in the quarter to power both their internal infrastructure and publicly available instances. Microsoft announced they have added EPYC processors to power their Office Online applications used by more than 200 million monthly users. Tencent upped multiple millions of EPYC processor-powered virtual machines to support enhanced collaboration services. Google announced that EPYC processors were being used exclusively to power their unique confidential computing VMs that encrypt data while it is being processed. And AWS launched global availability of new compute-optimized EPYC-based EC2 instances. +In enterprise, we have significantly expanded our TAM as the number of AMD platforms has increased by more than 40% so far this year. Recent additions include Dell and HPE introducing multiple hyperconverged infrastructure solutions; Lenovo launching dual-socket servers for financial, retail and manufacturing; and NVIDIA selecting AMD EPYC processors to power its latest DGX AI platforms. We also secured new HPC wins based on the leadership performance and scalability of second-gen EPYC processors. Public highlights include new wins with leading research institutions, including Indiana University, Purdue and CERN as well as Amazon, IBM, Microsoft and Oracle all announcing cloud-based HPC offerings powered by EPYC processors. +We are pleased with the momentum in our Server business and expect to continue gaining share as additional second-gen EPYC platforms and cloud deployments ramp to volume in the second half of the year. We remain on track to begin shipping our next-generation Milan server processor, featuring Zen 3 late this year. +In closing, I want to thank our employees and partners for the strong execution during this unprecedented time as we continue to focus on delivering on our commitments. While there continues to be some macroeconomic uncertainty and pockets of demand softness, our product portfolio is very strong, and our markets are resilient. We are on track to deliver strong growth in the second half of the year driven by our current product portfolio and initial shipments of our next-generation Zen 3 CPUs and RDNA 2 GPUs that are on track to launch in late 2020. +I am very proud of the progress we have made over the last few years, placing AMD on a long-term growth trajectory. I'm even more excited about the opportunities in front of us as we enter our next phase of growth driven by accelerating our business in multiple markets. We remain focused on consistently gaining share across the $79 billion market for our high-performance products. We are investing significantly and have added resources to further extend our leadership IP and go-to-market capabilities as we pursue our ambitious goal to make AMD a best-in-class growth franchise. +Now I'd like to turn the call over to Devinder to provide some additional color on our second quarter financial performance. Devinder? + +-------------------------------------------------------------------------------- +Devinder Kumar, Advanced Micro Devices, Inc. - Senior VP, CFO & Treasurer [4] +-------------------------------------------------------------------------------- +Thank you, Lisa, and good afternoon, everyone. +We executed the second quarter very well. Amidst the COVID-19 backdrop, we delivered strong financial results, introduced industry-leading products and gain CPU market share. The second quarter results and increased full year revenue guidance highlight our ability to consistently deliver on our commitments as we continue to drive long-term financial growth. +Second quarter revenue was $1.93 billion, up 26% from a year ago and 8% from the prior quarter. Year-over-year growth was driven by strong Ryzen and EPYC processor sales. Gross margin was 44%, up 330 basis points from a year ago driven by client and server processor sales. Operating expenses were $617 million compared to $512 million a year ago, primarily due to ongoing investments in the business. Operating income more than doubled year-over-year to $233 million, up $122 million from a year ago, driven primarily by revenue growth. Operating margin increased to 12% as compared to 7% a year ago. Net income was $216 million, up $124 million from a year ago, and diluted earnings per share were $0.18 per share compared to $0.08 per share a year ago. +Now turning to the business segment results. Computing and Graphics segment revenue was $1.37 billion, up 45% year-over-year, driven by significant growth in Ryzen process sales. Computing and Graphics segment operating income was $200 million or 15% of revenue compared to $22 million or 2% of revenue a year ago. Enterprise Embedded and semi-custom segment revenue was $565 million, down 4% year-over-year due to lower semi-custom sales, which were largely offset by higher EPYC processor sales. EESC segment operating income was $33 million or 6% of revenue compared to an operating income of $89 million a year ago. +Turning to the balance sheet. Cash and cash equivalents totaled $1.8 billion, including $200 million from our revolving line of credit, which was fully repaid in the third quarter. Inventory was $1.3 billion, up 25% from the prior quarter in anticipation of the revenue ramp in the second half of 2020 and new product launches. Free cash flow was $152 million in the second quarter. I am very pleased with our cash performance in the quarter, which resulted in the first quarter of the year -- or the first half of the year being free cash flow positive. +Let me now turn to the outlook for the third quarter of 2020. Today's outlook is based on current expectations and contemplates the current COVID-19 environment, global economic backdrop and customer demand signals. We expect revenue to be approximately $2.55 billion, plus or minus $100 million, an increase of approximately 42% year-over-year and approximately 32% sequentially. The year-over-year and sequential increases are expected to be driven by higher Ryzen and EPYC processor sales and next-generation semi-custom products. In addition, for Q3 2020, we expect non-GAAP gross margin to be approximately 44%, non-GAAP operating expenses to be approximately $660 million, non-GAAP interest expense, taxes and other to be approximately $25 million and the diluted share count in the third quarter is expected to be approximately 1.23 billion shares. +For the full year 2020, we now expect higher annual revenue growth up approximately 32% driven by the strength of our PC, gaming and data center products. We continue to expect gross margin of approximately 45% for the full year, up 2 points from the prior year. +In closing, while there continues to be global economic uncertainty due to COVID-19, we have significant opportunities ahead of us with strong product demand across multiple markets. We are in a good position to accelerate our financial momentum, expand gross margins and generate significant cash. +With that, I'll turn it back to Ruth for the question-and-answer session. Ruth? + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [5] +-------------------------------------------------------------------------------- +Thank you, Devinder, and operator, please pool the audience for the question-and-answer session. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Our first question today is coming from Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- +A question for Lisa. You've said in the past that your customers they don't buy CPUs but they buy road maps. And I was hoping that you could tell us about your road map, particularly in servers going forward, how it compares to your competition? And does your -- as part of that, does your view of the competitive environment change after your biggest competitor last week noted a push in its 7-nanometer processor? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- +Hi, Mark. Yes, thanks for the question. So look, we've been very focused over the last couple of years on our road map and our strategy, and for sure, when we talk to our customers, it's about ensuring that they understand we have a consistent road map that is pushing the leading edge of performance and ensuring that we deliver the performance improvements that we promise. +As you know, with these road maps, many of these decisions are made years in advance. And so we look at process technology as well as design and architecture and leading-edge packaging. So we feel good about our road map. We just -- we updated our road maps at our financial Analyst Day in March, and we continue to be very focused on executing to our road maps. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- +And on the -- and when you talk about the -- your focus both on your transistor or the process and the architectural lead, can you give us a sense to what extent the share gains that you're taking right now are driven by one or the other or both? And would you expect to maintain a lead in both as you launch Milan and further on down in '21 and '22? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [5] +-------------------------------------------------------------------------------- +Well, look, I would say that the road map is dependent on all of those factors. So you have to get the process technology and manufacturing right. We feel good about our road map there and our partnership with TSMC. And you also have to make the right design and architectural decisions, and we feel good about our CPU road map. So right now, we are on Zen 2 with Rome. We saw a very nice acceleration of our data center business due to some of the key customers that have launched. We are on track or we expect to start shipping Milan here late this year. And then we're also working in development on Zen 4, which is slated for 5-nanometer. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Our next question today is coming from Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [7] +-------------------------------------------------------------------------------- +And congratulations on the strong growth despite all of the headwinds. Lisa, for my first one, when I think back to the last time AMD was really big in the server market was in that 2004 to 2006 time frame, when market share went from 7% to 26% in kind of that 3-year-or-so period. How would you contrast the current environment, right, from -- whether it's from a competitive perspective or just a customer willingness to adopt your platform? What will it take for your market share to kind of approach those peaks? What are the puts and takes, and how different or similar is your experience now? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [8] +-------------------------------------------------------------------------------- +Yes, sure, Vivek. Thanks for the question. So look, the server market, we've said, is very strategic for us. We think there's a high demand for sort of pushing the leading edge of performance. When I look at our road map right now, I feel very good about our road map. I think we have executed well to our road map. I think we are differentiated in terms of the performance that we're offering in the server market. +We've always said that the data center market is a bit of a journey, and so this is about putting together multiple generations of strong execution. So we're pleased with where we are with Rome and the progress that we've made this year. I would say we're still in the early innings of what we believe we can do in the server market. I think Rome is a very, very competitive product. I think as we go into Milan, we see that as also a very competitive product. And our goal is to really satisfy a broad swath of the server workloads, and we think we have the capabilities of doing that. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- +Okay. For my follow-up, Lisa, so you raised full year growth outlook to 32% or so, I believe, from 25%. Can you give us some more color on what in that upside? How much of that is coming from PCs? How much from server? How much from semi-custom? And I noticed that you kept the gross margin outlook kind of steady, and I'm wondering how do we think about gross margins going forward? How sensitive is that to your success in the server market? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- +Yes. So we did update full year guidance. When we look at sort of what's changed over the last 90 days, when we were here talking to you in April, we were actually expecting that there might be some COVID-19-related weakness in the second half due to macroeconomic factors or other things like that. What we see now is better visibility into the second half of the year, and so we had originally assumed that the PC market would be down in the second half. And we now expect that PCs -- that we will grow in the PC processors for the second half compared to the first half. We also see data center growing from the second half to the first half. And then we have our game console ramp that is a strong ramp here in the second half. +So I think it's a number of factors. We do believe that the market is a little bit better than we thought 90 days ago. But we also believe that our product traction is strong, and we're seeing that come through with our customer demand. So those are the reasons for the guidance. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [11] +-------------------------------------------------------------------------------- +Anything on gross margins? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [12] +-------------------------------------------------------------------------------- +Oh, I'm sorry. Yes. On gross margins, I think that depends a lot on mix. That depends on -- certainly, your question was about server. Server is certainly accretive to margin. And I think in the PC business, the second half of the year tends to be a bit more consumer-focused and notebook-focused. And so that's some of the mix relation there. And then we've said that the consoles are decretive to margin. We expect that consoles will be very strong in the third quarter. And although the fourth quarter will be lower for consoles, it's still going to be a very strong second half of the year. So those are the puts and takes there, but we feel that the mix is about right to -- for the annual guide at 45%. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Our next question today is coming from Matt Ramsay from Cowen & Company. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [14] +-------------------------------------------------------------------------------- +Lisa, I wanted to ask about the PC market, and you just gave some comments about maybe some stronger trends than you might have anticipated 90 days ago in the back half. But pretty remarkable for a notebook business to more double and for the second quarter to be your record client sales. I wonder if you might talk about the momentum, particularly in the notebook market of the 4000. And then how are you feeling the pull of the enterprise notebook market? And what's the traction like there so far into the back half? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [15] +-------------------------------------------------------------------------------- +Sure, Matt. So the PC market was strong for us, and the PC business was strong for us in the second quarter and as we look into the second half. What we saw was that desktops were down as expected, but the COVID-19-type phenomenon has increased, overall, the PC market. And we see a strong shift from desktop to notebooks. At the same time, I think our notebook portfolio, particularly the Ryzen 4000, has done extremely well. We've seen strong adoption. We have over 50 platforms in market. We watch the sell-through and the consumption of those. And I would say it has been very strong, even exceeded our expectations for the early ramp. +And our view is that the second half will continue to be good for notebooks and PCs overall. And that's part of this idea that PCs are now essential. And so we see strength in consumer. We see strength in gaming notebooks, which we had previously been underrepresented. We have a nice commercial ramp, and we do see good pipeline around commercial PCs as well as the education market is quite strong as well. So you put that together, and I think the PC business has performed well for us. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [16] +-------------------------------------------------------------------------------- +Got it. As a follow-up, maybe a piece of the business that's been asked about a little less frequently over the last few quarters is your gaming GPU business. And I'm interested if you could just put into context what the expectations are for improvements and new opportunities for Big Navi as you launch later this year? And maybe size those opportunities from a data center perspective versus what you might expect in the gaming channel? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [17] +-------------------------------------------------------------------------------- +Yes. So I think the Graphics, as we mentioned in the prepared remarks, was down year-over-year. We saw a nice ramp of mobile as we launched some of the Navi-based mobile products, but the desktop channel was lower. This was somewhat as expected from the standpoint of the second quarter is usually a lower quarter for the desktop channel. +What we did see is that sell-through was pretty good, so I think gaming overall is good. We are in the process of a product transition. We are on track to launch RDNA 2 or, as you call it, Big Navi late this year. We're excited about the RDNA 2 architecture. I think it's a full refresh for us from the top of the stack through the rest of the stack. And so I think that will be more of a contributor here as we go into later this year and into next year. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +Our next question today is coming from Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan Chase & Co, Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- +Good job on the quarterly execution. Could you see the team hit the double-digits percentage market share targets and a broadening out of the end market penetration with EPYC, just Lisa, just given your customer and design win pipeline and rollout of Milan in the back half of this year, how are you thinking or how should we be thinking about further EPYC share gains over the next 12 to 18 months? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [20] +-------------------------------------------------------------------------------- +Sure, Harlan. So look, we are optimistic about our product positioning in the server market. Much of what we've been doing up through now, frankly, is making sure that our customers were ready to take advantage of Rome and EPYC. And so we saw some nice traction here in the first half of the year, particularly in the second quarter around some top cloud accounts that have started to ramp in good volume. As we look forward to the second half of the year, there are more platforms coming with Rome. We have a number of OEM platforms that are in the process of being launched. And we have additional cloud platforms as well. So I think Rome is going to continue to be a strong driver of our growth into the second half of this year as well as next year. +We're excited about Milan. Milan is looking good in the labs. We're working with our customers on Milan, and we expect to start shipping that later this year. So I think the way to think about our Server business is, again, it's a journey, and we're pleased with where we are today, but there's a significant opportunity for us if we continue to execute well over the next, I would say, more than 12 to 18 months. But really, we see this as a multiyear opportunity. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan Chase & Co, Research Division - Senior Analyst [21] +-------------------------------------------------------------------------------- +Yes, absolutely. And then as a follow-up, we do an annual CIO survey here at JPMorgan. For the past 3 years, we've been asking global CIOs, are they thinking about or planning to use EPYC-based platforms for on-prem. And then the most recent survey that we did in June, we actually saw a 60% year-over-year increase in the number of CIOs that are thinking about using EPYC for on-prem. Our interpretation is that interest level and mind share is growing quite rapidly. I guess my question to you, Lisa, is the AMD -- what is the A&D team seeing from an actual adoption perspective? And what's your sense of your enterprise mix sort of 2 to 3 years from now? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [22] +-------------------------------------------------------------------------------- +Yes. Actually, Harlan, I saw that data, and I thought it was good data. So the -- what I would say is that we are making progress in the enterprise business. And that comes from a number of different factors. First is the availability of platforms. We have a very diverse set of platforms from our OEM partners that are now in market. We've also done quite a bit on the ecosystem and ensuring that we have the partnerships with the ISVs, and then just basically feet on the street where we're talking directly to some of these enterprise customers. So I feel good about the progress that we've made. +Again, I would refer to the fact that mind share is a leading indicator, but there is a lot for us to do to convert that into market share and revenue growth. But we feel like we're on a good path, and we're going to continue to focus on both cloud and enterprise growth. And I'll also mention, HPC is another key vector for us, where we're very focused on showing a strong value proposition for those sort of toughest, most scientific workloads. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Our next question today is coming from Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [24] +-------------------------------------------------------------------------------- +Great. To stay away from the previous question, can you talk a little bit about your enterprise prospects on the PC client side? Can you give us a sense for how much at this point of your business is skewed to consumer? And how much progress are you making there in terms of penetrating enterprise business? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [25] +-------------------------------------------------------------------------------- +Sure, Joe. No question, our business is more consumer-weighted today. I will say we're growing nicely in commercial PCs. I think the strength of the Ryzen 4000 product has been good for us. I think there's a lot of positivity around the performance, the battery life, the capabilities there. We continue to expand our go-to-market efforts there. We're partnering very well with our top OEM partners. So I would say that we're still underrepresented in commercial. But no question that commercial notebook is a big focus for us, and we're going to continue to invest and hopefully make progress in that subsegment. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [26] +-------------------------------------------------------------------------------- +Great. And then as a follow-up, there's been a bunch of press about console builds getting revised up meaningfully by several million units coming from Nikkei. And yet your upside for the year seems fairly balanced across the segments. Can you give us just color on what's happening in that console segment? Is there that much upside? And could your numbers prove conservative as we move through the back half? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [27] +-------------------------------------------------------------------------------- +Yes. So I will say that our upside is balanced across the segments. There's no question that there's a strong ramp in the second half of the year for consoles. We're continuing to increase supply to meet that demand. But overall, I view it as -- again, consoles are a multiyear cycle, and the first year, I mean, there's a lot of pent-up demand for consoles, but we should think about this as really a multiyear cycle, and this is just the beginning of the ramp. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question today is coming from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- +I wanted to follow-up on that capacity point. What is your capacity and supply situation look like? And is any of the full year raise related to capacity freeing up at your foundry partners? And maybe put another way, are you supply rather than demand-limited at this point? What does that capacity situation look like? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- +Yes, sure, Stacy. So look, we have a strong supply chain. There's no question. It's been a very dynamic year if you just think about all the puts and takes over the last 4 or 5 months. I've said before and I'll say again, 7-nanometer is tight, and we continue to partner closely with TSMC to ensure that we can satisfy our customer demand. +When you ask about the full year raise, the full year raise is because demand has gone up from our initial expectations, and some of that is due to the market, and some of that is due to the strength of our product traction. We are increasing capacity to meet those needs, but it is tight. And I would say that as we continue to increase capacity, we see opportunity there. So from that standpoint, demand is strong. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- +For my follow-up, your competitor was talking about data center -- potential for data center digestion into the second half. And I understand you're coming from a different place with the new product ramps and everything, so I understand why you are growing in the second half one way than not. But what are you seeing just broadly with your customers? Are you seeing signs of the market within hyperscale entering the digestion phase, even if it's not impacting you for well-understood reasons? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [32] +-------------------------------------------------------------------------------- +Yes. Stacy, I think it's a bit hard to generalize. And from our visibility, what I would say is we have some customers that we see demand increasing in the second half versus the first half. We have some customers who are a little bit lower. The main thing for us, and I think you said it, it's about the ramping of our platforms. And so I'm not sure I would point to a particular digestion phenomena. I would say it's very customer-dependent and depending on how much they built out in the first half and some customers will be up, and some customers will be a little bit down. But overall, we see an opportunity to grow in the second half. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [33] +-------------------------------------------------------------------------------- +Got it. Is that the same across our hyperscale and enterprise? Or is it mostly hyperscale that's driving it? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [34] +-------------------------------------------------------------------------------- +So my comment was a hyperscale comment, since that's what you were asking about. When I look at enterprise, what I would say about enterprise is it's also -- different things happening. I would say in terms of enterprise and HPC, we continue to see build-out. And as I said, we have new platforms ramping that I mentioned in the prepared remarks. +There is a bit of softness in SMB or some of the transactional business, and again, we were not very exposed to that portion of the market. So I don't see it as it's going down, it's just perhaps not increasing as fast as we wanted it to. But overall, it really depends on customer-specific stuff. And we don't see sort of this large-scale people slowing down, I would say it that way. I think there's a need for infrastructure, and we see people continuing to invest in infrastructure. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Our next question today is coming from Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [36] +-------------------------------------------------------------------------------- +Congratulations on the quarter. I wanted to ask about the data center GPU business. I know you talked about the path for the CD&A product going forward. I'm just curious, as you look to your cloud opportunities, how do you gauge or how are you thinking about the ability to kind of participate in some of the AI opportunities in the data center GPU business? And do you have any update on kind of [RAKM] and how that has opened up opportunities or what we should expect from a software platform perspective? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [37] +-------------------------------------------------------------------------------- +Yes, sure, Aaron. So look, I think the data center GPU business is a -- is sort of a midterm growth vector for us. This year, I mentioned in the second quarter that revenue was lower year-on-year, but the second half, we expect it to go up modestly. I think the view is we have good design wins in cloud gaming, we have good design wins across sort of cloud, VDI-type instances. Very strong in supercomputing and HPC around Frontier and El Capitan as sort of our anchor supercomputing wins. +As it relates to machine learning and AI, we continue to invest in [RAKM]. We continue to work sort of our strategy around machine learning is partnered deeply with a couple of large cloud vendors who can invest in the software with us. And we see that as a multiyear opportunity. But it will -- it's not a big revenue contributor here in 2020. But we see a growth opportunity as we go into 2021 and beyond. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [38] +-------------------------------------------------------------------------------- +Okay. And then as a quick follow-up, we talked a lot about kind of just ramping EPYC and the road map. I'm just curious of how you've invested in the support organization to support this expansion, how has that progressed? Has that been at all a limiting factor to some of your ability in the server CPU market? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [39] +-------------------------------------------------------------------------------- +Yes. I think in server CPUs, it just takes time. There's a customer qualification process that takes time. But we have -- we've been very pleased with sort of the efforts on both the part of our customers as well as sort of our own support teams. We're continuing to invest, so if you look at our OpEx, we're continuing to invest. One of the key areas is building out, not just that support infrastructure, but just overall sales and go-to-market for the enterprise business. +So I feel good about where we are. Our strategy was always to go through some of the top cloud customers first, and I'm really pleased to see some of those get to high volume production, and we'll continue to build out that infrastructure in both cloud as well as enterprise. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Our next question today is coming from Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [41] +-------------------------------------------------------------------------------- +I guess, Lisa, I wanted to ask maybe in the past month or 6 weeks or even 2 months since it's become probably more apparent to the customers that your competitors are having some manufacturing issues. Can you speak a little bit to the tenor of the customer conversations? Has it changed at all? Have you felt them incrementally more willing to adopt your products? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [42] +-------------------------------------------------------------------------------- +Yes. I don't think I would say -- I mean, 4 to 6 weeks is kind of a short time. I think I would back up a little bit and say, over the past couple of quarters, what have we seen? And I think over the past couple of quarters, what we have seen is they've seen our performance capability, and we feel very good about where our products are positioned. I think what we've also said is, look, you can count on us for a consistent road map, and we're going to show you each of those data points. +I think the Milan point is an important point for us, and that's why we're very focused on ensuring that, that ships here later this year. I think the Zen 4 general point, we've already started engaging customers. Customers are very eager to understand what the long-term road map is. +And so what I would say is it's not sort of a short-term thing. It's more the notion of -- we feel that customers are very open across cloud, OEM, enterprise. It's on us to execute, and we think about that every day. But in terms of where the road map is, what are we trying to accomplish, where the customers are, there's a pull from customers to engage us across a number of workloads, we feel well positioned. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [43] +-------------------------------------------------------------------------------- +Got it. And then I guess, also in data center, I think you've highlighted before that a potential bottleneck might be to build out your software capabilities, and can you -- are there any metrics you can give us in terms of your ability to attract talent? Has that improved recently sort of in terms of the number of software engineers you've hired? Anything like that to help? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [44] +-------------------------------------------------------------------------------- +Yes. So I think if you're talking about software, it's more of a GPU -- a data center GPU statement versus a CPU statement. I think we feel actually that our CPU tools, infrastructure and all that stuff is actually pretty well built out. There is some work that we do with some of the applications and the ISVs to optimize and tune our software, but I think that's going very well. +As it relates to the data center GPU, yes, I think there is more mind share. I think the supercomputing wins in the data center GPU side have really helped raise the profile of our GPU capabilities and our software capabilities. So I think we are in a good position there. And from our standpoint, again, this is about building out sort of multiple vertical applications and doing that very well. So we continue to invest in the data center. It is a very strategic part of our business, but we're making good progress. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Our next question is coming from Mitch Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [46] +-------------------------------------------------------------------------------- +I wanted to focus on a little bit of a different topic, kind of comparing x86 and ARM. So I'm sure you guys saw the announcement that Apple is displacing Intel with its own ARM-based chip. And historically, the reason why you couldn't really use an ARM-based chip because there was no real developers around it. +So I guess, is there any risk -- or how do you guys think about ARM-based servers becoming a potential competitive threat in the future? How would that impact the x86 market and Intel as well? So do you have any comments on that in terms of Apple's potential entrance in developing an ARM-based seeker system? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [47] +-------------------------------------------------------------------------------- +Yes. I think what I would say is there are going to be some people who develop their own chips. Apple has announced it in the MAC space, and there are some who are building their own in the data center space. I still believe this is not about ARM versus x86. I think it's more about what performance do you offer, what capabilities do you offer, where the overall ecosystem is. +And in that sense, I think we still feel quite confident that both the PC market as well as the server processor market are predominantly x86. I think there's a very good set of offerings out there that are available. And it's on us -- frankly, on us to make sure that the performance that you get, the power that you get, the performance per dollar, the capabilities are very, very competitive so that we're offering sort of the best-in-class processors in the market. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [48] +-------------------------------------------------------------------------------- +Got it. And then just one small one follow-up. Just on the data center 20% of revenues, is still -- the data center graphics piece still a small part of the business? Or was that better this quarter? I'm just trying to get a qualitative understanding of what happened there. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [49] +-------------------------------------------------------------------------------- +Yes, Mitch. So we did say that overall data center revenue was over 20% of revenue this quarter, and it was predominantly CPUs. So the GPU portion of that is still relatively small. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [50] +-------------------------------------------------------------------------------- +So just to be clear, GPUs were not -- were basically flat sequentially? Or were they up? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [51] +-------------------------------------------------------------------------------- +They were actually down sequentially. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Our next question today is coming from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [53] +-------------------------------------------------------------------------------- +Congrats on the strong results. Lisa, I actually had one short-term question and one long-term question for you. On the short-term side of things, you have some significant moving parts with new product launches, et cetera, in both the third and fourth quarter. So I was hoping, on the 32% sequential guide, if you can give a little color by the 2 end markets, the C&G and the EESC side? And then a similar sort of thing when you go into the fourth quarter, you said semi-custom will be down sequentially, which is kind of typical seasonality. But the ability for you guys to still grow sequentially, what's really driving that? And then I'll follow-up with the long-term question. + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [54] +-------------------------------------------------------------------------------- +Sure. So let's see. Let me try to do that. So I think -- so when you talk about the Q3 guide, so 32% sequentially, there is a large component of that, which is game consoles. So the game console revenue was relatively modest in the second quarter, and it's going to become larger here in the third quarter. But we do see PCs growing sequentially as well as server CPUs growing sequentially. +And then as we go into the fourth quarter, I mentioned earlier that we expect that semi-custom will be down a bit, probably not as much as it's historically down, frankly, because it's the first year of the launch, but it should be down a bit. And then we do have product launches that we've stated around sort of the Zen 3 product families as well as the RDNA 2 product families that would drive some of the sequential growth in the fourth quarter. Did I answer that? + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [55] +-------------------------------------------------------------------------------- +Yes. That's exactly what I wanted. And then maybe this one will be a little clearer on the long-term side of things. An earlier question was asked about OpEx and expanding your capabilities, et cetera, and you gave a thoughtful answer to that. But generally speaking, it seems like your opportunities to take share in aggregate just improved due to your competitors' missteps. +So when you look at that opportunity, how do you think about organic investments? Would OpEx staying at, say, 29% of revenues like you're talking about for this year, be a good way to capitalize on that opportunity as opposed to going down to the 26% or 27% you mentioned at your analyst meeting? Or within that, would you keep that a little bit tighter in line with your analyst meeting and maybe even consider going inorganic and tapping into the M&A market now that you have some cash and a very attractive currency to use as well? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [56] +-------------------------------------------------------------------------------- +Yes. So yes, let me answer it this way. So look, we are very excited about our organic growth opportunities. I think we want to stay sort of at that sort of very significant growth in that over 20% CAGR for the next couple, 3 or 4 years. I think the way we've managed the business is the prudent way to manage the business. +And so OpEx will grow. OpEx will grow, and you've seen it in the dollar numbers, but it's going to grow a little bit slower than revenue. And we think that's the right thing to do just to make sure that we do see some leverage. That being the case, because the business is growing so much, I mean, we are investing quite heavily in OpEx across the business in both R&D and go to market. +So what was the second part of your question, Ross? + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [57] +-------------------------------------------------------------------------------- +Which is the inorganic way, would that be an avenue to broaden your offering to some of your customers? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [58] +-------------------------------------------------------------------------------- +Well, look, I think we have been focused on the organic growth path because there is so much opportunity there. We'll look -- we'll always keep an eye open for are there opportunities to enhance the portfolio or do some skills acquisition if that makes sense. But I think we're very focused on executing the organic growth path. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Our final question today is coming from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [60] +-------------------------------------------------------------------------------- +Congratulations on a strong quarter. Lisa, it's really great to see embedded in the implied fourth quarter guide a gross margin that needs to go up about 200 basis points sequentially to meet your full year guidance. And especially with gaming consoles being down less than seasonal, I'm wondering if you can just help me unpack that a little bit. +When you think about the gaming console cycle, is the gross margin improvement available to you as that cycle ramps and matures? And I guess more importantly, when you look at both the PC market and the server fleet, where are you relative to optimal product mix vis-à-vis kind of longer-term gross margin aspirations? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [61] +-------------------------------------------------------------------------------- +Yes, sure. So obviously, there's a lot to happen between now and the fourth quarter. But I think from the guide, what you get is we see the server and PC growth generally positive. If you think about what we have planned from now through the rest of the year, we do have some significant new products that will start shipping that will be positive from a gross margin standpoint. +On a console basis, it is true that the console margins typically improve. Over the first sort of 4 to 6 quarters, because you would expect that, as we ramp into higher volume, that there are improvements in manufacturing costs and so on and so forth. So those are the factors that are in there. +A lot will depend on mix, and the mix of the business being what is a mix of consumer versus commercial on the PC side, and then on the data center side, the mix between cloud and enterprise. And so we have to see how some of those things play out as we go out through the end of the year. But overall, I think the trend is such that you should see sequential growth in the gross margins as we go into the fourth quarter for some of the reasons that I mentioned. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [62] +-------------------------------------------------------------------------------- +That's helpful. And then Lisa, as a follow-on, you've always talked about this being a marathon more than a sprint, and you guys have had a pretty methodical strategy to which you've executed to. But I just -- given the revelations of Intel's missteps last week, what might you do differently from here to try to take advantage of it? + +-------------------------------------------------------------------------------- +Lisa T. Su, Advanced Micro Devices, Inc. - President, CEO & Non-Independent Director [63] +-------------------------------------------------------------------------------- +Well, John, I think the most important thing for us is to execute to our commitments to customers, and that -- by the way, that's been the same focus for us over the last few years, and it will continue to be the same focus for the next few years. I think consistency in road map, consistency in performance expectations, being capable of ramping across -- basically, what we're asking is for people to trust us with their most important applications. +And so our focus is very much execute on the road map that we've committed to, and that's key for us. And no question, there's a lot of things to do in engineering to make that happen. But I think we're very clear on what we want to deliver, and we're excited, frankly, about the road map we have in front of us. + +-------------------------------------------------------------------------------- +Ruth Cotter, Advanced Micro Devices, Inc. - SVP of Worldwide Marketing, HR & IR [64] +-------------------------------------------------------------------------------- +Thank you, everybody, for joining the call today. We appreciate it, and we look forward to seeing many of you virtually throughout the quarter. +Operator, if you can close the call, please. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- +Certainly. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2016-Apr-28-AMZN.txt b/Transcripts/AMZN/2016-Apr-28-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba668d14fbe5d0aff92aafe9856a84ca1fb7fc25 --- /dev/null +++ b/Transcripts/AMZN/2016-Apr-28-AMZN.txt @@ -0,0 +1,543 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Amazon.com Inc Earnings Call +APRIL 28, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Douglas Anmuth + JPMorgan - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * John Blackledge + Cowen and Company - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Bob Peck + SunTrust Robinson Humphrey - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aaron Kessler + Raymond James & Associates, Inc. - Analyst + * Benjamin Schachter + Macquarie Research - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q1 2016 financial results teleconference. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q1 2016 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's view as of today, April 28, 2016 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. Now, I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our first-quarter financial results. Trailing 12-month operating cash flow increased 44% to $11.3 billion. Trailing 12-month free cash flow increased to $6.4 billion, up from $3.2 billion. Trailing 12-month free cash flow less lease principal repayments increased to $3.5 billion up from $1.5 billion. Trailing 12-month free cash flow less financed lease principal repayments and assets required under capital leases increased to $1.6 billion, up from an outflow of $1.2 billion. +Trailing 12-month capital expenditures were $4.9 billion. Capital expenditures do not include the impact of property and equipment acquired under capital and finance and lease obligations. These capital expenditures and capital leases reflect additional investments in support of continued business growth due to investments in technology infrastructure, the majority of which is to support AWS and additional capacity to support our fulfillment operations. +The combination of common stock and stock-based awards outstanding was 490 million shares compared with 483 million one year ago. Worldwide revenue increased 28% to $29.1 billion, or 29% excluding the $210 million unfavorable impact from year-over-year changes in foreign exchange. Worldwide active customer accounts, excluding customers who only had pre-orders in the preceding 12-month period, exceeded 285 million. Worldwide paid unit growth was 27%. Worldwide seller units represented 48% of paid units. +Now, I'll talk about our segment results. In the first quarter of 2016, we began to allocate stock-based compensation and other operating expense net to our segment results. These amounts are combined and titled stock-based compensation and other in our segment results and reflect the way we now evaluate our business performance and manage our operations. For reference this quarter, I'll also mention segment operating income excluding stock-based compensation and other. +In the North America segment, revenue grew 27% to $17 billion. Media revenue grew 8% to $3.2 billion. EGM revenue grew 32% to $13.5 billion. North America segment operating income including stock-based compensation and other was $588 million, a 3.5% operating margin compared with $254 million in the prior year. This includes $5 million of favorable impact from foreign exchange. North America's segment operating income before stock-based compensation and other was $924 million, a 5.4% operating margin compared with $517 million in the prior year. +In the international segment, revenue grew 24% to $9.6 billion. Excluding the $177 million year-over-year unfavorable foreign exchange impact, revenue growth was 26%. Media revenue increased 7% to $2.5 billion, or 9% excluding foreign exchange. EGM revenue grew 31% to $7 billion, or 33% excluding foreign exchange. International segment operating loss including stock-based compensation and other was $121 million compared with a loss of $194 million in the prior year. This includes $21 million of favorable impact from foreign exchange. International segment operating income before stock-based compensation and other was $20 million compared with a loss of $76 million in the prior year. +In the Amazon Web Services segment, revenue grew 64% to $2.6 billion. Amazon Web Services segment operating income including stock-based compensation and other was $604 million, a 23.5% operating margin compared with $195 million in the prior year. This includes $24 million of favorable impact from foreign exchange. Amazon Web Services segment operating income before stock-based compensation and other was $716 million, a 27.9% operating margin compared with $265 million in the prior year. +Our operating income includes stock-based compensation expense and other operating expense. Operating income was $1.1 billion, or 3.7% of revenue, up approximately 260 basis points year-over-year. This includes $50 million of favorable impact from foreign exchange. Consolidated segment operating income before stock-based compensation and other was $1.7 billion, or 5.7% of revenue compared to $706 million in the prior year. Our income tax expense was $475 million. Net income was $513 million, or $1.07 per diluted share compared with a net loss of $57 million, or loss of $0.12 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $2.1 billion year-over-year to $15.9 billion. Inventory increased 30% to $9.6 billion, and inventory turns were 8.6 down from 8.8 turns a year ago as we expand selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 26% to $15 billion, and accounts payable days increased to 72 from 70 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable, and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as changes in global economic conditions and customer spending, world events, the rate of growth of the internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. It is not possible to accurately predict demand, and therefore, our actual results could differ materially from our guidance. +As we describe in more detail on our public filings, issues such as settling inter-Company balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rate can all have a material effect on our results. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they've been recently. +For Q2 2016, we expect net sales of between $28 billion and $30.5 billion, or growth of between 21% and 32%. This guidance anticipates approximately 70 basis points of favorable impact from foreign exchange rates. Operating income to be between $375 million and $975 million compared with $464 million in second-quarter 2015. This includes approximately $825 million for stock-based compensation and other operating expense net. +We are grateful to our customers and remain heads-down focused on driving a better customer experience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. And, with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question is from Mark May of Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks a lot. Lots here, but international retail revenue -- the international retail segment really stood out. Revenue accelerated. Seemed like a bit of a milestone also that the CSOI turned positive in a non-Q4 quarter. Can you shed any more light in what the key driver there was? And, how sustainable it is? And, AWS just mathematically, the comps get tougher starting in Q2, just given what happened in 2014. Is that something that we should be taking into account in terms of thinking about how the rest of the year may progress? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Sure. Your first question on international. Yes, all three segments had very strong growth in the quarter. International's 26% for FX-neutral growth rate was actually the strongest we've seen in 3.5 years. I would attribute it to the Prime Fly Wheel. As we may have mentioned in the past -- feel that Europe and the large countries in Europe and Japan are a few years behind the US on a lot of the key Prime metrics, but we also said last year that Prime subscriptions were up 51% year-over-year in 2015. 47% of that was in the US and a higher rate than that internationally. +So, certainly a lot going on in the international. A lot that's really good adding Prime subscribers at a high clip. Continuing to add selection at FBA sellers. So, you'll see devices, you see video content. It's the whole array of Prime offering. Prime Now, Same-day, everything is in Europe. Maybe getting there a little slower than starting point at the US. We see it really showing up in customer engagement and customer purchases. +On the AWS side, I think the 2016 to 2015 comparison probably stands on its own and 2014 falls by the wayside so I would encourage you to look at recent trends. We don't forecast, obviously, by segment. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Just wanted to ask you about unit growth overall and if we look back over the last three quarters, you've accelerated it now to a materially higher level than what we saw in 2014 and the first half of 2015, and I realize in 3Q last year you had Prime Day. I was hoping you could comment on the overall acceleration we've seen here and key drivers behind that? And, if there's something different perhaps than what you talked about on international? +Also, on AWS, can you talk about the underlying drivers here of margins and thinking about that a little bit going forward primary sources of leverage? As you open up six new regions in coming months, should we expect this to be constant build-out? Or, something that's more lumpy over time and more in waves? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [6] +-------------------------------------------------------------------------------- + + This is Phil Hardin. I'll take the units question. Really the units are driven by very similar trends to what Brian described. When we look at the bridges for revenue, and obviously, units is our key driver of revenue. Things like Prime are key in that bridge. I would also call out selection growth. That has been a big area of focus for us. +One important way we drive selection is through FBA. We continue to be very pleased with the progress we're making in FBA. What that means for our Prime customers is there's more for them to choose from. Obviously, that gives them more they can purchase. It makes Prime more valuable. For sellers, it means they sell more. I would say that FBA is helping drive some of the selection growth we're seeing here. Selection growth and Prime though are two very key drivers of our growth. On the second part, I think Brian -- . + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + One other comment I didn't say earlier, I do want to point out that because of the leap year there was an extra day in Q1. Every Company would have seen this obviously. But, we estimate it was worth about 150 basis points to our growth rate in revenue. That would be consistent North America and international. +Your other comment -- question was on AWS and a bit about margins and margin outlook. We're very pleased with the quarter. We came in at 23.5% operating margin on the new basis including stock-based compensation and other. We're very pleased. But, stepping back with the 64% growth in AWS which is now a $10 billion business. On the margin side, I would caution you that we're pleased, but it is very early to start drawing too many conclusions on the long-term margins in this business. They'll be bumpy over time. At any point in time, they are going to reflect the balance of investing including global expansion that he's talked about. Price reductions we may offer and also driving cost efficiency which for us is a very important driver in not only this business but also the North American and international segments. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question is from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [9] +-------------------------------------------------------------------------------- + + Great. Thanks. Looking at the active customer account number, it looks like growth slowed pretty significantly, about 10 percentage points. Just curious if you can give us a sense of anything that might be throwing that number off, assuming we're reading it the right way? And then, as you roll out on AWS -- as you roll out the fixed new availability zones over the course of the year, is there a way to quantify what kind of an impact that's going to have on the capacity at AWS? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [10] +-------------------------------------------------------------------------------- + + I'll take the first part of your question about active customers. As we look at our metrics and what information we provide each year, we often make some changes. So, this quarter we only gave the active customers with a paid purchase in the trailing 12 months. So, that number was more than 285 million. I think that's pretty similar to the trend that we've seen in that metric. +In the past, sometimes we had also given a total active customers count. That number for this quarter was over 310 million so that may be where you're making the statement about the slowdown in growth. The trajectory was very similar from prior quarters for both of those numbers. But, we opted just to give the other one, but you now have the number for the total number of customers as well. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [11] +-------------------------------------------------------------------------------- + + And, on your AWS footprint question so we ended the quarter with 33 availability zones and 12 geographic regions, and we have 11 more availability zones opening in the next year. The impact on capital, yes, there will be additional capital investment as we build out those zones. Some of it has already taken place. But, I'll also say that by and large, the largest increases in capital leases is to support the growth of incremental usage of customers we have now and agreements we have now. You should expect to see us continue to invest to support this business. We have a leadership position. We intend to maintain it, and we're very excited about where we are. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question is from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- + + The first one is on Prime. You've had two straight years of around 50% Prime subscriber growth. Curious about how you think about keys to driving Prime sub-growth going forward? And, the thought process behind the reported monthly Prime subscription? And, the second one on the logistics investments, there's been a lot about truck investments and logistics investments. Any comments at all about learnings, and what you're seeing from some of the investments in your truck fleet and your own delivery network? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [14] +-------------------------------------------------------------------------------- + + Let me start with the Prime. Yes, we have had very strong growth the last two years and earlier obviously on Prime growth of members. I would say it's a culmination of a lot of separate investments that we're making. If you look at the success of our devices, we are seeing tablets sell twice the volume in Q1 year-over-year. Fire TV stick, you may have read in our press release that it has greater than 100,000 customer reviews, the most reviewed product ever. Over 62,000 of those reviews are 5-star reviews. We've not only had the Echo, but we have the Echo Dot and Tap. We're branching off that product line and having trouble keeping those in stock. And, of course, we launched the new Kindle Oasis, our e-reader. +That is an important part of the series as is the digital content. You may have seen the recent announcements that we're working on a great amount of new content for Prime members. Customers love the content, and we like the results we see particularly around Prime free trial conversion and renewal rates for subscribers who use and take advantage of Prime. So, beyond the awards that the content is winning and the success we're having with Amazon particularly Amazon Originals, we feel that program is working. We're going to significantly increase our spend in that area. Some of that is in Q2. You'll see that more in the next few quarters. But, we think that's working and look forward to bringing a lot of new content to our Prime subscriber base. Both to our normal Prime subscription and also the monthly plan that you alluded to. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [15] +-------------------------------------------------------------------------------- + + This is Phil Hardin. I'll jump in on the second part of your question. For the trucks, really it's trailers. The typical use case is running a lag between a fulfillment center and a sort center. So, we're running enough volume there that we were using trucks already. We thought it made sense to go ahead and buy some trailers. We're actually still contracting out for the truck part, and it gives us flexibility. We think the economics will make sense over time. Similarly, we've announced an agreement to lease some airplanes with air transport services group, agreement to lease up to 20 Boeing 767s there. And, similar use case, it's products that are already boxed, and we think again this is activities we've been doing already which means we grow at a very rapid rate. This gives us extra capacity, and we think it's good to be able to deliver to customers. We think it makes sense over the long-term. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- + + Great. Two questions related to Prime overseas. Could you talk about the status of Prime in international markets? How far rolled out it is in most of your major markets? Then, you talk about Prime Fly Wheels, and you did last year. But, it seems likes those Fly Wheels spun faster than you expected in the fourth quarter of last year that caused some near-term expense issues for you? Can you talk about how you're thinking about planning against that as the Prime Fly Wheels are getting broader for you, how do you try to get ahead of that into the peak season later this year? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [18] +-------------------------------------------------------------------------------- + + Sure. This is Brian. Let me start with the second question first. It wasn't necessarily the Prime Fly Wheel that was the issue. It was more the FBA demand that we had from FBA sellers for space in our warehouses. We were very full. It was a high-class problem to have. +But, as I mentioned last quarter, it did result in higher fulfillment costs in the fourth quarter as a result. I think you'll see some of that dissipated now in Q1. You can tell it was a Q4 issue. +We learn from every Q4. This one was no exception. We are already making plans for a smoother Q4 next year. We will continue to add fulfillment capacity. We'll work with FBA sellers on inventory stocking and timing, and we think that there's things that we can do better as we do every year, come out of the fourth quarter with immense learnings. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [19] +-------------------------------------------------------------------------------- + + This is Phil. On the Prime question, we launched Prime in the US in 2005. Followed that in 2007 with UK, Germany, and Japan. And then, other countries after. We have Prime in all the countries where we have marketplaces with the exception of Mexico, China, and India. +And, Prime is really in varying stages in those countries. We have some kind of an expedited shipping offer in all of them. Here in the US, we've been talking quite a bit about Prime Now. That's also in Italy and Japan and the UK at this point and not others. Also, varying levels of digital benefits as well. +Generally, the international countries are not as far along with selection or the fullness of the digital offers. We've got Prime Video in the UK, in Germany, and Japan. Music is not fully rolled out yet all together. That's where we are with Prime. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you. I have two. I think it's the first time 1Q 2011 that we see tech and content counted as a percentage of revenue declining or flat. Is it just a sign of your inability to increase investment in line with revenue growth? Or, is there something going on, if yes, what? +Secondly, Brian, you said that the growth of Prime has been driven by investments you have made or are making. You gave the examples of devices that you are selling. I think it's a mathematical certainty that Prime subscribers would accelerate in North America at some point from 50% growth. As penetration increases and growth slows, will we see a deceleration in the investment levels? In other words, how do we think about the effect of deceleration in Prime on the North American margin structure in the future? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [22] +-------------------------------------------------------------------------------- + + Sure. Let me start with that second one. We think there's a lot of room to grow not only in our international countries but also in the US. We plan on continuing to build the benefits of the Prime program from music to video to two-day shipping to same-day shipping to Prime Now. I don't see that dissipating, and it remains the best deal in retail so hopefully everyone signs up for that. +On the tech and content question, I don't have a lot to call out in the quarter. I would say there's no letup in the pace of invention here particularly on the AWS side. We used quote the number of new features and services to you each quarter. We had 214 in Q1 up from the 170 this first quarter of last year. Over 26% growth in this quarter alone coming off a year where I believe the number was 722 significant new features and services delivered for AWS customers last year. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Pitz of Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [24] +-------------------------------------------------------------------------------- + + Thanks for the question. Any comments on your business in India? How is that market ramping up? On the competitive front there, any sense of where the local incumbents may actually have some advantage in the region? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Thanks. I actually just returned from India where I spent a week with our teams in Bangalore and Hyderabad. We're breaking ground on a new 10-acre campus there. So, we are solidifying and increasing our investment in India on all fronts. +I had a chance to see firsthand the level of invention going on with both customers and sellers making deliveries to customers, seeing the I have space program we have with merchants. It's a very exciting time in India, and again, the invention is off the charts. We're inventing things in India that do not exist in other parts of the world. And, the team there is one of our best. You can see it in some of the external commentary as well. For the second year in a row, customers selected Amazon India as Amazon's most trusted online shopping brand. +During the quarter we rolled out a feature called Tatkal which is a studio on wheels that we go to the sellers to help them sign up. We let them do registration, imaging, catalog, uploads, and basic seller training. We're taking it to the sellers -- taking the business to the sellers. We've already reached sellers in 25 cities, and we're really helping them expand their business. Not only within their home region, throughout the whole country. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [27] +-------------------------------------------------------------------------------- + + Thanks. My question is on the international margins. They're quite a bit below where they were many years ago and trailing the US. Maybe talk about the dynamics there and what is it going to take to catch up over time? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + Sure. On the op margin side, although there was improvement year-over-year, you're right, it is still on an FX-neutral basis negative. We have, as I said earlier, fulfillment network and digital content. We continue to build the underpinnings of the Prime program in our international countries. You also have to keep in mind that we're making large investments in India. We're very excited about what we see. And, we will continue to invest heavily in India. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- + + Great. I just had two questions on AWS. First, last fall at re:Invent, you disclosed that data management revenue was at a $1 billion run rate. Can you provide an update on that figure? And, maybe talk about how much of AWS revenue today is outside of the storage and compute layers. +And then, the second question is on the AWS margin. I think everybody is trying to learn more about the structural long-term margin, and it was down a tad quarter-on-quarter. Is that solely from FX impact? Or, was there some seasonality of expenses? Any color on what's driving the AWS margin, and how we should think about that over the longer term? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [31] +-------------------------------------------------------------------------------- + + I'll take your second question first. So, again, we had margin expansion year-over-year that was quite significant from 12.4% to 23.5%. But, again, it's very early in this business. We're very pleased with the results we're seeing on the top and bottom line. But, margins are going to be bumpy and affected by levels of investing, price reductions, and also cost efficiency that we're driving. So, quarter to quarter, it will very. We are concerned at this point about capital efficiency, returning price to customers periodically with price reductions, and adding feature sets for them to make the business more valuable. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [32] +-------------------------------------------------------------------------------- + + This is Phil. For your other part of the question, we're not providing an update on the $1 billion stat. What I would say is that the AWS team has strong revenue growth across their suite of products. The fastest growing product in their history is actually Aurora, the new database. We're very excited by what we're seeing in that space, but we're not breaking out the revenue for those various components today. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan of UBS Investment Research. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [34] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Looking at the gross margin, impressive performance in Q1. There were a few headwinds it looked like in gross margin in Q4. Wanted to understand how we should think about the puts and takes in gross margin. It has evolved to be a much higher number in the last few years. What some of the puts and takes are going forward especially with respect to content costs? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + Sure. I don't have a forecast for you on content cost in isolation or really forward looks on anything besides the guidance I've given you. Yes, it hits in the gross margin. Content costs do show up there. I think the bigger issues that you should look at in gross margin, and again, starting with the comment that we expanded by 300 basis points year-over-year. That is really driven by, first of all, the AWS growth. And again, $10 billion business growing 64%. We're very pleased with that, and that affects gross margin as well. +The other bigger element though is the third-party contribution. Third-party units are now up to 48% of paid units, and that's up 400 basis points year-over-year. That continues to be a factor in gross margin. We book that on a net basis. The third-party revenue. It's a positive factor in gross margin. It can be a negative factor in fulfillment costs and some of the other metrics. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [36] +-------------------------------------------------------------------------------- + + This is Phil. Also, just to jump in, gross margin is not the primary metric we use to measure the business. We're much more focused on free cash flow dollars and operating profit dollars. So, there are a whole lot of moving parts in gross margin, and Brian mentioned a lot of them. But, it's not a primary metric for us. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Kessler of Raymond James. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James & Associates, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Thanks. Couple of questions. First, if you can update us on your new advertising initiatives in terms of how the sponsored links are performing? Additionally, if you can give us an update on Prime Now. Seems like you've rolled out a number of cities for that. How that's involving and the traction with Prime Now? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [39] +-------------------------------------------------------------------------------- + + We're very excited about the advertising business, and we think it's still very early days for this opportunity. So, it's an offering we've been working on. We're trying to take a very customer-centric approach. You've probably noticed some changes in the treatment on the website, and we did move away from text ads and product ads in favor of some of the other, newer products. We're really excited about the opportunity there is for third-party sellers and for other vendors on the site. But, we're not breaking out numbers today. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [40] +-------------------------------------------------------------------------------- + + On Prime Now, we're now in 30 metro areas. Really from a standing start 16 months ago when we opened our first Prime Now location, and it's now a worldwide business in the US, UK, Italy, and Japan. The five cities we added in the first quarter were Raleigh, North Carolina, Cincinnati, Tampa, Liverpool, England, and Osaka, Japan. +How do we feel about that business? Again, it offers tens of thousands of daily essential products. We think it's a service that customers like. Certainly is hard for companies to do. We think the natural evolution of our operations network and our scale gives us a chance to do this, and we are happy to invest in it as a service for our customers. We're taking a long-term approach on this one though. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju of Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + Thanks. Your capital lease-driven property and equipment acquisitions is down again year-over-year. So, will you help tie this to perhaps the overall usage growth at AWS? Or, maybe the changing nature of how your enterprise customers may be using the platform to be more compute versus storage or database-heavy? I think historically on the e-commerce side, you have been price followers as opposed to price leaders. AWS, you have been price leaders for the most part for actively taking down price. Now, given your leadership position, do you think you'll continue to be price leaders? Or, do you think it's now time for you to follow instead? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + Let me start with your CapEx question. We like to look at both capital expenditures and capital leases because they're both essentially our level of investment. Those totaled $9.5 billion in the trailing 12 months, and it was up 7% from the 12-month period ending this quarter last year. I will point out that the prior year was $6.1 billion. We have stepped up investment. Although it did not go up as much year-over-year this quarter, we are still spending almost $10 billion on what essentially is fulfillment capacity in support of really strong growth -- unit growth in FBA and global expansion and then also on AWS. Additional capacity for existing customers as they grow their business and also in new regions. We've been working and continue to work very hard on capital productivity. It's very important to us and I attribute a good piece of the ability to keep that at a modest growth rate year-over-year to our capital efficiency and better purchasing across all capital and capital leases quite frankly. But, again, we are spending almost $10 billion. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [44] +-------------------------------------------------------------------------------- + + Stephen, this is Phil. Just to jump on the usage growth comment, we continue to see really strong usage growth. We're not in the business of raising prices. We lower prices for AWS. There can be mix for products, but by and large, if you see our revenue growth, we're also lowering prices which means that by math we're typically going to be growing usage at a very strong rate. Just wanted to jump on that. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question comes from John Blackledge of Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [46] +-------------------------------------------------------------------------------- + + Great. Thanks. The North American EGM segment outperformed our expectations of growth accelerating on a year-over-year basis. Given you don't break out GMV by vertical within the EGM segment and given the strong growth at massive scale, can you cite any key verticals that were particularly strong? +Second question is just an update on Fresh. Rollout has obviously been much slower than Prime Now. How should we think about the Fresh rollout and the impact over the long-term? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [47] +-------------------------------------------------------------------------------- + + This is Phil. I'll take the EGM question first. So, just to put numbers on that, the year-over-year in the US, or North in America, was 32% growth which was up from 28% in Q4. There's not any single categories we're calling out there. To grow on a base that big, that kind of rate, you need pretty strong performance across the board. A lot of categories are selling a lot. It's a lot of the drivers we talked about. As Brian mentioned on the revenue growth side -- Prime, selection growth. We also benefited from the extra day in quarter due to the leap year. Strong performance from many of the categories. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [48] +-------------------------------------------------------------------------------- + + On Amazon Fresh, we continue to have a strong Fresh business in a number of cities in the US. We know customers love it. We're making good progress on the economics. You'll also notice we have other ways for people to buy consumable products. We have Prime Pantry. We have Prime Now. We're playing with a lot of different models to see what resonates with consumers, and it will guide our investment decisions going forward. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Our next question comes from Ben Schachter of Macquarie Equities Research. + +-------------------------------------------------------------------------------- +Benjamin Schachter, Macquarie Research - Analyst [50] +-------------------------------------------------------------------------------- + + First, congratulations on the great quarter. Couple on Prime and one on China. First, a point of clarification. You answered a previous question by saying that you will significantly increase investment in Prime. Was that specifically in reference to video? Or, should we expect new types of offerings beyond video and music? +And, secondly on Prime, membership is likely hitting some saturation levels for certain demographics in the US? Do you intend to focus on more lower income households for growth there? Then finally, on China, anything notable to call out there that's been different over the recent past driving results? The free trade zone, et cetera? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [51] +-------------------------------------------------------------------------------- + + I'll take the first question on content. Yes, my comment on Prime benefits was essentially one about video content and our investment there. Not saying other investments may not go up as well, but that is the one we're focusing on that I called out. +On the comment about Prime -- I guess what I'll call availability or saturation. I think that's one of the thoughts behind our monthly plan. We want to create flexibility for consumers to try Prime in a low cost way if that's how they choose. We've always had our free trial program, but it is a hurdle for many people, or there's a hesitancy to put up a full year's payment for a year of Prime. Annual is still going to be a better deal. But, we know customers may try it more frequently if it's a monthly plan. And, that's what we're looking for. We know that once customers try it, generally they'll really like it. So, we think that will purge some other demographic groups as well. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [52] +-------------------------------------------------------------------------------- + + This is Phil. Another comment on the Prime. Your saturation question. Keep in mind, even in the US, which is our most mature by years of launch, we still grew last year at 47% year-over-year membership growth, and we continue to make the program better and better. I think the monthly offers are great for flexibility. Give people a chance to try new ways, and we continue to add content. We continue to add selection. Prime Now is a huge benefit that didn't even exist two years ago. We're still out trying to meet as many customers as possible. We're very committed to driving Prime and it's part of the Company. +Your question on China, probably the biggest thing to point to is more progress and selection on the Amazon global store. This is our website -- this is the offer that allows Chinese customers to shop from the US website, Amazon.com with prices in RMB and with Chinese language pages. It's focused on items that may be hard to get. And, Amazon is really trying to become the trusted source for many of these goods. So, really that's a big part of the focus. If you've been tracking that number over time, we're now up over $10 million which is good progress on that front. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question comes from Ron Josey of JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [54] +-------------------------------------------------------------------------------- + + Thanks for taking the question. I want to go back to North America but focus on margins. 5.5%, 5.4% margins, I think that's the highest level since maybe Q2 2010 and resumes the margin expansion we saw for most of last year. Just hoping we can understand -- help us understand a little more what's driving that? I'm sure the more mature Prime Fly Wheel you mentioned that's happening in Europe. Is there anything else that's going on besides Prime Fly Wheel, maybe more efficient shipping or things along those lines? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [55] +-------------------------------------------------------------------------------- + + I'll start. You see the growth rate of the segment at 27%. It's showing the success we're having with customers. When we grow at that clip, we can do a lot of good things with it. We can on the cost side run our facilities more efficiently. We can buy better. We can look to in-source some things that we may have paid externally for. There's a number of things that we can do that I think will show up on the bottom line. But, principally, what we're trying to do now is make the Prime experience as strong as possible for consumers. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [56] +-------------------------------------------------------------------------------- + + This is Phil. The other thing I would add to that is that the margin you see in any quarter is the output of our rate of investment in some places and drive for efficiencies in others. We're not really trying to optimize for any particular number in a given quarter. We're just trying to make the best decisions we can to grow long-term free cash flow per share. We're juggling the investment in the places where we feel like we have long-term opportunities where we need to invest with making sure we're getting continuously better in all our other processes at the same time. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Our final question will come from Bob Peck of SunTrust. + +-------------------------------------------------------------------------------- +Bob Peck, SunTrust Robinson Humphrey - Analyst [58] +-------------------------------------------------------------------------------- + + Thank you. Two quick ones. Back to India for a second, I was wondering if you could talk about the regulatory environment there, particularly how it pertains to Amazon cloud tail? Two, on logistics, could you talk about excess capacity in logistics as you build out air, freight, sea, et cetera. Would you ever entertain delivering other Companies' items, i.e., like a FedEx or UPS? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [59] +-------------------------------------------------------------------------------- + + This is Phil. I'll take the India question. We're happy to see the recent clarifications. Then, we're happy to operate in any regime. Frankly, the more clarity the better. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [60] +-------------------------------------------------------------------------------- + + Then, on the logistics question. Stepping back, the reason we add logistics capability and transportation capability is so we can serve our customers faster and faster delivery speeds, and we've needed to add more of our own capacity to supplement our carriers and partners. They're still, again, great partners, have been, and will continue to be for the future. But, we see opportunities where we need to add additional capacity, and we're filling those voids. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [61] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + This concludes today's teleconference. Thank you for your participation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2016-Jan-28-AMZN.txt b/Transcripts/AMZN/2016-Jan-28-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..62261127b14eee7e7e5fbcc0a32d9c85b81b2f4a --- /dev/null +++ b/Transcripts/AMZN/2016-Jan-28-AMZN.txt @@ -0,0 +1,714 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Amazon.com Inc Earnings Call +JANUARY 28, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com Inc - CFO + * Phil Hardin + Amazon.com Inc - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore ISI - Analyst + * Ronald Josey + JMP Securities - Analyst + * Neil Doshi + Mizuho Securities Co., Ltd. - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Kerry Rice + Needham & Company - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aram Rubinson + Wolfe Research - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2015 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please, go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [2] +-------------------------------------------------------------------------------- + + + Hello, and welcome to our Q4 2015 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, January 28, 2016 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2014. Now I will turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + + Thanks, Phil. I'll begin with comments on our fourth quarter financial results. Trailing 12-month operating cash flow increased 74% to $11.9 billion. Trailing 12-month free cash flow increased to $7.3 billion, up from $1.9 billion. +Trailing 12-month free cash flow less lease principle repayments increased to $4.7 billion, up from $529 million. Trailing 12-month free cash flow less finance lease principle repayments and assets acquired under capital leases increased to $2.5 billion, up from an outflow of $2.2 billion. Trailing 12-month capital expenditures were $4.6 billion. +Capital expenditures does not include the impact of property and equipment acquired under capital and finance lease obligations. These capital expenditures and capital leases reflect additional investments in support of continued business growth, due to investments in technology infrastructure, the majority of which is to support AWS, and additional capacity to support our fulfillment operations. The combination of common stock and stock-based awards outstanding was 490 million shares, compared with 483 million one year ago. +Worldwide revenue increased 22% to $35.7 billion, or 26% excluding the $1.2 billion unfavorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 26%. Worldwide active customer accounts were approximately 304 million. Excluding customers who only had free orders in the preceding 12-month period, worldwide active customers accounts were approximately 280 million, up from approximately 254 million in the comparable prior year period. +Worldwide paid Prime members increased 51% year-over-year. Worldwide seller units represented 47% of paid units. Fulfillment by Amazon or FBA units represented nearly 50% of seller units. Worldwide active Amazon web services customers exceeded 1 million. +Now I'll discuss operating expenses, excluding stock-based compensation. Cost of sales was $24.3 billion or 68.1% of revenue, compared with 70.5%. Fulfillment, marketing, technology and content and G&A combined was $9.7 billion or 27.1% of sales, up approximately 100 basis points year-over-year. Fulfillment was $4.4 billion or 12.3% of revenue, compared with 11.3%. Tech and content was $3.2 billion or 9% of revenue, compared with 8.2%. Marketing was $1.7 billion or 4.8% of revenue, compared with 5.1%. +Now I'll talk about our segment results. As a reminder, in the first quarter we changed our reportable segments to report North America, international, and Amazon web services. Consistent with prior periods, we do not allocate segments, our stock-based compensation, or the other operating expense line item. +In the North America segment, revenue grew 24% to $21.5 billion. Media revenue grew 11% to $3.9 billion, or 12% excluding foreign exchange. EGM revenue grew 28% to $17.3 billion. North America segment operating income was $1 billion, a 4.7% operating margin, compared with $733 million in the prior year period. North America segment operating income includes $6 million of favorable impact from foreign exchange. +In the international segment, revenue grew 12% to $11.8 billion. Excluding the $1.1 billion year-over-year unfavorable foreign exchange impact, revenue growth was 22%. Media revenue decreased 3% to $3.3 billion, or increased 5% excluding foreign exchange. +EGM revenue grew 19% to $8.5 billion, or 31% excluding foreign exchange. International segment operating income was $60 million, compared with $65 million in the prior year. International segment operating income includes $47 million of unfavorable impact from foreign exchange. +In the Amazon web services segment, revenue grew 69% to $2.4 billion. Amazon web services segment operating income was $687 million, a 28.5% operating margin, compared with $240 million in the prior year period. AWS segment operating income includes $60 million of favorable impact from foreign exchange. Consolidated segment operating income was $1.8 billion or 4.9% of revenue, up approximately 140 basis points year-over-year. CSOI includes $20 million of favorable impact from foreign exchange. +Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income grew 88% to $1.1 billion. Our income tax expense was $453 million. GAAP net income was $482 million or $1 per diluted share, compared with a net income of $214 million and $0.45 per diluted share. +Now I'll discuss the full year results. Revenue increased 20% to $107 billion, or 26% excluding year-over-year changes in foreign exchange. North America revenue grew 25% to $63.7 billion, or 26% excluding year-over-year changes in foreign exchange. International revenue grew 6% to $35.4 billion, or 21% excluding year-over-year changes in foreign exchange. +Excluding year-over-year changes in foreign exchange, Germany revenue grew 18%. Japan revenue grew 19%, and UK revenue grew 16%. AWS revenue grew 70% to $7.9 billion. +Consolidated segment operating income was $4.5 billion or 4.2% of revenue, up approximately 220 basis points year-over-year. CSOI includes $16 million of favorable impact from foreign exchange. GAAP operating income was $2.2 billion, compared with $178 million in the prior year. +Turning to the balance sheet, cash and marketable securities increased $2.4 billion year-over-year to $19.8 billion. Inventory increased 23% to $10.2 billion. And inventory turns were 8.5, down from 8.6 turns a year ago, as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 24% to $20.4 billion, and accounts payable days increased to 77 from 73 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date, and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable, and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy, and customer spending. It's not possible to accurately predict demand, and therefore our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rate can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, recording further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they have been recently. +For Q1 2016, we expect net sales of between $26.5 billion and $29 billion, or growth of between 17% and 28%. This guidance anticipates approximately 130 basis points of unfavorable impact from foreign exchange rates. GAAP operating income to be between $100 million and $700 million, compared with $255 million in first quarter of 2015. +This includes approximately $600 million for stock-based compensation and other operating expenses net. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense net, to be between $700 million and $1.3 billion, compared with $706 million in the first quarter of 2015. +We are grateful to our customers, and remain heads-down focused on driving a better customer experience. We believe putting customers first, is the only reliable way to create lasting value for shareholders. Thanks. And with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [4] +-------------------------------------------------------------------------------- + + + Great. Thanks, Brian. Let's move onto the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + (Operator Instructions) +Thank you. Our first question is coming from analyst, Stephen Ju with Credit Suisse. Please proceed with your question. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [2] +-------------------------------------------------------------------------------- + + + Okay, thanks. So Brian, I think in the past, you've given some indication as to what usage growth may be at AWS. I was wondering if you have an update for that in the fourth quarter? And secondarily, is there any way to characterize what the pricing environment is right now for AWS as well? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + + Yes, thanks, Stephen. No, I don't have a usage growth number for you. We'll say we're -- it's been very strong. AWS revenue is on a -- just short of a $10 billion run rate at the end of Q4. +As far as pricing is concerned, we had a price reduction in January for our EC2 services. It was our 51st price reduction since we launched AWS years ago. And generally, what we find is that price is important, but so is speed and agility for customers, and the ability to deliver services and features that are beneficial to them. I will point out that we added 722 new features and services in 2015, and that was up 40% year-over-year. So we feel we have a lead in this space. And we don't take it for granted, and we want to serve customers better each year. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [4] +-------------------------------------------------------------------------------- + + + Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + + Thank you. Our next question is from analyst, Jason Helfstein with Oppenheimer. Please proceed with your question. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [6] +-------------------------------------------------------------------------------- + + + Thank you. Can you talk a little bit about the dynamics in fourth quarter, eCommerce, particularly in the US? Did we see more aggressive promotional activity? And maybe talk about how you tried to work that to continue to drive the Prime number of members going forward? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [7] +-------------------------------------------------------------------------------- + + + Sure. Well, what I can say is our approach to pricing has not changed. And through Q4, we did everything we could to have the best prices available for customers, and in-stock in time for the holiday. Another dynamic of Q4 was that, it was a huge FBA quarter. Nearly 50% of our third-party units were FBA, and our third-party units were also up to 47% of our paid units, so up 400 basis points year-over-year. +So a really strong quarter for our FBA sellers, using our FBA services. It did put a lot of demands on our warehouses, and we were full. It was a very busy quarter, and it did increase some of our variable costs as a result, primarily in the US. But a very strong quarter for FBA. It exceeded our -- even our expectations. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [8] +-------------------------------------------------------------------------------- + + + Perhaps how are you able to integrate that into holiday promotions? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [9] +-------------------------------------------------------------------------------- + + + I'm sorry. You cut off there. Could you repeat your question? + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [10] +-------------------------------------------------------------------------------- + + + Sure. Just any additional color around Prime, and how you were able to integrate that into holiday promotions? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [11] +-------------------------------------------------------------------------------- + + + Nothing specific. I will say, one interesting enhancement this year was our Prime Now service, which allowed people to order in selected markets up until 11:59 on New Year -- or excuse me, Christmas Eve. So that was a valuable service to many late shoppers, last-minute shoppers. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + + Thank you. Our next question is from Aram Rubinson with Wolfe Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [13] +-------------------------------------------------------------------------------- + + + Hey, thanks very much. Two questions, both on the logistics side. It seems pretty clear that you guys are trafficking in some old world assets, like truck trailers, and ship lanes, and air fields. Can you help, give us a sense as to maybe what we're trying to accomplish with that? If it's defensive to protect your service to your existing customers, or if you're looking to maybe start new businesses with those assets? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [14] +-------------------------------------------------------------------------------- + + + Sure, Aram. Thanks for your question. I would say that -- what we've found, is in order to properly serve our customers at peak, we've needed to add more of our own logistics to supplement our existing partners. That's not meant to replace them, and those carriers are just not -- no longer able to handle all of our capacity that we need at peak. They have been, and continue to be great partners, and we look forward to working with them in the future. +It's just we've had to add some resources on our own. You mentioned trucks. The Amazon trucks, we did invest in those this past year. We use those primarily for movement between our warehouses and our sort centers. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + + Thanks for taking my questions. I've got two. The first one is just on gross margins. I think they were down about 200 basis points sequentially. It's the biggest fall in the fourth quarter in quite sometime. Anything you would call out there? Is it devices, or more sortation centers? Is there anything pressuring gross margins we should think about in the fourth quarter? +And then on the fulfillment line, you mentioned FBA being a big driver of the growth in the fulfillment costs. Anything else you would call out, leading to incremental fulfillment costs? Maybe India or something else? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [17] +-------------------------------------------------------------------------------- + + + No. And again, keep in mind, that the fulfillment as a percent of revenue is impacted by the calculation of FBA revenue being a net number, as opposed to a full revenue number. But our fulfillment costs per unit actually decreased year-over-year. It's just that we are now shipping more and more of our -- other than demand, out of our warehouses because of the strength in retail and FBA. +On gross margin, I -- first, I'll caution you and say, we would encourage you to look at free cash flow which was -- it grew at a minimum $4 billion on each of the metrics that we point out. And Op profit, which was up 88% year-over-year. If you look sequentially, also keep in mind that in Q3, when it was up about 500 basis points year-over-year, that was lapping the write-down of our Amazon phone inventory the prior year. So there was a little bit of noise in the Q3 number. But generally, again, we're happy with the ability to service customers, the reaction of customers in Q4, and the bottom line results that we had. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Colin Sebastian with Baird Equity Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + + Great, thanks. One follow-up, and then another question. On the logistics and transportation side, I was curious if that's to date, just to supplement some of the other carriers? But more broadly or longer term, is there an ambition from the services side, to perhaps provide capacity to other companies? +And then on AWS margins, was just wondering if we should expect more leverage there going forward? And whether Q1, whether that should demonstrate some seasonality, versus what we've seen in terms of sequential growth in prior years? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [20] +-------------------------------------------------------------------------------- + + + Sure. Let me work backwards -- don't give guidance by segment, so cannot really comment on AWS specifically in Q1. The -- and the operational improvements -- excuse me, the gross margin -- the operating margin year-over-year that we've seen in the AWS business has been heavily driven by operating efficiencies, both purchase reductions and purchase prices, and also efficiency in driving greater utilization of the assets that we have. So we're very happy with that. +Keep in mind that we did have -- although the year-over-year increase in capital expenditures and capital leases was not as great as we saw in 2013 to 2014, we did spend over $9 billion on those -- on capital, and expenditures and capital lease obligations, up from prior year was -- excuse me -- (multiple speakers) + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + + Thank you. Our next question come -- (multiple speakers) + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [22] +-------------------------------------------------------------------------------- + + + Sorry, let me finish my answer to him, please? We grew up, we grew from in the $5 billion range in 2013, to $8.9 billion in 2014, and now over $9 billion in 2015. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Ken Sena with Evercore ISI. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [24] +-------------------------------------------------------------------------------- + + + Hi. So a lot of headlines around Amazon's activity at SunDance. I was hoping maybe you could expand once more on the video strategy, and specifically are you seeing an inflection in Prime Video usage? And maybe, just also on your streaming partners program, what the general reception is like? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [25] +-------------------------------------------------------------------------------- + + + Sure. We're very thrilled with the customer response to Prime Video. Again, when Prime Video is used by our Prime members, it drives adoption and retention, higher free trial conversion rates, and higher renewal rates for subscribers. So what we were encouraged by in Q4 was that globally, we doubled the number of -- our Prime members doubled the number of viewing hours of the Prime Video year-over-year. And internationally, we had twice as member Prime members streaming year-over-year. So very encouraged by the pick up, and the response of customers. +The other comment I would say about video is, we're very happy with the Amazon studios content, in particular. We've had some great success in 2014 and 2015. As you probably know, Transparent has won multiple Golden Globes and Emmys, both for actors and for the show itself. Mozart in the Jungle just won two Golden Globe Awards. +So very pleased with the critical acclaim to the Amazon Studios content, and we've got a lot of new content coming out this year. Catastrophe Season 2, Bosch Season 2, we're all looking forward to. And in February, we will have Chi-Raq, our first original movie that we got to work with Spike Lee on, which won many critical -- made many critics' Best Films list in 2015. That will be coming to Prime Video in February. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [26] +-------------------------------------------------------------------------------- + + + Just to add to that, this is Phil. On your question about the streaming partners program, so that's our new over-the-top streaming subscription program for Prime members. We think it's a really convenient way for them to access additional content, content from sources like ShowTime and Starz. And it's really early, so it's just out of the gate, but we've been very pleased with what we've seen so far. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Mark Mahaney with RBC Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + + Two things, please. Any call outs on the macro side? Occasionally, you called anything -- you've called things out, anything this time? And then, could you talk a little bit about Amazon business? +I know that there is a little bit of a line in the press release on it. I know you've had this for a couple of years. But any indications to the materiality of that, the kind of momentum it's gaining, the kind of traction it's gaining? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [29] +-------------------------------------------------------------------------------- + + + Sure, Mark. Thanks for your questions. No macroeconomic comments. Again, we feel we're very encouraged by the customer response to our offerings in Q4. +Amazon business, yes, in April, you may remember we launched it as a marketplace, with specific features and benefits for businesses. That -- Amazon business now serves more than 200,000 businesses, from small organizations to Fortune 500 companies. So it's still early, but we're encouraged, and we think we're creating some value, a lot of value for our business customers. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Mark May with Citi. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [31] +-------------------------------------------------------------------------------- + + + Thanks. Brian, question on the international retail business. I think you added well over $1 billion in revenue year-on-year in the quarter, but from a CSOI perspective, you really didn't see any improvement there. I'm sure there is -- there are a lot of different things going on. +I just wonder if you could unpack that a little bit, and give us a sense of what profitability looks like maybe in some of your more mature, established countries and regions, relative to the investments you're making in other countries? So that we can kind of get a better picture of what's actually going on under the hood there? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [32] +-------------------------------------------------------------------------------- + + + Yes. Sure, Mark. Thanks for your question. We are very pleased by the international growth, 22% FX neutral, was up 1,000 basis points year-over-year. We saw that the -- we told you that the Prime growth, Prime membership growth, 50% in -- excuse me, 51% globally. 47% in the US means that the international Prime programs grew at a faster clip than that. So very, very pleased with the uptick. +We rolled out a lot of additional Prime features internationally as well this year, from free same-day, to Prime Now, to Prime Music, and Prime Video in Japan, to name a few. So very happy with that. But in general, if I step back, our investments in national are twofold. +First, there's the Prime platform and all the features I just mentioned, including the fulfillment, adding more fulfillment resources to handle higher and higher retail volumes, and a very strong FBA program as well. And then, the remainder -- the biggest other investment area is obviously India. And we like -- we continue to see, like what we see in India. In Q4, Amazon India was the top e-commerce site in India, throughout the very busy -- Diwali shopping season, including the shopping season, according to comScore. +And sales by sellers in Q4 were greater than all of 2014 combined, in Q4. So seeing great progress with downloads, innovations for sellers and customers alike. And we like the ramp there, and we're continuing to invest in India. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Douglas Anmuth with JPMorgan. Please proceed with your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [34] +-------------------------------------------------------------------------------- + + + Thanks for taking the question. Two things. Just first, on the North America EGM growth, if you could just talk about the 28% there? And the decel on an easier comp, and whether there's any particular factors within that we should be thinking about? And perhaps, if there was any weather and apparel impact there? +And then second, last quarter, and I don't want to misquote you, but you said something along the lines of, being able to invest as you would like, and also deliver good profit, and that the pendulum wouldn't swing as far perhaps as it has in the past. Is that statement and thought still hold, as you head into 2016? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [35] +-------------------------------------------------------------------------------- + + + Sure. Let me start with EGM. So EGM growth, North America EGM growth of 28% was actually also the highest in the last four years. So we're happy with that. +The deceleration you're seeing of 700 basis points is more a function of the Prime Day that we had in Q3, if you remember. We didn't break it out by segment, but we said that Prime Day contributed 200 basis points to our Q3 run rate, revenue growth rate. So sequentially last year, in North America EGM, we dropped from 31% to 27%. +This year, it's 35% to 28%. So there is always a -- generally, a sequential drop in Q4. But certainly very happy with that business and its role in Prime as well, in total customer satisfaction. +Your other question, investments. Yes, we continue to have healthy investments as we've stated across the globe. To step back again on that, our general philosophy is, we want to find things, businesses that customers love, that can grow to be large, will provide strong financial returns, and are durable. They can last for decades. We think Prime is that, we think Marketplace is that, we think AWS is that, and we are constantly looking for a fourth or fifth business that fits that criteria. +But as we continue to invest primarily in, as I said in Prime, the Prime platform, Prime features for customers, expansion for fulfillment capacity, as we build out to support 26% unit growth in Q4, for instance, and much greater FBA share, and not to mention all the investments in AWS, we are constantly looking for cost efficiencies, in fixing variable productivity. I think a thing to think about is, the investments will ebb and flow over time, but our focus on cost reductions and improvement on customer experience will be constant. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Heath Terry with Goldman Sachs. Please proceed with your question. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [37] +-------------------------------------------------------------------------------- + + + Great, thanks. I was wondering if you could give us a sense, as we look at the slowing growth in AWS, obviously, still from an incredibly high level, and still very strong growth there. But try and take that into context, with the growth in margins that you keep seeing in that business, to levels that certainly seem a lot higher than you would anticipate for an Amazon business. Is there any capacity constraint or management that, that's driving pricing strategy in AWS? +We've heard the comments about the number of availability zones that are being launched this year, which is obviously about a big part of driving incremental capacity in that business. I'm just trying to balance those, think about how we should balance those three things? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [38] +-------------------------------------------------------------------------------- + + + Sure. Let me work backwards from your footprint question or comment. We have -- we just announced Korea as a region. And we'll be adding five more regions in the next, in the future, in the near future as we mentioned. CapEx, let me start with that first. CapEx, we've seen great efficiencies in capital expenditures, in particularly in AWS. And we continue to work on better purchase efficiencies and driving utilization rates in our data centers. +CapEx, as I mentioned, grew quite a bit in 2014. It grew even more to over $9 billion, across all of our capital expenditures and capital leases in 2015. From the new regions, they are not the major driver in any way. Most of our capacity, and capital and capital leases in AWS is to service existing regions, and existing customers' demand growth. But there's certainly expenditures when we open up new regions. Some of that is not always in the year that we open the region, so we spent a good bit on those new regions already in 2015. +But as far as pricing, there's no capacity constraint. And I would a little bit dispute the deceleration comment on the -- yes, on a percentage basis, 69% is lower than Q3. But as I've said before, we're approaching a $10 billion run rate in this business. On a dollar basis, we continue to grow. We saw the greatest growth year-over-year and quarter-over-quarter. And again, we continue to invent, it's not all about price-- we continue to innovate on behalf of customers, and see great customer response. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [39] +-------------------------------------------------------------------------------- + + + Sure, sure. Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Kerry Rice with Needham & Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [41] +-------------------------------------------------------------------------------- + + + Thanks a lot. First question is, if you can provide maybe some context around linearity within Q4, more as a -- compared to your expectations? Obviously, you have a ramp-up into the holiday season, but was -- did December tail off faster than you expected, or did the ramp-up, did it spike higher than you expected? And then, just on the follow-up, maybe can you add some context about how the mobile played a role in the holiday season for Amazon? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [42] +-------------------------------------------------------------------------------- + + + So in terms of -- this is Phil. In terms of expectations, I think we were pleased with what we saw this Q4. And if you look at what we gave for guidance, we were in the upper half of the range there for revenue. So no real call outs there. I think, what was your second part of your question? +Oh, and mobile, we said for a long time continues to be a tail wind for the business. We're working very hard to make sure that it's very easy for customers to buy the things they want to buy, and access a lot of the features they have grown accustomed to on the website. And so, we're very focused on the convenience factor. And if you look at some of our new offerings like Prime Now that's available through a mobile app, and very, very convenient for customers. And as Brian has mentioned, allowed them to shop even up to Christmas Eve, and then have their items delivered in two hours. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from Carlos Kirjner with Bernstein. Please proceed with your question. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [44] +-------------------------------------------------------------------------------- + + + Thank you. I have two. I want to go back to AWS margins. You talked briefly about purchasing an asset utilization. But do this explain the 800 bps or so, on your year-on-year margin expansion? +And are you seeing anything else? Like is there any impact of scale driving leverage over fixed costs? Is there some benefit from revenue mix shift, like services, like Aurora and RedShift growing faster than EC2, or is all the margin expansion due to purchasing and asset utilization? So that's the first question. +And the second, I have a question about your streaming content expenses or cost of revenues to be more precise. Last year, you told us they were $1.3 billion, but if you didn't give us a figure for 2015. In lieu of that, can you comment on whether 4Q saw higher than usual costs for streaming content, compared to other quarters in the year? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [45] +-------------------------------------------------------------------------------- + + + Carlos, this is Phil. So your question about the AWS margins, that business as they continued to learn, and as we continue to invent and get better at designing and operating the infrastructure and assets, we have been able to drive costs out of that business. And so, that's one of the primary drivers of the improvements that you've seen in margin year-over-year. +There is also an FX tail wind in there as well, which I think was about $60 million this quarter, which would contribute on a year-over-year basis, which really arises, because we're largely priced in dollars, but have assets with local currency costs throughout the world. As for the streaming content, we haven't given another update this year, and haven't given any commentary on the profile quarter to quarter. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + + Thank you. The next question comes from Brian Pitz with Jefferies. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [47] +-------------------------------------------------------------------------------- + + + Thank you. You mentioned Amazon Dash in the press release. Can you give us some color around how you're viewing the traction there, both with customers, and with brands and devices? And then, maybe any update on Twitch? How is traffic and user engagement been trending on that site? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [48] +-------------------------------------------------------------------------------- + + + This is Phil. So on the Dash buttons, we're really excited about what we're delivering there. I think, as you saw in the release, there are some new devices that take advantage of the underlying service, that we think will be really convenient for sellers, and interesting for device makers. We're excited about what we're building there. I don't have any stats for you today. +On the Twitch side, we continue to let Twitch do what Twitch does best. And so, don't have any updates on numbers there, but they continue to really engage customers, and offer a really unique experience, which was one of the reasons we were attracted to them to start with. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [49] +-------------------------------------------------------------------------------- + + + And maybe just quickly, end of year fulfillment and sortation centers? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [50] +-------------------------------------------------------------------------------- + + + Yes, I'll take that. So we ended the year at 123 fulfillment centers, up a net 14, and we have 20 -- excuse me, 23 sortation centers in the US, up 4 year-over-year. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + + Our next question comes from the line of Gene Munster with Piper Jaffray. Please proceed with your questions. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [52] +-------------------------------------------------------------------------------- + + + Hey, good afternoon. I want to just quickly revisit the margin pendulum question in some of your comments, as you mentioned that to kind of expect it to ebb and flow. Could you tell us if you expect it to ebb and flow, but moving higher? Or is ebb and flow just mean that, that it's kind of undetermined in 2016? And then, a second follow-up, is the robotics. Any update in terms of number of robots, or how you see that expansion going forward? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [53] +-------------------------------------------------------------------------------- + + + Yes, my comment on ebb and flow was more about the investment, and also including capital expenditures and capital leases. So not around gross margins. And merely, I was pointing out that again, we've laid out all the invested areas, where we're seeing heavy investment. We continue -- we see the continuation of that certainly, into 2016 and beyond. +There are quarter-to-quarter and even year-to-year fluctuations in some accounts, and some investment areas. But generally, we're pretty transparent on where we're investing our dollars. And against that backdrop, we are always looking for efficiency. And the nice thing about growing the top line at such a high clip, is we have a lot more areas for opportunity to save money year-over-year. And we always look to do that. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [54] +-------------------------------------------------------------------------------- + + + And this is Phil. On the Kiva question, the last update we've given is more than 30,000 robots. We continue to be really pleased with the program, and like what it does in the warehouse, both from a density of storage, as well as from making the jobs easier for the associates who are picking packages, by bringing the packages actually to the associates. But no new numbers on that. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + + Our next question comes from the line of Justin Post with Bank of America Merrill Lynch. Please proceed with your question. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [56] +-------------------------------------------------------------------------------- + + + Thank you. Two questions. Was there any category mix impacts in the quarter on gross margins? That's just a quick one. +And then secondly, as you look back at last year, you had some quarters where you really exceeded your guidance on the CSOI line. Maybe looking back, or just looking forward, what are the types of things that causes you to come in at the high end, versus maybe the low end, when you look back, or when you look forward? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [57] +-------------------------------------------------------------------------------- + + + Sure. First, on guidance, we keep it pretty, a consistent process on how we look at guidance, and how we estimate the near-term view of the business. I will point out that Q4 is obviously, a very large quarter, the largest revenue quarter by far of the year. There's a lot of demand that comes in the last six weeks of the year as well. +So very, very little visibility at the time of guidance when we do the call. So we are using are best projections on a lot of fronts. We think it's a similar -- we know it's a consistent process. And there are times, when we under-run and sometimes we over run it. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [58] +-------------------------------------------------------------------------------- + + + On the -- this is Phil. On the category mix question, obviously, category mix does play a role in gross margin. I would say though, that we're much more focused on operating profit dollars, and free cash flow dollars, as we've probably talked about before. +The gross margins are impacted by first-party versus third-party mix, as well as AWS mix, if you're looking at the total for the Company. So we're much more focused on the dollars. And no specific categories we're calling out, as a driver for gross margin, because, again, we're much more focused on the profit dollars. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Paul Vogel with Barclays. Please proceed with your question. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [60] +-------------------------------------------------------------------------------- + + + Great. Thanks. Just wonder if you could give an update on the strategy around same-day shipping? How we should think about kind of further expansion of that? And kind of what parameters do you guys use to determine what markets to go in? Is it density of the market? Is it proximity of your distribution facilities? Just some color on that would be great. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [61] +-------------------------------------------------------------------------------- + + + So we deliver, really quickly, a couple of ways. One is the free same-day, that you've seen us roll out in a number of markets in the US. The other is Prime Now. And we're now in more than 25 metropolitan areas for Prime Now. Delivering for free in two hours is difficult and expensive, but customers love it. +So we feel like this is the natural evolution of our delivery, and we're happy to invest in that service. We like what it does for Prime members. We like the convenience factor. And so, we're taking a long-term approach, and doing what we normally do, which is really focus on continuing to drive greater and greater efficiency. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Ron Josey with JMP Securities. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ronald Josey, JMP Securities - Analyst [63] +-------------------------------------------------------------------------------- + + + Great. Thanks for taking the questions. I wanted to ask more about North American operating margins, because I think they expanded just under 50 bps this quarter to 4.7%. And that compares to an average of 200 basis points thereabouts, expansion in the prior three quarters. +So I'm just wondering, if in 4Q maybe higher FPA costs or something else in there that led to, maybe an expansion not as great as we saw in prior quarters. And then, following up on the Prime Now question just now, I'm wondering how an hour delivery or two-hour delivery has changed a consumer's perception of just delivery overall? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [64] +-------------------------------------------------------------------------------- + + + Sure. Yes, again, I'll point out that the demand for FBA services was very high, nearly 50% of our third-party units, again were FBA. And the demand for space and services was very large by our seller base, which was great from a lot of standpoints, and it did exceed our expectations. But did make our warehouses rather full, and did cause us to incur some additional variable costs in the US. And there is also the dynamic that we were fulfilling more of these units ourselves, at our warehouses because of the FBA growth, and the retail growth. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [65] +-------------------------------------------------------------------------------- + + + On the speed of delivery, this is Phil. All I can say is, the customers love the service. It's very convenient, and it gives them flexibility, and the ability to get products really quickly. I don't know that there's any big trends we are ready to call out at this point, but they seem to really, really like it. So we're encouraged by that. We're excited to invest in it, and excited what we can do for our Prime members. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Neil Doshi with Mizuho. Please proceed with your question. + +-------------------------------------------------------------------------------- +Neil Doshi, Mizuho Securities Co., Ltd. - Analyst [67] +-------------------------------------------------------------------------------- + + + Great. Two questions, please. One, it seems like the Echo did perform well. Can you talk more broadly about your Internet of Things ambitions, and kind of how Echo plays into that strategy? +And then, secondly, just wanted to know a little bit more about restaurant delivery? It seems a little bit outside of the wheelhouse. What's the impetus behind doing more in terms of food delivery, and what are your ambitions there? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [68] +-------------------------------------------------------------------------------- + + + So on the Echo, we like what -- how Echo has done. We're really excited about the ecosystem, and some of the skills that are being added to Echo, as well as some of the other devices that are taking advantage of Alexa, which is the brains behind Echo. So we like our device business in general. +As you probably saw from the press release, we had a good Q4, where we did almost double the, or double what we did last year, so very excited about the devices. We like that they pump more energy into Prime, and really the whole ecosystem. Not sure on the Internet of Things, but it's very exciting for devices standpoint. And the brains of Echo are in the AWS cloud. And so, Echo gets new capabilities all the time, as Alexa gets better and better. +On the restaurant delivery, it's just another great service we can offer for our Prime members. This is tied in with the Prime Now offering in a handful of cities at this point. And so, we have the delivery people going out and making the deliveries in the neighborhoods. And so, this is one more really valuable convenient service we can offer for our Prime customers. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + + Thank you. Our final question will come from John Blackledge with Cowen and Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [70] +-------------------------------------------------------------------------------- + + + Great, thanks. Two questions. First one, shipping costs were higher than we expected. I think it was 12.5% of net revenue, versus 11% last year. +Just any color on the higher shipping costs? And is that percentage of net revenue a new normal, as we are in 2016 now, and as we look out? And then the second question on Prime Now, in 25 markets globally, how should we think about the total number of markets that, additional markets you can enter with the Prime Now offering in 2016? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [71] +-------------------------------------------------------------------------------- + + + Sure. Yes, as you say, the net shipping margin was up 70 basis points year-over-year. Again, this is all tied in with the increase in FBA growth, and the demand from Prime members. We're shipping more units -- more of our units, so this ripples through our ship cost per unit. And, again, the calculation of ship costs, as margin is a percent of revenue, and that is impacted by the denominator effect on the FBA sales, being booked at a net revenue. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [72] +-------------------------------------------------------------------------------- + + + Related to your Prime Now question, this is Phil. We're in more than 25 metropolitan locations. It's -- if you've been watching, this roll out has really happened in the last year, so it's been a pretty rapid rollout. We're excited to bring it to more places. +We don't have a target for you today, but we are working hard to bring it to more and more places. We're outside the US now in a handful of countries, in the UK and Japan and Italy, and working to expand. So it's a program we're really excited about, and we're happy to bring it to more customers. +Thank you for joining us on the call today, and for your questions. A replay will be available on our Investor Relations website, at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2016-Jul-28-AMZN.txt b/Transcripts/AMZN/2016-Jul-28-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..5feb9effbca5fedbaefdc6aee14bf8afe7bc22b2 --- /dev/null +++ b/Transcripts/AMZN/2016-Jul-28-AMZN.txt @@ -0,0 +1,438 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Amazon.com Inc Earnings Call +JULY 28, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Darin Manney + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Victor Anthony + Axiom Capital - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ray McDonough + Oppenheimer & Co. - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2016 financial results teleconference. At this time all participants are in a listen only mode. After the presentation we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- +Hello and welcome to our Q2 2016 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and the responses to your questions reflect management's views as of today July 28, 2016, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on form 10K and subsequent filings. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. During this call we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. Now I will turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Thanks, Darin. I'll begin with comments on our second-quarter financial results. +Trailing 12-month operating cash flow increased 42% to $12.7 billion. Trailing 12-month free cash flow increased to $7.3 billion, up from $4.4 billion. Trailing 12-month free cash flow, less lease principal repayments, increased to $3.9 billion, up from $2.4 billion. Trailing 12-month free cash flow, less financed lease principal repayments and assets acquired under capital leases, increased to $2.5 billion, up from an outflow of $492 million. +Worldwide revenue increased 31% to $30.4 billion or 30% excluding the $166 million favorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 28%. Worldwide seller units represented 49% of paid units. +Now I will talk about our segment results. North America revenue grew 28% to $17.7 billion. North America operating income was $702 million, a 4% operating margin, compared with $348 million in the prior year. This includes $5 million of favorable impact from foreign exchange. +International revenue grew 30% to $9.8 billion. Excluding the $184 million year-over-year favorable foreign exchange impact, revenue growth was 28%. International operating loss was $135 million, compared with a loss of $189 million in the prior year. This includes $40 million of favorable impact from foreign exchange. +Amazon Web Services revenue grew 58% to $2.9 billion. Amazon Web Services operating income was $718 million, a 24.9% operating margin, compared with $305 million in the prior year. Our operating income was $1.3 billion, or 4.2% of revenue, up approximately 220 basis points year over year. This includes $45 million of favorable impact from foreign exchange. Net income was $857 million, or $1.78 per diluted share, compared with the net income of $92 million, or $0.19 per diluted share. +I'll conclude my portion of today's call with guidance. For Q3 2016, we expect net sales of between $31 billion and $33.5 billion, or growth of between 22% and 32%. This guidance anticipates approximately 30 basis points of favorable impact from foreign exchange rates. Operating income to be between $50 million and $650 million, compared with $406 million in third quarter 2015. +We are grateful to our customers and remain heads-down focused on driving a better customer experience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks, and with that I will hand it back to Darin. +Thank you, Brian. Before we move to questions I need to remind you that our guidance incorporates the order trend that we've seen to date, and what we believe to be appropriate assumptions. +Our results are inherently unpredictable and may be materially affected by many factors including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes that we do not conclude any additional business acquisitions, investments, restructurings or legal settlements and that foreign exchange rates remain approximately where they have been recently. It is not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that let's move to the Q&A portion of the call. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [1] +-------------------------------------------------------------------------------- +At this time, we will now open the call up for questions. In the interest of time, we ask that you limit yourself to one question. +(Operation Instructions) +Thank you. Our first question is from Mark May of Citi. Please proceed. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking my question. We've noticed some data points out there that suggest that you're accelerating your build-out of fulfillment capacity in North America and obviously also in India. Can you give us a sense of what sort of impact that, that might have in the near to mid-term on your CapEx, depreciation and ultimately CSOI? Especially as it relates to your Q3 guidance? And then just a maintenance question, how much is FX impacting your Q3 guidance? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Okay. Thanks, Mark. Yes, let me talk a little bit about guidance, and I'll incorporate the answer to the fulfillment question. So, you'll notice on the top line guidance of $31 billion to $33.5 billion or 22% to 32% growth incorporates the Prime Day results and I can talk more about that later. But Prime Day was very successful for us. It was up 60% on a worldwide basis over the prior year, and it was also a record day for our Amazon devices, as well as sellers and customers alike. +In the bottom line, you'll need to remember that Q3 is a typically a lower operating income quarter as we prepare for Q4, the holiday peak. It's a little bit more exaggerated this year in that we're opening 18 fulfillment centers this quarter. To put that in perspective, we launched six in Q3 of last year. This will bring us up to 21 net FCs for the year by the end of Q3, and that compares with 10 fulfillment centers for the first three quarters of last year on a net basis. So, why are we expanding so much? If you remember back to Q4 and the capacity constraints we had in Q4, primarily due to really strong FBA growth, we talked a lot in the Q4 call about the operational cost of that in Q4. Customers are well taken care of, but we had additional fulfillment costs from being so tight on capacity. +This year, with that in mind and then knowing that our growth rate is actually accelerating on a unit basis, we are - Q2 was 28% unit growth for paid units, but fulfilled by - units fulfilled by Amazon is much higher than that due to the growth of Prime and FBA. That compares with last year in Q2 when we saw 22% unit growth. So we're 600 basis points faster growth in Q2 this year than last year and that 22% last year turned into 26% in Q4. So it ramped up in the back end of the year. +So a lot of data points there, but the bottom line is that there's a large step up in the amount of fulfillment capacity in Q2 - excuse me, Q3 versus Q2. There's a couple of other factors while I'm at it for guidance. We are also nearly doubling our content spend in the second half of this year versus the second half of 2015. We have a great slate of new Amazon Originals coming out later this year, both in the US and internationally, and we're nearly tripling our number of new Amazon Original shows - TV shows and movies compared with the second half of last year. There are other investments, certainly, that are increasing sequentially. I'd point to India and AWS, but primarily the two biggest issues in Q3 guidance I would say are the operational ramp and also the increase in digital content spend. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- +And, Mark, to follow up on the other question, our net sales guidance anticipates approximately 30 basis points of favorable impact from foreign exchange rates. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [5] +-------------------------------------------------------------------------------- +And, Brian, where does that bring your video content spend to with the doubling in the second half if we look at it on an annualized basis? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [6] +-------------------------------------------------------------------------------- +We're not disclosing that at this time. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [7] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Our next question comes from Douglas Anmuth from JPMorgan. Please state your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking the questions. I just want to go back to Prime Day for a minute. I didn't hear any commentary around new Prime members in particular. Obviously a lot of other metrics that you gave but hoping you could provide a little bit more color around that. +And then also, is there anything else that stood out in terms of what you learned around operations and systems ahead of the holiday season? And then just going back to the 3Q guide, what's the right way for us to think about stock-based comp in the third quarter and if we looked at your 2Q numbers, is that a fair assumption for what you're thinking about? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure. Let me circle back on Prime Day. So again, it was the biggest global day ever for Amazon and was up 60% on a order product sales basis versus Prime Day 2015. It was a record day for Amazon devices. It was a great day for small businesses and sellers who saw great year-over improvement in their sales. And more importantly, it was a great day for customers. Globally they saved over double what they had saved in Prime Day 2015. +So we're very pleased with the results of Prime Day, and the impact of Prime Day is factored into this guidance. As far as new customers and new Prime members, we're not disclosing that, but suffice to say that it was a great day for both existing Prime members and also new customers who were trying us out for the first time. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [11] +-------------------------------------------------------------------------------- +And on the stock-based compensation, you'll recall beginning in Q1 this year, we began allocating stock-based compensation and other operating expense to our North America, international and AWS segments. So we're including that in our guidance on operating income and have not separately guided to stock-based comp and other income expense this quarter. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Our next question comes from Gene Munster from Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [13] +-------------------------------------------------------------------------------- +Hello, good afternoon. First, love the conference call format here. Get right to it. In terms of questions, the customer count, can you give us a little bit of guidance on that? And then also talk about the theme of automated consumption and separately, the importance of Prime Now and how you can grow those SKUs. Thanks. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [14] +-------------------------------------------------------------------------------- +Hi, Gene. This is Darin. I'll start with the customer accounts. As we noted again in our Q1 release, our active customer accounts exceeded 300 million. However, today we're not going to update that number. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [15] +-------------------------------------------------------------------------------- +To your question on Prime Now, so I will point out Prime Now is now in more than 40 metro areas worldwide. In the past quarter we expanded further internationally to Germany, Spain and France, so it's a global program, again, offering free two-hour delivery on tens of thousands of items. We also have in the same vein of, I think what you called maybe automated consumption, the same day has expanded. Now we've added 11 metro areas, bringing the total to 27 metro areas that are qualified for same day. +So, yes, we think this is an important part of our Prime offering. We know customers love it. We're very happy with their order patterns from Prime Now, and very happy with it. Of course, we do always talk about - we always usually get asked about profitability, and it is a very hard service to deliver and make money on. But we know customers love it and we're in a great position to do this because of our long-term approach, our drive of greater efficiencies and our proximity to the customer with our vast global FC network. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Our next question comes from Heath Terry from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [17] +-------------------------------------------------------------------------------- +Great, thanks. I was wondering as it relates to the Q3 guidance, can you give us a bit of a sense of just how we should think about margins in the AWS business, especially as the next eight availability zones roll out? Presumably that kind of increase in capacity likely has an impact on margins, but would appreciate any direction you can share on how to think about that. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [18] +-------------------------------------------------------------------------------- +Sure. We don't give - obviously we don't give segment-based guidance. But to your question about AWS, we actually see nine availability zones in four regions coming out in the next - in the coming year. The impact on short-term is pretty much indistinguishable from the growth that we're seeing in our expansion of our base customers in our existing regions, so we don't see a large step-up from the addition of new regions relative to the large and rapid growth in the business itself. +We do think that it does pay benefits both for ourselves and for our customers because of the expansion, and we're happy to have added the region in Mumbai this past quarter. We think when we expand geographically, existing customers will run more of their workloads on AWS. Sometimes they have local latency concerns or security issues that require them to run things in their country, so that helps. And we also open up to new customers when we add these regions. So not a large impact on Q3 guidance, but certainly an exciting investment for our customer base. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Our next question comes from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [20] +-------------------------------------------------------------------------------- +Thank you. Two questions if I may. As I look at your tech and content expense as a percentage of revenues, we see year-on-year decline for the last two quarters, which is something we hadn't seen since mid-2010, and of course it's reflected in the AWS margins. Can you help us understand what has driven this significant change in relative trajectory in tech and content expenses? And the second question is, why is it that the rate at which you are deploying Prime Now is so much greater or faster than the rate at which you are deploying Fresh? What's different between them and how is it that you are deploying Fresh in new markets but not as fast as Prime Now, and what drives the difference? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [21] +-------------------------------------------------------------------------------- +Sure. On tech and content, that's going to be a combination of our people cost related to many areas of the website and also the infrastructure cost to run it, at both the Amazon Web Services and also the Amazon site. We've been seeing some great efficiencies in our infrastructure, both internally as Amazon and also as part of AWS. We have great people working on not only better efficiency, but also driving cost out of our acquisition prices. So, there's a lot of great work going on there and I think that's what you're seeing reflected in the tech and content line. Again, this can fluctuate quarter-to-quarter, but we're happy with the current trend and you see it in the AWS margins. +On Prime Now versus Fresh, they are separate - sorry. The - we'll point out in Q2 that we added London and Boston as two new sites in London for AmazonFresh, and that was the first international location. But we've been running AmazonFresh for seven years, or excuse me, since 2007 in Seattle. And what you've seen as we've been testing the model, we've been expanding in North America and more so we've been expanding within the cities that we're in, adding zip codes, adding additional customers. So, the move into Boston and also now into London give us some really good data points and as - it's a great customer feature for the Prime offering. +Prime Now is a little bit easier to build up from scratch, I would say. The - it has a different purpose, although some of the products overlap. Again, this is more about immediacy of one-hour and two-hour delivery of a curated list of important products that people need in a short period of time. So, they have different roles. Some of the products overlap, of course, but we're happy with both, and we think that customers like both of them. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Our next question is from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I have two. The first one is on the Echo. Anything you could share at all on some of the most commonly used searches? How are consumers using the Echo as of now most commonly, and then anything on uplift in purchase behavior from Echo households? And the second one on Prime, on AWS margins, can you just walk us through some of the puts and takes that have been driving the AWS margin expansion we've seen in the first half of this year? Is it utilization, product mixes? What's been driving the margin expansion? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [24] +-------------------------------------------------------------------------------- +Sure. Well, in Echo, again, we continue to build out the list of devices, launching the Dot and Tap and Fire TV skills this past year. And now we have 1,900 third-party skills for the Alexa, including new skills from Kayak, Lyft, NBC, Honeywell and more. So there's a lot of uses that we're seeing for Echo. A lot ties into our Prime Music offering. It's just a great way to access Prime Music and more and more the Amazon site. We don't have anything to disclose on physical orders from - through - excuse me, orders through Echo. +On Amazon Web Services margin, again, this is primarily due to efficiencies gained on our infrastructure, better utilization, better cost out. There is a - certainly a mix of products and services. I don't have a bridge for you on whether that's helpful or hurtful, but the - these margins in AWS will fluctuate from quarter to quarter, and that's what you're seeing. But we're very happy with the year-over-year improvement. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Next question is from Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [26] +-------------------------------------------------------------------------------- +Okay. Brian, could you give us some whys as to the revenue growth acceleration that you're seeing, a little more color about the revenue growth acceleration in North American retail and in international retail? I remember last quarter you called out really starting to see, I don't know, critical mass, tipping point, whatever the buzzword is, from Prime and from FBA in international markets. Is that what's continuing, I assume, to drive that re-acceleration in any geographic country comments behind that? Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [27] +-------------------------------------------------------------------------------- +Sure. Yes, I have the same buzzwords for you, Mark. It's really -- the flywheel of Prime is definitely working. It's as simple as that. The low prices, vast selection and convenience continue to resonate with customers. Prime membership increases and selection through FBA makes Prime more valuable. So it's a bit as simple as that in the consumer business in North America and international, we are seeing great acceptance of Prime and usage of Prime benefits. We continue to expand the list of Prime benefits for customers to make it more valuable, and none is more valuable than FBA, which we've talked a lot about the value of Prime to FBA and vice-versa. +FBA is bringing more Prime-eligible selection to Prime and then the growth of Prime and the type of customers that utilize Prime and their buying behavior is a great traction for other FBA sellers. So that is essentially what we're seeing, and we're certainly pleased with the customer response to those offers globally. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from Youssef Squali from Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [29] +-------------------------------------------------------------------------------- +Thank you. Two questions, please. Brian, your operating income has been come in stronger than expectations, but more importantly, stronger than your own guidance, at least in the last couple of quarters. I was just wondering as you look back at where you guided relative to actual, where do you think that delta was most pronounced? Why wouldn't we assume that maybe, at least on the margin, the investment intensity in the business has maybe decelerated a bit? +And second, on Prime Video, just was wondering, considering what the main competitor there is doing, i.e., expanding aggressively around the world, you guys have been growing in a more measured manner, is that still the plan or are you guys interested in maybe instead of moving into a few countries, expand globally in one fell swoop? That's it. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [30] +-------------------------------------------------------------------------------- +Sure. Let me start with the second question first. So on Prime Video, again, we're very happy with the customer adoption of Prime Video, and we know the customers love it. We like the results that we see, particularly with the free trial conversion, the renewal rates for subscriptions. So it's clearly working. I mentioned earlier how we're doubling the investment rate in the second half of the year versus last year's second half, and we're tripling the Amazon Originals content. +That Originals content for TV and movies, that content can be used globally. We've talked a bit about our Prime launch in India, and alluded to the fact that we'll be having video soon in India, but local content and also Amazon Originals. So, stay tuned for that. I don't have any more to announce on that today. On the variance to guidance, what I'll say is, we came in the very high end of our revenue guidance. I would say that our business model usually reacts well to high volume as we get a really good leverage on our fixed expenses. So that's part of what we saw, very strong operating efficiencies as we hit essentially the highest end of our revenue guidance. +But we do have a lot of diverse profit streams here at Amazon and a lot of investments going on at any point in time. I think I heard a question there about level of investment. We continue to invest heavily. In fact, I just called out a few things that are going to be stepping up in investment levels in Q3, mostly ops and digital content. So we continue to invest on behalf of customers. But we also work very hard at efficiencies and scaling the businesses that we have. So we take both roles very seriously around here, investing on the right - in the right things, seeing results on behalf of customers, and also driving efficiencies. And there can be timing, quarter-to-quarter, the operating margin and levels of investment can fluctuate, but certainly continue to expand. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Our next question comes from Jason Helfstein from Oppenheimer. Mr. Helfstein, your line is live. + +-------------------------------------------------------------------------------- +Ray McDonough, Oppenheimer & Co. - Analyst [32] +-------------------------------------------------------------------------------- +Hi. Sorry about that. This is Ray McDonough on for Jason Helfstein. Just on the AWS side, we've been hearing a lot of talk and especially a lot of media reports that larger customers tend to use AWS, they might use Google and Microsoft Azure in tandem in a multi-cloud kind of architecture. Just wondering your thoughts on how you see AWS fitting in the overall ecosystem and kind of your place longer term in the ecosystem. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [33] +-------------------------------------------------------------------------------- +Sure. Well, first of all, we believe customers will choose AWS primarily for three factors, the functionality and pace of innovation that we bring to the table, our partner and customer ecosystem and our experience. We've been in this business longer than anyone. Having said that, there's plenty of room for multiple winners in this business. What we focus on is innovating on behalf of customers and expanding the geographic footprint to make our services more widely available. +You can see us continue to invest in things like new application services, higher up the stack, additional technologies that will make integrating with AWS seamless for those companies that have a hybrid IT environment and then continuing to add functionality for data analytics, mobile, Internet of things, machine learning offerings, things like that, that will add greater and greater value for AWS customers. And I would say the rapid pace of innovation continues to stretch our lead in that dimension. We have had 422 new significant services and features added in the first half of this year. That's a faster pace than last year when we added 722 services and features. So we feel good about the business position we're in and our position with customers. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Our next question comes from Colin Sebastian from Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [35] +-------------------------------------------------------------------------------- +Okay. Thanks, guys. As another follow up on the margins, I was hoping you could comment on any impact from the investments and build out of enhanced transportation capabilities including the air cargo leases. And then secondly, was hoping you could identify any categories within EGM that are becoming more meaningful drivers of growth or at least are an increasing focus on the retail side? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- +Yes, sure. First, on EGM, I'll just say the growth is across a lot of different products, none to exactly call out here, and we think that a lot of it is, of course, driven by the growth of Prime itself. EGM in North America grew 32%, which was higher than the revenue growth rate, and also grew 36% internationally. So when people join Prime, they are certainly buying EGM in strong quantity. So that continues to grow with the growth of the Prime program. +On transportation, I think your question was about whether that's impacting our short-term results. No, the answer is no. We are certainly expanding our service offerings in the transportation side and we have been for many years, things like sortation centers and delivery methods. The plane deal that we were talking about is essentially planes that we're going to be leasing from other companies, and you'll hear more about that as we go forward, but that is to essentially take on the demand for internal flights as we move product around. It certainly will be well utilized. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Our next question comes from Brian Pitz from Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [38] +-------------------------------------------------------------------------------- +Thanks for the questions. First, on FC build out, is the cost of building centers scaling over time given the use of Kiva, other technologies or general learnings, or are those costs still relatively consistent? And also, we noticed some device sellout in the next four to five weeks, post-Prime Day. Was this a bit of a planned inventory reduction for some of the devices or did volumes take you by surprise here? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [39] +-------------------------------------------------------------------------------- +I will start with the second question. So I would just say Prime Day had enormous impact on the device business and devices were well featured and also well adopted by customers. So it was the largest device sales day that we've ever had and essentially pretty much across all of our device types, E-readers, tablets, Fire TV and Echo. +And I'm sorry, your first question was around - the cost of fulfillment centers. Not disclosing that we do continue to change our fulfillment centers. We've changed, again, the automation, the size, the scale many times and we continue to learn and grow there. So no general trends I can point to on cost per fulfillment center to start up, but because they do vary in size and mission and some have fully outfitted in using Amazon Robotics, others - some don't for economic reasons. Maybe the volume is not perfect for robot volume. But, yes, so I can't give you any real distinct trends there. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Our next question is from Justin Post from Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- +Great. Thank you. First on the customers, I'm guessing - I'm wondering why you aren't giving the number, a lot of people use it for their models. And then second thing, when you look at the US Prime penetration versus total US customers, how do you feel about that and do you think there's still a lot of room for Prime growth in the US? Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [42] +-------------------------------------------------------------------------------- +Hi, Justin. This is Darin. I'll comment on the customer accounts again. We may consider updating that in the future, but really we encourage you and our investors to look at our free cash flow measures, our revenue and our GAAP operating profit since our customer purchasing behavior can vary. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [43] +-------------------------------------------------------------------------------- +And on Prime penetration, of course, we haven't released Prime subscription levels. We have talked about growth certainly globally and in North America. What I can tell you there is we still think there's a lot of room in Prime. We've tailored programs to students, we've tailored video programs, we've rolled out monthly plans, we have plans with grocery delivery. +So there's a lot of different flavors of Prime and we are aggressively looking for a perfect Prime for everybody. We know that, again, when customers try Prime, they like it. So it's really just about getting them to try Prime and continuing to deliver great Prime benefits and great low prices and selection. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Our next question comes from Ross Sandler from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [45] +-------------------------------------------------------------------------------- +Thanks, guys. I just had two. First as a follow up on the logistics topic. So, in addition to the cargo planes you just mentioned for in-network moving products around, you guys have registered and received a US maritime license to operate as a freight forwarder and you recently announced this partnership with the UK for drone delivery that you've been working for a couple years. At a high level, can you just talk about how the overall logistics strategy is evolving from trucks and fulfillment centers to incorporate some of these new methods and how that might impact your unit costs going forward? +And then the second question's on AWS. So you continue to put up really strong results, and you guys obviously talk to a lot of customers across lots of different verticals. Just a high level, what percent of enterprise workloads do you think have shifted to the public cloud at this stage? Is it low-single digit to mid-single-digit? And any color there on where we are in terms of penetration in the space. Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [46] +-------------------------------------------------------------------------------- +So thank you, Ross. This is Darin. Let me take that first question. On Prime Air in the UK, we've been working with and developing Prime Air for some time to develop a rapid delivery system that is safe, environmentally sound and it really enhances the services that we provide for millions of customers. And we're extremely happy to partner with the UK government to advance the safe use of drones for small parcel delivery. This is providing us with permission to trial new methods in the space, including beyond line-of-sight operation, sense-and-avoid technologies and flights where one person operates multiple drones. +So we definitely appreciate the pragmatic and forward-looking approach on this topic with the UK, and we're going to continue to work with regulators and policymakers in many countries, including the US, so we're excited about there. As for the ocean-going licenses, we have no comment on that today. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [47] +-------------------------------------------------------------------------------- +As far as AWS, essentially penetration question you asked. We think still very early. Again, we like our position, our industry leading position in the cloud space, and we're working on things that would incent more and more customers to accelerate their cloud conversion. The lower prices and services that we offer, and as I said, we'll work on things that will make it easier and easier for customers to work with us with their hybrid data centers or transfer their volume to us. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Our next question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [49] +-------------------------------------------------------------------------------- +Thanks for taking the questions. Maybe one clarification and one big picture topic. On the clarification, appreciate the disclosure on content and how that'll double year-on-year in the second half. For purposes of just making sure we can understand the trajectory, is there any way to frame it within second half of this year versus first half of this year, just so we can try to triangulate on a gross margin basis from the content spend? And the bigger picture topic would be China, hasn't come up yet on the call. I wanted to understand your latest thoughts there on either the competitive landscape, relative positioning in China and how you think about investments in China. Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [50] +-------------------------------------------------------------------------------- +So, hi, Eric. This is Darin. I'll take the second question on China. So we continue to operate well in China. We see China as a - and the way we're approaching China as a way to - a trusted avenue for our Chinese customers to access authentic international brands and we'll focus on those global brands and bringing those to Chinese customers. Offerings like the Amazon Global Store where Chinese customers can access those international brands on the China website and have them shipped directly to their houses is something we're focused on. So, yes, it's still early days and some of those experiments that we're doing, but we're seeing good traction on those things and we like that. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [51] +-------------------------------------------------------------------------------- +Yes, and on the content spend, I think the only other data point I can give you is probably a dated one at this point, but we spent $1.3 billion in 2014, that's the last number that we disclosed and we continue to add content. The best I can give you at this point is that it will be double, nearly double what we spent in the second half of 2015. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Our final question will come from Victor Anthony from Axiom. + +-------------------------------------------------------------------------------- +Victor Anthony, Axiom Capital - Analyst [53] +-------------------------------------------------------------------------------- +Thanks for putting me on. Maybe I'll just ask a question about India. You called out India was - you had the most visited e-commerce site as well as the most downloaded mobile app, and you also launched Prime. So maybe you could just talk about the opportunities and the challenges that you see in that market. And second, there was some press reports that you invested about $500 million of incremental capital in Italy. I was wondering, what are you seeing in that market that justifies that level of investment? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [54] +-------------------------------------------------------------------------------- +Sure. So India, we're very encouraged by what we've seen so far in India, both with customers and also sellers; that's a third-party seller market. You heard that we launched the Prime program this week, which will be a whole new experience for Indian customers. In hundreds of cities we'll now have unlimited free one-day and two-day delivery, and we also mentioned that Prime Video is coming there, both Indian and global content. +We're also starting to see exclusive online sales partnerships. Recently, we've had partnerships with Motorola, Samsung, Lenovo on select phones. But more importantly, again, we really like the opportunity in India. We like the initial results that we see from customers and also sellers. We really like our team there. We have a great team of Amazonians who've been very inventive in India. +Every time there's an obstacle or something that's different from the US or another major business, they'll invent around it, whether it's a shipping method or a payment method or whatever. So, very creative and the customer response has been really strong. So we are very excited about the Prime program. We think it'll enter into a new chapter in India, and we've seen great success in every country in the world that we've launched Prime, and we feel India is going to be no different. So we're looking forward to seeing what we can do on behalf of the Indian customer. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [55] +-------------------------------------------------------------------------------- +And hi, Victor, this is Darin. On Italy, yes, we continue to invest in Italy and really throughout Europe to keep pace with the strong customer demand we see. Since opening Italy in 2010, we've invested over EUR450 million and created 1,700 jobs in Italy, and this increased investment will be to add future FC near Rome and other infrastructure assets. So, yes, this is really to support both the customers that we have there in Italy and throughout Europe, and we'll continue to invest in the coming years. +So thank you for joining the call today and for your questions. A replay will be available on our investor website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2016-Oct-27-AMZN.txt b/Transcripts/AMZN/2016-Oct-27-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..d99e3729d5ed4ae2952db61bbb52bf4c439df75d --- /dev/null +++ b/Transcripts/AMZN/2016-Oct-27-AMZN.txt @@ -0,0 +1,372 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Amazon.com Inc Earnings Call +OCTOBER 27, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Darin Manney + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gene Munster + Piper Jaffray & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Neil Doshi + Mizuho Securities - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Baird Equity Research - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Good day, everyone and welcome to the Amazon.com Q3 2016 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- +Hello and welcome to our Q3 2016 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you which includes our financial result as well as metric and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. +Our comments and responses to your questions reflect Management's view as of today, October 27th, 2016, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial result is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filing. +During this call, we may discuss certain non-GAAP financial measures. In the press release, slides accompanying this webcast and our filings with the SEC, each of which are posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we have seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world event, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investment restructurings or legal settlements. It is not possible to accurately predict demand for our goods and services and therefore our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question comes from Douglas Anmuth with JPMorgan. Please state your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking the question. The international retail segment margin was the lowest we have seen in quite a while. I was hoping that you could provide some of the key drivers there in terms of the drag and any color on how to think about the incremental international investment that might be impacting the 4Q guide. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Sure. Thanks, Doug. Specifically to international, we are seeing expansion to support selection expansion fulfillment network increases. We're also investing in digital content and additional prime benefits, Fresh location and Prime Now. By far the biggest individual thing is the investment in India that we continue to make. Very excited about the initial reaction in India from both customers and also sellers. That is essentially the international margin guidance in Q4. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [4] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Gene Munster with Piper Jaffray. Please proceed with your question. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [6] +-------------------------------------------------------------------------------- +Great. Thanks. I guess when we think about the progression in margins in the second half versus the second half of 2015 and kind of the flat lining of overall margin at this point, excluding AWS, should we think about this as a temporary plateau that will at some point will resume once you start leveraging your fulfillment build-out or is there something structural that is philosophically changing with the way that you operate your business. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- +Yes. Thanks, Gene. We will continue to invest in the business where we are seeing significant customer traction. The things that I'm about to mention fall into that category. The largest individual reasons for the ramp-up in investment between the first half and second half of this year and also second half of this year versus second half of last year are the things that I mentioned on the call last quarter. +First, video content and marketing associated with that is nearly doubling year over year in the second half of the year. It continues to be a large increase for both Q3 and Q4. In the quarter in Q3, we added 18 fulfillment centers and we have added 5 more in October. For the year, we will add 26. Most of those are in North America. +That compares to 14 last year and I would -- looking back, there is -- the last time we had double-digit increase in fulfillment centers was 2012 when we added 11 in the third quarter. There was a rare aggregation of startups in Q3 and into Q4. It is helping us position better for Q4 volumes, because paid unit growth continues to be strong and Amazon fulfilled unit growth, which includes what we ship, includes FBA is significantly higher than even that. We are continuing to build for high AFN, or Amazon fulfilled network demand, including both retail and FBA. +The number of warehouses that we added represent the 30% increase in square footage year over year. Last year we increased square footage by just under 20%. The definition of square footage in this case is all of our warehouses, plus our sortation and delivery centers, so it's pretty much our end-customer service centers. It's pretty much our square footage that support operations. +Those will dissipate as we -- as they burn in. We've talked about fulfillment centers initial startup costs include increase in fixed cost but also variable cost as we train workers and also bring in inventory. There's a number of transportation costs also related to the startup of a new fulfillment center, both inbound and outbound. They are inherently less efficient than more established, mature buildings. There will be a cycle where those will be more productive next year than they are this year and more productive in 2018 than they are in 2017. +What you are seeing, essentially, in the second half of this year is a step-up investment, primarily around digital content and also the fulfillment center investment, but also things like Echo and Alexa which we're adding a lot of resources to, India and AWS as we add people there to support additional service rapid growth in that business. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking my question. I have two. The first one, just to go back, Brian, to the fulfillment build. In the past you talked about how it takes time to kind of get the fulfillment centers to peak efficiencies. With these new FCs opening, can you talk about if you become more efficient, so if you get into a lower volume quarter next year, there's less risk of deleverage or should we still think about it's going to take time to get up to peak efficiency? +The second one at AWS, Amazon the Company is good in removing friction in the purchase process. Can you talk about some of the main hurdles you have to overcome for large enterprises to start using AWS more? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure. In the fulfillment network, as we build it yes, they will be more productive next year than this holiday peak and probably even more productive in 2018. I can't forecast it for you into next year quite yet, but we certainly had productivity and additional costs in Q3 and even into Q4 of this year as we built the additional capacity. Again, the underlying reason for that capacity build is the strength in paid units and even more so in the units that we're fulfilling, driven by our FBA program. +The FBA program is the key pillar of our Prime offering. It adds selection. It makes Prime stronger. That's a self-reinforcing loop where Prime -- the Prime success attracts more sellers. We're glad to have that problem. We are just working very hard to get capacity in place and productive use for Q4 and beyond. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [11] +-------------------------------------------------------------------------------- +Hi, Brian. This is Darin. On the AWS question, we continue to invest in AWS on behalf of our customers. In addition to the technologies that make integrations easier and it helps companies move from an on-prem or a hybrid IT environment into AWS if we're going to continue to do that. Specifically, the database migration tool that are helpful for customers when they move production databases from on premises to the cloud with virtually no downtime. +Also, many of our AWS customers are beginning to choose and continue to choose the AWS schema conversion tool which really switches database engines to get out of old-guard proprietary databases and on to AWS. We will continue to react to customer needs and that will include opening up new regions. We have opened up Ohio this past quarter. We've highlighted that we will have a number of regions coming online in a few months. Yes, we're doing a lot of things to help make it easier for all customers to migrate to AWS. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Mark Mahaney with RBC Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- +Okay. Hey, Brian, would you give us any commentary on two categories in particular, groceries and fashion and apparel? Particularly on groceries, I know in the release there was a couple of data points about Fresh rolling out into newer areas like Maryland. Great to see that. Can you just talk about that in the investment horizon? Is that moving the needle for you and how big that -- any way to help us quantify how big that already is to your -- to the revenue growth that you're seeing, particularly on groceries and any particular comment on fashion and apparel. Same line of thinking. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [14] +-------------------------------------------------------------------------------- +Sure. Thanks, Mark. I will start with Fresh and groceries in general. Yes, this quarter we launched in Northern Virginia, Maryland, Dallas and Chicago. We also launched a new pricing plan, which is a monthly $14.99 add-on to Prime in the US. We have expanded, as you know, previously into London. +We're very happy with the progression both in the geographies that we have been in for a long time where we are at, continuing to add zip codes and additional neighborhoods and also in these new cities. Certainly a business where we continue to work on costs and profitability. We are finding at the very attractive service to our customers, which is what we're after. +Similarly, but not exactly the same, is the Prime Now business which has similar overlap on things besides groceries. It is a slightly different model, obviously, where we're more about immediacy and smaller list items available in one to two hours. There's certainly a lot of people who are using that for groceries and consumable items. That is now up to 40 cities across 7 countries versus 17 this time last year. We're also adding Amazon Restaurant Delivery to the Prime Now offer in 19 metropolitan cities in the US. That is up from two last year. +We continue to believe consumables, groceries are a key part of the offer to customers. We are playing with very different models to see which works and for what needs. We're very happy with the Amazon Fresh and we have now expanded quite a bit as you see in this year. Prime Now we're also very happy with, although obviously the economics in that business are even tougher, but we do feel that our scale makes that possible because of our geographic footprint and how close we already are to customers. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [15] +-------------------------------------------------------------------------------- +Hi, Mark, this is Darin. On fashion, fashion and apparel continue to be a large part of our EGM business and one that we're very excited about. We continue to make it easier for brands and manufacturers to come on board in that category. We continue to work with brands to come on board. We're happy with the traction that we're seeing with those brands. As we get more and more selection, we're really pleased with the customer engagement that we have there, both from the discoverability, the technology that goes behind making it easier to shop fashion on our site, as well as the (inaudible) selection by adding the brand. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [16] +-------------------------------------------------------------------------------- +Sorry. To answer your question about whether that is part of investment. Yes, it certainly is part of our investment. The larger ramp, if you will, in investment that we're seeing from the back end of last year and also the first half of this year is more related to digital content and the building our fulfillment network, which I already discussed. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Mark May with Citi. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [18] +-------------------------------------------------------------------------------- +Thanks a lot. In some of these incremental investment areas like warehouses, logistics and also content, I know in some cases you expense up front. In some cases you amortized over time. Wondering if you can give us a sense of how much of the recent step-up is being expensed. I'm particularly looking at your COGS as a percent of retail revenues that was up year over year for the first time in quite a while. How much of that was because of content that expensed in the period? Just trying to better understand that. +I think also you have been changing around, and this is happening here shortly, FBA pricing, including increasing your storage fees but also reducing your handling fees. I guess the question is, are these changes designed to just pass through kind of increasing shipping costs or is this more of a net neutral change where really the goal is to try to free up capacity in some of your facilities? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [19] +-------------------------------------------------------------------------------- +Let me start with your second question on FBA. Yes, we did make some changes to the pricing formula for this holiday season. They're essentially meant to incent the right behavior among sellers around holiday. The biggest issue you're trying to get at is having the most valuable products for holiday in the warehouse, in the Prime space and not having the warehouse filled with things that may not sell until after the New Year. We are trying to incentivize that behavior. We're also trying to incentivize getting inventory into the warehouse quicker. Yes, the formulas were -- the changes to the pricing formulas were really with that in mind, to help the flow and the space utilization in Q4. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [20] +-------------------------------------------------------------------------------- +Yes. Hi, Mark. This is Darin. On the capitalization point, I'd say the things that get capitalized are the core buildings and the leasehold improvements in the buildings. The things that we're seeing hit the P&L are the fixed and variable expenses that it takes to run the building. I think that is what Brian is pointing out most pointedly in terms of what is impacting our profitability of second half. Yes, the capitalization is relatively small in terms of -- other than the building itself. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Youssef Squali with Cantor Fitzgerald. Please proceed with your question. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [22] +-------------------------------------------------------------------------------- +Yes. Two quick questions. With the step-up in investments and content from Prime Video as you mentioned before, you would also be stepping up the international expansion? Maybe you can just remind us how many countries you're in with Prime Video and whether there is a potential chance of stripping Prime Video from Prime to allow it to be extended to other countries. Do you -- I know you're not guiding to 2017, but just looking at the capacity increase that you had for FCs for 2016, should we expect that kind of as an ongoing expense going forward or is the current build-up enough to give you spare capacity to cool that down for 2017? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [23] +-------------------------------------------------------------------------------- +Sure. First on your video comment, we're in four countries right now, the US, UK, Germany and Japan and we have stated that we will be in India soon. The content that we are creating, through Amazon studios, we are generally holding the worldwide rights to and can use that in other countries as well. The cost of that then get amortized to the country and becomes part of the international segment results. Yes, we consider that to be very valuable as opposed to versus licensing many times, by country the third-party rights to content that we don't create ourselves. +Your question on fulfillment expenses, I can't extend the guidance into next year. We will do that, obviously, at the end of next quarter. I would say we are -- this was in extraordinary step-up as I mentioned in Q3 that is tied to very rapid growth in not only paid units but Amazon fulfilled units. Really our forecast for additional capacity additions and the rate of addition will be tied to those growth factors as well. +We will have to see. We right now are working on getting the capacity in. It was very lumpy this time, with 18 warehouses in one quarter and another 5 in the first three weeks of the next quarter. Obviously we will be working on the efficiencies of all of the warehouse we have, including the ones that we just started up this year. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Colin Sebastian with Baird Equity Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Colin Sebastian, Baird Equity Research - Analyst [25] +-------------------------------------------------------------------------------- +Thanks. A follow-up on the FC question. I guess more specifically, it sounds like you have enough capacity in terms of fulfillment centers for the holidays. Also wondering what your comfort level is in terms of your shipping partners to manage those deliveries. Secondly, was wondering how you would characterize the pricing environment for AWS, in particular with more deep pocketed competitors in the space now. Google in fact highlighted this on their conference call today. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [26] +-------------------------------------------------------------------------------- +Sure. Let me start with transportation. Yes, we are looking forward to a great holiday. That includes working with our shipping partners, both in the US and globally. We have worked very closely with them to line up capacity, share capacity plans. We certainly have additional delivery capability of our own, but with all of our partners, we work well in advance of the holiday to get our plans in place. We feel very confident we're looking forward to a great holiday not only for customers but also for sellers. +On your question on AWS, I didn't listen to the Google call. You will have to fill me in on that later. The thing that I can tell you about pricing is that our pricing is -- price reductions are a core part of our philosophy, of course. We had a price decrease in Q3. That was our 52nd since we started this business. It's -- we are comfortable with price decreases. Not only did we lower the prices of our products but we also create new services that are cheaper that customers can switch to. They can also benefit from that as well. +If you step back and say, why do people choose AWS? I'll give you the points I said last quarter. Basically what we hear are the functionality and pace of innovation. It is greater than our competition. We have added new -- more new significant features and services this year already than we had all of last year when we added 722. We have a partner and customer ecosystem. You've read about the VMware deal that we signed this quarter. We continue to extend with partners and build ecosystems that better can support customers. +Finally, experience. We have been in this business a long time, longer than anyone else. We've used that time to make our product and services better. There's going to be a lot of winners in the space, as we said, but we are very happy with our position and the customer reception to our products. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Justin Post with Merrill Lynch. Please proceed with your question. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [28] +-------------------------------------------------------------------------------- +Great. Thank you. I guess when you look at fourth-quarter guidance and you back out AWS, it suggests that margins are -- on the core business are going to be pretty down versus last year. Do you view this as an abnormal investment cycle or just part of the overall kind of ebbs and flows of the business? Long term, I know several years ago you talked about maybe high-single-digit, low-double-digit margins long term. I wonder if you could refresh us on that and also let us know if you think international has structural marginal differences than the US, the core retail business. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [29] +-------------------------------------------------------------------------------- +Sure. Yes. As far as the continuation of the investment and into next year, I cannot give you as much color on that today. What I can tell you again is that we have ramped up considerably. We have been investing quite openly in a lot of areas and continue to do so. We are experiencing a ramp-up, if you will, in the second half of this year, particularly tied again to the fulfillment center and expanded also the video content spend. +We will continue to invest in video content. We will continue to invest in fulfillment space to handle higher and higher paid unit volumes than shipped unit volumes. We will continue to invest in things that we believe enhance the customer experience, particularly the Prime experience. Devices we will invest in, particularly Alexa and the Echo products. We will continue to invest in getting faster and faster shipping methods for our consumers. We believe that is working. We are very happy with the results. We're very happy with all of the customers we have but particularly the Prime customers that we have. +As far as long-term operating margins, I can't forecast that right now. I can't forecast that for our AWS business, either. We are, again, working on two fronts. We are honing the businesses that we're in and making them as efficient, as profitable as possible while also investing very pointedly and very wisely, we believe in things that will enhance customer experience and create lasting businesses for us down the line. +We have said we want things that customers will love, can grow to be large, will have strong financial returns and durable and can last for decades. That is still our mission. We have pillars of the business right now with Marketplace, AWS and Prime and we're actively looking for a fourth and fifth pillar. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Heath Terry with Goldman Sachs. Please proceed with your question. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [31] +-------------------------------------------------------------------------------- +Great. I'm wondering, there obviously have been some headlines since the call that you did earlier with the press on the scale of this investment cycle relative to other investment cycles that you have been through. With the 2014 cycle sort of being the most recent, could you quantify a little bit more how you would compare this investment cycle to that most recent one? To the extent that we're in the midst of this investment cycle, would you say we're in sort of the earlier or later stages? Any sort of clarity around that would be useful. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [32] +-------------------------------------------------------------------------------- +Sure. Yes. The word cycle, if I mentioned that, was an omission. It was a misspeak. The investment that we are seeing is a step-up versus what we have experienced in particularly the first half of this year and the last half, the second half of last year, which I mentioned. +We have said investments are going to be lumpy. They are going to be high sometimes and they will be moderate at other times. We are right now, the second half of this year looks like a big step-up compared to the first half, and it is. But, again, it is all areas that we will continue to investment in, some of which I just actually went through the laundry list. +I would not characterize it as the cycle. I would characterize it as continued investments. We make investments with the idea that they are going to pay off and they pay off in either directly in the business they're in or in their contribution to the total business, many times as a part of the Prime program. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of John Blackledge with Cowen and Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [34] +-------------------------------------------------------------------------------- +Great. Thanks. Two questions. It seems that you're increasing your efforts in the auto vertical with the recent launch of Amazon Vehicles. Just wondering if you can discuss some of the dynamics of the auto industry that make it attractive and maybe how it aligns with the Prime value prop. Also wondering if you had any plans to work directly with auto shops, just given your ability to service most areas in one to two days. +The second question, on grocery, would you consider physical locations in an effort to kind of expand and/or accelerate growth in that vertical? Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [35] +-------------------------------------------------------------------------------- +Hi, John. This is Darin. On vehicle, Amazon Vehicles is really a car research destination and built the automotive community for customers. Gets information that they need when shopping for vehicles offsite or shopping for parts and accessories on-site. The features include research tools, community engagement, where you can talk to other customers. Certainly we try to build a one-stop shop for vehicles as an extension to the automotive store, which engages customers to add information about their cars in the garage which makes it actually easier to shop for parts and accessories for your particular vehicle. +We think there's a lot of opportunity there to add convenience for customers. On the b2b side, certainly we do have an Amazon business offering. Businesses of all shapes and sizes can sign up to be a b2b customer. The selection that we have in our parts and automotive categories are certainly open to that channel. I wouldn't speculate on anything that we might do in a particular vertical for those business customers. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- +Sure. Your comment on -- your question on grocery and physical stores, I can't comment on any rumors or speculations there might be regarding that. What I will tell you is that we have experimented with physical stores. As you may know, we have three physical bookstores, one in Seattle, one in San Diego and one in Portland and two more coming, one in Boston and one in Chicago. +What we're finding is they're great places for customers to browse what ends up being a curated selection of books and they also get to try out our devices, which is very beneficial. They get to touch and try our e-readers, tablets, Fire TV and Echo. We like what we see with that connection. We also have pop-up stores that you may see and also college pick-up points. We will try different delivery methods or pick-up points or ways of getting product to customers, but nothing specific to point out on the grocery side right now. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Ben Schachter with Macquarie. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [38] +-------------------------------------------------------------------------------- +Given the low unemployment rates that you are seeing in the US, do you expect any unusual impact on wages for seasonal workers this year? Are you seeing overall wage pressure in the fulfillment centers? Separately, if you could talk about trend lines you are seeing in paid units versus shipping units. Are they diverging meaningfully versus the past? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [39] +-------------------------------------------------------------------------------- +Yes. On wages, nothing to point out for this holiday. Our challenge generally is the volume of head count that we're looking to hire. We work well in advance with agencies to help to get seasonal employees and many of them turn into full-time employees after the holiday. Nothing specific on the wage pressure front. As you probably saw, head count is up 38% year over year in Q3 and that is continuation of a lot of ops roles that are supporting this high demand, the opening the fulfillment centers we talked about, new Fresh locations, Prime Now, but also and a lot of hiring in our tech areas, strictly around AWS and also the Echo/Alexa areas. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [41] +-------------------------------------------------------------------------------- +I'm sorry. The second question? + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Sorry, go ahead. Okay. Our final question will come from the line of Neil Doshi with Mizuho. Please proceed with your question. + +-------------------------------------------------------------------------------- +Neil Doshi, Mizuho Securities - Analyst [43] +-------------------------------------------------------------------------------- +Thanks. Can you provide a little more color into the investments that you're making in India? What is driving that growth and what stage is India in today relative to some of the other large international markets that you have launched in the past? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [44] +-------------------------------------------------------------------------------- +Yes, sure. We are very encouraged by what we're seeing in India, but it is certainly very early on still. Most recent highlights would be the launch of the Prime program in India this past quarter. It's now one of the top-selling units on Amazon.India. It has been well received by customers. +It is hard to compare India to any other country. It is very different in its stage and structure. Being a third-party market has caused a lot of invention on our side. We're being creative. The team there in India has been very creative on whenever they find a roadblock or something that has not existed in another country, they create it themselves, whether that's from delivery stations to working with small merchants to you name it. We're very happy with both the customer engagement that we're seeing and also the seller engagement, which is very important in India. Very pleased with the team that brought that over there and the way they work with teams throughout the world. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [45] +-------------------------------------------------------------------------------- +Brian, to step back to Ben's other question on units. Ben, this is Darin. Paid units grew at 28% again this year, as it did in the prior quarter. As Brian pointed out earlier, our AFN units, our Amazon Fulfilled Units, which includes our first-party units as well as FBA unit that's that go through our warehouses, are continuing -- are certainly higher than that 28%. That is a result of the traction we're getting with our FBA sellers. +Thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2017-Apr-27-AMZN.txt b/Transcripts/AMZN/2017-Apr-27-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..d5a558fee5f102dc3c5809af65c6f0b4c81a8c7f --- /dev/null +++ b/Transcripts/AMZN/2017-Apr-27-AMZN.txt @@ -0,0 +1,420 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Amazon.com Inc Earnings Call +APRIL 27, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - CFO and SVP + * Darin Manney + Amazon.com, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Ronald V. Josey + JMP Securities LLC, Research Division - MD and Senior Research Analyst + * Stephen D. Ju + Credit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Gregory Scott Melich + Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Mark S. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Scott W. Devitt + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q1 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q1 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, April 27, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including in our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world event; the rate of growth of the Internet, online commerce and cloud services; and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. +Before moving to Q&A, I would like to draw attention to a new accounting rule that we implemented in Q1. The new rule requires excess tax benefits from stock-based compensation to be presented as an operating activity in the consolidated statements of cash flows. We retrospectively adjusted our consolidated statements of cash flows to reclassify excess tax benefits from financing activities to operating activities. And as a result, you will see an increase in our free cash flow measures for prior periods. +Additionally, beginning January 1, 2017, the excess tax benefit or deficiency for stock-based compensation is recognized as a component of tax expense rather than equity. This change resulted in a decrease to our tax expense for the quarter and a corresponding increase to our net income and earnings per share. Specific changes are presented in the footnotes to the consolidated statement of cash flows and related metrics provided in our press release. Further disclosure of the impact of the adoption of this accounting change can be found in our Form 10-Q. +With that, we'll move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Got it. Saw on the front pages of release you're really focused on India. Can you give us a progress update on how you're doing? Any thoughts on how far you're willing to take the investment levels there? And what are your thoughts on maybe when international margins can start to make progress? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Sure, Justin. Thank you. Yes, I think Jeff's comments were pretty dead on. The launch of Prime last year was a big turning point. We've increased Prime selection by 75% since launching that 9 months ago in India, also increased the fulfillment capacity for sellers by 26% this year. On the content side, we've announced 18 Indian Original TV series, and we're customizing the content. So it's a really vast selection of local and global movies and TV shows that are available to the Indian public. You'll also notice that the Fire TV Stick was -- the new version of it was launched in India with some important features there, such as the ability to search in Hindi and in English, free data usage for 3 months and also data monitoring, which is important there. So we're -- again, we continue to be encouraged by both the response from customers and sellers. As far as level of investment is concerned, it is certainly one of our important investment areas. We see a lot of potential for the country and our business there. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [4] +-------------------------------------------------------------------------------- + + Any thoughts on how much this is impacting your international profitability? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [5] +-------------------------------------------------------------------------------- + + Sure. I can't quantify it, but -- or break out specifically, but I will say it's a large factor as well as a couple other things in the international segment. So keep in mind that we launched Prime Video in the fourth quarter, and now we have that in over 200 countries and territories. We're spreading a lot of the Prime benefits that we've seen in North America to other countries. We just opened up AmazonFresh in Tokyo last weekend, but also Prime Now. You saw other things like our business -- B2B business just opened up in the U.K. We have Amazon devices. So there's a lot of moving parts here. The other big influence is the same trends are happening in international with respect to FBA growth and the fact that our Amazon fulfilled network or the units we shipped are growing at much faster clip than our paid unit growth. Last year, we said that was a 40% -- nearly 40% growth worldwide, so we're making the investments in warehouses, fulfillment capacity and delivery capacity to handle that. So there's a lot going on in international. We are very encouraged with the growth of the Prime program, and we're hopeful for the Prime Video that we launched in the fall. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark S. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [7] +-------------------------------------------------------------------------------- + + Okay. 2 questions. The North American operating margins seem to come down like 70 bps year-over-year, and I know it's not a big focus of you, the margins. I get that, but it's sort of a change. You've had margins be flat or up year-over-year for quite some time and now they dip down. Just could you explain that? And then secondly, on these -- on the Echo devices, the Echo family, Alexa devices that are coming out, could you comment at all about what kind of impact you're seeing in terms of increased wallet or per share within household? Are you seeing that have an impact in terms of Amazon customers more likely to spend more once they have these devices in particular categories like groceries or household products, Pantry, products that they're more likely to spend because they have these devices in their houses, in their kitchens, in their living rooms? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [8] +-------------------------------------------------------------------------------- + + Sure, Mark. Let me start with the Echo question first. So yes, we're very encouraged by the customer response to the Echo products. Not only the Echo products, but the ability to use tablets -- our tablets now as Echo devices since we've spread the Alexa technology to many of those devices. And we're also happy with the success we've had with developers. There's over now over 12,000 Alexa skills. So we think that's all foundational. The monetization, as you might call it, is -- the theme of your questions, that's not our primary issue right now. It's about building great products and delighting customers. We think as engagement -- as we pick up engagement with the devices, it helps the engagement with Amazon as a whole. So whether someone is ordering off their Alexa device or whether they're going to their phone or going to their computer, it all has the same effect for us. So very, very pleased with the initial progress. We see a lot of momentum there, and we continue to invest. And that's one of the answers to your second question on North America operating margin. So if I step back, let me just talk generally about investment. So right now we're just seeing a lot of great opportunities before us, and we're continuing to ramp up the investments in pursuit of those opportunities. And the big picture is, again, as we've said, customers -- we want the things that customers love, can grow to be large, will have strong financial returns and they're durable and can last for decades. So in that category and some of the things that we are investing the most in are, as you say, the Echo and Alexa devices. We're doubling down on that investment, video content and marketing, not only in the U.S. but globally with the launch of our Prime Video in the fall. So we're building global scale in that business in both content and marketing. As I said earlier, we're expanding Prime benefits in the U.S. and also globally, things like Prime Music, Prime Now, AmazonFresh, all expanding globally. And we've launched Prime in India, China and Mexico. I know I'm drifting a bit from North America, but it's all part of the same theme. We also have this trend going on in our fulfillment networks where strong FBA growth and high growth in Amazon fulfilled units is resulting in a large increase in fulfillment capacity. We're also investing in new technologies, such as artificial intelligence, machine learning. You're starting to see some of that show up in things like Amazon Go, our beta store that we've developed in Seattle; drones. We use those technologies a lot in our internal businesses, and we're also developing services for AWS customers. So -- and that's -- of course, another area as AWS continues to grow and add services and features and doing so at an accelerating rate. So there's a long list and I can keep going, but I think the general theme is we're -- there's a lot of investment in front of us that we're optimistic about and we continue to ramp those investments. In North America, that manifests itself mostly in the device area, the content area and also the expansion of the fulfillment networks. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- + + I have 2. Just the first one, Amazon always has a pretty big focus on efficiency. So I'd be curious to talk -- if you could talk about examples or areas where you've been able to iron out inefficiencies in the fulfillment process. And there's -- any still existing examples where you see low-hanging fruit to really improve fulfillment efficiency? And then just back to the point on investment, you didn't mention brick-and-mortar at all, yet there's been a lot of mention in the press about Amazon brick-and-mortar. I guess I'd be curious to hear how you think about the importance of an Amazon brick-and-mortar presence and how that fits into the long-term strategy. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [11] +-------------------------------------------------------------------------------- + + Sure thing. So particularly as it pertains to our fulfillment center networks, I think the biggest areas of efficiency right now are in our Amazon robotics areas. That technology continues to improve, and we've -- we're now multiple generations down. We just launched a Amazon robotics fulfillment center in the Tokyo area recently. And so toward that last month, and it's just amazing to see the strides that the Amazon robotics has taken and the efficiency we're getting in our warehouse as a result. The other efficiencies we're seeing are network efficiencies, especially as we had things like sort centers. It's a collaboration and a movement between warehouses and sort centers and then to the end customer. The ability to have control through our sort centers has allowed us over the last few years to cut off our -- to extend our cut off times from 3 p.m., in most cases, till midnight. So greater control of our processes. If we do it cost-effectively, it can also have favorable benefits both for our warehouse flow and also for our customers and their ordering pattern. So there's a lot of efficiencies that are going on day-to-day around here. One of the benefits of rapid growth and -- is the ability to create leverage on purchases and a lot of the processes that we run. So your second question was on stores. Yes, yes, I think you're seeing the expansion of our bookstores. We have 6 bookstores right now, and we've announced another 6. The Amazon Go is in beta in Seattle. And while that's not large and it's only one site, we're excited about the potential there and the use of the technologies of computer vision, sensor fusion and deep learning. We think that has a lot of potential. Again, it's only one location. That's still in beta. But along with the bookstores, we also have -- you'll see us in pop-up stores and college pickup points. So for us, it's another way to reach the customer and test what resonates with them, and we're pleased with the results. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald V. Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + Brian, I think you mentioned accelerating growth within AWS on new products, and last year you added about 1,000. Can you just talk about maybe the plans for AWS and product growth going forward here in 2017 and the focus on innovation? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [14] +-------------------------------------------------------------------------------- + + Sure. Yes, we haven't updated that number, but suffice to say, the innovation pace continues to accelerate. We are very proud of the launches in Q4: the Amazon Connect, which we think will provide customer service-like capability to customers; and Amazon Chime, which we also believe will resonate with customers. We've had a lot of adoption of our new services. We've got customers migrated more than 23,000 databases using the AWS data -- database migration service since that launched last year. And just generally, we continue to expand geographically. We've announced additional Availability Zones and regions worldwide. So again, we signed a number of big customers. I guess I would point out in the quarter Liberty Mutual, Snap and Live Nation, all starting relationships with us or expanding their current relationship. We're now over $14 billion run rate, but we're happy with the business and the team. And again, for us innovation is going to be key as we move forward. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [16] +-------------------------------------------------------------------------------- + + Brian, a couple questions about your growing advertising business. We see more and more of it appearing on the site, and I was interested to hear a little bit more about how you expect that business to roll out internationally. I think it's largely U.S.-based today, but be curious to hear about that. And then second, I think it's fairly obvious what someone selling within the Amazon ecosystem would be interested in promoting on the platform. But maybe tell us a little bit about maybe over the long term, there are opportunities for sort of non-endemic advertisers within your platform. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [17] +-------------------------------------------------------------------------------- + + Sure. Yes, we're -- it's pretty early in the days with advertising, but we're very pleased with the team we have and the results. Our goal is to help -- is to be helpful to consumers and enhance their shopping or their viewing experience with targeted recommendations, and we think a lot of the information we have and preferences of customers and recommendations help us do that for customers. We have -- Sponsored Products is off to a great start, and it's a very effective way for advertisers to reach those especially interested customers. While you're on the topic of advertising, I thought I'd point out that in other revenue -- advertising is in other revenue, as is co-branded credit card agreements and also some other advertising services. That decelerated from 99% to -- in Q4 to 58% in Q1, but the fluctuation and the volatility was essentially in the co-branded credit card agreements and the other services, which can fluctuate quarter-to-quarter based on contract terms and that's what happened. Advertising was -- remains strong and was consistent growth with Q4. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju with Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Credit Suisse AG, Research Division - Director [19] +-------------------------------------------------------------------------------- + + So you periodically disclosed usage growth for AWS, but it has been some time since we saw one. So we're wondering if you can update us in terms of where you are now. If not, I mean, should we think about the growth in your cash deployment as an indicator of the ongoing growth? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [20] +-------------------------------------------------------------------------------- + + Yes, sorry, I don't have a usage number to share with you today. If it'll help, I will tell you that, again, we're now over $14 billion run rate. You clearly see our -- we break out very clearly our AWS segment revenue and operating income. And you'll also keep in mind that there's price decreases that are part of the business, and we're pretty public when we do those. And if you remember last call, I mentioned that we had 7 price increase -- or excuse me, price decreases that were timed for December 1. So about 1/3 of the impact of those was seen in Q4 and then, again, that's one element of the sequential operating margin. But in general, we're very happy with that team and the progress they're making. And we're deploying more capital, as you can see, to support the usage growth. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [22] +-------------------------------------------------------------------------------- + + I just want to ask you about CapEx. It looks like CapEx, including leases, more than doubled year-over-year. So I know you listed kind of a long list of the many investment opportunities here, but can you just point out anything else in particular that drove the pretty substantial increase there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [23] +-------------------------------------------------------------------------------- + + Sure. Yes, CapEx, which is principally the fulfillment centers, was -- grew 51% year-over-year. As you'll remember, we added 26 warehouses last -- fulfillment centers last year, 23 in the second half of the year. Some of that cost of startup is before the startup. Some comes in a quarter afterwards. So there was some carryover from that. But generally, the biggest trend here is that the difference -- differential between Amazon fulfilled network unit growth and paid unit growth. So that nearly 40% growth in Amazon fulfilled units last year and the continuation of the strong growth higher than the paid unit growth that we see in 2017 is resulting in a lot of fulfillment center capacity. And the fulfillment centers, I will also say, with the robotics technology tend to be more capital intensive than prior versions of warehouses and then they're -- generally have much better operating efficiencies and variable costs following their start up. On the capital leases, as grew 45%. A good deal of that is tied to the AWS business. As I just mentioned, a lot of that's tied to unit -- excuse me -- usage growth. But I'll caution, CapEx can fluctuate quarter-to-quarter. And if you look back to last year, the trailing 12 months was only 7% growth from the quarters through Q1 of last year. So certainly, there was a bigger step up in 2016, now carrying into 2017. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [25] +-------------------------------------------------------------------------------- + + I know that we talked about over the last couple quarters that part of the step up in CapEx was to catch up from the underinvestment in '15. Just curious if you'd say -- have you made a lot of progress in terms of catching up with some of the fulfillment needs that you saw necessary in the business at the beginning of last year? And then I know you just said that you're -- it still is early days in terms of advertising. But there's a perception out there that over the last year or so, that the company has sort of really begun to focus more on this business opportunity. Has something really changed at the business in the last year? And do you see advertising becoming a more meaningful part of the business over the near to midterm, I guess? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [26] +-------------------------------------------------------------------------------- + + Sure. Let me start with advertising. So yes, I think scale is helping. We have great teams working on advertising for a while now. Our scale in number of customers, number of clicks, number of eyeballs and new content -- or excuse me, video content and other opportunities for advertising has really helped create some scale in that business. So we're very happy. I can't project it forward, but we're happy with the growth there. I think the Sponsored Products was a very inventive move for us, and I think that is having some really good impact on advertising growth. On your second point about fulfillment capacity, here's how I'd generally -- I'd generalize it. We -- in Q4 of 2015, we were pretty vocal, or pretty transparent anyway, that we ran out of space in Q4, especially due to some very strong demand for FBA space and services. Last year, we changed some of our incentives to -- and worked with FBA merchants to try and have their throughput to our FCs, particularly in Q4. That, combined with the step up in fulfillment centers that I mentioned, the 26 new ones, left us in a really good position. We had a very clean holiday, and we think it worked well for both customers, Amazon and also for sellers, especially for FBA sellers. So yes, that leaves us now continuing to grow internationally as well because we continue to see strong FBA adoption, and it's a big part of our business, and it's a big part of our value with the additional Prime eligible ASINs that FBA provides. So again, it's -- they're self-reinforcing, the FBA program and also our Prime program. Prime program attracts more people to Amazon, and they buy more, including FBA products. And conversely, more FBA products in our warehouses helps our in stock of things that people want to buy, Prime eligible in stock, and that helps reinforce the Prime program. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- + + Wondering if you could give us a sense of how we should think about the increase in unearned revenue. Obviously this quarter, the biggest increase that you've seen from at least from a dollar perspective. What does that say about the way customers are changing in the behavior in the AWS business? How should we think about the way that, that might be impacting pricing mix, near-term growth? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [29] +-------------------------------------------------------------------------------- + + Heath, this is Darin. Yes, on the deferred revenue balances, as we've said in the past, the primary drivers of that increase are both the activity that we're seeing with our AWS customers and the purchase of Reserved Instances and prepaid credits for their account as well as Prime member purchases. We're not breaking out the specific growth rates for Prime. But certainly, we like what we see in terms of the growth, and it's been consistent with what we've seen over the last quarter or so. Certainly, part of that increase in deferred balances is related to Reserved Instances as customers get more comfortable and begin to put more sustained workloads into the AWS services. Through buying RIs, they're able to get fairly significant discounts on their usage. And so we like that model, customers certainly like that model and collecting that through deferred revenue and then letting customers use that over time is very helpful. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31] +-------------------------------------------------------------------------------- + + Question on the transportation and logistics initiatives and, in particular, if you could share any of the facts or learnings thus far with air cargo. In particular, what kind of performance or cost efficiencies that you may be realizing or expect to realize from this effort. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [32] +-------------------------------------------------------------------------------- + + Sure, Colin. As you pointed out, we're -- we've expanded our own fleet. We now have 18 planes in service for Amazon, and we've announced rights to lease up to 40 planes. So it's gone very well. The ability to control shipments within our network has gone up, and we think the cost is very good. So on that front, it's better control -- better capacity control and especially search capacity and also good costs. So we have great relationships with third-party carriers. We will continue to, and we value all of our partner relationships as we develop our own capability, particularly in intra-network. We're putting it to good use, as I mentioned before, with the sortation center example. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott W. Devitt, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [34] +-------------------------------------------------------------------------------- + + I was wondering if you could talk a little bit about where you are in terms of investment and capabilities in India at this point and how you think about that market longer term. And then secondly, also if you could just comment on the limitations and your willingness to invest more throughout LatAm, the way you have more recently in markets like China and India. And if I could, just finally, you've previously discussed satisfaction with the measurements of success for the video product in terms of consumer engagement and the effects on Prime. I was just wondering if you could comment on whether these metrics are continuing to improve as spending continues to rise on video and consumer awareness is seemingly growing as well. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [35] +-------------------------------------------------------------------------------- + + Let me start with your middle question. I think it was about Latin America growth. Let me step back and talk about international growth in general. So it -- our approach varies by country. If you look historically, we've taken multiple approaches. So in China, we bought an existing business, Joyo.com, and built off that base. In India, we started from scratch and have built a lot of things ourselves. And it's always going to depend on the country, the dynamics in that country both for retail, for online and for foreign investment. But a real key factor in all of this generally is management bandwidth as well. So we pick our spots carefully. You'll see -- you heard in the quarter that we've announced the intention to buy Souq in the Middle East. Where does that fit into the strategy? Well, Souq is a pioneered e-commerce in the Middle East, and they're creating great shipping experience for the customers and their multiple countries and they're doing a great job. So we see this as an example where we can learn from them and also support their efforts with our Amazon technology and global resources. So we -- we are in Mexico, but we're not in other parts of Latin America. We're -- we have a business in Brazil, but other countries will take on a case-by-case basis, again, bounded by what our management bandwidth can support and prioritization versus other things. You obviously heard my long list of investments. All of those are pretty much gated by the need for people and software engineers and strong teams to approach them. So international expansion gets played off in the same prioritization that other efforts do. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question comes from Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [37] +-------------------------------------------------------------------------------- + + So is there -- just an accounting housekeeping, a way to think about stock-based comp. You guys aren't providing that by segment anymore, but the rates of growth kind of differed by the businesses. And so is there just a way to think about, a, will that be in the Q, or are you not disclosing anymore? And is there a way to think about would, I guess, the patterns be consistent with historical patterns by segment? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [38] +-------------------------------------------------------------------------------- + + Jason, this is Darin. We, a number of quarters back, started breaking out stock-based compensation by segment, and now we've collapsed that in our op income by segment. So it's definitely in there. We do provide some disclosure by P&L line item on a consolidated basis that helps you identify that stock-based compensation expense in total, and you'll see the trend analysis in the metrics at the back of the press release. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [40] +-------------------------------------------------------------------------------- + + Maybe I could take 2 away from the press release just to understand a little bit of the quarter-over-quarter cadence. The retail subscription services, that's a pretty big jump up in the growth rate year-on-year in Q1 versus Q4. I think that might be Prime memberships had come on to paid from trial, but just want to understand what maybe what some of the driver was of that quarter-over-quarter in terms of the growth rate. And net shipping costs actually grew at the slowest rate by our count in a couple years. It looks like you're starting to get some improvements there in terms of revenue over costs on the shipping line. I just wanted to know what that was in terms of what's driving that, and can we expect that to possibly continue. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [41] +-------------------------------------------------------------------------------- + + Sure. Let me start with the retail subscription services revenue. So there's multiple things in that category, the largest is Prime membership fees, but also other subscription services like audiobooks, e-books, digital video, digital music and other subscription services. So you're right, there was an acceleration. Much like the comment I had on advertising and the other revenue category, the Prime membership growth rates for Q1 and Q4 last year are relatively consistent. So the volatility is in those other items. So I'm not quantifying the Prime membership or commenting on the growth rates other than to say it's been very strong and Q4 strength has continued into Q1. Your comment on shipping costs, yes, that is going to -- that was a lower unit volume as well. But generally, costs are going to be a combination of the tailwind -- the headwinds obviously are going to be FBA growth and shipping more products ourselves and this expansion of our Prime program and the demand for products from our Prime customers. And demand's been great. Again, there's over 50 million items that people can get delivered to their doorstep within 2 days or, in some cases, next day or same day. So it's going to be a big part of our cost structure, but it's an investment we work hard to reduce as far as rates and we're glad to spend it to support our Prime program. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And our final question will come from Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [43] +-------------------------------------------------------------------------------- + + I have a follow-up and then a new question. The follow-up is would love an update. You talked about the fulfillment centers, but could you update us on where we are in terms of rolling out Prime Now facilities and sorting centers -- just a count? And if you feel that's an area to really ramp-up investment this year, or what you got last year is sort of what you need. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [44] +-------------------------------------------------------------------------------- + + Sure. I'm sorry, you said Prime Now. And what was the other thing? + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [45] +-------------------------------------------------------------------------------- + + And the sorting centers. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [46] +-------------------------------------------------------------------------------- + + Sort centers, right. Well, I don't have updated numbers for you, but the Prime Now is available in more than 45 cities across 8 countries. The same day is available in 30 cities in the U.S. So that's a bit on the quantification of those. I can't tell you much more on sort centers. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [47] +-------------------------------------------------------------------------------- + + But when you think about building out the capacity, it sounds like last year you had that big surge in fulfillment centers. There isn't a similar surge about to happen this year on some of those other areas? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [48] +-------------------------------------------------------------------------------- + + Yes, I can't project that. We're still growing that, and we're happy with the progress in Prime Now and the service that -- the value it creates for Prime customers. And as I said, we've expanded internationally, which is a big goal of ours as well. So we will continue to grow that. I can't quantify it for you right now. The other similar-like facility metric you might want is AmazonFresh is now in 21 metro areas in the U.S. as well as London and Tokyo. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [49] +-------------------------------------------------------------------------------- + + Thank you for joining us on our call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2017-Feb-02-AMZN.txt b/Transcripts/AMZN/2017-Feb-02-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..13baa6cd67bce3eb5cf89473b498b0cb47ccd330 --- /dev/null +++ b/Transcripts/AMZN/2017-Feb-02-AMZN.txt @@ -0,0 +1,460 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Amazon.com Inc Earnings Call +FEBRUARY 02, 2017 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com Inc. - CFO + * Darin Manney + Amazon.com Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Anthony DiClemente + Nomura Instinet - Analyst + * Scott Devitt + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q4 2016 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q4 2016 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. +Our comments and responses to your questions reflect management's views as of today, February 2, 2017 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we have seen to date, and what we believe today to be appropriate assumptions. Our results are inherently unpredictable, and may be materially affected by many factors. Including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude additional business acquisitions, investments, restructurings or legal settlements. It is not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +And just briefly before we move to questions, I would like to address our Form 10-K that we will be filing with the SEC. We received a comment letter from the SEC's Division of Corporate Finance regarding our 2015 Form 10-K, and have subsequently been engaged with the SEC staff regarding our disclosures. +We will be revising the disclosures of net, product and service sales in our Form 10-K. As a result, we expect to file our 2016 Form 10-K later than we typically have, but before the SEC's due date of March 1. These changes relate to our entity-wide disclosures and do not impact the financial results that we report for the Company or our segments. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +John Blackledge, Cowen. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks for the question. So the first quarter GAAP operating income guide essentially implies negative incremental margins at the low, mid and high end of guidance. So just wondering if you can frame in order of possible the investment areas that are driving the negative incremental margins, and then just generally how should we think about the margin profile in 2017? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thank you, John. First, let me talk about revenue just to get that out there as well. +We are guiding to 17% to 25% growth on an FX-neutral basis. That includes approximately -- on top of that is approximately 250 basis points or $730 million of FX negative impact, which brings the non-FX adjusted range down to 14% to 23%. +I will also point out we that had the Leap Year comp from last year. Last year, the extra day of Leap Year was worth 150 basis points to us in our Q1 revenue. This year that reverses, so we have 150 basis point headwind to growth and it's been factored into our guidance range. +But your question was on bottom line. So yes, what you are seeing, John, is the continuation of the step-up investment that we saw in the second half of last year. I talked about in prior calls about the fulfillment center step up. +We had 26 warehouses we added last year, 23 of them were in the second half of the year. Digital content, digital video content, end marketing stepped up quite a bit in the second half of the year. +We continue to invest heavily in those two areas. We also have investments in other Prime benefits from Prime Now to Amazon Fresh, and of course we're continuing to invest in Alexa in our Echo devices. And finally I'd point out India which continues to be a rather large investment for us. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Scott Devitt, Stifel. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [5] +-------------------------------------------------------------------------------- + + Hello, thank you. The question is on video. I was wondering if you could just give any quantification in terms of the magnitude of video spend in 2017, as well as the lumpiness from an expensing standpoint quarterly? +And then separately as it relates to just the video service. From a positioning standpoint in the market, how do you think about the unique aspects of the product that Amazon has relative to others in the market in terms of is the aggregation tools that are being provided now where some of the value is being perceived longer term? +Is it the uniqueness of the content or is it other things? If you could provide a little bit of color on that, that would be helpful. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [6] +-------------------------------------------------------------------------------- + + Well ultimately, I will step back and say one of the main things we look at on Prime Video is customer usage patterns. And in 2016, we had a doubling of Prime hours for video, music and reading. So we are happy with the engagement that customers have. +We're also happy with the -- especially on the studio side, the people we have been able to work with. Some of the most talented people in the entertainment industry. And our customers have responded really well to the shows that we have created. We have garnered awards of course, but mainly what we were focused on is good content that is attractive to customers. +I will also point out that we rolled out the global Prime Video offer in the second half of last -- in Q4, and what we see there is again original content is a fixed cost expense. The more we can amortize it over a large base, the better off we will be. But more importantly, we have great content that we want to share with people outside of our primary retail countries and this takes us to over 200 more countries. +So we are very happy with the results in video. Yes, the investment did step up in the second half of last year, including marketing and that will continue in 2017 and likely beyond. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [8] +-------------------------------------------------------------------------------- + + Can you discuss what you're doing to help merchants in China sell and ship directly to consumers in the US and other developed economies, and how the business has been evolving over time? Thanks. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [9] +-------------------------------------------------------------------------------- + + Hello, Ben. This is Darin. We are very pleased with our FBA offering, and that's really helpful to sellers around the world. Certainly, our international sellers have access to more and more customers through that offering, and that doesn't exclude sellers in China as well. +The offering in China that we have for consumers is also a great trusted customer engagement. We have a very strong and trusted venue for Chinese customers to access international brands there, as we continue to focus on great offerings through the Amazon global store which offers great brands from outside of China to customers. And so there is a mix of things going on in China, and we're happy with what we are seeing in both of those. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Justin Post, Bank of America/Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you. A follow up on India and China. I know you are investing a lot, I'd love to hear how much but you probably won't tell us. +But can you tell us why you think the market is worth investment, and what really attracts you to the market as you think out longer term? And then China, can you give us any updates there on how financial performance is doing, and if you have changed your strategy and if anything has gotten better there this year? Thank you + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Let me start with India. So it's still very early. We continue to say that, but we're very encouraged with what we have created with customers and sellers alike in India over the last few years. +We continue to develop new functionality for that country, whether it's delivery, whether it's seller features. We rolled out Prime last summer, if you'll remember, and we recently launched Prime Video there. +So we've had success with Prime in every country we've been in, we don't expect India to be any different. We will continue to build our business there, and continue to do a great job for both customers and sellers. We are bullish on India longer term, and it's early but we like the initial engagement we are seeing and the response again from both customers and sellers. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + And this is Darin. On China, like I said, we are very pleased with our offering in China. Our strategy there has been one of bringing a trusted and authentic product to customers in China, both domestically and from international offers. +So we will continue to focus on the global store there. As you may know, we've launched the Prime program that's focused around the availability of international goods in China, and we are pleased with what we are seeing there. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Two primary questions. Can you give us a sense of what the best way to think about the impact that the shift to third-party? And within that the growth in FBA is having on these sequential growth rates? +To the extent that there is 150 basis point impact from Leap Year on a year-over-year basis, is there a way to quantify the impact that that shift to third party is having on the growth rate for the first quarter or for what you have reported in the fourth? And then on the AWS side of the business, with the price cut in November can you give us some sense of what impact the price cut had on the deceleration in growth compared to the impact that presumably it had in driving incremental volume to the platform? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Let me start with that second question first. So more basically on AWS, very happy with the response from customers. We feel we've got a very broad base of customers from startups, to small medium businesses, to large enterprises, to the public sector, and we are continuing to see strong growth across all those sectors. +The business is now a $14 billion annualized -- running at a $14 billion run rate. You are right that we had seven price cuts in Q4 essentially timed for December 1, so about a third of the impact was seen in Q4. But that's going to be constant in this business. +We have been pretty clear that this business is all about creating new functionality for customers, giving price cuts, and then working on the operating efficiency. So very pleased with Q4 and the pace of the business. +The new services and features last year were over 1,000 versus 700 or so in 2015. So we continue to innovate on behalf of customers. We are working with some very large customers in each industry. +You have seen probably press releases on companies like Capital One, Workday, salesforce and others. So again, widespread usage and new customer adoption which is great. +Your second question on FBA, I can't break out the year-over-year difference there. What I will say the impact of FBA on our business is, and first that's -- one of the things that we look at is how well are we attracting new FBA sellers. Because again, FBA reinforces Prime, Prime reinforces FBA. It's a good flywheel. +We added active sellers in FBA grew 70% year over year in 2016. So we are very happy with the continued adoption of FBA and what that does to Prime eligible selection for Prime members. +The other data point I will give you that affects our cost structure is our Amazon fulfilled units, which is the combination of retail plus FBA, grew nearly 40% last year. That compares to our paid unit growth of 24% in Q4. I'm giving you Q4 and a full-year number, but they are similar in relative proportion. +The fulfillment center expenses and a lot of our shipping costs are tied to the increase in that FBA percentage, and that growth of Amazon fulfilled units. So that is certainly a factor that we consider a positive from a customer standpoint, and it's one from a cost standpoint that we certainly continue to work on every day. But I think that's the most I can give you on FBA at this point. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [18] +-------------------------------------------------------------------------------- + + Thanks very much. Maybe as a quick follow up on the quarter, we have heard from other e-commerce companies and retailers about a higher degree of promotional activity during Q4. So I wonder if there was any conscious decision on your part to pull back from some of the more aggressive discounting? +And then my other question is whether you can shed any more light on the motivation to build out the air cargo hub in Cincinnati, understanding the need to support the growth of the core retail business? But also if this gives you more of an opportunity to build out direct connections to suppliers, for example, or longer-term offer excess capacity or logistics as a service? Thank you very much. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Sure, Colin. On your first question, holidays are always a very promotional period, so we don't see -- I can't really comment on the year-over-year differential in promotional activity to us. We are always looking to not be beat on price. We want to offer the best options to customers, and we saw a lot of great response from customers this holiday season. I think we'd be a very trusted holiday partner, particularly as you get closer to the holiday. +So on the promotion side, we don't consider it a huge factor either way. It's pretty much a cost of doing business 12 months a year for us. +Sorry, the second question was on the hub in Cincinnati or Kentucky. Yes, that is -- I saw the announcement on that, that is a partnership we have to build out a facility at the Hebron, Kentucky airport. We think it will create thousands of jobs over time. +What it does for us is it this gives us a base for future growth. It's all about supplementing our existing capacity, both our Partners and ourselves, and essentially building capacity that can handle this top line growth and also the growth in AFN, or Amazon fulfilled network units which as I just mentioned is even higher than our paid unit growth. +So same as some of the investments you saw in airplanes last year or partnerships with companies that do air cargo, this is about supplying our need for our customers and our sellers. We value the partnership with the external providers as well, and I think we're all dealing with the problem of having lots of incremental volume year over year. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you. Just a question on paid unit growth. For the last several quarters here it's been accelerating on a year-on-year basis, and I think this quarter 24% was below the 26% that you reported in Q4 of 2015. Just curious what had been driving the acceleration over the past few quarters, and what may be changed this quarter? +And then in terms of the Q1 revenue guidance, wondering if you could provide a little bit of color in terms of the impact that maybe the recent AWS price adjustments are having on your Q1 guidance? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [22] +-------------------------------------------------------------------------------- + + Let me start with the second one. We factored it in, and obviously into the numbers I gave through guidance the timing of it was again closer to December 1. So there will be a incremental differential in Q1 on those price cuts, but this is something that we again have quite frequently and I don't think it's a large factor in Q1. +The bigger one is more mechanical that Leap Day comp I would say. And if you are looking on a non-FX adjusted basis, the foreign exchange exposure which I mentioned was $730 million or 250 basis points expected in this guidance. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [23] +-------------------------------------------------------------------------------- + + Hello, Mark. This is Darin. On that unit growth, we're very happy with the 24% unit growth that we saw in Q4, like you mentioned. Our unit growth has been strong, it's primarily attributable to our Prime program and the customers and members that enjoy that program. +As Brian mentioned, that 28% is only part of the story. Our Amazon fulfilled units, the amount going through our fulfillment centers which essentially includes our first-party retail and our FBA sales, grew nearly 40% over 2016. So we are very pleased with those results, and happy with the fundamentals of the business from that perspective. +Customers continue to respond very well to the low prices, the vast selection, which is helped by the FBA sellers, and the strong convenience that we can offer through free two-day shipping and the multitude of other faster shipping options. Such as same day, next day, and in some cases with Prime Now the 1 to 2 hour delivery. Prime membership and selection continues to drive growth, and you'll see that in our unit growth numbers. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking the question. A lot of talk obviously about border tax. I was hoping that you could give us some of your initial thoughts there and how you might think about some of the key considerations around a potential border tax. +And then secondly, can you talk a little bit about fulfillment centers? You mentioned the 26 fulfillment center build out in 2016. Any color that you can give us in terms of how you're thinking about that for 2017? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [26] +-------------------------------------------------------------------------------- + + On the first one, we have a long-standing practice of not commenting on regulatory or tax matters. So I am not going to comment on any proposed issues out there. We certainly keep an eye on external issues and weigh in when we think it's going to impact our business. +But the -- sorry, your second question was on FCs. We will continue to invest in FCs. The comparable I will give you is that I won't forecast 2017, but the 20% growth in square footage that we saw in 2015 was followed by 30% square footage increase in 2016 that generally went to service that 40% growth in units in AFN units. +It also included some of the additional logistics delivery stations and all too, so it's not all FC capacity that's square footage. But I would say that we're going to continue to invest in fulfillment centers as long as our AFN growth rate maintains high, and we certainly want to keep that high and growing. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks, two questions please. First, any comment on customer growth qualitatively how that trended throughout the year, accelerated, consistent, decelerated? And then would you be willing to give any commentary on the engagement impact you're seeing from all of these Echo devices that are getting into households? +Are you seeing people shop more? Are they engaging more with other parts of Amazon? Just any impact on what people with these Echo devices do that's different than Amazon customers that don't have them? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Let me start with the Echo. I don't think I'm going to answer your exact question there on quantifying the retail sales through Echo devices. It's still very early days on that, so that's not material. +But the engagement is just like any other Prime benefit or investment that we have. We do look at engagement, and we like the engagement of customers who have Echos. But let me step back and give some highlights on that, Alexa and Echo together. +As we mentioned in our press release, the unit sales of Echos grew nine times 9x year over year during the holiday period. So great customer adoption. We are really glad to see that, and that creates a great base of Echo and Alexa fans out there. +We've added 4,000 skills to Alexa since I last spoke to you in October, and we are working with a lot of major companies as they add abilities for our customer base to use the Alexa or the Echo to reach them. Tens of thousands of developers are building new skills for Alexa, so the skills addition should continue. And just as importantly, tens of thousands of developers are also using the Alexa voice service to help integrate Alexa into their products which then creates a great network effect. +We're doing that ourselves. If you've seen in the quarter, we added Alexa capabilities to our tablets and Fire TV devices, making them better. So it's a great part of the flywheel in that Echo and Alexa make the devices better, and it builds the engagement, not only with Echo and Alexa but also with Amazon. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [30] +-------------------------------------------------------------------------------- + + Hello, Mark. This is Darin. On the customer account, no absolute number to give this quarter. As you know, back in Q1 we gave an active customer account that exceeded $300 million. I can see it's still growing, and we're pleased with the number there. +What we do like is the engagement with Prime. We continue to add Prime members, and similar to the flywheel that Brian was just mentioning the FBA selection helps us with engaging customers, and in particular the Prime program. So we are very pleased with our customer engagement this year. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks for taking my questions, I have two. The first one is on the last mile on the Logistics build. Can you help us at all on what you are seeing in some of these markets, like the UK where you have more of the last mile build out done on your own? Is there anything you're seeing about Prime behavior? +What are the advantages and even the challenges you are facing as you're building out a last mile? And secondly, on the brick-and-mortar stores, any learnings and strategically just talk to the strategic advantage of having a bigger Amazon storefront? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Let me start with your first question. So as you point out, we have had Amazon Logistics deliveries in the UK for more years than some of our other countries, and what we see is it gives us control of the shipment for a lot longer. We can shift order cutoff times out, and time is valuable to us because again we can avoid split shipments, we can avoid other costs of acceleration. +So having control later in the process is very valuable to us, especially as we're working across multiple nodes in a network. But I have driven with drivers in downtown London, and it's a very interesting experience. I think it's a great value to our customers. +It's interesting to see the route density that we see in high cities or in some cities, and the challenges and the upside of that. But I would say essentially in a nutshell, our logistics deliveries allow us to have better control of the end delivery in markets where we use it. The challenge is always going to be cost, and as we get better at this and get economies of scale we lower those costs over time. So that's essentially my overview of Amazon Logistics. +Sorry, your second question was on the stores. You probably noticed we opened the Amazon Go store in Seattle in the fourth quarter. We think that is very interesting. +It's only one store at this time, but it's using some of the same technologies you would see in self-driving cars, computer vision, sensor, fusion, deep learning. So it's a great accomplishment by that team. It's in beta right now and we like the promise of that. +Probably more advanced and further along are the Amazon Bookstores. We have three physical stores Seattle, San Diego and Portland right now. We see adding five more this year. So we are still in that phase where we are testing and learning and getting better, even on the bookstore. +I would say there's other things that are physical in nature, the pop-up stores and college pickup points that we learn from as well, and think creates a great value particularly at the college pickup points. So not much projection beyond where we are today, except for the fact that we will be adding more bookstores. +But we test, we innovate. We think the bookstores, for instance, are a really great way for customers to engage with our devices and see them, touch them and play with them and become fans. So we see a lot of value in that as well. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Jason Helfstein, Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks, two questions. As we think about investment in the first quarter in 2017, any color how to think about domestic versus international? You did give some comments about India, but any other color or how to think about it. +And then on AWS, you announced both new products at re:Invent at the low end and at the high end. Any commentary on if that impacted the types of customers who you have been adding on AWS with those new products? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [36] +-------------------------------------------------------------------------------- + + I can't give an exact split of the investments by geography, but I would say most of the fulfillment expansion was in North America last year, most of those 26 warehouses we talked about. We see that being more balanced over time, and being more global as we move forward. +Video content is with the new global program. Global Prime Video is becoming more global with the launch in India as well, and of course we had Prime Video in some of our existing countries prior to that. So that is going more global, and will be more balanced as you see devices rollout to other countries same thing. +So I would say over time, it will become more balanced and probably what you have seen in the short run tended to be more North America focused. But I can't give you a great split of -- I'm not giving you absolutes anyway, so I can't give you a great split of the two. +And I will also say that not all of our investments are on the consumer side. AWS continues to expand their global footprint. Last year, we added regions in the UK and Canada, we now have 42 availability zones in 16 geographic regions and will continue to grow that business globally. And India again, we've mentioned, but that is obviously an international investment. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [37] +-------------------------------------------------------------------------------- + + On the customer split, we serve, in AWS, we serve millions of active customers along the spectrum of large enterprise companies, as well as small startups and the public company or public environment as well. The multitude of launches that we had in re:Invent was great for all sizes of customers really, both large and small. +Both companies just getting there start with AWS, but also companies that have been engaged with AWS for many years. So we're really happy about the engagement of re:Invent and the participation in that conference, as well as the engagement of the new services that we have launched in Q4 and all of 2016 really. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks for taking the question, maybe two if I can ask. One, the other North America revenue line in our view has a lot of advertising revenue in it, and that line continues to show a lot of momentum, come in better than expected. Can you talk holistically short, medium, long term about how you think you are approaching an advertising business across your broad properties? +What that might become longer term, and how that might impact the P&L? And then one housekeeping item, anything to call out as an impact from demonetization efforts India in either Q4 or Q1? Thanks so much. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [40] +-------------------------------------------------------------------------------- + + Yes, I will take the advertising question. Yes, it's very early in the advertising space, but what our goals there are to be helpful to customers and enhance their shopping and viewing experiences. Mostly with targeted recommendations. We think that is a good strategy rather than invasive things that take away from the shopping experience. +I would sponsored products is off to a great start. They're finding a very effective way for advertisers to reach interested customers. +We also on Video have not added much in the way of advertising yet. There is some pre-roll as we call it, but for the most part we like to the progression. We are balancing customer experience with advertising at all times, and we like the team that's working on it. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [41] +-------------------------------------------------------------------------------- + + And on other revenue, I just want to call out. There's a number of things going into that particular line. These things include revenue from our co-branded credit card arrangements and certain advertising, particularly display advertising. +We have other types of advertising that spread out throughout the P&L, whether that's a shared marketing investment from our vendors which goes into contra COGS and lowers the cost of sales or its related to other seller advertising which is generally within the EGM and media categories. I would say other revenue incorporates a number of things, not just advertising. And on India demonetization, nothing particular to call out today on that. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Nomura Instinet. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Instinet - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. It's about Prime Video, you said you were pleased with the hours of engagement. My question is do you think that the hours of video stream need to accelerate from here to get to an adequate return on the invested capital in video, or are you happy with those returns with the current levels of engagement? +And then relatedly on Prime Video, could you just talk about your ambitions to potentially extend the video offering beyond on demand and into possibly a virtual cable bundle? And then finally, just a question of do you need to aggressively partner with distributors, whether they be cable distributors or hardware device companies, in order to get better distribution of the Amazon Prime Instant Video app and content to your customers? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [44] +-------------------------------------------------------------------------------- + + I can't add too much or won't add too much on the last two questions, but I will say on -- you're talking about the levels of engagement now that we are seeing versus what would be the long-term model over time. We're certainly spending ahead of the value of the engagement right now. But it's a good sign that it's building, an important step was that global Prime program that we launched in the fall, excuse me, in Q4. +As I said, it's very much a fixed expense game, especially with original content. The fixed amount can go up or down, but the ability to amortize it over large population is what we are looking for. So we see a double benefit of the global Prime Video program, again, both to amortize the investment in original content but also to show that original content to more and more people. +Because we think it's done really well. We think it's won a lot of awards, and we have worked with some great talented people. It's our ability to scale that and to amortize it over a much larger customer base, which will help us in the future. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [45] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking to you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2017-Jul-27-AMZN.txt b/Transcripts/AMZN/2017-Jul-27-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..06e12cd6de84fcffaae5da948290c880f09c5f26 --- /dev/null +++ b/Transcripts/AMZN/2017-Jul-27-AMZN.txt @@ -0,0 +1,333 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Amazon.com Inc Earnings Call +JULY 27, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - CFO and SVP + * Darin Manney + Amazon.com, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Brian Patrick Fitzgerald + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, July 27, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements and excludes the impact of our proposed acquisition of Whole Foods Market. It is not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I was just wondering if you could give us a sense on the investments that are planned in Q3. Previously, you've been willing to provide sort of some qualitative guidance around how you're rank ordering those in terms of the ones that are -- the largest areas of investment in the quarter. Just wondering if you could update us on that just given the guidance for Q3 and what we saw in investment in Q2. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Sure. Let me see what I can tell you on that. First of all, I want to remind you that Q3 is typically a lower operating income quarter as we're preparing for the Q4 holiday peak. The other dynamic is that similar to last year, a large percentage of our new fulfillment centers are coming online in the second half of the year, a lot of them in Q3. So to give that some perspective, the Amazon-Fulfilled Network or the combination of retail and FBA shipments coming out of our warehouses has been nearly 40%. It was that last year and it's continued through this year. Last year, we added 30% additional square footage to handle that additional shipping volume, and about 80% of that went in to service in the back end of last year. That's what I mentioned about this time last year. The -- similar dynamic this year. We're going to have about 80% of our increase in square footage for fulfillment and shipping coming online in the back end of the year. So that's a major increase. The other comment I would make is on the content -- video content. Video content, last year I highlighted the fact that it was going to be a significant step up between first half -- second half of 2016 and the second half of 2015. We are still -- we lapped that most of the first half of this year, and we'll also be increasing video spend on a sequential and year-over-year basis in Q3 and that's included in this guidance. Other than that, I can't give much more specifics except to say that the large investment areas remain increasing fulfillment capacity to service the strong growth of the FBA business. I'll also point out that the strong usage growth at AWS has led us to a step up in infrastructure in the form of capital leases. We've built capital leases in the trailing 12 months. They've increased 71% through the end of Q2 versus last year. That is servicing -- accelerating usage in our largest AWS services as well as geographic expansion. So that's additional factor sequentially in the quarter year-over-year. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + A question on the grocery category and the announcement that we have -- that we heard recently. Specifically, does that imply that the strategy has changed around Fresh, which was presumably replacing the trip to the grocery store? Or should we think about adding different modes, such as pickup points and bricks-and-mortar, as serving a distinct customer base or geared to reduce the cost bottleneck around home delivery? Any comments would be helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [6] +-------------------------------------------------------------------------------- + + Sure, Colin. First, as far as Whole Foods is concerned, as Darin mentioned, it's not included in this guidance since it hasn't closed yet, but we are excited about that acquisition and looking forward to working with the team at Whole Foods. We think they're very customer-centric just like us. They've built a great business focused around quality and customers. So we're really glad to join up with them. On your larger question about with the place of AmazonFresh, that include Prime Now and some of our other efforts, I would say we believe there will be no one solution. So we're experimenting with a number of the formats, from physical pickup points in Amazon Go to online ordering and delivery to your door through Prime Now and AmazonFresh. And we'll see how customers respond. We like the response that we've seen so far. We think they're valuable. All those are valuable services. Amazon Go is not out of beta, but the other ones are. On top of that, we're looking forward to adding the Whole Foods team and their great reputation for quality and customer service to this offering. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [8] +-------------------------------------------------------------------------------- + + A couple of questions. It definitely seems relative to your guidance, you may have stepped up spending in the second quarter. Anything in particular to call out, India or anything like that? And then just thinking bigger picture, I'm wondering why physical locations might make sense for Amazon. Why is that a positive use of capital going forward? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [9] +-------------------------------------------------------------------------------- + + Sure. As far as Q2 is concerned, we were very encouraged by the revenue and unit growth acceleration, particularly in North America. We see that as tied to the Prime growth and the adoption of Prime and success of that program. Also point out that AWS stepped up its run rate from a $14 billion run rate last quarter to $16 billion. So we saw the largest quarter-over-quarter and year-over-year increase in revenue in that businesses as well, and gross margin expanded 130 basis points. So as you point out, the year-over-year difference is primarily driven by investments. The -- we're within the guidance range, and we continue to invest in, as I said, fulfillment capacity and logistic services, digital video, our Echo and Alexa -- Echo devices and Alexa platform, India, the buildup at AWS infrastructure, all the things I mentioned, not to mention Prime Now and AmazonFresh and Prime benefits. We did see a big jump in headcount in year-over-year. You'll see it's 42%, and in the past I've said most of that is driven by operations hiring. And I've even said that headquarters office hiring many times in the past was below the level of revenue growth. Right now what we're seeing is an accelerated growth rate in software engineers and also sales teams to support primarily AWS and advertising. So yes, those -- the growth rate of those 2 job categories actually exceeded the company growth rates. So we are adding -- having success hiring a lot of people and pointing them at some very important programs and customer-facing efforts. On the place of physical, again, as I mentioned in the earlier question, we are experimenting with a number of formats. You've seen the physical bookstores, and I would say that the benefit there is -- again, we have a curated selection of titles and it's also a great opportunity for people to touch and feel our devices and see them, especially the new Echo devices. I went into the store in Seattle last week and I saw about 1/3 of the people were standing around the device table, learning how they work, how they interact with the devices. So I saw firsthand the customer experience. I think that's where we're seeing the benefit to the physical stores right now. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [11] +-------------------------------------------------------------------------------- + + Question on the comments around the fulfillment investments. Could you characterize or maybe even quantify how much of the fulfillment infrastructure investment that you're making is going to incrementally gear towards handling growth in sort of the existing business and infrastructure versus expanding your capabilities in fulfillment, like adding more inbound or last mile and/or from entering new international markets where you need to invest ahead of growth versus just sort of keeping up and maintaining growth within sort of your existing footprint? And then AWS, you had some price adjustments in May, yet the Q2 growth was quite good. Can you just comment about the impact that those cuts may have had in Q2? And if you're modeling those also in your Q3 guidance, maybe the impact there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [12] +-------------------------------------------------------------------------------- + + Yes, let me start with the second one. So yes, we've had numerous price increase -- or decrease, excuse me, and we continue to have that in the AWS business, both absolute decreases in service costs and also rolling out new services that may be cannibalizing more expensive, other services that we provide. So nothing really to note on Q2 or Q3 from that standpoint. The fulfillment investments, I can't split it out for you between Amazon Logistics support sort centers and fulfillment centers. What I can say, the biggest dynamic going on, again, is that Amazon-Fulfilled unit growth of nearly 40%, which was last year and carrying it to this year. It's a global number, and we are very glad of the success of the FBA program. We're matching that with just over 30% increase in square footage. And yes, you're right, that does include some shipping sort centers and things that are incremental and new functions for us, if you will. But that's about all I can say on that right now. I think we're very happy -- we're very happy with the FBA program, its impact on Prime and we think Prime and FBA are self-reinforcing. We know customers really like it, the additional selection that FBA provides. So we like those combined, and we are working very hard to match that with capacity in an efficient manner. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [14] +-------------------------------------------------------------------------------- + + I just wanted to follow up on AWS and just on the back of the price cut, obviously 1Q being the first full quarter, but it looks like 2Q, as Mark said, things did stabilize some. Can you just talk about whether you're seeing more of a volume pickup response here and companies kind of more actively moving volume into the cloud at these lower prices? And then just secondly on Prime, the value of the Prime subscription for the consumer seems to continue to increase as you add more features in there. Can you just talk about your view around the flexibility of the price of an annual Prime subscription? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [15] +-------------------------------------------------------------------------------- + + Sure. On the price of Prime, I have nothing to add at this time. We think that the -- we're increasing the value of the Prime program every day. So it becomes more and more valuable and again, as we've said, it's the best deal in retail. On AWS, yes, the -- we are seeing great customer adoption. The -- again, as I've said earlier, the run rate's gone up from $14 billion to $16 billion in Q2. And also, we had the largest sequential and year-over-year dollar rise in revenues. Our usage in all of our large services are actually accelerating, so -- and they're growing at a rate higher than our revenue growth. So we're seeing great adoption. We are seeing AWS customers migrate more than 30,000 databases over the last 1.5 years. We've signed some very big customer wins like Ancestry, Hightail, California Polytechnic State University and others that we're very proud to have. So yes, the momentum in the businesses is very strong. We continue to open new regions. We'll be opening 5 regions in the near future in France, China, Sweden, Hong Kong and a second government cloud region in the east. So yes, we like the momentum in that business. Stepping back, I would say that where pricing is important, again, we're generally being selected because of our functionality and pace of innovation. The innovation keeps accelerating. It did in the first half of this year, the pace of new services and features. We also know that customers value our partner and customer ecosystem, and really the experience we've had. We've been at this longer than anybody else. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [17] +-------------------------------------------------------------------------------- + + I want to stick with AWS, please. So the AWS revenue growth showed almost no change, but the AWS operating margin was lower, I guess, than we've seen in, I don't know, 6 quarters or something like that. I find that a little surprising, but then I also saw that the tech and content came in materially heavy, I think, versus our and, I assume, other expectations. So could you just talk about that a little bit, the profitability, if there's anything that's changed in the profitability of AWS? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [18] +-------------------------------------------------------------------------------- + + Sure. Those margins, as we say frequently, are going to fluctuate quarter-to-quarter and always going to be a net of investments, price reductions and cost efficiencies that we drive. So I would say the biggest impact in the margin that you're seeing in Q2 is really around the 71% increase in assets acquired under capital leases. Most of that is for the AWS business. So we've really stepped up the infrastructure to match the large usage growth and also the geographic expansion, and that is showing up in tech and content. On the marketing, if you look under the marketing expenses, they are also up and that is driven by the increases we're seeing in the sales team, both in AWS and advertising. So I would point to those 2 as probably larger-than-normal impacts on Q2 operating margin. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [20] +-------------------------------------------------------------------------------- + + I have 2. The first one, as you continue to add more Prime Now markets with 1- to 2-hour shipping, can you just talk to some of the logistical challenges you've already encountered and worked through? And talk to kind of -- if you really do see 1- to 2-hour shipping become a larger piece of the business over the next year, what's the biggest challenge to make sure that you manage? And the second one on the subscription revenue. Looks like subscription revenue growth was strong again, over 50%. Can you just talk to what drove that acceleration? Was it Prime, or was there something else in there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [21] +-------------------------------------------------------------------------------- + + Sure. Let me start with your second question. On the subscription revenue, grew 53% year-over-year versus 52% in Q1. So yes, we continue to see strong Prime membership growth. That is the main thing. There's also, in that line item, are also other monthly fees associated with some of our other subscription services like audiobooks, eBooks, digital video and digital music. But again, I would say that we're very happy with the Prime membership growth, and it remained pretty consistent both in Q4 and then through Q1 and Q2 of this year. On your second question on Prime Now, so Prime Now is now available in 50 cities across 8 countries. We do learn something new in every city and have different -- slightly different shapes and sizes of those buildings and different density profiles. And so we are learning as we go. We learn as we grow internationally as well. That is a service that customers love. That's not an inexpensive service though, and we also have -- so we're constantly working on our cost of delivery and our route densities. And again, we like what we see, and we'll continue to expand that and we'll be working very hard on making that not only a valuable Prime offering, Prime benefit, but also lower-cost operation as well. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [23] +-------------------------------------------------------------------------------- + + Brian, I think I heard you earlier say that your headcount for advertising salespeople is growing faster than the company as a whole -- or company's headcount growth rate as a whole. I'd just like to use that maybe as a springboard to talk a little bit about what you think the right mix is for how you sell in terms of the self-service versus salespeople. And then a second one would just be a quick one. I know it's early, but I'd be curious to see what you're seeing with users of the Echo Show with the screen on it and if you're seeing any particularly different type of user behavior there versus the original devices without one. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [24] +-------------------------------------------------------------------------------- + + Sure. Yes, it's early on the Echo Show. As you know, we just started shipping those in late June, but we're very excited about the potential and the additional -- the addition of the video screen and the messaging capability and video capability. So it's -- I've used mine and it's awesome. It's a big step up, in my mind, but we'll get more customer feedback as we go along. On advertising, technically, what I said is the sales force has grown higher than the rate of growth in the business itself, which was 42% regular headcount, and that sales force is primarily AWS and advertising. So we build self-service tools and obviously that we want to make those as efficient as possible for customers and advertisers, but we realize it will need actual sales contact with accounts as well. So it's a mix. I can't get into the split really, but I would see both growing. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [26] +-------------------------------------------------------------------------------- + + Maybe 2. One, with respect to international margins, is there anything there you can give us in terms of rank order or color, whether it'd be geographies or category expansion that we should be thinking about that are driving some of the cost curve in the international side of the business? That would be number one. Number two, stock-based comp stepped up a lot both quarter-over-quarter and year-on-year. Wanted to know if there was anything either organic or inorganic that was driving that step up in stock-based compensation. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [27] +-------------------------------------------------------------------------------- + + Sure. I'll start with the second one. Yes, as you noted in the press release or the 8-K, we had an absolute step up from Q1 of $792 million to Q2 of $1.2 billion. So it increased 51% year-over-year in Q2 versus a headcount increase of 42%. I'll also say that we generally see a step up from Q1 to Q2 because we do our employee RSU grants in Q2 of each year. So that's a normal trend. But the 51% year-over-year is also -- is a combination of the hiring we've done, but also an adjustment we've made to our estimated forfeiture rate. We're seeing less forfeitures, which is a great sign for our employee retention, but you have to make adjustments to your reserves as you see that. So that was another influence in Q2. On operating margins internationally, I'd step back and say, we -- a lot of the investments we're making in North America, we're also making in international: Prime benefits, including Prime Video and remember, we launched global video in Q4 of last year to 200 countries; Prime Now; AmazonFresh; the general rise of FBA and added selection, both retail and FBA, to make Prime more attractive and the fulfillment and logistics costs that go with that, any additional constant effort to reduce prices and accelerate shipping. So that all impacts both North America segment and international. The North America segment is a little further along in the Prime -- or excuse me, yes, the Prime membership growth curve. And so in some respects, we are giving benefits earlier in the life cycle to international Prime customers than we did in North America just because it launched later. And then there's also India. As I mentioned, we continue to invest in India. We're very hopeful with the progress we've made with sellers and customers alike in India, and we see great momentum and success there. So we'll continue to invest, and we have some of our best people in that business. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Fitzgerald with Jefferies. + +-------------------------------------------------------------------------------- +Brian Patrick Fitzgerald, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- + + You mentioned before as you stand up new fulfillment centers, it takes a bit of time for them to ramp up optimization. How should we think about that path optimization over a year or so as you continue to scale operations and you bring data to bear in robotics, in Kivas and AI machine learning? Are you finding that kind of new fulfillment center optimization curve is accelerating? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [30] +-------------------------------------------------------------------------------- + + Brian, this is Darin. Yes, we're getting more efficient every time we put new capacity into the network, whether that's through automation or just through the experience that we've gained over the years. We still say it takes up to 3 years or 3 peaks to get to kind of network efficiency for a new particular facility. And that's about staying the same, although the whole network gets efficient over time. So there's a big mix going on, and we like the new innovation that we're bringing to the capabilities, but that ramp stills stays about consistent as it was. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [32] +-------------------------------------------------------------------------------- + + Just one. Other slowed from 58% in the first quarter to 53% year-over-year. Anything to call out? And then you made a comment about the physical stores in reaction to one of the other questions that was really about showcasing new devices. Is it fair to say that probably means locations would have small footprints versus the large footprints if you were thinking about that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [33] +-------------------------------------------------------------------------------- + + I'm sorry, what was the first part of your question? + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [34] +-------------------------------------------------------------------------------- + + Other revenue slowed from 58% in the first quarter to 53%. Is there anything to call out around that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [35] +-------------------------------------------------------------------------------- + + No, nothing. In that other line item is advertising and also other things like co-branded credit card agreements. I would say that the main -- excuse me, advertising revenue growth has been strong and fairly consistent over the past 3 quarters. So that number will move around, but there's other things that more the variance in the volatility as in the other line items. Your question on stores. We are -- again, I personally think that new devices -- the ability to see new devices is a great asset, but I don't want to shortchange our -- the rest of the bookstore and the ability to have curated selection and the creativity we've had in taking a new look at the bookstore. So we are experimenting with different formats, and we look at different sizes and we look at revenue and cost per square foot just like any other physical retailer. So we haven't essentially nailed the model yet, and we continue to experiment and see what works and how it differs by city or more suburban locations. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [36] +-------------------------------------------------------------------------------- + + So thank you, Brian, and thank you all for joining us on the call today and for your questions. A replay will be available on our Investor Relations website through at least the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking to you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2017-Oct-26-AMZN.txt b/Transcripts/AMZN/2017-Oct-26-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..d97c619ac93201fac55abd1e5659678caf0ebb71 --- /dev/null +++ b/Transcripts/AMZN/2017-Oct-26-AMZN.txt @@ -0,0 +1,378 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Amazon.com Inc Earnings Call +OCTOBER 26, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Ronald Victor Josey + JMP Securities LLC, Research Division - MD and Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Scott W. Devitt + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q3 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, - [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q3 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, October 26, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict the demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Great. I guess I'll just start with, can you give us your thoughts on the Whole Foods integration? How you see that contributing to the bottom line over time? And then on a quick balance sheet note, we obviously saw the strong AWS results, but unearned revenue doesn't seem to be growing at the rate it was in the past. Maybe comment a little bit on the unearned revenue growth on the balance sheet, why it might be slower than the past? + +-------------------------------------------------------------------------------- +Dave Fildes, - [3] +-------------------------------------------------------------------------------- + + Yes, thanks, Justin. This is Dave. I'd also point you to beyond the balance sheet. There's some disclosure around additions to unearned revenue as part of the cash flow statement. So when you look at that, for the 3 months ended, you'll see that up around 34%, 35% versus the same time last year. +And historically, what we've seen with unearned revenue is big and leading contributor to that is Prime memberships. The example is a customer signing up, paying $99 upfront and having that amortize over the 12 month period. That continues to be the biggest absolute contributor to what you see there. The other one area that's been growing over the past few years is Amazon Web Services, features like reserved instances where those customers can pay for services upfront, in some cases and receive discounts over a multiyear period. What we're seeing and more recently, I think, is on the Prime piece, we launched month-to-month Prime last year, and if you think about how that works, customers are paying $10.99 per month as they go. So there's less that's deferred. So, that's I think one of a number of factors. There's obviously other mix factors going in there besides the pieces that I just mentioned. But we've seen monthly Prime has been a good driver of getting more members into the program. So that's part of what you're seeing. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + And your question about Whole Foods, yes, we're really excited to have them as part of the team now after the acquisition in late August. What you see in the financial results for this quarter is a -- it's shown actually in the new physical stores, revenue component $1.3 billion of revenue, $21 million of operating income. And that's where you'll be seeing Whole Foods revenue showing up. In addition, that is -- that class of revenue, physical store's revenue is going to be where we are going to book any sales that where a customer physically select an item in a store. So it also -- it does include our Amazon Books. If you step back on Whole Foods, again, I think we've had busy months since we've joined forces, offering lower prices on a range of key grocery items in the stores. Launching the private-label -- Whole Foods private-label products on Amazon, we've got technical work to make Prime the Whole Foods customer rewards program, and we'll have that coming out in the future. We've added Amazon Lockers to select Whole Foods stores. So lots of activity, lots of energy and we're real excited to show customers what's possible when we join forces here. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [6] +-------------------------------------------------------------------------------- + + Guess I'll ask 2 as well. The first one is, that was a bit of a usual upside to your guidance, even stripping out Whole Foods. Is there -- what would you -- what's most surprised you in the quarter? You've been pretty consistent to how you reported versus your guide. So something unusual happened or somewhat unusual happen? What would you attribute that to? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure. In Q3, yes, I would say we had a very strong Prime Day. As you know, we talked about that on the last call, but it really carried into the quarter. We had a record day for sign-ups for free trials for Prime and Prime Day globally. Had a very strong Prime Day in particular internationally. So it really got a lot more traction in this, the third year that we've had it. So I would point mostly to those factors. There's also very strong quarter for AWS, revenue growth was the same as Q2 and now we're at an $18 billion run rate. Whereas last quarter, when I had this call, we were at $16 billion. So very pleased with the customer response in the AWS business as well. And usage growth is actually growing a lot higher than revenue growth. So particularly pleased with the new customers that we've added and the additional workloads that we've picked up from existing customers. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [8] +-------------------------------------------------------------------------------- + + And then briefly on the international retail, that growth also by itself was intrinsically stronger than you've seen in a while. Any particular markets geographic markets, you would call out there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes, it was pretty strong across the board. We had the impact of Souq, obviously this quarter internationally and the Diwali holiday in India was a few days earlier, which maybe pushed some sales into Q3 versus Q4. But generally, it was the strength of Prime Day internationally and it carried through the quarter. So it's -- but generally, I would point to the increase selection, a lot of the building blocks we've been working on. All the Prime benefits, advancement and free shipping offers or faster shipping offers, the Prime benefits that drive engagement, of course, adding selection, adding Fulfilled by Amazon partners and the selection that they bring. So again, I wouldn't point to anything other than the Prime Day pickup, but stronger than -- it was stronger than probably I anticipated. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [11] +-------------------------------------------------------------------------------- + + I have 2. Just on Whole Foods again, I was wondering, could you talk about 1 or 2 of the biggest surprises you've seen so far? And then maybe just a strategic opportunity, as you see, of having a brick-and-mortar presence as you look to continue to grow your overall business? And the second one on the subscriptions revenue, you accelerated to 59%, could you just talk about which countries or which regions are driving that? And maybe talk a little bit about the growth or the cadence of what's happening in the U.S., your oldest market? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. On Whole Foods, I would say it is early. August 28 was the close date and -- what I could tell you is, I've been in meetings with John Mackey and his team and they're very like-minded with us, customer-obsessed, ready to work together to continue their mission then expand on their offerings that we can offer customers. The other things I mentioned, price reductions early on, selling products on -- their products on Amazon.com and also installing Amazon Lockers. I think over time, you'll see more cooperation and working together between AmazonFresh, Prime Now and Whole Foods, as we can explore different ways to serve the customer. So that's kind of the earlier report on Whole Foods. So far so good, and we're thrilled to finally be working together after the summer of closing the deal. On subscription revenue, let me just remember your question there. We had essentially 59% growth, you said, 600 basis points higher than Q2. In this line item is certainly the fees associated with Amazon Prime and also it's where a lot of our subscription services from digital music, digital video, audio books, eBooks. So there's some moving parts in there. The growth in Prime has been fairly consistent over the last recent quarters in Prime memberships. And as I said, we had a great -- the largest new Prime -- new sign-ups on Prime Day for the Prime program. The monthly program is gaining traction. It's an attractive option for a lot of people. And again, on this -- on the other subscription services, music especially, it works just so well with our Echo device that we're seeing a lot of growth in that area as we increase the number of Echo devices and customers using the Echo devices. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [14] +-------------------------------------------------------------------------------- + + In the comment in the release on seasonal workers, that looks roughly flat year-on-year. I wanted to know if you could understand a little bit more about the trajectory around the workers needed to fulfill seasonal holiday demand and what that might also mean for automation or efficiency benefits you're getting inside your fulfillment centers. + +-------------------------------------------------------------------------------- +Dave Fildes, - [15] +-------------------------------------------------------------------------------- + + Yes, Eric. This is Dave. I think we put out a release saying earlier this quarter talking about 120,000 operations folks to bring into our fulfillment centers this year. So we're continuing to hire and hire across a number of locations. We talked earlier this year about expecting to see a greater than -- roughly greater than 30% square footage growth in an operations, so we're certainly hiring to support that. More of these facilities do have Amazon Robotics and certainly that helps with the efficiencies there, but it requires tremendous effort from a number of our folks as well. And so we'll continue to hire there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + While we're on this subject of headcount. Headcount grew 77% year-over-year in the quarter. That includes the impact of the Whole Foods and Souq acquisitions. Without those -- without that headcount, the base Amazon grew 47%, which is still up from 42% in Q2. So a lot of the additional pickup in Q3 was tied to our ramp for the holidays. We continue to hire a lot of software engineers. We continue to hire a lot of sales reps, and it's tied directly to our major investment areas of AWS, Prime Video and devices. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [18] +-------------------------------------------------------------------------------- + + Brian, I was hoping you could help us understand how at this point you're prioritizing expansion into new product categories. In particular, there's a lot of talk now about potentially using Whole Foods stores for physical pharmacy presence and also that you've perhaps got an approvals across multiple states in that category. Can you just help us understand the approach in general to new categories and pharmacy, in particular? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes, I can't confirm or deny any of the rumors related to pharmacy or anything else. I will say we do see a lot of opportunity with Whole Foods. As I said, there will be a lot of work together between Prime Now, AmazonFresh, Whole Foods, Whole Foods products on the Amazon site, Lockers at the Amazon -- excuse me, Amazon Lockers at the Whole Foods stores. So there'll be a lot of integration, a lot of touch points and a lot of working together as we go forward. And we think we'll also be developing new store formats and everything else just as we've talked about in the past with before Whole Foods, amazon Bookstores, Amazon Go and the opportunity that technology presents. We have campus -- on-campus bookstores. So we're experimenting with a lot of formats. I think that Whole Foods really gives us a vast head start on that and a great base and a great team to work with who has a lot of history, and a lot of -- they probably have 10 to 20 years of learnings that we don't have and wouldn't have. So we're really excited about that. And I think working together will bring our different strengths to the table and really be able to build on behalf of customers. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [21] +-------------------------------------------------------------------------------- + + The other category which includes advertising accelerated 58% in the quarter. I think the common view there is that's a fairly high-margin business, certainly higher than corporate average. Is there any reason why that isn't the right assumption to make? Essentially what impact is the growth in the ad business having on the company's overall profitability? And in terms of the increased losses in the international retail segment of the business, can you provide some color around how much of that's being driven by Amazon launching into new markets, which I know you continue to do, versus investing more heavily in existing markets? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + Sure. Let me start with the revenue. So you're right. Other revenue grew 58% in the quarter, and that includes advertising services and other things such as our cobranded credit card agreements. Advertising revenue continues to grow very quickly, and its year-over-year growth rate is actually faster than the other revenue line item that you see there. But I would say generally, we're very pleased with the advertising business. Our goal here is to be helpful to consumers and help them make better shopping and selection choices. We'll also provide in giving them targeted recommendations. So making it helpful for customers rather than intrusive. And then we believe that by creating that (inaudible) and engaging advertising experience with the customers, it will also maximize success for our advertisers. So it's an important part of the flywheel and the -- so it's -- the traffic and the customers, especially the Prime customers that come to the site, are really the ones that we can use to help them select items and use advertising to help make their decisions more informed when they're picking products. +On the international, yes, I can't split it, the effects. But I'll tell you again, it is international expansion in -- primarily in India where we're continuing to add benefits, and we launched Prime there a year ago, if you remember, and we've had more Prime members joined in India than in any other country in the first 12 months. We have free shipping on 10 million items there, and we're continuing to add benefits: Prime Video, Amazon Family, we've had a first Prime Day there this year, Prime Music. Amazon business is also expanding in India. So a lot of positive momentum and investment going on in India. Very pleased with that. We also recently announced Echo and Alexa are available in India. So that -- that should be well received by the Indian consumer base. But excluding India and Souq, the rest is the Prime benefits and the continued growth in the other countries that we've been in for a while, continue to roll out Prime Now and AmazonFresh. In Video, we launched -if you remember in Q4 of last year, we launched Prime Video in 200 -- over 200 countries globally, continue to build up not only the offerings but also the engagement that we see from those Prime customers. So becoming more engaged, and we're also doing the basic blocking, tackling of adding selection, especially FBA selection, increasing free shipping offers and also speed of shipping offers. So there's a lot of -- a lot of different influences there. You saw the growth rate. It's, we believe, it's resonating with customers. So we will continue to invest and think that we have a good path forward. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [24] +-------------------------------------------------------------------------------- + + Two questions. There's been some news flow recently about Brazil expansion. Can you just talk about how Brazil compares to maybe some of the other international markets that you're investing in? What level of investment should we expect in Brazil maybe relative to like in Australia or in India? And then the follow-up on the Whole Foods. So do you feel like the store footprint at 460-odd stores is adequate? Or any color on plans to expand either the Whole Foods store footprint or the Amazon bookstores or those other ones you mentioned? + +-------------------------------------------------------------------------------- +Dave Fildes, - [25] +-------------------------------------------------------------------------------- + + Yes, Ross. Thanks for the question. This is Dave. On Brazil, just briefly, yes, we did recently expand and add an electronics category there in Brazil. It's a third-party marketplace offering. You may recall we've been in Brazil for a number of years now, initially launched with really a Kindle and eBooks offering without the sort of physical categories and more recently added physical books again, a third-party marketplace offering. So I think we're excited about the electronics that are getting out there. There's a wide variety of products included in that category: Smartphones, tablets, cameras, TVs, what have you. So I think, really excited to get that technology out there for Brazilians. And I think beyond that, really just focus on those categories and growing selection there, but I can't speculate on what we might do in the future there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + And on Whole Foods, yes, I believe the total is 465 stores or thereabouts. And we have 12 bookstores now. We are adding a few more in the near future in California, Washington D.C. and Austin. So yes, you will see more expansion from us. We're not ready to announce any, what that will look like, and we're working with the Whole Foods team on what maybe what they will -- how many more stores we might have in that area. But still early. So, those plans will develop over time. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- + + I understand you can't comment on rumors one way or the other, but curious as you think about categories like health care and obviously you guys are already in health care to some degree through Amazon Business, can you give us a bit of a status update on what you do have out there now? And particularly how the company and management thinks about entering more regulated businesses over time? How you would approach that versus a standard category that you might go into? Or maybe again, I know you can't comment on rumors, how you have approached to that in the past or in other market? And then to the extent that we are thinking about AWS growth in the fourth quarter, you guys are lapping the price cuts from last year and obviously have about an 800 basis point easier comp Q3 to Q4, taking those 2 things into consideration, how should we think about AWS growth through the end of the year? + +-------------------------------------------------------------------------------- +Dave Fildes, - [29] +-------------------------------------------------------------------------------- + + Yes, Heath, this is Dave. I'll take that first question in relation to health care. I think where you're seeing us do some work on that, I think is in the areas of Amazon Business, and that's really just from the standpoint of there are many different types of businesses that we can serve with that offering, and we're in our third year now. And so there's a lot of different sectors, whether they're hospitals, educational institutions, labs, government agencies. I mean there's a lot of different shapes and sizes across industries that we can serve with that. And so I think what you're seeing us do is really focus on services that meet those businesses, multiuser accounts, improving approval workflow tools, and just more recently, we introduced Amazon Business for Business Prime shipping, which we think will be a great way for our businesses use multiuser -- Business customers that have multiuser accounts, and that's in the U.S. and in Germany. So I think it's part of that offering, and we really have to see how that evolves. And the other side, too, is certainly health care is one of many sectors as part of Amazon Web Services that are important customers that we're focusing on and building tools for. So probably nothing specific to call out on that one, but that's a lot of what you're seeing from us today. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes, on AWS, we don't provide segment level estimates, but we did consider in our guidance the impact of the price cuts last year. You're right, we had a number of price cuts on (inaudible) time to -- about around December 1 of last year that certainly had an impact on Q4 of last year. But again, price cuts and not only price cuts, but new products that have lower average costs and can cannibalize more expensive products is pretty much a part of our business all the time in AWS. So we're looking forward to a strong Q4 and re:Invent is in December, so that's -- the end of November, early December, so that is also an exciting time of year for the AWS business. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott W. Devitt, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [32] +-------------------------------------------------------------------------------- + + I had 2, please. The first, Prime Now, Fresh Prime Pantry and Whole Foods, they're all distinct offerings, but it does seem like there's natural overlap with the potential to be further connected. And I was just wondering if you could just speak to how we should think about those 4 as distinct product offerings in the future versus being more integrated and possibly even, in some cases, eliminated to remove overlap from a customer experience standpoint? And then secondly, given the recent management changes in video, Brian, I was just wondering if you could speak to any strategic shifts in Video or changes in the pace of content portfolio build in coming years? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Sure, let me start with Video, and I just want to be clear, we are going to continue to invest in video and increase that investment in 2018. And why are we going to do that? It's because the Video business is having great results with our most important customer base, which is our Prime customers. They continue to -- it continues to drive better conversion of free trials, higher membership renewal rates for existing subscribers and higher overall engagement. We're seeing engagement go up year after year in video and also music and a lot of the other Prime benefits. We also know Prime members who watch video also spend more on Amazon. And we have a lot of data. We're -- that's the advantage we have is that we see the viewing patterns and we also see the sales patterns, so we can tie the 2 together and understand which video resonates with Prime members, which video doesn't, and make midcourse corrections. So we always do that, the -- we're always changing the emphasis and looking for those more impactful shows, more shows that resonate better with our customer base and things they want to see. And -- so that will always be an important part of our Prime offer, and we'll continue to use the data that we have to make better and better decisions about where to invest our dollars in Prime Video. So we're very -- we remain very bullish on the Video business, and we're looking forward to a lot of interesting new projects back end of this year and also lined up into next year. On the -- sorry, the second comment was, the overlap. Yes, so Whole Foods, I think I mentioned this earlier, but we definitely see commonality and overlap with the Whole Foods business as well as Amazon in total, but specifically, Prime Now, and also, AmazonFresh. And we're going to work to see how we expand those offerings, and in some cases, combine them. We're not sure how it will play out, but we're going to cooperate across those different customer touch points and trying to make them better for customers. We know customers are going to buy just like in the physical world, sometimes you go to a convenience store, sometimes you go to a supermarket, sometimes you go to a superstore. Sometimes you need things within an hour, sometimes you can wait days for shipment. So there's no one paradigm for all customer engagement, and we're looking for the ones that resonate best with customers, and we're going to continue to work on those. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jason Helfstein with Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [35] +-------------------------------------------------------------------------------- + + I'll actually ask 2 if I can. Just any way you can comment on the increase in Whole Foods traffic after the close? And then second, talk about your desire to have an ad-supported business on Fire TV or through Prime Video? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + I think I'll start on traffic. So we're not disclosing traffic figures. Whole Foods will be issuing a final 10-K at the end of the -- early next month, so you'll see a better perspective on the entire quarter. The quarter -- the 4-week period that you see running through the Amazon P&L this quarter is pretty hard to draw conclusions on other than revenue at this point. But Dave, do you have more on the... + +-------------------------------------------------------------------------------- +Dave Fildes, - [37] +-------------------------------------------------------------------------------- + + Yes, Jason, this is Dave. On the ad-supported question, I think what you've seen to date is really particularly as you're looking as a customer as a Prime Video member and watching content, we view that as you paid into that service and able to watch those shows ad-free. There may be instances where you're viewing a first episode and there's an ad leading into that if it's the first free episode, but generally like to have that as customers have paid into that program and they'll be able to enjoy that without interruption. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Just wanted to ask about delivery, in just over the last several months, we've seen a lot of announcements in products around delivery options between Lockers, testing the Kohl's partnership, Whole Foods, obviously, Amazon Key came out recently. I just wanted to better understand this investment. Is this a result of -- or the thesis that more options could drive, obviously, more sales on the flip side? Do you think you're losing some sales by not having those options? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + Probably a little of both. We think that, especially as we get into more and more Amazon Logistics deliveries, we're going to experiment with different ways to deliver things that make it easier on consumers, things that cut down on potential theft on doorsteps, but really it's mostly about increasing convenience for them. + +-------------------------------------------------------------------------------- +Dave Fildes, - [41] +-------------------------------------------------------------------------------- + + Yes, I think that's right, in terms of overall investments there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [42] +-------------------------------------------------------------------------------- + + And the other investments, obviously, are maybe the bigger-ish things are like planes and transportation capacity in general. And there our philosophy is, again, we're going to watch out for our customers, we're going to build capacity that gives them great service 12 months a year but particularly at holidays, by investing in those transportation options, we do so at same costs or cost parity, I would say, at the very minimum, but it also allows us to do interesting things like extend cutoff times for customers, enable Sunday delivery, enable better weekend delivery. So we're seeing a lot of benefits, just the ability to stretch the order cut off from what once was 3 p.m. in the afternoon to midnight, has huge benefits both for the customer and also for Amazon. It results in incremental sales, it also builds that trust that when you need something, Amazon's going to be there for you. And I need to remind you that the Thursday Night Football game will start in 2 hours and 20 minutes so. + +-------------------------------------------------------------------------------- +Dave Fildes, - [43] +-------------------------------------------------------------------------------- + + On that, thanks for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2018-Apr-26-AMZN.txt b/Transcripts/AMZN/2018-Apr-26-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..1076de836289feb93f97310044f4ead1a90d198d --- /dev/null +++ b/Transcripts/AMZN/2018-Apr-26-AMZN.txt @@ -0,0 +1,343 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Amazon.com Inc Earnings Call +APRIL 26, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Gregory Scott Melich + MoffettNathanson LLC - Partner + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q1 2018 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. +For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q1 2018 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2017. +Our comments and responses to your questions reflect management's views as of today, April 26, 2018, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict the demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we'll move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + I wanted to ask if you had any update on the state of the advertising business? Sort of the state of conversations with advertisers, what product uptake you're seeing out in the marketplace? And sort of how that's looking now as we move out of '17 and into 2018, broadly, for the platform? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Yes. Sure, Eric. I would say, advertising continues to be a bright spot, both from a product standpoint, and also, financially. It was -- continued to be a strong contributor to profitability in Q1. It's now a multibillion-dollar program. You can see the -- in our supplemental revenue disclosure, it's in other revenue, and it's the majority of the other revenue in that line item. So we -- our philosophy there, again, is we're continuing to focus on finding valuable ways to make our advertising opportunities better for customers, showing them new products that they may not have seen otherwise, and also for emerging and established brands, helping them to reach customers. I think the advertisers, generally, are all shapes and sizes, and their common theme is they want to reach our customers, generally, to drive brand awareness, discovery, and eventually, purchase. Before I go on to the second question, I want to make a comment about the Prime program. Prime program continues to drive great strength in our top line, as you've seen over the last few years, actually. We continue to increase the value of Prime, including speed selection and digital entertainment options. We've been expanding FREE Same-Day Shipping and 1-day options. And our 2-day shipping, it's now available on over 100 million items, up from 20 million as recently as 2014. And we continue to add digital benefits, like Prime Video. The value of Prime to customers has never been greater. And the cost is also high. As we pointed out especially with shipping options and digital benefits, we continue to see rises in costs. So effective May 11, we're going to increase the price of our U.S. annual plan from $99 to $119, for new members. The new price will apply to renewals starting on June 16. Prime provides a unique combination of benefits, and we continue to invest in making this Prime program even more valuable for our members. As a reminder, we haven't increased the U.S. annual price Prime since our single increase, which was in March of 2014. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Yes. And Eric, sorry to just go back to your initial question too, just to hop back on that, I just want to remind folks that we've mentioned this last quarter on the call, but on January 1, we adopted an accounting standard update that amended our revenue recognition policies. So the net impact to revenue in the first quarter was not material, but I do want to highlight a few areas. As part of the adoption beginning in Q1, certain advertising services are classified as revenue, rather than a reduction of costs to sales. So the impact of this change was an increase of $560 million to other revenue in Q1, which is the other revenue was, of course, part of our supplemental sales disclosure. So you'll see that other revenue, in total, increased 132% ex FX year-over-year to about $2 billion in the first quarter, again, $560 million is included in there, and the majority of that is -- would be included in the North America segment. As you look at the other supplemental line items, just a few items of note. The line item online stores revenue increased about 13%, ex FX. Beginning in the first quarter, sales of apps, in-app content, certain digital media content, are now presented on a net revenue basis and included in third-party seller services revenue, rather than net online stores revenue. So in the first quarter, online stores revenue would have been higher, but for this new standard. And then, the line item, subscription services revenue, that increased about 56% ex FX year-over-year. Prime members are -- Prime memberships are included in that line. Again, beginning in the first quarter, we now recognize annual Prime membership revenue straight line over the 12-month period. Prior to 2018, we recognize this revenue over the 12-month period with more revenue allocated to the fourth quarter each year. So in Q1 of this year's subscription services revenue would have been lower, but for this new standard. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [6] +-------------------------------------------------------------------------------- + + So the first one, on Prime, let me ask you this. As you think about your U.S. Prime penetration, there's some data that shows you're doing a very good job at capturing a lot of the middle to higher income households and now you're raising price. Talk about the tension point you need to solve to sort of reach some of the lower income households and even households that are not yet Prime. What are the main reasons why people in the U.S. are not signing on for Prime at this point? And the second one, on early learnings from the integration of Prime Now and Whole Foods, recognizing it's only in a few cities. What can you share about what you're seeing about purchase behavior, early learnings? And what are the main signposts you're watching as you determine how quickly to roll that out to more cities in the U.S., and hopefully, New York soon? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure. On your first question about Prime penetration, without getting into any statistics on penetration and by country, I would say we do have other options for, if you'll notice, there's the monthly option, obviously provides more flexibility for people who want to try out Prime before committing to the annual plan. There's discounted student plans. There's also discounts for other groups. So we do feel it's still the best deal in retail, and we just work to make it better and better each day. The second thing you mentioned is a good example. So the ability in 10 cities to get Prime Now deliveries of Whole Foods groceries is an added benefit for people in that market using Prime -- those markets using Prime Now. So as far as the Whole Foods, specifically on the question of what'll -- what we'll look at as far as expanding that grocery delivery, we're going to use the 10 cities as a test and see how customers respond, just like we always do, and make sure that our deliveries are great for those people, and then we'll announce expansion plans once we digest that, the feedback we get from customers. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [9] +-------------------------------------------------------------------------------- + + I was just wondering if you could give us a sense. The accelerating growth that we saw in the U.S. business in Q1, how much of that or how would you sort of segment that in terms of specific categories? Are there any specific categories that you would call out in terms of driving that? And then, as we look at the like acceleration in the AWS business, any sense that you can give us in terms of what volumes or customer you specifically call out sort of customer additions in some of your comments, what customer additions have looked like in terms of driving that business, particularly against sort of the comp against last year's price cuts? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [10] +-------------------------------------------------------------------------------- + + Sure. So first, with the -- you've mentioned North America revenue growth, and you can calculate that with and without the impact of Whole Foods, I'm sure, but the general drivers continues to be Prime and the Prime Flywheel, so we see strong customer demand, not only for the benefits that we associate with Prime, we're seeing better engagement with Prime Benefits, especially Digital and Benefits, and that is always good news for eventual sales of other things. We're also selling more subscriptions, Amazon Music Unlimited, multiple -- Kindle Unlimited, there's a number of services. So there's different revenue streams that we see. So not much more I can add by product line to North America. Now I talk about AWS revenue, again, we're -- we are accelerating. We've accelerated for the last 2 quarters. The FX-neutral growth was 48% in Q1, up from 44% on the same basis in Q4 and 42% in Q3. And now nearly a $22 billion run rate. So what we're seeing is just continued strong usage, both by existing customers and signing new customers for -- see an increased pace of enterprise migrations as customers are having success with AWS and increasingly trying new services. We are seeing people move more and more of their workloads to AWS and at a faster pace. And customers are moving databases to AWS as their work continues to grow at a very rapid clip. So stepping back, I would say, what is driving the growth, we believe, again, it's the value that we create for AWS customers. We have the functionality and pace of innovation that others don't. We have partner and ecosystem that others don't, and we have proven operational capability and security expertise that's highly valued to AWS customer base. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [12] +-------------------------------------------------------------------------------- + + Some of the data that we've seen suggests that this year, your -- the rate of growth in the build out of fulfillment centers and other parts of the retail logistics network as well as data centers, but more on the former, that rate of growth is slowing this year relative to last year and even the year before. I know that you guys go through periods of kind of heavy investment then you grow into that capacity. But I just wonder if you could comment a little bit about where we are kind of in that ebb and flow of that cycle right now. And in terms of the accounting change that Dave referenced earlier, with regard to revenue going from cost of revenue to the other line, can you comment if that particular type of advertising, that trade dollars type of marketing, is that growing at a meaningfully different rate than the ad revenue that's already booked as revenue? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + Yes, Mark, this is Dave. On that second question, we've not commented on the growth rate or given the prior year period, so not much we can say there. As I said, the $560 million, if you were to back that out and look at the sort of pre-existing advertised or other revenue, rather, that was included in that line item, we'd be growing about 72%, but again, that's not in relation to the COGS portion. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [14] +-------------------------------------------------------------------------------- + + And on the question on capacity, excuse me, cap -- I'll address this CapEx and capital leases, we're still seeing strong investment there. If I look at the quarterly trends, you're right that this quarter was up 33% in isolation versus last year. I look back to last year's first quarter and we grew 82% year-over-year. So it was a particularly heavy quarter, particularly for investment and warehouses. So if I step back on the trailing 12 months though, CapEx, which is predominantly tied to our fulfillment center network, is up 47%. That is above the Amazon fulfilled unit growth rate, but we've combined the strength of the FBA program and the space requirements as we -- get into bigger and bigger products. That -- it's a representative number for that period. On the capital leases, which is a good proxy for the spend to support the AWS business, that's up 49% year-over-year on the trailing 12 months. So again, usage rates continue to exceed the revenue growth rates. Usage rates are strong, but we also have a number of projects underway that seek to increase our efficiency of our data centers. So there's a couple of things at play there that, hopefully, keep that number closer to the revenue growth rate. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [16] +-------------------------------------------------------------------------------- + + Brian, you had significant operating income upside in 1Q and I think a better outlook for the second quarter than many expected. Can you just talk about the biggest factors that drove the delta relative to your 1Q guide? And is there any reason to think that you couldn't see similar leverage in the back half of the year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + Sure. Yes, we came in well above our range that we had given of $300 million to $1 billion. I would attribute it primarily to a few things. First, the top line growth was -- continued to be strong coming out of Q4. We had great consumer business strength. We also had strong AWS revenue strength, where I already mentioned that we accelerated into the quarter, which is a different trend than we've seen recently. So customer adoption and AWS remained strong. And when we hit the higher end of our range or just above our range on -- with FX included, we generally see really good drop through on the incremental sales, given our -- the fixed costs we have in fulfillment centers and data centers, and quite frankly, people. So we saw great efficiencies at the higher level of revenue, and we're able to handle it. So that was generally very good financially. We -- at the time of guidance, we were concerned a bit about the high -- relatively high inventory we had at year-end in space utilizations. We were still very full in our fulfillment centers. But we were able to correct that due to the high sales without handling -- without having additional handling and transportation cost that you would normally see to reconfigure inventory locations. So that also helped and probably was a differential versus the guidance estimate. And then, lastly, I would say, advertising continues to be a strong contributor to profitability and had strong results this quarter. As far as what that portends for future quarters, for now, I want to focus on Q2 and it's incorporated into our Q2 guidance. So we expect a lot of the strength areas to continue, consumer demand, AWS and advertising. We will definitely see higher investments as we move through the year. For example, video content spend will increase year-over-year, and we'll continue to hire, in particular, software engineers. We'll have some cost in Q2 ahead of what's anticipated to be a Prime Day in early Q3. So -- and then as you know, Q3 is generally a lower quarter due to all the work to get ready for holiday and the hiring of people and building teams. So I won't go beyond Q2 at this point, but again, we're very happy with customer reception we had in Q1, and then, the income that that drove. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [19] +-------------------------------------------------------------------------------- + + Two questions. That $239 million in other income, what was that? And then, could you just wax a little bit, eloquently, hopefully, on advertising revenue? And like how do you balance what our -- what should be a monstrous amount of ad revenue opportunities, especially high-profit, high-margin ad revenue opportunities against an ideal or optimal consumer experience? These sponsored units I see in every search I do on Amazon seems great from an advertising perspective, but I sometimes wonder if it doesn't dilute to consumer experience. So just talk about how you balance that. And then, finally, as part of advertising, you've got, also, a heck of a lot inventory around all of that video, that Prime Video that you have that you don't allow -- that you don't directly charge for. How do you think about that as an advertising revenue opportunity? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + Sure. Let me wax eloquently, try to anyway. So let's start with the $239 million, that is essentially where attributable to warrants that we have in companies that we've partnered with. We have transportation companies that we've partnered with and other technology companies. As the stock market increased in Q1, a lot of those companies also went up. So that's where we book the gain on warrants that we have with -- on investments. It's also -- there was a good bit of FX gain due to the shift in currency and the weakening of the dollar. That showed up on a lot of lines on the P&L, but that one was positive. On advertising, so let's step back a bit. It's now a multibillion-dollar program and growing very quickly. Our main goal here is to help customers discover new brands and products. So when we show sponsored products, we're trying to show people things that they had -- maybe wouldn't have seen otherwise in their normal search results. So we're looking for a good balance here, as we said. We want customers to get the benefit of the new brand and product discovery, and then, we want to let sellers, for both emerging and established brands, reach those customers. Those advertisers are all shapes and sizes with the main goal of, again, trying to reach our customers whether it's to drive brand awareness, discovery or hopefully, purchase. So we take the responsibility for that very seriously and are always balancing the helpfulness of the advertising and try not to make it disruptive. But you're right, there are always pressures in that we will come down on the side of the customer. On your question on video advertising, yes, there may be opportunities over time to have more advertising in our Video, but we choose to not do that right now. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [21] +-------------------------------------------------------------------------------- + + Yes. The only thing I'd add too on that, just related to Prime Video. As you may have seen the announcement earlier today, about the renewed agreement for the streaming partnership with Thursday Night Football. So we'll have 11 games in 2018 and 2019, be able to deliver that to over 100 million Prime members globally, which is a great continuation of the partnership we've had with the NFL. We've done some things like the Prime Original Series, All or Nothing, the third season's coming up soon, focused on the Dallas Cowboys. So that was one of our first forays in the live format that -- one of the first forays in the live format where we had live ads and kind of not only learning the technology, but learning to -- learning that business. And I think we've been pleased with what we've seen so far, obviously, and look forward to the next few seasons with the NFL. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju with Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [23] +-------------------------------------------------------------------------------- + + So I think, Brian, I had a question on your international shopping rollout. So I think this was recently announced. Where do you think you measure up versus some of the more local players where you might not have a direct presence in the country? And where do you think your value proposition lies? And presumably this is informed by users coming in from those regions where you don't really have an official site, but people come in to buy stuff from you anyway. So which regions or countries are accounting for most of the demand that you are seeing? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + Stephen, if you're still on, can you elaborate on the countries you're talking about, specifically? + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [25] +-------------------------------------------------------------------------------- + + No, I'm just wondering, you already have a direct presence in some of the countries like China, Japan, et cetera, and the international shopping rollout presumably expands, so that's selection to most of the globe. So just wondering if you are seeing incremental demand, and where you might be seeing demand coming in from countries where you might not have a direct presence? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Oh, on the global store? Okay. Yes. Yes. Sorry, I thought you meant to some of our expansion countries. So yes, I don't have a lot to share on that today, but I think you hit on the main point, is selection and opportunities for sellers in -- who are with us in different countries to reach buyers outside of their home country. So it's a great benefit for sellers, and it only works if it's a great benefit for customers on the other side. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [28] +-------------------------------------------------------------------------------- + + I'd like to maybe dive into a couple of the local recent overhangs. First, on shipping partners, just wondering how dependent are you on any shipping partner? And can you talk about any initiatives you've had to build out your own shipping network? I know in some countries, you might be over 50% of the stuff you're delivering. Could you talk a little bit about dependency there? And then, secondly, on taxes, can you remind us what happened when Amazon started collecting taxes on your own items in various states, and just kind of overview of your view on collecting third-party sales -- taxes from third parties in other states if that were to pass? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + Sure. Let me start with transportation. We have a great group of carriers that we use globally and you know who they are, but we're also growing our teams and capabilities to ensure that we can keep up with increased volume on our own, particularly around the holiday season. So that's driven a lot of our expansion of Amazon Logistics, it's driven the creation of sort centers, it's driven the purchase of airplanes to move product between points within our delivery network. So we will continue to operate with this combination of external partners and internal capability. We like what we see so far with our Amazon Logistics capability. It's well over 50% in some countries, particularly the U.K. It helps with, again, Prime Now and AmazonFresh and a lot of initiatives that we'll see, which again, we've mentioned that Prime Now is tied in with Whole Foods, now in 10 cities. So we think it's a core competency that we have and we need to have, and we'll continue to invest in that. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [30] +-------------------------------------------------------------------------------- + + Yes, and Justin, this is Dave, just on the sales tax piece. Today, on the first-party sales, we collect on our own products in all 45 states that have a state-imposed sales tax. On the 3P piece, we do collect on behalf of our sellers in 2 states, Washington State as of the first of this year and then, Pennsylvania turned on here on April 1. So in terms of your question of sort of impact from the first-party pieces coming online, many of those states came on over a period of time to get to that 45 total, going back over many years. So nothing really more to add on that. I think I would say we do continue to believe that the sales tax issue needs to be resolved at the federal level, and we're actively working with the states, with retailers and Congress to get federal legislation passed. We're not opposed to collecting sales tax within a constitutionally-permissible system that is both simple and applied evenhandedly. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from Greg Melich with MoffettNathanson. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, MoffettNathanson LLC - Partner [32] +-------------------------------------------------------------------------------- + + I want to follow up on Prime little bit. The fee increase, why now? I mean, we've been adding value for a long time, obviously, shipping costs are going up. Why is now the right time to have that fee hike, especially since membership looks like the growth number's starting to slow? And tied into that, there's a lot of Alexa mentioned in the release. Could you give us some uptake on the importance of Alexa and basically voice commerce, and so the metrics you get in terms of usage there and the flywheel? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Sure. We always evaluate the price of Prime in all the countries we're in, and we're looking for creative ways to reach the customer, as I mentioned earlier, create -- or excuse me, monthly plans, student plans, et cetera. So it's really nothing more than looking at the state of the program, the high benefit it's delivering. I mentioned that 4 years ago, when we last increased the price of Prime, if you get 20 million products within 2 days, today you can get over 100 million products within 2 days, and many, many, many, products within 1 day, same day, or 2 hours. So there's all kinds of new features that we've continually added to the Prime program. It's much different than it was in 2014. This is a reflection of that, that's a better reflection of the cost value of the program. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from John Blackledge with Cowen and Company. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [35] +-------------------------------------------------------------------------------- + + So the U.S. international revenue mix, ex Whole Foods and ex AWS, looks about 64%, 36%. Given investments in international markets, would you envision international kind of closing the gap in the coming years? And what would be the key drivers of the mix shift getting closer to 50-50? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + Sure. Yes, I don't want to project relative proportions of the different segments, but what I can say is, that international continues to see the same level of investment as we're seeing in North America or have seen in North America. So when we add Benefits, Prime Benefits, we're probably adding them at an earlier stage of life in the Prime program internationally than we did in the U.S. So they have different dynamics. We think, at the end of the day, customers behave the same globally, and that they value low prices, selection and great customer experience. So we'll continue to make these investments in Prime. We'll continue to expand selection, continue to build FBA programs so that it increases selection even more and build great partnerships with sellers. We'll continue to accelerate shipping. We'll continue to lower prices. And sorry, I cut out -- the last person got cut off a bit. We'll continue to build device business globally including Alexa, which we think has great stickiness with -- in the home and I think creates a lot of value in the home and also allows you to access, over time, Amazon products better. We'll continue to invest in India where we're seeing great progress with both sellers, and also, customers. And we like the momentum we've seen there. The Prime program started in the first year in India, grew faster than any Prime -- excuse me, any Prime program we had seen in other countries. We're adding local content in India -- video content, excuse me. We're also adding other benefits, Prime Benefits. We are rolling out devices there, and we're seeing Indian developers developing skills for Alexa, and Alexa's up -- as you saw the press release, to 40,000 skills +(technical difficulty) +But it's -- it is important to us that they all are still delighting customers and growing to the best of their ability. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [37] +-------------------------------------------------------------------------------- + + Thanks, Brian, and thanks for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. +We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2018-Feb-01-AMZN.txt b/Transcripts/AMZN/2018-Feb-01-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2ee2bf0b615f26e6041f9e063bf671a9e3a3729 --- /dev/null +++ b/Transcripts/AMZN/2018-Feb-01-AMZN.txt @@ -0,0 +1,345 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Amazon.com Inc Earnings Call +FEBRUARY 01, 2018 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Kenneth Michael Sena + Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Scott Andrew Mushkin + Wolfe Research, LLC - MD and Senior Retail & Staples Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. +For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, - [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. Our comments and responses to your questions reflect management's views as of today, February 1, 2018, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +I'd also like to update you on the impact of the recent U.S. tax reform legislation. In our fourth quarter results, we recorded a provisional tax benefit for the impact of the new tax legislation of approximately $789 million, which is primarily driven by the remeasurement of federal net deferred tax liabilities, resulting from the permanent reduction in the U.S. statutory corporate tax rate to 21% from 35%. As we complete our analysis of this new legislation, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes in the period in which the adjustments are made. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [2] +-------------------------------------------------------------------------------- + + I'd like to focus on the North American retail operating margins. That 4.5% was the highest, I think, we've seen in a couple of years, maybe the highest since you've actually broken that segment out. So could you just go through the drivers behind that? I know you called out Alexa as being better than expected. Was that one of the factors? Was it the full quarter of the Whole Foods impact? Was it advertising revenue? Just what drove that result and how sustainable is it? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, Mark. Let me address your question by answering the entire company. I'll note where the North America elements are strongest. So for the quarter, we came in at the highest end of our revenue range, $60.5 billion, 26 -- 36% FX-neutral growth and 25% FX-neutral growth, excluding the Whole Foods acquisition. So the fact that we came in at the high end of the range, volume was high, especially in North America, and a lot of times in Q4 and other quarters actually, we see better efficiencies when the warehouses are busy. So it was very clean operational quarter, I would say. The ops team did a great job handling record volumes in Q4 and also incorporating all the new capacity we had opened in 2017. If you remember, we have added over 30% to our fulfillment square footage in 2017, coming off a similar increase in 2016. So amid all these opening of new buildings, many of them late in the year, the ops team did a fantastic job. Advertising was also a key contributor as we're continuing to make more value -- the offerings more valuable, both to customers and advertisers alike, and that was particularly strong in North America. Although not in the North America segment, I would also point out, AWS had a strong quarter, accelerating growth versus Q3 and also expanding operating margins by 100 basis points. So particularly in North America, I would say it was the -- the strong volume -- top line volume, combined with increased advertising revenues and also a very clean operational performance. Obviously, there's a lot of things that can happen in Q4 from weather to demand patterns changing. We've seen additional costs creep in, in the name of customer experience in prior years. And this was, in hindsight, probably one of the cleaner Q4s recently. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + Brian, I was hoping you could talk about how you're thinking about your primary investment areas in 2018 and perhaps if you could put it in context of '17. Are there things that are notably different this year relative to last year and also how you would think about the margin trajectory relative to what we saw last year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Sure. I -- we'll be giving you guidance quarter by quarter, but I can talk to the general trends in the large investment areas. Let me start with AWS infrastructure and growth in technical and sales teams. That will continue. We're in a $20 billion run rate in top line revenues for AWS, up from 18% -- excuse me, $18 billion last quarter. So we're very happy with the -- both the progression in new services and features that we've been able to bring to customers and also their response. We'll continue geographic expansion and continuing to, again, build on our tech teams and our sales teams. So that would -- that expense is going to continue and likely increase. Prime benefits will continue to increase as well. Prime Now -- excuse me, Prime Video, Prime Now, AmazonFresh, all of our major Prime benefits we continue to expand globally. Devices, as Jeff said in the press release, we are very happy with the results of Alexa. It's a very positive surprise for us, both on a -- adding a little bit more to that, we had record device sales, we had very high levels of customer engagement, including increased levels of voice shopping, growth in functionality, growth in our partner -- partners we work with. Skills there, we've increased rapidly. We're over 30,000 skills for Alexa. We've got 4,000-plus smart home devices from 1,200 unique brands. So the -- the relationships we're having with external companies is actually helping to accelerate the adoption of Alexa with customers. So really strong usage of -- excuse me, Alexa with our devices. Obviously, Echo, Echo Show and the Echo family all directly tied to Alexa, but also Fire TV and tablets. And we're seeing more and more engagement. Alexa usage on Fire TV is up 9x year-over-year. Music listening time on Alexa was 3x higher this holiday season. So that's what we mean when we said far exceeding our expectations. Those are the things I would point to. And that is an area, again, where we'll continue to invest heavily and as we say, double down on that. Fulfillment, again, is -- fulfillment capacity, especially to fuel the strong top line growth and growth in Amazon fulfilled units, which, again, is growing much quicker than our unit growth rate, we expect that and hope that to continue as well into 2018. Video content, we spoke about on the last call, we do like the results we're seeing with engagement on customers, their buying habits, their engagement with the video content, their use of it on devices. And we will continue to increase our budget in that area. But I'll be release -- yes, I'll incorporate that into the guidance each quarter as we move through the year. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [8] +-------------------------------------------------------------------------------- + + Hey guys, just 2 questions. AWS reaccelerated again this quarter. Can you just give us some color on what were the key drivers there? Was it lapping some of the price activity from a year ago? Was it higher utilization, moving up the stack? Any color there would be helpful. And then a question on shipping costs. So it looks like it grew about 31% up on shipping costs in the quarter, and that's been kind of moving in tandem with the Amazon fulfilled unit growth. Is that the right way to think about it? It looks like it might be getting a little bit of leverage in the model right now as -- is that -- what's driving that, the shipping cost leverage? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Sure. Let me start with that last one. Yes, shipping costs are going to be very tied to AFN unit growth and also the impact of greater Prime adoption and faster shipping methods. So yes, we consider that a very strong quarter, down sequentially in the growth that we've seen recently. That will fluctuate quarter to quarter. Again, it was a very strong operational quarter in Q4, and we've expanded the number of items that shipped free. We're now over 100 million items in the U.S. So yes, shipping cost is always going to be a strong part of our offering, and we're -- it's going to be increasing due to our business model. And we, at the same time, look to minimize the cost by getting more and more efficient in that area. AWS, yes, if you remember last year, we did have price increases in December of last year towards the end. So it had a partial impact on the quarter. But generally, just strong usage growth. Usage growth continues to be strong, growing at a higher rate than our revenue growth rate and customers continue to add workloads and expand. And as I said, we're adding new services and features all the time, over 1,400 in 2017 alone. So it's a number of factors, I would say. It's not as simple as lapping a cost there -- excuse me, a price decrease last year, but very happy with the performance in -- of the AWS business. Now over a $20 billion run rate. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [11] +-------------------------------------------------------------------------------- + + Brian, if you look back historically, your Q1 operating income guidance is typically about $300 million, $400 million lower than your Q4. Obviously, it's significantly greater than that this quarter. Maybe if you could shed a little light on why that is so and what are some of the key drivers there. And AWS and cloud pricing appears to have been more subtle in recent quarters. Maybe if you could talk a little bit about the pricing environment and why that has been the case at least compared to trends from back in '14, '15 and previously. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. Let me start with guidance. So yes, the operating income guidance is $300 million to $1 billion. Operating income last year was $1 billion. Q1 is generally when we see the volume drop off from Q4, obviously, but a lot of the costs remain from the year-over-year buildup in costs, particularly in the fulfillment network. So it's generally a headwind every Q1. It's -- given the 30%-plus growth in square footage last year that we've built, that's one major headwind from Q4 to Q1. But we also continue to invest, particularly in Alexa and our device area. As I mentioned in a number of comments earlier, we're very happy with the results, the customer adoption, the device sales that we're seeing and the general customer acceptance there. So we will continue to invest there. Those are probably the 2 largest factors in Q1, I would say. + +-------------------------------------------------------------------------------- +Dave Fildes, - [13] +-------------------------------------------------------------------------------- + + Yes. This is Dave. Just on the second piece on just pricing. I think in the pricing environment, I mean, nothing really to call out there. I guess, just a reminder on our pricing philosophy for AWS. Periodic price reductions are a normal part of our business. We reduced prices more than 60 times with AWS since launching. So really, our kind of goal and philosophy here is to drive efficiencies in our ops and pass those savings on to customers. And some of that's through, again, with the more than 60 price reductions, but also finding through new service and feature launches better options for a customer that present -- customers to present more efficient features for them to be able to run their businesses. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [15] +-------------------------------------------------------------------------------- + + First, Brian, any comments on the impact of ASC 606 accounting changes on your first quarter guidance here? And then just second on the advertising business, in particular, the ads that we see in the search results on the site, the headline search ad, sponsored product ads, do you aim for a certain particular ad load across the entire platform? Do you look at sort of tailoring it based on user's activity, maybe a combination of both? Would just be interested in your thoughts on that. + +-------------------------------------------------------------------------------- +Dave Fildes, - [16] +-------------------------------------------------------------------------------- + + Yes. This is Dave. I'll take the first part of that question just around the new revenue recognition standard. We did adopt the new standard on January 1 of this year, 2018. And you'll see that reflected in our financials for the first quarter coming up. There -- it touches on a number of different parts of our business in terms of how we recognize revenue. In terms of in the aggregate and the impact to our expectations for the revenue guidance for the first quarter, it's not material. There's a number of different areas, at least, that we've called out in our filings with the 10-Q in the past and the 10-K that will be on file shortly that talk about the different areas that are impacted with this. But again, not material in the aggregate. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + And on advertising, I would say our strategy is to make the customer experience additive by the ad process. We want customers to be able to see new brands and have easier time discovering products that they're looking for. For brands, we think the value proposition is that we can find ways for them, especially emerging brands, to reach new customers. So we're working with advertisers of all types and sizes to help them reach our customer base and the goal of driving brand awareness, discovery and better purchase decisions by the customer. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [19] +-------------------------------------------------------------------------------- + + I think I have 2 questions. First, Whole Foods, you've got over a quarter under your belt. How's it going versus your expectations? And what can Amazon really bring now that you've been there for a while, how you're thinking about that? And then secondly, international decelerated a little bit this quarter, just wondering if there was any country to call out or anything going on there. And we know that you spent about $3 billion international investment, I guess, last year. Where do you think the high-water mark is on that? So just maybe a little bit more color on your international business. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + Sure. Let me start with the Whole Foods question. We're continuing to be very excited about the opportunities we have to innovate with the Whole Foods and Amazon teams together in our physical stores. It states in our supplemental disclosure that physical stores revenue was $4.5 billion in Q4, which is primarily comprised of Whole Foods and was slightly better than what was built into our guidance that I gave you last call. So -- so far, our focus has been on continuing to lower prices even beyond the initial ones that we discussed at the close of the deal in late August. We've launched Whole Foods products on our Amazon website. And the technical work continues to make Prime the Whole Foods customer rewards program. And we expect to have more on that later in the year. We've also added Lockers and much more to come. So we're very happy with the initial results out of the team in Whole Foods down in Austin. Also, I will mention that we did see a small operating income/loss for the quarter from Whole Foods. At the time of the acquisition, we had stepped up the fair market value of certain assets on the balance sheet. This is going to increase the amortization. It's a noncash charge, but it will increase the amortization over the useful life. And a lot of that is forward front-loaded, so we'll see higher amortization in the first few years and then it reverses later. So excluding these noncash expense items, Whole Foods had a positive operating income in Q4, but you'll see in the 10-K that the operating income, including the charges, was slightly negative in Q4. International growth, your comment about slowing down, I think there's a slowdown versus Q4 -- 3, if that was your point. 28% growth in Q3, FX neutral, was helped quite a bit by Prime Day and kind of the strengthening of Prime Day in a number of locales. Although we've had Prime Day in most of those countries, it's really starting to gain more and more traction there. So that is probably more of a help to Q3 than a discussion of any weakness in Q4. So we're -- continue to be pursuing the same strategy as we have in North America, adding Prime benefits, adding devices, adding video content, adding AmazonFresh, Prime Now, giving a lot of value to the Prime customers in international countries as well. And also in that number is India. And India continues to be a good story for us. We feel that it's had a lot of growth in the past year. In fact, more Prime members joined India's Prime program in the first year than we've seen in any other country in the history of the world, our world. So the selection is also increasing Prime eligible selection is up over 25 million items, launching video there and also continuing to add other Prime benefits such as Prime Music will be coming soon. Amazon Family is there. As I said, Prime Video, and we had our first Prime Day in India. So that's a little bit on international growth. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [22] +-------------------------------------------------------------------------------- + + I have 2. The first one, in the press release, you talk about the strength of the Prime member growth in 2017. Could you talk a little bit about to the -- what you're seeing in growth in Prime subscribers in the United States at this point? And are you still seeing a similar tick up in consumer spending as they come into Prime as you have in the past? And the second one, Brian, to go back to an earlier question on areas of investment this year, you didn't talk a whole lot about kind of new categories to expand into beyond the old retail business. Curious to hear about the investment needed to go into logistics, health care and kind of new areas you haven't really cracked into as hard yet. + +-------------------------------------------------------------------------------- +Dave Fildes, - [23] +-------------------------------------------------------------------------------- + + Yes. This is Dave. Thanks for the question, Brian. Just on the first piece, in terms of just Prime membership and Prime behavior, we continue to see that we're seeing sign-ups for memberships at a strong clip. When we look at the year-over-year growth in paid Prime members on a global basis, it's been consistent in Q4 year-over-year, similar growth rates year-over-year to what we've seen in some of the earlier quarters of this year. So that's, of course, a mix of strength in the U.S. and also strength in some of the newer markets that we've launched or introduced the Prime program in. We continue to see that as Prime members sign up and engage into the program, their purchasing patterns change and they do spend more as they move into the program. And of course, our focus is -- continues to be on adding some of the features around Prime that Brian's been talking about, but also importantly, making sure we're adding more selection to the offering through our own efforts, first party, but also programs like Fulfillment by Amazon, which is -- continues to be a fast grower for us. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes. And on new businesses or expansion of categories, as you discussed, I would not talk to anything that's not been publicly announced, but on some of the ones you mentioned, they are underway and are continuing. I would say on logistics, we will continue to build our logistics capability both -- and that will be all the way, too. And delivery, we've been able to increase service levels in many cases by delivering it ourselves. And although we have a strong partner network here, we will always be able to leverage our strength and our knowledge about where shipments are going, both within our network and to final customers that will create opportunities for us there as we increase or better the customer experience as well. We continue -- I would say on the category side, the biggest effort will continue to be on groceries and consumables with the Whole Foods acquisition. And again, we continue to look at our whole offering of AmazonFresh, Prime Now, Whole Foods, how can they work together to create better and better offerings for our customer base. And to a lesser extent, versus grocery, I would say, we continue to build our business, B2B businesses, and very happy with the initial performance there with a number of the companies and universities that we've been working with and their initial results. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Scott Mushkin with Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Andrew Mushkin, Wolfe Research, LLC - MD and Senior Retail & Staples Analyst [26] +-------------------------------------------------------------------------------- + + So I want to go back to -- and I think you said one of the big focuses of the year is going to be on the consumables, Now, Fresh, Whole Foods. There's been a lot of press on the Whole Foods front, the out-of-stock issue and then clearly in the Now as we've been testing it and Fresh has the same issue. So I was wondering if you guys could talk about what the company plans to do. I mean, there is obviously the reputational risk that could come from that to kind of correct some of these issues and kind of what the view of the company is on the out-of-stock issues, not just at Whole Foods, but just generally across the consumables business in Fresh and Now. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes. I'm not -- let me just back it to a more general statement. I'd say, Whole Foods is not less in their commitment to providing the best selection of high-quality products and having them in stock for customers. We made no changes post the acquisition that would have impacted anything related to in-stock, except perhaps the fact that price decreases have brought up demand and there's an amount of rebalancing related to that. So I think the out-of-stock issues that may be getting press are tied more to the increased demand that we're seeing and also selective weather-related restocking issues. But stepping beyond any short-term issues, the commitment is -- remains to have healthy, high-quality selection in stock for products. That's what the Whole Foods team has committed to. That's what the Amazon team, with them, is committed to. And also across any delivery channel that we have, AmazonFresh, Prime Now or Whole Foods. So where there's issues, they'll be corrected. Where there's areas we can improve our selection and delivery for customers, we'll do so. But it'll be something that we're working on. So the immediacy, the perishability are all challenges everyone has in this area, but we're confident that we will have a good service and continue to delight customers. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Youssef Squali with SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [29] +-------------------------------------------------------------------------------- + + We've seen that the number of private-label products on the site has increased pretty dramatically over the last 12, 18 months. Can you speak to your private-label strategy in general? How big is that segment today? How big can it become? And just broadly speaking, how are the margins in that segment versus comparable third-party products? + +-------------------------------------------------------------------------------- +Dave Fildes, - [30] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question. This is Dave. I think broadly, when I look at our strategy, it's focused on, number one, providing a broad selection for customers across a number of categories so that they can find and buy exactly what they're looking for. When you look at private brands, it's very much meant to supplement that great selection. And we look for ways to be able to find private-label items that have a high caliber of quality, but also can bring that selection and that convenience for customers and really supplement what vendors and sellers are already providing to customers in many cases. We've not broken out kind of how significant or how large that is. I think for a lot of these initiatives, when you look across categories that we offer, many of them are still earlier stage and have been around even from kind of infancy for shorter period of time, a year, a couple of years in some cases. Amazon Fashion is one area where you're seeing us offer a number of private apparel brands. Some of the more sort of popular lines with customers have been things like Goodthreads, Amazon Essentials, which is men's and women's basics. Consumables is, of course, another big area where we have the benefit of working with some of the Whole Foods private label, but also doing some of our other Amazon brands, things like Happy Belly and Wickedly Prime and others so. I think we'll continue to iterate on those and try to find different areas. And certainly, there's other verticals that I didn't mention there that we're interested in continuing to kind of learn from customers what they want and what they're looking for there. And so we'll keep adding selection. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ken Sena with Wells Fargo. + +-------------------------------------------------------------------------------- +Kenneth Michael Sena, Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst [32] +-------------------------------------------------------------------------------- + + Maybe if you could just remind us of the thinking that -- behind keeping AWS and retail under one corporate structure. And does it make sense given the scale of where AWS is right now? And then -- and I'm sorry I have a little bit of an echo, I don't know why, but -- and we're hearing from marketers just how important Amazon is to their media strategy. So I don't know if you could just maybe talk about that a little bit more broadly in terms of the approach and your philosophy to that business. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Sure. We see a lot of value in all of our businesses. And AWS is a key component as is the physical consumer business. The -- what I'll point out is the management team is a common management team. The consumer business, if you will, is, if not the biggest, one of the largest customers of AWS. So we see a lot of commonality there where we as -- depending on position in the company. On the consumer side, the use of AWS has driven great infrastructure efficiencies, just like other companies see when they use AWS, turning fixed cost into variable cost and pooling resources and not having a lot of trapped capacity throughout the company and taking advantage of all the new services and features. So as a internal customer, the consumer business is very happy with AWS. And I think AWS is also very benefited by the fact that they have a large internal beta customer that tries out and uses a lot of their products and services. So it's a good combination for a lot of reasons, and we see no reason to change the structure that we have. + +-------------------------------------------------------------------------------- +Dave Fildes, - [34] +-------------------------------------------------------------------------------- + + Yes. And sorry, Ken, your second question was? + +-------------------------------------------------------------------------------- +Kenneth Michael Sena, Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst [35] +-------------------------------------------------------------------------------- + + Yes. The second question was just on the advertising side. And just -- we're just hearing so much more how important Amazon is to broader media budgets. And so just hoping to get maybe a little bit more color just on your approach to the business right now, some of the drivers behind the recent success and just maybe just more of a sort of, as you look out over the next few years, kind of how important do you see this business becoming in the grand scheme of things? + +-------------------------------------------------------------------------------- +Dave Fildes, - [36] +-------------------------------------------------------------------------------- + + Yes. I mean, I think right now, we're really just focused on finding ways to work with those companies, whether it's vendors or sellers that are coming to us and offer them a great experience on the website and an ability to be able to reach customers. So I think there's more to come on that side. As we said, we're definitely seeing some strong growth in our advertising revenue as part of the other revenue line item. And I think we're going to keep building more new tools based on what we're learning from our customers there to better serve in the future. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- + + I think we're also part of the key lean in from a lot of brands and agencies into the e-commerce marketing space. So whether it's our site alongside search or social marketing, it's really helping them engage customers on a high, efficient -- highly efficient manner. + +-------------------------------------------------------------------------------- +Dave Fildes, - [38] +-------------------------------------------------------------------------------- + + Thanks for joining us on the call today and for your questions. A replay will be available on our IR website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2018-Jul-26-AMZN.txt b/Transcripts/AMZN/2018-Jul-26-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..5f9929d540109bd858220673750410528ea92de7 --- /dev/null +++ b/Transcripts/AMZN/2018-Jul-26-AMZN.txt @@ -0,0 +1,319 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Amazon.com Inc Earnings Call +JULY 26, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2018 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2018 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2017. Our comments and responses to your questions reflect management's views as of today, July 26, 2018, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Justin Post from Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess the standout metric of the quarter was the profitability and the margins. Both U.S. and international have improved year-over-year. Could you talk about, was it better than your expectations for the quarter? And then maybe a reason for the ad business to accelerate within the other line. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, yes. Thanks, Justin. Yes, for the quarter, so it was a strong quarter. We had, what I attribute it to is continued strength in some of our most profitable areas. AWS had its third consecutive quarter of accelerating growth, 49% FX-neutral growth. Advertising also had strong growth. Elsewhere, we saw probably better-than-expected efficiencies in operations, our infrastructure costs and generally all of our fixed costs. You'll note that in the first half of the year, capital leases were flat year-over-year, although we're up 20% for the full trailing 12 months. In the last 6 months it's been pretty flat as the team has really worked well to plan our data centers, run our data centers more efficiently even to meet, again, increasing usage by our customers, usage rates that are exceeding our growth rate. So that's what I would point to. Internationally, a lot of the same factors hold. I would say that in addition to the operating efficiencies, advertising is also starting to make an impact on gross profit, although advertising is smaller in international segment than it is in North America. It's growing at the same rapid clip year-over-year. Even while in international, we're continuing to invest in a lot of areas. We continue to frontload Prime benefits for the newer geographies. We continue to launch new countries. We launched Prime in Australia recently. We've launched devices in multiple countries. Echo and Alexa were launched in France. Echo Spot was launched in India and Japan in the last quarter. So continued -- it's a mix of operating efficiencies as we grow and then also continuing to invest on a lot of fronts. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [5] +-------------------------------------------------------------------------------- + + Okay. Hey, maybe 2 things. Just a little bit of color on that unit growth. I think it was 17%. Any particular things to call out there that would have stunted that growth or negatively limit it? Or is that just kind of a new, new normal? And then Brian, I'm sorry. You just talk better-than-expected efficiencies in operations. Can I ask you to tease that out a little bit more? And a little more color, particularly on the retail side of the business. Are there particularly newfound efficiencies that are sustainable? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Sure. Let's start with the unit growth. So I will note, we did a very strong unit growth rate last year in Q2 with 27%, so we're comping against that. As we look back on that, there were a number of factors. I mean, in any quarter, there can be product mix or ASP differentials would shift the unit growth figure, but if you also remember, we dropped our Super Saver shipping threshold twice in early part of last year from $49 to $35 and then down to $25. So there was a bit of growth, particularly in lower ASP items from that, that we saw a last year. So we're comping that. Another factor is digital content that moves to subscription. So Amazon Music and Kindle Unlimited, while they're very successful and it's a good transition, they just -- the units do not count in this unit calculation. So there's some things like that, that maybe obfuscate the numbers a bit, but we're really pleased with the retail growth. We think it's driven by, again, Prime -- the Prime program, the efficiency -- or excuse me, the engagement of Prime customers as well as increased selection and particularly third-party selection. On operations, if you look at probably the last 18 months, you're going to see a lot of different pace of increase in both infrastructure, cost and capital cost and the addition of fixed cost heads. So one thing that you'll notice is that we've grown -- that we've stepped down our rate of growth of fixed headcount, excluding acquisitions. We've grown 26% year-over-year at the end of June on a trailing 12-month basis. But the 23% of that was in the second half of last year. So we are continuing to look at where we're investing headcount. We're seeing a lot of our growth areas being fueled by headcount that's moving within the company. There's a lot of movement of tech headcount. And so there was less external hiring in the first half of this year. We don't think that, that's necessarily the long-term trend, but it's certainly created a lot of operating efficiencies and now we'll reset and evaluate where we need to still add people. So I think the first half of the year can be a good test of where our cost structure is coming off of the investment that leads up to the holiday. Last year, there was a lot of first half investment. If you look back on infrastructure and fixed headcount, that may be made that less pronounced. But this year, it's a little more apparent. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from line of Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [8] +-------------------------------------------------------------------------------- + + I want to ask 2 if I could. First, 3Q is typically a heavy fulfillment center build-out period, ahead of the holidays and then lower utilization, but obviously your outlook is good. Can you just give us a sense of how you're thinking about FC build-out in square footage increases this year? And then secondly, a lot of excitement around the pharmacy opportunity with the acquisition of PillPack. Can you frame some of the strategic rationale there around the acquisition and how that helps advance your efforts and how we should think about integration going forward? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Sure. On the fulfillment center capacity, I don't have a number for you today. I'll probably clarify that at the end of next quarter as we head into the holiday. But if you think back the last 2 years, we've added square footage that's exceeded 30% growth both in 2016 and 2017. We anticipate it's going to be lower this year as we get some efficiencies off what we've built over the last few years. But we don't have a number for you today. I will say that the majority of it is being put in service in the back end of the year, just like in the last 2 years. But we'll clarify that next quarter. On PillPack, yes, the deal of course, hasn't closed yet. We expect to close it in the second half of the year, so I'll limit my comments right now. But we're excited. I think the company has a really highly differentiated customer experience, and they've done a great job getting to the size and scale that they're at today. We think that working together with them, we can expand on that in the future. They're like a lot of the other acquisitions we've done. Recently, we're looking for well-run companies with highly differentiated customer experience and a real sense of customer obsession that matches ours. So we think PillPack has got all those traits, and we look forward to the deal closing and working with them. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [11] +-------------------------------------------------------------------------------- + + On AWS, does the backlog there give you confidence in the ability for this business to continue to post the type of robust growth that you've seen of late? And on Alexa, now that you're reaching a meaningful number of Alexa users, I wondered if you could discuss a bit more about how Alexa is impacting their retail business. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. Let me start with AWS. Yes, we're very happy with the results we're seeing and the backlog that we see and the new contracts and new customers and the expansion of existing customer business that we see. Again, the businesses accelerated in the last 3 quarters, and we're seeing great signs in a number of areas. We've added 800 new services and features so far this year. That's an accelerated pace from last year, which was a record year. We see customers have migrated more than 80,000 databases using the AWS data migration service -- excuse me, Database Migration Service. And customers are just branching out to a lot of new products from us. There are new areas like machine learning, artificial intelligence, Internet of Things. Serverless computing and database and analytics are really big. So we think that when you look at it, why do people come to us essentially? It's that functionality and pace of innovation that we've demonstrated for multiple years. We've built a very strong partner and customer ecosystem. And frankly, we're the most proven in reliability, security and performance, and we've been at this longer than anyone else. So again, we continue to deliver for customers. We continue to use feedback from customers to develop new services and features. The operating margin itself will fluctuate quarter-to-quarter. A very strong performance this quarter, obviously. Part of that was in the capital expenditures -- excuse me, or capital leases being flat year-over-year and the team's ability to really run the data centers at a higher efficiency. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + Yes, and I think the second question was really just how is Alexa impacting the business overall. Hey, this is Dave. And I think we're having a lot of success with devices and customers are enjoying those. We talked to coming out of Prime Day, had some good success and happy customers enjoying some of the devices there. So I think that's a lot of -- the focus now is really having good and exciting roadmap of recent revises and more to come ahead and getting those into customers' hands. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [15] +-------------------------------------------------------------------------------- + + Just on the AWS point, as you're seeing in customers to AWS -- you're adding new customers to AWS, can you give us a sense of sort of where you're seeing customers spend focus? How successful you mentioned database, but what other areas are you potentially seeing as customers move up the stack with you and grow? And then you flagged the flat capital lease growth on a year-over-year basis. In the past, when you've talked about the growth in CapEx and capital lease, you generally referred to trying to grow those numbers or that infrastructure growth overall with more or less with the business. Is there some level of efficiency breakthrough that you've gotten there where that's no longer the case? Or is it a function of timing? How should we think about what that CapEx and capital lease spend signals about your expectations for growth? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + Sure. I would say it's just a demonstration of a very tight period where we -- we're still adding a lot. I mean, $4.6 billion is a lot of capital leases. But the rate of growth over last year was flat. So what I would say is, I'm not sure about the breakthrough element of it. We do spend a lot of time driving better efficiency in our data centers. We do see it. Sometimes it is higher than other quarters. The starting point for our expectation would be that usage growth would be very -- that our growth in infrastructure cost would start with the growth in usage, which has been exceeding the revenue growth rate. But we can do -- we can drive more efficiently and we can sometimes bank the efficiencies of prior investments that we've made in other periods. So it will fluctuate quarter-to-quarter. I would say last year, in the first half, was a pretty large investment area. I'll lump it in with capital expenditures. But in the first 2 quarters, Q1 of last year was 82% growth year-over-year in capital expenditures. Q2 was 67%. This year, those numbers are 33% in Q1 and 1% in Q2. So there's a bit of timing at play here, but I think overall, in the longer term, we certainly work to drive efficiency in both AWS infrastructure capability and also in our warehouse networks. I don't have, on the other piece, on the product detail, I don't have anything more for you. I would just say that our growth is coming from customers that span from start-ups to enterprise customers to government agencies, and they start small and then they continue to build and shift their businesses to us. And many of them have gone -- a large number have gone all-in on AWS and have had a chance to lower their cost structures as a result. I would count Amazon in that category because on the consumer side of the business, we increasingly see infrastructure savings due to the conversion to AWS resources. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [18] +-------------------------------------------------------------------------------- + + I have 2. The first one, on the ad business. Brian, I was just wondering, could you give us some examples of some products you have particular success with on the ad side? And then I know you guys are always focused on removing customer friction points and solving pain points for customers. Maybe talk to us about some of the still existing pain points for your advertiser customers you're looking to address with the advertising product. And the second one, I know it's an accounting question, but we're going to be asked a lot. On revenue accounting, can you just sort of walk us through any of the accounting changes that any of the revenue lines had in the current quarter because of the multiple accounting moving pieces? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes, let me give Dave a chance afterwards to talk about that piece, but I'll start with advertising. So conceptually, stepping back, it's now a multibillion-dollar business for us. We're seeing strong adoption across a number of fronts. Amazon vendors, sellers, authors, as well as third-party advertisers who want to reach Amazon customers. So we have hundreds of thousands of emerging and established advertisings -- advertisers, and they're using our services to achieve their marketing goals, whether that's to drive new brand awareness, discovery or ultimately purchase decisions on our site. Pain points and improvements, I would say our priorities include improving the usability of our tools for advertisers, helping make smarter recommendations for customers. Automating, we're doing a lot of work on automating the activities that the advertisers need to do and continue to invent new products for the advertisers. We also think measurement is going to be important, so we're focused on our measurement capabilities, so advertisers understand what outcomes they're driving on our properties. And we think that we're uniquely positioned to show them the direct benefit of their advertising. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [20] +-------------------------------------------------------------------------------- + + Yes, and Brian, this is Dave. Just on the accounting piece, specifically to Q2, the impact of the accounting standards update revenue recognition changes we did starting in the first part of year, it's $640 million increase to other revenue, specifically related to how we treat some of the advertising service. So you remember, as part of the adoption, beginning in 2018, certain of the advertising services were classified as revenue rather than cost of sales. So $640 million more is another revenue this second quarter. You'd see that in that line item, which is about $2.2 billion here in the second quarter. In addition to that, some of the other factors I talked about last quarter, some of the treatment of gross to net changes in some sales of apps and app content, digital media costs, some of that shift created a headwind for online stores revenue. So that year-over-year growth rate for that line item would have been higher but for that change. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [22] +-------------------------------------------------------------------------------- + + Two questions, if I can. On Whole Foods, any update on the integration of Whole Foods within the broader Prime ecosystem, the way in which you're tying those assets and customer bases together to sort of promote the flywheel that you've talked about a fair bit? And Prime Now, any update on the scale of markets globally and what you're learning as Prime Now continues to scale in terms of how users adopt the service, putting SKUs closer to prem, what that does to the velocity of purchasing? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + Sure. So it's a big quarter for Whole Foods and Prime. We launched Prime for -- sorry, we launched Additional Savings for Prime members at Whole Foods. If you go a Whole Foods store or a Whole Foods market, 365 store, you'll see a lot of yellow stickers for 10% discount off hundreds of sale items. You'll also see deep discounts on selected popular products. So Prime members have adopted this benefit. It's one of the fastest rates we've ever seen for a Prime benefit, and they've already saved millions of dollars on everything from seasonal favorites to, as I said, popular daily sales. So in addition, we've expanded the grocery delivery to 20 cities, so that's picking up steam. During the Prime Day, we had some unique deals with -- for Prime customers at Whole Foods. Actually, the deals lasted for a week at Whole Foods, and people had, again, the ability to see the benefit that Prime membership -- save incremental dollars because of it at Whole Foods. And the Prime Rewards Visa card, which gives you $5 -- excuse me 5% off on all purchases, has been applied to Whole Foods purchases as well. So that is the second wave. Probably after the first wave, when we've talked in previous calls about initial price drops, putting lockers in the stores, selling some of the Whole Foods products on the Amazon site and other things. So the invention level is still really high. We're -- we think it's a big milestone this quarter to launch Prime benefits with Whole Foods, and we'll keep going. We'll see how that develops. Prime Now, I guess my comments are that it's in 50 cities worldwide. It's across 9 countries. The -- it is different than -- we have multiple options for you in grocery delivery. We have the delivery services, so AmazonFresh and Prime Now, which serve a certain need. We have a traditional grocery store now with Whole Foods. And then we have the combination of those 2 with home delivery and we're using Prime Now or Whole Foods products through Prime Now to make those deliveries, as well as the new kind of stores with Amazon Go that we're experimenting with. So lots of innovation, invention on that front as well. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [25] +-------------------------------------------------------------------------------- + + Hey guys, I had 2 questions. First is on the Music business. So I think you said recently you have tens of millions of paying subscribers. So are those paying music listeners coming from Prime and using the mobile app? Or are they coming in from Echo? Any color on what's driving that uptick and converting users into paid members? And then the second question is, you mentioned efficiency gains in retail and the improvement in retail operating margin. If we look at international, it's still negative, but it's also improving pretty meaningfully. So can you parse where that improvement is coming from between India and the other emerging markets versus some of the more mature markets in Western Europe? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Sure, let me start with that second question. So yes, we have seen, over the last few quarters, improved operating margins internationally. I would say in places like Europe and Japan, we're seeing many of the efficiencies I talked about earlier on fixed headcount, operations cost, infrastructure cost and also things like marketing, working to be very efficient. I would also say that although it's smaller internationally, the impact of advertising is starting to show up more and more internationally. It's growing quite quickly just as it is in North America. But you're right. We continue to invest. We're investing in India, obviously, and have seen good traction there. We just passed our fifth year anniversary. We just celebrated our fifth year anniversary. And it's the most visited site in India. So we think there's a lot of great innovation that has continued to occur for Indian customers, consumers and sellers, and that will continue. But you're also seeing additional expansion. So we launched Prime Australia. We're rolling devices out. We launched Echo and Alexa in France. The Echo Spot in India and Japan, and we announced that we're going to expand Echo and Alexa soon to Italy, Mexico and Spain. So I would say that we're continuing to frontload Prime Benefits in the newer geographies. So that's one of the issues that we see with operating margin. But we think it's the right thing to do. We are seeing strong traction in that front as well. We also like that on Prime Day, we're able to expand our list of countries that experienced Prime Day this year to Australia, Singapore, the Netherlands and Luxembourg. So we're very bullish on our international business. We do realize it's a period of investment, and we're at different stages of growth in different countries. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [27] +-------------------------------------------------------------------------------- + + Yes, this is Dave. Just quickly on Music, as you mentioned, tens of millions of paid customers are enjoying Amazon Music. When you look at the Amazon Music Unlimited subscription, it continues to grow very quickly. We've got those offerings in more than 30 countries now, and the catalog, there's tens of millions of songs, and a lot of rich playlists, personalized stations, those kinds of things. Of course, we started in Music with Prime Music a little bit earlier in that space, and I think that's been a great way for Prime members to enjoy some of that catalog for free, and then as they enjoy that, be able to move into the Amazon Music Unlimited scale. One of the great things that's also part of that, I think, you alluded to is just Alexa, and one of the most popular features we see, as you probably imagine, for using those devices or just interacting with Alexa wherever you may be is being able to listen to music, so that's proven to be, I think, a good skill for folks to be able to enjoy, in addition to a really kind of rich and growing Amazon skill set. We now have more than 45,000 skills available to customers. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from Youssef Squali with SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [29] +-------------------------------------------------------------------------------- + + On the new Supreme Court decision, you guys have been collecting state taxes in all 45 states where it's applicable for 1P. And for 3P, I think it was in 2 states. Have you seen any slowdown to growth in these 2 states since you began collecting taxes? I think you started maybe last 12 months or so. When will you start collecting taxes in the rest of the other -- in the rest of the country? And will you charge for it? Because my understanding is that in those 2 states, you do not collect or you do not charge to help these 3P sellers file taxes or collect state taxes. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [30] +-------------------------------------------------------------------------------- + + Yes, hey, Youssef, this is Dave. So right now, as you mentioned, 45 states that have state-imposed sales tax, first-party products, we do our own collection on that. For 3P sellers, right now, it's 3 states. So Washington State started as of January 1, Pennsylvania as of April 1, and most recently, Oklahoma on July 1. So those are the ones where we're collecting in and remitting. We haven't said -- and to your second point, we've not talked about any kind of trends. As you imagine, some of these are still really early days. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our final question comes from Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [32] +-------------------------------------------------------------------------------- + + Given the focus in the press release about Alexa Voice Services, any thoughts about how you would monetize on third-party devices? And then just a follow-up, Amazon Prime Video channels, any plans to offer standard skinny bundles to become a cable replacement thing? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Yes, let me start with Alexa. So right now, our emphasis is around expanding the reach of Alexa and the usefulness. So as Dave mentioned, we're now up over 45,000 skills. We have a developer network that's expanded, and we have over 13,000 smart home devices from 2,500 unique brands. You're seeing things like expansion into the hotel space, where we're partnering with hotels to allow you to experience Alexa while you're traveling. And you saw from the quote that was in our press release that Jeff -- from Jeff, the number of Alexa-enabled devices has tripled in the past year, including some really large companies like Polk, Sonos, Acer, Hewlett-Packard, Lenovo, BMW, Ford, Toyota, to name a few. So that's the biggest emphasis, is getting the expansion of Alexa to places where it can be useful. We also are developing new machine learning tools to help developers more easily build Alexa skills. We feel like we're getting great traction there. So I think your original question was about monetization of Alexa, but right now, the biggest thing we can do is to make it as useful as possible and make devices that can use the skills. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [34] +-------------------------------------------------------------------------------- + + Yes, and then just on the second question, I mean, I can't speculate on what we might do in the future, but I'd say today, with Prime channels, I think we're very pleased with the growth we're seeing. We've seen some good channels come online over the last few quarters and have seen some good traction there. So we'll keep focusing on building out even better selection because it's clear to us that customers want that option to be able to add that content as part of their Prime memberships. +Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2018-Oct-25-AMZN.txt b/Transcripts/AMZN/2018-Oct-25-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..f5a7721f148155ae843a86a0ad0ec0a36d072425 --- /dev/null +++ b/Transcripts/AMZN/2018-Oct-25-AMZN.txt @@ -0,0 +1,370 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Amazon.com Inc Earnings Call +OCTOBER 25, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Lloyd Wharton Walmsley + Deutsche Bank AG, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q3 2018 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. +For opening remarks, I will be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q3 2018 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2017. Our comments and responses to your questions reflect management's views as of today, October 25, 2018, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures in our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we'll move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess the big one is the deceleration in unit growth or online stores which is probably related to that. I know it's a tough Q3 comp, but could you comment a little bit about that? And then kind of what initiatives could be most interesting to maybe reaccelerate that over the next couple of years, what categories? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Justin. Yes, let me just remind you of a couple of things from last year. We had 2 reductions on our super saver shipping threshold in the first half of the year between February and May. That did spur a lot of unit growth in the second and third quarter. We also have issue with digital content -- not an issue, but the fact that digital content is moving to subscriptions, Amazon Music Unlimited and Kindle Unlimited, in particular. It's been really popular. I'll just remind you just the units, those do not count in our unit totals nor do the units from Whole Foods Market. So yes, I would say, essentially with that backdrop, we're still very encouraged by the demand and the reception from customers. On the consumer side, we have -- Amazon-fulfilled units are still growing faster than paid units. 3P is now up to 53% of total paid units. In-stock is very strong, especially as we head into the holiday period. I think we're well positioned for the holiday. We have over 100 million Prime-eligible items available for free 2-day shipping for Prime members. And again, all -- a lot of -- when I'm talking about the unit deceleration, a lot of the fastest-growing areas, things like subscription services, AWS and advertising, are not caught in that metric. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Yes. And Justin, this is Dave. Just to add on that, you mentioned the online stores, just a reminder there is a little bit of impact from the revenue recognition. So you see the online stores revenue growing about 11% ex FX to be higher than that, but -- for the adoption of the standard. So there's a little bit of a headwind there as well. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [6] +-------------------------------------------------------------------------------- + + Okay, I was going to also then ask you to drill down a little bit on the international retail business that seemed to slow down, I guess, that -- whatever, 15% or something year-over-year. Any particularly color? Any markets that would've led to that? Though the comp was tougher, but anything else you'd call out there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure. So on a year-over-year basis, I think you have to look at 2 things. We did the Souq acquisition last year in May, so the full pick up on that year-over-year was in 2017, and now, we're lapping that. There's also material change in the Diwali calendar in India. About half of our Diwali sales last year were in Q3. This year, they'll be fully in Q4. So those are a couple of factors that hit the international growth area, particularly. But I'll also point out that we launched Turkey in the quarter, and now, we have 17 Amazon websites globally. So we're still very pleased again with the international business, continuing to invest in Prime Benefits, international expansion, as I just mentioned, and we're still seeing very good pick up. Story is different country-by-country, obviously. Some are much further along than others, but overall, we're very happy. India, although Diwali moved into Q4, so far, that's going really well. We've seen great response from customers. We've had 60% growth in new customers during the period. Orders are coming in from 99% of the pin codes in the country. So a great first wave of the -- what we call the Amazon's Great Indian Festival, which leads into Diwali. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [9] +-------------------------------------------------------------------------------- + + You had significant operating income upside in 3Q relative to your guide. Could you just talk about the biggest drivers there in terms of out-performance? And then when you think about your 4Q outlook, how should we think about the minimum wage increase that you've talked about? And any other one-time or special items that might be weighing on that operating income outlook? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [10] +-------------------------------------------------------------------------------- + + Sure. Let me start with Q3. And this will be a commentary pretty much on the whole year. That was especially true in Q4. So first of all, we've had very strong growth in some very profitable businesses that we have, most notably AWS and advertising. But we've also had great cost performance this year in 3 specific areas I'll call out. So first, on headcount. If you'll remember, we grew headcount 48% in 2016 and 38% last year, if you adjust for Whole Foods. With Whole Foods, it was 66%. But without Whole Foods, we still grew 38%. We have looked to really leverage our investment from the last couple of years. And as we funded and moved, invested in a lot of new areas, as we've talked about AWS, devices, digital content, we've had a lot of movement within the company that has filled a lot of these roles. So we're only up 13% on headcount through 9 months year-over-year, so a real step-down in that. Again, the theme here is going to be banking some of the investments from prior years and looking to gain greater control. In our fulfillment center world, we had grown square footage for our fulfillment center and shipping areas by over 30% the last 2 years, 2016 and 2017. I've talked about that in prior calls. It's -- we're making that investment to match up with very strong Fulfilled by Amazon demand and AFN, or Amazon-Fulfilled Network units, that are growing at a faster rate than our paid units. This year, we're only adding about 15% to our square footage. So again, getting better efficiencies on what we have and banking the multi-year investment that we've been making. And the last one which is really significant is on the infrastructure side. You see the operating margin for AWS is up to 31% this quarter. A lot of that is based on efficiencies of our data centers, not only for the AWS business but also for our Amazon consumer businesses, which is AWS' biggest customer. If you look at capital leases, which is where we spend money for the data centers, it's up only 9% year-over-year trailing 12 months, and it was up 69% last year at the end of the year. So those 3 areas have driven a lot of the cost performance and a lot of the deviation from probably the estimates that I've come up with this year. So we are really happy that, again, we're seeing great cost performance in a number of areas across the business. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [12] +-------------------------------------------------------------------------------- + + A question on AWS. Obviously, in the last few quarters, you've seen accelerating revenue growth. This quarter, 46%. Still quite strong. But dollar and percentage growth did slow. And I'm just kind of curious, are you just reaching a point in terms of law of large numbers, where it will be more difficult to sustain, not only accelerating growth but sustain kind of the 40-plus-percent growth levels where we've been recently? Or was there something else going on kind of in the quarter that maybe drove that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes, thanks for your question. This growth rate's going to bounce around. We've had sequential increase in growth rate the last prior 3 quarters, I believe, it was. This quarter is slightly down, but still, 46% growth is very strong. We are at an annualized run rate above $26 billion, and that was about $18 billion this time last year. So we're very happy with the growth in the business, the momentum that we're seeing with enterprise customers. So -- and let me mention, on the cost side, it's been a very good year from gaining greater efficiencies in our infrastructure costs. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [15] +-------------------------------------------------------------------------------- + + I have 2. The first one, the fourth quarter revenue guide and the fourth quarter revenue deceleration, maybe can you just help us understand a little bit any of the specific categories or countries that have been the largest contributors to revenue growth throughout the course of this year? And which of those are really slowing down sort of driving this potential deceleration that you're guiding to? Then the second one, you've applied robotics to the warehouses now around Kiva. Curious of your thoughts about the need or desire to invest in autonomous driving technologies as you think about some of the other retailers partnering with Waymo and other players, et cetera. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + Sure. Let me talk about guidance. So our guidance for the fourth quarter implies 10% to 20% growth. It includes an 80 basis point unfavorable impact from foreign exchange. I wouldn't point to any specific country. Once you adjust for the fact that Whole Foods -- it was purchased in August of last year, and that has impacted every quarter since then. Q4 will be -- the first solid non-Whole Foods comp since before we bought them in Q2 of -- since Q2 of last year. So if you -- even factoring that in. We're looking at Q4 and -- we often have very high error bars on the quarter. Much of our -- not only our revenue for the quarter but also for the year comes in that very tight window between middle of November and the end of the year. So it's always a very difficult period for us to estimate. What I would say is that we feel like we're in great shape for the holiday. The warehouses are very clean. We feel like we're going to have great capacity, not only for retail products but also for FBA. We're going to have great capacity for shipping to our customers. So we're very ready to go. Selection should be at its highest point, especially for Prime members. So we're very bullish on the fourth quarter. We'll just have to see how revenue comes in. I will say there's one housekeeping item on Prime revenue recognition that you should be aware of and may have -- removed it from prior quarters. This year, we took Prime subscription revenue and amortized it over the quarters on a straight-line method. Previously, we had done it on a -- it's tilted more to Q4, was based more on shipping units. So what you've seen is a push of revenue and income from Q4 into Q1, 2 and 3 that we've mentioned on each call. This is the quarter where that will reverse. That is, to scale it for you, under the old methodology, we would have had $300 million more of both revenue and operating income in the quarter. That has, again, been caught up for in prior quarters. But again, not a huge factor on the growth rate for revenue, but just another item to consider. On the robotics, I don't have much to say on autonomous driving. We are putting most of our efforts right now -- continue to -- into our robotics program. We think it's been a great addition to our fulfillment capacity. It makes the jobs in our warehouse that much better. It makes the people around the robots that much more productive. It allows us to have much greater density of product storage and a number of other benefits. It has some additional capital intensity, but it has good return on invested capital from our standpoint. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [18] +-------------------------------------------------------------------------------- + + With a lot of offline retailers talking more about omnichannel, I wanted to understand some of the investments you might be making around unifying the efforts with Whole Foods and Amazon Prime Now, speeding up delivery, giving consumers as much choice as possible and moving SKUs closer to households. How should we be thinking about that push in '19 to '20 and how that might open up new areas of wallet share for the company? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Sure. Yes, I think we started to show our strategy on the Whole Foods side. You'll see, even in this quarter, we started to have greater expansion of our grocery delivery out of Whole Foods using Prime Now. We're now in 60 cities that's -- in the U.S. giving customers delivery in as fast as an hour, thousands of great organic products from Whole Foods. We've also expanded grocery pick up, and that's available in 10 cities, so the customers can pick up at the Whole Foods store. You'll see that we've started to tie Whole Foods into Alexa. You can order -- you can build your cart using Alexa and then checkout using the Prime Now app. So there's going to be a lot of, as you say, omnichannel overlap, especially in the grocery business. On the storefront, we're also, as you can see, experimenting with numerous store formats. Amazon Go is now up to 6 stores. We opened 5 in the quarter. We're getting great feedback on that. Customers love the ability to quickly walk in, select items they want and leave without waiting in a checkout line. We opened up an Amazon 4-star location in New York City, where we're going to test the concept of a highly curated selection of top categories across Amazon. We, of course, have Amazon bookstores, 18 bookstores in the U.S. So we're going to experiment with multiple ways of reaching the customer wherever they happen to be. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [21] +-------------------------------------------------------------------------------- + + I have 2 questions. Any color on -- it looks like shipping costs and maybe labor costs might see some inflation in 2019. So do you agree with that? Or what are some of the things you can do to potentially offset some of that pressure? And then the 15% fulfillment square-footage growth, you're obviously deploying a lot of automation and there's a lot more efficiency gains in the current generation in fulfillment centers than maybe the older ones. So how should we think about that 15%? Is that not a good reading indicator on growth into 2019? Or is it -- any color there would be helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + Sure. I think it's comparable to -- last question first. I think the 15% is comparable to the 30% that -- plus that I mentioned in 2016 and 2017. We are debating whether the dynamics of the warehouse are changing, so that square footage may not be the main indicator. It might be cubic feet, but we will -- if we switch to that way of looking at it, we'll make sure that we bridge the gap on the difference between the 2. But the other comment about cost, I believe you're probably referring to the U.S. rumored USPS rate hikes in transportation cost. We're not expecting a material impact from these rate changes in 2019. Annual rate increases from our transportation partners is a really regular occurrence. And we negotiate hard, and we'll always work hard internally to get even more efficient on our shipping methods. So we don't see that as being a huge issue. On wages, of course, we did raise wages. And starting November 1, over 400 -- or excuse me, just under 400,000 employees, both full time and part time in the U.S. and the U.K., will be getting a substantial wage increase. So that is factored -- I'm not quantifying that today, but it's factored into our Q4 guidance, and it will be, obviously, factored into the guidance into 2019. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Youssef Squali with SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [24] +-------------------------------------------------------------------------------- + + Two quick questions. First, can you quantify the contribution of PillPack acquisition in the quarter? Maybe help us understand the strategy there. And then there are some new reports suggesting that you guys were working on an ad-supported video streaming service under the IMDb brand. Can you just help shed any more light on that? Is that especially relative to your Prime Video offering? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + Let me start with PillPack. The deal closed in September, so it was a material impact back on the quarter. But we're excited, really excited to start working with the management team there. They're very strong. They've done a great job building a highly differentiated customer experience that's customer centric like we are. And right now, our focus is on learning from them and innovating with them on how to best to meet customer needs over time. I'll let Dave handle the second question. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [26] +-------------------------------------------------------------------------------- + + Yes. We have no plans to build an ad-supported Prime Video offering for free at this time. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [28] +-------------------------------------------------------------------------------- + + Two questions. First, I think I may have missed earlier if you gave out the impact of ASC 606. And then maybe second question, I think what -- one of the things people are trying to think through is you obviously guide to revenue and operating income. But obviously -- but as the business shifts more to 3P and advertising, gross profits is now much more important than just the way you capture the value you provide. So maybe if you can guide, is there a way to just help us foot perhaps slower revenue growth we're seeing versus what's obviously you extracting more value for your partners and customers and for yourself. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [29] +-------------------------------------------------------------------------------- + + Yes, thanks, Jason. This is Dave. Just quickly on the ASC impact. Brian mentioned earlier that, of course, we've been talking about it all year, the changing in the subscription revenue recognition to now a straight line. So on a comp basis, you'd expect to see subscription revenue will be about $300 million lower due to that accounting change. The other piece that we haven't talked about is the re-class that we've given in the past few quarters, specifically around the advertising services that have moved from contra COGS into other revenue beginning in 2018. That was about $750 million increase to that other sales revenue category here in the third quarter. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes. And your comment on revenue versus operating income versus potentially gross profit, I would say the impact of third-party growth, and we're now up to 53% of our paid units in the quarter were a third party, it's steadily been going up. It's up 300 basis points year-over-year. So I think the impact on revenue growth rates, since the revenue component of that is not as large, is probably something to consider on a year-over-year period. I think it tends to not be as big a factor sequentially quarter-over-quarter as -- since it has a gradual growth in it. But again, we'll continue to give revenue guidance and also operating income to an appropriately conservative level that we've tried to maintain over time. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Anthony DiClemente with Evercore ISI. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [32] +-------------------------------------------------------------------------------- + + Just wanted to dig in a little bit on advertising and the growth opportunity there. If you can help us on the potential for higher ad pricing in terms of the ROI for your marketers hopefully being reflected in higher price per ad. And then what about the ad loads? So are we kind of close to being at a full ad load? Is there a long runway there? Just trying to get a sense for pricing and volume underneath the advertising. And then also along the lines of advertising. Heading into the holiday season, should we expect any increase in your efforts around Alexa commercialization, voice, keyword, ads, let's say? And does that fit into your broader advertising growth strategy? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Yes, let me talk a little more broadly about advertising. So yes, we are seeing really strong adoption across a number of groups, Amazon vendors and sellers, for sure, authors as well as third-party advertisers who want to reach Amazon customers. As far as penetration, we don't have that quantified for you, but we still believe that there is a lot of room to continue to improve the presentation of bringing to our customers new and more relevant purchase options. So we don't think -- we'll continue to invent both on the product side, the tools side, with our goal being improve the usability of the tools for advertisers, make smarter recommendations for customers, automate activities so that advertisers don't have to work as hard and invent new products for advertisers. If we do this right, we think we'll both help advertisers and help Amazon consumers at the same time. So don't have -- I know it doesn't answer your question about specific rate increases or capacity, but that is the general strategy that we're seeing in advertising. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [34] +-------------------------------------------------------------------------------- + + Yes, and this is Dave, just jumping in on the Alexa point. I mean, I think the short answer is we don't have any plans to add paid advertising to Alexa. I think we clearly had a lot of exciting things happen in the last month or 2 in terms of new announcements and devices out there. And I mean, I think really looking at that, the goal is make customers lives easier and make it more convenient. And a lot of that is you're seeing that in homes, and to some extent, on the go. So I think if you look at the recent announcements, you've seen a few things. I mean, one, we're bringing a lot of cool hardware options to customers. Second thing, I mean, making the Alexa service smarter -- just getting smarter and more capable. And then also delivering tools for developers, helping them build for and really with Alexa. So I think making her smarter and seeing that she gets smarter with all the skills, leveraging the cloud and AI, becoming more knowledgeable, and introducing a lot of really cool new features. So really excited about the customer response with those devices and those tools so far and looking forward to doing even more. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Lloyd Walmsley with Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Wharton Walmsley, Deutsche Bank AG, Research Division - Research Analyst [36] +-------------------------------------------------------------------------------- + + Wanted to just follow up on the advertising side and get a sense for how much you guys feel like you're demand constrained versus supply constrained, either in the ability to put more ads on your property and/or just provide the tools to advertisers, and you feel like there's more demand than you can satisfy. Any color you can share there? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [37] +-------------------------------------------------------------------------------- + + This is Dave. I mean, nothing specific. I mean, I think so much of what we're focused on is making sure that there's a high degree of relevancy and usefulness for customers when you look at advertisements that you see on the site, in particular, and how we position those. And so we spend a lot of time looking at the data to make sure that customer behavior and feedback is telling us that it's useful and helpful when customers are making those purchase decisions. And so we're always testing different levels of that and trying to understand the various features, whether it's display or some of the sponsored elements that are out there, what kind of feedback's that are out there, but certainly keep that in mind as we roll out new things. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our final question will come from the line of Colin Sebastian with Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + I guess 2 quick ones. Any change in the trajectory of Prime membership growth since the June price increase? And then how would you describe the pricing environments for the core AWS services? And is this still a key lever that you use for business development? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + Yes, sure. Let me start with the Amazon Prime price increase. Of course, that went into effect earlier in the year in May. We're very pleased with the renewal data and annual sign-up data that we've seen since then. Program remains very strong, both in membership and engagement. And a lot of our video content, music and shipping, definitely, as well as other Prime Benefits, we just continue to see that ramp up, not only in the U.S. but in other countries. So we do continue to make the Prime offer better as well. I'd mentioned earlier the linkage with Prime member savings at Whole Foods market that we set up in Q2, the expansion of grocery delivery to more than 60 cities in the U.S. using Prime Now and Whole Foods stores, the ability to pick up groceries from Whole Foods, adding content. We have a great slate of content coming out in the fourth quarter here. Hopefully, you've seen already Jack Ryan and The Romanoffs, and pretty soon, you'll see the follow-up season to The Marvelous Mrs. Maisel, and also a couple other things. And hopefully, you'll see Thursday Night Football tonight when you get home. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [41] +-------------------------------------------------------------------------------- + + Yes, just on the -- this is Dave. Just on the AWS pricing philosophy. I mean just a reminder, the way to look at this, our pricing philosophy is work relentlessly, take costs out of our own cost structure and, when we can, pass savings on to the web services customers in the form of lower prices. So it's easy to lower prices, but it's much harder to be able to afford to lower prices. And that's something we work very hard in all our businesses, including AWS, to do that. So when you look at AWS now, we've lowered prices of 67x since we launched, including a few more in the last few months. So those periodic price reductions are a normal part of our business for us. +Thank you for your call today and for your questions. A replay will be available on our IR website at least through the end of the quarter. +We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2019-Apr-25-AMZN.txt b/Transcripts/AMZN/2019-Apr-25-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..a6302a7848569380c1ea7302a0487920b29d8df1 --- /dev/null +++ b/Transcripts/AMZN/2019-Apr-25-AMZN.txt @@ -0,0 +1,368 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Amazon.com Inc Earnings Call +APRIL 25, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + * Shelly Kay Pfeiffer + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Benjamin Ari Schachter + Macquarie Research - Head of TMET Research + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com First Quarter 2019 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Shelly Kay Pfeiffer. Thank you. Please go ahead. + +-------------------------------------------------------------------------------- +Shelly Kay Pfeiffer, - [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q1 2019 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO; and Dave Fildes, Director of Investor Relations. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2018. Our comments and responses to your questions reflect management's views as of today, April 25, 2019, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world events; the rate of growth of the Internet, online commerce and cloud services; and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [2] +-------------------------------------------------------------------------------- + + Okay. I'm going to ask 2 questions because the first one is really simple. Unit growth of 10%, is this a meaningless metric? Just talk through that number. I think it's the lowest unit growth I think we've ever seen, but just talk through us a little bit about that. And then international sales growth decelerated 16%. I know last -- ex FX, I know last quarter, you talked about some challenges in the India market. Just give us some color, please, around that growth rate. How do we think about the sustainability of that? Was that negatively impacted by developments in India? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, Mark. Thanks for your questions. I'll start on unit growth. So unit growth was 10%. Again, as I mentioned last quarter, it is measurement, excludes a lot of our fastest growing businesses, things like AWS, advertising, subscription services which cannibalize the unit calculations, things like Kindle Unlimited and Amazon Music Unlimited. And also, it doesn't include Whole Foods Market. So while it is meaningful, it needs to be understood and caveated. +So your second question was on international growth. Yes, talking more about specifically India, so India, for those of you on the call last quarter, we are just heading into an uncertain period with the PN2 ruling. We did make some changes to our structure to stay in compliance with all regulations. There was a few days of downtime for some of our selection. But for the full quarter, the impact was minimal. And we're in compliance, and we're very happy with the progress of the business in India. So as far as the growth is concerned in international, we had some noise in Q3 and Q4, if you remember, with the timing of the Diwali holiday, but we feel pretty good about the Q1 growth there even despite some downtime in India. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + I'll also ask 2, if I can. Just first, Brian, can you just talk about the outperformance in operating income in 1Q, pretty significant there? It looks like local sales and booking and so hoping you can provide some more color. And then why would the margin be materially lower in Q2 as you're guiding? And then just second, on the outlook for revenue in the second quarter on an FX-neutral basis, the higher end implies a nice acceleration. So curious what gives you the confidence. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Sure, Doug. Yes, let's start with Q1. So if you remember last quarter, I made the point that 2018 saw lower growth in some of our key cost areas. Things like fulfillment capacity, which have been growing over 30% a year in 2016 and '17, dropped to 15% last year. Headcount growth was 48% in 2016, 38% if you exclude Whole Foods and Souq acquisitions in 2017. That dropped to 14% last year. And then financial leases for infrastructure, which are good proxy for capital investment and infrastructure, after growing 69% in 2017, grew 10%. So all of those trailing 12-month metrics actually stayed the same or slightly declined in Q1. So we had continued efficiency. We didn't put a lot of new fulfillment center capacity or infrastructure into place at least compared to Q1 of last year. And hiring was moderate. We actually are down to 12% on a trailing 12-month basis. So I would say that is a continuation of last year, but my point from the last call still holds in that we do expect those growth rates to be higher for all of 2019. So most of that will happen in the next 3 quarters, and we have that built into the Q2 guidance. We also hit the high end of the revenue range, which is always good from efficiency standpoint and the drop-through on the higher end of the revenue. +So now turning into Q2, I would like to tell you a bit about why that's lower. So we have -- we're currently working on evolving our Prime free 2-day shipping program to be a free 1-day shipping program. We're able to do this because we spent 20-plus years expanding our fulfillment and logistics network, but this is still a big investment and a lot of work to do ahead of us. For Q2 guidance, we've included approximately $800 million of incremental spend related to this investment. And just to clarify, to give a little more information, we have been offering, obviously, faster than 2-day shipping for Prime members for years, 1 day, same day, even down to 1- to 2-hour delivery for Prime Now. So we're going to continue to do -- to offer same-day and Prime Now selection on an accelerated basis. But this is all about the core free 2-day offer morphing into -- or evolving into a free 1-day offer. We've already started down this path. We've, in the past months, significantly expanded our 1-day eligible selection and also expanded the number of zip codes eligible for 1-day shipping. So we're taking a significant step. It wasn't showing up in Q1. It was minimal in Q2 -- in Q1's results. This is a significant step and it will take us time to achieve and we want to ensure that we have good delivery experience for our customers as we evolve the software. +And lastly, I would say in Q2, as a reminder, each year, we -- it's -- Q2 is a time when we grant RSUs to employees and we traditionally see a step-up in stock-based compensation expense in Q2. We're seeing the same thing this year. And that's -- sorry, and that's also tied in with your question about revenue acceleration. We do believe that although there's not explicit lift built in for the faster shipping, we have seen good order trends to -- month to date and we expect -- we built the Q2 range about -- around what we've seen. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question is from Justin Post from Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [8] +-------------------------------------------------------------------------------- + + As users consume more services and maybe get less boxes, although I guess you could see a pickup in Q2, what does that mean for customer stickiness? How are you thinking about getting more advertising and getting more subscription services? And maybe you could just give us a little insight into what you're seeing with Prime churn especially in the more mature U.S. market. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes. Sure. Justin, I would say, as I said, I believe, on the last call, we had more people sign up for Prime in 2018 than any other year before. So we are very happy with the -- not only the absolute membership levels of the Prime program, but also the engagement. Our engagement in video benefit -- or excuse me, Prime benefits, shipping, hours watched on video, hours listened to on music, all of them are trending in the right direction and continue to get more and more sticky. So while I can't share -- I wouldn't share with you today the Prime -- any Prime -- specific Prime statistics about churn, it does remain a very compelling program. I think the announcement I just made about morphing to a 1-day free shipping offer will make it even more the best deal in retail as we say. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [11] +-------------------------------------------------------------------------------- + + The advertising business saw what looks like a little bit of a step-down again in Q1 versus Q4. Q4 was a fairly big step-down when you strip out the accounting benefit over the last quarter -- the accounting benefit. Can you talk a little bit about the supply and demand dynamics in the advertising business? How much of that will you might be controlling to making decisions about ad load versus the demand to advertise among sellers on the platform? And any color you could give us on what you might be seeing in the advertising business domestically versus internationally would be helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. Yes. We're seeing -- as you can see in the operating margin, we're seeing good advertising growth both in North America and also internationally. While I can't get into some of the questions about ad loads and inventory, I would say really what we're focused on right now is driving relevancy, ensuring that we service the most useful ad as possible. I think that's going to be the best experience for customers and also for advertisers. So most of our focus has been on again adding more functionality, adding more products and adding -- reporting for businesses and advertisers so they can understand the incremental customers they're seeing on Amazon through advertising with Amazon. So it's more right now around tools and making better recommendations, making it easier to use our Amazon demand-side platform, things like that, operational improvements. +And then I guess we're very focused on serving brands as well. That's another theme that we have. These brand stores that we have our easy to create, customize, and we've had great pickup on that from brands where they can show shoppers who they are and tell their story. So it builds a better engagement for the brand and the customer. It builds better customer loyalty both to that brand and also to Amazon. +And then on the brand side itself, we have new reporting where we're again looking to measure the new to the brand shoppers and what lift they're seeing. So I would say right now, it's more about efficiency and also performance of the advertisement themselves. The other revenue growth that you see does include some non-advertising things as well. So while other revenue grew 36% and it is principally advertising, advertising grew a bit higher than that. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Stephen Ju from Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [14] +-------------------------------------------------------------------------------- + + I'm sure you can share in regards to the Prime users' awareness of the availability of stuff from Whole Foods. Is the order flow coming in from a wide number of users? Or is the activity coming in from a small but very dedicated number of customers? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes. Thanks, Stephen. I would say that we're very -- it's widespread and more Prime members have adopted the Whole Foods benefit than almost any other benefit we've offered them, and they're saving, as a result, hundreds of millions of dollars. We continue to expand the coverage for delivery. We have delivery from 75 -- into 75 U.S. metros through the Prime Now app, and we also have pickup in over 30 metros also through the Prime Now app. +So we're very -- the other point I'll make is just like last quarter, I'll remind you that the physical stores revenue is principally Whole Foods revenue, but it excludes the online ordering component where people order on the Prime Now app and it's delivered to them. That shows up in our online stores classification. So last quarter, I told you that our growth in store sales, including both shopping and also online deliveries, was closer to 6% in Q4 and it's a similar number in Q1. So again, we're very happy with both the Prime adoption of -- or the recognition of the Prime benefits by -- at Whole Foods and also the purchases. And you may have also noticed that we lowered prices for the third major round of price cuts since we joined forces with Whole Foods in the summer of 2017. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is from Dan Salmon from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [17] +-------------------------------------------------------------------------------- + + Maybe, Brian, just to return to the advertising business for a moment. It does sound like, as Eric noted, that there was a bit more of a slowdown again. I mean I guess I'll ask it this way. Do you believe that some of the improved relevance, some of the improved focus on brands as well as some of the new products can lead that business to reaccelerate at some point again? Or is it facing law of large numbers? And then just a follow-up, just to return to the $800 million investment to improve 1-day shipping, it sounds like that investment is underway already and that -- in noting that it'll help contribute to the high end of the guidance this quarter, it sounds like the timing of that is fairly [quick] (corrected by the company after the call). I would imagine it's just simply expanding availability and that $800 million is largely related to shipping cost. But I just want to make sure we're understanding that quickly that the -- this investment rolled out relatively quickly and starts to take effect relatively quickly. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + Yes. I'm glad you asked that. I would say that while our 20-year head start in investments in logistics and fulfillment capacity and partner networks that we've built are helping us, we also do have a network that is tuned to 2-day delivery right now, principally for 2-day delivery. So we do need to build out more 1-day capacity along with our transportation partners, but we're moving quickly and we've got a good head start. There is a certain tranche that we can dial up quickly, and we've started to do that and you'll see that very quickly in Q2. And then stay tuned because we'll be building this -- most of this capacity through the year in 2019. +And then your question about advertising, I wouldn't comment on acceleration or deceleration of growth. I would just say we're early on in this venture. There's a lot of -- it's having a lot of pickup by both vendors, sellers and also authors. So again, we feel like if we work on the inputs on this business and continue to grow traffic to the site, we will have a good outcome in the advertising space. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question is from Anthony DiClemente from Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [20] +-------------------------------------------------------------------------------- + + A couple of questions. In the shareholder letter, Jeff wrote third-party sellers are kicking our first-party butt, and we read through that, but as we kind of look at the trending and the pacing of the 3P business, you can see a little bit of a deceleration in the 3P sellers services line and then 3P unit slowdown might suggest that the third-party GMV expansion may not be happening quite as fast. So maybe just talk a little bit about that. Is this just law of large numbers as time goes by? What is Amazon doing to sort of sustain that growth rate in the third-party marketplace business? And then second question is maybe just quickly on media spend. Just update us on how you're thinking about the trajectory of video content spend. Any strategic changes there in terms of library versus originals versus films or TV content? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + Yes, let's step back on the third-party question. So again, let me reiterate our approach. So main goal here is that it will allow customers to have the broadest selection, the best available price and also the most convenient options on how they receive the item. If we're delivering on those 3 elements, we're indifferent as to whether it's sold by us or a third party. We actively recruit sellers to sell on our platform. It's because it adds selection. It adds -- if it's in the FBA program, it adds Prime-eligible selection. We spend billions of dollars a year, as Jeff said, on infrastructure, tools and services not only to allow sellers to sell but to help themselves more successfully. So we have a vested interest in the success of our sellers. Any growth acceleration or deceleration that you see can be very much tied to the total sales of the customer that we have, the customers in any country. So you'll still see the percentage of third-party units increased and has been steadily over the last few years. So again, the sellers are as important to us as anything for servicing the customers' need for price selection and convenience. The elements I just talked about of investment, further investment in 1-day shipping, is directly going to be a cost that we bear and it's also going to be a direct benefit to sellers as well as the Prime-eligible selection in our warehouses. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [22] +-------------------------------------------------------------------------------- + + Anthony, just real quick, this is Dave. On your question around media and probably more particularly the video strategy and what we're investing in, I mean, we are continuing to invest meaningfully in digital video. It's an area where we're very excited about. Lots of very popular, critically acclaimed shows have obviously come out, things like Homecoming, Jack Ryan, more recently Hanna, Guava Island, and some great titles. So I think look for us to continue to invest there. +There was -- on the accounting side, we did adopt an accounting standard in January that amended our accounting for how we cap for produced original video content. And under that new guidance, we capitalize production cost for original video content. Previously, we only capitalized a portion of those costs. So the net impact for the first quarter to operating income wasn't material. It was -- for Q1, the impact of a change was a decrease of about $130 million to cost of sales due to the capitalization change. As we go through 2019 though, we would expect the impact to increase in the latter part -- or the second half of the year, in line with our production schedule as it grows throughout the year. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question is from John Blackledge from Cowen and Company. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + Just coming back to the Prime 1-day delivery, will it be available to most of the U.S. by the holidays or by the end of the year? And I think you had about 100 million items available for 2-day delivery, Prime delivery. As the 1-day program starts, how many SKUs will be available? And would you expect to get the entire 100 million SKUs for 1-day at some point? And then second question, just on grocery, just curious the upside for further expansion outside of kind of all the enhancements you're doing with Whole Foods. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + Sure. So yes, on the 1-day free shipping versus the 2-day free shipping, our goal is to evolve the 2-day free shipping program into a 1-day free shipping program, and we're making strides on that. I got into a little bit about the capacity we have to add and changes we have to make to our supply chain in order to deliver on that. We expect to make steady progress quickly and through the year. We'll have more for you at the end of Q2 obviously. There's a lot of error bars around this program, especially from the cost side. We are -- feel we're doing something very important for the customer. And we are -- again trying to take advantage of the fulfillment capacity and transportation capacity especially with third-party partners that we have. And we'll just have to see what changes have to be made to get more and more selection into that 1-day category. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [26] +-------------------------------------------------------------------------------- + + And then this is Dave again. Just on the grocery side of it, as you mentioned, Brian talked a bit about the Whole Foods Market growth over 500 stores, 75 metros with delivery capability, so continuing to grow that out. We are also continuing to invest in our other grocery initiatives. Amazon Fresh, Prime Now, which offers grocery as one of the components of the selection there for the 2-hour or even 1-hour delivery capabilities. And so I think we'll keep investing in those areas -- and in other initiatives as well where we can get food through Pantry, Go. There's a number of initiatives there, so excited about what we'll be able to continue to bring to customers on that space. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question is from Ben Schachter from Macquarie Group. + +-------------------------------------------------------------------------------- +Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [28] +-------------------------------------------------------------------------------- + + So more on the 1-day shipping. Should we expect that to rely mostly on USPS, UPS or other shipping services or you're really going to try to build out more your Amazon owned and operated shipping? And on the numbers, $800 million for the quarter, how should we think about that ramping into the back half of the year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + Yes. Sure, Ben. I would say we're going to be using all of the available levers that we have right now, both AMZL and also third party, all third-party carriers, and we'll just see how it develops going forward. But we're going to need definitely the continued support of our external transportation partners. So outside of the ramp, I would say that the $800 million is what I have for you today. We will see where we stand at the end of the quarter, and I'll give you insight as to what we just saw and what our outlook is for future quarters at that time. +I would like to -- as I don't want to run out of time here. So I'm going to ask a question for myself about AWS because I want to get some information to you. Most of the questions I can tell around 1-day are topical and important. I do want to highlight the AWS performance in Q1. We're now over $30 billion annualized run rate, 42% FX-neutral growth and $2 billion more of revenue this Q1 versus last Q1. The operating margin has also expanded in that time period by 320 basis points as a result of a lot of the good work on infrastructure and efficiencies that I talked about earlier in the call because this is against a backdrop of a very large expansion of our tech teams and our sales teams that supports this business. We're continuing to engage with many large customers globally. I'm particularly happy about the Volkswagen alliance that we've joined up with them to power their Volkswagen Industrial Cloud. That's going to integrate more than 30,000 facilities and 1,500 suppliers and partners in Volkswagen's global supply chain over time. We have deals going with Ford on powering the cars of the future, Lyft, Gogo, a lot of really good customer wins in the quarter. And I think just more broadly, we're seeing continued momentum in enterprise migrations to AWS, and people are moving their workloads to AWS at a faster pace. Usage growth continues to be higher than revenue growth rates. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is from Mark May from Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [31] +-------------------------------------------------------------------------------- + + And actually a follow-on to AWS, the growth clearly impressive, but we did see, I think sequentially -- and I apologize I'm not in front of the model, but I think the growth was somewhere 3% or 4% sequentially. There was a little bit of a slowdown in the quarter. I just wondered if there's anything that you'd call out there, pricing or any other factors that you could call out that may have contributed to that. And I apologize but another 1-day shipping question here. In terms of the $800 million, just curious where that gets you to in terms of coverage of zip codes and SKUs. I assume right now, this is a project that's in the U.S. Where that gets you from a coverage standpoint? And is this something that you expect to be a near- to medium-term priority in some of your other developed markets like the U.K., Germany, et cetera? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [32] +-------------------------------------------------------------------------------- + + Yes. So I'm glad you asked that, Mark. It is -- I'm going to start with the second question. The program will be global. Most of the spend that we are seeing in Q2 is starting in North America, but this is intended to be a global improvement in speed tied to our Prime program. So you will see more going forward. I can't give you exact percentages of selection and all that mainly because we are still again working through that and we've -- while we have ratcheted up a significant -- we turned the dial significantly in April, and so we'll see the cost impact almost immediately in the quarter. We're really going to have to see how it goes this quarter both on our pace of selection addition and expansion of 1-day and let you know probably at the end of the quarter. I would say in the short run, it's also expanding and increasing our speed on all of our orders quite frankly. +On AWS revenue, yes, let me just remind you the quarterly growth last year on an FX-neutral basis. So Q1 was 48% then 49% then 46% and 46%. So in the first half of the year, we have a tougher comp, if you will, versus some strong growth in the first half of last year. This is always going to be a lumpy business. It's not only dependent on us. It's also dependent on the companies that are adopting Amazon. So there's -- or excuse me, AWS. So there's differences in sales cycles. There's differences in adoption of the cloud. There's differences in migration patterns that will make any quarter-to-quarter movements lumpy, as I said. So we're happy with the growth, 42% on an FX-neutral basis and again a $30 billion -- greater than $30 billion annualized run rate. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question is from Heath Terry from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [34] +-------------------------------------------------------------------------------- + + I guess somewhat along those lines or at least along the lines of growth, we saw CapEx spending and investment in capital leases decelerate to the lowest rate that it's been in, in several years, maybe even the lowest rate ever. And you guys have said in the past that generally, CapEx sort of tracks your -- that you're investing at the level of growth that you expect. I'm sure that's not representative of what you expect growth to look like. So just trying to understand sort of where the disconnect is there and to the extent that your -- the level of investment in physical infrastructure says anything about your expectations for future growth, what the right way to read that is. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + Sure. Thanks for that question, Heath. No, I would say, a, we're not expecting diminished returns in any of our businesses or growth rates nor are we restraining the business or constraining the businesses in any way with our capital. I would point you back again to the investments that we made in 2016 and 2017. So we did front-load a lot of the investment both in fulfillment centers and also infrastructure. But more than that, it's more than kind of bleeding through excess capacity. We have some really, really impressive gains in efficiencies in both the warehouses and also the data centers. We talk efficiency and every percentage utilization in our data centers is worth tens and more millions of dollars. So again, that's -- a big part of our model is not only investing but also working on efficiencies, adding new products and features for customers. And as we lower costs, we pass those along to customers either through new rates or new deals that we have. +So I would say that -- I would look back on the performance in 2018 and say that, that was great work with -- on a lot of efficiency as we also banked a lot of that capacity that had been built previously. Moving forward, that's why I say it will be increasing as we move through the year, and that will be a constant battle between again growth, geographic expansion in AWS and also efficiencies to limit how much we actually need. I think we're also getting much better at adding capacity faster so there's less need to build it 6 to 12 months in advance, I would say. Although we did just launch our Hong Kong region today as well, and I want to point that out. The business in China is going really well and we continue to see strong growth there. And launching the Hong Kong region is -- gets us to a footprint of 19 cities in China. So it continues to be a really good story for us. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Thank you. Our final question will come from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [37] +-------------------------------------------------------------------------------- + + I'll go to a new topic, 1-day shipping. So Amazon, the first principle is customer obsession. And Brian, you talked about record Prime sub growth last year. I guess the question is what are the signals or the key strategic rationale behind investing in 1-day? Are there certain types of users, demographics of users, categories of products, countries? Do you think this will help you attract and retain? It seems like Prime is growing pretty well. Just talk us through what you see as the big opportunity to invest in 1-day? And then the second one, just maybe talk to us a little bit about the early learnings on the health care industry side and potentially trying to move larger into health care. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [38] +-------------------------------------------------------------------------------- + + Great. Yes. Brian, I would say it's as simple as price selection and convenience, which is the mantra that we talk about quite often. By going to 1-day increases the convenience and it increases the available selection into the consideration set. Although we have many items that are available in 1 to 2 hours and also same-day, the vast majority of our selection is available to you in 2 days. If we get that to 1 day, we'd literally cut it in half. That's tough math for you. I'm sorry to do that but the -- we think that, that will open up a lot of potential purchases that -- and will open up convenience to those customers. So we've been experimenting on a lot of different formats, as you know, 2-day, 1-day, same-day, 2-hour stores. There's all types of points of being there for the customer when they need us at different points in their consideration set. So we really think it's going to be groundbreaking for Prime customers, and we're very excited to add this capability. And again, part of this is we have the capability because we've been at this for over 20 years and continue to invest in our fulfillment capacity, our logistics capacity and also fine-tune it, but I thank you for your question. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [39] +-------------------------------------------------------------------------------- + + Yes. Brian, this is Dave. Just briefly on health care, I mean that term can touch upon any number of different parts of our businesses. Of course, we talked in the past about how Amazon Business serves many other companies, including the health care industry, and providing them some great selection, and fast delivery is part of that -- the business program there. So -- and that continues to do well and it's a focus of Amazon Business amongst other verticals there that they serve. PillPack, we're probably around 6 months or so in since that acquisition closed and continuing to support them in their mission and learn from them certainly, so no real update on that but excited about the potential there, to be sure. +Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2019-Jan-31-AMZN.txt b/Transcripts/AMZN/2019-Jan-31-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..0edf025e50ca630c587b4529c0e3349316769537 --- /dev/null +++ b/Transcripts/AMZN/2019-Jan-31-AMZN.txt @@ -0,0 +1,388 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Amazon.com Inc Earnings Call +JANUARY 31, 2019 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Lloyd Wharton Walmsley + Deutsche Bank AG, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2018 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2018 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2017. Our comments and responses to your questions reflect management's views as of today, January 31, 2019, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures in our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisition, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess I'll ask about units, 14% in the quarter. Just how do you feel about the overall unit growth here given that growth was higher last year in the 20s? And do you think there's some investments you can make in other areas to kind of reaccelerate that going forward? And then, secondly, just if you could remind us or help us understand the Prime accounting change impact on subscription revenues in Q4? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [3] +-------------------------------------------------------------------------------- + + Justin, this is Dave. On the second question, on the subscription service, we'd said on the last call, you probably remember, related to the adoption of the Accounting Standards Update and revenue recognition policies that was impacting our results in a number of areas in 2018, we'd said we'd anticipated about $300 million lower sort of headwind to subscription services revenue due to the accounting change. So that's where we came out for the quarter. So you'll see that we reported subscription services revenue increased 26%, when you exclude FX. So the $300 million is certainly part of that decelerate, a sequential deceleration in the growth rate in that line item. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Yes, and on unit deceleration, I think the unit numbers more and more require some interpretation because it doesn't include the fast -- some of our fastest growing areas, things like, as Dave mentioned, subscription services, AWS, advertising, Whole Foods units are not in that number. So we don't focus as much on the number. I would direct you more to the supplemental revenue guidance that breaks out the component parts. But in general, we feel good about the growth in the quarter. We think it was a -- Q4, in particular, was a great quarter for customers. The retail, a lot of strength in the retail part of the businesses. The teams here had done a great job planning, preparing and then executing on the quarter. AWS maintained a very strong growth rate and continue to deliver for customers. We had a great re:Invent conference in the quarter. So we feel good about the growth in the quarter and also the total revenue and income. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [6] +-------------------------------------------------------------------------------- + + Do you want to just comment a little bit on the international revenue outlook and any commentary on India and whether you think there's a material impact on your business? Secondly, could you talk about advertising revenue, just qualitatively or quantitatively, how that's doing? And third, if I could, you spent a lot on marketing in the quarter. It's a real step up. Do you want to just talk about the ROI that you think you're getting on that marketing spend? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure, Mark. The first question's on India. Let me start with that. So we have incorporated into our guidance estimate, the best estimate we have for Q1 in India. However, there's much uncertainty as to what the impact of the government role changes is going to have on the e-commerce sector there. We remain committed to complying with all laws and regulations, and we will, but we're evaluating the situation. Our main issue and our main concern is trying to minimize the impact to our customers and sellers in India. We've built our business around price selection and convenience. We don't think the changes help in those dimensions for both the customers in India and also the sellers. Dave, why don't you talk about the advertising growth? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [8] +-------------------------------------------------------------------------------- + + Yes. I think, I mean, we're continuing to -- there's a lot of focus on serving that customer set. One of the things we're trying to do is continually evolve our tools and the products to help that customer set, agencies, advertisers, make sure they've got a variety of ways to meet their goals. Some of the things we've done more recently over the last few months or so was expanded sponsor, brands placements, rolled out new campaign reports, so improve campaign manager features. So a number of -- there's a number of things beyond that, but features out there that are just going to, I think, make it easier for companies to grow with ad tools and the ad services that we offer. And we're continually excited about the opportunity there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + And then, on your question on marketing, yes, the marketing percent of revenue was up 110 basis points year-over-year. The -- this category also includes AWS sales and marketing. Keep that in mind because that's where a lot of our headcount investment is going. Headcount only grew 14% year-over-year, but the areas that we're growing in that mix were things like technology teams, device areas, AWS, especially sales and marketing. So variable marketing was pretty consistent with prior periods, and we feel good about our return on investment on the marketing, the variable marketing. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [11] +-------------------------------------------------------------------------------- + + I just wanted to follow up on India. Just bigger picture, Brian, did the new policies change your view at all the attractiveness or the potential of operating in India? And how do you think about your investment strategy there in the near term? And then, also, just hoping you could talk about some of the impact in the U.S. and U.K. from free shipping during the fourth quarter holidays? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes, really, we're still evaluating the situation in India. We feel very good about the long-term prospects in India and doing a good job for both Indian customers and Indian sellers. The new regulations need to be interpreted, need to be -- need to make sure they don't have unintended consequences. And again, I don't think it's necessarily consistent with better price, better selection, better convenience for the Indian customer. So it's all we can say on that topic right now. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + Yes, and I think, Doug, your second point was just around shipping, some of the shipping offers in the holiday. We did lower the free shipping threshold at the end of the fourth quarter, so customers took advantage of that. That was a great offer for them in the holidays. Brian talked a little about it before, but pleased with the holiday season, both from sort of a first-party side, but also sellers continue to do well. That's part of the holiday offering. We sold a number of record-breaking number of Alexa devices as well. And I think, just in that shipping vein, really pleased with the continued engagement from Prime members. We had the most-ever number of Prime members sign up this quarter than any quarter we've had. So really pleased with that. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [15] +-------------------------------------------------------------------------------- + + When I try to back out the impact of factors like Whole Foods, the advertising accounting change and other factors, what I see is stable and pretty healthy revenue growth in the retail segment but a slowdown in Q4 from what seems to have been, in more recent quarters, meaningful gross margin expansion in the retail segment. Can you discuss what may have driven that and how to think about retail gross margins going forward? And then, somewhat separately, retail margins last year benefited from several factors, including more modest hiring and more modest growth in fulfillment center capacity. Do you see these factors persisting this year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes, thank you. Let me start with that last part because I think if we step back and put 2018 in perspective, there's some clear trends regarding our cost structure, starting with fulfillment costs. So in the prior 2 years, 2016, 2017, we had grown our square footage tied to fulfillment and shipping by greater than 30%. In 2018, that number grew by 15%. Certainly, unit demand was lower, but AFN, or Amazon Fulfilled Demand, where, if we combine FBA and retail, remained strong. So we had a banking, if you will, of some large expansions in the prior 2 years. Similarly, on headcount, we grew headcount by 48% in 2016, 38% in 2017, if you exclude the acquisitions of Whole Foods and Souq, which drove the number up to closer to 68%, I believe. Last year, we had 14% growth, and so there was a lot of leverage and a lot of -- in a way, there was a lot of prehiring in 2017 that we digested in 2018, while we still -- in some areas, especially things like our core retail business and also G&A functions, but then we continue to invest again in the technology tied to AWS sales team to an AWS device area. So their groups are growing considerably higher than that 14%, but in total, the company grew 14%. And then, on capital, especially infrastructure capital, if you use the capital lease line as maybe an indicator for what we had invested into our AWS business support infrastructure and global expansion, that number grew 10% last year when it had grown 69% in 2017. So in a lot of ways, 2018 was about banking the efficiencies of investments in people, warehouses, infrastructure that we had put in place in 2016 and '17. So while we will continue to concurrently drive growth and customer offering in Prime Benefits, we certainly do take costs seriously, and we will continue to work on operational efficiencies. I would expect those investments to increase relative to 2018. And we've reflected what we've seen so far in Q1 in our guidance. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [18] +-------------------------------------------------------------------------------- + + A little bit -- to dig a little bit deeper into the CapEx capital lease side of things, you guys have said in the past that, generally, you work to build in line with your expectations for guidance so that you're trying not to overbuild or underbuild when thinking about your fulfillment and data center capacity. We saw that investment reaccelerate in the fourth quarter after getting the lows that you referenced in Q3. Anything to read into that about sort of what your expectations are for growth in those businesses, seeing that re-acceleration after the deceleration that we saw over the course of, at least, the first 3 quarters of last year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes, I see total CapEx that was -- grew 33% in Q1, 1% in Q2, negative 1% in Q3, and then positive 17% in Q4, just the quarter itself. So there was, as you say, a bit of an investment in Q4 relative to Q2 and Q3. I still think the 17% is a low number for us when you talk about supporting the AWS business that's still growing at a very high clip and a very strong and healthy growth in FBA and customer demand and our expansion into new countries, both with AWS and also with our core consumer business. So I'm not prepared to give you the forecast for the year right now. I would say that I would consider 2018 to be a lighter investment year and a lighter year for adding fixed headcount, certainly compared to 2016 and 2017, and we'll reveal that as we go through the year, but we've built into the first quarter what we expect in the first 3 months. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [21] +-------------------------------------------------------------------------------- + + I have 2. Just the first one is, to go back to the fourth quarter gross margins, I think, if we try to back out AWS, it looks like there was a little more gross margin pressure. Can you just talk to any of the puts and takes we should know about from a gross margin perspective in the fourth quarter? And then, that other line that I think includes the advertising business, can you just help us, any help at all on the growth of the advertising business or the impact of any of the accounting changes in the quarter? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + Yes. Sure. Sorry, I skipped over that gross margin question earlier, but yes, gross margins were, while up 180 basis points year-over-year, were not up as much as prior quarters. I would say, the positive tailwinds still remain. AWS had strong growth of 46% on an FX-neutral basis, third-party units continue to grow, advertising dollars continue to grow very well. Some of the headwinds, I would say, were outbound shipping costs, including the free shipping that we did, but mostly it was the higher Amazon Fulfilled units and the greater use of Amazon Logistics. And I would also say retail was very strong. We had, I think Dave mentioned, the Echo Dot was the highest selling unit globally. So devices had a very strong sales in the quarter. We discussed how we don't price devices to make money. We usually will expand -- our content expanding our device and usage throughout our group of customers who use our devices and then we monetize that in different ways to commitment to Amazon and the video and everything else. So a bit of it was mixed, but I would say that retail, which has a lower gross margin, more because of the revenue treatment was stronger in Q4. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [23] +-------------------------------------------------------------------------------- + + Yes, and just on the other revenue piece, Brian, just to get back to the accounting side, we did adopt that revenue recognition standard in 2018, as I mentioned. As part of the adoption, certain advertising services were classified as revenue rather than a reduction of cost of sales. So specific to Q4, the impact of that change was an increase of approximately $1 billion to other revenue. So you'll see that in the other revenue in total. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [25] +-------------------------------------------------------------------------------- + + I guess, 2 for me as well. In the quarter, looking backwards, not considering India and the impact going forward, but the international growth accelerated. So I was curious, any particular regions or product categories to call out, especially given some of the weakness in the U.K.? And then marketplace fees are changing in several categories, including home furnishings, health and beauty. Curious what the strategy is there. I assume to expand selection. But is it also an indication of an increasing focus on those retailer categories? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Sure. Let me start with your second question. Obviously, third-party sellers are an important part of our value proposition there. They've had great success on our site. More than half of our units sold are from third-party sellers. So it's very important to us that we have the right business profile, both for Amazon and for the sellers. So we will always be evolving that. Part of that involves changing fee structures, sometimes adding new fees or subtracting old ones. Part of it involves raising or lowering fees that sellers pay. So you're going to see this continually from us. We generally work to change the fees to make sure that the incentives are strong on both sides, and we continue to have a healthy growth in third-party. On the international, on an FX-neutral basis, the growth was 15% in Q3 and 19% in Q4, but last call, if you remember, I talked about the timing of Diwali and the impact that had on our growth rates. If we adjust for that, and again, Diwali had -- took place primarily in Q4 this year and it was split between Q3 and Q4 last year, if we adjust for that, international growth is pretty flat Q3 to Q4. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Lloyd Walmsley with Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Wharton Walmsley, Deutsche Bank AG, Research Division - Research Analyst [28] +-------------------------------------------------------------------------------- + + Two, if I can. First, just on the advertising side. We hear a lot of positive feedback from customers, but also, we hear suggestions, there are supply constraints. So how do you guys see inventory growth versus pricing growth as a driver in that business? And are there things you can do to grow inventory? And then, secondly, there've been some reports, your Amazon shipping effort is kind of expanding beyond some test markets. So wondering if you can give us a sense for what you've seen in those test markets and how you think about expanding your shipping efforts on that productized basis going forward? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [29] +-------------------------------------------------------------------------------- + + Yes, Lloyd. Thanks for the question. I'll take the advertising piece first. I mean, I think, as I talked before, we're working on improving usability of tools. I mean, our priorities in this space, that's certainly one of them, looking for ways to make smarter recommendations, addressing the needs of brands, automating activities, inventing new products. And I think, in all those regards and those priorities, we think there's some good growth to continue to come, both in advertising for -- on our own properties, but also potentially beyond -- over the longer term. So -- but even as we look for advertising opportunities on places like Amazon.com, we think there's a lot of opportunity and a lot of experimentation. I think we're learning and are a very data-interested company and working with a lot of great brands to be able to develop better toolkits for them, understand what types of metrics they want to make them more successful based on what they're telling us. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes, and on transportation, I assume you're just talking about our expansion of Amazon deliveries and Amazon Logistics. Again, we have great partners in place for our business and support globally. What we do is add capacity where we feel we need to speed up service or ensure demand, particularly at peak. So we will continue to build out our DSP or -- and Flex and Ship with Amazon programs. So during the quarter, it was a much bigger presence obviously year-over-year. So we're happy with that, both from a performance standpoint. The delivery estimate accuracy, as we call it, was very strong on our self-delivered products and also the cost profile is very good as well. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [32] +-------------------------------------------------------------------------------- + + Maybe 2, if I can. One, on the media side, has there been any step up in terms of investments around media content to support your ambition with respect to Prime and Video? It's been a couple of years now since we got an update on rate of spend or how it might impact either historical periods or going forward periods. That would be number one. And then, number two, going back to Lloyd's question on the advertising front, how do you think about the video opportunity? You're moving beyond just branded opportunities or sponsored product search on your own properties, thinking about experimenting with over-the-top video or connected TV opportunities that might look in front of you going forward? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Let me start with video. We're not quantifying the Prime Video spend today, but we do -- it has been increasing. We expect it to increase even further in 2019. We're seeing a lot of, again, continued strong adoption in the usage and viewing and hours watched of both our music and our -- excuse me, video and music. And as -- if you step back, it builds stronger Prime connectivity with our Prime members. It leads to higher membership renewal rates and higher overall engagement. And we like what we see. We continue to see that engagement growing. I would say that we've had some particular success in -- recently with 10 Golden Globe nominations and 3 Oscar nominations, and Jack Ryan Homecoming and season 2 of the Marvelous Mrs. Maisel, in particular, were very well-received during the quarter. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [34] +-------------------------------------------------------------------------------- + + Yes, and then, on your second question just around advertising opportunities and around video, you may have seen not that long ago, IMDb, Internet Movie Database, one of our subsidiaries, launched Free Dive, which is an ad-supported free streaming video channel that's available in the U.S., and it enables customers to watch hit TV shows and movies without purchasing a subscription. So, ad-supported. So that's available on the IMDb website with your laptop or personal computer. And I think it's definitely on the Fire TV devices as well, as a great way to consume content. So I think excited about that. Other opportunities we've been working with in ads and video for a bit longer period of time had been things like our sports offerings, some of the live sports that we've done, things like Thursday Night Football. I really like the success that we've seen on those and a bit of learning from that, looking forward to pursuing more opportunities to engage and serve with customers of those types of video offers, but also take some opportunities to monetize with the advertising. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jason Helfstein with Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [36] +-------------------------------------------------------------------------------- + + Just two. So just can you comment, did advertising slow down relative to third quarter? One. You're kind of adjusting for 606. And then, secondly, was there any reallocation in segments between online and physical stores? And if not, any commentary why physical stores was down year-over-year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- + + Yes, thanks, Jason, for your questions. Let me start with the physical stores revenue. So physical stores decreased 3% year-over-year, and this is primarily Whole Foods, but also includes our other stores, the Amazon Bookstores, Amazon Go, Amazon Four Star. What happened in the quarter was we were lapping a period last year when we had purchased Whole Foods in Q3, as you remember, of 2017. In Q4, we adjusted their fiscal calendar to link it up with Amazon's, and it added about 5 days of revenue into Q4 of last year. So we're comping that year-over-year. The second piece is that the -- as you said, the online orders where people go to the Prime Now app or Whole -- and then order for delivery or pickup at Whole Foods stores does count or is counted in the online stores component of revenue. So if you adjust for those, what's the Whole Foods growth year-over-year on an apples-to-apples basis was approximately 6%. Because of some of those, again, mostly the year-over-year counting or days true-up issue, it's showing up as negative 3% in physical stores. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [38] +-------------------------------------------------------------------------------- + + Yes, and then just on your second question around advertising, if you look at the other revenue, the growth rate decelerated some. So it's -- at 97%, still very strong year-over-year growth in the fourth quarter. In other revenue, as I think you're aware, there are a number of components, but the largest by a good margin is the advertising revenue. And we are comping a period of rapid growth in the prior year. So that is part of the factor there, as you mentioned. But I'd just reiterate, we're continuing to see quite strong adoption across Amazon's vendors, sellers, authors, all types of advertisers that are utilizing that. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [40] +-------------------------------------------------------------------------------- + + Brian, can we just return to your comment earlier about the increased use of Amazon Logistics, not a surprise there, but just curious, through the holiday season, any particular learnings that you can offer some color on? And how do you view the balance between using your own proprietary logistics versus third-parties as you go into 2019? And then, just a quick follow-up, obviously, the HQ2 news came out during the quarter. What would you highlight as maybe the most important next steps there? And maybe some color on the feedback from that process would be interested to hear that as well. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [41] +-------------------------------------------------------------------------------- + + Yes, sure. So let's start with HQ2. Of course, in November, we announced we selected New York City and Northern Virginia, and between the 2 cities we'll be investing $5 billion and creating more than 50,000 jobs. We also announced an operation center of excellence to be opened up in Nashville, which is about -- estimate of about 5,000 jobs. So right now, we're working through some next issues in both cities. We're looking forward to investing in New York and Northern Virginia and being a good community partner as well as Nashville. So not really much else to report at this time on that. On your comment or question on transportation, we do continue to expand our Amazon Logistics and our delivery capability, and it also matches up with our faster ship speed that we're seeing for Prime members as well. We added, of course, we have over 100 million items that customers can get within 2 days, but there's now over 3 million that will be delivered within 1 day or faster in 10,000 cities and towns. So Amazon Deliveries are a big part of that. Again, we have great third-party partners as well in the transportation space. What we like about our ability to participate in transportation is that, a lot of times, we can do it at same cost or better, and we like the cost profile of it, too. We can also invest selectively because we have more perfect information, we know where our demand is, we know where we're moving things between warehouses and sort centers. And by not involving third-parties all the time, we can -- we found that we can extend our ship cut-off -- excuse me, our order cut-offs, and we've done that over the last few years. So that's also another helpful side benefit for consumers when we are doing our own logistics -- excuse me, transportation final delivery. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [43] +-------------------------------------------------------------------------------- + + So the AWS operating margins historically kind of moved around a bit. Any color on what drove the decline sequentially from 3Q to 4Q? And then, I guess, going back to the investment catch-up team, it sounds like 2019 will be a little bit more aggressive push from you guys. Can you parse out whether you expect the pace of retail margin expansion that we're seeing in North America right now, is that going to continue and most of these investments are going to be in international and some of the stuff going on in India? And any color on the North America operating margin trajectory? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [44] +-------------------------------------------------------------------------------- + + Yes, sure. Let me start with the AWS operating margin, as you called it out. That number will move around. We're very pleased with the 29.3% that we saw during the quarter. Of course, at any point in time, this business is going to be a combination of lowering prices, expanding geographically, adding people to build new -- especially tech teams and sales teams to build new and innovative products and staying very relevant and ahead of our customers' minds. And infrastructure will -- again, it will bounce between quarters a bit. Our capital lease expenditure in Q4 was a bit higher than the prior 3 quarters. That had a slight impact on the operating margin. But again, year-over-year, operating margins were up and were almost 280 basis points. We've said quite openly that this is going to bounce around. What we do is create great value for the customer on one end and then work to minimize our cost of infrastructure, and we're getting more and more creative around getting efficiency up and getting our cost of acquisition down. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [45] +-------------------------------------------------------------------------------- + + Thanks for joining us on the call today and for your questions. A replay will be available on our Investor Relations site at least through the end of the quarter. We appreciate your interest in Amazon, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2019-Jul-25-AMZN.txt b/Transcripts/AMZN/2019-Jul-25-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..132c2ff9c8cc00bb134e6a90f78823eb8e556af3 --- /dev/null +++ b/Transcripts/AMZN/2019-Jul-25-AMZN.txt @@ -0,0 +1,358 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Amazon.com Inc Earnings Call +JULY 25, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + - + * Shelly Kay Pfeiffer + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2019 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Shelly Kay Pfeiffer. Please go ahead. + +-------------------------------------------------------------------------------- +Shelly Kay Pfeiffer, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2019 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO; and Dave Fildes, Director of Investor Relations. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2018. +Our comments and responses to your questions reflect management's views as of today, July 25, 2019, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world events; the rate of growth of the Internet; online commerce and cloud services; and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question is coming from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + I have 2. It looks like the overall retail business accelerated pretty nicely in the quarter. Maybe could you just talk about whether 24-hour shipping is driving that? And if so which specific categories of consumption are you seeing really drive that acceleration? And then sort of the opposite question on AWS which has slowed down a little bit, can you just talk about some of the puts and takes in the AWS revenue growth this quarter versus the prior Q? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, Brian. Thanks for your questions. Let me start with AWS. We had a really strong quarter. We had a growth year-over-year in our run rate from $24 billion to $33 billion, so 37% growth. The $9 billion that we increased our run rate by was second only to Q4 of last year as far as our history. So as you can tell, we've been pretty transparent with our AWS revenue and income numbers, we've been breaking it out since 2015. And we're very happy with the growth in absolute dollar terms, we're seeing the pickup from customers and their usage, their increased pace of enterprise migrations, increased adoption of our services, especially our machine learning services. And continually, again, AWS is being chosen as a partner to many companies because of our leadership position both in technology, our vibrant partner ecosystem and also the stronger security that we offer. +On your question about one-day, let me update you on that because obviously that was a big topic of conversation last quarter, and you can see that it's starting to show up in our results in Q2. So we are really pleased with the customer response to our growing one-day offering. In Q2, we had a meaningful step-up in the one-day shipments, primarily in North America. And volume was -- one-day volume was accelerating throughout the quarter. The ops team did a fantastic job here, not only being able to expand one-day selection and delivery capacity, but also preparing for and handling some very high volumes on Prime Day earlier in the month. +So we're in the middle of a journey here. We expect to see a continued ramp of the one-day selection and availability for the next few quarters both in North America and international. International was up slightly in Q2, but for the most part, the improvement in delivery speeds will be, in future quarters, there. On the cost side, we talked last time about $800 million estimate of transportation cost to supply one-day -- the addition of one-day in Q2. We were a little bit higher than that number in total cost. We saw some additional transition costs in our warehouses. We saw some lower productivity as we were expanding rather quickly both local capacity and the off-season also in our delivery networks. We also saw some costs for moving -- buying more inventory and moving inventory around in our network to have it be closer to the customers. And we built that, not only that cost structure, but an accelerating cost penalty into our Q3 guidance that was released with our earnings today. +And as I said in another setting, we've seen this before. We have had large changes to our distribution and transportation network repeatedly in our history, from going from media to a vast variety of different product lines, hardlines, nonsortable as we call them, the initial 2-day Prime shipping offer that we launched many years ago, the great expansion of our network to include FBA merchants and capacity for them and more recently, the first steps to increase one-day and same-day, although on a much smaller scale. So it does create a shock to the system. We're working through that now, and we expect we'll be working through that for a number of quarters. But when the dust settles, we will regain our cost efficiency over time. +As far as you asked about specific product lines, nothing really to share there. We have seen lower ASP generally in Q2, higher unit growth versus revenue growth in North America, and we -- could be that we are mixing into some lower ASP items as we launch one-day, but we haven't drawn that total conclusion yet. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [5] +-------------------------------------------------------------------------------- + + Just wondering back on the AWS side of things, can you give us a sense of sort of what you're seeing from a volume perspective? Obviously, price is always a big component of growth in this, but just trying to understand whether or not you're seeing similar trends in terms of growth rate deceleration on the volume side of things. And then to the extent that we're sort of thinking about the mix of either revenue or usage within that business, are there any products or sort of product areas, AI obviously being one that's been a major initiative for you, that you're seeing particular either outside growth or under growth relative to the overall business that you would call out? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Yes, sure. On that second point, I'd say we're seeing a lot of increased adoption in machine learning services, especially Amazon SageMaker. We've had tens of thousands of customers who are now using AWS machine learning services, and we'll continue to innovate on behalf of those customers and released more than 200 machine learning features and capabilities in 2018 alone in this area. Database is also a multibillion-dollar business propelled by Aurora. So we're seeing a lot of strength. We're seeing strong usage growth that outpaces revenue growth as usual, increased pace of enterprise migrations. So I would say that, on a percentage growth basis, again, on a dollar basis, it's growing very strongly. On a percentage growth basis, we are lapping some very strong growth in the first half of last year. We were growing about 50% in the first half of last year, and there are some particular unique customer volumes that were flowing through that, some customers have really high usage tied to their businesses. But for the most part, we continue to grow usage and our expansion of our services with all of our customers. So very happy. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question is from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [8] +-------------------------------------------------------------------------------- + + Great. Couple of questions. I guess the first question is just what happens with customer behavior when they do have one-day availability? I'm assuming units go up, but can you give us any details on what happens or a category that switches to one-day, what happens? +And the second question, we've heard from some of our checks that some of the smaller merchants are moving to 3P, not getting orders on the 1P's side as much. Is there any change in your business there to really kind of focus more towards third party from first party? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Sure. No, we don't have category specifics to really share with you today on the move to one-day. I did say that generally in Q2, the unit volume was greater than revenue volume. So we did see some lower ASPs. But I think what you're seeing is just a lot more products enter the consideration set for our customers. So things that maybe they can't wait 2 days on, they can wait 1 day, and it lights up a whole separate usefulness for the Amazon site. I've noticed that personally myself, they're just -- with one-day shipments, it's here before you know it. So what categories that hits specifically, we'll have to see over time. +On your comment, I assume you meant vendors, not merchants, but -- on the move from 1P to 3P, but no, there shouldn't be -- I can't highlight anything related to shift in channel there, but I would say that we remain indifferent on whether -- we're focused on price, convenience and selection for our customers. And whether a product is a retail offering, a third-party offering is not that important to us, as long as it's in stock, as long as it's priced competitively. So as you know, our 3P selection has -- our 3P percent of units has been increasing over time. It increased again in this quarter to 54% of units. We continue to invest very heavily in our systems, both for retail vendors and also for third-party merchants, invest billions of dollars a year on behalf of them making Amazon a better place for customers to buy and increasing not only vendor sales but also third-party merchant sales. +In particular, on Prime Day, I think you'll see that we had over -- in our press release, we had more than $2 billion of products were bought from small and medium-sized businesses. So when we win, we win together with our vendor partners and also our seller partners. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Jason Helfstein with Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [11] +-------------------------------------------------------------------------------- + + So in the release, you made a comment about automotive and Alexa. Anything you want to elaborate a little more that looks like that could be very interesting opportunity? And then with respect to India, there were 2 comments in the release, but anything you can comment on kind of getting past some of the issues that had impacted the business in the past? I know you're past that now. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes, let me start with India. So yes, continue to see growth in programs for both sellers -- for our sellers and delivery partners. In the last 18 months, we've doubled the number of paid Prime members, which we're very excited about. We've invested a lot in our global selling program, which helps Indian sellers not only reach customers in India but also in other geographies around the world. We started Amazon Flex in India which helps our local partners to deliver packages, gives them jobs, grows our delivery capacity for sellers and increases our speed of delivery. So it's a win-win. We've also introduced package-free shipment program in 9 cities. This is going to be a big part of our Shipment Zero program, it's a vision to make all Amazon shipments net carbon zero. +On the government side, our engagement with the Indian government makes us optimistic about partnering and collaborating to seek a stable, predictable policy that allows to continue investing in our technology and infrastructure. And it also helps us to create jobs and scale local businesses. So we think there's a lot of shared purpose there and a good quarter where -- looking forward to the Diwali holiday this year. The events we have for Diwali were all in Q4 last year. Some of them are in Q3 this year based on the timing of the holiday. So that's factored into our international -- or excuse me, our revenue growth rate for the quarter. + +-------------------------------------------------------------------------------- +Dave Fildes, - [13] +-------------------------------------------------------------------------------- + + Yes. And Jason, this is Dave. Just quickly on the Alexa point and auto, Alexa is really in more and more places. I think the point you're probably referencing is we're now seeing hundreds of third-party devices with Alexa built in. So that runs the gamut from smart thermostat and other smart home devices, headphones, but also vehicles. So we've seen a lot of good partnerships and arrangements with companies like BMW and Mini, and not just in the U.S, but in places like Europe as well. So a lot of this, of course, is just around the great power of Alexa and being able to offer even greater convenience and touch points where customers can interact with that, and we're seeing a lot of great momentum with usage and how customers are interacting with Alexa, but also when you look at the broader environment of third-party devices, devices that we're rolling out in all those things, it's -- we're seeing a lot of good momentum there. And I think it's underpinned by the fact that Alexa is always getting smarter, and so customers are enjoying the benefit of that enhanced experience. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from Youssef Squali with SunTrust. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [15] +-------------------------------------------------------------------------------- + + Two quick questions for me, please. Can you quantify the cost of one-day shipping to Q3 guidance kind of similarly to what you did into 4Q too with that $800 million? And when does it plateau? How should we be thinking about it as we map it out over the next several quarters? And then you guys made a very intriguing acquisition, the Sizmek acquisition sometime back. Just wondering, how does it fit in the overall strategy? And is the idea to try to build maybe a double-click like-minded model, sorry, using that platform? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + Youssef, let me start with your question on one-day. I'm not breaking out the specific cost this quarter as I did last year -- last quarter. Some of this is because it's very hard to pinpoint exactly the lines between one-day and other cost issues. So we're always working within a range. We're confident we were near but just above our $800 million estimate in Q2. And as I said, this is going to take multiple quarters to play out. We had a meaningful step-up in North America in Q2. We'll -- and it was accelerating through the quarter. We'll see more cost in Q3. We'll see about Q4 when we talk -- and everything we know about or anticipate about Q3 is built into our guidance. So I wouldn't break out the dollar term. I will tell you at the end of the quarter kind of what we're seeing on cost and how it looks for Q4 as well. +And the other thing I would point out on the trajectory is that we're just getting started in international, and most of that work is ahead of us, although the speed did tick up a bit in Q1 -- or excuse me, Q2, but -- and will do even more so in Q3 and future quarters. + +-------------------------------------------------------------------------------- +Dave Fildes, - [17] +-------------------------------------------------------------------------------- + + Yes, and then just on Sizmek quickly. We're excited to have acquired the Sizmek ad server and then Sizmek's Dynamic Creative Optimization, or DCO. Customers are going to be able to continue to use those proven products and services. We're invested in the long-term success of Sizmek. And Amazon advertising and Sizmek has many mutual customers, so we know how valued these proven solutions are to their customer base. So we're looking forward to working with that team, and we'll share more updates as we invent and create new opportunities to serve advertisers in the future. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [19] +-------------------------------------------------------------------------------- + + Hey, Brian, could you talk a little bit about the elasticity you're seeing -- you expect to see in international markets with the rollout of one-day? And I just -- the commentary in the press release about this acceleration from one-day sounds great. It's a little surprising that you would see the reaction that quickly, but maybe this really is -- well, you're obviously seeing it. You're confident that you'll also see it as you roll out into international markets, if you could just comment on that. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + Sure. The -- of course, the proportion of one-day shipments is higher in international, to begin with, in a lot of our countries. So we will -- we expect it to be very valuable to customers as we add selection into that one-day category. But we think the biggest elasticity is probably in North America where the standard has been 2-day shipping for Prime. So yes, I would say you're faced with the -- you see it every time you go to our site. It's automatically built in. You're surprised by the speed. It's not like you have to search one-day shipping specifically to find out what's available. It's growing, and it's pervasive. So I think what that does is, again, it strengthens your purchase decision. It strengthens the need to not have to go elsewhere to buy a product because you need it quickly. So I think it becomes a part of your routine. At least that's what we're seeing in North America. And we hope, again, as we build this capacity to more and more regions and more and more ZIP codes and more -- adding more and more selection that everyone will see the same thing that we see already in major cities. +I do want to add one point though because when we talk about operating income and both in Q2 and Q3 and we talk about the cost and penalty of one-day, I would like to highlight there are some other investment areas that are certainly going on here. If you look at Q2, our marketing expense was up 48% year-over-year, and that's a combination of a few things. First, we're continuing to add to our AWS sales and marketing teams. We see great opportunity there to help customers engage with our services and migrate to our products. So we continue to build out our sales force and our marketing programs. We're also adding more and more advertising as we roll out devices and Prime Video -- new Prime Video content, in particular internationally. So we're seeing higher marketing costs. We're also seeing a higher stock-based compensation expense. That was up 36% year-over-year. And you'll see that our headcount grew 13% year-over-year. So when you look at some of our most quickly growing areas, things like Alexa and AWS and also teams working on machine learning and other high-end technical projects, our technical headcount actually grew twice that rate or nearly twice that rate based on the total headcount. So there's a lot of moving parts within our headcount number, but there's a very strong investment going on in AWS, devices and videos, in particular. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [22] +-------------------------------------------------------------------------------- + + Hey guys, just 2 questions. The North America retail acceleration, 3.5 points, and you mentioned that international is about 1. So can we attribute the difference to one-day? Or was there other organic acceleration in North America happening aside from the move to one-day? +And then, Brian, related to that investing question, AWS operating margin came down a bit. I know they had a tough comp. But anything you would call out aside from the headcount stuff that you just mentioned that may have been lumpy in the quarter on AWS? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + Sure. Let me start with that second question. So yes, the -- sorry, the operating margin in AWS, just like the revenue rate, it's such a rapidly growing business with different timing of investments, in global expansion and investment in marketing and other -- in infrastructure that is going to vary quarter to quarter. We had a -- we've come off a period where, if you remember last year, we had less investment needed in infrastructure both for AWS and for Amazon in total. The -- I don't have the number directly in front of me, but anyway, the -- oh, I'm sorry, we grew finance leases, which is essentially our proxy for capital leases, for infrastructure, by 9% in Q1, and it was 10% all of last year, coming off a year in 2017 where we had growth of 69%. So we had that dynamic. Our trailing 12-month growth in that number is 21% after Q2. So it's stepped up from 9% to 21%. So we are starting to see, as I mentioned in earlier calls, that the investment will be stepping up in 2019. So started to see that in Q2. But the biggest -- I would say the biggest impact in the operating profit was the addition of sales and marketing personnel in AWS and also, to a lesser extent, the stock-based compensation which certainly hits across all of our businesses. +Your comment on revenue growth differential, I mean there are so many different factors going on in every country that's hard to compare North America to international. But I would say that we are attributing a good bit of the revenue growth acceleration from 17% in Q1 to 20% in Q2 to the rollout of one-day and the impact of that. If there's other things obviously we continue to add selection, and we have again lots of engagement points with customers through Prime benefits and video and devices that certainly contribute to our revenue run rate and our retention of Prime members. But if we're going to point to one thing in Q1 that's different -- Q2, excuse me, that's different, it was obviously the start of the -- and the step-up in one-day shipments. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [25] +-------------------------------------------------------------------------------- + + First, I guess sort of an organizational question but some of the feedback I've heard from the ecosystem is that it appears the combination of the way Amazon's organized internally and just the rapid growth in the ad business, 1P, 3P, that at times, there are signs that kind of these teams internally are not always aligned and maybe that creates some issues. And just wonder, first, do you generally agree with this? And if so, what is the company doing to kind of better optimize these increasingly related functions that maybe, in the past, haven't always been organized internally that way? And then secondly, in terms of subscription revenue, where are we in terms of the benefit from the price increase announcement announced last year and rolled through to existing members throughout the last year? And will this have any meaningful impact in that line's growth, say, in Q3 or the back half of the year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Sure. So I assume your first question is about the coordination of advertiser with teams that are interacting with vendors and sellers perhaps, is that what you meant? + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [27] +-------------------------------------------------------------------------------- + + Exactly. Yes. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [28] +-------------------------------------------------------------------------------- + + Okay. Yes, so first, I'd say we're customer-focused first and primarily, but we need to have good coordination across our teams, and we grow fast, and we add new things. So there's always learnings that we have that's why we say it's still Day 1 here. But we're trying to minimize the negative impact on any vendor or seller out there. So I can't comment on any certain -- on exactly what issues you might be talking about. We have teams dedicated to the seller experience and the vendor experience, and we think that they do a good job of selling the whole suite of products, including advertising -- with the advertising teams at Amazon. But as we say, they're separately run and they can meet at different points. And sometimes, at certain vendors, perhaps that may get out of hand, get out of sync. But hopefully, that is a temporary condition. +On subscription revenue, yes, we -- you'll remember, we raised the price of Prime in the U.S. last June from $99 to $119. So the largest impact, favorable impact from that, at least from a subscription revenue standpoint, would have happened in the subsequent 4 quarters, less in Q2, more in Q3 through Q2 of this year. So yes, that will be a factor that we're comping for the next 12 months. It's offset by the growth in the Prime program itself and the expansion of Prime Benefits -- or the Prime program globally. You may see that we -- may have seen that we launched Prime in United Arab Emirates this quarter. So it's not something -- it's something we've certainly seen in the past with timing of price increases, but it's built into the Q3 guidance that I've given. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [30] +-------------------------------------------------------------------------------- + + I guess first off, curious just to follow up on the ASP comment, if those were -- the said shift was within the same categories or just lower ASPs imply diversification into new categories. But my main question is just looking ahead of the holiday period, given some of the moving parts, 3PL and shipping ecosystem and then, of course, with the transition to one-day, are you confident that there is enough capacity from your own first-party logistics as well as third-party partners to meet that seasonal demand? And should we now expect a faster ramp in Amazon Air as the means to move cargo between fulfillment centers? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + Yes. So I would say the first time we started discussing the rollout of one-day, our first thoughts went to Q4 this year and our capability for holiday and as much as Q2 and Q3. So we are confident that we will have the ability to handle seasonal demand. We are working very hard to expand our one-day capacity, add carriers, add delivery partners at our own AMZL capability and have our partners expand their capabilities as well. So we're feeling good about Q4. It's a little early to discuss that now, but we certainly had a really good test on Prime Day. It was the 2 biggest days we've ever had. A lot of good work went into Prime Day. A lot of benefit for customers, a lot of benefit for our selling partners, the small business merchants as well. So it was a good test for us. +And sorry, and your question on low ASP, I think we're still figuring that out a bit. I mean, they -- what I'm reacting to is the high unit growth relative to what was also good growth in revenue, but unit growth grew faster. I'm always a little leery to put too much into the unit growth number. As I've talked in other quarters, it's a number that excludes AWS subscription services, advertising and Whole Foods, which are some of our fastest-growing areas, and we also have -- or actively selling subscription services like Kindle Unlimited and Amazon Music Unlimited, which can cannibalize unit sales. +So there's a lot of moving parts, usually headwinds to our unit growth number, but again, happy with the 800 basis point quarter-over-quarter jump in that. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question comes from Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [33] +-------------------------------------------------------------------------------- + + Brian, just on the income guide for the next quarter, it's significantly below where many of us are at. I'm curious if you could just talk to any changes around expenses and the success of the one-day just doubling down. Or can you just walk through what transpires in the next quarter? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [34] +-------------------------------------------------------------------------------- + + Yes, sure. So again, the biggest individual item is the one-day shipping. As I said earlier, we had a meaningful step-up in shipments in Q2 versus Q1, but we're still on our way, and Q3 will be a step-up over Q2 in North America, and we'll see more in international. So it's that increase in one-day shipping and the associated cost of additional transportation and getting capacity in place, as I mentioned earlier, new costs and things like expanding inventory, getting it closer to the customer. Just a lot of things moving -- a lot of moving parts in the fulfillment center world right now and our transportation network. So that is the biggest individual contributor, but as I mentioned in Q2's results, some of the investments in marketing, the step-up in infrastructure spending, that should continue. We certainly have a lot of areas where we continue to invest, not the least of which is our AWS business, devices, video, the global expansion of a lot of our Prime benefits and things like stores and grocery delivery through Whole Foods, Prime Now and AmazonFresh. So I would say yes, we had a -- as we've mentioned in the last couple of calls, we had some lessening of expenses in some key areas last year, mostly tied to headcount growth, infrastructure and fulfillment capacity. We expected a step-up in 2019. We didn't see as much of it in Q1 mainly because of the timing and the seasonality of the year and getting things going. We're seeing more of it in Q2, and we'll see it through the remainder of the year. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our final question will come from Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [36] +-------------------------------------------------------------------------------- + + Maybe a few small questions on the advertising side of the business if I can. How much of the advertising business, if you're willing to say, is driven by domestic sellers and domestic brands versus the international side? Two, how do you think about the video ad revenue opportunity? We hear from a lot of people in the advertising industry that you might be a bigger player in video advertising later this year or more into next year. How do you think about making investments against that possibility or even just the possibility of it being a driver on your platform overall? + +-------------------------------------------------------------------------------- +Dave Fildes, - [37] +-------------------------------------------------------------------------------- + + Yes, Eric, this is Dave. I think starting with the video advertising, I think that one focus area for us is expanding our video and over-the-top offerings for brands. We've taken some steps with live sports and then IMDb TV, but we'll continue to do things like add more OTT video supply, so things like Amazon Publisher Services integrations, simplifying access for third-party apps and add more inventory through things like Fire TV apps and IMDb TV. So I think some interesting areas that we're continuing to put a lot of focus into. +On the first part of your question in terms of geographical mix, I mean it's fair to assume that like a lot of our business, advertising in the North America segment is the bigger piece of that. But I think we're really excited about the international opportunity. A lot of the tools that we've rolled out, introduced in places like the United States are available in many of the international regions. And so it's a matter of continuing to work with advertisers and brands and kind of build up not only awareness but just how those ad things like Sponsored Products interact with customers, how they receive, building up the things we talk about many times here around. Improving relevancy on each of those geographic websites is an important thing that we're measuring. So expect to continue to see us look for new ways to be able to roll that out. +Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2019-Oct-24-AMZN.txt b/Transcripts/AMZN/2019-Oct-24-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..355683f44d9ebd807dce81358a7223b384c1193d --- /dev/null +++ b/Transcripts/AMZN/2019-Oct-24-AMZN.txt @@ -0,0 +1,355 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Amazon.com Inc Earnings Call +OCTOBER 24, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + * Shelly Kay Pfeiffer + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Lloyd Wharton Walmsley + Deutsche Bank AG, Research Division - Research Analyst + * Scott William Devitt + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q3 2019 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Shelly Kay Pfeiffer. Please go ahead. + +-------------------------------------------------------------------------------- +Shelly Kay Pfeiffer, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q3 2019 Financial Results Conference Call. Joining us today to answer your questions is Brian Olsavsky, our CFO; and Dave Fildes, Director of Investor Relations. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2018. +Our comments and responses to your questions reflect management's views as of today, October 24, 2019, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world events; the rate of growth of the Internet; online commerce and cloud services; and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + I wanted to know if I can go a little bit deeper in the framework you gave around revenue guidance for Q4. Historically, you have seen deceleration in the year-on-year growth rate in Q4 versus Q3, but many of your businesses look like they reaccelerated in Q3 over Q2. So just wanted to know whether it was AWS or advertising or some of the things in the e-commerce business, whether there are things we should be keeping in front of mind from a headwind or tailwind perspective as we dig through some of the moving pieces in Q4. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, Eric. Yes. Let me make clear. We are really excited and looking forward to a great holiday season. We feel like we had a great Q3 as well and have made rapid progress on our one-day shipping. The Ops team has done a great job getting us in a position where we're in, and I think it's going to be a great additional service for customers in Q4. +On the guidance front, here's what I would have you keep in mind. If you look back over the last few years and adjust for the acquisition of Whole Foods and Souq, which obscured this a bit in the last couple years. There's been a noticeable drop in run rate between Q2 -- or excuse me, Q3 and Q4 generally along the lines about 300 basis points. We are factoring that in this year. That's just something we're expecting. It's a bit about the law of large numbers and the differential between growth in the holiday season, that very tight few weeks of the holiday season versus the rest of the year, but -- so we factored that in. +And then there's also 2 other issues. The Diwali holiday in India was all in Q4 last year, and a bit of it was in Q3 this year. Also, the Japan consumption tax was raised from 8% to 10% on October 1. And what we saw was a prebuy a bit in Q3 at the end of the quarter. And based on our history with the last time that consumption tax went up many years ago, we've expected a slight negative impact from that tax in Q4 in Japan. So if you wrap those together, we expect it's going to be more of an issue with our international growth rate. I would say it's -- has made -- have helped us by 150 basis points in Q3 and will be a negative headwind of 300 basis points year-over-year in Q4. +For the company, it's not as large an issue at -- it's about 40 basis points of favorability in Q3 and it's expected to be about an 80 basis point headwind in Q4. +So that's a little bit more on our guidance, but again, we're looking -- really looking forward to Q4. I think we're well positioned to make it the best holiday ever for our customers. I think one day should help with holiday shipping. We've got a great new device line up you may have seen announced in September. And on the AWS side, we're looking forward to our re:Invent conference in Las Vegas, where we welcome over 65,000 conference attendees. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question is from Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + Brian, just wanted to ask you kind of more broadly about Prime One-Day, what your biggest learnings have been so far over the past several months as you've been increasing availability. And then how should we think about that availability now when we get into the heart of the holiday season? And can you also just help us understand how that's playing into your operating income guidance for 4Q? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Sure, sure. Let me start with the second part of that. So we're -- back in Q2, I said that we were estimating an $800 million expense in -- tied to one-day in Q2, and we actually were just above that in Q2. +In Q3, we expected that to grow. We've put it into our guidance, and we hit essentially where we expected on the guidance. So as we head into Q4, we've added what's just nearly $1.5 billion penalty in Q4 year-over-year for the cost of shipping, which is essentially transportation cost, the cost of expanding our transportation capacity, things like adding additional pulls in shifts in our warehouses, the cost of forward deploying inventory closer to customers. There's a lot of tangential costs. But by and away, the biggest expenses is on the actual transportation cost. +So we've built that into our Q4 guidance estimate. But we're very pleased with the customer response to one-day. You can see it in our revenue acceleration and also in our unit growth acceleration. Once again, the Ops team has really done yeoman's work here to create this capacity for us, and they continue to unlock additional capacity daily. We're expecting that it will be, again, a great help to customers in Q4. We have seen Prime members increase their orders, spend more, so they must also see it as a real help to them in their daily lives. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Youssef Squali with SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [8] +-------------------------------------------------------------------------------- + + Brian, just a couple of quick ones. Of the 400 basis point sequential acceleration growth, can you help us just understand maybe how much of that was driven by Prime Day, which I think you guys said was a record day for you versus one-day shipping. Just trying to extract one versus the other because, obviously going into Q4, you're only going to have the latter. +And then on a lot of news around counterfeit and whatnot on the site, can you just help quantify that for us if there is a way for you to do that? And is the higher OpEx for Q4 also driven, at least in part, by the higher investment to combat that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes, sure. So on the second one, I would say, the -- we're certainly very diligent on the -- trying to catch counterfeit products. I would put a lot of effort into that. We put a lot of human effort. We put a lot of machine learning and algorithmic effort into that as well. But I would say the bigger investments in Q4 are certainly twofold, one, around the AWS -- excuse me, the one-day shipping that I just mentioned. The other would be on AWS. We have -- we continue to invest in AWS. If you look at the progression of our operating margin in that business, we've reached a high of 31% last Q4 -- or excuse me, Q3. That was a time when we were -- as we mentioned at that time, it was very efficient. We had been banking some savings from forward investments in infrastructure in 2017. We continue to feel really good about not only the top line but also the bottom line in that business, but we are investing a lot more this year in sales force and marketing personnel mainly to handle a wider group of customers, a increasingly wide group of products. We continue to add thousands of new products and features a year, and we continue to expand geographically. +So the biggest impact that we saw in Q3 year-over-year in the AWS segment was tied to costs related to sales and marketing year-over-year and also, to secondary extent, infrastructure, which, if you look at our capital leases or equipment leases line, it grew 30% on trailing 12-month basis in Q3 of this year, and that was 9% last year. So there's been a step-up in infrastructure cost to support the higher usage demand. So we see those trends continuing into Q4, and that's essentially probably the other element of operating income year-over-year that's shorter than in prior quarters. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [11] +-------------------------------------------------------------------------------- + + I have 2. Just to go back to the one-day cost, appreciate the color. Be curious to hear about how you think about what portion of these costs are sort of transitory versus structural. It sounds like there are some shipping costs in there. Can you just sort of talk to some of the steps you have to take over the next 1 to 2 years to get the one-day shipping cost closer to what they used to be for two day? And how do you think about how long it's going to take? Then secondly on one day, I think it's mostly U.S. to date. Is that right? And then if not, how do we think about sort of timing and pushing more internationally? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. Yes, most of the expense has been in international -- or excuse me, in the U.S., but we have also increased our one-day selection internationally. We're starting to see some benefits from that. But I would say, the biggest impact so far both on the top line lift and also the bottom line cost is in the U.S. +We're still learning here on the one-day cost as we go about what the long-term cost structure will be. We have -- we know we have temporary cost in the short run as we do things like forward deploy inventory, get greater inbound into those warehouses, set up new Amazon Logistics, AMZL capacity staff, multiple shifts so that we can have later pull times to hit one-day cutoffs, things like that, adding sort centers. +So it's a drastic change to the whole network topology that we're glad to do and working through it. And we've been down this road before obviously in a number of different incarnations in Amazon's history. So we will keep you posted on a quarterly basis as best we can, but right now, all I'm really forward guiding is for Q4. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [14] +-------------------------------------------------------------------------------- + + I know most of the focus on one day has been on speed, but based on the vans we're all seeing, it would seem that the shift to more of your own last-mile infrastructures may be the bigger part of this. As it scales and you get to higher levels of efficiency and utilization, does that become margin accretive or profitability accretive relative to using third parties almost exclusively in the way that you have in the past? And then this was also a very big hiring quarter for you, 100,000 people. Can you give us a sense of where those people are going relative to AWS fulfillment, retail, kind of understanding sort of where they've been prioritized? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- + + Sure. Thank you for your questions, Heath. On the first question, I think it boils down to whether we'll be competitive long term with other options out there. Yes, we will be. We believe that in many cases we already are and places where we have very high AMZL percentages, the U.K. for instance. There, in some cases, there's -- we're lacking alternative options for the type of delivery that we're doing. But in the long run, we're going to have a combination both of our own capacity certainly fueled by -- helped with third-party carriers, large carriers that we've used in the past. +So we see a role for all carriers. In fact, including the delivery service partner program that we've developed to help spur small businesses to help fill this need as well. So -- but on the cost side, yes, it's going to be the route density, and other things will improve over time and get our cost structure down. But for now there's certainly some start-up pain in adding new capacity. +On the headcount question, yes, we increased, as you said, close to 100,000 people in Q3, and we're up 22% year-over-year. In the past, I've pointed to investments in technology teams, and that's certainly part of it. But by and away, the biggest driver this time is the people that we're adding for fulfillment and transportation roles, especially as we head into Q4 and add this additional transportation capacity to service one day. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from Steven Ju with Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [17] +-------------------------------------------------------------------------------- + + So Brian, wondering if you can weigh in on the puts and takes on the long-term potential margin for AWS. When this was first launched, it pretty much sold itself, and now you are employing a greater number of salespeople and with that, I guess, the incremental marketing dollars. But -- and on the other hand, it seems like the engineering talent hiring just slowed down over time. So I'm just wondering if you can weigh in on the -- on what's coming in and what's coming out. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + Yes, sure. I would say the margins -- our margins expectations are that we will price competitively and continue to pass along pricing reductions to customers both in the form of absolute price reductions and also in the form of new products that will, in effect, cannibalize the old ones. And we're -- we also see a point out that in -- increasingly, what we're doing is renegotiating or negotiating incremental price decreases for customers who then commit to us long term. And if you look in our disclosure on our 10-Q, it shows that we have $27 billion in future commitments for AWS -- from AWS customers, and that's up 54% year-over-year. So that's another thing to watch. It's not only the short-term commitment but also the long-term commitment that we see. +On the rest of the P&L there, again, we have, I believe, some of the best infrastructure people in the industry, if not, the best. We're continually driving up efficiency and lowering down -- lowering costs, and we see that in our bottom line. The sales and marketing investment, we're chasing a large opportunity here, and that will be, as we say, bumpy as we go along. But we're fully confident that, that will be a very leveraged cost as we get to scale. So -- and then on technology side, as you said, yes, we will continue to invest in tech, SDEs and software engineers to build these products that customers love, continue to respond to their demands, and that'll push our -- inform our product portfolio. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question is from Lloyd Walmsley with Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Wharton Walmsley, Deutsche Bank AG, Research Division - Research Analyst [20] +-------------------------------------------------------------------------------- + + Can you talk about the key drivers of the acceleration in what looks like advertising revenue within "Other?"[KJ1] And related to that, the press release mentions, I think, you now have 37 million Fire Stick users worldwide. So can you talk about maybe how much ad inventory you've been able to get inside of networks within that? And how meaningful is this to the overall kind of advertising strategy? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + Yes, sure. Let me start with the first question on advertising. So "Other Revenue," [KJ2]which is principally advertising, grew 45% this quarter, up from 37% last quarter. And the biggest thing in there is advertising, and advertising grew at rate higher than that, 45%. So we're very happy with the progress in the advertising business, continue to focus on inventing advertising experiences that are helpful for customers, helping them to see new products. We want to empower our businesses to find, attract and engage these customers. And it's increasingly popular with vendors, sellers and third-party advertisers. So it's still early, and what we're focused on really at this point is relevancy, making sure that the ads are relevant to our customers, helpful to our customers. And to do that, we use machine learning, and that's helping us to drive better and better relevancy. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [22] +-------------------------------------------------------------------------------- + + Yes, and then Lloyd, hey, Dave -- this is Dave. Just quickly on Fire TV, I mean I have to start with the fact that we did recently introduce 20 new Fire TV products. That includes the new -- the first Fire TV Edition soundbar, Fire TV Cube. So a number of things have come out recently we're really excited to get into customers' hands. So more to come there. +I think specifically on the advertising side and the opportunity with that, we are continuing to see some increased adoption. One of our areas of focus is expanding our video and OTT offerings for brands. It's still early in the space, but we've done a few things with IMDb TV, live sports, things like adding more inventory through Fire TV apps and as I said, IMDb TV, adding more OTT video supply through Amazon Publisher Services or APS integrations and streamlining access for third-party apps and really just making it easier for advertisers to manage their campaigns and provide better results. So as I said, early days, but I think with the engagements of the device community, the fact that we're really excited with the progress and improvements of these devices, I think, yes, we gain a lot of opportunity there. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our question comes from Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott William Devitt, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [24] +-------------------------------------------------------------------------------- + + There's been a meaningful reacceleration in paid unit growth in the past 2 quarters with the expansion of the one-day guarantees from Prime customers and just wondering if consumers are responding more in certain categories that you would highlight over others. Or is the response fairly broad based across the product categories where one day has been expanded? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + Scott, yes, what I can tell you is that, yes, the unit growth has been reaccelerated in the last 2 quarters. And actually, the Amazon fulfilled unit growth is growing at a higher clip. So we do attribute it to one day. We're seeing broad sales across all categories. So yes, there's been some reduction in the threshold for some low ASP items that we've been doing separately over the last 6 months that have spurred some sales in lower ASP items. But we think that is, again, the right decision for customers, especially over the long term. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [27] +-------------------------------------------------------------------------------- + + I want to go back to AWS. When asked about the margins, you referred to -- Brian, you first referred to bringing down prices. Have you seen anything different in terms of the level of price competition? Could you talk about what kind of traction you've had building out into the enterprise? And I know it's a broad question, but take a shot at it. And the third part of this is your interest and your success in going in and generating more app -- going up the stack and getting more into the application software space, all that AWS related. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [28] +-------------------------------------------------------------------------------- + + Sure. So yes, I would say my comments around pricing were as much mix as absolute price decreases or competitive price pressures. It's certainly a competitive market that we see and we've seen for really a number of years. So everyone is very sharp on their pricing, is very eager to lock up long-term commitments from AWS customers. We do it with a combination of price and capability that we think is unmatched. So the bigger element of that really is around us creating new products and services that are cheaper and less expensive than the old ones. So there's a certain bit of mix issue that we're always up against. +But again, on the -- and your question on enterprise penetration. I think the enterprise, we're making great progress there. It's going to be hard to -- on revenue growth, it's going to fluctuate quarter to quarter. It's hard to predict the pace of some of the sales cycles and the enterprise migrations that companies are willing to make or some are faster than others and some have other work to do before they can migrate. So there's a lot of factors at play there on the enterprise business. But we are having great success, and we're adding a lot of the sales force -- or sales representatives, especially for the enterprise market. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [29] +-------------------------------------------------------------------------------- + + Yes. And Mark, hey, this is Dave. Just really quickly just in terms of your question on the stack. I mean I think for really since as long as AWS has been around, we really pride ourselves in getting really top, high-caliber people, both the technical side but also salespeople, that are plugged in and listening to customers, understanding issues that are emerging, having open lines of communication. And that's really allowed us to innovate quickly and really faster than anyone else. And we see that in terms of the services and feature breadth and depth that we have. So a lot of the focus for us is really making sure that that flywheel keeps spinning and that we continue to roll out a lot of great services that customers are looking for. So I think that's largely what dictates our road map and making sure that we give ourselves autonomy and availability to look to new areas and stay on the cusp of whether it's kind of emerging technologies or really just our customer needs or pain points that need to be solved. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31] +-------------------------------------------------------------------------------- + + Maybe first as a follow-up on the logistics and delivery side. Wondering if you'd give us some sense for the portion of SKUs in the U.S. or orders in the U.S. that are now delivered through your own network of drivers and partners. And then secondly, there have been some reports that Amazon is or, on occasion, is delivering products for other merchants or suppliers not specifically tied to an Amazon order. So just wondering if you view this as another potential opportunity down the road as you get excess capacity on the logistics side. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [32] +-------------------------------------------------------------------------------- + + Yes, Colin. Hey, it's Dave. Thanks for the question. On that second point in terms of how we think about the capacity we might have for our own, I think I'd start with we've got a great relationship with third-party carriers across the countries where we operate. Over time, I think we'll look and expect to be able to grow our internal volumes using AMZL or Amazon Logistics but also continue to grow our 3P volumes with carriers and transporters around the world. But our focus is really on ensuring that we've got capacity from available resources, whether it's our own or our great -- our carrier partners to be able to serve the small- and medium-sized businesses in the 3P realm but also the first-party items that we're receiving orders from customers, making sure we're able to deliver those things quickly and reliably. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our final question will come from Justin Post of Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [34] +-------------------------------------------------------------------------------- + + I'll grab you a couple here. Just wondering back on the shorter holiday season. Do you think that's going to be a headwind for overall online sales in the quarter? Anything specific to Amazon? And then secondly, just thinking about the regulatory environment. I wonder if you can just comment on the opportunities and the competitiveness for third-party sellers. Are there other platforms that you see for them? And how do you think about their profitability on Amazon if you can comment on that at all? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + Sure. Yes. On third party, I would say we only succeed if the third-party seller succeeds. So we're heavily invested in them as they are in us. So we are constantly investing on their behalf, adding new projects -- products and features, and we're cognizant of their economics as well, and we want a business that works for both of us, and we set our fees accordingly. +So I think that we've -- and I'll also point out that with the one-day, the increase in one-day, sellers have participated in that as much as anyone else -- I mean as much as our 1P offering. So it's been a great boon for sellers as well as particularly our FBA program. +On the holiday season question, we are not anticipating that the move of the shorter time period between Thanksgiving and Christmas Day is going to be that impactful. What we've found in the past is that there's generally a holiday budget that is spent somewhere between November 15 and -- or November 1 maybe and December 25. And while certainly Black Friday and Cyber Monday are important dates in that holiday period, there's -- the purchases tend to move around. Some have been moving early in the quarter. Some have been moving later in the quarter as customers count on and receive very quick shipments at the end and have higher faith in delivery just before the holidays. So that's all the color. That's what's anticipated in our guidance that we've given. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [36] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. +[KJ1]This is referring to a financial line item on our earnings release. Not sure how you guys would prefer to format this. +[KJ2]Same comment as above. How do you prefer to format this name of our financial line item? + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2020-Apr-30-AMZN.txt b/Transcripts/AMZN/2020-Apr-30-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2d344f232db4d481086077f21d9add91ddeec4c --- /dev/null +++ b/Transcripts/AMZN/2020-Apr-30-AMZN.txt @@ -0,0 +1,291 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Amazon.com Inc Earnings Call +APRIL 30, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + * Shelly Kay Pfeiffer + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q1 2020 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. +For opening remarks, I will be turning the call over to Director of Investor Relations, Shelly Kay Pfeiffer. Please go ahead. + +-------------------------------------------------------------------------------- +Shelly Kay Pfeiffer, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- +Hello, and welcome to our Q1 2020 financial results conference call. Joining us today to answer your questions are Brian Olsavsky, our CFO; and Dave Fildes, Director of Investor Relations. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2019. +Our comments and responses to your questions reflect management's views as of today, April 30, 2020, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world events; the rate of growth of the Internet, online commerce and cloud services; and the various factors detailed in our filings with the SEC. This guidance also reflects our estimates to date regarding the impact of the COVID-19 pandemic on our operations, including those discussed in our filings with the SEC and is highly dependent on numerous factors that we may not be able to predict or control, including the duration and spread of the pandemic; actions taken by governments, businesses and individuals in response to the pandemic; the impact of the pandemic on global and regional economies and economic activity, workforce staffing and productivity and our significant and continuing spending on employee safety measures; our ability to continue operations in affected areas; and consumer demand and consumer spending patterns as well as the effects on suppliers, creditors and third-party sellers, all of which are uncertain. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +And now I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- +Before we move on to the Q&A, I'd like to lead off with a few comments. What we've all seen transpire in the past 2 months has been gut-wrenching and unprecedented. But it's also been a time of heroic action by health care workers, government officials, police and emergency personnel and all essential workers in our communities. This includes frontline Amazonians, including our Whole Foods team and our partners around the world. They've provided a lifeline of groceries and other critical supplies to the doorsteps of all of us at this critical time. +I'd like to give you some insight into what we have seen in Amazon and how we are responding to this crisis. Beginning in early March, we experienced a major surge in customer demand, particularly for household staples and other essential products across categories such as health and personal care, groceries and even home office supplies. At the same time, we saw lower demand for discretionary items such as apparel, shoes and wireless products. This large demand spike created major challenges in our operations network and with our seller community and our suppliers. +While we generally have experience in getting ready for spikes in demand for known events like the holiday season and Prime Day, we also generally spend months ramping up for these periods. The COVID crisis allowed for no such preparation. We took quick action to react to the higher order levels while continuing to provide for the safety of our workforce. We established rigorous safety and cleaning protocols, including maintaining 6-foot social distancing, procuring 100 million masks, tens of millions of gloves and wipes and other cleaning supplies. We began requiring temperature checks across our operations network. +In our Whole Food stores, we added plexiglass barriers between cashiers and customers and reserved special hours for senior customers to shop. We temporarily raised wages and overtime premiums, we funded a new Amazon relief fund and we allowed employees to take unpaid time off at their discretion. To deal with the unprecedented demand, we hired an additional 175,000 new employees, many of whom were displaced from other jobs in the economy. We took steps to dampen demand for nonessential products, including reducing our marketing spend. +Our network pivoted to shipping priority of products within 1 to 4 days and extending promises on nonpriority items. Our independent third-party sellers, most of whom are small and medium-sized businesses, worked tremendously hard to serve our customers, and we are grateful for their efforts. Third-party sellers continue to see strong growth in our stores as more than half of our units sold are from third-party sellers. +We increased grocery delivery capacity by more than 60% and expanded in-store pickup at Whole Food stores from over -- from 80 stores to more than 150 stores. And other Amazon teams shifted their focus to directly helping customers in the overall effort to fight the COVID virus. +AWS has created data lake to assist health care workers, researchers, scientists and public health officials who are working to understand and fight the coronavirus. Many of our AWS products are helping in the government response to the crisis and are there for customers who are seeing their own demand spikes, companies enabling videoconferencing, remote learning and online health services, for example. +Amazon Flex is supporting food banks by donating delivery services of groceries to serve 6 million meals in Los Angeles, Miami, Nashville, Orlando, San Francisco, Seattle and Washington, D.C. with plans to ramp this up to 25 cities across the U.S. And Alexa is helping customers access important CDC guidance and help them evaluate their own COVID-19 risk levels. +How is all this impacting our business? While customer demand remains high, the incremental revenue we are seeing on many of the lower ASP essential products is basically coming at a cost. We've invested more than $600 million in COVID-related costs in Q1 and expect these costs could grow to $4 billion or more in Q2. These include productivity headwinds in our facilities as we provide for social distancing and allow for the ramp-up of new employees, investments in personal protective equipment for employees, enhanced cleaning of our facilities, higher wages for our hourly teams and hundreds of millions of dollars to develop COVID-19 testing capabilities. In Q1, we also had another $400 million of costs related to increased reserves for doubtful accounts. On the flip side, we did see a drop in travel, entertainment and meeting costs as well as lower marketing as a way to dampen our demand for nonessential items. +While we can't have great certainty about what the next few quarters will look like, I'm humbled by the efforts of my fellow Amazonians in delivering essential goods and services to so many people. We take this responsibility seriously, and we're proud of the work our teams are doing to help customers through this difficult time. +With that, let's open up for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Your first question comes from the line of Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [2] +-------------------------------------------------------------------------------- +Great. First, I just wanted to ask, within the $4 billion of COVID-related incremental costs in 2Q, you talked about spending hundreds of millions on your own testing capabilities. Can you just talk about the strategic thinking there underlying, trying to build this in-house versus sourcing from elsewhere? And does this potentially take you into a new business path over time? And then how do you think about the spending here in 2Q and whether over time, does that change your margin structure for an extended period of time beyond just the next quarter? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- +Yes. Sure, Doug. First, on testing. So we estimate the testing will be about $300 million in Q2 if we're successful. We've put some of our best people on it. I think everyone is trying to get testing. It's not readily available on the scale that we need it for -- to test our scale of employees. So we are working to do that ourselves and to build protocols and to -- and again, we'll see how we do that differently. And I don't know, again, about future business opportunities. Our main concern is getting testing in the hands of our employees. And then potentially as we have excess capacity, perhaps we can help in other areas. On the spending, the -- a lot of the costs that we're seeing are tied to this COVID response. Most of it is hitting in people costs, both in productivity and also in wages and relief funds and all. So we can't really tell how long that will last. It's probably good that I'm only giving -- we're only giving guidance for Q2 at this point. We're going to probably learn a lot more in the next few weeks, next few months, and we'll continue to update this. But for now, most of what we see are temporary costs in the scheme of things but certainly very expensive temporary costs and also ones that we're not sure how long that will last. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [5] +-------------------------------------------------------------------------------- +I have 2, Brian. The first one is the current situation is sort of, I think, in many ways, sort of showcased the ability of your network to provide goods for people and the value of Prime and Amazon to customers. So I guess in light of that, can you talk to us at all about the impact you've seen on the Prime customer account from the current situation? Any color on how you've been able to expand Prime's reach into new customers or demographics from this? Then the second one, I know there's a lot of changes going on in logistics and things, but Amazon is always a learning company. So any learnings you've had so far on the logistics side about how you actually may be able to learn some new best practices to run more efficiently post-COVID from the current fire that we've been going through? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- +Well, I think we have learned that it's easier to get ready for a holiday or for a Prime Day than it is to get ready for something like this when everything hits at once, high demand and then also a need to restock automatically and not prepare for it. So that's not something we want to keep learning, but we're doing our best to maintain and provide key services for -- and essential items for our Prime customers and all our Amazon customers. On the Prime -- excuse me, Prime program, what we're seeing is, again, we're seeing a lot of pickup in Prime shopping benefits. We see our Prime customers are shopping more often and they have larger basket sizes. We're also seeing a lot more use of our video benefits and our digital benefits. So in March, the first-time viewers nearly doubled, which is, I think, a good time for people to -- when they're -- a lot of them are staying at home to stay entertained and see our video collection. +It's also beyond kind of Prime Video, it's also our channels and video rentals also went up as I'm sure others in the entertainment business saw it as well. I think people are finding more benefit from Alexa when they're at home. They're listening to more music, asking questions, particularly questions related to COVID and issues around it. They're using it in education with their children. And I think we're seeing a lot more on the communication side using it -- people using Alexa Calling and Drop In. So I think the Prime story is that shopping is really important for people now, especially when they -- those people can't leave their houses. I think the digital benefits are scaling well. I think they're handling the additional demand, and it gives people a good time and reason to use all of their Prime benefits that maybe they hadn't used as much in the past. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Your next question comes from the line of Mark Mahaney with RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [8] +-------------------------------------------------------------------------------- +Two, please. First, could you just talk about where you are in terms of fulfillment efficiencies, the way you track it? Pre-COVID, Amazon was able to had some sort of level of standard of meeting demand within a certain period of time, how low that got given the surge in demand and where you are in terms of the recovery. In other words, when are you going to be -- how long will it take for Amazon to get back to a point where you'd have the same sort of service efficiency levels on the retail side that you had pre-COVID? How far are you away from that? And then the second one is can you talk about the AWS business? And I guess I would have expected -- maybe the growth rate is really robust, but maybe even a kick up in the growth rate is -- what are you seeing there in terms of -- I assume there's much greater usage of AWS now. Is that something that would show up in the P&L maybe on a delayed basis? Just talk about what's happening to that side of the business in this crisis. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- +Sure. Well, we're happy with the growth in Q1 on such a large base. Again, we're -- now it's a $41 billion run rate, and that's grown 33% year-over-year. But what we're seeing kind of post-COVID is it varies by industry. I think -- we think what is -- probably where we're a bit well positioned is that we have such a breadth of customers. There's millions of active customers from start-ups to enterprises to public sector. So there's a lot of variance and, again, in what individual industries are seeing right now, things like video conferencing, gaming, remote learning, entertainment, all are seeing much higher growth and usage. And things like hospitality and travel certainly have contracted very severely, very quickly. So I think there's going to be a mixed bag on industries. And of course, this would be tied to general economic conditions for the country and the world, quite frankly. So right now, we're -- we want to be there for our customers. We want to be able to scale up when they need us. We want to be there and support them regionally around the world. And we've been doing a good job with that, I believe. +On the fulfillment efficiency, I think you're talking about 1-day probably is the heart of your question, when will we get back to what we have seen in levels of 1-day. So a little bit on that. So again, as I mentioned in my introductory comments, we had to kind of absorb this shock of top line demand and also ability to stabilize our operations. And we had to take the step to focus on essential items, extend the shipping period from 1 to 4 days and then further on nonessential items. Had to restrict things that were coming into the warehouses and focus on essential products. So we think that is still the -- was the right course of action. And as we add capacity, we're trying to resume more normal operations as far as the shipping of nonessential items and the speeding up of 1-day shipments. +I will explain a bit on the 1-day shipping cost because it's aligned with this. So we had originally thought we would spend $1 billion roughly on 1-day shipping in Q1. And what we're seeing is we pretty much spent about that same amount because it's -- in the old days, we would have perhaps had the option to shift things 2-day, 3-day, 4-day and seen a break on rates for the actual shipment. But most of our 1-day costs are really what we've done to our logistics networks to allow for 1-day shipping, things like putting inventory closer to the customer, things like building up our AMZL network and delivery network and also having multiple pull times and shipping windows during the day. So those are actually coming in. All those things are coming in very handy to us to help get more capacity out of what we currently have, and we're glad we've made that investment. But we don't actually see a savings because we're still shipping things once they're available very quickly to customers. +So it's really a combination of how long it takes to get things in stock picked, packed and shipped. The shipping is still pretty fast and is still coming quickly. It's just it's taking longer to get things into our warehouse and out of our warehouse. So that's really the challenge right now is to speed that up, and that will -- when we do that, we'll see a resumption of more 1-day service. But right now, things are still so up in the air that I can't really project when that day will be or at what point in Q2 or Q3 or beyond. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Your next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [11] +-------------------------------------------------------------------------------- +Great. I did want to dig just a little bit deeper into your comments on AWS. Yesterday, during Microsoft's call, they mentioned that they had seen 2 years' worth of digital transformation in the cloud in 2 months. I'm curious if you -- how you would characterize sort of what you have seen as we've gone into August or into April in terms of cloud adoption and what this is, what this has meant for AWS and the adoption of the -- rate of adoption or acceleration in that business, maybe more broadly? And then as we look at the guidance, the $4 billion for the expenses in the second quarter, if we adjust for that, that implies a pretty material increase in profitability quarter-over-quarter. Any sense of -- or any sense that you can sort of share with us of just what the drivers behind that profitability is? How much of that is annualizing the 1-day investments and the efficiencies that you're seeing there versus anything else in particular that you would call out? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- +Yes. So first on AWS. I mean I don't have comments that -- you may have heard also about digital transformation. I think what I would say is we've continued to see a healthy adoption of our business and healthy usage, not only in the United States but globally. Our backlog of future contracts continues to build. And I still think the basic value proposition of AWS that we've always pointed to, things like having the largest -- most functionality, the largest in those vibrant community of customers and partners, having really proven operational and security experience and building what customers need in the areas of machine learning, artificial intelligence and other really key areas is -- has not been impeded by this COVID crisis yet. And yes, we're seeing different performance in different industries, but our sales force is still there to help not only with current capacity but also to transition to new and -- as people make that journey on to the cloud and then expand their use of the cloud. +On the $4 billion -- or sorry, on the Q2 guidance, I think the question is, perhaps if -- how do we have a range that's above 0 if we have $4 billion of cost, is that pretty much the essence of your question? I think there's -- there are some efficiencies that we'd leverage, that we get on fixed cost on higher volumes, even if they are somewhat breakeven on a contribution profit basis. There's some improvement in our cost structure when we have high volumes. There's also been a resumption of seller volume, especially from third parties using direct shipments to customers as companies are -- you get more capability, both in this country and other countries. We will continue to moderate our marketing in the time period when we have -- again, pretty much the demand we are trying to fulfill is there, and there are some products that are still out of stock. So it doesn't make sense to always do marketing, especially variable marketing in those situations. And we continue to -- we believe, we'll be saving travel and entertainment costs through the quarter. That's in the, I would say, in a couple of hundred million dollar size ranges on the cost. So there's a lot of moving parts here. But certainly, the investment we're making in the COVID response is pretty significant. +On the 1-day, I would remind you that the 1-day started in earnest Q2 of last year. So we're starting to lap that investment. It's not as large on a year-over-year basis as it's been in the past 4 quarters. And then the other thing that I would just point out is the -- remember the impact of our change in the useful life of our servers mostly hitting in the AWS business. That was an $800 million benefit year-over-year in Q1, and that will continue into the rest of the year. And that, again, is the benefit we're seeing from being able to use our server and infrastructure assets for a longer time period. We've been working on the ability to run them longer, and it's both a hardware and a software challenge. And as we have had success there operating at scale for over 13 years now, we've been able to extend our useful life for assets or recognize that we have been extending the life. So that's a benefit that we've seen in Q1, and we'll see it remaining from here on out. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [13] +-------------------------------------------------------------------------------- +Yes. And just to add to that, too, I think it's about $800 million or nearly $800 million benefit in the first quarter. We do expect the change to decrease as the year progresses, keep that in mind. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [15] +-------------------------------------------------------------------------------- +Maybe 2, if I can. One on demand and the revenue side, any difference in behavior you saw in various shelter-in-place geographies across the world, whether it be Europe versus the U.S. or Asia and the U.S. or India in terms of consumer behavior or certain elements of adoption of certain product categories as we went through the month of March? I'm curious what differences you saw on a global scale, including on Prime adoption in response to COVID-19. And one quick one on the cost side of the equation. The cost of energy and oil have come down dramatically. I wanted to know if there was any way you would be able to call that out or an element of that in your overall cost structure as you do more of your own logistics over time. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- +Sure. Sorry, Eric. I don't have much for you on the second point. Certainly, we would look to see lower shipping costs, although I would -- a lot of -- I mean there's certainly things that we do long haul. There's things that we reposition with the airplanes. There's things that we do on long-haul trucking and that's where probably the fuel component would be larger. And we've -- but we haven't quantified that or not for -- it's in our guidance, but I can't break it out for you right now. On the -- how this may have played out differently in different geographies, we're actually seeing a lot of consistency, I would say, in the types of products that people are buying and the stay-at-home restrictions and the -- so it's been pretty consistent. There's obviously timing differences between countries on when it's hitting certain countries and when it's -- maybe when it's -- where they are in their curve and flattening their curve and all that. +I think the biggest impact internationally has been in India where, of course, we -- similar to all companies in India, we were -- we're now only fulfilling our essential goods such as grocery. So that's cut back a lot on our offering. And we will further expand when the Indian government announces that we're allow to resume operations. So we're in a bit of a holding pattern, except for grocery in India. And in France, there's been restrictions placed on us by the French courts. They did not impact Q1 business because it essentially led to the closure of our French fulfillment centers in the middle of April. French customers are still able to order many millions of products from the selling partners we have who can ship directly to customers and through our global fulfillment. And we're continuing to appeal this court decision, but that's also a different experience than the other countries internationally. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Our next question comes from the line of Justin Post with Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [18] +-------------------------------------------------------------------------------- +Great. A couple. Just wondering if you're seeing any sustainable changes in consumer habits you could call out, such as people converting to Prime at a more rapid rate, adding more products in the consumable categories to their Subscribe & Save. Anything you see that could really signal a longer-term change in consumer habits, faster adoption of certain categories? And the second thing, for the revenue guidance for 2Q, does that assume a slowdown in growth in May and June related to the crisis? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [19] +-------------------------------------------------------------------------------- +Justin, it's Dave. Yes. I think on some of the consumer behavior, I'd certainly point to grocery. If you look at the -- as a reminder, the online grocery is up on our online sales. So it's not isolated like you can see for physical stores. But we have seen an increased demand in online grocery shopping, and we have a number of ways for customers to do that, Prime Now, Fresh and then, of course, Whole Foods online for delivery or pickup. And really beginning in March and continuing now through April, seeing that increased demand, so that's continued. And a lot of our focus is on working around the clock and offering as much delivery as possible. We've increased delivery order capacity more than 60%, and our stores have gone up -- Whole Food stores that offer pickup capability has gone from roughly 80 stores before the events to more than 150. So a lot of work being done there. +On the physical stores, which you can see the growth there, it increased year-over-year about 8%. That is predominantly Whole Foods, but it's the Whole Foods in-store shopping experience rather than the online order. So that's up quite a bit from the run rate you've seen in some recent quarters. It's, again, similar that you saw a lot of folks that were, when stay-at-home measures were not yet in place, were shopping in large volumes and stocking up at our stores. Since that time, more recently, we have seen some of those growth rates for the in-store shopping moderate some. Still a lot of work being done there, both in -- for the workers that are doing the delivery and the workers that are in the stores, a lot of focus on our part to make sure that they're safe and healthy and able to accommodate customers and make sure customers are comfortable however they choose to shop. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- +And I'd add to that, Justin. I think the changes we've seen in the digital offerings will make people accustomed to those benefits and maybe advance their knowledge of what's available through music, video, Alexa, certainly, communication features on our devices. We launched Prime Video Cinema in U.S., U.K. and Germany where movies are going direct to pay-per-view because of lack of theaters. And that was a good move by the team, and that's been very well received. We've also made a lot of kids and family content available free to watch on Prime Video. So I think people are getting a better look at what's available with their Prime memberships. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [21] +-------------------------------------------------------------------------------- +Great. And then second half of the quarter, are you assuming kind of we go back to normal as the quarter progresses and some deceleration? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- +Well, we are heavily constrained -- again, it's an odd quarter because generally, the biggest uncertainty we have is customer demand and what they'll order and how much of it they'll order. Demand has been strong. And the biggest questions we have in Q2 are more about ability to service that demand and that -- the products that people are ordering in a full way, not blocking or making it hard to find nonessential items, increasing marketing and everything else. So I think the challenge is really on everything besides the top line. Top line is certainly not to be taken for granted. There's always the importance of having attractive offerings in stock for customers. But usually, things that you can count on, the cost structure, the ability to get products, your capacity for shipping and delivering, those are usually things that you can take for granted and in this quarter, you can't. And that's really where the uncertainty is driven. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Your next question comes from Stephen Ju with Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [24] +-------------------------------------------------------------------------------- +Okay. So Brian, I think the third-party unit mix de-indexed a little bit as a percentage of the total this quarter. I know that number kind of jumps around a little bit. But is this primarily a matter of the constrained delivery resources and, I guess, the heightened demand? And any sort of ongoing supply chain concerns that remain worrisome for you from either a first-party perspective or from what the third-party sellers may be calling out? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- +Sure. I think there's still supply chain concerns on a lot of PPE, not only that we use but also that we sell to customers, things like masks. There's general availability, but still outages of things like cleaning wipes, masks -- I've talked about testing, but that's not something that we resell. But -- so there's -- there are a lot of supply chain concerns mostly in those areas right now. I'm sorry, I forgot the other part of your question. Can you remind me what you just -- the first question... + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [26] +-------------------------------------------------------------------------------- +The third-party unit mix de-indexing a little bit as a percentage of the total this quarter. I'm just wondering if that's just normal fluctuations? Or are you just prioritizing the first-party delivery against what's probably a limited delivery resources on the heightened demand? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- +Yes. Thanks, Stephen. I would say that, yes, it's a little off during this period because it's not so much we're restricting and favoring 1P or anything, it's we're prioritizing essential items. And a lot of those tend to be, especially in the consumable area, tend to be retail supplied items from vendors. So I would say that, that is the reason that FDA would have not been as high as it normally would be. MFN is picking up a lot of the opportunity, though, to -- and sellers are taking that opportunity to ship direct because then it doesn't have to come into our warehouse, obviously. So it's a bit of a different type of 3P mix right now. We're trying to minimize the impact on FBA sellers as we open up our warehouses as well. Many of them are also MFN or direct shippers to our customers. So it's -- the ability to satisfy demand of our customers from our seller community has never been more important. And we're very grateful to our third-party sellers because they've been through a lot as well. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our final question comes from the line of John Blackledge with Cowen. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [29] +-------------------------------------------------------------------------------- +Great. On advertising, the other revenue growth line accelerated, could you just discuss how the advertising business performed in the first quarter? And any color on how it's trending in the second quarter, if possible? And then in the release, you indicated more -- potentially more hiring above the 175,000 head count additions. Any way to quantify? And does this hiring replace kind of the seasonal hiring that you typically do at the end of the third quarter? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- +Yes. Sure. Let me start with that second one. I don't have more for you on that. I think we'll announce -- as we change any thresholds on hiring, we'll announce that at the time. Right now, we've fully hired the 175,000 people that we had discussed prior. 80,000 of them were in place at the end of the quarter. So the other 95,000 have been hired in April. On advertising, what we've seen is it's been a very strong quarter in ad revenue. And your comment about other revenue accelerating, there's some other things going on in that other revenue account. The majority is revenue, but there's other -- some other things. What I can tell you underneath it is that advertising growth rate has stayed consistent with last quarter. And we're very happy with the progression of that offering for not only sellers, authors, vendors and impact it's -- positive impact it's had on customer selection. +But we did start to see some impact in March, some pullback from advertisers and some downward pressure on price. But advertisers continue to advertise at a high clip. It wasn't as noticeable as maybe with some others we're seeing, and it's probably offset a bit by the continued strong traffic we have to the site. So it's a bit of a mixed bag. We have, again, as I said, downward pressure a bit on pricing. But I think we have -- a large portion of our advertising relates to Amazon sales, not things like travel and auto which -- off-site which may have been disproportionately impacted, at least early on here in the COVID crisis. And I think our advertising will prove to be very efficient as well, and it can be directly measured. So even as people are cutting back perhaps on advertising or their costs, I think this will be one area that will prove its value as it has in the past. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [31] +-------------------------------------------------------------------------------- +Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2020-Jan-30-AMZN.txt b/Transcripts/AMZN/2020-Jan-30-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..c1783ab4c03f1a5e2fa99af98f46dfa9346b52d0 --- /dev/null +++ b/Transcripts/AMZN/2020-Jan-30-AMZN.txt @@ -0,0 +1,376 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Amazon.com Inc Earnings Call +JANUARY 30, 2020 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + * Shelly Kay Pfeiffer + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Heath Patrick Terry + Goldman Sachs Group Inc., Research Division - MD + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Ronald Victor Josey + JMP Securities LLC, Research Division - MD and Senior Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2019 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Shelly Kay Pfeiffer. Please go ahead. + +-------------------------------------------------------------------------------- +Shelly Kay Pfeiffer, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2019 financial results conference call. Joining us today to answer your questions are Brian Olsavsky, our CFO; and Dave Fildes, Director of Investor Relations. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2018. Our comments and responses to your questions reflect management's views as of today, January 30, 2020, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we'll move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question is coming from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + Great. Really appreciate this. Just on the AWS business, as you look sort of at the strength that you saw in the quarter, particularly represented by the amount of dollars added quarter-over-quarter, is there anything in particular that you would call out either in terms of specific types of workloads, regions, specific customer types that you felt like drove the strength, particularly relative to the directional -- direction of growth that we were seeing in the earlier parts of the year? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + No, I would not isolate it to any one set of customers or products. I think it's been pretty broad-based. And it's kind of the culmination of a lot of work on adding new products and features, adding to our sales and marketing teams and having better penetration in enterprise customers and hitting a lot of very different industries. So I think that's what you're seeing. We feel that our product set is -- leads the market. And we add to it at a quicker pace than our competition, so actually, the gap on capacity and features is growing as we speak. +We also think that there's a real network effect when you use AWS with the millions of active customers and tens of thousands of global partners. And we continue to expand. We're now in 69 availability zones across 22 geographic regions. So I think it's the combination of increased sales support, more and better products that hit customers' needs and also the geographic expansion is what you're seeing. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + Was just hoping you guys could disaggregate a bit the strength in seller services, how much of that was third-party marketplace commission specifically? And are you seeing more of an uptick in some of the other content and services? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + On seller services, I would say it was just a very strong quarter, if that's what you're referring to, 31% growth in revenue. It was strong on a unit basis. And as you said, there's probably additional strength in FBA, which has higher fee set than MFN does. So -- but in general, if you step away, I think what you're seeing is more and more participation of third-party sellers in our one-day delivery program as we move through the year. That was particularly strong in Q4, and I think you'll see that more as we move into 2020. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Justin Post with Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [8] +-------------------------------------------------------------------------------- + + Just wondering if you could go high level what drove upside to your guidance on revenue in the quarter on the retail side. Anything there that you'd really call out? And then on the AWS investments, obviously, you just talked about investments starting in 3Q. Where are you in that investment? Your margins are still below peak. Where are you kind of in that investment cycle? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Sure. Well, as I said, on revenue, we came in at $87.4 billion, which exceeded the high end of our range of $86.5 billion. $400 million of -- roughly $400 million of that was due to foreign exchange. But what we saw was essentially very strong holiday performance from the middle of November on. We also had a very big uptick in response to the one-day availability that's been building through the year. +I think Prime has been very strong. We mentioned that we have more than 150 million paid Prime members globally now. And we mentioned that more people joined Prime in Q4 than any other quarter before. So a lot of good momentum there built up on the aggregation of benefits that we continue to add to the Prime program, most recently the one-day -- expansion of one-day shipping. +On AWS, where are we in the cycle? I talked more in 2018, when the margins in AWS were closer to 30%, about the efficiency of infrastructure spend and -- versus prior years. So we continue to -- since that point, we've continued to add infrastructure capability and -- to support our global expansion as well. But what you're seeing probably more in the margins is the expansion of our sales and marketing effort at some of those costs as well as price decreases and longer-term contracts that we've signed with some of our customers. You notice on our balance sheet that our future commitments on the multiyear deals now stands at $30 billion at year-end, and that's up 54% year-over-year. So there's a lot of good momentum on the enterprise side as well. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [11] +-------------------------------------------------------------------------------- + + Just to ask about AWS again. The investors have become, I guess, recently concerned just about, again, the slowing AWS revenue and margin and whether it's a function of increased competition. So maybe just talk about how you're reacting. You did talk about spending on sales and price cuts. But just any more you can talk about the competitive environment. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. I would probably argue a bit with the growth comments. As we see it here, we grew from a $30 billion revenue run rate at the end of 2018 to a $40 billion revenue run rate at the end of 2019. So we continue to be happy with our top line growth. The -- in dollar terms as opposed to percentages, we had a larger dollar increase in revenue, both year-over-year and quarter-over-quarter. So we're very happy with the progress of the revenue and our adoption and acceptance by customers. +As far as competitive set is concerned, we -- again, we think that we have -- start with a very big lead in this space because of our many years of investment, not only in capacity but also in services and features that we provide to customers. We've learned from customers. We just had a great re:Invent conference in December, where all of our -- it was a great aggregation of partners and customers and developers. And at those events, we not only get to present our new products, and there were over 100 that were launched in December, but we also get to hear customer issues and help -- that helps sign our -- educate our forward road map. +So it's a great shared learning. I think customers react to it. Customers will be at different stages of their adoption curve. There's always different phases: first, moving to the cloud, then organizing on the cloud and then growing further. So there's a lot of movement. I said that repeatedly, I think, in the setting that any quarter -- quarter-to-quarter movement is going to be a little bumpy. But generally, what you're seeing is the convergence of a lot of investment, a lot of operational efficiency and a lot of innovation on behalf of customers. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stephen Ju with Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [14] +-------------------------------------------------------------------------------- + + I wanted to switch it up a little bit. I guess you guys called this out in your press release, but I'm wondering if you could talk about your efforts to get the SMBs and the micro SMBs online in India. What exactly is involved from a practical perspective? Do you need to have door-to-door sales folks? And what can you do to reduce friction between logistics payments and some of the other factors there? And second, what are these SMBs selling? Is it like long-tail inventory? Is it merchandise that you can get to exports to global buyer base? And do you think this could be content that could be exclusive to Amazon? + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [15] +-------------------------------------------------------------------------------- + + Yes. Stephen, this is Dave. Thanks for the question. As you said, and I think we mentioned this in the release, we're definitely continuing to improve the experience in India for customers and sellers. Excited by some of the response we've seen. We are continuing to invest meaningfully in digitizing those, say, MSMBs, micro, small and medium-sized businesses. We did pledge to invest $1 billion to help digitize traders and those micro and small businesses across India. And we've got a goal of bringing more than 10 million online by 2025. So this billion dollar investment will help to enable $10 billion in cumulative Indian exports by 2025. +A lot of different facets to those types of investments. I won't go into too much for specifics. But a lot of work being done there. We're also focused on job growth, job creation over there. Since we launched over in India in 2013, we've created over 700,000 direct and indirect jobs. So -- we also recently announced plans to create an additional 1 million jobs in India by 2025. So a lot of, I think, innovation, ideas, investment. That team over there continues to do a great job locally of taking a lot of the tenets that we've had at Amazon around innovation building and really run with that over there and done a great job of coming up with some interesting and new services and features that I think are specific to that region. And hopefully, as we continue to do that, we'll keep identifying areas over in India and tool sets and features over in India that we can bring back to other regions to help benefit other sellers and the other websites more broadly. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [17] +-------------------------------------------------------------------------------- + + I have 2. Just the first one, Brian, I think on one of the media interviews, you talked about how you're becoming more efficient with one-day and you continue -- with next-day delivery and continue to do so and talked about a billion dollars of cost in that current quarter. Maybe just sort of talk to us about some of the largest qualitative fix in variable cost sort of still associated with one-day and the processes and the opportunities for efficiency to really get that number down as we go throughout 2020. And then maybe any specific product categories or good categories where you've seen an acceleration in demand from one-day that you'd call out? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + Sure. Let me make sure the numbers are understood. We had talked about, last year, about an initial step-up in cost of close to $800 million in the second quarter. We -- that carried into Q3, slightly higher in Q3. And then in Q4, last time that we were on this call, I mentioned that we estimated Q4 would be $1.5 billion penalty. Was slightly under that despite the higher volumes and revenue growth than was in our guidance. +And looking ahead to Q1, we estimate approximately $1 billion of additional costs year-over-year. And again in Q2, we'll start to lap this. And that doesn't mean the delta goes to 0. It means that there'll be a step-up as we grow and expand on a volume basis, and then we'll see where our rates are on actually delivering and fulfilling one-day. So I will keep you posted on our results and guide in the future as to where we see those costs going. +If you look at the efficiency or the -- first, the cost, they generally fall into a few buckets. It's obviously transportation where you're building out new transportation modes, you're adding new deliveries. Partners are adding new routes. Many times, they start with subscale volumes, and you build them out, you get more efficient, you get more volume, more package density. And that creates efficiency. When we started this, again, Q2 of last year, we also had an abrupt change to our fulfillment network in that when it's tuned for two-day delivery on the most part and you move to one-day, in a lot of cases, it's advantageous from a cost and transportation standpoint to have that inventory closer to the customer. +So we've -- last year, we're in the middle of that transition. We still are as we shift inventory to be more local, it will enable local deliveries to hit shorter cutoff times. So that will continue to become more efficient. We do see a -- we will have to scale our fulfillment center network further. We grew the square footage for fulfillment and transportation by 15% each of the last 2 years. And we look ahead and see a step-up in that this year as we start to build more capacity for the one-day. I haven't guided beyond Q1, but that's certainly something that will step up. But we get efficiencies as we learn and grow and handle more one-day volume. +The third area is foregone ship revenue, just simply because we're having free shipment and no longer charging for it. That unfortunately doesn't leverage, but it -- we do start to lap it after a while. So I would say that just as we've had other shocks to our warehouse system over the years from going to -- from media to almost every product you can imagine to having a cycle of increased third-party presence in the FBA program now to one-day, we have a history here where we can look for opportunities to be more efficient and lower the -- any cost penalties as we move forward. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [20] +-------------------------------------------------------------------------------- + + Just to follow up on one-day shipping. You noted that you begin to lap the beginning of the initiative here in the second quarter, and that, naturally, costs can flow up with volumes. But just to be clear with you, is the idea here is we anniversary at that sort of incremental expansion of one-day shipping, either regionally or certain SKUs is functionally finished? I just want to make sure I understand that properly. And then just -- we can see the other number reported. Just any color within there on the advertising business. And in particular, would love to hear an update just a bit on some of your brand initiatives there. I know that probably wasn't the focus in the holiday season, but it seems to be an important growing part. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + Sure. Let me start on the one-day. So yes, we do see expansion of the one-day program as we move through the year. We've been expanding since we started this effort in Q2 of last year. Expansion means additional cities, additional routes, additional ZIP codes. But more -- I think what you'll see more in 2020 is also an -- more effort internationally, more costs internationally. We have greatly improved our selection of one-day in -- particularly in Europe and Japan. We started with higher one-day percentage of our shipments in those geographies, but we do have to take steps and are taking steps to increase that. And we expect that to be -- start to be a little more balanced cost globally as we move into 2020. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [22] +-------------------------------------------------------------------------------- + + Yes. Dan, in terms of your question around brands. We're focused on certainly brands as an advertising customer set and a lot of focus on providing the products and tools that are going to help customers and really inspire them. So things that we're really excited about, stores, so a brand can customize and curate a multipage store. It allows them to better tell customers who they are and share their story. So we can help deepen the brand engagement and the customer loyalty through that type of option. +Some other things like posts, which helps customers discover products and brands. And it's through a curated feed that features the brand's lifestyle content, and it's on a mobile detail page. And there's international expansion in some other areas. I think broadly, with advertising, so much of this is about having -- developing great relationships with these advertisers because I think they appreciate the fidelity we can provide around shopping outcomes. We're uniquely positioned to do this, given our retail business. +On the advertising business -- or rather, I should say, other revenue, that line item grew about 41% year-over-year. Advertising is the biggest piece of that. That line item is growing at about the same rate. Advertising revenue is, as a subset, been growing at about the same rate year-over-year in the fourth quarter than it did in the third quarter. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [24] +-------------------------------------------------------------------------------- + + Maybe a 2-part question on AWS, if I can. You called out the depreciation change with respect to AWS going forward. Just wanted to better understand some of the decisions that were made on useful life that drove that decision and how to think about that from a modeling perspective going forward. And then the second part would be, what does that mean in terms of the way you're thinking about forward CapEx cycles for the AWS business, if you're assuming useful life is moving out maybe than prior assumptions? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + Sure. Thanks for bringing that up. So we, as a practice, monitor and review the useful life of our depreciable assets on a regular basis to make sure that our financial statements reflect our best estimate of how long the assets are going to be used in operations. In Q4, and we've been looking at it in both the FCs, fulfillment centers, and also AWS annually. As we looked in Q4 of 2019, we believe it's -- there's enough trend now to show that the useful life is exceeding 4 years. We have been -- for our servers, and we had been depreciating them over 3 years. So we are going to start depreciating them on a 4-year basis. It doesn't unwind any depreciation that's already been booked. It just takes the asset from its current status and extends the depreciation period, and then new assets will be put into play -- will extend out for 4 years instead of 3, and we'll continue to revisit this. +I do want to point out it's not just an accounting-related change. It's rather a reflection of the work that we've done to make our server capacity last longer. We've been operating at scale for over 13 years in this business, and we continue to refine our software to run more efficiently on the hardware. It then lowers stress and extends the useful life both through the servers that we use in the AWS business and also the service that we use to support our own Amazon businesses. So -- and despite that, we give AWS customers and actually, because of this, AWS customers continue to get access to the latest technologies more quickly than ever before. +So we are essentially reflecting the fact that we have gotten better at extending the useful life here and now building that into our financials moving forward. Yes, you're right, it should also impact our need and our timing of capital. I would say that it's also been part of the reason that we've been able to keep capital relatively in check the last 2 years in the infrastructure area. But it's $800 -- excuse me, $800 million lower depreciation expense in the quarter, and it will be consistent. It will change quarter-to-quarter; we will update you. But as you can see in our financial statements, it's about $2.3 billion impact in 2020. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [26] +-------------------------------------------------------------------------------- + + Yes. And just kind of on the modeling point too, on that, the $800 million is in Q1. We do think that the -- for that accounting impact effectively, we expect that, that amount will decrease as we go through the year. And it's tech infrastructure assets. So it's -- I should say the servers are tech infrastructure assets. So when you think about segments, the majority of these relate to the AWS segment. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [28] +-------------------------------------------------------------------------------- + + Brian, I just want to ask a little bit more about the holiday season, given the beat on the top line and see if there's any way to quantify maybe the impact from the shortened holiday shopping season. I mean it doesn't seem like much, just given the better results in online sales and retail third-party seller services. But is there any way to think about the 6 less days? And then also, you mentioned last quarter an impact from the Japanese consumption tax. Any sort of impact? Did that go according to plan? Or any thoughts there would be helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + Yes. First of all, on the -- there were 2 items we discussed last quarter with the Japan consumption tax raising from 8% to 10% effective October 1. The net result was a pull forward of some purchases by Japanese customers into Q3 and also some negative elasticity effects post October 1. The other item was Diwali timing, the Indian holiday, which has a very large swing factor on international revenues, is it moved more into the third quarter this year versus -- in 2019 versus 2018. So it was a help to Q3 and a penalty to Q4. Those 2 items impacted the Q4 growth rate negatively by about 300 basis points. That was our estimate, and we believe that was the actual outcome. + +-------------------------------------------------------------------------------- +Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [30] +-------------------------------------------------------------------------------- + + On the international. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + On the international segment, excuse me, yes. The -- sorry, the first question was, oh, the holiday season. Yes. We don't see that as a factor actually. And I mentioned that last call as it wasn't incorporated into our guidance in a negative fashion. The way we look at it and the way we believe it works, at least in our business, is that customers will have a holiday budget, and they will spend it between generally the middle of November. It's creeping up to the early part of November through the holiday season. And we do see obviously spikes in Black Friday and Cyber Monday, and we also see relative tick-up in trends as we get closer to the holiday and before the shipping threshold cutoff. So there's a polarization of -- tends to be a polarization to early shipping -- or excuse me, early purchase and late purchases. +As far as the 6 days sort of time period between Thanksgiving and the Christmas holiday, we don't see an impact on that. Perhaps it's a bigger issue for stores and foot traffic, but we don't notice it in our business. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [33] +-------------------------------------------------------------------------------- + + I just want to shift gears to grocery. I know you added AmazonFresh into Prime, kind of removing the previous $14.99 a month component there and putting it into Prime, and you talked about the 2,000 U.S. cities and towns with 2-hour delivery. Can you just talk about what the early impact there is of bundling kind of Fresh into Prime at this point and then just how you're thinking about your grocery strategy as you're positioned now? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [34] +-------------------------------------------------------------------------------- + + Sure. Thanks for your question. So early results are good. We -- our grocery delivery orders from the combination of AmazonFresh and Whole Foods Market more than doubled in the fourth quarter year-over-year. So we believe customers are starting to notice and take advantage of this. We wanted to take -- we will see where people's tastes and preferences will take them. We are -- whether they go to the store, the Whole Foods Market store, whether they use Prime Now or Amazon delivery for their groceries. Right now, we're really just testing and reacting to the customer demand and the customers' preferences, and we'll do so for the foreseeable future. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our final question will come from the line of Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Then I'll throw off 3 quick ones. Just talk a little bit more about gross margins in the quarter. You had -- the year-over-year trend was negative last quarter, but it turned, reversed and was up this quarter. So if there are any unusual factors you'd want to call out there. Second, the -- I don't want to read over a lot into your guidance, but every year for the last 5 years, you've always guided to operating profit down sequentially, and then you maybe delivered better than that, but you always guided down. This year, your high end of your range is actually above what you obviously did in the fourth quarter. Are you just trying to remind people, tell people, educate people on how the mix shift in the business towards AWS and advertising is just changing the profit profile of the business? So any more color there. And then last one, since Sunday is coming up, I know you talked about the AWS customers, and you mentioned the Seattle Seahawks, but what about the 49ers? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- + + Good luck, 49ers. I'll get that out there first. Good luck, Kansas City Chiefs fans. We're indifferent. Let me start with your second one on -- sorry, the -- start with gross margin. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [38] +-------------------------------------------------------------------------------- + + Yes. So I don't think there's anything too surprising you caught there. I think we continue to see some good growth in the third-party business. You saw that accelerate some. We're continuing to see that trend of more FBA sellers signing and taking a larger percentage of the total 3P mix of units that are sold through, so that continues to do well. And as Brian mentioned earlier, we think some of that has to do with the program keeps getting better with faster shipping and whatnot. We've invested many billions of dollars in that program to make it even better for sellers. AWS had a strong quarter, of course, so that helps on the gross margin side as well. +And then on transportation, I think you saw the outbound shipping costs to grow around 43% year-over-year. So certainly up a good deal versus the trend line we saw in 2018. But of course, that's reflective of one-day and overall relative to our expectations. As Brian said, with the $1.5 billion we guided to, we came in a bit under that. So some of that was certainly part of some better-than-expected transportation efficiencies. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [39] +-------------------------------------------------------------------------------- + + And on the comment on seasonality of guidance and Q1, that -- I think the historic trend of peaking a bit in operating income in Q4 and then stepping down in Q1 has been broken up a little bit as we've had the balance of AWS and some other things. But if you actually look back to Q1 of last year, it was the highest operating income quarter on record, and that's one of the -- makes a difficult comp this year because we had the, if you remember, the slowdown in expenditures in 2018 in things like fixed -- adding of headcount, warehouse space, infrastructure costs, not to 0 but like down off of prior investment levels in 2016 and 2017. A lot of that continued -- that cost baseline continued into Q1 of 2019, and it actually was a super efficient quarter from a cost and profit standpoint. +Q2 of last year, we started to again make larger investments, particularly in one-day. And so that's now something that is lapping in Q1 of this year because we didn't really have one-day in Q1 of last year. But -- so I think there's -- it's hard to draw those parallels between quarters anymore. I will though mention the guidance that we do have the $800 million of lower depreciation from our extension of our server useful lives, which is part of the range that we gave you of $3 billion to $4.2 billion. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [40] +-------------------------------------------------------------------------------- + + Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon, and we look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/AMZN/2020-Jul-30-AMZN.txt b/Transcripts/AMZN/2020-Jul-30-AMZN.txt new file mode 100644 index 0000000000000000000000000000000000000000..c98923e9964a15ff511c1927f4295b9782d3f0dd --- /dev/null +++ b/Transcripts/AMZN/2020-Jul-30-AMZN.txt @@ -0,0 +1,345 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Amazon.com Inc Earnings Call +JULY 30, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + Amazon.com, Inc. - Director of IR + * David A. Zapolsky + Amazon.com, Inc. - Senior VP, General Counsel & Secretary + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Aaron Michael Kessler + Raymond James & Associates, Inc., Research Division - Senior Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Douglas Till Anmuth + JPMorgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2020 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. +For opening remarks, I will be turning the call over to Director of Investor Relations, David Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2020 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2019. +Our comments and responses to your questions reflect management's views as of today, July 30, 2020, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During the call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +This guidance also reflects our estimates to date regarding the impact of the COVID-19 pandemic on our operations, including those discussed in our filings with the SEC, and is highly dependent on numerous factors that we may not be able to predict or control, including: the duration and scope of the pandemic, including any recurrence; actions taken by governments, businesses and individuals in response to the pandemic; the impact of the pandemic on global and regional economies and economic activity, workforce staffing and productivity and our significant and continuing spending on employee safety measures; our ability to continue operations in affected areas; and consumer demand and spending patterns as well as the effects on suppliers, creditors and third-party sellers, all of which are uncertain. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +And now I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you for joining us today. I'd like to start by thanking and recognizing the contributions of hundreds of thousands of Amazon employees and delivery partners and hundreds of thousands of small and medium-sized businesses who are working hard to serve our customers all around the world in these uncertain times. +Amazon's second quarter was another highly unusual quarter. As I mentioned on our last earnings call, we began to see a significant increase in customer demand beginning in early March, and demand remained elevated throughout Q2. Strong early demand in groceries and consumable products continued into Q2, while demand increased during the quarter in our other major product categories like hardlines and softlines. +At the same time, we continue to focus on stepped up employee safety, particularly in our fulfillment and logistics operations, to help ensure the safety and well-being of our employees and partners. In Q2, we incurred more than $4 billion of COVID-related expenses, getting products to customers and keeping employees safe. The largest portion of these costs related to compensation for our frontline employees, including higher hourly wages through the end of May and a more than $500 million Thank You bonus in June. +We also experienced productivity headwinds in our facilities. This included changes to over 150 of our processes to provide for social distancing as well as costs to onboard and train over 175,000 new employees who are hired to meet the higher customer demand. This $4 billion also included investments in personal protective equipment for employees and enhanced cleaning for our facilities. +Our consolidated revenue and operating income significantly exceeded the top end of our guidance range. Strong top line performance was driven by increased consumer demand, led by Prime members. We continue to see high Prime member engagement throughout the quarter. Prime members shop more often with larger basket sizes. Worldwide streaming video hours doubled year-over-year driven largely by Prime video. We're reaching more customers with our grocery offerings. Online grocery sales tripled year-over-year. Existing Prime member renewal rates improved, and the Prime member growth rate accelerated both in the U.S. and worldwide. +Our 3P sellers, who are largely comprised of small and medium-sized businesses, also stepped up to help make more selection available for customers. And as a result, these small and medium-sized businesses have seen significant growth in their sales. +Our third-party seller services revenue grew faster than online stores revenue in Q2, with strong growth in both fulfillment by Amazon and merchant fulfilled or MFN seller sales. Third-party units continue to represent more than half of overall unit volume, helped by improved quarter-over-quarter growth in active sellers. +We are more committed than ever to supporting the success of the hundreds of thousands of small and medium-sized businesses to sell their products in Amazon stores. We were able to meet this heightened demand because we were also able to open up more fulfillment network capacity as the quarter progressed with faster delivery across more selection. +I'd point to a few capacity improvements that have allowed us to enhance throughput. First, our regular headcount grew 34% year-over-year as of the end of Q2 and continues to grow. We welcomed more than 175,000 new employees in March and April, many of whom were displaced from other jobs in the economy. As we've seen demand remain high, we are in the process of bringing 125,000 of these employees into regular full-time positions. +I would also note that Amazon has created more jobs over the last decade than any other company, and we are proud that we're continuing to create good jobs with industry-leading wages and great benefits during this challenging time. Our combined number of regular and seasonal employees is currently over 1 million. +We've also been able to expand the output in our existing facilities as we've had time to implement, learn and iterate on the new process paths we put in place. Additionally, as a reminder, Q2 is typically our lightest volume quarter for the retail business. That's not the case this year, but what that's meant is that we can flex into space normally used for second half peak demand. This led to strong operating leverage in Q2. As we move towards peak in the second half of the year, we will ramp up our space needs even further, and we'll be adding significant fulfillment center and transportation capacity in the second half of the year. +Turning to AWS. This is now a $43 billion annualized run rate business, up nearly $10 billion in run rate in the last 12 months. Customer usage remains strong, although growth varies across industries as a result of the COVID-19 crisis. +Lastly, I'll touch upon our Q3 guidance, which we provided as part of our earnings release. A few additional data points on this guidance. We expect to incur more than $2 billion in COVID-related expenses in Q3 to help keep employees safe, including continued investment in social distancing, PP&E and testing. Costs are expected to be lower than in Q2 primarily due to better cost efficiency at the high demand levels we are seeing. +In addition, I'll remind you that the third quarter is typically when we open the majority of our new fulfillment network capacity, and we expect the same this year. We continue to invest meaningfully, including $9.4 billion in CapEx and finance leases in Q2 alone, an increase of 65% year-over-year, primarily driven by investments in our fulfillment and logistics footprint. Once these buildings open, they are a headwind to profitability as they ramp up and we prepare for Q4 peak. +In 2019, we increased network square footage by approximately 15%. This year, we expect a meaningfully higher year-over-year square footage growth of approximately 50%. This includes strong growth in new fulfillment center space as well as sort centers and delivery stations. We expect the majority of this capacity to come online in late Q3 and into Q4. +Lastly, we plan to host Prime Day in Q4 this year rather than Q3 as it has been in prior years. The one exception is Amazon India, which will host Prime Day on August 6 and August 7. +In summary, we know that people are relying on online shopping more than ever during this unprecedented time, and we are working hard to add capacity to serve customers. We're extremely grateful to our employees across Amazon for continuously stepping up to meet the needs of customers. +With that, let's move on to Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe I could just dive in on the normalized trends you're seeing as you exit June and get into July. You made a push into essentials and deemphasized nonessentials, as we talked about in the last earnings call. Where are we in terms of the company getting the mix between essentials versus nonessentials right in terms of offering to customers? Where are you in terms of returning to normal on next-day and 2-day shipping initiatives to drive Prime? If there was any color on the state of affairs with either of those by geo or region of the world, that would be great. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure, Eric. Thanks for your question. So first, on the trend. So if you remember, we exited Q1 and spoke at the end of April. We had taken a lot of steps in March and April to, first, limit the incoming nonessential products into our warehouses, and then we reversed that or eliminated that decision in mid-April. +So we started to normalize on our channel mix. And I would say, as we moved into late April and early May, we expected that because a lot of the sellers can toggle between MFN or FBA sales that we would see MFN drop as FBA picked up. But to a large extent, MFN remained strong even as FBA picked up. So we had a very favorable mix, if you will, coming from March on. It started to normalize a little bit more to normal levels towards the end of the quarter, but MFN still remains high. +On the product side, a lot of what we saw in March and early April was sales of consumables and groceries and safety items. And we talked a lot about the fact that, that was coming at pretty much 0 cost -- or excuse me, 0 profit when you factored in the COVID-related costs. We've got better on our cost structure, and we also resumed a more normal mix in, I'd say, early part of May. +So since then, I would say it's getting closer to what we call a more normal mix. Demand is still super high. What we're seeing on -- it's driven by Prime members and Prime member engagement. They're shopping more often. They have larger basket sizes. There's still a heavy component of grocery -- online grocery sales tripled year-over-year in the quarter as we added capacity there. +So well, there's shifts in the mix based on what customers want. It's looking a little more normal, and it's staying at a very high level. On 1 day, we realize that our first priority is to keep our employees safe, and the second is focus on getting our capacity increased. Once we've done that, we are working very hard to get faster shipments. And we've seen the 1-day and 2-day recover through the quarter, but it's still probably considerably behind the going in rate before any of this happen. So we'll continue to work on that. But again, first priority is definitely keeping employees safe, and second is increasing our capacity. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Yes. And this is just David. I think just from a geographic perspective, Brian's opening comments there, a lot of these order trends and activity, you can see that both the North America and the International segment are growing well. So a lot of those kind of trends in category performances and first-party and third-party seller growth, whether it be merchant fulfilled or FBA sellers, we're seeing a lot of growth across the board, kind of similar-type broad trends when you think about the U.S. and North America as well as our international regions, in particular, our more established international regions. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question is from Mark Mahaney with RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [6] +-------------------------------------------------------------------------------- + + Okay. So 2, just a quick follow-up on Eric's question. Brian, when do you think you'll get back to par in terms of 1 day being 1 day? And then secondly, these profit levels are super high now. They're becoming super high at the company if you ex out the COVID costs. Is Jeff aware of how profitable the company is becoming? Is he happy about it? And I'm kind of being facetious, obviously, when I asked that. +But what I also want to ask really is when you think about new investment areas, and at the top of the list, maybe some new international launches are really building out some of the markets that you've -- like India, Brazil and Mexico or the business-to-business operations, like there's a ton of new investment areas, and it seems like the Amazon historically, and I'm sure it's the same now, would be using this kind of revenue surge and really investing aggressively in these new areas. So just talk about that. I know you've got spend on COVID, but as you think about the next 3 to 5 years, you've got these really profit surges. How can you deploy those? Or how do you want to deploy those into some of the newer investment areas? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure. Thanks for your questions, Mark. First, on when we get back to par, we don't know yet. We're getting progressively better, but we're also balancing what is going to be very stepped up demand and capacity in Q3 and Q4. So if you look at our historic run rates and can see how big a quarter Q2 was, Q2 was actually higher revenue than Q4 of last year, which is unheard of. And Q3 is now forecast to be also higher than Q4 of last year. +So we've kind of moved the peak forward, and for different reasons, we're trying to, mainly, like as I said, first priority is getting -- is making sure our employees are safe and that we continue to do social distancing and keep everybody safe and healthy. Second priority is getting capacity online because we do not have -- in Q2, we generally have lower revenue. And in Q2, like I mentioned, we were able to use the excess capacity that did exist to serve the higher demand. +Now as we move into Q3, we're starting to -- we need to build the inventory more for Q4, and we've run out of space. So we've got our hands full on that challenge, but we've got a really good team that's been working very hard probably since late February on this issue. +And when you talk about profitability, we'll also mention that there are a couple of expenses that have gone down in the interim. Marketing, we cut marketing probably by about 1/3 in Q2 as -- mainly because we're trying to manage demand. It started to normalize and get back to somewhat normal levels in -- at the end of Q2, but -- and therefore, we'll see a higher level in Q3. But certainly, marketing costs were lower. You probably saw it in a lot of companies. Travel expenses have almost drawn to a halt. Meeting costs, even medical costs in some examples or in some cases have been delayed as people don't go to the doctor or don't go there as quickly. We think that will normalize over time. +And as far as investments, we've got a lot of investments already in play. So I don't think it's a matter of necessarily accelerating investment or -- we're always looking for new investments that make sense to us. But during this time, I would say we've actually accelerated our ops investment. We pulled in capacity that we probably didn't think would be needed until 2021, maybe later. On grocery, we've also greatly expanded our grocery delivery capacity, and that's probably ahead of schedule. + +-------------------------------------------------------------------------------- +David A. Zapolsky, Amazon.com, Inc. - Senior VP, General Counsel & Secretary [8] +-------------------------------------------------------------------------------- + + Yes. This is Dave. Just to add to that, I think Prime is such a big focus, and some of the growth statements that Brian talked about at the opening of the call, whether it was strength in Prime membership and the acceleration we saw in the U.S. or worldwide or some of the usage stats like the grocery momentum or the doubling of video hours, for us, it's just another encouraging sign. We think there's still a lot more value we can add to that program. And that's not just in the United States where we've got sort of a broader set of services than some of the other regions, but really focusing on supporting in some of those other regions. And so we've got places like Australia, the Middle East. We've talked about India many times, but a lot of focus on building that out. +I think what's great about a place -- all geographies with a place like India is we're really focused on digitizing the Indian sellers. A lot of micro, small and medium-sized businesses there. We launched some new features there to help support the digitization efforts with some of those brands and just a lot of work, great work being done by that team. They have some goals there around getting more sellers on board and hiring many more people as well. So a lot of focus there. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- + + I have 2. The first one, Brian, is going back to the investments, and you're often making multiyear investments for customers and customer offerings, and you're the man behind the capital allocation plan. I guess I'd be curious to hear about can you give us some examples of areas of investment that may have been pushed out this year because of shelter in place and the higher demand that you've been seeing? So what were areas where you thought you were going to spend more at the start of the year than you actually have now in the current 2020 plan? +And then the second one, the international strength, I appreciate the color on Europe and Japan. Nice to see the profitability. Maybe just talk to us sort of qualitatively about some puts and takes around your core international markets, Europe and Japan? And how to think about whether or not they could be more or less profitable than the U.S. long term? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [11] +-------------------------------------------------------------------------------- + + Sure. I think you'll -- starting with that second one. You'll notice that the International segment was profitable this quarter, and that's a great sign. It is heavily driven by the pickup in demand that we saw, as I mentioned, I believe, in multiple calls. What's going on internationally is we have some very healthy established countries that we've been in a long time. And we have probably accelerated their adoption of Prime benefits. We've pushed video and devices and music and other things to those countries probably earlier in the life cycle than you would have seen in the U.S. So there's a bit of a forward investment on Prime benefits in many of those countries. +But what you also see are investments in new countries. Obviously, India is the biggest one, but also, to a lesser extent, the Middle East, Brazil, Turkey and Australia are recent addition. So there's always an element of expansion going on there. Advertising is growing, so that's a good source of profitability. But if you look at what happened in Q2, it was essentially just the much higher volumes than we had anticipated or had on a run rate. So our fixed costs were leveraged to the hilt. Obviously, we will add some capacity and things in transportation and fulfillment centers, but all other fixed costs were pretty much leveraged on that higher demand. The U.K. in particular, was very strong because there's probably more stay-at-home orders and the way the economy was developing in the U.K. We had a very, very strong quarter there. +So I would say that the surge in demand internationally also helped drive that profitable, maybe a little earlier than the trajectory would have shown. And I'm not sure that, that is going to continue for the next couple of quarters, but it's a good sign that we could leverage that. And a lot of the same trends in the U.S. were apparent internationally, higher Prime -- more frequent Prime purchases and higher basket sizes. So all good signs, and perhaps we got a glimpse of the future on the demand curve. +Your second question on slowing investments. The list is very short on what we've had to slow down. It's mostly -- it hasn't been done necessarily for cost reasons, it's been done for people reasons. The one I'd point to is studios. We've had to delay production. I think most studios have. And that's been augmented by some new things like our Amazon cinema where we're having first run movies. And so I think in this time, when people want entertainment, people are having trouble creating new content across the board. And that's a bit of a challenge, but it's not something we're doing intentionally. We're doing it to protect the actors and film crews, and we think that's the right decision. +As I said, a lot of the investments are being pulled in, especially on the upside and grocery delivery, same-store pickup. A number of whole food stores that you can pick up deliveries on tripled this quarter. So the list is short on things that we're slowing down on, I would say. It's just we're adapting and probably looking at whether some things have changed and creating some things for the new environment, especially in the entertainment area. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Doug Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JPMorgan Chase & Co, Research Division - MD [13] +-------------------------------------------------------------------------------- + + I have 2. Brian, first, just curious about your overall thoughts on how the e-commerce adoption curve has been shifted here over the next few years. And anything you can share around behavior for new and existing customers. And then separately, on AWS, the $43 billion run rate obviously slowed some in the quarter, but hoping you could comment just on the pace of IT decision-making in this environment, whether you're still impacted by some clients more highly exposed to challenged verticals? And due to those factors, is it possible that AWS can accelerate growth going forward? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [14] +-------------------------------------------------------------------------------- + + Yes. Let me start with that second one. Thanks, Doug. So in the AWS segment revenue, what we see are companies are working really hard right now to cut expenses, especially in the more challenged businesses like hospitality and travel but pretty much across the board. We're helping them. We're actively, with our sales force, looking for ways that we can help them save money. This includes things like scaling down the usage where it makes sense or benchmarking their workloads against our architectural best practices. So that's not going to help our usage growth in the short run, but it will help those customers save money. And we think that's the right thing to do, not only for their success and so they can come out of this at a better shape but also for the long-term health of our relationship with them as an AWS provider. +But we're also seeing a lot of companies that are really wishing that they had made more progress on the cloud because they're seeing how companies that are on the cloud can turn into a variable cost and either scale up or scale down depending on their particular situation. They realize their on-premise infrastructure is not really flexible to go up or down. And especially in the time of sinking demand, it's a big fixed cost for them. So we expect -- we're seeing migration plans accelerate. They're certainly not going to happen overnight, but we see companies moving more in that direction. We think that will be a good long-term trend. And there's certainly winners in this area right now, things like video conferencing, gaming, remote learning and entertainment. All are seeing usage growth. And it's a bifurcated world out there. +So the -- on your e-commerce adoption, I think it's hard to tell. We're super encouraged by the fact that grocery delivery has picked up, and that's been accelerated versus what we would have thought. We certainly are glad to be there for our Prime members who are shopping more frequently and buying more. We do know that there's reasons that there are other options are limited. I mean there are always retail options out there, especially to go pick up in store, but less people want to go into stores perhaps now. So we're going to have to see what is maybe a step-up in the curve and getting to a point quicker versus what are some onetime sales and things like -- hopefully, things like masks and gloves and cleaning supplies in the fullness of time become onetime purchases, but we'll see. +And sorry, your last point was on new customers versus existing customers. We're seeing similar trends. We're seeing good pickup in frequency and basket size for new members in Prime as well, certainly not the same as people have been Prime members for a number of years. But it's encouraging. And as you saw, Prime growth retention has increased. We've accelerated the number of -- the growth of Prime members, both in the U.S. and internationally. So that's a good sign that we're happy about. And we hope that, that has long-term ramifications. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [16] +-------------------------------------------------------------------------------- + + Yes. Just a follow-up to that last comment. So the Prime behavior for international Prime members, you guys have talked about how like in the 16, 17 countries, the overall service levels are a little bit behind, selection is a little bit behind. So has the last few months in the pandemic closed that gap meaningfully in terms of GMV per Prime member for international versus what you see in the U.S.? Any comment there? +And then on the 3Q guidance, you pushed Prime day for western markets into 4Q. So how much of the deceleration -- it's obviously a really strong number for 3Q, but the growth rate is decelerating a little bit. Is that mostly from Prime Day? Or can you just talk about what kind of behaviors you're seeing right now as you go into 3Q? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + Right. Well, we ramped up through the quarter in Q2 and ended up with 41% year-over-year growth in FX-neutral -- on an FX-neutral basis. A lot of those trends are continuing into Q3. You see our revenue range is $87 billion to $93 billion coming off of $89 billion quarter. So I would say that the -- if you look at the growth rate, that translates into somewhere in the 24% to 33% growth rate in Q3. So I can't break out exactly the Prime impact because there's -- but suffice to say, it's a big driver on why 41% growth in Q2 turns into 24% to 33% growth in Q3 on what turns out to be higher revenue volume. +And then on Prime behavior, it's -- I can't really give you more on that because it is actually a very localized set of staff by country. In international, aggregate does not matter that much. And what I would say is, generally, what we're seeing is similar trends in international in response to COVID purchasing patterns. I wouldn't say it closed the gap. I said -- I would say they both went up. And we'll see how it goes from there. I think there's definitely any differences in selection or differences in shipping. There's a myriad of factors that go into a Prime member's decision to be a Prime member and to what they buy and what they use as far as our benefits that we give them. So I don't want to make too many sweeping comments on that right now. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [19] +-------------------------------------------------------------------------------- + + I was curious if you could just expand on AWS. There was a little bit of a slowdown across the board and a number of the cloud numbers. I'm just curious if there's a common trend that you're seeing there. And perhaps just talk about the backlog. I know you've disclosed the backlog has been improving in the filings, but a little more color on AWS would be certainly helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, sure. I'll give you the backlog number. It grew 65% year-over-year and 21% quarter-over-quarter. So that's healthy, and we have the average contract length is over 3 years for our AWS contracts. +I would say contract volume and negotiations are strong and have maintained through this period. So it is -- that's a good sign. It really does boil down to short-term versus long-term incentives here for a lot of our customers. They're -- if you're in an industry that's been heavily impacted by COVID in the economy, you're looking for ways to save money and you're trying to do a click and we're trying to help in that regard. And one of the best ways to save money long term is to use the cloud, not only to turn it into a variable cost, it could be a fixed cost, but also to be able to take advantage of the partner network that we have, the security that we have and also the constant evolution of products and services that we bring to market. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Kessler with Raymond James. + +-------------------------------------------------------------------------------- +Aaron Michael Kessler, Raymond James & Associates, Inc., Research Division - Senior Internet Analyst [22] +-------------------------------------------------------------------------------- + + Great. A couple of questions. First, maybe just one of your competitors noted that growth was slowing in some markets that have opened up, I guess, probably more in Europe. Maybe just thoughts there. Are you seeing any changes in sort of the markets that are starting to open up? And just any commentary on the Zoox acquisition, how you kind of -- can use that technology longer term as well? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + I imagine you mean on consumer business, countries opening up. + +-------------------------------------------------------------------------------- +Aaron Michael Kessler, Raymond James & Associates, Inc., Research Division - Senior Internet Analyst [24] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + Yes. Well, we still see strong demand. So I don't have any particular color on that regard by country. We do think probably the U.K. was very -- grew very strongly in Q2, and that, I believe, is starting to moderate a bit but still stronger than normal. So I don't want to go by country, but I think those trends will start to perhaps become evident. But the -- from our vantage point, the Prime members still continue to order more frequently and in larger basket sizes. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [26] +-------------------------------------------------------------------------------- + + Yes. And then, Aaron, just on your second question on Zoox, I mean, it's -- there's not too much to say at this point. It's still pretty early, but I think it probably goes without saying it's a tremendously forward-thinking team, which resonates with us. And they really do kind of pioneer in that space, the ride-hailing space. +So a lot of cool work they're doing, designing autonomous vehicles and focused on the passenger, right, in front of mind in that. So I think, again, just as we think about kind of the innovation components and commitments to solving kind of problems and challenges for customers, it's pretty exciting for us to be able to work with them and bring that vision to fruition in the years ahead. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our final question comes from Justin Post with Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [28] +-------------------------------------------------------------------------------- + + Great. A couple of questions. Obviously, a great cost quarter on the leverage side. Any changes in e-commerce gross margins to call out? Is scale and getting size, improving gross margins or anything on the mix shift there that's interesting? +And then secondly, we talked about a lot about 1 day investment last year. Obviously, the shipping times were impacted by COVID, but are you back to kind of normal times? And where are you on the 1 day investment? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + Sure. On 1 day, again, we're first prioritizing employee safety. We have a lot of effort in that regard. We've changed over 150 process paths. We've instituted social distancing, cleaning, temperature taking, both with our warehouse employees and also our transportation employees. So that's really still priority one. +And second is capacity expansion, especially as we head into the second half of the year, which generally sees a step-up in volume even over the first half of the year. So we will -- we are improving the percentage of 1 day. We're not back to where we were pre-COVID. We don't think we're going to be back in the short run, but we will continue to improve it. And hopefully, it'll be less noticeable for our consumer base. +On the gross margin side, it's very much a mixed bag right now. There's -- before the COVID outbreak, the positives were generally AMZL costs -- delivery costs were becoming more efficient. Advertising was -- and AWS were certainly a strong component of gross margin increases. Product mix could go either way depending on the country. But as this COVID has played out, consumables and grocery, which are lower margin, have started to -- have been a negative impact on gross margin. But the -- we feel good about where we are. Gross margin for the quarter was 40.8% and was down 200 basis points from last year. It's probably more tied to the addition of 1-day shipping. And even if we didn't do as much 1-day shipping as we've been doing post-COVID, the costs of 1-day shipping are already built into our structure. We've already reconfigured our network. We've already created the capacity to be able to ship. It's just a matter of whether or not we can get it out through the warehouse and to you in 1 day or not. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com, Inc. - Director of IR [30] +-------------------------------------------------------------------------------- + + Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2016-Apr-20-ASML.txt b/Transcripts/ASML/2016-Apr-20-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..dd89cd2a7911b9641dfc0df82bbcac4fa865ec74 --- /dev/null +++ b/Transcripts/ASML/2016-Apr-20-ASML.txt @@ -0,0 +1,796 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 ASML Holding NV Earnings Call +APRIL 20, 2016 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Wolfgang Nickl + ASML Holding NV - EVP & CFO + * Craig DeYoung + ASML Holding NV - VP, IR + * Peter Wennink + ASML Holding NV - President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + Susquehanna - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + * Jagadish Iyer + Redstone - Analyst + * Douglas Smith + Agency Partners - Analyst + * Gareth Jenkins + UBS - Analyst + * Francois Meunier + Morgan Stanley - Analyst + * Andrew Gardiner + Barclays - Analyst + * Amit Harchandani + Citigroup - Analyst + * CJ Muse + Evercore ISI - Analyst + * Sandeep Deshpande + JPMorgan - Analyst + * Farhan Ahmad + Credit Suisse - Analyst + * Kai Korschelt + BofA Merrill Lynch - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2016 First Quarter Financial Results Conference Call on April 20, 2016. Throughout today's introduction, all participants will be in a listen-only mode. After ASML introduction there will be an opportunity to ask questions. (Operator Instructions) +I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from our headquarters here in Veldhoven, the Netherlands is ASML's CEO Peter Wennink, and our CFO Wolfgang Nickl. The subject of today's call is ASML's first quarter 2016 results. +Just as a reminder, for this call and for subsequent calls the Q&A queue starts with the operator's instructions at the opening of the call and not before then, just FYI. And as mentioned, questions will be taken in the order that they are received. +There's another reminder, the length of the call will be 60 minutes. This call is also being broadcast live over the Internet at www.asml.com, and a replay of the call will be available on our website. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meanings of the Federal Securities Laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Safe Harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's Annual Report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. Peter? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Craig. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our first quarter 2016 results conference call. +Before we begin the question-and-answer session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter and provide you our view of the coming quarters. +Wolfgang will start with a review of the first quarter financial performance with some added comments on our short-term outlook, and I will complete the introduction with some further comments on the current general business environment and on our future business outlook. Wolfgang? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you Peter and welcome everyone. For Q1, our net sales came in at EUR1.33 billion. This included system sales of EUR856 million, of which memory represented 42% with logic representing 58%. Service and field option sales came in at EUR477 million. +Our gross margin for the quarter came in at 42.6%, slightly above our guidance. R&D expenses came in at EUR275 million and SG&A expenses came in at EUR89 million, essentially as guided. +Regarding the order book, Q1 system bookings came in at EUR835 million. As this level is 30% below our prior quarter bookings. I would guess that some listeners might find this confusing relative to our guidance, which includes a 30% increase in Q2 revenues. +I'd like to remind you that we are not an order-driven company and that the order patterning varies from customer to customer. Therefore, our bookings are not always a real indication of our near-term business opportunity. +However, you can clearly see that our Q1 bookings have changed the complexion of our backlog in a way that supports our Q2 guide of growing strength in logic and flattening in memory. +I can also tell you that we expect strong logic bookings in Q2. Just as a further reference in this regard, I would like to draw your attention to our consolidated statement of operations found on slide 21 of our Q1 2016 results presentation, where you can see the lumpy nature of our bookings over the last five quarters as well. +Turning to the balance sheet, quarter-over-quarter, cash, cash equivalents and short-term investments came in at EUR3.14 billion. Our free cash flow for the quarter was negative EUR65 million. This was expected, since we received a significant amount of customer prepayments on orders received in Q4, where free cash flow totaled EUR864 million. We expect free cash flow to return to a more normal level in Q2. +Year-to-date through April 3, we repurchased 2.7 million shares for EUR223 million as part of our newly announced EUR1.5 billion share buyback program for 2016 and 2017 combined. +With that, I would like to turn to our expectations and guidance for the second quarter of 2016. We expect Q2 total revenue of approximately EUR1.7 billion. +Due to recent demand forecast increases, we now expect continued stable memory shipments for the rest of this calendar year. Memory shipments for the second half of the year should be roughly equal to shipments for the first half of the year. +Logic shipments in Q1 were primarily for the 28 nanometer node. We expect some level of continued capacity adds throughout the year at this node, but as mentioned last quarter, we expect a strong pickup of total logic shipments in Q2 in support of 10 nanometer production ramps. +Our current view of combined logic indicates that the second half of the year will be greater than the first half of the year, the extent being determined by ultimate 10 nanometer ramp levels in 2016. +Last quarter, service and field option sales came in at EUR477 million and is anticipated to grow throughout the year. We continue to plan on a year-over-year increase of approximately 10% in 2016. +This part of our business' growth continues to be driven by strong demand for holistic lithography options, high value upgrades and a growing installed base. +Gross margin for Q2 is expected to come in around 42%. Gross margin will be significantly influenced by revenue recognition of two EUV systems in the quarter. Our second quarter net sales guidance includes about EUR110 million for EUV. +As previously stated, we can only recognize part of the system revenue but must recognize the full cost. This along with an initial low profitability on EUV will cause a negative impact of approximately 5 percentage points on the gross margin for Q2, which is included in our guidance. +R&D expenses for the second quarter will be about EUR270 million and SG&A is expected to come in at about EUR90 million, both roughly at the same levels as the previous quarter. +Peter will talk more about the status of our EUV program, but I would like to mention that we completed the shipment of one EUV system in Q1. This shipment will lead to revenue in 2017. We expect to ship one additional system in Q2. +And finally, at our upcoming Annual General Meeting of Shareholders on April 29, shareholders will vote on our proposal to increase our dividend by 50% to a level of EUR1.05 per ordinary share. We fully expect that this proposal will be supported by our shareholders. +With that I'd like to turn the call back over to you Peter. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. As Wolfgang highlighted, our first quarter results were very much in line with expectations and our business is developing along the lines that we communicated over the last two quarters. +While Wolfgang gave a qualitative outlook for 2016, with combined memory appearing flattish, half over half, with combined logic up in H2 over H1, and with combined services up half over half as well, we do see trends and developments that we believe are worthwhile mentioning. +First one, despite a difficult pricing environment in DRAM, our forecast has further strengthened a bit in support of a continued drive by our customers to keep shrinking cost, and specifically for low 20 nanometer, and sub 20 nanometer nodes. This has resulted in our current flattish half over half sales view for our combined memory business. +For 3D NAND, shipments continue to new fabs and to fabs preparing for 2D to 3D conversions. Of course, we are watching with interest the developments in the volume introduction of the cross-point architecture, as we will become quite litho-intensive in time versus the 3D NAND architecture. +Secondly, as mentioned in previous earnings calls and evidenced by our backlog, it is clear that our sales to our combined logic customers will become more important starting in the second quarter. +This will continue as we are expecting a continued increase in logic orders in the coming quarter, in support of initial 10 nanometer node ramps. And as a result, we now forecast the significant increase in combined system and service, and field option sales in Q2 to be at the level of EUR1.7 billion. +Also of note in the first quarter, we saw shipments for 28-nanometer logic capacity additions continue. I would like to make an observation here regarding logic node ramp behavior. +Looking at the ramp speed, size and length of the latest, most advanced nodes, it appears to us that the rollout pattern of such nodes is changing. +Previously node transitions followed each other in a rather predictable pattern throughout our entire logic customer base, whereby new nodes ramp quickly, in turn ending the capacity ramp of the previous nodes concurrently. +What we see today, effectively starting with the 28-nanometer node, is that the initial new node ramp is done by a very limited number of customers, but with greater intensity, meaning speed and initial size of the ramp. +Then the rest of the node ramp is executed over a prolonged period, whereby the rest of the logic customer base follows the initial customers in phases. +Current evidence of this trend is the aforementioned continued shipments for [20]-nanometer logic capacity additions. This still continuing, more than four years after the initial introduction. +In discussions with our logic customers, we see similar capacity expansion behavior over time for future nodes. With litho intensity rising significantly node by node, initial node transitions are lengthening two, three years with the aforementioned longer tail and of previous nodes. +This will likely make shipment and order patterns for a specific node, as well as the ultimate wafer capacities less transparent over time. However, based on the inputs from industry analysts' forecasts of end-market developments, we believe that our long-term assumption of a 10% node on node reduction of the ultimate installed wafer capacity is still appropriate. +As you all know, this was one of the pillars underlying the simulation leading to our EUR10 billion sales target by 2020. +As for 10-nanometer node, its introduction is clearly progressing. The speed and initial size of this ramp can be explained by the value proposition provided by the significant shrink of these nodes versus the prior node. +The ultimate spend levels for logic in 2016 will depend on, amongst other things, both the level of end demand and the rate at which our customers will be able to execute their ramps. This is why it is still a bit too early to predict the overall 2016 spend levels today. +For field options and services, we see continued strength in 2016 and this should show growth as previously estimated in the range of 10% over 2015. On the ASML product side, we continue to focus R&D spend on lithography products that are essential to the ramp of our current and advanced processes. +In deep UV, addressing the growing litho challenges of complex and lithography-intense multi-pass patterning, our recently launched TWINSCAN NXT:1980 with significant improvements in all key performance metrics, has rapidly reached productivity of more than 4,000 wafers per day, demonstrating the maturity of our latest NXT platform. +In holistic lithography, we started rolling out our YieldStar 350, Integrated Metrology System. YieldStar enables highly accurate metrology for subsequent analysis in ASML's holistic lithography software products, which allows customers to control leading edge production processes for increased yield. +Holistic lithography products are now extending into EUV processes with customers evaluating our EUV source mask optimization software for development of 7 nanometer and 5 nanometer logic technologies. +In EUV, you are all aware that our continued focus has been on improving EUV stability, availability and productivity, the key performance metrics that drive new technology adoption. Expect no changes in this focus for the foreseeable future. +In the past three months, we again demonstrated improved productivity and availability, moving EUV towards manufacturing readiness. By way of example, we achieved productivity of more than 1,350 wafers per day in our factory on an NXE:3350, bringing us closer to our 1,500 wafer per day target for 2016. +Separately, three customers showed availability of more than 80% on average for four weeks on the NXE:3300s. In addition, industry-leading customers presented an abundance of EUV results at the SPIE Advanced Lithography Conference this past quarter that reinforce the need for EUV and demonstrated real and significant progress in key two performance areas, making increased customer confidence in EUV for manufacturing insertion apparent. +ASML's commitment remains to do everything within our capability and power to bring EUV to manufacturing readiness. +Now, with that, we would be happy to take your questions. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR [6] +-------------------------------------------------------------------------------- + + Thank you, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A. But beforehand, as I always do, I would like to kindly ask you to limit yourself to one question and one short follow-up if necessary. And, of course, this will allow us to get as many callers on to the call or questions on the call as possible. +Now, operator, could we have your instructions and then the first question please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Francois Meunier, Morgan Stanley. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Yes, I think you're making some comments about customers making improvement in terms of availability, which is the key metric for EUV this year. I was wondering is there anyone making, you know, like a pure DRAM maker in those three customers improving the availability? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [3] +-------------------------------------------------------------------------------- + + There is not a pure memory maker, these are customers that are either doing both memory and logic, or they are focused on logic. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + So actually when in the video, you talk about your customers ramping EUV from the end of 2018 in terms of production up to 2020, it is for logic and memory, not just for logic? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [5] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Farhan Ahmad, Credit Suisse. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [7] +-------------------------------------------------------------------------------- + + My first question is on EUV. There was good progress demonstrated at the SPIE Conference and all the companies appear to be working on it. +In terms of the work that you're doing with your customers, can you talk about how many layers of adoption do you expect at the 7-nanometer node and also on memory? How should we think about the number of layers progressing for different nodes? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [8] +-------------------------------------------------------------------------------- + + The most relevant information in that sense we have on the node that's upcoming first, and that's a 7-nanometer node. The 7-nanometer nodes for logic, that is the 7-nanometer node, not the 7-nanometer node that you need to look at in conjunction with 10, so that is what we call 7 or 5, that can be anywhere between 8 and 12 layers. It depends on the customer. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [9] +-------------------------------------------------------------------------------- + + And then the second question I have is in terms of your memory shipments. Previously, if I remember correctly, you had indicated that first half shipments would be roughly flat from second half of last year. +If I take your first quarter shipment level and I assume that second quarter is flat, maybe down a little bit, it appears the first half of the year is down about 20% from second half of last year and then it's going to remain at about that level for rest of the year. +Is that a reasonable assumption on how I'm looking at the memory shipments, and also if you could clarify if there were any pushouts on the memory that led to the somewhat change in the linearity? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [10] +-------------------------------------------------------------------------------- + + Farhan, it's Wolfgang here. You are correct, the first half is going to be a little bit lower than the second half of last year, but then the second half of this year is higher than we originally expected. So, overall, there's always like a push and pull, but overall, it's actually slightly higher than we thought about last call and also on the call before that. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna - Analyst [12] +-------------------------------------------------------------------------------- + + Peter, can you please remind us when we are going to learn more about the 3350s that are being installed at the customer site and what do we need to see or track for milestone, to better assess the timing of EUV insertion for 7-nanometer logic? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [13] +-------------------------------------------------------------------------------- + + Yes. The 3350s, we started shipping 3350s two in the fourth quarter of last year, one in this quarter. It takes about six months to install and to qualify the processor. +So far in this quarter, the second quarter, you will see the first tools released, which actually drives the partial revenue recognition that we just guided. +So when that is done, then customers start preparing their integration wafers and then basically running them in what we call marathon tests of sometimes months, sometimes quarters. We've actually done some marathon tests with one of our customers on the 3300, by the way, which involved 13 weeks, so that's one quarter. +Now, this will then start in Q2, so somewhere in Q3 we will see the first results. And the results will be focusing on the metrics that we just talked about. It's productivity, availability; that's what they will be looking at. +And we expect that customers will repeat what we have seen in our own factory, simply because we have the 3350 there since the second half of last year. We've done internal tests also. +So what you need do track is really data coming out of the customers and we will support you also with that by the time those marathon tests have been run at the customers, then we will give you the data. (multiple speakers) + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna - Analyst [14] +-------------------------------------------------------------------------------- + + And having the 1,500 throughput target? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [15] +-------------------------------------------------------------------------------- + + Yes. I think that's the throughput target that we want to see in a marathon test, and at least to see the capability of that tool. Marathon tests for a customer could be focusing at different productivity levels, but we would like to see in the installed base the capability [shown] several times that we can do 1,500 wafers per day by the end of the year. +Don't forget that customers don't run 1,500 wafers per day at the current level of the N7 rollout. I mean, they don't have 1,500 wafers per day for 13 weeks. So it's the capability that we need to show on a regular basis, plus the agreed upon results out of marathon tests regarding availability and productivity. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna - Analyst [16] +-------------------------------------------------------------------------------- + + And just one clarification for Wolfgang. I think in your prepared remarks you said logic bookings will be up in Q2, but you didn't mention in memory. Were you referring to booking, and if so, any qualitative assessment on memory booking into Q2? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [17] +-------------------------------------------------------------------------------- + + Yes, if you look at our total backlog, you see about a quarter is in memory. On a total of [EUR3 billion] that makes like [EUR750 million] and with what we shipped already and with our expectations with two equal halves, we will get some more bookings. +So there will be memory bookings in Q2 as well, but you will see again the bookings weight towards logic, because the 10 nanometer ramp is continuing strongly in Q3. So you'll see both there. But overall, you will see strong bookings for the second quarter maybe. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Timothy Arcuri, Cowen and Company. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [19] +-------------------------------------------------------------------------------- + + I had two. I guess, first of all, Wolfgang I had a question about the customer co-investment program. And what happens when the program ends at the end of next year and sort of how to think about your development burden? Does the overall R&D spend decline after the end of next year or does your portion of that burden go up? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, first of all, yes, the CCIP is about EUR1.4 billion over five years, and those contributions will end. As you may recall, there is a portion of that recorded through the gross margin, there is a portion in other income and there's actually a portion that goes straight to the balance sheet. +So [non-operated] actually is recorded in R&D. Your expectation should be that we're currently running at the [EUR1.1 billion] level, we're pretty stable on that and I would expect that it stays at that level as we continue to invest in EUV, but then also on what prolongs EUV [INA], holistic lithography. +So, for planning purposes I would just keep it at that level and just to be safe, in our EUR10 billion model by 2020, we have modeled 13% that would give us some room to grow and invest here, but for now, I would just keep it flattish at the [EUR1.1 billion], Tim. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [21] +-------------------------------------------------------------------------------- + + But even though you are being reimbursed through other means, if the development spending isn't going to change if you're not getting reimbursed any more, then your burden basically goes up. Is that right? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [22] +-------------------------------------------------------------------------------- + + That's right. I mean, we get co-investment and for that co-investment we meet our co-investors, also shareholders, and when that period is over, of the co-investment payments we're getting in, we have to decide by ourselves whether we keep the investment levels and we look at our future business plan and feel it's justified to keep it at that level. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [23] +-------------------------------------------------------------------------------- + + And don't forget, Tim, that the co-investment program was designed to be kind of a bridge R&D support until we started shipping EUV. By 2018, you will see the ramp of EUV starting, which also has an impact on the topline and will have an impact on the gross margin. So by that time, we should be able to stand on our own feet. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [24] +-------------------------------------------------------------------------------- + + And then as my second question, do you still plan to ship six to seven EUV systems this year? I think you said six to seven, is that still the plan for the full year? Thanks. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [25] +-------------------------------------------------------------------------------- + + Yes. That is still the plan. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [27] +-------------------------------------------------------------------------------- + + My first question is on the short term. I mean, you are talking about this flattish memory trend into the second half, which is not what you were saying earlier. Clearly things look better than before, Wolfgang. +So can you talk about where you are seeing these positive trends in the memory market into the second half of the year, given the difficult memory environment at this point? And I have a few small follow-up. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [28] +-------------------------------------------------------------------------------- + + I'll start and I'll let Peter chime in. But, first of all, it is not one customer. I mean, we see forecast at multiple customers. It's also supporting like in DRAM, the new nodes, 80-nanometer nodes to start initial production on that. +And then we also see in NAND, continued investments in China with new 3D factories in Singapore and in Japan. So it's not one customer, it's pretty much every customer. It's not like we see overall the same memory levels that we have last year. +So, memory overall will still be down quite a bit year-over-year, but it came out a little bit better than we expected versus the last two calls. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [29] +-------------------------------------------------------------------------------- + + Following on from that, when you look at the third quarter, when you talked to us in January and you had indicated EUR1.3 billion in the first quarter, you had indicated that you would see this significant ramp of revenues into the second quarter. +How do you see the third quarter and fourth quarter developing at this point in terms of revenue, from the second quarter levels? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [30] +-------------------------------------------------------------------------------- + + You got to just add up the bits and pieces. I mean in logic, we were pretty clear, in both mine and Peter's remarks, logic will be higher in the second half than in the first half. +The ramp is not a one quarter affair. Q3 is pretty strong, Q4 it remains to be seen just how our customers tape out with their customers and what the yields are and so forth. Memory is stable. +And then you see field options and services, which I haven't talked about that yet. We had a modest start into the year, but every quarter now should be better than the prior quarter and that will lead us to a 10% increase also year-over-year. So it's also quite a bit better in the second half than the first half. +So it's relatively safe to assume that the second half is going to be stronger than the first half of the year. +Now, as you know, we guide only if we've clarity and certainty. And you also know one of these systems is [EUR50 million] and it can go left or right in a quarter, so that's why we rather not do a quantitative guide right now. But we are looking pretty good for the year and now also for Q3. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Jagadish Iyer. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone - Analyst [32] +-------------------------------------------------------------------------------- + + Two questions, Peter. First, one of the things if I look at it, why did your services revenue go down disproportionately when your immersion sales went up quarter-over-quarter in the first -- in Q1? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [33] +-------------------------------------------------------------------------------- + + Yes. I can take this. This is Wolfgang. A little bit -- something that we got to consider over time. We actually call this field option and services that [477] bundle. +What you see is that -- and we got to quite frankly consider in the future whether we report on this slightly different. The service portion, which is dependent on certain projects like relocations, but mainly on the installed base is a relatively stable slowly growing number. +What brings the volatility into the combined installed base-related revenue are the field options and services, and those include everything from a software option to very, very complex SNEP upgrades that can go into the [EUR20 million] or so, even higher than that. +And those vary quarter-by-quarter. You have seen the exact same thing last year, by the way. Our Q1 in last year was also -- it was just a tad over [EUR400 million], we were up 20% year-over-year. +So the service portion is pretty stable. And then the options -- the field options is the one that brings a little bit volatility in it. But in summary, we look at our forecasts and we are very confident that we grow the number year-over-year by about 10% or so. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone - Analyst [34] +-------------------------------------------------------------------------------- + + This is a follow-up question. Given how your gross margin is going to be impacted because of the two EUV tools in Q2, and if bulk of the EUV revenue recognition happens next year, what kind of gross margin levels should we be thinking about broadly, as we look at in terms of your partial revenue recognition of the six or seven tools that you shipped this year? Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [35] +-------------------------------------------------------------------------------- + + First of all, I mean, the Q2 dilutive effect from EUV are probably the only dilution effect on gross margin that I like, because it means we're actually shipping the products and the customers are accepting the products. +And you're right, I mean, the consequence of what we said is if we have quarters now where we have partial revenue and full cost, we will have in the future quarters where we have partial revenue and no cost. So, it will be accretive to a level in a future quarter. +It's very difficult for us, because it depends on various things and it varies customer by customer. It's very difficult for us to pinpoint that and therefore would rather don't give you numbers, but directionally, it will be accretive in the future, of course. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + (Inaudible). + +-------------------------------------------------------------------------------- +CJ Muse, Evercore ISI - Analyst [37] +-------------------------------------------------------------------------------- + + CJ Muse with Evercore ISI. I guess first question, now that you have pretty decent visibility into the 10-nanometer ramp, curious how you're thinking about litho intensity relative to [2016, 2014]? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [38] +-------------------------------------------------------------------------------- + + Yes, I think 10-nanometer, looking at [10-nanometer] versus 2016 we think about -- anywhere between 30% and 40% litho intensity. So take an average of 35%. + +-------------------------------------------------------------------------------- +CJ Muse, Evercore ISI - Analyst [39] +-------------------------------------------------------------------------------- + + And I guess as a follow-up here, it sounds like not only a 10-nanometer ramp, but also a nice follow through of [2016, 2014] spend. And if we -- I believe, exited last year with about 250,000 wafer starts, of equipment shipped, plus what you're expecting here, as well as the EDA guys talking about tape-outs of [250, 300] to date. +I'm curious that down 10% node to node that you are talking about, is that something that you actually see in [2016, 2014] or does that start at 10, in your view, given the robust tape-outs to date at the [16, 14] level? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [40] +-------------------------------------------------------------------------------- + + Well, you actually start in our simulation, in our estimates, it starts at 2016. But like I said in the early comments that we made is that as of 28-nanometer, we see this pattern of this prolonged node in our -- 24% of our system sales in the first quarter was 28-nanometer, which is of course more than four years after its initial introduction is a significant amount of units going to a relatively mature node. +When we look at the comments customer currently make about the 20 and the 60-nanometer node intensity rising, we expect the same thing. When we look at a 10-nanometer node, we see the initial ramp being relatively speedy by only a very few customers and that also means that when we talk to the other logic customers, they have plans of going to 10-nanometer is a couple of years down the road. So, the same pattern that we've seen at 28 is going to repeat itself. +Now when we look at the industry analyst reports and we take couple of analyst reports of -- and you know the analyst firms, Gartner (inaudible) Research and those. And we look at what their current expectation is of the end markets that we currently know, and it's all the products that we currently know, like PCs and the tablets and the servers, and the automotive, and there's nothing new in there, like IoT, because nobody knows what that is. +So let's take what we know and we look at the conservative estimates and the changed estimates based on the most current insight [in terms of] the PC market, we can calculate the number of bits, or the bit growth going forward. +And the bit growth we can then translate, looking at the roadmap of our customers into square inches wafers that need to be processed. We add it all up and we look at the forecast, we just come to a number that is for those nodes, is about a 10% node on node, no reduction. It's based on what we currently know and it's based on what we currently see, it's based on what customers tell us, which is corroborated by the analyst firms. +And that is actually what we've used to calculate our EUR10 billion by 2020 number. And this is how we do it and everything that we currently see points into that direction, that 10% node on node capacity reduction, but the nodes will be extended. That's going to be the message. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Kai Korschelt, Merrill Lynch. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- + + My first question was just on the EUV revenue recognition. So it's clear that I think you?ve taken the full cost, only half the revenue, and I think you also mentioned that certainly the EUV tool is shipping in Q1, you don't expect it to generate any revenues in this year. +So I'm just wondering how should we think about the balance of this year in terms of revenues, and then also looking into 2017, because I think by then you probably would have built up a backlog of, I guess, six or seven EUV tools for which you may have recognized half, possibly less, in a gross margin dilutive fashion. So I'm just wondering how should we think about from a phasing perspective about that. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [43] +-------------------------------------------------------------------------------- + + I will go into that Kai. First of all, we shipped one system in Q1. We are planning to ship one in Q2, that leaves four to five in Q3, Q4. +If you recall, some of these systems are actually the 3300 that customers have already paid for, some of -- they are getting some enhancements, those will lead to quicker revenues. So you can expect some revenue there in the second half. +And then, we are also making progress on the maturity of the products and the predictability of the installation process. And you see, for instance, we said on these two systems, the 110, we previously said mid-year, and now we're saying it's in Q2. +So you see we are making some progress, which also makes it easier for us to recognize revenue. I won't give you a number here, but the additional units that we are shipping, plus some of the performance milestones on the revenue that we already recognize that we may achieve this year will certainly lead to more EUV revenue this year. +And next year, you are right, there is going to be a carryover amount. I mean, we're shipping certain shipments that have no revenue this year, they'll have it next year. +Plus then, as Peter mentioned before, we are ready to do like a system layer on top of that per month, that will be a bit back-end loaded from a shipment perspective. But if you go to a 7 nanometer insertion, or 7 nanometer equivalent, and we talked early about DRAM going to be around the same time, when you look at order lead times, people will have to take delivery starting end of 2017 and beginning of 2018. +So, yes, you'll have a carryover, it's hard to tell you what that number is. Plus we are going to ship more systems next year. So the revenue will be -- plus the predictability of the installation will go up, which in general means you can recognize earlier, so the EUV revenue should be quite a bit up next year versus this year. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [44] +-------------------------------------------------------------------------------- + + I think, I can't help you any further in that sense, only to mention that that 2016 and 2017 will be complex in terms of revenue recognition, and that's unfortunately what it is, this is very strict accounting rules for new technology, we have to follow them. +And on top of that the first customers that actually place the orders and put certain criteria in there, performance criteria, those are looked the same for every customer. The first customer actually took the first -- or gave us the first orders without knowing less than the second customer. +So our ability to negotiate terms and conditions and certain performance conditions with second customer are different than from the first, which will be different from the third. +And all those performance criterias drive revenue recognition. So it is not only what Wolfgang just said, it's also the fact that per customer it is different. We'll just have to guide you quarter-by-quarter and it's unfortunately also for us not always that simple to predict when we do, what level of revenue recognition at what margin. +But I think for the next two years, 2016 and 2017, it is what it is. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [45] +-------------------------------------------------------------------------------- + + And then I just had a quick follow-up, because you mentioned it. So I believe the 3300s are already prepaid. In terms of cash flow or cash collections on the 3350, how exactly does that work, does that follow the revenue recognition pattern or how should we think about the impact on that? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [46] +-------------------------------------------------------------------------------- + + We said this also earlier, when we think about our EUV priorities, we think about order first, then shipment, then cash, then revenue recognition. +And I don't want to sound sloppy, but the revenue recognition is what the revenue recognition is for [new] technology. But we have the cash flow much earlier. So it again -- it depends customer by customer, but you can make an average assumption that there is a significant portion of the cash coming at shipment. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Andrew Gardiner, Barclays. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [48] +-------------------------------------------------------------------------------- + + Just a bit of a follow-up on that last one, in terms of the -- sort of the planning for production next year. You've reiterated your confidence in six to seven EUV tools this year with a gradual ramp in the back half of the year, and clearly this time last year we had the sizable multi-year order from Intel. +I'm just wondering how the conversations are going with the others in the customer base in terms of planning for those production slots. You're clearly planning on increasing the capacity to one a month, as you said, but depending on how people demand the tools or plan for that you could see some bottlenecks. +Just can you give us any insight as to how 2017 is -- sort of the planning is firming up? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [49] +-------------------------------------------------------------------------------- + + Yes, I think we've also said it on the previous call, I think for next year we have a capacity to anywhere between 12 units and 15 units. +Now, your question how the conversation is going with the other customers, I think an indication of -- you can imagine how that goes. I still like to refer back to what we said at SPIE, or what the customers said at SPIE. +There's a lot of good data coming out of the customer base that show a lot of confidence in the fact that EUV will reach manufacturing maturity. +Now, you have to remember that those presentations are very often done by the R&D people of our customers, and that the people who have to run the tools and have to commit output to their customers, are the people in operations. +So the discussion that we currently having are with the operations people, and they are about availability, and levels of productivity, where they have given us certain targets and we have given them our internal targets. And they would like to see them, they would like to see them running at the 3350, which is going to be the production tools, together with the 3400. +And this is exactly the phase that we're in, where we are shipping 3350s to the key customers, they're in installation, or in this quarter will -- some of them will be turned over to the customer. And then we'll see the first results and that will drive also the order interaction with us and the customers. +So to be very honest, I think it's just a matter of time this year that we will see a follow on. We are confident that what we see in our factory we can repeat at the customer site and that will drive orders, just like you said. If you want to ship 12 units to 15 units next year, orders need to come and they will come. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [50] +-------------------------------------------------------------------------------- + + And then perhaps just a quick follow-up. Wolfgang, you mentioned that the EUV tool 3350 that shipped in the first quarter, you're not going to recognize any revenue on that until 2017. +If anything that seems like a slightly longer timeframe from ship and install to rev rec than you've just planned for with the first two shipments, is there any reason for that? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [51] +-------------------------------------------------------------------------------- + + Andrew, I can't go into much details there, because some of this stuff is all the customer specific. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [52] +-------------------------------------------------------------------------------- + + So I just refer to my answer on the previous question. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Gareth Jenkins, UBS. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [54] +-------------------------------------------------------------------------------- + + Couple of good follow-ups. Firstly, I just wondered if you could talk about the applications of the three customers running at 80%, [are these] intended applications for the processes for those customers. +And secondly I just want to -- Peter, whether you'd expect to step down in availability as you move from kind of ASML, Veldhoven factory environment to a more production-orientated customer site? And then I've got a follow-up on something else. Thanks. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [55] +-------------------------------------------------------------------------------- + + Well to answer your last question, a step down in the [particular] node, that is not what we anticipate. We're running these tools here as much as we can and the circumstances which are comparable to what the customer will do. So that should not be the case. What you're referring to the 80%, I believe you're referring to availability, Gareth? + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [56] +-------------------------------------------------------------------------------- + + Yes. Just the customers in terms of what applications they intend to take EUV to eventually? What are they trialing the 80% availability, what are they (multiple speakers)? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [57] +-------------------------------------------------------------------------------- + + It's logic and also memory. I mean there's also memory customers doing this. I mean, the 3300s that are currently running are running predominantly in a logic environment, but also in some leading edge DRAM environments. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [58] +-------------------------------------------------------------------------------- + + And the last one is just on cross-point. I just wonder whether you could talk about the litho-intensity of cross-point that you see, maybe excluding EUV as a factor in the potential step-up there? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [59] +-------------------------------------------------------------------------------- + + I think the cross-point is quite interesting. I mean this has been introduced. It holds -- if you listen to the customers, it holds great promise in terms of speed and application space. +Currently, those cross-point products are made with deep UV immersion technology and ultimately we believe, because it's a shrink capability, or at least an X and Y and Z direction shrink capability, gives us a lot of space for EUV. But it's not going to happen before the end of the decade. +But when you take it all into consideration, and it would ramp in volume towards the end of the decade, then you would think about a three times higher intensity for cross-point as compared to 3D NAND. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [61] +-------------------------------------------------------------------------------- + + Hi, [Doug Smith] from [Agency Partners]. Wolfgang, you have continuously guided to around 10% growth in field options and services, but it's actually continuously grown much faster than that. I'm not complaining, but since it's around a third of revenues now, can you provide a little more breakdown into that business? I think you hinted that you might want to, or you needed to provide more detail. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [62] +-------------------------------------------------------------------------------- + + Yes, you can roughly, in average, think about half of it being service. Like I said that's pretty stable and that is growing with the installed base, of course. +And then the other half, in average, sometimes a bit more than half, sometimes a little bit less, are various field options in all of our businesses. Will also be the case for EUV. But prominent one is the SNEP upgrade, which is basically -- it stands for system node enhancement package, which is basically a complete open-heart surgery on a scanner, where you, for instance, can make a 1950 and 1970 or go even beyond that. +Those have been introduced last year in volume, with quite a few there, and that provided for one of the step functions. We often get asked why is your system revenue flattening out. And part of the reason is because we are providing a win-win alternative to the customer, it helps them with capital intensity and we are getting an option, where the economics for us are acceptable as well. +And then in the past you may remember we had several one-time events that gave us growth spurts. For instance, we included Cymer at one year, that's quite a big business as well. And now we are at a pretty decent level. Last year it was one-third of our business, it's about [EUR2 billion] plus. And we continue to believe that it's growing at least as strong as the rest of our business and that's pretty exciting for us. + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [63] +-------------------------------------------------------------------------------- + + Can you say whether the services and field options have higher or lower margins than the systems business? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [64] +-------------------------------------------------------------------------------- + + Service is lower than the corporate average, [field adoptions] are higher than the corporate average. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [65] +-------------------------------------------------------------------------------- + + There's a lot of software in there also. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [66] +-------------------------------------------------------------------------------- + + Lot of software components. + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [67] +-------------------------------------------------------------------------------- + + And finally, does a lot of that actually come from backlog? I mean I would imagine for field upgrades. It's not like something you would do on the spur of the moment. It must have quite a bit of visibility to it. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [68] +-------------------------------------------------------------------------------- + + That's a correct. I mean when we rethink, because just for clarification for everybody on the call. Our backlog that we report is just for systems. +So if we would report that differently, some of the options have longer order lead times. If you think about the SNEP that I mentioned, I mean that's a six to seven week project and there's limited amount of teams and material, so you get a schedule there. +So there we have more visibility. In some of the software upgrades we have a little bit shorter lead times. So there is some visibility on some of the options. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [69] +-------------------------------------------------------------------------------- + + In the early comments he said we might -- if that becomes bigger and becomes more relevant, we just need to look at how we're going to report that. + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [70] +-------------------------------------------------------------------------------- + + Right, because If it keeps on growing at the previous rate, it will be [EUR2.5 billion] this year or something, if it's -- just using the trend from the previous years. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [71] +-------------------------------------------------------------------------------- + + Yes. And like Wolfgang said, there are sometimes these SNEP system upgrades, could be anywhere between [EUR20 million to EUR30 million] a piece. If you just add up them that's [EUR300 million], that's a lot of money. +We just have need to look how that's going to develop and if that becomes significant, then I think we need to start thinking about different way to report it, so you guys can actually follow it. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + Amit Harchandani, Citi. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [73] +-------------------------------------------------------------------------------- + + Two quick clarifications, if I may. Firstly, with regards to the topic of equipment reuse, we have again seen some comments from some of your larger customers that have reported Q1 results, talking about reusing equipment. +Just wanted to confirm if you think the level of reuse in the industry being talked about is still consistent with your longer-term financial model? And then, I have -- and also if you could share any updated thoughts on equipment reuse. And then I have a follow-up. Thank you. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [74] +-------------------------------------------------------------------------------- + + Yes. I think in our long-term financial model, we have included, as you pointed out, we have included the possibility of our customers making use of the reuse capability. +And what we're currently seeing is that it's still in line with what we are planning, and that is because of this -- like Wolfgang pointed out, these upgrades are open-heart surgeries in the field and they are planned per node. +So when we discuss a node with a customer, 7 nanometer node, for instance, there is an assumption in there, in the discussion with the customers, because of the higher litho intensity, how much of that litho intensity will be split between increase of new systems versus upgrades of existing systems. +So we have a pretty good view as to how the customers think and we work that thinking into our long-term planning. So it's pretty consistent, but it is not a surprise, because we're executing according to plan. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [75] +-------------------------------------------------------------------------------- + + And to add one thing, if I may. I mean, we are aware of the comments, but I also need to let you know that for us the 10 and the 7 for instance is -- in that applications for instance, the litho requirements are the same and that customer also said that's exactly the same as 16 was to 20, so that part we wouldn't even classify as reuse. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [76] +-------------------------------------------------------------------------------- + + And to be honest, we also -- when we looked at 28-nanometer where -- with some customers we actually planned reuse of the equipment, but given the strength of the 28 nanometer node, it never got to any reuse. I mean, we never got to the point. +Well, with other customers, the 28 nanometer node was not that successful, and we reused it in 14, or in 16, or in 20. So it's a bit different per customer, but also the ultimate size of the capacity in a particular node will also determine how much reuse there will be. Other customers will keep using the machine as is. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [77] +-------------------------------------------------------------------------------- + + And in terms of the second clarification, if I may, you talked about memory or DRAM in particular shaping up to be better in the second half versus the first half. You talked about second half being higher than the first half. +Would you be willing to also comment and compare it to current market expectations out there for your full-year revenues, and say whether you think that that implies an increase in market expectation, or are there any downward trends that we should be aware of that would deviate away from the market expectation? Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [78] +-------------------------------------------------------------------------------- + + Yes. On the first part, just to clarify, we said memory would be approximately the same in the second half than in the first half. And if I would comment on the market expectations, then I would essentially give guidance. +So we'd better stay away from this and remain -- and I'll just probably repeat it. Logic is going to be up second half, memory is going to be stable, H1 versus H2. And like we just discussed with Doug, service and field options will go up in the second half. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR [79] +-------------------------------------------------------------------------------- + + I'd like to jump in here momentarily. Ladies and gentlemen, we have time for one last question, if you were unable to get through on this call, and still have a question, feel free to contact the ASML Investor Relations department with your question, and we'll do our very best to get back to you as quickly as we can. +Operator, if we can have the last caller, please. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + David O'Connor. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR [81] +-------------------------------------------------------------------------------- + + Operator let's go ahead --. + +-------------------------------------------------------------------------------- +Operator [82] +-------------------------------------------------------------------------------- + + Amit Daryanani. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [83] +-------------------------------------------------------------------------------- + + Hi, this is (inaudible) for Amit. And we're from RBC Capital Markets. +So one question, the previous one to two large node transitions, your bookings were at high levels for about three to four quarters, and given the 10% node to node reduction you mentioned, and also the quicker ramp at a few customers that you're seeing right now for 10 nanometer, is it fair to assume that 10 nanometer ramp will be probably one to two quarters shorter than previous node transition, and probably the booking euro amount will be smaller? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President & CEO [84] +-------------------------------------------------------------------------------- + + I think, because if the litho density goes up, it's not likely the bookings amount will be smaller, it's not likely. And also you've to -- I tried to explain in my introductory statements that these nodes -- if you talk about a ramp of a node or a node to a total capacity, it takes a very long time, it has a very long tail end, so there will be an initial ramp. +And since the pattern is changing, it is very difficult to compare the initial, let's say, first two, three, four quarters of a new node with the nodes -- with the previous ones. +But I would summarize it like this. I said, the number of customers that over the last couple of years have been able to start an initial new logic node has shrunk, there is only a very few. +They are more aggressive in ramping the first part of that node, because they have to make sure that they can provide their key customers with wafers, so that's what you will see. And they've a long tail end. +So I don't think you can draw any conclusions from that other than that the nodes will be longer, and that the litho intensity will go up. Hence, when you also will look at the need for EUV, ASML is looking to grow its topline and we still stick to our simulated number, by 2020 EUR10 billion. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [85] +-------------------------------------------------------------------------------- + + And one follow-up. Last year you had an EUV volume purchase agreement with at least 15 tools with a US logic customer. I mean, given the discussion you have right now with this customer, do you have any update on the number of tools will be shipped under this agreement? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP & CFO [86] +-------------------------------------------------------------------------------- + + We will give you update when we get the orders. This is volume purchase agreement, and where we -- purchase orders are issued according to a predetermined pattern, which is a reflection of when the customers need the tools to put them into production. So, we will inform you when we get the orders. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR [87] +-------------------------------------------------------------------------------- + + On behalf of ASML's Board and management, I'd now like to thank you for joining us on the call today. Operator, if you could formerly conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [88] +-------------------------------------------------------------------------------- + + Thank you, sir. Ladies and gentlemen, this concludes the ASML 2016 first quarter financial results. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2016-Jan-20-ASML.txt b/Transcripts/ASML/2016-Jan-20-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..8813d96213100f267a2c10f551d985a1fa26b66b --- /dev/null +++ b/Transcripts/ASML/2016-Jan-20-ASML.txt @@ -0,0 +1,999 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 ASML Holding NV Earnings Call +JANUARY 20, 2016 / 2:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Wolfgang Nickl + ASML Holding NV - EVP and CFO + * Craig DeYoung + ASML Holding NV - VP, IR Worldwide + * Peter Wennink + ASML Holding NV - President and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + SIG - Analyst + * Andrew Gardiner + Barclays - Analyst + * Francois Meunier + Morgan Stanley - Analyst + * Amit Harchandani + Citigroup - Analyst + * Pierre Ferragu + Bernstein - Analyst + * Jerome Ramel + Exane BNP Paribas - Analyst + * Farhan Ahmad + Credit Suisse - Analyst + * Mahesh Sanganeria + RBC Capital Markets - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + * Gareth Jenkins + UBS Equities - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Sandeep Deshpande + JPMorgan - Analyst + * Kai Korschelt + BofA Merrill Lynch - Analyst + * Patrick Ho + Stifel Nicolaus and Company - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + Ladies and gentlemen, thank you standing by, and welcome to ASML 2015 fourth-quarter and annual results conference call on January 20, 2016. (Operator Instructions). +I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR Worldwide [2] +-------------------------------------------------------------------------------- + + + Thank you, Aaron, and good morning and good afternoon, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from our headquarters here in Veldhoven, the Netherlands, is Mr. Peter Wennink, our CEO; and Wolfgang Nickl, ASML's CFO. +The subject of today's call is ASML's 2015 fourth-quarter and annual results. Before we start, I'd like to take a brief moment to address some questions from previous calls about our Q&A queue. The process is -- you will be advised that the Q&A starts upon the operator's instructions at the opening of the call, and not before. Therefore, there's really no value in calling in too long before the call starts in an attempt to get into the queue. And as the operator mentioned, questions will be taken in the order that they are received. +The length of the call will be 60 minutes. The call will be broadcast, and is being broadcast live over the Internet at ASML.com, and a replay of the call will be available on our website for approximately 90 days. +Lastly, before we begin, I'd like to caution listeners that comments made by management during the conference call will include forward-looking statements within the meanings of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of these risk factors, I encourage you to review the Safe Harbor statement today, contained in today's press release and presentation found on our website at ASML.com, and in ASML's annual report on Form 20-F and other documents, as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [3] +-------------------------------------------------------------------------------- + + + Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our fourth-quarter and annual 2015 results conference call. Before we begin the question-and-answer session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter, and provide our review of the coming quarters. Wolfgang will start with a review of the Q4 financial performance with added comments on our short-term outlook, and I will complete the introduction with some further comments on the current channel business environment and on our future business outlook. +So, Wolfgang, if you will? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [4] +-------------------------------------------------------------------------------- + + + Thank you, Peter, and welcome, everyone. For Q4, our sales came in at EUR1.43 billion. This included system sales of EUR881 million, of which memory represented 44% and logic represented 56%. Service and field option sales came in strong at EUR553 million. This part of our businesses grows, continues to strengthened by strong demand for holistic lithography options, high-value upgrades, and a growing installed base. +Our gross margin for the quarter came in at 46%, slightly above the guidance. R&D expenses came in at EUR273 million, and SG&A expenses came in at EUR90 million, essentially as we guided. +For the full year, our net sales reached a new record of EUR6.3 billion, which is up 7% from the prior year, and includes over EUR2 billion for field options and services. Gross margin for 2015 was 46.1%, up from 44.3% in 2014. Our basic earnings per share for 2015 were EUR3.22, up 18% year-over-year. +Turning to the balance sheet, quarter-over-quarter cash, cash equivalents, and short-term investments grew from EUR2.68 billion to EUR3.41 billion, driven by strong free cash flow which was impacted by a significant amount of customer prepayments on orders received. In Q4, we repurchased shares worth EUR141 million, bringing the total amount for repurchased shares in 2015 to EUR565 million. +Regarding the order book, Q4 bookings came in at EUR1.2 billion, 31% above our Q3 bookings. Strength in memory bookings continued to be notable, with a significant growth in our foundry bookings, leading to a strong and nicely balanced backlog across all industry sectors of approximately EUR3.2 billion. +What that, I would like to turn to our expectations and guidance for the first quarter of 2016. We expect continued healthy memory shipments, supported by a strong backlog. Our servers and field option sales will be around the EUR500 million mark again. We expect relatively modest logic shipments in the first quarter of 2016, leading us to guide Q1 revenue at approximately EUR1.3 billion. As indicated at this time last quarter, we do, however, expect our logic customers to take shipments in Q2 which will start the ramp of 10 nanometer, and as a result we expect Q2 sales to increase significantly from Q1. +Based upon expected customer and product mix, a lower in sales volume forecast, and lower field option sales, we expect gross margin for Q1 to come in at around 42%. R&D expenses for the first quarter will be about EUR275 million, and SG&A is expected to come in about EUR90 million, both roughly the same as the previous quarter. Our annualized tax rate for 2016 is expected to increase to around 13%, based upon a change in tax rules that transfer some tax benefits into R&D credits. +Peter will talk more about our 2015 EUV accomplishments and 2016 key performance targets shortly. But I would like to make a few points regarding 2016 EUV shipments, and explain a bit further the current and expected situation related to EUV revenue recognition. We completed three EUV shipments in 2015, and started the shipment of a fourth system before year-end. One of the three systems was recognized in revenue during 2015. The other two systems that shipped, and the one system where shipment was started, should lead to a revenue of about EUR110 million in the middle of 2016, with the balance booked in 2017. +For 2016, we expect to ship between six and seven EUV systems. The 2016 shipments will be a combination of NXE:3300s, 3350s, and 3400s, going to both logic and memory customers. As a reminder, we will continue to guide expected revenue timing on additional EUV systems as they ship. +And, finally, but certainly not with significant importance, ASML paid EUR302 million in dividends in 2015, and we purchased 6.3 million of our own shares for EUR565 million, providing a total cash return to shareholders of EUR867 million during the year. +In 2016, we are proposing to our Annual General Meeting of Shareholders on April 29 to increase our dividend by 50% to a level of EUR1.05 per ordinary share. Today, we have also announced the plan for an additional EUR1 billion of share repurchases over 2016 and 2017, on top of the remaining EUR500 million from our prior program. +With that, I would like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [5] +-------------------------------------------------------------------------------- + + + Thank you, Wolfgang. As Wolfgang highlighted, we concluded a financially very satisfying year. Expectations for the first-quarter sales are approximately EUR1.3 billion, reflecting continued shipments for 28, 16, 14 nanometer logic capacity additions, albeit at a relatively low level, and shipments to memory customers consisting of a mix of advanced and more mature system types. +While first-quarter sales are expected to be relatively moderate, we clearly see, as Wolfgang said, a significant increase in combined system and service sales in the second quarter, largely driven by system shipments for the initial ramp of advanced 10 nanometer production processes at our logic customers. +While it is still a bit too early to say anything quantitatively about 2016, we do see trends and developments that we believe are worthwhile mentioning. In memory, as evidenced by the fourth-quarter bookings and our current backlog strength, our customers have indicated that their system demands will continue throughout the first half of 2016 at levels roughly equivalent to those of Q4. +Although we expect that two DRAM fabs will continue to install some additional tools largely meant to support the next DRAM node, we also believe that 2016 shipments to this application will be down versus a strong 2015. +On NAND, we believe that the capacity expansions will be focused on 3D NAND applications. With the announcement of the conversion of a Chinese fab to 3D NAND that is now largely supported in our current backlog, we expect a flattish level of NAND systems revenues versus 2015. +One additional memory development that appears to be worth following is the introduction of the XPoint architecture. While the full opportunity extent of this new memory architecture is still under evaluation, its potential seems significant and could, therefore, become important to our business as the advanced processes anticipated in this application are quite litho-intensive. +As for logic, it has now become clear to us that the introduction of the advanced 10 nanometer node ramp is progressing well, hence the continued and clear customer commitment to ramp this node starting in Q2 2016. The speed and initial size of this ramp can be explained by the value proposition provided by the significant shrink of this node versus the 16 and 14 nanometer node. +The ultimate spend levels for logic in 2016 will depend, amongst other things, about the level of end demand, and the rate at which our customers will be able to execute their ramp; and it's, therefore, too early to accurately predict this today. For field options and services, we see continued strength in 2016, and this should show growth, previously estimated to be in the range of 10%. +On the product side, ASML continues to focus R&D spend on lithography tools that are essential to ramp all of the current and advanced processes. With the growing litho challenges of complex and costly multipass patterning, our recently launched TWINSCAN NXT:1980 deep UV immersion scanner, with significant improvements in all key performance metrics, started volume shipment last quarter. And now with its widespread acceptance, it is ramping at a rate greater than any other advanced system in our history. +Our holistic lithography products continue to gain acceptance at leading-edge customers, who are using our full suite of immersion process window enhancements and process control solutions to optimize yields at the most advanced product nodes. Holistic lithography products are now extending also into EUV processes, with customers evaluating our EUV Source Mask Optimization software for the development of their 7 and 5 nanometer technologies. +And finally on EUV, as most of you are aware, our 2015 focus has been on improving EUV stability, availability, and productivity, the key performance metrics that drive new technology adoption. In several recent public presentations, our customers have clearly recognized our EUV progress in these areas. In a four-week, customer-run manufacturing readiness test at production conditions, we've seen 15,000 wafers exposed with comparable results achieved using the same power configuration at multiple customers. +On the raw productivity side, we have a new system configuration, the NXT:3350, that has demonstrated in our factory more than 1,250 wafers exposed in a 24-hour period. Six out of eight systems at customer sites have achieved four-week average system availability of greater than 70%, with one system reaching the 80% mark. However, the worldwide average is currently still lower, indicating that performance stability in the entire installed base needs to be further improved. +We believe that our 2016 performance targets of 1,500 wafers per day and 80% total system availability are achievable, and will therefore be aggressively pursued over the course of this calendar year. +Now, with that, we would be happy to take your questions. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR Worldwide [6] +-------------------------------------------------------------------------------- + + + Thank you, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. But beforehand, as I always do, I would like to ask you to kindly limit yourself to one question, with one short follow-up if necessary. This will allow us to get as many callers on today as possible. +Now, operator, can we have your instructions and then the first caller, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + (Operator Instructions). Kai Korschelt, Bank of America. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + + So the first one was just on the second quarter. So I'm just wondering, what level of visibility do you have? What could be the magnitude of the snapback? And the reason I'm asking is, I think if I just take your bookings in the fourth quarter, and if I add maybe EUR0.5 billion service sales, then it looks like we should be well above EUR1.6 billion. So I'm just wondering if that's the right ballpark. And then I have a follow-up. Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [3] +-------------------------------------------------------------------------------- + + + Well, we don't want to leave you down any particular number, but we chose the word significantly wisely, so we wouldn't do that if it would be just a little bit up. So we'll leave it at that today, but it's all underpinned by a strong ramp in 10 nanometer. And we also said that memory will be, throughout the first half, at Q4 levels, so I think you can approximate it from there pretty well. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- + + + Okay. And then just a quick one on the gross margin. So, I think the Q1 guidance is probably below where most people think it would be, even if we look back at quarters with similar revenue -- run rates. So I'm just wondering, broadly, what are the reasons? And should we expect that if we do see the recovery in demand and revenues in the second quarter, that we should settle back at the 47%, 48% level that I think we've become used to it, as obviously before EUV? Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [5] +-------------------------------------------------------------------------------- + + + Yes, Kai, I can address it, as well. First of all, there are no structural changes in the sense that you should be worried that pricing came down, or we have any cost issues. This is purely a function of lower volume at one, and then more so a change in mix between products and customers. And then also within the service and field options, that the service is a bit higher when compared to the field options, which come at higher margin. And then you can also read that when we say foundry is lower and memory is higher, foundry tools are usually in a richer configuration going to the customer. +Now, if you want to look at Q2, we won't give you an exact number. But when you consider that the volume will go up and the foundry shipments will go up, and it's 10 nanometer, it will be pretty nicely configured tools, you'll know in which direction the margin will go. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [6] +-------------------------------------------------------------------------------- + + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + + Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [8] +-------------------------------------------------------------------------------- + + + Sandeep Deshpande from JP Morgan. My question would be, Peter, on the memory market. You've said that you are going to have a flattish trend in the first half in the memory market. Do you see this, into the second half, substantially correcting? Or you don't have visibility at this point into this segment? +Secondly, I have a quick question on EUV as well. Clearly, EUV is progressing much better at this point in terms of throughput, and you've given some of the statistics. What time frame do you see EUV actually being built for production volumes? Thanks. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [9] +-------------------------------------------------------------------------------- + + + Okay. On the memory market, like I said in the introductory comments, we have very clear visibility given by our customers, also evidenced by our bookings that we received in the fourth quarter. On what we are going to ship in the first half, we're just focused on also the introduction of the new DRAM nodes. So you could say it's clearly a technology transition that is driving the shipments in the first half. +We don't have that visibility yet on the second half, is our current thinking. I can only give you some indication of what was said by some of the market research analyst firms. They expect -- and if they are right, and 25% bit growth for next year would mean about flat wafer capacity year-on-year, 2016 versus 2015. So that means that if the initial shipments of the technology [trends] happen in the first half, then the second half will be lower than all capacity additions needed. +How much lower? That's a bit too early to say. But clearly first-half technology trend and transitions; and second half, probably a lot less. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [10] +-------------------------------------------------------------------------------- + + + Thank you. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [11] +-------------------------------------------------------------------------------- + + + On EUV throughput, yes, and on that we've made good progress. We've agreed with our customers the targets for 2016, and we have good confidence that we are going to get there. You have to look at 2016 as, I would say, the last phase in the EUV introduction of where our customers are developing their next nodes for which they are planning their production output in 2018 and 2019. So, it's the last phase of the development node, and the qualification of those architectures that we will see in 2018, 2019, hitting the market. +That means that 2017 will be the year where we will start to see the start of the EUV shipments for production, and they will be used in 2018. And that will accelerate through 2018. So 2017 will see the first start to make sure we can do -- customers can do the output in 2018, which will accelerate in 2018 further on. So, that's nothing different than we said, I think, last quarter; so, no change from that respect. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [12] +-------------------------------------------------------------------------------- + + + Thanks, Peter. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + + Gareth Jenkins. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Equities - Analyst [14] +-------------------------------------------------------------------------------- + + + Yes, a couple if I could -- or rather one, and one follow-up. So, I just wondered if we could talk about 10 nanometer ramp, now you've got maybe a bit more visibility around it. Should we still be thinking about 10% pure wafer starts between the 2016 14 node and the 7/10 nodes, but also a 40% to 50% lithography intensity increase? Just wondered if we could elaborate on that, now you've got more line of sight. And that I have a follow-up on EUV. Thank you. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [15] +-------------------------------------------------------------------------------- + + + Yes, just for clarification, I just missed part of your question on your 10%. You referred to 10% (technical difficulty). + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Equities - Analyst [16] +-------------------------------------------------------------------------------- + + + The low wafer starts, Peter, between -- so, 2016 -- 14, and 7/10. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [17] +-------------------------------------------------------------------------------- + + + Okay, okay, sorry. Yes, yes. Yes, it's basically --that's the assumption on the 10% that we still work with. We don't have any other data. I'll comment on that a bit later, also. The 40% litho intensity, yes, that's what node-on-node -- that's still what we think is a realistic number. On the node-on-node wafer capacity reduction, the 10% is still what we are using. You have to bear in mind that, starting from the 28 nanometer node, we see those nodes extending a lot longer than what we saw in the past. +And you've been around a long time, so you know that, between 5 and 10 years ago, nodes had a two-year life. And then the previous nodes stopped, next node came, and lasted about two years, and almost all logic customers moved in that same time period, which is less the case today, or not the case today. We see the initial acceptance of a new node being driven by the leading-edge customers. And they install, rather swiftly and rather fast, a quite a significant amount of capacity. And then you see the other customers in that segment, you could say the second-tier customers, following later. +That is also what we see today. 28 nanometer is still being shipped, even in Q1 of 2016, which is more than four years after the initial introduction. So, you can see kind of a camel back in the first phase of that node, and then a much longer tail. Which also makes it more difficult for us to say how much will that wafer capacity for that node be. We assume 10%, but over time we will -- it needs to be proven whether this is the correct number. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Equities - Analyst [18] +-------------------------------------------------------------------------------- + + + That's fair. And just one follow-up. It looks like your Chinese orders are very strong, somewhere around EUR500 million, which I would assume is mostly Dalian. Can you just give us a sense of your market share into China through the course of this year, or rather on those orders? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [19] +-------------------------------------------------------------------------------- + + + Well, our market share in China has always been pretty good, and it will stay pretty good. I'm not going to give you an exact number, but we have no worries about our market share in China. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [20] +-------------------------------------------------------------------------------- + + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + + Jerome Ramel. + +-------------------------------------------------------------------------------- +Jerome Ramel, Exane BNP Paribas - Analyst [22] +-------------------------------------------------------------------------------- + + + Good afternoon. Jerome Ramel from Exane BNP Paribas. Peter, just want to come back to the point you made that your clients seem to be keen on moving to the 10 nanometer node because that's a [terrific] count improvement compared to the 16/14 versus the 20. Could you just give us a sense what is better? Is it the term of yield, it's in term of cost per transistor? What would make the 10 nanometer node more attractive than the 16/14? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [23] +-------------------------------------------------------------------------------- + + + Yes. From a lithography point of view, the 16/14 node is very similar from a little half-pitch dimension point of view, very similar to the 20 nanometer node. So you really should not go past 16 and 14, from a litho pitch point of view, to 10, but really 20 to 10. And that's a big shrink. And, as you know, shrink has a big impact on the cost per bit. And so it is driven by cost per bit. And for some customers, actually it's also value; just putting more functionality on the same square surface. That's what's driving it. + +-------------------------------------------------------------------------------- +Jerome Ramel, Exane BNP Paribas - Analyst [24] +-------------------------------------------------------------------------------- + + + So you'd see -- to make clear, you see the cost per transistor going down at 10 nanometer node? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [25] +-------------------------------------------------------------------------------- + + + Yes. Yes. + +-------------------------------------------------------------------------------- +Jerome Ramel, Exane BNP Paribas - Analyst [26] +-------------------------------------------------------------------------------- + + + Okay. And maybe just one follow-up. You gave guidance for the full year -- I mean quantitative guidance for the memory -- so Flash being flat, and DRAM going down. I'm not sure I understood for logic and foundry what the trend are, in term of quantitatively compared to 2015. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [27] +-------------------------------------------------------------------------------- + + + Well, I think the -- Wolfgang said the first quarter is relatively benign, but we really see the ramp starting in Q2. And then also we are extending into IDM, not only for foundry but also IDM on 10 nanometer, which will be the remainder of the year, which will drive the remainder of the year. Now, if you just look at the size of that ramp -- and the ultimate size for this year is always a bit difficult to predict in the third week of January, so as we are very early in this year. +But if you look at that -- what customers are telling us, it's going to be a significant ramp, and will be driven by the leading-edge players, not so much by the followers, which will follow on, I said as an answer to an earlier question, which will probably have a much longer tail. But the initial ramp up we are seeing will be significant, and that causes us to state that the 2016 logic market for us will be significantly higher than 2015. + +-------------------------------------------------------------------------------- +Jerome Ramel, Exane BNP Paribas - Analyst [28] +-------------------------------------------------------------------------------- + + + For logic, that includes logic and foundry, or that's just purely logic? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [29] +-------------------------------------------------------------------------------- + + + That's logic versus foundry and IDM. + +-------------------------------------------------------------------------------- +Jerome Ramel, Exane BNP Paribas - Analyst [30] +-------------------------------------------------------------------------------- + + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + + C.J. Muse. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [32] +-------------------------------------------------------------------------------- + + + Good afternoon, C.J. Muse with Evercore ISI. I guess first question, I know there's a lot of moving parts here, but curious what are the key milestones we should be watching for EUV to be designed in at the 7 nanometer node. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [33] +-------------------------------------------------------------------------------- + + + I think we mentioned those. I think, for our customers, it's most important that they have a certain level of productivity. But it's very important that when you start planning your production, that availability is critical. So, the 80% availability target is what we agreed with our customers. This is what we are, at least, following. I also like to refer to our presentation, where you can see that. +On productivity, quite interesting: one of our key customers -- in the question that was asked recently on where the 500 wafers spread day would be sufficient for them to go into production, assuming a reliable or a, let's say, good availability of the tool. And the answer was yes, they would use it. So, you can draw a conclusion from that answer, that it's not so much now about the productivity, it is about the availability. So this is what we are really focusing on this year. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [34] +-------------------------------------------------------------------------------- + + + That's helpful. And as a follow-up, in terms of foundry logic spend this year, clearly a very good year for 10 nanometer. Curious if you could share your thoughts on the mix this year between 10 nanometer China foundry spending year-over-year, as well as whether you're seeing any incremental capacity adds at the 14/16 nanometer nodes. And then to follow on to that, your expectations for that 10 nanometer ramp to continue into 2017. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [35] +-------------------------------------------------------------------------------- + + + Yes, I made some notes. The 10 nanometer ramp is predominantly outside China, if you refer to China. When we see China -- the Chinese logic or foundry market, we are clearly focusing on the nodes before 10. So the 28 nanometer node is still relatively strong in China, but also very clear indications of the move to 16 and 14. And that is where we see Chinese foundries going. Like I said, the 10 nanometer ramp will be outside China. +2017 is a good question. I think it's too early for us to say anything about 2017. I think what we'll have to go through is the next two, three quarters of the initial ramp, which we have a pretty decent visibility of. And 2017 will be driven, I think, by the end markets. And we'll just -- a bit too early to comment on that, C.J. (multiple speakers). + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [36] +-------------------------------------------------------------------------------- + + + But C.J., directionally for 2016, the 10 nanometer will make up the majority of our shipments. But there will still be 28 and 16 and 14 shipments as well. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [37] +-------------------------------------------------------------------------------- + + + Yes, but those are then predominantly in the direction of China, and somewhat in Taiwan. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [38] +-------------------------------------------------------------------------------- + + + Great. Thank you so much. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + + Mr. Hosseini. +Mr. Hosseini, you can ask your question. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR Worldwide [40] +-------------------------------------------------------------------------------- + + + Sound like he's not there, operator. Want to go to the next one? + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + + Amit Harchandani, Citi. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [42] +-------------------------------------------------------------------------------- + + + This is Amit Harchandani from Citigroup. Good afternoon, ladies and gentlemen. Two questions: firstly, with regards to a topic that does come up often for discussion, which is equipment reuse -- we've heard some of your peers talk about it, the customers talk about it. Could you give us a sense for how you see equipment reuse impacting your prospects for this year as compared to last year? I'm also looking forward to your medium-term financial roadmap across the different end segments. So that would be my first question, and I have a follow-up. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [43] +-------------------------------------------------------------------------------- + + + Okay. The equipment reuse is always -- it appears to dominate some of our discussions lately, but it's always been there. Large IDMs have always done this, and it's a very sensible way to manage your capital efficiency. Now, with tool prices going up to where they currently are -- advanced DPV prices are EUR50 million -- there is more and more focus of our customers on capital efficiency. +And the reuse program, which we have designed by adapting the architecture in such a way that we can upgrade from one node to the other. And with litho intensity going up with about 40% node-on-node. And there's a very clear driver of our customers to say, what part of my installed base can we upgrade to the next node? That's called a reuse. That doesn't cover the 40% litho intensity at all. It just covers part of it. +And we have had situations whereby reuses, let's say upgrades, were planned on the previous node, that never happened because the previous node extended longer than the original planning. So, it's nothing new. I think it's going to be part of our business going forward. Very healthy part, if you think about an extensive upgrade from a 1950 to a 1970, for instance, is a EUR20 million-plus upgrade, with these margins. Which is good business for us; helps us increase our services and option sales business, and helps our customers to manage their installed base. +So I think it's going to be part of our business, going forward. It might be new to some of our peers. But it isn't to us because, our tools have always been one of the most expensive in the customer fabs. So, it's here to stay, and it's good. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [44] +-------------------------------------------------------------------------------- + + + Thanks, Peter. And then just to clarify, the extent of reuse that you're seeing out there right now is in line with your 2020 financial roadmap? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [45] +-------------------------------------------------------------------------------- + + + Absolutely. Yes, in our 2020 roadmap, we have actually included that reuse. It is an inevitable event. And the level of reuse that we are seeing is very much in line with our expectations. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [46] +-------------------------------------------------------------------------------- + + + Thank you. And just as a follow-up if I may, Wolfgang, could you kindly just once again explain or elaborate upon your comment of EUV revenue recognition for this year? I'm afraid I did not catch it correctly. Was it EUR110 million in the middle of the year? So what are we looking for, in terms of EUV revenues this year? If you could shed some light on that. Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [47] +-------------------------------------------------------------------------------- + + + You got that right. Well, first of all, we told you that while we're in this transition period where we can recognize not when a tool leaves our factory, we will give you guidance as we ship the tools. And I said we shipped three tools last year, and of which only one recognized. And on top of that, we started the shipment of another tool. Of the two tools that shipped and have not recognized last year, and the tool that has started to ship, from these three tools together you should expect approximately EUR110 million in revenue. And that will be somewhere in the Q2, Q3, mid-year time frame. And the balance of the revenue will likely recognize in 2017. +Now (multiple speakers) the starting point, and then we also said that we will ship more tools this year. And those, of course, will -- we also told you there is, for instance, a 3300 amongst them, which will recognize faster because there the recognition rules are different because we just need to demonstrate that we can print the wafer. So there's more to come, so you've got to bear with us as we make these shipments. +And lastly, I'll say also that we will start to see some service revenue in the EUV field. We already had some last year. Our total revenue was about EUR100 million or so, and only a little bit over EUR60 million came from systems. So you have to bear with us, Amit. We will give you information as we go through the year. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [48] +-------------------------------------------------------------------------------- + + + Just to confirm, a minimum of EUR110 million, but the actual number could vary depending on your updates as you go through the quarters now? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [49] +-------------------------------------------------------------------------------- + + + That is correct. + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [50] +-------------------------------------------------------------------------------- + + + Thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + + Mr. Sanganeria. One moment. + +-------------------------------------------------------------------------------- +Mahesh Sanganeria, RBC Capital Markets - Analyst [52] +-------------------------------------------------------------------------------- + + + (technical difficulty) there is same level as -- hello? +Yes. Okay, so you said memory at similar level to Q4, which was about EUR350 million, down 35%. So, first half at that level, and second half you said decline. That will indicate a significant down, year-over-year. Did I understand that clearly? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [53] +-------------------------------------------------------------------------------- + + + Well, I referred to DRAM system. And since we don't split out DRAM in the fourth quarter results -- so, DRAM shipments will be about equivalent to Q4. NAND will be over the year, year-on-year, will be about flat. + +-------------------------------------------------------------------------------- +Mahesh Sanganeria, RBC Capital Markets - Analyst [54] +-------------------------------------------------------------------------------- + + + Okay. And I want to follow up on the China. You had pretty strong orders on China; somebody mentioned EUR500 million, pretty close. And mostly, probably on NAND side, is that shipment to China mostly in Q2? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [55] +-------------------------------------------------------------------------------- + + + That shipment starts in Q1. + +-------------------------------------------------------------------------------- +Mahesh Sanganeria, RBC Capital Markets - Analyst [56] +-------------------------------------------------------------------------------- + + + Starts in Q1? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [57] +-------------------------------------------------------------------------------- + + + And (multiple speakers) will continue. + +-------------------------------------------------------------------------------- +Mahesh Sanganeria, RBC Capital Markets - Analyst [58] +-------------------------------------------------------------------------------- + + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + + Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [60] +-------------------------------------------------------------------------------- + + + Peter, going back to your 2015 performance, your foundry revenues were up 36%, but immersion systems shipment was down, and ASPs were down, too. Can you help me understand how did this mix change, despite the fact that foundries were up so much? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [61] +-------------------------------------------------------------------------------- + + + For 2016, you said? + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [62] +-------------------------------------------------------------------------------- + + + 2015. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [63] +-------------------------------------------------------------------------------- + + + Yes. Foundry shipments are up -- the ASP -- we shipped significantly more systems altogether. And they were also KrF and other systems in there. So like-for-like, the ASP didn't go down; but because of the mix, the ASP went down. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [64] +-------------------------------------------------------------------------------- + + + Yes, and it's KrF. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [65] +-------------------------------------------------------------------------------- + + + Does not reflect that foundries spend more on their trailing edge versus leading edge? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [66] +-------------------------------------------------------------------------------- + + + That is absolutely -- like we said earlier, we are currently shipping a different node layers. We're -- 28 nanometer, 14/16, the first 10 nanometer R&D tools. So it's quite a mixed bag of those tools. So to draw a conclusion on ASPs or ASP trends is a bit difficult because it's quite a mixed bag. But what we can say is that with every node transition, the ASP goes up because of the richer configuration, including a lot more holistic litho options. +Now in 2015, which is true, we had a mixed bag of 28 nanometer node, 14/16 nanometer node, and some early 10 nanometer node shipments. So, I think it's a bit difficult. And it did include, as we put in the presentation, there's a lot more KrF. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [67] +-------------------------------------------------------------------------------- + + + Okay. And then my final question [is actually] China. Can you elaborate more whether the key end markets or device stock that is driving such a strong growth in backlog, as it relates to China? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [68] +-------------------------------------------------------------------------------- + + + Well, it's both foundry and now also memory. So it's shipped due -- so it's the ship to region is indeed stronger. And that's because memory is now also adding, on top of the logic shipments, which are predominantly driven by 28 nanometer. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [69] +-------------------------------------------------------------------------------- + + + So there is a new NAND fab that is coming online, but also one of your Korean customers has a fab [Icheon]. How should we think about the mix -- new fab/existing fab on the 3-D NAND, and also the foundry market? Is it evenly split, or is one more than the others? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [70] +-------------------------------------------------------------------------------- + + + Well, I think there are existing fabs and the refurb fab -- one of the existing fabs that you referred to is already full. So, that means that the refurb fab is going to take tools. That's what it is. It's as simple as that, and not more difficult than that. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [71] +-------------------------------------------------------------------------------- + + + Got it. Thank you. (multiple speakers) + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + + Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Bernstein - Analyst [73] +-------------------------------------------------------------------------------- + + + Good morning, it's Pierre Ferragu, Bernstein. So, I have a question on your gross margin for the back end of the year. If I understand you correctly, foundry is going to be very strong. That's a 10 nanometer node. It's very high-end tools, a lot of options and upgrades, and memory is going to be low. So should we expect a very, very healthy gross margin development beyond Q2? So in Q3 and Q4, gross margin should be also heading in the right direction? So that's one question. +And then I have just a quick follow-up on EUV. I got, at some point, confused about insertion. By understanding is that both your IDM customers and your foundry customers are going to insert EUV at the 5 nanometer nodes, so not the next one but the one after. Is that also how you see the world from where you are? +And then maybe on this 5 nanometer node insertion, how much visibility do you have today on how heavy an insertion it is going to be? Are we going to use EUV tools only at a very, very low level for the first layers? Or are we heading into a more massive adoption of EUV at this 5 nanometer node? Thanks. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [74] +-------------------------------------------------------------------------------- + + + Yes, let me answer that EUV question first. Whether it's called 5 nanometer or 7 nanometer, I don't want to go into that nomenclature, because there is a lot of confusion about what is what. I'm also not going to tell you what we believe the lithography pitch is, because that's what's probably going to make it easier to understand that we're talking about this same thing. +What is most important -- and that's what we should focus on, is whether you call it 5 or whether you call it 7 -- our customers, our leading-edge customers, make it very clear to us that they will start the output of their chip architectures that need EUV -- whether that's 5 or whether that's 7, and I don't know how they call it, and I don't care -- but when they need EUV for output is 2018 starting; 2018, 2019. Which actually means that our shipments for production purposes need to start in 2017. It takes about a year to really qualify for a production run. +So, this is what we are focused on. This is what we are discussing with our customers. And this is also driving the decision points and the entry points for our customer for production insertion. It's this 2018-2019 time frame (multiple speakers). + +-------------------------------------------------------------------------------- +Pierre Ferragu, Bernstein - Analyst [75] +-------------------------------------------------------------------------------- + + + Okay, and in terms of the volume of insertion, so is that going -- do you have already visibility? And how high in the architecture of the chip EUV is going to be used? Is it just going to be the most critical layers, or more than that? Do you have that visibility already, or is that still something that has to be defined? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [76] +-------------------------------------------------------------------------------- + + + Yes, we have that visibility -- reasonable visibility from our customers. But it actually leads us to believe what we said in the past that the first year of volume ramp -- and, as you know, with the lengthening of the nodes -- we discussed it a couple of quarters ago -- everything is about 6 to 12 months later than we thought about a year ago. But we believe that the initial year of the production shipment will be a dozen or so tools. And then this will double every year that we move on. +So, we are still -- all our simulation models still show the same thing. So the first year of the production shipments is about a dozen tools. And then it will double the year after that, and double the year after that. (multiple speakers) right model. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [77] +-------------------------------------------------------------------------------- + + + And that's related to the gross margin question, Pierre. Yes, you are right from the direction in the second half, as logic will be a bigger part of it. Directionally, margin goes up. Of course, we don't know the exact volume yet, so we can't describe that volume effect; but, directionally, you are right. One caveat: if there's a concentration of EUV revenue recognition in a quarter, you will see some distortion. But when we get to that bridge, we will explain to you how that works, and show you the margin without EUV as well. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Bernstein - Analyst [78] +-------------------------------------------------------------------------------- + + + Excellent. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + + Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [80] +-------------------------------------------------------------------------------- + + + Thank you. It's Barclays. Good afternoon, guys. Just another one on EUV. In terms of the -- looking at the milestones you are targeting for this year, I'm just trying to understand roughly when we might be able to get a better idea as to how you are making progress. +You seem to be in a bit of a gap at the moment. Clearly, the customers have the 3300 tools installed and running, and those are a lot of the metrics you are talking about. The 3350s are there, or on their way. So when can we expect to see some of the first news on the 3350 tools at the customer sites? Is SPIE too early, or is it going to be a bit later than that? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [81] +-------------------------------------------------------------------------------- + + + That's a good question. You pointed out the 3350 is really the tool that has the improvements on it that will give us the 1,500 wafers per day and the 80% availability capability. Those tools are just starting to ship. They need to be installed. The installation only takes a quarter or three months, which actually makes it too late for any significant information on the SPIE conference, which is in February. So it will be around mid-year. That's what you need to focus on. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [82] +-------------------------------------------------------------------------------- + + + Okay. And then just a quick follow-up. You've highlighted the 6 to 7 EUV tool shipments this year. Can you give us any sense as to when those are coming? Or you haven't really -- I know there's no revenue recognition for those tools. But just in terms of the rough timing of shipment to -- for us to gauge when those are leaving the facility. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [83] +-------------------------------------------------------------------------------- + + + Well, they are starting to leave the facility this quarter, the first one. So it will be throughout the year. There will be tools shipping every quarter. And as to revenue recognition, Wolfgang already said it. I gave some clear guidance for the revenue recognition of the tools that we shipped last year, and the one that was in the process of shipping towards the end of the year. But of the 6 to 7 tools that will ship in this year, there will be some revenue recognition because there's a 3300 in there, which will very likely -- two of them, could be, which will book revenue. +And also on the 3350s, it depends on the commissions or the order conditions, where we can take some revenue already in 2016. So that's why Wolfgang said, it's the minimum, and there's very likely going to be EUV revenue on top of that in the course of the year. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [84] +-------------------------------------------------------------------------------- + + + Understood. Thanks very much, guys. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- + + + Francois Meunier. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [86] +-------------------------------------------------------------------------------- + + + I just wanted to have some technical details about this 3350B that you are currently running in your factory. And first, congratulations for achieving the 1,250 wafers per day in Q4. That's a great achievement. What is, or what was, the availability of this machine actually during Q4? And maybe if you could give us some details about the laser which was used, if it was a 120 watts or a different laser source for EUV? That's the first question. +The second question is -- I know it's a bit cheeky, but it's good to announce the EUR1 billion share buyback. But why not more, given the progress made by EUV [adornment] and your confidence in the 2020 target of EUR10 billion revenues? Thank you. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [87] +-------------------------------------------------------------------------------- + + + Well, I'll start with the second part, and then Peter the first part. Well, this is just another layer. We have a very clearly stated financial policy that says we evaluate what our minimum cash needs are, then we service the dividend first; that we want to have at least stable, preferably growing. Last six years, we have always been growing it. And then all the balance will go towards share buybacks. +Now, we just roll out layers of these share buybacks. And as soon as we have used up the money, we will introduce the next layer of (technical difficulty) be concerned by that at all. We're executing and the financial policy. And as we generate the free cash flow, once we are through the remaining 1.5, you should expect us to announce the next tranche. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [88] +-------------------------------------------------------------------------------- + + + On your question on the technical details of the 3350, well, we started shipping the 3350 in our factory, and we measure availability at that customer sites. While we haven't installed it yet and are running it at the customer sites, so it would be a bit difficult to give you an answer there. It's too early. +Also to the question of -- there's an earlier question: when are we going to see data on availability and wafer spread per day? Probably more towards the middle of the year. +So the technical details -- but there are some features in the 3350, like the in situ cleaning and some other features, that give us the confidence that we should have a higher availability and also a higher throughput. Not so much because we have a stronger laser; the laser is the same, but more because of the transparency of the illuminator and the optics that gives us a better transmission. And that's why we get better throughput. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [89] +-------------------------------------------------------------------------------- + + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [90] +-------------------------------------------------------------------------------- + + + Mr. Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [91] +-------------------------------------------------------------------------------- + + + Hello, this is Farhan Ahmad from Credit Suisse. Thanks for taking my question. Peter, my first question is regarding 3D NAND. I just wanted to make sure I understand correctly, relative to your last call, it seems like you are up-ticking on the overall NAND CapEx. And I wanted to understand whether the linearity of the CapEx is also more weighted like the DRAM CapEx in the first half, or do you expect the NAND CapEx to be more evenly split throughout the year? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [92] +-------------------------------------------------------------------------------- + + + Well, the 3D NAND guidance is up as compared to last quarter, where we thought we were going to be down in this year. But that's because we have this new refurb fab of 3D NAND in China. That actually came up. And it's relatively flat throughout the year, so it's not a big bias to one or the other half. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [93] +-------------------------------------------------------------------------------- + + + Got it. And then relative to your NXE:3350 systems, they are supposed to get you to about 80% availability and 1,500 wafers per day. Where do you see the performance in the lab today? And what should we expect when the tools are at the customer's site? Should we start getting like 1,500 wafers per day from the get-go, or will that take some time to get demonstrated at the customer sites? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [94] +-------------------------------------------------------------------------------- + + + Well, what customers will actually do, because they are very expensive machines, they will always ramp these tools slowly. They go through a process of qualification, and then they will start increasing the power; they will start increasing -- with increasing the power, they will get more wafers. So it's going to be through cycles of learning. So, it is not to be expected that they will go gung-ho from day one. They will probably say, let's start where the 3300 left off, and then they are going to gradually increase. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [95] +-------------------------------------------------------------------------------- + + + Got it. Thank you. That's all I had. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + + Patrick Ho. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus and Company - Analyst [97] +-------------------------------------------------------------------------------- + + + Stifel Nicolaus. Peter, just in terms of the EUV insertion at the 7 nanometer logic node, do you believe the change in cadence with their tick-tock process -- do you believe that buys you a little more time, in terms of guaranteeing the insertion for high-volume production at 7 nanometers? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [98] +-------------------------------------------------------------------------------- + + + Well, I don't think they are that related. Customers have their plans, and whether they follow cadence A or cadence B. What they tell us is that they need their production output in a certain period, in a certain year, which is starting (technical difficulty) and in 2018. And then you just calculate back, using the cycle time that we need. And then we come to a moment where we need to start shipping the tool. +And what ultimately drives the decision of the customer to say, I need that output in 2018 or 2019 -- there are many, many reasons. It is not only cadence. It is also time that they need to actually develop that next node. And, for us, it's not that relevant. Most relevant is when do they need the tool? When do they tell us that they need the tool? And that's [for] 2018-2019 output, 2017 shipment, starting for us. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus and Company - Analyst [99] +-------------------------------------------------------------------------------- + + + Right. And my follow-up question, in terms of the holistic lithography growth that you've seen over the last few years, how do you project the growth first in 2016 and maybe over the next couple of years? Given that it's gotten strong adoption, do you see the growth rates tapering out somewhat? Or where do you expect to continue to see that growth in that segment of your business? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding NV - EVP and CFO [100] +-------------------------------------------------------------------------------- + + + Yes, so, in 2014, our holistic lithography business was just over EUR500 million. Last year, it was over EUR600 million, so it's growing nicely. We've previously talked about by 2017, 2018, we want to be at EUR1 billion for this business. And as a reminder, to a very large degree, a software type of business with very healthy gross margins, only the yields start being the hardware there. +And then you can anticipate that it will continue to grow going into our 2020 plan. It's part of helping us on the accretion of the gross margin to a 50% level. And we have also started to see, and reported back to you, that customers are evaluating some of the software features for EUV, as well. So it's not going to go away when EUV is coming in. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [101] +-------------------------------------------------------------------------------- + + + Yes, and I think just to add to this, I think on the total service end option sales, which includes holistic litho that Wolfgang referred to, in our model we see that growing from the EUR2 billion where we are today to the EUR3 billion to EUR3.5 billion by that time, by 2020. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus and Company - Analyst [102] +-------------------------------------------------------------------------------- + + + Great. Thank you. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR Worldwide [103] +-------------------------------------------------------------------------------- + + + Excuse me. Ladies and gentlemen, we have time for one last call. So if you were unable to get through on this call and still have questions, please feel free to contact the Investor Relations department with your question, and we'll get back to you soon as we can. +Now, Arran, can we have the last caller please? + +-------------------------------------------------------------------------------- +Operator [104] +-------------------------------------------------------------------------------- + + + Timothy Arcuri. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [105] +-------------------------------------------------------------------------------- + + + Cowen and Company, thanks. I had two questions. I guess first of all, Peter, just on the overall 2016 outlook -- I know you said that DRAM is going to be down a lot, NAND is flat, and logic is up a lot due to 10 nanometer. So, where do you and Wolfgang think that that leaves us for the year? Obviously it's going to be up, but how much? Is up 10 a comfortable number for the year, at least? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [106] +-------------------------------------------------------------------------------- + + + Well, we're all well-trained accountants. So if you take 2015, and I would give you a percentage up, we would guide you for 2016, which we said we weren't going to do. So, unfortunately, we have to stick to what we call this qualitative guidance. And I think throughout the year we get -- there's a better feel for how the back end of the year is developing, and really talk about really the Q4 back end of 2016. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [107] +-------------------------------------------------------------------------------- + + + Okay. And then just to follow up on China, I know that there was some questions asked about this. But the big order number of roughly $500 million -- sounds like this is really 3D NAND. But if I divide the numbers, that suggests it's like 120,000 of wafer starts worth of capacity. And we know that the Korea fab in China is full, and the only fab this big is the one that's still searching for a technology partner. I think the fab you talked about in the prepared remarks was half this size. So are we seeing orders for this other fab that is still looking for a technology partner? Or is my math not right? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [108] +-------------------------------------------------------------------------------- + + + Let me make one thing clear: China is not only 3D NAND. That's a new feature of the Chinese market, on this particular refurb fab. But it's only part of the story. There's also Chinese foundries in there. So there's also onesies and twosies shipment to a fab that are almost full. So it's a mixed bag. It's definitely not only 3D NAND. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [109] +-------------------------------------------------------------------------------- + + + Okay. Thanks so much. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding NV - President and CEO [110] +-------------------------------------------------------------------------------- + + + Yes, okay. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding NV - VP, IR Worldwide [111] +-------------------------------------------------------------------------------- + + + Well, thank you, everybody. On behalf of ASML's Board and management, I'd like to thank you for joining us on the call today. +So, operator, if you could formerly close the call, we'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + + Ladies and gentlemen, this concludes the ASML 2015 fourth-quarter and annual results conference call. Thank you for participating. You may now disconnect your line. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2016-Jul-20-ASML.txt b/Transcripts/ASML/2016-Jul-20-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..a8ccf3c3da658a2ea151102720a52146f3eb7cb4 --- /dev/null +++ b/Transcripts/ASML/2016-Jul-20-ASML.txt @@ -0,0 +1,562 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 ASML Holding NV Earnings Call +JULY 20, 2016 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Wolfgang Nickl + ASML Holding N.V. - EVP & CFO + * Peter Wennink + ASML Holding N.V. - President & CEO + * Craig DeYoung + ASML Holding N.V. - VP, IR Worldwide + +================================================================================ +Conference Call Participiants +================================================================================ + + * Timothy Arcuri + Cowen & Company - Analyst + * Mehdi Hosseini + Susquehanna International Group - Analyst + * Francois Meunier + Morgan Stanley - Analyst + * Sandeep Deshpande + JP Morgan - Analyst + * Andrew Gardiner + Barclays Capital - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Kai Korschelt + Bank of America Merrill Lynch - Analyst + * Jagadish Iyer + Redstone Technology Research - Analyst + * Pierre Ferragu + Sanford C. Bernstein & Co. - Analyst + * Robert Sanders + Deutsche Bank - Analyst + * Gareth Jenkins + UBS - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Unidentified Audience Member [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2016 second quarter financial results conference call on July 20, 2016. Throughout today's introduction, all participants will be in a listen-only mode. After ASML's introduction, there will be an opportunity to ask your questions. (Operator Instructions) I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP, IR Worldwide [2] +-------------------------------------------------------------------------------- +Thank you, Arnan, and good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. As per our usual habit, joining me today from ASML headquarters in Veldhoven, The Netherlands is ASML's CEO, Peter Wennink; and our CFO, Wolfgang Nickl. The subject of today's call is ASML's 2016 second quarter results. The length of the call will be 60 minutes and questions will be taken in the order that they're received. This call is also being broadcast live over the Internet at asml.com and a replay of the call will be available on our website. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the Federal Securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Safe Harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Craig. Good morning and good afternoon, ladies and gentlemen, and thank you for joining us for our second quarter 2016 results conference call. You might have noticed that I'm suffering from a bad cold so if you wonder who's on the phone, it's me Peter. So before we begin the Q&A session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter and provide you our view on the coming quarters. Wolfgang will start with a review of the Q2 financial performance with some added comments on our short-term outlook. Then I will complete the introduction with some further comments on the current general business environment and our future business outlook. Wolfgang, if you will? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, Peter, and welcome everyone. For Q2, our net sales came in at a very strong EUR1.74 billion including system sales of EUR1.25 billion driven by logic, which represented 65% of sales with memory representing the balance. Service and field option sales came in at EUR486 million. System sales included partial revenue for two EUV systems of approximately EUR100 million as forecasted at the beginning of last quarter. During the quarter we shipped an additional EUV 3350 system, which will lead to revenue in 2017. Our gross margin for the quarter came in at 42.6%, slightly above our guidance. R&D expenses came in at EUR270 million and SG&A expenses came in at EUR90 million, both essentially as we guided. +Regarding the order book, Q2 system bookings came in at almost EUR1.6 billion. This represents a near doubling of orders from the previous quarter and demonstrates again the lumpy nature of our bookings that we discussed in April. As suggested in our last call, our bookings strength came from the logic sector supporting the 10 nanometer volume ramp plans of our customer. The growing strength in logic and flattening in memory also supports our previous commentary that the balance of 2016 will be logic driven against the stable backdrop of memory spend. We took orders for four new EUV systems bringing our total EUV production tool order book to 10 systems valued at about EUR1 billion. Our overall system backlog now adds up to approximately EUR3.4 billion. +Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents, and short-term investments came in at EUR2.93 billion. Our free cash flow for the quarter returned to a more normal level of EUR381 million after two quarters of quite varied cash flows due to significant amount of customer prepayments on orders received in Q4 in turn resulting in a negative free cash flow for Q1. During Q2 we paid our 2015 dividend worth EUR446 million and executed share buybacks worth EUR164 million. With that, I would like to turn to our expectations and guidance for the third quarter of 2016. We expect Q3 total net sales of approximately EUR1.7 billion. As indicated by our backlog, logic shipment strength in Q2 is set to continue in Q3. We do not expect any EUV system revenue in Q3. +We expect to ship one EUV 3350 system in Q3 leading to partial system revenue in Q4. Last quarter service and field option sales came at EUR486 million. We continue to plan a year-over-year increase of approximately 10% in 2016 for this portion of our business. Field growth continues to be driven by strong demand for Holistic Lithography options, high value upgrades, and a growing install base. For Q3 we expect field options and services revenue of well above EUR500 million. For the full year, we expect overall sales to exceed our 2015 record year. The ultimate level will depend on the timing of EUV revenue recognition as well as the size of the initial ramp of 10/7 nanometer capacity at our logic customers. Gross margin for Q3 is expected to come in at around 47%. R&D expenses for the third quarter will be about EUR275 million and SG&A is expected to again come in at about EUR90 million. +Regarding share buybacks, I would like to mention that we will pause our share buyback program for a few quarters while we are in the midst of the HMI acquisition process. At this time we however expect to complete the EUR1.5 billion program for 2016 and 2017, which we announced earlier this year. And finally, a couple of comments on our intent to acquire HMI as announced on June 16. On July 4, we placed two Eurobonds totaling EUR1.5 billion. The proceeds have been received after quarter-end and are intended to be used for partial financing of the acquisition. We expect the acquisition to close in Q4 of 2016 subject to customary closing conditions including the approval of HMI shareholders scheduled to occur on August 3 and government regulatory approvals from Taiwan, Korea, Singapore, and the United States. +With that, I'd like to turn the call back over to you, Peter. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [5] +-------------------------------------------------------------------------------- +Thank you, Wolfgang. As Wolfgang highlighted, our business continues to perform well. We took system orders of almost EUR1.6 billion and posted sales of EUR1.7 billion, which were very much in line with the prior expectations. Hence our business is developing along the lines that we've communicated over the last few quarters. While Wolfgang reviewed our outlook for the balance of 2016, there are a couple of things I believe are worthwhile highlighting. First, our memory business continues to remain fairly robust with DRAM orders and shipments supporting continued shrink for cost mostly to low 20 nanometer and sub 20 nanometer nodes. Meanwhile NAND manufacturers continue to qualify their 3D NAND products and are ramping their processes through new fab constructions as well as all the 2D NAND fab conversions. +Secondly, as seen in our second quarter results evidence of the 10-nanometer logic ramp is now clear, as our sales to our combined logic customers has developed as expected. This will continue in Q3 supported by strong orders in Q2. As a result, we see combined sales in Q3 at the level of EUR1.7 billion. And as mentioned on previous occasions, the ultimate spend levels for logic in 2016 will depend on, amongst the other things, both the level of end demand and the rate at which our customers will be able to execute their 10/7 nanometer ramps. On the ASML product side, let me jump straight into a discussion on the development of our EUV business. In EUV you're all aware that our continued focus has been on improving EUV stability, availability, and productivity; which are the key performance metrics that drive new technology adoption. +The latest progress on these metrics was shared at SemiCon West last week and we have observed a peak wafer per day performance of 1,488 wafers and recorded system availabilities of over 80% on five field installed systems. These are encouraging results showing continued progress in EUV industrialization allowing for a growing customer confidence towards production adoption. We shipped two EUV systems year-to-date and are on target to ship an additional four to five systems this year, for which we have purchase orders in hand. We believe that the intake of four EUV production orders from two different customers this quarter when added to our existing six orders strongly signals the intent of our customers to insert EUV into production at their next full node transition. +We expect our order book for our production systems to continue to grow in the coming quarters filling up our 2017 shipment capacity of approximately a dozen systems. The tools shipped over the next 12 to 18 months will support integration and device qualification using EUV technology for production insertion at logic sectors 7 nanometer node and at DRAM sectors mid-teens node. In Deep UV, the rollout of our TWINSCAN NXT:1980 immersion system is progressing well. Since introduction, we've shipped a total of 23 systems and upgraded an additional five systems at customer sites to NXT:1980 specifications. We have also installed an enhanced version of the TWINSCAN XT:1460 ArF dry system with a 40% improvement in matched machine overlay demonstrating our commitment to continue to improve the performance of our dry lithography product portfolio. +In Holistic Lithography, we have shipped multiple YieldStar 350 metrology systems to our leading customers to support the qualification and ramp of the 10/7 nanometer logic node. And we have also released a new version of our process window enhancement software suite involving resolution enhancement techniques aimed at helping to maximize manufacturing yields for EUV and immersion-based lithography at the 7 and 5 nanometer logic and 1x memory nodes. Related to Holistic Lithography as announced in June, we have submitted an offer to acquire Hermes Microvision. It is also our clear intent to create through the combination of HMI's industry leading e-beam metrology technology and our unique Holistic Lithography product offering a new class of products for patterning control creating customer value through improved yield and time to market in their pursuit of the extension of Moore's Law. +And finally, as suggested last quarter, expect no changes in our business focus for the foreseeable future. Support of our customers' clear intent of moving EUV into production is our number one priority. Increasing customer confidence in EUV for manufacturing readiness is critical at this point in time. ASML remains committed to do everything within our capability and power to bring EUV to manufacturing readiness. And with that, we will be happy to take your questions. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP, IR Worldwide [6] +-------------------------------------------------------------------------------- +Thanks, Peter and Wolfgang. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. But beforehand, I'd like to ask that you kindly limit your question to one with one short follow-up if necessary. This will allow us to get on as many callers as possible. Now Arnan, can we have your final instructions and then the first question, please? + + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Unidentified Audience Member [1] +-------------------------------------------------------------------------------- +Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator instructions) Sandeep Deshpande, JP Morgan. + + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JP Morgan - Analyst [2] +-------------------------------------------------------------------------------- +My question is clearly, Peter, you're seeing very strong sales trends into the third quarter. How do you see your sales trends into the fourth quarter in terms of EUV? Do you expect of these tools that you're going to ship this year, in the earlier conversation that you mentioned that there was one tool to be recognized in Q4, are there likely to be more of those tools that ship in Q4 recognized in Q4 itself or is that going to be a 2017 phenomenon? And then secondly, regarding early part of 2017 with the foundry 10 nanometer ramp coming to an end by the end of this year, what do you see developing in the first half of next year before the whole? You probably will get a lot of EUV related orders in the second half of next year given that production starts in 2019. So, how do you see developments in the first half of 2017? Thank you. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [3] +-------------------------------------------------------------------------------- +I'll answer the second part of the question. I think on the revenue recognition part, I'll refer to Wolfgang. As you said, the foundry 10 nanometer ramp ending towards the end of the year. As we know, the 10 nanometer ramp for foundry is in fact a part of a let's say bigger logic node, what you call the 10/7 nanometer node. So, what we will see in 2017 the 7 nanometer is expected to be as a strong and a large node. We expect that in 2017 the continuation as almost a logical evolution from 10 nanometer into the 7nanometer node to happen. And you're correct that for 2018 on EUV, we said it before, our production capacity in 2018 will double from 2017. And with the current customer focus on the introduction of EUV in the next logic nodes, yes, we do expect that we will see an order flow in 2017 for EUV to support the shipment capacity and I think also the shipment demand from our customers in 2018. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [4] +-------------------------------------------------------------------------------- +And as it relates to the 2016 EUV revenue recognition, as we mentioned, one of the areas that's not quite clear at this point yet, that's why we can't guide for the full year. But I think there are several elements that I can summarize. First of all, we just recognized partial revenue for two systems last quarter. It is expected that we meet more of the performance metrics this year so there will be additional revenue coming in the fourth quarter. Secondly, we have a shipment that's going out in Q3 that will also have partial revenue recognition in Q4. Thirdly, we will have shipped three systems by the end of Q3 so that leaves three to four systems in Q4 and amongst those systems are systems where we have the opportunity to recognize revenue. +If we ship it in time and the customer accepts it in time that would enable us to recognize revenue also in the fourth quarter and namely those are the systems that were originally the 3300 where the customers have requested certain upgrades and have requested shipment. So, there it depends a little bit on the timing. So, those are the three main revenue drivers for Q4 and on top of that, you'll have a little bit of option service and other EUV related revenue that's also relatively difficult to predict at this point. So nothing in Q3, but then a meaningful number in Q4 and we'll focus on shipping and performing and then the revenue in Q4 should be pretty healthy on EUV. I hope that helps, Sandeep. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [5] +-------------------------------------------------------------------------------- +Kai Korschelt, Bank of America Merrill Lynch. + + +-------------------------------------------------------------------------------- +Kai Korschelt, Bank of America Merrill Lynch - Analyst [6] +-------------------------------------------------------------------------------- +So, I wanted to just continue on the question on the fourth quarter. So I think you laid out the kind of EUV puts and takes, but also you said the lengths of the 10 nanometer and then 7 nanometer nodes and I think you also just said that you expect that to continue into next year. I think TSMC raised CapEx, they also said they have more customer interest at 7 nanometer than they had previously expected. So I guess my question is how conservative is the implied revenue run rate, which I believe is around EUR1.6 billion for Q4, as you see things right now? And then my second question was on EUV, you have a backlog of 10 tools now. Could you just kindly let us know how many customers make up those 10 tools? And also what is the magnitude of potential further orders in the second half of this year or will 2017 be a meaningfully bigger year potentially for EUV orders just so we know what to look for? Thank you. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [7] +-------------------------------------------------------------------------------- +To answer your first question on the 10/7 nanometer continuation, we said it's going to be in 2017. I think what we're hearing our foundry customer say is that 7 nanometer is what they're focusing on. It's not only a single customer, but every foundry customer that we're having and that is talking to us about leading edge, they talk about 7 nanometer. So yes, I do think we will see that continuation in 2017. I don't think it has a major impact yet in Q4. It will have an impact in 2017 onwards. So I think for Q4 and we are not guiding for Q4, but I don't think you should see a significant upside in that particular quarter. That upside in that 7 nanometer node will definitely happen next year. Now the backlog of the 10 tools, how many customers do we have in the backlog? We currently have three customers in the backlog. +And the magnitudes for orders in the second half of the year, I said it in my prepared comments, I believe that by the end of the year we'll have an order book that will be at a level whereby we can ship our entire production capacity for 2017, which is about a dozen tools. So 2017 definitely I think if you look at the customer roadmaps for the next generation logic node and also the mid-teens DRAM; then 2018, beginning 2019 that will be where first risk production will start. That means that the tools need to be in and that means that 2017 must see more orders than in 2016 for EUV because that ramp profile, I think our capacity is probably a good indication of the customer demand and our capacity can actually double for 2018 as compared to 2017. So yes, then we must also see more orders and we will. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [8] +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI. + + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [9] +-------------------------------------------------------------------------------- +First question, I was hoping you could elaborate on the 1Y nanometer DRAM EUV orders that you received this quarter. So as part of that, would love to hear is that two or three tools and when you expect to see follow-on orders and whether that should come from just one chip maker or you expect that from all as they migrate down to 1Y? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [10] +-------------------------------------------------------------------------------- +You are talking about the Deep UV tools? + + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [11] +-------------------------------------------------------------------------------- +No, EUV tools. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [12] +-------------------------------------------------------------------------------- +I think that clearly EUV is focused on the mid-teens DRAM node. I'm not going to go into customer specifics, but you can imagine that leaders act first and how many tools will we ship. This is the first, it's clear that others will follow, but we also need to put it into perspective. Our expectation is that EUV will be used at mid-teen DRAM node for about two layers. So it's a sizeable business, but number of layers is limited. So yes, there will be more tool orders following. It will not stay with this one or two, it will be indeed more, but it's not lot a level of layer accounts that we see in the advanced logic nodes for our logic customers. + + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [13] +-------------------------------------------------------------------------------- +If I could follow up on your 4Q outlook. Can you kind of help us out in terms of thinking in terms of the uncertainly, how much of it is related to the timing of EUV recognition as opposed to uncertainty as to what demand will look like for 10 nanometer and 7 nanometer DUV tools? And as part of that question, do you expect DUV to actually decline QonQ in Q4 as there is a pause at the Tier 1 foundry maker as they move from 10 nanometer to 7 nanometer? Thank you. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [14] +-------------------------------------------------------------------------------- +I'll take that. First of all in my script, I said that the record level of 2015 that we would exceed that. So in that sense albeit to Peter's point, don't expect huge upsides but we will clearly view that at this point as some sort of a floor. And you can see in the EUV, like I mentioned, the upgraded 3300s. If they recognize or not recognize; that EUR60 million, EUR70 million tool holds pretty substantial. And to the 10/7 nanometer ramp, somebody mentioned earlier that TSMC has raised the CapEx budget by $0.5 billion. They seem to be pretty confident. I'd like to just remind you that one of these tools is EUR50 million and it can very easily be that two or three tools go to the left or the right of a quarter and then it's also a pretty substantial difference. +As it relates to Q1, Q2, Q3, Q4 revenue recognition, again we will guide you as we ship these tools; but we ship like we said three to four tools in the last quarter of the year so they will not all recognize in the last quarter. So, you should assume that we're going on to a more regular EUV revenue floor. Also quite frankly as we show that we can reliably install these tools and we can therefore, like we discussed on prior call, hopefully recognize at least portions of it much closer to shipment date rather than waiting for the complete installation in the field. So, 2017 will make this all closer connected to the shipment date. I hope this helps, C.J. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [15] +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company. + + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [16] +-------------------------------------------------------------------------------- +The first question, Peter, is again around logic. I'm wondering sort of how the transition is going to look between 10 nanometer and 7 nanometer and I'm trying to compare it back to the transition between 20 nanometer and 16 nanometer. 16 nanometer wasn't really a real litho shrink so of course there was a lot of reuse from the litho side between 20 nanometer and 16 nanometer. So, I'm curious what you think the reuse will be for what gets ordered for 10 nanometer to get reused at 7 nanometer. Obviously I know that there is going to be some EUV tools used at 7 nanometer that are being used at 10 nanometer. But just sort of in general, what do you think the reuse will look like between 10 nanometer and 7 nanometer? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [17] +-------------------------------------------------------------------------------- +It's a good question. But what we're currently planning is like you pointed out that the 10 nanometer node is not a very large node, it will not entirely go away, and the expectation for the 7 nanometer node are actually quite strong. So, there's always going to be some level of reusage actually planned. We don't think that percentage of reuse is going to be anything significantly different than what we saw in the past. Having said that, reuse is not something that you can generically apply over the logic or the foundry customers. Some customers that are extremely successful at a certain node or are very successful at a certain node get also follow-on orders on that node, we've actually seen that also in the past, and they will have a very limited percentage of tools that they will apply for or go reuse to the next node. +And others are less successful in a certain node and they do a lot of reuse for another node. So, it really depends on whether the installed capacity for the 10 nanometer node currently has enough customer base and you have to remember, it is not a lot. The 10 nanometer installed by the end of this year maximum [35,000, 40,000k]. So, that's not a lot. So, you have some big customers and you are full and then everybody moves to 7 nanometer, which will be different customers. So it's difficult to say very customer specific, very specific to their customer base, and what we are currently planning and also our longer-term planning is that we don't see as a major shift or a major impact of that reuse model going forward. + + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [18] +-------------------------------------------------------------------------------- +And then second question for Wolfgang. Wolfgang, now that obviously EUV is going to I think be inserted at least partially at 7 nanometer, that's clear. Can you again remind us of what the margin targets will be? So maybe you need to ship X number of tools to have EUV be 30% margin, you need to ship Y number of tools to have EUV be 40% gross margin. Can you give us those mileposts again? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [19] +-------------------------------------------------------------------------------- +So in order to get to our 2020 target of 50% overall gross margin, we would have to arrive at 40% for EUV. Of course we are much lower than the net today. There are several elements that contribute, I think the biggest one is using our production facilities. We have built a factory that can do many more tools than we're doing this year or next year or even in 2018. So, that is the big thing. The second thing is of course the learning curve both at us and our suppliers so for instance, the number of hours it takes you to put one of these systems together and then the takedown costs at the suppliers. The third one is as you learn, you're also having less E&O, excess and obsolete, due to redesign. +And also, and this is often getting overlooked, if you launch a product and you go from a 3300 to a 3350 and to a 3400, you often have to do rework in the field that you cannot necessarily always charge, but it goes into your gross margin and that will go away over the next one or two years. I think as an orientation we believe from a volume perspective, we should be in the neighborhood of 40 tools to be able to get to the 40% gross margin. And depending on the ramp of production for 7 nanometer or 5 nanometer respectively in 2019 and then associated DRAM volume, I think the result of that volume you could see in the 2019 timeframe so well in time for our 2020 objective. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [20] +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna. + + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [21] +-------------------------------------------------------------------------------- +Of the 10 EUV systems you have in your backlog, can you help me with the mix between 3350 and 3400? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [22] +-------------------------------------------------------------------------------- +Let me think. I want to say there is only one 3350 in there. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [23] +-------------------------------------------------------------------------------- +Three. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [24] +-------------------------------------------------------------------------------- +It's three 3350, seven 3400. + + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [25] +-------------------------------------------------------------------------------- +How does the ASP change as you go from mature generation to the next generation like from 3350 to 3400? Should we assume like that there is a 10%, 20% increase in ASP? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [26] +-------------------------------------------------------------------------------- +List price 3300 was somewhere between EUR60 million and EUR65 million, 3350 is mid EUR90s million, and then the 3400 is about EUR20 million higher than that. + + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [27] +-------------------------------------------------------------------------------- +Okay. And then my final question, it's good to know that at 50 nanometer DRAM EUV is going to be inserted for two layer. Is there any update on the logic side 7 nanometer logic? I think in the past you have talked about a range of two to six or eight layers, it will be great if you could provide an update? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [28] +-------------------------------------------------------------------------------- +I think this is of course device specific, Mehdi, but it is definitely not two. I think we're looking at layer counts anywhere between six and nine. + + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [29] +-------------------------------------------------------------------------------- +Six and nine. But given the fact that there is a ton more DRAM wafer capacity, would it make sense that by 2020 DRAM actually would account for a larger mix of EUV demand than logic just because there is more wafer capacity? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [30] +-------------------------------------------------------------------------------- +That's a good point. If you look at it, the wafer capacity is a lot bigger and going forward you could also argue whether let's say the mid-teens DRAM, the layer count will stay at two. Also could grow. But that's indeed true that it's a much bigger market so that means it's a very substantial part of the EUV business. Now how big it will be also depends on the aggression with which customers are going to add EUV layers and it also depends on the growth rate of the memory market. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [31] +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley. + + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [32] +-------------------------------------------------------------------------------- +So, I'd like to know a bit more details about the previous question actually because I think you said in the past that logic was 250,000 wafer per month probably at 7 nanometer. So I think given the layer of assumption, it's relatively easy to find the number of tools which are needed. I'm a bit struggling to do the same exercise for DRAM. So like let's say if the addressable market is 60 to 80 EUV tools for logic, how much would it be for DRAM? Is it like 25%, is it 50% of that market; is it more, is it less? Just like if you could give us at least a few numbers we can play with. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [33] +-------------------------------------------------------------------------------- +I can give you any number to play with and you can have several simulations. But what I said earlier, I think it is important to understand that there will be two layers or will be more going forward. That is very important, but we don't have that information yet so that's why it's pretty difficult for us to make that particular assessment. And also the growth of the memory market and the DRAM market of course is definitely of impact. I think most important here is that I think by 2020 we would have a build capacity of maximum 60 units. I'm not saying that we're going to sell all those 60 units because like I said earlier, we don't have all the information yet to understand what our customers are planning. +But memory is going to be a significant part of our EUV business, that is clear. And like Wolfgang said, to be profitable in 2019 to 40% gross margin that we need 40 systems. Now when we look at 2019, look at the logic part, look at the memory market; I don't think that 40 systems is a big challenge or a big stretch when you look at our current assumptions of the growth of the memory market and of the logic market. But how it is divided between the two, that still remains to be seen. So, you have to give us a break on this and I can give you a couple of numbers so you can play with those numbers, but I think you can do that yourself also. + + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [34] +-------------------------------------------------------------------------------- +Okay. Just a quick follow-up. On your R&D budget, I was wondering if suddenly there's a scrutiny of the public market and maybe you were a private company and you could maybe increase your R&D budget more than it is today, on what would you spend it on and is there anything that would be tried to make EUV happen not necessarily quicker but in an even easier way for the customers? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [35] +-------------------------------------------------------------------------------- +I think whether we are a public company or a private company, we would spend the money wisely and that means that yes, we have an R&D budget today about EUR1.1 billion. If we think we in the interest of our customers and in creating value for ASML need to increase that to EUR1.2 billion or EUR1.3 billion, we would; but we are not doing that. So, I don't think there's a big difference between whether we're public or whether we are private. We're spending the money as wisely as we can. We've also said that when we look at the EUR10 billion target, our R&D could be about 13% so it's EUR1.3 billion. What will we spend that money on? I can give you some indication there. +There's the next generation EUV. We have a 0.33 NA EUV tool today, which is the 3350 and the 3400. We will go to then a higher NA, higher numerical aperture tool, in the next decade; probably seeing first shipment early next decade. We would start spending money on that because the 3300 or the 3350 is just the first of a series. As the NA improvement will drive down, the geometries will push the shrink. So, that's definitely something that we would engage in. And don't worry, our engineers when we look at EUV and we look at our Holistic Lithography focus, they will find ways to spend EUR1.3 billion. And if you would ask them, they will also find ways to spend EUR1.5 billion, but we want them to (inaudible). + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [36] +-------------------------------------------------------------------------------- +Pierre Ferragu, Bernstein. + + +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford C. Bernstein & Co. - Analyst [37] +-------------------------------------------------------------------------------- +So, I'm trying to wrap up the overall picture of this EUV trajectory for logic and when I'm thinking about how much uncertainty is left in what's going to happen in the next let's say three years. So I like to think of it in terms of timing and when I hear you, it feels like timing is fairly nailed down and volume production is going to be 2019. So, my first question would be am I right thinking that's the right timing; very unlikely things happen earlier, very unlikely things happen later? And then I would have the second question about the volume of insertion, six to nine layers as you said and in line with TSMC comments, feels like a fairly large volume insertion of EUV so maybe in the higher end of the range of what you've been talking maybe a year ago. And then my last question of course is the volume of production like the capacity that you're going to be ramped at for the 7 nanometer and 5 nanometer nodes. I think we talked in the past that capacity is declining from one node to the next one around 10%, but with a fairly wide range of possible outcome there. So, how much more visibility do you have on that metric? So the first one is timing, the second one is volume of insertion, and the third one is production capacity ramp at each node. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [38] +-------------------------------------------------------------------------------- +I think I'll leave the third question to Wolfgang. On timing, I think you're about right, 2019, 2020 volume introduction which means for us at least a year, 12 to 18 months earlier you need to start shipping. Don't forget also this is the first high volume ramp of a new lithography technology in high volume manufacturing so customers will take a bit more time to get the tools installed, qualify their process. It will just take us a bit more time. But from a customer perspective 2019, 2020 high volume usage, that's about the right timing. The volume of insertion, yes, the high end of the range six to nine layers, that could be. We have more insight now than we had one year ago. Customers have more insight now. Customers have also found out we suppose and that's basically on what we hear from them that trying to do 7 nanometer on the critical layers with multiple patterning strategies is a very costly and a very painful exercise. So we're just closer let's say to the insertion points and to the decision points, customers have done a lot more work. That's why we have a bit more clarity and it is indeed at somewhat of the higher end of that range that we talked about last year, but it is what it is. Wolfgang? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [39] +-------------------------------------------------------------------------------- +On the volume assumptions, historically we have always counted on like 300,000 wafer starts per month. Certainly was still true for the 2080s, actually exceed a bit, and our assumptions haven't changed. We assume that over time the semiconductor growth rates will come down a little bit from what they have been in the last 10 years to potentially approach GDP at one point in time. That's why we have modeled a 10% reduction node over node. So 2016; 14 would be about 270; 10 including those 10 equivalent would be in the 220s and 230s; and then 7 and the 7 equivalent would be somewhere around 200. But don't forget that the litho intensity is going up for these nodes so that still enables us to have the revenue growth that we have forecasted. Those are our assumptions on the wafer start. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [40] +-------------------------------------------------------------------------------- +I'd like to add to that that last quarter we also made it clear, I at least hope, that you see especially in logic that you have layers of nodes that are now on top of each other. We are still shipping 28 nanometer capacity and there is a move of those let's say second tier logic makers to move to 14 nanometer and 16 nanometer. So, these are not nodes that have ended. There is a much longer tail life of those nodes, which makes it more difficult to also predict how big nodes are going to be because the lifetime of that node is much longer than we saw five, six, seven, eight years ago. + + +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford C. Bernstein & Co. - Analyst [41] +-------------------------------------------------------------------------------- +Okay. And one very quick follow-up. So far in the ramp of the 10 nanometer node when you talk planning with your clients, you feel that your assumption of capacity of 230 for that node still is the right ballpark assumption? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [42] +-------------------------------------------------------------------------------- +Yes. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [43] +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone. + + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [44] +-------------------------------------------------------------------------------- +First on the post HMI, how realistic will you be able to intercept the 7 nanometer with the radical inspection product or should we think beyond 7 nanometer with the HMI product? And then I have a follow-up. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [45] +-------------------------------------------------------------------------------- +I think the 7 nanometer product if you listened carefully, 7/5 nanometer customers are discussing that's a 2020 timeframe in high volume production. I think that's what we're focusing on. This is 2016, there's still three, four years from now. So yes, we are focusing on catching that node. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [46] +-------------------------------------------------------------------------------- +And we also said in the announcement of the acquisition that we peg that market at about EUR200 million by 2020. So that assumes that for these nodes, there would be a revenue opportunity there. + + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [47] +-------------------------------------------------------------------------------- +Okay. And then you had a big uptick in the foundry bookings. So, how would you characterize that between leading edge versus trailing edge and how should we think about your core immersion segment evolving over the next two to four quarters? Thank you. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [48] +-------------------------------------------------------------------------------- +I think it's fair to assume that the majority of the bookings are for the leading nodes 10 nanometer and that's pretty clear. But to Peter's point just a minute ago, we do have the situation that nodes are stretching out. And if I can remind you about the first quarter of this year, I think it was 35% of our system revenue came from China and a good chunk of that was driven by lagging nodes that are still very good business for our customers. And in terms of forward looking, the exposures on new nodes will go up and just because we're doing more with EUV in the future doesn't mean that the DUV business is going away. We continue to invest, as you probably know, close to half of our R&D budget on non-EUV. +So, we keep advancing it so that customers can get the cost down on these layers as well and as a consequence when you look at our EUR10 billion plan by 2020, the DUV business will not look much different than it does today. Somebody asked earlier about reuse, what you do see is that we help customers significantly in bringing the cost down and instead of unnecessarily shipping a scanner, we're also helping them to upgrade the scanners that they already have, which is capital efficient for them and very good business for us. So, that continues to be very, very good business for many years to come for us. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [49] +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS. + + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [50] +-------------------------------------------------------------------------------- +Could I just ask a couple of questions on the HMI deal in particular? I wondered if you could talk about feedback from customers with regard to regulatory approval? And secondly, I wondered if you could talk about the market share expectations on the EUR2.3 billion TAM that you see incremental from doing this deal? And then I have one more follow-up. Thanks. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [51] +-------------------------------------------------------------------------------- +I can do the regulatory and you want to do the market share assumption? So on the regulatory, we haven't gotten any negative feedback from customers. Quite the opposite, I think customers see the uniqueness of a combined solution in particular bringing the software aspects in there and that helping them to bring this from the R&D into the production environment and go much more to a controlled solution rather than just a monitoring or qualification solution. On the regulatory front, we have submitted our applications in Taiwan, Korea, and Singapore. I think that should go reasonably well. We also have a [SEC] filing in the US that's due to be filed before this month is over. We so far don't see any hurdles on that front. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [52] +-------------------------------------------------------------------------------- +On your market share assumptions, I think we basically show the entire market which includes the wafer monitoring control, also it's the high volume. All together we think it's about EUR2.3 billion. The market share assumptions that we have I think are not for public disclosure now. I think what is the most important is to realize that what we're trying to do is to create a product that does not exist today. We think that at sub 10 nanometer, the pattern fidelity control is going to be more important with the resolutions going down and that's why we need a different solution and that solution is in a sense new and is driven by the uniqueness of the holistic lithography capabilities of ASML. That is something that you will not find in any other place. +Now if you can combine that with the leading e-beam, that is a very good opportunity to actually help our customers manage their yield. But you have to realize also that we need a e-beam solution and we believe HMI is a leader and we can introduce it faster. But we could have also chosen to actually partner with another e-beam manufacturer. We could have chosen to acquire e-beam intellectual property and do it ourselves. That's all being part of our assessment of how do we bring this new solution to the market that is being driven by the uniqueness of ASML Holistic Lithography. And e-beam in itself is a highly competitive market and HMI is a great company and it just allows us to be faster, but it doesn't mean that that's the only way to bring the solution that we have in mind to the market. + + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [53] +-------------------------------------------------------------------------------- +Could I just ask one follow-up on that, Peter? What's the timetable for combined products between your litho and their e-beam solution for this whole pattern integrity products and do you need to inject R&D into HMI to bring that to market? Thanks. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [54] +-------------------------------------------------------------------------------- +Yes, the R&D will grow, that's clear. It will grow both at ASML side and at HMI side. On the other hand, there's also projected growth of the topline. So, I think it's too early to talk about the financial models, but yes, there will be additional R&D needed and I think that's going to be funded out of our projected business growth. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [55] +-------------------------------------------------------------------------------- +I think one addition probably on the timeline, that's not completely nailed down. But that's again where one of the benefits comes in on combining the two solutions because you can't wait all the way for multi-beam. If you use the software to guide the beam to areas of interest, you potentially get a solution faster to the market. That's one of the uniqueness of what we add to this combination. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [56] +-------------------------------------------------------------------------------- +Robert Sanders, Deutsche Bank. + + +-------------------------------------------------------------------------------- +Robert Sanders, Deutsche Bank - Analyst [57] +-------------------------------------------------------------------------------- +First question would just be on Intel specifically. Do you agree that 7 nanometer design rules are fairly well locked down now therefore your EUV opportunity is more limited in terms of the number of critical layers? I'm talking about sort of three to six rather than the six to nine that you talked about generally before. And then second question would just be around the possibility to sign volume purchase agreements from TSMC and Samsung in the same way that you have with Intel. It would seem to me a very important thing to do in order to build confidence in the supply chain to expand capacity. Thanks a lot. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [58] +-------------------------------------------------------------------------------- +On your last comment, thanks for your business advice and we will definitely do that. The PPAs are going to be particularly important not only for the supply chain, but also to guide the EUV business with the two names that you just mentioned. Now I'm not going to be specific on any customer and I made this comment of six to nine because we are in contact with customers and somebody else asked the question earlier on in the call, you seem to be at the higher end of your range as compared to one year ago. We just know more and I think the customers also know more. And it's interesting to understand that you think it's three to six. So, I would invite you to contact our Investor Relations department and discuss with them why you think it's three to six while we based on our customer interactions think it's six to nine. + + +-------------------------------------------------------------------------------- +Robert Sanders, Deutsche Bank - Analyst [59] +-------------------------------------------------------------------------------- +That was from IR this morning. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [60] +-------------------------------------------------------------------------------- +Three to six? I look at IR here and they look with amazement. + + +-------------------------------------------------------------------------------- +Robert Sanders, Deutsche Bank - Analyst [61] +-------------------------------------------------------------------------------- +Okay. I'll follow up offline. Thanks. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP, IR Worldwide [62] +-------------------------------------------------------------------------------- +Operator, let me jump in here. I think we have time for just one last call. And if anybody was trying to get into call and couldn't, I would offer IR's time this afternoon or in the coming few days to answer any questions you might have. And with that, Arnan, can we have the last caller, please? + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [63] +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays. + + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays Capital - Analyst [64] +-------------------------------------------------------------------------------- +We spent quite a bit of time talking through what's happening on the foundry side and particularly with 7 nanometer growing into next year. I'm just wondering if you could help us with a bit more detail on memory as well. Clearly it's been a slightly tougher year in terms of revenue from that customer group particularly on the DRAM side and it looks like we're going to be down somewhere in sort of the mid-20% range in 2016. But given what you've described about transitions and what you know about happening with 3D NAND and sort of filling some of these facilities, why wouldn't we see memory spending come back up to some of the levels that we'd seen in prior years after this more transition year? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [65] +-------------------------------------------------------------------------------- +That's a good question and I think there is no reason why we shouldn't. You just mentioned a couple of those drivers. 3D NAND is particularly strong. There will be new 3D NAND constructions coming online next year, they need tools. They are Greenfield fabs, they need a lot more litho. So, that will drive the business definitely. And as with respect to DRAM, you're correct. You could argue that we're in a bit of a slow period. And what we mentioned on the EUV insertion in DRAM is clearly again driven by the necessary technology transitions to reduce cost. Everything that we're currently shipping into DRAM is with those customers really focused on their next node. So, it's technology transitions that are driving the DRAM demand currently. 3D NAND we're expecting as you said for 2017 definitely an increase because of the new construction sites that are coming onstream. And DRAM, yes, it's been a slow period. I would be with you if you would say there's an opportunity next year for the memory space, I would agree with you. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP, IR Worldwide [66] +-------------------------------------------------------------------------------- +On behalf of ASML's Board of Management, I'd like to thank those that joined us today for taking the time to do so. And operator, if you could formally conclude the call, we'd appreciate it. Thanks. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [67] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this concludes the ASML 2016 second quarter financial results conference call. Thank you for participating. You may now disconnect. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2016-Oct-19-ASML.txt b/Transcripts/ASML/2016-Oct-19-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d0640e59f1808f686e51946db08e584e6f60233 --- /dev/null +++ b/Transcripts/ASML/2016-Oct-19-ASML.txt @@ -0,0 +1,607 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 ASML Holding NV Earnings Call +OCTOBER 19, 2016 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Wolfgang Nickl + ASML Holdings NV - EVP & CFO + * Craig DeYoung + ASML Holdings NV - VP IR & Corporate Communications + * Peter Wennink + ASML Holdings NV - President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Timothy Arcuri + Cowen and Company - Analyst + * Gareth Jenkins + UBS - Analyst + * Andrew Gardiner + Barclays - Analyst + * Francois Meunier + Morgan Stanley - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Sandeep Deshpande + JPMorgan - Analyst + * Kai Korschelt + BofA Merrill Lynch - Analyst + * Farhan Ahmad + Credit Suisse - Analyst + * Patrick Ho + Stifel Nicolaus & Company, Inc. - Analyst + * Amit Ramchandani + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2016 third-quarter financial results conference call on October 19, 2016. (Operator Instructions). +I would now like to open the question and answer queue. (Operator Instructions). +I would now like to turn the conference over to Mr. Craig DeYoung. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holdings NV - VP IR & Corporate Communications [2] +-------------------------------------------------------------------------------- +Thank you, Patricia, and good afternoon and good morning, ladies and gentlemen. This is Craig De-Young, Vice President of Investor Relations at ASML. Joining me today from our headquarters here in Veldhoven, the Netherlands, are Peter Wennink, ASML's CEO; and Wolfgang Nickl, our CFO. +The subject of today's call is ASML's 2016 third-quarter results. The length of the call will be 60 minutes, and questions will be taken in the order that they're received. The call is also being broadcast live over the Internet at www.asml.com, and a replay of the call will be available on our website. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. +For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website and in ASML's annual report on Form 20-F and other documents, as filed with the Securities and Exchange Commissions. +Now with that, I'd like to turn the call over Peter Wennink for a brief introduction. +Peter. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Craig. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our third-quarter 2016 results conference call. Before we begin the question and answer session, Wolfgang and I would like to provide you with an overview and some commentary on the recent quarter, and provide you our view of the coming quarters. +Wolfgang will start with a review of the third-quarter financial performance with some added comments on the short-term outlook, and I will complete the introduction with some comments on our longer-term outlook and of EUV's [facts]. +Wolfgang, if you will. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, Peter, and welcome, everyone. +For Q3, our net sales came in at a very strong EUR1.81 billion. System sales accounted for EUR1.24 billion, driven by logic, which represented 84% of sales, with memory softening temporarily to 16%. +System sales included partial revenue recognition of approximately EUR85 million for the one EUV system we shipped during the quarter. This EUV revenue was not forecasted at the beginning of the quarter, and was made possible because EUV system installation timing became predictable earlier than expected. +From this point forward, on new EUV shipments, a majority of revenue can be recognized at completion of system shipment. +Service and field option sales for last quarter came in at a strong EUR577 million. +Our gross margin for the quarter came in at 46%. This margin was negatively impacted by 1.4 percentage points due to the partial revenue recognition of the one EUV system not originally forecast in revenue. Non-EUV gross margin came in above our expectations. +R&D expenses came in at EUR273 million, and SG&A expenses came in at EUR89 million, both essentially as guided. +At quarter end, we had to make a fair value adjustment for the foreign exchange hedging instruments that we entered into in connection with the planned acquisition of HMI. This adjustment reduced our net income by approximately EUR28 million, and was recorded in the interest line of our P&L. +Shifting to the order book. +Q3 system bookings came in just over EUR1.4 billion. This included more than EUR300 million in EUV orders. Strong bookings continued in the logic sector in support of the 10-nanometer RAMs, with memory bookings increasing from last quarter, supporting stronger memory shipments expected in Q4. +Logic and memory bookings strength was in part due to three new EUV orders received from both sectors. These orders bring our total EUV system order book for 3350s and 3400s to 12 systems valued at about EUR1.3 billion. Our overall system backlog grew by approximately EUR90 million to EUR3.5 billion. +Turning to the balance sheet. +Quarter-over-quarter cash, cash equivalents and short-term investments, came in at EUR4.31 billion. This includes the proceeds from two eurobonds that we issued in July to partially finance our acquisition of HMI, which is expected to close later this year. +Free cash flow for the quarter was a negative EUR72 million driven by shipment linearity and shipments for which we had received partial prepayments during the prior quarter. +With that, I would like to turn to our expectations and guidance for the fourth quarter of 2016. +We expect Q4 total net sales of between EUR1.7 billion and EUR1.8 billion. While logic shipments supporting 10-nanometer ramps will continue in Q4, we will see them a bit more balanced against memory shipments. +We expect to ship one NXE:3300 EUV system in Q4, with an associated partial revenue recognition of approximately EUR60 million. Furthermore, we expect recognition of deferred EUV revenue of approximately EUR80 million in the quarter. Total 2016 EUV shipments will then come in at four systems, two systems short of our targeted minimum of six systems. +For one system, the customer's factory is not ready yet to receive the system; and for the other system, we experienced a delay of inbound material. +The two systems that will move to 2017 will be incremental to our 2017 plan. As a reminder, we have a production capacity of around a dozen systems next year, and expect the outstanding orders to fill up that capacity by the end of this year. +We expect Q4 service and field options revenue to come in above EUR600 million, driven by ongoing strong demand for holistic lithography options, high-value upgrades, and our growing installed base. +Gross margin for Q4 is expected to come in between 47% and 48%, benefiting from the recognition of the deferred EUV revenue I mentioned earlier. +R&D expenses for the fourth quarter will be about EUR275 million, and SG&A is expected to come in at about EUR100 million. SG&A is impacted by one-time costs which are related to the planned acquisition of HMI. +Regarding share buybacks, as mentioned last quarter, they have been passed while we were in the midst of the HMI acquisition process. +Let me conclude with a couple of comments on the status of our acquisition of HMI which we announced on June 16. +In early August, HMI shareholders have voted in favor of the acquisition. We have received regulatory approval from CFIUS in the United States, from the Competition Commission in Singapore, from the Taiwan FTC, and from the Taiwan Investment Commission for our inbound investment. We're awaiting approvals from the Korean FTC and the Taiwanese Investment Commission for an outbound investment related to the private placement in ASML shares. +Closure of the acquisition is still planned for Q4 of this year, and we have begun the transfer of funds to Taiwan for final execution of the purchase. +With that, I would like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [5] +-------------------------------------------------------------------------------- +Thank you, Wolfgang. +As Wolfgang highlighted, our business continues to perform well and as expected. He has discussed the most relevant point of the quarter and our outlook for the balance of this year. I would like to take a bit of time to talk about our initial view of 2017 and review the status of our EUV program and customer interaction. +Although it's too early to formulate a full quantitative view about next year, we've started to develop a qualitative view based upon early customer forecasts and our own modeling capability. Both of the memory sectors are expected to show solid bit growth again next year, not too dissimilar from this year. +Given the available wafer capacity in the memory industry, this in turn should drive our memory sales to levels of little spend at slightly higher than this year. +We expect 10-nanometer logic ramps to continue in support of the healthy demand levels for this generation of devices, as also recently confirmed by one of our large foundry customers. +Service and field option sales is expected to continue to grow in 2017, well on track to support our 2020 target of around EUR3 billion. This is in part driven by significant sales of scanner system upgrades, supporting the efficient capital deployment of customers in the leading-edge node transitions. +Regarding EUV in 2017, we will start to see the real impact of EUV system sales on our top line, with recognition of systems shipped in the calendar year, as well as pieces of remaining revenue recognition from systems shipped this year. +As Wolfgang mentioned, EUV system installation timing became predictable this quarter such that we're now able to recognize the majority of system revenues upon shipment. +You all may have heard a significant amount of -- I would call it chatter this quarter about what one might call a go, or no-go issues with EUV in logic. This is understandable given the current status of EUV maturity and its related stability performance. +However, let me remind you at this point that our customers are facing unprecedented imaging and overlay challenges, and that they're all convinced that this imaging technology will help to overcome those challenges. And as a result, it should be no surprise to you that our efforts are fully focused on the [utilization] of this technology, specifically on the system availability of these highly capable yet complex tools. +We believe the commitment of our customers is evidenced by the fact that we now have 12 NXE:3350 and 3400 production systems in our backlog. We will also ship the final two NXE:3300 systems, one before year end, and the other in early 2017, to two different customers such that they may also begin their in-house qualification of EUV for eventual production insertion. This will bring the total number of customers qualifying EUV for mass production to six, both in memory and logic sector. +All of our major customers have now publicly announced their intent to insert EUV into their production roadmaps. Final decisions on the exact timing of EUV insertion by our customers will vary from customer to customer. +Next to the timing of customers' development programs, the number of EUV specific layers and their related planned timing of the high-volume ramp, it also depends on key tool performance metrics, all within a fairly tight but well defined time window. +Given the current status of the aforementioned, we expect that the production insertion of EUV will require shipping systems in volume starting in the 2018/2019 timeframe. +Just to remind you of our production capability, we will be able to produce around 12 new NXE:3400 systems in 2017, doubling this in 2018, and again approximately doubling this is in 2019. +Currently, our leading EUV adoption customers are executing real pre-production layer qualifications, trusting that we will bring litho system reliability to an acceptable level for high-volume manufacturing insertion in the timeframes I just mentioned. +To finish, supporting our customers' clear intent of moving EUV into production is our number 1 priority in order to ensure that our customers can execute their planned next node industrialization. ASML remains committed to do everything within our capability and power to bring EUV to manufacturing readiness as soon as possible. +And with those comments, I will be happy to take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holdings NV - VP IR & Corporate Communications [1] +-------------------------------------------------------------------------------- +Thanks, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session, but beforehand as I always do, I would ask you to kindly limit yourself to one question with one short follow-up if necessary, and this will allow us, of course, to get in as many callers as possible. +Now, Patricia, could we have your final instructions and then the first question, please? + +-------------------------------------------------------------------------------- +Operator [2] +-------------------------------------------------------------------------------- +Thank you, sir. (Operator Instructions). Sandeep Deshpande, JPMorgan. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [3] +-------------------------------------------------------------------------------- +My first question is regarding EUV, Peter. EUV seems to have reached many of the landmarks that you have talked about. You've highlighted today the 1,500 wafers per day. One of your tools is doing 90% availability. But the question I have is, is there a moment where TSMC, or Intel, or Samsung says, well, the EUV tool from ASML, say, NXE:3350 is now qualified by us and we will be implementing it? Or this is not -- do you not [agree] that that happens, that disqualification is announced, and this is just an ongoing process with the customer? +And I have one quick follow-up. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [4] +-------------------------------------------------------------------------------- +Yes. I think you basically gave the answer. This is basically an ongoing process and it has to do with the fact that, yes, we are reaching the targets that you just mentioned on a regular basis, where it's the variability of the tools in field or in the entire installed base that is not consistently at those levels. And I think this is really what customers and ourselves are now working on to execute on those programs that will bring that consistency, and that will be an ongoing process. +And like I said in my introductory statement, the requirements for us to start shipping EUV tools for insertion in high volume is for us the 2018 and 2019 timeframe. +So we have still some time, and this is exactly what we're going to use to get that consistency there so that us and our customers can take that informed position. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- +Thank you. And then in the follow-up, you talked about what you expect for 2017. I'm sure you've heard one of your major foundry customers' conference call last week where they said that they believe the 7-nanometer node for them is going to be as big as the 28-nanometer node. The 28-nanometer node, as you've highlighted yourself, was a very major node at the foundries as such, and have you taken that into account in terms of your views into 2017 in terms of growth from the foundry/logic customers? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [6] +-------------------------------------------------------------------------------- +Well, I think we've always said that we believe that potential 7-nanometer node was going to be a real node and a real node in volume, and we just get the confirmation from our customers that that is indeed the case, and that statement was made last year is just a confirmation of what we have believed all along. +So, yes. We will see a continuation, a strong continuation. And let's be honest, 2016 was a strong logic year for us, and we see that continuing into 2017. There's no sign of any waning of our customers' intents. + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [7] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +C.J. Muse. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [9] +-------------------------------------------------------------------------------- +I guess the first question, I wanted to get a little bit deeper into deferred revenues and how would you think about EUV prospectively. So once you recognize the EUR80 million in Q4, can you share with us what deferred revenues will be remaining? +And then as part of that, how we should think about what percentage of ASP will be revenued immediately upon shipment. +And then lastly, how should we think about gross margin trajectory now that your revenue-ing upon shipment in the calendar 2017 timeframe? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [10] +-------------------------------------------------------------------------------- +Okay. I will take this, C.J. +First on deferred revenue. First of all, it's in our mind a significant achievement that we now have this predictability of the installation because that takes one of the big hurdles to recognize revenue in the same way as the EUV way. +So we basically have two elements. We have the shipment, and then we have certain fulfillments criteria that we have to achieve later on. +So in this particular case with the 3350, you know what the price of that tool is. It's in the mid EUR90 millions, so you can do the math what we're going to recognize for that tool in 2017, I guess. +Performance criteria is linked to the targets that Peter mentioned in his remarks, so as we are achieving these, you should expect us in the next year, 2017, to also recognize that part closer to shipment. +So also in Peter's remarks, already we said that for the 2017 shipments we'll recognize the majority. And I have to tell you it's a little bit different customer by customer, but it is the majority, as you have just seen from this 3350. +We will be not only able to recognize the majority of revenue closer to the shipment, but we will also have catch-up from this year's shipment. So we shipped units for instance in the first half of the year that will see no revenue in 2016, so you'll see catch-up there. +So very pleased with that. In the meantime, well, we're working through the last couple of bumps there to get to the DUV-like revenue recognition. We will update you on a quarterly basis on what the revenue will look like. Just like we did it for Q4, we have one system at EUR60 million, but then we have deferred revenue coming in at an additional EUR80 million. +As it relates to the gross margin, a couple of points there. +First of all, the objective is clear. By 2020, we want to be at 40% gross margin. If you pair that with our other businesses, DUV where we're somewhere in the 50% range, and holistic lithography where we're north of 70%, and then our [CLS] business, that's the Siemer service business which is also in the mid 50% or so, you can see that that gets us to the 50%. +On a standard cost basis, we are very close to where we want to be right now. You can impute that from the information we gave you that the one shipment that we recognized last quarter had a 1.4% dilutive effect. If you do the math, you'll figure out it's somewhere in the mid teens percentage-wise, and that's not full revenue. +So you can see from a standard perspective we're doing okay, but of course, we're shipping only a few systems this year. If you look at the total EUV business isolated from one machine, you have to take several other considerations. +Number 1, we have the infrastructure to build many more systems. So we have cost of under-absorption. We have a service model where eventually we will charge per wafer, per good wafer out. We provide the service already, but there's not many good wafers out, so you can imagine that this is a very significant loss business for us right now. +The learning curve; we're still working on cost, not only internally but also with our suppliers. +And then there are other areas like we still have to go out in the field and bring these systems that we shipped up to the latest standard, which is also work that we need to perform that is unpaid. +And lastly, we have, of course, shipped this year mainly -- shipped and will ship 3350s and 3300s, and then going -- starting next year, we'll have 3400s which come at a higher ASP. +So if you take this all into consideration and you look at the overall EUV business, it is still a significantly negative gross margin for us, but the standard is approaching where we need it to be, and with the volume coming in, it really depends on volume and learning curve. And we believe based on what we see in backlog and based on what we hear from our customers, TSMC for instance, was very explicit about their EUV plans going forward. And Peter mentioned the ramp will be in 2018/2019. We believe we can get to that 40% that gets the Company to 50%. +I hope that was not too much detail, but you asked, so -- + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [11] +-------------------------------------------------------------------------------- +(laughter). No, that was fantastic. I greatly appreciate the detail. And I guess there was multi parts to it, but if I could sneak in a quick second one. +On the foundry logic side, your [emergent] shipments are going to grow probably 60% year on year this year. I'm just curious. Clearly, 7-nanometer will be a meaningful node, but is that sort of shipment level sustainable? And as part of that, as you think through calendar 2017, how do you think about linearity of spend? +Thanks very much. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [12] +-------------------------------------------------------------------------------- +Yes, C.J. I think, like I said in my introductory statement, it's too early for us. You will understand that to be quantitative on 2017 is not possible. But we do have very clear discussions with our customers on their requirements for 2017, and we do our own market forecast and simulations, and we corroborate the two. And the way we're looking at today is that we believe that the logic ramp will continue as strongly as we've seen in 2016, also in 2017. +Memory, given the wafer capacity situation and what we hear from customers, that we believe the memory business will be at least at the same level, if not slightly up. And I think on the services and options and upgrade business, I think we will grow next year. +So I think [going to be] from a quantitative point of view very difficult for us to see -- let's leave EUV a bit to the side -- that on the rest of the business that 2017 would be a lower year than 2016. Very difficult for us to see that, because logic strong; memory is at least as good, perhaps slightly up; and we have a service and option and upgrade business that will be up. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [13] +-------------------------------------------------------------------------------- +Very helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Kai Korschelt. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [15] +-------------------------------------------------------------------------------- +Bank of America. I just had a follow-up on the EUV adoption question earlier, and I think you had said it's obviously an ongoing process and there is not -- there's probably not going to be the moment where your customers just flick on a switch in their minds and say we're going to go for it. +But I'm just wondering in terms of maybe on the availability targets which seems to be the main criteria. You obviously said 90% is the key level, but I guess the question that we all have, how long is that 90% availability? How long do the tools need to deliver that availability? Is it a couple of months? Is it six months? Because I think you have mentioned you achieved it for about a month now with an old tool. So I'm just wondering how close are we to that potentially critical availability level. +Thank you. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [16] +-------------------------------------------------------------------------------- +Yes. I think we've said in the past 85% is probably the threshold where the customers are going to say, fine, let's go. But it's about the predictability. So when we talk about 85% it is 85%. It is not [for a] day, it's not for a months. It is with the constant use of the tool versus 85% availability of your installed base. +So that is what it is today. For instance, we are talking with [DUV]; we are talking about availability percentages of way over 90%. And that's for the entire installed base. That's not over a week, not over a 13-week period. It is maybe ever. +Now that is -- that's a very clear target, and you see where we are today, 2016, and where we will be in two years' time. We believe that having seen the levels of availability and the capability of individual tools in the field -- not the entire installed base yet -- and looking at the projects and the programs that we will execute on, because we know what to do, that given the fact that we can show that availability over a really prolonged period -- it's not days, it's weeks and in effect months -- then we believe that we can get there at 2018/2019 when we start shipping them in volume. +And that will happen over time. If you look at the number of programs and projects that we are running to get to that level, there are dozens, and they all need to be executed one by one and every one will actually go and contribute to a percentage point of increase, or several percentage points of increase in that availability. +So it's going to be an ongoing thing like it was an ongoing thing coming from 30% to where we are today. It's a continuous process together with our customers, but with a very clear roadmap. + +-------------------------------------------------------------------------------- +Kai Korschelt, BofA Merrill Lynch - Analyst [17] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +Timothy Arcuri. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [19] +-------------------------------------------------------------------------------- +Cowan & Company. I had two, I guess. First of all, Wolfgang, I'm still trying to understand margins on EUV. I think we had previously been talking about needing 20 to 25 systems a year to get to roughly 40% margin. And then I think now that's going to maybe having to ship 40 systems to get to 40% gross margin. So you're certainly making progress, but it seems like the supply chain is beginning to hold you back. +So I guess my question is really around your need to subsidize the -- your suppliers, because certainly, your customers wrote you checks, but it seems like maybe you have to write your suppliers checks and what the impact that could have on margins. +Thanks. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [20] +-------------------------------------------------------------------------------- +Okay. So, Tim, let me [go there]. +So one think I can tell you clearly, there is no additional [costs] coming in from increased prices of suppliers. Yes, it's true that we have supported suppliers with certain prepayments, but those are basically financing transactions. That's nothing to do with gross margin and the P&L. +You are also right in a sense that volume clearly is the biggest contributor to the overall gross margin. You can -- I think you have been here; you can look at the factory, it's there. And if you only ship three or four units, those units have to carry the burden of that entire infrastructure, including the management that's in there and the quality systems and everything that's in there. +So in that sense, volume is clearly the greatest driver to get to the gross margin. And there was a bit of a debate in last quarter call; well, can you pinpoint it to an exact number? It's difficult, because I can tell you we could ship 50 systems. If we don't make any progress on the learning curve and our customers we may not achieve the 40%. But reversely, we can be at 25 systems and we're making good profits on the learning and we'll be at the target earlier. +So I don't want to link it to a specific volume, but it's very clear volume is the biggest contributor to getting to that 40% gross margin. +I hope that helps, Tim. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [21] +-------------------------------------------------------------------------------- +Yes. Thanks. It does. +I guess just as a last follow-up, Wolfgang, can you normalize the guidance if you strip out both of the effects of EUV? What is the gross margin in the fourth quarter minus the effect of EUV? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [22] +-------------------------------------------------------------------------------- +It's a roughly 2.5 point impact. So if you take 47.5%, in the midpoint of our guidance, we would be somewhere in the -- just above 45%, which is in line with what we have done before; actually, a little bit higher because the field options and services are driven up this quarter, and a lot of it is options. So we will be over 45% without EUV. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [23] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [25] +-------------------------------------------------------------------------------- +Barclays. I just had another one on EUV. Peter, you reiterated the expectation of the 12 units plus the additional two that slipped, but 12 units next year being manufactured; doubling in 2018; doubling again in 2019. And I can see what you're saying in terms of the 2017 shipments being supported by the current backlog. But I'm just -- +You've given us that, but obviously, we always want more, so I'm interested in starting to think about 2018 and when we might need to see orders start to come in. So where are lead times at the moment? When would you need customers to start committing? +I suppose another part of that would be the big volume purchase order made by Intel in the second quarter last year. Clearly, you've got that hanging around there. It's outside -- I think still out of the official backlog, but presumably starts to step in at some point over the next year because some of those tools will be destined for 2018. So any insight you can provide on some of those moving parts would be very helpful. +Thank you. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [26] +-------------------------------------------------------------------------------- +Yes. I think clearly, like Wolfgang said, by the end of the year, I think we have in the backlog at least the 2017 output secured to orders. But also, I think what we are seeing is that the next two quarters or so we will see also the first orders for 2018 coming in filling that up. Because doubling in 2018 with the lead times that we currently have means that we need to start booking those orders as we speak, and that is also exactly the activity of our sales force as we speak with our major customers. +Now having said that, because these are volume shipments, it should not be a surprise to you and to others that we are in deep discussions with volume purchase agreements with those key customers as we speak. And I think the orders will be a subset, or will be, let's say, an integral part of those volume purchase agreements, so-called VPAs. And that's happening as we speak. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [27] +-------------------------------------------------------------------------------- +Can I chime in for a second with a correction, Tim, for your question? I just got my calculator out. I misunderstood your question, I believe. +What I quoted to you was just taking the deferred revenue out, but then, of course you need to take the 3300 out as well. So if you take both aspects of EUV out, we would be more like 46.5%, or something like that. And that's the increase that's driven by the increase in field options. +I hope that is clear. I wanted to make sure that you have the full EUV effect because I think that's what you had asked me. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [28] +-------------------------------------------------------------------------------- +Yes. I think that this was an addition to the question that [Tim asked earlier] (multiple speakers). +Do we have [understand] or --? + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [29] +-------------------------------------------------------------------------------- +So, Peter, so you are suggesting that we can anticipate perhaps a mix of ones and twos of orders, but also for some of the bigger customers you anticipate a similar type of announcement to that which we had from Intel in the second quarter last year? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [30] +-------------------------------------------------------------------------------- +Yes. I think that's normally how we work, which is not typical for EUV. It's typical for [DUV] and our other businesses also. +We are actually -- have these volume purchase agreements over a longer period of time. Could be years, could be [a node], could be 18 months. It depends on the customer, where basically we say at this particular volume these are the conditions, the terms and conditions under which we will ship. +That's also true for EUV. And for ones-es and twos-es, you don't need volume purchase agreements. Let that be clear. But for volume you need volume purchase agreements because that has an impact on pricing and customers would like to see that impact. +So this is also not a surprise that we are in deep discussions as we speak on those volume purchase agreements, which will be the trigger, you could say, which will be the umbrella under which the individual POs will be issued. + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays - Analyst [31] +-------------------------------------------------------------------------------- +Okay. That's great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Gareth Jenkins. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [33] +-------------------------------------------------------------------------------- +Just one quick one from me on the co-investment plan. I wondered. You've helpfully reiterated the EUR10 billion revenue target and the tripling of EPS, but could you talk about the OpEx in between and what your expectations are when the co-investment plan comes to an end? Do you think you'll roll this forward, or will you subsume the OpEx that you're currently enjoying the benefits from your peers? Thanks. Or customers, I should say. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [34] +-------------------------------------------------------------------------------- +Yes. Again, we will talk in more detail in one and a half weeks from now, but we continue to forecast about 13% of revenue for R&D, and that does not assume a continuation of the customer co-investment plan. +Having said that, it also doesn't really hit OpEx in terms of R&D. It's actually in gross margin part of it is other income and part of it is a balance sheet straight into equity transaction. So it doesn't impact R&D, but we have not modeled a continuation of that plan. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [35] +-------------------------------------------------------------------------------- +If I may, Wolfgang, just refreshing memory, this customer co-investment program was specifically made to support ASML in the, let's say, double investment time of let's say about five years where we had to invest in [leading SDPV] but also had to invest in EUV, and initially we thought it could have been [for 50]. +Now when you look at when that ends, it will end in the next of year, and when you look at when you start ramping in volume, well, our plan is doubling the [12] in 2018. And bearing in mind the discussion that we had on the very significant impact that volume has on EUV margins by that time where we're in 2018, there will be margin inflow to actually pay for the R&D money that we need to spend for EUV going forward. +So I think it's almost like a perfect match in a sense when the CCIP tails off and our EUV business, for which this CCIP was intended, actually takes off. So it was well planned, well timed. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [36] +-------------------------------------------------------------------------------- +Great. And can I just do one follow-up on Hermes? I understand you've just got two approvals left. But could you talk about your aspirations in terms of market share for the combined product with HMI? +Thanks. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [37] +-------------------------------------------------------------------------------- +We always have aspirations to drive market share up, but that in itself is not a goal. It is a result. We are focusing really with the HMI acquisition to combine the competences of the two companies and create something which from a value point of view is not available in the market today. +So it effectively means we are looking for industrial product synergy and this is the reason for the acquisition. You could argue that the product that we are focusing on, or that we're envisaging, is a product that does not exist today. +So in that sense, call it a dream, but I think we think it's a little bit more than a dream. I think it is doable. It is executable. But it is something that is not available today. +Now how much of that will be valued by our customer base as being high value remains to be seen. We have high hopes but we do believe that in this new product combination we will create significant value for our customers to control their yields and their patterning costs, and this is what we are focusing on. +And when we're successful, we'll grow market share. Where we're not successful, then we'll be sorry, but it's not what we expect. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [38] +-------------------------------------------------------------------------------- +And then while we cannot express it that well in market share, to Peter's point, we're planning in two weeks when we meet in New York for the Investor Day to at least give you a sizing of what we expect business-wise in terms of revenue of these new products by 2020. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS - Analyst [39] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Patrick Ho. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus & Company, Inc. - Analyst [41] +-------------------------------------------------------------------------------- +Stifel Nicolaus. First on the EUV side, you've talked about the percentages and the increases there over the short period of time, but what are, I guess, some of the remaining key variables that will get you more consistently at that 90% level for an extended period of time? What are some of the final things that you need to do to get past that metric point? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [42] +-------------------------------------------------------------------------------- +Yes. These things are basically looking at the -- as you know, and I suppose that you know, that the EUV plasma is created by using a high-power CO2 laser. So it's in fact the continued laser stability, which is a program that we're running with our supplier Trumpf in the south of Germany. +A second point is the tin management in the vessel which basically we need to contain any contamination coming out of tin distribution over time, and we have several programs running there. +So I would summarize it as those two. So it's tin management in the vessel and it's the stability of the drive laser. And that's a drive laser to basically create the EUV plasma out of tin. +And those are [this whole slew] of smaller projects and some bigger projects that we are running with our customer base and with our supply base, but those are very well defined. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus & Company, Inc. - Analyst [43] +-------------------------------------------------------------------------------- +Great. That was really helpful. And my follow-up question in terms of your core business. +As the DRAM industry migrates to the 1X-nanometer node, how do you see capital intensity rising for lithography given the more patterning stuffs that are going to be involved? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [44] +-------------------------------------------------------------------------------- +It's a good question. We've seen the introduction of first multiple patterning in DRAM because of that. That's one. But I think when you talk about 1X, let's say the mid-node 1X, we see the introduction of EUV being planned because of the complexities that come with the patterning strategies at that level. And using [DPV] is simply deemed not possible and EUV is the way to go. +So, yes. Litho intensity will -- when we get to 1X will go up, but largely in the 1X node and 1 bit node starting you'll see the introduction of [EUV]. + +-------------------------------------------------------------------------------- +Patrick Ho, Stifel Nicolaus & Company, Inc. - Analyst [45] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Amit Ramchandani. + +-------------------------------------------------------------------------------- +Amit Ramchandani, Citigroup - Analyst [47] +-------------------------------------------------------------------------------- +Citigroup, London. My first question is really with respect to the demand evolution for emerging tools. You've talked about strength from the 10-nanometer. You've touched upon memory. Could you maybe give us granular insight into how does that break down between DRAM and NAND, and whether the lead times for your tools have any role to play in terms of how you're seeing the orders shaping up for you? +You talked about a pickup in Q4. You talked about memory being slightly higher next year. So I was wondering if you would share some more granularity in terms of DRAM and NAND, and how you think that shapes up in Q4 and beyond. +That would be my first question. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [48] +-------------------------------------------------------------------------------- +Like I said, we've given you some qualitative indications. Wolfgang said in his introductory comment that we see memory shipments going up in Q4 as compared to Q3. And if you look at the total year 2016, we believe that memory shipments based on the installed wafer capacity and the customer demand and the bit growth assumption that we currently have that memory will be upwards -- will be flat or slightly up next year. +Now the split or the granularity that you're asking for between -- in DRAM and NAND is a bit difficult, because what we're seeing very much is that the DRAM tools, currently leading DRAM tools, are relocated to NAND. And then basically, NAND litho is then growing in terms of installed base. But then we ship to DRAM to replace the relocated tool that went to the NAND factory. +So it looks like a DRAM shipment, but in fact it's a NAND shipment. So this is all why we basically combined this into -- memory is very difficult to give you a detailed breakdown of what is DRAM capacity growth or NAND capacity growth. There's a lot of relocation going on between the two memory sectors. + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [49] +-------------------------------------------------------------------------------- +And as it relates to the lead time, we have about a six-month lead time. Also, I want to remind you again that even though you may not see the order in the order book, we have VPAs, volume purchasing agreements, with all of these customers where they also regularly provide us with sales forecasts. So we're prepared with some variation to whatever the demand is going to be in 2017. + +-------------------------------------------------------------------------------- +Amit Ramchandani, Citigroup - Analyst [50] +-------------------------------------------------------------------------------- +Thank you. And maybe as a quick unrelated follow-up, with respect to your service and field option sales, the idea was to get to, I think, 10% growth year on year this year. Seems like you need a strong Q4 well above [600] to get there. +And even beyond that, I appreciate you'll give us the roadmap in two weeks' time, but should we expect more of a linear trajectory going forward? Is that still the best way to model it? And how does reuse come into all of this? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [51] +-------------------------------------------------------------------------------- +Okay. Good question. First of all, Amit, correct. You did the math, apparently. If you get to 10%, you need [650]. We have said that we'll be over 600 so we'll be anywhere between 7% and 10%. We'll see how that goes. +In terms of the makeup, a little bit less than half of this is service, and in general, if you take the full year, and that is fairly predictable. You know what your installed base is and what the contracts are, and that's a pretty steady state, nicely growing business for us. +Options have two portions to it. There are the upgrades, and the upgrades need to be somewhat linear because you've got to have the teams that perform the upgrades. So we need to schedule those, and these will be growing over time, but it will be more like a linear growth. +But then you have various options, and increasingly with holistic lithography software options that can be deployed at relatively short notice, and that's the difference that you see in a quarter that we have [ended] it now, and there you can see that you have one quarter that's stronger than the other. +So a strong business for us. I think that you'll see that we -- whether it's 7% or 10%, we'll be over EUR2.1 billion/EUR2.2 billion this year, which is close to one-third of our business. And when we're talking in 2020 and when we talk in two weeks at our Investor Day, you'll see that it will also continue to grow strong. I think you'll see that business well over EUR3 billion by 2020. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [52] +-------------------------------------------------------------------------------- +And perhaps, Amit, the term reuse is a [container] term. There's so much in there. Let me give you an indication. You could do a reuse by basically saying, okay, I have a [litho] tool in a logic wafer fab and I'm going to add [for the next node] and the next-generation litho tool, but I'm going to reuse some of those tools that are in there for that new node. That is one. +Reuse also is relocations. You move from one fab to the other tool to go to a different part. I just gave you the example of memory. Reuse is also I have this tool sitting there which is a leading-edge tool and I'm going to upgrade it to the next level. So actually, that leading-edge tool remain still leading edge tool, but not in the same shape because it has a very significant upgrade that can be anywhere between EUR15 million to EUR35 million. +So it's a heterogeneous container term that you have to be careful with using in more general terms. + +-------------------------------------------------------------------------------- +Amit Ramchandani, Citigroup - Analyst [53] +-------------------------------------------------------------------------------- +That's very helpful. Thank you, gentlemen. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- +Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [55] +-------------------------------------------------------------------------------- +Credit Suisse. My first question is on EUV. You guys have been making very good progress on EUV, but some of the challenges it seems like are outside of what you guys do and more in the bucket of what your customers are doing. So I just want to get your perspective on three things that have come up from one of your customers as a challenge. +One is on the mask blank inspection. Second is on pellicle. It seems like the transmission is very low, like 30% losses right now; and there is an extra coding that needs to be applied which takes up even more of the [UV] life. And third is on mask inspection, like actinic mask inspection. If UV has to be adopted in high volume and multiple layers, it seems some of your customers are asking for that. +So I just want to hear your thoughts on how important these challenges are. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [56] +-------------------------------------------------------------------------------- +Yes. It's a good question. I think they're all important. Mask blank inspection, that needs to happen, clearly, but we have a solution there. I think our partners, (inaudible), start to ship the mask blank inspection tools to actually do that and I think the first tool is in the shipment right now. +So there are solutions there and they will go to the first customers. I think that's the major issue. And if you asked me, Peter, is there a tool installed right now, no, but it's in shipment, and more will follow. +The pellicle transmission, yes, that is an issue, but the 30% loss that you just quoted, there are better results as we speak. That is also something that has been developed, or started to develop last year. And if you look at the curve of development, we've made clear progress. +Now our biggest challenge is not so much the transmission of the pellicle. I think we're making progress there. Now it is we need to start -- we, the industry, need to start making pellicles as a kind of volume product at the right specifications, and that production process is just starting up. So there, we need to have improvements in the yields that the pellicle producer currently has, but that's all normal when you look at where we are in the initial stage of that volume in our production process. +But we don't expect that to be a showstopper. That's going to be just hard work basically in -- like the same with ASML. It's hard work on the industrialization. +And then mask inspection, actinic inspection, we said it before. For the 7-nanometer node, we don't need that. Going forward, 5-nanometer, 3-nanometer, that is a potential for some customers. Some customers won't need it because they actually say we can afford -- if you're a memory customer; you're not as sensitive if you're a high-value logic customer. +So for the upcoming nodes, let's say 'til the end of the decade, that is not a major issue, and we need to find a solution beyond that. Whether it's an actinic inspection tool or another solution, that still remains to be seen, but that's not a hindrance for the initial introduction of EUV at the 7-nanometer/10-nanometer node. +So, yes, they're all issues that need to be worked on. They are not signed off as absolutely concern free. There are issues that need to be resolved. But that's pretty normal when you look at when those developments have started and where we are today. + +-------------------------------------------------------------------------------- +Amit Ramchandani, Citigroup - Analyst [57] +-------------------------------------------------------------------------------- +Thanks, Peter. And then as a follow-up, one question on EUV high-NA system. I just want to understand if your OpEx or R&D level of 13% assumes that a high-NA system would be needed. +And secondly, is there an opportunity for another customer co-investment program when you guys are getting to those discussions? + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [58] +-------------------------------------------------------------------------------- +Well, it's a very good question. If you think about EUV high-NA, you talk about the next-generation EUV tool that will be introduced somewhere in the course of the next decade. That will require quite a significant investment in R&D. +I think on average, the 13% R&D with our EUR10 billion target should be able to deal with it. It's more a matter of -- if you take the cumulative planned R&D that we would need over the next five years or so, then cumulatively, yes, that would suffice. +However, when customers start telling us that they want this earlier, we need to put it in, then you might see a hump, which then of course we will have the discussions with our customers how we will, let's say, craft or stage the customer commitments to make sure that the interests of ASML with the increased R&D and the requirements of the customers are well aligned. And that, of course, always goes with some level of financial commitment. +And what that is, we don't know yet, but when it is clear what customers want in what timeframe, then we will definitely have those discussions. But what form it will take, I don't know. It could be simple commitments of placing purchase orders with a high level of prepayments. Stuff like that could also be. + +-------------------------------------------------------------------------------- +Amit Ramchandani, Citigroup - Analyst [59] +-------------------------------------------------------------------------------- +Got it. Thank you. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holdings NV - VP IR & Corporate Communications [60] +-------------------------------------------------------------------------------- +Ladies and gentlemen, I think we can squeeze in one more short question. So Patricia, if you could pick a short question, that would be terrific (laughter). Just kidding. But anyway, we do have time for one more question. +And by the way, if you have trouble getting through, or you had trouble getting through, as always, feel free to call the IR department and we'll do our very best to get back to you as soon as possible with an answer to your question. +So, Patricia, if we could have that one last question, that would be great. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- +Francois Meunier. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [62] +-------------------------------------------------------------------------------- +Morgan Stanley. So just a quick one, actually, on maybe something a bit more longer term when everyone is so focused on the gross margin. +Is there a market for laser spare parts going forward? So basically, at some point, you will have an installed base of -- I don't know; like 50/100 EUV machines. So is there a market for changing the lasers from the ex-Siemer business, and how significant could it be from 2020 onwards? + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holdings NV - EVP & CFO [63] +-------------------------------------------------------------------------------- +On spare parts, the way how we're going to deal with this for EUV is we're going to have a service model that actually will -- the customer's cost is predictable for the customer and we're going to set [amount] of a good wafer, and that would, of course, then cover the labor and the parts required to keep the machine running. + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holdings NV - President & CEO [64] +-------------------------------------------------------------------------------- +If you want to make any connection or any comparison with the Siemer model, which is the on-pulse model where basically the customer pays per pulse, this is in that sense similar, and we've agreed with our customers that they pay per wafer. So that would actually mean that the spare part usage would be our problem, not the customer's problem, because the customer has a variable cost now per wafer. + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [65] +-------------------------------------------------------------------------------- +Okay. Very good. See you in two weeks. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holdings NV - VP IR & Corporate Communications [66] +-------------------------------------------------------------------------------- +Along with thanking everybody for joining the call, I would, as Wolfgang referred to a couple of times, we do have an Investor Day coming up on Halloween, October 31 in New York City, and we hope that you will be able to join us; and if not, at least be able to listen in. +Now, operator, if you could formally conclude the call, we would appreciate it. +Thanks. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- +Thank you, sir. Ladies and gentlemen, this concludes the ASML 2016 third-quarter financial results conference call. Thank you for participating. You can disconnect your line now. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2017-Apr-19-ASML.txt b/Transcripts/ASML/2017-Apr-19-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..54cc143b111ecaf662ae81e99654c2a0341e213e --- /dev/null +++ b/Transcripts/ASML/2017-Apr-19-ASML.txt @@ -0,0 +1,595 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 ASML Holding NV Earnings Call +APRIL 19, 2017 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, CEO and President + * Wolfgang U. Nickl + ASML Holding N.V. - CFO, EVP and Member of the Management Board + * Craig DeYoung + ASML Holding N.V. - VP of IR - ASML Tempe + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Francois Auguste Roger Meunier + Morgan Stanley, Research Division - MD + * Douglas Smith + - + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Timothy Michael Arcuri + Cowen and Company, LLC, Research Division - MD and Senior Analyst + * Farhan Ahmad + Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector + * Pierre C. Ferragu + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Gareth Jenkins + UBS Investment Bank, Research Division - MD and Equity Analyst + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays PLC, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2017 First Quarter Financial Results Conference Call on April 19, 2017. (Operator Instructions) +I would now like to turn the conference call over to Mr. Craig DeYoung. Go ahead please, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [2] +-------------------------------------------------------------------------------- + + Thank you, Peter. And good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from ASML's headquarters in Veldhoven, the Netherlands, is ASML CEO Peter Wennink; and our CFO, Wolfgang Nickl. The subject of today's call is ASML's 2017 first quarter results. The length of the call will be 60 minutes and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at www.asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of the call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meanings of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +And with that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Thank you, Craig. Good morning. Good afternoon, ladies and gentlemen, and thank you for joining us for our first quarter results conference call. And before we begin the question-and-answer session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter, as well as provide our view of the coming quarters. Wolfgang will start with a review of our first quarter financial performance with some added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and on our future business outlook. Wolfgang, if you will? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter. And welcome, everyone. 2017 is off to a great start with a stronger-than-expected quarter. I would like to first highlight some of last quarter's financial accomplishments and then finish with our view of the coming quarter. +Turning to the Q1 results. Net sales came in at EUR 1.94 billion. Net system sales accounted for EUR 1.22 billion, nicely balanced between logic and memory. With the addition of HMI products, we are now including metrology and inspection equipment in the system sales versus previously reporting it as service and field option revenue. This also means that metrology and inspection systems orders are from now onwards included in our booking and backlog numbers. This provides more visibility of our current and future system business in this product group. +Net service and field option sales for the quarter came in much stronger than expected at a level of EUR 728 million, driven by major DUV and Holistic Lithography upgrades. As noted, YieldStar and HMI system revenue are now reported in net system revenue. Otherwise the service and field option revenue would have been even higher at approximately EUR 790 million. +Our gross margin for the quarter came in at 47.6%, slightly higher than guided, driven by a higher top line and favorable mix. Gross margin includes the amortization of intangibles, as well as the effects from the fair value assessment of HMI's inventory as of the closing date of the acquisition. Overall, OpEx came in as guided, although R&D expenses came in slightly lower at EUR 315 million and SG&A expenses came in slightly higher at EUR 99 million. +Moving on to the order book. Q1 system bookings came in at EUR 1.9 billion, including orders for 3 3400 EUV systems from 2 customers. Strong bookings continued in the logic sector in support of the 10-nanometer ramps and in support of the EUV insertion at the 7-nanometer node. Memory bookings strengthened further from its strong Q4 level supporting expected year-on-year growth in the memory sector in 2017. The continuing order flow for EUV systems increases our EUV backlog to 21 systems valued at EUR 2.3 billion. Our overall systems backlog now stands at EUR 4.5 billion. In addition, we also have 4 EUV upgrade orders valued at approximately EUR 200 million. This will bring these 4 NXE systems to NXE:3400 performance. In total, we have 14 3300 and 3350 systems in the field, which are candidates for upgrades. As a reminder, system upgrades are not included in our system backlog. +Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at EUR 3.84 billion. As already mentioned in January, we saw a significant level of early payments from customers in Q4 of last year, which resulted in a negative free cash flow of EUR 212 million in Q1. +As a reminder, in Q2, we have several extraordinary cash outflows, which will bring the overall cash balance back to our target level. Assuming approval at our AGM, we will pay a dividend of EUR 1.20 per ordinary share or approximately EUR 515 million in total to shareholders. We also have a bond maturing in Q2 with an outstanding value of EUR 238 million. And lastly, we expect to close the acquisition of 24.9% of Carl Zeiss SMT during the quarter for EUR 1 billion. +Based on our current business view, we see a continued strong demand for DUV, Holistic Lithography and EUV products throughout the year in both memory and logic. Our view is supported by our highest backlog ever. +With that, I would like to turn to our expectations and guidance for the second quarter of 2017. We expect continuing sales strength in Q2 with total net sales between EUR 1.9 billion and EUR 2 billion, including an estimated EUR 200 million of EUV revenue. We plan to ship 3 NXE:3400s in the June quarter. Our EUV shipment plan for the full year includes 12 systems and is back-end loaded. We expect our Q2 service and field options revenue to again come in above EUR 650 million, driven by continued demand for Holistic Lithography options, high-value upgrades and our growing installed base. +Gross margin for Q2 is expected to be between 43% and 44%, driven by the recognition of EUV system revenue. Excluding the EUV revenue, gross margin would be approximately at the same level as Q1. Q2 gross margin also continues to carry the effect from the purchase price allocation for the HMI acquisition. The negative impact of these purchase price allocation adjustments for Q2 is more than 1 percentage point. The impact for the full fiscal year is about EUR 90 million and will reduce to about EUR 40 million per year from 2018 onwards. +R&D expenses for Q2 will be about EUR 315 million and SG&A is expected to come in at about EUR 100 million. As a reminder, our share buyback program remains paused for the time being as we close our planned equity investment in Carl Zeiss SMT. The remaining approval from China is expected in time to close the transaction in Q2 2017. +And finally, as mentioned before, an increase of our annual dividend from EUR 1.05 to EUR 1.20 is submitted for approval at our Annual General Meeting of Shareholders on April 26. +With that, I'd like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. As Wolfgang highlighted, our business continues to perform well. We started the year with a very strong quarter, and we expect this positive momentum to continue throughout the year. While Wolfgang reviewed our current quarter performance and outlook for the coming quarter, I would like to provide some additional commentary on our markets and our longer-term outlook as well as provide a few highlights on our product portfolio. +As seen in our first quarter results, logic demand remains solid. And our memory demand continues to strengthen with DRAM largely compensating for weak spending in 2016. Logic demand is driven by continued ramp of 10-nanometer with memory demand driven by DRAM 1x nanometer node and additions of 3D NAND capacity. +The strength in shipments to China this quarter was driven by existing Chinese and non-Chinese customers. As for new China business, we are in discussion with multiple Chinese logic and memory customers regarding timing of system demand for their new fab projects. We expect shipments to support pilot production in these new fabs starting in 2018. +While it is still too early to provide quantitative guidance for 2017, our directional view, as expressed last quarter, remains largely unchanged. However, in terms of potential magnitude of our business, it now appears that memory demand will be up significantly as compared to prior year. +On the ASML product side, let me start with an update on our EUV business. We started shipment of our NXE:3400 system, which will be the EUV workhorse in volume manufacturing over the coming years. Furthermore, we continue to make progress towards our 125 wafer per hour productivity and 90% availability commitment. At the SPIE Advanced Lithography Conference in February, our customers presented their latest results confirming our progress on these metrics. The status of the EUV infrastructure was also presented by our customers. And while there's still work to be done on things like pellicle, there appear to be no major roadblocks for EUV insertion in the time frames as indicated by our customers. +Regarding demand, we took 3 EUV production orders from 2 different customers this quarter, bringing our total EUV backlog to 21 systems. And as Wolfgang mentioned, on top of this, we booked 4 orders for a total value of around EUR 200 million for upgrades of EUV systems currently in the field to NXE:3400 production specifications. And by the way, these orders are field upgrades and do not show in our reported order backlog. +EUV order flow continues while we work to finalize a VPA with at least one of our major customers, which will translate into additional orders over the next quarters. As customers continue to assess timing of their roadmaps and firm up the layer adoption, we're beginning to get a clearer view of EUV demand for next year. The average analyst demand expectation stands at around 20 new systems shipped in 2018 which, given our current view seems reasonable, while we still have the option to build up to 24 systems next year. In DUV lithography, demand for our TWINSCAN NXT:1980Di immersion systems continues for both logic 10-nanometer and DRAM 1x nanometer nodes, bringing the installed base to more than 60 systems. We're also seeing strong demand on our KrF platform where we boosted the productivity of our XT:860 system further to 250 wafers per hour. For our 3D NAND customers, we released new options that improve focus and alignment performance of high-topography layers typical for this application. And to maximize capital efficiency, a number of customers also upgraded their immersion systems through significant announcements to productivity, imaging and overlay. And these upgrades drove significant growth in our option business, which will continue to drive growth through 2017. +In Holistic Lithography, we continue to ship our most advanced YieldStar 350 metrology systems to our customers, supporting qualification and ramp of the 10- and 7-nanometer logic node, as well as the 1x nanometer DRAM node. In addition to YieldStar metrology systems, we're also shipping HMI e-beam systems that are now reported as part of our systems revenue as Wolfgang mentioned. The integration of HMI is progressing well and customer interest in our pattern fidelity products remains high. +So in summary, a great start to the year with a very solid quarter. Strong DUV demand, service and options business show a further growth momentum and continued EUV order flow provides a clear indication that this technology has now become a part of our mainstream business. We expect the positive industry environment to continue resulting in a very good year for ASML. +And with that, we'd be happy to take your questions. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [6] +-------------------------------------------------------------------------------- + + Thanks, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now Peter, could we have your final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [2] +-------------------------------------------------------------------------------- + + C.J. Muse, Evercore ISI. I guess first question, I was hoping to get an update from you on your expectations for adoption of EUV by DRAM. I saw on the slide deck that you reiterated 1y. Would love to hear how your discussions are progressing and how you're seeing adoption? And what kind of layer count we should be assuming at that first part of the adoption curve? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Okay. Yes, like we said, we are talking to logic and memory customers. So on DRAM, the expectation is indeed -- 1y to be specific, it's the mid-teens, 16, 15-nanometer DRAM. That's what -- that would be the introduction node. And that would involve 1 to 2 layers. So you have to remember that, of course, the DRAM market is quite a significant market. So 1 to 2 layers is a decent start for EUV technology at this node. And we're talking, at least, to one customer very specifically, but other customers have shown similar interest and they will follow suit. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [4] +-------------------------------------------------------------------------------- + + Very helpful. And then I guess as my follow-up, Wolfgang, if you could give us an update on how you're seeing the trajectory for EUV gross margins. And I guess within that, would love to hear how you see the cascade effect of 100% gross margin biz as it comes through this year. And then how we should see reaching that 20% target into the calendar '18 time frame. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [5] +-------------------------------------------------------------------------------- + + Yes. C.J., so the story there is pretty much unchanged from what we communicated at our Capital Markets Day in late last year. We were at minus 75% or so last year. Our objective is to get to 40% by 2020. We're targeting breakeven this year. There were several components to get this accomplished. One is simply volume, shipping 3x as much as last year. As you can imagine, it's the same factory producing that, so that will help. The second one was mix. Last year, we shipped 3350s. This year we're shipping 3400s. As you know from prior calls, the list price on those is approximately EUR 20 million higher. And the cost is not EUR 20 million higher, so that will help. And then of course, we have the service business where we've talked before that we're charging per wafer, which of course, ultimately is a lucrative business model, but as we are not churning out a lot of wafers right now, but have to man the systems is a -- has a significant dilutive effect on gross margin. And last but not least, we are progressing on the learning curve as well as in our own factory, the number of hours to -- it takes to put one of these things together. And also with our suppliers as well as work that we have to do in the field to upgrade these systems and bring them to the latest level. I think the expectation of 20% is still good for next year as we, again go from 12 systems to around 20 systems as mentioned earlier. And then, we made some progress last year where we can now do partial revenue recognition upon shipment. But again, it's partial revenue recognition because in case we have some performance criteria that will be met later, we got to defer some of the revenue. But on the other hand side, it will help that some revenue that we deferred in the past will come in at no cost. So that's why we believe in this year the deferral and what's coming in is roughly offsetting each other. That's why we said also in our communication that the revenue should be somewhere in the EUR 1 billion to EUR 1.2 billion range. And again, I think we are on the right path to get to 40%. And volume is the biggest driver of it. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [7] +-------------------------------------------------------------------------------- + + This is Farhan Ahmad from Credit Suisse. My first question is on the orders that you have this quarter. The [ order ] was pretty high -- strong. I just want to ask how sustainable do you think the order trend is. And in particular, on the memory order. +(technical difficulty) +In particular on the memory orders, the orders are significantly higher than anytime in the last 2 years. Can you just, a bit more color on -- is it driven by capacity additions of 1x nanometer and any kind of visibility on whether it's NAND or DRAM? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [8] +-------------------------------------------------------------------------------- + + Yes, just making a small note here, NAND or DRAM. The orders in Q1, yes, I think that's sustainable for the next few quarters. Given the fact that -- given the outlook that customers are giving us. And yes, it is significantly higher than the last 2 years. But you have to remember, that what we saw over the last 2 years was especially weaker order flow from DRAM-type customers. Because the DRAM market was -- over the last 18 to 24 months, not that strong. And it had to do with the fact that in 2014, we ended -- beginning of 2015 and '14 of [ high mix ] (inaudible) assumption came online, which were big fabs that actually -- we actually saw when you added them up, it was quite a significant step-up in capacity. But we haven't seen any new fabs coming online at that size since. But what we did see -- and it has to do with your NAND and DRAM question, what we did see is that given the economics of the DRAM markets over the last 2 years, we've seen leading edge litho capacity being used in NAND productions. And that has actually happened, and I think we mentioned that on previous calls also, but bringing the wafer out capacity down with double-digit percentages. Now that has created the situation clearly where demand and supply of DRAM end products was somewhat unbalanced over the last 9 months, which led to increase in DRAM prices, which is not unsurprising that now customers are back filling that capacity that they actually used to basically produce NAND over the last couple of years. And it also is an entry into your question on NAND versus DRAM. It makes it all very opaque if we have NAND and DRAM sitting next to each other. And depending on the market situations, leading-edge litho can be used for either/or. And that's why we look at memory now. And we said it also before as one segment. But looking at it, let's say, from a bit demand point of view, what we currently believe and also looking at last year's bit growth numbers, 30% in DRAM, 40% plus in NAND, looking where the capacity situation is today, looking at the price situation, I can fully understand why memory customers are filling up their open spots in their fabs to make sure that they have sufficient capacity to fulfill the demand of their customers. Now sorry for the very long answer, but you asked 3 questions, so that's why I had a longer answer. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [9] +-------------------------------------------------------------------------------- + + And if I can just squeeze a quick question. Last month, ASML signed MoU with Shanghai Micro Electronics Equipment Company. I believe they are one of your new emerging competitors in China. So I just wanted to understand like what exactly is the terms of the agreement? Is it something where you're just supplying the (inaudible) or is there more to it? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [10] +-------------------------------------------------------------------------------- + + It's a different kind of cooperation. We're not competitors. They build lithography-type machines for a different part of the market. They are largely active in the packaging market. What we have done is effectively created a memorandum of understanding to start working together, whereby we actually use them as one of our suppliers, one of our suppliers in -- not so much in the lithography market, but more in the metrology systems area. And we have a cooperation which is focused on making sure that they will get a better understanding of how you manage a modern, complex supply chain. So it is not directly focused on areas where there could be logical competition between the 2 companies. It's in different areas. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [12] +-------------------------------------------------------------------------------- + + My question is regarding your revenues for 2017. Peter, I mean when we look at the consensus ahead of today, it's about approximately EUR 7.9 billion. Last year, you did about EUR 7.6 billion. Wolfgang, you've said that you're going to do revenues between EUR 1 billion to EUR 1.2 billion in EUV. So if you took EUR 1.1 billion as the midpoint, it would mean that this year, the additional revenue outside EUV is about EUR 100 million. With DRAM particularly looking much better, are you more positive there are EUR 100 million incremental revenues from the memory market this year? And I have a short follow-up. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [13] +-------------------------------------------------------------------------------- + + Yes. I think... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [14] +-------------------------------------------------------------------------------- + + I think Wolfgang can answer this... + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [15] +-------------------------------------------------------------------------------- + + I'll do the revenue piece and -- I mean if you look at what we said last quarter and what we said this quarter, I mean on the -- if I go excluded EUV first, we had a very strong year on logic. And we continue to believe that that's going to be flattish year-over-year. It's good news. We have a memory business. I think we both used the words significantly up for us as what we previously believed. Last quarter, we said -- right now, I think it's flat, but it could be up. And now we think it's significantly up. I think that's more than EUR 100 million definitely. And then we have our EUV business, which was only EUR 350 million or so, which we -- like we said before think it's going to be between EUR 1 billion and EUR 1.2 billion. And then don't forget field options and services. Even with the adjustment that we made, we made EUR 2.1 billion last year. And if you add up the 2 quarters, the actual and the guidance, we're almost at EUR 1.4 billion. So we're at a significantly higher run rate there. So I -- without giving a quantitative guidance, I'd say the EUR 7.9 billion is pretty much, very much on the conservative side. I'll give you one other way to look at that maybe helpful for you, Sandeep. If you look at the first half, the actual and the guidance and you deduct that we only have EUR 200 million in EUV revenue in there. So you know in the second half, the bulk of the EUV revenue will come in, and we have not indicated that our non-EUV business is going down. So if you do these 2 exercises, I think you'll get to a pretty good range that is quite a bit higher than EUR 7.9 billion. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [16] +-------------------------------------------------------------------------------- + + Peter, just one quick follow-up on EUV. I mean market has been focused on the top 3 customers. What about the next tier of customers in EUV? Are you engaged with them? And when would they start to placing significant orders? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [17] +-------------------------------------------------------------------------------- + + Yes, we think we have orders in our backlog of more than the top 3. We have an additional 2, and so that makes it 5. And we are in discussion with 2 others, very close. So I think that is now spreading, which is clear, of course. That's -- the top 3 is now leading the pack in terms of speed of EUV introduction, but the others are clearly following. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- + + It's Pierre Ferragu from Bernstein. So if I kind of think about what I heard on the call is very positive developments about EUV, you have already 20 to 21 orders in the backlog. You'll have more in the next couple of quarters. So next year, like 20, 22 is also probably what we are going to see. And at the same time, I heard also that the DUV business is likely to do well in 2018 as well because, mostly because of China generating like a new area of demand in DUV. And when I look at consensus expectations, basically if I assume there is about like $2 billion of EUV revenues -- sorry, EUR 2 billion of EUV revenues with about 20 tools, then that implies the DUV business would be down about $1 billion in 2018. Do you think that kind of pullback makes sense and would reflect maybe like a sustaining of the rollout of the 10-nanometer node? Or do you think actually to 28 and could be another very strong year in DUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [20] +-------------------------------------------------------------------------------- + + Good question. Although what you're asking me is to just give you some reasonable financial feedback on what we think 2018 is going to look like, which I'm not going to do. But qualitatively, I don't see anything at this moment in time that will bring the DUV business significantly down. There is continued strength in the memory business when I look at the strength of the logic business. And leading-edge logic needs a performance memory, so it needs DRAM, and that's clear. I don't see major new DRAM fabs coming online within the next 12 to 18 months. That means that all available spots in -- or let's say, slots in factories that can take leading-edge DUV will take leading-edge DUV given the fact that I don't see that bit demand, end demand will go down significantly. So -- and if memory will stay strong, you mentioned China. I think China longer term -- and I think I said it on the last call, medium to longer term, that will be a, is a big opportunity for the entire industry. However in 2018, what we're seeing in terms of memory projects coming online, it will be focused on, let's say, finishing the construction and then putting the first pilot lines in, which will not drive a big, let's say, addition to installed memory capacity. It will take time. I think all those memory projects are all new. You could call it greenfield, not only a greenfield fab, there are greenfield companies, is going to take a bit of time. Now, the positive thing is that, of course, all those choices for technology and for wafer fab equipment will be made in the next 12 months' time frame. So it's going to be strategically very important to be in China and to actually have -- and to sign up those Chinese customers. But the rollout of that capacity will not be in 2018. 2018 will be pilot production. And you see an acceleration of that roll out in 2019 and 2020. So -- but all in all, we do not foresee a DUV market in 2018. I think what we're currently seeing in the end market simply does not support such a negative view. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [21] +-------------------------------------------------------------------------------- + + And then a very quick follow-up on China. How would you qualify demand you anticipate there? So it's a [ 19 20 ] story, okay. Is that mostly leading-edge tools? So are we going to look at high-end immersion tools mostly? Or is it going to be more leading edge in terms of demand in China? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [22] +-------------------------------------------------------------------------------- + + Well, I think you will see some of it -- probably both. But I think the emphasis will be on the leading edge, will be on leading-edge logic and leading-edge memory. But that like China currently has a lot of installed capacity, which is currently 45- and 28-nanometer. And also 28-nanometer fabs will still take tools in 2018. So it will be a -- it's a bit of both. But I would say the emphasis will be on the leading edge. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question, Mr. Gareth Jenkins. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Investment Bank, Research Division - MD and Equity Analyst [24] +-------------------------------------------------------------------------------- + + One question and a couple of follow-ups. Gareth Jenkins, UBS. The question I had is around the light source. I just wondered whether any of your customers are asking for Gigaphoton light source rather than your own Cymer solution on EUV. And just a couple of follow-ups, if I could, Peter, on other issues. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [25] +-------------------------------------------------------------------------------- + + Well, if they will be interested in using EUV way into the next decade, they will be asking for a Gigaphoton, but most of them aren't, so they want it now or they want it soon. It's the only available EUV source, and Gigaphoton is potentially something for the future, but I would say, way into the next decade. + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Investment Bank, Research Division - MD and Equity Analyst [26] +-------------------------------------------------------------------------------- + + Okay. And Wolfgang, I just wanted to clarify, EUR 200 million of EUV revenue in Q2, EUR 800 million to EUR 1 billion in H2. The EUR 800 million to EUR 1 billion, that will come at 0 gross margin? Is that the expectation or allowing for some catch up, it will come at 0 gross margin? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [27] +-------------------------------------------------------------------------------- + + Yes, for modeling purposes, I would not distinguish between the first half and the second half, it's making it too complicated. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + The next question is coming from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + Mehdi Hosseini, Susquehanna International. Peter, can you please give us an update on HMI. When would you expect the dual beam product to be available for evaluation? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [30] +-------------------------------------------------------------------------------- + + Well, we'll see the first integrated product, that's a combination of the ASML product and competency with HMI shipped to the first pilot customers by the end of the year, the end of this year, beginning of next year. And (inaudible) dual beam is probably you'll refer to multi-beam. Well, our plan is to have that available relatively soon, but we first need to finish the development. It won't be this year. It will be 2018 at the earliest. But more important is I think that we have the whole concept of using the ASML Holistic Lithography capability with the inspection capability of HMI and combine it into one product. That will be available much sooner. I think that's the most important part, and then multi-beam is just a natural extension of this product. And like I said, this combined product the first shipment is to be started at the end of the year to the first pilot customers. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + Sure. And then I have a follow-up on the EUV 12 system shipment this year, maybe as high as 24 next year. Would that be fair to assume that the systems are going to be for 7-nanometer maybe insertion for a few layers? And then shipment in 2019 and on will include maybe 1 or 2 layer for DRAM, and then as you look into 5-nanometer logic, then the number of critical layers that would use EUV would go higher, and that's how we [ grow ] the doubling playing out? So 12 system this year, 24 next year, the 7-nanometer introduction and then as we go into '19 and '20, the doubling is driven by DRAM and higher critical layer as you migrate to 5-nanometer logic. Is that fair? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [32] +-------------------------------------------------------------------------------- + + So I think it's a little bit more complex than that, because 7-nanometer is not ending in 2018. I think as you will see the production ramp for our customers in late 2018, '19, and it will continue into 2020. But you will be seeing layers on top -- these node layers will be on top of each other, like we discussed earlier on these calls. What we're currently seeing is that you all see an acceleration of a capacity ramp for a new node by the leading customers, which is almost like a camelback. It's like a hump, and now you have a very long tail. Now that long tail in 7-nanometer will be extending into 2020 and 2021, but it is not by the 1 or 2 leaders in logic, but there are also followers that will move into that 7-nanometer node, and they will start using the EUV in that time frame. So you will see layer upon layer. So this is not nice clean-cut end of 7-nanometer node followed by a 5 nanometer. It's going to be layered. On memory, you said 2019, DRAM 1 or 2 layers. Yes, in production, but I think we'll see probably earlier adoption of 1 or 2 layers in DRAM than 2019. And this will also be some of the systems that you referred to, the 12 systems 2017 and potentially 20 systems in 2018 will be used for DRAM 1 or 2 layer production on this mid-teen node. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [33] +-------------------------------------------------------------------------------- + + Is that why they haven't finalized the option part of the package? What they have booked so far is just for the equipment and options are finalized later? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [34] +-------------------------------------------------------------------------------- + + Well, this is specifically to one customer where we have the tool price is indeed fixed, and then the options is really the commercial negotiations on what do you want in terms of options which is specific to their production process and to the -- you could say the design of the customer specifically. And those are options that are add-ons that they need in their production process, which of course for us is good business and for the customer always an area where they think they can have some purchasing advantages. So that's just a matter of time, but I don't think you can draw any conclusions other than that. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question, Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [36] +-------------------------------------------------------------------------------- + + It's Andrew Gardiner from Barclays. Peter, I was just interested in following up a bit more on some of those comments you were making on the EUV decision-making process. You highlighted during your prepared comments, the public comments from all 3 of your lead customers acknowledging the progress that's been made on EUV not only by yourselves but also across the ecosystem that was fairly well publicized at SPIE. Yet, we are still not seeing all 3 step up sort of equally in terms of orders. I think TSMC has been pretty clear and consistent with what they are intending to do over the last couple of quarters. We can see some of that in your backlog. Samsung also seem to have been clear in their statements, yet as you just highlighted, we don't yet have the volume purchase agreement or indeed the sort of volume orders that you'd highlighted or that you had perhaps expected in the first quarter. And then, finally, Intel, they were the first to sign a VPA 2 years ago now, and yet they still haven't really acted on it. And they had publicly said they would do so when the technology was ready. And again, publicly, they seem to admit that it is, yet they haven't stepped up in terms of their order rates. And given what you described in terms of their 2019 ramps, I'm just wondering sort of why you think we are seeing such sort of different positioning from these lead customers and with a closing order window later this year, where's your confidence level that indeed the 2 who are lagging are going to step up over the next, say, 2 quarters? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [37] +-------------------------------------------------------------------------------- + + Well, to be honest, I don't think customers are really lagging, one. But they have different areas of focus, and they have different road maps and timing of road maps, which they would like to execute and also the size at which they want to do it is also different. So this is not a homogeneous pack. This is heterogeneous, 3 different customers, 3 different road maps, 3 different ways in which they want to execute this. But I think you are absolutely correct when you refer to the public statements, which are very convincing. But it is only the public statements. As you can imagine, we are in a very close contact with them, and we're also seeing what they're doing in preparation of that EUV ramp. And that's real tangible. I mean, those are factories. Those are EUV pedestals. Those are -- that's EUV infrastructure. It's being built and being put into place into those fabs. So that is also tangible, which is not that visible, but to us, it is. On the negotiation process, that's also different per customer. For instance, one of those customers doesn't have a volume purchase agreement yet, but they have orders in our backlog. So they order tools without the VPA. But the volume purchase agreement is really to determine, in their best interest, what the pricing is on a certain volume. Now that is a commercial negotiation, which -- as Mehdi asked in the previous question, is also a matter of how many options do you want and what do you want to pay for those options. So these things are commercial negotiations, which are not fully detached from the planning of what they want to do, but it is a different process. So you have the planning process for the production, which we're pretty close to, which actually drives our own planning, our own production planning and you have the commercial process. And that commercial process ends when it ends, and that's where we are. So I think in summary, 3 different customers, not homogeneous in the way they look at their road maps, the timing of their road maps, not homogeneous in the way that they negotiate and not homogeneous also in the speed at which they want to do something and the speed of their ramp. So this is what we have to take into consideration, but -- again, it's -- I'll try to put some color on what we said before, and what we said before is that we see this ramp of EUV very clearly coming on the 7-nanometer, which means 12 units this year, which are now, say, around 20 units next year, and we could see a further doubling in the years thereafter when we look at the customer road maps and their execution planning. And I think that is the most important to mention right now. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [38] +-------------------------------------------------------------------------------- + + Okay. That's very helpful. Also, just a quick follow-up for you, Wolfgang. The guidance that you, or sort of the 1Q installed base revenue and the guidance you just gave for 2Q, clearly, very rapid growth there. Are you still saying that, that sort of revised installed base revenue of about EUR 2.1 billion last year, is that still a 8% to 10% revenue growth target for '17? It's seems you are tracking significantly ahead of that at the moment, given the one half guidance as you've already mentioned. What kind of growth should we be thinking there? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [39] +-------------------------------------------------------------------------------- + + Yes. It certainly looks like -- we said in average we think this business is going to grow 10% over the next couple of years. But as customers are optimizing their installed base, they are using some of these performance enhancing options, very capital efficient for them. And you're right, I mean, 728 plus 650, I don't see this deteriorating much in the second half. You can do the math. It will very likely be quite a bit above 10% this year. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + The next question, Mr. Timothy Arcuri. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, Cowen and Company, LLC, Research Division - MD and Senior Analyst [41] +-------------------------------------------------------------------------------- + + Cowen. I guess I had 2. First of all, Wolfgang, I wanted to ask about the 2018 EUV comments. I know you still have 24 slots, that has not changed. And I think last call, you said that you'd be totally full for those slots and even have some backlog by the end of the year for 2019 shipments. So I guess, I'm wondering why you'd only ship 20 systems next year versus 24. It would seem like you have to ship -- you are like totally full on those slots. Why wouldn't you ship all those slots versus only 20. I'm just getting some questions from investors that it seems like a downtick, and I just wanted you to address that. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [42] +-------------------------------------------------------------------------------- + + I think when you look at the 20 -- you have to remember that we also booked 4 upgrade orders. So there are customers that are taking those tools, those 3350s and 3300s out of the R&D. They want them upgraded and put them into production. So that adds another 4. So we always said when we look at our production capacity and we look at the road map and the timing of the road maps that our customers are currently talking about in terms of their road maps ramps and look at that time, we said we will have to use that 24 capacity. Well, 4 of them at least are now being upgraded. So that's basically taking out of R&D and then put into production, which is probably efficient use of the capital. It also means that we need to allocate some of our production people to upgrade in the field, not in our factory, but in the field. Which also has an impact on our own capability. Because you actually have people in the field, competent people, production people, that are in the field doing these open-heart surgeries. So it is a mix now. I want to say new systems and customers wanting those upgrades, because it is capital efficient. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, Cowen and Company, LLC, Research Division - MD and Senior Analyst [43] +-------------------------------------------------------------------------------- + + Got it, Peter. That's helpful. Very, very helpful. I guess my follow-up was just on how to think about China timing. I know you said that you expect shipments to support pilot production, I think you said in 2018. Does that mean, for the indigenous China projects, does that mean that you'll ship tools in the second half of this year for pilot production for them next year? Or does that mean that you won't ship tools to these fabs until next year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [44] +-------------------------------------------------------------------------------- + + It's a bit of a mixed bag. I think the first tools will ship towards the end of this year and then will continue shipping in the first half of 2018. So before that's all installed and the production process is qualified, you won't see any output out of those pilots fabs, I would say, way into the second half of 2018. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + The next question, Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [46] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citigroup. I just wanted to come back to the topic of EUV shipments, orders and lead times. And I was hoping if you could help me with some math here. You've got 21 tools in your backlog at the end of the Q, first quarter. My understanding is the lead times are including the supply chain about 18 months, and if you're looking at shipments cumulatively in 2017 for the rest of the year and what you said for 2018, it's about 30 tools -- 30, 32 tools to be shipped. So does that mean you need around 9 to 10 orders coming through by the end of June? Or is it okay the orders come in later and your lead times will get shorter allowing you to fulfill or meet the shipment target by the end of 2018? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [47] +-------------------------------------------------------------------------------- + + First of all, I think you see independent of any VPAs you see -- you'll see a decent order flow in the next quarter, although the quarter we just started. Then it's not a hard and fast rule, right, where you have 18 months. And it's not just the order that's the communication between us and the customer, I mean we are sitting together with these customers on a weekly basis. And just because we don't have a piece of paper that says VPA because some final detail on the term and condition is not done means that we don't have a very good view on what these customers need in which quarter in the next year. And it comes down a little bit to trust as well, right, where you trust the forecast is eventually translating into an order. Of course, in the long run, you've got to have the discipline to have the orders coming in because we can certainly not be the inventory holder of the industry. But I think we are in pretty good shape. You'll see orders in Q2 with pretty good forecast on it. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [48] +-------------------------------------------------------------------------------- + + And I think in addition to what Wolfgang said, Amit, I said in earlier calls, it is our focus to have the orders needed for shipment in 2018 in the backlog by the end of this year. I mean, it is exactly what Wolfgang said, it is not a piece of paper that drives us to start ordering lenses and the long lead time items for the EUV source. It's really the weekly connection that we have with our customers and the almost weekly, or you can say, monthly updates that we're getting on that EUV planning. That is driving this. So we would be looking at getting in 2017 all the orders that we need for 2018. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [49] +-------------------------------------------------------------------------------- + + And just maybe as a follow-up on the lead times, could you give us a sense of how we should think about the lead times contracting as we look out over the next 2 to 3 years? And what are the key parameters that will help you get them down besides of course experiential learning? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [50] +-------------------------------------------------------------------------------- + + Yes, I think it is experiential learning. It is the learning curve. And we will be looking at halving the lead time over the next 3 years, so I said till the end of the decade. So by 2020, we should have half the lead time. Which is by the way, this is what we did with DUV. And with DUV -- as a matter of fact, we are reducing the factory cycle time in our factory and the overall lead time of a DUV system still. So it is a continuous process, but it is continuous learning. It's almost exponential learning. That's what it is. That will drive the lead time down. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + The next question is coming from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas Smith, - [52] +-------------------------------------------------------------------------------- + + Agency Partners. The question I had actually is on high NA. I saw in one of the slides at SPIE, a diagram of what high NA looks like. It looks like a much larger machine than the current EUV system, then the specs are much higher and so on. And have you already thought what the price of such a machine is? Are we looking at like a EUR 200 million kind of number for high NA? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [53] +-------------------------------------------------------------------------------- + + Yes, EUR 200 million plus. + +-------------------------------------------------------------------------------- +Douglas Smith, - [54] +-------------------------------------------------------------------------------- + + Okay. And maybe a little bit in the same direction, do you have people who are willing to do double patterning for EUV? Or is that something they want to avoid and would prefer to use high NA? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [55] +-------------------------------------------------------------------------------- + + Yes, I think this is a very good question, I think this exactly goes down to the economics of high-end manufacturing. It is all about the cost for a leading edge transistor. And now the question is, can you do that through multiple patterning or double patterning EUV, which would cut the productivity in half or would you do that with basically a shrink capability with higher productivity through a high NA tool. And the economics that we have calculated on the high NA tool is clearly preferring a high NA solution instead of double patterning EUV when you go to the 3-nanometer node. So as far as we are concerned, looking at the specs, high NA is the preferred economical solution. + +-------------------------------------------------------------------------------- +Douglas Smith, - [56] +-------------------------------------------------------------------------------- + + All right. And so just to clarify my first question, more or less, EUV was 2x the price of DUV, so you expect high NA to be about 2x the price of today's EUV? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [57] +-------------------------------------------------------------------------------- + + That's a decent assumption. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + The next question is coming from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [59] +-------------------------------------------------------------------------------- + + It's Bank of America. I have a quick follow-up. My questions have largely been answered. Wolfgang, could you give us some color on the total amount of deferred revenue that you have on the balance sheet related to EUV that you haven't still recognized in the P&L? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [60] +-------------------------------------------------------------------------------- + + I want to say it's -- the overall deferred revenue is about EUR 1.2 billion. I'd say EUV is probably somewhere in the EUR 200 million range or so. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + The next question is coming from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [62] +-------------------------------------------------------------------------------- + + Deutsche Bank. First question would just be on DRAM. As I understand it, Samsung is exploring DRAM insertion for EUV for performance DRAM only, and that they were deferring the decision of commodity DRAM. Is that something you recognize? And I'm just wondering is that what you are factoring into your forecast? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [63] +-------------------------------------------------------------------------------- + + We don't know the exact application of what type of product it's going to be used on. The only thing that we know it's on this particular mid-teens node and whether that's used for commodity DRAM or for performance DRAM, I suppose it's going to be supported -- it's going to be performance DRAM. That's seems the most logical. But I cannot give you a definitive answer on this, because you really have to ask Samsung, and obviously that you did. So we have to believe what our customer say. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [64] +-------------------------------------------------------------------------------- + + Got it. I mean I'm only asking because performance DRAM is about 1/3 of capacity in DRAM. So the second question would just be on TSMC and other customers. I mean I think TSMC is the only customer that's actually moved EUV tools into the manufacturing line. I was just wondering when you thought Samsung and Intel would have to move tools into the actual line to meet insertion at 7-nanometer. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [65] +-------------------------------------------------------------------------------- + + Well, I think this is really dependent on how they plan the introduction and the ramp of their nodes. So it is really -- it is a question that we can't answer for the customers. If you ask them and they give you a timing and one timing looks more aggressive than the other timing, then you can probably draw a conclusion on what they believe the need of their customers is. And so it's not up to us to draw any conclusions there. It's really driven by how they look at their own road map and their customer demands that will determine when they start to ramp up and put tools into production and start ramping capacity. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [66] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. We're going to squeeze one more. If you are unable to get through on the call and still have questions, feel free to reach out to the IR Department. We'll be around for a while. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + The last question is coming from Mr. Francois Meunier. + +-------------------------------------------------------------------------------- +Francois Auguste Roger Meunier, Morgan Stanley, Research Division - MD [68] +-------------------------------------------------------------------------------- + + So I'm not going to ask why 20 or 21 or 22 next year, because if we roll back in time, probably no one would have believed you would have even shipped more than 10 next year. No, the question really is about the gross margin. 47.6%, with no EUV revenues this year. If my calculations are correct, it's something like 500 bps, like higher than last year or something. So can you help us to understand what the bridge is between last year and this year? Is it really around the mix effect with more services revenues and more options and stuff like that? Or is it also because like -- even at the tool level your margins are going higher? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [69] +-------------------------------------------------------------------------------- + + Yes, I think, Francois, there's 2 elements. First of all, our revenue in the first quarter was 46% higher this Q1 when compared to last Q1. So we had quite a bit of volume effect there. Plus, of course, our mix is developing, right? I mean, you see more Holistic Lithography as a percent of revenue, you see HMI with the full quarter in there. And you see indeed, as you mentioned, you see a lot of upgrade options that have very, very high margins. So it's a combination of all of the above. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [70] +-------------------------------------------------------------------------------- + + Now on behalf of ASML's board and management, I'd like to thank you all for joining us today. And operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2017 First Quarter Financial Results Conference Call. You may -- thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2017-Jan-18-ASML.txt b/Transcripts/ASML/2017-Jan-18-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..fd1cec86b71e21a44c8773ac5ecd943f6daaecae --- /dev/null +++ b/Transcripts/ASML/2017-Jan-18-ASML.txt @@ -0,0 +1,674 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 ASML Holding NV Earnings Call +JANUARY 18, 2017 / 2:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Wolfgang Nickl + ASML Holding N.V. - EVP & CFO + * Peter Wennink + ASML Holding N.V. - President & CEO + * Craig DeYoung + ASML Holding N.V. - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Francois Meunier + Morgan Stanley - Analyst + * Gareth Jenkins + UBS Securities - Analyst + * Jagadish Iyer + Summit Redstone - Analyst + * Farhan Ahmad + Credit Suisse - Analyst + * Timothy Arcuri + Cowen & Company - Analyst + * Sandeep Deshpande + JPMorgan - Analyst + * Amit Harchandani + Citigroup - Analyst + * Weston Twigg + Pacific Crest Securities - Analyst + * Douglas Smith + Agency Partners - Analyst + * Andrew Gardiner + Barclays Capital - Analyst + * C.J Muse + Evercore ISI - Analyst + * Kai Korschelt + Bank of America Merrill Lynch - Analyst + * Robert Sanders + Deutsche Bank - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Unidentified Audience Member [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2016 fourth quarter and annual financial results conference call on January 18, 2017. Throughout today's introduction, all participants will be in a listen-only mode. After ASML's introduction, there will be an opportunity to ask questions. I would now like to open the question-and-answer queue. (Operator Instructions) I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Aaron, and good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from ASML's headquarters in Veldhoven, The Netherlands is ASML's CEO, Peter Wennink; and our CFO, Wolfgang Nickl. The subject of today's call is ASML's 2016 fourth quarter and annual results. As always, the length of the call will be 60 minutes and questions will be taken in the order that they're received. This call is also being broadcast live over the Internet at asml.com and a replay of the call will be available on our website. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the Federal Securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Safe Harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's Annual Report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Craig. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our fourth quarter 2016 and 2016 annual results conference call. Before we begin the Q&A session, Wolfgang and I would like to provide you with an overview and some commentary on 2016, the fourth quarter, and beyond. Wolfgang will start with a review of our annual 2016 and fourth quarter financial performance with some added comments on our short-term outlook. Then I will complete the introduction with some additional comments on key 2016 accomplishments and some of our near-term expectations. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome everyone. 2016 was a remarkable year for ASML both financially and strategically. I would like to first highlight some of our financial accomplishments and then finish with our view of the coming quarter. 2016 was a record breaking year in many financial respects with total net sales, gross profit, net income, and earnings per share all reaching record levels. In addition, we finished the year with the highest backlog ever which combined with our current business view allows us to look forward to another great year in 2017 where EUV becomes an integral and growing part of our system revenues contributing significantly to our topline growth through the balance of this decade and beyond. +Turning to our Q4 results. Net sales came in at EUR1.91 billion. Net system sales accounted for EUR1.22 billion driven by logic which represented 61% of net system sales with memory returning to strength versus Q3 accounting for 39% of net system sales. System sales included EUR144 million of EUV revenue, in line with the guidance given during our earnings call in October. Net service and field sales for the quarter came in strong as expected at a level of EUR684 million driven by ongoing strong demand for Holistic Lithography options, high value upgrades, and our growing install base. Furthermore, we closed the acquisition of HMI in November and net service and field option sales include about EUR25 million for this new and exciting part of our business. Our gross margin for the quarter came in at 47.2%. +This includes starting the amortization of intangibles as well as the effects from the fair value assessment of HMI's inventory as of the closing date of the acquisition. The negative impact on gross margin for both of these purchase price allocation related items was approximately 1 percentage point. R&D expenses came in at EUR287 million, slightly higher than guided due to both the R&D expenses of HMI and the start of our partial funding of Zeiss SMT for our High NA EUV program. SG&A expenses came in at EUR107 million, also slightly higher than guided due to the inclusion of HMI. We also had an impact from foreign currency revaluations on transactions and balances relating to the HMI acquisition. You may remember that this was an unfavorable effect of about EUR28 million in Q3 as reported during our last call. +For Q4 we had a more than offsetting favorable effect of about EUR83 million. These effects are reported in the interest and other line in our P&L. Moving to the order book. Q4 system bookings came in at EUR1.6 billion for 44 systems including six 3400 EUV systems. Strong bookings continued in the logic sector in support of the 10 nanometer ramps and in support of EUV insertion at the 7 nanometer node. Memory bookings strengthened further from its strong Q3 level supporting expected strength in memory shipments continuing in 2017 driven by DRAM. Continuing order flow for EUV systems brings our total year-end EUV system order book to 18 systems. Our overall systems backlog now stands at nearly EUR4 billion. Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents, and short-term investments came in at EUR4.06 billion. A major driver was our free cash flow of EUR1.1 billion in Q4. +As we experienced in the last quarter of 2015, we saw a significant level of early payments from customers which will impact Q1 2017 cash flows. Also as already mentioned before, we closed the HMI acquisition during the quarter and also issued a EUR750 million bond to support part of our planned strategic investment in Zeiss SMT, which is expected to close in Q2 of 2017. With that, I would like to turn to our expectations and guidance for the first quarter of 2017. We expect continuing sales strength in Q1 with total net sales of approximately EUR1.8 billion, of which an estimated EUR30 million will be deferred EUV revenue. Foundry shipment strength supporting 10 nanometer RAMs will continue in Q1 and will be firmly supported by memory shipments. We also expect to ship our first NXE:3400 EUV system in the quarter. +We expect to record the revenue for the system in the third quarter of the year since this system will ship in a non-final configuration. I would also like to mention here that one of the EUV systems that we expected to ship early this year was pulled from Q4 last year due to a customer readiness issue will not ship this year as originally planned. Due to other extenuating circumstances, this customer has now decided to place a system upgrade order for this tool and will take delivery of it in 2018 where it will add to two other systems at the customer side to be shipped this year. This leaves our system output plan at 12 new systems and our shipment plan at 13 considering the one additional system that missed delivery for material availability reasons in Q4 2016. +We expect our Q1 service and field options revenue to again come in above EUR650 million driven by continued demand for Holistic Lithography options, high value upgrades, and our growing install base. For now we will report HMI revenues under field options and services. Gross margin for Q1 is again expected to be around 47% including the effect from the purchase price allocation for the HMI acquisition. The negative impact of this purchase price allocation adjustment for Q1 is more than 1 percentage point. The impact for the full year is about EUR90 million and will reduce to about EUR40 million per year from 2018 onwards. R&D expenses for Q1 will be about EUR320 million and SG&A is expected to come in at about EUR95 million. +The uptick in R&D spend is driven by the inclusion of HMI and accelerated investments in pattern fidelity metrology our contributions to SMT's High NA developments, our own High NA development acceleration, and the strong US dollar. As a reminder regarding our share buyback program. Last year we purchased EUR400 million worth of our own shares before the program was paused during our acquisition of HMI. It remains paused for the time being as we close our planned investment in Zeiss SMT. The transaction is in the regulatory approval process in the required jurisdictions. We've already received the approval in South Korea and expect the approval from Germany and China in time to close the transaction in Q2 2017. And finally, an increase of our annual dividend from EUR1.05 to EUR1.20 will be proposed at our Annual General Meeting of shareholders in April. +With that, I would like to turn the call back over to Peter. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. 2016 was indeed a remarkable year for ASML not only financially as highlighted by Wolfgang, but strategically and product technology wise as we continue to prepare ourselves for continued growth in the coming decade and beyond. I'd like to take a moment to highlight some of these key events. Firstly, our acquisition of HMI will enable us to move from simple imaging and imaging placement significantly in the direction of full pattern fidelity control, which is a key requirement and value provider for our customers at 7 nanometer and below. This along with an expansion of our current products into broader types of applications allows us to lay the foundation for future growth in our Holistic Lithography products group. +Secondly, we brought a key supplier partnership to the next level by agreeing to acquire a minority stake of Carl Zeiss, our major critical optics supplier, for the purpose of not only securing the extension of EUV imaging technology, but also strengthening the current combined businesses of the two companies to improve cooperation and governance. The co-investment of about EUR760 million over a six year period centers on the R&D investments of next generation lenses and related capital expenditure also referred to as High NA, which is critical in meeting our customers' imaging roadmaps throughout the next decade. Lastly and probably more significantly, the industry has turned the corner on EUV. Throughout the year we continued to execute on mutually agreed performance milestones, which allowed our customers to grow confidence in the technology and tool performance. +This resulted in customer decisions to allocate their most critical layers of the next generation nodes to EUV beginning with the industry 7 nanometer logic node. With customers backing this confidence up with orders, we ended the year with an EUV backlog of 18 systems as mentioned. Together with the anticipated Q1 orders, this will cover our 2017 and early 2018 EUV output. As mentioned before, our output capability for 2018 will be around 24 systems. Based on the timing of high volume manufacturing introduction of the advanced logic and memory nodes as announced by our customers, it is realistic to assume that this production capability will be fully utilized by our customers. This means we would expect a continued order flow in the coming quarters. +As we move into the next phase of industrialization of EUV, our focus will remain on continued improvement of key HVM performance metrics very much in line with what customers expect of our DPV offering, above 90% availability and productivity per tool specifications. Furthermore, we are heightening our focus on our supply chain to provide the required number of EUV systems on time and on preparing a competent and sufficiently sizable EUV field service organization capable of supporting our customers in the volume manufacturing installation plants. With respect to our core product lines, we continued to develop industry leading imaging systems evidenced by the introduction of our latest immersion product offering, the NXT:1980, which has demonstrated the fastest ramp of a new product in our history with 46 systems shipped in 2016. +For our Holistic Lithography product line, 2016 was also a good year where we launched new products by penetrating new large customer accounts promising significant new business in the years to come. Together with the aforementioned progress on the EUV product performance and related business opportunities, we feel confident in further anchoring our leadership position in the semiconductor equipment marketplace. And turning to the short term, as Wolfgang mentioned, we expect to build upon a record 2016 seeing further significant opportunities to grow in 2017. We see a continued ramp of the foundry logic 10 nanometer node as recently confirmed by one of our large foundry customers with memory strength driven by expected stronger bit growth in 2017. In addition, service and field option sales are again expected to continue to grow in 2017. +This will continue to be driven by sales of scanner system upgrades and our growing Holistic Lithography product offering. In 2017, we'll see the first real impact of EUV system sales with the recognition of systems shipped in the calendar year as well as pieces of remaining revenue recognition from systems shipped in the past. For 2017, our opportunities and challenges are crystal clear. The commitment of our customers to EUV is now apparent and evidenced by our significant and growing EUV backlog. Supporting our customer's intent for moving EUV into volume production in the coming 24 months will remain our number one priority in order to ensure that our customers can deliver the next node transitions as planned. ASML remains committed to do everything within our capability and power to bring EUV to manufacturing as soon as possible. +With that, we would be happy to take your questions. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Thank you for letting us to take some extra time to review in some depth key events of 2016 and their impact on our future. The operator will instruct you momentarily on the protocol for the Q&A session. But beforehand as I always do, I'd like to ask you kindly to limit yourself to one question and one short follow-up if necessary. This will allow us to get as many callers in the hour as possible. Now Aaron, could we have your final instructions and then the first question please? + + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Unidentified Audience Member [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, at this time we will start the question-and-answer session. (Operator Instructions) Weston Twigg. + + +-------------------------------------------------------------------------------- +Weston Twigg, Pacific Crest Securities - Analyst [2] +-------------------------------------------------------------------------------- + + Weston Twigg, Pacific Crest. So, my question is related to the memory strength. You mentioned that it should stay strong through 2017 particularly on the DRAM side with bit growth and I was just wondering if you're seeing new DRAM capacity being installed given the pricing trends or if these are tools that are being shipped in the end and then replaced in the DRAM fabs? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [3] +-------------------------------------------------------------------------------- + + It's more of the latter. So, we've seen significant relocations from DRAM capacity into NAND throughout 2016 or starting in 2015 and is really feeling it all back up. Like we said in the previous call, we saw quite a significant capacity drop in 2016 in terms of wafer starts per month in DRAM, which is a double-digit drop and that's being filled up with new DRAM capacity. + + +-------------------------------------------------------------------------------- +Weston Twigg, Pacific Crest Securities - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then I guess as my follow-up, those upgrades on the NAND side, are those being upgrades that are contributing to your field and service options or is that a different revenue line or are those even being upgraded? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [5] +-------------------------------------------------------------------------------- + + It's the first. These are the upgrades that are in the field service and option line. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [6] +-------------------------------------------------------------------------------- + + Kai Korschelt. + + +-------------------------------------------------------------------------------- +Kai Korschelt, Bank of America Merrill Lynch - Analyst [7] +-------------------------------------------------------------------------------- + + Kai Korschelt, Bank of America. The first one was, Peter, just to clarify your commentary around the EUV shipments next year. So, I think I heard you say it's realistic to expect 24 tools. What would be the sort of puts and takes on kind of whether you would ship capacity or maybe potentially slightly less in terms of adoption and capacity? And the second question was on the Chinese CapEx and I think you said something on the video on your website. Some of the data points that has been making the rounds of the press suggests that there could be tens of billions of dollars spend on new memory fabs in China. So I'm just wondering in terms of the phasing, timing, or magnitude; how much visibility do you have on those projects? Thank you. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [8] +-------------------------------------------------------------------------------- + + On 2018 the determining factor is not so much our capability or the performance of the tool, it is really as you can understand the next nodes of our customers have complexities in there that are not only driven by our capability or our lithography capability. This is really based on the introduction timing of our customers. So when all our major customers make public statements about when they want to introduce their next nodes and start using EUV, we take those statements and actually we don't only take the public statements to be honest, we have very detailed discussions with those customers on those public statements and what that means. +So, we get very detailed plans of when they need what tool when and that is really driving the let's say realistic assumption that when we have 24 units to sell, we will sell 24 units when they stick to their plans. So this is basically what it is, there's nothing more to it than that. So, customers will decide and it could be that if one customer says I for whatever reason need to do an introduction six months or later, there will be a six month rescheduling. That's what really drives the business. China CapEx, it's interesting. We also have a lot of interest following every comment that comes out of China, all the tens of billions that will be invested in all kinds of fabs all over the place. But you also have to look at what impact that will have on our short-term business. +Now short term yes, there are many ceremonies of fab openings or fab extensions I would say, the number of real new fabs is limited or let's say Chinese owned companies. Of course there are the foreign companies that open fabs in China, but I think the reference to the tens of billions are really Chinese owned companies. Definitely I promise when we look at the next 12 to 18 months, it is good. There's some good logic opportunity, there's some memory opportunity there; but it's all within the realms of good business and not the extraordinary growth that some people are portraying. That will very likely happen, but it's very likely also going to take a bit more time than the 2017/2018 timeframe. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [9] +-------------------------------------------------------------------------------- + + Sandeep Deshpande. + + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [10] +-------------------------------------------------------------------------------- + + This is Sandeep Deshpande, JPMorgan. Just a quick question, Peter, on the order intake. In the fourth quarter you took orders for six EUV tools and at the same time we have some expectation that you will sign volume purchase agreements with some of your large customers for these EUV tools. So, is it now that you will be taking these EUV orders as a normal part of the business as you seem to have done in the fourth quarter or are we to still expect volume purchase agreements in the next few months? And I have one quick follow-up question on the 2018 shipments. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [11] +-------------------------------------------------------------------------------- + + On the order intake in Q4, that was based on a volume purchase agreement for you could say the 3400 delivery. It does not include yet the additional options that they need on those 3400. So you could say if there's a fully signed and closed volume purchase agreement with that customer not entirely because the options are still under discussion, what they need and the economics of it. But yes, those orders were indeed taken under the agreements that we have on the pricing and the pricing models. That's just for one customer. Other customers will follow suit as we continue in 2017. And for those who will introduce EUV later, those VPAs will be also signed later on in 2018. So as you said, it's the normal course of business. + + +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan - Analyst [12] +-------------------------------------------------------------------------------- + + And then following on to 2018 shipments, you're going to have this capacity for 24 tools potentially and then you've already got six of those orders at this point. By which point do you need to get all your orders so that that capacity will be readied for the customer? Because you've said in the past that you take almost a year to ship these tools and then there is a time which the customer takes to install the tool in their own facility and get it stabilized. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [13] +-------------------------------------------------------------------------------- + + The time to ship and install is about a year so it's not plus, plus. So, it's not for us a time of the year to ship the tool. Our time is we can ship an EUV tool so we can install an EUV tool in about three to four months and we have currently an interval or a cycle time in the factory of about six months. So all-in-all for us it takes about nine months from start of the tool to get it installed at the customer side. Now then the customer needs to of course start to qualify the production. The issue is in their supply chain and in their supply chain we need lenses, we need large mechanical modules that need to be produced, and this is limiting our output capability right now. +However, having said that to your earlier questions, we are in very intense and deep discussions with customers on volume purchase agreements and it is also clear that those customers need those tools at a certain moment, day, and time. And taking into account our cycle time reduction plans, it is not absolutely necessary throughout 2017 that we need to keep on to this two year timeline. That will go down, that will be shorter because we will reduce the cycle time as volumes go up. However, to be able to ship 24 units in 2018, those systems need to be booked by the end of the year so in this year. Now if you're going to ask me when should those orders come in; is it Q1, is it Q2, or really Q3; I don't know yet and it's not that important. But what I do know is that if we need to ship 24 units in 2017, those orders need to be in. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [14] +-------------------------------------------------------------------------------- + + C.J Muse. + + +-------------------------------------------------------------------------------- +C.J Muse, Evercore ISI - Analyst [15] +-------------------------------------------------------------------------------- + + C.J. Muse, Evercore ISI. So first question, can you walk through how we should think about the gross margin for EUV through calendar 2017 and particularly interested how we should think about the inclusion of deferred 100% margins through the year? Thank you. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [16] +-------------------------------------------------------------------------------- + + I'll take that, C.J. We painted the picture at our Investor Day as well. The starting point is a gross margin if you take everything into consideration of about minus 75% in 2016. Our objective is to get this business breakeven from a gross margin perspective in 2017 and then in 2018 you would make another significant step forward we are thinking somewhere in the 20%s or so. Of course there are a few things that contribute to that and you're right, some of the catch-up revenue that essentially comes at no or low cost will help. But it also will help that this year we are shipping the 3400, which has a list price that's about EUR20 million higher than that the 3350s. We're also going to continue to make progress on the cost side. +We still have significant amounts of field upgrades that we have to do for no charges. We have learning to do, we are making progress on that front as well. And if you then take into consideration also the service business where as you know, we are charging per wafer out; but we got to mind a growing installed base that is not productive in churning out a lot of wafers. So, we are still spending a significant amount of money on this without revenue coming in. But if you take it all into consideration, we are targeting around breakeven. As it relates to the total business, we were about 45% gross margin in 2016. +I think we are going to continue to make progress in both businesses EUV going from minus 75% to about breakeven, but also the non-EUV business because the mix is shifting towards applications and more higher value systems will make progress as well. But overall I think for your modeling purposes, you should assume that the total Company gross margin will somewhat go down because you're growing the revenue significantly on the EUV line. So, should expect a little bit of a step back there before then in 2018 we are marching towards the 50% plus that we're targeting for 2020. + + +-------------------------------------------------------------------------------- +C.J Muse, Evercore ISI - Analyst [17] +-------------------------------------------------------------------------------- + + Just as a quick follow-up there, are you thinking closer to like 43%, 44%? And then as my follow-up on the foundry side, orders ex-EUV came in fairly weak I think sub EUR300 million in the December quarter. How should we think about the timing of a pickup there? Is that simply turns where they will place the order upon your shipment and therefore really not an issue and how do we think about the trajectory as we contemplate 10 nanometer and 7 nanometer RAM? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [18] +-------------------------------------------------------------------------------- + + Without tying it down to a specific number, but I think with everything that we gave you between Peter on the shipments, on EUV, and the margin; I think you are in the right zip code there on the gross margins. Related to orders, first of all we are thrilled to be at an overall backlog of EUR4 billion. Having said that, same story as in prior calls. We published the backlog because it gives you a decent structural view on what's happening in the business; you see memory picking up, you see a lot of EUV orders coming in. But we always say that just merely looking at bookings or backlog should not be your main input barometer in the outlook because as you know, the order at the end of the day in particular for the more mature business is merely an administrative act. We have VPAs with all of our customers and every other week we get a detailed sales forecast and order forecast against that and that is what's giving us the confidence in the numbers. So, we were not the slightest bit disappointed about bookings last quarter. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [19] +-------------------------------------------------------------------------------- + + Timothy Arcuri. + + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [20] +-------------------------------------------------------------------------------- + + Timothy Arcuri, Cowen & Company. Wolfgang, first of all in the presentation on the metrics around EUV, you definitely showed some continued improvement in availability. You had two tools that showed a four week average of greater than 90% versus one last quarter, but there was no improvement in productivity. Is that because it's not your focus right now? I guess I would have thought maybe you've seen more than just one tool producing 1,500 wafers per day over that three day period. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [21] +-------------------------------------------------------------------------------- + + Let me answer that, Tim. First of all, the reason why we put those metrics in there is one, to be able to communicate to you; but also to our customers what we believed at that time when we created those metrics the most relevant milestones were that customers used to get convinced that EUV was going to be the choice of their next generation leading edge litho production. Having said that, meeting those targets and not only those targets, it was continued let's say showing off of those targets throughout the year that actually raised the customer's confidence to the level to also publicly state we're going to use EUV and they followed that up with orders as you have seen. Now just for your information, we are over 200 wattsorders which will actually provide us way more than 1,500 wafers per day and that's what we've shown the customers. That's all. +It is about the confidence that we will be at high volume production requirements by the time that customers need it and that's what's shown with those targets. The targets going forward I would like to relate to are the targets that they need for higher volume introduction like I said in my introductory comments. It's like with Deep UV where we're moving into that in all direction. Like Sandeep said, it's business as usual; we will be over if we have to be and we will be over 90% availability when they need it when they start [HVI] production and we'll be at the productivity of wafers per day as specified by the tool specifications, i.e. 125 wafers per hour. This is where we are and this is why we're absolutely confident that we're going to get there and that's why it is the last time we are going to give you these targeted numbers because those milestones have been met evidenced by their customer orders. + + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [22] +-------------------------------------------------------------------------------- + + And then as just as it relates to backlog on EUV. So you have 18 systems in backlog, you have slots for 12 this year so obviously 6 of those are going to ship next year. Since you have 24 slots give or take next year, does that mean that backlog can only be 24 exiting this year or is the policy such that if you get an order even if it's going to ship 18 months from now, you're going to put in backlog so that the backlog exiting this year can be actually a lot higher than the 24 slots that you have next year? Thanks. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [23] +-------------------------------------------------------------------------------- + + That's correct. Like I said, probably if you would in 2016 we had 24-month lead time. That will go down, but it's not going to be 12 months by the end of this year. So, it's very likely that there are going to be 2019 orders in there. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [24] +-------------------------------------------------------------------------------- + + Amit Harchandani. + + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [25] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citigroup. Firstly, my question is with respect to the technical milestones that you referred to earlier. Could you maybe talk about what are the key areas of improvement that you're working on within the tool that need to be completed this year or are on the verge of being completed that would take you to the targets you've talked about for commercial introduction in terms of the technological progress? And secondly, could you also give us a sense of what's happening in the wider ecosystem particularly around defectivity and pellicles any other components within the ecosystem, if you could kindly share any updates around those? Thank you. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [26] +-------------------------------------------------------------------------------- + + On the key areas of improvement, it's really focused on lifetime extensions of parts. So it's the industrialization of those parts, lifetime extensions, taking out some of the quality issues that we know what to do. That actually brings us to those targets that customers need for high volume introduction, 90% plus availability and productivity at spec. On the ecosystem I think two things, resist and pellicles. Resist, good progress and we get progress reports every now and then and over the last couple of weeks we got some good progress reports of photoresist and on photoresist sensitivity, on linage roughness data and information that give customers good confidence that by end of 2018, 2019 we're going to get what we want. On the pellicle, we have started to outsource the pellicle production to a supplier that actually should make the pellicles for the industry for our customers. +Initially there was a process that yielded low because pellicles still had some defects on it on the pellicle itself. As you can imagine if a pellicle is a membrane sitting in front of the photomask, you don't want any a defects on that pellicle because they're big, they will actually print. Now by the end of the year we actually received the first defect free pellicle and also there we were seeing progress that everybody is looking for. It is not our main concern. What our concern is yes, the supply base of those pellicles will be maturing also so we get a constant flow of defect free pellicles. But if you look at the progress that we have made in the last six months, that gives us the confidence that also by the time when we need the [H] volume, the HVM requirements, we will be there. + + +-------------------------------------------------------------------------------- +Amit Harchandani, Citigroup - Analyst [27] +-------------------------------------------------------------------------------- + + Just a couple of clarifications on what you said. Firstly, with respect to the technical progress with respect to your tool. But just so that I understand correctly there are all incremental improvements really around lifetime extensions, but there is no radical improvement that you need to do, all of that is behind us in 2016. That would not be a correct statement to make technically. And secondly, is the topic of actinic inspection tool when it comes to EUV behind us or does that still come up in your conversations that you think the workaround is pretty much accepted now by all the customers who are looking to move on with EUV? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [28] +-------------------------------------------------------------------------------- + + That's correct. We do not have any discussions on actinic inspection at this moment and the workarounds that we currently have either through the pellicle use or on-wafer inspection using tools EVM tools. That is really what the solutions are that customers are currently using. Now the discussion on actinic inspection tools over time and in the next decade might come back, but we'll see how effectively current solutions are. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [29] +-------------------------------------------------------------------------------- + + Gareth Jenkins. + + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Securities - Analyst [30] +-------------------------------------------------------------------------------- + + Gareth Jenkins from UBS. Just a follow-up on memory, you have a slightly more positive tone on this. Does this include in addition to the 1980s that you're talking about some KrF business? And secondly, I just wonder whether you could talk about your expectation in terms of conversion of the 7 nanometer node for your large foundry customers from 10 nanometer. Thank you. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [31] +-------------------------------------------------------------------------------- + + Gareth, could you be a bit more specific on your last question on the conversion, what do you want to know? + + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Securities - Analyst [32] +-------------------------------------------------------------------------------- + + + + I just like to know the sort of level of conversion that you expect between the 10 nanometer and the 7 nanometer node given the similarity or the commonality between the tools. So, would you expect it to be more or less than kind of what we saw with prior nodes? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [33] +-------------------------------------------------------------------------------- + + On the memory, presumably yes, with only 1980s; we always ship if you add some extra capacity some KrF. But going back to an earlier question, this is really backing up the installed capacity that was relocated to NAND, which were basically immersion systems where they were upgraded in the NAND space. So it's predominantly NXTs, but we always have some level of capacity space that is in the existing fabs which also need some KrF, but it's largely NXTs. The level of conversion from 10 nanometer to 7 nanometer. There's always a level of conversion from 10 nanometer to 7 nanometer, which would include upgrades. So the level of commonality from a platform point of view is always there, but it's really the performance on overlay and focus that drives really upgrades. +So when there is a reuse of an existing body in the 10 nanometer space or a previous node on to the new node, then you see upgrade business. And this is a part of the business that we see growing in 2017 where we indeed see the number of upgrades in the logic space, but also in the memory space from let's say previous platforms to the newest specification of the NXT platform really happening and that is part of the business growth that we see in the services and options. So not much different than previous nodes, it does lead to a lot of new business in terms of system upgrades. + + +-------------------------------------------------------------------------------- +Gareth Jenkins, UBS Securities - Analyst [34] +-------------------------------------------------------------------------------- + + Can I just follow-up and just ask what your expectations for the 10 nanometer. I think you've always talked about wafer starts from 10 nanometer and 7 nanometer geometries combined. I wondered whether there's been any change in the full process around the starts on 10 nanometer and 7 nanometer? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [35] +-------------------------------------------------------------------------------- + + No, currently not. The only thing that we can say is that of course we discuss with customers their business and their plans. I only can say that the 10 nanometer/7 nanometer confidence that our customers have in being a big node driven by more than just the smartphone applications they're all talking about and it's real because it's about customers in the automotive space, customers in the space that is dealing with artificial intelligence and augmented reality, virtual reality, big data, and big data analytics. They are seeing customer applications in that space and that is driving their confidence on the node sizes and they keep repeating to us that they strongly believe based on what they see and the tape outs that are coming that it's going to be a big node. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [36] +-------------------------------------------------------------------------------- + + Francois Meunier. + + +-------------------------------------------------------------------------------- +Francois Meunier, Morgan Stanley - Analyst [37] +-------------------------------------------------------------------------------- + + Francois Meunier from Morgan Stanley. I understand what was the question around the gross margins and like the effects around it, but there is one I would like to understand a bit more. I think you guys have been talking about PPA having a negative impact this year of around EUR90 million. So it's actually a non-cash impact so like when you guide for 47% gross margin in Q1, actually the cash gross margin is more like 48%, 48.2%, or something for Q1. Is that the right way to look at it? + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [38] +-------------------------------------------------------------------------------- + + I'll be careful with the cash because there are other cash, non-cash related items; but in principle you're right, we're guiding to about 47%. And if you just look at the two elements, one being the amortization of intangibles, we said that's going to be about EUR40 million per year; but that's linear so it's about EUR10 million. And then we said there was EUR50 million that result from the revaluation of the inventory to a fair value or market value at the time of closing. We've got to work ourselves through this and as you can imagine, this is going to be a bit more skewed to the front of the year rather than the back of the year and therefore there is as you state a probably closer to 1.5% impact on the gross margin in Q1. Or in other words had we not done the acquisition and the deal with the purchase price allocation, we would have been north of 48% in the first quarter. But I wouldn't associate it with cash and non-cash because there's other stuff. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [39] +-------------------------------------------------------------------------------- + + Farhan Ahmad. + + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [40] +-------------------------------------------------------------------------------- + + Farhan Ahmad, Credit Suisse. I have a question related to EUV. What are some of the risk factors that you see going forward? Is there anything that you have to deliver for EUV to be adopted or should we take these orders as a sign that EUV is now at a point that we can count on its delivery in 2018? And also can you remind us again on what the lead time is for EUV going forward? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [41] +-------------------------------------------------------------------------------- + + I think ultimately the proof of the pudding is when the customers give you an unconditional commitment to pay you a lot of money, which I think has happened. I think that decision, which most customers have been public about EUV, when they want to use it and how they want to use it, is following this up by orders. So, I think it is true. Somebody asked a question earlier is that what could happen to make 2018 a year where you're not going to fully ship your production capacity. I just answered one of the things is customer roadmaps might change, but what they're telling us today and we know the number of layers that they want to use EUV on that we have to use that capacity and only if a customer changes their minds that things will change, but that's not the case today. On lead time like I said, lead time 2016 was just (inaudible). We had a supply chain that we have to kick out of hibernation. They're now awake I can assure you so lead times will also compress somewhat also throughout 2017. I'd love to have a lead time by the end of the year of about 18 months. + + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + And can you talk about how do you see the linearity of 2017? Some of your peers have indicated like there is a stronger first half relative to second half, is that something you see also? And related to the China 500,000 wafer starts, is any of it hitting this year or next year? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [43] +-------------------------------------------------------------------------------- + + So on the linearity, it's too early to say. Generally we have lead times of about six months for our tools so customers probably gave us a very clear indication of the next six months, which looks very good. The rest of the year is a bit driven by expectations and so that's always a bit more uncertain to a certain extent. So, that might be the reason why some of our peers focus more on the first half. It's just visibility. On China 500,000 wafer starts next year, we don't see 500,000 wafer starts next year, it's too much. It will be there, but as I said earlier it's going to take a bit of time. With some of our customers, we've been talking about building new fabs now for two-and-a-half years. In that same timeframe, our logic customers built the fab and we're shipping tools while we're still talking about the others. So, this just has to kick into a different gear also because 500,000 wafer starts next year is absolutely not what we expect good business. Yes, we will expect shipments into new pedestals for our tools, into fab extensions, and perhaps a new fab; but nothing to the level that you just mentioned. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [44] +-------------------------------------------------------------------------------- + + Jagadish Iyer. + + +-------------------------------------------------------------------------------- +Jagadish Iyer, Summit Redstone - Analyst [45] +-------------------------------------------------------------------------------- + + Jagadish Iyer, Summit Redstone. First Peter, if you look at your immersion revenue systems, it has been pretty much stable through the last three years and in fact has trended up. So I just was wondering as EUV starts to progress, how should we think about the immersion system trajectory over the next 12 to 24 months? And then I have a follow-up. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [46] +-------------------------------------------------------------------------------- + + The next 12 to 24 months I do believe that when you look at what is driving our customers business is this 10 nanometer logic and it's memory, that still needs those immersion systems. So, I think next 12 to 18 months I don't think you will see a lot of change. Although longer term when complexity of chip design increases, the number of layers will also go up. Now the increase of the incremental layers are very much the critical ones, which is going to be EUV and as EUV progresses in terms of maturity and productivity, also EUV will grow into the realm of leading edge Deep UV. +But how you look at it, there's also I think clearly discussed at our Capital Markets Day, immersion and Deep UV will be with us forever and also means over the next 10 years or so it's going to be a very significant part of our business, for the next 12 to 18 months is going to be the majority part and the key part of our business given the fact that those nodes that they are being designed into are the nodes that we're currently using and ramping which is not an EUV node. 10 nanometer is an immersion node and the high-teens DRAM is an immersion node. So, that will be with us for the next 12 to 18 months. + + +-------------------------------------------------------------------------------- +Jagadish Iyer, Summit Redstone - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. Then briefly so on the six EUV system orders that you got as a VPA, is it fair to conclude that you have met the 7 nanometer initial insertion specification with this key customer? Thanks. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [48] +-------------------------------------------------------------------------------- + + Yes. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [49] +-------------------------------------------------------------------------------- + + Andrew Gardiner. + + +-------------------------------------------------------------------------------- +Andrew Gardiner, Barclays Capital - Analyst [50] +-------------------------------------------------------------------------------- + + Andrew Gardiner, Barclays. Just one on your outlook for 2017. You've given fairly clear messaging around what you see on the logic space and on the memory space and of course services and options continue to grow. Just the statement around significant revenue from EUV for the first time. If I go back to the Capital Markets Day in late October, you seemed to be indicating at that point something on the order of sort of below EUR1 billion mark as a combination of rev rec at shipment as well as the deferred revenue coming through. Is that still a reasonable assumption given better visibility in how you see EUV trending for this year? And also within services and options for this year now that HMI is closed and you're in the integration process, what are your expectations for that business over the next couple of quarters? Thank you. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [51] +-------------------------------------------------------------------------------- + + EUV, what we said before continues to apply. We said we can ship a maximum of 13 tools, which is a 12 plus 1 carryover. Revenue recognition is now close to shipment with shipment for a majority and yes, there will be some catch-up revenue from last year where we shipped systems with no revenue recognition. So without tying it down too much, but I think the number will have a [1] in for sure and some of [1.2] is clearly within the realm of possibilities. Service and field options will continue to grow even if you start with excluding HMI, we grew 7%, 8% this year. And also based on some of Peter's comments on the upgrades, we think it will grow at least by that level, it could grow at 10% or so year-over-year. +And then we have HMI, which are going in for like two months last year and we are not intending to break this out in the future. But you know from the standalone reporting that this should be somewhere in the EUR200 million zip code that is incremental. I think you will see us announcing new products during the year, but they will not lead to any significant revenue in the year. So EUV, field options and services, and HMI are all growth drivers and then you have the rest of the business that is stable and in some cases up a little bit. So like we said in our prior remarks, it should be a pretty good revenue year in 2017. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [52] +-------------------------------------------------------------------------------- + + Douglas Smith. + + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [53] +-------------------------------------------------------------------------------- + + Doug Smith from Agency Partners. I was wondering can you break down the 18 EUV systems backlog into your foundry, memory, and IDM groups? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [54] +-------------------------------------------------------------------------------- + + Yes, we could, but we generally say we're not doing it because it will be very customer specific because you could easily say who is who and that's not what I want. But there are few memory orders in there and that's just less than a handful and the rest, most is logic and IDM. + + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [55] +-------------------------------------------------------------------------------- + + Okay. And just a clarification, were you saying that the six EUV orders in Q4 were all from one customer? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [56] +-------------------------------------------------------------------------------- + + No. There were five from one customer, one was an addition. + + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [57] +-------------------------------------------------------------------------------- + + Okay. So five from one customer? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [58] +-------------------------------------------------------------------------------- + + One memory customer and one logic customer. + + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [59] +-------------------------------------------------------------------------------- + + Okay. And the one that was in this group of five was what you call the kind of quasi PPN? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [60] +-------------------------------------------------------------------------------- + + I have to correct you, I think that it was all logic. Six were all logic, but with two customers; (inaudible). + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [61] +-------------------------------------------------------------------------------- + + On the 18 systems, we have said before that it's five customers in total not like only the (inaudible). It's five customers in total that have orders in with us. + + +-------------------------------------------------------------------------------- +Douglas Smith, Agency Partners - Analyst [62] +-------------------------------------------------------------------------------- + + And it's the one that had the five which were I think that you called kind of a quasi PPN? + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [63] +-------------------------------------------------------------------------------- + + Yes. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR [64] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. So if you are unable to get through, as always feel free to contact the Investor Relations department and we'll get back to you as soon as we possibly can to try to help. Now operator, if we can have the last caller, please. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [65] +-------------------------------------------------------------------------------- + + Robert Sanders. + + +-------------------------------------------------------------------------------- +Robert Sanders, Deutsche Bank - Analyst [66] +-------------------------------------------------------------------------------- + + Just a question about the 3400. So the shipments that customers have ordered, are you going to upgrade the source to 250 watts at a later stage and is that a free upgrade? And then the second question would just be on the HMI business, it does seem to be tracking below expectations from June when you acquired it. I was just wondering what's the update there on the outlook and how that business is tracking? Thanks. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [67] +-------------------------------------------------------------------------------- + + On the 3400, there's no major source upgrades just cranking up the power and so that is not necessary the source is the source and we'll be capable of doing 250 watts or at least it's going to be above 205 watts whereas 250 watts doesn't really matter because 205 watts worth 125 wafers per hour and that's the throughput specification. But 250 watts by the way is also not with this particular source design is not our end target. I think with this particular design, we can go higher, we can go 300 watts and above. On HMI, below expectations. + + +-------------------------------------------------------------------------------- +Wolfgang Nickl, ASML Holding N.V. - EVP & CFO [68] +-------------------------------------------------------------------------------- + + There is no significant difference in what we have seen already during our due diligence time and since this is a growing business, more importantly the roadmap going forward is well aligned not only within us and HMI more importantly also with the technology folks at the customers. So, we're looking forward to a significant opportunity like we said at our October call which could be up to a EUR1 billion by 2020. + + +-------------------------------------------------------------------------------- +Peter Wennink, ASML Holding N.V. - President & CEO [69] +-------------------------------------------------------------------------------- + + Rob, you have to remember that in 2017 we still have the majority of the HMI sales or you would call the standalone HMI sales. What we're really looking at is you may remember the presentation that we had at the time of the acquisition that the area where we believe we will have a significant growth opportunity is the combination of the holistic lithography or the computational lithography competencies of ASML with the HMI capabilities creating a new product. That is where we think there is going to be a big market and a big growth opportunity and that's not for 2017, it will be 2018 onwards. + + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR [70] +-------------------------------------------------------------------------------- + + Thank you, everybody. On behalf of ASML's Board of Management, we'd like to thank you for joining us in the call today. And operator, if we could have your formal conclusion to the call, we'd appreciate it. Thank you. + + +-------------------------------------------------------------------------------- +Unidentified Audience Member [71] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2016 fourth quarter and annual financial results conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2017-Jul-19-ASML.txt b/Transcripts/ASML/2017-Jul-19-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..9ea13da5a010d023c6aaada6e9ab9c616278ff23 --- /dev/null +++ b/Transcripts/ASML/2017-Jul-19-ASML.txt @@ -0,0 +1,547 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 ASML Holding NV Earnings Call +JULY 19, 2017 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, CEO and President + * Wolfgang U. Nickl + ASML Holding N.V. - CFO, EVP and Member of the Management Board + * Craig DeYoung + ASML Holding N.V. - VP of IR - ASML Tempe + +================================================================================ +Conference Call Participiants +================================================================================ + + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Douglas Smith + - + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays PLC, Research Division - Director + * Alexander Duval + Goldman Sachs Group Inc., Research Division - Equity Analyst + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Farhan Ahmad + Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Jagadish Kalyanam Iyer + Summit Redstone Partners, L.L.C - MD and Senior Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to ASML 2017 Second Quarter Financial Results Conference Call on July 19, 2017. (Operator Instructions) +I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [2] +-------------------------------------------------------------------------------- + + Thank you, Peter. Good afternoon, and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations here at ASML. Joining me today, as always, from our headquarters here in Veldhoven in Netherlands is our CEO, Peter Wennink; and our CFO, Wolfgang Nickl. +As a reminder, the subject of today's call is ASML's Q2 2017 results. The length of the call will be 60 minutes, and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of the call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Good morning and good afternoon, ladies and gentlemen, and thank you for joining us for our Q2 results conference call. +Before we begin the question-and-answer session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter as well as provide our view of the coming quarters. Wolfgang will start with a review of our second quarter financial performance with added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Wolfgang, if you will? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome everyone. I would like to first highlight some of the second quarter financial accomplishments and then provide our view for the coming quarter. +Q2 net sales came in at EUR 2.1 billion. Net system sales accounted for EUR 1.38 billion, showing another quarter of increasing memory business, which is now at 54% of net system sales, and also a strong quarter of logic sales, which represented the remaining 46%. Installed base revenue for the quarter came in stronger than expected at a level of EUR 717 million, driven by major DUV and Holistic Lithography upgrades. The first half of the year, our total installed base revenue is already at EUR 1.45 billion compared to a full year sales of EUR 2.12 billion in 2016. Gross margin for the quarter came in at 45%, slightly higher than guided, driven by a higher top line and a favorable mix. Overall OpEx came in as guided, although R&D expenses came in slightly lower at EUR 313 million and SG&A expenses came in slightly higher at EUR 102 million, driven by litigation expenses. +Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at EUR 2.51 billion. As a reminder, in Q2, we had several extraordinary cash outflows, which have brought the overall cash balance back to our target level. We've paid a dividend of EUR 1.20 per ordinary share or approximately EUR 517 million in total to our shareholders. We also have repaid a maturing bond with an outstanding balance of EUR 238 million. And lastly, we have closed the acquisition of a 24.9% interest in Carl Zeiss SMT during the quarter for EUR 1 billion. +Moving on to the order book. Q2 system bookings came in at EUR 2.37 billion, including orders for 8 3400 EUV systems from 2 customers. Six of the EUV orders came from one customer for use in both logic and DRAM. Total bookings were almost EUR 500 million higher than in the previous quarter. Breakdown of the bookings of 60% logic and 40% memory is the same as in the previous quarter. Strong bookings in the logic sector are in support of the 10-nanometer ramps and in support of the EUV insertion at the 7-nanometer node. Memory bookings, mainly in DUVs, strengthened further from its strong Q1 level, supporting an expected 50% year-on-year revenue growth in the memory sector in 2017. The continuing order flow for EUV systems increases our EUV backlog to 27 systems valued at EUR 2.8 billion. Our overall systems backlog now stands at a record EUR 5.35 billion. After 2 strong quarters in 2017, in combination with a record order book, we are now expecting full year net sales, which are up approximately 25% from our previous record revenue of EUR 6.8 billion in 2016. 2017 revenue is driven by continued strong demand for our entire portfolio, driven by both logic and memory. +With that, I would like to turn to our expectations and guidance for the third quarter of 2017. We expect continuing sales strength in Q3 with total net sales of around EUR 2.2 billion, including an estimated EUR 300 million of EUV revenue. We plan to ship 3 NXE:3400s in the September quarter. Our EUV shipment plan for the full year remains at 12 systems and is back-end loaded. We expect our Q3 installed base revenue to come in around EUR 600 million, driven by continued demand for Holistic Lithography options, high-value upgrades and our growing installed base. For the full year, we expect our installed base revenue to be up by approximately 20% versus the 2016 levels. Gross margin for Q3 is expected to be around 43%. Excluding EUV systems, gross margin is approximately going to be at the same levels as in Q1 and in Q2. R&D expenses for Q3 will be around EUR 315 million, and SG&A is expected to come in at about EUR 105 million. SG&A includes expected increases in legal expenses. +Finally, ASML will resume share buybacks in Q3. As a reminder, we had paused our share buyback program for about 1 year to acquire HMI and the minority share of 24.9% in Carl Zeiss SMT. We have EUR 1.1 billion remaining for 2017 from our previously announced share buyback program. We do not expect to execute the entire remainder of the program in Q3 and Q4. In line with our policy, we will return excess cash to our shareholders through share buybacks, and we will make announcements on future share buyback programs when appropriate. +With that, I'd like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. As Wolfgang has highlighted, our business continues to perform very well. We expect our positive momentum to continue throughout the year based on the market environment and the related strong demand for our products. We should deliver another record year with net sales growth expected at about 25%, representing one of the strongest gains in annual revenues in our history. +While Wolfgang reviewed our current quarter performance and outlook for the coming quarter, I would like to provide some commentary on the longer-term outlook of our market drivers, followed by an update on the progress and plans for our product groups. Let me start by making some comments on the market drivers and the impact on litho demand. As we have moved further into the year, the demand for memory has continued to strengthen, especially noticeable in DRAM. We are on track to see our memory revenue grow by around 50% year-on-year, creating the highest memory demand in history of ASML. However, we need to remember that this growth in spend coming off 1.5 years of wafer capacity reduction due to significant underspend in 2016 and relocations of leading-edge tools to 3D NAND and that combined with a significant end market demand growth this year. In 3D NAND, the industry continues to witness a number of greenfield fabs that are ramping, which is driving very strong lithography growth. Logic demand, where our tools is expected to grow around 15% year-on-year, driven by the continued ramp of 10 nanometer as well as the start of the 7-nanometer node, which is particularly driving the logic growth this year as it concentrates on the planned EUV adoption. +With regards to China, we've been doing business in this region for over 25 years and currently have over 600 employees in 11 cities supporting an installed base of more than 400 lithography systems. We also have 2 R&D centers in China and are working to deepen our relationship with Chinese semiconductor industry customers by collaborating with industry consortia. We signed a memorandum of understanding with the Shanghai Integrated Circuit Research and Development Center, ICRD, a public research consortium dedicated to the advancements of the semiconductor industry in China, set up a jointly owned world-class application and training center in Shanghai. We have seen continued revenue growth for China -- from China over the last 5 years by both domestic Chinese as well as nondomestic companies, and we see a lot of opportunity for growth in this region going forward. However, as we mentioned on earlier occasions, the speed with which this growth will translate into sales and earnings is dependent on the ability of our new Chinese semiconductor customers, who effectively bring qualified and competitive products in volume to the market. This might take some time. We are currently in discussions with 5 domestic logic and memory customers, which per published fab plans, that translates into a lithography opportunity of more than EUR 3 billion. This opportunity led last quarter to bookings from a new Chinese domestic memory customer with shipments later this year. +In summary, we will see significant growth in memory demand versus prior year, and logic will build further on the healthy demand level seen in 2016, largely driven by EUV and China providing a meaningful medium-term growth opportunity. Installed base revenue continues to grow at an even greater rate than last year, driven by broad-based adoption of high-value field options and upgrades. And finally, demand will be further accelerated with the EUV adoption as customers start ramping this technology and volume production. Our current view is that the positive business trends that we're seeing in 2017 are likely to continue as we enter 2018. +On the ASML product side, let me start with an update on our EUV business. In EUV, we continue to make progress as planned. We now have demonstrated all key performance specifications on our NXE:3400 system, and this includes a throughput of 125 wafers per hour. We also demonstrated 250 watts of a source power, enabling productivity improvements beyond 125 wafers per hour. Availability continues to make progress towards the 90%-plus target with continued focus on reducing the variability. We now have a system configuration that provides all of the agreed product specifications, which will enable us to now focus our work on executing on the plant availability improvements that will drive broad-based EUV insertion in mass production. +In addition, clear progress on the ecosystem continues as communicated by many of our customers. We have produced 0-defect pellicles, and our customers continue to make progress on photoresist sensitivity, enabling higher wafer per hour productivity. Based on this progress, customers are now more and more confident inserting EUV technology in manufacturing, as clearly indicated by the continued order flow. +Our deep UV business is expected to grow this year of a record revenue in 2016, fueled by the demand for our immersion and KrF products in both logic and memory. We announced our latest TWINSCAN NXT:2000 immersion system at SEMICON this past week, and this new deep UV immersion system reaches several hardware innovations that to deliver improved imaging and overlay performance in support of aggressive lithography requirements on future nodes, including mix and match with EUV. We're also seeing exceptional demand with our KrF products, notably in 3D NAND. +In Holistic Lithography, where we bring together scanner, metrology and software to provide high-value process control solutions for our customers, we expect sales to grow about 50% from last year. We have announced our latest metrology system, the YieldStar 365 -- sorry, 375, featuring new optics technology that generates more accurate data at the highest speed, providing increased quality data to feed the process control systems. In addition to YieldStar metrology systems, we're also shipping HMI e-beam systems in support of 3D NAND voltage contrast and defect inspection applications at both memory and logic customers. Product integration of HMI is progressing well with Pattern Fidelity Metrology e-beam tools being evaluated by customers, which enables Pattern Fidelity Control capability in support of the 7-nanometer node. To drive -- through further drive productivity improvements in the e-beam area, we're in the process of developing a multi-e-beam system that combines leading edge e-beam technology with ASML's unique stage and computational lithography technology. +Finally, we also closed the acquisition of a 24.9% interest in Carl Zeiss SMT. The main objective of this agreement is to strengthen our world-standing partnership with Carl Zeiss and facilitate the development of next-generation EUV lithography system, which we call high NA, due in the first few years of the next decade. This technology should enable the semiconductor industry to produce much higher performance microchips at a lower cost, supporting customer road maps throughout the next decade. +So in summary, great first half of the year with strong industry demand across all market segments, translating to very strong growth across our complete product and service portfolio for 2017. In previous quarters, we mentioned that we felt we passed an EUV inflection point. Now we see volume orders from all segments of the industry clearly marking an increased rate of adoption with order flow expected to continue, providing significant EUV growth in the coming years. As mentioned earlier, our current view is that the positive business trends that we're seeing in 2017 are likely to continue as we enter into 2018. +And with that, we'll be happy to take your questions. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [6] +-------------------------------------------------------------------------------- + + Thank you, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A sessions. (Operator Instructions) +Now Peter, operator Peter, could you -- we have the final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [2] +-------------------------------------------------------------------------------- + + This is David from UBS. Just -- first question, just on the EUV. Obviously, very good progress in the quarter, and you've put a slide in the presentation showing, potentially, for 15 to 16 layers that you could see EUV adoption up for 7 nanometers. I just wondered if you could let us know has there been any changes on your base case assumption for how many layers you could see the adoption of 7 and maybe even 5-nanometer as well in logic, and then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Okay. I don't think we currently have any reason to change our base case assumptions. We put that in there because the additional 5 or 6 layers that you have identified on top of the 10 that has been communicated earlier, are really layers that, in the discussion with the customers, we have identified as potential additional layers. Now that really depends on the speed with which we will be able to mature our EUV systems and drive the productivity up and the availability. Because it's all a matter of cost, and I think the initial 10 are driven, you could say, by the lithographic needs. You just need to use EUV. The additional 5 to 6 will be a function of productivity and the maturity of the tool. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [4] +-------------------------------------------------------------------------------- + + That's great. And then secondly, just one on the commentary on the installed base and field option sales. You obviously have very strong growth in H1. And given the commentary that you've given for the full year, maybe my math's wrong, but it would suggest a bit of a slowdown in the absolute level in the second half. I wonder if you could just comment on why you feel that's the case or maybe correct if I've got something wrong on that. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [5] +-------------------------------------------------------------------------------- + + Now David, this is Wolfgang. First of all, you're right. I mean, the -- we had an extremely strong start into the year. We have at EUR 1.45 billion, was a EUR 2.1 billion for the total last year. So it's incredibly strong start. We think we'll be up 20%. Be reminded, last year, we said we think we grow that business by approximately -- at a run rate of 10%, which we were very close to last year. But this year, it's 20% [up]. Within that, you have approximately half service and half options. The service piece is pretty stable with an upward trend. It's a function of the installed base to the last degree. The upgrades are a little bit more volatile, and that has largely to do with when our customers can afford to take the upgrade. Because you've got to remember, some of these upgrades take their machines down for 5 weeks or so. And when they're firing on all cylinders, they -- even though they see the great -- even pegged off the upgrade down the road, in the short run, for their yields, they can just simply not afford to take the machines down. And that is why, in the second half, the options piece is coming down a little bit. But having said that, we're having a fantastic yield there, 20% up year-over-year. And I think the trends are of continuous growth there will all go into next year. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [7] +-------------------------------------------------------------------------------- + + I guess first question, as you look at the building UV backlog, clearly, confidence is rising with your customers. So I would love to hear from you guys, too, what kind of improvements you're showing, particularly on the reliability in uptime side, which I think is the clear factor that is causing these guys to commit. So I would love to hear, over the last 3 months, what kind of data you've seen? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [8] +-------------------------------------------------------------------------------- + + well, I think the most important factor that drives the confidence of the customer is actually in the key forms requirements that they need. It's in 250 watts, which we show, the 125 wafers per hour. And of course, we make gradual progress in the availability and in the maturity of that system. But like we said on earlier occasions, that is going to bring us to a situation where we have that when they ramp in volume in 2019. So they know that will take some time, just like the development of the ecosystem for them with photomask and with photoresist, will take some time also. But the most important part of that, actually drove that conference calls down to meeting all the key lithographic performance criteria, that drove the conference. We now have a system that actually has all that performance in it. We just have to make it a bit more reliable, and that will take a bit of time. And we will know it, and there's a whole program driving it. And it's as simple as that. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [9] +-------------------------------------------------------------------------------- + + Very helpful. And I guess as my follow-up, in terms of your commentary around memory, in particular, DRAM, can you specify how much of that strength you're seeing across-the-board on shrinks versus 2D NAND upgrades over to DRAM? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [10] +-------------------------------------------------------------------------------- + + Difficult question to answer. I'm not going to guess in this particular case. But what we are seeing is both a combination of filling up available spots, open spots in current DRAM fabs because of the market demand, and the technology transitions that are happening across the customer base. And some customers are leading in that sense, and other customers are followers. But all do technology migration. It's across the base. So it's a mix, whereby open spots in, you can say, open pedestals in effect to these are currently being filled because of the strong end market demand in DRAM, which is particularly driven by the data centers. So it's a combination of both. With DRAM, that's strong. There are not that many 3D NAND relocations happening. But that happened in the past. That happened over the last 18 months, which created this space to backfill with leading-edge lithography systems to address the rising demand in DRAM market. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [12] +-------------------------------------------------------------------------------- + + Andrew Gardiner with Barclays. I was just wondering if we could revisit to the 2020 model, particularly in light of the strength you're now seeing in 2017 and your expectation heading into next year as well. If I go back to the scenarios, you guys outlined at the Capital Markets Day last year, you gave us sort of 4 scenarios that supported the EUR 10 billion revenue pre-HMI. But given what we're seeing, some of the lower sort of end scenarios that you have there, in particularly unlikely, I mean, first of all, you have talked about the sort of layer count -- initial layer count expectations of EUV. You're now seeing sort of 10 layers. At the time, we were still between 6 and 10. So 6 layers quite a bit lower at the low end of that range. And then similarly, in terms of the end market assumptions you are using for your lower-demand scenario, a 20% node-on-node decline in wafer starts seems particularly cautious at this point, given what we're hearing in terms of new compute applications and the greenfield build-outs you've highlighted in China. So given that, I mean, do you not think it's sort of more fair to look at the 2 higher-end scenarios that you've outlined there we should sort of minimize likelihood of the 2 weaker ones? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [13] +-------------------------------------------------------------------------------- + + Well, you did a good job almost providing the answer, along with your question. I think you're exactly right. I mean, we will not be standing there in New York last year telling you exactly where to pinpoint the revenue in 2020. We gave you a bit of a model with the key sensitivities and, as we've explained, the 2 major ones when we go through all of our sensitivities end market demand. And there, we have shown a little bit of sensitivity, and you see, there's not been that much of an upside and a downside compared to the intensity of the EUV and insertion, where we've seen between a high insertion and low insertion, it was quite a bit of a difference. I think the market assumptions provided another EUR 1 billion to the upside and then was another EUR 2 billion or so in the EUV insertion. I think what we can say is that we were certainly more confident that we're not going through the bottom end of the scenarios because you're absolutely right with everything that you're hearing from the end markets, be it frames and memory, being it new applications, being it like autonomous driving or a move towards autonomous driving, data centers, big data, analytics. Whatever you hear is pointing that the market is not going to be soft. And then with the recent accomplishments on EUV, if we follow through, which is our intent to -- now that we have the specs met, that we get the availability up. And to Peter's earlier point, right now, we've highlighted 10 layers, for instance, in logic that will be initial layers. As we move this further up, we have an opportunity to overachieve that number. But it's too early to pinpoint a new number. That's why we have given you these sensitivities. But we feel pretty comfortable right now. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [14] +-------------------------------------------------------------------------------- + + Okay, understood. Just a quick follow-up. Wolfgang, in terms of the EUV rev rec this year. So earlier in the year, you were thinking, if I recall, sort of EUR 1.1 billion, EUR 1.2 billion. Is that still a reasonable number given sort of shipments and tool performance in the field? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [15] +-------------------------------------------------------------------------------- + + Yes. It's a good question. I mean, at this point, I would say that it's going to be around EUR 1 billion or so. I mean, it has to do with a whole bunch of things. Like you know, since last year, we can recognize majority of revenue with shipments, but there are still a few things that we need to defer. For instance, if -- the installation, we have a little bit if we provide a longer warranty. We have to defer a little bit there. And we also got to really look at whether the configuration at the factory test is exactly the same as when we retest the system at the customer's site, which in a time when you're struggling to get all your material together can sometimes -- small pieces are different than the final test at the customer. And there, we have to defer again by a quarter or so. So I'd be careful there. And even though we shipped 12 systems and even though we get some deferred revenue in from the past, we will still have to defer a bit of the revenue into 2018. So if you want to be on the safe side, I would count on EUR 1 billion right now. Of course, this has the effect now that we have a stable configuration. Next year, we're going to recognize in the same year, plus we then have a catch-up. I mean, we'll have a deferred revenue balance at the end of this year. So next year, not only will the shipments go up from 12 to 20 before upgrades, but we're going to get a couple of hundred million on deferred revenue. So I would plan on EUR 1 billion right now, Andrew. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Alex Duval. + +-------------------------------------------------------------------------------- +Alexander Duval, Goldman Sachs Group Inc., Research Division - Equity Analyst [17] +-------------------------------------------------------------------------------- + + Alex Duval from Goldman Sachs. Just a quick question on HMI. You've talked a bit more about the innovations ASML is driving to combine e-beam with your computational lithography. Wondered if you could give a bit more color on the key technical aspects you're working on, what's the feedback been from customers you've been discussing with and anything else important on the solutions so far. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [18] +-------------------------------------------------------------------------------- + + Yes. Thank you, Alex. The development that we're seeing there is that we're executing as planned, as part of the acquisition, on the combination of the ASML lithographic -- let's say the Holistic Lithographic computational competence with the e-beam competence that HMI has in the field. Now the combination of those to the first product will be shipped in the second half of this year and will be evaluated by 3 customers. With positive evaluation, we will then start to ship that product in 2018, which will be a single-beam tool, combined with the ASML computational lithography competence. Now that will be an intermediate solution and will be focused on defect inspection, on wafer inspection. That will be -- that will follow by a more, let's say, economic solution, which will involve multi beam. Multi beam, which actually has the advantage of being able to inspect the wafer much faster, which will bring the cost of inspection down, will also -- the -- you could -- so array or the service that you can inspect will also go up, which will also -- which could have a very positive impact on the customer yields. So that is a product. That's scheduled for the year thereafter, so after next year, whereby it's not only the multi-beam column. Because if you have a capability to move the wafer faster, you also need faster stages. Now lo and behold, there's one company on this planet that's very good at fast stages, and that's ASML. So I think fast-stage technology, combined with good computational lithography, combined with a multi-e-beam solution will get a very powerful solution for wafer inspection going forward. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + The next question is coming from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + Just going back to the EUV revenue recognition. Wolfgang, how should we think or how should we model deferred EUV revenue by year-end '17? And as shipment starts in '18, should we think of revenue recognition on this EUV system happening at an earlier time? Or in other words, would deferred revenue start to go down? And I have a follow-up. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [21] +-------------------------------------------------------------------------------- + + Yes, Mehdi, you're right. So for next year, on the shipments, you should clearly think of the revenue in that -- in the same period as the shipment. And then we currently think that we'll have a deferred revenue balance of up to EUR 500 million at the end of this year. So again, next year, you will very likely see our revenue be higher than the number of shipment times the price because all the deferred revenue is coming in next year. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + Great. And then follow-up regarding the DUV business. Your booking for the June quarter was down 4%, excluding the EUV. And in that context, should I assume that DUV shipment in the second half of the year would be slightly down compared to the first half? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [23] +-------------------------------------------------------------------------------- + + Yes. I think -- I mean, you can do the math if you take what we said with the 25%, and then you take the EUV shipments and within -- and installed base revenue a little bit down in the second half. I mean, the end of the story is DUV in the second half is not going to be too different from what it was in the first half. I think we said also on the call that this business was already very, very good last year, and we're up another 15% or so. And I wouldn't put too much weight, albeit it gives you some info on the structure of the backlog. But I wouldn't put too much on the details on the bookings there. And although we get asked a lot about this [party] over next year, but we see trends continuing in 2018. So EUV is also going to be strong next year. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [24] +-------------------------------------------------------------------------------- + + Yes. And to add to that, I mean, a 4% down quarter-on-quarter, I mean, you know how our quarterly bookings vary. We have only a few customers, and they tend to send those orders in by batches and then shipped. And then 4% single digit, low single-digit percentages, in my mind, are completely meaningless. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [26] +-------------------------------------------------------------------------------- + + This is Farhan Ahmad from Credit Suisse. My first question is on memory shipments that are up 50% year-on-year. Peter, can you just talk about how much of the growth is driven by increase in capital intensity and EUV? And how much of it is really going to drive the demand higher this year. And also, if you could touch on what percentage of bit growth do you expect in NAND, DRAM market this year based on the shipments that you're supporting? That would be all. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [27] +-------------------------------------------------------------------------------- + + Could you repeat the first question? Because I thought you talked about memory and then growth in capital intensity, but I thought you said EUV. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [28] +-------------------------------------------------------------------------------- + + So 50% growth that you have in memory shipment, there is some EUV component in that as well, I'm imagining. Please correct me. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [29] +-------------------------------------------------------------------------------- + + Well, I think in -- when you think about the growth in capital intensity, where the 50% growth, is really deep UV. I mean, we do take some EUV memory orders, but that is not for capacity additions. Those are really for ramping up and qualifying the product, and the ramp will be at the end of the second half of 2018 going into 2019. So that is not driven by any EUV shipments. It's really deep UV and particularly strong in DRAM. And that is like I said in the prepared remarks also, but I'd like to repeat it. It's not a major surprise, if you think about it. I mean, the DRAM supply and demand curves are -- I'm going to talk about the end product, the DRAM device, really driven by the capacity situation and the end demand. And in a situation like we had in 2014 going into 2015, where 2 major fabs in Korea, M14 and L17, came online, started to take as many tools as they could to fill up the fab, you got a big step up in capacity, where, of course, the end demand doesn't follow that step curve. And so you have a period in which there is a supply and demand imbalance and, at least, a lower DRAM prices, which actually, at that moment in time, memory makers that could also see strong demand in 3D NAND start to relocate capacity out of DRAM into 3D NAND. Now that end demand, driven by strong data center demand, when that goes up, we'll catch up. And that has actually happened the second half of last year, leading to increased DRAM prices. And that is not a surprise then that those empty pedestals, where previously they had litho tools that are now in 3D NAND, are being backfilled with the technology transitions on top of that. And that is creating the strong demand this year, also driven by a strong end market where the data center demand is very strong for leading-edge DRAM. Now what does that mean for bit growth? Well, bit growth, 26% is what market research firms say, now listening to customers that might come up with some different numbers. But trying to predict those numbers is very dangerous. Because last year, we saw market research firms talking about DRAM growth rates, and I'm talking about the end demand growth rates, of lower than 20%, and it ended up north in the high 20s. So difficult to predict. I would suggest we keep looking at the DRAM prices. The DRAM price, it is a commodity, is a reflection of the supply and demand balance. And currently, there is some undersupply, and that's for sure. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [30] +-------------------------------------------------------------------------------- + + And I think for NAND, we expect around 40%. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [31] +-------------------------------------------------------------------------------- + + Yes, around 40%. Well, we expect nothing. We just repeat what other people are saying, which is around 40%, but who knows. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [32] +-------------------------------------------------------------------------------- + + Got it. And then on the EUV, I saw in the presentation that you posted online, that there is a mention of unidirectional and bidirectional design. And just based on my industry chatter also, it seems at least one of the customers has picked up the activity on doing bidirectional design. So I just wanted to ask you, in terms of the insertion of EUV, how does it affect the opportunity for you, whether it's bidirectional or unidirectional? Is it fair to think that if it's bidirectional, then there would be a lot fewer steps that are needed for (inaudible) edge? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [33] +-------------------------------------------------------------------------------- + + Well, I think it doesn't really matter. And when I can refer to Slide 17 and that you're -- what you're referring to is that 2D patterning, 1 EUV exposure; 1D patterning, 1 EUV exposure. That's the same. So it doesn't really matter, yes? So it's -- well, I'm not going to comment on (inaudible) edge because we're not experts on it. So -- but from an EUV point of view, there's no issue. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Next question comes from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas Smith, - [35] +-------------------------------------------------------------------------------- + + It's Doug Smith from Agency Partners. From my tracking of the industry, it looks as though the percentage of litho spend versus total wafer fab equipment has dropped a little bit the last maybe 2 years or so. First of all, do you agree with that assessment? And second, do you imagine that going forward that litho intensity might go back up again? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [36] +-------------------------------------------------------------------------------- + + Yes, Doug. This is Wolfgang. I got to disappoint you there a little bit. I -- we are not big trackers of this metric. We're solely focused on our EUR 11 billion and the potential upsides to that. And the reason why we're not focusing on this too much is twofold. Number one, historically, the customer CapEx has not shown a strong correlation to our own revenue in a given year. But more importantly, it is something that is very difficult to normalize because you got to think about FX, for instance. I mean, 2.5 years ago, the exchange rate was $1.40, and then it went down to $1.10 to euro. And all of a sudden, the litho spend looks lower, but had nothing to do with our business. It's just the different exchange rate. Secondly, if you heard earlier in the call, we have a very specific strategy to provide upgrades to our customers that we have in field options and services and that they don't necessarily count in the different people's calculation on adding up these numbers. I think from that perspective, we are not looking at it. But we're not worried about our share on the overall spend. We're worried about executing our road maps and getting to our revenue, and it will be whatever share of whatever somebody puts together. + +-------------------------------------------------------------------------------- +Douglas Smith, - [37] +-------------------------------------------------------------------------------- + + Got it. But perhaps I can ask another question, like a more technical question. And that is we're seeing a lot of chips made these days using full pellicle sizes, 800-plus millimeters. Is that going to be a problem for the current generation of EUV print such large chips and how about for high NA, where you're using anamorphic production? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [38] +-------------------------------------------------------------------------------- + + Yes, I think not for the current EUV generations, potentially, for the high NA. But we don't think it's going to be a major issue. In the discussions we've had with customers, that's being addressed. It also has to do -- is a matter of design parameters that you can take into consideration. So that's the sole part of the equation of why high NA is an economic solution or not and everything that we currently calculate. And I think our customers agree with us that the high NA specification, which includes in the different mask size, is very likely. I point you into the direction that it's highly economical to do it. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [40] +-------------------------------------------------------------------------------- + + My question, Peter, is on 2019. I mean, clearly, now you have orders in your book for '18 of the '20 orders that -- or '20 tools that are going to bid in next year. How do you see 2019? I mean, are you already talking to your customers about 2019? Because some of your customers have indicated 7 nanometers starting with as much as 8-plus layers. So some of that will have to be shipping in the first half of '19 as well as some of the memory customers. So maybe you can make a comment on 2019 conversations you're having with customers. And I have a quick follow-up after that. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [41] +-------------------------------------------------------------------------------- + + Yes. Well, I think you're absolutely right. I mean, 27 systems in the order book with shipment pattern that we gave you means that we're virtually done for 2017 and '18. So everything moves into 2019. Now with the order lead times that we're currently having, yes, you're absolutely right. This -- the order discussion that we're currently having are about 2019, and that's the case, yes. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [42] +-------------------------------------------------------------------------------- + + And people are giving you indications in terms of what they might be building at this point? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [43] +-------------------------------------------------------------------------------- + + I think when you add it all up, you see 2019 and what we ship in 2018, I think we're currently seeing -- we're currently added up. It's around 30 units, could be a bit more than that, that they need for 2019, which, by the way, could be almost similar to what we're currently looking at where we can ramp in terms of our own capacity. We've said before, we will ramp our capacity double, double from 2018 to 2019. That is true for our build capacity here in Veldhoven, but we're seeing 1- or 2-quarter delays in that capacity in the supply chain. So that means that, that capacity buildup of, let's say, 45-systems capacity is really there in 2020, but in 2019, we see 1 or 2 quarters delay. So that -- around 30 demand, if I add it all up today, is -- that would -- could probably nicely fit to what our capacity is, could be a bit more than 30. But it's a bit too early to give you a final number. But since you asked me the question, I add it up today, and that's what the number is. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [44] +-------------------------------------------------------------------------------- + + Okay, thanks Peter. And just a quick follow-up for Wolfgang. I mean, Wolfgang, in terms of the numbers that you've given at the Analyst Day last year, I mean, the moderate case was EUR 11 billion in sales and EUR 9-plus in EPS. If you actually just roll out the numbers that you printed in 2Q, you're well ahead that on a full year basis already. So would you need to give new guidance at this point or you think that you are at a much higher level in terms of demand or something else has changed in terms of demand at this point where we are in the cycle? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [45] +-------------------------------------------------------------------------------- + + I'm not sure whether you were on -- early on the call. We tried to address that. I mean, we're not changing the EUR 11 billion right now, but we pointed towards the sensitivities we showed last year in New York. And I think you can at least, at this point, conclude that the bottom end of the scenarios, both on the demand side and on the number of litho layers, seems more and more unlikely. If there's any bias, I think everybody would say now that we have an upside opportunity. But let's just get this year under our belt. And next year and at the appropriate time, we'll give you a formal update on the model with new sensitivities. But we're -- like I said earlier, we're feeling pretty comfortable about those levels at this point. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [47] +-------------------------------------------------------------------------------- + + I'm Amit Harchandani from Citi. Two questions, if I may. The first one really is a clarification to what was said earlier. So if I understood correctly, Wolfgang, did you indicate that the deferred revenue for next year would be around EUR 500 million and also the shipments next year with fee revenues being fully recognized? And so if I assume, say, EUR 100 million per tool, does that imply 20 and 200 (sic) [EUR 2 billion], plus EUR 500 million, we are looking at a revenue of EUR 2.5 billion, if you could just help me... + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [48] +-------------------------------------------------------------------------------- + + Your math reflects what I said. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [49] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And also, given that there is EUR 500 million of deferred revenue, wouldn't that have a one-off implication for the gross margin because most of that would be the fairly high gross margin? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [50] +-------------------------------------------------------------------------------- + + Well, also there, I mean, it certainly helps, but we knew that. I mean, we have said we're coming on a journey from minus 75% last year to 40%. So now you can argue whether it makes the breakeven a little bit tougher this year and the 20% a bit easier. But in general, it has a little bit of a relocation left and right, but it doesn't change our trajectory that what we have in mind is really 40%. We need that to get to our rate of 50%. And we always said the biggest variable there is the volume, and the second biggest variable is the serviceability of the tool. And then we have -- with the learning curve and avoiding E&O. And with the tool now performing to the specs and that enabling us to "freeze" the spec and really work on availability, that makes us really much more comfortable that also on the financial side, we can deliver on that 40%. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [51] +-------------------------------------------------------------------------------- + + And just for a second question, with respect to the supply chain with the comment I think Peter referred to earlier. Just wanted to understand, would you -- are you looking at potentially helping your suppliers or supply chain build up capacity to give you the flexibility to potentially ship more EUV tools by 2019? Or in other words, is that already starting to emerge as a constraint in your view? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [52] +-------------------------------------------------------------------------------- + + I think the ramp-up is a good question. I think the ramp-up in the supply chain, of course, when we said customers turned the corner, but the order flow is also a good evidence of it and is also has ignited a lot of activity in the supply chain. However, going from a very low level to then ramping it up here and there, it doesn't always go as smooth as we would want. That's why I alluded to a 1- or 2-quarter delay to the capacity ramp to, let's say, 40, 45 units. And that's where we are. And I think it's not so much a matter of money. Money doesn't always help you. It's just a matter of can you get the people on time trained, can you get the materials on time with long lead times. And then you could argue money will help you to put -- to get people in faster. But the learning curve is the learning curve. So these are the kind of things that we are -- as we're driving together with our suppliers, and this is what we -- what the current status is. Now rest assured, we'll do anything to get more out. If the demand is higher, then we'll just put everything that we can. But I'm afraid money alone will not do it. So it has to be people, knowledge, and how far we can push it is too early to say. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Jagadish Iyer. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [54] +-------------------------------------------------------------------------------- + + Two questions. First, Peter, one of the things that some of the companies were involved in multi-patterning have been settings that EUV insertion will initially happen for vias and cuts. But looking at the cartoon on Slide 17, it looks like your insertion is going to be for metal lines and spaces. Just want to understand the disconnect where we are on that in terms of that. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [55] +-------------------------------------------------------------------------------- + + Well, you should ask the other companies. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [56] +-------------------------------------------------------------------------------- + + Okay, okay. So the second follow-up question I wanted to ask you is that you did mention in your prepared remarks about China where you said there are about 5 fabs. How would you characterize between the need for leading edge versus the trailing edge there? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [57] +-------------------------------------------------------------------------------- + + I think that's a good question, interesting question, but it is not the case at all 5 of those customers are all leading edge. And then you have to define what is trailing edge. If you would say in logic, 28 nanometers and below, you qualify as leading edge, then all the logic is leading edge. Now for memory, at 2 DRAM initiatives there, there are definitely -- I would call them leading edge if look at the nodes that they are focusing on. And in 3D NAND, it's 3D NAND. What's leading edge? It's a number of layers, yes? And I think that is where they will start on the learning curve and will not be immediately 64 or 72 layers, but it's going to be a learning curve. Now you have to put that into perspective of why China has taken this step. China's taken this step from a very strategic point of view. In the discussion we have had, very clear that the reason why the stepping up is this, let's say, investment in capacity, leading-edge capacity, is because of the dependence that they currently have on non-Chinese companies who provide China with the right technology. And the geopolitical situation is -- has not become more stable or more reliable or more trustworthy from their point of view. So China has decided that leading technology, leading-edge technology should also be local. And that fits perfectly in the 5-year plan. If you read their 5-year plan, that's what they want. So I don't think that the investment money that will be allocated to those companies that are focusing on trailing-edge technology, that's not going to happen. It's going to be all leading edge. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [59] +-------------------------------------------------------------------------------- + + It's Deutsche Bank. Quick follow-up for Wolfgang on this deferral question. So how should we think about Q4 gross margin, given the deferred revenue into 2018? And then I guess flip of that is what -- how should we think about 2018 gross margin, given this rather skewing effect? Then I have a follow-up. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, EVP and Member of the Management Board [60] +-------------------------------------------------------------------------------- + + I think it's a little bit early to hash out. We haven't even given a revenue guidance for Q4, and I think I'm not going to start with the gross margin guidance. I mean, in general, it's clearer next year. Even if we -- I think I've said before, if we defer revenue, in general, it makes it a little bit more difficult to get to the breakeven, but it makes it more simple to get over the 20% next year. It's a bit of a positive effect. But next year, it just depends on -- we got to just see the overall business, and it depends on the rest of the business, right? Because if -- I think Amit did the math before, if you're going from EUR 1 billion to over EUR 2 billion and even if you go from around breakeven to 20%, it's still far below the average of the rest of the business. So without a specific number, which I'm not going to give today, on the non-EUV business for 2018, I can't answer the gross margin question either. But I think the most important thing for us is what I said earlier. Our confidence in EUV volume and EUV gross margin is growing. Our gross margin in DUV, in CLS, in HMI, in applications is healthy. It's exactly where we need it to be, and therefore, we feel very comfortable that we get all the 50% in 2020. But it's too early to talk about Q4 and next year's specifics, Rob. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [61] +-------------------------------------------------------------------------------- + + Got it, fair enough. I just had a follow-up on the 250 watts demo. Looks like you're going to get that in the field by 2019. So given that that's beyond the performance spec, how will you monetize that? I assume through a software upgrade. But how should we think about the value of that software upgrade in terms of when you look out to 2019? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [62] +-------------------------------------------------------------------------------- + + Yes, I think it's a good question. One correction, I think, 250 watts is not going to be 2019. We have 2 in the 250 watts now. We have the modules that will be inserted in our tool shipments by the end of year, which will provide our customers with 250 watts. So we'll be available as of next year, yes, so one. Two, the -- as you know, because you've been following the company for a long time, the value of our tool is really driven by the ability of our customers to keep cutting cost, the cost per wafer, and that -- the biggest driver there is productivity. So if, going forward, we can improve, for instance, the transmission of the lens, we can improve the transmission of the pellicle, which all takes -- currently takes a way bit of light. The -- like I said in the prepared remarks, customers are progressing on the sensitivity of the photoresist. These are all things that are actually helping to get more light on the wafer. When you get more light on the wafer, you move the wafer faster. When you move the wafer beyond 125 wafers per hour and you can guarantee that, then the tool provides more value. And that's exactly how we're going to do this, and this is a general concept which customers accept. Now when we give them -- instead of 125, 145 wafers per hour, 145, then we'll charge a higher price because we basically split the value of that 20 extra wafers, 50% for the customer, 50% for ASML. So that will also mean a higher sales price for the EUV system. But that happens after we can guarantee the over 125 wafers per hour performance, which is the function of the things that I just mentioned. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [63] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, I'm afraid we ran out of time today. If you're unable to get through onto the call and still have a question, feel free to contact ASML's Investor Relations department, and we'll get back to you as quickly as we can to answer your questions. +Now on behalf of ASML's board and management, I'd like to thank you all for joining the call today. And Peter, if we could formally conclude the call, that'd be great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2017 Second Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2017-Oct-18-ASML.txt b/Transcripts/ASML/2017-Oct-18-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..169af07b25c7d54bed7bda0178df094506a154d7 --- /dev/null +++ b/Transcripts/ASML/2017-Oct-18-ASML.txt @@ -0,0 +1,615 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 ASML Holding NV Earnings Call +OCTOBER 18, 2017 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, CEO and President + * Wolfgang U. Nickl + ASML Holding N.V. - CFO, Executive VP & Member of the Management Board + * Craig DeYoung + ASML Holding N.V. - VP of IR - ASML Tempe + +================================================================================ +Conference Call Participiants +================================================================================ + + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Weston David Twigg + KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Francois Auguste Roger Meunier + Morgan Stanley, Research Division - MD + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Andrew Michael Gardiner + Barclays PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Farhan Ahmad + Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Jagadish Kalyanam Iyer + Summit Redstone Partners, L.L.C - MD and Senior Analyst + * Douglas P.E. Smith + Agency Partners LLP - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2017 Third Quarter Financial Results Conference Call on October 18, 2017. (Operator Instructions) +I would now like to turn the conference call over to Mr. Craig DeYoung. Go ahead, please, sir. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [2] +-------------------------------------------------------------------------------- + + Thank you, Peter. Good afternoon. Good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven in Netherlands is ASML's CEO, Peter Wennink; and ASML's CFO, Wolfgang Nickl. +The subject of today's call is ASML's 2017 third quarter results. The length of this call will be 60 minutes, and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com, and the transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal security laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. Peter? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Thank you, Craig. Good morning. Good afternoon, ladies and gentlemen, and thank you for joining us for our Q3 results conference call. Before we begin the Q&A session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter as well as provide our view of the coming quarters. Wolfgang will start with a review of our Q3 financial performance with added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and on our future business outlook. +Wolfgang, if you will? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. I would like to first highlight some of the third quarter financial accomplishments, and then provide our view for the coming quarter. Q3 net sales exceeded our guidance coming in at EUR 2.45 billion, largely due to the revenue recognition of an additional EUV system. Net system sales of EUR 1.82 billion was nicely balanced between foundry, memory and IDM, and was more than EUR 400 million higher than in Q2. +Installed base management revenue for the quarter came in at EUR 628 million, slightly above our expectation. Our gross margin for the quarter came in at 42.9%. Gross margin was diluted by the additional EUV revenue recognized, but compensated by higher-than-expected DUV and Holistic Lithography sales. Overall OpEx came in slightly below guidance, with R&D expenses at EUR 315 million and SG&A expenses at EUR 103 million. +Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at EUR 2.68 billion. As highlighted during our July call, we resumed share buybacks in Q3. During the quarter, we purchased EUR 169 million worth of shares. Since January 2016, we have purchased shares of approximately 6 million shares with a value of EUR 569 million against our 2016 and 2017 authorization of EUR 1.5 billion. +Moving to the order book. The 3 system bookings came in at EUR 2.15 billion. The growth in the immerse and KrF order intake is an indication of the strength of our EUV business. Last quarter's strong bookings were driven by the memory sector, which represented 77% of orders compared to 40% in Q2. Our EUV backlog now reflects 23 systems valued at EUR 2.6 billion. As for EUV orders, we are working closely with our customers to understand the EUV demand through 2020 and use this as the basis for our shipment planning. Actual order intake is always lumpy, and we do expect to take additional orders in Q4. Our overall system backlog now totals a record EUR 5.69 billion. +With that, I would like to turn to our expectations and guidance for the fourth quarter of 2017. We expect continuing sales trends in Q4, with total net sales of around EUR 2.1 billion. While we target to ship 6 NXE:3400s in the December quarter, we expect revenue recognition of about EUR 300 million for our EUV business. We expect our Q4 installed base management revenue to come in around EUR 600 million. This revenue guidance for Q4 brings our total revenue expectation for 2017 to approximately EUR 8.6 billion, which reflects a greater than 25% year-on-year increase. +Installed base revenue will account for almost EUR 2.7 billion for the year, also reflecting a 25% increase. Total EUV revenue for 2017 will be around EUR 1 billion, which represents more than 2.5x the 2016 level. +Gross margin for Q4 is expected to be around 44%, R&D expenses for Q4 will be about EUR 315 million, and SG&A is expected to come in at about EUR 110 million. With this guidance for Q4, our total operating income for the year is expected to exceed EUR 2.25 billion, reflecting a greater than 35% year-on-year increase. +With that, I would like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. As Wolfgang highlighted, our business continues to perform very well, and demand for our products is very strong. Based on our guidance for the upcoming quarter, we expect to deliver another record year with net sales growth of at least 25% over 2016. The positive industry environment across multiple end market segments continues to fuel strong demand for our products as we move into 2018. +While Wolfgang reviewed our current performance and outlook for the coming quarter, I would like to provide some commentary on the longer-term outlook of our market drivers, followed by an update on the progress and plans for our product groups. This year's memory strength will translate into a record memory revenue year for us. This, in combination with our strong memory backlog, seems to serve as a solid foundation for further growth into 2018. As our customers further migrate next year to the sub-20-nanometer DRAM nodes, we benefit from a significantly increasing litho intensity for those nodes, driving litho intensity up over 30%. +Additionally, we do not see significant near-term completion of new DRAM fabs. This is amidst a healthy mid-20s DRAM bit demand growth scenario, largely driven by demand for performance memory in the service space. All in all, a strong base for our 2018 DRAM business. +In 3D NAND, litho demand is also strong with a number of greenfield fabs ramping. Current greenfield fabs take approximately 10% more litho spend than the previous 2D NAND fabs. As this technology scales vertically, there are challenges in building these very tall stacks. In response on NAND memory, manufacturers are implementing so-called stacks of stacks, where every new stack needs additional litho, driving litho intensity up by another 20%. But adding the NAND opportunity to the DRAM business outlook for next year, we can see another strong memory year ahead of us. +Logic demand remains solid, driven by the continued ramp of 10-nanometer as well as the start of the 7-nanometer node. Litho intensity continues to increase as we migrate to future nodes, and further strengthens with the adoption of EUV at 7-nanometer. As expensive multiple patterning schemes keep driving up the cost of every new node, EUV provides process simplification, cycle time reductions and yield improvement, ultimately resulting in customer cost benefits, which clearly explains the stated desire to introduce EUV for the next nodes. +With regards to China, we continue to see revenue increase throughout the year, and are on pace to set a new net revenue from this region in 2017. This trend of increasing sales to the Chinese region will continue in 2018, as we see strong demand from notable customers building out fabs in China, including additional system orders from new domestic Chinese customers. We expect to see a number of new customers starting pilot ramps next year, and are further expanding our customer support footprint in order to meet the future significant demand growth in this region. +As we mentioned last quarter, we estimate the initial lithography opportunity on these new domestic Chinese customers to be around EUR 3 billion over the next 3 years. +On the ASML product side, let me start with an update of our EUV business. In EUV, availability continues to make progress in both average performance as well as reducing variation. In addition to delivering 0 defect pellicles, we also demonstrated the capability of these pellicles to withstand 250 watts of power in support of 125 wafers per hour and beyond targets. +We continue to work closely with our customers to align on their EUV demand plans and the required timing of tool shipments. Supporting our customers' delivery timing requirements depends predominantly on the ramp-up speed of our supply chain, specifically optics. Long lead time for EUV systems, combined with the inherent fluctuations of our customers' ramp plans poses significant planning challenges. To address these challenges, we continue to work intensely with our supply chain to bring the lead times for EUV down from 24 to 18 months. +Taking all of the aforementioned into account, we currently have a production plan of 20 EUV systems next year, at least 30 in 2019 and 40-plus in 2020. Also, in support of EUV production implementation, we shipped the first e-beam EUV reticle inspection tool, the eXplore 6000, to a logic foundry customer. This system enables improved defect detection, as optical inspection has resolution challenges on EUV reticles. +In deep UV, we see continued revenue growth across the product lines, driven by immersion and KrF technology. We provided early access to our latest TWINSCAN NXT:2000 immersion system for initial development of the 5-nanometer node. This new system features several hardware innovations that deliver improved imaging and overlay performance in support of aggressive meshed machine overlay to EUV, which is required for future nodes. The very high demand for our immersion systems equals the fastest ramp of our NXT platform industry as we shipped the 100th NXT:1980 system in Q3. Strong demand for our KrF product is across multiple market segments, but primarily driven by 3D NAND. +In Holistic Lithography, we shipped our first jointly developed product less than 1 year after closing of the HMI acquisition. This product, the ePfm5, is a Pattern Fidelity Metrology system that leverages HMI's high-resolution e-beam metrology with ASML's computational lithography technology. This product's high-resolution capability enables a high capture rate of systematic patterning defects, so customers can accelerate the yield learning curves and drive higher production yields. This integrated system enables the first-ever guided metrology, delivering faster, effective throughput to support volume production. +In summary, we have demand growth continuing across our entire product portfolio. And we expect another record year, at least 25% revenue growth, largely driven by continued strength of memory demand, alongside solid logic demand. Although it's too early to fully quantify 2018, our current view is that the positive business trends that we're seeing in 2017 will continue in 2018. +With that, we'll be happy to take your questions. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [6] +-------------------------------------------------------------------------------- + + Thanks, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now Peter, could you have your final instructions, and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) First question comes from Mr. Dave Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [2] +-------------------------------------------------------------------------------- + + Just firstly, I think one of the interesting comments you made on the 3D NAND shifting to customer stack, and I'm wondering if you could just help us to understand how broadly you see that happening throughout the customer base in 3D NAND. Is it selectively or are all of your customers moving towards that trend? And then secondly, on EUV, just one quick update as a follow up if you could. I think on the last call, you mentioned there was potentially going to be EUR 500 million of revenue to be caught up or unrecognized at the end of this year. Is that still the case? And could you help us understand when we should expect that to be recognized into 2018? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- + + Yes. I will answer the first one. I'll give the second question to you, Wolfgang. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [5] +-------------------------------------------------------------------------------- + + Yes. The 3D NAND, how broadly do we see that? We see that with a few customers, not with all of them. But what we understand is that customers have similar issues. Now you can always argue, at what level of specs do they encounter those issues? And that might be different from customer to customer. But I think it's our belief, based on the feedback that we get from customers, that ultimately, they will all have to get to some kind of stack-of-stack approach. But it has started. And it has started not with all of them, but with a few customers. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [6] +-------------------------------------------------------------------------------- + + Yes. And Dave, on the deferred revenue on EUV, you're correct, same thing, like what we said last quarter. We will carry a significant deferred revenue balance into next year, which means that our total revenue for next year will be higher than what the 20 shipments that we have planned and, of course, the 4 upgrades that we also still plan to do. So the total revenue will include some of that deferred revenue. And there will be a little bit of revenue deferred of the 20 systems, but the majority will be recognized. Therefore, we continue to say that for next year, you should use a planning assumption of around EUR 2.5 billion for total EUV revenue. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [7] +-------------------------------------------------------------------------------- + + And if I may just quickly follow up on the profitability of the deferral, is that still quite dilutive on where you're recognizing for the 3 tools in Q4? And then is it very profitable next year? Or is there less difference in the deferral this time around? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [8] +-------------------------------------------------------------------------------- + + It's very different by different line items. But for your planning purposes, just assume the same profitability. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [10] +-------------------------------------------------------------------------------- + + Farhan Ahmad from Credit Suisse. My question is on the memory. You're seeing very strong orders in Q3, and I just want to understand what's the sustainability in that business. And is there any concern that there might be too much additions? And if you can give some color on how much of it is revenue capacity versus just conversion, that will be helpful. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [11] +-------------------------------------------------------------------------------- + + The answer on the new capacity is a difficult one. Like I said, let me first answer your first question on the sustainability. On DRAM, like as I said in my prepared remarks, there are no significant new fab plants that will take tools in 2018. So next year. So in other words, in terms of new fab capacity, it will be pretty limited what you will see in terms of wafers out in 2018, which actually means that the bit demand, which is currently around the mid-20s, needs to come from shrink, from innovation, which actually happens. I mean, there's a lot of innovation happening in DRAM. So we got sub 20-nanometer, and then we'll provide those bits. At least that is what the expectation is. And I would support that, I mean, that the innovation drive should be sufficient to deal with the demand, but there would be no relief. +On 3D NAND, a lot of greenfield fabs, and that means that there's a lot of shipments to those greenfield fabs. Now when we look at the forecasted bit growth on NAND, it is the reason really where the big question is whether that bit growth is going to be able to absorb all that new capacity in 2018. +We don't know yet. I mean, we've -- currently, we've been surprised also this year about a bit stronger bit demand growth that we originally anticipated. That's where probably a bit of a question is probably too early to answer. But all our memory customers, they indicate that, also, on 3D NAND, they see significant bit growth next year from the demand side. +So if anything, if you would want to place a question on sustainability, now start asking our customers on what they believe how much capacity is now added or will be added in 2018 and what they think about the demand situation. And the demand situation, of course, we're further away from that, so it's more difficult for us to give you an answer in that direction. Now what is new capacity? Well, I actually answered. I said new capacities -- a lot of new capacity is being added in the 3D NAND space, not a lot of new capacity in the DRAM space. But all in all, if we look, like I said in my prepared remarks, what the drivers are, very much the end drivers as customers tell us are the server markets or the markets for the take-up of the new 3D NAND products all looks very healthy. And customers are very upbeat, as also evidenced by the intake in our order book in Q3. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [12] +-------------------------------------------------------------------------------- + + And then a quick question on EUV. Can you just remind us what are the main bottlenecks that you have in terms of the supply chain, which you are working on? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [13] +-------------------------------------------------------------------------------- + + Yes. The main bottlenecks, as I mentioned also in my prepared remarks, are the lenses, the optics. The optics are the gating item right now. So we're working very hard with ZEISS to make sure that we can get a bit more output. But as we currently see it, I mean, we've mentioned in all of the numbers, which are up 20 for next year, at least 30 for 2019 and 40-plus for 2020, that is what our current planning is. But we also have started to run programs with our supply chain to shorter -- to shorten the lead time and to shorter the cycle time in their factory. So the total lead time for EUV can come down from 24 to our target by 2019 of around 18 months. So we're working hard, but it's currently optics. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [15] +-------------------------------------------------------------------------------- + + C.J. Muse with Evercore ISI. I guess, first question, on the EUV front, and specifically the memory, can you provide an update on where we are in terms of DRAM adoption at 1Y? And as part of that, are you including a meaningful number of tool shipments in your 30 shipment outlook for calendar '19? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [16] +-------------------------------------------------------------------------------- + + Memory-specific? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [17] +-------------------------------------------------------------------------------- + + Yes, just DRAM specific, yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [18] +-------------------------------------------------------------------------------- + + Yes. I think we don't single out the DRAM memory customer or customers. And 2019 would be -- that would be not wise to do that because it would pinpoint to specific customers, and we won't do that. But for EUV memory DRAM, the adoption is currently target -- initial adoption is currently targeted at the end of next year. So that means drivers for that are, of course, the productivity of the tool. But those targets are in our outlets. So that would mean initial adoption for initial production at the end of 2018 going into 2019, in that time frame. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [19] +-------------------------------------------------------------------------------- + + Very helpful. And I guess, as my follow-up, Wolfgang, can you talk about gross margin trajectory for EUV as well as the entirety of the company? I think you talked about 20%, if my memory serves me right, for calendar '18. And curious, does that include the benefit of deferred revenues in the mix? +And then as a second part to that, when do you think at high volume, call it, 6, 7, 8 EUV tools per quarter, can you get to kind of a 45-plus percent gross margin overall? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [20] +-------------------------------------------------------------------------------- + + Okay. C.J., Our plan stands as we have communicated it before. It -- the target is to get to close to breakeven or breakeven this year, and that includes everything. All the numbers I give you include everything. It includes service. It includes all the (inaudible) systems, inclusive the deferred revenue rollover. And then for 2018, we're targeting 20%, and our objective for 2020 is 40%. So we haven't quite spelled out 45% yet. +We have also said that 40% is not the end of the road. If you look at our other businesses, they return more than 40% gross margin. But that would always include the deferred pieces as well. So breakeven this year, 20% in '18, 40% in 2020, and 2019, somewhere in between 20% and 40%. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + The first one has to do with your EUV manufacturing. What would be your shipment forecast if your manufacturing cycle time has actually been reduced to 18 months? Specifically, where would the 30- and 40-plus unit in '19 and 2020 would go to? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [23] +-------------------------------------------------------------------------------- + + That's a good question. That's an interesting question. And in fact, I think what we can say is that the customer demand that we're seeing for 2019 is in excess of that 30. Now we can just add it all up, and then think about 2 years ahead and what customers indicate to us. That is, I would say, decently above that 30 number. And decently means that it's at least 30% from that number. But how much it, in fact, would be in 2019 is a bit difficult because it is still 2 years out. So but what we're currently seeing is that would be about 30% higher than the number that we -- that I quoted you. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + Got it. And then it's been a few quarters since you have broken out the metrology inspection. Maybe this is more for Wolfgang. Can you help us? How should we think about revenue contribution in '17? And where would it go into '18? Is there any parameter? Is there any metrics that you can offer so we could better model this? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [25] +-------------------------------------------------------------------------------- + + Yes. I mean, the one thing that we have been clear on is a good chunk of that is, of course, the newly acquired HMI business. And there, we said that revenue this year will significantly increase, almost double, albeit from a relatively low level of last year. So it will be somewhere in the $220 million, $230 million, somewhere in that range. And then that business will continue to strongly grow next year based also on the eXplore product and the ePfm5 product that Peter had in his introductory remarks. It's a little bit early to put a number in, but it's a significant step-up, all in support of a business that is going to be around EUR 1 billion in 2020. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + I think what I was trying to get at is if there are 2 buckets, EUV and DUV, which one of these 2 buckets or factors are going to be critical in sustaining the growth and hitting that EUR 1 billion revenue target in 2020? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [27] +-------------------------------------------------------------------------------- + + It's not that easily to tie it to one or the other. It has to do with the total production process and the total development process of our customers. So we don't look at it this way. We just look at it as a total section in the metrology group. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Jagadish Iyer. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [29] +-------------------------------------------------------------------------------- + + Yes, Summit Redstone Partners. Two questions, Peter. First, on the -- in terms of the Pattern Fidelity Metrology that you provided, how big can the market be? And can you clarify in terms of the adoption between foundry, logic, as well as memory customers? And then I have a brief follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [30] +-------------------------------------------------------------------------------- + + Yes. On the last question, it is predominantly being used initially, I would say initially, by logic, yes, because that's where the biggest challenges are because of the more random patterns that you see there. So that will be the first area where you would see the introduction. But as we've seen with all the solutions that ultimately provide customers with more certainty, what happens on the wafer and gives them the ability to make changes, so that it can really manage yield, that also crosses over to the memory products also. We've seen the same with YieldStar, NetStar (inaudible) logic, and it also moves now over into the memory space. +And how big is that market? Well, that's a good question because where actually it is a product for which a market does not exist yet, because it's a product that actually -- or the Pattern Fidelity Metrology where you have, where you use the predictive capability to actually manage yield through the scanner is a completely new area. So we have our ideas of what it can mean, but -- and we think it can create -- there's a lot of value. If you look at the first PFM, the Pattern Fidelity tool -- metrology tool that we're shipping this year, which we're shipping a few, but the first one we did in Q3, I mean, that has a high level of interest with our logic customers. +So how big is that market? It depends on the value that we're going to provide. We have high hopes and expectations, but that needs to be basically worked out together with the customer because that really -- you really show the value on the wafer. So that is -- that jury is still out, but we have high hopes, and actually because it provides an efficacy forward loop that nobody else does. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And just as a follow-up, you had an e-beam inspection product rollout for this EUV mask. Where do you see the insertion point for this product? What time frame? And where do you see that ramping through 2020 and beyond? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [32] +-------------------------------------------------------------------------------- + + Well, I think it's -- we see that ramping at the same time as we ramp EUV. I mean, you need EUV masks. You need the inspection of EUV masks. So that's why we are -- start shipping the first tools now. So those will not go into volume production because volume production really initially starts at the end of next year, in the course of next year and going into 2019. So it is the time frame where you also need to see the ramp of this product. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Next question comes from Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [34] +-------------------------------------------------------------------------------- + + It's Andrew Gardiner from Barclays. I just had a couple of modeling questions for you, Wolfgang. Just as we sit here towards the end of 2017, I was just wondering if you could start to give us a bit more of a steer on some of the OpEx items in 2018, particularly around R&D. You guys have been pretty consistent this year at about EUR 315 million a quarter. Just interested how to -- sort of how that might step up, particularly when we consider the contribution to ZEISS next year, and also likewise on capital spending, particularly as you're continuing to fit out for the EUV ramp. +And then finally, just do you have any thoughts on tax? I know that some of the tax proposal by the coalition government in Ireland are not yet finalized, but have you guys looked at how that might impact your ongoing tax rate? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [35] +-------------------------------------------------------------------------------- + + Andrew, OpEx first. Let's start with SG&A. SG&A should grow only very modestly. I mean, we have very few variable pieces in there, but we invest a bit in sales. We invest a bit in HR, a little bit in IT systems. But I think that we'll be growing at a much lower rate than the revenue, and we'll stay around that 1 10 rate, probably a little bit up. If you look -- and our objective there for 2020 is 4% of revenue. +For R&D, we're going to add up to 1 25 or 1 26 for this year, which is based on our revenue guidance now with the fourth quarter somewhere just shy of 15%. And if you contrast that to 2014, 2015, 2016, it was 18%, 17%, 16%, the spend, respectively. Now we're around 15%. We will spend more in absolute terms next year, exactly for the reasons that you mentioned. High NA, both on our premises, but then also on Zeiss SMT's premises. And then we do continue to invest strongly also in the Holistic Lithography field. We're actually accelerating investments there. +A bit too early to give a number. It will be up, but I think it will be 14%. So it will be up in absolute terms. It will come down in relative terms towards our target of 13% in 2020. +CapEx, we're not that super CapEx intense ourselves. We spend around EUR 200 million for the first 9 months. I usually don't guide, but assume that we're getting out somewhere between EUR 270 million, EUR 280 million. The last 3 years, we're somewhere between EUR 310 million and EUR 370 million. So this year, we'll be around 3% only of revenue. Our long-term model is 4%. And there, you should expect it to come up a little bit over the next 2 or 3 years, but not beyond the 4%, I think, that we have in our 2020 model. And that is, indeed, to prepare the site for high NA prototypes and high NA manufacturing later on. +Tax rate model is 14%. The innovation box, negotiations have been going very well. We're in the documentation phase. So we have a principal agreement. We're in the documentation phase that very well supports our 14% model. As it relates to the outcome of the coalition negotiations here in the Netherlands, they're -- and there's no law yet. That's just a proposal. But if that comes through, the benefit of the innovation box will reduce slightly -- without going into the technical details, will reduce slightly, but it's accompanied with a reduction in the corporate tax rate. So both are literally offsetting to each other. +There may be a slight timing difference that the reduction of the benefit comes earlier than the reduction of the corporate tax rate, but I think that will not be a significant impact on the 14% model, Andrew. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Francois Meunier. + +-------------------------------------------------------------------------------- +Francois Auguste Roger Meunier, Morgan Stanley, Research Division - MD [37] +-------------------------------------------------------------------------------- + + Yes. I've got questions regarding the ecosystem of EUVs. In your opening remark, you talked about the pellicle withstanding a 250-watt EUV beam, which is really good. Hopefully, it doesn't get too dark too quickly. If you could give us a bit of an update regarding the other elements of the ecosystem, like the photoresist, the mask manufacturing, but also maybe more longer term, the actinic mask inspection tool that we've been waiting for a very long time now. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [38] +-------------------------------------------------------------------------------- + + Yes. To start with your last one, the actinic inspection tool is not an issue where we are today, and I don't think it's going to be an issue for the 7-nanometer ramp either. I mean, we're going to patent the inspection. So we basically print the photomask, and you inspect the pattern on the repeatable defects. And then you can now weigh this on the photomask. And you inspect the photomask with e-beam preferably, and then you can do the correction. +So masks, I think we have all the solutions that we can think of for the 7-nanometer introduction. Photoresist actually makes some good progress, and especially on the sensitivity side. I mean, we're seeing continuous numbers coming back out of the industry and industry participants on sensitivity of the photoresist, which is good, because the more sensitive the photoresist is, the faster you can move the wafer, the higher the throughput. +So pellicles, you just mentioned, pellicles being able to withstand 250 watts of EUV power is very good. So I think from an ecosystem point of view, all those elements are increasingly coming to phase, where you can call them mass production-ready. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [40] +-------------------------------------------------------------------------------- + + Yes, JPMorgan. My question is regarding DRAM, Peter. I mean, DRAM is possibly likely to use EUV in 2019. But I mean, there haven't been new DRAM fabs built in the last decade with DRAM capacity having internal demand, et cetera. Do you see the 2 actually -- for the footprint of the EUV tool, et cetera, that to get the EUV tool into DRAM fabs, that do you need actually new DRAM capacity rebuilt? Or based on what your application is, you know already that these existing fabs can be actually upgraded to EUV once the conversion starts? And how quick do you expect a memory DRAM conversion to happen? And I want a follow-up after that. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [41] +-------------------------------------------------------------------------------- + + Yes. I think on the first shipment to DRAM fabs will be to existing fabs. So we don't need to build new fabs to house an EUV tool. However, if you say we're going to use EUV more broadly and widely in DRAM in the next decade, I'm pretty sure it's going to be fabs built that can accommodate a larger number of EUV tools. +Now as a matter -- when you said the last decade, no new DRAM fabs, I may remind you that we have in Korea L17 and M14, which were completely new fabs, which actually are very large fabs that actually drove up the available capacity a couple of years ago, 3 or 4 years ago, to quite significant heights, which I think also led to an oversupply of DRAM at that time. Well, that's not happening today. Well, we're not seeing the announcement of any major new DRAM fab. So that means that the EUV tools that we will be shipping will be shipping to existing fabs that will be able to take them. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [42] +-------------------------------------------------------------------------------- + + And quickly following up, I mean, you've taken a stake now in Carl Zeiss and how that will be showing up on your P&L maybe for the full year this year or next year, because there will probably be a dividend payment from Carl Zeiss, and then there's going to be outgoing payments from you regarding funding their CapEx plans for high NA as well as the R&D for high NA. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [43] +-------------------------------------------------------------------------------- + + Okay. I'll take that, Sandeep. If you recall, we have entered into 2 separate contracts. We have an equity investment, and then we have a high NA agreement. The equity investment is EUR 1 billion for 24.9%. That is already showing on the line equity method investments. If you look to our U.S. GAAP statements, you already see that there. And that will show a P&L contribution from Carl Zeiss' profit to us. So that's basically 24.9% of the profit is going to show in our P&L. It will show for the first time in Q4. So you see the investment already, but you don't see any contribution in Q3. And that simply has to do with our close process being faster than SMT's close process. So the accounting rules allow us there to do a 3-month offset. +And for Q2, we only really had 4 days. So we didn't bother to put that in Q3 because it's not material. We will walk you through the math on how that profit will show up in our P&L because it wouldn't be accounting if it would be easy, because we'll have to do a lot of adjustments here. First of all, they are IFRS. We have to translate that into U.S. GAAP. Believe it or not, at 24.9%, you need to do like a mini purchase price allocation. So there will be some amortization of intangibles, writeup of inventories, all the good stuff that you know. So it will be slightly convoluted at the beginning. But the end result, and from a cash perspective, SMT is a very, very healthy profitable business, and we'll get solid returns on our investment there. +As it relates to the high NA agreement, we will make R&D contributions, and we will make CapEx contributions. The R&D contributions will show up in our R&D line. Again, it gets complicated. Some of it has to go through the equity piece because we're a partial owner as well, but the CapEx piece will be recorded on our assets, PP&E repayments. And as a reminder there, the return on our investment, other than getting a high NA tool, is that we get these investments back through adjustments to the price of the lenses later on when we take delivery of the lenses, similar to what we have done previously with our partner there. +So right now, you have just R&D in there, a couple of prepayments and the investment. And then starting next quarter, you'll have some of the profits in there as well. And we'll walk you through in more details in January. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [45] +-------------------------------------------------------------------------------- + + It's Bank of America Merrill Lynch. So I have basically a quick question on EUV gross margins in the third quarter. Maybe if you could give us some color around that, and if you still expect EUV to be at a breakeven level this year, given you're deferring a lot more revenue -- EUV revenues than you were expecting to defer at the end of the last quarter. +And secondly, just as a follow-up, if you could give us some color on what drove these deferrals. Last quarter, I was thinking you'd be doing around EUR 1.1 billion in EUV revenues, and now it looks like it's going to be a bit lower than that. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [46] +-------------------------------------------------------------------------------- + + Yes. First of all, I'll check if it's still together after the year to breakeven level. And then like we said, 20% next year, 40% in 2020. We have always said we will be above EUR 1 billion. I think at the beginning of the year, we said EUR 1.22 billion. It always depends on which customers do you ship to and when do you ship. I mean, admittedly, the 12 shipments this year are back-end-loaded. And from that perspective, a little bit more goes into next year. +Deferrals, in general, I'll address them by multiple different items. I mean, it could be that you have a new component in the system, which you can demonstrate in your factory. But you have to replicate in the customer factory to take full revenue. And that is the main reason why the revenue this year came down. We have made an adjustment to some systems. It's not a performance adjustment. It's a maintainability adjustment, which is good news because it will help us down the road with service profitability, which, if you recall, is a main contributor to get to the 14%. But since it's a new feature, we cannot go straight to what we achieved last year. +Revenue recognition at shipment, we've got to replicate it at what we call SAT, which is the Site Acceptance Test that the customers require. It's a little bit deferred. That's the difference from the beginning of the year. But it's good news. I think the rest we said earlier. We have a deferred balance that we will start netting into the number in 2018. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [47] +-------------------------------------------------------------------------------- + + Very clear. Just a quick clarification on the R&D next year. Did I hear you correctly? Did you say it was going to be 14% of revenues? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [48] +-------------------------------------------------------------------------------- + + Yes. I said this year is around 15%. Next year will be around 14%. So it will go up in absolute terms. But right now, if you model 14%, you should be okay. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [49] +-------------------------------------------------------------------------------- + + This year, it's -- I mean, looking at it so far, it looks like it's more around 13.5%, not 15%, unless -- actually, no, no, that's fine. Sorry. Apologies. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [50] +-------------------------------------------------------------------------------- + + We made progress, but I don't think we made that much progress. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [51] +-------------------------------------------------------------------------------- + + No, no. Of course. Ignore me. Sorry, that was my bad. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [52] +-------------------------------------------------------------------------------- + + No worries. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Next question comes from Mr. Weston Twigg. + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [54] +-------------------------------------------------------------------------------- + + With KeyBanc Capital Markets. I had a couple questions. First, just on the uptick in IDM revenue. I was wondering if that was more EUV revenue recognition-related or if you're seeing a pickup in the 10-nanometer ramp? And is that increase in demand levels sustainable moving forward? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [55] +-------------------------------------------------------------------------------- + + Mainly driven by 10-nanometer, but there was a system shipped there as well in EUV, so a little bit of (inaudible). + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [56] +-------------------------------------------------------------------------------- + + Okay. And then as a follow-up, the installed base revenue, it's coming down quite a bit in the second half from the first half. Just wondering if you can help us understand what kind of growth you expect in 2018 on that line item. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [57] +-------------------------------------------------------------------------------- + + Yes. I don't think that we're going to give that detail. Probably, in general, on 2018, there have been a lot of questions there as well lately. I can't be completely quantitative on this right now, but I think we can give you a few pieces that will help you form an opinion. And certainly, I don't want to go down to a customer level here, but we already talked about EUV. We get to EUR 1 billion this year, and then we get to EUR 2.5 billion next year. So that's a EUR 1.5 billion increase. You will have seen an extremely strong installed base revenue this year. I mean, we're going to almost EUR 2.7 billion, which is up 25%. And if you'll recall, we said in our longer-term trajectory, we see that business going up in average by 10%. Of course, the service part of it is a pretty stable growth. It's a function of the installed base, but then the options and upgrades are a little bit more volatile. But I would, right now, assume that, that business is flat to slightly up next year. +And then for the rest of the business, the combination of EUV, holistic, in memory and in logic, we have experienced an extremely strong year this year, and we see 2018 at approximately the same level. And you have a bit of evidence there also when you look at our backlog, we've got EUR 5.7 billion in backlog. And even though we don't guide to backlog, I think the Street expectation was about just over EUR 1 billion in the orders for last quarter, and we took almost twice as much, EUR 2.1 billion. So I think, without going into customer details, but you should expect another very strong 2018 from us. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [59] +-------------------------------------------------------------------------------- + + It's Doug Smith from Agency Partners. Wolfgang, I was wondering if you could perhaps give us an approximate breakdown of the R&D spend between the EUV, metrology and inspection and DUV. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [60] +-------------------------------------------------------------------------------- + + I'll be -- if we get to about EUR 1.25 billion, I -- roughly, you see about half of that being spent on EUV. I don't know how far we have gone, but then on the other half, you have a good chunk of what I would call fundamental research that benefits all businesses. And then the -- but it's less than EUR 100 million, and then the balance of EUR 500 million is all the way towards DUV. But from a directional perspective, EUV -- we're still investing by the way, because we still have significant innovation. You heard about the 2000 coming out, for instance, now. We're just having upgrade of the first system to this 2000 level. But the rest is a bit more overweighed to deep UV, which over the next couple of years will start to come down. But applications, we're investing very heavily, like I said earlier in metrology. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [61] +-------------------------------------------------------------------------------- + + Right. And it's getting pretty close to the anniversary of the analyst meeting last year, where you provided the 2020 model update. I was wondering, when would you expect to update that again? A lot of other companies have provided some 2020 models based on an upwardly revised WFE market. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [62] +-------------------------------------------------------------------------------- + + Yes. I mean, we haven't scheduled that yet, but we did one in '14. We did one in '16. So it's probably a good assumption that somewhere in '18, we're going to do one. I think we gave you quite a bit to work with because we pinpointed an EUR 11 billion revenue, but we gave some sensitivities, both around the market vector and the EUV intensity vector. And we're not updating this today. But I think what you can say is that the EUV adoption is well underway, and the lay accounts are not on the low end, as we talked before. And also, if anything, the market is very enthusiastic about end demand. So without updating it today, I think the probability on the low-low or the lower combination has gone down since the year. But expect we haven't picked a date yet, but I would say somewhere next year, we're going to do a session. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [63] +-------------------------------------------------------------------------------- + + If I may add, Doug. I think we actually gave you, also at the Analyst Day last year, a few scenarios. And Wolfgang alluded to it that you could argue that the, let's say, low scenario has become less likely. But I think you guys -- looking at where the market is, I think we gave you enough information to just pick whatever you feel is more appropriate, right? And right now, I think an update on that model is really something we will do next year. And I think you have enough to work with. +And by the way, we first started to talk about 2020 2 years ago, and I think it's good that we have some followers now. That's no reason for us to come out with something different. May I remind you too of the fact that 1 year, 1.5 years ago, people were saying we were way too optimistic on our 2020 targets. And now people seem to indicate that we're too pessimistic on that target. We just stay very consistent on what we've said, and I think we've given you enough to work with to the upside, if you believe in that. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [65] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. I really wanted to touch upon the topic of high NA EUV. Given the enthusiasm and the strong progress you have made around EUV, how are your conversations happening right now with your customers? What kind of traction or commitment are they showing towards high NA EUV? Do they want you to accelerate adoption? If so, what would make you do that? And also, what would that mean in terms of the supply chain besides the ZEISS deal that you've already carried out? I'm very keen to understand how the thought process is right now around high NA EUV adoption. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [66] +-------------------------------------------------------------------------------- + + Yes, I think that's a very good question. I think in the latest discussions we've had with customers, there is no doubt they see the benefit of EUV full-stop. Now the question is about timing. And then we do see that from a timing point of view, there are some different requirements from customers from when they want to have the first tool. Now some of those customers would indicate, and then we have also pretty decent and deep discussions with them on what we could do there. So those customers indicated they would like to have this capability rather sooner than later. And if that would mean that we would have to set up an accelerated program, that actually means that we would also ask our customers to commit also in the acceleration and the cost of that acceleration. And that would be, I think, a precondition for us to accelerate. +Now this is the level of discussion that we are having today. Now -- and I think -- and it's not superficial. Those are pretty deep discussions. And we're pretty clear also on what it would take to accelerate and what are commitments from the customers, how that would have to look like, which, by the way, we haven't reached an agreement yet. So it's just for your information. +Now on the supply side, the gating item here is really the new optics, the optics that comes from ZEISS. This is exactly why we did what Wolfgang explained earlier. With the investment in ZEISS, we signed the R&D and the CapEx program. That's the gating item. Both will get from an EUV source point of view, the EUV high NA tool will have the same EUV source. No source difference. +The tool will be bigger, but we know how to deal with that. The real challenge is in the optics, and this is why we have started to go into this agreement with Carl Zeiss. And I would say that from this point onwards and from this moment onwards, that's really the gating item in this project. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [67] +-------------------------------------------------------------------------------- + + And just maybe as an unrelated follow-up. You obviously had no EUV orders in this quarter, but I understand that you work on a commitment basis. You're in close touch with your customers. You could potentially still be doing some work in progress even if the administrative stuff hasn't happened. But at what stage does it become a balance sheet risk and you say, "Okay. We really need these orders. Otherwise, we cannot just keep on working based on the conversations." Is there is some kind of limitation or some hard line? I guess, where it's coming from is what's the minimum level of orders that I would need to see next quarter in order to ensure you'll still end up shipping 30 -- or at least 30 shipments in 2019? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [68] +-------------------------------------------------------------------------------- + + I think what you would then need to see is that 2018 is fully booked and the first part of 2019 also. And like I said, we're also working closely with our supply team to get some of the cycle times down. And actually, that should result over the next couple of quarters into at least a lead time reduction. Don't forget -- I mean, the order pressure is really driven by the fact that we have a 24-month lead time in total, which is, of course, very, very long if you look at the planning process of our customers. +So -- but I have no worry that we will be at that point where we close out 2018 and moving nicely into 2019, also as a result of the order intake in Q4. + +-------------------------------------------------------------------------------- +Craig DeYoung, ASML Holding N.V. - VP of IR - ASML Tempe [69] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, with that, well, we've run out of time. If you were unable to get through on the call and still have a question, feel free to contact the ASML investor relations department with your question. And with that, I'd like to say it's been my great pleasure to host 60 or so of these quarterly conference calls over the last many years. But with this call, it will be my last. As previously shared, I will be turning over my global IR management responsibilities with this quarter's results to Skip Miller and, therefore, you'll be hearing his voice instead of mine each quarter going forward. With that, I'd like to thank you for your mostly strict adherence to my call instructions and your kind patience in any safe harbor references I might have made over these many years. Now on behalf of ASML's board of management, I'd like to thank you all for joining us today. +Peter, if you could formally conclude the call, I'd appreciate it. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2017 third quarter financial results conference call. Thank you for participating. You may now disconnect your line. Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2018-Apr-18-ASML.txt b/Transcripts/ASML/2018-Apr-18-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..59e69586ee33e96ea2e18aa62b0a2aeffab30a06 --- /dev/null +++ b/Transcripts/ASML/2018-Apr-18-ASML.txt @@ -0,0 +1,559 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 ASML Holding NV Earnings Call +APRIL 18, 2018 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * Wolfgang U. Nickl + ASML Holding N.V. - CFO, Executive VP & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * Alexander Duval + Goldman Sachs Group Inc., Research Division - Equity Analyst + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Farhan Ahmad + Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Tammy Qiu + Berenberg, Research Division - Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Douglas P.E. Smith + Agency Partners LLP - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2018 First Quarter Financial Results Conference Call on April 18, 2018. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Go ahead, please, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon and good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven, The Netherlands is ASML's CEO, Peter Wennink; and CFO, Wolfgang Nickl. +The subject of today's call is ASML's 2018 first quarter results. Length of this call will be 60 minutes, and questions will be taken in the order that they were received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities law. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I would like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning and good afternoon, ladies and gentlemen, and thank you for joining us for our Q1 2018 results conference call. +Before we begin the question-and-answer session, Wolfgang and I would like to provide an overview and some commentary on the first quarter as well as provide our view of the coming quarters. Wolfgang will start with a review of our Q1 financial performance with added comments on our short-term outlook. I will complete the introduction with some additional comments, the current business environment and our future business outlook. +Wolfgang, if you will. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. I will first highlight some of the first quarter accomplishments and then provide our guidance for the second quarter of 2018. +Q1 net sales came in at EUR 2.29 billion, somewhat stronger than guided, driven by product mix and a strong DUV business. Net system sales of EUR 1.67 billion was primarily driven by strong memory revenue, which contributed 74% of sales. Logic, which now combines foundry and IDM sales, made up 26% of system sales. +Installed Base Management sales for the quarter came in at EUR 617 million, which was just above our guidance. Gross margin for the quarter came in at 48.7%, which was 70 basis points above the upper end of our guidance range, driven by both volume and mix. Overall OpEx came in slightly above guidance, with R&D expense at EUR 357 million and SG&A expenses at EUR 114 million. +Turning to the balance sheet. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 3.19 billion. During the quarter, we purchased approximately EUR 170 million worth of shares. This means we still have EUR 2.33 billion of our 2018/2019 share buyback program remaining. +Moving to the order book. Q1 system bookings came in at a strong EUR 2.44 billion. 57% of the order intake was from logic customers, driven by EUV. Memory made up the remaining 43% of our order volume, driven by Deep UV. We took 9 new EUV orders in the quarter. Additionally, we received 4 orders for High-NA R&D systems from 3 customers, and on top of this, we sold options for 8 High-NA early volume systems. +High-NA is our next-generation EUV system, which will enable geometrical shrink beyond the next decade. The initial selling price for these High-NA systems is around EUR 270 million. We will receive 40% as a down payment, and the remaining 60% will be milestone based, with the majority of the milestone payments expected before shipment. The options were sold for EUR 50 million each, with payments starting this year. +At this point, I would like to comment on our reporting of bookings and backlog going forward. As we have communicated a number of times in the past, we establish our joint demand forecast with our customers, they are very routine and comprehensive planning cycles. Order flow can be lumpy and therefore does not always reflect our business accurately. We believe reporting bookings and backlog provides limited value, and therefore, backlog will no longer be reported. If we want to provide some additional visibility during our initial EUV ramp phase, we will continue to report bookings throughout this year. We currently plan to no longer report bookings beginning in 2019. +With that, I would like to turn to our expectations and guidance for the second quarter of 2018. We expect Q2 total net sales between EUR 2.5 billion and EUR 2.6 billion. Our total net sales forecast includes almost EUR 600 million for our EUV business, while we target to ship 3 EUV systems in the quarter. Our Q2 EUV revenue forecast is a combination of revenue upon shipment and deferred revenue from prior quarters. This catch-up of deferred revenue was previously forecasted for the second half of the year. +On EUV revenue guidance, we have communicated that we will provide quarterly guidance until we are recognizing the majority of revenue for a system at the time of its shipment. We expect this to happen in Q2 and will therefore no longer provide quarterly EUV revenue guidance starting in 2019. +For the full year, our shipment plan has changed from 22 to 20 EUV systems. The change was due to a combination of anticipated end-of-year shipment logistic challenges due to multiple shipments in the fourth quarter as well as customer fab readiness. The 2 affected systems this year will ship early 2019 and will not impact customers' EUV production ramp plans. As a result of this adjustment, our EUV revenue for 2018 is now expected to be around EUR 2.1 billion versus EUR 2.3 billion that we had indicated previously. I would like to highlight, though, that we expect this reduction to be more than compensated by stronger DUV and applications businesses. We expect our Q2 Installed Base Management revenue to again come in around EUR 600 million. +Gross margin for the quarter is expected to be around 43%, impacted by the significant increase in EUV sales in the quarter. R&D expenses for Q2 will reflect continued accelerated investments in our portfolio and will come in at around EUR 375 million. SG&A is expected to come in at about EUR 115 million. +We have started a new share buyback program for 2018 and 2019 of up to EUR 2.5 billion. In Q1, EUR 170 million worth of shares were repurchased. Additionally, we have also proposed a 17% increase in our dividend to EUR 1.40 per share to our Annual Shareholder Meeting, which takes place on April 25 here in Veldhoven. The dividend payment is valued at around EUR 600 million. +We are excited about 2018. Customers' demand for our products continues to be strong, with strengthening demand in DUV as well as applications. In addition, we see strong demand for EUV as customers ramp this technology in production and have committed to this next-generation technology. We look forward to a year of continued strong growth in both revenue and profitability. +With that, I would like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Wolfgang. I would like to start off by announcing a major milestone reached this quarter regarding our next-generation EUV technology of high numerical aperture or High-NA. We have aligned our development time line with customers, and we received orders for 4 High-NA R&D systems from 3 leading semiconductor manufacturers, targeted to start shipping in Q4 2021. We also sold to customers options to buy 8 early volume systems targeted to start shipping in 2024. Now this is a significant milestone in that it demonstrates customers' commitment to EUV technology for future nodes and provides great growth opportunity as we extend lithography technology beyond the next decade. +I will highlight some of the key product features in more detail later, but I would like to first address our view of the business and the demand drivers. As Wolfgang highlighted, had a good start to the year, and our business continues to perform very well. The positive industry environment and increasing litho intensity as customers migrate to more advanced nodes continues to drive strong demand for our products in both logic and memory markets. +Although this not -- this does not come as a surprise, we're increasingly optimistic about our 2018 outlook as compared to a quarter ago as we see strengthening demand in memory while logic demand remains solid. Based on expected growth and current guidance, we expect to see a significant increase in revenue in the second half of the year. And in [some ways] stronger Deep UV will be primarily driven by memory, and stronger EUV will be primarily driven by logic. +We plan to ship to over 15 greenfield fabs in 2018. It may be interesting to note that, of these fabs, the majority will be in the China region, of which 7 are for domestic Chinese customers. +Memory strength in both DRAM and NAND is driven by increasing content as well as expanding end market applications. In DRAM, our customers continue to migrate to the 1x nanometer node along with required wafer capacity additions to meet the increased bit demand. In NAND, a number of customers continue to ramp greenfield -- new greenfield fabs and scale vertically via stacks-of-stacks, which requires additional lithography. +With strengthening demand in both DRAM and NAND, we see significant year-over-year growth. Based on current third-party estimates for both DRAM and NAND, bit demand growth against our view of bit supply growth, we don't see major concerns regarding supply-demand balance throughout the year. Logic demand continues to be solid as customers ramp 10- and 7-nanometer nodes, while the initial demand for the latter, the 7-nanometer node, is the primary driver behind the significant increase in EUV demand in this year. +On the ASML product side, let me start with an update of our EUV business. In EUV, we continue to make progress as this technology starts to ramp in volume production. We delivered a configuration that achieved 125 wafers per hour at a customer site and continue to drive improvements in throughput performance, demonstrating 140 wafers per hour at ASML factories. We continue to focus on improving availability and work with our customers in support of infrastructure around EUV and volume production. +Demand from our customers continues to be strong as they start ramping this technology in production. With a plan of 20 shipments in 2018, this represents a doubling of output over last year's shipments. As we now move into the volume phase of this new technology ramp, we will focus our operations and industrialization efforts on managing our supply chain and helping our customers with their fab readiness preparations. +As Wolfgang mentioned, we have shifted 2 systems to early 2019 due to a combination of customer fab readiness and anticipated challenges regarding the logistics around year-end shipments. However, based on our discussions with customers, our previously communicated estimates of their EUV layer adoption plans remain unchanged. As a reflection of their continued commitment to EUV production plans, we took orders for 9 NXE:3400 systems this quarter in support of our 2019 shipment plan of at least 30 systems. +As mentioned in my introduction, High-NA is our next-generation EUV technology, which extends lithography and enables cost-effective scaling beyond the next decade. The NA of the new optical system will increase from 0.33 on current EUV systems to 0.55 on High-NA systems. +In addition to new advanced optics driving improvements in imaging, platform innovations in stage technology will drive improvements in overlay and productivity. We're currently targeting an initial increase in productivity to 185 wafers per hour. Last year's investments in Carl Zeiss SMT will further solidify our development time line and reduces the execution risk. And with the addition of High-NA, ASML's product portfolio will include 0.33 NA, 0.55 NA EUV, dry and immersion Deep UV, i-Line as well as holistic products, all designed to work together seamlessly in production. +In Deep UV, we will increase our factory output to meet the market demand. Furthermore, our focus on productivity means we continue to boost our new system output, and we expect to exceed the record productivity level reached last year. In addition to increasing the maximum configuration output per system, we are also continuously increasing productivity of our systems in the field. For instance, we achieved an output of 6,000 wafers per day on NXT systems in a NAND fab, which translates to a 5% increase in productivity over a 12-month period. With both increased system shipment output as well as productivity increases of systems in the fab, we are delivering further value to our customers via capacity and cost efficiency. +In Holistic Lithography, we continue to see growth across our full portfolio of software and metrology products. Our YieldStar metrology continues to gain broadening adoption, with recent growth via expansion in the memory market. We also shipped our first YieldStar 1375 system, which measures actual in-device lithography performance, enabling more accurate measurements of the device and thus driving yield improvements. We've shipped multiple pattern fidelity metrology tools, ePfm5, and are seeing initial positive customer results. This technology, where ASML's high-resolution e-beam technology is combined with our computational lithography software, will enable e-beam-based feedback to the scanner and deliver improved yield performance in volume production. +To further drive e-beam productivity performance and expand application opportunity in volume production, we are developing multi-beam technology. We successfully captured first images from our 3-by-3 beam proof-of-concept system. We see great growth opportunity in holistic litho business and expect its growth rate to exceed our overall revenue growth in the coming years. +To summarize, this year, we expect solid growth in both sales and profitability. We are more optimistic about our view of the year than we were a quarter ago due to the continued strengthening of memory demand while logic demand continues to be solid. We are on track to achieve our 2020 targets, with significant growth potential beyond 2020. We plan to communicate our growth opportunity beyond 2020 at our Investor Day on November 8 this year. +And so last but not least, as many of you know, this quarterly call is the last call with Wolfgang online helping us to bring clarity to our results and operations. It goes without saying that at least with ASML, we'll miss him dearly, and we'd like to take the opportunity to thank him wholeheartedly for his invaluable contribution to ASML. Wish him all the best in his new challenge at Bayer, and we will follow him closely, you can rest assured. +And with that, we will be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + All right. Thank you, Wolfgang and Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now operator, we have your final instructions and then the first question, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [2] +-------------------------------------------------------------------------------- + + All right. Farhan Ahmad from Crédit Suisse. My first question is in regards to China on -- did I hear correctly that now you're seeing 7 domestic companies in China, whereas on the last call, you had mentioned 5? Can you just talk about what customer activity are you seeing in China? And how is it split between memory and logic foundry? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Yes. I think China is a rapidly developing market, but I have to tell you that these are -- like we said in the prepared remarks, these are greenfield fabs of different sizes but also 200-millimeter fabs. They are 200-millimeter initiatives. So it is -- basically expands across all segments. It's logic, DRAM, NAND, logic being foundry. There's DRAM initiatives. There is NAND initiatives. So it's the -- I would say, it's the entire breadth of the business that we're covering. And yes, it is moving, but we have to say these are greenfield fabs, which have a different pattern or an expected different pattern of ramping. Many of those fabs put in a first line to qualify the process, to qualify the first product, which will take some time. So we have to be careful with -- although the number is significant, 7, we have to be a bit careful with the assessment of the speed with which they will ramp up, which will be a function of the successes that they have in qualifying process and product. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [4] +-------------------------------------------------------------------------------- + + Got it. And then one quick question on the sustainability of memory shipments that you have seen this year. On your comments, you talked about the sustainability. Can you talk about some of the analytics that you have done that give you confidence that the memory demand that you're seeing is sustainable? And also, if I look at your orders, the orders in memory had declined a lot. Is that an indication that the customers are being disciplined in how they are ordering, and even though the memory industry profitability is very high, they're kind of building to meet the supply -- the demand that they are seeing? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Yes. First, to talk about memory you have to split between DRAM and NAND. The way that we calculate this is that of course, we don't know what the bit demand will be. So we focus -- basically, we use the available data from industry analysts, and we corroborate that with discussions that we have with customers and see how customers see this. I must admit that personally, I have sometimes the view that we're parroting after each other. We're all using the same percentages. There's not a lot of difference there. So this is on the bit demand side. Now what we know better is the bit supply side. We know pretty well how many tools are out there. We know pretty well how they are used in terms of availability and throughput. We pretty know -- we know pretty well what kind of technology is actually used, so we can calculate the bit supply pretty well as installed and as planned to be shipped. +Now with DRAM, that's pretty accurate because we know this pretty well. With NAND, there's a bit of a caveat there. We have to make certain assumptions on the mix of layer stacks and the timing of when they increase layer stacks and, of course, some assumptions on the yields that they are having. Now you could argue that ASML might not be the most or the best-positioned company to have an insight in there, but we work with what we know and what we hear. So this is what we then use, basically applying the same methodologies with DRAM, taking how many systems do we have in the field, what's their productivity, what is our assumption on the mix of the layer stacks out there and so on, in our yield assumption. That's how we come to this view that we currently have that supply and demand are pretty much in balance for this year, taking into account the caveats, which I think there are a little more caveats in there than there are in DRAM as far as our insights are concerned. +On the order trends, well, actually, you're giving exactly the argument why we stop giving order guidance because it -- you can draw easily very strange conclusions for it. I mean, the way that we plan our shipments is an 18-months in-depth view with our customers on their expansion plans, on their capacity rollout plans and on technology transitions. And orders come in from a very few customers in batches. So it doesn't say anything. When we give you guidance on what we believe the memory business is, it is based not on the order flow, it is based on the continued discussions we have with our customers on their ramp-up plans, their technology transitions. And that really drives our view of the business, not the order intake. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [7] +-------------------------------------------------------------------------------- + + I have 2 questions. Firstly, for Wolfgang. I'm trying to understand the R&D guidance that you have given. The R&D guidance for Q2 is higher than the 2020, even if you took an absolute amount on your 2020 guidance, 13% of EUR 11 billion, on a quarterly basis, it is higher. Why it is higher? And is it going to sustainably remain higher? And secondly, if it is going to remain higher, why are you not capitalizing some of this R&D, given that, I mean, just what Peter said in his prepared remarks that some of these shipments on High-NA EUV are really going to happen in 2024, et cetera? So it's a very long way away as yet. +And secondly, Peter, I have a question overall on the High-NA EUV business. Is the cost structure any different with -- in High-NA EUV given that Carl Zeiss is going to be such an important supplier there? I mean, clearly, it's an important supplier now and probably an even more important supplier. And I'd like to thank you, Wolfgang, for all your support over the last few years while you were CFO of ASML. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [8] +-------------------------------------------------------------------------------- + + Okay. Thanks, Sandeep. As it relates to R&D, we have taken the investments up. We're very heavily investing in High-NA, both here at ASML and through our High-NA agreement order size. But we are also investing heavily in Holistic Lithography in the guided beam and the multi-beam solutions. We do firmly keep our 13% of revenue envelope in mind, and we're not going to be quite there this year, but we're going to make progress year-over-year in terms of a percent of revenues that we'll keep that in front of us. +As it relates to the capitalization, that's a function of the accounting rules. And as you know, when we talk to you, we talk based on our U.S. GAAP numbers. And there, you simply have to expense it. If you're interested in the capitalized version, you can always look at our IFRS numbers that we don't use internally in the management process where they get capitalized. Quite frankly, at the end of the day, it's all about cash flow. And there, you don't have a difference. So we manage ourselves based on the U.S. GAAP numbers, which we also, quite frankly, like because it's a bit more conservative. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [9] +-------------------------------------------------------------------------------- + + Yes. On your second question on will there be a different cost structure on the High-NA EUV business, I think from a product cost, yes. I think [from the start], there will be optics in there. Of course, there will be EUV source there. But I think in terms of the cost buildup, it will be somewhat different. To start with the optics, I mean, I think we explained this before. We've taken an equity interest in Carl Zeiss, but also, we've agreed with them that we will co-fund their R&D as well as their CapEx. And the way that we get repaid on that funding is that we run this as a "2 companies and one business" kind of venture. So it means that we should both have -- and there's an equal internal rate of return. Only as you can imagine, if we put significantly more absolute euros in there than they do, then of course, somehow you need to get an absolute euro return, which is also significantly higher. +And the way that we balance this or we compensate this is through the lens price. So it actually means that it's a pre-investment whereby you can get a discount on the lens price to get a return on your investment. So that's one, and that's different than what we do today. And secondly, we use a -- we will use with High-NA the same source, the same EUV source, which is the source that we're currently using also for 0.33 NA. So all that, you could say a learning curve of that cost price of the current source will be captured by the time that we start shipping High-NA. I think those will be the 2 main drivers for a different cost structure in High-NA as compared to 0.33 NA, which should have a positive impact on the gross margin to start with. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Hameed Awan. + +-------------------------------------------------------------------------------- +Alexander Duval, Goldman Sachs Group Inc., Research Division - Equity Analyst [11] +-------------------------------------------------------------------------------- + + Yes. It's actually Alex Duval from Goldman Sachs. Just wanted to clarify very quickly what you said in terms of the High-NA orders and option sales. Can I just clarify that you said the average selling price is actually EUR 170 million for the original tool sale? And therefore, how should we be thinking about the total amount of cash that you'll be getting from those initial 4 orders and when we get that? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [12] +-------------------------------------------------------------------------------- + + Alex, so just to be clear, 2-7-0, that's EUR 270 million is the initial price of these tools. And the way how the arrangement has been done on the R&D tools is that we get 40% right away. And then there are 6 equal milestone-based payments that will happen over the next couple of years. And like I said in the prepared remark, we expect the majority of these payments will be in before the shipment actually happens. And then on top of that, we sold 8 options for early volume shipments, and they go at EUR 50, 5-0, million apiece, and those payments start this year. So it does exactly what we designed it for. We go through an accelerated development program to get this new technology in as soon as possible. And our customers help us with the cash flow because we talked about R&D, and we talked about our assistance in the Zeiss business. So I think those are the most important parameters around the cash flow. + +-------------------------------------------------------------------------------- +Alexander Duval, Goldman Sachs Group Inc., Research Division - Equity Analyst [13] +-------------------------------------------------------------------------------- + + Helpful. And just as a very quick follow-up, you obviously talked about these very high ASPs for High-NA. But there will be new iterations of the current generation of EUV, as I understand it, before we get to High-NA in coming years. So could you help us understand, should there be price inflation on these EUV machines in the meantime? And how should we think about that in the next couple of years? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [14] +-------------------------------------------------------------------------------- + + Well, we -- with that, we will do what we always do. I mean, when we provide more value to the customer, we actually look at what that means for them in terms of the litho cost per wafer or litho cost per transistor, however you want to calculate it. And in fact, we just split that value increase 50-50. We've always done that. We've done that since the inception of the company. And of course, value is very much driven by productivity. This is why productivity improvements in the current EUV and NA will happen over time, over the next couple of years. And that will drive also the value, which we're going to split with our customers. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [16] +-------------------------------------------------------------------------------- + + I guess, Peter, first question. You've got the longest-lead time equipment in the industry. So curious, as you think about announced and unannounced greenfield capacity as well as emerging spend out of China, could you talk about visibility and how you're thinking about 2019? I know it's only April, but would love to hear your thoughts. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [17] +-------------------------------------------------------------------------------- + + You're talking about 2019 for the total business or for China? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [18] +-------------------------------------------------------------------------------- + + Sorry, the question was specific to your Deep UV business in aggregate as you take into account the visibility you have plus your longer lead times. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [19] +-------------------------------------------------------------------------------- + + Yes. I think you have to -- I think it's way too early to go anything -- to start guiding on 2019. But just qualitatively, it's all driven by 2 things. It's technology transitions. I think technology transitions, 10-nanometer and 7-nanometer, they need significant amounts of Deep UV machines. The 7-nanometer node, as Mark Liu also mentioned, is in the minds of a lot of people. 10/7 is a big node. So -- but that -- the context of big, you need to see in the context of the end demand, yes? So I mean, what we're currently seeing in memory, for instance, is also a big user of our Deep UV systems, and it's driven by the demand out of the data centers. So it is really -- and the question which you're asking is really the question about, will we -- do we believe that the end demand will stick? It's strong today. Will it stick in 2019? I think the general belief, and I'm quoting also customers, is that they believe that it actually will, that the technology transitions will indeed happen. So the Deep UV demand for 2019 will be strong. That's our -- that's what we currently feel, yes? Now like I said, the end markets are really driving the ultimate demand for capacity extensions. And of course, we don't have a crystal ball, you don't have it, and we just have to see how that will develop over the next couple of quarters. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [20] +-------------------------------------------------------------------------------- + + Sure, that's helpful. And I guess as my follow-up, on the EUV side, I guess 2 quick ones if I could sneak it in there. The first part is, how do we think about gross margins into the second half given the pull-in of some of the deferred revenues? And then given that you pushed 2 tools into 2019, should we infer that 32 could be the new number? Or is that just not reasonable? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [21] +-------------------------------------------------------------------------------- + + Yes. On the gross margin, I think it's right to assume that we are steadily increasing the margin. I mean, we're not spelling it out anymore because of movements between quarters and also how the gross margin is done and how we sell to customers. But in general, that is indeed the case. And we've also talked about our EUV business. I mean, you have seen, in the first half, we were over EUR 150 million in first quarter, 600 in the -- almost EUR 600 million in the second quarter. It was EUR 2.1 billion for the year, so you see we have 2 heavy quarters coming. So you can clearly assume that the margin is going up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + Yes. On the shift of the 2 systems, yes, I mean, if you do -- if we said 30 before, well, 30 plus 2 is 32, I think I can do that math. But you have to realize that we're looking into 2019 where we really need to also understand the cutoff. At the end of 2019, I don't know exactly what we are going to have because we're not fully booked for 2019 yet. So I think, to be -- to stay on the safe side, I will just say we said we are planning for shipping our capacity of 30 units. I would, for the time being, stay at the 30 units. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + Actually, Peter, just as a follow-up, 7-nanometer plus wasn't supposed to lead to any meaningful changes to the design as it relates to the EUV insertion. It has -- it had more to do with the mask set. But 5-nanometer is going to have some implication or improvement especially with the layout. When do you expect your customers will be able to provide those design libraries with the EUV insertion that would enable design community to better understand the cost benefit of EUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [25] +-------------------------------------------------------------------------------- + + Well, I think actually, that's pretty fast and is already as a key attention for our customers. I mean, that's a question you really need to ask our customers, but I can give you some qualitative indication. I mean, when we talk to our customers, they actually are very happy with the progress that they're making on their 5-nanometer designs also using EUV. As what we said before, it reduces the complexity. So I think we got some very good feedback there. Although we, of course, don't know exactly where they are with their customers and how they present their designs and their libraries to their customers. But we don't know, but the sounds that we're getting out of the customer base are optimistic, and I think it's corroborated by what they say publicly. We listen to our major customers and what they say about EUV. I mean, it's pretty bullish. So, that's not us. That's the only thing I can say, Mehdi. I mean, we get similar feedback from them as they are publicly stating. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + Sure. And just a quick follow on DRAM. Last call, you talked about trying to target a 2,000 wafer per day throughput as a milestone for getting your DRAM customers incrementally upbeat about adoption of EUV. Where are we with those targets? And any incremental color on the DRAM adoption of EUV? Especially as you -- as we go from 1x to 1y, there's only 1- or 2-nanometer decline, and I'm not sure about the cost benefit. Is that impacting? And then any context of a throughput target? If you could provide any incremental color, it would be great. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [27] +-------------------------------------------------------------------------------- + + Yes. I think we've always said, DRAM introduction will be for 1 or 2 layers, and it really depends on the specific customer situation, what they will go for. I think -- but you're right, I think the 2,000 wafer per day is kind of a generally accepted target in the DRAM space because of the lower cost that they can, of course, bear for their devices. I think 2,000 wafers per day is a function of the wafer per hour throughput, which we said we actually reached 25 and in -- at the customer's site and then 40 wafers per hour here at ASML. So that's good. And that is a function of the availability, which is -- actually, we have a clear target of going over 90%. We're executing on that target with some good achievements made over the last quarter, especially on the collector degradation. We are getting the collector degradation under control, so we are a little bit ahead of our target there. So then -- and we're rolling out several improvements -- availability improvement, as we speak. Which actually mean that we have some major upgrades ongoing in the field. So if you would take average availability today, that is hampered also by the fact that we have to take tools down to do those upgrades. So -- but it -- but that all looks very much that we're on target to reach our over 90% availability when customers need it. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + But that incremental improvement isn't enough to get you excited about 2019 shipment? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [29] +-------------------------------------------------------------------------------- + + That remains to be seen. I mean, like I said, 1 to 2 layers. Whether it's 1 or going to be 2 layers is up to the customers to this, and we're early in the -- in Q2 of 2018. I think customers will change their minds as they see performance going up in the course of this year. I think that's what they will do. So they'll very likely -- and I'm a bit assessing the situation that -- of course, they won't tell us everything in detail, but they will have plan A and plan B, which is a 1-layer application or a 2-layer application. So -- and that really depends on the progress that they will see throughout the year, and that will drive their implementation in 2019. But like I said, we're on our targets -- we're on our way to meet our targets for 2,000 wafers per day for the DRAM application. There are many availability solutions that we're currently rolling out into the field. So throughout the year, we'll know more. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [31] +-------------------------------------------------------------------------------- + + It's Andrew Gardiner from Barclays. I had another one on EUV, perhaps more on the demand side than sort of your capacity supply side. Peter, a couple of quarters ago, you had said that sort of the theoretical demand you were seeing from customers was sort of about 30% above the 30-tool capacity that you had for 2019. There's quite a few questions out there in the market about sort of levels of commitment, levels of layers. You just said that customers are confident and that they're comfortable with the progress you guys are making. And so therefore, you haven't seen any change in that -- in your expectation of the layers. So is -- 2 quarters on from when you first said that, is the demand level for 2019 still at that kind of a level, so far outstripping the capacity today? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [32] +-------------------------------------------------------------------------------- + + Yes. I think it is still over that capacity number. It is changing from time to time, up or down, because of the timing that our customers are currently looking at for their ramp. Because it is not only whether you use 6 or you use 10 layers, but it's also what is the wafer capacity that you are going to build. So I think it is -- there is some changes back and forth, up and down, which is driven more by how much wafer capacity do they want to build. That has less to do with the technology but more with the end demand. And that is still above our capacity -- build capacity. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [33] +-------------------------------------------------------------------------------- + + Okay. I suppose to put it another way, then, sort of from a logic point of view, the 10 layers or more, you still stick to that sort of layer count expectation? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [34] +-------------------------------------------------------------------------------- + + Yes, but that is a method of how big is the end market. So it's also a bit of how quickly do they want to ramp to a certain first phase of that node, yes? So that is also, of course, determining whether -- how much the end demand will be over our capacity. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [36] +-------------------------------------------------------------------------------- + + It's Pierre Ferragu from New Street Research. I'd just like to get back, Peter, on what you said about the memory markets, I listened well -- you have, like, very good insight in how capacity is building up and that you see it meeting very well the expected demand. My question is, it seems that it's costing way more in terms of lithography today than it was a few years ago because your revenues from memory are very significant. So could you explain us, maybe is there an easy way to explain us why, in order to increase bits capacity, the industry needs to spend more today than it was maybe a few years ago? Is that because shrink is delivering less bit growth and they need to install more capacity? And is that something you see as a new normal, as something that will be sustainable over time? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [37] +-------------------------------------------------------------------------------- + + Well, it is clear that they are spending more now than they did a few years ago in terms of litho tools. It doesn't mean that your cost per bit goes up, no, because you're actually shrinking. So your cost per bit, even if you spent more on litho and on equipment, as -- I don't need to explain it to you. But then your cost per bit still goes up, and then that still goes down. But what we're currently seeing, and I think that's kind of -- a long time that we've seen memory prices, especially DRAM prices, staying very strong and even growing, while you could argue the cost of manufacturing goes up. That tells you something. I mean, we've always said memory is a commodity, and a commodity has a high price elasticity. Well, the price elasticity when prices go up doesn't mean that the demand goes down. No, it's just the opposite. I think the demand is extremely high, and that means that even customers -- that end customers are willing to pay the high prices. So for our memory customers, that's an easy choice. You have a net market that wants your product more than you can deliver, which actually means you buy the capacity, which may be at higher wafer cost, but your margins are significantly higher because of the market situation. So it is just business. They will buy what they need if the end market is there. And what you will see, if the end market is not there, they will buy less, and they will just squeeze everything out of the current installed base. So I don't see the issue, yes? And I don't think customers see the issues because they see the end markets, they see their profit margins, they see the opportunities. We don't see, and certainly not in the DRAM space, an exaggerated buildup of supply. So they buy what they need, and it costs a bit more, but they also earn more. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [38] +-------------------------------------------------------------------------------- + + Okay, that's very clear. So cost of bit still comes down, but it just, over time, gets -- translates into more spending in lithography. And then maybe more specifically on NAND, you mentioned like clients who started adding to their stack on 3D NAND, increasing the number of layers. Do you have an early insight on whether stacking up NAND like that is delivering on its promise in terms of reducing the cost per bit? Do you have visibility on that already? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [39] +-------------------------------------------------------------------------------- + + Well, the cost per bit, when you stack and you use historical yield assumptions for this type of device, then it's clear, the cost per bit goes down, yes? So now from a lithography point of view, it is also clear to us there will be stacks-of-stacks. I mean, that's what every customer confirms. Now the big question is, after how many stacks do you need another? Well, after how many layers do you need another stack? That might be different customer per customer. But that's a thing that is certain to us. So yes, cost per bit will go down with vertical scaling. But like I said earlier, the ultimate cost is also a function of a couple of things. And one of them, a very important thing is, of course, yield. When yields go up, cost per bit goes down. It's that simple. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Dave Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [41] +-------------------------------------------------------------------------------- + + It's David Mulholland from UBS. Just quickly on the -- you made a comment earlier to say you're still increasing your DUV capacity. And I guess for the next year or 2, as you start to ramp up EUV in volume more significantly, there's general expectation DUV will go into decline. So just wondering if you can help us understand how you think about your DUV business over the next couple of years and why increased capacity now in that context? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [42] +-------------------------------------------------------------------------------- + + I think when we say we increase capacity, don't think about adding square meters, building factories and putting tooling in. I mean, it's really, yes, you get a bit more people in because you just work somewhat longer hours. But the most important part is operational efficiency. So you're reducing cycle time in the factory and basically getting more machines out using -- at the same fixed cost. That's how you do it. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [43] +-------------------------------------------------------------------------------- + + Okay. So it's not to say that you suddenly got a more optimistic view on payer (inaudible) on a 2-, 3-year view? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [44] +-------------------------------------------------------------------------------- + + No, no. I think we are increasing capacity because the customer demand is there. And like I said, you can do this in a couple of ways. By taking the long route, and that's basically building a factory and hiring people and don't change your processes; or you can drive down cycle times and just get more out of the same square meters. And that's what we're doing today. (multiple speakers) faster and it's cheaper. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [45] +-------------------------------------------------------------------------------- + + That's clear. And then just coming back on the EUV High-NA discussion, you've made a few comments on value and pricing. But just obviously, there's been quite a challenging ramp from a gross margin perspective as the initial ramp of EUVs come in. Do you expect that we'll see a similar challenge as we start to introduce High-NA, start low and then increase? Or will it be starting from a much better starting point given what you've already learned on EUV as we transition to High-NA? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [46] +-------------------------------------------------------------------------------- + + Yes. We'll start from a much better starting point. You will always see that the first tools have a lower gross margin than the tools when you're in volume because you have the learning curve and the warranty that goes with that, which is always higher with the first tools. But like I said earlier, we have this agreement on our return on investment of the R&D and the CapEx we do with Carl Zeiss, which will translate into a reduction, a discount on the optics, which is the most expensive part of the entire tool. And the EUV source is the same source as we use in 0.33. So that learning curve will have kicked in by the time that we start shipping the High-NA tools. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [48] +-------------------------------------------------------------------------------- + + It's Doug Smith from Agency Partners. I saw that the wafer throughput for High-NA was actually higher than for low NA at 185 wafers per hour. Does that mean that the 2, low NA and High-NA, won't coexist, that the High-NA will just take over eventually? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [49] +-------------------------------------------------------------------------------- + + That's a good question. I mean, it used to be the case that when you introduce a new technology, that you see a cannibalization of the previous one, which will not be the case for High-NA EUV. High-NA EUV will be used for the absolute critical layers. It will be an expensive tool, EUR 268 million, but it will provide not only more productivity but also the geometrical shrink, as Wolfgang mentioned. So it means, for those layers where you need the shrink, you will apply the High-NA tool. For those layers where you don't need the shrink capability of a High-NA tool, you will use the 0.33 tool. So it's going be a mix and match. Everything that we're currently seeing and discussing with customers is going to be mix and match of 0.33 and the 0.55 NA tool. So that means that the 0.33 EUV tool will have a very long life. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [50] +-------------------------------------------------------------------------------- + + Okay, very clear. And one quick question. The metrology and inspection business looked like it had a pretty small quarter. Are there some issues going on in that business? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [51] +-------------------------------------------------------------------------------- + + No, it was -- I don't know how you come to that conclusion. We had -- of course, the whole business is within our systems number, and a part of it is within our service number. But we didn't have a bad quarter. We -- this whole business is steadily increasing. And Holistic Lithography altogether is probably the strongest-growing business amongst all of our businesses. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [53] +-------------------------------------------------------------------------------- + + It's Adi from Bank of America Merrill Lynch. So I had 2 questions. Firstly, looking at the growth drivers in 2018, you're saying you're confident that memory has increased in the last quarter. Can you give us some color on how much you see your memory tool revenues increasing this year in 2018? And secondly, just a clarification on the EUV shipments. Clearly, the shipment numbers were very different to the revenue recognition numbers. So how should we think about that as we go through the rest of the year? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [54] +-------------------------------------------------------------------------------- + + I'll take the second one. You're right, if you take Q2, we've guided to almost EUR 600 million on 3 shipments. So we are planning to achieve a very important milestone where we basically can recognize revenue at the point of shipment. We're confident that we'll achieve that, so that means we can recognize these 3 shipments right away when we ship them. But not only that. We can also recognize tools from Q1 and even Q4 that we had previously shipped. If you recall, Q1, we shipped 3 systems, and we recognized only one. So we basically have that catch-up order. And then from now on, you will see the revenue recognition at the time of shipment, so it's going to be much more in sync. So you have that one catch-up order in Q2. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [55] +-------------------------------------------------------------------------------- + + Yes. And on the growth drivers for 2018, yes, it is memory. We've -- throughout the quarter, we've seen there's a steady increase of the -- or let's say a change in the demand plans from key memory customers. And when I try to analyze this, I think it is more focused on the DRAM situation. That's where we really saw -- from month to month, we saw an adjustment of the demand plans. And as we said earlier, it's not so much the order pattern, it's more the 18-month forecast, and more importantly, the next 9 months that we have to agree with the customer, taking into account our own lead time. And this is where we have seen this gradual increase in the end demand and making sense. I mean, if you look at the end markets, I mean, the DRAM markets, look at the DRAM pricing, and look at the announced capacity additions over the last 3, 4 months, customers are reallocating memory types to free up space for memories where they can make most money, which in this case is DRAM. And all that's happened over the last 3, 4 months, and that drives up the demand. And we're able to respond to that demand because we have reduced our cycle times. So that -- it's -- that's what it is. It's just the more clarity that we've been given by our customers on what they need this year. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [56] +-------------------------------------------------------------------------------- + + Okay, understood. And just a quick follow-up if I could. There is a lot of concern around this news article that recently came out around Apple not using EUV at TSMC. Do you have any thoughts around that? And finally, just all the best to Wolfgang. I hope your time at Bayer is just as exciting as it's been at ASML. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + I'll let Wolfgang answer that last one. Just listen, I mean, we never comment on what customers of customers say because, yes, this is always -- we hear this constantly, customer A is going to supplier B and then switches back to A. There's many, many rumors in this space. What we focus on is what our customers are telling us on what they need and the orders that they place and the commitments that they want from us in terms of their tool demand. And that has not changed. Actually, and this is why we have a very healthy backlog, and we took 9 EUV orders in Q2. So whatever is out there is going to be whatever it is in terms of rumors, but customers are committing hard euros to us to get tools. And that's what counts. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [58] +-------------------------------------------------------------------------------- + + All right. Ladies and gentlemen, we have time for one last question. If you are unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations department with your question. Now, operator, may we have the last caller, please? + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + The last question will come from Ms. Tammy Qiu. + +-------------------------------------------------------------------------------- +Tammy Qiu, Berenberg, Research Division - Analyst [60] +-------------------------------------------------------------------------------- + + Tammy Qiu from Berenberg. Firstly, can you talk briefly about what trend you are seeing at foundry and logic? Because from my understanding, apart from EUV momentum in the second half, foundry and logic should be stronger than your January expectation. Can you just talk us through what's the driver and what can be the early indication into beginning of 2019? And also, the second question is on multi-beam tools. You said that in the presentation, you already demonstrated the first 9-beam tool. And can you actually talk about what exactly can you bundle that tool with your new system so that you can have a higher ASP with existing system? Or are you going to sell that tool as individual tool? And also, what's the potential number of beams you can bundle into the single machine? Because from my understanding, everyone in the industry has been working on a real multi-beam tool for the past 2 decades, but no one has achieved anywhere close to commercialization. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [61] +-------------------------------------------------------------------------------- + + Okay. Now the trends foundry and logic, like we said, we have a very detailed demand planning forecast process with our customers. I would agree with you that we see foundry and logic being very strong. I don't feel that we're currently looking at a significant uptick in that strong demand. I think it's been pretty well laid out. We feel pretty happy with this also in terms of business volume. So I think it's a bit too early to -- for us to currently help you with any indication on an accelerated growth in that area. I would love to do that, but I have to rely on our own process, and our own process says it's going to be pretty healthy, that it's pretty stable. +Now on the e-beam, yes, 9-beam is a prototype, so we've made the -- we captured the first images. And as we showed also in the presentation, the more beams that you have, the more servers you can actually inspect in one go. So that means the whole focus is on maximizing the potential number of beams. And the -- since that is a productivity advantage, a significant one, that also means that the value out of a tool like that will be higher than a single tool. So you could actually say that the value of the tool scales with the number of beams. And that will also -- it's too early to give you an indication of what that would mean. We'd rather discuss it with our customers first. But the potential number of beams, we're not disclosing anything yet. I mean, there are several companies working on their solutions. We'd like to keep it a little bit to our chest, but the 9 beams is just first prototype to show that multi-beam works, and we're very hard to -- we're working very hard to maximize that to the point where we have the highest value out of this type of solution. But I can tell you one thing: it's going to be significantly more than 9 beams. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [62] +-------------------------------------------------------------------------------- + + All right. Before we sign off, I'd like to remind you that we'll be hosting an Investor Day here at our headquarters in Veldhoven on the afternoon, November 8. We hope you'll be able to join us. +Now on behalf of ASML's board and management, I'd like to thank you all for joining us today. Operator, if you could formally conclude the call, I would appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Thank you, sir. Ladies and gentlemen, this concludes the ASML 2018 First Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2018-Jan-17-ASML.txt b/Transcripts/ASML/2018-Jan-17-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..18f5b000345298ece0ce30a87b3fc9f8f4057068 --- /dev/null +++ b/Transcripts/ASML/2018-Jan-17-ASML.txt @@ -0,0 +1,550 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 ASML Holding NV Earnings Call +JANUARY 17, 2018 / 2:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, CEO and President + * Wolfgang U. Nickl + ASML Holding N.V. - CFO, Executive VP & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Jerome Andre Charles Ramel + Exane BNP Paribas, Research Division - Analyst of IT hardware and Semiconductor + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Farhan Ahmad + Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Tammy Qiu + Berenberg, Research Division - Analyst + * Jagadish Kalyanam Iyer + Summit Redstone Partners, L.L.C - MD & Senior Analyst + * Douglas P.E. Smith + Agency Partners LLP - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2017 Fourth Quarter and Annual Financial Results Conference Call on January 17, 2018. (Operator Instructions) +I would now like to open the question-and-answer queue. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Go ahead, please, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you, operator. Good afternoon, good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven in Netherlands is ASML CEO, Peter Wennink; and CFO, Wolfgang Nickl. +The subject of today's call is ASML's 2017 fourth quarter and annual results. The length of this call will be 60 minutes, and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- +Thank you, Skip. Good morning and good afternoon, ladies and gentlemen, and thank you for joining us for our Fourth Quarter and 2017 Annual Results Conference Call. +Before we begin the question-and-answer session, Wolfgang and I would like to provide you with an overview and some commentary on the fourth quarter and the full year 2017 as well as provide our view of the coming quarters. Wolfgang will start with a review of our fourth quarter financial performance with the -- some added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Thank you. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [4] +-------------------------------------------------------------------------------- +Thank you, Peter, and welcome, everyone. I will first highlight some of the fourth quarter and full year financial accomplishments and then provide our guidance for the first quarter of 2018. +Q4 net sales came in at EUR 2.56 billion, exceeding our guidance by over EUR 400 million. Due to demand strength, some customers requested earlier shipments of lithography systems, which we were able to accommodate late in the quarter. This accounted for almost half of the EUR 400 million, and the other half came from earlier-than-expected acceptance of the performance of 2 previously shipped EUV systems by a customer, which led to recognition of deferred revenue in Q4. Net system sales of EUR 1.95 billion was strengthened by memory, which contributed 53% of sales, foundry accounted for 29% and IDM was 18% of system sales. Installed Base Management sales for the quarter came in at EUR 606 million, which was in line with our guidance. +Gross margin for the quarter came in at 45.2%, which was 120 basis points higher than our guidance. This was the result of much stronger-than-expected DUV sales, more than offsetting the dilutive effect from incremental EUV revenue that was recognized during the quarter. Overall OpEx came in slightly above guidance, with R&D expenses at EUR 317 million and SG&A expenses at EUR 113 million. +Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at EUR 3.29 billion. During the quarter, we purchased approximately EUR 331 million worth of shares. Since January 2016, we have purchased a total of approximately 8.2 million shares with a value of EUR 900 million against our 2016 and '17 authorization of EUR 1.5 billion. +Moving on to the order book. Q4 systems bookings came in at a strong EUR 2.93 billion. This is almost an EUR 800 million increase compared to Q3 bookings. The order intake was driven by the memory sector, representing 55% of orders, compared to 30% for foundry and 15% for IDM. We took 10 new orders for EUV systems, and our EUV backlog now reflects 28 systems valued at EUR 3.1 billion. Our overall system backlog now totals a record EUR 6.68 billion and is balanced nicely between memory, foundry and IDM. +Our strong Q4 results marked the closure of an exceptional year for the industry and ASML. For the full year, our net sales grew 33% to a record of EUR 9.05 billion. Net Installed Base Management sales grew more than 25% to a record of EUR 2.68 billion. With total EUV sales almost at EUR 1.2 billion, 2017 was the year when preparations for inserting EUV into high-volume chip manufacturing shifted into a higher gear. Of the 12 EUV shipments planned for 2017, we shipped 10 during the year. One shipment is in progress, and one shipment is planned this month. This means that our 2018 shipment plan will increase by 2 to a total of 22 systems. +We made considerable improvements on our EUV gross margin in 2017, achieving 0% in the fourth quarter. Due to accelerated investments in EUV service infrastructure, we had not achieved 0% for the full year. Nevertheless, even with a more than 3x increase in EUV revenue from 2016 to 2017, we were able to improve our corporate gross margin to 45%. We are on track to achieving overall gross margins exceeding 50% in 2020. +We continue to invest in the long-term future of ASML, and increased R&D from EUR 1.1 billion in 2016 to EUR 1.26 billion in 2017. This increase was driven by accounting for a full year of HMI, our contributions to Zeiss SMT and our own investments in high NA. Overall R&D investments as a percentage of revenue decreased from about 16% in 2016 to about 14% in 2017. +SG&A as a percentage of revenue reduced by almost 1 percentage point to about 4.6% of revenue. Our net income for the full year grew 44% to a record of EUR 2.12 billion, resulting in a net margin of 23.4% and an EPS of EUR 4.93. +With that, I would like to turn to our expectations and guidance for the first quarter of 2018. We expect Q1 total net sales of around EUR 2.2 billion. As a reminder, we pulled approximately EUR 400 million from this quarter into Q4 2017. While we target to ship 4 EUV systems in the March quarter, we expect revenue recognition of about EUR 150 million for all EUV business. Overall, we do expect quarter-over-quarter revenue growth throughout 2018. We expect our Q1 Installed Base Management revenue to come in around EUR 600 million. +Gross margin for Q1 is expected to be between 47% and 48%. R&D expenses for Q1 will reflect continued accelerated investments in our portfolio and will come in at around EUR 350 million. SG&A is expected to come in at about EUR 115 million. We are excited about 2018, which will be a year of continued strong growth in revenue and profitability. +Today, we also announced a new share buyback program for 2018 and '19 of up to EUR 2.5 billion. We intend to cancel these shares after repurchase with the exception of up to 2.4 million shares, which will be used to cover employee share plans. Additionally, we also will propose a 17% increase in our dividend to EUR 1.40 per share at our Annual Shareholder Meeting, which takes place on April 25 in Veldhoven. The dividend payment is valued at around EUR 600 million. +With that, I would like to turn the call back over to you, Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [5] +-------------------------------------------------------------------------------- +Thank you, Wolfgang. As Wolfgang highlighted, that we had another record year in 2017. The demand for our full product portfolio was very strong, and our business continues to perform very well. The strong demand in both logic and memory set new revenue records across both sectors in 2017. Expanding end market applications, IC device content growth, increasing litho intensity, all evidenced by our strong backlog, provide a good basis for this positive momentum to continue in 2018. +Most others, but certainly due to high demand from the server market, DRAM system demand remained strong as our customers continue to migrate to sub-20 nanometer nodes. Advanced nodes are more litho-intensive and, thus, drive increased litho demand. In 3D NAND, litho demand is also strong, as a number of customers continue to ramp through greenfield fabs and scale vertically with so-called stack-of-stacks. Additional lithography is required to connect these stacks, which further drives up litho intensity. But adding the NAND opportunity to the DRAM business outlook for next year, we see another strong memory year ahead. +Logic demand continues to be solid as customers ramp 10-nanometer and starts transition to the 7-nanometer node. Litho intensity continues to increase with migration to more advanced nodes with further growth with the adoption of EUV at 7-nanometers. EUV production ramp will accelerate in 2018 as customers are eager to realize the benefits of process simplification, cycle time reduction, yield improvement and ultimately resulting in cost benefits. +In regards to China, we set a new record for this region in 2017 with over EUR 700 million in revenue. In addition to strong demand from existing customers in the region, we're also planning to ship to 5 domestic Chinese customers in 2018 for both memory and logic applications. With continued ramp of fabs in China, both from domestic and nondomestic customers, we see a very clear growth opportunity in this region over the coming years. +On the ASML product side, let me start with an update on our EUV business. In EUV, we continued to make significant progress in 2017. We demonstrated all system specifications, including 125 wafers per hour, while continuing to improve availability. Customer demand is strong, evidenced by public statements of their plans to introduce this technology, with volume production starting in 2018. We booked 10 EUV orders in Q4, bringing our backlog to 28 systems in which we plan to shipment 22 in 2018. Shipment profile, however, will be back half-loaded as our planned step-up in move rate will effectively only have an impact in the second half of 2018. Our EUV shipment plan beyond 2018 is unchanged with 30-plus in 2019 and 40-plus in 2020. +In Deep UV, we shipped a total of 161 new systems in 2017, which is a 21% increase from 2016. We were able to significantly boost output in support of our increased customer demand in both memory and logic. We also provided customers with an early access version of TWINSCAN NXT:2000, which is our most advanced immersion lithography system. It's used for process development of the NXT node devices. As a sign of the continuously increasing maturity of the NXT platform, the NXT:2000 system already meets or exceeds all of its performance targets. With 3D NAND customers, we expanded our options portfolio. We addressed critical process challenges and delivery of improved performance. +In Holistic Lithography, we showed growth across the full portfolio of software and metrology products. We shipped our first jointly developed product less than 1 year after closing of the HMI acquisition. This product, ePfm5, the pattern fidelity metrology system that leverages HMI's high-resolution e-beam metrology with ASML's computational lithography technology. This product's high-resolution capability enables high capture rate of systematic patterning defects so customers can accelerate their yield learning curves and drive higher production yields. Both of these, we shipped our first EUV e-beam mask inspection system. +As to 2018, we expect continued solid growth in both sales and profitability. Our high-level view of 2018 business is largely unchanged relative to comments that we made last quarter. While we were able to recognize an additional EUR 400 million of revenue in 2017, which could be seen as a pull-in from 2018, it will not impact our view of 2018 as it will be wholly compensated by increased Deep UV demand. +In summary, we had another record year in 2017 with 33% revenue growth and 44% net income growth over 2016, strong demand in both logic and memory set new revenue records in 2017, and we expect both sectors to see continued growth in 2018, supported by increased EUV sales. Expanding end market applications, device IC content growth, increasing litho intensity, as evidenced by our record backlog, provide a strong indication that this positive momentum will continue in 2018. +With that, we will be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- +Thank you, Peter. (Operator Instructions) +Now operator, do we have your final instruction and 10 first questions, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) The first question comes from Mr. Farhan Ahmad. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [2] +-------------------------------------------------------------------------------- +This is Farhan Ahmad from Credit Suisse. My question is on EUV. You booked them, the system orders. Can you talk about the mix of customers within that? Is it coming from memory or foundry? And are there many multiple customers within that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [3] +-------------------------------------------------------------------------------- +Yes. There are multiple customers. It is dominated by the logic side of our business, and that is also -- when we look at next year, next year, we see sales increase in logic really driven by EUV, and the memory sales increase is driven by Deep UV. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Crédit Suisse AG, Research Division - VP and Senior Analyst for Semiconductor Capital Equipment sector [4] +-------------------------------------------------------------------------------- +Got it. And then in terms of the linearity for the year, is there much change between memory and logic lengths in the year as first half, more memory demand, and second, more foundry logic as some of the other companies have said? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [5] +-------------------------------------------------------------------------------- +Not on the Deep UV side and on EUV side. And on the EUV side, as mentioned in the prepared remarks, it will be a more back end-loaded. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [7] +-------------------------------------------------------------------------------- +C.J. Muse with Evercore ISI. First question, I guess -- was hoping that you could discuss, Peter, what you're seeing in the supply chain on the EUV side. Would love to get an update in terms of optics and things like that and whether you're feeling better, same, worse in terms of hitting that 30 tool target into the 2019 time frame? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [8] +-------------------------------------------------------------------------------- +Yes. I think with respect to my feeling, no changes. I think it's the same as we said last quarter. It has to do with the fact that the step-ups in capacity are really long lead time items. So this is not something that you change one quarter to the other. So the supply chain situation is what it is. And I think the 30-plus is limited, as we said before, by the supply chain, and the 40-plus is really when this supply chain can kick into the next steps. So no real change. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [9] +-------------------------------------------------------------------------------- +Okay. And I guess as my follow-up, you guided gross margin higher year-over-year despite the nice tick higher in EUV shipments. So curious, if you think about non-EUV and growth in inspection and an uptick on the DUV side, is it fair to say that, overall, that part of your business can do roughly 53%, 54% gross margin through the year? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [10] +-------------------------------------------------------------------------------- +I wouldn't like to nail it down to an exact percentage. But if you look at both other businesses, so the Holistic Lithography business and the Deep UV business, you will see an increased mix towards the more powerful machines, and that has a positive effect on gross margins. Also, we continue to do a lot of very profitable upgrades. And then from a mix between Deep UV and Holistic Lithography, you will see also, the next 2 or 3 years, a continued mix towards Holistic Lithography, which will have a slightly higher mix in our overall revenue. And since this is a very software-driven, it structurally also contributes to the non-EUV business being up, so both effects. Both of these businesses go up based on the products that we offer, and then you also have a mix base effect. And that, of course, comes together with us making significant progress on the EUV. And that's why we feel confident that from the 45%, we can advance in 2018 and then get to our 50%-plus in 2020. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [11] +-------------------------------------------------------------------------------- +C.J., if I just may add one general comment on this is, going forward, I mean, we are guiding -- and as we did, we are guiding a corporate gross margin, and going forward, we will do that. Because if you look at what our customers really want from us is node-to-node transitions, and node-to-node transitions, going forward, are really a combination of the entire set of products and services that we are offering. So you will see agreements with our customers that involve EUV, Deep UV, Holistic and applications in one go, and we will make one PPA, which expects -- which effectively gives us one gross margin. So going forward, we will guide you more and more on the overall corporate gross margin because it doesn't make sense to give you -- and I don't want to do that either, to give you any specific gross margin guidance for those products because we have the PPAs for the entire product portfolio of ASML. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [13] +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan. My first question is on EUV. Could you possibly help us understand in terms of the recognition on EUV into 2018, are you going to be recognizing that in all the tools on shipments by the second half of this year as well as the past deferred revenue on EUV will be fully recognized in 2018? And I have a quick follow-up on EUV as well. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [14] +-------------------------------------------------------------------------------- +Okay. Let me see whether I can structure this for you because there's a lot of moving parts here. The first comment is by the end of the year, we should be able to recognize the majority of the revenue of a system as we ship it. At the beginning of the year, we still have shipments, as you have heard from my prepared remarks. Q1, for instance, we're planning to ship 4 systems, recognizing only EUR 150 million. There are still shipments that have -- of tools that have changes in them that require us to wait with revenue recognition for an acceptance of the tool at the customer side. So these Q1 shipments will, however, recognize in the second half of the year. On top of that, we are carrying a deferred revenue balance of around EUR 500 million on our balance sheet from prior shipments, and they're both short term and long term. So some of them will come into the P&L in 2018, and some will even carry a little bit into 2019. If you put it altogether, we expect the revenue for the EUV business to be somewhere in the EUR 2.3 billion range for the year. As a reminder, just so for clarification, we said EUR 2.5 billion in the last call. But of course, we achieved the acceptance of 2 tools already in 2017, and of course, they moved into 2017, where we overachieved by EUR 200 million. I hope that helps, Sandeep. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [15] +-------------------------------------------------------------------------------- +Good. And then following up to your earlier response, Peter, regarding EUV for 2019. I mean, some of those very strong orders you talked in the fourth quarter are clearly 2019-related. How do you see -- I mean, the order [bearing] for 2019, do you expect that because of your lead time, you'll get almost all the 2019-related EUV orders in this year itself? Or this is going to continue right through next year in terms of getting orders? And then -- had -- will you also start seeing a 2020 level of indication from customers for EUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [16] +-------------------------------------------------------------------------------- +Yes. I think what we're working on, and because it's also on customer request, is clearly a reduction of the cycle time of our EUV tools. I mean, it has to come down by 2020. We really like to be at the cycle time anywhere between 12 and 15 months. That means also customers will take account of that, and that means that they will actually postpone issuing the orders to reflect that reduced cycle time. Now the first cycle time reductions, we will probably see somewhere at the -- towards the end of 2018. But I would suspect that the majority, I think the significant majority of everything that we will ship in 2019 will be booked in 2018, because these cycle time reductions will really take effect later, and that will then have an effect on the order lead time of our customers. So vast majority should be in this year. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +The next question comes from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [18] +-------------------------------------------------------------------------------- +Amit Harchandani from Citigroup. My first question would be with regards to the current traction you're seeing on the high NA EUV side. If you could please update us on the same, and I say so in the context of your 2020 ambition, but clearly the market is looking for some color or trajectory in terms of how revenues are likely to shape up beyond 2020, and high NA is a critical ingredient of the same. So would be great to know your thoughts on the same, and then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [19] +-------------------------------------------------------------------------------- +Yes. That's a good question. I think we have had extensive discussion with our customers on our high NA concept, and I mean, the -- how the machine looks like and the performance specifications that we started and already way into 2017. I think we got confirmation from all our major customers that high NA makes complete sense from a technical point of view, from an economical point of view. So they want us to execute on this. Now currently, we are in discussion with our customers under what terms and conditions we should start shipping the first R&D tools and how quickly after the R&D tools we should start ramping up for volume. Now having said that, we do realize that a high NA tool is really a new scanner. It's not so much a new EUV source. As you know, the EUV source being the main reason why there was a delay with the EUV introduction. We were using the same source as for the current EUV generation. So that means that we would be able to actually see a high-volume high NA EUV tools shipping somewhere in the middle of the next decade, starting to be used in the high-volume production and then ramping in the second half of the next decade. Now those will be tools that we're currently looking at pricing significantly over EUR 200 million. And that means that if you then look beyond the 2020 target number in terms of sales end, you don't need a lot of imagination to foresee our top line growing significantly beyond 2020, and it will be driven by EUV and the next generation. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [20] +-------------------------------------------------------------------------------- +And as an unrelated follow-up, if I could get some clarity around China. You've given us an idea of shipment to domestic customers in 2018. In the past, you've talked about the cumulative LIFO opportunity, if I remember correctly, of around EUR 3 billion. Could you give us a sense on -- have -- is your sentiment more positive, more negative? And how are you thinking about China over the next 2 to 3 years? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [21] +-------------------------------------------------------------------------------- +Yes. I think we actually mentioned that EUR 3 billion mark, but that takes into account, I think, our view as to the speed, realistic speed with which our domestic Chinese customers will be able to ramp their fabs and to get their products qualified. Now if they can do this faster, then you would probably see an uptick on that EUR 3 billion. And if they would do it, let's say, at a speed with which we would normally see in memory and in logic, you could probably get to a number that's almost twice as high as the EUR 3 billion. But that is given the fact that many of these are greenfield -- not only greenfield fabs, but also greenfield companies, and that's why we take a more conservative view. But I would say, let's stick to the EUR 3 billion, and let's work very closely together with those customer to see whether they can accelerate. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +The next question comes from Mr. Jagadish Iyer. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD & Senior Analyst [23] +-------------------------------------------------------------------------------- +Yes, Summit Redstone. Two questions, Peter. If you look at the foundry logic, if you look at calendar '17, there's not been a significant uptick in your revenue in foundry logic segment. Whereas if you compare it to the memory, there's been a significant uptick there. So how should we think about growth in memory revenues in calendar '18? And is there a potential risk that these customers decide to scale back on capital spending if the pricing environment does not support such a situation? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [24] +-------------------------------------------------------------------------------- +Yes. I think we've -- both for memory and logic, we see similar patterns in 2018 with -- there are some potential upside, which is customer-driven. I think that the second half of your question is probably more relevant one because it comes up time and time again. The way we look at this is, are we creating an overcapacity in terms of the bit supply into the memory market, both DRAM and the NAND. Now if we look at what our customers are currently asking us and the forecast that they give is for what they want in 2018 is, of course, not fully yet in the backlog. And if we take that and we take into account the nodes that they want to use this on, the effect it will have on the bit density, then we can calculate what the capacity addition will be in terms of bits. And in DRAM, where we will be probably anywhere -- let's say, mid-20s max, yes? So anywhere between 22% to 25%. And in NAND, the capacity addition of what we can see based on litho will be around mid-40s. And these are -- the way currently our customers are talking about and the analysts are talking about it, it's about the same as the demand bit growth looks like. So when we take those 2 together and we look at the capability of the lithography machines to add bits, it seems that it's pretty much in balance. So is there a risk? There's always a risk because it's about the end markets, it's about the global economy. But from where we are today, we don't see that as a major issue. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD & Senior Analyst [25] +-------------------------------------------------------------------------------- +Okay. And then I have a follow-up. So you talked about EUV, and you talked about 125 wafers an hour. On a high level, can you kind of quantify in calendar '17 in terms of your progress, in terms of productivity of it and availability? And what should be the milestone for calendar '18 -- not quarter-to-quarter variation, but just on an overall annual level milestones? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [26] +-------------------------------------------------------------------------------- +Yes. You have to realize that nobody has EUV in full production yet. I mean, it's all coming out of the development phase. So they're qualifying product, which actually means nobody runs 125 wafers per hour continuously. I mean, we're not there yet. We'll eventually start in the back half of 2018, but that capability is actually there. And there are some tests that are being done by customers and by us. They'll show us that capability. Now with respect to the availability with the 3400, we're over 80%. We seek significantly over 80%. And I think the target by the end of this year will be that the availability numbers are such that customers feel comfortable to put the tools into production that will give them around 1,500, maximum 2,000 wafers per day. And that is then a result of 125 wafers per hour on average, and availability and the -- let's say, in active hours that customers are planning for their own production. So that part of the 1,500 to 2,000 wafers per day, that is what we're focusing on, and that seems very feasible with everything we have on the table today, which I think is evidenced by the fact that customers are giving us orders. We got 10 orders in Q4. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +The next question comes from Mr. Dave Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [28] +-------------------------------------------------------------------------------- +It's David Mulholland from UBS. Firstly, one of the strengths in the quarter was clearly the memory bookings. And I wonder if you could just help us understand how that breaks down in the quarter for as much visibility as you have between DRAM and NAND and how that's changed versus Q3 and also how much of it's coming from China at this stage. And then I've got a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [29] +-------------------------------------------------------------------------------- +Yes. To answer the last part, China, of course, we have greenfield fabs there. They don't go into ramp, like I said, in -- as an answer to an earlier question, aren't going to ramp up with the same speed as the mature memory companies. So they will take those tools and will use those tools to create a first line where they can qualify their product. So it will be -- it is in there in terms of the bookings. Now split between DRAM and NAND is very difficult for the simple reason that customers are continuously assessing how to allocate their lithography capabilities and their capacity between DRAM and between NAND, and there are a lot of relocations going on between DRAM and NAND. That's why some time ago, we decided to just give you the memory segment as one segment and don't split between DRAM and NAND because they are continuously changing because of those -- the reallocations. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [30] +-------------------------------------------------------------------------------- +That's clear. And then just on the follow-up. One of the comments you made was, obviously, 2 tools being recognized earlier in Q4. I just wondered if you can give us some clarity on what drove that. Was it the customer lowering the performance requirement that got you there earlier? Or was it better performance on your side in terms of getting to the targets quicker? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [31] +-------------------------------------------------------------------------------- +It was because the customer signed off on the specification that we agreed when we shipped the tool. So no better or worse specification, just we met the specification in the sign-off. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +The next question comes from Mr. Jerome Ramel. + +-------------------------------------------------------------------------------- +Jerome Andre Charles Ramel, Exane BNP Paribas, Research Division - Analyst of IT hardware and Semiconductor [33] +-------------------------------------------------------------------------------- +Yes. Jerome Ramel, Exane BNP Paribas. One quick question on EUV. Can you update us on the mask inspection and pellicles? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [34] +-------------------------------------------------------------------------------- +Okay. Mask inspection, well, we shipped the first e-beam mask inspection tool through our HMI subsidiary. Mask, in itself, as we also showed in the presentation this morning, whether you have the excess -- but at least, we show we make significant progress on the pellicle development. So let's say pellicles are now able to be used at the 250-watt power level. Lifetime of pellicles is going up. We're all moving very nicely into the volume production area. And so masks and the mask infrastructure, we don't think there's any issue that will prevent our customers to put EUV into volume production in the course of the year. + +-------------------------------------------------------------------------------- +Jerome Andre Charles Ramel, Exane BNP Paribas, Research Division - Analyst of IT hardware and Semiconductor [35] +-------------------------------------------------------------------------------- +And another follow-up on the high NA EUV. Some of your potential client made a comment that they might need to build new fabs to go with the new tools. Is that the reason you are sharing? The question is, can we eventually use high NA EUV in existing fabs? Or do we have to redesign the fabs? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [36] +-------------------------------------------------------------------------------- +Well, I think it's similar to the current EUV tool. I mean, when we -- 5 years ago, the current EUV tool did not fit into many of the fabs at that moment in time. I mean, it's a better fab height. It's the strength of the floor. It's -- those are bigger tools. But this is -- as long as we -- and this is why we have such a coordinated and very detailed interaction with our customers on the high NA, is also to make sure that they understand the full specification sets, not only from a lithography point of view, but also from a logistics and a facility management point of view. That's been communicated, and I hope customers will build new fabs, not only because high NA, because the market is growing and we need more of those devices. And I think that was the main reason why we start building new fabs and then take into account that some of the tools are a bit bigger. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +The next question comes from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [38] +-------------------------------------------------------------------------------- +Great quarter, by the way. I noticed that the dry EUV moved up from 20 units to 25 units, Q3 to Q4, but the immersion went from 22 to 20. Is that evidence of the increasing importance of NAND in your portfolio? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [39] +-------------------------------------------------------------------------------- +No. I think to draw conclusions on the quarter-to-quarter comparison between Q3 and Q4 is -- I think you probably shouldn't do that because it's -- it could be all kinds of incidental factors, customer-specific shipments. But generally, I would say that the dry Deep UV systems are going up in numbers going forward, because, yes, you are absolutely correct, there is a higher need in the 3D NAND space. Now it's not only because the 3D NAND space grows, but it's for different reasons. One, we use stacks-of-stacks, like I said in my prepared comments, which actually means you need extra litho steps to connect those stacks. That is one. But also there is -- there are specific requirements that we need to put there as dry tools, but because there are peculiarities, I could say, with the 3D NAND manufacturing, which have to do with what wafers, which have to do with opaque layers so that the alignment needs to be different. And all those specific peculiarities of 3D NAND will be addressed by us by bringing out the tools and options on the tools that will enable our customers to increase their yields and to make sure that they can do effective 3D NAND production. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [40] +-------------------------------------------------------------------------------- +Got it. On a kind of related issue, I was wondering, are you seeing any evidence yet that with the traction of EUV, customers might be planning on ordering fewer immersion systems, which I guess is kind the whole point of introducing EUV in the longer term? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [41] +-------------------------------------------------------------------------------- +Yes. I think -- what I think, it's probably best is we look at our Analyst Day of 2016. We gave you a couple of scenarios where high EUV introduction, lower EUV introduction for several reasons. It could be EUV not as effective as we then, at that moment in time, planned or whether markets were different. And you can actually conclude from those scenarios that higher EUV will lead to somewhat lower immersion, but still significant. And it's logical because it will cannibalize some of the multiple patterning layers. On the other hand also, layers are growing, yes? So it also -- so basically, there is a dilutive effect in that sense that you have more layers, and some of those layers will be deep UV layers, will be the immersion layers. So no matter how you look at it, the number of EUV and of immersion systems will still remain significant, also with high EUV introduction. So -- this is I'd like to refer back to that -- to those 4 scenarios that we showed in the end of 2016. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [42] +-------------------------------------------------------------------------------- +And just to give you the numbers, I mean, these 4 scenarios had anything between 50 and 80 tools. And that -- right in the middle of that range, around 70, is what we're shipping right now. It's not -- in no case it is going down significantly. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [43] +-------------------------------------------------------------------------------- +Right. So it's that you're saying it's too early, really, to judge the level of cannibalization of EUV to immersion? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [44] +-------------------------------------------------------------------------------- +Yes. There will be probably some. I mean, if we now look at a quite -- at a good EUV adoption, which is -- I think is a realistic assumption right now, then yes, there will be some effect on immersion tools. But it's not going to be significant. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [45] +-------------------------------------------------------------------------------- +I think, by the way, that if you look at over the lifetime, over a very long period, it's actually not cannibalizing immersion at all because EUV, at one point in -- without EUV at one point in time, there wouldn't be even new nodes. And if there's a new node, there will also always be layers for immersion. So if you don't get it at a very long period of time, it's actually not cannibalizing at all. It's actually keeping it alive. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [46] +-------------------------------------------------------------------------------- +Yes, that's a good point. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +The next question comes from Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [48] +-------------------------------------------------------------------------------- +Yes. Mehdi Hosseini from Susquehanna International. A couple of follow-up. Peter, how should I think about your DRAM customers that are planning for EUV? Would that take for you to hit that 2,000-wafer-per-day target before you see a step-up in booking activity? Or is there any other metric that I need to track? And any insight here would be great. And I have a couple of follow-ups. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [49] +-------------------------------------------------------------------------------- +Yes. I think it's not a surprise that DRAM devices are more cost sensitive than advanced logic. So it is true that the 2,000 wafers per day is -- we've said it before, is a realistic economic productivity target. I think if we meet that target or, let's say, on a continuous basis, it's our assessment that, that will be a very attractive economic entry point for DRAM. Now -- and how realistic is 2,000 wafers per day? With everything that we have on the road map today, I think it is realistic to be there by the end of the year. So now, that -- let's work very hard and execute on it and work very closely together with our customers to get to that point because that, of course, it will be only for a very few layers, but there's a lot of DRAM wafers. So that could give an extra impetus to our EUV story. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [50] +-------------------------------------------------------------------------------- +Sure. Now I wanted to reconcile this with large-source capacity. How long will it take for ZEISS to add additional capacity? Do you have any flexibility to accelerate investment there or accelerate capacity, manufacturing capacity so that your 30-plus target for 2019 could increase? And I'm asking you this because if you're able to increase confidence among your DRAM customers that you can actually do 2,000 wafer per day, wouldn't they need to place a PO before '19? And wouldn't some of these EUV shipment would have to take place into DRAM customer by late '19? So doesn't that create a kind of a double-edged sword? And I want to get your view on the kind of levers that you can pull to accommodate these DRAM customers. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [51] +-------------------------------------------------------------------------------- +Yes. It's -- you're making -- you're asking very elaborate question, and I'll give you a very simple answer. The way that we -- the lead time to increase capacity at ZEISS has lapsed. I mean, we are where we are today. The only way to get 30-plus and how much the plus is, is dependent on the cycle time reduction in the factory of ZEISS. The faster they can do that and the better they can do that, the more we can squeeze out. Because everything else are long lead time items in terms of capacities, buildings, machines, people, training, the whole thing. That will not happen until 2020 and our output in 2020, which is their output in 2019. So that means we have what we have, yes? And that also means we are very transparent to our customers on the 2019 potential shipment plan and when those machines will come available. We're very transparent to every customer, and it's up to them to decide whether they want to take up that capacity. And there's very little we can do other than just working very hard with our ZEISS colleagues to keep reducing the cycle time to squeeze out a few extras. But that's what it is, and it's up to the customers to react on the transparency that we will give them. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [52] +-------------------------------------------------------------------------------- +And probably 2 clarifications, just in case I got your questions wrong. So you referred to the light source. Of course, the light source is not done at ZEISS. It's the optical system. And secondly, you seem to imply that DRAM EUV shipments would start late in 2019. We are already shipping EUV systems now. So I mean, it will also be in DRAM in high-volume manufacturing in 2019. Just so that's clear. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [53] +-------------------------------------------------------------------------------- +Does the elaborate question give me a quick follow-up? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [54] +-------------------------------------------------------------------------------- +Yes, because (inaudible) -- and we know it's your (inaudible) -- for your (inaudible) of time (inaudible). + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [55] +-------------------------------------------------------------------------------- +Okay, great. You made an interesting point about the e-beam mask inspection. You said that you have already shipped your first tool. How should we think about a year or 2 from now? Should we assume that you actually can turn this into a volume production and actually help customers meet the inspection or mask inspection without relying on other vendors? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [56] +-------------------------------------------------------------------------------- +Well, yes. It's a fully equipped mask inspection tool. So it's an e-beam tool, it can be used for e-beam mask inspection. And the more EUVs is used in terms of layers, the more mask inspection tools are needed. So I think we just are going to deliver and ship in that market, and yes, it's what it is. And I think when we did the HMI acquisition last year, I think we also put a date, the year before in 2016. I think we did discuss the opportunity of e-beam mask inspection as a couple of hundred million euros of -- this is -- it is where it is, and I think the success of EUV will, of course, help us also penetrate that market. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- +The next question comes from Ms. Tammy Qiu. + +-------------------------------------------------------------------------------- +Tammy Qiu, Berenberg, Research Division - Analyst [58] +-------------------------------------------------------------------------------- +Tammy Qiu from Berenberg. So the first question is on the cycle. I understand that based on your comment, 2018 is likely to be a nice year. I'm just wondering, what's your view on 2019 and what going to be the end market driver there? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [59] +-------------------------------------------------------------------------------- +Well, I've just sold my crystal ball, so I can't -- I really can't answer this, but it all depends on the end markets. I mean, the -- at least on the -- but just a more high-level answer is the proliferation and the penetration of IC devices into almost everything now is -- it actually makes it more volatile, I think, macroeconomics swings. So you want to talk about cycles, I think there will be macroeconomic cycles. I said it in the press conference this morning also, and -- but when that happens, I don't know, yes? The only thing is when it happens, we will be able to react up or down. And in your case, you seem to communicate what's the possibility of a downward question, I don't know. But when it happens, we have all the means and the flexibility to react. + +-------------------------------------------------------------------------------- +Tammy Qiu, Berenberg, Research Division - Analyst [60] +-------------------------------------------------------------------------------- +Okay. And the second question is, you talked about the EUV won't actually limit the demand for Deep UV. So in general, I would say, does that mean equipment have to become more and more expensive for the chip makers over time, so therefore they will have to keep buying the more expensive and more equipment for making a leading edge node? So I'm not sure how you view this point. Do you, as an equipment maker, need to cut the price at certain point so that they don't have to pay crazy CapEx all the time? Or can they actually pass on the incremental CapEx to their customers? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [61] +-------------------------------------------------------------------------------- +Well, what you're basically asking is, is Moore's Law still viable, yes? Because when I just -- well, just before the press conference, I bumped into one of the really senior ASML lab leads, and he said, "You know, this is great where the company is going. I still remember sending out the first invoice for $1 million. Now we're selling a EUR 120 million tool." So to your point, yes, customers have started to pay a lot more for those tools. But of course, the transition and the cost per function has continuously gone down on a logarithmic scale, yes? So is Moore's Law viable? Yes, we believe it's still viable, and yes, our customers will pay higher price for our machines whereby the cost per function will keep going down. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +The next question will come from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [63] +-------------------------------------------------------------------------------- +It's Andrew Gardiner from Barclays. We spent quite a bit of time talking about memory this afternoon. I was just wondering if we could spend a minute or 2 on logic and just in terms of the -- first on the near-term thinking through 2018 and the sort of strength or sort of node migration plans in place there. How do you view your sort of visibility into that logic business this year? I presume it's better or sort of firmer than we see in memory, where you seem to be highlighting the potential risk in the back half or, at least, lack of visibility in the back half. But how -- so where's your conviction level or -- to where a customer sort of order rates in terms of the 10 and 7 nanometer migrations? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [64] +-------------------------------------------------------------------------------- +Yes. I think what we've -- we haven't changed our view as compared to 1 or 2 quarters ago. I mean, the logic 10-nanometer ramp is still going, actually, to the areas in China, where we're shipping 14 and 28. And more importantly, I think what we will see is by the back half of the year, we'll start to see EUV going into 7-nanometer pilot production. This ramp, I think -- and also, if you look at the comments made by our customers and their assessment of the size of the nodes, there is no reason whatsoever to believe that they -- that there is an indication that those nodes will actually dwindle in terms of number of wafers that they would need to build that capacity. And on the contrary, I think comments are being made by customers on the 7 and 10-nanometer nodes as being very large nodes, and they're seeing a lot of [date bounce]. So there is no indication whatsoever to change our view. And like I said earlier and we look at the memory and the logic business, we see 2018 developing at least at the same level as 2017 for both logic and memory with some upside here and there. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [65] +-------------------------------------------------------------------------------- +Okay. If I could just have a quick sort of accounting follow-up for Wolfgang. We're starting to see the sort of the ZEISS investment come through in terms of the equity income line. It was somewhat negative in the fourth quarter. Is there a rough rule of thumb we should be thinking of as we put that in our models for future periods? + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [66] +-------------------------------------------------------------------------------- +Yes. The -- first of all for everybody, we had 2 agreements with ZEISS: one was a high NA investment agreement and one was an equity agreement. The high NA one, obviously, goes through our R&D line and also through our balance sheet as it relates to the CapEx. But as it relates to the equity investment, you will see that equity method investment on the balance sheet of about EUR 1 billion for the 24.9% that we own, and then you see 2 elements in our financial statements. First of all, you see in the P&L a profit that's attributed to those 24.9%, and therefore, the first quarter, you saw a negative EUR 17 million. And the second thing that you see is in our cash flow from investing. You see the dividend attributed to that investment, and you see that we received a dividend also for 3 months period of almost EUR 20 million. So the dividend is basically, since SMT basically distributes their earnings, a very good reflection of the profitability of that business. Now accounting makes this a little bit complicated because you need to do numerous things, but you start from a very healthy profit. And then you start off with, number one, the adjustment from IFRS to U.S. GAAP. Number two, you adjust for differences in accounting policies between the companies. But then number three is where it really hits you. Even though it's not an acquisition, you still need to do purchase price accounting. That means you need to write up the inventory to the fair market value. You need to identify intangibles. And then you do the same thing that what you have heard us talking about when we talked about HMI, you need to consume that inventory and you need to amortize these intangibles. And that takes your profit all the way to a EUR 17 million loss. Now as it relates to the future, this is something that will still be with us for a long time because these intangible has a lifetime of 15 years plus. But the inventory part, we will walk through within a year or so. So I think, net-net for 2018, this will still be a loss. And then in 2019, you will also see a profit on that line and then depreciate. And then the cash, of course, follows the true profit and cash flow of SMT. And from a cash flow perspective, you should see a much, much higher number every year. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays PLC, Research Division - Director [67] +-------------------------------------------------------------------------------- +It wasn't such a good follow-up, sorry. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [68] +-------------------------------------------------------------------------------- +Yes, good one to end though. Ladies and gentlemen, we have time for one last question. If you were unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations department with your question. Now operator, may we have the last caller please? + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- +The final question will come from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [70] +-------------------------------------------------------------------------------- +It's Deutsche Bank. I just had a last question on the EUV backlog. Just in terms of how many of those 28 tools are with the planned 251 configuration as opposed to -- I think it's 205 of the standard tool? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [71] +-------------------------------------------------------------------------------- +All of them, because there will be -- even if it's -- we have the commitment to have all those tool ultimately to be at 251. But -- so in fact, they're all at the 251 configuration. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [72] +-------------------------------------------------------------------------------- +I got it. So all of them will have an extra amount of money to be billed to the customer once you get up to 251 because that's beyond the spec, right? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, CEO and President [73] +-------------------------------------------------------------------------------- +No, because the spec is we need to do 251 to get the 125 wafers. So when we get over 251, we get more wafers out there, we get extra money. But 125 wafers is what we sold to them. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [74] +-------------------------------------------------------------------------------- +Okay. And just last question for Wolfgang, just on the gross margin in 2018. Given what you said about being higher than, I think, 45%, is 45% to 46% a kind of good model number for our models for 2018? You can just give us a vague range, that'd be great. + +-------------------------------------------------------------------------------- +Wolfgang U. Nickl, ASML Holding N.V. - CFO, Executive VP & Member of the Management Board [75] +-------------------------------------------------------------------------------- +I think we would have [knocked] the result if it's only extremely marginal, but I don't want to tie it down to a specific number at this point either. So we'll go through the year. And the more important thing is it will be a good step forward towards the 50 plus in 2020. That's really what we're working for. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [76] +-------------------------------------------------------------------------------- +Now on behalf of ASML's board and management, I would like to thank you all for joining us today. +Operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this concludes the ASML 2017 Fourth Quarter and Annual Financial Results Conference Call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2018-Jul-18-ASML.txt b/Transcripts/ASML/2018-Jul-18-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..5740a0ee7222d1287430deb1ca1f3962feab69c5 --- /dev/null +++ b/Transcripts/ASML/2018-Jul-18-ASML.txt @@ -0,0 +1,631 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 ASML Holding NV Earnings Call +JULY 18, 2018 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * R.J.M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Yeuk-Fai Mok + Needham & Company, LLC, Research Division - Senior Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Tammy Qiu + Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Sreekrishnan Sankarnarayanan + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Douglas P.E. Smith + Agency Partners LLP - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the ASML 2018 Second Quarter Financial Results Conference Call on July 18, 2018. (Operator Instructions) +I would now like to turn the conference over to Mr. Skip Miller. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Patricia. Good afternoon, good morning, ladies and gentlemen. This is Skip Miller, Vice President, Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven in the Netherlands is ASML CEO, Peter Wennink; and we would like to welcome our new CFO, Roger Dassen. +The subject of today's call is ASML's 2018 second quarter results. The length of this call will be 60 minutes, and questions will be taken in the order they were -- are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a reply -- a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during the conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentations on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning and good afternoon, ladies and gentlemen. And thank you for joining us for our Q2 2018 results conference call. +Before we begin the Q&A session, Roger and I would like to provide an overview and some commentary on the second quarter as well as provide our view of the coming quarters. Roger will start with a review of our Q2 financial performance with added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Roger, if you will. + +-------------------------------------------------------------------------------- +R.J.M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. As Peter mentioned, I will first highlight some of the second quarter accomplishments and then provide our guidance for this third quarter of 2018. +Q2 net sales came in at EUR 2.74 billion, somewhat higher than we guided, driven by strong demand across our full product portfolio. Net system sales of EUR 2.09 billion was nicely balanced between memory at 54% and logic at 46%. DUV revenue of EUR 667 million was a combination of revenue from 4 shipments, one more than previously guided, and deferred revenue from previous quarters. And as you know, we are now recognizing the majority of revenue for an EUV system at the time of shipment. +Installed Base Management sales for the quarter came in at EUR 654 million. Overall gross margin for the quarter came in at 43.3%, which was just above our guidance, reflecting the strength of our DUV and Holistic Lithography business as well as progress in EUV profitability. +Overall CapEx -- OpEx came in slightly above guidance, with R&D expenses at EUR 380 million and SG&A expenses at EUR 117 million. +Turning to the balance sheet. After paying a total amount of EUR 866 million on dividends and share buybacks, we ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 2.98 billion. +Moving to the order book. Q2 system bookings came in at EUR 1.95 billion. 45% of the order intake was from logic customers. Memory made up the remaining 55% of order volume. The bookings are mainly driven by the strong EUV business. We took one new EUV order in this quarter. +In Q2, EUR 269 million worth of shares were repurchased. This leaves around EUR 2 billion of the 2018/2019 share buyback remaining. Additionally, we paid a dividend of EUR 1.40 per share, valued at EUR 597 million. +With that, I would like to turn to our expectations and guidance for the third quarter of 2018. We expect Q3 total net sales to be similar to Q2 at between EUR 2.7 billion and EUR 2.8 billion. Our total net sales forecast includes around EUR 500 million of EUV system revenue from 5 EUV systems, which we target to ship in the quarter. +For EUV shipment plan, it's still 20 systems for 2018. We expect EUV order flow to continue in the second half of the year in support of our 2019 shipment plan of at least 30 systems. +We expect our Q3 Installed Base Management revenue to step up a bit from previous quarters to around EUR 700 million. The service portion of this business is pretty stable, whereas the upgrade revenue is more dependent on system utilization. In current business environments, when systems are running at high utilization, customers are less willing to take systems down for upgrades. +Gross margin for Q3 is expected to be between 47% and 48%, reflecting growth and profitability across all products. The higher R&D expenses in Q3 of about EUR 395 million are due to an acceleration of the NXE:3400 road map and the High-NA EUV program. SG&A is expected to come in at about EUR 120 million. +We remain excited about the balance of 2018. Customers' demand for our products continues to be strong. We look forward to a year of continued strong growth in both revenue and profitability. +With that, Peter, over to you. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger has highlighted, we had a good first half of the year, and our business continues to perform very well. The positive industry environment and increasing litho intensity continues to drive strong demand in both logic and memory markets as customers migrate to more advanced nodes requiring our full suite of products. +For the second half of the year, we see strength in Deep UV driven by memory and EUV driven by logic. After an excellent first half in 2018, we expect the second half to be stronger, with improved sales and profitability and as well as continued growth from Q3 to Q4. +Logic demand continues to be solid as both existing and new market applications require more high-performance compute power. Customers are preparing the ramp of the 7-nanometer node, which is driving a significant increase in EUV demand. Given the progress made in EUV execution, there's now increased customer confidence in the future logic road map, and furthermore, plans are being put in place to secure the next-generation High-NA EUV. +Progress in high-performance compute requires similar advances in the memory road map execution for both volatile and nonvolatile memory. Memory strength in both DRAM and NAND is driven by increasing content per device as well as expanding end market applications. And in DRAM, to meet the current bit growth demand expectations of between 20% to 25%, we see customers continuing with technology migrations and greater capacity additions. As fewer bits are being supplied via technology node migrations, it drives an increased need for wafer capacity additions. +In NAND, with planned 2D-to-3D NAND conversions nearly finished, customers require new greenfield fab capacity. This, along with protocol scaling via stacks of stacks, drives additional lithography demand. Significant investments in greenfield fabs, although dampened by high NAND growth rates, which are expected to stay in the 40% to 45% range, may create some short-term volatility. In memory overall, we don't see any structural supply imbalance concerns that would significantly change our positive view of this market segment. +On the ASML product side, let me start with an update on our EUV business. In EUV, we continue to make good progress as this technology ramps in volume production. Priority continues to be on productivity or wafers per day, which is a combination of system throughput and availability. On availability, we have made significant improvements that have enabled 4-week availability above 85% on a number of systems with the latest configuration, our NXE:3400. +On throughput, we have customer systems running at 125 wafers per hour, and we have demonstrated performance beyond [140] wafers per hour. Focused execution on our EUV program is enabling an acceleration of our road map in terms of throughput, availability and overlay, creating the opportunity for value creation for both our customers and ASML. +With this in mind, we decided to accelerate some of the R&D spending to pull in these benefits. And we are working to finalize the configuration and specifications of this accelerated road map and will provide an update later this year. And these improvements will provide an even stronger foundation for our EUV business going forward. +In Deep UV, we're now shipping the NXT:2000 system, which delivers increased customer value via improved lithography performance. We're planning an aggressive ramp of these systems in the second half of the year, driven by strong customer demand in both memory and logic. +In Holistic Lithography, we continue to see growth across our full portfolio of software and metrology products, enabled by the continued integration of HMI's e-beam technology and ASML's computational and control products. +To summarize 2018, we expect continued solid growth in sales and profitability versus 2017. And after an excellent first half, we expect revenue in the second half to be stronger with an improved profitability. We furthermore expect the growth to continue from Q3 to Q4, as mentioned earlier. +Regarding 2019, it's a bit too early to provide quantitative guidance, but I will provide some comments regarding our initial view on high-level trends going into the start of next year. +In memory, we see strong Deep UV demand continuing, with an initial EUV opportunity at more advanced nodes. In logic, 7-nanometer node will continue to ramp, driving a further increase in EUV demand on top of a solid demand in Deep UV. +In our Installed Base Management segment, we expect continued growth via service revenue from a growing installed base as well as upgrade business opportunity, although the latter is somewhat dependent on the customers' willingness to sacrifice utilization in the periods during upgrade. +In summary, at present, we currently expect the strong growth that we experienced this year to continue into 2019. We're well on track to achieve our 2020 targets with significant growth potential beyond 2020. And we plan to communicate our growth opportunity through 2025 at our Investor Day on November 8 this year. +With that, we'll be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Operator, we'll have your final instructions and then the first question, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) First question is from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + This is Sandeep Deshpande from JPMorgan. Peter, I have 2 quick questions. I mean, firstly, on your gross margin guidance with the third quarter, I mean, you clearly are guiding to a much stronger gross margin than the market expected. Can you give us the dynamics? I mean, is this EUV related, that EUV gross margins are beginning to ramp up and which is why gross margin is improving so quickly from the second quarter when you had a larger number of EUV shipments? Or is there some other mechanism which is causing the gross margin to improve? And secondly, I mean, the market has been worried about issues in the memory supply CapEx environment, and you have said in your introductory remarks as well that you are not seeing any of this. Can you confirm at this point that you have not seen any DRAM-related pushouts or anything of that sort at this point and that your customers remain confident on their existing road maps in terms of capacity additions that you mentioned on the wafers as well into 2019? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Okay, thank you. Sandeep, I will answer the second question, and Roger will go into the gross margin question on Q3. On the memory markets, as you said, our customers, which is multiple, and we've always seen that in the road map execution, customers from time to time have some pushouts and some pull-ins, and that's what we're seeing. We're seeing one customer pushing out a few tools and other customers pulling in. So as a memory segment, and especially DRAM, and you referred to DRAM, we haven't seen any change. So those were some pushouts and pull-ins, and that's actually quite normal. Roger, you want to take the first one? + +-------------------------------------------------------------------------------- +R.J.M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Sure. On gross margin, Sandeep, it's a combination actually of 3 things. So as you see, there was a full percentage point increase in gross margin. About half of that is a result of the mix within DUV, so the mix in DUV is such that we see a 10% -- a 2% uplift of gross margin as a result of that. The remaining 2% uplift is in EUV, and that is a combination of 2 things. So first off, as you've heard, we plan to recognize 5 system sales in this -- in Q3 rather than 7. So that is an uplift. And secondly, we also are looking at an improvement of the EUV margin overall. So mix in DUV, improvement of EUV margin and 2 less systems in EUV. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Following question is from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + I guess, first question, you talked about accelerating your EUV road map. And curious, I guess short-term/long-term question is part of that. What impact is that having on your ability to close orders for EUV shipments into '19? And I think I guess, medium-term looking into 2020, what does higher throughput mean in terms of your thought process, in terms of what capacity and/or growth in shipments in EUV you'll require? Then I've got a quick follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [7] +-------------------------------------------------------------------------------- + + Okay. Yes, I think the acceleration of the road map is clearly driven by the fact that we see an opportunity to improve the productivity. And I said, that's a function of availability and the wafer-per-hour capability of the tool. And that is the result of the execution results that we've seen over the last 6 months. So having said that, we'd like to pull in that value, which is clear value for the customer because -- and that basically means that customers are, of course, wanting that value sooner than later. But this is an R&D program that we're just starting in Q3. So we will make -- it takes time for that productivity increase to become available in 2019. Until that moment in time, customers have the availability for a machine which is the 3400B that does 125 wafers per hour and provides full value for the price that they are paying. So for the customers, there's a very good alternative to keep going on EUV because there's a very capable tool out there with the expectation and with the promise of an even more valuable tool in the course of 2019. So it is what it is. The tools will be available when they are available. Our customers need to ramp their 7-nanometer logic, and they will do so. But I think in answer to your second question, clearly, if we keep increasing the productivity of the tool, that means that cost per layer will be more and more in favor of EUV. You will see layer adoption going forward beyond 2019, of course, potentially being more in favor of EUV than it was before because higher productivity means a lower cost. Now from a capacity point of view, from our point of view, it means that with the improved performance of that machine, we can provide our customers with more wafers. So we don't need to do that by actually selling more tools that have 125 wafers per hour, but we can sell the same number of tools that we're currently planning with a higher throughput. So that will help our customers, and we don't see, at this moment yet, a need for a very fast increase of our current capacity at ASML. I think what we will see first, give our customers more wafers on EUV at a lower cost per wafer. Long answer, but I hope it will help you, C.J. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [8] +-------------------------------------------------------------------------------- + + Yes, no, very helpful. And then I guess as a quick follow-up, you talked about early indications pointing to another strong year in '19. If I look at your DUV order book, excluding EUV, it looks like that business accelerated 30% Q-on-Q. So I guess how far is your visibility [expected]? And should order momentum within DUV continue into the coming few quarters? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [9] +-------------------------------------------------------------------------------- + + Well, given our longer lead time as compared to some other players in the industry, I mean, the visibility that we're getting from our customers goes into 2019. It's generally 9 to 12 months. We're going to be pretty detailed on what they need and what we can provide because we have a supply chain also. So when we say we see this Deep UV strength, both memory and logic moving into 2019, that is based on the interaction that we have with our customers on this 9- to 12-month horizon. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [11] +-------------------------------------------------------------------------------- + + It's from Cowen and Company. I had 2 questions on gross margin, one on the near term. You guys mentioned revenue should grow from Q3 to Q4. How should we think about gross margin in Q4 relative to Q3? And then in the longer term, looks like your EUV gross margin is in the mid-teens. What level is due to have the [size of] volume to drive it to a 40% gross margin for EUV based on your 2020 model? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [12] +-------------------------------------------------------------------------------- + + Well, we gave you gross margin guidance on the Q3. We gave you that clearly. And that -- so we won't give it on Q4. But we gave you an overall comment in the prepared remarks that we believe that both our sales and profitability will go up. So I'm not going to give you any details on the gross margin. But clearly, we see it -- we see an improvement on both counts, sales and profitability. And the first evidence, we actually gave you for the Q3 gross margin guidance. On the gross margin on EUV of 2020, I think there are 4 ingredients, [let's call it] this way, how to get to the 40% gross margin. And we've always said that is the volume. Well, the volume, we haven't changed really. I mean, volume is -- we set at 20 initially, 30 in 2019, growing to potentially 40 in 2020. You can look that up into our -- into the scenarios that we gave you. That hasn't changed, but the volume is very important for gross margin increase because it gives us a better coverage of our fixed cost. The fixed cost for our total capacity with 40 to 45 [systems] is already there. So that will be a big help, one. Two is mix. Mix, we said -- the gross margin, we said before, was based on our views that we would, in 2020, ship a combination of a 125 wafer-per-hour tool and a potentially higher wafer-per-hour tool. Now we've pulled that in. So if anything, the second pillar of the gross margin increase has now actually been pulled in and has positively changed in the sense that by 2020, we will have only the higher-productivity tool instead of a mix of a lower- and a higher-productivity tool. So that helps. Number three is cost reductions. But the cost reductions is a part of the program, it's a part of the plan, and we are on track. And it means higher volume will drive their cost per module down, and we will benefit. Fourth is service. Now we've mentioned that before, service, currently, we are still in a warranty period. So we cannot collect a real good sales income from a wafer -- sorry, from a sales per wafer system that we're going to apply going forward. But tools that are out of warranty by 2020 will, of course, create a service income that we currently do not have and will give us coverage for our service cost infrastructure. Now there is an upside there. It might well be in 2020, might be a bit too early. But later on, we are selling higher-productivity tools. Higher-productivity tools will give more wafers per hour and will give more wafers per day and will give us a potential upside of our service income beyond 2020. Now so if you look at it and you look at those 4 ingredients, then I think we have a good level of -- a high level of confidence, I would say, to meet our 40% gross margin target by 2020. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Following question is from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [14] +-------------------------------------------------------------------------------- + + It's Andrew Gardiner from Barclays. Peter, I was interested in some of the comments you were making in terms of EUV tool shipments or capacity, and you guys have talked specifically about 2019 and the sort of the 30-unit level in prior quarters. Last couple of quarters, you talked about how that was a challenging target in particular sort of through the supply chain and the lead times you're dealing with in terms of different components, different modules. So perhaps I'm reading between the lines here, but you sounded a little more confident in some of your comments on that 30-tool unit or at least 30-tool unit for next year. Is that the case? And is it indeed a case that you're sort of working through some of those capacity constraints, and so there could be more likely to be upside to the 30-unit mark for next year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [15] +-------------------------------------------------------------------------------- + + Yes. I think currently, we stick to the 30-unit mark. But yes, of course, we're up in the learning curve, and that also is true for our supply chain. So I think from a supply point of view, we are more confident about the 30 units. But I think it's too early to promise anyone, including our customers, anything more than that. Now of course, we will try to get every 1 or 2 units extra out of it, but our plan currently stays at that 30 units. And that 30 units is going to be a mix between what we call our B system and our C system, like I explained earlier, whereby the C system will be introduced in the course of 2019. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [16] +-------------------------------------------------------------------------------- + + Okay. And then just a quick follow-up. In terms of the EUV revenue recognition this year, you previously said EUR 2.1 billion. Is that still the case? Or given you did a little better in the current second quarter and you're expecting a reasonable amount in the third quarter, it's likely to be a bit higher than that now? + +-------------------------------------------------------------------------------- +R.J.M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [17] +-------------------------------------------------------------------------------- + + Andrew, I think we're still aiming for the EUR 2.1 billion in this year. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Following question is from Mr. Edwin Mok. + +-------------------------------------------------------------------------------- +Yeuk-Fai Mok, Needham & Company, LLC, Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- + + So my first question on kind of your outlook for 2019. Just curious, how much of that growth or the strength you expect on industry comes from indigenous Chinese customer versus [kind of more of] the multinational in China? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [20] +-------------------------------------------------------------------------------- + + Yes. I think what we're seeing in China -- yes, you have to make a separation between, let's say, the local Chinese customers and the multinationals having their operations in China. There are some activities on the latter, so the multinationals into China. For instance, there is an investment ongoing in Wuxi, which is from a Korean memory maker. So that will happen next year. There are some others from other -- some multinational customers, especially in the memory space. There is in -- something happening in the logic space. So that's still going pretty strong. But the local Chinese customers will use 2019 to further ramp their first lines. We see shipments through the first lines of local Chinese customers happening this year. And depending on the success of their products and the qualification of their products for the use in the local Chinese customer market, that will drive the level of tools that they need to further ramp their first and their second line. And that is really dependent on the success with which they can execute on the qualification of their products, be it memory or be it logic products, for their local customers. And that's something that we have not full insight in, but that is a potential upside if they do this very well. But I believe the Chinese market will be strong for both local and for international customers. + +-------------------------------------------------------------------------------- +Yeuk-Fai Mok, Needham & Company, LLC, Research Division - Senior Analyst [21] +-------------------------------------------------------------------------------- + + Great, that's very helpful color. And just my quick follow-up. Can you remind us what's the timing of the High-NA tool and maybe give some color on that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + Yes. The first High-NA tool is scheduled late 2021, and we'll ship through 2022 into 2023 the first R&D systems, what we call the early volume systems. And that in total is about 12 systems. So 2021, late 2021 starting through 2022, 2023, about 12 systems. And then 2024 onwards, we will see the high-volume introduction. Is that clear? + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our following question is from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [24] +-------------------------------------------------------------------------------- + + Just coming back on the -- it's David Mulholland from UBS. Just coming back on the road map acceleration comments you made, I know you said you're still finalizing the specification. But if I recall from the road map you've presented before, you'd said the next stage was 155 wafers per hour. Is that essentially what you're pulling in? Or do you think you can do a little bit better than that? And can you help us understand what this means for ASPs? I know you've said it will deliver value to yourself and the customers, but can you help us quantify that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [25] +-------------------------------------------------------------------------------- + + Yes. I think the -- what we presented last week at SEMICON West, we gave you a teaser in the sense that we said, well, there's a road map beyond 155 wafers per hour, but 155 is the first target. Now how much that will be and the details of it, I think we'll be very happy to go away into detail with you and your colleagues on November 8. We'll do an extensive review of the road map and how we see that develop in the couple of years -- the next couple of years. And yes, that will have an impact on the ASPs because we will provide higher throughput, which will drive, of course, the cost per wafer down, which will also lead to a review by our customers of the layers that they want to allocate to EUV versus Deep UV, and that will lead to higher ASPs. What we've normally done, we've always said to the customer, listen, we're going to share that upside value. And the trend that you've seen of increasing ASPs on Deep UV, where ASPs rose generally with the productivity, that is also what you would see in EUV. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [26] +-------------------------------------------------------------------------------- + + And then just a quick follow-up. On the confidence you have on current DRAM adoption, obviously, probably the most sensitive to the productivity of the tool. So given the progress you've been making, can you maybe just comment on your confidence on seeing DRAM adoption in the next year or 2 of EUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [27] +-------------------------------------------------------------------------------- + + Well, I think clearly, higher productivity, better availability leads to significantly lower wafer cost, which is more sensitive in the memory space than in the logic space. So yes, I mean, it is our expectation that when we execute our road map, that the advantages of applying that lower cost per wafer to the DRAM market are also obvious, yes? So one of our drives, of course, is to make sure that we can have the consistency of that productivity also extended into the market for DRAM. And it may not be a surprise that, of course, the key focus of our DRAM customer is on the productivity and on this 3400C road map. So yes, that will have a positive effect. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [29] +-------------------------------------------------------------------------------- + + This is Stephane Houri from ODDO BHF. So I have a question about R&D. We see R&D budgets going up. Do you have a view or could you help us understanding how this budget is going to evolve in the coming years? I understand this is to accelerate the EUV road map, but could you give us some clarity on the numbers? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [30] +-------------------------------------------------------------------------------- + + Yes. I think when you -- I think about R&D and the R&D increase that we're currently seeing as 2 reasons -- 2 key reasons. There's one that's the pull-in of the High-NA EUV tool, which we explained also last quarter. And this quarter, we see the acceleration of the 0.33 NA road map. That, of course, is there to support the ramp-up of the higher-productivity tool. That will, of course, tail off at a certain moment in time. I think it will still extend into 2019. Like I said in the -- as an answer to the previous question, in our -- at our Capital Markets Day in November, we'll give you more details on the productivity road map, and I will not stop at the 155 wafers. So some of that R&D that is needed there will continue in 2019. But going forward, I think the R&D in itself cannot be seen as a separate item. You also have to look at what we see as an upside opportunity in terms of sales. With progress we've made with EUV, the fact that EUV can be used on more layers, I think it is good to realize that our sales numbers beyond 2020 will also grow. And that means that to support that growth -- and we'll give you more details in the fourth quarter, we also will adjust our R&D spend to it. Now clearly, that is going to be well explained and in detail explained. So it's too early to give you a quantitative guidance on the R&D number going forward because it's very much tied to the upside opportunity and the sales opportunity that we are seeing, which we believe is, beyond 2020, significant. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And I have a quick follow-up, if I may. Did you see, in your recent discussions with your customer, any distortion regarding the potential trade war between the U.S. and China? Did it have any impact on your discussion? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [32] +-------------------------------------------------------------------------------- + + I can be short on that note. I mean, we have not had any negative feedback or feedback that has an impact on our business from our customers due to this dispute. That is not the case. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our following question is from Mr. John Pitzer. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [34] +-------------------------------------------------------------------------------- + + It's Crédit Suisse. Peter, I'm wondering if you could elaborate a little bit around your comments around the expected uptick in upgrade revenues in the calendar third quarter that you talked about in your opening commentary. As you pointed out, customers are only really willing to do that when they're willing to take a utilization hit. And it's a little bit surprising given that Q3 is supposed to be the seasonally strong period that customers would make so much upgrade in that quarter. Is that sort of specific to a device type, a certain customer? Or are you at all worried that utilizations for your customers -- or your customers are willing to take a utilization hit in the calendar third quarter? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [35] +-------------------------------------------------------------------------------- + + Well, I think our total Installed Base Management business for the second half, and I think year-on-year, does see an effect of the fact that our customers don't want to put the tool down to do an upgrade. I think that makes sense if you look at the profitability of the customers and the price that they can get for their devices right now. So generally, I don't think there is any issue with the upgrades. The upgrades that are currently not happening will happen later, yes? And it is really -- it is not even seasonal. Whether it's Q3 or Q4 doesn't really matter. And as long as the business and especially the memory business of our customers stays really strong, that means that the upgrades that they planned earlier, they are -- they, in the end, don't want to do because there is a revenue downside that they don't want to take. So this will just move up. We'll just move to 2019. And as long as the memory business stays healthy and stays very strong, they will keep pushing back those upgrades to a point in time where they have to do it. So it's all, you could say, deferred revenue to a point where customers can allow it, and there's nothing more to it that -- but if you can then say, now what does it mean to the installed base? It means, well, to the installed base, it means year-on-year, probably likely to be flatter than we anticipated at the beginning of the year. And that simply is caused by what I just talked about. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [36] +-------------------------------------------------------------------------------- + + That's helpful, Peter. Then as my follow-up, just as you make progress on improving EUV wafer throughput per hour, one of the trade-offs we're hearing is just as you raise power on the tool, the offset is kind of increased consumable cost for the customers, especially with reticle light. Is that a meaningful consideration on the ROI for your customer and rate of adoption? And then is there anything that you can do at the tool level to help on the consumable cost side? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [37] +-------------------------------------------------------------------------------- + + Yes. I think on the -- when you think about the pellicles, for instance -- and we are working constantly on lifetime of the consumables. And I think that is not a major hindrance for our customers to start introducing a higher-productivity tool because the benefits of the higher productivity are so large that they can deal with the initial higher cost of the consumables. But we as an industry are all working on driving the cost of the consumables down. And you have to realize that when you take, for instance, pellicles, it's only very recent that we started to have pellicles that can withstand 250 watt. So it's just a matter of time and matter of learning curve. That's not going to be a major issue. And in the discussions that we have with our customers on the 3400C, on the high-productivity tool, there was no concern at all in this direction. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Next question is from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- + + Mehdi Hosseini, SIG. Peter, I have 2 follow-ups. You talked about the internal capacity to be able to ship at a minimum of 30 EUV system in 2019. Can you help us understand perhaps qualitatively about the breadth of customer or customer diversity? And should we expect any DRAM application to be included in these targets? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [40] +-------------------------------------------------------------------------------- + + Yes. I think the breadth of the customer diversity, clearly, Deep UV, you can look at the order book. I mean, it's been driven by the top 3 customers that we have in -- both in logic and in memory, and they will be the drivers also for our shipments in 2019. And we -- and our plan in DRAM is going to be part of that. So it's the top 3 customers. But then again, as you all see in 2019, customers following both in memory and in the logic space, starting to receive their first EUV production tools. But again, the top 3 customers will drive the bulk of the business, including DRAM. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + Sure. And the reason I asked the question is that it seems to me that there's a bifurcation among your logic/foundry customer, where one particular customer is pulling away, winning all the designs. And I'm just wondering how you think about any potential downside risk if that particular customer continues to win all the designs for 7- and the 5-nanometer. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [42] +-------------------------------------------------------------------------------- + + Well, we look at this as an -- at this from an industry segment point of view. I mean, we wish all our customers the best, and we hope that they compete fairly, and one win and the other won't. But as an industry segment, we are not that concerned because we are concerned about the ultimate demand for the 7-nanometer devices and the 5-nanometer devices, which are driven by the value that is being created by those devices, which will be taken up by the customers of our customers. So the end markets will, in the end, determine what the demand will be for EUV wafers. And where we're going to ship them, we'll just have to wait and see who wins the business. So what we ship is determined by the end markets and the customers of our customers, not per se by our customers from a segment point of view -- from an industry segment point of view. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [43] +-------------------------------------------------------------------------------- + + And just to be clear, your capacity to ship 30 plus, that doesn't include any upgrades, correct? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [44] +-------------------------------------------------------------------------------- + + That's correct, yes. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Following question is from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [46] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citigroup. My first question relates to maybe an update from your side with respect to the e-beam business. If you could kindly share with us, what is the progress in terms of the road map of the new product as well as potentially customer traction? And how should we think about that shaping up going towards the 2020 targets? And I have an unrelated follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [47] +-------------------------------------------------------------------------------- + + Yes. I think the e-beam business, we showed you last quarters some -- [same] pictures of a 3x3 multi-beam prototype, which are basically we're building that today, and we will ship that commercially to our customers in 2019. But that will not end, there will be a next version, which has more beams in 2020. So currently, it's execution of the R&D in our program, making sure we can ship the first 3x3 e-beam tool in 2019. And more will follow in '20. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [48] +-------------------------------------------------------------------------------- + + Okay. And as an unrelated follow-up, when we think about your Installed Base Management revenues, and as you said, EUV tools gradually move out of their warranty period, can you maybe help us understand if there's a step-up in the opportunity you get in the Installed Base Management side with respect to EUV? Would the associated services revenues be dramatically different or higher than what you are generating today for DUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [49] +-------------------------------------------------------------------------------- + + Yes. I think the service revenue per tool with EUV is significantly higher, but also, the costs are significantly higher. You could argue that in EUV and this source, we have some consumables, or I would say wearables, with this EUV collected over time and some other parts of that tool. So that needs to be replaced from time to time, and I think the service charge is now based on a charge per wafer. So yes, you will see a step-up once you see a significant number of our EUV systems coming out of warranty. And when they are more productive, they will produce more wafers, which gives us an upside in the service revenue. But also clearly, when you have more wafers, then you also have an impact of your cost of the wearable. So -- but overall, the increase in the EUV shipments coming out of warranty after 2020 will definitely give an impetus to our service top line, whereby, as we said on earlier calls, EUR 5 million to EUR 6 million of service revenue per EUV system is currently what we are planning or what we have in our long-term financial models. Now clearly, when we have higher productivity and we can sustain that, then there is some upside to that number. But this is what we are working with beyond 2020. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Next question is from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [51] +-------------------------------------------------------------------------------- + + It's Deutsche Bank. First question, which is beyond the 3400C, it looks like you're making good progress there on availability, but that won't ship until the mid of next year. So how do you ensure customers don't defer taking delivery of the older generation B tool in situations where they don't have to ramp before 2020? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [52] +-------------------------------------------------------------------------------- + + Yes. I think the customers' ramp plans are based on a certain capacity that they need for EUV wafers. Now the 3400C in 2019 is not going to fulfill that capacity on its own. You need the 3400B, yes? But that is a fully equipped, high-volume productivity tool, which, of course, is a lower price. So you get fewer wafers, but you pay a lower price. So it is, in that sense, relatively simple that the EUV wafers that are needed in 2019, they need to be made and can only be made in a mixed combination of 3400Bs and 3400Cs. And that's pretty clear to our customers and pretty clear to us. And that's why we say the 30 units that we have in our capacity plan, that's very valid. But I cannot give you any detail yet on the mix or the combination of a B and a C. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [53] +-------------------------------------------------------------------------------- + + Okay, great. And just one point of clarification. I just wanted to check that you said that both Q4 sales and Q4 profit would be higher than the third quarter. I just wanted to check what you just said, you indicated a rough kind of direction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [54] +-------------------------------------------------------------------------------- + + Yes. Well, the rough direction is as follows: Q3 to Q4 sales will be up, and H2 sales and profitability will be up as compared to H1. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Next question is from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [56] +-------------------------------------------------------------------------------- + + It's Bank of America. So just looking at the gross margins on your EUV revenues in the second quarter -- on your -- in your third quarter rather, based on your guidance, it looks like you will be doing something like 38% gross margin on your EUV revenues in the third quarter. And this uplift is not coming from any deferred revenue recognition. So in light of this, can you provide some color on how much higher your EUV gross margins in 2020 can be, higher than the 40% you've guided for, especially given the ASP and productivity of new EUV tools would be higher than what you've been planning previously. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + Yes. I think, well, what I would suggest that you do, because the 38% gross margin is not something that I can easily relate to, so why don't you, after this call, get in touch with our IR folks, and they will probably -- can help you understand where you're -- or that they can understand where you're coming from in your calculation of the 38%. Because if it would be 38% in Q3, then the 40% in 2020 would be really sandbagging. So that's probably not what you are suggesting. So somewhere -- and we need -- probably need to help you understand this or we need to understand what your thinking is. I don't think this call is suitable for that. So I would ask you to call our guys. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [58] +-------------------------------------------------------------------------------- + + Okay. And just as a quick follow-up then, where are your EUV gross margins in the third quarter? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [59] +-------------------------------------------------------------------------------- + + We don't guide specifically on EUV gross margins, but we can say we've given you some guidance in the past of the, I would say, gross margin improvement to the 40% being almost on a linear scale from where we were in 2017. I think that is year-on-year, that is approximately correct, and we are on that trajectory. So we're not guiding on the quarterly. We're guiding year-on-year in more general terms. And there's some upside there that I would agree to. If people say, fine, if you start selling higher-productivity tools in 2020 with some higher productivity and some higher value, that might be a support of your 40% margin target for 2020, which I explained in one of the first questions. So no quarterly guidance. The linear improvement from 2017 to 2020, that's what you have to deal with. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Our next question is from Ms. Tammy Qiu. + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [61] +-------------------------------------------------------------------------------- + + So I only have one question. So you talk about your accelerating your EUV R&D process. Does that actually change your estimation of the layer count we can see in the logic and foundry initial adoption? Because I remember you actually said 10 to 15 layers insertion in the first phase. Does that actually increase the potential layers EUV can address because you are actually doing better than previously expected? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [62] +-------------------------------------------------------------------------------- + + Well, I think, I mean, initially not. I mean, customers have done their designs. They've done the qualification work. I mean, that's what it is. But I think clearly, 2020 and beyond, having a better cost per wafer through higher productivity clearly creates an opportunity for customers to start thinking of adding more layers. But initially, I would say they stick to where they are today because it would probably be too much of a hassle to do that, they are going to start 7-nanometer. Like I said, it's 2019. They're going to use the 3400B for it. And over time, you'll see an increased productivity will likely have an impact on the number of EUV layers. + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [63] +-------------------------------------------------------------------------------- + + Okay. So Peter, you actually mean the adoption layer increase can actually accelerate based on your accelerated road map of EUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [64] +-------------------------------------------------------------------------------- + + Oh, I think so because it's a matter of cost, but now it's a matter of when. I don't think it happens in 2019. It'll happen probably 2020 and beyond. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Next question is from Mr. Douglas Smith. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [66] +-------------------------------------------------------------------------------- + + It's Doug Smith from Agency Partners. I have a longer-term question about High-NA. I think in the last call, you said that the R&D units that are going to be shipped were priced at around EUR 270 million. I recalled some time ago the R&D units for low-NA EUV were about 60, and now we see it's obviously much higher than that. Is the expectation that high volume-manufacturing High-NA is going to be EUR 350 million per unit? That's my first question. And second, the production capacity for High-NA you're putting in at ZEISS and Eindhoven, is it targeting around the 20-unit level for mid-2020s? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [67] +-------------------------------------------------------------------------------- + + Yes. I think we're -- on your last question, we're going to give you a bit more detail on the supply capacity around 2025 at the Capital Markets Day. But on the -- on your question on the R&D tools, you have to realize that when we started EUV, it was completely new technology. So the first EUV low-NA R&D tool was really a research tool. But when we think about High-NA EUV, it's the second-generation EUV, whereby for instance, we use the same source, we have a mature EUV source by that time, which maybe we've had 60 million. That was a very immature EUV source that was not able to produce many wafers. Now the High-NA tool will actually benefit, and that means that the R&D tool will be extremely close to the high-volume configuration, yes? So it actually means that R&D is almost the same as the High-NA tool -- sorry, as the volume tool, which is the same as the current Deep UV tool. If we sell a NXT:2000, which will be used in R&D first, that tool will also have the same configuration and the same price as the tool that is used in high volume. That will be also the same for High-NA. So the comparison that you've made between low-NA and High-NA is really a comparison between immaturity and maturity, and that's why it doesn't add up. But I would say EUR 270 million for a high-volume tool is still a pretty good price. + +-------------------------------------------------------------------------------- +Douglas P.E. Smith, Agency Partners LLP - Research Analyst [68] +-------------------------------------------------------------------------------- + + Sure, that's a very good price. And just a quick follow-up. I think it was mentioned also previously, the wafer throughput for High-NA would be greater than current low-NA. But do you think it might actually be able to exceed 200 wafers per hour eventually? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [69] +-------------------------------------------------------------------------------- + + Well, I think this is something that we're very happy to answer at our Analyst Day because that's where we'll go into those details. I mean, like I said earlier, we have now a road map that we're working on for our low-NA tool, which starts at next -- starts at 125, the next data point is 155, and it goes beyond 155, and we'll tell you then how much. But it also will show the road map of High-NA, and whether that goes over 200 wafers per hour, we'd like to save that for that date. And otherwise, it doesn't make sense to have a Capital Markets Day because everything is known by that time. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [70] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. If you're unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations Department with your question. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + The last question is from Mr. Mitch Stevens. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [72] +-------------------------------------------------------------------------------- + + It's Mitch Steves from RBC Capital Markets. Yes, I just had a quick one to follow up on the EUV comments about pulling in kind of the spending there. So does that mean that you're going to essentially have a lower spending going forward? I just want to understand the implications from an operating margin front, assuming the gross margins will continue to [drive the] plan. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [73] +-------------------------------------------------------------------------------- + + Yes. I think the EUV spend in terms of the acceleration R&D programs that will bring the productivity of the tool to 155 wafers per hour to pull that in but also to accelerate that productivity beyond 155 wafers per hour, that R&D program will start around now. That will also be still a program running in 2019. That's what I've said, that ultimately, when you get to the highest level of productivity on the 3400s, that's the 0.33 NA tool, that will reach a certain maximum. Then before that time, the R&D will tail off for that particular part of the EUV program. On the other hand, we will then see that High-NA comes up. Now what the impact will be on the total R&D has to be seen in the context of total sales of the company at that time. And I believe that the progress of EUV will provide us with ample opportunity to drive the top line because EUV will be more and more cost-effective going forward. And that top line will enable us to spend the R&D that we need. And we will be more detailed, like I said, in the November time frame when we put this into the context of the total long-term financial planning of the company. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [74] +-------------------------------------------------------------------------------- + + All right. Before we sign off, yesterday, you should have received an invitation to our Investor Day, which will be here at our headquarters in Veldhoven on the afternoon of November 8. Please let Investor Relations know if you did not receive an invitation, and we hope you'll be able to join us in November. +Now on behalf of the ASML's board and management, I'd like to thank you all for joining us today. Operator, if you could formally conclude the call, I would appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2018 Second Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect your line. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2018-Oct-17-ASML.txt b/Transcripts/ASML/2018-Oct-17-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..4ec3620d7b2e9501a952d43ea3b739b0cb68ad12 --- /dev/null +++ b/Transcripts/ASML/2018-Oct-17-ASML.txt @@ -0,0 +1,657 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 ASML Holding NV Earnings Call +OCTOBER 17, 2018 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * R. J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Alexander Duval + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Tammy Qiu + Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Sreekrishnan Sankarnarayanan + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2018 Third Quarter Financial Results Conference Call on October 17, 2018. (Operator Instructions) I would now like to open the question-and-answer queue. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Go ahead please, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon. Good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. +Joining me today from ASML headquarters in Veldhoven in the Netherlands is ASML CEO, Peter Wennink; and our CFO, Roger Dassen. +The subject of today's call is ASML's 2018 third quarter results. The length of this call will be 60 minutes, and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities law. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning and good afternoon, ladies and gentlemen. And thank you for joining us for our Q3 2018 results conference call. +Before we begin the question-and-answer session, Roger and I would like to provide an overview and some commentary on the third quarter as well as provide our view of the coming quarters. Roger will start with a review of the third quarter financial performance and -- with some added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and our future business outlook. +And Roger, if you will? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. +I will first highlight some of the third quarter accomplishments and then provide our expectations for the fourth quarter of 2018. Q3 net sales came in at EUR 2.78 billion, which was towards the higher end of our expectation. Net system sales of EUR 2.08 billion was a bit more weighted towards memory at 58%, with the remaining 42% from logic. EUV revenue of EUR 513 million was from 5 shipments. Installed Base Management sales for the quarter came in at EUR 695 million. Gross margin for the quarter was 48.1%, just above our expectation, reflecting the strength of our Deep UV and Applications business as well as the progress in EUV profitability. Overall, R&D and SG&A expenses basically came in as expected, with R&D expenses at EUR 397 million and SG&A expenses at EUR 122 million. +Turning to the balance sheet. EUR 362 million worth of shares were repurchased in Q3. This leaves around EUR 1.7 billion on the 2018/19 share buyback program remaining. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 2.95 billion. +Moving to the order book. Q3 system bookings came in at EUR 2.20 billion. Memory order intake continued to be strong, 64% of total value. Logic made up the remaining 36% of the bookings. We took 5 new EUV orders in the quarter, which contained a mix of both logic and memory. +With that, I would like to turn to our expectations for the fourth quarter of 2018. We expect Q4 total net sales of about EUR 3 billion, leading us to expect another record year with close to EUR 11 billion of revenue. Our total net sales forecast for the quarter includes around EUR 500 million of EUV system revenue from 5 EUV systems. We currently expect to ship 6 systems in Q4, including 1 EUV system to a collaborative research center, imec, which will not be recorded in revenue but will be used to settle R&D services from imec. Q4 will be our highest EUV shipment quarter to date, bringing the total to 18 systems in 2018. +Due to a combination of end-of-year production challenges and customer readiness, we now expect a couple of the originally planned 2018 ship -- systems to ship in early 2019. We expect the EUV order flow to continue next quarter in which -- that we will basically have our 30 systems planned for 2019 covered by purchase orders by the end of this year. +We expect our Q4 Installed Base Management revenue to be similar to last quarter at around EUR 700 million. Gross margin for Q4 is expected to be around 48%. Taking Q4 guidance into account, gross margin for the full year would be around 47%, which is a step-up from last year's 45% gross margin. This reflects the strength of our Deep UV and Applications business as well as continued progress in EUV profitability. The higher R&D expenses for Q4 of about EUR 420 million are due to an acceleration of the NXE:3400C road map and the High-NA EUV program. SG&A is expected to come in at about EUR 135 million. We remain excited about 2018 as the customers' demand for our products continues to be strong. We look forward to delivering another record year with continued strong growth in both sales and profitability. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. +As Roger highlighted, we had another good quarter, and we expect the fourth quarter to be even stronger. With the current guidance, we expect that our sales for the year will be close to EUR 11 billion and that our profitability will improve over last year. Now we continue to see strong demand for our products in both logic and memory as witnessed by our strong order book. Logic customers continue to ramp the 10-nanometer node and are also starting to ramp 7-nanometer. As customers prepare the ramp of the 7-nanometer node, it's -- it not only drives EUV demand but also drives significant demand of increase for EUV. +In DRAM, customers are continuing with technology migrations as well as adding wafer capacity additions to meet bit demand growth, evidenced by our strong third quarter order intake for memory. Now we believe that the limited number of wafer capacity additions by a limited number of customers combined with a healthy demand for DRAM bits should not lead to a structural overcapacity in this industry segment. +In NAND, significant 2D to 3D conversions have taken place next to investments in several greenfield fabs. This is likely creating a period of some digestion as we mentioned in prior quarters. With regards to China, we continue to see strong demand for a broad suite of our products. The China region has delivered around 20% of our sales this year, is on track to set another record revenue number. This is driven by both multinational customers as well as domestic China customers. And all 5 domestic customers that we discussed in prior quarters, at least -- so far with capacity in place now and are looking to begin the ramping next year. We believe this region presents a significant growth opportunity under the assumption that these ramps of the domestic customers are successful and that more domestic customers will follow through with their investment plans. +On the ASML product side, let me start with an update on our EUV business. +In EUV, we continue to make good progress. We have multiple NXE:3400C systems at customer sites that are running at 125 wafers per hour or higher and are ready for high-volume manufacturing. Availability is progressing in support of customer volume ramp with a clear focus on machine consistency. The overall progress has led to the decision to accelerate our EUV road map. And we are, as a result of this, now planning the introduction of our next-generation 0.33 NA EUV system called the NXE:3400C in the second half of 2019. This system will deliver productivity of over 155 wafers per hour. But we will talk more about the performance specifications and the road map during our Investor Day next month. +As Roger mentioned, we continue to increase our shipments per quarter and plan to ship 6 systems in Q4, bringing the total to 18 systems in 2018. As we mentioned in earlier calls, this year our production output is heavily back-end loaded, which has led to some production output challenges, combined with customer fab readiness logistics. We now plan to ship a couple of systems originally planned in 2018 now in early 2019. Our shipment plan for 2019 remains at 30 systems as we now have an increased mix of the NXE:3400C systems in the second half of 2019, which will enable a significantly higher wafer output capability in the earlier specified 125 wafers per hour. With this higher productivity, we expect that we'll be able to meet our customers' current EUV capacity plans in 2019. And as Roger mentioned, we expect order flow to continue next quarter, expect to have our 2019 demand for EUV will be covered by orders by the end of the year. +In Deep UV, on the introduction of the NXT:2000 system into the market is making significant progress and will be used in volume manufacturing for both memory and logic. We're also seeing significant demand for our dry products in support of a number of greenfield fab ramps in China and other regions. +In our application business, we continue to see growth across our full portfolio of software and metrology products, notably related to the adoption of our +YieldStar 375 system expanding from logic and DRAM now also into 3D NAND manufacturing. +To summarize 2018, we expect the growth to continue from Q3 to Q4 to set us up for another record year in both sales and profitability. +Now regarding 2019, it's a bit too early to provide detailed guidance, but I will provide some qualitative comments regarding our initial views. We continue to see strong demand for our products in both memory and logic in support of our bookings, and DEEP UV demand continues to be healthy in memory, as discussed earlier. And we expect DEEP UV demand in logic to further strengthen in 2019, driven by the 10- and 7-nanometer ramps. +Furthermore, we expect continued growth for our applications business with the expansion of both metrology as well as software products. EUV demand continues to be driven by logic, but also with the clear opportunity in DRAM that we meet our availability and productivity targets. +EUV revenue growth is expected from both the significant increase in new shipments as well as a higher ASP of the NXE:3400C, which shipments are planned starting, as we said earlier, the second half of 2019. +Furthermore, we expect customers to take advantage of system performance upgrades of their installed base to maximize capital efficiency. Our current view of the overall business next year remains positive. We expect the first half to be somewhat similar to the second half of this year, with business strengthening in the second half 2019. Our installed base will continue to grow, driving increased service revenue. Furthermore, we expect customers to take advantage of system performance upgrades of our installed base to maximize capital efficiency. +Now putting this all together, we expect another year with good growth opportunity. I think we're well on track to achieve our 2020 targets. We have a significant growth potential beyond 2020, and we plan to communicate the size and the extent of this growth opportunity through 2025 in our Investor Day, which we will hold on November 8 this year. +And with that, we will be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now operator, can we have your final instructions and then the first question, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Sreekrish Sankar. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [2] +-------------------------------------------------------------------------------- + + Hello. can you hear me? + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [3] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [4] +-------------------------------------------------------------------------------- + + Loud and clear. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + Two of them. First one, Peter, looks like your demand from your memory customers has been very strong so far. And you also -- both in terms of bookings and sales and you're also guiding to have strength into 2019. Just want to know, can you tell what's been going on in the memory industry with NAND, pricing, business and potential CapEx, plus in NAND and DRAM? And how do you confirm that your numbers, and where do you see the strength in 2019? Is it going to be DRAM or NAND in the first half? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [6] +-------------------------------------------------------------------------------- + + Okay. Well, I think you're all throwing memory into one big heap. But it is, of course, you need to separate, as you indicated, between NAND and DRAM. So let me talk about those separately. On DRAM, we haven't see CapEx [crest]. We have seen, in this year, some pushouts but also pull-ins for different customers. So it's -- you could argue it's customer-specific, but we haven't really seen a change in the DRAM memory demand for our products this year. And we don't see it also in 2019. Now we all seem to forget recent history, so let me talk about DRAM, yes, to put it all into perspective. Up to -- including 2016, there has been a significant conversion of DRAM into 3D NAND, which resulted in reduced DRAM capacity, which actually also led to a reduced DRAM memory spend of about 30% in litho and also a 10% to 50% reduction in the wafer capacity at our own customers. Now in 2017 and '18, customers have been working to recover this wafer capacity and to increase the bit supplies. The bit demand also was higher than anticipated. So this required and needed a much higher litho spend per unit in growth. And it's due to a combination of increasing litho intensity at these new nodes due to, say, increasing number of critical layers, which includes double patterning now and the smaller of the shrink road map, which actually means you don't get the bits -- the same number of bits through shrink, that you get less, both leading to higher wafer capacity additions to -- +made this 20% to 25% demand in bit growth. So this is what we have seen. So in that context, the high investments in DRAM from our customers is not a surprise and is also what we are seeing in 2019. Now on 3D NAND, over the last several years, all the 2D to 3D conversions have taken place. That actually happened. And those were very significant. Now we have not participated in a lesser litho supply because we basically use the same litho and next to that were investments in greenfield fabs. And if you add those 2 together, is the 3D conversions and then the greenfield fabs. And that has indeed lapsed to a level of capacity. And don't forget, these are big fabs, so they're step-ups in capacity. With that created weakness of the 3D NAND pricing, which we've all witnessed. That is the digestion that we go through as we speak. And what you call -- and especially if you look at the number of greenfield fabs that have been opened and the capacity, the wafer capacity that's been added to the industry, it's quite normal. Don't forget that the growth range of 3D NAND are particularly good at 40% plus. So I think this is how we look at the market. And this is why I also think that it's not a big surprise that our customers are still significantly spending on increased -- in wafer capacity both for DRAM. And to a lesser extent, today, 3D NAND. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + Got it. Got it. Peter, that's very helpful. And then just as a follow-up. If I look at your commentary on calendar first half '19 from the second half of this year and strengthening the second half of next year, the fact that DUV should be strong in memory and further in logic. Is it fair to assume that DUV units next year should be higher than this year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [8] +-------------------------------------------------------------------------------- + + Well, I think the DUV units will be at least at the same level as this year, whereby I think the mix, which was this year, will be skewed towards memory, will probably skew a bit more towards [budget], although it's too early to say which part of the industry sector is going to be the largest. But in Deep UV, I think we'll see at least the same number of Deep UV shipments and sales in 2019 as in 2018. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + The next question comes from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [10] +-------------------------------------------------------------------------------- + + It's David from UBS. Just combing through the comments you made on EUV and good to see the progress on the 3400C. I just wanted to clarify a couple of things. Firstly, of the bookings that you've seen in the quarter for EUV, are those still the 3400B? Or are you now booking the 3400C? And then as we look into 2020, I want a few comments just on what impact and the way that this is potentially slightly dampening the number of tools needed in H2 '19, what they might mean on 2020. Obviously, we have assumed that some of that's made back on pricing. But where do you end up in kind of revenue expectations for 2020 from EUV as you kind of net those 2 higher productive systems for potentially higher value? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [11] +-------------------------------------------------------------------------------- + + Okay. Good. Well, I think everything we are booking is 3400C. I mean, we're not taking any orders for Bs because the only thing we will sell as of the middle of next year is Cs. And yes, there will be a higher potential productivity coming out of these systems, which of course will have an impact on the number of systems that customers potentially want if they look at their wafer capacity that they are planning for. Now having said that, there's also a flip side for higher productivity and higher rev time, which is cost. Cost is actually going down in these higher productivity tools. It actually means that it opens -- that's also a possibility to add one, in logic more or less; and two, in memory DRAM to start using EUV in DRAM. Generally, you could say if you have more than 2,000 wafers per day productivity on a DRAM system, it becomes attractive at -- to basically +start using EUV for several layers in DRAM. And that will drive the 2020 number. So -- and what's important for us is that we execute that's why we pulled the R&D in because we want the 3400C ASAP because it will, one, as you indicated, provide us with a higher value; and two, it will also provide a higher value, i.e., lower cost to our customers, which will drive the demand for EUV, which means that we still stick to our production capacity of 40 units in 2020. And I think the final 2020 number will be a function of our successful introduction of the productivity and the availability metrics that we have currently in our targets. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [12] +-------------------------------------------------------------------------------- + + Maybe one just quick follow-up. You haven't commented as directly in numbers in terms of the progress and availability for EUV. Obviously, it seems like you're saying it's at the level you need for insertion with customers. But in the last quarter, you were saying you had to get to over 90%. Can you quantify where you are? And where you're heading? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [13] +-------------------------------------------------------------------------------- + + Yes. Yes. I think we're -- as we said, we want to have a target of 88% availability by the end of the year. This is where we're heading to. I think with the 3400C, we will go over 90%. I think -- and we have a target of 92%. I think what I said earlier, we need that 90% threshold. That's what we said in earlier calls. It is our opinion today that with the current availability targets, customers will use EUV in HEM. And it's very simple -- in logic, it's very simple because without EUV -- and I just refer to comments that was made by some of our customers, without EUV, it simply won't work. And that it's so much of a 7-nanometer demand or -- if you want or 7-plus and/or a 5-nanometer demand that you cannot escape using EUV. They will use EUV at 88%. We'd love it to be higher. And it will be higher, but that is not a make-or-break number. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [15] +-------------------------------------------------------------------------------- + + I guess the question, if I could go back to your 2019 outlook for DUV. It sounds like you're now saying kind of first half similar to second half and already growth into the second half of '19. And just curious, is that a changed statement from your views 3, 6 months ago? And if so, what has changed, I guess, vis-à-vis DRAM contribution, advanced logic in China? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [16] +-------------------------------------------------------------------------------- + + Well, I think it has not changed. I think it's going to -- one, we haven't qualitatively guided any trend for 2019 until today. So I think this is the first time. But for that, internally, of course, we have this outlook. I don't think it has changed that much. Absolutely not. And in China, nothing changed in the sense that what Chinese customers were planning, let's say, this time a year ago on 2019, they're actually executing on. So you could argue that their execution of their first lines and their pilot lines have actually gone well. So I think it's -- there's no change. I think it was -- no significant change, nor in memory nor in logic. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [17] +-------------------------------------------------------------------------------- + + Very helpful. And I guess as my follow-up, can you talk to how you're expecting linearity of shipments for the 30 EUV tools in 2019? And how we should think about the progression of gross margins in that same time frame? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [18] +-------------------------------------------------------------------------------- + + Yes. The linearity is what you would expect with a ramp. I mean, this year, we -- and if you look at the quarter, we do 3, 4, 5, 6. And I think this is the kind of linearity that you would also expect next year whereby the 3400C, of course, is the model that customers would really like. So you would clearly see also the second half will be the -- demands for that product going up. Now on the -- Roger, on -- your turn. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [19] +-------------------------------------------------------------------------------- + + On gross margin, I think we have articulated a target of 40% there for 2020. I think we're on track to get there and I think, as we've mentioned before, 4 levers to get there. The first lever, obviously, is ASP, higher ASP, which is to a very large extent, correlated with the productivity and the throughput of the machine. So that's a major driver of the gross margin. Second, volume. Fixed cost coverage obviously increases to the extent that volume of the ramps. Third, learning curve. And we're already experiencing that, and we continue to experience that into the next couple of years. And fourth, service. Service revenue and service margin will go up as well. And the combination of those 4 levers, we believe, gets us to the 40% target that we've articulated before for 2020. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Mitch Steves. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [21] +-------------------------------------------------------------------------------- + + Mitch Steves from RBC. I just had a quick question on EUV. So basically, because you guys are off by about 2 units here in 2020 -- I'm sorry, 2018, you guys are still reguiding to 30. Is the 40 units still the right number for 2020? And then second, I guess why doesn't the '19 number go up by 2 units? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + Yes. I'm going to answer your last question. We're introducing, by the middle of the year, the 3400C, which has a productivity, which is over 155 wafers per hour, which is a significant improvement in terms of productivity, which means that customers are not planning systems. They are planning wafers. So when you get more wafers out of a machine, then you might potentially use less machines. So that's why the 30 unit is still good when we -- and it's not more than that. You could argue that the 2 units are then cannibalized by the higher productivity of the 3400C. Okay. I mean, that's good because the 3400C is also a higher-value tool, we'll just price it higher. So from a sales point of view, I think it's a good progression. Of the 40 units -- I said it earlier in the previous answer, I think the 40 units is the capacity that we have. I think that is -- whether we will sell it all is really a function of the success with which we're going to introduce the 3400C, and we're able to start running up the availability of the machine over to 90%. That will drive down costs for our customers significantly. And cost is the main driver for our customers to buy tools, yes? And I think the opportunity here is in the memory space, in the DRAM space. And also somewhat in the logic space because there you can add a few more layers to EUV because the cost is just better. And in DRAM, like I said, if we order 2,000 wafers per day, we come in the real where customers are really seeing the economic benefits of EUV application in DRAM. So for this capacity, let's go after it by executing on our 3400C program. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [24] +-------------------------------------------------------------------------------- + + It's Andrew from Barclays. I just got a few more quick ones on the EUV program. Firstly, Peter, you just mentioned it briefly there again, the question of layer count within logic. If I go back to this time last year, we were talking about 10 layers at the 7-nanometer node. To your point, the improved productivity and specs on the 3400C suggest it's going to be higher than that. Can you give us any initial indication from your customers as to how much higher the layer count may be relative to that initial number of 10? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [25] +-------------------------------------------------------------------------------- + + Yes. I think it's really different numbers. But again, like I said earlier, I assume a successful execution of our 3400C specification targets. And you could look at anywhere between 12 and 14. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [26] +-------------------------------------------------------------------------------- + + Okay. And then just as quick follow-ups on EUV. Can you give us some idea of mix between logic and memory in the 30-tool shipments next year? Clearly, again, if I go back a couple of quarters, logic was going to dominate but just sounding a bit more optimistic about DRAM demand. And also last one for Roger. Is there going to be any EUV deferred revenue left to recognize in 2019? Or is the rev rec next year purely on the 30-tool shipments? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [27] +-------------------------------------------------------------------------------- + + Yes. On -- I think the mix is predominantly logic. But like I said, there is an opportunity there. And of course, throughout 2019, when we see the first module results, the test results of the critical modules of the 3400C, we can probably engage with our customers at that time, the memory customers, who will see whether they would like an increased number of memory tools. That is an opportunity, I would say, but it's predominantly logic. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [28] +-------------------------------------------------------------------------------- + + In terms of revenue recognition, as you know, at this stage, the systems revenue gets recognized upon shipment. And that will obviously continue for this model into 2019. The interaction of 3400C at this stage, again, we believe that we will recognize the revenue at shipment at this stage. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Alex Duval. + +-------------------------------------------------------------------------------- +Alexander Duval, Goldman Sachs Group Inc., Research Division - Equity Analyst [30] +-------------------------------------------------------------------------------- + + Alex Duval from Goldman Sachs. Just a quick one on logic spending in 2019. You obviously talked about most memory and logic spending remaining on high levels in 2019. But you talked about DUV logic actually being up even though revenues were already on a high level. So I wondered if you could just talk about what the key swing factors are that are driving that? And as a brief follow-up, you talked about the 2H weighted year for your overall group revenues in 2019. And you just talked about a flattish half-on-half growth rate in the first half. So how should we be thinking about the step-up into the second half? What is the key reason for that step-up? And are we talking low single-digits growth half-on-half or something of great magnitude? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [31] +-------------------------------------------------------------------------------- + + Okay. The logic spending in 2019 is up. But don't forget that means the majority of the spend this year was in memory. And logic will be ramping 10-nanometer in macro processes and 7-nanometer in the foundry space. And that's happening because the -- when we listened to the customers, the tape outs are there, customer orders are there. Now that will happen, and that will increase. Now like I said earlier, that's why I think that the Deep UV business for 2019 will be at least as good as in 2018. But by -- a little bit more skewed towards logic. And it's driven by 7- and 10-nanometer. Now on the half-on-half, I said in earlier answer that our view as to 2019 and the, let's say, the shipment levels in the first half, second half haven't changed that much from where we were 1 or 2 quarters ago. But effectively means that our customer plans, which is a result also of when their fabs are ready, when can they take the tools, yes, that hasn't changed that much. So I would say that half-on-half is more a function of when the customers need the tools. So when do they ramp what? Then that's the main reason. So there's nothing magical behind it. There's no reason why there would be this particular cyclicality, if you want to call it this way. Yes? No, I think it's just the way how customers plan. And this means that the first half of 2019 will be somewhat the same as the second half of 2018, which was a pretty good half. So -- and any accelerations, you will see in the second half also at the EUV numbers will go up, yes. And the 3400C will be there, but also the second half skewed. So that's probably the only answer I can give. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [33] +-------------------------------------------------------------------------------- + + This is Stephane Houri from ODDO BHF. Actually, I have a question about the OpEx side because we saw a -- really, an increase in R&D. And as you said, it's DRAM tool and your EUV tool. But the pace is accelerating throughout the year. We are now up 26% year-on-year on R&D. Where do we go? And how do we model it for 2019? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [34] +-------------------------------------------------------------------------------- + + I think we've said before also on the Q2 call, I think we've mentioned that we believe in the short term, there will be an uptick in R&D. And that uptick is to a very large extent or is uniquely related to 2 things. It's the acceleration of the 0.33 EUV road map, as we mentioned before, the 3400C; and also the High-NA program acceleration. So that's why we said midterm, we expect that -- so we've said short term that will lead to an uptick of the numbers. We also said that medium term, we expect that to go back to the model that you've seen before and that we've given to you for 2020, which is 13%. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [35] +-------------------------------------------------------------------------------- + + Sales. Yes. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [36] +-------------------------------------------------------------------------------- + + Sales. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [37] +-------------------------------------------------------------------------------- + + All right. And the follow-up is about metrology and inspection. You had a very good quarter this quarter. Is it a trend that we should push forward? Or is there -- was there anything special this quarter? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [38] +-------------------------------------------------------------------------------- + + No. I think it's just a trend that metrology and inspection will become more important that there's a couple of drivers there. I think the introduction of YieldStar 375 is a metrology system that is now not only being used in logic and in DRAM but now also is introduced into 3D NAND with very clear involvement just for our customers. On top of that, we see good growth, very clear growth in HMI in the e-beam business. We're planning to ship the first 3x3 multi-beam tool in 2019. That will also help the top line. And there's a whole suite of software products that we're helping our customers deal with the complexities and intricacies of 7-nanometer and the 5-nanometer development nodes. So there's a whole suite of products that are actually helping our customers to basically deal with the increased cost of the NXT nodes. And that's particularly helpful when you look at our metrology and inspection business. So it's a trend. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Next question comes from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [40] +-------------------------------------------------------------------------------- + + Mehdi Hosseini from SIG. Peter, I just want to go back to your comment about 2019, first half of '19 versus second half. And I appreciate the details and still the same view as a couple of quarters ago. I'm just wondering, does that reflect the finalized CapEx plans by your key customers? Or if there's a change to those CapEx plans related this year or early next year that could either -- something that could have an impact on your view that has not yet materialized? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [41] +-------------------------------------------------------------------------------- + + Mehdi, what you're asking me is look at my crystal ball what the customer CapEx plans are going to be going forward. I don't know. I mean, if they -- if they're going to change, they're going to change. But there's nothing today that leads us to believe that they're going to do that. Yes. When you look at their plans, it's about technology transition in logic. Trust me, it's going to happen, yes? If you now look at the DRAM expansion plans -- we have a limited number of customers, only 3, and 2 of them have some capacity expansion plans where the fabs are being built. And you're long enough into this industry to understand that once you have the DRAM structure there, you're going to fill it up because it's the only way to cover your fixed cost is to bring out as many DRAM business you can in this new fab. So these are all plans that are really cost installed, yes? And whether they are going to cut or to slow down that ramp, I don't know. But the current plans are what they are, which means that the shipments that we're seeing in H1 and H2 that's been planned for some time now, they're still valid. And what changes in the future, I don't know. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [42] +-------------------------------------------------------------------------------- + + Sure. Thanks for the sincerity and the fact that your customer mix has increasingly consolidated does make it more challenging to forecast. Just moving on... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [43] +-------------------------------------------------------------------------------- + + Or it makes it easier. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [44] +-------------------------------------------------------------------------------- + + Yes. Or your -- it's easier for you because your crystal ball is better than mine. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [45] +-------------------------------------------------------------------------------- + + That's absolutely true. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [46] +-------------------------------------------------------------------------------- + + Right. One thing with EUV, I'm just very intrigued. We started the year with a commentary that you could ship 22. You see now it's down to 18. I appreciate the improved throughput with the 3400C coming out second half of next year. But on the flip side, your customer mix has also consolidated. One of the key foundries is no longer pursuing leading edge. And the leading foundry is now the leading semiconductor manufacturer, and they're well ahead of others. And perhaps the DRAM industry is waiting for 3400C before they finalize their plans. And I'm just trying to better understand, when we dial in the 30-unit system into our expectation and 40 into 2020, what are the key wafer capacity targets that you're looking at? You -- in the past, you've talked about certain foundry capacity for leading edge. Is there any metric that you could provide us so that we could have a more realistic set of expectation and if there is a change we know what are the key parameters that have changed? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [47] +-------------------------------------------------------------------------------- + + Okay. Well, I think the more realistic expectation is the expectation that I gave you. Because I think it is realistic, yes? And it has to do with the fact that yes, our customer base is consolidating, which in itself, generally leads to a better capital efficiency in the industry because every customer plans for winning business. And if you have multiple customers all planning for the same business that -- yes, that might be a reason or that might be a very good reason why you ship a few more systems. Now in this particular case, it's not the case because like you said, there's 1 -- a customer has stepped out of 7-nanometer from the foundries. And that base is now close to Taiwan. But -- and the real question is, as you know, if that's a 7 plus or a 5-nanometer-type business, yes, what is the size of that 7-plus and 5-nanometer business for that customer? And that is significant. I can only repeat what the CEO of that company said a couple of times. 7-nanometer, 7-plus and 5 is going to be big. And that's based on what their customers are telling them what they need in terms of wafer capacity. Since they're the only one really in that space -- and we're not going to tell you anything about the plant wafer, capacity, you should ask them. That's not my role. But I can tell you that this is a big driver for the 2019 EUV shipments, yes? And that's only for the foundry business. On top of that, you have the micro processes and you have the first start of some 5 production on DRAM. If you add it all up, you see those plans and you see the road maps, then the 30 number we think is a realistic number. Now if there's some upside, hey, if the 3400C turns out to be -- is a very good tool and we'll figure it out in, of course, 2019 given our module testing in all level and ways, can we -- could we output 1 or 2 or 3 more eventually, but then let the customers decide, and I would think it's going to be in logic, that upside would probably be in memory and in DRAM. So that's the situation today, and we're giving you clear guidance on the 30 units. That's really based on a realistic scenario as presented to us by our customers. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [49] +-------------------------------------------------------------------------------- + + JP Morgan. Peter, my question is, I mean, I'm trying to understand what you've been saying about 2019. Clearly, EUV is up to 30 tools is what you're guiding. Your metrology business is growing into next year. Your Installed Base Management business is growing into next year. So I don't think there are questions about that. So the question is about the DUV business. I mean, from what I'm hearing you're saying into -- in response to earlier questions that you're looking for a flattish trend. And I mean that is dominated by the growth in logic and memory not that strong. But I mean, you still have a flattish trend in DUV next year. I mean, I think everybody's estimates for your -- on revenue for ASML are wrong. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [50] +-------------------------------------------------------------------------------- + + Well, it's not my responsibility to come up with an estimate. But what I said at least means I see a bottom for our Deep UV business to be at least the same, yes? Now Deep UV business has a lead time that is a bit shorter, so there are changes from time to time. So customers could still change for this second memory to -- of 2019 to go up. And I just called a bottom, which actually means that there could be upside. And yes, and I would not be surprised if there would be. But how big that upside would be? I don't know. So that is a bit where I have to stay qualitative and cannot speak quantitative. Yes? + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [51] +-------------------------------------------------------------------------------- + + Because, I mean, I'm just looking at the consensus ahead of today. The market is looking at about 7% revenue growth for ASML. So are you suggesting -- because we know approximately from the other 3 line items where your growth would be for 2019. But if you have flat DUV, we are looking at well into double-digit growth. So would you say that you should -- you can potentially grow well into the double digits into 2019? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [52] +-------------------------------------------------------------------------------- + + I think you've done the math for us. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + The next question comes from Mr. John Pitzer. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [54] +-------------------------------------------------------------------------------- + + Yes. It's Credit Suisse. Peter, you mentioned in your prepared comments that China's going to end up being about 20% of business in calendar year '18. What's domestic China going to be this year? And as you look out to your '19 forecast, is China domestic a breakout year in '19? Or is it more in line with trend line growth? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [55] +-------------------------------------------------------------------------------- + + Well, I think what I said in my prepared comments that 5 of those domestic customers are now planning to ramp in 2019, which actually means that we see our business in 2019 from China also growing. Now beyond that, I think everything -- and I said it also in the prepared comments, how big the growth will be also depends on how successful all those ramps are going to be because the first pilot lines have been installed and they're actually executing on their 2019 ramp plans. But as we all know, some of these companies are greenfield companies. Are they all going to be as successful? We don't know. But if they would be, and they're executing on their plans as we currently see it, then our business in China will be up next year. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [56] +-------------------------------------------------------------------------------- + + And then Peter, my second question is just managing through the transition on EUV as you bring out these higher-NA more productive tools. You mentioned in an earlier question that you thought about few tools next year got cannibalized on productivity. The 30 new EUV tools you have, what's it -- potentially at risk for further cannibalization? Can customers future-proof? Can you upgrade an EUV tool to a higher NA once you've installed it? Or is that not an option? And to the extent that, that 30 number does get cannibalized, should that just upside our 2020 number for you guys? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + No. I think the -- you cannot upgrade to higher NA. The higher NA, the High-NA EUV tool is a completely different tool, different dimension, so it doesn't work. But that you can upgrade from actually a 3350 to a 3400 if you would like to do that. That is a big open heart surgery in the field. We -- that could happen in 2020. We see some of those upgrades. But I certainly would say that there is not much downside to further cannibalization than what we just said. I think there is some upside if the 3400C turns out to be quicker meeting the performance targets, then we could -- we were in if 1 or 2 or 3 more systems in 2019 going into 2020 as a start for higher adoption in the DRAM market. But still, it's too early to speculate any further beyond the 30 units. I would certainly not speculate down. I wouldn't speculate up yet. But if there is a chance for a change, I would say, it depends on the performance of the C, especially all of those have the possibility in the DRAM space. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [59] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citigroup. I really wanted to just circle back on a broader topic, Peter, if I could. Let's just first talk about the trade wars that's going on right now and potential implications for supply chain. Could you maybe give us a sense of if you have done any assessment that you are likely to be impacted by the second tranche of tariffs? And if you see any need within your own supply chain to make any changes based on what's already been made public today. Then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [60] +-------------------------------------------------------------------------------- + + We're going to be pretty short on this. We don't see any significant impact. Not for our business, not for our supply chain either. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [61] +-------------------------------------------------------------------------------- + + Okay. And secondly, in terms of just us without trying to belabor too much on the point for the 30 tools. So you said that the capacity would be 30 tools, and then of course it depends on the output for the 3400C. So would it be fair to assume that in terms of the production output or the demand that your customers are seeing out there right now, it's as strong as it was 3 months ago? If anything, it has gotten even stronger, which is why you were saying there's more likelihood of numbers being up than down. Would that be a fair assessment to make? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [62] +-------------------------------------------------------------------------------- + + Yes. At first, there's a little correction, Amit. Yes, the capacity is indeed around 30 systems. Now if you add the 2 so you could do a 32. But what we're saying, we are shipping 30, which includes the 2 that they are shifting from 2018 because the wafer capacity that customers are needing that only because we have a higher productivity tool that -- yes, then that mean they need 30 units, 28 plus 2, yes? So it's driven by the higher wafer capacity output that's coming out of the 3400C. Now that actually means that there could be, from a manufacturing point of view, there's a few 1 or 2 or 3 upside that now would only materialize if we get our customers convinced that productivity of our EUV in 3400C number is also -- is good enough and is reliable enough to put them into an earlier production for memory, for DRAM in this space. So I said it a couple of times. I hope it's clear now. So that -- this is why I said I don't think from a demand point of view that there is a big change. What we said before is that when we looked at the overall demand for EUV, we did include, for instance, customers like GLOBALFOUNDRIES, which of course have fallen off. That could have driven the demand over 30 units. Now they're not there anymore. That is consolidated into one other customer. So that's the only thing that probably changed. It's the consolidation in the industry, but it doesn't have an effect on our shipment plan. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [63] +-------------------------------------------------------------------------------- + + And then just if I could very quickly ask, have you -- because you talked about the productivity of the 3400C, have you decided what level of markup in price with your -- price for 3400C over the 3400B? Or is that still to be fixed? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [64] +-------------------------------------------------------------------------------- + + Yes. That is still to be fixed. We are talking to a few customers on that final pricing. So let's not do the price negotiation over this conference call. We'll do that when we have this -- in the -- in the private rooms of the customers. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + The next question comes from Ms. Tammy Qiu. + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [66] +-------------------------------------------------------------------------------- + + Tammy Qiu from Berenberg. The first one is, Peter, you mentioned that next year, Deep UV spending is mainly skewed towards the logic foundry side. I'm just wondering because when logic foundry make a like TSMC move into a new generation, their reuses percentage can be as high as 95%. I'm just wondering to what extent you're actually reflecting high reusage in your estimation. And also, at the same time, would you say in your backlog of EUV shipment, has anyone already got full allocation of tools for ramping up next-generation 7-nanometer plus equivalent? Or they are still ordering for that generation? And I have a short follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [67] +-------------------------------------------------------------------------------- + + I think for anything, we don't use N7 this, let's say, 7-nanometer or N7. There are still orders that we'll be taking. So that's now easy. Reuse, you have to define reuse. What customers are mentioning when they talk about their reuse is that the existing installed base can be reused for the next node, yes? The next node needs more capacity. So what we're looking at for next year for logic is through capacity additions, extra wafers out. And when I said 2019, I didn't say it was mainly skewed towards logic. I said logic is going to increase in terms of its share in the Deep UV shipment as compared to 2018, yes? Memory is still going to be strong, but logic is also going to be a higher component of Deep UV shipments than it was in 2018. + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [68] +-------------------------------------------------------------------------------- + + Okay. And also, you mentioned last quarter that you are accelerating your R&D process for High-NA. I'm just wondering, has your accelerated R&D been impacting a number of layers EUV can be used by the time of High-NA is available? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [69] +-------------------------------------------------------------------------------- + + Yes. Sorry, could you repeat 2? + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [70] +-------------------------------------------------------------------------------- + + So basically, last quarter, you have been accelerating your R&D process for High-NA EUV tool, right? So I'm just wondering, with your accelerated R&D process for High-NA, has chip makers been making decision about introducing EUV for more layers when High-NA is available because it's available... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [71] +-------------------------------------------------------------------------------- + + Oh, okay, okay. Sorry. Yes. I think what you will see going forward is that High-NA will be introduced in high-volume manufacturing by the middle of the next decade. Then you will see a very clear mix of 0.33, you can say, low-NA layers and the use of High-NA layers. They're going to be used next to each other. So High-NA is now going to cannibalize that much of the low NA, but they're going to address the additional critical layers of the N3 and the N2 nodes. So this is how it actually works. So yes, on EUV, if you think about EUV in total, of course, there will be more layers allocated to EUV in a combination of low NA and High-NA. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [73] +-------------------------------------------------------------------------------- + + It's Adi Metuku from Bank of America. I have 2 questions. Firstly, a clarification on the OpEx. So obviously, your OpEx is ramping up a lot into 4Q. And when we look at the run rate, quarterly run rate for 2019, should we assume that the 4Q run rate would be a reasonable number? Or do you think that'll start to trickle down as we go through 2019? And secondly, just looking at 5-nanometer demand and how the ecosystem is developing. I wondered if Peter, if you could comment a bit on how the ecosystem is progressing, especially from a pellicle and inspection tool viewpoint. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [74] +-------------------------------------------------------------------------------- + + Yes. I can take the last question and Roger can take your first question. On the 5-nanometer development, that, if anything, is accelerating. And I think the issue with pellicle is a function of the effectivity, yes? So it's a -- the effectivity numbers and the effectivity control is increasing significantly. So we have made a lot of progress this year together with our customers on the effectivity control. And I think on the 5-nanometer node, the current use or the use of the current pellicles and the effectivity measures are sufficient to support 5-nanometer. That's what we believe. At 3-nanometer, which is a couple of years beyond that, we might want to look into whether we need additional inspection tools. That is really depending on how successful we are in the effectivity control at the 7-plus and the 5-nanometer node, which looks to be very good. So whether we need that inspection tool going forward is still a question that needs to be answered, then perhaps it's negative that we don't need it, that it depends on the progress that we will make on the effectivity with the current generations. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [75] +-------------------------------------------------------------------------------- + + That's right. So CapEx, it's, in essence, the same logic as we had for R&D, which is over time and particularly when you talk about acceleration that you can see a bit of an uptick. And you won't be surprised that CapEx, to a certain extent, correlates with R&D. So with R&D going up, there is logic that certain CapEx goes up as well. So that will go hand-in-hand and that's something that we see in the short term. Medium term and long term, you will once again see that's -- it models back to what we presented to you in our 2020 model, which is 4% of CapEx, 4% of sales would be assumed in the CapEx. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [76] +-------------------------------------------------------------------------------- + + Sorry, Roger, apologies for the CapEx. I meant OpEx. So when I look at 4Q '18, OpEx as a proportion of revenues, obviously, when I take your guidance, it's -- you're seeing a pretty strong uptake. And it's -- and the OpEx run rate is significantly higher than what consensus modeling for 2019. So I just wondered, you made a comment earlier on OpEx picking up short term, but coming down medium term. So as we go through 2019, should that -- when should we expect that uptick to come down? When should we expect that downtick? That's the question. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [77] +-------------------------------------------------------------------------------- + + You can expect that downtick, and that's going back to the model that we presented to you, in the course of 2019 -- early in 2019. So there are reasons for SG&A, in particular, because I think we need to distinguish here between SG&A and R&D. I mentioned to you R&D as it relates to SG&A, we see a bit of an uptick in what we expect for Q4. You will see that come down to the 4% model that we guided for -- in the course of 2019. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [78] +-------------------------------------------------------------------------------- + + And a lot of that -- yes, I think you already answered it because as you know, we are driving the High-NA introduction and the 3400C, which will mean that we see an elevated level of R&D spending in 2019, which would actually -- would give a very clear indication in Q4 of what the levels could be. But medium term, that will come down again. And where will that be? I think somewhere in the 2020, 2021 time frame, you will see that because that's when the peak of the High-NA program will have happened, yes? And because I -- we are going to -- we're planning to ship High-NA starting 2022. So end of 2021, beginning of 2022. So that peak will be for the next 2 years, and then it will level off. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [79] +-------------------------------------------------------------------------------- + + All right. Before we sign off, we'd like to remind you that we'll be hosting our Investor Day here at our headquarters in Veldhoven on the afternoon of November 8. As the event is currently fully booked, we ask those that are -- have not already confirmed to please join us via webcast. We will provide the webcast details in advance of the event. You can contact Investor Relations with any questions. +Now on behalf of the ASML board and management, I'd like to thank you all for joining us today. +Operator, if you could formally conclude the call, I would appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Of course, sir. Ladies and gentlemen, this concludes the ASML 2018 Third Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2019-Apr-17-ASML.txt b/Transcripts/ASML/2019-Apr-17-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..12c91353d3a673ca8cd70d967ce55b6f5bb39573 --- /dev/null +++ b/Transcripts/ASML/2019-Apr-17-ASML.txt @@ -0,0 +1,630 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 ASML Holding NV Earnings Call +APRIL 17, 2019 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Weston David Twigg + KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * David O'Connor + Exane BNP Paribas, Research Division - Analyst of IT Hardware and Semiconductors + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Tammy Qiu + Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2019 First Quarter Financial Results Conference Call on April 17, 2019. (Operator Instructions) I would now like to open the Q&A. (Operator Instructions) +I would now like to turn this conference call over to Mr. Skip Miller. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon and good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today from ASML's headquarters in Veldhoven, The Netherlands, is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. Subject of today's call is ASML's 2019 first quarter results. The length of this call will be 60 minutes, and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our first quarter 2019 results conference call. +Before we begin the question-and-answer session, Roger and I would like to provide an overview and some commentary on the first quarter as well as provide our view of the coming quarters. And Roger will start with a review of our Q1 financial performance with some added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Roger, if you will. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter. Welcome, everyone. I will first highlight some of the first quarter accomplishments and then provide our guidance for the second quarter of 2019. +Although this was a modest quarter, in absolute numbers, we did report both sales and gross margin above our guidance. Q1 net sales came in at EUR 2.23 billion, slightly above guidance, driven by an additional EUV shipment in the quarter. Net systems sales of EUR 1.69 billion was more weighted towards Logic, 60%, with the remaining 40% for Memory, the same split as previous quarter. We reported EUV system revenue of EUR 371 million from 4 shipments. Installed base management sales for the quarter came in at EUR 540 million, which was slightly lower than guided due to lower upgrade business. +Gross margin for the quarter was 41.6%, which is slightly higher than the 40% guided due to a favorable Deep UV mix more than compensating for gross margin impact of one additional EUV system. Overall, R&D and SG&A expenses came in a little lower than guided with R&D expenses of EUR 473 million and SG&A expenses at EUR 121 million. +Turning to the balance sheet. EUR 55 million worth of shares were repurchased in Q1. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 3.28 billion. +Moving to the order book. Q1 system bookings came in at EUR 1.40 billion. Logic order intake was 75% of total value with the remaining 25% from Memory, again reflecting the strong logic demand expected this year. We took 3 new EUV orders in the quarter. +Net income in Q1 was EUR 355 million, representing 15.9% of net sales and an EPS of EUR 0.84. This was favorably impacted by a one-off tax benefit. +With that, I would like to turn to our expectations for the second quarter of 2019. We expect Q2 total net sales between EUR 2.5 billion and EUR 2.6 billion. Our total net sales forecast to Q2 includes around EUR 600 million of EUV system revenue on 6 expected shipments in Q2. We expect our Q2 installed base management revenue to be around EUR 700 million. +Gross margin for Q2 is expected to be between 41% and 42%. The lower-margin EUV revenue will be compensated by higher-margin non-EUV business. We continue to expect further improvements in gross margin in the second half driven by higher system sales, increased field upgrades, shipment of higher-margin NXT:3400C systems as well as contribution of EUV service revenue. This will provide a significant step towards our 2020 target of over 50%. +Expected R&D expenses for Q2 are around EUR 485 million, and SG&A is expected to come in at around EUR 125 million. Our estimated 2019 annualized effective tax rate is around 11% because of a one-off tax benefit in 2019. We still expect our long-term effective tax rate to be 14%. +As we remain confident in our long-term growth, we will propose a 50% increase versus last year in our dividend to EUR 2.10 per share at our Annual Shareholder Meeting, which takes place on April 24 in Veldhoven. The dividend payment is valued at around EUR 0.9 billion. We still expect to execute the remaining EUR 1.3 billion of the 2018-2019 share buyback program this year with a weighting towards the back of the year. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger highlighted, although it was a modest quarter, the results came in above our guidance, and we expect further strengthening in the coming quarters. There continues to be volatility in the markets due to the macroeconomic environment, and some uncertainty remains in the semiconductor industry. Our memory customers are going through a period of rebalancing supply and demand with an expected improvement in their business conditions over the course of the year. +Our view of 2019 remains unchanged from last quarter. We continue to expect overall growth in 2019 with increasing demand for our products as we move through the year. The fundamental end market drivers clearly remain in place as expanding end market applications continue to fuel the demand for high-performance compute and high-performance memory. +In Memory, the NAND market continues to digest the high level of capacity additions over the past few years, and this digestion started last year and will likely extend through most of this year. DRAM market is also seeing softening in the near-term demand as they work through an inventory correction. And based on our customers' view, we continue to expect memory demand for our litho systems down around 20% relative to last year. But bear in mind, there is a portion of this memory demand that supports new technology as well as new domestic Chinese customers, and this demand is clearly more strategic and will -- is very likely to happen independent of the near-term global bit demand. +If you remove these 2 components from our estimated 2019 memory demand, you get the lithography spend for memory bit supply that is 30% lower than the comparable spend in 2018. This reduction in spend is significant and will help in correcting the supply-demand balance. And on top of this, we have seen a significant reduction in wafer output in the memory space. This quick reaction to the changes in the end market demand is clearly different from what we've seen in earlier cycles and will also help in correcting the inventory situation. +The Logic segment is expected to be the growth driver in 2019 with the majority of the demand linked to technology transitions and production capacity for advanced nodes. We still expect this Logic business to be up around 50% relative to last year, driven by Deep UV as well as significant EUV demand. Furthermore, we still expect single-digit percentage growth of installed base revenue. +On the ASML product side, let me start with an update of our EUV business. In EUV customers are starting production of the most advanced logic processes on our NXE:3400B systems, with plans to transition to the higher-productivity NXE:3400C systems in the second half of the year. First set of qualified NXE:3400C optics are in our factory. These higher transmission optics will enable the higher throughput of 170 wafers per hour. We expect these systems will deliver the next level of cost-effective shrink in both Logic and Memory. We shipped 4 EUV systems in Q1 and are all in track to ship to plants 30 systems in 2019. +In Deep UV, we continue to innovate in support of future nodes and new applications. Driven by continued high level of demand for Dry products, we will bring the Dry -- the Deep UV Dry products to the high-performance NXT platform, starting with the NXT:1470 planned for delivery mid next year. We also see increasing demand for 200-millimeter TWINSCAN systems across all dry wavelengths and industry segments. For instance, in thin film head manufacturing, we recently received an order for a special version of the XT:1470K (sic) [XT:1460K], which is a dry ArF platform, which is expected to enable the shrink road map at a leading hard disk storage manufacturer. +In our application business, our computational lithography deep-learning technology has been adopted at several leading-edge customers. We continue to make progress in e-beam technology and are on track to deliver a multi-beam system for this year for R&D with plans for commercial product shipments in 2020. With the announcement of the acquisition of Mapper's IP assets in January, more than 100 former Mapper employees accepted jobs from ASML and are now working on the development road map of our e-beam and application products. +In summary, despite uncertainty in the current environment, we continue to see market demand that supports another growth year with strengthening of both sales and profitability quarter-on-quarter this year. Logic will be the primary driver of growth this year, supported by technology transitions and production ramp of the most advanced nodes. +As discussed, Memory includes more uncertainty, on the one hand, because of the uncertainty of global bit demand, but on the other hand, due to fast adjustment of production capacity and, therefore, presents both a risk and an opportunity. Overall, our view of the business is largely unchanged from last quarter. We are on track to achieve our 2020 targets with significant growth potential beyond 2020. +With that, we would be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. Beforehand, I'd like to ask that you kindly limit yourself to one question with one short follow-up, if necessary. This will allow us to get to as many callers as possible. +Now operator, could we have your final instructions and then first question please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question is from Mr. C.J. Muse of Evercore ISI. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess first question on your Memory outlook, if I were to exclude expected EUV shipments, it looks like Memory half -- over half for you guys is roughly up 30%, give or take, in the second half. And so curious there, is that all largely shrinks? Or are you starting to see greenfield from the 3D NAND side? I would love to hear your thoughts and any color on that from you. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Well, thank you, CJ. No capacity additions on the 3D NAND side. That's not what we're seeing. It's really technology transitions other than EUV. So it's largely in the DRAM space. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Helpful. And then I guess as my follow-up, as you think about DRAM and adoption of EUV, it sounds like, perhaps, layer count could increase from perhaps to as many as 4 layers, would love to hear how you're thinking about that, how you're thinking about that ramp and I guess what contributions to EUV we could see into the 2020-2021 time frame. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Yes. That's a very good question. I think as you know, DRAM is much more -- we started -- I think we discussed this on previous calls also. It's much more cost-sensitive than the logic space. It actually means that the higher productivity EUV tool, the 3400C, is the tool of record for DRAM manufacturing. +Now clearly, we're in the process of maturing that 3400C tool in terms of availability, in terms of the productivity, of course, we seem to be proven in the customer fab. So I would expect that by the end of this year, I would say somewhere in Q4, where we see the first results of those tools in the customer fabs. And we would need the projected wafers-per-day productivity, which is a result of the raw throughput plus the availability. That will really drive the number of layers, ultimately, in application of DRAM. +I would expect, though, that customers will first allocate a relatively small portion of their output to EUV because it's a new technology, it's a new process. But when that is proven, that can accelerate. So it's -- you could really say it's really up to us to make sure -- and of course, together with our customers, because we -- it's new technology, new process technology, we need to prove that in the course of this year really towards the end of the year that the promised productivity and availability is there, that we beat the 2,000 wafer per day target that we've set ourselves and even see whether we can get higher. And going up, I would say, significantly above the 2,000 wafers per day, which ultimately, should be possible, will drive the adoption of the number of DRAM layers. +So it's a bit too early to give you a guidance on the 2020-2021. It really depends on how we perform, and of course, it's our -- in our best interest and that of our customers to do as good as possible. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + It's Cowen and Co. I have two of them. Peter, you kind of reiterated your EUV outlook for this year with 30 units. So is it fair to assume that these units are pretty much locked and loaded and your customers have gotten the green light from their customers to proceed with EUV for their end products in the second half? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [8] +-------------------------------------------------------------------------------- + + Why -- I think -- Krish, I think that is a fair assumption because these are not cheap tools. So to spend that kind of CapEx without having the business and without having some -- decent level of commitments from your end customer, that's probably not very likely. So yes. I would say yes. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + Got it, got it. That's very helpful. And then a question on the Memory side. Your Memory orders have been down sharply for the last 2 quarters, and it looks like it's stabilizing at least EUR 300 million run rate levels. And you also mentioned that Memory business should improve as a course -- through the course of the year. But given your long lead times, is there a way to figure out if your -- if DRAM or NAND is going to bottom out at some point for your customers? How many quarters before they will come and place the orders for ASML tools? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [10] +-------------------------------------------------------------------------------- + + Yes. Like I said in my introductory comments, what we're seeing is there's a bit difference to what we're seeing in previous cycles. There's the pretty rapid reaction of customers to actually reduce output, so basically to lower the utilization. I think that is an attempt of the customers to quickly adapt the imbalance in supply and demand. +Now that will lead to a situation whereby in the course of the year -- and many customers have actually said this, that they expect throughout this year, could be middle of the year or at the end of the year, but throughout this year, a better situation for them and a return to better business levels for them. +Actually, so what that means is that we don't expect this year that there will be a big snapback in demand for those systems, because if you lower the utilization now, first, what you will do is use that utilization when you go up. So that probably means that if we see a correction, it's going to be next year and not this year. +Now having said that, the -- we are preparing the supply chain. We always have in the supply chain a certain level of buffers so we can have a rapid response shipment ready, which is true for the long lead time items. That's our optic supply and some very long lead time electromechanical parts of our tool. +So the first snapback, we probably can do within a relatively short period of time, and that gives us a time to also organize the supply chain if the ramp turns out to be more substantial and longer term. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Next question is from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [12] +-------------------------------------------------------------------------------- + + JPMorgan. Peter, just one first question from me on EUV. You just -- from an earlier question, you responded regarding the Memory, and Memory adoption of EUV into 2020 depends on the 3400C. So how confident are you on the EUV shipments into 2020 based on what guidance you've given in the past? And what will drive those shipments into 2020 at this point based on -- clearly, you've already -- from -- probably getting indications from your customers on these trends? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [13] +-------------------------------------------------------------------------------- + + Yes, we did. I think what we are planning -- what we have given you as an indication in the past, and I'd like to refer to the update that we gave at the Capital Markets Day last year where we gave you kind of a mid-scenario, where we look at that number. Then I think everything that we're currently seeing in terms of logic demand, the use of EUV at 7, 7 plus, 6 and 5 nanometer, I think that confirms our thinking for that particular number that we gave you. +And there is a level of memory shipments in there also, whereby we assume that at least in a moderate market scenario, we will ship some numbers to -- some shipments to Memory customers also. So all in all, I think we have in our moderate market scenario 2020 about 33 EUV units, and that's what we're targeting at. +Now is there some upside potential? I think if the 3400C works indeed as smoothly as we're planning, that could be. But that means we should have, I would say, double-digit, above the 2,000 wafers per day level. Then yes, this could spark some additional demand. And then customers should give us approval to get more out than those 33 systems. But this is what we're currently seeing as the most likely scenario. So that's what we told you back in November last year. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [14] +-------------------------------------------------------------------------------- + + And just -- I mean following up on margin question associated with EUV, I mean, in the second half of this year, I mean, you're looking at shipping about 10 tools a quarter. So essentially, you're at scale in terms of quarterly volume on EUV. So would you be expecting to be shipping scale margin as well? You've talked about in the past that EUV can grow about 40% gross margin initially, but then by 2022 or so, going towards the DUV level of gross margins. So do you think that you will be at that scale margin? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [15] +-------------------------------------------------------------------------------- + + No. That's roughly speaking the trajectory that we're on. I think what is important to recognize, Sandeep, is that for the second half, it will still be a mix, right? It will be a mix of 3400B machines and 3400C machines. But in the course of the second half, starting in Q3, we'll see the first C shipments with the considerably better gross margin profile associated with that. +But what you just mentioned, the 40% for 2020 and then that gradually growing towards the margin that we have on DPV, that's exactly what we confirmed at the Capital Markets Day. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Weston Twigg. + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + With KeyBanc Capital Markets. Just wondering if you could help us on the Logic side, just like you did on the Memory. If you stripped out the EUV ramp or the technology purchases, what do you think the core Logic revenue growth would be this year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [18] +-------------------------------------------------------------------------------- + + It's very hard to strip the technology component out there because nearly everything that we have in Logic is related to that. We would say about 85% of our shipments would be related to technology upgrade. So that's the vast majority of what's in there. + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Okay. Yes, that makes sense. Maybe on e-beam then, just wondering if you have any expected changes in the growth rate related to the multi-beam launch in 2020, if you could give us an idea for what that might mean for revenue or ASP opportunity next year. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [20] +-------------------------------------------------------------------------------- + + Yes. I think the most important part is here to make sure that our lead system lens by the end of the year, and that is what we're still planning. And then because it's a new technology, to give you a detailed outlook on growth rates for 2020 for this technology is a bit too early, because it also very much depends on how the technology being used and on the application space. +So for us, the most important part of e-beam is to get the node to beam out, yes, get the node to beam out and to have the first qualifications done with our customers. And based on that, we'll be, by the end of the year or early next year, in much better position to guide you on growth rates and market expectations. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + It's Mehdi Hosseini from Susquehanna International. Peter, I want to go back your comment from January earning conference call. You said you expect up to 13 EUV system, 3400C, but you were still not really clear of those systems, how many would be an upgrade from B to C. Is there an update here? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [23] +-------------------------------------------------------------------------------- + + Yes. The full Cs are actually less, I mean, if you have a kind of intermediate version. So the full Cs is probably around 5, yes, and so the rest is an intermediate version that will be upgraded later on. So that was a bit of a confusion. That has to do with the fact that not all modules are fully ready when we start shipping the first C with the improved lens and there are other features to that C system that come later. So the -- that is the upgrade in the C version, which is relatively minor. +But the upgrades you're probably referring to, from the B to the C, and this is where we don't think there will be a lot of upgrades for the simple reason that the B is a lower productivity tool with a lower price. And if you want to go to the C version, you really need to have the new optical path there, which actually doesn't [advise]. It's possible, but and then you have to have such a major upgrade in the field that it's questionable whether it's economical for customers to take the tool down for such a long time and then pay such a high price for the upgrades. +So I think the Bs will remain the Bs and the Cs -- the real Cs, the final [N] Cs are probably a handful, yes? And there is then this version that is going to be shipped at least with the right lens and with some other modules later on. So those are small upgrades, which are part of the purchase price. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + And then -- and rather, a quick follow-up. I estimate the installed base of all EUV systems out there this year to be around 60. And obviously, some of these systems are for R&D and some of them are older generations. So let's say 60%, 70% of the 60 units could potentially be upgraded. I mean, you just referenced the economic challenges for upgrading, but then again, I can't ignore the fact that there is a large installed base. +And in that context, how should I think about the tools that are already being paid for and some of them maybe halfway through depreciation versus benefit of purchasing an outright C version? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [25] +-------------------------------------------------------------------------------- + + Yes. I think it's not 60. It's just below 50, those in the field. But you have to realize that the number of those tools are 3300s, 3350s, and some of them -- and most of those tools are being used in the qualification in the R&D space, yes? So we are -- you are right, some of them actually they are entering into their last term of depreciation. +Now -- so some [wafers] be used also in the R&D space and will not be upgraded. And also, it's like the 3400Bs, they are, yes, lower productivity tools but also lower-priced tools, but are perfectly capable production tools, and those will stay in production. And that's nothing different than what we did in the past when we had NXT versions, yes, where basically you have a 1950 followed by a 1960 and a 1970. Yes, some of them can be upgraded, but as I've said earlier, the upgradability of the 3400B is there, but it's very expensive and you could argue whether it's economical. So I don't expect it there. +On the 3300s, not the 34, the 3300s, I see limited upgrade possibilities, but many of those tools will stay in an R&D space. And some of them we can negotiate with the customers to take some of them back and refurbish them here in the factory, and those are the kind of the plans that we are developing with our customers today, just to make sure that they have a efficient use of their assets. +And then those are programs that will probably run over the next couple of years, yes, to make sure that we can help our customers get the maximum amount of their installed base, which is, by that time, fully depreciated. And it will be kind of a trade-in and upgrade program, but that -- those details still need to be worked out. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Mitchell Steves. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [27] +-------------------------------------------------------------------------------- + + Mitch Steves from RBC. So I really have 2. The first one is kind of on a gross margin side. So you guys saw a better shipment in EUV and you guys are talking about better EUV profitability, but then you're kind of guiding to similar gross margins for next quarter. So I'm trying to understand why you're not seeing any scale from the extra EUR 300 million sequentially. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [28] +-------------------------------------------------------------------------------- + + So it's a -- so the gross margin from Q1 into Q2 is a bit of a blend. So as you rightly said, we'll have more EUV shipments. And as you know with the 3400B, that means that the gross margin, for that reason, would go down. It will be compensated by the Deep UV business and will also be compensated by the fact that we do have better installed base revenue with some field upgrades in there into second quarter. +So if you take the negative from more EUV shipments, that gets compensated by the other 2 developments. And that gets you, as we already said, by the way, on our call after Q4, that gets you to essentially the same gross margin in Q2 as you have in Q1. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [29] +-------------------------------------------------------------------------------- + + Got it. And then secondly, you guys have a pretty large target in terms of 50% out there for gross margin. So when do we see that step function in terms of the gross margins? Is that driven by the type of EUV shipments you're going to have? Or is that driven by mix? So just how do we get to kind of a step function from 41% to, call it, the high 40s going forward? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [30] +-------------------------------------------------------------------------------- + + You're on a roll there. So you absolutely mentioned 2 very, very important elements in there. So indeed, it is the introduction of the 3400C model, which is -- which as we said is going to start in Q3, and that will be a significant uptick in our gross margin. So that's one big component. +The second component, indeed, is mix, which is also envisaged for the second half of the mix in the Deep UV business more towards -- even more towards immersion. A very significant part that we talked about quite extensively also on the call last time is installed base revenue and then, in particular, the EUV service cost and service revenue. So we're working very hard, as you know, at this stage to get our customers and help our customers and go to high-volume manufacturing. +So there's a lot of costs that we incur as a result right now, whereas the revenue is very limited, because as you probably know, most of the revenue and service is tied to wafer output, which, of course, at this stage, it's very, very low. So there's a big mismatch at this stage between the cost and the revenue. That will obviously remedy itself in the second half and then significantly into 2020 and beyond. +So those are the key drivers. And then we have factory loading to the extent that the business goes up and some other components in installed base, base revenue, including field upgrades. +So those are the main levers that we're pulling in order to, indeed, get to the over 50% that we've guided for 2020. And we believe we're on track. So the step change, you will see significant elements of that step change in the course of the second sales -- second half. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [32] +-------------------------------------------------------------------------------- + + This is Stephane Houri from ODDO. I have a question again on the services because you've said that services will jump in Q2 to EUR 700 million. So just to understand the dynamic, I thought that services recovery would've come with EUV services revenue in Q3 and Q4. So what services are driving the growth in Q2? And basically, are you -- will you be significantly above the EUR 700 million level quarter in Q3-Q4? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [33] +-------------------------------------------------------------------------------- + + So the main driver of getting it from the Q1 number to the Q2 number is not related to the EUV. That is -- that would include field upgrades. So that's an important driver where we had a limited number of that in Q1, as we also indicated, which is also a -- was also a function of the supplier situation that we talked about last time. So field upgrades is one significant -- one important driver of the higher number in Q2. +In the second half, the second half, we expect installed base revenue to be higher than in the first half. As you said, we're still looking at single-digit growth for installed base revenue. So if you can do the math of the first half and the second half, you would see that there is about a 20%, 25% increase that you would have to have over the first half into the second half to get to that number. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + Okay. Maybe a quick follow-up on the price of EUV tools. There has been a fall, significant fall if -- I might correct, in Q1 versus Q4. Is there any reason for that? And where do you see the EUV average price going, given the introduction of the 3300C? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [35] +-------------------------------------------------------------------------------- + + So if you compare the -- I guess what you say is you compare Q4 '18 to the Q1, the Q1 '19 number, right, and then the average, yes, I mean the average pricing of all of our machines, including the EUV machines, is obvious to -- obviously, to a large extent, contingent upon the configuration of the machine and also the mix, what customers will it -- let's say, will it go to, what's decide on the customer, et cetera. So there's a number of drivers there. And sometimes, that's a little higher than the average sales price of 100 that we've -- that you typically work with, and sometimes, it's a little bit lower. +As it relates to the introduction of the 3400C, I think we've been very clear there. We're looking at a more than 35% -- we're looking at 35% increase in the throughput in terms of wafer -- wafers per hour, and that's, we've always said, translates into an ASP increase from the B to the C model. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question is from Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [37] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. I would like to maybe get your thought with respect to EUV orders and shipments going into 2020. As you alluded to earlier for 2019, your shipment plan look fairly secure in terms of customer commitments. +But as we look towards 2020 and we look at some of the recent order flow around EUV, how are you thinking -- what's your confidence level with respect to hitting the 33 to 35 that you have referenced earlier? Do you need to demonstrate more improvement to your customers? Are there -- is there -- do the customers have to come through -- I guess I'm just trying to get comfort in terms of when do we start seeing the EUV orders per quarter tracking close with the shipment level that's expected for next year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [38] +-------------------------------------------------------------------------------- + + Yes. Two things here. One is it is -- these orders come in choppy. There's only a few customers there. So it means that it's not a whole bunch of customers. We get onesies and twosies to come in these batches. So that's what you have, one. +And it's about the same as we were last year. Last year, first quarter 2018, same thing, where we include the orders come from for 2019 this year, the 30 units. This was the same question, same situation, choppy. But we said at that time, before the end of 2018, we have all the orders for 2019. I think it's the same situation now. +I mean, when we look at 33 systems, we look at -- and I relate back to an earlier question, where is the demand come from? It comes from the logic transition, 7 plus, 6 nanometer, 5 nanometer for 3 customers, the potential for DRAM that we talked about in a moderate market scenario. Those are the discussion that we're having with our customers and gives us the confidence that we're preparing for these 33 unit numbers. And we will have those orders by the end of the year to fulfill 2020 like we did last year. +On top of that, we are reducing our order lead time to our customers. I mean, when we're in this phase where our customers need to order 2 years in advance, with a semiconductor industry that's quite choppy, they don't like 2 years. Those were actually agreed with them that we're going down to 18 months and 15 months and, ultimately, one hand, at the 12-month lead time for EUV systems. That gives them some more flexibility to better plan. +Well, part of that, you're already seeing. So with that planned lead time reduction, our customers will take that into account in placing the orders that are going to be choppy. And that will fill the order book to make sure that by the end of this year, we'll have the units there for 2020 shipments. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [39] +-------------------------------------------------------------------------------- + + And as a follow-up, if I may. Could you maybe give us a quick update on the business momentum out of indigenous Chinese customers across the different end markets? Have you seen any changes versus previous quarters? Any further updates from your side would be helpful. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [40] +-------------------------------------------------------------------------------- + + Yes. I think as I said in my introductory comments, these -- especially in the memory space, these investments are of a strategic nature because their greenfield companies have greenfield fabs. And the first qualification rounds of the devices that they're making have -- they actually have -- they are behind us. So actually, they are looking at ramping their first lines, and this is what we're -- that's what they're doing this year. So that will happen. So I think that -- we don't see any change there. +And I think the same is true for some of our indigenous Logic customers. They have technology transitions ongoing to either 28 or 14 nanometer, which is strategic and that happens, albeit at a somewhat lower level. I think in China we see memory quite significant volume and logic is more modest. But all those plans are stay on track. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question is from Ms. Tammy Qiu. + +-------------------------------------------------------------------------------- +Tammy Qiu, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [42] +-------------------------------------------------------------------------------- + + So firstly, I have noticed that R&D has been -- keep increasing since last year. Understand that last year you've started accelerating your R&D for the High-NA generation tools. So I'm just wondering that -- is 2019 another up year for R&D compared to 2018 and of course, the year before? Or are we actually seeing some time H1 2019 will be top of the R&D cycle? +And also secondly, after 2020, in theory, if you have done all the R&D and all the preparation for High-NA launch, your free cash flow should increasing significantly. So what's your view in terms of your future capital return program? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [43] +-------------------------------------------------------------------------------- + + So in terms of the R&D, we're looking at about EUR 1.9 billion R&D for the year. And that's what we've communicated, and I think we're on track. I think the number that you've seen for Q1 is very consistent with that number. And indeed, we said that there's a number of reasons why we're doing that. One is in the continued preparation for High-NA, pulling in of the 3400C development and also, for instance, around the development of multi-beams. So there are distinct programs that underpin that. +We've also said that we believe that in the course of 2020, we will see that we're gradually navigating that back to the longer-term 14% number that we've indicated. So you will still see a higher percentage for 2020. But in the course of 2020, you will see us navigating back to that 14% longer-term number. +I don't want to spoil the party, but we shouldn't expect that the R&D work on High-NA comes to a grinding halt by 2020. Obviously, that will continue to be there, and a significant part of the R&D work in 2021 and beyond will still obviously be related to High-NA. +But you are right, there will be a significant generation of free cash flow. And I think we've been fairly clear on that during Capital Markets Day, where we said, first off, we're going to make all those investments that we deem necessary for the continuation of the business as we run it today, which is primarily R&D, and that's the number we just talked about. We said on the M&A front that it's unlikely that there will be targets both available and attractive for us, such that there would be a significant expenditure on that front. +We will sustain our cash balances, as we've indicated. And anything that is available over and above that, we said we'll return to our shareholders. And we'll do that in a policy of increasing dividends. And I think the dividend proposal that we've given for this year, I think, is testimony to that. And anything else that we have available, we'll return in -- by way of the share buyback programs as you've seen we execute on -- in quite a disciplined way. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [45] +-------------------------------------------------------------------------------- + + Peter, I was wondering if you have any perspective on how things are happening in terms of the clients, of your clients in Logic added things to nodes in which EUV is ran. So there are some reports that the 7 plus nodes might be not as popular and successful as initially anticipated and maybe the 5-nanometer node would end up being the bigger one and the 7 plus the smaller one. So my first question is do you have any visibility and perspective on that? +And my second question is, if that were the case, does that impact in any way the cadence at which you're going to deliver your tools? Or would that be actually less impacting it? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [46] +-------------------------------------------------------------------------------- + + Yes. Pierre, I think to answer your last question, I don't think it has an impact on the cadence. What you will see is there's going to be more nodes and half nodes and quarter nodes that people are using for different purposes, a different device for different end markets and different applications. I mean, it was clear some of our largest customers in the Logic space have indeed announced nodes that they call 7 plus, 6, 5, 3 for different types of customers. +But more importantly, I think when you talk to our customers, they actually say, and especially in the foundry space, that the number of tape-outs for those devices are very significant. And I think you will see a more heterogeneous supply of those nodes for different application and different customers. So -- but when we add it all up, it is the most important. And we see what we think the EUV demand will be next year and years thereafter. There's no reason why we change our -- let's say, our moderate market view for next year. It all fits. But you will see a more heterogeneous and, thereby, perhaps for you guys, a less transparent node-to-node transition. It's getting a bit more complicated. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Your next question is from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [48] +-------------------------------------------------------------------------------- + + Barclays. Just another one on the memory space, perhaps slightly more near term. With the fourth quarter results, I suppose with third quarter results before as well, you had talked about pushouts from certain customers. I'm just wondering -- I mean clearly, you're keeping the full year guidance the same in terms of the down 20 for memory overall and down 30 as you described for the underlying business. +But just within that, as the customers are trying to find the bottom in the cycle and return to supply-demand equilibrium, have you seen any further pushouts at least from perhaps quarter-to-quarter basis within the year? Or have things been fairly steady for the last couple of months? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [49] +-------------------------------------------------------------------------------- + + I would say they have been pretty steady, Andrew. Like I said also earlier in my earlier comments, there is always the fact that we're in this digestion or this supply-demand balancing phase. There's always a question of how long will it last. And it's going to be basically a function of the bit demand for the end markets, which for DRAM, I think our latest outside analysts -- when we think about Gartner or these guys, for DRAM, hover around to 20% and for 3D NAND between 30% and 35%. +If you follow that then, and we just stick to what our customers says and say, well, you could see a rebound in their business throughout this year. And that's basically because the first thing they're going to do, like I said earlier, they've reduced their utilization, which is pretty unique for us. I mean we haven't seen that in earlier cycles to this extent, and they will first reuse that. So they will see their business pick up, of course, earlier. +So there are no signs that at this moment, in any case, that they're going to have another round of reductions. I think what they're doing is they're just trying to get the supply-demand balance in order as soon as possible by -- through their own actions. It's basically controlling the utilization, yes, and that's good. So maybe that's the reason why they feel, based on things on the 20% bit growth in DRAM and 30% to 35% in 3D NAND, that they believe -- that is why -- that somewhere in the course of this year, they'll see a rebound in their business. That could very well be. +So no, no further adjustments that we've seen. Of course, there is absolutely no security or certainty with these comments because nobody can really predict where the end markets are going. But at this moment, no change. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [51] +-------------------------------------------------------------------------------- + + All my questions have been answered. But just a quick clarification from Roger maybe, just on the CapEx. I noticed Q1 was pretty high in terms of CapEx, the proportion of sales. How should we think about CapEx for the full year? Is it going to be in line with your 2020 targets? So is it -- and should we expect something different this year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [52] +-------------------------------------------------------------------------------- + + CapEx this year will be fairly high. It will be higher than the typical run rate that we see on a long-term basis, but that's the nature of CapEx, right? It's CapEx. CapEx is -- it's not a smooth line. So this year will be fairly high in CapEx because we have quite some development preparation that we're doing for High-NA, for instance. So that's why CapEx is fairly high this year. +But longer term, the guidance that we've given for 2020-2025, that percentage of 4% is still the right percentage to look at. But it will vary over the years, up and under, and this year, it will be higher. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [53] +-------------------------------------------------------------------------------- + + So if I were to annualize the Q1 number, would that be a fair representation or too excessive? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [54] +-------------------------------------------------------------------------------- + + I think that would not be excessive. I think that is a reasonable number to go by. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question is from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [56] +-------------------------------------------------------------------------------- + + It's David from UBS. Just one quick question on the kind of pace of node introductions. I think you touched on it briefly. But we're normally having this discussion in terms of whether the cadence might slow. And overnight, it was -- TSMC has been talking about introducing a 6-nanometer node and seemingly moving to annual node introductions. I just wonder if you could comment on what you think that might mean for your Logic business going forward, whether it becomes a bit more stable and less lumpy or doesn't change it that much. +And then just as a quick follow-up, we've commented on a little bit, but given the messaging around the 3400C, is it fair to assume that the next kind of sway to the EUV bookings for 2020 is likely to be quite back-end loaded this year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + Okay. Yes, that could very well be. I mean I do expect that to be also, also given the reduced lead time. So that the -- it's more back-end loaded. But on the -- so yes. +And your first question, yes, the impact of this cadence change, like I said earlier, I think it's a bit more heterogeneous and it's more -- it's less transparent what that means. I also think customers are going to make -- customers of customers are probably going to make more application-specific choices of what they want to use with that particular application because it's not a full node. This is a half node. You can even say quarter nodes, yes? That makes it less transparent and also for us. +But we do enter discussion with our customers. We talk -- do talk about those nodes that require EUV because that's where the question is, how much EUV would they need. And in that discussion, we will just look at -- we have to look at this blend of EUV applications and the number of wafers that you would need per node. We would need to get to some kind of equilibrium almost to assess how much EUV we would need. +But everything we've heard until now with all those node changes, we do believe that what we have in our moderate market scenario for 2020 is the right number. So -- but yes, you are right. I mean it's just starting, and we don't have the full transparency on this. We'll have to figure this out as we go with our customers. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [59] +-------------------------------------------------------------------------------- + + It's Deutsche Bank. First question, just on your U.S. Logic customer, I was just wondering if you're assuming that they will roll out 10 nanometer across their 3 mega sites? Or do you think they're actually sort of revisiting what they're doing there? Because I guess it's an important assumption, given what you're seeing in their terms of DUV spend in 2019. +And the second question was just one for Roger, just on the buyback. I noticed it slowed down a lot, but clearly, you've raised the dividends. So is that just a general philosophy now to prioritize dividends over buybacks? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [60] +-------------------------------------------------------------------------------- + + Okay. Well, Robert, as you know, I mean we're -- on the U.S. Logic side, there's not many choices. So we're going to -- cannot be very specific on that customer. But I think that's -- to answer in the general sense, we haven't seen changes in that sense. +If you look at it from a point of view of the node introductions, the planned node introductions are actually happening. And the existing nodes are at high utilization because there's a particularly high demand for that current node, which is not a surprise either. And everything else is according to plan. +So we haven't seen that much change, to be honest. That's on the -- on that particular customer, but no names. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [61] +-------------------------------------------------------------------------------- + + On the dividend versus share buyback, as we said, we are looking also on a go-forward basis, we are looking on growing dividends. I wouldn't people -- I wouldn't want people to assume that it's going to be a 50% uptick every single time, but we are looking at a policy of growing dividends. +That's -- as I already answered to a previous question, given the free cash flow generation that we expect in the years to come, we believe there will be significant amounts available also for share buybacks, and particularly on the share buyback program that we're looking at for this year and for the previous year. Indeed, the amount that we have in this quarter was fairly limited, but we are expecting to complete that program by the end of this year in accordance with what we've indicated. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [62] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. If you're unable to get through on this call and still have questions, please feel free to contact ASML Investor Relations Department with your question. Now operator, may we have the last caller please? + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Our last question is from Mr. David O'Connor. + +-------------------------------------------------------------------------------- +David O'Connor, Exane BNP Paribas, Research Division - Analyst of IT Hardware and Semiconductors [64] +-------------------------------------------------------------------------------- + + Great. It's David here from Exane BNP. Maybe Peter, 1 or 2 smaller follow-ons from previous questions. Firstly, the smaller node transitions and the cadence change that we're now seeing, what does that mean for the change in customer ordering patterns for ASML? Does that smooth the kind of ordering? And how should we model that from a litho intensity viewpoint? +And maybe just one second question on the Memory customers in this cycle reducing utilization versus the previous cycle. What do you think is really behind that? What's the real big change there? And can we expect that in future cycles going forward? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [65] +-------------------------------------------------------------------------------- + + I think I don't know exactly what is behind that. You should ask our customers. But it's just simply what we are seeing. I think it is -- had a certain logic to it. I mean you can keep your utilization as high as you can, but just -- that basically means you're driving the cost per device down, so the cost per chip, because you basically use the fixed cost pattern. That's one strategy. +The other strategy is to say -- but that could mean that the cycles last longer, yes? You could also have a strategy, say, basically, we would have shorter cycles. They go a little bit deeper, but then the recovery is also faster. And I think this is where -- when you see this, and quite a significant reduction in utilization in the memory space, that looks like that's the type of decision that they've taken. +On the small node transitions, the change in order patterns, I don't think so. What I basically think is that it's more the end markets with our customers where they have different nodes that they can offer to their customers and different nodes for different purposes, different customers, whereby the positive here is that the tape-outs that our customers are talking about, the number of tape-outs, are as high as ever. +So that means that there's a lot of demand for different solutions. And as long as you all use EUV, I don't see it's going to be any choppy pattern here or a smoothing of their pattern. They think -- it doesn't make a big difference in my opinion. It's just more diversity. So no big change. I don't expect that. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [66] +-------------------------------------------------------------------------------- + + Now on behalf of ASML's Board of Management, I'd like to thank you all for joining us today. +Operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes the ASML 2019 First Quarter Financial Results Conference Call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2019-Jan-23-ASML.txt b/Transcripts/ASML/2019-Jan-23-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f259e45e31fa7a52d4a33902e0819aee0a6eac1 --- /dev/null +++ b/Transcripts/ASML/2019-Jan-23-ASML.txt @@ -0,0 +1,578 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 ASML Holding NV Earnings Call +JANUARY 23, 2019 / 2:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * R. J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Sreekrishnan Sankarnarayanan + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to ASML 2018 fourth quarter and annual financial results conference call on January 23, 2019. (Operator Instructions) I would now like to open the question-and-answer queue. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Go ahead, please, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Right. Thank you, operator. Good afternoon and good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today from ASML's headquarters in Veldhoven in The Netherlands is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. +The subject of today's call is ASML's 2019 fourth quarter and annual results. The length of this call will be 60 minutes, and questions will be taken in the order they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in the ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning, good afternoon, ladies and gentlemen. Thank you for joining us for our Q4 and 2018 annual results conference call. +Before we begin the question-and-answer session, Roger and I would like to provide an overview and some commentary on the fourth quarter and the full year 2018 as well as provide our view of the coming quarters. Roger will start with a review of our Q4 and full year financial performance with added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Roger, if you will? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. I will first highlight some of the fourth quarter and full year financial accomplishments and then provide our guidance for the first quarter of 2019. +Q4 net sales came in at EUR 3.14 billion, slightly higher than our guidance. Net system sales of EUR 2.42 billion was more weighted towards Logic at 60% with the remaining 40% from Memory. We shipped 6 EUV systems and recognized EUV revenue of EUR 579 million from 5 shipments. 1 system was shipped to collaborative research center Imec, was not recorded as revenue, which we mentioned last quarter. +Installed Base Management sales for the quarter came in at EUR 719 million. Gross margin for the quarter was 44.3%, which was negatively impacted by the Nikon settlement. Without this charge, the gross margin was 48.5%. +We signed a memorandum of understanding with Nikon to settle our legal disputes over the alleged patent infringements that was initiated by Nikon. Therefore, we recorded a provision in our 2018 accounts, which has a negative impact of EUR 131 million on gross margin in 2018. Overall, R&D and SG&A expenses came in a little higher than guidance with R&D expenses at EUR 442 million and SG&A expenses at EUR 135 million. +Turning to the balance sheet. EUR 345 million worth of shares were repurchased in Q4. This leaves around EUR 1.35 billion of the 2018-2019 share buyback remaining. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 4.03 billion, which was higher than expected due to early payments by multiple customers at the end of the year. +Moving to the order book. Q4 system bookings came in at EUR 1.59 billion. Logic order intake was 80% of total value with the remaining 20% from Memory. We took 5 new EUV orders in the quarter. +For the full year, our net sales grew 22% to a record of EUR 10.9 billion. Net Installed Base Management sales was similar to last year at EUR 2.68 billion. We shipped 18 EUV systems with a total EUV system sale of EUR 1.9 billion, representing a significant growth over 2017. +Our gross margin for 2018 was 46%, which would have been 47.2% without the Nikon settlement charges. We made considerable improvements on our gross margin in 2018 and remain on track to achieving overall gross margins exceeding 50% in 2020 as confirmed during our Investor Day in November last year. +We continue to invest in the long-term future of ASML and increased R&D from EUR 1.26 billion in 2017 to EUR 1.58 billion in 2018. The increase was primarily driven by the acceleration of our EUV road map. Overall, R&D investments as a percentage of 2018 revenue was about 14% and SG&A was about 5 -- 4.5% of revenue, both similar to 2017 as a percentage of revenue. Net income for the full year grew 25% to a record of EUR 2.6 billion, resulting in 23.7% of net sales and an EPS of EUR 6.10. +With that, I would like to turn to our expectations for the first quarter of 2019. We expect Q1 total net sales of about EUR 2.1 billion. The lower revenue guidance is due to a combination of revenue pull into Q4 2018 as well as a reduction in shipments due to a fire at one of our suppliers, Prodrive, and some system demand change. +As announced in a press release on December 3 last year, there was a fire at one of our suppliers of electronics components and modules. This resulted in a loss of work in progress as well as some inventory. Due to the integral cycle time of about 1 quarter for these modules, our first quarter sales will be negatively affected -- impacted by around EUR 300 million, which we expect to largely recover in Q2. We expect the remainder to be recovered in the second half. +Our total net sales forecast for Q1 includes around EUR 300 million of EUV system revenue. We currently expect to ship 3 EUV systems in Q1. We expect our Q1 Installed Base Management revenue to be around EUR 600 million, which is primarily due to lower field upgrades as a result of the Prodrive fire. +Gross margin for Q1 is expected to be around 40%. The lower gross margin is due to a combination of mix, lower field upgrades, factory loading and EUV service burden. The mix relates to a reduction in higher-margin immersion systems and field upgrades as a result of the Prodrive fire and some system demand change. With lower system sales, there is also a reduction in factory loading, which has a negative impact on gross margins. +As our EUV installed base continues to grow, we must expand our service infrastructure to support these systems in the field, which is an increased burden on gross margins until we start collecting service revenue later this year. We see the impact from these items continuing into Q2 with an expected recovery in second half. +The positive margin recovery in the second half will be driven by higher revenue, does improve factory loading as well as increased field upgrades, and we will start shipping the higher-margin NXE:3400C, in addition to realizing EUV service revenue. We expect to move towards our 2020 target of over 50% gross margin as we exit the year. +The higher R&D expenses for Q1, around EUR 480 million, are due to an acceleration of the NXE:3400 road map and growing investments in the High-NA EUV program. SG&A is expected to come in at around EUR 130 million, which is similar to prior quarter. +Although we are currently going through a period of uncertainty in the industry, we look forward to a growth opportunity in 2019. As we remain confident in our long-term growth, we will propose a 50% increase in our dividends to EUR 2.10 per share at our Annual Shareholder Meeting, which takes place on April 24 in Veldhoven. The dividend payment is valued at around EUR 880 million. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger highlighted, we had another good quarter, closing a great year for us with a record demand from our memory and logic customers combined across our entire product portfolio. While the current geopolitical landscape and economic environments are creating volatility in the markets and uncertainty on the near term, as mentioned before, we still expect overall growth in 2019. +At the very end of last year, we saw the continued slowdown of memory end market demand as well as some demand reduction in the logic end markets primarily driven by the mobile and the server markets. And this translated into pushouts of our planned systems to both memory and logic customers from the first half 2019 in their attempt to regain balance of supply against demand. +The net market, as mentioned today -- in prior quarters, remains in an overbuy situation -- oversupply situation and is going through a digestion phase after a period of significant 2D to 3D conversions, yield improvements and wafer capacity additions. +DRAM is experiencing softening of bit demand, largely driven by decreased demand in mobile market as well as some inventory correction in the server market. All this has resulted in some pushouts of planned shipments by memory customers in the first half of 2019. Customers have indicated that they believe there will be a recovery the second half of the year, and they expect that inventory levels will be managed down swiftly. +In Logic, while we see some softening in Deep UV demand, which is primarily driven by the mobile market, we still expect strong demand in support of the ramp of 10 and 7-nanometer nodes. We also expect to see strong growth in EUV demand, supporting the customers' ramp of 7 and 7-plus nanometer nodes as well as a transition to the 5-nanometer node. +Although future developments in the macroeconomic environment can impact our current view, currently expect Logic demand to increase around 50% year-over-year and Memory to be down around [20%] year-over-year. We still expect single-digit percentage growth of Installed Base revenue. In summary, 2019 will be a growth year, largely driven by Logic. +On the ASML product side, we -- let me start with update of our EUV business. In EUV, we continue to make solid progress as evident in the positive public comments from our logic and memory customers with the use of EUV in their most advanced nodes. Logic customers are installing systems in support of volume manufacturing for the 7 and 5-nanometer nodes. DRAM customers are also working on qualifying EUV with their future nodes. And this year, we expect that the first commercial EUV-enabled chip reach the consumer market. +2018, we demonstrated over 145 wafers per hour, and we are accelerating our EUV road map to deliver 170 wafers per hour with our NXE:3400C with first shipments planned in second half of 2019. NXE:3400C will also include a number of innovations that will further improve availability. +As Roger mentioned, we shipped 6 systems in Q4, which translates to a total of 8 EUV shipments in 2018. With the 5 orders booked this quarter, our shipment plan of 30 systems for 2019 is covered. +In Deep UV, we shipped out 189 systems in 2018, an increase of 17% over 2017, and we were able to further increase our output in support of the demand from both logic and memory customers. And we continue ramping our latest immersion system, NXT:2000 with a record time to achieve mature customer yields. +Our application portfolio has continued to see strong adoption in all market segments. Our latest YieldStar system continues to gain adoption in memory customers following the strong adoption we saw in Logic. Integrated products using the combined technology of HMI and ASML are being evaluated at multiple customer sites to help improve customer yields and time to market. +So to summarize 2018, our fourth quarter came in slightly above our guidance, and we nearly achieved EUR 11 billion sales for the year, which was a milestone originally set for 2020. Although 2018 was a very good year from a financial perspective, I think it was also a milestone year in terms of technology innovations across all our products. This not only provides our customers with higher value solutions, it also fuels our future growth. +Turning to 2019. We currently see some uncertainty in the market, but after a long period of strong capacity investments, driven by healthy demand over the past years, it is normal to see a period of digestion, which we expect in first half of 2019. +With regards to the markets we serve, our customers responded quite late in Q4, slowing demand in their end markets by delaying deliveries of litho systems for the first half of 2019 to balance supply and demand. We now see our first half of 2019 lower than the second half of 2018 with the reduction being roughly an equal split between Memory and Logic. +The fundamental drivers of high-performance compute with associated high-performance memory and data storage are still in place and our customers clearly indicated the need for a strong shipment settled in the second half of 2019 in support of their 2020 business potential. The demand in the second half of 2019 will, therefore, be 50% higher than the first half of the year. +For 2019, the Logic segment is expected to be the growth driver, investing strongly in technology transitions as well as production capacity with our advanced nodes. As we have consistently done in prior slowdowns, we sustained or even accelerated our investments in R&D, deliver on the leading-edge technology where the market turns up, which has been and will be the key driver to secure our long-term growth. We expect to increase our investments in R&D to EUR 1.9 billion for 2019. +We reiterate that we see market demand that supports yet another growth -- supports yet another year of growth for ASML in 2019 with significantly stronger demand in the second half of the year. As Roger explained, we see similar developments in our profitability with lower margins expected in the first half of 2019, improving towards our 2020 targets of over 50% as we exit the year. +Despite some uncertainty in the current environment, we remain confident about our sales and profit targets for 2020 and beyond as we communicated during our Investor Day in November last year. We're happy to underline this confidence with our proposal of a 50% increase in our dividend. +And with that, we'd be happy to take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Mitch Steve. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [2] +-------------------------------------------------------------------------------- + + Mitch Steves from RBC. I just had to really focus on the Q1 and kind of the quarterly numbers going forward. So I understand a EUR 300 million hit from the fire, but how do I think about kind of June and then going forward to September, December in terms of sequentials? And secondly, also for the gross margin line, I think it's pretty difficult to get from 40% to kind of 50% at the exit. So any help there would also be very useful. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [3] +-------------------------------------------------------------------------------- + + Okay, thank you. So let me start by talking about the gross margin and the gross margin drivers, if you like, in the first quarter and then reconciling that to how we see the rest of the year. So as I mentioned in my introduction, the main drivers of gross margin in the quarter, so bringing back the gross margin from 48.5%, which is the gross margin that we had in Q4 if you adjust for Nikon and then bringing it down to the 40% that we essentially guide for Q1, the main drivers there are the loading in the factory. As we said, that is the result of obviously, lower sales level. That would account for about 1% in that bridge. The second element is the mix in DUV, and that is essentially as a result of some of the pushouts from the first quarter into essentially the second half. And that generates approximately a 2.5% impact in that bridge of the gross margin. The biggest impact on gross margin actually is from what we call the field upgrades and service, and that has 2 components to it, and I mentioned both components in my introduction. One component is the lower field upgrades. And the lower field upgrades that we expect to have in Q1 are, to a very large extent, related to the Prodrive situation because it means that there is no availability for field upgrades for certain components. So that's one element. And if we talk about the EUV's -- EUV service burden, which I mentioned in my introduction, again just to recap what we mean by that, as you know, the installed base in EUV is growing. A number of our customers are looking into high-volume manufacturing for EUV, not too long from now. That means that we have to support them, obviously, in the field to get everything up and running. While the revenue associated with the service from EUV will only kick in once wafers are being produced, which we expect to happen at the end of this year. So that means that we have a significant cost burden right now, while the revenues only kick in at the end of the year. If you take those 2 together, so the lower field upgrades and the EUV service burden, that accounts for approximately 4% in that gross margin bridge that I gave you. And then there's about 1% left, which is miscellaneous. That has a number of elements in there. So that kind of gives you the bridge from the 48.5% to the 40% that we had in Q1. Now back to your question, how is all of that going to -- how we going to recover to normal margin levels, if you like, in H2, and as I mentioned, how we going to get from this situation into the -- towards 50% gross margin that we expect as we exit 2019 into 2020. So as it relates to the mix effect and also the loading effect as a result of the uptake of the business that we expect for the second half, that is what is the main driver -- the main driver behind that. We also expect some of the field upgrades that we lost as a result of Prodrive in the first quarter. We expect some of that to be recouped in the second half of this year. Third important point in getting the margin up to that level is the shipment in the course of the second half of the 3400C model, which is the model that, as you know, has a significantly better margin profile. And then, finally, again related to what I just mentioned at the end of this year when high-volume manufacturing starts to kick in on EUV, that's where we also expect service revenue to come up. So that's essentially how we came back from 48.5% to 40%. But also, it gives you the bridge how we believe we're going to exit the year at the level of towards 50% gross margin. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [4] +-------------------------------------------------------------------------------- + + Yes. And Mitch, let me answer the, I'd say, the Q-on-Q sequence. Let me say half-on-half sequence. So first of all, I'd like to reiterate what I said earlier that, for the year, we expect the Logic sales to be 50% up from last year, Memory about 20% down and a single-digit growth in Installed Base Management. Now you can add it all up. And if you then come to that number, that sales number will be divided half-on-half. As such, we believe that the second half of 2019, as I said earlier, will be about 50% higher than the first. So if you take those numbers, then you can calculate the Q-on-Q, I would say, the half-on-half trend. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [6] +-------------------------------------------------------------------------------- + + Sankar from Cowen. Thanks for taking my questions. I have 2 of them. First one, Peter, given the DRAM outlook has incrementally worsened over the last couple of months and now you view that these tools that have been pushed out from first half into second half of the year, what kind of tangible data points that you or your customers have on a conviction in the second half shipment recovery? And is there a risk it can get pushed out further? And I also had a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [7] +-------------------------------------------------------------------------------- + + Yes. I think, Krish, that is a good question. I think what our customers are actually seeing is what their customers are telling them what they need. So there's nobody there with a crystal ball that can say -- that can tell us that the second half is going to be absolutely certain at a certain level. It's simply not there. I think, therefore, the economic uncertainties are simply there, and they need to basically stabilize to give us a bit more confidence. However, having said that, the feedback we get, especially from our DRAM customers, is that -- from our largest customers, is that they said we should not underestimate their ability to react swiftly and that's what they have done. So they said, to what we are looking -- where we're looking now, that is a 20% bit growth or even slightly less this year. And then looking what they have installed in terms of capacity and their ability to react swiftly, which they have already done, they believe that, with that bit demand, they should be back into a more positive territory in the second half of this year. That's what they've told us. But again, if you're asking for absolute certainty, which somebody did during our press conference this morning, there is no absolute certainty, but it is very much related to the economic environment. But based on these data points, our customers believe that we need to be ready to start shipping again in H2. + +-------------------------------------------------------------------------------- +Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [8] +-------------------------------------------------------------------------------- + + Got it, got it. Peter, that's very helpful. And then just as a follow-up. When I look at your memory orders in Q4, it's like down almost 80% from the peak, and it's also back to like early 2016 levels. So should we expect memory bookings to rebound in calendar Q1 in the current quarter? Or do you think it's going to take a quarter or 2 before you see that happening? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [9] +-------------------------------------------------------------------------------- + + Well, it is what I said earlier. I think it is a swift reaction. So it's quite a significant reduction. And I think that the low memory order intake is a reflection of what the customers decided they wanted to do in Q4 with respect to the 2019 shipments. Now if they're right, on the second half of the year, we should see a rebound of those orders in the course of the year. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question comes from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [11] +-------------------------------------------------------------------------------- + + It's David Mulholland from UBS. Just one question, firstly, on the EUV road map. Obviously, you talked a lot about this at your Capital Markets Day and, at some point, this needing to move towards multipatterning. I think some of the comments that we've seen in some industry events were suggesting that might even be the case at kind of the 5-nanometer node or the industry 5-nanometer node. So wonder if you could maybe comment on how you see that progressing, and then I've got a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [12] +-------------------------------------------------------------------------------- + + Yes. I think if you talk about the industry 5-nanometer node, which some of our customers then call the N3 node, yes, there is some discussion on this. Now I don't think we can say with 100% certainty that it's going to happen, but it's definitely something that's being considered. That's correct. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [13] +-------------------------------------------------------------------------------- + + And then just in terms of the follow-up. On the comment you made on China, I'm still seeing looking quite strong even after what happened on one of the customers there being banned from buying from the U.S. Have you started seeing more confirmations on orders from the likes of YMTC or Innotron at this stage? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [14] +-------------------------------------------------------------------------------- + + Well, I think the -- you have to make a split between the domestic and the nondomestic customers. I think some of the slowdowns that we have seen, they do relate to the nondomestic Chinese customers and effects about the Chinese fabs, but the domestic demand is still as strong as it was 1 or 2 or 3 quarters ago. I mean -- and it's understandable. If you look at what they're doing, I mean, many of those starts are new. They are strategic investments. Some of their products have been qualified. And that means they can start ramping, which I think, from a strategic point of view, is something that they will do anyhow, which is also a -- I think, a confirmation of the fact that what they say they're going to do. I mean, that's what we see today. So yes, from a domestic point of view, that was pretty strong. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [15] +-------------------------------------------------------------------------------- + + Just one quick follow-up on the comment in your response to the multipatterning question. What assumption had you made in the model that you presented for 2025 on the industry 5 node? Were you assuming single patterning in that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [16] +-------------------------------------------------------------------------------- + + I don't think so. It was not there. And I think it's still uncertain whether it will happen, but we assume single patterning solutions. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + The next question comes from Mr. John Pitzer. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [18] +-------------------------------------------------------------------------------- + + Yes, it's Credit Suisse. Peter, you did a really good job kind of helping us understand for the overall business how that half-on-half recovery will look like in 2019. I'm wondering if you could just do the same thing for sort of the EUV expectations. Clearly, given the slower start to the year, it feels like the half-on-half growth in EUV needs to be even stronger than the 50% you referenced for the overall business. And I'd be curious, as you think about 30 tools for this year, how that breaks down Logic versus Memory. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [19] +-------------------------------------------------------------------------------- + + Yes. Well, to answer your last question, we, of course, have a customer that does both. So -- but if you could say -- I would say about 80% to 90% is going to be Logic, yes, and 10%, 15% DRAM related, but we have 80% to 90% Logic. And it's true. I think you will see the same pattern for EUV shipments in the second half of the year being significantly higher than the first half. That's the fact that, that was actually planned also. I don't think it's got anything to do with the pushback. It's more than just the logistic planning of our customers shapes this pattern, yes. So yes, it's going to be more than 50%, but it's just a matter of planning logistics, which we already had. Nothing changed there. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [20] +-------------------------------------------------------------------------------- + + Helpful. Then as my follow-up for Roger. Can you just talk a little bit about the R&D costs going forward? It was a little bit higher than we were modeling, both in the December and the March quarters. How should we think about R&D here? And you mentioned kind of the cost you're incurring now for EUV service without service revenue. Is that now fully baked into the model so that it's now a leverageable event as EUV revenue ramps? Or how do we think about that? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [21] +-------------------------------------------------------------------------------- + + Yes, so let me start with answering that latter question. The answer is yes. So that is modeled -- that is included now in the model, for sure. On the R&D side, the guidance we get for Q1, EUR 480 million, in essence, that's kind of the run rate that we would expect for the quarters in this year. So our expectation for the full year would be about 4x this number. And so the number that we expect for 2019 with the road maps in there that you're very familiar with, particularly the High-NA, the pulling in of the 3400C multibeam and a number of other things. Going into 2020, I think the guide that we gave there at that stage of around 14% of our revenue, that's probably where we see that for 2020. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + And perhaps on the R&D number for 2019, I think where we said we took the decision to accelerate the introduction of the 3400C and High-NA as the logical next node in EUV, the multibeam development, we accelerated in the second half of 2018 the hiring of the people to make sure that, at the beginning of 2019, we had all the people onboard. So if you take our Q1 guidance, this is -- and you basically take that on average -- or sorry, on an annual basis, you can argue that we actually created the infrastructure -- R&D infrastructure to do this, and we wanted to finalize that by the end of 2018. And this is what we did. So this is basically the full year effect that you're seeing now in 2019 of the decisions that we have taken in 2018. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [24] +-------------------------------------------------------------------------------- + + It's Pierre, New Street Research. I was wondering about like the inflation of the 3400C later this year, how this is going to look like in terms of deliveries. Is there a point in time from which all of the vast majority of your deliveries are related to 3400C? Or is it going to be more gradual with like half of shipments being B, half of shipment being C? And then do you have any update or more like color on how is the economics are going to work between the 2 tools, so the difference in ASP? And then last but not least, I was wondering if your B tools that you are shipping today are going to be upgradable to C and, same thing, what the economics would be there. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [25] +-------------------------------------------------------------------------------- + + Okay. Yes, the 3400C will ship in the second half of the year, and you could assume that any ship within Q4, they will be Cs, yes, and some of it will be in Q3. But the majority of the shipments this year will still be Bs, and everything that we're booking now are Cs. So it's going to be a handover, you could say, from the B to the C starting in the end of Q3. Roger, you want to take the economics? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [26] +-------------------------------------------------------------------------------- + + So on your other 2 questions, on the economics, as you know, in terms of the specs, the current machine that we ship has a spec of 125 wafers per hour. We've guided that for the 3400C. It's going to be 170 -- more -- over 170 wafers per hour, which means approximately a 35% increase in the throughput. And I think as we've guided in the past, you can typically assume that the ASP kind of correlates with that percentage. So currently, the ASP for the machine that we ship today is about EUR 100 million. So you can kind of calculate what the ASP expectation is that we have for this machine. In terms of upgrades, indeed, we do have options to have a part of the performance update that the C has over the B to also make that available to the B machines in the form of upgrade. Not entirely, but the vast majority of the performance upgrade can be obtained through a few upgrades. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [27] +-------------------------------------------------------------------------------- + + Yes. But having said that, I mean, it's going to be a question of economics on this because it's a different lens. So actually, basically, you need to be able to take the hit of quite an expensive upgrade and that, of course, needs to be balanced with the real performance of the B and the real performance with -- of the C. So we'll just have to see whether that's going to happen. But when it happens, it's going to be an expensive -- an upgrade. But having a new lens into that system is not trivial. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + Peter, just as a follow-up to the prior question. After 30 system -- EUV system in your backlog, how should we think about the mix of the 3400 -- 3400C, I'm sorry. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [30] +-------------------------------------------------------------------------------- + + Yes. It's the -- sort of like I said, the fourth quarter shipments will probably be -- are going to be all 3400Cs. So if you think about this, it's probably going to be around, yes, 5 to 10, but the total is 13. But now I'm going to confuse you that some of the Cs will have -- be fully upgraded new vessel, yes, which is 5 to 10. So there's going to be an in-between version of the 3400C, which was at a, we could say, older-type EUV source vessel. So it's 13 in total. But really, the ones with all the new vessels is going to be 5 to 10. We try to do 10, could be 5 if the supply chain is a bit slower than we think. But overall, it's going to be 13. And that also means that from a price point of view, we will start -- of course, it will be higher, but the 35% that Roger mentioned, that applies to the full-fledged 3400C with the new modular vessel. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + Got it, okay. And I have a follow-up regarding the -- just the big picture and how do you see the overall demand environment. If I were to strip away the EUV revenue, it seems like the core business could have a couple of quarters of sequential decline, which is typical of a downturn. If I were to look at the late '15, early '16, you had 3 quarters of sequential decline in revenues. And the prior downturns were also a multiquarter revenue decline. In that context, how do you see the current downturn compared to prior cycles? What is different now? And what are the things that are similar to the prior downturns? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [32] +-------------------------------------------------------------------------------- + + Well, downturns are always similar in the sense that supply is higher than the demand. And now the question is how big is that difference. To be very frank, we can only repeat or tell you what we get from the discussions from our customers because they have a better view of their market in the discussions with their customers. So this is -- I can only repeat what I said earlier. They talk about a 2-quarter correction in inventory. That is driven, I think, very much by the macroeconomic situation and the macroeconomic uncertainty. So this is a big crystal ball that I don't have and nobody has, so we'll have to see. I'd like to really comment on what you started your question off with, and that's of if you strip away EUV and look at the core business. May I remind you that EUV is our core business, yes, and that we can only ship those leading-edge Deep UV tools because there is EUV solution for 7 and 5-nanometer. Without the EUV, there would not be a 5 and 7-nanometer transition. So that means that everything that we are shipping is -- and that includes EUV, has to do with the technology transitions that our customers are planning to actually capture the value of everything that we still talk about and that will happen which has to do with cloud, Big Data -- and I could repeat the whole thing again. That is unabated. That will happen. And you cannot strip EUV out because it drives this technology transition. It's part of the core business. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [34] +-------------------------------------------------------------------------------- + + Evercore ISI. I guess, Peter, another follow-up excluding EUV, which you may not like. But if you look at 2019, and if I pull out immersion, which is obviously being weighed down by pushouts on the Memory side, and excluding EUV, what's interesting, I guess, it looks like KrF and ArF dry and i-Line are actually growing year-on-year. So can you kind of walk through what you're seeing that's driving that, whether it's legacy 200-millimeter China advanced logic? Would love to hear what is driving that, including as well whether there's a rising litho intensity that we should be thinking about. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [35] +-------------------------------------------------------------------------------- + + Yes. I think it's -- C.J., that's answered as well as you are right. If you read those numbers, I think there are 2 areas where we see, from a product point of view, an increase, which is eerie, which we talked about. And like I said earlier, you cannot strip this out because it's just part of the entire development in the industry. And indeed, we have KrF. We have dry. Deep UV is also higher currently than what we think that we saw in 2018, and that has to do with, indeed new fabs, has to do with China. It is not that much higher, but indeed, it doesn't show a reduction in system sales. And this is also what Roger referred to, that this mix, this Deep UV mix, which is a mix of immersion and KrF, is of course in the first half leading to this 2.5% reduction in the gross margin. But with the immersion systems picking up in the second half, that will resolve itself. But it is indeed the right correction -- the right conclusion that you drew of the KrF systems being higher than in previous quarters. And of course, EUV in entirety of 2019. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [36] +-------------------------------------------------------------------------------- + + Very helpful. And as a follow-up, I guess, specific to EUV gross margins, it looks like you came in around 20% in Q4 of '18, if I pro-forma that onetime charge. I think you've talked about exiting calendar '19 at 30%. Can you walk through how we should think about the ramp there? And as well, can you talk about where you're seeing bottlenecks? Is it still primarily Carl Zeiss? Are we still at roughly 9-month cycle time? Can we get it down to 6? Would love to hear the working parts to gross margins and cycle times as we go through the year. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [37] +-------------------------------------------------------------------------------- + + The main driver of that improvement is that we already mentioned the introduction of the 3400C model. So that is the main driver through its higher ASP. Of course, there is an element in there of further reducing cycle time, and as a result of that, being more efficient in the manufacturing of the machines. But the main driver in getting to this uptick of 10% in the gross margin on systems really is the higher ASP on the 3400C model. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [38] +-------------------------------------------------------------------------------- + + And then on your question on the 20%, I think you're about right when you say the blended EUV margin is about 20%. The system margin, by the way, is over 30%. So that goes into the right direction. The issue is, and I said it earlier, that we decided in 2018 to at least make sure that we step up the infrastructure for EUV service that we are at that point. We're not going to grow that any further in 2019. But we do get the full brunt in terms of cost starting January 1, 2019, because the EUV infrastructure, given the ramp profile of our customers, needs to be ready and the learning curve for our people in the field is more than a year. So that effectively brings the blended EUV gross margin down. And we said it earlier, we don't have yet coverage of that EUV service infrastructure. It will only start by the end of the year when we start seeing the first HVM, high-volume manufacturing, wafer output, for which we will get paid. And of course, that will accelerate throughout 2020 and beyond. So the service burden, and Roger talked about it, is I think the main reason why there is a gap between the 30% and the 20% that you calculated. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [40] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. Just a quick question, if I may, to begin with on the Installed Base Management side of things. Given your comments, you've talked about a mid-single-digit or a single-digit growth in installed base over the course of 2019. Just wondering if you could elaborate on the puts and takes of that and what could push it lower or higher. The reason I ask this is because, as I look at the number for 2019 and then I look at some of the scenarios you had laid out for 2020, I think the Installed Base number was seen at about EUR 3.6 billion to EUR 3.7 billion in 2020. Just wondering if you still think you could get to that number, what would drive that around? And again, what would be the implications for gross margin? Because I do understand this is a [lid] of the higher gross margin. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [41] +-------------------------------------------------------------------------------- + + Yes, yes. I think on the gross margins, you do understand this always will have an impact -- a positive impact on the gross margin. But the single-digit number for this year is also driven by what Roger said earlier. I mean, we did have a supply chain issue because of the supplier of some of the electronics and the motion control, Prodrive. That fire had an impact on the upgrades that we were planning to do in the first half of this year. Now we're using those components to shipments. That actually means that the upgrades are coming back in the second half of the year, but those are complex upgrades for which we simply don't have the service capacity to do all the upgrades to basically catch up 6 months -- or it's actually 12 months of business in 6 months' time. So for the year, you would see that, that actually gives you a lot -- you just lose upgrade business, and that brings the growth percentage down to single digit. Now hopefully, I do assume we do not have a similar situation in 2020. And then, it should really correct itself. So it is the single-digit growth has to do with the fact that we cannot recuperate 12 months in 6 months. That's the main reason. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [42] +-------------------------------------------------------------------------------- + + okay. So you still are quite confident in getting to that EUR 3.6 billion, EUR 3.7 billion. It's just a temporary issue? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [43] +-------------------------------------------------------------------------------- + + Still our target. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [45] +-------------------------------------------------------------------------------- + + This is Stephane Houri from ODDO. I have a question about the second half outlook. Just to understand a little bit more what you're saying basically. Are you banking on any recovery in the memory DRAM or nonspace to talk about this tool increase? Or is it just based on the Logic business? And if ever it was happening, do you have enough -- would you have enough capacity to meet the demand? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [46] +-------------------------------------------------------------------------------- + + To answer your last question, yes, we will have enough capacity. Generally, it's really driven by Logic, a strength in the second half. We do expect, when we talk to our memory customers, that we do expect some recovery in H2. But when you look at H2, it will be a strong Logic-driven half. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [47] +-------------------------------------------------------------------------------- + + Okay, okay. And I have a short follow-up. You said during your remarks that the EUV deliveries, the 30 machines that you're talking about, were covered by your order book. How do you see 2020 for EUV shipments? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [48] +-------------------------------------------------------------------------------- + + 2020 shipments, well, I can only refer to what we showed at the Capital Markets Day where we showed you the moderate numbers. You should take that number. Now that can change. And as a very wise person told me lately, I'm an optimist that worries a lot. So -- but I am optimistic on 2020 because I'm optimistic on the performance of the 3400C. And that means that if we can prove, and I think we will, that by the end of this year you have a EUV tool that has availability of over 90% with 170 wafers per hour and the economics for EUV are so convincing that I believe that our customers are definitely going to -- will look at their plans and you'll see which layers in Logic, but particularly at DRAM, are now eligible for EUV introduction. So I would refer to right now -- I would refer to the Capital Markets Day and the moderate market scenario we've put in there. It gives you the EUV number. But I -- that also tell you that I've been very much looking forward to the performance of the 3400C, which we have a lot of confidence. And that might trigger additional demand in 2020. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [50] +-------------------------------------------------------------------------------- + + It's Bank of America. Two questions, if I could. Firstly, just looking through the ramp that you'll need to deliver on EUV and DUV, I just wanted to better understand what EUV tool capacity you will have in the second half of this year. My understanding was it will be 10 per quarter in 2020. So any color there would be very helpful. And then secondly, just trying to practically think about why R&D would come down in 2020 versus 2019 levels. Practically, what exactly will drive this cut? If you could give some color on that, that'd be helpful. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [51] +-------------------------------------------------------------------------------- + + Yes, I think the shipment capability, I think you're about right. The second half of the year, in Q4, we should have a tempered quarter run rate, which actually means, to one of the earlier questions, that the cycle time is coming down -- the factory cycle time. The integral cycle time of EUV, which includes also the supply chain, is still well over 12 months. But our integral cycle time in the factory should go down to anywhere between 15 and 18 weeks. So that is a big task for us. And that will actually mean that we will be able to do 10 shipments per quarter. + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [52] +-------------------------------------------------------------------------------- + + As it relates to R&D, an important portion of the acceleration of the R&D effort that we talked about is related to the introduction of the 3400C model, which, as we've already explained, is going to happen this year. So with that essentially done, that means that there is some leeway there and that we would be able to manage down the total R&D expenses because that research is done. And we're very well able to do that because, in addition to all headcount that Peter already talked about, there is a lot of farm-out that we have there. So in that way, we think we can manage that down to the number that we've guided for 2020. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [53] +-------------------------------------------------------------------------------- + + Understood. And just a quick clarification on Q2 gross margin. You clearly said gross margins will improve in the second half. Would it be reasonable to assume that Q2 gross margin will be similar to the Q1 gross margin? Or would that be too pessimistic? + +-------------------------------------------------------------------------------- +R. J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [54] +-------------------------------------------------------------------------------- + + We'll get there in a couple of months. As we said, we think the conditions that exist for Q1, to a very large extent, also exists for Q2 and the major recovery items that we discussed are going to kick in, in the second half. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [56] +-------------------------------------------------------------------------------- + + It's Andrew from Barclays. I had another one on EUV, also one follow-up and then another question. Peter, in response to an earlier question, you suggested that, indeed, there had not really been any change to delivery plans or shipment plans through the quarters of 2019. Clearly, you're still saying 30 units in total but I just wanted to, first of all, make sure that, indeed, your customers haven't really changed any plans on that front. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + Yes, that's correct. I mean, we haven't seen any customer pushbacks on the EUV shipments. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [58] +-------------------------------------------------------------------------------- + + Okay. And in relation to that, there's some discussion in parts of the industry and parts of the financial markets about perhaps not so much concerns on your customer side but (inaudible) side but perhaps the customers' customer, some of the fabless guys with a little bit of trepidation as to how the ramp of EUV is going to go and what that means for high-volume manufacturing and their ability to get the chips out to the other side. Are you having -- are you hearing those fears? Are you having those discussions with some of the fabless chip vendors? What are you doing to help sort of, yes, satisfy those concerns? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [59] +-------------------------------------------------------------------------------- + + Well, the customers are our customers. They're a bit more distance, as you can imagine. We do have interactions with customers of customers, but that's largely on the road map and not so much on the operational situation at our customers. I mean, we don't discuss our customers' production capability or the capacity of our customers. We don't have that insight. Like I said, we do talk about the road map, and I think in the discussions that we've had with customers of our customers, it's also in our mind pretty clear that they all understand that EUV is here and it actually works. Now having said that, what is particularly important is not so much the lithographic performance. I think the lithographic performance of the machine itself is actually better. Every time, it's better than what was anticipated and that's -- that actually drives a lot of the design. So this is good. Now we are, of course, not yet at a availability and at a, let's say, maturity level that we would like to see for high-volume manufacturing. The 3400C, with all the improvements that are in there, there's also a lot of availability improvements in there, and that is going to be the proof of the pudding. And I think this will -- this is why I also said in an answer to an earlier question that the 3400C and its performance is going to be a big driver also in 2020. And we're confident that we're going to get there. And I can't imagine that customers of our customers that are -- even though they are further away from us, that they want to see this first. Well, they will get an opportunity to see this in the second half of the year. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [60] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. If you're unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations Department with your question. Operator, may we have the last caller, please? + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Yes, sir. The last question will come from Mr. Varun Rajwanshi. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [62] +-------------------------------------------------------------------------------- + + Sandeep Deshpande here at JPMorgan. My question is regarding, Peter, about the -- you mentioned in one of your press releases that your DRAM windows are looking at EUV at this point. My question is, with this throughput going to 170 wafers per hour, I mean, in 2019, you've got majority of your tools going to probably TSMC. Will the DRAM guys be able to contribute enough tools to do that 33 to 35 tools next year? Or you think there are going to be other contributors beyond DRAM in terms of EUV tools in 2020? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [63] +-------------------------------------------------------------------------------- + + No, I think DRAM is definitely an additional contributor. It will be small this year, as I said earlier. But they're going to be more -- it's just more than one DRAM manufacturer we're going to ship the retool to. So that is very much a function of our ability to bring the 3400C up to maturity levels that customers need for DRAM. I think we can do that. I think the -- everything that is -- that we have in front of us, which is the availability improvements in the EUV source, the higher productivity, the 170 wafers per hour, those are all ingredients that make it attractive for DRAM customers to start using EUV in DRAM. So I think there is little doubt there. So it's up to us. It's up to us and to the customer to make sure that what is in the 3400C can actually be used in high-volume manufacturing. And then that will drive 2020 demand also. It's really the success of the introduction that will drive this additional demand. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [64] +-------------------------------------------------------------------------------- + + And then one quick follow-up on your gross margin. I mean, given the weaker first half gross margin with the -- your expectation that there'll be a big snapback in the second half, do you still think that your gross margin on an overall basis will grow in 2019 versus 2018? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [65] +-------------------------------------------------------------------------------- + + You can do the math. I mean, you have 6 months of pushback in the overall gross margin. You have to be pretty -- it has to be pretty high to make that --- to make it all up. Now what we actually said is, I think the recovery, driven by all the reasons that Roger talked about, I think we will see gross margin exiting the year in Q4 that are trending nicely towards the 50%-plus that we said we would see in 2020. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [66] +-------------------------------------------------------------------------------- + + Now on behalf of ASML's Board of Management, I'd like to thank you all for joining us today. Operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Of course, sir. Ladies and gentlemen, this concludes the ASML 2018 fourth quarter and annual financial results conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2019-Jul-17-ASML.txt b/Transcripts/ASML/2019-Jul-17-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..9311d8208bd2811b290780b6b0042339618e54ab --- /dev/null +++ b/Transcripts/ASML/2019-Jul-17-ASML.txt @@ -0,0 +1,577 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 ASML Holding NV Earnings Call +JULY 17, 2019 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Michael Quatrochi + Wells Fargo Securities, LLC, Research Division - Associate Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Janardan Nedyam Menon + Liberum Capital Limited, Research Division - Technology Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Dominik P. Olszewski + Morgan Stanley, Research Division - Research Analyst + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2019 Second Quarter Financial Results Conference Call on July 17, 2019. (Operator Instructions) I would now like to open the question-and-answer queue. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Go ahead, please, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon, good morning, ladies and gentlemen. This is Skip Miller, Vice President of Investor Relations at ASML. +Joining me today from ASML's headquarters in Veldhoven, the Netherlands, is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. +Subject of today's call is ASML's 2019 second quarter results. Length of this call will be 60 minutes, and questions will be taken in the order they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during the conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Good morning, and good afternoon, ladies and gentlemen, and thank you for joining us for our Q2 2019 results conference call. +And before we begin the question-and-answer session, Roger and I would like to provide an overview and some commentary on the second quarter as well as provide our view of the coming quarters. And Roger will start with a review of our second quarter financial performance with some added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. +Roger, if you will. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. I will first highlight some of the second quarter accomplishments and then provide our guidance for the third quarter of 2019. +Q2 net sales came in at EUR 2.57 billion, within our guidance. Net system sales of EUR 1.85 billion was more weighted towards Logic at 61% with the remaining 39% from Memory, representing a similar split as the previous quarter. We reported EUV system revenue of EUR 764 million on 7 shipments, which was 1 more than guided. Installed Base Management sales for the quarter came in at EUR 717 million, which was a bit higher than guided. +Gross margin for the quarter was 43.0%, which was above guidance due to better EUV manufacturing results and higher field upgrades sales, more than compensating the negative mix effect in comparison to Q1. +Overall R&D and SG&A expenses came in as guided with R&D expense at EUR 487 million and SG&A expenses at EUR 123 million. +Turning to the balance sheet. EUR 884 million was paid as dividend and EUR 15 million worth of shares were repurchased in Q2. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 2.34 billion. +Moving to the order book. Q2 system bookings came in at EUR 2.83 billion, which was 100% up from Q1 bookings, mainly driven by EUV where we took 10 new orders in the quarter. Logic order intake was 67% of total value with the remaining 33% from Memory, again reflecting the strong Logic demand expected this year. +Net income in Q2 was EUR 476 million, representing 18.5% of net sales and an EPS of EUR 1.13. This was positively impacted by higher gross margin and a onetime tax benefit. +With that, I would like to turn to our expectations for the third quarter of 2019. +We expect Q3 total net sales of around EUR 3.0 billion. Our total net sales forecast for Q3 includes around EUR 750 million of EUV system revenue on 7 planned shipments. We expect our Q3 Installed Base Management revenue to be around EUR 700 million. +Gross margin for Q3 is expected to be between 43% and 44%, which is slightly higher than Q2. The expected improvement in margin due to expected higher volume will be partially offset by customer configuration mix. We continue to expect significant improvements in gross margin in the fourth quarter driven by higher system sales, improved product mix, increased field upgrades, shipment of higher-margin NXE:3400C systems as well as contribution of EUV service revenue. This will enable us to achieve a gross margin for Q4, which approaches our 2020 target of over 50%. +The expected R&D expenses for Q3 are around EUR 495 million and SG&A is expected to come in at around EUR 125 million. Our estimated 2019 annualized effective tax rate is around 9% because of a onetime tax benefit in 2019. We still expect our long-term effective tax rate to be 14%. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger as highlighted, although it was another modest, but decent quarter, results came in at above guidance, and we expect further strengthening in the coming quarters. The macroeconomic environment continues to provide market volatility, which translates to a level of uncertainty in the semiconductor industry. The demand for Memory remains soft while excess inventories are being worked down in the supply chain. And some of the second half Memory demand risk that we discussed last quarter has meanwhile materialized and resulted in system push outs of this year into 2020. This Memory weakness is being compensated by strengthening of Logic demand such that our view of 2019 total sales remains unchanged. As such, we expect 2019 to be a growth year with sales and profitability increasing throughout 2019. +In Memory, the market continues to digest the high level of capacity additions that are put in place over the past few years. The digestion started last year was exacerbated by decelerating macroeconomic growth. This will likely extend throughout most of this year. Based on lower demands from our Memory customers, we now see our Memory sales down around 30% year-on-year versus 20% indicated last quarter. +As discussed last quarter, we see 2 contributing components with Memory demand this year. And we have characterized 1 as strategic, which we expect will happen largely independent of market conditions, which includes both early Chinese domestic Memory ramp and EUV for DRAM. This component is valued at approximately at EUR 1 billion, which we believe has low risk of pushouts. +The second is the bit supply component, which we previously indicated as having a higher risk. And if you remove the strategic component from our estimated 2019 Memory demand, we get a lithography spend for Memory bit supply of around EUR 2.1 billion, which is around 45% lower than the comparable spend in 2018. And as we have already shipped around EUR 1.2 billion to Memory bit supply the first half of the year, it leaves around EUR 900 million in the second half of the year targeted for Memory bit supply, which has an inherently higher risk profile than the strategic investments in Memory. +On the positive side though, our Memory customers continue to indicate they are making significant reductions in wafer output to an extent we haven't seen in previous downturns. This reduction in spend and lower wafer output will help in reaching a more normalized supply/demand balance. +Logic will clearly be our growth driver in 2019 with the majority of the demand linked to new technology transitions and advanced node additions. We are seeing increased demand from our customers driven by accelerated ramp of 7-nanometer node and beyond, supporting amongst others the introduction of 5G technology. With this strengthening, we now expect our Logic business to be up around 65% for the year relative to last year, which is 15 percentage points up from the 50% that we communicated last quarter. +Along with increased system demand in the second half, we also expect stronger demand from field upgrades, which translates to low single-digit percentage growth of Installed Base Management revenue. +Now let me turn to the ASML product side and update you on our EUV business. In EUV, we recently demonstrated more than 170 wafers per hour on our first NXE:3400C system. We have also run more than 2,000 wafers a per day and the customer Memory production conditions and this is a significant milestone and that it confirms the required capability for Memory production, which means that our focus will be on stability and uptime to secure our customers ramp plans. We plan to ship the first NXE:3400C system in Q3, with a higher number of C systems planned in Q4. +And as Roger mentioned, we shipped 7 systems in Q2, 1 more than guided and received 10 orders. As a confirmation of the potential of the NXE:3400C for cost-effective high-volume memory production, we received a number of EUV orders this quarter for systems slated for use in Memory. The customers are aggressively bringing new technology to the market, which reflects on the solid demand for 30 systems this year. Demand for NXE:3400C systems has proven to be high. Our 2019 shipment plan is significantly skewed towards the second half of the year and to Q4 specifically. Next to the back loaded plan, we're also transitioning to a new scanner model, like I said earlier, the 3400C, which suppliers need to ramp their production. Taking both of these into account, there is a risk of a few systems planned for Q4 moving into the first weeks of 2020. However, this risk has been taken into account in our comments regarding our full year 2019 sales outlook. +In any case, strong demand for NXE:3400C as well as the continued progress in the ramp up of our production capacity is clear. +In summary, despite uncertainty in the current environment, we continue to see a stronger second half with the strengthening of both sales and profitability quarter-on-quarter. Logic will be the primary driver of growth this year and demand has further strengthened from last quarter as customers accelerated ramp of their advanced nodes. Memory demand has more uncertainty and has further weakened since last quarter. However, as mentioned before, the stronger Logic demand compensates for the weaker Memory demand. And in total, our overall sales outlook for the year, as I mentioned before, remains unchanged, and we expect 2019 to be another year of growth. +With that, we'll be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Thank you, Roger and Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. Beforehand, I would like to ask that you kindly limit yourself to 1 question with 1 short follow-up, if necessary. This will allow us to get in -- to get to as many callers as possible. +Now operator, could you have your final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Mitch Steves, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [2] +-------------------------------------------------------------------------------- + + Mitch Steves from RBC. I just have 2 quick ones. First one is on EUV. You guys talked about 33 to 35 units for 2020. I am just curious to how much of that is network related to EUV and is that still on track? And then secondly on the Memory side, I think you guys said that it should be down 30% versus 20%. Was that Memory in general or was that ASML-related revenue? I just want to be clear about that. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [3] +-------------------------------------------------------------------------------- + + Yes. On the last one, it's '19 -- the 30% down is the total Memory sales of ASML into the Memory segment as compared to 2018. And so that's what the 30% meant. On EUV, 30 to 35, yes, that's our shipment capacity next year. Memory related, interesting question that is. Like I said in earlier calls, Memory has clearly given us a kind of a breakeven point where they can move into EUV as it relates to DRAM production and has to do with the productivity. And we gave a target of 2,000 wafers per day. Now we have shown in our factory under Memory production conditions that we can get over 2,000 wafers per day. So it's really about the uptime and the availability of the system. Now we're shipping the first C system this quarter, we will install it. So by the end of the year, we will be able to see really some, let's say, you could say, more marathon evidence of the 2,000 wafers per day. That will drive the demand for EUV next year. Having said that, I strongly believe that 2020 will be dominated by Logic in terms of EUV. It means the 3400C and I think currently when we talk to our Logic customers, as a very clear roadmap, a path into 2024, 7-nanometer and beyond. So no matter how you look at it, it's clearly an upside DRAM for next year, but the majority will still be different by the Logic demands from our customers. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Next question comes from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [5] +-------------------------------------------------------------------------------- + + It's David from UBS. Just 2 quick ones. Firstly on the EUV bookings in the quarter. I am kind of following up from last question. But can you -- also can you help us understand how that breaks down between Memory and Logic in terms of what you're seeing so far? And is it fair to presume those are all 3400C? And then just secondly, I think last quarter you commented that EUV bookings this year would be quite back-end-loaded. So with you seeing 10 already in Q2 is quite solid. But is it fair to say then we shouldn't expect too much in Q3, that it will take that 3400C to be in the field to then get more bookings in Q4? Or how should we think about the phasing? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [6] +-------------------------------------------------------------------------------- + + So just a clarification question, David. You are really talking about the bookings now, the -- let's say, the bookings sequence in Q3 and Q4 going forward. That's what you mean? Is that correct? + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [7] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [8] +-------------------------------------------------------------------------------- + + Okay. Yes, on the EUV bookings, I think the majority of the bookings that we shipped in Q2 are for Logic. There are a few systems, which are slated for Memory production, which is understandable because you want -- given the current state of the capability performance, it is logical that you would see some of those systems being shipped to go into a DRAM pilot [low] production. So the majority will be for our Logic customers. We had a good order intake in Q2. It's my expectation that, that will continue in Q3 and Q4. Because like I said, we have a production capacity actually between 30 and 35 units. And I think by the end of the year, we'll be fully booked for those tools because I do believe also that by the end of the year, we'll be able to actually show in longer test, marathon test that the DRAM conditions that we were able to show here at ASML were not a unique event and we'll be able to basically replicate that. So I don't think there will be an order low. I think it will be a gradual intake of orders towards the end of the year. Like we saw last year, last year we said the same thing. By the end of 2018, we'll have 2019 booked. It's my expectation that we'll see the same thing by the end of this year. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [10] +-------------------------------------------------------------------------------- + + Just 2 follow-ups, Peter, regarding your confidence on the Q4. I'm just curious, it seems to me that your confidence comes from the scenarios that you have contemplated. For instance, if the supply chain causes some delay in the shipment of 3400C, I assume that you have emergent tools that you can ship, and therefore, is that what gives you the confidence for Q4 shipment? And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [11] +-------------------------------------------------------------------------------- + + Yes. I mean you can advance with the follow-up because you're right. I mean you gave me the answer and it was -- indeed that's what it is. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + Sure. And then if there is -- if there are a few systems that are pushed to 2020, then is that going to increase the 30 to 35 system planned to be shipped next year? Or how should we think about the targets for next year? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [13] +-------------------------------------------------------------------------------- + + Yes. I think we have this -- when we look at the production capacity 30 to 35, that is basically on the 12-month period. So if we have to shift few of those systems into January of 2020, they naturally would come on top of those 30 to 35. Under the assumption that we cannot have that same kind of supply chain risk at the end of 2020, which you could argue, there's a lot more learning curve so we should be able to keep the production schedule or the supply chain schedule better than we could in 2019 because we're introducing a new machine there. So yes, normally, it will be on top. But like I said, 30 to 35 is still a range of 5 tools. So I would stick to the 30 to 35. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Okay. Now in terms of the supply/demand for Memory, it has continued to weaken. What if it remains weak into 2020? I remember from the November Analyst Day, you guided to 15%, 20% DRAM bit production growth and NAND bit production growth of 35% to 40%. But what if we started 2020 very far from those targets, would -- is there also a sensitivity to your 2020 revenue target where -- if DRAM -- I'm sorry, if Memory were to remain weak, there will be other areas that would help offset that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [15] +-------------------------------------------------------------------------------- + + Yes. I think there's a lot of questions in one question. But let me answer this. I mean 2020 where we gave you the 2020 number, there was basically a mid-market scenario that we gave you, yes. And a mid-market scenario, like you said, that had a certain percentage growth on Memory, as I mentioned, 20% and 35%. And that is indeed the case. But what we're seeing today is also that Logic is a bit stronger than we anticipated. So that could be a compensating factor. But all in all, I think it's too early to make an educated guess on whether 2020 will be a moderate market or will be a low market. I think it's too early. I can only say that where we see Memory is today with indeed significantly lower growth, bit growth numbers than the ones you mentioned and the fact that our customers are cutting 45% of the their -- at least litho purchases for bit capacity. And they are lowering their wafer starts, I mean something will happen. So this is -- so it's too early. But I think the trends are clearly such that I believe customers are doing everything, try to rebalance the supply and the demand. And whether that will be at the end of the year, early 2020, it's simply too early to say. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [17] +-------------------------------------------------------------------------------- + + Evercore ISI. I guess, Peter, very encouraging to see the DRAM EUV orders in the quarter. I'm curious if you could speak a little bit about what the total cost of ownership requirements are as we move to 1z and then 1 alpha. Timeline of hitting those requirements that you see? And if you're able to hit them, what are you thinking about layer count as we transition to 1 alpha? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [18] +-------------------------------------------------------------------------------- + + Yes. I think it's an interesting question. I mean we're really looking at the introduction time of EUV in DRAM. And it is driven by -- I think it's just the economics. And like I said in previous quarters, also it's not only the economics, I think we also get a very clear feedback that the device performance using EUV is also significantly better. So it's a combination of the 2. And it will be an introduction time whether it's 1z or it's another alphabetical letter, it doesn't matter. At that moment in time, EUV is there to stay, yes. And as you pointed out, going forward with those next generations, after the introduction node, there will be more layers added to EUV. And we currently think about you could -- whether it's alpha or whether it's gamma, whether it's the 3 to 4, but even 5 could -- is something that could happen. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [19] +-------------------------------------------------------------------------------- + + Very helpful. And then if you could speak to the Bloomberg business you're seeing from Logic in the second half. How sustainable is that beyond Q4? And then as part of that considering you're likely building emergent tools for Memory and then having to build for Logic, are there any negative gross margin implications from that change over? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [20] +-------------------------------------------------------------------------------- + + Could you elaborate a bit on your last part of the question? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [21] +-------------------------------------------------------------------------------- + + Obviously, Logic emergent tools, higher speed, better gross margins. But I presume you were building initially emergent for Memory and now retrofitting to Logic. Are there any negative implications to gross margins because of that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + No. No. That question on your -- well, the answer to the question -- to the last question is indeed, no. There are real no implications. Is Logic sustainable in Q4? Well, to be honest, I think the way that we look at it after having discussions with our customers, I think it is that demand that we're currently seeing in the second half of the year is incremental. I don't think it's a pull in. I think that the majority of what we're seeing is incremental. And these are not borrowing from 2020. So in that sense, I think it's much more sustainable. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Janardan Menon. + +-------------------------------------------------------------------------------- +Janardan Nedyam Menon, Liberum Capital Limited, Research Division - Technology Analyst [24] +-------------------------------------------------------------------------------- + + It's Janardan from Liberum. I just wanted to dive in a bit into the gross margins. You said your gross margins in Q3 were affected by some customization work. Would you be able to give us any number as to -- in percentage terms as to what that hit is? And you're also suggesting that your gross margin in Q4 is likely to be quite close to sort of the 50% range, the high 40s. Would you be shipping any 3400Bs in that quarter? Or would that shipment be entirely 3400Cs? And one small one, if I might push through is if DRAM were to improve, I mean DRAM were to start adopting EUV after the first runs of the 3400C and they do come in with orders, would you be able to accommodate more than 35 machines for next year? Or is that sort of an upper limit of what you can do with your current capacity? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [25] +-------------------------------------------------------------------------------- + + A couple of comments on the gross margin. So in terms of composition, Q3 resembles Q2 quite a bit, so in terms of sales mix. So that's why the basic point of departure there is kind of similar. It will be higher, right. So the total volume will be higher, and therefore, factory loading will be higher that has an uptick in gross margins. And then we also said that in the mix, the configuration mix, Q3 is a little less favorable, if you like, than Q2. But that's minimal and just based on the configuration of the specific systems that we provide. And that's the reason why Q3 is a little bit higher than Q2, but not dramatically so. +If we then move to Q4, I think you will see that the company is really going to run -- is going to fire on all cylinders. So then you really have the impact of a number of structural developments that are going to occur. First is the 3400C, to your point, Q4 will be -- still be a mix of B and C models, but the C model will be dominant in that total mix. But so you will have the increased benefit of the 3400C pricing and margin. At that point in time, we would also see that the service revenue on EUV will go up and service margin will go up. For Q4, we also predict better field upgrades, which is business that has a solid [positive] gross margin. We would also see higher factory loading as a result of the significantly higher volume that we have there. And Q4, as a result of all of the things that we just discussed, also has a very significant portion of emergent in there. So at that stage, we have 5 very significant developments that indeed will position us such that we are going to approach the over 50% guidance or indication that we've given for gross margin in 2020. +Peter, I think there was 1 question on the... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [26] +-------------------------------------------------------------------------------- + + Yes. I think on the capacity, I think it'll be very hard stretched to get out more than 35 systems. I think the 30 to 35 is a little bit depending on the speed of the ramp and the issues that we are encountering on the new model, the C. We're sticking to 30 to 35. I think 35 is the maximum we can do next year. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [28] +-------------------------------------------------------------------------------- + + It's Andrew from Barclays. Peter, if you could just go back to some of the comments you were making on Logic, in particular around the fourth quarter and into 2020. I can understand visibility is less so on the Memory side, but it seems much greater in terms of Logic. If that 4Q increase is indeed incremental rather than pull forward, how are you thinking about Logic demand into 2020 given the continued move down the process node ladder by foundry and microprocessors? Any further insight there would be helpful. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [29] +-------------------------------------------------------------------------------- + + Yes. I think answering that question, I also want to go back to last year. We basically said EUV has turned the corner. And I said that I think on earlier occasions that I believe 2018 was a very significant year for a simple fact that the confidence that our customers had in EUV as the key enabler for next generation device innovations, that, that confidence got to a much higher level. Now with the 3400C and the results that we're seeing now, I think that has only strengthened. +So when you look at the road maps that our customers are now presenting to us, very clearly to see an acceleration. And you can't imagine that. You can't imagine that, that there are -- if you look at the end markets, which is not only high-power compute in the mobile market, but it is much wide (technical difficulty) are actually increasing, looking at a competitive edge in a growing market. It's much wider application space. And I think this is what drives the road maps of our customers. And actually the road maps of our customers are more aggressive because of EUV and because that it works, I mean they see the results today. So this is why I believe that what we're currently seeing I mean is incremental and I think has basically a runway. This is -- and it makes sense. If you look at where they are, they have a production technology that they can apply in terms of the innovation of the next generation nodes that their customers need. Where is the -- I think it is the more aggressive road maps that our customers are showing as our underpinning why I believe this is more sustainable. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Joe Quatrochi. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [31] +-------------------------------------------------------------------------------- + + It's Wells Fargo. I was wondering if you could talk a little bit about the demand you're seeing in China. And maybe can you help us understand as part of the -- in the Memory side, EUR 1 billion of strategic revenue that you expect to recognize this year, how much of that has been recognized this year? And then how do we think about the trade negotiations between the U.S. and China maybe impacting the timing of equipment installations there? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [32] +-------------------------------------------------------------------------------- + + Yes. I'll just make some comments on the -- I'm just writing down your questions. Yes, I think on the Memory side and especially China, I mean you have to realize that these are greenfield companies creating greenfield fabs, ramping their first nodes, their first device generations. And they need a certain level of output capacity that they need to put in place. That's happening this year. That's very strategic, that will happen. And of the EUR 1 billion, I mean half is China EUV roughly. And it doesn't matter that much or how it spread over the year. But that's roughly what it is and that is just happening. I mean it's -- we're not -- that's not waning, that's not increasing, it's just execution according to plan like we said last quarter. +And I think the trade negotiations, they are what they are. And currently, there is no limit on what we can ship to China, which is basically DPV. This is 15-year-old technology and we've been shipping that for a long time, more than 10 years to China and that's what we still do. So I don't know where trade negotiations will end up. And I think we are in a state where we know what's going on, but business as usual. Our customers want the machines, we're able and capable. And we are allowed to ship those systems, so we will. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [33] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then just a quick follow-up. Could you give us your thoughts on how we should think about free cash flow for the remainder of the year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [34] +-------------------------------------------------------------------------------- + + Free cash flow clearly is very back loaded. I mean if you look at the way sales are composed this year, sales are back loaded, and therefore, free cash flow is also very much back loaded. That is also the result of the fact that on EUV, we have a payment schedule with our customers, which is very back loaded. And as a result of that, you really will see that the second half and in particular, Q4 will be very, very cash rich. And there will be a very significant generation of free cash flow. But all of it will be very back loaded in this year. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [36] +-------------------------------------------------------------------------------- + + So this is Stephane Houri from ODDO. I have a question about EUV again. I would like to discuss a bit about your lead times and to understand on EUV specifically and understand what is the limit that you need to receive the orders from your customer to make sure that you will be in the range of 30 to 35 machines in 2020? And the short follow-up is about the OpEx that keep on rising. Do you think you will continue on that trend going forward for the rest of the year and also for 2020? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [37] +-------------------------------------------------------------------------------- + + Yes. I will answer the question on the lead time and Roger will answer the question on the OpEx. On the lead time, there is an order lead time which we give our customers of about 18 months. And now having said that, we are negotiating with our customers from time-to-time. And they don't always hold to the 18 months. It sometimes depends on some certain conditions that are not that significant, but we only have a deal when you have a signature. So but that -- the lead time is 18 months, it was 24. We're driving it down, we have to, because you have to realize that it's pretty difficult also for our customers to guess what they need in terms of capacity ramp and the size of the capacity ramp 18 or 24 months out, nobody knows. +So it is essential that we keep reducing the cycle time in the supply chain and the cycle time in our factory so we make sure that we can deal with that flexibility. We don't put a limit to it. It is not that if you don't give an 18-month order, you won't get the slot because we have other ways to secure the shipment and that's basically knowing that we do the installation inspections when the factory is built, when the factory is finished. We work together with suppliers of the equipment that is attached to our tools. We work together with the suppliers and actually making all the facilities and all the piping and then -- and everything that goes with a semiconductor fab. So we know that customers are realistic and it's real that they are planning those EUV tools. And that gives us the confidence that while some customers might not adhere to the 18 months for all kinds of commercial reasons and that they sign the orders a bit later, the tool will ship, and that's how it works. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [38] +-------------------------------------------------------------------------------- + + On OpEx, as you know, 2 main components in there: SG&A, SG&A, as you would've seen, is fairly consistent over the quarters. So if you look at 2018, 2019, it's fairly consistent. And the guidance that we've given for next quarter, EUR 125 million, and that's the number that I'm pretty comfortable with that we'll be able to keep at that level for a little while. And as it relates to R&D, you're absolutely right. We've pushed down the accelerator last year on R&D. We've indicated why. So this is on the pulling end of the low-NA program, we're really accelerating that program. Again, the fact that we're now talking about the EUV, the first EUV 3400C shipment in this quarter. And the fact that we've been able to, in essence, pull that in with the year I think is the result of that effort. And we'll continue to speed up in that process and the low-NA development. +High-NA is a big ticket item obviously in R&D and also the continued development of multi-beam. So those are the 3 main categories, as a result of which we told you last year, we're pushing down the accelerator. What we've guided for next quarter, EUR 495 million. I think it's reasonable to assume that, that's a number that you will also see in Q4. And then gradually you will see with -- an expected development of our business, I would expect that, let's say, at the second half of 2020 that you will see it get back gradually to the 40% that we've guided at the Capital Markets Day. That's the current plan. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [40] +-------------------------------------------------------------------------------- + + My first question is on the EUV tools, Peter. I mean I wanted to slightly look longer term rather than 2020 where everybody is focused on. How do you see -- I mean you've talked about this, again, in your Capital Markets Day. But do you see TSMC and the foundry market coming back in the following year as they begin to add more capacity in 2021? And what do you think is going to be your long-term capacity for EUV tools post this 2020, which is the big initial ramp up of EUV? And then secondly, when we -- Roger, my question to you on the gross margin. Can you just -- in your opening remarks, you said that your gross margin in the fourth quarter is going to be higher than 50%? Or is it going to be close to 50%? I just was trying to clarify on that one. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [41] +-------------------------------------------------------------------------------- + + Okay. Let me say, I think on the longer term EUV tools, what you -- what -- EUV tools will be first used, let's say, at the industry 7-nanometer node. As I say, there's layers ranging anywhere from between 7, 8 to 12. It depends on what customers are actually doing and with a tendency to go up. The next node, which industry 5, that's a significant increase. I think you'll see likely more than 20 EUV layers. So yes, that will, of course, create a demand for more EUV tools. However, we also have a productivity increase road map that should deal with part of it. But it cannot only be taken up by productivity improvement, so we need more EUV tools. This is why we have a capacity of around 45 units in our factory. +If you look at our Capital Markets Day presentation, then with our mid-market scenario, that is -- this is probably what we would need taking into account the higher productivity. Now if it turns out that the end demand, when I talk about the customer end, the demand is even stronger, then yes, there are scenarios where we have to go over 45. We are not planning that yet. I think we have some time in terms of square meters that we need to build then because then we need to just extend the factories. We're not at that point yet, but we will watch that closely. But currently, I would say 45 units for a system with higher productivity capability, that should be sufficient for next couple of years. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [42] +-------------------------------------------------------------------------------- + + And Sandeep, on the -- on your question on the gross margin, what I said in the introductory comments was that the Q4 gross margin approaches our 2020 target of greater than 50%. So the 2020 target is greater than 50%. We'll approach that in Q4, which you should read as high 40s, therefore. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + The next question comes from Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + It's Krish from Cowen. I have 2 of them. First one -- both on 2020. The first one for Roger, if you look at next year, it looks like you're going to do EUR 4.2 billion to EUR 4.4 billion-or-so in EUV revenue. Is this figure within that whole revenue stream should come in at a 40% gross margin or is 40% more the exit run rate for next year? And then a question for -- a follow-up for Peter. If your customers mix and demand is similar in 2020 as in 2019 and you're shipping more EUV units, should we assume DUV units start coming down in 2020 because of more EUV? Or you think that transition is still for the down the road? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [45] +-------------------------------------------------------------------------------- + + Yes. To answer that question, I think it's further down the road. I mean, next year, you will still see very clear mix. Don't forget, let's take an example, there are Logic makers that have said we're going to ramp a 7-nanometer product in 2021, which means they need the tools in 2020. But still they're ramping capacity of the previous nodes, which is real capacity that they need to ship. So it's going to be a bit of a mix next year. The 2020 -- I don't think I've said at the 2020 EUV mix is going to be similar to 2019 because that is dependent on I think the success, you could call it or the demand for DRAM in the next year, which is a bit -- still needs to be proven like I tried to explain earlier. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [46] +-------------------------------------------------------------------------------- + + But the margin that we've given for EUV for 2020 is 40%. That's the margin that we've indicated. And we're comfortable that we'll get there in 2020. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [47] +-------------------------------------------------------------------------------- + + Next caller? + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + The next question comes from Mr. John Pitzer. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [49] +-------------------------------------------------------------------------------- + + Yes, it's Crédit Suisse. Peter, as always, I appreciate all the detail. I'm just kind of curious you talked about in your prepared comments that the non-EUV memory revenue for the back half of the year needs to be about EUR 900 million. I'm kind of curious if you could help us understand the profile between Q3 and Q4, i.e., how important is the Memory tick up to kind of your Q4 implied outlook? And do you think the current run rate is kind of, for better or worse, a bouncing along the bottom run rate and the risk is timing for an upturn? Or could you actually envision a scenario where Memory would actually go lower from these levels? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [50] +-------------------------------------------------------------------------------- + + Yes. It's a good question. So John, to answer the last one, I need a crystal ball because I don't know, whether it's going to be lower or not. I mean is it the bottom run rate? Well, EUR 900 million, annualized EUR 1.8 billion for capacity in an industry that is growing and also looking at where Logic is going, it's pretty tough to see that much lower than it is. Now I think the spread of the EUR 900 million, I don't have the exact details here, but I think it's about half-half, I mean it's not that much different. I am looking at -- yes, I think it's about half-half, yes. So it's not skewed to one of -- to Q3 or Q4. But by any means, EUR 900 million for 6 months or EUR 1.8 billion on an annualized basis for capacity -- for bit capacity in litho is not a very large number if you analyze it -- if you annualize it. So that's actually, that's a low -- that's a relatively low number. +Now is that a bottom? I don't know. I don't know what is going to happen, but like I said earlier, on the positive side, customers are also changing their wafer output plans to the down side. So all these things will, of course, help. It's like with every memory cycle, you have to grind through it and lowering CapEx. And in this particular case, which is different than previous cycles, as you know, turning -- or closing the faucets here, basically slowing down the number of wafer starts. That is something that we haven't seen before. So all these things will help. I'm not that pessimistic on the length of this downturn, this Memory downturn. It will turn whether it's the end of the year or beginning of next year, I mean I don't think it's going to last out a lot longer. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [51] +-------------------------------------------------------------------------------- + + That's helpful, Peter. For my follow-up, I just wanted to go back to the impact of improving productivity on EUV tools shipment. It's pretty obvious that in the Memory space, DRAM space, there should be a pretty high correlation as productivity goes up, economics make more sense and even intra-node insertion of more layers seems like very plausible for DRAM. But I'm kind of curious about Logic foundry side just given that there's sort of a design cycle time for 5- and 7-nanometers, if you start to exceed productivity targets, does that actually drive more tool units or fewer tool units? Because my guess is intra-node insertion would be a much more difficult, timely, costly thing for your customers, your customers' customers. Are we still focused on units because if productivity is going up, I am assuming you're going to get better ASPs. So should we be more focused on a revenue target for litho instead of unit targets -- for EUV instead of a unit target? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [52] +-------------------------------------------------------------------------------- + + Yes. I'll let Roger comment on the last part. Yes, I think when you look at customers and the EUV uncertainty that I have seen over the last couple of years, the fact that they actually have changed layer adoption of EUV as we went -- as we -- as they gained more confidence and got more information out of their R&D, they actually changed the layer counts. It did -- it wasn't stable. I mean it actually changed. And actually, there's a tendency to go up. So that proves that the customers do take -- they have alternatives. Not that they're completely developing 2 separate techs, I think there's some interchangeability there, where they can swap certain layers to EUV if the economics make sense. I think it's taken into account in the design process. I mean that's what we've seen. And although why, as you know, the strength that we've seen by adding more layers could not have happened and we're seeing it. So it means that they're taking account of it. And they're designing probably in a manner where they have some flexibility to either -- to do either or. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [53] +-------------------------------------------------------------------------------- + + And John, (inaudible) your last comment, that was music to my ears because you're absolutely spot on. I think more and more we need to look at the EUV business not in terms of units, but in terms of the euro value that is attributed to that because you're absolutely right. The number of units is meaningless to the extent that you see the very significant uptick that we've been able to demonstrate in productivity and then translates into higher ASP. So that's why, on the go-forward basis, I do believe that we all need to think much more in terms of EUV revenue rather than EUV units. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + The next question will come from Mr. Dominik Olszewski. + +-------------------------------------------------------------------------------- +Dominik P. Olszewski, Morgan Stanley, Research Division - Research Analyst [55] +-------------------------------------------------------------------------------- + + I'm from Morgan Stanley. As you mentioned, the Q4 will be a larger quarter with key focus on execution on supply chain. I appreciate that obviously building the tools requires a lot of complicated steps, but just curious whether there is any particular color on the specific aspects of execution that have greater risks than others in Q4 that we should watch for? And then I have a just quick follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [56] +-------------------------------------------------------------------------------- + + Yes. I think we are introducing several new features on the 3400C, which includes -- actually it ranges from optics to laser alignment systems to the module vessel, which we're using to create EUV plasma. And it's all of the above and it all needs to come together at the right time. So when you have one of these components a few weeks later then you're a few weeks behind the shipment schedule. So this is what -- and this is normal when you introduce a new system, which has quite a significantly number -- higher number of new parts in it. So this is what it is. It is -- it can be all of the above and we just need to make sure that they're suppliers, which we know, I just mentioned them, source-related, the laser-related, optics, they're all ramping as fast as they can. There are at a maximum capacity. And of course, when with a new product, things don't go as planned because it takes a little bit longer to ship to us, then we have a delay. And that's pretty normal with this complex technology. But we're pushing them, we're sitting on top, but you have to take into account there is a level of risk there that we will -- might lose as a few systems that we need to push into January 2020. + +-------------------------------------------------------------------------------- +Dominik P. Olszewski, Morgan Stanley, Research Division - Research Analyst [57] +-------------------------------------------------------------------------------- + + Okay. So no specific kind of math then, just broader kind of (inaudible). And then secondly, from your advantage points, I'm curious whether you have thoughts on DRAM? And specifically you have really quantified your perspective on DRAM utilization rates, whether you've seen anything and have you quantified them? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [58] +-------------------------------------------------------------------------------- + + Well, we're seeing certain things, but we're not in customer fabs, although we have some level of information. And I don't think we should mention on this call any utilization rates or our assessment of the utilization rates of our customer, that is pretty confidential. But it's been their statements also, that is -- basically, they have lowered their wafer stocks, which is true. I mean we can -- our data that we see actually confirm this. So that's what it is and I think that's a good sign. But how much it is, I don't think we should discuss this in this call. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [59] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, we have time for one last question. If you were unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations department with your question. Now, operator, may we have the last caller please? + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + The last question will come from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [61] +-------------------------------------------------------------------------------- + + Two, if I may from my side. Firstly, since -- it could be helpful to get an update from your side on how the e-beam side of business is coming along in terms of its trajectory into the second half of the year and into 2020? And then I have another question, please. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [62] +-------------------------------------------------------------------------------- + + Yes. I think not much different as we said last quarter. I mean we're on track to ship the first systems through R&D sites of our customers and talk about the multi-beam systems, which actually means we should ship multi-beam systems next year in volume to the market. It's -- in that sense, it's an update and update is what we said last quarter. It's no change there. The plan is still intact. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [63] +-------------------------------------------------------------------------------- + + Okay. And secondly, if I may, you obviously have a macroeconomic backdrop with the trade wars between the U.S. and China. You clearly did not design a company to be supplying separately to U.S. and China, but given in terms of the opportunity going forward from China longer term, is there anything strategically or conceptually you need to think of in terms of how you're structured as an organization or as a supply chain to ensure you can keep on supplying both of these key geographies going forward? I guess it's a bit hypothetical, but certainly something to consider given what you've seen over the past 1 year. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [64] +-------------------------------------------------------------------------------- + + I think I would say, Amit, that that's a very good question because, one, the answer is it's too early. I mean we don't know how this is going to pan out. And this is -- overall, it is a concern, it is more a strategic concern that we need to start thinking of, just like you said. And I think it's absolutely not the time to take drastic decisions because I don't know how this is going to pan out. But we'll follow it very closely. And you're right, it is our intention to service our customers and our customers that are going to place orders, and we are wanting to -- we're completely willing and wanting to ship those orders. And unless there are legal boundaries that we cannot cross and we will not, then we will keep doing what we are doing. But you are right. Speculating where this might end up is a bit dangerous, but it is definitely too early to start thinking of any big strategic organizational moves into another direction to make sure that we can ship to our customers. It's a bit of a wait and see. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [65] +-------------------------------------------------------------------------------- + + Now on behalf of ASML, I'd like to thank you all for joining us today. Operator, if you could formally conclude the call, I would appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Sure. Ladies and gentlemen, this concludes the ASML 2019 Second Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2019-Oct-16-ASML.txt b/Transcripts/ASML/2019-Oct-16-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..052f8b65bdadf34645652848809516c157ebe26e --- /dev/null +++ b/Transcripts/ASML/2019-Oct-16-ASML.txt @@ -0,0 +1,658 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 ASML Holding NV Earnings Call +OCTOBER 16, 2019 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Michael Quatrochi + Wells Fargo Securities, LLC, Research Division - Associate Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Aleksander Peterc + Societe Generale Cross Asset Research - Equity Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Achal Sultania + Crédit Suisse AG, Research Division - Director + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Robert Duncan Cobban Sanders + Deutsche Bank AG, Research Division - Director + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Unidentified Participant + - + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [1] +-------------------------------------------------------------------------------- + + (technical difficulty) +Veldhoven, the Netherlands is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. The subject of today's call is ASML's 2019 third quarter results. The length of this call will be 60 minutes, and questions will be taken from the order that they are received. This call is also being broadcast live on the Internet at asml.com. A transcript of management's opening remarks and replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I would like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [2] +-------------------------------------------------------------------------------- + + Thank you, Skip. Welcome, everyone. Thank you for joining us for our third quarter 2019 results conference call. +Before we begin the question-and-answer session, Roger and I would like to provide an overview and some commentary on the third quarter as well as provide our view of the coming quarters. Roger will start with a review of our third quarter financial performance with added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. +So Roger, if you will. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Peter. Welcome, everyone. +I will first highlight some of the third quarter accomplishments and then provide our guidance for the fourth quarter of 2019. Q3 net sales came in at EUR 3 billion as guided. Net system sales of EUR 2.3 billion was heavily weighted towards Logic at 79% with the remaining 21% from Memory, clearly showing the current strength of Logic business and the digestion mode of Memory business. We reported EUV system sales of EUR 743 million from 7 shipments as guided. +Installed Base Management sales for the quarter came in at EUR 661 million, which was a bit lower than guided. We expect this will be captured in a higher Q4 installed base sales. Gross margin for the quarter was 43.7%, nicely within the range we guided. Overall R&D and SG&A expenses came in as guided with R&D expenses at EUR 493 million and SG&A expenses at EUR 129 million. +Turning to the balance sheet. EUR 154 million worth of shares were repurchased in Q3. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 2.1 billion +Moving to the order book. Q3 systems bookings came in at a record EUR 5.1 billion, mainly driven by EUV where we received 23 new orders in the quarter, both from Logic and Memory customers. Logic order intake was 73% of the total value with the remaining 27% from Memory, again reflecting the strong Logic demand. Net income in Q3 was EUR 627 million, representing 21% of net sales and resulting in an EPS of EUR 1.49. +With that, I would like to turn to our expectations for the fourth quarter of 2019. We expect Q4 total net sales of around EUR 3.9 billion, which will represent another record year with approximately EUR 11.7 billion of sales. Our total net sales forecast for Q4 includes around EUR 950 million of EUV system sales from 8 planned shipments. 4 systems originally planned in Q4 will now ship in early 2020 due to temporary supply constraints in the NXE:3400C ram. We expect our Q4 Installed Base Management sales to be around EUR 850 million, which is almost EUR 200 million higher than Q3 driven by strong demand for field. +Gross margin for Q4 is expected to be between 48% and 49%, which is significantly higher than Q3. The expected improvement in margin is due to higher system volume, higher ASP for NXE:3400C model, Deep UV product mix, higher EUV service sales and higher field upgrade sales. The expected R&D expenses for Q4 are around EUR 500 million, and SG&A is expected to come in at around EUR 135 million. Our estimated 2019 annualized effective tax rate is around 7% due to several tax benefits in 2019. We still expect our long-term effective tax rate to be 14%. +Regarding our capital return. ASML announced that it has revised its capital return policy to provide for dividend payments on a semiannual basis. ASML dividend proposals will continue to be subject to the availability of distributable profits or retained earnings and other factors such as future liquidity requirements. +The interim dividend over 2019 will be EUR 1.05 per ordinary share. The ex-dividend date as well as the fixing date for the euro/U.S. dollar conversion will be November 4, 2019, and the record date will be November 5, 2019. The dividend will be made payable on November 15, 2019. In January 2018, ASML announced its intention to purchase up to EUR 2.5 billion worth of shares to be executed within the 2018-2019 time frame. ASML intends to cancel these shares after repurchase with the exception of up to 2.4 million shares, which will be used to cover employee share plans. +Through September 29, 2019, ASML has acquired 8.2 million shares under this program for a total consideration of EUR 1.4 billion. ASML does not expect to purchase the full EUR 2.5 billion worth of shares within the 2018-2019 time frame. In line with our policy to return excess cash to shareholders through growing annualized dividends and regularly timed share buybacks, we will decide on a new share buyback program next year. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Roger. +As Roger highlighted, it was a good quarter and provided another clear signal on the increasing customer confidence in EUV technology as witnessed by the strong EUV order volume for both Logic and Memory manufacturing. We expect a very strong fourth quarter in both sales and profitability, again driven by Logic demand for both EUV and Deep UV, and this further confirms 2019 to be a Logic-driven year as we indicated at the start of the year, fueled by end-market applications requiring high-performance computes, such as 5G and AI, which drives demand for leading-edge Logic. This in turn translates to demand for both EUV and Deep UV in support of the most advanced nodes as customers accelerate their ramp plans for 7-nanometer and beyond. +In Memory, the market continues to digest inventory in the supply chain and operate with reduced wafer output as they work to reach a more normalized supply/demand balance. And this translates into a weak demand from our Memory customers, and we see a significant reduction in our Memory business this year as indicated in earlier conference calls. We expect this weaker demand environment to continue through Q4 of this year, whereby the timing of the recovery still remains uncertain. We continue to expect low single-digit percentage increase in our installed base sales this year. +Let me now turn [the page] on our product side and update you on our EUV business. EUV customers continue to ramp this technology in volume manufacturing and have publicly announced some of their first EUV-manufactured devices. We continue to make solid progress and shipped our first NXE:3400C systems this quarter for use in volume manufacturing. The NXE:3400C will deliver an increase in productivity of over 35%, which will provide significant customer value and bring profitability in our EUV business more in line with the rest of the business. +The high productivity of the NXE:3400C demonstrated the required capability for Memory insertion as evidenced by the system orders as well as a potential increase of layer adoption in Logic. Of the 7 EUV systems shipped this quarter, 3 were NXE:3400C systems, and we plan to ship another 34006 -- 3400C systems next quarter of the total 8 systems planned in Q4. +As Roger mentioned, there were some temporary challenges in the supply chain as we ramp our output capability and transition to a new fully configured 3400C model. These supply constraints resulted in a movement of a few systems originally planned to ship in Q4 and to early next year. Customers are aggressively bringing new technology to the market. And with increased customer confidence around EUV technology, we're seeing strong demand for our EV systems at -- as witnessed by the strong order intake of 23 systems in Q3. These systems are planned for the ramp of 7-nanometer Logic and beyond as well as insertion in 1z and 1a DRAM production. To meet strong customer demand for our 3400C systems, we have a production plan in place for 35 EUV systems next year, which includes the systems originally planned in 2019. +To summarize 2019, we see a strong fourth quarter in both sales and profitability. Logic has been the primary driver of growth this year, and demand has strengthened as customers accelerate the ramp of their advanced nodes. Memory demand remains weak as customers work to reduce inventory and improve factory utilization. Our overall view for the year remains largely unchanged, and we confirm 2019 to be another year growth. +Regarding our outlook for next year, it's too early to provide quantitative expectations, but we'll make a few qualitative comments. Major innovation drivers and applications like artificial intelligence, 5G, autonomous driving and big data are driving a clear secular growth path in high-performance Logic at the advanced nodes. Logic demand is currently strong. And although different, Logic customers are at different phases of accelerating their road map. We expect this demand to remain healthy, primarily driven by EUV, as we look into next year. +As customers transition to the 7-nanometer node and beyond with increase in EUV layers, it is also driving strong demand for our UV systems. As all systems are expected to be NXE:3400C systems next year, we expect to not only see an increase in unit volume, but also expect to see significant growth in UV sales next year. These new applications -- these new application drivers not only require high-performance Logic, but also require high-performance Memory to maximize value. Memory demand is more critical in nature -- sorry, memory demand is more cyclical in nature, and the memory market conditions today do not yet reflect what we would call moderate market conditions, but a scenario that we used to model 2020 as we -- as was shown during our Investor Day last year. +Although the Memory market is widely expected to recover next year, there is uncertainty on the timing and when it will trigger the demand for wafer fab equipment and more specifically, demand for our DPV and application products. Where the Memory market recovers, history has shown that the demand can change quickly and it likely will be the case again this time. The timing and the degree of this Memory recovery, in combination with the current outlook for the Logic demand, will determine the ultimate 2020 product mix between EUV, Deep UV and application products. This not only forms the basis for another year of growth but, depending on this mix, will also determine the margin profile for the year as our EUV margin improvement is well underway but not yet at the Deep UV levels. +Regarding installed base business next year, we expect the service portion of this business to grow nicely as our installed base grows. As our customers start running EUV in high-volume production, we therefore expect to see more EUV service sales next year. There are also a large number of upgrades planned next year that we expect to drive significant growth in our upgrade business. +In summary, the positive momentum in EUV is reflected in the increasing confidence of our customers as they accelerate the adoption of EUV technology in volume manufacturing. And although there is still some short-term uncertainty around timing and the degree of the Memory recovery, we are optimistic on a medium- to long-term secular trend which underpins the confidence we have in our 2025 growth scenarios. +With that, we would be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [5] +-------------------------------------------------------------------------------- + + The operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) +Now operator, could we have your final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Joe Quatrochi, Wells Fargo. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2] +-------------------------------------------------------------------------------- + + Wondering if you could help us with your 2020 EUV guide. The 35 systems that you're shipping, correct me, I think I've heard you correctly that those include the 4 tools that have slipped from 2019. I was wondering if you could help us understand how do we think about the EUV revenue relative to your expectations entering 2020. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [3] +-------------------------------------------------------------------------------- + + Sure, Joe. So you're right. The 35 systems for 2020, they do include the 4 that slipped from 2019 into 2020. The systems that we're looking at for 2020 will be 3400C systems and importantly, they will be 3400C systems in final configuration, which is important. And therefore, the average sales price of those systems will reflect the -- about 30% increase over the 3400B systems. So that's the way to calculate the revenue for 2020. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [4] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then just as a follow-up, did the -- those systems, meaning the full 3400C systems, have an impact on the number of systems that ultimately you plan to ship in 2020, I guess, just given the higher throughput? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [5] +-------------------------------------------------------------------------------- + + No. No. The calculation of 35 is reflective of the total throughput that the 3400C in final configuration will bring. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Next question is from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [7] +-------------------------------------------------------------------------------- + + It's Dave Mulholland from UBS. Just following up on the planning for next year because obviously, previously, we've been talking about anywhere between 30 and 35 systems to ship next year and obviously, in theory, that could then have become 39 unit capacity for next year at the high end. Do you still have optionality to do that into next year? And then just as a follow-up, on HMI, I'm just wondering if you could give us an update on where we are with the progress on that because the revenue run rate has still been quite low in the last few quarters compared to what your aspirations were when you closed the deal. So it'd be helpful just to get some thoughts on what progress we're seeing on that business into 2020. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [8] +-------------------------------------------------------------------------------- + + Yes. Okay. Thank you, David. On the 30 to 35 systems, that's what we said before. And indeed, you are correct, unless, as Roger mentioned, we have 4 systems that we're planning to ship in 2019, moving to 2020, so we put them on top. But as you also know, that in 2019, we were back-end loaded this year. So we always said that that's the beginning of the year. And with the introduction of the C, we experienced a few weeks' delay on certain modules that are part of the final configuration of the C. So that's why it moved into 2020. +So just to be on the safe side, we are -- you could argue, without the forces that moved from 2019 through '20, we're on the lower side of this 30 to 35 range, and that is correct. So plus 4, that's why we say 31 plus 4 is about 35 systems. Does that mean that we don't have more capability? No. We do have more capability. I think we're just more on the conservative side. Also, given what happened this year, back-end loaded, that could mean that you always have a risk of moving some systems into 2021. So you should look at it in this context. +Now on HMI, as you know, HMI shipments were largely focused on the Memory business. It's voltage contrast applications in the 3D NAND space. That, of course, has been lackluster, as we all know, and -- especially for 2019. So yes. That recovery of that sales number will of course happen when the Memory market and especially the 3D NAND market comes back. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [9] +-------------------------------------------------------------------------------- + + Can you just help, how do you feel on the axial technology programs, first, multi-beam and kind of the big steps that you were hoping to see in the business? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [10] +-------------------------------------------------------------------------------- + + Okay. Yes. Oh, yes. I think we are -- the first pilot system will ship early Q1 of next year. And that means that -- and as I mentioned on earlier calls, we had a 6- to 9-month delay on the program as compared to the timing that we discussed with you at the time of the acquisition. That had to do with the fact that we focused on partnering up with one of our key suppliers for the optics. Now for well-known reasons and good reasons, that particular participation of that partner could not happen and that actually meant we had to do it ourselves, which created a 6- to 9-month delay. So that means that the first pilot systems are going out in Q1 next year, which you have to add about a year before you go into HBM. So the anti -- note the HBM ramp will be about 12 months later move into 2021. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Next question is from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + Just a follow-up, Peter, to the last question. Would it be fair to say that as you ship this first multi-beam e-beam system early next year, you gain more momentum, then by the time you have your next Capital Market Day, you would be able to discuss more how the Holistic Lithography part of the story is going to be scaled? And I'm asking you this because e-beam was supposed to be part of it. It was delayed, and now it's back on track. And I think now that the EUV is in high-volume manufacturing, it will be great to get an update on how holistic and part of it how multi-beam e-beam inspection going to play out throughout 2020. And I have a short follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [13] +-------------------------------------------------------------------------------- + + Well, in 2020 -- if you refer to my answer to the last question, I think in 2020, we're going to ship pilot systems. I think the HBM be in 2021. So I don't think that is a major issue for 2020. I think when you referenced to a Capital Market Day of next year, which, of course, we'll talk about a bit later, but we'll definitely have one, we will talk about the holistic strategy of the company as an integral part of our entire product strategy, and it will be a growth area. +But you say EUV being there. Yes. It is ramping in HBM in 2020, definitely, but it's just the beginning. I mean the growth of the company does not depend on the growth in our holistic business. It's -- that's going to be an integral part of our growth profile. EUV, as you may remember from the previous analyst, the -- is the significant part of our business by 2025 with a significant growth profile. So I think it is both holistic applications. And you need to remember, our holistic strategy is a combination of our application business, our EUV and Deep UV business, yes? So I think all will contribute to the growth profile of the company and specifically to multi-beam, which is the first pilot shipments in 2020 and HBM after that in 2021. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Great. And then a follow-up to your comment from last earning conference call, you talked about $1 billion of investment. You referred to it as a strategic investment from China and EUV insertion for DRAM. How do you see that $1 billion, which you characterized as having very minimum downside risk, trending into 2020? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [15] +-------------------------------------------------------------------------------- + + Well, nothing changed in my mind. Absent any major geopolitical movements, the plans are still there. Chinese customers are taking the tools, and they are more or less ramping according to plan. So it also means that their expansion plans for 2020 and beyond remain very much intact. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + Well, perhaps, where does the $1 billion go? How do you see that growth trending? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [17] +-------------------------------------------------------------------------------- + + Oh, you mean beyond 2019 into 2020 and beyond. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + Yes. Yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [19] +-------------------------------------------------------------------------------- + + Yes. I think the medium-term trend to that is -- and it could be that it all depends on how the event profiles of those customers really look like. But if you look at it over, let's say, 2-, 3-year period, it's going to be at least at that level. Now it could be 1 year, it could be a little bit more. 1 year could be a little bit less, but it's going to be at least at that level. And I think medium term, if we follow the road maps of our customers' investment plans, it will grow. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Next question is from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [21] +-------------------------------------------------------------------------------- + + It's Cowen and Co. I have 2 of them. First one for Peter and Roger. When I look at your Memory shipment last quarter, it's almost at a 3-year low, but you have a pretty high bookings run rate. Is there a way to split up the Memory bookings by EUV and non-EUV? And along the same path, Peter, at some point next year, if and when Memory recovers, do you think it's going to be NAND or DRAM that would drive the recovery? And then I also had a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [22] +-------------------------------------------------------------------------------- + + Well, I think on the booking side, it's predominantly EUV. So the non-EUV bookings are really light. So it's a -- that -- yes. Like I said, it is predominantly EUV. On the -- and that is a strategic investment. Like I said, it's the 1z and the 1a preparations. Whether NAND or DRAM is going to recover, you tell me. And always it's a -- what we need to watch as has always been the case is the pricing levels, what is the pricing trend. When the pricing trend turns for both, you just need to see how sustainable it is. So you really need to be kind of objective from 1 or 2 weeks. We have to look at it from a little bit longer period and then look at that trend. And then you need to remember when that trend turns, that our Memory customers still have some idle capacity that they are going to use first before they start to add more wafer fab equipment. That's all. This is the general trend, both true for NAND and for DRAM. So I would advise all of us to just keep looking at the pricing trends. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + Got it. Got it. That's very helpful, Peter. And then just as a follow-up for Roger. I don't want to split hairs on the EUV units for next year, but I think that is 32% or 35% and higher. How do we think about the gross margin for EUV? Does it still like fit in with your prior plan, you're going to have a 40% exit run rate next year for EUV gross margin? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [24] +-------------------------------------------------------------------------------- + + Yes. I think that's right. For next year, we are looking at a 40%-plus gross margin for EUV systems. That's still the plan, not just to exit the year, but in fact for the full year. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Next question is from Ms. (sic) [Mr.] Achal Sultania. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [26] +-------------------------------------------------------------------------------- + + It's Achal from Credit Suisse. Maybe a question on -- again, on margins on EUV. Like obviously, Roger, you're saying it's 40% or north of 40% for whole of 2020. Like just looking at like a long-term view, your DUV margins are much higher, probably 50%, even higher than 50%. What's the -- is there any specific reason why EUV shouldn't go up towards DUV levels, not in the next 1 or 2 years but let's say, over the next 3 to 5 years? Why -- can it actually happen? Or are there some structural issues which prevent EUV margins reaching those levels? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [27] +-------------------------------------------------------------------------------- + + No. I would agree. That is definitely our ambition. And more than our ambition, that is our plan to get EUV to -- not just to, I would say, the overall gross margin that we see for DPV, but to get EUV to the margin level where we currently have immersion, which is our leading lithography tool in terms of gross margin. That is the ambition, and we have the plans to get there. And that will, of course, fully depend on the value that we bring to our customers. But we're confident that with the road map that we have in front of us that we are going to get there. So that is what we're driving on the system side. +And then the other that I mentioned that we're driving is EUV service, which, obviously, this year, has a gross margin that we talked about, which is not favorable. And -- but we do have plans in place in the next couple of years to get also the EUV service margin to a level that will significantly contribute to... + +-------------------------------------------------------------------------------- +Unidentified Participant, - [28] +-------------------------------------------------------------------------------- + + Let's say for the company... + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [29] +-------------------------------------------------------------------------------- + + I think there is a bit of background noise, that might be confusing. + +-------------------------------------------------------------------------------- +Unidentified Participant, - [30] +-------------------------------------------------------------------------------- + + [So I felt some reason will follow.] + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + I think it's on the line of Mr. Sultania, sir. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [32] +-------------------------------------------------------------------------------- + + Yes. Can you hear me now? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [33] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [34] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [35] +-------------------------------------------------------------------------------- + + Yes. And then maybe just a follow-up on the DRAM market. Obviously, we now see one of your customers starting to use EUV for 1z and then 1 alpha RAM. Like how are the talks going on with other DRAM customers? Is it still early days to figure out what their ambitions are? Or are you making decent progress with the other 2 lead customers? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [36] +-------------------------------------------------------------------------------- + + Yes. I think there's no doubt in my mind that all DRAM customers are going to use EUV. Now the question is different customers have different road maps and different timings when the road maps will lead to insertion of EUV. Clearly, there's a major customer that has started to do that, which means that the others will follow. And they follow in different time schedules. One is much closer than the other. That's the way that I would like to explain it. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Next question is from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [38] +-------------------------------------------------------------------------------- + + Please, can I understand in terms of what development needs to happen in terms of manufacturing to ramp up your capacity in EUV now that for 2020, you have on the book more orders than you have capacity, what do you need to do to ramp up your capacity? And then secondly, with regards to Memory usage of -- or DRAM usage of EUV, how the progress is on that front and how you see that ramping up? Are we seeing the TSMC started it, but then next year, it does seem to be very, very strong Logic orders. So do you expect that Memory will follow in that sort of way when Memory adopts EUV? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [39] +-------------------------------------------------------------------------------- + + Yes. To answer your last question, I think Memory will follow. But I think that the insertion timing of EUV for Logic customers is much closer to each other where you could say that the difference of insertion is a year, 1.5 years max, whereby I think with DRAM, it could be a bit longer. And so I think, yes, you will see this trend, but it will be -- but it will definitely be, let's say, more spread out over time where just like I said on the answer of the previous call -- of the previous question, that one of those other Memory makers or DRAM makers is closer to the leader and other one is following at more distance. So it will take more time before all players in the DRAM markets are EUV users as opposed to the Logic market where it all happens within, let's say, a 12-month time frame. +So on the manufacturing capacity, what needs to happen, I don't think -- our current plan is that with the focus of cycle time reduction, that's what it is, we can probably push our capacity in the supply chain and the ASML to launch UV systems. Now I'm not going to say that, that's going to be there next year. But next year, we'll be over 40. That our final plan is that with the cycle time reduction and production efficiencies, we should be able to push with the current square meters that we have and that -- perhaps a few more people, then we can push it to 50 units. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Next question is from Mr. Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [41] +-------------------------------------------------------------------------------- + + It's Bank of America Merrill Lynch, just Adi. First question is really on the EUV gross profit margin in the quarter. I just wondered if you could give us some color on what the margin was in 3Q and what do you expect us to do in 4Q, and then just any color on the ramp into 2020 as well. I know you've given the number for the full year, but any -- how should we think about the cadence? And my follow-up is on the CapEx. You previously said that annualizing the 1Q number would be a good proxy for CapEx for this year. Is that still true? And how should we think about that into next year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [42] +-------------------------------------------------------------------------------- + + So on the gross margin for EUV in Q3, I think we said that for the full year, you would look at the full year around 30%; for Q3, you're looking at slightly under 30%; for Q4, you're looking at slightly over 30%. That's the way to look at it. +Again, we should bear in mind that in Q4, we don't get the full benefit of the pricing of the 3400C because of what we discussed earlier on, which is that they are not yet in final configuration. So you will see for 2020 that there is more potential there. And that added to what Peter was discussing, which is the reduction of cycle time, all those are the factors that will ultimately drive EUV system sales to the 30%, 40% and above that, that we discussed earlier on. +In terms of CapEx, I think that the CapEx number that you've seen for the first quarters, I think you will see a slight increase. And that's for the fourth quarter. So for the full year, you're going to see approximately EUR 800 million to EUR 900 million of CapEx. For the next -- for 1 or 2 years thereafter, you might see similar levels of CapEx because as we have pointed out before, we are at a point where we are really accelerating the developments of our High-NA. And of course, that will lead to building of clean rooms. It will lead to significant investments that we're making together with ZEISS. We're building a logistics center. So we have -- we're really preparing for a sort of the ramp of both low-NA EUV, but also for High-NA. So we will see that for, let's say, another 2 years. And then gradually, you will see that the CapEx levels, as a percentage of sales, will develop to the kind of 3% that we've modeled for 2025. So I think that's the way to look at it. So a few years of significant investments and then getting to a more steady state, 30%, that we've indicated for 2025. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Next question is from Mr. Robert Sanders. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [44] +-------------------------------------------------------------------------------- + + Deutsche Bank. Yes. I just had a question on DUV sales in 2020. How are you thinking about your year-on-year growth rate in 2020, given the kind of ongoing uncertainty in Memory and the substitution of immersion for EUV with your Logic customers? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [45] +-------------------------------------------------------------------------------- + + Yes. Well, I think on -- that substitution has happened with the intake of the orders, but that's all planned. So that was not a big surprise. And I think the DPV sales has always -- it will not be driven by Logic because Logic is pretty strong. DPV sales and the trend of DPV sales will be driven by the timing of the recovery of the Memory market. So I think what we will see in DPV sales is a -- it's a bit of -- it will happen. I'm pretty confident that the Memory rebound will happen in 2020. It's just a matter of when. But if that's the case, then I would see an improvement of the DPV sales profile throughout 2020. To what level really depends on the timing of the recovery. + +-------------------------------------------------------------------------------- +Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [46] +-------------------------------------------------------------------------------- + + Got it. And just one follow-up for Roger. What is the actual gross margin you're going to be getting on the per-wafer services model for EUV when those 2 get in production? I mean excluding any pro bono structure doing for early-stage customers. I mean just the per wafer margin on the services revenue, the EUR 5 million to EUR 6 million plateau. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [47] +-------------------------------------------------------------------------------- + + Well, Bob, we're looking at -- for the end of 2010, we're looking at breaking even on the gross margin for EUV services. As you know and as we've talked about before, this year, we have a mismatch because on the one hand, we have significant cost of helping our customers prepare for high volume and manufacturing, whereas the service revenue is based on wafer output, which, of course, is only kicking in gradually this quarter and last quarter at a very low pace. Of course, that will rebalance itself in the course of 2020. So at that stage, we will get an imbalance. And then from 2021 onwards, we'll see a significant, positive development in the gross margin development of EUV service sales. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Next question is from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [49] +-------------------------------------------------------------------------------- + + It's Pierre, New Street Research. So I just wanted to maybe check with you where we stand in the ramp of EUV in Logic in terms of penetration in the node that are rolling out, being ramped up now and the next generation that is going to be ramping up maybe in 1 or 2 years from now. And my question is, if you sell like X number of tools or X number of players in the 7-nanometer, 7-plus node, what kind of number of tools or what kind of number of layers should we expect in the next-generation models of 5-nanometer or 5 node? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [50] +-------------------------------------------------------------------------------- + + Yes. Thank you. It's -- when you look at the 7-nanometer node, I mean we said this before, on average, there is about 10 layers, yes. That's all in average. And then with different customers, we have different layers. But the average, if you take 10, you're probably right. When you go to the next node, which is going to be 5-nanometer node, you should look at doubling it, yes. So -- and this is about the main rule that you can use. But again, it depends on the customer architecture. Some could be a bit lower, other could be a bit higher. But if you say 10 and then double it to 20, then you're probably on the safe side. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [51] +-------------------------------------------------------------------------------- + + Okay. Right. And then if you think of anything in terms of how you translate that into the outlook revenue for yourself, then we need to take into account the improvement of productivity in tools and then increase in prices. But is that safe to assume that very roughly, the revenue you get, let's say, on the per-layer basis, very, very rough, is about the same between the first 10 layers and the next 10 layers when you're producing 5 -- in 5-nanometer? Or would you have like an increase in terms of value per layer for you? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [52] +-------------------------------------------------------------------------------- + + Yes. I think it's not simply a function of volume. It's also a function of the value. So when we look at our road map there, the road map is really driven by the productivity of our tools. And we are still focusing on improving the next-generation points you see in NA EUV tools in terms of productivity. So that will be a higher value. But also, it's not only that, it is also the more stringent and more -- I'd say, more aggressive on product overlay numbers that are also going to provide a little value to our customers. So it is a combination of those 2. So it's that -- it's -- so the growth of the sales will not only be a function of the volume, but definitely also volume times the value increase. And the value increase will be driven by the things I just said. It's productivity and overlay. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [53] +-------------------------------------------------------------------------------- + + And just simply the way to look at it if you want to model this, at the current technology and the current throughput numbers that we have, typically, 1 layer translates for 45 AK wafer star translates into 1 tool. That's the way to look at it. But then, exactly as Peter says, to the extent that you get throughput improvements, then obviously you need to do the math how that translates into a reduction of that. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [54] +-------------------------------------------------------------------------------- + + And the -- you have to realize, it's all about cost. So if you have a machine that has a higher throughput and that throughput is recognized by the customer, that also means that the breakeven point between the multiple patterning layer and that EUV layer comes closer and closer, yes? So yes, we will see with a higher productivity, higher uptime, the better non-maturity of the tool, the better overlay, I think you're all right to just basically transfer multiple layers into EUV. That's also a thing to consider, and that's something we will figure out in the next 2 to 3 years. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Next question is from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [56] +-------------------------------------------------------------------------------- + + C.J. with Evercore ISI. I guess first question, if I go back to your commentary in early September around Memory, you were talking about an increase in utilization and giving some comfort to a recovery, whereas I think the language here seems a little bit more, I don't know, conservative. And so I guess would love to hear if anything has changed in your Memory outlook over the last month or 2. And then as you think about a recovery into 2020, if you could parse how you're thinking about NAND versus DRAM, given that your intensity on the NAND side is so much less than the DRAM side. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [57] +-------------------------------------------------------------------------------- + + Yes. I think you are absolutely right on the last point. I mean it depends. And I think it was an earlier question, what do we think is going to rebound first, NAND or DRAM? And I answered that by saying we don't know. But it's true. If NAND ramps first, the litho intensity in NAND is lower than in DRAM. At the other hand, it's very difficult to predict which one will go first. +On the increase in utilization, we have actually said in terms of the utilization, what we have seen is that the utilization numbers have stabilized and it's just a matter of to see how DRAM pricing will recover, how inventories that are in the chain, how inventories will be in and up and will be absorbed over what time periods, then customers will start to utilize the tools even at the higher level before they start putting in orders for new wafer fab equipment. I think it's the utilization leveling that we have seen, which is always good. We talked about it in that context. But then it doesn't tell you anything about the end market yet because that is a matter of people buying more bits. +And with reference to what I said earlier in our 2020 model, which was the scenario modeling that we did, we assumed for 2020 a 20% bit growth in DRAM and a 40% in NAND. This is not where we are today. Now that doesn't tell us anything about next year because it could change and it probably will and it very likely will. But to what extent would it then grow in 2020, that's something we just have to wait and see. And like I said, I would suggest we all look at the pricing levels of those devices and take that as an early indicator of what's going to happen. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [58] +-------------------------------------------------------------------------------- + + That's very helpful. As my follow-up, you talked about not achieving your target at least on the near-term buyback plan. I guess is the reasoning there that investing in High-NA and multi-beam and that's the reason why for the push? Then as a follow-up to that, your target model for 2020 was 410 million shares, and we're sitting here today at 422 million. Do you think the buybacks that you have planned into 2020 can get us to that target model level? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [59] +-------------------------------------------------------------------------------- + + So C.J., a couple of reasons for the share buyback program and the delay in execution thereof, if you like. So one, we should not forget that we also introduced an interim dividend and, of course, we can only distribute the euros once, right? So that is one -- a key element. You're right, CapEx. And we talked about CapEx is significant. So that's another driver. And also, the further ramping of EUV and also the fact that we're pretty backloaded this year in terms of sales. I mean all of that contributes to a free cash flow pattern this year, which is a bit of an anomaly. And that's -- so that's combined with the interim dividend. I think that created the circumstance that we just described. +Tempting, what you do, to ask us to make any projections on the share buyback program in 2020. We're going to do that in 2020. And in 2020, we'll announced what the share buyback program will look like at that point. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Next question is from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [61] +-------------------------------------------------------------------------------- + + It's Andrew Gardiner from Barclays. A bit of a -- if I could start with a follow-up actually to one of the earlier questions on layer count. Peter, in your prepared comments as well, you sort of referenced the performance of 3400C and sort of talked about customers being -- sort of having greater conviction in the tools operation and therefore, layer count going up. So when you talk about sort of 10 layers on average at 7-nanometer, doubling to 20 at 5-nanometer, that has been a moving target higher. 7-nanometer's relatively fixed at this point. But as we look at the 5-nanometer, is there still the opportunity for that to go higher? What are you hearing from the customers in terms of those plans? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [62] +-------------------------------------------------------------------------------- + + Yes. I think it's a good question. Of course, our planning of the number of layers that we use EUV is also based on the assumption that our -- that we share with our customers or customers share with us. And you should not forget, there's always a level of conservatism in there. You have to -- where you have the tool, let's say, 2 years back, and we talked about layers of 7-nanometer. And of course, they look at those layers at the absolute necessarily layers that needed EUV. And over time, when we got more confidence and customers got more confidence on EUV as a production technology, the layer count went up. It gradually went up. And it's logical because you get more confidence and that means your level of risk-taking is also different, which I think will also be true for 5 -- when you go to 5-nanometer. +And we would -- and we will execute on our productivity improvement plans, we will execute on our uptime plans, we will execute on the plans that we have for the improvement along product overlay. When you look at that and we do this and customer will gain more confidence over time and obviously in 2020 on the use of EUV in high-volume production and we execute on our plans, I see a trend similar to what we saw on the 7-nanometer, is that the number of layers might go up. And that would be quite logical, but it's all a matter of cost. So yes, there is definitely upside opportunity. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [63] +-------------------------------------------------------------------------------- + + Okay. And Roger, if I could follow up just on OpEx. So it's been creeping higher through the course of the year for a number of reasons, but we still got those 2020 targets that you set out around this time last year, and it's looking increasingly harder with each passing quarter to get -- and particularly on the R&D side the -- sort of the 14% of sales number. Can you just give us a better sense as to how we should be thinking about your OpEx plans into next year relative to that? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [64] +-------------------------------------------------------------------------------- + + Sure. So on the SG&A side, I think the 4% that we've modeled, that's -- I think that's still what we're targeting for. So I think that's probably still the right number to go for. +In terms of R&D, I guess the way to look at it is this year, we're probably going to end approximately EUR 2 billion. That's the R&D number that we're looking at for this year. I think if we look at the capacity that we have today after the significant increase in capacity in terms of number of people that we have in the R&D department, I think we're now at a stage where we say that's the right capacity to have for the -- at least for the near-term development plans that we have. We talk about the acceleration for low-NA. We talk about High-NA. We talk about multi-beam. We talked to you before about, for instance, the people that we hired as a result of the Mapper transaction for multi-beam. So I think at this stage, we're comfortable with the people that we have. So for the foreseeable future, I think what you're looking at is that the capacity is okay. And therefore, for the years to come, you will primarily see an increase that is, let's call it, inflation related. But the capacity that we have today, we think we'll do it for the foreseeable future. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [65] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Next question is from Mr. Aleksander Peterc. + +-------------------------------------------------------------------------------- +Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [67] +-------------------------------------------------------------------------------- + + This is Alex Peterc from Soc Gen. Just a few follow-up questions. Could you be more specific on what the [knot] final configuration of C machine that you're currently shipping means exactly in terms of throughputs? And I suppose there will be later upgrade within this sort of payments from customers. That's the first one. And the second question is really more on the DRAM layer side. I understand that in 1z, there is only 1 EUV layer for now being planned. But I guess the 1 alpha generation will be more fruitful for you. So how many layers do you plan for the next-generation DRAM? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [68] +-------------------------------------------------------------------------------- + + Yes. So on the throughput for the 3400C, as we said before, for the machine, it's 170 that the throughput that which, again, is a more than 30% uptick from the 125 that we had on the B machines. The changes that we're going to make to the machines that are out in the field now, both for this quarter and for next quarter, in essence, they're not really related to throughput, they are more related on the availability of the tool. So -- because it's all related primarily to the modular vessel. And that is not so much a factor, if you like, in throughput, it's a factor in the availability. Now we expect that, that will be done next year. +In terms of upgrades, for the 3400B machines, we do have a number of upgrades available for 3400Bs do not exactly get into the same throughput out of 3400C because that would mean swapping of LANs, which wouldn't make economic sense. But we do have a number of upgrades available to customers that they can choose from that would substantially drive up the performance of our 3400B machine. + +-------------------------------------------------------------------------------- +Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [69] +-------------------------------------------------------------------------------- + + At 20%? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [70] +-------------------------------------------------------------------------------- + + Yes. About 20%, I'm sorry. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [71] +-------------------------------------------------------------------------------- + + Yes. On the -- and on the DRAM layer count, yes. I mean on 1z, it's 1 layer. On 1 alpha -- also, what is true for Logic is also true for DRAM. I think its throughput is amazing. And DRAM is more cost-sensitive in a sense. So higher throughput to more attractive. It could be to replace these multiple patterning layers with EUV. So that is one thing. At the other hand also, what we are seeing is that device performance in DRAM is also very much favorable when it comes to these critical layers for EUV. +So now 1 alpha is not in HBM yet, as you know. So it's still in -- you could say, that is still in the development phase. But currently, we are looking at 3 to 4 layers. So I mean we've been surprised. I've been getting some feedback on the reasons why our customers want to move with DRAM in -- sorry, with EUV in DRAM. And one of the reasons is not so much the current productivity, but it is the device performance that you get when you use EUV as compared to Deep UV. So currently, 3 to 4 layers. But like I said, it's in the development stage, so we don't know what is still in there when we really get to a maturity level. So let's wait and see, but I think that would be a safe bet. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [72] +-------------------------------------------------------------------------------- + + We have time for one last question. So if you were unable to get through on this call and still have questions, please free to contact ASML investor relations department. Now operator, may we have the last caller, please? + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + The last question is from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [74] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. Two questions, if I may. Firstly, maybe for Roger. When we look at -- you touched upon the free cash flow development earlier. And when we look at the change in assets and liabilities over the first 9 months, it does seem significantly more negative than in previous year. I would assume that's to do with the EUV ramp. But could you give us a sense for how you think free cash flow development might shape up going into next year? Any parts in terms of how we should model that would be appreciated. And secondly, if I may, going back to the 23 orders, just wanted to understand the thought process in terms of customer discussions. Clearly, a large number. Do you think the customer has gone ahead and placed this order because they are worried that EUV is accelerating and they might fall behind in the queue? You think it's a one-off? Is it a sign of maturity? Just trying to understand what's led to the customer go ahead and place such a large order at this stage. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [75] +-------------------------------------------------------------------------------- + + Amit, thank you. I'll take the free cash flow question and Peter will take the customer question. So on the free cash flow, I think it's actually a combination of things. I think, rightfully, you point at the continued EUV ramp. That's definitely the case. I mean the way EUV is ramping indeed does lead to a free cash flow anomaly, as I call it. So therefore, you would expect at some stage for that to normalize. And also, given where we are today, we are talking to our customers to look at different models and also in terms of prepayment there and down payments in there. So that's what we're addressing. And I think given the level of maturity that we currently have on the products, I think that is the right way for us to go. +Secondly, as we've all seen, this year is very much back-loaded in terms of sales. And obviously, that also results in a situation where free cash flow is following an anomalous pattern. So if both of those issues are addressed, I would expect that next year, you're going to see a cash conversion, which is much more natural than what you've seen in this year. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [76] +-------------------------------------------------------------------------------- + + Yes. On the question for -- on the customer orders and why so large now. You mentioned is it fair that they're going to end up in the back of the queue, I think customers are -- the way that we interact with our customers and the transparency that we give them on our manufacturing capability, on our manufacturing plans, I don't think that give rise to a lot of fear. It is really driven by the fact that the customers have figured out that in the devices that they want to make, whether it's 7-nanometer or whether it's DRAM, 1z products, that the performance of EUV layers and the productivity that they can now count on gives them the confidence that this is the way to go. And so this is the first question that they will internally answer and then we'll share it with us. And then they come to the next question and say, and then how much do we need and what is available? And then, of course, it's -- well, it was a public knowledge where that -- what our capacity is. It's -- and EUV is very complex technology, and we also know that we're ramping a supply chain that from time to time might be a bit late, a couple of weeks late, as we have seen at the end of this year. +So this is the order. Why did they come? They come because they know that EUV will provide them with the solutions that they need, and it's going to provide them significant value. And if you listen to the customer statements, you can actually get confirmation on that. Now -- and then of course, they come to us and we're very transparent on our capacity and say, fine, if this is the EUV performance, this is our wafer start ramp plan and this is the number of tools that we need. +Yes. You are capacity limited, let's put the order in. It's in that order and not the other way around. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [77] +-------------------------------------------------------------------------------- + + Now on behalf of ASML, I'd like to thank you all for joining us today. Operator, if you could formally conclude the call, I'd appreciate it. Thank you. Operator? This concludes the ASML -- good ahead. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- + + This concludes the ASML 2019 Third Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [79] +-------------------------------------------------------------------------------- + + Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2020-Apr-15-ASML.txt b/Transcripts/ASML/2020-Apr-15-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..aa640459e1aec6bd8cf8f68fe86e35814b341f96 --- /dev/null +++ b/Transcripts/ASML/2020-Apr-15-ASML.txt @@ -0,0 +1,441 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 ASML Holding NV Earnings Call +APRIL 15, 2020 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, President & CEO + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Michael Quatrochi + Wells Fargo Securities, LLC, Research Division - Associate Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + * Achal Sultania + Crédit Suisse AG, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Welcome to ASML's 2020 First Quarter Financial Results Conference Call on April 15, 2020. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you, operator. Welcome, everyone. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today on the call is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. The subject of today's call is ASML's 2020 first quarter results. +The length of this call will be 60 minutes and questions will be taken in the order they are received. This call is also being broadcast live over the internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Skip. Welcome, everyone, and thank you for joining us for our Q1 2020 Results Conference Call. I hope all of you and your families are healthy and safe. +And before we start our normal quarterly results review, I would like to first talk about the topic on everybody's mind, which is the COVID-19 pandemic and the situation. Well, these are unprecedented and challenging times and the COVID-19 pandemic affects all of us. Our primary goal at ASML continues to be to ensure, as best as we can that our colleagues and their families stay safe. Our second goal is to ensure that we continue to serve our customers and to secure the delivery of our product road map, including the continuity of our supply. We have been taking and continue to take precautionary measures to limit the risks. Most of our nonmanufacturing employees now work from home and travel is restricted. In China, our colleagues are returning to the office, but also there, we remain vigilant. +In our own facilities, we have implemented a restricted access to our manufacturing facilities worldwide, and in particular, our clean rooms to ensure our colleagues can work safely. We put in place measures to help ensure isolation between shifts. We've also implemented additional safety and cleaning protocols to minimize contamination risks. We work closely with our customer, suppliers and partners to share information and determine best practices. We see a lot of creativity, resilience and dedication at ASML and the industry and overall, as we work to manage through this crisis. +To date, we have experienced limited impact on ASML's manufacturing capability, although there have been additional challenges with absenteeism, transportation and support logistics that we have had to manage. Some of the quarantine requirements have had an impact on our efficiency, while travel restrictions have posted challenge for installs and major upgrades. We're working with our customers to plan ahead and find creative solutions such as the use of remote monitoring, augmented reality solutions and diagnostic technologies to aid in the service and repair of systems. With regard to our supply chain as some of our suppliers have experienced temporary closures resulting from governmental lockdown and shelter-in-place orders. +At this stage, we've either been able to work around these temporary disruptions or the closure has been resolved. We are managing risk via alternative sourcing and again, a lot of creativity. We're closely monitoring the status and will use safety stock as much as possible to ensure minimum interruption. At this point in time, we've been able to find solutions for these challenges. Regarding customer demand, we've currently not seen a reduction in demand this year and we have seen a strong order intake. I will talk more on this later. +On cash management, although we have a very healthy balance sheet as well as flexibility in our cost structure. We feel it's prudent to preserve cash should the situation continue for an extended period of time, not just for our own operation, but also in order to be able to support our suppliers as best we can in these extraordinary circumstances and Roger will talk more on the detailed actions. You will all understand that in this environment, it's difficult to determine how things will develop, how long it will last, and the impact this will have on the global GDP development that can affect our entire industry. We're taking the necessary steps in terms of safety, risk mitigation and financial measures to best manage through these challenging times. It's very encouraging to see the creativity, resilience and dedication at ASML and the industry overall. +Now I would like to turn our normal quarterly results process. Before we begin the Q&A session, Roger and I would like to provide an overview and some commentary on the first quarter. And Roger will start with a review of our Q1 financial performance with added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and our -- on our future business outlook. +Thank you, Roger. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- +Thank you, Peter. Welcome, everyone. I hope you're all safe and healthy. +I will first review the first quarter financial results and then make some comments on the second quarter of 2020. I would also provide more detail around measures we are taking with regards to cash management. +Net sales came in at EUR 2.4 billion, below our original guidance of EUR 3.1 billion to EUR 3.3 billion, which was primarily related to COVID-19 impact. Net system sales of EUR 1.6 billion was again heavily weighted towards Logic at 73% with the remaining 27% from Memory, clearly showing the continued strength of Logic business. We actually shipped 4 EUV systems in Q1, but we're only able to recognize revenue on 2 systems, which I will explain in more detail later. Installed Base Management sales for the quarter came in at EUR 857 million. This was around EUR 100 million lower than guided due to lack of access to machine time as well as a delay in acceptance of upgrades. We expect these upgrades to translate to revenue in Q2. +Let me provide a bit more detail on the items that occurred in the quarter that resulted in a system revenue shift of around EUR 700 million, consisting of a Deep UV-related revenue shift over EUR 200 million and EUV-related revenue shift of over EUR 500 million primarily related to COVID-19 impact. +First, we experienced some delays in Deep UV shipments to customers in Wuhan, China as well as other customers due to operational and travel restrictions regarding COVID-19. We are working with our customers to prepare for these shipments in the next quarters. Second, we experienced some issues in our supply chain as a result of a temporary disruption from EUV component suppliers that encountered operational restrictions due to COVID-19 regulations. These supply chain issues have been sourced for now. Also we experienced longer than initially planned EUV cycle times for the first NXE:3400C models in final configuration, primarily driven by the complex deployment of inline 10 refill as part of the modular vessel. +Cycle time related to this aspect is now being reduced every week and we are on track to achieving the aspired cycle time reduction envisaged for the end of this year. As you know, this is an important element in achieving the capability of 45 to 50 EUV tools in 2021 and beyond. As a result of the longer-than-expected cycle times as well as COVID-19-related supply issues, we saw some delays in EUV shipments for the quarter resulting in fewer system shipments than originally planned. Third, due to concerns around the continued ability to ship systems in the current circumstances, some customers have asked us to expedite the delivery of EUV systems in the quarter by shipping the systems before the normal factory acceptance tests. The implication of this is a delay in our revenue recognition as final acceptance will now take place after successful installation at the customer side. We expect the revenue that we were not able to recognize for Q1 as a result of the issues listed above to shift to Q2 and Q3 of this year. +Gross margin for the quarter was 45.1%, also below our original guidance, primarily due to a combination of delayed field upgrades as well as delayed Deep UV systems revenue related to COVID-19 impact. Overall operating expenses came within guidance with R&D expenses at EUR 544 million and SG&A expenses at EUR 130 million. +Turning to the balance sheet. EUR 507 million worth of shares were repurchased in Q1. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 4.1 billion. +Moving to the order book. Q1 system bookings came in at a strong EUR 3.1 billion, including EUR 1.5 billion from 11 EUV systems. Logic order intake was 66% of the total value with the remaining 34% for Memory, again reflecting the continued strong Logic demand for leading-edge lithography for this year and next year, but also indicating a recovery of the demand for Memory. Net income in Q1 was EUR 391 million, representing 16% of net sales and resulting in an EPS of EUR 0.93. +With that, I would like to make some comments on Q2 of 2020. As Peter mentioned, we have not seen a reduction in demand this year and we continued to see a strong order intake, up around 28% from Q4. Based on current plans, without any COVID interruption, Q2 can be a strong shipment quarter with revenue up potentially over 50% from Q1 and a significant improvement of gross margin. We are still planning to execute to current plan. However, due to significant uncertainty in this COVID-19 environment, we decided it is prudent to refrain from giving formal guidance for Q2. +Finally, on cash management. Although we have a very healthy balance sheet as well as flexibility in our cost structure, we, like many of our peers and customers, are dependent on the short and longer-term implications of the COVID-19 outbreak. Due to these uncertainties, we feel it is prudent to preserve cash should the situation continue for an extended period of time, not just for our own operations, but also in order to be able to support our suppliers as best we can in these extraordinary circumstances. We have decided not to execute any share buybacks in Q2 2020. This decision follows the pause in the execution of the program in the first quarter after having already performed share buybacks under the new program for an amount of approximately EUR 507 million. The previously announced 3-year share buyback program of up to EUR 6 billion to be executed in the 2020-2022 time frame is still in place. +We have also implemented measures to limit our growth in the workforce. Nonbusiness-critical vacancies have been put on hold. We continue to hire for business-critical positions. This way, our workforce will grow less than originally planned this year. We are also postponing any nonbusiness-critical OpEx and CapEx. However, we will continue to invest in the development of future technology road maps, including High-NA, at an unadjusted pace in order to allow our customers the continuation of their road maps once the situation has been normalized. +As communicated last quarter, ASML has submitted a proposal at a 2020 Annual General Meeting of Shareholders to declare a total dividend for 2019 of EUR 2.40 per ordinary share. Recognizing the interim dividend of EUR 1.05 paid in November 2019, this leads to a final dividend payment of EUR 1.35 to be paid in the second quarter. This is a 14% increase compared to the 2018 dividend. The 2020 Annual General Meeting of Shareholders will take place on April 22 in Veldhoven. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [5] +-------------------------------------------------------------------------------- +Thank you, Roger. As Roger highlighted, our order intake is strong and we have not yet seen any significant pushouts or cancellations this year. Many investments of our customers are strategic and support their technology road maps, a lifeline for our leading-edge customers. These strategic investments are, therefore, primarily related to leading-edge equipment, such as EUV and high-end immersion scanners, requiring longer lead times and qualification schedules. +It was also confirmed recently by leading-edge customers that have also told us that they see an unabated demand for leading-edge devices, at least throughout this year. Keep in mind, the lead time and the qualification of lithography systems are the longest in the fab, and customers will not want to jeopardize any adjustment to their technology and capacity ramps that will negatively affect their ability to keep serving their leading-edge customers. As the current situation is very fluid, we're meeting with our customers on a more frequent basis to understand any changes they may be seeing regarding demand outlook. In general, most customers are still indicating that they are continuing relatively normal fab operations so far. Logic customers are currently continuing to ramp their 7- and 5-nanometer node in support of end market applications like 5G, AI and high performance compute. +There are also some positive sign being reported on data center demand as well as demand for notebook and communication infrastructure driven by the significant increase in work from home and virtual learning activities. These applications drive the demand for both Logic and Memory. However, it can also be expected that consumer-related electronics, for example, smartphones, may be under stress, in addition to the potential negative impact the COVID-19 crisis will have on GDP. +We expect installed base business to continue to scale with growing installed base numbers, and we'll also see EUV contribute to service revenue as these systems are running wafers in volume manufacturing. We currently have plans for upgrades of several customers, however, with the realization, there is a supply and a demand risk in the current environment. +Our bookings show an increase in Memory over the prior quarter driven by Deep UV, while Logic continues to show a transition from Deep UV to EUV ordering as customers' confidence in EUV increases, translating into more layers in Logic production. On EUV, along with the industry, ASML continues to make progress in ramping EUV technology in high-volume manufacturing as was recently showcased at the SPIE Lithology Conference in February. Our customers continue to adopt and ramp EUV in high-volume manufacturing in both Logic and Memory. And one of our Memory customers recently announced that they have successfully shipped 1 million of the industry's first 10-nanometer class DRAM modules based on EUV technology. They also stated EUV will be fully deployed in future generation of DRAM, starting with its fourth-generation 10-nanometer D1A next year. +We continue to target EUV revenue of around EUR 4.5 billion from 35 systems this year, thereby assuming that we will not face any significant supply/demand risks, as mentioned before. On margins for EUV, we continue to drive profitability in both the systems as well as the service business. And we're still on track to achieve at least 40% system gross margin this year and breakeven with our EUV service business by the end of the year. Increased customer confidence in EUV technology is translating to strong EUV demand in both Logic and Memory. This is reflected in the strong order flow in the first quarter in support of our 2021 output. As mentioned in earlier calls, we're currently working towards a capacity of 45 to 50 systems in 2021, which we feel can be achieved through reductions in cycle time. We continue to make progress on our next-generation EUV technology, High-NA and are on track to ship the initial development systems in 2022. +Now regarding our outlook on the quarter and on the year, based on the current customer demand plans and without any COVID interruption, Q2 can be a strong shipment quarter, with significant improvement of gross margin, as Roger mentioned. We're currently in execution of this plan. On the full year, customer demand is currently strong as well and the current shipment plans would position us well for another year of growth. However, there is a significant uncertainty about how the current COVID-19 crisis will impact the global GDP development and markets, our manufacturing capability and supply chain. In light of these risks and uncertainties, we decided it's prudent to refrain from giving formal guidance for Q2 and for the full year 2020. +Again, these are unprecedented and challenging times, but we will get through it. The world looks a lot different today than it did 3 months ago. Though it is hard to make predictions and we're certainly not adding opinions, we continue to look at the facts day-by-day and act accordingly. We're taking the necessary steps for the safety of our employees, the community and our customers as well as the necessary risk mitigation and financial steps. +I would like also to take the opportunity to thank the entire ASML team and their families as well as our many partners who stepped up in these demanding times in support of our company and our stakeholders. I've seen great examples of teamwork and incredible creativity to make sure that we can continue our work, serving our customers by keeping our people and partners safe. Despite the fact that the current environment provides clearly near-term challenges and uncertainties, the positive industry momentum around innovation and expanding new markets further strengthens our confidence in our future growth scenarios. +With that, we'd be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- +Thank you, Peter and Roger. The operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now operator, can we have your final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) The first question comes from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- +Sandeep Deshpande, JPMorgan. My first question to you, Peter, is that you've seen very great order strength in the first quarter. Is this order strength, essentially, what -- if you remember in January, it said that you were hoping the Memory orders would come in through the year. It was these Memory orders coming in, which caused this order strength? Or was it something else like customers were worried that they could -- they may not get tools from you and so they expedited their orders to -- and brought them forward from later in the year, which is what caused this order strength? And my second question, which is a follow -- not a follow-up, but with regard to your 40% gross margin indication in EUV for the year, is -- I mean given this -- the social distancing, et cetera, associated with -- which you may be implementing even in manufacturing, will that not have an impact on the cycle times and thus the gross margin? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [3] +-------------------------------------------------------------------------------- +Okay. Let me answer this first question. I think the order strength, and I think Roger said it, about 2/3 of the order intake was Logic and 1/3 was Memory. So I don't think it is an acceleration of it. It is something that we would -- that we expected. Also driven by, I think, what we observed as a continued increase in utilization in the Memory space of our machines. So that actually fits in quite nicely. I don't think there were pull-ins either. These orders are there to support our outlook for 2021 and this was planned. So basically, you could say it's more a confirmation of the technology road map that our customers have in front of them. So in that sense, good. +On the gross margin indication of 40%, the cycle time impact, we've been able to manage. I mentioned it. We did see an increase in absenteeism in the factories because of the guidelines that people followed by the government, the health authorities, basically saying, if you have symptoms like some of the COVID-19 symptoms, you should stay at home, which people did, even when they had a cold, which actually meant that we did have, indeed, some shortages in the factory, but we've been able to reorder shift patterns. And also what we're seeing is that people that are eligible to work in the factory, for instance, on R&D environment, they are now also working in the factory to make sure that we can do the output. So I think we can manage and I don't think it will have an impact on the 40% gross margin indication that we gave you. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +The next question is from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [5] +-------------------------------------------------------------------------------- +It's David from UBS. Just following up on one of the comments that Roger made in terms of how you're looking to, I guess, in some respects, support your supplier base. Can you just give us a little bit more detail about what you're considering there? And are there any particular suppliers that you might be worried about where a particular other part of their business might be, I guess, heavily, or that was exposed that we've seen a very sudden downturn? Just a little more color on how you're planning to support your supplier base. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [6] +-------------------------------------------------------------------------------- +Yes. Let me answer that. I think we are managing our suppliers almost on a day-to-day basis. And most of what we see in the supply chain currently are delays in delivery of modules that are a result of those, let's say, lockdown situations or shelter-in-place situation where we need to find different solutions leading to a delay of parts. However, as you pointed out, when this situation lasts longer, we also could see that some of our suppliers that are also exposed to other industries that currently are not in the, perhaps, somewhat more enviable position where we are, they might be looking for help from our side. And then that help would largely be requests for prepayments. Now we don't see that yet. But I would expect if this lasts long that this would come and they want some prepayments on orders when our demand profile stays as strong as it is. +Having said that, you have to look at the -- at our integral supply chain, which includes our customers. I mean what is true for our supplier is also true for us. So we are, of course, also in discussion with our customers to say, listen, we need to look at the continuity of the supply chain from an integral point of view. So if we need to prepay suppliers, I need prepayments from our customers, yes? So it is almost, you could say, it's a back-to-back link in terms of potential financing requests. I'm pretty sure that some of them will come, yes, and especially in those areas where, as you pointed out, some of our suppliers are losing significant business in other industries. +So this is what we are -- we don't see it yet, but I mean have been around long enough and also in some other crises, going back to the Internet bubble burst and then the financial crisis and 9/11, there will -- in the supply chain, some potential issues will pop-up, that will just happen. But again, we need to look at this from an integral point of view, from an integral supply chain point of view and our customers play a significant role there also which, by the way, we are in discussion with them and I think these are good discussions. So I'm pretty positive that we can help those areas in our supply chain, which could become critical going forward. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [7] +-------------------------------------------------------------------------------- +That's great. And just one follow-up on the R&D side of the business. As you said as many as can are working from home, but I presume you haven't closed on R&D facilities because, I guess, a lot of the work you do still needs to be, I guess, physical tests, particularly in the case of High-NA and work that's going on there. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [8] +-------------------------------------------------------------------------------- +Yes. I think if you really talk about the physical tests, I mean that is done in clean rooms and we build modules. So that's an agreement and we talked about this. I mean we have very strict regulations there now almost for -- I would say, almost for 2 months and they are effective. On the R&D side itself, it is -- when we look at the latest productivity numbers, which we follow on a day-to-day basis, I think 90% of our R&D engineers, they work from home. But with the current possibilities that we have in creating virtual teams and working off-site, I can say that I'm pleasantly surprised with the productivity numbers that I see, whether it's the number of design sign-offs, whether it's the number of software builds, the software calculations. Our IT infrastructure is holding up very well, which we prepared, by the way. So that's going well. +And when we look at those productivity numbers, they actually are very similar to the productivity numbers that we saw before starting to work at home, which I think is very good, which is also attributed to the flexibility of our people. You see also in the log-on numbers that people make much longer hours. I mean they log-on the same time, but they log-off much later. So there's a lot of working in the evening. And we check very regularly with our managers across the company of how we are doing. And there's a lot of virtual teamwork going on, even leading to virtual drinks in Friday afternoon where they all sit together in front of the camera with a glass of beer. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +The next question is from Mr. Joe Quatrochi. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [10] +-------------------------------------------------------------------------------- +Yes, it's Wells Fargo. I was hoping you could kind of give us some more color on the strong Memory bookings that you reported. Can you help us understand are you starting to see demand largely driven by NAND or DRAM? And then to the extent that you can help us understand what was EUV in terms of the Memory bookings? Was that also a driver this quarter? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [11] +-------------------------------------------------------------------------------- +Yes. EUV, the last question is, it's really Logic. So very few EUV orders. That will come -- sorry, very few EUV orders for Memory, and that will come. So it is predominantly Logic. And the strong Memory bookings are -- I actually said it earlier. They are also the result of what at least we're seeing in terms of utilization of our systems in the Memory space, both in DRAM and in NAND. The trend, we -- the cautious trend that we saw at the end of Q4 of last year has continued in terms of increased utilization throughout Q1 until -- very recently until last week. So the trends are upward. So that explains why Memory bookings are going up also because customers see this also. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [12] +-------------------------------------------------------------------------------- +That's helpful. And then you talked a lot about what ASML is doing in terms of services to meet your customers' needs. Is there any kind of updated thoughts you can give us on -- I think you talked about EUR 3.4 billion for revenue for 2020 for services? And should we think about, like the first quarter or March quarter being kind of a low point for services this year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [13] +-------------------------------------------------------------------------------- +Yes. Yes. I think we mentioned why Q1 was about EUR 100 million below our guidance and we gave you the reason for that. It is the lack of machine time that we had on particular upgrades that we were doing. And as a result of that that will fall into Q2. And other than that, in the installed base business still looks good. So the number that we talked about in the past is a number that has still relevance with all the caveats that we talk about in the entire call around the current uncertainty. Indeed, the EUR 3.4 billion is the number that we talked about on the Q4 call. So that's a good recollection of what we mentioned there. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +The next question is from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [15] +-------------------------------------------------------------------------------- +Yes, Evercore ISI. I guess, Peter, first question, just to follow-up on the Memory side of things. It looks like ex-EUV, your orders are up, like 80% Q-on-Q. And so curious on that front, is that more NAND versus DRAM? And then on the last call, you talked about optionality to a stronger DRAM recovery into the second half of the year. I'm curious what your thoughts are as it relates to that potential reality? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [16] +-------------------------------------------------------------------------------- +Yes. I think when I answer, you have to take into consideration that customers, for instance, do, do relocations. So we might be shipping to a DRAM fab, a leading-edge machine that is replacing a machine that was on a pedestal that now goes to NAND. So there is some relocation there. But I would say that the Memory intake is driven by DRAM. And then with the caveat that we do obviously see some relocation out of DRAM into 3D NAND. But I would say if you would have to answer and say, where is the -- what's the emphasis, the emphasis is on DRAM. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [17] +-------------------------------------------------------------------------------- +Okay. Great. Very helpful. My follow-up, can you speak directly to how you're thinking about cycle time improvements on EUV? And as part of that, what will it take to get the ability for you to have double-digit shipments on a quarterly basis, which it looks like you need to do to hit that 35-unit forecast? And I guess as part of that, should we be thinking about the potential for customers to expedite again in the coming quarters and therefore, perhaps maybe revenue on 1 or 2 tools gets delayed into '21? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [18] +-------------------------------------------------------------------------------- +Well, on the last point, I mean it's April 15, so I don't know what's going to happen in December. So that's not what our customers tell us today. Our customers tell us today that they want the 35 systems. On the cycle time improvement and our ability to ship double-digit numbers, we are planning and without any supply chain or capacity disruptions because of COVID, we will ship double-digit numbers in this quarter in Q2 of 2020. So we have that capability. And when you look at this, and let's say, customers have a number of 36 units that they want, it's not 9999 every quarter. That's not how it works. And it works when do the customers need it because it's their ramp schedule that is going to determine when we ship. +For instance, in Q1, we only shipped 4 systems, but we planned before the COVID-19 impact, 6 in Q1, not that we couldn't make more, it just -- it also has to do it with when the customers need the machines, yes? So we will do double-digit in this quarter, yes? And actually, it means that we have the capability, which is, of course, very important to get to the 35 numbers. I think the cycle time reductions -- and was one of the earlier comment, we have some absenteeism in the factory. We're dealing with that. I think we will get to the cycle time reductions as planned and we will have the capability to do 35 systems this year. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +The next question is from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [20] +-------------------------------------------------------------------------------- +Krish from Cowen. I have 2 of them. First one, Peter, to the extent you can answer this, what do you think you would ship in terms of DUV units this year either in absolute unit numbers or relative to 2019? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [21] +-------------------------------------------------------------------------------- +Relative to 2019, you will see -- that's just a general comment. I'm not going to guide you on a specific Deep UV number. But as we said before and I have said for some time now that when you look at EUV, EUV is cannibalizing, you could say, some multiple patterning layers. So there will be a reduction of Deep UV systems in 2020 and that will be more than compensated by the sales number in EUV. And that's logical. That's what we've always said. EUV is there to cannibalize multiple pattern and layers. Now how much that in the end will be, it's going to be somewhat now lower. It's not going to be significant, but that is the trend. It's a trend going forward. As you can also see from our 2025 Capital Market Day information, where you also see that in 2025, the Deep UV numbers are lower than what they used to be and that's because EUV is going to replace those. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [22] +-------------------------------------------------------------------------------- +Got it. Got it. That's helpful, Peter. And then as my follow-up, if I look at your -- for the last 2 quarters, if I look at your Memory shipments and compare it, it's very similar to the sales into China. So a, is most of your Memory shipments in the last 2 quarters coming mainly from China? And b, how do you expect that to trend over the next couple of quarters? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [23] +-------------------------------------------------------------------------------- +Well, it's -- as you know, and I said, we actually mentioned that the shipments in Q1 were impacted by the COVID-19 crisis in China, especially Wuhan, where there's a Memory customer there, yes? Well, you can imagine, we didn't ship anything to that customer. The other customer took a few tools according to plan. But the majority, of course, of everything that we shipped, was outside China. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +The next question comes from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [25] +-------------------------------------------------------------------------------- +It's Pierre at New Street. So Peter and Roger, from your prepared remarks, I understand like the near-term of COVID-19 played out clearly not so bad for you and your value chain and that you're managing very well logistics disruption and more like the supply side of the story. Now, of course, my next concern is what happens next. And I hear you that we have very little visibility, so it's very -- it's impossible to make like a near-term forecast. But my question would be like a what-if question. So let's assume that in the second half of the year, demand for PCs, servers and smartphones are down 20%, 25% year-on-year. If that happens at a high level, how do you see your clients impacted -- are impacted? And how do you see that's impacting ASML? +And I have 2 specific like question marks in mind. One is, in that kind of scenario, would your clients push out EUV orders? Or do you think they need to take orders anyway because they need to take your supply of the technology? And then the second one I had in mind was what about a very steep decline risk in DUV because I imagine that if volumes are not where they were expected when rollout plans were made 6 months ago, I would expect a lot of reuse of DUV tools as node migrations continue. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [26] +-------------------------------------------------------------------------------- +Let me first answer your question, how does it impact ASML on a certain scenario? Basically, I couldn't answer that. I would be a bit mean and say, that's your work, not mine, yes? But... + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [27] +-------------------------------------------------------------------------------- +Point taken, point taken. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [28] +-------------------------------------------------------------------------------- +So -- but what I would answer is that if you don't know where you're going, you'd better be flexible, yes? And this is what we're organizing. We're organizing for flexibility in the supply chain. As you know, 80% or 80% plus is in the supply chain. That means that we -- very like with every crisis, we hardly ever saw cancellations. We saw pushouts. So it basically means you would be looking at in the supply chain financing of working capital, which is also particularly important in the context of the answer I gave to a question earlier, what do you want to do in the supply chain, which I think is an integral supply chain problem, which includes our customers. I mean they cannot do without supply in the end either. So it's a working capital issue, which I think is manageable. +I think from a flexibility point of view, we have a lot of cost flexibility here with our variable cost on labor. It was a lot of variable cost, it's like variable income to our people, which, of course, when the business goes down, that will go down also. I don't think there will be a lot of pushouts for EUV orders. What our customers are telling us now. And when I listen well to them, they are not blind. They see that the impact on GDP will be recessionary. And that will very likely have an impact on consumer spending and on the consumer electronics. What they do notice is that the customers of our customers are not blind either that the demand on the leading-edge Logic, which includes 5- and 7-nanometer is still strong. +I mean our customers tell us every time, every week that we talk to them, please stay on target with your shipments of your leading-edge machines. Now if data centers would require 25% less service, which, by the way, if you think about it, it's probably that it's -- then something very bad has actually happened because we need more data center capacity and not less, yes? So -- and that's where the high compute goes, yes? So I think push out of EUV orders, it can always happen. I don't think it's going to be significant. We're not planning for an Armageddon scenario where the entire world economy crumbles into an abyss. We were not planning that. I don't think it's going to happen either. I think it's a low likelihood. +So all in all, I think we're flexible enough. I think EUV, with the -- with key focus on leading-edge solutions that our customers' customers need is going to be relatively safe. And I think reuse of Deep UV tools is -- the story of reuse of Deep UV tools has always been very prominent in every cycle. But you need to realize that when you look at leading edge, it's not only EUV, it's leading-edge Deep UV, but you need Deep UV not so much for the geometrical shrink, you need it for overlay, yes? And that is very important for those new leading-edge devices. So the overlay requirements for an NXT:2050, which will be our leading-edge immersion tool, is significantly different than in 1980, because in 1980 we will not be able to do what the 2050 should be doing to make sure that they can support our leading-edge nodes. So reuse will be limited. It simply has to do with the fact that the requirements that are needed for leading-edge nodes for Deep UV tools are different and they are also more difficult for the older generations to achieve. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +The next question is from Mr. Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- +Peter, going back to the topic of where we're going to, I'm still confused. You talked about improvement in the supply chain. You talked about sequential revenue growth that could exceed 50%, but you're not providing a guide, not even for Q2. What is it out there? And we are halfway through April. What is it out there that makes you uncomfortable given what you see in the next 2 months? I'm not asking about the second half, I'm asking just the Q2. And I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [31] +-------------------------------------------------------------------------------- +Yes. No, I fully understand your question, Mehdi, because we always say, well, we have very long lead times in the supply chain, which is true for the critical suppliers like, for instance, ZEISS. We have, in the end, if you take Tier 2 also thousands of suppliers, which some of them have lead times which are a lot shorter. We've had delays in EUV in Q1 of a couple of weeks because one particular supplier couldn't provide rings, your flow rings, which is not the most advanced part that we need. But if you don't have it, you don't have it. So this is where our concern comes from. It's the tiered supply chain, which is not always that visible to us. +We have tiered suppliers coming from Malaysia, Mexico, you name it, and they are supplying to our Tier 2 and Tier 1 suppliers. And if that supply basically stops then even a part that has a relatively short lead time doesn't arrive on time, and we get a delay. I think, ultimately, we get those parts, it's just a delay. And if we tell you, if we give you a number and we get a significant delay in some of those short lead-time parts, we cannot ship tools and that can be significant. You may remember that the 3400C now is EUR 130 million tool. That's a big number. And I don't want to give you a range from x billion to y billion. That doesn't make sense, yes? So this is where it comes from, yes? +And I think it is really based on the experience that we've had in Q1 where we were able to manage it, but we did see some delays. And since we cannot judge what the impact will be of these governmental orders in different parts of the world, we cannot assess what that risk is. But it's there because we've seen it. We've been able to manage it with a lot of creativity. It doesn't give me any assurance or certainty that we will be able to manage it going forward always. So this is where it comes from. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- +Very clear. And if you could give us an update on Hermes multi-beam shipment. I think the beta tool was supposed to be shipped to the customer in Q1. And what's the update there? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [33] +-------------------------------------------------------------------------------- +Yes. I think it was ready. It was in packing. And then the shelter in place in the Bay Area, because that's where it comes from, it comes from San Jose, just stopped the tool. So it was -- that the trucks were pulling up and they had to return. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- +But do you see the trucks are going to resume their destination in Q2? Or they're going to be more... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [35] +-------------------------------------------------------------------------------- +Well, I think -- listen, I mean what we are doing now, we are assessing whether we and this particular tool falls under the definition of a critical business. And actually, we're looking into what our possibilities are to actually ship the tool. And I would love to ship the tool ASAP because it's ready and the customer wants it. So let's see how things go. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +The next question is from Mr. Mitch Steves. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [37] +-------------------------------------------------------------------------------- +This is Mitch Steves from RBC. Just had a question on the services business. I'm trying to understand it a little better. So I'm guessing you guys are able to do some of this remotely. But can you maybe walk us through how much revenue you guys think will come back? How much revenue you may have lost in Q1? And then how it would work if, like, we get out of the shelter in place, say, earlier? Would that be a lot of pent-up demand where you see a snap-up? Or does the services business kind of actually just get hit and some of the revenues are lost? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [38] +-------------------------------------------------------------------------------- +I think the revenue, Mitch, that we lost in Q1, as we mentioned, is around EUR 100 million and it's primarily related to certain upgrades. I would say it's not even related to COVID-19 in particular. It was related to the fact that we didn't get sufficient machine time from customers. So that revenue we missed for Q1, we'll get it in Q2. There's hardly any doubt in my mind, we will get that in Q2. And other than that, I don't think there is going -- as far as we can see right now, we don't see any anomalies. So at this stage, still on track for the EUR 3.4 billion in IBM revenue that we talked about in the previous quarter. +As we also mentioned in the video, and as Peter talked about in the introduction, we are deploying new technologies, right? So of course, we're less able than we were in the past to have people go from Veldhoven from Wilton, et cetera, and go to the customer locations for obvious reasons, for the travel restriction and what have you. But by using artificial -- by using virtual reality, augmented reality type technology, we are able to support the huge local support teams that we have with very specialized knowledge that we have at the different hubs. And in that way, so far, we think we're still well positioned to keep up providing the service and the upgrade work that we need to do. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [39] +-------------------------------------------------------------------------------- +One additional comment here, it's more anecdotal, but actually, we were preparing as a kind of a prototype project somewhere deep in the organization, how could we support remotely through augmented reality and HoloLens, basically people sitting 6,000 kilometers from the actual service action. And then we have now over-the-shoulder 3D augmented reality support that service engineers with 6 months of training that would normally have to do this after a 2- to 3-year training, we're now operating and doing service actions with the support of experts that were sitting 6,000 kilometers away and basically providing them with 3D images, how they should do the service actions and it works. So this is also something that amazed us also. And actually, our service levels, we keep up all our service levels up in terms of maintenance and servicing of our tools, which I think is a really good achievement. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +The next question is from Mr. Achal Sultania. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [41] +-------------------------------------------------------------------------------- +It's Crédit Suisse. Peter, maybe one question from my side, on the services. You mentioned that so far, you've tried to do a lot of remote working and local team assisting to get maintenance and upgrades done. How should we think about the EUV installation part? Do you have teams in place at customer fabs or at customer locations to make sure that EUV installation can still go ahead as per plan, at least during Q2, if travel restrictions are not lifted? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [42] +-------------------------------------------------------------------------------- +Yes, that's a very good question. Luckily, we have 3 main sites where we do EUV and that's also the sites where we have most of our service engineers. I mean we have to think of 1,000 plus. So there is a lot of experience there. And this is exactly where this remote support comes in. We do send people across the globe, but that's where we have hundreds of people, hundreds of people traveling, it's now probably not more than 50, 60. They have to go into 2 weeks of quarantine. They have to get a special travel visa. So we need to plan and prepare this much more rigorously than we did in the past. And this is where we do send experts. But I think a lot of these service actions that are not of the really topnotch expert level are being trained and being done with the kind of novel remote support technologies that I just mentioned. So it's a combination of both. And I think we'll be able to do all the installations. We have been able to actually do that and we are. So yes, we still do travel. It's not going back to 0, but it's a fraction of what we were able to do, but it works + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [43] +-------------------------------------------------------------------------------- +And maybe one follow-up for Roger. Then, Roger, on the services side, you mentioned EUR 3.4 billion is still in sight for the full year. Can you help us understand like how much of that -- within that will be EUV specifically? And also how much of losses for EUV services can we expect? I know you mentioned breakeven, hopefully, by the end of the year. Because the thing that I'm trying to understand is how much of a drag on services gross margin has EUV been last year or maybe this year, just to help us get to what the number should be going forward. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [44] +-------------------------------------------------------------------------------- +Let me be very short on that. So for this year, I think quarter-over-quarter, what -- so if you compare the last quarter, so Q4 to today, that would probably account for 0.5% in gross margin. So the improvement in EUV this year is going to account for about 0.5% in gross margin for the year. So that's an answer to that question. In general, if you look at the EUR 3.4 billion, it's about 50-50 in terms of regular service and maintenance, if you like, and upgrades. And the regular service and maintenance, EUV is still a fairly small number, given, of course, the installed base for Deep UV is so much larger. But the impact on the gross margin percentage, about 0.5%. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [45] +-------------------------------------------------------------------------------- +All right. We have time for one last question. If you were unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations department with your question. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +The last question is from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [47] +-------------------------------------------------------------------------------- +It's Andrew from Barclays. Just a follow-up, really, on the comments you guys have been making on the Memory tool utilization. Peter, you said you've seen it improve sort of from late fourth quarter into first quarter and just up this quarter. I'm just wondering, how much flex do you think the industry still has to continue to grow bit output by raising utilization? And when are they going to get close to full utilization, again, based on the current trends? Obviously, I know we've got the global caveats. But just if trends were to continue, how close are we to that full utilization where they'd need to start adding capacity again? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [48] +-------------------------------------------------------------------------------- +I think that will be this quarter. When I look at the trend, it's going to be -- it's pretty close. There's still a little bit of underutilization to go, but it will be this quarter. Sorry to be short, Andrew, but it is what it is. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [49] +-------------------------------------------------------------------------------- +That's just fine. The best answer. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [50] +-------------------------------------------------------------------------------- +Do you have a second question, Andrew? + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [51] +-------------------------------------------------------------------------------- +No. I'll let you close quickly then. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [52] +-------------------------------------------------------------------------------- +All right. Thank you. Now on behalf of ASML, I would like to thank you all for joining us today. Operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +This concludes the ASML 2020 First Quarter Financial Results Conference Call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2020-Jan-22-ASML.txt b/Transcripts/ASML/2020-Jan-22-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d62dc1ac3263b682c62900ffa1e19cccfa7938e --- /dev/null +++ b/Transcripts/ASML/2020-Jan-22-ASML.txt @@ -0,0 +1,568 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 ASML Holding NV Earnings Call +JANUARY 22, 2020 / 2:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - President, CEO & Chairman of the Management Board + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Michael Quatrochi + Wells Fargo Securities, LLC, Research Division - Associate Analyst + * Sandeep Sudhir Deshpande + JP Morgan Chase & Co, Research Division - Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Aleksander Peterc + Societe Generale Cross Asset Research - Equity Analyst + * Amit B. Harchandani + Citigroup Inc, Research Division - VP and Analyst + * Janardan Nedyam Menon + Liberum Capital Limited, Research Division - Technology Analyst + * Alexander Duval + Goldman Sachs Group Inc., Research Division - Equity Analyst + * David Terence Mulholland + UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Adithya Satyanarayana Metuku + BofA Merrill Lynch, Research Division - Associate + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Welcome to the ASML 2019 Fourth Quarter and Full Year Financial Results Conference Call on January 22, 2020. (Operator Instructions) I would now like to open the question-and-answer queue. (Operator Instructions) +I would now like to turn the conference call over to Skip Miller. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Welcome, everyone. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven, The Netherlands, is ASML CEO, Peter Wennink; and our CFO, Roger Dassen. +The subject of today's call is ASML's 2019 fourth quarter and full year results. The length of this call will be 60 minutes, and questions will be taken in the order that they are received. The call is also broadcast being live over the internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. +Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in the ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Welcome, everyone. Thank you for joining us for our Q4 and full year 2019 annual results conference call. +Before begin -- we begin the Q&A session, Roger and I would like to provide an overview and some commentary on the fourth quarter and the full year 2019 as well as provide our view of the coming quarters. Roger will start with a review of our Q4 and full year 2019 financial performance with added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and on our future business outlook. Thank you. Roger? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter, and welcome, everyone. I will first highlight some of the fourth quarter and full year financial accomplishments and then provide our guidance for the first quarter of 2020. +Q4 results were basically in line with our guidance. Net sales came in at EUR 4 billion. Net system sales of EUR 3.1 billion was heavily weighted towards Logic at 83%, with the remaining 17% from Memory, clearly showing the continued strength of Logic business as well as the ongoing digestion phase of the Memory business. We reported EUV system sales of EUR 922 million from 8 shipments. +Installed Base Management sales for the quarter came in at EUR 906 million. Gross margin for the quarter was 48.1%. +Overall, operating expenses came in above our guidance, with R&D expenses at EUR 516 million and SG&A expenses at EUR 148 million. Higher than guided SG&A is due to additional employee benefit costs and costs related to our IT implementation. +Turning to the balance sheet, EUR 186 million worth of shares were repurchased in Q4. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 4.7 billion. This amount is significantly higher than anticipated with most of the cash coming in, in the December period. +Moving to the order book, Q4 system bookings came in at EUR 2.4 billion, including EUR 1.1 billion for 9 EUV systems. Logic order intake was 79% of the total value, with the remaining 21% from Memory, again, reflecting the continued strong Logic demand for our leading-edge lithography. +Net income in Q4 was EUR 1.134 billion, representing 28.1% of net sales and resulting in an EPS of EUR 2.70. For the full year, net sales grew 8% to EUR 11.8 billion. The Installed Base Management sales was EUR 2.8 billion, which was a small increase compared to previous year. +In 2019, we booked EUR 6.2 billion of EUV orders, which is more than 50% of the total bookings value for the year, reflecting customers' strong demand for EUV technology. We continue to invest in the future of ASML and increased R&D spend to EUR 2 billion in 2019. The increase was primarily driven by the acceleration of our EUV road map, low and High-NA program. Overall R&D investments as a percentage of 2019 sales was about 17%, SG&A was about 4% of sales. +In addition, ASML invested EUR 886 million in CapEx supporting our long-term growth opportunities primarily around High-NA capacity and infrastructure. +Net income for the full year was EUR 2.6 billion, resulting in 21.9% of net sales and an EPS of EUR 6.16. +With that, I would like to turn to our expectations for the first quarter of 2020. We expect Q1 total net sales between EUR 3.1 billion and EUR 3.3 billion. We expect our Q1 Installed Base Management sales to be around EUR 950 million driven by strong demand for field upgrades, especially EUV. +Gross margin for Q1 is expected to be between 46% and 47%. The lower gross margin relative to the strong Q4 number is primarily due to Deep UV mix effect, fewer immersion and more drive systems with some positive EUV mix effect. +The expected R&D expenses for Q1 are around EUR 550 million, and SG&A is expected to come in at around EUR 140 million. Our estimated 2020 annualized effective tax rate is around 13%. +Regarding our capital return, ASML paid total dividends of EUR 1.3 billion that made up of the 2018 dividend and 2019 interim dividend, and purchased EUR 410 million worth of shares in 2019. +Through December 31, 2019, ASML acquired 9 million shares of the 2018-2019 program for a total amount of EUR 1.6 billion. Supported by our long-term business plan, ASML will submit a proposal at the 2020 Annual General Meeting of Shareholders to declare a dividend for 2019 of EUR 2.40 per ordinary share. Recognizing the interim dividend of EUR 1.05 paid in November 2019, this leads to a final dividend of EUR 1.35 to be paid in the second quarter. This is a 14% increase compared to the 2018 dividend. The 2020 Annual General Meeting of Shareholders will take place on April 22 in Veldhoven. +ASML announces a 3-year share buyback program of up to EUR 6 billion to be executed in 2020 through 2022. ASML intends to cancel these shares after repurchase with the exception of up to 0.4 million shares, which will be used to cover employee share plans. +With that, I'd like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger highlighted, we had a very strong quarter, resulting in another solid year of growth driven by Logic and EUV. We were able to achieve an 8% top line growth despite an overall industry decline of around 10% due to a weak Memory market. There's always a reflection of our Logic customers drive to continue to innovate and invest in technology for future nodes. For 2020, we currently expect a year of double-digit growth in both sales and profitability primarily driven by EUV and installed base business. +Major innovation drivers such as artificial intelligence, 5G, high-performance compute, autonomous driving and big data are creating new end-user applications, and these applications require more high-performance Logic, fueling increased demand for leading-edge nodes. And this is evident in several customer announcements regarding ramp plans for the 7- and 5-nanometer nodes, which will drive another strong Logic year and an increased demand for EUV. +In the Memory market, the customers have indicated they're seeing signs of demand recovery in some market channels, and improvements in Memory chip pricing also support this view. +As customers have lowered litho tool utilization to reduce wafer output throughout the weak Memory demand period, they will first use this underutilization to return to normal supply levels, which will take some time. Subsequently, this will also trigger equipment demand, albeit a bit later than the supply/demand recovery for Memory devices. Taking the slope of the recovery of our litho equipment utilization as a proxy, it seems likely that we will see stronger litho equipment demand for Memory in the second half of the year. +We expect significant growth in our installed base business, service business will continue to scale as our installed base grows, and we'll also see EUV contribute to service revenue as these systems start running wafers and volume manufacturing now. We expect significant demand for upgrades, particularly in EUV, as customers utilize upgrades as a quick way to increase capacity. In EUV, it was a breakthrough year, with the technology now starting in high-volume production and producing consumer products that are already available in the market. +As we continue to execute on our accelerated EUV road map, we were able to ship our first NXE 3400C in 2019, which provides high productivity, translating to increased customer value, delivering higher ASPs and improved gross margins. We shipped 6 3400C systems in Q4 of the 8 EUV systems total we shipped in the quarter, bringing the total to 26 EUV systems and full year sales of around EUR 2.8 billion in 2019. +Increasing customer confidence in the EUV is translating into more layers in Logic production as well as expanding to new markets with the adoption in Memory. For full year 2020, we plan for EUV sales of around EUR 4.5 billion on 35 systems. We continue to see demand building for next year's shipments and expect a healthy order flow to continue. +In order to fulfill the expected strong demand increase, we're working on the cycle time reduction to enable a capacity of 45 to 50 systems next year. 2021 is shaping up to be a very busy year. +Regarding our current outlook for the year, we expect 2020 to be another growth year as mentioned before. Although it's too early to provide quantitative expectations, let me make a few qualitative comments. +Major innovation drivers and applications that require high-performance Logic are driving increased demand at the advanced nodes. Logic demand is currently strong, and we expect this demand to remain healthy primarily driven by EUV. And as previously communicated, we expect sales of EUR 4.5 billion on 35 systems this year, which translates to EUV sales growth of approximately 60%. +Memory is showing early signs of recovery. And although there's still uncertainty around exact timing of the recovery, it is likely we will see stronger demand in the second half of the year. And taking this into account, we expect a stronger second half with strengthening sales throughout the year. +Summary, 2019 was another great year, with continued positive momentum in EUV as well as short demand across our entire product portfolio. We expect another growth year supported by healthy Logic demand and likely recovery of the Memory market, with increased sales from our installed base business as well as demand for EUV. The positive industry momentum around innovation and expanding new markets further strengthens our confidence in 2021 outlook and our 2025 growth scenarios. +With that, we'd be happy to take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [1] +-------------------------------------------------------------------------------- + + Thank you, Peter and Roger. The operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) Now, operator, could we have your final instructions and then the first question, please? + +-------------------------------------------------------------------------------- +Operator [2] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mehdi Hosseini. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [3] +-------------------------------------------------------------------------------- + + My question has to do with your comment regarding EUV manufacturing capacity of 50 system by 2021. Peter, do you think your backlog would reflect that capacity as we progress through the year? In other words, would you be able to have a full commitment from your customer for full capacity? And my short follow-up has to do with your -- the multibeam EUV wafer inspection. Are we still on target for the first shipment in the first half? And how should we think about the time it would take for your customers to evaluate the tool? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [4] +-------------------------------------------------------------------------------- + + Okay, Mehdi, thanks. On the EUV capacity, yes, I think the backlog will reflect this. I think the order intake on EUV is looking very healthy. So I have little doubt that we'll have the backlog fill this year to support the capacity that we have lined out now for 2021. I think the issue here is really we need to reduce the cycle time, which we have good plans for. I mean we see first progress. I think the focus is on cycle time reduction in this case. MB, multibeam inspection, yes, we will ship in the first half. And I think the customers will probably take throughout this year to evaluate the tool so that we can start shipping next year in higher volume. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is from Mr. David Mulholland. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [6] +-------------------------------------------------------------------------------- + + It is Dave Mulholland from UBS. Just to follow-up on some of the comments you made around Memory. Obviously, there are some indicators, things are improving. I think some of the checks we've been doing through the supply chain are certainly pointing to improved capacity plans particularly potentially from Q2. When do you think you could start seeing that in orders? And I guess in some respects, why haven't we already seen some of it in Q4? And then I'll come back with a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [7] +-------------------------------------------------------------------------------- + + Yes. Thanks, David. It's a good question. I wish I had a definite answer because that would make things easier. So I'm basically saying, we have -- when we -- when I said in my prepared remarks that we see the utilization of our tools going up, and we just extrapolate the slope of utilization increase. And I think it would mean at the end of the first half of this year, we will see likely a return to a normal supply/demand balance for our customers. Now they see that also and taking into account the order delivery times, the order lead times, then I would expect orders have to come in somewhere in Q2 in order for us to make sure that in the second half of the year, we could see an increase of our Memory business. +Again, we're in this business for quite a long time, and in my experience, Memory always comes back with a vengeance. They -- when it comes, it always comes quick, so we'll just have to wait. So I think it makes a big difference whether orders come back in Q2 or they come back in Q1 or in early Q3, I mean it makes a big difference for the year. So we just have to wait and see, and I wish I had a final and definite answer. + +-------------------------------------------------------------------------------- +David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [8] +-------------------------------------------------------------------------------- + + Okay. And just one, second follow-up on the Installed Base Management business. Obviously, a very strong run rate in Q1 at EUR 950 million. How do you think about this on a full year basis? In the past, you've had a target, I think, of EUR 3.7 billion but been slightly more conservative run rate through the last couple of years. What's driving the pickup in Q1? How should we think about that on a full year basis? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [9] +-------------------------------------------------------------------------------- + + David, I think the -- if you look at Q1 and also if you look at Q4, you see that the momentum was already building up in Q4, where we were already slightly over EUR 900 million, EUR 950 million for the quarter. We expect that we will not be able to sustain it at this level for the entire year. I think a good way to go would be to say that we're probably going to see a 20% increase over last year annualized. So that would get you to approximately EUR 3.4 billion for the year. That's where we would see it for the for the full year. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question comes from Mr. C. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [11] +-------------------------------------------------------------------------------- + + C.J. Muse with Evercore ISI. I guess first, I was hoping to hit on gross margins. Can you walk through where we exited on EUV in the fourth quarter? And then how you are seeing the trajectory for overall gross margins through the year, increased EUV shipments as well as likely higher immersion shipments in the back half for DRAM? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [12] +-------------------------------------------------------------------------------- + + Yes. Thank you, C.J. So let me first talk about gross margin for EUV and then give you the wider picture on gross margin. So on EUV, what we said, as you know, last year, on the systems side, systems gross margin for EUV, we're looking at about 30%, this year, we're looking at about 40%, 4-0. So that's what we have in the plan, and that's what we're executing for, and that's also in our models for this year. +On the wider picture for gross margin, and I know that many of you are looking at the Capital Markets Day. At the Capital Markets Day, we mentioned 50%. So let me start there, let me start at the 50% and let's look at what the circumstances were at the time, what the circumstances are today, and then we will start talking about how we see this to unfold and what the potential is that we see for this year. +So back in November -- at the Capital Markets Day in November 2018, I think there are 3 things that we should bear in mind. First off, at that stage -- what we modeled at that stage for you, and that had the 50% in there was what we called a mid-market growth scenario. And I think in all likelihood if we look at the circumstances today, if we look at the circumstances of the Memory market today, then I think it will be hard to say that for the full year, we're looking at a mid-market scenario. It's definitely not what we're looking at today, depending on when it's going to come back, and as Peter said, how it's going to come back. You could, on average, see a mid-market scenario. But at this stage, I think it's hard to say that we're looking at a mid-market scenario for that. At this stage, the Memory market in these months is fairly flat. So that's one important circumstance I think to recognize. +The second thing that I think changed from November 2018, and I think Peter already responded to that in the first question, is the multibeam. So the delay in the multibeam, we're -- I think we're going to see commercial application and commercial sales of multibeam only in 2021, we're at a Capital Markets Day, as you know and as we already told you also last year, we were still looking for 2020 as commercial application of multibeam. So that's, in essence, shifted with a little under 1 year. So that's the second circumstance to bear in mind. +The third thing that deviates a little bit from what we told you in the Capital Markets Day in November 2018 is a bit of accounting issue, and that has to do with High-NA. We are preparing for High-NA not just on the R&D side, but we're also preparing for High-NA on the manufacturing side and on the supply chain side. And we are incurring cost there that we cannot capitalize and have to run through cost of sales, which is a bit weird because we're not selling High-NA, but nonetheless, that's what the accounting will dictate you to do. And that represents a little short of 1% alone in gross margin. So those are 3 things to bear in mind that might be different from the perspective and the model that existed in November 2018. +So now let's look at this year, and let's look at the 46% to 47% that we have for Q1, and let's look at the potential for the rest of the year. And I think there's a number of drivers in there that I think could further drive the gross margin up. The first one obviously is related to the situation in the Memory market, and that is pretty important, not just for the top line but it's also very important for gross margin. Because if we see a solid recovery in the second half of the Memory market, that will have a significant impact on the sale of immersion tools, which, as all of you know, comes with pretty high gross margin and also with a good recovery in our voltage contrast business, which, as you know, is also very much tied to the Memory business. And again, that is a very high-margin product that we have. So if we get the recovery in the Memory market, that will also have a significant impact on the gross margin on those 2 elements alone. +The second element that will -- that is expected to further drive up the gross margin throughout the year is the EUV service. EUV service for the full year is still expected to be -- to have negative gross margin. But over the quarter-over-quarter, you will see a sustained improvement in the gross margin that we have on EUV service. For 2 reasons, first off, because, as you know, with a number of customers we have the pay-per-wafer model. And to the extent that EUV continues to go into high-volume manufacturing, obviously we get more revenue. And secondly, the cost that we have per EUV machine goes down because we get more efficient in doing it, and we also get scale effects as a result of that. +So quarter-over-quarter, you will see that the EUV service margin will improve. For the full year, it's still negative, but at least in Q4, maybe even a little before that, we will see that it starts to become positive. +Third improvement that we expect to occur in the course of this year will be the introduction of our new immersion tool, the 250 -- the NXT:2050, which, again, comes with a good improvement of our gross margin. So those are 3 significant drivers that we have, that we believe give us a good shot at achieving a significant improvement of our gross margin particularly in the half and a good shot at the 50%. +And then this 50%, we will be able to then sustain further into 2021, which, as Peter already alluded to, we think is going to be a very busy year. And a very busy year at that stage would also come with a number of scale benefits in our gross margin, better fixed cost coverage. And also in 2021, we would see the introduction of a successor to EUV that would also again, come with gross margin improvement. So then we think that momentum that would be created in the second half around reaching the 50% would then be further sustained and elaborated on into 2021 time frame. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- + + Very, very helpful. If I may follow up. I think the buyback announcement, as we're moving into high-volume manufacturing EUV, seems to be a bit of an inflection here for ASML begin the cash cow mode. So curious if there are metrics that we should be looking at whether it's free cash flow margins or working on working capital or perhaps CapEx intensity coming down as you've invested in EUV capacity, High-NA, multibeam. So curious if there's kind of a metric we should be looking at to gauge free cash flow in the coming years. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [14] +-------------------------------------------------------------------------------- + + Yes. And then -- so in the short term, you will see that with the increase in EUV and EUV becoming increasingly important for the company, given the cycle time of EUV is significantly lower than Deep UV, in the short term, you may expect that inventory levels will continue to go up a little bit. That's a dynamic on the one hand. And also in the short term, as you -- as I think we've said before, you might expect that the CapEx level that you've seen for 2019, that will be above the CapEx level that you might expect for this year and for next year. So around EUR 900 million to EUR 1 billion is the CapEx number that we think is likely for this year and for next year. So those are dynamics in, I would say, in the short term. +In the years thereafter, I expect CapEx level to level off and actually go down because then the significant preparation for our future, I think, CapEx-wise, I think will have been done and will be able to go down. Also I would expect that in 1- to 2-year time frame, you might expect inventory levels to go down for a number of reasons. First off, at that stage, we talked about 2021, there is a significant buildup of our capacity for EUV. But once you are there and once you are at those levels, then the further buildup of inventory will no longer have an impact on your inventory levels. +And secondly, as we mentioned before, the way we believe we will be able to get an increase in our capacity from the 35-ish that we have for this year to the 45, 50 that we talked about for 2021 will primarily be the reduction of cycle time. And of course, the reduction of cycle time will then kick in and further reduce working capital requirement. +So in the short term, I think the burden on working capital will still be there. In the longer run, so let's say, 1.5, 2 years, you will see that we will be able to get it under control better. +One final dynamic as far as that is concerned, we talked to you in previous calls on the introduction of down payments for EUV, which we're pushing and where we had the initial accomplishments on that in 2019, and we'll continue to drive that. And that will also be a mitigating factor, if you like, in our working capital burden. So long-winding answer, just to tell you that in spite of all of that and in spite of this preparation for the growth, we're still looking at a pretty healthy free cash flow development, both this year and next year. And then the years thereafter, I think the free cash flow that we generate will further increase substantially. And all of that taken together gives us more than enough comfort to introduce this EUR 6 billion program for the next 3 years. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Next question, Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [16] +-------------------------------------------------------------------------------- + + It's Krish Sankar from Cowen. I had two questions. First one, on EUV. So Peter, it looks like your commentary on 2020 EUV of 35 systems at EUR 4.5 billion revenue and next year about 45 to 50 systems capacity is similar to about 3 months ago. I was in the impression that over the last 3 months, at the margin, there was more incremental demand from DRAM for EUV. So I'm just wondering, is it an issue that you're still capacity-constrained and that's why you cannot ship more? Or are you being conservative? And then my second question is, how to think about DUV units this year relative to 2019, would it be similar levels, lower, higher? Any color would be helpful. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [17] +-------------------------------------------------------------------------------- + + Yes. On your first question, I actually -- I tried to answer that in an earlier question that the issue with 2021 is to make sure that we can reduce the cycle time so much that we can create a capacity between 45 and 50 units, which is a capacity issue, not a demand issue. So yes, DRAM will be there. I would just have to make sure that we can squeeze as many EUV systems out of our available square meters so that we can fulfill the customer demand. It's not a demand issue, it's a capacity issue. +So in joined essence, that's why the commentary is similar to what we did last quarter because the capacity lead time, fortunately, is a lot longer than just the customer order lead time. +Now on the DPV units, good question. Very much changes on, and Roger said it, on the recovery of the Memory market, yes? So the Memory is still very much driven by immersion. Of course, we are seeing with the increased number of EUV systems in Logics on cannibalization because of multiple patterning schemes that will actually move on to single patterning EUV schemes. +Now -- so if we would not see a recovery of the Memory business, which I do not expect, because we do expect recovery, clearly, the Deep UV units would be down. But it's really the timing of the Memory recovery that will determine how much of the Deep UV units we are going to see this year. As I said, it is really hinging on the timing of the Memory recovery. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + The next question, Alexander Duval. + +-------------------------------------------------------------------------------- +Alexander Duval, Goldman Sachs Group Inc., Research Division - Equity Analyst [19] +-------------------------------------------------------------------------------- + + Alex from Goldman Sachs. I just wanted to ask or clarify on the extra R&D and SG&A for the first quarter that you've guided to versus where the street was? And just wondered if you could help decompose a bit the most important drivers and sort of what underpins them? For example, to what extent is this more about investing in faster cycle times for those 50 or 45 to 50 units in '22 -- '21? To what extent is it about increasing functionality of future EUV versions as we move beyond the 3400C? And to what extent does it hinge on any other key factors? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [20] +-------------------------------------------------------------------------------- + + So on R&D, last quarter, we were at EUR 516 million, this quarter, we're guiding EUR 550 million. And I think that the vast majority of that increase is labor cost increase. As we mentioned before, at this stage, we have about a capacity that we think we need in order to accomplish the R&D objectives that we have, which are all of the things that you just mentioned, but primarily focused on the Low-NA, High-NA road map, multibeam, but also a number of developments in Deep UV, obviously. +So we think we have the capacity that we need in order to get that done. And that's why we said on previous calls, expect the going out rate for the fourth quarter to be the basis. And then obviously, it needs to be, what we call, inflation-adjusted, which is obviously linked to wage increases for that. And that's what you see. So the 6% increase from EUR 516 million to EUR 550 million really is primarily the wage increase on the R&D department. +In terms of SG&A, SG&A, I think is modeled at EUR 140 million which is I think very much in line with what you saw in previous quarters. Q4 had a little bit of a spike. There was some accounting adjustments in there in Q4 that had a little impact. And also we're in the process of implementing a new IT system, which has some impact on the SG&A number. But those are small things. But the guidance of EUR 140 million I think is pretty much in line with what we were in previous quarters, and obviously, there to the wage impact. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [21] +-------------------------------------------------------------------------------- + + Yes. I think on the wage impact, don't think we give our people 10% wage increase because they will probably raise a lot of questions when people start listening to this call, but it's the combination of the normally inflationary wage increase and the fact that of course we added people in 2019. So you see the full year effect now of that growth in R&D in 2020, which actually happened throughout 2019. But now you see the full year wage impact. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Next question is from Joe Quatrochi. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [23] +-------------------------------------------------------------------------------- + + Yes. It's Wells Fargo. I had a question on the Memory side. I know that ASML has historically been more tied to DRAM than NAND. So I was hoping you could kind of help us kind of parse out the comments that you've made in terms of the recovery and seeing potentially improve bookings kind of looking into 2Q. Is that more of a NAND Flash comment? Or should we think about that from a DRAM perspective? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [24] +-------------------------------------------------------------------------------- + + Yes. I think if you split the DRAM and NAND, and I only -- like I said, the proxy that we have is basically looking at some utilization data. I think it is first noticeable in 3D NAND. I also think the slope of the recovery is a bit more aggressive in NAND than in DRAM, but they are both there. Having said that, I also mentioned in my prepared remarks that customers were creating underutilization in order to make sure that they could rebalance the supply and the demand in the Memory space sooner. That underutilization correction was also deeper in 3D NAND. So it was also not a big surprise that, of course, the return slope back up is also a bit steeper. So -- but that's where we are. I think 3D NAND started a bit earlier, it's a bit steeper slope, but both are trending in the upward direction. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [25] +-------------------------------------------------------------------------------- + + Okay, that's helpful. And then just for the March quarter guide, I was wondering in the past, you guys have given us kind of the EUV shipment and revenue expectation for the quarter. So I was curious if you could give us that for the March quarter? Because I know that there's 4 shipment systems rather that are included from 2019. And then maybe just any thoughts on the cadence for 2020 just now, given that the 3400C is available for the full year? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [26] +-------------------------------------------------------------------------------- + + Yes. I think we've indicated in the past that as soon as we really see that EUV is, in essence, going into high-volume manufacturing and also at a point where we can take revenue upon shipment that that would be the time where we're no longer going to give separate guidance on EUV shipments. So that is clearly the case by now. So that's the reason why, starting this year, we no longer do that. +What we do, do, however, is continue to indicate, at least for 2020, for the full year, we giving an indication of the euro value and also the number of units for EUV for the full year. And of course, we will report quarter-by-quarter. We will report to you what the euro number and the unit number of that will be. +As it relates to your second question on how is it distributed over the year, it's not completely evenly distributed. It's a little bit tilted towards the second half, but only -- but modestly so. So it's not as exacerbated, if you like, as we had it in 2019. There's a better balance, but it is still a little bit tilted towards the second half of 2020. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Next question, Janardan Menon. + +-------------------------------------------------------------------------------- +Janardan Nedyam Menon, Liberum Capital Limited, Research Division - Technology Analyst [28] +-------------------------------------------------------------------------------- + + It's Janardan Menon from Liberum. I just had two follow-ups on the Logic side, especially on the EUV front -- sorry, on the DUV front. So if I take your growth number for this year, just calculating EUV revenues alone, you're going from EUR 2.8 billion to EUR 4.5 billion. I'm assuming that much of that is going to be Logic shipments. And so if I put that EUR 1.7 billion of additional revenue, which, on the Logic revenue of EUR 6.6 billion last year, that's about 25% of additional growth in Logic for this year. I'm just wondering given that, DUV shipments would probably come down during the year, what kind of a decline in DUV are we looking at? Is it 3 or 4 units, in which case, you will still be growing your Logic revenues at about 20% or higher? Or will the DUV drop a bit more than that and you could be sort of in the 10% to 20% range of growth on your Logic side? +And a short follow-up is on the EUV capacity. Given that you're seeing so much of demand for EUV right now, and you're saying that in 2020, it's more a capacity issue, otherwise, you probably could ship 50 units. What can you do to add capacity further into 2022 if this kind of strength, and especially if the Memory market -- the DRAM market comes in more strongly for EUV in 2022 and the Logic strength continues? Is there a scope to further reduce cycle time to take your unit shipments above 50? Or can you use some of the bays in your High-NA new facility for Low-NA systems, if that were to be required? Is there a way you can go above 50 units by 2022? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [29] +-------------------------------------------------------------------------------- + + Let me take the first question and then Peter can go into the second question. If you piece together the data points that we gave you, I think you can find sort of an answer to your first question. So as Peter said in the video, we're looking at a double-digit growth. If you do that math and you have a number that you arrive at. And then we gave you 2 other important components. On the one hand, indeed, as you mentioned, the EUR 4.5 billion for EUV, and also on this call, gave you the 20% increase over the installed base, which would get you to approximately EUR 3.4 billion. So then you can sort of calculate where DUV and apps combined where they would land for the year. I think that's what you're looking. And of course, as Peter said, it will be dependent upon the timing and the extent of the recovery, but we believe that the number that you derive in that way is a safe number to go by with some potential obviously if the Memory recovery is significant and timing. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [30] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [31] +-------------------------------------------------------------------------------- + + Peter, second question on... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [32] +-------------------------------------------------------------------------------- + + Yes. Second question on -- when you look at the EUV capacity that we currently have and like I said, it will be driven by cycle time reduction because the lead time reduction for capacity adds is longer. Yes, for 2020 -- beyond 2021, we are looking to bring the output capability above 50. Now -- which is what we're doing today is really looking at how much should that be. If we have to go over 60, we probably need to extend square meters of production capacity at ASML and at suppliers, which could be, like you said, using production facilities that we're currently building for High-NA, use that for temporary use in a Low-NA. Although, we'd like to prevent that because you have been here, Janardan, I mean these bays are different, the high-NA bays are different than the Low-NA bays. So it would mean some extra cost, but if push comes to shove, you could probably do that. But I think we can -- with our cycle time, probably we can go over 50. But I think it will be very difficult to go over 60. So if we have to go over 60, then we probably need to quickly add some manufacturing capacity at ASML and at the supply chain. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Next question is Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [34] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. A couple, if I may. The first question goes back to the demand for EUV. You've talked about obviously the capacity for 2021. In terms of the drivers of demand from your customers, what really do you think is changing or accelerating from a customer standpoint? Is it the number of layers of adoption? Is it the base of guidance down the nodes? Is it their end customers' push? Could you give us a sense for what really do you think is driving this optimism and acceleration towards the number that you've talked about for 2021 from a customer standpoint? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [35] +-------------------------------------------------------------------------------- + + Yes. Amit, I mean the easy answer is all of the above. Yes, we are seeing increase of lay account. The fact that EUV works also gives the customer the confidence on their road map and when they get confidence on the road map, you see a cadence change, there's a push, maybe a pull-in, yes? But also I think the discussion that we're having with customers and customers are having with us, although without going to very specific customer details, we will never do that, it's very clear that the number of tape-outs and the request from their customers, our customers' customers on different types of end applications is going up. So it is basically the combination of those 3 things, I mean you've mentioned them all. And that's what it is. And I think we are responding to what our customers are asking us based on those 3 drivers, and this is why we come to the problem of more of a capacity issue in 2021 than demand issue. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [36] +-------------------------------------------------------------------------------- + + And secondly, if I may, could you maybe give us your latest thoughts on how you're thinking about demand from indigenous customers in China. There's obviously news flow around the EUV tool, and you've commented on that very clearly. But more broadly, as you think of your 2020 guidance and 2021, things have changed a bit since November 2018. Any clarity on demand from indigenous China, the various end markets? And what are baked into your assumptions right now? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [37] +-------------------------------------------------------------------------------- + + Yes. I think things have of course changed with markets change and -- since November 2018. But I would say on China, we are pretty much on target in terms of the strategic rollout, especially in the Memory space. In Logic, and it's not so much leading-edge Logic, it's more the mature Logic systems. I think our current assessment of the market is a bit higher than it was at 2018. So if anything at the leading-edge, we're on plan. On the trailing actually, the more mature technology, I do see -- we see an upside, but no downside. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Next question, Achal Sultania. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc, Research Division - VP and Analyst [39] +-------------------------------------------------------------------------------- + + It's Achal from Crédit Suisse. Roger, maybe on EUV services gross margins, just trying to understand like how much of a headwind it has been on -- at a group level in 2019. Obviously, you made a comment that it will get to -- it will still be loss-making this year. But basically, we have improvement through the year. So I'm just trying to understand how much of it has been already a headwind in '19? And then how quickly can that business ramp up towards a 40%, 45% services gross margins like you have most likely in DUV? Does it take 2 years, 3 years? Any color on that would be helpful. +And then secondly, on the mix, when you talk about this 45 to 50 capacity for EUV in 2021, can you help us understand like obviously Logic is a -- foundry is a big part of that number. But what are you hearing from Logic and DRAM customers in terms of the unit breakdown of that 45 to 50 unit number? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [40] +-------------------------------------------------------------------------------- + + Thank you. So on the gross margin impact of EUV service, that was around 2% for 2019. So that's the gross margin impact of that in 2019. As I mentioned to you, we do see it's coming to a positive number in the course of this year. I expect it to be at least Q4, maybe even before that that it will turn positive. +Before we have EUV service gross margin at the corporate gross margin level, I think we're probably 2, 3 years away from that. But the aspiration clearly is there to have it at that stage in that time frame. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [41] +-------------------------------------------------------------------------------- + + And on the split, the 45- to 50-unit split, I can kind of give you -- I'm not going to give you any details, but the majority and I mean the -- it's above the 50% is going to go to the Logic space. So we're still dominated by Logic. But clearly, the 2021 numbers for DRAM are -- will go up as logical. I mean we have -- in the Logic space, we have several customers, in the DRAM space, we still have one so that's also an issue that will drive the division between Logic and between DRAM. But maybe it's going to be significantly above 50% is going to be Logic. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Next question, Adithya Metuku. + +-------------------------------------------------------------------------------- +Adithya Satyanarayana Metuku, BofA Merrill Lynch, Research Division - Associate [43] +-------------------------------------------------------------------------------- + + It's Bank of America. I had two questions. Firstly, just thinking about the Memory demand as we go through this year and into next year. Obviously, when we look at the last [2] years, going into 2018, we had a very strong increase. We had a doubling in '17 and then another 50% increase in revenues from Memory customers in '18. Now when you look at the next 2 years, obviously things may be a little different. And I know it's very difficult to give a pinpoint number, but I just wondered what do you have, in your scenarios, internally? Where do you see -- if Memory was to come back in 1Q? Where do you see Memory revenues for this year? And if it were to come back in 3Q, where do you see that coming? Any color that you can give us to help us get a rough sense of where we might end up would be very helpful. +And then secondly, just a question for Roger, just on OpEx. Just wondered if you could confirm whether the OpEx annualizing 1Q number would be a good proxy for the full year or whether there is anything else we need to think about. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [44] +-------------------------------------------------------------------------------- + + Yes. Well, I think on the question on the Memory demand, I did give you some indication. I can repeat myself. But when I look at -- the best proxy we have is to just look at how our machines are being used. And that's why I said, I do believe that in the first half, and it's a bit difficult to understand the exact timing or to gauge the exact timing. They will be in the first half, I think our customers will come back to this more healthy supply/demand balance, and they will see this coming so they will place orders. So for us, it's going to be -- likely going to be a second half event. But having said that, I mean 2019 was of course a weak Memory market for us, also the first half of 2020 could be not very strong as Roger indicated. But when it come back to the second half, we will have an impact on our business, also on our financial performance. +But when the Memory goes -- comes back, then I think you need to look into 2021. I think I said it earlier, 2020, we do see strong EUV demand. I see no reason why the demand of our customers for leading-edge products in the Memory space, 5 nanometer will kick in then we will go down. But when the Memory recovery starts in the second half of the year, for us, is we'll extend it to 2021. So you would then have had effectively 1.5 years of a Memory downturn, which I think historically is not long and not short either. So it's just -- it all seems to fit, and this is the kind of call that I can give you based on top of what I already said. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [45] +-------------------------------------------------------------------------------- + + And Adithya, on your questions on the -- on OpEx, indeed, I can confirm that that what we have sort of EUR 550 million R&D and the EUR 140 million for SG&A. Those are good run rates for the quarters in this year. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Next question, Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [47] +-------------------------------------------------------------------------------- + + Sandeep Deshpande at JPMorgan. Most of my questions have been answered, but just actually a clarification, Peter. Firstly, on whenever this Memory recovery occurs, I mean you can see how the customer utilization is doing. Your exposure to NAND is lower than your exposure in DRAM. But do you see that NAND utilization is rising faster than DRAM more or vice versa at this point because that will determine the timing of when your orders come in? +And then secondly, regarding these -- the multibeam tools that you're working on, you think -- at this point, is the view that these will begin shipping in 2021 and that's the -- that there could be even further accretion to the margin in 2021? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [48] +-------------------------------------------------------------------------------- + + All right. I think I will do the Memory recovery. Like I said earlier, with the slope of the utilization recovery is a bit faster, a bit steeper for 3D NAND, but it also come from a deeper point. So in that sense -- and yes, we have, as you mentioned, less exposure to the 3D NAND market, but 3D NAND market needs a lot of exposures. So I mean this is what we are accounting, and this is what we are seeing. So I think NAND probably rising a bit faster, I think that could be the conclusion. +And sorry, sorry, second part was? + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [49] +-------------------------------------------------------------------------------- + + The second part was on the gross margin and multi-beam tools. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [50] +-------------------------------------------------------------------------------- + + Oh, the multibeam tools. Okay. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [51] +-------------------------------------------------------------------------------- + + And indeed, multibeam, as I mentioned, multibeam is expected to be a high-margin product. So to the extent that when it will go into commercial application, and that is expected for 2021, we do believe that it will be accretive to our gross margin. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [52] +-------------------------------------------------------------------------------- + + Roger, (inaudible) if you look at multi -- as you look at an e-beam tool, it's a machine but it's very much -- it is compute power. So there's a lot of software also that's why margins are generally higher in e-beam space than in the lithography space. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Next question, Aleksander Peterc. + +-------------------------------------------------------------------------------- +Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [54] +-------------------------------------------------------------------------------- + + It's Alex from SocGen. I'd just like to understand, as you now contemplate 45 to 50 EUV units in '21, does this, in any meaningful way, accelerate your path to higher gross margins, more -- closer to DUV for your EUV business overall? Or there's nothing changed in terms of your gross margin scenario for this business unit? And then just briefly, your comment regarding the timing of free cash flow generation. It looks like over the next 3 years, you will have an acceleration in free cash flow generation. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [55] +-------------------------------------------------------------------------------- + + Yes. So let's first talk about the gross margin for EUV. I do believe a further increase in numbers will improve our gross margin for 3 reasons. One is obvious, right? To the extent that, given the capacity that we have, we have a higher output, of course, your fixed cost coverage will improve. And as we mentioned, the increase in capacity will be achieved by reducing cycle time and will not be achieved by further Capex. So that's why more units will result in gross margin improvement. That's one element. +The second element is to the extent that we have more of these tools in the fields, that also means that our service margin will, in all likelihood, improve because the number of -- the more tools we have in one location, the more efficiency we have in having our service crews there. So then the efficiency per tool will further increase. +And thirdly, not necessarily related to the number of units, but since you talked specifically to 2021, as I mentioned, that would also see the introduction of the successor to the 3400C, which, again, we are hopeful will bring such value to our customers that the gross margin will benefit from that. So yes, a number of reasons why I think -- why we believe gross margin for EUV will continue to further improve through 2021 and beyond. +On the free cash flow question, I think that is right as well. So I mentioned to you that in the very short term, the working capital burden that we have from further growing to, let's say, this capacity level that we talked about will be there. Because given the cycle time, it will mean that we have to take significantly more inventory on-board to get it done. But then, at a certain stage, you will see the offsetting factor of the fact that cycle times get reduced. +So I think in this 1-year window, you will see a spike and then a leveling off as a result of the reduction of the cycle time. And as I also mentioned, we do want to get down payments more as the default in our commercial model. And that should also at some stage, lead to an offset in the working capital burden. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [56] +-------------------------------------------------------------------------------- + + We have time for one last question. If you're unable to get through on this call and still have questions, please feel free to contact the ASML Investor Relations department. Now, operator, may we have the last caller, please? + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Yes, sir. Mitch Steves. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [58] +-------------------------------------------------------------------------------- + + RBC Capital Markets. Most of my questions answered, but I just want to clarify a couple of small points. So first of all, based on the tone of this call, it sounds like 2021 will probably be an accelerated growth year relative to 2020? I want to make sure that that's a reasonable assumption? +And then secondly, I realize you guys can't time the exact recovery of Memory. But from a historical perspective, when you look at when the Memory market recovers, what type of sequential growth you expect in the initial first batch of recovery if I look at Q-over-Q number? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - President, CEO & Chairman of the Management Board [59] +-------------------------------------------------------------------------------- + + Well, I think the second question is always impossible to answer. I mean it is a -- you could say the Memory business is quite different than it was a couple of years ago. I mean 6 players in 3D NAND, 3 in DRAM, so those patents will also be a function of the composition of that market and the individual position of those companies in that market. So that's really, really difficult to use historical rates as a proxy for what's going to happen now. +I think yes, 2021 could be an accelerated growth year. However, Roger said it, I mean even without the assumption on the recovery of the Memory market and the growth of the Memory market, we'll always see a double-digit growth here this year based on Logic and on the Installed Base Management. On top of that, we could see a recovery of the Memory market. So I think you could see an acceleration this year also. Now that's not for the full year, all right, granted, because we do expect it in the second half. So -- but it will definitely continue. Like I said earlier, once this Memory market recovers, it doesn't recover for 2 quarters. I mean it recovers for a longer period, like it always does on top of the Logic market. So I think we're looking forward to some acceleration. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [60] +-------------------------------------------------------------------------------- + + Now on behalf of ASML, I'd like to thank you for joining us today. Operator, if you could formally conclude the call, I'd appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + This concludes the ASML 2019 fourth quarter and full year financial results conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/ASML/2020-Jul-15-ASML.txt b/Transcripts/ASML/2020-Jul-15-ASML.txt new file mode 100644 index 0000000000000000000000000000000000000000..abb7894f457ba41577118023149e1a62cf81b4d4 --- /dev/null +++ b/Transcripts/ASML/2020-Jul-15-ASML.txt @@ -0,0 +1,561 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 ASML Holding NV Earnings Call +JULY 15, 2020 / 1:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Skip Miller + ASML Holding N.V. - VP of IR + * Peter T. F. M. Wennink + ASML Holding N.V. - Chairman of the Management Board, President & CEO + * Roger J. M. Dassen + ASML Holding N.V. - Executive VP, CFO & Member of the Management Board + +================================================================================ +Conference Call Participiants +================================================================================ + + * Krish Sankar + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Michael Quatrochi + Wells Fargo Securities, LLC, Research Division - Associate Analyst + * Sandeep Sudhir Deshpande + JPMorgan Chase & Co, Research Division - Research Analyst + * Aleksander Peterc + Societe Generale Cross Asset Research - Equity Analyst + * Stephane Houri + ODDO BHF Corporate & Markets, Research Division - Research Analyst + * Amit B. Harchandani + Citigroup Inc., Research Division - Director & Head of EMEA Technology Research + * Andrew Michael Gardiner + Barclays Bank PLC, Research Division - Director + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + * Achal Sultania + Crédit Suisse AG, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the ASML 2020 Second Quarter Financial Results Conference Call on July 15, 2020. (Operator Instructions) +I would now like to turn the conference call over to Mr. Skip Miller. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Welcome, everyone. This is Skip Miller, Vice President of Investor Relations at ASML. Joining me today on the call is ASML's CEO, Peter Wennink; and our CFO, Roger Dassen. The subject of today's call is ASML's 2020 second quarter results. The length of this call will be 60 minutes, and questions will be taken in the order they are received. +This call is also being broadcast live over the internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website at asml.com and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. +With that, I'd like to turn the call over to Peter Wennink for a brief introduction. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Skip. Welcome, everyone, and thank you for joining us for our second quarter 2020 results conference call. First of all, I hope all of you and your families are healthy and safe. And before we start our normal quarterly results review, I would like to provide you a brief update on the COVID-19 situation. I think thanks to the commitment, engagement and creativity of our people, we managed the quarter very well and this translated into growth in both revenue and profitability in the quarter. And Roger will, of course, provide some more details on those results. +Although we experienced some challenges early in the quarter around supply delays and increased absenteeism, we did not encounter any new disruptions due to COVID-19. We continue to operate with special measures in place around isolation and contamination protocols to ensure the safety of our employees and to reduce the risk of operational disruption. Even though this created some initial inefficiencies and production delays, operations capabilities are largely back to normal. +Regarding transportation, logistics and customer support, we were able to continue to secure flights to meet customer shipment requirements, and we have managed to support our customers in this challenging environment. We have significantly increased the capability of our teams in the field to more independently support the customer and continue to deploy more novel, remote diagnostics and augmented reality support. Maturity of this remote technology has accelerated throughout this COVID period, and we expect to deploy even more of this in the future. +In summary, we've been able to successfully navigate to the current environment and our operations capabilities are largely back to normal. And -- but as COVID-19 is not yet behind us, we will remain vigilant to ensure the safety of our employees while providing the best possible customer support. +Thanks again to our people and everyone in our supply chain who did an outstanding job servicing our customers during these challenging times. And now I would like to turn to our normal quarterly results process. And before we begin the Q&A session, Roger and I would like to provide an overview and some commentary on the second quarter as well as provide our view on the coming quarters. Roger will start with a review of our Q2 financial performance with added comments on our short-term outlook, and I will complete the introduction with some additional comments on the current business environment and our future business outlook. Roger, if you will? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [4] +-------------------------------------------------------------------------------- + + Thank you, Peter. Welcome, everyone. I will first review the second quarter financial results and then provide guidance on the third quarter of 2020. +Net sales came in at EUR 3.3 billion. We executed quite well considering the risks in the COVID-19 environment, translating to strong growth of more than 35% over Q1. We shipped 9 EUV systems and recognized revenue on 7 systems in the quarter. Taking into account the additional approximately EUR 260 million of revenue from the net 2 systems we didn't recognize in Q2, this would hypothetically have resulted in revenue of around EUR 3.6 billion and a growth of around 50%. +Similar to Q1, some EUV systems were expedited for shipments without factory acceptance testing in Q2. We expect to recognize revenue on these systems at site acceptance in the second half of the year. We shipped 9 EUV systems in the quarter with 4 systems not receiving factory acceptance testing, meaning 5 systems recognized revenue upon shipment. For the 2 systems that shipped in Q1 but did not receive factory acceptance testing before shipment, we were able to complete customer site acceptance tests and recognized revenue this quarter, bringing the total to 7 EUV revenue systems in Q2. +Net system sales of EUR 2.4 billion was again more weighted towards Logic at 62% with the remaining 38% for Memory. Although Logic remains very strong, Memory has been growing over the last 3 quarters as a percentage of system sales. Installed Base Management sales for the quarter came in at EUR 887 million. This brings the total of installed base revenue in the first half to around EUR 1.7 billion. +Gross margin for the quarter was 48.2%, a significant improvement over Q1, primarily due to deep UV mix and an improvement of the EUV installed base gross margin. On operating expenses, R&D expenses came in at EUR 567 million and SG&A expenses came in at EUR 131 million. The effective tax rate was higher, 18.5% based on a one-off tax assessment recorded in Q2. Net income in Q2 was EUR 751 million, representing 22.6% of net sales and resulting in an EPS of EUR 1.79. +Turning to the balance sheet. ASML paid EUR 565 million in dividends or EUR 1.35 per ordinary share in Q2 together with the interim dividend of EUR 1.05 per ordinary share paid in Q4 '19, this resulted in a total dividend for 2019 of EUR 2.40 per ordinary share. We ended last quarter with cash, cash equivalents and short-term investments at a level of EUR 4.4 billion, which is EUR 300 million higher than Q1. +Moving to the order book. Q2 system bookings came in at EUR 1.1 billion, including EUR 461 million from 3 EUV systems. Order intake was balanced between market segments with both Logic and Memory at 50%. Logic demand continues to be strong with Memory increasing as a percentage of bookings over the past 3 quarters. +With that, I would like to turn to our expectations for the third quarter of 2020. We expect Q3 total net sales of between EUR 3.6 billion and EUR 3.8 billion. We expect our Q3 Installed Base Management sales to be around EUR 850 million, which is driven by strong demand for field upgrades and growing service revenue with a more meaningful contribution from EUV service. +Gross margin for Q3 is expected to be between 47% and 48%, which is a little below Q2, primarily due to deep UV mix with fewer immersion systems. We've previously highlighted a number of levers that could positively impact gross margins in the second half. These levers being a richer mix of deep UV, more immersion less dry, primarily driven by the Memory recovery; second, growing EUV service revenue; and third, improved immersion margins from our 2050 system. These levers remain and provide the opportunity to achieve 50% gross margin in Q4. +The expected R&D expenses for Q3 are around EUR 545 million, and SG&A is expected to come in around EUR 140 million. Our estimated 2020 annualized effective tax rate is still expected to be around 14%. +Finally, I would like to talk about capital allocation and working capital. Our capital allocation policy remains unchanged. In the next few years, we expect to generate a significant amount of free cash flow, cash that will not be required to support the future growth of our business will be returned to our shareholders in a combination of growing dividends and share buybacks. +Regarding investments in our business, we plan to have CapEx at levels previously communicated in support of future technology and required expansions. Regarding working capital, we are working our way through a transition period. We come from a period where contracts did not include down payments and actually provided extended payment terms for customers given the maturity curve that our EUV tools were on and are moving into a direction where we ask for down payments of EUV tools, reflecting the long lead times and early supply chain commitments that ASML has to enter into. This means a temporarily higher level of working capital in 2020 with a plan to significantly reduce this level in 2021. All in all, we expect to see a significant increase in the generation of free cash flow in the course of the second half of this year. Once this occurs and the risk profile for our entire ecosystem has returned to acceptable levels, then we will resume the execution of share buyback in line with the plans that we have communicated earlier this year, EUR 6 billion over 3 years. +With that, I would like to turn the call back over to Peter. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [5] +-------------------------------------------------------------------------------- + + Thank you, Roger. As Roger highlighted, we had a strong quarter with over 35% growth in revenue and improved profitability. In this challenging macroeconomic environment, we saw growth in both Logic and Memory markets, which is a reflection of our customers' drive to innovate and continue to invest in future technology nodes. With significant work-from-home and remote learning activities continuing, segments such as data center and communication infrastructure continue to be strong. Demand for consumer-related electronics, for example, smartphones, maybe under some near-term stress due to the economic impact from COVID. And our customers indicate they see continued strength in end markets, requiring advanced nodes, and this is reflected in our stable demand. +For 2020, our growth expectations that we indicated at the start of the year are largely unchanged despite the disruptions caused by the worldwide COVID-induced crisis. We, therefore, expect a year of double-digit growth in sales and profitability. In Logic, customers continue to ramp advanced technology nodes, 7 and 5-nanometer. In support of the buildup of the digital infrastructure, driving end market applications such as 5G, AI and high-performance compute, requiring leading-edge equipment, which have longer lead times and qualification schedules. +We expect Logic demand to remain healthy, which continues to drive demand for EUV systems as well as our other products. In Memory, customers are continuing to indicate that they are seeing signs of recovery, driven by healthy demand in data centers and expectations of improved demand in consumer electronics. Increasing lithography utilization levels support this view and with this continued trend in mind, it's understandable that we see additional demand in the second half of the year. This is supported in our bookings, with Memory increasing as a percentage of bookings over the past 3 quarters. +Sales to China continued to grow and accounted for 23% of our systems revenue this quarter. This is driven by demand from both Logic and Memory customers in China, and we expect sales growth from the China region this year. Regarding changes to the U.S. export rules that went into effect at the end of June, we expect minimal impact to our business. And regarding the impact of recent U.S. restrictions, it's difficult to determine how near-term dynamics will evolve, but when you look at the end-market demand and the growing digital economy with secular growth drivers, like 5G, AI and high-performance compute, the demand for semiconductors for these products will continue and it will fuel future innovations. Wafers and products to support this technology and innovation will be produced somewhere in the world, and it will certainly require advanced lithography. +On our installed base business, we still expect significant growth this year. First half of the year, we realized revenue of around EUR 1.7 billion, and we expect a similar level of business in the second half of the year. Services business will continue to scale as our installed base grows, and EUV will contribute in a more meaningful way to service revenue as these systems run more wafers in volume manufacturing. +We expect significant demand for upgrades as customers utilize upgrades to increase capacity and improve imaging and overlay performance. On EUV, this technology has now entered the realm of high-volume manufacturing and is an integral part of our core operational activities as evidenced by the large EUV share of our sales in Q2. We've successfully implemented the improvement to the modular vessel we discussed last quarter, and this vessel is designed to deliver higher availability. With 9 shipments this quarter, we have shipped 13 systems in the first half of the year. And as COVID-related transportation and support risks are now lower, we plan to resume the normal qualification process, including factory acceptance testing, meaning we expect to recognize revenue at shipments on all systems in Q3. +We plan to be back on track with our cycle time reduction plan in Q3, and I feel comfortable about our capacity to produce and ship double-digit numbers of EUV systems per quarter. We're therefore still targeting a revenue of around EUR 4.5 billion on 35 systems this year. +On EUV margins, after more than a decade of investments in EUV, we're well on track to improve profitability in both systems and service. EUV service margins are expected to break even in the second half of the year, and EUV system gross margin is on track to meet or exceed the 40% target for the year, still planning a capacity of 45 to 50 systems next year. This is planned within our existing factory footprint by reducing cycle time in our factory to around 20 weeks by the end of this year. +We currently have a backlog of 54 systems with 28 system orders for 2021 delivery, covering over half of this capacity, and we expect orders to continue in the second half of the year in support of the 2021 demand. Understandably, customers are currently reviewing how COVID will impact the global economy. And as we proceed through the second half of this year, we will have a better view of how this ultimately translates to the technology ramp plans next year. +In our deep UV business, we shipped the first NXT:1470 to a customer. This is the first dry NXT system. Building on the NXT immersion platform with significant improvements in matched machine overlay and productivity, helping our customers to deal with the increasing cost of complexity when introducing new nodes. The higher output per fab area from an NXT system also maximizes fab capacity and therefore, customer profitability. +Our applications business shipped the first generation multi-beam inspection system, the eScan 1000, targeted for 5-nanometer nodes and beyond. The eScan 1000 demonstrated successful multi-beam operation, simultaneously scanning with 9 beams. The eScan 1000 will increase throughput up to 600% compared to the single e-beam inspection systems targeted for in-line defect inspection applications. +In summary, although the macroeconomic environment provides some challenges, we see stable demand and a strong second half. Our 2020 sales growth expectations are largely unchanged from the beginning of the year. We expect Logic demand to continue to be healthy with an expected Memory recovery in the second half, and we expect a continuation of the significant growth in our installed base business as already seen in the first half of the year. Meaning, we still expect double-digit growth in sales and profitability in 2020. Although we, of course, do not yet know the full impact of COVID on global GDP and how this will translate to end market demand in the coming year, the COVID crisis told us that the expanding digital economy with secular drivers such as 5G, AI and high-performance compute provide significant opportunities over the long term. Our 2025 growth trajectory is, therefore, still very much intact. +With that, we'd be happy to take your questions. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [6] +-------------------------------------------------------------------------------- + + Thank you, Roger and Peter. The operator will instruct you momentarily on the protocol for the Q&A session. (Operator Instructions) +Now operator, could we have your final instructions and then the first question, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from Mr. Mitch Steven. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [2] +-------------------------------------------------------------------------------- + + Mitch Steves from RBC Capital Markets. So I'm just going to ask the 2 upfront. The first one is just the commentary about Memory demand being -- coming in stronger and you guys are still seeing high-quality bookings in Logic. So first question is just basically for '21, is there a scenario where you could actually see growth in both DUV and EUV units in kind of a more bullish scenario? Or are you seeing customers kind of opt to just buy more EUV systems? +And then secondly, I just wanted to double-click on kind of the gross margin comments. I thought that was just to be up a little bit more in Q3, so what is kind of the trajectory in both EUV and the corporate margin as we get to Q4 and beyond? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [3] +-------------------------------------------------------------------------------- + + Yes. I think as your question directed for '21, you just started your question with Memory demand picking up and strong and healthy Logic. And then the question for '21 is directed at both the combined business of Memory and Logic or at one of those, just as an explanation. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [4] +-------------------------------------------------------------------------------- + + No, so same for -- so total DUV and -- deep UV and total EUV units, is there a scenario where both of those are up due to high demand? Or does it have to be kind of one versus the other? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [5] +-------------------------------------------------------------------------------- + + No. I think if you see a continued uptick of the Memory market, which will have a positive effect on the deep UV immersion systems, you could see both of them, yes? So it's really a matter of a strong demand continuing Logic and a continued strengthening of the Memory market. I could see that happening. But in general, of course, the more EUV layers that are chosen by our customers will take away deep UV layers. So you could argue if there is and if it's only a technology transition, you would probably see a cannibalization of deep UV versus EUV. But if you have a capacity ramp, then both in Memory, and you see the capacity ramp in Logic continuing, then you could see both numbers up. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [6] +-------------------------------------------------------------------------------- + + Let me take the question on the -- on gross margin, and maybe the best way to do it is just give you the bridge for -- between the 3 quarters. So moving from Q1 to Q2, the improvement that we saw in gross margin. Two main drivers, I would say, one is the deep UV, the deep UV mix; and secondly, IBM, Installed Base Management margins. So those are the primary drivers to get you from the gross margin we had in Q1 up to the 48.2% that we recognized in Q2. +So then from Q2 to Q3, you see a slight deterioration in the gross margin. And that really is down to the mix in deep UV, where we expect to have less immersion systems in that mix in Q3 in comparison to Q2. And then going from Q3 to Q4, where, again, as we said, we think that the 50% up is achievable in the current plans that we see. Main drivers there, again, immersion, but this time positively, so there would be more immersion in the mix. And secondly, an important driver there, again, would be EUV service gross margin. A result of 2 things, on the one hand, bringing down the cost per EUV machine. And on the other hand, as Peter alluded to it, the fact that these tools are getting into high-volume manufacturing, which means that also the wafer output is increasing as a result of that, the revenue will increase as well. So that, in essence, gives you the bridges over the 3 quarters and the basis for the potential to get to 50% up in Q4. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Next question is from Mr. Andrew Gardiner. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [8] +-------------------------------------------------------------------------------- + + Andrew Gardiner from Barclays. Roger, one for you, if I could, just on your comments on the cash flow and capital allocation. You said for some of the points, I think CapEx, in particular, that you expect it at previously communicated levels, so that's clear. But in terms of working capital, can you help sort of quantify the pressure a bit more for us. Clearly, there was significant working capital outflow during the first half of the year. Is that expected to continue into third quarter, perhaps start to improve by fourth quarter? Just a bit of help around that would be useful. And also, the point you made about once this sort of transition is clear, then you would plan to return to the share buyback. Is that something we could expect by the fourth quarter of this year? Or is it more likely to be into next year? And again, it's sort of is there any metrics you can give us that could help guide there? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [9] +-------------------------------------------------------------------------------- + + Yes. Sure, Andrew. Happy to do that. So you're right. If you look at the first half, you would look at a negative free cash flow, you would actually see that in the second quarter, it already started to become positive. But if you look at the full half year, it would be a negative free cash flow, not unlike I should add what we saw in last year. And last year, you saw a similar pattern. The expectation is that in the second half, we will -- that will change and there will be a significant in working -- in both the working capital but also in the free cash flow generation. And the main reasons are the reasons that I pointed out in the initial comments, so it's associated with the fact that on the one hand, we are entering into a period where we are actually asking down payments on EUV tools. But that takes time and that takes contractual renegotiations. So that's one element. +And the second element is that based on the old contracts and the old contracts on the base of which we're still executing quite some shipments, those actually provided for extended payment to customers. So that's the situation that we find ourselves in on the, let's say, the accounts receivable side. Secondly, as you will appreciate with the ramp that we're doing and with the increase that we're seeing in EUV, obviously, that also means that from an inventory perspective, that leads to an uptick as well. So those are the 2 main dynamics why it is the way it is. +So my expectation is, and I won't give specific numbers, but my expectation is that, indeed, you will see a significant recovery of the free cash flow generation in the second half. More or less along the lines of what we saw last year, where you also saw a very significant recovery. Maybe not at that level. Last year, it was pretty spectacular. The way it picked up in the second half given the ramp profile and given the AR profile that I just talked about, I expect a little less in the second half of this year in comparison to last year, but nonetheless, a very significant improvement. And once we see that, and once we see that, that free cash flow generation starts to become healthy again, we also conclude that the main risk our ecosystem are more or less under control. +At that point in time, yes, we do believe that -- and we can start executing on share buyback again. And that could be this year. That could definitely be in Q4. And our expectations as it relates to the free cash flow generation would be in line with that model. That indeed, in Q4, we can start generating and can start executing on share buyback again. + +-------------------------------------------------------------------------------- +Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [10] +-------------------------------------------------------------------------------- + + Okay. And just a quick follow-up. I mean it's a fairly minor point. Given the COVID-19 issues this year, not only did you stopped the buyback, but of course, you didn't declare an interim dividend either, which you had started with last year. Would the intent be to return to that sort of phasing in '21? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [11] +-------------------------------------------------------------------------------- + + No, no, just to be clear. So the interim dividend that we do is an interim dividend that we would do in the -- at the end of the year. So what we said, we declared an interim dividend in November of last year and we said that, that was the plan that we had. So it's not like -- so we had an interim dividend in November. Then we had the final dividend in April right after the AGM, and that's the pattern that, in essence, we are looking at again. So if everything remains normal, then you would see that pattern repeated in the next year. So November interim dividend and final dividend in April. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Next question is from Mr. Amit Harchandani. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc., Research Division - Director & Head of EMEA Technology Research [13] +-------------------------------------------------------------------------------- + + Amit Harchandani from Citi. A question and a follow-up, if I may. So my question relates to 2021, please. And Peter and Roger, I would appreciate your thoughts in terms of helping us understand how do you think it all shakes up in terms of litho intensity and capacity going into 2021? Logic has been on an elevated level from 2019. Memory is picking up, but to what extent are your customers talking about 2021? And what's the level of visibility there, please? That would be my first question. And I have a clarification follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [14] +-------------------------------------------------------------------------------- + + Yes, I think that's a very good question. I think when we think about 2021, and we look at the situation today as compared to, let's say, 6 months ago at the beginning of the year, I mean it's -- it may not be a surprise that in the boardrooms of our customers, but also of our peers and ourselves, we -- the level of uncertainty as to the GDP environment and -- has, of course, gone up. So I mean there's a high level of uncertainty on what that could mean because we haven't really got a very good assessment, and as a quantifiable assessment on what 2021 means. And I hope you'll understand. +Now having said that, the -- as I also said in my prepared remarks that the innovation and the road map innovation of our customers are still continuing, which is true for Logic and is true for Memory. And as it relates to EUVs, particularly for DRAM and for the 7 and the 5-nanometer expansions. That will continue, there's no doubt in our minds. Now when we then look at 2021, what can we see at this moment in time? And as you know, I don't have a crystal ball. I don't know how 2021 is going to look from a macroeconomic point of view. But when you take our 2020 guidance, if you want to call it this way, we said Logic as compared to 2019, flat; Memory as compared to 2019, 30% up; installed base, 20% up to a level of EUR 3.4 billion. You take those numbers, you come to a number. Now -- and if you take that as a 2021 targeted number and look at where we are today in the discussions with our customers, on Logic and on DRAM and of course, with all the caveats that I just mentioned on COVID-19, we could still see double-digit sales number growth in 2021. +That's based on what we see today. Now the only -- the biggest difference with now and 6 months ago has to do with what I started off with, where the level of uncertainty is, of course, different today than it was 6 months ago. But this is where we are. And I think we'll probably get some more clarity over the next 2 quarters towards the end of the year, we'll probably get a better view on what this all means and we have the first quarters of the COVID-19 and GDP impact behind us. +Now I hope, Amit, I just gave you a little bit of our guidance, and I also hope that you understand that we, at this moment in time, it's very difficult to be quantitative on 2021. + +-------------------------------------------------------------------------------- +Amit B. Harchandani, Citigroup Inc., Research Division - Director & Head of EMEA Technology Research [15] +-------------------------------------------------------------------------------- + + Understood, Peter. That's helpful. And secondly, as a clarification, if I may, looking at your bookings number, three EUV systems for about EUR 461 million suggests it was a mix of 3400C and potentially 3600D tools and clearly, a higher ASP of around EUV 160 million for 3600D. And as we look towards 2021, are you in a position to at least give us some help in terms of how we should think of the mix of shipments of 3400C and D? And what that means for ASP and what that would mean for the 45 to 50 capacity that we are talking about? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [16] +-------------------------------------------------------------------------------- + + Yes. It will be a mix of 3400Cs and 3400Ds. So you have seen this mix also in the ASP of the bookings, I mean, as you pointed out. But this is the trend going forward. I think the first half of 2021 will probably be more skewed towards the Cs, but then it will translate into the Ds. So the second half of the year, you will see Ds. And we're going to ship the first, let's say, plan to ship the first 3600D this year. That's -- there's only one. So that will be a year of ramp of the D version in 2021. And I said -- like I said in my prepared remarks, we are preparing the capacity, as we talked about, to be between 45 and 50 systems. And yes, you will see that transition using that capacity from Cs to Ds throughout the year, like I said, second half will involve the Ds and in the first half of the year, a mix. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Next question comes from Mr. C.J. Muse. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [18] +-------------------------------------------------------------------------------- + + Yes. Evercore ISI. I guess first question to follow up on the last one, with the 3600D, I guess, first, you had 3 tool orders. Can you help us understand the mix between Logic and Memory and also provide geography? And then as part of the deramping throughout 2021, how should we think about the gross margin implications? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [19] +-------------------------------------------------------------------------------- + + Okay. I'll give the last part to Roger. Yes, the level of granularity with the 3 orders is, of course, could be significant. But the 3 orders were evenly spread -- no, evenly spread, it was -- there were at least one for a Memory customer, which is, I would now say that all our key Memory customers have now EUV ordered and shipped, which is good. And there was also some Logic orders there. But it was a mix. But more importantly, I think when you think about Memory and DRAM, we now have all our Memory customers in our order book. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [20] +-------------------------------------------------------------------------------- + + And C.J., as it relates to gross margin, on the D, in terms of ASP, we're looking at 15%, maybe a little bit more increase in ASP. As you know, this year, what we're looking at is over 40% on EUV gross margin on system sales. I think with the 50% up, we should definitely be able to get EUV gross margin at the level of the corporate gross margin. That's what we're looking at. So that's the kind of improvement that we're eyeing for that. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [21] +-------------------------------------------------------------------------------- + + That's very helpful. If I could just sneak in another gross margin question. Curious how we should be thinking about the new 2050 immersion and the 1470 dry in context with the D as you think about gross margins into 2021. Is 50 what we should be thinking about or because of the new product profiling coming in, is there more upside? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [22] +-------------------------------------------------------------------------------- + + I think the combination of the 1470 and the 2050 should give us approximately 1% uptick in the [income] gross margin. That's the way you should look at that. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Krish Sankar. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + It's Krish from Cowen. Two of them. First one, Peter, when you look into the second half with the Memory strength continuing, how do you parse it between China, DRAM and NAND, which is driving the incremental strength in Memory in the second half? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [25] +-------------------------------------------------------------------------------- + + The Memory strength -- is your question, Krish, just to make sure that I understand it clearly. The memory strength in the second half, are you asking how much of that has to do with China? + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + I'm just trying to figure out what is driving the growth? Is it China? Is it DRAM? How do you categorize between DRAM and NAND? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [27] +-------------------------------------------------------------------------------- + + Yes. I think it is basically all of that. It's our Chinese customers, which is a mix of Logic and NAND and DRAM customers. But it's also the traditional DRAM customers that are driving the demand in the second half. So it's a mix, and it's pretty well spread. But if you would say where's the emphasis, the emphasis would be on, I would say, the more traditional DRAM customers in the second half. + +-------------------------------------------------------------------------------- +Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [28] +-------------------------------------------------------------------------------- + + Got it. Got it. That's very helpful. And then a follow-up for Roger. You mentioned about the EUV services gross margin hitting breakeven in the second half. So when you look into 2021, would there be a big inflection in the services gross margin because EUV is now profitable? Or do you think it's going to be more gradual? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [29] +-------------------------------------------------------------------------------- + + Sorry, would it be what? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [30] +-------------------------------------------------------------------------------- + + More gradual. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [31] +-------------------------------------------------------------------------------- + + More gradual. It will be gradual. And because both drivers that I mentioned before, both on the revenue side and the cost side, that will continue to ramp. So it's not like a flip of the switch that is going up. This is a gradual process that you will see continue throughout the year, the quarters to come. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Next question from Mr. Sandeep Deshpande. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JPMorgan Chase & Co, Research Division - Research Analyst [33] +-------------------------------------------------------------------------------- + + JPMorgan. Roger, Peter, can you talk about EUV and Memory? I mean, clearly, you had said earlier in the year, you're shipping a couple of EUV to DRAM this year. How you see that as part of that 45 to 50 tools for next year and what you are hearing from your customers in terms of the development of EUV layers in the DRAM releases of next year? And I have one quick follow-up question. + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [34] +-------------------------------------------------------------------------------- + + Yes. I think the EUV business for next year will be predominantly Logic. But yes, we will ship the first EUV systems to DRAM. It will be a limited number of -- there will be -- the layer application for the first DRAM node for the first EUV application in the DRAM node will be limited, just probably one layer. But it will grow in the nodes thereafter. And the DRAM road map in terms of node introduction has actually accelerated somewhat. So I would expect that the introduction of this one layer node will happen next year. But in '22 and '23, that will accelerate. And I think we have models up to potentially 5 layers in DRAM, but that's not in the node for which we'll use EUV next year. The majority of our shipments in 2021 on EUV will be for Logic. + +-------------------------------------------------------------------------------- +Sandeep Sudhir Deshpande, JPMorgan Chase & Co, Research Division - Research Analyst [35] +-------------------------------------------------------------------------------- + + Understood. And then, Roger, how are you looking at this whole margin -- gross margin in EUV trending towards the deep UV level? And I mean are you on track to do this in '22 or '23? And I mean you've talked about this in your Analyst Day in the past. So when does that cross over with that? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [36] +-------------------------------------------------------------------------------- + + Yes, I think that's indeed the right time frame that you're referencing. So -- and by the way, when you -- '22, '23. And by the way, when you talk about deep UV gross margins, of course, we have to recognize that within deep UV, between different tools, there are some significant differences in gross margin. But indeed, with the D model and then obviously, at some stage, getting to its successor as well. That's the point in time where the lines between, let's say, emerging gross margin and EUV gross margin need to get close or cross. And I think the '22, '23 time frame is the right way to look at that. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Next question is from Mr. Achal Sultania. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [38] +-------------------------------------------------------------------------------- + + It's Crédit Suisse. Peter, maybe a question on the bookings again. Obviously, the bookings number is EUR 1.1 billion for this quarter, much lower than what we have seen over the last few quarters. I know you already have a large order backlog. I think you mentioned about EUR 10 billion in your interview this morning. So I guess, how much of this is a function of your customers basically saying, okay, let's hold on, we already have a lot of orders backlog with you, let's wait for those orders to be fulfilled? And how much is it a function of the fact that they themselves have limited visibility on what the shape of recovery will be on the macro side as we go into the back half of the year? Can you just help us understand like what are you hearing from your customers on that front? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [39] +-------------------------------------------------------------------------------- + + Yes. I think you just mentioned it. I mean I can repeat your question as an answer in the sense that you just touched on all of it. Yes, we have seen over the last 2 quarters, that's Q1 and Q4 of last year, about EUR 5.6 billion in total over those 2 quarters. That is basically adding up to an order backlog of EUR 10 billion with -- even for 2021, already 28 systems slated for 2021 shipment for EUV, which is more than half of our production capacity. And mind you, we're in the middle of 2020. +So I think that, of course, gives the customer the confidence that they have secured a significant part of their capacity ramp. If you add to that, that in Q2 of this year, of course, the full extent of the COVID crisis and the uncertainty associated hit the boardrooms of our customers that they also said, listen, yes, there's a higher level of uncertainty, I think that has definitely played in this particular situation. Having said that, I think in the discussion with our customers, we are very confident that we will keep booking EUV systems throughout the remainder of the year. So -- and I would be -- I think by the end of the year when we do our Q4 conference call in 6 months from now, we have a very good view on what 2021 is going to look like and I think we'll probably be fully booked. And what that fully booked means is fully booked on the demand of whatever is going to be. But we're preparing, like I said earlier, for our capacity, 45 to 50 systems, just in case our customers come back and said the demand for 2021 is going to be that high and I want you to make those systems. +So the preparations for the capacity are ongoing, what the ultimate demand of customers will be is a function of what I just said. And that level of uncertainty has clearly gone up as compared to 6 months ago what it's finally going to be. But all in all, I can only repeat 2021, when you take our, let's say, guidance, you could say, for 2020, you add up those numbers, we see a real opportunity based on what we see today of, again, a double-digit growth in 2021. + +-------------------------------------------------------------------------------- +Achal Sultania, Crédit Suisse AG, Research Division - Director [40] +-------------------------------------------------------------------------------- + + Right. Okay. That's helpful. And maybe a follow-up. I guess when we look at the 35 EUV shipment number or target that you have for this year, how should we think about the mix between logic foundry and DRAM? Can you give us some color like any rough ranges, just to help us understand where we are in the adoption curve for DRAM market? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [41] +-------------------------------------------------------------------------------- + + The adoption curve for DRAM market, you really need to look at next year. I mean this year, these are the first few systems into the DRAM customer base. And it's really predominantly, 80% to 90% is just Logic. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Pierre Ferragu. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [43] +-------------------------------------------------------------------------------- + + It's Pierre from New Street Research. Peter, I wanted to ask you about China. So it's fair to assume that China is going to make a lot of efforts to continue to improve its manufacturing capabilities, and we've seen a player there doing a significant capital raise not so long ago. So is that probably going to build an ability to assemble manufacturing lines despite the pressures... + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [44] +-------------------------------------------------------------------------------- + + So. As there could be new controls that could be implemented. There could be new laws and legislations we need to comply with so it might be a bit harder, but a complete stop, I don't see. I see more, let's say, regulations and more compliance that will be put on us, but I think on the equipment industry at large. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Stephane Houri. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [46] +-------------------------------------------------------------------------------- + + Stephane Houri from ODDO BHF. Quick question on the logic foundry spending that seems to be continuing to be strong in the second half and maybe in 2021. So can you just share with us your view on why is logic foundry so strong and so long because the cycle seems to be a bit long this time? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [47] +-------------------------------------------------------------------------------- + + Yes. I think it has to do with the fact that the road maps are accelerating. I mean I can probably go back to 2018 when we -- all right, at these conference calls or during these conference calls that one thing has now changed, and that is that EUV has turned the corner. And I think EUV gives a very clear road map to our customers to start thinking about an economic way to continue with their road map so you can shrink at affordable cost. And that meant that we saw the road maps of our customers accelerate or at least the 2-year cadence in their design road maps are still there. And on top of that, with that new technology, with those new nodes, they could provide their customers, which are much more now in the space of 5G of platform companies, artificial intelligence, virtual and augmented reality, the electrification of the automotive industry. +The customer base has expanded so much to make use of that technology. Now -- and to just -- in the discussions we have with our customers, we really see -- we have these discussions that certain of these nodes, these new nodes, I'd say, the 5 and 7-nanometer nodes might be as big as the 14 and the 20 and the 28-nanometer node. Because of the fact that the customer base has expanded so much and they're going to make use of this more economical transition of these nodes. It basically is going to provide a lot of value. And this is why this length of this cycle, if you want to call it, but it's -- you could say it's just the multiple cycles, closer together with a bigger customer base, that looks like it's one big cycle, but there are more cycles. It's innovation cycles driven by more customers and basically shorter. And that's what's happening today. And I think it's also thanks to EUV, I mean, we can now make this economical. + +-------------------------------------------------------------------------------- +Stephane Houri, ODDO BHF Corporate & Markets, Research Division - Research Analyst [48] +-------------------------------------------------------------------------------- + + Okay. And with the ramp of EUV solid logic foundry, as you said, and the recovery in Memory, it is likely that you will reach the low end of the 2025 guidance by 2021. So the question is, do you intend to update us on that anytime soon? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [49] +-------------------------------------------------------------------------------- + + In everything that I said, you have to refer to the lower end of the guidance, what is the lower end of the guidance in your there, 15, that's what -- that's what you're probably referring to. I think like I said, I'm not going to be quantitative. I just gave you this vision on what is happening today and everything -- and go back to our 2018 Capital Markets Day, that it was not about, like in 2016, will EUV work or will it not work? No, no, EUV will work. And the guidance was really driven by the market scenarios. Are we talking about a low market scenario or a high market scenario, this will drive the number. +Now I can only go back to what I said earlier and what it is going in the end, I'm not going to comment that on -- in a quantitative way. But what I said earlier, if you take our 2020 guidance, we see real opportunity of what we see today, I think it is realistic to soon we see double-digit growth also in our 2021. And I think what that number is going to be in the end, where it's going to hit exactly on the low end of the 2025 scenario number, I don't know, we'll see. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Aleksander Peterc. + +-------------------------------------------------------------------------------- +Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [51] +-------------------------------------------------------------------------------- + + This is Aleksander, SocGen. I just have two. So the first one would be on the new model, the model D of the EUV machine, will there be an upgradability path from C to D coming through in the next year, because obviously the B to C migration wasn't that obvious. But I'm wondering if this is slightly different with the C to D migration. And then just secondly, on working capital, can you help me understand this prepayments for EUV are instrumental in the projected improvement of your operating working capital metrics? And will that come through as and when you have a significant amount of new orders coming through? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [52] +-------------------------------------------------------------------------------- + + Yes. I think the upgradability of the C to D, that's what a lot of customers are actually asking. It will be expensive. So it's really -- I think it's technically possible, but I think it's going to be a matter of economic feasibility and the time it will take to do the upgrade because the C tools will be down to do the upgrade. And these are very expensive tools. So I think technically possible. We just need to see whether we can -- whether it can be economically done. So still not something that we are planning for today, but there is a technical capability. On the working capital? + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [53] +-------------------------------------------------------------------------------- + + On the working capital, indeed, the down payments is part of, as you call it, is instrumental in the working capital and free cash flow recovery that you talked about. And we'll come with new orders with orders coming in this year. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [54] +-------------------------------------------------------------------------------- + + All right. We have time for 1 last question. If you were unable to get through on this call and still have questions, please feel free to contact the ASML Investors Relation department with your question. Now operator, may we have the last caller, please? + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + The final question is from Mr. Joe Quatrochi. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [56] +-------------------------------------------------------------------------------- + + Yes. It's Wells Fargo. On the Foundry, Logic side for 2020, you talked about it being relatively flat. So that would kind of imply revenue for the second half to be down in the low double-digit range year-over-year, despite what should be a back-end loaded year for EUV on the revenue rec side. So I guess number one, am I thinking about that right? And then number two, if I am, can you talk about the puts and takes of what's driving that? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [57] +-------------------------------------------------------------------------------- + + Yes. I think we don't only sell EUV, we also sell deep UV. So I mean it's going to be a mix. And of course, like we said, the year-on-year will be flat for Logic. And yes, EUV is going to be higher in the second half than in the first half. But it doesn't change the overall picture in Logic. And we feel comfortable if we currently look at our order book and our shipment pattern that Logic, which is a combination of deep UV and EUV, will be about the same, maybe flat year-on-year. + +-------------------------------------------------------------------------------- +Roger J. M. Dassen, ASML Holding N.V. - Executive VP, CFO & Member of the Management Board [58] +-------------------------------------------------------------------------------- + + And Joe, just to be clear, on Logic, so if you look at the material, we recorded 2.7 for Logic in the first half. So that means that 3.9 are necessary or expected if you like, to get to the 6.6 that you would get to if you stay flat on Logic. So that would lead to an increase, as Peter rightfully pointed it out, it would lead to an increase in the second half, but then it would be in the mix of EUV and deep UV. + +-------------------------------------------------------------------------------- +Joseph Michael Quatrochi, Wells Fargo Securities, LLC, Research Division - Associate Analyst [59] +-------------------------------------------------------------------------------- + + Okay. I understand it's more about the year-over-year decline in the second half versus second half? + +-------------------------------------------------------------------------------- +Peter T. F. M. Wennink, ASML Holding N.V. - Chairman of the Management Board, President & CEO [60] +-------------------------------------------------------------------------------- + + I don't -- that could be second half over second half. But I mean it's actually -- I need to look at that data, but I don't think it's that relevant. I mean we're not -- it is just the timing when customers require those systems. I think quarter-on-quarter, there could be big differences, half-on-half could be big differences. I think really looking year-to-year, that's a longer period, that makes sense. It shouldn't make those periods too short to compare because they are big changes. The big tools, customer shipment patterns vary quarter-to-quarter quite significantly. So that's a bit dangerous to draw any conclusion from that. Operator? Skip? + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [61] +-------------------------------------------------------------------------------- + + Operator, can you close the call? + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Yes. Ladies and gentlemen, this concludes the ASML 2020 Second Quarter Financial Results Conference Call. Thank you for your participation. You may now disconnect your lines. + +-------------------------------------------------------------------------------- +Skip Miller, ASML Holding N.V. - VP of IR [63] +-------------------------------------------------------------------------------- + + Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2016-Aug-17-CSCO.txt b/Transcripts/CSCO/2016-Aug-17-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..c12f58315fd5391749400e8d5c2c7cfdfea9b1fe --- /dev/null +++ b/Transcripts/CSCO/2016-Aug-17-CSCO.txt @@ -0,0 +1,508 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Cisco Systems Inc Earnings Call +AUGUST 17, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kelly Kramer + Cisco Systems Inc - CFO + * Chuck Robbins + Cisco Systems Inc - CEO + * Marilyn Mora + Cisco Systems Inc - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Tal Liani + BofA Merrill Lynch - Analyst + * James Faucette + Morgan Stanley - Analyst + * Jayson Noland + Robert W. Baird & Company - Analyst + * James Suva + Citigroup Global Markets - Analyst + * Ittai Kidron + Oppenheimer & Company - Analyst + * Vijay Bhagavath + Deutsche Bank Securities - Analyst + * Mark Moskowitz + Barclays Capital - Analyst + * Simon Leopold + Raymond James & Associates - Analyst + * Jess Lubert + Wells Fargo Securities - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + * Steve Milunovich + UBS - Analyst + * Mitch Steves + RBC Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco Systems' fourth-quarter and FY16 financial results conference call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [2] +-------------------------------------------------------------------------------- +Thanks, Sam. Welcome, everyone, to Cisco's fourth-quarter FY16 quarterly earnings conference call. +This is Marilyn Mora, Head of Investor Relations; and I'm joined by Chuck Robbins, our CEO; and Kelly Kramer, our CFO. By now you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be available on our website in the Investor Relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements and other financial information can also be found on the financial information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and will discuss product results in terms of revenue, and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of FY17. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call, for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. As a reminder, in Q2, on November 20, we completed the sale of the customer premises equipment portion of our SP Video Connected Devices business, and accordingly, had no revenue or expense from that business in Q4 FY16. +As such, all of the revenue, non-GAAP, product orders and backlog information we will be discussing, is normalized to exclude the SP Video CPE business from our historical results. We have provided historical financial information for the SP Video CPE business in the slides that accompany this call and on our website to help to understand these impacts. As a reminder, the guidance we provided during our Q3 earnings call and today's call has been normalized in the same way. +So with that, I'll go ahead and turn it over to Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [3] +-------------------------------------------------------------------------------- +Thank you, Marilyn. We executed extremely well in Q4, with revenue growth of 2% and record non-GAAP EPS, which grew 9%. This was another strong quarter, wrapping up a great year. We closed out our fiscal year with $48.7 billion in revenue, up 3%, and non-GAAP EPS, which grew 8% to a record $2.36. Gross margins and operating margins were consistently strong throughout the year. We continue to manage our business well, and these results underscore our ability to execute against our strategic priorities and our rigorous discipline on profitability. +Over this past fiscal year, we experienced a challenging environment with significant volatility. Our fourth quarter was no exception. After three consecutive quarters of growth, both Service Provider and Emerging Markets turned negative. Service Provider orders declined 5%, reflecting the many challenges in that customer segment that you've heard from our peers. +In addition, Emerging Markets orders were down 6%. The remainder of the business remained healthy, with orders growing 5%. While the overall macro environment remains uncertain, we are well-positioned to capture the benefits of any tailwinds. +At the same time, we're aggressively investing in priority areas to drive growth over the long term, regardless of the environment. We had strong performance in Security, Data Center, Switching, Collaboration and Services, as well as continued success in the transition of our business model to software and subscriptions. We remained focused on accelerating innovation across our portfolio, and we've made great progress over the past year in these priority areas, where we continue to see momentum. +First, security. Security is the number-one priority for every customer. As the global leader in networking, Cisco is uniquely positioned to deliver security at scale with leading-edge innovation, as we lead the transition to cloud-delivered security. Our team has done a phenomenal job of capitalizing on this distinct advantage that Cisco has in the most critical area for our customers. +For example, we've been rapidly shifting our model from a primarily hardware business to a software and services business. This past quarter, we delivered our third-consecutive quarter of double-digit growth, with revenue up 16% and deferred revenue growing 29% as a result of this shift. +We continue to add significant features and functionality to our security portfolio, both through internal innovation and M&A, to meet our customers' most pressing needs. Such as cloud Defense Orchestrator, which provides cloud-based security policy management. Stealthwatch Learning Networks, which leverages a network infrastructure, analytics and distributed machine learning to provide visibility and security intelligence across the enterprise. +We have also extended our cloud-based security platform through our acquisition of CloudLock, an as-a-service offering enabling the ability to secure cloud applications. Over the past year, we've demonstrated tremendous success in rapidly deploying Cisco's advanced threat solutions to our global customer base with our AMP solution, now deployed at over 17,000 customers around the world. +As we have done in the advanced threat market, we are now deeply focused on winning in the next-generation firewall market. We launched our full-featured next-generation firewall in March, and we added over 6,000 customers this past quarter. +Second, next-generation data center. Over the past year, we have continued to invest heavily in our data center portfolio, building upon our core networking foundation as customers look to Cisco for an open, programmable and automated infrastructure that accelerates application deployments and provides network services in an agile way. +We are delivering technologies across physical, virtual and cloud-based deployments. In Q4, we launched our Tetration Analytics platform, providing complete visibility across the data center. Combining Tetration with Cisco Cloud Center, we can automate and orchestrate data center application workloads real-time between hybrid and private clouds, while enabling policy management with ACI. Our ACI family of products continued to see strong revenue growth in Q4, growing 36% at over a $2.3 billion annualized run rate. +In addition, this past quarter marked our first full quarter with HyperFlex, our hyper-converged solution, and we already have approximately 500 customers, and over a quarter of these are net new to UCS. We're off to a great start, with a solid pipeline and strong customer feedback. +Third, collaboration. This continues to be a consistent growth driver for us. Our strategy and highly differentiated portfolio, delivered both on-premise and from the cloud, enabled us in FY16 to grow revenue 9% to $4.4 billion. In Q4, we delivered another consecutive quarter of solid growth, with revenue growing 6%, and deferred revenue growing at 13%. +Lastly, we continue to see great progress in our transition to software- and subscription-based models. I've mentioned the success we've had in this area in both security and collaboration, and overall, our product-deferred revenue related to our recurring software and subscription businesses grew 33% in Q4. Our momentum here is strong, and we'll continue to accelerate this transition. +Today's market requires Cisco and our customers to be decisive, move with greater speed, and drive more innovation than we've seen in our history. Today we announced a restructuring, enabling us to optimize our cost base and lower growth areas of our portfolio, and further invest in key priority areas, such as security, IoT, collaboration, next-generation data center, and cloud. We expect to reinvest substantially all of the cost savings from these actions back into the businesses, and we'll continue to aggressively invest to focus on our areas of future growth. +Now I'll turn it over to Kelly to walk you through more detail on our financials. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. We executed well on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments, and delivering shareholder value. First, on delivering profitable growth. +We had another good quarter, with revenue growing 2% and non-GAAP EPS growing 9%. For the full fiscal year, we grew revenue 3%, and non-GAAP EPS 8%. For the quarter and full year, we expanded both our gross and operating margins. For the full fiscal year, total revenue was $48.7 billion, with product up 2% and services up 5%. +Let me now walk through the details for Q4. Total revenue was $12.6 billion, up 2%, with growth in product revenue of 1% and services of 5%. Switching grew 2%, driven by strength in data center switching, with continued momentum in ACI and the next-generation data center. Routing declined 6%, largely driven by the weakness we saw in Service Provider. +Collaboration grew 6%, driven by continued strength of our TelePresence portfolio, which grew in the double digits, and continued solid performance of WebEx. Deferred revenue grew 13%. Data center declined 1%. +Our hyper-converged offering, HyperFlex, is experiencing solid early uptake by our customers, led by its highly differentiated architecture. Wireless grew 5%, led by growth in cloud-based Meraki, partially offset by a decline in controllers. +Security grew 16%, with deferred revenue growth of 29%. We had strong performance in our advanced threat security and web security solutions, which grew over 80% and 50%, respectively. SP Video declined 12%, driven by the weakness we saw in China this quarter. Services grew 5%, driven by our focus on renewals and attach. +We continue to make solid progress in our goal of driving more recurring revenue. Total deferred revenue grew 8%, with product up 8% and services up 9%. And as Chuck mentioned, the portion of our deferred product revenue related to our recurring software and subscription businesses, grew 33%. From an orders perspective, total product orders grew 1%, with our book-to-bill comfortably above 1. +Looking at our geographies, which is the primary way we run the business, Americas grew 3%, EMEA was down 3% and APJC grew 4%. Total Emerging Markets declined 6%, with the BRICs plus Mexico down 2%. India was up 20%, while we saw declines in China of 12%. +In terms of customer segments, it was good to see a return to growth in enterprise of 3%, as well as a solid performance in commercial of 5%. Public sector grew 1%, and Service Provider was down 5%. Our product backlog as we ended Q4 was approximately $4.6 billion, up 1%. +We drove strong profitability with expanding leverage in Q4. From a non-GAAP perspective, total gross margin was 64.6%, growing 0.7 points, with product gross margin of 63.9%, up 0.7 points, and service gross margin of 67%, up 1.1 points. We increased our non-GAAP operating margin to 31.4%, up 1.3 points. +We also saw good momentum and improvement in the profitability for the full fiscal year. On a non-GAAP basis, our total gross margin for the year was 64.7%, an increase of 50 basis points, with increases in both product gross margin and service gross margin, up 0.3 points and 1.4 points, respectively. Our non-GAAP operating margin expanded to 31%, up 1.4 points. +We remain disciplined, and focused on continuing to drive operational efficiencies and productivity. In terms of our bottom line, we delivered non-GAAP EPS of $0.63, up 9%. GAAP EPS was $0.56. For the full year, we had record non-GAAP EPS of $2.36, up 8%, while GAAP EPS was $2.11. +Moving to our portfolio and strategic investments, in Q4, we announced our intent to acquire CloudLock, which has since closed, early Q1. The CloudLock acquisition will further enhance Cisco's security portfolio and build on our Security Everywhere strategy, designed to provide protection from the cloud to the network to the end point, and also aligns with our strategy to deliver more cloud-based subscription services. We continued our strategy of investing in key growth areas including security, but also cloud collaboration and IoT, and we are committed to looking at the right acquisitions at the right price, to drive our growth strategy. +Moving on to shareholder value, in Q4, we delivered operating cash flows of $3.8 billion. Total cash, cash equivalents and investments at the end of Q4 were $65.8 billion, with $5.9 billion available in the US. We returned $2.1 billion to shareholders during the quarter. That included $800 million of share repurchases and $1.3 billion for our quarterly dividend. +For the full fiscal year, operating cash flow grew 8% to a record $13.6 billion, with free cash flow of $12.4 billion. We returned $8.7 billion to shareholders through share buybacks and dividends, which represented 70% of our total free cash flow. We are firmly committed to continuing our capital allocation strategy of returning a minimum of 50% of our free cash flow to shareholders annually. +To summarize, in Q4 and for the full fiscal year, we executed well, despite a volatile environment. We focused on consistent, solid execution, driving profitable growth, cash generation and operating leverage. We're making the tough decisions and key investments to drive strong financial performance over the long term, and continuing our firm commitment to delivering shareholder value. +Let me now reiterate the guidance we provided in the press release for the first quarter of FY17. This guidance includes the type of forward-looking information that Marilyn referred to earlier. The guidance for the first quarter of FY17 is as follows. We expect our revenue growth to be in the range of minus 1% to plus 1% year over year, normalized to exclude the SP Video CPE business from Q1 FY16. +We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29% to 30%. And the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.58 to $0.60. +The restructuring action Chuck discussed earlier will impact up to 5,500 employees, representing approximately 7% of our global workforce. We will take these actions starting in Q1 of FY17, and estimate that we will recognize pretax charges to our GAAP financial results up to $700 million. We expect that approximately $325 million to $400 million of these charges will be recognized during the first quarter of FY17, with the remaining amount recognized during the rest of the fiscal year. +I'll now turn it back to Chuck to summarize the call. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [5] +-------------------------------------------------------------------------------- +Thanks, Kelly. To wrap up, I want to summarize our priorities as we head into the year ahead, and why I'm confident about our opportunities. First, we expect to continue to execute against our strategic priorities, and drive profitability regardless of the market conditions. We are committed to making the necessary decisions to drive our future growth and that of our customers and our partners. +Second, we believe we will transition more of our revenues to a software- and subscription-based model, and accelerate our shift across our portfolio. Third, we remain committed to increasing our pace of innovation that will help our customers succeed. Lastly, we will continue to execute on our of long-term strategy to create even greater value for our customers and shareholders, while positioning Cisco for long-term success. +Marilyn, I'll turn it back over to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [6] +-------------------------------------------------------------------------------- +Thanks, Chuck. Sam, let's go ahead and open the line for questions. And while Sam is doing that, I would like to remind the audience that we ask you to please ask one question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you. And our first question comes from the line of Vijay Bhagavath with Deutsche Bank Securities. Your line is now open. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank Securities - Analyst [2] +-------------------------------------------------------------------------------- +Hi, thanks, Chuck. Kelly, Marilyn. My question is around demand trends. A lot of clients are asking me this since the press release came out. Help us with any color you can in terms of end markets, product categories, product cycles -- anything and everything on demand trends looking into the rest of the year? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Vijay. So I'll provide some comments and ask Kelly for anything else that she'd like to add. So when you look at, in Q4, what we obviously saw was, after three quarters of growth in the Service Provider and emerging countries, we saw those turn negative, as I said. And the rest of the business was up 5%, from an orders perspective. We also highlighted the fact that enterprise was up 3%. A little more color on that is that every geography around the world experienced positive enterprise growth. +Commercial was up 5%. Every geography around the world experienced positive growth in commercial. And then in public sector, it was up 1% and I believe all except perhaps Europe were positive as well, in public sector. So outside of SP and emerging, we saw fairly consistent demand. And I think that pretty much summarizes it. Kelly, what other comments do you have? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [4] +-------------------------------------------------------------------------------- +No, I think you summarized it well. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [5] +-------------------------------------------------------------------------------- +Okay, Sam. Let's go ahead and tee up for the next question, please? + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Thank you. Our next question is from Ittai Kidron with Oppenheimer. Your line is now open. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Company - Analyst [7] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for the question. Couple things from me. And Chuck, this is the same question I asked last quarter. Your UCS, your data center business, has now been stuck in range for seven quarters in a row. And I understand that HyperFlex has seen some traction, but how do we get that business back to growth again? What is the time line by which you think that could happen? And will you consider going after parts of the market that are maybe more margin-sensitive? +And then just another small question there. The Tetration solution you introduced, can you just remind us in what product category in the future that will be included, and maybe some color on first comments from customers? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [8] +-------------------------------------------------------------------------------- +Absolutely, Ittai, thank you very much. So on the UCS front, we talked about a couple things. There's an overall sort of macro demand issue in that space. I think the overall blade market has been somewhat benign. But we've also had -- we've also experienced, as we talked about, a transition to rack, and our teams have been working on subsequent innovation across both the blade and the rack business, as well as the introduction of the HyperFlex system. +So we have -- I believe the team has a real clear plan. They've got innovation priorities outlined across all of those platforms, and we'll be executing that over the next few quarters. Kelly and I actually reviewed this just a couple days ago. So I feel good about the leadership there. I feel good about their plan, and now it's about execution. +Kelly, any -- on the Tetration front, let me give you a little color, and then Kelly, you can talk about where we're going to report it. Tetration is -- we announced it in Q4. We're generally beginning orderability, I think, sometime around now. It is a combination of premise-based hardware with subscription software. +And so, we're just very much in the early days. We have taken a couple of orders from customers. I will tell you that the general feedback from our customers is that it solves a problem that they've had for a very long time, that nothing else has solved. So again, we've got that offer ready to go in a combination of premise-based and subscription-based solution, and it is just being turned off on an orderability perspective. Where will we report that? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [9] +-------------------------------------------------------------------------------- +Right now, since it is in the data center solution, it will be in data center switching. As we expand that portfolio across we can (inaudible). + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [10] +-------------------------------------------------------------------------------- +We'll call it out. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [11] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [12] +-------------------------------------------------------------------------------- +Thanks, Chuck and Kelly. Sam, we'll go ahead and take the next question, please. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Thank you. Our next question is from Simona Jankowski with Goldman Sachs & Company. Your line is now open. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- +Hi, thank you. I just had a clarification first, which is, what percent of the business right now is recurring software and subscription revenue? And then as far as my question, gross margins and operating margins were ahead of your target ranges, and that's in a quarter when gross margins are typically seasonally down. So just curious, Kelly and Chuck, about raising your target margin ranges over time? And just more broadly, how are you thinking about the tradeoff between margins and revenue growth? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [15] +-------------------------------------------------------------------------------- +Yes, so I'll start, and Chuck, you can jump in. But to your first question, the portion of our business that is recurring revenue is up to 28%, and that compares to 25% in Q4 of 2015. So we made really solid progress this year. +In terms of the margins, this has been a huge focus for us all quarter long, and it is really great to see that we actually had our margins -- gross margins and operating margins -- up year over year for us this year. It's part of what we're driving in our shift to software. Those businesses have great margins, and it's part of the overall transition. In terms of, when do we change our model or our guidance, I think that will come over time as we make bigger shifts at the Company level. But that is our goal, as we shift to more software that have those nice, great margins. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [16] +-------------------------------------------------------------------------------- +The only other comment I'd make is that when we look at our success relative to subscription and software businesses, we have the product-deferred revenue that's associated with software and subscriptions, that we said was up 33%. We also have another category of total contract value that we have not recognized revenue on yet that we will be billing customers on, on a monthly basis going forward. +We track both those numbers. The second one doesn't show up on our balance sheet yet. But if you look at those two combined, which is really reflective of our progress here, that number was actually up 43% over the same period a year ago, just to share one more data point there. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [17] +-------------------------------------------------------------------------------- +Next question, please? + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +And our next question comes from the line of Tal Liani with Banc of America Securities. Your line is now open. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch - Analyst [19] +-------------------------------------------------------------------------------- +Hi, guys. My questions are about the restructuring program. Two things. First, are you -- you say that you're doing it in order to increase investments in growth areas versus areas that are not growing. Are you anticipating further declining growth rates, or any issues beyond what we're seeing now in the legacy areas, that prompt this kind of program? +And second, when we talk about less lower-growth areas, these are your largest areas, so switches and routers. And the question is, how do you deal with -- how do you balance between the need to compete and the need to invest? And maybe you can give us some color on the restructuring and what you plan on doing? Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [20] +-------------------------------------------------------------------------------- +I'll make some initial comments and again pass it to Kelly. Tal, good questions. Primarily, we are looking at the areas of growth that we believe will grow faster than others. So it's more of a relative statement than it is an absolute statement. At the same time, we actually are working very diligently on bringing innovation to our core. We're focused on a tighter coupling of security into the core. We're focused on policy and orchestration and cloud-based management across the entire portfolio. +So there is a significant amount of innovation the teams are working on there over the next several quarters as well. So it's not that we're ignoring one in favor of another. We just want to make sure that our of investments are commensurate with the growth opportunity from a relative perspective. Kelly? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [21] +-------------------------------------------------------------------------------- +I think you said it well. We are investing in basically every business unit we have, right? So we're investing in the core and key areas. We're looking for those pockets of where the growth is, whether it's in core routing and switching or security and collaboration. So we're being very smart about where we're putting our money, and that's how we're looking at this. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [22] +-------------------------------------------------------------------------------- +We'll go ahead and take our next question, please. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Thank you. Our next question is from Steve Milunovich with UBS Securities. Your line is now open. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [24] +-------------------------------------------------------------------------------- +Thank you very much. Could you talk a bit more about the factors behind your first-quarter guidance? Revenue being flat is clearly below the recent growth rate, and the gross margin is also down a fair amount sequentially. So what do you attribute that to? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [25] +-------------------------------------------------------------------------------- +I'll give a couple of macro comments here. So we obviously, are calling out the weakness we saw from a demand perspective in Q4 relative to SP and emerging countries. We also -- obviously as we look forward, we're just uncertain how to model any improvement in those two, in particular, going forward. +And the other issue is that there is some impact from the transition in our business model. I'll give you a quick example. We restructured and drove new value in how we put together certain Cisco One Software packages for our customers. And in Q4, as an example, there was about $139 million that would have been recognized as revenue that, because of the way we have now structured those offers and the value the customers see in those, those are going to transition to ratable revenue recognition. So there is a slight impact from that as we look forward as well. And those are the key things that led us to our guide. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [26] +-------------------------------------------------------------------------------- +Yes, and just on -- the only thing to add to that -- again, we base it on what we see, and again, we did see the additional slowdown in SP and emerging. That makes us a bit cautious. On the margins, Steve, we're going to be driving as much as we can in those margins, and we'll be working that. But as of right now, this is what we see. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [27] +-------------------------------------------------------------------------------- +Next question, please? + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from James Faucette with Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley - Analyst [29] +-------------------------------------------------------------------------------- +Thank you very much. I just wanted a quick question. I think this ties into Service Provider. Routing was surprising to us, that it wasn't a little bit better, and I think that's probably attributable to Service Provider, and I want to make sure that's the case. +And I guess I'd like kind of your view -- it seems like with new products in that category, that maybe that, that category at some point becomes pretty spring-loaded, as at least we would expect the valuation units to be shipped in and pent-up demand to develop. But I want to know if we're thinking about that correctly, and kind of how we should think about the router segment going forward? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [30] +-------------------------------------------------------------------------------- +Yes, James. You're correct in that over 50% of our routing business comes from Service Providers. So there's a direct correlation there. And I think if you look at the discussions that have are have taken place with our peers, you look at some of the analyst reports on SP CapEx, we actually saw exactly what the analysts have talked about. I saw one report that discussed double-digit declines outside of the United States, and maybe flat to slightly up inside the US, which is effectively what we saw from a demand perspective. So it was very much in line with that. +As far as what we see going forward, look, we certainly don't expect that these networks over time, that the traffic will decline. So I think it's a matter of timing. The video loads on the networks continue to increase. So we would think about it the same way you do, but we also know that in uncertain times, that customers tend to sweat assets as long as they possibly can. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [31] +-------------------------------------------------------------------------------- +Thanks, Chuck. Sam, we'll go ahead and take our next question, please. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Yes, our next question is from James Suva with Citigroup Global Markets. Your line is now open. + +-------------------------------------------------------------------------------- +James Suva, Citigroup Global Markets - Analyst [33] +-------------------------------------------------------------------------------- +Thanks very much, I appreciate the opportunity. And congratulations, Chuck and Kelly, to your good results. My question is just one part and pretty simple. Regarding Brexit, you're one of the first major tech companies to report that have a full-month post of the Brexit event happening. Can you talk about, did that influence your visibility, your spending patterns or demand orders, or book-to-bill, or anything like that? Any push-outs, any hesitations? +Chuck, you talked many times about uncertain economic times we're in. I was wondering, has it been compounded by Brexit, or was that kind of built in and you actually didn't see much of an impact? Thank you very much. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [34] +-------------------------------------------------------------------------------- +Thanks, Jim. Well, I'll tell you, after the first year in this job, I know for a fact that every month there are new things that we face. And the good news is we tend to execute well and we deal with those. As it relates to -- first off, let me just say, in the EMEA business, the decline there was largely attributed to Service Providers. So I just want to make that clear. We would not suggest that the broad-based shift in the EMEA results was solely dependent upon Brexit. +What we saw from a Brexit perspective is exactly what you would expect. In the UK proper, we saw customers pause. We saw them just kind of slow a bit because they're uncertain. And we also saw the impact of the currency devaluation, which you would expect. But we remain very committed there. We think we'll work through this. But those are the real impacts. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [35] +-------------------------------------------------------------------------------- +Great, thanks, Chuck. Sam, let's go ahead and take the next question, please. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Yes, our next question is from Mark Moskowitz with Barclays. Your line is now open. + +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays Capital - Analyst [37] +-------------------------------------------------------------------------------- +Yes, thank you, good afternoon. I wanted to ask a follow-up around the restructuring. Can you give us any sense, Chuck or Kelly, is there any benefit here from the early stages of the Ericsson relationship, allowing you to leverage that JV so that you can actually drive some of this restructuring? And does that imply there could be incremental restructuring down the road? +And then my question is around the cloud. We keep getting a lot of questions around what is Cisco's exposure to the cloud in terms of, can you give us any sense around the percentage of revenue, at least to private cloud or public cloud deployments that you're serving, from an infrastructure perspective? Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [38] +-------------------------------------------------------------------------------- +On the Ericsson front, I'll tell you that the partnership continues to move forward, and there was really no correlation or discussion of the Ericsson partnership as it related to the decision on restructuring. We think that, again, that the original benefits that we saw with that partnership, with their global scale for services, their OSS capabilities, their radio expertise, combined with our IT expertise in data center and security, and other of capabilities, as well as the enterprise and IoT, were really the drivers there. So we see that continuing. +As it relates to the cloud impact, I think when we look at sort of next-generation data center build-out in the private cloud, we look at our ACI portfolio, and we saw a $2.3 billion annualized business that grew 36%. So we feel like customers continue to move towards a hybrid cloud environment. The orchestration capability that we talked about with cloud center, which is from the CliQr acquisition, combined with the knowledge that we're going to be able to provide the customers through Tetration. +So think about Tetration providing analytics about what's going on, CliQr and ACI then being able to deploy policy and move workloads between public and private cloud. And that's what we think customers are going to look for, and we think we're in a pretty good spot there. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [39] +-------------------------------------------------------------------------------- +Sam, let's go ahead and take the next question, please? + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Yes. Our next question is from Mitch Steves with RBC Capital Markets. Your line is now open. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [41] +-------------------------------------------------------------------------------- +Hi, guys, thanks for taking my question. So my first part is kind of on the product gross margin. So it looks like it was actually down sequentially in July, and I think that's primarily due to selling more switching and routing. So does that mean in October quarter, you think that the mix is going to shift more to legacy kind of routing and switching, versus the remaining, I guess, call it, advanced portfolio? +And then just one small one. What was the total acquisition revenue you guys got from all the acquisitions this quarter? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [42] +-------------------------------------------------------------------------------- +Yes, so I'll take that. So on the gross margins, we do have seasonality of when different mix of our products are bigger. For example, data center and services are bigger in Q2 and Q4, so you can see that normal seasonality in there. +As I said to the earlier question, I think from an overall perspective, we feel great about our gross margins. We are being smart about the tradeoff on top line and bottom line, and the teams continue to do great work in terms of driving productivity and costs out of the products that allow us to do that. +From a pricing perspective, our price ASP price erosion that we saw in Q4 was basically in line with what we saw in Q3 -- actually, 20 basis points better. So we're still in that same range; we're not seeing any change there. In terms of acquisition revenue, we don't typically disclose that, but I can tell you it was roughly less than a point. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [43] +-------------------------------------------------------------------------------- +Next question, please. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [44] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [45] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +And our next question is from Jess Lubert with Wells Fargo Securities. Your line is now open. + +-------------------------------------------------------------------------------- +Jess Lubert, Wells Fargo Securities - Analyst [47] +-------------------------------------------------------------------------------- +Hi, guys. I was hoping you could touch upon the activity you saw from some of your top cloud customers, to what degree you're continuing to see strength in that vertical? And then on the switching business, which saw a return to growth following several soft quarters, I was hoping you could help us understand to what extent ACI revenues are now greater than some of the legacy data center offerings? +And presuming the mix of legacy in the data center is now smaller than ACI, would you expect the switching business overall to grow moving forward? Or are there offsets that could cause that to vacillate going forward? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [48] +-------------------------------------------------------------------------------- +Thanks, Jess. On the web scale players, what we reported in the last couple of quarters was our top-10 web scale customers, and that business was up 2% this quarter. But it is a -- when you have 10 customers in sort of a reporting segment like that, it's highly dependent upon ordering cycles. So I'm not concerned about our relevance or anything relative to that. +On the switching business, I think it's important to understand a couple things. Number one, your question relative to the ACI portfolio, and has it exceeded the traditional portfolio, I think we -- the answer to that is, yes. And our orders there were -- I think grew in the data center switching business, were up mid single-digits. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [49] +-------------------------------------------------------------------------------- +Yes, in the revenue, on the revenue side, yes. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [50] +-------------------------------------------------------------------------------- +On the revenue side. And so that transition continues to go well, and we see customers that are investing in new cloud-ready architectures, are choosing the ACI platforms, which is showing in the results. When you look at our overall switching portfolio, it's just important to understand the math on what percentage of that business is still attributed to our campus portfolio. +And as we said, any time we have these macro -- these environments where customers have any level of uncertainty, that tends to be an area that they will continue to sweat, if they can. And our job over the next several quarters is to drive innovation in that portfolio, integrate security more tightly, and again, focus on orchestration policy and helping our customers lower their costs. And that's what we're going to try to do. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [51] +-------------------------------------------------------------------------------- +Thanks, Chuck. Next question, please? + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Yes, our next question is from Jayson Noland with Robert Baird. Your line is now open. + +-------------------------------------------------------------------------------- +Jayson Noland, Robert W. Baird & Company - Analyst [53] +-------------------------------------------------------------------------------- +Okay, great. I wanted to ask about long-term revenue growth. I think, Kelly, 3% to 6% has been discussed in the past, but with the shift to software and subscription, and service provider uncertainty, that seems like a stretch. And I'm not asking for specific guidance, but is there some direction that you would suggest for our long-term models? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems Inc - CFO [54] +-------------------------------------------------------------------------------- +Yes, you know, I think that's a great question, Jayson. If you go back to -- I think that was back in June of 2015, was our last financial analyst conference, it has changed quite a bit. Our transition has accelerated, that we've been accelerating. And I'd say the other major change from that long-term guidance was certainly our expectation of the data center business, and that market has changed. +So I'd say there is no long-term model change per se right now, but we're in the process of planning an analyst conference hopefully at the end of the calendar year here, and we'll update that. But I would say those are the two major assumption changes since we did that. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [55] +-------------------------------------------------------------------------------- +Thanks, Kelly. We have one more question, time for one more question. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- +Yes, and our last question comes from Simon Leopold with Raymond James. Your line is now open. + +-------------------------------------------------------------------------------- +Simon Leopold, Raymond James & Associates - Analyst [57] +-------------------------------------------------------------------------------- +Great, thank you very much. I wanted to see if we could talk a little bit about longer term on the routing business, specifically. What you laid out sounds like very much the cyclical challenges facing your peers, as well as weak carrier CapEx. But if you could help us understand some of the longer-term themes around what's going on in routing, and how that sector may grow and your business may grow. And I'm pondering the implications around sort of SDN, as well as some of the architectural shifts of putting more of the burden into the optical space. Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems Inc - CEO [58] +-------------------------------------------------------------------------------- +Yes, Simon, thanks for the question. When I think about routing, I actually think about it in several different ways. Number one, you've got the SP traditional portfolio with Edge access and core, which we discussed earlier, which is largely just a consumption-driven cycle that we go through. +In the enterprise space, we have this transition to software-defined wide-area networking, which we're very well-positioned in right now with our IWAN portfolio. And we're actually working on a key differentiator for us, which I think is, as our teams have built out the ability to really drive the next-generation secure Edge. With our cloud security capabilities, the combination of dynamically provisioning those branch solutions, with the ability to have robust cloud security and Edge security, is going to be a real differentiator for us. So we see that being another opportunity for us going forward in the routing space. +And then finally, when we talk about the security and the security-driven refresh of our core, in Q4 we actually had a couple of customers -- I talked earlier in the opening comments about Stealthwatch Learning Networks. Which is effectively a machine-learning algorithm that runs at the edge of the network in the branch, and it actually does machine learning and a little bit of AI to determine normalcy for customers, and then flag for them when they see abnormal behavior going on. And we saw a couple of customers that actually made the decision to do a branch router refresh based on that capability, which we just launched in July. +So we believe that there's innovation that we can bring that will lead us to a refresh opportunity in the core, and we think that's largely going to be driven around security. And we're seeing some real early examples. We need to see how it plays out, but we're seeing some early examples there. +All right, Marilyn. Thank you very much. In wrapping up, I just want to summarize our priorities again as we think about the year ahead. First off, we're committed to executing against the financial model and against our priorities, regardless of the conditions of the market. And we're committed to making the decisions that are necessary to drive our growth, and also to fulfill the commitments and obligations that we made to our customers, partners, and shareholders. +We also are pleased with where we are on the transition to software and subscription models, and you can assume that we'll continue to accelerate that over the next year. We also -- I believe we'll drive a greater pace of innovation than you've seen in the last several years from Cisco. Our teams are very excited. There's a lot of things going on. So we're very committed to driving innovation. +And then finally, just to reiterate, our long-term strategy to create greater value for our customers and our shareholders, while ensuring that we're also making the decisions for Cisco's long-term success, will remain at the forefront. So I want to thank everyone for spending time with us today, and we'll look forward to talking to all of you soon. Marilyn? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems Inc - Head of IR [59] +-------------------------------------------------------------------------------- +Thanks, Chuck. Cisco's next quarterly call, which will reflect our FY17 first-quarter results, will be on Wednesday, November 16, 2016, at 1:30 PM Pacific Time, 4:30 PM Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, please feel free to contact any member of the Cisco Investor Relations department. And we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-888-566-0452. For participants dialing from outside the US, please dial 1-203-369-3048. This concludes today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2016-Feb-10-CSCO.txt b/Transcripts/CSCO/2016-Feb-10-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..0c7a483dfab13876818e03d699c8181398cd7d72 --- /dev/null +++ b/Transcripts/CSCO/2016-Feb-10-CSCO.txt @@ -0,0 +1,413 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Cisco Systems Inc Earnings Call +FEBRUARY 10, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kelly Kramer + Cisco Systems, Inc. - CFO + * Chuck Robbins + Cisco Systems, Inc. - CEO + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Jim Suva + Citigroup - Analyst + * Brent Bracelin + Pacific Crest Securities - Analyst + * James Faucette + Morgan Stanley - Analyst + * Pierre Ferragu + Sanford C. Bernstein & Co. - Analyst + * Tim Long + BMO Capital Markets - Analyst + * Jeff Kvaal + Nomura Securities Intl - Analyst + * Ittai Kidron + Oppenheimer & Co. - Analyst + * Vijay Bhagavath + Deutsche Bank - Analyst + * Mark Moskowitz + Barclays Capital - Analyst + * Simon Leopold + Raymond James & Associates, Inc. - Analyst + * Jess Lubert + Wells Fargo Securities, LLC - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco Systems second-quarter and FY16 financial results conference call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- +Thanks, Kim. Welcome, everyone, to Cisco's second-quarter FY16 quarterly conference call. This is Marilyn Mora, Head of Investor Relations. I am joined by Chuck Robbins, our CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be available on our website in the investor relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found on the financial information section of our investor relations website. Throughout this call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be on a year-over-year basis unless stated otherwise. +The matters we will be discussing today include forward-looking statements including the guidance we will be providing for the third quarter. They are subject to the risks and uncertainties that we will discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +Please note that during Q2 on November 20, we completed the sale of the customer premises equipment portion of our SP video-connected devices business to Technicolor. As such, all of the revenue, non-GAAP, and product orders information we will be discussing is normalized to exclude the SP video CPE business from both the Q2, FY16, and historical results. We have provided Q2 FY16 and historical financial information for the SP video CPE business in the slides that accompany this call and on our website to help to understand these impacts. As a reminder, the guidance we provided during our Q1 earnings call and today's call have been normalized in the same way. +With that, I would like to go ahead and turn it over to Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Marilyn. We delivered a strong Q2 in a challenging macro environment. Recently, we've experienced one of the most volatile times in the global markets. This volatility led to a slowdown in spending impacting our business especially during the last few weeks of January as we closed our quarter. Despite this slowdown, we executed very well with total revenue growth of 2% and non-GAAP EPS growth of 8%, strong margins and operating cash flow up 36%. +Our ability to deliver strong profitability in a challenging environment reflects the operating leverage we have created in our business over the last several years. Our portfolio is more strategic than ever to Companies and countries that are digitizing everything. As billions of things become connected creating massive amounts of data, Cisco is playing an increasingly critical role enabling our customers to drive their priorities with industry-leading security. +Cisco is unique in our ability to connect everything for our customers from the sensor to the data center with security and analytics. As a result, our conversations are no longer just in IT. They have become prevalent in the C-suite and the boardroom. +When I took this role two quarters ago, I discussed my focus on accelerating our innovation engine and portfolio transformation to execute on the opportunity ahead of us. I believe we are executing well, and I would like to highlight our momentum in four key areas. +First, we are defining the next generation of networking, beginning with the data center with our ACI platform providing the automation and programmability for our customers most critical business applications with the scale, speed, and security they require. In just two years, we have built ACI to a $2 billion run rate business that grew once again last quarter over 100%. We are aggressively focused on winning in the 10-gig, 40-gig and 100-gig transition and firmly establishing our leadership in the next-generation data center. +Second, security remains the most critical priority for our customers, and as everything connects, it makes the network even more relevant. As the largest security provider, we have been focused on driving the growth of this business while at the same time migrating our model from a primarily hardware business to a software and services business. In Q2, not only did our security business grow 11%, but our security-deferred revenue grew 26%. +Third, we saw double-digit growth in our cloud-based SaaS businesses, specifically WebEx, Meraki cloud networking, and security. You are seeing us move more of our portfolio to be delivered in both on-premise and cloud-based models, and we are aggressively driving this transition. +And, fourth, we are using M&A to augment our internal innovation in key growth areas. In the last 12 months, we have added critical capabilities and talent in the growth areas of cloud, security, SaaS, IoT, and analytics. +Our recently-announced acquisition of Jasper, combined with our other capabilities, is a strong example of how we will play a unique and strategic role in unlocking the value of IoT. We will enable our customers to monetize the data from the billions of sensors and connections with the security, speed, and reliability they have come to expect from Cisco. Our momentum reflects the uniqueness of our business model and our ability to weather volatility while accelerating innovation in key markets to drive our long-term growth. +Now, I will turn it over to Kelly to walk through more detail on our financials. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. I am pleased with our continued execution on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments, and delivering shareholder value. +Starting with delivering profitable growth, total revenue was $11.8 billion, up 2% with product revenue growth of 2% led by growth in security, routing, and collaboration. In switching, as Chuck mentioned, we are driving the next-generation data center architectures and are very pleased with our ACI momentum. The 4% decline in switching was largely driven by macro weakness in our campus business something that we have observed in the past during volatile times as customers pause spending decisions. +We saw our routing business grow 5%, driven by double-digit growth in our CRS platforms with particular strength in mobility and web-scale service providers. Collaboration grew 3%, driven by a 17% growth in WebEx, partially offset by some slowdown in our unified communications business. Deferred revenues showed continued strength growing 15%. +Our data center decline of 3% was also driven by a slowdown in spend. In addition, we have tough comparisons from Q2 2015 when revenue grew 40%. UCS continues to be a strong franchise for us and is a foundational piece of our next-generation data center stack. +Wireless was flat as result of declines in our access [plane] controller business offset by strong growth in our cloud-based Meraki platform. SP video grew 37% larger driven by strength in China. Security grew 11% with deferred revenue growth of 26%. +We had strong growth in our advanced threat security and web security solutions which grew over 180% and 40%, respectively. We added over 2,000 customers on our amp advanced malware solution bringing the total customer base to over 10,000. Services revenue grew 3%, and we continued to show very good progress against our goal of driving more recurring revenue. +Deferred revenue had a solid growth of 8% in total with product up 11% and service up 7%. The portion of our product-deferred revenue which is related to our recurring software and subscription businesses grew 34%. In total, product orders grew 2%. Our book to bill was approximately 1. +Looking at our geographies, which is the primary way we run our business, Americas was flat. EMEA declined 1%, and APJC grew 17%. Total emerging markets grew 7% with the BRICs plus Mexico showing strength at up 70%. With China up 64%, and India up 23%. Total emerging minus the BRICM countries was down 3%. +In terms of customer segments, enterprise declined 2%, and commercial grew 4% -- both of which were impacted by macro uncertainty. Public sector was flat, and service provider grew 5%. We drove strong profitability with discipline and rigor on gross margins and operating expense. +Non-GAAP gross margin was 64.2% with non-GAAP product gross margin of 63.3%, and non-GAAP service gross margin of 66.7%. Non-GAAP operating expenses were 33% of revenue, and non-GAAP operating margin expanded to 31.2%. We will remain disciplined with our operating expenses and portfolio management. +From a profitability perspective, we delivered non-GAAP EPS of $0.57, up 8% with $0.015 attributable to a lower non-GAAP tax rate resulting from the permanent reinstatement of the federal R&D tax credit. From a GAAP perspective, EPS was $0.62. +In addition to the typical reconciling items between GAAP and non-GAAP EPS, there were three material items to call out which we excluded from our non-GAAP results; The gain on the sale of the SP video CPE business, the impact of the settlement of federal tax audit, and prior-year fiscal-year impact of the reinstatement of the federal R&D tax credit. The total impact of these and other immaterial items was a benefit to GAAP EPS of $0.13. Q2 non-GAAP net income was $2.9 billion, up 8%. GAAP net income was $3.1 billion. +Moving on to shareholder value. In Q2, we delivered operating cash flow of $3.9 billion, up 36%. Total cash, cash equivalents, and investments at the end of Q2 were $60.4 billion with $3.9 billion available in the US. In the first half of FY16, we have returned $4.6 billion, or 75% of our free cash flow to our shareholders, comprised of $2.5 billion of share repurchases and $2.1 billion of dividends. +Today, we announced a 24%, or $0.05 increase to the quarterly dividend to $0.26 per share. This represents a yield of approximately 4.6% based on today's closing price. We also announced a $15 billion increase to the authorization of the share repurchase program raising the remaining share repurchase authorization to approximately $16.9 billion. This significant dividend increase and additional share repurchase authorization reinforces our commitment to returning capital to our shareholders and our confidence in the strength and stability of our ongoing cash flows. +Overall, Q2 was a solid quarter in a volatile macro environment. We saw good top line growth, strong profitability, and operating leverage. We continue to shift our business model to more software and subscription recurring revenue. +Let me now reiterate the guidance we provided in the press release for the third quarter of FY16. This guidance includes the type of forward-looking information that Marilyn referred to earlier. +Q3 does include an extra week which occurs every five to six years for us. We have factored this extra week into our guidance for both revenue and expenses. Although it is difficult to forecast the impact of the extra week, we have assumed roughly a 2% year-over-year impact on total revenue growth along with approximately $40 million of incremental cost of sales and $110 million of operating expenses. +The guidance for Q3 is as follows. We expect revenue growth to be in the range of 1% to 4% year-over-year, normalized to exclude the SP video CPE business from Q3 FY15. We anticipate the non-GAAP gross margin rate to be in the range of 62.5% to 63.5%. The non-GAAP operating margin rate is expected to be in the range of 28.5% to 29.5%, and the non-GAAP tax provision rate is expected to be [22%]. +Non-GAAP earnings per share is expected to range from $0.54 to $0.56. We anticipate our GAAP EPS to be lower than the non-GAAP EPS by $0.08 to $0.12. Further details to this range are included in the slides and press release that accompany this call. +I'll now turn it back over to Chuck to summarize the call. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [5] +-------------------------------------------------------------------------------- +Thanks, Kelly. Let me quickly summarize. While macro growth has clearly slowed, the speed with which technology is changing every industry and every country has not slowed, and we are moving full speed ahead. This speed, coupled with our innovation, strategic partnerships, and our M&A capabilities will allow us to meet the expectations of our customers and lead into the future. On this front, I feel very confident, and that conviction about our future business is what led us to increase our dividend by 24%. +My confidence in our future is confirmed every day by CEOs, Boards, and country leaders as we preview our strategy and road maps. They see the next-generation data center and cloud architectures we're building on UCS and ACI. They see our extensive security portfolio that protects them before, during, and after an attack. +The see the IoT and analytics platforms that will enable them to act on and monetize data and connections, and they want us to be their strategic partner as they drive their digital agendas. They trust us. They value our innovation, and they believe our portfolio is critical to their ability to execute on their vision. +Our customers and countries around the world know this move to digital is real, and it is happening now. As we help them through this transition, you will see us operate on two fronts. In the near term, you will continue to see us to be a well-run Company that executes even in challenging markets. Longer term, we will continue to make the right investments that will accelerate our growth as our customers embrace and adopt this next wave of technology. +Marilyn, I will turn it back to for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [6] +-------------------------------------------------------------------------------- +Great. Thanks, Chuck. Kim, let's go ahead and open the line for questions. While Kim is doing that, I would like to remind the audience that all analysts -- we ask you to please ask one question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford Bernstein. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford C. Bernstein & Co. - Analyst [2] +-------------------------------------------------------------------------------- +Chuck, what I would like to understand is your perspective on the macro environment? So, first of all -- you, of course see Bloomberg TV and read the Financial Times as we all do. But, what can you see through Cisco if you get feedback from your channel? From your sales force? Your country managers? What do they really tell you about and what color can you bring us that we do not necessarily see from where we are? And also, on the same front on the macro environments, your guide for next quarter -- what kind of macro scenario have you baked in? Would you qualify that as prudent -- very prudent? And, if you can take us through the thought process of how you came up with that guidance that would be very helpful? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Pierre, thanks for the questions. Good to hear from you. On the macro front, I think the thing that I can tell you is that as we began last quarter, we certainly have a set of expectations as we have run our business for a long time and really know what to expect, and our expectations were obviously based on the discussions we had with all of you at the end of our first quarter. I would tell you that through the first 10 weeks of the quarter that was very much in line with what we expected. We were executing very much in line with how we would have expected the quarter to go. +Our week 10 -- just so you have the data point was the end of the calendar year. So, while a number of companies have reported earlier this year, not many have actually had their quarter end in January. So, we ended at the end of the third week of January which we all know those first three weeks were reflective of the uncertainty that occurred in a lot of the financial markets. What I will tell you is that after week 10 through those three weeks, we saw customers as they were trying to digest what was going on. They paused a bit, and you see customers say -- I want to just wait and see what is going on. Let me take a look at this. We want to understand this a little better. I think to Kelly's point when she talked about the switching business, the campus refresh opportunities that have been actually pretty consistent for us over the last few quarters, we saw customers say, hey, our infrastructure is working so we're going to hold on that for some period of time and let's see where things go. +That is probably the extent that I can add to what we all know from what we're seeing every day. What I would tell you -- and I will ask Kelly to comment on our guidance -- is I would say that we took that feeling of those first three weeks into consideration as we built our guidance. And, that is what we based it on. Is what the last three weeks of last quarter led us to relative to this level of uncertainty. Kelly, any comments? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- +I think -- to your question, Pierre. I think Chuck summarized it well. When we do our guidance, we look at everything we know at the time which is our funnel, the momentum we see, and everything else. I would say to put it in the words you use, I would say that our guidance is prudent. I think you see that we expanded our range to 3 points of range versus our normal 2 because I think it is more volatile than normal. So, I would go with prudent based on what we see right now. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- +My question is around is Cisco a tale of two cities here? We're seeing enterprise products turning light versus consensus while your service provider product -- routing, video et cetera -- are beating expectations. I would like to get your view on this enterprise versus service provider dichotomy, if any? +And then, you have a bigger picture strategy around software and your cutting services fully believing that strategy and model. My question is really around do you see IT spending queuing quickly toward OpEx versus the traditional CapEx model of spending? How would Cisco [deliver] to this higher than usual OpEx IT spending moving forward? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [7] +-------------------------------------------------------------------------------- +Thanks, Vijay. I would say the initial question you asked relative to the difference between the enterprise and the service provider space, I think what we saw was that our customers were spending in areas that are incredibly mission-critical for them even in these times where there is uncertainty. So, you see them continuing to spend in security. You see them continuing to spend in the next-generation data center evolution which was indicative of the 100% growth we saw in that portion of our portfolio. And, I think we saw customers where they had the option to wait, they chose to wait a bit. So, I don't view it as -- I don't see any fundamental issues relative to the enterprise portfolio or things like that. I think that it was largely a prioritization effort that we saw within our customer base on the enterprise side. +The service provider side, I think if you go back a couple of quarters, what I said was that our teams have been working hard to really get to alignment with our customers around the future of the industry, the future of their architectures. How they were going to evolve to position them for the opportunities ahead, and I think we did that. And, I would say that our teams have really executed well over the last couple of quarters as they align with our service providers on those priorities across the portfolio. We are pleased with where we are. I don't think that if you really unpack those numbers over two or three quarters that you are going to see -- you'd be able to delineate a whole lot between what went on with the exception of the enterprise customers prioritizing where they spent their money. +As it relates to the OpEx versus CapEx move, I will ask Kelly and maybe she can comment on the software part of the question. But, I didn't see any fundamental change this quarter in how our customers look at that versus what they have been doing for the last three, four, five, six quarters. It's something that we deal with as it relates to -- as an example, our collaboration portfolio, we made announcements last quarter that all of that portfolio, the entire portfolio, is now available. Or, we announced that it will be available to our customers from both an on-premise and a cloud-based perspective. And, in many cases, it will be a hybrid model. To the extent that our customers would like to procure our solutions in that way, then we will make that available to them. Kelly? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [8] +-------------------------------------------------------------------------------- +I think you summarized it well. On the software shift, Vijay, we are making great progress. Whether it is internal -- we talk about how we're driving that in our software and SaaS businesses within collaboration and security. But also, in other parts of our portfolio, we are really developing new offers. There are ways to monetize our services and software along that way so we will continue to disclose more especially as we look at our business and it becomes a bigger part of that. So, I'd say it is progressing well, and we're adding to our models with acquisitions like OpenDNS and Jasper which are both SaaS models. We will continue to build that out as it becomes a bigger part of our portfolio. +On the IT to OpEx, just to add to what Chuck said, I would say one thing that we have tremendous flexibility on is leveraging our great balance sheet to help provide solutions for whatever it is. So, whether it is our Cisco capital offers or for the ability of us to build managed service as a service -- those kind of offers. We are very active working with our customers that want different ways to consume our products and services differently that we're coming up with all kinds of new solutions for different ways of consumption. And, we have that flexibility because of our strong balance sheet. I'd say we're making a lot of progress on both of those accounts. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [10] +-------------------------------------------------------------------------------- +I just wanted to clarify first, Kelly, in terms of the 2-percentage-point bump that you've embedded into the guidance for the extra week that compares to 4 to 5 points that you saw last time you had this kind of pattern back in 2010. I just wanted to understand if there's anything different this time? Or, if that is just an extra measure of conservatism? And then, just more for the substantive question, Chuck. I heard your comments on the pause on the campus-switching side of the business. I wanted to also ask what is happening on the data center side of your switching business? Is that returning to growth in the first half of this calendar year as you had expected it to? Any update there would be helpful. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [11] +-------------------------------------------------------------------------------- +Simona, on the 2%. Great question. Let me give a little context there. Back -- the last we had this was in Q3 of FY10, and it was about a 4% to 5% increase. I would say, what I've baked into my 2% -- so it's roughly about $250 million to $275 million. What I've baked in the guidance is the incremental revenue I know that we will get from things like our services subscription businesses, our SaaS businesses, as well as some product flow-through on the distribution that we're seeing. That is what I baked into the guidance. +I am not assuming there is going to be a lot more because of the current macro environment. The sales guys are out there. The teams driving to a monthly number and a quarterly number and given the spending constraints that we're seeing right now, I'm not being over-bullish in my guidance on that. That is how I built [that] up. Just to remind you, back in Q3 of 2010 -- our growth that quarter was 27% so it was a much different macro environment. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [12] +-------------------------------------------------------------------------------- +Simona, the second part of your question. I think the word that we would use relative to how Kelly modeled in that would be the same that we talked about with Vijay which would be prudent. On the switching front from a revenue perspective, it was negative this quarter. We're trying not to give you lots of random pieces of information every quarter so that we can build some consistency in how you look at how we are performing. But, I will tell you that on the new order side on the data center switching business this quarter we did see slightly positive growth on orders. And, I would say in the context of that last three weeks that we felt in enterprise that we are cautiously optimistic. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Jim Suva, Citi. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [14] +-------------------------------------------------------------------------------- +My question is now that it has been a few months with the new partnership in Ericsson, can you let us know if you've actually had any concrete wins or anything you can [point to] showing up in the NGN segment of reporting? Or, is it too early to see? Or, any anecdotes about that new partnership? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [15] +-------------------------------------------------------------------------------- +Jim, first of all, thanks for your favorable comments. I appreciate that. On the Ericsson front, we have seen -- I will tell you that we have never seen --. Outside of Apple, we have never seen a partnership that has gotten so much energy and excitement inside the Company. And, as you know on the Apple front, we are actively doing the development. I think Tim alluded to it on his conference call that we are -- both Companies are doing the development that we need to do to actually deliver that join innovation to our customers. +But, the Ericsson partnership has immediate opportunity with it, and we have begun to close transactions together. I would not translate that to a significant impact to any of the numbers that we put out there today because we are literally in the handful stage right now. But, we do see that accelerating. We have a lot of focus on it with our teams. Hans, their CEO and I are going to be together quite a bit. Mobile World Congress in a couple of weeks, and we're also going to have a lot of the next-generation joint solutions that we are putting together for our customers that will be on display in both of our booths there. Hans and I are actually on a panel together at mobile world. That partnership is going probably as well as we thought it would be at this point, and I think you will really see the acceleration over the next 12 months. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays Capital - Analyst [17] +-------------------------------------------------------------------------------- +Just wanted to see if you can give us a little more context about how we should think about the routing glide path going forward in the next few quarters given the nice growth you generated this past quarter. How much of it is related to the CRS cycle continuing? Does it have to do with more vertical penetration or service provider penetration? Any color you can give us? I'm trying to understand, can you still be in the 3% to 4% or 5% bogey for that business for the next couple quarters from a growth perspective? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [18] +-------------------------------------------------------------------------------- +I will speak to some of the areas of strength, and I will let Kelly talk about the numbers and how we think about it going forward. We did see strength in our core routing, and we saw strength in enterprise access routing this past quarter. We have some new products in our portfolio that are very early. One of them was the co-development effort that I had talked about over the last couple of calls that we would expect to see some positive momentum out of over the next few quarters. We have got some virtualized routing capabilities that our teams are working on. I think the portfolio looks good. The pipeline looks good from an innovation perspective. And then, Kelly, any comments on how we think about the numbers going forward? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [19] +-------------------------------------------------------------------------------- +I think you summarized it well, Chuck. I think we feel fantastic about the portfolio, and we feel good about what it looks like. But, I don't really give guidance by business unit because there's a lot of volatility. But, I would say we feel really good about how the portfolio is sitting and the new products that we have launched on that -- in that platform. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Brent Bracelin, Pacific Crest Securities. + +-------------------------------------------------------------------------------- +Brent Bracelin, Pacific Crest Securities - Analyst [21] +-------------------------------------------------------------------------------- +One clarification and one question, Chuck. Could you clarify, was the pause you saw with customers the last couple weeks. Was that global, or was that concentrated in the Americas? And, my question is really around APJC, the recovery you are seeing there? The recovery you are seeing in China? What is driving that? Is that sustainable? Is that easy compares? Walk us through what you are seeing in APJC that drove the rebound this quarter? And, I guess -- A, is it sustainable? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [22] +-------------------------------------------------------------------------------- +Thanks, Brent. On the pause that we saw, this is typical. When there is uncertainty in the market, we see enterprise customers and they just basically say, let's just wait. Let's see what's going to happen. They may say, let's wait a week. They may say, let's wait a couple of weeks. When you're in the last three weeks of your quarter, those kinds of decisions have an impact. I just want to clarify. Your specific question. We saw it pretty holistically around the globe. And then, the other thing that we haven't really talked about is obviously outside of the United States we saw currency -- we talked about it on the last call -- in Europe and Asia that clearly continued and maybe even get a little worse in some places. +On the APJC recovery, the team there has done a great job. We've talked a lot about what we have seen happening in India. We have seen tremendous success there. That is one of the key countries that we have a country digitization effort that John has been leading for us, and our business there continues to grow very well. In China, which is the crux of your question. I would tell you that as we've navigated our way through the last three years, and I think, Brent, you and I have talked about the amount of time that I spent over there during that window. The team did a great job, and what they really did is they diversified our business strategy across customer segments. So, not only being aligned to state on enterprises but moving out and creating a commercial market strategy. Moving out into second and third-tier cities, so geographic diversification. And, they really focused on their teams being able to sell our entire portfolio. +The good news is what I will tell you is that the growth we saw in China was very well balanced across our portfolio. We saw routing up -- Kelly, keep me honest. But, routing in double digits. Switching in double digits. Wireless in double digits as well as SP video in double digits. It was a very balanced performance for the second quarter in a row. There's clearly a lot of uncertainty out there so we're going to take things a quarter at a time, but we are pleased with where they are. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley. + +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- +A couple of quick questions. First on acquisitions. You have been fairly active in the last few quarters. Should we expect this type of pace to persist, both in terms of tuck-in acquisitions and maybe more detailed acquisitions? And then, the second question I had was security -- it seemed like there was some acceleration in that business this quarter. Is that just the result of the SaaS model starting to accrue to the P&L? Or, was there underlying improvement in the billings and activity in that business? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [25] +-------------------------------------------------------------------------------- +Thanks, James. Let me comment on the M&A activity that you have seen. We have built a strategic framework that is guiding us for what we believe we need to have in our portfolio and the architectures that we need to be able to build relative to cloud security analytics, SaaS, IoT. We have built that framework with our team in the first two or three months that I was in the role. We then stepped back and looked at where do we have R&D activities that are going to fill some of those opportunities and where are there opportunities like what we saw with Jasper where we can move and actually fill a substantive portion of our portfolio. That is what is driving us. It is very much connected to our broader strategy and connected to what I believe our customers care about in the future. I would say that you should expect us to continue the pace, and obviously valuations in today's market -- that is one piece of good news is that they're more attractive. +As it relates to security -- on the security front, I would say that it is primarily -- and Kelly can again keep me honest on the deferred piece of this -- if it is flowing through. But, what we talked about was the integration of the Sourcefire assets as well as the Cisco assets as well as other acquisitions we made along the way plus the other innovation that our teams internally have done. And, that has -- we put all that together about two quarters ago, and we told you that we thought that this would continue to improve. And, our teams have driven that. When you look at that advanced malware portfolio, we added yet another 2,000 customers this quarter. So, we're up to 10,000 which is they've really done a great job of executing on that strategy. +During the quarter, we also launched our next-generation firewall product that we need to get out in the marketplace for obvious reasons. We're hoping for similar success. But, I think primarily it is because of continued improvement in the portfolio and the work our team has done. I wouldn't suggest that there is a significant revenue impact coming back in from the deferred yet although we are seeing -- . + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [26] +-------------------------------------------------------------------------------- +That is what we expected. What we said a couple of quarters ago. That ramp that we talked about two quarters ago is happening in addition to the growth that you are highlighting in just the core businesses. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Jess Lubert, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Jess Lubert, Wells Fargo Securities, LLC - Analyst [28] +-------------------------------------------------------------------------------- +Two quick ones. First, for Chuck. I was hoping you could provide some additional details regarding the weakness in the data center business? What changed there? How you expect that to progress moving forward? +And then, for Kelly, with respect to capital allocation. It seems like you have a little bit less than $4 billion in US cash yet you materially raised the dividend and the buyback. I was hoping to understand if we should be expecting a debt raise? And, to what degree this means any acquisitions we may see are likely to be on the smaller side? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [29] +-------------------------------------------------------------------------------- +Jess, I'm surprised we got this far in the questions before someone asked about data center so I was beginning to worry. We track that business very closely, obviously, and largely what we believe is that it is connected to the broader macro issue. That data center business has a strong buying season that actually runs into the end of December, and while it is a fantastic franchise for us that has contributed and will contribute to not only our success in the data center in the past but also in our success in the next-gen data center as we build next-generation data center stacks going forward. But, it also -- we also believe that in the December quarter that we actually still gained share with that performance. We had a tough comp from a year ago -- 40%. But, I will tell you the other thing that we looked at is even with the lower performance, it still remained the same percentage of our business this quarter that it was last quarter that it was a quarter a year ago which says that it just in my mind it says it suffered at the same rate that the rest of the business did from the macro. Kelly, second part of the question? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [30] +-------------------------------------------------------------------------------- +On capital allocations. Overall, our strategy around capital allocation hasn't changed. We want to give a minimum of the 50% back to our shareholders. We've been listening to our shareholders, and the bottom line is we feel very, very good about our business model and our ongoing cash flows. You saw our operating cash up 36% this quarter that we thought we would increase the amount of our dividend sustainably going forward. It is a blend. We also increased our authorization just as we would normally would increase our authorization -- the $15 billion. +In terms of flexibility, yes, we will be accessing debt in the near future. Again, that is one of the benefits of our balance sheet and our access to capital. It is very, very good so we will continue to do that until anything changes with our overseas cash. But, it does not change our flexibility in any way in terms of acquisitions. When we think through these capital allocation decisions, we're playing out what we're thinking about acquisition-wise. How we're building that out as well as our future cash flow. I think, no change to our acquisition strategy. It does not hamper us in any way. We have easy access to capital, and again, wanted to share some of that cash back with our shareholders. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Jeff Kvaal, Nomura Securities International, Inc. + +-------------------------------------------------------------------------------- +Jeff Kvaal, Nomura Securities Intl - Analyst [32] +-------------------------------------------------------------------------------- +I have a few margin questions, Kelly, for you perhaps. Can you talk a little bit about the drivers inside of the gross margin structure? It was a little bit ahead of plan this quarter. It seems to be going back to the norm next quarter. What are the moving parts there? +The second part of that is on the operating margins. I know 30% is the target. When should we be thinking about that? How much progress are you making in that regard? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [33] +-------------------------------------------------------------------------------- +On gross margins, we continue be very focused on margins, and we look at it as all the different levers in there. As you know, we continually have some price erosion, and we use price as a lever to drive selling. Our price erosion has remained very, very disciplined. You'll see that it has been in the normal ranges that we have been in the last quarter and actually slightly better than a year ago. So, that continues. We're getting real traction -- continued traction from our engineers and supply chain on the productivity side. So, for the price erosion we have, we are more than offsetting it with productivity, and we're continuing to drive those projects to continue to do that so we can have the flexibility to make sure we're taking advantage of all opportunities for growth out there. That is continuing. +On the operating margin side -- again, we're are going to be smart about managing the overall equation. We want to make sure we're taking advantage and investing in the right areas to be able to take advantage of future growth and balancing that equation. There is a bit of good [news] coming through at the OM line because of FX favorability that you are aware of that falls through the bottom line. But, in general, I would say that we're being very disciplined in terms of how we make these trade-offs and balance the bottom line with the investments we're trying to make to accelerate growth. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. - Analyst [35] +-------------------------------------------------------------------------------- +I wanted to think a little bit ahead, Kelly, just given this extra week that you had in the guidance. Historically as you move into your fourth quarter, you typically post a solid sequential increase quarter over quarter. As we lose this week, should we assume a little bit more of a flattish performance then into July versus April? And then, regarding the software in SaaS, clearly you're making very good progress over there. Is there a way to quantify from your standpoint how much of growth are you giving up right now as you transition businesses, more and more of your products into those type of purchasing model? How much of a growth headwind this transition is impacting you near-term? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [36] +-------------------------------------------------------------------------------- +On the extra week, this is how I think you can think about it. I tried to be pretty transparent of what we are assuming in there so literally the $250 million or so, the $275 million that we're assuming literally is just the businesses where it is just because we have weekly billing it is going to amortize off our balance sheet. That is basically a guarantee. Just marginally a little bit more for some of the distribution flow business. I would say as you are modeling for Q4, I think you should assume the normal ranges. Take that out -- that $250 million to $275 million and assume the normal ranges of growth in Q4. +On the software and SaaS. I know you and others ask me this question a lot, and it is tough to quantify. Certainly, it is 1 point or 2 easy to say, off the top. Some of the businesses we're growing -- our businesses that we've had that are great like [collaboration] and security. We are adding more to this profile with some of these different offers. These big enterprise ELAs that we have. It is hard to quantify for any one quarter, right, of when it is going to fall in. But, there is certainly something on the top line, but we will see that come back through as we continue to build that out and amortize it. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Simon Leopold, Raymond James. + +-------------------------------------------------------------------------------- +Simon Leopold, Raymond James & Associates, Inc. - Analyst [38] +-------------------------------------------------------------------------------- +Quick clarification. Strength in service provider video, I think you highlighted China. If you could just talk to what you think the duration is? And then, in terms of market verticals, I was interested if you could talk a little bit more about your exposure to what we have often called Web 2.0 or web-scale operators? Certainly, there is the idea that they buy white box, but we know you sell to them. I would like to get a sense of your exposure and the trends from that group of customers if we might? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [39] +-------------------------------------------------------------------------------- +Simon, thanks. This is Chuck. On the SP video front, I think that the team has done a great job of evolving that portfolio and really building some great solutions. They're engaged with lots of customers. Our strategy when we divested of the video CPE business was to really focus on a cloud-based delivery model, and that is occurring. We're having obviously good success with that platform in China. That tends to be an ongoing -- a longer-term solution that the customers deploy. So, we will see. Again, we're taking things quarter by quarter, but we feel good about where they are there. +On the second part of your question, relative to the web-scale guys. We have talked the last couple of quarters about how we had been having success with them. And, I talked about us really changing our strategy about 18 months ago and moving more into a collaborative, co-development mode with them thinking about what they're very unique needs are. I will tell you that our business with them last quarter grew 17% so we continue to see relatively good strength with those customers. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Tim Long, BMO Capital Markets. + +-------------------------------------------------------------------------------- +Tim Long, BMO Capital Markets - Analyst [41] +-------------------------------------------------------------------------------- +Chuck, maybe just to go back to the data center, if we could. I get the macro and the tough compares there. Just looking more broadly at that market, I think though the share gains are starting to normalize a little bit at least in the server market. So, when you think about the continued growth on the hardware side of the data center, do you think we need to broaden the server offering? Maybe get more involved in storage or ADC or some other products that are important to the data center that Cisco might not fully be participating in? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [42] +-------------------------------------------------------------------------------- +Tim, it is good to hear from you, and that is a very good question. What I would tell you is that we are currently -- we have a lot of work going on around the future -- the next-generation data center and what the future stacks look like in that data center which will be a combination of infrastructure hardware with a heavy dose of software and orchestration. And, you can assume that we're looking at our role up and down that stack going forward. I would tell you that there was a recent article, I think late last week in InfoWorld where [Barry Sing] actually outlined how we are thinking about this market. So, you are spot on, and we are spending a lot of time thinking through what role we play there and what the opportunity is. But, we believe it is going to be significant. Appreciate the question. +Tim, thanks. That was apparently the last question we have. I'm going to close with some short comments. I am incredibly pleased with how we executed this quarter, as I said, in a very uncertain macro environment. Our teams did a great job, and as we look forward, I think about how we're operating the Company on these two fronts. +The first front is that we will continue to execute and run this Company in a well-managed way even in challenging environments, but at the same time, we're going to move full speed ahead. The second front is that we are going to make the long-term investments and build our strategy and the architectures and the solutions that our customers need, and I believe that our growth will accelerate as our customers embrace and move towards this next wave of technology that is going to fundamentally change every Company and every country around the world. I believe we can do both. I think that will allow us to take advantage of the incredible opportunity ahead of us, and I have a great deal of confidence in our ability to execute against that. Thank you for spending time with us today, and we look forward to talking to you soon. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [43] +-------------------------------------------------------------------------------- +Thanks, Chuck. Cisco's next quarterly call, which will reflect our FY16 third-quarter results will be on Wednesday, May 18, 2016 at 1.30 PM Pacific time, 4.30 PM Eastern time. +Again, I would like to remind the audience that in light of regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, please for free to contact the Cisco investor relations department, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-888-562-6191. Or, participants dialing from outside of the US, please dial 1-402-280-9986. This concludes today's conference. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2016-May-18-CSCO.txt b/Transcripts/CSCO/2016-May-18-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..d187693e0ecd97802b2ef2d7621ac1e9fc4182bb --- /dev/null +++ b/Transcripts/CSCO/2016-May-18-CSCO.txt @@ -0,0 +1,594 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Cisco Systems Inc Earnings Call +MAY 18, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kelly Kramer + Cisco Systems, Inc. - CFO + * Chuck Robbins + Cisco Systems, Inc. - CEO + * Marilyn Mora + Cisco Systems, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Jim Suva + Citigroup - Analyst + * Pierre Ferragu + Sanford C. Bernstein & Co. - Analyst + * Simon Leopold + Raymond James & Associates, Inc. - Analyst + * Paul Silverstein + Cowen and Company - Analyst + * Brian White + Drexel Hamilton - Analyst + * Mark Moskowtiz + Barclays Capital - Analyst + * Brent Bracelin + Pacific Crest Securities - Analyst + * Tal Liani + BofA Merrill Lynch - Analyst + * James Faucette + Morgan Stanley - Analyst + * Ittai Kidron + Oppenheimer & Co. - Analyst + * Vijay Bhagavath + Deutsche Bank - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + * Steve Milunovich + UBS - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco Systems third-quarter 2016 earnings conference call. +At the request of Cisco Systems today's call is being recorded. +If you have any objections you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Thanks, Kim. +Welcome, everyone, to Cisco's third-quarter FY16 quarterly conference call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO, and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found on the financial information section of our Investor Relations website. +Throughout this call we will be referencing both GAAP and non-GAAP financial results, and we'll also discuss product results in terms of revenue, and geographic and customer results in terms of product orders unless stated otherwise. All comparisons throughout this call will be on a year-over-year basis unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +As a reminder, in Q2 on November 20, we completed the sale of the customer premises equipment portion of our SP video connected devices business, and, accordingly, had no revenue or expense from that business in Q3 FY16. As such, all of the revenue, non-GAAP and product orders information we will be discussing is normalized to exclude the SP video, CPE business from our historical results. +We have provided historical financial information for the SP video CPE business in the slides that accompany this call and on our website to help understand these impacts. As a reminder, the guidance we provided during our Q2 earnings call and today's call has been normalized in the same way. +With that, I will turn go ahead and turn it over to Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn. +We delivered strong Q3 results against the back drop of a macro environment that continues to be uncertain. Despite this uncertainty we executed very well, with revenue growth of 3% and non-GAAP EPS growth of 6%. +We continued to generate strong operating cash flow of over $3 billion in the quarter, returning nearly $2 billion to shareholders through dividends and share repurchases. Our commitment to operating discipline continues to yield solid results in spite of the challenging environment. The operational changes we continue to make will further enable our customers to leverage the strategic role of the network as they transform their businesses to become digital. +As I did last quarter, I'd like to highlight our momentum in four key areas. First, in security, we saw continued acceleration in the third quarter with revenue growth of 17%, while deferred revenue grew 31% driven by our ongoing shift from hardware to more software and subscription services. +Our security business is tracking as we indicated it would earlier in the year. As one of the largest IT security vendors, we believe our portfolio is the most comprehensive and effective in enabling our customers to protect their businesses. Security is and will remain one of our absolute highest priorities. +Second, collaboration, revenue accelerated by 10% and deferred revenue here grew 16%. This is yet another example of a successful transition to a cloud-based platform, increasing our market leadership, which we expect will give us sustainable long-term differentiation. +Third, our next-generation data center portfolio is extremely well-positioned to meet our customers' needs regardless of where they place their work loads, enabling public, private or hybrid cloud employments. At our Partner Summit we received a very strong response to our innovations as customers adopt our next-generation data center solutions. Our strong position is evident in our install base of 52,000 UCS customers and the continued success of our ACI portfolio. +In March we announced a dramatic improvement in price performance, and by this I mean 100-gig performance for 40-gig pricing, driven by new ASICs, which provide us a time to market advantage of 18 to 24 months, while maintaining the same margin profile. In Q3, our ACI platform grew revenue approximately 100%, while it exceeded a $2 billion annualized run rate, far outpacing our next closest competitor in both size of business and growth rate. Our entry into the hyper-converged market with HyperFlex, as well as our acquisition of CliQr, an innovator in multi cloud orchestration to extend our leadership position in the data center. +Finally, we continue to make great progress in transitioning more of our revenue to recurring, with increased emphasis on software and subscription offers. Our software subscription deferred revenue balance continues to exhibit accelerated growth, this quarter up 36%. +We have a number of strong proof points for how we've executed successfully against our objective and the potential to apply the same model to the rest of our portfolio. In addition to the success I've highlighted in our security and collaboration businesses, we had double-digit revenue growth again this quarter in Meraki, which stands out as an excellent example of how we've begun to scale our enterprise networking into a subscription model. +As I look to the future, you will see us expand the approach we have taken with the success of Meraki, collaboration and security, and apply it to our data center and core networking for both enterprise and service providers. Our $180 billion of install base, with by far the most widely adopted operating systems for networking, makes us uniquely positioned to lead this migration. +While the overall macro environment remains uncertain, we are nicely positioned to benefit from any rebound in the global economy. At the same time we will continue to manage our business to capitalize on the key growth areas in front of us. I'm very pleased with our demonstrated ability to execute operationally and strategically in virtually any environment. +Now I'll turn it over to Kelly to walk through more details on our financials. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. +I am pleased with our continued execution on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments, and delivering shareholder value. +Starting with delivering profitable growth, total revenue was $12 billion, up 3%, with growth in product revenue of 1% and services of 11%. We did have an extra week in Q3. Consistent with our guidance for the quarter, the benefit to revenue was approximately $265 million, $200 million of which was from our services, subscription businesses, and $65 million from our SaaS businesses like WebEx, as well as some from our product distribution. +In switching, as Chuck mentioned, we continue to see good momentum with ACI in the next-generation data center. The 3% decline in switching was mostly driven by macro-related weakness in our campus business, offset by positive growth in data center switching. +Routing experienced 5% decline, mostly driven by the high end. We are seeing continued strength with our web-scale customers where our co-development continues and our sales to the top 10 web-scale customers was up 31%. +Collaboration grew 10% by strength across the entire portfolio, and deferred revenue grew 16%. WebEx continued its double-digit growth, with solid performance in telepresence and unified communications, driven by our new offerings in those areas. +Data center grew 1%, with the slower growth largely driven by continued macro challenges impacting customer spend. We expect that our HyperFlex offering will further expand our growth opportunities in the data center. +Wireless grew 1%, led by strong double-digit growth in our cloud-based Meraki platform, partially offset by declines in our controller and access point businesses. Security grew 17% along with continued strong deferred revenue growth of 31%. We had great performance in our advance threat security and web security solutions, which grew over 100% and 50%, respectively. +SP video grew 18% with ongoing strength in China. Services revenue grew a very solid 11%, which includes the $200 million for the extra week I mentioned. Normalized for the extra week the growth was 4%. +We again saw very good progress against our goal of driving more recurring revenue. Deferred revenue had solid growth of 8% with product deferred revenue up 9% and service up 7%. The portion of our product deferred revenue relating to our recurring software and subscription business grew 36%. From an orders perspective, product orders grew 3% with a book to bill comfortably above 1. +Looking at our geographies, which is the primary way we run our business, Americas grew 4%, EMEA was up 2%, and APJC grew 1%. Total emerging markets grew 4%, with the BRICs plus Mexico showing strength up 4%, and China up 22%, and India up 18%. Brazil and Russia continue to be challenged and now combined representing less than 2% of our total product bookings. +In terms of customer segments, enterprise declined 2% and commercial grew 8%. Public sector grew 6% and service provider was flat. Similar to Q2 we are seeing pressure in the enterprise segment driven by the macro uncertainty. +We drove strong profitability this quarter, especially with gross margins. From a non-GAAP perspective gross margin was 65.2%, with product gross margin of 64.5%, and service gross margin of 67.1%. Operating expenses were 35.2% of revenue, and operating margin was 30%. +The total impact of the extra week on our non-GAAP cost of sales and operating expenses was $150 million. We're being very disciplined in this tough macro and pricing environment, focused on making the right investments, while driving operational efficiencies and productivity. +From a bottom-line perspective, we delivered non-GAAP EPS of $0.57, up 6%, while GAAP EPS was $0.46. Q3 non-GAAP net income was $2.9 billion, up 4%, while GAAP net income was $2.3 billion. +We have been very active from an M&A perspective, closing five acquisitions in Q3: Jasper Technologies, making Cisco the largest cloud-based IoT service platform, helping enterprises and service providers launch, manage and monetize IoT services on a global scale; Acano, which provides on-premise and cloud-based video infrastructure and collaboration software; Synata, which enables us to deliver search capabilities for collaboration cloud applications; Leaba, a fabless semiconductor company; and CliQr, which provides an application-defined cloud orchestration platform, which is expected to help Cisco customers simplify and accelerate their private, public and hybrid cloud deployments. +These acquisitions are clearly focused on our key growth areas, including IoT, software, cloud and collaboration, as well as continuing to strengthen our core. We have also seen solid momentum with our Ericsson partnership, closing 17 deals this quarter. +Moving on to shareholder value, in Q3 we delivered operating cash flow of $3.1 billion. Total cash, cash equivalents and investments at the end of Q3 were $63.5 billion, with $6.3 billion available in the US. We returned $2 billion to shareholders during the quarter that included $649 million of share repurchases, and $1.3 billion for our quarterly dividend, which we increased by 24% in Q3. +Overall Q3 was a very solid quarter in a difficult macro environment. We focused on strong operational execution, resulting in top-line growth, strong gross margins and continued operating leverage consistent with our expectations. We're making the right investments in the growth areas of the business, balancing our decisions with sound portfolio management. +Let me now reiterate the guidance we provided in the press release for the fourth quarter of FY2016. This guidance includes the type of forward-looking information that Marilyn referred to earlier. +The guidance for Q4 is as follows. We expect revenue growth to be in the range of zero to 3% year over year, normalized to exclude SP video CPE video from Q4 2015. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29% to 30%, and the non-GAAP tax provision rate is expected to be 22%. +Non-GAAP earnings per share is expected to range from $0.59 to $0.61. We anticipate our GAAP EPS to be lower than the non-GAAP EPS by $0.08 or $0.11. Further details to this range are included in the slides and press release that accompany this call. +I'll now turn it back over to Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. +Let me quickly summarize before we move to questions. First, I think the number one key takeaway is that we continue to execute well, even in an obviously very tough environment. +Secondly, we have proven our ability to transition certain elements of our portfolio, like we have done with Meraki security and collaboration, and we believe we can accelerate long-term growth by bringing this same approach to our core, and this process has begun. Finally, everything we do will be done through a lens of enabling our customer success while driving value for our shareholders. +Marilyn, I'll turn it over to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [6] +-------------------------------------------------------------------------------- + + Thanks, Chuck. +Kim, let's go ahead and open the line for questions. And while Kim is doing that, I'd like to remind the audience that we ask you to please ask one question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Simona Jankowski, Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thank you very much. I just wanted to clarify your guidance for the July quarter. How much of the revenues embedded in that guidance comes from acquisitions that closed in the last year, just so we can get a sense for the organic trends in the business. And then when we think about the 3% growth in bookings in the quarter, how much of that was benefited by the extra week in the quarter? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + I'll answer the second part, first, Simona. In terms of how much benefit we got from the extra week, we don't think there's much. What we saw this quarter was the forecast was pretty straightforward. The team saw deal closure and conversion rates drag on, especially in the enterprise segment. And, quite, frankly the deals that we closed were more in line. So, we don't think we had any upside from the extra week in bookings sitting there. +In terms of your first question on the acquisitions, we'll start to see -- in the current run rate you have the bulk of, like OpenDNS and everything else. For the new acquisitions that you don't have a full quarter in the run rate, we'll get a bit of a benefit from Jasper and Acano, but it is not terribly material in the overall growth rate. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Ittai Kidron, Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks, and congrats on great execution. First question is with regards to the data center. I hear your comments with regards to the macro impact on it, but it's five quarters in a row now where that business is stuck between the $800 million to $850 million in revenue. And this business has accounted for about one-third of your growth in the past few years. So, if you can us a little bit more color as to why isn't this moving, that would be great. +The second question with regards to the gross margins, I have to go back all the way to 2010 to find product gross margins that are equal to those that you just reported. Can you just give us a little bit more maybe of a framework to think about what is really changing in the portfolio, whether it be through mix or change in the competitive environment, anything that can justify the increase in gross margins and how sustainable you think that is. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [6] +-------------------------------------------------------------------------------- + + Ittai, this is Chuck. Thanks for the questions. I'll answer the first one and I'll give Kelly the gross margin question. +As we look at the data center business we see a few things going on. First of all, we think that there is an impact coming from the overall macro environment that is relatively undeniable. We also saw, as our peers have, some caution in, I would say, the CapEx spend in the SP space, and that was one of the segments that we saw weakness this quarter even with our data center portfolio. When we say data center in this context we're talking about UCS, in particular. +The other thing that's going on is there is a transition going on in the data center relative to work loads. I talked a little bit about it on the last call. We see workload-specific use cases being deployed on high-performance blade systems like our classic UCS. Then we see also this move to hyper-converged systems, which led us to the launch of our HyperFlex platform last quarter. +We also see a transition to rack-based systems which also result in stacks that are driven by container-based architectures. So in the past quarter 30% of our UCS business was actually from our rack portfolio, which we do have for the appropriate use cases. And you'll see us continue to expand our offerings. +So we have UCS as a blade system. We have a rack version of UCS. We have HyperFlex in the market. And you'll see us continue to expand our portfolio to meet the evolving use cases in the data center. I think that's what's going on right now. +Kelly, on the gross margin question? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + On the gross margins, I would say, Ittai, it is a couple things. You're absolutely right when you go back and look historically. If you go back and normalize, the biggest thing that we did was obviously when we got out of the set-top box business. That helped us quite a bit. +And normalized, if you go to just Q1 of this year we were at a 64.9%, and we even in last year we had 65.1%. So, I would say it is the new normal in that 63%, 64% range. I would say the only other thing, when you go back and you update your models for the extra week -- because a lot of the top line that I talked about comes off the balance sheet and there's no incremental costs -- I did get a 0.5 point benefit just from the extra week in my gross margin. So, I would say a normalized view on the gross margin would have been closer to 64.5%. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Vijay Bhagavath, Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [9] +-------------------------------------------------------------------------------- + + Yes, hi, thanks. Hi, Chuck, hi, Kelly. You did clearly better than feared results. Congratulations to you and your team. My question is as follows. This is Chuck. Heading into the back half, what gets you most excited in terms of new product refresh opportunities? +And then, now that your security business honestly is starting to turn the corner, especially versus the peer plays, would you double down on security investments both organically and [a money]? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [10] +-------------------------------------------------------------------------------- + + Vijay, I think the number one thing that I am feeling very positive about right now is, again, we have shown that we can drive the transition in our collaboration portfolio, which when you see that business over the last two years, the team has done a great job of transitioning it to a portfolio that is available to our customers as cloud-based services, and seeing it growing double digits and also growing our deferred revenue balance up 16%. I think that's one example. +In security, 46% of our business now comes from software and subscription services, which is clearly the direction that we had indicated we were going to take it, at the same time growing 17%. Our Meraki business, which really shows the evolution of networking to cloud-based management and policy, is over $1 billion now and growing double digits. And I think the thing I'm most excited about longer term is that we see a path to deploying that model across the rest of our portfolio. And, again, that work has begun. +I think in the near term we see, obviously a mix of a pretty cautious environment still, because we do see customers spending where they need to spend. But don't misunderstand, there is still a fair amount of caution in the market. But I think that we've executed well this quarter. We had five of our seven product categories that were in positive growth, with three of those in double-digits. We had all the geos in positive growth from an order perspective. And we saw pretty good strength across our segments. So that's the first question. +The second one relative to security, the answer is yes, yes, and yes. We will continue investing both organically and any other way that we see appropriate to drive that architecture. The team has done a phenomenal job. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Steve Milunovich, UBS. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [12] +-------------------------------------------------------------------------------- + + Your switching and routing businesses were both down. How concerned are you about that? Do you think your new product portfolio is yet to impact that? Do you believe your losing share or it's the markets? And then, finally, what is the impact on your services businesses, in other words, how much of that is maintenance that could be impacted by declining hardware? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [13] +-------------------------------------------------------------------------------- + + Let me take the first one and then, Kelly, you can maybe make a connection from the services to the hardware. On the switching business I'll point out a couple things. Last quarter we indicated that our campus switching business, the growth there is largely driven by refresh, which in an uncertain time, enterprises that have infrastructure that's functioning for them, they're not going to make the move to upgrade. So, we see a pause in that refresh cycle, which we talked about last quarter, and nothing really changed there. +What we did see is we saw our data center switching revenue growth increase. And the other thing that I'll point out is that we had indicated that we believe that our data center switching growth -- the new product portfolio would surpass the declines of the traditional products that we've had. And our order growth rate, which we haven't put in any of the documentation, our order growth rate this past quarter on that $4 billion portfolio was double digits. +So we're pleased with the progress that we have made in the data center switching space. And, again, that's $4 billion and it grew double digits in orders. So, we feel okay about that. On the routing front it's a combination of things, I think that there's certainly --$1 billion in the quarter, $4 billion in annualized run rate on the data center switching -- Kelly is making sure we're clear. +On the routing business, we've seen a few things. Clearly there is a macro issue that we're dealing with. We also saw, again, as you heard from some of our peers, we saw some increased caution in the service provider space. We saw slow movement in the core of those networks -- flattish activity at the edge. +And we do have a number of new platforms that are in certification with several of the key players that we, at some point in the coming quarters, we would expect those to begin to show up favorably. But that's what we see right now. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [14] +-------------------------------------------------------------------------------- + + And then in terms of, Steve, your question on impact on the services business, typically for new sockets there would be a little lag for that. But I will say that our service business has been laser focused on driving renewals. So, even if enterprises are holding on to their switches and routers longer, our services team and sales team has been very focused on getting the contracts renewed. And we're seeing that pay dividends with the acceleration of growth. +Again, if you normalize our service revenue growth this quarter for the extra week, they still grew 4%, which is up from 3% year-over-year growth in Q2 and it was 1% in Q1. So, we're really starting to get traction there. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [15] +-------------------------------------------------------------------------------- + + Steve, if I can just pile on to what Kelly just said, the team has been building out, trying to strengthen our capability around the entire software and subscription business model, which requires a lot of focus on adoption and renewals. We've also taken the same approach to just sharpen our focus on our services renewal business. And we did see improvement in that in the last quarter. So, I'm happy with the progress the team is making there, as well. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Jim Suva, Citigroup. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup - Analyst [17] +-------------------------------------------------------------------------------- + + Thank you. And congratulations, Chuck and Kelly, to your team there at Cisco. One thing that stood out was the very impressive gross margins this quarter. If I calculated it correctly, it looked like it was around 65.2%. And that was meaningfully above -- I think your guidance was 62.5% to 63.5%. Can you help us to understand what were the factors to drive it higher? I know the guidance all included an extra week. +And then for the outlook, are there any type of swing factors we should be aware of and the causes of why it will be lower than the reported gross margins just from this quarter? And, again, congratulations to you and your team. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [18] +-------------------------------------------------------------------------------- + + Yes, sure. Thanks for the question, Jim. Again, the thing to keep in mind -- true, we did guide with the extra week which came in, in line -- but just, again, a couple things. When we guide we tend to have a little conservatism in the gross margin rate. But take off that 0.5 points, we're still parked at the 64.5% range. +We do have normal seasonality quarter in and quarter out. So, always Q1 and Q3 are our strongest gross margin quarters, and Q2 and Q4 are weaker, and it is typically driven by our mix, especially mix of servers in those two quarters. That is also a driver. +And I think, just operationally speaking, again, the teams are doing a very good job from a productivity perspective in terms of driving costs out of the product. We had a lot of efficiencies out of the supply chain in terms of managing our freight and our inventory management. So, I would say there has just been real -- we had a very strong quarter from operational excellence. +If I look at pricing this quarter we are being very disciplined on pricing. We're starting to see a tiny bit of a tick up, and you'll see that in our Q, where the impact to our gross margin rate year to date is about 2.2 points and Q3 was 2.4. So, still strong but we are still seeing price erosion. But, again, the strength we're seeing this quarter mostly came from just improvements in productivity. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Pierre Ferragu, Sanford Bernstein. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford C. Bernstein & Co. - Analyst [20] +-------------------------------------------------------------------------------- + + Hi, good evening. Thank you for taking my question. I just wanted to come back on what you said about your stuff in hyperscale, web-scale clients. If I get that correctly you had revenues up 31% there. Could you give us a sense of what made most of this revenue and most of these growth? Was that mostly switching, routing, anything else? +And then if we exclude that very strong performance on that segment, what did the rest of enterprise look like in terms of, so you were down 2% over all? I assume that is web-scale at 31%. Probably the rest is enterprise, was down quite significantly. +And, lastly, could you help us quantify any of the macro impact? You mentioned about enterprise in this quarter and in your guide for next quarter, I don't know -- maybe in points of revenues or whatever, do you have a sense of how much you've lost because of the uncertain macro environment? Thanks a lot. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [21] +-------------------------------------------------------------------------------- + + Okay. I'll start. And make sure I don't forget the rest of the pieces, here, Chuck. You've got me covered there. Of our massively scalable data center customers, of that amount more than half of it is certainly switching, and then the next biggest follower is routing. So, it's more than 50%, significantly more than 50% is our switching products. +To your point on then, you inferred -- what does it mean that switching overall was down 3%. I just want to reiterate. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [22] +-------------------------------------------------------------------------------- + + Let me just clarify the question. He believes that we rolled the web-scale into our enterprise business. So, he was saying we were negative 2% on enterprise. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [23] +-------------------------------------------------------------------------------- + + Definitely in our service provider segment. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [24] +-------------------------------------------------------------------------------- + + In our service provider segment, Pierre. Now you can answer that question. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Sorry about that, Pierre. These web-scale customers are definitely in our service provider segment, which was flat overall for the quarter from a bookings perspective. On the rest of the portfolio, to your question on service provider, we're seeing, again, the slowdown from just the overall service provider CapEx spend. And you're seeing that reflected certainly on our routing portfolio. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [26] +-------------------------------------------------------------------------------- + + Just a couple comments. I don't think we have ever exposed that over half of that business is coming from switching. So, clearly there is value in our switching portfolios that the web-scale players are seeing. +I also think that there is still a small percentage of the overall SP business as it relates, which is you'll see flat when the segment was up 31% given the size of the business. But obviously, you could have done that math. But I do think that our teams have done a really good job here. +Kelly, the other question, the third portion of the question, was that relative to any revenue impact in Q4 that we have built into the guidance relative to the macro environment, just generically we are not modeling any improvement, I think is the safest way to say it. We do see continued amount of uncertainty out there and we're not modeling any improvement into Q4. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Brent Bracelin, Pacific Crest Securities. + +-------------------------------------------------------------------------------- +Brent Bracelin, Pacific Crest Securities - Analyst [28] +-------------------------------------------------------------------------------- + + Thank you for taking the question. Chuck, I wanted to follow up on services revenue. I get there was a clear benefit of an extra week but this now marks, I think, the second quarter in a row of upside coming from the services segment. I imagine most of the return of double-digit growth was the extra week. My question is, are you seeing a broader increase in services driven by digitization or solutions selling trends? And if so, do you expect the services recovery to potentially be a leading indicator for a future product recovery? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [29] +-------------------------------------------------------------------------------- + + Thanks for the question, Brent. Let me, first of all, say that I think over the last few quarters Joe Cozzolino and his team have been incredibly focussed on driving the operational excellence around the P&L element of that, which is what you have seen with the gross margins, and I think some of the discussion I had earlier around the focus on the renewal capability. I think we're seeing general improvement in the execution there. +We see advance services obviously doing reasonably well; security services doing reasonably well. And then, as I mentioned earlier, the renewal activity, our teams did a better job this past quarter. So, I think a lot of what you're seeing is operational discipline and execution, to be honest. +However, I think that there is an opportunity, and more of our customers are asking us to help them, as they look at their strategies to take advantage of this digital transition that's occurring. I'm not sure that I'm in a position where I would give you any tangible connection between it and future product growth, but we definitely see that as a required service that we're going to need to provide to our customers because they're looking to us as one of the few large, capable, financially viable partners that really understand this transition. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Mark Moskowitz, Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowtiz, Barclays Capital - Analyst [31] +-------------------------------------------------------------------------------- + + Yes, thanks, good afternoon. I just want to see if we can talk a little more about the cloud. You talked about the ACI momentum. How should we think about the mix of just cloud revenue for Cisco in terms of how much is going into public cloud versus private cloud as the run rate improves? And then is there any change in terms of public cloud versus private cloud related to margin, either from a gross margin perspective or operating margin perspective that we should be aware of? Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [32] +-------------------------------------------------------------------------------- + + Thanks, Mark. I'll let Kelly tackle the second question. If you look at what we declared and we stated our strategy is around cloud, it really is focused on enabling what we believe is going to be the long-term desire of our customers, which is to operate in a hybrid cloud model. +And we said that we're going to do three primary things. We're going to make sure that we provide the infrastructure to the cloud providers. And we've done that with SPs and we've done that, obviously, with the top 10 web-scale providers, given the business was up 31%. +We also said that we were going to transition our portfolio to be cloud-delivered and as a service, delivered where it makes sense, and over time across the entire portfolio. And you've seen us do that with our continued growth in Meraki in collaboration and security. And now the plans are actually under way on a project to deploy that across the rest of our portfolio, although it's early days. I think when you look at deferred revenue of 36% on the balance sheet, that says that we're being successful in that second pillar. +And then the third pillar was to help our customers with the infrastructure needed to actually take advantage of both private and public clouds or enabling hybrid. And when you look at the data center switching portfolio on an annualized $4 billion business, with new orders growing in double digits, I think that customers are driving both. And I think that the three pillars of that strategy are working. +As far as gross margins when we sell to private cloud versus public cloud, Kelly, can you comment there? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Yes. I'd say we obviously have different margin profiles within both. But I'll say both, whether it's campus versus data center, or whether it's to the service providers versus enterprises, both margin profiles are well above the Cisco average gross margin rates. And between campus and the data center side, we're within 5 to 6 points of gross margin. So, the differentiation is not much there. +We can have variations within that. We have some public cloud customers on some deals that might have better or worse margins. But overall, the portfolio is within those ranges, and again, way accretive to the overall Cisco margins. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + James Faucette, Morgan Stanley. + +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley - Analyst [35] +-------------------------------------------------------------------------------- + + Great, thank you very much. I just had a clarification. You talked about ACI hitting about $2 billion annualized run rate. And I think our notes have suggested it was at a similar level the last couple of quarters, at least you gave a similar level. I just want to make sure our notes are right there. +And then, really, my question is around acquisitions. You guys clearly have been quite active doing acquisitions and doing a lot of what looked to be pretty promising technology related acquisitions. Should we expect the current pace to persist or are we going through an accelerated period that you think that we're pretty close to slowing down from? Thanks. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + I'll take the first one. On the first one, yes, we were being rounding. It's actually closer to a $2.2 billion run rate, so sequentially I'm certainly up sequentially than what I was last quarter. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [37] +-------------------------------------------------------------------------------- + + Yes, I think when we hit it last quarter it was probably roughly $2 billion. This time it is closer to $2.2 billion, $2.25 billion on the ACI portfolio. +And then on the acquisition front, what I would say is that, given the valuations and given the movement in the tech industry, that we'll continue to be opportunistic. We're in a good position as a strategic buyer with some of the challenges in the public market and some of the valuations becoming a little more realistic. +What I suggest to you, that over the next 12 months we'll be quite as active as we have been in the last 12. I probably wouldn't expect it to be quite as fast-paced as it has been but we will continue to be opportunistic around the areas of growth that are important to our future. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Paul Silverstein, Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks very much. Chuck, going back to the question about the top 10 web 2.0, I don't think you have ever broken it out, at least in my memory. But if routing is 15% of your total revenue, and service provider typically, if I remember the numbers correctly, are 80% of routing. That would suggest that the web 2.0 guys are somewhere in the range of 15% of total revenue, if I'm looking at the current numbers correctly. Is that in the ballpark? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [40] +-------------------------------------------------------------------------------- + + 15% of our overall total revenue? Or 15% of our service provider revenue? + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [41] +-------------------------------------------------------------------------------- + + I'm basing it off of -- if routing is 15% of total and service provider is 80% of routing again, that would suggest that traditional service providers, being the bulk of your routing revenue, are somewhere in the order of 12% of total revenue. I recognize it by more than just routing. If I saw the service category correctly in terms of 30% of total bookings -- maybe I misread the number -- that would suggest the web 2.0 guys -- let me just ask the question directly. Can you give us any sense for how large the web 2.0 category is? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [42] +-------------------------------------------------------------------------------- + + Paul, we haven't been disclosing that. We just don't disclose that. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [43] +-------------------------------------------------------------------------------- + + In that 15% range? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [44] +-------------------------------------------------------------------------------- + + Again, Paul, it is not something we give out. I apologize. But it is not. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [45] +-------------------------------------------------------------------------------- + + Let me ask you a simple question, and I think you mentioned it before. But can you give us any insight of the linearity of the quarter? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [46] +-------------------------------------------------------------------------------- + + Yes, I would say, it was -- it wasn't that crazy. Obviously our extra week, when it actually fell in from a calendar perspective, was in February. But, again, because the way the teams were forecasting, I would say the linearity in terms of what we see usually coming through month three was in the normal ranges. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Tal Liano, Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch - Analyst [48] +-------------------------------------------------------------------------------- + + Hopefully you can hear me. I have just one clarification. The tone of the previous conference call was very different. It was about the very weak environment and we didn't speak about the growth trends. The tone of this conference call is so much more positive in a very similar business environment. +So, what happened in the last three months that makes you so much more positive about -- everything you have done basically also before, very little is new now -- what makes you so much more positive now versus three months ago in a similar environment? Or unless maybe the environment has gotten better. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [49] +-------------------------------------------------------------------------------- + + It's a good question, Tal. I'm just having a better week this week. No, I'm kidding. I think the difference is, if you go back to when we ended our last quarter it was towards the end of January. And if you recall, the last few weeks of that quarter were the weeks when the stock markets were having those incredibly wild swings, and our customers actually put the brakes on pretty significantly. +So, coming into that earnings call, we had seen a very tough close to the quarter from an orders perspective. We saw our enterprise customers, in particular, really put the brakes on because they were just completely unsure of what was going to transpire. And I think that led us to a very cautious tone. So, that would be the number one reason why we were more cautious then. +I just want to make sure that we are balanced here, that while we're optimistic and we're pleased with our execution, we still are operating in a relatively uncertain environment. We got the Brexit coming up, the vote coming up in June. We've got the news out of the Fed today. We've got all the election dynamics. We got issues in Brazil, we've got geopolitical dynamics. +So there is a relatively broad set of unknown issues out there. So, we're still operating in an uncertain environment. But I think the stock market issue and the timing of the end of our last quarter would probably be the biggest difference. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Simon Leopold, Raymond James. + +-------------------------------------------------------------------------------- +Simon Leopold, Raymond James & Associates, Inc. - Analyst [51] +-------------------------------------------------------------------------------- + + Great. Thank you. I wanted to go back to the web-scale vertical a bit. I know that is beating a dead horse a little on this call. But I wanted to see if you could talk about the bigger trend around the white box competitive threat, because it seems apparent that there is not the dramatic shift to white box that many had feared. But maybe it has yet to happen. So if you could talk how you're countering the threat or the substitution effect of those web-scale customers building or buying unbranded switches, rather than your products. Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [52] +-------------------------------------------------------------------------------- + + Yes, Simon, it's a good question. I think that there's a misconception about what's driving this belief that all the customers want to buy white box switching. And I think this is in the same vein of -- it is all about cloud, or all about SDN, or all about white box. None of these customers are fundamentally chasing a technology trend. There are underlying business drivers that are leading them to these solutions. +So, what we've been doing is focusing on attacking the business driver and not so much the technology trend that everybody writes about. In the case of the web-scale players, what they're looking at is, they're looking for significant automation. They're looking for the ability to run massive data centers at huge scale, very low cost, with a ton of automation, which over time will become the norm, I think, for all customers. There is this massive focus on operational expense reduction, which is all around automation, programmability, which is where we are headed with our core platforms in the enterprise, as well. +So, what we did is we built some really aggressive products. Our teams, again the ASICs improvements that have been built that give us the advantage on the price performance, and then enabling our portfolio to fit within the operational environments of these customers, I think, has been the key. +That's where what they're looking for. They're not singularly focused on white box. They're looking at how do they solve that problem. And we're just spending more time with them to really understand what they need and how we can fit their requirements. And you're going to see us continue to evolve our portfolio in whatever way we need to, to make sure that we remain relevant there. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Brian White, Drexel Hamilton. + +-------------------------------------------------------------------------------- +Brian White, Drexel Hamilton - Analyst [54] +-------------------------------------------------------------------------------- + + I'm wondering if you could walk us through what you've seen so far with the Inspur relationship in China. I see China revenue decelerated but it still grew very strongly at 22%. And also the Ericsson relationship -- it sounds like you've got some big deals in the quarter, or a few deals in the quarter. Maybe just highlight if you feel like that relationship is still on track for this $1 billion by 2018. The reason I ask, obviously Ericsson had a very soft March quarter. Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [55] +-------------------------------------------------------------------------------- + + Brian, it is a great question. I actually didn't expect anyone to highlight the fact that our China was decelerating, as our third quarter of really solid growth in China. I will point out that, that is across the board, it is across the portfolio. The team has done an amazing job there. I've spent a fair amount of time over there and I think that we're really pleased with where we are in China right now, in the midst of the uncertainty that's being discussed in the marketplace. +On the Inspur partnership, in September we signed the MOU, which was basically a letter of intent to formulate the venture. I was over there three weeks ago where we formalized the term sheet basically, and we're in the final stages of getting that one put together. I would expect that we'll be in market sometime in the fall with some of the early products and solutions with them. We're spending a lot of time with them right now. So I think late this year is when we'll begin to see some early results from that. +I think on the Ericsson front, any time you do these really large partnerships, they always take a little longer probably than we would all hope, but we're very optimistic. We've spent a ton of time together. I think on the last call we talked about the number of joint solutions within the first 100 days that we actually had on display together at Mobile World Congress, which was pretty amazing. And then this past quarter we saw 17 transactions close between our teams, in the midst of a time where Hans is doing a pretty significant organizational restructuring and our teams are getting to know each other. We'd all want it to go faster but we're pretty pleased where that partnership is right now. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [56] +-------------------------------------------------------------------------------- + + All right, Chuck, I think that was our last question. Why don't I go ahead and turn it over to you to close it out. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [57] +-------------------------------------------------------------------------------- + + Thanks, Marilyn. First of all, I want to thank everybody for spending time with us today and I want to thank you for your questions. I would just go back to the three things that I stated earlier. I'm really proud of what we've done. I'm proud of the way the teams have executed. It is a challenging environment out there and I think that our teams have proven that we continue to execute regardless of the environment we face. +As I said last call, we're running the Company on two fronts. We're focused on the execution and operational excellence, and at the same time we're focused on transitioning our business and investing in the future, which I think was displayed by our progress in the different areas that I highlighted during the call today. +I think that, again, if you look at our success in security and collaboration, next-gen data center, the Meraki cloud networking platform, and overall in our transition to software and subscription; I think we're on that journey. We have proven that we can transition elements of our portfolio and we're going to apply that same approach again to the rest of our business. +We're in the early days on the front end of a long journey, but I'm pleased with where we are. I want to thank all of you for spending time with us today and we'll look forward to talking to you soon. Marilyn? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [58] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Cisco's next quarterly call, which will reflect our FY16 fourth-quarter and annual results, will be on Wednesday, August 17, 2016, at 1.30 PM Pacific time, 4.30 PM eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions please feel free to contact the Cisco Investor Relations department. We thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-866-457-5715. For participants dialing from outside the US, please dial 1-203-369-1293. This concludes today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2016-Nov-16-CSCO.txt b/Transcripts/CSCO/2016-Nov-16-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..0af7429c6e1105cc2a88f418f6a767b0e9b4332c --- /dev/null +++ b/Transcripts/CSCO/2016-Nov-16-CSCO.txt @@ -0,0 +1,471 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Cisco Systems Inc Earnings Call +NOVEMBER 16, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kelly Kramer + Cisco Systems, Inc. - CFO + * Chuck Robbins + Cisco Systems, Inc. - CEO + * Marilyn Mora + Cisco Systems, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Tal Liani + BofA Merrill Lynch - Analyst + * James Faucette + Morgan Stanley - Analyst + * Pierre Ferragu + Bernstein & Company - Analyst + * James Suva + Citigroup Global Markets, Inc. - Analyst + * Jeff Kvaal + Nomura Securities - Analyst + * Ittai Kidron + Oppenheimer & Co. - Analyst + * Vijay Bhagavath + Deutsche Bank - Analyst + * Mark Moskowitz + Barclays Capital - Analyst + * Jess Lubert + Wells Fargo Securities, LLC - Analyst + * Simona Jankowski + Goldman Sachs - Analyst + * Paul Silverstein + Cowen and Company - Analyst + * Steve Milunovich + UBS - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco Systems' first quarter and FY17 financial results conference call. +At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. +Now, I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- +Thanks, Sam. Welcome, everyone, to Cisco's first-quarter FY17 quarterly conference call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO, and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding Webcast with slides, including supplemental information, will be available on our website in the Investor Relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found on a financial information section of our Investor Relations website. As is customary in Q1, we have made certain reclassifications to our prior-period amounts to conform to the current period's presentation. The reclassified amounts have been posted on our website. Click on the Financial Reporting section of the website to access these documents. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we will discuss product results in terms of revenue, and geographic and customer results in terms of product orders, unless stated otherwise. All comparison throughout this call will be made on a year-over-year basis unless stated other wise. +The matters we will be discussing include forward-looking statements, including the guidance we will be providing for the second quarter of FY17. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent annual report on form 10-K, which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +As a reminder in Q2 FY16, on November 20, 2015, we completed the sale of the Customer Premises Equipment portion of our SP Video Connected Devises business and accordingly had no revenue or expense from that business in Q1 FY17. As such, all of the revenue, non-GAAP and product orders information we will be discussing is normalized to exclude the SP Video CPE business from our historical results. +We have provided historical financial information for the SP Video CPE business in the slides that accompany this call and on our website to help to understand these impacts. As a reminder, the guidance we provided during our Q4 earnings call and today's call has been normalized in the same way. +With that, I'll go ahead and turn it over to you, Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Thank you, Marilyn. +We delivered a strong Q1 in an environment that continues to be challenging. We executed very well in the quarter, with revenue growing 1% and non-GAAP earnings per share growing 3%, along with continued strength in non-GAAP gross and operating margins. This quarter total product orders declined 2%, largely due to Service Provider orders declining 12%, which was worse than our expectations heading into the quarter. +We continued to show great product in how we are aligning our business model to the way our customers want to consume Cisco technology. There are many strong indicators that we are driving this change, including the 48% growth in our product deferred revenue related to our recurring software and subscriptions. At the same time, we are delivering more innovation with simple, intelligent automated solutions with industry-leading security across our portfolio. +Let me review a few areas of our business where our innovation is driving momentum. First, security. Our security revenue grew 11%, marking the fourth consecutive quarter of double-digit growth. We're driving more subscription-based recurring business, resulting in deferred revenue growth of 39%. +Our competitive position in security is growing stronger, as our integrated architecture approach and best-of-breed portfolio resonates with our customers. In fact, we're the only company with security product revenue exceeding a $2 billion annualized run rate with double-digit growth. I'm incredibly pleased with how the team has transformed this business from where we were just a few years ago, establishing Cisco as the market leader in the most critical priority area for our customers. +This past quarter, we again drove rapid adoption of our advanced threat solutions, with AMP revenue growing over 70% and now deployed at over 22,000 customers globally. We also see ongoing traction with our next-generation firewall revenue growing over 35%, as we added 5,300 customers in Q1 bringing our total next-gen firewall customer base to approximately 62,000. +Going forward, we are driving innovation, as we extend our security architecture from the network to the endpoint to the cloud. Over two weeks ago at our partner summit, we launched our enhanced AMP for Endpoints, a SaaS-based cloud managed security solution combining prevention, detection and response capabilities delivering simplified and effective endpoint security through our threat-centric architecture. +Second, our next-generation data center, our goal is to build the best private and hybrid cloud solutions for our customers. We are investing heavily in our data center portfolio to extend our market leadership. To do this, we are delivering software, hardware and systems at all levels of the data center stack and across delivery models. Our customers' widespread adoption of Cisco's ACI family of data center networking products continued in Q1, with revenue growth of 33% to an annualized revenue run rate now of $3 billion. +The automation of data center networks that ACI delivers is the first step in enabling our customers to move work loads in and out of public cloud environments, while maintaining enterprise security and policy. We are building on the foundation of ACI by extending our capabilities with analytics through tetration, agnostic cloud management with cloud center from our CliQr acquisition and our hyper converge offering, HyperFlex. +This will give our customers flexibility, agility and savings by delivering the benefits of both private and public clouds. We have a unique set of capabilities to lead in this market and address our customers needs for delivering business applications quickly, cost effectively and at scale. +In collaboration, we are adding new capabilities to our collaboration and IOT offerings through organic investments, acquisitions and partnerships. As a global market leader, Cisco's collaboration business has a solid foundation to drive our road map of products and services that will increasingly be delivered from the cloud such as Spark, our end-to-end business collaboration suite. Over the last few months, we've added two significant partners to our collaboration ecosystem. We announced a global strategic alliance with Salesforce to natively integrate Cisco's cloud collaboration platform with Salesforce's Lightning platform. This will deliver expanded reach and relevance as part of our cloud strategy. +We also formed an alliance with IBM to further enhance the collaboration experience for our customers by combining our collaboration and analytics technologies. We are integrating our Cisco Spark and WebEx offerings with IBM's cloud collaboration solutions, along with cognitive computing capabilities enabled by the IBM Watson platform. While the dynamics in service provider and emerging markets continue to present headwinds to overall growth, I'm pleased with our success in accelerating our momentum in our key investment areas and our commitment to operational discipline. +Now let me hand it over to Kelly to walk through our Q1 results and outlook in more detail. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. +We executed well on our financial strategy of driving profitable growth, managing our portfolio and strategic investments and delivering shareholder value. On driving profitable growth, total revenue grew 1%, while our non-GAAP EPS was up 3%. We expanded our profitability year over year, with increases in both non-GAAP gross margin and non-GAAP operating margins. +Let me provide some details on revenue. Total product revenue was down 1%. We saw switching decline 7%, driven by weakness in campus, partially offset by continued strong momentum in ACI, which was up 33%, as Chuck mentioned. In campus, we still see a pause in enterprise spend, largely driven by uncertainty in the macro environment. +Routing grew 6%, driven by growth in both SPCORE and Edge. Collaboration was down 3%, although we did have solid order growth. The revenue decrease was driven by telepresence and unified communications endpoints, partially offset by strong growth of 10% in conferencing as we see more customers each quarter committing to WebEx. We saw good momentum again in the transition to subscriptions and SaaS offers with deferred revenue up 14%. +Data center declined 3%, impacted by the market shift we've seen from Blade to Rack. While not significant in terms of revenue at this point, we did see our new hyper converged offering, HyperFlex, as solid early uptake by our customers. Wireless declined 2%, lead by a decline in controllers and soft e-rate funding, partially offset by strong growth in Meraki with our cloud managed product line. +Security grew 11%, with deferred revenue growth of 39% as we transition to more software and recurring revenue. We had strong performance in our advanced threat security, up 100% as well as web security solutions, which was up 60%. Services grew 7% with our ongoing focus on renewals and attach rates. Overall, we're making progress each quarter on our goal of driving more recurring revenue. Total deferred revenue grew 12%, with product up 19% and services up 8%. The portion of our product deferred revenue related to our recurring software and subscription businesses grew 48% to $3.8 billion. +From an orders perspective, total product orders declined 2%, with book-to-bill below one. Looking at our geographies, which is the primary way we run our business, Americas was down 4%, EMEA grew 1%, and APJC grew 4%. Total emerging markets declined 2%, with the BRICs plus Mexico up 2%. In terms of customer segments, enterprise grew 5%, commercial grew 1%, public sector was flat, and service provider declined 12%. +We are driving consistent profitability. From a non-GAAP perspective, total gross margin was 65.2%, growing 0.3 points, with product gross margin of 64.8%, up 0.3 points and service gross margin flat at 66.2%. We increased our non-GAAP operating margin to 31.6%, improving 0.2 points. We remain disciplined and focused on increasing operational efficiencies and productivity. In terms of our bottom line, we delivered non-GAAP EPS of $0.61, up 3%. GAAP EPS was $0.46. +Moving to our portfolio and strategic investments, we completed three acquisitions in Q1, increasing our investments in key priority and growth areas including CloudLock, which specializes in cloud access security broker technology, which is part of our security business, ContainerX that develops enterprise-class container management technology and Worklife, which develops meeting software that is complimentary to our collaboration business. +Moving on to shareholder value, in Q1 we delivered operating cash flow of $2.7 billion. Total cash, cash equivalents and investments at the end of Q1 were $71 billion, with $10.4 billion available in the US. We returned $2.3 billion to shareholders during the quarter. That included $1 billion of share repurchases and $1.3 billion for our quarterly dividend. To summarize, we executed well in Q1 delivering, strong profitable growth. We also made solid progress on our transition to more software and subscription based models. We're committed to making the key strategic moves and disciplined investments to drive long-term financial performance and deliver shareholder value. +Now let me reiterate the guidance we provided in the press release for the second quarter of FY17. This guidance includes the type of forward-looking information that Marilyn referred to earlier. The guidance for the second quarter of FY17 is as follows. We expect revenue to decline in the range of minus-2% to minus-4% year over year, normalize to exclude the SP Video CPE business from Q2 FY16. +We anticipate non-GAAP gross margin rate to be in the range of 63% to 64% and the non-GAAP operating margin rate is expected to be in the range of 29% to 30%. The non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to be in the range of $0.55 to $0.57. +I'll now turn it back over to Chuck to summarize the call. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [5] +-------------------------------------------------------------------------------- +Thanks, Kelly. I'm very pleased with the success of the investments we've made in priority growth areas such as security, collaboration and our ACI platform. These areas are key building blocks, along with our strong franchise and switching and routing, that place Cisco in a unique position with our customers as they become increasingly digital. +As you've seen with our Meraki platform, we've achieved rapid adoption of cloud managed networking, with enterprise security and policy delivered as a service. Over the next several years, we will bring this automation, management and security at scale to the balance of our switching and routing portfolio as we continue to offer new consumption models aligned to our customers' needs. While this is no small task, it's an incredible opportunity for Cisco as we bring this successful model to the largest part of our business. +As we make these investments we also remain firmly committed to operational discipline and driving long-term value for our customers and shareholders and I'm very optimistic about our future. +Marilyn, now I'll turn it back to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [6] +-------------------------------------------------------------------------------- +Thanks, Chuck. Sam, let's go ahead and open the line for questions. While Sam is doing that, I would like to remind the audience we ask you to please ask one question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you. Our first question is from Ittai Kidron with Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. - Analyst [2] +-------------------------------------------------------------------------------- +Chuck, I want to talk a little bit about the product mix between the divisions. The switching results are very disappointing. Clearly the wireless is now declining. Data center, and I have been asking you about data center for three quarters in a row and it's still not delivering and you've had changes in the leadership over there as well, which suggests still not where it needs to be. I guess I'm trying to gauge how much of the challenges that you are seeing here right now, in your opinion, are macro driven versus perhaps portfolio driven, because it seemed like a lot of competitors in some of these areas are actually doing very well in switching, for example, and (inaudible) and wireless, HP, even in the data centers doing well, (inaudible) clearly doing well. +These are key major areas for you and we're seeing revenue decline. Help us understand kind of a little bit of what's going on under the surface here and what is it that makes you feel comfortable that there's no big problem. On the flip side, is there anything on the portfolio side that you think could turn the tide here? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Hey, Ittai, thanks for the question. Let me hit a few of those areas. Let me first just acknowledge that there are always areas we can execute more effectively. We are working right now, the teams have been working over the last year on innovation in many of the areas you mentioned and again, I'm optimistic about the pipeline of innovation we have right now. +I think when you look at the switching portfolio for us, back in January, when we saw the real market declines at that time and we called out the first pause we saw in the enterprise campus refresh, it's just basically maintained. It stayed the same way throughout the year. I'm pretty comfortable with our position there and as we continue to work on bringing automation and security and cloud-based management to the rest of the portfolio, I think that, that will help our customers see the opportunity to refresh. +For me, it's really about as we look at the key driver of refresh over the longer term in the campus, I think that it's going to be really around automation, which can substantially reduce the operating expenses for our customers, as well as security into the network and analytics out of the network. In a couple other areas you mentioned, I think in UCS there's been a fundamental shift in the data center to, again, we've talked about the rack technology and in hyper converge we have some early success with HyperFlex and we have some new capabilities that will be coming out after the first of the calendar year that I think will help us in that space. +On the wireless front, there are really, I think there are two key drivers there. First of all is the market is transitioning to a controller-less architecture, so in large part, our access points were actually positive but the controller side of that business was down, Meraki was positive, and then also we are a pretty substantial recipient to the e-rate business, so as that has moved out much more slowly than expected, I think that, that has also impacted that business. Hopefully that gives you some color around those areas. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Our next question is from Vijay Bhagavath with Deutsche Bank. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [6] +-------------------------------------------------------------------------------- +Are you there? + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [7] +-------------------------------------------------------------------------------- +Oh, yes, I'm here. I'm sorry, I was talking to myself on mute. Yes, so once again, a replay. Hi, Chuck, Kelly. In some sense, the January quarter guide is a snapshot in time and it lags what CEOs, CIOs could be thinking latest in terms of their spending intentions for the New Year. My question for both of you is in your latest cause for business leaders, post elections in particular, has CEO/CIO sentiment here in the US in particular improved in your view? Where do you think would be focus areas of spending in the context of your portfolio? Kelly, internally in the Company, where would you invest the most in terms of the product roadmap? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [8] +-------------------------------------------------------------------------------- +Thanks, Vijay. I think if you just look at our guidance, let me be clear. It's predominantly the SP weakness and the overall CapEx challenges that we've seen in SP. That business is large account driven. You can assume that we have done an account by account by account analysis in that space and understand what's going on there. Right now I think there are a unique set of characteristics, particularly in the SP space. You have the overarching macro uncertainty in the economy, which I think has lead to the SP CapEx weakness that's been reported all year by the analysts, as well as you have political and regulatory environments that are somewhat uncertain, both in the US and around the world. +Some of those could turn more favorable. Some of those could remain negative. We're just not going to model any improvement there and that's the real reason for the guide, just to be clear on that. Post election, I think that most CEOs that I talk to, we are pragmatic about the result and now we are all focused on the policy issues that matter to each of our companies. We're -- I think that President-elect Trump appears to be very business oriented and is very focused on driving the US economy and any time the US economy improves, that's certainly good for us. Kelly, any comments? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [9] +-------------------------------------------------------------------------------- +No, I agree. To address where we're investing the most, because no matter what the economy we're going to be investing for the future. I'd say it's in the same areas we have been. We are continuing to invest heavily in security. We think there's a lot of room to run there. I think we're benefiting and you're seeing us benefit from having not only a best-of-breed portfolio but an integrated solution that ultimately we do think once CIOs start spending again we'll see also drive some of the campus, hopefully. +For sure security, data centers a focus for us and Chuck mentioned some of the innovation we have with the data center but also with the analytics around that. Then even in the core we're investing. Chuck talked about how we're driving automation and things along those lines. We're putting heavily our investment there as we drive innovation that you'll see today as well as going forward the next few quarters. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [10] +-------------------------------------------------------------------------------- +Great, thanks, Kelly. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Next question is from Pierre Ferragu from Bernstein. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Bernstein & Company - Analyst [12] +-------------------------------------------------------------------------------- +Hi, Chuck, Kelly and Marilyn. Thanks for taking the question. I just wanted to dig a bit into your deferred product revenues this quarter that have increased I think by a bit more than $1 billion year on year and actually $700 million or so, almost $700 million sequentially. It's a very impressive performance. The question I have is how do I take that into account when I look at your overall product performance that you had (inaudible) revenues slightly down in the quarter, but I would assume that a lot of that is related to the transition towards your subscription business. Do you have an estimate as how much this transition has impacted your number this quarter? Then of course I have the same question for next quarter. Your guide is very conservative. How much of this transition is actually impacting your guide for Q2 as well? Thank you. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [13] +-------------------------------------------------------------------------------- +Thanks, Pierre. I appreciate the question. Yes, we are very happy with the progress we are making on it and you can see it on the balance sheet, to your point. We are up sequentially as well as over $1 billion, $1.2 billion year over year. I'd say it's a couple points for sure impact on our growth and it's a combination of -- its largely been historically collaboration and security and Meraki, but we are continuing to add on our core platform with our Cisco ONE suite, like I mentioned last quarter, which that is now being recognized ratable where a year ago, we would have recognized that as a perpetual license sale. For example, just using Cisco ONE as an example in this quarter, it would have been a point and a half just on that if we had recognized it perpetually like we had a year ago. +It's for sure about at least two points and clearly that continues to grow and accelerate, so you can assume we're assuming that in my guidance. My guidance for the next quarter is as Chuck mentioned, right? We definitely saw the same thing we saw last quarter with the slowdown in SP, but it actually accelerated. I wouldn't call my guidance conservative. I'd say it's absolutely what we see right now based on all of the factors we take into account. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Thank you. Next question is from Simona Jankowski with Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Jankowski, Goldman Sachs - Analyst [15] +-------------------------------------------------------------------------------- +Hi, thank you very much. I just wanted to confirm, Chuck, that the reason for the guidance being a little weaker is entirely to do with the softness you described in Service Provider orders. Just to dig into that and understand that a little better, it looked like your routing business was I think you said up 7% in the prepared remarks, although I see it as up 17% in the numbers posted online. Regardless, it looks like routing was quite strong. What other products within that Service Provider vertical accounted for the weakness. When we look at the CapEx trends, they definitely have been weak year to date, but they are implied to improve quite a bit into year end, so just curious if you aren't seeing that. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [16] +-------------------------------------------------------------------------------- +Thanks, Simona. I'll let Kelly keep me honest on this, but I think our routing revenue that we reported in Q1 was 6% positive, so if that's incorrect we need to fix that. On the guide, what I believe is that the predominant reason for the guide down is this Service Provider space. It's 25% of our business, roughly, and it was down 12% in new orders. You guys know the content of our revenue that is from current quarter bookings so the forecast this past quarter and the performance was negative 12% and we're just not modeling, right now, any improvement. You've written some great stuff around the SP CapEx environment, so I think you know it as well as anyone. +While there is some forward-looking optimism, many of those cases there's money being spent on density and mobile networks in areas that we may not be a direct recipient as well as we also know there's a lot of variability in how the actuals actually play out vis-a-vis the forecast. We're just making sure that we really see that. I think there's also consternation around the world relative to what's going to happen in the political environment and just a little bit of a wait and see and I think that's going to have an impact. Could be positive, could be tough based on the SP CapEx, but most of the guide challenge that we have is related to SP. +Kelly, anything to add? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [17] +-------------------------------------------------------------------------------- +I think you summarized it well. Just to add to your question, Simona, I'm not going to go into the grungy detail of what else is in there besides SP core and routing, but obviously our enterprise routing business is in there, mobile packet core, those kind of areas that we saw that are included in the revenue. To Chuck's point, the routing business is certainly got a lot of big deals driven and the pressure we see from the orders, you can expect to see coming in the future, as Chuck mentioned. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [18] +-------------------------------------------------------------------------------- +One other comment or two. When I talk about customers that we saw just fundamentally freeze CapEx, some of those did it for their own earnings requirements. Some of it did it -- we have examples that occurred based on currency challenges, FX issues. We saw some that were connected to consolidation that's going on in the industry, so we saw different flavors but we did see a fair number of customers around the world that just put the brakes on. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [19] +-------------------------------------------------------------------------------- +Thanks, Chuck. Next question please? + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Thank you. Next question is from James Faucette with Morgan Stanley. + +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley - Analyst [21] +-------------------------------------------------------------------------------- +Thank you very much. I wanted to ask just around the security business. Obviously, as been pointed out, is that it's developing pretty well, but I'm wondering two things. First, the pace of acquisitions, and specifically what looked to be tuck-in acquisitions, seemed to have slowed a little bit this quarter versus what it had been running. I'm just wondering if you're feeling like you've got the portfolio and the technology where you need it or should we expect to see acquisitions continue to run pretty high and that perhaps those reaccelerate. My second question is on security. I think, Kelly, you kind of alluded to this, but at what point do we start to see incremental benefit on some of the other businesses from security footprint? It seems like a lot of the value of security could be tied to new hardware and switching and networking, et cetera. Should we expect to see some incremental pull through or benefit to the more traditional hardware businesses and if so, when should we expect that? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [22] +-------------------------------------------------------------------------------- +James, thanks. This is Chuck. As it relates to the first part of your question on the acquisition capabilities, I think what you'll find with this team is that there's a ton of internal innovation occurring. We, again, at the partner summit launched AMP for Endpoints, which is to bring the endpoints into the consolidated architecture. You can assume that we are actively continuing to scan the landscape relative to acquisitions that fit within the architecture, that bring new capabilities. +I think when I took the role I would probably suggest that there was a little bit of a pent-up demand around companies that teams wanted to move on and we moved relatively quickly in the first year or so. I wouldn't assume that, that suggests that there's no more activity that we will see there. I think we will. +As it relates to the core networking platforms and at what point we'll see security pulling through, I think we have had some examples over the last few years where we've seen particularly security portfolios integrated into routing platforms as the teams have done that we have seen as we sell those as licenses that run on top of routers. Assuming the routers have the right horsepower, they're fine. If they don't, then they'll drive a refresh. There's some capabilities the teams are work on that actually provide security at the packet level inside the network. Our intent over the next several quarters is to bring that technology to market and give our customers greater visibility and give them yet another source of contributing to the threat landscape out of the network itself. We'll have to wait and see how successful we are, but that's our plan. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Next question is from James Suva with Citigroup Global Markets. + +-------------------------------------------------------------------------------- +James Suva, Citigroup Global Markets, Inc. - Analyst [24] +-------------------------------------------------------------------------------- +Great, thanks very much. Chuck and Kelly, when you mentioned putting the brakes on for some of the demand, can you clarify a little bit? Was that mostly due to the uncertainty around the election or just more uncertainty global demand and now that the election is over, there's a political uncertainty about how the tax and policy changes, what happens, cause those brakes to last in your opinion? How long or when do the brakes come off? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [25] +-------------------------------------------------------------------------------- +Well, Jim, thanks. I think there's not one answer to that question, honestly. As I said earlier, there's some customers that are looking at consolidation that lead them to take a pause. There's some that are focused on density of their mobile networks as opposed to their core routing platforms or the edge routing platforms. There's some that outside the United States who faced incredible currency headwinds and decided to stop their CapEx spend until they had better clarity around the currency situation. Then there's some providers around the world, not necessarily in the US even, that are dealing with political dynamics and potential regulatory issues that just aren't clear. +I think it's a little bit of all of that and my assessment of when those issues are resolved is dependent upon the issues themselves and we're going to have to wait and see how they play out. I have not heard a lot, say, US-based service providers who have paused directly related to the election, but I do believe that the regulatory environment in the US is obviously in flux now around the telecom environment and that could have implications for the service providers and some of them may wait and see how that plays out. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Thank you next question is from Jess Lubert with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Jess Lubert, Wells Fargo Securities, LLC - Analyst [27] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for taking my question. I was hoping you could update us on what the saw in the cloud vertical last quarter. You saw weakness there so I was curious if that bounced back, what products you're seeing success with, with this customer set and where you are in your process to drive share with these operators. Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [28] +-------------------------------------------------------------------------------- +What we talked about the last couple quarters is just the top 10 that we have and they were roughly flat this quarter, but I'll tell you we had some performances that were incredibly strong within that, at an account level, and some that were pausing for various reasons. I think that each account is different and I think over the last couple of years what we've been talking about is a deep engagement at the individual customer level. Where we've done that, we had begun to see success. You can assume we are having discussions with each of them individually. We also are, I think, uniquely positioned where in many cases these companies are markets of one and we have the ability to assign dedicated engineering teams to line up our offerings against their specific requirements and those are the discussions we're having right now. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [29] +-------------------------------------------------------------------------------- +Thanks, Jess, for the question. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Thank you. Our next question is from Paul Silverstein with Cowen & Company. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [31] +-------------------------------------------------------------------------------- +Thanks. Kelly, a clarification and then a question. The question is what's the pricing environment look like? Has there been any change? I was hoping, I don't know if you gave the number earlier, but if not, what was software as a percentage of total revenue? Can you remind us, I think it was 29% last quarter but if you could remind us what it was and what it was this quarter? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [32] +-------------------------------------------------------------------------------- +Sure. I'll answer that one. The recurring revenue number I think is what you're talking about, which is a combination of our product recurring revenue from the software and SaaS business plus recurring revenue from services. This quarter that was 29% and we continue to make progress of product, that has grown to be 9%, up from 6% of our product revenue in Q1 2016, so we continue to make progress there. That's up to 29% versus it was 28% in Q4 and 25.5% in Q1, so making the progress there. +On the pricing question, Paul, we're definitely in the same ranges that we normally have been. It's actually year over year slightly better than we were last quarter can, which is largely driven by the mix of what we saw. I'd say that it's in normal ranges, but how we're driving that internally is, of course, we're very disciplined around pricing like we've talked about but we empower our sales leaders and country leaders to -- we measure them on three things. We measure them on revenue growth, we measure them on operating margin growth and we measure them on driving market share. They are empowered to make tradeoffs between those and if they need to give more price to win the franchises they want to win, they will do that. The good news is they are again continuing to be very disciplined making those tradeoffs and the pricing is staying in the normal ranges. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Our next question is from Steve Milunovich with UBS. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [34] +-------------------------------------------------------------------------------- +Thank you very much. Chuck, we just wrapped up our tech conference and we had a panel on folks who helped companies move to the cloud. The general consensus was that private cloud implementations generally are not working in many companies that begin on a private cloud path, end up going down a public cloud path. Obviously there's still a lot of legacy and so forth, but if in fact private cloud is not going to do very well, you and others are very focused on that business and the risk is that on-prem pie is declining. Are you seeing something different and do you believe the on-prem business will grow for Cisco? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [35] +-------------------------------------------------------------------------------- +Thanks, Steve. I think that over the next year to two years that a lot of the complexity in building out private infrastructure and private clouds for our customers will be alleviated. The entire industry is going to focus on, much like we talked about, even in the networking systems of how we bring automation and operational relief to our customers and give them the ability to automate policy and security and manage all of these devises from their private cloud or from the cloud. I think that, that level of simplicity and those capabilities will improve. +I think what we see is best represented by our ACI portfolio. When you look at our customers who are building out modern data center infrastructure, I think those are representative of the customers who believe that they are going to have a hybrid environment. That piece of business grew 33% and is up to $3 billion run rate. I think your observations are probably valid, particularly if you look at a lot of the open stack, early open stack implementations. I do think that customers are going to want to have that capability and I think we as an industry will continue to work on simplifying how that operational capability shows up within our customer base. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Thank you. Next question is from Mark Moskowitz with Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays Capital - Analyst [37] +-------------------------------------------------------------------------------- +Yes, thanks, good afternoon. Chuck and Kelly, I want to get a sense here if there's been any change tactically related to how the teams are incentivized around margin, just given the Company continues to outpace the guidance on the gross margin line. Is there something going on there tactically or is this all just because of mix due to the broader macro weaknesses? Thank you. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [38] +-------------------------------------------------------------------------------- +Sure. I think this has been a multi-year thing that we have been driving. I'd say that we incent, like I mentioned, the leadership at the higher levels, at a margin level and then they have also controls at certain discount levels, so they can also manage that within their region. It is definitely part of the focus. We have tools that are set up that when a sales person puts a deal in, it's easy to see how that deal falls in from a margin perspective to help them make good deals, if you will, so the incentives haven't changed at all this year. I think that it's just the sales teams are incredibly disciplined around it. +I'd say the whole Company understands the tradeoff of that. We are all focused on making the tradeoff so we can optimize and drive as much growth as we possibly can and go after every point of market share that we can but they also understand the power of the margins and that helps drive it. I'd say only the other thing to think about is with the acquisitions that we have been doing that have been largely software related, whether it's in security or cloud, those SaaS businesses certainly have very high margins that just help add to the mix. Again, as we continue to do that, you'll continue to see a positive bias on our margins. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [39] +-------------------------------------------------------------------------------- +Just one comment, Mark. Kelly and I have worked with the teams and from a leadership team perspective, we have three measurements that they are held accountable for, revenue, margins and market share. That's how we just try to keep people focused on a healthy balance. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [40] +-------------------------------------------------------------------------------- +This is not just -- this is at all levels of the organization. Our Head of Sales and our Head of Partner Sales, you know they are all part of this pricing council that we have that we try to be very agile of when we make pricing, either new product pricing or changes to product pricing, to take advantage of where any elasticity is. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Next question is from Tal Liani with Banc of America Securities. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- +Hi guys. I had some macro questions and I want to ask it in the context of switching. There's a very big gap between the next quarter guidance year-over-year growth rate and your long term growth rate. The question that I have is, what part of the difference is macro, so if the macro slightly improves can you get there? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [43] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch - Analyst [44] +-------------------------------------------------------------------------------- +Or is there anything that you can do on the product side that will get you closer? I want to ask it in the context of switching given that you had a major overhaul or major upgrade to your switching in the last two years, but we haven't seen the growth rates improving that dramatically. What can you do and what is macro? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [45] +-------------------------------------------------------------------------------- +I think that's a great question. I'd say -- let's just talk about switching. I'd say for campus switching, which is 2/3, roughly, of our entire switching business, which is our biggest business unit, I'd say most of that is macro, right? It is the one area, and I think we've talked about before. It's the one area that people can put off doing a refresh if there is any macro concerns. That's what we typically see any time you see any economic pause or macro event. I do truly feel that if the optimism we've seen this week in the stock market continues giving that feeling of optimism in the economy, I would expect that to raise all boats in our campus switching side. +I'd say on the data center, you understand the dynamic there, right? To your point, we launched a fantastic product a couple years ago but we had to manage through the transition of a very sizeable legacy business data center portfolio declining as that accelerated and so we managed through that. Again, that business has continued to grow as we go through that intersection and cross through now as the legacy piece we've worked largely through. I'd say that's why I say it's largely macro, especially on the campus side. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Thank you. Our next question is from Jeff Kvaal with Nomura. + +-------------------------------------------------------------------------------- +Jeff Kvaal, Nomura Securities - Analyst [47] +-------------------------------------------------------------------------------- +Thank you very much. Can you hear me okay? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [48] +-------------------------------------------------------------------------------- +Yes, we can, Jeff. + +-------------------------------------------------------------------------------- +Jeff Kvaal, Nomura Securities - Analyst [49] +-------------------------------------------------------------------------------- +Wonderful, thanks. I wanted to swift gears and talk about the balance sheet, if I could. Obviously, you and many other companies in tech space have been advocating for repatriation for a decade, a very long time. Could you help us understand or remind us where you would like to take that money, should you bring it back to the US? The second part of that question is there's some sentiment that investment, or I'm sorry, interest rates will start heading north again. Do you take that into account when considering your dividend policy? Thank you. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [50] +-------------------------------------------------------------------------------- +Jeff, so great question. I love balance sheet questions, actually. Yes, I mean again, we have talked about tax reform for a very long time. I can say that what's encouraging is with the incoming administration is this is one of their top priorities that they said they would prioritize in their first hundred days, so we're encouraged that something will happen. Now, it's very early and we don't really know the details besides what his platform was during his campaign, so we're going to watch it very closely and look forward to as the details flush out there. +Just high level, as you could imagine, we have many, many scenarios of what we would do when repatriation comes, which is a combination of obviously we would ring fence in our debt and then we would have a blend of actions we can certainly take with our dividend as well as our share buyback, as well as leading flexibility for us to be able to do M&A and strategic investments. It'd be a combination of all those things. Obviously we listen very closely to our shareholders and how we want to do that and we recognize it will certainly give us a lot more flexibility. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [51] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [52] +-------------------------------------------------------------------------------- +I'm sorry, I apologize. On the interest rates, would it affect our dividend policy? Again, we've been committed to growing our dividend with our earnings and again driving that to a great yield as our EPS grows. Interest rates go up, they go down. We're committed to growing it as our earnings grow. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [53] +-------------------------------------------------------------------------------- +I believe that is our last question. I'll now turn it over to Chuck to wrap it up. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [54] +-------------------------------------------------------------------------------- +Thanks Marilyn. In summary, once again, we delivered a strong quarter in an environment that obviously continues to be challenging. I'm very pleased with the success that we've seen in security, collab, ACI, our deferred product revenue from software and subscription and we remain focused on executing against the things that we control. To that extent, I think the teams have done a very good job. We're obviously focused now on continuing to execute in those areas as well as, as I talked about earlier, bringing automation management and security at scale to the balance of our switching and routing portfolio and aligning with our customers' desires and how they consume our technology. +Finally, we'll obviously remain very committed to operational discipline and long-term value for our customers and our shareholders. We thank you all for spending time with us today. Marilyn, I'll kick it back to you. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Head of IR [55] +-------------------------------------------------------------------------------- +Thanks, Chuck. Cisco's next quarterly call, which will reflect our FY17 second-quarter results, will be on Wednesday, February 15, 2017, at 1.30 PM Pacific Time, 4.30 PM Eastern Time. I would like to remind the audience in light of regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, please feel free to contact the Cisco Investor Relations team. We thank you very much for joining the call today. Thank you. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- +Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-866-439-3743. For participants dial from outside the US, please dial 1-203-369-1047. This concludes today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2017-Aug-16-CSCO.txt b/Transcripts/CSCO/2017-Aug-16-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..47b75df6b6bbc9e58ae396cae9296333188937a1 --- /dev/null +++ b/Transcripts/CSCO/2017-Aug-16-CSCO.txt @@ -0,0 +1,589 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Cisco Systems Inc Earnings Call +AUGUST 16, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - CEO and Director + * Kelly A. Kramer + Cisco Systems, Inc. - CFO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Mark Alan Moskowitz + Barclays PLC, Research Division - Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Timothy Patrick Long + BMO Capital Markets Equity Research - Senior Equity Analyst + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Roderick B. Hall + JP Morgan Chase & Co, Research Division - VP and Senior Analyst + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD + * Pierre C. Ferragu + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Cisco Systems Fourth Quarter and Fiscal Year 2017 Financial Results Conference Call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Mark. Welcome, everyone, to Cisco's Fourth Quarter Fiscal 2017 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis unless stated otherwise, and the full year revenue and non-GAAP comparisons have been normalized to exclude the divested SP Video CPE business from our historical results. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. As you know, it's only been 7 weeks since we last spoke at our Financial Analyst Day, and our overall outlook remains consistent with what we outlined at that time. +In fiscal 2017, we continued to execute well against our vision of delivering customers a highly secure, intelligent platform for their digital business. We managed our business through a dynamic environment and, at the same time, delivered significant innovation to further accelerate the next phase of our transformation. +In Q4, we generated revenue of $12.1 billion and non-GAAP earnings per share of $0.61. For the full fiscal year, revenue was $48 billion, and we delivered non-GAAP earnings per share of $2.39. We drove strong margins and record operating cash flow for the year. Our results demonstrate solid execution against our strategic priorities, accelerating our pace of innovation, increasing the value of the network and delivering technology in the way our customers want to consume it. +In June, we announced a new era of networking with the launch of the network intuitive. This is an example of the industry-leading innovation Cisco is providing to its customers. The network intuitive is a new intent-based network that creates a fully integrated, intuitive system that is designed to anticipate actions, stop security threats in their tracks and continue to evolve and learn over time. We're applying the latest technologies, such as machine learning and advanced analytics, to operate and define the network. +From a security standpoint, the new network enables our customers to detect threats in encrypted traffic with unprecedented accuracy using Cisco's Encrypted Traffic Analytics and intelligence from Cisco's Talos cyber intelligence unit. We have created the only network that is designed for security while maintaining privacy, solving a previously unsolvable problem. +Our new Catalyst 9000 switches represent the foundation of our intent-based networking capabilities and provide highly differentiated advancements in security, programmability, performance and lower operating costs by innovating at the hardware and software layer. This offering is also a great example of how we're moving our core business to a recurring revenue model. +Customer reception to this new innovation has been incredibly positive. As we've always said, transitions of this nature are multiyear, but during the first 4 weeks in the market, our pipeline and product orders are strong with over 200 customers having ordered the new Catalyst 9000, the heart of the network intuitive platform. Our software value proposition in this portfolio is also compelling as the large majority of our customers are adopting the most advanced subscription offer available. +Building on this early success, we intend to further accelerate our leadership in intent-based networking through the combination of our expertise in network infrastructure, AppDynamics visibility into applications and Viptela's automation capabilities. +I believe that, over the next several years, we will see continued increasing relevance of technology as customers add billions of new connections to their enterprises. The network has never been more critical to business success, and we're looking forward to helping our customers take advantage of the insights and intelligence that are only accessible through our highly differentiated platforms. +In Q4, we also announced an extension of our strategic partnerships with Apple, IBM and Microsoft. We plan to deliver the first enterprise security application on Apple iOS, and we're integrating our comprehensive security portfolio with IBM's Cognitive Security operations platform. Additionally, we're collaborating with Microsoft in 2 important ways. First, we're implementing a software layer on our data center switches that gives Microsoft the flexibility to run their own operating system on our industry-leading hardware platforms in their Azure infrastructure. Second, we're collaborating together to enable businesses to build and host their IoT applications in Microsoft Azure while extending the power of those applications to the Edge via Cisco's leading fog computing solutions. +Now let's review other key parts of our business, starting with Security. We believe we are well positioned as the #1 enterprise security vendor. With growing cyberattacks and the need for our customers to protect their business-critical data and applications, we are aggressively providing security everywhere: in the network, in the cloud and at the endpoint. We don't believe any other company can match our capabilities given the criticality of the network in our customers' security architecture. Our best-of-breed products and integrated security architecture, combining analytics and automation, are winning in the market. +Our Security business delivered a solid quarter with double-digit orders and 49% deferred revenue growth. This caps off a year in which we delivered 9% revenue growth with more than $2 billion in revenue, making us the only company growing at this scale. +Our leadership position in network security continues to expand, driven by our next-generation firewall portfolio with over 6,000 new customers added in the quarter, which is 3x our nearest competitor, bringing our total customer base to nearly 80,000. +Customers continue to rapidly adopt our advanced threat portfolio. We delivered revenue growth of 9%, and we added over 7,600 new customers, bringing the total number of AMP customers to over 42,000. +Building on our differentiated security innovations, we recently completed the acquisition of Observable Networks, which extends our Stealthwatch solution into the cloud with highly scalable behavior analytics and comprehensive visibility. This platform expands our security -- our cloud security capabilities by providing greater support and compliance for applications deployed in Amazon Web Services as well as Microsoft Azure environments. +Additionally, to combat the 90% increase in cyber attacks against IoT devices over the last year, we launched IoT Threat Defense Solution, an extensible, scalable security architecture created to defend devices in connected health care, electric utilities and manufacturing industries. +In the Data Center, we're helping our customers take full advantage of a multicloud world that has become the norm in managing their applications and hybrid cloud solutions. Our goal is to deliver the best multicloud platform built on an intelligent, intuitive network, enabling faster, automated and highly secure delivery of applications in the cloud. We believe Cisco is best positioned to do this as everything we do in the Data Center is in support of both modern and traditional applications, both on-premise and in the cloud. +Cisco has led the industry over the past 4 years with ACI, combined with UCS, Tetration, CloudCenter and our security solutions. In Q4, we saw strong performance of our multicloud infrastructure portfolio combined with our cloud-based SaaS offerings, including WebEx and Meraki cloud networking. +For example, ACI, our fastest-growing data center switching platform, had a record quarter with growth of 38%. We continue to see strong customer adoption, driven by our ability to accelerate data center application deployments across private to public clouds. +HyperFlex, our hyperconverged offering, combined with CloudCenter, is gaining traction with customers, benefiting from simplicity and scalability to support their hybrid cloud strategy. You will see us continue to strengthen our partnerships with public cloud providers as they look to Cisco to help our joint customers manage workloads across their private and public clouds. +Lastly, we're delivering the right consumption models to enable continuous value and innovation for our customers. Our strong momentum continued in Q4 with 50% growth to $5 billion in deferred product revenue related to software and subscriptions, which has doubled from 2 years ago. For the first time, over $1 billion or 11% of our product revenue, came from recurring offers, which grew 40% year-over-year. +Overall, 31% of our total revenue was recurring, and revenue from subscriptions now represents 51% of our software revenue. Going forward, you should expect to see our software business benefit from the transition of our campus networking portfolio to a subscription model. +To summarize, our Q4 and full fiscal year results reflect a strong year of progress. We see tremendous opportunity in intent-based capabilities across our portfolio, and we will continue to evolve our business to be the leading provider of highly secure, software-defined, automated and intent-based infrastructure. Our innovation is as strong as ever as we focus on accelerating our core networking, security, software and cloud-based businesses. While it will take time, I firmly believe our core business is better positioned for the long term as we realize the benefits from our next-generation intent-based networking portfolio. +Now I'll turn it over to Kelly to walk through more detail on our financials. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter and full fiscal year, followed by the Q1 outlook. +This quarter played out generally as we expected, and as we indicated in our guidance in our last call, we executed well, drove solid profitability, strong cash flow, and we continued to deliver on our strategic growth priorities. Total revenue was $12.1 billion, down 4%. We continued to focus on driving margins and profitability with strong non-GAAP operating margin of 31.5%. Non-GAAP EPS was $0.61, down 3%, and operating cash flow was strong, growing 5% to $4 billion. +For the full fiscal year, we had revenue of $48 billion, down 2%, with product down 3% and services up 3%. Non-GAAP operating margin was a record $15.2 billion, expanding to 31.6% of revenue, up 0.6 points. Non-GAAP EPS, also a record, was $2.39, up 1%. And we generated record operating cash flow of $13.9 billion, up 2%. +Let me provide some more details on our Q4 revenue breakdown. Total product revenue was down 5%. Switching declined 9%, driven by weakness in campus, partially offset by growth in the ACI portfolio, which was up 38%. We saw good initial traction of our new intent-based networking portfolio of the Catalyst 9000 family of switches. +Routing was down 9%, driven by weakness in enterprise access. We did see a spending pause related to our acquisition of Viptela that we will integrate into our SD-WAN portfolio. +Collaboration was down 3% due primarily to a decline in Unified Communications endpoints, partially offset by continued growth in conferencing. Deferred revenue grew 4%. Combined with the unbilled deferred, the 2 were up 16%. +Data Center declined 4% with the continued market shift from blade to rack. However, we did see solid traction of our hyperconverged offering, HyperFlex. During the quarter, we launched our UCS M5 servers, bringing greater simplicity and performance for next-generation data-intensive workloads and applications. +Wireless grew 5% with strong Meraki performance as well as the ramp of our 11ac Wave 2 portfolio. Security was up 3% with strong performance in unified threat, web security and advanced threat, offset by declines in our legacy firewall products. We did see very strong order growth during the quarter. Deferred revenue grew 49% as we continued to drive more subscription-based software offers. +Service revenue was up 1%, driven by growth in software and solution services, partially offset by a decline in hardware maintenance. We drove good growth in deferred revenue, which was up 12% in total with product up 23% and services up 6%. Deferred product revenue from our recurring software and subscription offers was up 50% to $5 billion. +We continue to transform our business to delivering more software offerings and driving more subscriptions and recurring revenues. In Q4, we generated 31% of our total revenue from recurring offers, an increase of almost 4 points from a year ago. Revenue from subscriptions increased 18% and now represents over 50% of our software revenue. In terms of orders in Q4, total product orders were flat. +Looking at our geographies. Americas was down 2%, EMEA was up 3%. And APJC grew 2%. Total emerging markets declined 2% with the BRICS plus Mexico also down 2%. In our customer segments, enterprise declined 1%, commercial grew 4%, public sector was up 2%, and service provider declined 7%. Our product backlog as we ended Q4 was $4.8 billion, up 3% compared to the end of fiscal year '16. +From a non-GAAP profitability perspective, total Q4 gross margin was 63.7%, down 0.9 points. Product gross margin was 61.9%, down 2 points, and service gross margin was 68.8%, growing 1.8 points. While our total gross margin was solid, our product gross margin is continuing to be negatively impacted by memory pricing, which we expect to continue in the near term. Our operating margin was strong at 31.5%. +For the full fiscal year, on a non-GAAP basis, our total gross margin was 64.3%, a decrease of 0.4 points with product gross margin down 0.9 points and service gross margin up 1.1 points. Our non-GAAP operating margin expanded to 31.6%, up 0.6 points via our focus on driving cost improvements, operational efficiencies and productivity. +In terms of the bottom line, our Q4 non-GAAP EPS was $0.61, down 3%, while GAAP EPS was $0.48. For the full year, we had non-GAAP EPS of $2.39, up 1%, while GAAP EPS was $1.90. +We ended Q4 with total cash, cash equivalents and investments of $70.5 billion with $3 billion available in the U.S. Q4 operating cash flow increased a solid 5% to $4 billion with free cash flow of $3.8 billion, up 7%. From a capital allocation perspective, we returned $2.6 billion to shareholders during the quarter. That included $1.2 billion of share repurchases and $1.4 billion for our quarterly dividend. +For the full fiscal year, operating cash flow grew 2% to a record $13.9 billion with free cash flow of $12.9 billion, up 4%. We returned $9.2 billion to shareholders over the fiscal year through share buybacks and dividends, which represented 71% of our free cash flow. We are firmly committed to continuing our capital allocation strategy of returning a minimum of 50% of our free cash flow to shareholders annually. +To summarize, in Q4 and for the full fiscal year, we executed well, and we're focused on driving operational efficiencies and profitability to drive strong cash flow, enabling us to make the strategic investments to build long-term shareholder value. +Let me reiterate our guidance for the first quarter of fiscal year '18. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue in the range of minus 1% to minus 3% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%. And the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.59 to $0.61. +Consistent with how we talked about our business at our Financial Analyst Conference, in fiscal 2018, we will be redefining and simplifying our product reporting categories to better align with our evolving business model. We will continue to primarily run and operate our business by the 3 geographic segments, and so this change will only impact how we report on our products. Starting in Q1 fiscal year '18, we will realign our reporting into 5 distinct categories: infrastructure platforms, applications, security, services and other. +I'll now turn it back to Chuck for some closing comments. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly, and thanks again to all of you for joining us today. As we've discussed many times in the past, we're working on a multiyear transition, and while I'm confident with our progress, it's clear there's more for us to do. +In Q4, we made ongoing progress, generating 31% of our total revenue from recurring offers and growing 50% in deferred product revenue related to software and subscriptions to $5 billion. +I'm optimistic about our future, the direction we're headed and how we're transforming Cisco for the future. We are well positioned to succeed in a cloud- and digital-ready world, where the network is one of the most strategic assets for our customers. +Looking forward to fiscal '18, as I said earlier, you can expect us to do the following: execute against our strategy and invest in priority areas to drive profitable growth and enhance shareholder value; leverage the power of the network to maximize our opportunities and differentiation in existing and new markets; drive relentless focus on innovation, creating continuous customer value across every element of our portfolio; and drive the right consumption models for our customers and accelerate our shift towards more software and subscription revenue. +Marilyn, now I'll turn it back to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [6] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Mark, let's go ahead and open the line for questions. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question is from Ittai Kidron with Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I appreciate the color around the software and our current metrics. Very helpful. I guess just a couple from me. Just a easy clarification, Kelly. You haven't mentioned the number of Cisco ONE customers, would love to get that. And then as to the question itself, Chuck, Switching has had a little bit of a difficulty, or I think 3 out of the 4 quarters was down quite substantially, actually, on a year-over-year basis. As we look into '18, do you -- how do you think about that business in that year? Is that another year of transition where the portfolio, through, for example, your most recent announcements, will go for potential pause and update and learning curve, where that business could still be prone to declines? Or we should finally see some better results in that category? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- + + Ittai, I'm shocked you asked a Switching question. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [4] +-------------------------------------------------------------------------------- + + I'll answer the easy one first. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [5] +-------------------------------------------------------------------------------- + + I've given up on the Data Center business. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [6] +-------------------------------------------------------------------------------- + + Okay, good. Well, I have an easy answer. Cisco ONE -- we have over 20,000 customers now with Cisco ONE. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [7] +-------------------------------------------------------------------------------- + + Okay. So Ittai, let me touch on the Switching situation. First of all, the results we saw this quarter were not a surprise to us. If you think about our guide last quarter, we anticipated this. And we also knew at the time that we're going to be making the announcement in June about the new platform. And so we anticipated these results. Now anytime we do a major platform announcement, particularly in Switching, there is a period of time where our customers pause because they want to understand what this means. So we did see a pause, and we actually anticipated it. But we saw great traction with the new platform. As I said earlier, just in the 4 weeks where we closed the quarter, we had 200 customers that embraced this new architecture and purchased the new Catalyst 9000 platform. And as I said in the opening comments, the great majority of them also opted for the advanced software subscription that goes on top of it. And we've had a lot of conversations over the last 2 years as to whether we could really drive a subscription business on our core switching platforms. And what we see is that, at least, early indications are that we can do that. So we talked about our Data Center business. The ACI portfolio, again, record quarter, growing 38%. And then if you look at what we launched in the campus, typically, what we see is -- these are 3-year cycles to transition these platforms. But this is also not a typical platform transition. This is not speeds and feeds only. We brought forward some incredible innovation in this platform. And if you think about not only the actual product itself but the solutions that we announced around automation, which really gets at the operating expenses that our customers are incurring to manage their infrastructure, you look at one of the key drivers of why customers moved to the cloud, it was because of the complexity and the cost of their private infrastructure. So the ability to go drive significant cost out for our customers while managing this stuff over the next few years, we think, is a huge difference from a normal transition. The other is the fact that we launched Encrypted Traffic Analytics, which is our ability to determine when there's malware inside encrypted traffic without decrypting it, and that's an innovation that only Cisco can actually deliver. And both of those pieces of technology are what are included in that advanced subscription, which is what tells us that the customers see tremendous value in that subscription. So normally, we see 3 years. It's very early. And we would like to believe that we can accelerate that based on the incremental innovation that's being delivered as part of the platform, Ittai, but we'll have to see how it goes over the next quarter or 2. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question is from [Gene] Suva with Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [9] +-------------------------------------------------------------------------------- + + It's Jim Suva here from Citi. Last quarter, I believe you gave a little bit of commentary of a bit of a pause in the federal government spending and also Europe. It appears -- is that still continuing yet? Has it taken a step up to improve or deteriorate a little bit? And how should we think about that? And does Europe have any impact from Brexit? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [10] +-------------------------------------------------------------------------------- + + Jim, thanks for the question. Since you asked, why don't I just quickly cover sort of all the headwinds that we talked about in Q3? I'll give you a quick update on all of them, including the 2 that you asked. First of all, we talked about Mexico last quarter, which is generally in the same state it was last quarter. We didn't see any significant change, and again, that's largely driven by service provider weakness due to regulatory transitions as well as geopolitical dynamics, NAFTA renegotiation, et cetera. Emerging countries were slightly better, but there's still just tremendous uncertainty and disparity between performance in those countries. And service provider is generally the same as it was last quarter. The 2 that you asked about, in particular, we did see some shifts. In U.S. federal, I would say, in Q3, we had a real lack of clarity around budgets. In early May, we began to see, obviously, the clarity with the continuing resolution. And the way that the dollars get released in federal, we're in like the fourth phase based on how they prioritize releasing those budget funds. So we saw some improvement, not where we'd like for it to be, but we saw some improvement, particularly late in the quarter. And obviously, in federal, we're going to be facing the same issue again in 90 days, at the end of September, as we try to get another budget resolution passed. But you can see, on a global public sector perspective, you saw our orders last quarter were at minus 4%. This quarter, they were at plus 2%, and that was clearly -- a big part of that was the improvement we saw in the U.S. federal business. On the U.K., if you go back to Q3, we talked about it being significantly down. And one of the primary drivers was the headwind created by currency. In Q4, what I'll tell you is that headwind from currency remained. It did not ease up. However, our teams did a really amazing job, and we saw significant improvement in our enterprise and commercial business in the U.K. And if you look at the overall performance in EMEAR, you can see that the strengthening in the U.K. for us actually helped achieve the result at the EMEAR level. I'll say one final thing. In U.K., while enterprise and commercial were -- we saw a good uptick, service provider remained about the same. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from Pierre Ferragu with Sanford C. Bernstein & Co. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + I'd like to get a sense for how you see like your near-term trends in the business. If I look at your revenue guide for next quarter, so we're still slightly down year-on-year, but sequentially, the kind of revenue change you're guiding for is actually probably better than the average seasonality for Q1 of the last few years. So am I right thinking that the environment -- you see the environment, the business environment, slightly improving sequentially after this quarter -- this weaker quarter you were anticipating? So that's on the revenue front. And then on the margin front, I think like from the top of my mind, you've fully been beating your gross margin guidance range for like 8 or 9 quarters in a row or something like that. And your gross margin came in slightly down sequentially. And so -- and you're guiding for a slightly lower operating margin next quarter than what the consensus is anticipating. So if you could give some perspective on what's happening at the gross margin level. It's relatively small movements, but I'm sure you can give us some visibility on what were the drivers there. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [13] +-------------------------------------------------------------------------------- + + Yes, Pierre, let me give you a little color on the revenue question and sort of the business conditions, and then I'll let Kelly talk about the Q1 guide as well as the margins. In general, I think if you just look at our order rates that we released today, we went from negative 4% last quarter to flat in Q4 -- I'm sorry, from Q3, negative 4% to flat in Q4. So clearly, we saw improvement there. I will tell you that across the customer segments, just so you have some visibility, I think we showed the high-level numbers. I'll give a little bit of a double-click. On the enterprise side, we didn't see a lot of variability around the world in the performance there. Commercial, every region around the world improved from Q3 to Q4. Public sector, every region improved from Q3 to Q4. In SP, we had weakness everywhere. So that's just sort of a little color on the orders that we saw in Q4. Kelly, you want to talk a little bit about the revenue guide and margins? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [14] +-------------------------------------------------------------------------------- + + Yes, sure. On the revenue guide, as you know, Pierre, we call it like we see it. And as Chuck mentioned, the bookings being much better in Q4 than Q3 certainly helped a lot. And I'll just mention that we are starting off with a strong backlog with our backlog being up 3%. And we have good momentum as we go in the quarter. So we feel good about the revenue call for Q1. As I talk about margins, yes, our margins for Q4 were in the range, but we definitely saw our product margins go down 2 points year-over-year. And it really comes down quite simply to 3 points. The one and the biggest impact, by far, has been the increase of memory pricing and DRAM, specifically, for the overall business. That accounts for more than half of the 2 point decline. The second point that's really impacting that is in overall productivity. Whenever you have large parts of the portfolio or my largest business unit down 9%, like Switching, which is also a very profitable business, it impacts your ability to get cost savings in that quarter. So that was the second biggest driver. And then we just had a third driver, but to a much lesser extent, was a slight uptick in pricing erosion. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question is from Steven Milunovich with UBS Securities. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [16] +-------------------------------------------------------------------------------- + + On the Security side, you said at the Analyst Day you expect low to mid-teens growth. You did talk about strong orders today, but the revenue growth was much less. I think you cited some legacy products holding things back. Do you have confidence that the reported revenue is going to get back into the double digits consistently? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [17] +-------------------------------------------------------------------------------- + + Yes, Steve. So first, all I'll say on the Security, this is -- I have zero concerns about the business. This is a revenue timing issue. Our orders were -- they were some of the strongest -- we saw some of the strongest order growth in the quarter as we've seen in the last 2 years. So it's simply a revenue timing issue. It's funny. If you go back to Q4 of '15, the first call I did, there was concern about our Security revenue at 4%, and at the time, our deferred software was growing 26%. And this time, we had 3% revenue, but our deferred software was growing 49%. So the strength in the business, I'm still comfortable with. Kelly, you need comment on that...? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [18] +-------------------------------------------------------------------------------- + + No, I think you said it well, and it's literally just timing. We expect an uptick come back there in the next quarter. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question is from Vijay Bhagavath with Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [20] +-------------------------------------------------------------------------------- + + My question is on what feedback and commentary you are hearing from your sales teams, your top customers, channel partners in this new model to purchase products like the Catalyst 9k with subscriptions paying OpEx dollars. Hopefully, you get the software security feature attach. And then the next part of the question is, is demand for the subscriptions OpEx model primarily coming from your U.S. corporate customers? Or are you also... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [21] +-------------------------------------------------------------------------------- + + Vijay, can you speak up a little bit? It's a bit hard to hear you. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [22] +-------------------------------------------------------------------------------- + + Okay. So I think, yes, the question is what commentary you are hearing from your customers and channel partners and your sales teams on purchasing these newer products such as the Catalyst 9k with software and security features using the subscriptions model. And is it... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [23] +-------------------------------------------------------------------------------- + + Vijay, speak up just a tad bit higher there. We still... + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [24] +-------------------------------------------------------------------------------- + + Can you guys hear me now? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [25] +-------------------------------------------------------------------------------- + + Much better. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [26] +-------------------------------------------------------------------------------- + + Much better. Much better. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [27] +-------------------------------------------------------------------------------- + + Yes. So yes, I think the first part of the question is the commentary from your customers on purchasing new products with subscriptions model. The second part of the question is, is the demand for the subscriptions model primarily coming from U.S. customers? Or are you seeing overseas demand as well for subscriptions-based purchasing? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [28] +-------------------------------------------------------------------------------- + + Okay. So I'll answer the first part. And I think, Kelly, I have an instinctive answer on the second part, but you probably have the mathematical answer. So what we're -- first of all, I think that when you look back at what we announced, probably -- I think FAC was 7 weeks ago, so it must have been 8 weeks ago or 9 weeks ago when we announced the actual network intuitive. It was probably one of the most significant launches we've had in almost a decade. And what I would tell you is there's a lot of emotional momentum right now within the employee base, with our customers, with our partners, with our sales organization about the innovation. And specifically, your question, I think that what we always knew was that if -- when we attempted to introduce a subscription model on a Switching product, we knew that we had to bring innovation that was -- that had such a high return for our customers that they would not have a problem buying it in that model, and that's what we've seen. When you look at the automation platform that we're going to -- that we're delivering to our customers and we're going to continue to enhance over the next several years and you look at the security capability that, frankly, only Cisco with our understanding of the network and with our threat intelligence that we get from Talos and with our ability to build silicon that can actually make that happen, I think our customers are actually quite pleased with the innovation. And so far, we've seen a high correlation with that to the advanced subscription. So as far as the geographic issue, Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [29] +-------------------------------------------------------------------------------- + + Yes. I mean, the -- as far as the geographic, it's following very closely with our natural split. We definitely have more in the Americas, but we've a very healthy pipeline in Europe as well as APJC. So it's getting traction everywhere. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is from Timothy Long with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Timothy Patrick Long, BMO Capital Markets Equity Research - Senior Equity Analyst [31] +-------------------------------------------------------------------------------- + + Just wanted to check in on the web scale client base. How's that -- how did that trend in the quarter? Can you also address the kind of the Switching and routing competitive environment there? It seems like white box really not taking off, but some of your competitors are having good traction. So if you could just update us on progress with that large customer base, that's great. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [32] +-------------------------------------------------------------------------------- + + Yes. Thanks, Tim. So we were together 7 weeks ago. The story here hasn't changed significantly. As I've said in the past, we have reengaged in a very big way. I will tell you that we've had some wins. We actually had the press release that I talked about in my earlier comments with Microsoft about running their OS on our cloud silicon switches. And we continue to make traction with these customers. As I've said, we're looking at each of them very individually as to what it is they need. And we're also looking at broad-based partnerships with them, not only for their own infrastructure but as they realize that the importance of having this multicloud capability and the ability to run not only applications in a central public cloud but be able to run portions of those applications out of the edge of the network is leading to a very complementary partnership that we're talking about with all of them. So I would say that not a lot's changed in the last 7 weeks, but we're still continuing to make solid progress, and I'm optimistic. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question is from Tal Liani with Bank of America [Securities] Merrill Lynch. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [34] +-------------------------------------------------------------------------------- + + I have actually 2 questions, but it's about margin and cash. You touched on it a little bit, but you knew about memory pricing when you entered the quarter, I think, when you gave the guidance. Still, product gross margin was weak. What was the delta? What was weaker than expected during the quarter that drove gross margin down? And the second question is cash repatriation, if it doesn't happen. You already now have $70 billion in cash but only $3 billion in the U.S. So do you consider Plan B for bringing the cash to the U.S.? Or any other use for the cash? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [35] +-------------------------------------------------------------------------------- + + All right. So on the memory, yes, we've talked about memory for the last 3 quarters. We started to see this as a headwind initially in Q2, and it's just gotten progressively worse. I think it's very much public information that the prices continue to climb. And in this scarce supply environment, our supply chain team has done a great job securing supply for us, but those prices continue to be at market -- at prices as it goes forward. So it's continuing to be a moving target. And again, as I will say to the guide, our gross margin ended up in the range of our guide. So those are just some of the variables as we go forward. As I look forward, I think we expect the memory pressure to continue on in the near term, and we're taking that into account as we give you guidance going forward for Q1. On the cash, yes, we have $3 billion of cash domestically. We've been able to -- we've been accessing commercial paper. We increased that a little bit this past quarter. And we've been able to access and get access to capital to take out debt if we need to as we go forward because, again, we are continuing to ensure we have the flexibility we need, whether it's for strategic M&A or to continue with, obviously, our dividend and share repurchase. So we don't see any issues with that going forward, and we'll continue to be as efficient as possible in managing our cash and any debt we need to take out. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question is from Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [37] +-------------------------------------------------------------------------------- + + Just 2 clarifications from Kelly and then the question -- clarifications being, Kelly, you mentioned the tick-up in price erosion. Did that remain below 3%? And then on the other clarification, on the Switching commentary, can you give us the data center Switching growth all-in beyond just the ACI portfolio and what the campus switching decline was? And the real question is, looking at the drag on growth from the shift to subscriptions, what was +(technical difficulty) + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [38] +-------------------------------------------------------------------------------- + + Paul, are you on mute? Let's go ahead and take the next question. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question is from Rod Hall with JPMorgan Securities. + +-------------------------------------------------------------------------------- +Roderick B. Hall, JP Morgan Chase & Co, Research Division - VP and Senior Analyst [40] +-------------------------------------------------------------------------------- + + I wanted to, Kelly, maybe get you to comment on the inventory movement. The inventory's up quite a bit this quarter. I'm assuming that might be forward purchasing in memory. And then I assume that might protect your margin looking forward. But I wonder if you -- could you confirm that? And if it is the case that it's memory, how long are you protected? How long are you hedged? And then also, Chuck, maybe going back to that carrier order volume, could you just maybe dig into where you're seeing weakness in orders in the network? Can you help us pinpoint that? Or is it more broad and related to product slowdown? Just kind of generally from a part of the network point of view, where is that sluggishness materializing? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [41] +-------------------------------------------------------------------------------- + + Yes. So Rod, on the inventory, you're correct. A large majority of the inventory increase is driven by memory advanced purchases. So that protects us in -- for a large portion, but we also have been, as I mentioned in the last call, we've also been securing and committing to our purchase commitments for even more access to supply. That also will ensure that we have the supply, albeit, perhaps, at higher prices if they continue to rise. But the bulk of the inventory going up, the $400 million is memory. And then there's also a little bit of just inventory built up as we continue just to execute on our revenue in Q1. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [42] +-------------------------------------------------------------------------------- + + And Rod, on the second part, thanks for asking about the service provider business. I think the way I would characterize it is it's less about different portions of the network, and it's really about the disparity across large customers. As I said in the last couple of calls, we literally had some very big customers that were growing double digits and others that were on the opposite side of that. So it really is more of a customer variability issue than it is a single place in the network infrastructure that is causing a problem. And that's what we've seen for several quarters. And again, some of it is based on regulatory issues and geopolitical dynamics. Others are based on consolidation going on in a certain part of the industry. So that's kind of color as to how I see it. Hopefully, that's helpful. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question is from Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + Chuck, Kelly, Marilyn, can you hear me? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [45] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [46] +-------------------------------------------------------------------------------- + + We can hear you now. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [47] +-------------------------------------------------------------------------------- + + So let me ask you a question and 2 clarifications, the question being, what was the drag on growth from the shift to subscriptions this quarter? And can you talk about what your product segment growth would look like on a normalized basis, i.e., adjusting for the shift in subscriptions? I'm aware that wireless WAN in Collaboration have been the 2 places where -- in Security, where it's been first implemented. But can you talk to us about what the growth will look like on a product line basis correcting for that? And the clarification, Kelly, you mentioned the tick-up in price erosion. Was it still below 3%? And can you tell us what the decline in campus switching was and what was the all-in growth rate of Data Center? So not just ACI but taking into account the 7,000 and whatever other products are in that. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [48] +-------------------------------------------------------------------------------- + + Yes, sure. So on the shift, first, it's not much different than we told you. It's basically about 2%, between the 1.5% and 2%. And you hit the -- obviously, Security impacts the most. Collaboration has always been that way, and that just continues to grow. But if you restated it Security will be impacted, wireless will be impacted. And now with Cisco ONE really ramping up and added hundreds of millions of dollars on the balance sheet, that would have an impact as well. And that is the piece that will accelerate even more as we get more traction on the Catalyst 9000 switches platform. So it's kind of across the board. In terms of Data Center overall -- so if I look at Switching and Switching being down 9%, the bulk of it was campus switching, and that was over double digit. So that was the biggest drag. data center switching, all-in, was basically flattish to slightly up but basically flattish. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [49] +-------------------------------------------------------------------------------- + + And price decline? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [50] +-------------------------------------------------------------------------------- + + And price decline, yes, it is -- you're talking about a year-over-year rate impact? + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [51] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [52] +-------------------------------------------------------------------------------- + + Yes, so it is below the 3%. And you'll see that in the K. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question is from Simon Leopold with Raymond James & Associates. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [54] +-------------------------------------------------------------------------------- + + I wanted to see if we could maybe double-click down on the Security business. In light of the headlines we've heard in the security space over the last couple months in terms of attacks, I think of the case of Nuance, it highlighted employing Cisco. And I recall your discussions in the past about the need for security to be an architectural solution and not a point solution. So it sounds like the market is moving towards the pitch you've made, and it's made sense for a long time. I'm just trying to see if you can help us quantify the outlook for your Security business, if you see an inflection point of the business moving more towards a solution sale than point products versus what we've seen in the past. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [55] +-------------------------------------------------------------------------------- + + Thanks for the question, Simon. The short answer is yes. And what's happened is if you think about how our customers are building their IT infrastructure or how their IT assets are being deployed, they're in a massively distributed mode. And they're trying to navigate and manage technology assets, spanning from the public cloud to connected vehicles, connected mining operations, all the way back to their private data center over to SaaS applications. So the architecture of sort of hair-pinning all that stuff back to a central point in the enterprise is not going to be sustainable. Therefore, we see our customers transitioning to a new -- fundamentally new architecture that's enabled by the network. And that's why they're moving to the security architecture because, as I said, our teams have built this strategy where you have to deploy Security Everywhere, which is at the endpoint in the network in the cloud. And I think as it relates to some of the attacks, I don't remember the number exactly last quarter or the quarter before relative to our -- the threat, new threat customers that we have, the AMP customers. But I believe the 7,600 this quarter was a pretty significant increase over what we saw during a quarter over the last 2 quarters. And I think that's probably related to not only the architectural buy-in that our customers have but also the fact that, that solution was pretty resilient during the recent ransomware attacks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Our next question is from Jeffrey Kvaal with Nomura Securities International. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD [57] +-------------------------------------------------------------------------------- + + I would like to delve into the service provider outlook a little bit, if we could. It sounds as though -- we understand that things aren't perfect around the world for you. My question is, how much of where we are in service provider do you consider to be cyclical? And how much of this is structural? I mean, do you think that we should see the service provider orders be in that 1% to 3% growth range that you've highlighted for the overall business? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [58] +-------------------------------------------------------------------------------- + + Let me see if I can break this down into 3 sort of qualitative areas that, I think, we are focused on that can actually improve the service provider performance over the next 3 to 7 quarters over the next 2 years. I think first is we have increased our presence, our relevance in the web scale cloud providers that we've talked about. That's first and foremost. Second is there are -- there's innovation that we are working on that we talked a little bit about at the Financial Analyst Conference that will be coming out probably a few quarters from now that will give us some transition opportunities in some of our platforms. And then finally, I think the other is there's -- I would characterize as a combination of sort of macro issues as well as technology transitions. I think you're going to see customers -- and we're beginning to have discussions with customers who are thinking about 5G. And while we're not in the macro radio space, one of the key things that they are working on or thinking about is, as I add a significant number of new devices at higher speeds and lower latency out of the edge of the network, what is that going to mean for the performance I'm going to need in the core of the network? So I think as we see some of the geopolitical dynamics hopefully settle down, but I wouldn't count on that right now, but the overall -- I think the 5G trend and that transition is the other one that could help us over the next couple years. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Our last question comes from the line of Mark Moskowitz with Barclays Capital. + +-------------------------------------------------------------------------------- +Mark Alan Moskowitz, Barclays PLC, Research Division - Research Analyst [60] +-------------------------------------------------------------------------------- + + Just want to follow up on the gross margin question, a lot of focus today on the call. How should investors anticipate potential margin volatility over the next 1 to 2 years related to the transition to the highly attractive subscription model? And then, Kelly, can you weigh in on rev rec 606? Like when could we see Cisco introduce some guidance around that as well? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [61] +-------------------------------------------------------------------------------- + + Sure. So on the gross margin, I think we need to -- well, we will have an impact on the memory for the next couple quarters coming up here, for sure. I think the public information out there on what's happening with the supply, there are people that think that maybe it eases up, but it's too hard to call. So I think that's going to be a headwind for us. I think the other parts of gross margin are continuing to -- we're executing and managing those well, like we always have, on the cost savings sides and managing price as well. So I think it's really -- the big question mark and the big headwind is the memory. On rev rec change of ASC 606, we will be giving more color on that in our 10-K and kind of give you a feel of what some of the implications will be. So we'll get more color in that, and we'll try to quantify for you the impact from a revenue and bottom line perspective. I will also just reference you back to -- I did have a page in the analyst conference deck laying out what of our offers would be impacted and what wouldn't be to kind of give you a feel along those lines as well to help you think through it. But we'll give you progressively more detail, starting with our K coming up here in a few weeks. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [62] +-------------------------------------------------------------------------------- + + Thanks, Kelly, and thanks, Mark, for the questions. Chuck, why don't I turn it over to you to wrap it up? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [63] +-------------------------------------------------------------------------------- + + All right. Thanks, Marilyn. And thanks, everybody, for participating with us today. +I think there are 4 key messages that I would probably leave you with. First is that this launch that we announced back about 8 weeks ago was the first of what I believe you should expect from us in just an ongoing cycle of innovation and very positively received by the press, analysts, customers, partners, employees. And I said, when I took this job, we're going to increase the pace of innovation, and this is the first wave of what you're going to see coming from us. And when you look at the innovation that was introduced, particularly around the automation, around the new platform and the innovation we drove in the security capabilities, that's what you're going to see from us going forward. +Secondly, I think with the -- our customers and the environments in which they're operating now, the network's never been more relevant. And I talked about how they're building out their infrastructure in very distributed ways. They're managing hundreds and thousands of devices today, and they have to be ready to manage 1 million or more by 2020. And I think that, that is why this automation and analytics capability and the security built into the network is so important. +The third is that we continue to have our customers looking for us to help them really build out the secure intelligent platform that spans across this multicloud environment for their digital business. And I think that our Security results on the number of new customers embracing the technology, I think, is indicative of how they're buying into this new architecture. +And then fourth, I would say that the strategy we laid out, we're executing very well against. We're managing the business through this transition. When you look at the year that we just completed, having record EPS, record cash flow at the same time that we, this past quarter, increased the software and subscription deferred business, 50% to $5 billion. +And so I'm very pleased with where our teams are, what our teams are doing, how we're executing and how we've increased the innovation and the response from our customers. So we look forward to talking to you all again next quarter, and thanks for joining us today. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [64] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'm going to go ahead and provide some last closing remarks here. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2018 first quarter results, will be on Wednesday, November 15, 2017, at 1:30 p.m. Pacific time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that, in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, please feel free to reach out to the Investor Relations team at Cisco. And we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1 (866) 357-1423. For participants dialing from outside the U.S., please dial 1 (203) 369-0115. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2017-Feb-15-CSCO.txt b/Transcripts/CSCO/2017-Feb-15-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..ca702f66cf6e4633d3e7c4089eeede03d44e1f26 --- /dev/null +++ b/Transcripts/CSCO/2017-Feb-15-CSCO.txt @@ -0,0 +1,606 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Cisco Systems Inc Earnings Call +FEBRUARY 15, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kelly Kramer + Cisco Systems, Inc. - CFO + * Chuck Robbins + Cisco Systems, Inc. - CEO + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Unidentified Participant + - Analyst + * Pierre Ferragu + Sanford C. Bernstein & Co. - Analyst + * Simon Leopold + Raymond James & Associates, Inc. - Analyst + * Jess Lubert + Wells Fargo Securities, LLC - Analyst + * Paul Silverstein + Cowen and Company - Analyst + * Mitch Steves + RBC Capital Markets - Analyst + * James Faucette + Morgan Stanley - Analyst + * Jayson Noland + Robert W. Baird & Company, Inc. - Analyst + * Jeff Kvaal + Nomura Securities Intl - Analyst + * Ittai Kidron + Oppenheimer & Co. - Analyst + * Vijay Bhagavath + Deutsche Bank - Analyst + * Mark Moskowitz + Barclays Capital - Analyst + * Steve Milunovich + UBS - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco Systems' second-quarter and FY17 financial results conference call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now, I'd like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Sam. Welcome, everyone, to Cisco's second-quarter FY17 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO, and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be available on our website in the investor relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found in the financial information section of our investor relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and will discuss product results in terms of revenue, and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the third quarter of FY17. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +As a reminder, in Q2 FY16 on November 20, 2015, we completed the sale of the Customer Premises Equipment portion of our SP Video connected devices business, and accordingly had no revenue or expense from that business in Q2 FY17. As such, all of the revenue, non-GAAP, and product orders information we will be discussing is normalized to exclude the SP Video CPE business from our historical results. We have provided historical financial information for the SP Video CPE business in the slides that accompany this call and on our website to help understand these impacts. As a reminder, the guidance we provided during our Q1 earnings call also has been normalized in the same way. With that, I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. We performed well this quarter, delivering total revenue of $11.6 billion and non-GAAP earnings per share of $0.57. We drove strong profitability, healthy cash flow, and growth in deferred revenue, continuing our shift towards software and recurring revenue. +We also drove 51% growth in our product deferred revenue related to our recurring software and subscriptions, which now stands at $4 billion. We're also pleased that the Board approved a 12% increase to our quarterly dividend to $0.29. +We are delivering against our strategic priorities, offering unparalleled value to our customers, and we're executing and managing the Business to deliver greater shareholder return. Through a disciplined investment approach, we are focused on expanding our growth opportunities and strengthening our customer value proposition. +We were very pleased to announce our intent to acquire AppDynamics as a continuation of our strategy to provide customers with deep analytics across the data center, the network, as well as their applications. Increasingly, customers are seeing significant business value being delivered through applications and access through intelligent networks. Combining Cisco's infrastructure, networking, and security analytics with the application analytics from AppDynamics, we will provide customers with unprecedented insights to improve business performance. +The conversations I have every day with business and government leaders around the world reinforce the importance of our strategy. They look to Cisco to connect everything and everyone by building highly secure, software-defined, automated, and intelligent infrastructure platforms. We offer these solutions through a variety of consumption options, giving our customers choice and flexibility. +I would now like to cover some key business highlights, starting with our Security business. We had another great quarter in Security, which continued its strong momentum and growth. Revenue grew 14%, and deferred revenue grew 45%, reflecting the strength of our best-of-breed offerings and architectural approach to security from the network to the endpoint to the cloud. +Two weeks ago, we released the 10th annual Cisco cybersecurity report which highlights the increasing risk customers are facing around the world. Of the organizations we surveyed, over one-third of those who experienced a breach in 2016 reported substantial losses to their business. Customers are relying on Cisco's comprehensive portfolio of best-of-breach security products and services brought together in an integrated architectural approach to prevent and reduce the risk of business loss. As a proof point, deployments of our advanced threat solutions continue to be strong, as we added over 6,000 new customers, bringing the total to approximately 29,000 now using AMP, which led to revenue growth of 65% in the quarter. +Similar to our success in the advanced threat market, we added over 5,500 next-generation firewall customers, bringing our total customer base to 67,500. In addition to our leadership in network and advanced security, Cisco is leading the market in delivering innovative, cloud-based security solutions. Last week, we announced Cisco Umbrella, the industry's first secure Internet Gateway to address new enterprise security challenges in today's mobile and cloud world. Cisco Umbrella is designed to help users gain secure access to the Internet anywhere they go, even when they are off the enterprise network. +Now, let's turn to collaboration. This quarter, we saw strong customer growth across our collaboration portfolio, with revenue growing 4% and deferred revenue growing 14%. Further expanding our portfolio of subscription-based offerings, we introduced Cisco's Spark Board, the first all-in-one, cloud-based collaboration and meeting room solution. Cisco Spark Board enables screen sharing, interactive white-boarding, and video conferencing, and is complemented by a new version of our Cisco Spark application, a messaging and meeting platform for mobile and desktop endpoints. In the few weeks since launch, we have already had several hundred Cisco Spark Board customers who will be receiving ongoing innovation as part of the Cisco Spark subscription that they purchased together with the device. +We are seeing good customer momentum in our Data Center business, with customers choosing Cisco for the breadth of our private and hybrid cloud solutions. Across our next-generation data center portfolio, we saw healthy customer traction, including our ACI data center switching portfolio grew revenue by 28%. This includes 1,300 new Nexus 9000 customers and 450 new ACI customers in Q2, bringing the total install base to 10,800 and 3,100, respectively. We are the only company to offer end-to-end visibility and security for 100 gig network build-outs. +In our core business, the network has never been more relevant in a world of increasing connectivity driven by cloud, social, IoT, and digitization. Over the last year, we have been working hard on driving innovation in our core business, and we are starting to see some of the benefits, such as our wireless portfolio this quarter. We believe we are in the early stages of a product innovation cycle driven by security, automation, and analytics across the portfolio. +To further strengthen our cloud software and IoT portfolio, as I mentioned earlier, we announced our intent to acquire AppDynamics, a market leader in application intelligence whose solutions are helping the world's largest companies improve their application and business performance. Customers will now have unprecedented insight into their data center, security infrastructure, and networking performance through real-time application analytics in the cloud and on-premise. Approximately 75% of AppDynamics product revenue is subscription-based, which aligns well with the way customers increasingly want to consume technology and with Cisco's strategic objective of moving towards more recurring revenue. +The growing customer demand for real-time data is enabled by the increasing number of connected devices. We continue to build on the Jasper cloud IoT platform with new solutions. Today, Jasper connects more than 40 million devices, including over 12 million connected vehicles, and we are adding more than 1.5 million new devices per month. The number of enterprise customers utilizing data from the Jasper platform has grown from 4,000 a year ago to more than 9,000 this quarter. +In summary, we are confident in our strategy. We are delivering accelerated innovation across our portfolio. And we are pleased with the momentum across our businesses, and in our strategic shift towards recurring software- and subscription-based revenue. Now, let me hand it over to Kelly to walk through our Q2 results and outlook in more detail. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Okay, great. Thanks, Chuck. So, I will start with an overview of our financial results for the quarter, followed by some comments about our capital allocation and the Q3 outlook. +Overall, Q2 was a solid quarter, with revenue of $11.6 billion, down 2%, and non-GAAP EPS of $0.57, flat year over year. We continued to make progress on our strategic growth priorities, while maintaining rigorous discipline on profitability and cash generation. As part of our strategy to drive long-term profitable growth, we are prioritizing key investments, both organically and inorganically, such as the intended acquisition of AppDynamics. +Today, our Board approved an increase of $0.03 to the quarterly dividend, bringing it to $0.29 per share, a 12% increase, representing a yield of approximately 3.5% on today's closing price. We remain firmly committed to our capital allocation strategy and returning value to our shareholders. +Let me provide some more details on our revenue breakdown. Total product revenue was down 4%, and let me walk through each of the product areas. Switching declined 5%, driven by weakness in Campus, partially offset by strength in the ACI portfolio, which was up 28%. Routing was down 10%, although we did see growth in orders. Collaboration grew 4%, driven by ongoing solid performance of WebEx, Unified Communications, and TelePresence. We saw good momentum again in the transition to subscriptions in SaaS offers with deferred revenue growing 14%. +Data Center declined 4%, impacted by the continued market shift from blade to rack, though last week we announced expansion of our UCS portfolio by offering the Microsoft Azure stack on UCS via an integrated validated system that enables organizations to deliver Microsoft Azure services from their on-premise data centers. The joint Cisco and Microsoft solution provides the tools for enterprises to grow and modernize their applications in a highly flexible and scalable hybrid cloud environment. +Wireless grew 3%, with ongoing strength in Meraki and the continued ramp of our 11ac Wave 2 portfolio. Security grew 14%, with deferred revenue growth of 45%, as we offer more solutions to customers with increasing software content that results in greater recurring revenue. We had very strong performance in our advanced threat security of 65%, as well as strength in unified threat management and web security solutions. Our focus continues to be developing a best-of-breed portfolio, while offering customers the benefit of deep architectural integration spanning the network cloud endpoint, which we believe is outpacing our competitors. Services continues to execute well, growing 5%, with a strong focus on renewals and attach rates. +Overall, we drove13% growth in total deferred revenue, with product up 19% and services up 9%. We continued to build our product deferred revenue related to recurring software and subscription businesses to $4 billion, up 51%. We made good progress on increasing our recurring revenue, with 31% of our total Q2 revenue generated from recurring offers, up from 28% a year ago. In terms of orders, total product orders growth was flat, with book-to-bill greater than 1. +Let's take a look at our geographies, which is the primary way we run the Business. We are seeing continued strength in the Americas, which grew 4%. EMEA was down 4%, and APJC was down 5%. Total emerging markets declined 7%, with the BRICs plus Mexico down 5%. In terms of customer segments, enterprise grew 1%, commercial grew 3%, public sector was down 6%, and service provider declined 1%. +From a non-GAAP profitability perspective, total gross margin was 64.1%, down slightly by 0.1 points. Our product gross margin was 62.4%, down 0.9 points, and service gross margin was 68.8%, growing 2.1 points. Operating margin was solid at 31%. We are maintaining our discipline and driving productivity with an ongoing focus of cost improvements and operational efficiencies, making the necessary trade-off to drive operating margin. +At the bottom line, we delivered non-GAAP EPS of $0.57 and GAAP EPS of $0.47. We delivered operating cash flow of $3.8 billion, and ended Q2 with total cash, cash equivalents, and investments of $71.8 billion, with $9.6 billion available in the US. From a capital allocation perspective, we returned $2.3 billion to shareholders during the quarter, that included $1 billion for share repurchases and $1.3 billion for our quarterly dividend. +To summarize, we had solid performance in Q2 and managed the Business well. We're making the investments we need to deliver shareholder value over the long term, and we are being very disciplined in driving continuous cost efficiencies. +Let me now reiterate our guidance for the third quarter. This guidance includes the type of forward-looking information that Marilyn referred to earlier. As a reminder, the third quarter of last year included an extra week, which resulted in higher revenue of $265 million, and higher non-GAAP cost of sales and operating expenses of $150 million, netting into $115 million of non-GAAP operating income. +The guidance for the third quarter is as follows. We expect revenue in the range of minus 2% to 0% year over year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29% to 30%. The non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.57 to $0.59. My guidance does not reflect any impact from AppDynamics. I'll now turn it back to Chuck for some closing comments. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Once again, we had a solid quarter, and I am pleased with how we're executing against our strategy. Let me summarize why I am confident in our ability to bring even greater value to our customers, partners, and shareholders. First, we delivered strong innovation in key areas such as security, collaboration, and next-generation data center, as we continue to also drive innovation in our core. Second, we have strong momentum in our transition, as seen with 51% growth in our product deferred revenue related to our recurring software and subscriptions, as we continue to add more software offers like you see with Cisco Spark Board. Third, profitable growth: We continue to stay focused on driving productivity and operational efficiencies. Lastly, we remain committed to increasing shareholder return, as you've seen with our dividend increase of 12%. +Our customers have never cared more about what technology can do for their business. They are looking for speed, agility, visibility, and security in everything that they do. Cisco is uniquely qualified to meet these demands with our ability to drive automation analytics with intelligence and security, all the way from the network to the application. And that's why I am confident in our future. Marilyn, now I'll turn it back to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [6] +-------------------------------------------------------------------------------- + + Great. Thanks, Chuck. Sam, let's go ahead and open the line for questions. I just wanted to remind folks -- while Sam is doing that, I'd like to remind the audience that we ask you to ask one question. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Pierre Ferragu, Bernstein. + +-------------------------------------------------------------------------------- +Pierre Ferragu, Sanford C. Bernstein & Co. - Analyst [2] +-------------------------------------------------------------------------------- + + Hi. Thank you for taking my question. I was trying to understand where we stand in the weakness you saw when you talked about three months ago. If I look at your guide, it's very encouraging. It shows that you were getting back to a sequential growth that is better than slightly above what you have done on average in recent years. And then, if I hear your comments, Campus was very weak in the quarter. Routing as well. And, you see orders coming back in routing. My question would be whether you see something similar in Campus? Can we expect that part of the business to improve in coming months and coming quarters? And then, maybe just more broadly, what's your feeling about the macro today? The uncertainty and the weakness in orders you could see three months ago, is this something that is improving now, already? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Pierre. Let me just start, and then, Kelly, you can add whatever you like here. I think as it relates to our core portfolio, we have seen, obviously, some macro dynamics. Europe is clearly stressed with all the geopolitical dynamics that are occurring in Europe right now across several countries. And we also have begun to invest pretty significantly over the last year, and you'll see it over the coming year, in ensuring we had the appropriate investments in innovation in our core. But, you also see what we did with AppDynamics, and what I would tell you is that when you combine the analytics that we can deliver out of the data center with the analytics that we will deliver out of the core networking space with our security threat information and analytics out of our security portfolio combined with the application analytics that they have, we believe that we can create a differentiated architecture for our customers going forward. And, that's what we are -- that's the purpose in the acquisition and what we intend to do going forward. So, Kelly, any other comments on the macro and the sequentials? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + No. I think just to add to that, I think, we do feel good about what we're seeing from macro in the US certainly and in commercial and enterprise. And, I would say to your point, Pierre, when you do adjust for that extra week last year, we are -- our guide -- we always call it like we see it, and it does show a bit of improvement there on both the top line and bottom line. So, I think like Chuck said, I think that the US is solid, and again, we're still cautious on outside the US and Europe and Asia. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Great. Thanks, Kelly. Sam, we will go ahead and take our next question. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + James Suva, Citi. + +-------------------------------------------------------------------------------- +Unidentified Participant, - Analyst [7] +-------------------------------------------------------------------------------- + + This is Justin on for Jim Suva. Thanks, Chuck and Kelly, for taking the question. I was just wondering if you could comment a little bit on your partnership with Ericsson? I know recently you've had a couple of different rollouts and then some good press releases in terms of what you are doing. I'm just wondering if you could maybe provide any updates or any milestones now that it's been about a year since you've had the partnership going? Thanks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [8] +-------------------------------------------------------------------------------- + + I think it was Justin, right? Justin, thanks for the question. It's pretty timely. In fact, we -- obviously, there's been a lot of uncertainty on the Ericsson side, and we believe that all the original business drivers that led us to establish the partnership with Ericsson are still very valid. I think we have had some 300 customer engagements together, and their new CEO came on board just about five weeks ago, I believe. And, we have been in a great deal of discussion since then on ways in which we could accelerate the partnership. He is committed to continuing and trying to make this as successful as we possibly can. We're going to meet again in Barcelona at Mobile World Congress, and I would say we're focused right now on how do we accelerate from here. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [9] +-------------------------------------------------------------------------------- + + Thanks, Justin. Sam will go ahead and take the next question please. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Paul Silverstein, Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [11] +-------------------------------------------------------------------------------- + + If I could ask for a quick clarification and then a question. Kelly, I think last quarter you quantified the impact of the shift in the business model is over 2 percentage points in terms of the hit to growth as you increase your future visibility on the shift. Can you update -- I don't think I heard you give an update this quarter? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [12] +-------------------------------------------------------------------------------- + + I think what I say is between 1% and 2%. So, we are in that 1.5% to 2% range. + +-------------------------------------------------------------------------------- +Paul Silverstein, Cowen and Company - Analyst [13] +-------------------------------------------------------------------------------- + + Okay, and would that be your expectation on an ongoing basis? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [14] +-------------------------------------------------------------------------------- + + Again, as we continue to accelerate the growth -- as we're continuing to grow it like we have been growing -- I referred it. It may get even more until it evens out, but in the last few quarters, it has been in that range. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [15] +-------------------------------------------------------------------------------- + + Thanks, Paul. Sam, we will take the next question. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Mitch Steves, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- + + Thanks for taking my question. I want to circle back on the security piece. You have given out advanced threat numbers in the past and the breakdown there. So, how does the margin structure change as you grow the advanced threat and the web security piece versus the legacy security portfolio that you've had? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [18] +-------------------------------------------------------------------------------- + + We don't share gross margins by businesses, but I can tell you the margins are growing in our security portfolio overall between the mix of the growth in these areas and the acquisitions of the SaaS businesses we've been adding. So, it's very accretive to the Cisco average. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [19] +-------------------------------------------------------------------------------- + + Just one quick, small follow-up. Just on a repatriation potential, are you leaning more towards essentially M&A or buybacks or a dividend because you have raised it by 12% now. Just wondering how you think about that? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [20] +-------------------------------------------------------------------------------- + + Mitch, first priority will be strategic investments that we will make, and then, obviously, followed with a focus on continued capital allocation and our commitment to returning capital to shareholders. It would be a combination. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [21] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Sam, let's go ahead and tee up for the next question. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Jeff Kvaal, Nomura. + +-------------------------------------------------------------------------------- +Jeff Kvaal, Nomura Securities Intl - Analyst [23] +-------------------------------------------------------------------------------- + + Yes. Thank you very much for taking the question. One of the big themes with some of the other folks across the [com] landscape is web scale. That wasn't a major theme of the opening script. I am hoping that you could help us understand your positioning in web scale. Certainly in switching where the competition is heightened and also in routing and even DCI. Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [24] +-------------------------------------------------------------------------------- + + Thanks, Jeff. So, as we look at MSDC what we've given you over the last few quarters is a very fixed list of 10 customers that we have given. And, I have said over and over that we have been spending a lot of time with these customers, really focused on understanding what their unique needs are. Frankly, some of them are so big they are a market of one unto themselves, and I'm very pleased with the progress we're making. If you look at those 10 just to give you the numbers this time. Overall, those 10 would be down, but if you normalize out one of those providers and you take the combination of the other nine, and that one had some pretty tough year-over-year comps. The other nine were up double digits, and we have one of the largest that was up triple digits for the second quarter in a row. So, I feel like we are making good progress, but we still have a long way to go. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [25] +-------------------------------------------------------------------------------- + + Thanks for the question, Jeff. We will go ahead and take the next question, Sam. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Ittai Kidron, Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. - Analyst [27] +-------------------------------------------------------------------------------- + + Thanks. Chuck, appreciate the opportunity. I guess I'm going to sound like a broken record and ask the same question I've asked over four or five quarters now which is your data center revenue. Your server business which has again continued to stay in range. Not showing much progress. How do you feel about the progress that you are making over there with hyperconverged? It just doesn't seem to be moving the dial [be it]? How do you resolve the issues in this business going forward? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [28] +-------------------------------------------------------------------------------- + + Thanks, Ittai. We can always count on you for that question. (laughter) First of all, I think in our next-gen data center switching portfolio, you can see continued performance and continued good adoption of those solutions from our customer base. I think on the hyperconverged, we certainly would like to see it moving more quickly. We have recently had a release of software that has helped with some of the capabilities, and I think that there are a couple more coming that should continue to give us more capabilities in that space. I think that we are also looking, as you would expect, at our broad strategy in the data center and where we need to go to ensure that we best position ourselves going forward. So, that work is going on as well right now, Ittai. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [29] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Sam, let's go ahead and tee up the next question. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Vijay Bhagavath, Deutsche Bank Securities. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [31] +-------------------------------------------------------------------------------- + + Thanks. Hi Chuck, Kelly. I'd like to get bigger picture thoughts, Chuck and Kelly, on how you plan to broaden your senior management team? Any new areas or skill sets you will be looking for in the management team to drive profit and growth through the rest of this year and over the next few years? And, is the strategy focused primarily on doubling down on security, analytics, AI, automation? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [32] +-------------------------------------------------------------------------------- + + Vijay, don't mean to interrupt. Can you speak up just a little bit? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [33] +-------------------------------------------------------------------------------- + + We're having trouble hearing you. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [34] +-------------------------------------------------------------------------------- + + Can you hear me now? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [35] +-------------------------------------------------------------------------------- + + Not really. Try a little louder. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Is this better? + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [37] +-------------------------------------------------------------------------------- + + That's better. + +-------------------------------------------------------------------------------- +Vijay Bhagavath, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- + + Okay. Chuck, my question was more on the senior management team. Any new skill sets, any new areas or avenues you will be looking for to round out the management team to drive top line growth? Or, will you primarily be doubling down on security, analytics, AI? Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [39] +-------------------------------------------------------------------------------- + + It's a great question. I think that when you look at the improvement we've been making around our transition to software and subscription business, you can assume that we will continue to look for people who have those kinds of capabilities. And, if you look at even the AppDynamics acquisition, David Wadhwani, who is their CEO, was one of the key drivers behind the software transition that occurred at Adobe so he very much understands how this transition will occur. You can assume that we are adding talent in the areas of artificial intelligence, machine learning, analytics, software skills around simplicity and automation. As you know if you look at our core, one of the biggest things are customers are looking for is to take out the cost of operating this infrastructure. And so, as we build out automation capabilities that allow them to very dynamically change their environments as opposed to the manual way it has been done in the past -- those skill sets as well. So, it's a combination of all those in addition to security and all the other areas you mentioned. So, it's broad-based. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [40] +-------------------------------------------------------------------------------- + + Thanks for the question, Vijay. We'll go ahead and take the next question. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Steve Milunovich, UBS Securities. + +-------------------------------------------------------------------------------- +Steve Milunovich, UBS - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you. Kelly, you mentioned the percentage of recurrent revenues, 31%. If you exclude services, are we still around 9% to 10% of product revenue being recurring? And, is there any way to turn that core routing switching business into something more recurring? We've never seen a hardware Company do that, if you will. But, through ELAs or something else, is there any way to turn that into little more of a subscription -- consistent basis? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + That's a great question, Steve. So, actually, product as a percentage of my total product revenue -- it is up to 10% now this quarter for the first time. So, we're happy about that. And, we are trying to make that shift in the core part of the business. Cisco 1 is an example of where we are taking our ELAs and our big cross-enterprise ELAs that really are our core networking business to do that. So, we're trying to find ways to find other offers. +I will just point to another example though like the Spark Board that Chuck mentioned. It's a great new innovation and extension of TelePresence, but it's a great example of where we are selling that -- we used to sell it always as a system, now we're selling the equipment. But, we are selling it with a subscription. So, that's an example of how we have been able to drive new offers that had been traditionally just pure system or hardware. And, again, the teams are driving hard to find more ways to accelerate new offers that way. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [44] +-------------------------------------------------------------------------------- + + Steve, I want to just make a couple comments on this. One, if you look -- six quarters ago when I came into the job, our overall revenue -- our recurring revenue was 26%. In the first four quarters, we spent time taking our teams and helping our teams understand the transition that we were going to make. So, in the first four quarters, we gained 2 points. We took it up to 28%, and in the last two quarters, we've added 3 points. So, we've accelerated it. It has gone to 31% in the last two quarters. And, on the product side, that went from 6% to 7% in the first year, and then in the last two quarters, it's gone from 7% to 10%. I think we are finding ways to move that forward. +As it relates to the core, I think you'll see us come out with services around automation and analytics and other things that will be sold as subscriptions on top of the platforms. And, the last thing I will tell you is that we pulled some of -- one of the key leaders from the security portfolio who had really driven the whole product management portion of that transition to the heavy content of software and subscription that you see today, and he is now leading that for us in our core networking space in the enterprise networking. So, it's clearly a focus that he is trying to drive for us. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [45] +-------------------------------------------------------------------------------- + + We will take the next question. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Mark Moskowitz, Barclays. + +-------------------------------------------------------------------------------- +Mark Moskowitz, Barclays Capital - Analyst [47] +-------------------------------------------------------------------------------- + + Thanks. Good afternoon. Just following up on the cash repatriation M&A question, Chuck. Just want to get a sense going forward, should we think about a continuation of more of the string of pearls approach similar to AppDynamics? Or, can you make more sizable acquisitions? And then, Kelly, I wanted to get a sense if you could help us understand how we should think about deferred revenue, clearly growing nicely. What is the feedback loop 1 year, 1.5 years out from now in terms of does gross margin start to trend higher because of the deferred revenue mix is becoming [richer] in configuration? Thank you. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [48] +-------------------------------------------------------------------------------- + + Mark, first off, I'll take the repatriation and the M&A question, and Kelly, you can take the next one. So, you are free to make comments on mine as well. (laughter) I think our M&A strategy is going to remain intact. Repatriation doesn't fundamentally change how we think about what we're going to do going forward. You can assume that we will continue to look for opportunities to drive the business value and the relevance to our customers like we did with AppD. They have a tremendous platform that really translates application analytics to real business performance information for our customers. +And, just to comment on AppDynamics, they have a very robust enterprise solution that is delivered either from the cloud or on-premise and can be delivered to the customer on-premise or in the cloud. So, it's very flexible. And, they basically have 275 of the Fortune 2000, and they really have never had a substantial partner model. Those are the reasons we think that makes a lot of sense. So, strategic alignment and the ability for us to take it through our ecosystem are always positive. Kelly, comments on the deferred and the margins? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [49] +-------------------------------------------------------------------------------- + + On the deferred, Mark, that is part of why we're trying to make this shift to software. Our customers want those offers and to have an easier way to run their IT departments. It clearly enables us to get higher margins, for sure. And, it's not only just the gross margins coming out of deferred revenue, but we are looking at our whole end-to-end operations and how we go to market, how we drive operations in the back end here. And, there is really opportunities to drive both gross margins and operating margins. So, that's why we are so focused on it. That's why we are looking at acquisitions to add to it, and it will continue to help improve our mix on the margins line. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [50] +-------------------------------------------------------------------------------- + + Thanks, Chuck and Kelly. Sam, let's go ahead and take the next question. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + James Faucette, Morgan Stanley. + +-------------------------------------------------------------------------------- +James Faucette, Morgan Stanley - Analyst [52] +-------------------------------------------------------------------------------- + + Thank you very much. I just wanted to ask about product gross margins. They were a bit weaker than we had at least modeled, and I think in the 8-K, there's some indication that there was some pricing. But, I would like some more color there. Particularly, one thing that we noticed that the APAC margins were look particularly weak. Is this related to customer, geography? Just a little help on understanding where the pressures are on [product gross] margin? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [53] +-------------------------------------------------------------------------------- + + Sure, I will take that one and a great question. Gross margins, we have been -- again, continue to operate well. I will say there were two specific headwinds that we faced this quarter. And, to your point on APJC, I will refer back to a year ago we were benefiting from a national program in China where they were rolling out set-top boxes to tier 2 and tier 3 cities. Not our set-top boxes, but we were providing the smart cards to go with that which were -- they are basically for secure access, and it was very, very high margin. So, we had if you go back a year ago, SP Video in Asia was extremely strong because of that. That program has dramatically slowed down. And, again, that pure margin just isn't there any more, and you are seeing that flow through both the margins and the year-over-year revenues for both SP Video and APJC. +The other item that's a headwind for us this quarter is we are facing a significant cost increase to our memory costs -- our DRAM memory costs that we are paying. It's a very tight supply right now. And, we are seeing dramatic increases there. So, that's hurting us quite a bit as well. But, other than that, I would say the color is in the same line. Our pricing is in the ranges that we have been the last six to eight quarters. I'd say a little on the higher end, but in line with where we were Q3, Q4. A little worse than last quarter, but we were very low last quarter. So, in the normal ranges. It really those two specific things. I will say that I do anticipate those two headwinds to remain there next quarter as well as we had very strong SP Video -- that China program in Q3 as well. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [54] +-------------------------------------------------------------------------------- + + Let's go ahead and take the next question, Sam. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Jess Lubert, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Jess Lubert, Wells Fargo Securities, LLC - Analyst [56] +-------------------------------------------------------------------------------- + + Hi. Thanks for taking my question and congrats on a nice quarter. First, just had a clarification. There were a number of articles regarding a faulty clocking component over the last few weeks. Just wanted to see if you could comment to what degree that is or isn't impacting customer activities? And then, the question -- I was hoping you might be able to update us in a little greater detail regarding the trends you're seeing in the service provider vertical? You mentioned some encouraging order development? So, was hoping you could help us understand what you are seeing across geographies? What you are seeing from a product perspective? And, to what degree that improvement is coming from routing optical security or some other part of the service provider business? + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [57] +-------------------------------------------------------------------------------- + + Sure. I will start on the supplier component issue. So, yes, those articles are out there. We have had an issue from a supplier come out. And, we did book a reserve for $125 million you can see in our GAAP results and in the press release to cover that. We always and continue to stand by our customers through any situations like this. This is very proactive. This is a failure rate that will happen over time, but we are working with our customers to work through that so we're not anticipating any impact from that from a top line perspective. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [58] +-------------------------------------------------------------------------------- + + I will take the SP portion, Kelly. So, Jess, on the service provider space, it's really similar to last time. We talked about SP CapEx -- different service providers are looking at different areas of investment depending on what's going on in their network. So, you have some who are looking at macro radio densification as an example, and others are looking at building out capacity in the quarter. And so, we have -- and it's a segment that is very dominated by large customers. +So, from a quarter-to-quarter basis, any number of customers that make any shift in their buying behavior can have an impact either positively or negatively. It's a space that I will just encourage you to look at longer term, but we did see -- we saw a definite improvement. We saw -- I would say from a regional perspective what I would tell you is the Americas was very strong. And, we saw general weakness in Europe and then the China space you had a lot of this SP Video implication that Kelly was talking about earlier. So, overall, I think the teams did a great job. We have -- I think the teams are working incredibly well on the next generation of capabilities in the platforms and in some of the software and automation and some of the same themes that we've been talking about in the enterprise core networks. I feel good about where they are right now. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [59] +-------------------------------------------------------------------------------- + + Thanks for the question, Jess. We'll go ahead and take the next question, Sam. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Simon Leopold, Raymond James. + +-------------------------------------------------------------------------------- +Simon Leopold, Raymond James & Associates, Inc. - Analyst [61] +-------------------------------------------------------------------------------- + + Great. Thank you for taking my question here. I wanted a little bit of hand-holding and help with interpreting this deferred revenue growth. 51%, obviously, a very big number. Looking at the balance sheet, it looks like it rose year-over-year by about $1.9 billion, and you talked about the total of software and recurring revenue at $4 billion. Could you help us get a better understanding of what are the components? And, I'm presuming there are some elements that maybe are growing much slower, some growing faster. So, help us understand what are the big drivers for that 51% growth. Thank you. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [62] +-------------------------------------------------------------------------------- + + Sure. So, that 51% growth is year-over-year growth of over $1.3 billion. And, everything is growing in that space. I would say from a pure size, collaboration and security and Meraki are the biggest pieces of that because they have just continued to grow their businesses significantly, and they are all growing huge double digits. But, I will also say my switching and my routing as well as data center, we've done fiscal one bundles as well as big enterprise license agreements. They've also been growing huge double digits as well. So, at the end of the day, the year-over-year increases across the board, everything is up massively to drive to that 51%. And, again, just the biggest chunk of it between collaboration, security, and wireless, they are two-thirds I would say of the balance but the other pieces -- . + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [63] +-------------------------------------------------------------------------------- + + Wireless being Meraki. + +-------------------------------------------------------------------------------- +Kelly Kramer, Cisco Systems, Inc. - CFO [64] +-------------------------------------------------------------------------------- + + Wireless being Meraki, yes. Hopefully, that gives you the color you are looking for. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [65] +-------------------------------------------------------------------------------- + + All right. Thanks, Kelly. Sam, let's go ahead and take that next question. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Jayson Noland, Robert Baird. Okay, great. Thank you. Kelly, just to clarify. There is no expectation of revenue or earnings impact from this clock issue in the current quarter? + +-------------------------------------------------------------------------------- +Jayson Noland, Robert W. Baird & Company, Inc. - Analyst [67] +-------------------------------------------------------------------------------- + + Not as of right now. Again, we're working very proactively with our customers in terms of how quickly and where they want to do their replacement. So, we're working very, very closely. But, as of right now, we have not seen and don't anticipate any massive revenue impact from this. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [68] +-------------------------------------------------------------------------------- + + All right. Thank you. That was our last question for today. I'm going to turn it over to Chuck for some closing remarks. + +-------------------------------------------------------------------------------- +Chuck Robbins, Cisco Systems, Inc. - CEO [69] +-------------------------------------------------------------------------------- + + Just a couple of comments, and first of all, I want to just thank you all again for joining us today. We did deliver strong innovation, I believe, which was reflective in the performance that we've had in security collaboration, next-gen data center, and we continue to drive innovation in our core enterprise and SP portfolio. The deferred revenue from our subscription and software business is indicative, I think, of the transition that you should continue to expect from us. We will continue to focus on driving profitable growth with productivity and operational efficiencies, and you also can count on the fact that we remain very committed to our shareholder return as was indicated in both our buybacks and our dividend, and then, the increase in the dividend this quarter. So, I just want to thank all of you for being with us today. And then, Marilyn, I will let you take it from here. Thank you. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [70] +-------------------------------------------------------------------------------- + + Thank you, Chuck. Cisco's next quarterly earnings conference call which will reflect all our FY17 third quarter results will be on Wednesday, May 17, 2017 at 1.30 PM Pacific time, 4.30 PM Eastern time. Again, I'd like to remind the audience that in light of regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to reach out and contact the Cisco investor relations group, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-866-357-1423. For participants dialing from outside the US, please dial 1-203-369-0115. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2017-May-17-CSCO.txt b/Transcripts/CSCO/2017-May-17-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..be41bdf4e961bcc544c5ca562ce0e9d4f5805bd6 --- /dev/null +++ b/Transcripts/CSCO/2017-May-17-CSCO.txt @@ -0,0 +1,529 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Cisco Systems Inc Earnings Call +MAY 17, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + - + * Charles H. Robbins + Cisco Systems, Inc. - CEO and Director + * Kelly A. Kramer + Cisco Systems, Inc. - CFO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Steven Mark Milunovich + UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst + * Mark Alan Moskowitz + Barclays PLC, Research Division - Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Jess L. Lubert + Wells Fargo Securities, LLC, Research Division - Director and Senior Equity Analyst + * Simona Kiritsov Jankowski + Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Kulbinder S. Garcha + Crédit Suisse AG, Research Division - MD + * Roderick B. Hall + JP Morgan Chase & Co, Research Division - VP and Senior Analyst + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Pierre C. Ferragu + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco Systems' Third Quarter and Fiscal Year 2017 Financial Results Conference Call. +At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect. +Now I'd like to introduce Ms. Marilyn Mora, Head of Investor Relations. You may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, - [2] +-------------------------------------------------------------------------------- + + Thanks, Shaun. Welcome, everyone, to Cisco's Third Quarter Fiscal 2017 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter of fiscal 2017. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. +Our results this quarter demonstrated that we are delivering against our strategic priorities and realizing the benefits of our investments to transform our business and drive long-term shareholder value. +We delivered a solid quarter, with total revenue of $11.9 billion and non-GAAP earnings per share of $0.60. We had strong margins yet again and great operating cash flow, up 10%. We are managing the business well through a multiyear transformation of the company while remaining focused on delivering customers unparalleled value through highly secure, software-defined automated and intelligent infrastructure. +We are on a journey, which as we consistently stated, will take a number of years, but we are pleased with the progress we're making. As our customers add billions of new connections in the years ahead, the network will become more critical than ever. They will be looking for intelligent networks that deliver automation, security and analytics that help them derive meaningful business value from these connections. These will be delivered through a combination of new platforms as well as software and subscription-based services, which we've been focused on accelerating over the last 18 months. +My vision for this company is to be the most relevant and most important partner for our customers as they enable their digital businesses, and we will deliver on that vision. I look forward to discussing this in a lot more detail at our Investor Day on June 28. +We continue to innovate across our networking portfolio with analytics being a key element of this innovation. This quarter, we completed the acquisition of AppDynamics, enabling us to provide customers with unprecedented visibility across networking, data center, security and applications. As I talk to our customers and partners, I'm getting great feedback about the value of the insights AppDynamics provides to help them make informed business decisions. We are in the early stages of scaling out the AppDynamics solutions through the Cisco Salesforce and partner ecosystem, and I'm excited about the future of this space. +We were also pleased to announce our intent to acquire some new additions to our software and analytics portfolio. Software-defined WAN is a critical market transition and addresses the evolving customer demands and branch routing as a foundational block of executing in cloud networking. +Viptela, combined with Cisco's IWAN technology, will provide an industry-leading cloud-first SD WAN platform that addresses the Edge networking needs of our most demanding customers. +MindMeld provides an AI platform to build intelligent and humanlike conversational interfaces for any application or device and will complement our already strong collaboration portfolio. These acquisitions support our goal of offering customers extraordinary value through a combination of organic and inorganic innovation, and they are aligned to our strategy of investing to drive longer-term growth and helping us transition to more recurring software and subscription revenue. +We will continue to deploy our capital resources to give us first-mover advantage as we extend our technology portfolio. +In addition to our inorganic growth, we are seeing strong organic growth of our next-generation products and solutions in both networking and security. +Now let me share some business highlights, starting with our security business, which has never been more relevant, as we've seen in recent days. +Last week's WannaCry ransomware attack was another example of the devastating impact cybercrime can inflict on individuals, companies and countries around the world. Since Friday's attack, our Talos cyber threat intelligence team has been working around-the-clock to dissect the WannaCry ransomware, understand its attack patterns and keep our customers protected. It's important that the tech industry and customers work together to defend against these attacks from cyber criminals. We will continue to do everything we can to help our customers anticipate, prevent and protect themselves from any future attack by harnessing the intelligence of the network and the power of our security portfolio. +Our security business delivered another solid quarter with 9% revenue growth and 39% deferred revenue growth, reflecting our combination of best-of-breed solutions, together with the industry's broadest security portfolio and a highly effective end-to-end security architecture. +We continue to lead in network security. Our next-generation firewall portfolio grew 49% with 6,000 new customers in the quarter, bringing our total customer base to over 73,000. +We expanded our portfolio with the announcement of our Firepower 2100 Series, which offers both performance and protection for mission-critical applications. +Our Advanced threat portfolio continues to deliver strong revenue growth of over 30%, and we added 6,600 new customers, bringing the total number of AMP customers to over 35,000. +Now let's turn to collaboration. In January, we introduced Cisco's Spark Board, the first all-in-one cloud-based collaboration and meeting room solution. We've seen good early traction with this SaaS-based service, with nearly 700 customers adopting this solution in the quarter. This is a great example of the transition I mentioned earlier focused on moving from standalone systems to best-of-breed products, combined with software subscriptions. +Our intended acquisition of MindMeld will help us simplify and enhance the collaboration experience even further through the power of artificial intelligence and machine learning. As chat and voice quickly become the interfaces of choice, MindMeld's AI technology will enable Cisco to deliver unique experiences throughout its portfolio. This acquisition will power new conversational interfaces for Cisco's collaboration products, revolutionizing how users will interact with our technology while increasing ease-of-use and enabling new capabilities. For example, users will be able to interact with Cisco Spark via Natural Language Commands, providing an experience that is highly customized to the user and their work. +In our data center switching business, we now have a combined install base of over 20,000 customers, who are using our portfolio to help them build, run and manage their private and hybrid cloud environments. +Our ACI portfolio grew 42%, as customers moved to 100-gig and look to automate the network and increase network performance, visibility and security. We added almost 1,200 new Nexus 9K customers in the quarter, bringing the total installed base to 12,000. +Our APIC adoption continues to increase rapidly with over 380 new ACI customers in Q3, bringing our total to nearly 3,500. +Before I turn it over to Kelly, let me reiterate a few key points. I'm pleased with the progress we're making. As I've consistently stated, this transition will take time, but we are remaking this company to succeed in a dramatically changing marketplace. We are laser-focused on delivering innovation as well as aggressively managing the business to optimize profitability, cash flows and value for our shareholders. +Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter followed by the Q4 outlook. +Q3 was a solid quarter with financial results consistent with our expectations. We executed well, driving solid profitability, strong cash flow, and we continued to deliver on our strategic growth priorities. +Total revenue was $11.9 billion, down 1%. Non-GAAP EPS was $0.60, up 5%, and operating cash flow grew 10% to $3.4 billion. We generated 31% of our total revenue from recurring offers, up from 29% a year ago. We continue to be extremely focused on driving margins and profitability, increasing our non-GAAP operating margin to 32.3%, up 2.3 points. +Before I go through Q3 in more detail, I want to remind you that Q3 last year included an extra week, it resulted in higher revenue in that quarter of $265 million, $200 million of which was in Services and $65 million from our SaaS businesses like WebEx and some from product distributions. We also had higher non-GAAP cost of sales and operating expenses of $150 million. This netted to $115 million of higher non-GAAP operating income last year. +So onto this quarter. Total product revenue was flat year-over-year. I'll walk through each of the product areas. +Switching grew 2%, with solid growth in data center switching, driven by ongoing strength in the ACI portfolio, which was up 42%. We also saw a slight positive growth in our campus business. +Routing was down 2%, driven primarily by weakness in mobile packet core. Collaboration was down 4%, but adjusting for the extra week last year, it was down 2%. The drivers are primarily a decline in Unified Communications' endpoints, partially offset by continued growth in WebEx. Deferred revenue grew 10%. +Data center declined 5% with the continued market shift from blade to rack. However, we are seeing solid traction with our hyperconverged offering, HyperFlex. +This quarter, we also further extended our innovations in UCS with new converged solutions for IBM versus stack and with our strategic alliance with Docker to deliver containerized applications. +Wireless grew 13% with strong Meraki performance as well as the ramp of our 11 AC Wave 2 portfolio. We continue to innovate with the launch in the quarter of new wireless networking solutions, including a new Wave 2 access point and a wireless controller. +Security was up 9% with strong performance in unified threat management, with growth of approximately 50% as well as growth of over 30% in both advanced threat and web security. Deferred revenue grew 39%, demonstrating the value of our solutions and ongoing delivery of innovation. +Services was down 2%. Normalized for the extra week, it grew 4%. We're continuing to focus on renewals and attach rates. +We drove good growth in deferred revenue, which was 13% in total, with product up 26% and services up 7%. Deferred products revenue from our recurring software and subscription businesses was up 57% to $4.4 billion, which includes the acquisition of AppDynamics during the Quarter. Excluding AppDynamics, the increase was 51%. +In terms of orders, total product orders declined 4%. +Looking at our geographies, which is a primary way we run the business, Americas was down 4%, EMEA was down 6% and APJC grew 2%. +Total emerging markets declined 12%, with the BRICS plus Mexico down 10%. +In our customer segments, Enterprise declined 2%, Commercial grew 1%, Public Sector was down 4%, and Service Provider declined 10%. +From a non-GAAP profitability perspective, total gross margin was 64.4%, down by 0.8 points. In Q3 '16, the extra week resulted in a 0.5 point benefit in that quarter. So adjusting for that, total gross margin decreased 0.3 points. +In Q3 '17, our Product gross margin was 63.2%, down 1.3 points, and Service gross margin was 67.8%, growing 0.7 points. We increased our operating margin by 2.3 points to 32.3% from a year ago. +In terms of the bottom line, we grew non-GAAP EPS 5% to $0.60, while GAAP EPS was $0.50. +We ended Q3 with total cash, cash equivalents and investments of $68.0 billion, with $2.9 billion available in the U.S. From a capital allocation perspective, we returned approximately $2 billion to our shareholders during the quarter that included $0.5 billion of share repurchases and $1.5 billion for our quarterly dividend, reflecting the 12% increase we announced last quarter. +To summarize, Q3 was a solid quarter, and we executed well. We're focused on driving operational efficiencies and profitability, enabling us to make the strategic investments to drive long-term shareholder value. +Let me reiterate our guidance for the fourth quarter. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue in the range of minus 4% to minus 6% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%, and the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.60 to $0.62. +I'll now turn it back to Chuck for some closing comments. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly, and thanks again to all of you for joining us today. +As I mentioned earlier, we delivered another solid quarter, and we are executing well. We're confident in our strategy for long-term growth and profitability. We believe that the network will become increasingly important in solving our customers' most complex business problems and helping them get secure and stay secure. +We also believe that we will continue to see strong momentum in our shift towards more software and subscription revenue. This reflects the success of the investments we are making in this area -- in these areas, together with the flexible consumption and buying models we're offering our customers. +Marilyn, and I'll turn it back to you for questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, - [6] +-------------------------------------------------------------------------------- + + Great. Thanks, Chuck. Shaun, let's go ahead and open the line for questions. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question is coming from the line of Mr. Mark Moskowitz of Barclays Capital. + +-------------------------------------------------------------------------------- +Mark Alan Moskowitz, Barclays PLC, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + I wanted to see if we could understand more of the guidance, Kelly and Chuck. The revenues are little lighter than we had anticipated. Is that a function of macro factors? Or is that a function more of the shift to the subscription model or maybe there's going to be some disturbance here and there. Clearly, the deferred revenue -- product revenue growth is quite nice, but I was just wondering if there's any sort of puts and takes you could walk us through there. I really appreciate it. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- + + Kelly, why don't you take him through the bridge, and then I'll just make some comments? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Sure. So Mark, when we look at guidance, it's a combination of many factors, right? It starts with our backlog and then orders on them, the funnel. And then yes, definitely, we take into account our transition to more software and subscriptions and how that's impacting it. So when I look at the guidance we just gave, our orders were a little weaker in Q3, which does mean that I'm starting with the lower backlog than anticipated. And then when I'm assuming, when I look at the order strength, we're assuming what we saw in Q3 continues on in Q4. So just to give some color around that. Where we had -- we have been facing headwinds all quarter long with SP and emerging. We saw them get worse this quarter that you saw in the numbers there. I'm expecting that to continue. And then we saw some new kind of macro issues in the areas like Public Sector and the U.S. Fed space and things like that. So I'm assuming that orders in line that we saw in Q3 is going to continue on in Q4. And then finally, we are seeing an impact because you're seeing it go to the balance sheet of this transition that we are just accelerating through to the tune of 1.5 to 2 points. So the combination of those 3 things are driving the guidance into that minus-4 to minus-6 range. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- + + Yes, just -- Mark, a couple of comments on what Kelly just described. I mean, the Public Sector business, particularly in the United States, the federal business is, frankly, it's about 1 point of that guide. It's a pretty significant stall right now with the lack of budget visibility. And when you think about the strategy that we're deploying, the 57% growth in the software and subscription business, if you just go back 8 quarters ago, we had $2 billion on our balance sheet relative to software and subscription. And the first 2 or 3 quarters, we were convincing the teams that, that was the shift we were going to make. And now we have more than doubled that to $4.4 billion, and the growth there is accelerating. So we are very pleased with that transition. And at the same time we deal with all of these challenges, we're also, -- we remain very committed to earnings. We remain very committed to our capital return strategy. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Ittai Kidron from Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [7] +-------------------------------------------------------------------------------- + + Chuck, I'm going to take a U-turn this time, actually not ask you about the data center business but rather focus a little bit more on the gross margins. Some of the commentary in your press release talked about some pricing pressures. If you could give us a little bit more color on the guidance and your gross margin assumption into the guidance, how much of that is mix-related and how much of that is pricing? And if -- any color you could give on the pricing, how much is competitive versus, I don't know, product shifts or something like that, that'll be great. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [8] +-------------------------------------------------------------------------------- + + Thanks, Ittai. So Kelly, let's have the same strategy. You want to go through the math on this and then... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [9] +-------------------------------------------------------------------------------- + + So Ittai, when we look at the drivers of our growth margin, price in Q3 actually has been in the same range that it was pretty much last year as well as last quarter in terms of the price index that we're seeing. So that's in the same range. Again, it's high, but it's in the range. It's not increasing. I would say in terms of the guidance for Q4, we're assuming that. We are also making sure the teams are being very aggressive where they need to be aggressive in areas and then against competitors where we need to be. But overall, the pricing hasn't changed dramatically besides the normal erosion that we see in churned business lines. I'd say, in terms of mix, that hasn't dramatically changed as well, with switching being positive this quarter, that helped a lot. And again, well, the mix isn't changing. There's mix changes with [MBEs] in the guidance going forward but it's nothing dramatic. So I'd say we feel good about being able to continue driving the margins that we have. The only other piece I'll comment on, because we mentioned it before, we are still seeing some cost pressure from the increase in DRAM pricing that was got baked in both our Q3 as well as into Q4. But we've been doing a lot of work, and our supply chain team has done working with our suppliers to make sure we can secure our forward supply at prices that we can plan on. So I think we've pretty much got that boxed in for the guidance. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Next question is coming from James Faucette of Morgan Stanley. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [11] +-------------------------------------------------------------------------------- + + Just a couple of quick follow-up questions to some of the comments that have already been made. Can you talk a little bit about the orders and you mentioned that fed was weak. But when you look at the other areas of weakness, can you talk about, like, what's driving those, et cetera? And I guess, more long term, it continues to be a good deferred revenue growth, and you mentioned the security. What are the priorities that your customers are showing in the security space generally? And what are you able to address now versus where are the things that they're asking for that you think you need to improve on? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [12] +-------------------------------------------------------------------------------- + + Great. Thanks, James. And so we have some order color and then securities. So let me take the order stuff, and then, Kelly, chime in as you'd like. So if we just go around -- sort of go around the globe, let me just highlight what we saw. And I'm just going to tell you what drove the weakness in these areas so you can assume the other pieces of the business were pretty much as expected. In the Americas, it was primarily the U.S. federal -- I mean, there's so much uncertainty around budgets. The U.S. federal business was a significant driver. Mexico, there has been a lot of uncertainty in Mexico, and that was actually down 49% for us year-over-year. So it was -- there's a great deal of uncertainty around the investment landscape there. And then the third element would have been the Service Provider business in the Americas. So those were the things that really drove the orders in the U.S. In Europe, the U.K., the currency issue in the U.K. is real and was very impactful in that business. And then we continue to see pressure in the Middle East relative to oil prices. We also -- obviously, there's been a lot of uncertainty around the geopolitical dynamics, some of which have been clarified recently, obviously. And we did see some strength in some countries there, but the U.K. is a big country for us. And the Middle East, obviously, with the uncertainty around oil prices, continues to be a little bit of a pressure as well. In APJC, we saw Japan and Australia were reasonable. India was solid again. And China, we had tough comps from the SP Video business from a year ago that we talked about. So that's really what we saw from an orders perspective. I think if you look at customer segments, just to give you some color, Enterprise, the challenge was largely driven by Europe. Commercial, the lightness there was driven by Europe. Public Sector, as I said, was U.S. Federal, and SP was fairly consistent. So Kelly, any other comments on that? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [13] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [14] +-------------------------------------------------------------------------------- + + Just quickly on the securities, since you snuck that one in, too, James. The -- what our customers -- what we see happening in security right now is that as our customers prepare for the next few years and literally adding billions of new connections, we obviously believe that the network is going to become even more relevant than it ever has been. And our customers are going to need -- to deal with that scale, they're going to need significant automation. They're going to need greater insights coming out of their technology infrastructure like the network through analytics. They're going to need security embedded at the network layer because you're going to have to begin to secure the infrastructure the minute these packets hit the wire. So what they're looking for is -- they are looking for an end-to-end architecture now for dealing with security. They're looking for an open architecture that actually allows them to buy the best-of-breed technology, which we have across many elements of what they're trying to do. But they are looking for an architecture, and they're looking for -- to leverage as much of that from the cloud, and which correspondingly turns into the subscription business, as you pointed out. So that's what we see happening there. There's obviously lots of other areas within that architecture that we don't play today where we could, and we continue to assess all of those opportunities. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + The next question is coming from Vijay Bhagavath of Deutsche Bank. The next question on queue, coming from Simon (sic) [Simona] Jankowski of Goldman Sachs. + +-------------------------------------------------------------------------------- +Simona Kiritsov Jankowski, Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst [16] +-------------------------------------------------------------------------------- + + It's Simona Jankowski. Just a couple of follow-ups. First, if you can clarify in terms of the weakness you saw incrementally in the Service Provider and emerging market theaters. How much of that was related to competition or pricing pressure such as from Huawei versus some of the macro factors you discussed? And then just a quick follow-up on how did your cloud business do this quarter. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [17] +-------------------------------------------------------------------------------- + + So let me comment on the first one, and then, Kelly, maybe you can talk about the cloud business and how we -- I'll talk about both of them but then how we measure that specifically. So the weakness in emerging and SP, I would say, in emerging, I would say it's less. We clearly -- we've been -- we've had competition from several vendors. And clearly, Huawei is a very strong competitor. I don't feel like it has increased significantly in the emerging countries. It's been pretty consistent there, and our teams know how to compete, and we continue to evolve our strategy and bring different tools to help them compete. So I don't -- I wouldn't say that had much to do with it. I think on our overarching cloud business, Simona, we look at that in many, many different ways. So we look at, obviously, our private cloud business, which is made up of the UCS business as well as our data center switching portfolio, which we talked about earlier. Both of those, the UCS business was down 5, as you saw. And then the -- obviously, our next-generation switching portfolio continues to do well, the ACI elements up 42%. And if you're asking about the MSDC guys, which are the web scale cloud guys, it's the same as we were last quarter. These -- we have -- we're engaging with them on an individual basis. We look at the big ones as, frankly, markets of one. We have made great progress with a few of them. Others we're in the early stages, and we have codevelopment opportunities. But I would tell you, we're in very deep discussions with most all of them, and we're looking at very strategic partnerships that scale beyond even just selling infrastructure to them in many cases. So I'm not sure where you're going with cloud. Hopefully one of those answers cover what you're looking for. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Next question on queue is coming from Jess Lubert of Wells Fargo. Your next on queue is coming from Kulbinder Garcha of Credit Suisse Securities. + +-------------------------------------------------------------------------------- +Kulbinder S. Garcha, Crédit Suisse AG, Research Division - MD [19] +-------------------------------------------------------------------------------- + + For Chuck maybe. On the revenue side, I take your points on the macro economy and the weakness in emerging markets. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [20] +-------------------------------------------------------------------------------- + + Kulbinder, could you just speak up just a hair, buddy? + +-------------------------------------------------------------------------------- +Kulbinder S. Garcha, Crédit Suisse AG, Research Division - MD [21] +-------------------------------------------------------------------------------- + + Sorry (foreign language) My question is on revenue growth, I think the drivers of the weak guidance you're talking about. I guess, the broader question is how important is getting this company back to growth? It looks like last year, you did grow. This year, you're probably not going to grow very much, i.e. especially organically. So is there something more transformative have to happen on the M&A front? Do you think this is temporary in nature? I know you're having this headwind of this business transformation, but just the importance of revenue growth to Cisco as a company, if you could comment on that for the long-term. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [22] +-------------------------------------------------------------------------------- + + Yes, Kulbinder, I think that -- when we look to the future right now and you really think about the number of new connections that are going to be added, that our customers will be adding over the coming years and the need for automation, the need for analytics and security, what we have done, and it'll be done -- our solutions that we'll bringing in the space with a combination, to your point, of inorganic capabilities, as we have shown our ability to do, as well as some organic innovation. I've talked to several of you over the last few quarters about the fact that we went in and reallocated a fair amount of our R&D expense last year and over last 18 months. And many of those solutions are targeting these next-generation networks that our customers are going to need to build out to support this new infrastructure. And with a high degree of automation across the network, with a high degree of analytics, with distributed compute capabilities for processing the data at the Edge as well as the security piece. So we have future innovation that will come in that space. We'll also use a combination of inorganic options where we need it. And we believe that as we get into the next generation of the networks that the customers need to build out, that we will be very successful with our capabilities. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question is from Jess Lubert of Wells Fargo, you may now begin. + +-------------------------------------------------------------------------------- +Jess L. Lubert, Wells Fargo Securities, LLC, Research Division - Director and Senior Equity Analyst [24] +-------------------------------------------------------------------------------- + + I was hoping you could provide a little more detail regarding the order weakness you're flagging in the North American service provider vertical. Last quarter, if I remember correctly, you suggested orders there were improving a little bit. So I just want to understand the change. To what degree it's a technology issue versus a macro issue, the duration, you think, that's likely to be weak for and if there's if any areas within the vertical that are better or worse, that would be helpful. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [25] +-------------------------------------------------------------------------------- + + Let me just give you a couple of comments, and then Kelly can give us any specifics. As I said 2 quarters back, I think, when we had the negative 10% growth or 12% or whatever it was, 12%, I think. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [26] +-------------------------------------------------------------------------------- + + Yes, (inaudible). + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [27] +-------------------------------------------------------------------------------- + + This -- Our entire SP business around the world is driven by very large customers. And so when some number of them have an off quarter, it can affect the business. And I think the Americas would be probably an example of that this quarter as well. And the Mexico business that I discussed is heavily influenced by service providers. And so that's a bit of what we've seen. We had some customers in the U.S. that were performed very well this quarter for us and others that did not. Kelly, any comment on the numbers? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [28] +-------------------------------------------------------------------------------- + + Yes. No, I'd say, I think you hit on it. I think with the Americas being down so much, it was a combination of Mexico. Again, these are big customers, and that was down. Chuck already mentioned Mexico was down 49%. It was a huge chunk of that was in the SP. And then in the U.S., the service providers, that was modestly down, not dramatic at all. Again, and that is, again, we had a lot of customers that were up and a lot that were down, so balanced overall. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + The next question is coming from Pierre Ferragu of Sanford C. Bernstein Company. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + I was wondering, Kelly and Chuck, if how much we should read in the weak guide you gave us against at least expectations we had on The Street. Is there a change we should expect in your seasonality pattern as you're going to watch more subscription services like natural, like trends of the first quarter that we've seen in the past? Is that something that we should see or we should expect to see changing over time? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [31] +-------------------------------------------------------------------------------- + + Yes, I'll make a comment and let Kelly answer the seasonality portion of it. But clearly, the transition to the software and subscription business obviously impacts how to think about guidance going forward. And when you -- when we see particularly large quarters with high growth like we saw this quarter, I think it will have an impact. I'm not sure exactly how we look at what it means seasonally. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [32] +-------------------------------------------------------------------------------- + + Yes, I mean, I do think that the models that we've looked at, tried and true over the years, where we could look at normal sequential from Q3 and Q4, I think those models are changing because we are accelerating what is -- we're putting more on the balance sheet than what is amortizing off. While we are part of our revenue guide takes into account the growth of what's coming from our recurring offers, we're still adding so much more because we're adding more and more offers every day. So I do think it is changing a bit. I think we'll talk about this a bit more when we get to our Analyst conference in June as well. But we'll give you clarity of how we can continue to model that. We certainly saw the big chunk of our business that's driven by the core orders in the book and ship, because we still have a lot of our business that we haven't transitioned yet, but as we drive more and more of that, I do think it's going to have to change how we've modeled in the past as an analyst, right? And we'll give you the clarity to help that. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Next question is coming from the line of Steve Milunovich of UBS Securities. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - MD and IT Hardware and EMS Analyst [34] +-------------------------------------------------------------------------------- + + Kelly, can you give us any guidance by product segment for next quarter? For example, Services, I assume, will be up again. So in terms of kind of the deceleration of the downside, where will we see that? Will Switching likely be down, Routing be down more kind of in terms of things getting a bit worse? Where do you think we'll see that? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [35] +-------------------------------------------------------------------------------- + + Yes, I mean, again, Steve, that we -- because so much of our core business is still very much related to the orders that we have yet to book, our backlog accounts were less than 1/3. And so much of our quarter comes from the order yet to come. We don't give guidance by business unit. But directionally, I think you're thinking about it the right way, right? I mean, I think last quarter, we tried to guide, when we were talking about Routing. We knew we had strong orders a quarter ago in Routing, which is why it wasn't as bad as it had been in the quarter before this quarter on revenue. So again, it takes into account all of that. I do think, as you know, our Switching business is very fluid, so I don't think you should assume that, that is going to continue to be -- that goes up and down, so I don't think you should draw a trend having that being positive this quarter. So I think it's very fluid within business units. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question is coming from Rod Hall of JPMorgan. + +-------------------------------------------------------------------------------- +Roderick B. Hall, JP Morgan Chase & Co, Research Division - VP and Senior Analyst [37] +-------------------------------------------------------------------------------- + + I just wanted to see if you could comment a little bit on the 31% recurring revenue. Maybe help us understand how much of that is SMARTnet and maintenance-type services and how much is, let's call it, next-gen recurring revenue. And so that -- and I also would like it, if you could comment, I know the carrier situation in the U.S. is pretty weak, and we've seen that across other companies as well. But could you comment on specific projects like the Metro Optical buildout? Is that still a bright spot? Do you still see that project moving ahead as expected? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [38] +-------------------------------------------------------------------------------- + + Sure. I'll hit the first one. So yes, if I break out the 31%, so the way to think about it, Rod, is basically, 90% of my services revenue is recurring, okay? So of the 31%, 75% of that dollar amount, so the $3.6 billion -- over $3.6 billion, 75% of that comes from the Services business. On the product side, 10% of my product revenue is now coming from recurring, so that's over $900 million. So 25% of that over $3.6 billion. And so again, I think that Services has continued to be in that 90% range. And again, what we're really trying to drive is more and more of those offers on the product side. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [39] +-------------------------------------------------------------------------------- + + Yes, and Rod, this is Chuck. Like 6 quarters ago, the product number, I think, was 6%, so we have made progress, and we'll continue to, as we see the amount of business that we're putting on the balance sheet is accelerating. On your second question, we absolutely continue to see the projects like Metro Optical moving forward. We've actually continued to do well in some of the next-generation areas that we're working with many of the U.S. service providers. So we see that going well, and we do believe that as they make some of these transitions, we are going to be right in the middle of them with them. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + The next question is coming from Vijay Bhagavath of Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [41] +-------------------------------------------------------------------------------- + + I mean, Chuck, I'm just a research analyst. I've noticed you're using AI machine learning quite a bit more recently. So like to get your idea, Chuck, and also, Kelly, if you could, in terms of which might be the product areas within Cisco where you're apply AI machine learning to the max initially, where you see kind of low-hanging fruit, immediate kind of business outcomes from AI machine learning. Would it be in which parts of the portfolio? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [42] +-------------------------------------------------------------------------------- + + Thanks, Vijay. Yes, it's -- your point is actually quite accurate that we look at how we use it -- both of those as tools across our entire portfolio. And I would tell you that there are initiatives underway and there are active solutions already in the marketplace that have elements of that. In our security portfolio, there are absolutely elements of the that, that are in our collaboration portfolio already. We see lots of opportunities when you start talking about automation and analytics and things like network assurance, capabilities or in service provider, self-healing networks. So we see the opportunity across everything we do, and we have initiatives both already working with customers as well as a lot of work going on inside the business units to leverage AI machine learning and other technologies going forward. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + The next question is from Paul Silverstein of Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + I'm hoping for a clarification on certain issues. One, going back to the earlier question on pricing. Kelly, did I hear you say that pricing was relatively stable? And can you give us some granularity in terms of what you're seeing in Europe Switching and Routing in terms of pricing? And just very quickly, 2 quarters ago, you quantified the impact of the shift to recurring revenue model. I think you'd cited 100- to 200-plus basis point adverse impact. Can you give us quantification of that impact this quarter? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [45] +-------------------------------------------------------------------------------- + + Sure. So on the pricing, yes, just to give you the clarification of the pricing, and I'll pull up actually between Europe here, so just give me a second. But so to clarify, so we do have normal price erosion every period for, mostly, in our switching and routing portfolio, those are the ones that are most sensitive to it. It's been in the same consistent percentage in terms of price reduction year-over-year that it has been both last quarter, a year ago and so in the last -- we had one favorable quarter where we had some favorability for some rebates, but overall, it's been in the same range. But it hasn't gotten worse. I'll pull up about -- I'll try to pull up here as I'm answering the second question, any difference between Europe and the Americas. But I think it's fairly consistent across the regions. The second clarification was on -- what was it, Marilyn? The... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [46] +-------------------------------------------------------------------------------- + + On the impact of the recurring business. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [47] +-------------------------------------------------------------------------------- + + Yes. Yes, so I have been saying it's in the 1 to 2 range. It is definitely pushing closer to the 2% range at this point. I mean, I think, it's clearly driven. We share with you the balance and that's accelerating, and I certainly look at the short-term portion of that and try to quarterize that together with it. But it's definitely -- it's pointing to the 2% more than the 1%. And Paul, I'll get back to you on that -- if there's any difference between Americas and Europe on that. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Next question is from Tal Liani of Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [49] +-------------------------------------------------------------------------------- + + If my numbers are correct, your recurring revenues grew 6% year-over-year, and it was 14% the previous quarters. And I'm trying to see what could cause reacceleration. The question I have is whether you focus the recurring part mostly on new types of businesses, such as security and others, or you can find ways to go back to Switching and Routing and change either pricing scheme or add features or do something such that recurring revenues outside of maintenance, of course, recurring revenues grow, and you can add software features on top will do that. The question is whether the customers will accept it or is this is going to be a traditional business model forever? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [50] +-------------------------------------------------------------------------------- + + Yes, Tal, thanks for the question. So even in our current deferred revenue from Software and Subscription, there are elements of our core portfolio that are included in that $4.4 billion that you saw primarily through our Cisco ONE offerings that we put together. Probably 18 months ago, we started that journey and we got those offers and they began to ramp. But we also are looking -- obviously, security is ramping. Collaboration has been the one probably the longest in this model. But we do believe that across the portfolio, with future offers, we have the opportunity to do that, and you'll see that as we deliver on some of the new capabilities. Kelly, any commentary on the... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - CFO and EVP [51] +-------------------------------------------------------------------------------- + + Yes, on the slowdown, so Tal, we're actually not slowing down. The reason it looks like it's slowing down is for the Services piece, we do have the extra week compare. So if you adjust for that, it's up double digits in total. And if I look at just product, the growth of product, which I said is over $900 million, that's growing 34% year-over-year, and it was 30% last quarter. So that continues to grow faster. + +-------------------------------------------------------------------------------- +Marilyn Mora, - [52] +-------------------------------------------------------------------------------- + + I believe that was our last question. Chuck, maybe I'll turn it to you for over for final words. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - CEO and Director [53] +-------------------------------------------------------------------------------- + + Yes, so first of all, I want to thank all of you for joining the call today. I wanted to just take a minute and reiterate that I believe that our strategy is working, and I'm really -- I'm optimistic about where we're going to go over the next 3 to 5 years. We set out 18 months ago to transition the business to one of more software and subscription. At the time, 8 quarters ago, it was $2 billion on our balance sheet. Today, we've more than doubled that, up 57% this quarter to $4.4 billion and accelerating. So I believe that is working, and we'll continue to shift more and more of our offers into that space. We also, obviously, wanted to be very clear about the areas that we needed to invest in, and you've seen significant investments in security and collaboration over the years. About 15 months ago, we made obvious reallocations of expenses more towards the core, and you're going to see future innovation in that space as well. Our customers really are going to be adding billions of connections in the future, and they are going to need a next-generation network with security automation and analytics. And so we're transitioning the business model. We're transitioning the network offers that we're going to deliver to our customers as they move into this next generation. And at the same time, we are leveraging our capability to do inorganic as well as organic innovation to make that happen. And in the midst of all this change, we remain very committed to our execution model and ensuring that we're focused on profitability as well as capital returns to our shareholders. So that's a summary of where I think we are right now, and I wanted to thank all of you for spending time with us today. Thanks. + +-------------------------------------------------------------------------------- +Marilyn Mora, - [54] +-------------------------------------------------------------------------------- + + Thanks, Chuck, and I'll go ahead and close it up here. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2017 fourth quarter and annual results, will be on Wednesday, August 16, 2017, at 1:30 p.m. Pacific time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it's done through an explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to contact the Investor Relations Department here. And we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1 (866) 443-8010. For participants dialing from outside the U.S., please dial 1 (203) 369-1121. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2017-Nov-15-CSCO.txt b/Transcripts/CSCO/2017-Nov-15-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..496d27d85958fcba0fbe91465e6207f59f1a417a --- /dev/null +++ b/Transcripts/CSCO/2017-Nov-15-CSCO.txt @@ -0,0 +1,572 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Cisco Systems Inc Earnings Call +NOVEMBER 15, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Mark Alan Moskowitz + Barclays Bank PLC, Research Division - Former Director + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD of Communications + * Pierre C. Ferragu + Sanford C. Bernstein & Co., LLC., Research Division - Former Senior Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * George Charles Notter + Jefferies LLC, Research Division - MD & Equity Research Analyst + * Steven Mark Milunovich + UBS Investment Bank, Research Division - Former MD and IT Hardware & EMS Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Erik Loren Suppiger + JMP Securities LLC, Research Division - MD & Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's First Quarter of Fiscal Year 2018 Financial Results Conference Call. At the request of Cisco, today's call is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Mark. Welcome, everyone, to Cisco's First Quarter Fiscal 2018 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +As a reminder, effective in Q1, we began reporting our revenue in the following categories: Infrastructure platforms, Applications, Security, Other Products and Services. As discussed in our Q4 earnings call and in our October 23 press release, this change better aligns our product categories with our evolving business model. +Our segments will continue to be based on geographies, which consists of the Americas, EMEA and APJC. So this change only impacts how we report revenue by product category. We've included quarterly reclassified revenue amounts for the last 3 fiscal years on our website. Click on the Financial Reporting section of the website to access these documents. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue, and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the second quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Form 10-K, which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I'll turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. Our results this quarter demonstrate the continued progress we're making on our strategic priorities. +In Q1, we delivered a solid quarter with revenue of $12.1 billion and non-GAAP EPS of $0.61. We are seeing great traction with our new intent-based networking solutions, delivering accelerated innovation across our portfolio and offering a broader range of new consumption options to our customers, resulting in strong increases in our software and subscription revenue. The progress we've made resulted in all 3 of our geographic regions returning to orders growth during Q1. +Cisco has always been about connecting people, information and machines at scale. Today, the network is becoming more pervasive and critical to business success as billions of new connections are added. We expect these new connections will become increasingly automated, intelligent and secure, delivering unprecedented insights and intelligence to our customers. +Cisco's vision is to deliver highly secure, intuitive technology across our portfolio that is designed to constantly learn, adapt and protect to drive business outcomes with greater speed and agility. This extends to the network, next-generation data center architectures, advanced IoT applications, end-to-end analytics and our collaboration technologies. Our vision is resonating with customers and partners around the world as we help them build more secure, intelligent platforms for their digital businesses. +Today, most of our customers are operating in complex, multi-cloud environments, and Cisco is well-positioned to provide them with networking capabilities, enterprise-class security and support, together with cloud scale, agility and economics. Our new partnership with Google is a good example of this. Over the last few months, our engineering teams have been working closely together to jointly develop a new hybrid cloud solution that is designed to enable applications and services to be deployed, managed and secured across on-premise environments as well as the Google Cloud Platform, bringing the best of cloud to the enterprise. +This partnership is an example of the work we are doing with all of the large web scale providers. We are also investing to develop and acquire new technologies to extend our multi-cloud portfolio. This includes ACI Anywhere, which we announced this quarter; and acquisitions such as CliQr, OpenDNS, CloudLock, AppDynamics and Viptela. +Now I'd like to cover some key business highlights in our new product reporting categories. First, let's start with Infrastructure Platforms. Our launch of the network intuitive in June is an example of the investment and innovation we're driving in our core business. These new intent-based networking capabilities are providing customers unparalleled insights and intelligence, together with highly differentiated security and programmability. +Our new subscription-based Catalyst 9000 Switching platform has been adopted by more than 1,100 customers in just over 3 months. We expect continued momentum throughout fiscal 2018, and we're pleased that the vast majority of Catalyst 9000 customers are buying our most advanced software subscription offer. +Additionally, we saw good performance in our next-generation data center switching platforms, as customers continue to shift to 10-gig, 40-gig and 100-gig architectures and embrace multi-cloud adoption. We continue to advance our intent-based networking for data center and private cloud environments with the latest software release of ACI. Over 4,000 ACI customers are benefiting from increased business agility with network automation, simplified management and improved security. +Going forward, we see a tremendous opportunity to benefit from a shift in customer demand from standalone products to integrated platforms with our intent-based infrastructure portfolio providing unmatched benefits. +Now turning to Applications. Applications are absolutely essential to every digital business strategy. To maximize their effectiveness, companies require a highly secure network that closely monitors applications and workload performance across a complex multi-cloud environment. Our acquisition of AppDynamics is core to our capability of providing end-to-end analytics from the network to the data center to the application. +Within our Applications business, we are enabling new capabilities based on advanced AI and machine learning across our portfolio. An example of this is our acquisition of Perspica, providing deep machine learning, driven analytics to further extend AppDynamics' leading capabilities in application intelligence. Additionally, we announced our latest innovation on the Cisco Spark platform, Spark Assistant, which is the world's first enterprise-ready, AI-powered voice assistant to further enhance our customers' meeting experience. +Our intended acquisition of BroadSoft will enhance our subscription and cloud-based business. BroadSoft has 19 million subscribers in the growing cloud voice and contact center space and will enable Cisco to offer an even broader portfolio of collaboration solutions to our customers, on-premise and in the cloud. We expect this acquisition to accelerate the pace of innovation in our collaboration business, and we see many opportunities to extend the reach of the BroadSoft portfolio. +Moving to Security. With an expanding threat landscape, cybersecurity is the #1 priority for businesses worldwide and is at the heart of every company's digital strategy. In a multi-cloud world, as our customers' environments become increasingly distributed, security requirements only increase. At Cisco, security continues to be a strategic imperative and fundamental to everything we do. +As customers adopt and advance intent-based networking, our end-to-end security is the foundation to keep our customers protected from advanced threats. This architecture, combined with the best-of-breed portfolio across the network, endpoint and cloud, enables our customers to reduce the time to detection as well as complexity and cost. +As a result, we believe Cisco is delivering the most effective and comprehensive security solutions in the market. This differentiated strategy drove the 8% revenue growth in our Security portfolio, and we also saw continued momentum in our Security deferred revenue with 42% growth. +To summarize, we delivered a solid quarter as we continue to execute well against our strategic priorities. I firmly believe that Cisco is well positioned to capture long-term growth opportunities ahead. We remain focused on providing our customers with the most innovative portfolio of offerings in the industry, powered by intent-based capabilities and delivered through a range of consumption models, providing more flexibility than ever before. +Now I'll turn it over to Kelly to walk through more detail on our financials. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter followed by the Q2 outlook. +Total revenue was $12.1 billion, down 2%. We continue to focus on driving margins and profitability with non-GAAP operating margin of 30.4%. Non-GAAP EPS was $0.61, and operating cash flow was strong, growing 13% to $3.1 billion. +The rule of enterprise IT is dramatically changing with the move to an application-centric focus and adoption of hybrid cloud architectures, with customers increasingly seeing the value of integrated platforms over standalone products. Cisco's intent-driven architecture with a focus on simplicity, automation and security allows enterprises to manage and govern the interactions of users, devices and applications across the environment. +Starting in Q1, to better reflect this shift, we've changed our product reporting categories, which are now Infrastructure Platforms, Applications, Security, Other Products and Services. +So let me give you a little bit more detail on our Q1 revenue. +Total product revenue was down 3%. Infrastructure Platforms declined 4%, with the vast majority of the decline driven by routing products. This was driven by continued weakness in Service Provider and a slowdown in enterprise routing. +Our Switching revenue was down modestly, but we saw good momentum on orders and Campus Switching with the network intuitive launch. Additionally, we did see continued strong wireless revenue performance and solid uptake of our HyperFlex data center offering. +Let's move on to Applications. To remind you, applications is made up our collaboration portfolio of Unified Communications, conferencing and TelePresence as well as our IoT and application software businesses such as AppDynamics and Jasper. Applications increased 6% in total, with collaboration up modestly and AppDynamics driving most of the increase. We did see strong growth in deferred revenue of 18%. There was also a strong increase in the unbilled deferred, which is not on the balance sheet, bringing the combined total of deferred revenue plus unbilled deferred up 32%. +Security was up 8%, with strong performance in unified threat, advanced threat and web security, and deferred revenue grew 42% as we continue to drive more subscription-based software offers. +Service revenue was up 1%, driven by growth in software and solution services. During the quarter, we introduced a new portfolio of subscription offers called Business Critical and High-value Services, powered by AI to predict future IT failures before they happen. We drove good growth in deferred revenue, which was up 10% in total, with product up 16% and services up 5%. Deferred product revenue from our recurring software and subscription offers was up 37% to $5.2 billion. +We continue to transform our business, delivering more software offerings and driving more subscriptions in recurring revenue. In Q1, we generated 32% of our total revenue from recurring offers, an increase of over 3 points from a year ago. Revenue from software subscriptions was 52% of our software revenue. +In terms of orders in Q1, total products orders grew 1%. Looking at our geographies, Americas grew 1%, EMEA was up 2% and APJC grew 1%. Total emerging markets declined 6%, with the BRICs plus Mexico also down 9%. +In our customer segments, enterprise declined 5%, commercial grew 12%, public sector was up 3% and service provider declined 6%. +From a non-GAAP profitability perspective, total Q1 growth margin was 63.7%, down 1.5 points; product gross margin was 63.0%, down 1.8 points; and service gross margin was 65.6%, down 0.6 points. We continue to be negatively impacted by higher memory pricing, like we've discussed over the past several calls, which we expect to continue in the near term. +Our operating margin was 30.4%, down 1.2 points. +When we look at the impact of acquisitions on our results year-over-year, there has been a 60 basis point positive impact on revenue, no impact on gross margin, a 3-point increase on non-GAAP operating expenses, all resulting in a negative 70 basis points impact on our non-GAAP operating margin rate and a negative $0.01 year-over-year impact on our GAAP EPS. +In terms of the bottom line, our Q1 non-GAAP EPS was $0.61, while GAAP EPS was $0.48. +We ended Q1 with total cash, cash equivalents and investments of $71.6 billion, with $2.5 billion available in the U.S. Q1 operating cash flow had very strong growth of 13% to $3.1 billion. And free cash flow was also very strong with growth of 19% to $2.9 billion. +From a capital allocation perspective, we returned $3.1 billion to shareholders during the quarter that included $1.6 billion of share repurchases and $1.4 billion for our quarterly dividend. +To summarize, in Q1, we continued to make progress on our strategic growth priorities while maintaining rigorous discipline on profitability and cash generation. We continue to prioritize our key investments to drive long-term profitable growth. +Let me reiterate our guidance for the second quarter of fiscal year '18. This guidance includes the type of forward-looking information that Marilyn referred to earlier. And also, as Chuck mentioned, we announced a definitive agreement to acquire BroadSoft. The acquisition is expected to close after completion of the customary regulatory reviews, and therefore, it is not included in the guidance. +We expect revenue growth in the range of 1% to 3% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 62.5% to 63.5%. And the non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%, and the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.58 to $0.60. +I'll now turn it back to Marilyn so we can move into Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Mark, let's go ahead and open the line for questions. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from the line of Pierre Ferragu with Sanford C. Bernstein & Co. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, Sanford C. Bernstein & Co., LLC., Research Division - Former Senior Analyst [2] +-------------------------------------------------------------------------------- + + Kelly, I can't help asking you an update on gross margin movements. So can you give us a bit of a sense of how big is memory prices in the 1.5 points gross margin declines that you've seen year-on-year? And then sequentially, your guide for gross margin in -- for Q2 was slightly below what you've been guiding for Q1. Is there still like incremental headwind coming from compound pricing hurting you from the Q1 to Q2? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Yes. Thanks, Pierre. Great question. Yes, so the vast majority of the impact on our gross margin is driven by memory. It is basically 1.3 points of my product gross margin decline year-over-year. Everything else in our gross margin is basically in the normal ranges. So we expect that to continue. When you look at the guidance, we did bring it down 0.5 point to account for that because we are still seeing increases as we look forward -- moving forward. But otherwise, we kind of see everything else in the normal range of things. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moskowitz with Barclays Capital. + +-------------------------------------------------------------------------------- +Mark Alan Moskowitz, Barclays Bank PLC, Research Division - Former Director [5] +-------------------------------------------------------------------------------- + + Chuck, you talked about 1,100 customers have already adopted the intuitive network. I just want to get a sense in terms of how does that underpin, longer term, the steady-state growth? You guys guided to about 1% to 3% growth for the current quarter. But as more and more of those customers adopt and they move beyond the labs and move beyond the proof-of-concept, can we actually see your growth tick higher than 1% to 3% on a steady-state? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [6] +-------------------------------------------------------------------------------- + + Yes, Mark. Thanks for the question. So clearly, we're pleased with where we're going right now with this product portfolio. We're pleased with the early feedback. I'll tell you that our sales teams, our partners and our customers, are very excited about the architecture that we've announced. It's still one quarter, so we have to get a little more time under our belt. +But what I will tell you is that when we look back at a transition like the 3850 years and years ago, it's very much in line. And I think that as more customers have the opportunity to test the automation and programmability and all those software features that they're testing right now, we would hope that the platform continues to accelerate. So one quarter down, but we feel good about where we are. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Steven Milunovich with UBS Securities. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, UBS Investment Bank, Research Division - Former MD and IT Hardware & EMS Analyst [8] +-------------------------------------------------------------------------------- + + To continue along those lines, Chuck, you talked a little bit about the software attach rates. Could you elaborate on that? And particularly the advantage premium, which, I think, has the encryption capability and so forth? Exactly what sort of mix are you seeing? And do you think that customers are going to be willing to pay up for the premium? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + Well, thanks, Steve. So what I said in the script is that a vast majority of our customers that are buying these platforms are opting for the advanced. And I would say that it's a vast majority. We knew when we introduced a subscription on a switch that we needed to ensure that there was unique innovation that was available to our customers in order for them to see value in that. +We couldn't just simply shift the capabilities that they had gotten before in a perpetual model. We needed to drive new innovation. So the anchors that are in that advanced subscription are the overall automation capability, which really gets at the OpEx of running these networks; and the second part is the Encrypted Traffic Analytics, where we can determine when there's malware inside encrypted traffic without decrypting it. +And we think that those 2 are phenomenal incremental capabilities that our customers didn't have before, and I think that's why we're seeing such a high attach rate. So we're very pleased with where we are on that as well. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question is from Vijay Bhagavath with Deutsche Bank securities. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [11] +-------------------------------------------------------------------------------- + + Yes, my question for you, Chuck, and Kelly, please join in, is has anything changed in your sales motion in terms of data center switching? And the reason I ask is we are starting to see this positive news flow, Alibaba cloud recently and, perhaps here in Microsoft as well. +What has changed in your view, Chuck, in terms of the sales motion? Is it the clouds paying attention to things like software automation tools, security? Anything else? Or is it just a sales focus on cloud? Help us understand. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Vijay, thanks for the question. We've been talking about this for several calls now, about how we've reengaged with the large web scale providers back -- right after I became CEO, and these are long processes as they made major architectural decisions and they have franchises that you're trying to reenter. +But if you look at whether it's the announcements we've made with Microsoft a couple of quarters ago, the announcement we made with Google, you alluded to Alibaba, which there's a summary of that win on our website, if you want to go see that. It's our first insertion there. And actually, it was before the large sales day they experienced, I think, last week. +And so we continue to make progress, and we're continuing to execute on what I told you that we're executing on over the last 1.5 years, which is trying to go deeper. I think the other thing that has become eminently clear is that these large web scale providers realize that it is going to be a multi-cloud world, and they definitely have come to the conclusion that the Edge is going to be mission-critical for our customers going forward. +And as I think about that, we're a very natural -- we're the very natural partner for them to partner with as the network is the only common denominator across all these cloud environments all the way out to the edge of our enterprise customers' networks. So we're just continuing to execute against what we set out 2 years ago, and we hope to continue to seek success. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [14] +-------------------------------------------------------------------------------- + + Chuck and Kelly, recognize you guys are no longer breaking it out, but I'm hoping that you'll throw us a bone and put numbers on the data center switching revenue growth, given how important it is and how stronger growth market that's been. And as part of that, Chuck, related to the previous question, can you give us any quantification of your progress with the Web 2.0 hyperscale customer segment, given the importance of that segment? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes. So Paul, yes, I mean, obviously, we're trying to go to new groupings. But just to give you some color. I mean, we continue to see the double-digit growth that we've been talking about of our ACI portfolio, continue in the strong double digits. And overall, data center was certainly up from a revenue perspective. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + And I think, Paul, from a perspective of the web scale, I mean, it's really just what I described. We're in discussions with all of them. We have made announcements with several of them, and we continue to execute against our strategy. And again, it's -- these are large franchises. There's 2 facets. And if you remember on a call back -- 2 or 3 calls back, I said that we're now expanding our discussions into 360-degree relationship discussions. +The Google announcement was reflective of that comment because not only are we working on their infrastructure, but we're also working significantly on this multi-cloud enablement, hybrid cloud enablement and helping bridge our customers -- their premise-based solutions, their Edge-based solutions, their cloud applications, their SaaS applications. And so we just -- we're continuing to execute on that right now. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question is from Ittai Kidron with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [18] +-------------------------------------------------------------------------------- + + Nice to see growth on the guide. I had a couple of things. First of all, for you, Kelly, can you update us on the number of Cisco ONE customers? Just as a housekeeping. And then for you, Chuck, getting a little bit deeper into the infrastructure part of the business. Great color there on the product lines, but maybe you can help us fine tune a couple of things. One, on the hyperconverged, I think Kelly actually mentioned that you were off to a good start there. +But maybe you can help us understand where you stand on that product line, how good you feel about the platform, how stable it is. And then the weakness in the enterprise routing, I'm just trying to understand how much of it is a secular issue, meaning SD-WAN is starting to make an impact there versus an execution or seasonal element. Is this going to be another part of your business that's just going to be under pressure for a long time as routing has been? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + Kelly, you want to... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, I'll just hit the Cisco ONE. Cisco ONE continues to have great momentum. We're over 22,000 customers at this point with that. So still great momentum. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Yes, Ittai, just -- so thanks for your comments, by the way. On the hyperconverged offer or HyperFlex offer, I would tell you that it has continued to probably be at the high-end of my expectations. I'd say a couple of quarters ago, it began to exceed what I was expecting, so I changed my expectations. And it's -- but they're doing a great job. The teams are doing well. I think we know the use cases where it's very competitive, and I think that it continues to -- they continue to operate at the high end of what I expected from them. So we're very pleased with that. +On the question relative to SD-WAN, I think you nailed it, right. The -- our customers, and we've talked about this for a couple of calls, our customers have been trying to assess what this SD-WAN architectural transition looks like. And I think that after we acquired Viptela, we have now, at our sales meeting, we provided tremendous clarity to our sales organization and our partner community at the Partner Summit about what our strategy is. We've now taken customers through the road maps of what they can expect and then -- and how to position the different alternatives that we have and how those portfolios are going to come together over the next 12 to 18 months. +So I think that it is a by-product of the SD-WAN discussion. And I would expect that we'll start to see customers move somewhat this quarter. And then in the second half of the year, I think our customers will continue to begin to deploy some of these solutions. So again, happy with where we are relative to the positioning of the different platforms. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question is from George Notter with Jefferies. + +-------------------------------------------------------------------------------- +George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [23] +-------------------------------------------------------------------------------- + + I guess, I was curious about the revenue headwind associated with the move to a subscription model, including Cisco ONE. Can you remind us what you wound up seeing in terms of the headwind in the October quarter, and then also, what you're assuming for January? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes, George, thanks for the question. Yes, right now, we're still seeing it around that 2% range. We expect the headwind to grow once the -- once we continue to grow the intuitive network that has a subscription. As that grows, that'll grow. But right now, it's in that 2% range, 1.5% to 2% range. And we expect that to be roughly in that range next quarter as well. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question is from Tal Liani with Bank of America Securities Merrill Lynch. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [26] +-------------------------------------------------------------------------------- + + My question is almost a follow-up to the previous question. Can you elaborate? I know you started at the beginning of the year to do the Subscription for Switching. Can you elaborate on, first of all, the experience you've had so far, cases where customers took the subscription versus didn't take? +What does it include? Just elaborate on the subscription and kind of the profile of it and also the take rate so far and whether you need to make any changes to it in order to improve take rates, et cetera. I'm just trying to understand the implications for future years. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + Yes. So Tal, thanks for the question. Let me break it down. So the advanced subscription today is primarily being sold on the new Catalyst 9000, even though it's backwards compatible with a couple of years worth of our, I don't know, 2, 3 years' worth of products that we've shipped in wireless and in routing, et cetera. +But what the customers are doing right now is they're basically becoming accustomed to the platform. They're testing the platform before they make an investment on any sort of backwards compatibility is what I would tell you. I don't think we need to make any changes right now because the attach rate of the most advanced subscription offer is at the very high end of what I would've expected. +So I think we're very pleased with where it is right now. And assuming we execute on the value and the innovation that our customers continue to gain from that, then I think that we'll begin to see them then buy the subscriptions on some of their installed base as well. That would be our intent. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + And just to add to that, I mean, just to be clear, 100% of the switches we're selling come with a subscription. It's just a difference on what additional features and security are added between the Advantage and the Essentials. So 100% of the new switches are sold with a subscription, and that's going well. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question is from Mitchell Steves with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [30] +-------------------------------------------------------------------------------- + + I wanted to focus on the Security angle. So despite having pretty difficult comparisons last year, still up 8%, so can you maybe provide some color what's going well there? And then secondly, any sort of growth rates or rough numbers with the advanced threat versus web security growth rates? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [31] +-------------------------------------------------------------------------------- + + Thanks, Mitch. So I think that the thing that is resonating with the customer is if you look at the environments that they're all beginning to operate in, they're operating in an environment where they have multiple SaaS providers, multiple cloud providers. They've got their private data centers with applications running. They've got their branch networks. They've got now Edge connectivity with IoT coming in. +And so the robustness of an architecture that they have to have that protects across the network, across the endpoint, across the cloud is really what, I think, is differentiating it. And we've also -- we've been on a multi-year journey of selling software and subscriptions against the threat intelligence and the malware intelligence that we have, and I think that's what's continuing to pay off. So I think it's resonating with our customers, and it's an architecture that we can continue to innovate on. We continue to expand on. And Kelly, any comments on the... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Yes. I mean, I'd just say advanced threat and unified threat as well as even web security, they're all up big double digits. I mean, just really strong growth. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Next question is from James Faucette with Morgan Stanley Investment Research. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [34] +-------------------------------------------------------------------------------- + + I wanted to ask a question on capital structure. Can you give us an idea of what your preference is and priorities will be in capital structure in terms of buybacks and acquisitions, et cetera, if the proposed new tax changes pass versus if that change in tax law gets derailed? I'm particularly curious as to how you're thinking about the pacing of acquisitions versus buybacks, et cetera. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Yes, I'll take that one. What I'd say is in terms of acquisitions, the tax policy isn't impacting us either way because we are lucky to have a great cash flow and access to capital. So it hasn't been stopping us from anything from an acquisition perspective, and it won't. So that will continue. I would say we're definitely encouraged by the progress that's going on in the tax reform. +So like we said in the past, when that happens and if we get a repatriation, which most plans currently have, we're going to continue, like we have, growing our dividend with our earnings growth. And where we have opportunity is really to get much more aggressive than we have been on the share buyback. And of course, we want to make sure we continue to have enough firepower to continue to able to do the right acquisitions to help us position Cisco right for the long term. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question is from Simon Leopold with Raymond James & Associates. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [37] +-------------------------------------------------------------------------------- + + I wanted to see if you could give us a little bit more insight into what you would attribute the outlook to in terms of this is the first quarter with year-over-year growth we've seen in quite some time. So I'm wondering, if we attribute it to an easy comparison or lapping the buildup of deferred revenue or some specific product cycles, if you could help us assess the key elements bringing you back to year-over-year growth. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Kelly, you want to... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Yes, sure. I mean, I'll give you some color. I'd say, it's a combination of things, right? I mean, if I go to the amount of revenue coming off the balance sheet from the progress we've been steadily making on growing our software and subscriptions, it's now up to 12% of our product revenue is now coming from recurring offers and off the balance sheet. So that's helping. +I would say also, the launch that we had on the intuitive network and the excitement around the reinvention of the core is having an impact. So we're encouraged. And you heard me mention, we're seeing positive demand on [man or wan] Campus Switching overall, which is great, and that has a big impact because it's one of the biggest pieces of our portfolio. +So that, combined with pretty good orders like we had in Q1, gives us a very good backlog position that allows us to have a good view into what the next quarter looks like. So I'd say, overall, the overall strategy, what we've been executing and talking about for the last couple of years here is we've been making progress, and all of this is benefiting us in the outlook. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + James, just to clarify one point or just to add to it, actually, when Kelly says 12% of our product revenue is coming from recurring offers, just to put that in perspective, when I became CEO, it was 6%. So we've effectively doubled that. And I think that's certainly helpful. And just we have seen -- we're seeing positive feedback on the launch. So I'm sorry that was Simon. I apologize, Simon. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question is from Jeffrey Kvaal with Nomura Securities International. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [42] +-------------------------------------------------------------------------------- + + Jeff? + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [43] +-------------------------------------------------------------------------------- + + Oh, sorry. I'm on mute. Pardon me. Yes, I was hoping to ask about competition in the Enterprise Switching space. And we've seen a little bit more out of Huawei perhaps, not in the U.S., of course, but international. I'm wondering if you could put some of that color into context for us, both from them and also from some of your traditional rivals. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + In the enterprise switches? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [45] +-------------------------------------------------------------------------------- + + Yes, enterprise. Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + So thanks for the question, Jeff. I think that if you look at some of the performance we saw around the world, to your point, in Europe and Asia, we've talked about Huawei's activity over the last couple of quarters. I would say that our teams have been very focused on it. I think that the intuitive network launch that we did in June really changes the discussion. +And where we compete with competitors who their value prop is upfront cost of the hardware, I think we're changing the discussion, because if you look at the cost of operating this infrastructure over a 5-year period, it's probably 10x the cost of the upfront hardware. +So going and helping our customers really reduced that is a value proposition that helps us change the discussion relative to the competition. So they continue to be very tough, but we think that competing on the price of the box upfront is something that we can shift over the next couple of years. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Our next question is from Erik Suppiger with JMP Securities. + +-------------------------------------------------------------------------------- +Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [48] +-------------------------------------------------------------------------------- + + It was good to see Security picking up. What are your expectations for Security growth? In the past, you've talked about driving double-digit growth on the Security side. Is that still a goal? And where do you think you are in terms of getting there? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + Yes, Erik, thanks for that. So at our financial analyst conference this summer, we articulated a long-range guide in line with what you just described. We're going to have quarters that are going to be -- that are going to vary from that. But that's definitely our long-term objective. +And I think our teams are focused now on what is it we need to do for the next wave of this architecture. Once we have this architecture built, where we can actually defend and apply real-time defense against known threats, we can learn about a threat through malware and e-mail, and we can protect against it in the network and the cloud and the devices at the endpoint all at the same time. +So the teams are working hard to continue to drive innovation there, but also looking at what other elements can we fit into this architecture over time. And I think that's how we think about the long-term guide. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our last question comes from the line of Jim Suva with Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [51] +-------------------------------------------------------------------------------- + + It's Jim Suva from Citi. On your guidance of up 1 to 3, as talked about earlier, it's the first time you guys have seen year-over-year revenue growth for quite a long time. Kelly and Chuck, you've mentioned strength in orders and also the subscription model taking traction. +Are we now at a point where a shift to subscription is no longer dragging down year-over-year comps? Or that still a bit of a challenge in the orders that Chuck mentioned are just so much stronger? And Chuck, any end market areas we should think about for that order strength? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [52] +-------------------------------------------------------------------------------- + + Yes, I'll take the first part. I'd say no. We're still, I'd say, growing the base of the offers faster and putting it on the balance sheet than it's coming off. But again, both the year-over-year increase of the balance of $5.2 billion was up 37%, and my income statement was up 37% as well. But I'm still putting more and more offers. And as we get scale through the core networking, not just on Switching but the whole DNA Center, I think that'll continue to add. +So it's still going to be a headwind. And as I said before, this 1.5 to 2 points will move to more like a 2 to 3 points in the upcoming years as we get more scale there. So more to come, but again, we're benefiting from -- we're starting to see the benefit of just having more stability and being able to have a better line of sight and less massive fluctuation by having that. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + And Jim, just a market segment perspective that it's probably pretty clear. We saw service provider pretty much the same as it has been for some period of time. Our largest enterprise customers, which the way we define it, is really just an organizational segment that we have, we did see -- we saw negative mid-single digits there, which you saw on the slides. +In our commercial business, we saw 12% growth on a global basis, and it was double digits in every geography, which is always good to see. Our enterprise customers, what I would tell you is that they are -- they're some of the biggest customers who take the longest amount of time to evaluate new platforms and new capabilities like the network intuitive as well as this whole SD-WAN discussion. So we're actively in those discussions with the enterprise customers. +And our commercial customers tend to just move more quickly than others. And then finally, on the Public Sector side, which we didn't talk about a lot, I think, the big call-out there, I would say, is that 2 quarters ago, we talked about the pressure in the Federal, business. Last quarter, we said we saw it improving. And what I would tell you is that in this quarter, we saw the year end that was -- that seemed fairly normal. +While they still have a lot of leadership roles that haven't been filled and we still have the impending December debt ceiling issue, overall, for this quarter, we saw the federal business pretty much back to what we expected as we closed the quarter. So that's probably commentary I can provide on the market segments. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [54] +-------------------------------------------------------------------------------- + + Okay. I think we are... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + Well, that's it, isn't it? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [56] +-------------------------------------------------------------------------------- + + Yes. We're going to wrap up. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [57] +-------------------------------------------------------------------------------- + + Okay. I'll wrap it. Thanks, everyone, again for joining us today. I want to -- I just want to wrap with a few points. First off, we are committed to executing on this vision to deliver a highly secure, intelligent platform for our customers' digital business. And we are laser focused on 5 key elements of that strategy to enable our customer success and drive profitable growth for us and shareholder value as well. +First, we are fundamentally reinventing networking with our intent-based networking platform. We intend to further accelerate our leadership here, extending intuitive technologies across the broad portfolio that we have while increasing application visibility and automation. +Secondly, security is fundamental to everything we do. You can't build a next-generation digital business without a comprehensive security strategy across endpoints, network and the cloud. Third, it is very clear that it's a multi-cloud world, and Cisco is in a unique position to help our customers navigate this by expanding our multi-cloud portfolio and extending our web scale partnerships with strategic cloud providers. +Our Google partnership's an example of the work we are doing with all of the large web scale providers. Fourth, we're unlocking the power of the data with advanced analytics such as our solutions with AppDynamics, Encrypted Traffic Analytics and TELUS threat intelligence. +We are also embedding AI and machine learning technologies across the breadth of our portfolio. And lastly, we will continue to deliver a more enhanced customer and employee experience through our broad collaboration portfolio, including our intent to acquire BroadSoft. +Marilyn, I'll turn it back over to you. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [58] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2018 second quarter results, will be on Wednesday, February 14, 2018 at 1:30 p.m. Pacific time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, please feel free to contact the Cisco Investor Relations Department, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (866) 421-0447. For participants dialing from outside the U.S, please dial (203) 369-0803. This concludes today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2018-Aug-15-CSCO.txt b/Transcripts/CSCO/2018-Aug-15-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..aad0fca672475a73aeabe1e41dc1d7c804c84b52 --- /dev/null +++ b/Transcripts/CSCO/2018-Aug-15-CSCO.txt @@ -0,0 +1,494 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Cisco Systems Inc Earnings Call +AUGUST 15, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * James Edward Fish + Piper Jaffray Companies, Research Division - Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Jim Suva + Citigroup Inc, Research Division - Director + * George Charles Notter + Jefferies LLC, Research Division - MD & Equity Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Fourth Quarter Fiscal Year 2018 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's Fourth Quarter Fiscal 2018 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be on a year-over-year basis unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2019. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. +As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. We had a very strong finish to a great year. We generated our highest quarterly revenue of $12.8 billion and non-GAAP EPS of $0.70, as growth accelerated for another consecutive quarter. +Our momentum was broad-based across our portfolio, customer segments and geographies. We also continued to generate solid margins, cash flow and returns for our shareholders. Our results demonstrate a combination of strong customer adoption of our latest innovations, the ongoing value customers see in our software and subscription offerings and excellent execution across our customer segments and geographies. Our strategy is working, and we believe that we are well-positioned to capture growth across the portfolio with our pipeline of innovation. +The broad adoption of multi-cloud environments is changing the very nature of how modern IT infrastructures are built and secured, and Cisco is at the center of this transition. The recently announced intent to acquire Duo Security is another example of how we are extending our intent-based networking portfolio for the multi-cloud world. Duo's SaaS-delivered solution will expand our cloud security capabilities to help enable any user on any device to securely connect to any application on any network. Combining Cisco's network, endpoint and cloud security platform with Duo's zero-trust authentication and access solutions, we will be able to further enhance the industry's broadest and most effective security architecture in the market. +Now I'll briefly highlight some of our innovation and the great momentum we're seeing across our key product areas. +Starting with Infrastructure Platforms. We continue to rapidly innovate and transform our technology portfolio to drive even greater customer value. A year ago, we reinvented Enterprise Networking with the launch of our intent-based networking architecture. This quarter, we saw continued strength in Infrastructure Platforms, driven by the Catalyst 9000, as customers look to us to simplify and automate their networks. Over the last year, we introduced additional innovations across our networking portfolio, including new access, WAN and data center offerings. In June, we announced new developer capabilities across our intent-based networking portfolio, spanning all network domains: Campus switching, wireless, WAN, data center and cloud. +We're also excited that our developer program, DevNet, surpassed 500,000 registered members. As part of this program, we introduced new offerings to help developers and network engineers innovate throughout our intent-based architecture. +As we all know, the WAN is undergoing an architectural transition to a software-defined WAN to enable IT to rapidly respond to changing business needs in a digital and cloud world. Our customers are driving this transition and looking to Cisco to help them make this shift. Our SD-WAN portfolio leverages our leading networking products, automation and robust security architecture to enable greater flexibility, increased bandwidth and lower costs. This quarter, we saw significant traction with Viptela, as it has now been deployed at over 800 customers, driven by our ability to provide higher capacity at a lower cost. We are pleased with the ongoing integration of Viptela with our core portfolio to drive even more value for our customers. +As our customers move to a multi-cloud environment, we see tremendous opportunities to provide value to them by redesigning their IT architecture, delivering security and building, orchestrating and managing applications. In Q4, we saw the production launch of our hybrid cloud solution with Google, the introduction of a multi-cloud solution with NetApp and numerous engagements with customers redesigning their IT architectures. We continue to believe Cisco is very well-positioned to benefit from the increasing adoption of multi-cloud. +Turning to security. Security continues to be our customers' #1 concern and it is a top priority for us. Our strategy is to simplify and increase security efficacy through an architectural approach, with products that work together and share analytics and actionable threat intelligence. This architecture is supported by Talos, one of the largest commercial threat intelligence teams in the world. We identify and protect against new and emerging threats, like the recent VPN filter vulnerability, through our sophisticated infrastructure and unrivaled telemetry of data. +Cisco is the largest network and enterprise security company, and our approach of bringing security into the intent-based architecture and offering security across the network, endpoint and cloud has proven to be very successful. This quarter, we saw continued strong momentum with revenue again accelerating and growing double digits year-over-year. +We continue to invest in our product and technology innovation as we are committed to helping our customers on their multi-cloud journey. Our focus is on delivering cloud security solutions that provide ease-of-use, scalability and protect end users. As I mentioned earlier, with our acquisition of Duo Security, we will further enhance how we deliver simple, automated, trusted access anywhere for our customers' environments. +Moving to applications. In May, we announced the launch of WebEx Teams, bringing together meetings, calling and teamwork into an integrated experience as part of the WebEx platform. In Q4, we introduced major new enhancements to the platform, including a new user design for WebEx Meetings and a new solution with Google, combining their contact center AI service with the WebEx platform. With more than 3 million customer service agents globally using Cisco's contact center software, our integration with Google will help to automate responses in our call centers by leveraging data and intelligence from AI. +We also achieved another robust quarter of growth with AppDynamics, underscoring the importance and value of our unique end-to-end visibility and analytics from the end user to the network to the application. +To wrap up, 2018 was a great year. We returned to growth, invested in our core franchises, delivered new innovative platforms and continued to shift our business to more software and subscriptions. Our record results demonstrate the strength of our business as well as the strategic focus and execution that we have delivered over the past 12 months. I want to thank our teams around the globe for delivering these results. +We are looking forward to fiscal year '19 with a clear focus on growth, execution and innovation. We see incredible opportunities across our business and believe we are uniquely positioned to deliver on our vision to be one of the most strategic partners to our customers as they go through their digital transformation. +Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter, then cover the full fiscal year and the Q1 outlook. +Q4 was a solid quarter across the business. We executed well with strong orders, revenue growth, margins, EPS and operating cash flow. It was great to see accelerated momentum in product orders, which grew 7%. +Total revenue was $12.8 billion, up 6%. Our non-GAAP operating margin rate was 30.9%. Non-GAAP net income was $3.3 billion, up 8%. And non-GAAP EPS was $0.70, up 15%. +Let me provide some more detail on our Q4 revenue. Total product revenue was up 7%, with broad strength across the portfolio. Infrastructure Platforms grew 7%, with growth in all businesses except for routing, which was down slightly. Switching had another great quarter with strong growth in campus, driven by the ramp of the Cat 9K and growth in data center driven by the Nexus 9K. We saw good growth in wireless with strength in Meraki and our Wave 2 offerings. Data center had very strong double-digit growth driven by servers and HyperFlex. Routing declined slightly driven by weakness in SP routing. Applications was up 10% in total with growth across all the businesses. We saw very solid growth in Unified Communications, TelePresence, conferencing and AppDynamics. Security was up 12%, with strong performance in network security, unified threat, policy and access and web security. Service revenue was up 3%, driven by growth in advanced services as well as Software and Solution Support. +We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q4, recurring revenue was 32% of total revenue, an increase of 1 point from a year ago. Revenue from subscriptions was 56% of our total software revenue, up 5 points year-over-year. We drove good growth in deferred revenue, which was up 6% in total, with product up 15% and services up 1%. Deferred product revenue from our recurring software and subscription offers was $6.1 billion, up 23%. There was also a strong increase in the unbilled deferred, which is not on the balance sheet. The combined total deferred revenue plus unbilled deferred was up 28%. +When we look at the impact of acquisitions on our Q4 results year-over-year, there was a 90 basis point positive impact on revenue. We saw especially strong momentum in Q4 with total product orders growing 7%. +Looking at our geographies. Americas grew 6%, EMEA was up 6% and APJC was up 12%. Total emerging markets was up 12%, with the BRICS plus Mexico up 22%. +In our customer segments, enterprise was up 11%; commercial was up 9%; public sector was up 1%; and service provider returned to growth, up 6%. Our product backlog at the end of Q4 was $6.6 billion, up 38% year-over-year. +From a non-GAAP gross margin perspective, total Q4 gross margin was 62.9%, down 0.8 points. Product gross margin was 61.5%, down 0.4 points. And service gross margin was 67.1%, down 1.7 points. Product gross margin was down 0.4 points, driven by our APJC region related to some SP-specific deals as well as negative product mix. Product gross margin for the Americas and EMEA were both up year-over-year. +Overall, pricing continued to have relatively modest erosion, as we have seen over the past couple of quarters, and we continue to be negatively impacted by higher component costs, which we expect to continue in the near term. +In terms of the bottom line from a GAAP perspective, Q4 net income was $3.8 billion and EPS was $0.81. The GAAP results include an $863 million benefit related to the Tax Cuts and Jobs Act. We've excluded the benefit from our non-GAAP results. +We ended Q4 with total cash, cash equivalents and investments of $46.5 billion. Q4 operating cash flow was $4.1 billion, up 2%, with free cash flow of $3.9 billion, also up 2%. From a capital allocation perspective, we returned $7.5 billion to our shareholders during the quarter that was comprised of $6 billion of share repurchases and $1.5 billion for our quarterly dividend. +I'll now cover the full fiscal year. We delivered solid revenue, margins, net income, EPS and operating cash flows. Revenue was $49.3 billion, up 3%. Our non-GAAP operating margin rate was 31.1%. Non-GAAP net income was $12.7 billion, up 5%. And non-GAAP EPS was $2.60, up 9%. +Our total non-GAAP gross margin was 63.8%, a decrease of 0.5 points, with product gross margin down 0.4 points and service gross margin down 0.9 points. GAAP net income was $110 million, and GAAP EPS was $0.02, which includes the charges related to the Tax Cuts and Jobs Act of $10.4 billion. +For the full fiscal year, we delivered operating cash flow of $13.7 billion. We paid approximately $1.4 billion of onetime foreign taxes during the year related to the Tax Cuts and Jobs Act. Operating cash flow increased 8%, normalized for these tax payments. +We returned $23.6 billion to shareholders over the fiscal year, which represented 184% of our free cash flow that was made up of $17.7 billion of share repurchases and $6 billion for our quarterly dividend. +To summarize, we had a strong Q4 and fiscal year. We executed well with strong top line growth and profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +As a reminder, we are adopting the new revenue recognition standard, ASC 606, as of Q1 fiscal year '19 on a modified retrospective basis. Its primary impact will be to accelerate our revenue recognition for certain software licenses and sales to 2-tier distributors as well as the recognition of a deferred commissions asset that will be amortized over the terms of our sales contracts. +Let me reiterate our guidance for the first quarter of fiscal year '19. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue growth in the range of 5% to 7% year-over-year. This range includes the impact of ASC 606, which we estimate to be a benefit of about 1%. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 30% to 31%. And the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.70 to $0.72. The guidance includes our Service Provider Video Software Solutions business that we recently agreed to sell and excludes the Duo acquisition, since both transactions have not closed. We expect the SPVSS transaction to close in the first half of fiscal '19, subject to customary closing conditions and regulatory approvals. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) +I'll now turn it over to Michelle. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Vijay Bhagavath from Deutsche Bank Securities. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [2] +-------------------------------------------------------------------------------- + + So my question to you, Chuck, and Kelly, please chime in, is it reasonable to assume you'd be extending the software subscription idea and plan across the portfolio? Give us an early glimpse as to how is it going? What are some of the challenges? What are some of the positive surprises? And would the makeup of the software subscription portfolio meaningfully change as you look to extend this model across the portfolio? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Vijay. So most of you know that we -- when we began the sell of the Catalyst 9000, that was the first attempt to sell a subscription software offering on top of a core networking product. And that has gone, as we've said on prior calls, reasonably well. I'm very pleased with how the adoption has been from our customers. They understand the value. As I said early on, we put -- we knew when we started that process that we would need to deliver significant innovation that wasn't available in the traditional methodology of buying it in order for our customers to adopt it. And some of those were the Encrypted Traffic Analytics, the overarching analytic -- I mean, the automation capability and then recently, some Assurance. And you'll see us over the next coming quarters, when we bring new products to market in the -- particularly in the enterprise networking space, but across the portfolio, we will apply that same strategy. So I think that we've been pleased. And our job now is to ensure that the operational infrastructure of the company is prepared, and we're working towards being able to ensure that customers are deriving the value from that software as well as obviously putting in the operational capabilities to ensure the renewals, et cetera. So that's what we're focused on. Kelly, any...? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + No, I think you hit it. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [6] +-------------------------------------------------------------------------------- + + I'm kind of beside myself, don't know where to start. These are so good. But let me -- I guess, let me kick off with a question on the deferred revenue, Kelly. The -- you said that including this off-balance sheet, deferred is up 28%. Is that total deferred or product deferred? Can you just clarify what you meant by that? And also, maybe help us understand what that ASC 606 impact on deferred was because that was, I guess, negative? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Yes, sure. So on your question on the deferred revenue plus unbilled deferred, so that was up 28%. The big driver we have for that, that is just purely product, okay? So it is -- what we mostly have in our unbilled deferred is from our collaboration, our Applications business. They have a lot of periodic billing that they book month-to-month. That is a very large number. So it is kind of apples-to-apples of business that we have booked that we will recognize in the future. So that's why we look at both. When we do adopt ASC 606 for Q1, that will be one of our disclosures, showing you the combination of deferred plus unbilled, so you have our remaining performance obligations. But it is just product, that 28%. As far as the ASC 606, we adopt that in Q1. So in the results we just went through, of the $6.1 billion of deferred from software and subscriptions, that is related to how we've been accounting for it under the old ASC 605. So when we go in... + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + Just to clarify, though, would you write down some -- you'll write some of the deferred down in Q1 as a result of the change or not much or...? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes. So yes, I can give you some direction. You'll see that in our K. So we will be writing off a portion of that balance. So of the $6 billion, we will be writing off and restating because you basically restate your balance sheet for the new accounting rules. And like we've said over the past year, where we will have that impact is things that were term-based software licenses, things like our ELAs or Cisco ONE, those will now be recognized upfront where they used to be deferred. So the deferred revenue balance will be written down for that, and we'll take -- so we'll take -- we'll lower the balance of the deferred revenue. And then as we go into Q1, we will be recognizing any new business that we bill upfront from that. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Ittai Kidron from Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [11] +-------------------------------------------------------------------------------- + + I guess, Chuck, maybe you can help me figure out how you managed to navigate so well in what seems to be such treacherous waters out there between some deceleration in economic activity in Europe; the FX movement recently, which is not favorable to you, although you price in dollars, nonetheless, makes your products a little bit more expensive internationally; poor CapEx matrix out of the large telcos; tariff wars. Globally, you seem to be moving along, sidestepping all of those things. Which of these things really bother you, concern you or you're watchful, you're preparing for? And then second question, maybe you can kind of dig in a little bit on the networking, the Cat 9K, clearly, good progress. Are there any customer matrix or anything you can give us there to help us solidify or get better visibility into the trend there? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Yes, Ittai. I was feeling pretty good until you asked the first part of your question. I have said publicly, I think we're operating in a -- we have been operating in, what I would call, it's been a very consistent global economic scenario. There's clearly, even in the last few weeks, been things that have arisen. You've got the strengthening of the dollar that you mentioned. You've got some uncertainty in a couple of emerging countries. So those are clearly things that we'll watch. And we're -- we've seen these in the past, and we know how to deal with them. We obviously have the impending tariff situation, which we're watching closely. And on that front, we're in deep discussions in Washington with the administration on trying to get to a favorable outcome. We'd like to see that land in a good place. But overall, all of those are things that we are very actively involved with and we watch on a daily basis. As it relates to the networking business, the Catalyst 9000, as I said previously, has been the fastest-ramping product that we've ever built. So the customer count became less of an indicator pretty quickly, and it flowed through to the infrastructure systems growth that you saw this quarter. So we didn't see it as a metric that was -- we usually use that metric on customer count when we're just trying to give you visibility to the ramp of a new product when it hasn't become real material to the revenue line. And I think that we exceeded that point in time with the 9K pretty quickly. But I will tell you, just so you know, I think -- Kelly, keep me honest on this -- I think we had roughly 9,650-plus customers on the 9K as of the end of the quarter. We had a great Q4, great adoption. And we're very happy with where that product and that architecture is. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [14] +-------------------------------------------------------------------------------- + + I actually wanted to ask you about service provider. So you returned to growth this quarter, which is fantastic. And I think you mentioned as well that your routing business was weak, and most of that weakness was in the service provider vertical as well. So I was curious to understand how you grew revenues, if -- even if routing was negative or maybe I got something wrong? And then, of course, I'm very curious to hear whether this recovering service provider spending might be driven by 5G already. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Let me answer the macro question about the overall situation we see in service provider, and then, Kelly, maybe you can cover the routing and the impact, the first part of the question. So Pierre, the -- in the service provider space, we were obviously pleased. I've said a number of times over the last couple of years that this is a business that is dominated by large customers. And so as we've always said, when we have several of them that are slowing their spending, then it looks bad; when we have several that are spending, it looks pretty good. And that's just the nature of this business. Relative to 5G, I will tell you that -- I think I've said this on prior calls. Starting at Mobile World Congress earlier this year, we really -- we heard these customers in earnest begin and engage in discussions around what network requirements would look like for the infrastructure to support 5G, assuming that they're going to add lots of high-speed connections at the edge, it will require high-performance networks with quality of service and slicing and all those things. So I would say that -- I would not say that this is a material result of the implementation of 5G, to be honest. We expect that is still a year out before many will start and probably see it in earnest into 2020, to be fair. But we're pleased with what our teams have done. It's been a tough market. Our teams have continued to battle. And our engineering team continues to work on next-generation innovation, and we're pleased with the results this quarter. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes, and to the point of -- this why have better revenue, if you remember last quarter, the SP segment was down 4%. And you're seeing that flow through the revenue this quarter when we talked about routing overall. So when I look forward, we don't kind of talk about our guidance in the upfront by business. But some of this, on the order side, might play well as you go into Q1. What I will say, adding on to Chuck's comments is, I do think and as you know very well, our service provider segment is made up of very, very large customers. And in any one quarter, we can get big orders, and that can fluctuate around. So as to the sustainability, I would say we feel good about our position, though I expect this could move around either way as we look forward. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Sami Badri from Credit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + My first question has a lot to do with Europe and the strength you saw in the region in this last quarter. And then is it safe to assume that going into next quarter and your very strong guidance, are you expecting to see the same kind of magnitude of strength in Europe again despite all the moving pieces politically? And then the second question I really have is about the Viptela product launch. Are you addressing customers that are already big users, end customers of the campus product and the Meraki products to kind of up-sell customers into your new Viptela product? Or maybe you can give us just an idea on the sales cycle and the customer base that you're addressing. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + If you don't mind, Sami, I'm going to answer the second one, and then I'll give you a little qualitative color on Europe. And then Kelly will answer the specifics on the business expectations. So on the second part of your question relative to Viptela and software-defined WAN, we have 2 offers. We have -- Meraki has an offer -- for those customers who have embraced the Meraki architecture, they have a very effective SD-WAN solution that is actually being well received in their customer base, and they're using it to extend their customer base. So that's been very successful. On the Viptela front, we have been working hard on the integration between the Viptela platform and Cisco's product. And so we're going to have a variety of offerings for our customers. We'll have a version that will have software running on different types of hardware. We'll have a software-only solution. We'll have our integrated ISR solution. And so we're seeing a number of those. This was a quarter where, I would say, we really saw the engagement level increase significantly. We got the offers in the marketplace, the first wave of those. And I said on the Q3 call that our teams were signaling us that Q4 was where we're going to see some of this come to fruition, and we, in fact, did. So we feel good about where we are right now. There's more work to go. We haven't gotten the SD-WAN integration into DNA Center yet. So that will only be, I think, a positive boost when we get that done. The teams are working on that. I think it's coming in one of the upcoming releases. So in general, we're pleased with where we are at this moment in time with Viptela. Europe, our team is doing really well there. Our teams are executing well. I think that they are competing very well because we have some very tough competition there. We have --- the team in Europe is always one of the early teams leading with some of these new technology areas. So they've had a lot of success in this core enterprise networking space as we move to intent-based networking. So we're pleased with what they're doing. We feel the entire global macro environment right now, there are so many dynamics that we're calling it like we see it based on what we know today. And Kelly, you want to comment just on how we see the...? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, I mean, I think just to add to your point, I think the environment's very strong in Europe despite the political things that are going on. And just as a data point, the U.K. is up double digits for us on product orders this quarter. So again, it is -- I think like Chuck was saying, the overall environment is very favorable as of right now. So we're hoping we see this continued strength. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Yes, and a lot of the innovation that we're bringing right now is actually targeted at helping our customers lower the expenses of running this infrastructure. So there's a significant play to be made in -- almost like as customers look at where they are economically, there's reduction of cost by going to this automation platform. There's reduction of cost by moving to SD-WAN. So these are technologies that we are hopeful will continue to be important to our customers regardless. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Samik Chatterjee, you may go ahead, from JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [23] +-------------------------------------------------------------------------------- + + I just had a question on the guide for the first quarter. You clearly have good momentum on the top line, although when I look at the operating margin guidance, it's kind of flat year-over-year. So I was -- just want to check if there's something that's limiting kind of the flow-through of the solid momentum on the top line to the operating margin? Is there something that's limiting the leverage of that to the bottom line? And is that something we should hope for in the future and provides kind of a second leg to the earnings growth? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes, thanks for the question. No, I don't think you need to read anything different of what's happening on the margin. I mean, if I look at the puts and takes that we have to our margin, I spoke a little bit about we can have -- we have a little margin pressure this quarter in some specific deals in APJC. But otherwise, our margin is driven by the same things, right? Our pricing is very robust. We're being very disciplined. The price that you've seen in the last couple of quarters is in a range that's very, very strong, so that's good. We are still facing component headwinds. And even though it's less of a headwind, it is still higher year-over-year. The prices are up, it's, again, just the slope is less. But that's part of what we see, both in Q4 and the guide. And then everything else, it kind of balances out. So right now, this is kind of what we see. We obviously are going to be driving for as much as we possibly can, but it's really the same dynamics. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Paul Silverstein from Cowen. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + A clarification question. Kelly, just in response -- your previous response, I trust you expect DRAM, at a minimum, to moderate come next year. And I'm wondering what -- if you have any thoughts on the impact. And the larger question, I recognize this has been asked and answered in various forms. But Chuck and Kelly, my takeaway from your comments is that there's an awful lot of things going right. And my simple question is, how much of this do you attribute to the macro? And I recognize even in that portion, it's not simple in terms of different moving pieces globally. But how much of the strength is macro-related? How much of it is better execution in various areas like campus switching, et cetera? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + You want to take the first, the clarification on... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes, sure. So on the component stuff, yes, DRAM is loosening, though, again, as I said, the prices still are up, whether you look quarter-on-quarter or year-over-year. But we are optimistic that both on the demand side, which is also driving some of that pricing, we expect that to get better through '19. And I don't know if you want to hit the other broader... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + Paul, it's a virtually impossible question to answer, although I'm pragmatic enough to know that it's a combination of both. I will say that I think that it's -- clearly, the economy has been pretty consistent, and the markets have been positive. So that has certainly helped. And I think correspondingly, this new architecture and the new technology that we brought out first -- about 4 quarters back, actually, right at the end of Q4 from a year earlier, has clearly been adopted at a record pace for us. So I could never possibly give you any sort of split on what that looks like. The best I can do is acknowledge that it's a bit of both. And there are a lot of things going right, right now. But there's also, as we said earlier, and Ittai asked the question, there's a lot of dynamics out there that we're watching very closely. So sorry, I can't give you a better, more specific answer. But I think that's as honest as I can be. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + James Fish from Piper Jaffray. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - Research Analyst [31] +-------------------------------------------------------------------------------- + + It's been a while since we got a security metric update. Can you just kind of walk through some of the past metrics you've given or what you're willing to give today? I know in the past, you've given deferred revenue growth as well as penetration of certain products like FireAMP. And then secondly, HyperFlex version 3.0 was released, I believe, recently. Can we get an update as to kind of how we should think about the sizing of that business or any metrics around hyperconverged infrastructure and how it's competing against the Nutanixes of the world? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Sure. So like I said in the prepared remarks, on the security side, they continue to have -- they're over -- 60% of their business is software. And so obviously, they have a lot of their business going through deferred revenue, and they continue to grow in high double digits. So we feel good about that. They had a very strong Q4. And like I said, from a revenue perspective, it was broad-based this quarter, driving that 12% up on revenue. It was across all of their subsegments. So I'd say it's continuing to grow very quickly. And with this addition of Duo, it really just rounds out the portfolio very well. In terms of HyperFlex, I mean, that's growing very strongly for us. I think this new release has been well-received. And again, we find ourselves in a lot of head-to-head deals and winning against Nutanix, which is obviously a really tough competitor out there. But we feel good about the offer we have. Now it's really fairly small compared to the broader data center business that has all of our servers in there. But we're pleased with how it's ramping and how we're competing. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [33] +-------------------------------------------------------------------------------- + + I think that's exactly right. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Simon Leopold from Raymond James. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [35] +-------------------------------------------------------------------------------- + + I wanted to see if maybe we could talk a little bit longer-term trending, big picture around the concept of multi-cloud, which you talked about at Cisco Live! and on a number of other occasions. Within the answer, I think what I'm looking for is how does this help the evolution and transformation? And importantly, how does this help Cisco do more business with the web-scale customers? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Yes, Simon, so it's a really good question. And I think the key message for us that we're trying to get across is that this transition to this multi-cloud world actually is changing the way our customers look at building their IT infrastructure and how they secure it. So if you just think very simply that -- look back over the last 5 to 7 to 10 years, a great majority of the traffic in our enterprise customers' networks was terminating in their private data centers. So networks were architected and security architectures were built to deal with that reality. Now we're moving into a world where there is still some percentage, depending on the customer, of their traffic that is obviously terminating in a private data center. Then they have traffic terminating in SaaS applications, in multiple public cloud providers. They have this whole IoT edge data aggregation issue. So what's happened is the traffic flows, and the way data is moving across their networks and across their infrastructure, is much more complex than it was 5 to 7 years ago, where it was all very predictable, which leads us to, when you think about, ultimately, our customers are going to just need to build a world where you look at the user, you look at the application, you look at their policy and you look at the destination, and then you have technology in the network that actually provides policy routing, quality security in that world. And that's the role that we're playing with our customers because they need to re-architect their networks to accommodate a massively diverse traffic flow scenario that they're going to deal with. So I'll stop with that right now, but that's why it's so important. And you asked what does that do to our partnerships with the web-scale providers. Well, they understand this dynamic that is going on. And so many of the -- you're seeing some early -- some of the early work we're doing with some of the web-scale providers to ensure that we have integrated hybrid cloud solutions so that we can provide security and policy, whether applications are in the private data center or in the public. They're interested in our ability to process data at the edge as customers are building out IoT applications. They're interested in us helping define security architectures that make it simple for our customers to take advantage of their services. So it's emerging as a really attractive partnership because of the reality that everybody sees in the marketplace today. And hopefully, that was clear. If not, we can have some folks talk to you afterwards. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + James Suva from Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [38] +-------------------------------------------------------------------------------- + + A quick question, Chuck. Earlier in your remarks, you mentioned with service provider strength coming back that you don't believe it's 5G-related, that's more of a 2020 phenomenon. Can you give us a little bit about a history lesson here of back in 3G or 4G or 2G uptakes, was there a linear into-the-build that happened? Is there a pause before the [positive event] happens? Or is it just more of a steady as she goes, as we kind of look ahead more longer term, strategically to 5G impact to Cisco? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + Yes, Jim, it's a good question. I think if you go back and look at the earlier transitions in this space, they have largely been around delivering, and I don't want to say incrementally better, but a better performance for mobile devices that are connected to the network already. So when you go from 3G to 4G, you get better data performance. You're happier with your apps on your phones, et cetera. This is a step-level difference because we're talking about the latency dynamics of 5G and the belief that this will actually enable them to deliver real-time business applications to small offices or remote branches over 5G networks. That's a completely different dynamic. And so I would tell you that we're -- we don't know yet. But I think if you operate under the assumption that it lives up to its billing, then it is going to create a significant demand on the core networks of the service providers. And so I can't say that there's a huge historical example for us to learn from. But I think what you're going to see is just between now and when they start building these things out, they're going to be working on design. And then we're just going to see them begin to gradually build out. As they open up a certain market, they'll build out bandwidth and backbone capacity. And that's how we're thinking about it. And we'll be able to give you guys updates on upcoming quarters as to how we see this thing emerging. It's not going to happen overnight. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Tal Liani from Bank of America Securities Merrill Lynch. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [41] +-------------------------------------------------------------------------------- + + I want to ask about the routing. Just again, it's repeatedly under pressure. And you gave an answer before about Viptela. You're saying that it's going according to the plan. I'm wondering if there's a link between the 2 yet or that the pressure in routing has to do with other things and not to do with SD-WAN. That's the first question, kind of to understand -- or maybe you can provide a different explanation, to understand the pressure on routing and what's the outlook for recovery. Or is it like Nokia and others are saying, that maybe there is a long-term pressure on this market? Second question, just a follow-up on 606. What's the impact on operating margin if you've provided this or you provide this information? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Okay, Tal, let me make a comment on the first one, and then Kelly can add to it and then she can give the 606 answer as well. I think when you look at our routing business, first of all -- Kelly, half of it, 50%, 60% of it is SP, right? I mean, it's -- so it's significantly impacted by the SP. Some of the players you mentioned, they probably have a much higher percentage of their routing businesses coming from service providers, would be my guess. So that's just sort of couched in the discussion on 5G and everything that we've said so far about SP, I'd say, is the answer on that piece of it. From an enterprise perspective, Tal, I think over the last couple of years, we've just seen a classic architectural stall in the marketplace, as we've talked about historically when there's a big architectural transition. And you said that we believe Viptela was going according to plan. I think the way I would characterize it is we've begun to see customers actually move forward with deployments, but it's early. But we like where we are and we like what we see. So I think that -- I think we'll see the enterprise continue to improve relative to this architectural clarity. And I'll let Kelly answer sort of how you think about the overall routing or the 606 question. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + Yes, so on 606, Tal, so just to kind of, again, ground everybody on how we're impacted on 606, so one thing I will say is operationally, nothing has changed, right? We've made no changes to our offers. We've made no changes to our contracts or any changes to our cash conversion cycle. So it is literally just an accounting change. Now what the implications are to us is, like we've said, this is going to accelerate some of our term-based licenses. So we will have to write off some of our deferred revenue. We won't see that revenue, but we will offset that with acceleration of those offers when we book new orders and bill new orders. Net-net, we think it will be a net positive for us of approximately 1%. And so that's the impact on the revenue. It will fall through down through margin. So it's on operating margin, 0.5 point to 70 basis points, roughly, of goodness falling through there. And as we go into the new rev standard as part of our disclosures, we'll be laying out very clearly for everybody, since we have -- we're adopting the modified retrospective approach, we'll lay out very clearly the implications of the new accounting versus what it would have been under the old accounting. So hopefully, that answers your question. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + George Notter, you may go ahead, from Jefferies LLC. + +-------------------------------------------------------------------------------- +George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [45] +-------------------------------------------------------------------------------- + + I guess, Kelly, I was curious about the revenue headwinds that you're seeing from the subscription transition. You've talked about that in the past. I'm just curious about what that might have looked like in the July quarter. And then what do you think that will look like for the October quarter? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [46] +-------------------------------------------------------------------------------- + + Yes, no, that's a great question, George. So there's good news. There's good news there, I would say. So like we anticipated, as we are so rapidly ramping the Cat 9K and as we are blowing out DNA across not only that, but also our Viptela offerings and across wireless, the revenue headwind was getting more closer to 2.5 to 3 points. Now the good news on this is with the new revenue standard going forward, because it's accelerating some of these offers that we did have previously defer, that headwind will become less of a headwind, okay? So as opposed to the 2.5 to 3 under current accounting standards, that will be much less, closer to like 1.5 point or so, if I had to guess roughly. And again, this will all flush out as we go through it, but it will become less of a headwind because we have such a big portion of things that we will now be recognizing upfront. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + You said that it was a 1% increase on the other side... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [48] +-------------------------------------------------------------------------------- + + On the revenue, exactly, exactly. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + So mathematically, it would become a down a point. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [50] +-------------------------------------------------------------------------------- + + The good thing about this accounting standard is it does normalize some of the -- some of the natural headwinds we've had on revenue and margins because of it is now going to kind of come back and benefit us. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [51] +-------------------------------------------------------------------------------- + + All right. I want to -- I think that was the last question, Marilyn? So if I could, just thank everybody for spending time with us today. Thanks for the questions and the dialogue. And Marilyn, I'll turn it back over to you. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [52] +-------------------------------------------------------------------------------- + + Thanks, Chuck, and thanks, everyone. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2019 first quarter earnings results, will be on Wednesday, November 14, 2018, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, please feel free to contact Cisco's Investor Relations department, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (866) 417-5767. For participants dialing from outside the U.S., please dial (203) 369-0735. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2018-Feb-14-CSCO.txt b/Transcripts/CSCO/2018-Feb-14-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e2e75d8be366ef2b8d033a19d79d303b1e93df2 --- /dev/null +++ b/Transcripts/CSCO/2018-Feb-14-CSCO.txt @@ -0,0 +1,524 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Cisco Systems Inc Earnings Call +FEBRUARY 14, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * James Edward Fish + Piper Jaffray Companies, Research Division - Research Analyst + * Jayson Noland + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan Moskowitz + Barclays PLC, Research Division - Research Analyst + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - Research Analyst + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Jason Noah Ader + William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media, and Communications + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco Systems Second Quarter Fiscal Year 2018 Financial Results Conference Call. At the request of Cisco Systems, today's call is being recorded. If anyone has any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- +Thanks, Kim. Welcome, everyone, to Cisco's Second Quarter Fiscal 2018 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the third quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Marilyn, and good afternoon, everyone. We had a great quarter. In Q2, we returned to revenue growth, we continued to drive momentum in our intent-based networking portfolio and saw strength across the business. We made continued progress in shifting more of our business toward software and subscriptions. This performance led to strong margins, solid cash flow and double-digit non-GAAP EPS growth. We are clearly seeing the results of the strategy we've articulated to you over the last 10 quarters. We also increased the dividend and share repurchase authorization, reinforcing the confidence we have in our future. +As we shared with you previously, customers are facing ever-increasing complexity in their IT environments with the proliferation of devices and IoT, the adoption of multiple clouds and the exponential growth of security threats. The network has never been more critical to business success because of its ability to simplify this complexity while enabling real-time informed business decisions. This is why Cisco is well positioned for the future as we help our customers move to highly secure and intelligent platforms for their digital businesses. +Now let me take you through what I'm seeing across the business and how Cisco's innovation is driving momentum across the portfolio. First, let's start with infrastructure platforms. We continue to be intensely focused on delivering differentiated innovation in our core, which has resulted in our return to revenue growth this quarter. Last June, we launched The Network. Intuitive., a fundamental reinvention of networking and the industry's leading intent-based networking portfolio. Two weeks ago, we announced the next phase of this intent-based network innovation with powerful assurance capability spanning across our Data Center, Campus and Wireless portfolios. These will help our customers unlock the power of network data and will bring greater insights and visibility with rich predictive analytics. +We saw strong adoption of our subscription-based Catalyst 9000 switching platform as we more than doubled our customer base from last quarter to over 3,100 customers. This is the fastest-ramping new product introductions we've had in our history and a fantastic example of the innovation we've delivered over the past 2 years. +When I became CEO, I challenged our team to increase the pace of innovation in the space, and I could not be more proud of what they've accomplished. +The network is also a key enabler for our customers as they increasingly adopt a multi-cloud strategy. They need a unified, automated and scalable environment across their data centers, private clouds and public clouds. Cisco's cloud management, analytics, automation and security, combined with strategic partnerships such as Microsoft and Google, position us very well to meet customer needs. +Further extending our cloud-focused software offers, we recently introduced a Cisco container platform to simplify the deployment of cloud-native applications in containers with Kubernetes. This marks an important milestone in our partnership with Google to deliver the future hybrid cloud architecture. In general, we are encouraged with the overall progress we are making with the web-scale community. +Now turning to security. Cybersecurity continues to be a top concern for customers as they evolve their enterprise architectures to address the challenges of a pervasive threat environment. We are leading the security industry with an integrated architecture and a comprehensive best-of-breed portfolio across the network, endpoint and cloud. This approach enables us to share context, intelligence, visibility and policy to reduce the time to detect and respond to threats. +We expanded our endpoint protection capabilities with Cisco Security Connector, a unique security application designed to give enterprises the deepest visibility and control over network activity on iOS devices. Together with Apple, we are helping our joint customers become the most connected, collaborative and secured organizations in the world. +Additionally, Cisco, Apple, Allianz and Aon are collaborating on an industry-first cyber risk management solution, which integrates technology, services and enhanced cyber insurance to make businesses more resilient. +Now moving to applications. The future of applications will unlock the power of trillions of terabytes of data across connected users, things and devices. In today's digital world, we are executing on our strategy to transition more of our business to cloud-based subscriptions and driving increased relevance at the application layer of the stack to enable a better experience for our customers. +We continue to see progress in scaling AppDynamics analytics capabilities. Over 20% of our top 500 global enterprise accounts have already adopted this technology. This is another example of our ability to scale acquisitions through our unparalleled go-to-market model. We also closed the BroadSoft acquisition earlier this month, which provides us with access to its strong user base of 20 million and greatly strengthens our cloud-based collaboration subscription portfolio. +To summarize, I'm very pleased with the traction we're seeing in our business, the progress we're making against our strategy, and I'm very optimistic about our future. +I'd also just like to say how incredibly proud I am of Cisco's leadership in environmental, social and governance issues, including the work we're doing to help solve the global skills gap. Our recent recognition by Barron's as the #1 most sustainable company in the United States underscores our deep commitment to enable a better world in which everyone has the opportunity to thrive. +Now I'll turn it over to Kelly to walk through more details on our financials. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by a discussion of the impact of tax reform and then end with Q3 guidance. +Q2 was a strong quarter with results exceeding our expectations. We executed well in a number of areas, including good orders momentum, solid revenue growth and strong margins and cash flow. Total revenue was $11.9 billion, up 3%. Non-GAAP net income was $3.1 billion, up 10%; and non-GAAP EPS was $0.63, up 11%. Operating cash flow grew 8% to $4.1 billion, with free cash flow up 10%. We continue to focus on driving margins and profitability, increasing our non-GAAP operating margin rate to 31.7%, up 0.7 points. +Let me provide more detail on our Q2 revenue. Total product revenue was up 3%. Infrastructure platforms returned to growth, up 2%, with broad strength across the businesses. Within Switching, we had strong growth in data center switching, and we're seeing great momentum with our new campus switch, the Cat 9K. We also had strong Wireless growth, driven by our Wave 2 offerings and Meraki. Data Center was up double digits, driven by server products as well as our HyperFlex offerings. These increases were partially offset by a modest decline in our routing products, driven by continued weakness in Service Provider. +Let's move on to applications. Applications is made up of our collaboration portfolio of Unified Communications, conferencing and TelePresence; as well as our IoT and application software businesses, Jasper and AppDynamics. Applications was up 6% in total, with strength in TelePresence and conferencing as well as AppDynamics, offset by some weakness in UC endpoints. There was also a strong increase in deferred revenue, up 18%. +Security was up 6%, with strong performance in unified threat and web security. Deferred revenue grew 38% as we continue to drive more subscription-based software offers. +Service revenue was up 3%, driven by growth in software and solutions support. +We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q2, we generated 33% of our total revenue from recurring offers, an increase of 2 points from a year ago. Revenue from subscriptions was 52% of our software revenue. We drove good growth in deferred revenue, which was up 10% in total, with product up 19% and services up 4%. Deferred revenue, product revenue from our recurring software and subscription offers was $5.5 billion, up 36%. +We saw strong momentum in Q2 product orders, growing 5% in total. Looking in our geographies, Americas grew 6%, EMEA was up 6% and APJC was flat. Total emerging markets was up 1%, with the BRICS plus Mexico down 1%. In our customer segments, enterprise was up 3%, commercial grew 14%, public sector was up 8% and service provider declined 5%. +From a non-GAAP profitability perspective, total Q2 growth margin was 64.7%, up 0.6 points. Product gross margin was 63.3%, up 0.9 points. And service gross margin was 68.5%, down 0.3 points. +We continue to be negatively impacted by the higher memory pricing we have discussed over the past several calls, which we expect to continue in the near term. Our operating margin was 31.7%, up 0.7 points. +When we look at the impact of acquisitions on our results year-over-year, there's been an 80 basis point positive impact on revenue and a negative $0.01 year-over-year impact on our non-GAAP EPS. +In terms of the bottom line, our Q2 non-GAAP EPS was $0.63, up 11%. GAAP EPS was a loss of $1.78, driven by the onetime charges related to U.S. tax reform. +We're very pleased with the tax rate reduction related to the Tax Cuts and Jobs Act. Since our fiscal year ends in July, we won't realize a full benefit this year but will start -- and we will start to realize that full year's worth in fiscal year '19. For Q2, our non-GAAP tax rate was 20% to adjust to our full year estimated non-GAAP tax rate of 21%. We are currently forecasting our estimated non-GAAP tax rate for fiscal year '19 to be 20%. This quarter, we incurred an $11.1 billion charge to our income tax provision that is comprised of $9 billion related to the U.S. transition tax, $1.2 billion of foreign withholding tax and $0.9 billion for the remeasurement of our net deferred tax assets related with the lower tax rate. Our Q2 GAAP tax rate includes the impact of this charge while our non-GAAP rate excludes it. +We ended Q2 with total cash, cash equivalents and investments of $73.7 billion, with $2.4 billion available in the U.S. We plan on repatriating $67 billion of our offshore funds to the U.S. in Q3 of fiscal year '18. Q2 operating cash flow of $4.1 billion reflects strong growth of 8%. Free cash flow was also very strong with growth of 10% to $3.9 billion. From a capital allocation perspective, we returned $5.4 billion to shareholders during the quarter that included $4 billion of share repurchases and $1.4 billion for our quarterly dividend. +Today, we announced a $0.04 increase to the quarterly dividend to $0.33 per share, up 14% year-over-year. This represents a yield of approximately 3.1% based on today's closing price. We also announced a $25 billion increase to the authorization of the share repurchase program. This raises the remaining share repurchase authorization to approximately $31 billion. We expect to utilize this over the next 18 to 24 months. This significant dividend increase and additional share repurchase authorization reinforces our commitment to returning capital to our shareholders and our confidence in the strength and stability of our ongoing cash flows. +To summarize, Q2 was a strong quarter with solid top line growth, strong profitability, cash flows and order growth. We continue to make solid progress on our strategic priorities, making key investments to drive our long-term growth. +Let me reiterate our guidance for the third quarter of fiscal year '18. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We closed the acquisition of BroadSoft in early Q3, and the impact of the acquisition is factored into our guidance. +We expect revenue growth in the range of 3% to 5% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%. And the non-GAAP tax provision rate is expected to be 21%. Non-GAAP earnings per share is expected to range from $0.64 to $0.66. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- +Tanks, Kelly. Kim, let's go ahead and open the line for questions. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Our first question comes from Vijay Bhagavath with Deutsche Bank Securities. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [2] +-------------------------------------------------------------------------------- +So my question is around intent based, Chuck and Kelly, please join in, which it seems like it's resonating with your customers. Is this mostly a U.S. phenomenon, Chuck? Are your overseas customers also looking into intent based? And then how do you see intent based kind of catching across the portfolio? Why not extend the intent based across the broader portfolio? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Yes. It's a great question, Vijay. First of all, we're incredibly pleased with the early acceptance of this intent-based portfolio. I called out in my opening comments that this Catalyst 9000 is the fastest-ramping product in our history, which is pretty impressive. I'd say, it's fairly balanced across the geographic regions, probably pretty much in line with what percentage of the business they represent, but Kelly can validate that in just a moment. What I would tell you is that we have 3,100 customers who have adopted this platform. We obviously have the opportunity, and we will extend the capabilities across the rest of our portfolio so that our customers who are driving automation can drive it across not only campus switching but also routing, bringing the Viptela SD-WAN capabilities to play. We are integrating it backwards with ACI in the Data Center as well as within our Security portfolio. So our strategy is to continue to enhance our customers' ability to drive intent across their -- all of their technology areas as well as to gain context through analytics out of all of their technologies. So 3,100 customers so far. I think our total customer population is well over 800,000, so we obviously have room to run. And we also have seen it, I'd say, from a segment perspective, the commercial marketplace has been a great adopter of the technology. And what I would tell you is that the enterprises are -- have been evaluating it because it represents a different architectural approach with automation and analytics and security built into the network. So Kelly, comments on those? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Yes. No, just to add to that, I mean, you're correct, I mean, the geography is split kind of in proportion, as you would expect. And across commercial, enterprise and public sector, it's fairly balanced as well. So it's just very broad-based adoption across the board. And again, we're very happy about the adoption of the more advanced software package on the advantage that's very heavily weighted towards that. So we're excited about that. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Our next question comes from James Faucette with Morgan Stanley. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [6] +-------------------------------------------------------------------------------- +I wanted to follow up on Vijay's question, particularly as it relates to the 9000. Some of the people that we've talked to have indicated that availability of the 9000 may be a little bit limited. I'm just wondering how and over what time frame you may be able to address that. And I guess, as part of that, what are you seeing in terms of attach rates of additional services to the 9000? And are those changing at all as the product rolls out globally? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [7] +-------------------------------------------------------------------------------- +Yes. Let me just make a comment on the overall sort of strategy with the attach, and then Kelly can talk a bit about the supply. James, our original plan was to deliver a subscription model on the switch, and we've been very pleased with the attach rate and the percentage of customers in dollars in that subscription category that are actually being attached in the -- to the advanced subscription, which is -- really contains the automation and it contains the Encrypted Traffic Analytics. And we'll continue to add more and more of the Assurance stuff that we just launched 2 weeks ago. So we wanted to create real value in that subscription so that our customers would believe that it was worthwhile. And I think we're seeing exactly that. So Kelly, comments on demand and... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [8] +-------------------------------------------------------------------------------- +Yes. No, I mean, I think I saw a couple of reports on that. I can tell you, from a demand perspective, we're very excited about how quickly this demand has been. And with any new product launch, we're going to get orders in faster than we recognize them in revenue. That's normal, and I'd say this ramp is normal as well. We did not have any significant supply chain issues of any sort or any shortages on this product line as well. So it's really more just we have tons of demand, and we're very happy to see how quickly the take-up is going. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Your next question comes from Rod Hall with Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- +I wanted to start off by asking about the OpEx line. That line held relatively stable, even though your revenue beat our expectations. And so I just wanted to see if you could talk a little bit about how you expect that to move in the future. Do you think this should remain roughly flat on last year? Or where should we be going with OpEx? And then secondly, I want to come back to this Cat 9K supply-demand question and just see if -- is this kind of a situation -- I feel like we usually ask this about smartphone launches, but has the take-up been so fast that you couldn't keep up with demand and now you're able to meet demand? Is that kind of what you're telling us with those comments? I just want to clarify that a little bit. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [11] +-------------------------------------------------------------------------------- +Sure. So just to follow up quickly on the supply and demand. Yes, as I said, it's not a supply constraint issue at all from our supply chain or a parts shortage in any way. I mean, literally, we operate to lead times on our products. And if we get a lot of orders in the last week or 2 of a quarter when, again, as this thing is just ramping every week, we fulfill to our lead times. So there's nothing anything more than that than just we have a lot of demand for the product. So I wouldn't expect any issues as you look forward. In terms of OpEx, Rod, as you know, we are very focused on driving efficiencies. The only thing that will change in our OpEx is we are adding BroadSoft. So in our guidance, we will have obviously the revenue and the margin and the OpEx that comes with BroadSoft. But other than that, we are basically being very disciplined about where we're investing our R&D and making sure we're investing our R&D dollars in the best return project. So you're going to see it move around if we do acquisitions. But otherwise, we're going to be disciplined around that and invest when we can. And when we see margins go up, we're going to be investing as well. But otherwise, we're going to be managing that tightly like we have been. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Your next question comes from Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [13] +-------------------------------------------------------------------------------- +Kelly, I know we're going to see it when you publish the Q, but I was hoping you could tell us the rate of price erosion. And I'm assuming, from the margin structure, there wasn't a change, at least not for the worse, but let me ask the question. And I'm hoping you'll speak about -- I know you haven't gotten there yet. Chuck, you've been very candid about saying that you're late making progress with respect to the cloud. Can you give us any quantification of the growth as well as, as a percentage of revenue? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [14] +-------------------------------------------------------------------------------- +Okay. So Paul, yes, let me address the gross margin rate question first. So yes, we're very happy with our product gross margin rate. And as you and I talk about every quarter, we look at it in terms of what we're getting from price -- what headwinds we're getting from price, offset by what productivity. I would say, this quarter, we had a very, very effective price. We still had a price headwind, but it's at the lowest that it's been in many quarters. So it's less -- it's 1.3 points the way that you'll see it in the Q, Paul. So we're very pleased with that. We haven't been in that level for quite some time. I think maybe Q1 of '17, we're close to that. But again, it shows the discipline between both our product management teams as well as the sales forces being very disciplined about discounting. So we're happy there. We also made some improvements on our productivity, where our productivity this quarter is offsetting the price erosion. So that helped a lot. And then when we get our infrastructure platforms of business going like we did, seeing that return to growth, that helps from a mix perspective. So basically, all 3 of those were very helpful to our gross margin rate this quarter. In terms of the web scale question, Paul, I mean, we don't disclose it. It's not a huge number as we break out the broader company. But I will say that we are making some traction. I don't know, Chuck, do you want to add some comments there? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [15] +-------------------------------------------------------------------------------- +Yes. Paul, I appreciate the recognition. We've been trying to be transparent about this. And we continue to make progress, and I put the comment in the opening comments for a reason that we do continue to make progress. You see the announcements we've made with Google. I said a few quarters back that we were focused on 360-degree relationships with these, and we have more to bring. And certainly, we feel good about where we are, but we still have a lot of work to do. But I would say that every quarter, we're making progress. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Your next question comes from Tal Liani with Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [17] +-------------------------------------------------------------------------------- +I have a question. When Juniper discussed kind of network trends, they discussed 2 things: migration from edge routers to what they call PTX or MPLS boxes in the core, which brings down prices; and second is the introduction of routing into switching and what Juniper -- sorry, what Arista calls the 7500R. Could you please discuss the implications of these 2 trends on your switching and routing portfolios? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [18] +-------------------------------------------------------------------------------- +Yes. Thanks, Tal. So we talked about this before, and this is happening in some of the big web-scale providers. And the great news for us is that we have several different product platforms that meet whatever need the customer's looking for because we have so many customers that will be looking at this transition at different paces. So for those customers that want to go now, we have platforms that address those. The NCS 5500, as an example, has gotten -- has been very well received. We've had routing capabilities in our Switching platforms. And we have our Nexus portfolio that continues to perform very well for customers who are building the data center architectures that we've been focused on for the last 2 or 3 years. So I think that what I would say in summary on this one is that we're probably best positioned to meet the customers' need regardless of which architecture they're choosing and where they are in that transition, and that would be what we would plan on doing going forward as well. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Our next question comes from Jayson Noland with Baird. + +-------------------------------------------------------------------------------- +Jayson Noland, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [20] +-------------------------------------------------------------------------------- +I wanted to ask on the 9K subscription model. Chuck, interested in customer and partner feedback and what the puts and takes are there from your customer base and partners. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- +On the subscription model itself? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [22] +-------------------------------------------------------------------------------- +Or the Cat 9K overall, both? + +-------------------------------------------------------------------------------- +Jayson Noland, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23] +-------------------------------------------------------------------------------- +Both and how extendable that would be across the portfolio. Most of the time, we hear positive feedback from large partners, but sometimes there's a cash flow dynamic. And just wondering how that nets out. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [24] +-------------------------------------------------------------------------------- +Yes, okay. So Kelly, keep me honest when we talk about how we price it. But -- so from a technological perspective, I mean, this thing, it's one product in a portfolio of switches that we've gotten out the door. So you can assume there's an architectural play we're running longer term. And when you look at the overarching automation platform, the DNA Center, which is also where the analytics come back to for our customers to drive some of these services like Assurance, we're actually quite pleased. And I think that for our customers, what we wanted to do was we wanted the base subscription plus the product to be somewhere at or slightly below what they would have paid for a previous switch with a perpetual license on it. And then our plan was to create so much new innovation -- not take stuff that they would have bought before because the customers would have felt like we were just changing our financial model at their expense. So what we wanted to put into the advanced subscription was fundamentally new technology that they have never gotten from us before, so that they could warrant the incremental spend because they're getting incremental capabilities. So it's not us taking $1 they've been spending in the past and telling them, "Now you've got to spend $1.20 a different way." It was us saying, "You spent $1 in the past. If you spend it the same way, you may only spend $0.95, but we think we're going to give you so much value that it's going to be $1.20 to $1.25." And that's been our plan. And I think that the switch itself and the upfront cost is still enough of the acquisition cost that I have not heard partners -- on this particular portion of our portfolio, I haven't heard a tremendous amount of pushback. In fact, I think our partners are thrilled that we've reignited innovation in our core portfolio and given them an opportunity to work these refreshes with our customers. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [25] +-------------------------------------------------------------------------------- +Yes. I mean, the only anecdote I will add to this is I was at a customer, and I was actually at an investor meeting and their CIO was talking about the new platform and they were talking about DNA Center, which allows them to manage not just your switches, but your newer version of the enterprise routing and wireless. And the CIO had said, "I wish I had known, then I wouldn't have bought a competitor's wireless product." So again, I'm encouraged from the whole ecosystem. We're getting very positive feedback from our customers that way. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Your next question comes from Ittai Kidron with Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [27] +-------------------------------------------------------------------------------- +Just a couple of things from me. Kelly, can you tell us how much of the product revenue was recurring and number of Cisco ONE customers? And then for you, Chuck, I mean, the commercial order is up 14%. I mean, to me, that was the most interesting number. I mean, it's been a while since we've seen such strong strength in such an important and big part of your business. Can you talk about the economic backdrop? What's driving this? What is changing, ability to maintain that momentum going forward? It's really quite an impressive number. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [28] +-------------------------------------------------------------------------------- +Kelly, you want to hit the stats? I know them, but I'll let you... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [29] +-------------------------------------------------------------------------------- +Yes, yes. So on the recurring revenue, we talked about, again, we're up to 33% recurring revenue in total. Of that -- again, on the products side of my product revenue, we are up to 13% is recurring. So again, that just continues to grow. That 13% is up over 3 points from what it was a year ago. So we continue to make progress. But 13% of our total product revenue is now recurring, of which all of our revenue 33% is. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30] +-------------------------------------------------------------------------------- +Just a couple of -- and Cisco ONE customers. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [31] +-------------------------------------------------------------------------------- +Oh, sorry, Cisco ONE customers are over 24,000 now. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [32] +-------------------------------------------------------------------------------- +Yes. And still on the percentage of product revenue that is coming from recurring, that was 6% just 10 quarters ago. So -- and I think the raw number was up 34% year-over-year. So we're pleased with that. And then I completely forgot the second part of the question. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [33] +-------------------------------------------------------------------------------- +The commercial strength. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [34] +-------------------------------------------------------------------------------- +Commercial strength, thank you. Yes. So we saw -- that was very consistent around the world. And you've heard us talk about, Ittai, in the past, that our commercial customers tend to be the early adopters and the customers that actually adopt the technology sooner and actually roll it out in the production sooner. Because our large enterprise customers and large service providers, they spend a fair amount of time putting it in the lab, evaluating it. As I said earlier, with the intent-based networking portfolio, they're looking at delivering the automation platforms and all those, which are just a fundamental different way of running their infrastructure. So it takes them a little longer. So largely that was the big driver, but I think it was pretty consistent across the board in the portfolio. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- +Yes, it was double digit in every region, and we were up in every single product category -- sub-product category. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- +So it was pretty comprehensive, which, I think, if we're honest, we've got some good new innovation in our portfolio. Obviously, the economy is providing a little bit of a tailwind as well. But I think our teams are executing really well. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Our next question comes from Jim Fish with Piper Jaffray and Company. +(technical difficulty) + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - Research Analyst [38] +-------------------------------------------------------------------------------- +Can you guys hear me now? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [39] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- +Jim, sorry about that. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - Research Analyst [41] +-------------------------------------------------------------------------------- +My question is actually more on the capital return, and so if my math is correct on the repatriation amount of $67 billion. It looks like aftertax-wise, it will be about $57 billion. And spending sounds as if you're going to spend $25 billion on the repo and then another $13 billion over the next 2 years on the dividend. That sort of leaves you, by my math, roughly about $20 billion. How should we think about sort of M&A versus either debt paydown over the next few years or other items? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [42] +-------------------------------------------------------------------------------- +Yes. I mean, I think there's a couple of pieces in there. Don't forget, I still have a very good dividend that I'm paying. I'm paying a $6 billion a year on... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [43] +-------------------------------------------------------------------------------- +Included the $13 billion over the next 2 years. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [44] +-------------------------------------------------------------------------------- +Did you have the $13 billion? If I look at it, I'm in a 34 net cash position right now. We've got the $66 billion we're bringing back. We've got the share buyback and the $31 billion we plan to try to utilize over the next 18 to 24 months. I'll still be in a net cash positive position of 10 to 12 without assuming anything else for acquisitions, and as you guys know, acquisitions are a critical part of our, and always has been, of our overall strategy. So I'd say the way to think about it longer term is we're going to be consistent with what we've said, right, from a capital allocation perspective. We're going to continue to be looking for the acquisitions that we can drive value and drive growth with. We're going to continue to support the dividend and drive that up with earnings, like you saw us do today. And we're going to, again, give back cash now that we have -- all of our cash basically is repatriated all the time now, we're going to be giving back to the shareholders through a healthy buyback. And I think we've got $30 billion to work through to do that. But we'll keep you updated as we go through this every quarter. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +The next one comes from Simon Leopold with Raymond James & Associates. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [46] +-------------------------------------------------------------------------------- +First, just a quick clarification. In the prepared remarks, you talked about Campus getting better. Did you indicate that it's up year-over-year? Or could you confirm if Campus switching is up year-over-year? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [47] +-------------------------------------------------------------------------------- +Yes -- no. So yes, basically, Campus has been up, it's up in orders. But from revenue, we're still slightly down -- modestly down from a revenue this quarter. And we saw strong growth on the Data Center side. But yes, the order side was very, very strong on Campus. So you'll see that flush through going forward. +(technical difficulty) + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [48] +-------------------------------------------------------------------------------- +Kim, are you there? + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- +Okay, one moment. Aaron Rakers, your line is open. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [50] +-------------------------------------------------------------------------------- +Can you hear me? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [51] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [52] +-------------------------------------------------------------------------------- +We can now, Aaron. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [53] +-------------------------------------------------------------------------------- +Apologies to everybody with our technical difficulties there. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [54] +-------------------------------------------------------------------------------- +I'm sorry about that. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [55] +-------------------------------------------------------------------------------- +No problem. I wanted to ask a question about just your Data Center segment. You talked about double-digit growth. It sounds like UCS was strong. Sounds like you're continuing to get some traction with your HyperFlex product. So kind of updates there on how many customers you have for HyperFlex and what you think -- do you think we're at a point in time where you could see some sustainable growth in that Data Center segment going forward? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [56] +-------------------------------------------------------------------------------- +Yes, I'll give you a little color on it, and then I think the number you -- I think that's correct, Kelly. We see -- we had a good couple of quarters where the team has really focused on next-generation innovation, lots of partnerships, integrated solutions with analytics and then working on some of the new capabilities around some of the Kubernetes stuff that was announced. And then HyperFlex is obviously still -- it's not a significant portion of that business, but it's growing. And I think, Kelly, 2,400 customers now, we're up to? And so we're pleased with the progress that the teams have been driving. I think that we continue to see new customer adoption. We actually see a lot of the HyperFlex customers that don't overlap with UCS. So we have that opportunity to pull those together. So pleased with how the team is executing there, for sure. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- +Your next question comes from Jeffrey Kvaal with Nomura Securities. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD [58] +-------------------------------------------------------------------------------- +A clarification and a question first, I guess. And the clarification is, Kelly, would you mind helping us understand how much BroadSoft is adding to the upcoming quarter and maybe to the most recent one, too, depending on the specific close date? And then a bigger-picture question is the macro outlook has, in the past, been a big focus for Cisco and something that has led to more confidence or less confidence in the business outlook. I'm wondering if you could share a little bit about what you are thinking through with the global picture and how that may be helpful or maybe overheated a little bit in certain places. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [59] +-------------------------------------------------------------------------------- +You want to go first? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [60] +-------------------------------------------------------------------------------- +Yes, I'll get the BroadSoft. So yes, so in Q2, like I mentioned, we had about 80 basis points of impact from acquisitions, which did not have BroadSoft. When I gave my Q3 guidance, overall inorganic impact bumps up another 0.5 point to about 130 basis points. So a full point is from inorganic. And for BroadSoft -- just to remind everybody, when we do an acquisition and we bring it on to our balance sheet, obviously, what deferred revenue they had ends up going through purchase accounting gets a bit of a haircut. So the first quarters will be slightly less than what they were when they were a public company. But overall, it adds -- we're at 130 basis points overall at the company level. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [61] +-------------------------------------------------------------------------------- +So Jeff, maybe I could just give you sort of a general view on what we saw around the world, and we'll talk a little bit about the sort of the overall economy. We referenced it earlier, the global strength in commercial was something that we're very happy to see. In U.S., we actually saw strength in our federal business. We haven't talked about that today. Across Europe, Middle East, Africa, positive -- everything was positive, except the SP business there. APJC was flat, but that was primarily driven by SP routing deals, largely in China and Japan. So the rest of business, we were pleased with, particularly enterprise and commercial in APJC. And then the emerging markets continued to be somewhat volatile, but I think we saw a slight growth this quarter as well. So from an overall economy perspective, look, we came out of World Economic Forum. We read and see and talk to the same customers and everyone that you do. There's a great deal of confidence right now on a global basis, probably more consistent than we've seen in a very long time. So that's good. But we also -- we believe that we also have driven innovation in our core technologies in the enterprise that we have needed for a long time. And so I think that both of those are contributing to how we feel about it, in addition to the strength across the rest of the portfolio. So we appreciate the strength in the economy, but we're also very pleased with the new innovation as well. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +Your next question comes from Mark Moskowitz with Barclays. + +-------------------------------------------------------------------------------- +Mark Alan Moskowitz, Barclays PLC, Research Division - Research Analyst [63] +-------------------------------------------------------------------------------- +A question on the revenue growth profile. Could we actually see accelerating revenue growth going into the back half of the year? Because the 9K intent-based networking product portfolio is providing for a longer evaluation and lab work by some of your bigger customers. And then once they overcome that, they actually -- you see more of a land-and-grab-expand dynamic. And then, Chuck, I had a question for you in terms of the cash that's going to be burning a hole in your pockets here even after all the different nice shareholder return initiatives you're undertaking here. Do you need to put a stamp on the company in terms of making a big transformative acquisition? Or can you do it in other ways? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [64] +-------------------------------------------------------------------------------- +Yes. Let me address the second one first, and then I'll let Kelly talk about some of the growth -- the first question relative to growth. I think what we have said all along even before tax reform is that when it did occur, that we would leverage our ability to continue our capital strategies, which you saw today relative to buybacks as well as dividend. But we also have kept plenty of powder dry. We also have, obviously, the ability to take on debt if necessary. And we've also said that in the past, by virtue of our cash being outside the United States with access to the debt markets, we really had no impact on our ability to do M&A. And the bottom line is that we'll continue to look for any M&A targets that actually line up in an integrated way with what we're trying to do strategically. And that's just what we're looking for. I wouldn't put any parameters around the size. I think it's really around strategic fit, both from a technological perspective from what our customers are looking for and then obviously the financial implications. So Kelly, any comments on the revenue? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [65] +-------------------------------------------------------------------------------- +On the revenue growth, we really do only guide one quarter at a time. But again, we are very, very encouraged with what we're seeing with the current portfolio of innovation certainly in the Switching portfolio. Both the Data Center side and the Campus side are pacing well. And again, we are going to keep executing through, and we'll see how that goes. But we feel good about what we see next quarter of the 3% to 5% growth, and we're just going to keep working it from there. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- +Jason Ader with William Blair & Company. + +-------------------------------------------------------------------------------- +Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media, and Communications [67] +-------------------------------------------------------------------------------- +Chuck, I was wondering what your thoughts are on the Service Provider business going forward and when do you think that might turn around and what would be the puts and takes or the drivers that could turn it around. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [68] +-------------------------------------------------------------------------------- +Yes. I think it's a great question, Jason. And the rest of the businesses were generally pretty strong. So when we think about SP, obviously, one of the key variables for us is continuing to make the progress that we've been making in the web-scale community, and that's a key focus area for us as they're included in this business. So that's certainly number one. Number two, the consistency of CapEx coming from everyone in the space around the world will certainly be a contributor to the future performance. So that's -- I think that's the other thing that we look for. And then third, as we mentioned at the Financial Analyst Conference, we're also working on some next-generation platforms that we think can help us here as well. So if I had to just pick 3 things, those are the ones that we're focused on. And we're going to take it quarter-by-quarter and keep executing in all of those areas to try to get that business moving in the right direction. +So with that, I just want to close by just thanking all of you for joining us today. We really appreciate you spending time with us. Appreciate the questions. And Marilyn, I'll just turn it back to you to talk about our next call. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [69] +-------------------------------------------------------------------------------- +Great. Thanks, Chuck. Cisco's next quarterly call, which will reflect our fiscal 2018 third quarter results will be on Wednesday, May 16, 2018, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, please feel free to contact the Cisco Investor Relations department, and we all thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- +Thank you for participating in today's conference call. If you would like to listen to the call in its entirety, you may call 1 (800) 391-9854. For participants dialing from outside the U.S., please dial 1 (402) 220-9828. This concludes today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2018-May-16-CSCO.txt b/Transcripts/CSCO/2018-May-16-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..0decee0544ab2c7bdeeb782f20238a9948b1b87a --- /dev/null +++ b/Transcripts/CSCO/2018-May-16-CSCO.txt @@ -0,0 +1,522 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Cisco Systems Inc Earnings Call +MAY 16, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Mark Alan Moskowitz + Barclays Bank PLC, Research Division - Director + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Jim Suva + Citigroup Inc, Research Division - Director + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * George Charles Notter + Jefferies LLC, Research Division - MD & Equity Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Third Quarter Fiscal Year 2018 Financial Results Conference Call. At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's Third Quarter Fiscal 2018 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statement and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and the press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn. Good afternoon, everyone. We had another great quarter. We are executing well against the strategy we put in place 3 years ago. Our innovation pipeline has never been stronger, and we continue to transform our business to reflect the way customers want to consume our technology. +We delivered another quarter of accelerating revenue growth of 4%, solid margins and record non-GAAP EPS up 10%. Our performance was driven by the acceleration of our intent-based networking portfolio, continuing strong customer demand for our innovative solutions and the increasing value of the network. We also made steady progress in shifting more of our business toward software and subscriptions. This resulted in broad-based strength across our products and geographies. +As I talk with customers around the world, it is clear that the network is playing an increasingly critical role in helping them manage their complex environments. They are consuming services from multiple cloud providers, multiple SaaS applications, connecting billions of new devices which are generating massive amounts of data, and the network is pervasive across all of these environments. We have been evolving our portfolio to help our customers deal with this complexity and provide unprecedented simplicity, visibility and security across on-premise, hybrid and multi-cloud environments. +Now I'd like to review our momentum across key priority areas and share some of the innovations we're driving across our portfolio. First, let's start with Infrastructure Platforms. We are leading the network industry's transformation to intent-based networking across the campus, branch, data center and the edge. We are paving the way to help customers simplify and manage the network. Only Cisco offers an end-to-end, intent-based networking portfolio that delivers assurance, industry-leading security, policy-based automation and segmentation. +We continue to see very strong adoption of the Catalyst 9000, the fastest-ramping new product introduction in our history. This includes another quarter of high uptake of our advanced subscription offer in DNA Center, our automation and analytics platform. The Catalyst 9000 now has over 5,800 customers, up from 3,100 last quarter. This is an excellent example of how we've begun to scale our enterprise networking business into a subscription model. We've also recently introduced additional intent-based networking innovations. These include new access solutions and routing software subscriptions which expand our software-defined WAN capabilities onto any platform. +We are extending our leadership in data center and cloud by providing highly secure and differentiated offerings such as our ACI SDN solution. With growing 100-gig deployments, especially in cloud infrastructure, we remain well positioned for future growth with our data center switching and intent-based portfolio. We also announced new hybrid cloud workload management solutions with ACI Multi-Site Management and new flexible consumption models, including SaaS delivery for our Tetration platform. Whether deploying enterprise applications or containers in a multi-cloud environment, customers are increasingly turning to Cisco's unique architectural approach. This is leading to strong momentum with UCS, our compute platform; and HyperFlex, our hyperconverged offering, as customers benefit from simplicity and scalability to support their hybrid cloud strategies. +Now turning to Security, which is foundational to everything we do. Our architecture delivers highly effective security from the network to the endpoint to the cloud. This unique ability to bring together networking and security at scale gives us a huge competitive advantage. With the largest customer base in enterprise security, it is clear that our strategy is working. The strength we saw in the quarter is driven by our integrated architecture, combined with best-of-breed products. +We are also leveraging artificial intelligence and machine learning to reduce time to detection and remediation. A great example of this is our Talos intelligence platform where we block 20 billion threats every day. +We continue to rapidly innovate in security to address key areas of concern for our customers such as security in their complex data centers. We introduced a comprehensive, integrated data center security architecture that is designed to protect the modern data center by seamlessly following any workload anywhere across physical and multi-cloud environments. +Now moving to Applications. This quarter, we introduced new innovations across our collaboration portfolio with the convergence of the Cisco Spark and WebEx platforms combined with new WebEx Meetings and WebEx Teams applications. We further enhanced our AI and machine learning capabilities across our collaboration portfolio with the acquisition of Accompany, a relationship intelligence platform with robust insights and intelligence to improve meeting and team experiences. We completed this acquisition last week. +We are pleased with the consistent progress we've made to deliver on the strategy we put in place nearly 3 years ago. We have solid business momentum. We are confident in our pipeline of innovation and future growth opportunities. And our commitment to driving value for our shareholders remains as strong as ever. This is clearly demonstrated by the fact that we delivered record capital returns this quarter. +As part of our commitment to shareholders, we are also very focused on our responsibility as a company to drive impact within our communities through innovation and active engagement. It is not only the right thing to do, but a key requirement for long-term business success. We are deeply committed to our long-standing efforts around sustainability, education and disaster relief as well as other key issues such as hunger and homelessness. I could not be prouder of our achievements or more excited about the impact we will have going forward. +Now I'll turn it over to Kelly to walk through more detail on our financials. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q4. +We were pleased with the financial performance in Q3 with broad strength across the business. We executed well with very good orders momentum, strong revenue growth and solid margins. +Total revenue was $12.5 billion, up 4%, and non-GAAP EPS was $0.66, up 10%. We continue to focus on driving margins and profitability with a strong non-GAAP operating margin rate of 31.5%. +Let me provide some more detail on our Q3 revenue. Total product revenue was up 5%, demonstrating the strength of our portfolio. Infrastructure Platforms grew 2% with strength in all businesses with the exception of routing. Switching returned to growth with revenue growth in both data center and campus. Campus growth was driven by our new switch, the Cat 9K. We saw solid growth in wireless with strength in Meraki and our Wave 2 offerings. Data center had very strong double-digit growth driven by servers as well as HyperFlex. Routing declined largely with the continued weakness in service provider. +Applications was up 19% in total with broad strength across the businesses. We saw very solid growth in TelePresence endpoints, UC infrastructure and AppDynamics. +Security was up 11% with strong performance in unified threat, advanced threat and web security. Deferred revenue grew 38% as we continue to drive more subscription-based software offers. +Service revenue was up 3%, driven by growth in advanced services as well as software and solutions support. +We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q3, we generated 32% of our total revenue from recurring offers, an increase of 2 points from a year ago. Revenue from subscriptions was 55% of our software revenue. +We drove good growth in deferred revenue, which was up 9% in total, with product up 18% and services up 4%. Deferred product revenue from our recurring software and subscription offers was $5.6 billion, up 29%. +We saw strong momentum in Q3 product orders growing 4% in total. Looking at our geographies, Americas grew 4%, EMEA was up 6% and APJC was up 3%. Total emerging markets was up 7%, with the BRICS plus Mexico up 12%. +In our customer segments, enterprise was up 11%, commercial grew 7%, public sector was up 2% and service provider declined 4%. +From a non-GAAP profitability perspective, total Q3 gross margin was 63.9%, down 0.5 points. Product gross margin was 62.9%, down 0.3 points. And service gross margin was 66.9%, down 0.9 points. We continue to be negatively impacted by the higher memory pricing we have discussed over the past several calls, which we expect to continue in the near term. Our operating margin was strong at 31.5%. +When we look at the impact of acquisitions on our results year-over-year, there's been 120 basis point positive impact on revenue and a negative $0.01 year-over-year impact on our non-GAAP EPS. +In terms of the bottom line, non-GAAP net income of $3.2 billion was up 6%, while GAAP net income was $2.7 billion. We grew non-GAAP EPS 10% to $0.66, while GAAP EPS was $0.56. +We delivered operating cash flow of $2.4 billion, down 28%. We paid $1.3 billion of onetime foreign taxes during the quarter related to the Tax Cuts and Jobs Act. Operating cash flow increased 11% normalized for these tax payments. +We repatriated $67 billion of our offshore funds to the U.S. and ended Q3 with total cash, cash equivalents and investments of $54.4 billion, with $47.5 billion available in the U.S. +From a capital allocation perspective, we returned $7.6 billion to shareholders during the quarter that included $6 billion of share repurchases and $1.6 billion for our quarterly dividend. +We recently announced an agreement to sell our Service Provider Video Software Solutions business. We expect this transaction to close in Q1 fiscal year '19 subject to any regulatory approvals and customary closing conditions. We are continually looking to optimize our portfolio. +To summarize, Q3 was a good quarter with solid top line growth, strong profitability and order growth. We continue to make solid progress on our strategic priorities, making key investments to drive our long-term growth. +Let me reiterate our guidance for the fourth quarter of fiscal year '18. This guidance includes the type of forward-looking information that Marilyn referred to earlier. +We expect revenue growth to be in the range of 4% to 6% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%. And the non-GAAP tax provision rate is expected to be 21%. Non-GAAP earnings per share is expected to range from $0.68 to $0.70. +I'll now turn it back to Marilyn so we can move on into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) So with that, I'll turn it to you, Michelle. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + James Faucette from Morgan Stanley Investment Research. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [2] +-------------------------------------------------------------------------------- + + Great. Chuck and Kelly, I guess I wanted to ask, as you -- one of the key things that investors are looking at is the continued growth in subscriptions, et cetera. And it seems like the deferred continues to grow nicely. One of the key questions that we have though is, as you continue to show good demand for the new Catalyst 9K products and distribution expands, what are you seeing in terms of attach rates for subscriptions to that new product? Are they maintaining the levels that you had seen at the early stages of launch or are they starting to normalize back to more traditional levels? Just trying to get a little color on how well that tying strategy is working for you. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Yes, James, thanks for the message. I'll comment. And then if Kelly wants to add anything, we'll let her do that as well. I would say it's been very consistent over the last 4 quarters, I think, since we put it in the marketplace in Q4 of last fiscal year. I think we had 1 month of activity. So it's been incredibly consistent. We're really pleased with the acceptance of this product. I think adding 2,700 more customers in the quarter, if you think about that, that means we added over 40 customers per day that acquired a Catalyst 9000 for the first time. And the acquisition of that product, in my opinion, is a clear belief in the next-generation architecture with the automation platform that we're announcing, which is what the advanced subscription model requires. And so I think that's reflected in the continued high uptake that we see on the advanced subscription. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Yes. No, I think that covers it. Vast majority is the Advantage, which has the advanced features and the higher margin profile. And then the only other thing I would add is, it is very evenly spread across commercial, enterprise and public sector in terms of the demand and where we're seeing all the business. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - Equity Analyst [6] +-------------------------------------------------------------------------------- + + I just wanted to try to dig under the covers a little bit on the revenue guidance. Obviously, service provider orders are weak and sounds like routing's weak, in line with that. Just wondering if you could, Kelly, maybe give us any idea how much service provider video is affecting that guide and also the routing within that guide, like what are you assuming there. Are you assuming routing continues to kind of drag that growth down? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Yes. So in general, I think the trends on both routing and service provider video, which is in the other bucket, have been consistent. And we're not assuming any improvement in either of those. So I would say our guide includes what we see. We feel really good about the rest of the portfolio, actually. And we see very good growth there, but those 2 trends are not improving. So that's basically what I have included. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - Equity Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And then, Kelly, could you also comment on the OpEx to sales? It's ticking up a little bit in the guide, at least implied. And I'm wondering if you could maybe give us any color on what's moving around in OpEx for fiscal Q4. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes, sure. On OpEx, it's mainly driven by -- the increase is mainly driven by the acquisitions we've run, specifically AppDynamics. As you know, when we bought AppDynamics, very early stage. We're in heavy investment phase with them. So that's part of it as well as we've consolidated now BroadSoft. And then that also has a fairly high OpEx impact. If I back out -- if you look at my OpEx growth for the quarter, which was up a little less than 6%, 4 points of that alone is just purely the acquisitions. And that's, as I mentioned, the impact of acquisitions on my top line and it's hurting me on EPS. It's mainly in the OpEx line. So that's what's driving that. We're being very disciplined within the rest of the business to managing the portfolio. So I think it'll continue kind of in that range as we look forward to Q4, but that's kind of the underlying driver. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Ittai Kidron from Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [11] +-------------------------------------------------------------------------------- + + Chuck, I had a couple of questions. First, on the Catalyst 9K, good progress, but help us understand how big is your Catalyst installed base from a customer standpoint? What percent of it do you really think the Cat 9K is relevant to? Because it's hard to gauge whether you're moving too slow or too fast. 40 customers a day sounds like a lot, but maybe for a company like Cisco it's not fast enough. So help me understand how do you think about driving that throughout your installed base especially with now Arista potentially coming to the marketplace. And then second question, I had a question about China. Clearly, relations there have not been on the good side recently. And you've been somewhat a little bit more optimistic on that country over the last year. What are you seeing out of there? And how do you take that into your outlook commentary? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Okay. First of all, thanks, Ittai, and thanks for the positive comments. On the 9K, I think that we have roughly 840,000 customers. And I would say that there's a very long list of customers that are still available to us to deliver this platform. If you look at -- the products that we have put in the market and the new Catalyst 9K family are sort of like -- if you stack our portfolio and you say, we have a very low-end switch and then you have the old Catalyst 3000, the old Catalyst 4000, those are kind of the platforms that the current 9K family replace. So there's still a very long tail of customers. +The other thing you have to remember is, many of these customers are buying the 9K and then it will become the standard platform. And they'll refresh the balance of their networks. The other thing I'll point out is that I think we said on one of the calls a while back that the enterprise segment, we would expect to lag the commercial segment with the 9K. And we did, in fact, see the enterprise business improve, and the 9K was part of that. So I think we still feel good about it. And this architecture has a long future for us. And there's a portfolio of products that sit within it. So I think if we're really honest, the number of customers who are making the decision to upgrade to the 9K, I would say it's not necessarily because, wow, what a new fantastic new Ethernet switch. It's really because they're buying into this automation strategy of which the entire portfolio will sit over time. And I think that's what we're banking on. And that's where we're banking on the long-term success. +So the China question, look, if you look at our China business this quarter, we actually saw strength in switching in both the enterprise and commercial segments. And overall, I think there's still uncertainty there. But I believe, and I have been optimistic, and I remain optimistic that the 2 countries will come to some closure on the trade issues and that we'll get stability there. And I think -- we still believe in it. It's going to be, obviously, the largest economy in the world in the coming decade. And we remain committed and actually, we're doing pretty well. If you look at the SP routing business in China, it continues to be stressed, like it is around the world, but much of the other portfolio elements, we're very pleased with. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Vijay Bhagavath from Deutsche Bank Securities. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [14] +-------------------------------------------------------------------------------- + + Chuck, Kelly, these are solid results here. You beat on all major categories. A quick question for you. A bigger-picture question actually, Chuck and Kelly as well which is, as your software subscription attach rate sees strength, could we see the sales OpEx, for example, start to trend down? Are you already seeing that impact to your sales OpEx line? And then just a quick tactical question in terms of, approximately, what was the run rate of the SP Video business you've sold to Permira? Because that would help us to inflate your July quarter guidance if it wasn't sold so that it helps us in kind of this if-what scenario basis. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Yes. Let me give some color around how we see the sales model evolving. And then I'll let Kelly answer the financial side of those questions for you. Vijay, I think what you're going to see is that we're actually building a traditional -- I'll say a traditional software model where we have a customer success organization that over time will take on more responsibility for all of the functions in the software company, the whole adoption expansion and particularly, the renewal space, which will allow us to renew a lot of these offers over time. It's a multiyear renewal window. But renewing over time at a much lower cost of sale, I would suggest that, that may give us either some, obviously, operating leverage or it may give us the ability to invest in more R&D or other areas. But that's the model. That's one of the key reasons that we brought in Maria Martinez, who is now our Chief Customer Experience Officer, who is helping us build out that capability, who has a long experience of doing that in several software companies. So that is one of the major efforts that we have underway right now to not only increase our ability and our rates of renewal, but also to do that at a much different cost structure going forward. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes. And just on the SPVSS business, we will -- it is in my guidance right now because we're going to -- obviously, we continue to run this business until the deal closes. It is the majority of what's in the other bucket, Vijay. So it's the bulk of that. But like we did when we divested the set-top box business, once we closed the transaction, we'll give you all the history so we can adjust the model and go forward from there. So you'll have complete visibility all the way through the P&L once we close the transaction. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [18] +-------------------------------------------------------------------------------- + + I just wanted to... + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [19] +-------------------------------------------------------------------------------- + + Pierre, can you speak up just a bit? + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [20] +-------------------------------------------------------------------------------- + + Yes. Okay. Is it better now? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [22] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [23] +-------------------------------------------------------------------------------- + + So on the gross margin, so you still suffer from these DRAM prices. Has it like improved or is that -- has the pressure like increased sequentially compared to last quarter? And then we've had this pricing for some time now in the market, and I was wondering if -- how are you going to reflect that in your pricing strategy? And when should we expect you to start like passing on these extra costs to your client? And then lastly on the gross margin, I assume that you're still like increasing very fast your share of software and subscription services in your revenue mix. So it should have a positive impact on gross margin. If you can comment on that as well that would be great. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Sure. So I'll take that. So first, on the memory. So yes, memory is still hurting us year-over-year. In my product gross margin, it hurt us to the tune of about 60 basis points year-over-year. So more than what we were down year-over-year. It is marginally less bad than it was last quarter, which was marginally less bad than it was a quarter before then. So the slope of the increases are getting less, though it's still increasing year-over-year. So it was about 60 basis points. +I would say, in terms of pricing, we had another very, very good quarter for price. We always have price erosion. But like you saw last quarter, our price erosion was at the very low end of what we've seen over the last 3 years, and that continues. And part of that reason of why that continues is, we have been passing on the memory DRAM cost increases through price increases on our servers, like we have been as well as a lot of our peers as well as our product managers in other parts of the portfolio have been really -- being very disciplined about looking at where we have some price elasticity and have been selectively and surgically looking for areas that we could take advantage of price elasticity. So I feel really good about where our price index was this quarter, much in line where it was last quarter. +And then to your third point on the software being a benefit, that is true, though, I will say, a portion of that is getting offset now that we're ramping the Catalyst 9K so quickly. And as you know, a portion of that gets deferred because it's a subscription. That has a negative impact on our rate as well. So this quarter, it was about 30 basis points alone just for the Cat 9K alone now becoming bigger in the revenue contribution and impact on our rate. +So again, the 3 things are: 60 basis points on memory, 30 basis points on the Cat 9 impact and then we had pretty strong price and some favorable mix coming through from software. The only other last point I will make, we had a very, very strong quarter on our UCS, our server business. And that has a little bit of negative mix for us as well, okay? + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Paul Silverstein from Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + Against my better judgment, I'm going to ask you a wide-open question, which is for either or both of you, Chuck and Kelly. What are you most excited about in terms of upside opportunity, whether revenue or margin? And what are you most concerned about in terms of downside risk? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + So I'll start, Paul, and thank you for that -- the opportunity. Listen, I think that what I am most optimistic about is the renewed innovation that we have brought and will continue to bring in our enterprise portfolio, particularly into our core franchises, which was one of the things -- when I spoke to many of you when I became CEO 3 years ago and even when we were on the road last year, I said the #1 priority for us right now. Obviously, we're going to continue the business model evolution, but the #1 priority was to get the enterprise portfolio and particularly the switching business stabilized, which our teams have done a great job. +And even if you look at the security portfolio with the team, and then I will tell you on the enterprise routing space, Kelly talked a little bit about the overall routing business. But SP routing is about half. And the enterprise routing, I will tell you that our teams have been working hard on the integration with the Viptela acquisition into our enterprise routing portfolio. And I actually feel really good about how that's coming along, and I'm optimistic about where that goes in the future. And I'm very optimistic about the overall innovation within the intent-based networking portfolio that we're going to bring forward over the next months, quarters and years. +I guess if I had to say what I would be most concerned about in general, it's just sort of the macro and/or some geopolitical risk. I mean, you've got -- you've obviously got lots of trade discussions, which I remain optimistic on. But as long as there's uncertainty, then we wait and see. Obviously, the dollar rising, while we had a good quarter in emerging countries, and we're pleased with our execution there, the rising dollar obviously is another macro issue, but I'm very pleased with what the teams are executing on right now. And that's how I'd leave it. Kelly, any comments? Good. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Jeff Kvaal from Nomura Securities International. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD [29] +-------------------------------------------------------------------------------- + + You spoke about your progress in the data center switching side of things. I'm wondering if you could help us understand how things are going in the enterprise data center market and how your relationships are progressing in the web-scale data center market or just web-scale in general would be helpful to us outside of data center switching. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Thanks, Jeff. So I'm very happy with what our teams are doing in the data center switching market. In general, I think that the 100-gig transition, we're pleased with the return to growth in both the data center and the campus from a switching perspective. +On the web-scale side, I would say the story continues to remain as I've articulated it. We continue to make progress. You've seen the announcement we made, obviously, with Google. We continue to work and execute on the details of those solutions that we announced with them. You'll see more coming out later this year from us there. We continue to engage deeply with all of these players. We've had continued progress with several of them and continued favorable discussions. But these are -- as I've said repeatedly, some of these are multiyear architectural decisions, and they take a while. But again, I'm optimistic and pleased with where we are right now. +And I think the other thing I'd point out is that, this environment that our enterprise customers are facing right now where, literally, 4 or 5 years ago, they thought they were going to move to the public cloud and have a much simpler IT world. They now find themselves with 3 or 4 public cloud providers that they're consuming services from. They have 50, 60, 100 SaaS providers. We're beginning to see this real explosion of IoT devices at the edge. They still have their private data centers. Those have not gone away. You've got all of the mobility in customers and suppliers. And so the network is so fundamental to making all that work. And the web-scale providers know that as well, which has really enabled us to build these broad relationships that extend well beyond just the data center. So we're still pleased with where we are and we have a long way to go. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + George Notter from Jefferies. + +-------------------------------------------------------------------------------- +George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [32] +-------------------------------------------------------------------------------- + + I wanted to circle back to a conversation from prior earnings calls. You guys had talked about the revenue headwind associated with the move to more subscription-oriented models. And Kelly, I'm wondering if you can give us an update there. Is that still a headwind this quarter? And how do you see that progressing going forward? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + Yes, sure. Thanks. And so yes, the headwind is still there because we are very much increasing the number of offers that we have as well as the revenue dollar that we're putting on the balance sheet. So the headwind is increasing. And just as we had talked in the past, now that the enterprise portfolio with the Cat 9K is starting to hit revenue, the headwind is increasing. So we said in the past it was 1.5 to 2 points. It definitely now is approaching the 2 to 2.5. And as we ramp more and more of the portfolio, we'll continue to see that. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Srini Pajjuri from Macquarie Capital. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [35] +-------------------------------------------------------------------------------- + + I guess my question is on the recurring revenue. It dipped a little bit to 32%. If you could give some color on that. And also, I think your target long term is exceeding 37% in fiscal '20. Is that primarily a function of Cat 9K ramping in volume? Are there any other products that could contribute to that? And also, I'm wondering if you need to expand the subscription model to other products to achieve that goal. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [36] +-------------------------------------------------------------------------------- + + Yes. So thanks for the question. So yes, on the recurring revenue, it's basically in the rounds. If I look at our product recurring revenue, again, it continues to grow over 30% to over 30% of our total product revenue. And overall, total recurring revenue is again growing in the double digits. So it's really the math and a little bit of the mix now that we have product revenue growing so much faster than services that's driving kind of just the pure math of the round from 33% to 32%. But we feel great about how it's progressing. +Yes, if you go to our Financial Analyst Conference, we feel we're right on track of what we projected as that goes out to fiscal year '20. The only caveat I'll give you on that is, when we go into our fiscal year '19, we have to adopt the new revenue standard, which will have some implication on some of the products that are included in this. So we plan to have a call where we can go through the anticipated area that will be impacted to give you guys more clarity. And then we'll adopt that Day 1 of our fiscal year '19. But overall, we feel great about the traction. We're executing very well. And we're on track, if not slightly ahead, of what we expected when we talked at the Financial Analyst Conference. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + And Srini, just one last comment on the part of your question where you asked if we would need to extend this to other parts of our portfolio. I mean, we will. If you look at the new enterprise routing, some of the comments I made in my opening was that we're extending our software and subscription business in the routing space. Many of those are software solutions. So we'll continue to evolve. And frankly, it's driven by how our customers want to consume the technology, which is great. And as Kelly said, it will create a short-term headwind, but we think long term for the business it's absolutely the right thing to do. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Jim Suva from Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [39] +-------------------------------------------------------------------------------- + + I have a brief question for Chuck and then Kelly, more of a clarification one. But Chuck, there wasn't any mention yet, at least on the Q&A, about competitors going into the campus side of things with Arista making an announcement. How do you look at that? I know competition isn't anything new. But do you need to step up your sales efforts? Or how should we think about that? And then Kelly, for the CFO question. How should we think about, you've got time now to think about the tax law, sort through all the changes. Is your outlook kind of 21% outlook long term? And stock cadence, you did a lot more stock buyback this quarter than normal with your new announcement. How should we think about those financial metrics? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Yes. So let me hit the first one. Relative to the competition in the campus, what I would say is that, look, we launched this architecture last June. And I think our customers have been incredibly excited about it. One of the very important things that we did is we made the architecture and DNA Center backwards compatible with at least one generation of our wireless products, our switching products, our routing products, et cetera. And I think that taking a look at all of those products is incredibly important because our customers don't want to have an automation platform that handles switching. They want an automation platform that handles the enterprise -- at a minimum, the enterprise network. And then over time, as we integrate our automation platform in the data center and the campus, you'll be looking at the ability to automate from the data center to the campus to the wireless network to the routing and frankly, the security architecture. And we think that is a unique architecture that we can deliver. We are leading right now. We see incredible acceleration of the Cat 9K and adoption by our customers. And we're very comfortable with where we are in this transition. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [41] +-------------------------------------------------------------------------------- + + And on the tax question. So again, we feel really good about where we stand in terms of that. As we said in the call, we brought back $67 billion from overseas. And we -- like we said in last quarter's earnings, we announced a big increase to our share buyback authorization. So we have $25 billion remaining in our share buyback. And we anticipate using that in the next, basically, 18 to 21 months. So we're being very aggressive there, like we had stated we would be once we got our cash back. So that's going well. As far as the tax rate, we also stated in Q2 that we expect our tax rate to be in the 21% for fiscal year '18. And we expect it to go down to 20% in fiscal year '19 when we get the full benefit of the U.S. -- the new U.S. federal rate. So overall, we feel great about the tax law and the implications for us. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Mitchell Steves from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [43] +-------------------------------------------------------------------------------- + + I actually wanted to circle back a little bit and poke at the recurring revenue piece. And now that it's 32%, and you're noting that you got 120 basis points from acquisitions. Can you help me understand what really drove the decline Q-over-Q from 33% to 32% given that the acquisitions you guys had done have been software in nature? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [44] +-------------------------------------------------------------------------------- + + Yes. I mean, again, I think, basically, AppDynamics has been in the numbers as we go along. I would say, BroadSoft has a mix of both perpetual and recurring, so it is not all recurring. I would say the bigger impact on the numbers, and again, it's really just the mix of the products. When we have product revenue growing 5%, services growing 3%. And within that product revenue, we had very, very strong server revenue growth, which has a very low software recurring proponent of it. That's what's really driving it. As I said, overall, the growth of product recurring revenue was over 30%, like it has been for the last 5 quarters. So that just continues to grow. It's really more the denominator of total revenue that's driving just the slight round down to 32%. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Tal Liani from Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [46] +-------------------------------------------------------------------------------- + + Security was up 11%, which is an acceleration from previous quarters -- the previous 2 quarters. Can you talk about what went right and what went wrong with security this quarter? And what are the things that are driving this acceleration? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + Yes. Thanks, Tal. So look, we remain confident in the security architecture that we built, even when we had some deviation in the revenue run rate over the last year. And I think that as you look at the architecture that we have, which extends from e-mail to endpoints to the network to the cloud and then has this massive state machine where we can correlate threats and then dynamically defend, it's a unique proposition. And we say that we have this integrated architecture but also best-of-breed products. So where we are convincing customers that the architecture is right, then we're winning. And I think that our teams are doing a really good job. I think that the engineering teams have continued to add new features and new capabilities that our customers are adopting. And I think it's as simple as that. It's just -- it's we have reasonably good traction in the field right now. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [48] +-------------------------------------------------------------------------------- + + And can you share with us maybe the areas where you think you need to strengthen your portfolio? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + Well, I mean, we have -- the great thing about this architecture when we build it is that you can continue to add virtually any source of threat intelligence to this because it's built to digest massive amounts. I mean, we see 20 billion threats every day. So you can assume that we can add any sort of capability that we like. That includes threat sources and frankly, the same thing from a defense perspective. So within the portfolio, I think there's always an opportunity for our teams to continue to improve and continue to add features. And there's a lot of good competition in the space. It's very fragmented. So we just continue to execute against delivering that architecture. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Mark Moskowitz from Barclays Capital. + +-------------------------------------------------------------------------------- +Mark Alan Moskowitz, Barclays Bank PLC, Research Division - Director [51] +-------------------------------------------------------------------------------- + + Just one more revenue question for me. Kelly and Chuck, how should we think about the second half of calendar '18 relative to your fourth quarter revenue guidance in terms of the 4% to 6% goalpost year-over-year? Is there any inflection point with respect to the selling cycle? We've heard anecdotally from some of our checks that it is a slightly longer selling cycle as customers try to understand more the subscription element. And as they do become more receptive, could you actually see accelerating revenue growth maybe closer to that 6% or better as you go into the October, January quarters? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [52] +-------------------------------------------------------------------------------- + + Mark, so as you guys know, we really do just give guidance one quarter in advance. And we feel very good about the guidance we gave of the 4% to 6% growth. As we look forward though, just to give you some color, context, in the Cat 9K, the demand is great. We have fantastic demand. We are taking orders like crazy. And there's great adoption out there by our customers that we don't see slowing down. So we feel great about that. But again, there's a lot of moving parts, and we'll take it one quarter at a time. The only other thing I just want to remind you is, we do have -- when our fiscal year starts in August for '19, we do have the tweak on the new revenue standard that we'll take you through any implications of. So feel really good about the Q4 guide, and we're just going to take it one quarter at a time. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [53] +-------------------------------------------------------------------------------- + + All right. Good. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + So I want to just thank everybody for joining us today. We appreciate you spending time with us. Appreciate the opportunity to answer your questions. And Marilyn, I'll kick it back to you for the details on the next call. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [55] +-------------------------------------------------------------------------------- + + Great. Thanks, Chuck. Cisco's next quarterly earnings call, which will reflect our full year 2018 fourth quarter and annual results, will be on Wednesday, August 15 at 1:30 p.m. Pacific time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to contact the Cisco Investor Relations department, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (888) 568-0890. For participants dialing from outside the U.S., please dial (402) 998-1566. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2018-Nov-14-CSCO.txt b/Transcripts/CSCO/2018-Nov-14-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..59da6650424cfdb0f6c8e3ad848b3c8efb55535a --- /dev/null +++ b/Transcripts/CSCO/2018-Nov-14-CSCO.txt @@ -0,0 +1,552 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Cisco Systems Inc Earnings Call +NOVEMBER 14, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * James Edward Fish + Piper Jaffray Companies, Research Division - Research Analyst + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD of Communications + * Thejeswi Banavathi Venkatesh + UBS Investment Bank, Research Division - Associate Director and Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's First Quarter Fiscal Year 2019 Financial Results Conference Call. At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. +Welcome, everyone, to Cisco's First Quarter Fiscal 2019 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations. And I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. +Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. As is customary in Q1, we have made certain reclassifications to our prior period amounts to conform to the current period's presentation. The reclassified amounts have been posted on our website. Click on the Financial Reporting section of the website to access these documents. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the second quarter of fiscal 2019. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Form 10-K, which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. +As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. +We delivered another great quarter. It is absolutely clear that the strategy and transformation that we laid out 3 years ago was working. We accelerated revenue growth, expanded margins and generated strong operating cash flow and double-digit earnings per share growth. We saw broad-based growth across all of our geographies, product categories and customer segments. This was driven by strong execution, differentiated innovation and our transition to more software and subscription offerings. We are well positioned to capture significant growth opportunities while creating long-term value for our shareholders. +In today's environment, there's an ever-increasing number of connected devices with users expecting an always-on experience with access to any application. The enterprise has expanded to now include multiple clouds, and applications are evolving at an unprecedented rate. Customers facing a new level of complexity are increasingly seeing the value of our integrated platforms over stand-alone products. +We are fundamentally changing the network and security industry. We're building an architecture that is designed to securely connect any user on any device on any network to any application running anywhere. This creates an enormous opportunity for us as we deliver a multi-domain, intent-based networking architecture that drives automation, simplicity and agility for our customers. +Now let's take a more detailed look at our results as we continue to deliver new innovation across our entire portfolio. +Starting with Infrastructure Platforms. Over a year ago, we set out on a strategy that would disrupt how growing data from a proliferation of new connected devices and complex traffic flows would be managed and secured from the private enterprise into multiple cloud environments. We brought to market an intent-based architecture capable of capturing business intent and applying it across wired, wireless and enterprise routing, including SD-WAN. This allows our customers to automate their operations, applications and security policies for efficiency and business agility. This value proposition resonates strongly with our customers and is driving continued strong customer ramp of our Catalyst 9000 family of switches. +Yesterday, at our Partner Summit, we announced several exciting, new additions to this architecture. We launched the next additions to the Cat 9K family, the 9200 and the 9800. The Catalyst 9200 series of switches extend intent-based networking to simple branch deployments and mid-market customers. The Catalyst 9800 is our newest wireless controller. We continue to help our customers run consistent security, automation and analytics services across wireless and wired environments. The 9800 gives our customers ultimate flexibility, running anywhere from on-premise and any cloud or embedded virtually on Catalyst 9000 switches. +We also announced a major new architectural change for the modern branch network. Cisco is unifying our security and SD-WAN technologies to help organizations embrace the cloud faster with choice and confidence. We provide the simplest way to integrate SD-WAN with our cloud security. This is a great example of how the expansion into the cloud is driving our entire portfolio. +In the Data Center, as more customers move to multi-cloud environments, the need for secure virtualized infrastructure grows. Our strategy is to enable our customers to address increasing connectivity and data growth while securely enabling workloads across any combination of private, public or multi-cloud environments. We continue to invest in innovation to help our customers transform their data centers for improved efficiency, scale and resiliency. This has resulted in tremendous traction with our Nexus 9K, ACI and UCS solutions as we architect security from the application to the network and support cloud workloads wherever they may reside. +Building on the success of our industry-leading Nexus switch portfolio, we recently unveiled new Nexus 400-gig switches. We are committed to leading the market transition from 100 gig to 400 gig, providing customers with increased bandwidth and scale in their data center environments, powering any workload in the cloud. The addition of 400 gig to our Nexus portfolio extends the power of ACI, providing intent-based networking to enterprises, web scale and service providers to enable them to build compact, fully-automated, high-bandwidth fabrics. Cisco is the only company that not only delivers a best-of-breed 400-gig portfolio but also brings customers the architectural solutions for today's multi-cloud world. +Last week, we expanded our hybrid cloud portfolio by introducing the industry's first hybrid solution for Kubernetes on Amazon Web Services. We are delivering a hybrid cloud solution that is designed to enable our customers to easily connect, secure and monitor Kubernetes-based applications across on-premise and the AWS cloud. +Turning to our Security business. We again delivered another robust performance with double-digit growth. Our goal is to be our customers' #1 security partner. We are building a comprehensive and integrated security portfolio focused on effectively detecting, rapidly containing and quickly responding to threats. Spanning from the Edge to the Data Center and to the cloud, our customers' users devices, applications and data are protected wherever they are. We continue to add more SaaS-based offerings to our broad security portfolio. A great example of this is our recent acquisition of Duo Security, which provides cloud-based identity solutions for Unified Access security and multifactor authentication. Duo solutions play an important role in extending our intent-based architecture into multi-cloud environments, simplifying policy for cloud security and expanding endpoint visibility coverage. The integration of Cisco's network, device and cloud security platforms with Duo's zero-trust authentication and access products is designed to allow us to easily and securely connect users to any application on any network device. +Moving to applications. Data intelligence continues to be critical for organizations to improve business outcomes and agility. Our AppDynamics solution uniquely addresses this need, resulting in another quarter of strong double-digit growth. Our innovative capabilities and application monitoring and analytics provides unparalleled real-time business insights to our growing customer base, making us the clear market leader. +We achieved a solid quarter in our collaboration business and continue to set the standard for how people connect, collaborate and create every single day. We are defining the future of productivity and collaboration by providing customers of all sizes with a comprehensive portfolio to help them share data through any device anywhere. Customers recognize the value we bring with more than 95% of the Fortune 500 using our collaboration solutions. We're delivering unique capabilities, enabling rich collaborative experiences, increased productivity and helping our customers transform their workspaces. This is accomplished through our new modern WebEx experience, AI-enabled devices and enhanced interoperability across our on-premise and cloud solutions. +Yesterday, we expanded our collaboration offerings with a full suite of cloud calling and team collaboration tools to extend our customers' on-premise investments with new hybrid solutions from the cloud to the end user. These innovations include the availability of BroadSoft cloud calling with WebEx Teams through service providers, 85-inch WebEx board and our new portfolio of huddle room solutions with Room Kit Mini and WebEx Share. +In summary, we had a great quarter, and our opportunity has never been greater. Our growth continued to accelerate as we executed well against our strategy, continued to drive innovation across our portfolio and delivered more software and cloud-based offerings. It is clear our customers are looking to Cisco as a trusted partner to help them operate in a multi-cloud world and to transform their businesses. We are well positioned with our growing portfolio across multiple domains as we continue to innovate to bring our customers a more secure, automated and simple IT infrastructure. We believe the strength and differentiation of our portfolio, combined with the power of our business model, provides us with a strong foundation for fiscal year '19 to create long-term growth and shareholder value. +Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + All right. Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q2. +We executed well across the business with strong orders, revenue growth, margins, EPS and operating cash flow. We had continued momentum in product orders, which grew 8%. Total revenue was $13.1 billion, up 8%. Our non-GAAP operating margin rate was 31.9%. Non-GAAP net income was $3.5 billion, up 14%. And non-GAAP EPS was $0.75, up 23%. +Let me provide some more detail on our Q1 revenue. Total product revenue was up 9% to $9.9 billion. Infrastructure Platforms grew 9% with strong growth across all businesses. Switching had another great quarter with growth in Campus driven by the continued ramp of the Cat 9K and growth in Data Center driven by the Nexus 9K. Routing returned to growth driven by Service Provider. Wireless had double-digit growth with strength in our Wave 2 offerings and Meraki. We also saw good growth in Data Center driven by servers and HyperFlex. +Applications was up 18% with growth across all the businesses. We saw good growth in Unified Communications, TelePresence and AppDynamics. +Security was up 11% with strong performance in identity and access, advanced threat and unified threat. Service revenue was up 3% driven by software and solution support. We continue to transform our business, delivering more software offerings and driving more subscriptions Software subscriptions were 57% of total software revenue, up 5 points year-over-year. To remind you, we adopted ASC 606 in Q1. There have been no changes to our offerings to customers or our cash conversion cycles. This is purely an accounting change. It does not impact the metrics that -- I'm sorry, it does impact the metrics that show our continued business transformation. We think the most meaningful metric going forward is software subscriptions as a percentage of total software revenue. +When we look at the impact of acquisitions in our Q1 results year-over-year, there was an 80 basis point positive impact on revenue. We saw strong momentum in Q1 with total product orders growing 8%. +Looking at our geographies. Americas grew 8%, EMEA was up 6%, and APJC was up 12%. Total emerging markets was up 16%, with the BRICS plus Mexico up 19%. In our customer segments, Enterprise was up 15%, Commercial grew 8%, Public Sector was up 8% and Service Provider grew 2%. +From a non-GAAP profitability perspective, total Q1 gross margin was 63.8%, up 0.1 point. Product gross margin was 63.2%, up 0.2 point. And service gross margin was 65.7%, up 0.1 point. Our operating margin was 31.9%, up 1.5 points. In terms of bottom line, from a GAAP perspective, Q1 net income was $3.5 billion, and EPS was $0.77. +We ended Q1 with total cash, cash equivalents and investments of $42.6 billion. Q1 operating cash flow was $3.8 billion, up 22%, with free cash flow of $3.6 billion, also up 22%. Normalized for the $400 million legal settlement we received from Arista, operating cash flow was up 9%. From a capital allocation perspective, we returned $6.5 billion to shareholders during the quarter. That was comprised of $5 billion of share repurchases and $1.5 billion for our quarterly dividend. +From a M&A perspective, we closed 2 acquisitions in Q1 with Duo Security and July Systems. These moves are consistent with our strategy of increasing investment in innovation and R&D for our growth areas. +To summarize, we had a great Q1. We executed well with strong top line growth and profitability. We're seeing the returns on the investments we making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the second quarter of fiscal '19. This guidance includes the type of forward-looking information that Marilyn referred to earlier. Note that we have normalized our second quarter guidance to exclude the SPVSS business for Q2 fiscal year '18, which we divested on October 28, 2018. We have provided historical financial information for the SPVSS business in the slides that accompany this call. +We expect revenue growth in the range of 5% to 7% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63.5% to 64.5%. The non-GAAP operating margin rate is expected to be in the range of 30.5% to 31.5%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.71 to $0.73. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the lines for questions. (Operator Instructions) I'll now turn it over to you, Michelle. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + James Faucette from Morgan Stanley Investment Research. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [2] +-------------------------------------------------------------------------------- + + I guess, maybe I'll direct to say, Chuck and Kelly, and you guys answer where you think it is appropriate. But one of the key questions we've been getting from investors is, if you're seeing any change in customer behavior, either because of pending tariff implementations or macro conditions around the world, you've seen -- in this past quarter, you've seen a lot of volatility on exchange rates as well as the pending implementation of these tariffs. So wondering if you're seeing any change, whether customers are pulling forward deals or reducing deal size, et cetera. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + So let me -- thanks, James. Let me give you some comments, first of all, and then I'll pass it over to Kelly. First of all, we -- the tariffs were immaterial to us in Q1. The 10% tariffs, I think, we implemented them with a month to go, so we did not see any impact. But I can tell you that from a demand perspective, when we implemented the pricing changes, which we told you we would on the last call, we saw absolutely no demand change from the week before and the week after we did that. We have talked to all of the sales leaders around the world, and I could tell you, there are probably only a handful of customers that have made any indication to us right now that they're doing any pull-forwards. Now that doesn't mean that there's not stuff out there that we don't see, but in general, we do not view this as a broad-based issue. And our momentum from the first week of the quarter until the last week of the quarter was incredibly consistent. So Kelly, any comments? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Yes. I mean, I'll say just to add some -- add to that. If I look at the linearity by month through the quarter of Q1, it was the exact same as it was in Q1 '18. So we didn't see -- for the 10% tariffs, we didn't see any pull-ins. And just to kind of remind everybody. We are actively working with our supply chain to mitigate as much of this as possible, and we've made progress. For that, that we couldn't mitigate, we passed on, and we passed on the price impact, so just to the products impacted versus broad-based. We were very specific and surgical where we applied it. But overall, we are very specific. Going into Q2, like Chuck said, it's pretty straightforward, but I would hope that it is a potential that drives some demand. But the underlying strength of the IT environment is still there. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Yes. Two other quick comments. I can just tell you, personally, I haven't had one conversation with any customer around the tariffs at this point. Secondly, I think that once we got past the midterms, we've begun to hear some positive, at least, headlines relative to the discussions. And I remain fairly optimistic that this has become a top priority for the administration, and we're hopeful that they'll come to some agreement before we move to anything more significant. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Vijay Bhagavath from Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [7] +-------------------------------------------------------------------------------- + + I have a bigger-picture question for both of you, if I may, which is the subscriptions model. The promise was to get a higher share of the purchasing dollars, the customers' budgets. Is that starting to happen? Are you starting to see it in your sales figures? And if you could give us any data anecdotes saying, yes, now that we have kind of expanded and extended software subscriptions across the portfolio, you're seeing X percentage more of the customer share of IT spending purchasing dollars would be very helpful. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + Yes, thanks, Vijay. Let me comment because this was at the heart of our presentation this week at the Partner Summit. And there's a significant recognition that, I think, is occurring in the marketplace right now. If you look at what our customers are dealing with, they are dealing with a world that truly does involve consuming services from multiple cloud providers. Most of our customers have well over 100 and beyond SaaS applications that they're dealing with. They still have increased investments in the Data Center. They're beginning to see IoT explosions at the Edge, data at the Edge, mobile workers everywhere, interconnectivity with suppliers and customers. And what that has done is it's completely made obsolete the original assumptions on which they define their IT infrastructure. And so the IT infrastructure was built based on assumption of traffic flows that just fundamentally don't exist anymore. And so what we're seeing is that they now need to drive security and policy and automation from the Campus to the Data Center to the branch into the cloud. And they're looking more and more at the simplicity of having a single architecture to provide that capability. So one of the big things that we talked about this week was the need to drive multi-domain architectures for our customers, which actually give them the ability. And you're seeing us extend and connect like policy in the Campus with policy in the data centers. So you're seeing ACI being connected into DNA and our Software-Defined Access technology in the Campus so that we can extend policy. You saw this week with the branch where we integrated our SD-WAN with our security -- cloud security portfolio. So -- and I think we're seeing that come through in more and more of these broad-based software licenses that we continue to see our customers adopting. So I think that we are seeing that play out exactly as we thought, Vijay. Kelly, any... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [11] +-------------------------------------------------------------------------------- + + I guess, I wanted to focus in on product revenue growth. It was really strong for the quarter, 9%. I know that's with SPVSS, which, if anything, dragged that down. And then -- so I mean, it feels like you've been pretty conservative in the guidance, and I know you'll probably say, "No, we aren't." But I'm just curious what could go better in this guidance, what you're contemplating in terms of elements of conservatism. Can you give us any idea of how you're thinking about that forward quarter right now and how things might go better if, let's say, we do get a trade deal, et cetera? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Rod, thanks for the question. Let me just give you some -- a little color, and then Kelly can answer some specifics on the math. I would say, the last 2 quarters were probably the most consistent, strong quarters that we've seen in years, honestly. And I think it's a combination, as we've talked about, of the macro environment but also, frankly, the innovation. If you look at the portfolio that we have put out there and you look at the number of announcements and the technology and the innovation that we delivered this week, I think you're going to continue to see strong execution. We're really proud of what our teams have done. So -- and I think that the recognition by the customers of this architectural shift that I was talking about earlier is really beginning to play out. So we feel really good about how we're performing. I'll let Kelly comment on both the product revenue growth and the outlook. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes. I'd say, actually, I think, Rod, I feel like this is a pretty, pretty good guide and actually better theoretically than maybe you guys were expecting. I mean, don't forget, that 6% growth in the midpoint of the guide we gave you, again, excluding SPVSS out of both periods, obviously, is really solid because we have much tougher comparison from a year ago. I mean, we see the strength, and I'm just trying to balance it with there is a lot of unknown depending on what tariffs do. But underlying strength in the macro gives us good confidence. So I feel actually very, very good about the call and... + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [14] +-------------------------------------------------------------------------------- + + Kelly, I just -- just one comment on that. What I would say -- and I didn't mean that it was disappointing from a guidance point of view. I just meant that you were so strong on growth in the reported quarter. Why not be more, I guess, aggressive with the guidance? That was really what I was asking. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + There is one -- there is -- you bring up a good point, which I do want to get out there. Our growth was very, very strong in Q3. And again, back to ASC 606, under new accounting rules, as you know, we have a very strong presence in the Enterprise. Our Enterprise business is going very, very well. Whenever we sign these big, multi-year enterprise agreements, under the new accounting rules, that will accelerate revenue. So in this current Q1, software came in very, very strong. We happen to have 2 very large multi-year enterprise agreements with some large enterprises where, in any one quarter, I might have one, but this was a big one. So that's one additional piece to it. But overall, I'd say all of the underlying fundamentals are very, very positive. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + And I think these enterprise agreements are actually reflective of what the question Vijay asked. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + That's a good point. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Paul Silverstein from Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Kelly, just 2 quick questions on pricing and the drag from the shift to recurring or does 606 address that? And the bigger question for you and Chuck -- and Chuck, if you can't answer this, I'm hoping you'll answer a different question. But I hear you keep citing the strength of the macro environment. And the thought arises that it's far from even throughout the world. U.S. has been strong, but there are plenty of other places far less so. In fact, I don't think the word strong would apply. And yet your revenue on a very broad base across geos is very strong and far outstripping what we see from a macro perspective. If you can't answer for the disconnect, my question to you would be, how -- what do you think is the time period? I know it's still early in the Catalyst switch architecture upgrade cycle. How far do you think that has to go? Where do you think you are in that process? How much strength is there to come? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Okay. Thanks, Paul. Thanks for the 4 questions. Just kidding. So Kelly, you'll talk about pricing and everything. Let me give you the broader answer, Paul. I think you're right. And I mean, when you look at our results in -- on an orders perspective and you see emerging countries up 16% in the face of a rising dollar, that's different than what we've seen historically when we were very -- what I would say is we were directly connected to the global GDP, and we move with it. I think maybe this is the beginning of us answering the question that I've been asked the last 2 calls, which is how much of this is macro and how much of it is your own execution. When we began to perform differently than what's perceived to be in the macro, I think that'll give us insight into how much of it is our execution or innovation. The other thing I'd point out is that -- and by the way, in the emerging countries, just to be clear, it was very consistent across the board. So we had incredible strength in -- we do have incredible strength in India. It was our second quarter of 50%-plus growth in India. So we have really done a great job there, and it's not just the large service providers. We had a large Public Sector deal this quarter. So we're -- that is a key market for us that we intend to win in, and the teams are doing a good job there. But I think the other thing to consider is that when you look at our customers even in a tough economic environment, what is one of the things that you want to do when you're in a tough economic environment is you want to continue to drive cost and productivity in your business. And at the heart of the automation strategy and at the heart of some of the SD-WAN stuff and at the heart of rearchitecting the infrastructure, the ending result is to drive cost out and drive productivity up. So it's unclear to me at this point what any sort of significant macro shift is going to do to the spending in this environment because it is connected to what you're trying to achieve when you do have a tough macro environment. So we're going to have to see how it goes. But -- so that's -- that question -- on the Cat 9K, look, we're still incredibly early. I mean, it's incredibly early. We just launched another product that addresses a market size similar to what we launched 1.5 years ago. And so we're just on the front end of it. And as customers adopt that architecture, then you're seeing -- we announced the wireless portfolio that's going to fit within that. In the spring, you'll see SD-WAN get integrated into the overall architecture in addition to the innovation we announced this week. So we feel good about where we are, and we'll see how the macro plays out. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + And Paul, on the price, we saw, from a rate impact on price, about 1.9 points down. So slightly up from what it has on the last couple of quarters, but still better than it was, say, in Q1 of '18, but a slight tick-up, 1.9 points. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Samik Chatterjee from JPMC. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [23] +-------------------------------------------------------------------------------- + + Kind of the macro question, which is just to focus on your EMEA business. You had a strong quarter there. Which are the countries kind of driving that strength? And as we kind of get to this point where we have some more clarity building around Brexit, how do you -- are you seeing any kind of enterprise customers starting to sort of step -- come off the fences and start to invest a bit more, given that there's now more clarity building around what the eventual deals will look like? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Again, I'll make some color commentary, and I'll let Kelly give you some details there on the numbers. But I think that, for us, Europe has held up in a time where there's been ongoing uncertainty, and I think this shows the resilience that we've seen around the world in the face of a lot of uncertainty. You have Brexit. You've got Italy. You've had elections. You've got Merkel's announcement, and yet we still see continued strength. And we -- it's been pretty consistent for the last, what, Kelly, 4 to 6 quarters, I'd say. It's been fairly consistent growth. So our teams are doing a good job there. I think that we're continuing to execute. And I think that any clarity on any of these issues like Brexit can do nothing but help in my opinion. So Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Yes. No, I'd just say it is very broad-based. I'd say Enterprise is exceptionally strong. So it's -- there is no -- and the U.K. specifically has been pretty good for us over the last, as I said, the last 4 quarters. So I think it does just go back to it's a resilient IT environment. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Jim Suva from Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [27] +-------------------------------------------------------------------------------- + + It's Jim Suva. I just have one question, and that is on memory pricing. Can you just remind us of -- the memory pricing was going up, say, the past 12 or 24 months with the actions the company did. And more importantly, what is the strategy going forward as memory pricing appears to have softened? How should we think about that in your strategy or pricing impact to your company? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes. So the historical -- what we did was memories around DRAM specifically. It was a combination of just prices going up and consistently for all of '17 and '18, and it was a very tight supply. So our strategy was securing supply. We bought inventory ahead. We did everything we could to try to minimize the impact. We had big purchase commitments. And we are still seeing year-over-year price increases. In this quarter, we still are seeing the prices being higher than they were a year ago. The good news is, though, when we look forward, and like I alluded to in the last call, we should see it go from a headwind to a tailwind starting in the second half of our fiscal quarters. So Q3 and Q4, we fully, fully expect the DRAM to be a tailwind for us, which will be good. And this quarter had an impact. There will be less of an impact next quarter, and then we get to goodness. And we did -- much like we're doing with tariffs, we did pass through a lot of the memory costs through price increases over that time as well. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Tejas Venkatesh from UBS. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [30] +-------------------------------------------------------------------------------- + + I'm on for John Roy. I wanted to focus on the Enterprise orders, which were up 15%, I think the best since 2011. Where is that strength coming from? And are there businesses that are accelerating versus the reported quarter? And maybe, secondly, somewhat related. You called out strength in Service Provider Routing. But Enterprise Routing is a significant portion of your Routing business, and it was down a lot last year after the Viptela acquisition. Now that, that's partly integrated, how's it going? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [31] +-------------------------------------------------------------------------------- + + So I would say, if you look at our Enterprise business, it was incredibly consistent globally. It was incredibly consistent across the breadth of our portfolio. I think every product category we had grew in the Enterprise space. And it's largely driven by the strategy in the automation side that we brought forward with this represented in sort of proxy by the Cat 9K from a revenue perspective. We've also -- our team and we talked about this before. Back in Q4 of '18, if you go back to the Q3 call, we said that we felt confident that the SD-WAN solutions would begin to be rolled out in Q4. We saw that, and so we've seen continued adoption of that. And I think with the announcements we made this week with the native integration into our cloud security portfolio that you'll even see that continue. So I think the -- our teams are doing a good job with helping our customers understand the costs and the operational simplicity that they can gain from some of the architectures that we're bringing forward, and I think that's what's driving it. Kelly, any comments on this? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Yes. No, I mean, it was across all -- basically, we were up across -- when I look across our businesses, basically just about everywhere. So it was, again, broad-based. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Sami Badri from Crédit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- + + My main question has to do with service provider growth in the quarter And you made a comment earlier about India being up 50%. If you were to exclude the India growth in the quarter, would Service Provider be flat to down? Maybe give some perspective on that. And then the second part is, as you think about Service Provider, the Service Provider segment or the customer vertical in next year or 2, are you seeing some customer spend being held back with the onset of 5G spending and deployments coming into the picture? And if we were to see a 5G revenue type of spending deployment or acceleration, where in the next 4 quarter do you think that would start to be very noticeable? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Let me get... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Go ahead, Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + Yes, I'll take the first one on the Service Provider excluding India. I will just say that our Service Provider segment was up in the Americas and EMEA as well. So again, it was... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Positive everywhere. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + It was not driven by India. Though, India had a very strong Service Provider as well. But it was up. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Up everywhere. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [41] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + I would say just a quick characterization on this market, and we've talked about this before. Different customers, different markets are in different phases of their architectural transitions. And we're seeing, in Asia, we had a couple of big wins obviously where we're helping them rearchitect their networks, try to simplify their architectures. And a lot of that is, in some ways, to prepare for 5G. So we're executing better and -- but I think -- I'll still say we've been saying is that we've been doing planning with many of the customers on 5G. I had a call with one CEO today talking about their roll-out plans. So we're actively in the discussions, and our teams are working on architectural designs to accommodate. You're going to see them go into trials. In fact, you've all heard some of the U.S. providers are going into trials in the first quarter of next calendar year. I still believe it'll be calendar 2020 before we see anything -- if we're looking for some broad-based movement. But we'll see how it goes if they move faster, then obviously, we could be a beneficiary of that. But we're staying close to it right now. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Jeff Kvaal from Nomura Instinet. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [44] +-------------------------------------------------------------------------------- + + Yes, I have a question and a clarification. The question is, on the 400-gig side, I think some of your peers in the space are hoping that this will be an opportunity for them to make insertions into the webscale market. It seems, Chuck, from your language that you're focused primarily on the Enterprise market. So I guess, I'm wondering, if not now for web scale, when? If I have that right. And then, Kelly, maybe on a clarification side. Could you help us understand if you've baked anything into the January outlook or pass-throughs of memory prices or increases in tariffs or what have you? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [45] +-------------------------------------------------------------------------------- + + Yes. So Jeff, my apologies if I misrepresented our 400-gig strategy. I think I said in the script that we were -- in the opening comments that we were absolutely focused on web scale. And I think this does represent an architectural transition that gives nonincumbents the opportunity to insert. So we will look for those opportunities as well. I think when you look at the 400-gig advantages we have, we're bringing forward much like we do with the Nexus. We're going to have a merchant version, and we then have an ASIC-based version we'll be delivering. We have telemetry. We've got optics, security automation, backward and forward compatibility that are going to provide differentiators for us. We're co-chairing some standard boards. We can extend ACI from the private cloud into the public cloud across these. So we think we have a lot of advantages. The teams -- we have the ability to analyze data flows, with security ACI automation policy. So the whole intent-based portfolio that our teams in the Data Center actually introduced years ago, we think will be a big differentiator as well as the breadth of the options that we'll have in the 400-gig space. But we absolutely do see the web scale as an opportunity that we're going to go after here. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [46] +-------------------------------------------------------------------------------- + + And on the clarification. So yes, in the January outlook, like I said when I was talking about component costs and memory costs, I still have some bit of a -- I will have still a headwind in Q2 from memory as well as some costs around the MLCCs. And I have an assumption baked in on certainly the tariff costs if they go up to 25% as well as an assumption on what we can offset with the prices pushing through. And so it's all incorporated in the guide I gave you on the gross margin. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [47] +-------------------------------------------------------------------------------- + + Yes. I'm sorry, Kelly. I meant on the revenue side. The pass-through on tariffs or memory. How much is that? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [48] +-------------------------------------------------------------------------------- + + Yes. So it's the same. I will tell you from an overall perspective. Let's assume they do cut in, in January. Because we will honor quotes. If they have quotes in the system that they took that we haven't taken a order yet, it'll take a while before both the price increase cuts through as well as even when the tariffs do cut in the cost side, we'll bleed through the inventory that has been brought in at the lower costs. So the real full, big impact we'll see, feel when the tariffs go to 25%, if they go to 25%, we'll be in the third quarter. But I have baked in some incremental on both the revenue and the margin side in -- from January. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Srini Pajjuri from Macquarie Capital. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [50] +-------------------------------------------------------------------------------- + + Kelly, one clarification on the question. First on ASC 606, is it just a one-quarter benefit to revenue? Or do you expect any more in Q2 or going forward? And then the question is, you talked a little bit about some of the metrics that you used to give us on the recurring front not being as well as in going forward. Could you give us some more color on that and what sort of metrics that we should focus on and then if you have any targets for those new metrics going forward? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [51] +-------------------------------------------------------------------------------- + + So on the first question on ASC 606, so we will benefit from that going forward. The point I was making earlier was this was a little abnormal this quarter because we had 2 very large enterprise multi-year deals that were very heavy software content that we recognized now -- on the new accounting rules recognized upfront. Just to remind everybody of where we are impacted on mostly from ASC 606. When we have enterprise agreements, whether it is our term-based or not, we will be recognizing them upfront if, basically, the functionality of the software goes to the customer. So a lot of the enterprise agreements we have will all be recognized upfront. Cisco ONE, for example, a lot of that's going to be recognized upfront. And even a portion of our Enterprise Networking like the Cat 9K subscription, a portion of that now will be upfront, even though some is still deferred. So it's accelerating basically big Enterprise license agreements. So this quarter, we had 2 very large ones, but we will be benefiting going forward. And again, it's incorporated in the guide. And overall, long term, it'll be in the 1%, 1.5% kind of range. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Yes. I just want to make a comment. When we set out to move to more of a software and subscription model, the real benefit for us is it gives us the opportunity to go in and monetize those licenses again in 3 years. That has not changed. And that was the big benefit. Because if you looked at the way we sold the switch previously, as an example, we would sell a switch with integrated software one time, and perhaps, 5 to 7 years later, we'd go in and try to sell another one. In this model, the underlying ability for us to go in at either the 3-year, the 5-year point, whenever that subscription is up, and renew it, that still exists. This is just an accounting change. So the underlying value to our business is still valid. So we're going to continue to move very hard in this direction. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [53] +-------------------------------------------------------------------------------- + + And so on the metrics then here, second question there. So that's why to that point, we think the right metric is looking -- of our software, what percentage is subscriptions, right? And that continues to just increase. And I'll use the Cat 9K as an example. We've talked in the past where we used to sell the previous switch sold for $100, and we recognized $100 upfront. We're selling the Cat before ASC 606, we sold that. Cat 9K for $100, but 25% of it was deferred. And we recognized that 25% over, say, a 3-year term. And then they would renew it for another 3-year term. With ASC 606, that 25% that was deferred, about 12% is now deferred, and other 11 is recognized upfront. But that full 25% is what we renew. And so that's why when you look at the software, that's still subscription software. That's why we think that's the relative metric. We don't think the -- like looking at our deferred revenue, we looked at that in the past. I mean, that was a proxy. But as you saw from our disclosures, we wrote off $1.3 billion of that balance with the adoption all of the new standard for those enterprise agreements and for Cisco ONE. So looking at that isn't as meaningful. And even with the recurring, like using that Cat 9K example, it's not as meaningful. That's kind of why we think using subscriptions, it shows we're still making the transformation. It's shows that we're making progress and have that -- again, nothing has changed with the customer. We still have that stickiness of having that subscription and the ability to continue to build out our offers with them. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + James Fish from Piper Jaffray. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - Research Analyst [55] +-------------------------------------------------------------------------------- + + Just quick one for me. The Edge is a topic popping up more and more. I guess, what are your thoughts around the move towards a distributed environment? How that will impact Cisco? And what investments are being made to win there? And just secondly, there's been a lot of larger M&A over the last few months. How is Cisco viewing the M&A pipeline today? And if a large enough deal were to come along, would this impact that share buyback plan? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [56] +-------------------------------------------------------------------------------- + + So let me talk a little bit about the Edge, and I'm going to pile on with a little bit of the cloud, a little bit of discussion around what we see happening with applications in the cloud and some of our announcements, and then we'll talk about the M&A question. So first off, the Edge is incredibly important, and I think that's what's leading us, in many cases, to some of these strategic partnerships that you hear us building with the webscale providers. Some of those are multifaceted where there's an Edge component involved. Because for us to be able to aggregate the data and give the application developers the ability to run microservices at the Edge, that's why we put x86 into our access products so that you can actually run services from within applications out at the Edge and process data as you need to. We've also built some data fabric technologies like Kinetic that are being used by our customers today. Very early days. So we think that what this Edge dynamic does is it gives us the ability to rearchitect the Edge like what you're seeing with SD-WAN. But frankly, it makes the network more relevant in the world that we live in today. Because the traffic flows and where the data is, where the applications are, where your users are, it's all just fundamentally dynamic. And so you have the architect an environment that accommodates for anything, anywhere. And so we think that this is actually good for us over time, and we'll continue to build technology that enables our customers to deal with it. The other thing I want to just talk about relative to this because part of the reason that these webscale partnerships are so important is that we are enabling these developers with things like the Kubernetes solution that we have to actually build applications once and then move them seamlessly between private cloud and public cloud. And we did that with our Google announcement. We've done it with our Amazon announcement. So what I think is going to happen is instead of creating this complex software architecture at the core that is necessary to map applications back and forth, for future apps, they're going to be built on Kubernetes, and we're going to give the customers -- if they want to start on the public cloud, they can seamlessly move them into the private cloud or if they've build in them in the private cloud, they can move them in the public cloud. And with our ACI being extended into the cloud now, customers can actually seamlessly take their policy in an ACI architecture and extend it into any cloud that they like. So we're trying to make that simple, and we think the combination of that and the Edge actually brings the network much more value in the future. Those were the questions? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [57] +-------------------------------------------------------------------------------- + + About M&A pipeline. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [58] +-------------------------------------------------------------------------------- + + Oh, M&A. Sorry, Jim. We've always said we'll look at any opportunity that arises, if it is strategically aligned and it's good for our fiscally. And I would say that the deals that you've seen done over the last few months have 0 bearing on how we think about it. We continue to look at the opportunities that makes sense for us and our part of our financial plan and makes sense for us in that perspective, and that's how we'll continue to look at it. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + That comes from Simon Leopold with Raymond James. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [60] +-------------------------------------------------------------------------------- + + I just wanted to ask one quick one and one thematic. On the quick one, there were some press reports about layoffs. And I know Cisco regularly does some pruning. If you could address that. And thematically, I'd like to get an understanding of how you think about the SD-WAN products. You've been in this marketplace for a while now, and it looks like it's getting traction. But my thought is this is a headwind for your router business but a tailwind for the SD-WAN platform. So how do you see this playing out over, let's say, the next several quarters? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [61] +-------------------------------------------------------------------------------- + + Okay. So let me address both. The first is that the restructuring that's going on right now is, first of all, it's not an OpEx reduction, and we've -- I've actually taken this issue and talked head on with our employees about what's going on right now very directly. And majority of this is part of the customer experience transition. If you look at what we've done relative to the software portfolio and how we're building out these offers for our customers, any great software company has a very successful customer experience organization. And if you'll recall, we brought in Maria Martinez from Salesforce back in May of this year, and she has been putting together a strategy for how we need to be structured for the future. And this is actually just -- it's an unfortunate step that we needed to take in order to expeditiously get to where we need to be relative to dealing with the renewals and the life cycle that our customers are going to want us to drive with them in this new portfolio. So that's really the predominant driver for what's going on right now. And again, I've been very clear with our employees. We've been very open and transparent with them about what's going on. On the SD-WAN side, I think you're -- it's probably generally accurate, what you described. However, I think that there's been such a stall in the Enterprise routing business for the last couple of years waiting for this to take off that I would view it as a net positive now because we have movement. And you got to remember, many branches are going to -- they're going to leverage SD-WAN technology on top of one of our ISRs anyway. So you're going to see various flavors at the Edge. You're going to see some software only on x86 type platforms all the way up to software running on high-end ISRs because you still need a high-performance branch but you want the flexibility in how you dynamically route your traffic out of that branch. So I view it as a positive. And frankly, I think when you see the Enterprise business, the consistency we've seen over the last few quarters, I think SD-WAN is a big part of that. +Just a couple of comments. I think I'll just leave you with I think that our teams are executing incredibly well. There's clearly some uncertainty out there, but I think the macroeconomy has shown a level of resilience that not many people expected. I think that what we're beginning to see and what is coming through here is that while the cloud 4 or 5 years ago was viewed as an existential threat to our business, I fundamentally believe that the cloud and the transition to the cloud that our customers are undergoing is actually driving our growth now. So we feel good about where we are. We feel good about the innovation, and we feel good about our team's execution. +Thank you guys for joining us, and we look forward to talking to you next quarter. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [62] +-------------------------------------------------------------------------------- + + Thank you, Chuck. Go ahead, Michelle. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may dial (866) 417-5767. For participants dialing from outside the U.S., please dial (203) 369-0735. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2019-Aug-14-CSCO.txt b/Transcripts/CSCO/2019-Aug-14-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6deba9f6d315060882d7bf4ad2ba56f42290b47 --- /dev/null +++ b/Transcripts/CSCO/2019-Aug-14-CSCO.txt @@ -0,0 +1,518 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Cisco Systems Inc Earnings Call +AUGUST 14, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Timothy Patrick Long + Barclays Bank PLC, Research Division - MD + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD of Communications + * Thejeswi Banavathi Venkatesh + UBS Investment Bank, Research Division - Associate Director and Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Fourth Quarter Fiscal and Year 2019 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's Fourth Quarter Fiscal 2019 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2020. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +In Q2, on October 28, we completed the sale of our SPVSS business and, accordingly, had no revenue or expense from that business in Q4 fiscal 2019. As such, all of the revenue, non-GAAP and product orders information we will be discussing today is normalized to exclude the SPVSS business from our historical results. We have provided historical financial information for the SPVSS business in the slides that accompany this call and on our website to help understand these impacts. This guidance we provided during our Q3 earnings call and today's call has been normalized in the same way. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. Our Q4 results marked a strong end to a great year. Our teams executed well through a very dynamic environment. We delivered significant innovation across our entire portfolio, and we continued our business model transition with software subscriptions now at 70% of total software revenue, up 12 points year-over-year. +We delivered strong revenue and double-digit non-GAAP earnings per share growth for the full year and in the fourth quarter. We also continued to generate healthy margins, cash flow and returns for our shareholders. Our technology is fundamentally redefining IT architectures to help our customers manage the complexities of a multicloud world and transform for the future. +Let me cover some recent highlights across our portfolio. Starting with Infrastructure Platforms. We continue to see strong performance with broad-based growth across the majority of our portfolio led by our next-generation enterprise networking solutions. Over the last 2 years, we have built the foundation for intent-based networking by rearchitecting our entire networking portfolio to deliver new capabilities through our automation platform. At Cisco Live!, we launched several new technology innovations across networking domains to more effectively secure and manage users and applications across the entire enterprise, from campus networks, in wide area networks to data centers and the IoT Edge. +We also added several AI and ML software capabilities to improve network management through automation. A great example of this is our new AI network analytics capability, which delivers greater visibility and insights across the entire enterprise network. In data center, we continue to execute well as we help enable our customers to securely access their applications and their data anywhere from private to public cloud environments as well as at the Edge. +We are innovating across every facet of our portfolio, integrating AI, automation, security and assurance into our Nexus switching platforms and our 400-gig offerings. This quarter, we delivered data center network insights, providing critical analytics and proactive network management capabilities through automation to increase our customers' ability to troubleshoot and remediate their environments. +We also continue to invest in silicon and optics to build the next-generation Internet for our customers. The recently announced intent to acquire Acacia is a good example of how we are enhancing our silicon and optics portfolio to enable web-scale service provider and data center operator customers to meet today's fast-growing consumer demand for data. +Now turning to Security, which had an incredible year. Cybersecurity continues to be the top priority for our customers, driving another consecutive quarter of double-digit growth. As the industry leader in networking and cybersecurity, we are investing in and extending our subscription-based security innovations across all networking domains in today's Zero Trust environment. By extending our ability to detect threats across public clouds and by protecting the campus, branch, WAN and data center against threats, we are the only company providing an integrated end-to-end security architecture across multicloud environments. +Throughout the year, we've expanded our family of cloud security solutions to help secure identity, end points and the network, which has led to accelerating customer adoption as they move or expand to the cloud. We're also extending this protection from the network to branch offices to roaming users with flexible solutions designed to secure our customers' SD-WAN environments. During the quarter, we were excited to announce the availability of a full web proxy capability on our global SaaS platform, Umbrella, to complement our on-premise appliances. +Trust plays a critical role as customers access their networking applications; and identity plays a critical role in delivering a secure, consistent experience no matter how, when or where they connect. This market dynamic was central to our Duo Security acquisition, and we continue to see customer momentum, reflecting the power of Duo's differentiated, market-leading SaaS platform. +Moving to applications. Our collaboration business continues to perform well as we execute against our strategy to accelerate the future of work, communications and collaboration. Earlier this year, we shared our vision for cognitive collaboration, which we believe is quickly becoming the foundation to deliver massively personalized experiences and transform how we work. +We are leading the market in integrating AI and ML into our enterprise collaboration portfolio, bringing intelligence and context to help our customers work smarter and increase productivity. Through our AI-driven innovations like people insights, facial recognition and WebEx Assistant, we're driving expanded collaboration experiences on any device integrated with our customers' business process workflows. +Building on these cognitive innovations, we announced our intent to acquire Voicea, a market-leading provider of voice-based artificial intelligence solutions. With Voicea's technology, we will enhance our entire WebEx portfolio with a powerful transcription service combining AI and automated speech recognition to enable more actionable meetings, improved productivity and enhanced experiences. +We also achieved another outstanding quarter of growth with our AppDynamics, demonstrating rapid customer adoption of our differentiated end-to-end visibility and analytics platform from the end user to the network to the application. +In summary, we had a great quarter and finish to fiscal year 2019, and I'm proud of what our teams have accomplished. We are executing well in a time of uncertainty, delivering differentiated innovation across our portfolio and extending our market leadership in enterprise networking applications and security. +Our performance reflects our relevance as well as the ongoing value we're providing our customers as they transform for the future. We are as committed as ever to providing them with the right innovation to drive greater impact and success. As I look ahead, I could not be more confident about our unique position in the market and the tremendous opportunity in front of us. +Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter then cover the full fiscal year followed by the guidance for Q1. +Q4 was a great quarter across the business. We executed well with strong revenue growth, margins, net income and EPS. Total revenue was $13.4 billion, up 6%. Our non-GAAP operating margin rate was 32.6%, up 1.4 points. Non-GAAP net income was $3.6 billion, up 9%. And non-GAAP EPS was $0.83, up 19%. +Let me provide some more detail on our Q4 revenue. Total product revenue was up 7% to $10.1 billion. Infrastructure Platforms grew 6%. All of the businesses were up with the exception of routing. Switching had a great quarter with double-digit growth driven by both campus and data center with the continued ramp of the Cat 9K and strength of the Nexus 9K. +We saw solid growth in wireless across the portfolio. Data center was up with growth in both HyperFlex and servers. Routing declined due to weakness in service provider. Applications was up 11% with Collaboration, AppDynamics and IoT software all up double digits. Security was up 14% with strong performance in identity and access, advanced threat, unified threat and web security. Service revenue was up 4% driven by software and solution support. We continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 70% of total software revenue, up 12 points year-over-year. +When we look at the impact of acquisitions on our Q4 results year-over-year, there was a 60 basis point positive impact on revenue. In terms of orders in Q4, total product orders growth was flat. +Looking at our geographies, Americas was up 1%, EMEA was up 4% and APJC was down 8%. Total emerging markets was down 8% with the BRICS plus Mexico down 20%. In our customer segments, enterprise was down 2%, commercial grew 7%, public sector was up 13% and service provider was down 21%. +Remaining performance obligations, or RPO, at the end of Q4 was $25.3 billion. RPO is our deferred revenue plus unbilled deferred and represents total committed, noncancelable future revenue. +From a non-GAAP profitability perspective, total Q4 gross margin was 65.5%, up 2.3 points. Product gross margin was 64.7%, up 2.8 points. And service gross margin was 67.9%, up 0.7 points. +In terms of the bottom line from a GAAP perspective, Q4 net income was $2.2 billion, and EPS was $0.51. The GAAP results include a charge of approximately $900 million, which is a reversal of a tax benefit recorded in Q4 fiscal year '18, which relates to new U.S. treasury regulations issued during the quarter related to the Tax Cuts and Jobs Act. +We ended Q4 with total cash, cash equivalents and investments of $33.4 billion. Operating cash flow was $3.9 billion, down 4%. From a capital allocation perspective, we returned $6 billion to shareholders during the quarter that was comprised of $4.5 billion of share repurchases and $1.5 billion for our quarterly dividend. +In our Q2 fiscal '18 earnings call, we said we would return $31 billion through share repurchases over the following 18 to 24 months. As of Q4 fiscal '19, we completed that commitment with share repurchases of $32.6 billion. Going forward, we will return to our capital allocation strategy of returning a minimum of 50% of our free cash flow to shareholders annually through share repurchases and dividends. +We continue to invest organically and inorganically in our innovation pipeline. During Q4, we announced our intent to acquire Acacia, an existing supplier that is focused on optical interconnect technologies. This move is consistent with our strategy of increasing investment in innovation and R&D for our growth areas. +I'll now cover the full fiscal year results. We delivered strong revenue growth, margins, net income, EPS and operating cash flow. Revenue was $51.7 billion, up 7%. Total non-GAAP gross margin was 64.6%, up 0.3 points. And our non-GAAP operating margin rate was 32.3%, up 0.7 points. +From a bottom line perspective, non-GAAP net income was $13.8 billion, up 9%. And non-GAAP EPS was $3.10, up 20%. GAAP net income was $11.6 billion, and GAAP EPS was $2.61. +We delivered operating cash flow of $15.8 billion, up 16%. Normalized for the tax payments related to the Tax Cuts and Jobs Act in each fiscal year and the cash received in Q1 fiscal '19 related to the legal settlement with Arista, operating cash flow was up 8%. +To summarize, we had a strong Q4 and fiscal year. We executed well with strong top line growth and profitability, and we're seeing the returns in the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the first quarter of fiscal '20. This guidance includes the type of forward-looking information that Marilyn referred to earlier. Note that we have normalized our first quarter guidance to exclude the SPVSS business for Q1 fiscal '19, which we divested on October 28, 2018. We have provided historical financial information for the SPVSS business in the slides that accompany this call. +We expect revenue growth in the range of 0% to 2% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64% to 65%. The non-GAAP operating margin rate is expected to be in the range of 32% to 33%, and non-GAAP tax provision rate is expected to be 20%. The 1% increase in tax rate over fiscal '19 is primarily due to a forecasted decrease in tax benefits from foreign income. Non-GAAP earnings per share is expected to range from $0.80 to $0.82. +I'll turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess I'm going to ask the obvious one and then maybe -- perhaps a little bit of detailed color, if I can get it. The guidance says weaker than, I think, we had anticipated. We know it's a tough macro environment. So just hoping, Chuck, that you would maybe comment on that. And maybe juxtapose the change in trend in enterprise orders, which did weaken quite a bit with commercial, which seems to be holding up fine and kind of why that is going on. And then Kelly, if you could comment on backlog as well. I know you guys usually give it in the K, so it'd be great to get that number as well. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Rod, thanks for the question. So let me start by saying, first of all, the strategy and the work that we've done on our portfolio and the engagement with our customers is absolutely going in the right direction. And we continue to make progress, and the strategy is working. So we're quite happy with what our teams have accomplished and where we are right now in that space. +There's a couple of things that we saw in the quarter, and I'll outline these and I'll answer, Rod, your question about the enterprise. +First is we had continued challenges in service provider, and I'll double click on that in just a moment, as you saw in the order growth that Kelly talked about. And then we did see in July some slight early indications of some macro shifts that we didn't see in the prior quarter. So those are the 2 things that happened. +Let me double click on service provider just a bit. The Americas was generally the same from an order perspective from the prior quarter, so no real shift, positive or negative. Europe was actually positive in the SP space. And Asia, we saw continued weakening in our China service provider business. And we had 2 massive build-outs in India a year ago that just didn't replicate this year with the 2 major players there. That's the net of the service provider situation. It's not more complicated than that. +If you look at our overall business, our orders outside of service provider grew mid-single digits. So we feel good in this environment about the rest of the portfolio and the work that we're doing with those customers. +As it relates to commercial enterprise and public sector, and I'm going to probably give you a little more granularity than normal just so you understand what we believe went on, you can see that the portfolio that is being sold into all 3 of those segments is obviously being well received. Our public sector business on a global basis was up 13%, so we continue to see success. And as you mentioned, Rod, global commercial was up 7%. +The enterprise business was really -- we saw weakness in China, which was -- contributed to it. We saw some weakness in the U.K. in enterprise. And then candidly, in the U.S., as much as I don't want to use compares for an excuse, we had 2 major software deals a year ago that were tough to compare against. +So that's really it. The rest of the business and everything that we see is still very positive, and we feel good about where we are. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Yes. And Rod, on your backlog question. So we have -- since we adopted ASC 606, we've been disclosing our RPO, which is a more meaningful metric of our future revenue because, again, the problem with our backlog, it didn't include our subscription businesses. So it didn't include anything on Collaboration or Security. So RPO has everything. It has the deferred revenue, the unbilled deferred and any committed future revenue. And like we've disclosed in our Qs, we expect -- of that $25.3 billion, we expect about 56% of that to be recognized over the next 12 months. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Paul Silverstein with Cowen. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [6] +-------------------------------------------------------------------------------- + + Just to follow up on Rod's question, Chuck, a clarification. I thought China was now down or have been down for a while still well less than 3% of revenue. And I guess it's not 0, so you still have exposure. But I'm surprised it impacted you to the extent you suggested. +And then I want to ask Kelly about the pricing environment. I assume there's been a change in what we should expect for margins throughout the year. I assume they're going up on both the gross and the operating line given DRAM and given the shift to -- ongoing shift to software while in a benign pricing environment. But if you could comment on that. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Yes. Let me just comment on the China situation. I mean you're right. It's down below 3%. It's a small part of our business. But obviously, when it falls very dramatically, it can still have some impact because it is greater than 0. But long term, it's not a concern that I worry about much at this point. And so that's really the extent of what we saw there. I mean the China reduction contributed to a point of the issue in all of enterprise for us, so it was that significant. And we definitely saw significant impact on our business in China as it relates to what's going on with trade war right now. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + Yes. And then Paul, on your margin question. So yes, pricing, the environment stays good. Actually, we had a very good quarter on pricing. It was less than 1 point that you'll see when we give you the Q. So that's been very good. And again, you can see we are benefiting in our gross margins and OMs from the tailwind from DRAM as we expected. And you're seeing that in not only the results but also as we've been guiding on the margin. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Tejas Venkatesh from UBS. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [10] +-------------------------------------------------------------------------------- + + You obviously give us year-over-year order growth number every quarter, but I wonder if you could give us a sense of what the sequentials look like versus historical seasonality. If I have my math right, sequential order growth looks somewhat in line with seasonality, but your revenue guide is a tad below where you've grown sequentially in recent years. So I just want to confirm that's right. +And then secondly, you're coming off a strong year of 7% revenue growth. I know you don't guide for the year, but investor expectations were somewhat high, and I wonder if you could comment even qualitatively on how to think about full year revenue growth. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + Tejas, so yes, you're right on our sequentials on orders. I mean we've had this phenomena -- it's not a phenomena, but our Q4 always has a double-digit growth, and Q4 is our largest quarter from a dollar perspective on orders growth for us. So that happens. And again, in Q1, it's a double-digit down. So this -- the sequential isn't a change from historical, and again, the year-over-year takes into account the kind of the phenomenon we're seeing now. +In terms of the long-term guide, again, we don't give more than 1 quarter. I would say, to Chuck's earlier point, in terms of how we feel about the portfolio and the margins and the update, we feel good about that. The macro and the certain segment issues like in SP, I mean I think that -- I don't foresee that -- I'm not planning on that changing in the near term. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Sami Badri with Credit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [13] +-------------------------------------------------------------------------------- + + I was hoping you could kind of just give us an update on the campus switching refresh and then perhaps maybe your view on where we'll be next year as you see the campus switching cycle playing out and maybe even potentially more consistent data center switching deployments play out, especially since we're going through some transitions in the industry. So I guess what I really just want to understand is where we are in the cycle. Where -- are we in like the fifth, maybe sixth, maybe even first or second inning the way you see it? And then maybe the equivalent of where we see that for data center switching for your customers. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [14] +-------------------------------------------------------------------------------- + + Sami, thanks. It's a great question. So in the last 120 to 180 days, I mean we completed the full refresh of our portfolio across switching, routing and wireless in the enterprise, and we're now in a position where all of those have mandatory subscriptions. So we've made that transition from a product development perspective, and now those are all out in the marketplace with our customers. +On the Catalyst 9000, Q4 was the -- we added more customers in Q4 for the Catalyst 9000 than in any quarter prior. So that continues to move forward favorably. +In the campus, what I would suggest to you is that we're -- I'd say maybe we're in the second inning at this point of this transition that we see from our customers. As you know, they're all rearchitecting their entire enterprise infrastructure to accommodate these traffic flows that are presented from the massive number of cloud applications that they're running. And so it requires a completely different architecture, which is what this portfolio is built for. +As it relates to data center, I think that next year, you'll probably begin to see some upgrades transitions when the pure 400-gig optics are available. And one of the things that we believe is a big differentiator for us is that we're extending this policy management out of the data center into the campus, from a campus into the wide area, from the wide area into the cloud security portfolio. So we think being able to enable our customers to deliver policy from the data center all the way across the campus to the branch into the cloud is a very unique differentiator for us, and we think we'll begin to see customers adopting and deploying that sometime in the next year as well. So that's how we see it playing out. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Tal Liani from Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [16] +-------------------------------------------------------------------------------- + + If you look at the growth this quarter, it's about 1%. And then a few quarters ago, you were... + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [17] +-------------------------------------------------------------------------------- + + Tal, can you speak up just a little bit? + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [18] +-------------------------------------------------------------------------------- + + Yes. Can you hear me? + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [19] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Yes. That's better. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [21] +-------------------------------------------------------------------------------- + + I'll pick it up. Here you go. Now it's better. This quarter -- you're guiding for 1% growth. A few quarters ago, you reported 8%, but you had roughly organically growing -- you were growing about 4% to 4.5%. Can you take the 1% that you have now and then build on top of it all the things that you're seeing today to see what's the growth environment now that is more sustainable going forward? I'm trying -- I have difficulties to go from 4%, 4.5% to 1% within like 3 quarters. And if it's not a major deceleration in the growth environment, what could it be? So you mentioned China. What are the other things that are happening today that are unique to Q1 that are bringing the growth down so much from the levels we have seen just a few quarters ago? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + Tal, I'll take a crack at it. I mean at the end of the day, when we are guiding, it's based on what we're seeing with the orders alone, the pipeline and everything else. And the biggest driver of the guide where it is, is the massive decline we've seen in service provider over the last 2 quarters. So that is the biggest driver. Again, like Chuck said, we feel good about the rest of the portfolio from an orders perspective growing in the mid-single digits. But -- China is part of it, but again, like we said, it's small in comparison. But SP is still a large part of the business, and that's driving this outlook that you're seeing. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [23] +-------------------------------------------------------------------------------- + + So what's the -- can you quantify this? Can you quantify what is the decline in the growth related to service providers? And I think you mentioned 1 point is related to China, am I correct? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + What we're talking about for that is for the orders rate that we just had -- the orders rate for enterprise being down 2 points, 1 point of that at the global level was attributed just to China alone. China overall was down over 25% this quarter for us. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [25] +-------------------------------------------------------------------------------- + + Got it. And if I can just have a follow-up on China. We always felt that you're not selling much in China, that it's hard to compete in China. Where are you -- where did you have position in China? I know you were selling some routers to service providers. But where are you selling in China? And what's being impacted in China? What are the types of products that you're selling into the Chinese market? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Yes. Let me just give you color and then Kelly can give you some numbers. I mean Tal, the overall Chinese market, as I said earlier, is certainly not a major play for us, but it has just dropped precipitously in light of the trade discussions. So it has a short-term impact. +And where we are selling, for years, we've sold infrastructure to the large carriers in China, which has just -- it's been slowly declining, and we saw it even decline more rapidly last quarter. And then what we've seen is in the state-owned enterprises anymore, we're just being -- we're being uninvited to bid. We're not being allowed to even participate anymore. So those are the enterprises. That's where the large impact was this past quarter. So it was just a much faster decline of what we candidly expected. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes. And I would just add to that. So again, we talked about the big impact. Enterprise had a -- it was the second largest -- was down in service provider, which is part of our overall service provider being down. But from a product perspective, we sell everything there, from switches, routers, all the way down through security and Meraki products. So we sell everything including cloud in China, and everything is being impacted. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Jim Suva from Citigroup Investment Research. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [29] +-------------------------------------------------------------------------------- + + Chuck and Kelly, you've been very clear about the softness in revenues when -- for the outlook. When you think about the outlook, and a lot of it seems to be service provider, a softness, that has not been a new theme. You've talked about it for the past several quarters. So where we sit today looking out, is there a lot of risk that it could get worse? Or are you kind of looking at this saying we're kind of near a bottom for service provider trends because it's been chugging along pretty low and they're starting to sweat their assets potentially? Or is there still some risk that you have there? Just kind of thinking about the service provider headwinds of could it get worse or is it you looking at it and saying, "Hey, we're calling for a bottom." + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Look, I think that when you get into this area, there's certainly pressure in the business models across all different types of service providers. I think that if you look at the early 5G build-outs, most of the telco customers we have, particularly in Americas, they're focused on the consumer 5G trials today. They're not -- I mean that is the primary focus and then getting their 5G consumer networks built out. But they also don't, I would say, don't anticipate that being a huge profit driver off of the 5G transition. That's going to come when they build a more robust, broader 5G infrastructure where they'll deliver enterprise services. And that's going to come after they do the consumer side. +So it's a bit unclear when that will take place. I'd say we are not modeling and don't anticipate any significant improvement in this business in the very near term. And we're just going to have to wait and see. It's been a tough business for us for years. And it's now -- it obviously represents a much smaller percentage of our business than it did 5 years ago. But it clearly was a major point of weakness for us in the last quarter. Do you want add anything to that, Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [31] +-------------------------------------------------------------------------------- + + I think you got it. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + James Faucette from Morgan Stanley. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [33] +-------------------------------------------------------------------------------- + + Great. I just had a couple of questions, one related to gross margins and one to the deferred revenue. On gross margins, Kelly, it looks like even though the August -- I'm sorry, the July quarter was very good is that you're guiding for -- on both to be -- gross margins to be flat to down a little bit. And sequentially, historically, we've seen at least some improvements. So I'm wondering if you can help parse a little bit what's maybe going on there. +And my second question is deferred revenue actually looks quite good. So can you give us some insight into how much of that may be ELAs or software or other aspects so we can get a little bit more color on what's driving the deferred revenue? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [34] +-------------------------------------------------------------------------------- + + Sure. So on the margin, yes, I mean I'd say the margins are going great. We feel good about it. I kept the range in that 64% to 65% to take into account the cutting in of List 4 of the tariffs. Again, we're going to run the same play that we have for all the other tariffs, and we'll be -- again, we continue to mitigate, we continue to do everything we can do. But we see that in that range, which I think is pretty good. And as you look -- as that falls down through OM, we're actually doing well and have actually raised a little bit on the OM guide. +So again, I think we're able to offset the headwinds from tariffs with, again, continued benefit from the software, which leads to your point on the deferred revenue. Yes. I mean again, we continue to add to deferred revenue, which again is why I think -- look at that RPO as a key metric, which has both the deferred revenue as well as unbilled deferred. When you have month-to-month contracts, it shows the progress we've made. +Just to remind you guys, when we adopted ASC 606 at the beginning of the fiscal year, we wrote off $2.8 billion from our deferred revenue balance for the new accounting rules. And again, you're seeing just big sequential increases. Since then, as we discontinue to ramp the portfolio with like, for example, the entire enterprise portfolio, that all has subscriptions. So it's broad-based. We continue to have great adoption of the new products, all the subscriptions, we have great adoption of the ELAs. We had really strong performance of software in ELAs in Q4. So it's all going in the right direction, which is -- again, that's why we're still -- despite any macro environment, why we're still bullish on the overall strategy of the company on what we're doing on the transformation. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + Yes. James, if I might add to that. I know -- like 3 years ago, I think I made a comment on one of the earnings calls that I felt like we had figured out how we could drive our subscription business on top of networking products. And now here we are, and we've got every product in our portfolio in the enterprise network now that has mandatory subscription. And we really started selling that 2 years ago. So the first renewal window was really still a year away. So the team has done a great job. That transition has been good. We're on track with what we told everyone in the Financial Analyst Conference, where we'd be relative to our software. And I think that's what you're seeing show up in the RPO metrics as well. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Tim Long from Barclays. + +-------------------------------------------------------------------------------- +Timothy Patrick Long, Barclays Bank PLC, Research Division - MD [37] +-------------------------------------------------------------------------------- + + Yes. Just to follow up on another question, if I could. Chuck, you mentioned a little bit of the weakness was also related to some macro shifts in the month of July. Could you talk a little bit about that, kind of what we're seeing? Was the deals pushing out, scaling down, more competition, anything like that? +And then you also mentioned the move to 400-gig upgrades next year. Can you talk a little bit about how you think Cisco will fare in these data center deals as we move to 400 gig? And the strategy to take in-house and develop more optics internally, do you think that helps as early as that 400-gig transition? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Yes. Thanks, Tim. So basically, we just felt a slight difference in July, I mean relative to the close rates and just -- it just wasn't as strong a finish as we would normally expect, particularly in Q4. And I think that's what kind of set off the flags for Kelly and I. I met with 17 customers in the last 5, 6 business days, and nothing's changed about how they're thinking about the role of technology and what we do and how we're playing there. So we're monitoring this. We're watching it. We'll see. Obviously, I think what we've seen in the markets in the last few weeks and what we hear from some of the other players would indicate that others have seen similar things, some a lot worse. And I do feel very good about our position and where we are and the level of criticality that we are playing with our customers now versus 5, 6 years ago. And I think that -- so I feel good about that piece. +But that's really what we felt, and we'll just have to see how it plays out and whether we get any resolution on some of these major geopolitical issues that are sort of lingering out there. I've said for like 18 months that I've been amazed at the resilience of the economy. And hopefully, it can bounce back pretty quick if we get to some -- get more clarity on some of these issues, which I think people are just -- I think they're just hedging their bets relative to some resolution on some of the stuff. +And then the second question was around the 400 gig and our own -- yes, I'll tell you, we have -- I feel good about it, number one. We're in the game. We have our technology road maps mapped out. Our teams have made these acquisitions, which allows us to have good control of our components that go into these products. We've talked to lots of customers, including the web-scale providers who are very supportive of where we're headed and what we're doing. They're supportive of the strategy. They like the acquisitions. And so we feel good that we'll be in a good place -- in a much better position to compete in this transition than we were last time around. So I feel good about where we are. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Simon Leopold from Raymond James. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [40] +-------------------------------------------------------------------------------- + + I know you don't want to guide beyond the quarter, but maybe if you could help us sort of level set how to think about the year given that I think you're facing a pretty tough comparison in October, and so guiding 0% to 2% seems to set a new level. But if I just apply normal seasonality through the balance of the year, it would look like the year-over-year growth rate should come back somewhat in the January through July quarters. I just want to see how we should think about, really, the full fiscal year trending. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [41] +-------------------------------------------------------------------------------- + + Yes. Simon, I think the way you're looking at -- I mean again, we don't guide, and again, there's a lot of unknown out there. But I'll say the way you're thinking about it is probably the right way. I think the way you're thinking about the second half -- certainly, you get more normalized, compares on that in the second half. But I think the way you're looking at it is very rational. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [42] +-------------------------------------------------------------------------------- + + And just a quick -- do you have a metric for percent of revenue that's recurring? I think you've given it in the past. And now with the fiscal year over, hope you maybe have that number. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + Yes. Simon, we stopped -- when we -- we stopped this fiscal year on that when we adopted 606 because a lot of our recurring subscriptions like, for example, DNA with the Cat 9K, because of the accounting, it changes how we have to recognize it. So that's why, really, the metric that we talk about now is how much of our software revenue is subscription-based. So recurring isn't that meaningful. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Jeff Kvaal from Nomura Instinet. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [45] +-------------------------------------------------------------------------------- + + Kelly, you had mentioned a little earlier that you're taking the operating margin up a shade. I'm wondering if you could comment about how you are making the magic happen there in light of a little bit of a lower revenue trajectory than we all might have hoped for a few months ago. And then just to clarify, your capital return plan sounds like it's going to be mostly about the dividends here rather than buybacks going forward. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [46] +-------------------------------------------------------------------------------- + + Yes. Sure. Yes. So on the probability, on OM, I think it's not magic, right? It is -- we're working the gross margins hard with -- like we talked earlier. And then we're also working the OpEx side hard as always as well. Our engineering teams do a really good job of rebalancing their portfolios and making sure they're investing in the right stuff, and we are constantly driving for efficiency. So it's good old-fashioned running the business and executing well despite the top line. So that's how that's happening. +And then on the capital allocation, yes, so if you go back to when we did tax reform back in Q2 of '18 and we announced the big buyback, we had a $31 billion authorization then and we said we'd use that $31 billion. We did effectively use that up through the -- up till now, the 18 months. And so now since we've really gotten our balance sheet where we want it in terms of we reduced our debt, we've brought our cash balance from $74 billion back then now to $33 billion, we've reduced our debt from $35 billion down to $25 billion, we're going to get back to our normal strategy, which is being very opportunistic when our stock's down like on days like today and buying, but really balancing between both the dividends and the buyback to be at least 50% of our free cash flow. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Samik Chatterjee from JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [48] +-------------------------------------------------------------------------------- + + I just wanted to follow up on the guidance that you guys mentioned, the service provider weakness is kind of what's driving the weakness in the guide, although there seems to be a broader concern here from investors related to a slowdown in the enterprise spending. So just wanted to get your thoughts, particularly given the change in the business towards kind of higher software subscription mix, how should we think about levers you can pull to drive growth even if enterprise spending does kind of see a slowdown next year? +And just a quick follow-up. At Cisco Live!, the team had talked about a major refresh of the Collaboration portfolio. So I just wanted to see what the early response to that refresh has been. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + Yes. I think one thing that is, I think, important to look at is when we talk about enterprise spending and when many companies talk about enterprise spending, that would be, in some cases, a combination at a minimum of our enterprise and commercial business. And in some cases, people would just include public sector in there, in that sort of a view. And that -- when you put it all together, it was actually quite healthy. The orders were quite healthy. We just had a little bit in July of a feel that -- we just didn't close as strong as we would like. And so we felt like there was even more that we could have done, and it just didn't feel like a normal Q4 finish. And it felt a little bit like some of the macro issues may be manifesting themselves. So that's really what we saw there. And then Kelly, you want to talk about the software and the... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [50] +-------------------------------------------------------------------------------- + + Yes. I mean again, just on the software, I think, again because more and more -- and again, even despite, like I talked about, the write-off of deferred revenue -- the adoption of 606, even despite that, the amount of revenue -- software revenue coming off the balance sheet continues just to grow as we put more on the balance sheet. So that helps buffer when you do go through any tough macro issues. So I think we'll continue to add to that, and it'll continue to help soften whenever there is any kind of macro slowdowns. But it's helping maintain kind of the growth that we do see as well as margins. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [51] +-------------------------------------------------------------------------------- + + Sorry, anything about on the Collaboration portfolio? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Sorry. I'm sorry. Yes. I think that what Amy and the team have been doing is really -- they've been refreshing new elements of the portfolio with end units, end points. They've been -- they've consolidated the -- to a single-user interface. We've got new refreshed versions of WebEx out there. They're bringing the cognitive capabilities in. There's a lot of new technology that they've been bringing. So I think they're in the midst of delivering on that right now. And the results in that business would suggest that our customers are viewing it favorably because it continues to perform really well for a decent-sized business. +So I just want to thank everybody for joining us today. Look, we're 4 years in, and I'm really proud of what our teams have accomplished. I mean we've come a long way in 4 years, and I don't actually judge where we are based on this quarter, I think -- or the quarterly guidance. I think that what we've built in the portfolio and the innovation and the value that we're bring to our customers is sustaining, and we'll continue to do that with our customers going forward. We have a strong record of our execution. I have high conviction in the portfolio, and I think we're well positioned for long-term growth opportunities. So thanks all of you for spending time with us today, and thanks for the questions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [53] +-------------------------------------------------------------------------------- + + All right. Thanks, Chuck. So Cisco's next quarterly earnings conference call, which will reflect our fiscal 2020 first quarter results, will be on Wednesday, November 13, 2019, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to contact the Cisco Investor Relations group, and we thank you very much for joining today. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (866) 463-4969. For participants dialing outside the U.S., please dial (203) 369-1404. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2019-Feb-13-CSCO.txt b/Transcripts/CSCO/2019-Feb-13-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..be6b977f64c09fac24a008ae3b308df075424314 --- /dev/null +++ b/Transcripts/CSCO/2019-Feb-13-CSCO.txt @@ -0,0 +1,563 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Cisco Systems Inc Earnings Call +FEBRUARY 13, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Steven Mark Milunovich + Wolfe Research, LLC - MD of Equity Research + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Thejeswi Banavathi Venkatesh + UBS Investment Bank, Research Division - Associate Director and Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Second Quarter Fiscal Year 2019 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's Second Quarter Fiscal 2019 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis, unless stated otherwise. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the third quarter of fiscal 2019. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +As a reminder, in Q2, on October 28, we completed the sale of our SPVSS business and, accordingly, had no revenue or expense from that business in Q2 fiscal 2019. As such, all of the revenue, non-GAAP and product orders information we will be discussing is normalized to exclude the SPVSS business from our historical results. We have provided historical financial information for the SPVSS business in the slides that accompany this call and on our website to help understand these impacts. As a reminder, the guidance we provided during our Q1 earnings call and today's call has been normalized in the same way. +I will now turn the call over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. This quarter, we again demonstrated that we have built a resilient growth engine that is firing on multiple cylinders. Our strategy of expanding our portfolio while investing in our core markets is delivering unprecedented innovation for our customers and sustainable value for our shareholders. We delivered revenue growth across all geographies and businesses, strong margins, double-digit non-GAAP earnings per share growth and continued solid cash generation. +We're building the technologies that enhance our customers' new digital capabilities and experiences like never before. With the continued expansion to the cloud, the increasing connectivity of users and devices and the need to secure their enterprises, our customers are facing the most complex and dynamic IT environment we've ever seen. Cisco's intent-based networking architecture helps them navigate this complexity by enabling them to simplify, automate and securely transform their infrastructure. +We are redefining every networking domain for our customers, from the campus to the wide area network, to the data center, to the cloud, delivering the agility, operational efficiency and, most importantly, the security our customers require to accelerate their digital transformations. +Only Cisco can build and deliver a multi-domain, intent-based architecture that sits at the intersection of users, devices, applications and data, that can securely connect any user on any device, on any network to any application. Simply put, the Cisco of today is at the center of our customers' strategies and no longer viewed just as an enabler of those strategies. +Now let's review some of the highlights in our key strategic growth areas. Starting with Infrastructure Platforms. Over the last 18 months, we've been reinventing networking from the ground up to connect every domain of the extended enterprise. And it's clear that the investments we've made in our core business are paying off. We are executing well with continued growth in our infrastructure portfolio and strong customer uptake of our Catalyst 9000 family of switches and our SD-WAN offerings. We are now extending our industry-leading security and intent-based networking capabilities to new IoT Edge platforms, connecting devices throughout the enterprise with unprecedented scale, unparalleled flexibility and control. Going forward, you'll see us continue to extend our intent-based networking innovations across the portfolio with subscription-based offers that will enable our customers to adopt a consistent architecture across every domain. +In the Data Center, we are enabling digital enterprises to securely access their applications and their data everywhere, from private to public cloud environments as well as the Edge. Two weeks ago, we announced a new architecture that extends the data center to wherever the data exists and across all applications running anywhere. We introduced several new innovations to extend our multi-cloud leadership with ACI Anywhere, HyperFlex Anywhere and cloud center capabilities. We're also well positioned to take advantage of 100-gig and 400-gig upgrade cycles across enterprise data centers, service provider and web-scale networks. +With global Internet traffic expected to increase threefold over the next 5 years, our customers are facing an exponential demand for capacity. To address their need for speed and performance, we continue to innovate to drive the industry's transition to next-generation high-speed networks of 400 gig and beyond. Our acquisition of Luxtera will further augment our existing capability around silicon and optics, enabling our customers to build the fastest and most efficient networks. +Now moving to our Security business. We generated strong double-digit growth, reflecting the increasing demand for our market-leading solutions and the trust our customers place in us. The attack surface is only increasing, and our comprehensive approach of integrating security into the intent-based architecture from the network to the cloud to the endpoint has been successful as our installed base continues to grow. With our industry-leading threat intelligence, we are redefining how security is delivered with our multi-domain architecture. For example, as a leader in both SD-WAN and security, Cisco provides the most robust SD-WAN platform integrated with cloud security. This helps to simplify and secure our customers' deployment, operation and management of their environments. +Increasingly, we are helping to secure our customers' distributed enterprises with remote access and cloud-based security solutions. A great example of this is Duo Security's cloud-delivered, zero-trust platform, which significantly expands our footprint in the identity and access market, bringing together user, device and application visibility and trust. We are seeing strong traction with Duo and good progress in scaling their capabilities while strengthening our cloud-based subscription portfolio. +Turning to applications. In Collaboration, enterprise communications continue to evolve as we move to a digital, cloud-based world. We are defining the future of work with next-generation collaboration platforms that have flexible, intuitive and intelligent on-premise and cloud-based solutions. This comprehensive approach to collaboration is a key reason why customers are adopting our market-leading portfolio, resulting in another quarter of exceptional growth. +Cisco provides a full suite of collaboration solutions for calling, meeting, team collaboration and care with flexible subscription offerings designed to easily integrate into customer workflows. With the deep integration of BroadSoft with our core capabilities, we are now the market leader for cloud-based calling and care solutions with compelling solutions for SMBs as well as enterprises globally. +AppDynamics is the largest APM vendor providing real-time analytics and insights across applications, infrastructure and the network, driving solid momentum with our customers. We have been investing in several new capabilities delivering the broadest application visibility and monitoring platform in the world. +Our real-time analytics and monitoring offerings are mission-critical for our customers as they face a growing, complex application environment. To simplify and automate their IT operations, we recently launched AIOps, leveraging AI, machine learning and automation to enable improved customer experiences and greater business performance. +In summary, we are very pleased with our strong quarter and first half performance. Our teams are executing incredibly well, aggressively transitioning to a software model and accelerating our pace of innovation, and I'm proud of the work they are doing. Our multi-domain, intent-based architecture is helping to simplify, automate and secure the complex IT environments our customers are facing, and I believe we are well positioned to play an even more strategic role in them as they embrace multi-cloud, Edge computing and digital transformation. +The innovation our teams have been driving has now given us the strongest portfolio that we've had in a very long time, and I couldn't be more confident about our future. +Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q3. +Q2 was a solid quarter across the business. We executed well with strong orders, revenue growth, margins, EPS and operating cash flow. We had continued momentum in product orders, which grew 8%. Total revenue was $12.4 billion, up 7%. Our non-GAAP operating margin rate was 32.1%. Non-GAAP net income was $3.3 billion, up 6%. And non-GAAP EPS was $0.73, up 16%. +Let me provide some more detail on our Q2 revenue. Total product revenue was up 9% to $9.3 billion. Infrastructure Platforms grew 6%. Switching had another great quarter with double-digit growth in the campus, driven by the continued ramp of the Cat 9K. Wireless also had double-digit growth with the strength of our Wave 2 offerings and Meraki. Routing declined due to weakness in service provider. We also saw a decline in Data Center servers, partially offset by strength in hyperconverged. Applications was up 24% with growth across all the businesses. We saw strong growth in Unified Communications, TelePresence and AppDynamics. Security was up 18% with strong performance in identity and access, advanced threat and unified threat. Service revenue was up 1%, driven by Software and Solution Support. +We continue to transform the business, delivering more software offerings and driving more subscriptions. Software subscriptions were 65% of total software revenue, up 10 points year-over-year. +When we look at the impact of acquisitions on our Q2 results year-over-year, there was 140 basis point positive impact on revenue. +We saw strong momentum in Q2 with total products orders growing 8%. +Looking at the geographies. Americas grew 7%, EMEA was up 11% and APJC was up 6%. Total emerging markets was up 6%, with the BRICS plus Mexico up 2%. In our customer segments, enterprise was up 11%, commercial grew 7%, public sector was up 18% and service provider was down 1%. +From a non-GAAP profitability perspective, total Q2 gross margin was 64.1%. In terms of the bottom line from a GAAP perspective, Q2 net income was $2.8 billion and EPS was $0.63. We ended Q2 with total cash, cash equivalents and investments of $40.4 billion. Q2 operating cash flow was $3.8 billion, down 7%. We paid $750 million for the first transition tax payment related to the Tax Cuts and Jobs Act. Normalized for that tax payment, operating cash flow was up 12%. +From a capital allocation perspective, we returned $6.5 billion to shareholders during the quarter that was comprised of $5 billion of share repurchases and $1.5 billion for our quarterly dividend. Today, we also announced a $0.02 increase to the quarterly dividend to $0.35 per share, up 6% year-over-year. This represents a yield of approximately 3% based on today's closing price. We also announced a $15 billion increase to the authorization of the share repurchase program. This raises the remaining share repurchase authorization to approximately $24 billion. This dividend increase and additional share repurchase authorization reinforces our commitment to returning capital to our shareholders and our confidence in the strength and stability of our ongoing cash flows. +We continue to invest organically and inorganically in our innovation pipeline. During the quarter, we announced the acquisition of Luxtera, a company focused on silicon photonics, which closed on February 6. +To summarize, we had a great Q2. We executed well, with strong top line growth and profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, driving long-term growth and shareholder value. +Let me reiterate our guidance for the third quarter of fiscal '19. This guidance includes the type of forward-looking information that Marilyn referred to earlier. Note again that we have normalized our third quarter guidance to exclude the SPVSS business for Q3 of fiscal '18, which we divested on October 28, 2018. We have provided historical financial information for the SPVSS business in the slides that accompany this call. +We expect revenue growth in the range of 4% to 6% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64% to 65%. The non-GAAP operating margin rate is expected to be in the range of 31% to 32%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.76 to $0.78. +I'll now turn it back to Marilyn so we can move to Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) I'll now turn it over to you, Michelle, to start the queuing process. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Jim Suva from Citi Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [2] +-------------------------------------------------------------------------------- + + When we look at a couple of dynamics, whether it be tariffs, government shutdown or maybe even weather for installation and shipping your product around the whole U.S., any thoughts around how we should think about those items, how they played out and in your forecast of what's built in? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Jim, this is Chuck. Look, first of all, I would tell you that we -- it certainly is one of the more complex macro, geopolitical environments that I think we've seen in quite a while with all the different moving parts. But to be honest, from the first day of the quarter to the last day of the quarter, we saw 0 difference. We saw very steady demand throughout the quarter and just saw great execution by our teams. When we look out ahead at the guide, there's -- we're looking at the conditions as they exist today. And so far, we've been able to navigate all the different dynamics, I think, pretty well. We're pretty proud of what the teams have accomplished. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Vijay Bhagavath from Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [5] +-------------------------------------------------------------------------------- + + My question, Chuck and Kelly, would like to get your thoughts into the secular growth portfolio you have around AppDynamics, Meraki, Viptela, Duo, et cetera. Are these assets starting to drive new sales opportunities, perhaps new product refresh for the core business? Or are these mostly like stand-alone, like they're growing in their respective areas? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [6] +-------------------------------------------------------------------------------- + + Thanks, Vijay, and thanks for the nice comment. If I look at the different acquisitions, if you look at, let me just pick a few, like BroadSoft and the integration that's been done with the Collaboration portfolio, that clearly enhances the overall architecture and, I would say, has a positive impact on the total business. As you look at things like Meraki and as we continue to do tighter integration between our -- the Meraki portfolio and the classic Cisco portfolio and we bring together the automation strategies on each side, it gives customers the ability to deploy a hybrid model with both of those technology areas, which I think is a benefit that many of our customers have. They might want the traditional Cisco portfolio in their core headquarters buildings, and they might like Meraki out in their retail outlets or in small branches. So that's very positive. When you think about an acquisition like Duo, that's clearly part of an overarching security architecture that, clearly, our customers are buying into, as you can see from the 18% growth, which is like the fastest growth rate we've seen in Security in many years. So it's -- I think it depends on the acquisition, but most of them are pulling forward an architecture that they're associated with. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + And just to add, I think we're also embedding it in our products, right? And you can look at like when we acquired Stealthwatch, it's now part of what we're doing with the Cat 9K; or what we announced with Umbrella being in part of other products. So I think it's a combination of both. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + Yes. And bringing together like some of the traditional technologies -- I mean, thinking about bringing together ISR with Viptela, with Umbrella, to create this new secure SD-WAN offering, I mean, that's a unique capability that only we have. And look at taking some of the security technologies like advanced malware and moving them into the Meraki portfolio, and those are obviously key differentiators for us. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Rod Hall with Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [10] +-------------------------------------------------------------------------------- + + I guess I wanted to start off with the public sector side of things. The order trajectory there improved a lot to 18%, and yet we're all sitting here expecting U.S. Fed to be weak. So I wonder if you could sort of comment on the U.S. Fed impact on the current quarter and then why we're seeing such a big order acceleration there. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Yes. I would tell you -- I think, first of all, it's important to understand the dynamics of the shutdown that we experienced. It was really -- only about 25% of the government agencies were impacted. And some of the groups that we do business with, when they had a sense the shutdown might be coming, some of them pulled some orders ahead and actually got them in the system. So I will tell you that we saw minimal impact. Our U.S. federal business, even with the shutdown, grew double digits, which is, I think, a testament to our team and the relationships and the execution. And so -- and around the world, when you look at our business in Europe, I mean, you look at the -- I mean, think about the 11% growth in EMEA. When we talk to our team there, a lot of that is public sector oriented, same across the world. We just saw -- obviously, at 18% growth in our public sector business around the world, that's obviously -- the technology is resonating in that vertical. That's for sure. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [12] +-------------------------------------------------------------------------------- + + Okay, great, Chuck. Appreciate that. And then I wanted to -- on the follow-up, just on the enterprise order rate. I mean, that was, I think, 15% last quarter. It's decelerated a little bit to 11%. Just comment on what you're seeing there. I mean, you've talked before about last year being such a strong year. And I'm just curious if you think that's just kind of a one-quarter thing or is that a trajectory we would expect to continue? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + Rod, I think that as I think about the enterprise and you look at our portfolio right now, we really line up with -- whether our customers are looking to strategies to drive revenue and looking at how our collaboration architecture or our location analytics in retail outlets can help them, or they're looking at how do they reduce their operating expenses and simplify and the automation we're driving in the networking space, the SD-WAN solutions, they're just -- these are all really core to what our enterprise customers are looking for. And we've talked about over the last several calls that this Cat 9K, the early phases of that, we're still in the very early innings. And now we've deployed a wireless portfolio that fits within that architecture, the SD-WAN solutions are going to be integrated into that architecture. And the customers are still on the very front end of deploying all this technology. So we feel good about where we are. And we think that assuming we continue to execute well on that technology and that portfolio, the benefits to the customer are such that I think that we should have a pretty successful run ahead of us in our enterprise accounts, assuming we continue to execute. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [15] +-------------------------------------------------------------------------------- + + I've got 2 related questions. One, my customary, what's your rate of price erosion? And Kelly, in connection with that, if you could talk about gross margin drivers looking forward. And related to that, if I do the math right, you all did $4.5 billion of operating cash flow if you exclude the $800 million in connection with that onetime tax item. That's a record by over $400 million or 10% of what historically is not your strongest cash flow quarter. The question is, is that a new normal? Or were there other extraordinary items in that number? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes. So just on the cash, there's nothing extraordinary in that. And again, that $750 million that we paid out, that's -- we'll be paying that -- those charges escalates in the later years over the next 8 years, right? That was just part of that transition tax. Besides that, no, there's no extraordinary. Remember, in Q1, we had the extraordinary $400 million payout from Arista, but there's nothing in Q2 besides that. Paul, to your question on price. This quarter, it was a 1 point impact on gross margin. Teams did a good job on that. And so that's in that range. And then if I go back to the gross margin drivers, like we talked about on last earnings call, it's been the same drivers, right? We still had a definitely negative headwind for the last quarter here in Q2 from DRAM and component costs. But as you look in our guide forward, you'll notice that the guide went up another 0.5 point because, like I expected last quarter and what we're seeing, the DRAM turns into a tailwind in Q3 and Q4. So that's why you see that tick up in the guide on the gross margin. So the drivers we had are really just again the headwinds being the component costs in Q2, that turns around. And then we still have a little bit of a drag on our rate for the -- as we continue to ramp the Cat 9K portfolio for that deferral impact. But otherwise, we're executing well. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + Kelly, I trust the ongoing shift to software has a -- will have a benefit over time? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + Yes. I mean, we're seeing that. I mean, that's what's offsetting a lot of these headwinds on the component stuff, right? So yes, that will continue, which is, again, why you continue to see them inch up. So when the DRAM -- which has been a significant headwind for us the last bunch of quarters, we'll continue to see that benefit us. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Ittai Kidron from Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [20] +-------------------------------------------------------------------------------- + + Maybe -- I have a 2-part question. I guess, Chuck, trying to kind of dig in to what Rod was asking before. You're running multiple product cycles in multiple product areas. But if you had to kind of put it all together across your entire customer base, in what phase of the adoption are we, embrace for the customers of this new portfolio? Are we early cycle, mid-cycle? Help me think about that. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Okay. Yes, Ittai, thank you. Look, here's the thing I think it's important to understand. We have been working over the years on building best-of-breed technology for what we talk about relative to domains with our customers. So we've been building the best data center switching portfolio, the best campus switching portfolio, the best campus wireless portfolio. Over the last 3 years, what we've done is we've built an automation architecture within a domain, okay? So we built ACI in the data center. We built DNA in the campus. We've got the SD-WAN platform in the branch. We've got a security control center that actually automates a security architecture. And now what we're doing is we're beginning to bring those together. So when you hear us talk about multidomain, it means that we're giving our customers the ability to drive automation across all of those domains. So -- and you're going to see even more announcements over the next few months relative to extending that. We extended it into the IoT architecture. So think about an application that's either running in the cloud or running in the data center that requires a certain policy that gets deployed across all those domains, and I think that's the thing that our customers are really excited about. So now where are we? We're still early. I mean, it's -- I would still say we're in the early innings. I mean, this transition, if you look back at the number of years that customers were buying and sweating a lot of this infrastructure, then that sort of the base that we have ahead of us to actually move into this new architecture. So I would say it's still very early across all those areas that I just described. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [22] +-------------------------------------------------------------------------------- + + That's great. And then just as a follow-up. I didn't catch the data center switch comment. Was there one or that's -- can you give us some color on where you stand there? And how do you envision 400 making its impact there, time line-wise? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Yes. I think what we gave -- Kelly, you gave a broader Switching number, I think. We said overall Switching business was up double digits. So I mean, it's a pretty big business. So we are pleased with that. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + And on the 400 gig, right, I mean... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + And the 400 gig, yes, I'll tell you, we've got a lot of work going on in both our data center switching portfolio, where we're in some early field trials, as well as in our networking portfolio with some of the work that's going on there. And we believe that sometime middle of this year, we'll begin to see broad-based deployments. We're happy with that. I think there's a couple of key differentiators for us, Ittai. We build our own silicon. The Luxtera acquisition is going to bring the optics into that for us as well. Instead of us having to go out and procure the optics, we'll be able to more tightly integrate them. The whole intent-based architecture we have and the ability for us with our silicon to do real-time packet examinations for the customers and let them look at packet flows dynamically, there's a lot of differentiators, including a lot of power consumption advantages we think we're going to have. So sort of middle of this year, we'll begin to see if all that comes to fruition, but I think the teams are in a good spot. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Samik Chatterjee from JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [27] +-------------------------------------------------------------------------------- + + Chuck, I just wanted to check with you how -- what you're seeing in terms of momentum in the emerging countries. I believe, last quarter, you had very solid momentum in countries like India. Are you seeing the stronger dollar catch up to them in terms of how -- what their appetite is in terms of IT spend? If you can just help us with that. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + Well, I think we -- we gave that number, right, the emerging markets? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [29] +-------------------------------------------------------------------------------- + + Yes, order's up 6%. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Yes, up 6% on orders. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [31] +-------------------------------------------------------------------------------- + + And BRICM was up 2%. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + BRICM was up 2%. So I think 6% in light of what we've heard from others around that space. And historically, what we've seen is when interest rates in the U.S. start rising, it creates challenges in emerging countries. And I think if you press Kelly, she'd probably tell you that currency was a slight headwind for us as well. So I think the teams are doing well, and it speaks to the relevance of what we've built. We've had some big build-outs in India. So India slowed a little bit for us but still quite positive. I think Russia was slightly negative. Mexico was positive. It's the same story. It's a portfolio of emerging countries. And right now, we have more that are performing well from a volume perspective. China was roughly flat for the last quarter. But overall, again, I'm pleased given the complexities that our teams are facing, both geopolitically and from a currency perspective. I think they executed really well. And I think it speaks to the teams themselves on the ground and the portfolio that our engineering organization's built. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Tal Liani from Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [34] +-------------------------------------------------------------------------------- + + I have 2 questions -- or 1 question, 1 follow-up. The first one is just about cloud spending. We hear a lot about weakness in spending. On one hand, you're not very, very exposed. You're exposed in certain areas; and other areas, not. On the other hand, it's a big growth opportunity for you. Can you discuss your participation in cloud and your comments on any weakness in cloud spending? And then I have a follow-up on the Chinese vendors. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + I think, Tal, the -- I guess this is a quarter where it helps not to have as much exposure. But I think we're still very happy with our progress we're making there. Some of these big transitions that we're talking about, the 100 gig, the 400 gig, those are going to be opportunities for us to try to insert. And we're working hard to actually position ourselves well for that. But I don't think that I could give any more color than what you've already heard from those who have a pretty significant exposure in that space. We're still plugging along and doing all the same things that we've told you we're doing. I would say that we still haven't gotten to a substantial different position than what we described to you probably 12 or 18 months ago, but we continue to make progress. And we've said it's going to be a long journey to get there. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [36] +-------------------------------------------------------------------------------- + + So maybe -- again, I have a follow-up just on that. But maybe you can discuss your exposure to cloud and the difference between hyperscale -- hyperscalers versus smaller cloud vendors and if you see similar trends with smaller companies, where you do have exposure, versus larger companies. But I wanted to ask you, this morning, I hosted a call with Huawei. And one of the things they were saying is they think they're actually going to gain market share despite all the issues. And I want to -- I know you don't have -- you don't compete with them in China on certain things but -- and you don't compete with them in the U.S. But you do compete with Huawei and ZTE globally. And the question is being asked repeatedly about share gains versus Huawei and ZTE. What is your position? What is your view? What kind of experiences you've had in the last few weeks and few months on the competition with Huawei when you talk with or when you discuss this with the carriers? And how do you see your portfolio versus Huawei's portfolio in light of these issues? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + Yes. It's a good question. So first of all, the magnitude of the market opportunity in China skews the overall global market share numbers. So when -- if you're not participating in a material way in China, then it's very difficult to gain share if you're just looking at it broadly across the world. So we've begun to look at it without China and with China just to see how we're doing. What I would tell you is that, look, I think our innovation -- I said this in my prepared comments at the beginning. I think our portfolio right now from an innovation perspective, and particularly with the work the teams are doing in the SP space and the work that we're doing around the 5G packet core and some of these next-generation platforms that are going to hit the market this year, I would put our innovation up against theirs and anybody else's in the world right now. I think if you look at our performance in EMEA and in APJC over the last few quarters, I would suggest that we're not only holding our own, but we're competing and winning. And I would tell you, last quarter, we saw positive growth in SP in both of those regions. And so I feel very confident that not only can we compete, but that we are and we're winning right now. And so the share comment from them could be related to the size of the Chinese market, and they're confident that the math works. But in other parts of the world, I'll tell you, we're doing really well right now. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Tejas Venkatesh from UBS. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [39] +-------------------------------------------------------------------------------- + + I'm on for John. You talked about double-digit growth in campus. Are the new Catalyst 9K products that you introduced about a quarter ago starting to contribute to revenue? I'm really just trying to get at how much more there is to go in campus and whether it's unreasonable to think campus could be up double digits for the full year as the newer Cat 9K products start to layer on. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Well, I think when you just look at the raw 9K sales versus the installed base of the products that the 9K replaces, we are very early in that cycle. And we just launched the 9200. When did that start? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [41] +-------------------------------------------------------------------------------- + + A quarter ago. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + A quarter ago. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + We just started shipping this quarter. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Just started shipping this quarter. So the products that we announced in the middle of 2017 clearly are flowing through revenue. The 9200 just started contributing to that. But again, if you look at where we are versus the installed base that these products replace, it's very early. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [45] +-------------------------------------------------------------------------------- + + And then a quick follow-up on M&A. I wonder if you could comment on capital allocation. Now that the core business is growing very healthy, is it time for accelerated M&A, perhaps? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + Well, I'll make a comment, and Kelly can add on to it. I don't think that the growth of the core fundamentally changes or -- our overarching acquisition strategy. I think that we've had an acquisition strategy that's continued to add to our portfolio and expanding our portfolio. What I alluded to early on is that our strategy of not only creating adjacent expansions to our portfolio but really driving innovation back into our core so that we can get growth from both given the size of our core markets, that's working. So I don't think that our overall M&A strategy changes because of the success of the core. But Kelly, you... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [47] +-------------------------------------------------------------------------------- + + Yes, no. It never has changed, right? I mean, I think our strategy has always been clear. We're going to invest in the business first. And we're always looking for M&A no matter what the environment is, and we're going to do smart M&A. And then we're committed to our dividend growth like we have been. And then, of course, the share buyback. And again, I think you saw the latter 2 there. We just announced again another increase to the dividend, just showing the commitment we have and the faith we have in the cash flows of the business, as well as just another increase in the share buyback authorization. So I'd say it's independent to how the core business is doing. It's just a critical part of our overall strategy. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [49] +-------------------------------------------------------------------------------- + + I'd like to come back to the comments you made, Chuck, on emerging market, on China. So what I heard is, clearly, that you're very happy with your performance there, relative. And it's true that having like a flat sales in China (inaudible) is great. And overall, your emerging market is holding well, especially when you take into account currency. But really, the question I would like to ask you is about how conversations with clients are going there? What's your outlook? Like you guys at Cisco used to be a bellwether. You have very, very good insight into how enterprises are feeling about the macro developments. So from all the conversations you've had with clients this -- in the last 3 months, what's your take? What's your 2019 macro perspective? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + Pierre, thanks for the question. What I've said several times in a lot of interviews is that I've been amazed at the resilience that we've seen around the world in light of all of the macro environment and the geopolitical dynamics, whether it's a shutdown or it's U.S.-China trade or it's Brexit or it's stress in Italy or it's political unrest in certain emerging countries. I mean, it's amazing the resilience that we've seen. What I would tell you is that our enterprise customers, given the focus, they really -- they don't view this technology anymore as an optional enabler of a strategy that they've come up with. They now view the technology as a core part of their strategy. So I mean, many of the strategies they're driving around revenue growth don't work if they don't continue to invest in technology. Many of the things they're trying to do around simplification and cost reduction and productivity in their IT infrastructure as well as being able to efficiently deal with this new multi-cloud world, which is super complicated, I mean, they can't just stop. I mean, they have to keep executing. And I'd say that most of them have a paranoia that if they do stop investing, their competitors will not and they'll fall behind. So all that being said, I will just tell you, our customers -- I haven't seen any general difference over the last 90 days in the discussions we've had, with the exception of talking to a customer who has very high exposure to the Chinese market. But even then, they talk about the impact of the geopolitical situation, but they never connect it to any sort of spending shift that -- some of them may do that, but I'm not having those conversations. Everybody seems to be moving the same place they were 3, 6 months ago. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Sami Badri from Crédit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [52] +-------------------------------------------------------------------------------- + + I just wanted to get a quick one regarding the number of ELAs you signed in the quarter and what percentage of revenues that actually reflected. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [53] +-------------------------------------------------------------------------------- + + Are you talking just Cisco ONE, what we have provided before? + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [54] +-------------------------------------------------------------------------------- + + Yes, exactly. That's right. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [55] +-------------------------------------------------------------------------------- + + Yes. I'd say, For Cisco ONE, we are now basically over 31,000, 31,500, in that range. And I'd say the thing to think about as you think about that going forward, as we move more and more of the portfolios to this DNA architecture and the architecture we're rolling out more and more, you're going to see more and more of our customers going to that kind of framework where the software is included in that as well. So we continue to grow the Cisco ONE bundles. But again, as we progress through the early innings of the Enterprise Networking, Cat 9K and so on portfolio transitioning, you're going to see more and more going to the DNA architecture and software bundles of that. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [56] +-------------------------------------------------------------------------------- + + And then are you comfortable giving a percentage of revenue, something like that, that we could get a little bit of an indicator from? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [57] +-------------------------------------------------------------------------------- + + No, we don't disclose that. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Steve Milunovich from Wolfe Research. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, Wolfe Research, LLC - MD of Equity Research [59] +-------------------------------------------------------------------------------- + + To follow on, at the last Analyst Day, Kelly, you talked about software as a percentage of total revenue, I think, going from 22% to 30% over 3 years. Can you indicate where you are in that range, if 30% is still the goal, if there's now a higher goal? And then how is 606 affecting that? And specifically, in this quarter, did 606 give you a revenue boost? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [60] +-------------------------------------------------------------------------------- + + Yes. Yes, I would say, to the first part of that question, we are continuing to progress along those lines. And with the new rev rec, because it's accelerating some of these things that -- when you pull a snapshot for this year, it's accelerating some of it. But overall, for the longer-term strategy, it's absolutely progressing like we said it would at FAC. And yes, this quarter, we were around 2% for the acceleration when you compare the 606 versus 605 accounting change difference. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + James Faucette from Morgan Stanley. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [62] +-------------------------------------------------------------------------------- + + Chuck, I wanted to ask you, it's interesting to me that the focus on hybrid and hybrid cloud is starting to evolve, especially given where people thought we might end up just a couple of years ago. Can you talk about how well-formed do you think your customers are? And I guess, are they seeing or can they understand the real value that Cisco can deliver in hybrid implementations yet, and how much missionary work [you] still have to do? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [63] +-------------------------------------------------------------------------------- + + Yes. Thanks, James. Look, here's the situation our customers find themselves in: if you contrast where they thought they were going to be 4 or 5 years ago, they thought that they were going to move to the cloud. And we've joked about it being a euphoric neighborhood where they just move and everything is simple. And somewhere along the way, they find themselves with 4 or 5 cloud providers, multiple collaboration cloud providers, 100 SaaS providers, an explosion of IoT at the Edge. And so what's happening is -- and by the way, they still have private data centers with applications that can't be migrated to the cloud. They've now gotten to a place where certain applications they're repatriating from the cloud. And the reality is that they now find themselves with a more complicated environment than they had 5 years ago when they began this journey to simplification. That's the irony. If you think about what I just described, there's only one piece of technology that is consistent across all of those things that I just talked about, and that is the network. And so what's happening is a lot of the things that have to occur to help them navigate this need to happen in the network. And so that's where this whole policy automation strategy that we have is really important, because for them to be able to deal with applications running anywhere, deal with users operating anywhere, the data flows and the traffic flows are nothing that look like what led them to architect their networks the way they did a decade ago. And then couple that with security and the fact that in security, you're not protecting a perimeter anymore. So it's not about a big, fat honking firewall. It's about an architecture that really does have integrated security from the network to the cloud, to the Edge, to email, where you're building a comprehensive integrated strategy, where you're seeing threats in one area and you're protecting across all those domains. So to answer your question, I think that 2 years ago, we had to convince customers that this is what we felt. And today, I'd say most enterprise customers, they could present a whole set of slides to you before we even start talking about the challenges they face and the importance of the network going forward. +So thanks for the last question. Thank you. I want to thank all of you for joining us today. I'll make a few closing comments. First of all, I think our teams have executed incredibly well in light of a very complicated macro and geopolitical environment that we find ourselves in. Our engineering teams over the last few years have delivered on innovation to a point where I will tell you that our portfolio is in the best shape it's been in years. And I think we are in a very good position with our customers based on the strategies that they're deploying going forward. And I have a high degree of confidence in our ability to execute. +When you look to the future, there's 2 things -- there's 2 elements that we have to consider. There's the geopolitical, macro issues, and we'll continue to navigate them to the best of our ability. And then there's our own execution, which I think is probably near the peak of what our teams have done in quite a while. So we feel good about where we are. There's obviously a lot of variables, a lot of complexities, but we're pleased with what we accomplished last quarter. We feel good about next quarter, and we're going to continue to execute. Thanks for joining us. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [64] +-------------------------------------------------------------------------------- + + Thanks, Chuck. And I'm just going to wrap up here. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2019 third quarter results, will be on Wednesday, May 15, 2019, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it's done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, feel free to contact Cisco's Investor Relations department, and we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (800) 391-9851. For participants dialing from outside the U.S., please dial (203) 369-3268. This concludes today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2019-May-15-CSCO.txt b/Transcripts/CSCO/2019-May-15-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..0f704d91948f3d46aac15f252d0ee165953cdf67 --- /dev/null +++ b/Transcripts/CSCO/2019-May-15-CSCO.txt @@ -0,0 +1,643 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Cisco Systems Inc Earnings Call +MAY 15, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * James Edward Fish + Piper Jaffray Companies, Research Division - Research Analyst + * Steven Mark Milunovich + Wolfe Research, LLC - MD of Equity Research + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Vijay Krishna Bhagavath + Deutsche Bank AG, Research Division - VP and Research Analyst + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD of Communications + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Jim Suva + Citigroup Inc, Research Division - Director + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Third Quarter Fiscal Year 2019 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. + + Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's Third Quarter Fiscal 2019 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. + + By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. + + Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis. + + The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter of fiscal 2019. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. + + With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. + + In Q2, on October 28, we completed the sale of our SPVSS business and accordingly, had no revenue or expense from that business in Q3 fiscal 2019. As such, all of the revenue, non-GAAP and product orders information we will be discussing is normalized to exclude the SPVSS business from our historical results. We have provided historical financial information for the SPVSS business in the slides that accompany this call and on our website to help understand these impacts. The guidance we provided during our Q2 earnings call and today's call has been normalized in the same way. + + I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn, and good afternoon, everyone. We had another strong quarter of performance across the business, demonstrating our ability to execute despite the ongoing uncertainty in both the macro and geopolitical environments. Technology continues to be at the heart of our customer strategy, and now, more than ever, our market-leading portfolio and differentiated innovation is resonating with them as they transform their IT infrastructure. + + In the quarter, we delivered strong revenue, margins, non-GAAP earnings growth and operating cash flow. As we continue to help our customers achieve their business objectives, I am confident about the future of Cisco and the growth opportunities ahead of us. + + New technologies like cloud, AI, IoT, 5G and WiFi 6, among others, are coming together to revolutionize the way we operate our businesses and deliver new experiences for our customers and teams. We are fundamentally changing the way our customers approach their technology infrastructure to address the rising complexity in their IT environments. We are building the only integrated, multi-domain, intent-based architecture with security at the foundation. This is designed to allow our customers to securely connect their users and devices over any network to any application no matter where they are. We are integrating capabilities like artificial intelligence and machine learning across the entire portfolio so customers have greater insights, resulting in better and faster business outcomes. + + Now for some highlights across our business, starting with Infrastructure Platforms. Over the past several years, we've been working to integrate intent-based networking across our enterprise access portfolio to help our customers manage more users, devices and things connecting to their networks. We brought to market tremendous innovation across wired, wireless and enterprise routing, including SD-WAN, resulting in a continued, strong traction of our Enterprise Networking portfolio. + + We are moving into an era of truly immersive and pervasive wireless connectivity, which generates demand for high-density, low-latency performance for real-time experiences over both wired and wireless networks. Enterprise networks today must be optimized for agility and security, leveraging cloud and wireless capabilities with the ability to garner insights from the data and security integrated throughout. Cisco is in a unique position to deliver this for our customers. + + We recently announced several new platforms expanding our Enterprise Networking portfolio with the launch of our subscription-based WiFi 6 access points and Catalyst 9600 Campus core switches, purpose-built for cloud scale networking. By combining our automation and analytics software with our broad portfolio of switches, access points and controllers, we are creating a seamless, end-to-end, wireless-first architecture for our customers. We also expanded our open roaming partnership ecosystem to now include Apple, Intel, Samsung and others to make Wi-Fi onboarding simple. + + With our newest Catalyst 9000 family additions, we have completed the most comprehensive Enterprise Networking portfolio refresh in our history. We have rebuilt our entire access portfolio with intent-based networking across wired and wireless. We also now have one unified operating system and policy management platform to drive simplicity and consistency across our customers' networks, all enabled by a software subscription model. + + In the Data Center, our strategy is to deliver multi-cloud architectures that bring policy and operational consistency no matter where applications or data resides by extending ACI and our hyperconverged offering, HyperFlex, to the cloud. Our partnerships with Amazon Web Services, Google Cloud and Microsoft Azure are great examples of how we continue to work with web-scale providers to deliver new innovation. For example, we recently introduced Cisco Cloud ACI for AWS, a service that allows customers to manage and secure applications running in a private data center or in Amazon Web Services cloud environments. We also expanded our partnership with Google. We announced support for their multi-cloud platform, Anthos, to help customers build secure applications everywhere from private data centers to public clouds with greater ease. Going forward, we will integrate this platform with our broad Data Center portfolio, including HyperFlex, ACI, SD-WAN and Stealthwatch Cloud to deliver the best multi-cloud experience for our Enterprise customers. + + Moving to Security. We continue to see strong momentum with another quarter of double-digit growth driven by our world-class Security portfolio. Cisco is the world's largest cybersecurity company for enterprises with thousands of cybersecurity experts helping our customers globally. Our portfolio covers the entire threat continuum of the modern enterprise and integrates security into every networking domain. We are enabling all of our customers to transform and secure their networks for the rapidly evolving multi-cloud world. We have a platform that continuously detects threats and verifies trust. By combining Duo, Umbrella, Stealthwatch, ISE and Tetration, we offer an end-to-end, zero-trust architecture that is strongly resonating with customers. + + Now turning to applications. We continue to execute very well on our collaboration business. These platforms are becoming increasingly critical to how enterprises operate and manage their workforce. Customers are always looking to enhance their meeting experiences, and cognitive collaboration is quickly becoming the de facto standard for delivering more personalized experiences and transforming how we work. + + At Enterprise Connect, we introduced several new cognitive collaboration capabilities within our WebEx portfolio integrating AI and ML to bring context and intelligence to meetings. The new innovations we launched include people insights, facial recognition and WebEx Calling, all which help to increase our customers' productivity making work simple and seamless. Going forward, you'll see this greater level of intelligence integrated into every piece of our collaboration portfolio across calling, messaging, meetings, devices and contact center. + + We also had another quarter of strong growth in AppDynamics as thousands of customers rapidly adopt our Application Intelligence platform for smarter and faster decision-making. The ability to manage end-to-end application performance across all cloud environments is increasingly important. AppDynamics is the market leader in application and infrastructure analytics delivering unparalleled innovation. We offer the most comprehensive, end-to-end visibility from connected devices and applications to the underlying network providing better application performance and user experience. + + To summarize, I'm very proud of the progress our teams have made against our strategic priorities to drive profitable growth, accelerate differentiated innovation for our customers and successfully execute on our own transformation to more software and subscriptions. Enterprise IT architectures must transform to help our customers get the most out of all of their IT investments. More than ever, our customers need a trusted partner with an end-to-end architecture strategy to simplify, transform and secure their businesses, and Cisco is that partner. + + Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Chuck. I'll start with a summary of our financial results for the quarter followed by the guidance for Q4. + + Q3 was a strong quarter across the business. We executed well with solid orders momentum, strong revenue growth, margins, EPS and operating cash flow. Product orders grew 4%. Total revenue was $13.0 billion, up 6%. Our non-GAAP operating margin rate was 32.2%, up 0.2 points. Non-GAAP net income was $3.5 billion, up 8%. And non-GAAP EPS was $0.78, up 18%. + + Let me provide some more detail on our Q3 revenue. Total product revenue was up 7% to $9.7 billion. Infrastructure Platforms grew 5% with solid growth across all businesses. Switching had another good quarter with growth driven by the continued ramp of the Cat 9K and strength in our ACI portfolio. Routing grew, driven by SD-WAN. We saw solid growth in Wireless driven by growth across the entire portfolio. And Data Center was up with growth in both HyperFlex and servers. Applications was up 9% with growth across all the businesses. We saw solid growth in Unified Communications software, TelePresence and AppDynamics. Security was up 21% with strong performance in identity and access, advanced threat and unified threat. We're very pleased also with integration of Duo into the Security portfolio. Service revenue was up 3% driven by software and solutions support. + + We continue to transform our business delivering more software offerings and driving more subscriptions. Software subscriptions were 65% of total software revenue, up 9 points year-over-year. + + When we look at the impact of acquisitions on our Q3 results year-over-year, there was a 40 basis point positive impact on revenue. We saw solid momentum in Q3 with total product orders growing 4%. + + Looking at our geographies. Americas was flat, EMEA was up 9% and APJC was up 6%. Total emerging markets was up 5% with the BRICS plus Mexico down 2%. + + In our customer segments, Enterprise was up 9%, Commercial grew 5%, Public Sector was up 10% and Service Provider was down 13%. + + From a non-GAAP profitability perspective, total Q3 gross margin was 64.6%. In terms of the bottom line from a GAAP perspective, Q3 net income was $3.0 billion, and EPS was $0.69. + + We ended Q3 with total cash, cash equivalent and investments of $34.6 billion. Q3 operating cash flow was $4.3 billion, up 79%. Normalized for the $1.3 billion of foreign taxes related to the Tax Cuts and Jobs Act we paid in Q3 of fiscal '18, operating cash flow was up 16%. From a capital allocation perspective, we returned $7.5 billion to shareholders during the quarter that was comprised of $6 billion of share repurchases and $1.5 billion of our quarterly dividend. + + We continue to invest organically and inorganically in our innovation pipeline. In terms of M&A, we closed on the Luxtera acquisition. These moves are consistent with our strategy of increasing investment in innovation and R&D for our growth areas. + + To summarize, we had a strong Q3. We executed well with strong top line growth and profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions delivering long-term growth and shareholder value. + + Let me reiterate our guidance for the fourth quarter of fiscal '19. This guidance includes a type of forward-looking information that Marilyn referred to earlier. Note that we have normalized our fourth quarter guidance to exclude the SPVSS business for Q4 of fiscal '18, which we divested on October 28, 2018. We have provided historical financial information for the SPVSS business in the slides that accompany this call. + + We expect revenue growth in the range of 4.5% to 6.5% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64% to 65%. The non-GAAP operating margin rate is expected to be in the range of 31% to 32%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.80 to $0.82. + + I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the lines for questions and start to begin the queuing process. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Rod Hall with Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess I'm going to ask an obvious one, and then from the order volumes, another obvious one. I wonder if you could comment on the trade situation and the 25% rate increase and just kind of give us some idea for how much is contemplated in guidance of that. And anything else you can tell us about exposure of the business? I know that you guys had said that you thought if it went to 25%, there would be price elasticity effects. So that's the first question. + + The second one is obviously the Service Provider orders down 13%. That is quite a lot worse number than we would have expected. So I wonder if you could just give us any more color on what's happening there. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Sure. Thanks, Rod. So on the tariffs, if you remember back many months ago when the 10% tariffs were announced, we said we had basically 3 phases to our strategy. The first was we would continue to dialogue with the administration to make sure they understand the impact. The second is we'll continue to do what we've always done, which is optimize our supply chain, which we've been doing for the last 20 years. And then the third is we will make pricing adjustments where necessary if needed. + + I'll tell you that the team has been working incredibly hard over the last 6 months. And so last week, when we saw the indication that the tariffs were going to move to 25% on Friday morning, the teams kicked in, and we actually have executed completely on everything that we need to do to deal with the tariffs. We are -- operationally, all that we needed to do is now behind us. And we see very minimal impact at this point based on all the great work the teams have done, and it is absolutely baked into our guide going forward. That's the first question. + + The second question on the Service Provider business, look, we've always talked about this business as being highly lumpy and very big customer-driven. And we've seen quarters where you see several big customers stall, and this is a result. And most of the impact of what we saw was in the Americas. And if you just look at the CapEx spend year-over-year, I think it's in the U.S., Kelly, the data that we had was -- the CapEx spend overall was down almost 20%. So this is something that we have always said from one quarter to the next, until we get into a real network buildout relative to 5G, that we knew these quarters are going to be lumpy. So it was very isolated to the Americas, and I think that the strength in our Public Sector and our Commercial and Enterprise business continues to indicate that the innovation that our teams have brought into the portfolio is still resonating with our customers. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Ittai Kidron with Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [5] +-------------------------------------------------------------------------------- + + Congrats on a great quarter and execution. Chuck, maybe you could talk about applications, a big deceleration from the level we've seen over the last 4 quarters. Clearly, AppDynamics is doing well in there. But now zoom out now in the marketplace, making a lot of noise. Help us think about WebEx, how that business is doing, how do you feel competitively positioned in the marketplace and how do you think about addressing potential competitive headwinds over there. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [6] +-------------------------------------------------------------------------------- + + Thanks, Ittai. So a couple of comments. Number one, the WebEx business continues to grow very solidly. We're very happy with what's been going on. The team has done a phenomenal job of really modernizing that platform over the last year under Amy's leadership. And the other thing to remember is that this is the first quarter where BroadSoft is normalized in the run rate, so we've had the benefit of that. So some of the growth rates that you've seen were obviously boosted by that over the last few quarters. So that's on the numbers front. + + I tell you what, the cognitive collab stuff that was announced at Enterprise Connect, I think, is going to be game-changing. What we see with some of our competitors is that they're focused on taking 4 collaboration endpoints into a customer and showing a great simple experience. And frankly, if we take 4 endpoints in with WebEx, the new WebEx, we can show a great, more rich, simple experience as well. + + So one of the things that we're focused on right now is transitioning all of our customers to our modern platforms. Because we've been in this business for years, and so our customers have varying combinations of technology. So one of the big things that we need to do is get everybody to the most modern platforms, which we think are very competitive. And when you put the cognitive capabilities on top of it that -- if you haven't seen it, we should get you a demo of it, it's pretty powerful. So we're very confident where we are in the space. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Vijay Bhagavath from Deutsche Bank. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [8] +-------------------------------------------------------------------------------- + + Chuck, Kelly, Marilyn... + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [9] +-------------------------------------------------------------------------------- + + Vijay, can you speak up a bit? We're having a hard time hearing you. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [10] +-------------------------------------------------------------------------------- + + Yes. Can you guys hear me? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Yes. That's better. Thank you. + +-------------------------------------------------------------------------------- +Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [12] +-------------------------------------------------------------------------------- + + Yes, yes. First, I mean honestly, I would like to commend you for your recent social contributions. We do monitor that news flow in addition to what's going on in the business with many programs -- mitigation programs. Honestly, I'd like to commend you on that. + + And then on the earnings call question, your General Manager seemed quite excited on this WiFi 6, the Campus core switch. So my question to you and helpful for all of us is, how impactful is this new Wi-Fi 6 refresh and the new Campus core, the Catalyst 6000 refresh heading into the back half and is that a pull forward across the portfolio? Or would this just be kind of a point product swap? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + Yes. Thanks for your comments, Vijay. On the -- look, I think we have to step back and look at what the teams has accomplished on the Enterprise Networking portfolio. We launched the first Catalyst 9000 in the summer of 2017. And 2 weeks ago, we completed the portfolio across -- our enterprise routing platforms are going through a refresh, our -- the Catalyst 9000 Switching family as well as all of the access points. + + And if you go back 2 years ago, we didn't have a single networking product with a software subscription on it. And today, every product in the enterprise routing space, the enterprise Wi-Fi space and the enterprise Campus switching space is sold with a mandatory subscription. So the progress that the teams have made is phenomenal. + + They've also -- we had multiple operating systems running across those different platforms. We've now consolidated it to a single operating system, and it all is running under a single automation platform so that our customers can deploy policy. So it's been an incredible amount of work that the teams have done. + + Now when I look at -- as we've talked about with the customers, we're still very early in the transition. If you look at -- you could assume customers used to keep Campus switching products for, I don't know, 7 years, 5 to 7 years. And we've been at small portions of this portfolio for the last 2 years but just very small portions, and so we still believe we're in the very early days of the transition. + + And what you see -- Wi-Fi 6 is effectively what used to be called 802.11ax. And what's happening now is when you get these high-performance access points into the organizations and you get the low-latency, immersive experience possibilities, then it's also going to drive the need to upgrade the backbones. Our guys like to say, "Behind every great wireless network is a great wired network," and so we think it's the beginning of an overarching refresh for our customers as they modernize their infrastructure based on this cloud transition that they're all going through. So that's how we look at it today. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Sami Badri with Crédit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [15] +-------------------------------------------------------------------------------- + + I'd like to focus in on Security and more specifically in the strength in the quarter that you saw. Is that being mainly driven by the new acquisitions you guys have made? Or is that more from legacy? Given that you are refreshing the Campus, are you pulling forward some of the more legacy security offerings that you had? Or is this predominantly just strength in the M&A, all the acquisitions you've made being integrated and finally going to market? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + I'll give you some color, and then, Kelly, I'll let you comment on the breakdown of the numbers. I think this is being driven -- if you think about what's happening with our customers today, they build their security architecture based on the underlying assumption that they had users at the edge of the network and they had applications in a private data center, and so the way you architected that was you protected your parameter. And now our customers are operating in an environment where they have mobile users everywhere. They have branches out there. They have this explosion of IoT connectivity that's occurring, and they have applications that are running in hundreds of different places between SaaS applications, their private data center, public clouds. And so the whole notion of a security architecture has changed completely, and our teams have been building towards that over the last couple of years. + + So what happens is we have to protect the customers' data and their traffic, wherever it is, and that's why we've been investing in all these new capabilities, making these acquisitions. And I think that architecture where you can actually see threats across the continuum and then dynamically defend across that same -- those same threat -- that same threat surface area is what's really driving the growth here. And it's also a part of our business that is very, very, very software-rich and is highly concentrated in subscriptions. And so we also have that recurring piece of this business, which is what we're trying to drive in the rest of our portfolio. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Yes. I think the only thing I'll add to that is -- I mean it's the revenue growth -- obviously, the Duo acquisition I talked about in the earlier comments was part of it. But I can tell you it was very broad-based across the entire Security portfolio, including network security, advanced threat, cloud security, the big drivers. So very broad-based. + + And just to add to Chuck's comments, don't forget that because we are embedding Security into this Enterprise Networking portfolio, we also benefit from the great growth that we're seeing in the Enterprise portfolio. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + Got it. And then just a small follow-up after this. It's just, are you disclosing recurring revenue percentage of total revenue this quarter just because some of the comments around subscription? Just wondering if you're giving that out. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes. No, we haven't given out the software revenue actual number, but I think the last time we gave it out was at our Financial Analyst Conference. And again, we're growing very quickly, the software portfolio, in line, if not faster, than what we had talked about then. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + So well on track or ahead of where we told everyone we would be at the Financial Analyst Conference in 2017. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [22] +-------------------------------------------------------------------------------- + + Two quick clarifications and a question. Kelly, I know we'll see it shortly, but can you talk about the rate of price erosion and what you're seeing specifically with respect to DRAM? + + And then, Chuck, on your comment earlier about the 25% tariff, I apologize if I misunderstood, but I just want to make sure. Are you telling us that you shifted all of your supply chain out of China so there's no exposure going forward? Or is it just a matter that you've incorporated into your guidance? + + And then for the question, some of your smaller peers have commented about a pause in wireless LAN and related switching deployments. As customers are waiting for Wi-Fi 6, you've now rolled out your Wi-Fi 6 access points, you upgraded the new 9600, et cetera, are you seeing that pent-up demand?. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [23] +-------------------------------------------------------------------------------- + + So maybe I'll start with the first few, and then, Chuck, you can hit on the wireless. So Paul, on price, we continue to be very disciplined on price. And what you'll see in the Q is from a product gross margin rate impact, it was 1.1 points year-over-year. So right in line, if not slightly better than what it has been in the last few quarters. + + And to your question on DRAM, yes, as we expected, DRAM turned this quarter and became a tailwind for us in Q3. So that is part of why I guided Q3 gross margin where I did and where we actually ended up on our gross margin at the 64.6%. We're benefiting from that. + + And if I'll just comment a little bit on the tariff question, as Chuck said, it is baked in our guidance. And from what we have baked in, there will be -- we still have some manufacturing happening in China, but we've greatly, greatly reduced our exposure working with our supply chain and our suppliers. So the impact that we're expecting that -- again, we're trying to mitigate. We have incorporated in the guide that we gave for Q4, and we think we can manage through that. Of course, we'll be watching that as the quarter goes on. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Yes. And Paul, then on the Wi-Fi, I don't think -- we've not -- I don't think we've seen any substantive change on the Wi-Fi front. I saw some of the same comments earlier in the week, I think. But in general, I think our customers -- I think that most of our customers are just continuing to build out, and I think they'll transition now to the new WiFi 6-enabled ones and keep moving. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + We launched in the last week of our quarter, so it was too early for the -- to take any... + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Yes, we wouldn't have any, given when we launched. And the tariffs, I'll tell you, our teams have just done an amazing job. I mean that's the bottom line. And so everybody worked so hard to a point where literally, last week, the teams executed on everything incremental we needed to do to deal with it. And it's relatively immaterial at this point, and it's baked in the guide. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + James Suva with Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [28] +-------------------------------------------------------------------------------- + + Some companies have talked about pauses in demand, whether it be digestion of inventory such as overbuilding, a uncertainty economic environment. It appears, if I'm reading your outlook and your results pretty correctly, you haven't seen that. Can you maybe help us bridge the gap of was it -- did you just have a lot better pulse on the inventory in the channel or end markets a little different? Because if I remember right, I think your cloud sales are north of 20% but maybe below 30% or something, but we've heard a lot about a pause in cloud spending. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + Yes. I think the only area where we saw a real shift was in Service Provider. And across the rest of the business, we watch the same TV shows you guys watch. We see the same stress around the world. We see the same risks. + + But if you go back and look at our quarter, if you just -- obviously, SP was SP. But in general, our linearity from the beginning of the quarter to the end of the quarter was pretty much the same as it was in the same quarter a year ago based on where we ended up. So outside of SP, I don't think we saw any substantive change. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + No, it was really SP. And Jim, just to clarify because I saw your note that you published. Again, ,when you say cloud -- if you're meeting the subset web scale, I guess, that's not the correct number out there of what our -- we've never -- we haven't given it out, but I just want to make sure that that's not really kind of like what our web-scale exposure is. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + James Faucette with Morgan Stanley. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [32] +-------------------------------------------------------------------------------- + + Great. I just wanted to ask a couple of questions, perhaps, maybe for Kelly on a couple of small things. First, deferred revenue was down a little bit quarter-over-quarter, and I know that there's been some adjustments around 606. So I'm just wondering if we can get a little reflection on kind of what the mix is doing there. + + And then also, I know you addressed gross margins and some benefit and tailwind you got from components there. But at least as the numbers were reported, it seemed like a lot of the improvement was concentrated in the APAC region. And just wondered if we're interpreting that correctly. And if so, was there anything unique happening there, perhaps, that we didn't see in the rest of the world? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + On the market? Yes. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [34] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Yes. So first, the deferred revenue. Yes -- no, it's a great pickup. I will say the only thing that's kind of changed in the deferred revenue is -- and we kind of talked about this maybe a couple of calls ago, is it's really driven by our collab business. They've gone much more to month-to-month billing. So therefore, it doesn't flow through deferred revenue anymore, whereas in the past, we might -- it might be financed with customers or it would go through -- they'd pay upfront. Now it's really going month-to-month, which again is just how it's recognized through the balance sheets. So that's really what's driving it. + + If you look at the rest of our businesses like with the ramp of the subscriptions of the Enterprise portfolio as well as Security, those are all growing quarter-on-quarter. And as you know, the big tick-down from a year ago is because of the change of the accounting standard down. But from a business operational thing, the only change is -- quarter-on-quarter is really just the shift of the collab business going more month-to-month versus paying upfront. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [36] +-------------------------------------------------------------------------------- + + And can I just ask just a quick follow-up there? And so when should we expect that to stop being a drag? And -- or are we going to see that happen across other parts of the business that you could see some volatility there? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + No. I think you're going to continue to see -- I mean. Again, the collab, I think, is just going through that just how we're changing our offers and what we're offering there. But I think the rest of the business is going to continue to start building up. So you'll see that get back to, I'd say, growing here over the next few quarters. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [38] +-------------------------------------------------------------------------------- + + Okay. And then the gross margin is seemingly concentrated in APAC. Any major reason for that? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Yes. Actually, the gross margin in APAC was literally very focused mostly in Japan and mostly driven by our -- some big deals in Service Provider that had some lower margins than the typical average that we have in Japan. But it's very isolated to that. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Mitch Steves with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [41] +-------------------------------------------------------------------------------- + + I really have 2. One in kind of the securities side, and secondly, maybe some back half update. On the Security side, you guys are growing at 20% plus. I think that back a couple of years ago, people would never believe that and would have viewed Cisco as kind of a shared donor. So I guess what has changed in terms of the products that you guys are selling? And then secondly, do you think that's something that's more sustainable, or let's call it, teens growth instead of the historical 10% growth? + + And then secondly, I know Cisco used to kind of give kind of a IT spend number. Can you maybe provide us any sort of commentary in terms of what you guys think of the back half? I mean is the demand environment in your guys' view going to be better, worse or kind of the same? Because I think it's a little bit difficult to figure out what you guys are going to grow at considering the first half has already been solid. So I just wanted to know if you guys can give any color there as well. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Yes, Mitch. So on the security front, I think it's really what I was talking about earlier. The architectures in our -- for our customers have changed. And I know -- I can remember conversations a couple of years ago about things that we're building. And the team would tell me, "Look, we're building for where our customers are going to be next year and the year after." And so -- because I was debating with them in some cases about where they were investing, and they were right. So they've -- we've had some very strategic acquisitions that have contributed to it and continue to grow. And I do believe that this -- the architectural approach as opposed to historically what we've seen, which is when you're defending a perimeter, you just -- you can just buy the best-of-breed all around. And just like if I'm defending e-mail, I buy this. If I'm -- I put in a firewall here and it can be -- they don't have to necessarily communicate. And today, the architecture really requires a platform where you ingest threat information from lots of different sources, and then you dynamically defend across all those same vectors, and I think that's what the teams have built. + + So as far as growth rates, we'll have to see. I'm sure they'll move around based on acquisitions and other things that we do. But I think that we're quite happy with where the teams are. I think it's a good, solid business for us for a very long time. + + As far as the IT spending, look, I don't have anything to add to what we -- what you've heard. I think that in today's world, we've -- I've said repeatedly that I've been pretty amazed at the resiliency of the global economy over the last couple of years. There are certainly -- as I said early in our prepared comments, there's a lot of dynamics at play around the world. There's a lot of geopolitical issues. We've heard some macro issues in certain cases. And we're just going to continue to execute on the things that we can do. And -- but what's going to happen 6 months from now, I don't have any greater visibility, I don't think, than anybody else. So... + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Jeff Kvaal from Nomura Instinet. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [44] +-------------------------------------------------------------------------------- + + Yes. Just following up on the prior question about web scale. Your progress on web scale has been a little bit TBD for a number of years. I'm wondering what you can tell us about when you think your efforts in that regard might pay off if you think the 400-gig migration is an entry point for you. Or what do we have to look forward to in that particular vertical? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [45] +-------------------------------------------------------------------------------- + + Yes, it's a very valid question. And we have a lot of things going on with the web scale providers today. I think 400 gig certainly will represent an opportunity for us to insert. I think that the architectural transition points is really where you have an opportunity. We've known that for decades from working with the telcos and service providers. You typically don't insert into an existing architecture. It really requires a transition. So I think thinking about those kinds of things and 400 gig would be representative of that. But to give you any time line, I think we're just going to have to wait and keep plugging away. + + We're still making progress. We've made a ton of progress on the relationship side. We've got a lot of deep, technical discussions that are going on. They're spending a lot of time on our Campus with us. So we continue to make progress, but these are big, long-term decisions that they're making, and we're going to keep plugging away. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [46] +-------------------------------------------------------------------------------- + + Okay. Well, I'll keep asking then, I guess. And then, Kelly, from your side, what can you tell us -- I guess -- I mean the mix of software does continue to increase. What can you tell us about where you would like the gross margins to be over an intermediate time frame or whatever time frame you choose, I guess? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [47] +-------------------------------------------------------------------------------- + + Yes. I mean, again, I think if you go back and look over the last couple of years of where -- just when even look at our guides over the last 3 years, and we've steadily moved up our gross margins. And I think if you go back 3 years, we were guiding 61% to 62%. We've steadily come up. And when I guided Q3, I moved up another 0.5 point to get to the 63%, 64%. + + So again, you're seeing that go through our gross margins as they're going up there. I think there's always puts and takes. We have the natural price erosion that we see every quarter, but we're driving productivity. DRAM turnaround is helping us a lot, and that's going to help us with positivity there. It's going to help us if we do have, again, incremental costs we can offset whether it's tariffs or anything else. + + So the 64% to 65% here we're guiding now, I think, is pretty good. And our whole goal and the whole reason we're making this shift to software besides to continue innovation is it's a great way to drive margin accretion. So you're just going to continue to see us shift our portfolio that way. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Jim Fish with Piper Jaffray. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - Research Analyst [49] +-------------------------------------------------------------------------------- + + Chuck and Kelly, congrats on a fantastic quarter and execution here. Maybe just going back to Rod's initial question specifically around 5G. Maybe what products do you expect to benefit with or are you seeing orders for already? I know it's early days. And then Kelly, maybe you could discuss, is there going to be any impact related to the shift of VNS on the model? Like should we expect lower revenue contribution in the cycle but higher gross margin kind of going off to what you were just saying before to? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + Okay. Jim, so let me -- on the 5G front, I think there's a couple of things I would call out. Number one, the CapEx data that we saw last quarter -- and even the forecasts don't look incredibly healthy for these guys. But where they are spending money primarily today as it relates to 5G is they're building out the macro radio portion of their networks first, and they're leveraging their existing core networks to run the early trials that they have on 5G basically. And we believe that sometime in the future, when they have -- when the number of connections increases and the capacity gets to a point, then they're obviously going to begin to build out these new backbones dedicated to the 5G infrastructure, which is where we will generally come into play. We're also obviously selling them packet core technology for the new 5G networks today, but the big play for us is when they begin to evolve their networks to accommodate the traffic. And we've always said we felt like that would be sometime in calendar 2020. + + We're working with lots of them on architectural designs and where they're going, but it's really going to be core routing backbone technology, where we're going to see -- we should see the big impact from 5G. And we'll obviously have to wait and see how it plays out. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [51] +-------------------------------------------------------------------------------- + + Yes. And just on the VNS, I would just say I don't -- SP customers are a little different than Enterprise customers, right? Everybody's looking for automation and software-defined, everything, and I think our entire portfolio is moving that direction. And it's just the nature of the beast, whether it's SP or enterprise, right? Prices for core are getting less and less the more that we're driving just more throughput and everything else. So it's nothing VNS-specific, but it's the entire portfolio. The software value -- the values where the software is in the automation that we're bringing to our customers. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Thank you. Steve Milunovich from Wolfe Research. + +-------------------------------------------------------------------------------- +Steven Mark Milunovich, Wolfe Research, LLC - MD of Equity Research [53] +-------------------------------------------------------------------------------- + + First, Kelly, any concern about bridging the 4% order growth to the 4.5% to 6.5% revenue growth? And maybe while you're talking about that you could net out the year-over-year impact of 606 M&A, which I think you gave us and then deferred, which I think is still a bit of a drag and maybe how that might look next quarter. + + And then, Chuck, I think you wanted to kind of tweak the culture a bit when you came in. And if you could update us in terms of things like your Net Promoter Score, externally, your return on employee surveys, how you sort of assess the culture and if that's part of the results that we're seeing. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [55] +-------------------------------------------------------------------------------- + + Yes, sure. So I'll take the top line first. So yes, the 4% orders growth, again, like Chuck said, if you look at the rest of the business, they were all up, the 9% for Enterprise, 10% for Public Sector, 5% for Commercial. So that's all great strength. It's service provider where we had the issue. And as you know, when we guide, we have what's sitting in backlog. We can -- we have very good visibility into the pipeline, and we have -- we work with all our regional sales leaders in terms of what they're seeing. So we feel very comfortable with the guide that we're giving you based on all of those factors. So it's basically incorporated for the SP slowdown that we saw in the orders. + + In terms of the revenue question, so yes, we talked about acquisitions. It's really only Duo and a very tiny bit of Luxtera as our inorganic from the acquisition. So that was only 40 basis points of our growth. And the 606 impact this quarter was only 1.2 points, so it was a relatively small number compared to the other quarter. So it was 1% -- slightly over 1%, 1.2 points from that perspective. + + And then on the deferred, it's -- that's more of a -- one of the puts and takes on the margin driver because we are -- like, for example, on the Enterprise Networking portfolio, deferring -- we're still deferring. Even though we're deferring last, we're still deferring. So that kind of, as we have these new replacement products that we have the subscription on, that hurts your rate a little bit, but it's nothing material. So from a revenue, the 606 and acquisitions are fairly small. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [56] +-------------------------------------------------------------------------------- + + And Steve, on the culture issue, we've basically, I think, been amplifying what's always been a core part of Cisco but really, really prioritizing it and trying to just create an environment in today's world where people want to work because it's an incredibly competitive environment for talent. And I guess the way that we look in metrics -- we've been focused on communication with our employees, clear, authentic frequent communication. We've been focused on giving back. And what we've discovered is that we have a lot of employees who care deeply about giving back to their communities, and so I told them that our ability to give back and our ability to do the things that they love to do is highly contingent upon us running a great business. And so the 2 are very interconnected. + + As far as how do we rate it. I mean if you look at every external employer ranking, we've moved up. The one -- I tell you, around the world, great places to work, I think we're #1 in countries around the world, maybe 15 to 20 countries around the world. And in the U.S., which is one that just came out recently, we -- I think when I became CEO, we're #87 in the U.S. And 2 months ago, we were rated #6. And over 70% of the input for that -- those rankings come directly from the employees. And we obviously watch Glassdoor, where we're above 4.0 and all those kinds of things. + + So we're working hard on it. We think it's important because of -- it's important because when your employees are happy, they actually do a much better job and help the overall results. So it's somewhat cyclical. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [58] +-------------------------------------------------------------------------------- + + Chuck, when -- I heard you talk about how Cisco technology gets more and more integrated with the platform of the leading cloud vendor. As you can imagine, I love hearing that having different -- quite a long time that the Enterprise IT will expand into the cloud that this is going to migrate to the cloud. + + So I was curious to hear from you a bit more on that in terms of how big it is today in your business. I don't know if you have an idea of the take rate of Cisco technology that are moved to -- that are integrated with the cloud vendors. And if so, how do you go to market with the technology? Do you go to market in partnership with cloud vendors? Is that something you sell directly to your clients? And of course, any idea of the business model, how big it is in your revenues already today? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [59] +-------------------------------------------------------------------------------- + + Yes. Thanks, Pierre. It's really hard to quantify because the technology that we're building that is either integrated in with the cloud providers or offered off the cloud platforms or enabling our customers to transition to the cloud or expand to the cloud, as you put, which is the same word we like to use. So we appreciate you coming up with that. We stole it. + + It's everything from extending ACI from the private data center into the cloud to offering virtualized routing functions off of AWS and Azure for developers, virtualized security services even to the SD-WAN technology and now integrating it with our cloud security gateways and then the integration of some of these hybrid stacks like Azure Stack or what we talked about from Google that they announced recently, integrating that with our technology on-premise, the Kubernetes stack that we've done. So there's an awful lot of areas where we play. + + We talk about the fact that while customers are moving some applications to the cloud, they didn't move their employees to the cloud. And so there's a big opportunity, which is what we've been focused on, which is to evolve this access portfolio to really enable this transition to the cloud that our customers have been undertaking. So it really is touching massive amounts of our portfolio, and I think you'll only see us continue to drive more technology that facilitates our customers' move in this area. So appreciate the question. + + So I'll wrap up. I want to thank everybody for spending time with us today. Obviously, we're proud of what our teams continue to accomplish. We're operating in an environment that has very complex macro and geopolitical dynamics right now. But we're continuing to execute as well as we can on the things that we control, and that's what we plan to do going forward. + + So thanks for spending time with us today, and we look forward to talking to you again next quarter. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [60] +-------------------------------------------------------------------------------- + + Thanks, Chuck. This is Marilyn. Just want to close up the call here. So Cisco's next quarterly earnings conference call, which will reflect our fiscal 2019 fourth quarter and annual results, will be on Wednesday, August 14, 2019 at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern time. + + Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it's done through an explicit public disclosure. + + We now plan to close the call. If you have any further questions, feel free to contact the Cisco Investor Relations department, and we're very much looking forward to speaking with you through the remainder of the week. Thank you for joining today. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (888) 446-2545. For participants dialing from outside the U.S., please dial (402) 998-1344. This concludes today's call. You may disconnect at this time. Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2019-Nov-13-CSCO.txt b/Transcripts/CSCO/2019-Nov-13-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..8d7960c13080df07d0bb3e808e1465284f0c0e21 --- /dev/null +++ b/Transcripts/CSCO/2019-Nov-13-CSCO.txt @@ -0,0 +1,471 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Cisco Systems Inc Earnings Call +NOVEMBER 13, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * James Edward Fish + Piper Jaffray Companies, Research Division - VP & Senior Research Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * James Eugene Faucette + Morgan Stanley, Research Division - Executive Director + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Thejeswi Banavathi Venkatesh + UBS Investment Bank, Research Division - Associate Director and Analyst + * Jim Suva + Citigroup Inc, Research Division - Director + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's First Quarter Fiscal Year 2020 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Michelle. Welcome, everyone, to Cisco's First Quarter Fiscal 2020 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. +As is customary in Q1, we have made certain reclassifications to prior period amounts to conform to the current period's presentation. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the second quarter of fiscal 2020. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Form 10-K, which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. +In Q2 of fiscal 2019, we completed the sale of our SPVSS business and, accordingly, had no revenue or expense from that business in Q1 fiscal 2020. As such, all of the revenue, non-GAAP and product orders information we will be discussing is normalized to exclude the SPVSS business from our historical results. We have provided historical financial information for the SPVSS business in the slides that accompany this call and on our website to help to understand these impacts. +The guidance we provided during our Q4 earnings call had been normalized in the same way. +I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Marilyn. We delivered a solid quarter against a challenging macro environment. While we're pleased with this performance, we're most focused on the environment as we move forward. We'll discuss this more in a moment. +What's happening inside Cisco, regardless of the macro, is an unrelenting focus on driving innovation, transforming our business and exceeding our customers' expectations. In Q1, as you've seen, we had revenue growth of 2% and double-digit non-GAAP earnings per share growth. We also delivered strong non-GAAP gross margins and non-GAAP operating margins, along with solid operating cash flow. We continue to invest in innovation and expand our market opportunities, while maintaining our commitment to maximizing shareholder return. +Over the last year, many of you have heard me talk about the resilience of the global macro environment. However, on our last earnings call, we indicated that we had begun to see some weakness, and that weakness continued throughout Q1 and was more broad-based. While the main challenges continue to be service provider and emerging markets, this quarter, we also saw relative weakness in enterprise and commercial. Despite these headwinds and because of key decisions we made 4 years ago to change our business model, we remain well positioned to capitalize on the tremendous opportunities across cloud, automation, 5G, Security and Collaboration. +Our transition to software continues to progress, and we are on track with where we said we would be at the end of fiscal year 2020. This transition to software not only aligns to how our customers want to consume our technology but we also believe it will lessen the impact of macroeconomic shifts in the future. +Despite the current uncertainty, our innovation pipeline remains strong. At our annual partner summit last week, we announced several exciting additions to our portfolio, including network automation and analytics, cloud-based networking, Collaboration as well as new Security capabilities. Over the next couple of months, you will see us deliver even more innovation to help our customers achieve their business objectives. +Now I'd like to share some recent highlights across the business. Our Enterprise Networking portfolio continued to grow as customers increasingly adopt our intent-based networking portfolio, spanning our Catalyst 9000 family of switches, Meraki cloud-based platforms and next-generation data center solutions. Our customers today are running applications across multiple cloud environments, and this shift requires a fundamental change in how they build their networks and their security architectures. +To help them achieve this, we are automating connectivity across any cloud. A good example of this is our recently announced partnership with Microsoft to help our customers improve network connectivity with the highest level of security, from branch offices to cloud-based applications, by integrating Cisco's SD-WAN solution with Azure's virtual WAN. +To further extend our enterprise networking leadership, we continue to expand our cloud-managed network and security offerings. Last week, we also announced an expansion of our Meraki portfolio, including continued integration between Meraki's Dashboard and Cisco's Switching portfolio as well as innovative new LTE-based WAN connectivity solutions. We believe our planned acquisition of Acacia will also play a critical role in building upon the strength of our switching, routing and optical networking portfolio. By utilizing our innovations across silicon, software and optics, we are enabling our customers to transform their networks. +Now let's turn to Security, which is always at the heart of everything we do. It's deeply integrated into the fabric of our entire portfolio to help secure our customers' data and address their modern application in multi-cloud environments. Cybersecurity continues to be a top concern for our customers as they evolve their enterprise architectures to address the challenges of an ever-changing threat environment. +We have the most comprehensive integrated cybersecurity platform in the market, designed to enable our customers to securely connect any application running on any cloud and delivered to any device. We have been building an expansive Zero Trust framework for securing access across the workforce, the workplace and the workload. As the leader in Zero Trust, our customers are increasingly turning to us to help them extend simple and trusted access to their users in hybrid and multi-cloud environments. +This is leading to strong uptake of Duo, our identity access management solution, which provides continuous authentication, ensuring the right people are able to access the right applications. +To further reduce complexity in our customers' environments, we recently announced new enhanced capabilities in our firewall, breach defense, endpoint protection and Talos incident response solutions. These innovations are designed to provide greater threat protection and enhance the benefits of our platform. +We also continue to leverage AI and ML capabilities through our industry-leading threat intelligence platform, Talos, along with Stealthwatch and Umbrella, to bring our customers simplicity, visibility and insight that no other company can deliver. +Moving to Applications. We are rapidly becoming the center of our customer strategy for empowering teams and increasing productivity as 95% of the Fortune 500 use our Collaboration portfolio. This is leading to the solid performance in our business as a growing number of customers adopt our unique solutions. +During the quarter, we expanded our offerings to empower our customers for the modern workplace, protecting data from ever-increasing cyber threats and delivering highly secure productivity and collaboration solutions. A good example of this is our next-generation WebEx, our cloud-based team collaboration platform, enabling better teamwork while helping users stay secure with integrated end-to-end encryption. +We also launched single platform, Advantage, delivering all collaboration workloads, including calling, messaging, meeting and contact center from a single platform. +In addition, we announced our new Cisco Webex Edge for devices as well as hardware-as-a-service options for phones, desk and room-based video systems. We are raising the bar for the industry by continuing to drive innovation in our expanding family of cognitive collaboration offers with AI and ML integrated capabilities. +During the quarter, we acquired CloudCherry, a market-leading customer experience management solution, to augment our contact center portfolio with cloud analytics and AI to increase productivity and enhance user experiences. +We also achieved a strong quarter in our AppDynamics business with yet another quarter of double-digit growth. Our investments in AppDynamics have made Cisco the leader in application monitoring and analytics. We are helping our customers transform their digital businesses through our comprehensive portfolio of solutions that turns data into actionable real-time insights by linking application performance to business outcomes. +To summarize, while we remain in a challenging macroeconomic environment, I'm proud of our progress, both in our own continued transformation and in how we are empowering customers to drive their own transformation and shift to the cloud. We have a clear vision and strategy and are executing well against it to capture the many opportunities ahead. I feel great about our portfolio, and I believe fully in our customers' commitment to our technology solutions. +We will also continue to invest in organic and inorganic innovation to position Cisco for the long term. We also remain committed to managing our business to ensure we drive the greatest long-term value for our customers, employees, partners and shareholders. +Now let me turn it over to Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q2. +Our overall Q1 results were solid. We executed well with revenue growth and strong margins, net income and EPS. Total revenue was $13.2 billion, up 2%. Our non-GAAP operating margin rate was 33.6%, up 1.3 points. Non-GAAP net income was $3.6 billion, up 5%. And non-GAAP EPS was $0.84, up 12%. +Let me provide some more detail on our Q1 revenue. Total product revenue was up 1% to $9.9 billion. Infrastructure Platforms was down 1%. All of the businesses were up except for routing. Switching had growth in both campus and data center with the continued ramp of the Cat 9K and strength of the Nexus 9K. Wireless grew, driven by Meraki. Data center had solid growth, led by HyperFlex. Routing declined due to weakness in service provider. +Applications was up 6%, with growth across all the businesses, including double-digit growth in AppDynamics. Security was up 22% with strong performance in identity and access, advanced threat, unified threat and web security. +Service revenue was up 4%, driven by software and solution support. And we continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 71% of total software revenue, up 12 points year-over-year. +When we look at the impact of acquisitions on our Q1 results year-over-year, there was a 50 basis point positive impact on revenue. In terms of orders in Q1, total products orders were down 4%. Looking at the geographies, Americas and EMEA were each down 3%, and APJC was down 5%. Total emerging markets were down 13%, with the BRICS plus Mexico down 26%. In our customer segments, public sector was up 6%, enterprise and commercial were each down 5%, and service provider was down 13%. Remaining performance obligations, or RPO, at the end of Q1 were $24.9 billion, up 11%. RPO is our total deferred revenue plus unbilled deferred and represents total committed noncancelable future revenue. +From a non-GAAP profitability perspective, total Q1 gross margin was 65.9%, up 1.7 points; product gross margin was 66.1%, up 2.5 points; and service gross margin was 65.4%, down 0.4 points. +In terms of the bottom line from a GAAP perspective, Q1 net income was $2.9 billion and EPS was $0.68. +We ended Q1 with total cash, cash equivalents and investments of $28 billion. Operating cash flow was $3.6 billion, down 5%. Normalized for the $400 million legal settlement we received from Arista in Q1 of fiscal '19, operating cash flow was up 7%. +From a capital allocation perspective, we returned $2.3 billion to shareholders during the quarter that was comprised of $0.8 billion of share repurchases and $1.5 billion for our quarterly dividend. +We continue to invest organically and inorganically in our innovation pipeline. During Q1, we closed 4 acquisitions, all in the Applications area. These moves are consistent with our strategy of increasing investment in innovation and R&D for our growth areas. +To summarize, we had a solid Q1. We executed well with top line growth and strong profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the second quarter of fiscal '20. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue to decline in the range of minus 3% to minus 5% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64.5% to 65.5%. The non-GAAP operating margin rate is expected to be in the range of 32.5% to 33.5%, and the non-GAAP tax provision rate is expected to be 20%. Non-GAAP earnings per share is expected to range from $0.75 to $0.77. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) Michelle, I'll turn it over to you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ittai Kidron from Oppenheimer. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + Chuck, maybe I'll -- you can kind of walk us through a little bit, kind of how the quarter evolved as far as the demand pattern. You've talked about weakness became, first of all, more broad-based, but also started into the enterprise and commercial. Any more color you could give us there, either from a product or regional standpoint? +And with regards to your working assumptions into the next quarter, into the January quarter, is it your assumption that the intensity of the softness you're seeing right now will just take as is or getting worse? Help us think about the framework you have in mind when you give the guidance. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Okay. Thanks, Ittai. So yes, what we -- if you recall on the last earnings call, I did say that we began to see some early signs of some macro impact towards the end of Q4. And then we just basically saw that continue throughout the quarter. And as obviously, the entire quarter was worse than we had expected when we began. And it was fairly broad-based. It was -- I mean, Kelly just read the regional numbers off from an orders perspective. So you saw negative 3, negative 3, negative 5 from Americas, EMEA and Asia. +I'd say, across the technology areas, it was pretty broad-based. The segments that we saw, public sector continued to be strong, but the rest were -- enterprise commercial did weaken. Service provider in emerging markets, which were stressed last quarter, were about the same. We had shown the ability to offset that with strength in these -- in commercial and enterprise and public sector. And when those weakened, obviously, this quarter, that impacted our ability to offset them. +And while I won't let my team make this excuse, it also had to happen in a quarter where we did have incredibly tough compares. So this is the worst quarter it could have occurred for us. So -- but that's really what we saw. +As far as what we've modeled going forward, we're -- we've effectively assumed that it will stay as is. I don't think -- we haven't modeled any material further deterioration or improvement, I think, in what we put forward today. Kelly, is it fair? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + That's right. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Samik Chatterjee from JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [6] +-------------------------------------------------------------------------------- + + Chuck, thanks for the detail on the last question. I just wanted to get a sense of what you're hearing from your customers in terms of, are you hearing that if some of the trade aspects of -- that are depressing the macro get resolved, do you expect some of them to come back in terms of spending? What are you hearing from your customers? And if you can give us an update on the order trends in China as well, that would be helpful. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Samik, thanks for the question. So from the customers, it feels like there's not a broad-based loud noise out there. It feels like there's a bit of a pause. We saw things like conversion rates on our pipeline were lower than normal, which says that things didn't close the way we would have historically seen it. We didn't see any incremental loss ratios. It was really just stuff slipping. We saw some large deals get done but got done smaller. Kelly and I were involved in a couple personally that we saw that when we began talking to the customers about the transactions, and by the time they got done, they were smaller than when we had begun. So that happened. And then we just saw deals that slipped. And so we saw a little bit of all that. +But it's not -- I'd say we also had our teams telling us that the approval process in several customers across a different number of industries were changing, which is usually indicative of, hey, let's add another signature requirement because we want to just put another set of eyes on every expenditure right now. +So those are the things we've seen. And unfortunately, I've done this long enough that I've seen it before, so you recognize it when you see it, and that's really effectively what we saw during the quarter. +And China, Kelly, was -- exact number. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + China continues its decline. It was down 31% versus last quarter. It was down 26%. So the momentum is continuing to just accelerate the decline in China. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Paul Silverstein from Cowen. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [10] +-------------------------------------------------------------------------------- + + Kelly, if you could tell us the pricing. I know we're going to see it in the Q, but if you could tell us the rate of price erosion, if there was any change? +And then, if I did the math correctly on OpEx, it looks like your guidance would suggest around $3.8 billion for the January quarter. That would be down $400 million sequentially and $150 million year-over-year. Do I have that right? Is that the way you're thinking about it? +And related to that, how should we think about OpEx going forward throughout the year? How do you plan to manage expenses given the less-than-expected revenue outlook? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + Yes. So let me take those. So on price, we had a really very, very good quarter on price. It is the lowest in some time in terms of the least amount of price erosion. So from an impact on our product gross margin rate, Paul, which is I know the metric you're looking at, it was only 40 basis points. +Now I will say that's great. And I think we've done a lot of great things on our pricing. For example, we've been selectively -- where we have price elasticity, we'll raise prices and we've been effective on driving some product transitions and we've been realizing that benefit. I will say, we are starting to see -- we didn't feel the impact of it this quarter, but we are starting to see pricing pressure in the server market that we expect to accelerate next quarter, but that's, of course, included in the guide. But for Q1, it was a very, very strong pricing quarter, which has been fantastic. +From an OpEx perspective, if you play down the ranges I just gave you, it does show that OpEx will be down on how you're thinking about it. And yes, we are managing it like we always do, which is balancing the investments we're making, plus driving trade-off and cost out. So you're looking at it correctly, and that's what we're driving it to. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + Kelly, the real question, can operating margin go up with revenue being slightly down? Can you drive higher operating margin? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + So let me break down the margins overall because I think that is the key question. I would say our margins are -- there's positives certainly driving the margin increase that you're seeing, and you're seeing that in the guide. On the positive side, we are definitely feeling the positive impact of the software mix on our margins. So that is driving benefit to us, just purely on the increased software content that we have and what we're selling. So that's helping tremendously. +I do think we're going to see some more pricing erosion as we go forward for some of the things that are specific, like, of course, the server market's going to get tougher now that the DRAM prices are going down. So that will be a little bit of a negative next quarter, but that's okay. And then, of course, we are still benefiting from the DRAM price decrease related to the server market that we started to feel the benefit of a couple of quarters ago. It's a very large impact this quarter, favorable to us. That will -- I expect to continue next quarter. But after that, as you recall, we started seeing the benefit in Q3 of '19. So that will become less of a year-over-year favorability for us. And then we'll see what happens to pricing there. +So net-net to your question, I don't think it will stay at this OM rate that we delivered in Q1, which is the highest it's been, because of those key things, but the underlying trends are all going in the right direction with software that's benefiting it and driving the favorable mix and then the real strong product management we're doing around managing price elasticity. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + James Faucette from Morgan Stanley Investment Research. + +-------------------------------------------------------------------------------- +James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [15] +-------------------------------------------------------------------------------- + + I'm wondering, Chuck or Kelly, or maybe both of you, if you can talk a little bit about the order growth versus your current expectations for economic development. Clearly, Chuck, as you pointed out, and Kelly, the -- we saw weakness kind of across the board in orders. But if we think about kind of a relatively flat environment from here going forward, as you said you're forecasting on, how long does it take us to start to get to more of a flattish and then even recovering order book in that kind of scenario and environment? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + Kelly, I'll let you handle that. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Thanks, boss. James, that's a tough question, right? I mean, I'd say, certainly, these headwinds we have right now are going to be with us, I think, in the short term, right? And again, whether it's just -- I don't see any catalyst to change the momentum right now with the uncertainty and business confidence in the macro, like talk -- like Chuck talked about. I do think, from a portfolio perspective, obviously, we feel good about the portfolio. And you're seeing still, regardless of the macro, the improvement we're making on the software metrics. That continues regardless. +Going forward, we do have easier compares as the second half comes around, not that that's a big victory, but that is the reality. And I think we're just going to keep executing through whatever the macro is. I don't know what you want to add, Chuck? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + Yes, James, I would say that if you just go around the world right now and you look at what's happening in Hong Kong, and you look at the China-U.S. trade situation, you look at what's going on in D.C., you've got Brexit, you've got uncertainty in Latin America, I mean, I think it's -- and any of those that are big issues, if they get resolved, then you could see some of the uncertainty removed, and I think that's what -- business confidence just suffers when there's lack of clarity. And there's been lack of clarity for so long that I think it finally just came into play. +So I think you're probably able to guess that as well as we are based on some of these bigger issues sort of coming to some level of conclusion. And then obviously, we have the elections coming in next year that we'll have to see how they work. +But I will reiterate what Kelly said, despite the order growth rate, this software transition that we've been embarking on is going exactly as we planned. It continued this quarter. We had solid results in our software portfolio again this quarter. And we put up some numbers at our analyst conference that we said we would hit by the end of 2020. We're on track to get there. So we feel good about that, and we're going to keep on executing. I think the teams have done a phenomenal job of getting our portfolio in the position that it's at. And that's why I said I have full confidence that our customers are committed to these technologies. Just because they pause and we see a slowdown in 1 quarter, I think for the long term, we're in good shape, and I feel good about where we are. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [20] +-------------------------------------------------------------------------------- + + I wanted to ask about the commercial order rate deterioration. I think last quarter, you guys hadn't really seen much deterioration at that at the end of the quarter. And then I'm assuming through this quarter, it's been getting worse. But wondering if you could just comment on what you're seeing there in that particular market? +And regionally, are you seeing -- is it mainly in the U.S. where you see that weakness? Do you see the weakness all over the place? Just any further color you could give there would be helpful. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Yes. Rod, that was one of the big -- it's a good question. That was one of the big signals to us that this thing is -- that there's definitely something going on because the commercial business is usually fairly resilient. And it was broad-based across the globe in each of the regions. I think all 3 were negative, right, Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Yes. So it was broad-based. But I think that will also be one of the first to bounce back when we start seeing that come back. That's a good sign. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Tejas Venkatesh from UBS. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Associate Director and Analyst [25] +-------------------------------------------------------------------------------- + + I wonder if you could provide more color on what you're seeing in the U.S. Service Provider business? And also more broadly, how you're thinking about the Service Provider vertical going forward? Obviously, it's been weak for a while, but assuming that environment stays that way, are there product refreshes and so forthcoming down the pipe that can better the year-over-year trends? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Yes, Tejas, it's a good question. So in the U.S., I think it's pretty clear, if you just follow what's going on with the major players here, is -- and we talked about this on the last call, that they're currently focused on building out their trials and then their broader consumer-based 5G services. And that's an area that they'll -- frankly, they'll run most of that traffic across their existing networks. +We've said that when they begin to build out the broad-based enterprise service delivery 5G networks, that that's where we would really come into play on helping reengineer backbones for higher throughput and more traffic. And I would suspect that we'll see them start to do some of that maybe in the second half of 2020. We'll have to see how fast they get moving. And we have some announcements coming over the next couple of months that I think line up with what they're trying to accomplish. And so we'll see how it moves. But we -- that's the transition that we would be looking for that could help get this business to a little better position. It was -- and on a global basis, I'll tell you it was weak. It was -- it got much weaker in Europe. It was about the same in the U.S., I think. And we had some pockets of strength in Asia, outside of China. We had some strength in -- particularly in Japan. So as we've always said about this business, it's so big deal driven. But right now, I think that's the story of what we see. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Tal Liani with Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [28] +-------------------------------------------------------------------------------- + + So if I take a 5-quarter view, 6-quarter view on your results, not just this quarter or the guidance, I see constant deterioration in the growth rate. Organically, from about 4.5%, now we're getting to minus 5%, or I have to look exactly at the guidance where we are. And the question I have is not about the environment, but rather, about the portfolio. +If you ignore the environment as much as we can, what can you do with the portfolio in order to change the trend line and reaccelerate the growth? Maybe even start with, can you identify what are the weak areas versus what are the strong areas? And then what's in your power to change versus something that may take longer? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + Yes, Tal, it's a good question. That's actually what we spend every day doing. I will tell you that we saw strength -- continued strength in the campus refresh in the portfolio that we brought forward there, which, obviously, if you think about what we've been doing over the last couple of years, and I made a comment in my opening remarks about this, is we have now transitioned our entire enterprise networking portfolio to a mandatory subscription model. And those products and that -- those areas -- those new products are still -- they're growing very strongly right now as customers continue to deploy. +So one of the big things we want to do is continue to transition towards this software model. We had 30 years of a net 30 CapEx model. So it's -- we're in the midst of that transition. We're making progress on the time line that we expected. That's the biggest strategic thing I think we can do. +From a portfolio perspective, I think you have -- if you go across the portfolio, we made a lot of new announcements last week. We've got new announcements coming up. And I think that, clearly, we have a lot of customers that are still buying a lot of stuff. So while there's a slowdown, I think there's still meaningful value that our customers are seeing with our technology, and we'll continue to do everything we can to try to find those areas that resonate the most right now. I think you see it with security, given the importance of that technology to them. And we're working on some other things that we haven't announced yet. So we're going to continue to do all the things that you described. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Jim Suva from Citigroup Global Markets. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - Director [31] +-------------------------------------------------------------------------------- + + Obviously, you laid out a lot of the details about the challenges. When we look back historically over Cisco, their history, the last time we kind of saw such negative trends were kind of July 2017. It was kind of about a 4-quarter pause before recovery. Is there anything different about it this time? And some people will say, well, white box is starting to hurt you a lot. Is it white box? Is it generally macro? Or why wouldn't it be like 4 quarters, like what we saw last year in 2017? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Yes. I -- first of all, I think that given the broad-based and the rapid change that we saw, I don't believe it's anything like white box or anything like that. It's broad across the portfolio. It's broad across geographies. And we're -- as Kelly said, obviously, in the second half, we don't like to talk about comps, but the math is different in the second half of the year. But we also have all the things that I just talked about with Tal. We also have this Wi-Fi 6 transition. At some point, we will have some spending going on around the 5G backbone transitions. We got 400-gig coming next year. So there are a lot of things. And I also believe that our customers, they will pause for a while, but technology is so absolutely core to their fundamental strategies that it just seems to me that the time that they're going to be able to pause is going to be shorter than what you would have seen in the past. I mean they worry about their competitors' investments. They worry about falling behind. So I think they'll hit the pause button because of all the uncertainty. I think we have to just see how long it lasts in today's world given the strategic value of all the technology. And frankly, everything that we're building is incredibly important to them as they deal with this new cloud world and rearchitecting their traffic flows and their security architecture, and there's only so long they're going to be able to pause on doing that. But we'll see how it turns out. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Aaron Rakers from Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [34] +-------------------------------------------------------------------------------- + + I want to go back to kind of the comments earlier made around kind of the software expansion and kind of progressing to what you had laid out at past analyst days. If I recall, it seemed to kind of map out that you would have about 20% of your total kind of revenue being -- product revenue being contributed from software. As we think about the product portfolio and the push to subscription, is that the right trajectory to think about? And as we look even beyond that, could you see an even higher mix of kind of just recurring nature of your business. I'm just trying to understand what more is left to kind of build out the product portfolio around this kind of subscription motion for the company? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Yes, I'll take that one. I'd say what we laid out is, we said, by the end of '20, we should have 30% of our revenue be software, and software and services be 50%. So that's the metric that we are pacing towards. And your 20% number, we are already past. So we are driving to be at that 30% by the end of this year. +So like Chuck mentioned, we are pacing well with that. This transition that we're driving has greatly increased the amount of software we are selling with our system. So that is all going well. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Yes, I think if you just think what Kelly said, by the end of 2020, our target was to be at 30% of our revenue coming from software. And if you also correlate the metric we shared today, which is in Q1, 71% of our software was coming from subscription and SaaS, which 4 years ago, that number was probably 1/3 or less. So that's the nature of the success of the transition that we've been driving so far. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + Yes, it's a good point. Actually, the target for the end of '20 for that was to be 66%. So we've passed that metric already. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Yes, that too. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + James Fish from Piper Jaffray. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [41] +-------------------------------------------------------------------------------- + + I was just hoping to get more color on sort of the campus switching cycle with the Cat 9K and just kind of where you think we are, especially with large enterprises as that really drives, it seems like, more of the growth of the business anyways. And just trying to understand that. +And then just to make sure that we're thinking about it correct, when you're talking subscription within this business line, you're talking more of a term license than kind of recurring monthly, correct? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [42] +-------------------------------------------------------------------------------- + + Yes, on that one, subscription, meaning, yes, so if I sell a Catalyst 9K switch now, it's sold with a subscription that gets renewed 3 or 5 years, depending on the term from now. So that's what we're talking about. So of all the software we're selling, is it based on a term-based value that gets renewed. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [43] +-------------------------------------------------------------------------------- + + Yes. And Jim, just to give you a little sense of where we are, I mean, we're still -- we're seeing very strong growth year-over-year in those platforms. The transition's happening from the old to the new, just like we would have expected. And we were actually talking about yesterday how we would answer the question relative to where we are in this. Because I think I said last time, we were in the second inning, and we joked that maybe we're in the bottom of the second inning now. But we're still very early in this transition and it's going very well. And we now have the entire enterprise networking portfolio in refresh mode with Wi-Fi 6 access points with the new Catalyst 9000. And then one of the things we announced last week was the ability to manage the Cat 9K, one of the products in the Cat 9K, onto the Meraki platform, so customers could take advantage of it. And we'll continue to extend that across the other portfolio of products. So it's going very well, and it's still early. +So let me just wrap up and say that, obviously, it's a complicated world right now, and we certainly felt the continuing impact that we talked about at the end of our last quarter. That being said, I have great confidence in where we are with the portfolio. We shared some metrics today on the software transition that I think is going incredibly well. And notwithstanding the short-term challenges, we feel really good about the future. +And so thank you all for being with us today. And I'll kick it back to you, Marilyn. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [44] +-------------------------------------------------------------------------------- + + Thanks, Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2020 second quarter results, will be on Wednesday, February 12, 2020, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. +Again, I'd like to remind the audience that in light of regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, please feel free to contact the Cisco Investor Relations department, and we thank you very much for joining the call today. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (800) 835-4610. For participants dialing from outside the U.S., please dial (203) 369-3352. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2020-Aug-12-CSCO.txt b/Transcripts/CSCO/2020-Aug-12-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..d05c339d59f0cb11b9fb9b0e4ad807972e1948e7 --- /dev/null +++ b/Transcripts/CSCO/2020-Aug-12-CSCO.txt @@ -0,0 +1,543 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2020 Cisco Systems Inc Earnings Call +AUGUST 12, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * James Edward Fish + Piper Sandler & Co., Research Division - VP & Senior Research Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Meta A. Marshall + Morgan Stanley, Research Division - VP + * Roderick B. Hall + Goldman Sachs Group, Inc., Research Division - MD + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Jeffrey Thomas Kvaal + Wolfe Research, LLC - Research Analyst + * James Dickey Suva + Citigroup Inc., Research Division - MD & Research Analyst + * George Charles Notter + Jefferies LLC, Research Division - MD & Equity Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Cisco's Fourth Quarter and Fiscal Year 2020 Financial Results Conference Call. At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- + + Thanks, Sue. Welcome, everyone, to Cisco's Fourth Quarter Fiscal '20 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2021. They are subject to the risks and uncertainties, including COVID-19, that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +In Q2 fiscal 2019, we completed the sale of our SPVSS business. As such, all of the financial information we will be discussing is normalized to exclude the SPVSS business from our historical results. +I will now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Marilyn. We hope all of you and your families are staying safe and healthy. Our thoughts remain with everyone who has been affected by the pandemic, and we are grateful to those who remain on the front lines, working to help those impacted during these challenging times. +As we've been preparing for this call, it's offered me some time to reflect on what we've achieved since I stepped into this role 5 years ago. Through the hard work of everyone at Cisco, we have undergone a significant transformation in the midst of some of the most complex times in our history. I am so proud of what our teams have accomplished. They have demonstrated resiliency, determination and compassion as we delivered on our financial commitments, brought market-leading innovation to our customers, transitioned our business model and driven a culture that has truly shined over the past 6 months. +The Cisco of today is more agile, innovative and focused. Through both organic and inorganic innovation, we delivered incredible new technology with new, more flexible consumption offers for our customers with more software and subscriptions. At our financial analyst conference in 2017, we laid out key metrics for our transformation. We set a goal of 30% of our revenue to come from software. And while we achieved 29% in fiscal year '20, we did achieve 31% in Q4. +We also delivered 51% of our revenue from software and services in FY '20, exceeding our target of 50%. Lastly, we now have 78% of our software revenue sold as subscription, beating our target of 66%. With our customers as our guide, we have successfully executed against our strategy to help them transform and modernize their organizations. We launched our intent-based networking architecture using automation and machine learning to help our customers drive simplicity and cost-effective management of their networks. As customers move more workloads to the cloud, we're offering fast, highly secure access to applications hosted anywhere, in the private data center, public cloud or a SaaS platform, with our cloud security integrated with our SD-WAN solution. +We introduced new capabilities across software, silicon and optics to help bring to life the Internet for the future. The innovation we've driven in our Security portfolio has helped us become the top enterprise security company in the world. With Webex, we have the most trusted secure platform for remote collaboration for the enterprise. And we're also delivering real-time insights for customers in their multi-cloud environments to optimize user experience with our insights and observability assets like AppDynamics. +Over the past few years, this transition has resulted in improvements in our financial performance, including expanding margins and demonstrating continued financial discipline. Once again, I want to thank our teams for what we've achieved. +If the past year has taught us anything, it's the need to always be nimble. I believe that the changes we've made to our business now put us in a position of strength as we focus on our future. We're a company that embraces change, and we've shown our ability to thrive in any environment. +The past 6 months have unquestionably reshaped our world. Industries, governments and work have changed dramatically, and many of these changes will become permanent. At Cisco, we are committed to helping our customers truly digitize their organizations for the future regardless of the challenges or fundamental shifts that we may face. +Like many other organizations, we've also had the opportunity to reexamine our business and our portfolio for this new world. As I said last quarter, we were going to take time to better understand the short- and long-term implications of COVID-19, and we now believe we have a better view. Based on the many conversations we've had with our customers around the world, we believe we have perspective into how they will adapt their technology strategies for the future to ensure greater resiliency, agility and innovation. We know how to adapt our business and strategy to align with where our customers are headed. The changes we are making to our business reflect how we are leveraging our existing strengths, investing for growth and unlocking new opportunities. +We will also be very disciplined on our cost structure, as we always have been. Over the next few quarters, we will be taking out over $1 billion on an annualized basis to reduce our cost structure. At the same time, we're going to rebalance our R&D investments to focus on key areas that will position us well for the future. More specifically, we will accelerate the transition of the majority of our portfolio to be delivered as a service. +We will also accelerate our investments in the following areas: cloud security, cloud collaboration; key enhancements for education, health care and other industries; increased automation in the enterprise; the future of work; and application insights and analytics. +At the same time, we will continue our focus in the following areas, many of which have been accelerated by the pandemic: multi-cloud investment, 5G and WiFi 6, 400 gig, optical networking, next-generation silicon, AI and more. +These investments will help define the next phase of our transformation and allow us to bring the best, most relevant innovation to our customers in simpler, more easily consumable ways. I am confident that, once again, we have the right strategy that will deliver what our customers need from us, and we will emerge from this challenging time as a stronger company than before. +Now let me discuss our performance in the quarter. While our results reflect the ongoing challenges in the current environment, we executed well. As you would expect, the pandemic has had the most impact on our enterprise and commercial orders driven by an overall slowdown in spending. We are seeing customers continue to delay their purchasing decisions in certain areas while increasing spend in others until they have greater visibility and clarity on the timing and shape of the global economic recovery. +Despite this challenging economic environment, the pandemic has also triggered a massive and rapid shift to remote operations and automation to maximize personal safety. With this, many customers are increasingly reliant on our broad portfolio of technologies, resulting in another quarter of strong demand for our Catalyst 9000, Security, Webex and other SaaS-based solutions. +Throughout fiscal year 2020, we demonstrated operational resilience based on our strong customer relationships, a solid financial foundation, differentiated innovation and a compelling strategic transformation built on the strength of our key technology platforms. +Now I'll cover a few highlights from the quarter. In June, we introduced an expanded business resiliency portfolio, offering health care and education solutions with simpler consumption models and services to accelerate adoption. We will continue to expand this portfolio to cover areas such as social distancing in the workplace, effective virtual employee engagement at scale and pop-up connected clinics. +Within our Infrastructure Platforms business, we continue to see a strong ramp of our Catalyst 9K portfolio as many customers take advantage of their employees working from home to refresh their aging infrastructure, enabling them to simplify, secure and automate the management of their networks. +Our acquisition of ThousandEyes will complement these capabilities by adding deeper and broader visibility and analytics across networks and applications, enabling us to deliver the best possible experiences for our customers. +By integrating their SaaS-based offering with our AppDynamics application intelligence portfolio and SD-WAN technology, we can provide unparalleled intelligence and insights at cloud scale, driving improved customer experience as well as reliability of their applications. +Security continues to be a top priority for our customers, particularly in this distributed digital world. Our ability to connect and protect our customers working from anywhere on any device is accelerating the adoption of our comprehensive Security portfolio, resulting in double-digit revenue growth this quarter. As more data goes to the cloud and users become more distributed, we had good momentum in our cloud security solutions, protecting workloads, applications and data. +We also continue to expand our capabilities to enable simplification and automation of our customer security infrastructure. A good example of this is our SecureX platform, which is designed to unify visibility, enable automation and deliver a consistent experience. Since our launch 6 weeks ago, we have over 2,100 active daily customers, 2/3 of which have 2 or more products active. +We're also delivering secure remote worker solutions that span our endpoint security portfolio combined with the power of our Zero Trust architecture with Duo, AnyConnect, Umbrella and AMP for Endpoints. +Applications have become a lifeline for so many organizations, and this has only increased over the past few months. As organizations define what their future looks like, our collaboration technology will play a key role in evolving how they work, transact and connect. Webex had strong performance this quarter with double-digit growth as businesses, governments, educators and frontline workers everywhere have embraced remote work. We expect this momentum to continue as we have begun to see the conversion of free trials into paid subscriptions. +AppDynamics also achieved another solid quarter. These monitoring tools offer our customers great value by providing real-time insights from a single pane of glass to optimize user experience in their multi-cloud environments. +As we think about all that we've achieved over the past 5 years, I want to take a moment to acknowledge Kelly Kramer, our Chief Financial Officer, who has been an incredible partner to me. She has played a key role in reshaping Cisco into the company we are today. I want to let you all know that Kelly has made the decision to retire from Cisco. Over her 8-plus years here, Kelly has led the effort to improve our financial performance, focused on investor confidence and help position Cisco for success. Kelly and I have been focused on simple, clear communication, absolute transparency, delivering on our commitments and always aligning Cisco for future growth. Kelly has graciously agreed to stay on as CFO until we have her successor on board and will advise us with the succession process. I can assure you that with Kelly staying on during the search and with our world-class finance team, we will have a seamless transition. Kelly, thank you so much for your partnership and your friendship. You will truly be missed. +Now before I turn it over to Kelly, I want to reiterate my confidence for what the future holds. Over the past 5 years, we have not shied away from making bold moves to position us for long-term growth, and now is no different. We are committed to running a strong business as well as leveraging technology for good to solve the world's biggest challenges and create new opportunities for the future. As we've demonstrated, we have helped our customers build resiliency in difficult environments through industry disruptions and in times of rapid growth. +We will also continue to use our position to make our communities and world a better place. Whether it's tackling the global health pandemic or social injustice and intolerance, we are committed to our purpose of powering an inclusive future for all. +As we start a new fiscal year, I believe we have incredible opportunities in front of us. We will navigate the pandemic in the most effective way possible while not damaging the long-term prospects for Cisco. We remain strongly aligned to our customers' priorities and deeply committed to delivering long-term growth. +Now I'll turn it over to Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Chuck. It really has been great, and I want to thank you, the leadership team and really all of Cisco. I also want to thank my finance team who does an amazing job. I'll certainly miss Cisco, but I'm looking forward to what's next. +I'll start with a summary of our financial results for the quarter, then cover the full year, followed by guidance for Q1. Our overall Q4 results reflect good execution with strong margins in a very challenging environment. Total revenue was $12.2 billion, down 9%. Our non-GAAP operating margin rate was 33%, up 0.4 points. Non-GAAP net income was $3.4 billion, down 5% year-over-year. And non-GAAP EPS was $0.80, down 4%. +Let me provide some more detail on our Q4 revenue. Total product revenue was down 13% to $8.8 billion. Infrastructure Platforms was down 16%. This is the product area most impacted by the COVID environment. We saw declines across switching, routing, data center and wireless driven primarily by the weakness we saw in the commercial and enterprise markets. We did see pockets of strength with the continued growth of Cat 9K, which was up double digits, and the ramp of our WiFi 6 products. Data center was particularly weak with the decline of the market and DRAM price declines. +Applications was down 9%. On the positive side, we saw a strong double-digit growth in Webex with the importance of remote working. We also saw solid growth in AppDynamics and IoT software. This was offset by declines in Unified Communication and TP endpoints. +Security was up 10% with strong performance in network security, identity and access, advanced threat and unified threat management. Our cloud security portfolio performed well, with strong double-digit growth and continued momentum with our Duo and Umbrella offerings. Service revenue was flat for the quarter, but we had growth in our maintenance business as well as software and support services. This was offset by our advisory services, which was impacted by the COVID environment. +We continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 78% of total software revenue, up 8 points year-over-year. +Remaining performance obligations, or RPO, at the end of Q4 were $28.4 billion, up 12%. RPO for product was up 17%, and service was up 9%. The continued growth in RPO demonstrates the strength of our portfolio of software and services. +In terms of orders in Q4, total product orders were down 10%. +Looking at our geographies, the Americas was down 11%. EMEA was down 6%, and APJC was down 13%. Total emerging markets were down 19%, with the BRICS plus Mexico down 26%. +In our customer segments, public sector was down 1%, while enterprise was down 7%. Commercial was down 23%, and service provider was down 5%. +From a non-GAAP profitability perspective, total Q4 gross margin was 65%, down 0.5 points. Product gross margin was 63.2%, down 1.5 points. And service gross margin was 69.8%, up 1.9 points year-over-year. Our Q4 GAAP tax rate was 16.7%, which reflects the true-ups to the annual tax rate. +In terms of the bottom line, from a GAAP perspective, Q4 net income was $2.6 billion, and EPS was $0.62. We ended Q4 with total cash, cash equivalents and investments of $29.4 billion. Operating cash flow was $3.8 billion, down 4% year-over-year. +From a capital allocation perspective, we returned $1.5 billion to shareholders for our quarterly dividend. We continue to invest organically and inorganically in our innovation pipeline. Just last week, we closed our acquisition of ThousandEyes. This move is consistent with our strategy of increasing investment in innovation and R&D for our growth areas. +I'll now cover the full fiscal year results. We delivered strong margins and grew EPS in a very challenging environment. Revenue was $49.3 billion, down 5%. Total non-GAAP gross margin was 66%, up 1.4 points. And our non-GAAP operating margin rate was 33.8%, up 1.5 points. From a bottom line perspective, non-GAAP net income was $13.7 billion, down 1%. And non-GAAP EPS was $3.21, up 4%. GAAP net income was $11.2 billion, and GAAP EPS was $2.64. +We delivered operating cash flow of $15.4 billion, down 3%. Normalized for the cash received in Q1 fiscal '19 related to the legal settlement with Arista, operating cash flow was flat for fiscal '20. +From a capital allocation perspective, we returned $8.6 billion to shareholders over the fiscal year, which represents 59% of our free cash flow. That was comprised of $2.6 billion of share repurchases and $6 billion for our quarterly dividend. +To summarize, we executed well in Q4 and the fiscal year with strong margins in a very challenging environment. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the first quarter of fiscal '21. This guidance is subject to the disclaimer regarding forward-looking information that Marilyn referred to earlier. We expect revenue to decline in the range of minus 9% to minus 11% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64% to 65%. The non-GAAP operating margin rate is expected to be in the range of 30% to 31%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.69 to $0.71. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- + + Thanks, Kelly. Sue, we'll now open up the queue for questions. (Operator Instructions) +Sue, I'll turn it over to you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + The first question is from Sami Badri with Credit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + My first question is for the team here. And just wanted to know that now that you've achieved the 50% of revenue coming from software and services, and that was the guidepost given at the 2017 Analyst Day, do you guys have a new target in mind and new range? I know you guys introduced some new products and new services and some new investment areas. I'm just hoping to understand it seems you get maybe a new road map or a new target that we should hold you guys or measure you against. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Yes. Sami, thanks for the question. And it's been a pretty successful 3 years as we've been making this transition, and we obviously still have ways to go, to your question, relative to a new target. We were talking about this in the last week or so. And we feel like we just need to get through this pandemic cycle that we have, and then we'll set some new targets, and we'll communicate them to you at that time. So we don't have one yet. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + The next question is from Meta Marshall with Morgan Stanley Investment Research. + +-------------------------------------------------------------------------------- +Meta A. Marshall, Morgan Stanley, Research Division - VP [5] +-------------------------------------------------------------------------------- + + Great. Chuck, you referred to kind of changes you're going to make to the portfolio based on conversations you were having with customers. Do you -- where do you feel like they are in terms of knowing what their kind of network architectures are looking like when they come back or just how their budgets are looking for the remainder of the year? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [6] +-------------------------------------------------------------------------------- + + Yes. Thanks, Meta. I think that when we think about the network architectures, I think one thing we know is that the -- our customers are living in this multi-cloud environment. And as they went into this work-from-home environment, as I said on our last call, those who had technical debt and those who had not really invested in modernizing their infrastructure, they know they will need to do that, and they'll do it at different paces based on their financial abilities. +I'd say that it's clear that many of our customers do want to consume the technology as a service. So we're currently looking at the entire portfolio to see what -- how deeply we can get into the portfolio relative to delivering as a service. And I think we'll have a lot of that in the marketplace by the end of the calendar year. +We will also be working with our customers on their network architectures, which are certainly going to be prevalent on -- or dependent upon cloud security, on SD-WAN and the integration of those. So we're going to accelerate that as well as helping them navigate this multi-cloud world because I do think that we have seen some customers accelerate that shift as well. So the network architectures that we built 15 years ago, as I've talked about, just aren't relevant today because the traffic flows are completely different. And so we'll continue to work with customers, and I think it will be at a different pace just based on how they all come out and how they manage the pandemic. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + The next question is from Ittai Kidron with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + Chuck, when you talk about the portfolio and the changes you need to make over there and the acceleration of R&D in some areas, can you talk about more specifically what areas you feel you need the most adjustment in? And also, it feels like the pace of technology evolution, it clearly is -- just keeps accelerating. There's so much of it you can do internally. And you've been very acquisitive in the past, but I can't help but feel like you need to move much faster and much more aggressive on M&A. And I know you've been very disciplined from a price standpoint. And clearly, a market like we have today is not necessarily conducive to that. But just given the fact that we're moving much, much faster, are you more open to get a bit more aggressive here on the M&A front to fill in gaps? Because it sounds like -- it feels like the longer you wait on this, the gaps will keep getting bigger, not smaller. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + Yes. Ittai, it's a great question. And your first question around the areas that we feel like we need to invest, I think this pandemic is basically just -- it's just giving us the air cover to accelerate the transition of R&D expense into cloud security, cloud collab away from the on-prem aspects of the portfolio. Clearly, we've got a lot of technology that we're working on today to help our customers over the next 3, 4, 5 years in this multi-cloud world that they're going to live in. And you'll see more of that come out over the next couple of years. +But on the M&A question, I think that there's clearly a recognition that the valuations of the assets that are attractive have achieved different levels. And so I think that we'll continue to be disciplined, but I would say that we're open to looking at the current world and the reality that we live in. So I think we're open to any and all ideas, and we continue to work through different options, and we have a list of potential targets that we maintain on a pretty regular basis. And so I think the real difference is -- there has to be a recognition that the valuations have changed, but we'll try to be disciplined and do the right thing at the right time. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question is from Jim Suva with Citigroup Investment Research. + +-------------------------------------------------------------------------------- +James Dickey Suva, Citigroup Inc., Research Division - MD & Research Analyst [11] +-------------------------------------------------------------------------------- + + Kelly, you'll be significantly missed, so thank you for the duration. But looking forward, if my model is right, and maybe it's wrong, it seems like year-over-year revenue comparisons get materially easily -- easier, maybe to the tune of 400 basis points year-over-year for the quarter outlook. And like with Huawei being pushed out and Cisco being preferred in many countries, even beyond the United States as well as an incumbency factor coming out of coronavirus, help me bridge your kind of year-over-year revenue growth. And maybe it's still yet to come about why things aren't more positive because the comps are easier. Huawei is less preferred than Cisco. Cisco has an incumbency factor, and we're coming out of coronavirus. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Well, I'll comment subjectively, and then I'll let Kelly talk a little bit about the numbers. I wouldn't say that we're coming out of the coronavirus right now. I think that it feels to me very much like it felt 90 days ago. And clearly, the -- in the U.S., we have not seen -- we've seen some areas that have gotten better and, obviously, some that have not. But I'd say in general, it feels pretty much the same as it did 90 days ago to us relative to that. +I think that some of the things you're talking about around service providers around the world and the possibility where we would be getting opportunities that we wouldn't have had before, I think some of those are still to be seen. But we would share that optimism, and we'll have to wait and see how that plays out. +Kelly, do you want to talk about the... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes. And then from our compares, I mean, Q1 of '20, so my guide for this next quarter, in Q1 of '21, that's our toughest compare to the -- obviously, we had -- Q3 and Q4 were very, very tough for us in '20 because of COVID. So comparing to Q1 of '20 right now, we still have some tougher compares. But they do get easier as the year goes on, assuming that the pandemic ends. But as you know, Jim, we forecast based on what we see, based on the order rates, and we feel this is a pretty accurate guide. + +-------------------------------------------------------------------------------- +James Dickey Suva, Citigroup Inc., Research Division - MD & Research Analyst [14] +-------------------------------------------------------------------------------- + + Kelly, thank you so much for your service. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Thanks, Jim. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + The next question is from Paul Silverstein with Cowen. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + Maybe sort of a question, 2 clarifications. Chuck, your response to Jim's question, when you talk about feeling pretty much the same as 90 days ago in the U.S., you're referring to both enterprise and commercial, your small, medium customers as well as your large customers across the board? And then with respect to the $1 billion that you referenced in terms of coming out of costs, will that all be out of OpEx? And I appreciate there's probably some sensitivity if it involves headcount reduction, as I suspect it does. But Kelly, I'm hoping you could give us a sense for the timing in that reduction and the nature of the reductions. Is that all in OpEx? Or is some of it out of cost of goods sold? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + Yes. Paul, let me just tell you a little bit. I'll give you a little sort of customer segment and around-the-world view of what it's felt like in the last 90 days or so. So maybe that will help add a little color. In the U.S., in particular, I'd say the -- we saw some strength in the very high end of enterprise. And then sort of as you go down in the marketplace, we just -- the weakness got a little bit worse as you just sort went straight down, as you would expect with small business, medium business and even smaller-size enterprises that were -- didn't perform as well as the very largest of enterprises. But we did see strength in the very large enterprise in the U.S. +We also saw some strength in federal in the U.S. clearly. And that was actually really promising because they had a very strong quarter a year ago. So they executed really well. +Service provider around the world. If you look at Asia and Europe, our service provider business was positive in both of those regions. And it was just slightly negative in the U.S. It was primarily Canada and Mexico in the Americas that drove the negative here. So overall, that was a bright spot, particularly outside the United States. +We did see countries -- a few countries that actually began to show some positives. And I'm trying to think through like can we build a model that says Asia went in first, and so they're going to come out first. And we did see Japan had a good quarter for us on the demand side. Korea had a good quarter for us on the demand side, and we're seeing some positives. Germany had a good quarter for us. And I'd say if we think about how our European team feels right now, they actually feel reasonably okay. Not great, great, but better than they did 90 days ago. The Americas is still sort of the wildcard, I'd say, that we see right now. +So hopefully, that gives you a little more color around what we're seeing up and down the stack. And then, Kelly, do you want to... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes. Sure. Where you'll see the cost coming out, I'd say, the majority is in OpEx. I'd say maybe an 80-20 split. We'll certainly have some in COGS, too, on that side, on the services side, but mostly in OpEx. And in terms of timing, we should see a lot of this -- most of this, the bulk of this coming out at the end of Q1 and a little bleeding over into Q2, depending on the country it's in. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [20] +-------------------------------------------------------------------------------- + + Kelly, you'll be missed. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + Thank you, Paul. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + The next question is from Rod Hall with Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group, Inc., Research Division - MD [23] +-------------------------------------------------------------------------------- + + I guess I wanted to go back to the linearity of this order trajectory, Chuck and Kelly, on particularly enterprise. I guess if we go back to 2009, we're starting to see commercial order volumes deteriorating into the range we saw back then in that recession. We haven't really seen enterprise do that. And I wonder whether you think that, that is where we're kind of headed here. It just feels like this is not turning out to be a V-shape recovery. It's more like a -- we're headed into a real recession, prolonged recession. So I'm just curious kind of what you think about the trajectory of those volumes, what they look like at the end of the quarter versus the beginning of the quarter. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Well, I would say that -- I'll make a couple of comments, and I'll kick it to Kelly to give you a little bit more color. I think that as Kelly and I looked at where we expected demand to be from the beginning of the quarter to the end of the quarter, we were pretty much in line. In fact, it was a slight, slight, slight bit better than we had anticipated at the beginning of the quarter. But I would not get too excited about it being slightly better, as you can tell from the guide. +But -- and then I think linearity was generally in line, but it was probably a little more back-end loaded than we've seen. And we had a lot of big enterprise activity towards the end of the quarter. So Kelly, anything to add? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Yes. The only thing I'll add, and Chuck kind of touched on this -- I mean, again, it is the biggest, biggest premier enterprise accounts, they are still investing significantly and we -- they had very good order rates. But it does -- as you go down the tiers in enterprise, it did slow down and just -- and commercial is not surprising. You saw what the commercial numbers are. +So I do think it is related to their waiting to see what comes out of the pandemic, and they're pausing their spends. But I think this is why seeing the big, big accounts still investing in their digital transformation, I think, gives us confidence that once we do get through this, we feel good about how we'll come out of it. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group, Inc., Research Division - MD [26] +-------------------------------------------------------------------------------- + + Okay. Can I have a follow-up? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [28] +-------------------------------------------------------------------------------- + + Go ahead. Go ahead, Rod. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group, Inc., Research Division - MD [29] +-------------------------------------------------------------------------------- + + Yes. I just wondered if you guys could talk a little bit about the -- kind of what sort of color you're hearing from the enterprise customers. Do you think that they've -- because they're investing so aggressively in work from home, are they pulling demand forward out of the back end of the year? Like are their budgets changing? Are they just kind of robbing from the back end-of-the-year budgets and moving it toward the front end of the year to compensate for work from home and all that stuff that's going on? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + I don't think that -- I haven't heard anything about anybody pulling anything forward. I think that the larger the companies are, the more confident they have in their ability to come out at some point. And they're going to continue to invest to position themselves when they come out. +And clearly, there are some large enterprises that are not investing, given -- depending on which industries they're in. But I don't -- I think it was just -- I think it's just normal investment cycles that certain large companies have just decided they're going to continue to pursue. +And I do think Kelly made a good point. As we've given like the number of software license agreements that we did, I mean, it says that the portfolio that we have and the strategy we have, I think, whether it's helping them with application visibility as they move more to the cloud, it's going to be more -- it's going to resonate even more. When you think about the security strategy we have, going to the cloud, it's going to be more required in the future. We look at this infrastructure transformation, as they deal with this multi-cloud world and these new traffic flows, I think that's going to be super relevant. And then obviously, the employee and customer experience that they have, which are all areas that we're investing in, I think when we come out of this, those will be even more in demand than they were when we went into it. We just got to get to the other side of it, and then I feel pretty good. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Next question is from Simon Leopold with Raymond James. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [32] +-------------------------------------------------------------------------------- + + Great. Kelly, we will miss you. So -- and you're too young to retire. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + Thanks, Simon. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + I wanted to follow up, Chuck, on the Cat 9K because you did mention the strength there. And I guess I'm trying to discern sort of the macro versus the product cycle issues. And my understanding is that the portfolio has been releasing platforms that are more suited for smaller enterprises just at the time when those are the weakest customers. So if you could help us maybe understand the overall contributions of this product and where you are in the product cycle and maybe even explain what's macro-related versus normal cycle-related. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + Yes. Simon, I'll let Kelly talk about the numbers in a minute, but I'm going to share with you my instinct on this because I thought about the same thing. Because the one thing that we know is that the campus business that we have, their -- people aren't in their campus offices. So the whole notion of refresh and upgrades clearly are not top of mind for every customer the way they might have been 9 months ago. +However, what I think is that the 9K is for those customers who are either in the process of a real commitment to modernizing their infrastructure and they're continuing to do that or they've made a decision and they have the financial wherewithal right now to actually embark on that, and the 9K is what they are using to do that in their campus environments. And some of them are using this opportunity, with no one in their campus environments, to upgrade. Clearly, that's not every customer. But I think what it says is those customers who are still on our older platforms, which we didn't see the growth on, it's sort of the story we talked about. They haven't committed to refresh. They haven't committed to that modernization piece, and so they're not -- that part is not accelerating, but the 9K has continued to accelerate. So it's been a positive story for us. +Kelly, do you want to answer the... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [36] +-------------------------------------------------------------------------------- + + No. I think you said it well. And I think, Simon, your point is well. I mean so the products you referenced, the Cat 9200, which was launched for the lower end -- the mid- to lower end, is in that commercial segment, to your point. But when I look at it individually, that product is still -- revenue is growing like amazing double digits. And so that just shows that we're still very early in the transition. What -- when the customers are buying, they are buying the new portfolio hand over fist. And it's just the COVID impact of the overall -- and again, the legacy products falling off is really what's driving, but that's why we have faith and feel good about the portfolio when we come out of the environment. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + Yes. Simon, I think 2 just comments on top of that. Number one is we're still very early in this whole process. And then the 9200, I think it's important to note, it is a small business product, but it's also an access layer product in enterprises. It goes into branches. It goes into, in some cases, wiring closets, et cetera. So we will still see some continued demand for that. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + The next question is from James Fish with Piper Sandler. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Sandler & Co., Research Division - VP & Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Congrats on the retirement there, Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [40] +-------------------------------------------------------------------------------- + + Thanks, James. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Sandler & Co., Research Division - VP & Senior Research Analyst [41] +-------------------------------------------------------------------------------- + + For me, I kind of want to bridge a few of the questions that have been asked together. But Chuck, you talked about accelerating the transition towards SaaS. Can you guys give us an update as to where that SaaS revenue is, not the term license contribution, and where you guys think it could accelerate given the investments? And then utilizing Ittai's question from before, do you need to acquire to help accelerate it? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Well, I'll let Kelly answer the numbers question. We gave you the total software number. We gave you the percent that's coming from subscriptions and SaaS, but I think you're asking specifically about SaaS. So -- and look, I think that we've made a lot of progress. If you do the math on where the software in our portfolio was 5 years ago and what percentage of it was coming from subscription and SaaS, we've certainly increased it significantly over the last 4 or 5 years without any major, major revenue-driving acquisitions. So that would certainly help. +And we continue -- as I said earlier, continue to look at alternatives in that space. And you should assume that we will continue to look at them, but we'll also be disciplined. So we'll -- Kelly, do you want to touch on the SaaS number or... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + Yes. I mean we don't disclose the total SaaS number. I mean, again, it's made up of our Webex business, a lot of our portfolio, Duo, Umbrella, in Security. And again, acquisition, Meraki is a hybrid, where we ship an appliance, but then it has the SaaS management. And things like ThousandEyes that we're adding to our networking portfolio and AppDynamics, I mean, that's just going to continue to accelerate. +So I think you're going to see it twofold, right? You're going to continue to see us to be -- those are the type of assets that we have been acquiring, and we'll continue to acquire. And you're seeing internally, this is also how we are developing product to try to accelerate that. But the growth in the SaaS portfolio has been really good for us. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Sandler & Co., Research Division - VP & Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + Understood. Appreciate the color. And congrats again, Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [45] +-------------------------------------------------------------------------------- + + Thanks, James. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + The next question is from Jeff Kvaal with Wolfe Research. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Wolfe Research, LLC - Research Analyst [47] +-------------------------------------------------------------------------------- + + My congratulations again, Kelly. We look forward to seeing you in a new role at some point down the road. I have a question and a clarification. I think the question, Chuck, last quarter, you spent a little bit of time talking with us about traction on the web scale side of things. I'm wondering if that traction has seen some follow-through, if you could update us on that. +And then secondly, for Kelly, when you suggest that the OpEx will come lower by $800 million, is that a gross number? Or is that a net number, i.e. you'll take it out by $800 million but bring some back in some of the growth areas in this business? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + Yes. Jeff, thanks for asking the question. I would have been in trouble if I've gotten off this call and not talk about the web scale. So we saw another positive quarter. So that's one of the areas that was really positive for us. It was a third quarter in a row where we've had double-digit growth with the web scale players. And again, as I said last quarter, it's -- we have had some traction with the 8K, some traction with our silicon, but nothing that's meaningfully moving the numbers yet. So it really is just the rest of the portfolio. But as I said, I think it speaks to the long-term effort that we've put in over the last few years of rebuilding these relationships. And I think it speaks to their belief in our strategy going forward. And we feel good about where we are. +And we believe over the next 1 to 2 years that they'll begin to be meaningful contributors. And we're excited about what we -- what the teams have done. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [49] +-------------------------------------------------------------------------------- + + And on the cost out. So it's -- again, we are taking out gross over $1 billion. So that is gross. But like anything, Jeff, there's puts and takes as we go forward. So whether it's things like the dollars, weaker FX, it's going to be a bit of a headwind this year. We reset the bonus, all that kind of stuff, that will be puts and takes. But that's -- it's a real cost out that we're taking out as we go through into our planning. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Our last question is from George Notter with Jefferies. + +-------------------------------------------------------------------------------- +George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [51] +-------------------------------------------------------------------------------- + + I guess I wanted to kind of go back to the discussion of moving more of the business to a as-a-service model. And could you just put a little bit more meat on the bone in terms of what areas are you specifically thinking about as new candidates to kind of move that direction? And how do you incentivize customers in those areas also? I'm just trying to think about the mechanics of how this works. And then congrats to Kelly also. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Literally, we're looking at everything. I mean we're trying to -- we're looking at everything from our compute portfolio to -- clearly, our software assets are already in the midst of that transition, and many of them are already being sold that way. And we're even looking at how we deliver our traditional networking hardware as a service over time. So it is literally across the portfolio. +And then we see an acceleration of some of the work that's already been underway. Obviously, the Collaboration portfolio has been transitioning to as a service for quite a while. We even launched last -- I don't know, 2, 3 quarters ago, we launched our hardware as a service and the Collaboration portfolio as a pilot. And we've been working hard on all the operational capabilities and the systems work that needs to be done to do that. So it literally is across the entire portfolio. And we'll give you an update on the next call, for sure. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [53] +-------------------------------------------------------------------------------- + + Right. I believe that was our last question. Thanks, George. I'll turn it back to you, Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + All right. I just want to recap and just thank, first of all, Kelly, for everything and the friendship and all the great work that you've done and reiterate that she's going to stay with us until we actually identify her successor. And she'll help advise us through that process. So we're excited about her sticking around and helping us do that. I want to thank the team for executing through a really challenging time. And I really want to reiterate that I think the strategy that we had going in, I believe when we come out of the pandemic, will be more relevant to our customers than it was 6, 9 months ago. So I'm optimistic about the future. And we're going to continue to execute through this. And thank you all for joining us today. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [55] +-------------------------------------------------------------------------------- + + Great. Thank you, Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2021 first quarter results will be on Thursday, November 12, 2020, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it's done through an explicit public disclosure. +We now plan to close the call, but if you have any further questions, feel free to contact the Cisco Investor Relations group. And we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (866) 429-0574. For participants dialing from outside of the U.S., please dial (203) 369-0916. This concludes today's call. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2020-Feb-12-CSCO.txt b/Transcripts/CSCO/2020-Feb-12-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..74b8b75afde229f37ea1e5cf3cf651732cf7f8e8 --- /dev/null +++ b/Transcripts/CSCO/2020-Feb-12-CSCO.txt @@ -0,0 +1,463 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Cisco Systems Inc Earnings Call +FEBRUARY 12, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * James Edward Fish + Piper Sandler & Co., Research Division - VP & Senior Research Analyst + * Samik Chatterjee + JP Morgan Chase & Co, Research Division - Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * Timothy Patrick Long + Barclays Bank PLC, Research Division - MD and Senior Technology Hardware & Networking Analyst + * Simon Matthew Leopold + Raymond James & Associates, Inc., Research Division - Research Analyst + * Meta A. Marshall + Morgan Stanley, Research Division - VP + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Jeffrey Thomas Kvaal + Nomura Securities Co. Ltd., Research Division - MD of Communications + * Thejeswi Banavathi Venkatesh + UBS Investment Bank, Research Division - Former Associate Analyst + * Jim Suva + Citigroup Inc, Research Division - MD & Research Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco's Second Quarter Fiscal Year 2020 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. +Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- +Thanks, Michelle. Welcome, everyone, to Cisco's Second Quarter Fiscal 2020 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the third quarter of fiscal 2020. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. +With that, I'll now turn it over to Chuck. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thanks, Marilyn, and good afternoon, everyone. As we told you last quarter and still see now, the feedback from our customers is that they remain strongly committed to both our products and services. However, like many in our industry, we are seeing longer decision-making cycles across our customer segments for a variety of reasons, including macro uncertainty as well as unique geographical issues. The good news is, once this uncertainty passes for our customers, we expect to see spending recover as technology continues to be at the heart of all they do. You'll see in our numbers this quarter that we continue to make progress on several key metrics, including our shift to more software and subscriptions, with 72% of our software now being sold as a subscription. While we still have a lot more work to do, I firmly believe we have a tremendous opportunity ahead of us. +The long-term secular growth trends of 5G, WiFi 6, 400 gig and the shift to the cloud remain, and we expect to benefit from them. This is a multiyear transformation, and we are managing our business well while staying focused on helping our customers build simpler, more secure and cost-effective networks. The broad adoption of multi-cloud and modern application environments is changing how the world's largest networks are built, operated and secured, and Cisco is at the center of this transition. We have made significant investments in the development of software, silicon and optics, the building blocks for the Internet of the future. We believe this strategy will change the economics of how the Internet will be built to support 5G, 400 gig and the demands of the future while helping our customers innovate and move faster than ever before. +In December, we introduced Cisco Silicon One, a first-ever single, unified silicon architecture; and the Cisco 8000 carrier-class router family built on Silicon One; as well as our new IOS XR7 operating system. We also announced new flexible purchasing options that enable customers to consume our technology, however they choose. We also collaborated closely with several of the largest web-scale and SP companies throughout the development process. Their participation in our launch demonstrates their strong support of our strategy as well as our commitment to continued innovation. Our goal is to accelerate the deployment of next-generation Internet infrastructure by offering our customers choices of components, white box or integrated systems in a flexible consumption model. +Now let me share a brief update on our businesses, starting with Infrastructure Platforms. As the global leader in networking, we believe we are well positioned with our intent-based networking portfolio given the strategic investments we've been making. Over the past several quarters, we've made tremendous progress integrating automation, analytics and security across our enterprise networking portfolio, while at the same time, shifting to a subscription-based model. A great example of our success is the ongoing strong adoption of our Catalyst 9000 platforms. We continue to extend our secure SD-WAN solutions as customers move more applications to the cloud. To do this, we are actively engaging with web-scale companies to help our customers extend their wide-area networks to the cloud and secure their business applications. Recently, we announced integration with Microsoft Azure Virtual WAN and Office 365, along with a deeper partnership with Amazon Web Services, to deliver highly secure end-to-end connectivity and better application performance. +Now to Security. We had another solid quarter with strength across our advanced threat and cloud-based solutions, including Duo and Umbrella, which are important growth drivers of our business. We continue to see significant opportunity as we execute on our strategy to deliver an integrated security platform. As the market moves to a multi-cloud environment and the need for visibility grows, we're benefiting from our strong position as our customers' most trusted partner. +Our differentiated end-to-end approach across the network, cloud and endpoint is winning customers with 100% of the Fortune 100 now using one or more of Cisco security solutions. This quarter, we expanded our security portfolio from the cloud to the edge. We brought to market an integrated IoT architecture, providing enhanced visibility, insights and threat detection across our customers' entire environment. This architecture includes our new software-based security solutions, Cyber Vision; and our Edge Intelligence data collection tool to enable our customers to make better business decisions. +Finally, Applications. There is no question that customers are undergoing a significant workplace transformation, and they are turning to Cisco to help them with this transition. As a global market leader, we believe we are the only company providing a cognitive, highly secure and analytics-driven collaboration platform, which is the foundation for their workplace transformation. This platform is becoming increasingly critical to how enterprises empower their teams by allowing their employees to work more effectively together. To extend our value proposition, we continue to make strategic investments. For example, we recently brought to market several key WebEx capabilities, which combine context, AI and machine learning to enable our customers and their teams to further enhance their meeting experiences. +We achieved another strong quarter of growth with AppDynamics, demonstrating our ability to deliver unique real-time, AI-powered insights from a single pane of glass, providing complete visibility. Our customers are looking to connect application performance monitoring with infrastructure automation to simplify IT and increase productivity. 2 weeks ago, we announced we are bringing together AppDynamics and our Intersight Workload Optimizer to deliver comprehensive visibility of applications and infrastructure, both on-prem and in the cloud, using machine learning and AI to proactively remediate problems and optimize user experiences. +To summarize, I am pleased with our business transformation and with the new innovative platforms we're bringing to market. While we continue to experience some pause in customer spending related to the uncertainty in the global macro environment, our long-term growth opportunities remain unchanged. Going forward, we will continue to focus on developing groundbreaking technologies and building a new Internet for the 5G era that will help our customers innovate faster than ever before. I remain incredibly confident that our execution against our strategy will drive profitable growth and generate strong shareholder returns for the long term. +I will now turn it over to Kelly. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q3. Our overall Q2 results were consistent with our expectations. We executed well with strong margins and EPS growth. Total revenue was down $12 billion -- was at $12 billion, down 4%. Our non-GAAP operating margin rate was 33.7%, up 1.6 points. Non-GAAP net income was $3.3 billion, flat year-over-year; and non-GAAP EPS was $0.77, up 5%. +Let me provide some more detail on our Q2 revenue. Total product revenue was down 6% to $8.7 billion. Infrastructure Platforms was down 8%. Switching revenue declined in both Campus and Data Center. We did see growth with the continued ramp of our Cat 9K and strength of the Nexus 9K. Routing declined driven by weakness in service provider. Wireless declined overall, but we did see strong growth in Meraki and are starting to see the ramp of our WiFi 6 products. Data Center revenue declined driven by servers, offset by strong growth in HyperFlex. Applications was down 8% driven by a decline in Unified Communications, partially offset by double-digit growth in AppDynamics. Security was 9% with strong performance in identity and access, advanced threat and unified threat management. Service revenue was up 5% driven by software and solution support. We continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 72% of total software revenue, up 7 points year-over-year. +In terms of orders in Q2, total product orders were down 6%. Looking at our geographies, the Americas was down 8%, EMEA was down 1% and APJC was down 4%. Total emerging markets were down 7%, with the BRICS plus Mexico down 20%. In our customer segments, public sector was flat, while enterprise was down 7%. Commercial was down 4%, and service provider was down 11%. Remaining performance obligations, or RPO, at the end of Q2 were $24.9 billion, up 11%. +From a non-GAAP profitability perspective, total Q2 gross margin was 66.4%, up 2.3 points. Product gross margin was 65.9%, up 3.1 points; and service gross margin was 67.7%, flat year-over-year. In terms of the bottom line, from a GAAP perspective, Q2 net income was $2.9 billion, and EPS was $0.68. +We ended Q2 with total cash, cash equivalents and investments of $27.1 billion. Operating cash flow was $3.8 billion, flat year-over-year. From a capital allocation perspective, we returned $2.4 billion to shareholders during the quarter that was comprised of $0.9 billion of share repurchases and $1.5 billion for our quarterly dividend. Today, we announced a $0.01 increase to the quarterly dividend to $0.36 per share, up 3% year-over-year. This represents a yield of approximately 2.9% based on today's closing price. This dividend increase reinforces our commitment to returning capital to our shareholders and our confidence in the strength and stability of our ongoing cash flows. +We continue to invest organically and inorganically in our innovation pipeline. In early Q3, we closed our acquisition of Exablaze, a designer and manufacturer of advanced network devices aimed at reducing latency and improving network performance. +To summarize, we executed well with strong margins and EPS growth. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the third quarter of fiscal '20. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue to decline in the range of minus 1.5% to minus 3.5% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64.5% to 65.5%. The non-GAAP operating margin rate is expected to be in the range of 32.5% to 33.5%, and the non-GAAP tax provision rate is expected to be 20%. Non-GAAP earnings per share is expected to range from $0.79 to $0.81. Our guidance does not reflect any potential disruptions in our global supply chain that could result from the coronavirus. We will continue to monitor the situation closely. +I'll now turn it back to Marilyn, so we can move into Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- +Thanks, Kelly. Michelle, let's go ahead and open the line for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Tim Long from Barclays. + +-------------------------------------------------------------------------------- +Timothy Patrick Long, Barclays Bank PLC, Research Division - MD and Senior Technology Hardware & Networking Analyst [2] +-------------------------------------------------------------------------------- +Yes. Chuck, maybe if I could just start talking about the macro and the kind of the longer decision process. In your sense, how long do you think this would last, particularly if you maybe put into the context that you mentioned a lot of industry drivers going on in 400 gig and WiFi 6? And obviously, you got some new router and silicon products out. So maybe just talk a little bit about the timing of that recovery and how you think you can maybe outperform it given all the different dynamics you have going across the businesses this year. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Yes. Tim, thanks. It's a great question. So I think, first of all, there are many secular growth drivers that are lined up, the 5G transition, the 400-gig transition, WiFi 6, the shift to cloud. And what we're seeing from customers is really just -- it's just pausing, just trying to see what's going on. Now what I'll say is that, clearly, late in the quarter, if you look at some of the issues that had been outstanding that were creating some of the uncertainty, like Brexit, we got closer to resolution. We obviously got a signature late in the quarter on a first phase of the U.S.-China trade deal, and USMCA has now gone through in the U.S. So hopefully, those will give our customers a little more viability. When I speak to the customers, they're still fully planning on moving forward. They're just a little cautious and trying to see what's going on. We obviously have the virus now that we'll see how it plays out. But overall, I don't think it's deep. And we expect that, given some of this uncertainty has now dissipated, notwithstanding what we see, obviously, from the virus, that hopefully we'll see our customers pick up again. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [4] +-------------------------------------------------------------------------------- +Thanks, Tim. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Tejas Venkatesh from UBS. + +-------------------------------------------------------------------------------- +Thejeswi Banavathi Venkatesh, UBS Investment Bank, Research Division - Former Associate Analyst [6] +-------------------------------------------------------------------------------- +I had a big-picture question. With the December routing announcements and the Cat 9K before that, a lot of the Cisco strategy is now around selling incremental automation software to lower customer OpEx. That seems to require a significant change in your organization. So how far along are you in the sales and channel transformation to fit that goal? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [7] +-------------------------------------------------------------------------------- +That's a very good question. Thank you. I -- we have done a lot of work on the transformation of being able to support the software model and the subscription software model, in particular, with the automation. And we have -- if you go back to 2017, when we first launched the Catalyst 9000 and we announced subscription businesses on our enterprise networking portfolio, the second half of this year will have some -- a number of -- a small amount of the early renewals on that. So our team has been working hard to be prepared for those renewals. And then in fiscal '21, we'll see a material number, a reasonably material number associated with that. So I think the sales organization, we've run pilots, and now we've scaled things. We're running other pilots, and we're scaling things. And we've got the customer experience organization that Maria Martina is leading that has been building out their capabilities. So we have more to do, but I feel good about the progress we've made, and I think that we're in a pretty good position right now. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Simon Leopold from Raymond James. + +-------------------------------------------------------------------------------- +Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [9] +-------------------------------------------------------------------------------- +I'm wondering if maybe you could talk a little bit more about the service provider vertical given it's been a long-running challenge and seems as if, maybe to some extent, it's less of a focus for Cisco given that it's such -- become a smaller part of the business. But I want to see if you can maybe talk about how you see this market eventually recovering, kind of the timing and the drivers, maybe double-clicking beyond just sort of the 5G hand-waving, if we could get a better understanding of what will drive it and when. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [10] +-------------------------------------------------------------------------------- +Simon, it's a lot better just to wave hands. Now let me tell you a little bit. I don't think that it's a market that we are ignoring or we -- in fact, if you look at the announcements we made in December, let me give you a little update on that. We have about 5 years of R&D effort in what we announced in December. So that's a lot of commitment to the market. So we do believe that there will be a resurgence. I think that -- I will talk about 5G and 400 gig as well. But just to give you an update on -- in December, as you know, we launched Silicon One, which is at the heart of these new systems called Cisco 8000 that we launched. And we also announced that we would be willing to sell our Silicon to go into a white box or sell it just directly to a customer, if that's how they like to procure it. I will tell you that across the cloud titans there, we're engaged with all of them on variations of those architectures. Several of them were with us at the announcement in December, which shows you their belief in what we're doing. We have taken orders for both from different cloud players, and so we feel good about the acceptance of that launch. The 8000 series will be a fundamental backbone product for 5G networks, and I will tell you that we have early wins on IP infrastructure to support 5G rollouts in over 30 customers around the world. They're early. Some of those are cell site aggregation, backhaul, some core wins. Most of them are in non-stand-alone, which means they're enhancing their current networks, and then they'll look to build stand-alone networks. As we've said, we believe that will start in 2021 where we could begin to see some of that pickup. So we think the 400-gig transition as well as the 5G build-out will be the drivers that we'd be looking for over the next couple of years. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [11] +-------------------------------------------------------------------------------- +Thanks, Chuck. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Paul Silverstein from Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [13] +-------------------------------------------------------------------------------- +Sorry, I'm still -- don't know how to use the cellphone. Kelly, your margin structure was particularly strong this quarter, and that represents a long-standing trend, both near term and longer term. I recognize the guidance represents an easing. I assume some of that is due to the backup in DRAM pricing or the pending backup. Can you go back through the drivers and what you expect over the next year or 2 both at gross and the operating level? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [14] +-------------------------------------------------------------------------------- +Yes, sure. Happy to. And I know we're really happy about where the -- both gross margins and op margins are. But as you know, Paul, it's driven by a few things. This software transformation has been benefiting us through both -- you can see it in the mix of our products when we show you the gross margin walks in our Qs as well as just overall, so we're benefiting from that. I'd say the second big driver is price. We've been very, very disciplined on price, meaning we're taking advantage of raising prices where we have elasticity, for example, on really older products that we want to shift to newer products or where we know we have room to move, we've been doing that, I think, very effectively. We've been managing the decline in the pricing and the server market fairly well, balancing that with the DRAM prices that are going down dramatically. +So what you're going to see in the reporting this quarter, Paul, and I know you always ask, you'll see our pricing. I mentioned in the last quarter's call that pricing was at an all-time lowest level of impact, meaning the most beneficial it's been. We're right back at 1.1 points on our year-over-year gross margin walk, so it's still very, very good for us and more in line of what it was, I'd say, a couple of quarters before Q1. So that's going well. DRAM is benefiting us this quarter for sure. And as you know, that's becoming less and less of a benefit to us now as we're starting to see the DRAM prices tick back up. But we've, again, managed that pricing and DRAM cost equation very well. So just in general, I think you can expect a little bit more pressure from DRAM pricing, the year-over-year compares getting less, which is why I guided what I guided. But overall, you're still going to see the goodness coming through from the continued increase of our business being software driven. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [15] +-------------------------------------------------------------------------------- +Kelly, if I could just quickly follow up. Looking beyond the quarter, looking beyond April, given the ongoing shift to software, is there any reason why margins should continue to head up, putting aside quarterly volatility? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [16] +-------------------------------------------------------------------------------- +Yes. I mean, again, I would say yes because what we're doing on the portfolio is more and more software content. So by definition, it will be good for us. We will always have the potential for large swings for things like component costs like DRAM, plus or minus. But as always, we'll let you know when those are happening. But yes, I mean, if you go back and look 3 years back from where we were there to where we are now, it is long term, just the shift of the overall portfolio that we've been driving. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Jim Suva from Citigroup Investment Research. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - MD & Research Analyst [18] +-------------------------------------------------------------------------------- +Thank you very much for the clarity so far. And I had one question that's kind of more broad. I don't know if it's -- for which of you. But on product orders, I was just kind of looking and thinking about the product orders. It looks like the enterprise product orders got incrementally a little more challenged. Public sector got a little more challenged. Service provider marginally improved compared to last quarter year-over-year. So can you maybe just give us some color on product orders? It looks like maybe enterprise, a little difficult year-over-year comps. Was it last year, a big product cycle in enterprise? Or why are we actually seeing enterprise kind of decline incrementally a little bit worse? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [19] +-------------------------------------------------------------------------------- +Yes. Jim, good question, and let me take a crack at it. So when I look at the segment, it's -- if I focus on enterprise, a lot of it is the Q2 '19 really, really strong product cycle ramps we had. So if I go back to Q2 '19, it was a record for the Campus switching for -- as well as for Collaboration back in Q2 '19. No excuse, but that's what that was. +I would say beyond that, if I would isolate overall kind of our regions from a bookings point of view, the Americas was down 8%. And if I look at that, the U.S. itself was slightly better but in that range, and I'd say it was driven by 2 areas. It was driven by the routing portfolio, largely SP segment. That was the biggest driver. And the second biggest driver was the decline we're seeing in the server market. And again, that's directly related to the decline of DRAM prices flowing through the entire market, and we saw that last quarter as well. So that drove the Americas. Europe was at minus 1%, basically flat. But that -- the biggest driver when I look at Europe was really the U.K. We are seeing a slowdown because of Brexit, and we did see it in the public sector significantly, which is always a big growth driver for the U.K. for us. So U.K., both enterprise and public sector slowed down for us, which drove Europe. Europe would have been up 2 points without the U.K. And then for APJC, it continues to be the rapid decline of China. China, as I've talked about, and the BRICS plus Mexico being down. China was down again over 30%. It's still only about 2% of our total business, but it still hurts the overall. I mean Asia Pac, excluding China, would have been up a couple of points as well, 3 points. +So from a geography, those are the key drivers. And again, to your point, we are going off against some tough compares in enterprise for both the Catalyst 9K ramp a year ago, and Collab just had a record quarter. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [20] +-------------------------------------------------------------------------------- +Thanks, Jim. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Ittai Kidron from Oppenheimer & Company. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [22] +-------------------------------------------------------------------------------- +Chuck, I wanted to dig into Applications, down 8% on a year-over-year basis. And I understand the pressure on the Unified Communications business, and it's good to see APPD is still growing. But you haven't talked WebEx. Am I to assume that WebEx is not growing, stuck in the middle here? Help me think about the transformation Amy has been doing over there, where we are in that transformation and how should I think about the growth and competitiveness of that platform going forward? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- +Yes. I think the -- first of all, they have re-architected all those platforms, integrated the back ends and have a very modern set of solutions to take to market. And we're currently working -- I was talking to the team yesterday. I think there's 11 workshops with major customers in the next 30 days to work on plans to get them to the modern portfolio because some customers have been running variations of the stuff that we've had out there for 10 to 15 years, so we're in good shape. In fact, there was a great analyst report that was written just a couple of days ago about -- industry analyst about the portfolio and how far it's come and how effective it is right now. So I feel good about what they're doing. I think if you look back a year ago, flat out -- Collab was up 24%. I mean -- and it's a huge business to be up that much. So they had a very tough year to compare against, but I'm pleased with where they are. There is competition. Obviously, there's some good competition in the space which frankly should just keep making us better. But the team is doing, I think, a really good job. Kelly, do you want to comment on... + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24] +-------------------------------------------------------------------------------- +Yes. I mean I'll just give you the -- I'd say the largest driver was the UC business and the revenue being down, the huge majority, followed by a bit on the endpoints on the TP. And conferencing was down marginally, hardly anything. So the biggest driver was, for sure, the -- on the Unified Communications side. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Jeff Kvaal from Nomura. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [26] +-------------------------------------------------------------------------------- +Yes. I was hoping that you could unpack sort of -- a bit of a bigger downtick maybe in IP than we were expecting a balanced by -- or better performance on the services line. Can you sort of help us understand what the dynamics are and some of that maybe accounting for where the software goes? I'd love to understand that a little bit better, please. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [27] +-------------------------------------------------------------------------------- +Yes. I would say -- I've talked about this. On the service increase, it has -- there's been no change on the accounting side for how we account for software. Service improvement, we've been really driving that. Maria Martinez, the lead CX for customer experience, has been really focused on driving renewal rates and adoption. And you've seen our services business from a revenue perspective tick up over the last 4 quarters. So I'd say that 5% growth you saw in services is just continued performance by that team to do that. +I'd say on the infrastructure platform side, it does go back to, again, just very, very -- we were peak -- not peak, but we were very, very high, ramping of Campus switching last year that -- so that's a tougher compare. I mean it's still growing like crazy, but that's a big driver. Routing is still down, driven by the SP segment. And then in terms of the last piece from a year, again, we talk about, and you saw that Applications was up 24%, again, which was all Collab basically a year ago as well. +So it's nothing more than those things, I would say. Combined with just the data center server market is -- we're starting to feel that you can see what's happening in the market there. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [28] +-------------------------------------------------------------------------------- +Does that imply, Kelly, that, that 5% services growth rate is a durable number? Or should we be thinking it will fluctuate between that and the sort of low single-digit growth that we've seen? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [29] +-------------------------------------------------------------------------------- +Well, we certainly -- we're certainly trying to make that a sustainable kind of range. We have no desire to have that slow down. But again, it's -- the team is doing everything they can. They're offering new solutions, not just -- they're trying to find more ways to drive incremental growth versus just being tied to the maintenance, to the product orders. And they're driving much more solutions along software and everything else, so they're working a lot of plays in the services area. + +-------------------------------------------------------------------------------- +Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD of Communications [30] +-------------------------------------------------------------------------------- +Obviously, they are. Congratulations. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [31] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [33] +-------------------------------------------------------------------------------- +Yes. I just had a quick question, trying to juxtapose the guidance with the order rates. If you look at the total product orders, the rate, they're down 6%; after, down 4%. So that deteriorated. And yes, your revenue guidance for the midpoint at least, your revenue decline is a little better than the quarter you just printed. So you printed down 3.5%; and the guide, down 2.5%. So kind of tailing on Jeff's question there, is the services making that up? And what should we be expecting for product revenue in the guided quarter? +And then I also -- I'm hoping, Chuck, maybe you'll make a comment on this whole 5G investment commentary coming out of the press and maybe the government. What do you think about -- how interested is Cisco in potentially helping deploy U.S. wireless infrastructure, not the stuff you do today, but actual base stations and things like that? Could you just comment on how you see some of those -- that commentary, how you think that might develop? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [34] +-------------------------------------------------------------------------------- +You want to go first? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [35] +-------------------------------------------------------------------------------- +Yes. I can go first. Yes. Your question is a good question, Rod, but I would say, really the -- where we ended up at the minus 6% was not a surprise. That's kind of when I gave guidance for the Q2, kind of what the expectation was. I would say, as you know, when we roll up the guide as we go for Q3, we just -- it's the same process, and we know exactly what's coming off the balance sheet. We have -- we know exactly what's in backlog. We know exactly what we expect for orders coming in, and it's just pure math. I think, again, back to a lot of the decline in the order rate was there's a bit of compares. But the rest, when you do the math and add it all up to what you expect to come through for the next quarter, it gives you the number I guided, the midpoint. If you look at that, it's very consistent with what our normal Q3 to Q2 sequentials are. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- +And, Rod, on the question around the 5G discussions in Washington, I mean, obviously, they're very interested in having U.S. companies participating in 5G and frankly lead in 5G. And so we have spent a lot of time educating different folks in Washington about what technologies actually constitute an entire 5G network. So you rightly said not the stuff we have, but the radio, which is pretty much what we don't have. But I think that -- I think the U.S. is in really good shape. I think we have packet core. We've got cell site and radio backhaul. We got the IP routing core. We got security, and we have -- obviously, there's a couple of companies in Europe, one in South Korea that provide the radio technology. There's also software players that are out there right now that are building disaggregated open RAN solutions that can be used in the future. And so we're spending a lot of time helping them understand that and working to just make sure that there's a recognition that there's a lot of technology that's been built and being built here in the United States that is leading in these 5G infrastructures. And I actually think the U.S. is in fine shape. I think, both from a carrier deployment perspective, I think we're in great shape, and I think we're in good position with the technology. I don't think the U.S. government should make investments in these companies, but we are certainly working with lots of industry peers, again, on both education and then trying to just make sure that the U.S. does have solutions with combining these European players with a lot of our technologies to make sure that everyone's comfortable with those solutions. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [37] +-------------------------------------------------------------------------------- +Thanks, Chuck. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Sami Badri from Crédit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- +I would like to ask about the SP orders that were down 11% in the quarter. And looking forward to the back half of this year and any kind of forward-looking indicator trajectory commentary would be helpful. If we look at 2 scenarios, one scenario assuming a recent telecom consolidation, right, that we've all heard about in the last 2 days; and then the scenario where no consolidation actually happens for the rest of the year, should we expect service provider orders to inflect positively in one of those scenarios or in both of those scenarios as we look at the back half and maybe kind of mid- to back half of 2020? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- +That's a tough question to answer. We've been dealing with challenges in this segment for a long time. I think the -- history would tell you that when we see consolidation, it creates a slowing. I'm not sure that this particular one represents that because I think they are going to be in investment mode and is triggering investment with other players as well. And I think the 5G build-out that all of them are working on will probably fuel investment. I think, for us, it just depends on how quickly they do that and how soon they decide to build a stand-alone 5G network for enterprises. I think most of them are looking at their consumer networks and believing they can accommodate them on their existing backbones with perhaps some minor upgrades, but I think that will determine it. So I think it's more connected to how fast they move on that than it has to do with any of the consolidation or no consolidation right now. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Samik Chatterjee from JPMorgan. + +-------------------------------------------------------------------------------- +Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [42] +-------------------------------------------------------------------------------- +I just wanted to see if we can drill down a bit more on the Cat 9k product portfolio. You mentioned already a couple of times on the call that the product -- the revenue momentum there is quite strong. I was just wondering if you can kind of talk about the impact on the growth rate that you've kind of seen directionally through this kind of broader landscape of slowing enterprise spending and if the growth rate there is kind of still substantially different from what you're seeing for the rest of the portfolio. Is it -- do you think it's more a reflection of the subscription kind of model that you're going with on that portfolio or more kind of the refresh that's driving that difference and kind of what you're seeing related to the rest of the portfolio? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [43] +-------------------------------------------------------------------------------- +Yes. I'll just say the growth rate of the Cat 9K is unbelievable still. I mean it is a very high double-digit number. I would say there's no -- we haven't heard issues. I'd say for maybe some of the smaller DCEs, there's a question about the subscription, but we've managed through that. But I would say those -- the new products from the 9200 through the 9600 that isn't slowing, and the growth rates are very, very strong. Obviously, the legacy products that they have replaced are falling off, as you would expect. But we have not seen any slow on the transition. It's the fast -- and again, we mentioned this in the early ramp of the Cat 9K. But at this point, the percentage of what the Cat 9K as of total Campus switching is the fastest ramp of any transition we've done. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [44] +-------------------------------------------------------------------------------- +And if you look at the -- what Kelly talked about earlier with WiFi 6 beginning to ramp, that's a subscription model. Our Meraki business is a subscription model which is still growing very well. So I don't think the subscription model has anything to do with it. I just think in certain cases, some of our larger customers who are watching some of the things going on just decided to just take a pause and take a look at what's happening, and then I think they'll kick back in. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Tal Liani from Bank of America Securities. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [46] +-------------------------------------------------------------------------------- +Yes. I want to ask you a broader question, and I will call it secular versus cyclical. Switching had a small cycle, short cycle with a new switch. There was growth acceleration. Now we see a decline overall in switching, and there's probably substitution between new and old. And routing is also declining. And the question I'm asking is, of the trends you see today, data center switching, Campus switching, routing, service providers, what is cyclical and what is secular, meaning when are we going to see a reversal -- or not when in terms of timing. What's going to drive, I should say -- what's going to drive a reversal of the trends in routing? What could drive a reversal in data centers and campuses? What are the things that could drive at least a cyclical growth from here or even secular growth kind of longer term? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [47] +-------------------------------------------------------------------------------- +So Tal, it's great question. I think in the routing space simply it's the 5G backbone build-out that we've been talking about for a few years. Once that starts, I think -- given the percentage of our routing business that is attributed to service providers, I think that's the key as well as us winning these Cisco 8000 insertions that we have proof of concepts going on today with many of the large customers, both service provider and web-scale players. So I think that's that one. +And I think on the Campus side, I just think that's a -- that's just a timing issue. I think that the growth we're seeing in the Catalyst 9000 is tremendous. And I think that customers that began to build out their refresh, given where we are as a percentage of the installed base that we have replaced, it's got a long road ahead of it. I think that the only reason that we saw a little slowdown is just because customers just decided to pause the deployments a bit. But I think that, that will come back when this uncertainty and the capital spending frees up. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [48] +-------------------------------------------------------------------------------- +And routing? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49] +-------------------------------------------------------------------------------- +Routing, I answered first with the SP, with the 5G backbone stuff because of how big a percentage service provider represents in our routing portfolio. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [50] +-------------------------------------------------------------------------------- +Thanks, Tal. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- +Meta Marshall from Morgan Stanley. + +-------------------------------------------------------------------------------- +Meta A. Marshall, Morgan Stanley, Research Division - VP [52] +-------------------------------------------------------------------------------- +Great. With subscriptions being 72% of software revenue, which you stated, I wondered if you kind of had an update as to how much of a headwind that kind of business model transition is. In the past, you kind of said a couple of hundred basis points. But just any -- directionally if that's still about right would be helpful. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [53] +-------------------------------------------------------------------------------- +Yes. I mean, again, I think back a few years ago before we adopted the new revenue standards, it was a bigger impact. It was up to like 250 or 300 basis points with ASC 606. It's come back down to that 100 basis points. But at this point, we don't even talk about it that way because we've been ramping so quickly the entire portfolio to that. But at max, it would be, I'd say, 100 bps or so. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- +Jim Fish from Piper Sandler. + +-------------------------------------------------------------------------------- +James Edward Fish, Piper Sandler & Co., Research Division - VP & Senior Research Analyst [55] +-------------------------------------------------------------------------------- +One part that we haven't talked about here today is on the security side. We have RSA coming up at the end of the month. So just wondering if we could double-click on where we are with Duo and Umbrella together as it seems like they're the biggest drivers of the business? Can you guys talk a little bit more about the contribution of these 2 specifically to the portfolio and how Umbrella specifically is impacting your adoption of secure SD-WAN versus some of the other vendors that are out there? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [56] +-------------------------------------------------------------------------------- +Yes. So I'll give you the sort of the qualitative answer, and Kelly can give you something on the data. But I think the secure SD-WAN is the solution that our customers are looking for. I mean they want the integration with their cloud gateways from their branches, and so it is a key differentiator for us. Our teams are working hard on continuing to build that out. And I think over the next couple of years, it will continue to -- it will be even more of a differentiator as we continue to get more and more integration between those 2 portfolios. Kelly? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [57] +-------------------------------------------------------------------------------- +Yes. No. I'd say that's absolutely right. And in terms of how important Umbrella and Duo are, they absolutely are the key growth drivers for us, the whole cloud security space for us and will continue to be so. And I'd say we recently launched our Security in a great way, which is just starting, and that will be all part of our cloud security portfolio as well, and we expect that to be a huge growth driver as well. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [58] +-------------------------------------------------------------------------------- +All right. Well, let me just thank everyone for joining us today, and I'll just recap by saying that while we have seen a bit of a pause, we actually feel really good. The conversations I have with our customers, I mean, all of the things they're trying to do, I believe, our technology is at the heart of. Whether it's rebuilding their applications, whether securing their data, transforming their infrastructure in this new era or changing their user experience as well as the way they interface with their customers, I think that we're in a very good position to help them do that, and we feel good about where we are. +So thank you all for joining us today, and we'll look forward to catching up with you next quarter. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [59] +-------------------------------------------------------------------------------- +Thanks, Chuck. Just to wrap the call, Cisco's next quarterly earnings conference call, which will reflect our fiscal 2020 third quarter results, will be on Wednesday, May 13, 2020, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. +Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. +We now plan to close the call. If there are any further questions, feel free to contact Cisco's Investor Relations group, and we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (800) 839-1160. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/CSCO/2020-May-13-CSCO.txt b/Transcripts/CSCO/2020-May-13-CSCO.txt new file mode 100644 index 0000000000000000000000000000000000000000..bf31845d5dea97d34187d1a8e7883e613db36d94 --- /dev/null +++ b/Transcripts/CSCO/2020-May-13-CSCO.txt @@ -0,0 +1,447 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2020 Cisco Systems Inc Earnings Call +MAY 13, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marilyn Mora + Cisco Systems, Inc. - Director of Global IR + * Charles H. Robbins + Cisco Systems, Inc. - Chairman & CEO + * Kelly A. Kramer + Cisco Systems, Inc. - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Jonas Silverstein + Cowen and Company, LLC, Research Division - MD & Senior Research Analyst + * Joseph Lima Cardoso + JP Morgan Chase & Co, Research Division - Analyst + * Tal Liani + BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector + * Amit Jawaharlaz Daryanani + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Ahmed Sami Badri + Crédit Suisse AG, Research Division - Senior Analyst + * Timothy Patrick Long + Barclays Bank PLC, Research Division - MD and Senior Technology Hardware & Networking Analyst + * Meta A. Marshall + Morgan Stanley, Research Division - VP + * Roderick B. Hall + Goldman Sachs Group Inc., Research Division - MD + * Ittai Kidron + Oppenheimer & Co. Inc., Research Division - MD + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Jim Suva + Citigroup Inc, Research Division - MD & Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Cisco's Third Quarter Fiscal Year 2020 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2] +-------------------------------------------------------------------------------- +Thanks, Michelle. Welcome, everyone, to Cisco's Third Quarter Fiscal 2020 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. +By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. +Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be on a year-over-year basis. +The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter of fiscal 2020. They are subject to the risks and uncertainties, including those related to COVID-19, that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. +With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during this quarter -- or during the quarter unless it is done through an explicit public disclosure. +Chuck, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thanks, Marilyn. Before we get started, I want to express my gratitude and appreciation for all the frontline workers, who are fighting this pandemic every day to keep so many safe. I also want to express my sympathies for those who have lost their lives and the families that have endured the deepest pains from the impact of this tragic situation we are in today. This truly is unlike anything any of us have ever experienced. +As you can imagine, we have been focused on helping our employees, customers, partners and communities. We currently have 95% of our global workforce working from home, which was a seamless transition for us as we already had a flexible work policy. And we build the technologies that allow organizations to stay connected, secure and productive. For those 5% who must be in the office to do their roles, we are clearly focused on their health and safety and are taking all of the necessary precautions. +During the crisis, many of our customers and partners have been under enormous pressure as they face cash flow challenges. This is why we introduced a variety of free offers and trials for our Webex and security technologies as they dramatically shifted entire workforces to be remote. In addition, we announced $2.5 billion in financing with a new Business Resiliency Program through Cisco Capital to offer financial flexibility and support their business continuity. This will help customers and partners access the technology they need now, invest for recovery and defer most of the payments until early 2021. +This pandemic is highlighting so many inequities that already existed and is exacerbating these problems. I'm proud to say that Cisco has committed nearly $300 million to date to support both global and local pandemic response efforts, including providing technology and financial support for nonprofits, first responders and governments. We are also donating personal protective equipment to hospital workers, including N95 masks and face shields 3D-printed by Cisco volunteers around the world. I'm so proud of our teams who have been relentlessly focused on these efforts and continuing to identify how we can be innovative to help those most in need. +I'd particularly like to call out our IT, Webex, Security and supply chain teams, along with our partners and suppliers, who have been working around the clock to ensure we are doing all that we can to keep organizations around the world up and running and giving back to our communities. Thank you. +Now turning to our third quarter performance. Despite the challenging environment we are all operating in, we delivered a solid quarter and financial performance in the midst of the greatest financial crisis of our lifetime. While we are not immune to the impacts of the global pandemic, we believe our underlying business fundamentals and financial position remains strong. +As we look at the quarter, it very much reflected the journey of the pandemic. In March, we were performing ahead of our expectations as companies focused on building resiliency in their IT environments. Then in April, we began to see a slowdown across the business as countries across the world were locked down. +While parts of our portfolio have been more impacted than others, we believe our leadership from a product, innovation and operational perspective remains solid. While there's so much uncertainty now, we believe our role has never been more important. And our responsibility has never been greater as much of the world is running on Cisco's technology from networking to collaboration to security to stay connected, secure and productive. +Organizations more than ever must focus on resiliency and agility, and those who had invested in digital capabilities were able to make this shift more seamlessly. While we cannot predict when it's going to happen, one thing we believe is that the demand for our products and services will be strong when we emerge from this situation. +We believe the transition in our own business model through our shift to more software- and subscription-based offerings is paying off. We saw continued strong adoption of our SaaS-based offerings and now have 74% of our software that is subscription versus 65% a year ago. +We also believe we remain well positioned over the long term to serve our customers and create differentiated value aligned to cloud, 5G, WiFi 6 and 400 gig. Our business model, diversified portfolio and ability to continue to invest in key growth priorities gives us a strong foundation to build even stronger customer relationships. As we prepare for the future, we will closely partner with our customers to modernize their infrastructure, secure their remote workforce and their data through our innovative solutions that will serve as the foundation for their digital organizations. +Next, I'll turn to the performance of our business segments, starting with Infrastructure Platforms. With the world going online practically overnight, the demand on networks has never been greater with users looking for secure connectivity, reliable performance and consistent experiences. This has led to our customers evaluating how to expand their capacity quickly, how best to protect their teams and how to keep their data secure while keeping their business productive. +It is also requiring enterprise IT to rapidly set up, deploy and provision mobile offices or mobile health care clinics. What I've seen IT teams do around the world and what they've made possible is simply astonishing. +Our strategy and value proposition are clear. We are powering the world's ability to stay connected, productive and secure while automating many of these capabilities. Our intent-based networking architecture was built for environments like this. For industries like health care, public services, financial services and service providers especially, having network infrastructure tightly integrated with security is mission-critical. +In Q3, we offered new cloud-based COVID-19 bundles for teleworker, mobile health care and pop-up branch use cases through our partners and service providers. As customers modernize their network infrastructure, we saw continued strong customer adoption of our subscription-based Catalyst 9000 as customers look to quickly scale remote access capabilities to keep their employees safe and their businesses running. +We continue to execute on our secure cloud scale SD-WAN strategy by investing in innovation and partnerships to help enterprises accelerate their multi-cloud strategies. As an example, we are now integrating with our Umbrella secure Internet gateway to give our customers flexibility to use best-of-breed cloud security with our industry-leading SD-WAN solution. +Our partnerships across web scale providers like AWS, Azure and our most recent announcement with Google Cloud allow us to offer a truly multi-cloud network fabric. As bandwidth and SaaS application demand increases, we are enabling our customers to securely connect branches and interconnect to different cloud providers to enable consistent application performance and user experience. +Moving on to Security, which is always at the heart of everything we do. In Q3, we saw solid growth, reflecting increased demand for our robust solutions to secure the rapid growth in remote workers and their devices. Being the largest enterprise security company in the world, we are uniquely positioned to safeguard our customers wherever they work. We have the most comprehensive and integrated end-to-end portfolio in the industry across the network, cloud, applications and end points. +As I mentioned earlier, we provided extended free licenses for key security technologies that are designed to protect remote workers, including Cisco Umbrella, Zero Trust Security from Duo, industry-leading secure network access from Cisco AnyConnect and end point protection from our AMP technology. We're also supporting our customers on their multi-cloud journey by enabling them to secure direct Internet access, cloud application usage and roaming users. We are only 2 quarters into our secure Internet gateway transition, and we are already seeing strong adoption from existing and new customers. +Building on the investments we made in innovation, partnerships and acquisitions, we also introduced SecureX. This is the industry's broadest cloud-based security platform, connecting the breadth of our portfolio and our customer security infrastructure by providing unified visibility, automation and simplified security across applications, network end points and the cloud. +Turning to Applications. Teleworking and collaboration tools have become a lifeline for businesses and their people to stay connected and productive with security and privacy being more critical than ever. Our portfolio is at the center of our customer strategy for empowering teams and increasing productivity as 95% of the Fortune 500 use our collaboration portfolio today. +We take a security-first approach to remote working and provide highly secure cloud-based collaboration solutions with integrated end-to-end encryption while protecting our customers' privacy. Throughout the quarter, we invested in scaling our platform at an unparalleled speed to deliver a highly secure, consistent experience and ensuring business continuity for our customers. We are now running our Webex platform at 3x the capacity we were running at in February to manage the dramatic increase in usage growth. We had well over 500 million meeting participants, generating 25 billion meeting minutes in April, more than triple the volume in February. +We also added many new prospects through free WebEx trials that we anticipate converting to revenue in the future. With applications at the core of every business and the surge in demand for monitoring tools that provide real-time business insights and optimize user experiences in multi-cloud environments, AppDynamics continues to perform well, particularly in this environment. +As I wrap up, I just want to reiterate how grateful I am to have our teams, our resources and our operational resiliency during this time. I also want to commend the heroic efforts of IT organizations and teams around the world, who have had to digitize their operations and support remote workforces at an unprecedented speed and scale. +This crisis has highlighted the importance of having highly resilient, globally scalable infrastructure technologies to keep the world running, and this is what we build. We are providing innovative solutions that help our customers support business continuity, drive productivity and ensure a highly secure work environment. We believe we will emerge from this crisis stronger than before. With our accelerated innovation cycle, refreshed portfolio and significant progress on our shift to more software and subscriptions, we are in a better position today than in past times of uncertainty. +Our confidence is further supported by our strong balance sheet to invest for the future and our proven ability to execute no matter the environment. I also believe our incredible culture has been amplified during this time. And I'm so proud of what our teams have achieved. I am confident Cisco is resilient, and we are built to last regardless of what the future brings. +Kelly, I'll now turn it over to you. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Chuck. I'll start with a summary of our financial results for the quarter followed by guidance for Q4. +Our overall Q3 results reflect good execution with strong margins and non-GAAP EPS growth in a very challenging environment. COVID-19 did have an impact on our financial results and business operations this quarter, especially in our supply chain, where we saw manufacturing challenges and component constraints. +Total revenue was $12 billion, down 8%. Our non-GAAP operating margin rate was 34.9%, up 2.7 points. Non-GAAP net income was $3.4 billion, down 2% year-over-year. And non-GAAP EPS was $0.79, up 1%. +Let me provide some more detail on our Q3 revenue. Total product revenue was down 12% to $8.6 billion. Infrastructure Platforms was down 15%. This is the area that was most impacted by the supply chain challenges. Switching revenue declined in both campus and in data center. We did see strong growth with the continued ramp of the Cat 9K. Routing declined in both service provider and in enterprise. Data center revenue declined driven by continued market contraction impacting both our servers and HyperFlex offerings. Wireless declined overall, but we did see strength in the ramp of our WiFi 6 products and solid growth in Meraki. +Applications was down 5% driven by a decline in Unified Communication and TP end points. We did see growth in conferencing as we saw strong uptake with the COVID-19 environment. We also saw strong double-digit growth in AppDynamics and IoT software. +Security was up 6% with strong performance in unified threat management, identity and access and advanced threat. Our cloud security portfolio performed well with strong double-digit growth and continued momentum with our Duo and Umbrella offerings. +Service revenue was up 5% driven by software and solution support. We continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 74% of total software revenue, up 9 points year-over-year. +In terms of orders in Q3, total product orders were down 5%. During the quarter, there was a slowdown in April as we saw the impact of the COVID-19 environment continue. +Looking at our geographies. The Americas was flat, EMEA was down 4%, and APJC was down 22%. Total emerging markets were down 21%, with the BRICS plus Mexico down 29%. +In our customer segments, public sector was up 1%, while enterprise was down 4%. Commercial was down 11%, and service provider was down 3%. +Remaining performance obligations, or RPO, at the end of Q3 were $25.5 billion, up 11%. The portion related to product was up 25%. +From a non-GAAP profitability perspective, total Q3 gross margin was 66.6%, up 2 points. Product gross margin was 65.8%, up 2.1 points. And service gross margin was 68.9%, up 1.6 points year-over-year. The increase in product gross margin was driven by productivity with continued memory cost savings and positive mix, partially offset by pricing. +In terms of the bottom line from a GAAP perspective, Q3 net income was $2.8 billion, and EPS was $0.65. We ended Q3 with a total cash, cash equivalents and investments of $28.6 billion. Operating cash flow was $4.2 billion, down 2% year-over-year. +We have a very strong balance sheet, healthy free cash flow generation and the ability to quickly access capital markets. This is a competitive advantage in a challenging environment. Our commitment to our capital allocation program remains unchanged, and we intend to continue to deliver long-term value to our shareholders through the return of a minimum of 50% of our free cash flow annually. In Q3, we returned $2.5 billion to shareholders during the quarter that was comprised of $1 billion of share repurchases and $1.5 billion for a quarterly dividend. +To summarize, we executed well with strong margins and non-GAAP EPS growth in a very challenging environment. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value. +Let me reiterate our guidance for the fourth quarter of fiscal '20. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue to decline in the range of minus 8.5% to minus 11.5% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 64% to 65%. The non-GAAP operating margin rate is expected to be in the range of 31.5% to 32.5%. The non-GAAP tax provision rate is expected to be 20%. Non-GAAP earnings per share is expected in the range from $0.72 to $0.74. +I'll now turn it back to Marilyn so we can move into the Q&A. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5] +-------------------------------------------------------------------------------- +Thanks, Kelly. Michelle, let's go ahead and plan to open up the line for questions. (Operator Instructions) Michelle? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Our first question comes from Paul Silverstein with Cowen and Company. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [2] +-------------------------------------------------------------------------------- +I'm torn whether to ask you about the infrastructure decline. So let me focus on that. Chuck and Kelly, maybe you could comment on pricing as a courtesy and the other aspects of the fine gross margin performance. But if I could ask you on the infrastructure side, the thought arises given that so many organizations shifted to work from home that's likely to persist to some degree. What's your outlook in terms of the benefits from the work from home in terms of the need for your solution for robust connectivity? But also the potential negative aspect, fewer employees within the 4 walls of the enterprise, how does that impact campus switching and wireless LAN? If you could, any insight would be appreciated. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Yes. Paul, thanks for your question. And you're spot on in how you should think about it. Look, from -- when we look at our customers working from home, there's clearly collaboration capabilities that I discussed around Webex. There's clearly more security that needs to be deployed. +And then the question about when they return to the office and how much -- how many people return to the office and what does that mean to the infrastructure supporting their campus environments is certainly one that we're going to be watching. I will tell you that I have had a lot of customers who are not at the center of this crisis who realized during this pandemic that they have a fair amount of technical debt, and they have a lot of aged equipment. And so we don't know what the time frame is, but many of them have said, "This is going -- this is a wake-up call, and this is going to actually give us air cover to talk to our senior leadership team about upgrading and building out a more robust, modernized infrastructure." +So again, different customers will be able to do that at different paces based on how they're impacted, what their capital situation is. But that's how we think about it going forward, and let's see how it plays out. Kelly, you want to talk at all about pricing? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Yes. So yes, Paul, on pricing, we, again, continue to have strong margins this quarter. But I will say some of the dynamics, we did benefit still this quarter because we had built up some inventory on memory at the lower prices. So we benefited greatly from that, which you'll see in the [VCP]. +But pricing did get a little bit worse. So pricing, to your question, Paul, from a gross margin rate on product year-over-year, it drove minus 1.9 points on pricing, which is slightly worse than it was year-over-year last quarter and certainly for the quarters ahead, the ones even before that even so. But overall, very, very strong productivity again driven by memory and cost savings as well as positive software mix. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [5] +-------------------------------------------------------------------------------- +And Kelly, you may want to talk about the correlation between the Infrastructure Platform's revenue number and the supply chain. + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [6] +-------------------------------------------------------------------------------- +Yes. I mean like I said in the prepared remarks, basically, the majority, if not all, of our supply chain challenges that we had with both components and the factories being impacted was on the Infrastructure Platform side. So that certainly drove a very large chunk of that revenue. + +-------------------------------------------------------------------------------- +Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [7] +-------------------------------------------------------------------------------- +Great. I appreciate that. Chuck, can you compare this to 10 years ago, to the financial crisis and 20 years ago to the bubble? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [8] +-------------------------------------------------------------------------------- +Well, I don't think you can compare it to the bubble because we were at the epicenter of that one, so that one felt a lot different. And this one, we are sort of -- we're secondary collateral damage, I would say. +But I think the difference here is the broad-based challenges that this thing has presented to customers around the world. And -- but we all know that the response from the Fed, the response from Congress on stimulus and the commitment to the economic acceleration or the attempt to slow the economic deceleration is certainly at a level we've never seen before. +So I think that like everybody else, depending on the availability of testing, the availability of therapeutics and clearly at some point when we get a vaccine, I do believe that the one difference that I see in this one is that this came upon us so quickly and so consistently around the world that I do think customers are now stepping back and asking themselves, "What do I need to do to harden my infrastructure and to better prepare my business for the next time something like this happens?" + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Ittai Kidron from Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [10] +-------------------------------------------------------------------------------- +I guess I had a question about applications. Just given the push with Webex and AppDynamics, I was a little bit surprised it was down on a year-over-year basis. I guess, Chuck, can you give me a little bit more transparency here and give us kind of a better understanding of the relative revenue levels of Webex and AppDynamics versus the unified IP? It's clearly declining and then overshadowing those businesses. I'm trying to understand, how close are we to a bottom in the declining businesses where the growth in the growth businesses can finally be transparent on an overall product category? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [11] +-------------------------------------------------------------------------------- +Yes. I think, Ittai, let me give you some color, and then Kelly can give you some metrics. But I think if you look over the last couple of years at the Applications business and Collaboration, I think they've performed reasonably well. +As you think about what happened with Webex this time, what I will tell you is that our #1 priority was to get customers up and running. And so we have -- we really have 3 categories of opportunity from customers that, as I said in my prepared remarks, that we believe we'll convert to revenue in the future. +So we have enterprise customers, many of whom already had licenses who need more licenses, and they've exceeded their usage. And we'll go back and we'll work with them to clean that up in the future. But again, our priority was getting them up and running and just allowing them to be productive. +The second is we had a number of new customers, enterprise customers, commercial customers who took advantage of Webex and deployed it for the first time in the 90-day free trial programs that we put out. +And then there was a third category, which are more of the individual free accounts that customers would sign up for online. I would say the first 2 categories represent the majority of what we believe to be the revenue opportunity going forward. But that's something we'll see in the future and wasn't really reflected in the quarter that we just announced. So Kelly, you want to make any comments? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [12] +-------------------------------------------------------------------------------- +Yes. I mean the thing I'll say in terms of just helping you think through the size, the relative size of these pieces of applications, monitoring and analytics, the AppD business is, as I said, growing double digit, super strong, very good but still fairly small in terms of the percentage of the overall applications. And then the same thing for the IoT software. So it comes down to collab, traditional collab. +And then when I break that down, the biggest chunk of total collab is Unified Communications. And that is where we are seeing the pressure, which we have been seeing, right, in the end points. So that's going to be with us for a while as that goes. We're clearly trying to transition there with some of the things that the teams are building there. But the -- that's a big portion that will continue down for a while, I would guess. +But again, conferencing is strong. And like Chuck said, the revenue -- this is the revenue we're talking about. When we look at the demand and when I look at the uptake, the significant uptake we had, the offers we had during this last quarter, just using our normal, what we expect to convert from free to paid is going to be a nice tailwind for us over the next few quarters here. + +-------------------------------------------------------------------------------- +Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [13] +-------------------------------------------------------------------------------- +Got it. And when you say end point, just to clarify, mostly IP, is that the right way to think about this? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [14] +-------------------------------------------------------------------------------- +Yes, that's the right way to think about the biggest driver. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Rod Hall from Goldman Sachs. + +-------------------------------------------------------------------------------- +Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [16] +-------------------------------------------------------------------------------- +I guess I've got 2. One is regarding the order volumes. I wondered if you guys could juxtapose the fact that the U.S. is kind of surprisingly flat after being down 8% last quarter. And then also the commercial order acceleration on the downside. Could you guys dig into the regional effects? Is that mostly APAC that's driving that? Or is -- was it also weak in the U.S.? And then the second question I had is on the $2.5 billion financing plan that you guys announced. I don't know, Kelly, could you give us some idea of how that affects cash flow? Like is it affecting cash flow in this quarter? And then how should we expect it to unwind in the cash flow over the next few quarters? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [17] +-------------------------------------------------------------------------------- +So Kelly, why don't I give a little color on the Americas and commercial, and then you can give some metrics and talk about the financial -- the programs. So Rod, on the Americas, we had a -- it was certainly stronger than what we saw in Asia and Europe. And frankly, if you just look at the timing of the pandemic, you can see Asia got hit early. So we saw the more consistent decline in the business. +What we did see in the Americas and in the U.S. is we saw, obviously, strength in Webex and Security as more -- as the customers executed on their business continuity. We also saw strength in service provider as they build out capacity. So we saw strength in cable. We saw strength in the web scale business. +And just to comment on the web scale space, which we haven't talked about in a while, we've been talking for years about how that was a marathon and that we have been investing both in our innovation as well as in the relationships with those customers. And we have had the second quarter in a row of robust growth in that part of the marketplace, which, frankly, is the beginnings of us seeing the results from the years of hard work and reestablishing ourselves there. So I'm really proud of what the teams have done. So that's been a bright spot in the last 2 quarters. +On commercial, if you think about it, commercial are midsized enterprises, small, medium businesses. And they have been disproportionately impacted by this pandemic. So it's not a surprise that, that business is going to be hit a little bit hard here harder than others. And Kelly, do you have any color to add on that and then talk about the financial planning program? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [18] +-------------------------------------------------------------------------------- +Yes. So yes, and also just to add to the U.S., just to add, switching was also up and strong in the America -- in the U.S. -- Americas as well. +On commercial, it's a similar story. All of the geos were down, but it was down the least in the Americas followed by EMEA. And the biggest chunk by far, it was down in APJC. So it's directly related to the kind of the geographical look when you look at overall how the orders went. +In terms of the capital -- Business Resiliency Program, we really just launched that at the end of April, so like the week or 2 before the quarter ended. So nothing impacted that in the quarter. So in Q4, there will be, I'd say, a small amount. We have a pipeline that we're going through. The early signs of the pipes that we're looking at, there's a big intake -- interest for smaller commercial customers, who haven't really done financing like a lot of health care systems, small health care systems, a lot of small colleges. But -- so there's a pipeline there. So we'll start to see that convert in Q4. +From a cash flow perspective, I don't expect a huge impact. There'll be some impact in Q4 and slightly more in Q1, but then they get back onto normal payments in the January month. So we'll be watching that. And hopefully, it's helpful to those customers that haven't leveraged it in the past. But no impact this quarter, and it will be a small impact, I think, in Q4. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Sami Badri from Crédit Suisse. + +-------------------------------------------------------------------------------- +Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- +I know you stated that routing was both down for SP and enterprise, but you also mentioned solid progress with web scale customers for 2 consecutive quarters. And given some of the big shifts you have made to work from home and also given the fact that you launched some new products in just December of 2019, how have the products like the Series 8000 performed during this entire shift? Are you seeing things accelerate or adoption of product accelerate? Or has adoption been a bit slower than your expectations? And maybe just a general update on the product. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [21] +-------------------------------------------------------------------------------- +Yes. Thanks. I guess the good news is that the success we've seen in the web scale space in the last 2 quarters hasn't even seen the impact of the 8000 yet. So it's in trials and lots of customers still -- they have very extended evaluation periods before they deploy it. But I will tell you, it's doing incredibly well in those trials. We're very optimistic about what the teams have built. We feel good about it. +Our service provider business was up mid-single digits in orders in the Americas in Q3, which indicates, obviously, the capacity build-outs that some of them we're seeing as well as that web scale business. So we'll see how it goes, but right now, we're very optimistic and feel good about where we are with that platform. And there are more versions of that platform coming. So we've just announced the first couple of members of the family. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Samik Chatterjee from JPMorgan. + +-------------------------------------------------------------------------------- +Joseph Lima Cardoso, JP Morgan Chase & Co, Research Division - Analyst [23] +-------------------------------------------------------------------------------- +This is Joe Cardoso on for Samik Chatterjee. I just wanted to get your thoughts around some of your key initiatives given the macro backdrop. Specifically, as you look at cloud, WiFi 6 or 400 gig, are you seeing any acceleration of demand or vice versa push out there versus your expectations 90 days ago given the change in environment? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [24] +-------------------------------------------------------------------------------- +So I think what we see happening with 5G is a little bit mixed, but generally, there is a tendency for our customers to want to sort of put their foot on the accelerator. I think you heard some of our customers that are looking for permits and with regional governments around the United States and other places that they're not sure they're going to be able to get that done during this pandemic. You got other customers who are saying that they actually are not having a problem. But it's a -- so we think generally, there's going to be an acceleration, particularly as our service provider customers also realize that some element of this work-from-home scenario will not go away. +And so we're going to be continuing in the future to work in these very hybrid worlds, where we're going to have even a much broader distribution of where our -- their users will be working from. And I think that that's the reason that they want to continue to accelerate the deployments and the strategies around 5G. +I'd say in WiFi 6, I don't see any big significant shift, I'd say, on the cloud. I've had mixed feedback from customers. I think that in general, it's probably a tailwind to cloud. But there are some customers that believe they have a cloud strategy, and this doesn't -- they don't understand why this would change and how they go about it. +So -- but it will -- as it relates to our strategy, we are going to continue to accelerate those technologies that help our customers use the cloud more effectively. We are going to -- as our customers -- some of our customers are going to need OpEx offers in the future given CapEx restraints. So we're working on a balance of our portfolio to be delivered in both OpEx and CapEx models to give customers the flexibility that they need. And we're definitely going to continue to accelerate the development and work around our Security portfolio as it relates to remote work and cloud connectivity because we think that's only going to accelerate as well. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Meta Marshall from Morgan Stanley. + +-------------------------------------------------------------------------------- +Meta A. Marshall, Morgan Stanley, Research Division - VP [26] +-------------------------------------------------------------------------------- +Great. Understanding the end of March and beginning of April were largely work from home or business continuity focus with customers, but as we get into kind of this new normal, do you feel like customers have had an initial sense of what revised budget look like -- budget outlooks are looking like for 2020? Or are customers still relatively uncertain that you're talking to? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27] +-------------------------------------------------------------------------------- +That's a very good question. I think that -- look, I think we went through a surge for a few weeks where customers were solely focused on business continuity and getting themselves prepared for this work-from-home environment. And then I think they took a breath for a couple of weeks, and then they stepped back. +And I could even see it in how we worked as a company. We were solely focused on the immediate virus response, getting our teams up and running, getting our customers up and running, making sure we had investments in the community and all those things. And then frankly, we took a breather. And now even my calendar and the things that we're focused on are much more sort of traditional business issues and how we move forward. +And I think our customers are in the same mode. I think, again, they dealt with business continuity. They took a few weeks to figure out, okay, based on this, what -- how do I reprioritize the projects that I have -- that I had planned for the rest of the year. And I think every customer is at a different phase right now on how they're deploying it. And it's going to be very industry-specific as to who moves forward. +I'll give you a few examples. Obviously, we're working very closely with higher education because you see in the news the discussion around whether students will be on campus in the fall. As one of the heads of one of the biggest systems in the United States told me, they used anything and everything they could to get students online back in March. And now they need to go step back and actually build the real, robust, long-term architecture that they need. And we're working with them to do that. +I think health care is one that they're going to make investments. I think telehealth is here, finally. And I think that's going to change forever. And I think that those -- that industry will continue to work and build out a more robust architecture to support telehealth as opposed to what we put together as quickly as we could with them over the last few months. +You got the hospitality, the leisure, the travel that are going to struggle, which is one of the big reasons we wanted to make sure we got our financing program out there, candidly, is if they need to make investments during this time, we want to help them do that. Not only is it the right thing to do, but they remember afterwards that we were partners to them during their tough time. And I think you see financial services moving ahead. So it's going to vary greatly by industry, but I think we're going to have better visibility in the next 60 days or so. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Tal Liani from Bank of America. + +-------------------------------------------------------------------------------- +Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [29] +-------------------------------------------------------------------------------- +Services was the -- one of the only areas that grew both sequentially and year-over-year. And the question is why don't we see the impact of -- first of all, what are the drivers for that? And why don't we see the impact of COVID-19? We're hearing from others that customers are less willing because of the uncertainty to sign on contracts that are longer than 1 year. So they see the parallel decline in services. I just -- I would like to get an update on this space. And how long does it take it to follow the trends in Infrastructure Platforms and the other products? + +-------------------------------------------------------------------------------- +Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [30] +-------------------------------------------------------------------------------- +Tal, that's a good question. So I would say, yes, we had another strong quarter in Q3. And again, it has been driven by like their solution support and their software support. That continues to be a big driver of it. +But your point of what you're hearing from other companies is absolutely true on what's happening to us. I would say that I expect pressure. In my guide for Q4, I have some pressure to services there. And where we're seeing it is on things that are like in our advanced services, our proactive services, consulting kind of things, those things that are either discretionary or you only make progress when you're actually in the enterprises. Those are seeing pressure that I think we'll see translate like hitting milestones or doing projects. +And then in terms of the maintenance, there is a lag usually on infrastructure maintenance. When the orders drag, it's usually a lag for a while. So we'll start to feel maybe a little bit of that in the upcoming quarters. But overall, that's a very solid business. And we've gone through cycles like this before, and we always come out pretty strong on that. But I think your point is a fair point. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Next question comes from Amit Daryanani from Evercore. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [32] +-------------------------------------------------------------------------------- +I guess a fairly common question I get on you guys is how does Cisco stack up this time versus the past recessions like '08 and '09, for example. So it would be really helpful to maybe get your perspective on how do you think Cisco handles and performs through this cycle versus past one and really to get to the bottom on how Cisco is different and perhaps better positioned to manage this correction versus the past one would be helpful. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [33] +-------------------------------------------------------------------------------- +I think that we're better positioned for sure, and you would expect me to say that. But I do believe it. I think that we've spent the last few years driving a significant refresh across our enterprise portfolio, across our service provider offerings, our 5G packet core capabilities. Our security portfolio is robust. +We spent the last 2 years rebuilding and modernizing the Webex architecture as well as unifying the user interface. We've now gone through 2 months of building out capacity on a global basis. Webex was the largest platform in the world in February, and now it's 3x what it was then. So we built that out. +And I think that if you look at the software content in our product portfolio and the percentage of our revenue that, that represents and the percentage of that is coming from subscriptions and SaaS versus where we were in 2008, I think all of those things just position us more effectively than perhaps we would have been back then. So I feel good about where we are. And I think that our balance sheet is strong. +Obviously, our ability to navigate this financially is strong. So I feel good. And I wasn't running the company in 2008, clearly, but I was here. And it just feels like we're fortunate that we've spent the last few years doing complete refreshes on almost all of our technology. So we have very relevant new offers for our customers right now. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Jim Suva from Citigroup Investment. + +-------------------------------------------------------------------------------- +Jim Suva, Citigroup Inc, Research Division - MD & Research Analyst [35] +-------------------------------------------------------------------------------- +Can you talk a little bit about enterprise, the orders, the trends, maybe the monthly cadence? And importantly, the color or commentary you have as enterprises are working from home with their employees, keeping their networks up and running, potentially delaying things, how does it kind of look as you go forward? Because it seems like a typical request for proposals might be a little bit different discussions now. And what I mean is, say, for example, does this help the incumbency of Cisco a little more to give you more visibility to, hey, Chuck, when things return back to normal in 3 years, 6 months or at some point, hey, do we have a buildup of more visibility than we -- what we currently have? If you could just help us with the enterprise, some commentary, that would be great. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- +Yes. Thanks, Jim. I will tell you this. The number of e-mails that I've gotten from my peers from virtually every industry about what our teams did to help them, many of them saying, "We had to get 150,000 people up and running remotely over VPN, and you guys helped us do that overnight. And for that, we're gracious." Or around Webex and how they couldn't be running their business right now if it wasn't for Webex. +And I mean -- so we hosted an advisory board call with about 50 of our strategic customers around the world last week or the week before. I can't remember exactly when it was at this point. And they spent like the majority of the first 1/3 of the call just going through stories of gratitude around what our teams have done. And I tell you that because I think what's happened is, to your point, Jim, I think there is a tendency during these times, you want to work with companies that you believe are strong or solid and are great partners and are going to do whatever it takes to make you successful during these times. And I think that's what our customers believe we do. +I think, again, as I said earlier, you're going to have some customers right now that are going to look at their infrastructure, the CEOs are looking at it and saying, "I will never be this unprepared for something like this again." And if there's a wave 2 coming in the fall, many of them may say, "We need to work on a lot of this right now." I don't know that yet, but we think there could be. +I talked earlier about what we see in certain industries, where there'll be investments like higher ed. Right now, frankly, there's K-12 contingency plans being made even though I know most K-12 institutions would much rather be teaching those kids in schools for obvious reasons, but it's also not a definite that they'll be going back into the classroom of the fall. So that's happening. +The pharmaceuticals and the drug manufacturers are working to beef up their infrastructure for all the research, building up their cyber infrastructure for obvious reasons. So there's a lot of things that are going really well. But then again, you have industries that are at the heart of this crisis, who I wouldn't expect to make significant investments until we get to the other side. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [38] +-------------------------------------------------------------------------------- +Chuck, I'd like to come back to your -- just the very last comment you made. You said some industries are getting hit very hard now, and it's going to be tough for them to make investments before we get on the other side of the crisis. And so what I'm trying to figure out is how much of the economy is already in a situation of feeling the pain, cutting IT budget and how much of the economy is not there yet and actually at risk of getting into that stage, maybe in 3 months or even in 6 months from now because as you say, the enterprises are like maintaining continuity, are actually more into a mode of making the right spending to keep the business running. But maybe in 3 to 6 months, they're going to actually start getting the more of macro pains, the recessionary environment hurting their business as well. And so my question is really how much are we into that already. What percentage of the economy has been hurt? And what percentage could be hurt further down the line? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [39] +-------------------------------------------------------------------------------- +Yes, Pierre, that's a very good question. I'm going to give you just my pure instinct on this. I think that any customer who potentially could be at risk in 3 to 6 months is already pausing. I don't think that anybody is going to be aggressive right now because any of us can see if we have liquidity issues, we have solvency issues, we have anything that is 3 to 6 months away, my peers, we're all planning -- we're working on that right now. No one's waiting. So I think most of the impact that you'll see in the next 6 or 9 months, I think, those customers who were impacted, let me say it that way, they know they're impacted. +I will tell you from our perspective, if you map the industries that we believe will continue to invest against our customer base, there's a good correlation that a lot of the industries that we believe will invest are already a large percentage of our customer makeup. So whether you look at public sector, service providers, financial services, higher education. I mean these are all big pieces of business for us, and we think that all those and others will also continue to invest. So it's mixed. +But to answer your specific question, I think anyone who's going to be in trouble 3 to 6 months from now is already pausing and has already been impacted. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Tim Long from Barclays. + +-------------------------------------------------------------------------------- +Timothy Patrick Long, Barclays Bank PLC, Research Division - MD and Senior Technology Hardware & Networking Analyst [41] +-------------------------------------------------------------------------------- +Chuck, I wanted to ask about competition, kind of a twofold question here. Number one, if you think about some of the pieces of your business where some competitors have been trying to take share of enterprise, networking comes to mind where several companies are focused on gaining share there. What do you think this major pandemic disruption does to other's ability to maybe disrupt the high market share that you have? And then conversely, if you think about some of the markets where Cisco has a real opportunity to gain share, it sounds like cloud would be one of those, and you guys are doing well. But do you think there's any of the markets where you're poised to take some share that are impacted either positively or negatively? + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- +Yes. That's a great question. I think you've even heard from some of our competitors on their earnings calls where they had planned on entering markets, and they've acknowledged that it's going to be more difficult to do that during this time in areas where we have good market share. +And again, I'll remind you that in those areas like in the Campus, we have probably the most robust portfolio we've had in a decade. So we're very -- in very good shape with the portfolio. And I think, again, customers, they are -- in times like these, they want to go with people they trust and know. And I think that will work in our favor. +But on the -- in the areas, to your point, where we can take share, I think certainly, the web scale play that we've been running for the last 4, 4.5 years, I think, is one area over the next year. I think in the service provider space with the 8000s and recapturing some routing share because of those portfolios. And both of those sets of customers, they will continue doing the evaluations and the new deployments because they have to, because they have just requirements that are increasing on a daily basis. +And I think that in the carrier space with 5G and the access networks, the backhaul networks, the core networks with the 8000 and some of our other technology we've come out with, I think we can take share there as well. So I feel good about where we are, and the things that we are in control of right now, I think we're in a pretty good position. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [43] +-------------------------------------------------------------------------------- +All right. Thanks, Tim, and that was the last question of our call. + +-------------------------------------------------------------------------------- +Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [44] +-------------------------------------------------------------------------------- +Yes. So let me just close quickly by, first of all, thanking all of you for being with us and just telling you all that we hope that you're safe and your family is safe and you continue to be safe. I also want to just reiterate our gratitude for the frontline workers. And these are the health care workers, the first responders, some of our colleagues locally who are in the homeless camps, helping try to stem the tide of this pandemic flowing through those kinds of environments, those people who live paycheck to paycheck, who are struggling right now. Our thoughts and prayers are with everybody, and our gratitude is especially with those who are on the frontlines. +We look forward to getting to the other side of this, and we look forward to doing our part in helping our customers and helping society actually thrive as much as possible during this very difficult time. So thanks for being with us today on our call. + +-------------------------------------------------------------------------------- +Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [45] +-------------------------------------------------------------------------------- +Thanks, Chuck. Cisco's next quarterly earnings call, which will reflect our Q4 2020 and annual results, will be on Wednesday, August 12 at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. +We now plan to close the call. If you have any further questions, feel free to contact the Cisco Investor Relations group. And we thank you very much for joining today's call. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 800-391-9847. And for participants dialing from outside the U.S., please dial 402-220-3093. This concludes today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2016-Apr-21-GOOGL.txt b/Transcripts/GOOGL/2016-Apr-21-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..ed1f626781bd75e5857dcce17e062a944fce4975 --- /dev/null +++ b/Transcripts/GOOGL/2016-Apr-21-GOOGL.txt @@ -0,0 +1,623 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Alphabet Inc Earnings Call +APRIL 21, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet, Inc. - Head of IR + * Ruth Porat + Alphabet, Inc. - CFO + * Sundar Pichai + Alphabet, Inc. - CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heather Bellini + Goldman Sachs - Analyst + * Anthony DiClemente + Nomura Securities - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Co. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Doug Anmuth + JPMorgan - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Dan Salmon + BMO Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet, Inc. first-quarter 2016 earnings conference call. +(Operator Instructions) +I would now like to turn the conference over to Ms. Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's first-quarter 2016 earnings conference call. With us today are Ruth Porat and Sundar Pichai. Some of the statements that we make today may be considered forward-looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. +For more information, please refer to the risk factors discussed in our Form 10-K for 2015 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at ABC. XYZ/investor. +This call is also being webcast from our IR website, where a replay of the call will be available later today. And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks. Our very strong revenue of $20.3 billion in Q1 underscored the great momentum of our businesses globally, with consolidated revenue growth again accelerating meaningfully, up 23% in constant currency versus last year. The primary driver was the increased use of mobile search by consumers, benefiting from our ongoing efforts to enhance the mobile search experience. +We also benefited from solid growth in desktop and tablet search, as well as continued strength in YouTube and programmatic advertising. We continue to rationalize our portfolio of products to ensure we efficiently and effectively focus our resources behind our biggest bets across Alphabet. +I will present to you in the following order. First, review the quarter on a consolidated basis for Alphabet. Second, review the results for each of Google and Other Bets. Finally, I will conclude with our outlook. Sundar will then review our business and product highlights for the quarter, after which we will take your questions. +Beginning with a summary of Alphabet's consolidated financial performance, total revenue was $20.3 billion, up 17% year over year, and down 5% sequentially. As a result of the ongoing strength of the US dollar, we realized a negative currency impact on our revenues year over year of $762 million, or $593 million after the benefit of our hedging program. Holding currency constant to prior periods, our total revenue grew 23% year over year and declined 4% sequentially, reflecting holiday seasonality. +Once again, Alphabet revenues by geography highlight both the strength of our business around the globe, as well as the impact that currency headwinds continue to have on our non-US business. US revenue was up 21% year over year to $9.4 billion, and down 9% versus Q4. +UK revenue was up 15% year over year to $1.9 billion, and flat sequentially. In fixed FX terms, the UK grew 21% year over year and 5% quarter over quarter. Rest of world revenue was up 14% versus last year to $9 billion and down 2% versus Q4. In fixed FX terms, revenues were up 25% year over year, and up 1% sequentially. +GAAP other cost of revenues were $3.9 billion. Non-GAAP other cost of revenues was $3.6 billion, up 27% year over year, primarily driven by Google-related expenses, most notably due to costs associated with operating our data centers, including depreciation, content acquisition costs, primarily for YouTube, and hardware costs related to sales of new Nexus, Chromecast and Pixel devices launched in the fall. +GAAP operating expenses were $7.3 billion in the quarter. Non-GAAP operating expenses were $6 billion, or 30% of revenue, up 11% year over year, and down 9% versus Q4. The year-over-year growth was primarily driven by R&D expense, mainly due to compensation expense related to head count growth. +On a GAAP basis, operating income was $5.3 billion, up 20% versus last year. The operating margin was 26%. Non-GAAP operating income was $6.8 billion, up 21% versus last year. The operating margin was 34%. +With respect to stock-based compensation, it totaled $1.5 billion, up 24% year over year, and up 4% sequentially, primarily reflecting increased head count and the impact of our senior executive equity refresh that occurs every two years. Head count at the end of the quarter was 64,115, up approximately 2,300 from last quarter. The vast majority of new hires continue to be engineers and product managers in areas where we've prioritized investment, such as Cloud and apps. +On a numbers basis, we're adding more head count in Google, while on a percentage basis we're growing faster in Other Bets. Other income and expense was negative $213 million. As discussed on prior calls, OI&E consists of a number of line items with different drivers, which makes it inherently unpredictable. +The key drivers this quarter were the ongoing drag from foreign exchange, given the volatility in currency markets, as well as losses recorded for marketable and nonmarketable securities. These items offset interest income from our investment portfolio, which remains fairly consistent. +Our effective tax rate was 18%, reflecting the geographic mix of our income and adoption of a new accounting standard that reflects certain SBC tax benefits in GAAP earnings that were previously recognized in equity. We have excluded these benefits in our non-GAAP earnings. +Net income was $4.2 billion on a GAAP basis, and $5.2 billion on a non-GAAP basis. Earnings per diluted share were $6.02 on a GAAP basis, and $7.50 on a non-GAAP basis. +Turning now to CapEx and operating cash flow, CapEx for the quarter was $2.4 billion, the substantial majority of which supported the Google segment. Operating cash flow was $7.7 billion, with free cash flow of $5.2 billion. We ended the quarter with cash and marketable securities of $75.3 billion, of which approximately $45 billion, or 60%, is held overseas. This reflects our strong operating cash flow offset by the impact of our share repurchases during the quarter of approximately $2.1 billion. +Let me now turn to our segment financial results. Starting with the Google segment, revenue was $20.1 billion, up 17% year over year, which includes the impact of FX. In terms of the revenue detail, Google sites revenue was $14.3 billion in the quarter, up 20% year over year, and down 4% sequentially. +Year-on-year growth reflects substantial strength in mobile search due to the ongoing benefit from the improvement in ad formats and delivery that we launched in the third quarter of last year. We continue to have solid growth from desktop and tablet search. +YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView and Google Preferred, with a growing contribution from app promotion. Network revenue was $3.7 billion, up 3% year on year, and down 11% sequentially, continuing to reflect the strong growth of programmatic, offset by the traditional network businesses. +Other revenue for Google was $2.1 billion, up 24% year over year, and down 1% sequentially. Year-over-year performance was driven by Play, as well as continued strong growth in Cloud and apps and a nice contribution from hardware. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. As a reminder, these metrics similarly are affected by currency movements. +Total traffic acquisition costs were $3.8 billion, or 21% of total advertising revenue, up 13% year over year, and down 7% sequentially. The increase in both sites TAC and network TAC as a percentage of revenue reflects the fact that our strongest growth areas, namely mobile and programmatic, carry higher TAC. +Operating income excluding SBC was $7.6 billion, up 22% versus last year, for an operating margin of 38%. Google stock-based compensation totaled $1.3 billion for the quarter, up 25% year over year. Operating income reflecting the impact of SBC was $6.3 billion, up 21% versus last year, and the operating margin was 31%. CapEx for the quarter was $2 billion, reflecting investments in production equipment, facilities, and data center construction. +Turning to Other Bets' financials, as a reminder, the majority of these efforts are pre revenue. We continue to invest across these opportunities, doing so in a disciplined way. Because Other Bets' results aggregate the revenues and expenses from a number of businesses, operating in different industries, there is likely to be lumpiness in the reported results from quarter to quarter, which is why we think it remains most instructive to look at them over a longer time horizon. +For Q1, Other Bets revenue was $166 million, up 108% versus last year. Reported revenue for Other Bets was primarily generated by Nest, Verily and Fiber. Operating loss excluding SBC was $657 million in the first quarter. Including the impact of SBC, operating loss was $802 million. Other Bets' CapEx was $280 million in Q1, primarily reflecting ongoing investment in our Fiber business. +Looking forward, a few observations. First, regarding revenue, our culture of innovation drives our strong revenue growth. We've talked previously about the benefits from changes made to ad formats and delivery in the third quarter of 2015 and that continues to be a tail wind. Mobile, as an example, continues to offer sizable opportunity for revenue enhancement, given the increasing ubiquity of mobile use by consumers and the strong location and contextual signals from mobile devices. Although we remain intensely focused on innovation across Alphabet, the timing and magnitude of ongoing changes obviously are inherently uncertain and are not designed with an eye toward quarterly schedules. +Second, as to expenses, within Google, we continue to be focused on managing the expenses that we can actually control, as you can see from our results again this quarter. However, the secular trends driving revenue are accompanied by greater required investment in our ecosystem to support that revenue growth, most specifically the continued trend of higher TAC due to an ongoing change in mix within our sites and network businesses. +Third, regarding CapEx, as we have consistently said, technical infrastructure is a key strategic asset for us. We have tremendous scale and continue to add to it. The team continues to deliver innovative solutions that are creating meaningful efficiencies in machine use, allowing us to benefit from earlier investments and meet our growing Google requirements cost effectively. With regard to CapEx investments for Other Bets, the bulk of that is directed to our Fiber business, where CapEx should obviously increase as we execute in a growing number of cities. +Fourth, about our balance sheet, as I discussed on our Q4 call, last quarter we initiated steps to align our capital structure consistent with the move to Alphabet, providing greater flexibility as we continue to grow. Our exchange offer will be completed on April 25 and we have completed the move of our commercial paper and revolving credit facility from Google to Alphabet. +Finally, our strategic prioritization -- as I indicated last quarter, there are a number of different execution paths we are pursuing to optimize our investments and opportunities. In some areas, we will be increasing investment if teams meet milestones we set as part of our 2016 budgeting process. In other areas, we've chosen to work with industry-leading partners who can increase our momentum. +Finally, in certain areas where we have had multiple teams developing different approaches to a similar technology, we've been evaluating how to rationalize these approaches, enabling us to increase investments around a smaller, more focused set of opportunities. So, my closing comment is that in Q1, we continue to see tremendous revenue growth across our businesses and we remain focused on disciplined investing for the long term. +I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. It's great to join you all today. Our teams are off to a great start this year and there is even more excitement in the month ahead as we gear up for big events like our annual developer conference, Google IO, our YouTube event Brandcast, and the Google Performance Summit for advertisers. +Google's mission is to organize the world's information and make it accessible and useful. And after 17 years, we have just scratched the surface of what's possible. We are reinvigorated around this mission and, as you will hear, we are making solid progress across many of our products. +Today, I'll quickly share a few highlights from the quarter, as well as some of the areas where we are enlisting to make our products more useful and intelligent. Then I'll give an update on our advertising business and our growing Cloud business. +A few highlights from the quarter. We continue to invest in making search more useful and assistive. In the early days when you did a search on your desktop, we gave you 10 blue links and then sent you on your way. Users still had to do too much work to find the information they were looking for. +We have made a lot of improvements over the years to add more comprehensive and assistive information right within the search results. For instance, 10 years ago, if you tried to find the score during your favorite soccer team's match, we would likely point to you some news articles or the team's website. Today, we show the live scores for nearly 200 soccer leagues across 70 countries so fans around the world can quickly find information, like upcoming schedules, team news, and conference standings, right in the search results. We are incredibly well positioned to better assist our users, thanks to our strengths in areas like search, geographical information, machine learning, image recognition, and natural language processing. +One of the key ingredients behind this push towards greater assistance is AI. We have long invested in building the best machine learning team and tools, and we are seeing these efforts bear fruit in many ways. +As many of you saw last month DeepMind's AlphaGo has been making great strides. It was a privilege to play legendary Go player, Lee Sedol, in such an important milestone for artificial intelligence. This is another step towards creating AI that could help us with everything from our daily tasks to potentially even bigger challenges, like climate change and cancer diagnosis. +At Google, machine learning is already helping us improve our products every day, in search and many other areas like photos, maps and more. Last quarter, I talked about how machine learning helps Smart Reply suggests responses in Inbox. +This quarter, we launched Goals in Google Calendar, an intelligent feature that helps users make the most of their time. You just add a personal goal, like "run three times a week," and Calendar will help you find the time, then help you stick to it. +There's still a lot more that we can do to make search and other Google services more assistive and helpful to you. You'll see a lot more from us this year. +On the content side, we are seeing great traction on Google Play and YouTube. YouTube still has incredible momentum and we continue to invest heavily here. What seemed like a moonshot a decade ago has grown into a booming community of engaged users, creators and brands, unlike any other video platform. YouTube on mobile alone now reaches more 18- to 34- and 18- to 49-year-olds in the US than any TV network, broadcast or cable. +This past quarter, we launched YouTube Originals, original content available on our premium service YouTube Red, and we are very pleased with how it's been going. And earlier this week we announced that we are making 360-degree live streaming available globally on YouTube. We are kicking things off by live streaming select performances at Coachella for fans around the world in 360 degrees. +Google Play remains a thriving hub for digital content across apps, games, music, movies, TV and books. Game developers of all sizes are building successful businesses in the Play store, thanks to its global reach of over 1 billion users. In fact, in 2015, we saw 50% more games reach over 1 million installs compared to the previous year. +And we keep adding great content to Google Play. For instance, performances by artists like Coldplay and Justin Bieber from the 2016 Brit Awards are available exclusively on Google Play music. +When we talk about great content, the mobile web is equally important. This quarter, our simple, fast and secure browser, Chrome, reached another important milestone, surpassing 1 billion monthly active users on mobile alone. And of course one of the keys to a great mobile web experience is fast content. As you know, we have teamed up with hundreds of publishers and tech companies to improve the mobile web for everyone with Accelerated Mobile Pages. Early data shows that these pages load 4 times faster and use 10 times less data than traditional pages. +We recently made it easy to find AMP in relevant mobile search and Google news results, giving users a lightning fast reading experience for top stories. And there are great advertising opportunities for publishers in these new fast pages. Another example is Progressive Web Apps, which combine the best of the web apps, allowing companies to build mobile sites that load quickly, send push notifications, have home screen icons, and much more. +Of course computing is the foundational layer through which all of our products are delivered. In March, we previewed the Android Nrelease to give developers an early look at what's coming in the next version of our software. This release has key features like multi-window support, direct reply notifications and battery efficiencies. +We are also building for future platforms. We expanded Android Auto to Brazil and Android Wear partners like Michael Kors and Fossil also announced that they are working on new devices coming later this year. In our newest platform, VR, we also recently introduced VR View, a quick and easy way for developers to include 360-degree VR images and videos in their apps and websites. +Now, moving on to some of the key drivers and trends in our advertising business. As people turn to their mobile phones in moments of high intent, which we call micro moments, Google has a compelling value proposition. We offer marketers four things -- the best ways to target commercial intent at the right moment, the best mobile ad formats, the best reach and range of quality inventory, and the leading measurement solutions. +First, thanks to our unique intent signals, we are able to connect marketers with the right customer at precisely the right time. A new example of this is Customer Match, which helps brands reach their most valued customers on Google search, YouTube and Gmail, with highly relevant and targeted ads. After using Customer Match to reactivate their loyal customers, specialty retailer Williams-Sonoma reported a 50% lift in revenue compared to previous campaigns that didn't use Customer Match. +Second, we continue to invest in the best new mobile ad formats tailored to help users find exactly what they need at the right moment. For example, we rolled out model automotive ads, which helps auto makers recreate the showroom experience by featuring images of cars alongside helpful information right in the mobile search results. On average, participating brands see a more than 30% increase in engagement rate with these new automotive ads compared to standard text ads. +Third, we provide advertisers with the best reach and inventory across many of the web's most coveted platforms. Marketers like HBO Now are seeing great results from our popular ad promotion offerings like universal app campaigns, which helps advertisers easily run campaigns in Google Play, YouTube, search, and across our display network. +In fact, in January, we saw a 200% year-over-year increase in ad-driven installs on android alone. And in our burgeoning programmatic business, we recently rolled out Programmatic Guaranteed, a new way to conduct direct deals between advertisers and publishers on high-quality inventory. +And, fourth, we give marketers powerful measurement tools so they know exactly how effective their ads are. Just this week, we announced the availability of sales lift studies to help consumer packaged brands better understand how their online videos are driving offline sales. This adds to our significant efforts in this area. +I want to specifically highlight the success we are seeing with YouTube advertising. As YouTube continues to grow with great content and engaged users, marketers can't get enough. For example, Microsoft Xbox hosted a six-hour live-streamed event on YouTube for their Halo 5 opening week, promoted with TrueView ads where 8 million people tuned in, helping it break sales records. +Excitement is especially high as we head into our annual Brandcast event coming up next month. Thanks to the success of Google preferred, this is the third year in a row we are making it the cornerstone of our offering to marketers. In fact,the number of brands in the US using Google Preferred has doubled year over year. +Now I want to spend some time on our exciting enterprise businesses, which have been gaining momentum. Last December, we have unified our Cloud businesses under one leader so we can innovate faster and better serve our customers. This decision is already paying off. +Enterprises are starting to see the power of combining Google Cloud platform with our suite of business applications, all of which are infused with our machine learning services. As companies accelerate their move to the Cloud, we can help them automate their IT operations, better understand their data, and become more cost effective and secure, while also offering them transformative office productivity. In addition, we are helping customers adopt our powerful Chromebooks and Android phones. +Our recent Next 2016 conference in San Francisco showed just how serious we are about the enterprise. It was wonderful to hear executives from Spotify and Coca-Cola share their stories about how they are benefiting from Google's Cloud technology, including our best-in-class security, reliability, and analytics. +We also introduced Cloud machine learning, which provides more on machine learning services with pretrained models, such as Cloud Vision API and Cloud Speech API. Our growth was accelerating going into that event and since then the quantity and quality of our enterprise conversations has risen to a whole new level. +Now we are investing in building our go-to-market activities to ensure we have the right expertise available for each of our business customers. We are enabling service partners to assist customers with everything from migrating to the Cloud to using machine learning to understanding their data. We are providing engineering to help them architect solutions and we are building out our support teams. +We are also helping businesses migrate to our suite of productivity applications, like Gmail, Docs and Drive, and customers love them. And we continue to accelerate our innovation in this area with new enhancements, such as Smart Reply and voice typing. It's gratifying to see the immensely positive response from our customers and partners who recognize that we offer a powerful combination that's unique to Google, unmatched product innovation combined with world-class security and reliability, technical transparency, and customer orientation. +To close, as I said before, Google's mission is and has always been to organize the world's information and make it universally accessible and useful. As I think about all of our businesses in each of the countries we reach, I have never been more excited about how our teams continue to bring this mission to life and make technology available for everyone. +I've been so proud to see us expanding our core products to more and more countries around the world. Street View in Sri Lanka, YouTube in Nepal and Pakistan, new Indic keyboards in India, and a new engineering center in Singapore that will help us get closer to the next billion users coming online by developing products that will work well for them. +We are laser focused on our mission at Google and I want to say thank you to all of the Googlers around the world who are helping us make it a reality each and every day. +Before we take your questions, Ruth and I wanted to take a moment to pay our respects to Bill Campbell, our very close friend and a mentor to many of us at Google and Alphabet who sadly passed on Monday. Bill spent endless hours with our founders and our leadership over the years, helping to build our board of directors and sustain our culture. He had a very big impact on our Company, made us all smile, and inspired many great leaders of the Valley. We offer our condolences to Bill's family and we will miss him. +And with that, I'll hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + We'll now turn it back to the operator for questions. Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +And our first question comes from Eric Sheridan of UBS. Please go ahead. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Maybe just two. First, on YouTube. You've now played around with the idea of original content, also injected a subscription offering into the marketplace. What have you learned from the early days of original content and a subscription offering and how that might allow YouTube to evolve and change over time as a product offering? +And, second, with respect to the advertising business, I was curious if there were any verticals or geographies that you might call out as either strengths or weaknesses in the advertising business during Q1? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [3] +-------------------------------------------------------------------------------- + + Thanks, Eric. On YouTube, we are definitely excited by the successful rollout of YouTube Red. It's been very well received. We have really focused on our creators and partners, so hopefully you caught some of our YouTube originals. We have released six so far, which are available to YouTube Red members. +Early indications are that this is something that's going to resonate well with users. And we are working on a lot more original content throughout the year and we'll see how it goes. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + And then in terms of your question on the regions, as I tried to make clear in my opening comments, what we saw was real strength across the board. I think you could see that from the growth rates with US up 21% year over year. That was really strength across products. +UK, we're really pleased with the team. We continue to see great execution there, on a fixed FX basis, as I noted, up 21%. The biggest contributor to growth in the UK was mobile search. +And then rest of world, growing at 25% on a fixed basis, that's about in line with last quarter. We continue to be really pleased with the growth we're seeing there. In addition to the ongoing contribution from mobile, the rest of world also benefited from Play. And then really nothing to note with respect to verticals. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [5] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Thank you. And your next question comes from Carlos Kirjner of Bernstein. Your line is now open. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Co. - Analyst [7] +-------------------------------------------------------------------------------- + + Hi. I have two quick questions. First, on margins, despite the increasing TAC as a percentage of revenues, adjusted operating margins expanded almost 140 bps for Google year on year. Can you help us understand, even if roughly, how much of this margin expansion is specific to the quarter, like due to FX versus systemic or secular, so to speak? +And the second question, I think maybe for Sundar, can you talk a bit about the decision you took last year to have an additional ad on mobile search response pages, relegating organic results below the fold? How is it good for the user experience to have ads instead of organic? And if it is good, what does it say about the potential for innovation in organic search? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + Thanks, Carlos. Starting on the margin question, you've hit a couple of the components. So, I'm going to try and just break it down into the drivers on cost of sales versus OpEx more broadly, as you asked it. +In cost of sales or the gross margin trend, as I tried to make clear, certain costs associated with revenue are going up, given secular trends in the market. So in sites, mobile carries higher TAC than does desktop, and mobile remains a strong growth driver, so we do expect this to continue. Then on the network side, we have strong growth in programmatic and that carries higher TAC than traditional ad buying. The obvious result is more revenue and gross margin dollars, but at a lower margin. +And then on OpEx, more broadly, we remain very committed to long-term revenue growth and profit, as we've talked about on prior calls. We did set priorities in the 2016 budget and we made some tough choices because our aim is to be as efficient and effective as possible with investment dollars, while properly funding the big opportunities that we have that are reflected in OpEx. +So as I've repeatedly said, some of the biggest bets are in Google. Sundar commented quite a bit on Cloud. That's an exciting opportunity. We want to continue to add head count to drive growth. And all of this is consistent with our goals of driving long-term growth in revenue and profit. +So, it goes to my opening comments that we're focused on controlling the expenses we have. And then there are certain trends, as I noted, in particular on the TAC side, that have been increasing with the strong growth we're seeing in mobile and programmatic. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [9] +-------------------------------------------------------------------------------- + + And, Carlos, on the ad side, we are incredibly sensitive to the user experience on search. So, we are constantly evolving how we display ads. But we take a very long-term view. Our ads quality efforts, these are people who have been working on this for many years, and they are squarely focused on optimizing for positive metrics across users and advertisers. +So, our utmost focus is making sure for users these changes have a positive impact. Mobile is an entirely different paradigm. There's a lot of things that are counter intuitive. For example, users are very comfortable swiping on mobile. We deeply think about these things and I'm very comfortable about how we are planning this for the very long term. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Co. - Analyst [10] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Ross Sandler of Deutsche Bank. Your line is now open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [12] +-------------------------------------------------------------------------------- + + Thank you. Ruth, I just had one question, a follow-up from a previous one on the regions. The US had greater than expected seasonal downtick. It was down 9% quarter on quarter. And I know that you picked up Yahoo and lost AOL from 4Q to 1Q. So is that the primary driver of that, or as YouTube becomes a bigger percent of your revenue, should we expect greater seasonal uptick in 4Q and seasonal downtick in 1Q? Can you just give us a little bit more color on what's driving that? Thanks. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [13] +-------------------------------------------------------------------------------- + + We don't, as you know, comment on any particular partners. So all I can add here is that the deceleration quarter on quarter does reflect holiday-related seasonality, which we did call out last quarter, and you see that in a number of the products. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Mark Mahaney of RBC Capital Markets. Your line is now open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks. You talked about TAC rising because of the increasing mix shift towards mobile and programmatic. It seems like there was a little bit extra bump-up this quarter. Would there have been any one major renewal of a deal that would have caused that? It did seem to spike more than what you would get, I assume, if you just rolled out mobile and programmatic. +and then any commentary on Nest? There seemed to be an unusual amount of press inter-quarter on troubles at that asset. Could you just comment quantitatively on how the asset is doing? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [16] +-------------------------------------------------------------------------------- + + On TAC, it's really the ongoing growth in mobile, as I've answered a couple of times here, and that reflects the strong secular trends behind mobile. So, really nothing to add on the Sites TAC side. And then on the network side, again, it's really the higher TAC that we're seeing on programmatic. So, nothing really to call out. +And then with respect to your question on Nest, what I'll add there is Nest products are best sellers in the category. It's a leading brand in the connected home. It's obviously early, but a very exciting category. And as we've talked about, our Other Bets are all very early stage, but continues to be best seller in the category. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And your next question comes from Heather Bellini of Goldman Sachs. Your line is now open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [19] +-------------------------------------------------------------------------------- + + Great. Thank you. This question is for Sundar. It's multipart. I was wondering if you could talk a little bit more about your Cloud ambitions and wondering what do you see as the biggest changes in strategy post Diane Greene's appointment? And then how are you getting enterprise customers to think of you as having enterprise DNA, if you will, which is something that took Amazon a long time to get? And then, lastly, if you could just help us think about which type of work loads do you see Google as being the most competitive for at this time? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [20] +-------------------------------------------------------------------------------- + + Thanks, Heather. Obviously, I talked about it a lot in my prepared remarks. We already had a lot of momentum in this area and in many ways, given the scale at which we have done this internally for us, we view it as an area we are very competent at. +What Diane has brought to us is a deep understanding of how to think about what enterprises need and adapt to it in a very detailed and nuanced way. You saw the momentum at the Next conference which she hosted. We are getting a lot more inbound. We are in much deeper conversations than we have ever been before. +We do think we are competitive across a range of workflows. And areas where we view we will be uniquely capable over time is because of our machine learning capabilities helping enterprises really understand their data, understand how best they can do what their core competencies, really revolutionize around that. It's early days and it's a long-term investment, but bringing on machine learning APIs over time through Cloud, to our enterprise customers is going to be a huge source of differentiation for us. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Doug Anmuth of JPMorgan. Your line is now open. + +-------------------------------------------------------------------------------- +Doug Anmuth, JPMorgan - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Two things. First, Sundar, I was hoping you could comment more on mobile search pricing. In particular, it gets a little bit lost just within overall pricing per click, especially with YouTube in there. So, I was hoping you could comment on pricing on more of a like-for-like basis. And as inventory perhaps stabilizes some, would you expect pricing here to increase over time as conversion improves? +And then, secondly, Ruth, if you could just comment a little bit more on other income and just help us understand some of the details there on the negative number in that line. Thanks. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [24] +-------------------------------------------------------------------------------- + + I'll take those. In terms of the first question, there's obviously some data, as I referenced, attached with the press release. And as you know well, all of the monetization data reflects a host of factors from geographic mix and device mix and property mix, as well as it's all on a floating FX basis and clearly FX is a contributor. +I think you're trying to get more color on mobile, and what's hopefully clear from the opening comments is that mobile continues to outperform. Desktop growth did pick up modestly in Q1, but from opening comments it should be clear that mobile search revenue was up significantly. +And then in terms of your question on other income, let me point you to the OI&E table that's at the end of our press release. This line consists of a number of different items. They can be affected by different trends, but you can see the breakout in that table, which hopefully is helpful there. +Interest income has been fairly consistent. We do continue to manage our portfolio conservatively. FX is consistently an expense here. It was slightly elevated again this quarter, given the ongoing volatility in foreign exchange markets. We haven't changed our approach yet, but upward volatility in the markets. +Then the OI&E line also includes changes in value or equity pickups related to marketable and nonmarketable securities and investments. We appreciate with all of those different line items, it's tough to forecast, but you can see the detail attached to the press release. + +-------------------------------------------------------------------------------- +Doug Anmuth, JPMorgan - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Stephen Ju of Credit Suisse. Your line is now open. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. Sundar, I think it was at IO last year when you started to call out the products which have over a billion users. At this point, are you able to elaborate on what percent of these users have either Google ID or are known users for you? +And, Ruth, a housekeeping item on the CapEx here. When you talk about CapEx for the Other Bets being primarily for Fiber, is this a fairly straightforward passing of homes, or is your cash used going toward developing new technology or products like Sky Vendor? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [28] +-------------------------------------------------------------------------------- + + Stephen, on the first question, maybe I can add more color this way. Our user base is scaling most -- we are also seeing tremendous shift towards mobile. So, many of these products we are already over 50% of these users are coming from mobile. And in mobile typically the users, all users are signed in. So, so I think over time as the shift continues, I think we have a user base which is signed in. And so that's the way we think about it. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [29] +-------------------------------------------------------------------------------- + + And then on the CapEx question, if I just broaden that a bit, the CapEx trend is in part efficiency, in part is timing. When you look at year-over-year spend compared to last year, we had some outsized machine spend that filled some recently constructed data centers. And as we've consistently said, our technical infrastructure is a really key strategic asset for us. We have tremendous scale. We continue to add to it and the team has done an extraordinary job innovating to deliver some meaningful efficiencies in machine use, and that enables us to benefit from earlier investments. +Although you asked about the Fiber side, just to build off of what Sundar was saying on Cloud, given what a strategic priority that is for us and the requirements for a leading Cloud business are clearly at the core of all that we do, and at a scale that's unmatched given our sustained investments in infrastructure, one of the things that was also mentioned at Next is that we plan to add 12 new regions. To be clear, we're going to be using multiple execution paths for those data center requirements. +In other words, every Cloud region isn't necessarily going to be housed in a Google data center, so we don't need to build data centers in all of these places. They will all incorporate the same Google hardware and software and meet the same performance, reliability and security requirements. And investing in Cloud isn't only about CapEx. We also put a lot of head count behind that again this quarter. +And then, more specifically, on the Fiber side, as you are pointing to, we do expect that to increase throughout the year as we execute on the cities that we've already announced. It's primarily about continuing to execute on those cities. We now are up to 22 announced cities, two most recent announcements being some buildings, we're bringing Fiber to select buildings in San Francisco and we're working with the city of Huntsville. That being said, I liked your question because we're also very focused on innovation and technology. So, so it's really both but predominantly continued execution against the cities that we've announced. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [30] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Dan Salmon of BMO Capital Markets. Your line is now open. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [32] +-------------------------------------------------------------------------------- + + Hi, good afternoon, everyone. Just a few questions on YouTube. First, on the preferred program, Ruth, you mentioned it sounds like the growth continues to be really strong there going into Brandcast. I was just curious, is the program now formally rolled out globally? And then I've got one follow-up on Red. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + In terms of preferred, you're right, I did note that the strong revenue growth there is driven virtually exclusively by video. That's TrueView and increasingly Google preferred and, as we said, nice app promotions there, as well. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [34] +-------------------------------------------------------------------------------- + + And it's largely rolled out in major markets and we'll continue to do that. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [35] +-------------------------------------------------------------------------------- + + Okay, great. Then just a quick one on Red. It seems as if the direction for the content remains to focus on your own originals right now. What may or may not make you consider looking at other licensed, maybe more traditional TV or film content? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [36] +-------------------------------------------------------------------------------- + + We are going to approach it comprehensively. And we have obviously had great early traction with the six original series we have released so far. This year we are on track to release 15 to 20 original series of films coming up, so I think that's an exciting direction we will pursue. But at the same time, we'll keep an open mind about all other avenues, as well. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [37] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Justin Post of Merrill Lynch. Your line is now open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [39] +-------------------------------------------------------------------------------- + + Great. Thank you. I have a few. First, for Sundar, could you talk about the Cloud, why really get more aggressive now? We've been riding on it for many years. I'm just wondering why now really ramping up the investment. +And how would you characterize the margins or the returns on capital in that business? Why is that interesting for you? +And then maybe for Ruth, you give us a lot of detail on click growth, but I'm just wondering if you can help us all on query growth, just how that's trended since mobile really took off. Is it growing? How is it trending? And do you have more room to monetize given where your ad coverage is now? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [40] +-------------------------------------------------------------------------------- + + Just on the first one, you know, I would say there are three points of inflection for us and that's why we are really ramping it up. The first is we have always been doing Cloud. It's just been consuming it all internally at Google. But as we have grown, really mature in terms of how we handle our data center investments and how we can do this at scale, we have definitely crossed over to the other side where we can thoughtfully serve external customers. So that's the first point of inflection. +The second point of inflection for us is, as we've been investing in machine learning and AI for years, but I think we are at an exceptionally interesting tipping point where these technologies are really taking off. And that is very applicable to businesses, as well. So, thoughtfully doing that externally, we view as a big differentiator we have over others. +And third is definitely Diane Greene coming in. I want her to scale our efforts here thoughtfully when it is set up with a great leader who understands this space deeply. And so those are the three main reasons why we are significantly ramping up what we are doing there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [41] +-------------------------------------------------------------------------------- + + And then on query growth, we don't really talk about query growth, as Sundar said, focused on answers, there are a lot of new ways to search on mobile, voice, et cetera. So let me actually try to add a little more on Cloud. +We've consistently said it's early days. You asked about ROIC. We're really excited about the magnitude of the opportunity, as Sundar has talked about. And one thing that's really powerful here is we're benefiting from our heritage, from our differentiated strength, the scale of our infrastructure. Those are investments we've made over many years that give us extraordinary efficiency. +We have robust security. Again, we've invested over many years. We have unparalleled machine learning. And so, really, when we think through to the ROIC opportunity compelling, building on investments that we've made and continue to make in a very exciting opportunity. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Thank you. And your next question comes from Anthony DiClemente of Nomura. Your line is now open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities - Analyst [44] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. First, for Sundar on Google Fiber, just at a higher level, would you please broadly update us on your learnings from Google Fiber up until this point? And what are the goals that Google is trying to achieve with Google Fiber in terms of longer-term ambitions, in terms of TV or video distribution? +And then, Ruth, you mentioned in your prepared remarks mobile search being driven by improvements in ad formats and deliveries starting in the third quarter of last year. Is there any way to frame or think about what sites revenue growth might be on a recurring basis if we were to try to exclude the impacts or benefits from the changes in formats that you mentioned, and as we start to think about the year-over-year growth comparisons there for the back half of 2016? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [45] +-------------------------------------------------------------------------------- + + Let me go ahead and start on the Fiber question. Fiber is one of the businesses that is in Other Bets. And like all of our access efforts, we're really focused and our vision here is to create abundant and ubiquitous networks. We think there's a lot of opportunity to improve the experience that users have. And that's where the Fiber team is focused. +We have some other efforts within Other Bets that are really exciting, as well, that address access, within our X businesses targeting the 4 billion people still offline, and we view that as a big opportunity and an important problem to address. +In terms of the early learnings, there have been a lot. As I talked about on the last-quarter call, we've really continued to refine and enhance our go-to-market strategy, the way we're working with cities, the way we're building out those cities, and really the level of technology and innovation that we can use to differentiate the offering, and are pleased with the ongoing efforts there. +And then in terms of the change in ad format, as we've talked about on a lot of calls, innovation is core to all we do. It obviously happens on its own time line. We have a culture of it. We're continuously focused on it. Not going to break out impact for any change. We're constantly looking to innovate and improve the user experience. +There was a stepup, which we've talked about, and we continue to look at other ways, as Sundar talked about, to continue to enhance the user experience. But I think the most important point, and somewhat implicit in your question, that shouldn't take away from the very strong underlying revenue and revenue growth that we have in that business. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities - Analyst [46] +-------------------------------------------------------------------------------- + + Thank you, Ruth. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Brian Nowak of Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [48] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. Just on mobile search and the mobile ad format changes in 3Q of last year, could you just help us, were those changes made globally last year in the third quarter? And if not, how should we think about when they will go globally or how you're phasing those changes? +Then the second one, on the desktop. Ruth, you mentioned that desktop picked up in the first quarter. What drove that pickup in growth? And any learnings from the change in the right-hand rail in the first quarter? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [49] +-------------------------------------------------------------------------------- + + The launch which you are talking about was global. We've been doing these changes for a long time. We try to roll it out globally and that's what we did. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [50] +-------------------------------------------------------------------------------- + + And then in terms of the desktop format change, we had a modest benefit from that change where, just to be clear for all, we reduced the ad load by removing ads on the right side of the screen, while adding a fourth ad slot for highly commercial queries. And, in the aggregate, that resulted in a cleaner, more useful presentation and improved user experience. It was a modest impact, but additive. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [51] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Ben Schachter of Macquarie. Your line is now open. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [53] +-------------------------------------------------------------------------------- + + A few questions. Sundar, your commentary on Play focused on games. But what needs to happen to have more verticals beyond games become meaningful? +And then, Ruth, a couple more on the sites TAC. At a high level, how do average TAC rates differ on mobile versus desktop? Aside from the TAC rates, are there any other notable contractual issues that differ meaningfully between mobile and desktop search partnerships? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [54] +-------------------------------------------------------------------------------- + + Ben, on the first question, I think that's a good question. We are seeing traction across categories, it's just that games are on a much larger scale. But for example, when we get into education, if you view that as a vertical, we do see traction there, and so on. +I think taking a very long-term view, it will probably reflect where there are commercial opportunities across every vertical. But game developers are the savviest developers in terms of getting ahead of this curve. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [55] +-------------------------------------------------------------------------------- + + And on your TAC question, as I've indicated a number of times already on the call, the TAC rate is higher on mobile. Mobile is growing at a faster rate and what you're seeing here is a mix shift. So, there is a delta between the two. +But I think, importantly, we're benefiting from an important secular trend behind mobile, and like the revenue dollars and the gross profit dollars that come as a result of that. And we'll continue to innovate on mobile and are excited about the opportunity in particular with all the changes that we continue to see in the way users use the phone and the opportunities. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Thank you. And our final question comes from Colin Sebastian of Robert Baird. Your line is now open. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [57] +-------------------------------------------------------------------------------- + + Okay, great, thanks very much. Sundar, first off, you mentioned a lot of the ongoing projects at Google. But I wonder if you could share with us the two or three areas that you're spending most of your time on or are focused on. +And related to that, one of the strengths of the Company is obviously the strong engineering orientation and ability to hire some of the best talents and acquire the best technology. And the Company's been able to adapt very quickly to change. But I wonder which areas of your business demonstrate where Google or Alphabet are really on the forefront of development, pushing innovation rather than adapting to changes you see in the market. Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet, Inc. - CEO of Google [58] +-------------------------------------------------------------------------------- + + Thanks, Colin. On the first thing, obviously we are doing many things, but I tend to spend my time at the core of our core product. I think we have a unique opportunity to evolve search to be very assistive in how we serve our users, and be an intelligent assistant that helps users throughout their needs in context, especially in the context of mobile. That's an area definitely I spend a lot of time on. +And related to that, we do think we can do a lot of that based on our core advancements in machine learning and AI. So, that's an area we invest a lot and I'm thoughtfully involved with that, as well. +And, third, definitely from a computing standpoint, computing is foundational to everything we do. So, thinking through about how computing evolves, be it emerging technologies like VR or how mobile advances over the next few years. These are all areas where I do spend time on. +And, overall, I do think in the long run, I think we will evolve in computing from a mobile-first to an AI-first world. And I do think we are at the forefront of the development. So, we don't view it as adapting to it as much as pushing hard and getting there. So that's the core of what we do and we'll continue to do that. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [59] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Ms. Ellen West for closing comments. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet, Inc. - CFO [61] +-------------------------------------------------------------------------------- + + Thanks to everyone for joining us today. We look forward to speaking with you again on our second-quarter 2016 call. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day, everyone. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2016-Feb-01-GOOGL.txt b/Transcripts/GOOGL/2016-Feb-01-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..f5347c6e5545c5e00e6d0cf1d9a1256a79ef9af0 --- /dev/null +++ b/Transcripts/GOOGL/2016-Feb-01-GOOGL.txt @@ -0,0 +1,571 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Alphabet Inc Earnings Call +FEBRUARY 01, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - CFO + * Sundar Pichai + Google Inc. - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen Ju + Credit Suisse - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Eric Sheridan + UBS - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Co. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Inc fourth-quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. +(Operator Instructions) +As a reminder, this call is being recorded. +I would now like to introduce your host for today's conference, Ellen West, Vice President of Investor Relations. Please go ahead, ma'am. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. +Good afternoon, everyone, and welcome to Alphabet's fourth-quarter 2015 earnings conference call. With us today are Ruth Porat and Sundar Pichai. +Some of the statements that we make today may be considered forward-looking including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. +For more information, please refer to the risk factors discussed in our Form 10-K for 2014 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +As you know, we distribute our earnings release through our Investor Relations website, located at abc.xyz/investor. Please refer to our IR website for our earnings releases. This call is also being webcast from abc.xyz/investor where a replay of the call will be available later today. +I'll now turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks. +Revenue momentum in Q4 underscored the strength of our businesses globally, with consolidated revenue growth accelerating meaningfully versus last year. The primary driver was the increased use of Mobile Search by consumers, benefiting from our ongoing efforts to enhance the efficacy of Mobile Search, as well as from the holiday season. In addition, results reflect ongoing momentum in YouTube and programmatic advertising. +There were a number of unusual items in the quarter that I will address during the discussion of results. With the move to our new Alphabet structure, we conducted a detailed review of business opportunities and investment levels across Google and Other Bets. +We made some important decisions to prioritize the allocation of resources and capital to maximize long-term potential within each area. We are pleased to be sharing financial results for each of Google, and what we call the Other Bets, and thereby provide more visibility into financial trends in each segment. +In light of our move to segment reporting, I'm going to present to you in this order. First, review the quarter on a consolidated basis for Alphabet. Second, review the results for each of Google and Other Bets. +Finally, I will conclude with key themes for the near term. Sundar will then review our business and product highlights for the quarter, after which we will take your questions. +Beginning with a summary of Alphabet's consolidated financial performance. Total revenue was $21.3 billion, up 18% year over year and up 14% sequentially. +As a result of the ongoing strength of the US dollar, we realized a negative currency impact on our revenues year over year of $1.3 billion, or $1 billion after the benefit of our hedging program. Holding currency constant to prior periods, our total revenue grew 24% year over year and 15% sequentially. Alphabet revenues by geography also highlight both the strength of our business around the globe, as well as the impact that currency headwinds continue to have on our non-US business. +US revenue was up 24% year over year to $10.3 billion, and up 18% versus Q3. UK revenue was up 16% year over year to $1.9 billion, and up 7% sequentially. +In fixed FX terms, the UK grew 20% year over year and 9% quarter over quarter. Rest-of-World revenue was up 12% versus last year to $9.1 billion, and up 12% versus Q3. In fixed FX terms, revenues were up 26% year over year, and up 14% sequentially. +Non-GAAP other cost of revenue was $3.9 billion in Q4, up 24% year over year, primarily driven by Google-related expenses, most notably due to costs associated with operating our data centers including depreciation, content acquisition costs, primarily for YouTube, and hardware costs, due to the launch of our new Nexus, Chromecast and Pixel devices. +Non-GAAP operating expenses were $6.6 billion, or 31% of revenue, up 14% year over year and up 15% versus Q3, primarily driven by R&D expense, particularly affected by expenses resulting from project milestones in Other Bets established several years ago. On a GAAP basis, operating income was $5.4 billion, up 22% versus last year. The operating margin was 25%. +Adjusting for stock-based compensation, our non-GAAP operating income was $6.8 billion, up 22% versus last year. The operating margin was 32%. +With respect to stock-based compensation, it totaled $1.4 billion, up 20% year over year and flat sequentially, primarily reflecting headcount, which was up 15% versus last year and 3% versus 3Q 2015. The vast majority of new hires continue to be engineers and product managers. +Other income and expense similarly included an unusual item this quarter. Specifically, other income and expense was negative $180 million due primarily to the write-down of securities received in conjunction with the sale of a business, offsetting interest income from the investment portfolio. Finally, taxes also reflect the impact of certain one-time items in the quarter affecting the US rate. +Specifically, taxes reflect the resolution of a multi-year audit in the US, as well as the full year impact in Q4 of the US Congress making the R&D tax credit permanent. Our effective tax rate for the full year, including these one-time items, was 17%. +Net income was $4.9 billion on a GAAP basis and $6 billion on a non-GAAP basis. Earnings per diluted share were $7.06 on a GAAP basis and $8.67 on a non-GAAP basis. +Turning now to CapEx and operating cash flow. CapEx for the quarter was $2.1 billion. Operating cash flow was $6.4 billion with free cash flow of $4.3 billion. We ended the quarter with a cash and marketable securities balance of approximately $73 billion, of which approximately $43 billion or 59% is held overseas. +Our cash balance reflects the impact of seasonal working capital requirements and our repurchase during the quarter of approximately 2.4 million shares of Alphabet Class C stock for a total repurchase amount of $1.8 billion. Our Board of Directors recently authorized a modest increase in the size of the stock repurchase we announced last quarter. You can find the details in our earnings release of the total remaining authorization. +Let me now turn for the first time to our segment financial results. In our earnings release, we are providing key financial metrics for Google on the one hand and the combined Other Bets businesses on the other hand. I will review the results for each segment with respect to revenues, operating income, and CapEx, which I will discuss. You can also find in the release details of stock-based compensation, as well as depreciation, amortization, and impairments for Google and the combined Other Bets. +As I go through the Google segment, I'll be providing the same level of detail we've presented in prior periods, both to best assist in comparability relative to prior periods, and given the fact that Google continues to represent the overwhelming majority of our results. For Other Bets, I'll be discussing revenue, operating income and CapEx for the full year [2015]. Detail on a quarterly basis is included in the press release. +Keep in mind that Other Bets represents an aggregation of businesses, many of which operate in distinct sectors with different business models. Given their stages of development, these businesses will have idiosyncrasies with respect to the timing of revenue, expenses, and CapEx resulting from milestones, partnerships, and other factors. You can expect that results for the combined Other Bets may be uneven in the near term, so it's likely to be more instructive to look at them on an annual or rolling 12-month basis to assess their trajectory. +Starting with the Google segment, which includes our Search and Ads business, as well as related businesses such as Play, hardware, and Cloud and Apps, as well as our newer efforts within Google such as Machine Learning and virtual reality. Google revenue was $21.2 billion, up 18% year over year. This reflects the impact of FX. In terms of the revenue detail, Google sites revenue was $14.9 billion in the quarter, up 20% year over year, and up 14% sequentially, notwithstanding currency headwinds. +Year-on-year growth reflects substantial strength in Mobile Search due to ongoing improvement in ad formats and delivery. As I mentioned previously, we also saw the benefits of consumers' greater use of mobile for shopping during this holiday season. +YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView and Google Preferred. Network revenue was $4.1 billion, up 7% year on year and up 12% sequentially, continuing to reflect the strong growth of programmatic, offset by the traditional network businesses. +Other revenue for Google was $2.1 billion, up 24% year over year and up 20% sequentially. Given the geographic mix of our Play business, FX also had an impact on other revenue. Year-over-year performance was driven by Play, as well as continued strong growth in Cloud and Apps. +Finally, on monetization, as a reminder, these metrics similarly are affected by currency movements. Aggregate paid clicks grew 31% year over year and 17% sequentially. Aggregate CPCs were down 13% year over year and 5% sequentially. +In terms of the drivers, within sites, paid clicks were up 40% year over year and up 22% sequentially. Sites CPCs were down 16% year over year and down 8% sequentially. The movement in Google sites, paid clicks and CPCs primarily reflects the continued growth in YouTube TrueView. +Network paid clicks were up 2% year over year and up 1% sequentially. Network CPCs were down 8% year over year and up 7% sequentially. Total traffic acquisition costs were $4.1 billion, or 21% of total advertising revenue, up 14% sequentially, and up 12% year over year. +As a reminder, the sites TAC line in our earnings release includes the TAC that we paid to search distribution partners for distributing Google Search as distinct from their own branded search. Operating income excluding SBC was $8 billion, up 28% versus last year for an operating margin of 38%. Google stock-based compensation totaled $1.3 billion for the quarter, up 18% year over year. +Operating income reflecting the impact of SBC was $6.8 billion, up 30% versus last year, and the operating margin was 32%. CapEx for the quarter was $1.8 billion, reflecting investments in data center construction, production equipment and facilities. Full year 2015 Google revenues were $74.5 billion, operating income excluding SBC was $28 billion, operating income including the impact of SBC was $23.4 billion, and CapEx was $8.8 billion. +Turning to Other Bets financials. Other Bets includes efforts such as all we are doing with Fiber, Verily, Calico, Nest, self-driving cars and our incubation activities in X. As discussed previously with respect to Other Bets, we're focused on optimizing resources across this portfolio in the near term with the objective of maximizing Alphabet's long-term value creation. +For the full year 2015, Other Bets revenue was $448 million, up 37% versus last year. Reported revenue for Other Bets was primarily generated by Nest, Fiber, and Verily. As noted previously, the majority of efforts within the Other Bets are pre-revenue. +On a full year basis, operating loss, excluding SBC, was $3.1 billion. As previously noted, these results reflect the impact of project milestones established several years ago. Including the impact of SBC, operating loss was $3.6 billion. +Other Bets CapEx was $869 million for the full year, primarily reflecting investment in our Fiber business. Let me conclude with some comments about our continuing transformation of Alphabet. +As Larry articulated in the 2013 founders letter, and then again when announcing the creation of Alphabet, incrementalism in technology leads to irrelevance over time because change tends to be revolutionary, not evolutionary. This belief was the impetus for our organizational structure, which enhances focus on opportunities within Google and across Alphabet, while also pushing our leadership to extend the frontier that we are addressing. +Consistent with the move to Alphabet, we expanded transparency internally regarding the expenses and CapEx required in each business, which benefited our 2016 budgeting process and capital allocation decision making. As part of this process, we established technical and business targets for a number of the businesses to set the appropriate pace of investment. We made necessary choices to align resources with those efforts that maximize the potential for long-term value creation, prioritizing certain efforts while making tough calls in others. +Given the fact that we are innovating in a number of exciting industries, in some areas, the optimal execution path could encourage accelerated investment. In others, we continue to receive interest in exploring partnerships or alternate approaches to commercializing our efforts. +Verily is a great example of where we formed strategic partnerships with companies like Dexcom, J&J, Novartis and Sanofi in order to accelerate our efforts. My main point here is that we remain on a journey and it is still early days. We are working diligently to build additional businesses that create long-term revenues, profits, and value. +Looking forward, a few observations. First, regarding revenue. As a reminder, the fourth quarter tends to be seasonally our strongest quarter, reflecting the benefit of the holidays. In addition, our GAAP results will continue to be affected by changes in the relative strength of the dollar. +Second, operating expenses. As I said last quarter, our priority remains revenue growth, but that doesn't give us a pass on a rigorous approach to expense management. We continue to invest in longer-term opportunities within both Google and Other Bets, consistent with our emphasis on pushing the frontier to adjacent areas and moon shots. Given the early stage nature of a number of these efforts, they're likely to require additional investment prior to generating meaningful revenues. +Notably, in many ways some of Alphabet's biggest moon shots are in Google itself. From driving the next wave of computing through machine learning, capitalizing on the shift to the cloud by enterprises, building platforms like virtual reality and pursuing the opportunities we see with the next billion users in emerging markets, you should expect Google to continue to invest in efforts to improve life for billions of people. +Third, CapEx. As we've indicated previously, the vast majority of CapEx supports Google. We view our computing capacity as a core competence and will continue to invest here given our advantages in providing efficient, secure computing to support growth in both our consumer products and services globally, as well as our cloud and apps businesses. +In Other Bets, the majority of CapEx supports the ongoing deployment of Google Fiber. We are still operating in only a few cities, but have announced plans for additional cities which we expect will be reflected in 2016 CapEx. +Fourth, our balance sheet. In 2016, we intend to align our capital structure with the Alphabet organization so that debt is held at the holding Company level. That alignment would allow us to have greater flexibility as we continue to grow, including the ability to utilize debt financing if appropriate and consistent with our changing product mix. +So my closing comment is that we saw tremendous revenue growth across our businesses and are applying discipline as we move to implement the Alphabet structure. +I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. It's great to be here to talk with you all again. +Above all, our Q4 results show the great momentum and opportunity we have in Mobile Search and across Google's range of businesses. What's most exciting is the incredible enthusiasm for our products among consumers and our partners. +Two things show this. First on our last call, I shared that six of our consumer products, Search, Android, Maps, Chrome, YouTube, and Google Play all have over 1 billion monthly active users each. I'm pleased to share that Gmail now joins those ranks, crossing that number last quarter. Of course, all of these products are very popular and continue to grow rapidly on mobile. +Second, there is incredible momentum behind the Android ecosystem and the model is working at scale. This is a group of companies with whom we have worked really hard to build strong relationships. At the center of this are Android phones and it's exciting to see the lineup of flagship devices our partners are working on this year. And there are newer areas which are showing a lot of promise. +In addition to an Android Wear partnership with New Balance and a new smart watch from our friends at Casio, over 40 car brands worldwide are bringing Android Auto to their cars. Dozens of partners are integrating Android TV and Google Cast technology into living room products launching this year. +I want to talk about two main things today. First, some thoughts on the approach we are taking to drive the next wave of innovation. And then some thoughts on our advertising business and our newer emerging businesses. +First, a few words on our approach. At Google, we've always tried to bring our unique technical strengths to areas where we think we can make a big difference, like indexing the world's information to make it discoverable. +We have focused a lot on really improving Search and Mobile and now we are investing in evolving this to actively assist our users throughout the day in smart and helpful ways. This comes thanks to our years of investments in areas like natural language processing, computer vision, Knowledge Graph and other areas. And the next wave will be powered by big advances in machine learning and artificial intelligence, an area where we believe we lead the industry. +Just last week, DeepMind published an incredible result, the first ever to master the game of Go with artificial intelligence, an amazing accomplishment, and I'm excited for the world championship in March. And in November, we open sourced TensorFlow, our new machine learning system, to help accelerate discovery and development in the field. +Machine learning is making our products smarter and more useful for people every day. It powers Smart Reply inInbox by Gmail which suggests short responses that are relevant to an incoming e-mail. +People absolutely love this feature. In fact, in just a few months, Smart Reply already makes up 10% of all mobile responses in Inbox. From image recognition in Photos, to eliminating e-mail spam, to better translation and voice recognition, our machine learning efforts are making a huge difference for people every day. +In sum, we believe we have only scratched the surface of truly being there for our users, any time, any where, across all devices, giving them the assistance they need. We are excited to make even more progress on this vision in 2016. +The second part of our approach is to make sure we are solving big problems for everyone. We believe that someone in Indonesia should get the same quality e-mail service or search results as someone in New York. +This quarter, I visited Korea, Vietnam and India to speak with partners, developers and students. It was a very inspiring trip. I even sat down at a local coffee shop with Dong Nguyen, the creator of the popular Flappy Bird game, which has inspired Vietnam's growing community of developers and startups to think hard about how to create worldwide hits. +From providing Internet access in India's railway stations to making Chromebooks available throughout the region, it reinforced what a huge opportunity we have to help the next billion users come online and to have great experiences with the whole Internet once they are there. That's why creating open platforms that anyone can build on is core to Google's DNA, from Chrome to Android to Brillo to our latest virtual reality efforts. +It's still incredibly early innings for virtual reality as a platform and Cardboard is just the first step, but we are excited by the progress we have seen. Our partners have shipped over 5 million Google Cardboard viewers and we recently teamed up with the New York Times on a virtual reality experience in which over 1 million Times subscribers received Cardboard. +And since launching in September, the Expeditions Pioneer Program has helped more than 500,000 students travel to places like the bottom of the sea or the surface of Mars. Beyond these early efforts, you'll see a lot more from us and our partners in 2016. +Now turning to the trends and highlights that we're seeing across our advertising business, as well as some of the newer areas. It's hard to believe that AdWords just celebrated its 15th birthday. Just like Google Search, and the computing devices we all use now, the product is largely unrecognizable from the first version that launched in 2000. But the key value proposition remains unchanged. +Google helps advertisers reach the right customer at precisely the right micro moment, when they're looking to buy something, go somewhere, know something or do something. Mobile is really helping us making these connections for marketers. As Ruth mentioned, Mobile Search was particularly strong in the fourth quarter. +This holiday season we found that shopping moments replaced shopping marathons. Shoppers turned to their mobile devices to purchase gifts online in spare moments throughout the day all season long, and marketers turned to our mobile ad offerings to reach those customers. And people are actively buying products when searching on mobile. +Our research those that 30% of all online shopping purchases now happen on mobile phones. In fact, in the US looking just at product listing ads, revenue from mobile phones exceeded desktop on Thanksgiving, Black Friday, and through the weekend. Not only were people using mobile ads to shop online, they also used their phones to find the best products and prices in stores around them. +Our local inventory ads helps people see if a product they are looking for is in stock at a retailer nearby. Marketers at Lowe's and Target find them useful because they can measure the foot traffic that their search ads drove. In fact, thanks to local inventory ads, Target reported millions of incremental store visits in the week leading up to Christmas. +We also continue to see great success in driving app downloads. Our app promotion offerings like universal app campaigns, which helped marketers easily run campaigns in Google Play, YouTube, Search and across our display network, are getting great traction and delivering results for our advertisers. We are now seeing a trend of advertisers moving their app install budgets to Google. +Now moving to video. People watch hundreds of millions of hours on YouTube every day and it continues to be a must have for all brand advertisers. Not only does YouTube on mobile reach more 18 to 49-year-olds than any cable network in the US, but the time people spent watching YouTube in the living room more than doubled in 2015. +Brands turn to YouTube to inspire and engage potential customers. And with our recently launched shoppable TrueView ads, marketers like Michael Kors can connect the dots between inspiration and purchase. And it is brands of all sizes. In fact, over the last two years the number of small and medium-sized businesses advertising on YouTube has doubled. We also continue to expand measurement options for marketers on YouTube to help them better understand the effectiveness of their ad spend. +In addition to our own measurement tools, we recently introduced support for third party viewability vendors on YouTube. YouTube is also a powerful platform for creators. Today, any creator can upload a video to YouTube and get discovered by over 1 billion people around the world. That global exposure has allowed YouTube and Google to pay out over $3 billion to the record industry to date. +We are also investing in the future of video. You can now watch VR videos on YouTube and content creators can now film in new YouTube spaces in Paris and Mumbai. Between incredibly strong viewership growth, the move of advertising budgets to digital video, great new features, as well as the successful rollouts of YouTube Music and our YouTube Red subscription offering, I couldn't be more excited about the prospects for YouTube in the years ahead. +In programmatic video and display, we continue to see strong momentum. More marketers and publishers used programmatic automated ad buying and tools through our DoubleClick platform this holiday season than ever before. Programmatic video impressions doubled compared to the holiday season last year. And in the week leading up to Black Friday, more than 60% of programmatic impressions came from mobile devices. +Lastly, I'll discuss some of our newer business areas where we continue to see tremendous potential. Google Play, our hub for digital content, continues to see great momentum. In 2015, spend per buyer in the Play store grew by more than 30% globally compared to 2014. We had particularly strong growth in this area in countries like Brazil, India, Indonesia, and Mexico, thanks to continued investments in payments capabilities. +On hardware, as you know, last quarter we launched the Nexus 5X and Nexus 6P in more than 30 countries. They are truly great examples of the best that Android can offer and have gotten great reviews. And the adoption of Chromebooks continues to gain a ton of momentum, particularly in education. +Before I wrap up, I want to share some thoughts on our Cloud and Apps group. Public cloud services are a natural place for us so we established a business unit late last year to take full advantage of the opportunity. +I'm excited that Diane Greene, a highly respected industry vet, joined to lead it. As you know, Google pioneered the cloud at scale. Our data centers have handled the workload of Google's own products from Search to YouTube for 17 years. We are able to take that infrastructure and computing power and optimize it for all customers. +Our data centers, infrastructure, machine learning and premium data services are leaders in the cloud space, as is our price to performance ratio. And we are now able to bring this to bear just as the movement to cloud has reached a tipping point. Businesses now see that the easiest to use, most price effective and secureinfrastructure can best be obtained through the major public cloud providers. +Google Cloud platform is already used by more than 4 million applications and we recently introduced a new way to purchase and use virtual machines called custom machine types, so that clients can tailor their purchases based on the memory they need to get the best possible cost and performance. +Our business collaboration and productivity suite, Google Apps, now incorporates the best of Google's new technologies like machine learning and natural language processing. Our adoption now extends from large healthcare providers to retailers to government. +Last quarter, Catholic Health Initiatives, the nation's second largest non-profit health system, with more than 100,000, employees announced it has moved to Google Apps. There's great buzz at Google around this area and we continue to heavily ramp up investment here. +I want to say thank you to all of the Googlers around the world for their amazing work, from cloud computing, digital video, and the mobile revolution, to machine learning, virtual reality and helping the next billion get online, Google has a front row seat on the trends that will define computing in the coming years. There is truly no more exciting place to come to work every day. +With that, I'll turn it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. We will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +And our first question comes from Carlos Kirjner from Bernstein. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Co. - Analyst [2] +-------------------------------------------------------------------------------- + + Hello. Thank you for taking my questions. I have a couple. First, Sundar, do you believe there's a non-trivial chance of Google and the DeepMind team achieving strong AI in the next five years or so? +And, secondly, on your revenues, can you tell us whether you feel the drivers of sites revenue growth and what seems to be an acceleration have legs and are more like improving user experience and advertising returns and less like increasing ad loads which one could argue have limited headway? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Carlos. I'll answer the first one, and turn it over to Ruth on the second. On AI, we are, obviously, seeing incredible progress in this field. We make great strides and we start taking it for granted and look to the years ahead. It's always tough to predict what happens over a five-year time frame, but I do see us making significant strides. +Even a year ago, I wouldn't have predicted that we would be in a strong position to mount a serious challenge to the world champion in Go this year. Looking at the pace of progress, I think we will have AI in a form in which it benefits a lot of users in the coming years, but I still think it's early days and this is a long-term investment for us. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [4] +-------------------------------------------------------------------------------- + + And then on sites revenue, what the results reflect is product strength, geographic breadth and obviously, the added backdrop of an active holiday season with the sites revenue up 20% year-on-year, notwithstanding the currency impact. The way we look at it is we've got extraordinary capability and strength in Search and then ongoing innovation across the platform. As we talked about last quarter, we did benefit from a change made in Q3 in ad format with respect to Mobile Search and we do continue to benefit from that change. +Mobile Search growth was the biggest driver again this quarter. And then in terms of YouTube, the momentum continues, the story continues to be about strong growth in video advertising, TrueView and Google Preferred as distinct from display on YouTube. And then just to round it out, desktop search remains a solid contributor, as well. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Co. - Analyst [5] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [6] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Eric Sheridan from UBS. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Maybe two on margins now that we have the new disclosure, and thanks for all of that information. With core Google, we saw a very nice operating margin improvement 2015 versus 2014. Wanted to know if we could get a little bit of color of what drove that, whether it was incremental revenue, pricing, cost efficiency, how you sort of think about what drove that? +And the opposite for Other Bets, clearly a bigger loss in 2015 versus 2014, maybe a little bit of color on the volatility, as you called it out, of how that might develop over time? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [9] +-------------------------------------------------------------------------------- + + Certainly. Starting with Other Bets, as I said in my prepared remarks, we're at the beginning of a journey with the creation of Alphabet and breaking this out into the segments is a meaningful step. As you look at some of the numbers, the reason I said it's more instructive to look at annual or rolling 12 months is that there can be some lumpy things on a quarterly basis, but we're continuing to invest across the businesses as we talked about. +So that would explain the 2014, 2015 trend here; it just underscores that we are investing in the business. We've made some tough choices, and as I said, in terms of you how we're allocating across the various businesses, but an important area for us and tried to give you the sizing here in the segment information. And then in terms of overall Google, we're continuing to invest there, as well. +We're investing quite meaningfully, as I previously said, the 70-20-10 model is an instructive framework that Larry has articulated for a long time. And as I tried to stress in my opening comments, we're looking to push the frontier both within Google and Other Bets. Ongoing innovation is key to all that we're doing in Google and it's benefiting users in the ecosystem broadly. So you're continuing to see us invest there and notwithstanding that you see the results that you have here today. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Heather Bellini from Goldman Sachs. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [11] +-------------------------------------------------------------------------------- + + Great. Thank you. Sundar, thank you for the color on your initiatives with the cloud and we're all very excited about Diane Greene's hiring. +I was wondering if you could share with us when you're having conversations with corporate customers over the last 12 months, what were the biggest areas of change, or things that they said Google needed to work on in order to win over their cloud business versus, say, them choosing to go with an AWS or an Azure? Can you talk to us about how that change might progress and how we might see that filter through in 2016? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [12] +-------------------------------------------------------------------------------- + + Thanks, Heather. I'm very excited to have Diane here, as well. We are already getting significant traction. It's a strongly growing business for us and we plan to invest significantly in 2016. +It will be one of our major investment areas. In terms of talking to customers, first of all, as I said earlier, the cloud platform is now already used and trusted by over 4 million applications. And a lot of it is about making sure we are very seriously committed to this space, which we are, and in terms of wanting -- there's a breadth of feature requirements, and so we've been carefully taking customer feedback and addressing all those needs. And as time goes by, I think we are getting very competitive. +We have natural advantages in doing this, but we also need to make sure we address all the feature needs and that's what we've been focused on. I think we are at a point now where the product is ready to be used at scale, and so I expect to get significant traction in 2016. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [13] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Mark Mahaney from RBC Capital Markets. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [15] +-------------------------------------------------------------------------------- + + Sundar, could you talk a little about -- provide any milestones for autonomous vehicles and Nest, they're two of the Other Bets that we're particularly intrigued by here. I know they're very long-term bets. The milestones that you've seen that kind of give you confidence in the forward direction of those businesses. Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [16] +-------------------------------------------------------------------------------- + + I'll take that. Those are two of the businesses that are, as we call them, Other Bets. Look, on self-driving cars, we have an extraordinary tech team. We've been working on it for many years. +The focus is developing technology with a real emphasis on safety and understanding what it takes to build and operate fully autonomous vehicles. We continue to make great progress. We've now driven 1.3 million miles with important data regarding safety and utility and that's what we're really focused on. We've got prototypes on streets in two cities. +So we're continuing to execute against that and continuing to build it out. And then on Nest, we have now more than 14,000 developers who have joined the Works with Nest program, enabling them to connect with Nest products through the cloud. The team refreshed the entire product portfolio in 2015. That resulted in very strong year-over-year and quarter-over-quarter revenue growth, and again, similarly, they're just executing against that business plan. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- + + Thank you, Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [18] +-------------------------------------------------------------------------------- + + Thanks, Mark. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Justin Post from Bank of America Merrill Lynch. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [20] +-------------------------------------------------------------------------------- + + Thank you. Ruth, I wonder if the you could give us a little more detail on the US acceleration? It's been pretty strong four quarters in a row. Is that YouTube and Search? +Any more detail on that would really be helpful, if those individual businesses have accelerated. And then on the Other Bets business, clearly -- and you've mentioned milestones a couple times. The losses have really increased over the last two quarters. Could you share any of those milestones with us? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [21] +-------------------------------------------------------------------------------- + + Sure. So starting with the US, I think the main point is that we've had meaningful growth in all geographies, reflecting the product strength and the added tailwind of the holiday season. And looking forward, we would expect typical seasonal patterns to hold to Q4. As you know well, it tends to be our strongest quarter. +Specifically on the US, that as we talked about last quarter, really reflects the diversity of our products here. Each is doing well. Mobile growth, as both Sundar and I talked about, was the key driver yet again. But YouTube and programmatic continue to deliver strong growth, and that translates into the results that you saw for the US. Obviously, we had a nice lift from retail, no surprise given the holiday season. +But I think simply put, it's the diversity doing a lot across a lot of different products. And then in terms of the milestones and your question regarding Other Bets, as I mentioned in opening comments, results this quarter were affected by project milestones. Those milestones were established several years ago, and that's why I called out that it could be lumpy on a quarterly basis and why we look at kind of year over rolling 12 months and not going to break it out in more detail than that. +As Larry said when we announced Alphabet, it's an exciting new chapter. It is about getting more ambitious things done. We're doing that in a framework to ensure we are disciplined with our resources. This was just calling out a milestone established some time ago. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [22] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Stephen Ju from Credit Suisse. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. Sundar, you just called out Gmail as the latest among your products to reach 1 billion users. I guess at this point you're explicitly monetizing Search, YouTube and Gmail to some degree, while some of the other products maybe they're a bit more nascent are still not monetized or under monetized it seems. Big picture as you look at the next billion users who are to come online and use your product, are you in any hurry to begin monetization at all? +And, Ruth, I think since you came on board CapEx is down basically every quarter. Granted fourth quarter of 2014 had the discretionary real estate purchase in there, but in your budgeting process for 2016 is the nature of what you're going to be spending money on changing much at all for core Google? And in regards to the CapEx for the Other Bets being primarily for Fiber, it seems like there's 6 upcoming cities and 11 potential cities. What is the greenlighting process for whether a city gets considered or not? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [25] +-------------------------------------------------------------------------------- + + I take a very long-term view towards this. When we look at the scale of mobile, for the first time in our lifetimes, I think we have a platform which is going to reach one day the entirety of the world's population. It will be over 5 billion users. +From our standpoint, core to our mission, we want to be in a position where we are helping users throughout the day. We are assisting users with their core information needs across all our products. And I think if you do that well, a lot of that information is commercial and hence our monetization works effectively as well as you've seen this year. And so very focused on long term, building that user experience to be assisting users and that's the framework with which we think about it. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [26] +-------------------------------------------------------------------------------- + + And then in terms of CapEx, you noted the important difference on a year-over-year basis, a couple of sizable real estate items as part of our facilities expansion that we called out last year, on top of continued investment in our technical infrastructure. But really to the heart of your question, looking ahead for 2016, we do expect to see accelerated investment in CapEx and that's to support both Google and Other Bets. +As we often talk about, we view our technical infrastructure as a key strategic asset for the Company. We have terrific scale and efficiency, and the team has done an extraordinary job innovating to achieve efficiencies following a period of heavier investment in 2014. So we're now delivering about three times the compute power for the same amount of power or dollars we did five years ago, and that's an important point because it explains some of the slower CapEx in 2015. +But given our commitment to have the most potent infrastructure, we do expect to increase CapEx in 2016. And for Google, that is intended to continue to support growth in our consumer products and services globally, as well as all that we're doing for our enterprise clients, as Sundar has already talked about. So that CapEx in both areas there. +And then in terms of Fiber and what we're doing more broadly in Other Bets, Fiber will continue to be, we expect, the biggest consumer. And again, you identified the driver of it. It obviously, increases as we execute in a growing number of cities. One of the main things that also affected 2015 is the rollout was really measured as we worked to enhance the construction process and efficiency, doing things like developing relationships with cities and establishing protocol with construction partners. But we have more cities announced and, obviously, as we execute on those that takes more CapEx, as well. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [28] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Douglas Anmuth from JPMorgan. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Two things. First, Sundar, if you could talk a little about YouTube? It's been several quarters now where you've talked about the mix shift toward true TrueView ads kind of bringing down the average CPC for sites. But can you talk about the trend that you're seeing there more on a like-for-like basis and whether in theory that should tighten up more relative to search ads going forward? +And then, secondly, Ruth, on the core Google business we've seen roughly 300 basis points of margin expansion here over the last year or so. I know you're talking, obviously, about the investments around cloud and machine learning. Do you think there is still potential there for profitability to improve in that segment? Thanks. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [31] +-------------------------------------------------------------------------------- + + Well, let me start first on YouTube monetization. There's really no change from my comment last quarter. YouTube had very healthy revenue growth, again, driven by growth in TrueView and other video ads, but the monetization story is still evolving. It's still early innings and we're focused on the opportunity to get larger offline budgets moved to YouTube. Given the level of user engagement globally and the compelling nature of demographics it does remain a very attractive platform. +In the near term, given the growth in viewership, YouTube TrueView CPC pricing is expected to continue to affect our overall sites monetization mix. And then in terms of Google and margin outlook, I think, is really what you're getting at. I'll go back to my prior comment. What we achieved here by pulling out the two pieces is providing, obviously, greater visibility into what we're investing within the Other Bets, but want to underscore that we continue to invest in Google. +We're in early innings in many areas, and I already referenced back to the framework we used which is to continue to push the frontier within Google, as well to adjacent areas. You named one. We've talked about it on this call. It's very important, Cloud and Apps, and all that we're looking to invest there. +But we're doing more than that. It's also the moon shot areas, it's virtual reality, and other areas. And these are exciting early stage efforts we do expect we'll be in a position to discuss in greater detail over time. I'll let you estimate the short-term impact, but we believe the investment is really important as we're enhancing the long-term potential for Google and continuing to really enrich the ecosystem. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [32] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Brian Nowak from Morgan Stanley. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [34] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. Just to go back to the YouTube comments you made, the progress in the living rooms and the progress of YouTube Red, can you just talk a little bit about how you think potentially going into more original scripted, longer form content, or even licensed longer-form content to go after an even larger share of offline ad budgets? +And then, secondly, on the Rest-of-World, can you just talk about what you're seeing in the emerging market CPCs on a constant currency basis? How big is that gap now between the emerging markets in the US, and how do you think about closing that longer term? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [35] +-------------------------------------------------------------------------------- + + Let me answer the YouTube question first. On YouTube, we have great momentum. We have over 1 billion users watching hundreds of millions of hours, and in fact, 80% of YouTube's views are from outside of the US. It's been an incredible year where I feel the team is on fire, focusing on launching YouTube Red, YouTube Music, and as you saw at Sundance a big push on YouTube originals, with a focus from our top creators, to create exclusive content for YouTube Red users. +And so I'm really excited about all the new investments we are doing there and users are responding very positively, and so I think it's going to be an exciting 2016 for YouTube. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [36] +-------------------------------------------------------------------------------- + + And then in the Rest-of-World, it's already growing at a high rate off a large base and we're really pleased with the ongoing progress there. In addition to mobile, we benefited from Play and our universal app campaigns, as Sundar said, we're continuing to invest meaningfully in Rest-of-World. We view it as a very sizable opportunity, bringing the next 4 billion online and all the opportunities there. So that's really the main focus for us at this point is continuing to build out availability, access and products for the Rest-of-World. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [37] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Paul Vogel from Barclays. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- + + Great. Thanks. Just two questions. One, just going back to the CPCs real quickly, if we were to sort of normalize out both TrueView and currency, I'm just wondering any comments on how core Search is doing and just how core Mobile Search is doing from a pricing standpoint? +And then, second, just on the CapEx side, I'm just sort of curious how you think about utilization across all of your products, and are we sort of -- you, obviously, spent a lot in the past. Are we kind of at a good spot? Do we need to spend ahead or is there a lot of capacity that isn't being utilized right now? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [40] +-------------------------------------------------------------------------------- + + So in terms of CPCs, other than YouTube, I guess the other comments to add are in the fourth quarter, we did see an impact from the ad format changes that we talked about in the third quarter. That also increased our overall click base and we believe this click growth is a positive indicator of ads that are proving to be more relevant to users. In other words, the CPC trend reflects the fact that the denominator is growing faster than the numerator, but we do view that as a long-term upside opportunity for both CPCs and revenue. +So mobile continues to be very healthy. I tried to indicate in my opening comments, and Sundar did as well, and similarly desktop growth remains very healthy. In terms of CapEx, so I guess the main point is we do expect that it will be increasing in 2016. I've already addressed that. +I think part of it's -- you got in the way you asked the question -- which is we've achieved efficiencies after this heavy spend in 2014, and that's where the team was very focused as we ramped up spend. And then we've been focused on what can we -- how to extract the most efficiency here, and that as I said, does explain some of the slower CapEx in 2015 and the reason we've been very focused on indicating that it will be increasing to support all that we're doing. +It's quite a bit of requirements on both the Google side and what we're doing in Other Bets and Fiber, specifically. So, part of it was the 2014 spend and the digestion in 2015. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [41] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [42] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from Ross Sandler from Deutsche Bank. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [44] +-------------------------------------------------------------------------------- + + Great, thanks. I just had two questions for Sundar. Most of them have been answered already. But on the UK, Sundar, it's now growing over 20% despite a tougher comp, and that's the most mature digital advertising economy globally, and we haven't been over 20% at Google for three-plus years. +So is this mostly a function of Mobile Search hitting its stride? Is there anything else that's driving that growth up? And what do you think that says about the maturity, or lack thereof, of digital advertising globally as we look at all other regions? And then you also made the comment during the prepared remarks that ARPU for Play, I believe you're referring to Play, is up 30%. +Is that on a like-for-like geo basis? And is that a function of the personalization efforts that Google's been doing within Play, or is that more a function of just the overall content flowing through Play evolving and maturing? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google Inc. - CEO [45] +-------------------------------------------------------------------------------- + + On the first, when I think about growth, you're right, and as Ruth mentioned earlier too, Mobile Search, YouTube, they're all working well. But I would take into account overall a secular shift to mobile, how users are adopting mobile, and on top of that, I think we are working hard to serve our users well on mobile. So it's a combination of all of that and I think the model is working well. +On Play, to be very clear, spend per buyer is up 30% and that's globally. And it's a function of, as you pointed out, I think we have made good strides in terms of personalizing the experience for each user and I think that's borne fruit. But a lot of it is also improving our ability to handle payments for users and developers and to do that better through time at a global scale. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Thank you. Our last question comes from Mark May from Citi. Your line is now open. Please go ahead. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [47] +-------------------------------------------------------------------------------- + + Thank you. I think they're both for Ruth. I just wanted to make sure I was interpreting your comments correctly earlier. You talked about looking at the trend line on a trailing 12-month basis at the Other Bets losses to get a sense of the trend line. +I think operating losses roughly doubled on a year-on-year basis on a trailing basis. Is that sort of the trajectory that you're wanting us to think about going forward? And then more of a housekeeping question around Other Bets. Can you just describe what you mean by project milestones and maybe provide an example of that? +And then on the Search business, can you talk about what sort of progress that you've seen in the auction in terms of closing the gap between the average mobile CPC and desktop? Thanks. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [48] +-------------------------------------------------------------------------------- + + So the trend, when I talked about looking at an annual or rolling 12-month to assess trends it was really to say that there can be idiosyncrasies on a quarterly basis that are -- so it leads to a lumpiness, just again, given how early stage these are, and any particular event in one or more companies can affect the overall numbers. It was not intended to say take the 2014 over 2015 and extrapolate, far from it. +The budgeting process that we went through was a very rigorous process, as I said in my opening comments. We prioritized some; we made some tough calls. But very much with a view of having a very disciplined envelope around the way we are looking at the opportunities we have across the Other Bets. And so we looked at them, again, opportunity by opportunity. +In terms of the milestones, they can really vary for a number of things, but it would be linked to anything at the Company, which in our view, whether it's technically or from a business perspective, advances the development of the Company, the value of the Company, and we're not going to go into detail on each one of the specific companies. +I think your second question was around Search in terms of the monetization trends in Search. And I think I've already addressed that one, as well. When I first provided color on desktop and mobile the point is really about the health of both of them. And as I've already said here on this call, mobile continues to outperform, desktop growth remains healthy, and with all the comments that both Sundar and I made with respect to mobile it should be clear that mobile Search revenue was up significantly this quarter. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Thank you. I you would now like to turn the call back to Ellen West for any further remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [50] +-------------------------------------------------------------------------------- + + Thank you, everyone, for joining us today, and we look forward to talking to you again on our first quarter 2016 call. Thank you and good afternoon. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2016-Jul-28-GOOGL.txt b/Transcripts/GOOGL/2016-Jul-28-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..3b2088dd80c36fefa2d5ddcf5d34891965cdd78e --- /dev/null +++ b/Transcripts/GOOGL/2016-Jul-28-GOOGL.txt @@ -0,0 +1,495 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Alphabet Inc Earnings Call +JULY 28, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - Head of IR + * Ruth Porat + Alphabet Inc. - CFO + * Sundar Pichai + Alphabet Inc. - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heather Bellini + Goldman Sachs - Analyst + * Anthony DiClemente + Nomura - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Dan Salmon + BMO Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen, and welcome to the Alphabet Q2 2016 earnings conference call. +(Operator Instructions) +As a reminder, today's conference call is being recorded. I would now turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - Head of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to Alphabet's second-quarter 2016 earnings conference call. With us today are Ruth Porat and Sundar Pichai. While you've been waiting for the call to start, you've been listening to Aurora, an incredible new artist from Norway, who is finding a rapidly growing audience on YouTube all over the world. +Now I'll quickly cover the Safe Harbor. Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. +For more information, please refer to the risk factors discussed in our Form 10-K for 2015 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As, we distribute our earnings release through our Investor Relations website located at ABC.XYZ/investor. This is call is also being webcast from our IR website where a replay of the call will be available later today. And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [3] +-------------------------------------------------------------------------------- +Thanks, Ellen. Our revenue of $21.5 billion in the second quarter underscores the great performance of our businesses globally. For the quarter, our consolidated revenue grew 25% in constant currency versus last year. +Once again, the primary driver was the increased use of mobile search by consumers, benefiting from our ongoing efforts to enhance the mobile search experience. We also benefited from solid growth in desktop and tablet search, as well as continued strength in YouTube and programmatic advertising. +I'm going to present to you in the following order: first, review the quarter on a consolidated basis for Alphabet. Second, review the results for each of Google and Other Bets. Finally, I will conclude with our outlook. Sundar will then review our business and product highlights for the quarter, after which we will take your questions. +Beginning with the summary of Alphabet's consolidated financial performance. Total revenue was $21.5 billion, up 21% year over year, and up 6% sequentially. We realized a negative currency impact on our revenues year over year of $113 million, or $35 million after the benefit of our hedging program. Holding currency constant to prior periods, our total revenue grew 25% year over year and increased 5% sequentially. +Once again, Alphabet revenues by geography highlight both the strength of our business around the globe, as well as the impact the currency headwinds continue to have on our non-US business relative to last year. US revenue was up 25% year over year to $10 billion. UK revenue was up 14% year over year to $1.9 billion. +In fixed FX terms, the UK grew 20% year over year. These results do not reflect the movement in the British pound subsequent to the results on the referendum on June 23rd. Rest-of-world revenue was up 19% versus last year to $9.6 billion. In fixed FX terms, revenues were up 26% year over year. GAAP other cost of revenues were $4.2 billion. Non-GAAP other cost of revenues, was $3.9 billion, up 28% year over year, primarily driven by Google-related expenses. Specifically, costs associated with operating our data centers, including depreciation; content acquisition costs primarily for YouTube; and hardware costs. +GAAP operating expenses were $7.4 billion in the quarter. Non-GAAP operating expenses were $6.2 billion, or 29% of revenue, up 15% year over year and up 2% versus Q1. The year-over-year growth was primarily driven by R&D expense mainly due to compensation expense related to head count growth. +On a GAAP basis, operating income was $6 billion, up 24% versus last year. The operating margin was 28%. Non-GAAP operating income was $7.5 billion, up 25% versus last year. The operating margin was 35%. Stock-based compensation totalled $1.5 billion, up 33% year over year and up 1% sequentially, primarily reflecting increased head count and the impact of our senior executive equity refresh that occurs every two years. +Head count at the end of the quarter was 66,575, up 2,460 from last quarter. The vast majority of new hires continue to be engineers and product managers to support growth in priority areas such as cloud and apps. On a numbers basis, we are adding more head count in Google, while on a percentage basis, we are growing faster in Other Bets. +Other income and expense was $151 million. As discussed on prior calls, OI&E consists of a number of line items impacted by market factors which makes it inherently unpredictable. We provide more detail on these line items in our earnings press release. Our effective tax rate was 20%. Net income was $4.9 billion on a GAAP and $5.9 billion on a non-GAAP basis. Earnings per diluted share were $7 on a GAAP basis and $8.42 on non-GAAP basis. +Turning now to CapEx and operating cash flow. CapEx for the quarter was $2.1 billion, the substantial majority of which supported the Google segment. Operating cash flow was $9.1 billion, with free cash flow of $7 billion. +We ended the quarter with cash and marketable securities of $78.5 billion, of which approximately $48 billion, or 61% is held overseas. This performance reflects our strong operating cash flow, offset by the impact of our share repurchases during the quarter of approximately $1.6 billion, completing the authorization under our share repurchase program. +Let me now turn to our segment financial results. Starting with the Google segment, revenue was $21.3 billion, up 21% year over year, which includes the impact of FX. In terms of the revenue detail, Google sites revenue was $15.4 billion in the quarter, up 24% year over year and up 7% sequentially. Year-on-year growth reflects substantial strength in mobile search due to the ongoing benefit in improvement in ad formats and delivery that we launched in the third quarter of last year. We continue to have solid growth from desktop and tablet search. +YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView, and increasingly, Google Preferred, with a growing contribution from buying on DoubleClick Bid Manager. Network revenue was $3.7 billion, up 3% year on year, and up 1% sequentially, continuing to reflect the strong growth of programmatic offset by the traditional network businesses. +Other revenue for Google was $2.2 billion, up 33% year over year and up 5% sequentially. Year-over-year growth was driven by cloud and apps as well as Play followed by hardware. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. Let me remind you that these metrics are, of course, affected by currency movements. +Total traffic acquisition costs were $4 billion, or 21% of total advertising revenue, up 18% year over year and up 5% sequentially. Total TAC as a percentage of total advertising revenues was down slightly as a result of a mix shift between sites revenue, which carries lower TAC, and network revenue. The increase in both sites TAC as a percentage of sites revenue, as well as network TAC as a percentage of network revenue, reflects the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. +Operating income excluding SBC was $8.3 billion, up 26% versus last year, for an operating margin of 39%. Google stock-based compensation totaled $1.3 billion for the quarter, up 33% year over year. Operating income reflecting the impact of SBC was $7 billion up 25% versus last year and the operating margin was 33%. CapEx for the quarter was $2.1 billion, reflecting investments in production equipment, facilities, and data center construction. +Turning to Other Bets financials. Let me again emphasize that the majority of these efforts are pre-revenue. We continue to invest across these opportunities and are doing so in a disciplined way. +We think it remains most instructive to look at them over a longer-time horizon, because as you have seen, quarterly revenues and expenses can be lumpy for three primary reasons. First, they are early stage; second, they represent an aggregation of businesses operating in different industries; and, third, they may be impacted by one-time items like partnership deals. +For the second quarter, Other Bets revenue was $185 million. Reported revenue for Other Bets was primarily generated by Nest, Fiber and Verily. Operating loss excluding SPC was $709 million in the second quarter. Including the impact of SBC, operating loss was $859 million. Other Bets CapEx was $280 million in Q2, primarily reflecting ongoing investment in our Fiber business. +I'd like to close with a few observations on our key themes. First, regarding revenue. Our Alphabet structure announced nearly a year ago gives us a framework for developing new sources of revenue growth within both Google and in Other Bets in a disciplined way. +You have seen over the past few quarters how our focus on innovation can drive strong revenue growth. We're continually working to enhance the search experience and making changes to our ads formats and tools, guided by substantial user testing. +We have repeatedly highlighted the 3Q 2015 change in format given the meaningful step-up it drove in our revenue growth rate. That benefit is evident again in the second quarter. As we have always said, we have been and remain committed to long-term revenue growth through innovation, but the timing and scale of the impact of innovation is inherently difficult to predict. +Second, as to expenses, I've commented many times that our focus on long-term revenue growth does not give us a pass on managing expenses. We invest a lot of time and effort in assessing how to manage for revenue growth, with the utmost respect for the resources deployed and a focus on getting the best return on those resources, recognizing that in some areas secular trends are creating margin headwinds. +As I mentioned last quarter, there are a number of factors driving higher TAC in both our sites and network businesses. For sites TAC, there are a number of factors that contribute to fluctuations, in particular, changes in the relative use of mobile, desktop, and tablet devices. For each of these devices, sites TAC also reflects and inter-related set of factors, including the mix of paid versus organic distribution points, partners, and agreement terms. Over the past year, the shift to mobile has been the primary driver of the increase in sites TAC, because more mobile searches are subject to TAC. +When looking at sites TAC as a percentage of revenue, it is important also to remember that while YouTube advertising revenue is reflected in our sites line, the associated content acquisition costs are included in other cost of revenues, not TAC. In addition, sites revenue includes hedging gains with no associated effect on TAC. The growth in network TAC is due to the ongoing adoption of programmatic platforms by advertisers, which are subject to a higher TAC rate. +In operating expenses people are our biggest area of investment. We continue to attract, develop, and retain the best people to drive our businesses forward. As you would expect, head count additions primarily align with our priority areas, such as cloud and apps and machine learning. +Two important points regarding the third quarter. First, you will see the impact in the third quarter of our annual equity refresh for our employees. As you have seen in prior years, the annual refresh results in a sequential step-up in SBC. +Second, headcount growth tends to be seasonally high in Q3 because that is when we bring on new graduates. In addition, please keep in mind that our marketing costs are typically weighted more heavily toward the back half of the year due to the holiday season. +Third, regarding CapEx. At Google, the team has been able to drive meaningful efficiencies in planning and operations for our technical infrastructure, which has enabled us to support growing demand at a stable investment level. These efficiencies include improvements in power and server utilization, the use of machine learning and deployment of innovations like our tensor processing unit. With regard to CapEx investments for Other Bets, our Fiber investment continues to be the driver. +Fourth, about our balance sheet. We remain focused on optimizing our capital structure, recognizing the strategic value of our balance sheet. We completed Alphabet's $1.7 billion debt exchange in the second quarter, which gives us flexibility, including the ability to using debt financing if appropriate. In light of the interest rate environment, we may opportunistically access the market to term out our commercial paper. +In conclusion, in the second quarter, we delivered very strong revenue growth and improved operating efficiency. These results reflect the tremendous talent and hard work of our teams around the globe. I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [4] +-------------------------------------------------------------------------------- +Thanks, Ruth. As you heard, we had a very strong second quarter. There is an amazing energy right now with Google. The strength of the quarter is about mobile. It's transformed the way that people consume information, and Google's products have become essential and much-loved part of their experience. +Our investment in mobile now underlines everything that we do today, from search and YouTube to Android and advertising. Mobile is the engine that drives a person. And now through our deep investments in machine learning and AI, we are building the engine that will drive our future. +Since the last earnings call, we had Google IO, our biggest event of the year, and I also wrote our annual founder's letter. Both of these allowed me to reflect on our past and look to our future. +We are at a pivotal and transformational moment. Thanks to advancements in machine learning, we have the unique opportunity to take a big step forward for the next 10 years. +In the letter, I wrote about how we think of our investments and our mission. Today, I'll walk through the six sections of the founder's letter and discuss our progress in each area, and then I'll call out three key highlights from the quarter that are driving our advertising business today and into the future. +The first thing I highlighted in the founder's letter was information. At Google's core, we remain focused on making information and knowledge available for everyone. This, of course, starts with search where we now have trillions of searches every year. +We continue to invest in making search smarter and more useful. In the US, we recently introduced a voter tool so when you search for register to vote, you'll get a detailed state-by-state guide with information on how to register, requirements, and deadlines. +Our new keyboard for iOS called Gboard is off to a great start. People love the ability to easily search right from the keyboard, swipe to type, and quickly send emojis. After just one year Google Photos is now helping over 200 million people every month organize and search their photos and memories. +At IO, I was excited to share our vision around the Google Assistant. We want to help people get things done in a conversational way across devices and context. This is possible thanks to advances in machine learning, voice and image recognition, and natural language processing, which we have invested in for years. You will be able to experience the Google Assistant in products like our new messaging app, Allo, and our voice-activated device Google Home. And we can't wait to show you what else we are working on in this area. +Second, machine learning. As I said, machine learning is the engine that will drive our future, and it's already making our products better and helping users every day. In fact, more than 100 teams are currently using machine learning at Google, from Street View to Gmail to voice search and more. +For example, in search, we use a ranking signal called RankBrain, which relies on deep learning to improve results. It's already enhancing the search experience in 40 languages, and based on user testing, RankBrain can accurately guess which results users will favor with about 80% accuracy. Advances like this help us make our search results even more relevant. +Machine learning is also creating an impact in other ways. Just last week, we announced a test that applied DeepMind's machine learning to our own Google data centers, resulting in up to a 40% reduction in the energy we use for [cooling] This will greatly improve efficiency, and when we publish our research, we hope it will enable others to reduce emissions, too. +Third, content. A big part of making information available is making great content accessible, such as on Google Play, YouTube, and the web. Our efforts to make the mobile web better for everyone with accelerated mobile pages, or AMP, has seen phenomenal global momentum. We now have over 150 million AMP pages in our index, and with over 4 million new ones published every week from nearly 200 countries. +Last week, we announced AMP for Ads, which helps advertisers build fast, simple, and beautiful ads and landing pages. This will help make the mobile web experience much faster for everyone and help fund it more sustainably. +Video is a huge component of digital content and YouTube continues to shine. It's a thriving home for creators, with more than 1,000 creators crossing the thousand subscribers' mark every single day. Our content ID system has now paid out over $2 billion to partners who use the system. +A big part of video, of course, is live, which we have invested in since 2011. YouTube is the first major platform that supports live content in 360 degrees, and we recently announced the ability for creators to go live from their phones with a touch of a button. +Earlier in the quarter, we teamed up with BT to live stream the Champions League on Europa League finals on YouTube in the UK. This special event was the UK's biggest ever live stream. All these innovations had a big reason why partner revenue has averaged 50% growth over the last three years. +Fourth, platforms. A key focus is building great computing promise like Chrome, Android, and our new virtual-reality platform Daydream, so that people can have wonderful experiences regardless of the device or screen they are using. Platforms are what make new computing experiences possible, and also power breakout hits like Pokemon Go, which I suspect a few of you are playing right now. +Android is thriving. In the last year alone, we have delivered over 65 billion app installs and are helping developers reach an audience of over 1 billion users every single month. +Our partners are also seeing incredible success with flagship devices like the Samsung Galaxy S7. It's a hit with consumers and a shining example of how to build a great experience on Android. +Our latest version of Android, called Nougat, focuses on performance, productivity, and security, and it also has a VR mode built in to help developers create immersive smartphone VR experiences. Speaking of VR, we are already working with leading Android partners to build out the Daydream ecosystem, so stay tuned for more Daydream-ready phones, controllers, and headsets coming this fall. +Fifth, the cloud. Many tremendous digital experiences are being built in the cloud today, and businesses are working to take advantage of the cloud as part of their digital transformation. We have been integrating our cloud and app start-ups to create more unified solutions for companies large and small, and these efforts are paying off. +We have strong momentum with businesses like Symphony, a secure communication and work-flow platform who recently announced that its cloud computing business is available on the Google cloud platform. We provide the high reliability and performance needed by Symphony's customers in the financial services industry. +Our data analytics product, BigQuery, helps mobile gaming company, Kabam, store and understand player actions within their games, from monetization and fraud to production bugs and level completion statistics. As I've said, machine learning has been a major focus and a key differentiator for Google, and that's true for our Google cloud customers as well. +This quarter, we introduced tensor processing units, or TPUs, which can deliver an order of magnitude better-optimized performance per watt for machine-learning projects. Google DeepMind's AlphaGo was powered by TPUs, enabling it to process faster and look farther ahead between moves. We are now passing this benefit on to our enterprise customers to supercharge their machine-learning applications. +Just last week we introduced two cloud machine-learning APIs for speech and natural language to help our enterprise customers convert audio to text and easily understand the structure and sentiment of the text in a variety of languages. +We also introduced a new undersea cable system, the highest capacity system ever built, which brings added capacity and performance to support our enterprise customers around the globe. This system has 60 terabytes per second of total capacity, more than any active undersea cable, and is 10 million times faster than your cable modem. This is especially exciting as we prepare to launch a new Google cloud platform East Asia region in Tokyo later this year. +In addition to building the best products and infrastructure, we are also hard at work building the best team to serve every aspect of our customers' businesses. We now have key leadership in place and centralized teams supporting customer-facing activities including, sales, marketing, global alliances, industry solutions, and professional services. We are building out our supported full-scale, as more and more Fortune 100 companies choose our cloud. +Sixth, building for everyone. Since the internet is one of the world's most powerful equalizers, we are committed to building technology and making information available for everyone, wherever they are. This has always been core to Google's DNA. +As we have shared before, we are working with Indian railways and RailTel to bring high-speed wireless access to the entire internet to millions of people who travel throughout India's stop railway stations. There are already 2 million people logging in every month, and they are using as much as 15 times the data they would otherwise use in a full day on their cellular networks. +We are also working hard to ensure that our products work well for everyone, regardless of where they live. We have been expanding better carrier billing in Google Play, with more than 100 partners in 40 countries. To give you a sense of the impact, in Indonesia alone, we have seen growth in monthly buyers quadruple in the last 18 months. +Switching gears from these six areas, it is our business success that enables us and our partners to grow and invest further. We are extraordinarily well positioned to take advantage of the mobile shift, and we are already seen strong growth in three key areas of our advertising business: mobile search, video, and programmatic. All of the momentum you're seeing is because our products are doing well in mobile and our customers are getting great results from them. +We offer advertisers and agencies the best ways to reach customers at the right moment of intent, the best reach in inventory, the best mobile formats, and the leading measurement solutions. Of course, we do all of this while making sure we are creating a great [ads] experience for users that is helpful and unobtrusive. +We know that people are constantly searching for things with commercial intent and are used to swiping and tapping. Our data shows that people respond really well to the ads we show. They are fresh, fast, and useful. +So let me turn to three key moments from the quarter for our advertising business. Number one, our Google Performance Summit for direct response marketers. We announced new expanded text ads and bit adjustments by device type, which are rolling out this week, as well as new local search ads in Google Maps. +Thanks to the rise in mobile phones, the line between online and offline experiences continues to blur. This creates even greater opportunity for businesses to use Google Maps to help bring customers into their physical store locations. Thanks to our strong intent signals, particularly on mobile, Google continues to offer great opportunities for direct response marketers to reach potential customers, whether they are visiting your website, calling your business, walking into your store, or downloading your app. +For instance, Walgreen's partnered closely with Google to promote their app across search, Google Play and our display networks. In one month, they increased the number of app downloads 87% from the previous month. +Number two, our annual Brandcast event for brand advertisers was a huge success. We announced Breakout Videos, the ability to advertise against fast-rising videos on YouTube; as well as a deal with the NBA to bring their inventory to Google Preferred. +As this point, the volume of Google Preferred bought this year is already more than double what it was at the same time last year. Fast-food chain Wendy's used Google Preferred to extend the reach of their TV ads, and thanks to our Brand Lift measurement solution, they were able to see that one of their campaigns drove an incredible 65% lift in ad recall and 146% lift in Google searches for the Wendy's brand. We are hearing a lot of the same feedback from many top brands who continue to invest more and more of their budgets on YouTube. +And number three our DoubleClick Leadership Summit held just last week for ad technology partners. We launched the ability to buy native ads programmatically across all screens in DoubleClick Bid Manager. [Since we're] providing fully designed creatives for each publisher, advertisers can simply upload the components of the ad, like headline, image and text, and double-click automatically a simples stamp to fit the context and format of the site or app where they appear. +Making native advertising simple at this scale will help to make ads faster, better, and less intrusive while driving great returns for publishers. So there's my top three moments from my advertising business this quarter. As you can see, it has been extremely busy. +More generally, from advertising to cloud to digital content to hardware and to so much more, we have tremendous long-term growth opportunities at Google. Today's great innovations are being driven by our investments in mobile; tomorrow's will be driven from our investments in machine learning and new computing platforms. But one thing is constant; we'll continue to focus on building the best experiences for billions of people around the world. +I want to thank all of the Googlers around the world who help us create these opportunities every day and help them bring to life for our users and partners. With that, I'll turn it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [5] +-------------------------------------------------------------------------------- +Thank you, Sundar. We will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Carlos Kirjner, Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [2] +-------------------------------------------------------------------------------- +Thank you. I have two questions. First, is about Search revenues. Search is probably a $50-billion business, and from today's results, it's clearly still growing strongly. Of course, if the business gets larger, it becomes harder and harder to sustain growth. As you look at this increasing growth challenge on your product innovations in Search, including recent changes and also those that you have in your road map for the next few years, how do you think about your ability to sustain such revenue growth and the trajectory for which they will ultimately accelerate? +The second questions is on Google Fiber. I think Ruth has been quite clear that we should expect an increasing Other Bets CapEx, and that Fiber is the main driver, suggesting more investment. Yet when we see the rate at which you have deployed in markets like Austin or some of the newer markets, they are quite slow. +You also have started to talk about wireless technologies, suggesting that you haven't fully figured this out yet, which in turn suggests that it's going to be slow to [climb]. So the question is, which one is it? Is it faster, more aggressive deployment given the CapEx commentary or is it going to be continued slow, multi-year deployment as your track record and the talk of new technologies suggest? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [3] +-------------------------------------------------------------------------------- +Thank you, Carlos, a lot in those questions. Starting with sites revenue and where we see the opportunities there, obviously, sites revenue up 24% year on year includes the currency impact. And as Sundar and I both commented on, the biggest driver again this quarter was mobile search. We do continue to have solid growth in desktop, tablet, we have strength in YouTube, particularly video advertising, both in our TrueView products and increasingly from Google Preferred. +As we've talked about every quarter since the third quarter of last year, we have benefited to the change to ad formats on mobile that we made in the third quarter of last year, and that is evident yet again this quarter. +And then as per your question, when we go back -- going back to that third quarter of 2015 when we made the change in ad formats on mobile, our growth rate meaningfully accelerated. And as we've noted in each subsequent quarter, that change has been the primary driver of the higher year-on-year revenue growth rate. +But importantly, as you've seen over the last several quarters, we're benefiting not just from the higher growth rate but also from the durability of the impact of the change. So that's really underscoring the efficacy of these ads for users, as per Sundar's comments, and it's reflected in revenues running at a higher level. And you can see where the revenue growth rate was prior to the third quarter introduction; I'll let you do your own forecasting. But when comparing growth rates, we're obviously at a higher revenue base versus last year. +And then Sundar talked about some of the recent events that we've had. Innovation is core to everything we're doing. We've launched several changes to ad formats and tools just a few days ago. As the team discussed at the Google Performance Summit, we believe the changes should result in a better, more useful experience for users and better performance for advertisers. And so that just continues to be core to the way we're looking at the business with a lot of incremental opportunity. +And then on your Fiber -- the Fiber and the CapEx question, look, we continue to see Fiber as a huge market opportunity. We're focused on creating abundant connectivity, networks that are always fast and always open, as we've talked about. And we're continuing to work closely with cities given their excitement. We're also looking to push the frontier with tech innovation, as you noted in your question, and different execution paths. +So, as you said in the question, we're exploring both Fiber and wireless and you may have seen our recent acquisition of WebPass. So we want to make sure we're executing against a very large and attractive market in the most effective and efficient manner. We did start adding customers in Charlotte in July, and so again, we view it as a big opportunity. We're being thoughtful and deliberate in our execution path. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Thank you. Next question from Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [5] +-------------------------------------------------------------------------------- +Thank you for taking the questions. Maybe following up on Carlos's question on Search, and Ruth your answer. I wanted to go a little deeper on the retail and the travel verticals; it's two areas where we see a lot of innovation from the Company right now, both on the product side that consumers are seeing, as well as on the advertising side. How should we think about the road map ahead for both increased user engagement with your product in those key verticals, as well as ability for advertiser conversion to lead to more advertising budgets for the Company over the medium to long term? +And then maybe one second question would be, with the buy-back authorization having been completed this quarter, Ruth, would love to get your thoughts how you're thinking about the balance sheet as an asset and how shareholders should think about ability for shareholder returns over the medium and long term. Thank you so much. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [6] +-------------------------------------------------------------------------------- +So why don't I start on your second question, then I'll pass it to Sundar on the first question. As you know, we announced the share repurchase program relatively recently, it was just in the third quarter of last year, and we just completed it, as per my opening comments. As we discussed back in the third quarter, we do always review our balance sheet and capital requirements and opportunities with our Board. And I'm not going to speculate about a potential for a future Board decision, so really nothing more to add at this point. And then, Sundar? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [7] +-------------------------------------------------------------------------------- +Look, we obviously think generally across all types of verticals, and you highlighted a couple of important verticals. To give an example on travel, many users start their travel inquiry on Google. And so we focus on doing a better job on getting them deeper information, new destinations and compare costs through new features in hotel search, Google flights, and the recently launched Destinations on Google. +In all of this we work closely with many different partners, including online travel agencies, and so we focus on product enhancements in partnership with them. The better job we do at answering user queries, the more qualified leads we can provide to our partners, and we think it's a win-win arrangement. And so, and the same concept applies to these other verticals as well, so we approach it very holistically. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [9] +-------------------------------------------------------------------------------- +Thank you very much. Sundar, I was wondering, I know you gave us some color on the cloud business just a few moments ago in your prepared remarks. But I was wondering if you could share with us some of the changes, if you could highlight some of them that Diane had made since she's come on board. And I'm wondering how some of those changes might be starting to impact conversations with potential customers that you're having. And, in particular, just trying to get a sense of are you seeing Google now with GCP getting invited to more RFPs and starting to see your win rates go up as a result of some of her initiatives? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [10] +-------------------------------------------------------------------------------- +Thanks, Heather. Absolutely, I think that Diane has initiated a set of changes, and essentially, she has integrated our go-to-market strategy with her engineering and product efforts. She has integrated our engineering efforts on the cloud. So for example, Google Apps, Drive, Docs, Gmail, Slides Sheets, Hangouts, et cetera, is on top of the cloud stack. +Our enterprise customers and partners, for them, now they have one enterprise [phase], and internally, from frictionless contracts to touch points across Google, to one person to work with them on our considerable enterprise technologies and products. So the big unifying one being cloud. +We now have new leadership in place across sales, professional services, marketing, and partnering, plus new customer-facing support in the form of professional services. We have an office of the CTO and customer reliability. +So it's a big set of changes, and it's obviously having an impact. Many of our customers are also partners, and so it's increasingly clear how much we can do together. So for me I see a shift to a world-class enterprise approach, and it's definitely having an impact on the type of conversations we are having and the outcome of the RFPs we are engaged in. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [11] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [13] +-------------------------------------------------------------------------------- +Sundar, I just had a question about machine learning. You spent a lot of time talking about how this is positively impacting Google as a whole and how you're building for the future, both tonight and at IO a few months ago. And you guys have mentioned things like reducing the error rates in search, and improving relevancy. But are there tangible examples of either engagement or volume also increasing as you roll out machine learning in search and in YouTube that you could share? +And then I think Google recently introduced Smart Bidding in AdWords using machine learning. So do you see something like this as a potential revenue driver? Any color there would be great. Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [14] +-------------------------------------------------------------------------------- +Yes, so we definitely -- a core part of improving the user experience for the next many years will be driven by machine learning. To give a specific example you asked about YouTube. YouTube watch time is something that we focus on. We use machine learning increasingly to give recommendations to users when they're watching a video in terms of what they could watch next. And that recommendation system is getting -- increasingly using machine learning, and that directly drives engagement. So there are several such examples I can give across the Company. +You mention AdWords, too. If you look at AdWords and thoughtful changes we do, over time, we are dealing with big [commentary] of space in terms of the kinds of changes and interactions that can happen. So deploying machine learning there over time, over many years I think is a more powerful and deeper way to explore the various possibilities that exist and I think will lead to long-term impacts. And so very optimistic on it. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [16] +-------------------------------------------------------------------------------- +Thank for taking the questions. I wanted to ask, too, first, Sundar, you talked about expanded text ads. And my question is just as the number of characters here increases, some would say up to 50% through expanded text ads, you're taking up more space on the page. How do you balance the higher percentage of clicks from these paid ads with the natural search experience? +Secondly, on YouTube, do you think you're taking share of TV dollars currently? And if not, what's needed to do that going forward? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [17] +-------------------------------------------------------------------------------- +On the first one, we obviously, over many, many years we always put users first, and as we present our search results, we have long-term metrics for user happiness around which we make -- that's the framework for all of the changes we make. Obviously with the shift to mobile, the user experience -- users are evolving in terms of how they use our product. And with that as a guidance, we have made changes. +We make many, many changes,, and I would look at it holistically. And even some of the changes you're talking about affect certain highly commercial queries where users are actually looking for that commercial information. So the metrics is what drives how we change these things, and I'm being very, very thoughtful about it. But we always step back and make sure that overall load, et cetera, is really working for users. So I'm pretty comfortable with how we are approaching it. +On YouTube, I think about it as we are seeing strong growth. I mentioned the momentum behind Google Preferred and how we are double the rate we were last year. So to me, that implies strong growth. It's tough for us to assess from TV or just advertisers in listing more because [of this traction] in YouTube. But we just see strong momentum. And as far as today, just look at how users are using mobile, videos, the killer format on mobile, and I think that is what gives us the secular trend moving forward. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [18] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [20] +-------------------------------------------------------------------------------- +I just want to ask one question. It has to do with mobile search and I want to throw an idea by you, which is we've been going through this mobile transition for four or five years. Consumers have, I think, dramatically led businesses and advertisers to mobile devices. +I'm wondering if what you're now seeing is finally, as e-commerce and travel and other commerce activities have really become critical material on mobile devices, you're finally starting to see ad budgets really shift over and you're starting to get option dynamics start pick up in mobile search. Could you just comment on whether you're finally seeing this back swing for advertisers to engage with mobile search in a way that you really hadn't seen before; it just took that many years for this to happen? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [21] +-------------------------------------------------------------------------------- +I would, Mark, thanks for the question. I would say at a higher level, this is a scale business, and, you're right. As we have had this shift to mobile that our second [order effects, which] kick in too, which is why when you look at our ad improvements and our revenue improvements I would focus more holistically. We do deeper changes across the board, not just visible changes on the page, and all of that contributes to it. So I do definitely think it has to shift to mobile [accelerates], we are getting some scale benefits and that is part of it. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Dan Salmon, BMO. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [23] +-------------------------------------------------------------------------------- +Good afternoon, everyone. Sundar, I was wondering if you could spend a little time talking about the launch of the My Activity site, which I think is an update to the controls that your users have over the use of their data. And, in particular, I would be interested to hear about the option to opt into greater personalization of ads from across usership on Google sites. As I believe that's the first time you've allowed on an opt-in basis certainly, to have search data be used to target ads elsewhere. +And then maybe as a follow-up to that what you're seeing in terms of early traction of users turning that on and where your expectations for that may be. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [24] +-------------------------------------------------------------------------------- +Look, we're very focused on giving users better controls, and so we wanted to give users a single place to see and control ad setting. And that will be [honored] as the user moves across devices. It's completely opt-in; users are absolutely in control. And consumers and advertisers have come to expect the ads to work better across devices, and this new option could help us better deliver on that. +For people who choose to opt in over time, we could make sure they see more relevant ads and fewer annoying ones, so effectively put them in better control of the experience they get. And so I think that helps the whole ecosystem work better. We are in very, very early days and -- but we're thoughtful about how we do this for users. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [25] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Colin Sebastian, Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [27] +-------------------------------------------------------------------------------- +Great, thanks. Two quick questions. First off, we understand that Google Shopping in particular continues to see strong growth, and I was hoping you could add color on relative mix or growth rates of PLA contrasting with other ad types, along with the adoption of the transactional capabilities. +And then, Sundar, I wanted to follow up on some of the conversational and voice applications and devices that you have in the pipeline. And more generally, how you envision voice really fitting in across the board, across the Google platform. Will this be a centerpiece as you also utilize machine learning, artificial intelligence? I'd like to hear more about your vision for that. Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [28] +-------------------------------------------------------------------------------- +Let me, quickly on the first one, we don't comment on the relative mix, et cetera, so I'll probably give more color on your second question. Voice is obviously very, very exciting for us. I mentioned this at IO, if you look at the Android, the Google app on Android in the US, 20% of the queries are voice queries. +Today, in terms of evolving to a conversational assistant, we have a big head start, people do this. We get millions of queries every single day, and it's incredibly exciting to see how people interact with voice differently from text. It's more intuitive, it's more personal, and it's a bit more emotional and engaging experience for users. +And so, I think to do this well requires deep computer science, understanding what they are saying, the natural language processing involved. These are areas in which we have now been working for over 15 years, and we believe we are the best in class. Bringing all of that together I think is what will help us do this at scale globally. +But it's still very early days in terms of getting the conversational assistant right. You will see us launch this throughout products as we go through the second half of this year, and I am excited to see how users respond to it. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [29] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura - Analyst [31] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I have one for Sundar and one for Ruth. Sundar, in terms of messaging, you mentioned Allo, your mobile messaging product, and Duo, which is a -- your video messaging product. Why is it important that Google is competitive in mobile messaging, and what gives you the confidence that you could take market share from the other players in the messaging space? +And then, Ruth, in terms of the driver of YouTube growth, you mentioned in your prepared remarks that one of the drivers was buying on DoubleClick Bid Manager. I just want to maybe hear a little bit more about that. Why has that been so successful recently and do you look at that as an incremental, forward driver of YouTube growth? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [32] +-------------------------------------------------------------------------------- +On your first question, I think messaging is obviously an important area. We approach these areas, if you believe we have insights by which we can create something very differentiated for users, that they're actually approaching it in a new and unique way. The core underlying insight we have is in the context of mobile and using a state-of-the-art machine learning, can we rethink some of these areas for our users? +That's the underlying framework with which we've approached this space. I've been really enjoying using these products, and we'll get it out to users soon. For example, I think if you take something like Duo today, I think especially on Android, high quality messaging is an experience that's still lacking for users. So we clearly see an opportunity there. And it's at the core of our mission, bringing informational experiences to users. And so that's why we are investing and we are optimistic about the space. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [33] +-------------------------------------------------------------------------------- +And I think the -- and the other part of your question, I think the key point is we've been talking about programmatic for quite some time. We're just seeing strong momentum across the board and continue to benefit from that. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura - Analyst [34] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [36] +-------------------------------------------------------------------------------- +Sundar, can you broadly discuss the Google hardware strategy and perhaps some of the lessons learned from previous Google hardware launches? And then relatedly, can you discuss a little bit about how you're thinking about auto strategy? Do you build your own vehicles, license technology? How do you determine which direction to take there and how long until we might see any auto-related revenue? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [37] +-------------------------------------------------------------------------------- +On our overall hardware strategy, we've always -- we've done devices like Nexus or Google Pixel, et cetera. We realize a lot of computing innovations happen at the intersection of hardware and software, and as we are building ecosystems and broad platforms we need a way to drive them forward. That is the context in which we do. +There are areas where we have done it seriously, like Chromecast is a great example. We now have over 30 million Chromecast devices sold. That's an example of [varying this deeply]. Especially as newer areas emerge like Google Home, we want our ability to put the best experience possible in front of our users and guide the ecosystem. So that's how we think about it. +We're being much more thoughtful in how we approach it, and we're building a world-class team so we can do this for our users. But we are very thoughtful about how to approach it and we make sure to work with the ecosystem to accomplish what we're trying to do. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [38] +-------------------------------------------------------------------------------- +And then on cars, self-driving cars is in Other Bets area, and so just a brief update there. We're now testing in four cities: Mountain View, Austin, most recently we expanded to Kirkland, Washington and to Phoenix. We've self-driven over 1.6 million miles. And the focus here for us is we're solving a really big need, safety, access and city efficiency. +The thing that's really motivating for us is when you look at over 30,000 car deaths in the US alone, that's what really inspired the founders to start working on this issue. And our approach is quite different from most others; we're focused on fully autonomous cars, because in early testing, we saw the risk of depending on drivers to remain engaged once you give them the option to switch off. So we've invested a lot there. +We're testing extensively based on this approach, and more specifically to your question, we're pleased to be working with FCA to advance the development of the self-driving cars. With them, we're more than doubling the number of cars that we have. But we do have huge respect for the expertise required so we do expect we'll work with many partners in this area. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [40] +-------------------------------------------------------------------------------- +Thank you, a couple of questions. First on YouTube, just thinking about premium content, a lot of activity with streaming deals out there. Obviously, YouTube would be a natural place for streaming content, but even professionally developed content. Do you think you're letting an opportunity get by? How do you think about that? +And then Ruth, I know you have a lot of experience dealing with regulatory agencies in your last CFO role. There's been some new filings. Can you talk at all about how Google is thinking about that right now? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [41] +-------------------------------------------------------------------------------- +I'll start on the second question. Look, we continue to work constructively with regulators. We don't have an update on timing on any of the specific issues. But the main points in our view are the regulators have found that our businesses do help consumers. And the key mantra here is if we do the right thing for the user, all else will follow. +With respect to consumers, we continue to invest in innovative opportunities that create great experiences and improve their lives. And we're empowering small businesses globally by providing greater reach to customers, not just in their towns but across countries and around the world. And in our discussions, one of the very important points is we operate in a very vibrant competitive environment, and we're also proud of the fact that we're investing meaningfully in the ecosystem. For example, Android has helped foster remarkable and sustainable ecosystem of manufacturers and app developers and entrepreneurs, based on open-source software and open innovation. That's really the thrust of it is -- and the emphasis as we're continuing to work constructively with regulators, no additional update. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [42] +-------------------------------------------------------------------------------- +And Justin, on the live streaming question, I already mentioned that Live stream is a big focus for us. We've been at it for a while, and we built a great robust and mature platform for big events. We just announced Vitcon, our plans to make mobile live streaming features available within our core YouTube app on all mobile devices. +Our stream time is -- live stream time has increased 3X since the beginning of the year alone. And YouTube is the first major platform to support live content in 360 degrees. And recent examples, even the RNC and the DNC conventions, they're being live streamed on YouTube in 360, and so there's a lot of momentum there and we are absolutely committed to the space. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [44] +-------------------------------------------------------------------------------- +Thank for taking my questions. I have two. The first one is on the US accelerated pretty nicely. Any specific buckets of advertisers or any of the innovative products that you'd call out as driving that acceleration in the quarter? +The second one, Sundar, you talked about using machine learning for better suggestions on YouTube. Could you just help us all think about what the level of engagement is on YouTube right now, whether it's minutes or maybe growth in minutes? How do we think about engagement in YouTube now? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [45] +-------------------------------------------------------------------------------- +In terms of the US, the 25% year-on-year growth reflects strength across products; there's really nothing to call out. It's a modest acceleration consistent with what we saw overall. But it's really about mobile search. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO [46] +-------------------------------------------------------------------------------- +On YouTube, I would, at a high level I would say we're not -- don't have any new metrics. But on mobile alone as I've said before, we reach more 18 to 34 and 18 to 49s than any other TV network, broadcast or cable. And every indication we see is that the growth is very, very strong, being driven by mobile and it's growing globally, as well. So overall, I think engagement is very, very healthy. I'm pretty excited about it. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- +Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Thank you. This concludes our question-and-answer session for today. I'd like to turn the call back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - Head of IR [49] +-------------------------------------------------------------------------------- +Thanks, everyone, for joining us today. We look forward to speaking with you again on our third-quarter 2016 call. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2016-Oct-27-GOOGL.txt b/Transcripts/GOOGL/2016-Oct-27-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..e5b4bf1d1525b4b7e95d7127d0b213303c29725c --- /dev/null +++ b/Transcripts/GOOGL/2016-Oct-27-GOOGL.txt @@ -0,0 +1,449 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Alphabet Inc Earnings Call +OCTOBER 27, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Sundar Pichai + Alphabet Inc. - CEO - Google Inc. + * Ellen West + Alphabet Inc. - Head of IR + * Ruth Porat + Alphabet Inc. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ross Sandler + Deutsche Bank - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Dan Salmon + BMO Capital Markets - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Eric Sheridan + UBS - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Ken Sena + Evercore ISI - Analyst + * Anthony DiClemente + Nomura Securities - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + Welcome to the Alphabet Q3 2016 earnings call. +(Operator Instructions) +As a reminder, today's conference call is being recorded. I would now like to turn the conference call over to Ellen West, Head of Investor Relations. Please go ahead + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - Head of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to Alphabet's third-quarter 2016 earnings conference call. With us today are Ruth Porat and Sundar Pichai. +While you've been waiting for the call to start, you've been listening to Dua Lipa, a rising new pop star from London whose most recent single on YouTube has found fans all over the world, and cracked the top 40 in the US, ahead of her debut album release early next year. +Now I'll quickly cover the Safe Harbor. Some of the statements that we make today may be considered forward-looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. +For information please refer to the risk factors discussed in our Form 10-K for 2015, filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +As you know, we distribute our earnings release through our Investor Relations website, located at ABC.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. And now, I'll turn the call over to Ruth + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [3] +-------------------------------------------------------------------------------- +Thank you, Ellen. Our revenue of $22.5 billion in the third quarter underscores the terrific performance of our businesses globally. +For the quarter, our consolidated revenue grew 23% in constant currency versus last year, notwithstanding a challenging year-on-year comparison. Once again, the primary driver was mobile search, with ongoing strength in YouTube, and important contributions for programmatic advertising and Play. I'm going to present you in the following order: +First, review the quarter on a consolidated basis for Alphabet. Second, review the results for each of Google and Other Bets. Finally I will conclude with our outlook. Sundar will then review our business and product highlights for the quarter, after which will take your questions. +Beginning with a summary of Alphabet's consolidated financial performance. Total revenue was $22.5 billion, up 20% year over year, and up 4% sequentially. We realized a negative currency impact on our revenues year over year of $196 million, or $91 million after the benefit of our hedging program. Holding currency constant to prior periods, our total revenue grew 23% year over year and increased 5% sequentially. +Alphabet revenues by geography highlight the strength of our business around the globe. US revenue was up 22% year over year to $10.6 billion. + UK revenue was up 5% year over year to $1.9 billion, reflecting the meaningful impact of the decline in the British pound, relative to last year. In fixed FX terms, the UK grew 18% year over year. +Rest of world revenue was up 22% versus last year to $9.9 billion. In fixed FX terms, revenues were up 25% year over year. +GAAP other cost of revenues was $4.5 billion, up 30% year over year. Non-GAAP other cost of revenues was $4.2 billion, up 29% year over year, primarily driven by Google-related expenses. Specifically, costs associated with operating our data centers, including depreciation, and content acquisition costs, primarily for YouTube. +GAAP operating expenses were $8 billion in the quarter, up 15% year over year. Non-GAAP operating expenses were $6.5 billion, up 13% year over year. On a GAAP basis, operating income was $5.8 billion, up 22% versus last year. +The operating margin was 26%. Non-GAAP operating income was $7.6 billion, up 24% versus last year. The operating margin was 34%. +Stock-based compensation totaled $1.9 billion up 30% year over year, and up 24% sequentially, primarily reflecting the step-up from our annual equity refresh for employees at the start of Q3. Headcount at the end of the quarter was 69,953, up 3,378 people from last quarter. Headcount growth is typically seasonally highest in the third quarter, as new graduates join. Consistent with prior quarters, the vast majority of new hires or engineers and product managers to support growth in priority areas such as Cloud. +Other income and expense was $278 million. We provide more detail on the line items within OI&E in our earnings press release. Our effective tax rate was 16%. +Net income was $5.1 billion on a GAAP basis and $6.3 billion on a non-GAAP basis. Earnings per diluted share were $7.25 on a GAAP basis, and $9.06 on a non-GAAP basis. +Turning now to CapEx and operating cash flow, CapEx for the quarter was $2.6 billion, the substantial majority of which supported the Google segment. Operating cash flow was $9.8 billion, with free cash flow of $7.3 billion. We ended the quarter with cash and marketable securities of $83.1 billion, of which approximately $50 billion or 60% is held overseas. +Let me now turn to our segment financial results. Starting with the Google segment, revenue was $22.3 billion, up 20% year over year, which includes the impact of FX. In terms of the revenue detail, Google Sites revenue was $16.1 billion in the quarter, up 23% year over year, and up 4% sequentially. Year-on-year growth reflects strength in mobile search. We continue to have decent growth from desktop and tablet search. +YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView, with a growing contribution from buying on DoubleClick Bid Manager. Network revenue was $3.7 billion, up 1% year on year and flat sequentially, reflecting the ongoing strong growth of programmatic and AdMob, offset by the traditional network businesses. Other revenue from Google was $2.4 billion, up 39% year over year, and up 12% sequentially. Year-over-year growth was driven by Play and Cloud. +Finally, we provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. Let me remind you that these metrics are affected by currency movements. +Total traffic acquisition costs were $4.2 billion or 21% of total advertising revenue, up 17% year over year, and up 5% sequentially. The increase in both sites TAC as a percentage of sites revenue, as well as network TAC as a percentage of network revenue, reflects the fact our strongest growth areas, namely mobile search and programmatic, carry higher TAC. Total TAC as a percentage of total advertising revenues was up slightly sequentially, as a result of higher TAC for mobile search, offsetting the benefits of a revenue mix shift from network to sites. +Operating income excluding SBC was $8.4 billion, up 19% versus last year, for an operating margin of 38%. Google's stock-based compensation totaled $1.6 billion for the quarter, up 28% year over year. Operating income, reflecting the impact of SBC, was $6.8 billion, up 17% versus last year, and the operating margin was 30%. CapEx for the quarter was $2.4 billion, reflecting investments in production equipment, facilities, and data center construction. +Turning to Other Bets, as we have said previously we think it remains most instructive to look at financials for Other Bets over a longer time horizon, because as you have seen, quarterly revenues and expenses can be lumpy for three primary reasons: First, the Other Bets are early stage. Second, they represent an aggregation of businesses operating in different industries. And finally, they maybe impacted by one-time items like partnership deals. +For the third quarter, Other Bets revenue was $197 million, primarily generated by Nest, Fiber and Verily. Operating loss, excluding SBC, was $665 million in the third quarter. Including the impact of SBC, operating loss was $865 million. Other Bets' CapEx was $324 million in Q3, primarily reflecting ongoing investment in our Fiber business. +I'd like to close with a few observations on our progress since the creation of Alphabet just over a year ago, as well as a review of our key themes. As we've frequently noted, our move to Alphabet was motivated by our belief that revolutionary ideas drive the next big growth areas. Long-term success requires a commitment to making bets, putting the right talent and resources behind those bets, and remaining flexible and dynamic as we pursue them. We believe our structure provides the transparency and oversight needed to make smart choices about our investment opportunities, both within Google and across Other Bets. +As we reach for moon shots that will have a big impact in the longer term, it's inevitable that will be course corrections along the way, and that some efforts will be more successful than others. Over the past year for example, you have seen us make progress and accelerate our efforts in some areas, while repositioning or taking a pause in others. We are taking the steps necessary to the lay the foundation for a stronger future. +Looking ahead, first regarding revenue, our revenue growth reflects our sustained investment in innovation. Within Google, this relentless focus has led to innovations across our advertising platforms, that have driven continued strong growth on a very large base, while at the same time we are building new businesses to serve as sources of future revenue growth. +Most notably, Google Cloud is generating substantial revenue growth reflecting the ongoing momentum in the business, as well as the enormous opportunity in this area. And earlier this month, we launched a new line of hardware devices that for the first time brings consumers the best of Google, through both hardware and software developed by Google. As discussed previously, because most of our Other Bets are pre-revenue, the other bet revenue line provides only partial insight regarding our progress, which we aim to supplement with insight regarding product progress. +For example, at Nest, product innovations and improvements including the new outdoor version of the Nest Cam are leading to increased consumer adoption of its suite of products for the home. Our self-driving car team is making terrific progress in transforming mobility, with our fleet of test cars recently passing the 2 million mile mark of autonomous driving. We are now testing our cars in four cities, enabling us to experience varied weather and driving conditions. +Second, as to expenses. As I mentioned last quarter, there are a number of factors driving higher TAC in both our sites and network businesses, and those factors persisted in the third quarter. The shift to mobile in Q3 remained the largest driver of the increase in sites TAC as a percentage of revenue. +We expect sites TAC to continue to increase as a percentage of sites revenue. The growth in network TAC in Q3 was due to the ongoing adoption of programmatic platforms by advertisers, which are subject to a higher TAC rate, a trend we expect to continue. Furthermore, with respect to Google's operating expenses, we remain committed to investing in the compelling opportunities we've identified. +Turning to Other Bets. We're building out these businesses systematically and thoughtfully, investing commensurate with requirements given the opportunities we see. Before moving on from expenses, one reminder regarding the fourth quarter: +As discussed in prior years, our marketing costs are typically weighted more heavily toward the back half of the year, due to the holiday season. Relative to last year, we have expanded portfolio of hardware products and therefore expect marketing cost to increase in the fourth quarter to support the line. +Third, regarding CapEx. At Google, the team continues to drive meaningful efficiencies in planning and operations for our technical infrastructure. With regard to CapEx investments for Other Bets, our fiber investment remains the primary driver. +Fourth, our balance sheet. Our balance sheet remains a powerful tool reflecting the strength of our cash flow, and thereby giving us the ability to invest aggressively to support our long-term growth. Our primary focus is just that, investing in the breadth of opportunities across Alphabet. And as discussed previously, our capital allocation framework begins with our outlook for the businesses, including a sensitivity analysis regarding potential CapEx and M&A, as well as view regarding working capital, and a prudent liquidity buffer. +This framework further considers complementary uses, such as a share repurchase. As announced today, our Board has authorized us to commence a repurchase of our Class C capital stock of up to $7.01934097683 billion. +In conclusion, in the third quarter, we again delivered strong revenue growth, while broadening our portfolio of products and services. Thanks to all of our colleagues around the globe, for their ingenuity and passion for pushing the frontier. I'll turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [4] +-------------------------------------------------------------------------------- + Thanks, Ruth. I don't think I can remember a busier time in Google's history in the past few months. We introduced the world to the Google Assistant, powered by our state-of-the-art machine learning technology. +We unveiled a beautiful line-up of new hardware devices, including Google Home and the Pixel Phone, which is getting great reviews. We launched a new messaging app, Allo, and a new video chat app, Duo. It's been an incredible quarter. +Through it all, we are laser focused on the priorities I outlined earlier this year, and in the next few minutes, I will quickly go through our progress this past quarter. We feel well-positioned as we transition to a new era of computing. This new era is one in which people will experience computing more naturally and seamlessly, in the context of their lives, powered by intelligent assistants and the Cloud. This transition is as significant as the move over the last decade from desktops to mobile devices. +As we have rolled out products like the Google Assistant, Pixel, Google Home, and Allo, we have gotten a glimpse of that future. And with our growing crowd business, we are helping our enterprise customers take advantage of this new era of computing, as well. +Today, I want to walk through our progress across Google's key focus areas, and the success of our growing advertising business. First, making knowledge and information accessible to everyone. We have long aimed to help people find the information that they want, right when they need it, and sometimes even before they think to ask for it. +We reached an important milestone in the journey this quarter, with the launch of the Google Assistant, which allows you to type or talk with Google in a natural conversational way, to help you get things done, regardless of the device you are using. We first introduced it in our smart messaging app, Allo, which lets you chat with the Assistant. You can even add it to a group conversation to help you and your friends decide where to go for dinner. +Early adoption of Allo and Duo has been great, and has exceeded our expectations. And the Assistant is core to the Pixel phone and Google Home. With Google Home, you can ask the Assistant to cast the salt your living room speaker, or turn on the lights in your kitchen. +And with Pixel, by simply holding the Home button, you can ask the Assistant to send a text to your mom, or pull up pictures of your cat in Google Photos. I hope you all get to try them out soon. The Assistant is simple, easy to use, and it is just the beginning. It's going to get so much better. +We are excited to bring new features to you across more of your contacts, soon. The Assistant is all possible thanks to our years of investments in computer science and machine learning. Our knowledge graph now understands over 70 billion facts about people, places, and things in the real world. And just last month, we announced our latest research on neural nets, which has given us a huge leap in translation quality. This breakthrough will help us provide even more accurate translations for people around the world. +And before I finish talking about access to information, I want to highlight the important work that our teams are doing to help American voters stay informed about the upcoming election. We've launched improved search tools to help voters get registered, find key deadlines, and learn how to vote early or by mail. We have launched these in both English and Spanish. I don't speak Spanish, but I check Google Translate, and I want to remind everyone, No Se Olvida de Votar. +Second, moving to our efforts to bring more content to more places, key to making information accessible is helping people find more great content across platforms like the web, YouTube, and Google Play. Just recently, one of our key efforts to make the mobile Web faster, The Open Source Project AMP celebrated its first birthday. It's being embraced by a very broad range of publishers and sites around the world, covering more than 700,000 domains. +One example. Tens of millions of WordPress sites now have AMP pages with page load speeds up to 90% faster than normal in some cases. We are also working on an initiative called AMP for Ads, a new approach to creating and serving ads, with speed at the heart of experience. +On YouTube, we continue to invest in bringing engaging content to the platform. We worked with many news organizations to live stream all three US presidential debates, and we saw record-breaking interest from the YouTube community. In fact, the three debates rank as the three most viewed political live streams of all time on YouTube, with over 8.5 million hours watched live, a 5X increase from the 2012 debates. +Elections-related searches on YouTube are also at an all-time high, with searches for US election content up almost 550%, compared to this time in the last election. And YouTube originals like the recently released Single by 30 remain incredibly popular, and continue to drive subscriptions for YouTube brand. And in Google Play, earlier this summer, we introduced Family Library, a way for up to six family members to share app, game, movie, TV show, or book purchases. +Third, powerful computing platforms and hardware. We have long been committed to building powerful computing platforms like Android, Chrome, and Daydream in VR, so that people can have great experiences, regardless of their device. Taking a step back, we've always believed that the open, horizontal, free platform like Android breeds more innovation, more options for users, and better business models for partners. +We open source our code. We build the most open APIs possible, and we work to create a sustainable open ecosystem. With over 4,000 distinct Android devices, we are really proud of how so many partners are having success on the platform. +This quarter, we began rolling out our newest update on Android, called Nougat, and shared that we're bringing Android apps to Chromebooks. We can't wait to see all of the incredible experiences that developers will build on Daydream, our newest platform for high-quality virtual reality experiences via smartphones. We also think there's an opportunity for us to more deeply integrate software and hardware together, to deliver great experiences that we hope will also contribute to future innovation and development of the ecosystem. +Earlier this month, we launched a family of hardware products made by Google, which in addition to the Google Pixel and Google home include the Daydream View headset and controller, our premium TV streaming device, Chromecast Ultra, and the new connected wi-fi system called Google Wifi. This portfolio of products is an example of how we can marry the best of hardware and software to deliver the best Google experience to people. +Fourth, our increasing momentum in Cloud. As we focus our efforts in the Cloud, we continue to see strong customer engagement. Last month, at the Horizon event, we introduced a new business unit, Google Cloud. Our unique and broad portfolio of products and services, that let our customers operate easily in a digital world, with the performance they demand. +Google Cloud includes Google Cloud Platform, our user-facing collaboration and productivity applications, now called G Suite, all of our data analytics and machine learning tools and APIs, and the enterprise-ready Android phones tablets and Chromebooks that access the Cloud. Our Cloud team has also been busy delivering new capabilities for our customers. +We announced plans to expand to eight new Cloud regions in 2017, from Mumbai, to Singapore, to Sao Paulo, to Frankfurt with more to come. We announced an enhanced media conference experience in Google Hangouts, with an updated user interface, instant screen sharing, support for 50 participants and a seamless integration into Calendar. +We have been using the same technology to power meetings at Google, and were so excited to share the improved experience with our customers. We also significantly upgraded Google BigQuery, our fully-managed data analytics warehouse, and make Google Cloud Machine Learning available in beta to help businesses easily train quality machine learning models. +In addition to building the best products and infrastructure we're partnering with great companies. This quarter, we forged new partnerships with Opta, Box, and Accenture. +Our investments in machine learning continue to be a very clear advantage for Google Cloud, and we're helping customers apply ML in very concrete ways. For example, Ocado, the world's largest online-only grocery retailer, is using machine learning to categorize and prioritize customer emails, which will help their support center respond to customers faster. +As we officially move into the Google Cloud era, our goal remains the same. We want to build and most open Cloud for all businesses, and make it easy for them to build and run great software. The team is firing on all cylinders to create the best Cloud products in the industry for our customers. +Now moving on to our growing advertising business, which is thriving in a mobile world. Our proposition to marketers on mobile is simple and is resonating. +Our mobile properties like Search, YouTube, Maps and Google Play are where people turn when they are actively interested in something. They're using our services because they want to actively watch something they're passionate about, or because they want to know, go, do, or buy something. They're super attentive and engaged. +It's just like people used to be glued to their TV screen during prime time. Our services are prime time for the mobile world. This matters for marketers, because those primetime moments, when people are actively interested and attentive, are the perfect time for a brand to place their ads. +For instance, hotel chain, La Quinta, now sees a third of their website traffic coming from mobile, and they use their hotel ads to help them reach travelers right when they're looking for hotel stays. They have found conversion rates to be twice as high with hotel ads, compared to regular mobile traffic, which is helping them capitalize on those prime time moments when travelers are on their phones and ready to book. +In video, YouTube continues to shine. More than 1 billion monthly users are watching hundreds of millions of hours every single day. YouTube has become the platform of choice for major brands, with a highly engaged audience, the best formats, and industry-leading measurement tools. +Recent research found that nearly half of US adults between the ages of 18 and 54 say that at least once a month, YouTube helps them when making a decision about buying something. One format that's been working really well for ad prices are bumper ads, which are stackable 6-second videos that help brands drive incremental reach and frequency. Brands like Universal Pictures have been pairing these shorter videos with their standard length ads on YouTube, and they're seeing great results, especially on mobile. +We also recently announced expanded capabilities to show marketers how TV and YouTube campaigns increase Google and YouTube searches for their brand. From early tests, we have seen that YouTube generates almost twice as many searches per impression than TV generates. In fact, across our advertising business, measurement is a critical investment. We want to give marketers the best tools out there to close the loop, between television and digital, online and off-line. +For example, global retailer IKEA, with their agency iProspect UK, used our store visits measurement tools to see how effective their digital marketing campaigns were at bringing shoppers into their stores. By incorporating store visit data, they realized that more than 10% of the people who clicked on their search ads went on to visit a physical store, and that their ROI from online ads was actually five times higher than they had previously estimated. +We introduced even more measurement solutions at this year's Advertising Week in New York, helping marketers close the loop with new tools like location extensions and store visit measurements for the Google Display Network. We have thousands of great partners who are getting terrific results from our products. +I'm really pleased with how our business teams are working closer than ever with our advertising partners, agencies, marketers, and publishers. We can't succeed unless they do, and we have made a huge push to develop deeper partnerships, and long-term win-win relationships. It's a big focus for us. +To wrap up, its been an incredibly exciting few months, and a very successful quarter. We feel extremely confident as we move into a new era of computing, and are thrilled to be working with our partners as we embark on the journey together. +I want to thank all of the Googlers around the world, who work tirelessly to turn ideas into reality for our users and partners. It's an honor to work alongside you every day. With that, I'll turn it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [5] +-------------------------------------------------------------------------------- +Thank you, Sundar. We will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- +Thank you so much for taking the question. Sundar, maybe for you, on the enterprise, thanks for laying out all the vision for the medium to long term on enterprise and Cloud. One of the big questions we get from investors all the time are where the key areas you need to invest going forward, in both capabilities and go to market, and how those might evolve over the next couple of years? +And then maybe a second question for Ruth, which one housekeeping matter. Ruth, with highlighting the increased marketing expense behind the product launches this year, were you referencing quarter over quarter or compared year over year, when you also launched products a year ago. Thanks so much. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [3] +-------------------------------------------------------------------------------- +On Cloud, let me talk about a few areas. We have stepped up our partnering considerably, so that we can offer customers everything they want, and we have more vehicles for going to market. So scaling up through partnerships is a big area of focus and investment for us. We are also establishing a large Cloud machine learning group, so that we can take advantage of working with our Cloud customers, and make machine learning more accessible to all of them. I would say other areas are hiring across sales, engineering and marketing. And as we head into 2017, I expect Cloud to be of our largest areas of investment and headcount growth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [4] +-------------------------------------------------------------------------------- +And then on your second question, there are really two parts to the statement. One, pretty obvious, is that just marking is seasonally higher whenever you go to the holiday season, and so year on year, I wanted just to accentuate the point that we expect this trend to be pronounced this year, because we're expanding and we're launching an even more expanded suite of hardware products. So I was really emphasizing the fact that the fourth quarter is higher, and even more so this year with the expanded suite. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [5] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [7] +-------------------------------------------------------------------------------- + I also wanted to ask a follow-up on the Cloud. I guess, I was wondering Sundar, if you could share with us what milestones should we be watching for in this business? And then also if you had to characterize, you mentioned a couple of different ones, but I'm wondering what type of workloads are you having most success with in GCP, and what's on your customers wish lists? What are the things, what's the top one or two things that your enterprise customers for Cloud might be asking for? Thanks + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [8] +-------------------------------------------------------------------------------- +Thanks, Heather. In general, the way we see is that customers don't want to be locked in, and they want to make sure their workloads can work in, and be managed by containers that run on any platform. So our virtual machines and containers, including excellent open-sourced container management communities, which was developed by Google, offers that solution. So communities just manages the provisioning, reliability, and order scaling of workloads. So we want to pursue a hybrid strategy, including on prem, and in all public Clouds. So from a customer standpoint, they will want to use an open source workload management product, and communities can work with multiple customers. So that's broadly how we think about it. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [10] +-------------------------------------------------------------------------------- +Two questions. Sundar, first on the Alphabet structure high level, so there's been some incredible innovation that's come out of Alphabet at the various businesses. If we look at something like Auto, which was acquired by Uber, or Niantic, which was the old Google Maps team, those were teams that were inside working so inside of Google better left Alphabet to start a new company, and could have been potentially wholly-owned businesses as Google in a parallel universe. So do you think the structure is ideal for entire companies, or is it just new products and new technologies, that you see as the vision here for Alphabet long-term? +And then Ruth, the second question, just on core operating margins for Google declined a little bit versus the prior quarter trend of increasing. Can you just give some color on how much of that was due to mix towards Cloud and other things that might carry lower margin versus margin compression within the advertising business? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [11] +-------------------------------------------------------------------------------- +Ross, on the first question I would say overall, when you look across Google and Alphabet, the number of areas where we been able to build world-class products and achieve scale and success, we have over seven products which serve 1 billion users each, so I think our track record speaks there. And we generally want to create the culture of innovation, and that's what we focus on. And I think it's very fine that some of them happen outside, so we don't view it as a zero-sum game, and we're very comfortable with how we approach it. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [12] +-------------------------------------------------------------------------------- +And then in terms of the margin trends, so overall operating margins year on year are up modestly on both the GAAP and non-GAAP basis, and that primarily reflects trends in Other Bets. I think your question was probably more within Google, the operating margin on a non-GAAP basis is down modestly year on year, that's primarily to other cost of sales, as distinct from TAC. The Google GAAP operating margins year on year and quarter on quarter do reflect the impact of the equity refresh that we called out last quarter, that I talked about. +I think one of the core things to your question is just as how we are looking at it, and our view continues to be that given the breadth of opportunities, and our commitment to long-term revenue growth, as we have talked about quarter after quarter, we do remain committed to investing in this growing set of opportunities, and we spend a lot of time trying to manage that revenue growth, and as I've said, manage expense growth with this -- the utmost respect for the resources deployed, and getting the best return on those resources. +So there are number of different factors in here. I think I mentioned one of the things as you're looking forward was the sales and marketing. And just to make another point, which I said in my opening comments, we do expect ongoing gross margin pressure from higher TAC in association with mobile search and with programmatic. That does still result in more revenue and gross profit dollars, but at a lower margin, and that's the other really important point, our starting point. We are continuing to invest, and we will point you to the revenue and gross profit dollars that come from that. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [14] +-------------------------------------------------------------------------------- +With Google Home and the Pixel phones, are you rethinking at all your go-to-market strategy in terms of distribution and marketing Google over the years, put out different hardware products. Have there been learnings from that, that make you approach those two particular areas in Google Home and the Pixel phone line up differently? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [15] +-------------------------------------------------------------------------------- +Thanks, Mark. And as you point out, we've done hardware products all over the years. But we saw an opportunity to bring all our display hardware progress together in a thoughtful structure. I'm glad Rick is here, and we been very focused on how we approach everything end to end, so that we can bring together software and hardware for a great user experience. So along those lines, both Google Home in Google Pixel are important new efforts for us, and I think we will thoughtfully evolve our go-to-market strategy, as well. These are important areas, and you already see with the Google Pixel, we have a deep partnership with Verizon, with which are going to market in the US. And so we're constantly thinking about how to do this well, and you'll see new approaches as we go through it more. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [17] +-------------------------------------------------------------------------------- +Sundar, you talked a lot about products across advertising and hardware. I think one thing we did not about was Maps, and you've talked about it in the past as 1 billion plus users and pretty massive engagement. So can you talk a little bit more about the monetization strategy here, and how you can really sell more advertising here, but also preserve the user experience at the same time? And maybe talk about the time frame that we could see more here? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [18] +-------------------------------------------------------------------------------- +That's a good question. Today, a big part of what you are seeing with our transition to mobile that's working really well, the reason mobile search and mobile monetization works really well for us is because a lot of it is inherently local by nature. And the thing which -- that helps us deliver a great local search experience is Maps, and so that's the direction we've always pointed in. We want it to be a great experience for consumers as Google Maps, but in terms of also really enhancing the local search experience. And I think you'll continue to see us pursue it that way, and over time to the extent there are opportunities to create value within the application itself, we will pursue that as well. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [20] +-------------------------------------------------------------------------------- +I wanted to ask one about Voice. Sundar, you have talked about the success you've had in improving your natural language recognition, and we know that Voice queries are growing quickly. Wondering if you could share your thoughts on how the increase in Voice queries may or may not impact monetization going forward. Is it a risk, or is the growth of voice queries much more skewed to less commercial activity? Just any thoughts there. Thanks so much. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [21] +-------------------------------------------------------------------------------- +Thanks, Peter. From my standpoint, I look at it as, and if you look back in time, all this is -- computing is becoming more important to people, so they are engaging with it more and more. So as we went from desktops to mobile, it's not like one replaced the other. The sum total of all of this, it expanded the pie. I approach this the same way, I think, as I see people using Voice, et cetera. They are interacting more with computing and with Google, too. So we view this as providing us more access across many different surfaces, many different contexts, being there for them when they need it. So in that view, I think it will all be a positive for us going forward. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- +Thanks for taking my question. Just to just to go back to the voice search question, Sundar, could you talk about if we do continue to migrate toward a world of voice search, could you just talk about infrastructure? Potential building that you need to put in place to continue to monetize search in a voice world, as well as you do in a phone or a desktop world. Secondly, could you talk a little bit about where you are in the role of extended text ads? I know you talked about a 20% bump to click-through rates. Just curious for where you are now? A push out, and is there any update on the click-throughs? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [24] +-------------------------------------------------------------------------------- +On the first question, I think I briefly answered it before. In terms of we're thinking about the Voice experience deeply end to end. A lot of it is going, because of how we are approaching our core investments, both from a software and hardware standpoint, so we leverage it all to make it better. So for example, even things like TPUs, which we talked about of Google I/O, played a role into something like Voice search you're talking about. +And as we evolve the Google Assistant, I think Voice is going to play a major role that way as well. So we are in very early days of all of this, in relation to our overall volumes we see, and so I think we will be thoughtful about it. For example, the Assistant team talked about conversational actions as a way by which we can integrate third parties into the voice experience. So it's early days, and I think we will evolve a lot in the coming years. +In terms of your second question around expanded text ads, I would say, again it's early. It's been adopted by advertisers across the board. We see both large and small advertisers using it, for us, we find advertisers who actually spend their time being thoughtful about the ad creatives and extensively testing and optimizing for this new format, they find strong performance. So we're pleased with the progress so far, but the transition is going to take some time, as advertisers get comfortable with it. But we are excited about it. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities - Analyst [26] +-------------------------------------------------------------------------------- +First one, for Ruth, heading into this quarter's results, you had called out the ad format change in the third quarter of last year, which had driven a step up in the year-ago growth rate. I wonder, is there anything specific on the revenue side that you'd like to call out in terms of comparisons versus the fourth quarter of last year, as we try to calibrate our revenue expectations for the fourth quarter, either in terms of mobile search, YouTube, or AdTech programmatic? +And then my second question is either for Ruth or Sundar, could you talk about the decision to pause efforts for Google Fiber? Wondering, was that decision more about financial discipline as you, I think, explained, Ruth, in your prepared remarks for the Other Bets. Or is it more has to do with the shift to wireless Internet technology or point-to-point wireless which ultimately can take the place of a Fiber or facilities-based infrastructure over time? Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [27] +-------------------------------------------------------------------------------- +Okay, great. Two good questions. So in terms of sites revenue, we are very pleased by the strength. It was broad-based. It had two real drivers. +First, the ongoing our ongoing focus on improving the experience for advertisers and users. And we introduced a number of enhancements including format changes and ad totals. I think the most important point is that no one enhancement came close to the magnitude of the changes that we made the third quarter of last year. That's why we kept calling out the 2015 change. And what's been gratifying is, in the aggregate, the results reflect the benefit of ongoing innovation, but very importantly, it wasn't one particular item. +The second contributor is the secular shift to mobile, and we continue to benefit from that, be an important part of enhancing opportunities for engagement. As we look forward to the fourth quarter, I think that was part of your question, as well. I think the only thing to point out is that in looking at growth rates, we're obviously at a revenue growth base versus last year, so just that to us is an important point to -- maybe obvious, but important to note there. +In terms of Fiber, the impetus for it was really about the opportunities that we see to focus on innovation, and what is does that mean if the objective with Other Bets is really these 10X opportunities. And when you go back to the initial impetus for creating the business, it was the Founders' view that there's a sizable opportunity, given the need for abundant connectivity on networks that are always fast and always open, and we do continue to be committed to that vision. +The team had some important breakthroughs in new technologies. You noted the most important in our view, all that we are doing with wireless, but also technologies that are key to implementation. And we believe that both of those, a number of things that are doing to enhance both our effectiveness and efficiency. And so we wanted to focus on the potential with these efforts before we reaccelerate deployment, and it was about being -- ensuring that we can take advantage of those, before again pushing forth. +We are very active in a lot of cities. In the third quarter alone, we rolled out four new cities, so that brings us to 12 cities across the US, where we are deployed, in construction, or in development. And we're making great progress in those cities. +We remain very committed to growth across those cities, and then we also have a presence in six cities with our wireless acquisition, Webpass. So we're pausing for now our work in eight cities, where we've been an exploratory discussions, but very much to your question, it's to better integrate some of the technology work we've been developing, and there's more detail in cities on the Fiber side to the extent you want to go into those. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [29] +-------------------------------------------------------------------------------- +So Sundar, it seems like from the outside looking in, the pace of product development and release seems to have accelerated, while at the same time, it seems like you're getting efficiencies with the assets you're deploying to run your business, as your CapEx growth is moderating. So I'm wondering what concrete steps you may have taken to increase productivity, or focus of the Company, and what you're doing now to continue to drive those gains going forward? And separately, as you called out earlier, you are shipping an unprecedented amount of hardware devices. So as you think about what your product portfolio might look like over the next five years or even the next decade, does the Pixel phone mark a change in direction for Google to become maybe more of an integrated software and hardware company? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [30] +-------------------------------------------------------------------------------- +Thanks, Stephen. On the first thing, I would say, we are very focused on our core mission, and we see a huge opportunity to do that in a unique way, thanks to what we view as a point of inflection with machine learning, so refocusing the Company on a set of initiatives, recognizing that point of inflection, is what has helped us really focus on things. And things like the Google Assistant are a manifestation of that, and you will see us continue to stay focused, and innovate that way. +In terms of hardware, I think in our vision, computing is becoming more and more integral. It's going to be there for users in many different contexts, and so to really think and evolve it, you need to think about software and hardware together. That's where a lot of innovations happen, and so for us to push the paradigm, push the boundary, we're very committed to doing that. +So it's a thoughtful effort from us, but overall, as I said in my remarks, we deeply remain committed to building an open ecosystem, because at the end of the day, we want Google to be there for every user, everywhere, and to do that well, we want to work with partners, and build a great ecosystem to make it happen. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [31] +-------------------------------------------------------------------------------- +And just to add a bit more to Sundar's first answer, first response to your question about efficiency, as it is expressed through CapEx spend, I think it's probably helpful to add, the pace of spend reflects the ongoing success of the team, deriving meaningful efficiencies in planning and operations for our technical infrastructure. And that's enabled us to support growing demand, but at the stable investment level. +We have talked about that on prior calls as well. But I think we're proud of what they've been doing there. Some examples of efficiencies include improvement in server utilization, and the use of machine learning that Sundar has talked about, and the deployment of innovations like our sensor processing units that he has commented. So the main thing is we're building greater productivity with existing machines, and what's important to note is that's not only good for Google products generally, but it's also valuable to our Cloud offering for our enterprise customers. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [33] +-------------------------------------------------------------------------------- +Sundar, you mentioned a point of inflection within machine learning. Can you talk about more about the trade-offs in the productization and sale of that inflection through Google Cloud versus leveraging that innovation yourself through Google Assistant? And maybe for Ruth, just any thoughts on potential future disclosures around the Cloud business? That would be great. Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [34] +-------------------------------------------------------------------------------- +On the first one, I think we are, this is -- it's a big platform shift, and it has to be available for everyone. So we've always, just like we've done with things like Android, when we see platform shifts, we provide Android to everyone, so that's the way we think about Google Cloud. We want to make sure that this -- that all these new capabilities for machine learning and AI are available through Google Cloud to all our partners. We don't see it as a zero-sum game. I think internally, core to our mission, we see areas where we can execute, and we will continue to do that, but we want to do both, and we can do it thoughtfully well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [35] +-------------------------------------------------------------------------------- +And then on your second question, we constantly look to assess if or when additional data makes sense, given specific performances. And we went through the third-quarter results, that was -- has been our intent with all of the color commentary. On Cloud, the other thing to add is that the largest percentage growth year on year in our other revenue line, and actually even across all of our revenue lines, was in our Google Cloud platform, and that reflects the significant momentum in compute and storage. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [37] +-------------------------------------------------------------------------------- + Sundar, I apologize if I missed it, but can you talk about machine learning in search, and how much it's making a difference over the last few quarters, and how much you still have to go? How important that is to the revenues? And then Ruth, a couple of questions. Any thoughts on whether hardware sales can make a difference to margins going forward? And also on the stock-based comp, how Google thinks about that expense internally? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [38] +-------------------------------------------------------------------------------- +On machine learning, in areas us like Search, and even ads, on Search, we have had an effort called RankBrain, which is bringing Google Brain in the context of Search, and we've made great progress on it, but I would still, I would characterize as very early stages in terms of the long-term impact we can have. Generally, and similarly, we are in very, very early stages of incorporating machine learning, the newer machine learning systems and ads, and again, that's the beginning of a long journey as well. Overall, I think all of these systems are incredibly complex systems, and they are handcrafted systems over many, many years. And so over time, I think machine learning will surface newer approaches and newer insights, and so we see it as a huge area of opportunity, but it will play out over a period of time. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO [39] +-------------------------------------------------------------------------------- +And then in terms of the hardware family, I think Sundar has given a lot of color on that. It's still early days with the roll out of some these newer lines that we're super excited about, and so early, to make a call on that, but certainly investing meaningfully in the line, given the importance we see in this. And then in terms of stock-based compensation, we've always said we would remain focused on long-term revenue growth, and that does require investing in talent, and we do believe equity ownership is a really valuable art of overall compensation, consistent with alignment of interests. It's something we keep an eye on, and we're mindful of the full cost of equity based compensation, and certainly look at that as part of the overall cost that we're investing in, in and across the businesses. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets. + +-------------------------------------------------------------------------------- +Dan Salmon, BMO Capital Markets - Analyst [41] +-------------------------------------------------------------------------------- +Sundar, last month, Google was part of the founding group, the partnership for the AI, and I was just curious to hear your thoughts on what your goals are for the group, and how you may take lessons back to your leadership at Google? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO - Google Inc. [42] +-------------------------------------------------------------------------------- +Look, I think, I'm very glad to see the group come together. We are in extraordinarily early days for AI, and it's super important that we approach it thoughtfully as an industry. I am encouraged to see the commitment across these companies. Our goal is to promote open collaboration, help the public understand AI, and establish best practices in R&D. +Without something like this, we think ideas would develop in silos, and so I think it's good to do this to promote an informed dialogue on the AI. And so I'm pretty excited all along, just like the TensorFlow, where we are doing this in an open way, and all the other things we have done at Google. I think it's important as we work on new technology to contribute and to give back. And so in that context, I think all of this is personally very meaningful to me. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + Thank you. That concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any further remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - Head of IR [44] +-------------------------------------------------------------------------------- +Thanks to everyone for joining us today. We look forward to speaking with you again on our fourth-quarter 2016 call. Thank you, and have a good day. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2017-Apr-27-GOOGL.txt b/Transcripts/GOOGL/2017-Apr-27-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..de781076af5133b7a9bd8aa8e92b3f45997bdc0d --- /dev/null +++ b/Transcripts/GOOGL/2017-Apr-27-GOOGL.txt @@ -0,0 +1,479 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Alphabet Inc Earnings Call +APRIL 27, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + - + * Ruth Porat + Alphabet Inc. - CFO and SVP + * Sundar Pichai + Alphabet Inc. - CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Peter Stabler + Wells Fargo Securities, LLC, Research Division - Director and Senior Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Benjamin Ari Schachter + Macquarie Research - Head of TMET Research + * Michael Brian Nathanson + MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet First Quarter 2017 Earnings Call. (Operator Instructions) +I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's First Quarter 2017 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. While you were waiting, you were listening to the infectious song, Diggy by Spencer Ludwig. Spencer is a new exciting artist on Warner Bros. Records, who is touring Europe this month. You have heard his trumpet stylings when he performed with Capital Cities on Safe and Sound. Be sure to check out his official Diggy video on his YouTube channel. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2016 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now I'll now turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. Our revenues of $24.8 billion in the first quarter demonstrate our broad-based strength globally, with revenues up 22% year-on-year. In constant currency, our consolidated revenues grew 24% versus 1Q '16. +Growth in advertising revenues was again driven by mobile search with ongoing strength in YouTube and programmatic. We also had substantial growth in other revenues from Play, hardware and cloud. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet. Given the obvious seasonality in Q4, I will focus on year-over-year changes in our results. +As a reminder, I will review our results on a GAAP basis, which includes stock-based compensation for operating income, net income and earnings per share. Second, I will review results for Google and then Other Bets. Finally, I will conclude with our outlook. Sundar will then discuss our business and product highlights for the quarter, after which we will take questions. +Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Total revenues were $24.8 billion, up 22% year-over-year. We realized a negative currency impact on our revenues year-over-year of $304 million, or $87 million after the benefit of our hedging program. Holding currency constant to the prior period, our total revenues grew 24% year-over-year. +Turning to Alphabet revenues by geography. As you can see in our press release, we've enhanced the geographic split to give you more insight into our businesses around the world. We are now reporting our revenues in 4 regions: The U.S.; EMEA, namely Europe, Middle East and Africa; APAC or Asia Pacific; and other Americas, which encompasses Canada and Latin America. To help you with the transition to our new geographic reporting, we're also sharing the U.K. revenues for this quarter. These groupings align more closely with how we manage our businesses, and also with the major currencies that affect our results. The results by region highlight the strength of our business around the globe. +U.S. revenues were up 25% year-over-year to $11.8 billion. EMEA revenues were $8.1 billion, up 13% year-over-year. In fixed FX terms, revenues were up 19%. U.K.-reported revenues continue to reflect the ongoing weakness of the British pound, with revenues up 5% year-over-year to $2 billion on a reported basis, yet up 16% in fixed FX terms. APAC revenues were $3.6 billion, up 29% versus last year and up 26% in fixed FX terms, reflecting strength of the Australian dollar and yen. Other Americas revenues, which include results from Canada and Latin America, were up 34% versus last year to $1.3 billion. In fixed FX terms, revenues were up 29% year-over-year, with fixed FX growth reflecting strength in the Brazilian real. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, were $9.8 billion, up 28% year-on-year. Other cost of revenues on a consolidated basis was $5.2 billion, up 34% year-over-year, primarily driven by Google-related expenses, specifically costs associated with operating our data centers, including depreciation; and content acquisition costs, primarily for YouTube; as well as hardware-related costs, reflecting the continued strong performance of our new Made by Google product line. +Operating expenses were $8.4 billion in the quarter, up 15% year-over-year. Year-on-year comparisons in part reflect the change in the timing of our annual equity refresh cycle with a half-year grant in Q1, which enables us to move to a single annual compensation cycle. As discussed last quarter, this affects the timing of stock-based compensation, but does not affect the overall size of the SBC expense for the year. The year-on-year increase is therefore more sizable in Q1 and Q2 compared to previous years, with less of a year-on-year impact in both Q3 and Q4. +More specifically, stock-based compensation totaled $2 billion, up 34% year-over-year. Headcount at the end of the quarter was 73,992, up 1,939 people from last quarter. The growth in consolidated headcount was somewhat muted by an internal reallocation of people from Fiber to Google. Consistent with prior quarters, the vast majority of new hires were engineers and product managers. +In terms of product areas, the most sizable headcount growth was in cloud, consistent with the priority we place on this business. Operating income was $6.6 billion, up 23% versus last year. The operating margin was 27%. Other income and expense was $251 million. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 20% for the first quarter, net income was $5.4 billion and earnings per diluted share were $7.73. Turning now to CapEx and operating cash flow. +Cash CapEx for the quarter was $2.5 billion. Operating cash flow was $9.5 billion with free cash flow of $7 billion. We ended the quarter with cash and marketable securities of $92.4 billion, of which approximately $55.7 billion or 60% is held overseas. Let me now turn to our segment financial results, starting with the Google segment. +Revenues were $24.5 billion, up 22% year-over-year, which includes the impact of FX. In terms of the revenue detail, Google sites revenues were $17.4 billion in the quarter, up 21% year-over-year. The biggest contributor to growth again this quarter was mobile search, reflecting the secular shift to mobile due to the greater utility of smartphones for users and advertisers, but obviously, also benefiting from our focus on continuously enhancing features and functionality. +YouTube revenues continue to grow at a significant rate, driven primarily by video advertising. Network revenues were $4 billion, up 9% year-on-year, reflecting the ongoing strong growth of Programmatic and AdMob. Results benefited from a slower rate of decline in the traditional network business than in prior periods, although it continues to be negatively affected by both the ongoing shift by advertisers to programmatic and our ongoing policy efforts. +Other revenues for Google were $3.1 billion, up 49%. Last quarter, we talked about our bigger investment areas, and you can see the strong momentum here, reflecting contributions from each of Play, hardware and cloud. +Specifically, Play benefited from both broad-based app strength, but also from all the work we have done in areas such as direct carrier billing, which helps more people globally access and buy their favorite apps and games on Google Play. Hardware continues to have strong growth and remains an important area for us with our family of products extending geographically. Google Cloud continues to drive sizable growth, with Google Cloud platform remaining one of the fastest-growing businesses across Alphabet. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. +Total traffic acquisition costs were $4.6 billion or 22% of total advertising revenues, and up 22% year-over-year. The increase in both sites TAC as a percentage of sites revenues, as well as network TAC as a percentage of network revenues, reflects the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. +Total TAC, as a percentage of total advertising revenues, was up year-over-year as a result of an increase in the sites TAC rate driven by the shift to mobile, which was again partially offset by a favorable revenue mix shift from network to sites, which carries lower TAC. +Google's stock-based compensation totaled $1.9 billion for the quarter, up 40% year-over-year. Operating income, including the impact of SBC, was $7.6 billion, up 22% versus last year. And the operating margin was 31%. +Accrued CapEx for the quarter was $2.4 billion, reflecting investments in production equipment, facilities and data center construction. +Turning to Other Bets. For the first quarter, Other Bets revenues were $244 million, primarily generated by Nest, Verily and Fiber. Operating loss, including the impact of SBC, was $855 million for the first quarter. Other Bets accrued CapEx was $170 million, primarily reflecting a reduced investment in fiber due to the pause in expansion we announced in 3Q '16. +Let me conclude. First, we benefited from our team's innovations that continually enhance our advertising business as evidenced by the ongoing growth of sites revenues. On a dollar basis, the increase in sites revenues reflects the healthy growth in mobile search. As we discussed in prior calls, even though mobile revenue growth requires an increasing investment in the mobile ecosystem in the form of higher TAC, our strength in mobile search is adding meaningfully to profit dollars. +Second, the strong performance in our advertising business allows us to take bigger bets within Google to fuel the growth of additional revenue streams, including those from cloud, hardware and YouTube subscription offerings. +Cloud is one of our most important strategic priorities, given the scale of opportunity in a rapidly evolving sector and the fact that the requirements for success align with many of our strengths. We will continue to invest here for the long-term opportunity. +Similarly, hardware remains an exciting growth opportunity for us, and you've seen the early indicators again this quarter. +Finally, in Other Bets. We're determining the size and pace of investment appropriate to each bet given their stage of development and achievements against milestones. We expect to increase near-term investment in certain areas while continuing to calibrate the pace of investment in others as they move along a path to commercialization. For example, as I hope you saw earlier this week, Waymo announced it has commenced the trial of its self-driving cars in the Phoenix area. Waymo also announced it is expanding its fleet of minivans to support this trial. These actions reflect the tremendous accomplishment of our team over many years, leading with safety and now beginning to bring the experience to consumers. +I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. It's been a terrific start to the year. This quarter was notable for the fantastic momentum across our products, advances for the Google Assistant, the launch of YouTube TV and lots of new features launched at our Google Cloud Next event. +In the next few weeks, there's much more to come. We'll host our annual developer conference, Google I/O; our advertising event, Google Marketing Mix; and our YouTube upfront, Brandcast. I hope you'll join us. +Today, I'll discuss 3 things. First, how our continued investments in machine learning are fueling innovation across Google, and particularly, how it's helping drive our core mission of providing access to information for everyone. Second, progress in 3 of our biggest bets: YouTube, cloud and hardware. And third, our platforms, such as Android and our advertising platform, which power businesses and computing experiences around the world. +Now turning first to machine learning and access to information. I'm really happy with how we are transitioning to on AI-first company. The Google Assistant is one of our first steps towards that future. This quarter, we brought the assistant to your wrist with Android Wear 2.0, announced that it will soon come to Android TV and began rolling it out to hundreds of millions of people with Android phones running Nougat and Marshmallow. +We also continued to announce new integration partners for the Google Assistant, so you can now ask it to do things like dim the living room lights. Stay tuned for more to come. +Advances in machine learning are helping us make many Google products better. One example from this quarter is the launch of parking predictions in Google Maps. Beyond that, we continue to set the pace in machine learning and AI research. We introduced a new technique for training deep neural networks on mobile devices called Federated Learning. This technique enables people to run a shared machine-learning model while keeping the underlying data stored locally on mobile phones. +DeepMind is bringing AlphaGo to China in May, pairing AI with the world's best players at the Future of Go Summit. And it's very exciting to see the incredible things that developers and researchers are building on the TensorFlow platform. There are more than 6,000 GitHub projects and counting. +Search remains the heart of our mission to make information available to everyone, and we are laser-focused on making search even better. In March, we introduced tappable shortcuts in Google search to help you easily access topics you care about like sports, entertainment and weather. And earlier this week, to improve our results further, we introduced algorithmic ranking improvements as well as easier ways for people to provide direct feedback in auto complete and featured snippets. +Last week, we made big improvements to one of our longest-standing and most-loved products, Google Earth. It's really beautiful and easy to use. Now you can experience breathtaking locations in virtual reality, like the top of Table Mountain in South Africa. +Moving on to 3 of our biggest bets, YouTube, cloud and hardware. First, YouTube, where we continue to see extraordinary growth and opportunities. People around the world are watching more content on YouTube than ever before. +In 2016, we passed a big milestone that continues to grow. Every day, users watch over 1 billion hours on YouTube. YouTube continues to be the most popular destination for online video globally, and we are focused on building awesome experiences. This quarter, we announced YouTube TV, which offers live TV from major broadcast and cable networks, a cloud-based DVR without storage limits and streaming on all of your devices. We have launched in 5 cities so far, and the positive feedback from customers has been really incredible. +Our destination for family and kids content called YouTube Kids also recently celebrated its second birthday. There have been more than 30 billion media views in the app to date. +Next, our growing cloud business. Our Google Cloud Next conference in March was a great opportunity to highlight core areas of differentiation for GCP, like new security products and the recognition that we had the highest cloud availability in 2016 according to CloudHarmony. It was attended by 5x as many people as last year. +We also demonstrated new machine-learning services and announced our acquisition of Kaggle, the largest community of data scientists focused on machine learning and AI. We introduced dozens of new products, including Spanner, a database optimized for distributed computing that can reliably update data across multiple data centers, and our G Suite team introduced a major expansion of our collaboration platform with Hangouts Meet and Hangouts Chat. +To give you a taste of the kinds of large enterprise customers and partners we are now working with across GCP, we were joined onstage by major companies like HSBC, Home Depot, Schlumberger and SAP as well as large new G Suite customers including Colgate-Palmolive. +We continue to see tremendous momentum in education, where our products are leading the industry, thanks to their simplicity, security and low cost. Chromebooks are now used by more than 20 million teachers and students, and more than 70 million people actively use G Suite for education. +Over the last several months, we have noticed a change in the types of conversations that Diane and her team are having with customers. Increasingly, we are being asked to partner for mission-critical projects and full migrations, moving data from on-prem data centers to the cloud. We are seeing a meaningful shift, and this momentum is resulting in a fast-growing business. On to our next big bet, hardware. +Last year, we debuted a beautiful new family of hardware devices, including the Pixel, Google Home and Google Wifi, bringing together the best of Google across hardware and software. We are finding that people who buy products like Pixel and Google Home are not only incredibly happy with their purchase, but also are very likely to recommend it to others. Sales continues to be strong, and we are actively working to bring these great devices to more people around the world. Just a few weeks ago, we announced that Google Home and Google Wifi are now available in the U.K. +Speaking of Google Home, last week, we made it possible for up to 6 people to connect their accounts to one Google Home. And thanks to our leading voice recognition technology, it can recognize who is speaking to it. It's really a game changer. +And finally, we are continuing to invest in our computing and advertising platforms. Our platforms have had great success over the years, creating incredible user experiences as well as real opportunities and economic success for partners, creators and developers around the globe. To illustrate, in the past 3 years, in Europe, the Middle East and Africa alone, we paid out more than $15 billion to our publisher, creator and app developer partners. That's across AdSense, YouTube and Google Play. And it doesn't even include device sales by many hardware partners who build on Android. There's tremendous momentum in the Android ecosystem, as evidenced by the great reception of the beautiful Samsung Galaxy S8. We'll have much more to say at I/O next month. +In March, we introduced the first developer preview of Android O, featuring improvements for battery life, notifications and picture-in-picture display. The Android platform is also seeing great growth in emerging markets. In 2016, nearly 300 million new users adopted Android devices from countries like India and Brazil. +We also announced the public launch of Android Wear 2.0 with 2 new flagship watches from LG. And thanks to partnerships with major brands like TAG and Fossil, there will be more than 20 different Android Wear watches available this year, doubling the number from last year. +Our virtual reality platform, Daydream, which debuted almost a year ago, continues to gain traction with more devices and more great content, like VR Video. More than 50% of time in Daydream is video consumption, and YouTube VR is Daydream's #1 app by time spent. +Lastly, I'll talk about the highlights and trends we are seeing across our growing advertising business, where there are still enormous opportunities. As you can see from our results, we continue to experience remarkable growth worldwide. Not only are existing advertisers choosing to spend more as they see the value of our ads, but many more businesses around the world are just getting started on our ad platforms, from India to Brazil and many more. +Our momentum continues to be driven by the shift to mobile. Our great properties like Search, Maps, YouTube and Google Play, are the prime time for the mobile world, where people are actively engaged and interested. We have increased our investment in machine learning in our advertising business with efforts like Smart Bidding, where our systems predict the performance of an ad and adjust advertisers' bids in real-time to maximize their results. Two areas where we are seeing particular strength are retailers and app developers. +Mobile has transformed the shopping experience. In the past year, local shopping queries have increased by 45% and the number of retailers that provide us with their local inventory feeds has doubled. Our investments in innovative ad formats, improved targeting and better measurement are really helping retailers, who see us an ally in their corner. Brands like Williams Sonoma have seen a 70% increase in mobile sales year-over-year, with Google's mobile shopping ads playing a big part. +Secondly, developers use us to help their app stand out from the crowd. Thanks to our app-installed advertising products, developers have already driven more than 5 billion app downloads. Our flagship product here, Universal App Campaigns, allows developers to easily promote their apps across Google Search, Play, YouTube and the Google Display Network. It incorporates machine learning to improve campaigns and drive great results for advertisers. We recently announced new innovations at the Game Developers Conference, including an interactive playable app format in Universal App Campaigns that lets users play a lightweight version of your game right in the ad. It's really effective in driving installs from engaged users. +Now on to our growing media advertising business. Brands love the reach and engagement that they get across YouTube, along with the effectiveness of formats like TrueView skippable ads and our new Bumper ads, which are snackable 6-second videos that drive incremental reach and frequency. We recently did research on more than 120 Bumper ad campaigns, and the data showed that they drove a significant lift in brand awareness and ad recall. +Under Armour used both Bumper ads and TrueView together to promote a new product launch recently, resulting in double the lift in product interest among people who saw both ads compared to those who only saw the TrueView ad. We work incredibly hard to get the -- to create the best environment for brands on YouTube. The cornerstone of our offering is Google Preferred, which allow brands to advertise against the top 5% of our content. +We also announced new safeguards for advertisers through a combination of updated ad policies and enforcement, new default settings around where ads can appear, improved controls for advertisers and third-party brand safety reporting. Brands and agencies understand how hard we work to create the safest possible environment. We do this while also being very careful to ensure YouTube's innovative creators can earn money to support their unique and popular content. +We've been actively engaged in conversations with clients about the new tools and controls we are providing, and we are having very productive discussions ahead of Brandcast next week. +Finally, programmatic advertising. As market has continued to shift to its programmatic ad buying, our DoubleClick platform makes it easy for them to effectively reach the right audiences. We've been focusing on making more inventory available to more advertisers, especially premium inventory. +For instance, we recently expanded our Programmatic Guaranteed reservation product to advertisers globally. And we made traditional TV inventory available to buy in DoubleClick Bid Manager. So that's a run-through of some highlights for the quarter. Thanks to every Googler for making Google such an exciting and inspiring place to work every day. +Over the last few days, we have had Take Your Child to Work Day at Google, which is one of my favorite events of the year. We have had thousands of excited screaming kids running around the Googleplex, which is how I feel some days, too. What motivates us at Google is building the technologies that will be central to all of their computing experiences, to give them opportunities to learn, to be heard and to succeed. +And with that, I will hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. And we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Douglas Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [2] +-------------------------------------------------------------------------------- + + I had 2. First, just you talked about cloud as a huge strategic priority. Can you just talk more about the go-to-market strategy for GCP and how you plan on building up the reseller channel there going forward? And then, secondly, Sundar, on Waymo. I was curious on some of your thoughts, I know it's early, but on the timing for Waymo to become commercially viable. And then what are the key guideposts and requirements along the way? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [3] +-------------------------------------------------------------------------------- + + On the cloud stuff, talking about go-to-market, as Ruth said, in Q1, our largest growth in headcount and CapEx was in cloud. So we are thrilled with the progress we have made there since Diane arrived, building out world-class sales, marketing and engineering teams. The heavy lifting, I would say, is around how we meet the enterprises in the market. We have reorganized, so we have one face to the customer. So it's not just sales reps. We've been thoughtful about how we have built out the entire go-to-market organization. So we created 2 new areas that customers can now take advantage of. One is the office of the CTO, which helps customers solve difficult technical problems. And the second is our Advanced Solutions Lab, where customers can get help for machine learning experts. And on top of that, now, we have a phenomenal support team that helps keep customers' applications up and running. So I think what we have done, our approach is One Google. When a customer signs up for Google Cloud, they get more than GCP and G Suite, they have access to the ads and analytics teams, YouTube teams and resources within our organization. So I think it's coming along quite well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [4] +-------------------------------------------------------------------------------- + + And then on your question on Waymo, we view Waymo as a great example of a graduate from X that's addressing a sizable problem and builds off of tremendous technology here. We started with safety. We remain a leader in safety, and we continue to view that as the foundation for success. And at this point, we're exploring many options, enabling ride-sharing, personal-use vehicles, logistics and deliveries. And we also see opportunities to work with cities to address public transportation. So the announcements that we made this week are a continuation of the progress the team has made. We do have a strong relationship with Fiat Chrysler, increased our car order given the opportunity. They have been our primary partner to date. But to note, we're in active discussions with others around the globe. And then I think, importantly, the trial in the Phoenix area is something that's been in the works for some time, and we do look forward to that trial. So it's still in the early days and we're excited about the upside from Waymo. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [6] +-------------------------------------------------------------------------------- + + I also wanted to ask a question about cloud, as a follow-up. I was just wondering, Sundar, if you could share with us, what's the feedback then since Next from your cloud customers? And could you share with us how, qualitatively, some things we can gauge just kind of whether this is starting to see -- whether this business is starting to see an inflection on growth or not? Is there anything you could give us qualitatively about how the pipeline is building in this area? And I guess, just what I'm interested in is also the types of conversations you're having with customers now versus maybe 6 years ago -- or I'm sorry, 6 months ago. Sorry about that. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [7] +-------------------------------------------------------------------------------- + + Time flies fast. I mean, Next was -- having them in Google I/O many, many times, I was surprised to see the scale and growth of Next from even last year to this year. We had 5 many times as (sic) [5x as many] people. I think everyone really appreciated seeing large customers, very sophisticated customers, like HSBC, eBay, Colgate-Palmolive, et cetera, discussing use of Google Cloud, GCP. Along with Diane, I did follow-up lunches with a set of people. And so the feedback has been very positive. People sense our commitment to the area. They understand the pace at which we are investing. They see that we have committed to machine learning and AI at a deep level. They appreciate how we are open sourcing things. Fei-Fei's talk was extraordinarily well received. They are noticing the acquisitions we are making of Kaggle and AppBridge, a couple of acquisitions which happened around that time. So all that, all those details, I think, clearly made an impact. I just spoke about the go-to-market progress. And I think that's beginning to get traction as well. In general, I think there is a very strong recognition that we have pivoted to being a deep enterprise company and conversations are very strategic. We are engaging at the highest levels within companies. And so overall, I can see qualitatively the momentum there. When we are in the middle of deals, we find we are very competitive and there are areas where our customers perceive us as best-in-class already. So it's been exciting to see. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And our next question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [9] +-------------------------------------------------------------------------------- + + Sundar, you mentioned Google Assistant in your remarks. I wanted to know, what have you seen in terms of consumer adoption of Google Assistant, whether at the Pixel level or the Google Home level? What does it give you in terms of sense in how people want to interact with the Assistant, what it might do in terms of putting artificial intelligence capabilities down to the consumer level and improve consumer experiences over the next couple of years? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [10] +-------------------------------------------------------------------------------- + + Good question, Eric. I mean, Pixel is a good example because I think it's the place where we do the leading work here. And how we presented Google Assistant in the Pixel, well received, both qualitatively in terms of consumer feedback we get, quantitatively in terms of how we see people using voice, how we see people interacting with overall Google Assistant and search better. So we find that when we drive the Assistant experience well, it works overall in helping people engage with Google at a broader level. It's always surprising to us, all they said. Even with search, every single day, we see so many new types of queries. When you bring the Assistant in the mix, you start getting even more different types of queries. And queries are more casual, more conversational. And so over time, I think it starts breaking down the barriers to computing people have, and that's what makes it very, very exciting. Now artificial intelligence will help us push all that further. Just to give an example, we will make text to speech much, much better over time. Yesterday, we announced our neural machine translation is launching in 9 new languages. So all that starts accruing to the Assistant and I think will overall improve the consumer experience pretty dramatically. We'll talk about all this a lot more at Google I/O. So stay tuned. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [12] +-------------------------------------------------------------------------------- + + Two questions, please, one on YouTube and one on Google Maps. Sundar or Ruth, there was some press about the -- some of the pushback or some of the controversy around content and advertising and monetization of that. Are those technical problems that can be solved over time? Or is it just the magnitude of the volume of content and trying to keep bad content off the site, however that's defined, and keep it from being monetized? Is that just -- is that an ongoing technology challenge? Or did you only already find a solution? And do you see any material impact to advertisers' budget interest with YouTube? And then if you could also comment briefly on Google Maps. This is one of those massive properties that you've owned that's highly used by almost everybody. And I think the monetization to date has been really de minimis. Is there anything that's changed for you in terms of your thought about the ability to monetize Google Maps over time? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [13] +-------------------------------------------------------------------------------- + + On advertising and monetization in YouTube, we talked a bit about it. We have taken it pretty seriously, and we are taking significant steps. And obviously, as part of doing that, we brought new technical solutions into place. Machine learning is a great example of it. It helps us enforce -- as we improve our policies, it helps us enforce it better. And we are in early days. So as machine learning gets better, I think we'll be able to do all of this even better and create that virtuous cycle. Overall, I'm pretty confident at the rate at which we have made progress. And we are going to continue investing a lot here. It is super important to us that this ecosystem works well. It matters for advertisers. It matters for content creators. And so we take that responsibility very seriously. I would say advertisers have clearly noticed all the improvements we have made. Our conversations with them are very, very positive. And so I'm pretty optimistic about how we'll continue to make progress here. On Google Maps, your question is -- it's a good question. I get surprised that for a property, which we had launched many, many years ago, even now that it's showing strong growth, especially in emerging markets. Maps is an integral part of your mobile phone. And as we get more -- as users get more interested in the real world around them, with AR and so on, I think Maps will continue to play a bigger role. We take a long-term view. It's already impacting monetization very significantly for us with local search. So today, when you use Google, a lot of the information we are able to do is because of Google Maps. But I'm sure you've noticed changes within Google Maps over the past few months. If you open Google Maps, you're traveling or you're out on a Friday evening, we start surfacing a lot more interesting information about what you can do, places to eat and so on. So those are beginning to get good feedback from users. And I think that gives us opportunity to add value there over time as well. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + And our next question comes from Peter Stabler of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities, LLC, Research Division - Director and Senior Analyst [15] +-------------------------------------------------------------------------------- + + I want to follow-up on Mark's question on the local opportunity. Assuming that you agree it's a large one, what kind of steps are you taking to educate the smaller businesses out there on the opportunities you have? You've mentioned increasing take-up of local inventory ads. We understand that. But more generally, your go-to-market strategy on how you reach the millions of SMBs out there in terms of educating them on the growing opportunities on a local basis. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [16] +-------------------------------------------------------------------------------- + + It's a great question, and I think there's a lot of opportunity for us. Today, we have many touch points. Obviously, people, we reach out to SMBs. They want to get listed in Search and in Maps. AdWords Express has been a big part of how they want to advertise on our platforms. We obviously provide things like Google Apps to SMBs. So we have a lot of touch points. And internally, we are beginning to do a much better job of reaching out and having a more thoughtful go-to-market approach. I think there's a lot more work there. But the rate at which we are seeing advertisers, small and medium businesses, on our platform has been growing very, very strongly as well. So indications are that it's already currently working at scale. We have millions and millions of SMBs on our platform, and the number continues to grow very well. But you'll see us invest a lot more here in the years ahead. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [18] +-------------------------------------------------------------------------------- + + Can you talk a little bit more about the retail search category? Any high-level commentary on consumer search, query trends in retail, either an area of strength or otherwise? And then you talked about the real-time local inventory integration. But Sundar, I'd be curious if you could talk about any opportunities or areas of innovation in the retail search space that you see to really continue to improve user's retail search experience. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [19] +-------------------------------------------------------------------------------- + + I think, obviously, when we see what users are looking for in mobile, how shopping is evolving, it's an area we are continuously working on. I've been happy to see the evolution in our shopping experiences. Retail, overall, also happens to be an amazing category for us from a Google Cloud standpoint. So in some ways, we are developing deeper partnerships with retailers around the world. And so as we start doing that, and I think as we get a better understanding of their inventory and the data, how we can translate all of that into our core experiences is a bit of the work ahead. I think that's what excites us about the longer term. Shorter term, I think it's a space we're continuing to invest in. We are actually seeing strong trends in that category. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [21] +-------------------------------------------------------------------------------- + + I've got 2 questions on YouTube for Sundar. First, this morning on the earnings call, WPP's CEO, Sir Martin Sorrell, noted that the company is being very responsive, I think, were his words, to some of the recent concerns that we had talked about earlier in the Q&A. We've also seen some official policy changes, things like that. I'd be interested, Sundar, to hear a little bit more about some of the softer outreach that you may be doing, thinking of Philipp Schindler's team, maybe the agency relations team and how your people are reaching out and connecting with their clients, especially as you go into Brandcast. And then the second follow-up on YouTube was, I'd be interested to hear your updated thoughts on the role of the YouTube Spaces. I think Ruth's prepared comments on CapEx mentioned some investments in production equipment, I don't know if that is related to that or something related to cloud, but it does seem that the Spaces remain an important part of YouTube and continue to grow, and I'd love to hear an updated view on them. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [22] +-------------------------------------------------------------------------------- + + On the first part, I mean, I think you've kind of (inaudible). One of the things I've noticed is depth of relationships we have with our advertisers was very evident to me as we went through this over the past few weeks. I would estimate, I think, Philipp Schindler's team has probably made literally thousands and thousands of calls, in-persons conversations. And I think that deep relationship is what allowed us to respond thoughtfully. And I think the feedback from our partners were very positive and constructive, and I think we are evolving overall to a better place. And so I think, to me, that shows the long-term investments you make in these relationships, et cetera, plays -- plays well at times like these. And Brandcast is, again, an important touch point. And the excitement out of Brandcast, both internally and from our partners, all has the right indications for us. On YouTube on Spaces, I visited the YouTube Space. I took my family to the YouTube Space in New York and we had a lot of fun. Our creators love these spaces. They are something we are thoughtfully building out. They have a good return on investment for us. But we are very thoughtful about it. And I don't think that's a major factor in any of the CapEx we talked about here. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [23] +-------------------------------------------------------------------------------- + + Yes, exactly. And the CapEx, when I talked about production equipment, we were talking about machines, and that was the primary driver here. We're investing more in machines, given both our growing requirements and the higher cost of the new generation of machines and accelerators. So that will be more expensive in the short term, and we are continuing to build our inventory, but it does increase performance and, we believe, reduce total cost of ownership in the longer term. Just to clarify that on CapEx. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [25] +-------------------------------------------------------------------------------- + + I'm not sure if this is for Sundar or Ruth, but a question about regulatory. You guys recently reached an agreement in Russia around the Android bundling issue, where you're going to provide options for other browsers and search engines and app stores when a new Android phone is activated. So just wondering if this is the right way to think about these kinds of disputes in other areas of the world where you may be under some regulatory pressure around Android bundles? Or if that was kind of a one-off isolated agreement? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [26] +-------------------------------------------------------------------------------- + + I think -- without getting into specifics, I think when we deal with regulatory issues, I mean, the concerns vary differently depending on local laws and what the concerns are. I think in the case of Russia, I think there were some specific issues, and I'm glad we were able to work together with the regulatory agencies there, with our partners there to come to a good solution. I'm not sure that's the right template, but as much as -- we are very committed to making sure we work with all the right agencies in all the countries we operate in. And I'm confident we'll get to a good place. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [28] +-------------------------------------------------------------------------------- + + Sundar, ahead of this advertising conference, I was thinking about search innovation. And over the last 4 years, you had an acceleration with PLAs, a really acceleration with the third ad link. I'm just wondering, maybe you could talk about what excites you. Or do you think there's still a lot to go on search monetization or coverage? And then from Ruth, obviously, so many areas you can invest in. You could cut price on cloud. You could really ramp up engineers in the core or cloud. Just a lot you can do. And just how does the management team think about balancing profitability versus driving market share and long-term growth? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [29] +-------------------------------------------------------------------------------- + + On search, I continue to get surprised by the kind of things users reach out to us for and how that keeps evolving and changing. So that -- and with the Assistant now, too, just exposes a whole new surface area. And so I think there's a lot of innovation ahead. In terms of monetization, I think about it. It still looks like there is a lot of -- for example, if you just look at retail, 90% of retail is still offline. So there are many, many secular trends like that which we look at and we see a huge opportunity to help connect users to the information they are looking for. So structurally, I do think we still have lots of both innovation and growth ahead for the long term, and that's how we think about it. Maybe to Ruth on the second part. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [30] +-------------------------------------------------------------------------------- + + Yes, and really actually building on that, to answer the second part of your question. When we look at the ongoing momentum that you're seeing here in sites revenue, it really does go to innovation. No one change tends to drive results. It's really the combined benefit of all that we're doing across the franchise, continuing to invest in the business and the benefits that we see there. And that's the way we look at it, is we have tremendous opportunity continuing in mobile search and in YouTube across the business there. And as we're looking at these newer opportunities, all that we're doing in cloud, in hardware, YouTube subscription businesses, we analyze each one of those individually, working very closely with the leaders and the milestones that are established there. We do very much across the business have an operating principle that too many resources and too few can lead to suboptimal decisions and execution. And so what we're looking at over a multiyear period is the pace of innovation that's appropriate, given the sizable opportunity. But the key point, and I've said on so many different calls, is that we remain focused on long-term value creation. And we're excited about the growth opportunities, not just within Google, but across Alphabet, with all that we're doing in Other Bets. And so we're looking at these, again, individually over a multiyear period, looking at milestones and appropriately calibrating the pace of investment that is logical. And at the same time, we continue to have a focus on enhancing efficiencies where we can. But overall, as I keep saying, our main priority remains revenue and profit dollar growth. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst [32] +-------------------------------------------------------------------------------- + + I have 2 for Sundar. The first is, now that you've launched YouTube TV, I wonder, can you tell us about the advertising opportunity there? And then what are you going to do, given all the assets, to maximize inventory for marketers? And then secondly, I wonder would that focus on brand safety. You hear it now from agencies and the bigger marketers. What's going to be the long-term impact, do you think, to YouTube programmatic from a more focused view on finding the right places to advertise? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [33] +-------------------------------------------------------------------------------- + + On your first question about YouTube TV, we're just getting started. I love -- I think the product is really intended for the YouTube generation. It's really great to see a take on how to consume TV, which is mobile-first for that generation. And I think -- I've been using the product and enjoying it. And I think that gives us -- as we rethink that experience and make it work better and scale it up, I think it's -- your question is valid, the delivery of ads on TV has also not evolved at the same speed as the delivery of ads and media content on the Internet. So I think -- we think we have a significant opportunity to improve that experience, and especially for advertisers to be able to think across all these surfaces. So I think there's a lot of opportunity, but I think we have -- we are very focused on the consumer experience first. On your second question around longer-term impact. Look, these types of issues are not new for us. Over the past many, many years, as we build services, scale it up on the web, constantly, things evolve. We adapt to it, be it from spam and e-mail or how we do search ranking and all the efforts we put into it. These are the classes of problems our engineers are really, really good at working. These are large-scale system problems, and especially with machine learning and AI over time, I think we can really put in the right systems in place. And our teams work very thoughtfully with the external ecosystem at our advertisers, agencies and partners. And I think that balance will help us get it right for the very long term. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Nomura. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [35] +-------------------------------------------------------------------------------- + + I have one for Ruth and one for Sundar. Ruth, sites TAC as a percentage of revenue grew sequentially and year-over-year. I totally understand that mobile search is contributing meaningfully to the profit dollars. But as we look at the sites TAC as a percentage, is there a quarter or is there a point in time looking forward where that sort of elevated TAC growth rate will anniversary or fall back into line with sites revenue growth as a growth rate? Is there anything you can do to proactively manage that TAC growth? And then for Sundar, on YouTube, as the competition out there for video content really intensifies, to what extent is YouTube providing more favorable economics to its content creators in order to ensure that YouTube remains the leading platform, and importantly, in a lot of cases, an exclusive platform for your most popular channel? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [36] +-------------------------------------------------------------------------------- + + So on sites TAC, as we've often discussed and as you said in your question, there are a number of factors that affect sites TAC as a percentage of sites revenue, and the primary driver has been the strong growth in mobile and the fact that more mobile searches are subject to TAC. And the other factors include the mix of paid versus organic as well as changes in partner mix or agreement terms. And when we look year-over-year, the primary driver of the increase is, very much to your question, the strength in mobile search, and we do expect sites TAC to increase as a percentage of revenues. But again, our focus continues to be on growing profit dollars. And I think the main point is we're very pleased to have a very strong business in a rapidly growing area, and that's benefiting our profit dollars even as the TAC percentage increases. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [37] +-------------------------------------------------------------------------------- + + And on YouTube, I look at it from a content creator standpoint. I think there are a lot of factors which are working well. So for example, when we recently invested in original shows, we find that like over half the time people spend watching originals is on their mobile phones. They find that creators who are featured in originals experience a significant boost in YouTube subscribers and watch time on their main channels as well, often from new fans. So all of this shows us that -- the enthusiasm which is there for the platform, how creators can do unique things which are different from what they can do on other platforms. And I think that's what gives us the differentiation here. And in these areas, we are just getting started, and so there's a lot more to come. And I think that will help us provide better economics to them, better engagement for them and I think positions us well. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And our next question comes from Ben Schachter of Macquarie. + +-------------------------------------------------------------------------------- +Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [39] +-------------------------------------------------------------------------------- + + Sundar, when we think about virtual reality and augmented reality, from your point of view, what are the key steps that are needed to see more mass-market appeal and usage? And could you help quantify the amount of investment that you are willing to place in this area before you expect to see a payoff? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [40] +-------------------------------------------------------------------------------- + + So I think, obviously, you're seeing we are very happy with the progress we have seen with Daydream, just like we built Android. And we've been -- we are good at building platforms and ecosystems, and I think we are taking the right first steps with VR there as well. When I broadly look at VR and AR, I think there are -- I think all of us clearly understand the potential, and technically, we are making the breakthroughs that are needed. And all of it needs to converge from a hardware, software, services standpoint to a stage where it has mass-market appeal. And I think that is still some ways away. The thing which gives me excitement is all these changes start happening with a set of early adopters and most mainstream. And so we are engaging at that level with the early adopters, and that's where Daydream is working well. We are learning how to write great content on top of VR. YouTube, Google Earth VR, they use tilt brush, these are all great examples. So we -- and underlying technology-wise, be it all the kinds of sensors and tracking you need to do, the machine learning and AI you need, things like voice recognition, everything, it's just a computing evolution. And so everything we are investing today in machine learning and AI, as well as what we are doing in our computing platforms, transitions well. So I think we are already well positioned to play this. And so I think we'll thoughtfully approach it and we'll approach it more holistically. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [42] +-------------------------------------------------------------------------------- + + I guess this is a follow-up to the question on voice interfaces and personal assistants, something that Larry also called out in his Founders letter. It appears there are more tests around monetization, including transactions and integration with Shopping Express. I wonder if there's a view internally now as to how best to make that transition in a voice-first world towards monetization towards voice and less text and video-centric. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO of Google [43] +-------------------------------------------------------------------------------- + + We are very focused actually on the consumer experience now. And it's a good question. And we have always had these questions, be it the early days of search or when YouTube was first built out. How do [I see these] experiences created, like, will YouTube ever make money? And so I think if you go and create these experiences in a way that works at scale for users, the monetization will follow. And obviously -- and the models will be different than we have today. But I think we are squarely focused right now on delivering a world-class experience through voice and through Assistant. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, - [45] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter 2017 call. Thank you, and good day. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2017-Jan-26-GOOGL.txt b/Transcripts/GOOGL/2017-Jan-26-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..47b27478ac591948a06fa97ff0e30ba7497ef096 --- /dev/null +++ b/Transcripts/GOOGL/2017-Jan-26-GOOGL.txt @@ -0,0 +1,545 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Alphabet Inc Earnings Call +JANUARY 26, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Sundar Pichai + Alphabet Inc - CEO, Google Inc. + * Ellen West + Alphabet Inc - Head of IR + * Ruth Porat + Alphabet Inc - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Eric Sheridan + UBS - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Michael Nathanson + MoffettNathanson LLC - Analyst + * Lloyd Walmsley + Deutsche Bank - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Ken Sena + Evercore ISI - Analyst + * Anthony DiClemente + Nomura Securities Intl (America) - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet fourth quarter 2016 earnings conference call. +(Operator Instructions) +As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's fourth quarter 2016 earnings conference call. With us today are Ruth Porat and Sundar Pichai. While you've been waiting for the call to start, you've been listening to Ingrid Michaelson. In just a decade, she has released six albums, five of which have charted. The song you just heard, Celebrate, is from her release titled, It Doesn't Have to Make Sense. Please check out her YouTube channel. +Now I will quickly cover the Safe Harbor. Some of the statements that we make today may be considered forward-looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2015 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at ABC.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. And now, I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [3] +-------------------------------------------------------------------------------- + + Thank you. Our revenue of $26.1 billion in the fourth quarter underscores the continued excellent performance of our businesses globally. For the fourth quarter, our consolidated revenue grew 24% in constant currency versus 4Q 2015, notwithstanding a challenging year-on-year comparison. Advertising revenue growth was driven by mobile search, with ongoing strength in YouTube and programmatic. We also had substantial growth in other revenues from hardware, play and cloud. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet. Given the obvious seasonality in Q4, I'll focus on year-over-year changes in our results. You can find quarterly comparisons in the earnings release. +Second, I'll review the results for Google and then Other Bets. Finally, I will conclude with a summary of the full year results and our outlook. Sundar will then review our business and product highlights for the quarter, after which we will take questions. +Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Total revenue was $26.1 billion, up 22% year-over-year. We realized a negative currency impact on our revenues year-over-year of $202 million, or $[15] million after the benefit of our hedging program. Holding currency constant to the prior period, our total revenue grew 24% year-over-year. +Alphabet revenues by geography highlight the strength of our business around the globe. US revenue was up 24% year-over-year to $12.7 billion. UK revenue was up 7% year-over-year to $2.1 [billion], reflecting the continued weakness of the British pound relative to last year. In fixed FX terms, the UK grew 21% year-over-year. Rest of world revenue was up 24% versus last year to $11.3 billion, in fixed FX terms revenues were up 26% year-over-year. +GAAP other cost of revenues, was $5.8 billion, up 41% year-over-year. Non-GAAP other cost of revenues was $5.5 billion, up 41% year-over-year primarily driven by Google-related expenses, specifically costs associated with operating our data centers including depreciation, and content acquisition costs primarily for YouTube, as well as hardware. +The impact of our Q4 hardware launches is reflected in both revenues and cost of revenues. However, it's important to note the cost of revenues was also affected by approximately $320 million of one-time charges related to equipment, and other adjustments which were unrelated to hardware. GAAP operating expenses were $8.8 billion in the quarter, up 13% year-over-year. Non-GAAP operating expenses were $7.3 billion, up 10% year-over-year. +Year-on-year comparisons in part reflect the impact of the expenses from project milestones and Other Bets in 4Q 2015 that we discussed last year. On a GAAP basis, operating income was $6.6 billion, up 23% versus last year. The operating margin was 25%. Non-GAAP operating income was $8.5 billion, up 24% versus last year. The operating margin was 33%. +Stock-based compensation totalled $1.8 billion, up 29% year-over-year. Head count at the end of the quarter was just over 72,000, up 2,100 people from last quarter. Consistent with prior quarters, the vast majority of new hires were engineers and product managers to support growth in priority areas such as cloud, including the addition of employees from our Apigee acquisition. Other income and expense was $218 million. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 22% for the fourth quarter, reflecting the geographic mix of earnings and certain discrete items affecting our US rate. Our effective tax rate for the full year 2016 was 19%. Net income was $5.3 billion on a GAAP basis, and $6.6 billion on a non-GAAP basis. Earnings per diluted share were $7.56 on a GAAP basis, and $9.36 on a non-GAAP basis. +Turning now to CapEx and operating cash flow, cash CapEx for the quarter was $3.1 billion. Operating cash flow was $9.4 billion, with free cash flow of $6.3 billion. We ended the quarter with cash and marketable securities of $86.3 billion, of which approximately $52 billion or 61% is held overseas. +Let me now turn to our segment financial results starting with the Google segment. Revenue was $25.8 billion, up 22% year-over-year which includes the impact of FX. In terms of the revenue detail, Google sites revenue was $18 billion in the quarter, up 20% year-over-year. Year-on-year growth reflects strength in mobile search. +YouTube revenue continues to grow at a very significant rate, driven primarily by video advertising across TrueView, including buying on DoubleClick Bid Manager. Network revenue was $4.4 billion, up 7% year-on-year reflecting the ongoing strong growth of programmatic and AdMob offset by the traditional network businesses. Other revenue for Google was $3.4 billion, up 62% year-over-year with strong performance from each of hardware, Play and Cloud. +Finally, we continued to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. Let me remind you that these metrics are affected by currency movements. +Total traffic acquisition costs were $4.8 billion or 22% of total advertising revenue, and up 20% year-over-year. The increase in both sites TAC as a percentage of sites revenue, as well as network TAC as a percentage of network revenue reflects the fact that our strongest growth areas, namely mobile search and programmatic carry higher TAC. Total TAC as a percentage of total advertising revenues was up as a result of an increase in the sites TAC rate driven by the shift to mobile, which was partially offset by a favorable revenue mix shift from network to sites which carries lower TAC. +Operating income excluding SBC was $9.5 billion, up 19% versus last year for an operating margin of 37%. Google stock-based compensation totaled $1.7 billion for the quarter, up 29% year-over-year. Operating income reflecting the impact of SBC was $7.9 billion, up 17% versus last year, and the operating margin was 31%. Accrued CapEx for the quarter was $2.9 billion, reflecting investments in production equipment, facilities, and data center construction. +Turning Other Bets, I'll cover results for the full year 2016, because it's most instructive to look at financials for Other Bets over a longer time horizon as discussed previously. Results for the quarter are in our earnings release. For the full year 2016 Other Bets revenue was $809 million, up 82% versus 2015 primarily generated by Nest, Fiber and Verily. Operating loss excluding SBC was $2.9 billion for the full year 2016, a slight decline from 2015. Including the impact of SBC, the operating loss was $3.6 billion for the full year, an increase of 4% over 2015. Other Bets accrued CapEx was $1.4 billion for the full year 2016, up 63% over 2015. +Before I move to my conclusion, I'll quickly cover some specific changes to our past practices. First, we are making changes to our non-GAAP reporting. SBC has always been an important part of how we reward our employees in a way that aligns their interest with those of all shareholders. Although it is not a cash expense, we consider it to be a real cost of running our business because SBC is critical to our ability to attract and retain the best talent in the world. +Starting with our first quarter results for 2017, we will no longer regularly exclude stock-based compensation expense from non-GAAP results. Non-cash stock-based compensation will continue to be reported on our cash flow statement, but we will no longer be providing a reconciliation from GAAP to non-GAAP measures that reflects SBC and related tax benefits. Second, we are shifting the timing of our annual equity refresh cycle for employees to the first quarter of every year. The next full year equity refresh will occur in the first quarter of 2018. +Because the last full employee equity refresh occurred in the third quarter of 2016, we are providing employees with a one-time half grant in the first quarter of 2017. Overall, total SBC for 2017 will be roughly the same as it would have been, had we maintained a Q3 refresh cycle. However, given the shift in refresh timing, there will not be the historical seasonal increase in SBC in Q3 and Q4. We do not plan any changes to our senior executive equity refresh, which occurs every two years with the next one planned for 2018. +Third, to hedge our non-US dollar earnings, we are moving from using options only to using primarily forwards. We believe they will be a more effective way to hedge earnings. We intend to continue to use options selectively. +We continue to believe that constant currency revenue growth provides the best insight into underlying trends by isolating the impact of currency movements on revenue. We will continue to provide constant currency results for consolidated revenues, as well as for revenues by geography. This will give you a view into the effects of currency movements on our revenue. +Turning now to our full year 2016 performance and outlook. 2016 was simply a great year for us. Our extraordinarily talented employees worked very hard and successfully for our users around the globe. That commitment is reflected in the Company's exceptional financial results. +For the full year 2016 consolidated revenue grew 20%, and excluding the impact of currency movements grew 24%. GAAP operating income was up 23%. This performance is a testament to the ongoing innovation that is driving our success in mobile search, YouTube, and programmatic advertising, each of which we believe has only begun to scratch the surface. We remain excited about the sizeable opportunities that have not yet been tapped. +Alongside these businesses, we are focused on growing additional revenue streams within Google over the medium- and long-term. In 2016, our other revenue line grew 41% on a full year basis reflecting the growth in our Play, hardware and cloud businesses. We see tremendous potential ahead for these businesses, as well as in the continued development of non-advertising revenue streams for YouTube. We're investing in our cloud and hardware businesses, as well as our newer non-ad revenue sources for YouTube, in order to accelerate their progress as major revenue drivers for Google in the next several years. +We're also investing significantly in the machine learning capabilities and next generation computing infrastructure that will propel Google's growth over the longer term. For our Other Bets, we continue to calibrate the magnitude and pace of investment appropriate to their individual execution paths. A couple of our recent announcements demonstrate our approach here. +First, in December, Waymo graduated into a standalone business within Other Bets. We did this because Waymo achieved agreed thresholds on the path to commercialization in its technical and business model. Waymo continues to excel at safety, has begun putting its new Chrysler Pacifica minivans on the road, and is continuing to drive down hardware costs. +Nest delivered an outstanding performance this holiday season with sales of key products more than doubling over the two weeks including Black Friday and Cyber Monday. And just this morning, Verily announced that Temasek has agreed to invest $800 million for a minority stake in the Company. Temasek's extensive experience with life sciences and healthcare companies, and deep understanding of Asian markets make it a valuable long-term partner for Verily. +The internal transparency we've provided to our business leaders across the Other Bets and Google is helping us to allocate resources more thoughtfully across the opportunities that we see. We remain committed to managing for long-term revenue and EPS growth, for dollars rather than margin targets, while exercising careful stewardship over the amounts and pace of investment. I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. 2016 was a great year for Google, and 2017 is shaping up to be even more exciting. This quarter was about the business firing on all cylinders, and terrific progress across Google's newer areas of investments. Today, I'm going to talk about three things. First, the key trend powering Google today, machine learning, and how it's improving our products and creating lots of opportunities. +In particular, how it's underpinning our core mission of providing access to information for everyone, especially via the Google Assistant which is off to a great start. Second, I want to talk about three of our biggest bets, YouTube, cloud, and hardware where we are making great progress. And third, I'll discuss the great trends we're seeing across the platforms, our vibrant computing platforms, Android, Chrome and Daydream, strong momentum in Google Play, as well are thriving advertising platform. First, machine learning, and access to information. +As I've shared, before computing is moving from a mobile first to AI first, with more universal ambient and intelligent computing that you can interact with naturally, all made smarter by the progress we are making with machine learning. 2016 was the year that this became central to who we are as a Company, and the products that we build. We had more than 350 launches powered by machine learning across areas like search, maps, messaging and Google Play. You've heard lots of these examples, easier email replies and inbox, better YouTube recommendations, the incredible cameras on our Pixel phones, and smarter bidding for advertisers in [adverts]. +A central piece of our machine learning efforts is the Google Assistant which allows users to have a natural conversation with Google, to help them get things done across their experience. It's off to a great start. You can easily ask it to navigate to home, tell you about your schedule for the day, or even play trivia. We reached a milestone last month with the announcement of the Assistant developer platform called Actions on Google. It gives developers like Uber, SongPop and Headspace the opportunity to build conversation actions for Google Home, and we will expand it even further this year. Our Assistant is baked into our smart messaging app, Allo, which we expanded this quarter in languages like Hindi, Brazilian Portuguese and Japanese. +This quarter, using neural machine translation, we have improved our translation ability more in one single leap, than all of our improvements over the last 10 years combined. We'll be rolling neural machine translation out across the more than 100 languages available in Google translated in 2017, and also for all of our Cloud customers through the Google Cloud translation API. And Google Photos, which as you know has machine learning at its heart, continues to grow in popularity. Last quarter, we launched PhotoScan which helps you digitize all of those old printed photos that are probably stored in a shoe box in your closet, to keep them safe, organized and sharable. In February, we are hosting a summit where our machine learning team and other experts will discuss the future of the TensorFlow open source initiative, and share some of their latest demos. +Now I want to spend some time talking about three big bets, YouTube, cloud and hardware. First, YouTube, which remains the premier destination for online video globally, and is seeing tremendous growth. At the heart of YouTube success is its booming community of creators. Every single day, over 1,000 creators reach the milestone of having 1,000 channel subscribers. +We are focused on two main areas of investment. First, creating the best video experience that's fast, personalized, searchable, and that just works. We have rolled out many new features to the platform, like 360-degree videos, mobile live streams, and support for videos and virtual reality. In regions with limited connectivity, we introduced YouTube Go, which has transparency and control of data usage. +Second, we are focused on delivering content that gives fans exactly what they want, through offerings like YouTube Music, YouTube Kids and YouTube [Red]. We have 27 originals, pairing some of the most popular YouTube creators, with the biggest directors and producers in Hollywood. One of our new originals called, This is Everything, Gigi Gorgeous, about the courageous journey of a transgender YouTube star officially premiered at Sundance, just a few days ago. The popularity of this original content has been successful in driving new subscribers and retaining existing ones, and we'll do more in 2017. +Second, our Cloud business is on a terrific upswing. In 2016, we made huge strides building out our product offerings across all areas of Google Cloud Platform or GCP. We routinely hear from customers that we have now moved well beyond table stakes, and we have truly differentiated offerings in four key areas, data analytics and machine learning, security and privacy, tools for application development, and the ability to create connected business platforms leveraging our recent acquisition of Apigee. +Our product advancements across all of GCP, in addition to our increased focus on how we work with enterprise customers have enabled us to accelerate growth with new Fortune 2000 customers, while also inspiring our current customers to substantially expand their use of GCP. We've also enjoyed strong growth with G Suite, our cloud-based collaboration and productivity applications. G Suite achieved a significant new customer milestone last quarter, more than 3 million paying businesses are now using G Suite to collaborate smartly and securely in the Cloud. +Our increased success with the enterprise customers relates to the unparalleled security and data production we can provide by offering an entirely cloud-based solution that enables an extremely strong level of protection. For both GCP and G Suite, expanding our partner ecosystem continues to be a big focus, and last quarter the team announced new alliances including Intel, Improbable, Slack, Pivotal and Red Hat. Our customers and partners are appreciating Google cloud's dramatically accelerated pace of product rollout, as for their responsiveness to both their needs and aspirations. We look forward to showcasing customers, partners, and all of Google cloud at our next annual next user conference in March. +Third, hardware. We introduced a new family of beautiful hardware devices in October that are made by Google, led by Google Home and our Pixel phone which feature the Google Assistant built in. We're thrilled with the reception, as well as the really happy customers we saw over the holiday season. In particular, Google Home was a very popular present that many people opened on Christmas morning. We have committed to this for the long-term, as a great way to bring a beautiful seamless Google experience to people. The early signs are promising, and you can expect us to see us expand our offerings thoughtfully. +We'll also continue working with our ecosystem partners to create the best experiences for our users. So those are three of our biggest bets. We are also continuing to push the platforms that are powering our business and our partners' businesses. The first, our computing platforms, and second, our advertising platforms. +Building powerful open platforms has always been core to Google, and our platforms like Android, Chrome and Daydream are creating more innovation, more choice for users, and more opportunities for partners. This was on full display at the CES show. There we saw partners like Nvidia and AirTV introduced new media players based on Android TV, and Casio and New Balance share their latest Android Wear smartwatches. +We also worked closely with Samsung on a new generation of Chromebooks called the Samsung Chromebook Pro and Plus which are getting great buzz. And in VR, we recently worked with partners like Huawei and ASUS and others to introduce even more new Daydream-ready devices. See, it is just a start, and there is a lot more coming from our great partners across these platforms in 2017, and we'll continue working hand-in-hand with them to provide the best experiences for our users. +We are also investing in ways to help developers succeed using our platforms. Last week, we announced that we are acquiring the Fabric mobile app development platform. This will work alongside our Firebase platform to help developers build better apps and grow their businesses. Since we launched Firebase at IO, developers have created over 1 million Firebase projects. That's incredible momentum. +Google Play helps bring our platforms to life, on mobile and beyond, and it's experiencing great momentum. As a piece of trivia, do you know what 2016's top movie was on Google Play? I'll provide the answer in a second. Play had a great quarter, with continued growth in our top markets. [As for the] emerging markets, where user spend grew by more than 70% year-over-year in countries like India, Mexico, Turkey and Saudi Arabia. +As a content hub across our growing platforms, the Play team is working hard to help users to get the most of their devices through apps, games and premium content. In Q4, the Play Store launched on Daydream, Android apps became available on Chromebooks, and we announced Play Store will soon be coming to Android Wear. The platform is also benefiting significantly from machine learning. We recently introduced a new Google Play music experience that makes music streaming smarter and easier to use with better recommendations and playlists. And the answer to my trivia question, the top movie in 2016 was Deadpool. + Lastly, I quickly touch on the highlights across our growing advertising businesses. I'm so pleased with the terrific partnerships we have continued to grow this year. We work incredibly closely and deeply with agencies, marketers, and publishers worldwide. +These relationships owe a lot to the hard work of our fantastic business teams around the world. Our mobile properties like search, YouTube, maps and Google Play are where people turn when they're actively engaged. They are the prime time in the mobile era. +We had another successful holiday season, where we saw two clear trends. First, this was the year that mobile shopping went truly mainstream. The shopper is using phones as a door to the store to locate nearby retailers, find promotions, and comparison shop. We recently introduced promoted places in Google maps, helping advertisers stand out with branded location icons showing promotions and live updates of popular times, right when someone is looking for it. +Gap Inc., is one example of a company that understands the importance of connecting with consumers on mobile devices. In December, they increased their US mobile search ad spend with us, and as a result they saw about 4 times the mobile traffic to their US e-commerce sites, compared to December of last year. Second, we saw this season that measurement really matters, and advertisers want reliable ways of understanding where their sales and traffic are coming from, and how their campaigns are working. We saw increased use of our popular store visits technology over the holiday shopping season, helping businesses understand how online ads bring customers into their physical stores. In less than two years, store visits has helped advertisers measure over 3 billion store visits globally. +Now turning to our thriving video ads business led by YouTube. Marketers are seeing terrific success here. Air France used YouTube's TrueView video adds in order to reach valuable business travellers and new customers around the world. By showing engaging videos, highlighting the unique experiences of Air France, they saw more than 100 million views throughout the campaign. +Turner Sports partnered with YouTube and DoubleClick for NBA opening night to try a new way to reach fans for the start of the season. We helped them deliver real-time video ads, with behind the scenes pre-game footage uploaded immediately into a YouTube TrueView ad campaign. Thanks to the campaign, they were able to reach 19 million more people across the web, with 17% [left] in ad recall. Speaking of DoubleClick, many news publishers who are using our accelerated mobile pages are now plugging into our Ad Exchange to drive revenue. We are thrilled that most publishers are getting higher click-through rates and effective CPMs with their ad pages. +Before I end, I want to highlight one area that I'm really proud of, that Google is truly leading the way. As you know our data centers from Oklahoma to Chile to Finland, enable our services to be blazing fast, and their work makes it possible for Google Photos to offer unlimited storage. But to do all this, they use lots of energy. In 2012, we set a long-term goal to reach 100% renewable energy for our operations. +In 2015, we procured enough renewable energy to cover 44% of our total, and in 2016 we increased it to more than 50%. I'm really proud that we will reach 100% renewable energy for global operations in 2017. This is great for the environment, and with renewable energy costs declining, it's a huge win for our business results too. With that, I want to thank the Googlers around the world, who helped make this another exciting over the earth. Over to you, Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar, and we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thank you. I have a question for Sundar. I was wondering, I wanted to focus on the cloud business. When we speak with CIOs about GCP, they highlight in many cases the need for Google to improve upon its enterprise sales strategy. I'm just wondering if you could share with us the changes you've been making in that organization, and the goals that you have for the cloud business for 2017? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [3] +-------------------------------------------------------------------------------- + + Thanks, Heather. As I said in my opening remarks, I do think we are seeing tremendous momentum with our partnerships team, and how we are approaching a lot of new alliances which I talked about. So now we have teams dedicated to partnering with GSIs, and we have a team focused on technology partnerships, too. On the GSI front, we announced a new alliance with Accenture last September, to create industry solutions for a number of industries including retail. +So for me I think overall, everywhere I look at, we are establishing a world-class enterprise team. Partnerships has been a big focus, and I've seen progress there. I think, as I said in my remarks, overall 2017 I expect to have a lot of momentum, because we have moved well beyond the table stakes. Now we are really competing on areas which we think we have differentiation. I talked about data analytics and machine learning, security, and so on. +So I think we are well-positioned. The momentum, when we look at the numbers internally, and as well as the traction we see in competitive situations, I definitely think we are going to have a great year. And hopefully, in the next conference coming up, Diane and team will share a lot more details. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you for taking the questions. Maybe first for Sundar. Now that you have this breadth of device ecosystem out there into the marketplace, I wanted to know if we can get a little more color about what your learnings about the adoption of the device ecosystem, how you are thinking about the go-to0market strategy over the medium to long term, and how we might see sort of an evolution across operating systems? And then if I can, maybe one for Ruth. You called out a one-time charge in, or a one-time impact on the number in the quarter. I wonder if we can get a little more granularity about what went into that one-time expense, so we can just factor that into the financials? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [7] +-------------------------------------------------------------------------------- + + Yes, Eric, I'm assuming, when you said the device ecosystem, you're talking about how our platforms are working at scale. The thing which I get excited about, is computing is increasingly moving, rather than just one device which is a dedicated computing device, to being there for users in their context. And you'll see computing increasingly embedded in many things, and we have a comprehensive strategy. We do want people -- we invest in it for the long run. +We are improving our computing experiences with machine learning. We expect to be there for users across -- across a device ecosystem. And we're also building things like Google Play to work across all of this, so that users can have one coherent experience. I think we see great momentum both across our partner ecosystem, as well as pushing the cutting edge of the experience, which is what we strive do with our own hardware devices. And so, I think the end-to-end strategy is working well for us. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [8] +-------------------------------------------------------------------------------- + + And in terms of, you noted the one-time item, there were really two, that I'm actually going to call out. One was in the cost of revenues. I noted that equipment costs were elevated by some one-time charges, and so there was some pressure there. And then, the other item I noted was, with respect to our tax rate. I noted that there was a slightly elevated tax rate this quarter. It's always affected by the geographic mix of results, but we did have a discrete item that affected the US tax rate, just to make that clear. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Thank you. Mark Mahaney, RBC. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks. Two questions, please. Again, Ruth, on that $320 million one-time charge, is there any more detail you can provide on that? It seems like a relatively sizeable amount. +And then, Sundar, if could you talk about voice search, particularly in the home and in the car, and the importance of getting devices out in the marketplace? And the challenge I'll throw to you is, it looks to me like Google devices are being outsold 10 to 1 or something like that in most -- in a lot of homes. And it's immaterial now, but I could see in five years, that there's a new voice search interface, and it's not Google in the home, that could be a real challenge for the Company. Thank you. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [11] +-------------------------------------------------------------------------------- + + So on the first one, trying to be helpful in giving you dimension and impact on cost of sales, but really not much more to add there. I think the other point is, is you're thinking about the hardware business, it was gross margin positive. There was just some other variables in there. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [12] +-------------------------------------------------------------------------------- + + And Mark, on voice search, we're really excited about it. I think it's a very natural way for users to interact. We think it will be one mode. Our users will have many different ways by which they interact with computing. And for voice, as you pointed out, we expect voice to work across many different contexts. So we're thinking about it phones, homes, TVs, cars, and trying to drive that ecosystem that way. And we want Google to be there for users when they need it. +And even with Google Home, we just launched it in Q4. We had a very strong quarter there, and we are going to invest a lot in it over 2017. It's very early days. When I look at what it would take to voice search well, our years of progress we have done in areas like natural language processing comes into play. And I think there is a lot of work ahead to make all of this work well for users. And this is the core area where we've invested in for the very long-term. And so, I feel very comfortable about how this would play out in the future. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Ruth, you commented on YouTube, and addressed some of the non-advertising revenue streams. I was just hoping you could elaborate there a little bit, what the goals would be there for your users? And then just to follow up on Mark's question on voice search. I understand, Sundar, it's early, but how do you think about the challenges and opportunities from a monetization perspective in voice? Thanks. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [16] +-------------------------------------------------------------------------------- + + So on the first question, in terms of YouTube as Sundar elaborated on my opening comments, we're really pleased with the ongoing strength we have there. As we've talked about on prior calls it's largely driven by video, primarily trivia with a strong contribution from DoubleClick Bid Manager. And we are continuing to invest significantly in the business, given the importance of supporting the ecosystem of content creators, through partner payments, marketing, YouTube originals, YouTube spaces. We're broadening the platform, we're investing in the requisite infrastructure given machines and bandwidth required. And Sundar elaborated on some of the upside, we see there on the non-ad side. +And really the point, I was trying to stress consistent with Sundar's comments is, we got the non-ads momentum here on the YouTube side, and we're also seeing tremendous momentum with cloud which we're excited about, and the hardware and investing behind those. So those continue to build out the revenue streams, as we're looking in the near- to medium- to long-term. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [17] +-------------------------------------------------------------------------------- + + And, Doug, I mean, just like Mark's question on voice search, I would encourage you to think about it as from a user's standpoint, they are looking for information, looking to get things done. The voice queries are one part of the total journey they are on. So when we think about something like the Google Assistant, we think about this as an ongoing conversation with our users across different contexts. +So they may ask a question on voice, later when they pick up their phone, they want connectivity, so we think of this as an end-to-end thing. What this means is that users engage more with us, more with computing, and look for more information. And I think, the trends we see are positive. So we think about it from a long-term perspective, and so I see more opportunity than challenge, when I think about voice search. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [18] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Peter Stabler, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [20] +-------------------------------------------------------------------------------- + + Thanks very much. Another one on YouTube, if I could. Would it possible to get any sort of metrics around YouTube Red, and how the subscription business has been progressing, realizing you're not going to be providing that every quarter, but that you do occasionally give us benchmarks in the market? Thanks so much. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [21] +-------------------------------------------------------------------------------- + + Well, at this point, we've launched in five countries. We're pleased with the early success, and it's still early days. It takes a while to build a subscription business here. And I'll pass it to Sundar for additional commentary. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [22] +-------------------------------------------------------------------------------- + + Look, I mean, I think, I would think about it as how we are investing a lot in developing this premium experience in the way of YouTube Red, YouTube music, and we do offer it across Google Play music as well. You will see us invest more, more countries, more original content. And we'll bring together the experiences we have over the course of this year, so it's even more compelling for users. But we are seeing tractions, with the rate of sign-ups. We're not disclosing specific numbers, but I'm excited at the progress there. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [23] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. The first one, just to back to YouTube. I appreciate the color around the content. Would be curious to here about how you think philosophically about partnering with more premium content players, to maybe drive even higher engagement and even better YouTube experience? And then the second one, if you step back into your mobile search business and the verticals, the innovation you've had at retail, and travel with shopping and hotel finder, I guess, I'd be curious to hear about where you see the biggest potential for more improvements in certain verticals, for an even more relevant and higher search result experience over the next years? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [26] +-------------------------------------------------------------------------------- + + On your first question, look, I mean, we think of YouTube again as an ecosystem. We are trying to connect creators with users, form a community, and so we work hard to bring more premium content. We already work with TV networks and their individual shows, whether it's a late night show like James Corden or Jimmy Fallon, afternoon shows like Ellen, sports programming like NBA and NFL. For example, sports is one of the most popular verticals, we have hundreds of sports partnership in place. And so, we'll continue to invest that way, and drive the premium content there. +On the second one, if we do look at the [internal] experience, look at what are the kinds of tasks which users are trying to get done, how mobile raises the bar, we want to provide those deeper experiences for users. And so, I generally, think local is a big area. We have strong assets there with maps. And so, we think about how we can improve the local experience a lot more for users. So for example, within local areas like dining, we work closely with our partners to make that better. So we get it at a pretty granular level, and we try to hit all of the areas. And so, I think you'll see progress in all these areas over the next few years. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl (America) - Analyst [29] +-------------------------------------------------------------------------------- + + Hi, thanks for taking my questions. Yes, just on YouTube, would love to hear about pricing, and then also about ad [lists]. So is there anything you can highlight on ad formats? And specifically, we noticed that recently you're enabling markers to target YouTube ads based on search. And so, I just want to hear about that strategy, and maybe relatedly the recently announced the non-typical YouTube ad format, would love to kind of hear about that? Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [30] +-------------------------------------------------------------------------------- + + Look, overall, I would say, there's been a -- been very pleased with how the team has been driving innovation in ad formats, and the ad experiences. I think, we're [realizing] that it's very early day. We see whenever -- [we are obviously in an] innovation phase, and advertiser response to all of these new formats has been really positive. So for example, our bumper ads, our six second video format that we launched is already being used by thousands of accounts, including major brands like Universal Pictures and Netflix. +On your question around, how we think about the experience across screens, it's really important to understand users consume on YouTube across screens, and so they experience consistent experience. And similarly from an advertising standpoint, we want that to be thoughtful for users, more relevant across screens as well. And so, that's the context in which we do this. +We give users control over that experience, but I do think as part of these changes, advertisers can get more detailed insights from their YouTube campaigns across devices. So they can better understand the impact of their marketing campaigns. So I think it's early days, but I think it's the right direction, and I think we'll see good traction from it. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Michael Nathanson, Moffett. + +-------------------------------------------------------------------------------- +Michael Nathanson, MoffettNathanson LLC - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks, I have two, one for Sundar, and one for Ruth. Sundar, sticking on the YouTube questions, there was a report that YouTube and CBS had agreed on an agreement to distribute CBS on YouTube. Can you talk a bit if that is -- actually happened? And if so, what is the opportunity to partner with networks, and how will that evolve over time? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [33] +-------------------------------------------------------------------------------- + + Look, I can't comment on any specific discussions, but I said a little bit earlier, we are constantly working with partners across these areas. We work very closely with TV networks on their individual shows. It 's a big part of the YouTube experience, and so you'll see us work hard to make these partnerships deeper, and bring more content to our users. So maybe I'll leave it at that. + +-------------------------------------------------------------------------------- +Michael Nathanson, MoffettNathanson LLC - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. And then, for Ruth, you mentioned programmatic drove the network numbers revenue growth this quarter. If you look at fourth quarter this year and last year, there seems to be an acceleration in Q4, and then it comes back. I wonder, what's happening seasonally to that revenue line, that drives fourth quarter up so much? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [35] +-------------------------------------------------------------------------------- + + Well, as we've talked about on prior calls, there are obviously, a number of businesses within the network line, and a number of things went right this quarter. I wouldn't extrapolate from it. As you noted that, there can be some seasonality, and Q1 is typically lower than the fourth quarter. +I think the main point is that the programmatic business continues to be a strong contributor, with significant growth reflecting the ongoing advertiser adoption, just given the overall efficiency of programmatic and improved targeting and benefit of inventory growth. And so, the story, it's pretty much unchanged. We continue to see the growth in programmatic, offset by the declines in the more traditional businesses. And when you're looking at the quarter-over-quarter, you're continuing to see things like the impact of policy changes, and timing of product launches. But I just think that there were a number of things that went well this quarter. Q3 was a bit lighter, so that then [flattered] the quarter-over-quarter comparison, but I wouldn't extrapolate from this. + +-------------------------------------------------------------------------------- +Michael Nathanson, MoffettNathanson LLC - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Lloyd Walmsley, Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Walmsley, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- + + Thanks. Wondering, Sundar, if you could just give us a sense on the Pixel phone hardware opportunity to kind of build direct mobile distribution, and capture hardware margin? And how you think about that versus the potential disruption, that having your own handset at a bigger scale could cause in the Android ecosystem? Do you think this is something that can get meaningful market share without disrupting the ecosystem? And then, a second follow-up related to this would be, on the Pixel phones, with Google Assistant having been built uniquely into the core of the experience, is there anything you're learning as the usage of that increases? Is it driving a step function increase in engagement with the hardware/software integration? Thanks. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [39] +-------------------------------------------------------------------------------- + + Look, I mean, we are in early days. I think it's really important when you work on a platform, you have to drive it forward. So we have always done by putting out the state-of-the-art. And I think it especially gets important in the vision we have for computing, where users are going to use it across many different contexts. And so, to do that end-to-end experience, it spans devices. So I think it's important for us to work at the intersection of hardware, software and services. And so, that is how we think about it. +And I think that we invest a lot more in our ecosystem. And I mentioned earlier, I'm incredibly excited at the line-up we for this year from our partners. So we do both, and we're very thoughtful about it. I think the scale at which we are doing it, shows it's working. And I'm confident, we'll be able to strike the balance well. +In terms of Google Assistant on the Pixel, along with how search works, I think definitely, it gives us a way to iterate and move faster, and make sure it's working better for users. Our thesis is that as we -- as we make it easier for users to have Google at their fingertips across what they are doing, and including many modes, whether they are typing or asking Google a question, we find that it overall benefits. And so, it'll be a long-term trend, but I think our earlier [research] show that our intuition is right there, and so we'll continue approaching it that way. + +-------------------------------------------------------------------------------- +Lloyd Walmsley, Deutsche Bank - Analyst [40] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. Thank you. So Sundar, you called out Google Play growth at emerging markets in your prepared remarks. So I thought from revenue size standpoint, it would be one of the big bets you would highlight. But I was wondering how you view your own instant apps, as well as products from some other operators to let consumers try apps, either in a Messenger product, or in an HTML5 environment? Do these innovations present an opportunity, or a challenge for you at a play franchise? Secondarily, it seems like the recurring theme in your prepared remarks is how AI is making the consumer products better. Is there anything you can share, in terms of how it may be making monetization better? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [43] +-------------------------------------------------------------------------------- + + So on Google Play for me, what makes it work well is, just with the vision of computing we have been talking about how it works across context. You need an ecosystem -- you need an apps and services ecosystem to work cohesively across all of this. And that's what I like about how we are approaching Google Play. And you saw us this quarter, see Google Play work beyond Android phones, they're coming to Chromebooks, they're working Daydream, they're working Android Wear. And so, it's an end-to-end thing which works well. +And that's the most important thing, so that as a user you know whether you're engaging with a game or a TV show, that you can get it reliably get it across your computing experiences. And we'll adapt, and I think we will drive innovations in play to go where, what's right for users and developers, and so, be it instant apps, or driving better HTML5 experiences. We invest in all that, and I think we'll move it all forward. +On your second question, about how machine learning and AI is improving our monetization, it definitely, just like we had many, many launches last year, which involved machine learning being incorporated across Google including our monetization products. And our monetization teams at Google have always been at the cutting edge of, what I would call [out], as machine learning techniques from early days on. And so, they are doing it. It is early days, now but I think we already have really new insights. And so, we'll bake it in, over the course of the year. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [44] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ken Sena, Evercore. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [46] +-------------------------------------------------------------------------------- + + Hi, just maybe another question on YouTube. Can you expand on the decision this quarter to remove third-party cookie and Pixel activity? It looks like as though you're favoring something much more identity-based, and maybe you could just think through the -- or explain a bit about the impetus there, and maybe the trade-offs for marketers, that would be great? Thank you very much. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [47] +-------------------------------------------------------------------------------- + + I spoke about it a bit earlier, but I think it's important that we evolve all of this from a user-centric standpoint. And users have an identity, they have preferences. And so, for example, think about it from a user standpoint, if they don't like one particular ad, or they don't want to see an ad from a particular advertiser, they want it work across that experience, across their cross-device experience. So we think about it that way. And so, we're working towards a long-term experience that's right for users, and which I think will make sense for advertisers reaching users too. So I think we are evolving it jointly and thoughtfully giving users control. And I think that's the right way to approach it over time. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [50] +-------------------------------------------------------------------------------- + + Thank you. I would like to ask first a question about ad coverage and click rates. Maybe just your thoughts on potential to increase ad coverage now, that you have a fourth link. Is there still room to help ad clicks with coverage increases? And just as you think out to this year, how do you feel about the innovation pipeline in ads? Do you think there is a lot more you can still do in search? And then two, housekeeping for you, Ruth. Maybe you could just let us know what kind of equipment was written off, so we can think how recurring that might be? And any comment on the buyback activity in the quarter? Thank you. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc - CEO, Google Inc. [51] +-------------------------------------------------------------------------------- + + On the -- on our monetization efforts, our teams always have been very thoughtful about planning, not just for the short-term, but planning for the long-term. We don't start the year, thinking our plan is to increase ad coverage or something like that, right? We are -- we have many experiments in the pipeline. We see how user behavior is evolving. And in conjunction with that, we evolve our ad experience. So for example, as people use mobiles, scroll more, et cetera, the user behavior changes, and we adapt to that in a very, very disciplined way. +So last year, you saw us maybe increase coverage in a certain way. For example, in desktop we removed ads on the right-hand side, and so we take a very holistic approach to these things. For me, I do think we have a lot of head room ahead. I still look at where most of transactions happen, and how the secular transformation is under way. And so, I think we see -- we have a lot more headroom left, and Ruth talk about --? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [52] +-------------------------------------------------------------------------------- + + And in terms of your second question, really not much more to add on the first part. In terms of the buyback, we weren't able to commence it on the fourth quarter due to trading restrictions, but we do look forward to getting back into the market. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [53] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thank you, and I'm showing no further questions at this time. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc - CFO [55] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2017 call. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Have a great day, everyone. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2017-Jul-24-GOOGL.txt b/Transcripts/GOOGL/2017-Jul-24-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..eddbc70e1342b7c701934756f2a2d540e996ddb6 --- /dev/null +++ b/Transcripts/GOOGL/2017-Jul-24-GOOGL.txt @@ -0,0 +1,494 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Alphabet Inc Earnings Call +JULY 24, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + - + * Ruth Porat + Alphabet Inc. - CFO and SVP + * Sundar Pichai + Alphabet Inc. - Director & CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Peter Coleman Stabler + Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies, and welcome to the Alphabet Second Quarter 2017 Earnings Call. (Operator Instructions) I'd now I'd like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Second Quarter 2017 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2016 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now I'll now turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Thanks, Ellen. Our revenues of $26 billion in the second quarter demonstrate the ongoing momentum in our businesses with broad-based strength globally. Revenues were up 21% year-on-year and up 23% in constant currency. +Advertising revenues benefited from the strong performance in sites, which was led in particular by tremendous results in mobile search with a strong contribution from YouTube. Healthy growth in network revenues was driven by our programmatic business. We also had substantial growth in other revenues from Cloud, Play and hardware. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. I will review our results on a GAAP basis, which include the impact of stock-based compensation. +The European Commission fine of USD 2.7 billion is reflected in our GAAP results with the fine displayed as a separate line item for clarity. In order to assist with comparing this quarter's results to prior periods, we are also providing operating income, net income and EPS results that exclude the impact of the fine. The fine is not reflected in our segment results. +Second, I will review results for Google and then Other Bets. Finally, I will conclude with our outlook. Sundar will then discuss our business and product highlights for the quarter, after which we will take questions. +I will start with a summary of Alphabet's consolidated financial performance for the quarter. Total revenues were $26 billion, up 21% year-over-year. We realized a negative currency impact on our revenues year-over-year of $364 million or $361 million after the benefits of our hedging program. Holding currency constant to the prior period, our total revenues grew 23% year-over-year. +Turning to Alphabet revenues by geography. You can see that our performance was strong in all regions. U.S. revenues were up 23% year-over-year to $12.3 billion. EMEA revenues were $8.5 billion, up 14% year-over-year, reflecting weakness in the British pound and the euro. Revenues were up 21% in fixed FX terms. +APAC revenues were $3.7 billion, up 28% versus last year and up 27% in fixed FX terms. Other Americas revenues, which include results from Canada and Latin America, were $1.4 billion, up 31% versus last year in both reported and fixed FX terms. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, were $10.4 billion, up 28% year-on-year. Other cost of revenues on a consolidated basis was $5.3 billion, up 27% year-over-year, primarily driven by Google-related expenses, specifically: costs associated with operating our data centers, including depreciation; content acquisition costs primarily for YouTube and hardware-related costs. +Operating expenses, including the impact of the EC fine, were $11.5 billion. Excluding the impact of the EC fine, operating expenses were $8.8 billion in the quarter, up 18% year-over-year. Year-on-year expense growth reflects the change in the timing of our annual equity refresh cycle from the third quarter to the first quarter of each year. +As discussed previously, this affects the quarterly pace of stock-based compensation in 2017 but not the overall size of the expense for the year. In order to transition to the new timing, we made a onetime half year grant in Q1 of this year, which is reflected in elevated year-on-year expense growth in Q2. As a result, stock-based compensation totaled $2 billion, up 33% year-over-year. +Headcount at the end of the quarter was 75,606, up 1,614 people from last quarter. Consistent with prior quarters, the vast majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount additions were once again made in cloud for both technical and sales roles consistent with the priority we place on this business. +Operating income was $4.1 billion. Excluding the impact of the EC fine, operating income was $6.9 billion, up 15% versus last year, and the operating margin was 26%. Other income and expense was $245 million. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 19.5% for the second quarter. Net income was $3.5 billion and earnings per diluted share were $5.01. Excluding the impact of the EC fine, net income was $6.3 billion and earnings per diluted share were $8.90. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $2.8 billion. Operating cash flow was $7.4 billion with free cash flow of $4.6 billion. We ended the quarter with cash and marketable securities of $94.7 billion, of which approximately $57.9 billion or 61% is held overseas. +Let me now turn to our segment financial results starting with the Google segment. Revenues were $25.8 billion, up 21% year-over-year. In terms of the revenue detail, Google Sites revenues were $18.4 billion in the quarter, up 20% year-over-year. The biggest contributors to growth again this quarter were mobile search and YouTube. Network revenues were $4.2 billion, up 13% year-on-year, reflecting the ongoing strength of programmatic and AdMob. Other revenues for Google were $3.1 billion, up 42% year-over-year. We have been talking about our bigger investment areas within Google, and you can see the momentum here, reflecting contributions from our newer revenue streams again this quarter on top of the ongoing strength in Play. +Specifically, Cloud continues to benefit from the ongoing investments in our go-to-market and products efforts. Hardware continues to grow at a healthy pace year-on-year with the extension of our product line geographically, particularly Google Home and Wifi. The dollar impact to growth was more muted than in prior quarters, reflecting seasonality. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. +Total traffic acquisition costs were $5.1 billion or 22% of total advertising revenues and up 28% year-over-year. The increase in both sites TAC as a percentage of sites revenue as well as network TAC as a percentage of network revenues continues to reflect the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. Total TAC, as a percentage of total advertising revenues, was up year-over-year as a result of an increase in the sites TAC rate driven by the shift to mobile, which was again partially offset by a favorable revenue mix shift from network to sites, which carries lower TAC. +Google stock-based compensation totaled $1.9 billion for the quarter, up 40% year-over-year. Operating income, including the impact of SBC, was $7.8 billion, up 12% versus last year, and the operating margin was 30%. Accrued CapEx for the quarter was $2.8 billion, reflecting investments in production equipment, facilities and data center construction. +A couple of Google reminders for the third quarter. Headcount additions tend to be seasonally high in Q3 because that is when we bring on new graduates. In addition, please keep in mind that our marketing costs are typically weighted more heavily toward the back half of the year due to the holiday season, particularly as we promote our Made by Google line of hardware products. +Let me now turn and talk about Other Bets. For the second quarter, Other Bets revenues were $248 million, primarily generated by Nest, Fiber and Verily. Operating loss, including the impact of SBC, was $772 million for the second quarter. Other Bets accrued CapEx was $151 million, primarily reflecting a reduced investment in Fiber due to the pause in expansion we announced in 3Q '16. +We're pleased with our progress across Other Bets. A couple of updates. Nest continues to drive ongoing product expansion such as our recent introduction of the indoor security camera, Nest Cam IQ, as well as geographic expansion, both of which support its position as the leading brand in the connected home. +In life sciences, in addition to our progress at Verily, Calico has focused its efforts on the basic mechanisms of aging and 3 aging-related diseases representing the leading causes of death. Calico has established more than 20 active collaborations with other life sciences companies and academic institutions. +With Loon, we recently demonstrated the technology in Peru by successfully delivering basic Internet connectivity to tens of thousands of people affected by the tragic floods there. We worked in partnership with the Peruvian government and Telefonica. +And our progress with Wamo continues nicely as is reflected in the rider program in Phoenix and our recently announced partnerships with Lyft and Avis. +Let me wrap up. Almost 2 years after the creation of Alphabet, we see the benefits of our focus within Google and Other Bets and are pleased with the opportunities we have for sustained revenue and earnings growth. We are obviously very happy with the ongoing strength in ads revenue, particularly in search. Our compelling secular trends continue to drive user adoption and engagement with mobile devices. Our engineering and machine learning acumen enables us to build better experiences for users and advertisers. +We continue to see increasing contributions from our growing non-ads revenue businesses. Play continues to be a strong contributor. In addition, we have been making big bets within Google focused on cloud, hardware and subscription businesses in YouTube in order to better serve customers while also building additional and differentiated revenue streams. These businesses are consistent with and complementary to our core capabilities and leverage our infrastructure, distribution and engineering. +We believe we have a compelling runway here. Longer term, we see great opportunity in the businesses we are building in Other Bets. These businesses reflect the incredible engineering talent across Alphabet, most notably in machine learning. +Our revenue growth and Alphabet's structure give us both the opportunity and confidence to invest in our businesses for the long term. We are doing that while being very deliberate about the focus, scale and pace of investments and remain committed to being conscientious in our use of all resources. We're increasing investment in areas where we see the most potential, scaling back in others and sharpening our organizational effectiveness to make the most of the resources available. +Thank you, and let me now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. We had a phenomenal quarter. Google continues to lead the shift to AI-driven computing. We are working to make this incredible technology available to everyone around the world. It's our focus on infusing our products and platforms with the power of machine learning and AI that's driving our success. +Today, I'll spend time talking about the areas where we are confidently investing for the future: first, the incredible momentum we are seeing in some of our core products powered by machine learning; next, an update on 3 of our most promising bets, YouTube, Cloud and our hardware businesses; and I'll conclude with the strong performance of our computing and advertising platforms. +To start, our core products and the AI powering them. Google has always been about using deep computer science and insights to solve some of the world's most complex problems. People are no longer only using a keyboard, mouse and multitouch but are also using emerging inputs, like voice and camera, to ask questions and get things done in the real world. We are seeing this in the way people interact with the Google Assistant, which is already now available on more than 100 million devices since launching last year, and there's more to come since we released an Assistant SDK that'll enable a wide range of new hardware devices, which will include the Google Assistant. +We now have more than 70 home automation partners on the Assistant on Google Home and phones, including Honeywell, Logitech and LG, so you can do everyday things around the house using your voice. +At Google I/O, we announced Google Lens available later this year. Lens is a set of vision-based computing capabilities that can understand what you're looking at and help you take action based on that information. So for example, if you saw a poster for your favorite band, you would be able to take a picture and get relevant information and buy tickets to their next concert. +In Search, a great feature we launched this quarter in the U.S. is job search to make looking for a job easier for everyone no matter what line of work you're in. Many of these products that make people's lives easier are being powered by machine learning. One focus area for us this quarter has been enabling our machine learning algorithms to learn and improve our products much faster. +One such research initiative, Auto ML, enables us to pursue approaches to automate the design of machine learning models. Our ability to rapidly deploy the best machine learning in all of our products enabled us this quarter to launch all sorts of new smart features to help moderate comments, such as smart replies in Gmail and improved translations. We rolled out new machine learning features in Google Maps, YouTube, Gmail and Google Photos, which now has more than 500 million monthly users who back up 1.2 billion photos and videos every day. +I was also pleased that DeepMind's AlphaGo team was in Beijing for the Future of Go Summit, where AlphaGo played against of the #1 world player, Ke Jie. Since playing AlphaGo, Ke Jie has been on a 20-game winning streak. He has said playing AlphaGo has fundamentally changed his understanding of the game. It's remarkable to see AI have such a profound effect on one of the world's oldest, most strategic games. It can have the same impact in so many fields from medicine to science to energy usage and more. +Now let's move to some of our biggest bets. First, YouTube. YouTube now has 1.5 billion monthly viewers, and people watch, on average, 60 minutes a day on their phones and tablets. That's incredible, and it helps thousands of passionate video creators make money. The fastest growing stream for YouTube is in the living room. YouTube watch time on TV screens has nearly doubled year-on-year. This quarter, we unveiled 6 new ad-supported YouTube originals from celebrities, including Ellen DeGeneres and Kevin Hart and YouTube creators like Rhett and Link. Advertiser feedback on these new shows has been extremely positive. Last week, our live TV service, YouTube TV, added 10 new metro areas across America, tripling the markets where it's available in just 4 months. +And to our next big bet with great momentum, Google Cloud. Google Cloud Platform, GCP, continues to experience impressive growth across products, sectors and geographies and increasingly with large enterprise customers and regulated sectors. To be more specific about our momentum with big customers, in Q2, the number of new deals we closed worth more than $0.5 million is 3x what it was last year. +Responding to the growth in existing and new customers around the world, we continue to invest in data centers to provide them the fastest, most reliable service. We opened new Google Cloud regions in Northern Virginia, Singapore, Sydney and London. +We also continue to build out our partnerships. In Q2, we announced an expansion of our partnership with SAP and a new partnership with Nutanix to integrate their products with GCP, so customers can run workloads in hybrid environments on prem and in the cloud using containers and Kubernetes. +Now let's talk about our hardware business. Sales of our new family of hardware continue to be encouraging, and we are making good progress bringing these devices to more people. Google Home is now available in 4 countries: the U.S, Canada, Australia and the U.K, and we have announced it's coming to France and Germany in early August. The Pixel phone continues to be really popular, and Google Wifi just launched in Canada, Germany and France to growing revenues. Every day, I hear of people who love this product and how it has made Wi-Fi work much better in their homes. +Shifting gears, our computing and advertising platforms are driving great results for our partners. There are now more than 2 billion monthly active Android devices around the world. It's really humbling so many people choose Android. We are seeing a number of hardware makers launching devices to positive reviews, including the Samsung Galaxy S8 and the LG G6. +At Google I/O this quarter, we gave developers early access to Android O, which will focus on vitals like battery life and performance. And Google Play continues to be a vital distribution platform for developers. An incredible 82 billion apps were downloaded from Google Play in the last year alone. That's 11 apps for every person on Earth. We continue to work on the next generation of computing platforms, virtual and augmented reality. By the end of this year, there'll be 11 Daydream-ready devices on the market from manufacturers like Samsung, LG, Motorola and ASUS. +Turning to our advertising platforms. Here too, machine learning is critical to helping advertisers and app developers analyze data in real time to reach consumers with more useful ads and measure campaign effectiveness. +At Google Marketing Next this quarter, we launched Google Attribution, a comprehensive measurement tool that allows marketers to measure the impact of their campaigns across devices and channels all in one place with no additional cost. We also launched new ad formats and bidding features in universal ad Campaigns to help developers grow their user base across Google Play, Search, YouTube, Gmail and the Display Network. At Google I/O in 2016, we announced we had driven 2 billion app installs. Today, that number is more than 5 billion. That's amazing growth. +With 90% of transactions still happening offline, we want to help consumers find what they are looking for in brick-and-mortar stores. Our store visits technology is instrumental in understanding customer behavior that starts online and ends in-store. Today, our store visits measurement is the largest program of its kind, and we have now measured over 5 billion store visits in 17 countries. This quarter, we also brought local ads and store visits measurement to video. +Speaking of video, we are seeing continued success with Bumper ads, our 6-second ad format. Both brands and viewers love the format as it's the ideal length to capture attention. L'Oreal, Hasbro, Xbox, Clinique and Neutrogena have all seen great success with Bumpers. +And Google Preferred continues to grow. We now have hundreds of brands buying Google Preferred in the U.S., nearly triple the number since it launched 3 years ago. We are not just helping large brands. We are also helping millions of small businesses get online and grow. +Every month, Google helps drive 100 billion visits to business websites and creates more than 3 billion direct connections between businesses and their customers. These interactions drive huge economic opportunities and growth for small businesses. +Last month, to increase these opportunities, we launched an easy way for millions of small businesses to create a free, simple mobile-optimized website. Small businesses can do it on a mobile phone in under 10 minutes using the listing information already available on Google Search and Maps. +And finally, helping publishers grow their revenues remains a huge focus for us. We are using the power of automation and machine learning to improve our auction algorithms for publishers. Both the improvements we have made since 2016 are generating 15% more revenue for publishers using DoubleClick AdExchange. +Those are the highlights from the second quarter. This week will be another highlight for me. I'm going to Africa for a Google for Nigeria event to announce new products for Nigeria and Sub-Saharan Africa. I'm looking forward to seeing firsthand how technology and Google's products can make a real difference in people's lives. +I want to express a very sincere thank you to every Googler who worked tirelessly this quarter to bring all of our technology and products to the world. And to everyone listening, thank you, and I hope you are enjoying starting the week off with us. And now back to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. We will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from John Blackledge -- I'm sorry. Our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe a big picture question directed to Sundar. As you think about the Google Assistant and what it can do medium to long term, maybe talk a little bit about how the Assistant, as a product, could narrow the gap between consumption and utility inside your products versus monetization over time with the specific focus -- I'd love to hear about local in particular. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [3] +-------------------------------------------------------------------------------- + + It's a good question. When I think about, we have -- we're very focused over the long term to making sure the Assistant can actually help people get things done in the real world. And so obviously, when you think about it from that standpoint, local becomes important. Over time, just like when the transition happened from desktop to mobile, people's bar for what they expect increased. They wanted more answers. They wanted more immediate gratification, right? And that's a continuum, and I think you'll see the trends. And so over time, we are laser focused on making sure we can deliver against those experiences. And I think local and their particular strength over time, both in terms of the expertise we have built in local as well as our investment in Maps is hopefully paying off. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + First one for Ruth. I was just hoping you could help us understand at least qualitatively how core margins for the advertising business are trending within the Google segment. And then, Sundar, just on the cloud business, I know you talked about 4 new regions being built out. Can you just talk about your strategy in building out that cloud infrastructure, how we should think about it in terms of building out extra capacity or whether it's more in line with near-term demand? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [6] +-------------------------------------------------------------------------------- + + Thanks. So starting with your margin question. Look, as we've often said, we're focused on revenue and operating income dollar growth and not on operating margins. We have strong positions in healthy, growing areas and are adding really exciting additional growth areas. And that's what we mean when we discuss driving long-term revenue and earnings growth. To get a little more specific, the gross margin this quarter obviously reflects our product mix shift, and although the cost of sales is higher as a percentage of revenues, these costs are associated with high-growth product areas that enable us to create value for all of our stakeholders. And then on the OpEx side, the second quarter reflects a number of factors. First, I think, really, to your question on an over time point, you can see the impact of the timing shift in the equity refresh, which we discussed previously. Now as a reminder, that does abate in the back half of the year, but you can see it here in the second quarter. And then what you're also seeing in OpEx growth is the investments in areas that we've spelled out. So for example, in R&D, you can see the impact of the headcount increases in our priority areas, particularly cloud and machine learning, and marketing spend similarly reflects the strategic priority areas we've delineated, particularly hardware and YouTube subscription. But as I said in my opening comments, we're increasing investment in areas where we see the most potential. We're scaling it back in others. We're focused on organizational effectiveness to make the most of all of our resources, and all of that really underpins the goal to sustain both revenue and earnings growth over the longer term. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [8] +-------------------------------------------------------------------------------- + + I was just wondering, Sundar, you mentioned some of the strength you're seeing in GCP, and I was just wondering if you could share with us, when you do win, is there any commonality around the type of workloads that people are choosing you for? And can you share with us any updates on the go to market and kind of how you feel about where you've come over the last year? But even more importantly, what do you need to do to get it where you need it to be over the next 12 months? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [9] +-------------------------------------------------------------------------------- + + All right. Thanks, Heather. Also, I'll take Doug's question on the infrastructure, too, and do it together since they are related to cloud. Overall, when we think about our infrastructure, obviously, we are serving cloud as well as our internal products, which are seeing tremendous growth as well. In terms of serving cloud customers, we are world class in availability and being reliable, and those are things we want to stay best in class. So we're clearly planning for that and planning ahead for our infrastructure, and we have been consistently doing that. And Heather, in terms of your question about workloads and stuff, we are actually seeing quite a diverse set of use cases across sectors and industries and geographies. And so I would say the breadth of what we have seen has really surprised me. In terms of go to market, I shared an update on it last quarter. Not sure there's much more interesting to add. We are continuing to do it well. We are scaling up, and all the teams and the structure Diane has put in place is beginning to work well. And we are continuing to hire and scale all of this up as quickly as we can. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [11] +-------------------------------------------------------------------------------- + + I had 2 questions, please. First, one on TAC. Ruth, the factors that cause -- have been causing TAC to rise seemed relatively structural, the outsized growth of mobile and the rise of programmatic. So there's no particular reason to think that we should see anything other than gradual increase in TAC as a percentage of both O&O and network revenue going forward. So are there any reasons why that wouldn't be the case in the next year or 2? And then, Sundar, I thought one of the more interesting innovations or that was -- that kind of came out of Google I/O was visual search. And could you just talk about the -- maybe a little bit the roadmap for that or the extent of which -- how long it will take us actually to see that broadly in the market and what you think the appetite -- or how do you think that will change the way people search for products in the future, the ability to also search visually through your phone? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [12] +-------------------------------------------------------------------------------- + + So on the first question, there are obviously a number of factors that affect sites TAC. We've talked about them over time. The primary driver again this quarter, as you note in your question, was the strong growth in mobile and the fact that more mobile searches are subject to TAC. But the increase in sites TAC year-over-year, I think what I would stress is it really provides another lens on just how strong our mobile business is. There are other factors that affect the TAC rate, including the mix of paid versus organic traffic as well as changes in partner mix and agreement terms. But I think the main point of your question here is we do continue to expect sites TAC to increase but our focus remains on growing profit dollars. And I'd go back to my comment. We're just really pleased with the strength of our mobile business, which is benefiting profit dollars even as the TAC percentage increases. And programmatic, kind of a very similar answer, which is we're pleased to have a strong position in the growing area. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [13] +-------------------------------------------------------------------------------- + + And on questions around visual search, when we think about Google Lens, we think about it as a set of capabilities, which will roll out across many different products. But we'll mainly start getting it in the hands of our users in Q4. I think early days, we want to make sure it works well for use cases where it can and bet on the long-term trends in computer vision as we make progress there. I also think there are cases where pulling out a phone and looking at it is a bit cumbersome, and so over time, as form factors emerge, where it's more natural for you to look at and input that into computing, it'll get used more. Overall, for humans, the way they see, visual input is a very high bandwidth way of communicating, and so it's important that we bring that in computing. So long run I'm very bullish on it, but we're going to roll this out slowly and thoughtfully. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + And our next question comes from Peter Stabler of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Coleman Stabler, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [15] +-------------------------------------------------------------------------------- + + One for Sundar. At Marketing Next, your team unveiled new ways that Google is leveraging consumer intent signals across your billion user plus platforms. And it seems that some of the walls between product data silos are being lowered a bit, and one of the obvious gains that Sridhar highlighted was search personalization. Wondering if you can speak broadly to the opportunity of looking at data from a targeting perspective more holistically across platforms. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [16] +-------------------------------------------------------------------------------- + + I think it's important we've always felt, as marketers, when they spend and try to reach users, the more we can give them visibility about how their spend is working and they can attribute across all the stages of the funnel, I think that will really help make everything work well. So we've always taken that long-term view. And everything we do, be it store visits, which we did a while ago or more recently at Google Marketing Next, we talked about Google Attribution as well. So all that starts adding up and I think pushes in this right long-term direction. And there's more work to be done. But I think as users use everything across multiple products and devices in a thoughtful way, I think making all of this work well, we see it as a opportunity ahead of us. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [18] +-------------------------------------------------------------------------------- + + I have 2. The first one, you've talked about micro-moments throughout the course of the year, micro-moments on mobile. I was wondering, could you give us a couple of examples of micro-moments or search verticals where you've really seen an increase in your monetization over the last year? And Sundar, as you look out across all the search verticals, what are the 2 biggest 1 or 2 use cases you still see to improve the overall relevancy of search results and potential monetization? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [19] +-------------------------------------------------------------------------------- + + On the first one, I would probably be -- rather than be very specific, any time people are looking to buy, find, go, do things, you could be looking for a local pizza, you could be buying -- we see queries like jeans near me, and people are looking for jeans next to them. So these are all very, very specific things. I mean, all of these cases we have found, we've been able to impact the experience for both users and advertisers. So I think that applies generally broadly. In terms of all the verticals, I think there are a lot of opportunities. Local has been an area of strength for us. We have seen a lot of traction. And I continue to think, as a vertical, given the assets we've built up over the years, we can continue to invest more and do better for our users. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [21] +-------------------------------------------------------------------------------- + + I had 2 questions for Sundar. First is you mentioned you had a 15% yield improvement on publisher yields for -- through DoubleClick from machine learning. Is there a comparable stat inside of Google on an operated search or YouTube: after implementing machine learning, you saw yield improvement of X? I'd be curious to hear that. And then the second question is, as we look out into the future and you guys mentioned 2 billion Android actives at I/O, and you just mentioned 11 apps per user in your prepared remarks, if Google is forced to unbundle their own apps from Android in the future, what's the strategy to ensure that Maps and YouTube and Search get distribution and Android doesn't kind of go the way of China in other markets? Be curious to hear that. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [22] +-------------------------------------------------------------------------------- + + Let me take the first one first. On machine learning, we definitely -- machine learning, we've been using it on Search. RankBrain has become one of the important signals in addition to the many other signals in Search and so definitely has had an impact. Same on YouTube across-the-board. I don't have any specific metrics to give, but we definitely are seeing impact, and we think we are in early days of the impact we can see. In terms of Android, we are obviously thoughtfully building Android out and scaling it out, and we offer our apps as part of it. OEMs get to distribute other apps as well. We think it's a very open market, open ecosystem, works well for everyone involved, and I expect that to continue. And a lot of our products which are successful on Android happen to be successful outside of Android as well, including on the Web. These are products generally used by billions of users. And by now we have worked hard to earn that trust and scale, and so I'm confident we can continue scaling those up. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [24] +-------------------------------------------------------------------------------- + + Sundar, I think the last update we heard publicly on promoted places on Maps was in December, when you announced that you'd be beginning some limited tests. I don't think there's been any public comment from the company since then, and quite frankly, we haven't heard a whole lot anecdotally about it either. So I was just hoping for a quick update on that product. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [25] +-------------------------------------------------------------------------------- + + Overall, I mean, it's an area where we are still like really focused on improving the consumer experience. I think we are evolving Maps to be a lot more beyond just driving directions, and users are responding to it. And I think we are in the process of making all that work better. And also, we have also focused in terms of what we see as local opportunity within search as well. But we'll continue testing and evolving. I think we want to make sure we get the consumer experience right before we invest more on promoted opportunities on Maps. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [27] +-------------------------------------------------------------------------------- + + A few for Ruth. First, I'm wondering if you could comment at all on the Cloud business profitability, medium or long term, how you're thinking about that. Second, I'll go ahead and take a shot at the EC decision lately. It clearly is material for financials. How are you thinking about approaching that decision? And does that impact any of your other advertising businesses as far as innovation? And then finally, any thoughts on verticals that were really strong this quarter that supported the organic revenue growth? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [28] +-------------------------------------------------------------------------------- + + So on -- as you know, we don't break out by product. Just add a bit more color on Cloud. We're clearly excited about the opportunity we have here, and it does continue to drive sizable revenue growth as I said in my opening comments, as did Sundar, and we are seeing momentum in the business. I think the comment that Sundar made about the number of new deals over 500,000 increasing 3x year-on-year gives you an indication of the momentum in the business. It's obviously not a financial forecast, but it does display the traction we're having with cloud in the market. And GCP remains one of the fastest growing businesses across Alphabet. G Suite continues to have strong growth. So we're really pleased with what that means for both the longer-term trends and the profitability. We do believe that from the many years of investment we've already made in things like technical infrastructure and security, which operate with tremendous efficiency, that provides us with a benefit. But near term, we're investing meaningfully in sales and engineering service, support, continuing to expand out regions to make sure that we're delivering the best experience for our enterprise customers. And that's what we're really focused on. In terms of -- I think your second question was the EC. There's really not much of an update there. We're still early in our analysis of the decision and the right next steps, and we do have time to notify the commission of proposed remedies as well as to implement changes. The main thing is we're very focused on helping users and advertisers and are reviewing our options. It's an ongoing legal matter, so there's not much more to comment on that one. And then the third question, what... + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [29] +-------------------------------------------------------------------------------- + + On verticals that were strong. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [30] +-------------------------------------------------------------------------------- + + Yes. In terms of -- I think that what you're trying to get at here on what are we seeing in particular with sites revenue, and there's not any one thing to call out, whether it's by vertical or steps that we're taking. And that's really what I would point you to more. I think it's an important point that we're very excited about the opportunities here given both the underlying secular trends broadly with mobile. Sundar's talked a lot about that. But also, all that we're able to layer on top of it just given the engineering acumen here, and we talked about this on prior calls, it's true again here this quarter that no one change has been driving the results. And so what you're seeing is the combined benefit of a number of changes we've made. It's really this maniacal focus on all elements of the user and advertiser experience and nothing to call out by vertical. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our next question comes from Mark May of Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [32] +-------------------------------------------------------------------------------- + + I think the first one for Sundar. Data, of course, is a key differentiator in digital advertising. I was hoping that maybe could talk about how you've changed your use of Google Search data in -- recently in areas outside of search and how that is or might impact the effectiveness of advertising on channels like YouTube and others outside of search. And then, Ruth, in your prepared remarks, you mentioned tremendous growth in mobile search in the quarter. I think that's a more emphatic statement than in the recent quarters. Hoping that maybe you could provide more color on some of the areas where you're seeing the change in growth trajectory coming from within mobile search. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [33] +-------------------------------------------------------------------------------- + + On your first question, obviously, we do these things with the foremost thing being -- making sure we do the right things for user privacy. But within our own products, we are trying to help users get a better experience across on the consumer side and the advertising side, and I think there is opportunity there. And so we'll be thoughtful as we move forward. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [34] +-------------------------------------------------------------------------------- + + And then on mobile search, I think what you're hearing is we're really pleased with the ongoing efforts there. And as I just said, there was no one change that really drove this. What's extraordinary about that team is with the focus on users and advertisers, what is it that is most useful. Sundar spoke about some of them with local, but it's really -- again, it's a lot of small, incremental efforts that, in the aggregate, continue to enable us to benefit from what's a really nice underlying secular trend here. And that's what we're seeing in the results again. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question comes from (inaudible)... + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [36] +-------------------------------------------------------------------------------- + + That's nothing around -- are you listening to this? That's nothing around like geography or platforms or... + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [37] +-------------------------------------------------------------------------------- + + I'm not sure if that was directed to me or -- but in terms of geography, I think one -- hopefully, one of the benefits of the way we've recast the data here last quarter was so you can actually get a bit more insight into what's going on around the globe, and that's why I made the comment that we're having really broad strength globally. You can see it in each one of the regions here. U.S. continues to deliver strong growth engagement across products. If you look at EMEA, on a fixed FX basis, up 21%. You can see the same in APAC. The same in other Americas. So yes, there is broad-based strength across geographies. And I think, as -- I'm not calling out one particular area because the -- what you're seeing here is the secular trend. I've used that term a couple of times now. And we're continuing to benefit from that around the globe, and we're continuing to benefit from, on top of that, the efforts of our team. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And our next question comes from Stephen Ju of Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [39] +-------------------------------------------------------------------------------- + + So Sundar, I'm just wondering if you can give us some sense of advertiser adoption, particularly among your retail clients per store visit product as it seems like there's still a large opportunity to drive off-line purchasing. And Ruth, can you give us some sense of any headwinds you might be seeing in your streams of revenue away from Play or GCP in the O&O revenue line, as we're just not that accustomed to seeing a sequentially flat revenue line there. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [40] +-------------------------------------------------------------------------------- + + I think I spoke about it in my opening remarks. But since store visits measurement was announced 3 years ago, advertisers have measured over 5 billion store visits globally. And I think we are just -- we have just barely scratched the surface. At our Marketing Next in May, we announced that the store visits measurement will also allow for YouTube TrueView campaigns, and we'll be rolling out store sales measurement in the coming months. So advertisers can actually measure in-store revenue in addition to store visits delivered by search and shopping ads. So we've had good proof points. Advertisers who have used it -- for example, Virgin Holidays used it, factored in-store sales measurements and they realized their search campaigns generate double the profit compared to looking at online KPIs alone. So I think there's a lot of opportunity there, and so we'll do more there over time. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [41] +-------------------------------------------------------------------------------- + + And then you asked on the other revenue line. It was up nicely again this quarter, up 42% year-on-year, and that obviously includes the impact of FX. It's obviously a mix of businesses, including some of our bigger investment areas, most notably Cloud and hardware. And as I said at the outset, Play continues to perform really well. I think if you were asking about the quarter-on-quarter sequentially, you noted, we're talking about a mix of business that have different characteristics. And to state the obvious, Play is more hit driven. It's highly seasonal. Hardware is also seasonal. So the year-on-year provides a better sense of the dynamics of the business, and that's what you can see in this lineup year-on-year really nicely this quarter. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + Maybe just one question for Sundar. I wonder if you could update us on your thoughts regarding the conversions of Chrome and Android operating systems. And in particular, I'm curious whether the emergence of Google Assistant and Voice as a corollary across devices is a reason to move forward with more integration between the 2 platforms. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [44] +-------------------------------------------------------------------------------- + + Look, I mean we've been thoughtfully doing it, putting users first, and I'm excited at how Android apps are coming to Chromebooks. And we see that as a great opportunity, and I think that will help us deliver a very compelling experience. And we just have started doing it this year, and I expect it to really get momentum as we go through to next year. So that's an example of conversions, and I think that will work really well. And so -- and in terms of products like Google Assistant and Voice, I think we will make sure, for users, it doesn't matter and that they work across every platform they use, including our platforms as well as other people's platforms. So we think about making sure our services reach as many users as possible, and so we are working on that as well. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + And our final question comes from the line of John Blackledge of Cowen and Company. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [46] +-------------------------------------------------------------------------------- + + Two questions. So for Sundar or Ruth, within cloud, could you talk about your view of G Suite's enterprise penetration right now, kind of key drivers of adoption longer term and if you view it as a potential differentiator for Google Cloud versus other large competitors? And then within YouTube, 60 minutes per day of viewing on phones and tablets isn't obviously incredible at that scale. Any thoughts on kind of what could drive further material viewing or engagement growth over time? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [47] +-------------------------------------------------------------------------------- + + Maybe on YouTube, I would say YouTube is one of those products which is scaling really well globally, just like Search did. And we are seeing real strong growth on mobile, and we are seeing real strong growth for YouTube on emerging markets as well. And we are seeing real strong growth on television. So if I look at YouTube on mobile, on emerging markets, on larger screens, they all look like newer opportunities, and so I think there's a lot more growth ahead. And on cloud, I think you have kind of answered it. Obviously, we see differentiated strengths in machine learning, data analytics, security and reliability. And the combination of not just GCP, G Suite working together with GCP, we are seeing increasing win rates and adoption across enterprise customers. And I also think all the investments we are doing in terms of broadening our ecosystem, including the newer partnerships with the companies I mentioned earlier, that should begin to pay off, and overall, the return on investment from the hiring and region expansion we are doing. So I think we are set up incredibly well, and I look forward to the momentum ahead. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Thank you, and that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, - [49] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our third quarter 2017 call. Thank you, and have a good day. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2017-Oct-26-GOOGL.txt b/Transcripts/GOOGL/2017-Oct-26-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..cdff6959b672dbd1d929f276c8357794233d53f3 --- /dev/null +++ b/Transcripts/GOOGL/2017-Oct-26-GOOGL.txt @@ -0,0 +1,469 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Alphabet Inc Earnings Call +OCTOBER 26, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + - + * Ruth Porat + Alphabet Inc. - CFO and SVP + * Sundar Pichai + Alphabet Inc. - Director & CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Third Quarter 2017 Earnings Call. (Operator Instructions) +I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Third Quarter 2017 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2016 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website where a replay of the call will be available later today. +And I will hand the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Thanks, Ellen. We had a terrific quarter. Revenues of $27.8 billion were up 24% year-on-year and also up 24% in constant currency. Advertising revenues benefited from strong performance in sites, which was powered by tremendous results in mobile search. Healthy growth in network revenues was again led by our programmatic business. We also benefited from substantial growth in other revenues from Cloud, Play and hardware. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. Next, I will review results for Google and then Other Bets. Finally, I will conclude with our outlook. Sundar will then discuss business and product highlights for the quarter, after which we will take your questions. +Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Total revenues were $27.8 billion, up 24% year-over-year. We realized a positive currency impact on our revenues year-over-year of $255 million or $64 million after the impact of our hedging program. Holding currency constant to the prior period, our total revenues grew 24% year-over-year. +Turning to Alphabet revenues by geography. Performance was strong in all regions. U.S. revenues were $12.9 billion, up 21% year-over-year. EMEA revenues were $9.1 billion, up 23% year-over-year in both reported and fixed FX terms. APAC revenues were $4.2 billion, up 29% versus last year and up 31% in fixed FX terms. Other Americas revenues were $1.5 billion, up 33% year-over-year and up 32% in fixed FX terms. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, were $11.1 billion, up 28% year-on-year. Other cost of revenues on a consolidated basis was $5.6 billion, up 25% year-over-year, primarily driven by Google-related expenses, specifically: costs associated with operating our data centers, including depreciation; content acquisition costs primarily for YouTube; and hardware-related costs. +Operating expenses were $8.8 billion, up 11% year-over-year. The year-on-year expense growth in part reflects the change in the timing of our annual equity refresh cycle from the third quarter to the first quarter of each year. As discussed previously, this change in SBC grant timing affects the quarterly pace of stock-based compensation in 2017 with elevated year-on-year expense growth in the first half of the year but benefits the year-on-year comparisons for Q3 and Q4. +Stock-based compensation totaled $1.8 billion. Headcount at the end of the quarter was 78,101, up 2,495 people from last quarter. As in prior quarters, the vast majority of new hires were engineers and product managers. +In terms of product areas, the most sizable headcount additions were once again made in Cloud for both technical and sales roles, consistent with the priority we placed on this business. Operating income was $7.8 billion, up 35% versus last year, and the operating margin was 28%. +Other income and expense was $197 million. We provide more detail on the line items within OI&E in our earnings press release. Our effective tax rate was 15.6% for the third quarter. Net income was $6.7 billion, and earnings per diluted share were $9.57. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $3.5 billion. Operating cash flow was $9.9 billion with free cash flow of $6.3 billion. We ended the quarter with cash and marketable securities of $100.1 billion, of which approximately $60.5 billion or 60% is held overseas. +Let me now turn to our segment financial results. Starting with the Google segment. Revenues were $27.5 billion, up 23% year-over-year. In terms of the revenue detail, Google sites revenues were $19.7 billion in the quarter, up 23% year-over-year, led again by mobile search, complemented by desktop search and strong performance from YouTube. Network revenues were $4.3 billion, up 16% year-on-year, reflecting the ongoing momentum of programmatic and AdMob. Other revenues for Google were $3.4 billion, up 40% year-over-year, fueled by Cloud, Play and hardware. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. +Total traffic acquisition costs were $5.5 billion or 23% of total advertising revenues and up 32% year-over-year. The increase in sites TAC as a percentage of sites revenues as well as network TAC as a percentage of network revenues continues to reflect the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. Total TAC as a percentage of total advertising revenues was up year-over-year, reflecting an increase in the sites' TAC rate, which was modestly offset by a favorable revenue mix shift from network to sites. +The increase in the sites' TAC rate year-over-year was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. Google's stock-based compensation totaled $1.7 billion for the quarter, up 2% year-over-year. +Operating income, including the impact of SBC, was $8.7 billion, up 29% versus last year, and the operating margin was 32%. Accrued CapEx for the quarter was $3.6 billion, reflecting investments in production equipment, facilities and data center construction. +Let me now turn and talk about Other Bets. For the third quarter, Other Bets revenues were $302 million, primarily generated by Nest, Fiber and Verily. Operating loss, including the impact of SBC, was $812 million for the third quarter. Other Bets accrued CapEx was $77 million, primarily reflecting a reduced investment in Fiber due to the pause in expansion we announced in 3Q '16. +We're pleased with our progress across Other Bets. A couple of updates. Nest continues to drive ongoing product expansion with a number of notable launches, including the Nest Thermostat E, which is offered at a lower price point than the Nest Learning Thermostat. Nest also announced a home security solution that includes the Nest Secure alarm system, Nest Hello video doorbell, the Nest Cam IQ outdoor security camera and corresponding software and services. +Waymo continues to expand its geographic presence and announced this morning that it will commence winter testing in Michigan to build on our progress to date addressing the challenge of autonomous driving in cold weather, particularly with snow, sleet and ice. Michigan is the sixth state where Waymo is testing its self-driving vehicles. Over the last 8 years, Waymo's cars have self-driven in more than 20 cities. +With Loon, we were pleased to announce just last week that the team is collaborating with AT&T to deliver emergency Internet service to the hardest-hit parts of Puerto Rico. +Let me close with some observations on the quarter and our longer-term outlook. First, in terms of revenues, results this quarter again reflect our relentless focus on innovation, which is growing our advertising revenues. I frequently highlight our culture of innovation. In that regard, the most important point is that we are data-driven with an extraordinary team of engineers, product managers and designers who constantly challenge assumptions and run thousands of experiments annually to enhance user and advertiser experiences. +This approach enables us to find new opportunities given that the way consumers seek information continues to evolve. Our teams work relentlessly to anticipate and adapt to the expanding capabilities of both software and hardware. +Further, our culture of innovation is building our nonadvertising revenue streams in Cloud, Play and hardware. Earlier this month, for example, we launched our expanded line of hardware products, bringing the best AI software and hardware together and building on the first generation of Made by Google products we introduced last year. Longer term, we remain excited about the opportunities in our Other Bets with ongoing progress. +Second, with respect to profitability. We continue to remain focused on long-term dollar growth versus margins. Pressure in our total cost of revenues reflects our product mix shift with a number of our higher-growth businesses also carrying higher cost of revenues. +In our advertising businesses, TAC continues to increase as our highest growth areas, mobile search and programmatic, carry higher TAC. We expect sites TAC to continue to increase as a percentage of sites revenue. As we frequently stated, we remain focused on profit dollar growth, and these areas are additive to our growth. +The other cost of revenues associated with our nonadvertising businesses is also affected by product mix. In the fourth quarter in particular, the impact of our growing hardware line will be more accentuated given the early stage of this business and the holiday seasonality. On operating expenses, we remain committed to investing to support our growing product areas. +The more modest OpEx growth in Q3 reflects both the timing of stock-based compensation and the timing of sales and marketing spend with the reality that not all investments fall neatly into a single calendar quarter. +In particular, we're committed to sales and marketing investments in Q4 for the important holiday season. The most significant uptick in marketing will be to support our new expanded hardware line, which was just announced at the beginning of the fourth quarter. In addition, we are investing to support YouTube and our other platforms. +Third, as to CapEx, we continue to invest to support business momentum, including increased compute power from machine learning, which is an asset across Alphabet, as well as to support cloud, search and YouTube growth. +In conclusion, a great quarter. Thank you, and let me now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [4] +-------------------------------------------------------------------------------- + + Thank you, Ruth. We had another great quarter. I've been really proud of the progress this quarter, launching popular new products and continuing to grow our business in new areas. It's been particularly exciting to see our early bet on artificial intelligence pay off and go from a research project to something that can solve new problems for 1 billion people a day. Even though we are in the early days of AI, we are already rethinking how to build products around machine learning. It's a new paradigm compared to mobile-first software, and I'm thrilled how Google is leading the way. +Consumers can already experience how AI allows them to interact with computing more naturally than ever before. Computers are adapting to people rather than people needing to adapt to computers. Fundamental to this experience is Google Search and Assistant. We introduced Assistant last year, and it continues to get better every day, helping people get things done in the real world. Walmart and Target have recently integrated with Google Home, which means you can order everyday items from them much more easily. 500 million people now use the machine learning smarts of Google Photos to manage and share their memories. The 1 billion-plus people using Google Maps now get thoughtfully contextual information like how to find parking where they are going. +And businesses are seeing how AI can help them grow. Our open-source software, TensorFlow, is allowing anyone to use machine learning to solve problems even in industries like agriculture. Researchers recently used TensorFlow to make smartphones able to identify disease in cassava plants, a major food source in the developing world. We made TensorFlow open-source and free because we fundamentally believe in creating computing platforms that developers can customize and build on. +I'm really pleased with the way our computing platforms, like Android and Chrome, have continued to grow, enabling great experiences for people all over the world and powering devices for more than 1,000 brands worldwide. This quarter, we released the latest operating system, Android 8.0, and released the preview of ARCore, which brings augmented reality to existing Android phones. Last week, we announced a partnership with Samsung to bring ARCore to all Galaxy devices. +Even though it's been an incredibly busy few years and technology is moving rapidly, at our core, we remain an information company. Our mission, to provide useful information to people in every corner of the world, is unchanged. We care deeply about the quality of information we provide and constantly work to get this right. As technology evolves, we have to evolve with it to ensure quality information can flourish. +Our teams are making a big effort to support journalists and other people who produce high-quality information around the world. We are supporting publishers as they decide the right approach to free articles and subscription content. We are moving away from First Click Free to a more flexible model of content sampling, and we are working with publishers to build a frictionless payment solution for subscriptions that can help them grow revenues and find new readers. +As new threats arise, we are committed to protecting journalists and media organizations from hacking and denial-of-service attacks. For example, we just launched the Advanced Protection Program for Google Accounts, which is designed to protect the accounts of those most at risk of targeted attacks, including journalists and other public figures. +To wrap up my overview, I'm thrilled with how Google is solving big problems and making products that billions of people use every day. +Now let's review our 3 big bets, starting with YouTube. YouTube continues to see phenomenal growth as the premier global destination where people go to watch video. Three of the key areas we are focused on are: strengthening the existing community; continuing to drive growth and expanding our subscriptions business. +On the community side, we are helping create meaningful interactions that bring creators and fans closer together. This quarter, we launched a new feature that lets viewers share videos directly in the app. So the minute you see a video from a creator you love, you can share the fun with friends and family. +We're also seeing significant growth in other areas. As I mentioned in the last earnings call, YouTube now has over 1.5 billion users. On average, these users spend 60 minutes a day on mobile. But this growth isn't just happening on desktop and mobile. YouTube now gets over 100 million hours of watch time in the living room every day, and that's up 70% in the past year alone. +We are continuing to invest in new subscription-based monetization models. YouTube Red, our first foray into the subscription market, is on track to release over 40 original shows this year, and YouTube TV, our live TV subscription service, continues to expand into new markets. It now covers 2/3 of U.S. households and is available in 50 metro areas. +Now on to Google Cloud. We continue to make progress winning over enterprise customers. Customers tell us they are switching to Google Cloud Platform because of our prowess in data analytics and machine learning. Our commitment to being an open platform with tools like Kubernetes, which runs in both cloud and hybrid environments and our leadership in security. +Just yesterday, we announced a new partnership with Cisco. We are collaborating on an open solution that gives customers an easy approach to their cloud, enabling them to run apps that span both on-prem environments and Google Cloud Platform. G Suite, our collaboration and productivity applications, are leading the industry. We have made improvements to Drive, Docs and Gmail, launching new features to help teams work better together. Nielsen recently moved to G Suite and said it's a great productivity and collaboration tool for their modern workflows. +All of these things are driving momentum with customers and partners. Companies like Kohl's, PayPal, Rolls-Royce Marine in Europe and popular messaging app, Hike in India, moved to Google Cloud. We also announced a new partnership with Marketo and expanded our relationships with Pivotal and VMware. To support our growing global customer base, we introduced 2 new regions in the quarter in São Paulo and Frankfurt and continue to grow our go-to-market team. +Next, our hardware business. Earlier this month, we launched our second-generation family of Made by Google hardware products built with AI at the core. Last year, we focused on building the foundation to launch a line of devices made by Google. This year, we are focused on bringing together the best AI software and hardware to give people a great user experience. For example, the new Google Home Max is a smart speaker powered by the Assistant. It has AI-based smart sound, which adapts the audio experience to the user's environment, context and preferences. +The new Pixel 2 has the world's best smartphone camera and a useful feature where you can summon the Google Assistant by just squeezing the phone. To get these devices in people's hands, we are also focused on scaling our go-to-market strategy. We are investing more in marketing. We are launching in more countries, and we are offering these devices in more retailers, and we are already seeing results. Preorders of Pixel on Day 1 this year were more than double what they were last year. +Also, this quarter, we signed a deal with HTC in Taiwan that will help accelerate our hardware business by bringing on a team of talented engineers. This deal lays the foundation for our continued efforts next year. +And our advertising platforms continue to drive greater sales for our partners. While mobile has given rise to an unprecedented amount of data and complexity for advertisers, we think that machine learning will help it make -- will help make it easier for advertisers to reach consumers. But even as we give advertisers incredible scale and reach across our ad platforms, we know consumer attention is scarce. That's why we are pleased YouTube ads continue to deliver the highest viewability rates in the industry. YouTube now has a 95% ad viewability rate, which is significantly higher than the average 66% viewability rate of other video ads. +We continue to see the industry shift to 6-second Bumper ads and saw great adoption this quarter from brands like Bayer, Ben & Jerry's, Louis Vuitton and [Walmart]. +And Google continues to be the platform of choice to help small business owners get online and grow their business. On our last earnings call, I mentioned the free website builder for small businesses. During the quarter, more than 1 million small businesses used it to build websites, helping many of them get online for the first time. +We also introduced local posts, which allows small business owners to easily post their latest updates like upcoming events, special offers and new arrivals right on Google Search and Maps. +Our commitment to both large and small advertisers shows how we build products that all businesses can succeed at. That mission also has a geographical dimension, and I wanted to say a word about the momentum we are seeing in Asia. Our revenues are up significantly in the region, driven by great results we are driving for existing and new advertisers. That holds true across developed markets like Japan and emerging markets like the Philippines and Vietnam, all of which have seen the number of active advertisers grow by 25% or more in the past 12 months. And this growth is bringing tremendous benefits to our partners there. In the past 3 years, we have paid out more than $24 billion to our publisher, creator and app developer partners in Asia-Pacific. +And to help millions of people, we are building products specifically designed for local markets in Asia. In India last month, we launched Tez, a mobile payments and commerce app that already has more than 7.5 million users who have made more than 30 million transactions. I'm really excited about the potential this brings for India's mostly cash-based economy. +As I said at the start, it's been a great quarter for Google. Just 2 weeks ago, I was in Pittsburgh launching our new Grow with Google initiative, which provides digital skills to millions of people and economic opportunity to countless businesses. It was amazing to see firsthand the transformative impact that information is having in schools, in the workplace and for local business. +As I said then, I remain a technology optimist not only because I believe in technology, but because I believe in people. +I want to thank all the Googlers who continue to work so hard to advance our mission and to help people everywhere. Thank you. + +-------------------------------------------------------------------------------- +Ellen West, - [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. And we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from the line of Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe 2 if I can. One, we see a lot of partnership announcements intra-quarter on the e-commerce side with Google Express and voice-assisted shopping on Google Home. Wanted to understand better your ambitions in e-commerce as a marketplace or a platform and how that might also feedback into the advertising business. Second question will be about the cash on the balance sheet and sort of how philosophically you think about deploying that cash against either shareholder returns or some of the big opportunities you laid out today. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [3] +-------------------------------------------------------------------------------- + + Maybe I'll take the first question and give it to Ruth on the cash question. We are very excited about the partnerships we are getting here with large retailers, and we're seeing traction globally. We have obviously partnered with them through our advertising products. But with shopping, especially as we move on to making shopping more seamless across mobile and newer computing categories like Google Home, I think there's tremendous interest here. So we are just getting started. And I think you will see us make a lot more progress and have a lot more announcements. And I think we are going to be relentlessly focused on making the buying experience much more seamless for users. So there's a lot more to come. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [4] +-------------------------------------------------------------------------------- + + So in terms of your second question, there was really no change from the approach we've talked about previously as we think about capital allocation. The priority is organic. As you said in your question, we have a host of really exciting opportunities, and ensuring that we're investing to support long-term growth remains #1. The second is strategic, continuing to add on where it makes sense. We're pleased to have added on HTC this quarter. Acquisitions have obviously been an important part of our history. And then the third is the return of capital, and no change or update there in terms of how we think about that. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [6] +-------------------------------------------------------------------------------- + + Two questions, please. Sundar, you talked about the APAC. You called out Asia, and I -- we noticed that, too, that year-over-year growth rate was higher than -- was the highest at least since you've been disclosing it. And you provided some of the whats, but any whys behind why that growth is accelerating? Is that something that has just naturally reached the tipping point? Is there something different that Alphabet, Google has done in Asia to accelerate that growth? And then, Ruth, can I ask you? You talked about the factors driving TAC, and you mentioned changes in partner agreements. Is there any way you could give us any more color? Did you just renew some major partner agreements and there's nothing of that magnitude into next year? Or should we just assume that this is just part of operations? There was nothing major [reason], you can have major ones coming up? Just something that -- help us qualify. I don't think you had used that language before what that indicated. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [7] +-------------------------------------------------------------------------------- + + The Asia question. Largely, I think we've been laying a foundation for a very, very long time. Our products are very heavily used there. And so we worked hard to build a user base, and then the mobile translation is -- mobile transformation is a secular shift there. That's definitely driving accelerated growth, new -- and it creates a virtuous cycle. We see new advertisers coming on. We are investing more in Asia as well in addition to our go-to-market themes. We are building out great product and engineering teams. That's what has led us to improve core products like Search, Maps, YouTube, et cetera, to work better in those regions. And we also launched region-specific products like Google Tez in India. So I think overall, that's creating a good virtuous cycle, and I'm looking forward to having more momentum there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [8] +-------------------------------------------------------------------------------- + + And on your TAC question. As I indicated in the opening comments, there are a couple of drivers here. One is changes in partner agreements. And I think the main point is we're very pleased with our strong partnerships across the mobile ecosystem. And the other was the ongoing shift to mobile, which we've talked about a lot, and the fact that it carries higher TAC because more mobile searches are channeled through paid access points. I think the most important point is what you're seeing is we have a very healthy mobile business, search business, and it is growing substantially. And our focus remains on long-term revenue and profit dollar growth. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + And our next question comes from Douglas Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [10] +-------------------------------------------------------------------------------- + + I had 2. First, Ruth, you talked about the ongoing advertising innovation, and it's pretty clear that, that's happening in mobile, which seems like it probably accelerated in the quarter. So I was hoping you could comment on that. But then also, how do you think about where you are in terms of optimization on mobile relative to desktop? And then just second, on YouTube. I was hoping you could comment on the extent which you're seeing marketers return to the platform post the brand safety issues of 2Q. And for a few of those who may not be back on yet, what are they looking for to fully return? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [11] +-------------------------------------------------------------------------------- + + So it -- so like, a number of calls talked about the fact that there was no one item that was driving the momentum we saw in our sites revenue. And that was the point of giving you a bit more color here. We are really pleased with the momentum in the business, excited about the opportunities we have given the ongoing strong underlying secular trend, but wanted to give you more color on what do we mean by a culture of innovation. And that's really why I tried to go into a bit more about the rigor of the process. And one of the key points is that we do have the opportunity and we anchor this in data. We're constantly challenging assumptions. We're running a lot of experiments to enhance user and advertiser experience. And the approach continues to be productive, especially because the line of inquiry evolves as user behavior evolves. And so what users wanted in the earlier days of smartphones when screens were smaller is obviously very different from expectations users have today. Each quarter, the ads team introduces more than 100 enhancements out of a much larger pool of assumptions that they've tested. Machine learning is at the center of our processes and systems, and we do remain excited about the potential. Desktop, I commented on. We are pleased with the ongoing strength of the business. It delivered solid revenue growth that remains an important form factor for certain, more complex tasks. We've talked about that in prior quarters, things like planning vacations or assessing insurance options. And so I think with the strength here underscores the importance of the desktop for many users in many tasks, notwithstanding the growing utility of mobile for users. And then in terms of YouTube, I think you asked it well. We've been doing a lot to protect the ecosystem and do the right things for advertisers and users and content creators. And the overwhelming majority of advertisers never left. And those who did, many are already back on the platform. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [13] +-------------------------------------------------------------------------------- + + Sundar, I was wondering if you could share with us your thoughts on Voice Search. And I guess, in particular, how do you think about maintaining Google's lead as the way we search changes and as we see increasing adoption of these voice-enabled digital assistants in the home? And part of this, I guess, I'm also wondering about is, how do you think about your relationships with the partners? And if the device space broadens out, does your leverage with the partners change? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [14] +-------------------------------------------------------------------------------- + + It's a good question, Heather. Voice -- and it's important to remember, voice is one input. When we -- when you look at how customers interact, they obviously are interacting more and more naturally, seamlessly across a set of screens, computing works and context for them. And even when they ask voice queries, the response always what they need is not voice alone. Think about walking into a store, and if you could only ask using voice and the person has to reply in voice when I was in the store. So that model applies. So we expect a lot of continual experiences across screens, across modalities. So it's a big opportunity. I think it's opening up newer ways in which we are working with partners. I spoke earlier about the kind of experiences we are now able to drive at Walmart and Target, which we couldn't have done a year before, thanks to voice, how we are using it in the Google Assistant and how we are driving these partnerships. So there's a lot of excitement about how we can do all of this differently. So we are using this as a good way to rethink everything we are doing with the caveat that voice tel, overall, is an emerging category compared to how users use our products. So there's a lot of room ahead. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [16] +-------------------------------------------------------------------------------- + + Okay. I'd like to maybe discuss a couple of your growth businesses. First, on Cloud. Maybe you could talk about some of the wins you're seeing and why people are initially choosing Google and the momentum there. And then secondly. On the hardware business, it feels a little confusing on what your real goal is there. Is that to build a real independent, separate hardware business? And how the Android relationships are going around that? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [17] +-------------------------------------------------------------------------------- + + First, on Cloud. Effectively, we are seeing strong momentum, and we already hear from customers that we have outstanding technology. So the reason we win deals, in many cases, is because we have superior technology. And people also see the room ahead, thanks to our lead in machine learning. And that's an area where I think we'll continue to drive advantage. The main area where we need to get better is to scale our go to market and be in more places to effectively get more customers, and we are doing that a few different ways. Diane and team have really scaled our global sales force. But more importantly, I think we are striking a lot of important partnerships with leading technology vendors to scale and reach more customers. And so we did a partnership with Cisco that we announced, or in this quarter, we also teamed up with Pivotal and VMware. And earlier the year, you saw us partner with SAP. Now all of this help customers more easily run their apps, both on prem and in the cloud. And we are doing this all in an open way with Kubernetes. So that's the overall strategy, and I think that's really beginning to pay off. And you will see us scale across all these dimensions for cloud in the year ahead. In terms of hardware, we are very seriously committed to making hardware. A few reasons. Hardware is -- the intersection of hardware and software is how you drive computing forward. And historically, hardware has been maybe a single-device business. For a long while, it was PCs and then maybe smartphones. But you're clearly entering an era where you're going to have different types of computing experiences. And so to do that and to stitch it all together across, I think it's important we thoughtfully put our opinion forward. We're equally committed to working with the ecosystem, and we provide the same basis on both sites, be it Android or Chrome. And it's going really well, our close partnership this quarter across a set of Android partners. You see great momentum at the recently launched Samsung Note 8. We announced ARCore on Samsung devices. So we have strong momentum there as well. So we are committed to pushing forward hard on all these areas. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [19] +-------------------------------------------------------------------------------- + + I had a question for either Sundar or Ruth. It's just a philosophical question on TAC. So as the mobile search market matures, particularly the Western markets, the question is, why does Google feel like it needs to pay any TAC to partners at all? Is the lesson that you learned from the Firefox desktop partner loss a couple of years ago was that you didn't lose any revenue and you stopped paying TAC on that agreement? Why wouldn't the same logic apply to mobile search if not now, at some point in the future? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [20] +-------------------------------------------------------------------------------- + + Look, I mean, first of all, we have a lot of experience in this area. We've been doing distribution deals for our search for well over a decade, and I've personally been involved all the way from the toolbar and the Chrome days. So by now, first of all, we want to construct a win-win construct. So we always want a construct in which we do better and our partners to better. And so doing TAC well aligns us in that way. And historically, it's driven a lot of growth. And so it's a model we understand. We understand the key economics behind it. And so we are very thoughtful about how we drive it forward. So we are driving it forward in a way in which we know it's going to give strong both revenue and earnings growth. And so I think we are pretty comfortable with how we are approaching it, and so we'll continue to do that. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [22] +-------------------------------------------------------------------------------- + + I have 2. Just the first one. A little bit on growing Alphabet's multi-app ecosystem. Sundar, how do you think about the strategic importance to drive Chrome and Google Assistant app installs and user growth on non-Android mobile platforms? Maybe talk about how you evaluate, how you're doing there so far. And then bigger picture. You have made large and exciting investment and growth opportunities across Google and Other Bets. I'd be curious to hear, philosophically, how do you evaluate these opportunities? And talk about some of the ROI thought processes or evaluation you make when making large capital allocation decisions. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [23] +-------------------------------------------------------------------------------- + + So on the first one, one of the unique things about how we approach product development is we have always, at Google, cared about building our products for everyone. And be it Search or Gmail or Google Photos or Chrome, we work hard to drive it across all platforms. Obviously, some products, the ability to make it work well on other platforms versus our native platforms, there are differences. And so we understand that. It's partly why we are very committed to driving success on our platforms, both through the ecosystem and our hardware efforts as well. So we think about it holistically. But you'll continue to see us put a lot of effort into other platforms as well. For example, over the past couple of years, I think we have meaningfully improved our products on iOS, as an example. On the other part -- or maybe, Ruth, do you want to give color? I will just say at a high level, we drive our investments because we think about it from a user perspective first. We see areas where there are clear user problems, and we think about whether we can use computer science on our technology advantage as Google and Alphabet to give a differentiated offering for users. So -- and we do that, and then we think long term. But that's how we deal about it. Maybe Ruth can give more color there, too. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [24] +-------------------------------------------------------------------------------- + + And then the numbers flow out of that, which is we look over a multiyear period. A lot of the things that we're doing are multiyear investments. And that's why we stress repeatedly that we're looking at what are the long-term needs and opportunities that we can be addressing. If we're doing that well, we're delivering long-term revenue and earnings growth. And those investments need to be seeded early for them to continue to grow and flourish around the globe, whether that response to the first question on what's going on in APAC or across Alphabet more broadly. We take a multiyear look. We look at the business, technical, financial, milestones along the way, and we allocate resources in order to make sure we're maximizing the long-term potential to deliver as we see as appropriate. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + I have 2 for Sundar. Wondered on HTC. Kind of interesting that you didn't buy the company but you bought talent. And I wonder, what does that move directly give you? And what did you think was lacking, I guess, in the product side before you made that move? And I had one on YouTube. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [27] +-------------------------------------------------------------------------------- + + On HTC, we were -- as we were working on our hardware efforts, we have been working with HTC very closely on the Pixel phones. So across the 2 companies, we saw win-win construct by which we could bring the team and the IP and other assets related to the Pixel business in-house. And it also allows HTC to focus better on their phones and the other products they're working on. So it just made a lot of sense to do it. And I would also think about the overall capability we are getting, not just to make phones, but as we get into other product categories like Google Home, VR and so on, right? And so it's important to continue to build that out. And the talent we saw there is definitely best-in-class. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [28] +-------------------------------------------------------------------------------- + + Okay. And then on DIRECTV -- sorry, YouTube TV, it's clear that you guys have pretty good momentum, 50 markets already. I wonder, what has surprised you about the early consumer engagements? Is there anything you could share about early findings on the rollout of YouTube TV? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [29] +-------------------------------------------------------------------------------- + + Main thing I would say is the consumer feedback, I think there's always been this promise on being able to -- just like today on Google Search when you want something, we make it so easy for you to find it. Bringing that kind of a seamless experience on to TV, when you think about something you want to watch, making it seamless. And so improving that process, I think, is really what people positively comment on. Other things are being able to personalize it, bringing our machine learning-based recommendations over time. So that's how they -- people notice. They get content which they're interested in and [surface] much better. So I think given where we are, I'm really excited about the initial reception. And we are gathering a lot of feedback, bringing it to more markets and are going to work hard at making the product better. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [31] +-------------------------------------------------------------------------------- + + Sundar, I'd like to just follow up on an earlier question about e-commerce and specifically a trend we see growing across the ecosystem of applying e-commerce data to targeting advertising. Maybe if you could describe how you view that at a high level and whether that's important to you and growing that opportunity across all of your platforms. And perhaps shed some light on areas where you may be able to tap into that. You discussed partnerships with retailers, Android Pay. You're tracking off-line conversions more. Even a product like Customer Match would seem like it'd be an opportunity to have your advertisers bring that type of data to the table. Would love to hear a little bit more about your thoughts on that. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [32] +-------------------------------------------------------------------------------- + + It's a good question, Dan. You kind of partially answered it, so you're welcome to come and work on our e-commerce team anytime. To us, as a vertical, we see huge opportunities there. There's a lot of flywheel FX we see. Almost all e-commerce providers, like, are really interested in, like, cloud for obvious reasons. So we see tremendous traction by which we are -- we can talk to them about cloud. They're already advertising partners. They're beginning to work with us much more closely on driving a seamless shopping experience. We're working on payments. And so it creates a nice flywheel effect then, and we can do this globally across all the countries we do it in. And so we are treating it more thoughtfully and investing and addressing the vertical opportunity we see in front of us. And we'll continue working on that. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [34] +-------------------------------------------------------------------------------- + + Maybe a couple of follow-ups. First, on TAC. Wondering if changes in partner agreements, since those are one of the key drivers of the increase in TAC, could we then see the rate of TAC growth moderate as you anniversary those deals? And then secondly, as it relates to voice and visual search inputs. I know it's too early for Google Lens. But overall, wondering what portion of those search queries are proving to be incremental to search, the search experience? Or are they largely substituting for searches on screens? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [35] +-------------------------------------------------------------------------------- + + So in terms of TAC, as I indicated, we've got a couple of things going on. We're pleased with our strong partnerships. We continue to stress the impact from the shift to mobile. And again, I -- both Sundar and I have said it, our focus remains on the profit dollar growth, and we've got a really nice position in a strong growth area. So that's what you're seeing here. But I also said we do expect it to increase some from here. Hence, we've got a couple of factors going on. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [36] +-------------------------------------------------------------------------------- + + On the second thing, look, I think based on every metric we see users' information need is only going up, and that amount of information they deal with are increasing. And as we add new modalities, it really drives a better experience for them. Google Lens, there's a long way to go. But today, as humans, visual input is really big for us. It means a lot higher bandwidth than everything else. And so bringing back to computing, I think, is a really important step in advancing how users can process information. And so I see that as an important step. And thanks to machine learning, we'll be able to do these things a lot more powerfully. All of this I think, overall, adds to the search experience. And so I view that as all incremental, but it'll play out slowly over many years. And so we see this as a big opportunity ahead, and we are investing for it. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [38] +-------------------------------------------------------------------------------- + + The revenue growth was one of the highest growth rates you've seen in 5 years. I'm just curious if there was something that surprised you in the quarter or something that perhaps was an anomaly that we should be thinking about modeling going forward. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [39] +-------------------------------------------------------------------------------- + + So I tried to give you a bit of color going across the major lines. We feel -- we're really pleased with the sites revenue growth, the performance in mobile desktop and YouTube. I think if you just go down to the big categories, network revenue also was quite strong. I think one thing to add there is programmatic continues to be a strong contributor, generates significant growth. We've talked about that on prior calls given all the ongoing advertiser adoption of programmatic buying, and AdMob continues to see strength here. What you're also seeing here is the traditional AdSense businesses. And overall, the pace of advertiser migration to programmatic affects this business kind of quarter-on-quarter as well as the policy changes that we've talked about in prior quarters. And those factors were less of a drag in the last couple of quarters. So you actually saw nicer revenue growth year-on-year here as well. It's up 16%. And then Sundar has talked a lot about the components of other revenues up nicely. We're really pleased with what's going on there. And then on top of that, Other Bets have got a couple of components to it. I tried to give you color on each one. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Stephen Ju of Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [41] +-------------------------------------------------------------------------------- + + So Sundar, can you talk about how Google's positioning in the emerging markets over the longer term can be different versus what we are used to seeing here in The States? I mean, you talked about Tez in India. And that's just the type of stuff that we're not even seeing here in The States. So is there a broader opportunity for you to do a larger land grab with more products? And Ruth, should we assume that the relative size of the dollar contribution to the other revenue growth happened in the order you gave out in the prepared remarks? I guess, Cloud, Play, hardware? And if so, this would make it the second quarter in a row in which Cloud is showing up as the largest contributor, I guess, as opposed to the third. So any perspective you can share in terms of the relative growth you may be seeing recently? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [42] +-------------------------------------------------------------------------------- + + On emerging markets, we do see differentiated opportunity there, partly because the characteristics of how truly many of these markets became mobile first, I think, gives rise to different ways users are adopting our products. And also, more importantly, the ecosystem, which it's built around. So for example, if you take e-commerce, the kind of models that are emerging in these countries are also a bit different. So I think we see a way to look at these markets with a lot more thought and address them for the opportunities that they have, not just apply our global products there. So I think that's what led us to do Google Tez in India, and we'll thoughtfully look at the opportunities in that region and invest a lot in the years ahead. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [43] +-------------------------------------------------------------------------------- + + And then we do -- we did list them in the order in which they're making a contribution. It's obviously a mix of businesses. And as we've talked about, we have very strong growth in each of Cloud and hardware that was tempered by slightly slower growth in Q3 for Play, reflecting what's the hit-driven nature of that business of gaming. But again, I feel really pleased with the progress, momentum that we're seeing in the various businesses. And I guess, the only other thing to note is obvious seasonality on the hardware as we move into the fourth quarter here. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, - [45] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our fourth quarter call. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2018-Apr-23-GOOGL.txt b/Transcripts/GOOGL/2018-Apr-23-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ef9e1c9df33cd901a27c989937db734f388420 --- /dev/null +++ b/Transcripts/GOOGL/2018-Apr-23-GOOGL.txt @@ -0,0 +1,443 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Alphabet Inc Earnings Call +APRIL 23, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + - + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Alphabet Inc. - Director & CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research and Senior Internet Analyst + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Evercore ISI, Research Division - Senior MD + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Inc. First Quarter 2018 Earnings Call. (Operator Instructions) I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's First Quarter 2018 earnings conference call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2017 filed with the SEC. Undue reliance should not be placed on any forward-looking statements, and they are made based on assumptions as of today. We undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. We delivered ongoing strong revenue growth, up 26% year-on-year and up 23% in constant currency. The sustained outstanding performance in sites revenues, in particular, reflects the combined benefits of innovation and secular growth, with mobile search again leading the way. Robust growth in network revenues was again led by our programmatic business. Ongoing substantial growth in other revenues, namely cloud, hardware and Play, continues to highlight the growing contribution of our non-ads opportunities. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. Second, I will review results for Google and then Other Bets. As we highlighted in our earnings press release, our results this quarter were affected by a new accounting standard that changes the way companies account for equity security investments. I'll highlight the impact on particular line items as I review the quarter. I will then conclude with our outlook. Sundar will then discuss business and product highlights, after which we will take your questions. +Starting with the summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $31.1 billion were up 26% year-over-year. We realized the positive currency impact on our revenues year-over-year of $1.3 billion or $1.1 billion after the impact of our hedging program. +Turning to Alphabet's revenue by geography. You can see that our performance was strong again in all regions. U.S. revenues were $14.1 billion, up 20% year-over-year. EMEA revenues were $10.5 billion, up 29% year-over-year. In constant currency terms, EMEA grew 21%, reflecting strengthening of both the euro and the British pound. APAC revenues were $4.8 billion, up 33% versus last year and up 30% in constant currency, reflecting strengthening of the Japanese yen and Australian dollar. Other America revenues were $1.7 billion, up 36% year-over-year and up 35% in constant currency. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, was $13.5 billion, up 37% year-on-year. Other cost of revenues on a consolidated basis was $7.2 billion, up 39% year-over-year, primarily driven by Google-related expenses. The key drivers were: first, costs associated with our data centers and other operations, including depreciation, which was affected by a reallocation of certain operating expenses primarily from G&A; second, content acquisition costs primarily for YouTube; and finally, hardware-related costs. +Operating expenses were $10.7 billion, up 27% year-over-year, with the biggest increase in R&D expenses reflecting our continued investment in technical talent. The growth in sales and marketing expenses reflects advertising investments in cloud and hardware as well as the Assistant. +G&A expense trends were affected this quarter by a number of factors, in particular, performance fees accrued in connection with the recognition of equity security gains, which were partially offset by the reallocation of certain expenses from G&A, primarily the other cost of revenues and the benefit of the Uber litigation settlement. +Stock-based compensation totaled $2.5 billion. The quarter-on-quarter step-up reflects the full year equity refresh grant to employees at the beginning of the quarter and the biannual grant to SVPs. +Headcount at the end of the quarter was 85,050, up 4,940 people from last quarter, including just over 2,000 people who joined at the end of January when we closed our previously announced deal with HTC. As in prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were the additions from HTC followed by hiring and cloud for both technical and sales roles. +Operating income was $7 billion, up 7% versus last year, and the operating margin was 22%. Other income and expense was $3.5 billion, which includes $3 billion of primarily unrealized gains in equity security investments recognized under the new accounting standard. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 11% for the first quarter. As outlined in our earnings press release, this includes a 5 percentage point reduction from the release of a deferred tax asset valuation allowance, which offset the income tax expense on the equity security gains. +Net income was $9.4 billion, and earnings per diluted share were $13.33. As indicated in the table in our earnings press release, these results reflect an increase in net income of $2.4 billion and $3.40 in earnings per diluted share due to the impact from the gains in equity security investments we've already discussed. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $7.3 billion, which I'll discuss in the Google segment results. Operating cash flow was $11.6 billion with free cash flow of $4.3 billion. We ended the quarter with cash and marketable securities of approximately $103 billion. +Let me now turn to our segment financial results, starting with the Google segment. Revenues were $31 billion, up 26% year-over-year. In terms of the revenue detail, Google sites revenues were $22 billion in the quarter, up 26% year-over-year, led again by mobile search complemented by solid growth from desktop search and strong performance from YouTube. +Network revenues were $4.6 billion, up 16% year-on-year, reflecting the ongoing momentum of programmatic and AdMob. Other revenues for Google were $4.4 billion, up 36% year-over-year fueled by cloud, hardware and Play. As a reminder, the hardware revenues in this line now include our Nest business, and prior periods were restated. +We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. As we previously announced, we made a change this quarter to impression-based monetization metrics for our network business given the ongoing growth of programmatic. +Total traffic acquisition costs were $6.3 billion or 24% of total advertising revenues and up 36% year-over-year. This year-on-year increase in sites TAC, as a percentage of sites revenues as well as network TAC as a percentage of network revenues, continues to reflect the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. Total TAC, as a percentage of total advertising revenues, was up year-over-year, reflecting primarily an increase in the sites TAC rate, which was modestly offset by a favorable revenue mix shift from network to sites. The increase in the sites TAC rate year-over-year was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC. The underlying trend affecting the network TAC rate year-over-year continues to be the shift to programmatic, which carries higher TAC. +Google's stock-based compensation totaled $2.3 billion for the quarter, up 22% year-over-year. Operating income was $8.4 billion, up 12% versus last year, and the operating margin was 27%. Accrued CapEx for the quarter was $7.7 billion, reflecting investments in facilities, production equipment and data center construction. Facilities was the largest component of CapEx of this quarter due primarily to the $2.4 billion purchase of Chelsea Market that we announced in March. +Let me now turn and talk about Other Bets. For the first quarter, Other Bets revenues were $150 million, primarily generated by Fiber and Verily. As a reminder, Nest results are now reported as part of the Google segment, with revenues reflected in the Google other revenues line. Operating loss was $571 million for the first quarter. Other Bets accrued CapEx was $55 million. +We're pleased with our progress across Other Bets. A couple of updates. At Waymo, we have achieved 5 million miles of driving on city streets, adding the latest million in just 3 months. We also announced a long-term partnership with Jaguar Land Rover for their fully electric I-PACE vehicles. Verily is seeing good progress with Onduo, its joint venture with Sanofi. The companies made its diabetes management platform commercially available in 3 states with Blue Cross Blue Shield of Arkansas and South Carolina and Anthem's health plan in Georgia. +Let me close with some observations on the quarter and our longer-term outlook. First, with respect to revenues. The opportunity set ahead of us is quite extraordinary, and we remain focused on investment to support long-term revenue and profit growth. We have both the business confidence to invest appropriately in the next phase of innovation as well as clarity about some very compelling opportunities that, in our judgment, will enable us to create shareholder value. We're pleased with the continued momentum of our revenue growth again this quarter, reflecting strong underlying trends across our business, which are amplified by our relentless focus on innovation, not only in our newer businesses, like cloud and hardware, but in our sites business. Specifically, we're excited by the still sizable opportunity in search advertising led by mobile. At 26% year-on-year revenue growth in our sites business, we continue to benefit from our investments to enhance the user and advertiser experience. +Second, with respect to profitability. Within cost of revenues, the biggest component is TAC. While we expect sites TAC to continue to increase as a percentage of sites revenues, reflecting ongoing strength in mobile search, we continue to anticipate that the pace of year-over-year growth in sites TAC, as a percentage of sites revenues, will slow beginning in this second quarter. +Within OpEx, as I said last quarter, we are continuing to support our priority investment areas. Within R&D, this is reflected in increased headcount, particularly for technical roles. Sales and marketing is similarly elevated to support these areas, both in the quarter and for the full year, and we expect expenses to remain more heavily weighted toward the back half of the year to support the holiday season. +As you've seen in prior quarters, G&A can be a more difficult line to forecast. In particular, this quarter, we had the impact of the accrual for performance fees related to the equity gains previously discussed, partially offset by the reallocation of some expenses to other cost of revenues and the Uber legal settlement. We appreciate the importance of prioritization and are keenly focused on the steps we can take to make the right investments with the proper intensity while being diligent about long-term plans and returns. +For our Other Bets, we remain focused on moving toward commercial applications in a number of areas with a continued focus on calibrating investment to metrics for success. +Third, with respect to CapEx. Our commitment to growth is evident in the trend in CapEx investment, almost equally split this quarter between compute capacity and facilities. Our facilities spent in Google dominated by the Chelsea Market acquisition reflects that we favor owning rather than leasing real estate when we see good opportunities. With respect to compute capacity, the largest component of CapEx is for machines that incorporate the latest technologies. We are also investing in data center growth and increased network capacity through undersea cables. These combined investments will expand our compute capacity to support our growth outlook across Google, including machine learning, the Assistant and cloud. +In many respects, these investments underscore my opening comment about both our confidence and clarity about future opportunities with our focus on proprietary solutions that enable us to deliver the secure, reliable, high-performing compute infrastructure to support new and emerging products and services for our users, advertisers and enterprise customers. +I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. The end of Q1 is always an exciting time as we prepare for our annual developer conference, Google I/O. Computing is evolving at a rapid rate, and we can't wait to share what's next and how we are tackling important issues. +I want to call out an important highlight from Q1, the Google news initiative that we unveiled in March. Over the years, we have worked closely with the news industry to address key challenges through projects like Accelerated Mobile Pages. We are building on that partnership with the $300 million investment to elevate and strengthen quality journalism. As part of this effort, we announced more than a dozen new products, including Subscribe with Google developed in close collaboration with publishers, which lets you use your Google account to buy a subscription on participating news sites. We've had overwhelming interest. +Since the launch, we have heard from more than 300 news publishers who are interested in Subscribe with Google. We also introduced new tools for journalists and improvements to our platforms to ensure that we are surfacing accurate quality content where it matters most. +Today, I'll quickly talk about how machine learning is helping us advance that mission, then I'll highlight progress in our 3 big areas, cloud, YouTube and hardware, and share updates on our computing and advertising platforms. +First, machine learning and making information accessible to everyone. Our own ML-powered products like Google Photos and Google Lens gets better every day. The Google Assistant is a great example of this. In the home, we have added over 200 new device partners that work with Assistant just on the last 4 months alone. We now partner with all major manufacturers of connected devices for the home in the U.S. +All told, the Google Assistant can now help you with over 1 million actions, including new things like reminding you to buy bread when you get to the store or sending money to friends or if you want to get a ride share home. For a concept we unveiled at I/O less than 2 years ago, this is great progress. +AI is also unlocking new opportunities for everyone. Just in the last few months, we have seen some amazing applications from dairy farmers in Georgia using TensorFlow to improve the health their herds to our own Google researchers who figured out how to use ML techniques to assess a person's risk of a heart attack. The possibilities of AI in health care are truly exciting. +At our recent TensorFlow summit, we introduced TensorFlow hub, making it easier for developers to share and reuse models so that we can work together to tackle even more problems and get to better ideas faster. Our investments in this area are helped because of our specialized Tensor Processing Units, which are specifically designed to be highly efficient for machine learning applications. +Of course, we continue to advance Google's core mission in other ways, too. We recently launched our Google Go app in 26 African countries. This app reduces the amount of data needed to display search results by 40%, and we continue to invest in ways to give people granular and easy controls over their information across all our products. Every single day, nearly 20 million people visit My Account, which gives them options to review their Google security, privacy and ad settings. Additionally, tools like security checkup and privacy checkup prompt people to keep their account secure and control their data settings. +Now turning to our 3 big areas: cloud, YouTube and hardware. Last quarter, we shared some exciting metrics about the progress of Google Cloud, including that we passed $1 billion per quarter in 2017. In Q1, we saw increasing momentum. We are growing across the board and are also signing significantly larger, more strategic deals for cloud. Our security capabilities, the easy-to-use advanced data analytics and machine learning solutions and the secure and industry-leading collaboration platform, G Suite, are winning customers over. Google Cloud is growing well. Some examples of new technologies announced in the quarter include Cloud AutoML, which makes it easier for companies without machine learning expertise to build complex neural nets and more than 20 new security products. +Our global infrastructure continues to expand to support demand. We commissioned 3 new subsea cables and announced new regions in Canada, Japan, Netherlands and Saudi Arabia, bringing our total of recently launched and upcoming regions to 20. +G Suite has reached a point where it can serve all the needs of a large enterprise, and as a result, grow at a certain inflection point. The Suite is growing from strength to strength. We believe our secure environment is an important factor in driving enterprise customer wins. G Suite customers like Colgate-Palmolive Company tell us that no one offers a better combination of hardware, network and data security. In Q1, we also signed agreements with customers like Airbus and Thailand's Krung Thai Bank. As a result, G Suite revenue growth accelerated in Q1. +Next, YouTube. The platform continues to grow as millions of creators build communities and find opportunity on YouTube. Over the last year, channels earnings 6 figures annually grew more than 40%. This quarter, Dua Lipa's video for New Rules became the 100th video on YouTube to reach 1 billion views. We are also investing in new experiences like life content, where we see tremendous momentum. One recent example was our exclusive Coachella live stream, which had more than 41 million live views from all over the world. +Coachella was YouTube's most viewed live music festival ever. And no surprise, Beyoncé was the most viewed Coachella performance ever on YouTube. Even as we invest in new experiences, we stay very focused on making sure that YouTube remains a safe platform with great content. We are aggressively combating content that violates our strict policies through a combination of user and machine flags. Over 6 million videos removed in Q4 were first flagged by our machine systems, and over 75% of those videos were removed before receiving a single view. We also changed our monetization requirements to better identify creators who contribute positively to the community and drive more ad revenue to them. +Moving to hardware. This quarter, we welcome Nest of the Google hardware team to supercharge our efforts. Nest is building industry-leading products for the home, including new additions like the Nest Hello doorbell and Nest temperature sensor. In 2017, they sold more devices than the previous 2 years combined. They are an incredibly talented team with fantastic momentum. +Google Home continues to be super popular, and we are making it available in many more countries. Just recently, we launched Google Home in many -- in India and Singapore, and the response has been terrific. +Our early 2018 Net Promoter Scores rank among the highest in the industry across all product categories. This shows how much love people have for Made by Google consumer hardware devices and makes us even more excited for what's ahead. +There's great momentum across our computing platforms, like Android and Chrome. At Mobile World Congress, a new generation of Android partner devices was introduced, including Android One phones like the Nokia 7 plus. Android One pairs high-quality hardware with a secured and streamlined software and experience from Google. This quarter, we launched the Acer Chromebook Tab 10, the first Chrome OS tablet designed specifically for education. It is a secure and easily shareable tablet equipped with all the Chromebook features that educators and students love. +And finally, our advertising platforms. We continue to make Google Search and Shopping the best places for people to find and buy products from a range of merchants. We recently announced shopping actions, allowing customers to easily buy from their choice of participating retailers on the Google Assistant and Search with the universal card across mobile, desktop and even Google Home. The results are really helping retailers. Early testing showed that participating retailers see an average increase in basket size of about 30%. +YouTube is delivering great results for our advertisers. To help brands reach broad audiences on YouTube with even more flexibility, we introduced TrueView for Reach, which optimizes in stream ads to reach a wide audience. In beta testing, 9 out of 10 campaigns drove a significant lift in ad recall, with an average lift of nearly 20%. +We are also helping small businesses take advantage of video with the expansion of YouTube Director onsite to over 170 U.S. cities. This gives SMBs access to a professional filmmaker to create and edit their video ads. +Finally, we remain focused on investing in our publisher partners. Last year, we paid $12.6 billion to publishing partners in our ad network. We recently announced AdSense Auto ads. This uses machine learning to analyze ad placements on a publisher's page and show ads when they are likely to perform well while providing a good user experience. +Google's success depends not just on the success of our partners but also on the community's very work. We recently announced the Rolling Study Halls program for rural areas across 12 states. It equips school buses with Wi-Fi devices and onboard educators so that students with long commutes can get their homework done during the trip. +We are also making long-term investments in our offices and data centers around the country. Last month, we announced the purchase of Manhattan's Chelsea Market building. And in Tennessee and Alabama, we broke ground on 2 new data centers, which will have a big economic impact on the local economies. These investments are made hand-in-hand with our commitment to sustainability. +In 2017, we officially met our goal to purchase enough renewable energy to match all electricity consumed by our operations around the world. +I want to close by saying thank you to our employees. It's been a particularly tough few weeks for the Google family, especially at YouTube. I'm so proud of the resilience that our employees have shown, and I'm so grateful for the support we have gotten across the industry and from the community. Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Douglas Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Ruth, just first on the accounting change, I was just hoping you could clarify. If we're trying to normalize that, is it right that we would be adding back about $632 million to operating income and then reducing EPS by $3.40, and then just on the EPS side, perhaps adjusting for the tax rate? And then just in terms of the business, I just wanted to ask about Waymo. If you could talk a little bit about just the latest timing for the commercial launch in Phoenix and how quickly you'd look to expand to other markets, and then just how you're thinking about the technology and whether you'll license it to others going forward or keep it more proprietary for Waymo services? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure. So on the accounting standard, we try to lay out all the component parts clearly on the cover of the earnings release so that you would have it all in one place. I think you summarized it right, but I'll just direct everybody to the earnings release. The net of which was the gain from the equity investments was $2.4 billion to net income. That is net of performance fees as well as the release of a deferred tax asset that we have, so it does reflect $3 billion in gains. And I think you know this, but this quarter, the accounting standard requires marks for everything where there is an observable raise. So these are unrealized -- the majority of them are unrealized, not actually monetized by Alphabet, and then the performance fees are calculated based on investment returns. They're accrued but not paid until an exit event occurs, and they do appear in OpEx. And as you noted, there is also, therefore, the benefit that flows through on the tax line, and that is 5 percentage points of benefit offset to the effective tax rate for the quarter. As it relates to your Waymo question, there was a lot in there. We do remain very excited about the opportunity with Waymo and our continued progress on multiple fronts. It is still very early. In terms of our progress, this year is about offering a service that is safe, that works, that delight users in the Phoenix area. The rider program in Phoenix is open to members of the public, and riders will use a Waymo app to hail one of our fully self-driving cars without a driver at the wheel, and we'll pay for the service. We've also had progress on the vehicle partnerships, as I mentioned in my opening comments. Last month, Waymo announced it signed a long-term strategic partnership with Jaguar beginning with a collaboration to design and manufacture self-driving I-PACE vehicles for Waymo's transportation service. These are all electric cars. This new partnership in the vehicles adds to our strong position with FCA, and the production of the cars begins in 2020. And then we are expanding our testing to more states. We're also working on additional areas like applying the technology to logistics and deliveries and working with cities to help strengthen public transportation and for personal use vehicles. And as we've talked about on a bunch of calls, the opportunity is here for us because we started with safety, and we remain a leader in safety, and we do believe that's the foundation for success, and it builds on the -- all the testing miles that we've done. So we keep coming back to when you create vehicles that drive themselves faithfully, we think there's a lot of potential uses and business opportunities, and that's what we're focused on. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [5] +-------------------------------------------------------------------------------- + + I wanted to ask 2 quick questions. One, just one on GDPR then one on cloud. On GDPR, just wondering if you could share with us kind of any impact you're thinking about as the implementation occurs later in May, and so any thoughts you could share there would be great. And then on cloud, Sundar, you had mentioned you're seeing a lot of momentum. You said G Suite, I believe, accelerated in Q1. I was wondering if there was any color on the GCP side that you could share from a growth perspective if that business accelerated or not and kind of how were the deal sites trending for that business in particular. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [6] +-------------------------------------------------------------------------------- + + Great. Maybe I'll do the GDPR first. GDPR, I realize, is a fairly new public OPEC. But for us, it's not new. We started working on GDPR compliance over 18 months ago and have been very, very engaged on it. It's really important, and we care about getting it right. And overall, we have long had a very robust and strong privacy program at Google, too. So we are committed to meeting requirements on May 25 and also long term. We are working very closely with advertisers, publishers and our partners. And we will also update all the privacy policies and controls we provide to users worldwide. So it's a big effort. We are very committed to it. We are very focused on getting it right by our users and partners, and that's where our focus is now. On -- Heather, on cloud, I guess your question was about overall growth, and we are continuing -- the momentum has been very strong on cloud as well. We haven't talked about G Suite much, and so we highlighted it the moment I'm there, but cloud is continuing its great growth. We are seeing it across the board. Things worth I would call out is we are seeing larger deals as well. We are seeing good synergies between G Suite and cloud. Areas where we have done acquisitions like Apigee, they are beginning to work in terms of driving synergies to cloud. And the efforts we are beginning to put particular with our partners, that is beginning to bear fruit as well. So we have go-to-market programs now with SAP, Cisco and Salesforce. And I think we are beginning to see early results from that, and hopefully, that translates into more momentum going forward. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [8] +-------------------------------------------------------------------------------- + + Maybe 2 for Sundar, if I can. One, on mobile search, continue to call that out as a point of strength in the results. What are you most excited about in terms of either the product innovation or the ability to get consumers to adopt mobile search more broadly on devices globally, which could lead to more ad budgets moving it to mobile search? And then on hardware, you've now been through 2 years of sort of Pixel devices. You've made the aqui-hire of ETC engineers. Can you give us a sense of what you've learned so far from your hardware efforts and how that might evolve product innovation or go-to-market strategies long term? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [9] +-------------------------------------------------------------------------------- + + On mobile search, for me, mobile obviously raises the bar. And if you look at the evolution of Search, we gave from -- we evolved to stay ahead of user expectations, and we evolved from just providing links to answers. I just feel at a high level the next big evolution we are doing as part of mobile search and assistant is to actually help users complete actions, to help get things done. And it's really hard to do at scale, and that's the work we are doing. And as we do that, it'll impact just -- not just the Assistant but mobile search more broadly. And obviously, that has a commercial impact as well. So we continue to be very excited about the opportunities there. On hardware, the exciting part for us is now, I think we have all the end-to-end capabilities of a world-class hardware organization, along with the quality of the software organizations we have always had. And in this area, it truly takes long-term planning. And so for example, if you think about silicon, et cetera, the longer you can do it, the more advantages you have. And so I definitely feel we are taking the steps towards being able to do this well for the long term. Part of that obviously involves scaling of our go-to-market strategies both in the U.S. and internationally so that we can drive adoption. I said earlier, our Net Promoter Scores show that we are right up there with the best-in-class devices and across all the products we have, not just our Pixel, across our Nest family and everything we do. So the opportunity is clearly there. We're going to lean into it, and it takes 2 to 3 years to really get to the scale where we want to see it and -- but we are committed to getting there. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [11] +-------------------------------------------------------------------------------- + + I want to follow up on Heather's question on GDPR, and the question I want to ask is, I understand that you're -- been working for a long time to make sure that you're compliant. But do you think that GDPR or other regulation that you see on the horizon is likely to impact materially the targeting capabilities about that advertisers have on Google? Is there something in the regulation that's going to make Google and its properties less attractive to advertisers? That's the action question I want to ask. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [12] +-------------------------------------------------------------------------------- + + Thanks, Mark. Above everything else, as we are working through GDPR, we are making sure we are focused on getting the user experience right for our users and our partners. But to clarify your question further, first of all, it's important to understand that most of our ad business is Search, where we rely on very limited information, essentially what is in the keywords to show a relevant ad or product. And so we've been preparing this for 18 months, and I think we are focused on getting the compliance right. It'll be a year's long effort, and we are helping not just us but our publishers and partners. But overall, we think we'll be able to do all that with the positive impact for users and publishers and the advertisers and so our business. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [14] +-------------------------------------------------------------------------------- + + I have 2. The first one on desktop search. So it's nice to hear that your oldest business is still growing. Just curious, could you give 1 or 2 tangible examples or products that are still driving the desktop search growth? And Sundar, I understand you're always focused on user experience. At a high level, what do you see is the biggest areas potential further improvement in desktop search? And let me ask you the same question about YouTube. What are sort of the biggest areas of tension that you're focused on improving from a user perspective on YouTube right now? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [15] +-------------------------------------------------------------------------------- + + So on desktop search -- sorry, is your question on the user experience on desktop search, how do we see improvements? Look, I mean, the same. First of all, users are having cross-device experiences, cross-screen experiences, right? So I think your desktop search experience, mobile search, everything goes hand-in-hand. And every -- all the work we are doing to make mobile search better translates to desktop search as well. Areas where desktop search historically has been a bit behind is in terms of things like identity and payments and having all that work well to enhance the user experience. And with Chrome now, we are investing a lot in those areas as well, and I think that will contribute overall to improvements there. On YouTube, there are many, many areas we are focused on YouTube. They're always very focused on making sure they are supporting emerging formats, be it mobile live streaming or emerging formats like VR, and so that's an area of focus for us. We are also really looking at what are all-new monetization options for creators beyond advertising. So be it subscriptions, features like super chat, which we have launched, are very popular. We have beta testing sponsorships, merchandise, merchandising and concept, ticketing and et cetera, right? So these are all areas by which we are improving. And obviously, there are additional areas like Music and YouTube TV, which are seeing great momentum as well. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research and Senior Internet Analyst [17] +-------------------------------------------------------------------------------- + + Just 2 questions, please. Americas revenue accelerated nicely on a currency neutral basis. It's a geography that rarely comes up on your calls. So any color about what's driving that acceleration and the sustainability of what's going on in the Americas region? And then, Ruth, a question on sites TAC. So I know you said the pace of deleverage is going to start to improve next quarter. Is this something that we should expect to happen for a year and then kind of normalize back to pretty steady pace of deleverage? Or is this -- are we over some critical threshold, and we should see this trend of moderating deleverage continue for several years into the future? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + So on your first question, other Americas. I would say, like the other regions, really pleased with the strength we have. Across the regions, it is obviously one of the smaller ones, so growing at a slightly faster clip and really pleased with the broad strength there. It starts with the sites revenue strength. But on top of that, they benefited from hardware devices launching in some additional markets over the past year. And then in terms of TAC, I would say there's not much to add to what we've already said after some -- a kind of sustained period of stronger increases. We were pleased last quarter to be able to signal that this quarter that pace of change is slowing, and just leave it at that for now. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI, Research Division - Senior MD [20] +-------------------------------------------------------------------------------- + + I have 2, one for Ruth and one for Sundar. Ruth, on CapEx, even if we exclude the Chelsea Market one-timer, the gross in CapEx, is it really substantial even on a kind of recurring basis. Should we expect that sort of dramatic growth or step-up in the growth of rate in ongoing CapEx to continue throughout the year? Or other than the Chelsea Market one-timer, were there any -- do we have any reason to think that it was timing in terms of the timing, front-end weighted, it's the first quarter for CapEx? And then secondly on -- Sundar, just a question on YouTube and your media strategy at a higher level. In view of the success of other competitive subscription TV products out there, Internet video products, can you just talk about YouTube Red and any thoughts on ways you can accelerate growth for your YouTube subscription video products, whether that may be organic investment and content original production or even via acquisition? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + So in terms of CapEx, it's about equally split between facilities and our technical infrastructure. And as you know that we have the $2.4 billion purchase in New York as well as discontinued ground-up development projects. Facilities does tend to be lumpier over time. We are continuing with the ground-up development projects. And as a reminder, we do favor owning rather than leasing real estate when we see good opportunities, and that has served us well over the years. But I think more to your question with respect to technical infrastructure, that reflects investments in compute power to support growth that we see across Google, and the largest component is on machines. It's also on data centers and undersea cables. And on machines, the biggest contributor is the demand that we're seeing. So in particular, it's the expanding application of the machine learning efforts across Alphabet, plus the requirements for cloud and Search and YouTube, and then secondarily, the increased cost of newer technologies, CPUs, memory, network. So I think, really, to answer your question most directly, it reflects the demand that we're seeing, so I wouldn't want to suggest a one-off in terms of the investments we're making in technical infrastructure. And then in terms of the data centers, we are investing globally. We currently have over 20 sites on 4 continents, and that's under different stages of construction, as Sundar noted. And it's across the U.S. Tennessee, Alabama, South Carolina, Iowa. So we're really building out to support the growth that we're seeing. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [22] +-------------------------------------------------------------------------------- + + Sorry, on the second question on YouTube, for sure, the adoption and feedback across both YouTube Red and YouTube Music has been great to see. We are doing a lot more work there. You will see us continue to invest further and develop those offerings better, and as part of that, further drive adoption. So for example, YouTube Originals end up playing a big part in YouTube Red subscriptions. And so far, we have launched in a handful of markets, and we'll continue to roll it out to more markets there. And on YouTube Music, we are working on enhancing the product, and I think this definitely create opportunities there as well. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [24] +-------------------------------------------------------------------------------- + + Sundar, I had 2 for you. First, during the quarter, where there were some reports of changes in leadership that your Search and AI divisions functionally sounds like separating leadership over those 2 very large, important businesses for the company. Could you talk a little bit more about that and how that may impact broader strategy for the company? And then second, a little bit more technical one on your advertising business you launched, shopping actions during the quarter with a pay-per-sale model, pricing model. And I was just curious to hear what type of feedback you were getting from advertisers that led to a product with that pricing model in particular, any other features of shopping actions that you think are important to highlight. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [25] +-------------------------------------------------------------------------------- + + Thanks, Dan. On the -- we obviously -- Search has been leading the company in terms of how they have been adopting machine learning and AI, and it's really working well through Search and Assistant. We sense that, obviously, as an AI-first company, AI cuts across everything we do in Google. And so as an organization, it's a horizontal organization, which needs to serve all our areas and in some ways, the change reflects that. And we have very capable leaders. Jeff, who runs -- was the Founder of Google Brain and really well positioned to lead our AI efforts. And Ben has been at Google since the early days of Search, started in Google in 2000 and has been driving Search for over 18 years. And so we are very excited, and we think the changes will serve the company well. On your second thing, the question was on shopping actions? + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [26] +-------------------------------------------------------------------------------- + + And in particular, the price per sale pricing model. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [27] +-------------------------------------------------------------------------------- + + Oh, so I think we announced the -- this new service in March, and the feedback has been very positive. I mentioned earlier, which is for retailers, when they are testing this, they see it drives an increase in basket size. So that means users are interacting with the product well, and that's all I have to share for now. It's still early days. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + A couple for me, please. First, on the cloud business. I was wondering if you could provide any color, at least in the relative momentum you're seeing in that segment from infrastructure services compared to platform or software services. And then related to the adoption of AMP. I guess, a key question we get asked is whether that ultimately changes usage, and maybe you have some perspective on this from Android. But in the ecosystem between mobile web pages and app usage, if you're seeing any shift among users between those formats. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [30] +-------------------------------------------------------------------------------- + + On the first question of cloud, look, I mean, I think the main thing I would say is the fundamental drivers of adoption of Google Cloud based on what we hear back from customers is our advantage in data analytics and machine learning. The fact that we really support open, agile development environment. Kubernetes has literally become the standard for workloads and the fact that we are open in terms of how we approach this space. Security is becoming a big differentiator for us and something we've been leading for a while, and I think that's driving it. G Suite, as I called out earlier, is a good synergistic driver. G Suite is doing well, and clearly, a very unique offering, and it's gotten very comprehensive. And so I think overall, it comes together well. On your second question around AMP, AMP has been definitely very successful. It's really made publisher content much more friendly for users in terms of latency and the user experience, and hence, that option has been great. For sure, AMP has definitely helped the mobile web, and that's part of the big reasons we did it. Mobile web is still a big part of how users consume content, especially around news, and so us investing there clearly makes a difference. I guess, for example, when we look at, I don't know, J.Crew adopted AMP, their mobile page loading times are now over 90% faster. And now they are integrating the Google payment request API. That reduces checkout times from 2 minutes to 30 seconds or so. So things like that. We are going to constantly stay on improving the mobile web, and that plays a big part in how our ecosystem works. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [32] +-------------------------------------------------------------------------------- + + I have 2, one for Sundar, one for Ruth. First, Sundar, can you give us any sense of how Google Home consumers are using Search in these devices differently than maybe the traditional ways of Search? And you're finding in those homes, is it additive to overall search activity? And then for Ruth, if you look at the last page of press release, where you've shown the new monetization metrics, you see a real increase in the cost per impression on network sites. So can you talk about maybe what's happening there? Is there a mix shift types of publishers, types of products? Or is that just market inflation? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [33] +-------------------------------------------------------------------------------- + + Look, for sure, Google Home gives rise to a lot of new and unique use cases, actions that are a big part of it. Call mom is a good example of something you say to Google Home a lot. I can -- which is different than what you would say to Search. We see this as a good complementary thing. You will see Search embrace some of the capabilities you find in Google Assistant and Google Home and vice versa. And so overall, I view this as additive in the long term, and we are definitely just getting started there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [34] +-------------------------------------------------------------------------------- + + And then on the network monetization trends. First, just to give people a bit more color. When we launched the AdSense businesses, our network revenues were largely click-based. And over time, there's been a meaningful mix change in our business given the strong growth in programmatic, which is impression-based. So as a result, the shift now covers more of the business. And then in terms of the question on impression growth versus CPM growth, as we've discussed on prior calls, the network business is actually a number of different businesses. And then within that, we have flat year-on-year growth in the number of impressions that was driven by efforts to improve user experience through a reduction of less relevant ads and AFC. And so these changes had a positive impact on the year-on-year growth in CPMs. And then the trend and impressions in CPMs can clearly be volatile from quarter-to-quarter as we're optimizing for the user publisher and advertiser, but it really goes to the efforts that we make. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill of Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [36] +-------------------------------------------------------------------------------- + + Just as a question regarding any changes on your framework for growth versus operating margins. The last few quarters, you've seen steady top line acceleration, yet the margins were down. Can you just talk about how you think about it at a high level for this year? Any changes from the past? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- + + Yes, it's an important question. As we've talked about on many, many calls, we have been and remain focused on supporting long-term revenue and profit growth, and we think the opportunity set ahead of us is quite extraordinary. And as I said in opening comments, just given our confidence and as we're looking forward, we want to make sure we're investing appropriately in the next phase of innovation, and we have clarity about some very compelling opportunities. And then our judgment, that enables us to maximize shareholder value. So we're taking the steps really to put in place the support for long-term -- longer-term growth. Part of what I'm saying, you can see in our sites revenue growth, try to make that clear in opening comments, we see this consistent, strong momentum globally, and we're really excited about the still sizable opportunity led by mobile search. And so we're continuing to invest to enhance the user and advertiser experience, and thereby, extend the growth in our ads business. You can see this also in the trend on the CapEx spend. As I noted in our opening comments, the investments we're making there really provide the compute capacity to support our growth outlook, and that's supporting the opportunities that come out of machine learning and the Assistant. And then we also see extraordinary upside in the newer markets, as Sundar has talked about, most notably cloud computing and hardware. And so we're investing to support the long-term growth opportunity there. And then finally, when we look at the market opportunity in both self-driving cars and life sciences, our judgment is it makes sense to place the kinds of investments that we are. And with all of this, what also hasn't changed is we appreciate the importance of prioritization and picking our spots, and we're keenly focused on steps we can take to both make the right investments with the proper intensity while being diligent about long-term plans and returns. So at a high level, the approach hasn't changed. You're seeing the investments here. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Stephen Ju of Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [39] +-------------------------------------------------------------------------------- + + So Sundar, I think one of the themes that you as a management team has talked about has been to, I guess, democratize advertising with AI to help SMBs who may have found advertising across Google's ad products to be perhaps overwhelming. So can you talk about the rate of uptake among the smaller advertisers and whether or not this is helping to catalyze growth in new budgets and where these guys might otherwise have not been able to advertise before? There's SMBs and then there's local also. So what will be the plan to get this technology into the hands of folks who will want to use them? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [40] +-------------------------------------------------------------------------------- + + Look, I mean, there's a big focus for us. And today, SMBs are -- play a big role in our ecosystem, and we are doing a lot of stuff to support them across the board, right, and from things like in our offerings to help SMBs get an online presence, create a website, be discovered in local, search and Google Maps. So we do a lot of detailed work to make sure SMBs are working well. We are also doing a lot of stuff on local as well, including efforts that are even around local services. So we have very specific initiatives. This is going to be -- I mean, it's actually -- to us, it's bread and butter of what we do here, and so there's a lot of effort underway, not to mention the fact that we provide G Suite for businesses as they scale up as well. So it's an end-to-end offering, and we'll -- you'll continue to see us invest more here. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, - [42] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter call. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2018-Feb-01-GOOGL.txt b/Transcripts/GOOGL/2018-Feb-01-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..bab99b2e3b13bd223504a6fa2c97f6fcc8570b67 --- /dev/null +++ b/Transcripts/GOOGL/2018-Feb-01-GOOGL.txt @@ -0,0 +1,465 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Alphabet Inc Earnings Call +FEBRUARY 01, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + - + * Ruth Porat + Alphabet Inc. - CFO and SVP + * Sundar Pichai + Alphabet Inc. - Director & CEO of Google + +================================================================================ +Conference Call Participiants +================================================================================ + + * Kenneth Michael Sena + Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Benjamin Ari Schachter + Macquarie Research - Head of TMET Research + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Evercore ISI, Research Division - Senior MD + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Inc. Fourth Quarter 2017 Earnings Call. (Operator Instructions) +I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2017 Earnings Conference call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2016 filed with the SEC. Undue reliance should not be placed on any forward-looking statements and they are made based on assumptions as of today. We undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now, I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. We had a fantastic 2017 with total revenues of $110.9 billion, up 23% over 2016; and operating income of $28.9 billion, up 22% year-on-year excluding the EC fine. Our momentum reflects a relentless focus on users, advertisers and enterprise customers, as well as the benefits of our commitment to long-term investing. +For the fourth quarter, revenues of $32.3 billion were up 24% year-on-year. The ongoing very strong performance in sites revenue, in particular, reflects the combined benefits of innovation and secular growth with mobile search again leading the way. Healthy growth in network revenues was again led by our programmatic business. Substantial growth in other revenues, namely hardware, Cloud and Play, continues to highlight the benefits of our investments. +Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. In order to facilitate comparisons of this quarter's results to prior periods, we have also provided the tax-affected line items, excluding the impact of the U.S. tax legislation enacted at the end of 2017. You can see the components in our earnings press release. +Second, I will review results for Google and then Other Bets. I will then conclude with our outlook. Sundar will then discuss business and product highlights, after which, we will take your questions. +Starting with a summary of Alphabet's consolidated financial performance for the quarter. Total revenues of $32.3 billion were up 24% year-over-year and strong across all regions. U.S. revenues were $15.4 billion, up 21% year-over-year. EMEA revenues were $10.3 billion, up 24% year-over-year. In fixed FX terms, EMEA grew 22%, reflecting strengthening of both the euro and the British pound. APAC revenues were $4.7 billion, up 30% versus last year and up 32% in fixed FX terms, reflecting weakening of the Japanese yen. Other Americas revenues were $1.9 billion, up 31% year-over-year and up 30% in fixed FX terms, reflecting strengthening of the Canadian dollar. On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, was $14.3 billion, up 34% year-on-year. +Other cost of revenues on a consolidated basis was $7.8 billion, up 34% year-over-year, primarily driven by Google-related expenses, specifically cost associated with our data centers and other operations, including depreciation, hardware-related costs for our expanded Made by Google family of products and content acquisition costs primarily for YouTube. +Operating expenses were $10.4 billion, up 19% year-over-year, in particular, reflecting an increase in marketing spend given the holiday season. Stock-based compensation totaled $1.8 billion. Headcount at the end of the quarter was 80,110, up 2,009 people from last quarter. As in prior quarters, the majority of new hires were engineers and product managers. +In terms of product areas, the most sizable headcount additions were once again made in Cloud for both technical and sales roles, consistent with the priority we placed on this business. Operating income was $7.7 billion, up 15% versus last year, and the operating margin was 24%. Other income and expense was $354 million. We provide more detail on the line items within OI&E in our earnings press release. +Our provision for income taxes on a reported basis includes $9.9 billion for items associated with the U.S. tax legislation, resulting in a reported net loss of $3 billion and loss per diluted share of $4.35. Excluding the impact of the U.S. tax legislation, our effective tax rate was 15%. Our net income was $6.8 billion, and earnings per diluted share were $9.70. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $4.3 billion. Operating cash flow was $10.3 billion with free cash flow of $6 billion. We ended the quarter with cash and marketable securities of approximately $102 billion. +Let me now turn to our segment financial results, starting with the Google segment. +Revenues were $31.9 billion, up 24% year-over-year. In terms of the revenue detail, Google sites revenues were $22.2 billion in the quarter, up 24% year-over-year, led again by mobile search, complemented by solid growth from desktop search and strong performance from YouTube. Network revenues were $5 billion, up 13% year-on-year, reflecting the ongoing momentum of programmatic and AdMob. Other revenues for Google were $4.7 billion, up 38% year-over-year, fueled by hardware, Cloud and Play. +Finally, we continue to provide monetization metrics to give you a sense of the price and volume dynamics of our advertising businesses. You can find the details in our earnings press release. +Total traffic acquisition costs were $6.5 billion or 24% of total advertising revenues and up 33% year-over-year. The increase in site's TAC as a percentage of sites revenues as well as network TAC as a percentage of network revenues continues to reflect the fact that our strongest growth areas, namely mobile search and programmatic, carry higher TAC. Total TAC as a percentage of total advertising revenues was up year-over-year, reflecting primarily an increase in the site's TAC rate, which was modestly offset by a favorable revenue mix shift from network to sites. The increase in the site's TAC rate year-over-year was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. +The underlying trend affecting the network TAC rate year-over-year continues to be the shift to programmatic, which carries higher TAC. Google's stock-based compensation totaled $1.7 billion for the year, up 1% year-over-year. Operating income was $8.8 billion, up 11% versus last year, and the operating margin was 27%. Accrued CapEx for the quarter was $3.8 billion, reflecting investments in production equipment, facilities and data center construction. +Let me now turn and talk about Other Bets. I'll cover results for the full year 2017 because it remains most instructive to look at financials for Other Bets over a longer time horizon, as discussed on prior calls. +Results for the quarter are in our earnings release. For the full year 2017, Other Bets revenues were $1.2 billion, up 49% versus 2016, primarily generated by Nest, Fiber and Verily. Operating loss was $3.4 billion for the full year 2017 versus an operating loss of $3.6 billion in 2016. Other Bets accrued CapEx was $507 million, down from $1.4 billion in 2016, primarily reflecting a reduced investment in Fiber. We're pleased with our progress across Other Bets. A couple of updates: +Nest turned in a strong holiday performance in the fourth quarter across an expanded family of products in energy, safety and security. In 2017, Nest products also became available in 12 new countries, more than double the number in 2016. Verily wrapped up its first field study, seeking to reduce the transmission of diseases through mosquitoes with positive results. And just last week Onduo, a joint venture between Verily and Sanofi, began a limited commercial launch of its diabetes management platform. +At Waymo, progress is accelerating. For example, Waymo surpassed 4 million miles of driving in the real world, taking only 6 months to achieve the last million miles compared to about 18 months for our first million miles. And in November, Waymo announced that it is the only company to have a fleet of driverless cars on public roads that are completely autonomous without anyone in the driver seat. Let me close with some observations on our priorities and longer-term outlook, +Our 23% revenue growth in 2017 was powered in particular by the ongoing extraordinary performance of our sites business. Both mobile and desktop search continue to grow and benefit from our approach to innovation with strong momentum as we identify additional opportunities to enhance the user and advertiser experience. +As we've consistently emphasized, alongside the continued momentum in our advertising business, we are focused on building a second wave of growth within Google over the medium and long term, which includes the rapidly growing revenue businesses in Google: Cloud, hardware and YouTube. +With respect to Cloud, we are seeing the benefits of a fully featured enterprise offering and an expanded go-to-market team, bringing our advantages in infrastructure, data analytics, security and machine learning to more customers. And we're pleased with the momentum in our hardware business in 2017, driven by an expansion in both our product line and geographic availability. +Finally, as we look further into the future for our third wave of growth, we remain excited about the longer-term potential for our Other Bets businesses. +Overall, operating income was up 22% year-over-year in 2017, excluding the impact of the EC fine, although there was obviously fluctuation in the rate of operating income growth quarter-to-quarter. Within cost of revenues, the biggest component is traffic acquisition cost, reflecting our strong revenue growth in mobile search and the fact that mobile search carries higher TAC than our desktop business. While we expect sites TAC to continue to increase as a percentage of sites revenue, reflecting ongoing strength in mobile search, we anticipate that the pace of year-over-year growth in sites TAC, as a percentage of sites revenue, will slow after the first quarter of 2018. +Within OpEx, we are keenly focused on prioritization in order to optimize the resources we're investing for longer-term growth. As I discussed on last quarter's call, marketing spend in the fourth quarter is significantly elevated, in particular, supporting hardware, but also across Cloud and YouTube. For 2018, we remain excited about the investments we are making to drive the next phase of growth in our big bets in Google, in Cloud, hardware and YouTube, and our machine learning efforts, which are powering innovation across our businesses. You'll see us continue to support our priority areas with increased headcount, which will remain concentrated in R&D. With the closing of our deal with HTC earlier this week, for example, we've added 2,000 employees to support our hardware business. +With respect to SBC, we've completed the transition to a single annual compensation cycle for employees with a full year equity refresh grant to employees in the first quarter of 2018. Our biannual grant to SVPs will also occur in the first quarter, and you will see the combined step up in our first quarter results. +For our Other Bets in 2018, we will continue to calibrate the magnitude and pace of investment appropriate to their individual execution paths. +Finally, our framework for capital allocation is unchanged from our prior discussions. The primary use of cash continues to be to support organic growth in the business. We're excited about the significant opportunities we've identified in our businesses and continue to invest appropriately. We then layer in a sensitivity analysis regarding potential M&A as well as CapEx, in particular, computing infrastructure to support the needs of these growing businesses. The most sizable catalyst for added investment in compute power include the expanding application of machine learning efforts across Alphabet, as well as additional requirements for Google's Cloud, Search and YouTube businesses. This framework further considers complementary uses such as a share repurchase. After taking these potential investments into account, our Board has decided to extend our share repurchase program up to an additional $8.6 billion of Class C capital stock. +In conclusion, 2017 was another great year, and we are very excited about the opportunities ahead. I will now turn it over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. Our teams are off to a great start in 2018. This year is special as it will mark 20 years since Google was founded. A lot has changed, but our mission, organizing the world's information and making it universally accessible and useful, remains the best guide for the next 10 years. +Technology is an incredibly dynamic industry. We've been laying a foundation for the next decade as we pivot to an AI-first company, powering the next generation of Google products, like the Google Assistant. And we have been making substantial investments in our 3 biggest bets: Cloud, YouTube and hardware. These bets have enormous potential and already, they are showing real momentum and gaining traction. Today, I'll start by sharing some of the exciting progress in these 3 big bets. +First, Google Cloud. Google Cloud, which includes Google Cloud Platform and G Suite, has reached meaningful scale. And I'm excited to share today that it's already $1 billion-per-quarter business. In fact, we believe that Google Cloud Platform, based on publicly reported data for the 12 months ending December 2017, is the fastest-growing major public cloud provider in the world. +We're also increasingly doing larger, more strategic deals with customers. In fact, a number of deals worth over $1 million across all cloud products more than tripled from 2016 to 2017. The strength of our products and the value of working with Google is increasingly clear to partners and customers. +In the fourth quarter, we forged new and deepened existing partnerships with industry leaders, including Cisco for open hybrid enrollments, Salesforce for customer insights and productivity and SAP for AI and data insights across their products. These collaborations span our entire companies from engineering integration to marketing programs to joint sales, and they cover Google Cloud Platform, G Suite and Google Analytics. +We also saw accelerating customer traction on our (inaudible) included global brands like Bed, Bath & Beyond, Dentsu Aegis Network, Keller Williams, Mattel and Tyco Retail Solutions. And underscoring the increasing importance of Google Cloud to the enterprise, we surpassed another new milestone, 4 million paying customers on G Suite. +Next, YouTube. Every month, more than 1.5 billion people come to YouTube to watch their favorable content on channels ranging from TheEllenShow, which has more than 22 million subscribers; to the NBA, with over 8 million subscribers; to SciShow, a really popular educational channel with more than 4.5 million subscribers. In fact, there are over 1 billion learning-related video views every day on YouTube. I learned that this week. +With all this great content, people are thinking of YouTube more as a key part of their TV viewing experience. For Tuesday night's State of the Union, more partners used YouTube to live stream the address than ever before, generating 5 million live views. And just yesterday, we announced a partnership with Major League Soccer's, LA Football Club. YouTube TV will be the exclusive home to watch all locally-televised English language matches in addition to their original programming and content. +YouTube TV is now also available on Roku. There is great momentum around the world with localized versions of YouTube now in 90 countries in 80 different languages. Just this morning, we announced that we are expanding the popular YouTube Go app to over 130 countries around the globe. The app has great data usage transparency and controls built in, which is especially useful for people living in regions with limited connectivity. +In the fourth quarter, we also strengthened our relationship with the music industry, signing new licensing deals with Sony Music Entertainment and Universal Music Group. We also partnered with Ticketmaster to help fans buy tickets to see their favorite artists perform live. +Third, our growing hardware business. Our Made by Google hardware products were very popular this holiday season. Device shipments in the fourth quarter have more than doubled year-over-year. Our retail partners also saw strong performance. Our devices are available in stores like Best Buy, Target and Walmart. I'm especially excited about the popularity of our Google devices for the home, like the Google Home Mini, Max and Chromecast. In the last year, we have sold tens of millions of these devices and counting. I want to call out the great work of our marketing and design teams. Our hardware is beautiful individually and as a family, and people love discovering the unique features like the built-in Google Assistant. +Earlier this week, we officially closed our deal with HTC, which will bring great talent to drive even more innovation in the years to come. +Turning to our efforts in machine learning. Or AI research and innovation leads the world. Our mission to better organize the world's information has been transformed by these technologies with our search products and the Google Assistant at the heart. There's great momentum around the Google Assistant, as we bring it to more people on more devices. It's now available on more than 400 million devices, including speakers like Google Home as well as Android phones and tablets, iPhones, headphones, televisions, watches and more. People love to use the Assistant on all these devices. There was a lot of excitement around the Google Assistant at CES from partners and consumers, where we brought the Assistant to new surfaces, like smart displays from brands like JBL and Lenovo as well as Android Auto, which is now available in more than 400 car models from brands like GM, Hyundai and Volvo. +One area that's really benefiting from our advancements in AI is photography. The Pixel 2 phone is the leader in video rankings by industry standards with smoother and clearer videos, thanks to machine learning and our video stabilization technique. +And Google Photos continues to go from strength to strength. On New Year's Eve alone, over 3 billion photos and videos were uploaded to Google Photos. +More broadly, we want everyone to be able to use machine learning for their own needs. We recently gave Google Cloud customers access to Auto ML, which makes it far easier to build complex new [enrollments]. Since its launched a few weeks ago, over 10,000 customers have already signed up to try it. +Lastly, I'll give a quick update on our computing and advertising platforms. First, Android. To provide a better, more tailored experience for our next billion users, we made Android Oreo Go edition available for our device partners. This year, we expect to see Go devices from dozens of manufacturers and with great support for mobile operators and app developers around the world. I'm confident that this will bring the power of smartphones to many more people for the first time. +Google Play is also growing well. Just last week, we introduced audiobooks so you can now catch up on your favorite books any time on multiple devices. And in Latin America, a number of unique monthly buyers on Google Play grew by over 50% year-over-year in 2017. +Chromebooks also continued to gain momentum and traction. Third party research tells us that fourth quarter sales of consumer Chromebooks in the U.S. grew by over 70% year-over-year. +Moving to our advertising platforms, which help large and small businesses. As shoppers turn to their mobile phones this holiday shopping season, Google was central to helping them discover new brands, compare products and find the best deals. We redesigned the mobile shopping experience on Google, bringing more product information to the forefront like reviews and ratings. We are also making the payments experience simpler, safer and more consistent. We brought our payments efforts together as the new Google Pay, which shoppers can use to pay online in stores and across Google products like Chrome and the Play Store. Companies like Airbnb and Insta Cart are using Google Pay to speed up mobile check out. And Hotel Tonight found that customers using Google Pay are 65% more likely to complete their bookings. +We also have really strong momentum in app promotion ads. The majority of our app promotion campaigns are now using universal app campaigns, which is part of our focus on simplifying the advertiser experience. Additionally, we introduced a new playable ad format in Google Play that allows users to sample games before they install. Ads in Google Play are performing really well for developers. +And our app promotion business on YouTube is flourishing. We launched major initiatives, such as [tourism measurement] and location-based ad formats to drive online to offline commerce. We are focused on making sure YouTube is a great place for users and advertisers while helping creators earn money from popular content. +In addition to the significant work we are doing to product users and stop abuse on the platform, just a few weeks ago, we announced changes to advertising on YouTube, including stricter monetization criteria, new manual reviews for all videos in Google Preferred and simpler controls for marketers. The feedback we have received from advertisers and creators so far has been really positive. +So as you can see, we are making great strides in our biggest bets, and I'm proud of the work we are doing across the company. I'm also incredibly proud that as Google grows, we are making significant contributions to our partners, the economy and our local communities. Our business continues to benefit our partners around the world. This includes news publishers, app developers and YouTube creators who we share revenue with. +Over the last 4 years, our partners have earned over $100 billion. That's incredible, and we are working on new ways to drive even more value to our partners. In the U.S. specifically, we have offices and data centers across 21 states, and we plan to hire thousands of people across the U.S. this year. +Last year in the U.S., we grew faster outside the Bay Area than in the Bay Area. To support this growth, we'll be making significant investments in offices across 9 states, including Colorado and Michigan. We'll also be building or opening 5 big new data centers in the U.S. And with digital skills in high demand by employers, our Grow with Google initiative will help jobseekers and small businesses gain education and skills to help them succeed. +Just a couple of weeks ago, we announced that we are creating an IT support certification program that will give thousands of people scholarships and job opportunities. More than 10,000 people have already signed up, which is amazing. +I want to thank all our employees, Google users, partners and advertisers around the world. I couldn't be more excited about what's in store for all of us this year. With that, I'll hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. And we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe 2. One for Sundar, one for Ruth. Sundar, coming out of CES and the success you had with Google Home and the Google Assistant during the holiday period based on the blog post you guys put out, can you identify some of the key investments in either partnerships or hardware capabilities that you're targeting over the next 1 to 2 years to make sure the momentum around Assistant is sustained? And then, Ruth, looking at cost of goods sold, that came in quite a bit higher than we thought, and you were lapping a one-time charge, if we have it right, versus the year-ago period. Maybe you could talk a little bit about some of the pressures in cost of goods sold that were either seasonal or maybe a new normal in terms of a higher level going forward. Any color there would be really appreciated. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [3] +-------------------------------------------------------------------------------- + + Thanks, Eric. On the Google Assistant and Google Home, we are very excited about the momentum we saw in CES. It actually reflects work we've been doing for a while. Google Assistant in some ways brings together all the technology we've been building for years, and it's an extension and it's supported by Google Search as well. We are also thinking about our capabilities broadly beyond just one device alone. And that's what we are doing here across phones, across all surfaces. So that's something big we are focused on. And the second is we always build ecosystems, be it Android or Chrome or Chromebooks. We work with many, many partners and scale up things, right? And so we are leveraging those best practices and trying to build this in a way in which the entire ecosystem can ship products with the Google Assistant and generate values. So I think the framework is great. And long term, our investments in AI will directly manifest those capabilities for users through the Google Assistant. So I'm very bullish on it. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [4] +-------------------------------------------------------------------------------- + + And then in terms of the gross margins, it obviously reflects our product mix. And as you know well, the TAC rate for each of sites and network as a percentage of those revenue lines does continue to increase because they're our strongest growth areas, namely mobile search and programmatic, and so carry higher TAC. But as I indicated in my opening comments, we do estimate that the year-on-year increase in the sites TAC rate will slow after the first quarter of 2018. And then the other thing to note, other cost of revenue does reflect the seasonality of hardware, having increased both the number of products in the Made by Google family as well as continuing to expand geographically in Western Europe and APAC. You can see that reflected here. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [6] +-------------------------------------------------------------------------------- + + Two quick questions. One for Ruth and Sundar. I guess, Ruth, just to follow-up on your comments there, the partner agreements which you just cited. Is there any color you could give us on how these typically work? And what I mean by that is are they typically multiyear deals on average? And how do we think about these impacting the rate of change in tax since you were talking about the pace of growth in TAC as we look out, call it, in year 2 if these are multiyear deals? And then for Sundar, I guess, I wanted to follow up a little bit with what we saw at CES. But how do you think about voice? And given the significant number of devices in the market, how do you think in the future about traffic acquisition strategies on these devices as you look 5 years down the road? Is there any reason to think that the strategies might be different that you're going to follow as you look ahead than what we've seen over the past, call it, since the advent of the iPhone? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [7] +-------------------------------------------------------------------------------- + + So on your first question, there's not much really that I'm going to be able to add there. I mean, given the ongoing momentum in our mobile search business, this does continue to be relevant as you look forward, given mobile carries higher TAC. But the rate, as per your question, has also reflected changes in partnership agreement. So all factors considered, we expect the year-on-year increases will slow after the first quarter of '18. And as I've said on many of these calls, we're very pleased to have a very strong position in a rapidly growing market, and that momentum does continue. I guess, the only other thing to add is that Q4 TAC as a percentage of revenues does benefit from the fact that the fourth quarter is a seasonally strong quarter for YouTube. So quarter-on-quarter changes are less insightful because CAC is distinct from TAC. It's not in this number. But not much more to add there. Pass it to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [8] +-------------------------------------------------------------------------------- + + And Heather, on voice, we are very excited by voice. We obviously see it being adopted strongly in countries like India. It's actually a significant part of just mobile search queries in general. And things like Google Assistant and doing Google Home kind of really accelerates the trend. But we definitely see more multi-modalities. So as you saw, we also announced many smart displays at CES. And I think that will be an exciting trend as well. So we'll bet on all of that. In general, I think about we want to be there for users when they need us and we want to serve everyone. That's why we work across the ecosystem. We do first-party devices. We do it globally. And so we are committed to doing that well. So I think it'll be an extension of how we have approached search from day 1 and trying to serve everyone. And so I don't, overall, see a big shift. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + And our next question comes from Douglas Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [10] +-------------------------------------------------------------------------------- + + Some big news earlier this week just in terms of Waymo with FCA talking about delivering thousands of minivans to Waymo later in the year. So I was hoping, Ruth, you could just talk to us more about the timing for that business and how we should think about the economic model there as you move to operations and deployment phase. And then, secondly, the cash, now obviously much more accessible in terms of what is held overseas. Can you just talk more about your plans there. Obviously, a bigger buyback there, but still not meaningful in terms of the overall size of the company. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [11] +-------------------------------------------------------------------------------- + + Sure. So first on Waymo, we do remain very excited about the opportunity with Waymo and our continued progress on multiple fronts, in particular, the rider program in Phoenix, we're excited about and we're expanding our testing to more states. In November, we announced that Waymo's self-driving TAC reached a major milestone, becoming the only company to have a fleet of driverless cars on public roads that are completely autonomous. And that builds on our more than 4 million test miles driven in the real world in 7 states, 25 US cities, we're currently driving -- self-driving, I should say, 10,000 miles every day, with billions of miles in simulation and robust testing at our private facility. So more to your question, we do continue to explore a range of options beyond the program we're piloting in Phoenix, including ride-sharing and personal use vehicles logistics, deliveries and working with cities to help them address public transportation objectives. That being said, our first commercial application is the ride service that we will launch in 2018 that would be open to members of the public in Phoenix. And riders will be able to use our Waymo app to hail one of our fully driving -- self-driving cars without a driver at the wheel. So very excited about that. And then in terms of cash. I think the main point, as we think about it, is there's no change in our approach to our capital allocation framework. We've consistently been focused on long-term investing. We talked a lot about that already on this call. And our framework has been, therefore, very consistent. The priority, the first use is organic. It's investing in the many opportunities that we have. And the second is strategic. And we do remain active with smaller M&A deals, in particular, to support our Cloud business in hardware. The HTC deal, which we just closed, is a good example of that. Third is CapEx. So we continue to invest in machines to support growth we see across Google. But in particular, supporting Cloud, Search, YouTube and all that we're doing in machine learning. And then finally, that leaves return of capital. When we considered all of that, that's what led us to extend -- have the Board extend the share repurchase program, which we announced a couple of years ago. And we'll let you determine what that number represents in true Google fashion, but it's just a modest increase to what we've been doing previously. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [13] +-------------------------------------------------------------------------------- + + I have 2. The first one, Ruth, you called out desktop search, I think, for the second straight quarter as being relatively strong. Could you just talk about some of the drivers of the strength of desktop. And how do you think about the sustainability of continued strong desktop growth into 2018 and beyond? The second one, kind of a question in search query volume. There's often speculation and question marks around how consumer behavior is changing in e-commerce and whether Google is still capturing as many e-commerce searches. Could you just talk to what you're seeing in retail search query volumes and search user growth within e-commerce in the United States? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [14] +-------------------------------------------------------------------------------- + + Overall, we -- obviously, search is very broad. And even when you talk about commercial, I think we serve across many, many categories, including things like -- from travel to hotels and to services, to products and so on. So we're very, very comprehensive. And obviously, e-commerce is evolving a lot, and we continue to invest there. Google Shopping is doing well. I mean, we work hard to make sure we bring the best experience possible, which is why [asset evolves] Search and Assistant be partner with companies like Walmart, for example, to make it much easier to buy products and so on. So we invest a lot there. You are right. Consumer behavior is changing, but we are comfortable given that breadth of how we do things and how that -- how we are focused on user experience there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [15] +-------------------------------------------------------------------------------- + + And on your question on desktop. There really isn't one particular item to call out here. And that's why last quarter, I tried to walk through the process that our team goes through and the way they look at innovations really stepping back and recognizing that the way we all use smartphones and desktop is continuing to evolve. And so therefore, there's utility and challenging assumptions about evolving user behavior and advertiser preferences, and that opens new lines of inquiry, which benefits not just mobile, but also desktop. And desktop did deliver solid revenue growth. It does remain an important form factor for certain more complex tasks such as planning vacations or assessing insurance options, and we're pleased with the ongoing strength. So I'll leave it to you to do any of the forecasting. But we just view it as yet another valuable form factor and are really pleased with the performance there. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI, Research Division - Senior MD [17] +-------------------------------------------------------------------------------- + + I have one for Sundar and one for Ruth. Sundar, on YouTube, you mentioned the 1.5 billion people come to YouTube. Any other information you can give us there on user growth or engagement trends, would be great, anything on time spent. I mean, particularly as YouTube becomes more mature, and mobile video, particularly in North America, gets more competitive. And then also on YouTube, anything around new products or features driving the monetization or ad business? And then Ruth, just a question on the growth in marketing spend. In the fourth quarter, I think you said that the 4Q is significantly elevated. Should we interpret that to mean that the growth rate in selling and marketing year-over-year should decelerate off the 4Q? And then just related to that, [in] getting a good return on investment from this marketing spend, particularly when you think about media mix and all the spend that we've seen on TV as compared to digital marketing. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [18] +-------------------------------------------------------------------------------- + + Look, on YouTube, we are continuing to see great momentum. Maybe one area, which for example highlights how well it's doing is if you think about YouTube on TV, people actually watching YouTube on the big screen, our growth has been significant there. And so increasingly, people will use YouTube for -- we see it being used across every possible use case. And I said it earlier in the call, every day, we get over 1 billion user on educational content alone. People use it to go catch up on sports, music, entertainment. And so you can think about the breadth of -- historically, YouTube has been very strong on mobile. It continues to be strong on mobile. It's doing particularly well in the next billion user markets. Our growth last year was very strong there, which is why we supported it with investments like YouTube Go. And we are seeing it now growth well beyond mobile, especially in the living room. So a lot of momentum there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [19] +-------------------------------------------------------------------------------- + + And then in terms of sales and marketing. As I said, it particularly supported hardware, but was also supporting Cloud and YouTube. And as Sundar and I have said, these are important Google growth areas for us and we are investing to support growth in the business. The elevated levels this quarter did reflect both seasonality and strategic decision to invest in these brands. And so we view it as a very important part of the overall investment in what we view as very sizable opportunities. And it's both supporting the brand and the momentum there for going into 2018, but it's very specific product-focused as well. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [21] +-------------------------------------------------------------------------------- + + Sundar, I'll go with the European theme. First, curious to hear your thoughts on the potential impact of GDPR maybe both on your own sites and properties and how any business practices may need to be adjusted for that, but also for tools like Customer Match that your advertisers may use. And then, second, I'll take a shot at it. Any updates on your dialogue with EU officials and regulators on the proceedings there? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [22] +-------------------------------------------------------------------------------- + + Good question. I was just in Europe last week. It was exciting to be there. There's clearly momentum we feel in terms of how Europe is doing, and we are very committed to the region. We are opening new offices there. We announced the AI center. We are committed to hiring more engineers and supporting staff there. So it's an important market for us. On things like GDPR, we want to be -- we have been thoughtfully engaged there. I think it's important to put privacy first for European citizens, and we are very supportive of the work that's underway there. And we are committed to complying with GDPR across all the services that we provide in Europe. There's still time. As a reminder, it doesn't go into effect until May or so. And we are working to make sure all our products are ready, and we'll work hard to make the transition well. In terms of, again, with EU -- with the European Commission, we have long had constructive conversations. We are understanding their concerns and responding with thoughtful changes, and we'll continue engaging in a thoughtful way. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + First, Sundar, your comments on Google Cloud were upbeat. And I wonder how much of the momentum there is related to machine-learning capabilities offered as a service. If you could frame just how important that is for the Cloud business overall. And then as a follow-up, on Google Home or the voice-based Assistant, if there's any update in how you're thinking about monetization from a transactional perspective, a transactional model with perhaps retail partners? Or do you see an ad-based model emerging there as well? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [25] +-------------------------------------------------------------------------------- + + On the first thing, Colin, on Cloud, particularly the last quarter, we obviously brought Auto ML to our Google Cloud customers. To me, that shows the rate at which we are bringing our internal advances. It's just a year ago, I remember, everyone reviewing with the team when they first showed me the Auto ML work. We spoke about it at Google I/O. And it's pretty cutting-edge work. And to turn it back around and to provide it to everyone in the world, I think that shows the power of what we can do with Google Cloud and get our state-of-the-art and get it to everyone. I think the momentum there, obviously, is due to our strength in machine learning, the kind of open agile development [enrollment] we provide security and then the combination with G Suite. But above all, I think we've always -- we've been doing cloud now for 19 years because Google itself was built on a cloud platform. But where the momentum is really coming from is over the past 2 years, we have put a lot of effort to make sure we are enterprise-scale ready. So now, we can handle any type of enterprise, any kind of regulatory complexities, security complexity and so on. And that's evident in the business wins we are seeing. So we are signing customers who are very large across the board globally, and I think that's driving a lot of momentum there. On your question on Google Home and voice-based Assistant and how we are thinking about monetization, there a lot of interesting ideas internally. So we acquire -- teams are excited about trying new things. We see a lot of potential. But the guidance have given the teams to be squarely focused on user experience. We are really getting started. I think these are going to be powerful technologies. But there are areas where we clearly feel all of us fall short for doing right by users and getting the expectation -- matching their expectations. So you'll see us focused on user experience there for a while to come. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + One for Sundar, one for Ruth. Both on YouTube. So first question was, as Google Preferred kicks up a little heat on types of qualities that makes the cut for your videos, do you feel that you have to take a more active stance in looking at what is in Google Preferred -- sorry, YouTube Preferred? And how are you going to go about that? And then for Ruth, the past year was one where we heard a lot about brand safety. And I wonder, when you look back at the YouTube results in '17, is there any noticeable signs of maybe a shift in ad spending from some of the brands who are making those complaints? So those are my questions. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [28] +-------------------------------------------------------------------------------- + + Thanks, Michael. Probably, we can talk about both as they're related. In -- we obviously want to make sure YouTube has a great experience for users, content creators and advertisers because it supports content creators. And we took a lot of steps last year, but particularly in December, we are up to a new rigorous approach. And that's a much more stringent standard for creators. For example, they need 1,000 subscribers to be eligible for monetization. We are manually reviewing Google Preferred videos. We obviously use machine learning to support that a lot, and they both go hand-in-hand. We've provided improved controls for marketers, and we are also working with trusted third-party vendors to assist brand suitability. So it's a comprehensive approach to make sure all of this works well. And so while there have been concerns and we are -- but we are working really hard to address them and respond strongly. And so I think it sets -- we are focused on the long-term opportunity here. And I think we are setting ourselves up well for the years ahead. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And the next question comes from Ken Sena of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Kenneth Michael Sena, Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst [30] +-------------------------------------------------------------------------------- + + So just a question on -- searches seem to be coming more qualified through travel as far as filtering the price that people want to pay, locations, amenities, et cetera. Is there any trend that goes along with that in terms of maybe depressing search volume growth to some extent because of the more filtered aspect? And then, secondly, does the higher qualification trend tie in at all to the shifts towards programmatic in terms of other parties that might be involved or the discussion that we've had around TAC? And then maybe, two, just as a follow-up. If you can provide just a little bit more color on Google Pay in terms of what might be different this round versus previous attempts? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [31] +-------------------------------------------------------------------------------- + + Maybe I'm not fully sure I understood all the specifics there. But at a high level, as people are on-the-go, they are traveling, etc., if anything, I think search is more invaluable than ever before. All the work we do in local searches applies incredibly when you travel. The properties we have, like Google Maps, et cetera, go along with it. So overall, I think they all add up to a better user experience, and hence, a better opportunity for us. Google Pay turns out to be an important part of all of this. As we move from just answers to helping users complete actions over time, including transactions, their ability to complete the transaction is an important part of it, and which is why making sure Google Pay, in a unified way, works as seamlessly as possible, is a big part of our long-term strategy. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question comes from Stephen Ju of Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [33] +-------------------------------------------------------------------------------- + + So Sundar, I think Ruth cited hardware in the prepared remarks as the largest contributor in the fourth quarter for the other revenue line. As you look at the road map going forward, you acquired the HTC engineers to bring that team in-house. So it looks like for the first time, you have an integrated hardware and a software team under one roof. So how do you think your product development pace and strategy will change for smartphones and other devices going forward? And also, does it make sense to bring the Nest team to be more integrated into core Google as well given the drive to increase the touch points for all the Google products [for the form] factors? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [34] +-------------------------------------------------------------------------------- + + Well, thanks, Stephen. Great question. You're right that part of the reason we are so excited about being able to bring this world-class team in-house is while we've been working together already, we've had to straddle a company boundary to do that. But now, having them as Googlers would really make that integrated development, which is so critical for us to do it better. We bring a unique approach to hardware. The combination of AI plus software, plus hardware. So being able to get those teams working together, I think, will really drive the pace forward. And the best example of that is you see the advances we have made with both still and media photography on our phones. And the Nest team is very, very closely aligned with the Google hardware team. They work hard to realize a lot of synergies there. We already shared a lot of our go-to-market efforts, and we increasingly are collaborating on product development as well. So we collaborate closely, and I'm excited at the possibilities there as well. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [36] +-------------------------------------------------------------------------------- + + First for Sundar. It didn't feel like there was many visible search changes this year as far as coverage or ad formats. So would love to hear your thoughts on search innovation pipeline as you look out to '18 and key growth drivers going forward. And then, Ruth, in the prepared remarks, there was a lot of comments on investment in your medium-term business growth drivers, offices, data centers and other areas. I'm just wondering if you view 2018 upcoming as an investment year, or kind of more of the same of what we've seen over the last couple of years? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [37] +-------------------------------------------------------------------------------- + + So Justin, when you think about search, one of the ways that I encourage you to think, we think about user journeys. So a lot of the innovation that we are doing has gone on to not just an individual query in how we respond, but how we think about what our user is trying to accomplish over a series of sessions. Are you trying to plan a trip and how do we do it better? Do you have a health-related area where you're trying to learn more about it? And how do we help you through that? And so it's not always just changing a specific format, but understanding context better and bringing you that information through a journey. And I think so, there's a lot of innovation that's happening in that direction. And also underlying is what I said earlier. It's not just providing the answers. How do you help them get to that information and act on it? And so maybe you found something and you want to call that place, or maybe you're trying to order a birthday gift and we actually want you to -- want to go a step further and help that -- help you buy that gift. So that's along the lines. And the innovation is happening across search and Assistant in an integrated way. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [38] +-------------------------------------------------------------------------------- + + And then in terms of your investment question, we've consistently been investing across Alphabet, and we've tried to be very clear about our investment priorities, all with a view to supporting healthy, long-term growth that goes back to the inception of the company. The year-on-year op inc growth that you've seen does include these sustained investments for all the areas that both Sundar and I have talked about. For the year, up 22% versus last year. Obviously, a lot of variability in growth quarter-to-quarter. And we just continue to be focused on doing the right things to support growth of the business. The fourth quarter does reflect the obvious seasonality. And again, we continue to look across the various products, their needs and try and prioritize, but we can remain committed to long-term growth. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + And our next question comes from Ben Schachter of Macquarie. + +-------------------------------------------------------------------------------- +Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [40] +-------------------------------------------------------------------------------- + + Just a couple of questions. Can you discuss the evolution of the business model for Waymo? You're launching the ride hailing service in Phoenix. You've worked with manufacturers. You talked about other models. But when you think about the sort of 5 to 10-year view of that, what will the primary business model look like? And separately, can you talk about what is interesting from a strategic point of view about the video game business? You're making some key hires there. And I'm just wondering what you think Google can bring to that industry that would be innovative. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - CFO and SVP [41] +-------------------------------------------------------------------------------- + + So on Waymo, really not much more to add. We're really pleased after years of work on technology where it was really about safety, safety, safety and developing the technology and the platform. And now, we're in a position where we have this opportunity to let people use and benefit from what we've developed. I think that safety has been a key driver and the opportunity for cities has been really exciting what it means about optimizing resource space that they have. So it's still very early days, and we're just -- we're pleased with all the progress the teams made. But it would be getting ahead of ourselves to go further out than we've laid out here. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - Director & CEO of Google [42] +-------------------------------------------------------------------------------- + + On the video gaming side, I think, look, we are -- we today have a lot of momentum in these areas, both with YouTube as a platform, Google Play. So these are assets that really work well. And we'll continue investing there. Nothing new or interesting to share with you at this time. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, - [44] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter call. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2018-Jul-23-GOOGL.txt b/Transcripts/GOOGL/2018-Jul-23-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..fc9f85dc4741783d02153934cd72c3cfc8fb0a63 --- /dev/null +++ b/Transcripts/GOOGL/2018-Jul-23-GOOGL.txt @@ -0,0 +1,455 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Alphabet Inc Earnings Call +JULY 23, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Google LLC - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Second Quarter 2018 Earnings Call. (Operator Instructions) I'd now like to turn the conference call over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Second Quarter 2018 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2017 filed with the SEC. Undue reliance should not be placed on any forward-looking statements, and they are made based on assumptions as of today. We undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. We delivered another quarter with strong operating performance, reflecting our focus on building great experiences for users, advertisers and enterprise customers around the world. In aggregate, we had substantial revenue growth, up 26% year-on-year and up 23% in constant currency. Sites revenues continue to exhibit strong year-on-year momentum, benefiting from innovation and secular growth with mobile search again leading the way. Our network advertising business maintained healthy growth led by AdMob and programmatic advertising. The businesses comprising other revenues, namely Cloud, Play and Hardware, again had substantial growth. +Our outline for today's call is I'll begin with results for the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. There are 2 items to note in our earnings press release. First, we provided a table to highlight the impacts of the European Commission fines on operating income, net income and EPS results in the second quarters of 2018 and 2017. Second, as discussed last quarter, our results are affected by the new accounting standard that changes the way companies account for equity security investments. This new standard continues to result in greater volatility in OI&E. I'll highlight the impact on particular line items as I review the quarter. I will then review results for Google, followed by Other Bets and will conclude with our outlook. Sundar will then discuss business and product highlights. After which, we will take your questions. +Starting with a summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $32.7 billion were up 26% year-over-year. We realized a positive currency impact on our revenues year-over-year of $768 million or $665 million after the impact of our hedging program. +Turning to Alphabet revenues by geography. You can see that our performance was strong again in all regions. U.S. revenues were $14.9 billion, up 21% year-over-year. EMEA revenues were $10.8 billion, up 26% year-over-year. In constant currency terms, EMEA grew 19%, reflecting strengthening of both the euro and the British pound. APAC revenues were $5.1 billion, up 36% versus last year and up 34% in constant currency, reflecting strengthening of the Japanese yen and Korean won. Other Americas revenues were $1.8 billion, up 31% year-over-year and up 34% in constant currency, reflecting strengthening of the dollar relative to the Brazilian real. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, was $13.9 billion, up 34% year-on-year. Other cost of revenues on a consolidated basis was $7.5 billion, up 41% year-over-year, primarily driven by Google-related expenses. The key drivers were costs associated with our data centers and other operations, including depreciation, which continued to be affected by a reallocation of certain operating expenses; and content acquisition costs primarily for YouTube, followed by hardware-related costs. +Operating expenses, including the impact of the EC fine, were $16 billion. Excluding the impact of the EC fines, operating expenses were $10.9 billion in the quarter, up 24% year-over-year. +Once again, the biggest increase was in R&D expenses, reflecting our continued investment in technical talent. The growth in sales and marketing expenses reflects increases in sales and marketing headcount, primarily for Cloud, followed by advertising investments in Cloud and the Assistant. +G&A expense trends in the second quarter were affected by a number of factors. In particular, performance fees accrued in connection with the recognition of equity security gains, which were again partially offset by the reallocation of certain expenses from G&A primarily to other cost of revenues. +Stock-based compensation totaled $2.4 billion. Headcount at the end of the quarter was 89,058, up 4,008 from last quarter. As in prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were in Cloud for both technical and sales roles. +Operating income was $2.8 billion. Excluding the impact of the EC fines, operating income was $7.9 billion, up 15% versus last year for an operating margin of 24%. Other income and expense was $1.4 billion, which includes $1.1 billion of gains and equity security investments. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 24.2% for the second quarter, reflecting a sizable impact from the nondeductibility of the EC fine. Net income was $3.2 billion, and earnings per diluted share were $4.54. Excluding the impact of the EC fine, net income was $8.3 billion and earnings per diluted share were $11.75. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $5.5 billion, which I'll discuss in the Google segment results. Operating cash flow was $10.1 billion with free cash flow of $4.7 billion. We ended the quarter with cash and marketable securities of approximately $102 billion. +Let me now turn to our segment financial results starting with the Google segment. Revenues were $32.5 billion, up 25% year-over-year. In terms of the revenue detail, Google Sites revenues were $23.3 billion in the quarter, up 26% year-over-year. In terms of dollar growth, results were led again by mobile search with strong contributions from both YouTube and desktop search. Network revenues were $4.8 billion, up 14% year-on-year, reflecting the ongoing momentum of AdMob and programmatic. Other revenues for Google were $4.4 billion, up 37% year-over-year, fueled by Cloud, Play and Hardware. We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. +Total traffic acquisition costs were $6.4 billion or 23% of total advertising revenues and up 26% year-over-year. Total TAC, as a percentage of total advertising revenues, was up year-over-year, primarily reflecting an increase in the Sites TAC rate, which was offset by a favorable revenue mix shift from network to Sites. The increase in the Sites TAC rate year-over-year was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC. +This quarter, we experienced the year-on-year decline in the network TAC rate as the result of a favorable mix shift within our programmatic business. Google's stock-based compensation totaled $2.3 billion for the quarter, up 21% year-over-year. Operating income was $9 billion, up 17% versus last year, and the operating margin was 27.6%. Accrued CapEx for the quarter was $5.3 billion, reflecting investments in production equipment, data center construction and facilities. +Let me now turn and talk about Other Bets. Other Bets revenues were $145 million, primarily generated by Fiber and Verily. Operating loss was $732 million for the second quarter. Other Bets accrued CapEx was $10 million. +We're pleased with our progress across Other Bets. A couple of updates. Waymo expanded its partnership with Fiat Chrysler with the option to add up to 62,000 Chrysler Pacifica minivans to its self-driving fleet. And last week, Waymo announced that it has driven more than 8 million fully autonomous miles with most of those on city streets. +A couple of weeks ago, X announced that Loon and Wing have graduated to become independent companies under Alphabet. Graduation from X signals that these companies have reached certain technical and business milestones and that their focus is shifting toward commercialization. And just last week, Loon indicated that it is partnering with Telkom Kenya to launch commercial service in regions of Kenya by early 2019. +Let me close with some observations on the quarter and our longer-term outlook. First, with respect to revenues, we're pleased with the ongoing momentum in our advertising businesses. As discussed previously, we continue to identify new opportunities through innovation, including the benefits of applying machine learning to create more useful experiences for users and advertisers. Looking ahead, our Hardware business is seasonal, typically experiencing lower growth in the third quarter in anticipation of the launch of new products for the holiday season. +Second, with respect to profitability, within cost of revenues, the biggest component is TAC. As we've discussed for the past couple of quarters, we expected the pace of year-on-year growth in Sites TAC as a percentage of Sites revenue would slow after the first quarter of 2018, and you can see that clearly in our results this quarter. As frequently discussed, we do expect the Sites TAC rate to continue to increase year-on-year, reflecting ongoing strength in mobile search, albeit at a more moderate pace relative to the year-on-year increases experienced over the past several quarters. +Within OpEx, we continue to take a disciplined approach to setting priorities as we invest for the long-term growth. The majority of our headcount growth continues to be in technical roles in engineering and product management. In terms of business areas, the largest number of headcount additions were in our Cloud business with hires for engineering, sales and marketing. +As a reminder, headcount additions tend to be seasonally higher in Q3 because that is when we bring on new graduates. As I mentioned last quarter regarding sales and marketing, we continue to expect expenses to be more heavily weighted toward the back half of the year to support the holiday season. +Another factor to consider in year-on-year comparisons next quarter is the timing of 2 expense items in Q3 last year. As we called out last year, there was a meaningful benefit in the third quarter of 2017 from the shift in timing of our annual equity refresh and also from the timing of sales and marketing spend, which was more heavily weighted to the fourth quarter. For our Other Bets, we remain focused on making progress on a number of commercial opportunities across the businesses while continuing to manage investment against achievement of key milestones. +Third, with respect to CapEx, as I discussed with you last quarter, our commitment to growth is evident in the ongoing trend in CapEx investment. We have been investing meaningfully in Search and Ads consistent with the opportunities we see to benefit the user and advertiser experience. And we are investing in the additional compute power required to support growth in the number of YouTube users globally. +We're also investing in new businesses that are growing at a rapid pace and have sizable compute needs, most notably Cloud. The investment pace also reflects the importance of machine learning across all of our products, including Search and Ads. Although machine learning is more compute intensive, it is increasingly core to businesses across Alphabet and opens up the possibility of accelerated innovation in products and services. +In keeping with our approach across Alphabet to invest thoughtfully for long-term value creation, we remain focused on both performance and cost effectiveness. I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. It's been a busy few months at Google, and we showed a lot of what we are working on at events like Google Marketing Live, Brandcast and of course, our annual developer conference, Google I/O. It was exciting to have millions of people join us in person and via live stream. Tomorrow, I hope you'll tune in to Google Cloud Next, where the great momentum and innovation in our Cloud business will be fully on display. +The common thread you'll hear on today's call is the benefit of machine learning and AI and how it's improving our products and generating great results for our users and partners. I also hope that everyone enjoyed the World Cup as much as I did. I know our French Googlers were very excited. I love the competition and was extremely proud to see positive feedback about how useful Google Translate was for people who traveled to Russia. The app translates about 143 billion words a day, and during the World Cup, we saw a huge bump in volume. +In these simple moments when you're in an unfamiliar place or you don't know the language, Google is there to help with the right information at the right time. This is what we aspire to be best at, and it's why billions of people continue to put their trust in our products. +Today, I'll start with how AI is enabling us to advance our mission of making information accessible and useful to everyone in new ways. Then, I'll share updates on our computing, video and advertising platforms, which are helping our partners succeed and grow. And finally, I'll talk about our growing Cloud business. Let's begin with AI helping our mission. +We revamped the Google News app in May to great reviews. It uses machine learning to highlight top stories organized for users, explore topics more deeply with articles from a range of trusted news sources. We believe in the need to deliver high-quality information and news to users and to support the news industry as we do so. +The Google Assistant is another great product based on machine learning. By the end of this year, it'll be available in more than 30 languages and 80 countries. We have worked with partners to expand the number of smart devices that are now compatible with the Google Assistant like doorbells, dryers, refrigerators and more and connect with than 5,000 devices in the home. +At Google I/O, we also highlighted how AI is improving Google Maps, including enhancing the experience with Assistant and AR features. Through our improvements in machine learning, we have seen a 25x increase in our ability to build maps algorithmically and we have added 110 million algorithmically drawn buildings to Maps since the beginning of this year. And with over 1 billion users, we are continuing to see tremendous growth in Maps with especially strong growth in countries like Indonesia, India and Nigeria, each of which are growing over 50% year-on-year. +There are many more great AI powered features we rolled out this quarter, including the new version of Gmail with Smart Compose, a new feature that helps users draft e-mails faster. And Google Photos now suggests actions help you brighten, share, rotate or archive a picture. +Next, our computing, video and advertising platforms. These platforms are providing real economic opportunities for developers, creators and publishers in every corner of the world. Last year, I announced that in the 3-year period from 2014 to 2016, we paid out over $15 million in revenue to our creator, publisher and app developer partners in Europe, Middle East and Africa via AdSense, YouTube and Google Play. Our contribution is accelerating. In 2017 alone, we generated an additional $7 billion for these partners. +First, our computing platforms. 10 years ago, we launched the first Android phone with a simple idea: to build a mobile platform that's free and open to everyone. Today, there are more than 24,000 devices at every price point for more than 1,300 different brands. The Android ecosystem supports thousands of phone makers and mobile network operators who build and sell Android devices, millions of app developers around the world who have built their businesses with Android and billions of consumers who can now afford and use cutting-edge Android smartphones. This is all supported by a business model that encourages and enables this open ecosystem to [triumph]. +Continuing this momentum, at I/O, we unveiled a plethora of new features throughout the Android platform like battery saving features in Android P, new Google Assistant capabilities on Wear OS, a new Android model to help developers optimize for a variety of devices and form factors as well as tools to help users understand and control how they are spending time on their device. +Our investments in our computing platforms as well as in AI and design are also helping us generate great momentum in our Made by Google Hardware business across Pixel, Home, Nest, Chromecast and more. We brought Google Home in many to Ireland, Australia, Spain and Mexico. Additionally, bringing the Nest and Google teams together is showing early results. The products can more seamlessly work together, and our product development and go to market are benefiting from the new alignment. There's a lot more to come here in the next few months. +Second, our video platform, YouTube, is growing tremendously. We launched a revamped YouTube Music service across 17 countries, and it's receiving great feedback from users and artists alike. This quarter, YouTube rebranded its subscription service, YouTube Premium, featuring originals like our hit series, Cobra Kai, which got 41 million views the first episode alone. While advertising on YouTube is an incredibly strong and growing source of income for creators, we are also investing in new ways for creators to generate revenue on the platform, including paid channel memberships, merchandise shelves on YouTube channels and endorsement opportunities through a company we acquired in 2016, FameBit. In fact, half of the creators that used FameBit in the first 3 months of 2018 doubled their YouTube revenue. And third, our advertising platforms, which are firing on all cylinders as we put the power of machine learning into marketers' hands. +At Google Marketing Live, we introduced our newly rebranded advertising products, our core product, Google Ads; Google Marketing Platform, which provides analytics and ad serving for large marketers and agencies; and Google Ad Manager, our monetization engine for publishers. We also announced a new ad format powered by machine learning called responsive search ads. It automates the manual process of building text ads and optimizes them in real time to show the best performing ad for each search query. +Advertisers also got a first look at local campaigns and Smart Campaigns. Local campaigns are designed exclusively to drive foot traffic to local businesses, and Smart Campaigns are now the default for new SMB advertisers. Small business owners love the simplicity and the results. This quarter, we announced shopping and commerce partnerships with leading global retailers like Carrefour designed to give people the power to shop wherever and however they want. Carrefour is a great example of how we can partner deeply with companies, bringing our Shopping and Ads and Cloud products together for them. They recently chose to migrate from Office to G Suite for their more than 160,000 employees and have selected us as their main cloud provider based on our ability to support the company's digital transformation. +Speaking of our efforts to help businesses succeed in the cloud, our Cloud business has great momentum. It's a natural extension of our long-time strengths in computing, data centers and machine learning. We have developed these over many years and they power our own services in the cloud and are now helping others. +This week's Google Cloud Next event will have more than 20,000 attendees, up from over 2,000 at our cloud conference in 2016 with over 250 customers speaking. I won't spoil any of the surprises, but I do want to call out Google Cloud's momentum. Success of our vertical strategy and customer-centric approach was illustrated by key wins, including Domino's Pizza, SoundCloud and PricewaterhouseCoopers. Target is migrating key areas of its business to Google Cloud Platform. +Financial institutions are increasingly turning to the cloud to modernize their systems, explore new business models and improve customer experiences. New customers include Banco Itaú in Brazil. We also have a rapidly growing business for our specialized cloud AI services. AirAsia expanded its relationship with us to use machine learning and data analytics. +We are seeing an acceleration in business adoption of Chromebooks, a more secure and cost-efficient way for businesses to enable their employees to work in the cloud. In Q2, unit sales of managed Chromebooks grew by more than 175% year-over-year, and we saw deployments at customers like Veolia. And to support our growing global customer base, we continue to invest in new cables, open new regions in Finland and Los Angeles and announced the Zürich region. We now have 17 open regions with 3 more on the way. +Before I close, I want to give a quick shout out to the work that we are doing to build great specialized products for the next wave of people coming online for the first time in countries like India, Indonesia, Brazil and Nigeria, many of whom experience the Web only through their mobile phone. This is a big area of focus for us. +Through a great partnership with Indian Railways and RailTel, we have hit our goal of enabling high-speed public Wi-Fi in 400 train stations across India. We have also rolled out this Google station model in Indonesia and Mexico. More to come soon. +And to help spur AI innovation in Africa, we recently announced a new Google AI research center in Ghana with the goal of bringing together top machine learning researchers and engineers to explore AI research and applications in Africa and beyond. +Of course, our commitment to help communities and people benefit from the digital economy extends beyond the products that they use. Last month, as part of our broader Grow with Google effort, we expanded the Google IT Support Professional Certificate program to more than 25 community colleges in the U.S. This will give students an opportunity to learn skills needed to jump-start their careers in IT support. +I want to thank Googlers for their hard work, which helps us create products that billions of people love and use every day. With that, I'll hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar, and we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Two questions if I can. Sundar, for you, following up on your comments, we've seen all of these partnerships announced in the e-commerce space. Want to understand how those partnerships might evolve over the next couple of years, what Google brings to the table for those partners, what it might do for the advertising services business as we think long term. And then we've been getting a lot of questions on Waymo in the quarter. Is there any sense you can give us of some of the key investment milestones or how we should be thinking about capital allocated to the Waymo business in the coming years? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Great. On the commerce front, obviously, it's a natural sector, I think, for us to drive partnerships. We already have deep advertising relationships with many of these providers. Increasingly, Shopping is an area where we are beginning to work together. And finally, I think cloud is another important way by which we can start working together. So I do think we are seeing a lot of traction there. I gave the Carrefour example. We also announced a strategic partnership and significant investment in JD.com, the second largest e-commerce company in China. Today, we are already, for example, in Google Express, we are partnering with over 100 merchants, including national retailers like Walmart, Costco, Target, Walgreens and PetSmart. So there's a lot of traction. I think we are building upon these relationships, trying to have more holistic conversations across the breadth of our offerings, and I think I see it all being very synergistic. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + And then in terms of Waymo, we remain very excited about the opportunity with Waymo. You've seen us talk about our progress on a number of fronts. I think the main point, it is still very early but -- in terms of our progress. So 2018, the focus has been to launch the commercial rider program in Phoenix that we've talked about, looking to do that by year-end. We do view that as a first step in building a more fully rolled out rider program in the future. And as we've discussed on prior calls, we continue to trial the program in Phoenix with an emphasis on delivering a safe experience that delights users. We've also continued to build out our vehicle relationships. You saw announcements regarding FCA and Jaguar. We're expanding our testing to more states. We're also working on additional areas such as logistics and deliveries. We talked this past quarter about licensing the technology for personal use vehicles, and we're also focused on working with cities to help strengthen public transportation. More specifically, your focus on CapEx, as I said, we're excited about the long-term opportunity, but creation of a new market does take time. And then on the CapEx versus OpEx, the way it works is once the commercial program is up and running beyond what's viewed as more of a development or R&D phase, then much of the investments are CapEx versus OpEx, and that's for car sensors and any other spend. So we're excited. We do think it's a really important market, but it is still very early. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [6] +-------------------------------------------------------------------------------- + + Great. I just had 2 questions. One, I was wondering if you could talk about what you've seen thus far with the rollout of GDPR. Anything you could share with us and just how that's played out versus your expectations at this point? And then, Sundar, as you mentioned, with Google Next upon us and you're obviously -- you guys are talking very positively about the business. But are there any more steps you can share with us even about the growth rates in G Suite or GCP or combined? And then when we think about this business scaling over time, is there any reason to think that the pace of gross margin progression would be materially different than, say, Azure or AWS at similar revenue levels? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [7] +-------------------------------------------------------------------------------- + + Thanks, Heather. On GDPR, obviously, it's something we have been working on for a long time, well over 18 months. But the rollout just happened towards the end of second quarter, so it's a bit early to ask us anything. But for us, it's been super important to get it right, and we've always been focused on user privacy. But it's been a big change for a lot of our partners as well, and so we are working closely with our partners and regulators and committed to doing it right. But it's too early to tell. And on Google Next and Cloud, obviously, the conference is tomorrow. So I will hold for the announcements there. A couple things. G Suite is definitely, I think, seeing a lot of momentum. We are definitely -- have noticed in the -- now I think it's -- it can definitely sell the needs of a large enterprise. It's clear. I gave the Carrefour example, but increasingly, we are seeing big companies take on the migration. So that's been, for sure, a positive development. And on Cloud, I think we are investing for the long run. We are definitely seeing traction. A lot of our effort from a product and technology standpoint, we are definitely there and differentiated. It's been a lot about investing in our go-to-market efforts, and as we do it, both developing our in-house strengths but as well as partnering, those things are beginning to pay dividends. And hopefully, you'll hear more details at tomorrow's conference. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [9] +-------------------------------------------------------------------------------- + + I have 2. The first one, the Google Assistant and the Hardware on the Google Home Minis, was curious if you could just talk about sort of early learnings and differences in consumer behavior with how they interact with those devices as opposed through -- as opposed to mobile search on the phones. And I know you're always very focused on the long-term value proposition for your users and advertisers, if you talk to what's the focus in the Hardware is long term for users and advertisers. And Sundar, appreciate your color on India and Indonesia in emerging markets. Talk about how you're strategically trying to position yourself or the business potentially beyond advertising and payments or other areas in those countries, if you could, please. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [10] +-------------------------------------------------------------------------------- + + So on Google Assistant, obviously, we see Google Assistant as an important evolution. And obviously, it's early days, but it's already exciting to see. People definitely are pushing the boundaries of what they can do with these devices. Home control and automation is a good example of the kind of use case that's very, very different consumer behavior and which is why our assets in Nest, et cetera, end up mattering over time. So there's a lot more actions people are trying to get things done, which is definitely areas where we are focused on. But I think it's important to understand that the experience not just in the context of Home and Home Mini but also your core mobile experience, how it evolves on the phone and across the screens you will have in your lives. So we are taking the end-to-end user experience in mind, and that's where all the investments we have done over many, many years, I think, will come into play as the product evolves. On your question about emerging markets, the user growth there is extraordinary to see, and we are seeing it across all our products. So all our major products, products which have over 1 billion users each, they are all doing well in these markets. And so that's where most of the growth is going to come from. And so it's an important area of focus. And we do see unique opportunities in these markets, which are different from the markets we are in here in our more mature markets. You highlighted payments as a good example, and you've seen us address that explicitly with Google Tez in India. And so we will look to do more like that. And beyond just getting our products working better, we're going to be opportunistic. We are investing in talent in these countries, and there's a lot of innovation, which is going to happen from these countries, both for their own markets and for the world beyond, and we want to be in a position to do that well. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [12] +-------------------------------------------------------------------------------- + + Two if I could. First for Ruth. You've talked about the higher cost as you shift to machine-learning-driven business and then also your tech upgrade cycle around machine. Can you give us a sense of where you are in making those transitions and absorbing those investments from a cost perspective? And then, Sundar, mobile strength clearly in the quarter. Can you just help us understand better how machine learning and AI are driving the stronger growth in mobile search and if there's any specific innovations or products you can point to that are driving that outsized growth? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + So in terms of your first question and kind of machine learning and I think you're kind of getting at cycle, you're really seeing it in 2 places. Part of it, as I called out, is with respect to OpEx. We're hiring, and what you're seeing is the investments we're making across the board. It's Ads. It's Cloud. It's Hardware. It's the Assistant. But it is also very much in machine learning, and we're really proud of the team that we have given the opportunity set that they're able to address. And I think you were trying -- you were getting more broadly at CapEx. The way we're focused on CapEx, as I've said last quarter as well, we view this as a lens into our outlook for growth in the required additional compute capacity. And there are a number of growth drivers there, and part is really to support growth that we're seeing in our Search and Ads business. That's really consistent with the momentum that we've commented on today and the exciting opportunities that we see to further enhance the user and advertiser experience. It's also for our newer businesses as I noted in opening comments. And then very importantly, it reflects the importance of machine learning across our products, including Search and Ads. We've talked about this in the past. Machine learning is more compute intensive, but it also opens up more services and products across Alphabet. And that's what we're investing in to make sure that we've got the capacity with best-in-class compute capacity. And so the build is really machines, data centers and network infrastructure. And just to make sure and put a fine point, while we're ensuring that we're well positioned to support the growth we see, we do constantly remain focused on efficiency per unit of compute. We've talked about that on many prior calls and are investing here for long-term value creation thoughtfully in order to be able to pursue the opportunities that we see ahead of us. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [14] +-------------------------------------------------------------------------------- + + And Doug, on your question on how is machine learning driving the mobile search experience, the key thing is it's doing it at a deeper foundational level. We've obviously used machine learning across the board, be it our ranking and actually understanding the intent and the context around the query and getting you the right answer. I think the experiences -- I mean, the improvements are happening continuously. And so we are -- I would just say we're getting deeper in terms of what we are able to do. In terms of specific innovations of products, it's super important to understand. I gave the Translate example earlier. While it may seem like a specific use case, it's obviously -- obviously, we can do Translate well because of machine learning. But where it helps us is we want Google to be the source you think of when you run into a problem. And the fact that the data shows that during the World Cup in Russia, our usage spiked up, to me shows that when people are running into new things, new experiences, when they have questions on their mind, Google is what they are reaching out to. And I think the way we continue to do that well is by -- increasingly by using machine learning. So that's the depth to which we think about this. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [16] +-------------------------------------------------------------------------------- + + First for Sundar. You talked about Android in your prepared remarks. In your blog post, you said that you're concerned that the Android ruling from the EC sends a troubling signal in favor of proprietary systems over open platforms. So I wonder, how are you thinking about the possible business impact from this Android ruling, specifically untying the Play Store from Search in the Chrome browser? And does it, in any way, change your strategic approach for Android going forward? And then for Ruth on the theme of OpEx investment trends, if we isolate just the other revenue businesses, Cloud, Play and Hardware, all growth drivers but clearly, structurally different in terms of the competitive landscape and profitability. You said most of the headcount additions are in Cloud, but would love to understand more about how you prioritize investment across Cloud, Play and Hardware, those 3. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [17] +-------------------------------------------------------------------------------- + + On Android, as I said in my blog post, Android has really worked well, I think, globally for users for everyone in the ecosystem. You can clearly see there's robust competition. There's a lot of innovation, lower prices that has made Android possible at every price point. And so I think, overall, it's created more choice for everyone, not less. We have -- it's -- we are analyzing the decision, and I think it's too early to comment or speculate beyond what we've already said. But we will always take a constructive approach. We'll appeal the commission's decision and take the due process available to us. But we're also looking forward to finding a solution above all that preserves the enormous benefits of Android to users and so on. So there is more work to be done, and I think it'll become clearer as we go along. But I'm confident that we can find a way to make sure Android is available at scale to users everywhere. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + And in terms of your question on investment priorities, I think one of the most important points to underscore is that one of the biggest opportunities for investment continues to be in our Ads business, where we're continuing to invest meaningfully given the opportunity set that we see there. Sundar commented on some of them. As did I., looking at opportunities to enhance the user experience, to continue to improve tools for advertisers and both of which extend the growth there. And that's for mobile, and what we're increasingly seeing is, as we focus on mobile, the benefits are across platform and help explain the growth we're seeing in desktop and YouTube. So we are continuing to invest here. I don't want to leave you with an answer, with the notion that the investment is just going to the newer businesses. And then more specifically to your question, what we look at is the opportunity set, the -- each one of these is different. When we start with Cloud, as Sundar commented, given the core capabilities that we are building upon, our technical infrastructure, security, apps, machine learning, analytical tools, our view is that we're addressing a rapidly growing market with the core pillars that are needed to win. And what has been the recurring theme that we've talked about on these calls is the need to further build out our go-to-market capabilities and ensure that we've got the functional requirements that enterprise customers deserve. So it's really looking at the scale of the opportunity, the pace of investment that can be done effectively and therefore, position us well. Our Hardware business continues to deliver significant growth, particularly with the sales of the Home family of products. And you've seen us invest there. We talked about the HTC acquisition last quarter because this is a scale business, and the ability to operate as effectively as possible underscores the types of investment we're making. Play continues to benefit from broad-based app strength, has been a long-standing strength of ours, and we're continuing to invest as needed there. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [20] +-------------------------------------------------------------------------------- + + Two questions. It seems like your commentary on cloud is very positive. It seems like that's also what we're hearing from Microsoft and my guess is from Amazon, what they're seeing. Do you think we're just at a broad industry inflection point in terms of cloud adoption? And any thoughts as to why we're seeing it now? And then on -- I had a question on advertising. There's this big bucket of ad spend called trade promotion spend that's largely been off-line I think, and it's almost as big maybe on a global basis as kind of traditional TV brand advertising. Any thoughts on that as an opportunity, whether there's an ability for that to really migrate heavily online and Google's ability to tap into those dollars? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [21] +-------------------------------------------------------------------------------- + + On the first question on cloud, for sure, I do think there is an inflection point, and that's why it feels far from a zero-sum game. I think all the major players are definitely seeing traction. And to me, the reason is, typically, when you look at enterprises, you -- once you've deployed and you have an architecture, you try and stay on it as long as you can in many, many cases because change is hard. But there's a case in which the benefits are super clear. And over time, I think there's a tremendous cost to your business of being on the wrong architecture, especially if you need to digitally transform yourself. Thinking through the cloud architecture becomes an important way by which you're improving your business. So I think, at a foundational level, it's clearly there on everyone's minds. It's not just on -- CEOs are asking questions about cloud. Almost all businesses I deal with I can clearly see the question is on the mind of their CEO, and so I think it's important. Also think it's going to be businesses are going to embrace multiple clouds over time, too. So I think not only is this early, but I think it is going to transform. And there's a lot of opportunity here. And our goal here is it's something we view. This is something we have built experience over 20 years, and we are thoughtfully gaining strength and committed to it for the very long term. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + And then in terms of kind of trends in advertising to your question, we have talked about this quite a bit in the past. Over 90% of commerce is still off-line, and we do see a great opportunity for digital to play a bigger role in that and tap into our budgets -- into other budgets that have traditionally been there. And so we are quite focused on the advertising opportunities I've said and the fact that ad budgets are off-line. And as we focus on these are opportunity and the tools for advertisers, we view that as another opportunity. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [24] +-------------------------------------------------------------------------------- + + Sundar, you mentioned in your prepared remarks or highlighted at least the launch of local campaigns at Marketing Live a couple of weeks ago. I recognize that's an initiative that will help drive demand across a number of Google properties. But I'm curious in particular about Maps, and with it being product aimed at driving store visits, one would assume Maps would play an interesting part in that. And in the past when we've asked you about Maps, it was focused more on getting the user experience right. So my question is, is do you see local campaigns as something that drives a bit of an incremental level of monetization of Maps. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [25] +-------------------------------------------------------------------------------- + + Look, I think it's a good question. Local is an extraordinary use case in mobile. Local mobile searches are growing faster than mobile searches for us and have increased by almost 50% in the last year alone. And we are continuing to invest in building a local experience that benefits merchants, users and advertisers. And local campaigns is something new, which we announced at Google Marketing Live a couple of weeks ago. It's a new campaign where if you're a local business, it's designed to drive foot traffic to you. You provide us with your budget, business locations and creatives, and we use machine learning to automatically optimize that to appear across our properties, right? And along with that, you've rightly noticed that we are beginning to experiment with new ad formats, which we have had in beta, but we are pushing on them a bit more in Maps itself, both promoted places and place page ads. So these are important ways by which we are exploring the commercial opportunity around Maps. I've always felt Maps is a tremendous asset we have. And we have really focused on the user side of things, and we will continue to do so because the growth is very, very high. So we see a lot of headroom. And -- but as their experience is -- we get a better understanding of it, we are developing our views on how we can bring monetization experiences. And so these are all steps in that direction. But we'll take it slowly, and we'll continue to evolve it here. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill of Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [27] +-------------------------------------------------------------------------------- + + Ruth, the U.S. and Asia businesses accelerated sequentially modestly. But Europe was down a touch, and I think there've been many questions around did GDPR have any impact. And Sundar said it was too early to call. But is that just completely unrelated to what happened and maybe there's something else that's going on that resulted from the small known TAC? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes. I mean, the way we look at it is we're pleased with the strength in each of the regions at 19% year-on-year growth in EMEA on a fixed basis. We're pleased with the strength in the business, and as Sundar said, I think it is too early to comment on GDPR. We then hope that the geographic split gives you a better sense of what's kind of the dynamics in each of the various regions. And as we both commented on, as long as you raised the regional question, I got to comment on APAC here. Really pleased with the growth, 34% on a fixed FX basis, and it underscores Sundar's comments about terrific products in rapidly growing markets as well as a superb leadership group. Mobile strength is the key there as well, and we're really pleased about the breadth by country that we're seeing. We're very focused on the region. So we're, as we look across the globe, pleased with the fact that it is -- all regions are contributing nicely. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [29] +-------------------------------------------------------------------------------- + + Okay. And a quick follow-up for Sundar. I -- you mentioned on the Cloud business that you're getting strong traction among some of the big financial institutions. One of the big questions we get is around the heavily regulated industries like health care and financial. It feels like you're starting to get better referenceability there. Are you happy with where you sit across the more heavily regulated industries now versus the tech-focused industries where you sit right now? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [30] +-------------------------------------------------------------------------------- + + Definitely, and I think that's where a lot of our investments have gone in, right, getting the necessary certifications needed depending on the industry and building the features that you need. And that's clearly starting to have an impact in both on GCP but as well as G Suite. And so we definitely are going to continue to build out our capabilities, and we'll be going after the opportunities in these areas very seriously. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [32] +-------------------------------------------------------------------------------- + + I have a couple. Maybe first going back to the commerce theme. I wanted to ask about Shopping Actions and the level of adoption you might be seeing with that format. And more generally, what do you envision monetization for Google Assistant if we should still expect to see more of a transactional bent to that platform? And then on TAC, Ruth, I wonder if it's worth adding a little more color perhaps on the timing or how much of the second quarter benefited from the moderation in growth in Sites TAC just so we can get a better sense as to how to model that expense item over the next few quarters. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [33] +-------------------------------------------------------------------------------- + + Colin, on Google Assistant and Shopping Actions, there, I do think it's been exciting to see the improvement there, but I still would like the experience to evolve a lot more before we play around with monetization. And in all of these areas, we always have a high bar to make sure the user experience is working well. You have seen us do that with Maps or something like that. And I think, today, while we have taken promising steps with Shopping Actions, for all of this to really work well and to delight users, I still feel we have some work ahead of us, and that's what we are focused on. So we'll stay focused there, get the experience, and then that will give us new avenues to monetize it. I've seen this with YouTube now. Beyond ads, we are experimenting with a lot of new formats, and the same thing here. So I'm pretty confident of our ability to do that well if you get the experience right. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [34] +-------------------------------------------------------------------------------- + + And then in terms of TAC, as we've talked about in the past, TAC as a percentage of revenues is affected by quite a number of factors. The main point is that we do continue to expect the TAC rate to increase on a year-on-year basis. And the primary reason is the one we've talked about with you in the past. It's the underlying shift to mobile, which carries higher TAC than desktop. So on a year-on-year basis, that's the trend that you're really seeing as the ongoing strength in mobile. Over the past 4 quarters, changes in partnership agreements have also been a driver of increases in the TAC rate, and then there are host of other factors that we've talked about that can have an impact in any quarter like device mix or partner mix or mix of organic in paid distribution points. And so as we called out last quarter, we did expect the pace of year-on-year growth in the Sites TAC rate to slow beginning in this quarter, the second quarter, and you can clearly see that in the data. And as we've repeatedly said, it is most instructive to focus on year-on-year changes given the significance of the shift to mobile and mobile growth. And so variations in quarter-on-quarter moves are less instructive. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [36] +-------------------------------------------------------------------------------- + + One for Sundar, and one for Ruth. Sundar, firstly, you went through a lot of your initiatives in your opening comments, but didn't mention Verily. So can you talk a bit what the bottlenecks are that need to be solved either by you or your clients before you could scale the Verily opportunity? And then for Ruth, you've been clear the CapEx ramp is due to your investing ahead of growth. What is usual time frame, do you think, do you see where those investments pay off? And what factors would make the CapEx-to-sales ratio start growing even faster from here? So those are my questions. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [37] +-------------------------------------------------------------------------------- + + Broadly, Verily is clearly set up as an other bet, and they are doing really important work on health care if you look at the recent progress on their diabetes monitoring and so on. So they're in deep work, and they have a lot more to talk about. Across health care, you see a big opportunity for both Google and Alphabet. It's a vertical which is very important for cloud. And we are obviously helping a lot of health care partners across their needs, and Verily is definitely doing very specialized solutions in this area. And we'll have a lot more to say on all of this over the course of time. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [38] +-------------------------------------------------------------------------------- + + And then with respect to CapEx, look, I think our view is that what you're seeing here is an aggressive pace of investment given our outlook for growth, and as I've said, the required additional compute capacity, we're quite focused on the kind of full resource utilization across businesses. If I go back a couple of years when we incorporated stock-based compensation into the way we're talking about the businesses, I made the point that, that is helpful both externally and internally. And looking at resource utilization, the same is clearly true of CapEx. And we're quite focused on long-term value creation, focused on ensuring that we're pursuing attractive opportunities in a prudent, appropriate way to capture the opportunity while making sure that we're looking at the full, again, resource requirements. So at this point, that's an interesting way of framing the question how does it grow even faster from here. We're quite focused on this being an aggressive pace and an appropriate one given the opportunity set we see, and it is across data centers, machines and network infrastructure as I said. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [40] +-------------------------------------------------------------------------------- + + Just want to get in to website growth. First, maybe you can help us a little bit understand strength in mobile search. Are there new -- any ad formats or ad changes? You mentioned local. Anything to call out there? And then just wondering, given the YouTube controversies last year, did YouTube accelerate this quarter? And what are some of the big content areas that you're investing in? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [41] +-------------------------------------------------------------------------------- + + So in terms of Sites revenue, I think our view is the ongoing strength reflects our focus on improving the user experience and enhancing tools for advertisers, and both Sundar and I have spoken about them. We've got an intense focus on innovation that we've discussed previously that's enabled us to deliver over 100 innovations each quarter, and really exciting area is the benefit of machine learning. It's a valuable driver of our growth, not only enhancing experiences for users but the tools that we talked about for advertisers and for app developers really helping them find the right audience to be able to optimize campaigns at scale to deliver more relevance and higher-quality ads. Sundar talked about a number of them. The Google Marketing Live, we really highlighted what we're seeing there and the benefits, whether we're talking about responsive search ads or local campaigns, smart shopping campaigns. Another great example is Universal App Campaigns. So across the board, and again, I'd made this comment previously, but the benefit we're seeing on mobile is extending to the growth opportunities across platforms. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [42] +-------------------------------------------------------------------------------- + + Yes. And I would add that a good way to think about it is, today, there's a lot of complexity you need to deal with as an advertiser, and increasingly, we are using machine learning to do all the hard work and get them to focus on the business problem they are trying to solve. And that turns out to be a big driver overall. On YouTube, we definitely are continuing to see great product momentum. It's the user adoption and interest, and our metrics are very strong, continues to grow. And the growth is global. And we see it across many, many verticals. And overall, we've invested a lot in making sure we are delivering the content responsibly, and it's a been a big area of focus across Google. We are investing a lot in people to review the content that going on, improving the policies and again, using machine learning to make all of this work better. And I think people are noticing it, including our advertisers, and they are engaging with the platform more. So I would say, overall, there's a lot of momentum there, and I'm excited about it. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [44] +-------------------------------------------------------------------------------- + + Great. Thanks, everyone, for joining us today. We look forward to speaking with you again in our third quarter call. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2018-Oct-25-GOOGL.txt b/Transcripts/GOOGL/2018-Oct-25-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..3c04adc84a631242f8b39107b962ae486d5b1bf4 --- /dev/null +++ b/Transcripts/GOOGL/2018-Oct-25-GOOGL.txt @@ -0,0 +1,458 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Alphabet Inc Earnings Call +OCTOBER 25, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Google LLC - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Third Quarter 2018 Earnings Call. (Operator Instructions) +I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Third Quarter 2018 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today may be considered forward looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our Form 10-K for 2017 filed with the SEC. Undue reliance should not be placed on any forward-looking statements, and they are made based on assumptions as of today. We undertake no obligation to update them. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. +And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. Our revenues in the third quarter continued to benefit from ongoing strength in mobile search with important contributions from YouTube, Cloud and desktop search, resulting in consolidated revenues of $33.7 billion, up 21% year-on-year and up 22% in constant currency. +For today's call, I will begin with results for the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. I will then review results for Google, followed by Other Bets, and we'll conclude with our outlook. Sundar will then discuss business and product highlights, after which, we will take your questions. +Starting with the summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $33.7 billion reflect a negative currency impact year-over-year of $385 million or $305 million after the impact of our hedging program. +Turning to Alphabet revenues by geography, you can see that our performance was strong again in all regions. U.S. revenues were $15.5 billion, up 20% year-over-year. EMEA revenues were $11 billion, up 20% year-over-year. In constant currency terms, EMEA grew 19%. APAC revenues were $5.4 billion, up 29% versus last year and up 30% in constant currency. Other Americas revenues were $1.8 billion, up 19% year-over-year and up 28% in constant currency, reflecting weakening of the Brazilian real and the Argentine peso. +On a consolidated basis, total cost of revenues, including TAC, which I'll discuss in the Google segment results, was $14.3 billion, up 28% year-on-year. Other cost of revenues on a consolidated basis was $7.7 billion, up 36% year-over-year, primarily driven by Google-related expenses. The key drivers were costs associated with our data centers and other operations, including depreciation, which continue to be affected by a reallocation of certain operating expenses, and content acquisition costs, primarily for YouTube. +Operating expenses were $11.1 billion, up 26% year-over-year. Once again, the biggest increase was in R&D expenses, reflecting our continued investment in technical talent. The growth in sales and marketing expenses reflects increases in sales and marketing headcount, primarily for Cloud and Ads, followed by advertising investments in Cloud, Chromebooks for the back-to-school season and the Google Assistant. +G&A expense trends in the third quarter were affected by a number of factors. In particular, the performance fees accrued in connection with recognition of equity security gains, which were again partially offset by the reallocation of certain expenses from G&A, primarily to other cost of revenues. +Stock-based compensation totaled $2.2 billion. Headcount at the end of the quarter was 94,372, up 5,314 from last quarter. Consistent with prior quarters, the majority of new hires were engineers and product managers. +In terms of product areas, the most sizable headcount increases were in Cloud for both technical and sales roles. Operating income was $8.3 billion, up 7% versus last year for an operating margin of 25%. As discussed in the previous 2 quarters, both operating income and OI&E are affected by the new accounting standard that changes the way companies account for equity security investments. This new standard continues to result in greater volatility. Once again, we've provided a table in our earnings press release to highlight the impact on particular line items. +Other income and expense was $1.8 billion, which includes $1.4 billion of gains in equity security investments. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 8.8% for the third quarter, reflecting discrete items, notably an adjustment associated with the U.S. Tax Act. Net income was $9.2 billion and earnings per diluted share were $13.06. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $5.3 billion, which I'll discuss in the Google segment results. Operating cash flow was $13.2 billion with free cash flow of $7.9 billion. We ended the quarter with cash and marketable securities of approximately $106 billion. Let me now turn to our segment financial results, starting with the Google segment. +Revenues were $33.6 billion, up 21% year-over-year. In terms of the revenue detail, Google sites revenues were $24.1 billion in the quarter, up 22% year-over-year. In terms of dollar growth, results were led again by mobile search, with a strong contribution from YouTube followed by desktop search. +Network revenues were $4.9 billion, up 13% year-on-year, reflecting the ongoing momentum of AdMob and programmatic. Other revenues for Google were $4.6 billion, up 29% year-over-year, fueled by Cloud and Play. +We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. Total traffic acquisition costs were $6.6 billion or 23% of total advertising revenues and up 20% year-over-year. Total TAC, as a percentage of total advertising revenues, was relatively flat year-over-year, primarily reflecting a favorable revenue mix shift from network to sites, offset by an increase in the sites TAC rate. The increase in the sites TAC rate year-over-year was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC. +This quarter, we experienced a year-on-year decline in the network TAC rate due to a combination of factors, none of which were individually significant. Google stock-based compensation totaled $2.1 billion for the quarter, up 23% year-over-year. Operating income was $9.5 billion, up 11% versus last year. And the operating margin was 28.2%. +Accrued CapEx for the quarter was $5.6 billion, reflecting investments in production equipment, data center construction and facilities. Let me now turn to Other Bets. Revenues were $146 million, primarily generated by Fiber and Verily. Operating loss was $727 million. Other Bets accrued CapEx was $55 million. In terms of Other Bets updates for the quarter. With Waymo in the third quarter, we built and our Early Rider Program, both expanding the group of participants and beginning to test pricing models. At Verily, the team continues to execute on its various partnerships with leading pharmaceutical companies, consistent with its mission to move medicine from reactive to proactive. Recently launched efforts included joint venture with ResMed to focus on sleeping disorders and a research collaboration with Gilead. +Finally, you can see in our results the benefit and quality of our investment teams, GV and CapitalG, which are also within Other Bets. Within the $1.4 billion of reported gains in equity securities in OI&E, approximately $400 million was realized in Q3. There will be more detail on these investment activities in the 10-Q. +Let me close with some observations on the quarter and our longer-term outlook. First, with respect to revenues. In the third quarter, results reflect FX headwinds with the U.S. dollar strengthening, in contrast to the tailwinds that enhanced reported results in the first half of the year. We continue to be pleased with the underlying momentum in our advertising businesses as we apply our strengths in machine learning to improve the experience for users and advertisers. As we noted, hardware was only a modest contributor in the third quarter as we launched a new Made by Google family of products for the fourth quarter holiday season. +Second, with respect to profitability. Within cost of revenues, the biggest component is TAC. We indicated on the fourth quarter 2017 call that the pace of year-on-year growth in sites TAC as a percentage of sites revenues would begin to slow after the first quarter of 2018, and you can see that again clearly in our results this quarter. +As frequently discussed, we do expect the sites TAC rate to continue to increase year-on-year, reflecting ongoing strength in mobile search. Looking ahead, we expect seasonal impacts to our other cost of sales from hardware sales, which are typically higher in the fourth quarter of the year as well as from increased content acquisition cost for YouTube, which have also historically been higher in the fourth quarter. +Within OpEx, we continue to prioritize our investments to support long-term growth. In terms of headcount, growth was seasonally higher in the third quarter because we brought on new graduates. We are continuing to invest in adding talent to our priority areas, particularly for technical roles in engineering and product management, and to support our most sizable growth areas, in particular, Cloud. As I've mentioned previously regarding sales and marketing, expenses are more heavily weighted toward the back half of the year. As you have seen in prior years, these expenses are particularly elevated in the fourth quarter to support the holiday season. +Other Bets remains a portfolio of earlier-stage businesses focused on addressing sizable markets. We are moving toward early stages of commercialization while continuing to calibrate the pace of investment against achievement of key milestones. +And finally, with respect to CapEx, you can see our continued investment as we build the infrastructure needed to support the opportunities we see across our businesses. This includes a number of data center construction projects in-flight as well as ongoing expansion in our compute capacity. +I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. We had a great quarter, and it was particularly special because last month, we celebrated Google's 20th birthday and the 10th birthday of Chrome. It's exciting to think that 20 years in, we are still just at the beginning of what's possible. We get billions of questions from users every day, and about 15% of those are queries we have never seen before. +Our mission to make the world's information accessible and useful is as relevant today as when we started. I want to begin by highlighting our recently launched family of hardware. It's a great example of how we bring together Google's strengths to help people through their day. Then I'll touch on ways AI is helping us approach our mission. I'll give an update on our video and advertising platforms. And finally, I'll talk about our growing Cloud business. +First, hardware. Every year, we have a new opportunity to push the boundaries of computing. Those experiences come to life in our Made by Google hardware, which combines the latest advances in software, hardware and AI. +Our third-generation is our best yet. It includes the Pixel 3, Google Home Hub, the Pixel Slate tablet and more. We're getting great feedback, and I'm very excited for users to try these devices, especially as the holiday season approaches. +Our new hardware lineup showcases the best of Google, including the Google Assistant, Android and Chrome. With the Pixel 3, we've used AI to create a best-in-class camera. New features like Top Shot make it so you never miss a shot. If your timing wasn't perfect, the camera will suggest a better frame and give you the option to save it. And Night Sight will help you take really good pictures even in bad light. Pixel 3 also has a custom security chip called Titan M. It was built to secure Google's own data centers, and now we are bringing it to our users. We also released Google Home Hub, our first smart speaker with a screen. It shows your morning commute, let's you control your smartphone and gives you hands-free help in the kitchen. And Pixel Slate Chrome OS reimagined as a tablet with all the great apps from the Play Store. +Our hardware efforts are picking up real momentum. For example, daily active users of our Google Home devices have grown by over 5x in the last year alone. I'm incredibly proud of our growing hardware team, including the talented employees who came over from HTC and Nest. Our investments are paying off as we bring the best of Google to more users and in more countries around the world. +Even as we build up our hardware business, we continue to advance our mission across our core products and platforms. Last month, we kicked off 20 years of Google Search by introducing some of the biggest updates in many years. They include a new AI-powered ranking approach that delivers more relevant results, a redesigned Google Feed called Discover to help you stay informed on topics that matter to you, and a new search experience for Google Images. +We also continue to tackle the information problem of connecting people to relevant jobs right from search. This has already helped connect over 100 million people in 92 countries to job listings that meet their needs and skills. Now U.S. service members can search for jobs for veterans and enter their military occupational code to see relevant civilian jobs. The Google Assistant continues to gain traction, drawing on our strengths in machine learning and helpful Google services like Search, YouTube and Maps. We have expanded the Assistant to 20 languages and 76 countries, and it can now understand and speak more than one language at a time. We launched our first set of smart displays with Lenovo and JBL as well as our own Google Home Hub. +Pixel users in the U.S. will be the first to try our new Duplex technology, which helps you complete real-world tasks over the phone, like calling a restaurant to book a table. And we introduced a new way to easily book ride services with your Google Assistant. +In Maps, we also made several improvements, including a commute tab with live traffic and transit information and support for mixed-mode commutes. Earlier this month, we announced an exciting test called Project Stream. We are working with video game publisher, Ubisoft, to stream their latest game, Assassin's Creed Odyssey, to Chrome browsers on laptops and desktops. Streaming graphically rich content for video games represents a great technical advance, and we look forward to seeing what's possible here. +I'm particularly proud that our strengths in AI are creating life-changing contributions in other fields. For example, our recent flood prediction efforts, which use AI to better predict when floods will occur, has the potential to help millions of people get out of harm's way. We are starting in India, where 20% of flood-related fatalities occur today, and we're looking to expand to more countries soon. +Earlier this month, our research has showed how they've applied deep learning models to improve the accuracy of diagnosis for metastatic breast cancer. Our research found that pathologists and AI can work together more effectively than either alone. +Moving to our video and advertising platforms, which are creating economic opportunities for partners around the world. First, YouTube. One particular area of focus is educational content. Every day, people from all over the world turn to YouTube to learn something new, from career skills to coding to cooking. Just this week, we announced a $20 million investment to expand our YouTube learning initiative, which will help fund established and emerging educational careers. We are also partnering with organizations like Goodwill and Year Up to create curated playlists that teach career skills directly in our new learning channel. YouTube's ads business continues to provide great results for marketers and creators. At Advertising Week, we announced that we'll be expanding our popular TrueView actions format. This helps users take action directly from video ads. They can now do things like sign up for a newsletter. And soon, they'll be able to find movie showtimes, download apps or even book a trip right from the ad. For creators, YouTube is continuing to build alternative revenue products, like Super Chat, Channel Memberships and the ability to sell merchandise directly to fans. YouTube Gaming creator, Markiplier, increased its revenue by 20% using Channel Memberships. We continue to see positive traction for our newest subscription experiences too. YouTube Premium, YouTube TV and YouTube Music premium are continuing to expand to many new countries. The team is also investing in growing and improving the news experience on YouTube. More prominently surfacing credible news sources on the platform is a big priority for us. +Next, our advertising platforms. Advertisers love that we are bringing our machine learning strengths to offerings like responsive search ads and Universal App Campaigns to create more effective ads. One new example is Smart Shopping campaigns, which use signals like seasonality and price to optimize where ads are shown. Tens of thousands of advertisers are using this and seeing an average of 20% more sales for the same budget. Just last week, we announced that Nike, Best Buy and Sephora are joining our Shopping Actions program. This allows people to move seamlessly from browsing to buying with a universal cart that works across Google Search and our system. +In apps, we announced a partnership with Unity Technologies, which gives our advertisers access to one of the largest global networks of mobile gaming titles across 1.5 billion devices. Unity's developers can monetize their apps with Google Ads without any additional development work. And lastly, our growing Cloud business. +At Google Cloud Next, we made over 100 announcements, including the Titan security key, which features Google-designed firmware to help verify that nothing on a customer's key has been tampered with. And we expanded our breakthrough Cloud AutoML portfolio, which now includes vision, natural language and translation. +And all over the world, we are seeing great customer adoption of our Cloud Platform. With the help of SAP, Metro, one of our largest B2B wholesalers globally, is centralizing their finance system on Google Cloud Platform. They're using BigQuery to generate data-driven insights to help create more personalized marketing campaigns. +In the U.S., we partnered with the National Institutes of Health to provide access to Cloud services that help researchers access large data sets to accelerate biomedical advances. We also added new customers like ING and Broadcom, joining existing customers like PayPal, ANZ Bank and Kroger. Our G Suite business continues to fuel transformation in companies large and small, and we crossed 2 important milestones in the quarter. Google Drive became the eighth Google product with 1 billion monthly active users. And Gmail now has more than 1.5 billion monthly active users. One of our big wins in the quarter was Fast Retailing, the Japanese retailer best known for its popular brand, UNIQLO, which is migrating its employees globally to G Suite, while also pursuing AI solutions like on-demand forecasting on Google Cloud Platform. Our Cloud business is benefiting from our investments in technical infrastructure, including a U.S.-Europe cable that will improve speeds for millions of people. +Before I wrap up, I want to quickly call out our continued momentum in Asia as well as the investments that we are making in the U.S. As you can see from our results, revenue growth in APAC remains strong. This is a reflection of our very focused efforts to build great experiences for the billions of people across the region. We have adapted many of our core products like Search, Maps and YouTube to work well for the next generation of users coming online. +We're also building products to meet the specific needs of users in the region like Tez, a digital payments app for India to help people easily pay their electrician or split a dinner bill with just a few taps. Just 1 year since it launched, over 30 million people in businesses across India now use the app every month, and they've collectively made more than 1 billion transactions. We have recently rebranded the app to Google Pay as we look to bring many of the app's features to others around the world. We are also investing closer to home. In Q3, more than 80% of Alphabet's total capital expenditures was within the U.S. Not only do these investments in data centers, machines and offices allow us to provide great services to users, they have a strong positive impact on the communities around them, supporting thousands of jobs and countless local businesses. +This year-to-date, we have added over 9,000 new employees in the U.S., and we continue to grow faster outside the Bay Area than in it. As you can see, there's exciting momentum across many different areas. I'm constantly struck by the number of incredible opportunities ahead of us as a company and how far we have come over the last 20 years. I want to say a big thank you to all of the Googlers around the world who help us deliver on that mission every day. +With that, I'll hand it back to Ruth + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar, and we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe 2 for Sundar, if I can. Referencing the blog posts and some of the changes about how you see the future of Search, I wanted to know what are some of the key investments you think the company needs to make so that Search becomes more visual or relevant. And what that might mean tying it back to the business for engagement with your products, relevancy of ads over the medium to long term. And then with respect to your comments on YouTube, we're starting to hear from advertisers there is some blurring between brand and direct response ad budgets as they look at products maybe more across blended lines. It sounds like the YouTube announcements coming out of Ad Week were about making YouTube more responsive or more direct response. How are you thinking about the blurring of those lines and what it means for product development long-term? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Eric. I'll take the two. The first on Search. You're right that with Search, we are always trying to anticipate where users -- what the user experience expectations are and trying to meet them there. And increasingly in mobile, people do want immersive, engaging experiences. They want their experiences to be more visual, and that's partly what you saw us announce in our 20th birthday event. And we are excited to move in that direction. And I do think we have a lot of important assets to bring here. YouTube is a big part of what we do. We are investing in image search, and we do have products like Google Maps and Photos, which all add to that visual experience. And as part of doing that, we are investing in our advertising offerings as well. And so over time, we'll adapt that so they go hand-in-hand. But I think it's an important evolution for us. In terms of YouTube, I think it is -- part of what makes YouTube great is I think we can offer different opportunities for advertisers. We've always felt direct response is something that can work well on YouTube, and our instinct is bearing out. And I look at my personal use cases. There are many times now, sometimes instead of search, I actually find something I want to do in YouTube, maybe thinking about going to a place and I research it on YouTube. So I think it offers the same opportunity over time. And from our standpoint, we want to make sure we are evolving the product to bring those opportunities to advertisers. I'm very excited about it. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [5] +-------------------------------------------------------------------------------- + + Sundar, 2 questions for you. First, earlier this month, or it might have been late last month, Sridhar Ramaswamy, your Head of Ads and Commerce, left to go to a VC firm. Betting that wasn't a surprise to you, but I'm just hoping you could shed a little light on sort of succession planning for that important role and whether or not you expect any sort of broad changes to ad product strategy. And then second, just amongst those announcements on the anniversary were the evolution of Feed to Discover. And I recognize that's an evolution of a product, but it does look like you're taking advantage of that long-unused white space on Google.com. And so just love to hear a little bit more, that's sort of a follow-up on Eric's question on the evolution of Search, but how you see that surface, in particular, evolving and particularly the potential for ad monetization over time. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [6] +-------------------------------------------------------------------------------- + + Good. On the first one, look, I mean, we -- one of the things I'm really proud about Google is we have a deep bench of talent and, for example, in the Ads team, almost all of our senior Ads leadership has been here for well over a decade. And so for us, we are fortunate to be able to tap into it. Our Ads leadership comes -- Prabhakar, who has taken over our Ads product and engineering efforts, is someone I worked with for many, many years, and most recently has led our G Suite business, but has done many roles before as a deep computer scientist. And I expect to -- for him to continue our tradition of technical excellence with which he approach our advertising work. Also, I want to mention Philipp and his team, his extraordinary team, who definitely lead many of our initiatives here. And Philipp and, Prabhakar, with them, I think it's in great hands. And I expect a lot of continuity there. On your question on Search and Discover, it's -- in addition to making Search more visual, one of the things we are very, very focused on is not always do users turn to us and actually ask a question. So we feel our job is to be there when users need us, anticipate what they want and, sometimes, proactively meet them. That's where services like Discover really play a role, right? I think -- and we are thinking hard about how we can surface relevant information for our users, stuff they are really looking for, can act on in a way in which it's delightful for them and it's showing up for them when they need it. So I see that as an important evolution of Search as well. And so you're going to see us investing more. Mobile offers us a great opportunity. And if you use it in Pixel 3, that's the latest product in which we bring our vision of how to bring all these products together. And we'll give you a good sense of how we plan to do that over time. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Evercore ISI. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [8] +-------------------------------------------------------------------------------- + + First for Sundar, you spent some time on hardware. You spent time discussing your suite of hardware devices, the Google Assistant, the Pixel. How are you measuring the returns on those investments in hardware, both in the products and on the marketing side here, in a pretty competitive marketplace? What are the milestones for success that we should be looking for on hardware? And then for Ruth, as we start to look ahead to 2019, as you plan for '19, how are you thinking about the relationship between revenue growth and dollars of operating income growth for next year, particularly if the macroeconomic environment were to become, let's say, less of a tailwind to the broader ads environment as it was this year and in prior years? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [9] +-------------------------------------------------------------------------------- + + On hardware, we always want to be at the forefront of computing. And so -- and a lot of times, that involves thinking across the whole stack, bringing together the entire experience in an integrated way for our users. And we genuinely see a very differentiated way to do this. We think our approach of bringing together AI, software and hardware is unique, and we think we can deliver the best-in-class experience. And we are committed to doing it. At the same time, we want to build a great business here as well. So we are investing in the long run because we see it clearly as an important business opportunity for us as well. So both go hand-in-hand. We closely look at metrics. And the metrics, we've been very focused on for the last couple of years. This is our third generation of hardware. It's the first time we actually are doing our products end-to-end, and we've expanded to newer categories. We look at user feedback and reception. We measure NPS scores. And our scores are now reflecting best-in-class in the category. And beyond that, we are looking at how the market adoption is, and we are thoughtfully building a business, but we are committed to building and investing for the long run. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [10] +-------------------------------------------------------------------------------- + + And in terms of how we're thinking about planning, we're in the middle of it now. And many of the questions that have been already asked sort of point to the direction that we feel really good about the underlying strength in the Ads business. As we've talked about on numerous calls, we continue to invest here because we see ongoing opportunities, in particular, as we leverage machine learning to provide better experience for users and for advertisers. And some of the comments that Sundar made about the opportunities that open up with visual search, again, continue to point to the direction of direct response, continue to point to some of the underlying areas in which we're focused. But as we've talked about on prior calls, that's one element of it, and we continue to invest for opportunities that are sizable over the long term. Sundar has already commented on both hardware and Cloud as really important examples. And we think the steps that we're taking, the investments we're making, are -- provide kind of the foundational support for ongoing long-term, sustained growth. And so then we marry that with the second part of your question, which is on how do we think about the pace of investment. As we've said repeatedly, we're very focused on investing for the long term. We're trying to make sure that we prioritize crisply across the opportunity set that we have and we make the right types of trade-offs, but we do remain focused on long-term investing given the scale of the opportunities that we see. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [12] +-------------------------------------------------------------------------------- + + Two questions, please. One, Sundar, could you just update us with your thinking on China, the China market and the extent -- I know Google is already in that market, but the extent to which you want to expand -- reexpand your presence there with Search? And then in terms of Waymo, just a quick question. Commercialization of Waymo, do you know when -- do you have a sense of when you'll have pricing established and you'll have a roughly well-defined and action -- acted-on go-to-market strategy with Waymo? Is that the end of this year, beginning of next year, whenever? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [13] +-------------------------------------------------------------------------------- + + And Mark on China, we obviously -- we deeply care about serving Chinese users. We've been investing for many years, and especially from developing Android. But more recently, we have launched mobile apps such as Google Translate and Files Go and improved our developer tools there. So we are constantly looking for ways by which we can better serve Chinese users. And that's where we are today. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [14] +-------------------------------------------------------------------------------- + + And then, in terms of Waymo, in the third quarter, as I think you know, we extended our Early Rider Program to a larger group, and we moved into very early days of commercialization. So we do now have people paying for rides, and we're also testing pricing models. I think the main point, we've said this repeatedly, is that we are intently focused on safety first and ensuring a great user experience. And so what that means is we're really expanding the program methodically. We're taking an iterative approach as we continue to broaden the geographic footprint. And then on top of that, as we've talked about on prior calls, we've been developing the B2B opportunity. So in Phoenix, as an example, we've been piloting with several partners who are sponsoring a service on behalf of their employees and customers. And again, it's early days, so small revenues. But we're pleased to be testing this out as well and then, on top of that, continuing to explore, applying our technology for logistics and deliveries and for personal use vehicles and for last-mile solutions for cities. So you can see a move in the third quarter. But as we said repeatedly, it's very early days, and we are taking a very deliberate, iterative approach to broadening it out. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [16] +-------------------------------------------------------------------------------- + + I have 2. The first one on map monetization and putting some more ads in the map. Can you just talk about sort of early learnings there? I know you talked about local mobile searches growing quite rapidly in the past. But any early learnings from the monetization, the return that advertisers are getting on that front? And the second one on video games and Project Stream. Could you just talk a little about how you think about the gaming opportunity for Alphabet and what you think are the key factors you need to tackle to really build and scale a direct-to-consumer-facing cloud gaming product? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [17] +-------------------------------------------------------------------------------- + + Look, on the ad stuff, we've had ad formats in Maps for some time, and we are constantly working to make it more useful and relevant. But I wouldn't underestimate the focus we have on local. Just to give you a sense, local mobile searches are growing faster than just mobile searches overall and have increased by almost 50% in the last year. So for us, that's an important focus area, and Maps plays a big role there. So we recently announced local campaigns, which is a new campaign type specifically designed to drive foot traffic to local businesses, right? And it's going to roll out in the coming months. And so that is a big focus. And as you pointed out, we are definitely launching and experimenting with newer ad formats on Maps itself. We have promoted places, which appears on the map itself. Have placed page ads, which appear on Google listings in Maps and Search. But we are definitely in the phase of putting those, testing it out, making sure the user experience works and making sure we can deliver value for advertisers. We are being patient here because the opportunity in local search, it's a big opportunity, and we are focused there. On your second question, look, we today serve our users on gaming across Google Alphabet in many ways, right? Obviously, Google Play does this a lot. It's a big important vertical on YouTube. And so we are -- so we touch with gaming developers across many areas already. And so we are thoughtfully thinking about what more we can do there. And Project Stream, I -- having spent my life on computing, I was blown away by seeing our ability to stream a game which needs real-time interactions, and to be able to do that from the Cloud. And it's one of the most important technological advances I've seen in a while. And so we are going to focus on that and make sure we are making progress there and bring newer experiences for gamers. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And our next question comes from Douglas Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [19] +-------------------------------------------------------------------------------- + + One for Sundar, one for Ruth. Sundar, can you help us better understand how the remedy in Europe will work in terms of licenses and TAC going forward? And what impact do you see that having on financials? And then Ruth, can you just talk about where you are in the hardware replacement cycle in your data centers? Pretty major step-up this year just given that large ramp. How are you thinking about the trajectory into '19? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [20] +-------------------------------------------------------------------------------- + + Thanks, Doug. On Europe, I mean, it's early to say. We'll begin on implementing the remedy in the next few weeks. But in all these cases, we always -- we're focused on complying with the commission's directive, and we want to make sure that the transition for both our users and our OEM partners is as smooth as possible. In this case, you're dealing with life cycles for mobile phones. So changes is going to take some time to reach users. And it's difficult to predict how the licensing model will be adopted. But our products are very popular with users across platforms. And so it's early to say, but we are focused on doing the right thing there. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + And then in terms of technical infrastructure and our CapEx. As we talked about last quarter, CapEx reflects our view of the growing opportunity set in our core Ads and Search businesses as well as the longer-term opportunities in newer businesses, in particular, to support Cloud and then very importantly, as we've talked about, machine learning across Alphabet. And we're particularly excited about the opportunity with machine learning because it opens up more services and products for users and for advertisers and for enterprise customers. And so given our view about the long-term potential with these opportunities, we're very focused on ensuring that we have the needed compute capacity to support growth. And that's what you're really seeing with the uptick in investment. To give you a bit of a breakdown, the largest component continues to be machines. But relative to last year, it's important to note that data center construction is an increasing percentage of our CapEx investment. And so we're now in various stages of developing more than 20 data center sites globally. We're also investing in network infrastructure, such as undersea cable, so we can deliver speed and quality. So again, this really goes to our view of the opportunity set. Having said, we do remain very focused on optimizing the use of CapEx and also on compute efficiency. We're very mindful of the fact that our decisions here on CapEx don't just result in CapEx spend, but also translate into higher depreciation expenses, and that goes both to cost of sales and OpEx. So very careful about how we're using it but want to make sure that we've built for the requirements that we have. And as much as you asked about technical infrastructure, just a quick note that our facility spend, namely real estate, was more muted this quarter, and it was primarily just the ongoing work on our ground-up development. So you're primarily seeing what's going on, on technical infrastructure here. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [23] +-------------------------------------------------------------------------------- + + Two questions, Ruth. So you guys posted pretty solid growth all around. But if we look at some of the international markets, each geography had a tougher comp and decelerated a little bit on a currency-neutral basis. So I guess, stepping back high level, the growth rates are solid. But can you give us any color on the overall macro picture here? I think we're getting mixed feedback from different companies across different sectors. So any high-level comments would be helpful on just the ad market, given that you're close to 20% of global advertising ex China. And then, Sundar, a question on, I guess, Pixel and just the overall advancement you're seeing in smartphone devices. So as you guys roll out more products like Lens and Gboard and some of these other utilities on top of your 1 billion-plus apps like Search and YouTube, is there any way to parse out what the overall engagement looks like in markets like the U.S. and Western Europe when the phones are improving their functionality and you keep adding these additional utilities? Is core volume going up on a per-user basis? Any color there will be helpful. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + So in terms of your first question, we actually felt pretty good about the strength globally, which I noted in the opening comments across the board, 20% growth in the U.S. on a $15 billion base. As Sundar noted what's going on in APAC, 30% year-on-year growth, it's now over a $5 billion revenue business, and we've had sustained quarter after quarter growth at this kind of 30%-ish area, feel really good about that. By country, it really does reflect broad-based strength. As you said, we're very focused on the region and we're delivering terrific products and experiences in rapidly growing markets. You see the same thing in Other Americas, neutralizing for currency movements, 28% year-on-year growth. So we're really proud of what the teams are doing around the globe. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [25] +-------------------------------------------------------------------------------- + + And on your second question, one of the things we clearly see when we make a hardware product like Pixel, in which all the tools and the utilities we build are conveniently there, integrated and the experience is great, we definitely see users engaging more. And so we see an opportunity. And that's one of the bigger reasons why we do hardware as well, to show that end-to-end experience, both for our ecosystem as well as for us. It helps us give users a much deeper engaged experience as well. And when you look at all our products, we see that. And so we do see that as an opportunity. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + And our next question comes from Michael Nathanson of MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + I have 2 for Sundar, kind of the same theme. One on the Pixel 3. The marketing message is clear. The product looks great. But I wonder when you look at to date, the success of ramping the product, what's been the gating factor? Has it been the carriers? Has it been the price? And when we look at the factors for why it hasn't scaled as much as the product should have scaled, what are the factors? And then on Verily, you called out some deals with kind of the big pharmaceutical companies this quarter. But again there, I wonder, who's your most natural partnership? Is it hospitals, insurance, governments? So when we think about the big opportunity, where's the most natural fit to drive Verily going forward? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [28] +-------------------------------------------------------------------------------- + + On Pixel. Look, first of all, part of the big thing is this is our third generation of hardware. Each generation, first of all, we've been scaling up the product in terms of even the number of units we can make and so on. So we -- if you remember the first couple of generations, we were struggling to meet the early demand we saw. This is the first year we have done it end-to-end, and we are ramping up from there. And so each year, when I look at all the metrics, be it NPS or be it our sales, be it our revenues, et cetera, everything is progressing well. But there are -- you're right, the gating factors to ramp this up, first of all, is to be able to build the supply we need. And second is go-to-market, getting ourselves in as many locations in retail as possible, in as many countries as possible, with as many carrier certifications as possible. So in each of those dimensions, we are making progress as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + In terms of Verily, what we've talked about there is they have partnered with a whole host of leading pharmaceutical companies focusing on specific diseases, whether it's diabetic retinopathy or across the board for neurological diseases. I announced a couple of new partnerships, the ResMed arrangement as well as Gilead. And that's what they tend to do. They partner with best-in-class to focus on specific areas where working with the pharmaceutical companies, they can -- and the technology we have and benefiting from machine learning, we can really move from reactive to proactive care. That's the Verily focus. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + The next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [31] +-------------------------------------------------------------------------------- + + I just wanted to focus on Cloud a little bit more. Sundar, you gave some good color in your prepared remarks. But I'm wondering if you could share with us any update maybe on the partner momentum and direct sales momentum you're seeing in the market, how you've seen that change. And also if you can highlight, if you've noticed that there's been noticeable changes in win rates over the last year as the product continues to mature. And you also, in the beginning of the year and exiting Q4, you would give us some high-level growth commentary about GCP, and I'm just wondering if you have anything else you could share. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [32] +-------------------------------------------------------------------------------- + + Thanks, Heather. Look, overall, I mean, it's now -- now we've been doing this seriously, the next level, for 3 years. And we are definitely seeing strong indicators that are -- the investment in product is clearly beginning to work. Our value proposition does come through in many competitive situations. I've seen many important wins in what seem like very, very competitive situations. I also don't -- from the way we see it, it doesn't look like a zero-sum game. As you know, we're addressing a large market opportunity here. It seems like very early days. And more importantly, the general sense I get is we are very aligned with where the market is headed in the long run. And this notion of supporting open architecture so that enterprises don't feel locked in and allowing for a multi-cloud environment to develop, that's the direction we are betting on, and there are indications that the market is headed in that direction as well. So that gives us a lot of comfort -- that leaves us -- that gives us a lot of comfort as well. And on the go-to-market side, we have really ramped up both in terms of our investments, our direct investments, but also our partnership strategy is beginning to work. And when I look at the pipeline ahead, we are clearly seeing momentum there as well. In this business, obviously, the enterprise business plays in the way in which you do you have wins, but those accounts turn into larger revenue deals over time. And so it's very clear to us that we are laying the foundation, and we are getting the strong early momentum. And that's the big reason why we are investing in a strong way in the area. And over time, we'll obviously share more here as well. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [33] +-------------------------------------------------------------------------------- + + And can I just ask one follow-up, if possible? I was just wondering, if you look at Microsoft, they have an on-premise and Cloud strategy. If you look at Amazon, what they're doing with AWS and VMware, they're kind of doing a similar strategy. Do you think there's a requirement for you to also have an on-premise strategy to solve this hybrid world as long as it's hybrid for? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [34] +-------------------------------------------------------------------------------- + + We are thoughtfully looking at it. I mean, we are increasingly working with partners like, for example, our partnership from SAP or Pivotal, VMware. These are all on hybrid cloud solutions. And so we are thinking about how to do that better. And our overall approach to cloud hybrid modernization, I think, is the right long-term direction. And so we are doing that. There are many, many situations we are in where on-prem is a big requirement for customers. But with our partnership approach, we've been able to address the needs well. So I don't see that as gating issue for us. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill of Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [36] +-------------------------------------------------------------------------------- + + Ruth, I just wanted to see if you could quantify the FX headwind. I think it was a negative 1% for Q3. And in Q4, do you anticipate that to be similar or a little worse? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- + + I will let you forecast the dollar. As you noted, it was a point here, went from a tailwind in the second quarter to a 1 point drag here going forward. But we called out the -- and we'll have more in the Q, but noted the impact, for example, of pretty big delta between our reported and fixed in Other Americas, 19% to 28% growth, and that was really what was going on with the Brazilian real and the Argentine peso. We saw some movements in other currencies around the globe. But you can see that, which is why we broke out the geography, the way we've done it a number of quarters ago to try and give you -- help give a better sense of the types of headwinds, and I'll let you forecast the dollar. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [38] +-------------------------------------------------------------------------------- + + Okay, we look forward to that. Real quick just on EMEA, you were flat on your constant currency growth, 19%, 19% the last 2 quarters despite with GDPR. So I believe that would suggest that you're probably not seeing as big a headwind, perhaps, as maybe some expected. Could you just talk to the European business and what you're seeing there? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [39] +-------------------------------------------------------------------------------- + + Look, I mean, specifically, I think your question is around GDPR and so on. First of all, I mean, we've always been, as a company, very, very focused on user privacy and security. And so in some ways, we were very early on engaged on GDPR. And we worked very hard to make sure our products are ready and in compliance. We've generally always approached our products with a strong privacy lens for our users. So -- and I think that helps us work through these changes because I don't think they are at odds with what we are trying to accomplish. I think GDPR is a very good and comprehensive set of regulations. And so I think it's been good to see a smooth transition on our products and for our users. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + And we're continuing to invest significantly in Europe because we see the opportunity across Europe, and are investing in the communities in which we're working. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Justin Post of Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [42] +-------------------------------------------------------------------------------- + + One quick one for Ruth. People are really asking about Amazon. Just wondering if your e-commerce vertical, was there any difference versus your other verticals in the quarter? Anything to call out there? And then, secondly, Sundar, a lot of interesting things going on with YouTube and Waymo and Cloud and other areas. As you look out 2 or 3 years, do you think any of these businesses could really make a financial positive difference on the bottom line for overall Google? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [43] +-------------------------------------------------------------------------------- + + Look, I mean, I think on the first thing on e-commerce, maybe -- really, people -- we do see a lot of activity in the vertical on our products, and we see strong growth there as well. We see it as an important use case and that's why we are investing a lot. If you look at our recent work with Shopping Actions, that's an example of the kind of work we are doing there. And when we do those things, we clearly see users respond. Like, for example, on Shopping Actions, I think we just recently had partnerships with Best Buy and Nike and Sephora, I mentioned it earlier. So we are continuing to invest there, and we are also driving strong partnerships with the retail sector, both in terms of our shopping experiences as well as through Cloud. And I think that continues to be a big opportunity. And on your broader question, look, the reason we are investing across Google and Alphabet in a set of areas is because, as a company, over the past 20 years, we have developed deep capabilities in technology, in computer science and especially with machine learning and AI. And we see an opportunity to apply that across a set of important areas. There are a lot of opportunities ahead of us. We are pretty disciplined about where we're focused on. And we are focused on real large opportunities. And when we mention areas like YouTube and Waymo and Cloud and hardware, they all fit that category. But we take a very long-term view. And we want to invest to get the user experience right. And we are pretty confident that when we do that, the value will follow. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [45] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our fourth quarter call. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2019-Apr-29-GOOGL.txt b/Transcripts/GOOGL/2019-Apr-29-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..66f902b41f727e3edd3973744e8de4a1f0076f05 --- /dev/null +++ b/Transcripts/GOOGL/2019-Apr-29-GOOGL.txt @@ -0,0 +1,425 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Alphabet Inc Earnings Call +APRIL 29, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Google LLC - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet First Quarter 2019 Earnings Call. (Operator Instructions) I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's first Quarter 2019 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward looking, and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. +For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And now I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen. In the first quarter, total revenues of $36.3 billion were up 17% year-on-year and up 19% in constant currency following a strong 2018. Once again, our results were driven by ongoing strength in mobile search along with important contributions from YouTube followed by Cloud. +For today's call, I will begin with a review of results for the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. I will then review results for Google followed by Other Bets and will include with our outlook. Sundar will then discuss business and product highlights, after which we will take your questions. Let me start with a summary of Alphabet's consolidated financial performance for the quarter. +Our total revenues of $36.3 billion reflect a negative currency impact year-over-year of $1.2 billion or $1 billion after the impact of our hedging program. With respect to Alphabet revenues by geography, U.S. revenues were $16.5 billion, up 17% year-over-year. EMEA revenues were $11.8 billion, up 13% year-over-year and up 16% in constant currency, reflecting weakening of the euro and the British pound. APAC revenues were $6.1 billion, up 27% versus last year and up 31% in constant currency, reflecting primarily the weakness of the Australian dollar and the Indian rupee. Other Americas revenues were $1.9 billion, up 10% year-over-year and up 21% in constant currency, reflecting primarily the weakening of the Brazilian real and Argentine peso. +Turning to profitability. In our earnings press release, we provide a table to highlight the impact of the European Commission fine on operating come, net income and EPS results in the first quarter. I will comment on results both with and without the impact of the fine as I review the results. +On a consolidated basis, total cost of revenues including TAC, which I will discuss in the Google segment results, was $16 billion, up 19% year-on-year. Other cost of revenues on a consolidated basis was $9.2 billion, up 27% year-over-year primarily driven by Google-related expenses. The biggest contributor was costs associated with our data centers and other operations, including depreciation, followed by content acquisition costs primarily for YouTube and mostly for our advertising-supported content but also for our newer subscription businesses, YouTube Premium and YouTube TV, which have higher CAC as a percentage of revenues. +Operating expenses, including the impact of the EC fine, were $13.7 billion. Excluding the impact of the fine, operating expenses were $12 billion, up 20% year-over-year. The biggest increase was in R&D expenses with headcount growth in Cloud as the largest driver. Growth in sales and marketing expenses primarily reflects additions to headcount. Growth in G&A expenses is primarily due to legal matters, including the effect of a legal settlement gain recorded in the first quarter of 2018. +Stock-based compensation totaled $2.8 billion. Headcount at the end of the quarter was 103,459, up 4,688 from last quarter. Consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were in Cloud for both technical and sales roles. +Operating income was $6.6 billion. Excluding the impact of the EC fine, operating income was $8.3 billion, up 9% versus last year for an operating margin of 23%. Other income and expense was $1.5 billion. As I trust most of you are aware, in 2018, this line item was meaningfully elevated because of the introduction of a new accounting standard that requires recognition of unrealized gains and losses on equity securities. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 18.3% for the first quarter reflecting a sizable impact from the nondeductibility of the EC fine. Net income was $6.7 billion, and earnings per diluted share were $9.50. Excluding the impact of the EC fine, net income was $8.3 billion and earnings per diluted share were $11.90. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $4.6 billion, which I will discuss in the Google segment results. Operating cash flow was $12 billion with free cash flow of $7.4 billion. We ended the quarter with cash and marketable securities of approximately $113 billion. +Let me now turn to our segment financial results. Starting with the Google segment. Revenues were $36.2 billion, up 17% year-over-year. In terms of the revenue detail, Google Sites revenues were $25.7 billion in the quarter, up 17% year-over-year. In terms of dollar growth, results were led again by mobile search with a strong contribution from YouTube followed by desktop search. +Network revenues were $5 billion, up 8% year-on-year, continuing to reflect the performance of the primary drivers of growth, AdMob, followed by Google Ad Manager. Other revenues for Google were $5.4 billion, up 25% year-over-year, fueled by Cloud and Play and partially offset by Hardware. +Google Cloud Platform remains one of the fastest growing businesses in Alphabet with strong customer momentum reflected in particular in demand for our compute and data analytics products. Strong growth in Play was driven particularly by performance in APAC. Hardware results reflect lower year-on-year sales of Pixel reflecting in part heavy promotional activity industry-wide given some of the recent pressures in the premium smartphone market. We provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. +Total traffic acquisition costs were $6.9 billion or 22% of total advertising revenues and up 9% year-over-year. Total TAC, as a percentage of total advertising revenues, was down year-over-year reflecting a favorable revenue mix shift from network to sites as well as a decrease in the network TAC rate. The sites TAC rate was flat year-over-year as the impact of the ongoing shift to mobile, which carries higher TAC, was offset by the growth in TAC free sites revenue primarily from YouTube. In Q1, the network TAC rate declined year-on-year primarily due to a favorable product mix shift. +Google stock-based compensation totaled $2.6 billion for the quarter, up 13% year-over-year. Operating income was $9.3 billion, up 11% versus last year, and the operating margin was 25.8%. Accrued CapEx for the quarter was $4.5 billion, reflecting investments in data centers, servers and office facilities. +Let me now turn to and talk about Other Bets. Revenues were $170 million primarily generated by Fiber and Verily. Operating loss was $868 million. Other Bets accrued CapEx was $59 million. Key recent accomplishments include: Waymo recently announced that it will expand its activities in Michigan opening a facility in Detroit that will be the first factory dedicated to the production of L4 autonomous vehicles. Last week, there were exciting announcements from 2 additional Other Bets that were originally incubated within X. Loon announced a long-term strategic relationship to advance the use of high-altitude vehicles to deliver connectivity with SoftBank's telecoms growth, HAPSMobile, which will invest $125 million in Loon. Wing became the first drone delivery company to receive air carrier certification from the FAA, an important step toward beginning a commercial service delivering goods from local businesses to homes in the U.S. +Let me close with some observations on our priorities and longer-term outlook. As we highlighted on our last call, there was a significant swing year-over-year in the impact of currency movements on our results this quarter from a big tailwind in the first quarter of 2018 to a headwind in 2019. These affect both revenues and operating income given the majority of our expenses are in the U.S. Based on the continued strengthening of the U.S. dollar relative to key currencies, we expect a continued headwind to our revenues and operating income again in the second quarter. +In terms of our key revenue drivers, with respect to Sites revenues as we indicated last quarter, the timing of product changes in ads at times can have an impact on year-on-year growth rates. We will continue to make changes with a focus on the long-term best interest of users and advertisers. We remain confident about the sizable opportunity ahead to improve the advertiser and user experience through our ongoing commitment to product innovation, in particular by leveraging machine learning across our ads, products and properties. +Turning to the key drivers of growth in other revenues. We are pleased with the momentum of Google Cloud Platform with balanced growth of both new customers and expansion within existing customers driving revenue growth. With respect to Hardware results, while the first quarter results reflect pressures in the premium smartphone industry, we are pleased with the ongoing momentum for assistant-enabled Home devices, particularly the Home Hub and Mini devices, and look forward to our May 7 announcement at I/O from the Hardware team. +Turning to profitability. With regard to Google OpEx, the first quarter results once again reflect our ongoing commitment to investing for the long term. You can see that in R&D, where we continue to invest in technical talent for priority areas like cloud, search and machine learning. +In terms of sales and marketing, the pace of investment in Q1 reflected a timing shift in spend, and we expect these expenses to pick up in the second quarter. In Other Bets OpEx, we are still early in the life of these companies and do plan to continue to invest meaningfully for the long-term opportunity. +With respect to CapEx, the year-on-year decline reflects the purchase of a building in New York in the first quarter of 2018. As discussed on our call last quarter, while we anticipate that our full year CapEx investments will exceed those in 2018, the growth in investments should be at a meaningfully lower rate than in 2018. We continue to expect a sizable investment in both compute requirements to support long-term growth as well as in office facilities. +In conclusion, we feel confident about the opportunities ahead, and we continue to invest thoughtfully for the long term. I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [4] +-------------------------------------------------------------------------------- + + Thanks, Ruth. It's great to be here with you all. Q1 was a very busy quarter at Google, and it's only going to get busier. Later this week, we'll host YouTube's upfront event, Brandcast, followed by our annual developer conference, Google I/O, next week and our advertising summit, Google Marketing Live, later in the month. You'll hear a lot more from each of these teams throughout May, so I hope you can join us. +We've always been a company that's focused on the long term willing to make investments that will help our businesses and our customers' businesses succeed as technology continues to evolve. You saw this in the transition to mobile computing years ago, and we are seeing that today in the shift to AI. We feel very positive about the enormous opportunities ahead involving Search and Assistant, capturing new ad budgets, cloud computing, AI and other areas. +What gives us these opportunities is Google's position to help people, businesses and society in countless ways through our products. Today, I will start by talking about our core mission of making information universally accessible and useful. Then, I'll provide an update on our computing video and advertising platforms. And finally, I'll discuss our Hardware and Cloud efforts. +First, an update in our mission to make information accessible and useful is helping people every day. A big focus for us is building products that are designed to help people in their day-to-day lives. Our Duplex technology within Google Assistant can now help you easily book a table at your favorite restaurant on all Android and iOS devices in 44 U.S. states. Just tell the Assistant where you want to go and when, and it'll do the rest. We've also begun testing AR walking navigation in Google Maps, which uses augmented reality and your phone's camera to show you where you are relative to the surroundings as you're walking. +Just last week, we announced an improved job search experience in the U.S. that helps people easily discover quality remote jobs allowing them to work right from home. As part of our Google News initiative, we kicked off the Local Experiments Project working with local publishers to uncover new approaches to their business models and operations, so they can continue bringing great local content to their readers. +AI is now spurring a new era of computing, which is more predictive and more assistive. We are committed to doing deep research and working to advance this space in a responsible way. AI is deeply embedded in our products from Search to Photos to Google Home, and we are also expanding others' ability to build on our advancements. +Recently at TensorFlow's Annual Developer Summit, we announced TensorFlow 2.0, making it easier than ever to build and use ML through improvements like TensorFlow Privacy, which helps train models with differential privacy, meaning that users' data is better protected. +Now on to our computing, video on advertising platforms. There's tremendous momentum across the Android ecosystem and our other computing platforms as we head into Google I/O. In the first quarter, we released the beta of Android Q, which brings added privacy protections, new tools for developers to engage users and more. Android Go edition, an optimized version of Android tailored for smartphones with 1 gig or less, delivers a powerful fast and secure experience specifically optimized for entry-level smartphones. Today, roughly 70% of entry-level Android devices are now activating with Go like Samsung's J2 Core. +We are seeing great momentum in Android Auto as well. At the Chicago Auto Show, Toyota announced that it'll include Android Auto in upcoming vehicles starting in 2020. That means all of the top 10 carmakers now support Android Auto. +And in Google Play, first-time buyers grew by nearly 50% year-over-year. I'm very pleased with how these platforms are growing and creating amazing experiences for users, developers and partners. Our newest platform, Stadia, which revolutionizes the way gamers access and play their favorite games and brings together the best of Google's infrastructure and open ecosystem approach. With Stadia, you'll be able to play advanced AAA games on any type of screen instantly without ever needing to download the game or install updates. The reception from gamers in the industry has been incredible, and we look forward to sharing more when it launches later this year. +Next, our video platform, YouTube. YouTube's top priority is responsibility. As one example, earlier this year, YouTube announced changes that reduce recommendations of content that comes close to violating our guidelines or that misinforms in harmful ways. There are a lot more improvements which we will be rolling out in the next few weeks, and our work is ongoing. +We have also expanded the content offering, availability and the functionality on some of our newer YouTube experiences. YouTube TV is now available nationwide with many new networks and channels added in Q1. YouTube Music and YouTube Premium are now available in 43 countries, up from 5 markets at the start of 2018. In mid-March, we launched YouTube Music in India, one of YouTube's fastest growing markets. Since launch, the YouTube Music app has been downloaded more than 15 million times in the country. +YouTube's ad business for both brand and direct response campaigns continues to grow and support our creators. In Q1, we again saw how YouTube is the go-to destination for watching the Super Bowl ads before, during and after the big game. This year, viewership of Super Bowl ads on YouTube during the game rose by nearly 60%. More broadly, across our ads business, our advertising product team, led by Prabhakar, continues to build new products for marketers with more than 100 enhancements introduced every quarter. We do rigorous testing on each of these improvements to ensure that we are creating the best experience for users and advertisers. Our focus has always been on investing for the long term rather than managing for results quarter-to-quarter. +I feel really positive about the opportunities ahead and the innovations that we are bringing to marketers, many of which are powered by machine learning. Philipp and our business teams have done a great job helping advertisers take full advantage of these new capabilities. For instance, more than 70% of our advertisers are already using automated bid strategies in Google Ads, and these ML powered technologies help customers get better results for their investments. +In Q1, we began testing new shoppable ad units in Google Images, so brands can highlight multiple products available for sale in sponsored image results. You've also seen us make it easier for people to buy products and take action when shopping on Google Assistant and Search with a universal cart on mobile, desktop and Google Home devices. Since we launched these capabilities a year ago, the number of participating merchants has increased sevenfold. +Lastly, at the Game Developers Conference, we introduced a host of new advertising solutions for developers like App Campaigns for Engagement, which help developers reengage players with relevant ads across Google's properties. +Next, I'll give an update on our Hardware and Cloud efforts. First, Hardware. I'm very proud that in only a few short years, we have built a strong foundation in Hardware. For example, demand for our Google Home family of products remains strong, especially the Home Mini and Home Hub. The breadth and depth of our product lines across Pixel, Nest and Home is amazing, and you will see us continue to develop this incredible lineup. The team has also done a lot of work to scale our operations, and we'll continue to optimize our distribution, branding and points of presence. +We also announced a new campus and engineering hub in Taiwan largely to support our Hardware efforts. Not only are features like Night Sight and Pixel winning industry awards, but Net Promoter Scores tell us that many people who use our Hardware products truly love them, which is particularly important as we move into this new era of computing. We are still early in our Hardware journey, and when I look ahead at the portfolio that we have created across Pixel, Home and Nest, I feel really good about the range of products that we have. +And finally, our growing Cloud business. Thomas has really hit the ground running. Just a few weeks ago, I was on stage with him at our Cloud Next event, where we hosted a sold-out crowd of more than 30,000 attendees. As I said at Next, moving to the Cloud should be simple and seamless. I was excited to announce Anthos, which gives customers a very elegant solution to both hybrid Cloud and multicloud in a single technology stack. +The early feedback from analysts, customers and partners has been really great. We also announced innovations across many of our other products that enable developers to build and deploy AI, help enterprises to better secure their data, allow Android users to leverage their phones as a security key and much more. We are also deeply committed to becoming the most customer-centric cloud provider for enterprise customers and making it easier for companies to do business with us thanks to new contracting, pricing and more. +Today, 9 of the world's 10 largest media companies, 7 of the 10 largest retailers and more than half of the 10 largest companies in manufacturing, financial services, communications and software use Google Cloud. Some of the companies that we announced at Next included the American Cancer Society and McKesson in health care, media and entertainment companies like USA TODAY and Viacom, consumer packaged goods brands like Unilever, manufacturing and industrial companies like Samsung and UPS and public sector organizations like Australia Post. +Finally, to support our customers' growth, we also announced the addition of 2 new Cloud regions in Seoul and Salt Lake City, which we plan to open in 2020. These new Cloud regions will build on our current footprint of 19 Cloud regions and 58 data centers around the world. +20 years in and over 100,000 employees strong, I'm incredibly proud of the work that our teams at Google do every day. We have so many bright opportunities ahead, and seizing those opportunities starts with our investment in the communities where we operate around the world and right here at home. In the U.S., not only are we expanding our workforce across the country, but we are helping people in every state gain the digital skills they need to succeed in today's economy. +In fact, just 1 year after kicking off our collaboration with Goodwill, 0.25 million Americans have learned new digital skills and 27,000 have found a job. We also feel a deep responsibility to make sure that we -- that as we grow our business, we are doing it with minimal impact on the environment. Today, a Google data center uses 50% less energy than a typical data center while delivering 7x more computing power than we did 5 years ago. +Since 2017, we have matched 100% of the electricity consumption of our operations with purchases of renewable energy, and I'm proud that Google is the world's largest corporate buyer of renewable energy. I've never been more excited about Google and where we are headed. I want to thank every Googler around the world for joining us on that journey. +With that, I'll hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + Thank you, Sundar. And we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe a couple of parts on the revenue performance in the quarter. Ruth, you'd called out potential volatility on the Q4 earnings call. Wanted to understand a little bit about what you were calling out in Q4 and how that might have manifested itself in Q1 on the product side of the equation, so we could just better understand how much of it was isolated to Q1 or it might be a headwind as we move through the year. And as you look at the individual performance of the ad divisions inside Sites, desktop, mobile search, YouTube, it seems like you were still calling out strength in mobile search and YouTube. So could it be desktop search where we actually saw some weakness in the quarter? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure. Thanks, Eric. So I tried to step back and start at the highest level. Obviously, on a reported GAAP basis, revenue growth in Q1 reflects the FX headwind that we talked about in contrast to the tailwind last year. And as you know well, we don't report Sites revenues on a fixed FX basis, but the delta between fixed and floating growth rates at the Alphabet level is a good proxy for the effect on Sites revenue. Beyond that, I tried to draw out that the year-on-year growth rate in part reflects our strong 2018. And then more to your question, as we indicated last quarter, the other item is the timing of product changes in ads can impact year-on-year growth rates. And we make changes with a focus on the best interest of users and advertisers. +Over the long term, we do not manage by quarter, so we are introducing enhancements only after product testing. And that was -- it's sort of the overarching color that I was trying to give you. And in terms of desktop, it was a modest contributor to revenue growth. It does remain an important form factor for certain more complex tasks such as planning vacations or assessing insurance options. And as we've talked about on prior calls, we continue to see the ongoing importance of desktop for many users and many tasks, notwithstanding the growing utility of mobile. So I led with the items that are really driving the growth, but that was a bit more color on desktop for you. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + So 2 questions. Just following up on Eric's on the revenue growth. Ruth, can you just give us a little bit more detail on the paid click growth, the decel that we saw to 39% from the 50s and 60s last year. So that's just a comp issue or something more specific? And then just on the spending side, wanted to understand a little more just how you're thinking about spending relative to 3 months ago. I know you talked about both CapEx moderating and also headcount moderating 3 months ago. Just curious at least if headcount is still in that camp for your thinking, just given that it seems like there's a pretty big ramp expected under the new Cloud CEO. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Okay. So starting with clicks and CPCs. As we've discussed on prior calls, the biggest driver affecting both CPCs and click trends is YouTube engagement ads with YouTube clicks representing the vast majority of total clicks. And so while YouTube clicks continued to grow at a substantial pace in the first quarter, the rate of YouTube click growth decelerated versus what was a strong Q1 last year, reflecting changes that we made in early 2018, which we believe are overall additive to the user and advertiser experience. +And then in terms of your 2 spending -- the investment questions. In terms of headcount, first, we do continue to expect the growth rate to moderate slightly in 2019 from the year-on-year growth in 2018. And as I indicated in opening comments, we are continuing to invest in technical talent for priority areas like Cloud, search and ML. And so Cloud has been and continues to be the primary area of headcount growth and as Thomas indicated as well and I think Sundar did as well. +In terms of CapEx, just to fill out the last part, I think, of your question, relative to my comments last quarter that we expect the full year 2019 growth rate for CapEx to moderate quite significantly versus the year-on-year growth in 2018, there's no change in our expectation for the year on that point either. The first quarter last year obviously included a sizable real estate acquisition in New York. But overall, we continue to invest meaningfully in our technical infrastructure given our outlook for compute requirements to support long-term growth. Technical infrastructure is the biggest driver of CapEx growth, but we do also continue to invest in office facilities. In fact, as we announced in the first quarter, we expect CapEx of over $13 billion in 2019 just in the U.S. in data center construction and offices with major expansions in 14 states. And more generally, while we're investing aggressively to support our outlook for compute requirements, we're also very focused on improving efficiency with our technical infrastructure. And you can see that through our innovations in things like custom server hardware and TPUs, which can be more cost effective especially for machine learning workloads. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [8] +-------------------------------------------------------------------------------- + + Sundar, I had a question about Cloud. You guys are obviously talking more and more about it. But when do you think you're going to be in a position to share revenue figures or even growth rates similar to what the others have been sharing for quite some time? And then, I guess, a couple follow-ups to that are what would you say the biggest competitive differentiators are of GCP. And what also -- what changes has Thomas implemented for 2019? What are any of the big changes he's focused on that maybe are different than what you were doing before? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [9] +-------------------------------------------------------------------------------- + + Thanks, Heather. Good question. Overall, I would say I think you saw it -- saw the momentum coming out of Next. And I would say at a high level, the key differentiators, which we are focused and which we hear from customers too, the 5 key things are security and reliability, being really open about hybrid multi-cloud customers don't want to be locked into any 1 cloud provider. We want to be a platform for open source, and so we're really working well there in enabling options, AI, ML as a capability. And finally, as customers think about digital transformations, we bring all of Google's advances to bear to help them through the journey. +I think I would say, Thomas is really building upon a strong foundation, but we're really accelerating and scaling up go to market both internally and through our channel partners has been a huge focus. I'm incredibly excited that we just announced a couple of weeks ago that [Robbins Linness] joined us to head go-to-market. And just along with Thomas, both of them bring close to 3 decades of serving enterprise customers. And so that reflects the commitment we have. I think we are building a strong business across all our verticals, and we definitely are seeing strong momentum and look forward to being able to share more at the appropriate time. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And our next question comes from Anthony DiClemente of Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [11] +-------------------------------------------------------------------------------- + + I have 2, 1 for Ruth, 1 for Sundar. We noticed that larger than expected slowdown in the properties TAC in the quarter, that includes cost of mobile search, while the other cost of revenues, which includes YouTube content costs, seem to maintain that expected growth rate despite what you said about more moderate turns in Hardware. So just wondering if that's a wise way to infer anything about the relative performance of mobile search revenue versus YouTube from those cost lines in the quarter. And then on Waymo, maybe for Sundar. We're hearing more and more about collaborations between ride-sharing networks and AV providers. So the idea of mixed fleets or part human, part AV as a means of potential deployment of AV technology, so can you just comment if that mixed fleet approach would be something that you think Waymo would consider versus its own full ride service network? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + So in terms of the Sites TAC rate, a couple of things. We've discussed this previous -- on previous calls. We have expected the year-on-year growth in the TAC rate would begin to slow starting in the second quarter last year. And you saw that through the balance of 2018. And this quarter, the constant TAC rate versus last year reflects ongoing growth in mobile, but it also benefited from growth in YouTube, where the associated content and costs are included in other cost of sales. And so that's the most important thing to point to. The other is --we've previously discussed is TAC as a percentage of revenues is also affected by a number of other factors such as changes in product mix, device mix, partner mix, et cetera. So I'd really point you to the first point there. +And then as it relates to Waymo, I guess a couple of things. We continue to be most focused on the ride-sharing business here. We're pleased with the expansion in the number of Waymo riders that we've added since the last quarter. But as we've talked about on prior calls, we do continue to pursue a number of other opportunities, long-haul trucking, we've talked about, logistics, deliveries, personal use vehicles, last mile solutions for cities and then probably more to your question, licensing our technology. And we did announce in March that we're making one of our 3D LiDAR sensors available to companies outside of the self-driving car service beginning with robotics and physical security, in other words, in -- for warehouse use or for farming. And our view is that, that can provide further operating leverage to our business. So we're actually looking at it in a number of different ways, but the primary focus continues to be on developing the ride-hailing business. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + And your next question comes from Stephen Ju of Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [14] +-------------------------------------------------------------------------------- + + So Sundar, I wanted to follow up on your Stadia commentary. How are your conversations with some of the larger PC and console publishers going right now? You obviously offered them additional distribution outlet with billions of users, which is something that they probably didn't have before. But what is the pushback that you might be getting from publishers, if any? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [15] +-------------------------------------------------------------------------------- + + I think their genuinely -- the main thing we see, genuine excitement because I think they see the opportunity for a shift, a point of inflection, but they realize the technical challenge of pulling something like this off, and so -- but once they get their hands on with the technology and then they see the experience, I think, it really wins people over. And so we are having conversations across the board, and I think people are definitely engaging in a very committed way, and they're investing in it. And so it's up to us to bring it all together and have a [coupling] service later this year, and that's what the team is, heads down, working on. But I think not pushback per se, but they want to see our commitment, which is what we demonstrate. And they are working hard to make the investments on their side. And so it's a big joint effort, and it's working well. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [17] +-------------------------------------------------------------------------------- + + I have 2. The first one, let's go back to the product changes. Ruth, any more color on sort of which products or regions are most impacted by these changes? And just so we can understand a little bit, can you just help us with the key user experience you're trying to solve for and sort of the message to your advertisers who may be spending -- who may be growing their spend less now, but why that's going to be positive for the long term? And then, Sundar, just go to your comments about YouTube. You mentioned more potential changes coming on YouTube in the next couple of weeks. Can you just talk to us about that a little bit? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [18] +-------------------------------------------------------------------------------- + + Maybe I'll start with the YouTube comments. I talked about, in the area of content responsibility, we are definitely focused on making sure we are constantly improving how we are handling both in terms of reducing the content that shouldn't be there on the platform and then more importantly, making sure, when we recommend content, that we are recommending high-quality content as well as reducing harmful content or low-quality content being recommended. I think we had a set of launch, which we have rolled out, but I think there are more launches coming, which will constantly improve what you see in YouTube and continues to be the most important area of focus for them. +On the first question in terms of products, I think we are -- I presume when you say back to product changes, I think you're talking about the advertising experience. I think the main thing I would say is, I mean, we don't -- I think we have a long, long-term way of thinking about where we want to go and we have a disciplined framework by which we think and evolve our products. We don't necessarily look at it from a quarter-on-quarter basis, though we obviously have had consistent performances. We approach our work differently, and so you are going to have quarter-to-quarter variations once in a while. But we remain confident about the opportunities we see. And I'm looking ahead to that, and we are focused on that. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [20] +-------------------------------------------------------------------------------- + + Sundar, you'd reminded us how April and May are pretty big months for the company with a series of your large annual events. And of course, each of them -- each of those businesses have their own goals and targets. But we also hear -- continue to hear more about your teams working together, for example, a large cloud engagement leading to higher ad spending from an enterprise. Can you talk to us just a little bit about how you balance having your leaders grow their own businesses with also incentivizing them to work together? And then second and kind of completely differently, would love to just hear your updated views on data collection and use. I'm sure you've continued to have some dialogue with politicians and regulators. We've seen some reports on more potential changes in Chrome or within the advertising platform. Would love to hear how maybe your latest discussions are in view -- are informing both the near- and long-term view on policies with regards to data collection and use. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [21] +-------------------------------------------------------------------------------- + + Thanks. And I mean you're right. These are a couple of very busy months, and it's particularly busy leading up to I/O. And I would say in terms of how we work together, first of all, as a company, I think we take our OKR process extraordinarily serious in a very committed way. And we do write cross-company OKRs, and it really reinforces ways by which different groups can work together. And we measure them and we will hold people accountable to that. That's an important part of how we get at businesses, both while they focus on their product areas, their business, they need to work together. Second, as a leadership attribute, it's something that's really important to me. And so it's something that the leaders across the table share that goal, and I think it's largely cultural as well. +Vis-à-vis, privacy, and it's actually one of our most important areas. As a company, we've always tried to stay a step ahead. User expectations around privacy are constantly evolving, and we stretch ourselves to meet them. And as part of that through this year, we are continuing to do a lot of work just with the overall goal of making sure privacy works for everyone and it's actually simple to use. And as part of that, we'll have more changes through the course of this year, be it Chrome. Chrome is super committed to making sure it's best in class in privacy and security, and we always put user experience first and follow through. +Through all these changes, we need to be mindful of the content ecosystem and the publisher ecosystem. Advertising continues to be an important way by which they create value and they see value. And so we are very thoughtful about how we approach our work. +And there's been a lot of interest across the board. I think we early on engaged with GDPR, they are big supporters of it in terms of being constructive and working early to get ready. I think it's important U.S. supports -- has a clear framework on a federal basis for privacy regulation, and it's something we feel is timely as well. And so we have called for it and happy to be thought leaders as well as engage where needed. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian of Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + I have a couple. First one, follow-up on the revenue growth dynamics, specifically the sequential growth trend. I wonder if we should assume now that there's greater seasonality in core search just given the increasing mix of shopping and product ad formats. And Sundar, question on AI and machine learning. Since clearly this remains an area of significant strength for the company, I'm wondering what stage of development you characterize these stools at being today? And whether we should expect the overall pace of advancement from AI to accelerate in terms of products and services? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [24] +-------------------------------------------------------------------------------- + + On the first question around seasonality and stuff, I mean, we -- throughout the course of the year, we always deal with many events, no patterns. There are a few patterns, which are consistent year-on-year, but there are always one-off events, which happen. So there is in-built variation, so, which we work through every quarter, and so I think that's a natural part of what we do. There's definitely seasonality in businesses like Hardware, and that you are right. Commercial behavior has seasonality associated with it. But we do deal a lot with one-off events as well and -- but we always work our way through it. +On machine learning, I do think we are at very early days. I'm excited that, over the last 3 years, taking an AI-first approach, we've really incorporated machine learning core -- in a core way across our product to benefit our users. And that's true for advertising as well. I think we are in early stages of making it easier for businesses to understand what they're looking for and us taking care of more and more work, and we are doing it across the board. But there is a lot of headroom here. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post of Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [26] +-------------------------------------------------------------------------------- + + Maybe one for Ruth and one for Sundar. First, Ruth, on mobile search, can you let us know how that did versus your expectations? I know there's a lot of noise from YouTube in that line. But how's mobile search doing? And what are the key drivers now for mobile search? Is it queries? Is it driving higher click-through rates, ad format changes? What are the drivers as you think about the next couple years? And then, Sundar, could you just -- on the Hardware business, I think there are some concerns that it's just not getting off to really strong trajectory, some comparisons to Microsoft 10 years ago. Really just help us understand how that Hardware business is important to Google and how you're thinking about it long term. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- + + So in terms of mobile search and the Sites revenue more broadly, I think the main point is -- we both tried to indicate in opening comments is we view the advertising opportunity as significant, in particular the opportunity with machine learning both for users and advertisers as well as our commitment to product innovation and being the backdrop of an environment which nearly half of ad budgets in the U.S. are still spent offline and about 90% of commerce in the U.S. is still offline. And we're focused on digital playing a bigger role in that and tapping into other marketing budgets by offering an attractive ROI. +And then apart from people spending more time on digital content, to your question, we know that better measurement, better ad delivery, better user experiences all help grow the pie for everyone in the ecosystem. And then more broadly within YouTube, as we talked about last quarter, we do continue to see significant growth in direct response, and we remain excited about the upside potential there. Brand advertising is still the largest part of the business. It's growing at a strong pace, but we called out direct response given what we see as the upside potential. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [28] +-------------------------------------------------------------------------------- + + And Justin, on the Hardware business, as I said earlier, we are still in our early days, but our commitment is very strong. We really see this incredibly important to drive the future of computing forward and to make sure our services are presented to users in a -- in the way that we intended them to be. And so overall, we view this as a hugely important opportunity. +When we look at the business even for -- given we are more recent to it, we already -- if you take areas like Google Home and Assistant product, we are doing really well. We see strong momentum. I think we are market leaders in the category and especially when you take a look at it on a global basis. And so for -- computing will continue to evolve even beyond phones. And so we want to make sure we are in there, and we are very committed to it for the long term. +Our phones, definitely across as an industry, I think they are working through a phase where there is definite year-on-year headwinds. But I do think -- especially the ecosystem is constantly pushing it forward. I continue to be excited about the innovation speed, 5G coming or the early look into foldable phones, which Android plays a big part in driving. So I do think there is a lot more to come, and we are focused on it. And I -- when I look at the product quality, how it's improving, user feedback in terms of Net Promoter Scores and the range of lineup that we are working and how our products are getting better year-on-year, I remain very excited. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [30] +-------------------------------------------------------------------------------- + + I guess I'll just beat the dead horse on the deceleration comment again but maybe a different way, Ruth. So why did Europe and U.S. -- Europe ex FX and U.S. growth rates drop off much more than Asia and then other? Any comment on why the decel was more pronounced in Western markets? And then stepping back, we've seen pretty solid growth rates from the digital ad sector broadly in the first quarter, and you flagged a lot of this back in February, so clearly, this isn't a surprise to you. But how much of the deceleration in Sites ex FX was from maybe advertiser demand issues in these markets versus proactive changes that you may have made on your end to the product? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + So in terms of the regions, the year-on-year growth rates reflect the product comments that I made with respect to the first quarter. The -- I think the -- you had the U.S. -- U.S. and Europe had about the same delta year-on-year. Other Americas was more pronounced. That was really more of the impact of Hardware. And then APAC, I think maybe is what was guiding some of your question, continues to be a very strong performer and continue to deliver in the 30% plus or I think 31% on a fixed FX basis. We're well positioned, growth throughout the region. Sundar's comment on some of the things that we're seeing, the big focus on the next billion users and excited about the opportunities across the board there. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [32] +-------------------------------------------------------------------------------- + + And I don't think there were any demand issues, to the last part of your question. And as we said earlier, we work through a set of product development pipeline in a very disciplined way focused on user experience. And that makes its way, too, and that's how we approach it. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our next question will be our final question today from the line of Brent Thill of Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [34] +-------------------------------------------------------------------------------- + + Just a follow-up on the last question on EMEA and U.S. Was there any go-to-market changes in terms of the sales force or how you set quota or anything that may have been effectively a Q1 seasonality issue that may see some snapback in Q2? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + The opening comment, I said that one of the points is that we had a strong year last year and we're looking at performance in line with that. I would say more broadly overall in terms of go to market, our long-term investment thesis remains unchanged. We're excited about the opportunities ahead. We do continue to invest to ensure we remain well positioned for the long term. That applies across the businesses. And so there wasn't a change that anything other than the comments that I had made. I think if I could just maybe expand on the investing pace, as we're looking at the pace of investing and supporting growth around the globe, what we're really looking at is what's needed to support long-term revenue and earnings growth. The operating margin did benefit in -- as I noted in my opening comments that -- from the fact that Q1 marketing expenses growth moderated, but that was a timing issue. We do expect a pickup in marketing expense in the second quarter, and other than that, really nothing to comment on. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [37] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter call. Thank you, and have a good afternoon. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2019-Feb-04-GOOGL.txt b/Transcripts/GOOGL/2019-Feb-04-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e4edf5295248d7dc3aea4422b829d2c7a7b3b3b --- /dev/null +++ b/Transcripts/GOOGL/2019-Feb-04-GOOGL.txt @@ -0,0 +1,432 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Alphabet Inc Earnings Call +FEBRUARY 04, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Sundar Pichai + Google LLC - CEO + * Ruth M. Porat + Alphabet Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Anthony Joseph DiClemente + Evercore ISI Institutional Equities, Research Division - Former Senior MD & Fundamental Research Analyst + * Heather Anne Bellini + Goldman Sachs Group, Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JPMorgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen, and welcome to the Alphabet Fourth Quarter 2018 Earnings Call. (Operator Instructions) I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2018 Earnings Conference Call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the safe harbor. +Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward looking, and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And now, I'll turn the call over to Ruth. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- +Thank you, Ellen. We had a strong 2018, with total revenues of $136.8 billion, up 23% over 2017, reflecting the benefit of our ongoing investments to deliver exceptional experiences for users, and compelling returns for our advertisers, partners and enterprise customers. +For the fourth quarter, revenues of $39.3 billion were up 22% year-on-year and up 23% in constant currency as we continue to benefit from ongoing strength in mobile search, with important contributions from YouTube, cloud and desktop search. +For today's call, I will begin with a review of results for the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. I will then review results for Google, followed by Other Bets, and we'll conclude with our outlook. Sundar will then discuss business and product highlights, after which we will take your questions. Let me start with the summary of Alphabet's consolidated financial performance for the quarter. +Our total revenues of $39.3 billion reflect a negative currency impact year-over-year of $724 million or $600 million after the impact of our hedging program. Turning to Alphabet revenues by geography. You can see that our performance was strong again in all regions. U.S. revenues were $18.7 billion, up 21% year-over-year. EMEA revenues were $12.4 billion, up 20% year-over-year in both reported and constant currency terms, with a slight headwind, primarily from the euro. APAC revenues were $6.1 billion, up 29% versus last year and up 32% in constant currency, reflecting weakness of the Australian dollar. Other Americas revenues were $2.2 billion, up 16% year-over-year and up 26% in constant currency, reflecting weakening of the Brazilian real and the Argentine peso. +On a consolidated basis, total cost of revenues, including TAC, which I will discuss in the Google segment results, was $17.9 billion, up 26% year-on-year. Other cost of revenues on a consolidated basis was $10.5 billion, up 34% year-over-year, primarily driven by Google-related expenses. The key drivers were, first, content acquisition costs, primarily for YouTube, mostly for our advertising-supported content in what is a seasonally strong quarter for YouTube, but also for our newer subscription businesses, YouTube Premium and YouTube TV, which have higher CAC as a percentage of revenues. +Second, cost associated with our data centers and other operations, including depreciation. And third, hardware-related costs for our Made by Google and Nest family of products. Operating expenses were $13.2 billion, up 27% year-over-year. The biggest increase was in R&D expenses, with the larger driver being headcount growth, followed by the accrual of compensation expenses to reflect increases in the valuation of equity in certain Other Bets. Growth in sales and marketing expenses reflect increases in sales and marketing headcount, primarily for cloud and ads, followed by advertising investments, mainly in search and the Assistant. +The growth in G&A expenses reflects mostly increases in headcount. Stock-based compensation totaled $2.3 billion. Headcount at the end of the quarter was 98,771, up 4,399 from last quarter. Consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were in cloud for both technical and sales roles. +Operating income was $8.2 billion, up 7% versus last year, for an operating margin of 21%. Other income and expense was $1.9 billion, which includes $1.3 billion of unrealized gain related to a nonmarketable debt security investment. We provide more detail on these line items within OI&E in our earnings press release. +Our effective tax rate was 11.2% for the fourth quarter, reflecting a discrete benefit due to the reversal of an accrual made as a result of updated guidance associated with the U.S. Tax Act. Net income was $8.9 billion and earnings per diluted share were $12.77. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $7.1 billion, which I will discuss in the Google segment results. Operating cash flow was $13 billion with free cash flow of $5.9 billion. We ended the quarter with cash and marketable securities of approximately $109 billion. Let me now turn to our segment financial results. +Starting with the Google segment. Revenues were $39.1 billion, up 22% year-over-year. In terms of the revenue detail, Google Sites revenues were $27 billion in the quarter, up 22% year-over-year. In terms of dollar growth, results were led again by mobile search, with a strong contribution from YouTube, followed by desktop search. Network revenues were $5.6 billion, up 12% year-on-year, reflecting the ongoing momentum of AdMob and Google Ad Manager. Other revenues for Google were $6.5 billion, up 31% year-over-year, fueled by Cloud, Hardware and Play. +We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. +Total traffic acquisition costs were $7.4 billion or 23% of total advertising revenues and up 15% year-over-year. Total TAC, as a percentage of total advertising revenues, was down year-over-year, primarily reflecting a favorable revenue mix shift from network to sites. The increase in the site's TAC rate year-over-year was driven by the ongoing shift to mobile, which carries higher TAC, followed by changes in partner agreements, offset by the seasonally higher proportion of YouTube advertising revenues in the fourth quarter. +In Q4, the network TAC rate declined year-on-year, primarily due to a revenue mix shift within our programmatic business. Google stock-based compensation totaled $2.1 billion for the quarter, up 22% year-over-year. Operating income was $9.7 billion, up 13% versus last year, and the operating margin was 24.8%. Accrued CapEx for the quarter was $6.8 billion, reflecting investments in office facilities, data centers and servers. +Let me now turn to and talk about Other Bets. I'll cover results for the full year 2018 because it remains most instructive to look at the financials for Other Bets over a longer term horizon, as we have discussed on prior calls. Results for the quarter are in our earnings release. +For the full year 2018, Other Bets revenues were $595 million, up 25% versus 2017, primarily generated by Fiber and Verily. Operating loss for Other Bets was $3.4 billion for the full year 2018 versus an operating loss of $2.7 billion in 2017. Other Bets accrued CapEx was $181 million, down from $493 million in 2017, primarily reflecting investments in Fiber. +Key recent accomplishments include: In December, Waymo launched Waymo One, which enables participants to use its app to hail and pay for rides; also, Verily recently announced a $1 billion investment of round led by Silver Lake as it advances on plans that are complementary and additive to its current life sciences portfolio. That investment, of course, was in addition to the $800 million it raised from Temasek previously. +Let me close with some observations on our priorities and longer-term outlook. First, with respect to revenues. Our 23% revenue growth in 2018 was powered in particular by the ongoing benefit of innovation in our Sites business. With 8 products with more than 1 billion users each and more people coming online every day, we remain excited by the opportunities to continue to create valuable experiences for users around the globe. In particular, we see significant ongoing potential to apply our machine-learning capabilities across our businesses. +In our advertising business, machine learning has enabled innovation in advertisers' ability to match consumer intent and to bid more effectively for improved ROI. It has also enhanced the ability of smaller businesses to benefit from advertising on our platforms. Machine learning is also driving differentiation for newer Google businesses, like Cloud and hardware, as well central to a number of Other Bets, most notably Waymo and Verily. +Looking ahead, a couple of things to note. First, as we've said many times, we continuously work to enhance the user and advertiser experience. Because we make changes with the focus on the best interest of users and advertisers over the long term, the timing of the introduction of new experiences, particularly in search advertising, can vary, which can result in an impact on quarterly year-on-year growth. +Second, during 2018, the FX tailwinds in the first half of the year turned to headwinds in the third and fourth quarters, in line with the strengthening of the U.S. dollar. Based on the continuing strengthening of the U.S. dollar, we expect a headwind to reported versus fixed FX results in the first quarter in contrast to the favorable impact of FX in the first quarter of 2018. +Turning to investments and profitability. In terms of gross margin, the biggest component within cost of revenues remains our traffic acquisition costs, reflecting our strong revenue growth in mobile search and the fact that mobile search carries higher TAC than our desktop business. As we've discussed on prior calls, while the pace of year-on-year growth in Sites TAC as a percentage of Sites revenues slowed after the first quarter of 2018, we do expect the Sites TAC rate to continue to increase year-on-year, reflecting ongoing strength in mobile search. +Within OpEx, we remain focused on prioritization in order to optimize resources for longer-term growth in sizable markets. You'll see us continue to support our priority areas with increased headcount, which will remain concentrated in R&D, although we expect the growth rate to moderate in 2019. +In 2018, we also saw continued progress on our goal to nurture new businesses outside of Google, our Other Bets, with the model of independence. While I've said previously that there is no monolithic approach to how the Other Bets execute against opportunities, a shared principle is aligning employee interest with the long-term value creation by these companies. Since inception, this has been an important part of our approach at Google, with stock grants comprising meaningful components of overall compensation across our employee base. +We're increasingly following that approach in the Other Bets with compensation programs that align employee and company interests. You've seen the impact of some of those programs in the fourth quarter as we accrued compensation expenses to reflect increases in the valuation of equity in certain Other Bets. While these expenses will recur, the timing of valuation events is unpredictable and can vary between bets, which can affect quarterly comparisons. +Finally, on capital allocation, our primary use continues to be to support organic growth in our businesses, followed by retaining flexibility for acquisitions. After taking these needs into account, our board has authorized the repurchase of up to an additional 12.5 billion of our Class C capital stock. +With respect to CapEx, we continue to invest in both compute requirements and for office facilities, although we expect the CapEx growth rate in 2019 to moderate quite significantly. +In conclusion, 2018 was another great year with tremendous ongoing opportunity ahead of us. I will now turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [4] +-------------------------------------------------------------------------------- +Thanks, Ruth. Last year, we set out to bring the benefits of AI to everyone through our products, and I'm proud of the tremendous progress we made towards that goal. From Smart Compose in Gmail to the new Google News experience, to call streaming on the Pixel and improving the overall safety of our products, AI is helping people get things done every day. +Beyond our products, AI is also helping us drive our mission forward at the scale we couldn't have imagined just a few years ago. Google AI Lead, Jeff Dean, recapped the results of our efforts in a great post on our AI blog, like using AI to better detect the spread of breast cancer or providing flood victims with real-time information in a crisis. I encourage everyone to check it out. +We also launched the Google AI impact challenge to help nonprofits find ways to use AI to solve social and environmental problems. In addition to our progress in AI, we saw great traction across newer areas, like the Google Assistant, Hardware and Cloud. And our core areas such as Search, Maps, News, YouTube and our computing and advertising platforms continue their strong momentum. +Everything we do at Google is united by the mission of making information accessible and useful for everyone. Providing accurate and trusted information at the scale the Internet has reached is an extremely complex challenge and one that is constantly getting harder. But we have 20 years of experience in these information challenges, and it's what we strive to do better than anyone else. As we do this, we feel a deep sense of responsibility to do the right thing and are continuing to build privacy and security into the core of our products, keeping users' data safe and secure with the industry's best security systems and giving people better and clearer controls. You'll see us continue to do a lot more here in 2019. +Today, I'll start by sharing some of the new ways that we are working towards our mission, then I'll give an update on our video and advertising platforms, followed by the latest on our hardware and cloud efforts. And I'll close with a few thoughts on our investments around the world. +First, advancing our mission of making information accessible and useful. The Google Assistant is a great example of how we help people throughout their day, and we demonstrated that at CES last month with lots of exciting new partners and features. From the Lenovo Smart Clock that wakes you up in the morning, to real-time navigation that helps during your commute, to a built-in interpreter that translates conversations across dozens of languages on Google Home. And speaking of languages, over the past year, the Google Assistant expanded from 8 languages in 14 countries to nearly 30 languages in 80 countries. In that time, the number of active users has quadrupled. As we add more partners, devices and capabilities, the Google Assistant will only get better and more helpful. +There's a lot of great progress in other areas, too. Last month, we announced the launch of activity cards in Search. Now when you search for a topic that you have previously explored, you can quickly see where you've already been and pick up where you left out. Thanks to our strength in AI and Search, Google Lens uses your smartphone camera to help identify more than 1 billion products. So if you see an item that you like, Lens can show you similar designs, along with useful information like product reviews. +We continue to see great momentum across our computing platforms, Android and Chrome. In Q4, we announced that Android will officially support foldable phones with partners like Samsung introducing their first foldable devices this year. We see continued traction with manufacturer adoption of Android Auto. We recently announced new media and messaging features to significantly simplify and improve the car dashboard experience. And building on the speed, simplicity and security of Chrome OS, partners like ASUS and HP introduced a slew of great new consumer and enterprise Chromebooks last months at CES. +Now let me provide an update on our video and advertising platforms, starting with YouTube. We are seeing great traction in some of our newer experiences on YouTube. YouTube Music and YouTube Premium are now available in nearly 30 countries, up from 5 countries at the start of 2018. Last month, YouTube TV announced that it has expanded nationwide to cover 98% of U.S. households, with the rest to follow shortly. YouTube continues to invest in its thriving community of creators and build great features for its nearly 2 billion monthly login users. +For instance, in Q4, we expanded access to tools like stories and community post that strengthen the connections between fans and creators. One of our newest tools, Premiers, is a breakout hit. Ariana Grande's premiere of her official music video for Thank U, Next in November holds the record for biggest music video debut in YouTube history, earning over 55 million views in its first day. We are driving revenue to the YouTube creator community, from established channels to newly emerging ones. The number of YouTube channels with more than 1 million subscribers nearly doubled in the last year, and the number of creators earning 5 or 6 figures grew by more than 40% year-over-year. +A big priority for YouTube in 2019 is to continue our work to quickly find and remove content that violates YouTube's content guidelines. It's an important challenge, and with advanced machine learning and investments in human reviewers, we are making continued progress. +Now I'll touch on some of the recent highlights of our advertising business, which continue to go from strength to strength. Recently, Warner Bros embedded the first full length film with an ad on YouTube and reached a record number of people, over 17 million users in a single day. Viewers who watched the trailer for Lego Movie 2 on Black Friday were served the franchise's original film for free within the ad. It's a great example of how advertisers continue to delight users on YouTube. +Performance advertisers loved TrueView for action, YouTube's direct response offering. Since the product launched in March 2018, over 30% of the advertisers who use TrueView for action were new to buying video ads on YouTube. In Q4, we also announced a global strategic ad tech relationship with The Walt Disney Company across their entire portfolio of brands and properties. With Google Ad Manager as its core platform, Disney will be able to sell across its digital properties seamlessly on the Web, in mobile apps, through connected TVs and even during live events. +Our shopping tools were also front and center during the holidays, helping retailers reach people during the busy holiday shopping season. In fact, the number of shopping daily active users on Google.com during the holidays doubled compared to last year, thanks in part to new features like productless modules that showcase the most popular products across the Web. Small retailers are also benefiting from automated bidding solutions, like smart shopping campaigns, which now has more than 20,000 live merchants, impressive progress since launching in April. +Now on to our growing hardware efforts. During the holiday season, our newest lineup of Made by Google devices topped many best of 2018 lists. The response from shoppers was equally positive. It was another record year for our Google Home family of devices, with millions sold this holiday season. They're helping people easily get things done around the house. For example, people use Google Home devices to cook over 16 million recipes this holiday season, 1 million on Christmas Day alone. Our newest smart displays were particularly popular. One out of every 7 Google Home devices activated over the holiday season was a Google Home Hub. In Q4, we launched significant advances in computational photography in our Pixel 3, with features such as night sight photo light photos. We also expanded availability to 4 more countries: Japan, France, Ireland and Taiwan. +And finally, our growing Cloud business. I want to thank Diane Greene for her leadership over the last 3 years. Google Cloud is a fast-growing, multi-billion dollar business that supports major Global 5000 companies in every important vertical with a robust enterprise organization. This was not the case just [3] years ago. What Diane and her team accomplished is phenomenal. Now, Diane's work is done, and she has handed the reins to Thomas Kurian, and I'm thrilled to have him here as our new Cloud leader. Google Cloud closed out the year strong with momentum across the business. Last year, we more than doubled both the number of Google Cloud Platform deals over $1 million as well as the number of multiyear contracts signed. +We also ended the year with another milestone, passing 5 million paying customers for our Cloud collaboration and productivity solution, G Suite. Our focus on helping customers digitally transform their businesses is paying off. We continue to see strong growth in all our major geographies and industries this quarter. +In financial services, we signed agreements with 2 of the top financial institutions in the U.S. to help them transition their business to Google Cloud with our highly secure solutions. In retail, brands like Bed Bath & Beyond, DSW and Ulta Beauty are using our Cloud to manage data and provide more personalized experiences to consumers. +In media and entertainment, The Telegraph in the U.K. is going all-in with Google Cloud because of our data and machine learning expertise. To support our global growth, in Q4, we launched our 18th Google Cloud region and announced plans for a new region in Jakarta. +So as you can see, we are investing in the many incredible opportunities across our business. We are also investing in communities around the world and right here at home. I was recently in Europe opening up our new office in Berlin, which will help us more than double the number of Googlers who work there. +Across Europe, we have invested more than EUR 4.3 billion in 5 data centers since 2007. And in Q4, we announced a new data center coming in Denmark. In all, it's estimated that these data centers have generated more than EUR 5.4 billion in GDP over the last decade. Of course, the amount generated by our creator, publisher and app developer partners across the region is orders of magnitude larger. +We also continue our substantial investments throughout the U.S. Last year, we made significant investments in new and expanded office space. In Q4, we opened the doors to our new office in Detroit and announced that we'll be investing over $1 billion in capital improvements to establish a new campus in New York City, which will begin to open in 2020. We're also continuing to invest in data center construction and expansion. It is an important, long-term investment that lay the groundwork for our future computing needs, primarily to accelerate machine learning across our businesses, but also to support the opportunities we see in Cloud, Search, ads and YouTube. +More than 20 years in, there is still tremendous opportunity for Google to help people save time, learn new things, grow their businesses and build stronger communities. I want to thank every Googler around the world for making 2018 a great year for users and our business. With that, I will hand it back over to Ruth. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- +Thank you, Sundar, and we will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) And our first question comes from Eric Sheridan of UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- +Two, if I could. Sundar, on YouTube, you now have a number of brands in the marketplace between YouTube Premium, TV, YouTube Music. How are you thinking about positioning those brands against the global opportunity, especially in mobile, to consume media on a global scale? And how are you positioning those brands for the opportunity? And then, Ruth, I wanted to come back to a comment on revenue versus expense with respect to YouTube. It sounds like you called out YouTube as strong in the quarter on the revenue side, but is depressed on the expense side. Was that because of licensed content for things like Music and YouTube TV? Or what is ad splits? How should we think about what the drivers were there and how they're permanent versus seasonal in Q4? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Eric. On the YouTube question, of course, our core effort is around the main YouTube product, and that is what works at scale globally across the world, and we are seeing continued engagement and it's doing very well. We are committed to making sure there is a premium experience on YouTube delivering the content people would want, and YouTube Music is an important part of that as well. So we are investing in both. As you know, YouTube TV is U.S. only, and we are definitely -- it's an exciting product, it's differentiated and has longer value for us because it brings our advertising products together, including being able to serve it across TV. So we're clearly investing in areas where we see opportunity. We are pretty thorough about making sure our investments deliver growth on the other side. And so we monitor it with metrics and -- be it engagement and revenue growth, and we see a lot of opportunity here. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- +And then, in terms of revenue and investments in YouTube, overall, as Sundar said, we're -- YouTube is continuing to benefit from the secular change and the way users are using content, and that's reflected in strong revenue growth. Brand advertising does remain the largest part of the business. It's grown at a strong pace. And as I've said in opening comments, we're particularly excited about the significant growth in direct response, both TrueView for action and app promo formats are delivering great value for users and advertisers, and that's driving growth across regions and channels. In terms of the expenses, I think what you're referring to is within other cost of revenues, the primary driver in the fourth quarter was the increase in content acquisition costs due to YouTube growth, and that's both for ad-supported content in what is typically a seasonally strong quarter and also for our newer subscription businesses, which do have higher CAC as a percentage of revenue. We're excited about the growth we're seeing here. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +And our next question comes from Anthony DiClemente of Evercore. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Evercore ISI Institutional Equities, Research Division - Former Senior MD & Fundamental Research Analyst [6] +-------------------------------------------------------------------------------- +I have one for Ruth and one for Sundar. Ruth, if I look at the segment operating losses for Other Bets, they were higher, both in the fourth quarter and for the year, '18 over '17. Is it safe to assume that's investments at Waymo? Or can you just flesh out a little bit more for us, if possible, were there other, Other Bets besides Waymo, which were worthy of call-out in terms of greater or decreasing investment, that would be great. And then, for Sundar, I'm just wondering if you could provide us any commentary about how growth at Cloud is going. Any milestones? Talked about the investment there. Ruth did, I think, in terms of headcount growth in technical and sales roles. And for the new leadership that you mentioned, what are the things that the new -- that Thomas Kurian can kind of do at Cloud to accelerate the next phase of growth in that business? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- +So in terms of the investment levels in Other Bets, the major point is that we're investing across Other Bets commensurate with what we think is required, kind of looking out at the opportunity set for each one, and we go through a regular process with weekly business reviews and quarterly board reviews and try and calibrate the appropriate pace of investment. In terms of the increase this quarter, as I indicated in the opening comments, we accrued some comp expenses for a number of bets, and that was really to reflect increases in the valuation of equity in certain Other Bets. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [8] +-------------------------------------------------------------------------------- +On Cloud, one of the things that was evident towards end of last year is, now, our ability to win very large customers, Global 5000 companies with multiyear contracts. And so that's definitely something we want to focus on. I think, Diane and Thomas have been working on closely on a transition with a lot of continuity. And you'll continue to see us -- it's very clear to us that our product offerings are ready and differentiated. And so we want to invest and scale our go-to-market, both in terms of direct sales and our channel partnerships. And maybe you will see us focus more on areas where we are clearly seeing returns, be it the geographic regions. We care about the 6 main verticals, where most of the momentum is. And within our product offerings, the 5 major areas, where we have clearly defined product with differentiated features, too. But I'm excited at the traction we are seeing. We're getting large wins, and I look forward to executing here. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +And our next question comes from Doug Anmuth of JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JPMorgan Chase & Co, Research Division - MD [10] +-------------------------------------------------------------------------------- +I just wanted to ask 2. First, as you think about the strong Google Sites growth, [22%], FX neutral. Can you just help us understand some of the mobile search innovations that you think are really driving things here beyond some of these just underlying secular strength, with the particular focus perhaps on the retail channel and just how you're thinking about the opportunities there? And then, second, Ruth, just wanted to go back to your comment on OpEx. Just wanted to go clarify. Were you saying that headcount growth specifically you think will moderate in '19? Or are you talking about overall CapEx spending? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [11] +-------------------------------------------------------------------------------- +Doug, on the first one, obviously, we have thousands of engineers working on continually launching search improvements. I think, for me, a lot of this has been the clear hard work that's gone into making sure search on mobile works really, really well. Removing friction where we can, constantly working to get the answers a bit quicker and faster and making them more relevant. So to me, it's more a set of continual innovation mentality that we have had in there for a long time, and that's really working at scale. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- +And then, the specific comment, I think, you're referencing is I was pointing to headcount growth. We are continuing to hire to support growth opportunities, particularly hiring engineers and product managers in Google and continuing to support growth in Cloud. And what I was just trying to draw out was we will continue to hire, but the year-on-year growth rate will moderate there. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +And our next question comes from Heather Bellini of Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group, Inc., Research Division - MD & Analyst [14] +-------------------------------------------------------------------------------- +Yes, I had a follow-up to Anthony's questions on Cloud. It doesn't seem like you want to share an update on the revenue run rate. But I was wondering if maybe you could share with us what you're seeing in terms of year-over-year growth rates, in particular, are they growing faster than what the competitors disclosed in their public results? Because maybe that will help think about the pace of growth in your Cloud business. And then, secondarily, I was just wondering if you could give us a sense of the types of workloads, if there's any commonality to the types of workloads you might be running more frequently than not? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- +So in terms of growth, Cloud does continue to deliver sizable revenue growth, driven by GCP. And GCP does remain one of the fastest-growing businesses across Alphabet. As Sundar said, we've doubled the number of GCP contracts greater than $1 million. We're also seeing early nice uptick in the number of deals that are greater than $100 million, and really pleased with the success and penetration there. At this point, not updating further. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [16] +-------------------------------------------------------------------------------- +And Heather, I think, maybe specifically a couple of examples, there's definitely, we see clear strength in data management and analytics, so we can take specific -- for example, in retail, or if you take someone like The Telegraph, those very important factors. Application platforms. So our ability to help customers deploy cloud-native applications has been a differentiator of customers like Unity, Ubisoft, et cetera. And multi-cloud ability to run cloud services across clouds on-prem turns out to be very important for global multinational companies like HSBC. So we do see a wide variety of stuff. We are clearly focus on infrastructure being an application platform, data management and smart analytics, and of course, with G Suite productivity and collaboration. So that's the core areas we are investing in from a product and a go-to-market standpoint. And we're seeing great traction there. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +And our next question comes from Brian Nowak of Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [18] +-------------------------------------------------------------------------------- +I have 2. Just first, I wanted to go back to YouTube. You had a very strong quarter, it sounds like, on branded advertising and now some of these new direct response ads. I was curious, Sundar, as you think about with an innovation focus, what do you see as being 1 or 2 of the biggest opportunities to further improve the quality or the efficacy of the ad product you provide for advertisers on YouTube from here? And then on Waymo had a couple of milestones throughout the last 3 to 6 months. Maybe talk us through how you see the next 1 or 2 big factors that you're really focused on ensuring that Waymo becomes what it could be? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [19] +-------------------------------------------------------------------------------- +On YouTube, I still think we are in early days of making sure YouTube is a better platform for direct response. And TrueView for action is still early. We see great traction, but I think there's a lot more to do. And I think we had a set of features, which we launched last year to make sure it works better. But I think there's a lot more to do. In the long run, I think, for me, YouTube is a place where we see users not only come for entertainment. They come to find information. They're coming to learn about things. They're coming to discover, do research. And so being able to match that intent over time in a way that we can bring the right value for our users and advertisers, I think, is a long-run opportunity. And we're taking all the right foundational steps to realize it. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- +And in terms of Waymo, as you know well, we are intently focused on safety first and ensuring a great user experience, and that's why we're expanding methodically. We are pleased that we've continued to broaden out our service in the Phoenix area and we're focused on expanding both the number of riders and the geographic reach around Phoenix. In addition, we're having conversations with a number of other interested cities, and we are continuing to explore applying our technology for logistics and deliveries and for personal use vehicles and for last mile solutions for cities, so continuing to execute, as we've described previously. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +And our next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [22] +-------------------------------------------------------------------------------- +Two questions. First, Ruth, could you just provide a little more color on the R&D expense buildup? Anything unusual on there? Just comment on the cadence of that. And then, Sundar, on hardware, that's -- it's been a multiyear effort. It seems like it's accelerated. There's a series of these new products we tried to do a report on to make sure we understood them. Could you talk about how the strategic and maybe the synergistic impacts that you're seeing of hardware on the rest of Google's business, on the rest of Alphabet's business? And do you think that it's still early days and maybe paint a picture of how significant those synergies could be? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- +So starting with R&D. The main driver is our ongoing investment in engineers, in particular, in Google, and then, as I said, the sizable increase in accrued comp for Other Bets. And just to build that out a bit more, give you a bit more color, in certain Other Bets, employees are compensated through equity-based programs, and that's because we believe that this alignment of interest is valuable. We do assess valuation on an ongoing basis. And at a minimum, we do a formal valuation assessment once every 12 months or when there's a significant event. And what you're seeing in the fourth quarter is the impact of higher valuation in certain Other Bets. And as we've talked about previously, a goal with the Alphabet structure is to enable us to build new businesses that would make a positive impact and create long-term value. And it's still early days. We're very excited about the opportunities we see. And so what you're seeing is the impact here of valuation. The way we approach it is very consistent with the way startups are typically valued, and that includes technical progress and a range of other items. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [24] +-------------------------------------------------------------------------------- +And Mark, on hardware, obviously, we are working hard to offer the best Google Experience we can, bringing together AI, software and hardware. And you are right that it does have a lot of synergistic value, but -- at this stage where we are in. The main way we do that today for our core products is by using hardware to drive where the rest of the computing ecosystem is. And so we get a very leveraged effect there. But over time, as we scale up our hardware efforts and do it thoughtfully so, it definitely -- when I look at the kind of experience we can deliver, for example, if you look at something like the Google Home Hub and how it delivers a nice experience across Search, Assistant and YouTube and photos when you want it, you can definitely see the glimpse of the future. And so we're investing to realize that. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +And our next question comes from Stephen Ju of Cr?dit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [26] +-------------------------------------------------------------------------------- +Sundar, just picking up on the AI for everyone theme, you've been highlighting at I/O as well as other venues. Our conversations with advertisers suggest that products like smart bidding are becoming a pretty increasingly popular tool to add to their bidding strategies. But how has the pickup been among the SMBs, especially among the local advertisers? Do you think you can target that market without a sales force? And secondarily, as we talk to companies transitioning to the Cloud, there's increased talk of collecting data, dealing data lakes as well as analyzing all that data to help their decision-making process, so from your standpoint running Google, do you feel like the current technology you have at your disposal is sophisticated enough to keep up with all of the needs for you to run the company as you collect all the data from across the Internet? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [27] +-------------------------------------------------------------------------------- +I think 2 questions on you. First question around using machine learning to help serve advertisers better and be able to reach newer advertisers, SMBs and local advertisers. I definitely think you highlight an exciting opportunity. Whenever we have done work like be it last year or the last couple of years through universal app campaigns or smart shopping campaigns last year, responsive search ads, those are all great examples of where we brought ML. And with that, we made process much easier for advertisers of all sizes and we see an impact. So I think it's a natural extension for us to continue working in that direction, and that will help us reach SMBs and local advertisers better over time. So I do think that's a good opportunity. And on the second part of your question, I want to make sure I understand it. If you're asking about how we invest in our security as a company, I think it's a foundation of how we do everything for the past 20 years. And we always -- we realize a deep responsibility that comes with being stewards of users' data. So everything we design is designed with privacy and security in mind. It's where some of our core investments go, be it securing our data centers, literally the practices we have across the company, the quality and talent in our security teams, and over time, using AI itself to do all this well. So it's a core part of what we do, and we take it very, very seriously. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +And our next question comes from Dan Salmon of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [29] +-------------------------------------------------------------------------------- +Sundar, in your review of some of the shopping products during the fourth quarter, you [didn't] mention shopping actions. And there were reports there that Walmart decided to leave the program recently. And I think there have been some public comments on social media from Googlers confirming that. So I'd just love to hear a little bit more about that. But maybe more broadly, the traction of shopping actions, and in particular, the price per sale metric that you rolled out with it during the holiday season? And then, Ruth, just a quick one for you. If we could return to your prepared remarks, there were a couple of sort of things to keep in mind that you are highlighting. One was FX going from a tailwind to a headwind. But just before that, you were talking about how new experiences can roll out over time to users. And I just wanted to clarify, were you referencing an experience that's rolling out currently or just generally that, that is a best practice in general for Google? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [30] +-------------------------------------------------------------------------------- +On shopping, I think we launched shopping actions around, if I remember, March of last year. And we have definitely seen a strong traction there. I think we have seen roughly a sevenfold increase in merchants in the program since we launched it. And just in Q4, we announced new partnerships with Best Buy, Nike, Sephora, as an example. And in terms of Walmart, we have -- Walmart is one of our deepest partners and they remain a strategic partner across multiple businesses for us, including Google Ads. And we have efforts underway to work closer together with shopping. But they are definitely a large partner who continue experimenting, and we'll support them in many ways. But I think, overall, I'm excited about the efforts we are doing in shopping, and you will see us focus more there on 2019. We see users come to Google a lot around key shopping moments, and we want to make sure we invest in that experience to get closer to what they want. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- +And then, on the second question, we've talked about this on prior calls. We've often talked about the fact that we have been and remain committed to long-term revenue growth through innovation. And the point I was trying to underscore is the timing and scale of the impact that's inherently difficult to predict. And so can be inconsistent from quarter-to-quarter. The main point is we remain very excited about the opportunities for users and advertisers in particular, building off of Sundar's comment, as we apply machine learning to solutions. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +And our next question comes from Colin Sebastian of Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33] +-------------------------------------------------------------------------------- +Two quick ones for me. First on Project Stream and YouTube TV. Just wondering how important it will be to invest in original content as well as how you might view the rollout of 5G as catalyzing consumer adoption of these services? And then, on the Discover feed, I know that's still pretty new, but curious if you have any color on usage and engagement to date, and if there's any way you expect to monetize that feed in the near future? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [34] +-------------------------------------------------------------------------------- +On Project Stream, being able to deliver gaming with a kind of real-time requirements, the low latency requirements, it's definitely, for us, it's an important computing advance. We think it'll help us drive the newer computing platforms we are working on. And I do think services like that will be a point of inflection as 5G rolls out as well. So I think it is a virtuous cycle. So we are excited. Early feedback on our Project Stream experience has been super positive, and so we are looking to build upon that. And you will see us do more there in 2019. On Discover, I think, traction has been, for us, we measure user engagement and satisfaction and happiness on anything new we do, and the metrics have been really strong. And we obviously -- we offer the best experience today on our products like Pixel Made by Google products. And we are looking to scale that up to reach more users. But we think we have a strong product there, and I think it's very synergistic to the search experience. And so we are looking to bring the best of both to our users, and you'll see us reach more users in 2019. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +And our next question comes from Justin Post of Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [36] +-------------------------------------------------------------------------------- +A couple of questions. First, looks like Google core margins were down about 3 points and what was an easier comp. So just wondering if you can give us any thoughts on how the core advertising business is doing in there. We know there's a lot of investment in Cloud and hardware and YouTube TV. But just would like to get an update on the health of the advertising business margins and any thoughts on if you'll ever do segment disclosure? And then, the second question is just on the Cloud strategy, there's been a pretty big leadership change. Just wondering if there's any new strategies or new things you'll be doing this year with the Cloud related to the management change? And I look forward to the Cloud conference in April. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [37] +-------------------------------------------------------------------------------- +Thanks. So in terms of overall Google margins, I think the main point you're seeing in the margins is we continue to see tremendous opportunity across Google, and so we're investing to support long-term revenue and earnings growth. We've talked a lot in this call already about the importance of machine learning, and it is a key component of incremental investment, particularly in CapEx for our technical infrastructure to support the existing businesses, but also the newer ones, and that's kind of flowing through here. We've talked on prior calls that we're very mindful of the fact that CapEx turns into depreciation, which is why I'd single this out. We're continuing to see tremendous opportunity in the ads business, search and ads businesses. And beyond machine learning, we're further investing to continue to enhance the experience for users and advertisers, and that's across mobile desktop and YouTube. So for example, a big priority in 2018 was expanding the availability of content for what we call the next billion user markets, which are, for us, a really important area. We're excited about the growth and the opportunity to deliver experiences across markets. We're also investing to enable more visual ways of finding information, such as photos and videos. And then, we're investing aggressively in our newer businesses within Google, particularly Cloud and hardware, as Sundar has already said. So what you're seeing reflected through in the margins on the cost of revenue side is the impact of the product mix that we've talked about, a big part of that is the ongoing growth in YouTube. And then, on the OpEx side, investing in engineers, in particular for Google and as well as on the sales and marketing side, the increased headcount to support not just ads, but in particular, Cloud. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [38] +-------------------------------------------------------------------------------- +And on the second question on Cloud. I answered it around Anthony and Heather's question. But to add a little bit more color why, it's the change in leadership, but it was a well-planned transition. And so Diane and Thomas together planned 2019. And the big things you're going to see are continued focus on Global 5000 companies. We are definitely seeing traction with large multiyear contracts, multi-million dollar contracts there. So you'll see us focus there. We'll continue to invest in and expand our sales and distribution channels to meet customer demand. So that's going to be an important area for 2019. But mostly, being highly focused on the 15 countries, 6 industries and the 5 major solution areas that we think will have the most impact and directing most of our resources to towards those efforts is probably something you will see continued emphasis in 2019. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +And our next question comes from Ross Sandler of Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [40] +-------------------------------------------------------------------------------- +Just 2 questions. First, there's a lot of discussion right now about alternatives to Google Play and Apple's App Store for distribution, and some of the large developers are starting to come up with these workarounds around the App Store fees. So I guess, just philosophically, how do you think about the 30%? Do you think that's the right long-term rate for Google Play? And then, Ruth, coming back to the headcount and CapEx growth moderating comments. So you had expenses growing well in excess of revenue for some time in the core Google segment, and 2018 was the lowest operating income growth since you started disclosing the segments. So are you just flagging this as a change of direction? Is this a material change? Or is this just a small amount of moderation in 2019? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [41] +-------------------------------------------------------------------------------- +On Google Play, obviously, we do this at scale, thousands of developers rely on it to safely and seamlessly distribute their game to billions of Android users worldwide. And we invest a lot in our infrastructure to continuously make sure their overall experience is safe and results in high engagement and for the developers back. So I think there's a value exchange there and it's been the industry standard. And so I think we'll continue down that path, and -- but obviously, always adapt to where the market is. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [42] +-------------------------------------------------------------------------------- +And then, in terms of the pace of investment. I've already laid out the focus areas and our commitment to continue to invest to support long-term revenue and earnings growth. And just wanted to put a fine point on both CapEx and headcount. So on CapEx, as I indicated in the opening remarks, we do expect the rate of year-on-year CapEx growth will slow meaningfully. So with the scale of our business and with our focus on user experience, it does require CapEx. We are committed to continue to invest in CapEx to deliver on that. In terms of the mix, we expect to see more of an uptick in 2019 in data center investments relative to servers. But the point which you asked in your question, the year-on-year growth rate will moderate meaningfully. And then in terms of headcount, we're -- I was just trying to make clear that the growth in headcount will moderate somewhat here just so that there's no interpolation. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- +And our final question comes from Brent Thill of Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [44] +-------------------------------------------------------------------------------- +For Sundar, the cash position has doubled the last 5 years to $109 billion. Yet in the last 4 years, M&A has been right around $3 billion, which is well below your peers. And I'm just curious, that it seems like the core is very strong, but is there hesitation that you're seeing in terms of valuation or other factors that are playing into that relative to what your peers are doing right now? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [45] +-------------------------------------------------------------------------------- +I think we've always approached M&A as, I think, really, we are always evaluating opportunities. We have a very high bar. And so to me, it's been more about us finding the right fit rather than being constrained by anything in particular. But I do think it's always an important part of our strategy and we have done great acquisitions in the past, things like YouTube and Android were big acquisitions for us. And so we continue to look for opportunities ahead. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [46] +-------------------------------------------------------------------------------- +And real quick for Ruth. Just the magnitude of spend, I think, goes back to what probably investors were most surprised by. And it sounds like, from your perspective, you don't really look at the margin structure as having any floor, you're just looking at this, as you said, there's tremendous long-term opportunity that you need to make these investments now. I think many are just trying to search for a framework in how you think about this investment cycle we're in right now. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [47] +-------------------------------------------------------------------------------- +So the reason I started by laying out, I think, in response to the question on margins, where we're investing and how we look at is we are very focused on investing to support long-term revenue and earnings growth. We're very mindful of the CapEx impacts on free cash flow and earnings growth. And so we're trying to get it right. Overinvesting, underinvesting, neither of those works for long-term value creation, but we are very mindful of the pace here and trying to lay out with more specificity how we're looking at the opportunity set where -- and making trade-offs where we can. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing comments. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [49] +-------------------------------------------------------------------------------- +Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2019 call. Thank you, and have a good evening. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2019-Jul-25-GOOGL.txt b/Transcripts/GOOGL/2019-Jul-25-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..b965c660c73bb3e0936a6cd86608bb0b051cc735 --- /dev/null +++ b/Transcripts/GOOGL/2019-Jul-25-GOOGL.txt @@ -0,0 +1,473 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Alphabet Inc Earnings Call +JULY 25, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Google LLC - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Former Director & Senior Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Alphabet Second Quarter 2019 Earnings Call. (Operator Instructions) I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Second Quarter 2019 Earnings Conference Call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly cover the safe harbor. +Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward-looking, and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And now I'll turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Helen. Q2 was an exciting quarter at Google. We made several big announcements at I/O, YouTube's Brandcast and Google Marketing Live. They're all part of our broader vision to build a more helpful Google for everyone. +When we say everyone, we mean users, developers, creators, partners, advertisers and all the customers of our growing cloud business and the communities we call home. From the beginning, Google's mission has been to organize the world's information and make it universally accessible and useful. Over the years, we have evolved from a company that helps people find answers to a company that helps you get things done. Today, I'll share how we are approaching this work. +Building a more helpful Google starts with advancing our core information mission. In Q2, we have made a number of improvements to our founding product, Search. We redesigned our mobile search page and brought our popular full coverage feature to Search to better organize news results. We are also integrating augmented reality into Search. So if, say, you're searching for new shoes online, you can view the shoes in 3D or even superimpose them onto your wardrobe to see if they match. +Thanks to advancements in AI, we are making significant improvements to the Google Assistant. The next-generation Assistant can process requests up to 10x faster, making it easier to multitask, compose e-mails and even work offline. With features like Duplex on the Web, the Assistant will soon be able to help users book rental cars and buy movie tickets. +If you are searching for the fastest way home, Google Maps will now tell you when your bus is delayed or how packed your next train will be. We have rolled this out to people in 200 cities worldwide. +Google Maps can also help people stay safe in times of crisis. Last month, we added more visual information and a new navigation warning system to help you understand where a natural disaster is and better anticipate where it may be headed. +Building a more helpful Google for everyone means that everyone should be able to access and enjoy our products. That's why we are applying the latest advances in AI to dramatically improve experiences for people with disabilities. One example of this is captions, which make content more accessible to the almost 500 million people in the world who are deaf or hard of hearing. In Android Q, we can now add automatic live captions to any media playing on your phone such as videos, podcasts and voicemails. +We are also developing technology for the next billion users coming online in places like India, Brazil and Indonesia. Yesterday, we introduced the Gallery Go app. It's a way for people living in low connectivity areas to manage their photos and videos while off-line. Google Photos continues to be one of our most popular and beloved products now with over 1 billion monthly users, and we are excited by the potential of Gallery Go to bring these benefits to the next billion users. +Building for everyone also means ensuring that privacy is equally available to everyone. In Q2, we announced privacy improvements to give users clear choices and more control around their data. We're making privacy controls more easily accessible, expanding our popular Incognito Mode to maps and adding new auto delete controls. And we continue to challenge the notion that products need more data to be more helpful. For example, we invented a new technique called Federated Learning that allows us to train AI models and make products smarter without raw data leaving your device. +To make products work even harder for you, we have continued to invest in our hardware business, bringing together the best of Google's hardware, software and AI. At I/O, we introduced some new additions to our hardware lineup, including Pixel 3a and Pixel 3a XL. By taking advantage of our leading software capabilities, we can offer users a premium phone experience at a much lower price point. +With the launch of Pixel 3a in May, overall Pixel unit sales in Q2 grew more than 2x year-over-year. In addition to Verizon and the Google Store, we successfully expanded our distribution to T-Mobile, Sprint, U.S. Cellular, Spectrum Mobile and additional partners, which has greatly diversified our sales footprint in the U.S. Finally, we're also pleased that the Pixel 3a launch was met with our highest Net Promoter Score ratings to date. +We are also doubling down on creating a helpful Home, bringing all of our Home products together under the Nest brand. In Q2, we launched the Nest Hub in 12 additional countries. Demand across our helpful Home products continues to increase as we expand to new markets. Our new Google Nest Hub Max, a voice-activated smart display powered by the Google Assistant, will be available later this summer. Stay tuned for even more on hardware this fall. +Beyond hardware, we continue to develop the open platforms and ecosystems that push computing forward such as Android, Google Play and Chrome. At I/O, we showed some exciting improvements to Android Q. It's the first operating system to support 5G, includes support for foldable phones and has nearly 50 updates focused on security and privacy, including more transparency and control over the location data you share with the apps. +And we continue to feel the excitement from users, developers and publishers following the announcement of our new gaming platform, Stadia. We recently announced pricing, availability and over 30 games coming to Stadia in time for the consumer launch in November. +Another area where we are investing deeply is YouTube. Every day, users come to YouTube to learn new things. As a result, YouTube has become one of the world's most accessible educational platforms. We see strong growth in a number of areas. Creators continue to build engaged fan bases on YouTube. Channels with more than 1 million subscribers grew by 75% year-over-year. Thousands of channels have doubled their total monthly revenue by using new monetization products like Super Chat, Channel Memberships and Merch. And we are building momentum with our subscription services, YouTube Music and YouTube Premium, now available in over 60 countries, up from 5 markets at the start of 2018. +At Brandcast, we introduced 2 important changes that help advertisers reach new audiences with premium content. First, new YouTube Original series, movies and live events will soon be made available for free supported by ads. Second, YouTube TV, with its 70-plus channels, will be accessible as a stand-alone lineup in Google Preferred. +As we continue to invest in the platform, responsibility remains our top priority. One significant change we made in Q2 was to update our hate speech policy, and we continue to be vigilant about removing harmful content quickly and at scale. In the first quarter alone, we removed more than 8 million videos that violated our community guidelines. The vast majority of those videos were flagged by machines and removed before getting a single view. We are also working to raise up high-quality content and support our creators, who are our next generation media businesses. These are a few of the many investments we have made to protect the community. The work is ongoing and we are committed to it. +Moving from YouTube to broader advertising platforms. At Google Marketing Live, we introduced new ad formats such as discovery ads, which offer a new visually rich mobile-first ad experience across Google properties. We also announced a unified shopping experience and universal shopping cart, all of which help to make Google more shoppable. We also announced Google Travel, a new centralized travel destination, where people can plan and organize all aspects of their next trip all in one place, from booking flights and accommodations to planning activities. +Now on to our Cloud business. Q2 was another strong quarter for Google Cloud, which reached an annual revenue run rate of over $8 billion and continues to grow at a significant pace. Customers are choosing Google Cloud for a variety of reasons. Reliability and uptime are critical. Retailers like Lowe's are leveraging the cloud as one of the important tools to transform their customer experience and supply chain. +Customers need flexibility to move to cloud in their own way. Anthos, announced earlier this year, provides advanced security and open architecture to support multi- and hybrid cloud environments. That's important to many companies, including financial services customers like HSBC and new clients such as KeyBanc. +Scalable data management and analytics solutions are another strength of Google Cloud. Vodafone is using cloud to drive real-time customer and network analytics; and BrightInsight, a leading health care platform for connected devices and drugs, uses our solutions to improve security and compliance. +Finally, Google Cloud's AI and ML solutions are also helping health care organizations like Sanofi accelerate drug discovery and [Ascension] improve the health care experience and outcomes. We continue to build our world-class cloud team to help support our customers and expand the business and are looking to triple our sales force over the next few years. +Finally, to support our rapidly growing cloud customer base and all of Google services globally, we broke ground on 3 data centers and launched our new Osaka cloud region, the seventh in the Asia Pacific. We also announced plans for a new cloud region in Las Vegas, our seventh in the United States. +Lastly, beyond investments in products, we are investing significantly in the communities where we operate. In Europe, we recently announced EUR 1 billion data center investment in the Netherlands as well as the opening of our Google Safety Engineering Center in Munich, Germany. And right here at home, we announced a $1 billion investment in housing across the Bay Area to help address the chronic shortage of affordable housing. +Earlier this week, we invested $50 million in Housing Trust Silicon Valley's TECH Fund, which furthers our goal to help communities succeed over the long term and expands access to housing for those who need it most. +Finally, I'm excited that Google is an official supporter of the Olympic and Paralympic Games Tokyo 2020. It's particularly special since that's where we opened our first international office back in 2001. Ahead of the games, we are working with the City of Tokyo to ensure Japanese businesses can better serve new customers and help visitors make the most of their time there using products like Search, Maps and Translate. +At Google, we feel incredibly privileged to have the opportunity to help so many people every day in moments big and small. There are many reasons to be optimistic about the direction technology is taking from the applications of AI to address disease to the potential of quantum computing to deepen our understanding of the world. +I want to thank Googlers around the world for another great quarter. With that, I will hand it over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sundar. In the second quarter, total revenues of $38.9 billion were up 19% year-on-year and up 22% in constant currency. Once again, our results were driven by ongoing strength in mobile search in particular as well as YouTube and Cloud. I will begin with a review of results for the quarter on a consolidated basis for Alphabet focusing on year-over-year changes. I will then review results for Google, followed by Other Bets and we'll include with our outlook. We will then take your questions. +Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $38.9 billion reflect an acceleration in both reported and constant currency revenue growth across all regions compared with the first quarter. Details of our results by geographic region are available in our earnings press release. +Turning to profitability. On a consolidated basis, total cost of revenues, including TAC, which I will discuss in the Google segment, was $17.3 billion, up 25% year-on-year. Other cost of revenues on a consolidated basis was $10.1 billion, up 35% year-over-year primarily driven by Google-related expenses. +The biggest contributor was costs associated with our data centers and other operations, including depreciation, followed by content acquisition costs primarily for YouTube and mostly for our advertising-supported content, but also for our newer subscription businesses, YouTube Premium and YouTube TV, which have higher CAC as a percentage of their revenues. This line was also impacted by growth in hardware costs associated with the launch of our line of mid-tier Pixel 3a smartphones. +Operating expenses were $12.5 billion with headcount growth as the largest driver across each of R&D, sales and marketing and G&A. The biggest increase once again was in R&D expenses reflecting our focus on product innovation. Growth in sales and marketing expenses also reflects an increase in advertising and promotional expense primarily for the launch of our Pixel 3a lineup. +Stock-based compensation totaled $2.8 billion. Headcount was up 4,187 from last quarter. And consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were again in cloud for both technical and sales roles. +Operating income was $9.2 billion, up 13% year-over-year excluding the impact of the EC fine in the second quarter of last year for an operating margin of 24%. Other income and expense was $3 billion reflecting sizable gains, which are primarily unrealized, from investments made by CapitalG, GV and more broadly at Alphabet. We provide more detail on the line items within OI&E in our earnings press release. Net income was $9.9 billion and earnings per diluted share were $14.21. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $6.1 billion, which I will discuss in the Google segment results. Operating cash flow was $12.6 billion with free cash flow of $6.5 billion. We ended the quarter with cash and marketable securities of approximately $121 billion. +Let me now turn to our segment financial results. Starting with the Google segment. Revenues were 38.9 -- $38.8 billion, up 19% year-over-year. In terms of the revenue detail, Google Sites revenues were $27.3 billion in the quarter, up 18% year-over-year. In terms of dollar growth, results were led again by mobile search with a strong contribution from YouTube followed by desktop search. +Network revenues were $5.3 billion, up 9% year-on-year, continuing to reflect the performance of the primary drivers of growth within network, namely Google Ad Manager followed by AdMob. +Other revenues for Google were $6.2 billion, up 40% year-over-year, fueled by Cloud, with an ongoing strong contribution from Play. Within Cloud, growth in GCP was once again the primary driver of performance with strong customer demand for our compute and data analytics products. G Suite continues to be a valued set of productivity and work transformation apps with results benefiting from both new pricing and seat growth. Play's results were driven by strong growth in a number of active buyers. +Hardware benefited from the successful launch of our Pixel 3a smartphones. We provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. +Total traffic acquisition costs were $7.2 billion or 22% of total advertising revenues and up 13% year-over-year. Total TAC as a percentage of total advertising revenues was down year-over-year reflecting primarily a favorable revenue mix shift from network to Sites. The Sites TAC rate increased year-over-year primarily due to the impact of the ongoing shift to mobile, which carries higher TAC, offset by the growth in TAC-free Sites revenues primarily from YouTube. +In Q2, the network TAC rate declined year-on-year primarily due to a favorable product mix shift. Operating income was $10.4 billion, up 16% versus last year and the operating margin was 26.8%. Accrued CapEx for the quarter was $6.9 billion reflecting investments in office facilities and data centers followed by servers. +Let me now turn to and talk about Other Bets. Revenues were $162 million primarily generated by Fiber and Verily with an operating loss of $989 million. +I'll note a couple of key recent accomplishments. Waymo now has over 1,000 active riders participating in Waymo One and has reached 10 billion miles driven in simulation. Waymo also announced that it has entered into an exclusive partnership with Renault and Nissan to explore driverless mobility services for passengers and deliveries in France and Japan. +Loon was once again able to step in and provide connectivity in the aftermath of a natural disaster after the recent earthquake in Peru. This follows previous deployments of Loon after hurricanes in Puerto Rico and floods in Peru. +Let me now conclude with some comments about our longer-term outlook. Based on the strength of the U.S. dollar to date relative to the third quarter of last year, we expect continued FX headwinds again in the third quarter. As a reminder, FX headwinds affect both revenues and operating income given the majority of our expenses are in the U.S. Turning to revenues. We are pleased with the ongoing momentum in our revenue growth, especially on a base of nearly $150 billion in revenues over the last 12 months. +With respect to Sites revenues. The strength in the second quarter again reflects our ongoing innovation in part from the benefits of applying machine learning. We remain confident about the ongoing opportunity set. +And within other revenues, once again, Cloud was the largest driver within other revenues and the third largest driver of revenue growth for Alphabet overall. In fact, in the second quarter of 2019, as Sundar mentioned, the annual run rate for Cloud revenues was over $8 billion and Cloud continues to deliver significant growth. +In terms of our hardware business, we were pleased with the reception of the Pixel 3a lineup of mid-tier smartphones in the second quarter and look forward to the fourth quarter launch of our newest devices, some of which we showcased at I/O. +Turning to profitability. With regard to Google operating expenses, the second quarter results once again reflect our ongoing commitment to investing for the long term. At this point, we expect that our 2019 headcount growth rate will be closer to the 2018 rate, in other words, slightly higher than we originally forecast for a couple of reasons. Strategically, we are increasing our hiring in Cloud and are incorporating the impact of the Looker acquisition, which we expect to close before the end of this year. And operationally, we're taking steps to optimize workforce deployment by moving certain customer support functions in-house, which is both OpEx-neutral and enhances operational effectiveness. As a reminder, headcount additions tend to be seasonally higher in Q3 because that is when we bring on new graduates. +In terms of sales and marketing, consistent with prior years, we expect sales and marketing to be more heavily weighted to the back half of the year to support the holiday season. In Other Bets, we continue to invest meaningfully for the long-term opportunity we see. +Turning to CapEx and capital allocation. To give you more insight into our investment and capital expenditures, I will discuss the 2 major components of Google CapEx separately. +First, the majority of our Google CapEx is what we refer to as technical infrastructure, which consists of our investments for compute, storage and networking requirements and includes data center land and construction, servers and network equipment. +The second category of CapEx is for our office facilities, including acquisitions, ground-up development projects and related building improvements. In the last couple of years within Google CapEx, on average, approximately 70% was for technical infrastructure and 30% was for office facilities. Both the split between the 2 components and year-on-year growth rates can vary significantly from quarter to quarter due primarily to the timing of sizable purchases of office facilities. +For example, in Q1, technical infrastructure was about 80% of Google CapEx, whereas in Q2, it accounts for about 60% due to the purchases of office facilities we made in the quarter. As we discussed on the fourth quarter call, we believe there are 2 important factors when considering our pace of CapEx investing. +First, we expect the overall growth rate will moderate quite significantly for the full year 2019 versus 2018. Second, in terms of the mix within technical infrastructure, we expect to see more of an uptick in 2019 in data center investments relative to servers in contrast to the ranking in 2018. +Growth in technical infrastructure is designed to support in particular our efforts in machine learning across our businesses as well as to support growth in Cloud, Search and YouTube. +With respect to capital allocation. Our primary use of capital continues to be to support organic growth in our businesses followed by retaining flexibility for acquisitions and investments. We complement these growth drivers with a return of capital. As we indicated in our press release today, our Board has authorized the repurchase of up to an additional $25 billion of our Class C capital stock. +In conclusion, we are confident about the opportunities ahead and continue to invest thoughtfully for the long term. We will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + I really appreciate all the additional commentary and disclosure in the remarks. I think investors will find that really helpful. +Sundar, maybe for you. One bigger picture question. A lot of innovation on the product side in the early part of this year. Now those products are going to start getting rolled out in the back part of this year and into 2020. Can you give us a little bit of additional color on what's some of the key investments you're making, some of the key themes you're trying to drive after in terms of pushing the organization to collaborate on product launches and leveraging the strength within Google? +And then the second part of the question would be as you lower friction for consumers on the product side, what are you hearing from advertisers on the monetization side about how those product might resonate on the monetization piece? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Eric. On -- in terms of the key investments, we still continue. We have been focused on our investments in AI. So that continues to be kind of a foundational investment we are making across the board, including getting a lot of our engineers trained on AI techniques, et cetera, across the board. So it's an important area we are focused on. And making sure digging deeper to push our products to be more helpful is the main theme by which we are evaluating everything we do. +Beyond that, be it the focus on Cloud has been a big part of it, continuing to scale up YouTube, including being focused on content responsibility. These are all some of the key things we are doing. And of course, deep focus on Search and Assistant being a core part of everything we do. +In terms of the work we are doing on consumers and the impact it has on monetization, and I do think they go hand in hand. As we are making the experience better for customers, including on products like Discover, so just getting information to them more seamlessly when they need it, I think they all tend to have a commercial aspect at the right intent when users are interested in it. So we've always seen them go hand to hand. And so taking a long-term view, I think it will resonate on the monetization side as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + And just building a bit on that question and the impact from some of the announcements that you've seen from us. I'll just comment a bit on the impact from Google Marketing Live that Sundar referenced at the outset. I think what's notable here is that every year at GML, we announce new changes to products and features, and most ads product launches are introduced in phases as advertisers initially experiment with new formats. And so as a result, the new products that were announced at GML typically are adopted over time. And so I just wanted to add in here because while we're excited about the new ads products we announced at GML last quarter, given they offer great new user experiences across new services, we don't view this year's slate of launches differently from introductions made in previous years. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Douglas Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [6] +-------------------------------------------------------------------------------- + + I was just hoping, Ruth, if you could talk a little bit more just about the accelerating growth that you saw in 2Q relative to the slowdown that we saw in 1Q. It seemed certainly in the previous quarter to skew more to the Google Search side than YouTube. I was just hoping you could provide a little more clarity on maybe how the product changes that you've talked about in the past played out across 1Q and 2Q. +And then just, Sundar, on user privacy and control over data. That was certainly a key theme across the multiple events in 2Q. Can you just talk about how you balance those initiatives as you're rolling out products going forward? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + So starting first with the strength in Sites revenue. The strength that we've talked about here this quarter reflects the same underlying trends that we discussed previously. And I tried to really call that out in opening comments. And part is the benefit from applying machine learning to both the user and advertiser experience. And it really just -- I'm echoing a lot of what we've said in prior quarters, last quarters. Well, we remain very positive about the opportunity set. We introduce product changes only after extensive testing, which means there can be some variability in quarterly growth rates, as you've seen. But we are very positive about the opportunity set. +And overall, as it relates to both Search and YouTube strength, just to add on YouTube, revenue growth for YouTube was strong in the first quarter. In fact, we called it out as the second largest driver of revenue growth across Alphabet. And in the second quarter, YouTube was again the second largest contributor of revenue growth. And we're really, really pleased with the ongoing momentum that we're seeing here. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [8] +-------------------------------------------------------------------------------- + + On user privacy and control, it's always been a big focus for us in some of the things we recently announced, where initiative is underway, for example, like Federated Learning for almost 3 years. So going forward, I think you'll continue to see us focus on it. It's one of the most important areas we are working on. But I think with AI, we are excited that we can give better experiences for users with less data over time. And those are the kind of directions we are pushing. +We are also -- we'll -- you'll see us continue to work hard to simplify user understanding of how their data is used and giving them better controls and making it more easy for them to manage and making sure more users actually exercise those controls. So those are all our goals, and we'll continue focusing on that as we move forward. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + And our next question comes from Stephen Ju from Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [10] +-------------------------------------------------------------------------------- + + So Ruth, in regards to the Cloud, $8 billion annual run rate commentary. Just wondering if we can get some clarifications there. Does this include GCP as well as G Suite? And further, is this apples-to-apples to, I guess, the $1 billion that you -- I think Sundar talked about? I think that was during the fourth quarter of '17. And any other commentary you can add there in terms of the mix between, I guess, the more GCP versus the more traditional G Suite? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [11] +-------------------------------------------------------------------------------- + + Yes. So it does include the entire business that Thomas Kurian is leading, our Cloud business that includes both GCP and G Suite. And it is on an apples-to-apples basis. It continues to be the business, the Cloud business. We're not breaking out the components of Cloud. As I tried to indicate in opening comments, pleased with the performance of both GCP and G Suite. +Growth in GCP was led by strong customer demand for our compute and data analytics products, and G Suite continues to deliver strong growth, as I noted in the opening comments with results benefiting from both new pricing and seat growth. And overall, GCP remains one of the fastest-growing businesses in Alphabet, and we're really pleased with how the team is executing on both. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [13] +-------------------------------------------------------------------------------- + + And I'll just echo people's comments about the new disclosure. It's much appreciated, so thank you so much for sharing. +I wanted to ask, Sundar, how you've seen your go-to-market and partnership strategies change under Thomas? It does seem as if Google has become the more friendly cloud company, if you will, from a -- when you think about partnering with other software companies. And I'm wondering if there's any tangible benefits you can point to because of this, whether it's in win rates or partner momentum or anything else that you can call out. +And then I also wanted to ask, you obviously made the acquisition of Looker recently. How are you thinking about organic versus inorganic product development? And I'm just wondering, has the thought process there changed with Thomas running the business now? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [14] +-------------------------------------------------------------------------------- + + Thanks, Heather. I appreciate it. Definitely, go-to-market, Thomas, has been heavily focused on it mainly with the realization that we are very competitive when we are there in the mix and so focusing on how we can scale up and really build a customer-facing organization. So we are investing heavily, be it in sales, service, partner and operational teams. And as I mentioned in my opening comments, we are looking to triple the size of our sales force over the next few years, and we are doing it aggressively in major markets around the world. +Some specifics. We did launch our new partner program, Partner Advantage. The SAP relationship has been super important to us. And so we've really focused on that, helping many customers. McKesson, Carrefour, Home Depot, Cardinal Health are some examples of that. +And a big part of it has been really expanding our customer-facing bench. Several new senior executive hires in addition to our new global Head of Sales. We recently added a 25-year customer experience veteran to build out our customer support. +So I think you're going to see that focus of being -- serving customers. We have done it in our other areas. We are used to building ecosystems. If you look at an ecosystem like Android, this is what we do. And so that's going to be a focus for us. +In terms of the second question about organic versus inorganic. I think we are clearly focused on the areas where we are differentiated. Data and business analytics was a key -- data management and analytics is a key area for us. And as part of that, we looked at gaps we have, which would help us complete the solution offering we have there for customers. And that's what drove the Looker acquisition. So we'll be customer-focused. And to the extent we see gaps there, gaps anywhere, we'll obviously look at doing it in-house versus whether there's an attractive opportunity outside, and take it on a case-by-case basis. But that's where it will come from. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney from RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [16] +-------------------------------------------------------------------------------- + + Two questions, please. First, Ruth, just any color on that $25 billion share repurchase authorization, why $25 billion, not $20 billion, not $30 billion? Any color there? +And then when you think about the ad business, we've seen this nice acceleration in Q2, but that's kind of back to norm. There's still this question about what happened in Q1. Was there something that happened in Q1 that you needed to correct in Q2? Is it just the normal rhythms of the Search and YouTube and advertising businesses? So I find Q1 still a little bit of a question mark. Q2 seems like very much the norm over the last several years. So any color on what could have transpired in Q1 and did that require a fix in Q2? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + I'll answer them in reverse order. I tried to comment on that last quarter and reiterated again this quarter. We are pleased with the ongoing momentum in the business. And the key point that I'll just reiterate is that as much as there is a lot of innovation going on in the business, and we've talked about that, we introduce product changes only after extensive testing, and that means there can be variability in quarterly growth rates, as you've seen. And so we're pleased with the strength of the business. The team is extremely focused on ensuring we're delivering for users and advertisers. +And as we're looking out, we talked in the past, we have introduced over 100 enhancements to the user set every quarter and no one change drives results. And as we discussed last quarter, there can be timing variability, and our view is let's ensure that we stay focused on the right things for the long term and the quality that we can deliver. +So there's really not much more to add there. And then on the capital return, I guess, the main point is we went back to the -- we're staying with the same capital allocation framework we've talked with you about before. The primary thing is we remain focused on investing for long-term growth and the primary use of capital really is to support that growth. And then the second use is really to support acquisitions and investments as we've already been talking about. +And given the -- our outlook on cash, our view was that it was appropriate to step in here again. We've increased our program 4x since we began the program in 2015 and pleased to have the opportunity to announce another increase here today, the $25 billion. And I think the main point is we view the repurchase program as an effective use of capital. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [19] +-------------------------------------------------------------------------------- + + I have 2. The first one. Ruth, your color on YouTube was really helpful on it being the second largest driver this quarter and last quarter. I guess with that as a backdrop, with the overall acceleration, can you just give us a couple of examples of what types of products or advertiser segments or regions resonated particularly well on YouTube this quarter versus last quarter? +And then sort of a question for Sundar or Ruth. There has been a decent amount in the press about children's safety on YouTube. And so I guess I'd be curious to hear for advertisers and parents on the call, what steps have you taken to really make sure that YouTube is safe for kids? And what are sort of the biggest areas you're focused on to ensure it stays that way? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + So in terms of YouTube growth, just maybe to add a bit more there given your question. I already noted that YouTube revenue growth was strong in the first quarter and again strong here in the second quarter. +To clarify, the changes in early 2018 that I referenced on the call last quarter regarding Sites click and CPC growth were not related to policy enforcement actions at YouTube. They had a negligible impact on YouTube revenues, just to be really clear. The revenue growth was strong last quarter. And so the click and CPC growth are unrelated to actions on policy enforcement. +And in terms of our ongoing efforts to protect the YouTube ecosystem, we do remain focused on taking the right steps in line with our goals regardless of the impact on revenues. But an important point is that our removal of content that violates our policies have virtually no impact on YouTube revenues. I just wanted to make sure that was clear. So consistent growth here. +Going into your -- the first part of your question. Where is that growth? Again, I'm going to reiterate what we've talked about on prior calls that we continue to see substantial growth in direct response. So brand advertising is still the largest part of the business. It's growing at a strong pace. But really, I would reiterate what we said previously that we continue to see substantial growth in direct response. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [21] +-------------------------------------------------------------------------------- + + And on your important question about kids' safety. As part of our content responsibility work, it's one of the most important areas we focus on. You will see us -- this is why we have put a lot of effort into developing YouTube Kids. And it's a product you're going to see us focus more and continue to evolve, add more curated content there and make sure it's safe for kids and gives parents peace of mind. Also ensuring that the content responsibility work applies to family-oriented content on the main YouTube app as well. +So all the work we are doing, be it the work we are doing to just remove bad content, raise up authoritative content, higher-quality content and reducing the spread of harming content, all applies everywhere and we're really focused on it. Rewarding trusted creators is a big way we can help -- ensuring creators who produce content which is great for children, rewarding them, et cetera, are also important goals for us. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [23] +-------------------------------------------------------------------------------- + + Maybe that's for Ruth, but Sundar, please feel free to jump in. The first one here is based on a couple of comments you reminded us in your prepared remarks about YouTube, which was the inclusion of Originals and YouTube TV in the Google Preferred inventory. You've given us a little bit of color on direct response growth at YouTube over the last little while. Can we assume that those 2 additions were a bit of a boost to the brand advertising side of the business as that's more inventory available for that sort of high-quality type of brand orientation that TV advertisers are looking for? +And then just second, coming back to Google Marketing Live, notwithstanding your comments, Ruth, that it takes some time for products to be adopted. Are there maybe 1 or 2 out of all of those announcements there that you would highlight as being potentially particularly material over the longer term? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [24] +-------------------------------------------------------------------------------- + + On the first stuff in terms of YouTube for brand, I would say it's more secular across the platform promoting higher-quality content. Our work on brand safety, content responsibility adds up to it. Also, creators just generating better content. I think all have played a part. And as I would say, it's more crosscutting. +On the second thing, on GML, in terms of things we were excited about. To me, be it discovery ads and gallery ads, I mean, they're both pushing us towards mobile-first, visually rich, immersive ad formats, which also offers a really great user experience. So I think I'm excited about changes like that, and I think they have the potential. +There is advertiser excitement. But as Ruth mentioned, it's early days. Anything we roll out now takes time to play out, but we definitely see excitement there. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + And our next question comes from Mark May from Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Former Director & Senior Analyst [26] +-------------------------------------------------------------------------------- + + Well, first is for Sundar. I think earlier, Ruth had mentioned the importance of machine learning for driving growth in the quarter and I'm sure in many recent quarters. I believe many have kind of a hard time understanding exactly what that means. I was hoping you might provide a couple of specific examples of how the company is leveraging machine learning recently to help drive growth and improvements for both users and advertisers. And then, secondly, for Ruth, in terms of the Sites TAC. I know there are a lot of variables that go in the changes in Sites TAC. But when you look at the puts and takes, how do you see that kind of trending over the next year or 2? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [27] +-------------------------------------------------------------------------------- + + For us, machine learning plays a critical role across both the consumer user experience and part of ads, too. Generally, using machine learning to simplify things for advertisers and make campaigns easier and give them better insights is where we see a lot of benefit on the ad side. So for example, processing complex datasets and giving back sophisticated, real-time insights really helps make a difference. And also, on the front end, for marketers, helping them find the right creator for every moment, helping them manage bidding in real time. And so every step in the consumer journey, I think machine learning is just making things more efficient, more easier to use and driving productivity for them. So that's what plays out through our systems. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [28] +-------------------------------------------------------------------------------- + + And in terms of the TAC rate. As we've talked about previously, the growth in mobile does put upward pressure on the Sites TAC rate, and that was the primary driver of the year-on-year increase in the second quarter. And we do expect the underlying trend to continue given the ongoing growth in mobile. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian from Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [30] +-------------------------------------------------------------------------------- + + A couple for me as well. First off, as you embrace more commerce and payments on the platform, broadly speaking, along with the new ad formats you've talked about, can you also talk about what role take rates might play in terms of future initiatives in revenue growth? And then secondly, on Assistant and Duplex, in terms of near-term search innovation, I wonder if you could characterize how important that is in terms of the momentum you're seeing and longer term how this might impact platform monetization. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [31] +-------------------------------------------------------------------------------- + + On the first question, I think it's a good question. There's a lot of discovery that happens across Google's properties and -- including Search and YouTube. And so anything we can do to make sure users have a better experience when they are interested in transacting will have a big role. So there's a lot more work underway to make sure payments work better. Sign in works better. Payments works better. And all of that, I think, will be -- over the long term will be drivers, drivers because it improves the overall user experience, especially for commercial queries. +In terms of Assistant and Duplex, I mean for us, Assistant is where we can clearly see we can really push our goal of being more helpful to users, helping them get things done, including things that matter in the real world. And so that's what we are focused on. And if we get that right, just like with Search, there are many things which users want to get done which do have commercial intent to them. And I think that's the value-creation opportunity as well. But we are focused on making sure the user experience constantly gets better, and we are investing to get there. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [33] +-------------------------------------------------------------------------------- + + Sundar, there's been a lot of regulatory news lately, especially from the DOJ. Just wondering how you think about a more intense regulatory environment, getting a lot of questions. I'm wondering if you think about that really affecting Google operations. And then, Ruth, definitely nice acceleration across the board. Of course, Europe accelerated as well. When you think about GDPR implementation last year and you're lapping that, is that helping Europe at all? Or was there really no impact from GDPR? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [34] +-------------------------------------------------------------------------------- + + On the regulatory question, we understand that there will be scrutiny. We are -- we will engage constructively. It's not new to us. We have participated in these processes before. Today, we do operate under a lot of regulation, be it on privacy, be it on competition, be it on copyright, intellectual property, et cetera. And even in the U.S., we have engaged in the process before. To the extent we have to answer questions, we will do so constructively. And to the extent there are concerns, we'll address them as well. +But I think for me, it's important that we stay focused on building helpful products to users and that's the value we ultimately provide our users. And I think that's what we'll stay focused on as a company. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + And in terms of GDPR, we did implement late in the second quarter of 2018. We think it's obviously a critical area of making sure we get it right. That said, the overall impact of regulation on consumers and businesses is still playing out, and we're very focused on making sure we're doing what's best for our users and ensuring we're compliant with the law, not based on any potential revenue impact. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [37] +-------------------------------------------------------------------------------- + + If I can squeeze 2 in real quick. Ruth, the Google segment operating profit was up 16%. That's the highest growth rate in about 2 years. So I guess how should we think about the cadence of that relative to your comments about the headcount growth and the Looker acquisition looking forward? +And then, Sundar, at I/O, you mentioned that the active Android installed base is now over 2.5 billion. That's up about 10% year-on-year, and a lot of that is coming from emerging markets. So I guess just big picture, how do we think about the growth rates that you can sustain in mobile search revenue relative to that 10% active Android growth rate? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [38] +-------------------------------------------------------------------------------- + + Yes. Thanks for that. I tried to enumerate the things as we're looking forward very much to your question. Our overall long-term investment thesis is unchanged. We are very focused on investing to support the ongoing growth we see across Google in particular, as we're talking about in Search, while we're also investing to build new businesses, most notably in Cloud, as we've talked a lot about here today. +And across all of Alphabet, we do continue to benefit from machine learning, that's both OpEx and CapEx. And as we both commented, given the opportunities we see with the application of machine learning across the business, we are continuing to invest. +Our lens on the pace of investing does have 3 facets in it. First is investing at the appropriate pace to support long-term earnings growth. And then we were very focused, second, on optimizing investments within each product area. And finally, as we've talked about, investing to support operational excellence. +But the mega point is that we are excited about the long-term opportunity and we're continuing to invest, which is why in opening comments, I wanted to make sure to call out what we're seeing with respect to ongoing investments in -- across the business, the increases in headcount and the reasons for them, the benefits of those investments as well as sales and marketing and the fact that, that is back-half-loaded and back-half-weighted, I should say. +And so tried to lay out the relevant points for you to ensure that we make it very clear. We are committed to continuing to invest for what we see as long-term opportunities. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [39] +-------------------------------------------------------------------------------- + + And on the mobile question. We are definitely investing in Android with a focus on the next billion users as well as making sure the mobile experience continues to evolve. In terms of the mobile experience, I still think from a user standpoint, there's a lot of information overload. So being helpful to users and helping them navigate it, be it Search, Assistant, Maps and YouTube, I think we are focused on the opportunities there. +And in terms of the next billion users, there's a lot of headroom there over time and we are focused on. That's why we take efforts like Android Go seriously. We are constantly working hard to lower the barrier so that more people can benefit from being online and participating in the digital economy. And so it will continue to be a focus for us. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [41] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our third quarter call. Thank you, and have a good afternoon. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2019-Oct-28-GOOGL.txt b/Transcripts/GOOGL/2019-Oct-28-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..692653cbe1f7c59d3efa375667c33e2087329189 --- /dev/null +++ b/Transcripts/GOOGL/2019-Oct-28-GOOGL.txt @@ -0,0 +1,451 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Alphabet Inc Earnings Call +OCTOBER 28, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Google LLC - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Lloyd Wharton Walmsley + Deutsche Bank AG, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Alphabet Third Quarter 2019 Earnings Call. (Operator Instructions) I'd now like to hand the conference over to your speaker today, Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's Third Quarter 2019 Earnings Conference Call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly cover the safe harbor. +Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward-looking, and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And now I'll turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen, and good afternoon. +Q3 was another great quarter at Google with strong revenue growth driven by mobile search, YouTube and Cloud. We celebrated Google's 21st birthday this quarter. While our mission to organize the world's information and make it universally accessible and useful hasn't changed, we have evolved from a company that helps people find answers to a company that helps you get things done. +Since the beginning, we have always invested in tackling deep computer science problems that can have a significant impact on society. The chance to be part of these fundamental engineering challenges is why so many people want to work at Google. In just the last week, we have announced 2 significant advances: first, powered by our long-term investment in AI, we dramatically improved our understanding of the questions people ask Google Search. It's the biggest leap forward for search in the past 5 years. It's all possible because of a new type of neural network-based technique for natural language processing called BERT, which recognizes subtle patterns in language and provides more relevant resource. +Second, we recently announced a major quantum computing milestone. I was extraordinarily proud to visit our team in Santa Barbara. To demonstrate supremacy, Google's 53-qubit quantum machine, Sycamore, successfully performed the test computation in just 200 seconds that would've taken the most powerful supercomputers much longer time to accomplish. It's the hello world moment we've been waiting for and represents a distinct milestone in our effort to harness the principles of quantum mechanics to solve computational problems. +Turning from quantum to the quarter. Today, I'll talk about the momentum we saw across the business in the last 3 months. First, Cloud. We saw customer momentum across multiple areas under Thomas' leadership. In September, we announced a landmark partnership with Mayo Clinic. Using Google Cloud to secure and store data and understand insights at scale, Mayo Clinic will partner with us in many ways. Together, we'll work to transform patient and clinician experiences, identify new methods of diagnosing diseases, conduct clinical research and find new models for delivering patient care. +National Australia Bank recently added Google Cloud to its multi-cloud strategy to help the company better use data and deliver new and improved customer experiences. Deutsche Börse Group, the fourth-largest stock exchange group worldwide, relies on Google Cloud to help them navigate the twin challenge of modernizing their digital operations and addressing significant regulatory requirements. Retailers are also turning to cloud solutions to help make the shopping experience as seamless and personalized as possible. For example, Macy's uses Google Cloud to streamline their operations from the distribution center to the shop floor. Public sector customers are modernizing their IT systems with Google Cloud with great results. For example, the State of Arizona already has more than 36,000 employees using our products to increase productivity, efficiency and security. And this quarter, it further extended our relationship. +We continue to extend our cloud services through partners including a new solution that enables customers to run VMware workloads on GCP for the first time. We announced a cloud region in Nevada. When it launches in 2020, it will be our seventh cloud region in the U.S. We also announced a new cloud region in Poland, our seventh in Europe. +Turning to Google's products that people use every day. We are excited about new features launched in Maps including detailed voice guidance while walking that will make it possible for people who have vision impairments or are blind to get around more easily; new tools that will allow users to see all of their flight and hotel reservations in one place; and another new feature that gives transit riders in 30 countries the ability to see ridesharing and biking options near their bus or train stop. In search, we made a number of improvements to make it easier for users to find key moments in videos, easily find products within images via Google Lens and discover new podcasts. +Our Hardware business is still in its early stages, but we are continuing to build the business and a portfolio of helpful products. 2 weeks ago, we unveiled our new Made by Google product lineup, bringing together the best of hardware, software and AI. Our new Pixel 4 and Pixel 4 XL are the first phones with motion sense. This allows users to use natural gestures to get things done without touching their phone. The new Google Assistant now gives users the ability to switch seamlessly between apps all via voice. And the new Pixelbook Go provides many of the great features of our premium Pixelbook at a more affordable price point. We also unveiled a new more powerful Nest Mini speaker and Nest Wifi. Finally, the team is looking forward to launching Pixel Buds, our first truly wireless headphones, as well as Stadia, our streaming gaming platform, which will soon be available in the U.S., U.K, Canada and throughout Europe. We are encouraged by the positive product reviews so far. With the holidays coming up, I think there's a gift for everyone on your list. +On to YouTube. Keeping YouTube safe for our users, creatives and partners while preserving the openness of our platform is a top priority. This quarter, we continue to update our community guidelines and enforcement to protect users from harmful content, and we'll keep doing this work. YouTube Music and YouTube Premium continue to expand globally and are now available in 71 countries. In September, YouTube launched its new fashion and beauty destination called YouTube/Fashion. It's designed to meet the growing demand from consumers for better ways to explore and connect with some of YouTube's biggest fashion and beauty creatives. +And I want to emphasize that as we build all these helpful products, we are committed to giving users more control of their data. This quarter, we extended one of our most popular features in Chrome and YouTube called Incognito mode to Maps. We expanded our auto-delete controls to YouTube history. These controls already enable people to set their location history and web and app activity to be deleted automatically after 3 or 18 months. +And to protect everyone's safety online, we introduced password checkup. It's a new feature that tells users if any of their passwords are weak, if they have been reused across multiple sites or if they have been compromised somewhere on the web. +Now moving on to how we are helping advertisers. We are bringing our strengths in machine learning to help advertisers build their ad campaigns. Machine learning-powered tools like search auto bidding are gaining traction. In fact, more than half of advertisers' search spend is now optimized via full auto bidding. We now have more than a million advertisers using responsive search ads, an ad format we launched a year ago that uses machine learning to create the right ad for each search query. And our new video reach campaigns allow marketers to upload multiple video ads into a single campaign. From there, we use machine learning to sell the most efficient combination of these ads to help brands reach audiences at scale. +This quarter, we expanded inventory for our very popular app campaigns to include new services including YouTube Search, display video ads and the Discover feed. We also launched YouTube masthead ads for TV, which enable advertisers to reach audiences right when they opened their YouTube app on their connected TVs, one of its fastest-growing streams. +It's also important for advertisers to have standardized measurement that's fair across all media and that delivers insights in a way that fully protects users' privacy. We're making it easier for businesses to do just that. Our next generation of Google Analytics unifies web and app measurement reporting for the first time to help businesses understand which channel is driving the best results. +On a personal note, I was in Dallas in October where I saw firsthand how important Google is in helping small and medium-sized businesses grow. I got to visit Peacock Alley, a bedding and bath manufacturer in Dallas with 75 employees. They've been using Google Ads for over 15 years to help drive traffic to their stores. Their e-commerce has grown 52% in the past year. They credit the guidance Google Analytics provides as well as Google Shopping and Product Listing Ads for that growth. +This isn't the only way we help small businesses grow and thrive. Our Grow with Google program has helped train 3 million Americans in digital skills including small business owners and entrepreneurs. Just a few weeks ago, we announced that our IT professional support certificate training course will expand to 100 community colleges. It's already helped tens of thousands of people pursue fast-growing, well-paying careers in IT support. I'm glad to see more community colleges offer this pathway to students. +Finally, to round out a busy quarter, sustainability has always been a core value for us, and I'm proud that we have been carbon neutral since 2007. In September, we announced the biggest corporate purchase of renewable energy in history. We are increasing Google's existing renewable energy portfolio by more than 40%. These purchases are happening globally, spurring the construction of more than $2 billion in new energy infrastructure including millions of solar panels and hundreds of wind turbines across 3 continents. +And at our Hardware event, we announced that we are committing to roughly $150 million in renewable energy projects in key manufacturing regions. Our hope is that this will spur even greater investments in sustainability. +So it's been a really great quarter. A personal highlight for me was our Take Our Parents to Work Day, which we held in September at our main campus in Mountain View. It was great to see thousands of parents take such pride in what their kids are building. I feel the same way. None of our work would be possible without our Googlers around the world. This quarter was another great example of the mission that brings us all together. +Thank you. Now I'll turn it over to Ruth. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sundar. +In the third quarter, total revenues of $40.5 billion were up 20% year-on-year and up 22% in constant currency. Once again, our results were driven by ongoing strength in mobile search, YouTube and Cloud. I will begin with a review of the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. I will then review results for Google followed by other bets and conclude with our outlook. Sundar and I will then take your questions. +Details of Alphabet's consolidated revenues by geographic region are available in our earnings press release. Regarding our key expense lines, on a consolidated basis, total cost of revenues including TAC, which I will discuss in the Google segment, was $17.6 billion, up 23% year-on-year. Other cost of revenues on a consolidated basis was $10.1 billion, up 31% year-over-year primarily driven by Google-related expenses. The biggest contributor again this quarter was costs associated with our data centers and other operations including depreciation, followed by content acquisition costs, primarily for YouTube and mostly for our advertising-supported content but also for our newer subscription businesses, YouTube Premium and YouTube TV, which have higher CAC as a percentage of their revenues. This line also includes the impact of hardware costs primarily associated with our mid-tier Pixel 3a smartphones. +Operating expenses were $13.8 billion with head count growth being the largest driver of year-on-year growth for both R&D and sales and marketing, which is reflected in both compensation and facilities expenses. With respect to R&D, the growth was again driven by the addition of engineering talent consistent with our focus on product innovation. The increase in G&A year-over-year was primarily due to a $554 million charge from our previously announced legal settlement in France. +Stock-based compensation totaled $2.6 billion. Head count was up 6,450 from the second quarter, and consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable head count increases were again in Cloud for both technical and sales roles. Operating income was $9.2 billion, up 6% year-over-year for an operating margin of 23%. Other income and expense was a loss of $549 million, which primarily reflects the impact of unrealized losses and marketable equity securities. As of September 30, the unrealized equity gain in the combined portfolio of marketable and nonmarketable securities was $5.8 billion. We provide more detail on the line items within OI&E in our earnings press release. Net income was $7.1 billion, and earnings per diluted share were $10.12. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $6.7 billion, which I will discuss in the Google segment results. Operating cash flow was $15.5 billion with free cash flow of $8.7 billion. We ended the quarter with cash and marketable securities of approximately $121 billion. +Let me now turn to our segment financial results, starting with the Google segment. Revenues were $40.3 billion, up 20% year-over-year. In terms of the revenue detail, Google Sites' revenues were $28.6 billion in the quarter, up 19% year-over-year. In terms of dollar growth, results were led again by mobile search with a strong contribution from YouTube followed by desktop search. +Network revenues were $5.3 billion, up 8% year-on-year, continuing to reflect the performance of the primary drivers of growth within network namely Google Ad Manager followed by AdMob. Other revenues for Google were $6.4 billion, up 39% year-over-year, once again fueled by Cloud followed by a strong performance from Play. Within Cloud, growth in GCP was once again the primary driver of performance with strong customer demand for our compute and data analytics products complemented by ongoing growth in G Suite, reflecting both new pricing and seat growth. Within Play, performance was driven once again by growth in the number of active buyers. In addition, the line reflects Hardware, which continue to benefit from the launch of our Pixel 3a mid-tier smartphones. +We provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. Total traffic acquisition costs were $7.5 billion or 22% of total advertising revenues and up 14% year-over-year. Total TAC as a percentage of total advertising revenues was down year-over-year, reflecting primarily a favorable revenue mix shift from network to sites. The sites' TAC rate increased year-over-year primarily due to the impact of the ongoing shift to mobile, which carries higher TAC, partially offset by the growth in TAC-free sites revenues primarily from YouTube. +In Q3, the network TAC rate declined year-on-year primarily due to a favorable product mix shift. Google operating income was $10.9 billion, up 14% versus last year, and the operating margin was 26.9%. Google accrued CapEx for the quarter was $7.2 billion, reflecting investments in office facilities and data centers followed by servers. Investments in office facilities included the $1 billion acquisition of a portfolio of buildings in Sunnyvale and the purchase of 2 buildings to expand our presence in the Seattle area. +Moving on to the performance of Other Bets. Revenues were $155 million, primarily generated by Fiber and Verily. Other Bets had an operating loss of $941 million. I'll note a couple of key accomplishments in Other Bets. +At Waymo, we're extending fully driverless opportunities on a small-scale to participants in our Early Rider Program in Metro Phoenix. We're also testing long-haul truck driving on Arizona freeways, and we're continuing to test Waymo vehicles in various geographies. The newest of which is heavy rain testing in Southern Florida. In addition, we have begun 3D mapping in Los Angeles. And 2 weeks ago, Wing launched its first commercial drone-delivery service to homes in Virginia in partnership with FedEx, Walgreens and local Virginia retailer, Sugar Magnolia. Wing is now operating on 3 continents in early test deliveries. +I will sum up with a few observations on the quarter and our longer-term outlook. Based on the strength of the U.S. dollar to date relative to the fourth quarter of last year, we expect continued FX headwinds again in the fourth quarter of 2019. As a reminder, foreign exchange headwinds affect both revenues and operating income given the majority of our expenses are in the U.S. +With respect to revenues, we're pleased with the performance of our advertising business. As a reminder, there is variability in year-on-year revenue growth rates from quarter-to-quarter. As we've often discussed, we manage our business for the long term and not on a quarterly basis, and we remain very focused on continuing to enhance the experience for users and advertisers over the long term. +Within other revenues, in addition to continued strength in compute, Google Cloud saw substantial growth from data analytics as customers are seeing the benefits from implementing BigQuery. Cloud continued to see significant growth in each region globally. Our new lineup of Made by Google hardware was announced 2 weeks ago with Pixel 4 hitting store shelves late last week. With the introduction of the Pixel 3a in the second quarter, we expect the seasonality of our Hardware business to be moderated somewhat. +Turning to elements of our profitability. With regard to Google operating expenses, while head count growth on an absolute basis in the third quarter was unusually high, reflecting the addition of new college hires, we do remain on pace for head count growth in 2019 to be in line with growth in 2018. Our investments in talent support innovation across our businesses and in particular support our ongoing momentum in cloud. +Regarding sales and marketing expenses, as I've mentioned on prior calls, these expenses are typically more heavily weighted toward the back half of the year and tend to be particularly elevated in the fourth quarter to support the holiday season. In Other Bets, we continued to invest meaningfully and thoughtfully for the long-term opportunities that we see. +Turning to capital allocation and CapEx. With respect to capital returns, consistent with announcing an increase in our stock buyback authorization last quarter to $25 billion, we were pleased to step up repurchase levels by nearly 60% to $5.7 billion in the third quarter. In terms of CapEx, as a reminder, over the last couple of years, the split between technical infrastructure and office facilities has averaged approximately 70% to 30%. Due to the sizable purchases of office facilities we made in Q3, technical infrastructure accounted for only about 60% of total CapEx and continue to be more heavily weighted to data center construction and servers. +Looking forward, we anticipate the primary driver of CapEx investment will continue to be our expected compute requirements, particularly to support ongoing demand for machine learning across our business as well as for Cloud, search and YouTube. At this scale of investment, we remain very focused on driving efficiency through fleet optimization and tight management of our supply chain. +In conclusion, we remain confident about the opportunities ahead. Sundar and I will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe two if I can. First, Sundar, a big-picture question. It feels like the concept of the ambient computing was sort of prevalent at the Made by Google event recently. It started with sort of a bit of a shift in theme, from what I could tell, at the I/O earlier this year. Can you just talk about what some of the key investments you want to make to capitalize on that opportunity over the medium to longer term, how you think Google and maybe broader Alphabet is positioned to capitalize on that, how it might show up at the product service layer? So I guess maybe a 3-part question of more of a bigger-picture nature. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Eric. We are very excited by the vision of ambient computing and evolving that. I think it's a continuity in the sense that, over time, computing should be more intuitive to users and computing should adapt to users, not the other way around. And the foundations of all this is all the work we have done with our computing platforms to date and the successful consumer services and the developer platforms we have built. And I think that's the most of the investments there. Phones will continue to be at the center of ambient computing for the future. So that's another important piece where we are already invested in. +I think as we expand beyond, that's what the Made by Google family is focused on, products in your home with our Nest family of products and wearables, which we do with Wear OS and so on. So supporting that ecosystem, so whether you're at home or on the go or at work, and making sure it works. Our investments in AI across the company, I think, will end up playing a key role, AI and Assistant. I think they will be at the center of making sure we can anticipate what users want and serve them better. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + Sundar, you talked about the new neural network techniques, talked about the biggest breakthrough in search in years. Can you just help us understand if that's impacting kind of the advertising and monetization side of the business yet or how that can play out going forward? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [6] +-------------------------------------------------------------------------------- + + Anytime -- maybe I'll answer it as, BERT, which is the name of the technique we are using, and we rolled it out in search now. And obviously, anytime we can better make sense of queries, we can serve users better, our search quality goes up, and people engage, and that's a -- engage more. So it's part of a long set of things we have been working on, but this is one of our bigger breakthroughs in terms of helping improve the search experience and search quality. And then BERT will help us in a certain set of queries. There are many queries which are already working well, but it helps us capture nuance and help understand human context better. And so I would just characterize this as a big improvement, which improves search quality and creates that virtuous cycle by which people engage more. Of course, a lot of times we take the same techniques, and sometimes it makes sense on the ad side and the underlying machine learning techniques, and we'll deploy it there as well. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [8] +-------------------------------------------------------------------------------- + + I just wanted to follow up on a couple of the comments you made about cloud, Sundar. I was wondering if you could just give us some color on the size of your GCP backlog. And maybe even if you just talk about the trajectory and how that's changed over the course of the last year. And then you mentioned the strength in the uptake of BigQuery. I'm just trying to think through how we should think of the margin level of a service like this versus the traditional compute offerings where you've seen strength to date. And just wondering if we start to see some positive mix shift benefits as some of these premium products start to ramp more aggressively. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [9] +-------------------------------------------------------------------------------- + + Thanks, Heather. Overall, I know we gave some visibility into our cloud business, and we'll continue to do that periodically. And the momentum has been great. Obviously, ever since Thomas has come in, he has continued to invest across the board. He definitely focused a lot on scaling of our sales partner and operational teams, and it's playing out well in this business. It's important for you to been asked many data situations as possible and get those wins which accrue over time. And so we are definitely seeing the momentum. Analytics is a huge area of strength for us, and it's an area which Thomas has a lot of expertise in as well. +And BigQuery is such a strong product, so it's a natural area we are seeing strength. And my sense is as we get -- if I look at the TAM, the percentage of TAM for which we were eligible compared to 2 years ago to last year to now, that number is shifting aggressively due to either completing our product feature set or completing some of the certifications we need. And so I think there are several strong forward-looking indicators and look forward to sharing more at the right time. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD and Analyst [11] +-------------------------------------------------------------------------------- + + Can I just ask you to draw a little bit more out on Google Maps? I know that's for Marketing Live earlier in the year that, that seems like that's now at a stage where it's going to be better integrated into the, I don't know, the purchase path or whatever, you're making it easier for small businesses to tap into what should be really nicely qualified leads. Just talk about the pace at which that -- the monetization of that or just the ad opportunities will be offered to small businesses. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [12] +-------------------------------------------------------------------------------- + + In general, local is an important area for us, and we are continuing to invest in building experience that connects merchants, advertisers and users. Google My Business has been our major effort there. Actually, millions of businesses are -- reach and engage both through search and Maps. Specifically, in GML, we announced that we'll expand local campaigns. I presume that's what you're talking about. It's still early. And in general, we want to make it easier for advertisers, particularly SMBs, to come to Google and be able to reach users across our set of owned and operated properties, so be it search, be it YouTube, be it Discover, be it Maps, and that's the way we envision that. And -- but small and medium business is a big area of focus, and Maps represents a big, long-term opportunity for us. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + And just to add on there, given you referenced back to GML, and I think we talked about this last quarter as well. Our view is that the products, they were introduced to GML. This year, like in previous years, they rolled out in phases. They're adopted over time, and so we will don't view the potential impact from this year's slate differently than the impact from products that were launched at previous events. And so just to kind of keep that in perspective. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + And our next question comes from Lloyd Walmsley from Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Wharton Walmsley, Deutsche Bank AG, Research Division - Research Analyst [15] +-------------------------------------------------------------------------------- + + I wanted to ask another one about a new product you guys announced earlier this year at GML, and that was really Google Shopping and moving that across some of the new different properties like YouTube and Image Search and Discover. Can you give us a sense for where you are in that migration? Kind of over what time frame should we be thinking about that? And then maybe just elaborate a bit on the long-term vision of moving shopping functionality into properties like YouTube and how you think that experience will evolve. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [16] +-------------------------------------------------------------------------------- + + In general, I think it's a great opportunity for us. We see tons of what I would call commercial user journeys across Google. Obviously, search is an important area. Image Search, YouTube, Maps are all great services by which I think users come with varying degrees of commercial interest, looking to discover and, at times, transact as well. So we've started thinking much more holistically about what are those experiences and how can we make that better. That involves helping improve the discovery experience, but when people are interested in it, being able to be -- making it easier to transact. So the equivalent of being signed in and being able to pay when you want and then of course fulfillment and logistics. So we are thinking through the end-to-end experience across all our services and are investing, but I see the user interest, and it's an area where I think we have significant opportunities ahead. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + And again, these are still earlier stage. And it's -- we're excited about the longer-term impact, but just to again make it clear, we're just still in the earlier stages of testing. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [19] +-------------------------------------------------------------------------------- + + I have 2. Ruth, I think you mentioned that desktop search might have been one of the contributor to growth. Can you just talk to us a little bit about what types of products or verticals you're still seeing growth? I know desktop search is really impressive given how old -- how long that this has been around. And then, Sundar, we've got all the exciting changes going on with search become more relevant, et cetera. Can you just talk to us about some of the KPIs that you monitor, what you're seeing when it comes to query volumes, click-through rates, overall response time? What are you seeing that sort of give you confidence that you're continuing to get more and more relevant results for your users? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + So in terms of desktop, I described it as a solid contributor to revenue growth. And what we see is that desktop does remain an important form factor for certain more complex tasks. So things like planning vacations or assessing insurance options, what we see is users continue to go back to desktop, notwithstanding the growing utility of mobile. And I think one of the things that we've been very focused on is that innovations that benefit mobile also enhanced the desktop experience for users and advertisers. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [21] +-------------------------------------------------------------------------------- + + And then in terms of obviously we've been -- over time, we have developed a very comprehensive metric for measuring and tracking search quality, to get a sense of search quality and how user satisfaction is through search. But to give you a sense of -- we continue to take that work deeper. We realize users sometimes do searches through sessions, understanding what is their satisfaction across the session, what is their engagement, are they getting at what they are looking for. Those are all some of the deeper work we are undertaking. And also understanding by vertical how we are helping users. There was an earlier question around shopping and commerce, that's an example of the kind of vertical and what can we do to make that experience better. Health as a vertical, another vertical in which we have a whole Google health team focused on understanding the in-depth experience that would give better experience overall in search. So very comprehensive effort, and we are constantly looking to do deeper and broader at the same time. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian from Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + I have 2. Sundar, there's clearly a lot of innovation happening at Google, but I'm wondering how you think about the increase in scrutiny and oversight possibly impacting your ability to explore new services or new markets over time and ultimately to remain competitive. And second, Sundar or Ruth, we don't often ask about the display network. But just wondering given all the concerns around privacy, ad block and the like, how do you view this business strategically as part of the overall ecosystem? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [24] +-------------------------------------------------------------------------------- + + On the first part, we consistently want to work and build products that benefit users and support the ecosystem. And so our products and services benefit consumers, small and medium businesses, advertisers, and overall, they help reduce prices and expand choice. And so that's our underlying approach, I think, which is what helps us engage and explain to regulators, and we'll continue to do that. I think there are also many new areas of opportunities available for us. And in many of these areas, we are the new entrant, and we create competition. And sometimes, the competitive pressures can lead to concerns from others. And so that's part of what's going on as well. But the other area is, in addition to developed markets, we are investing deeply in our next billion users, so markets like APAC continue to be big, long-term opportunities for us as well. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [26] +-------------------------------------------------------------------------------- + + Ruth, just if you rewind the clock a little bit when we entered this year, you had called out how some product changes may cause year-over-year growth rates to fluctuate from time to time. And we haven't heard that in a couple of quarters. So as we look out towards like 2020 and beyond, do you feel like a lot of the product queue is in a good place as far as search and YouTube are concerned and that this product changes might be a little bit more subtle going forward? Or could we return to having more meaningful impact in the future? Just any color there. And then on the third quarter, the Asia region, the growth rate was solid but a tad lower than the prior trends. So anything notable to call out on APAC? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- + + So in terms of the first question, look, I think as Sundar and I have talked about, we're pleased with the strength of the business that you've seen here again in the third quarter. And as we've said since the IPO, we don't manage the business to maximize quarterly results, and we'll always do the right thing for the long term. We're very focused on investing for the long term, and I tried to make it clear in the opening comments that, as a result, quarterly growth can vary and have varied. And I think to your question, our view is that quarterly growth around the rates you've seen since the beginning of the year, for us, underscore the strength and the vibrancy actually in our business. And that's particularly true at our size. In the last 12 months, we've generated over $150 billion in total revenues. That's about $25 billion of growth in the last year, and we are continuing to invest in long-term opportunities. And -- but I would make the point that we do keep a lens to the long term. +In terms of your question about geographies. When we look at performance on a fixed FX basis around the globe, pleased with the performance again in the third quarter. You aptly pointed out year-on-year growth in APAC in the third quarter was a bit lower than the second quarter. That primarily reflected slower growth in the network business, and that was in part due to policy changes. It also reflected the fact that the launch of the Pixel 3a was in the second quarter, which boosted the year-on-year growth rate in the second quarter. But I think also implicit in your question, at 26% year-on-year growth on a fixed FX basis running at about now $7 billion in quarterly revenues, we're really pleased with all that the team is doing in the year-on-year growth rate. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [29] +-------------------------------------------------------------------------------- + + Sundar, maybe you could give us a little bit of an update on the Discover feed, that's the new product that we featured in the past and I know a lot of users are getting more use out of. You gave us, I think, some updates on monthly active users or DAUs in the past. Any update there would be great or maybe any additional color on sort of how the total amounts of usage goes on there, as that's obviously been featured to users a little bit more. And then second, maybe just a follow-up for Ruth, Sundar spoke at length about your investments in renewable energy earlier. And maybe keeping with the theme of the earnings call, you could help us understand how that is or maybe is not helping drive efficiencies across the country -- or across the company and your operating cost overall? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [30] +-------------------------------------------------------------------------------- + + Discover is a product we are very excited about. I think it completes the other half of search. Search is -- we do our mission for our users and be helpful when they come to us looking for information. Discover is the other half, where we are proactively understanding what might be most helpful or relevant to them and getting it to them. And we definitely are focused on product quality and making sure the product is actually helpful to users. And when they engage with it, they find it useful. And it's definitely, we are making progress. Our investments in machine learning are helping as well. We are definitely able to better anticipate and give them information proactively. So over time, I see it as an important area for us, and it's done and closed. It's part of our search and knowledge efforts. And as we do that, you can imagine you may have started a query in search, and it's a session. Maybe you're looking to take a trip somewhere or you're researching a particular topic, we may be able to continue that session and the user journey in Discover, and that creates a virtuous cycle. So these are -- you want to be helpful to users in a way that makes sense for them more continually, and the combination of search and Discover helps us do that. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + And in terms of your question on sustainability, we're proud of the work that we're doing. We do think that it's a valuable part of what we do, and we do consider the impact on the business and on the financials. It really cuts across every element of what we do: what we're doing in our technical infrastructure; the way we're thinking about our products, as Sundar talked about; what we do with our facilities; what we're doing with AI. And I think it was about a year ago we talked about how we were applying machine learning to energy efficiency in our data centers, and it did have a net benefit. It helped us reduce energy consumption, not only positive for sustainability but was an efficiency effort. Sundar talked about the fact that we are investing -- recently announced that we are purchasing -- making a meaningful investment in renewable energy part of our commitment to offset 100% of our electricity use with renewables. And in our view, this is catalyzing further investments in renewables. That is going to have a modest short-term increase in cost, but we think it's beneficial to catalyzing the overall growth in traditional energy. So there are puts and takes, net-net, we are proud of the work across everything that we're doing to support sustainability. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill from Jefferies. +And our next question comes from Stephen Ju from Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [33] +-------------------------------------------------------------------------------- + + Sundar, I was wondering if you can put the quantum computing advancement into some sort of perspective. I mean the compute needs for Google has to be exponentially higher versus when you first launched. So we're wondering if this helps you get your arms around that ever-increasing compute need. And further, I think you'll find that investors are as impatient as you guys are for progress. So can you talk about what kind of products or services this will help you create that you otherwise wouldn't even think about doing before? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [34] +-------------------------------------------------------------------------------- + + I mean we're incredibly proud of the work that the team did and excited about that advancement in the whole industry. I think in general, obviously, we have relied on advances in computing to be able to do what we do. And when we look ahead, we definitely see being able to drive the pace of change here fastest is an important need for us as well as, I think, a source of competitive advantage. As Moore's Law effects have diminished, I think we are looking at a variety of approaches to make sure we can continue doing what we need to. And in that, this is an important tool in the arsenal. While quantum will take many years to really start making a difference, we want to be at the cutting edge of driving it. I do think over time for sure, cloud itself, we do see a lot of interest from cloud customers particularly in cutting-edge verticals about quantum computing. And so that's an area where I think we'll participate in as a business. And more importantly, applying it across other verticals we are in, be it health as an example, I think, will be where we will deliver value in the long run. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + And as much as we're extremely excited about the long-term implications for quantum computing, part of your question there about near-term computing requirements, given our outlook in particular across Google, we do expect to see ongoing demand for compute investments to support our growth particularly for machine learning, cloud, search and YouTube. And the primary driver of CapEx does continue to be our expectations for compute requirements, so investments in technical infrastructure as we talked about today. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question comes from Brent Thill from Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [37] +-------------------------------------------------------------------------------- + + Sundar, just on investments in GCP, you're in a really unique situation having both infrastructure and productivity applications. Can you just walk through how you prioritized the 2 big buckets? There's a lot of different ways you can go in GCP. And just want to follow up with Ruth. You'd alluded to some GC -- some G Suite pricing changes, and I know there were some prices that were changed earlier in the year. And I was just curious if you were referring to that price change earlier in the year or if there was something new. + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [38] +-------------------------------------------------------------------------------- + + I mean you're right. I mean these are 2 big buckets, and we treat them that way. Obviously, we talk a lot about GCP. But G Suite continues to be very differentiated. And we just announced a new leader, Javier Soltero, coming in with lots of experience to turbocharge this area as well. And in general, there are many G Suite customers with whom we are having GCP conversations and vice versa. So I think, in general, given we have a big go-to-market effort, the breadth you have allows us to have more conversations and engage through many different paths in the organization, so it's very synergistic as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [39] +-------------------------------------------------------------------------------- + + And in terms of the G Suite pricing, I was referencing the pricing that we announced back in April. It's all outlined in our blog post. Our view was it was the right time to increase prices given the ongoing functionality and tools that are included within G Suite. And as I said, what we're seeing here, as an addition to the benefit from the price change, we also continue to have nice seat growth. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [41] +-------------------------------------------------------------------------------- + + I think I'll ask on YouTube. Could you talk a little bit about your high-level OTT viewing strategy? Obviously, subscriptions are growing. And maybe give us an update on how your YouTube subscription product is doing versus expectations. And then on the paid click growth, it decelerated 18%. Anything to call out there especially related to YouTube? Any change to coverage going on or anything we should know about? + +-------------------------------------------------------------------------------- +Sundar Pichai, Google LLC - CEO [42] +-------------------------------------------------------------------------------- + + Subscription is an area we are definitely excited about. We are pleased with our option so far across both YouTube Music and YouTube Premium. They both -- they are now available in 71 countries, up from 5 markets at the start of 2018. So we are definitely scaling that up, and we are seeing great traction. YouTube TV is also doing well. I think we just announced that PBS is coming to YouTube TV in July. Last month, we announced YouTube TV is now launching on select Amazon Fire TV devices. So there is definite -- the user satisfaction on the product is very high, and so we're focused on continuing our expansion, building out a great service and building awareness for the service. So overall, I think engaging users with premium offerings on YouTube is a focus for us. And the efforts, while early, are definitely showing strong traction. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [43] +-------------------------------------------------------------------------------- + + And then you asked about click growth and the trend there. The biggest driver affecting the click trends continues to be the growth of YouTube engagement ads. As in the first and second quarter, the rate of YouTube click growth decelerated in the third quarter. That does continue to reflect the changes that we made in early 2018 to really improve the user and advertiser experience. And as we've talked about on prior calls, that did have an impact on click growth. But as we've also talked about, they weren't related to -- those changes in 2018 were not related to policy enforcement actions at YouTube. They had a negligible impact on YouTube revenues, so not a read-through. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any closing remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [45] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our fourth quarter call. Thank you again, and have a good evening. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2020-Apr-28-GOOGL.txt b/Transcripts/GOOGL/2020-Apr-28-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b30317da28996504f363c55d21048035914265a --- /dev/null +++ b/Transcripts/GOOGL/2020-Apr-28-GOOGL.txt @@ -0,0 +1,387 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Alphabet Inc Earnings Call +APRIL 28, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Sundar Pichai + Alphabet Inc. - CEO & Director + * Jim Friedland;Director of Investor Relations + - + * Ruth M. Porat + Alphabet Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Founding Partner & Senior Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Kevin Michael Rippey + Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by, and welcome to the Alphabet First Quarter 2020 Earnings Conference Call. (Operator Instructions) +I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Jim Friedland;Director of Investor Relations, - [2] +-------------------------------------------------------------------------------- +Thank you, Candice. Good afternoon, everyone, and welcome to Alphabet's First Quarter 2020 Earnings Conference Call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly go over the safe harbor. +Some of the statements that we make today regarding our business, operations and financial performance, including the effect of the COVID-19 pandemic on those areas, may be considered forward-looking. And such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. And in our Form 10-Q for the quarter ended March 31, 2020 expected to be filed with the SEC later today. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And I'll now turn over the call to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- +Thank you, Jim, and good afternoon, everyone. When I last spoke with you in early February, no one could have imagined how much the world would change and how suddenly. Our thoughts are with everyone who has been impacted by COVID-19, especially those who have lost loved ones or their livelihoods. It's a challenging moment for the world. Through it all, we are incredibly grateful for all of the essential workers on the front lines of this crisis: from health care workers and first responders; to the grocery store clerks and delivery workers; to teachers, grappling with new technology to help children learn remotely; to all the scientists and researchers working hard to develop vaccines and treatments; and many others who are leading through these difficult times. Thank you. These people fill us with hope and show us the power of human resilience. We'll need that energy and resolve in the months and years ahead. +Today, there is still a great deal of uncertainty regarding the path to recovery, but there are some things that we can understand better with the patterns we are seeing. For example, it's clear from data that people are being more cautious and are seeking authoritative advice and guidance to protect their families' health and safety. A return to normal economic activity depends on how effectively societies manage the spread of the virus. There is no one-size-fits-all, and the timing and pace of recovery will vary from location to location. This is a long-term effort. +It's also clear that this is the first major pandemic taking place in a digital world. Many parts of the economy are also able to continue with some semblance of normalcy, thanks to advances in remote work, online shopping, delivery options, home entertainment and telemedicine. At the same time, newer technologies like AI, Bluetooth exposure notifications and 3D printing are being used to help fight the disease head on. It's now clear that once the emergency has passed, the world will not look the same. Some social norms will change, and many businesses are speaking to us, looking to reinvent their operations. We have seen that the most pressing concern of small and large businesses right now is business continuity, solving for issues like employee safety, dramatic falls or surges in demand, supply chains and managing a remote workforce. Ultimately, we'll see a long-term acceleration of movement from businesses to digital services, including increased online work, education, medicine, shopping and entertainment. These changes will be significant and lasting. +Given the depth of challenges so many are facing, it's been a huge privilege to be able to help people and businesses at this moment. In today's call, I'll cover 4 areas. First, I'll mention some of the ways we have marshalled our resources and product development to help. Second, I'll talk about how people are using our products at this unprecedented moment. Third, I'll talk about our business, especially our advertising business, which was significantly impacted in the last few weeks of the quarter. And I'll close with our investment plans and focus for the rest of the year. +In the early days of the crisis, we were able to put in motion a number of efforts quickly. This is a testament to strategic areas where we have invested over recent years: products that people trust, our technical leadership and innovation, deep partnerships, a highly skilled workforce, and the scale and resilience of our operations. I've been proud of all these efforts and what they say about our company. I'll give just a few examples. +First, we've been working with health care providers, researchers, authorities and communities to help combat the virus. Our community mobility reports help authorities see and aggregate how social distancing requirements are working. Verily has tested thousands of people in California and has partnered with Rite Aid to bring free testing to 8 additional states. Google Cloud is forming deep partnerships such as with leading health care provider at CA Healthcare to understand data around ICU bed availability, ventilator supplies and test results. And you may have read about our exposure notification partnership with Apple designed specifically and carefully to protect users' privacy while helping public health authorities and governments manage countries reopening. +Second, we are working hard to provide accurate and authoritative information to people using our services. In Search, we have launched a number of features, such as up-to-date answers from health authorities and remote medical care options. On YouTube, we are quickly removing content that violates policy and raising authoritative content from news organizations and experts. Up to last week, our COVID-19 info panels have had 20 billion impressions. +Third, we are playing a role in supporting businesses and workers that are hurting because of the downturn. In March, we made a commitment upwards of $800 million to support small businesses and crisis response efforts through a combination of grants, small business loans and ad credits. And the Google News initiative is offering financial support to thousands of small, medium and local news publishers through a journalism emergency relief fund. We've also waived ad serving fees for news publishers globally on Ad Manager for the next 5 months. +Turning to the way people are using our products. People are relying on Google services more than ever. This is a strong recognition of the value of our products, particularly in important and urgent moments. As a few examples, we have seen a significant rise in search activity. To put it into perspective, in the U.S., coronavirus-related search activity at its peak was 4x greater than during the peak of the Super Bowl. People are spending significantly more time on their Android apps with downloads of apps from Google Play, rising 30% from February to March. YouTube watch time has also significantly increased. One area in particular is live streams. I hope you saw Andrea Bocelli on YouTube live on Easter, which has had over 39 million views, and it was truly beautiful. 100 million students and educators are using Google Classroom, double the number from the beginning of March. We've seen a massive increase in demand for Chromebooks. Analysts have reported a 400% increase during the week of March 21 year-over-year. And schools and businesses in particular, are using our secure video conferencing platform, Meet. Last week, we surpassed a significant milestone and are now adding roughly 3 million new users each day and have seen a thirtyfold increase in usage since January. There are now over 100 million daily Meet meeting participants. Stay tuned for much more. +Turning to our business. Let me touch on our performance this quarter. Q1 was, in many ways, the tale of 2 quarters. For our advertising business, the first 2 months of the quarter were strong. In March, we experienced a significant and sudden slowdown in ad revenues. The timing of the slowdown correlated to the locations and sectors impacted by the virus and related shutdown orders. As the impact of COVID-19 came into view, we delayed some ad launches and prioritized supporting our customers as many adjusted their strategies. We are focused on products where we can help most advertisers and merchants during the crisis. For example, under our new leader of commerce, Bill Ready, last week, we announced that merchants can list products in Google Shopping for free. It's been widely rolled out in the U.S., with more countries to come, and the response has been positive. Overall, recovery in ad spend will depend on a return to economic activity. +There are 2 key aspects of our business that give us confidence about the future. First, as we saw after 2008, one of the strongest features of Search is that it can be adjusted quickly, so it's relatively easier to turn off and then back on, and marketers see it as highly cost-effective and ROI-based. Second, our business is more diversified than it was in 2008. For example, cloud. In the public sector, we are helping governments deliver critical health and social services. We are supporting the state of New York's new online unemployment application system as it deals with a significant increase in demand. +In retail, we have helped Loblaw, one of Canada's largest food retailers, and Wayfair, scale to support exponential traffic increases. We are helping communication companies adapt to new behavior patents. Vodafone is using Google Cloud platform to help it analyze network traffic flows to keep everyone connected, and we are helping energy technologies keep real-time online games stay up and running. Institutions like Lloyds Bank are digitally transforming their businesses, and we are helping even more businesses do the same through new partnerships with Accenture, AT&T and T-Systems. We now have more than 6 million paying G Suite customers. G Suite is helping Netflix and German manufacturer, KAESER KOMPRESSOREN, transition quickly to remote work; while Twitter, Shopify, retailer Schnucks and Italian bank, Credem, are using Meet for things like all hands and customer meetings elsewhere across the business. +YouTube subscriptions continue to grow. The team has launched YouTube Kids in 15 new countries around the world since the beginning of the year and rolled out new features to make kids-focused channels safer. Android previewed Android 11, which includes seamless 5G connectivity and a smarter keyboard with a faster messaging experience. And as I mentioned, we have seen significant growth in Play. There are now over 2.5 billion monthly active Play devices worldwide. And in hardware, we saw a decline in device activations in the quarter due to falling consumer demand globally. But I'm excited about the product road map ahead for the year, including yesterday's launch of Pixel Buds 2. +Finally, moving on to our focus for rest of the year. We are taking a long view and continuing to invest in our long-term priorities, but are being thoughtful in the short term. So we made the decision to slow down the pace of hiring for the remainder of 2020, while maintaining momentum in a small number of strategic areas. We are also recalibrating the focus and pace of our investments in areas like data centers and machines and nonbusiness essential, marketing and travel. We'll also continue to thoughtfully manage our Other Bets portfolio. Waymo raised $2.25 billion in its first external investment round, a terrific validation of their technology and long-term business model. Wing saw a surge in deliveries and new users, increasing its daily volume fivefold with great momentum in test programs in Australia and Virginia. +At Google, we'll continue to be focused on the 4 key areas that I outlined in the last earnings call. First, creating the most helpful products for everyone, particularly at a time where people rely on us for information, work, education and entertainment. +Second, providing the most trusted experiences for our users. This includes our efforts to tackle misinformation and digital threats as well as our work to safeguard consumer privacy. +Third, executing at scale. I've been proud of how we continue to work so cohesively and productively, even with the distributed workforce. We'll continue to build on the internal tools, support systems and infrastructure we have built over the years. +And finally, creating sustainable value. We'll be optimizing the way our data centers work and prioritizing strategic areas of investment where we need to support our users and partners. +Let me express my thanks to our employees for their herculean efforts under these difficult circumstances. While the road ahead for everyone is uncertain, we'll continue to support our users, communities and partners, and we'll all emerge together from this moment. Thank you, and please take care, everyone. +Over to Ruth. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Sundar. Our results for the first quarter are a tale of 2 quarters, with strong results across our revenue lines for January and February, followed by an abrupt decline in March in our advertising revenues as governments globally instituted stay-at-home orders in response to COVID 19. At the same time, even through March, our non-advertising revenue lines maintained their strong performance, particularly Google Cloud. I'll provide more details on the impact of the crisis as I review the Google segment revenue results and conclude with an update to the outlook that I shared on our fourth quarter call. Sundar and I will then take your questions. +Starting with consolidated Alphabet results. In the first quarter, our total revenues were $41.2 billion, up 13% year-on-year and up 15% in constant currency, driven by Search, YouTube and Cloud. Details of Alphabet's consolidated revenues by geographic region are available in our earnings press release. In short, advertising results reflect, in large part, the nature and timing of actions around the globe in response to COVID-19. The decline in APAC was more muted than what we have seen in the rest of the world given the uneven impact of COVID as well as the composition of our revenues in the region. The impact in the rest of the world began later and was more acute by the end of the quarter. In terms of the foreign exchange impact, exchange rate movements resulted in a modest headwind to reported revenues. +Regarding our key expense lines, on a consolidated basis, total cost of revenues, including TAC, was $19 billion, up 19% year-on-year. Other cost of revenues on a consolidated basis was $11.5 billion, up 26% year-over-year, primarily driven by Google-related expenses. The biggest factors here again this quarter were costs associated with our data centers and other operations, including depreciation; and then content acquisition costs, primarily for YouTube's advertising-supported content; followed by content costs for YouTube TV and our paid YouTube Music and Premium subscription services. Operating expenses were $14.2 billion, with head count growth being the largest driver of year-on-year growth for R&D and sales and marketing expenses. For G&A, the biggest driver of expense growth was attributable to a reserve for estimated credit deterioration as a result of COVID-19. +Stock-based compensation totaled $3.2 billion. Headcount was up 4,149 from the fourth quarter. Again, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable head count increases were again in Google Cloud for both technical and sales roles. Operating income was $8 billion, down 4% year-over-year, excluding the impact of the EC fine in the first quarter of last year for an operating margin of 19%. Other income and expense was a loss of $220 million, driven primarily by losses in equity securities. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 11.9%. Net income was $6.8 billion, and earnings per diluted share were $9.87. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $6 billion, which I will discuss in the Google segment results. Operating cash flow was $11.5 million with free cash flow of $5.4 billion. We repurchased $8.5 billion of our shares. We ended the quarter with cash and marketable securities of approximately $117 billion. +Let me now turn to our segment financial results. Starting with our Google segment. Revenues were $41 billion, up 14% year-over-year. I'll now go through the individual advertising revenue lines. Starting with Google Search and other advertising revenues. We generated $24.5 billion in revenues in the quarter. That was up 9% year-over-year. This reflects strong year-on-year growth for the first 2 months of the quarter. In March, revenues began to decline and ended the month at a mid-teens percentage decline in year-on-year revenues. Although users' search activity increased, their interest shifted to less commercial topics. In addition, there was also reduced spending by our advertisers. YouTube advertising revenues were $4 billion, up 33% year-on-year. Significant YouTube revenue growth persisted until late in the first quarter, with different performance trajectories for the brand and direct response components. Direct response continued to have substantial year-on-year growth throughout the entire quarter. Brand advertising growth accelerated in the first 2 months of the quarter but began to experience a headwind in mid-March. As a result, by the end of March, total YouTube ads revenue growth had decelerated to a year-on-year growth rate in the high single digits. +Network advertising revenues were $5.2 billion, up 4% year-on-year, with healthy year-on-year growth for the first 2 months of the quarter. We ended March at a year-on-year percentage decline in network revenues in the low double digits. +Turning to Google Cloud, including GCP and G Suite. Revenues were $2.8 billion for the first quarter, up 52% year-over-year, driven by significant growth at GCP and ongoing strong growth at G Suite. Once again, the growth rate of GCP was meaningfully higher than that of cloud overall. GCP growth was led by our infrastructure offerings and our data and analytics platform. We're pleased with the ongoing growth in G Suite, which continues to reflect growth in both seat count and average revenue per seat. +With respect to the implications of the global crisis for Google Cloud, we're proud of the accelerated traction we achieved across sectors, including public sector and health care for disease monitoring and control, working with leading retailers on demand forecasting, working with companies across media and communications to enhance their customer service and across industries on supply chain optimization. +In the first quarter, other revenues were $4.4 billion, up 23% year-over-year, primarily driven by growth in YouTube non-advertising revenues and Play. YouTube's contribution to other revenues benefited from subscriber growth across its various offerings. Within Play, app revenues continued to benefit from strong growth in the number of active buyers in the first quarter. In addition, in the latter part of the quarter, we started to see an increase in user engagement in apps as well as in digital content. Total traffic acquisition costs were $7.5 billion or 22% of total advertising revenues and up 9% year-over-year. Total TAC as a percentage of total advertising revenues was down slightly year-over-year, reflecting once again a favorable revenue mix shift from network to Google properties. Google operating income was $9.3 billion, up 1% versus last year, and the operating margin was 23%. Google accrued CapEx for the quarter was $5.7 billion, reflecting investments in data centers, followed by servers and office facilities. +Moving on to the performance of Other Bets. For the first quarter, revenues were $135 million, primarily generated by Fiber and Verily. Operating loss was $1.1 billion for the first quarter. +Let me now conclude with our thoughts on the impact of the global crisis on our revenues and investments, including an update on the outlook I shared on our fourth quarter earnings call. +We remain optimistic about the underlying strength of our business over the long term. On a daily basis, our products play an important role for consumers and businesses globally. This has been evident throughout the crisis and the usage metrics that Sundar referenced earlier. We're humbled that users continue to turn to us as much as they do at a time of global need and uncertainty. We take that responsibility very seriously. Users clearly are depending on us to provide useful and accurate information. They are looking to YouTube for information, education and entertainment constantly as they study, create and work from home. They are using our G Suite products to collaboratively communicate, connect and work. Although users may not be focused as much on purely commercial activities right now, over the long term, the value we provide to billions of users globally serves us well. Our previous investments in technical infrastructure ensure that we have the capacity and resilience to meet the increased demand from our users in this extraordinary time. We are redoubling our efforts to help our advertising customers and partners by sharing insights and developing new tools to keep them connected to their customers and help them be best positioned for recovery. +In terms of more specific product points, I will start with search advertising, where our financial results are driven in part by users' search behavior. At the inception of the crisis, the increase in user interest was for information about COVID-19 and related noncommercial topics. Although we have seen some very early signs of recovery in commercial search behavior by users, it is not clear how durable or monetizable this behavior will be. In order to gauge the ongoing potential financial impact to our business from COVID-19, a key signal to monitor is macroeconomic performance, which is tended to be correlated with advertising spend. As of today, we anticipate that the second quarter will be a difficult one for our advertising business. As we move beyond the crisis and the global economy normalizes, this should be reflected in our advertising revenues, but it would be premature to comment on timing, given all the variables here. +In terms of Google Cloud, we remain very pleased with the execution by the team. Reflected in the ongoing pace of customer adoption of both GCP, industry-specific solutions and G Suite collaboration tools to help businesses operate efficiently and effectively. +Moving on to profitability. While TAC and content acquisition costs are obviously tied to revenues, there is a sizable percentage of items in other cost of revenues that are generally less variable in nature, such as depreciation and operations costs of our technical infrastructure as well as for activities like customer support and content review. Much of our operating expense is also not directly correlated to changes in revenues. Given that we are faced with a global crisis of uncertain depth and duration, we have been focused on taking steps to enhance efficiency, including slowing the pace of hiring and some categories of marketing spend as well as further enhancing machine utilization. More specifically, with respect to the pace of hiring, last quarter, I indicated that the rate of head count growth in 2020 would be slightly higher than the 20% growth in 2019. We now anticipate a deceleration in head count growth that should start to be visible in the third quarter and continue into the fourth quarter. Although we are focused on these and other steps to moderate the overall pace of investment, we remain committed to the long-term opportunities for which we are well positioned. So we will continue to invest in these areas, including Search, machine learning and Google Cloud. +Finally, with respect to CapEx, on the fourth quarter call, we shared our expectation that investments in both technical infrastructure and office facilities would increase compared to 2019. We now anticipate a modest decrease in the level of total CapEx in 2020 compared with last year. The biggest change in our outlook is a reduction in global office facility investments due to both the need to pause most of our ground-up construction and fit-outs in response to COVID-19, and our decision to slow down the pace at which we acquire office buildings. In terms of technical infrastructure, we expect a moderate reduction to our forecast relative to the beginning of the year given the impact of COVID-19 on data center construction delays as well as the benefit of our ongoing focus on server efficiency. Overall, we anticipate technical infrastructure investment to remain at roughly the same level as in 2019, with relatively more spend on servers than on data center construction. Thank you. +And Sundar and I will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Our first question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- +Hope all is safe and well with everyone on the team there at Alphabet. Two questions, if I can. One, on the comment with respect to direct response advertising on YouTube, would love to get a little more color on how direct response advertising as ad units continue to evolve and perform and how advertisers are using those ad units as part of their broader advertising goals. And then maybe, Ruth, for you. On the comment on expenses, I just want to understand a little bit of how much of what your messaging on expenses is efficiency gains that you were aiming for in 2020 before we got to COVID-19 versus elements of the cost structure that you're reexamining as a result of the pandemic. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- +Eric, thanks for the wishes. We, on YouTube direct response, we've definitely seen traction there. I think an area where it really for example, is app installs. That's a great example of it. Gaming is another good example of it. So to -- and we are working on iterating and making the formats work better so that it applies to more context as well. But in general, I think businesses are learning to adapt. Obviously, we've had great success with Search. And so we're bringing a lot of those learnings and we are sharing it with our customers. And so we expect to see more traction there over time. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- +And on your second question, I like the way you framed it. Yes, we do have efficiency efforts that we started that we had going as we enter this year. But as a result of what we're seeing in the environment, our view was that we should really double down on those. And so when we go through the various areas that I mentioned, we had started the year with an expectation about really optimizing head count around the various areas. What we've determined is we're going to, at this point, slow the pace of hiring. To be very clear, we are continuing to hire, but we are slowing the pace of hiring. And that's helping as we're driving a deeper look into how do you optimize within each area. +The same is true, for example, in some of the comments on marketing, we are continuing to invest in marketing. As you know well, sales and marketing line, the majority of it is head count-related, and we do continue to invest here in ads, and in particular, in cloud. As it relates to the marketing component, namely ads and promo spend, we did reduce it relative to our plans in the beginning of the year, and we continue to have a healthy budget for ads and promo, particularly in digital, to support many business areas. But as with the other areas of investment, we're really focused on optimizing across products and services. And with physical events canceled for much of the year, marketing spend is also reduced. And so that's another example. With machines and servers. We've been focused on efficiency of the fleet for some time now. This is giving us the opportunity to push that even further. +So we're looking at the operating environment and saying we should continue to lean into the efficiency programs we can. It does help us free up some resources for the growth areas that continue to be a priority, but it is an accentuation of where we were. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +And our next question comes from Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [6] +-------------------------------------------------------------------------------- +One for Sundar, one for Ruth. First, Sundar, you just talked about how once the crisis has passed, the world will not look the same. I'm curious if you can just elaborate a little bit more on how you think Alphabet comes out stronger on the other side of this downturn. And then, Ruth, maybe taking the question on expenses a little bit further. Does this give you any more opportunity to be even more disciplined or diligent on costs on the other side as well? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [7] +-------------------------------------------------------------------------------- +Thanks, Doug. It's a good question, and we are thinking deeply about it as well. In general, I would say, the highest level of opportunities across everywhere, we see businesses thinking deeper about the shift to digital. And that's true across marketing, cloud, in every place we see that trend. And so part of this is making sure our investments deliver value with respect to that shift. So if you look at advertising, people who in the past may have debated things like how do I get virtual showroom-ing, now, are really thinking about it. People who may have been hesitant to shift their budgets do -- are looking through moments like this and trying to get all that working better. Cloud is an obvious area. Every company has been thinking about digital transformation, but they are asking the questions deeper. For example, if you have data centers, there are fixed costs through something like this. And you learn going through a moment like that, and you're thinking about the opportunity harder. So across everything we do, be it Search, be it YouTube, be it Play, be it Cloud, I think we are investing to capitalize on this long-term opportunity. And I would say, overall, on Alphabet as well, when you look at investments like Waymo and Bing, you can imagine, in the future, these things working well, can play a significant role. And even in the limited areas of [Ingesan], we clearly saw its potential through a moment like this. So we're betting on those big trends. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [8] +-------------------------------------------------------------------------------- +And to your other question, if I understood it correctly, you're asking about the durability of some of the efficiency efforts. I think that the way I would answer that is after a decade of growth, there have to be opportunities for added efficiency, and we've been focused on that for some time. But painful times like this put a spotlight on an urgency around taking -- making sure you're focused on the levers that you have and, hopefully, those instill the right kinds of health metrics, et cetera, against what you're managing. So I would say that the intent most certainly is that these are durable investments to ensure that we're operating as effectively and efficiently as we can be. And I just need to reiterate, and Sundar and I have both said this, we remain committed to investing for the long term. So we're not compromising where we need to invest for long-term growth. We're trying to make sure that each dollar of investment is well managed. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +And our next question comes from Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [10] +-------------------------------------------------------------------------------- +Great. Ruth, I have 2 questions for you, actually. First, I wanted to thank you for the color around the growth you're seeing as you were exiting the quarter in the ad business. And there's been some signs from different partners or different companies that ad spending, while still down considerably, has actually improved a little bit, maybe some green shoots from the declines that you might have been referencing at the end of March. Any chance you can give us a sense of the type of growth you've been seeing for the first kind of 3, 4 weeks of the quarter, just kind of just to help level set us. And then just in regards to the provision you mentioned in G&A related to credit deterioration. Is there a chance you could tell us the amount of that provision? And do you expect to have to do this again in the second quarter? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [11] +-------------------------------------------------------------------------------- +Thank you for those. So in terms of ads revenue, as I said in the opening comments, for our ads business, a key signal to monitor is macroeconomic performance, which has tended to be correlated with ad spend. And I think it's premature for me to comment on the trend. In terms of what we saw in the first quarter, as I said, for Search and other revenues, they were up 9% year-on-year for the quarter. But in March, revenues began to decline and then ended the month at a mid-teens percentage decline in year-on-year revenues. And then with YouTube, we had strong revenue growth until late in the quarter when trajectories for direct response and brand diverged. And as I said, direct response does continue to have substantial -- had substantial growth throughout the quarter, while brand began to experience a sizable headwind starting in mid-March. So by the end of March, total YouTube ads revenue growth had decelerated to a year-on-year growth rate in the high single digits. +And then for the second quarter, so far, I think it's premature to gauge given uncertainty in the environment. And a few weeks, obviously, is not a quarter. So in such an unprecedented crisis, I would not want you to extrapolate from just a couple of weeks. That being said, the decline in our search and other ads revenue was abrupt in March. And although we're seeing some early signs at this point that users are returning to more commercial behavior, it's not clear how durable or monetizable that will be. So based on our estimates from the end of March through last week, for Search, we haven't seen further deterioration in the percentage of year-on-year revenue declines. For YouTube, direct response has remained strong. However, we've seen a continued decline in brand advertising, and it's really too early to add more. I think the main point, though, is a few weeks, obviously, is not a quarter. And given it is such an unprecedented environment, I would not extrapolate from these comments for the full quarter. +And then I'm sorry, you have the second question on the... + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [12] +-------------------------------------------------------------------------------- +The G&A -- sorry, that was very helpful. And then just the G&A that you mentioned, the credit provision that you said you took. I just was wondering if you could share the amount. It might be in the Q later tonight, but wondering if you could share with us the amount on the call. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- +It will be in the Q later -- it will be in the Q later tonight. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +And our next question comes from Michael Nathanson from MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Founding Partner & Senior Research Analyst [15] +-------------------------------------------------------------------------------- +I have one for Sundar and one for Ruth. Sundar, people asked you about your priorities. You talked about it. But I wonder, if you could back and think about what this crisis will do to the other side and maybe for reorienting of your priorities. So perhaps where you would shift spend in the long-term to maybe take advantage of where this is going. +And then, Ruth, we appreciate the color on YouTube. Just want to dig in some more. If you can give us any sense of YouTube geographies. Is there any difference by change by geography? That's really helpful, too. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [16] +-------------------------------------------------------------------------------- +In terms of overall priorities, I would say we've always taken a long-term view through -- on thinking through the arc of where things are going, and our deep focus on AI is an example of that. And we've been convinced for a while that those trends will play out in the long term. And so if anything, through moments like that, the strong foundation we have built allows us to continue to be able to invest in our long-term area. So AI is a good example of it. +The shift over time on computing to ambient computing is something we are going to be deeply committed to and continue to invest there. Cloud and productivity software for businesses of all sizes is a deep area of investment. And so the thesis still remains. So we continue to focus anywhere we think the actual work we are doing is based on deep technology, deep computing, deep computational scale, is the kind of investments we think still stand the test of time through things like that. +Beyond that, we are actively looking at how user patterns are emerging. So for example, e-commerce is an area, and you saw us respond through this with the changes we announced on our shopping property and going for comprehensiveness there and with new leaders in place. We're going to be making sure we work on the user experience there. And so we are looking at shifts, be it video conferencing with Google Meet and G suite. And adapting and investing in those areas as well. So that's how we're approaching it. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- +And then in terms of the geographic breakdown for YouTube, we haven't broken that down, although I think, as you know well, we have a breakdown for the major regions around the world. And to give you a little more color there in mid-February, revenue growth across the business began to decelerate in APAC. Although as I noted, the decline in APAC was more muted just given the uneven impact of COVID and the nature of our business across the region. And then the impact in EMEA was first evident in mid-February with a steeper fall off in March. And in the second week of March, we then saw results in the U.S. as well as other Americas fall off shortly. But nothing more specific by product. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +And our next question comes from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [19] +-------------------------------------------------------------------------------- +I have two. The first one, Ruth just to go back to your comments around the early signs of improvements in behavior in Search. I know it's early and don't want to over extrapolate, but just any more detail on the types of behavior you're seeing of which verticals or which categories or which geographies where you're seeing sort of the first sign of green shoots on the Search side. +And then Sundar, just to go back to your comments about the shift toward digital opportunities or digital transformation. Maybe talk to us about, as you sort of look back over the last couple of years at what you've done on the SMB side, and what are sort of 1 or 2 of the key hurdles where you see you really need to invest and build more comprehensive SMB products for post recovery? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- +Maybe I can give color both on the SMB and a bit on that side, too. On the SMB side, it's an area we've been investing for a while, and obviously, we have assets both across AdWords, Google Maps, Google My Business and, obviously, providing them with G Suite and the tools to get their business running. So I do think we have a lot of touch points. But the focus has been simplifying it, making it more of a one cohesive, easy experience, making sure it works well from mobile, that there is a truly lighter-weight AdWords experience so that they can get onboarded quicker. And so reducing the work they need to, and also, over time, bringing technologies like AI to just make it all much simpler and seamless for them. And it's going to be a continued focus for us and especially scaling this up and making sure it works internationally well as well. We have clear metrics and targets internally, and we are aligning the teams better to get there. And you will see us do more. +On the ad side, a question -- to your question about maybe I can give more qualitative cover to what Ruth said earlier. And we -- the good thing about search ads and direct response on YouTube as well, but search primarily, is that it's an extraordinarily effective system. It's a transparent system. You have a very clear sense of ROI. It's very measurable, highly cost effective. And so we have always seen, and we saw this in 2008 as well. People respond in the short term, but the recovery is also fast when it comes back, and so it tends to work. It is very diversified, not just geographically by different verticals. And even through moments like that, we do see businesses responding to demand shift. And so we see through our system if people suddenly are looking for office furniture or even pajamas, the system response, right? And so you see the dynamic nature of it. I mentioned earlier, people are really thinking about the shift to digital. So Philipp and our ads team are super engaged with our customers, helping them think through the opportunities through moments like that. I gave an earlier example. If you're thinking about cars and you've been hesitant to do virtual car showroom-ing, now is the time you're beginning to have those conversations in a deeper way. +There are budgets which are shifting in certain cases. Some of our large customers, maybe they've spent a lot of money on live sports. That is clearly on hold. So they are looking to shift some of those budgets into opportunities they see. But having said that, there are large sectors of the economy which are affected, things like travel and our large partners and customers are impacted. And so we clearly see the impact of that, and that's the color Ruth gave as well. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +And our next question comes from Brent Thill from Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [22] +-------------------------------------------------------------------------------- +I'm curious if you could just give us a little more color across SMB and Enterprise, any common threads that you saw between those 2 segments? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [23] +-------------------------------------------------------------------------------- +Maybe -- we have had tremendous momentum on G Suite. And if we can -- all of Google works this way. Products like Gmail, Google Docs, they're built from the ground up to really help people be productive and collaborative in a distributed work environment. And so we are clearly seeing traction there. Google Meet is seeing great traction. And I gave -- I mentioned some user momentum there. But we have more announcements coming up, including later this week. And so we are seeing tremendous traction and engagement on G Suite. On Cloud, the shift to digital has been a deep trend. And if anything, people are really engaged on it. I earlier talked about, you can imagine if you're a customer and you have data centers, these are fixed costs when you go through moments like this. And so people are really looking at opportunities there. And so our teams are super engaged. But I do want to acknowledge, maybe -- the small businesses across the world are deeply impacted. As a company, we've announced several efforts to support small and medium businesses, and we are going to be deeply engaged with them. But I think it's a tough journey we are all on, and we look forward to working with them to help them through this. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from Dan Salmon from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [25] +-------------------------------------------------------------------------------- +Sundar, I wanted to return to those long-term initiatives that you walked through earlier and the 1 that was most close to your core business and the changes that you -- were announced this week for Shopping. Could you explain a little bit more about the reasons for making those changes and expanding the free listings or creating the free listings, and what drove you to make that decision now? +And then a related follow-up for Ruth, same question essentially. But as we think about the financial impact of such a change, I imagine this is one of those things which may qualify as causing maybe some variability in the quarter-to-quarter rate, but something that benefits all parties over the long term, I think, is how we've often visited these sorts of changes. But any color you could add on sort of the near and the long-term impact of the Google Shopping changes would be great, too. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [26] +-------------------------------------------------------------------------------- +So going through a moment like this, it's very clear, part of what makes Google work well is people come across a diverse range of needs. And that's true for Shopping. They spend time discovering. And comprehensiveness really matters. That's how we can have a great user experience. And so as we've been thinking about the space, we realized, and this is our organic search works, for us to truly give that comprehensiveness and the quality of experience, we need the widest catalog possible. And then we are good at ranking it and providing -- and matching users to what they're looking for. And so it is -- it made a lot of sense for us. And just looking through the range of experiences people were seeking through the COVID pandemic validated it even more. And obviously, we have been executing really hard there with new leadership in place. And so we saw the opportunity to go back to our first principles and improve the comprehensiveness there. +One of the tricky things about when you do that is making sure you don't have spam and you're managing and giving people good quality experiences. And that's where our deeper partnership, be it with PayPal and other providers, so that we get the quality signals and really improve the experience as we improve comprehensiveness. So both of them are going hand-in-hand. And as we've demonstrated with Search, when we improve the organic experience, the advertising experience also gives an opportunity and the system works well. And so I'm really excited about this change. It is still early, and -- but it's been very positively received. And you're going to see us enhance the experience in this area deeply. +While we talk about Shopping, another area where we are investing and building the right foundation is with Google Pay. And we have great leadership there as well. We've been executing well over there for the past year. And the growth on Google Pay has been strong. And so being able to bring all of that together, along with strong players like PayPal, et cetera, will help us give great experience for our users here. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- +And in terms of your question about the financial implications of the effort, there's really not much to add here today. I would just say -- reecho Sundar's comment, we're excited to have Bill leading the effort. And as Sundar said, at the outset, 1 of the priorities is creating sustainable financial value, and we have a leader who has a demonstrated track record of doing that. So we're excited about what he is building here with the team. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +And our next question comes from Justin Post from Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [29] +-------------------------------------------------------------------------------- +Great. Appreciate all the advertising updates in March. Just wondering, your cloud growth was obviously quite stable in the low-50s. Any impact in March on workloads or a slowdown in the new customer pipeline? And then maybe, Sundar, if you could talk about what be the benefit for cloud as we get to the other side of this, more work from home, or just other things and secular changes in cloud that might come about from this. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [30] +-------------------------------------------------------------------------------- +Overall, on cloud, the interest and the momentum remains strong. We are obviously making a lot of progress both across GCP and G Suite. And we find our offerings are getting deeper, and we are really helping customers from a deeper standpoint. So we see overall momentum. There are cases where even though the deal trajectory is the same and we have the wins, things are taking a bit longer. Naturally, as you would expect, our customers are impacted through moments like this, too. So I would say time to closing some larger deals are impacted. But companies, if anything, all the way at a CEO level, are thinking about the shift to digital in a deeper way. And I think that's a longer-term trend we are excited about. Obviously, consumption gets impacted, depending on the sectors which companies are in. And so that has some correlation with the general underlying performance of that sector. And so that's something we'll have to wait and see how it develops. But the teams are doing well, and it's an area where we are committed to the course we are on and investing deeply for the long run. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- +And you asked about kind of Q2, nothing to highlight there. Just to reiterate what Sundar said, we're really pleased with the Q1 performance for both GCP and G Suite, and the dynamics affecting cloud are obviously very different than those from ads. And just to build on Sundar's comments with a little more on G Suite and some of our opening comments. In this work from home environment, what we're seeing is significant interest from governments and companies looking for work-for-home solutions. So just to add one more example, Cambridge Health Alliance is a U.S. health system with 140,000 patients. And they relied on G suite to support their staff and caregivers during COVID-19, helping them connect across hospitals, health centers that are from home. And it's just yet another example of how we're able to be present, helpful, useful in this time. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +And our next question comes from Kevin Rippey from Evercore ISI. + +-------------------------------------------------------------------------------- +Kevin Michael Rippey, Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research [33] +-------------------------------------------------------------------------------- +One for Sundar and then one for Ruth. Sundar, the question for you really relates to the resiliency you're seeing with the direct response piece of YouTube. Like, are there specific factors? Or is it a question of mix of advertisers there that's sustaining the growth? +And then the question for Ruth, you highlighted that this has given you an opportunity to refocus on cost discipline. It looks like that the capital returns by way of buyback will remain quite strong in the quarter. Has this affected your thoughts on buybacks and capital returns going forward? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [34] +-------------------------------------------------------------------------------- +Maybe stepping back, I would say we are overall seeing strong momentum on YouTube. People are turning to YouTube. Our watch time has increased across the board. People are also looking for authoritative news content. Viewership on YouTube has increased significantly compared to last year, too. So in many ways, through the pandemic, people are using YouTube, and the trends are global across North America, EMEA and Asia Pacific as well. +On direct response, I do think -- I think people are -- it's a journey, and people who have been investing or seeing that it is cost effective. And so over time, more people are looking at it. Our sales teams are doing an excellent job of helping our customers understand the opportunities there. And so being able to bring all of that to bear. In the case of app campaigns, we have done it with universal app campaigns. So we've just made it easier as a customer, not to think about whether you're trying to do this across Search or YouTube, and bring the simple holistic solution. So all of that is impacting. I mentioned gaming earlier. When you think about things like unboxing and product reviews, those are natural home for transactions as well. Now I earlier mentioned about all the work we are doing now on commerce. All of that, I'm looking forward to those integrations coming into YouTube and working better as well. And so those are some of the longer-term opportunities. We are working hard to get the experience right and building the right foundation for the future. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- +And then on your second question on capital returns, we believe a share repurchase program for us, appropriately sized, is responsible in the current environment based on our capital allocation framework and our cash balance. So at the beginning of the year, I indicated that we expected to repurchase shares at a pace at least consistent with the fourth quarter on the remaining authorization, and that remains our view for the second quarter. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +And our final question comes from the line of Mark Mahaney from RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [37] +-------------------------------------------------------------------------------- +In terms of the maybe less worse or somewhat positive trends at the end. You mentioned this recovery or modest move up in consumer commercial search queries. Have you also seen a small improvement in advertiser interest in running campaigns. I think you said both of those factors kind of deteriorated in March. One of them came back. Did the other come back, too? You also see advertisers starting to come back. +And then secondly, the YouTube result in the March quarter was phenomenally strong given what happened in the month of March to YouTube. Is that a comp issue? Was the comp much easier? It sounded like January and February could have been up strong 40% year-over-year. So is there any color? Is that just comps, easy comps? Or was there something that fundamentally changed that caused that kind of material acceleration? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [38] +-------------------------------------------------------------------------------- +So as I tried to be really clear in my response to Heather's question, I would not extrapolate from my comments for the full quarter. It's early, just giving you an early read, and there's really not much more to add than what I indicated. So nothing more to add there. And then in terms... + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [39] +-------------------------------------------------------------------------------- +Maybe just reiterate what Ruth said earlier and I said, that search tends to -- people respond to changes in search faster, brand trails. So brand is maybe slower to change, both on the downside and the upside, and search is much faster to adapt as well. And so I think that's worth keeping in mind. But overall, look, we see a vibrant system. Advertisers are definitely very engaged in looking at it. And we are seeing active conversations between our teams and our large advertisers where they're trying to understand the demand shifts and how they can respond. And so overall, I see the -- both from users, users that are engaging with Google, YouTube and our core products and services. And while, obviously, there's an impact on the economy and we are not immune to that, the engagement from advertisers across our products and with our teams has been very robust. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any closing remarks. + +-------------------------------------------------------------------------------- +Jim Friedland;Director of Investor Relations, - [41] +-------------------------------------------------------------------------------- +Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter 2020 call. Thank you, and have a good evening. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2020-Feb-03-GOOGL.txt b/Transcripts/GOOGL/2020-Feb-03-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..7d0676f669dbbaaeb21650984b53d3c7440bbb75 --- /dev/null +++ b/Transcripts/GOOGL/2020-Feb-03-GOOGL.txt @@ -0,0 +1,477 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Alphabet Inc Earnings Call +FEBRUARY 03, 2020 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ellen West + Alphabet Inc. - VP of IR + * Ruth Porat + Alphabet Inc. - Senior VP & CFO + * Sundar Pichai + Alphabet Inc. - CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Stephen D. Ju + Crédit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Kevin Michael Rippey + Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research + * Benjamin Wheeler + RBC Capital Markets, Research Division - Associate + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Alphabet Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) +I would now like to hand the conference over to your speaker today, Ellen West, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Candace. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2019 Earnings Conference Call. With us today are Sundar Pichai and Ruth Porat. +Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward-looking, and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. +And now I'll turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Ellen, and good afternoon, everyone. It's a privilege to join the call as the CEO of both Alphabet and Google after 4 years as CEO of Google. I'd like to start by thanking Larry and Sergey for giving all of us at Google a timeless mission, endearing values and an opportunity to have an impact on the world. +There's a lot I want to cover today, and I also want to leave plenty of time for any questions you may have for me and Ruth. As you've seen in our press release, we've added new revenue disclosures to give greater insight into our business. Search and other Google properties continue to drive great results with total revenues in 2019 of $98 billion and strong growth. I'm also really pleased with 2 of our newer growth areas. YouTube reached $15 billion in ads revenues in 2019, growing at 36% compared with 2018, and it now has over 20 million music and premium paid subscribers and over 2 million YouTube TV paid subscribers, ending 2019 at a $3 billion annual run rate in YouTube subscriptions and other nonadvertising revenues. Google Cloud ended 2019 at a more than $10 billion run rate, up 53% year-on-year, driven by significant growth in GCP. The growth rate of GCP was meaningfully higher than that of Cloud overall, and GCP's growth rate accelerated from 2018 to 2019. +Before I talk about the highlights of the quarter, I want to take a step back and give some early thoughts about my approach to managing Alphabet and Other Bets. We have always taken a long-term view, investing in deep computer science and technology. Important trends like the wider adoption and application of artificial intelligence, ambient computing and the move to the cloud underline our investments across Google and our other Alphabet companies. +Our work in health care is a great example of how our investments in these areas allows us to deliver solutions across an entire sector. Google Cloud works with hospitals and health care providers to securely manage their patients' data, data that is much more secure in the cloud than in paper records or on-premises. Our AI teams at Google also work with partners to apply AI to help them and their patients, whether it's developing better health systems or helping with the diagnosis and deduction of disease. +Among their broader efforts are Other Bets. Verily and Calico are also partnering with industry leaders to use AI and cloud technologies to improve clinical trials, research and drug development. Our thesis has always been to apply these deep computer science capabilities across Google and our Other Bets to grow and develop into new areas. The Alphabet structure allows us to have a portfolio of different businesses with different time horizons without trying to stretch a single management team across different areas. We'll continue to take a long-term view, managing the portfolio with the discipline and rigor needed to deliver long-term returns. +Many of our Other Bets are getting to the stage where it now makes sense for them to partner closely with other players and investors in the industry. Waymo's technological leadership is widely reported. Its cars have driven 20 million miles across more than 25 U.S. cities. Waymo is now serving over 1,500 monthly active riders in Metro Phoenix and continue scaling fully driverless by matching early riders with driverless vehicles and charging for these rides. As Waymo looks to its evolution as a business, it's focusing on strategic partnerships. For example, it's working closely with OEMs and other businesses to build out ride-hailing and delivery business lines. And Verily is an example of a company in the portfolio that has outside investors, Silver Lake and Temasek as well as its own board. We'll consider opportunities for some of our Other Bets to take similar steps over time. +Now on to highlights from the quarter. First, Search and related Google properties. As I mentioned on our last call, our neural network-based technique for natural language processing called BERT is the biggest advancement in search in the last 5 years. It now impacts 10% of searches. And in Q4, we rolled it out in over 70 languages. +In Maps, we are celebrating our 15th anniversary very soon. And in the past year, we brought reliable directions to 630 million additional people in locations that previously weren't well mapped. We added as many buildings to maps using ML in 2019 as we have added using all techniques in the previous decade. With all these improvements, user growth is strong, and the range of things people are doing with Google Maps continues to expand as well. +The Google Assistant now helps more than 500 million monthly users across 90 countries get things done, across smart speakers and smart displays, phones, TVs, cars and more. +Shopping and commerce is another exciting area. We are making strong leadership hires in this area to help build a thriving business for partners of all sizes. Over the Black Friday and Cyber Monday holiday weekend, we had the largest number of daily shoppers on google.com ever in our history. Throughout the entire holiday shopping season, we also expanded the selection of products on Google due to a 4x uptick in the number of U.S. merchants participating in our Shopping Actions program. +Second, YouTube. Speaking of shopping, people can now easily buy products in YouTube's home feed and search results, making it possible for advertisers to reach even more audiences. Try searching for Puma shoes review on YouTube to see an example. With all the related content on YouTube like unboxing and beauty videos, this is a format people love, and it delivers a simple in-video buying experience. +A huge focus is continuing our work to keep YouTube safe for users, creators and advertisers. You may have seen a blog post today about our work to promote authoritative content and remove misleading information about the upcoming 2020 elections. For example, we are applying our disruptive content policies to reduce misleading information about voting locations or the census process. As I mentioned earlier, we are pleased with YouTube's growth in advertising and subscriptions, and we're also pleased with the early results from other revenue options we offer creators, including memberships, brand integrations, merchandise and ticket sales. +Continuing on now to Cloud. We are really pleased with the momentum we are seeing in Cloud. Year-on-year, the number of deals over $50 million more than doubled. The investments in Cloud's go-to-market expansion are resulting in customer momentum. Wayfair is one of the many retailers who successfully ran holiday operations on Google Cloud. In addition, Lowe's, which began transitioning off its legacy e-commerce system in late 2018 to Google Cloud, worked with us during this year's peak holiday buying season to improve the stability of their e-commerce site. +Worth noting, at peak time, customers in our Black Friday/Cyber Monday program used 4x the compute resources compared to previous year, and our platform experienced 100% uptime. Lufthansa Group is using our AI solutions to develop new tools that will improve air travel operations. The U.S. Postal Service also chose Google Cloud AI to improve business processes and customer experience. We have recently signed a 10-year agreement with Sabre to help them improve operations and develop new airline and hospitality services. +Finally, Google other revenue. Android continues to thrive. I'm proud to announce that over $80 billion has been earned by developers around the world from Google Play, showing the popularity of our platform. There are now over 2 billion active monthly users of Google Play. Hardware is still in the early stages of delivering on our vision for ambient computing. Our home devices demonstrate how this vision can come to life in creating the home of the future with our new Nest Mini and Nest Hub Max selling well over the holidays, following on from the Pixel 3a, which sold well last year. With Pixel 4, we continue to build out our capabilities and are keenly focused on execution, delivering great user experiences and broadening our distribution. And our pending acquisition of Fitbit will give us a foundation in wearables. I'm excited about our road map ahead across our products. +Overall, in 2020, our teams at Google are focusing on 4 key things. First, creating the most helpful products for everyone. We are really focused on ensuring that our products like Search, Maps and Assistant are helping people in their daily lives. Second, providing the most trusted experiences for our users. We are doing lots of work to keep improving users' privacy and security while also keeping harmful content off our systems. Third, executing at scale. This will show up as more seamless products across various surfaces and platforms like the Google Assistant, deeper partnerships and better use of our shared infrastructure. For example, Activision Blizzard recently chose Google as a strategic partner, using Google Cloud's computing infrastructure, YouTube for live streaming and our AI tools. Putting together these multiproduct partnerships helps us unlock great opportunities for our partners. And fourth, creating sustainable value. This means optimizing our usage of computing resources and also growing business opportunities in areas like YouTube, Cloud, Play, Hardware and beyond. +So as you can see, there's a lot happening at the company and a real sense of excitement and focus. I want to thank our employees for all the great work in 2019. +With that, I'll turn it over to Ruth, and I look forward to your questions. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sundar. We're very pleased with our strong 2019 results with total Alphabet revenues of $162 billion, up 18% year-on-year or 20% in constant currency. In dollar terms, this represents an increase of $25 billion in revenues relative to 2018. I will review our quarterly and annual results, including our new revenue disclosures, and conclude with our outlook. Sundar and I will then take your questions. +Starting with consolidated Alphabet results. In the fourth quarter, our total revenues were $46.1 billion, up 17% year-on-year and up 19% in constant currency. Our results were driven by ongoing strength in Search, YouTube and Google Cloud, offset by a decline in Hardware revenues. Details of Alphabet's consolidated revenues by geographic region are available in our earnings press release. +Regarding our key expense lines. On a consolidated basis, total cost of revenues, including TAC, was $21 billion, up 17% year-on-year. Other cost of revenues on a consolidated basis was $12.5 billion, up 19% year-over-year, primarily driven by Google-related expenses. The biggest factors here again this quarter were costs associated with our data centers and other operations, including depreciation, and then content acquisition costs, primarily for YouTube and mostly for our advertising-supported content in what has been a seasonally strong quarter for YouTube, but also for our newer paid YouTube Music and Premium subscription services as well as YouTube TV, which have higher content acquisition costs as a percentage of their revenues. These were partially offset by a decline in costs associated with lower Hardware sales. +Operating expenses were $15.8 billion, with head count growth being the largest driver of year-on-year growth for R&D and sales and marketing expenses. Head count drives both compensation and related facilities expenses. After head count growth, the biggest driver in R&D expenses was an increase in valuation-based compensation charges in certain Other Bets. +Stock-based compensation totaled $2.6 billion. Head count was up 4,803 from the third quarter and up 20% over 2018. Again, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable head count increases were again in Google Cloud for both technical and sales roles, including the impact of the Looker acquisition, which closed in December. +Operating income was $9.3 billion, up 13% year-over-year for an operating margin of 20%. Other income and expense was $1.4 billion, which primarily reflects an increase in the market value of certain publicly traded equities as well as a noncash gain from the Verily transaction. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 0.3% for the fourth quarter and was 13% for the full year. The fourth quarter ETR reflects the impact of discrete items, including the resolution of multiyear audits. As you have seen in prior years, ETR can vary on a quarterly basis. Net income was $10.7 billion, and earnings per diluted share were $15.35. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $6 billion, which I will discuss in the Google segment results. Operating cash flow was $14.4 billion with free cash flow of $8.4 billion. We ended the quarter with cash and marketable securities of approximately $120 billion. +Let me now turn to our segment financial results, starting with the Google segment. Revenues were $45.8 billion, up 17% year-over-year, and this, of course, is on a GAAP or floating FX basis. Google Search and other advertising revenues were $27.2 billion in the quarter, up 17% year-over-year, reflecting ongoing momentum in mobile and desktop. YouTube advertising revenues were $4.7 billion, up 31% year-on-year, driven by substantial growth in direct response and ongoing healthy growth in brand advertising, which remains the largest component. Network advertising revenues were $6 billion, up 8% year-on-year, led by growth in Google Ad Manager. +Turning to Google Cloud, including GCP and G Suite. Revenues were $2.6 billion for the fourth quarter, up 53% year-over-year driven by significant growth at GCP and ongoing strong growth at G Suite. The growth rate of GCP was meaningfully higher than that of Cloud overall. GCP growth was led by our infrastructure offerings in our data and analytics platform. We also saw a strong uptake of our multi-cloud Anthos offering. Ongoing growth in G Suite continue to reflect growth in both SMB and enterprise segments and both seat count and average revenue per seat. +The other revenues line now consists of Google Play, followed by Hardware and YouTube's nonadvertising services, mainly its subscription offerings, YouTube Premium, YouTube Music and YouTube TV. In the fourth quarter, other revenues were $5.3 billion, up 10% year-over-year, primarily driven by growth in YouTube and Play, offset by declines in Hardware. YouTube's contribution to other revenues benefited from subscriber growth across its various offerings. Within Play, app revenues had strong growth driven by an increase in the number of active buyers. +Total traffic acquisition costs were $8.5 billion or 22% of total advertising revenues and up 14% year-over-year. Total TAC as a percentage of total advertising revenues was down year-over-year, reflecting once again a favorable revenue mix shift from network to Google properties. +Google operating income was $11.5 billion, up 20% versus last year, and the operating margin was 25%. Google accrued CapEx for the quarter was $6.6 billion, reflecting investments in data centers, followed by servers and office facilities. +Moving on to the performance of Other Bets. For the full year 2019, revenues were $659 million, up 11% versus 2018, primarily generated by Fiber and Verily. Operating loss for Other Bets was $4.8 billion for the full year 2019 versus an operating loss of $3.4 billion in 2018. +Let me conclude with a few observations on the quarter and our longer-term outlook. Based on the strength of the U.S. dollar to date relative to the first quarter of last year, we expect continued FX headwinds again in the first quarter of 2020. With our expanded revenue disclosures this quarter, I'll talk about the revenue and investment outlook for each of these newly disclosed component parts. +First, with respect to Search and other advertising. Although we don't report Search revenues on a fixed FX basis, the delta between fixed and floating growth rates at the Alphabet level is a good proxy for the effect on Search revenues or a headwind of approximately 2 percentage points in 2019. At our scale, we are pleased with our rate of growth for 2019 and see ample opportunity going forward. What's exciting for us as we look ahead at Search and other Google properties is the ongoing opportunity to support users and advertisers with new ads experiences and improved measurement. +Second, with respect to YouTube advertising. At a year-on-year growth rate of more than 30% in the fourth quarter, we're pleased with the ongoing strength and opportunity at YouTube. We see substantial, continuing opportunity in direct response as well as with brand advertisers. As Sundar shared earlier, the nonadvertising services at YouTube, mainly from subscriptions, reached a $3 billion revenue run rate in the fourth quarter. We continue to invest across YouTube to grow over the long term. In the ad-supported portion of YouTube, we pay out a majority of revenues to our creators, reflected in our content acquisition costs. On top of that, there are other expenses, including infrastructure and networking costs as well as the cost of our content responsibility efforts to keep YouTube safe for users, creators and advertisers. We're also investing meaningfully to grow our subscriptions, which have higher content acquisition cost ratios. +Turning next to Google Cloud. We are very confident that there is an enormous opportunity here that plays to our core strengths. We're pleased with the growth trajectory of GCP, which we see in customer momentum, the growing size of the average contract and, of course, revenues. The traction we're having with large customers who are making multiyear commitments with us is reflected in our backlog, which ended the year at $11.4 billion, substantially all of which relates to Google Cloud. Given our position as a challenger, we're investing aggressively, focused on building out our go-to-market capabilities, executing against our product road map and extending the global footprint of our infrastructure focused on 21 markets and 6 industries. +In terms of Hardware, as Sundar noted in his opening remarks, we remain focused on the long-term opportunity with ambient computing. We believe our strengths in AI and software give us an advantage in providing seamless experiences to users wherever they are across multiple surfaces. We have been investing heavily in developing our capabilities in hardware engineering as well as building out supply and physical distribution chains, and we've created a multi-billion dollar revenue business in the past 3 years. +We're looking forward to our acquisition of Fitbit, which will add strong capabilities in wearables and advance our vision of ambient computing for the Android ecosystem. As we look at the near-term product road map, we continue to execute at a measured pace. +In Other Bets, we are sharpening our focus on the metrics and milestones against which capital allocation is determined, and we continue to assess where external capital is additive to governance and execution. +I'll now turn to the investments we're making in head count and in CapEx to support the growth opportunities we see across Alphabet. With respect to head count, in 2019, Alphabet head count grew by 20%, reflecting investment in key areas such as Cloud. Overall, we expect the growth rate of head count to be slightly higher in 2020 due to the combined impact of investment in priority areas plus the decision to move certain vendor functions in-house as well as from the planned impact of the Fitbit acquisition. +On SBC, as a reminder, our full year equity refresh grants are made to employees during the first quarter of 2020, and you will see the step-up in our first quarter results. In terms of CapEx, in 2020, we intend to increase our investment in both technical infrastructure and office facilities versus 2019. Within technical infrastructure, the investments, in particular, support ongoing demand for machine learning across our business as well as for Cloud, Search, Ads and YouTube. Relative to 2019, we anticipate relatively more spend on servers than on data center construction. At this scale of investment, we remain very focused on driving efficiency through fleet optimization and tight management of our supply chain. +Finally on capital returns. In the fourth quarter, we repurchased $6.1 billion of shares, which was more than double the amount of repurchase in the fourth quarter of 2018. As of year-end, we had $21 billion remaining in the program and are focused on executing on the remaining authorization at a pace that is at least consistent with what you saw in the fourth quarter. +In conclusion, we remain very confident about the opportunities across Alphabet and in our ability to continue to deliver at the steady pace we've shown. +Sundar and I will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +And our first question comes from Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [2] +-------------------------------------------------------------------------------- + + Thank you very much, Sundar and Ruth, and I guess -- I'm sure you're going to hear this a million times tonight, but thank you so much for the enhanced disclosure. I think this is the best Google call or Alphabet call I've been on since I've covered the company. So thank you again. You've given us a lot of stuff here. +I just wanted to focus a little bit on GCP and the comments that you made and either if you want to think about this for Google Cloud collectively or just for GCP. Just given the revenue run rate that you're at, how do we think about the gross margin profile of this business? Is it fair to look at some of the other cloud players when they were disclosing similar run rates to get a sense of what their gross margins were? Or is there a reason why your business might look slightly different? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Thank you for those comments. So first and foremost, we're obviously really pleased with the momentum here. GCP had fantastic revenue momentum in the fourth quarter, and as we noted, it is growing at a meaningfully higher pace than Google Cloud overall. +In terms of your margin question, look, I think our view is, obviously, the competitive dynamics in the cloud market are very different today. We are investing aggressively given the opportunity, which I tried to make clear in opening comments. Given the opportunity we see and the momentum we're having, we've accelerated our investment in our go-to-market team. And as we've talked about before, we've set a goal to triple the size of the sales force. We're also focused on building out our product road map and extending the global footprint of our infrastructure. And I'll leave the forecasting to you. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [5] +-------------------------------------------------------------------------------- + + Maybe 2 parts, if I can. Sundar, for you first, a lot of innovation that the company put on display over the past year. Ruth talked in her sort of forward commentary section about sustainability of growth and outperformance going forward. What are you most excited about when you see the company trying to align what improves consumer utility along with what continues to drive growth in the various segments of the business? That would be number one. +And two, Ruth, maybe for you, you had talked about variability of revenue last quarter going into Q4. But unless I missed that, I don't think you used the same word again in Q4. What were you expecting in terms of variability in Q4? And any color you could give on how that played out or how we should be thinking about variability of revenue going forward? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [6] +-------------------------------------------------------------------------------- + + Eric, I think overall, I presume you're meaning across everything we do, and if that's the case, I am -- I mean the trends we are seeing -- and we've been investing on it for a while but applying it and actually driving use cases to users. So for example, using AI to dramatically improve natural language processing to make 10% of our search results better is a kind of opportunity I'm excited by. When I look at -- we do see a lot of commercial experiences across our properties, be it Search or YouTube and the opportunity to create a better experience there and hence bring more value to our users, that's something which we see as a big opportunity. And across our businesses, be it YouTube, Cloud, Play or Hardware in addition to Search, we are seeing strength in a lot of these areas, and we share a common technological approach across all of them. And so that gives us a synergistic way to approach these areas as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + And then on your second question, at our scale, we're pleased with the rate of growth in 2019 here in Search and our ads business overall, and we do see ample opportunity ahead. When we talk about variability of revenue, the way we've talked about it in the past very much holds true, which is we're -- we don't manage for any particular quarter, we manage focused on what's in the best -- best for users, and we have a lot of testing that goes around it. And so really, the point is there will be variability, and we're focused on continued -- the continued long-term opportunity and we do see that opportunity, the ads opportunity, to be significant. Apart from the secular shift to digital, we continue to be very focused on the benefit from better measurement, better ad delivery, better user experience. Our view is that all helps grow the addressable market, but there will be variability over time because we're very focused on what's in the right long-term interest. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [9] +-------------------------------------------------------------------------------- + + One for Sundar and one for Ruth. Sundar, first, just hoping you could talk more about Google Cloud. Great to see the $10 billion run rate. Just curious if you can help gauge the progress over the past year. Then where do you think the biggest areas of differentiation lie in an increasingly competitive space? +And then Ruth, can you just give some of your latest thoughts on balancing growth and profitability across the Google segment and Other Bets? And as you enter this year, do you see additional opportunities to drive increased profitability without impacting the long-term potential of the businesses? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [10] +-------------------------------------------------------------------------------- + + Doug, on Cloud, I think maybe a few thoughts on some of the progress we made last year and talk about the differentiation, which you asked about as well. Definitely under Thomas' leadership, I think we have clearly focused on 6 industry verticals across 21 markets and so doubling down on those efforts, bringing in a lot of new products and compliance certifications, so effectively expanding the TAM, which we serve. Ruth mentioned the team is on track to triple our sales force in 3 years, including bringing in a number of senior strategic hires and supplementing it with a channel partnership program. I think the progress I've seen in our customer focus with our customer success organization and the contracting framework have all been great progress for us. +Overall, every time we're in especially in one of these larger deals, they are effectively looking for a technology partner. So differentiation is not just what we bring to table in terms of Cloud where we have differentiated capabilities but, in many cases, it's what we bring as Google. So if you take an area like health care, all the investments we are making in health care across Google and, in some cases, Alphabet. If you look at Sabre, the partnership we can bring to them across our experience working in travel verticals as well. So I think -- and over time, I also think the AI-based, industry-specific solutions we are working on will end up being a differentiating factor as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [11] +-------------------------------------------------------------------------------- + + And in terms of your second question, investing for growth and how we balance growth and profitability, the approach to capital allocation and the pace of investing continues to be guided by the same 3 drivers that we've talked about previously: first and most important is investing to support the long-term earnings growth and the opportunities that we see there; second, we do remain focused on optimizing investments within each product area; and then third, as we've talked about on prior calls, is investing to support operational excellence, and that includes things like driving efficiencies in our technical infrastructure, which I spoke about. +When we look at the biggest investment areas within Google, we, as we've talked about already on this call, continue to be focused on investing to support the growth that we see. It starts with Search while also investing to build new businesses, and we've talked about a couple of them already today. Cloud is clearly an area where we're investing aggressively. In Hardware, we've been investing heavily by developing our capabilities in hardware engineering as well as building out supply and physical distribution chains. And then in YouTube, as I mentioned in opening comments, we do continue to build out our subscription services. It's still in the early days there, and we're making a sizable investment to build it out, taking a long-term view here. +So we are leaning into investing for long-term growth. That's been a core principle here and remains such while looking at where can we optimize within portfolios and where can operational efficiencies be additive. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [13] +-------------------------------------------------------------------------------- + + I have 2. Just Sundar, I thought your 2020 focal points are really helpful, creating the most helpful products for everyone and then the most trusted experience for users. Was curious to kind of focus in those comments on payments in YouTube. You've had a lot of payment strategies over the last couple of years, so talk about what types of investments or products you think you need to really remove friction and drive better payment adoption. And then on the YouTube side, if you sort of look at how people are using YouTube now from an engagement perspective, what types of changes do you foresee you need to make in order to really make it a more helpful product to drive engagement even higher on the YouTube platform? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [14] +-------------------------------------------------------------------------------- + + Brian, thanks. On the payment side, clearly, I spoke earlier about the kind of experiences people see across our properties, including people do come with an intent to discover, learn and commercially engage as well. And when they're looking to transact, payments ends up playing a critical role. So the less friction you have, it tends to work better. So we've been really focused on doing that and getting more of our users set up in the right state. We've had a lot of traction with our payments product over the past 18 months. We had a tremendously successful launch in India from which we learned a lot of features, and we are bringing that and we are revamping our payments products globally. And so I'm excited by that rollout, which is coming up in 2020. I think that will make the experience better. +On the YouTube side, what -- I guess your question is about how are users engaging with the product. Overall, all our user metrics are very strong. They're global in nature, and increasingly, we see newer verticals beginning to grow as well. So YouTube is working horizontally well at scale. And for us, it's making sure, as an ecosystem, it works better so that the content there, the experiences there are improving. We take our content responsibility work seriously, which makes more content creators engaged and makes it a more valuable product for advertisers as well but also supplementing the content you see there with other types of accessorizing things, be it merchandising, ticket sales. When we make it contextually relevant, what we have done in Search and Search ads over time, if we can bring that at YouTube when we see an opportunity, I think that sets us up well for the long term there. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill from Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [16] +-------------------------------------------------------------------------------- + + Ruth, in North America, was there anything that was abnormally unusual? Facebook had cited some weakness in North America. It looks like your North America number was relatively weak versus the last 4 years. Is there -- was there any anomaly that we should be aware of? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + Thanks for that. So the regional breakdown also reflects product mix within regions. The U.S. year-on-year growth rate does reflect a decline in Hardware revenues relative to what was a fairly strong Hardware revenue growth rate in 4Q '18 and not much more to call out than that. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And our next question comes from Stephen Ju from Crédit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Crédit Suisse AG, Research Division - Director [19] +-------------------------------------------------------------------------------- + + So Sundar, I guess some of the more cross-product line synergies are showing up in an integrated software and hardware effort with stuff like the Pixel. But you've come up through the ranks at Google, so you're undoubtedly pretty sensitive to the various interests across various teams. But we're wondering what you may be looking to do to break down, I guess, what might have been more of a siloed effort in Google's history. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [20] +-------------------------------------------------------------------------------- + + I think -- I spoke about execution at scale. And so for us, that means you have these product areas, which are focused on their users, but we are setting up teams which cut across all these areas and make sure they can bring their synergies and work at scale. So last year, we set up a core infrastructure team, which looks at things like how does the user journey work across, what does the shared infrastructure engineers can't use so that we don't reinvent the wheel in multiple areas, how can we commonly deploy AI across all these products. So I think that's been a good example of bringing teams together. +Another big area where we invested like that to break down silos is our partnerships. We set up a global partnerships team. And our ability to bring a common Google perspective to our big global partners has helped us strike many new partnerships. I mentioned Activision Blizzard as an example. And they work and they're very synergistic with Cloud as well. To my point earlier, when people engage with us on cloud, they're looking for -- they're interested in a bigger digital transformation across the board. +Google Assistant is a great example of -- because we are focused on the user, and the experience cuts across several of our product areas, it's been a great mechanism by which we can break down silos as well. But it's a great question, and I spend a lot of time on it. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + And our next question comes from Dan Salmon from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Analyst [22] +-------------------------------------------------------------------------------- + + I had 2 questions, one clarifying one for Ruth and then maybe a big picture one for Sundar. Ruth, you distinguished between the growth of brand advertising and direct response on YouTube. Those comments were very clear. I just want to follow up and ask you just how you make that distinction between brand and direct response. Is it a different pricing model? Is it the presence of ad revenue share with a creator or both? Would just be curious on that distinction. +And then to Sundar, the big picture one, we have heard others in the ecosystem talk about headwinds from targeting growing. Certainly, there are regulatory changes that also apply to you. You've made some changes to various Google advertising platforms. And of course, you're an owner of 2 of the largest, most important platforms in Chrome and the Android operating system. I could ask you 1 billion things on that last one. But what I'd really like to ask is the big picture question. If we roll up these sort of things for your total advertising business, how important are changes here to your top line growth? Are you seeing notable headwinds from these types of changes in the ecosystem as well? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + So on the first one, we have again this quarter talked about brand and direct response. And as we've talked about in prior quarters, brand is growing at a healthy pace and remains the largest component of YouTube ads. Direct response is growing -- continues to grow at a very substantial growth. The distinction here is the format for -- in direct response, we're letting brands insert a tailored call to action in a video ad, such as signing up for a newsletter or scheduling an appointment or downloading an app or booking a trip, things of those sort. And that's why it's the direct response category. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [24] +-------------------------------------------------------------------------------- + + And on the broader questions about headwinds, it's something we always need to take a look at. We try to stay focused on users and our partners. And we realize for these things to scale, you need to make sure the ecosystem is working well. And so we are engaged in these issues, and we anticipate and structurally work on them early on. So it's how we broadly approach these things. And so there's nothing notable to call out other than there will be continued changes in these ecosystems, and our ability to anticipate and adapt is key to the years ahead. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [26] +-------------------------------------------------------------------------------- + + I'd like to ask a couple of bigger picture things on the new disclosures. So first on YouTube monetization, assuming you have about 2 billion users, it's about $7 or $8 per user. Just wondering how you feel about that monetization level given all the usage you're seeing there. And is there significant room to raise that when you compare it to other social networks? +And then secondly, on the Cloud backlog, a very strong number, $11.4 billion versus our IaaS/PaaS revenue rates. Just wondering about how strong the new deals have been that you've signed in the last 6 months. It sounds like really good traction there. And then the profitability of these deals, how you feel about that? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [27] +-------------------------------------------------------------------------------- + + On the question around YouTube, I do think there is a lot of opportunity ahead. You're right, it's a platform working at scale. I think -- Ruth spoke a little bit about brand and direct response. I think direct response is a huge growth area for us. And increasingly, I think when you look at the fact that people are consuming a lot of goods and services as part of their experience in YouTube, how can we create better commerce experiences also is a big opportunity for us. So looking across, I think there is more room, significantly more room, over the mid to long term on monetization levels. And so I think we see that as a big opportunity and are investing for it. +On Cloud, definitely, we are increasingly doing much larger deals. And these deals can sometimes span beyond Cloud as well, and they can touch many areas. So as an example, if you're an automotive company, we can be talking to you across Cloud, Android Auto, in some cases, Waymo, and they all happen to be strong platforms -- partners on the advertising side as well. So these are large deals, and we do want to build these in a sustainable way so that we can serve the partner well, and so profitability has been something we are very focused on as well. + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [28] +-------------------------------------------------------------------------------- + + And just to add a little more to that, where the $11.4 billion backlog number is, for us, we view it as a way to quantify the traction that we're having. And as you know well, in the enterprise phase, these tend to grow over time, and profitability as such comes across the cohorts. However, the point that we were trying to make and have made a couple of times here on the call is we are investing aggressively in Cloud overall given the opportunity that we see and the momentum we're having, and we'll continue to do so. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our next question comes from Youssef Squali from SunTrust. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [30] +-------------------------------------------------------------------------------- + + Two quick ones. First, Ruth, has the shortened holiday season had much of an impact on your Search business in North America? And then Sundar, as you talk about automation, machine learning, AI, how much of advertisers' search spend is now on auto bidding? And how do you think smart bidding is effective -- is affecting spending growth and pricing? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + So on the holiday shopping season, there's really nothing to highlight there. What we find is there are seasonal puts and takes in any given period, so really nothing to note. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [32] +-------------------------------------------------------------------------------- + + On -- I don't have specific numbers here but -- to add here, but effectively, we do see significant traction in these areas, and advertisers are leveraging the features we have, we are bringing here, be it smart bidding, auto bidding. There's tremendous traction with our advertisers here. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our next question comes from Kevin Rippey from Evercore. + +-------------------------------------------------------------------------------- +Kevin Michael Rippey, Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research [34] +-------------------------------------------------------------------------------- + + This is primarily for Sundar. As you think about the risk profile of some of your businesses like Waymo, like Verily in health care, how do you manage those risks, which likely in a scenario where autonomous cars have some accident or something like that, having those in-house and perhaps brand damage that could do to Google versus what you could do if those were entirely separate enterprises? I know they're all held underneath the Alphabet umbrella, but just sort of big picture how you think about managing that risk over time. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [35] +-------------------------------------------------------------------------------- + + Thanks, Kevin. We are -- as I spoke earlier in the remarks, part of the reason we are making sure we are investing in the proper governance structures so that we don't try to scale as a management across these important areas. Some of these are -- have regulatory aspects to it. We are, for some of these bets as well, and Verily is a great example, we have brought in outside investors, people with expertise and setting up proper Board structures and governance for these. So I think those all help, and we'll continue to evaluate these on a periodic basis and bring that rigor and discipline. But I do think Alphabet gives us a more flexible framework, if you will, to both have the independence when we need but where we can have common shared synergies, like our AI investments, bring that to bear as well. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + And our next question comes from Mark Mahaney from RBC. + +-------------------------------------------------------------------------------- +Benjamin Wheeler, RBC Capital Markets, Research Division - Associate [37] +-------------------------------------------------------------------------------- + + This is Ben on for Mark. Ruth, I just kind of want to double-click on something you said before in terms of Other Bets kind of like a sharpening focus on the allocation there. Was that kind of -- is that kind of signaling more of the same? Or is that kind of potentially maybe prioritizing investments more towards like share buybacks and stuff like that as opposed to -- like basically, I'm trying to ask, should we expect greater rationalization in the Other Bets segment going forward? Or is it more of the same? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [38] +-------------------------------------------------------------------------------- + + So what I was saying is that when we look at the Other Bets and execution, we've talked over time about measuring them against specific metrics and milestones: operating, business, technology, financial performance. And we look at that as we calibrate the pace of investment, the approach to investments, and we are continuing to do that. We're putting a sharper focus on this, as Sundar indicated, looking at where does it make sense to work with external capital as we did with Verily as an example. But the bigger point is we continue to invest for the long term. And when we look at our capital return approach, it's very consistent with what we've talked about previously. The primary use of capital continues to be to support long-term growth in Google and in Other Bets, and then it's about strategic investments and, on top of that, return of capital to shareholders. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [40] +-------------------------------------------------------------------------------- + + Two questions. The Google segment margin looked really strong in the fourth quarter. I think this is the first time that mix shift actually helped you guys from a margin perspective. So Ruth, can you just talk about how much of that margin increase year-on-year was from the Hardware business dropping off versus improving elsewhere? And then as you look forward, you mentioned that head count is going to accelerate in 2020. So is this an investment year in your view or just kind of more of the steady kind of increase? +And then second question, on YouTube, a lot of discussion here about direct response impact and the opportunity there. What percent of AdWords advertisers are buying Search only versus buying Search and YouTube at this stage? And it looks like from your new disclosure that you did decelerate a little bit in the fourth quarter. Any color on what's driving that relative to the full year '19 growth rate? + +-------------------------------------------------------------------------------- +Ruth Porat, Alphabet Inc. - Senior VP & CFO [41] +-------------------------------------------------------------------------------- + + Okay. So taking the first part of that. In terms of the operating margin in the fourth quarter, there were a number of discrete items in the fourth quarter last year in 2018, so that did result in a favorable Google op inc year-on-year comparison for this year. And as you said, the other cost of sales does reflect lower expenses related to Hardware in Q4, in particular, versus last year. But I think the main point to leave you with is that we do intend to continue to invest aggressively to support growth in the areas that we've already talked about quite a bit on this call: in Search, in Cloud, in Hardware and in YouTube. +In terms of head count, I tried to break it out in my closing comments that it starts with those areas -- putting head count behind the areas where we're investing for the long term, and then we have a couple of additional factors that are somewhat expected to boost the year-on-year growth rate. One is bringing some support in-house that's OpEx-neutral, and the other is the Fitbit acquisition. +In terms of the third part of your question, I'm just trying to recall it. The -- in terms of the mix, I'm not sure there's much to add there. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Colin Sebastian from Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + I guess, first, just given the focus and new leadership team in commerce, was wondering if you could talk a little bit more about the opportunities you see for innovation there at the transactional part of the funnel. And then as a quick follow-up on the acceleration in GCP, beyond the size of the deals, were there particular product areas, like BigQuery or something else, worth calling out that might have inflected to drive that acceleration? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [44] +-------------------------------------------------------------------------------- + + Great. On commerce, I'm really excited Bill Ready is here. He brings a lot of experience. And you mentioned the transactional part of the funnel, and I think it's an area where he brings a lot of experience given his prior work. But we definitely see opportunity to improve the overall user experience in terms of how we present our results, the visual nature of it, making that experience more delightful. And when people are interested in something, how do you make it more seamless to complete the transaction and bringing in deep partnerships with merchants and retailers to making that happen. So excited about the opportunity there, and that's where we are investing. +On GCP, we did see -- it's been a lot to do with bringing to bear all the resources we have and engaging well on these deals, and the execution there has been great. And it's -- definitely, we see strong traction in data analytics. And so our strength there as a company is definitely contributing significantly as well as our overall leadership in AI. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ellen West for any further remarks. + +-------------------------------------------------------------------------------- +Ellen West, Alphabet Inc. - VP of IR [46] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2020 conference call. Thank you, and have a good evening. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/GOOGL/2020-Jul-30-GOOGL.txt b/Transcripts/GOOGL/2020-Jul-30-GOOGL.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0d6cf1343e45b683f6df2974837685f7f36f97d --- /dev/null +++ b/Transcripts/GOOGL/2020-Jul-30-GOOGL.txt @@ -0,0 +1,385 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Alphabet Inc Earnings Call +JULY 30, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Sundar Pichai + Alphabet Inc. - CEO & Director + * James H. Friedland + Alphabet Inc. - Director of IR + * Ruth M. Porat + Alphabet Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Ross Adam Sandler + Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Kevin Michael Rippey + Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research + * Heather Anne Bellini + Goldman Sachs Group, Inc., Research Division - MD & Analyst + * Douglas Till Anmuth + JPMorgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Alphabet Second Quarter 2020 Earnings Conference Call. (Operator Instructions) I'd now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +James H. Friedland, Alphabet Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to Alphabet's second quarter 2020 earnings conference call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly cover the safe harbor. +Some of the statements that we make today regarding our business, operations and financial performance, including the effect of the COVID-19 pandemic on those areas, may be considered forward-looking. And such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC and in our Form 10-Q for the quarter ended June 30, 2020 expected to be filed with the SEC later today. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. And now I'll turn the call over to Sundar. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Jim, and thank you, everyone, for joining in. It's certainly been a busy week, and I'm glad to be here. I hope everyone is staying safe and well. All of us at Google continue to send our deepest gratitude to everyone on the front lines of the pandemic all around the world. I also want to personally thank all our employees who continue to work so hard to make sure our products and services are available for everyone right now. People looking for important health information, hard-hit businesses working to inform customers about opening hours or delivery options or teachers connecting to their students. The macroeconomic environment caused by the pandemic created headwinds for our business. Our revenue declined on a reported basis and is flat year-over-year on a fixed FX basis. Like other companies, this quarter, we saw the early signs of stabilization as users return to commercial activity online. This is true across most of our advertising verticals and geographies. Of course, the economic climate remains fragile. +One thing I'd like to call out is our continuing journey to invest in and grow new businesses. We delivered strong growth in our non-ads revenues particularly from Cloud, Google Play and YouTube subscriptions. This, in turn, is helping our partners, developers and creators earn revenue and deliver valuable services to people. We are focused on the steps to build long-term value with these opportunities. +Today, I'll review the quarter by walking through the 4 key areas for 2020 that you heard me mention over the last several quarters: creating the most helpful products for everyone; providing the most trusted experiences for our users; executing at scale; and creating sustainable value. +First, creating the most helpful products for everyone. This has been especially important during this time. We are focused on providing locally relevant, helpful and authoritative information about COVID in over 70 languages in 200 countries. This has been an enormous effort across search and all our products. YouTube, for example, engage with public health officials in over 90 countries and services panels with locally relevant information in response to COVID-19 queries. +On Google Maps and Search, we now display more than 12,000 COVID-19 testing centers across 20 countries, working with local governments and data providers to source accurate and helpful information. Using our technical capabilities, we are helping people find more information about local businesses such as takeout, curbside, updated hours, donations, gift cards and virtual services. +With more kids at home, Google Play launched a special kids tab with only teacher-approved apps and YouTube has seen traction with learn at home as well as a virtual summer camp for kids called Camp YouTube, plus a virtual commencement series. +To help Indian Internet users, we announced a Google for India Digitization Fund. Through this effort, we'll invest approximately $10 billion over the next 5 to 7 years to accelerate and participate in India's burgeoning digital economy. We'll enable information in local languages and apply technology and AI to important areas like health, education and agriculture. Jio platforms is the first partnership agreement in the fund and will work with them to help millions of users in India become owners of smartphones. +Second, providing trusted experiences for our users. Doing even more to protect users' privacy, keep information safe and provide high-quality information was a key focus this quarter. In one important update, we now set people's location history and web in-app activity to delete automatically after 18 months as the default. We also integrated password checkup into our core security checkup to help people detect any instance of their online accounts being compromised. More than 100 million people have used it. Android 11 Beta launched this quarter with many new features to help people better manage their connected devices. It contains a significant focus on privacy and security, including more granular control over app permissions and restrictions on app's usage of background location. Our exposure notifications API for Android and iOS, developed with Apple, launched this quarter. It's designed to empower public health agencies to create apps to help fight the spread of COVID with the strongest user privacy safeguards. +As of today, authorities have rolled out official apps in 12 countries to alert people that they were in contact with another person who tested positive for the virus and that they should isolate and get tested. We expect several more apps to launch in the next week or 2, including the first state apps in the U.S. We are also focused on election security efforts around the globe, whether it's removing coordinated foreign influence operations, prevent hacking and phishing attempts or enforcing our political ad policies that require transparency and prohibit narrow micro targeting. +Moving on now to executing at scale. All businesses are adjusting to work-from-home and we are no exception. While building products across distributed teams was new for us, this experience allowed us to make good use of our infrastructure investments and productivity tools. G Suite products, in particular, Google Meet have been absolutely critical, and we quickly reengineered it and made it available widely to help millions of other businesses and organizations connect and collaborate. +One area where we have executed really well to improve the user and merchant experience in the last year is shopping. We know that we and merchants face incredible competition for consumer attention and wallets. We are helping merchants lower their costs and improve their reach in a few ways. They can now list their products for free on the Google Shopping tab and on Search helping them drive more traffic and making our results more comprehensive and useful. We also recently announced that sellers on Buy on Google will no longer pay us a commission fee. Plus, we are giving retailers more choice by opening our platform to third-party providers, starting with PayPal and Shopify. Shopping ads also continue to be a great tool for merchants with new visual features for retailers such as smart shopping campaigns that let customers know about free shipping. We are continually adding more ways for advertisers to reach shoppers. +Now let me talk about our fourth area, building sustainable value, which is all about driving business value for our partners and investing smartly in new areas. In our advertising business, our focus is on helping businesses find customers as they work to rebuild and recover. We gave search advisers the ability to add high-quality images to their ads, helping shoppers quickly see products to consider and take action faster. We added features to make video ads more easily shoppable and browsable on YouTube as more businesses are shifting to online to offset physical store closures. For SMBs, we are proud that so many are taking advantage of new features, including Smart Campaigns to reach new online audiences and promoted pins on Google Maps to let customers know that their businesses are open. And to empower businesses to understand in an easy and visual way, what products people are searching for, during the special circumstances that COVID-19 has created. The rising retail categories, too, surfaces fast-growing product-related categories. +As I mentioned earlier, beyond advertising revenue, we see good traction in areas such as YouTube subscriptions, Google Play and Cloud. YouTube Premium Music and TV subscriptions performed well during the quarter. We are seeing strong demand for these services and are adding content regularly, including many Viacom networks like BET and Comedy Central. In Q2, Google Play app and game downloads were up more than 35% year-over-year, which means that revenue for developers continue to grow. +Let me go a bit deeper on Cloud. In the first half of 2020, technology and innovation proved to be a significant recovery mechanism for businesses. Those who are shifting to digital and embracing the spirit to innovate are evolving and growing. Our commitment to bringing innovative products to market, building and scaling our go-to-market organization, and strengthening our partner network helped us continue to meet the growing needs of our customers this quarter. We see 2 distinct trends as businesses embrace the future of work. +First, the future of business will be more digital. Customers are choosing Google Cloud to either lower their cost by improving operating efficiency or to drive innovation through digital transformation. Brands like Keurig Dr. Pepper, Deutsche Bank, Lowe's, Telefónica, Orange and Group Renault. And we are helping many government agencies deliver care for their citizens, including the states of Oklahoma and New York here in the U.S., and Italy and Spain in Europe. +Second, the future of work will be more collaborative. Virtual collaboration is critical in order to adapt and succeed in the changing global landscape. In Q2, we saw continued demand from customers using G Suite to help their employees work from home, including Wipro in India and expanded our relationship with the state of Arizona here in the U.S. Our customers are using G Suite tools across industries in new ways, whether it be financial advisers working with clients, doctors and nurses turning to telemedicine or teachers educating students with remote learning. In Q2, we peaked at more than 600 million Meet participants in a single week. As one example, PwC employees reached nearly 10 million hours of video conferencing in Google Meet in a single month. To make collaboration easier for everyone, we introduced an integrated workspace for Gmail, Chat, Meet and Drive on mobile and desktop. Our Cloud product strategy is differentiated and our investments in direct sales and indirect distribution are beginning to deliver results. +Before I move to Other Bets, I want to note that our hardware team continues to make good progress, and I'm excited by the new upcoming devices we have coming this fall. +And finally, in our Other Bets. Waymo announced that Fiat Chrysler automobiles will work with Waymo as its strategic partner for L4 autonomous technology across our full portfolio. We also entered into a partnership agreement with Volvo Car Group to work together to integrate the Waymo driver into an all-new electric vehicle platform for ride-hailing services. Finally, Waymo closed its externally-led investment round, bringing the total funding to $3.2 billion, which includes investment from Alphabet. And Wing's drone delivery service started delivering library books to students in Virginia. +In closing, it's an important and uncertain time in the world. We are all grappling with the pandemic and a struggling economy, while also reckoning with centuries of injustice that affect our Black communities every day. John Lewis' funeral today provides a timely reminder of the struggle. In June, we announced a significant package of commitments to help our Black+ community internally at Google as well as the wider Black community. This included product experiences that matter to Black users, including the option for business owners to identify their business as Black-owned in Google Maps and search. We also announced $175 million economic opportunity package to support Black business owners, start-up founders, job seekers and developers. In addition to YouTube's $100 million fund to amplify Black creators and orders. We commit to contributing to long-term meaningful change, both externally and within Google. +And with that, I'll now turn it over to Ruth. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sundar. We are cautiously encouraged by our results for the second quarter, although mindful of the fragile global economic environment. Our advertising revenues gradually improved through the quarter, and our nonadvertising revenue lines maintained their strong performance particularly Google Cloud and Play. I will begin with a review of the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. I will then review results for Google, followed by Other Bets and conclude with outlook. Sundar and I will then take your questions. +Starting with consolidated Alphabet results, our total revenues in the second quarter were $38.3 billion, down 2% year-on-year and flat in constant currency. Year-on-year declines in our advertising revenues from Search and Network were offset by growth in Google Other and Google Cloud revenues. Details of Alphabet's consolidated revenues by geographic region are available in our earnings press release. Across each region, we saw a gradual improvement in revenues in the quarter with some differences reflecting product mix. In terms of the foreign exchange impact, exchange rate movements resulted in approximately a 2% headwind to reported revenues. +Regarding our key expense lines. On a consolidated basis, total cost of revenues, including TAC, was $18.6 billion, up 7% year-on-year. Other cost of revenues on a consolidated basis was $11.9 billion, up 18% year-over-year primarily driven by Google-related expenses. The biggest factors here again this quarter were costs associated with our data centers and other operations, including depreciation and then content acquisition costs primarily driven by content costs for YouTube TV and our paid YouTube Music and premium subscription services, followed by costs for YouTube's advertising-supported content. +Operating expenses were $13.4 billion, up 7% year-on-year. Headcount growth was the largest driver of year-on-year growth for both R&D and G&A. Secondarily, the increase in G&A reflects contributions mainly for COVID response and reserves for estimated credit losses of our customers. The year-on-year decline in sales and marketing expenses was due to lower advertising and promotional spend as we paused or rescheduled campaigns and pivoted to digital formats for flagship events. All 3 categories benefited from lower T&E expenses. Stock-based compensation totaled $3.3 billion. Headcount was up 4,450 from the first quarter. Again, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were again in Google Cloud for both technical and sales roles. +Operating income was $6.4 billion, down 30% year-over-year, and our operating margin in the quarter was 17%. Other income and expense was $1.9 billion, which primarily reflects an unrealized increase in the market value of equity securities. We provide more detail on the line items within OI&E in our earnings press release. +Our effective tax rate was 15.9%. Net income was $7 billion, and earnings per diluted share were $10.13. +Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $5.4 billion, which I will discuss in the Google segment results. Operating cash flow was $14 billion with free cash flow of $8.6 billion. We repurchased $6.9 billion of our shares. We ended the quarter with cash and marketable securities of approximately $121 billion. +Let me now turn to our segment financial results. Starting with our Google segment. Revenues were $38 billion, down 2% year-over-year. +I'll now go through the individual advertising revenue lines. Starting with Google Search and other advertising revenues. We generated $21.3 billion in revenues in the quarter, down 10% year-over-year in the aggregate with improvement as the quarter progressed. We saw a gradual return in user search activity to more commercial topics throughout the quarter followed by an increase in spending by advertisers. This resulted in an improvement in year-on-year search revenue trends during the quarter with Search revenues essentially flat to last year by the end of June. +YouTube advertising revenues were $3.8 billion, up 6% year-on-year driven by ongoing substantial growth in direct response offset by a continued decline in brand advertising, which then moderated toward the end of the quarter. +Network advertising revenues were $4.7 billion, down 10% year-on-year with trends improving somewhat toward the end of the quarter as advertisers spend began to return. +Turning to Google Cloud, including GCP and G Suite. Revenues were $3 billion for the second quarter, up 43% year-over-year. GCP maintained the strong level of revenue growth it delivered in the first quarter, and its revenue growth was again meaningfully above cloud overall. GCP growth was again led by our infrastructure offerings and our data and analytics platform. Overall, the lower Google Cloud revenue growth in the second quarter relative to the first quarter reflects the fact that G Suite lapped a price increase that was introduced in April last year. G suite maintained healthy growth in average revenue per seat as well as in seat growth, which does not include customers who took advantage of our free trials as they shifted their employees to work-from-home. +Other revenues were $5.1 billion, up 26% year-over-year primarily driven by growth in Play and YouTube nonadvertising revenues. Within Play, app revenues in the second quarter benefited from the impact of very strong growth in the number of active buyers with more people at home looking for entertainment. Within YouTube subscription revenues, we continue to benefit from subscriber growth across its various offerings. Total traffic acquisition costs were $6.7 billion or 22% of total advertising revenues and down 8% year-over-year. Total TAC, as a percentage of total advertising revenues, was up slightly year-over-year. +Google operating income was $7.6 billion, down 26% versus last year, and the operating margin was 20%. Google accrued CapEx for the quarter was $4.8 billion, reflecting investments in servers, data centers and office facilities. +Moving on to the performance of Other Bets. For the second quarter, revenues were $148 million primarily generated by Fiber and Verily. The operating loss was $1.1 billion. +Let me end with our outlook. As I said earlier, ads revenue gradually improved during the quarter across Search, YouTube and network. However, we believe it is premature to gauge the durability of recent trends, given the obvious uncertainty of the global macro environment. +As we discussed on last quarter's earnings call, global macroeconomic performance has tended to be correlated with ad spend and is a key signal to monitor. Over the long term, we remain optimistic about the underlying strength of our business. +In terms of Google Cloud, we are pleased with the traction we're having with large customers who are making multiyear commitments with us. This is reflected in the strength of our backlog, which ended the quarter at $14.8 billion, substantially all of which relates to Google Cloud. This performance is a result of the investments we are making into the cloud go-to-market organization. Google Play's Q2 results reflect growth in the number of new buyers with accelerated adoption as people stayed home. Performance also reflects the significant investments we have made in the ecosystem to support developers and users, such as successful promotion and adoption of our partners' apps and games in new locales around the world and expanding the availability of local forms of digital payments. +Moving on to profitability. The decline in our Search revenues put significant pressure on profitability, which was further impacted by our ongoing investments for long-term growth. As I discussed last quarter, much of our expense base, both in cost of revenues and OpEx is not directly correlated with changes in revenues. For example, although TAC and content acquisition costs are obviously tied to revenues, there's a sizable percentage of items in other cost of revenues that are generally less variable in nature, such as depreciation and operations costs of our technical infrastructure as well as for activities like customer support and content review. We remain focused on the user and customer experience, and we'll continue to invest to support our products. . +With respect to operating expenses, although we still expect the pace of headcount growth to decelerate somewhat in 2020, we're continuing to hire aggressively in priority areas like cloud. We still expect that headcount additions will be seasonally higher in Q3 as we bring on new graduates. Consistent with prior years, we expect sales and marketing expenses to be more heavily weighted to the back half of the year, in part to support product launches and the holiday season. +Turning to CapEx. We continue to expect a modest decrease in the level of total CapEx in 2020 compared with last year. This is particularly due to our decision to slow the pace at which we acquire office buildings in the near term as we focus on reimagining the optimal work environment. This also reflects the slower pace of ground-up construction for both our office facilities and data centers due to COVID-19. In terms of technical infrastructure, as we discussed last quarter, we anticipate investment to remain at roughly the same level as in 2019 with relatively more spend on servers than on data center construction and benefiting from our ongoing focus on server efficiency. With respect to capital allocation, our primary use of capital continues to be, to support organic growth in our businesses followed by retaining flexibility for acquisitions and investments. We complement these growth drivers with a return of capital. As we indicated in our press release today, our Board has authorized the repurchase of up to an additional $28 billion of our Class C stock. Thank you, and Sundar and I will now take your questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from the line of Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe 2, if I can, for Sundar. One, on the commerce initiatives, a lot of announcements from the company in the quarter, moving towards sort of commission-free and amplifying both the advertising and e-commerce efforts. I want to understand some of the moves you're making strategically and how you think that positions you broadly against, obviously, an e-commerce landscape that's seeing a lot of pulled forward penetration given the current environment. And second on YouTube, obviously, a fairly volatile brand advertising environment and TV advertising remains in flux. What are the opportunities both in the U.S. and globally to go after sort of TV ad budgets under the YouTube umbrella? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [3] +-------------------------------------------------------------------------------- + + On Shopping, I spoke a little bit in my remarks, but really excited at the potential there. The team has been executing very well. Overall, users come to Google a lot to find the products they are looking for, but we see an opportunity to invest and make the experience better. Sometimes the journeys may fail because they don't find what they're looking for. So we want to make sure it's comprehensive. +Next when people find what they like, we want to make it simple for them to transact. And so working on that end-to-end experience has been a big focus. And obviously, making sure for merchants, really making sure we are open to business for merchants, and we are giving value to them has been the focus. The early indications are that users are responding positively, both in terms of user engagement and more importantly, giving value back to merchants for their investment there. So in some ways, it's a return to our first principles. We want to ensure that Google is the best place for merchants to connect with users. And so I'm excited by it, and you'll continue to see us focus in this area. +The second was on YouTube brand. Obviously, YouTube has been doing well in terms of engagement and watch time. And so we see a long-term opportunity there. We've had strength on direct response as well through this quarter. But on brand, which was your question, we are obviously investing not just in YouTube main product, YouTube TV as well. And so areas where we can offer a bundle, advertisers are interested in streaming, and so bringing that bundle together, especially to advertisers and upfronts through YouTube Select is a big opportunity as well. So we are focused on that. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + And our next question comes from Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JPMorgan Chase & Co, Research Division - MD [5] +-------------------------------------------------------------------------------- + + I have 2. Just first, Ruth, curious if you can just talk about the cost structure a little bit more. We know you'll continue to invest to drive growth over the long term. Just curious how you're thinking about it as the top line starts to recover more hopefully over coming quarters. And then secondly, I know you said that search trends were flat to last year by the end of June. Just curious if there's anything you could add in terms of what you've seen more recently over the last month as well. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + Thanks for this, Doug. So in terms of cost structure, as we talked about last quarter, we have been focused on taking steps to enhance efficiency in the near term. And that being said, as Sundar and I both noted, what you're seeing is the fact that we do remain focused on investing for the long term. So sort of breaking that down in cost of revenues, while TAC and content acquisition costs are obviously tied to revenues, there is a sizable percentage of other cost of revenues that are not directly correlated with revenue growth, as I noted in opening comments, and we are very focused on the user experience and the overall ecosystem. So we are investing to make sure that we're supporting our products so they remain reliable in all environments. +And then in OpEx, much of our operating expense is generally less variable and not necessarily correlating to revenues in the near term. So in terms of a couple of the items, although we do continue to expect the year-on-year headcount growth rate to decelerate, as I noted, we are hiring aggressively in priority areas like Cloud. And so we're taking near-term steps to enhance efficiency but still investing for the long term. So we're trying to make sure that we're getting those tradeoffs right. And as I noted, we do expect the year-on-year headcount growth rate in 2020 to be down somewhat from the 20% year-on-year rate last year, and that's even adjusting for 2 items that put upward pressure on headcount growth. The first, we're moving certain customer support roles from third-party vendors to Google's in-house operation center. That is actually OpEx neutral, but does increase reported spend. And then second, the pending acquisition of Fitbit. So we're trying to navigate it appropriately. +In terms of your second question, in terms of search trends and what we saw throughout the quarter, I would say that following a rough end to the first quarter, ads revenue gradually improved in the quarter, not only in Search, but YouTube and Network. And so for Search, we ended March at a mid-teens percentage decline in year-on-year revenues. And then as we progressed through the second quarter, we saw a gradual return in user search activity to more commercial topics, and then that was followed by an increase in spending by advertisers. So that resulted in a gradual improvement in year-on-year Search revenue trends in the second quarter. We ended basically flat to last year by the end of June and you know to carry it forward, although we're pleased that ads revenue gradually improved throughout the quarter. +As I said, we do believe it's premature to say, they were out of the woods given the fragile nature of the macro environment. And as you're aware, ad spend does tend to be correlated with macroeconomic performance. And so the macro backdrop will continue to be a key signal to monitor. But to your question, based on our estimates from the end of June through last quarter, there has been a modest improvement in July. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group, Inc., Research Division - MD & Analyst [8] +-------------------------------------------------------------------------------- + + I just wanted to ask a question on -- 2 questions related to Google Cloud, if I could. One, Sundar, I was wondering if you could share with us how you've seen the change in pace of customers migrating workloads to the cloud given COVID? And I'm also wondering if you could share with us kind of the puts and takes, and Microsoft talked about this a little bit last week with their Azure business, but for those that have accelerated workload migration to the cloud, how much has that offset the impacted industries or companies that you might be serving where they're seeing lower utilization than what they normally do of cloud capacity? So if you can kind of talk about the puts and takes to the growth as well, that would be great. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [9] +-------------------------------------------------------------------------------- + + Thanks, Heather. Overall, from my vantage point, obviously with Google Cloud, we've been investing to scale up, especially on the people side, on engineering, go-to-market and then, obviously on our investment side with data centers, cloud regions and so on. And so for me, it's been good to see as we are scaling up, we are executing more effectively. I've been personally involved in many, many conversations last quarter. We had many large customers come on to cloud, big telco deals and banking deals, Deutsche Bank, as an example. So overall, I felt the momentum was strong. Generally, felt like things were continuing well through the course. Felt like more a secular interest in our digital transformation companies are deeply thinking long term and planning for us. So overall, I felt at the moment, almost there. And I felt our execution as we are scaling up. Obviously, we are scaling up a lot. And so it's -- the combination is working well. +Your second question in terms of puts and takes. Overall, I think there are -- I won't -- I don't know whether there's anything significant worth for me highlighting. Obviously, you are right to point out that it doesn't affect everyone the same, but nothing significant for me to highlight here today. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And our next question comes from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [11] +-------------------------------------------------------------------------------- + + I have 2. The first one, Sundar, we try to always figure out changes in consumer behavior. I guess as you have sort of been studying what people have been doing through shelter-in-place and from the way things are changing from a consumer perspective, talk to us about areas you're most focused on, investing in and driving your teams to create new products to really help consumers with their changing habits. And then the second one, Ruth, I know as we sort of we look ahead with potentially a larger percentage of the workforce, work remote or work from home, without looking for quantification, maybe just talk to us about some puts and takes to areas where you could see either efficiency or higher potential costs from a larger percentage of the workforce being remote over the long term. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [12] +-------------------------------------------------------------------------------- + + Yes. On the first one, when there is -- the shift to online is profound. We see people engaging a lot, doing newer things than they did before. People's interests have -- are broadening, I would say, across the board. And so for example, we are -- for me, I'm looking at different types of user journeys and making sure each of them is getting deeper and better. So for example, in Google, as people have started coming for more health-related information, how is that experience working, thinking about that for the long-term and investing in it. I obviously spoke about shopping earlier, and that's been a big focus for us. Education in general. And when we think through small, medium businesses and bigger companies thinking through collaboration, where G Suites' potential is, the investments we are undertaking, all that is very exciting to me. +But I would say cutting underneath all that, maybe while we didn't talk about it, really focused on our AI teams doing the investments they need, evolving our next-generation TPUs and the team's building better models and better algorithms. All that, I think, our ability to do more things is something I'm really interested in and focused on as well. So that's something I'm excited about -- for the longer term. + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + And then in terms of your question about work-from-home, I think it's a great point because it obviously feeds so much into a lot of the product work that we're doing in Cloud through G Suite, et cetera. So that's where I would actually start, but I appreciate what you're asking is how are we looking at our own cost base. And we called that out last quarter, in particular, with respect to CapEx, and you can sort of see it here this quarter. The main change in CapEx has really been we slowed the pace on the office facilities front. And what we're looking at is really how to reimagine what the workplace will look like. We continue to be very much focused on the fact that place and space are important. We believe in collaboration. Serendipity is key to innovation. So we do view space in office as important and are very focused on what does that mean over the long term. +We've actually opened quite a number of our offices, in fact, in 40 countries and do hope to reopen in many more. But your question to what does it mean for overall cost structure, we're looking at that with the place you see it now is in our CapEx, and the way we've been looking at it and our indication that we do expect 2020 will be lower CapEx on the facility side as a result. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + And our next question comes from Brent Thill from Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [15] +-------------------------------------------------------------------------------- + + I was just curious if you could just comment in terms of some of the near-term business trends and anything that's changed as you've gone through the month of July versus what you saw in June? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + Sure. I already commented on that with respect to Search, but to broaden it a bit more, and again, this is based on estimates from the end of June through last week. So for YouTube, we ended March with a year-on-year growth rate in the high single digits, and that's reflecting a substantial headwind from brand. The headwind from brand moderated modestly at the end of the second quarter, and then we saw a further improvement in July. Direct response has been consistently strong. +For Network, revenues improved toward the end of the second quarter, and we have seen a further slight improvement in July. Obviously, 3 weeks is not a quarter, but that's based on the estimates here from the end of June. And then as Sundar and I both said, when you look at, for example, Cloud, it has maintained its strength consistently. And I'd say that with a business that's growing at this pace, it's really much more about a secular trend to the move to cloud. So really nothing to comment on there. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + And our next question comes from Justin Post from Bank of America. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [18] +-------------------------------------------------------------------------------- + + Great. Sundar, I don't know how much you can comment on the regulatory environment, but it's obviously top of mind with the hearing yesterday. Maybe just characterize it for Google right now. And are you seeing any progress with the regulatory environment? And then secondly, we saw the YouTube TV price increase, a pretty interesting business model. But longer term, do you see that as really strategically important for the YouTube brand? Or do you think you can have a really profitable business on that? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [19] +-------------------------------------------------------------------------------- + + On the regulatory front, we've obviously been operating under scrutiny for a while, and we realize, at our scale, that's appropriate. And we've engaged constructively across jurisdictions. And from my standpoint, I'm confident in the approach we take, our focus on users and in the evidence in almost all areas we operate in. We expand choice or overall lower prices. And it's -- overall, there's a very fast pace of innovation. So it's dynamic and competitive. +Having said that, obviously, we will operate based on the rules. And so to the extent there are any areas where we need to adapt, we will. And as a company, I think we will be, I think, being flexible around those things is important, I think. I think the scrutiny is going to be here for a while, and so we are committed to working through it. On the second question around YouTube TV, yes, there is -- I mean it's a good question. I spoke earlier about even from a brand and how people think about it, they are interested in streaming. So as YouTube TV gets more scale, I think we will see more opportunities there. We are obviously still in the early stages of building out the product. And just recently, we've added a bunch of new channels and making sure it's working well. +In the U.S., the TV market is a big part of the advertising market, too. So overall, if we can invest here and scale up, I think the synergies with YouTube will become more meaningful over time. And so excited the traction the product is getting. But still too early. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + And our next question comes from Kevin Rippey from Evercore. + +-------------------------------------------------------------------------------- +Kevin Michael Rippey, Evercore ISI Institutional Equities, Research Division - Co-Head of Internet Research [21] +-------------------------------------------------------------------------------- + + This one is for Sundar. I was hoping you might be able to expand on the earlier comment you made about the AI strategy. I'm particularly wondering, if there's been things over the past 5 months since the pandemic began, that you thought an expansion of a very high strategy or an evolution of the past strategy might be able to solve for whether that relates to commercialization or monetization or really anything across the business. Just really, really curious. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [22] +-------------------------------------------------------------------------------- + + An area which -- first of all, across the board, the progress is steep. So I'm very happy with the pace at which our R&D on AI is progressing. And for me, it's important that we are state-of-the-art as a company, and we are leading. And to me, I'm excited at the pace at which our engineering and R&D teams are working both across Google and DeepMind. So I'm excited about it. Specifically, we are making good progress in areas like language understanding. And you saw some improvements last year, significant improvements with BERT and Search. But BERT took us a few years to get there. But things like that, I see more stuff in the future. And so excited by it. +An area where I think we are still under-tapped vis-à-vis potential is definitely Cloud. We see the potential there. But -- and I think it's a bit related to Heather's question, too. I think companies are thinking about migrating workloads and so on. But the longer run opportunity of actually using AI to truly have business solutions for you for whatever industry you are in, that feels like there's a lot of potential, and we are still very early there. And so part of it is, for us, connecting the dots internally and bringing it as solutions to our users. We have done it in certain product areas, but I see there's a bigger opportunity in the future. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays Bank PLC, Research Division - MD of Americas Equity Research & Senior Internet Analyst [24] +-------------------------------------------------------------------------------- + + Great. I just had 2 questions. First, on YouTube subscription. So can you talk about the size of that area of the business relative to that $15 billion? We had it at about 15% of total YouTube revenue. And then how is the faster growth in that area relative to advertising impacting your long-term profitability goals at YouTube? And then the second question is on Search. So it sounds like the flat exit run rate year-on-year is pretty encouraging. If we strip out travel, I'm guessing it's well above that. So how would you characterize the query growth versus just the ad auction dynamics outside of travel across the other categories? Are we back to pre-COVID levels in those areas? + +-------------------------------------------------------------------------------- +Ruth M. Porat, Alphabet Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + So in terms of the first question, we haven't broken out the specifics within the YouTube subscription revenues. YouTube subscriptions are in other revenues, it's not in advertising revenues. And overall, as we think about the opportunity -- our view is -- and we talked about this when we were launching the subscription product, it was really responsive to what we were hearing from users. And as we look at it, music is a key part of the overall YouTube experience. It's an important component of watch time. And what we found is that users wanted -- they wanted choice and some wanted a premium YouTube experience with ad-free viewing and the ability to download songs and videos. And that was really the impetus. +In addition, YouTube Premium provides additional revenue streams for music labels and publishers. So for example, in 2019, YouTube paid the music industry over $3 billion. And what we've done is meaningfully ramp our geographic presence from 5 countries in the beginning of 2018 to 94 countries today. And earlier this year, we announced that YouTube Premium had more than 20 million paid subscribers, up more than 60% versus the prior year. So our subscriber numbers have continued to grow there, and it really was driven by the goal to give users choice. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + And our next question comes from Colin Sebastian from Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + I guess maybe a follow-up to the earlier question on commerce. Beyond the marketplace functionality and some of the free year promotional transactions, I wonder how some of the other initiatives are going to play a role. And things I'm thinking specifically are, were you focused before on Google Checkout and Maps and some of the assistant functionality, how those may play a changing role in commerce on the Google platform. + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes. Great question. I think the bar is to have that super simple experience, which is delightful and that you have peace of mind and satisfaction in terms of getting the product and being able to return it and so on. So the end-to-end funnel matters a lot. And part of the reason why through the changes, a couple of things we have done. As you saw, we changed and we removed the commission for merchants to be on the platform. And part of it is by removing that. They can take that and invest in, be it shipping, be it delivery, be it the customer experience. And so that matters, matters I think in the overall experience. +And from our standpoint, the Buy on Google experience is something which deeply investing in. Obviously, our integrations with PayPal, our investments are underlying it to make sure for a lot of users that it's as close to a one-click experience as possible is a big part of the investment as well. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Mark Mahaney from RBC. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, Research Division - MD & Lead Internet Research Analyst [30] +-------------------------------------------------------------------------------- + + I want to ask a broad question about Google. Google's place or position, whatever, in online retail. And I asked this because Google has also -- obviously been central. Search has been central, but also YouTube has been central to commerce, online commerce for the last 20 years. We've gone through this pandemic where there's a real inflection point. We see it in Amazon's results. We see it in Shopify's results. And I'm not sure I see it in Google's results. So just talk about how you think, broadly, Google is positioned for what's really been like a 2- or 3-year pull-forward in accelerated ramp up of online retail demand. And are you positioned the way you want to be positioned now? Are there things you need to make to the -- changes you needed to make the products and services to be better positioned? + +-------------------------------------------------------------------------------- +Sundar Pichai, Alphabet Inc. - CEO & Director [31] +-------------------------------------------------------------------------------- + + Obviously, I think as a company, our strength comes from the diverse categories in which we serve users, right? And it's not just product, it's services, it's wide areas, including areas like travel. So it's diversified. And -- but it also means through a pandemic, there are areas of strength, but there are areas of -- areas where you get impacted as well. So I think that's what is reflected in what you see. On e-commerce, you're right, direct e-commerce providers are seeing a big inflection point. But in it are essential categories like groceries and stuff, which are built in, which we don't directly play in. But to us, the reason we are doing this long-term focused effort on shopping with the new leadership team is to precisely make sure as a platform, we are improving and as the shift continues, Google continues to be an important place by which people come and participate in those journeys. +So long run, I see a growth opportunity with related to what we are investing in there as well. Not just through Search, but a Search in the Shopping investments we are making, but in YouTube, and also helping retailers on the cloud side. It's an area where there's naturally a lot of interest to work -- to partner with Google, and so we see that as a big opportunity as well. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any closing remarks. + +-------------------------------------------------------------------------------- +James H. Friedland, Alphabet Inc. - Director of IR [33] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us today. We know you all have a busy evening. We look forward to speaking with you again on our third quarter 2020 call. Thank you, and have a good evening. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2016-Apr-19-INTC.txt b/Transcripts/INTC/2016-Apr-19-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..7cc86660fb5a8c85b2b984b521e3f8cbd54e98a5 --- /dev/null +++ b/Transcripts/INTC/2016-Apr-19-INTC.txt @@ -0,0 +1,770 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Intel Corp Earnings Call +APRIL 19, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Stacy Smith + Intel Corporation - EVP & CFO + * Mark Henninger + Intel Corporation - VP of Finance & Director of IR + * Brian Krzanich + Intel Corporation - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Amit Daryanani + RBC Capital Markets - Analyst + * Stacy Rasgon + Bernstein - Analyst + * Chris Danely + Citigroup - Analyst + * Harlan Sur + JPMorgan - Analyst + * John Pitzer + Credit Suisse - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Ambrish Srivastava + BMO Capital Markets - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen. Welcome to the Intel Corporation Q1 2016 earnings conference call. +(Operator Instructions) +As a reminder this conference call is being recorded. I would now like to turn the conference to Mark Henninger, Head of Investor Relations. You may begin. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Nicole, and welcome, everyone, to Intel's first-quarter 2016 earnings conference call. +By now you should have received a copy of our earnings release, CFO commentary, and the announcement of our restructuring program. If you have not received all three documents, they are available on our investor website INTC.com. +I'm joined today by Brian Krzanich, our CEO, and Stacy Smith, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them followed by the Q&A. +Before we begin let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +And a brief reminder that this quarter we provided both GAAP and non-GAAP financial measures following the acquisition of Altera, now our Programmable Solutions Group. Today we will be speaking to the non-GAAP financial measures. The CFO commentary and earnings release available on INTC.com include the full GAAP and non-GAAP reconciliations. +With that out of the way, let me turn it over to Brian. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. +Our results in Q1 were in the lower half of the range we set in January and reflect an extra work week in the quarter. Revenue increased year-over-year driven by an expanding business portfolio that now includes the Programmable Solutions Group formerly known as Altera. Strength in our Data Center, Internet of Things, and Programmable Solutions businesses partially offset weaker than expected PC revenues in our Client business. +I'll take a minute to review our Q1 results before talking about the restructuring program we're announcing today. CCG revenue grew 2% year-over-year. We saw ongoing declines in the PC TAM, particularly in China and other emerging markets, which also led to greater than anticipated reductions in worldwide PC supply chain inventory. Declines in the PC segment were offset by a richer core mix and a 14th workweek. +The Data Center business posted another good quarter, growing 9% over last year on strong cloud and comms service provider demand, partially offset by ongoing softness in the enterprise. The Internet of Things Group grew a remarkable 22% year-over-year, due largely to the performance of the video and retail verticals. In the Memory business, strong unit growth was offset by pricing declines, leading to revenue that was 6% lower year-over-year, and in our Security business, revenue grew 12% as this team continues to tighten its focus and execution. +And finally the PSG group, formerly known as Altera, got off to a great start. It delivered a revenue of $359 million, and after adjusting for $100 million in acquisition-related accounting charges, the business achieved mid-single-digit growth. And less than a quarter after the deal closed, we are shipping our first FPGA Xeon co-packaged parts to customers in sample form. +These results tell the story of Intel's ongoing strategic transformation, which is progressing well and will accelerate in 2016. We are evolving from a PC company to a company that powers the cloud and billions of smart connected and computing devices. The Data Center and Internet of Things businesses are now Intel's primary growth engines, and combined with Memory and FPGAs form and fuel a virtuous cycle of growth. +Last year we achieved record revenue in the Data Center, Internet of Things, and Memory businesses. We delivered a combined $2.2 billion in revenue growth, and made up 40% of our total revenue and contributed the majority of our operating process. Today we announced a series of actions that will build on the strength of those franchises and accelerate our strategic transformation. +Through this initiative we will intensify our investments in the products and technologies that fuel the growth in the Data Center, IoT, Memory, and FPGA businesses, and we expect it will result in an even more profitable Client business. These changes will reduce our global employment by about 12,000 positions by mid-2017. We will do this through site consolidation, voluntary and involuntary separations, project reevaluation, and an intensified focus on efficiency across a variety of programs. +These are not changes we take lightly. We will be saying goodbye to colleagues who have played an important role in Intel's success. Yet acting now gives us flexibility. Flexibility to continue to invest in those client segments that are growing, including 2-in-1, gaming, and home gateway, among others. +Even more importantly, acting now enables us to increase our investments in areas that are critical to our future success. This restructuring program will allow us to expand our investments in the Data Center, the Internet of Things, Memory, and connectivity, even as we reduce our spending run rate by roughly $1.4 billion by mid-2017. +This is a comprehensive initiative. It's designed to create long-term value by accelerating the fundamental long-term change already happening at the Company today. We will emerge as a more collaborative productive team with broader reach and sharper execution, and we expect it to result in the highest revenue per employee in the company's history. +Last, but certainly not least, we have one additional announcement today. I'm happy to share that Stacy Smith will be taking on a broader new role within Intel and reporting to me, leading sales, manufacturing, and operations. Stacy has been a great business partner and a world-class CFO, and I'm looking forward to continuing the partnership as he brings his leadership, his depth of knowledge, and his breadth into these critically important areas for Intel's future. We expect this transition to occur over the next few months following a formal CFO search that will assess internal and external candidates. Stacy will remain in his CFO role throughout the search and transition process. +Congratulations, Stacy, and with that, let me turn the call over to you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you very much, Brian, and I really appreciate the kind words. +Revenue for the first quarter was $13.8 billion, up 8% year-over-year. The quarter showed year-on-year growth and was in the low end of the range of our prior outlook. Within this, we are seeing growth in the Data Center, Internet of Things, Security, and Programmable Solutions Groups, all of which helped offset a weak PC market. +First-quarter gross margin of 62.7% was approximately a point higher than our expectations, driven by lower 14 nanometer costs. R&D and MG&A was $5.4 billion, down over $100 million from our guidance. Operating income of $3.3 billion was up 13% from a year ago. The effective tax rate for the quarter was 18.4%, about seven points lower than our prior outlook. Earnings per share of $0.54 was up 20% from a year ago. +The Client Computing Group had revenue of $7.5 billion, a 2% increase year-over-year. This was below our expectations due to a weaker than expected PC market. Operating profit for the Client Computing Group was $1.9 billion, up 34% from a year ago. This improvement is driven by lower 14 nanometer unit costs on notebooks, lower overall total spending, and margin improvements in our mobile products. +Data Center Group had revenue of $4 billion, delivering 9% growth on a year-over-year basis. Relative to our expectations, we saw weaker enterprise business offset by strength in the cloud segment. The Data Center Group had operating profit of $1.8 billion, up 4% year-over-year as we ramp our 14-nanometer server product. +Our Internet of Things segment achieved revenue of $651 million, with year-over-year growth of 22%. We saw strength in both the retail and video display segments of our Business. Internet of Things operating profit was $123 million, up over 40% relative to last year. Our Security business had revenue of $537 million, up 12% year-over-year. +Our Memory business had revenue of $557 million, up 6% year-over-year. The segment had an operating loss of $95 million as a result of challenging pricing, increased 3D XPoint spending, and startup costs as we ramped 3D NAND in our China factory. +The Programmable Solutions Group had revenue of $359 million. When adjusted for the approximately $100 million of deferred revenue, and compared to Altera's results for a year ago, the business achieved mid-single-digit revenue growth. +Operating profit was a negative $200 million. This included over $300 million in non-cast charges for deferred revenue and inventory adjustments, plus certain acquisition related charges. Excluding these charges would result in low double-digit operating margin growth for this business. +We generated $4.1 billion of cash from operations in the first quarter. We purchased $1.3 billion in capital assets, paid $1.2 billion in dividends, and repurchased approximately $800 million of stock in the first quarter. Total cash balance at the end of the quarter was roughly $15 billion, down $10 billion from the prior quarter as a result of closing the Altera acquisition. Our total debt is approximately $25 billion, consistent with our prior commentary on the financing plan for the Altera acquisition. +As we look forward to the second quarter of 2016, we are forecasting the mid-point of the revenue range at $13.5 billion. After adjusting for the extra work week in the first quarter, this forecast is in the low end of the average seasonal increase for the second quarter. We are forecasting the mid-point of the gross margin range to be 61%, plus or minus a couple of points. This decrease in comparison to the first quarter is driven by lower platform volumes. +Turning to the full-year 2016, we expect revenue growth in the mid-single digits from 2015, down from the prior guidance. We are forecasting robust growth rates in the Data Center, Internet of Things, Non-Volatile Memory Solutions, and Programmable Solutions Groups, which we expect to offset the decline in the Client Computing Group. +We now expect the PC market to decline in the high single digits in 2016, versus our prior forecast of mid single-digit decline. Our projection of the PC market remains more cautious than third party estimates. We are forecasting the mid-point of the full-year gross margin to be 62%, a one-point increase from the prior outlook, driven by lower platform volumes. +Our execution to our strategy is driving growth. We are building on our strong position in Client, and are investing for growth in the Data Center, Internet of Things markets, and disrupted differentiated memory technology. The trends over the last two years demonstrate that we are well into this transformational journey. +From 2013 to 2015 the PC TAM declined 10%, yet Intel's revenue grew 5%, and our operating profit grew 14% over this horizon. But as Brian mentioned, we want to accelerate that execution. In order to do that we're going to go through a significant restructuring over the next several months. The goal is to come out of this more agile, more efficient, with more investment in our key growth initiatives, and more profitable. +When completed by mid-2017, these actions will result in a 12,000 person workforce reduction, and a $1.4 billion reduction to our spending run rate. Relative to full year 2016, we are now revising our spending guidance down by over $700 million to $20.6 billion. +We expect to realize over half of the total workforce reduction by the end of this year. In the second quarter of this year, we are taking a $1.2 billion restructuring charge on the GAAP P&L, with an estimate for the related actions. +These actions are significant and we don't embark on this lightly, but we are confident that they will build on the strong position we have across markets, and accelerate the transformation of the Company that is already underway. +I would like to end on a brief personal note by saying thank you to Brian for the upcoming new leadership opportunity. Intel changes the world with amazing technology, and I am proud of what we've accomplished, and I'm excited about the opportunity that's in front of us. +With that let me turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [5] +-------------------------------------------------------------------------------- + + All right, thank you, Brian and Stacy. +Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask one question and just one follow-up if you have one. Nicole, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Hello. Thanks for letting me ask a question. First and foremost, B.K., if you can go into a little bit more about what led to the restructuring announcement, not only the one today, but there's been significant changes in the senior management over the last three months. So if you could just talk us through some of what's changed strategically in the Company that's led to such a large amount of turnover so recently? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Sure. I mean, if you take a look at it, so let's step back for a second and just talk about why are we doing the restructuring now, and then we can talk about some of the specifics beyond that. +So we've talked about this transformation, that we're moving from a client-centric, you know Intel's been typically known as the PC company, to a company that is focused more and more on a much broader set of products, and really focused around the cloud, right? And the cloud, and all the connected devices that connect to that cloud, and the connectivity that brings those devices to the cloud. +And that includes the PC, but it's much more than that. And so what this effort around the restructuring is, is to say, it's time now to try, and we've made enough progress, right? You take a look at it, 40% of our revenue, 60% of our margin comes from areas other than the PC right now. It's time to make this transition and push the Company over, all the way to that strategy and that strategic direction. So that's why we wanted to do it now. +Let's talk then about the leadership changes. There's really only been three leadership changes, if we just take the last couple of quarters. +We had Doug Davis, he is simply retiring. Those are personal reasons. That has nothing to do with his leadership or direction of the Company. +It's IoT. We've talked about IoT as one of our growth segments. It grew 22% this quarter. It's clearly -- his performance in the group is strong. And he's staying until we find a successor, roughly the end of the year, we think, something like that. +Kurt chose to leave for some outside opportunities. And the one that Stacy and I have been working for several months, actually several quarters, on what does he do next, how do we growth his both exposure to other parts of the company and also the rest of the company see his leadership style. +And so what we wanted to do is, as soon as we'd made the decision, is go ahead and start a search and start looking for a CFO replacement. We wanted to be completely transparent, be very open about that and let everyone know. +This is going to be an orderly transition. We are just going to start the search. Stacy is solid in the CFO seat in that meantime, but this gives him a chance to see other parts of the company. If you take a look at the group manufacturing operations, which is everything from purchasing to building construction and all, and sales, it's roughly half the Company and people. And so it's a really good opportunity to see how the real operations of the Company work. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- + + Okay, thanks for all those details. My follow-up would be the full-year guidance of mid single-digit growth. When I put that together with the high single-digit decline now that you have in the PC business, I'm having a little hard time seeing how, if you take the seasonality of PCs out of the equation, in large part, what would be the lever that would get you there in the back half of the year, considering that a ramp well into the $15 billion range in revenue seems to be a prerequisite. Are there some moving parts you could describe to us that get you comfortable with that number? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [5] +-------------------------------------------------------------------------------- + + Sure, let me walk you through how we're viewing the year. And first let me just put it at the highest level, right? +What we're projecting for the year is overall growth, and we think we'll see growth in the Data Center, growth in IoT, growth in Memory that's offsetting some, oh and of course we've added in Altera now into our product family, and so you take that and that's offsetting some of the weakness that we're seeing in the PC market. +Specific to the PC market, as we said in our prepared remarks, we are now expecting that the PC market is down in the high single digits, and when we started the year we were in the mid-single digits decline. +The linearity, so first you have to understand, the first half is impacted by the fact that as our customers view of the market came down, and if you recall we had a more cautious view of the market than they did when we started the year. They were bringing down inventory levels, and that impacted us in Q1 and I think you'll see the same impact as we forecast a roughly seasonal second quarter, that we'll continue to see those customers burning off inventory. We think that doesn't repeat in the back half, so it's a little bit of a tailwind. +I'd also say, you want to be careful of, we guided to mid-single digits. That's a range. If you are mathematically trying to drive to a specific number there, you may be driving more backend than what we're really anticipating. So just a caution there that that's a range, it's meant to be directional of how we see the Business. All of that said, I just want to say I think Brian and I are very comfortable with the back end and what's implied in our guide, based on everything that we know. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Blayne Curtis, Barclays. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks for taking my question. +I really just wanted to follow up on the restructuring. Is it more an effort to make the client more profitable, or are you really trying to drive revenue and redefining maybe more employees than you're letting go? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [9] +-------------------------------------------------------------------------------- + + So it is absolutely a situation where we are structuring to be able to allow ourselves to invest at a faster rate in those growth areas. +If you take a look at it, 2016 to 2015, in the areas of Memory, with our NAND technology, IoT, Data Center, even before this action, we were investing more in 2016 than in 2015 in those areas. This will allow us to, even with the cuts, even with the dollar figures that Stacy has read out on the savings, it's allowing us to invest even more in those segments. +And I always want to make sure, it's not just about cutting costs necessarily in the client area. You know, we think that we can become more focused. There are areas of the client space that are growing. 2-in-1s are growing at double-digit rates year-over-year. Gaming PCs are growing at double-digit rates year-over-year. Set-top boxes are growing, and we are gaining share in the set-top box space. +So we're doing very well in segments that are growing in the client space and the PC space. And we are going to continue to double down and focus on those. So it's really a narrowing down and allowing us as a result also to invest more in those growth areas. That's really what we're doing here with this restructuring. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [10] +-------------------------------------------------------------------------------- + + And Blayne, just to make sure, if you look at the CFO commentary, just to make sure the financial answer is clear there, the $1.4 billion in run rate savings is a net number. So I just want to be clear on that. That's what we expect to achieve, and that is encompassing the fact, like Brian said, that we'll be increasing investments in a lot of different areas. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [11] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [12] +-------------------------------------------------------------------------------- + + Thanks. +And then I know mobile is within Client, but I was wondering if that's a segment that you expect to contribute to growth this year, and if you can just talk about your confidence in reaching the cost savings for the year? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [13] +-------------------------------------------------------------------------------- + + Sure. Absolutely on schedule for hitting our committed $800 million, and just like last year we'll shoot to do better than that. Mobile is absolutely continuing to grow for us as a segment, and we're continuing to increase our profitability. If you look underneath the numbers here, you'll see that the profitability within the mobile space continues to improve for us, this year over last year. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [14] +-------------------------------------------------------------------------------- + + Yes, you can really see it, Blayne, in the CCG operating profit. That's up over 30%, which is on roughly flat revenues, revenues were up a little bit. And when you parse out the big contributions there, there's some ASP good news, but the really big chunks are the improvement in the margin on our mobile products, and decreases in investments that we talked to you about in the past that were all included in that mobile profitability. So you can, you'll see this play out in the CCG profitability over the course of this year, and you can see it in Q1. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [15] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [17] +-------------------------------------------------------------------------------- + + Good afternoon, thanks for taking my question. +I'm trying to see if you can be just a bit more specific on your full-year view. Does the team anticipate double-digits growth in DCG? If I look at it fundamentally, cloud and hyperscale CapEx looks to be up this year. There seems to be a big upgrade cycle in networking with the move to 25 gigabit ethernet. You are rolling out 14 nanometer Broadwell. Can you just be a bit more specific on expectations for DCG growth? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [18] +-------------------------------------------------------------------------------- + + Sure. You did a great job explaining exactly why we believe that the Data Center will continue in double-digit growth this year. And if you take a look at the numbers that Stacy has talked about, they incorporate double-digit growth, and for exactly those reasons. +We believe we have great products that we are introducing, with the Broadwell lineup. We've started shipping our first Xeon+FPGA samples to customers, which was part of our additionally gaining more footprint and more performance in certain segments of the Data Center. We shipping the Omni-Path Fabric now. Later this year we'll have Silicon Photonics. We've got 3D XPoint starting to be sampled and we'll start to ramp later this year. +So we're very confident on our Data Center road map, and we are still absolutely forecasting double-digit growth in that space. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [19] +-------------------------------------------------------------------------------- + + Great, thanks for the insights there. And then on the Memory Solutions Group, I mean that's a business that grew 20% last year. I think it was up year-over-year every single quarter last year. Obviously it was down in Q1. You mentioned aggressive price declines. +Can you just talk about some of the trends that you're seeing there? Are the sharp declines more focused on capacity or performance optimized SSDs? And then you also mentioned your view on a strong growth outlook for the full-year. So what drives the acceleration from the Q1 decline? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [20] +-------------------------------------------------------------------------------- + + Sure, so let me start and then we can just talk about, remember the majority of our Memory space is built into SSDs that are going into the Data Center, so you call those, really those higher-end performance class systems. +What we're saying, if you take a look at units, units grew quite nicely year-over-year and quarter-over-quarter for the Memory Group. You're right, we are seeing aggressive pricing in this space. +The Memory segment, the NAND segment especially, tends to go in these cycles where there's overcapacity in the industry, and aggressive pricing, and then it shifts back to more normal pricing, and then tight pricing, which is always very positive. +So this is just a normal cycle. We think we've done a very good job of structuring the business that we ride through these with a high degree of confidence. If I look forward, we believe the 3D NAND technology that we're just beginning to ramp in our factories today, and we're building out the Dalian factory for later this year startup, gives us a real cost advantage in this space and will allow us to even be more profitable in even these kinds of environments. +So we're still confident that this business will continue to grow. We'll ride through this capacity situation within the industry, and our 3D NAND technology will position us very nicely as we move out of this and start up our Dalian factory in China. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [21] +-------------------------------------------------------------------------------- + + And the operating margin, Harlan, when you're looking at that, part of it is the competitive pricing environment that Brian is talking about, but there's a big piece of that that is associated with the investments that we're making it 3D Xpoint, and the startup costs associated with the factory in China. And it just points to, yes, it's cyclically a tough time in what we consider a very good business, and we're investing in technology that we think gives us a very strong position as we go forward. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [22] +-------------------------------------------------------------------------------- + + Understand. Thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [24] +-------------------------------------------------------------------------------- + + Hello. Thanks for taking my questions. My first one on DCG in the quarter, so up 9% year-over-year, but that was with the extra week. Can you tell us what it might have been year-over-year without the extra week, and why did pricing fall again this quarter? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [25] +-------------------------------------------------------------------------------- + + Yes, so like we said when we started the quarter, that extra week was that week between Christmas and New Year's. When you look at where that 14th week fell, it's a relatively light, but it certainly had some impact, so I don't want to say none. But it's a little hard to figure it out on any given business. It certainly had some impact on DCG though. +In terms of the pricing, it's pretty simple in that it was the growth rate that we saw in the networking segment. So what you would see, with a constant mix we would have seen ASP up in the Data Center, but the networking segment grew 50% year-on-year, which is exactly consistent with our strategy, and so what you see there is strong unit growth offset by a little bit of a mix down. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [26] +-------------------------------------------------------------------------------- + + Got it, thank you. For my follow-up, I just wanted to touch on channel inventory. So, you had your notebook and desktop volumes down low single digits year-over-year. I think it's fair to say that PC builds in the industry were down quite a bit more than that. And yet you suggest that you drained out with the channel drain on inventory. What happened with your own inventory in the channel, and how do you see that changing for rest of the year? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [27] +-------------------------------------------------------------------------------- + + You said own inventory in the channel - + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [28] +-------------------------------------------------------------------------------- + + The stuff you're shipping into the channel. Because it seems like your performance year-over-year is quite a bit better than what the industry was. I mean maybe you did some share gains, maybe it's the extra week, although you just said the extra week didn't amount for very much. So can you explain the differential between your year-over-year unit shipment performance in PCs and what the market seems to be doing? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [29] +-------------------------------------------------------------------------------- + + Yes, so I would point to two things relative to the overall, what we saw from our customers. One is, yes, we had a 14th week that's going to make our compares different from IDC and Gartner, for sure. +But then the second thing is, when you look at the results of our customer base? They would see a weaker quarter, and I think that's because they were catching up to our view of the market and bringing inventory levels down. +So we were impacted by two things, I'll put it like that. We were impacted by a TAM that wasn't terribly strong, and the fact that our customers were bringing their inventory levels down some. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks, Stacy. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Romit Shah, Nomura. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [32] +-------------------------------------------------------------------------------- + + Yes, thanks very much. Stacy, you're below your run rate on CapEx in Q1, and I know you reiterated for the year, but curious if you're giving yourself flexibility in case the second half doesn't prove out to be as strong as you are anticipating. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [33] +-------------------------------------------------------------------------------- + + No. What's going on there is that when you look at the two items that really dominated our CapEx this year, it's 10 nanometer capacity, so it's getting that first production capability in place, and it's the ramp of the memory factory in China. And those are both back end loaded, so that causes the linearity to be off a little bit. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, thanks. And then just staying on the theme of CapEx, with the restructuring you guys are talking about site consolidation, and I'm wondering if longer-term there will be an impact to the capital expenditures required to support the business, and by extension, free cash flow. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [35] +-------------------------------------------------------------------------------- + + I'd say the same answer. When you look at those two items, the majority of what we're spending the CapEx on, 10 nanometer and Memory? Neither one of those is impacted by the restructuring, so we haven't let our foot off the gas one bit on those two things. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [36] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + C.J. Muse, Evercore ISI. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [38] +-------------------------------------------------------------------------------- + + Good afternoon, thank you for taking my question. I just have a follow-up on DCG. Thank you for the commentary around the pricing around network. But curious how we should think about the mix shift through, as we go through 2016, and here curious in terms of presumably slowing enterprise and uptick in hyperscale, and what that means to ASPs, and then as you layer in ongoing growth in networking, how we should think about platform versus ASPs moving through the year? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [39] +-------------------------------------------------------------------------------- + + Sure. A bit of a complex question, so let me try and give you a lot of data that I hope will answer various parts of that question. +So first the simple answer. If you take a look at our forecast, we continue to forecast ASPs increasing through this year. So that's absolutely built into our forecast, and we've modeled in things like you described: the weaker enterprise computing, and the difference between the pricing segments. +And I always remind people that, let's just start at the very top as, when you take a look at the Data Center, it's not one product. It's a family of products that really spanned from Xeon 5s that sell for several thousand dollars, to the networking processors that are a few hundred dollars at times. +But within each one of those families - so whether you have networking or cloud or hyperscale or enterprise computing - our ASPs are increasing, and that's mostly due to bringing in better products, people buying up the ladder in product, and resulting in a higher ASP on average for any one of those segments. So you will see slight shifts in the overall Data Center ASP. +We have a boomer quarter like this, like Stacy talked about. Networking is a little bit higher or something like that. But if you take a look inside any one of those segments, ASPs are increasing, and our forecast for the overall segment for the year is an increasing ASP. +And it's driven by people buying up the stock, and that's because we're bringing more performance for a better price to those customers. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [40] +-------------------------------------------------------------------------------- + + That's very helpful. And as a quick follow-up, you outlined the cost savings, but it doesn't appear as though there's really anything on the COGS side. So curious if you see a cost savings on that front, as well. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [41] +-------------------------------------------------------------------------------- + + Yes, certainly. We are equally focused on efficiencies in the factory space. There's a little bit baked into the 2016 gross margin. I think you'll see a bit more of it kick in in 2017. +And just realize the labor cost in the factories is a relatively small component. The real opportunity for us is some of the other things around capital efficiency, and how fast we convert over processes, and things like that, and that takes a little while to play through. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [42] +-------------------------------------------------------------------------------- + + Very helpful, thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [43] +-------------------------------------------------------------------------------- + + Thanks, C.J. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [45] +-------------------------------------------------------------------------------- + + Good afternoon. Thanks for letting me ask a question. My first one, I wanted to get a little more into profitability within the Data Center Group. You know revenue was down about $309 million sequentially. Operating profit was down $411 million sequentially. I know there's lots of moving parts, you have the extra week of OpEx that might not been fully covered by revenue. And Stacy, you talked about in your opening comments, the 14-nanometer ramp starting to hit there. +But with this new narrative of declining ASPs because of mix, I'm wondering if you could tell me how we should be thinking about operating profits in the business going forward? I think it was about 44% in the March quarter, down pretty significantly in the December quarter. Is this change in mix also having an impact on operating profits? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [46] +-------------------------------------------------------------------------------- + + Yes, so John, you nailed it in terms of what's going on with operating profit in Q1. It's just the early cost of the ramp of the 14-nanometer server product. That's what's causing that to behave a little differently from revenue. +And back to Brian's point, I would say no, there's nothing in the mix that per se would cause me to have a different view of the overall profit potential of this business. +So taking networking as the example, it does have a lower ASP than the Xeon product line does. It also has a very different cost structure than the Xeon product line does. So it doesn't cause us to being a different space from overall operating profit percent. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [47] +-------------------------------------------------------------------------------- + + That's helpful. +And maybe for my follow-up to Brian, you guys gave us your view for the PC market this year. I'm curious, in lieu of the restructuring, how you're thinking about the PC market longer-term. And specifically there's lots going on in the market that you probably can't control, but there's always been this view at Intel that the best use of cash is to invest in the business and to innovate, and innovation drives growth. +How do you balance that innovation desire with the realities of the PC market? And how do you think about the structural unit growth of PCs going forward, and do we run a risk at some point that PCs just don't provide the scale that you've talked about in the past, to invest in other businesses like DCG and IoT? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [48] +-------------------------------------------------------------------------------- + + Sure, so again John, that's a bit of a two-sided question. So let me start with the back half, and then we'll move into the first half. +First is, no, I'm not worried that the PC will shrink to a point where the scale won't get large enough to fund either the factories or the other innovation. In fact we talked about the restructuring actually makes us more profitable in the PC. That's allowing us to invest even more in those growth areas. Remember also those growth areas are growing, and so they are replacing some of the volume in the factories as they grow. +Now let's talk about the PC, you asked how do we take a look at the PC long-term, and how do we make sure we're making the right investments, which to me that's the key, right? That's what we really tried to do with this restructuring, is take a look at the areas that are growing, that we believe we can bring innovation to, that will make a difference to the end-user. +You are going to see more investments in 2-in-1s. You're going to see more investments in thin and light devices. You're going to see us push even harder on high-end gaming systems, which are growing at a very fast rate, and they tend to buy up the stack to the very, very top. And then we're continuing to gain share in segments like set-top boxes, which are becoming more and more PC-like with our capabilities, if you think about it from a hardware standpoint. +So there are absolutely segments we'll continue to invest and continue to innovate in. There's some very innovative systems in design right now, that bring new functionality and new thinness and lightness to the market for the second half of this year. And we'll do that. +What we're going to do is make sure we're doing this as most efficiently, and not doing it spread out across all PCs and all form factors. And that's what we've really tried to do with this effort right now. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [49] +-------------------------------------------------------------------------------- + + Helpful. Thanks. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [50] +-------------------------------------------------------------------------------- + + Thanks, John. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Amit Daryanani, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [52] +-------------------------------------------------------------------------------- + + Thanks a lot. Could you just talk about, from the restructuring cost perspective, how much of that is going to be cash versus non cash, and would all the cash outlays happen in the back half of this year? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [53] +-------------------------------------------------------------------------------- + + You were a bit faint. I think you asked on the restructuring how much of that is cash versus non cash, and how does that play out over the year? + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [54] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [55] +-------------------------------------------------------------------------------- + + Now you're loud and clear, thanks. I would say the restructuring charge is a mix of cash and non-cash, but it's probably, it's more heavily weighted towards cash costs, and it will be relatively front-end loaded on the year, but some of it will extend over the course of the year, and some of it frankly will extend into the first half of next year. + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [56] +-------------------------------------------------------------------------------- + + Perfect, and for the follow-up, ASPs on the client server up 19%. Just talk about how much of that was potentially CPU improvements on notebook and desktop pricing versus the lower mobility that may have had a better part to play there? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [57] +-------------------------------------------------------------------------------- + + Yes, and if you look at the CFO commentary, we actually gave you desktop and notebook. What you'll see is that notebook was pretty flat from an ASP standpoint year-on-year. Desktop was up 6%, so that is one of the [adverse] to profitability. +And then the big difference is what happened in phones and tablets. On a year-on-year basis, I think I termed it in the CFO commentary, up significantly as we weaned ourselves out of some of those counter revenue programs that we talked to you about. So that actually had a fairly significant impact on the overall ASP for CCG. + +-------------------------------------------------------------------------------- +Amit Daryanani, RBC Capital Markets - Analyst [58] +-------------------------------------------------------------------------------- + + Perfect, thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [59] +-------------------------------------------------------------------------------- + + You're welcome. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Vivek Arya, Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [61] +-------------------------------------------------------------------------------- + + Thank you for taking my question. +Brian, on the Data Center Group there's a lot of headlines from IBM, from the different arms, several lenders, and even from some of your cloud customers like Google who want to try new architectures, and I understand there is no new-term impact, but longer-term, how do you assess the competitive landscape, and especially how do you think it plays out on the compute market, where you are very large incumbent versus the comms market where you are not the incumbent? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [62] +-------------------------------------------------------------------------------- + + Sure, good question, Vivek. First I'll just tell you that, having been raised by Andy Grove, always paranoid about the competition, always driving, and you know that we live or die by the performance of our product. We believe that if you take a look at our road maps, we have strong competitive leadership that should allow us to continue to have the position in the market that we currently have. +I think also you have to take a look at some of our strategy that is becoming much much broader than just the CPU. What we're trying to do is really provide top of rack to bottom of rack solutions, that bring -- that work together and bring performance across the whole rack. And that starts with rack scale architecture itself, which is a very unique architecture that will allow people to build racks in a much more denser and lower cost way, through silicon photonics within rack communications. Then we go to 3D Xpoint. And then you have our whole CPU architecture, from networking, storage, up through server. +So we believe we are uniquely positioned to provide that whole rack viewpoint, and have everything work together and come together to bring, really, performance that is just unbelievable. And that's what's key to really keeping our position, is to understand the whole rack from top to bottom. And that really is our strategy when you take a look at it. +In the other areas, like you said, networking and storage and the telco area? Those are areas that we're gaining share, and as they move to software-defined infrastructure, and basically virtualized infrastructure, it plays right into the Intel architecture, and really what we do best which is general purpose computing. And that same architecture from top of rack to bottom of rack plays out in those areas as well, like in the telco area. +So we believe our strategy absolutely will maintain our position in that. But we're always paranoid and we're always realizing we get there by performance of those products. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [63] +-------------------------------------------------------------------------------- + + Got it, thanks for those details. As a follow-up, I know you probably have answered different pieces of this question, but perhaps Stacy, you could help us quantify what Intel started operating margins are this year, or maybe even longer term. Because when I look at a lot of fabless semiconductor companies, they can get towards 20%, 25% operating margins, and when I look at a Foundry, a DSMC, it's able to get close to 40% operating margin. So given those bookends, where should Intel be after all these restructuring actions are taken? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [64] +-------------------------------------------------------------------------------- + + Let me give you some elements of it, and then I would expect we'll have a much more in-depth conversation on that at the next investor meeting. But I'll give you some insight into how Brian and I are thinking of this. +First and foremost, we believe there's growth potential here. So from a top line overall company standpoint, we think that there's significant opportunity to grow. And I think we've executed well in terms of growing over the last couple few years, even as PC TAM declined, and that's very consistent with our strategy as invest in the Data Center, in Memory, and IoT, and things like 5G, where we think there's opportunity, and focus our investments in the Client that we've talked about. +In terms of the overall model, the financial model for the Company, I've given you this range of 55% to 65% gross margin as being -- most of the data points landing between those goal posts. If you look at it over the last five years, we've very consistently been in the very high end of that gross margin range, so it's more like between 60 and 65%. Last year we were 63%. This year we believe we are at 62%, so that continues. I don't see anything on the horizon that changes that in the near term. +And then with these actions that we're taking, when we get to full realization, and I want to stress, we do believe that this will give us an opportunity to reinvest in the business and actually accelerate growth, but if you just look at the cost side of it, it's 2 to 3 points of spending as a percent of revenue when we get to mid-2017, and full realization. That takes our spending as a percent of revenue, even just based on your estimate of 2016 revenue, it's 2 to 3 points, it takes us back down into the low 30s from a spending as percent of revenue. You can do the math from there and see what we think we can achieve next year in terms of overall operating range. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [65] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [66] +-------------------------------------------------------------------------------- + + You're welcome. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Chris Danely, Citigroup. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [68] +-------------------------------------------------------------------------------- + + Thanks, just a quick follow-up on the last question on restructuring. So should we assume that total expenses will drop roughly $150 million a quarter from 4Q 2016 to the second quarter of 2017? And then if you could break that out between how much of the savings would be on COGS versus OpEx? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [69] +-------------------------------------------------------------------------------- + + No, I'm not going to give that level of granularity of forecasting by quarter and 2017, but I'll say and I want to be clear that the $1.4 billion is all OpEx. That's an OpEx savings number that we think we get to by mid-2017. +So just to recap the financial data that we provided you, we get to that level by mid-2017, that's $1.4 billion in savings, and that is a net number, so that's including some reinvestment that we plan to make. We think that's 12,000 positions that get eliminated, which is a very difficult thing for us to go through, but that's what's in these numbers. We think we achieve half of those employment reductions by the end of this year. +And overall for 2016 we've brought down our OpEx by $700 million, that is again to get this restructuring program. And we've added in a line that you'll see on the GAAP P&L of $1.2 billion in restructuring charges to achieve that. So beyond that I'm not going to go into any more granular data. I think that should be plenty. And now we want to go have the conversation with the employees and help them understand what this program means. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [70] +-------------------------------------------------------------------------------- + + That's a very fair response. +And then for my follow-up, in terms of the growth opportunities that you are pushing for, IoT, DCG, etcetera, if you look at the margin profile of them, memory and basically cell phone processors, it's substantially below your current margins. My question is why would you want to pursue two markets like that where the margin profile is so much lower than yours? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [71] +-------------------------------------------------------------------------------- + + Sure, so let's dissect those. From memory, one, we believe that if you take a look at our typical margins, they're better than cell phone margins on typical quarters. But also it's integral to the Data Center, so it really actually is this virtual cycle that, especially as we move to 3D NAND and then to 3D Xpoint, as we've talked about 3D Xpoint and how that really re-architects how memory and storage is played out in the server rack and in the data center overall, it's a chance to really very uniquely shift that whole infrastructure. So we believe that's actually critical to our strategy in the Data Center. And we'll bring out a product with good margins. +Now let's talk about IoT. If you take a look at it, first, it's growing quite well and if you take a look at the Data Center, I mean the IoT, right now, it grew 22% this quarter, and it has PC-like margins, so this is not cell phone chips. They don't tend to be cell phone chips. +If you take a look at the segments we're really going after, which are things like automotive, or what I'll call autonomous vehicles, industrial and retail, they tend to be systems that have a fair amount of compute at the edge. They tend to have machine learning capabilities. These are systems and they tend to have a high degree of cons, more and more will move into 5G. +But that link also between those products in IoT and 5G, and the 5G infrastructure, we believe also plays into the Data Center, and the whole Data Center strategy, and will be critical that you can provide end-to-end solutions. So, if you're somebody out trying to build whatever that autonomous vehicle is, you need to be able to provide the 5G back end, but also the 5G out on the device, whether it's a car or a drone or a robot, or whatever it is out there autonomously moving about. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [72] +-------------------------------------------------------------------------------- + + And Chris, on the margin point, I'd take you back to points that Brian and I have made at the investor meeting and other places, which is, remember, and IoT's the perfect example of this, those businesses lever IP that we create broadly for the company. And so our cost of entry in something like IoT actually is relatively low, because we have the Atom core, we have the graphics, we're investing in the connectivity, we're investing in the wireless weigh in for other businesses. And that's where we really get leverage in this model, and that's one of the reasons that the IoT profit margins have been as high as they have been. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [73] +-------------------------------------------------------------------------------- + + Got it, thanks. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [74] +-------------------------------------------------------------------------------- + + Thanks, Chris, and Operator, I think we have time for two more questions. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Ambrish Srivastava, BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [76] +-------------------------------------------------------------------------------- + + Hi, thank you very much. I actually wanted to continue on IoT, Brian. A couple years ago, you had laid out a 20% tailored target for this, then I think a year later you had brought it down to mid-teens, and yes, it grew very strong this quarter, but last full-year it was a 7% grower. So the question is, what's the right way to think about the growth profile for this Business, and what happened in the past? Was it a one year off event, or help us understand the drivers, and why it should re-accelerate, and why the first quarter is not an anomaly? And then a quick follow-up. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [77] +-------------------------------------------------------------------------------- + + Sure. I would tell you that I'd reiterate what I said, which is it's a mid-teen type of growth rate. You've got to take a look at this over the long haul. +The IoT space is similar to the embedded space of old to some extent, and to the FPGA space, where you have, especially where we're trying to go, where you're trying to go into products that require that higher level of compute, the machine learning, and those capabilities. You have a design time, a design in time to win the design, and then you have a ramp for that product. And so those tend to take a little while. +Autonomous driving vehicles are good example. If you're out winning designs today, you're winning 2018, 2019 car designs. Those are what are being won today. So as you bring your products to market that's what you are winning. +So I'm still believing that over the long-term this will be a mid-teens growth. It will have for the most part PC-like margins. And we've tried to pick the segments that play to our strengths, and also use the connectivity that we believe we're uniquely qualified to bring. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [78] +-------------------------------------------------------------------------------- + + Okay, thank you, and then a quick follow up. Stacy, what explains such a big swing in the tax rate for the quarter, for the reported quarter, and then for the rest of the year? Thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP & CFO [79] +-------------------------------------------------------------------------------- + + Sure. For the reported quarter, the big driver of the tax rate was the discrete item associated with one of the divestitures that we drove out of our Security business, and we got a one-time tax benefit associated with that. +Just going back to the strategy, you can see the performance of the Security business both in terms of the revenue growth and their profit growth. I think the team there is doing a really good job of focusing in on a few key areas where we think we have competitive advantage, and then driving them hard. +And we've divested a few smaller business and we happened to get a tax benefit on one of them. As we look at the year, so part of it is what happened in Q1. And then the other part is we would expect to have a higher proportion of our profit in lower tax jurisdictions as we work our way through the year. It will bring down the tax rate a little bit. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [80] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [82] +-------------------------------------------------------------------------------- + + Thanks very much. A clarification of the commentary you gave earlier on your restructuring. Will there be any product lines or types of products that you'll be pulling out of in the future, with all the cuts that you're making? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [83] +-------------------------------------------------------------------------------- + + Yes, I'm sure that as we go through this and we finish the project evaluation, there will be some products that we'll exit from, those as they're defined. Murthy, we've brought into the company is doing a complete review of all of our products. And he's going to report back to me in the near future and give me a proposal for what those look like. So we don't have any that are set out today, but at the end I'm sure there is going to be a few that are part of that. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [84] +-------------------------------------------------------------------------------- + + Okay. And related to that, does the restructuring affect your longer-term expectations for technology transitions, and in particular are you still hoping to get back to a two-year tick-tock cadence? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [85] +-------------------------------------------------------------------------------- + + No, it does not have any effect on our technology cadence. It has not touched that at all. Stacy talked about even our CapEx and how the CapEx that we're spending this year, which has not moved, is mostly for either the 3D NAND ramp or 10 nanometers. +As far as Moore's Law, we are always constantly striving to get back to two years. We've given you a timing that's for 10 nanometers; that's more like 2 1/2 years. +We haven't talked about 7 nanometers. Partly it's still in definition and alignment, so we're not sure, but I can truly tell you we're constantly working to get back to two years. And I've tried to lay out that if you look at the history of Moore's Law, there have been anywhere from 18 months to three years in the length of cycles over the time. +More importantly what I always remind people is the leadership you have over the competition, which is always what's important, right? All of these are getting harder, and they get hard for everybody. And so you want to make sure also that your leadership gap, what you're able to do relative to the competition, remains constant, as well. Both of those are as important as the other. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [86] +-------------------------------------------------------------------------------- + + Great, thanks very much. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [87] +-------------------------------------------------------------------------------- + + Thanks, David, and thank you all for joining us today. Nicole, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [88] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2016-Jan-14-INTC.txt b/Transcripts/INTC/2016-Jan-14-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..fbb752aa623cdc1a7b145aa5c3a902f52b3f27f1 --- /dev/null +++ b/Transcripts/INTC/2016-Jan-14-INTC.txt @@ -0,0 +1,694 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Intel Corp Earnings Call +JANUARY 14, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Stacy Smith + Intel Corporation - CFO + * Mark Henninger + Intel Corporation - VP of Finance and Director of IR + * Brian Krzanich + Intel Corporation - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * Stacy Rasgon + Bernstein Research - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Harlan Sur + JPMorgan - Analyst + * Joe Moore + Morgan Stanley - Analyst + * John Pitzer + Credit Suisse - Analyst + * Chris Danely + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Intel Corporation Q4 2015 earnings conference call. +(Operator Instructions) +As a reminder, this call is being recorded. I would now like to turn the conference over to Mark Henninger. Please go ahead. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Sabrina, and welcome, everyone, to Intel's fourth-quarter 2015 earnings conference call. By now you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you've not received both documents they're available on our investor website, INTC.com. +I'm joined today by Brian Krzanich, our CEO, and Stacy Smith, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by the Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +Also, during this call, we'll be using non-GAAP financial measures and references. GAAP financial reconciliations are available in our earnings material, which was posted on our website, INTC.com, in advance of this call. The forecast that Stacy speaks to today will be on a non-GAAP basis. With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. Our results for the fourth quarter were consistent with expectations, and marked a strong finish to the year. Taken as a whole, 2015 demonstrated the benefits of our strategy, which is designed to capitalize on the growing need for the infrastructure powering the smart and connected world. That strategy is also resulting in the evolution of our business model, to focus on three key areas of growth: The data center, the Internet of Things, and memory. Our results reflect that evolution. Revenue for the year was nearly flat, despite a significant decline in PC demand. +2015 was also a year of revenue records and important milestones, and I'd like to take a minute to review some of them with you. Even though the Client Computing Group ended the full year down 8%, we were excited to see that we were able to grow sequentially in the second and third and fourth quarters. As of November, 14-nanometer products made up more than 50% of the client computing volume. And for the year, high end Core i7 micro processors and our K SKUs for gaming both set all-time volume records, leading to a rich product mix. +In our security business, we've refocused the organization on end point technology, where we enjoy a solid leadership position, and we've driven material efficiencies, as we fully integrated the McAfee organization into Intel. The results of these changes have been dramatic. On a constant currency basis, security revenue rose 6% for the year, while the organization's tighter focus drove a remarkable 44% improvement in operating income. The IoT group grew revenue 7% in 2015 to $2.3 billion, an all-time record. As the retail, transportation and video segments all saw strong double-digit year-over-year growth. +In our NAND solutions group, we introduced a revolutionary new class of memory called 3D XPoint, the industry's first new memory technology in more than two decades. 3D XPoint is a great example of our growth strategy at work, using our technology expertise to innovate and expand into profitably adjacent markets. We think it's a game-changing technology, moving forward. Our confidence in the technology led us to announce in the fourth quarter that we were upgrading our Dalian, China fab to manufacture both 3D NAND and 3D XPoint, with production beginning later this year. For the full year, our memory business grew more than 20% to $2.6 billion, another all-time record. +At the same time, the Data Center Group grew 11% over last year to an all-time record of $16 billion in revenue. Macro weakness weighed on enterprise demand and resulted in slower growth than we expected at the beginning of the year. However, DCG's overall performance highlighted the underlying trends driving data center demand, as cloud and communication service providers' revenue both grew more than 20% for the year. Within the cloud segment, 40% of our volume was custom SKUs as we left the year, demonstrating the ongoing value of working directly with the customers to tailor solutions to their needs. +Finally, just after our fiscal year ended, we closed our acquisition of Altera. We're thrilled to welcome the talented Altera team to Intel. Combined, our two companies will deliver powerful synergies based on Intel's process technology leadership, and the integration of Altera's FPGAs. +Wrapping up, our results over the last year leave me increasingly confident in our strategy. While our outlook for the first quarter reflects some caution about overall demand, particularly in China, we continue to expect solid growth in the business in 2016. Because it provides tremendous return to our shareholders, we will continue to drive innovation and differentiation in our core PC business. This business provides a foundation of IP, and a source of cash flow, but it's not the sole driver of our growth. +Our future as a Company will increasingly be a product of the virtuous cycle of opportunities in the data center, memory and IoT market segments. In fact, you can see the impact of that virtuous cycle in our 2015 results. DCG, IoTG and memory delivered nearly 40% of Intel's revenue, and more than 60% of Intel's operating margin in 2015. Additionally, these three adjacent markets delivered $2.2 billion in profitable revenue growth in 2015 alone, and as we look ahead to 2016, we'll continue to build on that strategy. Now with that, let me turn it over to Stacy. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. The fourth quarter was a strong finish to the year, with record revenue at $14.9 billion. We had record revenues in the data center and Internet of Things businesses. Gross margin of 64% was up 2 points to outlook, net income was $3.6 billion, down 1% year-over-year, and earnings per share was $0.74, flat over the same horizon. +I would like to provide context behind our full-year 2015 financials, as it provides insight into how we are executing to our strategy. Growth in the data center, memory and Internet of Things businesses partially offset a weaker than expected macroeconomic environment, and a weak PC client market. Overall, revenue for the year was $55.4 billion, which was down 1% from the prior year. +The Client Computing Group achieved $32 billion in revenue, and was down 8% for the year. Within the Client Computing Group, we achieved almost $1 billion in mobile profitability improvements over the course of the year, exceeding our goal. The data center business, at about $16 billion in revenue, grew 11%. The memory business, at over $2.5 billion in revenue, grew over 20%. And the Internet of Things business, at about $2.3 billion, grew 7%. +Gross margin for 2015 was approximately 63%, down about a point from 2014. Higher unit costs as we ramp 14-nanometer were offset by an increase in ASPs, driven by strong results in the data center business, and a rich mix in the client computing business. Operating profit for the year was $14 billion, down 9% year on year. Earnings per share for the year was $2.33, up 1% from the prior year. +In 2015, the business continued to generate significant cash, with $19 billion of cash from operations. We purchased $7.3 billion in capital assets. We paid $4.6 billion in dividends, and repurchased about $3 billion of stock. Total cash balance was $25.3 billion, up over $11 billion year-over-year. Our net cash balance, total cash less debt, and inclusive of our other longer-term investments is approximately $6.6 billion. We issued about $9.5 billion of new long-term debt to finance our acquisition of Altera, and in November we announced an $0.08 dividend increase to $1.04 per share on an annual basis, effective in the first quarter of 2016. +The acquisition of Altera was completed in early FY16, which means that the 2016 guidance includes the expected results for the FPGA business. As I talk to our guidance for 2016, it is important to note that we have excluded non-cash and one-time acquisition-related charges for Altera. The CFO commentary pre-released before this call and available on INTC.com includes the full GAAP and non-GAAP reconciliations. +For the first quarter of 2016, the midpoint of the revenue range is expected to be $14.1 billion. This forecast, which includes an extra work week, and the newly-acquired FPGA business, is on the low end of the average seasonal range. This outlook represents a soft start to the year as we remain cautious on the level of economic growth, particularly in China. We continue to believe the worldwide PC supply chain is healthy, with appropriate levels of inventory. Gross margin for the first quarter is expected to be approximately 62%, and spending is expected to be $5.5 billion. +Turning to the full year 2016, we are expecting revenue growth in the mid to high single digits, relative to 2015. This outlook is higher than our previous guidance provided at the November investor meeting. This higher range is driven by the addition of the FPGA business, partially offset by some caution as a result of uncertainty in the macroeconomic environment. Gross margin for the year is expected to be 63%, and spending is expected at $21.3 billion. The capital spending forecast for 2016 is $9.5 billion, up from 2015. +As the economic useful life of our manufacturing equipment lengthens, we are extending the depreciable life of equipment in our factories from four to five years. This change in depreciable life drives approximately $1.5 billion in lower depreciation expense for the year. Inclusive of this change, we are forecasting depreciation expense to be $6.5 billion this year, down $1.3 billion from 2015. +Our results demonstrate that we are transforming the Company. We are pivoting towards the cloud, with a diversified portfolio of businesses. Client is still the largest segment, but the other businesses now make up about 40% of our total revenue, and 2015 marked the first year where these businesses made up the majority of our operating profit. The data center business is growing fast, and is now a $16 billion business. That growth is being driven by growth rates in cloud computing that were over 40% year on year. +Our memory business grew over 20% year-over-year, and is well positioned to disrupt the industry with the launch of 3D XPoint technology. The Internet of Things business grew in 2015, and is expected to contribute more growth this year. And with the Altera acquisition, we expect to broaden our product portfolio in the data center and Internet of Things businesses, and enable even more innovation. Most importantly, we are pivoting towards the cloud, diversifying our client business, and building a strong foundation for long-term growth for the Company. With that, I'll turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, Brian and Stacy. Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask one question, and just one follow-up, if you have one. Sabrina, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from the line of Joe Moore of Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Great. Thank you so much. The client average selling prices went up again for the second quarter. Is that the same trend you saw in Q3, a stronger high end, and what's your assumption for the ASP trajectory going forward? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Sure. I'll start, Joe. This is Brian. It was the same type of trend we saw throughout 2015, with clients buying up the stack, and you saw it in our record revenue in Core i7 and K SKUs, which are really our top-end SKUs. The forecast for 2016 has us relatively flat in this space, so we don't know if it will continue. But right now, we forecast it at flat, the ASPs, for 2016. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [4] +-------------------------------------------------------------------------------- + + And just to add, Joe, so -- there was a client comment. In total, we see ASPs up a little bit in 2016. You can see it in the gross margin recon. +It's not -- as Brian said, we're maintaining the client ASP, but we are expecting that server becomes a larger percentage of the mix. So we've got some mix impact, based on what's going on in server. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- + + Okay. That makes sense. Thanks. +And then for my follow-up, the depreciation change -- was that something you had known about when you talked about the full-year guidance at the Analyst Day, and what was it that prompted you to make that change now? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [6] +-------------------------------------------------------------------------------- + + No, the depreciation change was not included in my forecast that I provided back in November. We were in the middle of the analysis. +What prompted it was -- we did an in-depth analysis based on the cadence of moving from one process technology node to the next. We talked about that at the beginning of 2015, and the third wave of products. And we completed our long-range planning in the fourth quarter, and that's what triggered the change in the depreciation cadence. +I'll also say -- so, just to then tie this out for you, in November I was forecasting a 62% gross margin for the year. I'm now projecting a 63% gross margin for the year. And the difference there is this change in depreciation. So, you can kind of see it in that gross margin recon. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of Vivek Arya of Bank of America Merrill Lynch. Your line is now open. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [9] +-------------------------------------------------------------------------------- + + Thanks for taking my question. First, Brian, you mentioned that there is some uncertainty near term in the broader environment. I was hoping you could provide us some more color around that, if possible, by your different segments, and perhaps by geography? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [10] +-------------------------------------------------------------------------------- + + Sure, Vivek. It's the same type of trends we saw in 2015: emerging markets slower than the mature markets; US, western Europe looking okay; China and the rest of Asia slow. +It was both consumer and enterprise. I'd say it's a little bit heavier on the client side, so the PC side, than the data center side. But we're seeing some of it on the data center side as well. Those are the two big drivers, and it's all the same geography. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [11] +-------------------------------------------------------------------------------- + + I see. And for my follow-up, maybe for Stacy -- Stacy, can you talk about the leverage in the model? Because if I take your full-year sales growth number, OpEx is roughly about 35%-ish or so of sales, which is in line with what you had given at analyst day. +I'm wondering what steps can you take to drive more leverage in the model? As an IDM, shouldn't the goal be to get to at least 30%-plus operating margins? What steps can you take this year to help drive more leverage in the model? Thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [12] +-------------------------------------------------------------------------------- + + Sure, and first, let me -- if you'll bear with me, let me just take a second to detangle the 2016 numbers, because with the extra work week, the Altera acquisition, which includes some one-time costs, and the change in depreciation, it becomes a little hard to, I think, get to the bottom of what's actually happening operationally in the Business. If you recall, in the investor meeting in November, Brian and I talked about the fact that we were looking to reduce spending as a percent of revenue by 0.5 points. +If you just take all of the adjustments out -- so, you don't adjust for the change in depreciation, you don't adjust for Altera, or anything like that -- we're getting that 0.5 points. When we add all of that in, we're getting a bit more than the 0.5 points improvement from 2015 to 2016, in terms of our projections. So, we feel we're delivering what we committed to; and when you put some of these adjustments on top of it, we'll deliver a little bit more. +In terms of the opportunities there, we articulated it, and I'll let Brian come in over the top, but we articulated at the investor meeting, we're still committed to drive spending as a percent of revenue down. We're in the midst of a transformation right now, and so we are going through a period where we're weeding and feeding our portfolio. We're making some dis-investments. +But very importantly, we're investing in areas that we think are critical for the long-term growth and health of the Company, and where we get lots of return, i.e., the data center, the Internet of Things, our process technology leadership, the memory business. So, we knew going into this year it would be a time of elevated investment. We're delivering what we committed, but there's more to come in future years. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [13] +-------------------------------------------------------------------------------- + + Thanks, Vivek. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [14] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of CJ Muse of Evercore. Your line is now open. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [16] +-------------------------------------------------------------------------------- + + Yes, good afternoon. Thank you for taking my question. I guess now with the Altera deal closed, curious if you could provide an update on your server chip road map and strategy, as we look into 2016 and beyond? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [17] +-------------------------------------------------------------------------------- + + Sure, CJ. This is Brian. +So let me just give you a broad picture of Altera, and where we're at. So, as you said, we just closed. We have just gotten through the employee integration, everybody's got a badge; if you go by, the signs out front say Intel now. Really excited; we're starting to dig in to some of the product road maps. +The good news is, we'd been working separate companies on the first of the server chips, which is a multi-chip package, so, FPGA and our Xeon in the same package. That will actually start sampling to select customers in the first quarter of this year, and it will continue to select in limited quantities, it will continue to sample throughout this year, with production in 2017. +Our road map will then -- we're still working on our road map beyond that of when do we integrate the full IP into our silicon, so make a monolithic die. We're actually spending an equal amount of time on that same kind of a road map, an MCP, or a multi-chip package, followed by a monolithic die in the IoT space. We feel pretty good about the progress, and we're already, in the first quarter, going to be sampling to the leading-edge cloud guys that you can think about. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [18] +-------------------------------------------------------------------------------- + + Very helpful. I guess as my follow-up, you provided a $10 billion CapEx budget, and now it looks like it's about $500 million lower at the midpoint. Curious what has changed there. Is that principally capacity on the logic side, as opposed to memory, given what we're seeing in the macro environment? Thank you. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [19] +-------------------------------------------------------------------------------- + + It's all logic, for the most part, and it's not as much a macro, or adjusting the capacity or anything like that; it's just the ins and outs. As we went from the investor meeting into the actual firm forecast for 2016, the teams just sharpened down all their numbers, and went through it in more detail. +I don't think there's anything more to it than that. I'll let Stacy comment if there's -- if he wants to give you any other light on this one. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [20] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [21] +-------------------------------------------------------------------------------- + + Great. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of Harlan Sur of JPMorgan. Your line is now open. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [23] +-------------------------------------------------------------------------------- + + Good afternoon. Thanks for taking my question. On the Data Center business, it decelerated as the team has expected, but 5% of your growth in Q4 was a bit more deceleration than what we were anticipating. So, I guess two questions: Was it all enterprise that drove the weakness, and do you expect to get back to a double-digits growth trajectory in the March quarter, and is the team still confident about driving mid-teens growth for DCG in 2016? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [24] +-------------------------------------------------------------------------------- + + Yes, there's a couple things I want to talk about on the Data Center. First, when you compare Q4 to Q4, you're looking at a comparative where Q4 2014 was one of our strongest quarters, as long as I can remember, with very strong -- greater than 20% growth for the quarter. So, that quarter was a little bit of unique, so the quarter-to-quarter comparative is a bit tough. +If you take a look at how the second half, which is really Q3 and Q4 looked similar, enterprise actually stabilized from the first half. So, enterprise was weak in the first half, and tended to -- got a little bit more stable in the second half. +And what we saw was a normal -- the cloud guys tend to slow down in the fourth quarter, because that's when a lot of the cloud -- they don't want to be upsetting the cloud infrastructure while the holiday seasons are on and people are buying things. And then we continued to see strong growth and strong share gain in the networking and telco side. +We're absolutely -- we continue to look out -- and again, we're very careful to not look at this on a quarter-by-quarter basis. We're looking at the long view, and we're very confident that, yes, we'll continue into this double-digit growth in the Data Center. It will continue to be fueled by the cloud in the first side, and then secondly by our growth in telco and networking, as our share grows there. Remember, we entered the year at less than 10% share in that space, and there's a lot of space there for us to grow in the networking and Telco space. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Let me just add one thing to the premise of your question. We weren't surprised by where we ended up in the Data Center. If you recall back in November, we talked about Data Center growth rate for the year being in the low-double digits. That's exactly where we came in. Based on what Brian was just talking about, in terms of the strength of Q4 2014, we were expecting this to be a tough compare, and that we'd have growth rates in the single digits. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [26] +-------------------------------------------------------------------------------- + + Great. Thanks for the insights there. +And then for my follow-up, the team is going to be launching its sixth generation vCore product line for enterprise, desktop, PCs, I think next week. There also hasn't been a refresh of desktop for two years. I guess the question is: What are you hearing from your corporate and enterprise customers as to the potential uptake of these new platforms, relative to the very muted enterprise demand profile that we had last year? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [27] +-------------------------------------------------------------------------------- + + As you said, we kind of went roughly a year or so without a desktop enterprise upgrade, and especially when you combine coming back now with a refresh -- that refresh being Skylake -- the combination of Skylake's great performance and great graphics. We're past the Windows 10 launch, which is another positive in this space. +We're hearing very good response, as far as people's interest, the form factors you're seeing. You're seeing all-in-ones; you're seeing classic desktop platforms; you're seeing great graphics; you're seeing OLED displays. Overall, it's just another segment where we think the best computing devices really the computing industry has ever built are going to be showcased. The excitement's there, and we've just got to get past the macroeconomics of enterprises saying -- we're going to do the upgrades. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [28] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of Stacy Rasgon of Bernstein Research. Your line is now open. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [30] +-------------------------------------------------------------------------------- + + Hi, guys. Thanks for taking my questions. First, I wanted to go to the equipment life extension. So, I know you were hopeful that eventually you'd be able to get your node migration trajectory back from three years to two, but this sounds like a fairly permanent change in terms of extending your equivalent lifetime. What should we take from this action, in terms of how you view the potential improvement ability of your node migration trajectory going forward? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [31] +-------------------------------------------------------------------------------- + + It's not an impact at all, Stacy. This is -- whether we're at 2 years or 2.5 or 3 wasn't going to dramatically shift that life expectancy like this. This is more about the amount of reuse, and the efficiency and speed at which we can do the conversion. And so, both of those numbers have improved. +Now, the cycle -- clearly it doesn't hurt to have, from this perspective, the longer node cycle. But independent of that, this is a change that was fundamental to the shift in reuse and rate at which we're able to move the tool from being able to run, say, 14 nanometers to 10 nanometers. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [32] +-------------------------------------------------------------------------------- + + And I would also just add -- that's exactly right. The reuse is something that's been shifting over time, and it gives us a lot of economic benefit. +I'll give you the accounting answer here, too, which is: If we got to 7 nanometer or 5 nanometer and there was something that caused us to look at the depreciable life, the economic usefulness of the equipment, we would change it. But we're certainly not expecting anything like that. But this is -- we go through this analysis every year. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [33] +-------------------------------------------------------------------------------- + + The only thing I would add to finish is: Within the manufacturing side, one of our objectives is to continue to improve on those vectors that I talked about, the reuse and speed at which we're able to do these transitions. And so, we'll be constantly trying to get this to be a longer and longer number, if possible, independent of the nodes, because it just shows that we're becoming more efficient. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [34] +-------------------------------------------------------------------------------- + + Got it. Thank you. +For my follow-up, I just wanted to take a look at the extra week that's in Q4. How much of your guidance is actually coming from that extra week? Is it the full -- I guess it would be 7.5% or whatever it is -- or is it less because that week is happening at the end of 2015 and beginning of 2016? How should we think about how that may influence normal seasonality in Q2? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [35] +-------------------------------------------------------------------------------- + + Maybe I didn't hear you right. Just want to clarify: The extra work week is in Q1 of 2016, not Q4 of 2015. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [36] +-------------------------------------------------------------------------------- + + Yes, but I think it's like December 28 through January 4 or something. So, how does that -- + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [37] +-------------------------------------------------------------------------------- + + A little earlier than that. So, the background on this is, we go through this every 5 to 7 years. Because we're on a work-week calendar, over a 5- to 7-year period, we get out of sync with the actual calendar. And then we add in a workweek, in order to get back on sync. It's a little -- it's easy actually to quantify the spending associated with that extra workweek, because we've got lights on, and factories running, and we're paying people. +The revenue associated with it is a little harder to calculate. When you look at where the week actually falls, it's that week between Christmas and New Year's. Our fiscal year ended, I think, the day after Christmas, and so it's that week between Christmas and New Year's that tends to be a billings week that's dramatically lower than any other week we see during the year. So, some revenue impact; hard to quantify it. +The way I'd look at it though, when you look at our guide, and you take out Altera, and you take into account any impact for the extra work week, what you'd see is that the guide for the first quarter is at the low end of what we normally see from a Q4 to a Q1, is how I'd think of it. And then you add Altera back on top of that, and you get to the revenue number that we provided. +And just to be totally transparent, the revenue number for Altera in Q1 is on the order of $400 million. So, you can do the math from there. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [38] +-------------------------------------------------------------------------------- + + Thanks, Stacy. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [39] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of John Pitzer of Credit Suisse. Your line is now open. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [41] +-------------------------------------------------------------------------------- + + Good afternoon, guys. Thanks for letting me ask the question. +Brian, the first question I have is on the DCG business. This quarter, the December quarter, you saw a modest drop in ASPs, both sequentially and year over year, which is somewhat of an anomaly for that business. And I guess I understand the mix shift, as cloud grows faster than enterprise. +I'm curious: Do you think this was a one-quarter anomaly? Is this something we should expect more of, as networking grows faster in 2016? And within the individual segments, are you still seeing customers buy up the stack? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [42] +-------------------------------------------------------------------------------- + + So, that's actually a great question, John. So, for Q4, the decline, or the decrease in ASP was mostly driven by the much higher growth rate in the networking, as you mentioned, and the fact that the percentage of Atom in networking tends to be a bit higher. If you look at networking as a whole, the ASPs in networking tend to be lower than, say, cloud or enterprise. +However, if you look at Q4's networking ASP -- so, if you took out just that ASP, and you compared that ASP relative to prior quarters, it was actually up as an average. So, it has a lower average selling price, but that average selling price is increasing as more people buy -- and as NFV and SDN take off, more people tend to buy up to core, because they're really searching for that performance. We do hope and expect this trend to continue into 2016, as we gain share in networking. +The relative strength -- so, then if you take a look at the cloud space and the enterprise space, we expect those to continue on the trends you've seen over the last few years. We don't expect any major shifts there, but we have very strategic plans to continue to grow in the networking, storage, and especially around the telco and networking space, as SDN and NFV really take hold. And you will see a slightly lower ASP from there, but we expect the ASP to continue to increase in that space as we bring more functionality. +Does that answer your question? + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [43] +-------------------------------------------------------------------------------- + + Yes, it does, very helpful. +Stacy, as my follow-on, you raised the full-year gross margin by about 100 basis points, but if I do the math, a $1.5 billion decrease in depreciation on a $60 billion revenue stream is more than 100 basis points. In addition, the Altera gross margin was higher than your core. And so I guess I'm trying to understand, what are the offsets? Is 10-nanometer cost coming in higher than expected? If you could help us understand the progression of 10-nanometer cost throughout the year, that would be helpful. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Sure. And a great question. I know there's a lot of moving parts here. +Let me just focus in on the depreciation change for a second, and I actually try to be very transparent. In the CFO commentary that was released, you'll see some of this written out, so you can always refer back to it. But the change in depreciation, you're right, in total, is about $1.5 billion. But only about half of that is flowing through COGS, and impacting gross margin in 2016. And that's where you get to the 1 point shift. +That really is the primary difference. There's a few other moving parts, but nothing that's material. That's the thing that changed from 62% gross margin forecast that we had in November to 63% gross margin forecast that we have today. +The rest of the change in depreciation -- about a quarter of it will flow through OpEx, because remember, all of the spending we do for research and development facilities actually flows through our research and development line, so you see a little bit of a benefit there. And then you have some of it that goes into inventory, and then ships out over time. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [45] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from the line of Chris Danely of Citigroup. Your line is now open. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [47] +-------------------------------------------------------------------------------- + + Hey, thanks, guys. Just another question on the weakness you're seeing: Can you just maybe go into some detail on when it started? Have you seen any stability? Is this just CPUs? And in your full-year forecast, are you implying that we get back to normal seasonality in Q2 through Q4? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [48] +-------------------------------------------------------------------------------- + + I'd articulate that what we're seeing -- we have a cautious stance as we start the year. There's a couple of things that feed into that. +Units were a little weaker for us in the client segment in Q4. As we worked our way through the Christmas selling season, what we saw is the sell-through all the way to the end customer was a little less than we thought. We made up for that with a rich mix, so that's why we ended up with a pretty good result. But a little -- we're watching that carefully. +And then, our team on the ground in China has gotten fairly cautious about what's going on in China right now. And as you know, that's the largest PC market. So, we're just a little cautious on the growth rates there. +In terms of from here, I think Brian said it well. We're expecting -- this is the environment as we work our way through 2016. So, against the backdrop of a somewhat weak macroeconomic environment, we expect the year to play out normally from here. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. Thanks. +And then, as far as the Altera revenue, I think you said $400 million. I think that's down like somewhere in the mid-teens or something like that, sequentially. Why the conservative forecast? And then, do you have any forecast for the year for the Altera business? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [50] +-------------------------------------------------------------------------------- + + I'm not going to speak -- they have not -- they didn't release results for 2015, and so I'm really not able to talk about their results for 2015. I can tell you from our perspective, we didn't see anything that was surprising, in terms of what we've seen about their business levels. We actually expect some revenue growth as we go from 2015 to 2016. +I'll give you in total what we expect for Altera. It's a little north of $1.6 billion in terms of revenue. Its gross margin, that as John was saying, is a little higher than the corporate average, so it gives us a slight mix. But because it's a relatively small business against the backdrop of Intel, it's not a big shift in our gross margin. And then we're expecting spending that's at a run rate of a couple hundred million dollars a quarter. +In addition to all of that, there will be a bunch of one-time acquisition deal-related costs. There's amortization of acquisition-related intangibles. You'll see all those in the GAAP number. I've excluded them from the non-GAAP numbers I just gave you. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [51] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Thank you, and our next question comes from the line of Ross Seymore of Deutsche Bank. Your line is now open. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Hi, guys. Thanks for letting me ask a question. +Stacy, one question on the OpEx side, back to that leverage question: You had a very useful slide at the analyst meeting about how you had dis-invested in some areas, and increased investments in another. I guess my net question is: Given that ability to do a substitution in the past, is there any limitation on that going forward? Or if you were going to keep spending more on some of the growth initiatives, is that actually going to be all incremental to the level we have now? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [54] +-------------------------------------------------------------------------------- + + No, I think that's actually part of our DNA, is we're pretty rigorous about trying to weed and feed where we invest, and where we disinvest. As you referred to in the investor meeting, I showed an up and down arrow chart, and the magnitude of those shifts was on the order of $1 billion for some of the big movers, as we added investments in some areas, and subtracted investments in others. +I'll also say there's a point at which we expect that we get more and more leverage in businesses like the Data Center, as well. I think there's lots of opportunities for us to bring down spending as a percent of revenue, as we go forward. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [55] +-------------------------------------------------------------------------------- + + I guess my final -- + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [56] +-------------------------------------------------------------------------------- + + Add anything to that? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [57] +-------------------------------------------------------------------------------- + + No. Go ahead. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [58] +-------------------------------------------------------------------------------- + + I guess as my follow-up question is just -- any more color you can provide on the channel inventory? You mentioned that the unit demand was a little weaker than you had expected. How's the channel looking right now, and what expectations should we have for your internal inventory, looking into this year? Thanks. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [59] +-------------------------------------------------------------------------------- + + Sure. So, we believe that 2015 ended with, I'd just call it, very healthy inventories. In fact, one of the things we saw was a slight decrease in inventory levels as we exited the fourth quarter. And if you take a look at what we had originally projected, and what would have been more an industry norm, would have been a slight increase in inventories. +We expect those healthy inventory levels to extend through 2016; there's no sign that anybody's adding inventory, or not moving off a cautious position on inventory. And that's what's been built into our forecast, as well. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [60] +-------------------------------------------------------------------------------- + + To the question on internal inventory levels, I'd just say we ended Q4 with a little more inventory than I was expecting, and a little higher than I'd like. Two drivers there: We saw, as I said, a little bit weaker units was made up for us in rich mix. But a little bit weaker units and we saw yields get better on 14-nanometer, and the combination of that left me with a little more inventory leaving Q4 than I'd like. +You'll see it -- if you look on a dollar basis, it will go up in Q1 as a result of Altera. So, Altera will cause the inventory levels to go up some. But when you look at it from a business standpoint, I think we'll work through the inventory we have. And when we get into the back half of the year, we'll bring inventory levels down. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [61] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Thank you. And our next question comes from the line of Blayne Curtis of Barclays. Your line is now open. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [63] +-------------------------------------------------------------------------------- + + Hey, guys. Thanks for taking my question. +Stacy, the roughly $400 million of Altera -- I don't expect you to report it going forward, but just curious, how does that fit into your reportable buckets? Can you just level set us for the first quarter out? +And then secondly, could you just talk about how you're integrating or not integrating Altera? I feel like I've heard both. It sounds like you wanted to keep the sales force separate, but just curious, where does that report under, and how much integration are you going to do? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [64] +-------------------------------------------------------------------------------- + + Sure. I'll take the accounting question, and then I'll have Brian give you his insight and philosophy on the whole integration. +On the reportable segments -- so actually, I do plan to give you full visibility into Altera. It's a relatively small business for us. It doesn't hit the SEC reporting requirement. So, it doesn't come across that threshold. +But we just feel strongly that, based on transparency, and the size of the acquisition, we want to give you transparency. So, you will see that in our financials going forward. +I'll let Brian answer the integration question. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [65] +-------------------------------------------------------------------------------- + + From an integration standpoint, I think what you see -- what you've seen we've done with McAfee is we've integrated it into Intel Security, and you saw the great results that we showed in the fourth quarter. Those are somewhat an example of what happens as you integrate, and you really get the focus on the business on a much higher level. +Same thing for Altera; we plan to fully integrate it. It's going to look like a business group, no different than, say, CCG, that does PCs and modems, phones, or DCG that does data center. +It's called PSG, Programmable Solutions Group. It reports directly to me, and it will be fully integrated. +The sales force at the beginning, because the sales tends to be a bit more technical, and a bit more like a field sales engineering-type role, we're keeping it separate. But that's something we're going to continue to evaluate. +But the organization, the engineering -- already in the first two weeks, we've had -- really for me, I'm really pleased with the level of integration and help that we've done to get products and road maps focused and integrated into our internal systems. So, you should expect it to be fully integrated. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [66] +-------------------------------------------------------------------------------- + + Thanks, Blayne. Operator, I think we have time for two more questions. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Perfect. Our next question comes from the line of David Wong of Wells Fargo. Your line is now open. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [68] +-------------------------------------------------------------------------------- + + Thanks very much. What might we expect in the way of new 14-nanometer data center processor families in 2016? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [69] +-------------------------------------------------------------------------------- + + Let's see, I think we've got Broadwell Xeon; it's going to launch in the first half here of 2016. So, that will be the first of the 14-nanometer, or the next 14-nanometer in 2016 is that E5 on Broadwell. The rest of them, we haven't put any other dates out there yet -- Skylake SKUs and so forth. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [70] +-------------------------------------------------------------------------------- + + Okay. Great. And my follow-up: With start-up and other charges, do you expect memory output in China in 2016 will be a positive or negative contribution to EPS, and should we expect a positive contribution in 2017 from the China fab? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [71] +-------------------------------------------------------------------------------- + + There will be some pretty significant costs. It's in the gross margin recon, associated with the startup of the factory in China. And we'll be in production in the back half of the year, but we're just ramping production. +I think if you were just looking at a six-month time period, you'd say it's negative, and you can see it in the gross margin. It's a slight negative on the gross margin. +It doesn't change the fact that we make these investments, and then we get this, what I would say, tremendous long-term benefit out of making that investment. So, that doesn't -- I don't want you to take from that, that we're somehow less bullish on the transformational capabilities of what the team has managed to pull off at 3D XPoint, because we're actually quite bullish on that. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [72] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Thank you. And our final question comes from the line of Timothy Arcuri of Cowen and Company. Your line is now open. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [74] +-------------------------------------------------------------------------------- + + Thanks a lot. I just had a question again on the depreciation change. I know, Stacy, you talked about it being due to reuse, but I guess relative to just the fundamental cadence of the migrations, your intent has been to get back on a normal, Moore's Law cadence. I just want to make sure that's still the case. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [75] +-------------------------------------------------------------------------------- + + Yes. We said that -- this is Brian, by the way, not Stacy -- that 10-nanometers would be closer to that 2.5 years than the 2 years; that we would continue to strive to get back on 2 years. Some of that was how, as we [still define] 7-nanometers, what the complexity of the technology looks like, whether EUV is ready or not. Absolutely, we're pushing to get back on that two-year cadence. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [76] +-------------------------------------------------------------------------------- + + I would just add, please don't take the accounting of the depreciable life to be somehow a signal that we're letting our foot off the gas on process technology cadence and process technology leadership. That's the heartbeat of the Company, and we're driving it; we're driving it hard. The accounting just is looking at how long that equipment is economically viable in our factories, and it's pretty clearly five years, as we go forward. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [77] +-------------------------------------------------------------------------------- + + Right. Okay. Got it. +And then just last question: So, on the mobile group, at the Investor Day you talked about another $800 million improvement this year in the losses. Is this still the target, and maybe talk about the progress there, and whether we could see any momentum for smartphone this year with 7360? Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [78] +-------------------------------------------------------------------------------- + + It's absolutely still the target. That has not changed one bit. +It's a little early in the year to talk about progress. We have -- I'd tell you that we have a large percentage of that $800 million already, I'll call it, planned out. In other words, we have projects. We know what we need to do, introduce products, align which SKUs are coming, and move products onto that. +So, I'd say a large percentage of that is well planned through the year, but it's throughout the year. So, I can't tell you -- I've already got $200 million of it, or something like that, not here in the second, third week of the year. +7360 -- it's out. It's sampling. The customers are going through their validations now at the systems, where they are building up systems and out testing them on networks, and so forth. And as far as the launches of those systems and the announcements, those are always up to our customers, and we don't make sure that we're the ones announcing that. And then, what we've told you is that what's even as important is that we're on a yearly cadence now of our modem technology, and we're very confident on that as well, for the next set of modems that comes out after the 7360. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance and Director of IR [79] +-------------------------------------------------------------------------------- + + Thanks, Tim. All right. Thank you all for joining us today. Sabrina, you can please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2016-Jul-20-INTC.txt b/Transcripts/INTC/2016-Jul-20-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..046746a6107e49d89e11e8126c41c042b2e1631c --- /dev/null +++ b/Transcripts/INTC/2016-Jul-20-INTC.txt @@ -0,0 +1,681 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Intel Corp Earnings Call +JULY 20, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Stacy Smith + Intel Corporation - CFO + * Mark Henninger + Intel Corporation - VP of Finance & Director of IR + * Brian Krzanich + Intel Corporation - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Chris Danely + Citigroup - Analyst + * Stacy Rasgon + Bernstein - Analyst + * John Pitzer + Credit Suisse - Analyst + * Harlan Sur + JPMorgan - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Chris Caso + CLSA - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen. Welcome to the Intel Corporation second-quarter 2016 earnings conference call. +(Operator Instructions) +As a reminder, this conference call may be recorded. I would now like to turn the conference over to Mark Henninger. You may begin. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [2] +-------------------------------------------------------------------------------- +Thank you, and welcome everyone to Intel's second-quarter 2016 earnings conference call. By now you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you've not received both documents, they're available on our investor website, intc.com. +I'm joined today by Brian Krzanich, our CEO, and Stacy Smith, our Chief Financial Officer. In a moment we will hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +Also if during this call we use any non-GAAP financial measures or references, we'll post the appropriate GAAP financial reconciliation to our website, intc.com. With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Mark. Our top-line results for the quarter came in right in line with outlook. And profitability this quarter exceeded our expectations. Year-over-year growth this quarter was 3% overall as we transformed Intel into a Company that powers the cloud and billions of smart, connected devices. We continue to focus on growth in line with this transformation, as evidenced by results in the data center, IoT and programmable solutions business this quarter. +I'd like to take a few minutes to walk through these results and their implications. I will start with the Client Computing Group, where we saw a 3% decline in revenue year over year this quarter while operating margin was up 19%. These results were a little better than we expected, as the PC supply chain reduced inventories at a slightly slower rate while the two-in-one and enthusiast product lines continued to grow. We also started shipping our seventh generation core microprocessor, formerly known as Kaby Lake, and our latest LTE modem, known as 7360. +Next the Data Center, where revenue grew 5% year over year. Cloud service providers grew 9%, comm service providers grew 10%, and enterprise was down 1%. We achieved some critical milestones in the quarter that give us confidence in our growing momentum as we enter the second half of the year. +In the data center, we're seeing an ongoing preference for performance up and down the pricing stack. Average selling prices increased year over year in every microprocessor product segment, from Adam and Xeon D SOCs at the low end up through Xeon and Xeon Phi at the high end. +We continued to gain share in network infrastructure throughout the entire segment, as Intel architecture becomes the solution of choice for the transformation of the network to SDN, NFE, and 5G. The significant share gains at the low end of the network infrastructure segment resulted in an overall 1% decline in data center CPU average selling prices. +Progress in the data center extended beyond our CPU product lines. Our latest Xeon Phi accelerator, formerly known as Knights Landing, continued to ramp after shipping the first limited production units in December of last year. Xeon Phi revenue grew eight times in the first six months of this year versus all of 2015, gaining share in the supercomputing and machine learning segments. +Omni-Path, our high performance computing fabric, was launched earlier this year and has already achieved 30% market segment share of the 100-gig fabric market. In June's top 500 supercomputing list, Omni-Path was deployed in half of the new 100-gig systems, pointing to the performance that this technology brings to the market. +This quarter we also shipped our first silicon Photonics products for revenue, the industry's only fully integrated solution. We expect DCG's adjacent product lines, including Omni-Path, Silicon Photonics and ethernet, to collectively grow more than 20% for the full year, and this quarter make up 12% of DCG's revenue. +The Internet of Things business was up 2% over last year, coming in below our expectations. We saw growth in the industrial and video verticals offset by an inventory burn after a very strong first quarter. We continue to see tremendous potential in this business. +A great example was demonstrated earlier this month when we announced our autonomous driving collaboration with BMW and Mobileye, marking a significant step for the auto industry as we work together to establish an industry standard, open platform for autonomous driving. In addition we're bringing Indian computing technology to power the next generation of BMW's highly autonomous and fully autonomous products, of the door locks to the data center. +Our Memory business was down 20% over last year, and fell short of our expectations as a result of a more competitive pricing environment. While we acknowledge the cyclical and competitive nature of this business, we remain confident in our long-term growth prospects as a result of the new technologies we're bringing to this market. +568 in Dalion, China started its initial 3-D NAND wafers late in the second quarter, but ahead of schedule. We also remain on track to ship 3-D Cross Point SSDs, branded Optane, by the end of the year, and look forward to delivering this exciting new breakthrough in memory to the industry. +The Programmable Solutions Group, formerly known as Altera, delivered great results. PSG grew 12% over Altera's results last year, a strength in [calms], infrastructure and the channel. PSG is on track to ship 14-nanometers, Stratex 10 samples this year. I'm very pleased with both the integration of this business and their strong execution. Our security business was up 10% as a restructuring the team completed last year, and their focused execution continues to deliver results. +And finally, our restructuring initiative that we began last quarter is solidly on track. This program is changing where and how we invest in everything from research and development to sales and marketing. +In April we announced some important changes to our roadmaps in areas like SOCs and perceptual computing. These changes are accelerating our transformation to a Company that powers the cloud and the billions of smart, connected computing devices while increasing the profitability in our Client business. In total we expect this initiative will drive in a net run rate OpEx savings of $1.4 billion by mid-2017. +Looking ahead, I am very excited about the growing momentum heading into the second half of the year. While we remain cautious about the PC segment and continue to expect a decline in the high single digits of this year, we're expecting our businesses outside of CCG to collectively deliver double digit growth in the third quarter. +We are seeing clear signs that our strategy is working, laying a solid foundation for growth built on the Data Center and the Internet of Things business, reinforced by the combination of Memory and FPGA, and bound together by connectivity. With that, let me turn it over to Stacy. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Brian. In the second quarter we met our financial commitments and made good progress towards our restructuring goals. Our forecast reflects growing momentum as we enter the back half of 2016. +Revenue for the second quarter was $13.5 billion, in line with expectations and up 3% year over year. Gross margin for the quarter of 62% was approximately 1 point higher than our expectations, primarily driven by lower platform unit costs. Spending on R&D and MG&A was $5.2 billion, in line with our expectations. We're on track to the restructuring announcement last earnings call, with a reduction of about 6,000 employees in the second quarter. +Operating income of $3.2 billion was down 2% from a year ago. The effective tax rate for the quarter was 20%. Earnings per share of $0.59 was down $0.03 from a year ago. +The Client Computing Group had revenue of $7.3 billion, down 3% year over year. Client Computing Group operating profit was $1.9 billion, up 19% from a year ago. This improvement is driven by lower overall spending and margin improvements in our mobile products and higher ASPs in the PC segment. The worldwide PC supply chain inventory levels came down a bit in the second quarter, and as we enter the second half they are at healthy levels. +Data Center revenue was $4 billion, up 5% year over year. The Data Center Group had operating profit of $1.8 billion, down 4% year over year, primarily driven by increased costs as we ramp 14-nanometer data center products. As we enter the second half we expect the enterprise segment of the business to stabilize and the cloud segment growth rate to accelerate. In addition, we expect increasing ASPs as we ramp our Broadwell-based server products. +Our Internet of Things segment achieved revenue of $572 million, with year over year growth of 2%. Our security business had revenue of $537 million, up 10% year over year. +Our Memory business had revenue of $554 million, down 20% year over year. This segment had an operating loss of $224 million as a result of continued pricing pressures, higher startup costs as we ramp 3-D NAND in our China factory, and an increased 3-D Cross Point spending. +The Programmable Solutions Group had revenue of $465 million, up 12% year over year when compared to Altera's results from a year ago. Operating profit was negative $62 million. This includes about $160 million in non-cash charges for inventory adjustments. Excluding these charges would result in about $100 million in positive operating profit. +Total cash balance at the end of the quarter was roughly $17.7 billion, up $2.6 billion from the first quarter. Our total debt is $28.6 billion. Our net cash balance, total cash less debt and inclusive of our other longer term investments, is negative $5.7 billion. We're projecting to improve this net cash balance over the second half of the year. +We are generating healthy levels of free cash flow, which enable us to invest in our business and return cash to shareholders. This is demonstrated in our Q2 results, as we generated $3.8 billion of cash from operations in the second quarter, purchased $2.3 billion in capital assets and repurchased approximately $800 million of stock. In the second quarter we also paid $1.2 billion in dividends. And as of yesterday's close of market our dividend yield was about 3%. +As we look forward to the third quarter of 2016, we are forecasting the midpoint of the revenue range of $14.9 billion. This forecast is at the high end of the average seasonal increase for the third quarter. We are forecasting the midpoint of the gross margin range to be 62%. +Turning to the full year 2016, we expect revenue growth in the mid single digits. We continue to expect the overall PC market to be down in the high single digits, and we expect to achieve low double digit growth in our Data Center business. Gross margin for the full year 2016 is expected to be 62%, consistent with our prior outlook. +You can see our strategy playing out in our first-half results and our expectations for the second half. We expect above seasonal growth in the back half of the year led by strong growth in the Data Center, Internet of Things and Memory businesses. And for the year we expect that growth in those business will offset the PC market decline, and with the addition of the Programmable Solutions Group, will result in mid-single digit revenue growth. +Additionally, we're executing to our restructuring program, which allows us to increase investments in strategically important areas, generate financial returns for our owners, and build the foundation for future financial growth. With that, let me turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [5] +-------------------------------------------------------------------------------- +Okay. Thank you, Brian and Stacy. Moving on now to the Q&A. +(Caller Instructions) +Operator, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Chris Danely, Citigroup. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- +Thanks, guys. Just a question on the server expectations for the second half. What's given you the confidence that things are going to bounce back so nicely? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- +Sure. I will start and then Stacy can add. This is Brian, Chris. +I think it's really a mix of a couple of things. One, we saw in the second quarter, and we project out into the second half, a bit of stabilization of the enterprise side of the market. Enterprise side was down only about 1%, which is a bit more stable than it has been. +Second thing is we are ramping our Broadwell E server in the second half of the year. So we expect strong demand. And we typically see an ASP uplift as people buy up in the stock with the new server systems coming out. And we have customers signals that just indicate that there is a second-half seasonal buying patterns kicking in a bit as well. +Those three things are the second-half keys. If you take a look at a broader view of this, just overall our view of the Data Center and really the cloud continues to be that the cloud is going to continue to expand. It's going to be driven by the many, many machines that connect to the cloud that drive orders of magnitudes more data than what the average human creates today, and that's getting to the cloud. So there's kind of the short versus the longer-term point of view. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [4] +-------------------------------------------------------------------------------- +Perfect. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [5] +-------------------------------------------------------------------------------- +And for my follow-up, you mentioned you started shipping the 7360. Was that material to Q2 or will it be material to the second half? And any comments on profitability there? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [6] +-------------------------------------------------------------------------------- +Yes. So I'm not going to talk specifically about the 7360, because our policy is let our customers announce any design wins that they want to announce when they want to announce them. +In terms of the overall impact on financials, when I look at the second half, you will note that we have an above seasonal growth rate in there. The biggest driver of that is what Brian just talked about in the Data Center. So that's kind of the biggest driver. +We were kind of below the average annual growth rate in the first half. We expect to be above that low double digits in the back half driven by the three things he talked about that. But in particularly the cloud buying patterns that we've identified with some of those large customers. +And then behind that we see an improvement in revenue in Memory and an improvement in revenue in IoT. So those are the big drivers as we go into the back half. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [7] +-------------------------------------------------------------------------------- +Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [9] +-------------------------------------------------------------------------------- +God afternoon, guys. Thanks for letting me ask the question. +Stacy, you did a nice job relative to the full-year guidance, kind of giving us your expectation for PC demand for the year. I'm just kind of curious as you look into the third quarter, the guide is sort of the high end of normal seasonal, as you talked about. How would you characterize kind of your view of the PC business going into Q3? And to the extent that it's still a subdued view, is this really confidence in Data Center, or what other parts of the business would drive above seasonal -- or high end of seasonal, sorry? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [10] +-------------------------------------------------------------------------------- +John, how about if I start on just the view of the PC, especially into the third quarter, and then Stacy can get into the where is the above seasonal numbers coming from? I think if you look at the second half, we already said that Q2 ended up being a little bit better than what we had anticipated. And we had built the year at the high single digits. And if you take a look at Q2, it ended up coming at kind of the mid-single digit decline. +We've tried to be relatively cautious as we look out into the rest of this year and built the year and the forecast around that high single digit number set for decline of the PC. We are carrying momentum out of Q2. So there's still data that needs to be collected on how it looks. But right now we have maintained our cautious view of the high single digits. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [11] +-------------------------------------------------------------------------------- +So just to translate that into seasonality against the backdrop of what Brian just said, which is high single digit decline in the PC business, we're expecting that to play out more or less seasonally, John. We tend to do a little bit better than that because of mix in ASP, but from a unit standpoint should be fairly seasonal. And then the driver is what I just talked about. +The Data Center growth rate as we move into the back half should be significantly higher than what we saw in the first half based on stabilization in enterprise, what we see with the cloud customers. And then some ASP uplift as we ramp Broadwell server -- 14-nanometer Broadwell servers into the product mix. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [12] +-------------------------------------------------------------------------------- +That's helpful, guys. Maybe for my follow-up, just looking at the Memory business. As you guys characterize, tough quarter in the June quarter, you analyze the operating loss, it's a fairly large number. +I'm just kind of curious, have startup cost there peaked? Did we have another couple of quarters of startup costs going up in Memory? And I guess more importantly, as Dalion ramps and as you think about Cross Point, how should we think about your profitability goals longer term and what the fall-through on that business looks like as revenue does start to accelerate? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [13] +-------------------------------------------------------------------------------- +There's a short-term and a long-term component to this. In the short term, as I think about the second half, in rough math I would expect a consistent loss in the second half to what we saw in the first half. I think startup costs will be slightly higher. +We will see the first production cost play through on 3-D Cross Point, which as you know from watching us over the year, those first production costs tend to be fairly high in any factory when you're starting it up. Offset by the underlying existing NAND business, I think gets a bit better as we go into the back half. So that's the short-term answer. +To your longer-term question, and I will turn this over to Brian to talk about the technology, but I think the combination of 3-D NAND and the cost structure we're going to achieve, and then the disruptive nature of 4-D Cross Point, we should have a very good value proposition and a very good overall profit position for the business. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [14] +-------------------------------------------------------------------------------- +John, I would just echo was Stacy said. We're just now starting to ramp our 3-D NAND. So as we go through this back half of this year and into next year, it's really starting to ramp up. +We think large cost advantages and good performance position there. And as we said, 3-D Cross Point SSDs start to ship at the end of this year. 3-D Cross Point and DIMMs next year. +And so these investments that we are making this year, which we have talked about, are really playing forward those two technologies. So I'm still very bullish on the long-term prospects. The units and the gigabytes continue to grow. +Our cost structure gets better and better as we go through the back half and into next year. And then 3-D Cross Point, as we've said, will really, in our minds, change the whole memory storage architecture. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [15] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- +Great. Thank you so much. +I wonder if you could talk about, first the Data Center, the growth, your mid-single digit growth for about three consecutive quarters. And I know you had higher expectations for that a few quarters ago. Can you talk about, is that entirely an enterprise phenomenon, or is that a timing issue around cloud? Just how should we think about the last few quarters of DCG? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [18] +-------------------------------------------------------------------------------- +So overall relative to expectations we had at the beginning of the year, let's say, it's primarily enterprise driven. And then there's what we commonly use as lumpiness quarter-on-quarter. +So to how you asked the question, we actually weren't surprised by the Q2 results. In fact, they came in right in line, actually just a hair above what our internal forecast was. We have, I think, pretty good insight into the large cloud customers. And so we had some good insight into the buying patterns as those customers went from Q1 to Q2. +And now as we look at the back half we see several purchasing cycles kicking in for some of the large guys. So we expect that the cloud piece will accelerate as we get into the back half. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [19] +-------------------------------------------------------------------------------- +Great. That's helpful. Thank you. +And then with regards to the balance sheet, I noticed both day sales outstanding and days of inventory bumped up a little bit. And I hadn't expected that. Can you just talk about what drove that? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [20] +-------------------------------------------------------------------------------- +Yes. Those are two different things. +I'll just start with the easy one, days sales outstanding. I'm not seeing anything unusual there. That's just the amount of net billings at the end of the quarter. The average day paid and all of that still looks really healthy. So I'm not seeing anything unusual there. +On the inventory side, as I talked to you last quarter, we ended Q1 higher than where I wanted to be. Our yields got better in Q1. Frankly, they got a lot better in Q2 as well. And we under-shipped a little bit in Q1 relative to the units that we were expecting. +So we took some actions in the second quarter to start bringing inventory levels down. What you see inside of inventory, it was kind of flattish, right in line with what we expected Q1 to Q2. It was a remixing. +So you see some more expensive server parts and some skylight parts going up, and then you see some of the older generation CPUs going down. And as we get into the back half we would expect inventory to click down, and be down pretty meaningfully by the time we get to Q4. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [21] +-------------------------------------------------------------------------------- +Great. Thanks so much. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [22] +-------------------------------------------------------------------------------- +Thanks, Joe. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [24] +-------------------------------------------------------------------------------- +Good afternoon, and thanks for taking my question. PC gaming has been a bright spot for the team with growth in the double digits year-over-year range for the past number of quarters. Your desktop ASPs were up again in Q2, maybe due to the strength here. +Seems like the graphics guys are rolling out some new products. There appears to be a good pipeline of new games for the second half. So I guess the question is, did the PC gaming segment continue to drive double digits growth for the team in Q2? And how do you see that trending into the second half? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [25] +-------------------------------------------------------------------------------- +Sure. If you take a look at it, there is 3-ish, maybe 4-ish, major segments of the PC that did better and continue to do better than the rest of the segment and overall. Laptops, mobile PCs continue to do better. They did better in the second quarter. Two-in-one devices specifically do -- are doing very well and continue to grow in double digits. +And then as you said, we often call it enthusiast gaming. You see our case SKUs in there. And then you saw us also announced the X SKU, which is our new 10-core system that has been selling much, much better than even we anticipated. And so yes, gaming and enthusiast continues to grow at a double digit rate. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [26] +-------------------------------------------------------------------------------- +Great. Thanks for the insights there. +And then on the deceleration in the IoT business in June, you talked about an inventory burn. Sorry if I missed this, but what vertical is that focused on? And does the team expect reacceleration on a year-over-year basis as you move into the second half of the year? And if so, what verticals are going to be driving the growth? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [27] +-------------------------------------------------------------------------------- +Let me take the revenue question and I will let Brian take the, what we see in the verticals part. It was not one vertical. +If you just look at it, I think our customers got out a little ahead of their skis in the first quarter. If you remember, I think we had a 21% or 22% year-on-year growth rate in Q1. There was a little more inventory out there than we anticipated, and that took some of the -- that was a bit of a headwind as we started Q2. +To your question on the back half, we do expect to reacceleration. I had said at the investor meeting that we expect double digit growth in excess of what we had achieved last year. We still expect that. We had a strong Q1, inventory burn in Q2, we expected a strong Q3 and Q4. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [28] +-------------------------------------------------------------------------------- +From a which verticals, the verticals that have been the strongest growing for us, especially in recent, has been industrial and in the security video type applications. Those have been the two real growth. +We have a lot of, I'll call it longer-term growth vectors. Retail's a longer-term growth factor. And then you saw, as we mentioned in the call, automotive ADAS section, like the announcement with BMW, some other programs in that space as well. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [29] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [31] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for taking my question. +I just wanted to verify, on the DCG growth target into the back half, it sounds like you need enterprise to keep getting better into the second half as well as for the cloud and comm side of DCG to significantly re-accelerate to get there. Cloud was up 9% year-over-year. It's good, but that's a significant deceleration. Can you sort of give us a feeling for what you need for enterprise into the back half and what drove the deceleration in the high growth parts of this business into Q2? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [32] +-------------------------------------------------------------------------------- +Yes. I would say -- I'd characterize enterprise in the back half consistent with what we saw in Q2. If it stabilizes at that rate, that gives us the ability to grow to the levels that we are projecting. +And then for the cloud, yes, you are right. It's what I said earlier. We actually forecasted a pause in purchasing based on what we knew of the customer -- the big cloud players' ordering patterns. And based on the signals we are seeing from them, we do expect a reacceleration in the back half to something more consistent with what we were seeing through the last couple of years. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [33] +-------------------------------------------------------------------------------- +So what gives you confidence in enterprise will continue to stabilize and that what we saw in Q1 is not a one-quarter blip, given it's been down pretty meaningfully for the last few years pretty consistently? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [34] +-------------------------------------------------------------------------------- +It's what we saw in Q2. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein - Analyst [35] +-------------------------------------------------------------------------------- +Q2, I mean. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [36] +-------------------------------------------------------------------------------- +We saw it down slightly. And again, it's just what we see of the big enterprise customers' signals to us in terms of what they want to purchase. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [37] +-------------------------------------------------------------------------------- +Thanks, Stacy. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [39] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for let me ask a question. +Given that dynamic in the cloud on the enterprise side within DCG, do you still expect a crossover in the percentage of revenues that those two generate in the back half of this year? Or is it pulled forward a little bit, or pushed out, given the dynamics that you've described so far? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [40] +-------------------------------------------------------------------------------- +Sorry crossover from what to what, Ross? + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [41] +-------------------------------------------------------------------------------- +When you said, I believe at your last analyst meeting you talk about the cloud revenue, the percentage of DCG would be somewhere in the mid-30%s and that would cross over the enterprise-generated revenue in that. And that was therefore viewed as a point of acceleration for the entire group. Wondering, given the slower growth year to date in the business, if that crossover is going to be achieved in the time you expected? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [42] +-------------------------------------------------------------------------------- +I will be honest. I haven't looked at the data from that lens. But what I'd say, let me just take you back to the answer that I gave, I think it was to Joe's question earlier. +That if you look to the expectations we had at the beginning of the year, the enterprise is a bit weaker than we thought overall for the year. And I think cloud will be in line with what we thought. So my guess is that still true. Which quarter it happens maybe a jump ball, but my guess is this still true. +But I would like the opportunity to actually go look at the data and I can give you a crisper answer next time we talk. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [43] +-------------------------------------------------------------------------------- +Okay. As my follow-up question, sticking with DCG then, is on the gross margin side. It sounds like you are expecting some pretty significant growth, not only in the unit side of the equation in DCG but also in the ASP side. +And then you also talked about some of the ASP benefits that might happen in CCG, at least in the PC portion of it. If I put that all together, I'm a little surprised that either mix or ASPs, neither of those are mentioned in your gross margin reconciliation for it to go to 62% in the third quarter. Can you talk a little bit about how those dynamics fit into your gross margin? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [44] +-------------------------------------------------------------------------------- +Sure. So first let me start with your question on Data Center. There's a lot in there. +So I do expect an operating margin improvement in the Data Center as we work through this year. I think we were kind of around mid-40%s in the second quarter, and historical ranges been closer to 50%, as I expected, that ticks up some as we move into the back half. The big driver there is costs. +So the early production on the Broadwell server is fairly expensive. Costs come down as we get into the back half. And as you said, we do expect some ASP uplift in the back half. +Overall for the Company what we're seeing, I'll use Q3 as the anchor point, we are seeing some good news in Q3 associated with higher volumes. And then the big offset there is we are seeing 10-nanometer startup costs going up pretty significantly in the back half. So that may be the piece that you are missing in the equation in Q3. +That continues into Q4, by the way. We see a little bit more startup costs. If you do your algebra, you are probably coming up with a gross margin for Q4 that's about 62%. So think of that as some good things happen, but we have again an increase in startup costs and we have some of the Dalion costs with the first production of 3-D Cross Point that also kick in a bit more in Q4. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [45] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [46] +-------------------------------------------------------------------------------- +You're welcome. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +Chris Caso, CLSA. + +-------------------------------------------------------------------------------- +Chris Caso, CLSA - Analyst [48] +-------------------------------------------------------------------------------- +Just a clarification on some of your earlier comments on inventory and PC. You talked about the customers taking down the inventory a little bit less than you had expected in Q2. Can you clarify why they chose to do that? And I guess with the inventory levels right now, where do they stand relative to where you would expect them to be into the third quarter? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [49] +-------------------------------------------------------------------------------- +Overall we continue to see inventory levels as being very healthy. I think that the PC -- the worldwide PC supply chain has moved towards a stance of being fairly lean and fairly cautious, and we see that continuing. +You would typically see an inventory burn in the second quarter. It was little bit less of an inventory burn then what we expected. I think it goes back to Brian's comments that he made at the beginning of the call that from their perspective the PC market was a little better in Q2. So I think they probably just brought down inventory levels a little bit less. + +-------------------------------------------------------------------------------- +Chris Caso, CLSA - Analyst [50] +-------------------------------------------------------------------------------- +Okay. As a follow-on to that, maybe you can clarify what you consider to be normal PC seasonality in the third quarter, because I think that's been changing over the past several years. +Last year the build into the third quarter was a little stronger. Obviously there were some product launches there. How do you characterize the build this year relative to what we have seen last year and the year before? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [51] +-------------------------------------------------------------------------------- +I would say for the Company you would expect to see the seasonality, a revenue seasonality for us that's in the high single digits as we go from Q2 to Q3. Our guide is a little higher than that for the reasons that we've been talking about. PC market is probably in line with that, maybe just an inch higher in terms of the overall PC channel. + +-------------------------------------------------------------------------------- +Chris Caso, CLSA - Analyst [52] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [54] +-------------------------------------------------------------------------------- +Yes. Thank you very much. Good afternoon. Thanks for taking my question. +I guess it's kind of a follow-on to the DCG question that Ross had brought up in terms of margins. Does the DCG business, is obviously going to diversify itself some going forward with some of the new products that you're introducing and the networking business taking off. +The operating margin percentage is down fairly sharply year-over-year. And I would expect that to ramp back up some as revenue reaccelerates, but maybe Stacy you could talk about what the long-term margin structure looks like from an operating margin perspective in DCG as the business diversified some? Thanks. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [55] +-------------------------------------------------------------------------------- +Sure. So we'll talk about that in more depth at the investor meeting, but I'll give you some off-the-cuff comments here. +First, to just put it in perspective, the operating margin percent decline that we saw in Q2 had nothing to do with the new products, or the new products weren't driving it. It was the 14-nanometer cost of Broadwell server. And we get in the back half we're going to see an ASP impact associated with that because we think that the performance of that product brings -- enables customers to get a better value proposition by buying a richer mix. So that's why I'm pretty confident we get in the back half, we see the margin snapping back towards that 50% that we've articulated as our long-term goal. +We'll talk more about the mix of products and whatnot at the investor meeting. But the one thing I'd point you to is remember, something like networking, which is at atom-based server product that's going in. While it does have a lower ASP than the average within DCG, it has an ASP that's actually been going up and it has a very different cost structure than a Xeon does. So I won't just immediately assume that because it's a lower price segment of the market that it's a margin-hindered segment of the market because that's not the case. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [56] +-------------------------------------------------------------------------------- +Great, thank you. That's very helpful. +And then I guess to follow up on, that sticking on margins, maybe you could talk a little bit about how adding the third chip on 14-nanometer may affect margins going into 2017 in the PC business to offset some of the 10-nanometer ramp costs you had talked about? I think it's a little bit of a different dynamic than we have seen with the business traditionally with the tick-tock approach. +So any sort of broader comments you could give there about margins would be really helpful. Appreciate it. Thanks. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [57] +-------------------------------------------------------------------------------- +Let me take the margin side and then I will let Brian come in over the top to talk a little bit about the roadmap and how we think about that from the customer's perspective. +From a -- first off, we haven't forecast 2017 margins. So we will give you the first glimpse of that at the investor meeting and then we put a formal stake in the ground when we get to next January. +But I would say that there is nothing that I am seeing in the overall roadmap that for me is a significant headwind as we go into 2017. So we will give you a lot more insight in that in a few months. But I am not seeing anything that has me worried as we go into 2017. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [58] +-------------------------------------------------------------------------------- +I guess what I would talk about is Kaby Lake. One of the things we have learned on 14-nanometers is how to make meaningful performance and improvements, both in the silicon and then with the silicon combined with the architecture. So we said we already started shipping Kaby Lake to our customers and OEMs. We're seeing meaningful performance across all of the various SKUs of Kaby Lake relative to Skylight. Kaby Lake's built off a Skylight core. +And as a result, the die size does not significantly grow. So you don't see -- there's no driver in the silicon itself to shift the margin structure of this product. We're able to get the performance and feature enhancements with relatively small silicon increases but good improvement on the silicon -- raw silicon technology itself. +So there's not an intrinsic driver that should say, die size got twice as big so margins are cut. There's nothing like that. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [59] +-------------------------------------------------------------------------------- +And it comes in on a process technology that's mature with healthy yields and healthy cost structures. So from that perspective you get a nice performance boost at a good cost structure. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [60] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [61] +-------------------------------------------------------------------------------- +Thanks, Matt. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [63] +-------------------------------------------------------------------------------- +Thanks. Brian, I know that you remain cautious overall in the PC market. But when you look at some of the third-party data it definitely seems like North America was better. Asia, Latin America, a little mix, I'm wondering has your view, at least on a regional basis, changed at all? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [64] +-------------------------------------------------------------------------------- +So my regional view would say that certain of the -- some North America and Western Europe has been stronger for us for some period of time, and it continues to be the stronger segment for us. As you said, South America, Latin America continues to be weak. +We see weakness in Asia, but it did get a little bit better than in the past. And that combined with North America were the two drivers that made Q2 perform better than what we'd modeled in our high single digits. +And as I said, I'm being relatively cautious in this and making sure that we put an estimate out there that we are very comfortable with. And that's why we've gone with -- stuck with our high single digit view of the year. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [65] +-------------------------------------------------------------------------------- +The other thing that's been reported is that commercial models have seen some momentum. Windows 10 has been a catalyst. Your view on commercial enterprise, has that improved at all over the last 90 days? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [66] +-------------------------------------------------------------------------------- +Yes. And we are hearing that same thing from our customers. And as we go out and talk to CIOs, we are hearing the same thing. +Those cycles, though, can sometimes take -- you will hear them, and then they sometimes can take some time to really kick in. So again, we kind of built that into the cautiousness of the second half and making sure that we know what we are going into the second half with. +But we are hearing similar things around the enterprise conversion. It's comfort with Windows 10, ability to make that transition, they're wanting to do it on new hardware. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [67] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [69] +-------------------------------------------------------------------------------- +Good afternoon. Thank you for taking my question. I guess first question on Cross Point. +You talked about stronger growth expectations looking over the next couple of years. Just curious if you could share what conversations you have had with customers, what use cases you've uncovered? And any thoughts in terms of sizing the market? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [70] +-------------------------------------------------------------------------------- +So we haven't really tried to -- we have pretty widespread guess times and models right now on sizing the market, because we are still really learning. We've actually started to ship some sample units to customers already to let them try out and start to learn. Those are to the big COG service providers, is mostly who we're sending those to. +You're going to see it enter as SSDs. You'll see those SSDs, both enterprise-class SSDs and also commercial consumer type SSDs. We've demonstrated in several live demonstrations, anywhere from 5 to 7, 8, 9, 10 times improvement in performance, depending on the workload through those SSDs. So you're going to see those be the first implications. +When I think about where the big volume will come from, I think it will come in that DIMM form factor. You're going to see it in cloud applications, everything from machine learning, big data, anyplace where you have memory-intensive and where you can do in-memory applications. The 3-D Cross Point is going to be nicely configured for that. It allows you to bring large amounts of storage-like data into a memory-like performance. And that's the real key here. +I also believe you will see it in consumer devices. You will see laptops and devices like that. Gaming machines, we think it will have gaming applications where you can preload in a cache-like environment the next level of your game. And so it loads almost instantly as you transition within the game. +So there's going to be a variety of those. And actually the more we go and start to play with it, start to give it out to customers, the more types of applications and workloads we're finding that it can be used for. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [71] +-------------------------------------------------------------------------------- +That's very helpful. And I guess as a quick follow-up. +Stacy, can you provide an update on your targeted capital structure here? And at what point with net leverage, net cash we should start to see more aggressive buybacks? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [72] +-------------------------------------------------------------------------------- +Sure. As I communicated, I think at the investor meeting or in the last six months, our goal is to get back to net cash zero. And one point I had predicted that that would happen in the back half of this year. +The combination of business levels being lower from what we thought at the beginning of the year as well as some pretty significant restructuring charges will push that out. So that will happen sometime in 2017, although I do think we will make good progress towards net cash zero as we move into the back half. Today our net debt level is right around $5 billion. So we will take a big chunk out of that as we move into the back half. +In terms of -- now that said, we're still generating excess free cash flow. You can see that even in the first half, even inclusive of the restructuring charges we did. +And so you can see we did, I think $1.6 billion of buybacks in the first half. And we have a dividend yield that as of yesterday was about 3%. So I think you see us executing to the priorities that we had articulated. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [73] +-------------------------------------------------------------------------------- +Thanks, C.J. Operator, I think we have time for two more questions. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- +Vivek Arya, Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [75] +-------------------------------------------------------------------------------- +Thanks for taking my question. For my first one Brian, I am curious, there are expectations of Intel becoming successful with your 4G modems in the back half. And I'm curious, how's the longer-term visibility around sustaining growth in the business? And just the timing as to when you can bring those products from foundry to your [facets]? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [76] +-------------------------------------------------------------------------------- +Sure. So let's just talk about modems. +Really to stay on a leading edge modem, you need to have a yearly cadence of modem technology. And so we have just that, a yearly cadence laid out. We had the 7260 last year. We had the 7360 this year. +We have a series of modems out. We've got them built out and planned for the next several years. +We haven't publicly stated when we will bring it inside, but clearly we plan to. We will do that when the right point of intercepting the roadmap and getting the right performance off the 14-nanometers is required. Right now I am more concerned about getting the leading edge momentum going for us with the 7360 and then the follow-on in 2017, and really showing that we are a world-class modem company. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [77] +-------------------------------------------------------------------------------- +As my follow-up, staying on the BCG team, are you still comfortable this can be a double digit growth business over the longer term? And I guess as part of that, what role does competition play into it with all the recent noise around [Sofbang and Bangar] presumably putting more resources into it. I understand there are no near-term implications, but just longer term how do you think about growth and competition in DCG? Thank you. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [78] +-------------------------------------------------------------------------------- +Sure. So let me try and talk about why I am so confident in growth. We could talk about competition. And we'll see if that does not answer your question. +When I think of the cloud, the cloud that we have today is really built on the backs of people. It's your Facebook data, it's your Salesforce data, it's your Twitter data. It's all data that is really across the devices that we pretty much handle day to day. +The current estimates are if you look out into 2020, that average person will generate about 1.5 gigabytes a day of data off those devices. Those are going to be all your posts and pictures and all that kind of information. +If you take a look at the average autonomous car in 2020, the estimates right now is it will throw off about 40 gigabytes a minute of data. If you take a look at the average autonomous drone doing some kind of scan looking for somebody lost in the forest or scanning a mine, it's going to throw off about 20 gigabytes a minute. If you take something like our replay technology that is filming in virtual reality a basketball game or a football game, it's throwing off 200 gigabytes a minute right now. And as we continue to refine the accuracy of that, that number will likely just grow. +So it's that growth in data and the need to both process it at the edge, and then through the data center and into the cloud to be able to store it, to be able to apply machine learning to all of those applications, those all tell me that the cloud is going to continue to grow. It's going to be lumpy. +These guys don't build out their data centers in a linear fashion. They go, they build out a big chunk of overcapacity so that they can go then sell that and have expansion space. And they don't build for a while. +And so I know people worry about, is it slowing down? But these trends and data that tell me, no, it's not slowing down over the long term. And what you're really going to see is just the buying patterns and the build-outs of the various structures that are going up. +As far as competition, there's always going to be competition in this market. I expect it. That's okay. We think of ourselves as competition, in fact. +We are built on a model that says we have to build a continuous improvement of our products such that we are replacing ourself with a better cost per performance model over time. And so we know that even if there was no competition, the competition is we've got to build a product that's better and drives replacement as well as growth. +And so, I look at the competition as it's welcome, it keeps us better, it's always been out there. There will always be somebody out there. But really what we have to do is build products that are so competitive that people want to replace our products with our new product. That then is one of the best models to use for making sure you stay ahead. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [79] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [80] +-------------------------------------------------------------------------------- +Thanks, Vivek. Operator, can you go -- please go ahead and introduce our first questioner -- or last questioner, excuse me. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- +David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [82] +-------------------------------------------------------------------------------- +Thanks very much. Just following up from the earlier round. Can you give us some feel for your attitude to total amount of debt? +You have a goal of net cash neutrality, but do you have an upper limit on the total amount of debt you're willing to carry? Might you choose at some point to repatriate overseas cash to bring down debt or pay dividends and stock purchases? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [83] +-------------------------------------------------------------------------------- +So there certainly is a limit to the amount of overall debt that I'd feel comfortable with, but it's not something that we have articulated externally and it'll vary by the size of the Company and the cash flow. To my philosophy just generally, I'm not a believer in taking on debt to do stock buybacks. You really have not seen us do that. +Obviously it's a Board decision, but I'm just sharing with you my view of it. I wouldn't take on debt in order to do buybacks or to do a special dividend or anything like that. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [84] +-------------------------------------------------------------------------------- +Great. Thanks so much. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - CFO [85] +-------------------------------------------------------------------------------- +You're welcome + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - VP of Finance & Director of IR [86] +-------------------------------------------------------------------------------- +David, did you have a follow up? Sounds like you're all set, David. +All right. Thank you all for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2016-Oct-18-INTC.txt b/Transcripts/INTC/2016-Oct-18-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..f31b47e2d63ef1698c2a8d10319a6382fc45f81c --- /dev/null +++ b/Transcripts/INTC/2016-Oct-18-INTC.txt @@ -0,0 +1,653 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Intel Corp Earnings Call +OCTOBER 18, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Stacy Smith + Intel Corporation - EVP of Manufacturing, Sales, and Operations + * Mark Henninger + Intel Corporation - Head of IR + * Bob Swan + Intel Corporation - CFO + * Brian Krzanich + Intel Corporation - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * Stacy Rasgon + Bernstein Research - Analyst + * Timothy Arcuri + Cowen & Company - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Harlan Sur + JPMorgan - Analyst + * John Pitzer + Credit Suisse - Analyst + * Chris Rolland + Susquehanna Financial Group - Analyst + * Chris Danely + Citigroup - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen, and welcome to the Intel Corporation third-quarter 2016 earnings conference call. +(Operator Instructions) +As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Mark Henninger, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- +Thank you, Jonathan, and welcome, everyone, to Intel's third-quarter 2016 earnings conference call. By now you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you've not received both documents, they're available on our investor website, INTC.com. I'm joined today by Brian Krzanich, our CEO; Stacy Smith, our Executive Vice President of Manufacturing, Sales, and Operations; and our Chief Financial Officer, Bob Swan. In a moment, we'll hear brief remarks from all three of them followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +Also, a brief reminder that this quarter we provided both GAAP and non-GAAP financial measures. Today we'll be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO commentary and earnings release available on INTC.com include the full GAAP and non-GAAP reconciliations. With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Mark. Q3 was an outstanding quarter, which produced records in a number of product lines, and serves as evidence of our transformation to a Company that powers the cloud and billions of smart connected devices. As a great proof point, third-quarter revenue grew 9% over last year to an all-time record of $15.8 billion on broad-based strength across our businesses. +I'd like to take a minute to share a few of the highlights with you now. I'll start with the client computing group, which had a stellar quarter. This team's focus on delivering an annual cadence of innovative new products, improving product costs, and driving operational efficiencies contributed to a remarkable 37% growth in CCG operating margins. +The client computing group's revenue grew 5% over last year, but just as importantly, DCG is playing in a direct and impactful role in our transformation. In the data center group, revenue grew 10% year over year to a record $4.5 billion. We saw the growth segments of the data center group accelerating at a rate above our forecast. +The cloud service provider segment was up 32%. In the [com] service provider segment, we continued to grow at a faster rate than the market, 16% growth, as the market converts to NFE and SDN and demand for our products increase. +In addition, non-CPU adjacencies across DCG grew an impressive 34%. This category includes our new omni-path high-performance fabric, which is leading in performance and gaining design-win momentum. It includes our Silicon Photonics and our Xeon Phi, all of which began their ramps this year. +However, enterprise revenue was down 3%, trending below our expectations of a roughly flat year over year. As a result, DCG revenue growth for the full year will likely be in the high single digits. +Another key growth opportunity for Intel, our Internet of Things business, grew 19% over last year, setting an all-time revenue record of nearly $700 million. We saw strength across the board in retail, video, and transportation segments. +Revenue in our memory business was approximately flat year over year. 3D NAND production at the Dalian factory is ramping ahead of schedule, with yields matching those of our other production facilities. We continue to see industry enthusiasm building for our ground-breaking new memory technology, 3D Crosspoint, and we're making steady progress toward bringing it into production. +Intel's programmable solutions group, formerly Altera, was up 6% on strength in wireline, industrial, and broadcast segments. I'm very pleased with the integration of Altera into Intel. We continued to execute against our [deal thesis], and PSG has produced three consecutive quarters of year-over-year growth compared to Altera's results after adjusting for acquisition-related accounting charges. +In the third quarter, we began sampling our Stratix 10 product, Intel's first FPGA produced on our own process technology, and also, the industry's first and only 14-nanometer FPGA. We are shipping our first co-packaged parts for the data center and are continuing to see opportunities for design wins with PSG products across many of Intel's businesses. PSG's results show the tremendous progress and execution. +The Intel security business was up 6% over last year. Last month we announced that we will sell 51% of Intel security to private equity firm TPG, and establish a jointly-owned, independent cybersecurity Company named McAfee. This transaction will position McAfee to invest as an independent Company while allowing Intel to continue to participate in McAfee's success and growth. +Intel's transformation continues and the restructuring program that we've announced in April remains on track. I'm really proud of the work our employees are doing to accelerate our strategy. A change of this magnitude is hard, and going through it has again reinforced just how talented, committed, and resilient this team is. +And finally, I'd like to welcome Bob to the Company as our Chief Financial Officer. He brings a wealth of leadership experience to Intel, and his financial acumen and strategic insights will be an asset to the Company. +At the same time, I'd like to thank Stacy for an outstanding nine years as CFO. He's been a great partner, and I'm excited to have his leadership in manufacturing, sales, and operations moving forward. +Wrapping things up, I'm very pleased with our results in the third quarter. We introduced exciting new products, delivered strong financials, and continued to realign our resources to our strategy. The progress we're making leaves me increasingly confident in our transformation. With that, let me turn the call over to Stacy. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [4] +-------------------------------------------------------------------------------- +Thanks, Brian. In the third quarter, we achieved record revenue of $15.8 billion, and also achieved $5.1 billion in operating income. Revenue growth of 9% year over year is driven by solid growth across the client computing, data center, and Internet of Things groups. +Gross margin at 64.8% was higher than expected, and up 3 points from the second quarter. Operating income grew 18% from a year ago. Earnings per share of $0.80 were up $0.14 from a year ago. +The client computing group had revenue of $8.9 billion, up 5% year over year During the third quarter, we saw strengthening of demand and an inventory build in the worldwide PC supply chain. This segment had another quarter of significant profit growth, with operating profit growing 37% from a year ago as revenue increased, costs came down, and investment levels declined. +The data center group had record revenue of $4.5 billion, up 10% year over year. In the third quarter, we continue to see robust growth in the cloud segment of the business, which grew over 30% year over year, partially offset by a 3% decline in enterprise segment over the same horizon. The data center group had operating profit of $2.1 billion, down 1% year over year, as we increased investments and ramp Broadwell, the first 14-nanometer server product. +Our Internet of Things business achieved revenue of $689 million, growing 19% year over year, driven by strength in our retail, video, and transportation segments. Operating profit for the business was $191 million, up 27% year over year. +Our memory business had revenue of $649 million, down 1% year over year. This segment had an operating loss of $134 million as a result of start-up costs for our China factory and costs associated with 3D Crosspoint. +The programmable solutions group had revenue of $425 million, up 6% when compared to Altera's results from a year ago. Operating profit was $78 million. +Our security business had revenue of $537 million, up 6% from a year ago. In the third quarter, we announced a newly formed, jointly owned, independent cybersecurity Company called McAfee. The transaction values the business at approximately $4.2 billion, and at deal close, we expect to realize a pretax gain on this sale of roughly $500 million when the transaction closes in the second quarter of 2017. +The costs associated with the transaction are factored into our restructuring and spending guide. Post deal close, we will own 49% of the new Company. +We are generating healthy levels of free cash flow, which enables us to invest in our business and return cash to shareholders. This is demonstrated in our third-quarter results, as we generated $5.8 billion of cash from operations, purchased $2.5 billion in capital assets, repaid $1 billion in commercial paper, repurchased approximately $500 million of stock, and paid $1.2 billion in dividends. +As we look forward to the fourth quarter of 2016, we are forecasting the midpoint of the revenue range at $15.7 billion, roughly flat to the third quarter. This is below the average seasonal increase for the fourth quarter, as we expect the worldwide PC supply chain to reduce the inventory. +Since the last earnings call, our view of second-half 2016 revenue has increased, as a result of strength in the client computing and Internet of Things groups, partially offset by weakness in the enterprise segment of the data center. We are now forecasting the midpoint of the fourth-quarter gross margin to be 63%. Spending is expected to be approximately $5.2 billion. +Intel is in the midst of a significant transformation. We are focusing on being more efficient, investing in higher growth segments, and with the McAfee transaction, we are focusing our business on core strategic areas. Given that, I would like to provide a little more context on each. +We are on track to achieve the run-rate savings and employment reductions associated with the restructuring program announced earlier this year, and in fact, we are moving faster than we anticipated. In addition, the deal involving the Intel security group, which was announced in the third quarter, will result in additional restructuring charges, a pretax gain, and reduced spending levels in 2017. +As a result of those restructuring charges, and the increased mix of retirements and European severances, we are increasing the restructuring and other charges forecast by $700 million to $2.3 billion. The majority of the remaining restructuring charges will be realized between now and the middle of 2017. +We are on track to the original restructuring and focusing our business on core strategic areas. This is allowing incremental investments in critical areas like the data center, Internet of Things, and memory. The overall impact of the announced reductions, Intel security group transaction, and reinvestment is that we expect our 2016 spending as a percent of revenue to be down almost 1 point versus 2015, and we expect to achieve another 1 point reduction in 2017 as we accelerate our transformation. +In the third quarter, we achieved record revenue and strong operating profit. But since this is my last earnings call, I would like to take the opportunity to provide some historical perspective on how the Company has changed over the 10 years since I've been attending these calls, which I really think shows the transformation of our business. +Ten years ago, virtually the entirety of our business was tied to the PC market. Today, we have a diversified portfolio of growing businesses with roughly half of our profits coming from the data center and Internet of Things businesses. +We are also a different Company in terms of how we look financially. Ten years ago, our revenue was approximately $35 billion with a gross margin of 52%. In 2016, we're on a path to almost $59 billion in revenue with a gross margin of 63%. Over the past 10 years, we've increased our dividend from $0.40 per share to $1.04 per share, and we've repurchased about $55 billion of stock. +Looking forward, Intel is positioned with technology leadership, an amazing workforce, and significant market opportunity as we power the cloud at the heart of all of these smart and connected devices. I am excited about how we're positioned for growth and my next role in the Company, and about the leadership, experience, and continued focus on driving long-term shareholder value that Bob will bring as CFO. With that, let me turn it over to Bob for a few words. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [5] +-------------------------------------------------------------------------------- +Thanks, Stacy, and thanks, Brian. I am both excited and very honored to be joining the team at Intel. The Company has had a profound impact on the world with industry-leading technologies, it has a great business model driven by Moore's Law, and an outstanding balance sheet. Additionally, I'm inheriting a top-notch, world-class finance organization. +It's an extremely exciting time in the Company's history, as we transition from a PC-centric Company to one that powers the cloud in billions of smart connected devices. I am looking forward to the journey. With that, let me turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [6] +-------------------------------------------------------------------------------- +Okay. Thank you, Brian, Stacy, and Bob. Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask one question and a follow-up if you have one. Jonathan, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Our first questioner comes from the line of CJ Muse from Evercore. Your question, please. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- +Good afternoon. Thank you for taking my question. First question on DCG, you took the number down for Q4. Curious how we should think about contribution from enterprise looking into 2017, when you think that could stabilize. And then as you start to think about greater contributions from hyperscale and networking, is that 10% to 15% sustainable or should we be thinking high single digits going forward? Thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [3] +-------------------------------------------------------------------------------- +Hi, CJ. This is Stacy. So, let me take the first part of that question. So yes, as we just said on the call, what we're seeing in the data center is very strong growth rates in the cloud, very strong growth rates in networking and storage, as those areas become virtualized and our products extend into those areas. And then we saw some weakness in the enterprise in Q4 -- or Q3, and that's what we're expecting for Q4. +I think we're going to hold off on providing a forecast for 2017 at this time. We would normally provide that to you in January, and then have a much more in-depth conversation in the investor meeting in February. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [4] +-------------------------------------------------------------------------------- +Okay. Very helpful. And on the PC front, given the volatility there, I wouldn't expect you guys to put the flag down and say that we've completely stabilized. But curious what trends you can speak to in terms of growth, perhaps, in emerging markets and what that speaks to in terms of the trajectory for unit demand from here. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [5] +-------------------------------------------------------------------------------- +Sure, and I would agree, we're not going to raise the flag and say everything's good again. If you take a look at this quarter, what we saw was an increased strength in the areas that have been strong in the past. So definitely the mature markets were a bit stronger. The one that was probably a little bit of a shift is China, it was a little bit better than we had forecasted as well. +Enterprise was again strong. Consumer was better, but it's still not back to where we consider it -- where we'd like to see the consumer side. And it was a good mix between desktop and mobile products, laptops, and two-in-ones and devices like that. So it was an increase in what's been strong in the past is really what drove the growth for this quarter. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [6] +-------------------------------------------------------------------------------- +Operator, please go ahead and introduce our next questioner. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Your next question comes from the line of Stacy Rasgon from Bernstein Research. Your question, please. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [8] +-------------------------------------------------------------------------------- +Hi guys. Thanks for taking my questions. First, DCG revenue's up 10% year over year. Operating profit down year over year. I know you had highlighted some increased investments. But we also have cloud growth and networking and some of the other non-CPU stuff that's been growing as well. +How should we think about that change in the growth drivers in terms of impacting the margins over the last year? And how should we think about the likely margin trends for the business as we go into next year? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [9] +-------------------------------------------------------------------------------- +I'll take that, and then Brian may want to talk about more of the longer term. It's not a driver in what we saw in the third quarter. There really are the two issues. We have been very consciously increasing investment there. We see a tremendous long-term opportunity, so that's been an ongoing process for us. +But then the thing that really kicked in this quarter is they're ramping their first 14-nanometer server product, which is Broadwell for the server market, and that -- those first products coming out on that product line are fairly expensive. +To the mix question, it doesn't really drive things probably as much as you would expect. We have very strong product margins across the portfolio of server products in the enterprise or in the data center, ranging from enterprise to storage to networking. And in fact, when we look at the server ASPs, we actually saw ASPs up across the board in every one of our server categories, so NP, DP. And so it really is a mix impact of what you see happening this quarter, where it was a little weaker on enterprise and a little stronger in places like networking. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [10] +-------------------------------------------------------------------------------- +Stacy, maybe -- this is Brian. Maybe let me help you just think about the data center from a larger perspective, right. As Stacy said, what you have to really take a look here is the growth areas that we said we were going to continue to grow in, the cloud service provider, the telco space, the networking and storage, networking specifically is some of our fastest growing areas of the data center. And in the adjacencies, which are all new, emerging markets for us around things like Silicon Photonics and Omni-Path fabric and all, all of those are growing at or above what we had forecasted. And doing quite well. +And as Stacy said, across each of those, our ASPs are both increasing. And if you take a look at that, even if you go down to like an Atom server, the Atom-based server, yes, their ASPs are lower, but the margins are still quite healthy down there because their costs are quite a bit lower. So you've got to keep all of that into perspective as you look at the mix that goes across these. +What happened this quarter is that we had anticipated the Enterprise to go from that low single-digit decline to roughly flat, and it just hasn't -- the enterprise market hasn't shored up there yet. We're working on tactics to shore that up over the next couple quarters, and we're still very convinced on the long-term path of -- that those growth areas that we described are going to be what drives the data center. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [11] +-------------------------------------------------------------------------------- +Thank you. For my follow-up, I'd like to touch on the last point you just made. So enterprise is, like you said, disappointing this quarter. But let's be honest, enterprise has been in decline for years. +Why would it stabilize? What would it start growing? Why is the -- I know we probably talked about this before, but why isn't the cloud grout that we're seeing in the enterprise indicative of that cloud growth? I don't understand why we should expect that business to ever turn around. Can you give us some color on that? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [12] +-------------------------------------------------------------------------------- +Sure. I think there's two parts to this. Certainly a certain amount of the enterprise weakness, right, that has occurred over the last few years is certainly driven by movement of those enterprise applications to the cloud. And we're very comfortable. It doesn't really matter for us, from a product definition or product performance standpoint, whether it goes -- those applications go to the cloud or whether they stay in the enterprise. +That said, there's several enterprises that we are in talks with that all want to grow their own private clouds, and they're really looking at how best to do that, when do they do that. So I think it's more the customer feedback we're getting that gives us some confidence that the enterprise side, with their own private clouds, will continue to see some improvement. +It's not going to be a growth area, though, so don't take this as I'm saying, Stacy, that this is going to be a growth segment. What we're saying is, given what we're seeing from customers, we should see some level of stabilization or less of a decline. Didn't show up this quarter. We'll have to take a look at that as we move through into 2017. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [13] +-------------------------------------------------------------------------------- +And just on a tactical basis, Stacy, to reinforce, our forecast now for the data center for Q4 also is not including improvement in this segment of the business. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Bernstein Research - Analyst [14] +-------------------------------------------------------------------------------- +Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Vivek Arya from Bank of America-Merrill Lynch. Your question, please. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [16] +-------------------------------------------------------------------------------- +Thanks for taking my question and before I forget, thanks and good luck to Stacy in his new role. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [17] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- +So first question is, again, staying on the data center theme, can you quantify the enterprise mix in DCG now? And is that required to be flat in order to maintain the double-digit growth in DCG or can it actually start growing double digit if the growth in other areas remains at this current pace, just because of the mix effect? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [19] +-------------------------------------------------------------------------------- +So let me take a shot at the quantification question. And again, I think we'll -- Brian talked about this bullishness on the long term for the data center, but we'll hold off on specific CAGRs and 2017 forecasts to both earnings and then the investor meeting. +On the -- I think you're referring back to what I showed a year ago, which was the size of the enterprise versus the size of the data center for the -- or size of the cloud for the server segment of DCG and that we were heading towards a crossover between those. Again, we'll update that explicitly come February. But based on what we've seen this year with really robust growth still occurring in the cloud, so again, this quarter over 30% and a weaker than expected enterprise, I think that crossover point pulls in. +And then I think you have a phenomenon that says the cloud portion of the enterprise becomes so big and continues to grow at a fast pace that we can certainly maintain a robust growth rate, even if the enterprise segment is not growing to slightly weak. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [20] +-------------------------------------------------------------------------------- +And as my follow-up, a longer-term question. I think there's a debate in the industry that computation is becoming more parallel with this growth in deep learning and machine learning, which benefits products like GPUs more than CPUs. I'm wondering, would you agree with that and do you think this parallel computing market is incremental or cannibalistic for Intel? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [21] +-------------------------------------------------------------------------------- +Sure, so first, to your first question, I 100% agree with what Stacy said. And I expect that these growing segments, that's why we focus on them so much and will be the dominant as we move out into the later parts of this decade. +Your question on accelerators really is what you're asking when you take a look at GPUs and things like deep learning. The first thing you have to separate out is things like is-- are you talking about the deep learning on the learning portion or the scoring portion? So we don't look at accelerators as cannibalistic, because you still have to have a Xeon system with those when you go to actually do the implementation of the deep learning application. +The second thing we tell you is that we actually had worked over the last two years or so to really implement a much broader collection of accelerators, when you think about these. If you want to think about the rates of performance of each one of these, you have FPGAs which are accelerators, and we see those accelerators go into everything from networking devices to machine learning applications. Those have high levels of flexibility that can be programmed on the fly, but maybe not quite the performance. +Then you have GPUs. GPUs do have, as you say, good accelerating performance in certain linear algorithms. Those are quite good, and we have our Xeon Phi in that space. +And then the highest performance area are ASICs, where they're very workload-specific and designed around the algorithm specifically, and you saw our applications of Nervana. We also did an acquisition of Movidius earlier this quarter. Those are all very specific workloads around machine learning that are ASIC-driven and even give higher performance. +So we look at those accelerators as being enhancing this growth. You sell a Xeon typically with that so it doesn't cannibalize the business. We believe we have the lightest really offerings of these accelerators from FPGAs through the Xeon Phi and then into ASIC-driven devices. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [22] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question, please. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [24] +-------------------------------------------------------------------------------- +Thanks for taking my question. My first one is on gross margins. In your Q4 guide, you have memory and higher factory start-up costs on 10-nanometer working against you. But I was curious when you would expect these items to fade and potentially provide a tailwind to gross margins. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [25] +-------------------------------------------------------------------------------- +So this is Stacy. That's a good question. So typically, on the shape of start-up costs, you would expect that 10-nanometer costs go up in the back half of this year, as you're seeing. They stay high into the first two to three quarters of next year, and then they start to fall off in the back half of next year. So I'll just stick with that for now and then leave it to Bob to show you the start-up cost trends, as he thinks that that's important. +On the memory costs, what you're seeing is really two impacts. One is the start-up costs associated with Dalian, or China, factory for memory, and then some of the first wafers coming out for 3D NAND and 3-D Crosspoint. And I'd expect that that starts to get better into next year. Hard to pick the quarter, but it should become a tailwind as we get into 2017. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [26] +-------------------------------------------------------------------------------- +Okay. Great. As my follow-up, I have a question on CapEx as well. Based on your annual guide, I think the implied Q4 number is close to $3.5 billion, which is clearly a pretty big number. Should we take this as a new normal for Intel, or is this a one-off quarter where you're spending aggressively in both the core business and in memory and that the quarterly run rate going forward should revert to somewhere in the $2 billion to $2.5 billion range? Thank you. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [27] +-------------------------------------------------------------------------------- +I think if you go back to the guide at the -- I think we probably talked about it some time prior April, that I pointed to Q4 as probably being a pretty high CapEx quarter. And it's the combination of where we're at in purchasing the first production set for 10-nanometer and where we're at with the memory factory in China. So I think you're seeing some lumpiness here. I wouldn't run rate that out. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [28] +-------------------------------------------------------------------------------- +Yes, this is Brian. Just having managed CapEx in this Company for years, you really have to take a look at our annual guidance, because literally, within the quarter, or quarter to quarter, the tools will push out. We'll try to always be more efficient and/or you'll have these kinds of one-time upside as things combine, come together. So we expect our annualized run rate for this year to be the $9.5 billion or so that we forecasted, and don't expect that quarterly run rate to be indicative of Q4. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [29] +-------------------------------------------------------------------------------- +Very helpful. Thank you so much. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [30] +-------------------------------------------------------------------------------- +Thanks, Toshiya. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of John Pitzer from Credit Suisse. Your question, please. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [32] +-------------------------------------------------------------------------------- +Hi, guys, thanks for letting me ask the question. My first question is just relative to what's embedded within PCs for the calendar fourth quarter. It's getting a little bit more difficult to track because of CCG, including the mobile. And if you look at the volume growth in the September quarter, it was clearly above normal seasonal trends for the core PC business. How much below seasonal do you think PCs will be in the calendar fourth quarter, and how are you guys thinking about the inventory channel management in Q4? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [33] +-------------------------------------------------------------------------------- +I'd say from an end-market standpoint, it's pretty seasonal. And then from our business, it's the impact that Brian and I both talked about, which is we saw some strengthening of demand in the third quarter. We saw some refilling of the pipeline, which was lean coming in. And then in Q4, we're expecting seasonal end demand but some depletion of inventory pipeline. +And it doesn't take much. If you think about the size of the PC market, you're down to changes in inventory levels across the worldwide PC supply chain that are measured in days or certainly less than a week of inventory that shifts around. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [34] +-------------------------------------------------------------------------------- +Got it, and then, guys, maybe as my follow-up, all year long, you guys have been giving what's turned out to be conservative gross margin guidance by quarter. You've been beating that guidance, in part, this quarter helped by all the PC volume. But I'm just curious, as you look at the calendar fourth quarter, I understand the headwinds coming from memory and 10-nanometer start-ups, but what about some of the tailwinds from14-nanometer? +You're going into a period now where you're reaching mature yields in PCs on 14. You should start to be reaching mature yields on servers for 14. How much of a tailwind is that? And are we looking at another quarter of conservative guide on the gross margin line? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [35] +-------------------------------------------------------------------------------- +I can only say I'm sure Bob will do a better job of forecasting gross margin than I have done., I highlighted for you the two big items from Q3 to Q4, which is the things that are worth a point, and it's, as stated, the increase in 10-nanometer start-up costs and what we see going on in the memory business for the elements that I saw. +Yes, I think we'll see some slight benefit associated with 14-nanometer. I also think we'll be down a little bit in terms of PC volume, but those are all relatively small impacts to the gross margin forecast. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [36] +-------------------------------------------------------------------------------- +Thanks, guys. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [37] +-------------------------------------------------------------------------------- +Thanks, John. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Ross Seymore from Deutsche Bank. Your question, please. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [39] +-------------------------------------------------------------------------------- +Hi, guys. My first question's on the CCG side of things. Specifically, in the third quarter, you talked about the ASPs year over year in desktops and notebooks and then overall. I think the ASPs were up 6% in CCG, but the desktop and notebook side were both well below that. Is that just the contra revenue still in there? Or is there anything we can read through onto the mobile business, given those differences? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [40] +-------------------------------------------------------------------------------- +Yes, that's a great question. So yes, you -- and we published what we saw happen in notebook and desktop ASPs. The piece that's missing, and it's relatively small, but it has a fairly big impact on the average is that within the phone and tablet products, we saw relatively less volume in Q4, so we got -- or Q3, sorry, we got some mix effect. And that ASP is up dramatically on a year-on-year basis as a result of the abatement of the contra revenue program. So that's the missing piece you need to get to the overall platform ASP math. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [41] +-------------------------------------------------------------------------------- +Great, and as a follow-up, switching over to the OpEx side of things. Stacy, in your script, you mentioned about the OpEx to revenue improving by about 1 point this year, year over year, and then again, another 1 point next year. Can you just walk us through a little bit about what that means, either from a linearity perspective or an absolute dollar perspective. Any more color would be appreciated. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [42] +-------------------------------------------------------------------------------- +Sure. I'd be happy to do that. So let me just -- let me take you all the way back to -- because I think this gets very confusing, because we obviously had the restructuring program in place. We now have the spinout or the divestiture, excuse me, of the Intel security business. The timing of those things will play out differently over the course of next year. So I just thought it was best to clean all of this up and give you one metric for the year that summarizes everything. +And so starting with restructuring, it's on track. When you look at the savings that we've already generated this year, really the only adjustment to the spending guide that we've made when we started the restructuring is the fact that profits and revenue is up, and we have some profit and revenue-dependent spending. +You can see we're over three quarters saving on the order of $700 million. You can think of that as an annualized run rate of a little north of $1 billion of savings that then rolls into next year. Then we'll get some incremental savings. We throw McAfee into the mix here, and we're going to make some reinvestments, as we've talked about in some of the areas that are important, think of data center and IoT and memory. +And so when you add all that up, to just give you an all-in number that captures the full calendar 2017, what we're expecting is that from the starting point of 2015, we're down about 1 point in 2016, and then we should be down on the order of another 1 point next year in 2017 with all of this all in, the restructuring, McAfee, and the reinvestment. I hope that helped. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [43] +-------------------------------------------------------------------------------- +Yes, that did. Thank you and congratulations on your new gig. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [44] +-------------------------------------------------------------------------------- +Thank you, sir. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Chris Danely from Citigroup. Your question, please. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [46] +-------------------------------------------------------------------------------- +Thanks, guys. Just on the PC, you guys were pretty much first to call the inventory burn in Q1 of this year. In terms of your call for inventory burn in the PC channel for Q4, is this reflected in your order book? Is this what your customers and channel partners are telling you? Or is this you guys think that, hey, things were a little too good in Q3 so they have to ease up a little bit in Q4? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [47] +-------------------------------------------------------------------------------- +I'd tell you it's some mix. We had some indications from some of our partners that there was some inventory building tied to various SKUs. We're also watching the sell-through as it goes all the way through the OEMs and out into the retail sectors. +So it's never a guess on our part. It's always some combination of that data set that is what the OEMs tell us, what we see in retail and our discussions with retail, and even just our own -- we go out and collect that data in the retail space of what people are doing, what's the basically population density at a place like Best Buy? How many people are out there buying PCs versus something else in the store? We compile all that data to give that forecast. +But like Stacy said, we're not talking about a major shift in the inventory. We're talking about a couple of days. But a couple of days when you ship 1 million units a day is a big number when you take a look at the ASPs in 1 million units a day. So it doesn't take a big swing. We're not talking weeks here; we're talking a couple of days. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [48] +-------------------------------------------------------------------------------- +I would just add, the order book is much less meaningful than it used to be, because in many cases, we hold inventory at a hub at our customer's location. The cancellation policy is such that they only pull demand when they need it. We have policies to make sure we're not creating false incentives for them to take demand they don't want. So while we do have some indication of what they want, it can change on a daily basis. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [49] +-------------------------------------------------------------------------------- +Got it. Great. And then for my follow-up, a question on inventory. So sales were up over $2 billion, but your inventory only went down a little bit. Can you just comment on why that happened and where utilization rates are going? What you feel comfortable as far as inventory levels go, does it worry you at all? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [50] +-------------------------------------------------------------------------------- +Yes, it came in pretty much right where I was expecting, Chris. What we saw is a reduction in CPU inventory in the third quarter, and even within that, a pretty sizable reduction in first-generation 14-nanometer products being replaced by second-generation 14-nanometer products. So that played out as expected. And then we saw some increases in other areas in inventory, non-CPU areas. +And then, we're still on track. I was looking at the -- what we're expecting from a sales standpoint, and what we're expecting from overall builds and yields and everything else, we're still on track to have inventory come down in Q4, which is what I signaled on the last call. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [51] +-------------------------------------------------------------------------------- +Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Blayne Curtis from Barclays. Your question, please. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [53] +-------------------------------------------------------------------------------- +Thanks for taking my question. Just want to circle back on DCG, just when you look at the way September played out and as you look into December, was enterprise really the only area that changed? And I'm just trying to understand. You talked about mix, the networking. Was there any difference. You had also talked about lumpiness in cloud. Did that all play out as you expected? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [54] +-------------------------------------------------------------------------------- +Yes, it absolutely did. We tried to talk about the numbers in the preview to the start of just showing you by segment there, cloud, telco, networking and storage, and then the adjacencies. They all grew at or above our forecast. +Those are still, as we talked about earlier in one of the questions, growing in a percentage of our overall data center business. So they weren't quite enough to offset the 3 percentage decline in the enterprise side. But absolutely, that was the story for the quarter. +We're quite happy, and I think our thesis of what continues to drive their growth is holding. When we go out and talk to our partners and customers about what's driving cloud growth, what's going to drive the networking and storage requirements out in time, we start to look at devices like autonomous cars and the IoT network in general, all of those things are driving large requirements into those data centers in those growth segments. And so that's what gives us the comfort that, yes, this will continue. And our forecasts are holding in those spaces. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [55] +-------------------------------------------------------------------------------- +Thanks. And then just on the [non-volatile group] you've been spending a lot of money. Another big CapEx in Q4 here. Can you just talk about when the capacity additions could lead to revenue? And then as you look at the operating margin of that business, when could it be a positive contributor? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [56] +-------------------------------------------------------------------------------- +I'll start with the first and then I'll let Stacy talk about the margin. Absolutely first, as we said and I think Stacy said a couple minutes ago as well, at our Dalian, China factory, we are now running wafers. The yields are quite good; they're as good as our existing factories. +So you'll see that factory now ramp through the first half, roughly, of next year, and as most of that spending will occur in that same time frame as far as adding the equipment to facilitate that ramp. From there then, it's just purely just running the volume and continuing to grow in that space. That's primarily 3D NAND. Again, we believe we have cost performance that is quite good relative to the rest of the market. +With the 3-D Crosspoint, we are in the process of shipping samples now to customers by the -- as we go through this quarter, we'll ship thousands of samples to customers. We're targeting to start or to finish qualification at the end of this quarter, and that ramp really starts -- it's really a 2018 ramp for that product. So you'll see, again, the revenue and, hence, the costs go down on 3-D Crosspoint as we go into next year as well. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [57] +-------------------------------------------------------------------------------- +Let me -- I'll hit on the margin, but I do want to do a shout-out to the China factory team. I was just out there and Brian was being a little humble. The yields on their first production material matched the yields on the mature production facility, which is a phenomenal result for a factory. So they're doing quite well. +In terms of the overall margin, if you look at the -- let's just focus on Q3. What we saw in Q3 is an improvement in the underlying NAND business being offset by increased start-up costs associated with Dalian, China, and some increased costs associated with 3-D Crosspoint. +As Brian said, when we get into the first half of next year, those products are ramping. And so we should start to see pretty significant improvements in the overall P&L because that headwind, if you will, goes away and we have a very competitive, very cost competitive product line that we're selling in the marketplace. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [58] +-------------------------------------------------------------------------------- +Hey, just a correction. The team here just caught me on. I think I had my years off. So on the 3-D Crosspoint, it will be qualified at the end of this quarter. We're shipping thousands of samples to customers. We're shipping samples already. We'll ship thousands through this quarter. And it ramps in 2017. +I think I said by mistake 2018. I'm sorry, I'm just -- too many years that we're talking through here. So ramp in 2017, revenue growth in 2017, samples, thousands in the fourth quarter and qualified at the end of the quarter. Sorry for that confusion. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [59] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Chris Rolland from Susquehanna. Your question, please. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [61] +-------------------------------------------------------------------------------- +Hey, guys, thanks for the question. Welcome, Bob, and congratulations on your guys' PC number. Do you guys think that there is some cannibalization here of Broadwell from those waiting for the release of the Purley platform next year? +And also, how do you guys view the value prop for Purley? You guys have a faster interface there, more pins and IO. But do you think there's some killer feature there that makes Purley much stronger than typical platform ramp? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [62] +-------------------------------------------------------------------------------- +Sure. So I think I heard all of your questions. But I think your question is -- you can correct me if I got it wrong, A, how much of the enterprise slowdown that we saw is being driven by cannibalization, basically, of people waiting for Purley, aka Skylake platform? And then what are the real features that we're looking for that drive Skylake performance? Did I get that right? + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [63] +-------------------------------------------------------------------------------- +Yes. I'm just trying to gauge if there could be a reacceleration in DCG around Purley. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [64] +-------------------------------------------------------------------------------- +So first, it's always very difficult for us. If you take a look at Broadwell, the Broadwell platform, the performance is quite good. What we find is that each one of these generations, as long as you stay on this cost-performance curve, people are willing to go buy those that are running these cloud platforms quite quickly. +And so we're seeing demand for Broadwell from the cloud service providers, from the networking and telco side, and quite strong. So we don't think we see -- if we were going to see performance-based cannibalization, you'd see it in those real high-level performance sectors first actually, I would think. So we don't see that. +On the Purley platform, we're actually starting to sample those products already to some of the leading-edge customers. And they're seeing not only just an overall TCO performance advantage that we typically see with each one of these, but this also continues our integration of things like the Omni-Path fabric. It has more integration of the Silicon Photonics. So it's those adjacency functions that are quite strong as you -- and they will get more and better as we go through each one of these. +There will be a second generation of Purley that includes 3-D Crosspoint. It allows pooling of memory, and then there will be future ones that allow additional pooling of things like FPGAs. So each one of these now adds some additional features across the rack that really helps in the overall system performance. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [65] +-------------------------------------------------------------------------------- +Great. Thanks for that. And then a lot of discussions that I've had with the channel recently have been fairly positive around PC ASP increases next year. And part of this is the mix towards enterprise as consumer mix down. But others are pointing to an inflection in ultrabooks, thin and light. So let's say we got a massive ASP increase in laptops, like they're up 10% or something like that. What fall-through would we expect for CPU ASPs? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [66] +-------------------------------------------------------------------------------- +100% of that. I mean -- (multiple speakers) So first let's -- it's ASP, it all flows through. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [67] +-------------------------------------------------------------------------------- +First, I do want to recognize that our OEM partners are putting out some great products, and I think you're going to have to take a look at this and really ask -- that's a pretty interesting scenario and I'm very hesitant to this. But typically, Stacy's right. If ASPs go up across the board at the system level, it tends to float all boats. +So our OEM partners would see an increase. We'd see an increase. The other partners within that infrastructure would see it. We really more think of our pricing, though, as value-based. So as we bring out new products and bring out new features, we make sure that the value-based pricing is there and that people are either getting more value for the same price or quite a bit more for a slightly increased price. +So I think that's such a unique scenario, as it just over, across the board, all of the sudden one day prices go up, actually, we wouldn't necessarily flow through that ASP to our end partners because we didn't necessarily drive that from a new features. If it happens with our 10-nanometer launch and it's because of features, then we do add those. So we do it based on what value we provide to the end user and our OEM partners. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [68] +-------------------------------------------------------------------------------- +And if I can just add, the way we would see that is actually with a mixing up. We don't raise our pricing. But the way you articulated this, if it's a bunch of high-end notebook ultrathins, thin and lights, we would see a mixing up of our overall demand. And in fact, it is one of the phenomenons that we've been seeing. I think we've done a good job of creating a differentiated product line. And this quarter, we saw great sales of I-7s and notebooks. And so I think it's consistent with what you're seeing in your channels. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [69] +-------------------------------------------------------------------------------- +Probably the best example of that is the gaming space. We continue to see -- we put out the [case] SKU, a 12-core monster, and we wonder how many people are going to go buy it and we find we're sold out. So I think that's an example where, quote, our ASPs go up but it's really a mix function. Otherwise, it's going to be -- we always just do pricing based on value and features that we bring. + +-------------------------------------------------------------------------------- +Chris Rolland, Susquehanna Financial Group - Analyst [70] +-------------------------------------------------------------------------------- +Great. Thanks for the detail. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [71] +-------------------------------------------------------------------------------- +Operator, I think we have time for two more questioners. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- +Our next question comes from the line of Timothy Arcuri from Cowen & Company. Your question, please. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [73] +-------------------------------------------------------------------------------- +Thank you very much. My first question is, I think you had said at the spring analyst meeting that the enterprise would be a little bit less than half of DCG this year, revenue-wise. Can you right-size us on what enterprise will be as a percentage of DCG just in the fourth quarter? + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [74] +-------------------------------------------------------------------------------- +This is Stacy. I think I took a stab at this earlier, but let me just reiterate what I said. To be clear, I was talking CPUs, enterprise server CPUs. And so if you take the slides that I showed back a year ago, we've seen robust growth rates in the cloud. We've seen less-than-expected growth rates in the enterprise. So if anything, we've pulled in those crossover points. +Beyond that, we haven't given a new percentage, and that would be something that we would logically talk about when we give the longer-term perspective to the market in this coming February investor meeting. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [75] +-------------------------------------------------------------------------------- +Got it. Okay. And then I want to ask a question on the mobile losses. I know that you don't break out MCG anymore. But I think I asked you last call about feeling good about this $800 million improvement in losses this year. That would get you to roughly a loss of 2.2 to 2.3 in the former MCG. +Can you talk in light of the iPhone win, can you talk maybe how you think about the degree to which you could get further improvement in that number next year? Thanks. + +-------------------------------------------------------------------------------- +Stacy Smith, Intel Corporation - EVP of Manufacturing, Sales, and Operations [76] +-------------------------------------------------------------------------------- +Sure. So first off, let me just say as is our standard practice, we don't talk about our customer -- what technology they use inside their products in this space. So I'm not going to confirm or anything on a particular win. But I'll take you back to the mobile loss here. +So as you got right, we no longer have a mobile segment; we haven't for a while. We had articulated that in 2015 we expected to improve the loss by $800 million. We actually ended up closer to $1 billion. +We said, hey, based on everything we know of what's going on with contra revenue and investments and margin improvements and all of that, that we'd expect something on the order of an $800 million improvement in 2016. Everything I know from there would say we're on track or exceeding that, just because we know that as we've gone through our restructuring, we've made some further disinvestments. We've, as you just heard earlier, our volume's a little lower, our contra revenue's looking a little lower, the product margins all look good. +So I'm not seeing anything that would say it's smaller. If anything, it's going to be bigger in terms of the overall savings. And I do just want to reiterate, it's impossible for us to detangle it going forward. Where you really see this is in the CCG operating results, and as we started this call, they had phenomenal operating margins this quarter. And everything went right. They had revenue growth. They saw unit costs coming down. They're making, I think, prudent disinvestment decisions. When you add all that up, they become a real cash and profit driver for the Company. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen & Company - Analyst [77] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- +Thank you. Our final question then comes from the line of Harlan Sur from JPMorgan. Your question, please. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [79] +-------------------------------------------------------------------------------- +Good afternoon. Thanks for taking my question. On the IoT business, it's good to see the reacceleration in growth. Can you just talk about the sustainability of the double-digits year-over-year growth trends and the sustainability of the 20%-plus operating margins on a go-forward basis? I know you mentioned broad-based strength across the verticals. Maybe you can just also talk about some of the product segments that are powering this growth. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [80] +-------------------------------------------------------------------------------- +Yes, sure. So I'm trying to make sure I really think about what question you're asking. From a -- can we sustain the double-digit growth? We absolutely believe that we can, and we've tested that with our -- the deals that we see on the plate going forward. So we've forward tested that. +And we've looked at our product road maps and what we're bringing out. And we've got products like Atlas Peak and Atlas Peak 2 that are coming that are Broxton-based products that are quite strong and quite capable in this segment, and priced and designed right for that. +The segments are going to continue to believe -- be, we believe, the video analytics segment; that continues to go well. There are other segments of the industrial segment that we believe will continue to grow on machine automation, machine factory automation, think of it as factory automation. +The retail segment will continue to be an area where it continues to grow. And then automotive, and you saw us make deals, for example, this quarter with BMW on autonomous driving, which is a little further out. But that's just an example. +You'll also see products from Land Rover and a variety of other OEMs that are a mix of everything from autonomous driving programs to in-vehicle infotainment-type systems. And those systems are quite -- we're thinking of them more and more as servers on wheels, as you start looking at all of the adjacencies too. They're needing connectivity. They're needing storage. They're needing Silicon Photonics for moving the infotainment, basically the graphics video around the system. They use FPGAs for accelerators, like we talked about earlier. +So when we look across those segments and we test it out, we do believe we can continue that. Those are also high compute areas, and it's what gives us the confidence in the margin functions as well. They tend to reuse a lot of our intellectual property from the PC segment and carry that down over into it. That's one of the real strengths of Intel's integrated device manufacturing business model. +And so the amount of investment required to bring those to market are less than if you start from scratch and that's your only product. That's what gives us the confidence in the margin space as well. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [81] +-------------------------------------------------------------------------------- +Great, and then thanks for the insights there. On the cellular modem front, obviously the team is driving good success here with the 7360 this year. Looks like you guys are continuing to drive the road maps. +I notice that your next-generation platform, the 7480, was just qualified at AT&T just this month. This was actually about the same time last year that you guys qualified the 7360 at AT&T. Now that it's qualified, can you just help us understand when should we expect 7480 to show up in mobile devices? Would this be 2017, and any other color you can provide us in terms of other global carriers that you've qualified this new chip set with? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [82] +-------------------------------------------------------------------------------- +Sure. So I think you really want to think the modem space as really an annual cadence. I think that's what it's taking us a while to get to is to get to that annual pace. But we really believe we're on a clip now. As you said, the 7480 is now qualified. As you said, it's qualified at AT&T there. +We typically go then out and around the world. So you'll see it at many of the same places that the 7360 got qualified, in Europe, in China, other parts of southeast Asia. So those will be ongoing now. +And you should just think about we're really targeting modem technology advancements on that annual basis, and typically, you're right; they get qualified in the third and fourth quarter of the year before. And then customers start to roll out those devices, typically, more towards the second half of the following year. So you should see these things start to show up in devices in the second half of 2017. +And you should just think about that from this business from here on. We should come out with another series next year at this time with the 2018 target. That's really our business model for the modems moving forward. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [83] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [84] +-------------------------------------------------------------------------------- +Great. Thank you all for joining us today and, Jonathan, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- +Certainly. This does conclude the question-and-answer session, as well as today's program. Thank you for your participation and have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2017-Apr-27-INTC.txt b/Transcripts/INTC/2017-Apr-27-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad8481b420c28f43c02fcca11c01f1bd8eba3f45 --- /dev/null +++ b/Transcripts/INTC/2017-Apr-27-INTC.txt @@ -0,0 +1,483 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Intel Corp Earnings Call +APRIL 27, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian M. Krzanich + Intel Corporation - CEO and Director + * Mark Henninger + - + * Robert H. Swan + Intel Corporation - CFO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Kevin E. Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * David M. Wong + Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Technology and Services Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + Cowen and Company, LLC, Research Division - MD and Senior Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Intel Corporation Q1 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. +I would now like to introduce your host for today's conference, Mr. Mark Henninger, Head of Investor Relations. Sir, you may begin. + +-------------------------------------------------------------------------------- +Mark Henninger, - [2] +-------------------------------------------------------------------------------- + + Thank you, Crystal, and welcome, everyone, to Intel's First Quarter 2017 Earnings Conference Call. By now, you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you've not received both documents, they're available on our investor website, intc.com. +I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter we have provided both GAAP and non-GAAP financial measures. Today, we'll be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO commentary and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +And finally, I'd like to draw your attention to a change we've made to our guidance practices for the current quarter and full year. Beginning with today's earnings release for the first quarter of 2017, our business outlook will speak only as of the date of our quarterly earnings releases, bringing our practices in line with virtually all of our peers. +With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. The first quarter marked a great start to the year. Coming off both Q4 and full year records in 2016, Q1 revenue was up 7% over the first quarter of last year, a record Q1. And operating margin was up 20%. It was another milestone in our transformation from a PC-centric company to one that powers the cloud and billions of smart and connected devices. Average selling prices or ASPs grew meaningfully across our PC, data center and IoT business, reflecting the market's demand for performance and our segmentation strategy. And our memory business set an all-time record revenue. +At our investor meeting in February, I outlined our strategy to make Intel the driving force of the data revolution across technologies and industries. I also detailed our top 4 priorities for the year: growing the data center and adjacencies; ensuring a strong and healthy PC business; growing IoT and devices; and executing flawlessly in memory and FPGAs. That's the framework we're using to measure our success throughout the year, and I'd like to take a few minutes to assess our progress so far. +First, the data center and its adjacencies. DCG grew 6% year-over-year despite a headwind resulting from a 14-week first quarter last year. The cloud service provider revenue was up 18%. The comms service provider segment was up 12%. And enterprise was down 3%, while non-CPU adjacencies grew more than 20% across all of the segments. Data center microprocessor ASPs were up in total across every product line, underscoring the market's demand for performance to transmit, aggregate and analyze data. +We're also on track for midsummer launch of our next-generation Skylake microprocessor. Skylake delivers significant performance gains across a wide range of workloads. For example, Skylake will include AVX-512 extensions that will deliver a 2x improvement in floating point operations per clock over the current generation, a gain that will have an especially high impact on HPC and artificial intelligence workloads. +And last month, we announced the formation of the artificial intelligence product group, bringing together all of our AI hardware and software assets and all of our AI engineering expertise across the company into a single group to accelerate our development of a full stack of AI solutions and explore novel approaches that will shape the next generation of AI products. +Second, a strong and healthy client business. Our annual cadence of product innovation, combined with a thoughtful segmentation strategy, continued to produce strong mix, which drove higher ASPs. This trend, along with our ramping modem business, drove revenue up 6% and operating margin up 60% over last year. Our expectations for the PC unit TAM haven't changed since we last talked with you. We're expecting a mid-single-digit percentage decline in the unit TAM. Our ASPs, however, are trending ahead of expectations and are contributing to our slightly higher revenue expectations for the full year. +Third, we've highlighted the importance of growing the IoT business as we drive and benefit from the rise of billions of smart and connected devices. IOTG revenue was up 11% year-over-year, where we saw strength in our industrial, video and automotive segments. We also announced our intention to acquire Mobileye, a highly profitable, fast-growing leader in computer vision for advanced driver assistance systems and autonomous driving. The transaction will combine mobilized expertise in computer vision with Intel's expertise in high-performance computing, artificial intelligence and connectivity. Together, we expect to be the global leader in the $70 billion autonomous driving systems, data and services opportunity by accelerating auto industry innovation and delivering cloud-to-car solutions faster and at a lower cost. +And finally, we emphasized the execution in memory and FPGAs. Our memory business grew 55% year-over-year in a tight supply environment; while Fab 68, our Dalian factory, continues to ramp 3D NAND production and is delivering outstanding product yields. We also shipped our first Optane SSDs for the data center and our Optane memory solution, which is available online now and in PC OEM systems later this quarter. +In our Programmable Solutions Group, revenue declined 7% over the last year after adjusting for acquisition-related accounting charges in the first quarter of 2016. The year-over-year decline was due to a weakness in the data center and comms segment, partially offset by growth in industrial and auto and consumer. We also announced an important pilot program with Alibaba cloud, the cloud computing arm of Alibaba Group, for our cloud-based FPGA acceleration service. +We're making good progress against our 4 top priorities for the year and our transformation goals. We're improving the profitability and health of our PC business. At the same time, our investments in the data center, IoT, memory and FPGAs are paying off with significant combined revenue growth. These are purposeful investments that will position Intel for years to come. At the same time, we recognize that there is an opportunity and responsibility to be more focused and efficient as a company, a goal we can achieve without compromising our most important investments: our transformation or our future. +Focus was one of our objectives in establishing McAfee as an independent cybersecurity company just weeks ago, and it is with efficiency in mind that we're making an important commitment to our owners today. We are establishing a spending target of approximately 30% of revenue, which I expect to reach no later than 2020. Following a 1 percentage point improvement from 2015 to 2016, we forecasted an additional 1 percentage point improvement in spending in 2017, and we're now expecting to do a little better than that. While we expect revenue growth to play a role in achieving these targets, hitting this goal will require spending discipline and an intense focus on our strategic priorities. +To sum up the quarter, we're off to a good start and executing well against our priorities. We're delivering a steady cadence of leading products, a powerful segmentation strategy and growing profitability in our client business. We're growing our data center, IoT and memory businesses as customers see data as a competitive advantage and look to Intel as a partner that can help them create, analyze and unlock the value of massive and growing flood of data. And finally, we are committing ourselves to a set of important new productivity goals intended to create value for our owners. +With that, I'll hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. 2016 was a record year for Intel, and 2017 is off to a strong start. We executed on several important milestones in the quarter. We delivered on innovative product and technology road maps across the business. Fab 68 in Dalian continued its impressive ramp. And Intel's transformation continued with the planned acquisition of Mobileye for autonomous driving and the sale of the Intel Security Group. +Revenue was $14.8 billion, up 7% year-over-year. Operating income was $3.9 billion, up 20% year-over-year. And earnings per share of $0.66 was up 22% year-over-year. Our EPS performance was a result of strong top line growth and significant margin expansion. First quarter operating margin was 27%, up 3 points year-over-year, and gross margin came in at 63%, up 0.5 point year-over-year. Direct spending came in at $5.4 billion, flat year-over-year and down 2 points as a percent of revenue from 2016 as we continued to execute on our restructuring program. +Let me touch briefly on our segment performance. The Client Computing Group had revenue of $8 billion, up 6% year-over-year. We continue to see the worldwide PC supply chain operate at healthy levels. Client ASPs were up 7% year-over-year as our segmentation strategies are paying off and core mix continues to be strong. This segment had yet another quarter of significant profit growth with operating profit growing over 60% from a year ago as the business continues to execute and benefit from continued improvements in 14-nanometer unit cost, richer product mix and lower spending, primarily from the client business having a decreased share of technology development and SG&A allocations. +The Data Center Group had revenue of $4.2 billion, up 6% year-over-year. The Data Center Group had operating profit of $1.5 billion, down 16% year-over-year. Operating margin percent was impacted by increased allocation of technology development and SG&A cost, higher product cost as we transitioned to 14-nanometer and the ramp of adjacency products. +Our Internet of Things business achieved revenue of $721 million, growing 11% year-over-year, driven by strength in the industrial and video segments and continued momentum in our automotive business. Operating profit for the business was $105 million, down 15% year-over-year from increased investments in autonomous driving and increased allocation of SG&A and technology development spending. +Our memory business had record revenue of $866 million, up 55% year-over-year, with strong demand for data center SSD solutions and demand signals outpacing supply. We continue to make outstanding progress ramping Fab 68 with yields and unit costs well ahead of expectations. This segment had an operating loss of $129 million largely driven by costs related with 3D XPoint and start-up costs for our memory capacity. +The Programmable Solutions Group had revenue of $425 million. Operating profit was $92 million, flat year-over-year after adjusting for acquisition-related impacts. +Our Intel Security Group business had revenue of $534 million, and operating profit was $95 million. Consistent with our prior guidance, the Intel Security transaction closed at the beginning of the second quarter. +Let me remind you of our capital allocation priorities and our progress: first, invest in our business; second, strategic acquisitions; and third, return cash to shareholders through dividends and buybacks. In the quarter, we generated $3.9 billion of cash from operations. We repurchased $2 billion in capital assets, paid $1.2 billion in dividends, increased the dividend by 5% and repurchased about $1.2 billion of stock. In addition, we generated approximately $400 million from the sale of some of our interest in ASML, which generated $235 million of pretax gains. At quarter-end, cash and other long-term investments was $23.7 billion, up $600 million. Total debt was $25.8 billion. +Today, we announced an increase in our share buyback authorization by $10 billion. Currently, we have approximately $15 billion authorization. We expect to continue to offset dilution from our stock-based programs and opportunistically reduce our outstanding share count over time. +Now let me turn to guidance. First, some context. First, while we see strong momentum in client ASPs contributing to slightly higher expectations of revenue for the year, we continue to take a more cautious view of PC consumption versus third-party analysts. We feel great about our annual cadence and product innovations with new product launches planned this year, including Skylake for data center, 8th Generation Core, 64 Tier 3D NAND SSDs and further extensions to our Optane product line. +Second, we continue to see strong demand signals in our memory business through the year and our Fab 68 in Dalian ramping to be able to supply higher demand levels. +Third, the data center business has solid momentum with the midsummer launch of our next-generation Skylake processor. +And fourth, as I indicated earlier, we completed the sale of the Intel Security Group. We expect to realize a pretax gain of approximately $375 million and a tax liability of approximately $850 million. This results in a GAAP tax rate of 39% and a non-GAAP tax rate of 21% in the second quarter. +And last, as Brian talked about earlier, we are committed to increasing efficiency as a company, and we are making an important commitment to our owners today. We expect to reduce our spending as a percent of revenue by 2 points from 2015 to 2017, and our plans are to continue to drive efficiencies in how we operate the business over time. We are establishing a spending target of approximately 30% of revenue, which we expect to reach no later than 2020. +As a result, we are raising our full year revenue guidance by $500 million to approximately $60 billion and our EPS guidance by $0.05 to approximately $2.85 per share. As we look to the second quarter of 2017, we are forecasting the midpoint of the revenue range of $14.4 billion, up 11% year-over-year excluding Intel Security and up 6% including Intel Security. +We expect operating margins to increase by 3 points year-over-year; gross margins to be up 1 point at approximately 63%; and spending to be approximately $5.2 billion, flat year-over-year. We expect our spending as a percent of revenue to be down 2 points in the first half of the year versus last year as we make solid progress in increasing efficiency in the company. We expect EPS to be approximately $0.68, up 15% year-over-year. +We feel good about where we are 90 days into our 3-year journey. We exceeded our expectations for Q1 and increased our profit expectations for the full year. At the same time, we are investing in the future by expanding our TAM from $45 billion to $220 billion. We are already seeing an impact with our growth-oriented businesses up double digits collectively as we continue to transform the company from a PC-centric company to a company of smart and connected devices that power the cloud. +With that, let me turn it over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, - [5] +-------------------------------------------------------------------------------- + + All right. Thank you, Brian and Bob. (Operator Instructions) Crystal, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first questioner comes from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Brian, I'm curious on the data center growth. The growth rate is now below 6% in Q1. Are you still committed to the high single-digit growth rate for this year? What will drive it? Is it just some pause ahead of the broader launch of the Skylake servers? If you could just give us some more color about why the growth rate is below trend right now and what will help it get back to trend later in the year and over the next few years. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [3] +-------------------------------------------------------------------------------- + + Sure, Vivek. So the simple answer is, absolutely, we're still committed to the high single-digit growth for the year. If you take a look at it, as Bob and I both mentioned in the call, when you take a look at Q1 comparatives, one, Q1 of last year was 14 weeks. This year, it's a normal 13 weeks. So you add that 1 extra week, that's a couple of percent that you're competing against on a year-over-year basis. Secondly, Q1 tends to be our lowest quarter in general, if you just look at our seasonality, in the year for overall revenue and output and growth in that business, in the data center business. And so as we look out and we see, as you said, the ramp of Skylake in the second half, as we see the normal seasonality, we are absolutely committed to that high single-digit growth rate for the rest of the year. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [4] +-------------------------------------------------------------------------------- + + That's helpful. And as my follow-up, the very rich mix in PCs, ASPs were up very strongly, how sustainable is that? And are you seeing any effect of competition from AMD's product launches? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [5] +-------------------------------------------------------------------------------- + + Sure, I'll start. Bob may want to jump in. Each quarter, we come in here and say we're a little concerned about the sustainability of those high ASPs, and we continue to have that. So we always forecast, if you take a look at the -- what we forecasted for the remainder of the year, we've forecasted a slight decline in ASPs as we move through the year. Now that said, we are continuing to improve our road map. We're continuing to pull in products. And the demand for those high-end, high-performance products from 2 in 1s, gaming, high-end workstations continues to grow faster than we are even able to project. So right now, we've forecasted a slight decline through the rest of the year. And we -- but we had strong demand for it in Q1. And I -- and we really believe that's a function of our products and our road map. From a competition standpoint, we're not seeing anything unusual right now as far as -- there's always some level of competition in this market, but -- and I'd tell you, for Q1 and our forecast for Q2, we're not seeing anything out of the ordinary from what we normally see. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [6] +-------------------------------------------------------------------------------- + + Yes. The only thing I would add, Brian, is the -- in the -- with the ASPs being a little bit stronger than we expected in the first quarter, as we mentioned, we expect full year revenue to be up $0.5 billion versus where we were 90 days ago. And I would say one of the contributors to that is kind of how we saw ASP trend in the first quarter of the year. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [8] +-------------------------------------------------------------------------------- + + I guess, first question, in terms your targeted 30% OpEx ratio by 2020, would love to hear what kind of revenue assumptions you're making as part of hitting that. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [9] +-------------------------------------------------------------------------------- + + Sure. So I'll start. First, I thought it would be good to give you a little background, right, why we do we come out and commit this now and kind of what's our thinking behind this. And part of it is we had good progress, brought down spending as a percent of revenue about 1% for 2016. We're a quarter in, and we're seeing good progress in our efforts along 2017 of taking it down another -- slightly more than 1% as we look at this year. And so we just really took a look at do we think we can maintain that progress and continue to drive efficiencies while driving growth. The growth we've expected is what we talked about in the analyst meeting back in February, which is that mid-single-digit type of growth for the overall company. And that's kind of where we're at from a growth perspective. And then the cost reduction and the efficiencies are driving the rest of it. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [10] +-------------------------------------------------------------------------------- + + Yes. And I would just say that the -- we kind of -- our focus is on growing the earnings performance for the company in the short, medium and long term. And what we laid out at Analyst Day, as Brian indicated, was, over the next 3 years, low single-digit growth, operating income growing faster than revenue and EPS growing faster than operating income. And that's the -- against that, we're trying to obviously make revenue grow faster, continue to manage the efficiency in which we operate the company and drive strong earnings growth performance over the short, medium and long term. So the 30% target is consistent with kind of the 3-year plan, and we know that there's opportunities for us to be more efficient as we go forward. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [11] +-------------------------------------------------------------------------------- + + That's very helpful. I guess, as my follow-up, was hoping to take a look at memory and here, would love to hear from you as to how we should think about layering in depreciation from Dalian this year, next and when you would expect to turn a profit on the operating margin line. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [12] +-------------------------------------------------------------------------------- + + Yes. On the depreciation, we kind of implied in our guidance really no change on a depreciation through course of the year. And what that assumes is roughly $2.5 billion additional CapEx from memory in the year. In terms of profitability, for this year, when we talked to you at Analyst Day, Rob kind of laid out a plan where the Core 3D NAND would be profitable in the second half of the year, but our losses for the business would still be roughly in line with where we were in 2016. And that was a function of really 3 things: good performance on 3D NAND, continuing to ramp Dalian and continuing to invest in our Optane product or 3D XPoint. So those dynamics have us breaking even for the core business in the second half of the year, and we said that near the end of 2018, as a whole, the memory business would be profitable. And to the first quarter, growth was stronger than we expected, and performance out of our fab was even better than we expected. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [14] +-------------------------------------------------------------------------------- + + I just wanted to go back to the DCG growth and into your outlook in June, flat or slight growth overall, is your expectation the DCG would be similar to that? And then as you look out the whole year, you talked about cloud growth. I know tough compares with 18%. Just curious, you're -- since you've been shipping early to these customers, what would be the time frame that you would actually see some benefit from Skylake? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [15] +-------------------------------------------------------------------------------- + + Sure. So I'm not exactly sure I completely understood your slight growth. What we said is we're -- for DCG as a business, we're in the high single-digits growth rate. So we're absolutely committing to that. We talked about the 6% in Q1 and how, as we go through the year, we'll continue to grow. From the standpoint we've been sampling Skylake to the cloud guys now for some period of time, in fact, backed into latter half of last year, but you really don't see the ramp of Skylake in volume at any of the customers, whether it be the cloud guys or the rest of the enterprise and networking and all until the second half. That's really when the volume kicks in on the server side. And that's absolutely what we had forecasted, and there's no change in that forecast whatsoever. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [16] +-------------------------------------------------------------------------------- + + And then maybe if I could just ask, I know you don't break it out anymore but just your view on your modem product this year and next. And if you could also maybe opine about your foundry strategy and opportunities there. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [17] +-------------------------------------------------------------------------------- + + Sure. I can start with the modem, and Bob can talk about -- I'm not going to break it out financially. Bob can talk about -- jump on top of this. But for us, on our modem, it continues to gain momentum. We've talked about our one large customer, but we continue to get other interest in it. We are on schedule to bring our next-generation modem into production and customer qualifications this year. And really, looking out over time, we have the next several series of modems over the next few years from an LTE perspective, and then we're already working on and believe we're leading, if you looked at our output from MWC back in February as well, on the 5G side, which is both at the modem and back through the base station. And that, we believe, is really the differential that we're able to provide in the communication space, is in a space like 5G where the modem and the base station and backhaul is so integrated and so important, we're able to provide that end-to-end solution. From a foundry perspective, we continue to talk to several large customers, and as we're able to, we'll talk about volumes and launching of new products. But for right now, we're just saying we're continuing to invest and grow that business. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [18] +-------------------------------------------------------------------------------- + + Yes. And the only thing that I would add is the strong CCG revenue growth of 6% in the quarter. As you'll remember, because our first launch client really didn't ramp until the second half of last year, the first half revenue growth for CCG will -- particularly because of modem, will have a relatively easy comp. So that's a contributor to growth in the first half. And as Brian said, we -- the comps get much tougher in the second half because our one client launched in the second half last year. But given the products we have, we feel relatively good about where we are. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Stacy Rasgon from Bernstein. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + First, I wanted to ask again about this 30% spending target. You guys just had an Analyst Day like 2 months ago. It seems like something that probably should have been talked about then. So what's changed in the last 2 months that means you need to roll the target out on today's call? And how should I try to reconcile that target with some of your other commentary at the Analyst Day where you were fairly gung ho about the need to invest to fund growth? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [21] +-------------------------------------------------------------------------------- + + So I'll start, Stacy. I think you have to take a look at where we're at. You're kind of asking a couple of questions. So first, from the growth standpoint, our position about investing and continuing to really drive growth is absolutely still just as strong as it was back in February at the Analyst Day. And I'd tell you, Q1 is a great example of that with year-over-year growth, another record quarter coming off a record year. And raising the year and forecasting another record year. So I feel very good about the investments we've made, both short term, medium term and long term, to drive that growth. That said, Bob and I have both been looking at now how do we do that and also at the same time, become more and more efficient. And what we've looked at now is that our performance and becoming more efficient in 2016 and taking about 1% out of our spending as a percent of revenue was very successful. We understand how we did that. As we looked at our first quarter performance and what we believe we can take out for the rest of 2017 is another percent of spending as a percent of revenue, slightly more actually. And then I think one of the things that Bob's really brought in as the CFO is new ways of thinking and new looks at how to continue that trend. And so taking 1% a year or so out of our spending as a percent of revenue is something we think we can go and accomplish while driving that growth. And that is the effort that we've spent over the last couple months really digging into those details. And that's why we felt like it was important we came out now and really said, yes, we are committing to that. We understand the details behind it. And we've got a history now that tells us we can say it with confidence. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + Got it. For my follow-up, I'd like to ask about DCG margins. So they were 35% this quarter. It doesn't sound like there was anything structural like the warranty charge that hit last quarter. This sounds like the drivers around allocation and everything else we've discussed. But it's still quite a bit lower than I think most would have expected. How should we think about that margin profile trending through the year as the Skylake parts ramp? And do you think, for the full year, you'll actually be within the data center margin targets that you provided at the Analyst Day? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [23] +-------------------------------------------------------------------------------- + + Yes, I would -- Stacy, we kind of provided a long-term outlook of 40% to 45% operating margin for DCG. Our expectations for this year were for growth, as Brian indicated earlier, high single digits and at the lower end of that range, of the 40% to 45%. In the first quarter, just to be clear, the 9-point drop in margin, 7 points of that is attributed to the fact that DCG is a bigger business, and we've indicated it will be first on 7-nanometer and a fast follow on 10-nanometer. As a result, it gets a bigger share of our technology development and our SG&A allocation. So 7 points of the 9 decline are simply a result of how we allocate costs to the business segments. I think in terms of going through the course of the year, the things that are going to change, as Brian indicated, we got strong product offering coming out in the second half of the year. We expect ASPs to improve as we go throughout the year. As you know, the first quarter is always the lower end of margin seasonality -- from a seasonal perspective. And we expect product costs to improve as we continue the transition from 22- to 14-nanometer. So it's in line with our long-term expectations, no change; our outlook for 2017, no change. The biggest fundamental driver to margin performance is simply the success of the data center business in terms of growing, in terms of being a bigger chunk of the overall business, in terms of being a beneficiary of leading-edge technology that bears 7 points impact because of the higher burden of our allocations on the business. So we feel good on where we are for the quarter and where we're positioned for the full year. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + But those allocation charges aren't going to go away anytime soon. It sounds like they're going to hang around for a while if you're talking about 10 and the 7-nanometer. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [25] +-------------------------------------------------------------------------------- + + Yes, that's true and that's reflected in our 40% to 45% and our improvement throughout the course of the year. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [27] +-------------------------------------------------------------------------------- + + Bob, maybe just a follow-on to Stacy's question, just some clarification around the allocation charges. The 7 points in March, does that represent a peak? Or do we run into a situation where as absolute costs for 7 and 10 go up throughout the year, you could see op margins in DCG continue to be down just because the percent doesn't change but the dollars are going up? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [28] +-------------------------------------------------------------------------------- + + Yes. I mean, our expectation is the operating margins for DCG will improve by quarter throughout the year. Again, it'll be a function of the normal seasonality of the profitability of the business. It will still bear a significant chunk of our tech development and SG&A costs. But you may remember that our development costs during the course of the year, as we indicated, I think maybe last couple quarters, that comes down from first half to second half. So as that cost comes down, all of our businesses will benefit from lower costs. And then the third thing, higher -- yes, the real fundamentals of the business are higher ASPs with good product with an outstanding performance and getting better and better yields on our 14-nanometer product going through the fab will be benefits to the profitability of the business. The lowest point Q1 expectations, it'll grow each quarter throughout the year, and we would expect full year operating margins, despite higher absorption, higher burden from our indirect costs, at roughly 40% for the year. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [29] +-------------------------------------------------------------------------------- + + And that clarification's helpful. And then, Brian, as my follow-up, one of the strengths of your model is just the free cash flow that you can generate, which enables you to reinvest organically back in the business. And you're clearly doing it this year on the CapEx front with CapEx up over 20% year-over-year. I guess what I'm trying to understand is should we be thinking of CapEx this year as sort of the new norm with rising capital intensity, investments in the memory business, maybe optionality around foundry? Or is the $12 billion this year sort of something that we should think about as being an above trend or particularly high spending year? Any color on that would be helpful. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [30] +-------------------------------------------------------------------------------- + + Sure, John. I'd tell you that the increase in CapEx that you're seeing this year is something that we kind of see as unique. But my guess is that we'll have to continue it for maybe 1 year more or so as we continue to build out that memory factory. But look, if you take a long-term view, I don't expect us to run these kinds of CapEx levels. I -- we'll always make good investments. So in a place like this where we think we have differential technology like 3D NAND and our Optane/3D XPoint, I'm going to look for ways to invest that have a positive NPV. But from this current view, we probably have another year and then probably go back down to what we'd consider a more normal rate. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David M. Wong, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Technology and Services Analyst [32] +-------------------------------------------------------------------------------- + + Can you give us some idea within data center of what revenues you're currently seeing from Xeon Phi? And also, you mentioned acceleration services at Alibaba. Can you fill us in on any other key customers adopting Xeon Phi, FPGAs or any of your other accelerators? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [33] +-------------------------------------------------------------------------------- + + Sure. So we don't break out revenue on specific products like Phi, but Xeon Phi does continue to ramp and grow from a product standpoint. We have some additional products that we'll launch in the second half of this year around Xeon Phi from Knights Mill. And from an FPGA or other accelerators, we continue to get several of the large cloud providers, networking providers who are continuing to use our FPGAs. But again, we don't break out on a -- by customer standpoint. But we still are committed to our 6% roughly growth on the PSG business this year. Q1 was down just because of some unique -- there was some extra buying in the latter half of last year around some cloud. And the networking guys are typically down in the first quarter. So it hit its forecast, but it's down year-over-year. We think we'll recover that as we go through the rest of the year from an FPGA. And then as we go out through the second half of this year, the first of the products comes out in silicon from our Nirvana acquisition, which is another form of AI acceleration. We'll get that first silicon. We'll start to work with customers, and you'll see that come in 2018 as an additional accelerator adding to our full AI portfolio. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Timothy Arcuri from Cowen and Company. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, Cowen and Company, LLC, Research Division - MD and Senior Analyst [35] +-------------------------------------------------------------------------------- + + I just wanted to clarify your answer to John's question. So in terms of the $300 million year-over-year burden on DCG operating margin that's due to the cost allocation, is that sort of a fixed number going forward? Or does that absolute number get better through the year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [36] +-------------------------------------------------------------------------------- + + The -- there's 2 dynamics on our total pool of indirect costs that are going on for the company. One is our SG&A indirect costs are coming down. Brian referred to that earlier about the progress we made on direct spending overall coming down another 1 point plus during the course of the year. And second, our R&D costs, particularly as it relates to Moore's Law for 10-nanometer and 7-nanometer, goes up a little bit. So during the course of the year, our overall costs will be roughly flat that we'll be allocating to the businesses. And DCG will get a larger portion of that than it has historically, roughly impacting the business by 7 points because of its bigger size and because of the decision to have it be a beneficiary of Moore's Law sooner than it has historically. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, Cowen and Company, LLC, Research Division - MD and Senior Analyst [37] +-------------------------------------------------------------------------------- + + And then as a follow-up, I -- so I just wanted to clarify. So the NSG, so you're expecting to still lose money into the first half of next year. And is that what you're saying? Or are you saying that for the entirety of the year next year you'll be profitable? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [38] +-------------------------------------------------------------------------------- + + So separate out again and remember we're making the large investments in Dalian. So from a pure 3D NAND perspective, we said it goes breakeven and beyond in the latter half of this year. So for next year, our standard NAND business will be profitable. 3D XPoint plus the Optane product is additional investments we're making. We said that that's in the second half of next year it goes to breakeven. And the overall business does as well. We haven't gotten any more granular than that for right now. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + And our next question will come from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [40] +-------------------------------------------------------------------------------- + + Wanted to ask the first one on the OpEx side of things, and I applaud the 30% target. It's good to see that commitment. But I wanted to focus a little bit more in the near term. In the first quarter, it was about $100 million above what you had guided. In the second quarter, it's a bit above what I expected, too, especially given McAfee. So could you give us a little color on why it was a little bit higher in the first quarter and where we are in the restructuring benefits and the McAfee benefits? If you can do anything to size either of those in the near term, that will be helpful. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [41] +-------------------------------------------------------------------------------- + + Yes. I think first quarter, a little bit over, I'd characterize it primarily in the round. I think for first half, we're basically implying $10.6 billion of OpEx, and we're committed to our $20.5 billion for the first -- sorry, for the full year. So $10.6 billion in first half drops to $9.9 billion in the second half, and there's really 2 primary drivers to that. One is, as you alluded, the exit of McAfee will be roughly $300 million out from the first half run rate. And then secondly, just the completion of our previously announced restructuring programs will continue to bear fruit on lower OpEx in the second half of the year. So first half, $10.6 billion; second half, $9.9 billion; McAfee exit, continued execution and feel good about full year of $20.5 billion. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [42] +-------------------------------------------------------------------------------- + + And just a reminder, that $20.5 billion takes another roughly 1%, slightly more, out of our spending as a percent of revenue. So that's all baked in. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [43] +-------------------------------------------------------------------------------- + + I guess my follow-up then switches to the gross margin side of things. It's staying solid, and I might be at the risk of a rounding error in this question as well. But considering that you raised your revenues and ASPs were a big portion of that, usually that's a pretty good follow-through. So the fact that you're keeping the gross margin guide for the year flat at 63%, are there any incremental offsets to the goodness that the revenue and the ASPs would generate? Or is it in fact just rounding? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CFO and EVP [44] +-------------------------------------------------------------------------------- + + I don't know if it's rounding or not. I'd say $0.5 billion of revenue upside at kind of roughly gross margin dynamics of the business will fall through an additional $0.05 of EPS. So we feel great about that. I think the dynamics of more the business is in the second half. ASPs will improve for data center. As Brian alluded earlier, we've assumed that ASPs will decline a little for the client business and the fast growth of memory and modem will have a negative mix impact on gross margin. So I think when we take that all together through the year, we felt a fairly consistent 63% with all those puts and takes throughout through the course of the year. And Q1 was where we expected; Q2, consistent with Q1 and full year. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + And our final question comes from Kevin Cassidy from Stifel. + +-------------------------------------------------------------------------------- +Kevin E. Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [46] +-------------------------------------------------------------------------------- + + Just on the capacity that you're building in Dalian, can you say what percentage increase you're getting? Or is it directly correlated to the revenue growth that you're seeing in the memory group? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [47] +-------------------------------------------------------------------------------- + + Percentage. So a, yes, the growth in the memory business that goes through the rest of this year is largely driven by the ramp of the Dalian factory along with some assumptions around strong ASPs as demand continues to outpace supply the market in general. And so if you take a look from here on, in fact, 2017 by then, as we go out into 2018 and beyond, Dalian will continue to be the driver of growth of that business. + +-------------------------------------------------------------------------------- +Kevin E. Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [48] +-------------------------------------------------------------------------------- + + I guess another way to phrase the question is what's the bit growth? Most other memory companies give a projection of what their bit growth is. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [49] +-------------------------------------------------------------------------------- + + Yes. I don't think we've actually ever given a bit growth. So that's not a public number. We can take a look at that for next quarter as to whether we want to start adding that to our normal distribution. But what we've always talked about is growth of the business from a profit or revenue standpoint and overall growth, partly because, remember, more and more of that business will become things like 3D XPoint/Optane, and bits will be a little bit different there, right? Not all bits are going to be created equal. That's a very differentiating technology. It's really got performance of DRAM-like devices with NAND non-volatility and pricing in between. And so those bits are a bit different than, say, typical NAND bits, and I wouldn't want to just lump those all into a standard number. So we need to think about how we'd really go and present this to you if you want to think about it from a bit standpoint. And that -- it's around 5% of the business this year, but as you go out into next year and beyond, it becomes a larger and larger percentage as we see more and more products, especially in the data centers, use the Optane technology. + +-------------------------------------------------------------------------------- +Kevin E. Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [50] +-------------------------------------------------------------------------------- + + Right. And maybe if I could ask that question, too, of Optane. When would it transfer to China? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO and Director [51] +-------------------------------------------------------------------------------- + + We haven't talked about a transfer date to China yet. That hasn't been made public right now. Right now, Dalian is 3D NAND. + +-------------------------------------------------------------------------------- +Mark Henninger, - [52] +-------------------------------------------------------------------------------- + + Thanks, Kevin, and thank you all for joining us. Crystal, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2017-Jan-26-INTC.txt b/Transcripts/INTC/2017-Jan-26-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..86975f4fe52ecbde8bbdfe3c484e921583a49a96 --- /dev/null +++ b/Transcripts/INTC/2017-Jan-26-INTC.txt @@ -0,0 +1,678 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Intel Corp Earnings Call +JANUARY 26, 2017 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Bob Swan + Intel Corporation - CFO + * Mark Henninger + Intel Corporation - Head of IR + * Brian Krzanich + Intel Corporation - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Chris Danely + Citigroup - Analyst + * Stacy Rasgon + Sanford C. Bernstein & Co. - Analyst + * John Pitzer + Credit Suisse - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Bill Peterson + JPMorgan - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Intel Corporation fourth-quarter 2016 earnings conference call. +(Operator Instructions) +As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Mark Henninger, Head of Investor Relations. Sir, you may begin. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Janelle, and welcome, everyone, to Intel's fourth-quarter 2016 earnings conference call. By now you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you have not received both documents, they are available on our investor website, INTC.com. I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to non-GAAP financial measures when describing our consolidated results. The CFO commentary and earnings release available on INTC.com include the full GAAP and non-GAAP reconciliation. +And finally, I would like to remind everyone that we'll be hosting our annual investor meeting, here at our Santa Clara headquarters, on Thursday, February 9. If you have any questions about the event or logistics, please contact Investor Relations. With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. I'd like to cover three things with you today before handing off to Bob: a brief review of our results for the year, an update on the transformation of the Company, and a look ahead at 2017 and Intel's future. +First, the review of our results. Q4 was a strong finish to a record year in which we increased revenue 7% and net income 9%. The Client Computing Group, Data Center Group, Internet of Things, and Intel Security all grew in 2016, with DCG and IoTG setting full-year revenue and volume records. +The acquisition of Altera added 3 percentage points to our overall growth rate. In the Data Center, cloud service provider revenue grew 24%, while enterprise revenue was down 3% for the full year. Additionally, we are very excited that Com Service Provider revenue grew 19%. And across all of our customer categories, adjacency revenue grew an incredible 21%, with strength in ethernet controllers, Omni-Path fabric controllers and switches, and network ASICs. +IoT revenue was up 15% for the full year, driven by strength in the video, retail, and industrial segment. In Q4, we launched new Apollo Lake and Kaby Lake product, and we won key designs in automotive and video. +Our Memory business finished the year with record quarterly revenue, while full-year revenue was down 1%. This was an investment year for the memory business, but NSG operating margins improved meaningfully in the fourth quarter. We're now shipping 3D NAND from our Fab68, and we just qualified our first 3D cross point-based Optane SSD, which we expect to ship for revenue in the first quarter. And our 3D cross point memory DIMMs are sampled to Data Center customers. +The Client Computing business achieved impressive results, driven by strong execution and higher ASPs, as customers bought a richer mix of Intel Core product. This was also a breakout year for CCG's wireless communications product line. Our 7360 LTE modem ramped into high volume and we shipped record Wi-Fi units. +I'm very proud of the Client Computing business, and what this team has delivered in 2016. Our strategy of delivering consistent product leadership, segmentation, and differentiation paid off. We achieved record i7 units, and overall core mix in 2016. And Client Computing revenue was up 2% for the year, despite the declining PC market. +The Programmable Solutions Group was up about 7% on a non-GAAP basis over Altera's 2015 results. PSG saw strength across many segments, with particular strength in compute and storage. The Programmable Solutions business sampled the industry's first, and only, 14-nanometer FPGAs this year, known as Stratix 10. This product line has the largest demand pipeline in Altera's history. The integration of Altera into Intel was an important milestone in what was a transformative year for Intel. This team did a great job of meeting integration objectives, while continuing to deliver new products and grow the business. +In 2016, we took other important, and in some cases difficult, steps to position the Company for future success, improve the alignment of our resources to our strategy, and accelerate our transformation to the company that powers the cloud and billions of smart and connected devices. Our restructuring initiative focused on our investments on the product and technologies that will fuel our growth. And that work, combined with improvements in 14-nanometer costs, drove a 30% operating margin improvement in our Client business. +Our decision to establish McAfee as a separate, independent company was another transformative move. This transaction will give McAfee the flexibility to invest independently, tighten our focus, and allow Intel to share in McAfee's future success as the market demand for world-class security product continues to grow. +And finally, looking ahead to 2017 at Intel's future, I am confident we are making the right investments to compete and win, not only in the segments where Intel is strong today, but also in new areas that are poised for growth driven by the emerging flood of data. By 2020, the average person will generate about 1.5 gigabytes of data per day, while smart and connected devices of the future will produce data at many times that rate. +Autonomous cars, for example, will generate about 4,000 gigabytes of data each day. The resulting explosion of data is creating tremendous opportunity. But data alone isn't valuable. It is the transmission, aggregation, and analysis of the data that results in value and impact. Intel will play a central role in those steps because our products are key to turning raw data into high-value insight and information. Our investments in advanced research and development are making this all possible, while significantly expanding our TAM at the same time. +These investments are creating opportunities in segments from autonomous driving, where we are uniquely positioned to be the compute engine in the vehicle and the data center; to 5G where we are building on our momentum in 4G to establish leadership; to artificial intelligence, where we are providing the industry's most complete range of products to accelerate all AI solutions, from the edge to the data center. We are already seeing signs of progress. In autonomous driving, we are winning key designs like BMW, Delphi, and Baidu. In 5G, we are leading in the definition of standards, prototyping, and field trial. +Our Network business saw strong growth as infrastructure moved to Intel architecture in anticipation of 5G. Our design wins and network virtualization innovation position us for leadership share in the wireless access market. Other proof points of our progress include important partnerships with AT&T, SK Telecom, Korea Telecom, and Verizon, and the announcement earlier this month of the industry's first global 5G modem. +Finally, in artificial intelligence, we believe we have the industry's strongest product portfolio. Intel processors power well over 90% of servers deployed to support machine-learning workload, and we are winning the vast majority of AI solution, based on strong product performance and customer value. +Wrapping things up, I am very pleased with Intel's performance in 2016. We have important work to do in 2017, as we continue to transfer the Company but the progress we have made leaves me increasingly confident in Intel's growth and Intel's future. And with that, I will hand it over to Bob. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. The fourth quarter was an outstanding quarter. Revenue was up 10%, operating income was up 11%, and EPS was up 4% year over year. Revenue set an all-time record at $16.4 billion, and operating income was $4.9 billion. Fourth-quarter operating margin was 30%, flat year over year. Gross margin, at 63%, was down 2 points, primarily driven by a couple of one-time events related to product warranty cost, and long-term IP agreements. Direct spending came in at $5.4 billion, up 4% year over year, and down 2 points as a percent of revenue. Earnings per share of $0.79 was up $0.03 from a year ago. The Client Computing Group had revenue of $9.1 billion, up 4% year over year. +During the fourth quarter, the worldwide PC supply chain remained healthy, and we saw some inventory burn during the quarter. Client ASPs were up 7% year over year, and core mix was at an all-time high as a result of the success of our segmentation strategies, and strength in gaming and high-end systems. This segment had another quarter of significant profit growth, with operating profit growing 30% from a year ago, as the business continues to benefit from lower spending, richer product mix, and continued improvements in 14-nanometer unit costs. +The Data Center Group had record revenue of $4.7 billion, up 8% year over year. In the fourth quarter, we continued to see robust growth in the cloud and com service provider segments of the business, which both grew approximately 30% year over year, partially offset by a 7% decline in the enterprise and government segment over the same horizon. The Data Center Group had operating profit of $1.9 billion, down 14% year over year. Operating margin was impacted by the two one-time items I referred to earlier, and the ramp of 14 nanometer on our server products, which we expect to generate continued cost improvements over time. +Our Internet of Things business achieved record revenue of $726 million, growing 16% year over year, driven by strength in both retail and industrial segment. Operating profit for the business was $182 million, up 37% year over year. +Our Memory business had a record revenue of $816 million, up 25% year over year, with strong demand for Data Center SSD solutions, with demand signals outpacing supply. We have made great progress ramping Fab68, with yields and unit costs well ahead of expectation. This segment had an operating loss of $91 million, largely driven by cost associated with 3D cross point, and start-up costs for our memory capacity. +The Programmable Solutions Group had revenue of $420 million, and operating profit was $80 million. Our Intel Security Group business had revenue of $550 million, and operating profit of $103 million. +Turning to the full-year 2016, revenue grew 7%, operating margin grew 11%, and EPS grew 9%. Operating margin percent improved by 1 point, while gross margin was approximately 63%, flat to 2015. Spending was $21 billion, or 35.4% of revenue, down 1 point from 2015, primarily from the restructuring programs we began earlier in the year. Operating profit for the year was $16.5 billion. Earnings per share for the year was $2.72, up $0.23 from the prior year. +In 2016, the business generated record cash from operations of $21.8 billion. We purchased $9.6 billion in capital assets, paid $4.9 billion in dividends, and repurchased about $2.6 billion of stock. Total cash balance was $17.1 billion, down $8.2 billion. Total debt was $25.3 billion. Our net cash balance, total cash less debt and inclusive of our other longer-term investments, is approximately negative $2.3 billion. +Now let me turn to guidance. First, some context. First, our guidance assumes a stable macroeconomic environment, but we have taken a more cautious view of PC consumption versus third parties, particularly in our outlook for the emerging markets including Russia, China, and Latin America. Second, for the Data Center, we continue to expect similar growth rates in the cloud and com segment, but we are not expecting an improvement in enterprise. This gets us to an expectation of high-single-digit growth in the Data Center business. +Third, as a reminder, we have one less week as a result of the inclusion of an extra work week in 2016. And last, we have assumed the Intel Security transaction will close in Q2, and our full-year guidance reflects one full quarter of the Group's consolidated results. We have lots of work to do to close this out, and in the event the close happens at the end of the second quarter, we would update our full-year guidance by approximately an additional $500 million of revenue, and $100 million of operating income. +As we look forward to the first quarter of 2017, we are forecasting a midpoint of the revenue range at $14.8 billion, up 7% year over year, and down from the fourth quarter. This is at the lower end of our seasonal range and reflects an expectation of lower Core brand mix, and ASP coming off a strong holiday-selling period for gaming and other premium PC systems. +For the first quarter, we expect operating margin percent to increase 4 points, year over year, gross margins to be flat at approximately 63%, and spending to be $5.3 billion, down 1%. We expect EPS to be approximately $0.65, up 20% year over year. +Turning to the full-year 2017, we are expecting revenue to be roughly flat. Revenue is expected to grow in the low-single digits, after excluding the Intel Security Group from both years. We expect operating margin percent to be up 1 point year over year, with flat gross margins, and direct spending as a percent of revenue, down 1 point versus 2016. +Let me provide a bit more detail on our year-over-year direct spending. Our restructuring plans are on track, including reducing our headcount by approximately 15,000 heads and generating gross savings of $1.6 billion. We are reallocating investments from CCG to higher growth segments, and are continuing to invest in areas that extend our leadership position in Moore's Law, and expand TAM opportunities, such as memory and autonomous driving. We anticipate the net benefit of these actions to result in an additional point of improvement in direct spending as a percent of revenue, in 2017. +We expect EPS of approximately $2.80, up 3% year over year. In 2016, we had a fairly significant gain from our ICAP Portfolio. Our 2017 guidance assumes that we'll have gains roughly in line with 2016 levels. The capital spending forecast for 2017 is $12 billion, up $2.5 billion from 2016, as we continue to ramp our memory capacity. +In closing, 2016 started out slow but finished strong. Our CCG business is focused and executing extremely well in a declining market, and provides the scale that is required to advance Moore's Law, generates significant cash flows, and enables investments for growth. +Our growth-oriented businesses were up 15% collectively, as we continue to transform the Company from PC-centric company to a company of smart and connected devices that power the cloud. We are excited about our plans for 2017 as we continue with our transformation, and we look forward to sharing more details with you at our Investor Day in February. With that let me turn it over, back to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- + + Okay. Thank you, Brian and Bob. Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask one question and just one follow-up if you have one. Janelle, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Chris Danely, Citigroup. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- + + Hey, thanks, guys. Just digging out on the segments. The CCG operating margins were, I think, the highest in the last few years. DCG was kind of the lowest in the last few years. Can you talk about the trend in operating margins for those two segments, for this year, given the guidance? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Yes, Chris, the CCG performance -- a couple dynamics that are driving the kind of record margins. One, higher ASPs on the strong mix that Brian referred to. Secondly, real strong unit cost. It has been on 14nm for a while, so we expect that to continue. +And then, constrained investments in the CCG business as we focus more on investing heavier in the higher growth businesses. Real good performance, and those are the dynamics we are expecting in 2017. +On the DCG front, good in Q4 and then project forward. Nice ASP performance in the quarter, as we migrate from Haswell to Broadwell, and as we think about Skylake in 2017, we expect that to continue. Unit costs in DCG is a little bit higher, because we are coming off great unit cost performance on 22nm, but as we migrate to 14nm. In the earlier stages of that cycle, unit costs are a little bit higher. And then we are increasing our investments in DCG on a year-over-year basis. So, dynamics are relatively good. +The one, I referred to it a little earlier, but in terms of Q4, we had a couple one-time items that really weighed on the profitability or operating margins of DCG that we think are well-bounded, and do not expect to continue into 2017. And just quickly, one we entered in a long-term cross-license agreement and patent-purchase agreement particularly in the com space in the quarter. And DCG was impacted by a portion of that cost in the quarter. +But secondly, and a little more significant, we were observing a product quality issue in the fourth quarter. We had slightly higher expected failure rates under certain use and time constraints, and we established a reserve to deal with that. We think we have it relatively well-bounded with a minor design fix that we are working with our client to resolve. +So those two, one-timers in the fourth quarter weighed on DCG margins, and we do not expect that to continue in 2017. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [4] +-------------------------------------------------------------------------------- + + Great, thank you. Do I get a follow-up? + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- + + Yes, please go ahead, Chris. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [6] +-------------------------------------------------------------------------------- + + Maybe just expand on the PC market. What do you see driving the strength here? How sustainable is it? Any thoughts on PC unit growth for this year? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [7] +-------------------------------------------------------------------------------- + + This is Brian, I can start, and then Bob can add in. +If you take a look-- Bob mentioned in his portion of the talk, of, hey, we have taken a slightly more conservative view of 2017 than third parties for what we see the overall PC unit market as. And we had extremely strong, I mean, record Core i7s, just record Core mix in the fourth quarter, that as we look at Q1 and we look at 2017, we've factored a little bit of caution into that as well. +Those two things put us in the PC market at a unit level in the mid-single-digit decline. That is better if you went back a year ago we were in the high single-digit. Depending on how you looked at it, and where you counted some the 2-in-1 devices. +So it is starting to get better, but I don't think we are back at a zero unit or positive unit. But as Bob said, what we have been really focusing on in that space is how do you make money? How do you sell up? How do you do better business performance in that kind of market? And we are comfortable that we can continue that into 2017. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [8] +-------------------------------------------------------------------------------- + + Chris, the only thing I would add is, we think it -- as Brian said, our outlook is a little more conservative than the third parties. And, our view is, that is probably the right posture, and the right caution to have as we go into the year. Obviously, the team has done a great job in adjusting its cost structure for a more cautious outlook, and then, we will see how it plays out during the course of the year. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [9] +-------------------------------------------------------------------------------- + + Great, thanks guys. Nice quarter. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [10] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [12] +-------------------------------------------------------------------------------- + + Great. Thank you. I wonder if I could ask about the DCG commentary of being up high-single digits. Obviously, that is a little more conservative than the longer-term numbers you had talked about. And I guess as you think about that, is there an element of the cloud spending that you think is causing the Enterprise to be weaker? Or maybe some give us the qualitative underpinnings for that change? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [13] +-------------------------------------------------------------------------------- + + Let me start, and then, again, Bob can jump in on this one. +As we said, we took a look at the 2017 view on Enterprise to be relatively equivalent to what we saw in 2016. Which says that Enterprise continues to decline. I think that is certainly some of that is that it's moving to a public cloud, it's moving to those areas at a faster rate than, I think, we expected. +It also has been a little bit slow about developing private clouds, and we are working with several partners like Microsoft Azure and others, around the private cloud segments, as well, for the Enterprise. But if you take a look at the long-term, we still see this as the growth engine and still getting into that double-digit regime. +Remember, for us, Enterprise is now less than 50% of our overall Data Center business. And areas that are growing even faster, or as fast as cloud in most cases, are the networking and storage space, which we have very low market share in still, and it is a great opportunity for us. And in the emerging areas like Silicon Photonics, Omni-Path fabric, Rack Scale Design and 3D Xpoint. And those areas are really, what we've always forecasted to be the growth engine of the Data Center group as we exit and go towards the back half of this decade. +So, for us, our view is, this is a -- anytime you're going through a market transition, you're not going to get the cloud-to-Enterprise mix perfect. And this is an anomaly right now, that we've forecasted, we think, accurately and adjusted for it the way it is. But our long-term growth was actually based on other factors, and we are still very confident in those growth areas. I don't know if Bob wants to add -- + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [14] +-------------------------------------------------------------------------------- + + Nope, I think you -- that's perfect. Nothing to add. Thanks. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Thank you for that. That's great. And then separately, on the PC market. The ASP growth that you guys saw over the course of 2016, is that strictly mix shift and strength in the higher-end segments as you've been talking about? And any thoughts on your ability to continue that price momentum over the course of this year. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [16] +-------------------------------------------------------------------------------- + + Sure. Yes. It's mostly, if not in almost every case, all mix shift. And it's, our customers buying up. +A great example was the K SKUs. The Enthusiasts, the 10 Core Systems that we've put out there -- they far and away exceeded our original sales forecast. So people are out there buying 10 Core gaming systems. +So we do believe that market -- that Enthusiast market will continue. We factored a little bit more caution into this, as we go into the 2017 and the first quarter. Some of that seasonality, holiday, people tend to by a lot of gaming systems. And some of it is just how much more can people buy up? And so, how much more growth in ASP can we see? But, we don't see a decline or anything of the average ASPs. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [17] +-------------------------------------------------------------------------------- + + And, the only thing I would add is, as we think about the full-year. The second-half comps get a little tougher on ASP, because of the strong ASP performance throughout the course of 2016. So, that's probably the only dynamic that I would add. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Great. Thank you, very much. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [20] +-------------------------------------------------------------------------------- + + Hi, guys. Thanks for letting me ask a question. I guess the first one on OpEx, and it's more of a conceptual one for you, Brian. On flat revenues it is great to see some OpEx leverage on there, but I think some people are hoping for a little bit more as you had the restructuring only halfway done, and then the McAfee sale that's pending. So, can you talk conceptually about how you balance the desire to reinvest versus the desire to get the profitability up to your long-term targets? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [21] +-------------------------------------------------------------------------------- + + Sure I'll let Bob talk about the McAfee financials and how that affects OpEx. It gets a little complex with Q1 -- end of Q1 target there. +But let's just talk about it in general. What we've always said, is that we were going to go through the program that we went through at the middle of last year, which we called [ACT] just continued through the end of last year, 2016 and we said would be completed about the middle of 2017. +We always said there would be some mix between taking that to the bottom line, and reinvesting it in those growth areas. And so, as we have done acquisitions like Nervana, for artificial intelligence, we want to invest in those businesses now, bring them onto our silicon, integrate them into our software stack. And so, we are going to make those kinds of investments in key areas. +We said the key areas around Data Center in general, we have Rack Scale Design, we have 3D Xpoint, we have artificial intelligence, around IoT, and we are making a big bets around autonomous driving. And so, you see us making the investment in HERE -- the investments with BMW. And that's really, when you take a look at autonomous driving, and why are we doing that? It is around Data and Data Centers, again. +Remember, every one of those high-definition maps is going to require data centers, they are going to require small data centers at the edge. So, it's all around, are we understanding and managing how data is going to flow in that system? +And then memory itself. And we are going to go make those investments around 3D Xpoint, and really bring that and 3D NAND to market in a big way. And so we will balance between those, and I think you will see some mix of bringing it to the bottom line. But, if I can invest, and think I can turn that into additional profitability in the future, I'm going to go do that. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [22] +-------------------------------------------------------------------------------- + + The only thing I would add, is just to maybe make it a little simple for people, as we look at our full-year guidance that we gave, and then we extract out three-quarters of McAfee. At the macro level, we are looking at low-single-digit growth, and mid-single-digit EPS growth. So, that is kind of the year-on-year, apples-to-apples dynamic. +On direct spending itself, we will be down roughly -- our guidance implies we'll be down roughly $0.5 billion year-on-year. And that is just a function of three things; one, continued benefits from the restructuring actions that we took in 2016 and continued to execute on in the first half in 2017; secondly, obviously the direct spend of McAfee kind of goes away; and third, as Brian mentioned, during this transformation, we continued to make investments in the higher-growth businesses. +We will continue to invest in 5G and ADAS, and then we will continue to invest in Moore's Law as we bring 10nm to life in 2017, and continue to invest in 7nm. So net-net, the implications of all that for direct spending was 1 point down, as a percentage of revenue in 2016, and another point down, as a percentage of revenue in 2017. +And then the only thing I would add, is in terms of the milestones that we employ during the course of the year, for these big bets, we'll continue to build milestones in to make sure those bets that we are making are turning out in the medium- and long-term, the way we expect. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [23] +-------------------------------------------------------------------------------- + + That's very helpful. I guess as my follow-up -- you talked about the ASPs in answering a prior question, I wondered about the competitive intensity in the PC market. You're taking a more conservative tack than the third-party vendors are forecasting, but your primary x86 competitor's coming out with the new architecture for the first time in many years. So I wonder whether it is on the ASP, or the unit, or the market share side, how you are factoring that into your forecast for the year? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [24] +-------------------------------------------------------------------------------- + + Sure. I would tell you that we always look at this environment and say, there is going to be a competitive risk in the environment. And we are always focused on, really, our own product roadmap and making sure we have the highest-performance product. +So, when we look at 2017, we still believe that our product roadmap is truly the best ever it's been. And, as we look at the Kaby Lake, and as it really ramps up through 2017, where it came out, really, just at the end of 2016, and now we'll ram with many more SKUs and higher-performance products as we go into 2017. +And then, we showed at CES, the first working 10nm Cannonlake product, which we are still planning to ship by the end of this year, and really ramp into 2018. We still believe that our roadmap and our leadership will continue to give us the performance the customers want and desire. And so, that did not necessarily factor into that more cautious forecast. That forecast was really much more a function of where we think the PC market really is over all. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [25] +-------------------------------------------------------------------------------- + + Great. Thank you guys. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Stacy Rasgon, Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [27] +-------------------------------------------------------------------------------- + + Hi guys. Thanks for taking my questions. I had a question, first, on the guidance for next year. Unless I am doing the math wrong, to get to $2.80 I need a fairly sizable reduction in share count. So, is that true? Could you tell us how you're thinking about shares for next year? Are you intending to use the cash from McAfee to buy back shares to get to that number? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [28] +-------------------------------------------------------------------------------- + + First, in essence, the guidance year-on-year doesn't really anticipate any dramatic change in our share count. I think philosophically, our approach is to offset dilution from our comp-base programs, so all else equal, share count relatively flat year-on-year. +I think, the one thing worth noting is -- in our ICAP Portfolio in 2016, we had a fairly significant gain, and what I indicated in the prepared remarks is we expect, roughly in 2017, that gain to be inline with what 2016 generated. +I think in terms of implied share count in our guidance, it is essentially flat year on year. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [29] +-------------------------------------------------------------------------------- + + Okay. For my follow-up, I wanted to, again, dig into the OpEx. You talked about a mix of the restructure and the cuts versus the reinvestment. But if I throw the McAfee cost back in, you've actually got OpEx going up fairly sizably year-over-year, and your employee count is actually up year-over-year, even though you supposedly had a pretty big layoff. +So I guess, can you talk little bit more specifically about exactly what the additional spending is going on? Is it people, versus technology, versus something else? Where is it going? And do you view those investments as looking to open up new markets versus being defensive in nature? Or maybe a mix of both? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Yes, in terms of the type of cost, maybe two-fold. Yes, people and yes, technology/Moore's law, at the macro level and that expresses itself in higher depreciation year-on-year. In our guide, our depreciation is up quite a bit, and a portion that will flow through direct spending. +Again, on a more macro basis, at the risk of maybe repeating myself, we are investing more in DCG, and in particular, bringing some of these adjacent products that Brian referred to, to market. We continue to invest in memory, and particularly in the 3D Xpoint product, and we continue to invest in IoT. So those three businesses are getting a disproportionate share of the investment, because those are the businesses that we have seen really strong growth in 2016, and we are counting on continued growth in 2017. +The second area, and again, we talked about this a little bit, but we see real opportunities in autonomous driving that play to our strengths and our capabilities. And we will -- we are making step function increase in our investments to position ourselves very well for that industry, and that market, as it evolves. +And then again, third, 7nm, a technology investment, and the spend associated with building a new pilot line in 2017, is also an additional investment. +So we are executing on our restructuring programs. It was -- we took out roughly -- we made the tough decisions in 2016 that resulted in roughly 11,000 fewer people as a result of our restructuring program. We are not quite done, but I would say we are on track. At the same time we are making investments both in technology and people, to strengthen and enhance our competitive position in the areas that we see as real opportunities for us. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [31] +-------------------------------------------------------------------------------- + + The only thing I would add, Stacy, as more of a blunt answer to your question, is if you take a look at the areas that we are talking about, in almost every case, these are new and expanding TAMs for us. So, even look at the places where we're going in the Data Center, and this is my point earlier about Enterprise versus cloud. +Enterprise is now less than 50% of our total makeup for the Data Center group. And the cloud is growing great, and that will continue, but if you look at the areas -- the majority of the rest of the growth for the rest of this decade, in the Data Center alone, it's networking and storage where we have very low market share today. But we are bringing things like software defined networking, and NFV to those. And so that is growing and expanding TAM, as those markets move to Intel architecture. +And then it is, going into Rack Scale Design, Omni-Path fabric, Silicon Photonic, those are all, again, new either nascent or expanding TAMs for us. Autonomous cars and the IoT space are new and expanding TAMs for us. 5G is a TAM that is brand-new that will be really being built out over the rest of this decade. +And then memory -- if you look at the large part of the investment we are making, it's 3D Xpoint, which really rearchitects memory and storage, and will create a new market in our mind. And we believe we are unique in having that technology. +So to me, when I look at the investment, they are all focused around data, they're all in support of how the Data Center ecosystem works, and they are all in either expanding or new TAMs for Intel. And so that is why I see the growth in those areas. It is not just enhancing the technologies that we already have. We will do that, but the new investments are really focused on the new areas. + +-------------------------------------------------------------------------------- +Stacy Rasgon, Sanford C. Bernstein & Co. - Analyst [32] +-------------------------------------------------------------------------------- + + Got it. Thank you guys. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [33] +-------------------------------------------------------------------------------- + + Thanks, Stacy. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [35] +-------------------------------------------------------------------------------- + + Good afternoon, guys. Thanks for letting me ask a question. +Brian, my first question, I want to go back to the DCG ASPs in the December quarter. There were up 4% year-over-year, which reverses, I think, a four or five quarter trend of ASPs going down. I know that you've had mix headwinds that have been driving blended ASPs down. I am curious, what happened the fourth-quarter to drive ASPs up, and do you think it is sustainable? Is this just what we would expect to see the first quarter of the Broadwell launch? And then it normalizes going forward? Or how do you think about ASPs from here? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [36] +-------------------------------------------------------------------------------- + + I will let Bob start with this, and then I will come in and talk a little bit about the macro view of this. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [37] +-------------------------------------------------------------------------------- + + Two dynamics in the fourth quarter where we had higher ASPs. One, the continued transition from Haswell to Broadwell is helpful, and then as we project forward, the next transition is Skylake -- we believe will be helpful as well. So those dynamics where we're delivering better performance for our customers, we are able to capture some of that in ASPs. And we saw a little bit of that in the fourth quarter. +And secondly, in the coms and network space, which is a share-gain opportunity for us in DSG, getting those clients to move up the stack in terms of the high-performance server CPUs is the second dynamic. Both of which we think are helpful as we exit 2016, and go into 2017. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [38] +-------------------------------------------------------------------------------- + + Yes the only thing I would add, John, is, we'll as we go back into the second half of this year; do the Skylake transition. And that is a technology that will increase performance, and a performance per cost to our customers -- one of the largest improvement in a long time, if not ever, on the Data Center. +So, we expect -- typically when that happens people see the value in that and they tend to buy up. They tend to buy the better SKUs. To my view, this trend of higher mix should continue. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [39] +-------------------------------------------------------------------------------- + + That's helpful. And then maybe as my follow-up, Brian, relative to the guide, you're kind of expecting a significant drop in free cash flow this year, with the increase in CapEx. And you highlighted that CapEx is going to the non-volatile memory group. +I'm just curious, given that business, even though it made some improvements in losses in the calendar fourth quarter, is still in a loss position. I'm assuming the higher CapEx is going to be a headwind to getting to profitability. But I guess, how do you think about the path to profitability? The longer-term business model in memory? And what it might do to the DCG growth rate longer term if Xpoint is successful? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [40] +-------------------------------------------------------------------------------- + + Sure. Let's talk about memory in kind of a big picture, John, and then we can -- I'll let Bob talk a little bit about how the CapEx weighs, and what our view of CapEx is in this space. +But, we are in this space for one reason. Because, I understand it is a cyclical business, that tends to be fairly difficult from a price-capacity standpoint. But, we believe we are coming at it with two, very unique technologies. Our 3D NAND technology has some of the best performance and best cost in the market. Our current version of 3D NAND has a 15% price -- or cost value over the competition, and our next version, second-generation has even a higher, when you look at it on a density basis. +And so, we believe we are going to be able to bring differential cost and performance in 3D NAND that will give us a unique position. And that combined with our knowledge of the Data Center should allow us to really provide compelling products for Data Center SSDs. +3D Xpoint is very different in that it's a unique technology that bridges between memory and storage. And, we believe it can rearchitect how big data applications, artificial intelligence applications where you want large amounts of data being brought up as close to the compute as you can, will really transform, not only the architecture of those systems but the performance of those systems. +And we have demonstrated on stage, even on client systems using these types of SSDs, on a equal price, you can get 5x to 7x performance improvement using 3D Xpoint as a large memory storage, kind of, combination. +So we are investing, surely because we believe we have this differential technology, and that is why we are in this business. I think, if I did not have that differential, I'm not sure it is a business that Intel would necessarily be in. Right? But with that leadership, and we believe we could sustain that leadership. We believe it is a good business and a good investment. +I'll have Bob talk about how long and how we view the capital. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [41] +-------------------------------------------------------------------------------- + + So yes, John. The CapEx dynamic, first kind of at the macro level, up $2.5 billion year-on-year, driven by two things. One, memory, obviously. But also bringing10nm capacity online. +If I just go down a level to memory. Roughly, $1.6 billion CapEx in 2016. Expectation is it will be roughly $2.5 billion in 2017, as we bring the incremental capacity online. Then as we look at memory specifically, in 2018 we think it begins to drop off a little bit, as we focus that capacity on 3D NAND and increasingly 3D Xpoint. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + Thanks guys. I appreciate it. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [43] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Vivek Arya, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Brian, I'm curious with this new US administration. There is a lot of interest in using US-made products. And since you are fairly sizable fabs here in the US, I am wondering how you can take advantage of this environment, or if you are interested in making a bigger push in your foundry business? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [46] +-------------------------------------------------------------------------------- + + Well, we are always open for business in foundry. And we are always interested -- remember we said our foundry strategy was really to be on the leading edge. So, because we can get paid for our technology, and it really allows us to use our unique differentiation in that space. +Beyond that, I would just tell you we have always been proud. It is not a new transition or new strategy for Intel. We have always been roughly between, a little more than half to two-thirds of our capacity in the US. We are the second largest exporter in the US. And we are proud of that position. But other than that, there is no real shift in our strategy right now. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + All right. And as my follow-up, back to DCG. There seem to be two moving pieces. You have this declining, but very profitable Enterprise part, but a faster growth, but perhaps less-profitable networking, and cloud and other areas. Is that fair characterization? And do you envision a point at which the non-Enterprise parts become dominant enough that you can actually see an acceleration in DCG back to your traditional double-digit type growth rate? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [48] +-------------------------------------------------------------------------------- + + So let me start, and then we can see. I think our view is that Enterprise will continue to decline. A lot of that is those workloads moving to the cloud. It will get to a point where it starts to stabilize and those -- because there are still things that -- workloads that will want to be in a private cloud. +At the same time, we believe as the world becomes connected, cloud will grow at a much faster rate. And, I made a point in the prepared remarks, where if you look at the cloud of today, seeing mostly based on people -- the average person will generate about 1.5 GB of data a day. An autonomous car, when those things start hitting the road, and we've started to build these Data Centers for some of the trials we're working with. And you are talking about petabytes of data that you are having to deal with, and 4,000 GB a day off the average autonomous car. You put a couple of those on the road, and you need petabytes of storage to handle that. +So we do believe that the cloud will move at a faster rate as these connected devices become, basically, more available. That said, the cloud is becoming bigger than Enterprise. We said Enterprise is now less than 50%. And we believe the other areas that will grow, networking and storage, the adjacencies like Omni-Path fabric, Silicon Photonics, Rack Scale Design, which we're working with our partners on, it really lowers the cost of the system and rearchitects how the Rack is laid out. +And 3D Xpoint should dramatically -- that will drive the growth for us, as we go through the rest of this decade. We believe when you add those up together, this thing will go back to double digits. Went exactly that is? Because it's pretty hard -- we're trying to grow these new nascent areas, and manage the decline of Enterprise. It's going to be hard to call exactly when. But we do still have a strong belief, and we believe the products are very compelling, that these will drive us to double-digit growth long-term. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [49] +-------------------------------------------------------------------------------- + + The only thing I would add, Brian, is on like-for-like product, ASPs have a tendency to be lower to the cloud service providers, but at the same time the cloud service providers really value performance. And in terms of the mix of their products, they will value performance in the higher-end products more than maybe Enterprise as a whole. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [50] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Romit Shah, Nomura. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [52] +-------------------------------------------------------------------------------- + + Thank you, I just had one question. I noticed that you did not raise the dividend in January, and Bob, I am curious if your view on capital returns, buybacks, and dividends is different than what Intel has done historically? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [53] +-------------------------------------------------------------------------------- + + I think, historically, the philosophy around first and foremost, investing in -- organically in our capabilities has always been the first priority. That will be the same. +Secondly, we will continue to look at M&A that will strengthen our capabilities so that is no different than the past. Third, in terms of capital returns, our expectation has been, and I think will continue to think it this way going forward as it relates to dividend, grow it in line with non-GAAP earnings. And have it be roughly 40% of the free cash flow for the Company -- those change around the margins over time depending on the CapEx intensity of the business. +But I don't expect that to change, and we will continue to look at how we move the dividend in line with that philosophy. As I said earlier, in terms of the more holistic capital returns bucket, we will continue to offset dilution, which I think is pretty consistent with what we have done in the past. +And then third, we have a great balance sheet. And I do think that, opportunistically, when it makes sense, reducing our outstanding float is an opportunity we have as we get closer to the net-cash zero position that we have been tracking towards over the last 12 months since the Altera acquisition. +So, philosophically no dramatic change. Dividend in line with non-GAAP earnings growth. But trying to stay in that roughly 40% free cash flow world. And maybe if opportunities present itself, be opportunistic in share counts without limiting our financial flexibility relative to the things that matter most, which is strengthening our business. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [54] +-------------------------------------------------------------------------------- + + Thank you. Nice quarter. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [55] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [56] +-------------------------------------------------------------------------------- + + Operator, I think we have time for two more questions. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [58] +-------------------------------------------------------------------------------- + + Hi. Good afternoon. This is Bill Peterson, calling for Harlan. Congratulations on the nice quarter. +Coming back to the storage market. Trying to understand how you view growth this year in light of, obviously, good sequential growth in the prior quarter, but also overlaying that with the Optane qualifications that are going on in progress. How should we view that as terms of the incremental growth driver in 2017? + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [59] +-------------------------------------------------------------------------------- + + Sure, So if you take a look at it -- as I said, this is a cyclical market. If you take a look at 2016, it started out with an oversupply. Came into the back half of the year with an under-supply, really, of capacity. +We are entering 2017 with a continued tightness in supply. That makes pricing stable to better. So, we expect that, at least, right now the estimates are through the first half. It's pretty hard to project out to the second half, and so we have kind of kept the second half relatively calm and cautious. +If you take a look at 3D Xpoint, as we said we've qualified. We've started to ship DIMM samples to the big cloud service guys. Those are targeted for 2018 revenue shipment. On an SSD basis, we will start shipping for revenue this quarter. And, if you take a look at the full year, I think the estimate is, it's around 10% of our total revenue is 3D Xpoint. +And that will be -- it could take off and it could be a little more than that. It could take a little while to qualify some things if it's a little off. But you should think it is around 10% of the revenue. And really, ramping much more into 2018. +What we are proud of, is you get past that first hurdle of getting the first one to production ready, and starting to ship samples to the cloud guys, and actually getting ready to start shipping SSDs for revenue to the client devices and all that. We are pretty excited about just getting to that point right now with 3D Xpoint. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [60] +-------------------------------------------------------------------------------- + + I appreciate the color. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [61] +-------------------------------------------------------------------------------- + + The full-year for memory was down 1%, 2016 over 2015. But the momentum that you saw is that supply chain dynamic that Brian highlighted changed. And as we began to scale our own capabilities, you saw the strong exit growth of 25% in the fourth quarter. +And so with that going into 2017, we feel pretty good about that growth rate in the fourth quarter, as we enter the new year. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [62] +-------------------------------------------------------------------------------- + + Great. I appreciate the color on that. Maybe a question on the Programmable Solutions. The group has shown sequential declines in the prior two quarters versus your main competitor, who has shown sequential growth, albeit modestly. Discuss taking share -- and now you have the 14nm-based product. I wonder if you could provide color on maybe why that group has lagged in the prior few quarters. But more importantly, when we should see the inflection in the business and how to think about growth in that business this year. + +-------------------------------------------------------------------------------- +Brian Krzanich, Intel Corporation - CEO [63] +-------------------------------------------------------------------------------- + + So, let's talk about that. If I look at 2016, as we showed, we had about 7% growth over what Altera had in 2015. If you take a look at it, there is a couple of big segments that are driving that, Telco, Data Center, and we are starting to see -- and in the networking space as well. Those a kind of the big three segments. +And we started to see as we went through, especially the back of the year, a good connection between our ability to go in, and we are better together, with Xeon and the FPGA, as we go into that networking space. Again, as our footprint grows in networking and storage, I think it also gives us an ability to continue to bring both products to those markets. +So, we think in 2016, we actually gained share relative to the competition. As we look out into 2017, we forecasted again, above market growth from what we understand, as a current estimate. And we believe we will gain a little bit of share, again, in 2017. And, remember these markets are slow-moving. You don't grow 10% share instantly, because of design cycles and design conversions are relatively difficult. +It is again driven by Data Center, Networking, and the telco industry. And with Stratix 10, as we said, largest design enablement in the history of Altera, so we are really excited. We believe it brings a performance and a cost to our customers, that is truly industry-leading and shifting. And, so we are very comfortable -- or confident in that, but again that will really start to shift in the second half of 2017. And so, I think that will really be driving growth in 2018. +And really if you think about these design cycles, that product will really continue to drive growth for probably the next three years, plus, just because these cycles are fairly long. + +-------------------------------------------------------------------------------- +Bill Peterson, JPMorgan - Analyst [64] +-------------------------------------------------------------------------------- + + Terrific color. Thanks, and congratulations on the quarter again. + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [65] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [66] +-------------------------------------------------------------------------------- + + And Shanelle, please go ahead and introduce our last questioner. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Blayne Curtis, Barclays. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [68] +-------------------------------------------------------------------------------- + + Hey guys. Thanks for squeezing me in. I want to ask, Bob, on the gross margin, your full year is equal to the Q1. Just maybe, as you look in the back half, I want to make sure I heard it straight. +It sounded like 14 on the server side. May have some initial yields, and that would be headwind, but I am curious on the PC client as well. So maybe you could just talk about the puts and takes as you ramp in 10, but you still ship a lot of 14. As you look in the second half, what are the headwinds and tailwinds to gross margin? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [69] +-------------------------------------------------------------------------------- + + Yes The two tailwinds on the year-on-year are flat, ASPs being a little better, and we anticipate that more on the DCG side. Secondly, unit cost being a little bit better, and we anticipate that more on the CCG side. And again, as I mentioned earlier, for DCG as we transition more from 22nm to 14nm, all else equal, that will be a little bit of a headwind in the early stages of yield for server on 14nm. +The headwinds, particularly, are strong growth coming from memory and modem. So those two dynamics, themselves: good growth, increasing profitability, good earnings, however, they are at a lower margin so the mix dynamic of those are real on a year-over-year basis. So, good ASP, good unit cost, but mix is a challenge. +And then year-on-year factory ramp, 10nm and memory are a headwind for the full year, but it gets a little bit better in the second half. The dynamic to first-half, second-half -- it gets a little bit better in the second half. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [70] +-------------------------------------------------------------------------------- + + Thanks, and then just maybe a clarification. The $3 billion that you are getting from the sale, should I assume that goes to debt retirement like you have been using your cash flow? And, then I guess, you should get at some point this year, potentially the end the year, near that net-cash zero. Should we think about buybacks at that point? + +-------------------------------------------------------------------------------- +Bob Swan, Intel Corporation - CFO [71] +-------------------------------------------------------------------------------- + + I think the dynamics of the $3 billion, the intention is that roughly $1 billion comes in line at time of transaction. And that we will provide dollar financing in the early stages. So we will only get roughly $1 billion upfront. +In terms of then, just the net debt position during the course of the year, you can assume that we have some maturities in 2015 -- sorry 2017 that we will take out. And we believe by the end of the year, given those dynamics, we will be closer to a net-cash zero position. +In terms of that, and that gives us a much stronger balance sheet, and how we think about that. We will continue, as I said earlier, invest in business, return capital to shareholders, and opportunistically, whether it is reducing outstanding float -- that's one that we'll continue to look at and be opportunistic as opportunities present themselves. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [72] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Mark Henninger, Intel Corporation - Head of IR [73] +-------------------------------------------------------------------------------- + + Thanks, Blayne. Alright, thank you all for joining us today. Shanelle, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2017-Jul-27-INTC.txt b/Transcripts/INTC/2017-Jul-27-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..ca59122536c8f11e4ca397bf17e0338d258145df --- /dev/null +++ b/Transcripts/INTC/2017-Jul-27-INTC.txt @@ -0,0 +1,438 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Intel Corp Earnings Call +JULY 27, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian M. Krzanich + Intel Corporation - CEO & Director + * Mark Henninger + - + * Robert H. Swan + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Q2 2017 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. +I would now like to introduce your host for today's conference, Mr. Mark Henninger, Head of Investor Relations. You may begin. + +-------------------------------------------------------------------------------- +Mark Henninger, - [2] +-------------------------------------------------------------------------------- + + Thank you, Crystal. And welcome, everyone, to Intel's Second Quarter 2017 Earnings Conference Call. By now, you should've received a copy of our earnings release and the CFO earnings presentation, which replaces the CFO commentary that we've previously provided. If you've not received both documents, they're available on our Investor website, intc.com. The CFO earnings presentation is also available via the webcast window for those joining us online. I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. A brief reminder that this quarter we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO earnings presentation and earnings release, available on intc.com, include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. Q2 was an outstanding quarter in which we set a number of records. We beat the expectations we set in April, primarily as a result of stronger desktop and notebook microprocessor volume, and set a second quarter revenue record. We're executing well to our priorities. And after adjusting for the McAfee transaction, revenue grew 14% year-over-year, while non-GAAP operating margin grew 30%. Our data-centric businesses were up 16% year-over-year. +Technology and performance leadership are fueling our results. And in Q2, we extended our leadership with new breakthrough products in client computing, the data center and memory. With industry-leading products and a strong first half results, we're on a clear path for another record year. +As we shared in February and reinforced in April, our strategy is to make Intel the driving force of the data revolution across technologies and industries. I outlined our top 4 priorities for the year in support of that strategy: growing the data center and adjacencies, ensuring a strong and healthy PC business, growing IoT and devices and executing flawlessly in memory and FPGAs. +I'd like to take a few minutes to highlight our progress in Q2. First, DCG. The data center business grew 9% in Q2 and remained on track to high single-digit growth for the year. Strong public cloud growth continued, with revenue up 35%. Enterprise was down 11%, as workloads continue to migrate to the cloud and memory and solid-state drive constraints impacted server deployment. Comms service provider revenue was up 17%, while adjacencies, which serve all customer segments, rose 12%. Cloud and comms service provider together are the growth engine in the data center and together now make up 60% of our DCG revenue. +In 5G, we're demonstrating end-to-end leadership in client and infrastructure. We have 5 ongoing trials with leading global service providers and 15 more in the pipeline. And we're on track with our development of IA, FPGA and ASIC silicon platforms based on new radio standards. +Earlier this month, we launched Xeon Scalable, formerly known as Skylake, and with it the industry's biggest platform advancement in a decade. Using Xeon Scalable, our customers have already achieved over 50 third-party-verified performance world records and are seeing more than 1.6x performance increase over our prior generation product across a wide range of real-world workloads. +For example, the new AVX-512 instructions, double floating point performance, benefiting use cases like HPC, VR and AI. In fact, artificial intelligence inference throughput improves by 2.4x gen-to-gen. And when this silicon innovation is combined with our AI software frameworks optimization, customers, like Amazon Web Services, are seeing inference performance for improvement of more than 100x. The enthusiasm for Xeon Scalable resulted in our largest early ship program ever. We delivered more than 500,000 units to over 30 customers who appreciate outright performance leadership. The data center is central to our strategy and is a remarkable opportunity. By 2021, we expect the data center to be a $65 billion silicon opportunity, and we're less than 40% of the total available segment today. +As we build out the adjacencies like Ethernet, silicon photonics and 3D XPoint memory and pool them all together with rack scale design, we'll be positioned to deliver even higher levels of performance and efficiency to our customers and increase our percentage of the total TAM. +The Client Computing Group also delivered fantastic result. Revenue was up 12% over last year, as product leadership, combined with a disciplined segmentation strategy, led to rising core mix. We, along with our customers and partners in the PC supply chain, are driving the evolution of the PC experience, as users seek out high performance and new form factors. +We launched a powerful, new Intel Core X-Series processor family, including a new Core i9 Extreme Edition Processor, extending our performance leadership. And we'll be shipping our first 10-nanometer product near the end of the year, beginning with a lower volume SKU and followed by multiple SKUs and a volume ramp in the first half of 2018. We've seen some modest improvements in the PC consumption, but we continue to expect a mid-single-digit TAM decline for the full year. +We also began shipping our next-generation 4G LTE modem, known as the 7480, to customers. As I mentioned earlier, we're continuing to make great progress with our wireless ecosystem laying the groundwork for 5G. And starting in 2018, Intel will partner on what is expected to be the first 5G showcase at the Olympic Games. +In our Internet of Things business, we're focused on 4 key verticals: retail, video, industrial and transportation. We saw strong growth across all 4, leading to a 26% increase in revenue. We're specifically excited to see the ramp of our IVI designs with both Jaguar Land Rover and Toyota. We're also about to mark a very important milestone in our transformation. +We expect to close the acquisition of Mobileye in the third quarter, several months earlier than expected. Autonomous driving is a massive compute workload that will disrupt industries and save lives, and we are investing to win in this important segment. I'm excited to welcome the Mobileye team to Intel. Together, we expect to be the global leader in the $70 billion autonomous driving system, data and services market opportunity by accelerating auto industry innovation and delivering cloud to car solutions faster and at a lower cost. And we're looking forward to talking with you in more detail about our plan and the progress we're making in the segment later this quarter. +Memory and FPGAs round out our priorities for the year. Our memory business grew 58% over last year, setting an all-time revenue record. A cornerstone for our strategy in this segment is differentiated technology. And that differentiation was on display earlier this month when we announced availability of the industry's first and to date only 64-layer 3D NAND SSDs. Our floating gate architecture already enabled industry-leading density at 32 layers. And we believe our density lead is even greater at 64. +We also shipped more than 200,000 units of our revolutionary Optane memory for clients, which are available via our OEM partners and channel partners, and have more than 50 data center customers testing Optane SSDs currently, which will ship for revenue this year. Optane DIMMs remaining on track for availability next year. +Our memory factory, Fab 68, continues to exceed expectations, ramping ahead of schedule in terms of both output and yield. This will be a big part of our overall supply growth in the second half, which we expect to be greater than 20%. The combination of strong execution and favorable market condition is accelerating our path to profitability. Core NAND returned to profitability this quarter, ahead of our earlier estimate, and we expected it to remain profitable for the balance of the year. We also now expect the entire NSG segment to be profitable for the full year of 2018 versus our prior end of 2018 target. +Lastly, our FPGA business was down 5% over last year on weaker data center and comp sectors but remain on track to our mid-single-digit growth target for the full year with broad re-acceleration in the second half across markets, including the data center segment. At their Build Conference in May, Microsoft disclosed a major advancement in the deployment of Intel FPGAs, resulting in the industry's fastest public cloud network and new technology for acceleration of deep neural networks. Audi selected Intel for the level 3 autonomous driving systems in its upcoming A8, where our Cyclone V SoC FPGA technology will perform object and map fusion as well as parking pilot and sensor data preprocessing. We're also seeing strong adoption of our 14-nanometer Stratix 10 FPGAs. We continue to gain key design wins in our focus segments, and we're on track to production later this year. +To sum it up, I'm very pleased with our progress, and I'm more confident than ever in Intel's future and growth. Based on our strong first half and higher expectations for the PC business and the expected close of Mobileye, we're raising our full year revenue forecast from $60 billion to $61.3 billion and our non-GAAP EPS forecast from $2.85 to $3. +We continue to see intense competition across our businesses. That's the reality of the attractive markets in which we participate. The competition makes us stronger, and we're ready for it. We're executing well to our strategy to transform from a PC-centric company to a data-centric company that powers the cloud and billions of smart and connected devices. The PC TAM is down more than 15% versus 4 years ago. Despite that headwind, our revenue is up more than 15%, and our operating profit has grown more than 30%. More than 40% of our revenue now comes from our data-centric businesses, outside the PC sector. And those businesses together are growing at double-digit rates. And while we're growing the top line, we're intensely focused on operating efficiency. +We now expect spending as a percent of revenue to decline about 160 basis points versus last year, bringing it below 34%, on track to the 30% goal we're committed to, to hit by 2020. And with that, I'd like to hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good afternoon. Like Brian said, we had an outstanding quarter and executed on several important milestones. Revenue was $14.8 billion, up 14% year-over-year, excluding the Intel Security Group. From an earnings perspective, operating income was $4.2 billion, up 30% year-over-year, and EPS of $0.72 was up 22% year-over-year. Our EPS performance was the result of strong top line growth, good gross margin improvement and excellent spending leverage. From a capital allocation perspective, we generated $4.7 billion in cash flow from operations, returned $2.6 billion to shareholders and have capital in place to fund the Mobileye acquisition. The planned acquisition of Mobileye, which will fuel our growth in the automotive segment, is expected to close in Q3, well ahead of our schedule. +At our Analyst Day in February, we talked about our strategy to transform from a PC-centric company to a data-centric company, a company well positioned to power the cloud and the billions of smart and connected devices. Our Q2 results demonstrated continued momentum in our transformation, with the data-centric businesses, those outside of the PC segment, up 16% year-over-year. Our PC-centric business executed extremely well in a declining market and was up 12%. Our data-centric businesses are more than 40% of the company's overall revenue. +Moving to earnings. We are seeing broad growth across the business, driving 4 points of operating margin leverage and 22% EPS growth year-over-year. Earnings growth is driven by strong top line growth for both the PC and data-centric businesses, improving unit cost with 14-nanometer ramp and gains from the sale of a portion of our equity investments in ASML. +On our Q1 earnings call, Brian and I talked about our commitment to achieving spending target of approximately 30% of revenue no later than 2020. We've made great progress in the second quarter, as total spending was down 330 basis points year-over-year. We've continued investments in our key priorities, including artificial intelligence, autonomous driving and Moore's Law, while at the same time capturing benefits of our previously announced restructuring program and significant leverage from strong top line growth. R&D spending was down 1 point, and our SG&A costs were down 2.2 points. On a full year basis, we expect direct spending to be below 34%, approximately a 0.5 point better than our prior guidance. +Let me touch briefly on our segment performance on Slide 5. The Client Computing Group had another outstanding quarter. Revenue of $8.2 billion was up 12% year-over-year. Client ASPs were up 8% year-over-year, as we continue to see strength in our gaming segment and strong core mix. We also continue to see the worldwide supply chain operate at healthy levels. This segment had another quarter of significant profit growth, with operating profit growing 58% from a year ago. And the business continues to execute and benefit from a continued improvement in 14-nanometer unit cost, richer product mix and lower spending. +Moving to Slide 6. The Data Center Group had revenue of $4.4 billion, up 9% year-over-year. The Data Center Group had operating profit of $1.7 billion, down 6% year-over-year. As Brian mentioned earlier, we had strong growth in both the comms and cloud service provider segments, which are nearly 60% of our DCG revenue. Operating margin percent was impacted by increased technology development cost and higher artificial intelligence and adjacency spending. Versus the first quarter, our revenue accelerated 3%, and our operating margin improved by 3 points. We are on track to our full year guide of revenue growth in the high single digits and operating margin of over 40% for the full year. +The IoT, NSG and PSG business segments are well positioned to capitalize on the explosion of data and are becoming a larger component of our overall business, growing 28% year-over-year. Our Internet of Things business achieved revenue of $720 million, growing 26% year-over-year, driven by strength in industrial and video and continued momentum in our automotive business. Operating profit was $139 million, up 56% year-over-year on higher volume and ASPs, offset by continued investment in automotive. +Our memory business had a record revenue of $874 million, up 58% year-over-year, with strong demand from data center SSD solutions and demand signals outpacing supply. This segment had an operating loss of $110 million, largely driven by cost associated with 3D XPoint and start-up cost for our memory capacity. Our memory fab in Dalian continues to make great progress and is ramping several weeks ahead of schedule. Yields continue to improve, and unit costs are well ahead of expectations. +The core NAND business returned to profitability in the second quarter. And we expect the core NAND business to be profitable for the full year and the memory business as a whole to be profitable in 2018, both ahead of our prior estimates. +The Programmable Solutions Group had revenue of $440 million, down 5% year-over-year. Operating profit was $97 million, flat year-over-year after acquisition-related impacts. We're making good progress in realizing cost synergies with the integration of this business. +Moving to Slide 8. Let me remind you of our capital allocation priorities and progress. Our priorities: first, invest in the business; second, strategic acquisitions; and third, return cash to our shareholders through dividends and buybacks. As I mentioned earlier, in the quarter we generated $4.7 billion of cash from operations. We purchased $2.8 billion in capital assets, paid $1.3 billion in dividends and repurchased about $1.3 billion of stocks. In addition, we received cash of approximately $900 million as a portion of our Intel Security divestiture. And we generated approximately $1.3 billion from the sales of some of our interest in ASML, which generated $796 million of pretax gains. At quarter end, cash and long-term investments was $34 billion, up $11 billion, and total debt was $32 billion. Offshore cash investments and proceeds from the sale of our ASML investments are being used to fund the Mobileye acquisition. +Now let me turn to guidance on Slide 9. Some context. First, while we see slightly higher PC TAM and supply chain inventory replenishment contributing to higher expectations for annual revenue, we continue to take a more cautious view of PC consumption versus third-party analysts. Second, we continue to see strong demand signals in our memory business through the year, and we expect the memory fab in Dalian to support higher second half demand levels. And third, as I mentioned earlier, we expect to close the acquisition of Mobileye in the third quarter and as such are including expectations for this business into our guidance. Based on these factors, we are raising our full year revenue guidance by $1.3 billion to $61.3 billion, operating income guidance by $600 million to $17.9 billion and EPS guidance by $0.15 to $3 per share. The improvement in revenue outlook is driven by a strong first half, higher expectations of the PC business and the inclusion of Mobileye. The improvement in operating margin is primarily driven by our increased revenue outlook. +Our outlook for full year spending is $20.7 billion, as we expect modest increases related to revenue growth and the integration of Mobileye. The increase in EPS is driven by higher expectations of revenue, coupled with gains on sale of our equity investments and the inclusion of Mobileye. We expect Mobileye to contribute approximately $200 million of revenue, $100 million of operating income and $0.02 of EPS in the second half of the year. +And on Slide 11. As we look to the third quarter of 2017, we are forecasting the midpoint of the revenue range at $15.7 billion, up 3% year-over-year, excluding Intel Security Group. And we expect operating income of $4.8 billion and EPS to be approximately $0.80. +2017 is shaping up to be another record year for Intel. We feel great about where we are 6 months into our 3-year transformation. We exceeded our EPS expectations for Q2 and increased our profit expectations for the full year. At the same time, we are investing to compete and win in an expanding market fueled by the growth of data. We are already seeing an impact from our data-centric-oriented businesses, up double digits collectively, as we continue to transform the company from a PC-centric company to a company of smart and connected devices that power the cloud. +With that, let me turn it over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, - [5] +-------------------------------------------------------------------------------- + + All right. Thank you, Brian and Bob. Moving on now to the Q&A. As is our normal practice, we would ask each participant to ask one question and a follow-up if you have one. Crystal, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [2] +-------------------------------------------------------------------------------- + + I was curious on the -- on the data center business, maybe you can just talk about the growth you need sequentially in the back half to get to that high single digits for the year. Maybe you can just talk about it by segment. I know cloud was up a lot in Q2, the enterprise down. Clarify by segment as well as the contribution from scalable into those segments. What's the right timing to think about as those ramp in? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure. Thanks, Blayne, for the question. So I'll start, and Bob can add some comments at the end. We think the data center continues to be just a great growth engine for the company. And you saw the 9% growth this quarter. What we have really been also focusing on at the same time is really increasing operating margin, and I want to make that point. You saw our operating margin increased to 38% this quarter. You'll see us continue to raise that operating margin so that we're back at the 40-plus-percent operating margin for the back half and for the year. First, kind of want to kind of lay that groundwork. What we've projected for the second half is quarters that are pretty much in line. We continue to expect enterprise to continue to decline. It declined a bit more in the second quarter than -- I think we had really projected a decline at about 11%. But if you look at Q1, it declined a little less than we expected at 3%, but we still expect it to decline in those high single-digit numbers. Cloud though grew greater than what we expected at 36%. We expect it to be in the mid-20s, probably more likely. And then data center -- I mean networking and comms, 17%. Adjacencies at 12%. So we expect that trend to continue. We don't need any big shift in those trends to really get to that high single-digit growth rate for the data center. We talked about Xeon Scalable. The initial reaction has been extremely positive. You see the largest number of prequalification samples sent out to customers. You see the cloud applications. We try to talk about it. It's the largest performance improvement in a decade gen-to-gen. So we're seeing a very large ramp in the second half as we move on with the Xeon Scalable. And so I think that's what's going to fuel second half '17. And then -- but it's going to continue on into '18 as well. So I think that's kind of how we see the second half playing out. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + The only thing I would add, Brian, is we came into the year looking at high single-digit growth for the business and margins expanding quarter-by-quarter throughout the year. And kind of 2 months in, we see nice acceleration on both top and bottom line. And as we go into the second half of the year, we're comfortable with the full year outlook that we've given. And the only dynamic other than the things Brian highlighted as Q3 comps are a little tougher as we enter the second half of the year, but we feel good about kind of the mix of the business as we go through '17 and beyond. Just to reiterate a point Brian said, with the strong cloud growth and the strong performance in the comms and networking space, we now generate 60% of our revenues from the higher-growth aspects of the business. So we think that, that bears well for us in 2017 but also going into '18 and beyond. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + And then I did want to ask you on the memory side. You're looking for a breakeven next year. What is driving that? Obviously, memory pricing has been strong, but I was just wondering if there's any other factors you're now adding to that outlook. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Sure. So let's make sure we clarify, right? So on traditional NAND, we are breakeven this year, and we broke even actually this quarter. And we expect to remain there the rest of the year. When we talk about for next year, that's inclusive of 3D XPoint. And so the difference is really as we ramp products on 3D XPoint and as we ramp out the rest of Fab 68, both of those -- whenever you're ramping a factory, you always -- because you have a certain amount of underutilization of the equipment just as you start to get it going, you tend to have slightly higher cost. And so that's what you see as the driver for the rest of the profitability growth as we go into next year. And what I'll also say that the 64-tier NAND product gives us cost and performance advantage just because they're leading-edge products as well. Now it's going to play into as we move to the remainder of this year and next year. So it's 64-tier products on traditional NAND, the ramp out of Fab 68 and then the real start-up and continuation and getting the rest of the products qualified on 3D XPoint is what gets us everything profitable next year. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [8] +-------------------------------------------------------------------------------- + + Brian, I wanted to follow up the data center side that Blayne just asked about and get a little more color about the acceleration on the cloud side and the deceleration on the enterprise side. Could you give any more color on why you think those were at the extremes and why do you think they normalize going forward, that would be helpful. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [9] +-------------------------------------------------------------------------------- + + I don't want to say that they're going to "normalize" and that they're going to -- there's not going to be a major shift. The trend of -- look, enterprise is going to continue to decline. We estimate, and again, this is just based on what we get from our customers, talking to the industry, it's going to be in a high single-digit decline. I think you'll see quarters like Q2 that was 11%. You'll see quarters like Q1 that were 3% or 4%. We've seen quarters higher than the 11% over the last couple of years. So it's going to be lumpy as we see this shift, but the overall macro shift of enterprise to cloud or traditional on-prem systems to cloud is going to continue. I think we'll also see -- we still, again, talking to our partners, thinking that mid-20s for cloud growth. But I think we'll see quarters like this quarter that was a little bit high. Other quarters we've had in the past have been more in line. So I don't think we're talking about something going normalizing. I'd say it's still going to stay relatively lumpy like this. But if you look at it over the long haul, even if you look at the first half of the year, 11% down this quarter, 3% down last quarter, you take a look at that as on average and you get to that high single-digit number. So I still feel like that's going to be roughly about where it goes down. And then the cloud will continue to grow at that rate plus additional as more of the growth goes into the cloud. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + The only thing I'd add Brian is the supply-demand and balance of SSDs in the quarter, we believe, had an impact on the enterprise sector. And as that supply-demand and balance kind of normals out, we think that will help. But all that being said, the trends Brian highlighted is still kind of how we see the workloads playing out over time. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [11] +-------------------------------------------------------------------------------- + + That's very helpful. I guess for my follow-up, if I could shift gears over to the margin side of things and specifically the fall-through. It was great to see that you guys beat your OpEx guidance for the second quarter. As we think about the full year with revenues going up, why isn't gross margin changing at all? And then the OpEx increase ex Mobileye, is that just the variable comp that comes in with bonuses, et cetera? Or is there something else in that roughly $150 million increase to your spending line? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes, just on the second one first. The short answer is yes. The combination of the incremental growth and the addition of Mobileye are the primary drivers for the slightly higher spend. I would -- your initial comment on flow-through, to put it into context, from where we were in January, our full year outlook, the revenue is up roughly $1.8 billion. And with that $1.8 billion, there'll be roughly $200 million of costs, primarily Mobileye. So in context, we feel like we're managing the cost and spending side of the business effectively as we position to a 30% spending of revenue by 2020 at the latest. In terms of the gross margin dynamics, I think the trends that you've seen over the last couple of quarters we expect to continue through the year. And it's really ASP improvements, good unit cost performance, volume leverage to the fab kind of working in our favor. And on the flip side, the strong growth of the memory and the modem business and the ramp cost for 10-nanometer are partial offsets. Those dynamics are what has driven the strong gross margins in the 63% range in the first half. And we expect those same dynamics to play out in the second half as well. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [14] +-------------------------------------------------------------------------------- + + Brian, for my first one. My question is on the competitive landscape and the data center. There's been a lot of discussion about AMD perhaps posing more competition than it has in the last several years. And I appreciate it's early days and you have a very strong product out. But are you hearing about them more in your customer conversations? Is that a more real threat than it has been in the past? Because they did have an event, they did show up with 10-plus potential customers. And some of the benchmark data, they are showing some performance that is perhaps better at a lower price. So how real is that competition and how are you reacting to it? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [15] +-------------------------------------------------------------------------------- + + Sure, Vivek. So I think in general we see competition across almost every one of our platforms, whether it be in the data center or in the client business. And it's come from a variety of sources. You're right, AMD has kind of raised up a bit with their more recent products, but you see us responding. This is a traditional performance battle that we're very accustomed to and we're comfortable in reacting and competing very aggressively in. And so you see us coming out with our Xeon Scalable. You'll see us make maneuvers like we accelerate our Core i9 products, which are all the way up to 18-thread systems on the client-based products. So I'd tell you that, yes, we're seeing increased competitive pressure from a variety of places. But that actually will just drive us even harder, make us better in the end. And we're comfortable that we can make the right products to deliver the right performance against those. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [16] +-------------------------------------------------------------------------------- + + And as my follow-up, Brian, if could you give us a little bit more color on your 10-nanometer progress. What is the timing of products around that node? And as part of that if Bob could remind us how the CapEx and depreciation and OpEx for that node are flowing through the financials? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [17] +-------------------------------------------------------------------------------- + + Sure. So on 10 nanometers, we are sampling engineering samples to customers currently. We -- the yields on 10 nanometers are continuing to improve pretty much right in line with the forecasted ramp rates. It's a new technology, so you always have some problems to go solve, but we're pretty comfortable with where we're at right now. Like we said in the earnings script, we are set to qualify the first production products right at -- right towards the end of the year. You'll see those start to ship in the first half of next year, and you'll see a ramp of SKUs. One of the things we're seeing is each one of these technologies -- and actually products that we generate, we're generating quite a few more SKUs, Vivek. And so you'll see a variety of SKUs progressing through to 2018 as we ramp the 10-nanometer products, starting with, I'll call it, more simpler SKUs at the beginning, going all the way through the high-performance, high-complexity SKUs towards the middle and back half of the year, which is -- it's a traditional ramp like you see us push out on a new product ramp. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + And then just in terms of the capital, yes, just as a reminder, our full year outlook for CapEx is roughly $12 billion. We did indicate that approximately $2.5 billion of that would be for memory. So underlying that, you have $9.5 billion CapEx for the logic business. For 10 nanometer, specifically, you have TD lines and pilot lines going in this year and beginning to scale, as we match the capacity with the production that scales in the first half and second half of next year. So that's reflected in the CapEx guide and the depreciation guide that we gave you earlier in the year, and that hasn't really changed. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + I had a question on the trajectory of data center growth into the second half. And to be honest, I'm still wondering why you don't think you can do better than high-single digits. I mean, I know you're calling out the tough comp in Q3, but it's only like 10%, right, which is roughly in line with the full year guidance. It's below kind of the longer-term CAGR. So you're going to seek no comps at that level or higher kind of in the perpetuity. I guess, why call that out as an excuse? And what are the issues in terms of hoping and driving for a bigger lift in the second half versus what you're still currently guiding for with the Skylake SP launch on its way? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + So I think Stacy, first, we're quite proud of the growth rate we're seeing and especially the growth rates in the growth segments. We're forecasting mid-20s for the cloud business, the networking and storage business and adjacencies on down. What we're having to counter is not only the comps that Bob talked about but the declining function of the enterprise, right? And so that -- those 2 things counter those growth rates. Now as the enterprise continues to shrink, it'll become less and less moving forward. So we agree that over time this will become a smaller and smaller impact to the growth rates. But right now it's still a large enough percentage. It weighs on our ability to get the growth rate higher. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + And I would -- if I sounded like I was giving an excuse, I maybe should correct that. We feel great about where we are. First half, up 7%. Full year, up high single digits. Profit expanded during the course of the year and continuing to win in those segment of the market that have differentiated growth rates. So 6 months into the year, we feel good about where we are, and we're excited about the new product that we launched. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + Got it. So my follow-up. On the PC side of things, I know you said that the channel's healthy, but you -- it's sound like you also had channel fill in the quarter, and it's also included in the guide going forward. So I guess if the channel's healthy, why is there inventory filling up? And what does that imply as we kind of get to the year and look into next year for the likely trajectory of your product sales into that market? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes, I think as we look at kind of the quarter performance -- I should start with kind of the TAM overall, and Brian highlighted this in the prepared remarks. We have assumed that PC TAM will continue to decline in the mid-single digits for the full year. On the margin, that might be a little bit better today than what it was 6 months ago. But we're still -- we're not counting on a dramatic change in the PC TAM consumption for the year. That being said, we've taken up our guidance quite a bit. So in that, there's a stronger Q2 performance with a little bit of more healthy inventory channels as we go into the second half of the year. So I wouldn't -- if they were -- if the inventory was maybe a little bit leaner over the last 3 to 4 quarters, I think we'd characterize them in the healthy level now. And we think the ecosystem is building for a second half that's consistent with our outlook for PC TAM. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + And it needs to build inventory to do that? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + Say it again? + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Any it needs to build inventory to do that? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + I think the inventory levels as we see it in the channel is slightly higher than the lean levels they've been for the last couple of quarters, but no dramatic difference from our perspective on how we see PC TAM for the full year. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [30] +-------------------------------------------------------------------------------- + + Brian, I apologize if I missed this in your prepared comments. My first question is just around pricing in DCG. It was down about 1% sequentially. There's always a lot of mixed things there. You usually have some commentary about ASPs per bucket. Were they still strong? And I guess more importantly, as you think about the product launches in the back half of the year, at least some of our initial checks are suggesting that customers are kind of chomping at the bit to high -- to buy higher up into the stack, which could drive some good ASPs. Can you talk about your expectations around ASPs and/or attach rates for adjacency data center businesses with the launch of the Xeon Scalable? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Sure, John. So we expect the second half of 2017, from an ASP perspective, to be pretty much what you've seen in the past where ASPs continue to increase on the various platforms of Xeon, right? So looking at each one, you'll see ASPs overall increasing. What you're seeing on this is a little bit of mix, right? So as you saw networking and storage grow at 17%, the adjacencies at 12%, those are starting to become a little bit more percentage of that business, and those draw down overall ASPs a little bit. But if you look within just the Xeon core function, those ASPs continue to decline -- to increase at about the normal rates that you'd expect as we move into -- especially as you move into a new architectural like Xeon Scalable. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [32] +-------------------------------------------------------------------------------- + + That's helpful. And for my follow-on, just turning to the client compute group. Your ability to sort of segment that market and drive higher mix has been sort of a multiyear endeavor with a lot of success. What inning do you think you guys are in, in that process, especially with AMD coming to market with new product? Is there still a mix -- a potential story here? And what would drive that? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [33] +-------------------------------------------------------------------------------- + + I actually think there is. I think if you take a look at this, John, what's driven this has not been clever segmentation necessarily. It's been the ability to segment into specific markets and specific performance. And so things like Core i9 are a good example, where you're really targeting performance. And so what you -- what I believe is that what -- the growth areas in the client space gaming, virtual reality, thin and light, they're requiring performance and power. And remember, those are always somewhat tradable as you take a look at the -- and so those trends are going to continue. And that's why -- that's -- as we talk about how do you feel about competition, where do you see competition playing, we believe our leadership in performance will continue to allow that trend to continue and continuing to allow the trend within CCG to continue as well. And that's part of what drove the forecast for the second half. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Romit Shah from Nomura Securities. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [35] +-------------------------------------------------------------------------------- + + It looks like this is the fifth consecutive quarter that CCG beat expectations. Revenues were up 12%. And I think there's a debate out there as to whether or not you deserve credit for this performance, with skeptics really pointing toward -- to sustainability more than anything else. When you break down that 12%, as you guys mentioned, ASPs are a big part of the increase. My question is as you look at sort of the mix in that business overall is there room to drive ASPs higher and effectively capture more value inside of the PC TAM? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + So yes, is the simple answer, Romit. Remember, this isn't necessarily us raising prices. So it's not we're out there and going and saying, "Okay, I'm going to charge $10 more for the next Core i7." It's actually the percentage of units that are being bought at those higher units. And we continue to deliver higher performance at the same price with each one of these generations. So what you're seeing is actually an overall trend that, yes, units are down. We talked about that, both [Brian] and Bob, around TAM being down somewhere in that low- to mid-single-digit range. And that's pretty much in line with what I'm seeing third parties. Sure, some third parties are a little bit better than that. But for the most part, we're within a couple of percent. But yes, we believe that there is room for continued demand for movement upwards. So if you a numbers of Core i7s, a number of Core i9, the number of people buying the performance thin and light laptops, those are going to continue. And you see it in our OEM partners and the type of systems they're producing and the type of systems they're bringing to market. Now they're targeting that more and more as well. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + The only thing I would add is, again, we have a business that has a declining market. It's growing not by raising prices but, to Brian's point, by a market that increasingly values performance. And the operating margins of the business for the first half of the year were up over 50%. So this team through its segmentation is executing extremely well. And then as we mentioned earlier, yes, with that great margin performance, we are redeploying our resources to invest in these data-centric set of businesses that have high-growth characteristics that collectively were up 16% again in the quarter. And through this journey of a PC TAM decline, we have a bigger business, a stronger business and a more profitable business, with an increasing portion, over 40%, coming from high-growth-oriented businesses. So great performance in a declining market, continuing to invest in it and reallocate across our portfolio and feel good about our -- the portfolio we have and with the addition of Mobileye as we head into the second half of the year. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [38] +-------------------------------------------------------------------------------- + + And in terms like -- you obviously provide ASPs for CCG. But is the core mix as a percentage of units a metric that we should be focusing on? And I -- if I remember correctly, that percentage was close to 70%. I'm curious where it is today. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [39] +-------------------------------------------------------------------------------- + + Yes, it's continuing to climb. It is, but don't forget even within that core mix, Romit, you have the ability to continue to scale up, so Core i3 versus Core i5 versus Core i7. And now we've introduce the Core i9, right, which is even a higher performance. So we saw earlier on people choosing Core over Pentium or Atom, for example, and you saw the core mix move up. You're now seeing not only that continue to climb, but you're going to see within Core the amount of Core i7s, Core i9s, Core i5s continue to climb as well. And that's why we continue to see that there's legs behind this. And you kind of said, hey, are we getting credit for this, right? We don't think when you look at overall this business, last year's performance with great growth in all of the segments, you look at this year's performance so far in the first half and our projections now in the second half, we think that our ability to segment, to drive better operating margin and to continue to drive performance into the PC and keep it more and more profitable while we invest and grow these other businesses, we think that there's an option around Intel that is quite good. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + And our last question comes from Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + In DCG, you guys are probably full throttle from a manufacturing perspective for Xeon Scalable, or Skylake, in the June quarter. But my question is how much of the data center growth in June was the initial production revenue shipments of Xeon Scalable to your customers? Or did that contribute just very little to the June quarter mix? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [42] +-------------------------------------------------------------------------------- + + Okay. Yes. It's very little. We don't give out exact percentages by SKU like that. But I can genuinely tell you that it is really just the beginning of the ramp of the Xeon Scalable. And so its impact into Q2 was minimal at best. What you'll see is as it ramps into the second half it becomes a higher and higher percentage. And really, the big volume is going to be 2018. So that's when it really takes over from way -- the way the data center looks from a revenue and profit standpoint. What we're excited about is -- we talked about the 500,000 units that are out there. That was the highest number of pre-samples. That shows you the demand by the big infrastructure guys around the performance. They were willing to take the product even before, "We are ready to start shipping it." And then the number of records we've broken already in performance, we talked about 50 records worldwide already, those are laying the groundwork for how this ramp is going to look and feel as we move into the second half and into '18. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [43] +-------------------------------------------------------------------------------- + + And good to see the profitability in the NAND segment. In enterprise SSD, I think you guys are still the #2 global market share leader there. And it looks like based on the first half performance you guys are outpacing the market. So I guess the question is, where's the team winning? Is it high capacity? Is it high performance for these enterprise and cloud drives? And similar to maybe some of your peers, is the team currently capacity constrained? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [44] +-------------------------------------------------------------------------------- + + Sure. So our whole strategy around the memory is that we are focused on differentiation and performance and specifically around supporting the data center. We do sell into client as well, but that's not the main focus of this business. And so I tell you that's -- when we talk about our growth and when we talk about our projections for the rest of this year and why we're investing in the future, that 64-tier NAND gives us the ability to be a better cost but at the high-performance end. So we're not going after commodity SSDs that you're going to see even in higher-end workstations necessarily. It's really focused towards the data center products. Even still, there's -- not all SSDs and data centers are high-end performance. So we're comfortable with where we are in the market share. We want to balance those investments against the demand for these high-performance areas and make sure we stay -- we keep that in balance. And our real goal is then to move more and more of the business towards the 3D XPoint as we move into next year because that really differentiates us again as we really change the hierarchy between memory and storage as the data center DIMM memory systems come out. + +-------------------------------------------------------------------------------- +Mark Henninger, - [45] +-------------------------------------------------------------------------------- + + Thanks, Harlan. All right. Thank you all for joining us today. Crystal, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2017-Oct-26-INTC.txt b/Transcripts/INTC/2017-Oct-26-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..6dfcef725185a04acb2429a0eac8b0340f5f8592 --- /dev/null +++ b/Transcripts/INTC/2017-Oct-26-INTC.txt @@ -0,0 +1,426 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Intel Corp Earnings Call +OCTOBER 26, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian M. Krzanich + Intel Corporation - CEO & Director + * Mark Henninger + - + * Robert H. Swan + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Canaccord Genuity Limited, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Q3 2017 Intel Corporation Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to Mark Henninger, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Mark Henninger, - [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's Third Quarter 2017 Earnings Conference Call. By now, you should have received a copy of our earnings release and the CFO earnings presentation, which replaces the CFO commentary that we provided in the past. If you've not received both documents, they're available on our Investor website, intc.com. The CFO earnings presentation is also available in the webcast window for those joining us online. +I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by the Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO commentary and earnings release, available on intc.com, include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. The third quarter exceeded our expectations with revenue of $16.1 billion, which was $400 million better than our outlook. Operating income of $5.6 billion was more than $700 million better than our outlook. Our data-centric businesses grew 15% year-over-year, reaching 45% of our revenue, proving that Intel is becoming a data-centric company. +The fiscal discipline that Bob and I have talked about is delivering results even faster than we had forecasted, while simultaneously allowing us to focus more on innovation in our key growth segments. +Revenue grew 2%, or 6% after adjusting for the McAfee transaction. Operating income grew 8%, and earnings per share grew 26%, both reaching all-time records. Added all together, and this was a remarkable quarter in what is shaping up to be a remarkable year. +Our strategy is to be the driving force of the data revolution across technologies and industries. Our data-centric businesses are the company's growth engine. Individually, these businesses provide great value to our customers. Collectively, they're solving our customers' problems in a way that no individual business or product could. +We've built a collection of capabilities that is unmatched. At the same time, our PC business remains central to our success. It's a source of great profit, cash flow, scale and intellectual property. We've made great progress in both our data-centric and PC-centric businesses over the last few months, and I'll share a few important milestones that illustrate that progress. +I'm going to start with CCG, which produced exceptional results despite a declining PC TAM. PC market conditions continued to improve, and we achieved record Core i5 plus Core i7 client mix. Our focus on an annual beat rate of innovation and thoughtful segmentation, combined with an investment strategy designed to produce results even in a declining market, is paying off. We're especially excited about the launch of our latest Eighth Generation Core processor, codenamed Coffee Lake. +The Coffee Lake family includes our first 6-core desktop CPU. And it's our best gaming processor to date, with up to 50% better performance than the competition on top-game titles. We're on track to ship our first low-volume 10-nanometer part by the end of the year. That will be followed by the initial ramp in the first half of 2018, with both high volume and system availability in the second half of 2018. We shipped our first modem into the auto industry, and our modem revenue was up 37% in total over last year. +Moving on to our data-centric businesses, DCG revenue grew 7% in Q3 and remains on track for high single-digit growth for the year. We saw strong cloud growth outgrew the comm service provider in market. And while the enterprise decline moderated sequentially, we still see workloads moving to the cloud. Cloud and comm service provider revenue combined is nearly 60% of DCG revenue now. +In less than 3 months, we've had more than 200 Xeon Scalable OEM systems begin production shipments. And our customers across all of our segments are beginning deployments that will continue to ramp in Q4 and through 2018. +In our Internet of Things business, revenue was up 23% with strengths across the retail, industrial and video segments. We also continue to build momentum in the vehicle infotainment market, winning designs from our competitors at leading automakers. +Earlier in the quarter, we closed the Mobileye transaction, a full 4 months ahead of schedule. So far this year, Mobileye has won 14 ADAS designs across 14 automakers, a pace well ahead of the 12 wins they recorded all of last year. These designs provide for typical features like automated emergency braking, lane keeping and adaptive cruise control, but several also include next step functionality like highway autonomous driving. +We're also winning marquee designs for Level 3 and higher levels of autonomy, including our strategic partnership with BMW and Fiat Chrysler. +Most recently, we announced that Waymo's newest vehicles, the self-driving Chrysler Pacifica hybrid minivans, feature Intel-based technologies for sensor processing, general compute and connectivity. With 3 million miles of real-world driving, Waymo cars with Intel technology inside have already processed more self-driving car miles than any other autonomous fleet on the U.S. roads. +Intel and Mobileye provide the auto industry with unmatched product breadth, the architectural flexibility to support open and closed implementations and technology leadership. Our progress in just a few short months illustrates the benefits of our combination. And together, we can deliver the promise of autonomous driving and a safer collision-free future. +Let's move on now to memory and FPGAs. Our memory business grew 37% over last year. And operating margin improved significantly as Fab 68, our Dalian factory, continued to beat both its ramp rate and yield goal. Fab 68 accounted for more than half of our supply in the quarter, where more than 70% of the total bits were 3D NAND. Our memory innovation and technology leadership is having an impact. We shipped the industry's first 64-layer data center SSDs and have a strong Optane design win pipeline. That leadership technology has also resulted in strong customer interest in long-term supply agreements, and we've already signed 2 such agreements. Bob will share more about our approach, but this is an important step that will mitigate the short-term cash flow impacts of ramping our memory capacity. +And finally in our FPGA business, revenue was up 10% over last year with growth in the data center, embedded and automotive segments, where we're ramping designs like the Level 3 autonomous 2018 Audi A8 and DENSO's stereo vision system. Strength in these segments was partially offset by continued weakness in comms infrastructure. +Our design win revenue value was up more than 10% in the third quarter, its highest level in more than 3 years. This business is essential to our success in artificial intelligence. In Q3, Microsoft announced that it would use our 14-nanometer Stratix 10 FPGAs for its accelerated deep learning platform that's codenamed Project Brainwave. And as part of a broadening engagement between our companies, Alibaba is using Intel FPGAs to power the acceleration of the service of Alibaba Cloud. +We made tremendous progress in AI and advanced computing technologies over the last few months. In addition to our FPGAs and autonomous driving wins, we launched the Movidius Myriad X, the world's first vision processing unit with a dedicated Neural Compute Engine to deliver artificial intelligence capabilities to the edge in a low-power, high-performance package. +We also achieved new research milestones, as Intel scientists pursue exciting, emerging forms of compute. We delivered a 17-qubit superconducting test chip for quantum computing to our research partner, QuTech, and we'll follow that up with a 49-qubit test chip by the end of the year. We also unveiled the Loihi, a self-learning test chip that mimics the brain's basic mechanics and makes machine learning faster and more efficient. Later this quarter, we'll ship the Nervana neural network processor, the industry's first commercially available processor of its kind. I also announced last week that Facebook is working in close collaboration with us, sharing their technical insights as we bring this new generation of AI hardware to market. +Together, these accomplishments reinforce several things for me. First, Intel is the leader in AI inference from the core of the data center to autonomous vehicles, out to the edge devices where low power is especially critical. Second, artificial intelligence takes many forms and will require computing solutions that are tailored for the workload, the environment and the user, rather than a one-size-fits-all. And third, our investments and pipeline of innovation position us to lead for years to come. +We had a quarter any CEO would be proud of. And I'd like to take a moment to remember our former CEO and my friend, Paul Otellini. Paul had an enormous impact on the industry and this company, and his Intel family will miss him. He would be proud of our growing momentum, and it's an important part of his legacy. +Wrapping things up, I'm excited about both our progress and our prospects. And we're competing aggressively for our $260 billion TAM, the largest opportunity in our history with lots of room to grow market segment share. In some of our segments, we're facing new or resurging competitors. In other segments, we are the new competitor. But in all cases, competition brings out the very best in our company, as our third quarter results demonstrates. +We're now well ahead of our commitments we made to you in January. Our transformation is accelerating. And we're raising our full year expectations for revenue by $700 million and for operating profit by $900 million, our third consecutive increase this year. This puts us solidly on track to deliver the best year in the company's history for the second year in a row. And with that great news, I'd like to hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good afternoon. This was an excellent quarter for Intel. Versus the expectations we set out at the beginning of the quarter, our revenue is better, our gross margins were stronger and our spending was lower. As Brian said, we're on track for another record in 2017. +Revenue in the quarter was $16.1 billion, up 6% year-over-year, excluding McAfee, and we achieved record earnings. Operating income was $5.6 billion, up 8% year-over-year. And EPS was $1.01, up 26% year-over-year. +From a capital allocation perspective, we closed the Mobileye transaction and funded a significant portion of the purchase price through the sale of noncore assets, including reducing our position in ASML and proceeds from the partial exit at McAfee. Additionally, we signed long-term NAND supply agreements providing more than $2 billion in prepayments through 2018, significantly improving free cash flow for our memory business. We generated $6.3 billion in cash flow from operations, and we returned $2.4 billion to shareholders. +At our Analyst Day in February, we talked about our strategy to transform from a PC-centric company to a data-centric company. Our Q3 results demonstrated continued momentum in our transformation. Intel's data-centric businesses, those outside of the PC segment, grew 15% year-over-year and now represent 45% of our revenue, up from approximately 30% in 2012. This collection of businesses is well positioned to capitalize on industry trends, create great value for our customers and represents the company's growth engine going forward. +Our PC-centric business generated flat revenue in the quarter and improved operating margin by over 3 points. The CCG team continues to execute extremely well in a declining PC TAM environment. Our focus on performance-leading products and a smart segmentation strategy is working. This business provides scale, funds IP and generates a significant portion of the company's profits and cash flows. +Moving to earnings. We generated significant EPS expansion in the quarter, up 26% year-on-year. Our EPS improvement was driven by solid platform execution, strong growth from our adjacent products and businesses and lower spending, resulting in $408 million growth in operating income. Additionally, we continued to monetize some of our ICAP Portfolio position, resulting in a gain of $0.13 per share. +We made a commitment at the beginning of the year to reduce spending to 30% of revenue by 2020 at the latest, while continuing to invest in key growth areas and capabilities. We are making great progress. Total spending was down 6% year-over-year in the third quarter. We've continued investments in our key priorities, including driving Moore's Law forward, artificial intelligence and autonomous driving. +At the same time, we're executing with operational discipline and generating significant leverage from higher revenue growth. Our R&D spending as a percent of revenue was flat, and our SG&A costs were down 3 points as we rationalize our marketing and sales programs and generate significant leverage in our G&A functions. +In addition, we made changes to our co-marketing programs to provide more flexibility and efficiency to our customers. These changes resulted in a reduction in revenue of approximately $200 million during the quarter, reducing year-over-year growth in CCG by approximately 2 points and DCG by just over 0.5 point, with a corresponding reduction in spending. These changes collectively have no impact on operating income. The impact of these changes will continue into Q4 at a slightly increased level. +On a full year basis, we expect direct spending to be approximately 33%, 1 point better than our prior guidance and down over 2 full points from last year. +Let me touch briefly on our segment performance on Slide 5. The Client Computing Group had another outstanding quarter. Revenue of $8.9 billion was flat year-over-year and operating margins grew by 3 points. Flat revenue was driven by client ASPs up 7%, unit volume down 7% and our adjacency business up 15%, partially offset by the changes to our co-marketing program. +We saw a typical Q3 inventory build ahead of the holiday season, and we believe the worldwide PC supply chain is operating at healthy levels. This segment had another quarter of significant profit growth with operating income growing 8% from strong core mix, continued improvement in 14-nanometer unit cost and lower spending. +The Data Center Group had revenue of $4.9 billion, up 7% year-over-year. And operating income of $2.3 billion grew 7%. Q3 operating margin was 46%. As Brian mentioned earlier, we had strong growth in both the comms and cloud service providers segments, which are nearly 60% of our DCG revenue. +Overall unit volume was up 4%, ASPs were up 2% and adjacencies grew 16%. We launched Purley in Q3, and in less than 3 months, we've had more than 200 OEM systems begin production shipments. +Revenue scale from leadership products and spending leverage and efficiency drove strong operating income growth for the business. We expect DCG to meet our full year expectations of high single-digit growth and operating margin percent in the low 40s. +The IoT, NSG and PSG business segments are becoming a larger component of our overall business, growing 25% year-over-year. Our Internet of Things business achieved record revenue of $849 million, up 23% year-over-year, driven by strength in industrial and video and continued momentum in our retail business. Operating profit was $146 million, down 24% year-over-year from continued investments in the automotive segment. +We closed the Mobileye transaction early August, 4 months sooner than we expected. The Mobileye team executed extremely well in the third quarter and exceeded our expectations with $82 million in revenue and $39 million in operating income. Going forward, results for the Mobileye acquisition will be included in our all other segment. Increases in spending in this segment will correspond with reductions in the IoTG segment as we realize cost synergies from this acquisition. +Our memory business had record revenue of $891 million, up 37% year-over-year, with strong demand from data center SSD solutions and demand signals outpacing supply. This segment had an operating loss of $52 million, an improvement of $82 million versus last year. Our memory fab in Dalian continues to make great progress. Yields continue to improve and unit costs are well ahead of expectations. The core NAND business continues to be profitable, and we expect the memory business as a whole to be profitable in 2018, both ahead of our prior estimates. +The Programmable Solutions Group had revenue of $469 million, up 10% year-over-year, driven by strength in advanced products, data center, automotive and military. Operating profit was $113 million, up 45% year-over-year. We're making good progress in realizing cost synergies with the integration of this business. +Moving to Slide 8. Our cash position of $17.5 billion at September 30 is basically unchanged from the beginning of the year, but we've had lots of moving pieces during the year. First, we have generated $7.2 billion in free cash flow year-to-date. And we've returned $7.4 billion to shareholders through the form of dividends of $3.8 billion and share repurchases of $3.6 billion, including $1.3 billion and $1.1 billion, respectively, in the quarter. +Second, as we mentioned earlier, we closed Mobileye in the third quarter for $14.5 billion in cash and funded over 50% of the purchase price from the sale of noncore assets during the year, including McAfee and the sale of ASML shares. +Earlier in the year, we received $924 million from the sale of 51% stake in McAfee. And in the quarter, McAfee re- +(technical difficulty) +notes of $2.2 billion and issued a dividend of $735 million. +Third, we expect to generate $1.5 billion to $2 billion more free cash flow versus where we were at the beginning of the year. The additional free cash flow is driven by higher earnings, lower CapEx, customer prepayments on supply agreements, partially offset by increases to working capital associated with stronger growth and NSG and modem momentum. +Based on these factors, we're raising our full year revenue guidance by $700 million to $62 billion, operating income guidance by $900 million to $18.8 billion; and EPS guidance by $0.25 to $3.25 per share. The improvement in revenue outlook is primarily driven by higher expectations of the PC business and continued momentum in memory. +The improvement in operating margin is primarily driven by our increased revenue outlook and lower spending. The increase in EPS is driven by higher expectations of revenue, coupled with gains on the sale of our equity investments. +And on Slide 11 as we look to the fourth quarter of 2017, we are forecasting the midpoint of the revenue range at $16.3 billion, up 3% year-over-year, excluding McAfee. We expect operating income of $5.2 billion, with gross margins flat year-over-year and spending as a percentage of revenue to be down approximately 2 points. We expect EPS at $0.86 driven by operating margin expansion and higher revenue. +2017 is shaping up to be a record year for Intel. We feel great about where we are 9 months into our 3-year transformation. Since January, we have raised our revenue outlook by $2.5 billion, our operating income by $1.7 billion and our EPS by $0.45. +At the same time, we are investing to compete and win in an expanded market. Our PC-centric team continues to operate very well in a down market. And our data-centric businesses are up double digits collectively, as we continue to transform the company to power the cloud and smart connected devices. With that, let me turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Henninger, - [5] +-------------------------------------------------------------------------------- + + Okay. Thank you, Brian and Bob. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from Ross Seymore with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [2] +-------------------------------------------------------------------------------- + + BK, a longer-term one for you. You rattled off a number of AI advancements that Intel is having, whether it be on the Nervana side or the Stratix side. Can you talk a little bit about the competitive environment in there? You mentioned that it's not going to be one size fit all -- fits all. But if you could give a little bit of how Intel does have an advantage versus some of the early movers in that space? And then perhaps more importantly, when will we, externally as investors, be able to start to see the financial benefits of these new products? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure, Ross. So let's talk about this. We can kind of break this down. So first, we are already seeing the benefits of AI in that number -- as I said, we lead in inference, which is the actual application of artificial intelligence, and we're continuing to really grow in that space. I think AI, if you take look at, in general, machine learning, it's the smallest segment or workload, if you look at the data center, but the fastest growing. So you're going to see it continue to become a bigger and bigger portion of our business. You're seeing the effects in our numbers already around Xeon, Xeon Scalable, the FPGAs. We talked about Microsoft Brainwave's launch that's occurring. So those products, you're going to see, I'll call those more of our traditional products. And also at the lower end outside the data center, things like Movidius and now Mobileye, you're seeing those hit our P&L as well real-time now as we speak. The other products like Nervana, you'll start to see really more towards the back end probably of 2018 from a P&L perspective. If you take a look at Nervana, it actually -- we get our first silicon out. It will be handed out as test silicons. We have a yearly cadence of products. And so I expect the first instantiations to be more people, figuring out how to use it. It won't be a big impact. But as we go through next year and move on beyond that and get the second generation and beyond, that will grow, we believe, quite considerably. And then products like Loihi, which is our neuromorphic, are same thing. That part we put out so far is really a chip for people to begin to use and learn how to program with neuromorphic, which is a very different type of machine learning. It lets you learn at hundreds of times faster rate than traditional, I'll say, GPUs and CPUs, especially around visual learning. Those as well, you'll start to see next -- late next year and beyond, as people really begin to learn how to program with these. So seeing it already and those newer products, I really think late '18 and beyond before they really start to hit P&Ls. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [4] +-------------------------------------------------------------------------------- + + Great. And then the follow-up question I had was actually for Bob, and it's on the OpEx side. And congrats on the great operating leverage in the quarter. As we think about the way you can get that operating leverage in the past, Intel seems to have focused mainly on keeping the OpEx relatively flat, and then revenue growth driving that leverage. But in the quarter and then the guide that you just delivered, it looks like OpEx is down about 6% year-over-year. Conceptually, as we go into the next couple of years, how do you think investors should think about the balance of delivering that cadence up to the 30% mark that you're looking for over the next couple of years? Is it more revenue growth? Or you are you indeed going to be cutting the absolute level of OpEx? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [5] +-------------------------------------------------------------------------------- + + Yes, Ross, great question. First, as you mentioned, we had great progress in the third quarter. We kind of started the year at a spending level which was a little over 35% of revenue. And we came into 2017 saying that we would get that down to roughly 34%. Reflected in our guidance is it will be closer to 33%. So we're delivering well ahead of our expectations, which have been a function of the 2 things you highlighted: one, much stronger growth; and two, lower spending levels. And those lower spending levels from the first half of this year to the second half are a function of continuing to look at every dollar that we spend, whether it's R&D, whether it sales and marketing, or whether it's G&A and making sure that those dollars are allocated towards the biggest growth opportunities. And we're not to redeploy that capital or to get it out of the ecosystem. So our first half to second half spend levels will be down roughly $700 million on a business that will be roughly $2.5 billion bigger in the second half versus the first half. So we're making great progress and making real trade-offs on our spending levels and getting the benefit of stronger growth. And we expect the combination of those 2 to continue as we go forward. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question is from Stacy Rasgon with Bernstein. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [7] +-------------------------------------------------------------------------------- + + First, I wanted to ask a little bit about the revenue drivers, revenue upside for the year and I guess margin up for 3 quarters. But it continues to look to be the same trend, almost entirely from PC and memory. In the meantime, I mean this is, in your words, your biggest server refresh in a decade, and we're not seeing any upside. We're doing 7% year-over-year pretty much for the full year, which I guess I would classify as barely high single digit. We're not really seeing meaningful ASP increases from mix as Purley. I was wondering if you could just kind of give us a view on, I guess, your expectations for data center, where it's coming in, why we're not seeing more upside from the Purley ramp versus what we've seen from prior platform introductions, and whether or not 7% actually would qualify as high single digits by your definition. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [8] +-------------------------------------------------------------------------------- + + So I'll start and Bob can jump in, Stacy. First, because you've kind of got a couple of questions in there, the way I would tell you is that the Purley ramp has just really started. It starts with the big comm service providers. You saw Google talk about it a couple of weeks ago. You saw Microsoft talk about it earlier this week. Those ramps are just beginning. I talked about the 200 design wins or design-ins at customers. Those are starting to come out. So we are really early. These ramps, remember because we have to -- it will go through the cloud service providers and then the Tier 2 cloud service provider, then on into comms and eventually into enterprise as well. This is going to be -- take a year or more. So it's -- I think it's early to make this judgment. The ramp's right within the range we predicted it to be from a ramp of that product. Your second part of your question is 7% high single digits. I will just make it simple and say, look, if you look, mathematically, I think it would meet a minima of high single digits, but it's certainly not necessarily where we're targeting to get to, but it's a high single-digit number. I'm not going to -- the math doesn't lie. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + Just to maybe add a little bit, I think the first part of your question, overall growth for the year relative to the expectations back in January, revenue will be up $2.5 billion. Obviously, PC is a significant part of that. Memory is growing faster. IoT is growing faster. PSG and data center -- PSG faster in the second half versus the first half, and DCG in line with our full year outlook at the beginning of the year to be high single digits. So real good strength on clients, on memory, on IoT and in line with the other businesses. The other thing I would just offer to -- follow up on Brian's commentary on DCG growth -- maybe 2 things. One, we started out at 6% in Q1. We were at 9% in Q2. We're at 7% in Q3 off a real tough comp last year of double-digit growth in the third quarter. So I would say from a top line perspective, we're right in line with kind of the guide that we gave at the end of the year. And secondly and as importantly, our operating margins has continued to grow significantly quarter-on-quarter through the course of the year, with 46% operating margins in the third quarter. And we told you early on despite a relatively slow start, we expect that operating margin for DCG to be above 40% for the year, and we're well on track to hit that important metric as well. So 9 months through the year, a great start to the year for us, and DCG in line with our expectations and building momentum as we exit the year. + +-------------------------------------------------------------------------------- +Mark Henninger, - [10] +-------------------------------------------------------------------------------- + + Did you have a follow-up, Stacy? + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + I do. I want to ask about gross margins really quick. So revenue was up 0.6%. I guess, year-over-year, excluding McAfee. Gross margins are down like 90 bps year-over-year. I was wondering -- I was hoping you could give us some color on the drivers of that shift. And in particular, how should we think about the trajectory exiting the year into 2018, puts and takes on gross margins as we go into next year and given what we've seen this year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes. On your first part, we laid out for the year 63% gross margins, and we're pretty much in line with that throughout the first -- in the first 9 months. And our outlook for Q4 is another 63%. So in line with kind of full year outlook, which is in the high end of our historical guide range. So we feel pretty good about where we are. And for the dynamics underneath the covers, the trends have been very consistent, volume leverage with good scale going through the fabs. ASPs modestly better, much better in the first half on easier comps, slightly better in the second half on tougher comps. Unit costs continues to come down. The ramp costs associated with 10-nanometer are lower. And offsetting those, you really have 3 things going on. One, we have a high growth in our adjacent businesses, memory and modem, that weigh on -- that are a big contributor to improved earnings, but they weigh on our gross margin. Secondly, we have higher engineering samples in the -- as we go into the fourth quarter. And third, the co-marketing change that we -- that I mentioned in the prepared remarks, Stacy, that has no impact in operating income, but a modest impact on gross margin, but offset by lower spending levels. So you take those all into account, and they have delivered solid Q3 dynamics, solid Q4 outlook. And the one change between Q3 and Q4 is primarily attributable to the mix of the higher growth adjacency businesses. Those trends and those dynamics, we'll talk much more about 2018 in January, but those trends have been fairly consistent for the last 4 quarters. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [14] +-------------------------------------------------------------------------------- + + Bob, I just wanted to go back to some of the comments you made. In DCG, op margin was up a ton. It's actually above your kind of full year. So just kind of curious where those cuts came from. And then as you look forward, I know you're not going to forecast for next year. But is there any reason why the spending will go up and down from here? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes. The first half gross margin -- I should say operating margins were lower, second half much stronger. Fundamentally, it's less about cuts, to be honest with you. It's more about continuing to grow the top line, continuing to get ASP improvements or compensated for the performance that we're delivering; modestly -- and modestly lower unit costs. So the combination of those 3 are getting really good leverage and allow us to expand operating margins while we continue to invest in obviously Xeon, but also in artificial intelligence. So that's what's driven the kind of first half to second half dynamics. And as I indicated, we kind of started out the year saying that we were highly confident we'd be above 40 for the year. And that's kind of how it's played out during the course of the year. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [16] +-------------------------------------------------------------------------------- + + Great. And then I wanted to go back to a question on AI and inference. Brian, I was wondering if you just comment on today -- I think you said it was small. Just curious, out of the cloud spend, how much is inference today? And when you look at future workloads driving server units, where could that be in a couple of years? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [17] +-------------------------------------------------------------------------------- + + Sure. We don't separate out inference. So we -- what we said is simply in the past publicly that AI is -- one of the smallest workloads, but one of the fastest growing. We haven't broken out. We don't -- beyond just saying there's -- here's what cloud is growing at and here's what comms and here's what enterprises, we don't break out by workloads. And there's a variety of reasons for that. Part of it is it's sometimes hard. The mixture of what -- when somebody goes out and build a rack, what is it going into, how much of its workload is really being used by AI is -- anybody who tells you exactly what that number is, is just wrong, to be honest with you. So it's hard for us to say with precision, x percent of our units went into AI workloads, because it's rare that a rack is purely AI except for in rare cases. But we know that's it's small, despite the type of interactions we have, but also fast growing and one of the biggest areas of interest. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question is from John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [19] +-------------------------------------------------------------------------------- + + Bob, maybe I can just ask Blayne's DCG op margin question a little bit differently. In the calendar third quarter, you actually I think had revenue up about $500 million sequentially in that business roughly, and operating profits grew by about $600 million sequentially. Can you just help us understand what drove that dynamic? Where there any onetimes? And just given how strong the operating margin is, I know you've reaffirmed for the full year. But is the Q3 level the new sort of norm we should start basing operating profit off of? Or was there something specific in Q3 that drove the op margin leverage above 100% sequentially? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + No onetimers. It's in one sense, John, it's no real surprises for us. We anticipated growing throughout the year. We anticipated higher ASPs, i.e., sequentially ASPs being a little bit stronger, and that would drive incremental operating income. And some of the benefits, just a lower overall G&A spending for the company is benefiting all the different P&Ls that G&A is actually lower. So that's what's really been driving the improvement sequentially. And as you can tell from our full year guide, there'll be more of the same in Q4 relative to Q3. And then we'll, in terms of implications going forward, we got a great business. We've redefined the role we play in the data center business to be a not high 90% share player, but a 30% share player with lots of room to grow. And we expect that to be a continued important source of growth, both top and bottom line for the company. The specifics around that, we'll talk more about it in January. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [21] +-------------------------------------------------------------------------------- + + That's helpful. Maybe for my follow-up for Brian, Brian, I know this is not a big part of your growth strategy going forward. But as you mentioned in your prepared comments, CCG is still very important to scale advantages, to profitability, to free cash flow, to your ability to invest in growth markets. And that's been a business that's been sort of remarkably stable over the last 4 or 5 quarters. It's grown over the last couple of years, in part because we've had relatively easy compares in the PC market. So I'm kind of curious as you think about this business over the next, call it 4 to 8 quarters, how are you guys thinking about the corporate upgrade cycle or refresh cycle on PCs, the consumer refresh cycle, the gaming market, and I guess importantly, the modem business, which is becoming a bigger and bigger part of this business over time? Do you think you can still keep this business sort of on a flat growth trajectory? Or how are you thinking about it? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [22] +-------------------------------------------------------------------------------- + + Sure. So you've captured that quite well, right? Let's just talk about there -- we can talk about it from a unit standpoint and then we can talk about it from how has our business done. From a unit standpoint, the decline has certainly slowed down, right? We -- if you go back a year or 2 ago, we were high single digits to low teens declines at times year-over-year from a unit basis. And that slowed into the low single digits that we're seeing today, but we still are seeing a decline on a unit level. And I always remind people, we've taken probably something like 25% of the annual units out of this business, yet grown in that time frame the profitability of that business significantly. So that I think just talks about both the great execution in products and segmentation strategy and just the leadership that, that team, at first with Navin Shenoy and now with Greg Bryant, have really delivered to the company. So our view is, John, that if you take a long-term view, we see the pattern kind of stabilizing at about where it is. I think we'll come in here, and there'll be quarters when the units are up slightly, and there'll be quarters when the units are down a little more slightly. But when we looked at it over the long haul, they're probably going to be down, those low single digits. But we also see segments that are growing that are very performance-focused, which allow us opportunities. So you talked about gaming, 2-in-1 devices, thin and light, the Ultrabook, as we like to think about it from the old. Those products are continuing to see growth actually. And they are pushing that record Core i5, i7. They're pushing the desire for Core i9, which is a new product that we introduced, right? Those are what's driving the segmentation, the ASP uplift and the increased profitability. We think to some level, that trend will continue. How long, I -- I'm not going to be that good of a prognosticator, but certainly for the near-term future, we don't see this trend shifting very much. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [23] +-------------------------------------------------------------------------------- + + And then Brian, just on the modem side, in your prepared comments, I think you said it was up 37% year-over-year. What's the sustainability of that business and your ability to kind of continue to grow that business through penetration? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + Yes. I'm excited about the modem business. We -- we've I think really gotten a team together that is world-class. We believe we now are on a yearly cadence of world-class modems, which is really critical. That's a big hurdle to get that technology to where you can reliably put out a yearly cadence, a world-class modem. We believe we're there now. We continue to increase the profitability or the efficiency of that organization, which we've always talked about in the past, and that's continued. So we think we can continue to both drive the technology and continue to grow that business. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question is from Romit Shah with Nomura. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [26] +-------------------------------------------------------------------------------- + + Great EPS growth. I -- Bob, I think some of us who are more on the optimistic side definitely see a path to $4 of EPS, which makes look -- makes Intel look compelling. I think some of the pushback, though, has been among value investors who look at free cash flow. In this year for example, even with the equity gains, it looks like free cash flow is tracking down. So I know that this is an investment year, but how should people be thinking about free cash flow growth relative to EPS growth next year and maybe even 2019 as well? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes, the -- first in 2017, people ought to be thinking about free cash flow growth being $1.5 billion to $2 billion higher than what we -- what was primarily reflected in our guidance. Because we're saying that our current forecast is -- will be much better than kind of where we started the year. And that improvement is really a function of 3 things: one, earnings growth, more operating earnings growth as opposed to the ICAP gains, but real solid operating earnings growth; secondly, we reduced our CapEx outlook for the year from $12 billion to $11.5 billion this year; and third, we -- the long-term agreements that we signed in the year. One of the benefits on what we're trying to do is really match our net capital deployed in memory in conjunction with demand from strategic clients and partners, which has the effect of reducing the impact of the memory capital intensity on the free cash flows of the business that makes sense for our customers and makes sense for us. So we'll continue to look for those opportunities. The biggest gap between our earnings performance and our free cash flow performance has been the higher capital associated with growth, number one, but in particular, memory. And we're really looking for opportunities to reduce our net capital deployed into memory, which in turn will grow free cash flow over time, just closer and closer to our EPS growth. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [28] +-------------------------------------------------------------------------------- + + And I guess along those lines, Brian, can you just give us an update on how you're thinking about CapEx at these levels and going forward? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [29] +-------------------------------------------------------------------------------- + + Sure. What -- I think in our statements and in the release, we showed you that we actually lowered CapEx to -- by about $500 million for this year. We've talked about CapEx and thinking about it kind of being in this range. I don't think we have anything else to say about it. It's pretty close. Right now, we're just focused on the execution into Q4 and prepping for our views into 2018. So I don't want to have any other discussion on CapEx until we get to the January time frame right now for 2018. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is from Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + On the ASP trend in DCG was up 2% year-over-year, but it can be skewed by mix. So if we look at the 4 subsegments, cloud, comm service provider, enterprise, adjacencies, if you just look at those buckets as a silo as you ramp Skylake, did ASPs move higher in all of those subsegments? I'm just trying to get a sense for how broad-based the value capture was. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Yes, I would just, without giving you all the specifics of ASPs by segment, I would just say the biggest driver of ASP improvement is really incremental performance. So as we continue to transition -- we're still transitioning Haswell to Broadwell, which all else equal, there is positive ASP implications as we transition to Xeon Scalable and deliver higher performance. That growing mix of higher performance products is the single biggest contributor to ASP. We're still in the early days, as Brian mentioned in Xeon Scalable, but that is a higher performance product. And we would expect that will share in the benefits of high performance for our clients with higher ASPs, but that's the biggest dynamic. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [33] +-------------------------------------------------------------------------------- + + Great. And the team has talked about accelerating the server road maps to be more closely aligned with the cadence of manufacturing technology migrations, I believe starting with the 10-nanometer nodes. Can you guys just give us an update there? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + Yes, think of it, so first, absolutely, you're right that we are going to move much more of our focus towards data center products coming first. It's not going to be the early part of the 10-nanometer, though. It just -- you got to look at the design cycles. And you make a decision like that, even you make it last year. You'll start to see the effect of the back end of 10-nanometers, and you'll really see it affect, 7-nanometers. So not these early products on 10, no. They were already in the hopper when we made that move. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our last question comes from Matthew Ramsay with Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - MD [36] +-------------------------------------------------------------------------------- + + Bob, I wouldn't -- I wanted to ask a little bit about G&A leverage. You talked about in the script and in some of the Q&A here, some changes to the co-marketing programs and the like going forward in both the PC and the data center business. Is there any way you could maybe bound for us the size of those and their contributions to what the run rate has been of overall OpEx, and what kind of opportunities there are potentially to further restructure those going forward? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + Yes, just on the co-marketing program in particular, this is really what we're trying to do is retain the value of the Intel Inside brand, but also to be more flexible and to kind of align our spending in conjunction with our customers -- more tailored programs by customer to drive more efficient demand. That's the intent of what we're trying to accomplish. And we're pretty excited about the change. The quantification of that strategy, in essence in the third quarter, was roughly $200 million that, in essence, shifted from spending to contra revenue. So no impact on operating income dollars, but roughly $200 million lower revenue, $200 million lower spending. And we expect that to be modestly higher as we go into the fourth quarter. So again, more effective and efficient way to spend our marketing dollars in conjunction with tailoring programs for -- with the OEMs. That drives a change in the geography of how those dollars were reflected in our P&L, but doesn't really impact our operating income. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - MD [38] +-------------------------------------------------------------------------------- + + That's really helpful. And then as a follow-up, Brian, in automotive space, I think you mentioned 14 ADAS wins from Mobileye versus 12 of all last year. And that's sort of in the ADAS space, and you have some of your competitors making quite bold announcements about wins towards autonomous driving programs long term. Maybe you could talk about how commitments are being made in ADAS versus autonomous, and then how the acquisition that you've seen so far of Mobileye has maybe pulled some of your computing assets into these conversations for longer term with autonomous? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [39] +-------------------------------------------------------------------------------- + + Sure. That's a great question. So we kind of mentioned that even out of those 14, many of those continue on up into Level 3, Level 4. The Level 5 work that you see out there is pretty far out there. And I'll tell you that's -- there's a lot of just kind of experimental work going on there. If I take a look at though kind of a bigger picture, which is what you're asking is, this whole picture that we've been putting together is, I kind of said in the statement that, individually, these businesses are great. But when you pull these together into one package and you're able to walk into a customer with a complete solution, they're truly world-class and something nobody else can deliver. So you're right, when we go into and we talk to somebody about autonomous driving in general, whether it's Level 2 plus, Level 3, Level 4, Level 5, we bring with us a suite of products, depending on what kind of architecture. And they're -- what we're seeing is different OEMs, different customers thinking about those architectures even differently across that spectrum. Some are thinking, "Well, by Level 5, I think my skills will be up. I want a closed system. I want to have much more of the control of the software." So we have a set of solutions we bring to them there. Some of them want to have more FPGAs for how they bring their software down onto the silicon earlier on. But what we're able to do is bring our modems. We shipped -- and we mentioned it in the release that -- our first automotive modem. So we're able to bring automotive modems all the way through 5G. Most of these car companies are having to build data centers. And not just data centers, centralized data centers, but really a data center kind of architecture that goes all the way out with data and compute at the edge. You're going to want to be able to manipulate and transfer mapping, high-precision mapping to the cars and data back from the cars to change those maps, construction and things like that. So we're building that architecture. And we have the products and the talent to uniquely work with them all through that infrastructure. And then you get out to the car again and we can bring the FPGA, the Mobileye for center fusion or compute. We can put Xeons in there. And so we -- in each one of these discussions, they're all a bit different. They all have multiple phases as you go to 3, 4 and 5 on the levels. And what we're able to do is say you don't just have to take this one solution. This is not the only solution there is. What would you like to do? What best solves your problem in the most cost-effective lower -- lowest power efficient way? How much work do you want us to do in software development versus how much work do you want to own and have IP within your company? And that's changing, as we said, over time. And that's part of also why we're building out that 100-car fleet. Amnon has really has driven a vision that says it's one thing to bring foils to a meeting. It's another thing to bring a car and say now let's go out and drive, and show you how all of these fit together. And so all of that is -- this package that we have is unique, and it's resonating quite well as we walk into the various car OEMs. And I'm out there with them in various modes almost every week, every other week. Amnon's out. We're all talking about a complete package. + +-------------------------------------------------------------------------------- +Mark Henninger, - [40] +-------------------------------------------------------------------------------- + + Thanks, Brian. Thanks, Matt. And thank you all for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Ladies and gentlemen. Thank you for participating in today's conference. You may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2018-Apr-26-INTC.txt b/Transcripts/INTC/2018-Apr-26-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..1440a19418c31b737f841421f631ba00300faeb4 --- /dev/null +++ b/Transcripts/INTC/2018-Apr-26-INTC.txt @@ -0,0 +1,364 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Intel Corp Earnings Call +APRIL 26, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian M. Krzanich + Intel Corporation - CEO & Director + * Robert H. Swan + Intel Corporation - Executive VP & CFO + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen, and welcome to the Intel Corporation First Quarter 2018 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference may be recorded. +I would now like to turn the conference over to Mr. Mark Henninger, Head of Investor Relations. Sir, you may begin. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- +Thank you, operator. And welcome, everyone, to Intel's first quarter 2018 earnings conference call. By now, you should have received a copy of our earnings release and the CFO earnings presentation that goes along with it. If you've not received both documents, they're available on our investor website, intc.com. +The CFO earnings presentation is also available on the webcast window for those joining us online. +I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thanks, Mark. Coming off a record 2017, 2018 is off to an exceptionally strong start. Q1 was Intel's best first quarter ever and significantly exceeded the expectations we set in January. Our Client Computing Group continue to execute well, producing growth within a declining PC market. And our transformation to a data-centric company accelerated with our data-centric businesses, booting McAfee up 25% over the first quarter of last year. +The strength of Intel's business underscores my confidence in our strategy. What we're seeing is an unrelenting demand for compute performance driven by the continuing growth of data and the need to process, analyze, store and share that data. That dynamic benefits our traditional CPU business and it reinforces the big bets we've made in memory, modems, FPGAs and autonomous vehicles. We're competing to win in our largest collection of addressable markets ever. And importantly, we're not just competing in these markets. We're leading and shaping them as our first quarter results demonstrate. +Data Center Group revenue was up 24% year-over-year. We saw broad-based demand strength across all DCG segments in Q1. And customer preference for high performance products, including Xeon Scalable drove a richer ASP mix. +The cloud segment grew 45%. And in the comm service provider segment, we continue to take share and grew revenue 33% as customers chose IA-based solutions to virtualize and transform their networks as the industry prepares for the 5G transition. +Intel's presence at the Winter Olympics in Pyongyang was a powerful showcase of our 5G capability. Intel and KT deployed the world's largest 5G network to date, including more than 20 5G links delivering 3,800 terabytes of network capacity. We've established leadership in 5G. And when commercial networks begin deploying around 2019, we'll be there with industry-leading products from the core of the data center to the edge to mobile devices. +And we also saw growth in our enterprise segments for the second consecutive quarter as macro strength continued and customers prioritized hybrid and on-premises infrastructure investments. Data center customers are also looking to FPGAs for workload acceleration. The Programmable Solutions Group again set a record for design win volume, and those design wins are translating directly into revenue. +PSG's business grew 17% in Q1 on data center and embedded strength along with last time buys. PSG's data center segment was up 150% over last year, and the Advanced products category, our 28-, 20- and 14-nanometer solutions grew more than 40%. +Microsoft also recently announced that they're using Intel's FPGAs to power new Bing intelligent search features using real-time AI. PSG's momentum is evidence that our 2016 acquisition of Altera is delivering value for our customers and contributing directly to Intel's growth. +Our IoTG business grew 17% on record unit volume with continuing momentum in the retail and video segment as compute increasingly moves to the edge. Consistent with our commitment to be disciplined with our resources, we made the decision to divest Wind River and sharpen the focus of IoTG on other growth opportunities that more closely align to our strategy. +The memory business set a revenue record, growing 20% in the first quarter, crossing over the $1 billion mark in revenue. The last business that passed that mark was DCG, crossing over that mark over a decade ago. +Both yields and output in our Dalian factory continue to ramp ahead of schedule. In fact, we believe the Dalian Fab extension is one of the fastest brownfield of wafer starts projects in memory industry history. +We also launched our first mainstream Optane SSDs for clients, known as the 800 series, driving further industry adoption of this revolutionary technology. The NSG remains on track to be profitable for the full year. +And we continue to demonstrate momentum in autonomous driving, and I'm happy to report that the Intel Mobileye autonomous vehicle test fleet has begun to operate in Israel and will expand to other geographies in the coming months. Our fleet fully implements the Responsible Sensitive Safety system or RSS that we introduced last year. This unique system applies a formal, common sense safety field to the vehicle's decision making, resulting in the optimal combination of provable safety and humanlike driving style. We believe that the winning path to autonomous driving will be a progression from ADAS capabilities to full autonomous driving. And we're seeing significant momentum in the marketplace, including a recent high-volume design win for EyeQ5 with a European premium vehicle manufacturer. +And finally, the Client Computing Group extended its strong track record of execution in a challenging PC environment. The revenue was up 3% despite a declining PC TAM on strength in the commercial and enthusiast segments, leading to a strong core mix. The CCG launched its first ever i9 processors for laptops in the first quarter, again demonstrating our outright product leadership. +We continue to make progress on our 10-nanometer process. We are shipping in low volume and yields are improving, so the rate of improvement is slower than we anticipated. As a result, volume production is moving from the second half of 2018 into 2019. We understand the yield issues and have defined improvements for them, but they will take time to implement and qualify. We have leadership products on the road map that continue to take advantage of 14-nanometer with Whiskey Lake for Client and Cascade Lake for the data center coming later this year. +Moore's Law is essential to our strategy and our product leadership. It continues to create significant value for Intel and our customers. While it's taking longer and costing more to deliver and yield advanced process technologies, we are able to optimize our process and products within a node to deliver meaningful performance improvements. For example, 14-nanometer process optimizations and architectural improvements have resulted in performance gains of more than 70% since the first 14-nanometer products were launched. We combined these advances in manufacturing technology and architecture that produced truly a leadership product, and it's that product leadership that ultimately matters most to our customers and end users. +Intel and the industry stepped up for a tough challenge as we responded to the security vulnerabilities known as Spectre and Meltdown. I'm pleased with our progress and proud of how Intel and industry partners address this issue collaboratively, with transparency and with customer-first urgency. We're delivering against our security-first pledge and we've now rolled out micro code-based mitigation for all Intel products launched over the last 9 years that require protection against Spectre and Meltdown. +We'll also begin delivering both client and data center products with the hardware-based mitigations later this year. +With our Data centric transformation accelerating, we're raising our expectations for our full year results, yet more evidence that our strategy is working. As Intel marks its 50th anniversary, we're well positioned to be the end-to-end platform provider for the new data world and the leader in artificial intelligence and the autonomous revolution. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Brian. Q1 was truly an outstanding start to 2018. Our transformation to a data-centric company continues to build momentum. Revenue was a first quarter record of $16.1 billion, up 13% year-over-year. Operating income was $4.8 billion, up 21% year-over-year. And EPS of $0.87 was up 32% year-over-year. +From a capital allocation perspective, we generated $6.3 billion of cash flow from operations and returned $3.3 billion to shareholders in the form of buybacks and dividend. As a result of the strength we are seeing in the business, we are raising our full year revenue guide by $2.5 billion to $67.5 billion. We're raising our EPS guide by $0.30 to $3.85. And we're raising our free cash flow guide by $1.5 billion to $14.5 billion. +Our Q1 results demonstrated continued momentum in our transformation from a PC-centric company to a data-centric company. Intel's data-centric businesses were up 25% collectively with each business individually growing double digits. Our data-centric businesses are now approaching 50% of our revenue, an all-time high. +Our PC-centric business was up 3% on strength in notebook, desktop and modem. DCG strong cash flows fund Intel's investment in new data-centric growth. +As a reminder, we adopted a new revenue recognition standard in Q1. The new standard drove $462 million in incremental Q1 revenue recognition. This predominantly affected CCG and NSG. By year-end, we expect roughly half of this to net out. +Moving to Q1 earnings. We generated significant EPS expansion in the quarter, up 32% year-on-year. Our non-GAAP EPS improvement was driven by strong top line growth, a 3-point improvement in operating margins and an 11-point reduction in our effective tax rate. The 3-point improvement in operating margins were driven by a 4-point reduction in spending, partially offset by a 1 point decline in gross margin. The 1 point decline in gross margin was driven by growth in our adjacencies, which have lower gross margins than our CPU products. +From a spending standpoint, versus last year, we delivered $1.3 billion more revenue on $200 million less spending. +As a second reminder, we adopted a new mark-to-market standard for our equity investments. In 2017, all realized gains and losses were recorded in our non-GAAP results. But in 2018, all mark-to-market adjustments flow through earnings. In an effort to eliminate volatility, we have excluded these adjustments from our non-GAAP results. Our Q1 GAAP EPS included approximately $0.13 for mark-to-market gains in our ICAP portfolio that were excluded from our non-GAAP results. +We are also making excellent progress in our operating efficiencies. In January, we pulled in our 30% spending goal from 2020 to 2019, and we're off to a good start in 2018. Total spending was down 4% year-over-year in the quarter. R&D spending as a percentage of revenue was down approximately 2 points. And our SG&A costs were down over 2 points. Our intensity on spending is designed to accelerate top line growth, and it is paying off. Currently, as a result of strong top line growth, we now expect to meet our 30% spending target in 2018, 2 years ahead of our original expectations. +Let me touch briefly on our Q1 performance by segment. The Data Center Group delivered a great quarter, much better than expected. DCG revenue of $5.2 billion was up 24% year-over-year, and operating income of $2.6 billion grew 75%. Q1 operating margin was 50%. Overall, unit volume was up 16%, and ASPs were up 7%. +We saw broad-based demand strength in Q1 with customer preference for high-performance products driving richer ASPs. Cloud and comms service providers segments were greater than 60% of the data center business. And this was the first quarter our cloud business has surpassed $2 billion in revenue, which made it our largest segment in the first quarter. +Additionally, we redefined our expanded TAM for DCG to markets beyond the CPU, like silicon photonics, Fabric, network ASICs and 3D XPoint memory. These adjacent businesses are gaining traction and grew 16% year-over-year. DCG performance in all segments was better than our January forecast, and we expect that strength to continue to aid DCG momentum through the second quarter. +Our additional data-centric businesses, IoTG, NSG and PSG, are becoming a larger component of our overall business, growing 18% year-over-year in the quarter. Our Internet of Things business achieved revenue of $840 million, growing 17% year-over-year, driven by strength in video and continued momentum in retail. Operating profit was $227 million, up 116% year-over-year on higher revenue and lower spending as we shifted our ADAS investments to Mobileye. +As you heard from Brian, the Mobileye business is going strong. Q1 revenue was $151 million. And while it's early in the journey, we are on track to our deal thesis. +Our memory business broke the $1 billion in quarterly revenue for the first time, up 20% year-over-year with strong demand for data center SSD solutions. +We reduced our operating losses by $48 million with strong gigabyte demand and unit cost reductions more than offsetting ASP reductions. +The transition to 64 3D NAND is improving our cost while we invest in and expand our Dalian factory. We expect the second half of '18 to be balanced between supply and demand, and we continue to expect this segment to be profitable for the full year of 2018. +The Programmable Solutions Group had revenue of $498 million with 17% growth, driven by strength in data center and the embedded segments. Operating profit was $97 million, up 5% year-over-year. The PSG team continues to perform and execute well. Our advanced FPGA products, those at 28-, 20- and 14-nanometer, grew over 40% in the quarter. In fact, PSG won more customer designs in Q1 than in any prior quarter. +Finally, the Client Computing Group had another strong quarter. Revenues of $8.2 billion were up 3%, and operating margins were down 4 points due to 10-nanometer transition cost and growth in our modem business. +Our PC-centric business continues to perform well in a challenging but improving market and serves as a significant source of cash flow for the company. We saw strength in the commercial and gaming businesses, and we believe the worldwide PC supply chain is operating at healthy levels. +We've laid out our capital allocation priorities: invest organically, expand acquisitively and return capital to our shareholders, and do it wisely. We continue to execute to these priorities. We generated $6.3 billion in cash from operations. This included $1.7 billion in cash received from NAND customer supply agreement. We invested $2.9 billion in CapEx and delivered $3.4 billion in free cash flow, up 73% year-over-year. We returned almost 100% of free cash flow to our shareholders in the form of $1.9 billion in buybacks and $1.4 billion in dividends, a 10% increase per share over last year. +Now moving to our full year outlook. Our strategy is working, and our investments are paying off. We are now forecasting the midpoint of the revenue range at $67.5 billion, up $2.5 billion versus our expectations in January. We expect operating margin of approximately 31%, up 1 point from January as spending as a percent of revenue drops to approximately 30%. +Versus prior estimates, gross margin will be approximately flat as broad-based strength in our business is offset by the higher cost associated with the 10-nanometer volume production shift to 2019. +We now expect a full year tax rate of 13%, 1 point down versus our prior estimate. Overall, stronger top line growth, improved operating margins and a lower tax rate will boost EPS to $3.85, up $0.30 versus prior estimate. From a cash flow perspective, we are increasing our free cash flow to $14.5 billion, up $1.5 billion from January. We now expect net capital deployed of approximately $12.5 billion, up $500 million versus the expectations we set in January. This reflects gross CapEx of approximately $14.5 billion offset by approximately $2 billion of customer prepayments for memory supply agreement. +In Q2, we expect strong growth to continue. We are forecasting the midpoint of the revenue range at $16.3 billion, up 10% year-over-year. We expect operating margin of approximately 30%, up 1 point versus last year, which reflects approximately 1.5 point decrease in gross margin and a 2.5 to 3-point decline in spending. +We expect EPS of $0.85, up 31% excluding equity adjustments from strong top line growth, spending reductions and a lower tax rate. +To sum it up, we believe 2018 will be another record year for Intel. We've met and exceeded our financial commitments, and we feel great about where we are relative to our 3-year plan. Our PC-centric team keeps winning in a challenging market, and our data-centric businesses are growing fast, fueling Intel's transformation to a company that powers the cloud in smart connected devices. +With that, let me turn it over to Mark, and we'll get to your questions. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [5] +-------------------------------------------------------------------------------- +All right. Thank you, Brian and Bob. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +And the first question will come from the line of Ross Seymore with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [2] +-------------------------------------------------------------------------------- +Brian, one for you about the sustainability of this demand, specifically in the data center side. I think people are pretty aware that the macroeconomic drivers are all kind of going the right way and that's helping the enterprise side of things. But the acceleration of the cloud and the comm side for the last 2 quarters is beating your own expectations for growth rates and been quite strong. How much of that do believe is Intel specific? And if you can go to the reasons why? Or is the macro side really the bigger driver in those 2 vectors as well? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Sure, Ross. That's a good question. Let me try and answer it. So first thing I'll tell you is that there is a bit here that is the transition to cloud continues to occur, occurring at a bit even faster rate so that -- you do see that trend is going on. But remember, we've always talked about that over the long haul, you have to look at these, it can sometimes be lumpy. So our forecast for the long term is still in that high teens, low 20s kind of range for that kind of growth. We thought that we -- the enterprise is clearly up. We think that -- as you said that a lot of that is reinvigoration of investments by companies in on-site data. Our view of long term there, I look out over the long term again, it's still -- that should be in a declining mode versus moving those workloads long term over to the cloud. So if I take a look at this, as Bob said in his prepared remarks, so we look at -- if I look at our data-centric businesses in general, so even just beyond the data center, we see these growing in that mid- to high teens range. And that's kind of how we view this. And we do believe that is sustainable. And it will move from cloud to enterprise. And sometimes, you'll see IoT pick up a bit, offset something, but that's why we grouped those into that data centric. But they're all really tied together. It's data coming from the edge, moving through the network into the data center and really being based in the cloud and analytics being applied to it and people using that data then to make decisions to drive businesses. So we think it's sustainable in kind of the data-centric numbers that you saw. But it will float between those various segments. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +The only thing, Ross, that I would add is in terms of our outlook in the more near term, our outlook for the year is kind of continued strength in the second quarter similar to the first quarter. And -- but beyond that, it's probably a little cloudier. I think we are benefiting from global macroeconomic environment. I think the higher earning is -- higher earnings and the ability to deduct IT related expenditures, I think is giving CIOs a little more money to spend. And we see ourselves benefiting from that through the first half of the year. +Second half is going to be a little bit of a wait and see as to whether the short-term dynamics continue into the second half. But you go back to Brian's comments, I think the -- what we do know is the -- this increased demand for compute data, analytics, storage, rapid retrieval is what's really driving the demand for high performance compute. And not only do we see the unit volume strength but also the ASP strength, which we think is a function of Intel-related products. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [5] +-------------------------------------------------------------------------------- +That's very helpful. For my follow-up question, one for either of you, frankly. In the 10-nanometer pushout, do you believe that the competitive lead you have versus your competition is shrinking? Or is this a challenge everybody's going to have? And then the gross margin side of that equation, Bob, you said it was going to be a headwind into the full year guide. Any sort of linearity about when that starts to move from being a headwind to a tailwind would be great. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- +Sure, Ross. So let me start -- we absolutely have product and process leadership. We're shipping 10-nanometer products today. So I did want to make sure that, that was very clear to you and that was our densest, highest performing product out there. We're slowing the ramp down as we go and fix the yields, and we were able to do that. A, we understand the yield issues. They're really tied to this being the last technology tied to not having EUV and the amount of multi-patterning and the effects of that or defects. But also, the real strengths of 14-nanometers, I mentioned in my prepared remarks that we've done 70% improvements in the performance of that technology over its current life time. And we believe it continues to have lags that we can continue to make improvement, both within that process technology and architecturally. That's really giving us the breathing room to go and make these yield improvements. So it's really balancing between delivering the world's best product. So we believe our road map for 2018 is strong and stronger than it's ever been. And we have the ability to carry that into 2019, allowing us to get the yields where we want them to be. So the cost and the spending are really in line with what you as a shareholder expect from us. We believe that if you take a look at others during this time frame, if you look at anybody else and said 70% improvement on a technology note, yes, let me rename those nodes as we go through this. And we have always chosen to be really transparent and clean and just say, it's improvements on the existing technology rather than renaming. So we believe we have that. Now as we look at -- out in time, we do see the density. You just take that component, the density gap is narrowing a bit. But that's out in time. But again, performance is really a function of multiple parts of the process around power and performance and in architecture. And that's why we think our products continue to lead and be the world standard. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- +And on the gross margin question, the strong -- both volume and ASP performance in the first quarter contributed to gross margins being 2 points ahead of kind of our expectations at the beginning of the year. So we saw that real good performance on top line flowing through in the first quarter. What we indicated for the full year, though, there's no change in our full year gross margin. That essentially is a function of continued volume and ASP strength but partially offset by yields that are improving, but not quite at the rate that we had anticipated on 10-nanometer. +And secondly, our cost associated with -- we expected, at the end of the year, that we'll have pre-PRQ reserves that will be a little bit higher as we shift into 2019. So strong first quarter, strong for the full year, but those 10-nanometer costs will be a little bit of a drag. We step back, we still look at kind of gross margins for the full year that are at the high end of kind of our historical range in the 60% to 65% range, which is good. And for us, that's despite the fact that we're getting really solid growth from our lower margin, but earnings-accretive businesses like modem and memory. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +The next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [9] +-------------------------------------------------------------------------------- +I wanted to follow-up on that 10-nanometer point. So as the volume production pushes out into 2019, given you understand the yield issue supposedly, is this a first half kind of push out? Or does it push out into the second half? And when it actually does ramp, do you think it actually will be the current 10-nanometer process that's shipping? Or will that be like slipping out to like 10, 10 nanometers plus potentially? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- +So I'm just going to correct you. You said that supposedly, we have the solutions. We do understand these things. So we do have confidence that we can go and work these issues, Stacy. Right now, as I said, we are shipping. We're going to start that ramp as soon as we think the yields are in line. So as I said, 2019. We didn't say first or second half, although we'll do it as quickly as we can based on the yield. And the last part of your question about whether -- will it be a 10 or a 10++ or a 10-plus, I think, was your question, these -- the yield improvements that we're making are just that, more focused on yield. So think of them as improvements to the various etch steps and lithography steps and cleans and things like that in order to really drive the multi-patterning and in some cases, the multi multi-patterning where we have 4, 5, 6 layers of patterning to produce a feature. It's really about that. They aren't necessarily around performance. We do have plans on 10-nanometer all ready similar to 14-nanometer, for 10-plus and 10++. And so we think all of these technologies now have multiple years of performance improvement built into them as they come off the floor. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- +For my follow up, I wanted to ask about gross margin drivers and free cash flow drivers into 2019. We have CapEx pretty significantly outpacing depreciation at the moment. You'll have that 10-nanometer ramp kind of starting. Memory and modems probably going to be growing. And then on the free cash flow side, we've got the reversal potentially of the NAND prepayments eventually as you start shipping the NAND that you've been paid for. So how do we think about the drivers, gross margin puts and takes around those elements and maybe others as we get into -- as we go through -- get into 2019? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- +First, I'm not -- probably not throw a whole lot in 2019 as we focus on trying to execute what we believe will be an outstanding 2018. But I think there's a few dynamics that we've been wrestling with. As you know, over the last couple of years we've seen a gap between earnings and cash flow, and it's really been driven by a couple of things. One, success and by that, I mean, accelerating rates of growth and the additional capital that goes along with that growth, both CapEx and inventory levels. So those have been one of the drivers. Secondly, we brought on 10-nanometer equipment but haven't necessarily put it to use yet. So that's a cash driver without an impact on earnings. And third, memory is in the investment phase. So those 3 things have really been what's been driving the gap, and we've done a few things in light of that, that you're aware of. One, memory, we engage in the strategic supply agreements that you mentioned, which really for us is a sign that our customers are excited and committed to the technologies that we're building such that we can help -- we can use their money to help fund the scaling of the business. And we think that's a good, positive short, medium and long-term move. And the other thing, just if you think about, Stacy, kind of how we guided this year, you have earnings -- if you don't give us credit for the ICAP gains last year and strip that out, you see earnings growth that's roughly 25%, 26% and you see free cash flow growth that's in the mid-30s. So you'll start to see that gap narrowing as we go through the course of this year. And then the other thing is we're going to make a fairly significant cash tax payment in 2018 as a result of the ICAP gains from last year, and that's roughly $1.2 billion that's going to weigh on our cash flows this year. If you strip that out for a second, what you see during the course of 2018 is roughly 25% earnings growth and roughly 50% free cash flow growth, and that gap begins to narrow while we're accelerating the growth rate of the business. So those are -- that's kind of the dynamics in terms of how we're deploying capital for accelerating top line growth and the improvements on free cash flow relative to earnings per share this year. As we get through the course of 2018, we'll start to shed a little more light on what that means for 2019 later in the year. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +The next question comes from the line of Chris Danely with Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [14] +-------------------------------------------------------------------------------- +I guess another question on the manufacturing. Can you just talk about why the ramp in 10-nanometer, why the yields have been a little bit slower than expected? Have there been any changes in manufacturing? And then also, should we expect this to extend to future generations as well, i.e., a little bit slower than it had been in the past? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [15] +-------------------------------------------------------------------------------- +Sure. So the issues around 10 nanometers, I kind of tried to lay that out without getting too deep into the technology, but this is the last technology with -- that doesn't incorporate EUV. And what you also need to understand is that we took very aggressive goals at 10 nanometers. So if you talk about the scaling factor or think about it as the multiple at which you shrink a feature, okay, we took a target of 2.7. So you took any feature and 1 over 2.7 is the dimensional shrink that you get to this device. For example, on 14 nanometers, we took a target of 2.4. So you're almost 10% more aggressive on 10 nanometers. And if you look at what more is the industry standard, what the foundries and other players are typically doing, they're typically in that 1.5 to 2.0 range. So they're -- we're maybe 20% more aggressive. So we took very aggressive goals to hit our cost targets and where we want the technology to be. And that, combined with end-of-life of emergent scanner before we hit EUV, has just created something that's a little bit more difficult. And so that's why I have the confidence that this is not something we're shipping, that transistors work. We know the performance is in line. So it's really just about getting the defects and the cost in line to where we want. As far as what does that imply for future technologies, we made a lot of changes at 7 nanometers. 7 nanometers currently is the first technology forecasted to implement EUV. So that immediately makes the lithography system different. We're going back to a more standard for us compaction number of 2.4 So that makes it a little bit easy. We think we've bit off a little too much in this case. And it may not seem like a lot, but 10% can make a lot of difference in this kind of the world. And thirdly, we are using some very unique packaging technologies and such that allow us that 7 nanometers and beyond, we really move into a world where you're not going to look at any piece of silicon as being a single node. You're going to use what we're going to call heterogeneous techniques that allow us to use silicon for multiple nodes. So you may use course from 7 nanometers and IP from 14 nanometers and even as far back as 22 nanometers for the parts that don't need the high performance. And we're able to put those together and make them perform and behave like a single piece of silicon in the package. So really, 7 nanometers is quite a bit different, and so I think as a result, we don't expect to see these kinds of impacts on 7 nanometers. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [16] +-------------------------------------------------------------------------------- +Great. For my follow up, I know in the presentation you mentioned that adjacency ramps will be responsible for some of the gross margins being down in Q2. Does that have any impact on gross margin for the rest of the year? Or are you assuming that data center growth is going to slow down in the second half of the year and that's another reason why the gross margin hasn't moved up? Or is it entirely the 10-nanometer issue? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- +No, it's -- maybe all 3. First, we do expect the adjacencies throughout the course of the year to continue to grow faster than the rest of the business, if you will. So that will have a compression kind of effect throughout the course of the year. Secondly, yes, 10-nanometer will be a headwind. And third, for data center growth, while we're kind of expecting strong growth through the first half of the year, the second half of the year implied in our guidance is a deceleration. And if you put it in the context of kind of the updated guide, we have data-centric growth going from mid-teens to higher teens. And you can attribute virtually all of that to DCG because obviously it's the biggest component. But we do expect there to be deceleration for DCG growth from first half to second half for sure. We hope we're wrong, but where we sit right now, we see the trends continuing to Q2. But we'll have tougher comps. We'll have tougher competition going into the second half, and we're going to wait to July to see kind of how we see the trends we've experienced through the first 4 months of the year play out for the second half. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +The next question comes from the line of Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [19] +-------------------------------------------------------------------------------- +Just first question is on CapEx that's been coming up a bit. If you could talk a little bit about the incremental growth in CapEx, what that's associated with. And are there any CapEx effects associated with the changes in the ramp up of 10-nanometer? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- +Yes, the -- just the CapEx that we took up, $0.5 billion is really a function of the incremental $2.5 billion of revenue. So of course, when we came into the year, we guided a logic CapEx of roughly $10.5 billion, and we had full year revenue of $65 billion. So we've taken $65 billion up to 67 50. That's going to require roughly $0.5 billion additional CapEx for the second half of the year and as we go into 2019. So it's the best I've ever felt about a CapEx increase, and it's a result of $2.5 billion more revenue and that the CapEx increase, as we indicated, will generate an additional $1.5 billion of free cash flow as well. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [21] +-------------------------------------------------------------------------------- +All right. Great. And as a follow up, perhaps you can give a bit more color on the expectations on memory as you go through the year. I know you talked about that being profitable and I think consistent with what you said -- what you guys said last quarter. Has there been any changes in your outlook for the year? And if you could talk a little bit about what's framed your expectations as you look through the year for memory. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- +First, no real changes. As Brian mentioned, it's our first $1 billion order in Q1. We feel good about the demand that we're seeing. Demand -- gigabyte demand is relatively strong. Our cost per gigabyte coming out of our Dalian fab continues to trend down. And at the same time, we see ASPs were down a bit. But as we go through the rest of the year, we see demand and supply to be relatively well balanced. We are ramping [mod a] in Dalian. So that is in the early stages of the ramp that's costing a little bit. Continued gigabyte demand, continuing to scale the Dalian fab and continuing to come down the gigabyte -- the cost per gigabyte curve are all contributing to what we believe will be a continued growth and profitability for the business for the full year. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [23] +-------------------------------------------------------------------------------- +And maybe the only thing I'd add to that is as Bob mentioned in his remarks, our 64 Tier product, we -- I still believe gives us really a leading-edge product and also a very good cost relative to the market. So as we ramp that technology in Dalian at 64 Tiers, we believe our costs are very competitive relative to the rest of the market. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +The next question comes from the line of John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [25] +-------------------------------------------------------------------------------- +Brian, I think within DCG, the cloud hyperscale dynamics are kind of well understood by investors. 90 days ago, I think what surprised everybody, probably including yourselves, was just the strength of enterprise in the December quarter. And I think when you reported December, you were reluctant to call that a trend and you wanted to get some more data points. I'm kind of curious as to kind of what the view of enterprise is now 90 days later. And specifically, a couple of your key software partners last year in Microsoft and VMware finally brought out kind of their hybrid cloud software stack solution, and I'm wondering if that's actually been the driver of some of this pent-up demand in the enterprise. And how sustainable do you think it is? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [26] +-------------------------------------------------------------------------------- +Yes, it's a great question, John. What I would tell you is clearly, as we look out into Q2, we're expecting the same kind of positive trend on enterprise for the second quarter. I think as we look at the long term though, that trend that enterprise should decline in that low single digit and it drives and helps fuel the growth of cloud, not all of those are drivers of the growth of cloud, that -- those workloads are moving over to the cloud base continues. I think you're right. Products like Microsoft Azure and others where you can be a hybrid, Azure on-prem versus Azure on cloud, are great examples how, I think, that low single digits is sustainable over the long haul. But I just don't see that trend. Again, I try and look at these businesses not over the quarter or even 1 to 2 quarters, but really thinking about how am I going to invest over the next 2 to 5 years. I got to look at that and say that trend's probably likely to continue. Now for us, you also need to understand that those other segments, so data center, the cloud and like networking and comms, as I look at the Data Center Group are now well over 50% of the revenue of that segment. So we are less and less impacted, I'd say, by the enterprise. If you go back when I started as CEO, enterprise was 60%, 70% of the business. And so we swung wildly by that. It's kind of the other way around now where the cloud and networking and storage are now that 60% to 70% growing to their right and the enterprise is less and less. So the other thing you need to realize, John, is we're more driven by what that cloud is doing anyway. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [27] +-------------------------------------------------------------------------------- +That's helpful. And as my follow up to Bob, just kind of a multipart question on the guide for Q2 and the full year. First, was the 606 impact embedded in the original March quarter guidance? Is that the only quarter where you'll have a 606 impact? Second, is Wind River now out of the Q2 and full year guide, or is that still in it? And kind of how big is that business? And then third, when you look at Q2 specifically, it just looks like the operating income beat seems a lot larger than the EPS beat. Is there anything going on below the line other than the tax rates that you guided to that can explain that? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- +Yes, great question. First, 606, what we expect for the full year, we had a strong benefit in the first quarter and roughly half of that unwinds during the course of the year. So it contribute to growth in Q1. It will unwind itself throughout the course of the year. So full year impact will be likely -- at this stage of the game, we get more around $200 million to $250 million, but it unwinds through the next several quarters. I think your second question, John, was Wind River. Our assumptions are that we will complete the sale of that business at the end of the second quarter. So it's in our second quarter guide, but it's a component of the first half to second half deceleration. The third question, I think it relates to in the first quarter we had good volume, operating margin flow-through to EPS. In the second quarter, the flow-through is not as rich. And the fundamental reason is we have some below-the-line charges associated with, a, the 2039 convertible securities that we have outstanding that have a exchange feature associated with them. And as people, as we hit a certain stock price, our holders can exercise that exchange feature. The implications are there's a noncash charge associated with that, which goes through our interest and other line that's negative. The good aspects of it is all else equal, it reduces our outstanding, our diluted shares and we avoid a coupon going forward. But that will have -- as more people exercise that exchange feature, we'll see that noncash charge below the line. So that's causing a little bit of a drag on the operating income growth flowing through to the EPS in Q2. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +And our next question will come from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [30] +-------------------------------------------------------------------------------- +I actually have a 2-part question on 10-nano. The issues seem to be going on now for some time, and it's almost as if the design libraries or something are flawed. And so I guess the first question is why not skip 10-nanometer and go directly to 7? You guys have a lot of EUV experience and it's going to cut out a lot of the multi-patterning layers. So that's the first question. And number two, the real question is that if you did that, would that be a net drag to gross margin looking out because you never really monetized 10-nanometer? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- +Okay. So let me try and answer your question. So no, there's nothing wrong with the design libraries or anything like that. I mean, the proof of that is that we're shipping products. So if there were basic functionality issues like that, you wouldn't be able to produce and ship a product. Again, as I said, this is all around how many layers are on multi-patterning and kind of the end-of-life of the emergent for the critical later. The second part of your question was would it benefit to just skip to 7 nanometers and would that have an effect on the capital or the gross margin. The simple answer is no, I don't think that's a good idea. The best answer is to fix -- there's a lot of learning that will happen that we can carry forward in the 7 nanometers, just like we carried from 14 to 10. The other thing is that we still hold roughly 80% of our capital equipment is fungible to the next node or backwards to the prior node. And so that's why as we shifted 10 and 14, we're able to do that without shifting our capital expenditures greatly. We're able to just move the capacity back and forth. The same thing is going to happen between 10 and 7. So you'll have some percentage, and it's always based on demand and how fast things are ramping and all of that. But the equipment will be fungible for the most part between 10 and 7 as well. But no, the right thing to do is exactly what we're doing. This is a unique opportunity we have. There's a lot, lot more performance in 14. We can keep driving that. We'll fix the yield issues. If 10, it's going to have a 10, a 10-plus, a 10++, you can see a lot of products and a lot of performance out of that technology. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +And the next question comes from the line of Romit Shah with Nomura Instinet. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [33] +-------------------------------------------------------------------------------- +Brian, I wanted to ask you about China. Your filings indicate that Mainland China was about 20-plus percent of revenue in 2017, and I have 2 questions. One, does that figure represent your exposure to the domestic vendors in China? And I guess just in light of the current environment between the U.S. and China, there's reports now of potential ban beyond ZTE. How concerned are you as it relates to the impact to Intel? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- +So yes, that number is much broader. So that would be -- if you think about it, so everything from shipments in companies like ZTE or Huawei that are more domestically oriented, although Huawei ships around the world now, it goes to Lenovo and companies like that, spread charm, all of those companies now, if you look at Chinese companies, very few are holdings within just China. They're almost all shipping products and selling across the world. So that's -- that number is really representative of all of the companies that are building within China. Our view is that China is an important market as you just described, right, 20-something-plus percent. It's one of our fastest-growing segments as well. It's important to us, and we're counting on our leaders and the leaders of the world to go resolve these issues. We believe in fair trade. We believe that countries and companies need to be able to play in markets fairly and compete, and we're counting on this getting worked out. That's very important to us. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [35] +-------------------------------------------------------------------------------- +Okay. Great. And then Bob, I'm curious if you'll shed more light on longer-term spending targets. But as we build our models for '19, do you think it's reasonable to assume that you can drive additional operating leverage beyond 2018? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [36] +-------------------------------------------------------------------------------- +You're right. I will shed more light on that later. No, but I think, look, the trends that you've seen over the last couple of years is in -- it's kind of how we frame things back at our Analyst Day early last year, I guess. And that is that we're going to see an expanded TAM and with that expanded TAM, accelerating growth in areas that have lower gross margins. And that we expect over time that there will be a modest degradation in gross margins as a result of growing earnings in different segments. But at the same time, we've said that, that gross margin modest erosion, we believe, will be offset by continued -- both continuing to invest in the critical priorities, but getting leverage on our existing spending base. So with that, I think you're going to have a natural offset, and we're 2 years ahead of our targets to get to 30%. We're excited about the accelerating growth of the company, and we do believe that as we continue to accelerate growth and invest in key priorities that our leverage on spending continue to come down. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [37] +-------------------------------------------------------------------------------- +Thanks, Romit, and thank you all for joining us. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Thank you. Ladies and gentlemen, this does conclude today's conference. You may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2018-Jan-25-INTC.txt b/Transcripts/INTC/2018-Jan-25-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..909f2da35abf5b64829635ddfbf499f4abb865c7 --- /dev/null +++ b/Transcripts/INTC/2018-Jan-25-INTC.txt @@ -0,0 +1,456 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Intel Corp Earnings Call +JANUARY 25, 2018 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian M. Krzanich + Intel Corporation - CEO & Director + * Robert H. Swan + Intel Corporation - Executive VP & CFO + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Intel Corporation Q4 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mark Henninger, Head of Investor Relations. Sir, you may begin. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's Fourth Quarter 2017 Earnings Conference Call. By now, you should have received a copy of our earnings release and the CFO earnings presentation, which replaces the CFO commentary that we've previously used. If you've not received both documents, they're available on our investor website, intc.com. The CFO earnings presentation is also available via the webcast window for those joining us online. I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by the Q&A. +Before we begin, let me remind everyone that today's discussions contain forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that, this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. CFO commentary and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Brian. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. 2017 was a record year for Intel, and fourth quarter results were outstanding, well ahead of the forecast we outlined in October, based on the strength of both our PC-centric and data-centric businesses. I'll review our results with you in just a moment, but before I do that, I'd like to share a few words about security. +We've been working around the clock with our customers and partners to address the security vulnerabilities known as Spectre and Meltdown. While we've made progress, I am acutely aware that we have more to do. We've committed to being transparent, keeping our customers and owners appraised (sic) [apprised] of our progress and, through our actions, building trust. Security is a top priority for Intel, foundational to our products, and it's critical to the success of our data-centric strategy. Our near-term focus is on delivering high-quality mitigations to protect our customers' infrastructure on these exploits. We're working to incorporate silicon-based changes to future products that will directly address the Spectre and Meltdown threats in hardware, and those products will begin appearing later this year. However, these circumstances are highly dynamic, and we updated our risk factors to reflect both the evolving nature of these specific threats and mitigations as well as the security challenge more broadly. +Security has always been a priority for us, and these events reinforce our continuous mission to develop the world's most secure products. This will be an ongoing journey, but we are committed to that task, and I'm confident we are up to the challenge. To keep you informed, we've created a dedicated website and we're approaching this work with customer-first urgency. I've assigned some of the very best minds at Intel to work through this, and we're making progress. +With that, let's turn to our 2017 and fourth quarter results. We just wrapped up the best year in Intel's history with the best quarter in Intel's history. Revenue was up 4% year-over-year in the fourth quarter, 8% if you exclude McAfee, setting an all-time record. Our data center, IoT and FPGA businesses each set revenue records. We met or exceeded all of the financial commitments we made to you at the beginning of the year, and our focus on efficiency and profitable growth produced significant leverage, driving non-GAAP operating income up 21%. +Our data-centric businesses delivered the technology foundations for the new data economy, making the analysis, storage and transfer of data possible, giving our customers the ability to turn data into amazing experiences and actionable insights. They're essential to our strategy. Data-centric revenue, excluding McAfee, was up an impressive 21% over the fourth quarter of last year, and I'd like to share a few highlights with you starting with DCG. +DCG's revenue was up 20% over the fourth quarter. The cloud segment was up 35%, comm service providers were up 16%, enterprise was up 11%, and our adjacency revenue was up 35%. We saw broad-based demand strength with customer preference for high-performance products driving richer ASP mix. Cloud segment results were driven by significant volume growth and continued customer preference for higher-performance products. In the comms service provider segment, we continued to take share and grow revenue as customers chose IA-based solutions to virtualize and transform their networks. Enterprise segment strength was driven mostly by ASP as customers transitioned to Xeon Scalable products in a seasonally strong fourth quarter IT buying window. +While we continue to see enterprise customers offload workloads to the public cloud, we are also seeing those customers prioritize performance solutions for hybrid and on-premise buildouts. Customers across all of our segments are accelerating deployment on Xeon Scalable processors, which is ramping roughly in line with our historical Xeon transition. +We continue to demonstrate leadership and progress in artificial intelligence with the data center, the edge and some hundreds of watts to milliwatts. Our software optimizations for the Caffe framework has improved already strong, beyond scalable ResNet-50 inference performance by 2x just since the launch in July. The first-generation Nervana neural network processor ran a neural network less than 2 weeks after we received silicon, and we've shipped our first customer units. +At the edge, Google announced its AIY Vision Kit featuring our Movidius vision processing unit, and Amazon announced DeepLens, the world's first deep learning-enabled video camera for developers, which uses an Intel CPU, graphics and compute libraries for deep neural networks. +We're also seeing design wins that combine technologies from multiple data-centric business units, reinforcing the idea that we have developed a unique and differentiated collection of capabilities that can address customer challenges together more effectively than any one business could alone. +A great example is Dahua's recent announcement of their Deep Sense product line, which combines Core CPU, Intel FPGA-based network video recorders, along with Movidius VPU-based cameras, to enable people and automobile detection and smart city application using artificial intelligence. +In the Programmable Solutions Group, we saw strong double-digit growth in the data center, auto, embedded and advanced products categories as well as last-time buys of legacy products. That strength was partially offset by softness in comms infrastructure. In Q4, we launched the Intel FPGA SDK for OpenCL that dramatically increased productivity for our customers. We also delivered first-to-market leadership innovations in the Stratix 10 product line, including the first SoC FPGA with an ARM processor at more than 1 million logic elements and the industry's first FPGA with integrated HBM2 memory. +Our Internet of Things Group grew 21% with continuing momentum in retail, video and in-vehicle infotainment verticals. Wind River saw strong multiyear contractor growth and delivered its profitable quarter ever for Intel. The memory business grew 9% and achieved profitability in Q4 as strong client volume was partially offset by a 1-quarter qualification delay of a data center's SSD volumes. +Last quarter, I shared with you that our leadership technology is resulting in strong customer interest in long-term supply arrangements. That interest has continued to grow. We have since signed additional agreements and now expect prepayments totaling roughly $2 billion over the course of 2018. +Mobileye had another strong quarter, and business momentum is growing. Our 30 design wins over the course of 2017 and 15 new program launches in 2018 are both increases of 2.5x over the prior period. We now have Level 2-plus and Level 3 design wins with 11 automakers who collectively represent more than 50% of global vehicle production. These advanced programs launch over the next 2 years, and they represent a major leap in functionality versus current semiautonomous system and are a significant step towards a scalable Level 4 and Level 5 fully autonomous system. +We reached an important milestone in the fourth quarter: the announcement of our Level 3 through 5 autonomous driving platform based on EyeQ5 and Atom, which we'll sample over the next few months. We believe this will be the most advanced, scalable and efficient platform of its kind. EyeQ5 will deliver 24 tera ops of deep learning performance in a 10-watt power envelope, or about 2.5x the efficiency of the competition. Just a couple of weeks ago at CES, we announced that, by the end of 2018, we expect 2 million EyeQ-equipped cars will be collecting crowdsourced data for REM, our Road Experience Management mapping solution. The resulting map will first be utilized in Level 3 beginning in 2019. The ability to crowdsource data to build and rapidly update the precision maps required for higher levels of automation is a major differentiator in our plan to build out the safest and most affordable autonomous vehicle system. It's also a great example of our data-centric strategy at work. +And finally, I'd like to touch on our PC-centric businesses, the Client Computing Group. Over the course of the year, the PC market improved. Our 14-nanometer manufacturing costs came down and the competitive environment intensified. Against that backdrop, PCG's focus on innovation and performance, especially in growth segments like gaming, 2-in-1s, thin and light notebooks and enterprise, led to a record Core mix and record i7 volume in the fourth quarter. We also shipped our first low-volume 10-nanometer SKU, and our modem business grew 26% over the fourth quarter of last year. +Intel is undergoing one of the most significant transformations in corporate history from a PC-centric company to a data-centric company. We have made thoughtful, disciplined investments along the way that have expanded our TAM to $260 billion. Those same investments have produced a collection of data-centric businesses that are unmatched, growing at double-digit rates and approaching 50% of the company's revenue. Our opportunity is larger than it's ever been, and we're hungry to compete and win. +In 2018, our highest priorities will be executing to our strategy and meeting the commitments we make to our owners and our customers. This includes our commitment to restoring customer confidence in the security of their data. +This year, Intel will celebrate 0.5 centuries of innovation that has profoundly changed the world. Over the last 50 years, we invented the architecture and manufacturing technologies that have made personal computing, the Internet and the cloud not only possible, but pervasive. The journey hasn't been without challenges. Nothing worth doing ever is. Our culture has been forged through taking challenges head-on and developing solutions our customers can count on. That includes working directly to address the Spectre and Meltdown security threats. +We leave 2017 on a financial high note, but I'm even more excited about what's to come, about our strategy producing great products for our customers and great returns for our owners. I see Intel innovation changing the world for another 50 years, and that journey starts with 2018. Over the coming year, we'll bring amazing innovation and performance to the PC market, advance the state of art in the artificial intelligence, lead the way towards mass 5G deployment, launch the industry's first new memory architecture in 2 decades and take another step toward a safer world in which autonomous driving is a reality. +Looking back on 2017, I could not be more proud of our team and all they have accomplished. As I look to our 50th year, I'm more optimistic and confident than I've ever been about Intel's future. +And with that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. The fourth quarter was an outstanding close to a record 2017, and we are building real momentum heading into 2018. Revenue for the quarter was $17.1 billion, up 8% year-over-year; operating income was $5.9 billion, up 21% year-over-year; and EPS of $1.08 cents was up 37% year-over-year. +From a capital allocation perspective, we redeemed $1.6 billion of 2035 convertible debt, reducing our share count by 59 million shares, and repurchased $500 million of higher-coupon debt and exchanged $1.8 billion into 30-year debt at a 1% lower coupon rate. +On tax reform, our Q4 GAAP earnings reflect a onetime tax impact of $5.4 billion, and our guidance reflects approximately 7-point improvement in our effective tax rate going forward. +To summarize, we had a fantastic quarter and year and are on track to exceed the 3-year targets we laid out at our Analyst Day, 1 full year ahead of schedule. Our Q4 results demonstrated continued momentum in our transformation from a PC-centric to a data-centric company. Intel's data-centric businesses, those outside of the PC segment, are at an all-time-high mix of 47% of our revenue, up from approximately 40% in 2012. We have made significant investments to expand our TAM into new data-rich markets like memory, programmable solutions and autonomous driving. These investments are just starting to pay off and will fuel Intel's growth going forward. +Our PC-centric business was down 2% in a declining PC market, and it continues to be a great source of profitability. DCG delivered its most profitable year since 2011 by focusing on premium and growth segments with industry-leading products. This business generated the cash to fund Intel's investments in new data center growth. +Moving to Q4 earnings. We generated significant EPS expansion in the quarter, up 37% year-on-year. Our EPS improvement was driven by strong top line growth, a 5-point improvement in operating margins and significant gains from our ICAP Portfolio. +Our gross margins expanded 2 points in the quarter, and our spending as a percent of revenue declined by 3 points as we delivered $700 million more revenue and $300 million less spending. +In terms of operating efficiency, we're well ahead of schedule of meeting our commitment by reducing spending to 30% by 2020. We now expect to achieve this goal no later than 2019. Total spending was down 6% year-over-year in the fourth quarter, while we continued investing in our key priorities including driving Moore's Law forward, winning in artificial intelligence and autonomous driving. R&D spending as a percent of revenue was down approximately 1 point, and our SG&A costs were down over 2 points as we rationalized our marketing and sales programs and generated significant leverage in our SG&A functions. +Let me touch briefly on our segment performance. Client Computing Group had another strong quarter. Revenue of $9 billion was down 2 points and operating margins were down 2 points. Operating margins were lower on 10-nanometer transition costs. We saw strength in the commercial gaming business, and we believe the worldwide PC supply chain is operating at healthy levels. +The Data Center Group had record revenue of $5.6 billion, up 20% year-over-year, and operating income of $3 billion grew 59%. Q4 operating margin was 54%. As Brian mentioned earlier, we had strong growth in execution across all segments. Overall unit volume was up 10%, ASPs were up 8%, and our adjacencies grew by 35%. Our ASP strength demonstrates the value customers see in our high-performance products. Xeon Scalable launched in July, is ramping well, with customers broadly deploying its leadership product family. Revenue scale from leadership products, ASP strength and the exclusion of 2016 onetime charges drove strong operating income growth for the business. For the full year, revenue was up 11% and operating margin came in at 44%, both ahead of the expectations we provided at the beginning of the year. +The IoT, NSG and PSG business segments are becoming a larger component of our overall business, collectively growing 19% year-over-year. Our Internet of Things business achieved record revenue of $879 million, growing 21% year-over-year, driven by strength in industrial and video and continued momentum in our retail business. Operating profit was $260 million, up 43% year-over-year. +The Mobileye business also had a record quarter, and we are on track to our deal thesis. As we called out last quarter, results for the Mobileye acquisition are included in our all other segment and reflects the Q4 integration of Intel's autonomous driving group spending into Mobileye. +Our memory business had revenue of $889 million, up 9% year-over-year, with strong demand for data center SSD solutions and demand signals outpacing supply. This segment was profitable for the quarter, and we expect this segment to be profitable for the full year of 2018. +Programmable Solutions Group had record revenue of $568 million with 35% growth, driven by strength in data center, automotive and embedded. Operating profit was $156 million, up 95% year-over-year. The Stratix 10 design win pipeline, which represents PSG's largest ever, doubled over the last year due to engagements in 5G, cloud computing and the infrastructure transition to network function virtualization. +We laid out our capital allocation priorities early in the year: invest organically, expand acquisitively and return capital to our shareholders and do it wisely. In the year, we delivered on our promise. First, we generated strong free cash flow of $10.3 billion in the year and returned $8.7 billion to shareholders through dividends of $5.1 billion and share repurchases of $3.6 billion. Second, we funded a majority of the Mobileye acquisition from the sale of noncore assets during the year, including McAfee and the sale of ASML shares. And third, we redeemed $1.6 billion in convertible debt, reducing 59 million shares, and we also tendered higher-coupon debt for lower-coupon debt. +Let me expand on the ICAP- and treasury-related transactions we executed in the quarter. First, we sold 11.4 million shares of our ASML holding, which generated $2 billion in cash proceeds and a gain of $1.5 billion. +Second, we redeemed our 2035 convertible debenture. This redemption created a $2.8 billion cash outflow and a noncash loss of $385 million, which was tax-deductible. Since this debenture was convertible and therefore dilutive, the redemption effectively acted as a buyback that will reduce diluted share count by 59 million shares. +And third, we successfully tendered $2.3 billion of high-coupon debt in the quarter. We exchanged $1.9 billion of old debt into $2 billion of 30-year new debt, reducing our coupon rate by 1%. We also redeemed $425 million of old debt for cash. This transaction both lowered our leverage and our interest expense. +Adding it all up, 2017 was another record year for Intel. Revenue of $62.8 billion was up 9% year-over-year, driven by 16% growth in our data-centric businesses and 3% growth in PC-centric business. Operating income of $19.6 billion was up 18% on strong execution across the businesses and disciplined spending. +Earnings per share of $3.46 was up 28% on excellent operational performance and the benefit of $0.35 from ICAP net gains. With the change to the accounting rules for recognizing price changes on equity investments, we do not expect to see these ICAP gains repeat. +Before I turn to guidance, let me provide a little more context on the impact of tax reform on our business. Intel's fourth quarter results reflect a higher GAAP income tax expense of $5.4 billion as a result of U.S. corporate tax reform enacted in December. This includes a onetime required tax adjustment on previously untaxed foreign earnings, payable over 8 years, which was partially offset by the remeasurement of deferred income taxes for the new U.S. statutory tax rate. Looking ahead, we expect the Tax Cuts and Jobs Act will help level the playing field for U.S. manufacturers like Intel that compete in today's global economy. We expect a 2018 tax rate of approximately 14%, driven by a lower U.S. statutory tax rate of 21%, lower tax on foreign income, benefits from U.S. exporters and the continuation of the R&D credit. The change in our tax rate drives approximately $0.28 in 2018 EPS. +Intel has a rich history of investing in U.S.-led research and development and U.S. manufacturing. Just last year, we committed to the fit-up of our Fab 42 facility, creating thousands of jobs at completion. These tax reforms provide further incentive to continue investments like this. +Before we turn to our 2018 outlook, I also want to highlight 2 accounting rule changes: first, new accounting rules for revenue recognition; and second, accounting for equity gains and losses. We do not expect a material impact to revenue from the revenue recognition accounting change. The changes in accounting for equity gains and losses will require the recognition of unrealized price changes each quarter, so equity holdings like our ASML position will see mark-to-market adjustments that will flow through earnings in 2018, which may create greater volatility on a GAAP basis. This change resulted in an impact of $2.7 billion of net unrealized gains at year-end that we booked to equity on January 1, 2018. +Now moving to the full year. We are forecasting the midpoint of the revenue range at $65 billion, up 4% year-over-year. We expect operating margin of approximately 30%, with gross margins down 2 to 2.5 points and spending as a percent of revenue to be down 1 to 1.5 points. The decline in gross margin is driven by growth in our adjacent businesses as we play in an expanded TAM and transition cost associated with 10-nanometer, both partially offset by higher gross margins from our 14-nanometer products. +We expect EPS of $3.55, up 14%, excluding the ICAP net gains, driven by a strong top line growth and a lower tax rate of approximately 14%, which will increase EPS by approximately $0.28. +We expect net capital deployed of $12 billion. This reflects gross CapEx of $14 billion, offset by approximately $2 billion of customer prepayments for memory supply agreements. Increase in CapEx reflects our and our customers' confidence in our memory technology leadership. +We expect free cash flow of $13 billion, an increase of approximately 30%, directly contributing to our decision to raise our dividend by a full 10%. +As we look to the first quarter of 2018, we are forecasting the midpoint of revenue range at $15 billion, up 5% year-over-year. We expect operating margin of approximately 27%, flat year-over-year, with a 3-point decline in gross margins offset by a 3-point decline in spending. We expect EPS of $0.70, up 11% excluding ICAP net gains, from strong top line growth and a lower effective tax rate. +We believe 2018 will be another record year for Intel, and we feel great about where we are entering year 2 of our 3-year transformation. We've met and exceeded our commitments. Our PC-centric team continues to operate very well in a down market, and our data-centric businesses are up double digits collectively as we continue to transform the company to power the cloud and smart connected devices. +With that, let me turn it back to Mark. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, Brian and Bob. Moving on now to the Q&A. (Operator Instructions) +Operator, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- + + Yes, my first question just revolves around the revenue guidance for the March quarter. At the midpoint, down about 12% sequentially is a lot worse than, I guess, normal seasonal. And I guess I'm trying to figure out kind of the parameters that you guys are using to come up with that number. Was there something in the DCG strength in the calendar fourth quarter that you don't think is repeatable? Given your comments around the PC supply chain being healthy, that to me feels a little bit more seasonal than not in the March quarter. So I'm just kind of curious as to why Q1 revenue would be so much below what has been kind of the 5-year median seasonality for Q1. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + John, thanks. It's Bob. So really 2 things going on. One, the enterprise growth in DCG, as Brian highlighted, was up 11% in the fourth quarter. So extremely strong seasonal growth for enterprise, a little bit more than we expected, frankly. That's number one. Number two, PSG's 35% growth was helped by end-of-life sales during the course of the quarter. And if you adjust for maybe a more normalized enterprise growth and PSG growth, you get to more of a seasonal Q4 to Q1 dynamic, so in line with seasonal if you make those 2 adjustments. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [4] +-------------------------------------------------------------------------------- + + That's very helpful. And then, Brian, on my second question revolves around CapEx. I think it was a year ago on this conference call that you kind of mentioned that you thought that calendar year '17 and calendar year '18 would be sort of above trend-line CapEx spending for you guys, and then you thought it would come down again in calendar year '19 to a more normal trend, albeit you didn't quantify the trend. Just given the big uptick in '18 to $14 billion, I realize $2 billion of that's already being covered by prepayments, but how do we think about kind of the trend-line CapEx from here, especially in light of the changing relationship between yourself and Micron on IMFT? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [5] +-------------------------------------------------------------------------------- + + Sure, John. So my perspective is, if you take a look at it, right, memory kind of -- I mean, logic on our CapEx just scaled with our increase in revenue and kind of our overall growth rate. So that's fell in line. With memory, we're going to take a look at it really on a year-by-year basis. And I'd tell you that Bob's really doing a good job of helping that business unit look over the capital. And when we have demand and people are willing to pay up front for that demand and reserve the capacity, like we've done this year, we're going to go ahead and put that capacity in place plus what we think the overall market we can do as distributing across the overall market. And that's really independent of that changing relationship with Micron. That's really more about how we're doing development work out in time, really, and that's actually still 2 generations away. That really didn't affect 2018. This was really about what we saw for the overall NAND memory market plus the additional capital and capacity that people wanted to reserve through that process. We'll look at that each year, John, and say, "Okay, as we look out into '19 at the end of '18, we'll do that same analysis." + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [6] +-------------------------------------------------------------------------------- + + (inaudible) + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + I would just -- sorry, I would just follow on to Brian's comments. The way we're looking at memory, and we talked a bit about this on the last call, is increased confidence in our customers and the technologies that we're developing where, those relationships, they will help fund the scaling of the capacity to grow the business. And we're really trying to match net capital employed to be in conjunction with known customer demand. So what that means -- what that meant for 2017 is the net capital was roughly $1.5 billion, and we've held that relatively flat in 2018. So while gross capital is higher, we have more conviction in the customer base to fund $2 billion of the gross capital. So memory, we're really trying to focus on customer adoption of our technology to effectively and efficiently scale the business. And then just the only other point I would make on logic, remember, a year ago in terms of our outlook for growth, we're well ahead of our outlook for growth. We were probably, at the time, implied in our outlook was probably a $62.5 billion kind of number in 2018. Obviously, with our guide now, it's $65 billion. We're $2.5 billion higher. And it's that incremental growth that's placing more demands on logic capacity, both for 14- -- 10-nanometer and, as we think forward, on that 7-nanometer. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from Joe Moore from Morgan Stanley + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [9] +-------------------------------------------------------------------------------- + + I wonder if you could talk about OpEx. Obviously, you've been pretty disciplined there bringing that down, but you've also got some other initiatives. You've -- you announced a discrete graphics effort. Maybe if you could talk about -- it seems like that would cost a lot, if I just look at what your competitors are spending. And then, at some point, you're going to spend money on NAND that used to be shared with Micron. So just can you talk about the puts and takes there? And is there something that we should think about that's coming down to sort of offset those potential increases? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- + + Sure. I'll start, and I'll let Bob kind of give you the under-the-cover detail of the dollars. But Joe, this -- really, we've already factored all of those things in. So things like the discrete graphics is a ramping spend. The memory is R&D spending out in time, so for '18 has no, really, effect. And then we've driven an overall efficiency in all of our R&D spending to offset that. So increasing in GPU spending, there's some other increases as well around things like autonomous driving and some of the other artificial intelligence and some of the emerging areas. You're right. Over time, we'll increase spending in NAND in R&D, but those are being offset by efficiencies that we're driving into the rest of our product R&D. And we really feel like we're getting to a good point where we can keep the pace of innovation going on our core products while we fund these new initiatives as well and not take a beat from our continued efficiency efforts across the spending as a percent of revenue. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + Yes, Joe, I'd just add some numbers to Brian's words. We've kind of come down from 36% to 35% to 34% to a second half of 2017 at roughly 31% of revenue. So we've been coming down as we've been doing 2 things: One, the investments that we'd been making are paying off in terms of higher growth; and number two, we're making real trade-offs in where we're investing our money. As we go into -- implied in our guidance, as we go into '18, we're expecting our spending levels to be roughly flat with an annualized 2017 spending level. So we're going to -- and underneath that, continuing to drive efficiencies in sales and marketing as we become more of a B2B or data-centric company and getting real leverage on our G&A functions across the board. So we've made real progress during the course of the last couple of years. Including the second half, we expect to make continued progress while making the critical investments in things like discrete graphics, autonomous driving, artificial intelligence and continuing to invest in Moore's Law. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [12] +-------------------------------------------------------------------------------- + + Okay, great. And then as you think about that NAND investment, I guess people have asked me what you're -- what the separation from Micron on a long-term path means. Does that mean there's sort of more of a focus on propriety products like 3D XPoint? Or do you remain firmly committed to sort of more -- to a more competitive NAND market? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [13] +-------------------------------------------------------------------------------- + + Sure. So I just want to make sure you -- we clarify a little bit, Joe. The separation of development work is, again, out in time. Think of it in the 2020 time frame is when the real independence come, and it's NAND-specific. So we continue to work together on 3D XPoint. So -- and this is really just -- it's not a separation of the companies or something about the relationship. The relationship with Micron continues to be a good one, and I foresee it will continue to be a good one in the future as well. This is about direction of where we're going to take our products. And we've talked about ours are very data center-centric and really tied to performance and aligning to the customer market that we're really looking at. And so the spending in R&D we're talking about right now is purely NAND-specific. 3D XPoint continues to be a joint effort. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from Ambrish Srivastava with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [15] +-------------------------------------------------------------------------------- + + Brian and Bob, I wanted to go back to DCG, specifically on the op margin front. We have not seen a [5-handle], if my model is correct, it's been 8-plus quarters. So can you please speak to the sustainability of the op margin and kind of what were the drivers that got you to that level? And then I had a follow-up as well, please. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes, so we came into the year and we indicated that we expected margins for the full year to be in the kind of 40% to 45% range. And obviously, we started out low, but we said our expectations were that it would grow throughout to the course of the year. A couple of things in the fourth quarter. Obviously, growth. So real good leverage on our existing investment was a big contributor. Secondly, ASPs were up 8%. So of the 20% growth, ASPs accounted for 8 points of that. And as Brian highlighted, whether it's cloud, comms or enterprise, customers in the quarter were really paying for performance. That performance for us was higher ASPs. Third, our continued progress on unit cost. And then, last, you may remember, last year's fourth quarter, we had some warranty- and IP-related charges in the data center business that I think cost us roughly 4 points a year ago. So last year's were a little bit deflated. But good volume leverage, strong ASPs as customers paid for performance and unit cost improving. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + So we should expect this level going forward, Bob? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + Yes, I think I wouldn't get too far away from the 40% to 45%, to be honest with you. I think, as we go into 2018, the good -- we think good cloud momentum, that's been consistent performance over the course of the year, last couple of years. Comms, our performance, we believe, was real strong in a somewhat sluggish market, so real share gains. But the high kind of seasonal enterprise growth and strong ASPs in the quarter, we think, are more seasonal in nature, and we're not anticipating enterprise growth to stay at these levels as we go into '18. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Okay, that's helpful. And then for my follow-up on the gross margin for next year, you provided the -- sort of qualitatively the adjacency as well as the cost impact from the XRAM. But, a, I was surprised you didn't mention competition because now AMD will have a full year of product in an area they never were for -- I shouldn't say never -- they were not in an area for a long time. So question is are you seeing any competition? Are you factoring that in? And then, b, would it be possible to quantify the 2 impacts that you mentioned? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, I'd just -- I'd highlight 3 things that are driving the deterioration. But I'd start first with we've always characterized our long-term gross margins to be in the 55% to 65% range. And for the last several years, and included in our guidance this year, we'll be at the upper end of that 60% to 65% range. But for the last couple of years, there's -- we've had maturity of 14-nanometer. And that maturity, both in terms of getting more and more performance and lower and lower unit costs, has been contributors to gross margin. As we go into '18, we see 14-nanometer modest contribution from profitability because we've matured on the cost curve. That's an increasingly competitive environment, and we don't anticipate dramatic ASP improvements over the entire company. In some cases, yes, but for the most part, no. So we'll see some continued improvement in 14-nanometer products during the course of the year. Secondly, we are really accelerating the growth of our adjacent businesses. The investments that we've been making in both the data-centric businesses and our growth in modem, those are contributing to our year-on-year EPS growth. However, those -- both of those product lines or businesses have lower margins. So our success in modem and memory is having a mix impact on our gross margins. The third area is we're going from 10-nanometer start-up, where our costs are coming down, to more the ramp to the 10-nanometer. And that ramp is going to weigh on the margins as we begin to develop production going into the second half of the year where we're way up the curve on where our yields and costs are. So those are kind of the 3 things as we see it, and if I were to characterize, roughly plus 1, roughly minus 2, roughly minus 1, rounding those. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Ambrish, on your question about -- specifically around competition, I think, every year we look at it as a competitive environment, and we're out to compete for our customers. And so we factor that in each year appropriately, I think, against the competition. So we've looked at the competitive environment, and we believe Xeon Scalable, great performance that has, our overall product road map, we think we have a highly competitive road map and -- have adjusted for that in our forecast. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Stacy Rasgon from Bernstein. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + Firstly, can you walk us through your free cash flow waterfall? I can't get there. Flattish operating income on 4% revenue growth. You lose a couple billion dollars in ICAP gains. CapEx, I guess, maybe it's flattish with the memory prepayments. Taxes maybe gets me 1/3 to half of the way there, but where does the rest of the free cash flow come from? Are you just draining a ton of working capital or what? Can you walk us through? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes. First, $13 billion in free cash flow, up roughly 30% year-on-year. First, higher cash earnings. Our guide has EPS up roughly 14%. In that guide, there's -- depreciation has grown in '18 relative to 2017. So that has just higher cash earnings. Secondly, we do expect lower working capital as we go through 2018. Third, we have higher strategic customer supply agreements. And those 3 things are all contributing to the positive. And then obviously, Stacy, the higher gross capital is a bit of an offset. So stronger cash earnings, better working capital, more strategic supply, partially offset by higher CapEx. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + Okay. For my follow-up, I want to ask about the growth next year of your kind of adjacent businesses versus your core businesses. Of that $65 billion of that 4%, can you give us a feeling how much of that is coming from the adjacent, I guess mostly memory and modems, versus the core? It must be decent, given the gross margin pressures. And I guess, as a corollary to that, you mentioned a one delay -- 1-quarter delay in data center memory. Is that -- was that a statement on XPoint? + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [26] +-------------------------------------------------------------------------------- + + No, that was a NAND -- I'll start with just the answer to that question first, Stacy, that, that was a 3D NAND SSD. We had some delays in the fourth quarter, and those are being addressed now. So that was that comment. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Okay. And growth -- I'm sorry, go ahead. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + No, I think, on your first question, in the $65 billion, we characterized it as roughly low single-digit decline in our PC-centric businesses. So implied in that is PC maybe declining a little bit more and modem, i.e., adjacency within the CCG segment, partially offsetting that. In the overall guide, we said that the data-centric businesses would be growing in the mid-teens. And obviously, that's -- we believe that'll be -- the strongest growth segment within the makeup of our data-centric businesses will be in memory. And it will be a function of customer quals that Brian just highlighted, and we expect NSG growth to accelerate throughout the course of 2018, so single-digit decline on PC-centric and mid-teen growth on data-centric businesses. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + So what does that memory strength imply for the data center growth, the DCG growth, particularly given the strong performance in Q4? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + For the most part, the [wins] for NSG that will go through data center will be late in 2018 and won't really have an impact on the overall growth rate of that business. So it's primarily about growth of 3D NAND during the course of the year. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [32] +-------------------------------------------------------------------------------- + + I guess a couple of housekeeping questions, if I could kind of put them together. Curious if you could share with us how you're thinking about CapEx spend between logic and memory. And then, on the 10-nanometer start-up, can you share with us when you're expecting to begin depreciating those costs? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + First on the CapEx, we indicated gross capital in the year of $14 billion, that we get customer strategic supply agreements of roughly $2 billion. So our net capital is $12 billion, $12 billion in the year. Again, I'd kind of break that into 2 pieces: memory, net capital employed, no change; and logic, CapEx up roughly $1 billion year-on-year. And as we mentioned earlier, that $1 billion is a function of, primarily growth, continuing to grow 14-nanometer; second, scaling up 10-nanometer; and third, investing in next node 7-nanometer during the course of the year. So those 3 things are really driving the $1 billion increase in CapEx for logic. The second part of your question, the -- so for 10-nanometer, as we bring that equipment online, we turn on -- there's some equipment now that's being depreciated. But as we build -- bring more online, as we ramp in the second half of the year, when we turn that equipment on is when we start depreciating it. So we'd expect our depreciation bill in the second half of the year to be growing. That's one of the contributors to -- yes, really to come full circle, that's one of the contributors to the gross margin deterioration during the course of the years as we start to ramp 10-nanometer. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [35] +-------------------------------------------------------------------------------- + + For the first one, Brian, I'm curious, are you baking in any effect on sales or cost or pricing from any resolution on the processor security issues? There is one line of thinking that says customers might decelerate their purchase, and then you have others in the industry saying that customers might accelerate their purchase later on. So I'm just curious how you're looking at the financial implications, positive or negative, from this issue near term and longer term. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Sure. So we'll try and kind of break it into 2 kind of answers for that, Vivek. From a cost standpoint, we've baked in and we've talked about that we don't expect any material impact of this security exploit on our spending or product costs or any of that. So that's how we baked that in. From a forecast standpoint, we actually made our forecast, and we've checked it, as we go through this -- the first few weeks here of the year, against our prior forecasts to make sure that the forecast incorporated any changes or any signs we're seeing up or down. And I'll tell you, at the highest level, we're not seeing much of a change in those forecasts as a result of this. So I'd tell you, it's pretty balanced right now. So spending, not material and didn't make any adds there. And then our forecast, we had a forecast. We've checked it as we go through the first few weeks of the year, and it hasn't really changed or altered as we looked at it. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + And the only other thing I'd add, per Brian's comment earlier, we kind of go into the year realizing that it's an increasingly competitive environment. And our focus is on, right now, continuing to bring the best, highest-performance products to market, but also to -- lots of time and energy spent on focusing on fixing this issue, primarily through software patches as opposed to short-term hardware things. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [38] +-------------------------------------------------------------------------------- + + Got it. And as my follow-up, for the full year, how should we think about growth in just the DCG business? I understand you gave some color around the entire data-centric group, which includes memory and other segments. But just sort of apples-to-apples, how should we think about growth in just DCG, which had a very strong double-digit growth year in '17? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Yes. Throughout the course of the year, we -- sorry, throughout the course of '17, we kind of guided to high single digits, and we kind of executed to that throughout. And then Q4 wasn't dramatically different than the first 3 quarters of the year, really, with the exception of the high seasonal spend for enterprise. And that really took us from a high single-digit to low double-digit or 11% growth for the year. As we go into '18, we do not expect that -- we think that, in the enterprise space, things will go back down to the negative single-digit range and, therefore, don't anticipate a dramatic difference in how we laid out DCG a year ago. So that's how we're thinking about it. If I maybe elevate that back up a little bit and just think about when we're putting together our plans for the year, there's 2 areas where our tendency is to be a little cautious on the outlook. One is PC TAM. We tend to be a little more cautious on PC TAM, and we tend to be a little more cautious as we think about enterprise growth in the DCG business. And the reason we do that is we think it's important to be cautious, get our costs in line. And if our assumptions on market rate to growth turn out to be conservative, we'll benefit from -- we believe we'd benefit from higher volume and real strong flow-through to net income. That's how we planned the year coming into 2017, and we did kind of the same thing for 2018. So I don't anticipate dramatically different DCG growth in how we laid out 2017 as we enter 2018, because we really haven't assumed a change in trajectory of enterprise CIO spending in the course of the year. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Yes, our last question comes from Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [41] +-------------------------------------------------------------------------------- + + I just wanted to go back to the DCG ASPs. You had talked about the ramp of Scalable being kind of to plan, but then I think you got a nice tailwind. I think you implied enterprise had a higher percent of Scalable. So I just wondered if you could just talk on broad strokes just where the Scalable ramp is here, and how your expectation kind of getting through the year, where that could go. + +-------------------------------------------------------------------------------- +Brian M. Krzanich, Intel Corporation - CEO & Director [42] +-------------------------------------------------------------------------------- + + Sure. So I'll start, and Bob can add some number detail and all. The Xeon Scalable ramp is right in line with prior ramp of similar products on our DCG road map. And what you saw when we talked about Q4 was not necessarily more Xeon Scalable but people buying up the stock on Xeon Scalable, which drove ASP. So they're buying the higher-performance, higher-priced parts. And that's not uncommon when, at the early stages of a ramp, people come in and they typically want to buy the highest-performing parts at the beginning, and then they fill out their distribution as other buyers come in and other parts of the market kind of open up. So ramp's on schedule and aligned with prior ramps, and the ASP was more about buying up on the higher-performance parts than necessarily a volume statement. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + Got you. And then I also want to go back on just -- sorry. I just want to go back on gross margin as well. As you look for March, you mentioned the drop is from adjacent business as well as 10-nanometer. Obviously, memory, you're signaling a big ramp, but it doesn't resolve fully. I'm just wondering if, Bob, you could just walk through the 10-nanometer start-up costs as they kind of move through the year, and kind of if you can outline, between those 2 in Q1, what's the bigger factor. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Executive VP & CFO [44] +-------------------------------------------------------------------------------- + + So I see mix dynamics are going to be a bigger factor overall for the year, both in Q1 and for the rest of the year, as our memory and modem business continue to accelerate strong growth. So that's going to be the biggest impact. I think 10-nanometer will have an impact just right out of the gate and will kind of continue throughout the year as we scale volume, but also need to improve yields during the course of the year. So hopefully, that's helpful. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [45] +-------------------------------------------------------------------------------- + + All right. Thank you all for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may now disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2018-Jul-26-INTC.txt b/Transcripts/INTC/2018-Jul-26-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..bf04c5fbc91c3f5827750ebf68bf04e59c91def5 --- /dev/null +++ b/Transcripts/INTC/2018-Jul-26-INTC.txt @@ -0,0 +1,483 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Intel Corp Earnings Call +JULY 26, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Navin Shenoy + Intel Corporation - Executive VP & GM of Data Center Group + * Robert H. Swan + Intel Corporation - Interim CEO, Executive VP & CFO + * Venkata S. Murthy Renduchintala + Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Tristan Gerra + Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher Adam Jackson Rolland + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Intel Corporation's Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. +I would now like to introduce your host for today's program, Mark Henninger, Head of Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's Second Quarter 2018 Earnings Conference Call. By now you should have received a copy of our earnings release and earnings presentation. If you've not received both documents, they're available on our Investor website, intc.com. The earnings presentation is also available in the webcast window, for those joining us online. +I'm joined today by Bob Swan, our Interim CEO and Chief Financial Officer; Murthy Renduchintala, Group President of the Technology, Systems Architecture & Client Group, and Chief Engineering Officer; as well as Navin Shenoy, Executive Vice President and General Manager of the Data Center Group. In a moment, we'll hear brief remarks from Bob, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter we have provided both GAAP and non-GAAP financial measures. Today, we'll be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. Our results for the quarter were outstanding, marking a record second quarter on our way to what we expect will be a record 2018. Last week, we celebrated Intel's 50th year as a company, which is a big deal in an industry that never stops evolving. Even more remarkable is that after 5 decades in tech, Intel is poised to deliver its third year in a row of record financial performance. +We set a course 5 years ago to transform the company. To do that, we made investments to enhance and extend our core microprocessor business along with a series of bold bets to compete and win in new markets. Our thesis was that Intel is uniquely positioned to capitalize on the world's insatiable need to process, store and move data. The results have been dramatic. We are now competing for a $260 billion TAM, the largest in the company's history, and we have lots of room to grow. +Just 5 years ago, roughly 1/3 of our revenue was data-centric. Today, nearly 1/2 of our revenue is data-centric and growing at a double-digit rate. Data has never been more pervasive nor more valuable. In fact, 90% of the digital data ever created was generated in just the past 2 years. But of that data, only 1% has been analyzed, indicating massive untapped potential. +I'd like to highlight a few indicators of Intel's accelerating transformation before going into our financial results. +First, in our data center business, our focus on the cloud, network transformation and AI and analytics produced outstanding results in a strong demand environment. Customer preference for our highest performance products continued, with Xeon Scalable at nearly 50% of our mix in the second quarter. +Cloud revenue grew as service provider CapEx continue to accelerate to meet the explosive demand for digital services, artificial intelligence and data analytics. Enterprise revenue is driven by a combination of macro strength and companies' increasing deployment of hybrid cloud solutions and data-intensive workloads. +In the comms service providers segment, we continue to gain share as customers choose to virtualize and transform their networks and prepare for the 5G transition using Intel Architecture. +Our Programmable Solutions Group also delivered strong results this quarter. PSG again set a record for design win volumes, indicating customers' confidence in our road map and growing adoption of FPGAs for workload acceleration from the data center through the network and out to the edge. +Earlier this month, we announced the planned acquisition of eASIC, which will give us a competitive differentiator and another solution to meet customers' diverse time-to-market performance, cost and power needs. +We combined Intel and Altera 2.5 years ago and we expected a key value driver to be the increasing use of FPGAs in the data center. In Q2, PSG's data center business more than doubled for the second consecutive quarter. +IoTG set an all-time revenue record with particular strength in the retail and industrial sectors as customers look to Intel not only for compute performance, but for solutions that drive business value. We also completed the sale of Wind River as we continue to redeploy resources to higher growth and return areas. +Building on this industry leadership in ADAS and driving the industry toward an autonomous future, Mobileye set another all-time revenue record. Customer momentum continued with several design wins, including a multimillion unit deal with ZF for a large global automaker. +We also announced that Baidu has adopted Mobileye's EyeQ base surround computer vision kit as the preferred vision solution for commercial Apollo pilot AV deployment. In both the open source and commercial Apollo programs, Baidu will also integrate Mobileye's responsibility sensitive safety model, an open and transparent model that provides safety assurance for AV decision-making, an industry imperative. +Our memory business also set an all-time revenue record. We are transforming the memory industry with a pair of differentiated platform-connected capabilities, high-density Floating Gate 3D NAND and high-performance persistent Optane technology. +We've recently announced that we are in production on the industry's first 4 bits per cell data center NAND PCIe SSDs. And at the same time, industry support for Intel Optane DC persistent memory continues to grow with technology leaders, including CERN, Google, SAP and Tencent already announcing plans for future use of the technology. Unlike traditional DRAM, Intel Optane DC persistent memory will offer the unprecedented combination of high capacity, up to 3 terabytes per socket, along with affordability and persistence. +Intel and Micron recently announced that we will develop future generations of 3D XPoint technology independently to better align the technology to our individual business needs and strategy. We'll continue to jointly manufacture 3D XPoint at the Intel Micron flash technology fab in Lehi. +Intel intends to extend its leadership with Intel Optane products based on 3D XPoint, which, combined with our high-density 3D NAND technology, offer the best solution for today's computing and storage needs. +And finally, in client computing, our focus on innovation and differentiation in the commercial, enthusiast and fin and light segments is producing results. Overall market conditions also continue to improve, and we now expect modest growth in the PC TAM this year for the first time since 2011. +The commercial segment remains strong as CIOs refreshing aging PC fleets are turning to Intel Core processors with vPro as the gold standard for performance and manageability. +At the same time, consumer interest in gaming and our outright performance leadership are driving strength in the enthusiast segment, producing another outstanding quarter in gaming. These trends reflect the market's demand for our highest performance products, resulting in strong overall product mix in CCG. +We also began shipping the 7560 modem, Intel's first CDMA and first multi-SIM capable modem. +Our industry-leading products continue to deliver outstanding results. We have a leadership 14-nanometer product lineup for 2019 and we continue to make progress on 10-nanometer. Yields are improving consistent with the time line we shared in April and we expect systems on shelves for the 2019 holiday season. +In the second quarter, we announced the CEO change. The board is making good progress determining the best person to be the next CEO of this great company. While there is no timetable, the board is working with a sense of urgency and the identification of candidates, both internal and external, is well underway. +Personally, and on behalf of Intel's 100,000-plus employees, I'd like to thank Brian for his many contributions to the company over his 35-year career. The investments he made set us on a course for transformation. Even more importantly, he developed the right strategy and leadership team to carry that transformation forward while we conduct the CEO search. Our financial results in the second quarter show we're doing just that. Let's turn to the numbers. +Revenue of $17 billion was up 15% year-over-year, marking a second record quarter. We saw strong performance across all of our businesses and record revenue in NSG, IoTG and Mobileye. Our data-centric businesses were collectively up 26%. Excellent operating margin leverage and a lower tax rate resulted in EPS of $1.04, up 44% year-on-year, even as we continue to invest for growth. +From a capital allocation perspective, year-to-date we have generated $6.3 billion of free cash flow, returned $8.6 billion to shareholders, including $2.8 billion in dividends and $5.8 billion in buybacks, repurchasing 117 million shares. +As a result of the continued strength we are seeing in the business, we are raising our full year revenue guide by $2 billion to $69.5 billion. We are also raising our EPS guide by $0.30 versus April to $4.15, and the free cash flow guide by $0.5 billion to $15 billion. +Our leadership products are winning in an expanded TAM and our data-centric businesses are now almost 50% of our total revenue. Our data-centric businesses had strong quarters, with each business individually growing at a double-digit rate. Our PC-centric business was up 6% on strength in the commercial and enthusiast segments. +Q2 was another quarter of significant EPS growth, up 44% year-on-year. And our operating margin expanded $1.4 billion and 5 points year-on-year. Our EPS improvement was driven by growing demand for high-performance products in the data center and client businesses, leading to higher volumes and ASPs, strong growth in our adjacent businesses and lower tax rate and lower share count as a result of buybacks. +In January, we pulled in our 30% spending goal for 2018, a full 2 years ahead of schedule. We are on track to meet that target and our operating efficiency continues to improve. We remain extremely diligent in managing spending while prioritizing investments in areas that will accelerate revenue growth, product leadership, artificial intelligence and autonomous driving. This focused approach is producing results. +Total Q2 spending came in at $5.1 billion, 30% of revenue. Total spending as a percentage of revenue is down 4.6 points year-over-year in the quarter while we continue to increase investment in our key priorities. Versus the second quarter of last year, we delivered $2.2 billion more revenue with no incremental spending. Let's talk now about our Q2 performance by segment. +The Data Center Group delivered another great double-digit growth quarter with revenue of $5.5 billion, up 27% year-over-year and operating income of $2.7 billion, up 65%. Q2 operating margin was 49%, and we continued to see strong growth in both the cloud and comms service providers segments, which now make up 2/3 of DCG revenue. +Platform unit volume was up 14% and ASPs were up 11%. Non-CPU adjacencies grew 30% over last year, yet another indicator that we are growing share in a larger data-centric TAM. +We saw continued broad-based demand strength this quarter with customer preference for leadership products like Xeon Scalable driving strong mix. The cloud business, our largest data center segment, grew 41% year-over-year as hyperscale CapEx expands to handle the explosive need to transmit, store and analyze data. +Our comms service providers segment grew 30% year-over-year as customers continue to choose Intel Architecture to transform their networks. And our enterprise segment was up 10% year-over-year against a strong IT spending environment and prioritized investment in hybrid cloud implementations. +Our other data-centric businesses, IoTG, NSG and PSG, also achieved double-digit growth in Q2. And together, we're up 22% year-on-year. Our Internet of Things business achieved record volume and record revenue of $880 million, up 22% year-over-year, driven by strength in retail and industrial, as I mentioned earlier. +Operating profit was $243 million, up 75% year-over-year on higher revenue and flat spending. We expect the Wind River divestiture, which closed in the second quarter, will have a negative impact to IoTG revenue of approximately $150 million in the second half of 2018. +Mobileye also had another strong double-digit growth in the quarter, up 37% over last year on increasing ADAS adoption. +Our memory business delivered more than $1 billion in revenue for the second quarter in a row, up 23% year-over-year. Optane gained momentum during the quarter, mostly on client strength, shipping over 1 million client Optane memory modules. We expect the memory segment to have full year profitability in 2018 as we scale revenue and transition a higher percentage of our output to a cost-effective 64-layer 3D NAND. +PSG's revenue came in at $517 million, up 18% in Q2, primarily from strength in the data center business. PSG's data center segment was up 140% over last year. In the Advanced products category, our 28-, 20- and 14-nanometer solutions grew 70%. Operating profit was $101 million, up 4% year-over-year. +Finally, the Client Computing Group continued to execute on all fronts with another outstanding quarter, generating $8.7 billion of revenue, up 6%. Operating margin percent was flat year-over-year as the customer preference for high-performance products drove a strong mix and higher ASPs, offset by 10-nanometer ramp costs. +DCG continues to be an extremely important source of IP, scale and cash flow for our company. +We are executing to our capital allocation priorities of investing organically, expanding acquisitively and returning capital to our shareholders. Year-to-date, we generated $13.7 billion in cash from operations, we invested $7.4 billion in capital expenditures and delivered $6.3 billion in free cash flow, up 61% over the first half of last year. +We returned well over 100% of our free cash flow to our shareholders. Buybacks totaled $5.8 billion and dividends totaled $2.8 billion. In addition, settlements of our convertible debt reduced fully diluted shares by 12 million. +Shifting gears to our full year outlook. Our strategy is working. Our products are winning and our investments in data center growth are paying off. We are now forecasting the midpoint of the revenue range at $69.5 billion, up $2 billion versus our expectations in April. This represents a $4.5 billion increase versus the expectations we set in January. Product innovation, a strong global economy and U.S. tax reform are spurring CIO investment in IT infrastructure, leading to higher data center demand and a stronger PC TAM. +We are seeing demand signals in supply feasibility to deliver on our revised expectations. Our biggest challenge in the second half will be meeting additional demand, and we are working intently with our customers and our factories to be prepared so we are not constraining our customers' growth. +Data center growth is now expected to be approximately 20%, up from our April guidance of high teens. We now expect operating margin of approximately 32%, an increase of 1 point from April. We remain on track to our 30% spending goal, a full 2 years ahead of our original target. +Gross margin is expected to be up slightly versus our April guidance on broad-based business strength. And we expect a full year tax rate of roughly 12.5%, down slightly from our prior estimate. +Overall, we expect stronger top line growth, improved operating margins and stronger demand will boost EPS to $4.15, up $0.30 from our estimate in April. +In response to the stronger demand, we are raising gross CapEx $0.5 billion to $15 billion or $13 billion net of memory prepayments. And we are now expecting free cash flow of $15 billion, up $0.5 billion from April. And we expect free cash flow per share as a percentage of EPS to improve by more than 10 points over last year. We remain intensely focused on closing the gap between free cash flow and EPS and expect to make more progress next year. +For Q3, we are forecasting the midpoint of the revenue range at $18.1 billion, up 12% year-over-year. We expect operating margin of approximately 34%, flat versus last year, which reflects about a 1 point decrease in gross margin and a roughly 1 point decline in spending. +We also expect EPS at $1.15, up 31%, excluding equity adjustments from stronger top line growth, spending reductions and a lower tax rate. +Again, last week, we celebrated our 50th anniversary and reflected on the impact Intel and our ecosystem partners have had on the world. It has been nothing short of extraordinary. At the same time, we are even more excited about the role Intel will play in technology's future. We're laser-focused on Intel's opportunity, which is larger than it has ever been. Intel's inventiveness, architectural innovation, manufacturing expertise and intense drive have allowed the company to create and capitalize on opportunity over the long haul. From the early days of DRAM to the era of the first microprocessors, from one architectural battle to the next, and from the PC to the Internet to the cloud, Intel has grown and thrived. I'm very excited about what lies ahead for the company. +With that, let me turn it over to Mark and we'll get to your questions. Thank you. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [4] +-------------------------------------------------------------------------------- + + All right. Thank you, Bob. Moving on to the Q&A. (Operator Instructions) +Operator, please go and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of C.J. Muse from Evercore ISI. +Our next question comes from the line of Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Bob, on 10-nanometer progress, any color on what you are doing. And systems you mentioned on shelves for second half '19, I assume that's mostly PC Client. Any sense to when we can think of timing for your server products on 10-nanometer also. + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [3] +-------------------------------------------------------------------------------- + + This is Murthy. I'll take that one. We continue to make progress on 10-nanometers. Yields are improving consistent with the time lines we shared in April. And yes, you're quite right. The systems on shelves that we expect in holiday '19 will be Client systems with Data Center products to follow shortly after. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + So good progress on 10-nanometer and what we think is a very good lineup on 14-nanometer products for next year on both client and server that we think will deliver best-in-class performance as we continue to ramp 10. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [6] +-------------------------------------------------------------------------------- + + A quick follow up on 10-nanometer. When you -- when I look at this time line between now and (inaudible) season next year, 18 months is a very long time to improve your yield. And I have 2 questions on this one. The first one is, could you give us some color on what are the most challenging aspects of the process that you need to address to improve yields? What's the most challenging dynamic or process? And then my second question is how do you think about the impact of this delay on your competitiveness? Where do you think it is going to hurt you the most? + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [7] +-------------------------------------------------------------------------------- + + So let me take that. I think as we look at what we need to do in 10 nanometers, again, let me replay some of the data we shared on our April call. Recall that 10 nanometers strive for a very aggressive density improvement target beyond 14 nanometers, almost a 2.7x scaling. And really, the challenges that we're facing on 10 nanometers is delivering on all the revolutionary modules that ultimately deliver on that program. And while there's risk and a degree of delay in our time line on that where we're very pleased with the resiliency of our 14-nanometer road map where in the last few years we've delivered in excess of 70% product performance improvement as we move through our 14-nanometer generation of products. So as we look at 2019, across both client and data center space, we feel very good about the product competitiveness of our 14-nanometer program. And that, to some degree, is factoring into our timing of 10-nanometer and launching 10-nanometer at a point in time where we believe the yields are at a level that make it prime for volume production. So 14-nanometer, I think through the rest of this year and through 2019, continues we believe to drive product leadership across all our portfolios in clients and server. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer from Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [9] +-------------------------------------------------------------------------------- + + Just relative to your data center expectations now for the full year, I'm just kind of curious what's been the biggest driver. You're kind of decelerating to mid-teens in the back half of the year, which is still very impressive. And I guess, as you talk about the question, maybe Navin can chime in. Once again, enterprise is much better than expected. And the 10% growth, I think, is what you referenced year-over-year in the June quarter. To what extent is that going to be more sustainable as you look into the second half of the year and into 2019? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + Yes, thanks, John, I'll start and then have Navin chime in. Q2 data center growth was outstanding. We kind of started -- when we talked to you back in April, we started the quarter out strong. The middle of the quarter was strong and the end of the quarter was strong. So 27% top line growth for data center was -- we feel very good about it and see that momentum continuing into the second half of the year. As you know, Q4 last year was an outstanding year, so we had slightly tougher comps in the fourth quarter. But we're looking at real strong growth for the full year. And as I indicated earlier, the strength was across the board: cloud, up over 40%; comms services, up 30%. And specifically to your question, enterprise strength continues. And not only volume, but the trajectory of Xeon Scalable and the adoption of Xeon Scalable has accelerated a little bit beyond what we expect to driving real good ASPs. So real good first half, strong outlook for the second half and slightly tougher -- strong outlook in the second half across the board and then slightly tougher comps as we go into Q4. + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [11] +-------------------------------------------------------------------------------- + + The only thing I'd add to that, John, is that the demand is broad-based across all the segments that Bob talked about. And it's also broad-based in terms of our product portfolio. Xeon Scalable, we launched about a year ago and it crossed over, getting close to crossing over at about 50% of our volumes. So a lot of room still to go on Xeon Scalable as we look forward. And as I think about the product portfolio beyond Xeon Scalable, you might have seen this week at the Google Next show, Google talked about adopting the Optane persistent memory DIMM, so we have that product portfolio ahead of us in the second half. And then our next-generation Xeon will begin to ramp in the early part of '19. So general macroeconomic, all segment growth, people applying information technology to handle their data problems, combined with a very strong product portfolio as we look forward. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [13] +-------------------------------------------------------------------------------- + + I guess, one question. I wanted to ask about gross margins. Your full year guide implies a very significant deceleration of gross margins in Q4, like 300 bps sequentially, down about 59%. Can you talk about what's driving that sequential decline from Q3 to Q4? And do those drivers sustain into 2019, for example, is it 10-nanometer or mix or whatever? Can you give us some color on what's going on there, please? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + Yes. Thanks, Stacy. First, I think the first half to second half dynamics, we're looking at an operating margin improvement by 1.5 to 2 points. So we see good solid op margin growth first half to second half. The dynamics are the gross margin, we expect to come down a bit and be more than offset by good volume leverage on a relatively stable spending base. So that trend of modest gross margin erosion more than offset by spending leverage driving op income improvement is the trend that you've been seeing for the last 6 to 8 quarters, and we expect that to continue into the second half of the year. When you look at -- implied in our guide for Q4, in particular, couple of things going on. One, accelerating growth of modem as we go through the second half of the year, accelerating growth of NSG or memory as we go through the second half of the year. A, we haven't assumed the continued strong ASP performance that we've seen through the first half. We hope that turns to be conservative, but we'll see how that plays out. And then, lastly, to your point, and Murthy mentioned earlier, we're ramping up 10-nanometer to improve the yield. So that's going to weigh on gross margins for the fourth quarter as well. So all things equal, we feel good about op margin expansion. We're up 500 basis points in the quarter. We'll be up another couple of points first half to second half, but the gross margin dynamics will weigh on us in the fourth quarter and spending will more than offset it. As we go into 2019, I think the way we've been running the business for the last few years, we have dramatically expanded our TAM. And with that TAM, we see more and more opportunities to invest and grow, and that growth is driving improved earnings for the company. At the same time, some of that growth has lower gross margins. But that expanded TAM, the higher revenue growth on a very well-controlled spending base is expanding our op income dollars and our earnings per share. So we feel pretty good about where we are as we exit 2018 and head into 2019 in terms of operating income for the business. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [16] +-------------------------------------------------------------------------------- + + I want to go back to the DCG side of things. Obviously, the 27% year-over-year growth in 2Q is very impressive in both its magnitude and its breadth. But I get a ton and an increasing amount of questions about competition, whether it's direct competition in the x86 CPU side of things or if it's a more indirect competition for a greater TAM from accelerators and FPGAs and the GPU compute, those sorts of things. So I don't know if it'd be Murthy or Navin, but I'd love to hear how you guys are looking at competition. And if you've taken the 10-nanometer aspect of competition and 7-nanometer for those folks off the table, talk about the design side where you think you can take share or there might actually be some pressure, and in general, how Intel reacts to the optimism we're hearing from a number of your aspiring new entrants. + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [17] +-------------------------------------------------------------------------------- + + Sure, I'll take that. It's Navin here. Look, we feel great about our competitive position. We came in to 2018 expecting a competitive environment. And against that backdrop, you've seen the results we've delivered over the last 2 or 3 quarters, and this is our third consecutive quarter above 20% growth. And really, that reflects our investments that we've made over several years. We have a leadership road map, not just in CPUs, but in, as you pointed out, a broad set of additional silicon, from ASICs to FPGAs to silicon photonics to memory. And our approach, really, has been to, over time, increasingly stitch all of those assets together to deliver a better solution for our customers. And that really sets us apart from everyone that we're competing with where one or another may have one of those solutions, but very few have -- in fact, none have that broad portfolio that we've been pursuing. So we are going to be aggressive in competing. We're going to have to go out and earn the business, just like we always have every day, every week, every month. And as I look at our road map now and as I look at our road map in the second half and as I look at our road map into 2019, I'm very confident that we continue to maintain that leadership on that broad portfolio of products. So we're set up for a great second half and another strong growth year as we head into 2019. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + The one thing I'd add, Ross, is on the accelerator side, particularly the FPGAs. 18% growth for FPGAs in the quarter, and as we mentioned earlier, real strong penetration in data center. So that growth has been fueled by 140% increase in PSG in the data center environment. So I think, Navin, if I could, had a choice to make when he took over in the data center business and it was protect our large microprocessor share or dramatically expand the market and both protect our share as well as participate in a much bigger market, and that's how he and the team have been focused. And that's resulted in both protection of CPUs, but expansion of share, and a much broader TAM. So again, I'll just close with we feel great about what the team is doing in expanding the role we play in the data center and at the edge. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [20] +-------------------------------------------------------------------------------- + + I just want to ask you about 7. You mentioned 10 and timing there and I don't expect you to put a date out there for 7. So maybe you can talk about what you've learned on 10, how you're applying it to 7 and any indications of that development, how it's going. + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [21] +-------------------------------------------------------------------------------- + + Sure, Blayne. So 7 is very much R&D in deep progress and we're making good progress on that development. We're not giving a direct time line right now. But we've also made some fairly judicious choices in defining 7, learning from our 10-nanometer experiences. And we're focusing on an optimum balance point between density, power and performance and schedule predictability. So I think what you'll see is a more balanced approach across those 3 vectors. So we're still going to drive density, but balancing that with a continued focus on driving transistor performance at the same time, which is highly valued as ASP drivers, both in our client and server businesses. And we're really also focusing on being much more precise in our ability to launch. So those are the key learnings that are coming out of 10 as we go into 7. And as we monitor progress on 7 just as closely as we are on 10, I feel those lessons are being well absorbed into our progress. And we're lining up to support our product plans as our road map dictates. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [23] +-------------------------------------------------------------------------------- + + I actually want to go back to the question about gross margins in Q4. And I wanted to see if you can segment out the pieces because it seems like the modem piece could maybe be a 200 basis point hit just by itself. So I wondered if you could maybe segment out some of the pieces between 10-nanometer, between the modem and between ASP. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes. I presume by segment out, you mean quantify, and my answer's probably unfulfilling if that's the case. But I think you hit on the 3 things. And as we go into the -- as we enter the second half and the fourth quarter in particular, we see modem accelerating. We have a great product that's getting good traction in the modem space, so that product's accelerating and that obviously has margins a little lower. NSG growth accelerating. Going into the fourth quarter, those margins are a little bit lower. 10-nanometer ramping, and that will weigh on gross margins. And lastly, just our outlook for ASPs. ASP has been a significant contributor to our high gross margin performance over the last couple of quarters. Now we've assumed that it won't kind of stay at those levels. So those are the 4 components of segmentation. And then I just go back to with this high growth, we're getting really good leverage and expect our operating margins to improve as we go to the back half of the year. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [26] +-------------------------------------------------------------------------------- + + I was wondering, so DCG, you guys have had an 11% ASP increase. And I know there's a lot of noisiness to that, but it's about double what you've sort of averaged over the last few years. Is that a Purley effect? And if so, do you sort of anniversary that and have less of an ASP increase going forward? Just how should I think about the price increase as you've seen there on average? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes, Joe. The ASP strength that we've seen, actually, really most of it this year is sort of a reflection of what we see our customers doing across the board. All of them are buying our highest performance products. There's sort of this insatiable appetite for performance on all the workloads that they're looking at. Certainly, we did expect the transition to Purley to be accretive to us from an ASP point of view. But if I look at our broad portfolio of products, our ASPs look very good. And year-on-year, our ASPs look good in the other parts of our products as well, Broadwell, for example. So in general, we're just seeing an almost insatiable appetite for the best products, the highest-performing products that we have. I don't see that slowing down as I look forward. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava from BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + I just wanted to go back to the comments you were making as you were concluding your prepared remarks about demand challenges in the second half. Is that specific to Clients? Servers? And where is that coming from? And then, more importantly, does that open up another -- or a window for a competitor to wedge in and take some share from you? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes, when we started the year, our outlook for the year was $65 billion in revenue. And 6 months through the year, given strong demand across the board, actually, both servers and PCs. Real strong demand has raised our outlook by $4.5 billion for the year. So we feel very good about the demand signals we see at the $69.5 billion level. We feel very good about having the supply in place for that fairly significant demand increase. And now as we go to the back half of the year to the extent demand continues to increase, which I'd say it has almost month-to-month the first 6 months of the year, we need to work with our customers and our fabs to make sure that we continue to have the capacity to fill demand to the extent that it rises beyond the $69.5 billion level. So we're working closely with our customer base, both on the server and the PC side, and very closely with our internal teams to make sure we're not a constraint to the extent that demand in the second half of the year continues to go up like it has through the first 6 months of the year. And our intent is to fill that demand along the way and not give others the opportunity to fill it for us. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Chris Danely from Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [32] +-------------------------------------------------------------------------------- + + Just a quick one on the DCG op margins. So Data Center rev was up sequentially, but the op margins were down. I think you talked about the 10-nanometer yield issues. Was that all that was going on there? And so essentially, our DCG operating margins kind of capped at this 49%-and-change level. What -- when are these 10-nanometer headwinds going to go away and reverse and start to become tailwinds? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + Yes. So just maybe repeat, 27% top line growth and 65% operating income growth with an 11-point improvement in operating margins year-on-year. So outstanding performance on product margin, as Navin indicated, particularly with strong ASP performance, our margins have continued to improve and I'd just say not at the expense of curtailing investments for data center business. We see real good growth opportunities and we continue to invest. So really good expansion in margin performance while continuing to invest. In terms of 10-nanometer, that is more -- again, with client being first on 10-nanometer, they are more feeling the effect of the 10-nanometer on their margins. That's relatively de minimis effect for the DCG business. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Christopher Rolland from Susquehanna. + +-------------------------------------------------------------------------------- +Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [35] +-------------------------------------------------------------------------------- + + Murthy, you might have actually answered this with your shortly after comment. But given some competitive threats in server in particular, are you guys thinking that you might ramp 10-nanometer server more quickly than you traditionally would after PC? + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [36] +-------------------------------------------------------------------------------- + + In general, we're going to see a much shorter ramp period between our products going forward in client and server. So yes, I think it's a good observation. But as we talk about our client systems on shelf by the second half of '18, you shouldn't expect too much of a delay before you see the data center products coming out. So much closer proximity albeit slightly delayed than we expected on 10, and then you should see that pretty much improve to almost parity of launch as we get into later technologies. So the traditional model of server following rather lengthily after client is probably going to become more sequential going forward. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question, we have C.J. Muse from Evercore back in the queue. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [38] +-------------------------------------------------------------------------------- + + Sorry about the gap earlier. A question for you on your evolving manufacturing strategy. It sounds like, as opposed to [copying exactly], we're moving to a world where you would consider building both 14 and 10 in the same factory. So curious what the implications of such a move are to gross margins and capital intensity as we look ahead. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Yes. I think, obviously, from node to node over the last several nodes, frankly, the capital intensity of the business with each node hasn't -- has increased over time. At the same time, the amount of reuse of equipment and tools from one node to the next is extremely high. So with the exception of particularly 10 going to 7 litho-changing quite a bit with EUV, with each node even with more capital intensity, we have relatively high reuse, then we can leverage the tools for longer and longer. So in terms of implications on gross margin, I'd just say it's a function of product leadership and maintaining that product leadership. And Navin talked about how customers are looking for high performance and the ASPs associated with that high performance allows us to continue to generate extremely attractive gross margins, despite increased capital intensity as you go to each node. + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [40] +-------------------------------------------------------------------------------- + + I just wanted to add to Bob's perspective. The way I look at our road map, what we're really focused on is delivering product leadership generation over generation, and that's at the system level. And while processes are very important part of that recipe, so are the other ingredients as well, such as product architecture, silicon design and packaging. And to Bob's point, as we look towards our road map, gross margin maximization is going to come from delivering excellence that drives performance, and therefore, we're taking a very balanced view on all the ingredients that go into that. So you should expect in our road map going forward a much longer overlap between generations of technology as we try and make sure that, along with process, we add the other ingredients of technology leadership that will become more and more apparent. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Kevin Cassidy from Stifel. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [42] +-------------------------------------------------------------------------------- + + Just looking at gross margin for the longer term, you named the 4 components. And as we look beyond fourth quarter, does modem gross margins improve? And is 10-nanometer less of a drag in the future? And can you kind of frame it, how long that would be? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + Yes. I mean, first, we've been -- our gross margin performance has been very strong, in the upper end of our kind of long-term gross margin target. So we feel pretty good about where gross margin sits today. In terms of modem in particular, yes, we do expect to improve gross margins for our modem business, both with our 7560 product that will begin to ship in the second half. But also as we migrate to a 5G world, we expect margins in the modem business to continue to improve. So yes, we expect modem profitability to improve. We don't see it at the 60-plus percent gross margin level, but we do expect it to be a contributor to earnings performance as we go forward. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Our final question for today comes from the line of Tristan Gerra from Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + So looking at the fact that you're ramping for the first time a very high volume non-x86 architecture, what are the longer-term implications of something that you haven't discussed much more recently, which is the custom foundry business for the medium term? + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [46] +-------------------------------------------------------------------------------- + + Yes. Again, while we haven't talked about it that much, the custom foundry aspects of our business still remain very particularly important to us. We believe that as we continue to explore growth and partnership opportunities in our data-centric businesses, the ability to develop custom silicon products together with our customers is going to become increasingly important. So as we see our customer relations going forward, you'll probably see a lot more codeveloped products using Intel process technology in order for their delivery and their interworking with the product portfolio that Navin talked about. So custom products through a custom foundry relationship remain a strategically important part of our customer engagement portfolio. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [47] +-------------------------------------------------------------------------------- + + All right. Thank you everyone for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Certainly. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2018-Oct-25-INTC.txt b/Transcripts/INTC/2018-Oct-25-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..6c3a94c5a9623949fcff665ab11c8f3c6c699d49 --- /dev/null +++ b/Transcripts/INTC/2018-Oct-25-INTC.txt @@ -0,0 +1,359 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Intel Corp Earnings Call +OCTOBER 25, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Robert H. Swan + Intel Corporation - Interim CEO, Executive VP & CFO + * Venkata S. Murthy Renduchintala + Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Weston David Twigg + KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to Intel Corporation's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. +And now I'd like to introduce your host for today's program, Mark Henninger, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. And welcome, everyone, to Intel's Third Quarter 2018 Earnings Conference Call. By now, you should have received a copy of our earnings release and the CFO earnings presentation that goes along with it. If you've not received both documents, they're available on our investor website, intc.com. The CFO earnings presentation is also available on the webcast window for those joining us online. I'm joined by Bob Swan, our interim CEO and Chief Financial Officer; and Murthy Renduchintala, Group President of the Technology, Systems Architecture & Client Group, and Chief Engineering Officer. Navin Shenoy and his wife are welcoming a new baby, and as a result, he won't be joining us today. In a moment, we'll hear brief remarks from Bob, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The CFO commentary and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. This summer, we celebrated our 50th anniversary, and this quarter was the best quarter in our 50-year history. Record quarterly revenue of $19.2 billion was up 19%. Our operating margins expanded 5 points, and earnings per share of $1.40 was up 39%. Our results were driven by incredibly strong demand and customer preference for the performance of our leadership products across the business. Our data center, client computing, Internet of Things, memory and Mobileye businesses all achieved record revenue. We expect 2018 to be the best year ever and our third record year in a row. +Before we get deeper into the financials, I'll take a few minutes to talk about our strategy, our products and our people. First, our strategy. We are growing share in a larger TAM, driving operating leverage while increasing our R&D investments and delivering attractive capital returns. Our thesis is that the massive growth of data worldwide will increase demand for the analysis, storage and sharing of data. We are one of the few companies that touches every part of the data revolution. And we've invested both organically and acquisitively to capitalize on these trends to accelerate the growth of the company while at the same time, delivering significant operating leverage and exiting noncore businesses. Our disciplined focus is delivering outstanding results. Demand in growth this year continue to exceed our expectations. Collectively, our data-centric businesses are up 22% year-to-date, led by growth in the cloud and communication service provider segments. +In both our data centric and PC businesses, our CPU leadership puts us in a great position to capitalize on this massive data opportunity by delivering more value to a broader set of customers. We've expanded beyond CPUs with memory, modems, FPGAs and silicon for emerging high-growth workloads like ADAS, artificial intelligence and 5G communications. We acquired Mobileye, which has integrated Intel Architecture to produce the industry's leading ADAS and autonomous driving platforms. Mobileye also just announced the ability to fully retrofit existing vehicles to deliver full autonomy, moving Mobileye further up the value chain. The acquisitions of Altera and Movidius are enabling us to partner with customers to expand the markets that they serve. They're developing new AI capabilities by combining our Core products with our FPGAs and VPUs. This is most evident in computer vision applications, which cut across all of our IoT verticals. +As a result, our opportunity has never been bigger. We are competing and winning share in a $300 billion TAM, transforming from a PC-centric company to a data-centric company in the process. We now expect full year revenue to grow more than $8.4 billion over 2017. And in the first 9 months of the year, we have returned $12.6 billion to shareholders in the form of buybacks and dividends or 112% of free cash flow. +We've also achieved outstanding growth in our PC-centric business. After 7 years of decline, we expect modest growth in the PC TAM this year, and we continue to gain share in modems. We've focused our investments in the PC sector and the areas where we see growth and where our performance leadership and differentiation matters most, the commercial, gaming and 2-in-1 segments. +Second, our products. Our strategy is delivering results because we have products that are solving our customers' problems. We're making the products we have even better and expanding our portfolio to deliver more value to customers. One of the most important things we do is collaborate with our customers and ecosystem partners to deliver exciting new computing experiences. We do that broadly with our OEMs. An example in our PC business was the launch of the stunning, new HP Spectre Folio, a 2-in-1 we worked closely with HP to develop. We leveraged our expertise in thermal tuning and motherboard miniaturization while achieving up to 19 hours battery life through power tuning and the use of Intel's low-power display technology. This sort of innovation is impossible without Intel's exceptionally broad range of IP and the scale and expertise to partner deeply with our customers on design. We also launched the new 9th Gen Intel Core desktop processors, including the world's best gaming processor. +In our data-centric businesses, we announced 95 new performance world records for Xeon Scalable and continue to see strong adoption while we work with customers to get ready for the transition to Cascade Lake. Cascade Lake introduces hardware-based side channel mitigation, Intel DL Boost with 11x inference speed-up and a revolutionary new technology, Optane DC persistent memory. And we're deepening our engagement with customers on custom SKUs. In fact, we'll have 60% more custom SKUs in the Cascade Lake family than the prior generation. +We shipped our first revenue units of Optane DC persistent memory to Google, Microsoft and Alibaba, and we're already receiving great feedback. Microsoft reported a new performance record of 13.7 million IOPs using Xeon Scalable and Optane, a level they said they've never seen with any other platform approach. Customers also continue to choose Intel as a partner as they use artificial intelligence to transform their businesses. Taboola chose Intel Xeon over GPUs for a massive inference speed-up and scale out across 7 data centers, delivering 360 billion content recommendations monthly. Rolls-Royce will design autonomous ships running inference on Xeon and are evaluating more of our portfolio in a multiyear engagement. +Mobileye customer momentum continued with 8 new design wins at major U.S. and global automakers, bringing our 2018 design win total to 20. Mobileye also shipped 3.3 million EyeQ SoCs in the third quarter, bringing lifetime total to more than 33 million units. +While our current product lineup is compelling, our road map is even more exciting. We continue to make good progress on 10-nanometer. Yields are improving, and we're on track for 10-nanometer-based systems on shelves during the holiday 2019 selling season. The breadth of IP we've assembled, combined with Intel's design, software, packaging and manufacturing capability, gives us an unmatched ability to invent the industry's future. +Third, and most importantly, our people. Intel has amazing talent, including world-class scientists and engineers, and we are making excellent progress toward our commitment to a fully representative workforce. Intel employees are at their best when they're working together to address challenges. And faced with explosive and unexpected demand this year, they've exhibited incredible problem-solving skills to deliver this quarter's results. The PC TAM has returned to growth, and our data center business is growing at more than twice the rate we expected in January. Our full year revenue outlook is now more than $6 billion higher than our January forecast. And we have supply to support this revised guidance, thanks to outstanding responsiveness from our factory teams. +We are focused on doing everything possible not to constrain our customers' growth. We've increased our CapEx by $1.5 billion since January to a record $15.5 billion. We've repositioned some 10-nanometer capacity to 14-nanometer, and we're making progress with our 10-nanometer process technology. +Supply is tightest at the entry-level of the PC market and in our IoTG business. Within our CPU product lines, we're prioritizing the production of our Xeon and Core processors so that we and our customers can serve the high performance segments in the market. Our biggest challenge in Q4 will be meeting any additional PC and IoTG demand beyond our guidance, and we do expect fourth quarter upside from here will be limited. +Summing it up, our strategy, leadership products and amazing people combined to produce the best quarter in the company's history. We're well on track to another record year. +With that, let's turn to the details. Third quarter revenue of $19.2 billion was up 19% year-over-year. Our data-centric businesses were collectively up 22%, and our PC-centric business was up 16%. Outstanding business performance, continued operating leverage and a lower tax rate resulted in non-GAAP net income of $6.5 billion, up 34% year-over-year. EPS of $1.40 was up 39% year-over-year. +Year-to-date, we have generated $11.2 billion of free cash flow and returned $12.6 billion to shareholders, including $4.2 billion in dividends and $8.5 billion in buybacks, repurchasing 167 million shares. We continue to see strong momentum in our business and are raising our full year revenue guide by $1.7 billion to $71.2 billion. We are also raising our EPS guide by $0.38 versus July to $4.53 and our free cash flow guide by $500 million to $15.5 billion. Our revenue guidance for 2018 is up greater than $6 billion versus our January expectations as we focus on a strong finish to a record year. +Our leadership products continue to win share in our expanded TAM as both our data-centric and PC-centric businesses grew at double-digit rates this quarter. Our data-centric businesses were up 22% as customers choose our performance products to move, store and process more data faster from the cloud to the edge. And our PC-centric business was up 16% as we saw continued strength in the commercial and gaming PC segments and grew modem share. +Operating income increased by more than $2 billion with margin up 5.1 points year-over-year in the third quarter, marking our highest operating margin percentage since 2011. EPS climbed to $1.40, up 39% year-on-year. Our EPS improvement was driven by growing demand for high-performance products in the data center and client businesses leading to higher volumes and ASPs, continued growth in our adjacent businesses, a lower tax rate and lower share count as a result of buybacks. +Our focus on operational efficiency continues to produce strong results. We now expect full year spending as a percentage of revenue to be approximately 29%, down about 7 points since 2015 while R&D is up $1.4 billion over the same period. We continue to improve our leverage while increasing investment in our key priorities such as product leadership, artificial intelligence and autonomous driving. Disciplined spending with a focus on prioritizing the most important investment opportunities is a key lever in magnifying our revenue opportunities and it's apparent in our results. Over the last 3 years, we've grown annual revenue by nearly $16 billion while adding less than $600 million in spending, resulting in a more than 25% increase in revenue per employee. +Now some Q3 performance highlights by segment. The Data Center Group delivered its first $6 billion revenue quarter as it shipped more than 8 million CPUs into an annual server, storage, network and CPU TAM that is greater than 30 million units. Revenue of $6.1 billion was up 26% year-over-year, and operating income of $3.1 billion was up 37% year-over-year. Q3 operating margin was 50%. And we continue to see strong acceleration in both the cloud and comms service providers segments, which make up more than 2/3 of DCG revenue. Platform unit volume was up 15%, and ASPs were up 10%. Non-CPU adjacencies grew 14% over last year. The cloud business grew 50% year-over-year with strong growth trends across our diversified customer base. Our comms service providers segment grew 30% year-over-year as customers continue to transform their networks with Intel Architecture as they prepare for 5G. And our enterprise segment was up 1% year-over-year as a strong IT spending environment continued with CIOs prioritizing investment in private and hybrid cloud implementations. +Our other data-centric businesses, IoTG, NSG and PSG, achieved solid growth in the third quarter and together were up 13% year-over-year or 17%, excluding Wind River. Our Internet of Things business achieved record revenue of $919 million on broad business strength, up 8% or 19% excluding Wind River. Operating profit was $321 million, up 120% year-over-year on growing demand and revenue scale. Mobileye had record revenue of $191 million, up approximately 50% over last year as ADAS adoption continues to accelerate. +Our memory business delivered record revenue of $1.1 billion, up 21% year-over-year as we continue to redefine the storage paradigm with industry-leading, low-cost, high-density NAND SSDs and the revolutionary performance of Optane drives. We have now reached the crossover point with 50% of our data center and client SSDs shifted to cost-effective, 64-layer 3D NAND, leading to rapidly improving cost per gigabyte. At the same time, as a result of pursuing 3D XPoint development independently and a tougher NAND pricing environment, we now expect NSG to be approximately breakeven for the full year. +Micron recently announced their intent to call the IMFT factory. Our agreements with Micron ensure a reliable and cost-effective supply of 3D XPoint through at least 2020. And we have developed internal manufacturing options, which can be executed well within that time frame. PSG's revenue came in at $496 million, up 6% on strength in data center and comms segments. PSG's data center segment was up 45% over last year. +In the advanced products category our 28-, 20- and 14-nanometer solutions grew 55%. Operating profit was $106 million, down 6% year-over-year. +Finally, the Client Computing Group delivered exceptional results with its first $10 billion quarter, up 16% year-over-year. Commercial and gaming demand continued to be very strong. The notebook segment grew 13% year-over-year. The desktop segment grew 9% year-over-year. And client adjacencies grew 66% year-over-year, led by the 131% growth in our modem business. +Operating profit grew $932 million year-over-year, while operating margin up 3.7 points. Leadership product performance and segmentation contribute to strong mix and higher ASPs. +The investments we have made in the business organically and through acquisition are delivering excellent cash flow generation. Year-to-date, we have generated $22.5 billion in cash from operations. We have invested $11.3 billion in capital expenditures and delivered $11.2 billion in free cash flow, up 57% over the first 3 quarters of last year. During this period, we returned 112% of our free cash flow to our shareholders. Buybacks totaled $8.5 billion, and dividends totaled $4.2 billion. In addition, settlements of our convertible debt reduced fully diluted shares by $22 million. +Now turning to our full year outlook. We started the year in January expecting to generate $65 billion in revenue, 30% operating margin and $3.55 in EPS. 9 months later, the growth that we and the industry has seen has been remarkable. We couldn't be more pleased that in an increasingly competitive market, our customers are choosing Intel. Our leadership products are winning across our data-centric businesses, and we're seeing strong demand upside in the client business that not long ago many thought was in perpetual decline. +We are now forecasting revenue of approximately $71.2 billion, up $1.7 billion versus our expectations in July. This represents a $6.2 billion increase versus the expectations we set just 9 months ago. We now expect data-centric growth to be approximately 20% year-over-year and PC-centric growth to be around 9% year-over-year. Our outlook for operating margin is approximately 34.5%, up 2.5 points from July as we now expect to deliver 29% spending to revenue, not only hitting our original goal 2 years early, but beating it. We expect the full year tax rate of around 12%, down slightly from our prior estimate. +Overall, we expect strong top line growth and improving operating leverage will drive EPS to $4.53, up $0.38 from our estimate in July. As a result of increased demand, we are raising our forecast for gross CapEx to $15.5 billion or approximately $14 billion net of memory prepayments. We are now expecting free cash flow of $15.5 billion, up $500 million from July. +For Q4, we are forecasting revenue of approximately $19 billion, up 11% year-over-year. We expect operating margins of approximately 34.5% and gross margin of approximately 62%. We also expect EPS at $1.22, up 38% excluding equity adjustments from business growth, spending leverage and a lower tax rate. We expect DCG to set another revenue record of approximately $6.3 billion in the fourth quarter. Due to supply constraints, we anticipate IoTG revenue will be down approximately 15% sequentially. +As we look forward to 2019, we expect to deliver another record year for the company. We'll have more to say about 2019 in January, but we're expecting that our operating margin percentage will be approximately flat next year. We expect gross margins to remain in the upper half of our historical 55% to 65% range. And while we expect 2019 gross margin percentage to be down slightly from Q4 '18 levels as we continue to gain share in our adjacent businesses and we ramp our 10-nanometer process, that will be offset by increasing OpEx leverage as we continue to make thoughtful trade-offs and invest in R&D that will accelerate our growth and profitability. And we expect the full year tax rate to be up a couple points following several beneficial discrete events in 2018. +Five years ago, we set out to transform Intel from a PC-centric company to a data-centric company. Today, our strategy, our products and our people are delivering on that ambition with strong growth, record results and the largest TAM opportunity in the company's history. And we're just getting started. +With that, let me turn it back over to Mark and we'll get to your questions. Thank you. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [4] +-------------------------------------------------------------------------------- + + All right. Thank you, Bob. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + On the competitive front, with your nearest competitor rolling out a second generation, 7-nanometer server product next year, I guess first question is, is the Intel team still on track to roll out its second-generation Xeon family, the Cascade Lake at the end of this year? And if you could just help us understand, what are some of the performance and portfolio differentiators that are going to help the team maintain relatively strong share in the server segment, 2019 and beyond? + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [3] +-------------------------------------------------------------------------------- + + Yes. Harlan, this is Murthy. Let me take that one. Yes, you're correct. We still intend to be making first shipments of Cascade Lake by Q4. And we're really excited with the stockpile of new features we have lined up for that platform, primarily the support of our Optane persistent memory that we'll launch in conjunction with Cascade Lake as we enter early 2019, we believe that will be a significant uplift in performance. We will also have a dedicated instruction set extensions to support artificial intelligence workloads. And we'll have continued generation over generation CPU improvements. So all in all, we think that Cascade Lake represents a power-packed addition to the data center road map. And of course, we have further excitement towards the end of next year as we launch our Cooper Lake platform as well. So we're really excited about the lineup we have in our DCG road map for next year and indeed, as you said, for the end of this quarter. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [5] +-------------------------------------------------------------------------------- + + Bob, you've done a great job in managing OpEx since coming on board. You talked about further leverage into 2019. Can you remind us which areas of the business you're deemphasizing from a spending perspective? And how should we think about the balance between R&D and SG&A in 2019 and beyond? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [6] +-------------------------------------------------------------------------------- + + Yes. First, I think the progress we made has been a team sport. And as I indicated in the prepared remarks, we're down 700 basis points from 2015. And during that time frame, it's not been at the expense of R&D, it's -- on the contrary, R&D has been -- has grown $1.4 billion during that time frame. So really, the underlying dynamics is we've made trade-offs to invest in higher growth segments of the business. That growth is, in fact, accelerating. And from that accelerating growth, we've been extremely disciplined on getting leverage on our SG&A, and we've exited some, what I'd characterize, noncore businesses. During the course of this year, we exited Wind River. We reduced our investments in wearables, products. And we exited these Saffron business as well. So as we go forward, we're going to continue to increase R&D. But -- and we're going to increase it in the areas that we think can generate differentiated growth for us. And from that growth, we expect to continue to get leverage as we go into -- as we enter 2019. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [8] +-------------------------------------------------------------------------------- + + Well, I wonder if you can just comment a little bit on when do you think the supply constraints will be over relative to your sort of capacity addition plans. And if I caught it right, it sounds like in the calendar fourth quarter, you're choosing to kind of shortchange the IoT Group. Does that mean that you're already kind of caught up in the PC market? Or how should we be thinking about that dynamic? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + First, John, as we mentioned earlier, the -- we were caught off guard a little bit this year by explosive growth well ahead of what our expectations were back in the beginning of the year. And that growth came from all different segments in the business. It put us in the unfortunate situation of constraining some of the demand signals that we were seeing from the market and our customer base. Our teams have done -- in conjunction with our customers, our teams have done an outstanding job in the third quarter and we project into the fourth quarter. And that has enabled us to increase our revenue outlook for the year by $1.7 billion. But I think as we go into the fourth quarter, given the demand signals we continue to see across the business, we, in fact, will be constraining growth. Our focus has been prioritizing in conjunction with our customers, Xeon and Core processors. And therefore, by definition, the lower end of PC and the IoT business is being constrained. So we are in a constrained scenario into the fourth quarter, both at low end PC and in IoT. As we go into next year and kind of the timing, we've put a lot of capital to work this year. It's a record year for CapEx for us at $15.5 billion. It's a $1.5 billion higher than what we expected entering the year. And we have kind of taken some of our 10-nanometer equipment tools and began to blow that back to meet the increased demand for 14. So we're working extremely hard to get back on track in 2019. But at this stage of the game, given the demand signals we've seen in the fourth quarter, we're going to be constrained a little bit. And we're trying to prioritize as best as we can with our customers. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava from Bank of Montreal. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [11] +-------------------------------------------------------------------------------- + + But one area you did not touch on was CapEx. And I'm asking if you could provide us some directional input on that on what we should expect for CapEx, specifically in light of the Micron call option and implications that has for your spend on the memory side. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes. I think on CapEx at the macro level as we think into '19, we expect logic CapEx to likely be a little higher, and memory CapEx, despite building self-sufficiency on Optane, to be a little bit lower. So at the macro level, those are the dynamics. The -- in terms of how it plays out on overall levels, it's still a work in process. And I'd characterize it, Ambrish, this way. First, it's going to be a function of growth. As we get clear around what growth looks like in 2019 for 14-nanometer, that will impact what the overall CapEx level is. Secondly, if we -- we've made some good progress on 10-nanometer yields over the course of the last 6 months. And as we progress through in the -- through the fourth quarter into 2019, if we're further ahead on 10-nanometer yields, that will influence the amount of CapEx next year. Third, our progress on 7-nanometer, how well we progress in 7-nanometer is also -- will influence how we think about CapEx. And last but not least, as it relates to memory, it's more the customer quals and adoption of our leading edge, 3D NAND 96-layer product as we continue to make progress on developing that. We may deploy that capital, and that pays for itself very quickly. So as we sit here today, CapEx -- I expect logic to be up, memory to be down. And as we look at those 4 things, all of which I'd characterize as being good things if we made progress on all 4 of those, that will influence the rate of CapEx spend next year. So we'll try to provide you a little more analytical color versus that qualitative cover in January. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [14] +-------------------------------------------------------------------------------- + + Wanted to get -- just give us a little more color on the PC numbers in the quarter. How much were you constrained by the shortages that you saw? And I guess, it looks like you grew a little bit more than seasonal on a sequential basis. And how much of the ASP lift that you saw do you think was a function of those shortages? And then just any color on could those shortages spread higher into this product stack over the course of Q4? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes, Joe. I think as you saw from the IDC and Gartner folks, growth for PC TAM in the quarter, probably around 1%. Our guess is it was probably a little bit stronger than that, 1% to 2% growth. And within that, we delivered 6% unit growth. So real strong unit growth and again, good ASP momentum. I would say in Q3, largely a function of customer collaboration in our fabs. I don't think we're too terribly constrained on the PC side to be honest with you. I think as we go into Q4 is where I think the constraints are impacting us a little bit more. So I don't think ASPs or supply constraints really -- we did not benefit from higher ASPs, nor were we constrained in terms of unit growth in the quarter. It's more a fourth quarter thing where demand signals remained relatively strong. And as you saw from our guide, while it's good year-on-year growth, it's relatively flat on -- overall on Q3 to Q4. And PCs -- low end of PCs and IoT will be impacted as we see the demand signals at this stage of the game. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Weston Twigg from KeyBanc Capital Markets. + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + I just wanted to ask a little bit. I get the demand's really good here in the back half of 2019, but with the trade war discussions, softening demand in China, some cycle risk indicators, are you seeing anything or talking to customers that would indicate that there would be any first half 2019 risk to demand? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + Yes. It's a great question. I think at the aggregate level, there's what I'd maybe characterize as some decent tailwinds as we go -- as we exit the year and then go into '19 but also some headwinds. The tailwinds, we've -- as you know, we've been talking about an expanded TAM where we play a bigger and bigger role in the increased needs for data. And that larger TAM and the momentum we're building across all of our products is a pretty good tailwind as we look at just demand for data, whether it's with consumers or with businesses going into the new year. That's a tailwind. Secondly, Murthy mentioned a few of the products that we have coming in down the pipe in fourth quarter and going in the next year. And those products, we believe, will deliver more and more performance for our clients, which I'd characterize as a tailwind. And then third in somewhat of a perverse way, as you know, when PC was 70% of the business and when enterprise was 50-plus percent of the data center business and those were declining, it was the headwind for the company's growth. But those more recently have been stable. So whether it's our expanded TAM, our new products or the mix of our business, we have some tailwinds as we think about 2019. At the same time, to your point, there's some headwinds. And the headwinds, first, this has been a fantastic year for us and I think for the industry, and that just makes comps a little bit tougher as we go into next year. Second, we have growing competition. And growing competition can be a headwind for us. And our expectations are we'll deal with that pretty effectively. And third, just global trade. In particular, as you know, China's a big market for us. We got some important customers there, and it's important -- it's an important part of our global supply chain. So as that -- as this most recent round of tariffs kind of play out and we're doing a lot of work with our customers to ensure that the global supply chain can be adjusted and adapted to deal with any tariffs that come down the way, but it's -- I think it's going to be a wait-and-see as we go into 2019. At this stage of the game, we don't see any impact on 2018's results. And in 2019, we have what I'd consider a world-class supply chain team that can manage and weather the dynamics of changes in movements of goods better than anybody else in the industry. So I think that would be a competitive advantage for us as we go into next year. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Tim Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [20] +-------------------------------------------------------------------------------- + + I wanted to ask on the DCG. You're not specifically guiding it next year, but it sounds like you're still pretty bullish. And there's a lot of investors, I think, worried about a hyperscale CapEx slow down next year. So I guess, is it that you're bullish on CapEx next year? Or is it kind of more a commentary on product cycle, maybe Xeon Scalable beginning to catalyze kind of a server upgrade cycle? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + Well, I think, first, we've -- in terms of growth for next year in the aggregate, we haven't really provided any quantitative color, more qualitative cover in terms of the dynamics that we see. That being said, our DCG growth this year is projected to be north of 20%, real strong for the first 3 quarters of the year. So fourth quarter, we expect really solid demand. But it's on a tough -- much tougher comp because fourth quarter last year was a great quarter for the DCG business. As we go into next year, we got -- Murthy highlighted, we've got a good product road map of expanded features for Cascade Lake as we exit this year, Cooper Lake, middle of next year. And we have a much more diverse business now with -- obviously, cloud has been a big accelerant for us. I don't expect that it will grow at 50% forever. 50% was our cloud growth in the quarter. But at the same time, our comms and networking business growth has been accelerating quite a bit, and the stability we've seen in enterprise and government has really helped. So I think next year, we have a much more diverse business. We got a good product lineup and we'll provide a little more color as we get into January. But outstanding year, this year, for data center, both top line and bottom line. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [23] +-------------------------------------------------------------------------------- + + Bob, I want to ask on the gross margins side. First, thank you for the color you gave on 2019. But if I back it up a step, what's the headwinds in the fourth quarter sequentially? And then any big picture moving parts, 10-nanometer yields, mix, what have you that gives you the confidence that you could still stay in the upper half of that 55% to 65% range for 2019? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes, yes, great question. First, a little color on Q3, and then I'll walk from Q3 to Q4 dynamics. Yes, it's as the -- we highlighted in the materials, 60% -- almost 66% gross margin in the quarter is high as it's been for a very long time. And it was a function of a few things: One, continued volume leverage with full factories; two, ASPs, both on a client side and on the data center side. And those were partially offset by platform cost going up and a change in mix, a growth of our modem and memory business. So those are the 4 dynamics that played out during the course of the quarter. I would say 66% was artificially high, and I'd say that for a couple of reasons. One, we had in our -- in the NSG business, we earned a government incentive that was from scaling our fabs outside the U.S. So that incentive was worth about $110 million. So a bit of a one-timer that we don't expect to repeat itself. Secondly, sell-through of product, either -- on the CPU side, we're working with our customers and shaping demand to where we had inventory. We had good sell-through for some inventory that was previously partially reserved. And then second, on our modem growth, our explosive modem growth in the quarter. We PRQ'd that product in the third quarter. So we got the benefit of previously fully reserved inventory. So what all that means when you adjust for kind of one-timers, the 66% is closer to 64% in terms of normalized basis going into the fourth quarter. Our guide in the fourth quarter, to your question, is 62%. So there's really 3 dynamics that we see playing out in the fourth quarter. One, we expect ASPs to be better. And that's going to be a little bit of a function of the prioritization of Xeon and Core processors, which are higher ASP mix. So we expect that to benefit us. But at the same time, there's 3 other things that as we go into the fourth quarter that I'd characterized as really good things but will have an impact on our gross margin. One is ramping 10-nanometer. We're making good progress on 10-nanometer. Yields are improving, and that's giving us the confidence to, in effect, turn on more equipment and incur the depreciation cost associated with that. So that will impact our Q3 to Q4 gross margins. And it's a function of the progress we're making on 10-nanometer. Second, memory continues to grow, a good 21% growth in the third quarter. We expect it to continue to grow in the fourth quarter. And that has -- our NAND business has been profitable during the course of the year but not at the gross margins of our logic business. And then third, we're experiencing explosive growth on modem with some really good share gains. And the modem product is also -- the combination of memory and modem are accretive to our year-on-year earnings growth but dilutive to our gross margins. So that's the kind of Q3 adjusted gross margin going into Q4 will likely cost us roughly a couple points. As we then step back and think about 2019, those -- we see those same dynamics playing out, primarily 14-nanometer volume. So continued good yield, unit cost performance on 14-nanometer. We don't expect ASPs to be dramatically better in an increasingly competitive environment, but we don't expect them to be much worse. 10-nanometer costs will ramp. And we do expect to continue to grow memory and modem. It'll be accretive to earnings but a little dilutive to gross margin. So again, a fairly long-winded walk from what drove Q3. The goodness operationally of what will happen to Q4 gross margins has been our comfort that 2019 will be a modest degradation. But when coupled with the leverage on our operating expense, our operating margins will be kind of roughly flat in the 34% range. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [25] +-------------------------------------------------------------------------------- + + And operator, I think we've got time for 2 more questions. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Certainly. Our next question comes from the line of Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [27] +-------------------------------------------------------------------------------- + + Bob, just one more on 10-nanometer. You mentioned it's on track. Is there a way to kind of quantify progress on 10-nanometer over the last 3 months? And if you were to kind of go back to a similar time when you were getting ready to make the jump to 14-nanometer, are the 10-nanometer yields and cost behaving in a similar way? Just any color around progress would be helpful. + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [28] +-------------------------------------------------------------------------------- + + Vivek, let me take that. This is Murphy. First of all, as Bob said in his opening remarks, the progress we've made in the quarter is very much in line with our expectations. While we can't give any specific numbers, I do believe that the yields as we speak now are tracking roughly in line with what we experienced in 14-nanometer. So we're still very much reinforcing and reaffirming our previous guidance that we believe that we'll have 10-nanometer shipping by holiday of 2019. And if anything, I feel more confident about that at this call than I did in the call a quarter ago. So we're making good progress, and I think we're making the quarter-on-quarter progress that's consistent with prior generations having reset the progress curve. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Romit Shah from Nomura Instinet. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors [30] +-------------------------------------------------------------------------------- + + Bob, you've -- you said that progress on 7-nanometer will also be a factor driving CapEx next year. And I was hoping you could maybe talk about that a little bit more. When you talk about progress, is that a statement about yields meaning if 7-nanometer yields are improving, you could potentially deploy more CapEx to ramp that process note a little earlier? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [31] +-------------------------------------------------------------------------------- + + Well, it's -- we haven't really given a time line for 7, so to say it's ramping earlier would be a little bit of a stretch. But this is -- we've been investing in EUV for a while, and we've obviously been investing in 7-nanometer. And when we step back and think about CapEx for next year, again, it's a function of growth on 14. It's a function of the rate in which we scale 10, and it's a function of investments we'd make to begin to prove out 7 in a more meaningful way. So those are just the dynamics that we're looking at and thinking about as we get closer to giving you a more definitive guide for CapEx in '19. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [32] +-------------------------------------------------------------------------------- + + All right. Thank you all for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Certainly. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2019-Apr-25-INTC.txt b/Transcripts/INTC/2019-Apr-25-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..9d265e8655392a67bdcb2cdfbba4ad4ac5be6fca --- /dev/null +++ b/Transcripts/INTC/2019-Apr-25-INTC.txt @@ -0,0 +1,422 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Intel Corp Earnings Call +APRIL 25, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Robert H. Swan + Intel Corporation - CEO & Director + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the First Quarter 2019 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. Mark Henninger, Head of Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's Second Quarter 2018 (sic) [First Quarter 2019] Earnings Conference Call. By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our Investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online. +I'm joined today by Bob Swan, our interim CEO and Chief Financial Officer; Murthy Renduchintala, Group President of the Technology, Systems Architecture and Client Group and Chief Engineering Officer; as well as Navin Shenoy, Executive Vice President and General Manager of the Data Center Group. In a moment, we'll hear brief remarks from Bob followed by Q&A. +(technical difficulty) +We're having technical difficulties. Let me jump back in here. I'm joined today by our CEO, Bob Swan; our CFO, George Davis; and in a moment, we'll hear brief remarks from both of them, followed by the Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when we describe our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. With the interim introduction, I thought on our outlook I was getting demoted already. But look, coming off a record 2018, our top line results came in slightly higher than expectations, with upsides in the PC and IoT segments, offset by incremental NAND pricing weakness. Total revenue of $16.1 billion was flat year-over-year, as our PC-centric business grew 4% and our data-centric businesses were down 5%. The team executed well, though underlying trends are concerning, and as a result, we've revised our expectations down for the full year. +I'll give you some insight into the customer trends informing our outlook, but first, I'd like to take a few minutes to recap the progress we've made over the first quarter. It's been just under 3 months since I was honored with the best job in the world. At that time, I said that our leadership team would focus relentlessly on delivering for our customers to take advantage of the biggest opportunity in our company's history. We're making important progress by intensifying our focus in 3 key areas: expanding our TAM, accelerating innovation and improving our execution while evolving our culture. I'd like to spend a few minutes talking about our philosophy and progress in each of those areas. +First, expanding our TAM. We are transforming from a PC-centric company to a data-centric company, and our ambitions are bigger than they've ever been. Our aim is to identify and capitalize on key technology inflections that set us up to play a larger role in our customers' success while improving returns for our owners. You can see the impact of this approach in our Q1 execution. +For example, our first-ever data-centric portfolio launch marked an important milestone in our efforts to capitalize on the AI opportunity and undisputed technology inflection. Our new second-generation Xeon Scalable is the only processor in the industry with built-in artificial intelligence acceleration. Not only did we deliver a 14x generation-over-generation performance improvement, but we also showed CPU performance beating GPU performance on major AI workloads like recommendation engines. And we worked closely with the software industry ahead of the launch to deliver a great out-of-the-box experience for customers like Siemens. They're collaborating with us on a breakthrough AI-based cardiac MRI model. This application has the potential to provide real-time diagnosis using the DL Boost technology in our newest Xeon Scalable processor. +Another TAM-expanding business that continues to gain traction is Mobileye, with 8 new global ADAS designs in the first quarter alone, including our first win in India. Mobileye's real-time crowd-sourced mapping technology, Road Experience Management or REM, continues to build momentum with a major North American automaker adopting this breakthrough data-centric capability. Autonomous driving is a technology inflection that we're ready to lead. +2019 will be a foundational year for another disruptive technology, 5G. As you know, we recently sharpened our 5G focus. When it became apparent that we don't have a clear path to profitability in 5G smartphone modems, we acted. We are now winding down that business and conducting a strategic assessment of 5G modems for the PC and IoT sectors while continuing to meet our current 4G customer commitments. By acting now, we focus our 5G efforts on the transformation of the wireless network and edge infrastructure, where we have a clear technology advantage, market share to win and a strategic role to play with customers. +At Mobile World Congress, we demonstrated a range of 5G products under development, including the 5G-ready N3000 FPGA acceleration card and the new 10-nanometer-based Snow Ridge network SoC for use in 5G base stations. As networks cloudify, Intel is in a great position to win in this base station segment, where we expect to grow to 40% market segment share by 2022. The vast majority of the 5G market opportunity and profit is in the transformation of network and edge infrastructure, where we are now laser focused. +Next, accelerating innovation. Successfully competing in a bigger TAM requires a broad range of products and technologies. Only Intel has the breadth of IP to deliver leadership products across increasingly diverse workloads for the data-centric era. Harnessing data for discovery, invention and business value is not a one-size-fits-all computing challenge. That's why we are investing in 6 important pillars of innovation: process technology, architecture, memory, interconnect, security features and software. Already this year, we've introduced incredible examples of this approach to innovation across the business. Let me take a minute to talk about a few. +We are currently architecting what we expect will be the United States' first exascale supercomputer for the U.S. Department of Energy's Argonne National Laboratory. This supercomputer, called Aurora, will be delivered in 2021 and powered by Intel technologies designed specifically for the convergence of artificial intelligence and high-performance computing. These include a future generation of the Intel Xeon Scalable processor, Intel's Xe compute architecture, a future generation of Optane persistent memory and Intel's One API software. It's a great example of how our data-centric products architected together can deliver technology breakthroughs for our customers. +We are also accelerating innovation in our PC-centric business. For example, our team is hard at work with our OEM customers to define and deliver a stunning new class of next-generation laptops. We call this Project Athena, and the first of these sleek, beautiful designs are coming in the second half of 2019. And just this week, we launched the most powerful generation of Intel Core mobile processors ever, designed for gamers and content creators. +On the process technology front, our teams executed well in Q1 and our velocity is increasing. We remain on track to have volume client systems on shelves for the holiday selling season. And over the past 4 months, the organization drove a nearly 2x improvement in the rate at which 10-nanometer products moved through our factories. +Finally, execution and culture. This is about concentrating our resources on the vital few programs that will have an impact on our customers' success and our owners' return, rather than the trivial many. Over the last couple of years, that focus has resulted in exiting McAfee and wearables business, shutting down Saffron and divesting Wind River. And our spending as a percentage of revenue has gone from approximately 36% to about 30% this quarter. It has allowed us to invest more of our resources, and just as importantly, our collective attention and focus, where it really counts. By doing fewer things, we'll execute better at the things that matter most. +Specific areas where we need to improve execution include meeting customer demand and delivering on our 10-nanometer lineup of products, and we are making progress. Our supply constraints have had a disruptive impact on our customers and ecosystem. We've committed never again to be a constraint on our customers' growth. We've increased capacity to improve our position in the second half, although product mix will continue to be a challenge in the third quarter as our teams align available supply with customer demand. +As I shared earlier, our confidence in 10-nanometer is also improving. In addition to the manufacturing velocity improvement I described earlier, we expect to qualify our first volume 10-nanometer product, Icelake, this quarter and are increasing our 10-nanometer volume goals for the year. +I'll shift now to our full year outlook. Going forward, George will deliver our forecast. But given this is his third week with us, I'll share my thoughts on our full year reset and he'll review our first quarter results and second quarter guide. +Our conversations with customers and partners across our PC and data-centric businesses over the past couple of months have made several trends clear. The decline in memory pricing has intensified. The data center inventory and capacity digestion that we described in January is more pronounced than we expected, and China headwinds have increased, leading to a more cautious IT spending environment. And yet those same customer conversations reinforce our confidence that demand will improve in the second half. So we've reassessed our '19 expectations based on the challenges we're seeing. +Our full year outlook is now $69 billion in revenue, down 3% year-over-year and down approximately $2.5 billion from our previous estimate. Given the magnitude of change, we'll be somewhat more granular in explaining the drivers. We now see data-centric revenue down low single digits year-over-year, with DCG down mid-single digits year-over-year off a tough compare, continued China weakness and inventory and capacity absorption. We are also anticipating an incrementally more challenging NAND pricing environment. +Our PC-centric forecast remains unchanged at low single digits. We are forecasting operating margin to be 32%, down approximately 3 points year-over-year and down approximately 2 points from our previous guide. This outlook reflects lower full year revenue and a year-over-year decline in gross margins as a result of the 10-nanometer ramp and NAND pricing. +We continue to see good discipline on spending and expect our exit from the 5G smartphone modem segment, annualized in 2018 spending actions, and incremental spending efficiencies to reduce OpEx by approximately $1 billion year-over-year, partially offsetting the impact of lower gross margin. We now forecast full year EPS at $4.35 per share, down approximately 5% year-over-year and $0.25 from our previous guide. We now expect our full year tax rate to be 12%, up 1 point year-over-year and down 1.5 points versus our prior guide, largely as a result of lower pretax income. +Before I hand the call over to George, I'd like to welcome him as Intel's new CFO. I've known George for a long time from his CFO days at Applied Materials while I was a board member. He brings deep industry knowledge from prior roles. He's a true team player and he cares deeply about people development and diversity. George will review our first quarter financials and second quarter guide, then we'll get to your questions. George? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Bob, and good afternoon, everyone. I'm delighted to be at Intel and look forward to regularly engaging with our key stakeholders. +Revenue for our first quarter came in at $16.1 billion, flat year-on-year and slightly higher than our guide. Data-centric revenue was $7.5 billion, down 5%; and PC-centric revenue was $8.6 billion, up 4% year-on-year. Q1 operating margin was 28%, down 2 points due to cost of our 10-nanometer ramp and NAND reserves, partially offset by platform ASP strength as supply constraints at the low end in CCG led to an especially rich mix as well as lower spending overall. +Q1 EPS came in at $0.89, up 2% versus the prior year and $0.02 over what we guided for the quarter. Year-to-date, we have generated $1.6 billion of free cash flow; returned $3.9 billion to shareholders, including dividends of $1.4 billion; and repurchased approximately 49 million shares. +We are pleased with the team's focused execution for the quarter. We anticipated a challenging start to 2019, and that's what we have encountered. We also knew that the timing of our 10-nanometer ramp would pressure margins in the first quarter. And while we continue to make progress on the road map, that pressure remains a factor. +We see customers becoming more cautious in their buying patterns, with the most acute deceleration happening in China. Demand pressure is particularly evident in our data center business, where we are seeing a continuing inventory correction in enterprise and comms and capacity digestion among cloud service providers who ramped consumption strongly in 2018. +Non-GAAP EPS was up 2% year-over-year driven by strength in our client and IoT ASPs, lower spending, lower shares outstanding and the McAfee dividend received in the quarter. Offsetting factors were continued NAND pricing pressure, 10-nanometer ramp cost and weak enterprise and government data center demand. Our tax rate came in at 12.5%, up almost 1 point year-over-year due to nonrecurring benefits in Q1 of 2018. +We continue to improve our operating efficiency year-over-year from 32.4% to 30.3% spending as a percent of revenue. Total spending was down 7% year-over-year in the quarter as we drove efficiencies in our SG&A spending and kept R&D spending flat compared to the prior year. Within that overall flat R&D spend, we are making thoughtful trade-offs so that we can amplify the investments into key priorities to grow the business. This has resulted in more investment in 10-nanometer and 7-nanometer process technology and accelerating road maps in DCG and CCG and in key growth areas like autonomous driving, AI and 5G network infrastructure. +Let me now break down our performance by segment. Our Data Center Group ended the quarter with revenue of $4.9 billion, down 6% from the prior year and 19% sequentially within our expected range of sequential decline, given the headwinds we noted last quarter. Against the challenging year-over-year compare, platform units were down 8%. We saw record Xeon ASPs as customers continue to select high-performance products. We also saw a strong ramp of network SoCs, resulting in moderation of our blended platform ASP. +Non-CPU adjacencies were up 2% driven by strength in network ASICs and silicon photonics. Cloud revenue grew 5% year-over-year in the first quarter as cloud service providers absorbed capacity put in place in 2018. Enterprise and government revenue declined by 21%, and comms service provider revenue declined 4% year-over-year in the first quarter as both enterprise and comms customers worked through inventory and China demand weakened. +Overall, our data-centric businesses were flat year-over-year. Our IoT businesses saw 19% revenue growth adjusted for Wind River and operating income growth of 11% year-on-year due to a mix shift to higher core products in the quarter, with the growth of compute-intensive applications like AI and computer vision. +Mobileye had record revenue, up 38% due to an extended -- expanded product portfolio and customer base. Our memory business was down 12% due to continued NAND pricing pressures, offset by NAND data center and client bit growth. Operating income for this group is down driven by NAND ASP deterioration and demand softness, resulting in inventory revaluations. +The PSG group declined 2% year-on-year due to weakness in cloud and enterprise, partially offset by strength in wireless and advanced node products. +The Client Computing Group showed continued growth, with revenue up 4% year-over-year. Platform revenue was up 3% driven by strength in large commercial and gaming. Modem drove the majority of strength in the adjacencies, resulting in a 26% increase over the prior year. We have added supply capacity and continue working closely with our customers to align our available supply to their demand. However, supply of our PC processors and chipsets remains tight, particularly for our small core products as we prioritize big core. We saw strong ASP growth in desktop and notebook in part due to the small core constraints, but also on strong performance in gaming. Constraints were also responsible for the year-over-year decline in volume. +This quarter, we generated $5 billion in operating cash flow, and we invested $3.3 billion to expand our 14-nanometer capacity and ramp 10-nanometer. We raised the dividend by 5% and repurchased 49 million shares. +Let me wrap up with our Q2 outlook. We expect Q2 revenue to be $15.6 billion, down 8% year-over-year. Our data-centric businesses are expected to decline in the high single digits year-over-year as memory pricing declines weigh on our NAND business and DCG customers continue to consume inventory and absorb capacity. We expect DCG to be approximately flat sequentially. The PC-centric segment is expected to decline in the high single digits on declining PC ASPs on a relative mix of more small core units. Operating margin in Q2 is expected to be 29%, down 4 points year-over-year on lower platform revenue, the 4G modem ramp and NAND pricing. +We forecast earnings per share of $0.89, flat sequentially and down $0.15 year-over-year. We expect the non-GAAP tax rate in the quarter to be 11.5%. +I will conclude here and turn the call back to Mark. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [5] +-------------------------------------------------------------------------------- + + Great. Thank you, George. After that eventful start to the call, we'll now move on to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first caller. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Certainly. Our first question comes from the line of Joe Moore from Morgan Stanley. +Our next question comes from the line of Aaron Rakers. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [2] +-------------------------------------------------------------------------------- + + Yes, as we think about the gross margin trajectory through the course of the year, I'm wondering if you could help us understand the delta between the impact of 10-nanometer ramping relative to kind of the impact that you're seeing. It seems like it's going to persist, related to NAND flash. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes, it's lots of movement going on in the gross margin line. I'd start by saying implied in our guide for the first half is roughly 60%, so it implies a little increase off of Q1. And our implied guide then for full year is almost 60%. So through all the ups and downs, there's going to be quite a bit of consistency. That being said, the Q1 will likely be the lowest, because as I indicated in my prepared remarks, that we're going to -- we intend to qualify the 10-nanometer part in the second quarter. So what that means is in the first quarter, all of our 10-nanometer cost is flowing through cost of sales. When we qualify, it goes on the balance sheet. And then when we sell those previously reserved units in the third quarter, those units go out with no cost. So the dynamics imply low Q1 and a much stronger Q3, but through it all, fairly stable at roughly 60% level. +On the year-on-year decline, obviously, the NSD -- sorry, NSG pricing is having a real impact on us. We expect NSG for the year to be down roughly 10% almost, and that is primarily driven by significant change in pricing dynamics during the course of the year. So that'll be a headwind for us throughout the year. +Aaron, sorry, I should probably add something, Mark. The one last thing is, as we indicated, we expect to have systems on shelf in the fourth quarter or for holiday season, so -- and that given the progress we've made on 10, we're going to be shifting more units in the fourth quarter than we previously anticipated. So all else equal, that implies Q4 would a little bit lower than the full year guide. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Once again, Joe Moore, your line is open. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [5] +-------------------------------------------------------------------------------- + + With regards to DCG being down mid-single digits for the year, I understand the issues in the first half. But it seems like the cloud guys were -- the CapEx has been okay, and I thought we had a little bit more snap back in the back half. Can you just talk a little bit more about the dynamics, specifically on the cloud side, and related to your -- the inventory that they may have of your parts there? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Yes. Joe, as you know, the -- we came off a very strong 2018, up 21%. As we came into the year, implied in our guide, particularly in Q1, was our expectations that we'd be in quite a digestion period, both for enterprise and government but cloud as well and that, that would really impact our Q1. Look, what we're highlighting today as it relates to cloud is 2 things: that we expect the digestion to continue into Q2; that demand is going to be soft in Q2. And it's even exacerbated in China where, if you'll remember, through the third quarter last year, our demand for cloud players in China was close to triple digits. That was negative in the first quarter. So overall, they're still in a digestion period, the cloud guys. And in China is even -- it's been even more dramatic in the first quarter and the first couple weeks here in the second quarter. +That being said, when we asked that, when we look at end demand in this data-centric environment, when we're looking at end demand, it still seems relatively strong. And the -- in our dialogues with our customers, they are implying an uptick as we move from first half into second half. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + I had a question on your enterprise business within DCG. I was a little bit surprised by the magnitude of the decline in Q1. Bob, in your view and based on what you know, what you hear from customers, how much of that decline is tied to true end demand versus inventory dynamics at your customers? And I ask that question because some of your customers may have pre-bought in fear of supply constraints. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [9] +-------------------------------------------------------------------------------- + + Yes, it's a great question. Truly, we believe that there's the end demand, and forget about which segment, but end demand remains relatively strong. But by segment, enterprise and government year-on-year decline was not way off what we expected, because we didn't have a real robust guide for Q1, but we have seen it continue into the second quarter. And I just think that the ordering ahead or the digestion of last year's strong growth, we expect now just to continue in enterprise and government through the first half and even a little more into the second half as it relates to E&G. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + I wanted to know, of the mid-single-digit decline for data center, how much of that do you think is units versus pricing? I would have expected, with the new platform launch, we might have seen better. And obviously, you have the inventory in digestion, but there's also competition that's coming in the second half. So how do you see units versus pricing declining within the envelope of your down mid-single digits for the business overall? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [12] +-------------------------------------------------------------------------------- + + Yes, we kind of -- as we came in -- the updated guide, the guide now is more a unit story. When we came into the year, back in January, our expectation on ASPs is they would be pressured in DCG by 2 things in particular: one, just we indicated at the time that we expected an increased competitive environment as we go into the second half; and then two, as we look at 5G SoCs beginning to ramp as we go into the fourth quarter, they tend to be at lower ASPs. So we expect product enhancements but offset by tougher competitive environment and mix of SoCs for the comms service providers. So the big change from January is really more a unit story. And we think we bounded the ASPs best we could back in January time frame. That hasn't changed. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [14] +-------------------------------------------------------------------------------- + + I guess a question on the modem side of things. As you think about the cost savings as you deemphasize that business, will that be repurposed? Or should that accrue to the bottom line? And can you give some thoughts as to what the cost savings will have -- look like and what time frame we should see it? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [15] +-------------------------------------------------------------------------------- + + Yes, let me -- C.J., let me take a run and ask George to chime in as well. We announced that we were going to exit the 5G smartphone business and that we are going to evaluate the 5G Modem in other applications, like PC and IoT, while assessing our alternatives as it relates to the 5G Modem overall. So what's reflected in kind of the updated guide we gave is we do expect lower spending for 5G smartphone as we go through the course of the year. That is part of the lower spending going into the second half that we reflected. But we also -- we haven't really completed our assessment about what to do with the wonderful IP that we've developed, the real strong team that we have and the other opportunities we have, whether it's in network infrastructure, where we're really excited about the role we'll play in 5G, or whether it's the role that 5G Modem plays in these non-smartphone applications. So that's something that we're working very hard on to try to get to the right answer about how we'll deal with the technologies we built, the capabilities we have and what the implications will be on cost structure as we go into the second half of the year and into next year. So that's still a work in progress. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + And C.J., I just might add, we talk about spending being down $1 billion year-over-year, I would say the expectations for slowing 5G spend or reducing 5G smartphone spend prior to getting through the decision process of -- that we're going through right now, is maybe 20% to 30% of that. So there is not a lot yet evident in the spend rate that we're talking about that results from the 5G Modem business. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [18] +-------------------------------------------------------------------------------- + + I know you would like us to focus a little bit more on op margin than gross margin, but I just want to go back to the gross margin line. As far as I can remember, with an in line revenue quarter for March, this is the most significant gross margin miss to Street estimates that I can remember for the company. And I know you've talked about 10-nanometer volumes being higher than you expected this year. Can you talk a little bit about the yield curve and kind of the cost of 10-nanometer? And I guess really importantly, if the long-term sort of upper range of your gross margin had been 60% to 65%, do you still think that that's the right sort of higher-end range as we go to the 10-nanometer node for CPUs, notwithstanding that some of the adjacencies are lower gross margin? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [19] +-------------------------------------------------------------------------------- + + Yes. Thanks, John. First, in the first quarter, kind of 2 things that really impacted gross margin: one, frankly, we planned for and played out as we expected; and two, we did not plan for. But the one we planned for is just as we ramp 10, and as you're aware and I mentioned earlier, until we qualify the product, which we expect to do in the second quarter, all that cost flows through cost of sales. So when we're in early stages of ramp prior to qualification, that does compress gross margin. And that played out as we expected, because I mentioned in my prepared remarks that our progress and our improvement on 10-nanometer yields was in line with what we've expected coming into the year, a little bit better, that gave us the comfort that we're going to increase volume at the end of the year. But Q1 is just the dynamics of all of that ramp cost going through cost of sales. That was planned and that was anticipated. The not planned in the quarter was just the ASP declined much greater than we had anticipated for NSG. We were in the -- we were expecting kind of mid-20s to 30% ASP declines. The reality is it was closer to the mid-40s. And as a result, and George flagged this, but as a result, we had to take a lower cost or market reserve against our inventory balance in the quarter. That cost us over 1 point of gross margins in the quarter. That we did not quite anticipate. +So gross margin Q1, in line with kind of what we thought, with the exception of inventory reserves that we took in the quarter. And as I said, Q2, we expect it to be better than Q1 because we'll begin to capitalize those costs because of the progress we're making on 10-nanometer. And then just to kind of go from your Q1 to your 5 years out point of view, I guess maybe on the gross margin, operating margin dynamics, maybe we'll defer that, kick the can couple of weeks, until we see you on May 8 when we kind of walk through our longer-range planning process. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [21] +-------------------------------------------------------------------------------- + + Bob, I wanted to ask you just a question strategically about memory. And I wanted to understand, obviously, you need to make cost [point], but relative to NAND, why the need to make NAND on your own? It seems like you could sell the factory and maybe strike some sort of a supply agreement and save a lot of free cash flow, particularly after a quarter rotation can cost you 100 basis points. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [22] +-------------------------------------------------------------------------------- + + Yes. First, maybe just some context on when we talk about expanded TAM, the -- maybe the criteria we think about and then I'll try to apply them to where we are in memory. First, we look for technology inflections where we think we have a real advantage, whether it's process manufacturing or performance-oriented design that is worth pursuing, number one; number two, such that we can play a more important role in the success of our customers; and third, in an area where we think we can get attractive returns for our investors. So those are our -- the 3 criteria that we're applying, and we're going to be increasingly disciplined on the third aspect of those criteria. +As it relates to memory, we have a high-performance Optane product that we think is really differentiated, coupled with our CPU that can do things best in industry that's really needed to keep pace with the increased performance of CPU processing. So strategically, we think it's really important. Technically, we think we have a real advantage. And third, we think we can get good returns. +As it relates to NAND, we think we have process technology advantage. We're in the stage where we've gone from 32-layer to 64-layer now. The profitability of the NAND business pre this massive decline in ASPs was okay last year as we were ramping the business. And our challenge going forward is we're just going to have to execute better on the NAND business, so we can check that third box of attractive returns for our investors. And I don't want to -- when the market's plummeting I don't want to conclude what the right decision is. I want to maybe look through the horizon a little bit to get to the right decision. But clearly, we got to generate more attractive returns on the NAND side of the business, and the team is very focused on making that a reality. And to the extent there is a partnership out there that's going to increase the likelihood and/or accelerate the pace, we're going to evaluate those partnerships along the way so it can be enhancing to the returns of what we do in the memory space. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of David Wong from Nomura. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [24] +-------------------------------------------------------------------------------- + + Bob, given your stance on concentration of resources, what are you thinking with regard to Intel developing a [term] GPU product? And if you are pressing ahead with this, can give us an update on where you are and when we might see the first Intel GPUs? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [25] +-------------------------------------------------------------------------------- + + Yes. I mean first, as we think about the key technologies that we believe are going to be increasingly important going forward, I flagged them earlier, but we characterize them as our -- kind of our 6 pillars of technology differentiation. Obviously, process technology is an important component; Second, architectures, I'll come back to that; third, memory; fourth, interconnect; fifth, security; and sixth, software. And how we bring the collection of those 6 things together that nobody else in the industry can do, we think is really what's going to allow us to capitalize on an increasingly data-centric world. +When we think about architecture, we just -- as we learn more and more about how workloads are evolving and the increasingly importance of artificial intelligence and parallel processing, we believe that architectures beyond the CPU, like GPU, like FPGA, like AI, like other accelerators, become increasingly important. So we have decided that we are going to invest in discrete GPUs. We're going to launch a new integrated GPU in the near term, which we're pretty excited about. But discrete GPUs, I think we said that we are going to launch it in 2020 time frame, both for clients and for data center. Increased workloads, we're going to leverage the integrated technology that we've enhanced and invested in discrete GPUs because we think it's an architecture that's increasingly important. And we think we can develop some real attractive products based on our existing core architecture. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [27] +-------------------------------------------------------------------------------- + + Bob, I had a question on 10-nanometer progress and the competition on the server side. I know your -- the team is sounding more confident about 10-nanometer on the client side. I'm curious what the progress is on 10-nanometer and the server side, and as part of that, how do you think your customers are reacting to a competitor bringing out their products in the back half? Your products are coming out next year. What are you hearing from customers as to how they are thinking about the next generation of server CPUs and the desire for perhaps diversifying suppliers? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + First, on 10-nanometer for server, what we've indicated is that we would have client systems on shelf for the holiday season, and our expectation is that server CPUs would be a fast follow. Historically, I think it's been more of a 12- to 18-month gap between client and then server. On 10-nanometer, that gap would be much shorter. And again, what we said is fast follow after client systems on shelf, so sometime in 2020, earlier versus later. In terms of just competitive positioning, with the -- we've been -- our Xeon Scalable product that we launched last year and then enhanced with our Cascade Lake launch just a few weeks ago I think, that has increased performance. It's got AI acceleration built into it. It's coupled with Optane memory. It's got a 56 core count. And the performance of that product, coupled with our knowledge of the environment in which -- our customers' environments, we think we really have demonstrated differentiated performance, a product leadership performance, even though it is still on 14-nanometer. +So we have a good product that really pulls together those 6 pillars that I talked about earlier. We launched it a few weeks ago. We said we expect it to ramp as fast as any launch that we've done in the past. And we think it positions us competitively in the second half of the year, despite increased competition prior to launching 10-nanometer in 2020. +So we feel good about 10-nanometer in general. We're going to be a fast follow with server in 2020. In the meantime, the Cascade Lake product has some real performance enhancements based on our deep domain knowledge of our customers. And it'll be an increased competitive environment, but we feel pretty good and we tried the best we could to capture that in our outlook for 2019. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + 5G network connectivity is very strong and projected to continue to accelerate on a go-forward basis. Korea, China, U.S., all starting to fire. You guys have a great lineup of products, Xeon D, full-blown Xeon, base station ASICs, FPGAs and so on. So help us understand, given all these dynamics, why did the comms service provider segment decline year-over-year in Q1? And maybe more importantly, just given the strong 5G lineup that you have, do you see comms service provider contributing to the strong second half implied growth in your data-centric segment guidance for the full year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Yes. I think, first, yes, we feel like we got a great product lineup for the launch of 5G. We have a strong position today, and we think 5G is only going to accelerate that across a broad swath of our products and technologies. The -- a couple of things going on, we believe, in Q1. One, just in terms of the increased demand, we do expect it to be coming maybe a little bit later in the year. I think FPGA is a little bit earlier, but the Xeon, we expect to follow later in the year and even more in 2020, to be honest with you. So timing, we expect it to be out a little bit, modest improvement in the second half but not dramatic. +And the other thing I would say is that we have a strong customer base in China in comms. And we -- like we saw in cloud and enterprise and government, comms growth we think was also impacted by strong comms growth last year that's probably being digested a little bit in the first couple of quarters of this year. Again, one of our large customers in China is a contributor to the question earlier about buying ahead and then digestion, is a weight on comms growth in the first quarter. So we're pretty excited about the demand signals we're seeing, the relationships we've built for 5G and think it's going to be a really important part of our story going forward. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava from BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [33] +-------------------------------------------------------------------------------- + + Bob, I just wanted to -- I was wondering if you could shed more light on the DCG op margin. We've not seen this low a number in quite a few quarters, I think 6 to 8 quarters, 38%. And you list 3 reasons, but it disproportionately seems to be lower versus the revenue decline. Could you shed a little bit more light? And more importantly, how should we expect this to trend as the year progresses? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + Yes, I mean I think the things we flagged, obviously, unit volume declines on a high-margin business worked against us. Secondly, it's really DCG now. I talked to you about the fast follow of DCG on 10-nanometer after client launch. So as a result, they're just now beginning to bear some of the brunt of the cost of sales that all went through the P&L in the first quarter until those products qualify. And then third, this is a -- this is a big growth area for us and we're going to continue to make investments. So those 3 things are really what drove the op margin decline in the quarter. +As you know, just from historical trends, data center margins tend to be a little bit lower in the first quarter. And obviously, implied in our guide first half to second half, second half is a little stronger. And with that strength on unit volumes despite maybe more intense ASP environment, we expect operating margins to kind of improve in line with revenue growth in the second half. Those trends are fairly consistent with how the quarterly dynamics of DCG operating margins go. They're just more exacerbated in Q1 with the 10-nanometer cost of sales starting to impact the business. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our final question for tonight comes from the line of Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [36] +-------------------------------------------------------------------------------- + + Just one more on gross margin, if possible, and I know you don't want to comment on '20. But I'm just trying to understand the trajectory here, because it seems like your 10-nanometer has been delayed. You're ramping it now. It does seem like it's on a portion of the product line, not like the old days, where it would flip over all of client. So I'm just trying to understand, if you look at the impact you saw this year, why is it incorrect to think about that you should see a similar impact next year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [37] +-------------------------------------------------------------------------------- + + Well, yes, I think you know that our expectations are as we begin to ramp high-volume manufacturing, that in conjunction with that, we expect to see improved yields and better [units-to-die] performance as we go throughout the course of the year and as we step on the pedal and ramping volumes. So the -- part of the answer is we expect to improve yields as we go forward. But that being said, any time we transition to a new node, the earlier stages tend to be -- have a little bit of a compression effect on gross margins until we get a little more maturity. And I don't want to get out ahead on 2020. We're more focused on '19 right now, but it's natural for the transition to a new node in early stages to have a bit of a downward pressure on gross margin. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [38] +-------------------------------------------------------------------------------- + + Thanks, Blayne. And thank you all for joining us today. Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Certainly. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2019-Jan-24-INTC.txt b/Transcripts/INTC/2019-Jan-24-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..aa70b2016e0b0ddc433a025a71be7e969db3694a --- /dev/null +++ b/Transcripts/INTC/2019-Jan-24-INTC.txt @@ -0,0 +1,438 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Intel Corp Earnings Call +JANUARY 24, 2019 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Navin Shenoy + Intel Corporation - Executive VP & GM of Data Center Group + * Robert H. Swan + Intel Corporation - Interim CEO, Executive VP & CFO + * Venkata S. Murthy Renduchintala + Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Q4 2018 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. +I would now like to introduce your host for today's conference, Mr. Mark Henninger, Head of Investor Relations. Sir, you may begin. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. And welcome, everyone, to Intel's Fourth Quarter and Full Year 2018 Earnings Conference Call. By now you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our Investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online. +I'm joined today by Bob Swan, Intel's Chief Financial Officer and interim CEO; Murthy Renduchintala, Group President of the Technology, Systems Architecture & Client Group and Chief Engineering Officer; as well as Navin Shenoy, Executive Vice President and General Manager of the Data Center Group. In a moment, we'll hear brief remarks from Bob followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. And thanks to Navin and Murthy who will participate in the Q&A later in the call. +Before I get into the results, I'll take a minute to address what I expect is a top of mind question: the status of Intel's CEO search. The board continues to evaluate candidates for what I believe is the biggest and best open job on the planet. They are proceeding with a sense of urgency while also ensuring that they make the right choice for this great company. +Meanwhile, Murthy, Navin, the entire management team and 107,000 employees have come together as a team to continue driving Intel's transformation to a data-centric company. Our 2018 results demonstrate the progress we made, and I'd like to share those results with you now. +2018 marked Intel's golden anniversary. It was a truly remarkable year for a remarkable company. Full year revenue grew 13% and crossed the $70 billion mark for the first time, setting an all-time revenue record for the third consecutive year. Our data center, Internet of Things, Programmable Solutions, memory, Mobileye and modem businesses each set all-time full year revenue records. +2018 was also a pivotal year in Intel's transformation to become a data-centric company, pursuing an expanded greater-than-$300 billion market opportunity. Intel's collection of data-centric businesses grew 20% in 2018 after adjusting for McAfee. The largest of our data-centric businesses, the Data Center Group, delivered record annual revenue of $23 billion, up 21% year-over-year on strong cloud demand and growing share with communication service provider customers. Our PC-centric business achieved 9% growth in 2018 as the PC market stabilized, and we gained share in modems. +While 2018 was a record year, we expected a stronger finish. Fourth quarter revenue of $18.7 billion was up 9% but short of our expectations as a result of a dramatically weakening modem demand, lower overall growth in China, cloud service providers absorbing capacity and a weakening NAND pricing environment. While revenue fell short, we exceeded our EPS outlook by $0.06 or about 5%. +We continued to deliver outstanding new products for our customers and previewed new innovations that position Intel to compete and win for years to come, and we also made significant progress in growth areas like AI, autonomous driving and 5G. I'll take a few minutes to give some specifics before we dive into the financial results. +Over the course of the quarter and culminating at CES, we highlighted breakthrough innovations that will be central to our product leadership for years to come. We outlined our product design philosophy, which combines 6 pillars of innovation: process technology, architecture, memory, interconnect, security features and software to consistently and reliably deliver leadership products that solve our customers' most challenging problems. +One example of this design philosophy in action is our unique Foveros 3D packaging technology. Foveros enables active stacking of logic chiplets for the first time in the industry's history and lets us mix and match process technologies and architectures to deliver breakthrough products. The first such product, Lakefield, is slated for production in 2019. +Lakefield features a 10-nanometer hybrid CPU architecture combining a Sunny Cove CPU core, 4 low-power Atom CPU cores, Gen11 graphics and more in a dime-sized product that enables the smallest PC motherboard ever possible. Foveros gives us tremendous design flexibility and paves the way for a myriad of devices and systems combining high performance, high density and low-power silicon process technologies. +In the data center, we began shipping the new Cascade Lake family of high-performance Xeon processors with DL Boost for accelerated AI performance, hardware-based security mitigations and the first implementation of Optane DC persistent memory. Many of our data-center OEMs and cloud customers are now offering early trials of Intel Optane DC persistent memory, which is enabling entirely new usage models and improved system performance. +In client computing, we launched our new ninth gen Intel Core desktop product lineup for gaming and content creation, growth segments that demand Intel performance. We also previewed our upcoming 10-nanometer Ice Lake client CPUs, which will deliver unprecedented levels of integration, including DL Boost inference acceleration, WiFi 6, Thunderbolt 3 and Gen11 graphics, our first integrated GPU with a full teraflop of performance. Our 10-nanometer yields continue to improve, and Ice Lake remains on track to be in volume systems on retail shelves for the 2019 holiday selling season. +In Q4, we also made important progress in AI, 5G and autonomous driving. For artificial intelligence, we saw accelerating adoption of OpenVINO, our open-source tool kit for neural network optimization and the rapid deployment of AI-based Computer Vision. In addition to the strong adoption of OpenVINO by the developer community, we also launched several new products during the year, including our third-generation Vision processing unit. +Our partners created a catalog of AI-based Vision accelerator cards with our VPU and FPGA products. While digital video was once a vertical within the IoT business, AI-based machine vision is becoming a critical horizontal capability that cuts across all IoTG verticals. And our leadership portfolio, both hardware and software solutions, is removing the barriers to deployment and accelerating IoTG's growth. +We also highlighted a new AI product on our road map, the Nervana Neural Network Processor for Inference, or NNPI, which is designed to accelerate inference workloads and achieve the highest performance per watt in the industry. We expect NNPI to be in production this year. +5G is another big opportunity for both our PC-centric and data-centric businesses. At CES, we unveiled the new 10-nanometer-based network system on chip, codenamed Snow Ridge, developed specifically for 5G wireless access and edge computing. Snow Ridge will bring Intel Architecture into wireless access base stations and allow more computing functions to be distributed out at the edge of the network. We expect to be in production on Snow Ridge in the second half of this year, which is also when we'll deliver our first 5G modem, the Intel XMM 8160 5G. +In autonomous driving and ADAS, mobilized effort to lead this revolution continues to build momentum with 28 new design wins and 78 vehicle model launches in 2018. In the fourth quarter, we announced plans to commercialize mobility as a service in Israel with Volkswagen and Champion Motors, making Mobileye's breadth of products, technologies and services unmatched in the industry. +Mobileye's products now span from open ADAS and AV compute platforms to turnkey vehicle retrofits to, ultimately, mobility as a service. And they are enabled by the industry's best vision algorithms and driving policy software, the groundbreaking RSS model for AV safety and REM real-time crowdsourced maps. +At CES, we announced important progress for both RSS and REM. ITS, China's leading industry organization for transportation standards, approved a proposal to standardize RSS for the China market. We also completed the mapping of Japan's highway system, 25,000 kilometers of roads, using data harvested from a customer fleet of vehicles outfitted with EyeQ4 in just 24 hours. +This is a task that would have previously required thousands of hours of driving and scanning using specialized vehicles. This sort of breakthrough is possible only with Mobileye's combination of technology and massive market scale, and it positions Mobileye to monetize ADAS and AV technology long before Level 4 and 5 autonomy are deployed at scale. +And REM will be monetized in areas beyond autonomous vehicles. We just announced a partnership with Ordnance Survey who use data collected via consumer vehicles outfitted with EyeQ4 to help utilities manage infrastructure. +Looking back at 2018, it is abundantly clear that Intel's employees, the unstoppable engine driving our innovation, are more determined than at any point in our history to make Intel technology the foundation for the world's most important innovations and advances. Not only was it a record year from a financial perspective, we achieved major milestones in terms of our diversity and inclusion goals. +We reached full representation in our U.S. workforce 2 years ahead of our plan. We also achieved gender pay equity across our global workforce. And to celebrate 50 years of Intel, more than 68,000 employees volunteered approximately 1.5 million hours in the communities where we operate. I'm proud of what Intel employees achieved in 2018, and I am equally proud on how they responded to challenges. +With that, let's turn to the financial results. The fourth quarter closed a record 50th anniversary year with strong data-centric and PC-centric growth. Revenue for the quarter was $18.7 billion, up 9% year-over-year. Our data-centric businesses were collectively up 9%, and our PC-centric business was up 10%. +Operating margin of 35% was approximately flat with strong mix and continued spending leverage, offset by 10-nanometer cost and growth in our adjacent businesses. Strong business performance, spending leverage and a lower tax rate resulted in non-GAAP net income of $5.9 billion, up 14% year-over-year. EPS of $1.28 was up 18% year-over-year. +For the full year of 2018, we generated $14.3 billion of free cash flow; returned $16.3 billion to shareholders, including $5.5 billion in dividends; repurchased 217 million shares; and increased our buyback authorization by $15 billion. Free cash flow was $1.2 billion short of our October expectations due largely to an increase in accounts receivable. +To summarize, we had a strong quarter and fantastic year with full year revenue up 13% or nearly $6 billion higher than our original forecast in January. Earnings per share was up 32%, and free cash flow was up 38% over last year. We're expecting another record year in 2019. And as a result of our continued growth, we are raising the dividend 5%. +Our leadership products continue to win share in our expanded TAM as both our data-centric and our PC-centric businesses continued to grow in the fourth quarter. Our data-centric businesses were up 9% for the quarter as customers choose our performance products to move, store and process more data faster from the cloud to the edge. And our PC-centric business was up 10% as we saw continued strength in the commercial and gaming PC segments and regained modem share. +Moving to earnings. We generated solid EPS expansion in the quarter, up 18% year-over-year, and our operating income increased $580 million with operating margin approximately flat year-over-year in the quarter. Our EPS improvement was driven by growing demand for higher-performance products in the data center and client businesses, leading to higher volumes and ASPs, continued spending leverage, a lower tax rate and lower share count as a result of buybacks. +Our focus on operational efficiency continues to produce strong results with 2018 spending as a percentage of revenue at 28.6%, down over 7 points since 2015 and meeting our 30% commitment 2 full years ahead of our goal. R&D is up $1.4 billion over the same period as we continue to increase investment in areas that will drive growth in our expanded TAM such as product leadership, artificial intelligence and autonomous driving. Over the last 3 years, we've grown annual revenue by more than $15 billion while adding less than $250 million in spending, resulting in a more than 25% increase in revenue per employee. +Now some Q4 performance highlights by segment. The Data Center Group delivered another greater-than-$6 billion revenue quarter and a growing storage and networking CPU TAM that is greater than 30 million units. Revenue of $6.1 billion was up 9% year-over-year but below our October expectations. +Year-over-year growth decelerated as all 3 major verticals within DCG were impacted by weakness in China demand and as some CSPs moved to consume capacity put in place earlier in the year. Platform unit volume was up 9%, and ASPs were up 1%. +Our Xeon ASP grew mid-single digits as customers continue to transition to Xeon Scalable and a richer mix of higher-performance products. We also saw ASP expansion in our SoC products and much higher SoC volume as we continued to have success in network transformation. The higher SoC volumes resulted in more modest blended platform ASP growth. +Non-CPU adjacencies were down 2%, driven by several large onetime deals in the fourth quarter of 2017 that did not repeat in the fourth quarter '18. Cloud revenue grew 24% year-over-year, decelerating from Q3 '18. Enterprise and government revenue declined 5% year-over-year on a very challenging compare versus fourth quarter 2017 and weaker China demand. Comms service provider revenue grew 12% year-over-year on continued MSS gains as customers choose to virtualize and transform their networks on Intel Architecture. +Our other data-centric businesses, IoTG, NSG and PSG, achieved solid growth in Q4, together were up 9% year-over-year or 13% excluding the Wind River divestiture. Our Internet of Things business had revenue of $816 million, down 7% or up 4% excluding Wind River, with operating profit of $189 million, down 27% year-over-year due primarily to supply constraints. Mobileye revenue was $183 million, up 43% over last year as design wins and ADAS adoption continue to accelerate. +Our memory business delivered revenue of $1.1 billion, up 25% year-over-year due to strong data center growth and continued Optane adoption offset by a weaker NAND pricing environment. The shift of our data center and client SSDs to our 64-layer 3D NAND continues in both the data center and client businesses with volume mix greater than 75%. NSG was approximately breakeven for the year. +As expected, Micron exercised its right to call Intel's interest in our joint venture IM Flash Technologies. This announcement does not change Intel's plans in the coming quarters, and the close of the call is at our discretion up to 1 year after the date of the call with a supply agreement that extends beyond the close. We have manufacturing options available and have been shipping a broad portfolio of Intel Optane technology products for more than a year. We will continue to expand our product line and lead the industry with this exciting new technology. +PSG's revenues came in at $612 million, up 8% on strength in the data center and comms segments. We saw continued momentum in PSG's data center segment, up 50% over last year. In the Advanced products category, our 28-, 20- and 14-nanometer solutions grew an outstanding 70%. Operating profit was $162 million, up 4% year-over-year. +Finally, the Client Computing Group delivered another outstanding quarter with revenue of $9.8 billion, up 10% year-over-year. Commercial and gaming demand continued to be strong. The notebook segment grew 8% year-over-year. The desktop segment grew 3% year-over-year. Supply remained constrained, particularly at the value end of our product range. We are working closely with our customers to align demand with available supply while we add capacity, and we expect supply-demand balance to improve by midyear. +Client adjacencies grew 45% year-over-year, driven primarily by increased modem share gains. Though modem revenue fell significantly below our expectations as a result of weaker smartphone demand. +Our operating profit grew $402 million year-over-year with operating margin up 1 point. While our PC volumes were down 2%, our leadership product performance and segmentation contributed to strong mix. +The investments we have made in the business organically and through acquisition are delivering excellent cash flow generation. For 2018, we generated $29.4 billion in cash from operations. We invested $15.2 billion in capital expenditures and delivered $14.3 billion in free cash flow, up 38% year-on-year and closing the gap versus EPS by 4.5 points. During this period, we returned 114% of our free cash flow to our shareholders. Buybacks totaled $10.7 billion, and dividends totaled $5.5 billion. In addition, settlements of our convertible debt reduced fully diluted shares by 40 million. +To wrap up with our full year results, we ended 2018, our 50th anniversary year, with our third consecutive year of record results, revenue of $70.8 billion, up 13% year-on-year driven by 20% growth in our data-centric businesses and 9% growth in our PC-centric businesses. We started the year in January expecting to generate $65 billion in revenue, 30% operating margin and $3.55 in EPS. +The growth that we and the industry have seen has been remarkable. We ended the year approximately $6 billion higher in revenue with operating margin of 35% and $4.58 in EPS. Operating income of $25 billion was up 25% on strong execution across the businesses and disciplined spending. +In October, we provided a preview of our outlook for 2019. At the time, we described a combination of tailwinds and headwinds that were balanced. The tailwinds were an expanded and growing TAM, product momentum and business mix. The headwinds were tougher compares following an especially strong 2018 and increasingly competitive environment in global trade. +Since that time, trade and macro concerns, especially in China, have intensified. Cloud service providers shifted from building capacity to absorbing capacity, and the NAND pricing environment has further deteriorated. Those incremental headwinds are impacting our revenue expectations and slightly reducing our operating margin percentage forecast. The remaining factors are roughly consistent with our October assessment. +Now turning to our outlook for 2019. We expect 2019 to be another record year for us as the world's appetite for the analysis, transmission and storage of data continues to grow. We are forecasting revenue of approximately $71.5 billion, up 1% year-on-year, and operating margin of approximately 34%, down less than a point year-on-year. +We expect a modest decrease in gross margin percentage driven by the 10-nanometer ramp and the growth of our adjacencies. This will be partially offset by increasing OpEx leverage as we continue to make thoughtful tradeoffs and invest in R&D that will accelerate our growth and profitability. We expect the full year tax rate to be approximately 13.5%, following several beneficial discrete events in 2018, and we expect EPS of $4.60. +We expect gross capital expenditures of $15.5 billion with logic spending up and memory spending down. The increase in logic CapEx reflects our effort to meet our customers' needs and avoid constraining their growth, while our investment in memory is focused on the sit-up of our independent technology development facility in New Mexico. And finally, we expect free cash flow of $16 billion, an increase of approximately 12%. +As we look to the first quarter of 2019, we are forecasting revenue of approximately $16 billion, flat year-on-year, excluding Wind River. We expect PC-centric revenue to be up low single digits on higher modem share and data-centric revenue to be down low single digits on broad weakness in data center and continued NAND pricing pressure. We expect operating margin of 29%, down 1 point year-over-year, with a decline in gross margin as a result of the 10-nanometer ramp and the growth of adjacencies, partially offset by increased spending leverage. We expect EPS of $0.87, flat year-on-year. +We expect 2019 to be our fourth record year in a row. We feel great about where we are and where we're going. Five years ago, we set out to transform Intel from a PC-centric company to a data-centric company. Today, our strategy, products and people are delivering on that ambition with strong growth, record results and the largest TAM opportunity in the company's history. +I have been inspired and humbled time and time again by our employees' commitment to this company, their colleagues and our customers. And we're just getting started. I am convinced the board will close on a new CEO in the near future, and I believe the management team, myself and 107,000 employees will rally behind him or her to take this company to a whole new level. In the meantime, we will not be distracted by the void. +With that, let me turn it over back to Mark, and we'll get to your questions. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [4] +-------------------------------------------------------------------------------- + + Okay. Thank you, Bob. Moving on now to the Q&A. (Operator Instructions) Operator, please introduce our first questioner. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from John Pitzer with Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- + + Just relative to the DC -- the data-centric guidance for the full year of up mid-single digits year-over-year in calendar year '19, you did a good job kind of explaining what's causing the weakness in Q1, DCG and the NAND pricing. +But as you look throughout the year from a minus kind of low single digits to full year being mid-single-digit growth, you are kind of looking for an acceleration against what becomes harder year-over-year compares in the June and September time frame at least. +I'm just kind of curious if you can help us frame how you think that that reacceleration occurs. How long of a pause are you seeing with the cloud customers? And importantly, how are you thinking about increased competition in '19 in the data-centric businesses, especially in the server business, as you think about mid-single-digit year-over-year growth? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Yes. Thanks for your one question, John. I'll take a stab, and then Navin is here with me as well, I'm sure he has a few comments. First, I would say that since we look at just overall demand for the data center environment, the end user demand by consumers and by enterprises, the workloads that we're seeing, the continued growth in workloads, we are as excited about the future as we've ever been. So we feel pretty good about the medium and long-term trends. +As you know, in 2018, our growth rate, particularly in the cloud, was up 45% through the first 9 months of the year. So what we saw in the fourth quarter was -- as I had mentioned, we saw a little bit of consumption going on. +As you know, the purchases are done in -- kind of in cycles, massive purchases through the first 9 months. And we started to see some of those purchases consumed in the fourth quarter. And we end the year, we think, with inventory levels on the server side of the business just a little bit higher than they had been historically. +So as we project forward in the first 6 months of the year, we think that it's going to continue to be both consumption on the server side and pricing in the NSG environment to be down through the first 6 months. And consistent with kind of historical patterns, we do expect the purchasing to start picking up again in the second half of the year. That's kind of how we see it. Long -- medium, long-term, we feel great, massive buying in the first 9 months. The buying slowed a bit in the fourth quarter, and we expect that to continue through the first 6 months. +I think just -- I think the last part of your question, I think just competitively, then I'll tick it over to Navin, look, we're going into 2019 with every expectation to compete, to protect our share position across our entire business. So we're going to -- we're obviously investing in the capital required to ensure we don't constrain customers' growth. We're continuing to invest in R&D. +And third, we're going to invest to protect our competitive position, both on the PC side and the data-centric side. So yes, we expect competition to be stronger as we go through '19, but we're going to -- our guidance incorporates the fact that we're going to fight to protect our position. Navin, any... + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [4] +-------------------------------------------------------------------------------- + + Maybe the only thing I'd add, John, is that from a product point of view, the dynamic to think about in 2019 is that, as Bob mentioned, we began shipping for production Cascade Lake, our next-generation Xeon. And really, that product is going to ramp -- start to ramp in the middle part of the year and into the second half of the year. +The design momentum looks very strong. The product features look very compelling. The AI capability we have with DL Boost, the support for Optane persistent memory, the security, hardware mitigation fixes, so that the customer momentum around that product line looks very strong. +But it really doesn't ramp until the middle to the second half of the year. So as Bob said, the first half, a little bit tougher but second half, with product momentum as well as what we're hearing from our customers, we expect to be better in the Data Center Group. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + And our next question comes from Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [6] +-------------------------------------------------------------------------------- + + To maybe generalize on that, if I just look through your guidance, you're basically guiding flat in Q1. And roughly flattish for the full year would suggest that overall, you're looking for a revenue trajectory in 2019 that's very similar to the trajectory you had in 2018, which was very, very strong sequentially, in many of the quarters. +So I guess, what is the risk, just given everything that's going on that that may be too aggressive, especially as you had a number of drivers in 2018, both on the data center as well as on the client side, that aren't going to be repeating in 2019? Like how do we think about that? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Well, first, yes, 2018 was a great year, as we mentioned earlier, it grew during the course of the year. But a function, we believe, Stacy, is just the end demand for data. And we haven't seen that slow down at all. Again, on workloads, insights from our customer in the industry, workloads continue to grow. The demand for analytics for compute, for storage, for rapid retrieval, we think, only continues to grow. +And we believe that we have a very good position as we go into the year, including the products that Navin referenced. So we go into the year, we think, setting expectations in line with how we expect things to play out. And I would say today, our outlook is a little more cautious than it was a few months ago. +And we try to take into account both the macroeconomics, the geopolitical risk, the modest inventory build as we enter the year and the competitive environment. We've kind of taken those into account, reflected them the best we can as we go into the year, and we feel pretty good about how things stack up right now. And our expectation as we have in the past is to deliver on the commitments we make as we kick off the year. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And our next question comes from Pierre Ferragu with New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [9] +-------------------------------------------------------------------------------- + + I was surprised, Bob, on your CapEx guidance and especially on the memory side. So my understanding is that last year, you spent about $3 billion there, with about half of that money actually coming from your clients, so not being actually Intel capital being deployed. +So if you had $1.5 billion of Intel capital deployed in memory last year, if I look at your guide and seeing logic is slightly up, memory is going to be slightly down, so the actual Intel capital invested, deployed into memory this year is going to be up massively, maybe close to 2x. And that's in a year in which everybody in the value chain, everybody in the memory industry is actually pulling back on CapEx and limiting capacity addition. So I'd love to understand how you see that and how you position Intel this year in memory. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + Yes. First, just to maybe start with as we see kind of free cash flow for the year, we expect to be up $2 billion year-on-year with gross capital relatively flat. And I think you said this, but just to repeat, $15.5 billion going to $15.5 billion. +During the course of '19, our expectations are, of that mix, that we'll be more logic-oriented. And that's really driven by a couple of things: one, ensuring we have the capacity to meet the 14-nanometer demand for our customers; secondly, as we ramp 10-nanometer in 2019 and position for 10- in 2020, we'll invest additional capital there; and then third, obviously, our expectations are to continue to invest in next-node technology, in particular, 7-nanometer. +So logic capital is going to be going up year-on-year. And as we indicated, memory capital will be coming down. We put the capacity in place in Dalian during the course of '17 and '18, and our expectations are in 2019 that we have sufficient capacity for demand. However, we are going to be investing in our own capabilities, our self-sufficiencies for Optane product. So we will use some capital on building out Optane capacity, but memory capital will be a bit lower, gross capital will be a bit lower during the course of the year. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Danely with Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [12] +-------------------------------------------------------------------------------- + + I'm going to shift to the expense line. So maybe give us a little more color on OpEx and gross margin trends and how you're going to hit the operating margin target. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes. So first, gross margin. The qualitative context is we expect gross margin to come down modestly off of Q4 levels and a little bit more off full year '18 levels. And we do expect that that will be largely, although not completely, offset by spending as a percentage of revenue coming down again in 2019. +I think just on the gross margin, the trends are going to be a little bit similar to what you've seen in the past, although we do expect a little bit less ASP -- gross margin improvement from ASP. We expect unit cost to be up a little bit, and that will be primarily as we ramp 10-nanometer. And then the mix dynamics of more memory and more modem will weigh on gross margin a bit. So year-on-year, we expect gross margins to come down a little bit. +On spending, as you know, we kind of -- we exit this year with spending levels down in the -- 26% in the fourth quarter and a little under 29% for the full year. So we're way ahead of our -- the 3-year plans that we laid out a couple of years ago, and we feel pretty good about the progress we made on the spending. And we've done it without cutting R&D. +During that time frame, R&D has grown. We've been investing in the right things. Those things are growing faster. As a result, spending has come down 700 points from 2015 levels. As we go into 2019, spending overall, we expect to come down. +Some things we did during the course of the second half of '18, including the exit of -- we exited Wind River. We exited wearables. We exited some of our new technology, small little businesses. We exited those businesses in the second half of the year, and we did some restructuring in the second half of the year. So as we go into '18, all that benefit from a relatively low Q4 $4.9 billion run rate, we expect that spending for the full year will be down year-on-year. +So you net all that together and we have a -- we've been really focused on growing the operating income dollars of the company. We're not -- we focus on, but we're not preoccupied, with where the gross margin's going to land. Our focus has been on how do we grow the operating income dollars of the company. And in a relatively small growth year, we see keeping operating margins at 34% to be in a relatively good place without cheating the investments we need to make to continue to progress into '19 and '20. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + And our next question comes from Ross Seymore with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [15] +-------------------------------------------------------------------------------- + + Just wanted to follow up, Bob, you gave a lot of great detail there on the margin side, especially on the OpEx side. I wanted to go right back to the gross margin side, though. And somewhat simplistically perhaps, but you kept the gross margin guide basically the same as you did at the end of last quarter despite the headwinds to mix seemingly with your data centric commentary and data center being worse and your revenue being lower. +So is there any more color you can give on the puts and takes that leads to just the modest decrease given those other variables that seem like they have increased as headwinds from when you last talked about gross margin in '19? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes. The gross margin, Ross, isn't really any different. The puts and takes back then, as I indicated, were modest ASP growth. As we are going to fight to protect our market share position, we don't expect a lot of ASP growth. Again, 10-nanometer ramp, not really any different. +I highlighted in the prepared remarks, we feel very good about kind of where we are in ramping 10-nanometer during the course of the year to get systems on the shelf for the holiday season, so no real change there. And modem and memory growth will be a little bit slower today versus where we were 90 days ago. So, on the operating margin -- or operating margin percent, that's a slight positive. +The real only change from 90 days ago is just we're a little more cautious on our revenue outlook, and our spending hasn't really changed. So we got a slight -- not as much leverage that we expected back in October but still good spending leverage during the course of the year. So not really any different on the gross margin and spending dynamics that we thought 90 days ago except a little less leverage on the spending line. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [18] +-------------------------------------------------------------------------------- + + Within DCG, how should we think about the mix, cloud versus comms versus enterprise for Q1 and 2019? + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [19] +-------------------------------------------------------------------------------- + + Yes. Thanks, Vivek, Navin here. Look, we've been -- over the last 18 months, been working hard to diversify the end customer segment mix inside of DCG, and there's 3 large components: the enterprise and government segment, the cloud segment and the comms segment. +Cloud and comms is about 2/3 of the business now, where it was about 1/3 several years ago. And so I don't see any major changes to the way things play out in terms of where the growth will come from as we look into 2019 and beyond. While the first half in the cloud will be a little bit tougher, we do expect that cloud continues to grow as they start to move and to build out again in the second half. +In comms segment, we continue to gain share in that segment, a large TAM where we have relatively small share. And as we grow our network SoC portfolio and as the market moves to 5G, we expect to continue to gain share. +And in the enterprise and government segment, while we've seen stabilization there over the last 4 or 5 quarters, we're not really counting on the enterprise and government segment for growth. We do expect that enterprises will continue to make strategic choices about what to deploy on-premise and what to deploy in the cloud. And in general, that business is not one that we count on for growth. So in general, you'll see us continue to push on comms and cloud to drive growth, particularly in the second half of the year. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [21] +-------------------------------------------------------------------------------- + + Just wanted to receive an update on some of the CPU shortages that you've been experiencing, how you're progressing on alleviating the shortages, what effect that may have had on the Q4 results given that, I guess, there was some supply tightness at least coming into the quarter. +And then on that, with demand slowing a bit, is there any fear? Do you have any visibility about customers who may have attempted or succeeded in building some inventory amid those shortages? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + Yes. First, in the fourth quarter, just in terms of isolating how we prioritize our capacity, there were no shortages within the client business, prioritization of big core and, to a lesser extent, small core, lower value-oriented products. +And so we did -- we do feel like we constrained a fairly healthy PC ecosystem in the fourth quarter. I think when the dust settles on PC TAM, our expectation is it was probably flat and our shipments were down 2%. That was a function of we delivered every product that we could right up through December 30 -- 31. So we did have some constraints on the ecosystem and on our customers during the course of the quarter. +At the end of the year, Chris, I think inventory levels relative to the beginning of the year were a little bit higher, maybe a 1.5 weeks, 2 weeks higher as we entered the year. And our expectations for the year is the PC TAM is going to be relatively flat. And that, for us, is a good place to be. +We're probably halfway through the PC refresh cycle. We feel things have been relatively flat during the year. Inventory levels in the channel is a little bit higher ending the year. For us, inventory levels were relatively low as you might imagine on CPU just because of the constraints we've been dealing with. +Our expectation is, working with our customers, that we will be through the supply constraints as we exit the second quarter of the year. Again, we'll use the same prioritization of server, big core, small core. But we'll be a little bit short on some product mix and on small core until we get probably through to the second quarter. And that will constrain us a little bit on just overall growth in the first half of the year. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And our next question comes from Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [24] +-------------------------------------------------------------------------------- + + Just wanted to get an update on 10-nanometer manufacturability. I know last quarter, the team mentioned that 10-nanometer yields where tracking 14-nanometer yields at a similar point prior to production ramp. Is the team still seeing good improvements in 10-nanometer yields? Are you still tracking 14-nanometer yield ramps? And can you just give us an update on early 7-nanometer development and manufacturability? + +-------------------------------------------------------------------------------- +Venkata S. Murthy Renduchintala, Intel Corporation - Chief Engineering Officer and Group President of Technology, Systems Architecture & Client Group [25] +-------------------------------------------------------------------------------- + + Harlan, this is Murthy. I'll take that question. I can only add to what Bob said in his opening statements that we continue to make solid progress against our plan that we shared with you during the course of 2018. And as I said on the last call, I feel better about our traction today than I did 90 days ago. +So that continues to bode well for our product launch ambitions, which Bob summarized as having systems on the shelf for holiday season in 2019, with a barrage of products across all of our businesses to follow shortly thereafter. +And I would like to take the opportunity to just remind everybody that at CES and in the analyst meeting we had at the end of last year, we did show 10-nanometers across the entire portfolio of our product ranges. We talked about Ice Lake clients, which clearly was top of mind in the early discussions, but we also talked about Lakefield, Bob mentioned that as well. We also -- Navin talked about 10-nanometers for Ice Lake server. And we also talked about 10-nanometers moving into our networking and 5G program, which we believe is going to be a big growth sector. +So the story is not just about 10-nanometer yields but 10-nanometer now being a key part of our entire product portfolio. And as I say, I think that, coupled with our focus on the pillars of technology that Bob talked about, in my mind, I think, puts our product portfolio looking forward in a pretty good position. +So net-net, I think 10-nanometer is looking better now than at the last earnings call. It's broadly deployed across our portfolio. And that, in combination with the other technology gradients, that Bob talked about, we believe, sets us up for a pretty exciting product road map. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Ambrish Srivastava with BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + Bob, I just wanted to go back to the NSG and the profitability in what was a really booming year for memory. Obviously, price has started to come down back half of the year, but NSG was barely profitable. +So just from a CFO perspective, what is your tolerance level for having a business, a segment that could go into a deep cyclical downturn and -- not could, it is heading into a deep cyclical downturn. So how do you think about having a commodity within the Intel umbrella and, again, the risk -- not risk tolerance, the tolerance for lack of profitability? Just your perspective on that, please. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes. First, a couple of things. When we look at -- I mentioned this in the prepared remarks, and Murthy touched on it. When we look at the technologies that we believe are going to be imperatives going forward in this increasingly data-centric world: process, CPU architecture, interconnect, software, memory is a key component. And all the advancements in CPUs will be constrained if you don't have differentiated technology in memory. So we think that the role memory plays going forward is increasingly important. +In terms of the -- just the CFO lens of having a commodity in the portfolio, I'm not too excited about it. And that's why the investments we're making in memory are for, what we believe, differentiated technology, both in the manufacturing process capabilities of 3D NAND but also the differentiated technology for Optane and the role that it plays, both on the PC side but, most importantly, for us on the data-centric side. +So we're not particularly excited about commodities. When we make these investments, it's really geared towards products and technologies that are increasingly important and those technologies that are differentiated from kind of the core memory space that help us, in conjunction with the CPU, solve customers' problems. + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [29] +-------------------------------------------------------------------------------- + + I'll just maybe add one thing, it's Navin. As an example of that, the Optane persistent memory combined with Cascade Lake, Xeon plus Optane, that is a platform play. Optane persistent memory works uniquely with Xeon. +And as I think about and talk to customers about the massive amount of data growth we're seeing, the ability for us to uniquely tie those 2 assets together to solve customer problems is a differentiator for us and allows us to drive growth. And so to the extent we can exploit more of those kinds of opportunities, things get more exciting from a business unit GM point of view. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + And our next question comes from Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [31] +-------------------------------------------------------------------------------- + + Navin, I had a question for you, and sort of there seems to be a little bit of a different tone between what we hear from your cloud customers, the compute guys, you and the memory guys are seeing weakness, but the networking companies still sound fine. So is it just an inventory digestion of computer and servers? Or is there something structural happening there? + +-------------------------------------------------------------------------------- +Navin Shenoy, Intel Corporation - Executive VP & GM of Data Center Group [32] +-------------------------------------------------------------------------------- + + Yes. I think, as Bob said, and I think we talked about a little bit, we had 3 quarters of really, really strong growth in 2018 in the cloud. And that was driven by a product cycle as well as a typical multiyear build-out pattern with Xeon Scalable. +And if you look back at all the historical trends we've had in the cloud business, we've always said there's some lumpiness to the business. And there's periods where people build, and then there's periods where people consume. The signals we get from our customers is a period of build for compute is going to shift now to a period of consumption. And that started in the second half, in the fourth quarter, and we expect that to continue through the first half of the year. +Secularly, over the long term, medium to long term, the cloud business is going to continue to grow. There's no doubt about that. Both the consumer cloud and the enterprise commercial cloud, we see both of those continuing to grow. And the appetite for compute, I think, is somewhat insatiable. +Bob talked about compute cycle growth. Our 5-year forecast for compute cycle growth, or MIPS growth, is 50% CAGR over the next 5 years. I see nothing slowing that down over the next number of years. So that would be how I'd kind of answer that one, Tim. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - Interim CEO, Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + All right. Let me -- maybe if I could just close out, Mark. Look, we think 2018 was a great year. Our -- strategically, what it is we're trying to do and the opportunities we see are as strong, if not stronger, today heading forward as they've ever been. We think '19 for us is going to be another record year. +At the same time, we realize that first quarter is just going to be lower. And the practical reality is we got -- we think we have a reasonably good read on the level of inventory that's in the ecosystem. I'd say this particularly for we're getting better and better on the diagnostics around the DCG business. The Q4 to Q1 dynamics for DCG historically have been sequentially down 8% to 10%. +And the practical reality is, as we see it now, is that could be double in the first quarter. But that has nothing to do with the strength of the business, the product line portfolio we have coming and our excitement about delivering a real strong 2019 as we go forward. So thank you very much for joining us, and I'm sure we'll talk to you soon. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [34] +-------------------------------------------------------------------------------- + + Operator, please go ahead and wrap up the call. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2019-Jul-25-INTC.txt b/Transcripts/INTC/2019-Jul-25-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..cb2bdbe1ebc546b4baca6341e9bde252ebc8f0c3 --- /dev/null +++ b/Transcripts/INTC/2019-Jul-25-INTC.txt @@ -0,0 +1,422 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Intel Corp Earnings Call +JULY 25, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Robert H. Swan + Intel Corporation - CEO & Director + * Mark H. Henninger + Intel Corporation - VP of Finance and Director of IR + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and welcome to the Second Quarter 2019 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mark Henninger, Head of Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's Second Quarter Earnings Conference Call. By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online. +I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Mark. The second quarter was significantly stronger than we forecasted in April, and our results demonstrated our customers' preference for the performance of Intel XPUs as workloads grow, diversify and become increasingly complex. That need for performance manifested in strong mix in ASPs across the business. Our Q2 results are proof points for the megatrends that underpin our strategy. The world's insatiable appetite for data is driving demand for solutions to process, store and move it faster and better. Customers want to work with partners who can deliver performance and platforms to address their most important technology challenges. +Our data-centric businesses overall performed roughly in line with our April expectations. Data center and IoTG customers chose our highest-performing products leading to strong mix in ASPs. While our cloud customers absorb capacity they put in place over the last year, we continue to expect cloud demand to improve in the second half. Enterprise and government spending remains weak, however, particularly in China. +PC demand continued to improve, particularly in the commercial segment. We now expect the PC TAM to be up slightly for the full year. Strong demand for our highest-performing products and the productivity and TCO gains they deliver continues. +Mix was stronger than we anticipated. While small core supply improved, we were not able to fully satisfy customer demand for these SKUs in the second quarter. Tariffs and trade uncertainties created anxiety across our customers supply chain and drove a pull-in of client CPU orders into the second quarter. +We also halted shipments to certain customers in response to the U.S. government's revised entity list. After a thorough review, we were able to resume shipments of some products in compliance with regulations and the net impact on the second quarter was limited. While we hope and expect trade issues to be resolved, further tightening of export restrictions would come with revenue risk to our business. As a result, we enter the second half of the year a little more cautious than we were 90 days ago. +We met with many of you in May at our investor meeting where we outlined 3 major thrusts of our game plan to transform our company and grow. First, we're pursuing the largest opportunity in our company's history, a nearly $300 billion TAM comprised not just of CPUs for PCs and servers but of XPUs and adjacent technologies for an incredibly wide range of workloads and devices. Second, we're strengthening our product leadership by accelerating the rate of innovation. And third, we're evolving our culture and improving our execution so that we can play an even greater role in our customers' growth and success. I'll take a few minutes to share some of the progress we're making. +I'll start with expanding our opportunity and expanding our TAM. Over the last few years, we have dramatically expanded our served market while the PC market was declining. Our served market now is more than 5x larger and growing faster, and we have reallocated spending to expand our capabilities in higher-growth areas. We are evolving Intel Inside from a CPU inside a PC to XPUs inside everything that processes, stores and moves data. Big bets in 5G, AI and autonomous systems are an important part of this transformation. +In May, I outlined a disciplined framework for investing in and evaluating big bets as we expand into new markets. First, we'll invest where we have an opportunity to lead major technology inflections. Second, our investments should allow us to play a larger role in our customers' success. And finally, they must show a clear path to profitability and attractive returns. +Network infrastructure, which is transforming as the industry transitions to 5G, is one of our most important areas of investment, and we are laser-focused on this opportunity. This business has grown at a 40% CAGR since 2014 from just over $1 billion in revenue to more than $4 billion last year. The network cloudification that comes with 5G expands our opportunity in the core network and at the edge as more data moves closer to where it is created. +We expect to be in production on Snow Ridge, Intel's 10-nanometer system-on-chip technology for 5G base stations early next year. We've already announced that 2 large telecom equipment manufacturers have committed to this architecture, and we're on track to 40% share in this market segment by 2022. +While the 5G network opportunity meets each of our investment criteria, the 5G smartphone opportunity does not. This is why we decided to exit the 5G smartphone modem business and conduct an analysis of our options for the remaining parts of that portfolio. Today, we announced the sale of the majority of our 5G smartphone modem business to Apple. This deal preserves Intel's access to critical IP we have developed. It enables us to focus on the more profitable 5G network opportunity where we are growing and winning share. +Another growth market we're gaining share is the Internet of Things. We are using our architecture, accelerators and software assets combined with unmatched scale and partners to develop one of the industry's fastest-growing IoT portfolios. Taken together, the IoTG and Mobileye businesses grew at 22% over last year after adjusting for the sale of Wind River. More intelligence is moving to the edge and more industries want to harness the power of data to create business value, innovate and grow. Devices and systems are becoming more autonomous. This is a trend IoTG is shaping and capitalizing on. +Our team's work is producing outstanding results. In the second quarter, we grew at roughly 3x the market rate and are positioned to significantly outgrow the market over time. Here again, we saw demand for performance and strength across all verticals we serve with computer vision being an especially critical workload. +Mobileye is positioned to lead another huge opportunity, autonomous driving. This business has grown at more than 30% CAGR since we acquired them in 2017. Our market leadership continues to build momentum with 20 new design wins this year, representing 11 million lifetime units. Nissan's ProPILOT 2.0 and NIO's pilot vehicles have begun production featuring Mobileye-based L2+ system for hands-free assisted driving technology. I visited the Mobileye team in Israel last month and was treated to an autonomous ride through the streets of Jerusalem. The progress we are making in Level 4 and Level 5 autonomy is extraordinary. Our mobility as a service JV with VW for deploying a commercial robotaxi service in Tel Aviv by 2022 is on track. Global coverage of REM, or Road Experience Management, mobilized real-time crowdsourced mapping capability, is expanding rapidly. Several major auto OEMs, most recently Ford, are adopting this breakthrough data-centric capability. +To understand the power of this data, consider this: 1.5 million kilometers is sent to the cloud daily from BMW production vehicles. With the data collected from just the last 4 weeks, Mobileye was able to automatically map 94% of the German autobahn and motorway network. And the commercial opportunity for REM extends beyond real-time maps for vehicles. Since announcing the agreement earlier this year, Mobileye and Ordnance Survey have jointly launched a service that delivers high-precision road network location data to companies across multiple sectors. +Artificial intelligence is a $10 billion data center silicon opportunity by 2023. And today, it's fueling cloud customer demand for solutions that accelerate demand in AI workloads. This is evidenced by the fact that key cloud customers, most recently Baidu, are collaborating on our Nervana Neural Network Processor for Training or NNP-T. NNP-T will sample to customers later this year, expanding our already diverse AI portfolio which spans multiple architectures, including ASICs like NNPI, TPUs, GPUs and FPGAs. All unified by single programming model, One API. +The second major element of our game plan is extending product leadership by accelerating the rate of innovation. The future of computing will require a solution-oriented mindset building on 6 pillars of innovation. Over the last 50 years, Intel has delivered breakthrough after breakthrough in computing performance that has propelled technology and society forward. We are far from finished as our product and customer announcements over the last quarter demonstrate. +Our Data Center Group just announced a very important strategic partnership with SAP to optimize Intel's platforms, including Xeon Scalable processors and Optane DC persistent memory for SAP's end-to-end enterprise software applications, including SAP S/4HANA. For over a decade, we have worked closely with SAP on developing differentiated breakthrough technologies that make organizations run more efficiently. The broadening of our strategic partnership with SAP will allow our mutual customers to accelerate their organization's digital transformation by deploying SAP business applications optimized for Intel-based infrastructure in the cloud, on-premises and in hybrid environments. +Our ecosystem partners have already received Ice Lake server samples. We are making good progress on Ice Lake server and are now planning to start production wafers in the first half of 2020 with the volume ramp in the second half of the year. +Both yield and defect density are ahead of schedule for our 10-nanometer data center products. Cascade Lake, which is ramping now, is on track to be one of our fastest ramping products ever, and we have a great solution for our customers in the first half of 2020 with Cooper Lake in the same platform as Ice Lake. We are working more deeply with our customers to understand their needs and become the partner that they rely on to innovate and grow their businesses. They challenge us. It's producing results, and it's making us better. +For example, in the second quarter, we announced a strategic partnership with Google to collaborate on Anthos, a new reference design based on the second-generation Xeon Scalable processor and an optimized Kubernetes software stack that will deliver increased workload portability to customers who want to take advantage of hybrid cloud environments. These deep customer engagements are frankly one of my favorite parts of the role. +We are constantly thinking about how we can help our data center customers harness the potential of data by processing, storing and moving it more efficiently. An essential part of the equation is interconnect technology, which is why we recently announced our intention to acquire Barefoot Networks. Barefoot Networks is an emerging leader in Ethernet switch silicon software with the programmability and flexibility necessary to meet the performance needs of the hyperscale cloud. We closed the transaction this week, and we are excited to have the Barefoot team as part of the Intel family. +Our client computing customers can look forward to exciting new Intel products this year. In the second quarter, we launched a special edition of the world's best gaming processor, the Core i9-9900KS. We also launched our new 10th Gen Core product family codenamed Ice Lake, which integrates WiFi 6, Gen11 graphics and AI acceleration. +While we are delivering on the present, we are also creating the future. Intel Labs is researching completely new architectures like quantum and neuromorphic computing that promise incredible leaps in performance and power efficiency. Neuromorphic computing strives to emulate the neural structure and operation of the human brain, which could deliver big advancements in artificial intelligence by allowing computers to sense, learn and behave more naturally and efficiently. Just this month, we announced an 8 million neuron neuromorphic system comprising 64 Intel Loihi research chips that's now available to the broader research community. +Finally, we are evolving our culture and improving execution because our customers are counting on us. Our process technology road map continues to improve, and we're making excellent progress on 10-nanometer. We began shipping Ice Lake client in the second quarter supporting systems on the shelf for the holiday selling season and expect to ship Agilex, our first 10-nanometer FPGA later this year. We now have 2 factories in full production on 10-nanometer. We are also on track to launch 7-nanometer in 2021. With a roughly 2x improvement in density over 10-nanometer, our 7-nanometer process, which will be comparable to competitors' 5-nanometer nodes, will put us on pace with the historical Moore's Law scaling. +We're also making steady progress increasing CPU supply. Through our investments, focused execution and tighter customer collaboration, we expect our PC CPU supply will be up mid-single digits this year while we expect the PC TAM to grow slightly. We'll continue to work with our customers to meet their required product mix and ramp additional capacity to ensure we are not a constraint on their growth. +A final point of pride in the second quarter that speaks to Intel's values is the release of our annual Corporate Responsibility Report, which highlights the progress made over the last year toward our 2020 goals around environmental sustainability, supply chain responsibility, diversity and inclusion and social impact. We achieved a number of our 2020 goals ahead of schedule: energy conservation, nonhazardous waste recycling, workforce diversity and technology empowerment. Being responsible stewards of the communities in which we operate is central to our culture and it is helping us transform and deliver the results you expect of us. I'm proud of what our team has accomplished over the last quarter and look forward to sharing more proof points of our progress with you in the coming months. +With that, I'll hand off to George, who will take you through the financial details. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Bob, and good afternoon, everyone. We had a solid Q2 with revenue coming in at $16.5 billion, down 3% year-on-year and higher by $900 million compared to our guide. Data-centric revenue was $7.7 billion, down 7%. And PC-centric revenue was $8.8 billion, up 1% year-on-year. Our Q2 operating margin was 31%, down 2 points as client ASP strength was more than offset by platform volume declines and continued NAND pricing degradation. +Q2 earnings per share came in at $1.06, up 2% year-on-year and $0.17 over our guide for the quarter. Year-to-date, we have generated $5.7 billion of free cash flow, returned $8.4 billion to shareholders, paid dividends of $2.8 billion and repurchased approximately 117 million shares. +As mentioned last quarter, we anticipated a more challenging year in 2019 coming off a large build-out of capacity in 2018 by DCG customers as well as the pricing dynamics in memory, which is largely playing out as expected. In light of these factors, I'm pleased with our results and operating performance for the quarter. +Non-GAAP EPS was up 2% year-over-year driven by strength in our platform ASPs, lower 10-nanometer startup costs, lower operating expenses as well as lower shares outstanding and a McAfee dividend. Offsetting factors were data-centric demand softness, continued NAND pricing pressure and PC supply constraints impacting our ability to fulfill low-end PC demand. Our non-GAAP tax rate came in at around 12%, in line with last year. +Let's now turn to segment performance. Our Data Center Group ended the quarter with revenue at $5 billion, down 10% from the prior year and up 2% sequentially. This was slightly ahead of our expectations with platform ASPs up 2% year-on-year. Xeon ASPs were up double digits year-on-year on mix as our customers continue to select high-performance products. Against the tough year-over-year compare, platform units were down 12%. +Cloud revenue was down 1% year-over-year as cloud service providers absorbed capacity after growing demand 40% in 2018. Enterprise and government revenue declined by 31% with particular weakness in China, while communication service providers revenue increased 3% year-over-year. We see comms service provider demand still in the early phase of a meaningful 5G-related build-out. +Overall, our other data-centric businesses were down 1% year-over-year or up 2%, excluding Wind River, on strength in our Internet of Things businesses, partially offset by ASP weakness in our memory business. Our Internet of Things businesses, which include IoTG and Mobileye, continue to show growth and delivered record revenue up 22%, excluding Wind River. IoTG showed strength across all segments with revenue growth of 23% year-over-year, excluding Wind River, and operating income growth of 21% on strong demand for higher-performance products in the quarter. We believe a portion of the revenue outperformance in IoTG is from tariff-related pull-ins. +Our Mobileye revenue and operating margin were up year-over-year 16% and 20%, respectively, on continued ADAS penetration. Our memory business revenue was down 13% as the industry supply surplus continued to feed a deteriorating NAND pricing environment. NSG operating income weakened by approximately $220 million year-over-year. PSG revenue declined 5% year-over-year as softness in cloud and enterprise demand more than offset growth in 5G wireless. Advanced products, which includes those manufactured on 28-nanometer through 14-nanometer process nodes, grew 15% year-on-year. PSG operating margin was down 49% year-over-year on lower revenue, product mix and 10-nanometer road map investments. +The Client Computing Group demonstrated strong execution this quarter with revenue up 1% year-over-year on mix-driven ASP strength, strong demand in commercial PCs and modems and $200 million to $300 million in revenue from order pull-ins due to trade and tariff concerns. We believe the PC TAM grew slightly in Q2 led by our commercial PC demand. +Our PC units were down 5% as our small core supply was constrained and we could not fulfill all of our customer demand. We have made significant progress against our supply challenges, and we expect supply and demand to return to balance in the second half. That said, demand has been stronger than expected and product mix will continue to be a challenge in the third quarter as our teams work to align available supply with demand. +We saw strong ASPs in the quarter with notebook ASPs up 3% year-over-year and desktop ASPs up 5%. Operating margin for our client group was 42%, up 5 points year-on-year on strong revenue and mix and lower cost of sales post qualification of our 10-nanometer Ice Lake client product. +For the first 2 quarters, we generated $12.5 billion in operating cash flow and we invested $6.9 billion in capital to ramp 10-nanometer capacity and for 7-nanometer product development. We also spent $5.6 billion to repurchase 117 million shares to date. Buyback was accelerated in the second quarter where our average purchase price was $46.78 per share. We have $11.7 billion remaining on our Board authorization. +Now let's talk about the full year outlook. For the full year, the market dynamics reflected in our April guide remain largely in place although memory has continued to weaken relative to our expectations. Although we have seen a weaker first half in our data center business, we expect a better second half as demand from cloud and comms service providers improves and our second gen Xeon Scalable continues to ramp. +We are increasing our revenue outlook for the full year by $500 million to $69.5 billion to reflect the outperformance in the second quarter somewhat offset by the effect of trade-related pull-ins and a weaker memory environment. We continue to expect revenue from our data-centric businesses to be down low single digits for the full year. Our guidance for full year PC-centric business growth remains a low single-digit decline for the year, reflecting share loss in small core applications where we have been short supply longer than expected and demand has remained healthy. We expect to have additional small core supply in the second half, which should allow us to regain some of that lost share. +Operating margin for the year is expected to be 32%, flat to our previous guide. Full year expectations for gross margin are unchanged at approximately 60%. We expect Q3 gross margins to be roughly in line with Q2 on strong flow-through of higher revenue offset by increased 10-nanometer cost as we ramp production. The cost increase in Q3 will be tempered as we will be selling through some of the previously reserved 10-nanometer in the quarter, and we see the benefit of a grant related to our NAND factory in China. We expect Q4 gross margin to be down 3 to 3.5 points sequentially as we continue to ramp 10-nanometer and will have sold through the previously reserved inventory and will also not see the benefit of the NAND grant. We are making great progress on 10-nanometer and expect to see continued yield improvement as we move into 2020 and work through the cost curve. +Full year spending is expected to be down almost $1 billion year-on-year in line with our prior outlook adjusted for costs related to our acquisition of Barefoot Networks. We are now expecting 2019 savings from our modem exit to rise to approximately $400 million to $500 million from our earlier estimates of $200 million to $300 million. The increased savings are being offset by higher spending on 10-nanometer and 7-nanometer processes and product R&D. +Earnings per share for the year is now expected to be $4.40, up $0.05 from our April guide, reflecting higher Q2 earnings offset somewhat by the impact of tariff pull-ins on the second half, weaker memory and a slightly higher full year tax rate. We now expect the non-GAAP tax rate for Q3 and Q4 to be approximately 13%, up slightly from our April guide as we anticipate a higher mix of our pretax income in the second half in higher tax domains. +Turning to Q3 outlook. We expect revenue of $18 billion, up 9% sequentially, which is within our normal seasonal range after adjusting for trade-related pull-ins in Q2. Our data-centric and PC-centric businesses will be down mid-single digits year-over-year in Q3 against very challenging compares. We expect Q3 operating margin of 35% and non-GAAP EPS of $1.24 on higher sequential revenue particularly in PC, data center and IoT. +I will conclude here and turn the call back to Mark. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) Operator, please go and introduce our first caller. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from the line of Chris Danely from Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Just a question on share expectations. I know in the Analyst Day, you expected the competitive environment to get a little more -- I guess a little more competitive, although it doesn't seem to happen in Q2. Maybe talk about how you expect your share to trend over the next 4 to 6 quarters in light of the competitor coming out with 7-nanometer and then you guys introducing 10-nanometer later on. Do you think you'll maybe lose share over the next 3 to 4 quarters and then gain it back? Or how should we think about things are going to play out? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Chris, it's Bob. First, I would say that during the course of this year, as George mentioned in his prepared comments, we lost a little bit of share in the second quarter particularly in CSG at the lower end small core primarily due to supply constraints. And our expectation is that we'll begin to work our way back in the second half of the year given the capacity we put in place to have more supply and meet our customers' demands. +But stepping back and just looking at the macro environment over the next several years and particularly in the second half of the year on the data center side, what we've indicated is it will be a much more competitive environment. Our intentions are with a -- not a 90% share position, but more like a 23% share position that we have significant prospects for growth across multiple aspects of our business. And our intentions are over the -- over that time frame to continue to grow our data-centric collection of businesses at or above market rates of growth. And that's consistent with what we said back in January. We reiterated it again at our May Investor Day and nothing's really changed from that standpoint. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [5] +-------------------------------------------------------------------------------- + + Okay. So a 2-part question on the Data Center Group. I guess first and foremost, could you just discuss a little bit about the differences between the subsegments? The cloud side was impressively strong in the quarter and it sounds like you think that's going to continue. But the enterprise and government side, I know you said that was China specific, but that was exceedingly weak. Any more color on what's going on on that enterprise side in the current quarter and probably of equal, if not greater importance, the second half looks like you still expect a really big ramp and potentially better than seasonal. What gives you the confidence in the second half ramp in DCG? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Ross, it's Bob. I'll comment and then George will pile on. First, on growth overall, we had -- cloud, I'd still put in the relatively soft category to the first half of the year as the cloud players continue to digest. And our expectations have been and still are that cloud will get a little bit stronger as we go into the second half. And as George mentioned, comms has been low single digits as our customers begin to build up for the transition to 5G, so we expect that growth to probably materialize more as we go into the latter part of this year, but I think more in 2020. +Enterprise and government has been brutal through the first 6 months of the year. Q1 was really soft. Q2 was even softer. And while we don't like it, it's been pretty much in line with how we expected the first half and even the second half of the year to kind of play out. A couple of dynamics. You'll remember last year was really strong for enterprise and government. Growth was much stronger than we expected. Our belief at the time is that that was largely a function of increased digital transformation by CIOs, a favorable tax reform environment that gave them a little more capacity to spend. And we benefited from that tremendously last year. +So the first half of this year, even the second half comps -- our comps are much tougher. And I would say our sense is that CIOs, broadly speaking, are a little more cautious as they go into the second half of the year. And then when you just take -- that's a broad-based comment. And then when you take China into account, China is even worse than that. So our thoughts through the first half of the year and even going into the second half of the year is the E&G environment won't get dramatically better. Cloud will get a little bit stronger and comms will get a little bit stronger in the context of our overall full year guide. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Yes. I would just add that we -- again, we saw enterprise and government down 31% year-over-year. I would say maybe a little bit weaker than even we were forecasting, which is for a pretty weak performance in that group. But in general, I wouldn't add any more to what Bob said. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [9] +-------------------------------------------------------------------------------- + + So we have gross margins coming down into Q4, you're probably in the low to mid 58%s. And I know at the Analyst Day, you had sort of given an indication for gross margins in like the 2021 time frame to be around 57% on a $77 billion number. I guess how do we think about the trajectory from where we're exiting this year to the gross margin profile in 2021? Does that imply that 2020 gross margins should be down from obviously 2019 and 2021 should be down from 2020? And then what happens if you actually don't hit your revenue guidance of $77 billion in 2021 because the margin impact is mostly fixed? Does that imply margins come down even more in that case? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + I think -- Stacy, it's George. We did say that we think we'll bottom out at 57% in '21. We didn't guide specifically for '20 but implied it would be closer to the 60% range. And I would say, one of the things that's going to help us -- two things that are probably going to help us as we think about 2019 to 2020, one is we're going to see more of the benefit of moving up the yield curve in 10-nanometer, which is pretty painful now, and you're seeing that really in the fourth quarter gross margin. +I would also say though, you're seeing a really pure impact of memory in the fourth quarter as well because they -- we have a grant in the third quarter. So you're going to see a sequential step down just because of the absence of the grant and it just tells you how much the impact on gross margin overall for the DC-centric group has been because of memory. I think memory, if we can start to see improvement on that in 2020 -- and there's some evidence of firming of the ASPs, but probably too early to call that. I think that could also be a factor. +But you're also seeing growth in our adjacent businesses, which have attractive margins. They'll continue to grow into 2020. And like I said, I think largely it's going to be 10-nanometer yield curve benefits, maybe a little bit improving memory and then improving adjacent businesses should be a little more positive than what we're seeing purely in Q4. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [12] +-------------------------------------------------------------------------------- + + I had a question for George. So George, I'm just trying to figure out the incremental accretion from the sale of the modem business. It doesn't seem like a lot of it is dropping through to the op margin because you're investing more in 7- and 10-nanometer. So I'm just wondering why that would be the case if yields are on track. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Well, one of the things that we talked about, Tim, was trying to pull in as much as possible both the 10-nanometer and 7-nanometer road map because we think the economics of that is more than worth the investment. And really, the investments we're making now are all focused on executing to that. We're going to see more accretion from this deal coming in the following year when we would expect a significant increase in the reduction in sort of the run rate OpEx for the piece that's going out at the end of the year. So maybe $400 million to $500 million this year, but you can probably double that number for next year, which we think will help on the total spending. +And the question is will we need to retain this higher level run rate that we're seeing today for acceleration fully into next year? I think there might be some opportunity there as well. But we're going to -- we're going to invest first in those things that we think drive yield improvement in 10 and product performance improvement in 10 and 7. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [15] +-------------------------------------------------------------------------------- + + Maybe just again to kind of step back on the data-centric businesses. On the revised full year outlook, you're still guiding data-centric to be down low single digits year-over-year. Previously, within data-centric, you guys were looking for DCG specifically to be down mid-single digits year-over-year, which implies about 20% growth in DCG second half versus first half. Is that still how the team sees DCG for the full year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [16] +-------------------------------------------------------------------------------- + + I would say we're still roughly in that ballpark. We haven't really changed our view of the full year. There may be a little bit that slipped into the first half relative to our original second half expectations on the pull-ins even though it's more of an impact on the PC side that we saw a little bit of that in DCG. So now we're looking to a strong second half for DCG. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Vivek Arya from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [18] +-------------------------------------------------------------------------------- + + On inventory, they were up about 12% sequentially in terms of dollars. Now when I look at your second half sales, you're forecasting them to grow 13% to 14% half over half, so it kind of makes sense. But just inventory in terms of historical levels, it's still quite elevated given the macro conditions. So is this all 10-nanometer-related inventory? Just what's driving this? How do you see it trending in the second half? And will there be any impact on the gross margins from any utilization changes that might be needed? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [19] +-------------------------------------------------------------------------------- + + Sure. Great question. And we're watching inventory very closely ourselves. The big bounce this quarter, as you suspected, was really about 10-nanometer within finished goods coming onto the balance sheet. And so there is actually some gross margin benefit, which we began to see this quarter and we'll see a little bit next quarter previously reserved inventory then flowing into the marketplace, so some gross margin benefit from that, and you've seen that in the CCG margins. +We -- yes, normally we'd be up going into the seasonally strong third and fourth quarters in this quarter. I would say overall that we think the adds this quarter, which are all related to 10-nanometer, make sense. I think we feel still that our inventory is higher than we would like in memory, and we will look to bring that down over time. It's a very tough market to bring it down in and then feel good about yourself. So we'll continue to watch that. But that's been part of the pressure on free cash flow has been some of these working capital, particularly inventory impacts. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [20] +-------------------------------------------------------------------------------- + + To George's point, while we're not big fans of growing inventory, we feel great about qualifying the Ice Lake product in the second quarter. And that qualification is the single biggest reason for the step function in inventory from Q1 to Q2. So we knew if we executed on our plans of the Ice Lake client qualification, we'd have a step-function in inventory and we feel good about getting that qualification done and behind us. The implications of that is the higher balance in Q2 versus Q1. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [22] +-------------------------------------------------------------------------------- + + Congratulations on the solid results. Maybe if I can go back to the gross margin from -- at the Q4 level, I'm just kind of curious, given that CapEx has been running significantly ahead of depreciation, I'm kind of curious if there's anything going on on the depreciation schedule, which is impacting the calendar fourth quarter gross margins. And George, to the extent that in the previous question you talked about maybe some tailwinds relative to the fourth quarter run rate next year in 2020, how do we think about the bridge from sort of the Q4 guide of kind of 58.5 to the Analyst Day guide for 2021 of 57, is that all just the impact of 7-nanometer coming on in that year? Or is there some price consideration? How should we conceptually think about that? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- + + Okay, John. That's a great 3-part question. There's nothing unusual going on in depreciation in the fourth quarter. As I said, most of the impact is really related to -- we'll have gotten through all of the previously reserved 10-nanometer products, so you're going to see more pressure on gross margin from the products that are coming into the marketplace while we're still at the low end of the yield curve on 10-nanometer, which is where we are today. +In 2020, how I think about 2020, I think we -- as I said earlier, we think we'll see a benefit from moving up the yield curve on 10-nanometer. We're pleased with our process work that's going on there now. And also, we would expect that memory, which has been a significant drag on gross margin this year, will help us a little bit overall. So no real change. Probably the easiest thing would have been to just go back to say no real change in our outlook that we gave at Analyst Day in terms of the gross margin trajectory over the next few years. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + George, the only thing I would add on the depreciation while there's nothing kind of out of the norm, there are 2 fairly big dynamics that happen over the course of the next several months. One is over time, we have more and more of our 14-nanometer equipment that's fully depreciated. So as you know, that's been our engine for a while, and we'll have more and more fully depreciated assets that are at work. That's obviously favorable. +On the flip side, we have -- we talked about ramping 2 fabs and we've had a lot of assets under construction on our balance sheet that weren't being depreciated. So in one sense, you have a drop off from the life of 14-nanometer equipment. At the same time, you're deploying some of the 10-nanometer equipment that we bought previously. So those 2 things underneath the cover at the macro level to George's point, there's not a dramatic change. But underneath the covers there's 2 fairly big dynamics in the makeup of our equipment base and what's fully depreciated versus what's being put into service. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [26] +-------------------------------------------------------------------------------- + + You talked about the reasons for being a little more conservative about the second half than you felt 90 days ago, but your second half guidance isn't materially different than it was 90 days ago. So I guess how are you thinking that relative to the forecast? And I guess when you talk about pull-ins, like what is that -- I'm surprised that there is pull-ins at the same that there's shortages. So maybe you can just describe what the behavior is that's pulling revenue into Q2. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + So again, for the second half, really for the full year, we're largely seeing the full year as we talked about it 90 days ago. What I think the biggest difference is just how strong you see demand has been and the pull-ins that came into the second quarter leading to a much stronger second quarter where we are passing obviously some of that through with the exception of the pull-ins to the full year. So I don't want to sound like we're going to -- we'll see the normal seasonal bounce and it will be a strong second half of the year for the company. +And I think we're expecting a strong DCG improvement in the second half as they get through the capacity digestion. We think the PC is going to continue to be quite strong. So relative to our forecast, I guess I may be countering a little bit this idea of a weaker second half other than memory has been a little bit weaker than we had expected. ASPs are certainly down more, and so we're anticipating some pain from that. And then of course, some level of demand was pulled into the second quarter, but it's really reflective of a year that is playing out largely as we expected with some upside on PC TAM. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes. And I think the only thing that I would add to that is relative to where we were in April looking out to the second half of the year, we still have the threat of tariffs going up for goods coming out of China and the implications of that. And there's still a little bit of -- a little lack of clarity about the implications of the entity lists and how quickly applications for licenses will be received and processed. So I think that the real -- we're kind of $900 million better in the quarter. You took the year up for $500 million. We attributed roughly $400 million to pull-ins. As we go into the second half, we're just at the -- there's still a little bit unknown about what -- how this China thing is going to play out. And that's a big important market for us, and that's probably what makes me a little more anxious. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matt Ramsay from Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [30] +-------------------------------------------------------------------------------- + + George and maybe Bob as well, we had heard and continue to hear rumblings of -- and you guys have addressed it at the Analyst Day and in other forums about how you might be price aggressive in certain sectors to try to protect market share. And I wonder if you might comment about how you're thinking about that strategically in your notebook business where you have 10-nanometer product coming online versus in your desktop business where you might be on 14-nanometer for a bit longer. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + First, I'd start with, at the risk of repeating myself, a TAM of $300 billion, the largest TAM in the company's history with a pretty decent wind at our back in terms of this insatiable appetite for data and what it means for the products that we build and design. So we view ourselves as having a relatively low-share position with significant opportunity to grow. But at the same time, we know it's just -- we're not the only ones that have seen a data-centric world and it will be a more intensely competitive environment. +And our expectations over time are to protect our market share position while continuing to invest in new prospects for growth. And that hasn't really changed. When you look at that by segment, we're going to be -- on the PC side, we've been protecting our position for the last couple of years. I'd say the competitive intensity on the PC side started probably in the first part of 2017. And during that time frame, we've tried to protect our position while moving end customers up to higher performance products that generate higher ASPs and with that have the capacity also to fight back and meet comps in targeted areas where we need to. +So that's -- how we think about it is big opportunity to grow, large market, protect our position while expanding into new vectors. And that transforms all segments, and we're a little more protective about some segments versus others in those cases, particularly when we're in a supply-constrained environment. So not a whole lot has really changed on that other than we know it's going to be more competitive and we try to take that into account as we've thought about not only our second half outlook but our 3-year outlook. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our final question then comes from the line of David Wong from Instinet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [33] +-------------------------------------------------------------------------------- + + Just a clarification of what you had said with regard to restrictions in shipments to various entities in China. Did you say that the net result was actually small in the second quarter? And will there be -- do you expect any meaningful impact on DCG revenues from restrictions and shipments in the third quarter? Or is that going to be small, too? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [34] +-------------------------------------------------------------------------------- + + Again, so it was small in the second quarter. In fact, it was probably a net positive because of pull-in activities. So if you looked at what we were prohibited from shipping versus what was pulled in on things we're allowed to ship where people were concerned that perhaps restrictions would become greater, that was a net positive in the second quarter. We think that dynamic just remains in play in the second half of the year. How much of the demand concerns were met in the second quarter, we'll have to see how that plays out. But our forecast is based on kind of the current state of activity. And as Bob said, we're -- it doesn't mean that we're not concerned or cautious about what could happen if there's a change in policy between now and the end of the year. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [35] +-------------------------------------------------------------------------------- + + Thanks, David. And we'll hand the call back over to Bob to wrap things up. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Thanks, Mark. Thanks, everybody, for joining us. I'd just kind of close where I started. We had a -- the quarter played out much stronger than we expected. Revenue better, gross margins better, spending in line, earnings greater. And therefore, from that confidence, we're raising our full year outlook and kind of feel good about our performance 6 months through the year. +Secondly and just more importantly, we continue to really work the supply chain so we're never in a position to constrain our customers' growth. We've made good progress through the first half. But I think more as we go into the second half, we're just in a better position than we've been in a while. We still have work to do. We're still working with our customers, but we feel pretty good on the supply as we enter the second half. +And then third, our progress on both 10-nanometer and our confidence in migrating from 10 to 7 continues to grow based on execution. So we kind of gave you a 3-year outlook. We consider this the second deposit of that 12 deposit 3-year outlook, and I'd say we feel pretty good about where we are. And we look forward to giving you another update 90 days from now about continued progress momentum on our multiyear journey. So thanks for joining us, and we look forward to talking to you again in 90 days. + +-------------------------------------------------------------------------------- +Mark H. Henninger, Intel Corporation - VP of Finance and Director of IR [37] +-------------------------------------------------------------------------------- + + Thanks, Bob, and thank you all for joining us today. Operator, can you please go ahead and wrap up the call? + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Certainly. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2019-Oct-24-INTC.txt b/Transcripts/INTC/2019-Oct-24-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..63664a38fc4e5215fd697cbaa634fa6c05f67c9c --- /dev/null +++ b/Transcripts/INTC/2019-Oct-24-INTC.txt @@ -0,0 +1,575 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Intel Corp Earnings Call +OCTOBER 24, 2019 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Trey Campbell + Intel Corporation - Head of IR + * Robert H. Swan + Intel Corporation - CEO & Director + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2019 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. + +And now I'd like to introduce your host for today's program, Trey Campbell, Head of Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's third quarter earnings conference call. + +By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online. + +I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them, followed by Q&A. + +Before we begin, let me remind everyone, today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. + +A brief reminder that, this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. + +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Trey. Q3 2019 was the best quarter in our company's history. We generated $19.2 billion in revenue and $1.42 in non-GAAP EPS, exceeding our guidance by $1.2 billion and $0.18, respectively. We achieved record revenue both overall and in our data-centric businesses while making continued progress on our strategic priorities. Simply put, our ambitions have never been greater. We are growing share in a large and expanding $300 billion market opportunity fueled by the exponential growth of data, which is reshaping computing. + +I want to start with a recap of our May Analyst Day and our 3 priorities: Accelerating growth, improving execution and deploying capital for attractive returns. First, growth. It starts with a core belief. We are at a key inflection point with the exponential growth of data creating massive demand for semiconductors. Cloud workloads are diversifying. Networks are transforming. And more computing performance is moving to the edge. + +We've been on a multiyear journey to reposition the company's portfolio to take advantage of this industry catalyst. Today, we have the product and technology leadership that uniquely positions us to capitalize on these trends and will invest in the IP required to help our customers win the inflections of the future. + +The opportunity is massive. As we told you in May, we expect to generate $85 billion in revenue and $6 in EPS in 3 to 4 years. But that doesn't happen just by saying it. Achieving this goal means delivering on our operational and financial priorities every 90 days. + +Growth starts with our Core business where our workload-optimized platforms are winning in a highly competitive marketplace. It's now been 9 quarters since the first Xeon Scalable processor launched, and we're proud to have delivered over 23 million units as customers rely on Xeon to power their data-centric workloads. + +In the third quarter, leading cloud customers ramped our second-generation Xeon Scalable processors with AWS, Google and Alibaba deploying instances based on Cascade Lake. Customers including BP and TU Darmstadt selected our highest-performance Xeon Scalable platform, the 9200 series, for their most demanding workloads. One key reason customers are choosing Xeon Scalable is the platform's built-in workload acceleration for AI. With the combination of Intel Deep Learning Boost and AVX-512 technologies, we're seeing advantages of up to 9x in AI inference versus competitor CPUs. + +We also see cloud and enterprise momentum building for our break-through memory technology, Intel Optane. This quarter, we announced a strategic collaboration with Oracle. Oracle is incorporating the high-performance capabilities of Intel Optane DC persistent memory into its next-generation Exadata platform, which powers high-performance database infrastructure at most of the world's leading banks, telecoms and retailers. And in client computing, we're excited that all our major PC OEM customers have Ice Lake designs, with 18 already shipping out of a total of 30 expected to launch this year. + +We recently announced the next generation of Intel Xeon W and X-series processors for high-end desktops. These platforms lead the industry in bringing Intel Deep Learning Boost-powered AI acceleration into high-end PCs and mainstream workstations for the first time. Available soon, these products deliver performance and value that give enthusiasts and creators more reasons to keep choosing Intel. + +We've also embarked on a multiyear program, called Project Athena, that charts a course for the PC ecosystem to raise the bar on laptop innovation. Amazing devices like the Dell XPS 13 2-in-1 and the HP Elite Dragonfly that meet the Project Athena spec are already available. + +Our PC and server franchises are vital, but our ambitions are even greater. We're extending our product leadership to power an increasingly 5G- and AI-enabled world. We have multibillion-dollar networking and IoT/Edge businesses delivering double-digit growth, and AI is driving significant revenue across our product portfolio. + +We began investing 10 years ago in network IP, SoC capabilities and software so that we could drive workload convergence on Intel's silicon. Today, we achieved #1 share in the network and silicon market with expected 2019 revenue of more than $5 billion, growing at 12% this year. We're also well-positioned for 5G deployments in 2020 and expect to grow our market segment share in wireless base stations to 40% by 2022. And we're ready for the next market inflection as 5G enables significant new IoT and Edge growth opportunities that extend from in-network and on-premise Edge equipment to smart connected endpoints. + +Winning here means blending the right compute performance per watt with the emerging killer apps of the Edge, Computer Vision and AI inference acceleration. These are the differentiating capabilities that have propelled our IOTG and Mobileye businesses to leadership share and the combined annual revenues approaching $5 billion. The businesses are also growing quickly, up 18% year-to-date, excluding Wind River. We're only at the bend of the curve in the Edge opportunity, and we're investing to lead. + +Finally, artificial intelligence. AI is becoming a pervasive use case. According to IDC, 75% of enterprise applications will use AI by 2021, and that's why we're infusing AI in everything we build. But this isn't just about the future. We are driving meaningful AI revenue inside Intel now. With products spanning from the data center to the edge, we expect to generate more than $3.5 billion in AI-driven data-centric revenue in 2019, up more than 20% year-over-year. + +We're confident in our growth, but we also need to improve our execution on multiple fronts. First, supply. We've increased our output in response to stronger-than-expected demand. We've invested record levels of CapEx the last 2 years to expand our capacity and support our customers' growth. With that investment, we've increased our 14-nanometer capacity 25% this year while also ramping 10-nanometer production. We expect our second half PC Client supply will be up double digits compared to the first half, and we expect to further increase our PC Client supply by mid- to high single digits in 2020. But that growth hasn't been sufficient. We're letting our customers down, and they're expecting more from us. + +PC demand has exceeded our expectations and surpassed third-party forecasts. We now think the market is stronger than we forecasted back in Q2, which has made building inventory buffers difficult. We are working hard to regain supply/demand balance, but we expect to continue to be challenged in the fourth quarter. + +Our manufacturing process node execution is also improving. We have fabs in Oregon and Israel in volume production on 10-nanometer and will soon start 10-nanometer production in Arizona. Yields are improving ahead of expectations for both client and data center products. The Intel 10-nanometer product era has begun, and our new 10th Gen Core Ice Lake processors are leading the way. + +In Q3, we also shipped our first 10-nanometer Agilex FPGAs. And in 2020, we'll continue to expand our 10-nanometer portfolio with exciting new products, including an AI inference accelerator, 5G base station SoC, Xeon CPUs for server storage and network, and a discrete GPU. This quarter, we've achieved power-on exits for our first discrete GPU, DG1, an important milestone. + +As we discussed at the May investor meeting, we are accelerating the pace of process node introductions and moving back to a 2- to 2.5-year cadence. Our process technology and design engineering teams are working closely to ease process design complexity and balance schedule, performance, power and cost. We are on track to launch our first 7-nanometer-based product, a data center-focused discrete GPU, in 2021, 2 years after the launch of 10-nanometer. We are also well down the engineering path on 5-nanometer. + +Last, a few thoughts on our capital deployment priorities. We are confident in our future, and our Board has approved an additional $20 billion share buyback authorization. We have an excellent balance sheet, generate strong free cash flow and continue to invest in R&D and CapEx to grow. We've also returned 100% free cash flow to shareholders over the last 10 years. + +At the same time, we're making tradeoffs. While we've increased R&D spending by more than $1 billion since 2015, we have reduced our total spending by 9 points over the same period. + +Additionally, we have established clear criteria for our big bets like Mobileye, 5G, and memory and storage. Our ambitions are to play a larger role in our customers' success and generate attractive returns for our shareholders. And if we can't do both, we'll take swift action. + +We are making great progress with our Mobileye acquisition. We've now shipped over 12 million EyeQ devices this year, up more than 40% over the same period last year. And in the third quarter, we delivered record revenue and secured 6 major new design wins, totaling nearly 10 million lifetime units. + +We've increased our investment in 5G, but we've also announced our 5G smartphone modem exit and the sale of the IMFT fab to Micron. We expect those to close in the fourth quarter. And we continue to take steps to improve 3D NAND profitability and reduce memory CapEx investments while evaluating a variety of partnership options that can accelerate the path to profitability and improve returns. + +We are confident in our multiyear business plan. And consistent with that, we are increasing our buyback commitment. We expect to repurchase approximately 20 billion shares over the next 15 to 18 months. We'll fund the buyback from proceeds we generate from partnerships and/or noncore asset dispositions and by returning approximately 100% of 2020 free cash flow to investors. + +In summary, our energies are focused on accelerating our growth, improving our execution and allocating our capital wisely. Thanks to the team for a great quarter. + +And now I'll hand the call over to George for more details on our Q3 results and business outlook. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Bob, and good afternoon, everyone. + +We had an outstanding Q3 with record revenue of $19.2 billion, approximately flat year-on-year and $1.2 billion higher than guide. We saw record data-centric revenue of $9.5 billion, representing just under 50% of our total revenue, an all-time high. DCG, IOTG, NSG and Mobileye all individually achieved record revenue in the quarter. PC-centric revenue was down 5% year-on-year on a very tough compare. + +Q3 operating margin was approximately 36%, 1 point ahead of our guide on revenue strength and spending leverage. Gross margin for the quarter was 60.4%, modestly below expectations as strong flow-through of higher DCG revenue was more than offset by mix effects of higher-than-expected NAND revenues and onetime impacts in NSG, including the absence of an expected grant associated with our NAND factory. + +Q3 EPS was $1.42, $0.18 above our guide. The results demonstrate strong top line performance, expense discipline, increased share buybacks as well as nonoperational factors like lower tax rate offset by the onetime items in our NSG business. Year-to-date, we have generated $11.7 billion of free cash flow and returned $14.3 billion to shareholders. + +Operating margin of 36% in quarter was down approximately 4 points versus last year as ASP strength in our server and client businesses and lower spending were more than offset by NAND pricing degradation, changes in modem reserves, platform volume declines and higher cost as we ramp our 10-nanometer client products. + +EPS was up 1% or $0.02 year-over-year as lower operating margin was offset by lower share count, the absence of onetime impairments related to the IMFT joint venture and a lower tax rate. Our non-GAAP tax rate in Q3 was approximately 11%, down 1 point versus last year and below our 13% guide as we reported a better-than-expected tax benefit related to our non-U.S. sales on our recently filed 2018 U.S. tax return as well as for the 2019 tax year. + +Let's move to segment performance. Our Data Center Group had record revenue at $6.4 billion, up 4% from the prior year and up 28% sequentially. These results beat our expectations with platform ASPs up 9% year-over-year on strong adoption of our highest performance 2nd Gen Xeon Scalable products. Against a tough year-over-year compare, platform units were down 6% while DCG adjacencies achieved 12% revenue growth driven by our connectivity solutions. DCG growth segments, cloud and comms, now represent over 2/3 of total DCG revenue. + +Cloud revenue was up 3% year-over-year, returning to growth after a historic 2018 platform refresh as cloud service providers exited a 3-quarter capacity absorption cycle. Enterprise and government revenue came in ahead of expectations, growing 1% on strong mix and better China demand, while communication service providers revenue increased 11% on continued adoption and share gains of IA-based solutions. + +We estimate in Q3 that the enterprise and government and communication service provider segments benefited from trade-related demand pull-ins of approximately $200 million in revenue from Q4. As a result of the strong top line performance, DCG achieved record quarterly operating income, and operating margin of 49% was up 13 points sequentially. + +Our other data-centric businesses were up 13% year-over-year, and Q3 marked IOTG's first $1 billion revenue quarter, up 9% year-over-year, underscoring Intel's expanding opportunity at the Edge. IOTG operating income was down 4% year-over-year due to lower benefits from inventory reserves and a mix shift to lower-margin products. Mobileye revenue and operating income were up year-over-year, 20% and 29%, respectively, on continued ADAS penetration and new program launches. + +NSG revenue returned to growth, up 19% on continued bit growth, partially offset by year-over-year pricing declines. These pricing declines, along with the onetime impacts discussed earlier, contributed to NSG's operating loss of approximately $500 million. PSG revenue grew 2% year-over-year on continued strength in wireless, partially offset by softness in cloud and enterprise, and operating income was down 13% on segment product mix. + +CCG revenue was $9.7 billion, down 5% year-over-year, as ASP strength partially offset lower platform volume. PC unit volumes were down 10% versus Q3 '18 where we benefited from drawing down internal inventory to satisfy demand. We continue to be supply-constrained in Q3, particularly at the value end of the market as higher-than-expected PC demand strength continues to outpace our supply despite the capacity additions that Bob discussed earlier. + +Adjacencies grew 10% year-over-year driven by strong demand for modems and connectivity solutions. Operating margin was 44%, flat year-on-year, as lower revenue was offset by lower spending driven by the 5G smartphone modem exit. + +Year-to-date, we have generated $23.3 billion dollars in operating cash flow and invested $11.5 billion in CapEx. We also returned 122% of free cash flow to shareholders through dividends and buybacks. During the quarter, we ramped buybacks, purchasing 92 million shares at an average price of $48.78 per share. + +Now moving to the full year outlook. As a result of our strong Q3 operating performance and momentum into Q4, we are increasing our revenue outlook for 2019 by $1.5 billion to $71 billion. We expect revenue from our data-centric businesses to be flat to slightly up for the full year and expect our PC-centric business to be flat to slightly down, both improving versus prior guidance. + +Operating margin for the year is expected to be approximately 32.5%, up 0.5 points from our prior guide. Full year expectations for gross margin are unchanged at approximately 60%. We expect Q4 gross margin to be down 2 to 2.5 points sequentially as we continue to ramp 10-nanometer and will have sold through the previously reserved inventory, consistent with prior expectations. Expectations for full year spending are unchanged, down approximately $900 million year-on-year. + +As a result, non-GAAP EPS for the year is now expected to be $4.60, up $0.20 from our July guide on strong top line performance and tight expense control. We are raising gross CapEx by $0.5 billion to $16 billion as a result of increased 10-nanometer and 7-nanometer investment. And we are raising our free cash flow guide by $1 billion to $16 billion. + +Let's turn to Q4. After adjusting for the impact of trade-related pull-ins in DCG, we expect Q4 revenue of $19.2 billion, up 3% year-over-year and flat sequentially. Our data-centric businesses are expected to be up 6% to 8% year-over-year on continued cloud recovery and sequential NAND pricing growth. Our PC-centric business is expected to be flat to slightly down year-over-year. We expect Q4 operating margin of approximately 33.5% and a tax rate of 13.5%. EPS is expected to be $1.24, down sequentially on lower gross margin, lower below-the-line nonoperational benefits and a higher tax rate. + +In summary, we are very pleased with the company's strong operating performance, and we will be very focused over the quarter on delivering a record year. + +With that, let me turn it back over to Trey. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first caller. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from the line of C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess a question on the data center side. It's just -- to clear up the numbers, it looks like you're suggesting DCG up maybe 5% year-on-year. So can you speak to the accuracy of that? And then, I guess, bigger picture, the comms service provider side, clearly, a very large source of strength for you guys, up 11% year-on-year and now representing more than 40% of the mix. So curious if you can kind of speak to the most important drivers of that business and how you're thinking about growth over the next 1, 2, 3 years? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes. Thanks, C.J. First, we gave a DC-centric guide of 6% to 8%. And yes, I would -- we didn't give DCG specifically, but I would say it's a little bit lower than our 6% to 8% data center growth, so you're in the ballpark. + +On comms service, the comms -- this has been an extremely important aspect of the business for a number of years now where we've seen the programmability at the networks with NFV and software-defined networks an opportunity for us to migrate the networking environment to IA architecture. So we've been doing this for a number of years. It's been a fulsome growth for us over time. And in the quarter, the 11% growth was significant in and of itself, but remember, last year's third quarter was also up in the mid- to high 20s. So we continue to make good -- great progress. + +What we see going forward in this business is really a big opportunity in 5G. So next year, you're going to see -- our good progress has been on 3G and 4G. Next year, we see real design wins that we've achieved, real growth as we go into that 5G world where we continue to see what we characterize as cloudification the network, more and more compute moving from the cloud and data centers out to a network and Edge. And that's been an opportunity for us that we've been investing in over the past, and we expect to be a big source of growth for us going forward. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer from Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [5] +-------------------------------------------------------------------------------- + + Congratulations on the solid results. I want to stick with DCG, Bob. If you look, impressive, but ASPs were up 9% year-over-year, especially as the mix shifted towards the comms business, which I believe tends to be lower ASPs. It's also happening in the quarter where you're seeing your competitor ramping their next-generation chips. So I guess I'm trying to understand what's the power of the Xeon Scalable upgrade cycle you referred to in your prepared comments? What inning are we in, in your mind? How much of an ASP lift can that give you? And do you anticipate any unusual pricing action as competition heats up in this market? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Oh, boy. Was that your one question, John? + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [7] +-------------------------------------------------------------------------------- + + Multiple parts. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [8] +-------------------------------------------------------------------------------- + + Yes. Okay. So first, I'd say in our -- obviously, we're well into Skylake, but the transition now is into Cascade Lake, and that's a higher performance SKU. In the quarter, the high ASPs were really driven by particularly cloud customers really moving to the highest end product within the Cascade Lake family. So we're seeing the transition from Skylake to Cascade Lake, and within Cascade Lake, real high-performance SKU that's our highest performance ASP. So that mix dynamic in Q3, I don't expect that to stay where it is. I think we'll go to more of a balance as we're into Q4 next year. + +In terms of competitive dynamics, I would just say that we got a great lineup of products. We got Skylake to Cascade Lake. First half to next year, we're looking at Cooper Lake. As we talked before, we're really excited about Ice Lake server coming out in the second half of next year. And we realize it will be a more competitive environment, and we've tried to capture that in essence in how we think about 2020 for both demand equation but also the margins that we've flagged a little bit on the -- on our Q2 call back at Analyst Day, I think. + +So good quarter, good momentum first half to second half; high performance SKUs driving real high ASPs even though, you're right, that the ASPs with comms have a tendency to be a little bit lower. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [10] +-------------------------------------------------------------------------------- + + I wonder if you could talk to the shortages a little bit more and, I guess, in the context of how much you said you brought 14-nanometer capacity up. And I realize demand is better, but it seems like it's a few points better, and yet the shortages are intensifying. Can you just talk a little bit about that? And when do you think we'll be in a position where you don't have those tensions in your business anymore? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [11] +-------------------------------------------------------------------------------- + + Yes. Thanks, Joe. First, just kind of try to put it in to context. Over the course of the last 3 years, I guess, we've grown the business by about 20%, so $13 billion in revenue over the last 3 years. And the practical reality is we didn't anticipate that kind of explosive growth 3 years ago. So we didn't have the capacity in place to deal with it. We've been working our tails off for the last 12 months to ensure for our customers that we wouldn't be a constraint on their growth. From the last 2 years, I think, as you know, we've spent over $30 billion in CapEx to both have more capacity for 14 while we also begin to ramp 10. + +In my prepared comments, I said we added 25% wafer start capacity 2018 to 2019. Our first half to second half unit volume will be up double digit, so we're making good progress throughout the course of the year, but our expectations were in the second half we will be back in a supply/demand equilibrium. And the fact of the matter is we're not there because the demand profile that's resulting in our $1.5 billion higher revenue is just higher than we had anticipated. So we have more work to do to meet our customers' demands in the fourth quarter and going into '20. + +As we see fourth quarter, we're still going to be constrained in our customers' growth, which is absolutely where we do not want to be, but with the higher demand, we will be constraining the growth in the fourth quarter. But as we go into 2020, our expectations are we'll add another 25% capacity both for 14 and 10 and that we will have -- particularly for PC Client, we expect to be able to do mid- to high single-digit unit volume growth next year. And that -- we don't expect the market to grow that fast, but we got to have just more inventory buffers so we're there when our customers need us. So Q4 will be a little challenging, and in 2020, we expect to be able to rectify things. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava from BMO Bank of Montreal. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + Bob, I wanted to go through the priority and the cadence that you talked about, bringing it back to 2, 2.5 here. Is that -- because my understanding is that they were just simply laws of physics that were causing the cadence to stretch out. So what problems have the engineers and the process folks solved out there? Or is it just limited to the 7-nanometer, and then you would revisit that again? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [14] +-------------------------------------------------------------------------------- + + Yes. It's a good question. Last -- back in our Analyst Day, we tried to go through this in quite a bit of detail, both, one, kind of our lessons learned coming out of the challenges we had with 10 and how we're capturing those lessons learned as we think about the next 2 generations. But first, our focus and energy is, right now, we're on scaling 10. And as we said, we feel very good about the capacity we put in place, the products we have coming down the pipeline and the yields that we're achieving, almost week-on-week improvement over the last 6 months. So for 10, we feel really good. + +Second, we -- when we put the design rules in for 7-nanometer, we were less aggressive in terms of density. Our learning from going from 14 to 10 is -- with the benefit of hindsight, we were just -- we tried to scale at a 2.7 factor, and that was -- that ended up putting too much indention or revolutionary nodes into the fab environment to meet those kind of hurdles. And the learning from that is we just can't hit those kind of really aggressive targets when, to your point, the dynamics are getting increasingly challenging, so lots of learnings out of 10. + +Our transition to 10 that we incorporated into 7, the design rules, there's less complexity. And for the last couple years, we've been working with EUV. Litho has been the challenge. We've had EUV that we've been working with for a few years now. And we expect to use EUV as we scale 7. And we indicated that our first product will be 2 years from this quarter, so fourth quarter of 2021, our first 7-nanometer product will come out. And our expectation is we'll get back on a 2-year cadence in 7 and beyond. So lots of learnings out of 10-nanometer that we've incorporated. And we said back in May and we reiterated today, we expect to be back to a 2- to 2.5-year cadence going forward, at least for the next few nodes. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [16] +-------------------------------------------------------------------------------- + + I'll ask one question that (technical difficulty) + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [17] +-------------------------------------------------------------------------------- + + Pierre, you're breaking up. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [18] +-------------------------------------------------------------------------------- + + Okay. Let me -- a little better now? + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [19] +-------------------------------------------------------------------------------- + + A little bit. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [20] +-------------------------------------------------------------------------------- + + Okay. So my question is really about your competitive landscape. So your main competitor [indicate 86] ecosystem has produced in the last 10 months or 9 (technical difficulty) that's why it's not even impressive in the data center and also (technical difficulty). And so my question is what's your perception on the evolution of your competitive landscape in the last 3 months? Are things [being mainly] in line with what you had in mind and what you are expecting when we spoke over the summer? And then how much of like the footprint you have in the data-centric you think you can produce competition with that in mind? + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [21] +-------------------------------------------------------------------------------- + + Pierre, let me kind of reframe that maybe. I think you were talking about competition and how we feel about that now maybe... + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + Both at the PC and the data center level. And I'll -- maybe I'll jump in on the PC because I think the year-over-year compare in Q3 is -- could be causing some concern. Just a reminder, in Q3 of last year, we had basically drawn down more than 1.5 weeks of inventory that -- which went into the channel. And so when you do compares year-over-year on Q3, PC looks a little bit light on demand. + +Really, as we look over the last 90 days, we haven't seen any difference in our view of the competitive dynamics. We are clearly being impacted significantly on the value end of the market, which is a supply issue for us. It's one of the reasons why we're building volume capacity -- continuing to build volume capacity into 2020 because we think it gives us an opportunity to compete for those units again next year. + +Bob, I don't know if you want to comment on the DCG side. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [23] +-------------------------------------------------------------------------------- + + Yes. I'll try because I'm not exactly sure I got the question, but yes, in terms of competitiveness, if that's the... + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + That was it. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [25] +-------------------------------------------------------------------------------- + + The question. Look, it's a more competitive world. And in that world, we just raised our full year outlook by $1.5 billion and increased our operating margin. So yes, I think, competitively, nothing's really changed in the last 3, 6, 9 months relative to what we expected, and our -- the only thing that's really changed is our performance. But we do know that, going into next year, that our role is to dramatically expand the role we play in our customers' success. So we're expanding the product, the architectures, the packaging technologies, the process capabilities and the software that we build so we can continue to deliver better and better product performance for our customers. And I'd just say that we feel really good about where we are, but we're not complacent by any means in terms of an increased competitive environment as we go into 2020. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + I was wondering if you could tell us, within your enterprise, cloud and comm businesses in DCG, in the quarter, how much of each of those was driven by China? And given the 200-millimeter -- $200 million pull-forward across enterprise and cloud that you mentioned -- enterprise and comm that you mentioned, was that beating enterprise relative to your expectations more or less than $200 million? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes. I think, Stacy, you've got the numbers right. $200 million was on the enterprise and government and comms area. And that's -- I would say it was more in line with our expectations. Once you take out that $200 million number, we had expected it to come up a little bit. The growth year-over-year was definitely above our expectations and... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + So by more than $200 million? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes, that was a fairly big number for us relative to our expectations. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + So how much of enterprise was China then? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [32] +-------------------------------------------------------------------------------- + + Yes. Look, I think in terms of the makeup of the business, for data center, you got roughly 2/3 is cloud and comms and roughly 1/3 is enterprise and government. So that, as you know, has changed dramatically over the years as we've continued to grow our presence in the cloud, and as I mentioned earlier to Joe's question, I think, gained share in comms. So now we're in kind of 2/3, 1/3 state. And enterprise and government was -- across the board in DCG in the quarter, the strength was much higher than we anticipated back in July. We had a first half to second half acceleration, but the acceleration was just more than we expected. And yes, I would say we saw strength across the board. + +But as we look at the E&G growth in particular, we're trying to determine what is kind of -- what has the tendency to like pull in versus what can we count on as we project things forward. And our best guess on our stronger performance is that the $1.2 billion that we are over, roughly $200 million of that was particularly related to enterprise and government than particularly related to China. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [34] +-------------------------------------------------------------------------------- + + Bob, it sounds like -- for 10-nanometer, it sounds like Ice Lake is still on track for the second half of next year. And it sounds like the 7-nanometer GPGPU is still on track for 2021. You did talk about, for the first time, about 5-nanometer. So can you talk a little bit about how you think of make versus outsource? And really what I'm after is, is sort of anything sacred? Or if going to a foundry partner to make CPU or maybe even like a chiplet strategy, if that would eliminate a significant piece of your competitive disadvantage, would you consider that? Or is that sort of off the table for now? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [35] +-------------------------------------------------------------------------------- + + Yes. I mean, first, to the comment, yes, the -- nothing new about process relative to what we said at Analyst Day, ramp 10, 2-year cadence for 7 and our expectations that the cadence going forward will be more like 2- to 2.5-year time frame. So intently focused on 10 now and 7 for the product you mentioned in the fourth quarter. So we're investing to recapture process leadership going forward. + +At the same time, we're going to be extremely open-minded about how do we ensure that we're building the best products, and where we build them is something that we'll always evaluate. I think, as you know with the other foundry players, they've been a source of our capacities over the years. And our expectation is, to the extent that they can do something to support our growth better and/or for peak kind of demands, we're always going to look at how do we evaluate the opportunity set that's going to position us best to meet our customers' demand for the growing diversity of products that we have in our portfolio. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [37] +-------------------------------------------------------------------------------- + + I wanted to ask on gross margin. A year ago in your third quarter call, Bob, you gave some directional commentary on what you thought for the out-year, for 2019. Today, as we look into 2020, you have a lot of moving parts with 2 nodes ramping, 10-nanometer, 7-nanometer, yields, competition, lots of moving parts, admittedly. But I was hoping, at least versus maybe the fourth quarter exit rate this year, that you could give some puts and takes on how you're feeling about next year's gross margin. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [38] +-------------------------------------------------------------------------------- + + Ross, this is George. Maybe I'll take that. Actually, with respect to 2020, there's no material change to my characterization on the last call where we were talking about a 58% outlook for Q4 and 57% in 2021. And the question was, well, should that -- is there -- are those good proxies for 2020? And my point was we think we'll be closer to 60% than to those numbers. + +But if you want to think about tailwinds and headwinds going into 2020 that we looked at as we think about that number, so tailwinds will be, obviously, we're going to have lower modem in the mix next year. Memory is starting to come out of that deep-down ASP period, and we think volumes are going to be up as we get a little better supply and demand situation. + +The headwinds that we're very mindful of is, obviously, 10-nanometer ramping is -- can be a little bit of a headwind on margins and also competitive impact on ASP. So those are the things that we'll continue to look at. But as we look at those today, no material change at all from my previous comments. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [39] +-------------------------------------------------------------------------------- + + Yes. I would probably just, I guess, echo. In all the complexity and all the moving parts, George kind of flagged -- what I'd characterize the 4 things that we're really dialing in on. One, going into next year, mix is going to be better because our modem volume will be lower and our NSG profitability will be better. So mix is going to have a -- mix has been a drag on 2019's gross margin, and it will be a big contributor as we go into 2020. + +And secondly, on the first half of 2019, we had a lot of the on [O] costs, your cost of sales related to pre-PRQ 10-nanometer product. So that will not repeat itself. So those 2 things are good, favorable things. + +The third thing is just -- George flagged this, I'd just simplify this node transition. And for us, node transition next year is going to be -- 14-nanometer will be a little better in terms of its profitability. Yields won't be dramatically different because we're extremely mature, but depreciation levels will be lower because a lot of these tools have been fully depreciated there because we've been on that node for so long. + +But for the node transition, 14 will be a little bit better. Our expectation is 10-nanometer yields will continue to improve, but at the same time, the mix of 10 versus 14 will be a little bit of a wait. So node transition will work against us. And we also -- we've tried to, as best we can, take into account competitive dynamics as we exit this year and go into next year. In our quest to play a bigger role in our customers' success, we're going to compete to protect our position and expand the role we play. + +So those are the 4 things and lots of complexity and lots of moving parts, but we -- a year ago, we dialed in 2019 pretty well. Now we've got to dial in 2020 as well. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [41] +-------------------------------------------------------------------------------- + + Bob, you mentioned you're still facing some capacity shortages. I wanted to understand how you're planning capacity for next year. What proportion will be 14? What will be 10? And will that mix require a higher or similar level of capital intensity as we saw this year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [42] +-------------------------------------------------------------------------------- + + Yes. I mean our intention next year is to not be a constraint on our customers' growth, first and foremost. And given that, what I indicated is we expect to increase capacity by 25% next year, which is the same kind of level that we did this year. We expect to do that again. So we believe that data center, we've been in pretty decent shape. But for client, we just want to get to mid-single-digit kind of unit output -- mid- to high single-digit unit output so, one, we can meet what we expect customer demand profiles to be but also so we can rebuild buffer levels of inventory so we can deal with these peaks, et cetera. So we're trying to put the capacity in place, but we think we'll meet the customer demand and try to give us the inventory buffer that has been depleted over the course of the last 9 months or so. + +In terms of capital, I would just say we'll probably give you more detail on that come January, but George kind of laid out back in May a multiyear view of capital. There wasn't any dramatic changes from kind of where we are now. So obviously, that'll be a function of growth. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + I would just add one thing to remind everybody is that, in 2019, we made a major shift from spending capital in the memory area to moving that capital over to expand our -- both our 10-nanometer and some 14-nanometer. We continue to add capacity in 14-nanometer and began adding capacity at 7-nanometer as well. So we're very focused on getting the capacity in place that will allow us to take the word shortage out of our quarterly discussions. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Our final question for today then comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [45] +-------------------------------------------------------------------------------- + + Great job on the quarterly execution. Last time we had a cloud and enterprise spending digestion pause was first half of 2017. It's kind of the same setup as this past, right? Similar to 2017, DCG had strong second half growth. And in fact, back in 2017, it kicked off what was a 4- or 5-quarter period of strong spending by your cloud customers. Do you guys get a sense in discussions with your customers that the spending reacceleration is sustainable for the next few quarters? I mean if I look at things like compute workload growth, that continues at a strong pace. Workload themselves are getting more complex. And so just wanted to get your views on sustainability of the strong growth profile in DCG into next year. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [46] +-------------------------------------------------------------------------------- + + Yes. I think the trends -- the macro trends that we see haven't subsided at all, and that is this insatiable appetite for the creation of data and the need to compute, process, store, move, make that data more relevant. Those macro trends have been very attractive for the long -- for a while, and we expect those to continue. + +But to your point, the -- our experience with the cloud providers is they go through big buying cycles and then relatively long digestion periods. What we did experience last year was a gangbuster year, but it's been 3 quarters coming into the third quarter where they went through digestions. And what we started to see in the third quarter was, particularly for high-performance compute, start to see them come back into the market to really begin to purchase a little bit more. So how long that cycle lasts is going to be a function of several variables, but their end demand seems to continue to be relatively strong. And therefore, the need to add capacity, we think, will follow their end demand given they've been out of the market a little bit for about 3 quarters now up 'til Q3. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [47] +-------------------------------------------------------------------------------- + + Thanks, Harlan. We're going to hand the call back over to Bob for some closing comments. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [48] +-------------------------------------------------------------------------------- + + Yes. Look, thanks for joining us. We feel great about the quarter. It's -- we're looking at -- we had a record quarter result, raising our outlook for the full year. The market we see, the trends we see are as big as they've ever been. And we're really focused on continuing to deliver for our customers. + +10-nanometer era is now. We're ramping a multitude of products. We have increased confidence in 5-nanometer. And as we mentioned for 7 and 5 getting back to a 2.5-, 2-year cadence is what we're focused on. And we're confident in the future. And you're seeing both in the first 9 months of the year as well as with our higher share buyback that we're putting your money where -- to work to reduce the float because we think there's a disconnect between the intrinsic value of the plan we shared with you back in May and how we're trading. So with our balance sheet, we're taking advantage of that. + +So thanks for joining us. Thanks for your questions. And we'll talk to you soon. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [49] +-------------------------------------------------------------------------------- + + Thanks, Bob and George, and thank you, everyone, for joining the call today. Operator, could you please go ahead and wrap up the call? + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Certainly. Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2020-Apr-23-INTC.txt b/Transcripts/INTC/2020-Apr-23-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..64455264bba896a268d00e3b737dcfddbbd8cf07 --- /dev/null +++ b/Transcripts/INTC/2020-Apr-23-INTC.txt @@ -0,0 +1,383 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Intel Corp Earnings Call +APRIL 23, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Trey Campbell + Intel Corporation - Head of IR + * Robert H. Swan + Intel Corporation - CEO & Director + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD & Analyst + * Srinivas Reddy Pajjuri + SMBC Nikko Securities America, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2020 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. +I would now like to introduce your host for today's program, Trey Campbell, Head of Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- +Thank you, operator, and welcome, everyone, to Intel's first quarter earnings conference call. By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online. I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we'll be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thanks, Trey, and thank you all for joining our call. We had an outstanding Q1 in the midst of incredibly challenging circumstances. We generated $19.8 billion in revenue, expanded operating margin by 10 points and delivered $1.45 in earnings per share. We exceeded our guidance by $800 million on the top line and $0.15 on the bottom line. Our data-centric businesses grew 34% and now represent approximately 51% of the company's revenue, and our PC-centric business grew 14%. +We'll talk about business trends later, but first, I want to thank and commend all the Intel employees and supply chain partners who have helped keep our business operating during this unprecedented challenge. I want to give a special praise to those in our factories and labs and other on-site personnel who have role modeled the values of our company every day and every shift. I am so incredibly proud of your effort and commitment. I also want to thank the rest of our employees who are largely working remotely to help support the social distancing requirements of those that need to work from our sites. Ensuring the safety and well-being of our global workforce has and will continue to be our #1 priority. That's why we are investing more than $100 million in additional benefits to aid and support employees, including a special recognition award for employees that have been working on site. +Intel's purpose is to create world-changing technology that enriches the lives of every person on earth. Never before has our delivery of that purpose been more essential. Intel technology runs 95% of the world's Internet communication and government digital infrastructure. And in a world where many of us are working remotely and socially distancing, the PCs and networking technologies delivered by Intel and our customers are providing a unifying fabric that's bringing us closer together, helping those directly struggling with the virus or caring for those who are enabling remote classrooms so that our children can continue to learn and connecting governments and businesses so they can operate and deliver goods and services. +Around the world, Intel platforms that support telemedicines have also taken on greater importance since the outbreak of COVID-19 as hospitals and health care workers scale to meet the increasing demand for care. Our products and capabilities are also delivering vital computing power for medical research, robotics for assisted patient care and artificial intelligence and data analytics for public health. We recognize that our local and global communities need us to continue delivering technology to help overcome this COVID-19 challenge, and we're fully focused on that task. Our world-class safety standards have allowed our factories to continue to operate safely on a relatively normal basis with greater than 90% on-time delivery. We only allow employees in our factories who are essential to the factories' operations. By design, our clean rooms and factories are among the cleanest places in the world. +While most of our construction projects have remained operational, we have had to temporarily pause a few projects due to local government restrictions at a small number of our sites. We will restart those projects in due course, and we expect these interruptions to have minimal impact on our ramp and no impact on our process technology transition time line. +We also realized that solving the enormous challenge of COVID-19 requires catalyzing the world's innovation in new ways. Intel is committed to accelerating access to technology that can combat the current pandemic and enable new technology and scientific discovery to better prepare society for future crisis. To that end, we've pledged $50 million in a global pandemic response technology initiative to combat the coronavirus through improved access to technology at the point of patient care, to speed scientific research and to ensure access to online learning for students and teachers. We are also granting free access to our IP to all COVID-19 researchers and scientists. +At the same time, we also know that our communities need help right now. Between Intel and our foundation, we are providing $10 million towards coronavirus relief in the communities where we have significant presence. This will aid community organizations focused on food security, shelter, medical equipment and small business support. We also want to assist our communities' critically important health care workers in any way possible, so we have committed more than 1 million items of personal protective equipment. We have already started delivering masks, gloves, face shields and other gear that we've sourced from our supply chain and inventory on hand to local health authorities who are best positioned to determine the areas of greatest need. Beyond Intel's donations, our employees inspire us every day with the many ways they are applying their skills, generous spirit and technical innovation to help people and communities across the globe persevere through this crisis. +George will give more detail on what we're seeing and expect in the business. But first, I want to reiterate our strategy and priorities. Even as COVID-19 drives significant disruptions across the globe, our long-term strategy, to deliver the world's best semiconductors for an increasingly data-centric world, is unchanged. And the environment is uncertain, but our priorities are unwavering. We are focused on accelerating the growth of the company, improving our execution and continuing to thoughtfully deploy your capital. +Over the last several years, we've transformed the company and are now positioned to grow our share in the largest market opportunity in our history. We live in a world where everything increasingly looks like a computer, including our homes, our cars, our cities, our hospitals and our factories. Additionally, we have redefined Intel Inside to include much more than the CPU as we've expanded our silicon offering to include ASICS, FPGAS, GPUs and Optane, among other capabilities. Our opportunity set is more and more Intel silicon inside more and more computers so that we can have a larger impact on our customers' success. And our quarterly results demonstrate the benefits of that diversity. Nowhere is growth accelerating more than in our cloud and networking businesses where we are helping our customers transform the way they move, store and process data. +Through this crisis, the world's cloud and network infrastructure has delivered massive scaling to support vital workloads for businesses and consumers. Cloud-delivered applications seen as conveniences a quarter ago, such as online shopping and video collaboration, have now become indispensable. We scaled our cloud and communication service provider businesses by 53% and 33% year-over-year, respectively, to help our customers meet these growing needs. These 2 segments now drive 70% of our data center segment revenue. +New usage and market needs are also pushing compute resources closer to the data source or point-of-service delivery, giving rise to an increasingly intelligent edge. Our edge business delivers a wide range of platforms, including some innovative solutions that are helping the medical community tackle COVID-19. One example is Medical Informatics' Sickbay platform. Powered by Intel technology, this solution can turn beds into virtual ICU beds in minutes, helping protect critical health care workers while expanding their care capacity significantly. Houston Methodist Hospital deployed Sickbay for its virtual ICU and was able to leverage it within 1 day to support remote monitoring of its COVID-19 patients without risking exposure to care providers. We are also partnering closely with Medtronic and Dyson as they use Intel technologies to deliver much needed ventilators. We also continue to demonstrate significant progress in ADAS and autonomous driving. While auto vehicle production is largely stalled, Mobileye delivered another proof point, demonstrating its leadership position with a landmark first-ever design win with a major Asian OEM. +Finally, we see AI as a significant growth opportunity and are embedding AI capability into everything we make. AI has the power to reimagine how we solve problems across industries, including cutting-edge health care diagnostics, for example, in China, Intel teams with Lenovo and BGI Genomics to accelerate the analysis of genomic characteristics of COVID-19. Our combined work will further advance the capabilities of BGI sequencing tools to help scientists investigate transmission patterns of the virus and create better diagnostic methods. And in India, we are working with government labs, academia and industry to achieve faster and cheaper testing, accelerate drug discovery through virus genome sequencing and help architect a pandemic response platform. +We acquired Habana in the fourth quarter of last year to strengthen our AI portfolio and accelerate our efforts in a nascent, fast-growing AI silicon market that we expect will grow to $25 billion by 2024. This quarter, we have largely completed the integration. We consolidated product road maps, aligned software resources and are executing to our deal thesis. We are also now sampling Habana's first deep learning training processor to large CSPs. +I'll now take a few minutes to discuss how we're executing to our supply and road map objectives. Shortly after our January call, we started to see the impact of COVID-19 in China, forcing many of our ODM partners to extend Chinese New Year factory shutdowns. ODM partners have now returned to work, and production is increasing every week. As I mentioned earlier, our factories remain operational. And in Q1, we are able to mitigate most of the COVID-19-related supply chain disruptions and fulfill all of our customers' committed client CPU orders as expected. We remain on track to add sufficient wafer capacity this year so that we meet market demand and restore our PC unit inventory to more normal levels. Near-term PC demand has increased due to work from home and online learning, but the second half demand picture is more uncertain. We continue to assess how COVID-19 impacts to the economy will offset the immediate catalysts for more remote work and will balance wafer start plans accordingly. +We have made strong progress on a wave of 10-nanometer-based product introductions this year. This quarter, we announced the new Intel Atom P5900 SoC, Snow Ridge, a 10-nanometer-based new addition to our portfolio of 5G capabilities. We are a leading silicon provider in 5G infrastructure, and Snow Ridge expands our reach to the fullest edges of the network. With major design wins at Ericsson, Nokia and ZTE, we expect to be the base station market segment leader by 2021, a year earlier than previously committed. +In the middle of this year, we'll debut our next-generation mobile processor, Tiger Lake. Using our second-generation 10-nanometer process, Tiger Lake will deliver breakthrough performance, and our customers have more than 50 fantastic Tiger Lake-based notebook designs lined up for the holiday season. Finally, in the latter part of 2020, we continue to expect initial production shipments of our first 10-nanometer-based Xeon Scalable product, Ice Lake. While product development in a work-from-home environment is extremely challenging, we are largely on track for our 2020 product deliverables. +We are always mindful of our role as stewards and thoughtful allocators of your capital. We generate significant cash flow and have an excellent balance sheet. We're committed to our dividends, and we repurchased $4.2 billion in shares during the quarter. In light of the uncertainty, we took some actions to dramatically strengthen our liquidity position that we felt were prudent. We raised $10.3 billion in debt to further underpin an already strong balance sheet, and we suspended our share buybacks. We think this level of conservatism is appropriate at this phase, and we intend to reinstate our buyback program as circumstances warrant. Our focus now is on investing in our products and process technology and ensuring we have the capacity to meet our customer needs. +We also continue to take a disciplined approach to our portfolio of investments, including an agreement to divest our Home Gateway Platform business. We have transformed our company to lead the data-driven revolution that's fueling our industry. Our belief is that opportunity is resolute. COVID-19 has only reinforced how important it is for Intel and our customers to accelerate the power of data to fight the current pandemic and avert the next one. To use Andy Grove's words, bad companies are destroyed by crises. Good companies survive them. Great companies are improved by them. Guided by our cultural values, competitive advantages and financial strength, we will emerge from this situation even stronger. +I'll now hand the call over to George for more details on our Q1 results, our Q2 outlook and how we're actively managing the business through this challenge. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Bob, and good afternoon, everyone. Q1 marked a strong start to the year amidst significant economic uncertainty and the unexpectedly strong demand for both PCs and servers as work-from-home and learn-from-home dynamics played out globally. Revenue came in at $19.8 billion, up 23% year-on-year and $800 million higher than guide. Data-centric revenue of $10.1 billion, up 34% year-on-year, represented 51% of our total revenue, an all-time high. Strong server demand across segments and a richer mix of our Xeon devices drove a significant portion of the upside. Q1 PC-centric revenue was $9.8 billion, up 14% year-on-year on strong notebook PC sales and increased supply resulting from capacity additions over the past year. +Gross margin for the quarter was 62%, beating expectations due to strong flow-through of higher platform revenue, partly offset by reserves associated with our memory business and from the sale of our Home Gateway Business. Operating margin of 38% in the quarter was up 10 points versus last year on higher gross margins and disciplined spending controls, consistent with the environment. +Q1 EPS was $1.45, $0.15 above our guide on strong operational performance, partially offset by losses in our ICAP and trading asset portfolios, along with the effects of a slightly higher tax rate. The strength of these results show the remarkable talent and commitment of our global workforce in a difficult and rapidly evolving environment. +In Q1, we generated $6.2 billion in operating cash flow and invested $3.3 billion in CapEx with $2.9 billion of free cash flow, up 76% year-over-year. We returned $5.6 billion to shareholders via dividends and share repurchases. As Bob mentioned, we announced a pause in our share repurchase program as we felt it was prudent to do so in the current economic environment. This does not change our commitment to returning $20 billion in repurchases as outlined in October last year, and we plan to resume the program when market dynamics stabilize. With Q1 buybacks at $4.2 billion, we have already more than offset expected dilution associated with employee stock compensation for this year. In addition, our dividend policy remains unchanged with $1.4 billion in dividends paid in Q1. +Let's move to segment performance in Q1. Data Center Group revenue of $7 billion was up 43% from the prior year, coming in higher than expectations with strength across our customer landscape. Year-over-year platform volumes and ASPs were up 27% and 13%, respectively. While year-over-year comparisons benefited from a weak Q1 '19, revenue in the quarter came in at the second-highest level ever for DCG. Revenue was up 53% in cloud, 34% in enterprise and government and 33% for communication service providers. DCG adjacencies also delivered solid growth with revenue up 35% year-on-year on strong adoption of networking solutions. +Our other data-centric businesses were up 19% year-over-year in Q1 despite more tangible COVID impact. IOTG operating income declined 3%, primarily on lower revenue from industrial and retail. Mobileye revenue and operating income were up 22% and 29%, respectively, driven by continued ADAS penetration and new IQ program launches, offset partially by eroding conditions in the automotive market. While Q1 marked a record for Mobileye revenue, we expect 2020 revenue growth will be lower than our prior expectations as automobile production and volume ramps are being materially impacted by COVID-19. NSG revenue grew 46% on strong bit growth and improved pricing. Better market conditions versus last year, along with cost reductions on strong factory performance, resulted in a lower operating loss of $66 million. PSG revenue grew 7% year-on-year on cloud and enterprise strength, partially offset by weaker embedded and communications segment. Operating income was up 9% on higher revenue. +CCG revenue was $9.8 billion in Q1, up 14% year-over-year, driven by notebook market strength and higher modem sales. PC unit volumes were up 13% year-over-year on higher notebook demand and increased supply. Notebook demand strength is expected to continue into Q2 with more people working and learning from home due to COVID-19-related shelter-in-place orders. Operating margin was 43%, up 7 points year-on-year, on higher revenue and lower spending driven by the 5G smartphone modem exits, partially offset by higher unit costs associated with the ramp of 10-nanometer products. +Let's move to our second quarter outlook. Given the environment and the global economy, the range of potential outcomes has a wider distribution than normal. Based on demand signals from our customers, we expect the strength in cloud and comms infrastructure to continue in Q2, while IOTG and Mobileye will see lower demand driven by COVID-19. As a result, we expect total revenue of $18.5 billion with PC-centric approximately flat to slightly up year-over-year and data-centric up approximately 25% year-over-year. Operating margin is expected to be approximately 30%, down 1 point year-on-year on lower gross margin, largely offset by lower spending on higher revenue. Gross margins are expected to be approximately 56%, down 6 points sequentially due primarily to 3 reasons: prequalification reserves associated with the ramp of our next 10-nanometer client product, code named Tiger Lake; lower sequential revenue; and an accelerated ramp of 10-nanometer products, including isolate client CPUs and 5G SoC. The Tiger lake reserves are not expected to impact full year gross margin as we expect to sell through the reserve inventory in the second half of the year. As a result, Q2 EPS is expected to be approximately $1.10 per share. +Moving to the full year. With limited visibility due to the uncertainty driven by COVID-19, we are not guiding the full year. However, I do want to spend a few minutes discussing the expected headwinds and tailwinds we are monitoring and our response to the market dynamics. +Tailwinds are most evident in the first half of the year on strong demand for mobile compute and related infrastructure on the dynamics of sheltering in place. In particular, mobile PCs, cloud and network infrastructure for 5G remain above seasonal trends. Headwinds include the impact of a global recession on IOTG end markets, particularly industrial and retail, lower automotive production impacting Mobileye and slowing enterprise and government data center demand. We also expect the PC TAM to weaken in the second half as GDP effects outweigh the initial demand bump from COVID. Also, given the volatility of the margins in Q1, our losses in our ICAP and trading asset portfolios were negatively impacting EPS by $0.03. Given the uncertain environment, this remains a watch item for the remainder of the year. In response to these market dynamics, we acted swiftly and strengthened liquidity. +In addition to spending repurchases, we issued $10.3 billion in debt in the quarter. Our total cash investment balance at quarter end was $20.8 billion. Our liquidity actions to date are expected to impact full year EPS performance by approximately $0.12. The company has an exceptional balance sheet and strong cash flow to handle a very wide range of scenarios. We have positioned the company to support investment in technology transitions, our new products, and our customers' requirements across these scenarios. As you would expect, we are very focused on cash flow management and believe our free cash flow generation this year will be resilient as impacts from COVID are tempered by first half demand strength, OpEx savings initiatives, capital actions and tight working capital oversight. +To conclude, I'd like to join Bob in thanking our employees worldwide who are working diligently in these challenging times to provide products essential to the world. +With that, I'll hand it back to Trey, and we'll get to your questions. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- +All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first call. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Certainly. Our first question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- +I'm just wondering if you could give us a little bit more detail on the gross margin decline heading into the calendar second quarter. George, you kind of broke it up into 3 different categories. I'd be interested on magnitude of Tiger Lake versus just lower volumes and then other 10-nanometer parts. And I guess, more importantly, how do we think about kind of normalized sort of gross margins as you get past some of the start-up costs for a faster 10-nanometer ramp? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- +Yes. Thanks, John. So the margin picture is really unchanged from what we've talked about in the past in terms of how we think our product road map is going to move products that we expect to introduce and their margin structure. And what you're seeing in Q2 is largely a timing issue. And about half of the impact that you're seeing in gross margin in the quarter is from the Tiger Lake pre PRQ reserves. Obviously, the fact that -- and that's both sequentially and year-over-year. And so I think the way we would look at it is pretty much we're not seeing anything as -- if you take COVID out of the year, we're really not seeing anything different in our basic view of gross margin dynamics, with the exception of we're seeing stronger pull-in of demand for some of our 10-nanometer products. I mean I think one of the things -- we got very strong demand for Tiger Lake. And so when you look at the impact that Tiger Lake reserves are having on the quarter, it's about the same level of impact that we had on Ice Lake in Q1 of '19. And yet we have about double the number of units in the -- being reserved. And I think it gives you an indication of just how much our performance was improving on 10-nanometer. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [4] +-------------------------------------------------------------------------------- +So John, I would just say, relative to where we were 90 days ago, gross margins are stronger through the first quarter. They're in line with our expectations through the second quarter. And to George's point, despite the timing dynamics of pre PRQ reserves that we take in the second quarter and recoup in the second half, the only other change is just that we feel confident in accelerating the ramp for 10. So from our vantage point, at or better than kind of how we started the year, and we feel very good about gross margin performance. We're very excited about the Tiger Lake products ramping going into the second half and the 5G Snow Ridge product that we announced. So all in all, gross margin dynamics, pretty strong. +On the second part of your question, I'd go back to the commentary that George provided back at our Analyst Day in the spring, which is, obviously, when we transition from a mature node to a new node, margins tend to come down. We indicated that we plan to get back on a 2- to 2.5-year cadence, which means in 2021, we'll be ramping 10-nanometer even more while we're investing in 7-nanometer that we anticipate having in the fourth quarter of 2021. So those dynamics of -- from a mature node to a new node, impacts the gross margins of the business, but we feel like it's -- we're well on track from the plans we laid out and feel pretty good about a dynamite first quarter and an outlook for the second quarter in line or better than what we expected. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Our next question comes from the line of Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [6] +-------------------------------------------------------------------------------- +I guess a follow-on, John, with the gross margin. I mean I know you're not guiding full year anymore, but when we look out at that trajectory that you had given us, I was wondering if you can just kind of step us through with the acceleration. And actually, maybe looking back to last year, if you look at the improvement you saw of that low quarter, just kind of any kind of directional guidance of where this gross margin can go from here. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- +Yes. I mean first off, I think you're going to see, Blayne, that gross margin is going to improve, all things being equal, just from the fact that starting in the third quarter, we'll start to see the chips that have been reserved this quarter coming out on a 0 cost basis in the gross margin. And again, it's really hard to think about the second half in terms of how demand is going to look compared to what we ultimately thought when we first gave guidance, which is because of the -- all the obvious issues related to COVID. I'd just go back to -- as we look at what we guided all the way back in May of '19, if anything, we're ramping 10-nanometer a little faster. We're seeing clear evidence of improved performance on 10-nanometer. And so we feel good about the overall gross margin dynamics. You can see how our other cost initiatives are helping 5 points out of the 6-point impact that's being offset by effectively the OpEx percentage. So overall, I would go back and say no real change to our fundamental outlook. But when you overlay COVID, it's -- we'll just have to see how that plays out. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Our next question comes from the line of Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- +I appreciate all the color in these uncertain times. I'm curious how you are directionally feeling about the CapEx guidance for the year. I think you had about a $17 billion number before. I understand the need to be responsive to the macro dynamics and in preserving the balance sheet. But you upsided first half by quite a bit, and you're also accelerating the move to 10-nanometers. Does that create some upward bias or at least protect the kind of capital spending plans that you had for the year? Any puts and takes would be very helpful. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- +Yes. Vivek, I'll start, and then George will fill in. First, both our R&D and our capital spend for this year are directed towards the multiyear plan that we shared with you back last year. So both the product road map over the next several years, the capital required to support the growth that we anticipate over the medium- to long-term horizon while adding capacity for the ramp of 10 as well. So coming into the year, we're very bullish about the medium- and long-term outlook. And we're putting our capital to work to support that medium- and long-term outlook, and that's not going to change. +That being said, in the near term, as we try to get a better read on what the demand signals will be for the second half, whether we're dealing with being very disciplined on our spending levels, ensuring that wafer starts are in line with true demand signals and being very disciplined on the capital that isn't directly related to more capacity and/or technology development, we are going to be very disciplined through this near-term horizon. But I'd just go back to the first point, which is we're very bullish about the multiyear view. We have the largest TAM in the company's history. We got a great set of products that we're building and developing, and we're going to invest to position ourselves well to capitalize on the current disruptions that we're wrestling with. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- +Yes. What I would add is there's some natural things in addition to the discipline that will help us lower CapEx a little bit. It's part of why we said we think our free cash flow is going to be pretty resilient in the year because we've seen in some of the geographies where we have major construction projects underway, we're actually seeing that being pushed somewhat by regulatory requirements. And so we -- the way I would describe it is we probably see 6 to 8 weeks' worth of capital pushing out of this year. But any capital that is important for our 10-nanometer, 7-nanometer and even the start of 5-nanometer is going to be spent in line with the timetables that we've already laid out. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [13] +-------------------------------------------------------------------------------- +Great. I wonder if you could talk about some of the changes to the server road map? And it seems like you've deemphasized Cooper Lake and are more focused on Ice Lake server. Is that about confidence of the -- in the 10-nanometer plus? Is that -- just kind of describe what led to that decision. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [14] +-------------------------------------------------------------------------------- +Yes. Thanks, Joe. Yes, during the course of the year, we've been -- our product road map for servers is very focused on delivering workload-optimized platform foundation that's scalable for the real-world environments that our customers are operating in. So we ramped -- Skylake was the fastest ramp in the Xeon history, followed by Cascade Lake, that was a very strong ramp. Next, we have a Cascade Lake refresh that is a relatively simple, simple upgrade, easier upgrade for our customers because the architecture is very simple to the fastest-growing Cascade Lake ramp. And we're very focused on Ice Lake in the second half of the year or in the fourth quarter, as we indicated. So as we step back and look at the market dynamics and the product road map, we feel like we got the right products at the right time as we ramp and scale the high end of Cascade Lake and refresh while positioning for Ice Lake. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [15] +-------------------------------------------------------------------------------- +Okay. That makes sense. And as you've started to ramp 10-nanometer plus, is it possible to talk about the changes that you'll see versus 10? Is it better clock speeds, better yields, better -- is there better transistor performance implicit in that transition? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [16] +-------------------------------------------------------------------------------- +I presume you're talking about second gen for server products, Sapphire Rapids product or -- oh, for clients, sorry. Yes, the client -- the Tiger Lake product, we are extremely excited about. We -- as I think I mentioned in our prepared remarks that we have 50 designs that we expect to ramp in the holiday season this year. Clock speed, battery life, AI incorporation into the core design, a platform offering that we think is a real differentiator for customers on -- in thin and light format. So this is going to be a great launch. We're very excited about it. And to George's earlier point, the demand signals we're seeing and our confidence in both the product and the yield is -- has us at a point where we expect to accelerate the ramp and adoption a bit faster than we did coming into the year. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- +I wanted to ask first about the 10-nanometer mix exiting the year just given what you're seeing: a strong Tiger Lake demand signals and a potentially faster 10-nanometer. Like what do you think your product mix by node is going to be exiting the year? Do you think there'll be a crossover point on 10-nanometers? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [19] +-------------------------------------------------------------------------------- +Stacy, this is George. I don't think we'll see a crossover point this year. And this is -- again, I'm just going to take COVID out of the equation, so thinking through, I do think we're going to see more demand on 10-nanometer this year than we thought going in. Again, I think Ice Lake demand was strong -- is going to be strong in the first half. We're seeing our 5G SoCs on 10-nanometer getting stronger demand as the market there just gets stronger and stronger on the comp side. But Tiger Lake is really, I think, going to be the driver for us in being above our expectations for all the reasons that Bob just covered. And -- but it won't be enough to cause a crossover. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Our next question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [21] +-------------------------------------------------------------------------------- +I want to go to the Data Center Group, you have the color commentary about the enterprise and government being weaker in the second half, and I don't think that surprises anybody. But I wanted to see what sort of color you're getting in the other 70% of that segment on the cloud and the comms side? And specifically, you had worried earlier this year that we'd enter a digestion period. So I wanted to see if your views have changed on that. And then in the comms service provider side, how much of that actually acts like the enterprise and government versus the side that benefits from the 5G ramp? Any pluses and minuses there would be helpful as well. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [22] +-------------------------------------------------------------------------------- +Yes. Thanks, Ross. First, on the cloud side, as you indicated, we came into the year off a very strong second half of 2019, and our expectations were that Q1 would continue that strength. But then the cloud service providers would go through their normal digestion stage, if you will. That was kind of what we indicated back in January. First quarter, as George flagged, demand was even stronger for the CSPs. In our raised outlook for Q2, we expect that demand for the cloud folks to -- the strong demand to continue. And possibly, even going into the second half of the year, that's TBD, but the trends are relatively encouraging, the demand signals are very high. The product that's being pulled is the XCC product. So ASPs, as you saw in our results, were very strong. So purchasing is extending beyond what we thought a few months ago. And that drove Q1 upside, it drove Q2 upside, and we think it will be relatively strong kind of going into Q3. That's TBD. +On the comms side, fantastic growth in the first quarter. Our expectations are, as we go through the course of the year, it will stay relatively strong as we continue to gain share in that segment. And as we've expanded the 5G SoC, expanded our TAM within that sector and with the product that we just qualified a few weeks back. So we expect share gains, the infrastructure -- share gains to continue, infrastructure in 5G to continue, if not go faster, and we're relatively well positioned in the -- with the key players of Nokia, Ericsson and ZTE going into the second half of the year. So we feel good about the comms segment as well. And as you flagged, the ones that we're proud -- that we're most anxious about is just enterprise and government and what kind of demand signals we'll see in the second half. So the first 2 are as good, if not stronger. Enterprise and government, a big -- a bit of an unknown for us at this stage. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Our next question comes from the line of Pierre Ferragu from New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [24] +-------------------------------------------------------------------------------- +I'd like to get back to your performance in PC in the first quarter. So you're up 14% year-on-year. I was wondering a couple of things. The first one is how much is that really stronger demand, and that's just about it? And how much of that is more you catching up on capacity and being better able to serve the market and catching up maybe on demand you couldn't meet in the 2, 3 previous quarters? And then what's your early view on market share? Are you starting to regain share in PCs? And if not, when do you see that happening this year? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- +Pierre, it's George. I think what we saw is clearly some impact relative to our expectations from the work-at-home, learn-at-home dynamics. But we had expected a strong quarter in our initial forecast, which really reflected the dynamics that we're talking about. We had customers who have been short of demand for a number of quarters who were seeing a chance to finally build some -- a little bit of inventory, which gave us a seasonally strong first quarter relative to anything we might see historically. But we saw notebook volumes up over 20% in the quarter. And I would say that that's more than just the pent-up demand. And that's at a time when some of the OEMs were really struggling in the early part of the quarter with their supply chains, which is why there's some parts in their channel that's all opened up now. So we think that actually -- one of the good signs is though even that's opened up, we're still seeing very strong demand coming in on the PC side. So -- and we had expected solid PC in the first half. But I would say it's -- with COVID, it's been even stronger and heavily weighted towards the netbook. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [26] +-------------------------------------------------------------------------------- +And the only thing I would add is in our fab network and the supply chain was able to -- coming out of last year, not only able to deal with the backlog coming into the year but also meet the higher demand signals that George flagged at the latter part of March. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- +Yes. I should have mentioned that. It's really heroic work, both at the supply chain level, we have a fantastic supply chain group, but also our manufacturing teams, keeping the factories up and running. Delivering a 90% on-time commits in a quarter like this is really remarkable. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from the line of C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- +I realized that you removed your guidance for the full year. But if I look at your results and your guide for Q2, it would suggest data-centric tracking, maybe down 2% half-on-half in the second half; and PC, down 14%. I'm just curious, is that directionally how you're seeing things? Or I guess given the positive trends in notebooks and the weakness on the enterprise and government side, perhaps it's a bit more muted, and would love to hear your thoughts on that. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- +Yes. We're -- I'm not going to be able to give you a full year guide by pieces. But I appreciate the question. I think the -- maybe talking a little bit, C.J., headwinds and tailwinds, which we referred to on the call, clearly, cloud is a tailwind and -- cloud and mobile compute are a tailwind for the first half for sure. I think cloud continues to be -- will probably be helpful throughout the year. The -- but at some point, we're going to see the impacts of the recession start to impact demand on PCs. So we're -- that's certainly a headwind. That is a reasonable expectation for the second half of the year. We're already seeing the impact of the recession on IOTG, particularly in industrial and retail. +We're seeing in automotive, Mobileye had a record quarter in Q1. But I think the full year is going to be certainly weaker than we had expected coming into the year. Now not nearly as weak as automotive overall because they continue to grow. They're in a part of the automotive market that is growing substantially. And they have the leadership position in ADAS. And so it will be more subtle of an impact, but still an impact nonetheless. And then as Bob said, on the data center side, enterprise and government appear to have been very strong in the first half, and so we would expect some digestion. How those things all play up and what percentages play out, C.J., I really can't say, but those are the things that we're watching to see how the year is going to play out. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Our next question comes from the line of Srini Pajjuri from SMBC Nikko. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [32] +-------------------------------------------------------------------------------- +George, I want to go back to the gross margins. I think you did a great job giving us color about half of the impact from Tiger Lake. I'm just wondering, the remaining half, is that because of reserves, which is going to reverse in the second half? Or is this something more structural or mix related that's going to persist for the next few quarters? I would love to hear some color on that. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [33] +-------------------------------------------------------------------------------- +Well, I think the things that are structural is we're going to see more 10-nanometer demand in the year than we had forecasted at the beginning of the year. And that will have a little bit of dampening on margins but not materially different from what we had seen coming into the year. The temporary impact is really the reserve action, which will reverse. It is about half of the year-over-year effect. And so I would say the other impact, again, is if we look year-over-year, we're just seeing a much larger uptake of Ice Lake and 5G SoCs year-over-year, but much of that was expected. I would say both Ice Lake and the 5G SoCs are a little bit stronger than we would have thought coming into the year and -- which is consistent with just the demand activity that we're seeing in mobility and the infrastructure around that. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- +Yes. And just we came into the year with an outlook of 59% gross margin for the year. And I would just say through the first 90 days, we're much better. To the next 90 days, we're better or in line. And the dynamics of the pre PRQ reserve are no impact on the full year. Therefore, net-net, to the first 6 months of the year, we feel just as good about our gross margin performance and even better about our ability to ramp 10-nanometer. So we're feeling very good about how the first half of the year is playing out relative to where we were 90 days ago across demand signals and gross margin performance. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Our next question comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [36] +-------------------------------------------------------------------------------- +I'm just wondering if you can talk about channel. Inventory, there's a -- customers in a lot of your end markets seem to be a little concerned about supply disruptions, and they -- sell-in seems to be a little bit above sell-through. Sell-through seems to be weakening a little bit. So can you talk about the potential for some inventory correction later this year and sort of how you track that? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- +We're -- obviously, we're very focused on understanding that. I would say the -- any kind of dislocation that we're looking at right now is more a function of just the supply chain challenges that some of the OEMs had, particularly in the first half of the first quarter. But we've been watching that pretty closely because we want to make sure that this kind of buildup at our customer level makes its way through to the end customer. And we're seeing customers telling us that their end-customer demand continues to be very strong, and their order profile reflects they're going to clear their existing revenue. Now when that plays out, I'm not sure. It's part of why we struggle to understand how that second half is going to play out. But we feel good about the demand signals we're seeing now, and we understand the movements of our products in the system from the dynamics that we saw in the first quarter. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [38] +-------------------------------------------------------------------------------- +Operator, I think we have time for one more question, and then we'll turn the call back over to Bob to wrap things up. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +Our final question then comes from Chris Danely from Citi. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD & Analyst [40] +-------------------------------------------------------------------------------- +Can you just run down the supply demand sort of balance throughout the server, desktop and notebook lines? I guess are you on track for the high single-digit unit increase in output? And then did the shortages anywhere get any worse during the during Q1? Or it sounds like they're abating in certain areas? Just any color there would be great. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [41] +-------------------------------------------------------------------------------- +Yes. On -- as we indicated at the beginning of the year, our intention -- well, we did add capacity last year, and our intention this year was to add another mid-20% growth in capacity, which would generate real strong output. And we are on track, maybe even a little bit better than what we said at the time. Obviously, in the first quarter, demand was also greater. It was greater for -- across the board, server and notebook, in particular. And we were able to keep pace with accelerating demand as the quarter closed. So we're in pretty good shape in terms of the promise we've made to our customers, and that is that we will not -- we'll put the capacity in place so we are not a constraint on their growth. So we're in very good shape despite all the challenges. That being said by, we haven't replenished inventory levels. So meaning mix dynamics across the board is -- we're still not quite there yet, but we're in line a little bit better than we had hoped. We delivered more demand, and we got to continue to build the inventory levels back so we can deal with the variation by SKU mix. +Yes. So look, thanks, everybody, for joining us today. I just kind of want to wrap with -- to reiterate our purpose, and that is to create world-changing technology that enriches the lives of every person on earth. And that's never been more important than it is during this time. Our strategy is resolute, and our business is built to withstand challenges. We have a very diversified portfolio of businesses that are highly leveraged to major technology inflections like cloud, 5G, intelligent and autonomous edge computing and artificial intelligence. We generate significant and durable free cash flows, and our team of 110,000 people is operating as one team to enable our customers' success. So guided by our cultural values, our competitive advantages and our financial strength, we're confident that we will emerge from this situation even stronger. +Thanks again for joining us. We hope you all stay safe as we work together to overcome this global crisis. And we look forward to hopefully seeing you in person over the near term. Thanks again for joining us. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [42] +-------------------------------------------------------------------------------- +Thanks, Bob, and thank you all for joining us today. Operator, could you please go ahead and wrap up the call? + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- +Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2020-Jan-23-INTC.txt b/Transcripts/INTC/2020-Jan-23-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..5aff4dddecfe149f65aeca42b4603144efd6ebdb --- /dev/null +++ b/Transcripts/INTC/2020-Jan-23-INTC.txt @@ -0,0 +1,465 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Intel Corp Earnings Call +JANUARY 23, 2020 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Trey Campbell + Intel Corporation - Head of IR + * Robert H. Swan + Intel Corporation - CEO & Director + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher Adam Jackson Rolland + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter 2019 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded. +And now I'd like to introduce your host for today's program, Trey Campbell, Head of Investor Relations. Please go ahead. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's fourth quarter earnings conference call. By now you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available on the webcast window for those joining us online. +I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Trey. +We exceeded our expectations for Q4 '19, capping off a fourth consecutive record year. In Q4, we generated $20.2 billion in revenue and $1.52 in earnings per share, exceeding our guidance by $1 billion and $0.28, respectively. +For the full year, we delivered $72 billion in revenue and $4.87 in EPS. The PC, Data Center, IoT, Memory and Mobileye businesses each set all-time annual revenue records. +Several years ago, we began a transformation to reposition the company to take advantage of the data revolution that is reshaping computing. Exiting this quarter, we now have greater than 50% of our revenue coming from our data-centric collection of businesses, but our journey is just beginning. To reach our multiyear goals, we will continuously focus on 3 key priorities: accelerating growth, improving execution and deploying our capital for attractive returns. +I'd like to share our progress against these priorities over the last 90 days. We are accelerating growth by expanding the capabilities of our workload-optimized platforms, playing a larger role in our customers' success. Demand for our Intel Xeon Scalable processors is very strong as customers continue to make Xeon the foundation for their AI-infused data center workloads. One of the reasons Cascade Lake is our fastest-ramping Xeon CPU is its unrivaled AI performance. Xeon's AI performance will take another step in the first half of 2020 when our third generation Xeon Scalable processor, Cooper Lake, debuts. Cooper Lake features new Intel DL Boost extensions for built-in AI training acceleration, providing up to a 60% increase in training performance over the previous family. Additionally, we've been expanding beyond the CPU, in the Data Center, with products such as Optane persistent memory, custom ASICs, Ethernet and silicon photonics. +In Q4, Data Center adjacent products grew more than 30% year-over-year. In client computing, we are seeing excellent momentum for our first 10-nanometer mobile CPU, Ice Lake, with 44 system designs already shipping. In addition to our CPU capabilities, we continue to deliver leadership PC platform connectivity. With WiFi 6, we're delivering gig plus speeds. And for wired connectivity, we just announced Thunderbolt 4 for platforms in 2020. +At CES, we also showed customer momentum for our Project Athena innovation program, including the first Project Athena-verified Chromebooks. Project Athena-verified laptops have been tuned, tested and verified to deliver fantastic system-level innovation and benefit spanning battery life, consistent responsiveness, instant wake, application compatibility and more. We verified 26 Project Athena designs to date and expect 50 more devices across Windows and Chrome to be verified this year. +In addition to strengthening our largest businesses, we're investing to win key data-driven technology inflections. These inflections include the rise of artificial intelligence, the transformation of networks and emergence of the intelligent and autonomous edge. +The market for AI-based silicon is growing and evolving quickly. New workloads are emerging, and existing workloads like high-performance computing are converging with AI. In 2019, we generated $3.8 billion in AI-based revenue. The AI market opportunity is expected to be $25 billion by 2024, and we're investing to lead with a strong portfolio of products. In addition to integrating AI into all our leading products, we've introduced and acquired new capabilities that deepen an already unparalleled portfolio of AI assets. We announced the acquisition of Habana Labs, a leading developer of programmable, deep learning accelerators for the data center. Habana, combined with Intel's existing AI ASICs and software expertise, will advance our AI offerings for the data center with high-performance training and inference processors and a standards-based programming environment to address evolving AI workloads. +Delivering the optimal AI silicon architecture is critical but not sufficient to solve customers' problems. That's why we launched the oneAPI industry initiative to deliver a unified and simplified programming model for application development across heterogeneous processing architectures. oneAPI marks a game-changing evolution from today's limiting proprietary program approaches to an open standard space model for cross-architecture developer engagement and innovation. +As expected, our networking business reached $5 billion in revenue in 2019. We've grown our business by helping our customers transform their networks by consolidating and virtualizing workloads on Intel Architecture-based servers. Now as we advance into the 5G era, we see our momentum and design win pipeline accelerating as we're positioned to win significant share in base stations. +This quarter, we announced a strategic agreement with Alibaba to support both the Tokyo and Beijing Olympics, building out 5G infrastructure utilizing Xeon Scalable, Optane persistent memory and Intel software. These data-optimized 5G networks will support amazing experiences such as immersive 8K VR, cloud 3D stadium simulations and cloud broadcasting. +We also delivered almost $5 billion in annual revenue from our IoT/Edge portfolio of products. In November, we disclosed our next-gen Movidius vision processing unit, Keem Bay. Keem Bay is highly optimized for edge inference with groundbreaking leaps forward in power-efficient performance, delivering up to 4x the performance or 6x the performance per watt over comparable competitive solutions. +It's been over 2 years since the acquisition of Mobileye, and we couldn't be more excited about the team's progress. This quarter, we announced several exciting new engagements. We established an agreement for RAM data harvesting with SAIC Motor and embarked on a strategic partnership with NIO to deploy Mobileye's self-driving systems as the full stack solution for NIO's consumer AV. +We also continued to accelerate the commercialization of driverless mobility as a service with 2 new partnerships, RATP in Paris and Daegu City in South Korea. In Q4, we were also excited to host analyst and investors at Mobileye's headquarters to discuss our strategy to win the more than $70 billion opportunity for ADAS, AV and data, and to expand our aspirations to an even larger role in the $160 billion opportunity for Mobility as a Service. Our guests had the chance to test drive our technology on the demanding roads of Jerusalem as we demonstrated industry's leading AV solution stack navigating a wide variety of driving complexities and delivering unmatched agility and safety. +We have significant opportunities, but realizing them requires improved execution, starting with delivering more supply for our customers. In response to continued strong demand, we invested record levels of CapEx in 2018 and 2019. That added capacity allowed us to increase our second half 2019 PC CPU supply by double digits relative to the first half. However, demand has continued to outpace PC supply, and supply remains tight in our PC business. We're continuing to add capacity, so we're not constraining our customers' growth. +Across our 14- and 10-nanometer nodes, we're adding 25% wafer capacity this year to deliver a high single-digit increase in PC unit volume. This will enable us to meet market demand, deliver our 2020 financial plan and increase inventory to more normalized levels. Our near-term challenge is working with our customers to support their desired product mix. +Our process technology execution continues to improve. In Q4, we ramped our 10-nanometer production and continue to see yields improve. We are planning 9 new product releases on 10-nanometer this year, including our next-gen mobile CPU, a 5G base station SoC, an AI inference accelerator, our first discrete GPU and Xeon for server, storage and networking. We're also on track to deliver 10-nanometer plus this year, our first performance upgrade on 10-nanometer. Our 7-nanometer process remains on track to deliver our lead 7-nanometer product, Ponte Vecchio, at the end of 2021, with CPU products following shortly after in 2022. We are also driving innovation in the next generation of computing. At CES, we provided a first look at our next-gen Intel core mobile processor, code named Tiger Lake, which is designed to offer groundbreaking advancements when it ships later this year. +Tiger Lake, built on Intel's 10-nanometer plus process, will deliver significant gains in compute, AI, graphics and interconnect over the prior generation. We will also deliver initial production shipments on our first 10-nanometer-based Xeon Scalable product, Ice Lake, in the latter part of 2020. We're also investing to lead the next wave of technology breakthroughs such as quantum computing. Our investment in quantum computing covers the full hardware and software stack in pursuit of a practical commercially viable quantum system. +For example, last month, we unveiled a first of its kind cryogenic control chip, Horse Ridge, that will speed up development of full stack quantum computing systems. We made good progress this quarter but will continue to be laser-focused on improving our execution. That means delivering the supply, leadership process technology and product innovations that allow us to play a larger role in our customers' success. +Our third priority is to thoughtfully deploy your capital to deliver attractive returns. That means, first, investing in the R&D and CapEx necessary to drive our long-term business plan. Since 2015, we have grown revenue by more than $16 billion while reducing spending by $500 million. Spending as a percentage of revenue is down 9 points, while over the same period we've increased R&D spending by $1.2 billion. We acquired Habana Labs, a fantastic company that will accelerate our AI plans, while also making thoughtful disinvestments. We closed both the 5G smartphone modem exit and the sale of IMFT in the quarter. We are confident in our future. And consistent with that, our Board has approved a 5% increase in our dividend to $1.32 per share. +Last quarter, we announced a commitment to execute $20 billion in share repurchases over the next 15 to 18 months. And 3 months into that window, we've already repurchased $3.5 billion in shares. +Finally, our role goes beyond delivering strong results to being a great corporate citizen that has real impact on the world around us and in the communities where we work. I'm proud of the many outside recognitions we've received for our responsible business practices. This reflects our culture and the efforts of our 100,000-plus employees around the world. Also, we continue to believe that a diverse workforce and inclusive culture are essential for executing our growth strategy, which is why we released detailed workforce representation data that raises the bar on ourselves and others for continued improvement. +And it's important to us to be a leader in environmental sustainability, and we're investing to continue to increase the energy efficiency of our operations and our products. And we're also making significant progress on our goal of restoring 100% of our global water use by 2025. +Back at our May Analyst Day, we told you that the industry was at an inflection point where the exponential growth of data is fueling massive expansion in multi-cloud environments, transforming networks and catalyzing the intelligent edge. We believe we're well positioned to lead this data revolution, and we expect to generate $85 billion in revenue and $6 in earnings per share in the next 3 to 4 years. 1 year into that plan, we are tracking well ahead of our commitment. We have $3 billion more revenue, and we've earned an additional $0.52 in earnings versus our May expectations. Our expectation is to continue to make deposits towards our multiyear goal every 90 days. +In summary, our priorities are to accelerate growth, improve execution and thoughtfully deploy our capital on behalf of our owners like you. I'm excited about the opportunities in front of us and appreciate your continued support. +I'll now hand the call over to George for details on our Q4 results and business outlook. George? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Bob, and good afternoon, everyone. +Q4 marked an outstanding finish to another record year, with $20.2 billion in revenue, up 8% year-on-year and $1 billion higher than guide. We saw record data-centric revenue of $10.2 billion, representing over 50% of our total revenue, an all-time high. DCG and Mobileye both achieved record revenue in the quarter. +Q4 PC-centric revenue was $10 billion, up 2% year-on-year, capping CCG's fourth consecutive year of revenue growth. Q4 operating margin was approximately 36%, 2 points ahead of our guide on higher gross margin and spending leverage. Gross margin for the quarter was 60.1%, beating expectations due to strong flow-through of higher DCG revenue. Q4 EPS was $1.52, $0.28 above our guide, primarily due to strong operational performance and further boosted by gains from our ICAP Portfolio. These results demonstrate the strong demand for our leadership products and solid execution to achieve a record-breaking year. +As a result, full year EPS of $4.87 was up 6% year-on-year. We generated $16.9 billion of free cash flow, up 19%, and returned $19.2 billion to shareholders. We anticipate another record year in 2020 and are raising the dividend by 5%. +Moving to more details on Q4 performance. Operating margin of 36% in the quarter was up over 0.5 point versus last year as higher volume and ASP strength in our data-centric portfolio and lower spending were partly offset by the ramp of our 10-nanometer process and NAND pricing degradation. EPS was up 19% or $0.24 year-over-year on higher operating margin, equity gains driven by our ICAP Portfolio and a lower share count, partially offset by a higher tax rate. Our non-GAAP tax rate in Q4 was 13.6%, in line with expectations, and up 5 points year-over-year due to tax benefits from tax reform and discrete items in Q4 '18. +Through to segment performance. Our Data Center Group had record revenue at $7.2 billion, up 19% from the prior year. These results beat our expectations, with platform volumes up 12% and platform ASPs up 5% year-over-year on strong cloud demand and continued adoption of our highest performance second-gen Xeon Scalable products. +In Q4, cloud revenue was up 48% year-over-year as cloud service providers continue building capacity to serve customer demand. Enterprise and government revenue was down 7%, while communications service providers revenue grew 14% as customers continue to adopt IA-based solutions to transform their networks and transition to the 5G era. All 3 segments exceeded our expectations for the quarter. +Our other data-centric businesses were up 6% year-over-year in Q4. IOTG achieved another double-digit growth quarter, with revenue up 13% and operating income up 29% year-over-year as customers increasingly adopt Intel AI-infused products to power the growing intelligent edge. And Mobileye revenue and operating income were up 31% and 54%, respectively, driven by the industry-leading EyeQ products, which offer unmatched computer vision and mapping capabilities and continue to win in a fast-growing ADAS market. EyeQ revenue was up 41% year-over-year. +NSG revenue grew 10% on continued bit growth, partially offset by year-over-year pricing declines. NSG reported an operating loss of $96 million as NAND cost improvements were more than offset by pricing declines. PSG revenue declined 17% year-over-year on softness in the embedded segment primarily driven by lower last-time buys versus Q4 '18, partially offset by strength in wireless. Operating income was down 48% on lower revenue and segment product mix. +CCG revenue was $10 billion in the fourth quarter, up 2% year-over-year, driven by higher PC and modem volumes. PC unit volumes were up 1% on continued market strength and increased capacity. Adjacencies, which include modems and wireless and wired connectivity solutions, grew 13% year-over-year driven by strong demand for modems and a better mix of connectivity solutions. Operating margin was 41%, up 4 points year-on-year on higher revenue and lower spending driven by the 5G smartphone modem exit. As a result, CCG achieved record operating income in 2019. +In 2019, we've generated $33.1 billion in operating cash flow and invested $16.2 billion in CapEx. We also returned 113% of free cash flow to shareholders through dividends and buybacks. During the quarter, we purchased 63 million shares at an average price of $55.32 per share. Total 2019 share repurchases were 272 million. And in 2020, we expect to turn in excess of 100% of free cash flow to shareholders under the $20 billion buyback program announced last quarter and the increased dividend announced today. +Let's move to outlook. 2020 is expected to be another record year for the company. We are forecasting revenue of $73.5 billion and EPS of approximately $5. We expect our PC-centric business to be down low single digits year-over-year on a slightly down PC TAM. Within 2020, we expect to see a strong first half and a moderating second half dynamic due to lower modem revenue and expected lower PC TAM in the second half of 2020 as the Windows 10 commercial refresh matures. +We expect revenue from our data-centric businesses to be up high single digits for the full year as we capitalize on the secular trends that Bob outlined. We are expecting an exceptionally strong Q1 as cloud customers continue to build capacity and adopt our highest-performing products. This would mark 3 quarters of strong cloud buildout, and we expect more modest capacity expansion for the remainder of the year as CSPs move to a digestion phase. +We are also planning for an increasingly competitive environment as we move through the year. As a result of these dynamics, we expect total revenue to be more front-end loaded in the first half than we've seen historically. Gross margin is expected to be 59% for the year, down a point versus 2019 on both mix of products and the impact of 10-nanometer costs. Spending for the year is expected to be approximately $19 billion or 26% of revenue, down 1 point, resulting in a flat operating margin of approximately 33%. We expect 2020 CapEx of approximately $17 billion. More than half of which is comprised of investments in fab space and 7- and 5-nanometer equipment. +Free cash flow is expected to be approximately $16.5 billion as the flow-through from revenue growth and higher depreciation is offset by higher CapEx and rebuilding of critical product inventory back to more normal operating levels. +Let's turn to Q1. We anticipate a particularly strong start to another record year, with Q1 revenue of $19 billion, up 18% year-over-year and well above normal seasonal patterns. This is being driven in particular by data-centric revenue growth expected to be above 25% year-over-year on continued cloud buildout and NAND bit growth. Our PC-centric business is also contributing and is expected to be up more than 10% year-over-year on continued PC market strength, additional supply and higher modem revenue. With strong top line growth and mix, we expect Q1 gross margin of approximately 61%, up 3 points year-over-year. +Q1 operating margin is expected to be approximately 35%, up 7 points versus last year on higher gross margin and spending leverage on higher revenue. Tax rate is expected to be 13%, and EPS is expected to be $1.30, up 46% year-over-year. +In summary, 2019 was Intel's best year ever, and we expect a strong start to 2020 on the way to another record year. +With that, let me turn it back over to Trey. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from the line of Ross Seymore from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Congrats on the strong end of last year and start to this year. George or Bob, whichever of you want to answer this, I want to go a little bit into the trajectory of revenues. George, you gave some great color there on the 2 different segments, PC-centric and data-centric. But it appears by the end of this year, you could even be going negative in both of those segments year-over-year. So it seems like it's a pretty significant drop. I appreciate conservatism in the end-of-life on the Windows side of things, but how do you factor in the increased competition that you mentioned and the fact that shortages should go away so you could actually have some market share gains? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes. Let me -- thanks, Ross. Let me start, George, and you can chime in. First, at the -- thank you for the compliment on our fourth quarter results. When we look at 2020 demand cycles, we kind of have 3 things going on that are -- that impact the first half to second half outlook. And George touched on a few of these. But first, at the macro level, the insatiable appetite for data and the processing resources that need to go to make that data relevant, those trends continue, and we feel very good about how we're positioned to capitalize on this increased demand. Second, the -- as you know, from a cloud perspective, which now is bigger and bigger part of our overall DCG revenue, we expect them to continue to benefit from the trajectories that I mentioned initially. At the same time, you'll remember from last year, our ability to predict the cloud -- the CSPs' purchasing and then kind of digestion patterns is relatively hard. So we look at first half to second half, Q1 will be the, in essence, the third quarter in a row of real strong consumption patterns from the cloud folks. So we know from history that at some point, they go into digestion mode and the buying patterns begin to slow down. And it doesn't impact medium- or long-term trends, but it does impact cyclical trends during the course of the year. And we've tried to, based on our past learnings, take that into account as much as we can. So hopefully, we're wrong. Hopefully, we're conservative. But at this stage of the game, that's kind of how we've looked at cloud purchases first half to the second half. +The second thing, PC TAM, we think, is going to be flat to down a little bit this year. And the expectation is the first half will continue to be a Windows 10 refresh that George flagged, and we expect that to slow down in the second half. +And then the third item is modem. It's -- as we go into the second half of the year, we expect modem volume to be lower as we phase out of that business, as smartphone modem moves to the 5G world. So those 3 things have us looking at the full year of kind of 2% growth. And inherent in that is we know we got a much more competitive environment. And our intention during the course of the year is to compete vigorously to protect our position while continuing to expand as compute moves further and further away from the cloud out to the network and to the edge. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Yes. And I guess I would just add that we feel really good about the year overall. It's just going to be a little flatter in terms of the pattern and certainly than we saw last year and certainly different than our normal seasonal pattern, but good strength growth in all of the businesses really outside of the PC, which is going to -- is coming across some headwinds from TAM, but we still expect it to work on gaining back share in some areas where it's had difficulties in the past as we can start to provide more units. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [5] +-------------------------------------------------------------------------------- + + And one last comment, I apologize. But I think just on a year-over-year basis, the comps in the first half of '20 are going to be easier. And then after a very strong second half of '19, comps a bit tougher in the second half of the year. But net-net, we're -- as George shaped it up, we're looking for another record year in 2020. Thanks, Rob. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Vivek Arya from Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [7] +-------------------------------------------------------------------------------- + + Congratulations on the strong results and especially the buybacks. Nearly 10% of shares retired in the last 2 years. Question, Bob, on 10-nanometer. I saw in the slides, you mentioned 10-nanometer yields ahead, right, of expectations. And you mentioned 9 product releases on 10. Can you help put that in context, what does it imply in terms of the range of desktop and server SKUs? I think there is some speculation that maybe 10-nanometer might be a small node rather than a regular node. Or I guess, asked in a different way, what percentage of your sales do you expect to be on 10-nanometer this year and maybe even next year? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [8] +-------------------------------------------------------------------------------- + + Yes. Well, first, we continue to make real progress on yields on 10-nanometer, and that's been -- after all the challenges we've had, that's been kind of a consistent theme over the last 4 to 6 quarters just on yield for 10. So we feel very good exiting the year and coming into this year and where we are in yields. +Second, in terms of the product road map, we have -- we launched Ice Lake for client in the fourth quarter. We launched FPGA's Agilex products on 10-nanometer in the fourth quarter. And then through the course of this year, we're going to have successive products as AI inference accelerator, 5G SoC that we're really excited about for the 5G network GPU launched. And then last and certainly not least, bringing out Ice Lake server product at the back end of the year. So we've launched it. Yields are good. Designs across our portfolio of products are good, and we'll ramp them up during the course of the year. +But primarily, in terms of volume, we'll still be -- the client business is the one we're going to ramp the fastest. It'll ramp during the course of the year. It'll be our second gen of 10-nanometer or what we'll call 10-plus in the second half of the year, which introduces a whole new level of performance for that product. But in the aggregate, we won't have a huge percentage of our overall company volume in the second half of the year. It'll grow as we exit the year and become a much bigger part of our overall volume in 2021. +And then last, I'd just say that our intention back in May, and we reiterated again today, is that we want to get back to a 2- to 2.5-year cadence. And shortly after launching 10, our expectations is we'll have our first 7-nanometer product launched in the latter part of 2021 with CPUs to closely follow. So -- and ramping will go to 10-plus for clients, and we'll ramp 7 on a 2-year cadence in 2021. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [10] +-------------------------------------------------------------------------------- + + Congrats on the great results. Bob, maybe just following on that because I remember 2 quarters ago, you talked about Ice Lake taping out, for servers in the first half. And there's a lot of different milestones, it gets confusing. When you say second half, do you actually -- is that a volume ramp? Or is that when you actually expect the 10-nanometer servers to be out? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [11] +-------------------------------------------------------------------------------- + + Yes. It's a good question. Just a few things. I think, first, in terms of how we deploy the technology. Today, our ecosystem partners have already received Ice Lake server samples. So that's kind of the first step for us. And then what we indicated is we'll start production wafers in the first half of this year, and that'll translate into production of shipments in the latter part of 2020. So that's the sequence of events. So production -- we load wafers. We deliver samples, check. We load wafers, first half. We deliver production output, latter part of the year. So that's been pretty consistent with how we've been trying to ramp this over the last several quarters. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + And then just clarity on the client side, I'm surprised by the seasonality, but I guess I understand with Win 10. With that growth or the strong year-over-year you're seeing in Q1, are you still shorting the market, I guess? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [13] +-------------------------------------------------------------------------------- + + Yes. Yes. First, very -- we came into 2019 looking at kind of a flat PC TAM. And when all was said and done, we ended the year with about 3% growth overall and even stronger in the fourth quarter. So we've had a real strong -- the market has had a real strong year in 2019. At the end of the year, as we indicated, we were still constraining our PC customers. And there's -- I'd say there's -- we left some backlog on the table that we are quickly trying to fill as we come into the first quarter. So that's obviously a disappointment in terms of our serving customers at the end of the year but adds to volume in the first quarter, first half. +As we go through the course of the year, just from a macro level, we spent record capital in '18; again, record capital in '19. As George laid out in his prepared remarks, we'll spend -- we'll have record capital in 2020. And it's really geared to ensure that we never constrain our customers' growth. And our expectations in 2020 is that we'll have high single-digit PC unit volume and against the market that we expect to be flat to down slightly. So we are going to be in a good position to meet customer -- the market demand in 2020 to deliver on our full year outlook and to begin to build the inventory levels to more natural position so that the mix dynamics of what product we're selling when we can manage the volatility in that much better than we have been able to in the fourth quarter. +So supply constraints, we are maniacal about eliminating those so that we can meet customer demand and don't have to worry about it. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + And we'll expect to see more small core in the second half, which may be part of the dynamic, but we haven't really been able to serve that end of the market in the way that we would like to. So that may be part of what you're looking at. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our next question comes from the line of John Pitzer from Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [16] +-------------------------------------------------------------------------------- + + Let me add my congratulations to the solid results. I guess I've got a similar question to Ross' first question on revenue, but mine is going to be on gross margin. If you just sort of look at the Q1 guide of 61% versus the full year of 59%, I'm just trying to understand kind of the puts and takes that brings gross margin down throughout the year. And explicitly, how much of this is kind of you guys baking in some increased competition? Or how much of this is a pull forward of 7-nanometer? Because 59% is pretty close to what you talked about at the Analyst Day, kind of flattish year-on-year, but it is slightly lower, and you were pretty explicit about gross margins going down in calendar year '21. I'm just kind of curious as to whether or not we're getting a pull forward of the 7 here? Or what are the puts and takes as you think about gross margin throughout the year? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Yes. So as we -- let me just start with the full year because I think that'll be helpful. At the highest level, what you're really seeing is the -- an impact of -- largely related to 10-nanometer costs that are coming into the system during this year and increasing as we go into the second half for all the reasons that Bob laid out. We're actually getting some help that is moderating the impact of that from improving NAND pricing year-over-year. That's actually going to help us on gross margin and lower modem mix in -- particularly in the second half of the year but in the year overall. So those are the big drivers of modems, and that nets out to about a 1% reduction. +And in Q1, what you're really seeing is lower modem and lower variable comp being the reason that we're moving up a point, say, from Q4. And so nothing unusual other than, normally, you would have expected to see a much bigger drop in Q1 gross margin because of the mix of products as it's the, obviously, the seasonally down quarter for many of our businesses. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [18] +-------------------------------------------------------------------------------- + + George, the only thing that I would add is we do -- inherent in our guide is our expectations for lower ASPs. And it's a function of 2 things: one that George mentioned, which is we will eliminate the supply constraints and begin to get more volume on small core, which, as you know, has lower ASPs; and secondly, we're anticipating a more competitive environment in the -- as we go through the course of the year. +So to kind of bring it back, we're ramping 10. It's great. And we're ramping 10 in the second half of the year. And in parallel with that, we are investing in 7 in 2020 and in 2021. And those are the things that we flagged back in May at the Analyst Day. +And I'd say the one thing that's really changed since then is that our yields on 10 are just a little bit better, and they're a contributor to slightly better gross margin in the second half of '19, and we expect that to be -- continue to be a contributor next -- this year, I should say. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + On the full year guide for data-centric, up high single digits. I appreciate the first half, second half profile on DCG. But how are you guys thinking about growth of DCG within that framework for the full year? Is it in line with the sort of high single-digits growth for data-centric? And then within that framework, how do you see the growth trends in other DCG segments, i.e., enterprise and comms service provider? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + Yes. So the way we would look at DCG, I would say the growth rate will be modestly lower than the overall growth rate. You've got some very high growers contributing to pulling that up a little bit. So a little below the average but still attractive growth in the year. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Stacy Rasgon from Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + I wanted to ask a bit about the capacity additions. So I kind of get this, adding 25% wafer capacity to support your own volumes, going up high single digits in a market that you think is down. Does that imply that you're actually going to be over shipping the market this year as you sort of rebuild those channel inventories? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + No, Stacy. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + And what does that imply if I'm going forward into 2021 where the PC market itself may still be in decline, and you'll be -- you'll have higher capacity and ideally like die shrink at that point? Like how do we think about that? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + Yes. No, I hear your point. One of the things that we mentioned is we are going to be producing in order to build inventory levels back up in the year. And so in the second half of the year, we would expect to be able to bring both our server products and most importantly, our PC products back to a more normalized inventory level. So we are -- being up in the high single digits is meant to allow us to not only satisfy our customers but also rebuild the inventory. So your math is correct. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Right. So that's your own inventory? Or inventory in the channel? Are you going to be selling that to the customers or keeping it on your books? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + It'll be our own inventories. And then we'll have to see -- if you look at the -- some of the channel information, you might see customers trying to build some inventory as well. But when we're talking about building inventories, it's our inventory levels. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [29] +-------------------------------------------------------------------------------- + + I'd also say the channel inventories exiting the year for PC, I'd say, are relatively low. And that's on us. So I do expect, during the course of the year, we will build our inventory levels to more deal with spikes in demand. But at the same time, we expect the channel to be at more healthy levels as we exit 2020 and enter 2021. +And then just the one other thing I'd mention is as we think about the business overall and kind of the demand signals, we continue to make really good progress on the comms sector, particularly with the growth in the network and the role that we play in the transition to 5G, and we characterize as the intelligent edge. We've delivered double-digit growth with IoT for the last several years. And network and IoT are bigger and bigger parts of our business that we think we're very well positioned. So when you think about PC volume up or down over time, we got this bigger growing aspect of our business that places demand on our manufacturing footprint. So that's the only other thing that I would add, Stacy. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [31] +-------------------------------------------------------------------------------- + + I guess going back to the PC constraints that you're seeing. So you'd like to build your inventory back up in, I think, you said earlier in the year, but it seems like we're just a few weeks from you going out to customers and telling them that you would be short. So at what point can they start to add inventory? Are you forecasting that would happen in the second half, in the first half? And then do you feel like when those constraints are eased that you'll be able to take back unit share on the client side? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [32] +-------------------------------------------------------------------------------- + + Yes. I think, first, it was middle of November, I should say, that we went out, and we want to be able to provide as much advance notice to our customer base as possible if supply is going to constrain their ability to grow to give them time to deal with it. And in November, with strong data center growth, PC demand continuing to grow and a factory excursion, combination of those things, we felt it was very important to get out to our customers as soon as possible. +I think as we close the year, one of the favorable things was we got more output from our factories. And because of the capacity we put in place in '18, '19 and going into '20, we're really beginning to build back the capacity to meet the demand. So our expectations are we'll have sufficient supply in the first quarter, or I should say, sufficient supply throughout the year. +I think our challenge is really going to be on 2 things, particularly in Q2 with PCs, and that is linearity, not just the supply in the quarter, but week on week supply as our customers are hoping for. And then second, particular SKUs or product mix, making sure that we have the right product mix. So we'll have enough capacity. +I think Q2 will be a little challenging as we try to deal with product mix and linearity. But overall, we really plan to be out of the supply-constrained environment in 2020. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [33] +-------------------------------------------------------------------------------- + + Okay. And then are the shortages anywhere other than client? Is it entirely client? Are there any -- anything in server or any other products? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + No. We're in pretty good shape on server. And I think that going with 19% growth in fourth quarter depleted our inventory level. So we're not -- you have that kind of spike in demand. We're not perfect across all products or all SKUs. But server CPUs, we really prioritize that and try to put ourselves in a position where we're not constrained, and we're in pretty good shape. Pretty great shape, macro, micro, a few challenges here and there, but server CPU supply is pretty good. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Christopher Rolland from Susquehanna. + +-------------------------------------------------------------------------------- +Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + On CapEx, specifically, $17 billion, you mentioned some of the parts there, but how do we divide that between kind of 7 and 5 versus what you're doing with 10? And I don't know if you're still adding some 14 even. And as we think about CapEx moving forward and capacity here, how do you guys feel about outsourcing non-CPU products like, for example, PSG, could you outsource that to foundries, how are you thinking about CapEx going forward? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + Sure. Why don't -- maybe I'll take CapEx, and Bob, you can cover the outsourcing piece. The -- so on CapEx, we're -- part of the reason we're at -- expecting $17 billion this year is we're building more space, some of the longer lead time items. One of the things that's really impacted us in terms of closing the gap on customer demand and our ability to support it has been not enough space available to fill with equipment, which you can do in a much shorter time frame if you already have a space in place. So we said over half is going to be for space. And then for 7- and 5-nanometer equipment, as you know, we've got all 3 nodes right on top of each other. And so we're going to be perhaps a little less capital efficient when you combine that with the fact that we are trying to close the gap on meeting our customers' requirements. And I think all of those things add to the $17 billion. But we also -- we're building for the future to make sure we have the kind of capacity, shelf space in place where we can quickly add capacity to meet demand, if necessary. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [38] +-------------------------------------------------------------------------------- + + Yes. And just on the -- the one other thing is maybe with the exception of litho, the reuse from 1 node to the next is still relatively high. So what we put in place for a 10 or a 7, for the most part, we can continue to reuse those tools for next generation. +On the second part of your question, we've historically leveraged third-party foundries for a long time. And it's always been in the probably 20% to 25% of our overall supply we get from third-party foundries. And we continue to look at -- particularly in the non-IA, non-CPU products, we continue to evaluate where is -- in a capital-intense business, where is the best place to have these things manufactured. That's an ongoing process. And I would say, all else equal, the broader -- the breadth of our portfolio as we play a larger and larger role in our customers' success, we build more products. And with that, the evaluation of what we do inside and what we do outside is a full-time effort at our end. So we'll continue to do it. We'll continue to prioritize where we can get the best, most efficient output and make those decisions over time. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [39] +-------------------------------------------------------------------------------- + + Jonathan, I think we have time for one more question, and then we'll turn the call back over to Bob to wrap things up. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Our final question then for the day comes from the line of Timothy Arcuri from UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [41] +-------------------------------------------------------------------------------- + + George, I wanted to go back to gross margin. I think last quarter, we were talking about 60% for this year, and we're now 59% for the year on a little bit better revenue. And yes, it's only 100 basis points less. But obviously, people are concerned about the competitive environment. So can you just talk specifically to what changed? And maybe as you exit the year, it looks like that number has to be in the 57%, 57.5% range, which is about where you said next year would be, 2021. So is that still the right number for next year, too? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [42] +-------------------------------------------------------------------------------- + + Yes. Tim, let me just kind of correct the history just a little bit. What we said over the last couple of quarters was, when the question was, hey, when we look at 58%, which is what we quoted for Q4, does that mean -- is that the number that we should be expecting for 2020 and also with the 57% on the table for '21, is that where we are? And I said we will be closer to 60% than we will be to either of those numbers. And so 59% is very much in line with what we believe we were guiding. So I don't really feel like we're down a point. But clearly, there -- the factors that we talked about, everything from product mix to 10-nanometer mix, those are all things that are having an effect, particularly as the year plays out, and also the shape of the year. Bob talked about some of the things where we're -- we'll be in -- the mix in the first half is going to be much richer than we would normally have seen, and we may see a little less rich mix in the second half. +So I think really nothing more than those type of movements, which are very much in line with what we were thinking we would see this year. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [43] +-------------------------------------------------------------------------------- + + Maybe -- Trey, maybe just to wrap. First, thanks for joining us. We feel great about how we wrapped up the year, our best quarter in the company's history, 2019, the best year in our company's history, and our outlook for 2020 is it'll -- is we'll do it again. We expect it to be another record year. And our ambitions have just never been greater. As you know, we're going after a larger TAM. We're expanding the role that we play in our customers' success. We're leveraging our CPU architecture but also evolving beyond the CPU to GPUs and visual processing units as workloads continue to evolve. And given the overall dynamics of the industry, we feel very good about where we stand and we realize it's an increasingly competitive world, and we feel like we're well positioned to deal with it. So thanks again for joining us. Our focus is on obsessing about how we serve our customers best. And if we -- and we expect to do that better and better, and that'll be what really drives the growth of the company. +So thanks, and we look forward to another deposit 90 days from now. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [44] +-------------------------------------------------------------------------------- + + Thanks, Bob and George, and thank you all for joining us today. Operator, can you please go ahead and wrap up the call? + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Certainly. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/INTC/2020-Jul-23-INTC.txt b/Transcripts/INTC/2020-Jul-23-INTC.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffabcce36309aa67e7f3d2a2700d9d59a24fab22 --- /dev/null +++ b/Transcripts/INTC/2020-Jul-23-INTC.txt @@ -0,0 +1,412 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Intel Corp Earnings Call +JULY 23, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Trey Campbell + Intel Corporation - Head of IR + * Robert H. Swan + Intel Corporation - CEO & Director + * George S. Davis + Intel Corporation - Executive VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Srinivas Reddy Pajjuri + SMBC Nikko Securities America, Inc., Research Division - Research Analyst + * Weston David Twigg + KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ross Clark Seymore + Deutsche Bank AG, Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter 2020 Intel Corporation Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) +I would now like to hand the conference over to your host today, Mr. Trey Campbell, Director of Investor Relations. Thank you. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator, and welcome, everyone, to Intel's second quarter earnings conference call. By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available in the webcast window for this joining us online. I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them, followed by Q&A. +Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. +A brief reminder that this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations. +With that, let me hand it over to Bob. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Trey, and thank you all for joining our call. Amid a very challenging environment, cloud and network infrastructure and PC capabilities have been vital in allowing businesses and people to continue to work, learn, stay connected and provide critical goods and services. Those trends contributed to a very strong quarter in which we generated $19.7 billion in revenue and delivered $1.23 in earnings per share. We exceeded our guidance by $1.2 billion on the top line and $0.13 on the bottom line. Our data-centric businesses grew 34% and drove approximately 52% of the company's revenue, and our PC-centric businesses grew 7%. +I continue to be amazed by our employees and supply chain partners who have diligently worked to keep our business operating at a high level during this unprecedented challenge. COVID-19 has driven redesigned workflows and added additional environmental stress that I know has strained employees and ecosystem partners as they try to maintain productivity in this new world. I want to thank our employees and partners for their incredible contributions. Our primary focus continues to be ensuring the safety and well-being of our global workforce, delivering for our customers and helping the communities in which we operate. +On each earnings call, I give updates about our progress against 3 key priorities: accelerating the growth of the company, improving our execution and continuing to thoughtfully deploy your capital. Let me give you a few thoughts on each. +We're transforming the company to accelerate growth. That means not just playing defense but position our business to grow share in the largest market opportunity in our history. We've built scale businesses indexed to key technology inflections such as cloud, AI, 5G and the intelligent and autonomous edge. We see a world where everything increasingly looks like a computer, including our homes, our cars, our cities, our hospitals, our factories and now even our schools. In this new world, our opportunity set becomes more than just the CPU. It's more and more Intel silicon inside more and more computers so we can have a larger impact on our customers' success. That diversity is one critical factor in driving today's results. +I'll highlight a few examples from the last 90 days. AI use cases are becoming pervasive, and we are embedding AI capability into all our products. Our Xeon platform is foundational for data center AI with value, scalability, built-in AI acceleration and inference leadership. This quarter, we launched our third-generation Intel Xeon Scalable processor, Cooper Lake, which is the first mainstream server CPU, bfloat16 support, which increases AI throughput by reducing the amount of data required for the same accuracy. Developers can use and test latest Intel optimized versions of TensorFlow and PyTorch to train their models using bfloat16 and the Intel distribution of OpenVINO to deploy optimized inference from cloud to edge. +In Q2, both our cloud and comms service provider businesses grew more than 40% year-over-year as critical cloud-delivered applications continued to scale and 5G build-outs accelerated. Leading cloud service providers, including Alibaba, Baidu, Facebook and Tencent, announced they are adopting our third-gen Intel Xeon Scalable processors into their infrastructure and services. +Also this quarter, Azure introduced several new Xeon Scalable instances, including general purpose and memory optimized Azure virtual machines. We were also excited to be part of an industry first with Rakuten's full-scale commercial launch of its mobile carrier service. This service is the world's first end-to-end, fully virtualized, cloud native mobile network, and it's powered by Intel processors and FPGAs from the radio access network to the 5G-ready mobile core. +Compute capabilities are moving from the cloud to the edge and catalyzing a vast array of new usages and market opportunities. The largest opportunity we see at the edge is the $230 billion 2030 TAM for ADAS, data and Mobility-as-a-Service technologies. Since the last call, we acquired Moovit, a leading Mobility-as-a-Service solution company. Combining Mobileye's market-leading ADAS and AD technologies with Moovit accelerates our ability to become a full-stack mobility provider and truly revolutionize transportation. The most important demonstration of the power of our technologies is the commitment of our customers, and we are excited this week to announce a significant design win with Ford. Design win to date in 2020 include multiple new ADAS production programs, representing cumulative volume of over 20 million units. +We're also driving incredible innovation for our customers across a wide spectrum of PC use cases. This quarter, we introduced 3 new additions to our 10th gen processor family, extending our leadership in gaming and business. The Core S- and H-series processors for desktop and mobile gaming deliver speeds out of the box reaching up to 5.3 gigahertz, making them the world's fastest gaming processors; and our new 10th-gen Intel Core vPRO processors deliver uncompromised productivity and hardware-based security for commercial PCs. Q2 also marked the launch of Lakefield, featuring our new Intel hybrid technology, which is a hybrid CPU architecture for power and performance scalability. +We also continue to work on improving our execution. Intel employees and our supply chain partners have role modeled teamwork in navigating difficult conditions while working to support customer upsides during the crisis. We have made significant progress in increasing our capacity and improving our supply while delivering $2 billion above our plans through the first 6 months of the year. We're on track to return to more normal levels of PC inventory as we work through the second half of the year. +Acceleration of our next-generation products continues. We now expect to increase our 10-nanometer-based product shipments for the year by more than 20% versus our January expectations. Customer demand for our family of 10-nanometer-based SoCs for 5G base station designs is also very strong. We delivered a full node of performance improvement within our 14-nanometer-based products by optimizing our product and process together, and the power of our intra-node improvements continues with our next-generation 10-nanometer-based client product, Tiger Lake. +Tiger Lake delivers breakthrough performance in CPU, graphics and AI, and we'll be shipping to customers in a matter of weeks. We are also targeting initial production shipments for our first 10-nanometer-based Xeon Scalable product, Ice Lake, for the end of the year. And we have a pipeline of exciting new product architectures for 2021 led by Alder Lake for client and Sapphire Rapids for server. Both products will start initial production shipments in the second half of '21. +Let me provide some updates on our technology road map. We continue to demonstrate proof points of our breakthrough advanced packaging technologies. Our Lakefield product, which I mentioned earlier, delivers scale production of our 3D packaging technology, Foveros, combining both 10-nanometer and 22-nanometer capabilities in a disaggregated architecture. +This quarter also marked a significant milestone in our data center GPU technology. We successfully powered a petaflop scale GPU with high bandwidth memory, using our advanced embedded multi-die interconnect bridge, or EMIB, 2D packaging technology. +Turning to our 7-nanometer technology. We are seeing an approximate 6-month shift in our 7-nanometer-based CPU product timing relative to prior expectations. The primary driver is the yield of our 7-nanometer process, which, based on recent data, is now trending approximately 12 months behind our internal target. We have identified a defect mode in our 7-nanometer process that resulted in yield degradation. We've root caused the issue, and believe there are no fundamental roadblocks. But we have also invested in contingency plans to hedge against further schedule uncertainty. We're mitigating the impact of the process delay on our product schedules by leveraging improvements in design methodology such as die disaggregation and advanced packaging. We have learned from the challenges in our 10-nanometer transition and have a milestone-driven approach to ensure our product competitiveness is not impacted by our process technology road map. +Our overarching priority is to deliver product leadership for our customers, and we are taking the right steps to produce a strong lineup of leadership products. We will continue to invest in our future process technology road map, but we will be pragmatic and objective in deploying the process technology that delivers the most predictability and performance for our customers, whether that be on our process, external foundry process or a combination of both. +Our advanced packaging technologies, combined with our disaggregated architecture, give us tremendous flexibility to use the process technology that best serves our customers. As an example, our data center GPU design, Ponte Vecchio, will now be released in late 2021 or early 2022, utilizing external and internal process technologies, combined with our world-leading packaging technologies. We now expect to see initial production shipments of our first Intel-based 7-nanometer product, a client CPU, in late '22 or early '23. We are also focused on maintaining an annual cadence of significant product improvements independent of our process road map, including the holiday refresh window of 2022. In addition, we expect to see initial production shipments of our first Intel-based 7-nanometer data center CPU design in the first half of '23. +Finally, while process technology is very important, it is only one of the 6 technology pillars of innovation that drive differentiation in our products. You will hear more about advances across all 6 technology pillars: process, packaging, architecture, memory, interconnect and security/software at the upcoming Intel Architecture Day. +Last, we are focused on the thoughtful allocation of your capital. We are investing to grow our capabilities even as we deliver significant free cash flow this year. Since 2015, we have grown R&D spending by more than $1 billion while divesting noncore assets and reducing overall spending as a percentage of revenue by 9 points. We also look for opportunities to augment our product lines and speed the pace at which we can grow the company. As discussed earlier, we acquired Moovit this quarter, investing approximately $900 million to dramatically accelerate our capability to capitalize on the $160 billion Mobility-as-a-Service opportunity. We also announced a $250 million investment in Jio Platforms, a high-speed wireless connectivity and digital services provider, to help fuel digital transformation in India. +Our purpose to deliver world-changing technology that enriches the lives of every person on Earth has never been more essential, but the global problems we face are bigger than any one company can solve alone. That's why we established 2030 corporate responsibility goals, which call for a collective response to revolutionize health and safety, make technology fully inclusive and help address climate change. We've also committed more than $50 million and extended our expertise, global reach and influence to combat COVID-19 as well as social injustice. The early results of our pandemic response technology initiative, which we announced earlier this week, underscore Intel's unique ability to partner and collectively solve critical problems. +In closing, I want to thank all our employees who are working through this challenging time to deliver our purpose and support our customers. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Bob, and good afternoon, everyone. The atypical seasonal effects of COVID-related demand for mobility products and data center infrastructure continued in Q2, resulting in record Q2 revenue for CCG, DCG and memory. Revenue came in at $19.7 billion, up 20% year-on-year, and $1.2 billion higher than guide. Data-centric revenue of $10.2 billion, up 34% year-on-year, represented 52% of our total revenue, an all-time high. Strong demand for NAND and 5G networking solutions and richer server mix drove most of the upside versus our expectations. Q2 PC-centric revenue was $9.5 billion, up 7% year-on-year on strong notebook PC sales enabled through increased manufacturing supply on capacity additions over the past year. +Gross margin for the quarter was 55%, slightly below expectations, on higher product costs from faster uptake of our 5G ASIC products, which are margin dilutive relative to the company average, and also continued acceleration of 10-nanometer products overall, partially offset by a shift of costs from cost of sales to R&D related to 7-nanometer product timing. As a reminder, we expected an approximate 3-point reduction in gross margin in the second quarter on the effect of pre-PRQ reserves for our Tiger Lake client product. This is largely a timing item with respect to the full year as we benefit from the $0 units in our initial sales of product, which will begin this quarter. +Operating margin of 31% in the quarter was approximately flat versus last year as spending efficiency offset lower gross margin. Q2 EPS was $1.23, $0.13 above our guide as stronger-than-expected operating results from notebook, memory and a richer mix of server products, along with higher gains in our trading asset portfolios, offset increased costs from our 10-nanometer acceleration and the effects of a discrete foreign tax item. +In Q2, we generated $11.2 billion in operating cash flow and invested $3.4 billion in CapEx, with $7.7 billion of free cash flow up 92% year-over-year. We returned $1.4 billion to shareholders via dividends. As a reminder, we paused our share repurchase program in Q1 as we felt it was prudent to do so in the current economic environment. We expect to complete the balance of our $20 billion share repurchase program and return to our historical capital return practices when market dynamics stabilize. +Moving to segment performance in Q2. Data Center Group revenue of $7.1 billion was up 43% from the prior year, coming in higher than expectations, with strength across our customer segments. Year-over-year platform volumes and ASPs were up 29% and 5%, respectively. DCG adjacencies also delivered significant growth with revenue up 118% year-on-year on strong adoption of 5G networking solutions. +While year-over-year comparisons for DCG benefited from a weaker Q2 '19, revenue in the quarter came in at the second highest level ever for DCG and the highest revenue ever in our cloud business. Revenue year-over-year was up 47% in cloud, 34% in enterprise and government and 44% for communications service providers. Operating margin was 44%, up 8% year-on-year on higher revenue and high-end compute mix. We see increased competition this year, but we've also seen strong customer response to our product portfolio and now expect to end the year with market share that is somewhat higher than our original expectations. +Our other data-centric businesses were up 14% year-over-year, primarily on the NAND dynamics in Q2, despite significant COVID headwinds impacting demand in our more GDP-sensitive businesses, IOTG and Mobileye. IOTG revenue and operating income declined 32% and 76%, respectively, primarily on lower revenue from industrial, retail and vision segments. Mobileye revenue was down 27%, and operating income turned to a modest loss as the decline in global auto sales more than offset continued ADAS penetration and new IQ program launches. +NSG's record quarterly revenue of approximately $1.7 billion was up 76% year-on-year on strong NAND bit growth and improved pricing. Q2 was an all-time record for quarterly revenue for our memory business. The business also returned to profitability this quarter, generating approximately $300 million in operating income. +PSG revenue grew 2% year-over-year on cloud strength, which was partially offset by weaker demand from embedded and communications segments. Operating income was up 54% on richer product mix and improved unit cost. +CCG revenue was $9.5 billion in Q2, up 7% year-over-year, driven by notebook demand and higher modem and WiFi sales, which more than offset lower desktop volumes. PC unit volumes were up 2% year-over-year on higher notebook demand and increased supply. We expect our share to improve throughout the remainder of the year as we begin to recover unit share in notebooks, utilizing our smaller core products which we have not been able to fully serve given the strength of demand for our large core products. +Operating margin was 30%, down 12 points year-on-year as higher unit costs associated with the ramp of 10-nanometer products and the pre-PRQ reserves ahead of our Q3 Tiger Lake launch more than offset the benefits of higher revenue. +Moving now to our third quarter outlook. Based on demand signals from our customers, we expect continued strength in cloud and comms infrastructure and consumer notebook PCs in Q3, but we expect that the weak economic environment will impact our commercial PC business, particularly the desktop form factor, and also drive lower demand for the enterprise and government segment in DCG and in IOTG and Mobileye. As a result, we expect total revenue of $18.2 billion, with PC-centric and data-centric businesses down mid-single digits year-over-year. +In Q3, we expect the PC TAM to be down high single digits year-over-year on OEM inventory drawdown, softer desktop demand and the effects of the global recession. Gross margin is expected to be approximately 57%, down 3.5 points year-over-year as the accelerated ramp of 10-nanometer products and lower platform revenue more than offset NAND margin improvement. +We are expecting a tax rate of approximately 15.5% in Q3. This is approximately 2 to 2.5 points above our previous expectations, primarily due to a lower FDII benefit in the year, a temporary reduction in R&D tax credits in California and the effect of a pushout of a foreign grant. The higher tax rate is reducing our EPS in the quarter by approximately $0.03 versus our prior rate expectations. As a result, Q3 EPS is expected to be approximately $1.10 per share. +Moving to full year. We are providing full year guidance, although visibility remains somewhat limited into the fourth quarter. Still, we do expect some part of the company's first half outperformance will be additive to our estimate for full year revenue. We are now forecasting revenue of $75 billion and EPS of approximately $4.85. We expect our PC-centric business to be flat to slightly down against the PC TAM that is down mid-single digits year-over-year. +Following a very strong first half of the year, we expect demand trends to moderate in the second half as weaker global GDP and the maturing Win 10 commercial refresh drive a lower PC TAM. Again, we also expect to increase our market segment share as we have greater supply for entry PC designs. Additionally, we are forecasting lower modem revenue in the second half. +We expect revenue from our data-centric businesses to be up approximately 10% for the full year on strong cloud demand and increased 5G build-outs. After significant cloud expansion in the first half and into Q3, we expect capacity expansion to moderate as CSPs move to a digestion phase. We are also planning for an increasingly competitive environment as we move into the second half. We expect continued global GDP-related impacts to our IOTG and Mobileye businesses in the second half of the year. Overall, our implied first half/second half revenue contribution is an anomalous 53% to 47% as opposed to a more typical year with underserved seasonal volume patterns of 46% and 54%, respectively. +Gross margin is expected to be 58% for the year, down 1 point versus our original expectations for the year and 2 points lower year-over-year. This change is being largely driven by higher costs from higher-than-expected demand for our 10-nanometer products and the pushout of a government grant for our memory business. These effects, coupled with softness in our IoT businesses, more than offset the stronger overall demand, improved mix in DCG and the shift in some spending between OpEx and cost of sales related to the product timing delays Bob discussed earlier. +Spending for the year is expected to be approximately $19.7 billion or 26% of revenue, down 1 point year-on-year. Full year spending is up versus our January expectations on higher R&D expenditures, including the previously discussed shift between OpEx and cost of sales and costs related to COVID, partially offsetting the cost reductions on the modem exit and other portfolio actions as well as ongoing SG&A productivity gains. The resulting operating margin is 32%, down 1 point year-over-year the tax rate is expected to be 14.5%, reflecting the impact of discrete items and the lower FDII benefit. +Full year EPS of $4.85 is $0.15 below our January expectations as increased server and notebook PC demand and slightly higher equity gains are more than offset by COVID-related impacts to IOTG and Mobileye, higher product costs from accelerating 10 nanometer, a higher tax rate and the impacts of improving our liquidity by raising additional debt and temporarily pausing our share buyback. The combination of our liquidity actions and the higher tax rate alone impact full year EPS by more than $0.15. We expect 2020 CapEx of approximately $15 billion and free cash flow of approximately $17.5 billion. +To conclude, I'd like to join Bob in thanking our employees worldwide. Very much appreciate the hard work of our employees and contractors who delivered excellent results in the face of a very difficult environment. +With that, I'll hand it back to Trey, and we'll get to your questions. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [5] +-------------------------------------------------------------------------------- + + All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first caller. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + I wanted to dig into the competitive and the financial implications of the 7-nanometer delays that, Bob, you mentioned. So on the competitive side, by the time you come out with 7, TSMC is planning to be on the 3-nanometer node so will still be a generation ahead. So what's the market share implication of that? +And then related, on the financial side, what's the CapEx and gross margin implications and even pricing implications if you stay on 10-nanometer longer next year? And I guess the bigger question that a lot of investors would have is, at what point Intel should just consider outsourcing a lot more to foundries so that you can keep in line with the state-of-the-art and manufacturing technology? + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [3] +-------------------------------------------------------------------------------- + + Yes. Thanks, Vivek. I mean, first, our primary focus is on ensuring that we're delivering leadership -- an annual cadence of leadership products each and every year for our customers in a predictable manner. So what we talked about today is a strong lineup for 2020, 2021, 2022 for both client and server. And we feel very good about that lineup. And our expectation on 10-nanometer, much like what we're able to do on 14-nanometer, is to get another node of performance within that -- within 10-nanometer in and of itself. So we feel very good about our product road map through 2022. +That being said, as we think about that next-generation of products in late '22 and '23 and beyond, we need to make sure that we continue to deliver strong performance. And our priorities in the ideal world is leadership products on our process technology, so we capture the economic benefits of IDM. But the focus will be leadership products. So to the extent that we need to view somebody else's process technology, and we call those contingency plans, we will be prepared to do that. And if we do, there's lots of moving parts, but the economic implications in the event that we decide to move to somebody else's foundry, and with our scale, how do you get ASPs in line with our cost, continue to deliver leadership products so we capture attractive ASPs and to reduce the amount of capital that we have to deploy to build a foundry on an older node or on a last gen kind of process node. +So in the aggregate, for the last couple of years, with the real focus on product leadership, we've been engaging with the ecosystem in a much more holistic way. We've been designing our products and advancing our packaging technology so that we have much more flexibility to decide if and when we will use our fabs or somebody else's to deliver that annual cadence of leadership products. We feel very good through '22 time frame, and now we're evaluating the optionality that we have on '23 and beyond. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Vivek, let me just comment on your question around what we're going to see -- what we might see next year. Next year is still going to be as it was when we talked about it last in May of '19, still going to be largely a 10-nanometer with some 14-nanometer year. And the dynamics there are as we're coming into it with having moved a little bit further along the yield curve, as we've seen more demand for 10-nanometer products in 2020 than we had expected. So we're not going to update '21 at this time, but I think we're more concerned about what the global economy is doing than where we are on 10-nanometer. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + I guess a follow-up question on the 7-nanometer delay. I guess curious how should we think about the implications for CapEx and required capacity adds at 10-nanometer and 14-nanometer. And then just to circle back on the comment around contingency plans after '22, considering your first data center CPU will launch in first half '23, are you suggesting that, that could be found out and not be built internally at Intel? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- + + Well, I think the first part of your question, in the -- with 2022 being, in essence, a full array of 10-nanometer products, the expectation is, all else equal, a little more 10-nanometer spend and less 7-nanometer spend, provided we decide to continue to do all of our production inside. In the event we decide that we're going to leverage third-party foundries more effectively, we would have a little more 10 and a lot less 7. And that's kind of the optionality that we've tried to build in as we evaluate the future of Moore's Law, invest in technology development leadership. In the event we're not there and there's a better alternative, be prepared to take advantage of it. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [9] +-------------------------------------------------------------------------------- + + Sticking on the same topic of 7-nanometer. Bob, if you could just help me understand, yields are 12-month behind where you would expect them, but the product ramp is only 6. If you could square that circle, that would be helpful. But more importantly, you had multiple sort of pushouts of 10-nanometer. You're identifying this 7-nanometer pushout today. What confidence level do you have that this is sort of a one-and-done issue and it doesn't turn into a repeat of 10 where you kind of had multiple periods of pushouts? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- + + Thanks, John. I mean, first, product schedule slippage of roughly 2 quarters, while process we expect now to be roughly 4 quarters. The difference of the gap is driven by a couple of things: one, a buffer in our planning process between process and products to make sure that we don't -- minimal disruption on customers because of process; second, as I've mentioned in the prepared remarks, die disaggregation and advanced packaging gives us the ability for a given SoC to do some stuff inside and some stuff outside and, therefore, further compress the product delivery in light of process slippage. So that's why we've been able to be confident in a 6-month product ship slip, even though process was moving out 12 months. +In terms of -- I think your second question was about we've seen this movie before, maybe. And I think the importance of our many lessons coming out of 10-nanometer, one of them was how do we ensure that we have contingency plans in the event that our advancements in process technology, as it gets increasingly complicated, do not play out the way we'd hope, how do we make sure that we can continue to deliver leadership products for our customers on that annual cadence. +So I'm sure things won't play out exactly the way we want. We think we've dialed in 7. But at the same time, what's different is we're going to be pretty pragmatic about if and when we should be making stuff inside or making outside and making sure that we have optionality to build internally, mix and match inside and outside or go outside in its entirety if we need to. And that's kind of one of our learnings coming out of 10 is, in the event process doesn't move along as we expect, let's make absolutely sure, with advanced contingency planning and real milestones, that we can glitch the best we can to leverage somebody else and not slip product schedules in light of process complexities. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Seymore with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [12] +-------------------------------------------------------------------------------- + + I'm going to stick with the theme and ask about the 7-nanometer as well. I guess, Bob, it's great to hear that you're being -- you're saying you're going to be more pragmatic about internal versus external. But it seems like contingency plan 3 years down the road is how the external option is being treated. I think investors are frustrated with how long the misexecution on the manufacturing has happened. Are there steps where, instead of being a contingency plan, you actually start making the external side the primary source before 2023, obviously, on the design side more than the revenue side? And maybe a follow-up. If 3 to 5 years down the road, the 20/80, 20 external, 80 internal mix, do you think that changes? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [13] +-------------------------------------------------------------------------------- + + Let me -- maybe I'll flip those around. Over the last couple of years, we've been talking about, as we expand our capacity, evaluating more holistically when do we use third-party foundries rather than do everything ourselves. And we call that engaging in the ecosystem in much more holistic ways for a variety of different reasons, so we don't have to build everything ourselves as the capital associated with each node becomes a bit higher. So in general, I would say, for planning purposes, we've been engaging with the ecosystem much more. And all else equal, I would expect that roughly 20% to be a little bit higher as we focus on growing the business. +Your first question in terms of planning then, we have -- we feel like we have a real solid product road map, again, for the second half of this year, for '21 and for '22, and that we'll do it on our existing 10-nanometer that's ramping faster than we expected. It yields in line with what we expected. So for the near term, we think we got a great lineup of products, and we expect to fight and protect our share while expanding the role we play in a variety of different places in the industry. +But now is when we're planning for '22, '23. And we are evaluating now -- in light of where we are, where we think the industry, the competition of third parties are, evaluating now what's the best option for us to make sure that we can deliver an annual cadence of product leadership for our customers. And those decisions are not decisions that we'll make in 2023. Those decisions based on the information that we have along the way will be made long before then, whether it's decisions about how much capacity we need to put in place or decisions about how do we leverage more effectively somebody else's process capabilities and factories so that we can get real good incremental returns on capital deployed. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [15] +-------------------------------------------------------------------------------- + + I want to ask about the acceleration in 10-nanometer. Is this really because yields are getting better and there's higher demand or because you're trying to offset the 7-nanometer delay? Because it's hitting the margins big time, which doesn't really tie in my head to, like, yields getting hugely better versus where you thought they were going to be in January. So how do I think about the drivers of that 7-nanometer acceleration in light of the 7 -- or 10-nanometer acceleration in light of the 7-nanometer delay given what it's doing to the margins? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Yes. Stacy, this is George. Maybe I'll just cover it in general on the margin picture for the year because it's clearly -- it's having an impact there. The acceleration is really definitionally tied to the fact that we're growing faster than we expected in 2020. And we're -- part of that growth is a higher mix on the PC side and, I would say, on the comms and 5G ASIC side, higher demand for products that are on 10-nanometer than we had forecasted for the year. So it's why you're seeing a little less flow-through on revenue than we would have expected for the year. It's a positive growth story in that, again, we're seeing customers attracted to the 10-nanometer products. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + But wait a minute, if I look at your annual guidance now versus where it was in the beginning of the year, it's higher, but it's actually lower in the second half versus what you had implied in -- when you first gave the annual guidance 6 months ago. How does that imply that demand is higher versus where you were now given you've actually lowered the second half? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + It's the demand for 10-nanometer products within the mix of our overall revenue, Stacy. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [19] +-------------------------------------------------------------------------------- + + Well, I think I'd start with our full year demand relative to where we were at the beginning of the year is our guidance is up by $1.5 billion in revenue. So that's... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + Yes, but you're just making it sound like where you can typically get to, is there... + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Let me just finish, Stacy. I think it's a good question, but maybe if you could give me a chance to answer it. So full year demand for the company is higher. Secondly, the yields for 10-nanometer we've kind of set are in line with what we expected coming into the year through the first 6 months, and we feel pretty good about where we are on yields. Third, that the overall demand for our products on PC side and for the 5G SoC in the comms sector is higher than we expected. That is part of the contribution to the $1.5 billion of higher revenue for the year. And as we accelerate 10 faster, because customers are banding it more, the implications are that our margins, all else equal, will be lower. George kind of highlighted those were the primary drivers of the 1 point decline. 10-nanometer products are ramping faster, and our 5G comms business and the Data Center Group is growing much quicker than we had anticipated. +I put that -- I put ramping of 10-nanometer faster in the good category. We feel -- we know margins are lower when we start a new node versus exit an old node. 10-nanometer margins are lower than 14 at this stage of the game. Ramping 10, we think, is a good thing for customers. We do take a dip in yield. If it's more of our growth than we had anticipated, all else equal, margins will be a little bit lower. And that's kind of the updated guidance for the year. Higher growth in a more challenging market, more demand for our 10-nanometer products that we're ramping as we -- ramping yields as we expected with more volume, all else equal, will have a modest impact on our gross margin for the full year. Thank you. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [23] +-------------------------------------------------------------------------------- + + I wanted to ask also on the same manufacturing topic. So I think, Bob, when you were talking about Ponte Vecchio, I think you said that you're going to package it internally, but it seemed like you were implying an external foundry contingency even for this first GPU product. I guess my question is, did I read that right? And also, I wanted to ask, George, what the long-term implications are if you move to somebody else's fab? What does this do to your 57% to 63% long-term gross margin? And how does it impact free cash flow? I mean, obviously, it saves you on CapEx, but can it be accretive to free cash flow? + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + Yes. On the -- on Ponte Vecchio, originally, the architecture of Ponte Vecchio includes an I/O-based die connectivity, a GPU and some memory tiles, all kind of packaged together. That's kind of the design of Ponte Vecchio. From the beginning, we would do some of those tiles inside and some of those tiles outside and again leverage the packaging technology as a proof point of how do we mix and match different designs into one package. So that was the design from the beginning. And again, when we talk about disaggregation, more flexibility, optionality in our designs, use some stuff inside, some stuff outside, Ponte Vecchio was really -- Ponte Vecchio on the data center side and Lakefield on the client side were kind of our test products, both the -- one of which we've launched; the other one, which is in development. So that design disaggregation gives us lots of flexibility. +As we go forward now, we can think about whether we introduce Ponte Vecchio with -- I think I said some of those tiles are inside and outside from the beginning. Now as we go forward, we can assess whether we swap out one of our tiles for a third-party foundry or not. Again, that's the beauty and the value of this change in design methodology that gives us much more optionality and flexibility. So in the event there's a process slip, we can buy something rather than make it all ourselves. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + And with respect to the long-term outlook, first off, our long-term margin outlook is not 57%. We've talked about it being well above that over time. But in terms of -- as we dynamically move -- potentially move product depending on where it is best provided, I think that certainly gives us more flexibility to optimize our capital spend, get a higher return on that capital spend. And it should be accretive to free cash flow. So we talked a little bit about that actually back in May of '19 that embracing the ecosystem and balancing some of our activity externally is going to be important as we look to improving returns over time. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Weston Twigg with KeyBanc Capital Markets. + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + I just wanted to ask about the data-centric revenue heading into Q3. The mid-single-digit decline year-over-year implies a pretty big decline from Q2. You helped a little bit on the call, but I'm wondering if you could help us better understand the reason for that big quarterly drop. And kind of as an aside, you also mentioned increased competition in DCG in the second half, and I'm just wondering what exactly you're referring to on that side. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Yes. As you look at the data-centric revenue, we'll see a number of factors at play. Obviously, year-over-year, you're going to see the impact of the falloff in IoT and in Mobileye. But what we're seeing in the data-centric -- or the DCG side is we think we peaked on cloud in the second quarter, and it was an all-time record, so not a bad peak. We've probably peaked back in Q4 of '19 on enterprise and government. And while it was reasonably strong in Q1, it's -- you can see it coming down over the next few quarters. It may have -- it often has a little bit of a bounce in Q4, we'll have to see. And our comms provider, I would say, we expect Q2 to have been a peak there, and that'll start rolling off from there. So everything on the DCG side has got a step-down from a very strong Q2 and probably continues down on cloud and comms as our current outlook. Does that help? + +-------------------------------------------------------------------------------- +Weston David Twigg, KeyBanc Capital Markets Inc., Research Division - MD & Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + Okay. Yes. That's helpful. And then the comment on increased competition in DCG in second half. + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes. We expected, based on the competition's product road map, that we would see increasing competition in the second half of this year. We also thought -- we've been a little bit pleasantly surprised in the strength of our -- the demand for our products in the first half of the year, and it's continuing into the second half. So we don't think the impact will be quite as large competitively in the second half as we had thought. And as I said on PC, we think we're going to actually gain share. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + I would just say it's -- we had -- when we guided back in January, in the context of our guidance, we made that statement. So George is just reiterating that, that we see a more competitive world, and we'll be prepared to deal with it. And we've factored that into our outlook for the second half of the year. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [32] +-------------------------------------------------------------------------------- + + Operator, I think we have time for one more question, and then we'll turn the call back over to Bob to wrap things up. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our final question comes from Srini Pajjuri with SMBC Nikko. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [34] +-------------------------------------------------------------------------------- + + George, I have a question about your guidance for the full year. I think it implies DCG declining again in Q4, pretty much in double-digit sequentially. So just trying to understand, I mean, is it primarily because of digestion that you talked about? And also if you can talk about to what extent you have visibility into Q4. Are you just taking a conservative stance because you just simply don't have visibility into Q4? + +-------------------------------------------------------------------------------- +George S. Davis, Intel Corporation - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + I think as I said on the last question that we have a reasonable view that spending is going to be coming down in the cloud and in enterprise and even comms off of very high levels, and we expect that to continue into Q4. And so again, I think when we look at the full year, stronger than expected. Overall, this is -- this would be -- in many ways, we're delighted to be as close to our forecast as we were given all of the things going on in the world. But again, we've seen very strong demand peaking for cloud in the third quarter -- excuse me, the second quarter; peaking for comms in the second quarter. And it's just going to be a period of a little bit of digestion as one would expect. + +-------------------------------------------------------------------------------- +Robert H. Swan, Intel Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Yes. Let me just kind of close out and end where we began. First, over the last couple of years, as you know, we've expanded our TAM in the quest to play a much larger role in our customers' success by investing in key leading technologies like 5G, AI and intelligence at the edge. And we feel pretty good about the investments that we've been making. And last year, we wrapped up our best year in the company's history, entering 2020. Obviously, this year has been an incredibly challenging year on multiple fronts. But at the same time, we expect '20 to be the best year in our company's history, our fifth record year in a row, delivering better results than we expected in January at a time when the market is worse than we expected. So competitively, we feel stronger as we exit 2020. +Third point I'd make is our execution has improved. Capacity and supply is in place. We're ramping a slew of 10-nanometer products across our portfolio. We are ramping 10 faster than we had planned and we have a strong leadership -- a strong pipeline over the next several years. And we believe we can deliver another notable performance on 10-nanometer itself. +Fourth point, at the same time, our 7-nanometer products will be delayed. We've pushed out the timing of the 7-nanometer node. But along the way, we have taken steps on die disaggregation, advanced packaging, deeper engagement with the ecosystem and contingency planning as a sign of strength, not as a sign of weakness, that gives us much more flexibility to make the decisions on where is the most effective way to build our products to deliver that annual cadence of leadership for our customers. And we feel pretty good about where we are, though we're not happy. I'm not pleased with our 7-nanometer process performance. +But as we sit here today, 6 months through the year, our people are safe. We're delivering for our customers. The communities we operate in are better as a result of our presence and the passion of our employees for making a difference. And next 90 days from now, we'll talk more about our efforts to create world-changing technologies that continue to enrich the lives of every person on earth. So thanks for joining us, and we'll talk to you soon. + +-------------------------------------------------------------------------------- +Trey Campbell, Intel Corporation - Head of IR [37] +-------------------------------------------------------------------------------- + + Thanks, Bob, and thank you all for joining us today. Operator, could you please go ahead and wrap up the call? + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2016-Apr-21-MSFT.txt b/Transcripts/MSFT/2016-Apr-21-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..a4f1439450f63960560220e435b0de2088b76522 --- /dev/null +++ b/Transcripts/MSFT/2016-Apr-21-MSFT.txt @@ -0,0 +1,588 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Microsoft Corp Earnings Call +APRIL 21, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO + * Chris Suh + Microsoft Corporation - General Manager of IR + * Amy Hood + Microsoft Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Kirk Materne + Evercore ISI - Analyst + * Kash Rangan + BofA Merrill Lynch - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Walter Pritchard + Citigroup - Analyst + * Philip Winslow + Credit Suisse - Analyst + * Ross MacMillan + RBC Capital Markets - Analyst + * Brent Thill + UBS - Analyst + * Keith Weiss + Morgan Stanley - Analyst + * Mark Moerdler + Bernstein - Analyst + * Karl Keirstead + Deutsche Bank - Analyst + * Mark Murphy + JPMorgan - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Microsoft's third quarter FY16 earnings call. +(Operator Instructions) +As a reminder, this conference is being recorded. I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and thank you for joining us today. On the call, with me today are Satya Nadella, Chief Executive Officer, Amy Hood, Chief Financial Officer, Frank Brod, Chief Accounting Officer, and John Seethoff, Deputy General Counsel and Corporate Secretary. +On our website, microsoft.com/investor, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call, and provide the reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP measures exclude the net impact from revenue deferrals, and the impact of integration and restructuring charges. The non-GAAP financial measures provided should not be considered as a substitute for, or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items, to aid investors in further understanding the Company's third quarter performance, in addition to the impact that these items and events had on the financial results. +All growth comparisons we make on the call relate to the corresponding period of last year, unless otherwise noted. We also provide growth rates in constant currency when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. At the segment level, we provide constant currency growth for both revenue and gross margin. However, due to recent change to our external reporting segments, we aren't able to provide segment level constant currency operating expense growth, and consequently, cannot derive constant currency segment operating income either. We do provide constant currency operating expense, and operating income growth at the company-wide level. +Please note that in the third quarter of FY16, we adopted a new standard issued by the FASB, that made certain changes to accounting for stock-based compensation. One of the more significant changes require that excess tax benefits and deficiencies be recorded as part of income tax expense, rather than as part of additional paid-in capital. Adoption of the new guidance requires us to reflect adjustments as of July 1, 2015, and hence impacts our previously reported quarterly results for FY16. You can find additional information in the financial summary slide deck, and in our 10-Q filing. +We will post our prepared remarks to our website immediately following the call, until the complete transcript is available. Today's call is being webcast live, and recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording. You can replay the call, and view the transcript on the Microsoft Investor Relations website until April 21, 2017. +During this call, we will be making forward-looking statements which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the risk factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Chris, and thanks to everyone on the phone for joining. Overall, we had a solid quarter. Amy and I look forward to sharing more about the results, and what's ahead. We delivered $22.1 billion in revenue, with an operating income of $6.8 billion. +We exceeded $10 billion in commercial cloud annualized revenue run rate. We are halfway to our FY18 goal of $20 billion. This quarter, we surpassed 270 million monthly active devices running Windows 10. We are proud of our progress, and look forward to making more, as enterprise deployments accelerate. +Now let's get to the specifics of each of our three segments, starting with productivity and business process. We set out to reinvent productivity and business process, because we believe that people should get more out of every moment, and organizations should be able to reach new levels of effectiveness. This approach is opening up new growth opportunity for Microsoft in three ways. We can reach more users, enter new markets, and build a developer platform. +Let me talk through each. First, we are reaching new users, and strengthening our productivity platform. Consumer subscriptions of Office grew to more than 22 million. Devices with our mobile apps grew approximately 4 times year-over-year. Commercial Office 365 customers surpassed 70 million monthly active users, and we grew seats by 57%. +Second, we are expanding into new markets such as security, analytics, and cloud voice, where we see an opportunity, and where we can differentiate. For example, the cybersecurity market is expanding rapidly, and it's a place where we have unique capabilities like advanced threat protection, cloud app security, and advanced e-discovery. This combination drove a 35% quarter-over-quarter growth of monthly active users of our premium information protection services in Office 365. A key driver of this growth is our new premium Office 365 Suite E5. +Lastly, we're making Office 365 more than a world-class productivity and communications service. It's becoming a growing platform for developers. There is an incredible amount of value developers can deliver by harnessing the data in this platform. It can be as simple as Starbucks enabling somebody to email a cup of coffee, or it can be as a sophisticated as DocuSign, streamlining processes for digital signatures based on the understanding of people's availability and organizational hierarchy. +We continue to make advances in our developer platform by expanding Microsoft Graph APIs, and opening Skype to developers. This is generating developer momentum. In fact, active apps calling on Microsoft Graph APIs are up month over month. +In business process applications, our Dynamics product line is expanding to include new scenarios such as IoT, field service, customer self-service, and built-in business intelligence and advanced analytics. For example, Echo Labs uses CRM online with Azure IoT, not only to help their customers use water systems more efficiently, but also to predict equipment failure, and direct field engineers to respond. And Just Eat in the UK uses Dynamics AX to make it easy for millions of people to order food for take-outs online. These are scenarios are driving new growth. Dynamics CRM online seats more than doubled this quarter, with over 80% of our new CRM customers deploying in the cloud. We grew Dynamics AX revenue double-digits. +Now let's move to the intelligent cloud segment. The cloud is being built into every organization's quest to optimize and grow. With our results this quarter, it remains clear, we are one of the two leaders in this market. +Azure revenue increased 120% in constant currency, with revenue from premium services growing triple-digits for the seventh consecutive quarter. We are innovating in new areas to help organizations digitally transform. We're expanding our competitive strength in hybrid computing. We're generating opportunity for developers and partners. +To start, we added more differentiation to high-value services in Azure this quarter in three areas that are top of mind for our customers, artificial intelligence, IoT and business analytics. We expanded Cortana Intelligence Suite, our big data and analytics service that transforms data into predictions and intelligent action. It now includes over 20 cognitive services ranging from object and emotion recognition to text and linguistic analysis. +The IoT market is expanding as companies look to deliver new services and value. Our new Azure IoT suite streamlines the process of building IoT applications, and acts as the hub for managing and monitoring millions of assets. Each week, more than 2 trillion IoT messages are processed by Azure. And analytics is another rapidly growing market, where Power BI has more than 200,000 customers and 5 million users. Companies like Toyota, BMW, Johnson Controls are all using Cortana Intelligence Suite, Azure IoT, and Power BI to transform themselves as well as their industries. +Siemens is also using Azure to connect and analyze data from medical imaging systems around the world, helping providers in their effort to transform healthcare. We're the only cloud provider that helps companies embrace the cloud on their own terms, and we continue to innovate in areas that make it easier for our customers, including the recently released preview of Azure Stack, and by bringing SQL Server to Linux. +A critical part of this flexibility is giving customers tools to secure their data, wherever it is, on-premise, in the cloud, and across all their devices. We continue to grow in this market with enterprise mobility suite customers more than doubling to over 27,000. This is three consecutive quarters of triple-digit customer growth. This growth is driven by strong adoption across cloud services. For example, more than one-third of our Office 365 enterprise suite installed base has also purchased Enterprise Mobility services. +And as I said earlier, perhaps the biggest impact we can make is to empower developers. To this end, we are making Windows and Azure the very best environment for developers who want to build applications that run across multiple platforms. Our acquisition of Xamarin, and the inclusion of Bash in Windows 10 will make it easier to build intelligent experiences and apps that leverage our cloud, and run natively on Windows, iOS and Android. We're excited to announce at Build that we're making Xamarin freely available as part of Visual Studio. +Now let's move to More Personal Computing segment. We are reinventing personal computers and personal computing for the mobile-first cloud-first world. In this world, what matters most is the mobility of a person's experience, not any one single device. +As I shared last quarter, we think about our strategy along three lines. First, we will deliver more value and innovation, particularly for enterprise customers. Second, we will grow new monetization through services across the unified Windows platform. Third, we will innovate in new device categories in partnership with our OEMs. +First, let me talk through the innovation we're delivering that brings new levels of ease-of-use, trust, productivity to Windows, and specifically more value to our enterprise customers. What we hear most frequently from these customers is how much they value the advanced productivity, security, and device management capabilities in Windows 10. In fact this is what led to one of the most security-conscious organizations in the world, the United States Department of Defense, to upgrade all of their PCs and mobile devices to Windows 10 this year. We see this trend across our enterprise customers, with 83% of them in active pilots to date. +We believe enterprise deployments will continue to drive up the over 270 million monthly active devices running Windows 10. The number of Windows 10 devices is twice that of Windows 7, over the same time period since launch. At Build, we gave people more reasons to upgrade with the announcement of new features in ink and touch interfaces, as well as Windows Hello biometric security, and deeper integration with Cortana, all coming this summer with the Windows 10 anniversary update. +Second, we're seeing new monetization through services across the Windows platform. Windows Store received more than 5 billion visits. We are excited about compelling new apps coming from Disney, Square Enix, Bank of America, King, Instagram and many others. We grew the number of universal Windows app developers 60% this quarter. +In search, developers have already built over 1,000 apps designed for Cortana. These new third-party experiences, and the 6.3 billion questions people have asked are helping make Cortana smarter and driving search engagement. Over 35% of our search revenue last month came from Windows 10 devices. +In gaming, monthly active users of Xbox Live grew 26% year-over-year, driven by the growth of Xbox One and Windows 10. Xbox One continues to outpace prior generations in both reach and engagement. At the same time, we continue to create synergies between Xbox One and Windows 10 devices. Bringing top Xbox One titles to Windows Store helped grow gaming hours on Windows 10 by 50% over last quarter. And starting this summer, universal Windows apps will run on Xbox One, making it easy to build applications and games that work across devices. +Third, we continue to innovate in new device categories in partnership with our OEMs. We're pleased with the results from Surface this quarter. This is our second $1 billion revenue quarter for Surface in a row, and it's the first outside of a holiday period. Revenue grew 61% in constant currency, driven by Surface Pro 4 and Surface Book. Certainly, consumers value these devices, but where we see the strongest momentum is through adoption in the commercial space, with particular strength in financial services, manufacturing, and healthcare. +Our OEM partners are also innovating in new device areas for consumers and business customers. In particular, they too, are seeing growth in the two-in-one device category. As you can see, we think about renewing growth of Windows, we think broadly about where growth can come from. We see early signs of success in Windows driving increased engagement and monetization of services like search, store and gaming, as well as new sources of revenue from Surface. As we build premium devices and premium categories, we're also stimulating demand across our entire ecosystem. +Ultimately, the largest potential for Microsoft's growth will come through reinvention of personal computers and personal computing, as well as the new platforms we create. This broader mobile-first cloud-first opportunity cuts across all of our financial segments and technology ambition. And this is what we shared with developers at Build, and with business leaders at EnVision a few weeks ago. I hope you have had the chance to watch these events as well. +We are creating entirely new ways for people to interact with technology, and also new ways for them to build technology. HoloLens developer kit is one such example. Organizations around the world like Volvo and NASA are using HoloLens to redefine what it means to build and explore, and Case Western University is redefining how students learn to be world-class surgeons. +Conversational interfaces is another example. We envision a world where people will more naturally interact with their devices in the future through conversation. Imagine simply asking Cortana to book a hotel, or being able to order a pizza through an instant message in Skype. Conversations will be a new platform that every business, every app, and every website will begin to embrace, and we're at the forefront driving this platform shift. We are building out cloud services and platform to enable every business, across every industry to digitally transform themselves, and in turn build their own capability to create more digital technology. +Empowering people and organizations to thrive in this digital world is central to Microsoft's mission. I'm proud of our execution so far, and what we have achieved, and I'm also grounded in the work ahead of us. With that, I'll hand over to Amy to go through this quarter's results in greater detail, and share our outlook for the next quarter. And I look forward to rejoining you, after that to answer questions. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $22.1 billion, up 2%, and up 5% in constant currency. Gross margin declined slightly, but was up 4% in constant currency. We grew operating income this quarter by 1%, and 10% in constant currency. And earnings per share was $0.62, flat year-over-year, and up 10% in constant currency. Our effective tax rate was 24%, higher than we anticipated, which impacted our EPS. +From a geographic perspective, our performance in most markets was as anticipated. However, Latin America, the Middle East and Africa were more unfavorable than we expected. In our commercial business, we continued to see healthy fundamentals which led to a solid quarter of results. Commercial bookings increased 7%, up 9% in constant currency. +Our total commercial annuity business had double-digit revenue growth in constant currency, and commercial annuity mix reached 86%, up 4 points year-over-year. Commercial unearned revenue grew to just under $18.8 billion, up 3% and 8% in constant currency, slightly below expectations due to a higher mix of contracts with more in-period recognition, and some deal weakness in the geographic markets mentioned earlier. Our contracted not billed balance again exceeded $25 billion. Most important, as Satya mentioned earlier, our commercial cloud annualized revenue run rate surpassed $10 billion. +This quarter, more than 65% of customers who signed enterprise agreements attached our commercial cloud offers, up 15 points from last year. Our customers continue to make long-term commitments based on our compelling road map. Our commercial cloud gross margin was 45% this quarter, declining year-over-year. This decrease was driven by a higher mix of Azure revenue, our ongoing investment in data center capacity and geographic expansion, and a small FX headwind. +As I mentioned last quarter, even as we're focused on gross margin improvement within each of our key cloud services, our total commercial cloud gross margin will reflect the dynamics of change in revenue mix, and targeted investment. In Q3, the FX impact of 3 points on year-over-year revenue growth was generally in line with the guidance, as the recent weakening in the US dollar created less than 1 point of impact overall, and across segments. +As Chris explained earlier, we're not able to provide constant currency impact at the segment level for operating expenses, and therefore segment operating income. In general, FX had a favorable impact of 1 point on operating expenses at the total Company level. As expected, our Company gross margin percentage declined this quarter, driven by our accelerating mix of cloud services, in our intelligent cloud, and productivity and business processes segment, offset by higher gross margin percentage performance from products within More Personal Computing. +Now to our segment results. This quarter, our productivity and business processes segment delivered in line with our expectations, with $6.5 billion in revenue increasing 1% and 6% in constant currency, with higher annuity mix offsetting lower transactional weakness results due to a weaker PC market. In office commercial, revenue was flat, and grew 7% in constant currency, driven by continued momentum in Office 365, with installed base growth across Office, Exchange, SharePoint, and Skype Workloads. Our channel again expanded this quarter, as more than 85,000 transacting partners sold Office 365 to small business customers. +Office consumer revenue increased 3% and 6% in constant currency, due to an increasing base of subscribers and recurring subscription revenue, and our dynamics business grew 4%, up 9% in constant currency. We more than doubled CRM online seats for the sixth consecutive quarter. Segment gross margin dollars declined 4%, up 1% in constant currency. +As we've discussed, gross margin percentage declined on a higher cloud services revenue mix within the segment. Operating expenses decreased 1%, even as we continued engineering investments in our Office 365 and dynamics businesses, and prioritized spend in growth areas like E5, security and voice capabilities. As a result, operating income declined 7%. +The intelligent cloud segment delivered $6.1 billion in revenue, which grew 3% and 8% in constant currency, just at the low end of our guidance range. Our total server products and cloud services revenue was flat year-over-year, and increased 5% in constant currency against a prior year comparable that had 16% constant currency growth. This quarter, our enterprise server customers continued their commitment to our hybrid cloud platform offerings, which resulted in double-digit annuity revenue growth in constant currency, including over 100% growth in Azure. That growth was partially offset by a larger than expected decline in our transactional on-premise server business, which impacted the in-quarter results. +Enterprise services continued to perform well, with 11% revenue growth or 15% in constant currency, driven by customer demand for our support services and solutions. Gross margin declined 2%, and grew 3% in constant currency. Gross margin percentage declined, as cloud mix accelerated, offsetting margin improvements in Azure and enterprise services. +In response to enterprise customer demand, and to increase our share in the cloud market, we grew operating expenses by 13% through Azure-focused investments across engineering, additional sales and marketing capacity, and the acquisition of Xamarin. This quarter, operating income declined 14%. +Now to our final segment, More Personal Computing. Revenue exceeded our expectations at $9.5 billion, up 1% and 3% in constant currency. First, our OEM results. Our total OEM business declined 2% this quarter, outperforming the overall PC market which was weaker than we expected. OEM non-Pro revenue increased 15%, driven primarily by a higher than expected mix of premium devices. OEM Pro revenue underperformed the commercial PC market, declining 11%, due to the higher inventory level in Q2, that I mentioned in my last earnings commentary. +Windows volume licensing grew 6% in constant currency, and IP licensing continued to decline, impacted by both a decrease in total unit volume, and a higher mix of lower royalty units. As expected, devices revenue decreased this quarter. Revenue declined 11% or 9% in constant currency, primarily due to phone, where revenue declined 46% in constant currency. Additionally, sell-through of our Lumia products was weak, and we exited the quarter with relatively high channel inventory. As Satya mentioned, momentum in our Surface business continued, as revenue increased 56% or 61% in constant currency, with strong commercial and consumer demand for our Surface lineup. Overall, device gross margin dollars grew, and gross margin percentage improved, primarily driven by a shift to our higher gross margin Surface portfolio. +Our search business remains strong this quarter, with growth driven by higher revenue per search, and higher search volume. We again had US PC share growth, and search continued to be profitable. In gaming, revenue grew 4% or 6% in constant currency, with continued progress in the monetization of our installed base. We saw higher revenue from Xbox Live, driven by both higher volumes of transactions, and higher revenue per transaction, as well as an increase in revenue from our gaming studios. As expected, Xbox hardware revenue declined, mainly driven by lower Xbox 360 consoles sold, and lower Xbox One pricing. +Segment gross margin increased 2% or 6% in constant currency, driven primarily by gross margin percentage improvements in devices and gaming. Operating expenses decreased 14%, primarily through our actions in phone, and the transition of our display business to AOL. As a result, segment operating income grew 57%. +Now back to our overall Company results. As planned, we accelerated our data center and cloud services investments to meet growing global demand. This quarter, we invested $2.3 billion in total capital expenditures, including an increase of 65% year-over-year primarily for data centers and servers. Other income was negative $247 million, driven by interest expense and net losses on derivatives, partially offset by dividends, interest income, and net recognized gains on investments. +Our non-GAAP effective tax rate was 24%, higher than we expected, which reflected the changing mix of revenue across geographies, as well as an accelerating shift in revenue from software licensing to cloud services. The rate for the quarter included a catch-up adjustment from Q1 and Q2, reflecting the new full-year -- the new expected full-year non-GAAP effective tax rate. This quarter, we returned $6.4 billion to shareholders through share repurchases and dividends. +Now let's move to the outlook. First on FX, consistent with our guidance last quarter, we still expect FX to negatively impact year-over-year growth in Q4 by 3 points. By segment, we expect 3 points of impact on productivity and business processes, 3 points in intelligent cloud, and 2 points in More Personal Computing. +Second, our commercial business. Our commercial business will be on pace for continued strong annuity growth, as both new and existing enterprise customers adopt and use our growing portfolio of cloud services. Even with projections of tightening global IT spend and currency headwinds, we expect commercial unearned revenue to be $24.3 billion to $24.5 billion, in line with historic seasonality. We remain on track toward our $20 billion commercial cloud revenue run rate goal, as we grow revenue, drive consumption, and focus on gross margin improvement in Office 365, Azure and Dynamics online. Finally, we will continue our investment in data centers and capital equipment to address customer demand for our cloud services. +With that, let me share our view by segment. In productivity and business processes, we expect revenue to be $6.5 billion to $6.7 billion, with continued annuity shift to the cloud, offsetting the impact of a weaker PC market on our transactional business in our consumer and commercial segments. In intelligent cloud, we expect revenue between $6.5 billion to $6.7 billion, driven by annuity growth, offset by continued transactional weakness. +In More Personal Computing, we expect revenue between $8.7 billion and $9 billion. Here's a bit more detail on its individual components. In Windows, we expect our OEM Pro revenue to be largely in line with the commercial PC market. Our non-Pro revenue is expected to be above the consumer PC market, similar to what we saw in Q3, primarily due to the continued benefit from a strong mix of premium devices. +In devices, we anticipate continued momentum and growth for Surface Pro 4 and Surface Book, particularly with business customers. For phone, we expect year-over-year revenue declines to steepen in Q4, as we work through our Lumia channel position. In search, we will continue to show healthy revenue growth, with full-year profitability. Finally in gaming, we expect to see continued healthy user engagement on our Xbox platform, and we look forward to E3, where we will announce new titles for the upcoming fiscal year. +We expect COGS to be $7.8 billion to $7.9 billion. We expect operating expenses between $8.2 billion and $8.3 billion. Our full-year guidance is now down to $31 billion to $31.1 billion, as we concentrate our investments in engineering and technical sales, to accelerate our cloud growth heading into the next fiscal year. +We expect other income and expenses to be negative $200 million in Q4. This includes the net cost of hedging and interest expense, offset by dividend and interest income. For tax, based on trends reflected in this quarter's full-year catch-up adjustment, we expect our Q4 effective tax rate to be 21% and 23%. We expect our full-year effective tax rate to be between 20% and 21%. +Before I wrap up, I'd like to share a few directional comments on FY17. This year, we saw strong growth in our commercial cloud portfolio, and we grew our annuity penetration across our commercial business. We anticipate those trends will continue next fiscal year, driving our revenue growth, and impacting our gross margin percentages. +As we continue to unify and modernize our Windows installed base across our business customers, we will advance our progress in our post sale monetization scenarios, and execute on the Windows 10 enterprise deployment opportunity. Throughout FY16, our significant investment in engineering, sales and marketing has positioned us to support our customers' digital transformations, and to innovate in device form factors like Surface and HoloLens. In FY17, we expect to continue that investment, and reallocation process, therefore total operating expenses should be flat to up slightly. I look forward to sharing more on our FY17 plans in July. With that, Chris, let's go to Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We will now move to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +Brent Thill, UBS. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Good afternoon. Amy, just on the Q4 guide. You're guiding below the Street on many of the individual line items on the top line. I'm just curious, is this more of the shift to the cloud, or is there some demand execution issues that you're seeing in the business? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Brent. It's really, as we talked about, transactional weakness in productivity and business process. We're continuing to expect strong annuity growth. We're continuing to expect a strong mix to the cloud. We're continuing to expect ARPU increases, premium mix increases, and installed base growth. So really, in that segment, it's the PC weakness, and our traditional transactional office business that's impacting that segment. +In intelligent cloud, it's a very similar dynamic. We're expecting renewal rates to remain strong as they've been. We're expecting the mix to Azure to continue to grow. We're expecting annuity double-digit revenue growth. And again, it's the transactional weakness that you're seeing overall, as well some -- the very specific geo weakness that we saw, which I called out earlier. +And in More Personal Computing, the largest change in that segment is frankly the phone. So I would really focus on that in that segment. The rest of it, frankly, is quite good. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [4] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Brent. We'll take the next question now, please? + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Philip Winslow, Credit Suisse. + +-------------------------------------------------------------------------------- +Philip Winslow, Credit Suisse - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks for taking my question, and congrats on a great quarter. I just want to focus in on Office here. Obviously, you called out Office 365 commercial suite growing 57% year-over-year, so very consistent with what your last quarter was. And Satya, you mentioned the mix shift as well with the release of E5. Wonder if you can just provide some color there, sort of a I guess, a grade of where you are right now? And then, as you're contemplating guidance for Q4, and then thinking about 2017, how should we think -- or how are you guys thinking about that Office 365 transition there, sort of units and pricing? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [8] +-------------------------------------------------------------------------------- + + I can start, and then Amy, you can add. Overall, the thing that we are most focused on with Office 365 is how do we make sure that we have the Office 365 endpoints everywhere and good usage. And I talked about how the mobile endpoints has been growing, and the mobile usage has been growing. I also talked about the 70 million monthly active users of Office. So we feel very good about that, which is users, both in terms of coverage and usage. +The next place where we're very focused on is really the new scenarios, and E5 is obviously a big element of it. I talked about it in some detail, the security value proposition. That is really showing a lot of good traction for us, but we're also seeing traction in analytics and voice. So we're in the very early innings of E5, but the value proposition and the TAM, or the total addressable market of those three scenarios is huge. And so, we remain very excited about it. +The other thing that I'm also excited about, when it comes to Office 365, is for the first time we're opening up Office 365. Not just as an end-user, and a enterprise tool and a service, but as a developer platform. In its own right, we think of Office as perhaps one of the most strategic developer assets we have, and with the Microsoft Graph API, and what we see as activity around it. We think about the platform effects of that, as also being very key. So that's, at least at the macro level, how I look at it. And Amy, if you want to talk a little more about it ? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [9] +-------------------------------------------------------------------------------- + + And I think that the way that shows itself in our financial results is, you'd expect to continue to see the strong mix shift to the cloud. You'd expect to continue to see installed base growth, as even some of the items Satya talked about have more relevance, and continue to make us, the value prop higher, even in small business, which is where you've seen new user adds. I would continue to expect to see ARPU growth, as we see E5 have its impact through the year. And so, think about these same dynamics, Phil, for us, where we focus on new users, and ARPU increases, as we shift to Office 365, those are trends I'd expect to see, obviously as we look into 2017. + +-------------------------------------------------------------------------------- +Philip Winslow, Credit Suisse - Analyst [10] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [11] +-------------------------------------------------------------------------------- + + Thanks, Phil. We will take the next question, please? + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Thank you. Mark Moerdler, Bernstein Research. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [13] +-------------------------------------------------------------------------------- + + Sure. Thank you very much. So if you look at productivity and process and intelligent cloud, obviously we're having a margin decrease that's occurring, and a good chunk of that is cloud. How should we think about the standalone license business, in terms of the margins, separated from the cloud side of it? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [14] +-------------------------------------------------------------------------------- + + The standalone margins on the licensing business have been pretty stable. Just because transactionally, we understand and continue to bring down the fixed cost base there, and any that's required. So I don't feel like you'd expect any material change in those, Mark. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [15] +-------------------------------------------------------------------------------- + + Okay. I appreciate. Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [16] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [17] +-------------------------------------------------------------------------------- + + Thank you, Mark. We'll take the next question, please? + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Thank you. Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [19] +-------------------------------------------------------------------------------- + + Great. Thank you so much. Satya, I wanted to see if you could share a little bit on Azure? Just how you're thinking about the competitive positioning, versus Amazon, where you think your strengths are, versus them? And also, as the business continues to ramp at such a fast pace, how do we think about the progression in gross margins? I mean, Amazon gives us operating margins. But I guess, I'm wondering, is there a reason you shouldn't be able to reach similar operating margins with Azure at a similar scale, if we went back and looked at the progression that Amazon's been disclosing? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [20] +-------------------------------------------------------------------------------- + + Sure, Heather. Thanks for the question. First of all, when Amy and I think about both our CapEx, as well as our OpEx, both on the engineering side, as well as on our sales and marketing side, we think about this still at a Microsoft cloud level. Just because if you take something like enterprise mobility suite, that gives you an indication of how, for example, we attach to Office 365, essentially an infrastructure service that hasn't [SaaS-like] margins. Or even some of our application services in Azure that attach to office developer experiences. So we think about this part more holistically, and same thing with dynamics. +But having said that, if -- to your specific question, of where our differentiation lies? The first one is hybrid. Most people think about hybrid where, they think about the cloud as the edge of their server. We obviously support that with all of our service. Every server product of ours has cloud enrollment rights, whether it be SQL, whether it be Windows server, and you'll see that increasingly, even in this next wave of servers. +But we also think of, in fact, our servers as the edge of our cloud. That I think is where the world is going to go to, where distributed computing will remain distributors. So Azure Stack is completely unique to Microsoft. No one else who is in the public cloud business at any scale has that kind of capability. So, I would say that's another point of differentiation. +So to your point about margins, I feel that we actually will have software licenses with hybrid rights. That's a different margin structure. We will have [IAS] services, and you talked about the existence proof, at least from Amazon about what margins at scale can be achieved there. We have PaaS services in infrastructure like EMS that have SaaS-like rev margins. And then, of course, we have SaaS services in Office 365. +So I think the mix of our gross -- or rather that mix will define a long-term gross margin, and operating margin for our cloud services. But the mix will also shift each quarter, just because the mix is not a stable mix, we'll see growth in different in parts, at different times. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [21] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [22] +-------------------------------------------------------------------------------- + + Thank you, Heather. We will go to the next one, please? + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Thank you. Keith Weiss, Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- + + Excellent. Thank you, guys, for taking my question. Amy, when you're talking about the transactional declines particularly (technical difficulty) and the server portion of that, can you help us understand how much of that is due to maybe more macro factors, weaker overall spending environment, and how much of that comes from perhaps demand being reallocated towards infrastructure-as-a-service offerings that you guys have in Azure? Is there something of a cannibalization taking place, within that transactional business today? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Keith, that's good question. Let me go through a number of factors that really impact transactional business. First, you're right. There's clearly a macro impact, especially on the transactional business. Transactional businesses tend to be more impacted in emerging markets, where we have a higher percentage of new -- of non-annuity business as transactional business. Those have been the weakest markets in this macro environment, and specifically some of the geos we called out have more exposure in this place. And so, you're certainly seeing the macro impact in the intelligent cloud segment, in the server weaknesses there. +And because frankly, we saw that macro weakness, you've even seen it, in terms of server shipments, right? If you look at server shipments, you'd say that's actually a macro statement. We didn't see it any one particular workload. It's weakness across workloads, which tends to make more sense, frankly, with a macro or a budget IT spend constraint. +And so, I actually think between those two items, it's the biggest impact that we've seen in the quarter. And I expect to see it again next quarter, given I don't think the macro or IT spend environment should change in any way between these two quarters. So I think less about it being cannibalistic, because so many of the scenarios in this time period, we've seen the growth we expected. We've seen it across our premium services, as well as core compute. I should also say most of the weakness we saw was in the standard workloads, which I think lends itself again to some of those pressures. +We also saw and I would expect annuity shifts there, which is the final component. Our annuity numbers and renewal numbers were very good in intelligent cloud. And in fact, they came right where we expected, in terms of unearned balances. And so, for me I do tend to think it's a bit more on the macro pressure and budget impacts than it is, frankly, any other statement or execution. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- + + Excellent. That's very helpful. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [27] +-------------------------------------------------------------------------------- + + Thank you, Keith. We'll take the next question, please? + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Thank you. Karl Keirstead, Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [29] +-------------------------------------------------------------------------------- + + Thanks. Amy, this one for you. I wouldn't mind asking about the gross margin guidance. If I take the midpoint of your revenue guidance, the midpoint of your COGS guidance, it looks like you're guiding to another roughly 200 basis point decline in gross margins in the June quarter, which is about what you did in March. +So if we look out to FY17, I know you touched on it a little bit, but just to be clear, it feels like you're guiding to a further year-over-year decline in gross margins. But it sounds like that will be offset in part by a continued good OpEx control. So is that the right way to think about it? And is there any way that you could sort of bracket what the gross margin percentage decline might be in FY17? You probably don't want to give specific guidance, but maybe some high level color? Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Directional. Karl, thanks for the question. And you're right, in general, and let me spend a few seconds on that. You're right, we saw about a 200 basis point change this quarter. It's entirely due to the shift to the cloud, both in our productivity and business process segment, as well as the intelligent cloud segment. Those are the exact same drivers in the gross margin change that we guided to in Q4. And I would expect stability as we've seen it, in our More Personal Computing segment. +And so, as you think about 2017, with the continued acceleration of our cloud mix, and actually continued momentum in annuity, I would to see the same -- the same pressures continue to exist. And you're right, in that our strong operating expense focus, because really this is the quarter when you've been able to see actually in Q2 and Q3 now, us really pivoting that investment in OpEx to our intelligent cloud, and the opportunity we see there across engineering, sales and marketing. And you're right, we do expect to see, and continue to do that as we lead into 2017, within the overall envelope I discussed. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [31] +-------------------------------------------------------------------------------- + + Great. Thanks, Amy. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [32] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [33] +-------------------------------------------------------------------------------- + + Thank you, Carl. Next question, please? + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Thank you. Walter Pritchard, Citi. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [35] +-------------------------------------------------------------------------------- + + Hi, thanks. Amy, my question just on guidance, and your posture on guidance, a two-part question. I think we've seen you give very conservative guidance say, for the first half of the year. And in Q3, you ended up, putting it all together, at the lower end of your guidance. And I'm wondering -- your posture, just generally around guidance, if it's changed at all, that you're factoring in things differently, and we should think about that range going forward? Should it be more like it's been in the past, where you've had very conservative assumptions, or more like what you just did here? +And then, the second part is, as you look forward maybe towards longer-term guidance, and the prospects of giving longer-term guidance, because I don't think I've seen an estimate spread on a company as large as this, in a long time, how are you thinking about possibly giving long-term guidance? What the factors that are influencing your comfort in doing that? Or is it more philosophical, and it's something you're just not going to do, that's not necessarily dependent on your view of the business? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Thanks, Walter. My philosophical position doesn't change much. I give the guidance that I expect for the quarter, and I do it on the earnings call to the best of my ability. +What you've seen this quarter is in fact the biggest in-quarter delta for us all the time is the non-annuity performance, than in our -- all of our segments, that is transactional business, that is the most impacted in quarter, by budget changes or macro changes. And so, the inherent volatility that you are talking about really, is about changes in quarter that we see and the impact of that. +So I don't think it's a philosophical shift. It's just where you see volatility in quarter has always been in the transactional side of our business. The guidance we gave in our annuity positions, in terms of renewals and where we saw them were exactly, frankly, what we expected, with the small exception of the geos that I called out. So I tend to think -- I'll talk a little bit about 2017, as I always do come July, give you all more of a shape to that. But I tend to think, I would like to focus on where the Company is going, which is cloud mix shift, annuity growth, and overall world view of bringing Windows and the ecosystem growth through MPC. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [37] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [38] +-------------------------------------------------------------------------------- + + Thank you, Walter. We'll take one more, please? + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Ross MacMillan, RBC Capital. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [40] +-------------------------------------------------------------------------------- + + Thanks a lot. Amy, I just wanted to go back on the intelligent cloud. We did see that deceleration in server product growth, but the comp was very tough. And as you commented, your annuity was up, and your deferred growth accelerated. That server product line has grown about 5% constant currency in the last 12 months. +I guess the question is, is there any structural reason why, going back to Keith's question, why that would decelerate more ex macro? And then, another question I just had that's related to this. Can you just remind us, in the server product ex Azure line, and in the commercial office traditional non 365 line, how much is transactional in those two segments? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [41] +-------------------------------------------------------------------------------- + + Sure. Ross, let me try to take this. The first question around, is there anything structural or different in that server product line? Really, it has been, and is that transactional component. You're right, we continue to see the annuity growth. We continue see the growth through Azure, and the offset to that has been the transactional business. +I'm not sure that I would say that there's any structural reason, other than -- that's changed my world view, other than maybe the budget and macro pressure tends to exert itself on that transactional business. But overall, continuing to see the renewals we've seen, continuing to see the cloud growth we've seen, I'm not sure I think of it as a fundamental trajectory change, outside of that component we discussed. +In terms of overall, rough orders of magnitude, the intelligent cloud segment has the least exposure to the transactional business. It's still less than 20%, but that 20%, right, lends itself in quarter to the volatility you see. The productivity and business process segment has a bit more transactional exposure, just because it has both the consumer and commercial office business, which is more attached on a transactional basis to PCs. So it's slightly higher, all up. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [43] +-------------------------------------------------------------------------------- + + Thanks, Ross. We'll go to the next question, please. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Thank you. Kash Rangan, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [45] +-------------------------------------------------------------------------------- + + Hi, a question for Amy. Amy, you've been able to grow your Op income on a constant currency basis nicely double-digits, as you've been investing in the cloud. As you look at the results this quarter, and the -- as you pointed out the Op margins in intelligent cloud and business process productivity that were impacted due to the shift to the cloud, do you think that as you look into next year that the cloud business is at scale, that it continues to grow and take share, relative to overall revenue? +The transaction business, who knows, it could be a bit of a macro pressure. Do you think that we're at the point where we could continue to entertain a scenario, that Op income could still continues to grow nicely, as it has in the last three, four quarters? Or is there some other structural change, with respect to the margin of the cloud business, or maybe the transaction business drops off a lot more dramatically, that it may be hard to sustain this nice double-digit Op income, at a very high level without going into the details? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [46] +-------------------------------------------------------------------------------- + + Yes, at a very high level, Kash, let me talk about the opportunity. The opportunity for us, across what the cloud mix is possible for our commercial business, and this moment in time that I'm a believer in, of where companies are going to change their businesses to rely more deeply on technology than they ever have. I believe that our setup for that is the investments we've been making for the past couple years, as well as the investments we're going to make for the next couple. I mean that, both in the capital concept, but also in my operating expense line. +We've managed to do that by continuing to pivot to what I believe are these very high ROI opportunities, and pivoting away from opportunities where we've had a chance to become more efficient, and where the returns are not going to be as high, or the structural growth, it isn't there. And so for me, at a -- to your point, at a high level, I think we can continue to drive revenue, especially annuity and cloud revenue. I think we can continue to improve gross margin percentages in the cloud, across all the core cloud services. +I think that we can grow profit dollars, and I think that we can do that, and the OpEx guidance I gave you from 2017, as we continue to pivot to that opportunity. So, I think this is one where my optimism, frankly, for the structure of the market in the segment you chose, and my optimism for our positioning within that market is reflected in that investment number that you have seen. And so, I would continue to expect to see us do it. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + It's good to see that you still expect profit to grow, because this seems like the new Microsoft, where you're balancing the need to invest strategically, but at the same time trying to grow profits in the near-term, versus the old Microsoft, where the investments were made, but with more of a longer term, quote/unquote, you never knew when the payoff was supposed -- was going to happen. So it's good to see you emphasize that you're still focused on profit growth, notwithstanding the mix of factors that you cannot forecast. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [48] +-------------------------------------------------------------------------------- + + Thank you, Kash. We'll go to the next question, please? + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Thank you. Mark Murphy, JPMorgan. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [50] +-------------------------------------------------------------------------------- + + Thank you very much. Satya, regarding the announcement that you will release your SQL Server database on the Linux platform. I was wondering if you can walk us through your decision tree, just in terms of what you think the potential risks are, and what you think the potential rewards are of reaching for that level of openness, if you will. And just how impactful do you think that that product can be in enhancing Microsoft's share of the database market? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [51] +-------------------------------------------------------------------------------- + + Thanks for the question. So the decision logic was driven primarily by what I would say is the increased competitiveness of SQL Server. If you think about where SQL Server now, with this new release, SQL Server 2016, it's become a fantastic database for many, many of the workloads, everything from OLTP to data warehousing, to BI, to advanced analytics. For the Tier 1, this is a capability that's been multiple decades in the work, but here we are, with very competitive total cost of ownership, price competitiveness, but with a technology that's in many cases, as Gartner talks about, at the top of the charts, when it comes to all of these workloads. +So now that we find ourselves with that capability, we're saying, look, what's the way to think about market, all the markets that we can, in fact, take this product to. And the Linux operating system database market is not something that, which is mostly, primarily a Tier 1 segment, is something that we've never worked in. And so, therefore, we look at that as an expansion opportunity, so we take that. We already made the call that Azure for Linux is first-class. We already have 20-plus points of -- 20%-plus of VNs in Azure are Linux, and we'll all increasingly have Linux, be a big share of our of percentage of what is happening in Azure. +So for the first time now, we have the ability to go to an enterprise, and talk about their entire data estate across Windows and Linux. Now people don't really move between operating systems. Those choices have been made, but they, at the same time, now they have a choice around database. And so, we think that that's a very good incremental opportunity for us. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [52] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [53] +-------------------------------------------------------------------------------- + + Thanks, Mark. We'll have time for one more question, operator. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thank you. Kirk Materne, Evercore ISI. + +-------------------------------------------------------------------------------- +Kirk Materne, Evercore ISI - Analyst [55] +-------------------------------------------------------------------------------- + + Thanks very much, and thanks for squeezing me in. Satya, I wanted to talk a little bit just about the ISV ecosystem on top of Azure, and where you think that is today, and where you'd hope that potentially to be in 12 months, when we think about the opportunity around sort of platform-as-a-service, and building out more enterprise apps? I think you made some comments around some IoT applications that are now sitting on Azure. +What is sort of a good -- what should we be looking for in terms of new partners? On, from a survey, ISV perspective, you've had companies like BlackBox who re-platformed? I'm wondering, do you expect that momentum to potentially accelerate, as we get further into the calendar year? Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [56] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question. I mean, I think the overall for me, across all of our product lines, whether it be Windows or whether it'd be Office 365 or Azure, developer momentum, ISV momentum is super important priority for us, both in terms of our developer evangelism, our product engineering teams, as well as everything that we will do to even create success for our partners, through our field sales organization is a top of mind priority. And this is something that Kevin Turner, myself, and Amy, and all of our leadership team is very focused on. So you will only increasingly see us deliver more design wins there. +In fact, I'm looking forward to our partner conference, to talk much more about what it is that we will be doing in the coming year, to drive more success for our partners, and in particular, ISVs. The thing that I'm seeing a lot of, is we've had traditional strength with SQL as well as dot-net. They are moving a significant number of them to the cloud, and in fact replatting, to be even multi-tenant cloud native. +At the same time, we're also seeing a lot of open source ISVs also join -- be part of the Azure marketplace. If you go up to the Azure marketplace, surely you will see that. So we are not only bringing people who have traditionally worked with us, helping them replat to a completely new model, but we're also bringing a lot of new ISVs into the fold as well. And that's pretty exciting to see. + +-------------------------------------------------------------------------------- +Kirk Materne, Evercore ISI - Analyst [57] +-------------------------------------------------------------------------------- + + Great. Thanks a lot. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [58] +-------------------------------------------------------------------------------- + + Great. Thanks, Kirk. So that wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, these events will be webcast at the Microsoft Investor Relations website. Thanks for joining us today. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [59] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [60] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2016-Jan-28-MSFT.txt b/Transcripts/MSFT/2016-Jan-28-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..e20f514d612be884d0aa863e1c97d77bd0293f15 --- /dev/null +++ b/Transcripts/MSFT/2016-Jan-28-MSFT.txt @@ -0,0 +1,488 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Microsoft Corp Earnings Call +JANUARY 28, 2016 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO + * Amy Hood + Microsoft Corporation - CFO + * Chris Suh + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brent Thill + UBS - Analyst + * Ed Maguire + CLSA - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Walter Pritchard + Citigroup - Analyst + * Keith Weiss + Morgan Stanley - Analyst + * Karl Keirstead + Deutsche Bank - Analyst + * Philip Winslow + Credit Suisse - Analyst + * Mark Moerdler + Bernstein Research - Analyst + * Raimo Lenschow + Barclays Capital - Analyst + * Kash Rangan + BofA Merrill Lynch - Analyst + * Ross MacMillan + RBC Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Microsoft's second-quarter FY16 earnings conference call. +(Operator Instructions) +As a reminder, this conference is being recorded. I would turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. +On our website, microsoft.com/investor you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. +Unless otherwise specified, we will refer to non-GAAP metrics on today's call. The non-GAAP measures exclude the net impact from revenue deferrals and the impact of integration and restructuring charges. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the Company's second-quarter performance, in addition to the impact of these items and events had on the financial results. +All growth comparisons we make on the call relate to the corresponding period of last year, unless otherwise noted. We also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. At the segment level we provide constant currency growth for both revenue and gross margin. However, due to recent change in our segment reporting groupings we aren't able to provide segment level constant currency operating expense growth. And consequently cannot derive constant currency segment operating income either. We do provide constant currency operating expense and operating income growth at the Company-wide level. +Please note that we have recast certain prior period items to conform to the current period presentation with no impact on consolidated net income or cash flow. Additionally, any mention of operating expense refers to segment operating expenses as defined in the footnotes of our form 10Q and includes research and development, sales and marketing, and general and administrative, but excludes the impact of last year's integration and restructuring charges. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included on our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until January 27, 2017. +During this call we will be making forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors section of our form 10K, form 10Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thank you Chris. Good afternoon everyone. Today Amy and I will share the results of our second quarter and look ahead. +Overall this quarter we had solid performance, and more importantly drove growth in areas that are key to our future. We delivered $25.7 billion in revenue with an operating income of $7.9 billion. We continue to advance towards our goals for FY18. Our commercial cloud run rate surpassed $9.4 billion, up over 70% year over year, and almost halfway to our goal of $20 billion. We nearly doubled our cloud customers over the last 12 months. +We also made progress towards our goal of more than $1 billion Windows 10 monthly active devices. We crossed the 200 million milestone, and Windows 10 is outpacing adoption of any of our previous operating systems. In fact, adoption is nearly 140% faster than Windows 7. I appreciate the incredible work and focus of both Microsoft team members and our partners to deliver these results. +Now let's get to the specifics for each of the three segments, starting with Productivity and Business Process. As we seek to help people get more out of every moment, we're delivering new innovation and seeing new opportunity with Office 365. Consumer response to Office is strong. Office attach rate is up. Office 2016 adoption is outperforming Office 2013 over the same period of time. And consumer subscriptions are up to more than 20 million. We are also enthusiastic about how people use Office on other platforms. On iOS and Android, Skype is more than 900 million downloads and Office apps surpass 340 million this quarter. There also 13 million iOS and Android active devices running Outlook. +Office 365 Commercial revenue grew nearly 70% in constant currency, while seats grew 59%. It is clear customers value the ongoing innovation we're delivering in Office 365 and this allows us to advance further into markets like voice and information protection. In December we released a major update to Skype for Business which drives productivity up and costs down. Our customers can now use Skype for Business to get a dial tone without the need of their own PBX and conduct online meetings for up to 10,000 attendees. +Security is both a mandate and an opportunity for Microsoft across all of our segments. As customers look to protect themselves, we are creating new demand for all of our security solutions. The number of people using our information protection capabilities built into Office 365 increased 25% quarter over quarter. At the same time, we released new capabilities like advanced [ware] protection, advanced E-discovery and customer lock box. These new innovations in voice and information protection accrue to our premium productivity and collaboration skew, E5, which we released last month. +Our Dynamics business is also contributing to our growth in the cloud. This quarter we released major updates to Dynamics NAV and Dynamics CRM, both of which deliver enhancements in mobility, insights, and organizational productivity as well as deeper integration with Azure and Office 365. Three out of four of our CRM customers are choosing to deploy in the cloud, which is driving continued triple digit paid seat growth for CRM online in the enterprise. +Our momentum with Office 365 and Dynamics creates a compelling case for developers. This quarter we exposed the data APIs which capture the relationships between people, conversations, projects, schedules, processes and content. We call these APIs the Microsoft Graph. The ability for developers to build on the Microsoft Graph presents a strategic opportunity for customers and partners. Smartsheet has already taken advantage of these APIs. Oracle plans to use Microsoft Graph to enhance their line of business applications, like Oracle Sales Cloud, and many innovative startups are extending it to create new generation of productivity applications. +Now let's move to the Intelligent Cloud segment. The enterprise cloud opportunity is massive, larger than any market we have ever participated in. Last quarter I reflected on how we are now one of the two leaders in this space. At the same time, we are the only one in this market providing SaaS, PasS, IaaS and hybrid cloud at scale. We are growing in each of these areas simultaneously. +Our unique approach is resonating. Our cloud architecture reflects real-world distributed cloud computing needs and services that enable businesses to convert data into intelligence and drive business transformation. Azure revenue grew 140% this quarter in constant currency, with revenue coming from new and existing customers. We saw organizations like NTT DOCOMO, Honeywell, NASA's jet propulsion labs, Dow Chemical and the UN Development Program deploy innovative solutions on Azure. +We see that Azure customers who also purchase Office 365 consume 8 times more Azure than other customers. More than 70% of the Fortune 500 have at least two different Microsoft cloud offerings, up 13 points year over year. And now we are continuing to grow in new ways. Together with Red Hat, Dell and Hewlett-Packard Enterprise, we will increase our ability to address real-world infrastructure needs. These partnerships give customers the flexibility to connect their existing on-premise infrastructure or Linux-based applications based applications with our cloud. +We are leading innovation in new agile and DevOps workloads as well, with Azure app services, power apps and Visual Studio team services where we surpassed 3.8 million developer subscriptions. We are adding thousands of new developers every day who are building cloud and mobile solutions that support industries like oil and gas, finance, e-commerce, consulting, and healthcare. As we expand into new markets our revenue from premium services like security, mobility, management, and analytics nearly tripled year over year. Enterprise mobility solution customers have more than doubled year over year, and we have nearly tripled our share among Fortune 500 in the last 12 months. +Security is now a major driver of the cloud adoption. As threats become more frequent and sophisticated, Azure's unique technologies like Machine Learning, empower customers to adapt to these new realities. This quarter we organized the Enterprise Cyber Security Group to help customers prepare for and respond to attacks. We unveiled plans for new data centers in Germany and the UK that address customers' data access and sovereignty needs. And we continue to release new capabilities like advanced threat analytics as part of our $1 billion product innovation and security spanning Azure, Office 365, Windows 10 and our enterprise mobility suite. +At the heart of every business in the future will be systems of intelligence, powerful AI that helps people understand the past and predict the future. Cortana Analytics is the building block for these systems of intelligence. We released Cortana Analytics last July. It's a comprehensive suite of services that enable businesses to reason over massive quantities of data that emanate from connected people, places, and things and converts them into intelligent insights and automation. Coca-Cola, Russell Reynolds, and the Dartmouth-Hitchcock Health System already use Cortana Analytics to dramatically change the way they market products to customers, uncover talent in the workforce and offer patients predictive and more personalized healthcare. Our goal is to make it possible for every company in every industry and every country to take advantage of this new artificial intelligence to transform. +In the More Personal Computing segment I'm encouraged by our progress to unify our install base on Windows 10 and to create new opportunities for Microsoft and our entire ecosystem. As of this month we crossed 200 million active devices running Windows 10. Near term, in what analysts predicts will be relative flat market over this next year, we're focused on three ways to drive growth for our partners and for Microsoft. First, deliver more value and innovation, particularly for enterprise customers who need advanced productivity, security, and device management. Second, grow new monetization through services across a unified Windows platform. Third, continue to innovate in new device categories in partnership with our OEMs. +Let me briefly expand on each. First, in November we released the first major update of Windows 10 with solutions designed to address critical business scenarios: security, manageability and ease of deployment. More than 76% of our enterprise customers are in active pilots, including organizations like Kimberly-Clark and Alaska Airlines, and 22 million enterprise and education devices are already running Windows 10. We are well-positioned to grow our commercial device footprint in the second half. +Next, as we unify and grow the Windows 10 platform we grow new monetization opportunities with the Windows store, search, and gaming. This holiday season we doubled Windows store paid transactions from PC and tablets customers. This increase is an outgrowth of Windows 10 monthly active devices all up and the addition of new Windows 10 applications. This quarter Netflix, Pandora, Uber, Wall Street Journal, NPR released new apps designed to take advantage of Windows 10 experiences. For example, you can ask Cortana to recognize a song on Shazam, play a movie on Netflix or book a ride via Uber. +With search, the clearest indicator of our progress is US search share, where Bing now exceeds 21%. Nearly 30% of our search revenue in December came from Windows 10 devices, partly as a result of user engagement with Cortana. We are seeing increased search engagement and monetization on Windows 10 over previous versions. +This holiday we saw record engagement on Xbox Live. Active users grew to an all-time high of 48 million across consoles and PCs. On December 28 we had more fans using Xbox Live that any of the other day in the Xbox history. Clearly with Xbox One now upgraded to Windows 10 our vibrant community joined the Windows ecosystem. +Our games also performed strongly this quarter. We doubled the number of Xbox One gamers playing Microsoft-published titles year over year. Minecraft concluded the holiday as the top paid app globally on Windows 10, iOS and Android. And we grew monthly active users by 18% year over year. +Lastly, we are innovating in new device categories and driving growth. With Surface we created a new type of device, the two-in-one, and partners are now bringing similar devices to market with success. At the same time this was the best quarter for Surface ever with over $1.3 billion in sales, driven by the launch of surface Pro 4 and the initial rollout of our brand-new Surface Book. We see more opportunity ahead with Surface Book coming soon to China, Japan, the UK, France, Germany and other markets in Europe and Asia. +We believe in our ability to grow the Windows ecosystem. Near term we are taking the right steps. We are also clear that long-term Windows growth and vibrancy rests on our ability to reinvent personal computers and personal computing. We accept the challenge as we see it as one of the greatest opportunities to prudently expand into new markets and generate shareholder value. +Before turning over to Amy, I want to briefly reflect on the past few months. I've had the opportunity to meet with customers from all over the globe and observe the effects of the macroeconomic trends impacting business today. Of course any macroeconomic uncertainty will create pressures for our business. But increasingly, I think it also creates opportunity for us. Every organization is looking for ways to gain efficiencies, insights, and ultimately transform. +This is at the heart of our mission. I believe Microsoft is uniquely positioned to empower them to find new growth areas while finding new growth for ourselves. +With that, I'll hand it over to Amy to go through this quarter's results in greater detail and share our outlook for the next quarter. And I look forward to rejoining you after to answer questions. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [4] +-------------------------------------------------------------------------------- +Thank you Satya, and good afternoon everyone. +This quarter revenue was $25.7 billion, down 2%, and up 3% in constant currency. Gross margin declined slightly, but was up 5% in constant currency. We grew operating income this quarter by 3%, and 13% in constant currency. And earnings per share was $0.78, growing 11%, or 23% in constant currency. +We achieved strong results this quarter through targeted investments in innovation and consistent execution. From a geographic perspective, our performance in most markets was as expected. The key markets like Brazil, China, Japan, and Russia continue to be challenging. +Our commercial business once again delivered solid results, as we executed well in a large quarter for annuity renewals. Commercial bookings increased 12%, up 19% in constant currency. And commercial unearned revenue was in line with expectations at $19.6 billion, or 8% growth in constant currency. In addition, our contracted-not-billed balance reached an all-time high of $25.5 billion. With our continued cloud growth, our commercial annuity mix reached 83%, up 5 points year over year. This quarter more than 60% of customers with enterprise agreements attached commercial cloud services, up 15 percentage points year over year. +Additionally, we continue to make progress in improving our cloud gross margins. In Q2 total commercial cloud gross margin was 46%, an increase of 9 points year over year, driven primarily by improvements in both Office 365 and Azure. +Last quarter I provided the expected foreign currency impact on total revenue as well as across each of the reporting segments. In Q2 the FX impact came in nearly as anticipated, though the US dollar trended stronger than expected in December. This resulted in less than 1 point of additional negative impact to total revenue as compared to expectations, rounding up to 5 points. Consistent with Q1, and as Chris explained, we are not able to provide constant currency impact at the segment level for operating expenses and therefore segment operating income. In general, FX had a favorable impact of 3% on operating expenses at the total Company level. +Now let's turn to each segment's results. This quarter our Productivity and Business Processes segment delivered in line with our expectations, with $6.7 billion in revenue, declining 2%, but growing 5% in constant currency. In office commercial revenue declined 1%, but grew 5% in constant currency driven by ongoing strength from Office 365, but revenue increased nearly 70% in constant currency. 80,000 transacting partners sold Office 365 to small business customers. And our installed base continued to expand across Office, Exchange, SharePoint, and the Skype for Business workloads. +Office consumer revenue declined 14%, down 8% in constant currency ahead of the consumer PC market. Subscribers increased to 20.6 million, attach rates grew and recurring subscription revenue continued to more than offset the impact of the customer transition to the cloud. And our Dynamics business grew 3%, or 11% in constant currency, with triple digit install base growth for Dynamics CRM online for the fifth consecutive quarter. We look forward to the upcoming launch of Dynamics AX, our ERP cloud solution built on and for Azure that increases the breadth of our offerings in the business process market. +Segment gross margin declined 6%, up 1% in constant currency. The gross margin percentage declined, reflecting the increasing mix of cloud services within the segment. Segment operating expenses decreased 3% as we repositioned resources to align with our highest growth opportunities and as a result operating income declined 8%. +The Intelligent Cloud segment delivered over $6.3 billion in revenue, slightly ahead of our expectations. And grew 5%, and 11% in constant currency. Our enterprise customers continue to choose, adopt, and use our hybrid cloud platform offerings, which resulted in server product and services growth, revenue growth of 10% in constant currency. Additionally, enterprise services revenue increased 10%, or 16% in constant currency, driven by our premier support services. Segment gross margin grew 4%, or 11% in constant currency. Gross margin percentages were flat, as the rapid and continued growth of our cloud mix offset margin improvements in Azure and enterprise services. Given the addressable market opportunity and enterprise customer demand, we continued our investment in research and development as well as sales and marketing resources. This quarter operating income declined 1%. +Now to our last segment, More Personal Computing. Revenue exceeded our expectations at $12.7 billion, down 5%, and 2% in constant currency. First, our OEM results. Our total OEM business declined 5% this quarter, outperforming the overall PC market. OEM non-Pro revenue declined 3%, outperforming the consumer PC market as we expected, driven by a higher mix of premium and midrange devices which led to higher average revenue per license then the prior year. OEM Pro revenue declined 6%, slightly better than the commercial PC market. Per license inventory is slightly above historical levels, which we expect to work through in Q3. +Windows volume licensing grew 3% in constant currency with annuity growth partially offset by transactional declines. IP licensing declined, impacted by both a decrease in total unit volume and a higher mix of low royalty units. Our search business performed well again this quarter with higher revenue per search, higher search volume and US market share growth, which resulted in continued profitability. +Devices revenue decreased 26%, or 22% in constant currency, primarily due to phone, where revenue declined 49% in constant currency, reflecting our change in strategy announced last July. Surface revenue increased 22%, or 29% in constant currency, with the launch of Surface Pro 4 and Surface Book, with continued channel expansion and growing commercial sales. On a constant currency basis, device gross margin dollars declined 18% and gross margin percentage improved, driven by a shift in revenue to our higher-margin service portfolio. As Satya referenced, we had a good holiday for Xbox. Gaming revenue increased 5%, or 9% in constant currency, driven by record Xbox Live transactions as well as first-party game releases. As expected, hardware revenue decreased due to lower volumes of Xbox 360 consoles sold. +Segment gross margin declined 1%, or increased 5% in constant currency. Operating expenses decreased 14%, primarily due to reduced expense in our phone business as well as a successful transition of display advertising sales to AOL. As a result, segment operating income grew 35%. +And now, back to our overall Company results. Customer adoption and usage of our cloud services continues to accelerate globally. And we are investing capital into our data centers and servers to respond to this demand. This quarter we invested $2 billion, up sequentially from the $1.5 billion invested last quarter. Other income was negative $171 million due to interest expense and net losses on derivatives, partially offset by dividend and interest income and net recognized gains on investments. Our non-GAAP effective tax rate was 19%, in line with our expectations, with the year-over-year decrease primarily due to an IRS audit adjustment in the prior year and lower nondeductible operating losses in the current. This quarter we returned $6.5 billion to shareholders, an increase of 42%. +Let's move to the outlook. I want to preface my remarks with three overall comments, and then move to more specific comments by segment. First, FX. I previously stated that we expected the FX impact on total revenue to be about 3 points in H2. For Q3, given the recent strengthening of the US dollar, we now expect an overall impact of 4 points. By segment, we expect 5 points of impact on Productivity and Business Processes, 4 points in Intelligent Cloud and 3 points in More Personal Computing. And we anticipate continued lessening of FX impacts by segment and on total revenue in Q4, assuming current rates stay stable. +Second, our commercial business. We expect our commercial business to remain healthy, with ongoing shift to annuity as new and existing customers adopt and use our commercial cloud services. Therefore, even with continuing currency headwinds, we expect commercial on our revenue to be within the range of $18.8 billion to $19 billion. Our commercial cloud run rate trajectory remains on path, with continued focus on gross margin improvement across each of our key services. Office 365, Azure, and Dynamics online (inaudible) the total commercial cloud gross margin percentage will be impacted by the mix of revenue. Third, we will continue to meet global customer demand for cloud services and we'll increase our investment in data centers and capital equipment in the second half of our fiscal year. +Now let me share some additional commentary on each segment. In Productivity and Business Processes we expect revenue of $6.4 billion to $6.6 billion, which reflects 5 points of negative FX impact. This represents 6% year-over-year growth in constant currency, driven by Office 365 momentum and Dynamics online. +For the Intelligent Cloud segment we expect revenue between $6.1 billion to $6.3 billion, which reflects 4 points of negative FX impact. Continued customer preference for our hybrid solutions will drive sustained growth in server products and cloud services, and robust demand for enterprise services. We expect this business to continue to grow double digits, as it has throughout the first half of our fiscal year. +For More Personal Computing we expect revenue between $9.1 billion and $9.4 billion, which includes 3 points of negative FX impact. As this segment has both devices and software, I'll provide a bit more detail. First, Windows. As I mentioned earlier, we will return to normal levels of Pro inventory in Q3. And we expect non-Pro revenue to align more closely with the consumer PC market. +In search, Bing will continue to gain share and will remain profitable. For phone, we expect similar year-over-year revenue climb, and in the gross margin percentage for Q3 should look similar to Q2. After a solid launch quarter with Surface Book and Surface Pro 4, we anticipate continued momentum and growth with Surface Book expanding into additional countries. And in gaming, we expect normal post-holiday seasonality. We expect COGS to be $7.7 billion to $7.8 billion with variability driven by device sales. We expect operating expenses between $7.7 billion and $7.8 billion. +And for the full year we are lowering our guidance to $31.4 billion to $31.6 billion, as we continue to improve efficiencies and invest in key growth opportunities. We expect other income and expenses to be negative $300 million in Q3. This includes the net cost of hedging and interest expense offset by dividend interest income. We expect our Q3 and full-year tax rate to be between 19% and 21%. +In closing, our Q2 results and our Q3 outlook demonstrate our execution discipline and our investment in strategic areas to sustain long-term growth. We remain focused as we both create new markets and take share in existing ones. +And with that, I'll turn it back to Chris for Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. We'll now move to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question comes from the line of Philip Winslow with Credit Suisse. + +-------------------------------------------------------------------------------- +Philip Winslow, Credit Suisse - Analyst [2] +-------------------------------------------------------------------------------- +Congrats on a great quarter. I just wanted to focus in on commercial cloud and Azure specifically. Commercial cloud, as you mentioned, the run rate was up $9.4 billion. That's up like $2 billion quarter to quarter, 70% year over year. That's higher growth rate than even last quarter. Azure [similar, if not even] accelerating growth versus even last quarter. +So a question, Satya, and I'll follow up for Amy. Satya, when you look at the growth rates there in commercial cloud, and particularly Azure, you talk about new customer wins but also existing customers transitioning more workloads into Azure. I hope you can give us maybe some more color there as far as what you're seeing and how you think about the growth going forward there? +And then Amy, based on our calculations, it seems like Azure had a meaningful improvement in just the gross margin year over year. Wondering if you could help us with the two curves in that business, and where we are in Azure's gross margin lifecycle? Again, the fixed costs and the variable costs and how you are thinking about that? Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Phil, for the question. The way we think about cloud is how I described it in my remarks, which is it's the combination of the work we are actually doing in the SaaS, PasS, IaaS, and also a hybrid cloud layer. Because we don't think, for example, of our servers as a distinct part. But it's in fact the edge of our cloud and we are building for that with things like Azure stack. We think what we have done here by bringing these things together as one architecture for distributed computing and how people will consume applications and build applications in the future, we speak to more of the real-world needs, I think, of an IT organization or a business organization that is transform through digital technology. +If you put yourself as a CIO of a multinational organization and you want to operate in multiple geographies with different regimes for data sovereignty and then you want to be able to take some workloads, move them all to the cloud. Some you want to be able to tier with the cloud, that's the kind of flexibility we provide. And we also see network effects between if you are using Office 365, you want to extend the data in Office 365 by building applications that join it with some other data inside of our data link service in Azure, obviously Azure becomes the natural choice for such application development. And we are increasingly seeing that. That's really our strategy. Our strategy is not to complete in these constituent parts independently with different competitors. It is to bring one architecture and really drive the value for our customers because of that. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [4] +-------------------------------------------------------------------------------- +Let me quickly cover, I think, your gross margin question. You are right, we did actually make significant progress in both Azure as well as Office 365. And then the mix of those, obviously impacts the overall commercial cloud gross margin. What's important, the dynamics are actually quite similar, even though the services are quite different. There are two fundamental components to gross margin improvement. +Number one is obviously scale efficiencies and where we are in that curve, which we are doing and continue to make consistent improvement in. The next, obviously, is the mix of premium services. Satya talked about some of the increasing mix of premium services in Azure. That has been encouraging, especially in existing customers over time and through adoption curves. And in Office 365, as you know, we continue to be excited by our premium mix in the commercial segment. So those two combinations each quarter impact it as well as the overall. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Phil. We will move to the next question, please. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Our next question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- +Very nice quarter, guys. And thank you for taking the question. Satya, you mentioned both new and existing customers increasingly using the Azure cloud. I was hoping you could give us some color into what that looks like, specifically when an existing customers starts using Azure in terms of how does their overall spending get impacted and what happens to their spending for the more traditional server and tools? How does that get impacted as people use the public cloud utility more and more? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [8] +-------------------------------------------------------------------------------- +The thing that we notice is that with anyone who has moved to the cloud there is a real opportunity for us to expand to multiple workloads over time because it's a design win. It's like essentially an ISV win in the client server area where you could get someone to build on your core infrastructure. They build their first application. And it turns out that you have done that, you would want to look at our infrastructure for a second workload and third workload. So that is one side of what is happening with the expansion. +The other side of the expansion is what I also referenced, which is if you are an Office 365 customer you have data in Office 365. You want to build applications that tap into that data, then you use Azure. That is the other piece. The EMS growth is also very much related to that, which is if you deploy Exchange online you have Azure A/D. And then the natural expansion from there is the full EMS suite with device management for all your mobile devices and also advanced threat protection and what have you. We see both those trends from an application workload development synergies, as well as infrastructure from identity management, device management work out. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [9] +-------------------------------------------------------------------------------- +Thanks, Keith. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Our next question comes from the line of Brent Thill with UBS. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [11] +-------------------------------------------------------------------------------- +Good afternoon. Amy, macro is on everyone's mind. I'm curious if you guys could comment a little bit about what you are seeing. I know it may be too early to see some of the weakness that others have seen. But how are you looking at the demand environment and how does that change your plans as you look towards the back half of the year? Does any assumptions change in your minds? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [12] +-------------------------------------------------------------------------------- +Thanks, Brent, for the question. The geos, I specifically called out, obviously are where we are the most impacted, and they are the bigger geos. Really I think the focus that we have here is how we can best execute no matter what the macro environment turns out to be. Focus on our own execution, focus on continuing to drive cloud services, focus on continuing to drive on annuity mix. Those movements actually -- and as we help customers transform, is really the best plan in the face of any uncertainty, which you are clearly asking me about. I tend to probably focus more on what we can control versus the external environment and how we can best react to that. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Our next question comes from Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- +Thank you very much. I was just wondering, Satya, you mentioned, and I know there is been a lot of questions on Azure, but you mentioned strong growth in compute, and SQL usage on Azure being up, I think you said 5 times. I was wondering if you could give us your take on how you see the mix of Azure workloads? Is it right now more new workload growth and it's very little existing workloads moving over? I'm just trying to get a sense for how you see the wave cresting for new workloads versus existing workloads that can migrate over. +I'm also wondering if you see it helping (technical difficulties). You mentioned it is like a design win or an ISV win. I am wondering if you could share with us how this might be impacting your share versus, say, 1X or versus other types of infrastructure platforms. Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [15] +-------------------------------------------------------------------------------- +The thing, Heather, the move to the cloud has done for us is expanded the market opportunity that we have had more than ever before. In some sense if you compare it to the TAM of STB versus what we now describe as Intelligent Cloud, we are operating in a much bigger market. And that's because, first of all, the move to the cloud combines a whole bunch of different categories, as well as take something that you mentioned, which is Linux. We now have the ability to take Linux workloads and run them first-class. And over 20%-plus of Azure is Linux workloads, which is sort of a growth opportunity we tapped into with the cloud which we didn't have previously. +And even take something like EMS, which is a service, you could say in the past, we participated with active directory, but we -- and some amount of system center. But now with the growth of actually mobile devices and SaaS applications our opportunity with EMS is much bigger than anything that we had in the client/server era. Clearly we are migrating some workloads. And structurally some of that helps us because we had that position in the client/server space. But when we look at what we're doing in the cloud it's mostly about attaching to one of the secular growth trajectories going forward, be it open source, Linux development, mobile use and SaaS applications. So those are things that we participate in which we didn't participate in the past. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [17] +-------------------------------------------------------------------------------- +Thank you. Satya, Amy, congrats on the quarter. I've got for Satya and then a quick follow-up with Amy. Satya, following up on the cloud discussion, recognizing that SaaS, PasS, infrastructure as a server hybrid, they're all related, but as Azure continues to grow fast and become a bigger part of the business, how should we think about the opportunities or the opportunity size for PasS versus infrastructure as a service? PasS is much smaller industry-wide today, but is the opportunity is big, bigger? How should we think about that? And then a follow-up for Amy. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [18] +-------------------------------------------------------------------------------- +The opportunity I believe in both cases is high because it just comes in different forms. IaaS growth comes because people already have existing code that they want to move over. And then they start extending by writing more PasS because it is more efficient for them to write new code and new apps in PasS. So I think that depending what -- if you are bringing something over, your IaaS will be heavy first and then PasS will grow. If you are starting new you will have Pass, which is going to be the first thing you do. But then you'll always find the need to go integrate with something that was already existing, existing data, existing code in a virtual machine. +I, myself, in fact one of the things that Amy and I do is when we think about our CapEx, we think about all of these layers together. In fact, we amortize our CapEx across all of these. And we pay attention to margin and premium mix because what we are comfortable -- understand is customers, depending on where they start, how they start have different mix profiles. So it is the [all-up]. As long as we're growing our premium services attach and margins for those remain strong, we feel that the mix can be different and it's okay. And we really want to speak to the needs of the customers more than any product strategy goal we have. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [19] +-------------------------------------------------------------------------------- +Perfect, thank you. Amy, slightly different topic. Free cash flow grew 25% year on year, much faster than the other metrics. How should we think about this trend continuing? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [20] +-------------------------------------------------------------------------------- +That was impacted, Mark, in the prior year by some integration and restructuring charges on the cash flow statement. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [21] +-------------------------------------------------------------------------------- +So it's really a one-time event more than anything else? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [22] +-------------------------------------------------------------------------------- +Yes. Just always make sure you check the integration and restructuring in the prior year. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [23] +-------------------------------------------------------------------------------- +Perfect. Thank you. I appreciate it. Congrats. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from the line of Raimo Lenschow with Barclays Capital. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [25] +-------------------------------------------------------------------------------- +Thanks for taking my question, and congrats from me as well. Quick question for Satya. Now that Windows 10 is on 200 million devices, what do you see on the developer network? (Inaudible)[aims worth] you have a uniform platform for developers to go against PC, tablet, et cetera. What do you see in terms of them starting to embrace the platform and use the opportunity there? Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [26] +-------------------------------------------------------------------------------- +Thanks for the question. Yes, you're absolutely right. That was one of our biggest strategic objectives was to get active devices and with store integrated into the install base and then a user experience so that we can increase the success for developers. We're seeing good early signs. +In my open commentary I talked about both the increased [whiz-its] to the store and transactions as well as the fact that we are attracting new applications from developers like Netflix to Wall Street Journal, to others. As you can imagine our share is today in desktops, in emerging, in tablets, in two-in-one. And of course now with Xbox as well, which is got great attraction to gaming developers. So those are the natural places where you will see us gain more developers and gain more traction. We're big believers in a unified developer platform and a unified store. And then as Windows 10 monthly active devices increases and the store usage increases, we will see more and more developers take advantage of it. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [27] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [29] +-------------------------------------------------------------------------------- +Just a numbers question for Amy. I noticed your long-term unearned revenue was up quite a bit. That is been a flattish trend, and it was paired with commercial bookings being much stronger, I think, than I was modeling. I'm wondering if you could help us understand what drove the unearned and how that contributed to those commercial bookings? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [30] +-------------------------------------------------------------------------------- +Sure. A couple things, Walter, which I know you recall. We do have a bit of lumpiness in our expirations. As I said on the call, this was a big expiration quarter for us. And so on occasion what that does, even with the negative currency impact on C&B, is have a bit of lumpiness over time. That being said, I want to point to the core which is that renewal rates were very good and a big quarter. There was very strong performance on that front, very strong performance in moving customers to annuity as well as to the cloud. So aside from a bit of the lumpiness that you do note, and we have from time to time, the execution in the quarter was very strong. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [31] +-------------------------------------------------------------------------------- +And then if I can just -- one other numbers question. It looked like in the Q you called out actually Windows server declining as an offset to Intelligent Cloud growth. I'm wondering, we haven't seen that comment in the Q before. Was there something, sort of one-off driving that, or any further detail on that? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [32] +-------------------------------------------------------------------------------- +The way I would think about that one, Walter, is in general our premium or enterprise workloads across Windows, SQL, system center, et cetera grew double digits. Some of that weakness, frankly, is in the non-annuity and very transactional business, which happened to impact Windows server a bit more than other workloads. That is where macro pressure on occasion shows itself first, is in some of that non-annuity lumpiness. So that's the nature of that comment. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [33] +-------------------------------------------------------------------------------- +Great, thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Our next question comes from the line Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [35] +-------------------------------------------------------------------------------- +Amy, relative to your Q2 guide, the upside surprise really came in the personal computing business. And at least relative to our third-quarter estimates, it's again the personal computing guidance that beat. I'm wondering if you could repeat the key factors that are contributing to the outperformance in that pretty important business? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [36] +-------------------------------------------------------------------------------- +Sure, Karl. In Q2, let me talk about two key ones. Number one is really the device launches. We actually launched a very broad portfolio of devices into the quarter with Surface Pro 4, Surface Book, Band 2, and the Lumia 950 and 950XL. Between all of those hardware products as well as our gaming performance, another hardware component in quarter, we did a little better than we had expected in our launches. Now, when you launch mid-quarter there's always some timing aspect to that. But I feel very good about the execution of those and that is a meaningful component of that outperformance. +The second one, which I talked about, is OEM Pro. We did a little better in the quarter than I expected, but inventory levels are a little higher. I expect to work through that in Q3. And that was a couple of points of impact, for example, on OEM Pro in quarter. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [37] +-------------------------------------------------------------------------------- +Okay, great. Amy, for the third quarter your guide for that business is also pretty good. Is that due to some of these similar factors or are there one or two others that are driving the, what appears to be appears to be, pretty solid 3Q performance in that unit as well? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [38] +-------------------------------------------------------------------------------- +It's similar drivers. In that segment there is also some topics I tend to not get asked about in Q&A. Let me take the opportunity to talk about them. Which is one, our search performance continues to be very good. Frankly, our display business has been quite good. If you go beyond that, I feel good about our gaming business sequentially. I feel good about the hardware, especially the Surface performance, as we launch into more geos. If you think about all those components, which actually were very similar to Q2 in terms of their strength, you see them again in Q3. So I'm not sure there's anything, quote-unquote, new, Karl, I would say other than that bit of mix between OEM Pro a little bit pulled into Q2 versus Q3. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [39] +-------------------------------------------------------------------------------- +Terrific color. Thank you, Amy. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Our next question comes from the line of Kash Rangan with Bank of America. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- +Thank you very much. Congrats on the quarter. I was curious to get your thoughts, Satya, on the Windows 10 upgrade cycle in the enterprise and also the consumer market, particularly after you anniversary the free offer for Windows 10. And secondly and finally, thoughts on Surface? It's off to a great start with the latest model. Could that play a more important role in the corporate computing landscape? Thank you. That's it for me. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [42] +-------------------------------------------------------------------------------- +Thanks, Kash, for the question. As far as the upgrade momentum, the fact that we crossed 200 million active devices, we feel very, very good about that. And the pilots, the most -- the place which in the second half is going to be a huge focus for us is the enterprise deployment. And that is where I think there's real excitement because of some of the core capabilities of Windows 10 when it comes to security, manageability. That I think is going to create great value for enterprises, and that's showing up in all the pilots and the accelerant. I've never seen a Windows in the enterprise with this level of accelerated deployment plans. So we obviously need to do a great job in continuing to push that and we are focused on it. +As far as Surface, Surface is playing a increasing role for us in both consumer as well as in the enterprise market. And also, we created a new category of two-in-ones where even our OEMs are finding success, which was one of our strategic objectives of doing the Surface. Overall, we do think that this tablets that can replace your laptop is ideally suited for productivity needs, which means it's great for your personal use as well as your use inside of the enterprise. And we continue to see good growth. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [43] +-------------------------------------------------------------------------------- +I would just add one thing, is that we've actually announced a number of important partners to help us take the Surface portfolio into commercial customers. And I think we will expect to see progress on that over the course of the year. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [44] +-------------------------------------------------------------------------------- +If I could, your excitement is pretty palpable. What could be driving that 140% increase in adoption relative to Windows 7? We all thought XP to 7 was a major transition, but it looks like there is another big transition happening here. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [45] +-------------------------------------------------------------------------------- +I think there two aspects of it. We have a good operating system release for the core desktop user. And second, I believe is that we also expand out into new usage patterns. If you look at even the thing that we're seeing is in terms of engagement with the browser, or things like Xbox Live, with the store or new device categories like the two-in-one; all I think make it much more possible for users to engage with Windows in more mobile formats and in more productivity scenarios. So I think it's the combination of all of that. But it starts with having a good product [truth], which Windows 10 does deliver on. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Our next question comes from the line of Ross MacMillan with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [47] +-------------------------------------------------------------------------------- +Satya, I had a question on commercial Office 365. I don't know if you gave us the number, but I think the last couple of quarters you've talked about monthly active users. And I'm curious if you have an update on that number. And then I also was curious about thoughts around ARPU because you introduced the E5 SKU in December. Where are we on the path of penetration, if you will, with the higher-value SKUs and the ability to see price list across the base over time? Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [48] +-------------------------------------------------------------------------------- +Yes, [Amy, maybe you can add]. That's right. Last time we talked about the 60 million monthly active users for Office 365, and that continues to grow. In fact there is always -- I think we also talked about how we get licenses sold and then all subscriptions sold. And then there is deployment. And there's always lumpiness as well as increased deployment that happens once the users migrate. And we'll continue to track that and we'll continue to disclose those numbers as they come along. But I feel very, very good in the growth of that. The best proxy for you, really, beyond any numbers we talk about in terms of monthly active is our capital. Because if you look at what we do is we spend our capital only to really fuel the growth, or to service the growth of usage across Office 365 and Azure, and you see that increasing. +In terms of the margin profile, the entire story of having the E3 mix first to be high and now E5, that is the thing that Amy talked about, which is we now have good premium tier value in all of our products. In Office 365 that is most evident with E3 and now E5. Even in Azure we have things like EMS, we have our data services, even our developer services. I think both of our cloud products, and the major cloud products, have these premium tiers that the mix shift to those, or the addition of those is something that we are focused on and we see in our result. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [49] +-------------------------------------------------------------------------------- +That's right. I would just add that we did see that premium mix go up in Office 365 on the commercial side, as you were noting. Really, E5 only been in market for the last month of the quarter. We are excited about the number of customers that are trying it and that all the value it offers. But I would expect that to be a longer-term evolution as opposed to in Q2. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [50] +-------------------------------------------------------------------------------- +Could I just ask a quick follow-up, Amy? That was great. Just on Windows, just so we all calibrate correctly. You've had this benefit from the RPL [columns] from last year. Should we think about Windows really now beginning to trend in line with PC units, or can there still be some variability around that? Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [51] +-------------------------------------------------------------------------------- +In my guidance comments I talked a little bit about that. On the Pro side, as I mentioned, we will have a couple point impact that will make a difference between that on the Pro side. And I would expect, I think we actually even talked about that last quarter, that the RPL delta which we've seen in Q1 and Q2 would go away in Q3 and Q4. And it would trend much more similarly to the overall consumer PC market. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [52] +-------------------------------------------------------------------------------- +Operator, we'll have time for one last question, please. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Our last question will come from the line of Ed Maguire with CLSA. + +-------------------------------------------------------------------------------- +Ed Maguire, CLSA - Analyst [54] +-------------------------------------------------------------------------------- +Good afternoon. I wanted to ask if you have been able to quantify some of the uplift since you've been opening up Office to different platforms like iOS and Android, and now with the recent alliance with Red Hat opening a lot of opportunity to Linux developers? Have you been able to quantify how much uplift you've gotten? And how do you see this impacting your broader market opportunity? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [55] +-------------------------------------------------------------------------------- +Let me speak to it in generic terms, because I don't think we have quantified it as narrowly perhaps just to address those specific moves we made. But overall the way we have thought about it is we want to make sure the Office subscription, both to consumers as well as to enterprise subscribers, is valuable across all their devices because it speaks to the vision that we have, which is the cloud is what enables the mobility of the human experience across all of the devices in your life. Because increasingly there will be more devices and we want to make sure that we are adding value. And if we add value in that context you would be more inclined to retain or purchase the Office subscription. That is been our goal, and that's working well. And it is sort of shows up in our all-up growth. +Similarly with Azure, we're making sure that as people are tapping into the cloud and moving to the cloud we can get all workloads to be as first-class on Azure. So that is why we have done the deals with Red Hat. We even did previously deals with Oracle. So Azure is a complete open platform where of course you can run all the Windows workloads, dot-net workloads. But we're increasingly seeing the open source workloads, the Linux workloads, the Oracle workloads, the SAPs and what have you. And more interestingly, a mix of all of them, because the enterprise is heterogeneous. It has been heterogeneous. We participated only in a portion of it. Whereas with Azure we can participate as the total open platform. And that is how we thought about it and that is what we are executing on. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [56] +-------------------------------------------------------------------------------- +Thanks Ed. And thanks everybody. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [57] +-------------------------------------------------------------------------------- +That wraps up the Q&A portion of today's call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, these events will be webcast and you can follow the comments at microsoft.com/investor. Please contact us if you need any additional details. And thank you again for joining us today. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- +Thank you. This concludes today's teleconference. You may disconnect your lines at this time. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2016-Jul-19-MSFT.txt b/Transcripts/MSFT/2016-Jul-19-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..1d9b71401f7d571e8a296bf3a94c8f378b82d2f8 --- /dev/null +++ b/Transcripts/MSFT/2016-Jul-19-MSFT.txt @@ -0,0 +1,586 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Microsoft Corp Earnings Call +JULY 19, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corp. - CEO + * Amy Hood + Microsoft Corp. - CFO + * Chris Suh + Microsoft Corp. - General Manager IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brent Thill + UBS - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Walter Pritchard + Citigroup - Analyst + * Keith Weiss + Morgan Stanley - Analyst + * Karl Keirstead + Deutsche Bank - Analyst + * Gregg Moskowitz + Cowen and Company - Analyst + * Michael Turits + Raymond James - Analyst + * Mark Moerdler + Bernstein Research - Analyst + * Raimo Lenschow + Barclays Capital - Analyst + * Mark Murphy + JPMorgan - Analyst + * Ross MacMillan + RBC Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Greetings and welcome to Microsoft's fourth-quarter FY16 earnings call. +(Operator Instructions) +It is now my pleasure to introduce your host, Mr. Chris Suh, General Manager Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon and thank you for joining us today. +On the call with me today are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer and John Seethoff Deputy General Counsel and Corporate Secretary. On our website, Microsoft.com/investor, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provide the reconciliation of differences between GAAP and non-GAAP financial measures. +Unless otherwise specified we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They're included as additional clarifying items to aid investors in further understanding the Company's fourth-quarter performance in addition to the impact of these items and events had on financial results. +Additionally, any mention of operating expense refers to segment operating expenses as defined in the footnotes of our Form 10-Q, which include research and development, sales and marketing, and general administrative, but excludes the impact of integration and restructuring charges. As a reminder, in May we announced plans to further streamline the phone hardware business. During the fourth quarter, restructuring and related impairment expenses were $1.1 billion. +All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. +At the segment level, we provide constant currency growth for both revenue and gross margin. However, due to recent changes to our segment reporting groupings, we're not able to provide segment level constant currency operating expense growth and consequently cannot derive constant currency segment operating income either. +We do provide constant currency operating expense and operating income growth at the Company-wide level. We'll post our prepared remarks to our website immediately following the call until the complete transcript is available. +Today's call is being Webcast live and recorded. If you ask a question it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until July 19th, 2017. +During this call we will be making forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainty. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [3] +-------------------------------------------------------------------------------- +Thank you, Chris, and to everyone on the call for joining. +I want to thank all the Microsoft team members and partners who contributed to a successful year. We are proud of what we achieved and particularly how we are positioned for new growth. +Today Amy and I will share our fourth-quarter results and our perspective on the year ahead. We delivered $22.6 billion in revenue this quarter, an increase of 5% for the quarter in constant currency. This past year was a pivotal one in both our transformation and in our partnerships with customers who are also driving their own digital transformation. +Our progress is best captured in the results of our three ambitions, starting with productivity and business process. In a world of infinite information but finite attention in time we aim to change the nature of work with digital technology. In pursuit of this ambition, we continue to add value to our products, grow usage and increase our addressable market. +Along these lines, let me start with Office 365 and then move to Dynamics 365. In the last quarter we advanced our collaboration tools. We launched Microsoft Planner which helps teams manage operations, as well as Skype meetings which is aimed at helping small businesses collaborate. +In June, we further strengthened our security value proposition with the release of Advanced Security Management. Lastly, we continue to add intelligence and machine learning to Office to help people out automate their tasks and glean insights from data. These advancements help to drive increased usage across enterprises, small and medium businesses and consumers. +In the enterprise, Office 365 commercial feeds grew 45% year-over-year and revenue grew 59% in constant currency. Also, 70% of our Office enterprise agreement renewals are in the Cloud. Innovative companies like Facebook, Hershey's, Discovery Communications, Cushman Wakefield, all adopted Office 365 and now see how transformative this service can be for their own business. +We are enthusiastic about the early feedback and growth opportunity from companies using our newly released Office 365 E5, which includes powerful security controls, advanced analytics and Cloud Voice. These customers tell us that they love the simplification that comes with standardizing across all of our productivity workloads. We see momentum in small and medium businesses with a growing number of partners selling Office 365, now up to nearly 90,000, a 25% increase year-over-year. We continue to grab share and adding over 50,000 customers each month for 28 consecutive months. +We also see momentum amongst consumers with now more than 23 million Office 365 subscribers. Across segments, customers increasingly experience the power of Office on their iOS and Android mobile devices. In fact, we now have more than 50 million iOS and Android monthly active devices, up more than four times over last year. +Now let's talk about progress with the other pillar of this ambition, Dynamics 365. We're removing any impedance that existed between productivity, collaboration and business process. This month we took a major step forward with the introduction of Microsoft Dynamics 365 and Microsoft AppSource. Dynamics 365 provides business users with purpose-built SaaS applications. +These applications have intelligence built in. They integrate deeply with communications and collaboration capabilities of Office 365. Dynamics 365, along with AppSource and our rich application platform, introduces a disruptive and customer-centric business model, so customers can build what they want and use just the capabilities they need. +The launch of Dynamics 365 builds on the momentum we're already seeing in this business. Customers around the globe are harnessing the power of Dynamics in their own transformation, including 24 Hour Fitness and AccuWeather. Overall, Dynamics now has nearly 10 million monthly paid seats, up more than 20% year-over-year and Q4 billings grew more than 20% year-over-year. +Overall, business processes represent an enormous addressable market projected to be more than $100 billion by 2020. It's a market we're increasingly focused on and I believe we're poised with both Dynamics 365 and Microsoft AppSource to grow and drive opportunity for our partners. Across Office 365 and Dynamics 365, developers increasingly see the opportunity to build innovative apps and experiences with the Microsoft Graph and we now have over 27,000 apps connected to it. +Microsoft AppSource will be a new way for developers to offer their services and reach customers worldwide. Lastly, with Office 365 and Dynamics 365, we have the opportunity to connect the world's professional cloud and the world's professional network with our pending LinkedIn deal. +Overall, the Microsoft Cloud is winning significant customer support. With more than $12 billion in commercial Cloud annualized revenue run rate, we are on track to achieve our goal of $20 billion in FY18. Also, nearly 60% of the Fortune 500 companies have at least three of our Cloud offerings. And we continue to grow our annuity mix of our business. In fact, commercial annuity mix increased year-over-year to 83%. +Now let's get into the specifics of the Intelligent Cloud, an area of massive opportunity as we are clearly one of the two enterprise cloud leaders. Companies looking to digitally transform need a trusted cloud partner and turn to Microsoft. As a result, Azure revenue and usage again grew by more than 100% this quarter. +We see customers choose Microsoft for three reasons. They want a cloud provider that offers solutions that reflect the realities of today's world and their enterprise grade needs. They want higher level services to drive digital transformation and they want a cloud open to developers of all types. +Let me expand on each. To start, a wide variety of customers turn to Azure because of their specific real world needs. Multinationals choose us because we are the only hybrid and hyper scale cloud spanning multiple jurisdictions. We cover more countries and regions than any other cloud provider from North America to Asia to Europe to Latin America. Our cloud respects data sovereignty and makes it possible for an enterprise application to work across these regions and jurisdictions. +More than 80% of the world's largest banks are Azure customers because of our leadership support for regulatory requirements, advanced security and commitment to privacy. Large ISVs like SAP and Citrix as well as startups like Sprinklr also choose Azure because of our global reach and our broad set of platform services Last week GE announced it will adopt our Cloud for its IoT approach. +Next, Azure customers also value our unique higher level services. Now with 33,000, we nearly doubled in one year the number of companies worldwide that have selected our Enterprise Mobility Solutions. The Dow Chemical Company leverages EMS along with Azure, Office 365 and Dynamics to give its thousands of employees secure real time access to data and apps from anywhere. +Just yesterday we announced Boeing will use Azure IoT Suite and Cortana Intelligence to drive digital transformation in commercial aviation with connected airline system optimization, predictive maintenance and much more. This builds on great momentum in IoT, including our work with Rolls Royce, Snyder Electric and others. +This is great progress, but our ambitions are set even higher. Our Intelligent Cloud also enables cognitive services. Cortana Intelligence Suite offers machine-learning capabilities and advanced predictive analytics. Customers like Jabil Circuit, Fruit of the Loom, Land O'Lakes, Libaire, already realize the benefits of these new capabilities. +Lastly, central to our Intelligent Cloud ambition is providing developers with the tools and capabilities they need to build apps and services for the platforms and devices of their choice. The new Azure Container Service, as well as .NET core 1.0 for open source and our ongoing work with companies such as Red Hat, Docker, Mesosphere, reflects significant progress on this front. We continue to see traction from open source with nearly a third of customer virtual machines on Azure running Linux. +On the server side, premium server revenue grew double digits in constant currency year-over-year. New SQL Server 2016 helps us expand into new markets with built-in advanced analytics and unparalleled performance. More than 15,000 customers, including over 50% of the Fortune 500, have registered for the private preview of SQL Server for Linux. And we're not slowing down. We will launch Windows Server 2016 and System 7 Server 2016 later this year. +Now let's talk about the progress in More Personal Computing. We've increased Windows 10 monthly active devices and are now at more than 350 million. This is the fastest adoption rate of any prior Windows release. +While we are proud of these results, given changes to our phone plan, we changed how we will assess progress. Going forward, we will track progress by regularly reporting the growth of Windows 10 monthly active devices, in addition to progress on three aspects of our Windows strategy. First, deliver more value and innovation, particularly for enterprise customers. Second, grow new monetization through services across our unified Windows platform. Third, innovate in new device categories in partnership with our OEMs. +Let me walk through each. We continue to pursue our goal of moving people from needing Windows to choosing Windows to loving Windows. In two weeks, we will launch Windows 10 Anniversary Update which takes a significant step forward in security. We're also extending Windows Hello to support apps and websites and delivering a range of new features like Windows Ink and updates to Microsoft Edge. We expect these advances will drive increased adoption of Windows 10, particularly in the enterprise in the coming year. We already have strong traction with over 96% of our enterprise customers piloting Windows 10. +Next, as we grow our install base in engagement, we generate more opportunity for Microsoft and our ecosystem. Ink profitability continues to grow with greater than 40% of the search revenue in June from Windows 10 devices. Bing PC query share in the United States approached 22% this quarter, not including volume from AOL and Yahoo. The Cortana search box has over 100 million monthly active users, with 8 billion questions asked to date. +We continue to drive growth in gaming by connecting fans on Xbox Live across Windows 10, IoS and Android. Just this quarter we launched our Minecraft Realm subscription on Android and IoS. Overall engagement on Xbox live is at record levels with more than 49 million monthly active users, up 33% year-over-year. +At E3 we announced our biggest lineup of exclusive games ever for Xbox One and Windows 10 PCs and we announced Xbox Play Anywhere titles where gamers can buy a game once and play it on both their Windows 10 PC and Xbox One. We also announced two new members of the Xbox One console family, the Xbox One S and Project Scorpio. The Windows Store continues to grow with new universal Windows apps like Bank of America, Roku, Cirrus FM, Instagram, Facebook, Wine, Hulu and popular PC games like Quantum Break. +Finally, we're innovating in new device categories in partnership with OEMs. Our hardware partners are embracing the new personal computing vision with over 1,500 new devices designed to take advantage of Windows 10 innovations like touch, pen, Hello, and better performance and power efficiency. Microsoft's family of Surface devices continues to drive category growth and we're reaching more commercial customers of all sizes with the support of our channel partners. We recently announced new Surface enterprise initiatives with IBM and Booz Allen Hamilton, to enable more customer segments. +Also in the past year, we grew our commercial Surface partner channel from over 150 to over 10,000. Lastly, this quarter more and more developers and enterprise customers got to experience two entirely new device categories from Microsoft Surface Hub and Microsoft HoloLens. While we are still in the early days of both of these devices, we are seeing great traction with both enterprise customers and developers, making us optimistic about future growth. +In closing, I want to reflect on the opportunity ahead of us. Simply put, businesses will not just use digital technologies, but they will become digital companies. This generates enormous opportunity for Microsoft and our partners. We are the ones who can empower digital transformation across all industries, companies and geographies with our technology and platforms. +With that, I'll hand it over to Amy to go through this quarter's results in greater detail and share our outlook, and I look forward to rejoining you after that to answer questions. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [4] +-------------------------------------------------------------------------------- +Thank you, Satya, and good afternoon, everyone. +This quarter revenue was $22.6 billion, up 2% and 5% in constant currency. Gross margin was flat, but up 4% in constant currency. +Operating income this quarter declined by 3% and grew 6% in constant currency. And Earnings Per Share was $0.69, increasing 11% year-over-year, or 27% in constant currency. Across most markets our execution and results were generally as expected with some strength in the US. But we did see additional softness in Brazil, the Middle East, and Africa, which were impacted by macroeconomic headwinds. +From a seasonality perspective, the fourth quarter is always an important one for our commercial business. Our results were strong as our sales teams led with our Cloud offers. Healthy renewals helped to drive double-digit annuity performance in constant currency. Our total annuity mix reached 83%, up 1 point year-over-year. +While our commercial Cloud continued to drive a higher annuity mix overall, we also had better than expected transactional revenue performance, as products like Office 2016 and SQL Server 2016 generated more deal volume. The dollar volume of expiring enterprise agreements was smaller this quarter than last year. +On that base, our commercial bookings increased 4% in constant currency, driven by customer preference for our Cloud offers. Commercial unearned revenue slightly beat our expectations at $24.6 billion, or 8% growth in constant currency. Our contracted-not-billed balance exceeded $25.5 billion. +As Satya called out earlier, our commercial Cloud annualized revenue run-rate exceeded $12.1 billion, growing more than 50% year-over-year. Additionally, more than 70% of customers who signed enterprise agreements this quarter attached Cloud offerings. Our commercial Cloud gross margin was 42%, declining year-over-year, driven by investments for cloud capacity, deployment, and support. +Now let's turn to Company gross margin performance. We were above our COGS expectations due to approximately $200 million of inventory adjustments from the change in our phone hardware business. And, as expected, our mix of Cloud services revenue continued to increase, resulting in gross margin percentage declines in the productivity and business processes and Intelligent Cloud segments. Importantly, gross margin dollars expanded year-over-year in constant currency. +In Q4, the FX impact on total and segment level revenue was in line with expectations. FX had a 3-point negative impact on productivity and business processes and Intelligent Cloud results and a 2-point negative impact on More Personal Computing results. +As we've noted in previous quarters, we're not able to provide constant currency impact at the segment level for operating expenses and therefore segment operating income. This quarter total operating expenses grew 1% in constant currency, above our expectations due to legal settlements and revenue driven sales cost. At the Company level, our operating income grew 6% in constant currency as FX had a 9-point impact on our results. +Now let's turn to each segment. This quarter our productivity and business processes segment delivered results above our expectations with nearly $7 billion in revenue, an increase of 5% and 8% in constant currency. In Office commercial, revenue increased by 5% and 9% in constant currency, as Office 365 growth outpaced the shift from our on-premises business. +Our seat growth was driven by broad-based momentum across commercial customers of all sizes. While we generally expect transactional purchasing to continue to decline, results across all products came in higher than anticipated this quarter. Office consumer revenue increased 19%, and 18% in constant currency, outperforming the consumer PC market, driven by seat growth, recurring subscription revenue and 6 points of growth from Japan, which had a particularly weak quarter a year ago. And our Dynamics business grew 6%, up 7% in constant currency, with strong billings and seat growth. +Segment gross margin dollars were flat and up 4% in constant currency. The gross margin percentage declined on a higher cloud revenue mix within the segment, coupled with an increase in cloud investments. +Operating expenses grew 6% from investments in commercial cloud sales programs and engineering. As a result, operating income declined 5%. The Intelligent Cloud segment delivered slightly more than $6.7 billion in revenue, growing 7% and 10% in constant currency. Demand and use of our hybrid cloud offerings led to another quarter of double-digit annuity revenue growth within Server products and Cloud services, partially offset by a decline in our transactional on-premises server business. +Enterprise services revenue grew 12%, 14% in constant currency, as customer demand for Windows Server 2003 end of support agreements and premier services continued this quarter. Gross margin dollars grew 1% and 5% in constant currency. And gross margin percentages declined as cloud mix accelerated. This quarter operating income declined 17%, driven by investment in sales resources and engineering. +Now to our final segment, More Personal Computing. Revenue was $8.9 billion, down 4% and 2% in constant currency. First, our OEM results. Our total OEM business grew 11% this quarter, outperforming the overall PC market, which was better than we expected in most markets including the US, the UK and Germany, partially offset by incremental weakness in India and Russia. +OEM non-Pro revenue increased 27% and, similar to last quarter, was driven by a higher mix of premium devices. OEM Pro revenue grew 2%, reflecting a stabilizing commercial PC market and a higher mix of business PCs sold with Windows Pro. +Inventory across both OEM Pro and non-Pro remained at normal levels. Windows volume licensing grew 3% and 9% in constant currency with ongoing annuity growth. IP licensing declined, impacted by both a decrease in total unit volume and lower revenue per unit. +We continued to execute well in our search business this quarter and, as we committed, Bing was profitable for the full fiscal year, driven by increasing revenue per search and search volume. As expected, devices revenues significantly decreased this quarter. Revenue declined 35%, also 35% in constant currency, due to phone, where revenue declined 70% in constant currency. +Surface revenue increased 9% in constant currency as Surface Pro 4 and Surface Book growth was partially offset by unit declines in our prior generation Surface 3. And in gaming, revenue declined 9%, or 8% in constant currency driven by lower Xbox 360 unit volumes and reduced Xbox One pricing. +Our overall gaming ecosystem showed healthy growth with 49 million monthly active Xbox Live users, or a 33% increase and 4% Xbox Live revenue growth. Segment gross margin dollars declined 3% or roughly flat in constant currency as decreases due to Xbox consoles and the phone inventory adjustment were partially offset by our OEM and search results. Operating expenses decreased this quarter by 13%, based primarily on reduced phone spend and the transition of display advertising cells to AOL, resulting in segment operating income growth of 59%. +Now back to our overall Company results. We invested $3.1 billion in capital expenditures, consistent with our plan for accelerated investment as we added both commercial and consumer global cloud capacity to meet near term and longer term customer demand. During the quarter we continued to rebalance our investment portfolio, which resulted in other income and expense of $267 million from net recognized gains on investments, partially offset by interest expense. +Our non-GAAP effective tax rate was 15% this quarter, lower than we expected. Our income tax expense reflected a favorable mix between US and foreign countries, as well as benefits associated with distributions from foreign affiliates. This quarter we returned $6.4 billion to shareholders through stock repurchases and dividends. +Before turning to next quarter's outlook, I want to share our view on the shape of next fiscal year. My commentary, both on the year and next quarter, does not include LinkedIn. However, we still expect the transaction to close in the second quarter. +For the full year we expect the FX impact to lessen throughout the year, assuming current rates remain stable. In H1 we expect a total impact of 1 point, reducing to zero in H2. The fundamentals of our commercial business remain strong and we anticipate that Cloud services and healthy renewals will continue to drive high annuity mix. +As I've noted before, our commercial transactional business is influenced by different dynamics. Most important, it's impacted by a structural transition to the cloud across all workloads. But it's also more sensitive to overall macroeconomic conditions and changes in corporate budgets. +We expect volatility, as we saw in both Q3 and Q4 this year, to continue in the next fiscal year. Before discussing our total Company gross margin expectations, let me first address commercial Cloud gross margin. We expect the commercial Cloud gross margin percentage and dollars to materially improve next fiscal year. We have invested heavily to build share, expand geographically and ensure world class support and reliability for our commercial customers. Going forward, we expect those investments to provide benefits of scale. +We also anticipate our cloud capital expenditure growth curve will slow. Given seasonality and revenue mix, commercial cloud gross margin will see variability quarter-to-quarter but an overall trend of material improvement. At the Company level, as each cloud service continues to grow and improve its gross margin percentage, our Company gross margin should only decline roughly a point in FY17. We now expect our full-year operating expense will be $31.1 billion to $31.4 billion as we continue to prioritize spend on strategic growth opportunities. +Lastly, our effective tax rate; our tax rate is impacted by three factors: the proportion of services revenue versus licensing revenue, the geographic mix of revenue and the timing of equity vests. As our Cloud continues to gain momentum, we expect our tax rate to increase. With quarterly variability based on these factors, we anticipate our non-GAAP tax rate to be 20% for the full year, plus or minus 2 points. +Now to the outlook for the next quarter. Based on current currency rates and forecasted geographic mix of revenue, we expect 2 points of negative impact on total revenue in Q1. By segment, the negative impact is 2 points in productivity and business process, 2 points in Intelligent Cloud, and 1 point in More Personal Computing. +We expect commercial unearned revenue to be within the range of $21.8 billion to $22 billion, in line with historic seasonality. In productivity and business process, we expect revenue to be $6.4 billion to $6.6 billion. We will continue to grow our install base and drive premium mix through offers like Office 365 E5. We anticipate continued transactional declines as customer migration to the cloud accelerates. +In our consumer business, we will outpace the consumer PC market. But the benefit from Japan's improved results over a weak prior period and the benefit from last year's Office 2016 launch are not expected to repeat. +For Intelligent Cloud we expect revenue between $6.1 billion and $6.3 billion driven by continued annuity strength across Azure and our hybrid cloud offerings, offset by ongoing declines in our transactional on-premises server business, and moderating growth from support agreements in enterprise services. +In More Personal Computing, we expect revenue between $8.7 billion and $9 billion. We anticipate that our OEM revenue will be more in line with overall PC market trends. Devices revenue will decline again from our actions in phone, gaming revenue will be driven by the same factors as in Q4. And in search, we expect Bing's growth trajectory to continue. +We expect COGS to be $7.5 billion to $7.6 billion with variability due to device sales. We expect operating expenses between $7.35 billion and $7.45 billion. We expect other income and expenses to be approximately zero as realized gains on investments should offset debt expense. +And with that, Chris, let's go to Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. +We'll move now to the Q&A section. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you. +(Operator Instructions). +Our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- +Excellent. Thank you for taking the question, and very nice quarter. I wanted to dig into Azure and maybe one question for Satya and one question for Amy. +Satya, you mentioned the Boeing agreement. What was interesting about that is, not just a large company moving significant workloads onto Azure, but from my reading, sounds like there's a distribution side of this agreement that you are going to help distribute some of those applications on a going-forward basis. I was wondering if you could touch a little bit on that? +Is that a one time thing or is that something that you look to do more often with some of these large companies? Moving workloads onto Azure. And then for Amy. Thank you for the additional detail on the cloud gross margin profile on a going forward basis. +When we dig into just Azure, you said in the past that you expect to match the gross margin profile of what we're seeing in Amazon web services. Does that commentary still hold? +And then you could give us a sort of mark-to-market on how you're doing in terms of matching up Azure's gross margin profile to what you've seen from your top competitor there? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Keith, for those questions. Let me start on the first one. +You're absolutely right that one of the phenomena now is that pretty much anyone who is a customer of Azure is also in some form an ISV. And that's no longer just limited to people who are quote-unquote in the classic tech industry or the software business. That's the same case with GE, it's the same case with Boeing, it's the same case with Seider Electric or ABB or any one of the customers we are working with, because they all are taking some of their assets and converting them into SaaS applications on Azure. +And that's something that we will in fact have distribution agreements with. And AppSource, it's a pretty major announcement for us, because we essentially created, for SaaS applications and infrastructure applications, a way to distribute their applications through us and our channel and I think it makes, in fact, our Cloud more attractive to many of them because of that. I think going forward we will -- you'll look to see or you'll see us do much more of this with many other customers of ours. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [4] +-------------------------------------------------------------------------------- +And to your question on Azure gross margin specifically and how we think about that in comparison, let me first say, the additional color I gave in terms of comments in terms of material improvement clearly also apply to our Azure portfolio as well. We're encouraged by the improvements we've seen year-over-year and we do expect material improvement in FY17, both from the benefits of scale and the investments we've made, but importantly also in the revenue trajectory we're seeing and the makeup of that revenue. +Boeing's agreement is one such agreement, in terms of embedding a premium service at a premium gross margin. We signed many of those this quarter that we feel quite good about. I think I have a strong line of sight to AWS's margin profile and still feel good about the progress we're making. +Not just on the workloads that are relevant, apples-to-apple with Azure, but also in our broader Cloud portfolio and our ability to have very healthy margins across Dynamics 365 as well as Office 365 in conjunction with many of the innovations we're doing across Azure. While I am focused on both the workload improvements, I'm also focused on what's possible across the entirety of the cloud. +Thanks, Keith. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- +Excellent. Thank you very much. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [6] +-------------------------------------------------------------------------------- +We'll go to the next question, please, Operator. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Our next question comes from the line of Karl Keirstead with Deutsche Bank. Please proceed with your question. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [8] +-------------------------------------------------------------------------------- +Thank you. +So Satya or Amy, last quarter, the stock was hit in part on a deceleration in your on-premises server product business, and I think your commentary around the transactional part of that suggested it softened a little bit. I think your tone on this call is a lot better around the transactional performance, and it looks like that business accelerated a little bit. Perhaps you could explain what changed in the course of the three months to make the transactional piece, at least if I'm hearing you correctly, feel a little bit better? +Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [9] +-------------------------------------------------------------------------------- +Let me start and then, Amy, you can add to it. Overall, Karl, the focus for us is in what I describe as this hyper scale plus hybrid approach. When you think about the cloud approach, which is pretty unique to us, and the way we track progress is to see how is our annuity growth of our server business and how is our Cloud growth. +And if you look at this last quarter, our annuity grew double digits and our cloud grew triple digits, and that's a pretty healthy growth rate. And that's something that, by design both in terms of the technical architecture, as well as the traction we have in the marketplace and our sales efforts, and so on are playing out well and we are very bullish about that going forward. The transactional business is much more volatile because of the macro environment, IT budgets and also the secular shift to the cloud. The question again that gets asked is about the cannibalization. +But if you look at Boeing or you look at any of the other examples that I talk about when it comes to the Cloud, our servers never did what these customers are now doing in our Cloud. So at a fundamental long-term secular basis, we have new growth, new workloads and that's what we're focused on and that's a much bigger addressable market than anything our transactional server business had in the past. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [10] +-------------------------------------------------------------------------------- +Thank you, Karl. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Our next question comes from the line of Brent Thill with UBS. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [12] +-------------------------------------------------------------------------------- +Thanks, Amy. +In Q3 the transactional business was weak and you said the business bounced back in Q4. Was that just a mere fact of you cleaning up some of the slipped business, or did you see additional strength on top of some of those closed transactions on the transactional business in Q4? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [13] +-------------------------------------------------------------------------------- +Thanks, Brent. Let me split your question into two components. +The first thing, really, that I think Satya and I both focus on every quarter, every month is how much of our business are we continuing to shift to annuity and specifically to the cloud. We structure all of our motions at this Company from how we engineer to how we do our go-to-markets, to how we think about sales engagement, to how we do our investments, Fundamentally, toward that long-term structural transition in the market. And so to your question on transactional performance, there were some deals that didn't get done in Q3 that got done in Q4. +And there were some deals done in Q4 on the Office side with large companies that I'm thrilled by. But at the same time we still will focus on those deals moving to the Cloud over time. And so this volatility that we are going to see because of macro and because of budget constraints, especially on transactional, we will focus on because we expect excellent execution and have accountability to do that in the field. But our first priority every time is to make sure we are focused on annuity growth and digital transformation at our Company, which is best done through that motion. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [14] +-------------------------------------------------------------------------------- +Just to be clear, Amy, in terms of the sales motion, are they incented more towards cloud versus transactional going into this year? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [15] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [16] +-------------------------------------------------------------------------------- +Absolutely. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [17] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [18] +-------------------------------------------------------------------------------- +Thanks, Brent. We'll move to the next question, please. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Our next question comes from the line of Heather Bellini with Goldman Sachs. Please proceed with your question. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- +Great. +Satya, I had a question for you on Azure. I was just wondering if you could talk about the percentage of Azure revenue coming from ISVs? And then how do you see this helping you compete with AWS? And can you talk about why these partners may be choosing you over the competition? +Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [21] +-------------------------------------------------------------------------------- +Sure. +Let me take that second part in terms of what is our differentiation. In my remarks I sort of pointed out the couple of dimensions. But overall, I believe this hyper scale plus hybrid architecturally helps us a lot with enterprise customers because we meet them where their realities are today and also the digital transformation needs going forward. So that's one massive advantage we have. +The second area for us is also the nexus between what's happening in Office 365, Dynamics 365, AppSource, and in fact this last quarter some of the most strategic announcements were all around our application platform. At our partner conference there was significant amount of excitement with the tools that we announced like PowerApps and Power BI, Azure functions and flow. These are tools that our developers and system integrators and solution partners will use in order to be able to customize applications around Azure. And so to me, that's another huge advantage and a competitive differentiation for us. +And then lastly, we have the best support for what I would say is the most open platform for all developers. Not only is .NET first class, but Linux is first class, Java is first class, Azure Container Service cuts across both containers running on Windows, running across Linux, so again, speaks to the enterprise realities. So those would be the places where we are fairly differentiated and that's what you see us gaining, both for enterprise customers and ISVs. +The question you asked is an interesting one, which is if I had to slice it by classic ISVs, it would be one-third or so of our revenue. But the thing that -- the first question that Keith asked is probably more indicative of what's happening, which is every customer's also an ISV. +So every customer who starts off consuming Azure is also turning what is their IP in some -- most cases into an ISV solution, which ultimately will even participate in AppSource. So at least the vision that we have is that every customer is a digital company that will have a digital IP component to it and that we want to be able to partner with them in pretty unique ways. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [22] +-------------------------------------------------------------------------------- +I would also add, Heather, the importance of the motion in our field organization and go-to-market with ISVs is incredibly high in terms of selling with and along with those ISVs, both making them successful and thereby helping us build very important scale through the platform. We've seen a lot of improvement in the past four quarters on that front. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [23] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [24] +-------------------------------------------------------------------------------- +Thanks, Heather. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [25] +-------------------------------------------------------------------------------- +Thank you, Heather. We'll move to the next question, please. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [27] +-------------------------------------------------------------------------------- +Thank you. +Amy, how much of the weakness in transactional has been caused by clients that otherwise would have bought a license now under annuity? In other words, are you driving the transactional weakness to some extent by driving the growth in on-prem? +And then I have a quick follow-up for Satya. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [28] +-------------------------------------------------------------------------------- +It's probably not exactly how I would say it, Mark. I do believe that every conversation that we're having with customers is Cloud-led. That Cloud-led conversation and making a plan for customers to best change and transform their own business, certainly far more in-depth one than on occasion is required by long-time transactional purchasers, especially in Office, as an example, because what we're talking about now is really pivoting your business for the long term. +And so I'm sure there are examples where that has elongated the sales cycle for good reason. But I would generally point back to say most of these are driven at the structural level, which is structurally over time on-premises transactional business will move to the cloud or to a hybrid structure through an annuity revenue stream. +Now over any short term period, the majority of what we have seen is really -- is either budget constraint, a macroeconomic change or people, to the question you've laid out, maybe in the midst of making their cloud transition plan and maybe that has elongated the sales cycle to an extent. But again, I don't view that as negative performance. I view that as strategic relevance long-term inside of digital accounts. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein Research - Analyst [29] +-------------------------------------------------------------------------------- +That makes a lot of sense. Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [30] +-------------------------------------------------------------------------------- +Thanks, Mark. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Our next question comes from the line of Walter Pritchard with Citi. Please proceed with your question. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [32] +-------------------------------------------------------------------------------- +Hi, thanks. +Amy, I'm wondering, you saw very strong unearned revenue in the quarter, but I note that you saw contracted backlog that grew sequentially below what a typical June quarter does in commercial bookings that were up about 4%, off of a fairly easy comp. But, I'm wondering if you could just help us understand the dynamics between -- in new and renewal signings that drove that combination of really strong unearned but somewhat weaker trends in the bookings? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [33] +-------------------------------------------------------------------------------- +Sure. +Strong unearned in particular was actually better than expected Azure billings in the quarter that drove unearned above the high end of our guide and I think we were quite pleased by that performance. In terms of [C and D], that's the reference I made in my comments to the lower expiry base. Quarter-to-quarter and year-to-year we just had different amounts of contracts expiring. And so this was one of our lower contract bases and was lower than a year ago. So the fact that we were able to grow in that low expiry base is actually very good structural performance. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [34] +-------------------------------------------------------------------------------- +Thank you, Walter. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed with your question. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [36] +-------------------------------------------------------------------------------- +Two questions on the Office side; first of all, you obviously reaching very large numbers in terms of the numbers of seats that you have. Can you talk a little bit about what's the seat growth because, both for consumer and for commercial, it seemed to be coming down? +Is that kind of the law of large numbers coming in or is there anything else? And then the consumer Office, the consumer Office performance was very, very strong and that almost needs to be stronger from transactions because otherwise I don't get to the numbers. Can you talk a little about the source of the strength there? +Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [37] +-------------------------------------------------------------------------------- +Thanks, Raimo. +Let me start with the Office consumer question. We haven't had a chance to touch on that. And then we'll talk about commercial seat growth. +You're right, the Office consumer growth still has quite a bit of transactional business to it, even though we have moved, and you saw that growth, the subscriber base sort of materially, the growth in quarter versus our expectations was really two things that are transactionally focused. One, the PC market was a little better than we thought. And particularly in developed markets, the PC growth was better than we thought. +And developed markets are where we see the most transactional business with consumer Office that impacts in quarter. So the strength from that outperformance or better market and consumer PCs in developed markets is a direct correlation to our performance in Office consumer. And so that's how to think about that big delta. +The other thing was Japan was a little better and when Japan is better, it's why you also see the interesting relationship in constant currency. We have a lot of yen exposure in that segment. So the Japan performance being better also helped. That is a purely -- it's more transactional than even our Rest-of-World business. So you're right, Raimo, in terms of what impacted that number in-quarter versus the underlying market dynamics. +On commercial seats, listen, we're very proud of that big number, growth number, but you're right, we're also getting a very big base. And so, while we feel great about continuing to add seats at that type of rate, converting and adding net new into our install base, you will see that growth rate come down just because the business is getting quite big. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [38] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [39] +-------------------------------------------------------------------------------- +Thanks, Raimo. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Our next question comes from the line of Gregg Moskowitz with Cowen & Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +Gregg Moskowitz, Cowen and Company - Analyst [41] +-------------------------------------------------------------------------------- +Okay. Thanks very much and good afternoon. +Amy, you spoke about a slowdown in the Cloud CapEx growth curve in FY17. I assume you're referring to the growth in absolute dollars moderating and not just the rate of change in percentage terms? But any additional color that you could provide on the Company's CapEx requirements over the course of the next year would be appreciated. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [42] +-------------------------------------------------------------------------------- +Thanks, Greg. +You're right, my comments are more pivoted toward the absolute dollar amounts, which is what I tend to focus on in my comments. It's a good clarification and thanks for asking. +In terms of how we think about the absolute numbers, first I should say I think most people assume, and it is true to a certain extent, so much of this is the growth in our commercial businesses across Azure and Dynamics and Office 365 and that's true. But we're also seeing quite good growth in some of the consumer businesses, which also are built on our Cloud infrastructure. Search, some of our gaming assets, our Xbox Live business going forward, and so many of these assets, including increased usage of our consumer properties inside our productivity business and Office do require capital spend. And so the growth is pretty broad-based to support. +And so, as I think about moderation, it is the absolute dollar. It's from -- it's not due to any change in our aspiration or belief in the growth curve of revenue and I want to be clear on that. It really is about continuing to benefit from scale and engineering improvements that will allow us to do that even as we see broad-based growth. + +-------------------------------------------------------------------------------- +Gregg Moskowitz, Cowen and Company - Analyst [43] +-------------------------------------------------------------------------------- +Very helpful. Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [44] +-------------------------------------------------------------------------------- +We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Our next question comes from the line of Ross MacMillan with RBC Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [46] +-------------------------------------------------------------------------------- +Thanks so much for taking my question. +Amy, I had one on the same lines on CapEx, and I just wondered if you could provide some insights? We're at 26 data center regions today. I think you have 34 planned. So that would imply we're about three quarters of the way through that spending cycle. But should we view 34 as a ceiling, or is it possible that we could see further data center regions built out beyond that 34? And then I had one follow-up. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [47] +-------------------------------------------------------------------------------- +Let me start and then, Amy, you can add to this. +In some sense Ross you're trying to ask us to project forward and say what is the legitimate digital security and digital sovereignty needs of all the different types of businesses that we want to serve using the cloud all over the world. The position that we have taken is that we want to serve customers where they are and not assume some very simplistically that that digital sovereignty needs of customers can be met out of a fewer data center approach. Because right now, given the secular trend to of move to the cloud across all of the regulated industries across the globe, we think it's wiser for us and our investors long-term to be able to meet them where they are and that's what you see us. +We were the only cloud that operates in China under Chinese law, the only cloud that operates in Germany under German law. And these are critical competitive advantages to us. And so we will track that and we'll be very demand-driven. +So there is, in this case, we're not taking these positions of which regions to open and where to open them well in advance of our demand. If anything, I think our cycle times have significantly come down. So it will be demand driven, but I don't want to essentially put a cap because if the opportunity arises and for us it's a higher ROI decision to open a new region, we will do so. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [48] +-------------------------------------------------------------------------------- +I would add, in addition to the number of regions, what Satya's talking about, it's also the capacity inside a region. Much of our spend is, as you note, on some of the infrastructure to put in place when you pick a location. The rest of it is continuing to build out in that location the number of servers and networking equipment required. So there's really two components and I think Satya's talked about why you would enter a region and its ROI and there's also the correlation to how many servers and that spend and pace over time based on demand. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [49] +-------------------------------------------------------------------------------- +Thanks so much. Maybe just one quick follow-up. +The server products business that Karl talked about did rebound this quarter and I think it was up about 4% constant currency for the year. I know you're not guiding to that number specifically and you talked about potential volatility. +But is there any range of outcomes that you're thinking about for that business? Will it grow? Is it not clear that it will grow? I'd just love any additional color there. Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [50] +-------------------------------------------------------------------------------- +In terms of server products and services, I tend to think of it as the all-up growth. It's really about growing the cloud, growing the hybrid, and then whatever happens in the transactional business happens. +And we -- I'm very proud, actually, of the growth this quarter. I think our guide for Q1, given some of the headwinds we expect in terms of support agreements that we talked about in enterprise services, continues to expect very healthy double-digit annuity growth driven fundamentally by Azure in that segment. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [51] +-------------------------------------------------------------------------------- +Thanks, Ross. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [52] +-------------------------------------------------------------------------------- +Thanks again. Congratulations. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +We'll go to the next question, please. Our next question comes from the line of Michael Turits with Raymond James. Please proceed with your question. + +-------------------------------------------------------------------------------- +Michael Turits, Raymond James - Analyst [54] +-------------------------------------------------------------------------------- +Hi, guys, thanks for taking my question. Satya, around the LinkedIn announcement there was a lot of discussion about some of the opportunities to use the assets and information there to help build your HCM and CRM capabilities, and then we fairly shortly afterwards got the announcement of Dynamics 365 and AppSource. Maybe given the amount of discussion here you could comment on the evolution of the strategy and your thought process around broad enterprise application? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [55] +-------------------------------------------------------------------------------- +Thanks for that question. +So I look at what we're doing with Office 365, Dynamics 365, AppSource, LinkedIn, as all being part of one strategy. So the move to the cloud for our customers and for us is not just about a new way of delivering the same value, just as a self service. It's really the transformation from having applications that are silos to becoming more services in the cloud where you can reason about the activity and the data underneath these services to benefit the customers who are using these services. +So that's what this notion of a graph represents. So when somebody moves to office 365, they graph their people, their relationships with other people inside the organization. Their work artifacts all move to the cloud. You can connect them with all the business process data that's in Dynamics 365. But not just in Dynamics 365, but all the applications in AppSource, because business process will always be a much more fragmented market as opposed to just one market share leader by industry, by vertical, by country. +And so that's our strategy there. And now the professional Cloud or the professional network helps usage across all of that professional usage, whether it's in Office 365, or whether you're a salesperson using any application related to sales, you want your professional network there. Of course it's relevant in recruiting. It's relevant in training. It's relevant in marketing. +So that's really our strategy with LinkedIn as the professional network needing the professional cloud. And so you're right to point out that these are all part of one overarching strategy, and ultimately it's about adding value to customers. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [56] +-------------------------------------------------------------------------------- +Thanks, Michael. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [57] +-------------------------------------------------------------------------------- +Thanks so much. We'll have time for one more question, please. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- +Our final question comes from the line of Mark Murphy with JPMorgan. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [59] +-------------------------------------------------------------------------------- +Yes, thank you very much. +Satya, we noticed Office 365 commercial seat growth of 45% produced Office 365 commercial revenue growth of 59% in constant currency. So a favorable spread of about 14 points suggesting ASP growth. Wondering if you could help us understand the drivers, both now and into the future, particularly in terms of the initial response to the E5 plan, and also which products you think are driving the strength as you consider across Exchange, Skype for Business, Power BI, Yammer, SharePoint, et cetera. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [60] +-------------------------------------------------------------------------------- +Let me start and, Amy, you can add to it. +Overall, I'd say even in this last year, even just the broader spread of E3 has driven a lot of the growth. And then of course we're very excited about E5, but the very, very early days of E5. E5 value proposition across all three of the areas, whether it's cloud voice or analytics or security are all three massive areas for us. +And I would say, if anything, the initial data from customers around security is very -- is gaining a lot of traction. But we're at the same time -- one of the things that customers are looking for is making an enterprise-wide architectural decision across all of the workloads. So E3, E5 and higher penetration of this is what's going to drive ASV growth. +And you can see -- you'll see us add more value to these packages as time goes on, as well, because our R&D is focused on that, which is how do we take these buckets of value creation and reinforce them with all of the future R&D as well. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corp. - General Manager IR [61] +-------------------------------------------------------------------------------- +Thanks, Mark. +So that wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person these events will be Webcast and you can follow our comments at the Microsoft Investor Relations website. Please contact us if you need any additional details and thank you for joining us today. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corp. - CFO [62] +-------------------------------------------------------------------------------- +Thanks all. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corp. - CEO [63] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- +This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2016-Oct-20-MSFT.txt b/Transcripts/MSFT/2016-Oct-20-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..c285122de732f23aca144725f06032a4d4e8a427 --- /dev/null +++ b/Transcripts/MSFT/2016-Oct-20-MSFT.txt @@ -0,0 +1,541 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Microsoft Corp Earnings Call +OCTOBER 20, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO + * Chris Suh + Microsoft Corporation - General Manager of IR + * Amy Hood + Microsoft Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brad Reback + Stifel Nicolaus - Analyst + * Kash Rangan + BofA Merrill Lynch - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Raimo Lenschow + Barclays Capital - Analyst + * Walter Pritchard + Citigroup - Analyst + * Ross MacMillan + RBC Capital Markets - Analyst + * Brent Thill + UBS - Analyst + * Gregg Moskowitz + Cowen and Company - Analyst + * Keith Weiss + Morgan Stanley - Analyst + * Karl Keirstead + Deutsche Bank - Analyst + * Mark Moerdler + Bernstein - Analyst + * Mark Murphy + JPMorgan - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to Microsoft's first quarter fiscal year 2017 earnings conference call. +(Operator Instructions) +As a reminder, this conference is being recorded. I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- +Thanks. Good afternoon, and thank you for joining us today. On the call with me today are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. +On our website, Microsoft.com/investor, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provide the reconciliation and differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. +The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as clarifying items to aid investors in further understanding the Company's first quarter performance, in addition to the impact that these items and events had on the financial results. +Additionally, any mention of operating expenses refers to segment operating expenses, as defined in the footnotes of our Form 10-Q, which includes research and development, sales and marketing, and general and administrative, but excludes the impact of integration and restructuring charges. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. +During Q1, we provided an update to our key investor metrics for fiscal 2017. We provide these additional metrics to enhance our financial reporting results and provide transparency into our progress against our strategic imperative. We introduced three new metrics: commercial cloud gross margin percentage; total gaming revenue; and Windows commercial product and cloud services revenue growth. We will be referencing these metrics throughout the commentary today, and you can see them in our published KPIs on the IR website. +We'll post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording. You can replay the call and view the transcript on the Microsoft investor relations website until October 20, 2017. +During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. +Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the risk factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thank you, Chris, and thanks to everyone on the phone for joining. Today I will share the results for the first quarter and discuss how we are innovating into growing each of our segments. Overall, we are off to a good start in FY17. We delivered $22.3 billion in revenue this quarter, an increase of 5% in constant currency. I am proud of the continued progress. +Our platforms are leading profound digital transformation outcomes for both people and organizations. At our IT conference, Ignite, I talked about how we are innovating in AI across the entire tech stack, and how AI will be infused into everything we do. To accelerate our innovation, we've created a dedicated organization to focus on artificial intelligence. +As I turn to progress we made by segment this quarter, I will highlight how these investments we're making in AI fuel innovation across all of our ambitions. Let's start with Productivity and Business Process. We're helping people be more productive by bringing intelligence to familiar office apps they use every day. +We recently introduced cloud-powered intelligence within Word, Excel, PowerPoint, and Outlook that uses machine learning and advanced natural language processing to help automate tasks, surface related content and connections, focus your inbox, and more easily create compelling content. We are also building intelligence into our apps to provide advanced security for customers. +This quarter we announced Office 365 Threat Intelligence, which analyzes billions of signals across Office, Azure, Windows, and external data sources to give customers broad visibility into attack trends and proactively recommend security policy adjustments. We're extending intelligence to compliance with our new Data Governance service, which helps customers achieve organizational compliance and automate data retention. These advancements are part of our ongoing commitment to strengthen security for our Office 365 E5 customers. +We are seeing broad momentum with customers across enterprises, small business, and consumers. Monthly active users of Office 365 commercials are now over 85 million, up more than 40% year over year. Office 365 commercial seats were also up 40% year over year and revenue up 54% in constant currency. +Across industries customers such as eBay; European airline, EasyJet; global pharmaceutical company Allergan; the Fortune 100 companies like the energy leader Exelon and Liberty Mutual Insurance, are choosing Office 365 to help make their employees more productive and secure. Customers love the power of Office on any device. We now have more than 45 million Outlook monthly active devices on iOS and Android, a more than 70% increase year over year. +Last week we unveiled a new class of purpose-built, intelligent apps in Dynamics 365, designed to remove any impedance that exists between productivity, collaboration, and business process. Using advanced analytics and machine learning, these new apps glean insights from previously siloed data to transform how people work across finance, sales, marketing, and customer service. They monitor customer relationship help, reveal connections, forecast demand, and predict risk. +And the deep integration with Office 365 makes it easy to take action, communicate, and collaborate in real-time or schedule a follow-up. Our innovations in Dynamics 365 build on our existing momentum. Dynamics CRM Online paid seats more than doubled year over year, and customers increasingly prefer our cloud solutions, with more than 70% of the new Dynamics CRM and ERP enterprise customers choosing Dynamics online. +Companies like HP Inc. are replacing their existing CRM systems with Dynamics 365 to take advantage of the built-in intelligence in our latest release and transform engagement with customers and partners. Overall, we are well-positioned to compete and grow our share in this large and growing market. +Now let's talk about the progress we are making in our Intelligent Cloud segment. Customers continue to choose the Microsoft Cloud to help transform their businesses and organizations. Our commercial cloud annualized revenue run rate now exceeds $13 billion, and we remain on track to achieve our goal of $20 billion in fiscal year 2018. Once enterprise customers choose one of our cloud services, they continue to adopt more services. +More than 60% of the Fortune 500 now have at least three of our cloud offerings, up 20 points year over year. And as with last quarter, we continue to grow our commercial annuity mix which is now at 88%. +Customers choose Microsoft for three reasons. They want a trusted, global, hyper-scale cloud provider to meet the enterprise-grade needs. They want hybrid support that is architected into both the hyper-scale service and the cloud servers. They want higher level services to help them build their own digital capability, inclusive of dev-ops, productivity, new IoT and Enterprise App development, advanced analytics, and machine learning and AI capability. These differentiated features are leading our cloud infrastructure growth. +Azure revenue, once again, grew triple-digits, 121% in constant currency, with Azure compute usage more than doubling year over year. We continue to invest in and expand our datacenter footprint, which now totals 38 regions including the announcement of our planned expansion into France and the recent opening of data centers in the United Kingdom and Germany. +Enterprises like Renault-Nissan Alliance, AccorHotels, as well as public sector customers such as the United Kingdom Ministry of Defense, the Ireland's Health Services Executive, are choosing Azure to transform their organizations while meeting European data sovereignty, security, and compliance needs. Security and compliance remain paramount for enterprise customers. Azure is already the most trusted, most compliant cloud, with 49 certifications, more than any other cloud provider. +And our US government cloud has the highest number of certifications and dedicated data center regions in the industry to meet the stringent requirements of our public sector customers. We are applying AI to security with the new Azure Security Center, which leverages advanced analytics and machine learning to detect threats and help enterprise customers respond with comprehensive cybersecurity and management. +Looking beyond infrastructure services, across industries, customers like Daimler Trucks North America, Uber, and Lowe's are using Azure's intelligent services to build powerful new offerings for their customers. More than half of the Fortune 500 have our Enterprise Mobility services, up more than 20 points year over year. +This quarter, we released a premium version of our Enterprise Mobility service that includes advanced security management for SaaS applications, automatic document classification and encryption, advanced identity protection, and we crossed 3/4 of a billion unique user identities in Azure Active Directory. This quarter, we announced a number of key partnerships. Adobe and SAP recognize Azure's leadership in the cloud and are bringing their industry-leading marketing and human resource solutions to our platform, giving our mutual customers powerful new ways to transform their business. +Customers and developers are also choosing Azure for its openness. Enabling digital transformation for everyone means supporting the widest range of platforms, frameworks, and tools. This quarter we announced that we open-sourced Windows PowerShell, our industry-leading infrastructure management tool, and made it available on Linux. We continue to see strong interest in the preview for SQL server on Linux with 19,000 customers registered, including more than half of the Fortune 500. +It's opening conversations with customers, spanning their entire data estate, both on premise and in the cloud. Azure's service fabric on Linux enables developers to build and manage high scale microservices and cloud applications. And we announced that our new FPGA-powered platform in Azure, capable of exascale compute, will support Caffe, TensorFlow, Torch, and our own CNTK frameworks for Deep Learning. +Finally, we're building our server products to become the edge of our cloud to support true hybrid computing. The new Windows Server 2016 gives IT professionals new layers of security and brings Azure- inspired innovation for infrastructure and cloud applications. And we extend our partnership with Docker to make the commercially-supported Docker Engine available to Windows 2016 customers at no additional cost. +Now let's talk about More Personal Computing, where we are also seeing intelligence transform Windows 10 and our ecosystem of devices. We now have more than 400 million monthly active devices on Windows 10 and nearly 200 billion hours of usage. And we are expanding our growth opportunities for Windows with enterprises and in areas such as gaming. +Last quarter, I outlined three aspects of our Windows strategy. First, deliver more value and innovation, particularly for enterprise customers. Second, grow new monetization through services across a unified Windows platform. Third, innovate in new device categories in partnership with our OEMs. Let me talk through the progress we are making in each. +This quarter, we released Windows 10 Anniversary Update, with advanced security features including Windows Defender Threat Protection, a cloud-enabled service that helps enterprises detect, investigate, and respond to advanced network attacks. And with threat intelligence sharing capabilities, we enable IT to investigate and respond to security threats across Windows 10 and Office 365. +Our advancements in security helped to drive a 3X increase in Windows 10 enterprise deployments over the last six months. The growth in customer adoption is also driving increased developer, search, and Cortana engagement. The number of developers building and updating Universal Windows apps is up 3X year over year. More than 1,000 applications have been developed using the Cortana API, and Windows 10 Cortana search box now has 141 million monthly active users, with almost 13 billion questions asked to date. +Gaming is a leading driver of engagement on Windows 10 and opens up new experiences and scenarios across Windows devices. For the past three consecutive months, Xbox One has been the number-one selling console in the United States, giving us strong momentum heading into the holiday season. +Our highly engaged Xbox Live fan base continues to grow across Windows 10, iOS, and Android, up 21% year over year, and we have more than 20 billion hours of gameplay on Windows 10 PCs and tablets, a more than 500% increase year over year. Our commitment to grow Xbox Live community led us to acquire Beam this quarter, an innovative and interactive livestreaming service that gives viewers the ability to watch and play along with their favorite game in real time. +Finally, let's talk about our progress in new device categories. Surface continues to drive category growth, and more commercial customers are choosing to deploy Surface, with deals of 500 devices or more increasing 70% year over year. And we are reaching more commercial customers of all sizes with the support of our channel partners. +The Windows Holographic Platform and Microsoft HoloLens are opening up new, differentiated opportunities on Windows. This quarter we made Microsoft HoloLens Development Edition available to all developers and business customers in the US and Canada, and last week we expanded our presence to six additional markets. +Enterprise customers like Audi, Volvo, Japan Airlines, and the PGA Tour are all embracing Microsoft HoloLens to transform the way they work and create new mixed reality experiences for customers. It's still early, but it's great to see the innovation and creativity that developers are bringing to the platform. And coming in 2017, we will enable our hardware partners to deliver entirely new, mixed-reality experiences with Windows Holographic and on Windows 10. +In closing, we are leading digital transformation across all industries and geographies, creating enormous opportunity for Microsoft and our partners. As we infuse AI into all of our computing platforms and experiences, we will drive even greater transformational value for our customers. In the coming weeks, I'm looking forward to sharing news about our new innovation in Windows 10 and Office 365. Now let me hand it over to Amy to walk through this quarter's results in more detail and share our outlook, and I look forward to rejoining you after for questions. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [4] +-------------------------------------------------------------------------------- +Thank you, Satya, and good afternoon, everyone. This quarter revenue was $22.3 billion, up 3% and 5% in constant currency. Gross margin was flat and up 2% in constant currency. Operating income was flat and grew 4% in constant currency, and earnings per share was $0.76, increasing 9%, or 13% in constant currency. +I'm pleased with the strong execution we saw in the first quarter from our sales teams and the partner ecosystem across both our commercial and consumer businesses. Across most markets, our results were in line with macroeconomic trends, with strength in key markets like the US, Western Europe, and Japan. Momentum and cloud services contributed to a total commercial annuity mix of 88%, up 2 points from the prior year. +We again saw higher-than-expected transactional deal volume, primarily driven by Office commercial products in our small and mid-size business segment. This quarter, the dollar volume of annuity expirations was significantly larger than the prior year, and with solid renewals from that base, we grew our commercial bookings by 18%. The larger base also drove our contracted not billed balance to more than $25.5 billion. Strong execution resulted in better-than-expected commercial unearned revenue of $22.3 billion or an 8% increase in constant currency. +Our commercial cloud revenue run rate exceeded $13 billion this quarter, growing 59%. As I've shared previously, we expect our commercial cloud gross margin percentage to materially improve throughout the year. This quarter, our commercial cloud gross margin percentage was 49%, up 7 points sequentially, although we do expect variability from quarter to quarter. Importantly, gross margin dollars grew by 61% across the total commercial cloud. +Now to Company gross margin. Our Company gross margin was approximately 65%, down a little less than 2 points from the prior year, impacted by an increasing mix of commercial cloud revenue, slightly offset by improvements in More Personal Computing. The revenue performance in More Personal Computing largely drove COGS above our expectations. +This quarter, the FX impact on total and segment level revenue was in line with expectations. FX had a 2 point negative impact on Productivity and Business Processes and Intelligent Cloud results, and a 1 point negative impact on More Personal Computing results. Total operating expenses were flat and grew 1% in constant currency from investments supporting our commercial cloud. At the Company level, operating income grew 4% in constant currency. +Let's turn to each segment, where we can now discuss constant currency impact at the revenue and operating income levels. This quarter, our Productivity and Business Processes segment delivered results above our expectations, with approximately $6.7 billion in revenue, an increase of 6% and 8% in constant currency. In Office Commercial, revenue increased by 5% and 8% in constant currency, as Office 365 growth continued to outpace the shift from our on-premise business. +We again grew our installed base across all key workloads. In our Office 365 commercial business, our premium workload mix was above 60%. As mentioned earlier, our transactional results were higher than expected in the small- and mid-size customer segment and benefited from a stabilizing commercial PC market. +Office consumer revenue grew 8%, also 8% in constant currency, benefited from a stronger-than-expected consumer PC market, subscriber seat growth, and recurring subscription revenue. And our Dynamics business grew 11%, up 13% in constant currency, as customer preference for our cloud services and CRM Online and Dynamics AX contributed to billings and seat growth. +Segment gross margin dollars were flat, up 2% in constant currency. Segment gross margin percentage declined on an increasing cloud revenue mix. Operating expenses grew 2%, also 2% in constant currency, primarily driven by investments in cloud engineering. Operating income declined slightly, but was up 2% in constant currency. +The Intelligent Cloud segment delivered nearly $6.4 billion in revenue, above our expectations, and grew 8%, or 10% in constant currency. Server products and cloud services grew 11% and 13% in constant currency. Demand for our hybrid cloud offerings led to another quarter of double-digit annuity revenue growth within server products and cloud services, partially offset by a decline in our transactional, on-premise server business. +Server premium products grew double digits in constant currency. As expected, enterprise services revenue growth slowed this quarter to 1% and 2% in constant currency, largely due to a decreasing volume of support agreements associated with Windows Server 2003 end of support. Gross margin dollars grew 2% and 4% in constant currency, and segment gross margin percentage declined, primarily due to increasing cloud revenue mix, partially offset by significant improvement in Azure gross margin. +Given the growth opportunity in cloud, we increased our operating expenses by 21%, also 21% in constant currency, to fund cloud engineering, sales capacity, and developer engagement. Consequently, operating income declined 14% and 11% in constant currency. +Now to our final segment, More Personal Computing. Revenue was $9.3 billion, down 2% and 1% in constant currency, and better than expected across multiple businesses. First, our OEM results. Our total OEM business was flat this quarter, more in line with the PC market and better than we expected. OEM Pro revenue grew 1%, reflecting the stabilizing commercial PC market, particularly in the US. +OEM Non-Pro revenue declined by 1%, slightly ahead of the consumer PC market driven by a higher mix of premium devices. Channel inventory levels for OEM Pro and Non-Pro remained at normal levels. As Satya said, we're seeing strong growth in Windows 10 enterprise deployments. +The annuity portion of our Windows commercial business grew again in constant currency, as customers continued to commit to our differentiated security and management solutions. Overall, our total Windows commercial business revenue across small and mid-size businesses, enterprises, and academic institutions was flat, and grew 2% year over year in constant currency. +Patent licensing revenue increased this quarter, primarily due to favorable results in our annual contractual agreements. Our search business grew again this quarter, driven by rate and volume improvements in Bing. Though our growth rate has moderated, we continued to gain share and scale while delivering profit. +As expected, devices revenue declined this quarter. Revenue decreased 27%, down 25% in constant currency, due to Phone, where revenue declined 72% and 71% in constant currency. Surface revenue increased 38%, 39% in constant currency, driven by year-over-year growth for SurfacePro 4 and Book, which launched in Q2 of the prior year. +In gaming, revenue declined 5%, or 4% in constant currency, due to lower console hardware revenue. We continue to see strong engagement on our platform, with monthly active Xbox Live users up 21%. Our software and services revenue from console, PC, and other gaming devices grew 6%, or 8% in constant currency. +Segment gross margin dollars declined 1%, up 1% in constant currency, as decreases due to Xbox consoles and Phone were partially offset by our search and Surface results. Segment gross margin percentage improved slightly, given the revenue shift to higher margin products and services. Operating expenses decreased 13%, also 13% in constant currency, primarily based on reduced Phone spend and lower marketing spend, resulting in segment operating income growth of 26% and 31% in constant currency. +Now back to our Company results. We invested $2.3 billion in capital expenditures, a decline from Q4, but consistent with our plan for investment to support customer and partner demand for our commercial and consumer cloud services. During the quarter, we continued to rebalance our investment portfolio, which resulted in other income and expense of $100 million from net recognized gains on investments and income from dividends and interest, partially offset by interest expense. +Our non-GAAP effective tax rate was 17% this quarter. As I've mentioned before, our income tax rate is impacted by three factors: the proportion of service revenue versus licensing revenue; the geographic mix of revenue; and the timing of equity vests. In our first quarter, equity vests impact the rate more significantly than in other quarters. +We returned $6.6 billion to shareholders through stock repurchases and dividends. We also raised our quarterly dividend by 8% to $0.39. With that overview of the quarter, let's turn to the outlook. My commentary for the upcoming quarter does not include LinkedIn. We still expect the transaction to close in the second quarter. +Turning to FX, we expect 1 point of revenue impact at both the total Company and individual segment levels. We expect our commercial business to remain healthy. Though we will still see and experience variability in our transactional business, we will also see strong annuity growth, driven by solid renewal execution and increasing customer adoption and use of our cloud services. Therefore, we expect commercial unearned revenue to be within the range of $21.05 billion to $21.25 billion. +Next on CapEx: we will continue to invest to meet growing demand and see quarterly variability in spend. We expect a sequential dollar increase in the upcoming quarter. For the full year, our total expected CapEx growth rate should be lower than FY16, given efficiency improvements. +Now let me share some additional thoughts for each segment. In Productivity and Business Processes, we expect revenue of $6.9 billion to $7.1 billion. We expect the ongoing transition to the cloud to drive installed base growth, with continuing declines in our transactional business. For the Intelligent Cloud segment, we expect revenue of $6.55 billion to $6.75 billion, driven by strong annuity growth across our server products and cloud services. +We anticipate that Enterprise Services revenue will decline due to lower volumes of Windows Server 2003 service agreements. We expect More Personal Computing revenue to be $11.2 billion to $11.6 billion. This segment is impacted by different trends than our other two segments, so some additional detail. +First, on Windows. We expect our OEM business and the underlying PC market to be closely aligned. As a reminder, in our OEM Pro business, we exited Q2 last year with a slightly higher level of inventory. We currently see normal inventory levels in the channel, which will dampen year-over-year growth a bit. +In Search, we expect Bing's revenue growth ex-TAC to be similar to Q1. Additionally, we expect that total Search revenue growth will slow considerably, as we pass the one-year anniversary of our Yahoo deal, and the associated change in revenue recognition. Phone revenue will continue to decline, and as we previously announced, we anticipate closing the sale of our feature phone business in Q2. +We expect Surface revenue to decline, as we anniversary the product launch from a year ago. And in Gaming, we expect strong share performance in key markets like the US and the UK this holiday, but overall revenue will decline, given lower price points and lower overall console units, as mix shifts towards Xbox One and Xbox One S. We expect continued active engagement growth on our gaming platform given the holiday season. +We expect COGS to be $9.7 billion to $9.9 billion, with variability driven by device sales. We expect operating expenses between $7.85 billion and $7.95 billion in Q2, and we remain on path for full-year operating expense of $31.1 billion to $31.4 billion. We expect other income and expenses to be $150 million, as we continue to balance gains on equity investments and income from interest and dividends against the interest expense and the net cost of hedging. +We continue to expect our full-year tax rate to be 20%, plus or minus 2 points, with variability due to the three factors discussed earlier. And with that, I'll turn it back to Chris for Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. We will now move to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Brent Thill, UBS. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [2] +-------------------------------------------------------------------------------- +Thanks, good afternoon. Satya, on Azure, the numbers were really impressive, given how hard the comp was. I'm curious if you could just help out, a little more color in terms of what you saw during the quarter, and maybe how some of the ticket sizes or size of these signs are changing from the past year? Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Brent. Overall, again, I go back to how we think about Azure. We really have a view of distributed computing, which is more expansive than just even our hyper-scale cloud. We think about Azure and our servers as one distributed computing fabric that they're building. +We also don't think of Office 365 and Dynamics 365 as independent; we think of them all together, building out our commercial cloud, because take one of the bigger growth areas we have in Azure, it is IoT. But it's not just people connecting sensors and collecting data. +They collect the data, they store the data, they analyze and do predictions on it. But then after you do predictions, you've got to do something about the predictions. So in many cases they choose to use, especially with the new Dynamics 365 field service module, automating field service. +So it is those higher-level scenarios that we are seeing in addition to the core infrastructure that supports hybrid that I think is accelerating, and that's something that obviously we didn't make the decision last quarter to do that. +This is a decision we made many, many years ago; in some sense, the inception of Azure was built for a future which is much more distributed computing done in a very different way than the client server era. I think we're just finally getting into the early innings of what is true hybrid computing, and it's good to see those in last quarter's results as well. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [4] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- +Thank you, guys, for taking the question, and very nice quarter. I want to zero in on Office 365 a little bit. 40% growth in commercial seats is a really nice number, but even a nicer number on the revenue line, I think 54% constant currency growth in Office 365 commercial. That seems to imply you guys are seeing some nice ASP increase as the platform matures. Can you talk to us about where we are in that cycle of guys moving from E1 to E3? Is E5 part of the equation yet; are guys actually moving there yet? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [8] +-------------------------------------------------------------------------------- +Thanks, Keith. Why don't I take that one? When I talk about the premium services mix in our Office commercial 365 business being above 60%, that is what's driving, whether that's the mix shift to E3 or ultimately to E5, you will continue to see it have headroom in that number. But you are right, we are encouraged by the ARPU growth and the value proposition that has customers choosing the premium SKUs and continuing to choose those premium SKUs over time. +I don't really think about there being a cap on that when you think about the mix percentage. Because part of it is, as you know, not just adding the first few nodes in E3, it's continuing to add E5 and new scenarios over time that will continue to create. So hopefully that's helpful, but you are right, it is ARPU-driven, the performance outside of the 40% seat growth. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Excellent. Thank you, guys. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [10] +-------------------------------------------------------------------------------- +We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [12] +-------------------------------------------------------------------------------- +Great, thank you. Satya, I know that Brent asked you about Azure, but I'm just wondering if you could share with us, you mentioned that compute usage on Azure, I think you said more than doubled or nearly doubled, something to that effect. I'm just wondering if you could share with us how you see paths coming along and where do you think we are in getting the easier workloads to the cloud? And are you now starting to see the inflection, given we did see an inflection in growth on a year-over-year basis this quarter where you are starting to see significant production workloads that are on-premise actually starting to move over as well? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [13] +-------------------------------------------------------------------------------- +Thanks, Heather. We definitely are seeing production workloads that are moving over from on-premise. But I think the more interesting thing, Heather, for us is to see new workloads. When I look at what's happening with [stage 6] some of the most innovative work we've done around distributed computing, which is service fabric, and how people are in fact going straight to building out, using our path services, some of the new hyper-scale cloud services using Micro Services. +And not only are they doing that, but we're also seeing great growth in our server-less infrastructure, which is Azure Functions. So I am actually as excited about new cloud growth from new cloud workloads from the same customers, so the most interesting thing that I am observing is that it could be the same model of customer that was participating with us in the client server area who are not just building or moving their IT, but they are building new digital services for hyper-scale. And that's what is probably unique in terms of what is changed year-over-year for us. It's not just the Silicon Valley startups anymore; it is the core enterprise that is also becoming a digital company. And we are well-positioned to serve them, and that's good to see. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- +Thank you so much. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [15] +-------------------------------------------------------------------------------- +We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [17] +-------------------------------------------------------------------------------- +Question for Amy. The operating cash flow generation, $11.6 billion, was extraordinary. I don't think you've had a 50%-plus cash flow margin since early 2012. Is this a little bit of an anomaly, maybe driven by unearned revenues? Or is something changing in the business model that might change the rate of cash flow generation in coming quarters as well? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [18] +-------------------------------------------------------------------------------- +Karl, it is actually impacted by the same thing that impacted free cash flow this quarter, which is about a $1.3 billion unsettled cash -- a cash settlement impact. So you'll actually see that revert in Q2, although our free cash flow growth of 8% in the quarter was actually very good, and I do feel good about that. But I want to make sure you don't misunderstand the root cause that makes the number a bit of an anomaly. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [19] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [20] +-------------------------------------------------------------------------------- +Thanks, Karl. We'll take the next one please. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [22] +-------------------------------------------------------------------------------- +Thank you, and congrats on the quarter. So want to drill in a little more. The margin for commercial cloud improved 7%, which given the size, is a large improvement. Can you give us some more details on what exactly is driving that margin improvement? You said it's going to be improving over the year, but how sustainable is that drive to improvement? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [23] +-------------------------------------------------------------------------------- +Let me start, Mark, and then, Amy, you can add to it. Again, Mark, this goes back to a little bit of understanding, how we think about both CapEx as well as OpEx in terms of our cloud. The architectural design we have, for example, when we do CapEx, we are buying the equipment for everything that Microsoft does, which is everything from Azure to Office 365 to Dynamics 365, as well as our consumer services, like Xbox Live. +And you see the growth that we talked about across all of this. Then we have a very common platform, both for our first-party workloads, as well as our third-party business. And so then as we drive efficiency in our cloud infrastructure, when we for example use FPGA to get more out of our network, that's efficiency that we gain across the marginal cost and gross margin that spans everything that we do. +Then also what we think about as the mix, our goal is not just to sell commodity services, but to actually use commodity services, in some cases, as a bootstrap for higher-level services, because of things like data gravity. So there will be differences quarter to quarter. We may, in fact, onboard a few customers who first onboard a lot of storage at commodity service levels, and then later on start consuming some of the higher-level services. +So the margin improvement over a period of time is something that we are absolutely going to see, but for quarter-to-quarter there will be more volatility, but I would ask our investor base to think more about the architecture as well as the financial outlays of what we're building. We're not just building Azure; we're building Azure, Office 365, Dynamics 365, as well as our consumer services, which are all cloud-oriented. And it's the combination of that that's driving margin. But Amy, I will let you add to it. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [24] +-------------------------------------------------------------------------------- +I would say on terms of sustainability, or quarter to quarter, Satya is right. There is going to be variability. The variability is really two things. One is the pace of the mix shift to Azure. As it grows at the pace we've seen, it does impact quarter-to-quarter the overall commercial cloud revenue mix. +But I would also say the directionality of the Azure gross margin, for example, which we said significantly improved, we expect to continue, certainly over the course of this year, as we have discussed. So I think the directionality of sustainability is correct. And I think the variability could certainly occur for many of the reasons Satya has talked about. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [25] +-------------------------------------------------------------------------------- +Thanks. Appreciate it. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [26] +-------------------------------------------------------------------------------- +We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Walter Pritchard. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [28] +-------------------------------------------------------------------------------- +Amy, I am wondering on the segment operating margins, I know you don't guide those per se, but you have flat performance in operating income in PBP and declines in IC with growth in MPC. Do you expect to see, as we get towards the end of the year, that the two enterprise cloud segments move positive and MPC is not as much of a driver? How should we think about the evolution of the product contribution of the three segments over the year? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [29] +-------------------------------------------------------------------------------- +Sure. I am actually going to cover our commercial segments as one. Because really, when you think about the commercial cloud, it's really about capturing the opportunity of selling more complete solutions, which include Dynamics and Office, plus some components of Azure which is, I think, really the trend you'll see us talk about from here on out. So what I would say is, you will continue to see us focus on gross margin improvement, and we've talked about that. +You will also continue to see us invest where we see massive market addressable expansion with sales capacity as well. So I think we have pivoted dollars to invest in that opportunity. You will continue to see us do that. But we also expect revenue growth and gross margin growth to come out of that investment. +So I do believe that's the continued pace you will see us on, and we feel good about the ROI of the investments we have made, especially in those commercial segments. In MPC, I generally expect you will continue to see improvement through the year, just based on the mix of products that we will have over the course of the year. That's not new. +You saw the same mechanism last year through the year as we pivot from our phone business to some of our higher-margin products. And so, I suspect you will see a similar pattern on a similar desire by Satya and I to continue to invest toward growth, especially on the commercial side. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [30] +-------------------------------------------------------------------------------- +Thanks, Walter. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [31] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [32] +-------------------------------------------------------------------------------- +We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [34] +-------------------------------------------------------------------------------- +Thank you. I will add my congratulations. So, Amy, you are reporting an impressive buildup of the long-term deferred revenue; it's up 162% year-over-year. At the same time, some of your partners feel that you are gradually doing away with the three-year EAs that have existed for so long, and that you are replacing them with the MPSA vehicle, which is a little more flexible in terms of length of contract, and there could be some shorter lengths. +Could you help us in terms of how to think through the long-term deferred revenue buildup as you do start to mix over to the MPSAs? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [35] +-------------------------------------------------------------------------------- +Thanks, Mark. Let me break apart that long-term unearned balance a bit. I do really focus, and I think it's important if you're trying to understand the buildup of our commercial business to focus only on the unearned commercial balance. Our overall long-term unearned balance has been impacted by the Windows 10 deferral over the past bit. And so, it can make a bit of a distraction towards seeing the underlying trend. +That being said, our commercial unearned balance has seen good growth; I'm proud of our performance this quarter, both sequentially and year-over-year. If you think about any change we're making or not, in our partner agreements, our customer agreements, we still do generally rely the vast majority on three-year agreements. So whether or not the term were to change, given how we recognize revenue, I would you let know if it was going to be material. And I do not expect the change you are talking about to be material in any way on the commercial unearned balance. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [36] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [37] +-------------------------------------------------------------------------------- +We will go to the next question, please. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- +Thanks for taking my question, and congrats as well. Quick question more on an industry theme for Satya. We obviously saw a very interesting answer from AWS and VMware, which seems to suggest a hybrid cloud is the way forward, and both vendors have to react. Can you talk a little bit about your customer feedback around the hybrid cloud offering from you, and how your customer is thinking about that working with you together? Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [40] +-------------------------------------------------------------------------------- +Thanks, Raimo. I spoke to this a little earlier, because in some sense, from day one we had this vision of how we want to build for a future of distributed computing that included our hyper-scale cloud service, which is Azure. And in fact, Azure is built on hyper-V, and we always said that we were going to build our server as the edge of our hyper-scale cloud, and so that's what Windows Server 2016 represents. That is what SQL Server 2016 represents, and so we have these unique capabilities, like being able to stretch even a single table in a database in SQL 2016 all the way to the cloud for having infinite table capacity, and then having your apps and queries work. +How we're doing containers: for example, in Windows Server 2016, we have great container support, as well as support for things like our Service Fabric, so that people can have absolute application portability, and in fact, people can even tier applications. We have had many customers who tier their storage and compute across a hybrid backplane. So this is an architectural design point that we have built for from the ground up from day one, and it's good to see people validating it now and elsewhere, and we will take that as a validation of something that we thought of a long time ago. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [41] +-------------------------------------------------------------------------------- +Thanks, Raimo. We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- +Thank you very much. Satya, can you just compare and contrast AWS versus Azure, Azure versus AWS from a standpoint of the technology footprint that you are offering both these companies? And Amy, if you could just comment on the margin structure of your Azure business relative to AWS, and if you have time, talk about the Windows 10 cycle. Why is it going to be the best Windows 10 cycle for the enterprise, compared to the previous cycle? Thank you so much. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [44] +-------------------------------------------------------------------------------- +Kash, I would say I talked about the reasons, the three big reasons why customers choose our cloud, and our cloud infrastructure in particular. One, it is about the hybrid design point that is at the core of how we are built, both Azure as well as our servers. It is because of the higher-level services that we have. +It is also because of the design point we have around not just Azure, but as well as Dynamics 365 and Office 365, and the extensibility of our cloud services across all three of them. And that's really the fundamental reasons why customers choose us. The other thing I would mention is, we have more of a commitment, I would say, which has been there from a long time, to build out a global footprint. We have more regions than anyone. We have more certifications than anyone in terms of adhering to both regulated industry, as well as digital sovereignty needs. +We've done unique things. We're the only public cloud provider, for example, that operates in China. We operate in Germany under German law. And that matters to multinational companies that also are trying to operate across many geographies and jurisdictions. So those are our core attributes that are driving our growth, and we'll continue to stay focused on them. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [45] +-------------------------------------------------------------------------------- +In terms of the gross margin question, I feel very good to talk about this quarter, about our improvement year-over-year and remain confident that we are heading in the right direction. And so, I think when you think about that plus the breadth of our offerings, I think we're pretty confident. +I will take the opportunity, because we haven't been asked about Windows 10 in the enterprise. I think we are encouraged by the pace of deployment, the number of proof-of-concepts, and actually some of the stability we've seen in the commercial PC market, in terms of starting to see some refresh rates. So I think overall, I think we will continue to watch, but our security and management value prop, I think really is paying off. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [46] +-------------------------------------------------------------------------------- +Thanks so much. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [47] +-------------------------------------------------------------------------------- +You bet. We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [49] +-------------------------------------------------------------------------------- +Thank you very much, and congrats from me as well. Satya, I actually had a question for you on SQL Server. As you think about the port to Linux, I wonder if you can provide an update on two things: one is just the timing of when we should see that in market, and then two, are there other things you need to do to meet that requirement of across the landscape? +So, for example, do you have to think about supporting Java runtimes inside of SQL server, moving a little bit away from the traditional thought net development environment. Just curious as to how you are thinking about getting your arms around a wider set of use cases on alternative operating systems. Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [50] +-------------------------------------------------------------------------------- +Overall, we are very, very excited about what we are seeing with SQL on Linux, because the entire idea was to be able to have a full conversation around the data estate with customers. And to now be able to talk about the full SQL estate, one of the other conversations that we are having is not just about SQL, but our analytics and advanced analytics with R, where we've done some very, very compelling work, again, across Linux and Windows. +And then, of course, the cloud. So it's really the combination of SQL advanced analytics and the cloud, with things like Azure Data Lake, that are really the choices customers are trying to make as they think about their digital capability and the next generation of services and both the storage and processing capability they need. +Now, in terms of having support for these different runtimes, you're absolutely right, that's the reason why, for example, on Azure itself, Java is first-class. We have Linux is first-class. We have real openness to all of the frameworks that you can call out to, and that's something that we stay very attuned to, which is we are not trying to fight some old battles. This is all about being able to serve customers on their needs today, and that's what is leading and driving a lot of our choices, as well as how we think about our market opportunity. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [51] +-------------------------------------------------------------------------------- +Thank you, Ross. We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Gregg Moskowitz, Cowen. + +-------------------------------------------------------------------------------- +Gregg Moskowitz, Cowen and Company - Analyst [53] +-------------------------------------------------------------------------------- +Thank you very much, and congratulations as well. Satya, you're making a much bigger bet on AI, and rightfully so. And you highlighted some very interesting use cases. Having said that, Microsoft has worked on AI projects for quite some time. So can you help us understand what degree of positive change you think will come from the combined group that you have recently formed, including when you think material AI benefits will become truly ingrained in your customers' workflows? And then secondly, how should we think about your incremental investment in AI going forward? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [54] +-------------------------------------------------------------------------------- +Overall, I am thrilled about both the AI group that we have formed, the AI research and the heritage we have with MSR. Even this week, I think we publicly are talking about setting the state-of-the-art when it comes to something like speech recognition, and it's something that we did even with image net and image recognition and object rec. So these are capabilities that are not easy to build if you don't have a real commitment to research, and then the ability to take that research and then ultimately turn it into products. +So the way to measure, though, from the investment side, is to see AI when it is infused into everything we do. Take HoloLens. The ability of HoloLens to be able to see the world, reconstruct it, and in that world to be able to superimpose holograms, that is AI -- applied AI that is working today. When you have Skype translate when two people are talking two different languages and are able to automatically translate without an interpreter between languages, it's using a deep neural net that is bringing together speech synthesis, speech recognition, and machine translation with Skype data. That is fairly magical. +When you seeing FPGA capable of running CNTK or TensorFlow to create intelligence, that is what we are using, in fact, for our speech and vision work. That is AI as applied today. So I am not waiting for some future date to see ROI from AI; we're very much going forward, even the Office tools example I used. They're all using AI today. +The PowerPoint designer, if you want the most practical use of it, even I can design great PowerPoint slides now because of AI. And so, that's how I measure progress. We are committed to long-term research, but we're also very focused on having the long-term research translated into everyday use products, and that's what you will see from us going forward. + +-------------------------------------------------------------------------------- +Gregg Moskowitz, Cowen and Company - Analyst [55] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [56] +-------------------------------------------------------------------------------- +We will have time for one last question please, Operator. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- +Brad Reback, Stifel. + +-------------------------------------------------------------------------------- +Brad Reback, Stifel Nicolaus - Analyst [58] +-------------------------------------------------------------------------------- +Great, thanks very much. Amy, quick question. With the recent release of Win Server 16, is there any reason to think that we shouldn't see some uptick in the transactional business, especially with the easing comps in the next couple of quarters? Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [59] +-------------------------------------------------------------------------------- +Thanks, Brad. With our annuity mix as high as it is, it can impact it a couple points either way. But I don't think about that as really a material impact you should think about in the next couple of quarters. And our focus will always be making sure where we have a clear roadmap for customers to make long-term commitments through annuity. And so we are really trying to get away from some of that, quote-unquote, launch impact that you may normally expect to see. + +-------------------------------------------------------------------------------- +Brad Reback, Stifel Nicolaus - Analyst [60] +-------------------------------------------------------------------------------- +Great, thanks very much. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [61] +-------------------------------------------------------------------------------- +So that wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, these events will be webcast, and you can follow our comments at the Microsoft Investor Relations website. Please contact us if you need any additional details, and thank you again for joining. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [62] +-------------------------------------------------------------------------------- +Thank you all. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- +Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2017-Apr-27-MSFT.txt b/Transcripts/MSFT/2017-Apr-27-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..f8781fc47320a138c9b3d20f7b182e63e0c40842 --- /dev/null +++ b/Transcripts/MSFT/2017-Apr-27-MSFT.txt @@ -0,0 +1,463 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Microsoft Corp Earnings Call +APRIL 27, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO and Non-Independent Director + * Amy E. Hood + Microsoft Corporation - CFO and EVP + * Chris Suh + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Stewart Kirk Materne + Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Ross MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Senior Equity Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to Microsoft's Third Quarter Fiscal Year 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Thanks, Maria. Good afternoon, and take you for joining us today. On the call with me today are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provide the reconciliation of differences between GAAP and non-GAAP financial measures. +As a reminder, this is the first full quarter of LinkedIn results. As a result, comparisons made to prior years will be affected accordingly. During the call, Amy will discuss the financial impact of LinkedIn as she provides the overview of business results for the quarter. Our key investor metrics remain unchanged due to the LinkedIn acquisition. +Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We'll also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until April 27, 2018. +During this call, we will make forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Chris, and thanks to everyone on the phone for joining. Today, I'll share the results of the third quarter and discuss what's ahead. +I'm proud of the progress this quarter. We delivered $23.6 billion in revenue, up 7% in constant currency. Across all industries, organizations are looking to digitally transform with the state-of-the-art cloud services, AI and new natural user interface technology. Increasingly, these organizations are turning to Microsoft as a partner they can trust for the innovation and building their own digital capability. +Now let's look at the progress we made this quarter by segment, starting with Productivity and Business Processes. We crossed a major milestone with more than 100 million monthly active users of Office 365 commercial. Office 365 commercial seats grew 35% year-over-year and revenue is up 45% in constant currency. +Across industries, customers recognize Office 365 is the productivity platform of choice. Companies like H&R Block, Johnson & Johnson, Deutsche Börse AG, LVMH has all chose Office 365. And we continue to innovate and add new value. This quarter, we made Microsoft Teams broadly available to Office 365 customers in 181 markets. Our new chat-based workspace is already empowering a new way to work for more than 50,000 customers, including Accenture, J. Walter Thompson, J.B. Hunt and Expedia. Teams also creates a new platform opportunity for developers to reach 100 million Office 365 users with rich extensibility for bots, apps and services. +Additionally, we're expanding the relevance of Office 365 to new segments. Retail, hospitality and manufacturing companies have a huge need to empower their frontline employees. Our expanded offering for this segment includes Microsoft StaffHub, Teams, OneDrive, Skype for Business and more to give these critical employees a robust collaboration toolkit to maximize their impact. +Now let me talk about the second part of our ambition in this segment, reinventing business process. Accelerating our growth with LinkedIn by driving value for members and customers remains our top priority. This quarter, we redesigned the LinkedIn desktop to create a more seamless intuitive experience across devices. We continue to invest in the LinkedIn feed, bringing curated news and views to help members stay informed on what's most important to them. Our innovation across both the desktop and mobile is driving strong engagement momentum, with sessions up more than 20% again this quarter. +LinkedIn marked an important milestone this week, exceeding 500 million members, and our jobs platform hit new record levels with more than 10 million jobs posted. The strong momentum with jobs and engagement is continuing to fuel the growth across talent, marketing, sales and learning solutions. +We took significant steps this week to redefine social selling with deeper integration of Sales Navigator with Dynamics 365, enabling sales professionals to dramatically increase their effectiveness by drawing on the relationships in their personal networks. Customers like Visa are choosing Dynamics 365 because of our deep integration across Office 365 and now Sales Navigator. I'm excited to put the Microsoft enterprise sales force and partner ecosystem behind this new opportunity. +Dynamics 365 solves a critical challenge for businesses, helping them break free of monolithic siloed suites of applications to unlock insights across the entire organization. You see this in our new Dynamics 365 talent applications, which combines HR business processes with LinkedIn Recruiter to help companies manage the employee life cycle from recruiting to retention. Our innovation in Dynamics is driving strong revenue growth, with Dynamics 365 up 82% in constant currency this quarter. +Now let's talk about the progress we're making in our Intelligent Cloud segment. Our commercial cloud annualized revenue run rate now exceeds $15.2 billion. Customers are increasingly choosing the Microsoft Cloud. They value our differentiated approach as the most trusted global hyperscale cloud with hybrid support and higher-level services to help drive their digital transformation. +Moreover, they appreciate the agility, operational consistency and security across the entire digital estate, spanning Enterprise Mobility, Office 365, Dynamics 365 and Azure. Take Maersk, the largest transport and logistics firm in the world with operations in 130 countries and a fleet of over 1,000 vessels. Maersk began the journey to the Microsoft Cloud with Office 365, Enterprise Mobility and Security and Windows 10. +They choose -- they chose Dynamics 365 for operations to streamline container production and maintenance. Now Maersk is using Azure to digitally transform its supply chain management and global trade. The intelligent services in Azure deliver up-to-the-minute insights on carrier performance and equipment usage with real-time data, visualization and advanced analytics, enabling them to trim costs and create new revenue streams. For a company that ships 17 million containers annually, the ability to react quickly can mean the difference of tens of millions of dollars to the bottom line. This is a great example of our 3 clouds coming together to enable deep digital transformation. +Across industries, customers are choosing Azure. UBS announced they're using Azure for risk management, and GEICO chose Azure for hybrid capabilities. Publicis Groupe announced that they will use Azure and Cortana Intelligence Suite to deliver AI-powered marketing solutions at scale. Flipkart, India's leading online marketplace, chose Azure as the platform to enable their rapid growth. +We continue to rapidly innovate and add new capability to drive further customer value. Microsoft IoT Central is the first SaaS offering that provides the end-to-end solution for organizations of all sizes to manage their entire IoT ecosystem across devices, cloud, analytics, networks and software. +This week at Hannover Messe, the world's largest industrial trade shows, manufacturers showcased how they're using our solutions to transform all aspects of manufacturing, from water management to food and beverage, packaging, to improving safety on the factory floor. +When it comes to AI, this quarter, we made our cognitive services for face recognition and computer vision broadly available to enable any developer to become an AI developer. +We're excited about how Azure Stack and SQL Server are helping define the edge computing paradigm. Azure Stack will enable computers -- our customers to extend Azure capability to their private data center in a truly consistent hybrid computing environment. SQL Server 2017, coming this fall, is the first database with cloud tiering and artificial intelligence built in. It runs on Windows and Linux, supports Docker container deployment and popular programming languages such as R and Python for machine learning and data science. We will share more about all these advances and more at our upcoming Build Developer Conference. +Now I'll turn to our progress in More Personal Computing. Almost 2 years ago, we introduced a new approach with Windows 10, transforming the way customers experience Windows on all their devices. Now customers are always up-to-date, running the most secure Windows ever. This quarter, the Windows business grew 5% in constant currency, and we delivered the next phase of innovation with the Creators Update. +Creators Update is about inspiring the creator in us all. We create technology so that others can create their own content and technology. We want to empower people to paint in 3D or paint with numbers in Excel. We empower people to create in Word or in Minecraft. These new forms of creation and expression are shaping Windows for the next generation. +Gaming is a key scenario to expand our opportunity across the PC and console. We're building on our already strong foundation with Xbox One and our Xbox LIVE community, up 13% to 52 million active users this quarter. With Creators Update, we integrated gameplay broadcasting into Windows 10 PCs as well as Xbox One. We're off to a very strong start with both streamers and viewers. In fact, the majority of the streaming in this industry today is on the PC and console. And we are uniquely positioned to provide the best, most complete gaming experience from hardware to software to broadcast services. It's early days and we are excited to pursue this new growing opportunity. +This quarter, we also revealed more about our forthcoming project, Scorpio, which will be the most powerful console ever and will enable true 4K gaming in the living room. +Our commercial customers continue to adopt Windows 10 as the secure trusted platform of choice. Customers like the Department of Education in the United Kingdom, British Telecommunications, the Adventist Health System, one of the largest health care providers in the United States, all chose Windows 10. +When I talk to businesses and government leaders, they value security and privacy of their data, the reliability of their systems and choice and control over how and when they deploy. We remain committed to our core values of trust, transparency, privacy and security for every customer. +Finally, Devices. This quarter, our Surface results fell short of expectations, impacted by end-of-product life cycle and increased price competition. We continue to innovate and invest in creating new computers and computing experiences. Surface Pro, Book, Hub, Studio, HoloLens are all creating new markets for the Windows ecosystem and pushing differentiation with new natural user interface capabilities: ink, vision, voice, touch and mixed reality. +In the context of mixed reality, we just passed the 1-year anniversary of Microsoft HoloLens. We now have more than 150 exclusive HoloLens apps in the store. Moreover, many of our commercial customers are using HoloLens to drive digital transformation and seeing real impact. HoloLens-based innovation was featured front and center at NRF, HIMSS and most recently, this week at Hannover. Digital transformation across these industries is being shaped by new technologies from IoT to mixed reality to AI and the cloud. +thyssenkrupp Elevator is using HoloLens and Azure to digitize their entire sales and order process, shortening delivery times by 4x, and they chose Dynamics 365 to enable transformation in their steel division. Leading global medical technology company, Stryker, chose Office 365 to empower employees and is using HoloLens to improve operating room design for surgeons, staff and ultimately, the patients. All this creates a strong foundation for the broader opportunity ahead with digital transformation. +I'm proud of the progress this quarter. I'm enthusiastic about what's to come. In the coming weeks, we will share more about how Microsoft is innovating uniquely to empower every customer, from students and teachers to business professionals to developers. Now let me hand it over to Amy to walk through this quarter's results in more detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $23.6 billion, up 6%, and 7% in constant currency. Gross margin grew 7%, and 9% in constant currency. Operating income grew 2% or 5% in constant currency, and earnings per share was $0.73, an increase of 16%, and 19% in constant currency. +This was the first full quarter of company results with LinkedIn, which had a significant impact on revenue, gross margin and operating income. At a company level, LinkedIn contributed approximately 4 points of revenue and gross margin growth and 6 points of drag on operating income growth, which includes $371 million from amortization of acquired intangibles. +From a geographic perspective, our results were mostly in line with macroeconomic trends. Our performance in Japan was better than expected, driven by increased public sector spending and improved market conditions. Our commercial annuity mix was 88%, even with another quarter of higher-than-expected transactional revenue results. Commercial bookings increased 12%, or 11% in constant currency. Commercial unearned revenue followed historical seasonal trends coming in at $20.4 billion and growing 9%, and 10% in constant currency. And our contracted not billed balance increased to more than $27.5 billion. +Another strong quarter of cloud services performance drove our commercial cloud revenue run rate over $15.2 billion, growing 52%. Our commercial cloud gross margin percentage increased to 51%, up 6 points from last year, with improvement across Office 365, Azure and Dynamics. And gross margin dollars grew 74%, keeping us on pace for material gross margin percentage and dollar improvement this fiscal year. +As a reminder, our commercial cloud includes Office 365, Azure, Dynamics 365 and other cloud properties, but does not include LinkedIn. Our company gross margin was 66%, better than anticipated and up 1 point as the sales mix of higher-margin products and services, coupled with commercial cloud margin improvement, more than offset the impact of $218 million of LinkedIn amortization. +Now to FX. This quarter, the U.S. dollar was weaker than expected. As such, we had 1 point less FX impact across our individual reporting segments even though overall company impact was still approximately 1 point, as guided. FX impacted the Productivity and Business Processes and Intelligent Cloud segments by 1 point and had minimal impact in More Personal Computing. Total operating expenses grew 12%, with LinkedIn contributing 13 points of growth, including $153 million of amortization of acquired intangibles expense. +Now let's move to segment results. Revenue from Productivity and Business Processes segment grew 22% and 23% in constant currency to $8 billion, with LinkedIn contributing 15 points of growth. Office commercial revenue increased 7%, and 8% in constant currency. Office 365 commercial revenue increased to 45%, driven by installed base growth across all workloads and continued ARPU expansion. +Our transactional results came in higher than expected, mostly from performance in large markets like Japan and Western Europe. Office consumer revenue increased 15% and 14% in constant currency, primarily from recurring subscription revenue as well as growth in our subscriber base. +Our Dynamics business grew 10% and 11% in constant currency, with Dynamics 365 customer momentum contributing to double-digit billings growth. LinkedIn revenue for the quarter was $975 million. Segment gross margin dollars grew 15% and 17% in constant currency, with 11 points of contribution from LinkedIn, including $218 million of amortization of acquired intangibles. +Gross margin percentage declined due to a higher mix of cloud revenue and the impact of LinkedIn-related amortization. Operating expenses increased 44% and 45% in constant currency with 43 points from LinkedIn, including $153 million of amortization expense. Operating income declined 7% and 4% in constant currency, with 13 points of impact from LinkedIn. +The Intelligent Cloud segment delivered approximately $6.8 billion in revenue, growing 11% and 12% in constant currency. Server products and cloud services revenue increased 15%, up 16% in constant currency, demonstrating durable double-digit growth. Azure revenue increased 93%, up 94% in constant currency and annuity revenue again grew double digits. Azure Premium revenue grew triple digits for the 11th consecutive quarter, with more than 80% of Azure customers using our premium services. +Our Windows Server and SQL Server transactional business continued to perform well, with better-than-expected results mainly from Japan and continuing post-launch demand. As expected, Enterprise Services revenue declined 1% and was flat in constant currency due to a lower volume of Windows Server 2003 custom support agreements. +Segment gross margin dollars grew 6% and 7% in constant currency, and segment gross margin percentage declined due to an increasing cloud revenue mix and lower Enterprise Services margins, partially offset by material improvement in Azure margins. We grew operating expenses by 11% with ongoing investment in sales capacity, cloud engineering and developer engagement. Operating income was flat and up 3% in constant currency. +Now to More Personal Computing. Revenue was $8.8 billion, declining 7% as phone and Surface results offset healthy growth in Windows, search and gaming. Our OEM business grew 5% this quarter. OEM Pro revenue grew 10% ahead of the commercial PC market mainly due to a higher mix of premium SKUs. Additionally, the commercial PC market was slightly below our expectations, negatively impacted by channel production timing changes and upcoming Windows SKU pricing changes. Commercial end customer demand signals remained consistent and positive. OEM non-Pro revenue declined 1%, ahead of the consumer PC market, with continued positive impact from the Windows premium device category. Overall, inventory levels remain in the normal range. +Windows commercial products and services grew 6%, with healthy enterprise demand as customers continue to deploy Windows 10 for its advanced security and management capabilities. Patent licensing declined this quarter, primarily from lower revenue per unit. Search revenue ex TAC grew 8% and 9% in constant currency, driven by higher revenue per search and search volume. +Devices revenue declined 51%. We had no material phone revenue this quarter. Our Surface business declined 26% and 25% in constant currency as heightened price competition and product end-of-life cycle dynamics resulted in lower-than-expected Surface Pro unit volumes. Our gaming business grew 4% and 6% in constant currency as Xbox LIVE revenue growth offset declines in hardware. Xbox LIVE monthly active users grew 13% across Xbox One, Windows 10 and mobile platforms, which contributed to software and services revenue growth of 7% and 8% in constant currency. +Segment gross margin dollars were flat, up 2% in constant currency. Gross margin percentage increased with a sales shift to higher-margin product and services. Operating expenses declined 11% and 10% in constant currency from lower phone expense and Surface launch-related marketing spend in the prior year. Operating income grew 20% and 23% in constant currency. +Now back to overall company results. We invested approximately $2.1 billion in capital expenditures, including capital leases, less than we expected, as a portion of the expense will move into Q4. Other income and expense was $322 million, greater than originally planned as we saw more opportunities in the equity market to realize gains during the quarter. +Our non-GAAP effective tax rate was approximately 23%. We returned $4.6 billion to shareholders, continuing our balanced approach to capital allocation through share repurchase and dividends. After a period of accelerated buyback, we've resumed a buyback pace consistent with our historical trend. +Now let's turn to the outlook. First, FX. Given current rates, we now expect less FX headwinds in our fourth quarter. We expect about 1 point of negative impact on total revenue. Within the segments, we anticipate about 2 points of negative impact in Productivity and Business Processes and Intelligent Cloud and 1 point in More Personal Computing. +Second, our commercial business. The fourth quarter is an important one for our commercial business, and we expect continued annuity growth and healthy renewals as customers adopt and use our growing portfolio of commercial cloud services. We expect unearned revenue between $26.8 billion and $27 billion, in line with historical seasonality. Additionally, we have a large expiry base in the fourth quarter, and our sales execution on renewals and upsell opportunities, while contemplated in our unearned revenue guidance, should also show up in a larger contracted not billed balance and commercial bookings growth. +Third, capital expenditure. We expect CapEx to grow sequentially and year-over-year. Quarterly spend variability will continue and we remain on track for our full year capital expenditure year-over-year growth curve to slow. +Let's move to the individual segments. In Productivity and Business Processes, we expect revenue of $8.2 billion to $8.4 billion, driven by the ongoing annuity shift to cloud and commercial Office 365. In Office consumer, we expect growth rates to moderate from prior quarters, which were impacted by prior year comparables. We expect consistent growth from Dynamics and approximately $1.05 billion of revenue from LinkedIn, adjusted for the impact of purchase accounting. Similar to Q3, we anticipate that LinkedIn, excluding amortization, will have minimal impact on segment operating income, and we continue to expect it to be minimally dilutive to non-GAAP EPS this fiscal year. +In Intelligent Cloud, we expect $7.2 billion to $7.4 billion in revenue. Performance trends from Q3 should continue into Q4, with annuity strength and double-digit revenue growth across our server products and cloud services. Enterprise Services should decline with lower volumes of Windows Server 2003 custom support agreements. +In More Personal Computing, we expect revenue of $8.4 billion to $8.7 billion. In our OEM business, we anticipate that revenue growth will be more aligned with the overall PC market. OEM Pro growth will continue to be driven by Windows 10 enterprise momentum and aligned to a commercial PC market that should return to typical seasonality. +Our non-Pro revenue is expected to be above the consumer PC market, with continued benefit from a strong mix of premium devices. In search, we expect Bing's revenue growth ex TAC to be similar to Q3. In gaming, we expect to see continued healthy user engagement on our Xbox platform and we look forward to E3 in June. We will share more on Project Scorpio and new titles for next fiscal year. +And in devices, we expect revenue to decline with negligible revenue from phone. With Surface, we expect a more moderate rate of decline, given the prior year comparable and current market dynamics. +We expect COGS of $8.2 billion to $8.3 billion. This includes approximately $420 million of LinkedIn COGS, of which $220 million is related to amortization. We expect operating expenses of $9.1 billion to $9.2 billion, with roughly $1 billion from LinkedIn, of which $150 million is related to amortization. We now expect full year operating expenses between $32.9 billion and $33 billion, with approximately $2.3 billion from LinkedIn. That includes about $360 million of amortization expense. Other income and expense should be about $150 million. And for tax, we expect the full fiscal year non-GAAP effective tax rate to be approximately 21%, plus or minus 1 point. +Finally, we encourage you to watch a few upcoming events: our education event on May 2, our Dynamics 365 event on May 3 and the upcoming keynotes from Bill to learn more about our ambitious plans leading into FY '18. We will also host our Financial Analyst Briefing on May 10. The webcast will be available on our Investor Relations website. Chris, let's move to Q&A + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move to the Q&A portion of today's call. Operator, can you please repeat the instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) The first question comes from the line of Keith Weiss from Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + I wanted to dig into Azure a little bit. You gave us some really interesting statistics about gross margins going up, premium mix going up. One of the concerns I hear a lot from investors is what happens when we get these price cuts that go back and forth between you guys and AWS? And it doesn't seem like the price cuts this quarter really affected you guys. So I was hoping could sort of shed some light on it and how -- to what degree do those price cuts actually affect you? And then on the flip side, where does all that growth come from? Where do you get that sort of tripling of premium growth from? What kind of workloads are coming on board to kind of actually drive the underlying growth in that business? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Sure, thanks for the question, Keith. Let me start and then Amy, if you want, you can add. Again, Keith, I talked -- when we look at either the capital expense or the technical architecture -- and the general approach we take is about all of our cloud. When you look at what we're trying to get done between Azure, we don't really see these scenes across Azure, O365, Dynamics 365 and also the things that we're doing with Xbox LIVE, for example. All build as one cloud infrastructure and a set of rich services in the cloud. So for example, some of the cognitive capabilities that are there in Azure first come because of our first-party AI investments, whether it's been speech or vision or anything else. Even the infrastructure that is there in Azure came out of some of our first-party investments in Office 365 or again, Bing and other areas. So we have an approach which takes all of our cloud pieces together. And that same thing is reflected even in the customer journeys. I think the Maersk example I walked you through is probably a good one. While it may start with some commodity workload on Azure or it may start with Office 365, but then it will end up with HoloLens and someone using Dynamics 365 for increased automation. In the case of Maersk, they were using field service and operations inside of Dynamics 365. So to me, those high-level services will, over time, attach in Azure but also in Dynamics as well as in Office 365. So to me, that's why Azure is pretty strategic for us, not just for the attachment of high-level services and what is defined as Azure, but the all-up digital transformation opportunity. That's how Amy and I even think about our margin structure. We need to improve in each one on the elements, but all-up we need to improve because we think that increased opportunity is what's unique about our approach. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [4] +-------------------------------------------------------------------------------- + + And I think what you're hearing in that answer from Satya, Keith, is really about whether the premium services exist as you heard at the Azure layer or whether they show themselves in our Productivity and Business Processes segment. The fact that you may see competition where there may be less differentiation, the real differentiation is where you've always been able to achieve margin and margin expansion, which is in the completeness of the solution or its delivery, the completeness of the business process change or not. And so I think, while I do understand that people ask a lot about that price competition at the lower level, I think what you're seeing is because we're able to continue to move people up the stack, including all the way up to the business process layer, I think you'll continue to see us be confident in our ability to move and create margin and growth. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + I've got a follow-up actually on Azure, maybe to you Satya. And it's the interplay between the cloud piece, Azure, and mostly the on-prem piece, what you guys call the server product. Most of your peers, obviously, when they're pivoting to the cloud, are seeing weakness on the on-prem side, but what's unique about Microsoft is not only is Azure growth accelerating, but your server product growth at 7% is up meaningfully year-over-year as well. So we're not seeing that trade-off with Microsoft. I suspect part of the explanation is that a lot of the Azure growth is net new, but I'm just curious, when do you think customers will actually start migrating existing on-prem Microsoft workloads into Azure such that, that server product line might start to decelerate? Do you think there's a prospect of that occurring in fiscal '18? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [7] +-------------------------------------------------------------------------------- + + Yes, the time frames of these migrations and so on are a lot more complicated than they perhaps appear on the surface. So here's what we think of. For example, right when everyone's talking about the cloud, the most interesting part is the edge of the cloud. Whether it's IoT, whether it's the auto industry, whether it's what's happening in retail, essentially, compute is going where the data gets generated and increasingly, data is getting generated at the volumes in which it's drawing compute to it, which is the edge. So if you look at even our announcements over this quarter, a lot of what we have done with IoT is create an IoT edge. Of course, we have an amazing cloud with sort of the SaaS services for IoT, but the edge compute, the ability to run a neural network at the edge, do inferences at the edge is exciting. Azure Stack is going to completely change what hybrid is and the expectations customers have with hybrid. I mean, GEICO example is a good one. What's happening with SQL Server? SQL Server is no longer just about a database that's on-premise. It's a database that's on-premise that can be tiered with the cloud. Our single table can be extended to the cloud. The queries will work across both the tiering. And so to me, the innovative work we are doing is what I would characterize as the future of true distributed computing, which is it will remain distributed. And that's what we are building towards. We'll talk a lot more and build on -- about that architecture and what we're seeing with customers. Then, given that, what you are saying is true, which is there will be some which will be lift and shift of workloads, but then there is lift, shift and modernizing of workloads. And in that modernizing phase, it's not just being modernized to live only in what is called a cloud, but it will also be modernized to live in the edge of the cloud. And so that's the transformation at play, that's a multiyear and a generational transformation. Quarter-to-quarter, there will be all kinds of volatility, but what is clear to me and clear to Microsoft's engineers is that we have a very clear worldview of what it is that we want to get done and we stay focused on it. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [8] +-------------------------------------------------------------------------------- + + And I think, Karl, to your question about how that shows up, it's why you hear us focus more on the all-up KPIs between Azure and this sort of transactional or on-premise number because the line between them, both strategically and literally, is more important to be blurred and going in that direction. And so this quarter, you saw a little bit healthier than we had thought, I pointed out. It tends to be -- in this instance, Japan was a little better. It can be product launch-related, it can be macro impacted. But whether or not you see that in transactional, the uber trend of being able to see it through the all-up KPI, the dynamics Satya has talked about, you're going to hear us talk more and more about whether it's a "on-prem server launch" or an Azure feature about the integration of the 2. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- + + Again, I had a follow-up on Azure as well. I was just wondering, Satya, if you could share with us, and I know I've asked this in the past, but just kind of any qualitative commentary you could give us about PaaS adoption. And I'm also wondering in particular, given the high percentage of workloads on Azure running Linux, what type of services are you typically seeing run on top of the OS? And how do you see your monetization of those workloads playing out over time? And then Amy, just a follow-up for you would just be -- and I apologize, we did another earnings call tonight, so I might have missed it. But you usually give a comment about out-year OpEx on the call, and I was just wondering if you had any high-level thoughts there. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [11] +-------------------------------------------------------------------------------- + + Sure, Heather, thanks for the question. Overall qualitatively in terms of PaaS adoption of Azure, a lot of it comes with what's happening, for example, in the services we talk about like IoT. We now have a much higher-level managed service. We even launched a new packaging of it with the IoT Central, which allows developers who are building IoT solutions and sort of assembling it themselves to be able to use this managed service to be that much more agile and productive. So that's usually the way we make the atomic parts available as well as these essentially SaaS services or PaaS services. Same thing with data. The DocumentDB is a massive thing for us. It's a planet scale database that supports JSON and much more, and we see that as a core part of the data tier for many, many applications. We even see -- or we see the end-user parts of the infrastructure when it comes to Enterprise Mobility. So all-up, we have multiple pieces. The other area is, of course, the entire tool chain of what's happening with Visual Studio to continuous integration to continuous deployment. And that's a place where we have a very, very differentiated solution for developers and developer productivity, which, in some sense, you can think of as it's kind of like the Office 365 for developers, but that's all part of Azure. So those are the places where there is PaaS services. But as I said earlier in response to the question, we also welcome the use of, I would say, the most atomic building blocks of Azure, whether it just be a Linux container, Azure functions, which is very cost-efficient for developers because we know that over time, maybe not just PaaS services in Azure, it could be, in fact, a Dynamics 365 module. I mean, the canonical example for me is someone who sort of collects data, does a prediction, ultimately then has to do something about that prediction, which means some automation, like field service. So a lot of what is Dynamics field service is actually in our module growth we are seeing because of Azure IoT. And that relationship is not just about Azure PaaS. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [12] +-------------------------------------------------------------------------------- + + And to your specific question, Heather, on FY '18 OpEx, I did not, because we're going to see each other and have more time on May 10 at the analyst briefing, and that's where I'll take some more time to walk through FY '18. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [14] +-------------------------------------------------------------------------------- + + Two questions. What was the drivers of the big growth in Dynamics 365? Is this large seasonality specifically in this quarter? Is it a big deal or should we expect growth in the same vicinity for the -- in your future? And then as a second question, as discussed in the previous -- one of the previous questions about Server & Tools and the healthiness of that growth, I'm trying to understand the drivers. Is this the product refresh cycle? Is it Azure driving customer upgrades? Is it something else? Can you give a bit more color? That would be helpful. I appreciate it. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [15] +-------------------------------------------------------------------------------- + + Sure, Mark, and let me start and then Amy, you can add. On the Dynamics 365, we're at the very, very beginning phase of the transition of Dynamics from primarily being on-premise to now being a very modern, modular SaaS service. The Dynamics 365 momentum is picking up. I talked about the revenue growth rate. And that's definitely going to be what's going to be true in the quarters to come and the years to come. But we do have a huge on-premise base. There is still a need for those on-premise products. That will continue, but our focus is on transitioning to the cloud. And you've seen us do this successfully with Office 365. You've seen us do that with Azure. And now we're ready to do that mainstream across what has been traditionally known as CRM and ERP without, in fact, us thinking and talking about those suites because we think that's a pretty old concept to have suites like that, which is we have now really made the entire Dynamics 365 much more modular, modern and much more efficient for customers, so that's what's happening in Dynamics. Same thing on Azure, which is the driver is -- a lot of it is net new. IoT, for example, was not a workload on the old server world whereas it's one of the big workloads for us. Same thing with AI, not an old workload. So there's new growth in Azure. There is the lift, shift and modernize motion as well as well as a new need for the edge of the cloud. So all 3 of them are in play while recognizing we had a large business called the server licensing business. So we have 3 new things that we are driving and the -- a lot of large licensing pieces that are just transitioning into these 3 motions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [16] +-------------------------------------------------------------------------------- + + And in particular, in this quarter, how to think about, I think, some of the in-period outperformance versus what we see consistently, in the bucket of consistently, premium workload growth has been consistent for us. The double-digit annuity growth has been consistent for us and that, I think, is a driver we continue to look for and be confident in its execution quarter-to-quarter. In the more temporal bucket this quarter, as well as last, you saw a bit of it, some geo help in certain geos that may see and be more transactional in nature. Japan happens to be one of those geos. And then we are still seeing some post-launch impact, specifically in the Windows Server side and selling higher-end SKUs post-launch, which has to do with some of the value inherent. So that's how I kind of break down the drivers, Mark. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [18] +-------------------------------------------------------------------------------- + + Two things, Amy. I think you mentioned in the script that Windows -- there was some Windows volatility around some new SKU pricing. Could you go into some detail there? And then, secondarily, I know we may get this at Analyst Day, but around 606, I know you're going to adopt that early, and I think that will change, to some degree, your annuity revenue. I wonder if you could give us any color, even directionally, on what percentage of that annuity revenue is licensed that after 606 will go up front. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [19] +-------------------------------------------------------------------------------- + + Great. On 606, we will talk about it in detail, actually on May 10, in terms of the timing and what you can expect. You'll also note in the Q this quarter, we do give a look at the initial impact on an annual basis, using last year as an example. The biggest difference on an annual basis with the adoption of 606 will really just be the change from Windows OEM. Now what we will talk about in more detail is that the quarter-to-quarter results in any given year will be a little bit more volatile. But over any annual period, the biggest difference will really just be the change, in some ways, back to how we thought about OEM revenue. So that's what I would think of on 606. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [20] +-------------------------------------------------------------------------------- + + And then question on the... + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [21] +-------------------------------------------------------------------------------- + + Oh Windows. I'm sorry, I answered them in the opposite order. And on the Windows pricing, which we talked about, we do and always have worked with Windows SKUs as we release new products and add new value. This quarter, we had a bit of a mix shift to a higher-end SKU. And starting in April, we've introduced other SKUs that have more value in them at lower processing specs. And so what you'll continue to see is that will normalize. Even though we saw some high-end SKUs this quarter do well, I would expect in Q4 to have the normal breadth of those SKUs and revert back to looking much more like the commercial PC market itself. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Senior Equity Research Analyst [23] +-------------------------------------------------------------------------------- + + Great. So 2 quick questions. First off, Amy, there's been a lot about talk about tax law changes on the corporate side. Would a repatriation holiday impact how you guys allocate capital back to shareholders? And then just real quickly, on the OpEx side, I know you don't want to get too specific, but over the last few years, you've been able to effectively reallocate upwards of $2 billion from the phone business elsewhere. Is there still a fair amount of ability to reallocate internally? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [24] +-------------------------------------------------------------------------------- + + Great, let me take both of those. Let me separate your first question because I think you're really asking too, that I probably don't relate as directly and I should do that for you. We've been a long-time advocate of structural tax reform, and so we'll just wait and see how things play out. And as decisions get made and proposals clarified, we'll share more about what that means for us. Next, in terms of how we thought about that impacting capital return. As you know, I think we've been -- and executed significant capital return program over the past couple of years, including accelerating a buyback program that I think I feel very good about at the corporate level in terms of the value it's created. And so I wouldn't say that I view those 2 things as waiting for one to do the other. We've, in fact, continued to do what we thought created the most value for shareholders, which is to invest in ourselves, acquire companies that help us expand our TAM and grow, return dividends as well as repurchase shares. And we've continued to do that this quarter as well. I think you'll continue to see us take a balanced approach, but I don't think of those as being related. The last question on OpEx, I think over the past couple of years, we've continued to make decisions that said every dollar we spend, are we putting it in the right place for the long term, whether that's reallocating or adding new. And what we expect is to grow new markets and perform really well in them with every dollar that we invest, whether frankly, Brad, it's in OpEx or in COGS. At this point, both of those are very large buckets of investments. What Satya and I as well as the whole senior leadership team spend the majority of our time, picking markets and making sure we execute in them. So in terms of our ability to continue to do that, of course, there's opportunities. We learn frankly, I think, every week where we can do better and where we can continue to invest to accelerate. That being said, I don't view any OpEx number as a constraint. More, I view, is the return healthy? Is it growing the top line? Are we executing well on it? And if we are, it will make sense to spend more, and if we aren't, it won't. And so I tend to take that approach as opposed to solving for any one number. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Kirk Materne with Evercore ISI. + +-------------------------------------------------------------------------------- +Stewart Kirk Materne, Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst [26] +-------------------------------------------------------------------------------- + + Amy, I want to follow up on your last point around investment and return on it. Around this time last year, you guys started spending a lot more or investing a lot more in OpEx on the Intelligent Cloud side in particular. This quarter, you saw Intelligent Cloud operating profit, on a constant currency basis, get back to growth again, which I think shows that those investments were indeed -- made some sense. Now that you've spent a lot, you've obviously added a lot in sales and marketing resources, R&D resources on that front. Could you just give us, I guess, qualitatively how you're thinking about that? It seemed like last year, you needed to catch up to a certain degree in terms of go-to-market capabilities. Do you feel better, I guess, where you are today versus your position, say, a year ago just in terms of being able to capture the opportunity on the Intelligent Cloud side? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [27] +-------------------------------------------------------------------------------- + + I'll start and then I'll transition to you, Amy. I mean, I don't view it that narrowly quarter-to-quarter or even year-to-year. These are generational opportunities, what's at play when it comes to the Intelligent Cloud or what's happening in augmented reality. Either one of those things, I think if we started viewing it quarter-to-quarter or year-to-year, we'll completely miss the trend. We definitely need to be smart about 2 things that Amy said before, which is pick markets that are secular growth markets and got big TAM. And most importantly, what's our role in it? Is this something that the world needs Microsoft to be doing? Or is it well served by others? That's where we spend most of our cycles in. The fact that we put some salespeople, and then there's increased productivity is something that we obviously celebrate and we track very closely. But the places where we are more likely to go and put our OpEx in the coming quarters, in the coming years are going to be about revenue that's going to show up for multiple years out. And it won't be very transparent to you, right, and that's how it is. I mean, if we had not gotten started on some of the distributed computing infrastructure in a completely different place, we wouldn't even have Azure. But I completely understand that all of you measure us by what we have done for you lately, and that's a fine way and we'll keep account of it, but that's not how it works. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [28] +-------------------------------------------------------------------------------- + + Yes, and I think the important part in what Satya said is the distinction between really engineering investments that take multiple years of investment and worldview on a TAM and holding ourselves accountable to sales and marketing investments and are they earning the right return? Are we doing them in the right way? Are they in the right market? Are we investing in the right types of people and the right capabilities? What I look and say that this number shows is that we are doing, and it is encouraging, that the plan that we put in place that the sales team has done a really terrific job of executing on. And all that does is build more confidence that both we picked a good market and we're investing in the right type of people to make sure we land that opportunity at customers. And then the most important thing is that the customer success is what will breed revenue for the next quarter, the next year. And especially in this market, a generational move here really means, especially for many of the workloads being moved, these pay off every year for the next 10. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [30] +-------------------------------------------------------------------------------- + + Satya, I'm curious how is the pace of conversations around Internet of Things, machine learning and cognitive services? And also what are you seeing as the killer app types of use cases that could resonate with customers in terms of the more mainstream applicability? And also Amy, just given the strength in commercial bookings and also commercial bookings guidance, macroeconomically, do you see any signs of enterprise budgets opening up somewhat or different activity levels, more receptivity to transformative projects? I'm just trying to understand maybe how we can separate out your company-specific momentum against any conceivable kind of incremental macro tailwinds. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [31] +-------------------------------------------------------------------------------- + + That's great, so let me start. The best way to think about how people are using, whether it's Azure, Dynamics 365 or other capabilities we have, is in the context of that digital transformation and the outcome. So when you say killer apps, the killer apps are how are customers able to reimagine how they think about customer engagement, how they think about employee empowerment or the operational efficiency or how they can change the products and the business models and the products. And if you look at even the examples I used in this quarterly earnings call, Maersk and what they're trying to do across all of those is pretty transformative. There is machine learning and AI, there is IoT, there is new type of business process automation with operations. All of that is sort of transforming Maersk. What ThyssenKrupp has done in their elevator business and other business units who are using anything from HoloLens to a front-line worker, to how they're fundamentally moving their business model from essentially the margin on the thing, to the margin on the service, which has machine learning and AI built into it. Those are the killer transformation opportunities that we are seeing. And in fact, it's not about, in fact, taking any old workload per se, but it's about reimagining what they want to do across these. And in that context, of course, they are lifting and shifting some of the older workloads but they're modernizing the entire business process flow. And that's what's, I think, the killer opportunity, not any one technology, but the entire flow. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [32] +-------------------------------------------------------------------------------- + + And I think your question about, is it really budgets, I think you used the phrase opening up. What I think is really interesting is, I don't know, I read probably the same CIO surveys you all do. Frankly, the numbers in those in terms of IT spend or intent to spend aren't much different than we've seen. For me, what I think is missing in that question is really -- it's not about any one customer saying, "Wait, I'm going to spend 2% more or 3% more." These are companies actually deciding that change is required, not from an infrastructure perspective but to change how they're running their business itself. And so things that used to look more to them like capital expense through COGS or not just an IT budget, this is literally changing every business process they run or changing the services they offer and thinking about literally driving their revenue differently. And so I don't really associate it probably as much with a "budget" that sits in IT very narrowly. This is really about every budget that sits not just in IT but under every functional leader of a company being spent differently and being spent on our technology. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross MacMillan with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [34] +-------------------------------------------------------------------------------- + + Two, I think, both for Amy. The first is that now that Azure gross margins have turned positive, would you say it'd be reasonable to assume that the [creative] cloud gross margin should continue to increase sequentially going forward? Or could other factors still create some volatility quarter-to-quarter? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [35] +-------------------------------------------------------------------------------- + + Overall, we continue to expect each service is going to get better and better. That happens from 2 things: premium mix, revenue doing well as well as the efficiencies we expect to get in COGS resulting in gross margin improvement. Now to your specific question on can you expect it every quarter sequentially, the answer is not really. The mix amongst the services will always result in a pacing change. And so while year-over-year, you may not see as much, but you will see more sequential volatility as, frankly, you've seen over the past 6 quarters even when we've seen improvements in each of the underlying services, which tends to be how I focus on it a bit more. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [36] +-------------------------------------------------------------------------------- + + That's helpful. And maybe one other if I could. Just on CapEx, I know that it was -- there's a timing delta here between Q3 and Q4, but I just wanted to step back. If you think about your CapEx plans ex LinkedIn as you came into the year and how you think you'll end up, are you going to be about on plan or do you think you'll be above or below? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [37] +-------------------------------------------------------------------------------- + + Thanks. In general, for the full fiscal year, we'll be right at or a little below where I thought we would have been. And so that's why the full year perspective that growth will slow is still on track. And for simplicity, I generally would think about all the delta from Q3, I would encourage you just to move it into Q4 as you think about what to expect. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our last question will come from the line of Philip Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- + + Just a question on Office commercial. You guys reported another strong quarter here, 8% constant currency growth. Obviously, continuing that acceleration that you've had over the first 3 quarters of this year. Now I guess the question to Satya and then Amy. Satya, you still have a positive mix shift going on here because we see the unit count growth but also the revenue growth, so a positive spread there. Maybe help me walk through where you think we are in sort of this life cycle of Office 365 because you obviously have a lot of SKUs. And then Amy, in that context, kind of to the last question on gross margins for commercial cloud. Obviously, you made a lot of headway on Azure. How do you think where we are similarly on the life cycle on the gross margin side of 365? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [40] +-------------------------------------------------------------------------------- + + Yes, I can start. I mean, I think with Office 365, we are trying to expand the appeal of Office 365 on multiple dimensions. A lot of what we're still seeing in play is the rapid adoption or the increased adoption of Office 365 E3, which is what I think is driving a lot of the growth, the ASP growth. Now we have a good start with what is the high end of the enterprise value, which is E5. Some of the value we have, whether it's voice or analytics and security, it resonates. And we're learning, we're improving and we're pushing forward on that front. At the same time, we are also introducing new SKUs for the front-line workers. This is one of the other first-time trends I'm seeing where CEOs on are more interested in productivity of their front-line workers, and so that's another exciting space. It comes at a different ASP point so it's not exactly the same as E5, but very important for us strategically to be able to increase the appeal of Office 365. We also are working to make Office 365 and seeing good traction in segments like small business. The other aspect of Office 365 which is important for us is the international element, because we really never had very high penetration of our higher-end server SKUs in the international markets, and we finally get to sort of do that with the service offering. So those are all the areas where there's significant room left, and we're not just standing still in terms of adding value for new segments, so those are all in play. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [41] +-------------------------------------------------------------------------------- + + And the way you've seen that and I'll relate it to margins, is this continued and consistent installed base growth and even still having the opportunities Satya laid out. And most of the ARPU improvement that we've seen has been, in fact, still due to the E3 transition, not due to the E5 transition, so we still feel quite good about the opportunity, especially in some of the customers that have already moved to E3. And then in terms of gross margin, margin actually here has been steadily improving. We've been in this business a bit longer and it's more mature. I do think, here, the opportunity is also ARPU-based actually here in terms of continuing to see margin improvement, is continuing to raise the dollars per user that we realize to continue to see that grow. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [42] +-------------------------------------------------------------------------------- + + That wraps up the Q&A portion of today's call. We look forward to seeing many of you in the coming months at various investor conferences and events. You can find the details, including webcast information, at the Microsoft Investor Relations website. Thank you for joining us today. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [43] +-------------------------------------------------------------------------------- + + Thanks, all. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [44] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2017-Jan-26-MSFT.txt b/Transcripts/MSFT/2017-Jan-26-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..641b1c249dd83f856df938101e24c6af86b73aee --- /dev/null +++ b/Transcripts/MSFT/2017-Jan-26-MSFT.txt @@ -0,0 +1,654 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Microsoft Corp Earnings Call +JANUARY 26, 2017 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO + * Amy Hood + Microsoft Corporation - CFO + * Chris Suh + Microsoft Corporation - General Manager IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brent Thill + UBS - Analyst + * Phil Winslow + Credit Suisse - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Walter Pritchard + Citigroup - Analyst + * Keith Weiss + Morgan Stanley - Analyst + * Karl Keirstead + Deutsche Bank - Analyst + * Mark Moerdler + Bernstein - Analyst + * Raimo Lenschow + Barclays Capital - Analyst + * Mark Murphy + JPMorgan - Analyst + * Kash Rangan + BofA Merrill Lynch - Analyst + * Ross MacMillan + RBC Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the second quarter of FY17 Microsoft Corporation earnings conference call. +(Operator Instructions) +As a reminder, this conference is being recorded. I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon, and thank you for joining us today. +On the call with me today are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. On our website, Microsoft.com/Investor, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. +Microsoft completed the acquisition of LinkedIn this quarter, and is reporting its results in the Productivity and Business Processes segment beginning on December 8, 2016. Accordingly, our key investor metrics do not include the impact of LinkedIn. +Additionally, for Q2 only we're providing non-GAAP results, excluding LinkedIn, to help investors compare our results to the guidance previously provided for the quarter. Our press release and slide deck contain supplemental information regarding the impact of LinkedIn on our financial results. +Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the Company's second-quarter performance, in addition to the impact that these items and events had on the financial results. +Additionally, any mention of operating expenses refers to segment operating expenses as defined in the footnotes of our Form 10-Q, which include research and development, sales and marketing, and general administrative, but excludes the impact of integration and restructuring charges. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. +We will post our prepared remarks to our website immediately following today's call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until January 26, 2018. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. +Actual results could materially differ because of factors discussed in today's earnings press release in the comments made during this conference call and in the risk factor section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Chris, and thanks to everyone on the phone for joining. Today I'll share the results for the second quarter and discuss what's ahead. +We had a solid quarter overall, delivering $26.1 billion in revenue, up 4% in constant currency. More importantly, we're making progress by innovating in new areas, growing our addressable market opportunity, and transforming our culture. +Wherever I go in my travels, whether it's in conversations with heads of state, NGOs or CEOs, the common thread is the transformative power of digital technology to unlock new opportunity. Everyone I meet is talking about building their own digital capability to transform their product, service and business model. They're looking to Microsoft for security, productivity, business process, cloud and AI platforms to help drive their own transformation. +In this last quarter we have continued to build momentum across all of these areas, and in particular AI. Just this month we acquired an AI deep learning startup, Maluuba, whose work in natural language processing will help advance our strategy to democratize AI for everyone. With that as the backdrop, I will turn to progress we've made this quarter by segment, starting with Productivity and Business Process. +Office 365 commercial seats grew 37% year over year, and revenue is up 49% in constant currency. We're changing the nature of work with Office as the universal toolkit to help people and teams accomplish more together. +To that end, this quarter we introduced Microsoft Teams, our new chat-based workspace for Office 365. It brings together the full breadth and depth of Office 365, as well as connection to third-party services, all in a secure hub for teamwork. We are seeing strong demand for the preview from our existing Office 365 customers, due to the deep integration of the rest of the Office platform. And at the same time, customers not yet on Office 365 are excited about this new work -- way to work to see Teams as a potential first cloud workload. +In addition to collaboration, our innovation in security and compliance continues to drive customer preference for Office 365. This quarter we added new capabilities to give IT better ways to help the user safely connect to the third-party applications. And for compliance, new E-discovery capabilities make it easier and faster for organizations to find and analyze information related to legal and regulatory requests. +Customers also find value in the integration of SharePoint with PowerApps and Microsoft Flow to quickly and easily build mobile apps and automate workflows. In fact, just eight weeks after availability, we have seen more than 0.5 million people use PowerApps for Flow. +This combination of productivity, security, and agility is incredibly valuable to customers, particularly in sectors like financial services and healthcare. Take Willis Towers Watson, a global financial services firm who chose our premium enterprise offering, including Office 365 E5; global fortune 500 companies; TD Bank and ACSA; as well as Partners HealthCare and the University of Pittsburgh Medical Center, all chose Office 365 for its powerful security and productivity platform. And AstraZeneca recently upgraded Office 365 E5 for its advanced voice capabilities. +We are also expanding our growth opportunity beyond information workers by creating productivity solutions for retail, restaurant, hospitality and manufacturing employees, who have traditionally been underserved by technology providers. Microsoft StaffHub, a new application in Office 365, provides shift scheduling, messaging and sharing capabilities for all these front-line workers. +Now let me talk about the second part of our ambition in the segment, reinventing business process. We completed the acquisition of LinkedIn in December, marking the start of our journey to bring together the world's professional cloud with the world's leading professional network. +Our top priority is to ensure we innovate and drive value for LinkedIn members and grow their daily engagement., The LinkedIn Business Solutions' higher market sell and learn represent an expanded market opportunity for Microsoft, and we plan to diligently execute on this opportunity, keeping the member first ethos and focus. +We are seeing good results with the core experience, with our revamped mobile app driving significant engagement growth in 2016. This quarter, the sessions on LinkedIn grew more than 20% year over year, a consistent level of growth throughout 2016. We also achieved record levels of mobile page views and feed interaction, creating a healthy foundation for LinkedIn's marketing solutions, which includes the rapidly growing Sponsored Updates. +We also saw members engage with LinkedIn's hiring products at record levels as part of Talent Solutions. And LinkedIn's Sales Solutions have also seen rapid growth, Sales Navigator seats up more than 20% year over year during the quarter. Sales Navigator's success on multiple CRM platforms makes it an essential tool for every B2B salesperson, and one of our first integration scenarios will be to redefine social selling by enhancing Dynamics 365 with LinkedIn capabilities. +The combination of LinkedIn's Business Solutions and Dynamics 365 gives us a more comprehensive portfolio of business SaaS solutions and strengthens our position in this growing and competitive market. Dynamics 365 paid seats more than doubled again this quarter, and new enterprise customers are increasingly choosing our Cloud Solutions, with more than 80% using Dynamics 365. +DefenseReady is using Dynamics to give military leaders a 360-degree view of their organizations to quickly make informed decisions about capacity, planning and operations. Amway is using Dynamics 365 to modernize and empower their entrepreneurial sales force around the globe. +Now let's talk about the progress we are making in our Intelligent Cloud Segment. Our commercial cloud annualized revenue run rate now exceeds $14 billion, and we're on track to achieve our $20 billion in FY18. +Customers choose the Microsoft Cloud of the following reasons. They want a trusted, global, hyperscale cloud provider that meets enterprise-grade needs. They want hybrid support that is architected into the hyperscale service, as well is the cloud servers. They want higher-level services to help build their own digital capability across IoT, enterprise, app-to-app, advanced analytics and AI capability. +Moreover, and most importantly, CIOs, CSOs, BDMs and developers are all seeing the benefit from operational consistency, productivity and security across their entire digital estate, spanning Windows 10, Cloud and Security Management, Office 365, Dynamics 365, Enterprise Mobility and Azure. A prime example is Mars, a $35 billion business with 60 brands. +An early adopter of Office 365, Mars is using Office and Windows 10 to transform how its 80,000-strong global workforce collaborates while staying secure. And more recently, they have begun running mission-critical workloads on Azure, with hundreds more on the way, including inventory management using Azure IoT. +Swift Transportation, one of the largest trucking companies in the United States, is digitizing work for nearly 20,000 drivers with Office 365 and Skype, and is using Azure to harness the data from their sensors-equipped trucks to optimize driver productivity and safety. Across industries we continue to see strong customer demand for our differentiated Cloud Solutions. +Azure revenue grew 95% in constant currency this quarter. Azure premium revenue grew triple digits for the 10th consecutive quarter, and more than three out of four Azure customers are using Premium Services. +We are also leading the next-generation programming model and developer services innovation, with conversational bots, microservices, and event-driven serverless compute to help businesses rapidly gain the benefits of cloud infrastructure. Our bot framework is being used by more than 77,000 developers to do everything from e-commerce to customer service. Azure Functions is helping companies like AccuWeather and [Plexture] to quickly and easily implement business-critical, event-driven serverless processes, and everyone from game developers to financial services companies are using Azure Service Fabric for their low-latency, high-scale microservices applications. +We're also rapidly expanding our portfolio of data and AI capabilities in Azure. Cognitive Services, now deeply integrated with Azure Data Lake, enables customers to use industry-leading AI capabilities to easily analyze images, text, emotions, speech, sentiments at terabyte scale. In our push to meet the needs of any developer on any platform, we joined the Lennox Foundation, welcomed Google to .NET foundation, and announced new Azure partnership with OpenAI to accelerate our vision. +At the edge of our cloud, Windows Server 2016 and SQL Server 2016 give enterprises Azure-inspired scale and innovation for secure infrastructure and cloud applications. Customers have already deployed more than 1 million instances of Windows Server 2016, and the new SQL Server drove a 5 times increase in developer downloads in Q2 versus Q1. +Now I'll turn to our progress in more personal computing. This quarter we saw growth across Windows broadly. First, Windows 10 commercial customers are rapidly adopting Windows 10, driven by the need for a secure and trusted platform. In fact, this quarter enterprise and education deployments increased 52%. +Accenture, Broward County School District, UnitedHealthcare Group, are just a few that are choosing Windows 10 as their modern, secure, enterprise-grade platform. These three commercial customers alone have already deployed more than 300,000 seats, with commitments to deploy over 0.5 million. +The consumer PC market is also stabilizing. Gamers are increasingly turning to Windows 10 Premium PCs for the best gaming experiences, logging more than 26 billion hours of game play on PCs and tablets this year. +One reason gamers love their Windows 10 PC is because they can connect to their favorite games and social network on Xbox Live. Xbox Live monthly active users grew to 55 million this quarter, a new record, with growth across PCs, mobile, as well as the console. +Windows 10 Creators update will bring 3-D mixed reality and game broadcasting to all Windows 10 customers. Partners like Dell, HP, Lenovo and Acer are investing to deliver cutting-edge virtual reality experiences for customers using Windows 10 holographic platform. We're also broadening our opportunity to partnerships with chips at makers Intel, as well as Qualcomm, who have committed to build the next generation of modern Windows PCs with advanced security, connectivity, AI and mixed reality in gaming. +Our services, innovation and user engagement on Windows 10 continues to grow. Users have asked Cortana more than 18 billion questions to date, and we're opening up new addressable markets with Cortana Devices SDK. BMW, Renault, Nissan, HAMANN are all using Cortana to embed voice-activated intelligence into their portfolio of products. +Finally, let's talk about devices. I'm excited about the customer reception to Surface Studio, our latest innovation in Surface line, and a new device category. Overall commercial demand for Surface remained strong, with three consecutive quarters of more than 25% growth. Organizations across industries are looking to Surface to help them achieve more, such as Her Majesty's Revenue and Customs in the United Kingdom, rolling out Surface to more than 25,000 of its employees. +We are expanding into new markets with HoloLens. Commercial customers, like ThyssenKrupp Elevator, are using HoloLens to enable servicing up to four times faster than ever before, and we look forward to making HoloLens available in China in the first half of this year. +As customers embrace these new computers and computing experiences, we're generating enthusiasm for Windows 10, and new forms of expression, creativity in gaming that it can unleash. I'm proud of the progress we made this quarter and during the entire first half of the year. +We look to the second half with a clear focus on execution and innovation. We have a significant opportunity this year and beyond for growth across every one of our segments. We are uniquely positioned to build a technology that helps every person and organization take advantage of new innovations, like AI, and use them to drive their own growth and transformation. +Now let me hand it over to Amy to walk through this quarter's results in more detail and share our outlook. And I look forward to rejoining you for questions. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya and good afternoon, everyone. I want to reiterate that my commentary reflects our performance, inclusive of approximately three weeks of LinkedIn results. For this quarter only, I will comment on our results, excluding LinkedIn, for consistency with the guidance provided last quarter. I encourage you to reference our earnings slides for supplemental information. +Our second-quarter revenue was $26.1 billion, up 2% and 4% in constant currency. Gross margin grew 3%, up 5% in constant currency. Operating income grew 5%, or 8% in constant currency. And earnings per share was $0.83, an increase of 9%, and 13% in constant currency. +Excluding LinkedIn, our second-quarter revenue was $25.8 billion, up 1%, and 3% in constant currency. Gross margin increased 3%, and 4% in constant currency. Operating income grew 8%, and 11% in constant currency. And our EPS was $0.84, increasing 11%, and 15% in constant currency. +Our investment agility and execution focus resulted in strong performance this quarter. From a geographic perspective, our results were largely in line with macroeconomic trends, with additional benefit from a healthier PC market, particularly in the commercial segment. +Our commercial cloud services drove our annuity mix up slightly year over year to 84%, even with better-than-expected transactional revenue performance. Commercial bookings increased 7%, or 12% in constant currency. Commercial unearned revenue met our guidance range at $21.1 billion, growing 8%, and 9% in constant currency, even with an FX headwind of approximately $150 million, due to the strengthening US dollar through the quarter. +And our contracted not billed balance reached an all-time high, exceeding $28 billion. Our commercial cloud revenue run rate grew to more than $14 billion, up 49%. Our commercial cloud gross margin percentage was 48%, up 2 points from last year, largely driven by improvement in the Azure gross margin percentage. +And gross margin dollars grew again, increasing 62% across the commercial cloud. We remain on track for material gross margin percentage and dollar improvement this fiscal year. +Now to Company gross margin. Gross margin was approximately 62%, inclusive of LinkedIn, up slightly from the prior year. This quarter, the strengthening of the US dollar relative to major currencies created additional negative FX impact on total and segment-level revenue. +On total revenue, FX had a 2-point negative impact, 1 point more than expected, with no additional impact from LinkedIn. In both Productivity and Business Processes and the Intelligent Cloud segments, the FX impact was 2 points, 1 point more than expected. And in More Personal Computing, FX had a 1-point impact, in line with expectations. +Total operating expenses grew 1%, and 2% in constant currency. Excluding LinkedIn, operating expenses declined 2%, also 2% in constant currency. Operating expenses were under our guidance range, primarily due to a favorable one-time legal settlement and FX benefits. +Now, let's turn to each segment. This quarter, revenue from our Productivity and Business Processes segment, which includes LinkedIn, grew 10%, and 12% in constant currency, to $7.4 billion. +In Office commercial, revenue increased by 5%, and 7% in constant currency, as Office 365 growth again outpaced the shift from the on-premise business. Office 365 commercial revenue increased by 47%, or 49% in constant currency, driven by a combination of install base growth across all workloads and ARPU expansion. +We also continued to see higher-than-expected results from our transactional business, in part due to an improving commercial PC market. Office Consumer revenue grew 22%, or 21% in constant currency, as we continued to see an increase in our subscriber base and growth of recurring subscription revenue. In addition, the higher growth rate this quarter aided by post-launch inventory drawdown in the prior period. +Our Dynamics business grew 7%, up 9% in constant currency, and our Dynamics 365 install base more than doubled. LinkedIn revenue for the three-week period from December 8 to the end of the quarter was $228 million. +Segment gross margin dollars grew 5%, and 6% in constant currency, while segment gross margin percentage declined due to increasing cloud sales mix, as well as roughly 1 point of impact from LinkedIn. +Operating expenses grew 13%, 14% in constant currency, driven by the LinkedIn acquisition. Operating income declined slightly, but was up 1% in constant currency, and up 7% in constant currency, excluding LinkedIn. +The Intelligent Cloud segment delivered $6.9 billion in revenue, growing 8%, and 10% in constant currency. Server grew 12%, and 14% in constant currency, with strong momentum in our Azure business and another quarter of double-digit annuity revenue growth. +Post-launch demand and purchasing ahead of currency-driven pricing adjustments contributed to a higher-than-expected transactional revenue, mainly from Windows and SQL Server 2016. As expected, enterprise services revenue growth declined this quarter 4%, and 2% in constant currency, due to lower volumes of Windows Server 2003 service agreements. +Gross margin dollars grew 2%, and 4% in constant currency. And segment gross margin percentage declined, due to an increasing cloud revenue mix and a lower enterprise services gross margin, partially offset by material improvement in Azure gross margin. +We grew operating expenses by 12%, and 13% in constant currency, with continued investment in cloud engineering sales capacity and developer engagement. Operating income declined 7% and 4% in constant currency. +Now to our final segment, More Personal Computing. Revenue exceeded our expectation at $11.8 billion, primarily from stronger-than-expected performance from our Windows business. Overall revenue declined 5%, and 4% in constant currency. +Our OEM business grew 5% this quarter. OEM Pro grew 6%, better than we anticipated, driven by an improving commercial PC market and enterprise demand for Windows 10. OEM non-Pro grew 5%, ahead of the consumer PC market, as our partner ecosystem continued to see growth and share gains in the Windows Premium device category. +Inventory levels remain normal. Windows commercial products and cloud services grew 5%, and 6% in constant currency, with double-digit annuity billings growth and install base expansion. +Patent licensing declined this quarter, driven by lower unit volume and revenue per unit. Our search business, ex-TAC, grew 10%, and 11% in constant currency, with improving profitability and continued growth in Bing from higher revenue per search and search volume. +In our Devices Business, revenue declined 35%, down 34% in constant currency. Phone revenue declined 81%. And we closed the sale of our feature phone business during this quarter. +Surface revenue was down 2%, and flat in constant currency, as we continue to phase out the Surface 3 device. Importantly, Surface gross margin dollars grew 6%, and 17% in constant currency, from increasing mix of Pro 4 and Book, replacing Surface 3 in the portfolio. +In gaming, revenue declined 3%, and 1% in constant currency, due to lower console hardware pricing and Xbox 360 volumes. In this holiday quarter, as Satya mentioned, we reached an all-time high of active Xbox Live users, which helped to drive our gaming software and services revenue to 18%, and 21% growth in constant currency. This marks our first billion-dollar quarter in digital transactions for our gaming business through our universal store across Windows 10 and Xbox One. +Segment gross margin percentage and dollars both increased this quarter. Gross margin dollars grew 3%, and 5% in constant currency. And gross margin percentage expanded, with the continued shift to higher-margin products and services. +Operating expenses declined by 12%, also 12% in constant currency, from lower phone expense, a one-time legal settlement and reduced marketing spend. Growth from Windows 10, the shift towards higher gross margin products and services, and devices and gaming, and disciplined operating expense management resulted in operating income growth of 33%, and 37% in constant currency. +Now back to our overall Company results. We invested $2.5 billion in capital expenditures, inclusive of capital leases, as we continue to support customer and partner demand across our commercial and consumer services. During the quarter, other income and expense was $186 million. +Our non-GAAP effective tax rate was 22%. We returned $6.5 billion to shareholders through stock repurchases and dividends, completing our prior $40 billion share repurchase program this quarter as we committed. +Now let's turn to the outlook. First, FX. We had originally expected FX rates to lessen going into H2; however, given current rates, we expect continued currency headwinds for the rest of the year. For Q3, we now expect about 1 point of negative impact on total revenue. +Within the segments, we anticipate about 2 points of negative FX impact in Productivity and Business Processes and Intelligent Cloud, and 1 point in More Personal Computing. In Q4, we anticipate about 2 points of negative FX impact on total revenue, 3 points in Productivity and Business Processes and Intelligent Cloud, and 1 point in More Personal Computing. +Second, our commercial business. We expect our commercial cloud services to continue to drive annuity growth, as we expand our install base, grow consumption and execute well on renewals. +We expect commercial unearned revenue of $20.2 billion to $20.4 billion, in line with historic seasonality. We continue to expect some volatility in our transactional business, due to macroeconomic conditions and the ongoing shift to the cloud. +Third, CapEx. We will continue to meet customer demand by expanding data center capacity, while driving efficiencies through new technologies. With the addition of LinkedIn, we expect our capital expenditures, including capital leases, to grow sequentially to support a broader portfolio. For the full year, including LinkedIn, we continue to expect the CapEx growth rate to be lower than last year. Let's turn to our outlook for the individual segments. +In Productivity and Business Processes, we expect revenue of $7.65 billion to $7.85 billion. This reflects a continued annuity shift to the cloud, with Office 365, Dynamics' double-digit billings growth, and LinkedIn revenue of approximately $950 million, adjusted for the impact of purchase accounting. +In Intelligent Cloud we expect $6.45 billion to $6.65 billion of revenue, with continued annuity strength and double-digit revenue growth across our server products and cloud services. +Enterprise Services. Revenue should decline again, due to a lower volume of Windows Server 2003 service agreements. +And, in More Personal Computing, we expect revenue of $9.05 billion to $9.35 billion. In our OEM business, we anticipate revenue growth will exceed the overall PC market. Continued growth in Pro, driven by enterprise momentum for Windows 10, should be roughly in line with the commercial PC market, with some additional benefit coming from the prior-year inventory build. Our OEM non-Pro performance should grow ahead of the market, due to strength in the Premium device category. +In search, we expect Bing's revenue growth ex-TAC to be similar to Q2. As a reminder, total search revenue growth will slow now that we've passed the one-year anniversary of our Yahoo deal and the associated change in revenue recognition. +And in gaming, we expect normal post-holiday trends, with declines in hardware console volumes and pricing, balanced by higher engagement, usage and transaction volume. In devices, we expect revenue to decline, driven primarily by phone. Surface revenue is expected to decline slightly, with our ongoing Surface portfolio mix shift to Pro 4 and Book. +We expect COGS of $8.35 billion to $8.45 billion, including approximately $400 million of LinkedIn expenses. LinkedIn COGS include approximately $220 million of amortization of acquired intangible assets. We expect operating expenses between $8.5 billion to $8.6 billion, with about $970 million from LinkedIn. The LinkedIn expense includes about $160 million for the amortization of acquired intangible assets. +For the full year, we now expect operating expenses of $33.1 billion to $33.3 billion, with about $2.3 billion from LinkedIn. The LinkedIn expense includes roughly $360 million of amortization of acquired intangible assets. +Other income and expense should be $150 million. We continue to expect our full-year non-GAAP tax rate to be 20%, plus or minus 2 points, with variability driven by the proportion of services revenue versus licensing revenue, the geographic mix of revenue, and the timing of equity vest. +Before moving to Q&A, I'd like to announce that we will hold a financial analyst briefing for the investor community in conjunction with our Build Developer Conference in May here in Seattle. We will share more details as we get closer to the date. Chris, let's move to Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [1] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move to the Q&A portion of today's call. Operator, can you please repeat your instructions? + +-------------------------------------------------------------------------------- +Operator [2] +-------------------------------------------------------------------------------- + + Thank you. We will now be conducting a question-and-answer session. +(Operator Instructions) +Keith Weiss, Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley - Analyst [3] +-------------------------------------------------------------------------------- + + Excellent. Very nice quarter, guys. Thank you for taking the questions. +I wanted to ask a question about LinkedIn -- what our expectations should be for achieving revenues synergies on LinkedIn. It seems like there's a lot of real interesting things you can do with that asset, and combining with your own portfolio. And how should we think about the potential for achieving some expense synergies? +Obviously, there's a big cloud base that you could utilize under their assets, and Amy [being bullish] and very good at keeping expenses very well-managed. So, as we go forward past the [forward] quarter, how should we think about the timeframe for achieving those benefits? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [4] +-------------------------------------------------------------------------------- + + Let me start, and then I'll turn it over to Amy to talk about the specifics of the synergies. The core focus, Keith, for us to start with, is to ensure that the innovation roadmap we have is all driving member value. The core ethos of LinkedIn needs to be about member first, how do we increase the engagement on the mobile flagship application, as well as the revamped desktop experience that is now rolling out. +We think that that's at the core of being able to, in fact, then have all of the revenue growth in their business solutions, which across higher markets sell. So, that's how I see it. It's a two-sided market, which starts with the help of membership and member engagement. +That is where the product roadmap, whether it's the integration with Office 365 or Dynamics 365 -- we'll be staying focused on it. We expect to see that rollout pretty rapidly. And as far as the guidance we've given at close, in terms of what to expect, for example, around EPS impact -- those are things that we'll stay committed to. And I'll let Amy add more to it. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Yes, I think Satya is correct. The guidance we gave at the time of the announcement in terms of EPS solution, excluding the impact of purchase accounting, being minimally dilutive, 1%, plus or minus, stands. Including the goal to achieve synergies where they make sense, as we continue to focus on growing the core business and keeping it incredibly healthy and realizing the revenue synergies that we know exist across the businesses. +As a reminder, the two biggest impacts of purchase accounting -- one, is it does impact the deferred revenue. So the in-quarter revenue in the guidance will look a bit lower due to that, as well as the amortization of intangible expenses, which also hit. We'll take care to give you insight into those so that you can continue to hold us against the goals we set for ourselves. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [6] +-------------------------------------------------------------------------------- + + Thank you, Keith. We'll move to the next question, please, operator. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Brent Thill, UBS. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks. There are a number of investors that have been wondering about the sales reorg that takes place February 1. Perhaps this is being worried and overstated. Can you just give us a sense -- are there changes that are happening that will take place February 1 that are different, or is this a minor tweak to the go-to-market going forward? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [9] +-------------------------------------------------------------------------------- + + I can comment on it. I'm not particularly sure exactly what is happening on February 1. +But, I would say the overall change that we're going through -- and this is been ongoing for, I would say, the last multiple years -- is transforming our field engagement model, where we are putting a lot more technical depth in the front line sellers so that they can engage. Whether it's data specialists, cloud specialists, security specialists, or even productivity specialists. Because it's super important for us in this phase, when people are looking for solutions to help them digitally transform, for us to have a very fundamentally different type of capability in terms of our sales. +And that's the transformation. We have really reorganized ourselves, both in the headquarters and the in the field to be able to recognize such shift. What used to be large accounts for us, for example, are not by PC count anymore. And that's a pretty fundamental change. +It's by consumption of cloud capacity, in many cases. And this is happening all over the world. So, that's the transformation that you will increasingly see us push forward. +And no status quo on any part of Microsoft's organization should be counted on. If anything, we'll push to make sure that we are addressing what is our growth opportunities pretty aggressively. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [10] +-------------------------------------------------------------------------------- + + And I think, Brent, in terms of there being a date -- or a particular date -- this is something, to Satya's point, we've been doing in a step function improvement over time for the past couple years. And we'll continue to do it. +The guidance certainly doesn't imply any type of slowdown in the commercial business. In fact, in some ways it actually includes an acceleration in certain areas. I think that's how I tend to look at it. + +-------------------------------------------------------------------------------- +Brent Thill, UBS - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [12] +-------------------------------------------------------------------------------- + + Thanks Brent. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Thank you. Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- + + Great. Thank you very much. Amy, you noted a material improvement in Azure margins this quarter. I was just wondering if you could share with us -- given how quickly revenue is growing in this area, how fast can we see margins ramp, which obviously were negative. +And now that you're getting to some big revenue numbers, is there any reason why, at a similar revenue scale you shouldn't be able to match the gross margins of what AWS -- what you can back into from the financials of AWS? Can you walk us through the puts and takes? And then once you hit that scale point, is it something that we should see inflect pretty quickly? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Thanks, Heather. Let me start by saying, we really do think about and talk about our cloud as containing all of the components. From the IS layer to the platform layer to the SaaS layer. You'll hear us talk about Dynamics 365, Office 36t, as well as our Azure Core and Premium services. +So, when I think about the material gross margin improvement we saw on Azure, it continues the path we've actually been on. Where we've been discussing, as you continue to see customers ask for us and our help in managing their digital estate consistently, securely, through one interface, you'll actually see growth across all components of that cloud. +It benefits margin, not just in Azure, but across, actually, the entirety of the cloud. That 2 point year-over-year increase in the commercial cloud gross margin really, even with the massive growth in Azure over the course of the year, certainly implies the improvement that we expected. +But, I tend to think you will consistently hear both Satya and I refer to our cloud in its entirety. But I do respect people always wonder, so I did comment that we saw material improvement in Azure, specifically + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [16] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [17] +-------------------------------------------------------------------------------- + + Thanks, Heather. We'll take the next call please. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Thank you. Karl Keirstead, Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [19] +-------------------------------------------------------------------------------- + + Thank you. Amy, I'm going to ask another question on gross margins, but this time at the Microsoft level. Your prior guidance was for ex-LinkedIn FY17 gross margins to be down 100 basis points. So the quarter you just posted gross margins ex-LinkedIn were actually up. And if I ran the math accurately, it looks like for your March quarter, ex-LinkedIn you're expecting gross margins to be about flat. +It feels like you are outperforming the core Microsoft gross margin guidance you gave before. Are you sticking with the down 100, or has that improved? And if it has, what are the one or two biggest drivers of the gross margins feeling a little bit better, ex-LinkedIn? Thank you. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [20] +-------------------------------------------------------------------------------- + + Thanks, Karl. I am sticking with it being about 1 point. That is the guidance we gave and, even inclusive of LinkedIn, I continue to believe it is about 1 point. So, in some ways I guess you could say it implies a slightly better at the Company level, if that's how you're thinking about it. +Really Karl, what can drive that, in addition to the overall gross margin improvement we talk about in the cloud, it's also really the strength we see in our Windows business. And I mean that, not just in our OEM business, but also across the commercial business for Windows. That tends to have a very good margin profile. +And as we continue to improve the margin profile of our devices, we continue to see the OEM business health improve. And, actually, we continue to see the growth in the consumer services around the transactions that run through Xbox. +That's also good margin business for us that looks quite different than the hardware profile. So, all of those can impact it, Karl, as we look through the rest of the year. But in general, inclusive of LinkedIn, I'm still around 100 BPS. + +-------------------------------------------------------------------------------- +Karl Keirstead, Deutsche Bank - Analyst [21] +-------------------------------------------------------------------------------- + + Got it. Thanks, Amy. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [22] +-------------------------------------------------------------------------------- + + Thank you, Karl. Next question, please. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Thank you. Mark Moerdler, Bernstein Research. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. Congrats on the strong quarter and thanks for taking the question. So, Amy, the on-premise server and tools business grew 5%, 7% in constant currency. It was obviously helped by Windows Server 2016, Sequel Server 2016. +How should we think about, on a longer-term horizon over the next 12 months or even longer -- how those two should help on the on-premise isis or annuity business on the cloud and Azure? How should we think about the impact of that? Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Thanks, Mark. Let me start by saying it's why we tend to focus all up at that server products and services KPI being double digits. Generally, an easier way for us to talk about it all up between Azure and the OnPrem business. +But let me talk a little bit about what impacted the transactional business this quarter. And then we can talk about how to think about it in Q3 and maybe going forward. We did, and we're encouraged by the customer reaction -- even our transactional customers -- to the security and management value prop, as well as the hybrid nature of our Sequel and Windows Server 2016 releases that have taken place this year. +That value prop is resonating. We saw some growth. I feel very good about that. And so I do think that can have an impact in H2. +You heard me talk a little bit about it. With the major currency changes we saw in Q2, we've also done some price adjustments between certain geos for us. It did pull forward a bit of revenue into Q2. +And so it will be a bit of a drag on Q3, which is taken into account in the guide. But, I would reiterate, the biggest driver of the transactional performance this quarter was really the value prop people saw. + +-------------------------------------------------------------------------------- +Mark Moerdler, Bernstein - Analyst [26] +-------------------------------------------------------------------------------- + + Excellent. Thank you so much. I appreciate it. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [27] +-------------------------------------------------------------------------------- + + Thank you, Mark. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Walter Pritchard, Citi. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [29] +-------------------------------------------------------------------------------- + + Hi. Thanks, Amy. I'm wondering if you could talk about -- we're still seeing the majority, or really all the growth, in operating profits come from MPC in the year-over-year basis. +And I'm wondering how we should think about the factors impacting and the timing in the handoff of profit growth from MPC to IC and PBP? Is that something that you expect? What are the factors and timing there? + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Right. I would say, actually, we've also seen some operating income growth in our PBP segment this quarter, up in constant currency to 7% before LinkedIn. I do want to say some of that impact is absolutely landing, as well as growth. +But, the heart of your question is really about the MPC transition in IC. The way I think about it, we really -- Satya and I and the leadership team decided, gosh, about 18 months ago -- it's been a little longer than that now -- to over-index on investing, because the TM we saw in the intelligent cloud. +We increased hiring, and we invested in direct customer acquisition costs, and we invested in many of the things Satya just talked about in terms of technical capabilities in our sales force. We're starting to see the benefit of that already in our top line numbers. +That 12% or 14% in the server product and services KPI is a very good number. And I continue to expect that we'll see growth in revenue as those resources both get hired, and get up to speed, and add value at accounts. +A lot of that account value, frankly, Walter, today is coming in the form of consumed revenue. Consumed revenue is actually a great leading indicator for what we expect our Azure growth going forward to be. And so some of the confidence that we have in the transition of that investment in operating expense and to even more revenue growth comes from seeing the consumed revenue trend that we're seeing today, as well as the pipeline of projects and customers that we have. +I do think about that being an 18-month investment we've been making. It's starting to pivot to consumed. It will then land as billings, and ultimately in RP&L as GAAP revenue in quarter off the balance sheet. +But I think you're right. We have been working, and continuing to reinvest and save through the year as we look to get everything here more efficient. People often think we focus on cut here or add here. +It's also about -- are we putting every dollar most efficiently to help customers be successful? And I think that's a lot about what you heard Satya talk about the sales transition we're going through. Whether it's how we build products, and so I actually am confident you will start to see that transition land. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [31] +-------------------------------------------------------------------------------- + + And I think Amy described it well in answering the very specific technical question of segment reporting and the margins in it. But architecturally, some of the examples are used are about the digital estate that actually doesn't start with Azure. In many cases, it starts with advanced [set] protection of Windows 10 estate, and then how does that relate to Office 365? How does that relate to Azure Active Directory? +And then the workloads that they may want to put, which are T01 workloads in Azure. It's very similar to what happened even in the client/server era, but of course, the starting points and how this progresses is very different. So we always think at least of the technical architecture that makes us unique in differentiated spanning all of it. So I don't think of it as margin shifts across the segments, and that's why we think of all of this as one digital estate, at least from a customer end perspective. + +-------------------------------------------------------------------------------- +Walter Pritchard, Citigroup - Analyst [32] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [33] +-------------------------------------------------------------------------------- + + Thanks, Walter. We'll go to the next question, please. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Thank you. Mark Murphy, JPMorgan. + +-------------------------------------------------------------------------------- +Mark Murphy, JPMorgan - Analyst [35] +-------------------------------------------------------------------------------- + + Yes. Thank you. Satya. I'm wondering what you think would be required to extend the hyper growth trajectory for Azure into the future. For example, are there incremental waves of activity on the horizon that you would tie to Tier 1 workloads, or large data center migrations, or serverless usage which would enable that? +And separate from that, Amy, I'm curious just philosophically, how do you plan to handle price cuts for compute and storage when they occur? Do you think you're better off matching them, exceeding them? Or does it make sense, perhaps, warranting a Premium in many cases due to the differentiated IP that you have up the stack? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [36] +-------------------------------------------------------------------------------- + + Let me start. Overall, I think some of the trends that you've referenced, whether it is Tier 1 workloads, or serverless, or even complete data center migrations, all of that is happening. +And even the customer examples I gave, they were littered with example after example. For example, in [finsa], some very Tier 1 trading applications now using some of our capabilities in service fabric, which is really a past service, which allows you to manage microservices with low latency and high scale. That's a place where we're seeing, in fact, activity, whether it is game development or trading applications. +We're seeing even interesting use cases of Azure Functions, which is completely serverless. In fact, you can even think of it as a price cut for anybody who cares about using consum -- being very, very smart about cloud consumption going serverless is something that we, in fact, advocate. Across the board, I feel we have the right mix of IaaS, PaaS, SaaS, and full user SaaS services, like Azure Active Directory, which gives us the right mix to be able to even have the right margins long-term. +We're not concentrated in any one layer of the stack, which is something we do by design. Because our vision has always been that we want to, of course, offer all of these layers, and customers will choose, depending on their needs and their scenarios. And we're now seeing even a single customer estate spanning all of these. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [37] +-------------------------------------------------------------------------------- + + And, Mark, I'm not sure I want to get into our pricing theory on the call on a go-forward basis in terms of whether or not we match competitors. But what I would say, is really fundamentally related to Satya's point around differentiation of the entire stack and what customers are doing in their digital estate. And the ability to earn margin through that is actually more impactful than whether or not you match pricing at the core. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [38] +-------------------------------------------------------------------------------- + + Thank you, Mark. We'll take the next question, please. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Thank you. Kash Rangan, BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [40] +-------------------------------------------------------------------------------- + + Hi. Congrats on finishing up a great quarter, as well. One for you, Amy, one for you, Satya. +One, Amy, when I look at your comments on gross margin, clearly you're not in a position to break out Azure-only gross margin. But I'm wondering if you could take -- come past your commercial cloud targets were about $20 billion. +So if I take what I believe could be a rough split between Azure versus the SaaS segment and look at the best (abrate) companies, I could get to about 70%, 75% gross margin when you hit your targets. Curious what you think about that. Is that too aggressive, or within the ballpark? +And for you, Satya, as cloud computing moves to the enterprise, there's some belief among investors that AWS is going to be a big, strong competitor in the enterprise, so just typically not the stronghold for them. How do we think of Microsoft's enduring strength in the enterprise? And how confident can we be that you should be able to capture your fair share of enterprise workloads as they move to the cloud? Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [41] +-------------------------------------------------------------------------------- + + Let me start with the second part, and then you can add. Kash, the way I think about it is, even in the client server era, we had tough competition. We had Oracle, we had VMware, and we had many other players we competed with and I grew up competing with. +And we now have AWS, who I think is going to be a credible competitor. So I feel that, as I said, we have a cloud strategy that is not just about infrastructure. It is about really SaaS and infrastructure. +We want to uniquely think about what are the things that we can do to differentiate and add value to our customers' digital estate in the cloud in that context. And that's where, if you will, our fair share will come from -- by competing hard where we have to, but also mostly thinking about differentiation. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [42] +-------------------------------------------------------------------------------- + + And in terms of, is there a long-term gross margin cloud number that is industry-leading, I think right now there's a benchmark in the SaaS community that's probably around the number you talked about in terms of more SaaS applications. And then as you go down through the layers from PaaS to IaaS, that margin declines, obviously, much as it did when that was run as a hardware solution. +The margins were not as high, either. I do think it will be a blend of those, but certainly at the SaaS end, I understand where you get that benchmark from. + +-------------------------------------------------------------------------------- +Kash Rangan, BofA Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- + + Great. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [44] +-------------------------------------------------------------------------------- + + Thank you Kash. We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Thank you. Phillip Winslow, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Phil Winslow, Credit Suisse - Analyst [46] +-------------------------------------------------------------------------------- + + Thanks for taking my question. I just wanted to focus back in on Office 365 on the commercial front. You have another strong quarter of revenue growth, obviously at 49% constant currency, but it continues to meaningfully outpace the seat growth, which is still strong, but 37%. +That commentary that you all are giving about premium mix in the past -- two questions here. First, to Satya, when you think about where we are in the progression -- call it up to E5, so to speak, or E3. How do you think this plays out? And how do you think about the mix of unit growth versus that premium mix and translating it to revenue? +And then to Amy, I'd argue that maybe we've done the low margin, or low gross margin parts of the Office 365 transition. And now as this mix goes up, you're actually not just increasing revenue, but the margin is better, too. Is that fair? And then, how do you tie that back to your commercial cloud gross margin expectations long term? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [47] +-------------------------------------------------------------------------------- + + Yes, I can start. On the product side, we think of actually three things which we're trying to do on a continuous basis in Office 365. First, even for the customers already in Office 365 at any given licensing level, we focus quite a bit on their increased usage and intensity. +So, for example, one of the comments I made in my remarks was, for example SharePoint with PowerApps and Flow. That's, to us, the best way for us to keep having that recurring value. And so we focus quite a bit on adding additional value, even to the existing licensing levels and increasing intensity of usage. +Then, things like, what we're doing to even go to non-knowledge workers, audiences in retail or manufacturing, with some of the things that we're doing with staff scheduling, for example. That's a way to expand seats, even beyond what is the traditional knowledge worker. Of course, we have a significant more opportunity in small- and medium-sized businesses, although we have good, healthy growth there. +I think seat growth will come, more from material increases internationally, as well as with some of the regulated segments of the market finally moving to the cloud. Those are all opportunities ahead. +And then the last one, of course, is these new value in things like E5 with voice or analytics and security. So all those three dimensions, there will be variability quarter to quarter in terms of what is happening, but in terms of our investments in the core product value, they are actually happening on all those three. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [48] +-------------------------------------------------------------------------------- + + And to your point on where we are and what's driving that delta and its consistency, frankly over time. Actually, still, the biggest impact is from the transition to E3. The transitions take time. +You're just starting to see some of the impact from E5. We're excited about all the customers in trial and already starting to use the value, whether it's security, increasingly analytics, and ultimately voice. But really, from an ARPU perspective, the biggest driver continues to be the transition to E3. +Then that leads to your question on, do you continue to believe there is some margin expansion possible as you add newer and higher value workloads? And of course, the answer to that is we do believe that. But it certainly comes over a period of time and runs through our annuity base over that pace. + +-------------------------------------------------------------------------------- +Phil Winslow, Credit Suisse - Analyst [49] +-------------------------------------------------------------------------------- + + Great. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [50] +-------------------------------------------------------------------------------- + + Thank you, Phil. We will take the next question, please. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Ross MacMillan, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [52] +-------------------------------------------------------------------------------- + + Thanks so much, and congratulations from me, as well. Two questions. One for Amy first. +When we look at CapEx, it actually declines year over year ex capital leases, but even with capital leases, the growth rate decelerated. And for the full year, it's obviously a pretty wide range, roughly 0% to 40% growth. I'm just curious, Amy, with LinkedIn, have you made any changes to your CapEx assumptions for core Microsoft? +I guess I'm pointing to the fact that it did seem to decelerate quite a lot this quarter. I wondered if there is any additional color you could frame around growth rate for all-up Cap-Ex plus capital leases. Thanks. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Sure. Let me first comment on that I've said it will be lower than it was previously. I certainly would help you in that number and say a little lower. Just so that you're getting into something closer -- I realize 0% to 40% is not as helpful. +I would also say that it does tend to be lumpy, and it's why I don't give very specific guidance every single quarter. And it was not at all impacted by LinkedIn. Our real goal for LinkedIn is over time, of course, I'm sure they'll want to take advantage as we build new services together of some of our infrastructure assets. +But in the short term, the most important thing, is they continue to add value and usage and great experience for their members. I have really no intention of messing with that in terms of capital expenditures in the short -- next six months, for sure. I think what you're seeing in terms of year-over-year and what does it mean for next year, this next quarter, it will be a sequential increase. But again, it is a bit lumpy. + +-------------------------------------------------------------------------------- +Ross MacMillan, RBC Capital Markets - Analyst [54] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [55] +-------------------------------------------------------------------------------- + + Thank you, Ross. We will have time for one more question, please, operator. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Thank you. Raimo Lenschow, Barclays Capital. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [57] +-------------------------------------------------------------------------------- + + Thanks for squeezing me in, and congratulations, as well. I wanted to ask on Windows 10 -- Satya, you talked about at the beginning of that [cast] is trying to adopt it. And you mentioned pretty large ones already. +Can you talk a little bit about that cycle and how you seeing that's unfolding? And what the customer feedback is in terms of their intention to adopt it now versus waiting for little bit? Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [58] +-------------------------------------------------------------------------------- + + Yes, I think the overall adoption cycle of Windows 10 in the enterprise is perhaps the best that we've seen in the enterprise for any new release of Windows. And primarily driven by security and manageability of the new Windows and that's what has been the driver. +But in addition to that, I must say there are two other things that are increasingly becoming fairly relevant in the adoption cycle, which is moving to both Office 365 and Windows 10 and getting essentially to this new frontier for productivity, which is an always up-to-date operating system, which is secure, and an always up-to-date office experience that is a fast service. We are increasingly seeing that resonate, not just in small business and high tech industry, as it has been in the past, but now even in the regulated parts of the enterprise. So we are very excited about that. +The other piece also that's driving is hardware innovation by the entire ecosystem. In fact, the work that we did with the Surface line has really stimulated the entire ecosystem to do some of the best innovative work. And you saw that, even as [TES]. And the enterprise adoption of these new devices is also driving the overall excitement around Windows 10 and Windows 10 innovation. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Capital - Analyst [59] +-------------------------------------------------------------------------------- + + Correct. Thank you. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager IR [60] +-------------------------------------------------------------------------------- + + Thank you, Raimo. That wraps up the Q&A portion of today's earnings call. We look forward to seeing many of you in the coming months at various investor conferences. For those unable to attend in person, the events will be webcast, and you can follow our comments on the Microsoft Investor Relations website. Please contact us if you need any additional details, and thank you for joining us today. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO [61] +-------------------------------------------------------------------------------- + + Thank you all. + +-------------------------------------------------------------------------------- +Amy Hood, Microsoft Corporation - CFO [62] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2017-Jul-20-MSFT.txt b/Transcripts/MSFT/2017-Jul-20-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..a0dc891402f21f1096bf0ec96072fa832f92e365 --- /dev/null +++ b/Transcripts/MSFT/2017-Jul-20-MSFT.txt @@ -0,0 +1,527 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Microsoft Corp Earnings Call +JULY 20, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO and Non-Independent Director + * Amy E. Hood + Microsoft Corporation - CFO and EVP + * Chris Suh + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Ross Stuart MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Raimo Lenschow + Barclays PLC, Research Division - Director and Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Senior Equity Research Analyst + * Kasthuri Gopalan Rangan + BofA Merrill Lynch, Research Division - MD and Head of Software + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Fourth Quarter Fiscal Year 2017 Microsoft Corporation earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Thank you, Rhea. Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and the financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provide the reconciliation of differences between GAAP and non-GAAP financial measures. +Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They're included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed excluding the effect of foreign currency rate fluctuation. +At the start of fiscal '18, Microsoft adopted ASU 606, the new revenue accounting standard. Today's Q4 earnings report and any forward-looking statements follow the current revenue accounting standard, consistent with our reporting throughout fiscal '17. In early August, we will be holding a conference call to provide you with information that will aid you in the transition to the new standard. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until July 20, 2018. +During the call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any update -- any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [3] +-------------------------------------------------------------------------------- + + Thank you, Chris, and thank you to everyone joining on the phone. This quarter, we delivered $24.7 billion in revenue, up 10% in constant currency. For the year, we are $96.7 billion in revenue, up 5%. I'm proud of the progress, particularly the strength of our commercial cloud results. FY '17 all up was a tremendous year of customer momentum with cloud, AI and digital transformation. +Our technology worldview of an intelligent cloud and an intelligent edge is resonating with businesses everywhere. Every customer I talk to is looking for both innovative technology to drive new growth as well as a strategic partner who can help build their own digital capability. Microsoft is that trusted partner. +Now let's look at the progress we have made this quarter by segment, starting with Productivity and Business Process. The workplace is transforming, from changing employee expectations, a need for more diverse skills and globally distributed teams and increasingly complex threat environment. Only Microsoft gives customers a comprehensive approach for this new culture of work. +Earlier this month, we introduced Microsoft 365, which brings together Office 365, Windows 10 and Enterprise Mobility + Security in a complete, secure solution to empower employees, safeguard businesses and simplify IT management. Microsoft 365 is a fundamental shift in how we design, build and go to market to address customer needs. +Fortune 500 customers FedEx, Dow Chemicals, Staples, Progressive Insurance all chose Microsoft 365. The success of our secure productive enterprise offering with its triple-digit seat growth is one reason we are investing in Microsoft 365 for businesses of all sizes. +We continue to see strong growth of Office 365, with customers like Nissan, Quicken Loans, KeyBanc, Deutsche Telekom all choosing Office 365. And importantly, customers are moving beyond core workloads to adopt higher-value workloads. For example, we have seen a significant increase in SharePoint usage, which nearly doubled year-over-year. +The classroom is also transforming. This quarter, we introduced Microsoft Teams in Office 365 for education, the digital hub for students and teachers. Microsoft Teams gives educators a whole new way to create and inspire modern classroom environments. With rich learning tools and the ability to have digital conversations with students, share materials, manage assignments, Teams gives educators more time to focus on doing what they love the most: teaching. +Now I'll talk about the second part of our ambition in this segment, reinventing business process. We are investing in LinkedIn flagship experience to create new value for members and customers and accelerate growth. We saw continued momentum in mobile and strong engagement across the platform, with sessions up more than 20% for the third consecutive quarter. And we continue to innovate new ways for members to maximize the value of the platform. We launched a new messaging overlay, resulting in record levels of messages sent on LinkedIn, and introduced a career advice marketplace that will let members easily tap into the professional expertise of more than 500 million members around the world. On top of that, Talent Solutions saw record-level growth in confirmed hires and InMail response rates this quarter. +I've talked about the opportunities with Dynamics and LinkedIn. Earlier this month, we launched Microsoft Relationship Sales solution, bringing together LinkedIn Sales Navigator and Microsoft Dynamics, as well as Dynamics 365 solution for retail and talent. In a world where customers are increasingly digitizing every business process, we continue to invest and expand our portfolio of modern modular business applications that are infused with AI. +We also introduced ISV Cloud Embed to make it easier for partners to modernize their existing business process applications, build new ones using Dynamics 365, Power BI, Power Apps and Microsoft Flow. A global health care solution provider and partner, Indegene, is using it to create a mobile CRM solution for medical sales. Customers like HSBC, Best Buy, Dolce & Gabbana all chose Dynamics 365 to transform their own business processes and experience the benefits of moving away from monolithic suites. +Now let's talk about the progress we are making in our Intelligent Cloud segment. Our commercial cloud annualized revenue run rate now exceeds $18.9 billion. This quarter's cloud growth puts us squarely on track to reach the goal we set a little over 2 years ago of $20 billion in commercial cloud ARR in fiscal 2018. More than ever before, customers are placing their trust in the Microsoft Cloud. +Azure revenue accelerated this quarter, growing 97% year-over-year. CIOs and business decision-makers increasingly prefer Azure as they make decisions about their cloud strategy. They value our hybrid consistency, developer productivity, AI capabilities and trusted approach. +And we keep investing in cloud computing to create broader economic benefit and opportunity, as we have done with our South Africa data center expansion, bringing Azure to 40 regions globally, more than any other cloud provider. And as part of our commitment to trust, we are helping our customers prepare to be GDPR-compliant and meet the requirements of the European Union ahead of the enforcement deadline. +AXA Global, KPMG, Dun & Bradstreet, Hearst, Walgreens, T-Mobile and Sephora all chose Azure to transform their businesses. Box announced that it'll bring its content and collaboration service to Azure and plans to use our AI to simplify discovery and use of all types of content across the enterprise. And Baidu will use Azure to take its autonomous driving platform worldwide. +The core currency of any business going forward will be the ability to convert their data into AI that drives competitive advantage. It all starts with having the support for the comprehensive data estate spanning Azure Database, Cosmos DB, Data Warehouse, Data Lake, combined with SQL Server. +Azure Cosmos DB is industry's first globally distributed database service. It enables customers to securely and reliably power data-intensive applications at unprecedented scale and performance, from IoT to AI to mobile and much more. Retailer jet.com is using Azure Cosmos DB to process trillions of transactions every day. +Customers are infusing AI into their products and services using Azure AI infrastructure and services such as bot framework and cognitive services. Sabre, a leading technology provider to the global travel industry, is piloting AI-powered solutions for travel agencies to better serve customers; and Dixons Carphone is using Azure and our cognitive services to boost customer engagement and provide a more consistent, seamless experience across online and in their stores. +Azure is also unique in its support for these emerging Intelligent Cloud and Intelligent Edge applications. Azure IoT Edge extends cloud intelligence to edge devices. This means IoT devices can act locally at the edge while taking advantage of the cloud for global coordination and machine learning at scale. +Azure is the first cloud to provide true hybrid support that customers predominantly choose. Azure Stack extends Azure to enable developers to build and deploy applications the same way, whether they run on the intelligent cloud or at the intelligent edge, so customers can meet any regulatory requirement and bring cloud applications to remote or disconnected locations like cruise ships or oil rigs. +Now I'll turn to our progress in More Personal Computing. Against the backdrop of more than 500 million Windows 10 monthly active devices and continued broad progress across the Windows ecosystem, I want to highlight a couple of key strategic areas this quarter. Windows 10 is made to inspire the creator in all of us and is pivotal to enabling employees to transform the way they work. Increasingly, commercial customers value Windows 10 as the foundation for a secure modern workplace. Enterprise and education deployments increased 33% over the last quarter as companies like NASCAR, Emirates Airline, BMW Group, Bank of China all adopt Windows 10. +This quarter, we introduced Windows 10 S, streamlined for simplicity, security and superior performance and tailored for the classroom. Our goal for Windows 10 S is to develop a vibrant ecosystem with partners like Acer, Asus, Dell, Fujitsu, HP, Samsung and Toshiba to introduce a new class of modern devices that enables affordable, powerful new scenarios, from Windows Ink to 3D. We also introduced the Surface Laptop and the new Surface Pro this quarter to continue to build and create momentum for new Windows device category. +Now on to gaming. Our gaming business now is more than $9 billion and growing profitably. The gaming world is evolving faster than ever before, from gameplay across multiple devices to the explosive growth in streaming and e-sports to new subscription services and mixed-reality scenarios. We're uniquely positioned to capture a large share of this opportunity because of our ability to unite the global community of gamers through Xbox Live, now 53 million strong and growing, and to enable new experiences across PC, console and mobile. +Our approach is to let gamers play the games they want with the people they want on the device they want. At E3, we celebrated the passion of gamers by introducing Xbox One X, broadening our portfolio of gaming devices with the world's most powerful console. We launched 2 new services that broaden our reach and enrich the gaming experience, both of which are off to a very strong start. Mixer, our new live-streaming service, makes it easier than ever before for gamers to create and share across platforms and to interact in entirely new ways. The Xbox Game Pass is a digital subscription service that expands our existing gaming value proposition. +In closing, I'm proud of the progress this year, both in our own continued transformation and in how we are empowering customers to digitally transform. As technology disrupts every industry and has the power to make a difference in the lives of everyone, we strive to create local opportunity and growth and impact in every country around the world. +Our platforms and tools help drive small business productivity, large business competitiveness and public sector efficiency. We also support new start-ups, improve educational health outcomes and empower human ingenuity. Our sense of purpose lies in our customers' success. Transformation is a continuous process of renewal and reinvestment. We will continue to invest in the high-growth opportunities, lead innovation in cloud and AI and bring our technology and products together into experiences and solutions that unlock new value for customers. +Now I'll hand it over to Amy to walk through this quarter's results in more detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $24.7 billion, up 9% and 10% in constant currency, with stronger-than-expected performance across all segments. Gross margin grew 11% and 12% in constant currency. Operating income increased 13% and 16% in constant currency. And earnings per share was $0.98, increasing 42% and 43% in constant currency, which includes $0.23 from the utilization of phone-related losses from prior years that were previously nondeductible. +At a company level, LinkedIn contributed approximately 5 points of revenue and gross margin growth. LinkedIn's operating loss of $361 million was a 6 point drag on total company operating income growth and is entirely attributable to the $371 million of amortization of acquired intangibles recorded in COGS and OpEx. +From a geographic perspective, our results were mostly in line with macroeconomic trends, though large markets like the U.S., Germany and Japan performed better than we expected. We had a strong quarter in our commercial business, reflecting terrific execution from our sales teams and partners in the largest quarter of our year. +We increased commitment to our commercial cloud and healthy renewals on a record volume of expirations. We closed the highest number of multimillion dollar Azure deals to date and improved our annuity mix to 86%, up 3 points year-over-year. As a result, commercial bookings grew 30% and commercial unearned revenue was $27.8 billion, significantly higher than we expected. +Our contracted not billed balance increased to more than $31.5 billion. As Satya mentioned earlier, our commercial cloud annualized revenue run rate exceeded $18.9 billion this quarter, growing 56%. We finished the year with nearly $15 billion in commercial cloud revenue. +At the start of the year, we committed to material improvement in commercial cloud gross margin percentage and dollars. This quarter, our commercial cloud gross margin percentage was 52%, up 10 points year-over-year, with positive gross margin in each cloud service. Commercial cloud gross margin dollars grew 92% from strength across all services. Our company gross margin was 66%, up 1 point from the prior year, as sales mix of higher-margin product and services offset the impact of a growing mix of cloud revenue and $217 million of LinkedIn amortization cost. +FX was mostly in line with our expectations with 1 point of negative impact on total revenue growth, even with a slightly weaker-than-expected U.S. dollar. At the segment level, FX had a negative impact of 2 points on Productivity and Business Processes, 1 point on Intelligent Cloud and 1 point on More Personal Computing. Total operating expenses grew 9% and 10% in constant currency, with LinkedIn contributing 12 points of growth, including $154 million of amortization of acquired intangibles expense. +Now to our segment results. Revenue from our Productivity and Business Processes segment grew 21% and 23% in constant currency to $8.4 billion, with LinkedIn contributing 15 points of growth. Office commercial revenue increased 5% and 6% in constant currency. Office 365 commercial revenue grew 43% and 44% in constant currency, with continued install base growth across all workloads, ARPU expansion and emerging E5 momentum. For the first time, Office 365 commercial revenue surpassed revenue from our traditional licensing business. +Office consumer revenue increased 13%, driven by recurring subscription revenue and growth in our subscriber base. Our Dynamics business grew 7% and 9% in constant currency, and Dynamics 365 grew 74% and 75% in constant currency. LinkedIn revenue for the quarter was approximately $1.1 billion, a bit better than expected. +Segment gross margin dollars grew 14% and 16% in constant currency, with 12 points of contribution from LinkedIn, including $217 million of amortization. Gross margin percentage declined from an increasing cloud revenue mix and the impact of LinkedIn-related amortization. Operating expenses increased 41%, with 40 points from LinkedIn, including $154 million of amortization expense. Operating income declined 8% and 5% in constant currency, with 12 points of impact from LinkedIn. +The Intelligent Cloud segment delivered $7.4 billion in revenue, growing 11% and 12% in constant currency. Our server products and cloud services revenue grew 15% and 16% in constant currency, with double-digit annuity revenue growth. +Azure revenue growth accelerated to 97%, up 98% in constant currency. Azure Premium revenue grew triple digits for the 12th consecutive quarter. Enterprise Services revenue declined 3% and 1% in constant currency, driven by a lower volume of Windows Server 2003 custom support agreements, partially offset by growth in premier support services. +Segment gross margin dollars grew 8% and 9% in constant currency, and segment gross margin percentage declined due to increasing cloud revenue mix and lower Enterprise Services margins, partially offset by material improvement in Azure margins. We grew operating expenses by 2% and 3% in constant currency, with continued investment in sales capacity and developer engagement. Operating income increased 15%, up 18% in constant currency. +Now to More Personal Computing. Revenue from this segment was $8.8 billion, down 2% and 1% in constant currency, with 4 points of decline from phone. Our OEM business grew 1% this quarter, as both our commercial and consumer OEM businesses were slightly ahead of the PC market. OEM Pro revenue grew 3%, ahead of the commercial PC market, mainly due to a higher mix of premium SKUs. Windows 10 deployment cycles continue to drive commercial customer hardware demand. OEM non-Pro revenue was flat ahead of the consumer PC market, with continued positive impact from Windows premium device mix. Inventories remain in their normal range. +Windows commercial cloud products and services grew 8%, driven by annuity revenue growth. Enterprise customers increasingly chose Windows 10 on new and existing devices, which led to install base growth and higher adoption of our cloud security solutions. Patent licensing declined this quarter primarily from lower revenue per unit. Search revenue ex TAC grew 10% and 11% in constant currency, driven by higher revenue per search and search volume. +Devices revenue declined 28% and 27% in constant currency. Our Surface business performed better than we expected, declining 2% and 1% in constant currency, with strong sales execution on our Surface Pro product transition and early positive signals from customers and partners on our Surface Laptop launch in June. +Our gaming business grew 3% and 4% in constant currency. Xbox software and services growth of 11%, 13% in constant currency, offset declines in hardware. And our engaged user base grew 8% to 53 million monthly active users across console, mobile and Windows 10 platforms. +Segment gross margin dollars increased 9% and 10% in constant currency. Gross margin percentage increased, primarily due to a sales mix shift to higher-margin products and services. Operating expenses declined 10% and 9% in constant currency from lower phone expense as well as Surface and gaming marketing spend in the prior year. As a result, operating income grew 68% and 72% in constant currency. +Now back to the overall company results. This quarter, we invested approximately $3.3 billion in capital expenditures, including capital leases, up sequentially in part due to the planned Q3 data center spend pushed into this Q4. This includes approximately $2.3 billion of cash paid for property and equipment, which was down year-over-year as we utilized more capital leases. +Free cash flow grew 50% year-over-year, driven primarily by operating cash flow growth of 30% as well as lower cash outlays for CapEx. Operating cash flow increased due to higher collections from customers following strong billings growth as well as working capital improvements in our hardware business. Other income and expense was $215 million, more than originally planned, as we continued to see opportunities in the equities market to realize gains throughout the quarter. +Our non-GAAP effective tax rate was negative 6%, significantly lower than we expected due to a $1.8 billion impact related to the utilization of prior years' losses from our phone business that were not deductible in the years incurred. Excluding this item, our non-GAAP effective tax rate was 19% this quarter and 20% for the full year. This quarter, we returned $4.6 billion to shareholders through share repurchases and dividends. +Now let's turn to the outlook. The key trends for FY '18 from the financial analyst briefing remain largely unchanged. For the full year, we expect about 1 point of negative FX impact, assuming current rates remain stable. In our Commercial business, we anticipate that increasing demand for cloud services and healthy renewals will continue to drive a higher annuity mix. Our commercial transactional business will continue to decline, driven by the transition to the cloud. We remain focused on improving our commercial cloud gross margin percentage in each of our cloud services. As a reminder, given seasonality and revenue mix, commercial cloud gross margin will experience quarterly variability. +Cloud migrations, deployments and new scenarios are driving greater customer usage. We will increase our capital investment to meet growing demand and capacity needs. Total CapEx spend will continue to have variability quarter-to-quarter. +At the company level, our gross margin percentage should decline about 1 point in FY '18, with increasing cloud revenue mix; a full year of LinkedIn amortization; and hardware launches, including our new console, Xbox One X. We expect LinkedIn quarterly amortization expense and COGS to be approximately $220 million or about $880 million for the full year. +Next, operating expenses. You should think about our FY '18 operating expenses in 2 categories: first, organic Microsoft expenses, which we expect to grow between 3% and 4%, reflecting the investments we are making to support our top line growth; second, LinkedIn. We are making incremental investments in LinkedIn to fuel its continued strong revenue growth. +Additionally, we will recognize our first full year of operating expenses, including $620 million of amortization expense. Importantly, we expect our company operating margin to only decline by about 1 point as we continue to grow our cloud revenue, we fund new investment to support growth in strategic areas and absorb $1.5 billion of LinkedIn amortization in COGS and OpEx. Excluding the LinkedIn impact, operating margin should be flat year-over-year. +Next, our effective tax rate. As a reminder, our tax rate is impacted by at least 3 major factors: the proportion of services revenue versus licensing revenue, the geographic mix of revenue and the timing of equity vest. As cloud revenue mix increases, we anticipate our tax rate will move higher. With quarterly variability based on these factors, we anticipate our full year non-GAAP tax rate to be 23%, plus or minus 2 points. And finally, we expect LinkedIn, ex purchase accounting, to be nondilutive in FY '18, as it was in Q4. +Now to the outlook for next quarter. Based on current FX rates, we expect less than 1 point of negative impact on revenue growth overall and for each segment. We expect commercial unearned revenue to be within the range of $24.85 billion to $25.05 billion. In Productivity and Business Processes, we expect revenue between $8.1 billion and $8.3 billion. Office 365 commercial revenue growth will continue to be driven by install base growth, ARPU expansion and adoption of premium services like E5 and should outpace the rate of transactional decline. +We expect a more moderate rate of growth in our Office consumer business, given prior year comparables. In our Dynamics business, Dynamics 365 will continue to drive our cloud mix higher. And we expect approximately $1.1 billion of revenue from LinkedIn, adjusted for the impact of purchase accounting. +For Intelligent Cloud, we expect revenue between $6.9 billion and $7.1 billion. Customer demand for Azure and our hybrid cloud offerings remains strong, and we anticipate another quarter of double-digit revenue growth across server products and cloud services. Enterprise Services should decline, given lower volumes of custom support agreements. +We expect More Personal Computing revenue between $8.6 billion and $8.9 billion. We anticipate OEM revenue will move more closely in line with the PC market. Devices revenue growth will continue to be impacted by the prior year phone comparable. Surface revenue will continue to be driven by the product life cycle transition between Pro 4 and our new Surface Laptop and Surface Pro. +In search, Bing's revenue growth ex TAC should be similar to prior quarters, and we expect gaming to have a typical seasonality revenue pattern for a preholiday quarter. +We expect COGS between $8.2 billion and $8.3 billion, including approximately $400 million from LinkedIn. LinkedIn COGS include about $220 million of amortization. +We expect CapEx on an accrual dollar basis to be similar to Q4 as we grow our investment to meet demand. We expect operating expenses of $8.6 billion to $8.7 billion, with about $1 billion of LinkedIn, of which roughly $155 million is related to amortization. Other income and expense should be about $250 million as we expect to realize more gains in our equities portfolio. Given the volume of equity vests that occur in our first quarter and based on today's stock value, we expect our first quarter non-GAAP effective tax rate to be approximately 4 points lower than the estimated full year tax rate. +Finally, we adopted the new revenue standard, ASU 606, effective at the start of fiscal year '18. To assist in the transition, Chris, along with our Chief Accounting Officer, Frank Brod, will be hosting a conference call in early August to discuss these changes, present historical restated financial results and share Q1 guidance converted to the new standard. And with that, let's go to Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move to the Q&A. Rhea, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + Great. Amy, I had a question about commercial cloud COGS, and I was wondering if you could give us a sense of what percentage of these roughly is related to depreciation, and how should we think about the pace of your CapEx deployments versus what you have been experiencing in commercial cloud to support the initiatives and the vast growth opportunities that you see ahead as we look out over the next 12 to 24 months? If there's anything you could share with us around that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [3] +-------------------------------------------------------------------------------- + + Let me break down the question a couple ways. Overall, when you think about COGS and the pacing, the depreciation rates of our servers don't change. It's generally over a 3-year period. And there's other pieces of equipment that have longer or shorter depreciation lives. So that pace of depreciation doesn't change per se. +If you're looking to see how we see demand, obviously this quarter, in Q4 we felt very good about cloud demand across all 3 services but in particular with Azure. I feel confident in our ability to produce gross margin improvement across all those services. I feel confident in our ability to continue to make progress on our overall commercial cloud gross margin growth. And I am encouraged by the demand signals we're getting. +All of those things, I think -- it's not really about the pace, it's as much about the progress and demand and meeting those things as closely as we can, and I feel really good about the team's execution. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [5] +-------------------------------------------------------------------------------- + + There's a lot of rumors and speculation around a sales reorganization, that you guys are sort of shifting around resources to sort of better distribute to cloud and new technologies. I was wondering if you guys could dig into that for us a little bit. What kind of changes are taking place in terms of go-to-market distribution heading into FY '18? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [6] +-------------------------------------------------------------------------------- + + Yes, let me start there. And first of all, thank you for the question, Keith. Overall, the approach we have taken for multiple years now is to transform everything that we do inside the company, whether it's the product creation; how we are organized in the R&D; how we think about breaking down any silos and category definitions we may have had in the past; how we think about even marketing and the marketing approach; and then, of course, even with the go-to-market. +And this transformation is ongoing. This has been happening over multiple years. But we have now got very good customer momentum, because ultimately this is all driven by the opportunity at hand, which is much bigger than anything that we have participated in the past. So the total addressable market is much bigger. And second, our customer expectations and our partner expectations of how we show up with them has changed. And so over the years, we have been making changes. And now that we have a lot more momentum and critical mass, we're going to that next phase. And that's what you are seeing us -- in terms of changing the skill sets, changing the scope of how we show up to support the digital transformation needs of both large customers as well as small businesses. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [7] +-------------------------------------------------------------------------------- + + And I think in many ways, Keith, what we've done is really a natural extension of some of the investments we've made over the past 18 months to add technical resources, to be more present in customer accounts, to really drive their transformation towards success outcomes. You're seeing it even in our Intelligent Cloud results last quarter and this quarter. We're taking that learning over the past 18 months and really applying it at a broader scale across the sales force to put those resources where we feel confident that they'll have a good long-term return in that next phase of transformation. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [8] +-------------------------------------------------------------------------------- + + Thank you, Keith. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [10] +-------------------------------------------------------------------------------- + + Question for Amy. Amy, there were a lot of numbers in this print that look very strong, but one that stood out to me was the commercial bookings growth of 30%. You did touch on it a little bit in your remarks, but if you don't mind, I'd love to ask you a few questions. One is, you mentioned that maybe part of the strength was terrific execution on renewals. Does it feel like maybe last quarter was a little bit of a renewal flush? In other words, it might have been a bit of a onetime phenomenon? +Secondly, is Microsoft doing anything different around contract structure or invoicing to -- that would result in bookings being unusually high, maybe collecting a little bit more up front? +And lastly, is it fair to interpret the strong bookings performance as giving us, and I suppose you, comfort in your revenue growth profile in fiscal '18 as all those bookings obviously convert to reported revs? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [11] +-------------------------------------------------------------------------------- + + Thanks, Karl. Let me make sure I cover off on most of those. Let me start by saying the biggest driver in commercial bookings growth this quarter was excellent execution on a large base of renewals. The second component of that is the execution on new revenue, in particular Azure, as well as Windows commercial. And billings in the quarter were very good and quite encouraging overall. There was no change in any way to invoicing, people paying earlier, paying more up front. That's definitely not an impact on that number. +And so overall I think, while it is certainly aided by the large expiry base because it tends to impact the CNB balance the most, it's really, I think, to your point, it is clearly encouraging because it gives us a very good base of support going into FY '18 to come in to the GAAP reporting numbers. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [13] +-------------------------------------------------------------------------------- + + Amy, I'm wondering, on the gross profit growth, I was looking through the slide deck, and it looked like gross profit growth in PBP was up about 2%. You saw some strong trends in different parts of that business, and I think that 2% I would have thought would have been higher. Could you help us understand the puts and takes around gross profit growth in PBP? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [14] +-------------------------------------------------------------------------------- + + There's a couple things, but in general, it's almost always mix shift. While we saw improvement in the gross margin percentage in Office 365 and continue to make progress on that, it's also the balance, right? This is the first quarter where we've actually seen the balance tip in terms of recognized revenue to online versus perpetual. So I actually feel very good that, as we continue to accelerate the growth trajectory, that you're not seeing, frankly, much impact on the gross margin line, and we're seeing a lot of leverage in that through OpEx all the way down to the operating income line. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [15] +-------------------------------------------------------------------------------- + + Great. Thank you, Walter. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + Amy, commercial cloud ARR grew 24% Q-over-Q, which is the largest Q-over-Q growth so far. Completely understand that Q4 is a big quarter for closing business, but $3.7 billion is a large number. Can you give us some more color on exactly what's driving this growth? And then I have a quick follow-up. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [18] +-------------------------------------------------------------------------------- + + Sure. When you think about -- you're right, it is a big number, and I feel very good about it. And for the year, on a pure basis, it was $15 billion of commercial cloud revenue. See, we're starting to get to that point, Mark, where you have a big base which is still growing at a fast rate, and so especially ARR numbers can see big jumps, in the one that you saw this quarter. And you're right, Q4 is also historically quite a big quarter, and this one certainly was as well. +But you also saw, and what really does matter, especially in Azure, is usage growth, really consumption growth, having customers use, deploy, be successful and really continue to get, you think, sort of meters up and running, and that continues to build on itself. And so when you start to see that, you can and I do think we'll continue to see good growth in this number. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Excellent. As a quick follow-up, how should we think of how that sets us up for '18 in terms of hitting expectations, beating expectations, continuing strong 40s, 50s percent year-over-year growth? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [20] +-------------------------------------------------------------------------------- + + Let me start by saying, first, I feel very good about meeting our stated goal of $20 billion in commercial cloud ARR. Next, I think across every service, the momentum we've seen in Q4 -- and in particular, I would say I think not many people focus on it, but even things like Windows, E5, Advanced Threat Protection services, those types of deployments really will add to momentum in our offerings. +One of the things we often talk about is we sell Microsoft 365. That's Windows 10 with security and services. It's a modern workplace that includes up-to-date Office 365. It includes EMS. We really did see strength across all of them. So I don't really think it's about a percentage but it's about each of them continuing to make progress. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + A question first for Amy on Office 365. Office 365 commercial revenue continues to outpace the unit growth, the monthly active users, so you're still seeing that trend up to E3, E5, et cetera. I wonder if you could take us through where we are in that life cycle. +And also, just to follow on your comment to the last question, Satya, you launched at Inspire Microsoft 365 that Amy just mentioned. How should we think about Microsoft 365 in the context of Office 365, also just given the fact that Windows Commercial actually accelerated this quarter as well? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [23] +-------------------------------------------------------------------------------- + + Yes, maybe I can start and then... + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [24] +-------------------------------------------------------------------------------- + + Why don't you start and I'll do the next one. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [25] +-------------------------------------------------------------------------------- + + So one of the things that we're very excited about and have learned a lot from is the Secure Productive Enterprise offer that we've had now last year, and in fact in Q4, it really accelerated significantly. And so that's helped us, in fact, come up with Microsoft 365 as this very strong offering that brings together Office 365, Windows 10 as well as our Enterprise Mobility + Security and support even cross-platform devices. So we think of the modern workplace as having a very significant footprint of Windows, but also people who use phones of iOS and Android, but they need both productivity, creativity, security across all of this estate of theirs. And that's where I think we have a competitive advantage and a great value proposition. +So that's what Microsoft 365 embodies. It's today available in -- for enterprises, and in the fall you will have the mid-market version of it, which I think is another very big opportunity, because it really helps take what we have learned in the large enterprises and scale it to where perhaps the need is even more acute. And so we are excited about that when -- at Inspire, the partner channel obviously is very excited about it as well. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [26] +-------------------------------------------------------------------------------- + + And Phil, to your point, and it's a nice transition from Satya's point about especially the mid-market offering coming in the fall for Microsoft 365, is the install base growth. You're right; in terms of Office Commercial 365, the primary driver is still install base, both the transition as well as new. I think we're optimistic as we head into FY '18 for the install base growth that's possible in particular for some of these mid-market offerings that we're quite proud of. +The ARPU growth that you saw and have seen the past couple of quarters continues to primarily, Phil, be related still to the E1 to E3 transition. When we mentioned E5, I think that's, frankly, encouraging for us, because all of these premium offers do best when you start the deployment motion. People start using E1, then they use E3, and then you start to see the momentum in E5. And we did see that. However, in terms of ARPU impact, very, very small in quarter. So that's something that, over time, you would continue to see improvement in, in terms of impact on ARPU. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [27] +-------------------------------------------------------------------------------- + + Thanks, Phil. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Kash Rangan with Merrill Lynch. + +-------------------------------------------------------------------------------- +Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [29] +-------------------------------------------------------------------------------- + + Curious if you can shed a little bit more light on commercial bookings growth of 30%. Clearly, that's off the charts. And also, when I look at the $18.9 billion of annualized revenue, and judging from the fact that the commercial business, non-Azure component of it, was about steady in growth rate (inaudible) that Azure went through some significant acceleration which is yet to be reflected in your forward-looking revenues, if you could just shed a little bit more light and drill into any 2 or 3 product SKUs or areas or geographies that contributed to that off-the-charts performance, that would be great. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [30] +-------------------------------------------------------------------------------- + + Thanks, Kash. Let me go through the bookings. Again, with that 30%, the first and best contributor to that is the strong performance on the renewals in-quarter. It was reasonably consistent, Kash. There's not a geo in particular that I would say was a massive outlier, although, in 2 of our largest geos, the U.S. and Germany, they did have very good years, in particular in Q4. +Now if you separate the fact that we had the large base, which clearly contributes to that bookings number being big, aside from that, in particular Azure, in the last, to your point, did it really show up in that $18.9 billion, it didn't. The strong billings growth really showed up in that unearned outperformance, which you saw versus the guide, and it was significant. And a lot of that is the Azure billings. I think we felt very good. Those as well, I think, were pretty broad-based across industry, I would also say across geos. And so while we, of course, get some strength from our largest geos, and I would say they were probably the largest contributors, it was actually quite broad. There's not really one place for me to say that "We just saw it here." +And then the final component that I would say was better than we anticipated and where you'd see that, Kash, again, versus the unearned guidance and the beat that we had there, was that final piece around our security value prop, ATP. Windows annuity growth was very good. That's in the KPI Windows commercial products and services, is the place you'll look and see that number. And outside of that, I mean, those really are the biggest contributors. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [31] +-------------------------------------------------------------------------------- + + Yes, I'm going to -- if I'll add one thing, I'll just say that nothing shows up in just 1 quarter. We have been working on this for a long time, whether it's the product and the approach we have taken from IaaS to PaaS to SaaS, even the diversity of our SaaS offerings, and also how we think about going to market. All of these have been multiple years of hard work. And clearly, there is momentum across the board, and that, I think, is what you're seeing. And we are excited about this quarter's execution and performance. And I think it bodes well for what we do in the future. But the key is for us to recognize that this is about sort of long-term commitment to a big opportunity and making sure that you line up your execution against that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [32] +-------------------------------------------------------------------------------- + + And I think maybe I should have also mentioned, when you think about seeing that type of performance, and Satya mentioned, it's not just because of work done this quarter. It's a great point. But it's also the investments we've made. We've committed. We did sales overlays. We added technical resources. We put resources at customers ahead of the curve. We did that. You saw that in the operating -- in the Intelligent Cloud OpEx growth over the past few quarters. That execution is what's landing. + +-------------------------------------------------------------------------------- +Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [33] +-------------------------------------------------------------------------------- + + Clearly something inflected and it looks like you're gaining share, so congratulations. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [35] +-------------------------------------------------------------------------------- + + Amy, going back to the size of -- the large size of the expiry base in Q4, when we look back 3 years to June of '14, the -- in that quarter, the commercial bookings grew 23%. I'm just curious, is that representative of the portfolio that flowed through into this quarter on a 3-year cycle? Or is it more complex than that? And also, does it include or exclude LinkedIn contributions for the current period? +And just finally, I'm wondering, again, looking back 3 years, it was a different number in the September quarter that follows, and can you help us just with the year-over-year growth of the expiry base for the September quarter? I'm not sure if you had commented on that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [36] +-------------------------------------------------------------------------------- + + Okay. You're right. Mark, it's not exactly. If I said is the Q3 from 3 years ago exactly the expiry base, it's not exactly, but it's directionally. And so that's a good example, to say every 3 years tends to be the length of our agreements. And so you do tend to see that repeated. And so that's what we mean by sort of the record or the largest expiry base, and that is the pattern. In terms of LinkedIn having any impact, it did not. So that is the cleanest way to think about that number. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [37] +-------------------------------------------------------------------------------- + + Thanks, Mark. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross MacMillan with RBC Capital. + +-------------------------------------------------------------------------------- +Ross Stuart MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [39] +-------------------------------------------------------------------------------- + + I'm actually going to ask a question about the traditional server products business, which once again had a pretty strong growth rate at 5%. I think the last 3 quarters we've been trending at mid-single digits or even higher. And Amy, I'd just love your thoughts, as we progress through fiscal '18 just so we think about this in the right way, how would you expect that sort of growth rate to trend? And should we be sort of aware of the comps that come up in Q2 and beyond? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [40] +-------------------------------------------------------------------------------- + + Maybe I can start and at least give you what -- how we think about it technically and product-wise, and then we can go into sort of talking about the future in terms of the results itself. +First of all, we don't think of our servers as distinct from our cloud. In other words, this intelligent cloud and the intelligent edge is the architecture or pattern for which we are building, whether it's SQL Server 2017 or with Windows Server, the Container Service. Everything that we do assumes that distributed computing will actually remain distributed. And it turns out that it's helpful to think about it that way both for customers who are rationalizing their portfolios of apps as they lift, shift, modernize as to what they run in their data centers or in our data centers but also forward-looking new workloads. If you look at some of the most exciting things that are happening in the cloud is cloud applications that actively require an edge. Azure IoT or Azure Stack are becoming the run times of the edge, where you do need not only the ability to do compute and storage but to run the AI inference and the edge. +So to me, that's what we are building to. It's actually a big architectural shift from thinking purely of this as a migration to some public cloud to really thinking of this as a real future distributed computing infrastructure and applications that I, quite frankly, feel very, very good about leading. And so in that context, our server license revenue will fluctuate based on what the macro is and these transitions and mix shifts. But from a forward-looking perspective, I want us to be very, very clear that we anticipate the edge to be actually one of the more exciting parts of what's happening with our infrastructure. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [41] +-------------------------------------------------------------------------------- + + And so that leads why I always tend to say I don't focus as much on the mix per se. I know both of them will matter. I know both of them are important. And so that's why I tend to focus on that all up server KPI combination of the progress in the cloud, Azure, as well as the Edge, which is the on-prem. And so I think we remain confident in that double-digit target that we have for that KPI. And there isn't really, I don't think, sort of a comparability challenge per se, but that's why we try to keep it at that high level, to not get too tied to one or the other, given we know the TAM expansion that's possible. We know we can grow within it. +And I apologize, I didn't answer Mark's last component, so let me just go back, and I had forgotten, which was, was there anything unique in the expiry base for Q1. The answer is it's up a little year-over-year but -- and certainly not through the same type of Q4 comparable. When we tend to have these, we try to call them out, like we did in Q3 leading into Q4. So Q1, I would say, is just up a little, so I wouldn't expect any material impact. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [42] +-------------------------------------------------------------------------------- + + Thank you, Ross. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays PLC, Research Division - Director and Analyst [44] +-------------------------------------------------------------------------------- + + I wanted to drill in on the premium service in Azure. Satya, you talked a little bit about SharePoint taking off and being a big part. Can you talk a little bit about the portfolio you have there? And I also wanted to contrast it a little bit with one of your main competitors who keeps coming up with new products just to kind of get to that premium service and the advantage that you guys have, given the IP that you've built up over the years. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [45] +-------------------------------------------------------------------------------- + + Yes, I mean, I think we have premium services, whether it's in Office 365 or in the SaaS side with Dynamics 365, and that's where the SharePoint comment came, that there's a lot more in Office 365 adoption cycle beyond Exchange or e-mail. +On the Azure side, my comments, in fact, walked that entire tree, so to speak, which is there's the infrastructure there, where in fact even in the infrastructure side there is no such thing as one generic infrastructure, when I look at the diversity of the virtual machines, what's happening with AI infrastructure, with GPU compute. So there's a lot of richness there. +The layer above that, for me, is the data estate. One of the exciting things is the growth in Azure DB, the growth in Cosmos DB, our data warehouse product the Data Lake. So that's a place where we are seeing significant attach. On top of the data is where the AI services, whether it's the bot framework, the cognitive services. So that's all the rich services where we're seeing significant customer action. +The other side of it is the edge. So Azure IoT, our service both in the cloud and the edge, and Azure Stack now, truly starting this quarter, is going to be another way to extend out the rich services of Azure even beyond public cloud deployment. So that's what hopefully gives you a flavor for the IP that we have. +And then one linchpin that we have between, in fact, our SaaS services as well as Azure is Azure Active Directory. 90% of all the enterprises use Azure -- use Active Directory, and all of them rendezvous with Azure Active Directory irrespective of what applications they have in whichever cloud, because that becomes a very key control plane for IT. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + And our last question will come from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Senior Equity Research Analyst [47] +-------------------------------------------------------------------------------- + + Amy, as the Azure business continues to gain scale and, to Raimo's question, the premium mix continues to become a bigger part of that, is there any reason to think that the gross margin gains shouldn't accelerate in '18 versus where they were in '17? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - CFO and EVP [48] +-------------------------------------------------------------------------------- + + Thanks, Brad. The way I tend to think about it is, with any service, you want the gross margin itself to improve. And that includes, in the Azure services, components themselves. The difference between core compute and store versus the premium layers can be significant, and we've had improvement across all of them. +So the real question on how and where should the Azure gross margin be is about sort of the ultimate mix of those. And we saw significant improvement this year. We expect a lot of improvement again next year on each of those service lines. And where the actual mix occurs among those lines, I think we'll just have to wait and see. But -- and that's why I tend to not focus at that layer. It's like, can you get every service better; can you make material improvement; and then, of course, can you get usage and consumption going. That leads to premium service usage. And of course, over time, you'd expect a higher mix of premium versus core. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [49] +-------------------------------------------------------------------------------- + + So that wraps up the Q&A portion of today's earnings call. As Amy mentioned, Frank and I will be hosting a conference call in early August to discuss the changes under the new revenue standard. You can find additional details for that on the Microsoft Investor Relations website when available. Thank you again for joining us today. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO and Non-Independent Director [50] +-------------------------------------------------------------------------------- + + Thank you all. Thanks. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2017-Oct-26-MSFT.txt b/Transcripts/MSFT/2017-Oct-26-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..6a6f19171e26b586afe0bf14319345ff75246e86 --- /dev/null +++ b/Transcripts/MSFT/2017-Oct-26-MSFT.txt @@ -0,0 +1,411 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Microsoft Corp Earnings Call +OCTOBER 26, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Non-Independent Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Chris Suh + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Ross Stuart MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Raimo Lenschow + Barclays PLC, Research Division - Director and Analyst + * Adam Hathaway Holt + MoffettNathanson LLC - Partner & Senior Research Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Stewart Kirk Materne + Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Michael Barry Nemeroff + Crédit Suisse AG, Research Division - Director + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Greetings, and welcome to the First Quarter Fiscal Year 2018 Microsoft Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- +Thanks, Jessie. Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call. +As a reminder, this is the first quarter we're reporting our results under the new revenue standard, ASC 606. As we detailed during a conference call we hosted on August 3, the adoption of this standard had several impacts but most materially, the revenue recognition of Windows 10 OEM licenses and the license component of on-premises annuity contracts. +As we discuss our Q1 results and share our outlook on the call, please keep in mind the following: first, the new standard allows us to simplify the communication of our results by eliminating the non-GAAP revenue reporting; second, there is no change in customer billings, cash flows or revenue recognition for our cloud services, hardware, Enterprise Services and advertising businesses; and lastly, the quarterly seasonality of our revenue within a given year does change, and we may experience higher quarterly volatility as well. +The prior periods we'll reference on this call and in the earnings materials on our IR website have been restated to reflect adoption of this new standard. During our August 3 call, we also translated our outlook for Q1 into the new standard, and all references to expectations on this call refer to that translated guidance. You can find additional information on this accounting change located on the IR website. +All growth comparisons we make on the call today will relate to the corresponding period of last year, unless otherwise noted. We'll also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. +Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until October 26, 2018. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- +Thank you, Chris, and thanks to everyone on the phone for joining. We're off to a very strong start in FY '18, delivering double-digit top and bottom line growth and exceeding $20 billion in commercial cloud ARR, outpacing the goal we set just over 2 years ago. I'm proud of our team's work behind these results that spanned all of our segments. +We now have 120 million monthly active users of Office 365 commercial. We have more than 530 million LinkedIn members. Dynamics 365 customers grew 40% year-over-year. Azure Compute usage more than doubled this quarter, and revenue grew 90%; and Windows 10 commercial monthly active devices grew 90% year-over-year. +These results reflect our accelerating innovation as well as increased usage and engagement across all businesses as customers continue to choose Microsoft to help them transform. Amy will cover our financial results in more detail, but today I wanted to talk about the key areas of innovation and opportunity for growth in 2018 and beyond. +Our focus is on bringing our technology and products together into experiences and solutions that deliver new value for customers by galvanizing around 5 key solution areas: first, top of mind for every CEO is empowering their own employees for the modern workplace. Microsoft 365 is our core offering to address this $500 billion-plus market. We are bringing together Office 365, Windows 10 and Enterprise Mobility and Security as a complete integrated solution for organizations of all sizes. It represents a profound shift in the way we design, build and deliver our productivity solutions, moving to a people-centered approach, spanning all their devices to unlock creativity and inspire teamwork, while simplifying security and management. +This past quarter, we launched a wave of innovation across Microsoft 365. The Windows 10 Fall Creators Update empowers people with new AI-first [in phases], ranging from voice-activated commands through Cortana, inking, immersive 3D content, storytelling and mixed reality experiences. Cloud sharing and co-authoring experiences are now natively enabled with OneDrive files on demand. +We are making Windows 10 more accessible to everyone with new features like the eye control, which gives people the ability to operate a PC using just their eyes. You'll see a great line-up of new Windows 10 devices this holiday, from the new Surface Book 2 to a vibrant range of devices from our OEM partners. +This month, we also introduced Windows mixed reality broadly. Mixed reality, which is a voice, gaze and gesture interface, will fundamentally change the way people and teams collaborate. Our work with Ford is a great example of this promise. Ford's designers are using mixed reality to blend 3D holograms digitally with models and physical production vehicles, allowing them to experiment and iterate on design much more quickly. HoloLens, Windows VR headsets and Microsoft 365 enable any customer to blend physical and digital worlds across devices, empowering people to collaborate in the same shared experience from anywhere in the world. +AI is infused across Microsoft 365 in a myriad of helpful ways, making it easier for people to create high-impact presentations and documents, automate routine tasks and search and discover people and content in highly personalized and relevant ways. +Beyond new AI capabilities in PowerPoint, Word, OneNote, SharePoint, we're enabling AI-first workloads like Bing and Cortana using the Microsoft Graph. Soon, you'll be able to search not only the public Internet but also corporate intranet sites, line of business applications and people with Bing for Business now in private preview. With Cortana, you'll be able to query your calendar and automate tasks like scheduling a meeting or replying to an e-mail using just your voice. +Microsoft Teams is core to our vision for the modern workplace as a digital hub for teamwork, bringing together conversations, meetings and content into a single canvas. We are integrating AI and cognitive services to make meetings more productive for users today and longer term. +Lastly, Microsoft 365 connects users, devices and SaaS applications into a single control plane to simplify IT management while providing comprehensive security across the entire digital estate. Today's sophisticated threats require AI-based security approaches. Using the Microsoft Intelligent Security Graph, we process billions of signals to detect and remediate threats. New conditional access capabilities evaluate risk in real-time based on the user's account, device and application and physical location. Our leading-edge security and management capabilities are just one reason customers trust Microsoft 365 for their modern workplace needs. +Now I'll turn to LinkedIn and our business applications. From the outset, the priority one was to ensure that LinkedIn, on its own, accelerate its mission and growth while retaining its culture as part of Microsoft. Nearly 1 year in, we are ahead of plan with LinkedIn contributing positively to EPS ex purchase accounting in fiscal '18. +Second, we're seeing record levels of engagement. LinkedIn is on target to surpass 21 billion sessions this calendar year and has seen its fourth consecutive quarter of 20%-plus sessions growth. Engagement across the platform is strong, with 65% year-over-year growth in jobs, visitors across mobile and desktop, 60% growth in feed update views and nearly 40% growth in messages sent, driven by more ubiquitous messaging. +Third, innovation and execution are accelerating in both the business and in the product integrations across Microsoft, with a positive reception to native video, career advice marketplace and this week's launch of smart reply messaging. LinkedIn profile integration in Office 365 delivers rich people insights from both the LinkedIn Graph and the Microsoft Graph. +The Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Microsoft Dynamics to transform business-to-business sales through social selling. Dynamics 365 for talent with LinkedIn Recruiter and Learning gives HR professionals a complete solution to compete in the talent marketplace. You'll see more product integration in fiscal '18 as we continue to accelerate our innovation to connect the world's leading professional cloud with the world's leading professional network. +Now I'll turn to 2 areas of our hybrid cloud value proposition: applications and infrastructure and data and AI. We've been focused on addressing the real-world needs of customers with our differentiated approach to the cloud, architecting for hybrid consistency, developer productivity, AI capabilities and trusted security and compliance. Moreover, customers are choosing the Microsoft Cloud for its operational consistency, productivity and security that spans the entire digital estate, inclusive of Windows 10, security and management, Dynamics 365, Enterprise Mobility and Security and Azure. +Let's double click on hybrid. To support the emerging Intelligent Cloud, Intelligent Edge application pattern, you need a consistent stack across the public cloud and the edge. Merely providing co-location services or connectivity between on-premise data centers and the public cloud is not sufficient to meet customer needs. You need consistency across the development environment, operating models and technology stacks. +Azure provides this consistency across the entire stack, inclusive of identity, data, app platform, security and management -- at the edge and in the cloud. Our hybrid cloud is one of the reasons nearly every Fortune 500 company has chosen to partner with Microsoft. Costco recently chose Azure as its hybrid cloud platform, and we are excited to partner with them on their digital transformation. +Core currency of any business going forward will be the ability to convert their data into AI that drives competitive advantage. Azure SQL DB makes it possible for customers to take SQL Server from their on-premise data center to a fully managed instance in the cloud with no code changes. SQL 2017 is now broadly available on Windows, Linux, Docker containers with everything built in, including the ability to run AI compute close to the data with Python or R. +Azure Cosmos DB is the first globally distributed multimodal database that enables developers to write apps for IoT and other event-based serverless applications. We're accelerating our innovation to help every developer be an AI developer with approachable new tools from Azure Machine Learning Studio for creating simple ML models to powerful Azure Machine Learning Workbench for the most advanced AI modeling in data science. We continue to enhance our cognitive services to give every enterprise powerful building blocks to create their own AI applications. +Finally, we continue to invest in making Azure the most trusted cloud with AI-based security built in. Azure confidential computing enables encryption of in-use data to ensure that information is always under customer control, a first for any public cloud. Our ongoing data center expansion brings Azure to 42 regions globally, more than any other cloud provider and 69 compliance offerings and the most comprehensive compliance coverage in the industry. And new Azure availability zones provide new levels of resiliency for high-availability apps within a region and across regions. +Now let me turn to our last solution area: gaming. We are mobilizing to pursue our expansive opportunity in the $100 billion-plus gaming industry, broadening our approach to how we think about gaming end-to-end from the way games are created and distributed to how they are played and viewed. We will continue to connect our gaming assets across PC, console and mobile and work to grow and engage the more than 53 million Xbox LIVE member network more deeply and frequently with new services like Game Pass and Mixer. And we are a few days away from launching the Xbox One X, the most technically advanced and powerful console ever built. +Moreover, we have high expectations for our gaming business to bring more people to more Microsoft experiences and broaden our engagement and usage scenarios. This means fundamentally rethinking how we measure progress in gaming. While we continue to innovate across the console, PC and Xbox LIVE services, we see substantial additional opportunities across e-sports and streaming. At 20% this quarter, our software and services revenue growth reflects the early-stage potential of this larger opportunity. +We also see the opportunity to empower developers who work on console, PC and mobile games to use our cloud infrastructure and services to enhance their gameplay and community. Gaming pushes the boundaries of hardware and software innovation, with some of the most CPU and GPU-intensive applications and content, giving us a huge opportunity in the cloud. As one example, PUBG Corp., with the hit game PlayerUnknown: Battlegrounds, is not only partnering to make Xbox the exclusive console at launch but is also running on Azure. +In closing, across the company, we are mobilizing to pursue our 5 core customer solution areas. We are partnering deeply with our customers so that our new technologies and innovations can help them digitally transform, grow and thrive. +Now I'll hand it over to Amy to walk through this quarter's results in more detail and share our outlook, and I look forward to rejoining you for the questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $24.5 billion, up 12% and 11% in constant currency with better-than-expected performance across all segments. Gross margin increased 15%, operating income increased 15% and earnings per share was $0.84, increasing 17%. Our strong start to the fiscal year with double-digit top and bottom line growth is a result of our consistent execution and ongoing investment in product innovation and sales capacity. +At a company level, LinkedIn contributed approximately 5 points of revenue and gross margin growth and had a 4-point drag on operating income. Excluding the cost amortization of acquired intangibles, LinkedIn contributed $78 million to operating income. We are confidently ahead of our original financial commitment for LinkedIn. We now expect LinkedIn, ex purchase accounting, to be accretive to EPS this fiscal year. +Our results were in line with macroeconomic trends, with better-than-expected performance from large markets like France, Japan and the U.K. and stabilization in markets like Brazil and Russia. Our sales team and partners delivered strong commercial results this quarter. Multiyear commitments from customers contributed to an 89% annuity mix. On a roughly flat dollar volume of EA expirations, we grew commercial bookings 14% and 9% in constant currency. Commercial unearned revenue came in higher than we expected at $21.5 billion, primarily from higher software assurance billings and FX benefit. +Our commercial cloud business had another quarter of robust revenue growth and material gross margin improvement. Revenue exceeded $5 billion this quarter, growing 56% year-over-year and gross margin increased 8 points to 57%, with improvement in each cloud service, most notably in Azure. +Our company gross margin was 66%, up 2 points from prior year as sales mix of higher-margin products and services, along with improving cloud margins, more than offset the impact of the growing cloud mix of revenue and LinkedIn amortization cost. +The FX impact of a weaker-than-expected U.S. dollar increased total company revenue growth by 1 point. At the segment level, FX had minimal impact on Productivity and Business Processes and increased revenue growth in both Intelligent Cloud and More Personal Computing by 1 point. FX added 1 point of growth to operating expenses this quarter, which grew 16% and 15% in constant currency. LinkedIn contributed 14 points of growth, including $154 million of amortization of acquired intangible expense. +Now to our segment results. Revenue from Productivity and Business Processes segment grew 28%, also 28% in constant currency to $8.2 billion, with better-than-expected results due to FX as well as Office commercial, consumer and LinkedIn. LinkedIn contributed 18 points of growth. +Office commercial revenue increased 10% as revenue mix continued to shift to Office 365 commercial. Office 365 commercial revenue grew 42% from strong installed base growth and ARPU expansion. Companies like Lowe's and Devon Energy chose Office 365 to connect their employees and empower them in the modern workplace. And with our channel partners, we added, on average, more than 50,000 small and medium business customers each month, a trend we have sustained for more than 3 years. +Office 365 commercial seat growth was up 1 point sequentially to 32% and declined 8 points year-over-year. We do expect that year-over-year trend to continue, given the increasing size of the base. Office consumer revenue increased 12% or 10% in constant currency, driven by recurring subscription revenue and growth in our subscriber base, now at 28 million. +Our Dynamics business grew 13% and 12% in constant currency, driven by the revenue mix shift to Dynamics 365. Customers like the U.S. Department of Veterans Affairs and the Seattle Seahawks, have adopted Dynamics 365 to modernize their business processes. Dynamics 365 grew 69%, same in constant currency with continued installed base and ARPU growth. +LinkedIn revenue for the quarter was approximately $1.1 billion, a bit better than we expected. Post-acquisition sales execution has been strong, with record levels of user engagement. This quarter, LinkedIn sessions again grew more than 20%. Segment gross margin dollars grew 25% and 24% in constant currency with 15 points of contribution from LinkedIn, including $218 million of amortization. Gross margin percentage declined due to the impact of LinkedIn-related amortization. +Operating expenses grew 54% and 53% in constant currency with 49 points from LinkedIn, including $154 million of amortization expense. Operating income increased 3% and 4% in constant currency, with 10 points of negative impact from LinkedIn. The Intelligent Cloud segment delivered $6.9 billion in revenue, growing 14% and 13% in constant currency with better-than-expected performance driven by hybrid cloud results as well as FX. +Server products and cloud services revenue grew 17%, also 17% in constant currency with another quarter of double-digit annuity revenue growth. Azure revenue grew 90% and 89% in constant currency, and Azure premium revenue grew triple digits for the 13th consecutive quarter. Our unique ability to provide a distributed hybrid model for the Intelligent Cloud and Intelligent Edge continues to attract customers to Microsoft. +Symantec, the industry's largest security vendor, has adopted a company-wide hybrid strategy with Azure, including delivery of its Norton consumer products to a global community of more than 50 million people. And financial services firms like Bank of America, TD Bank and Sumitomo Mitsui Banking Corporation, are all using Azure and its data services to improve customer experiences. +Enterprise Services revenue grew 1% and was flat in constant currency as premium support services growth offset declines in custom support agreements for Windows Server 2003. Segment gross margin dollars grew 10%, the same in constant currency, and segment gross margin percentage declined due to the increasing cloud revenue mix and lower Enterprise Services margins, partially offset by material improvement in Azure's gross margin. +This quarter, operating expenses grew 3% or 2% in constant currency from ongoing investments in sales capacity and engineering. Operating income increased 20%, the same in constant currency. +Now to More Personal Computing. Revenue from this segment was $9.4 billion with FX as well as each core business contributing to the segment's better-than-expected results. Excluding phone, revenue grew 3%, the same in constant currency. Both the commercial and the consumer PC markets were better than we expected, contributing to OEM revenue growth of 4%. OEM Pro revenue grew 7%, ahead of the commercial PC market from a higher mix of premium SKUs and a couple points from timing of license purchases. We continue to see Windows 10 deployment cycles drive commercial customer hardware demand. +OEM non-Pro revenue was down 1%, in line with the consumer PC market and reflecting healthier conditions in key markets like Brazil and Russia. Inventory levels were in the normal range for a preholiday quarter. Windows commercial products and services grew 7% and 6% in constant currency, mainly driven by seat growth. We continue to see enterprise customer momentum with Coca-Cola Company, Her Majesty Revenue and Customs and Rogers Communications choosing Windows 10 for its intelligent security features and advanced management capabilities. +Patent licensing declined this quarter, primarily due to onetime impact of IP deals signed in the prior year. Search revenue ex TAC grew 15%, the same in constant currency from higher revenue per search and stronger-than-expected performance from volume. Our online businesses showed healthy improvement in revenue growth and profitability as we realized the benefits of scale. +Our Surface business grew 12% and 11% in constant currency, driven by sales of the new Surface Laptop in both the commercial and consumer segments. We continued to see solid execution through the product life cycle transition between Pro 4 and our new devices. +Gaming revenue grew 1% and was flat in constant currency as Xbox software and services growth offset declines in hardware. Software and services revenue grew 21% or 20% in constant currency, driven by continued growth in monetization. Our engaged user base grew 13% to 53 million monthly active users across Xbox One, Windows 10 and mobile platforms. Additionally, new services like Game Pass and Mixer, which create more opportunity for engagement and monetization, showed encouraging early results. +Segment gross margin dollars increased 10%. Gross margin percentage increased, primarily due to sales mix shift to higher-margin products and services. Operating expenses declined 1% or 2% in constant currency from lower Windows and gaming marketing spend and our last full quarter of significant benefit from Phone savings. Operating income grew 26%, the same in constant currency. +Now back to our overall company results. This quarter, we invested approximately $2.7 billion in capital expenditures, including finance leases, down sequentially and lower-than-originally planned, mainly due to quarter-to-quarter volatility. Cash paid for property and equipment was approximately $2.1 billion. Our significant capital investment continues based on customer demand and usage signal, and the teams remain focused on gross margin improvement as they deploy services globally to meet that demand signal. +Free cash flow grew 10% from operating cash flow growth of 8%. As a reminder, in the prior year, we had $1.3 billion in unsettled cash equivalent positions that reversed the following quarter. Excluding this amount, free cash flow increased 27% from higher customer collections following strong billings growth and working capital improvement in the hardware business, primarily driven by our exit in the phone business. +Other income and expense was $276 million, a little more than planned as we continued to see opportunities in the equity market to realize gains throughout the quarter. Our effective tax rate was 18%, 1 point lower than we expected, primarily due to geographic mix of revenue. This quarter, we returned $4.8 billion to shareholders through dividends and share repurchases. +Now let's turn to the Q2 outlook. First on FX. Assuming current rates remain stable, we expect FX to increase revenue growth by 1 point, COGS growth by 1 point and OpEx growth by 2 points. Our commercial business should remain healthy, with solid renewal execution and increasing customer demand for our hybrid cloud services and new cloud solutions like Microsoft 365. +Turning to commercial bookings. As you know, the underlying dollar volume of EA expirations impacts commercial bookings growth. For the full year, total expirations will be up slightly, but Q2 expiration dollar volume will be down roughly 20%, impacting our Q2 commercial bookings growth. We expect commercial unearned revenue to be down approximately 7% sequentially, reflecting normal seasonality. +We remain committed to material improvement in our commercial cloud gross margin percentage. Margin performance is variable quarter-to-quarter, driven by revenue mix and seasonality as well as the timing of infrastructure spend. We expect continued year-over-year margin improvement and sequential trends consistent with prior years. +Next to CapEx. We will increase our capital investment to meet growing demand and capacity needs. And on accrual dollar basis, we expect a sequential dollar increase next quarter. In Productivity and Business Processes, we expect revenue between $8.75 billion and $8.95 billion. Office 365 commercial growth will continue to outpace the transactional decline. We expect a more moderate rate of growth in our Office consumer business, given the prior year comparable. In Dynamics, we expect continued double-digit revenue growth, driven by the shift to Dynamics 365. And we expect approximately $1.2 billion of LinkedIn revenue, reflecting continued strong sales execution by the team. +Intelligent Cloud, we expect revenue between $7.35 billion and $7.55 billion, with another quarter of double-digit revenue growth across server products and cloud services. As a reminder, starting in Q2 of last year, the launch of Windows Server 2016 drove strong on-premises performance, resulting in 6% constant currency growth for server products. This comparable will impact the segment year-over-year growth rate. +We expect enterprise services revenue growth to be similar to last quarter, driven by premier support services offsetting declines in custom support agreements. In More Personal Computing, we expect revenue between $11.7 billion to $12.1 billion. +First on Windows. OEM revenue should track roughly in line with the overall PC market. Specifically, OEM Pro revenue growth should be more aligned to the commercial PC market, normalizing for a couple of points of growth from the timing of licensing purchasing in the first quarter. +Next, devices. In Surface, we expect revenue to be up slightly from Q1 as we continue to transition to the new Surface Pro, ramp Surface Laptop and launch the Surface Book 2. Also in November of last year, we closed the sale of our feature phone business, so this will be the final quarter of revenue comparability impacted by the phone. We expect double-digit revenue growth in search ex TAC, reflecting continued strong performance in both rate and volume. +And finally, gaming. We expect revenue growth from the launch of the Xbox One console and continued healthy growth of software and services revenue. In Q2, the higher mix of gaming hardware revenue will significantly impact both the segment and company gross margin percentages. We expect COGS between $11 billion and $11.2 billion, in the normal range for a holiday quarter with new device launches and including 1 point of FX headwind. This includes approximately $400 million of LinkedIn COGS, of which $220 million is related to amortization expense. +We expect operating expenses of $9.1 billion to $9.2 billion, which includes 2 points of FX headwind. This includes $1.1 billion of LinkedIn expenses, of which $154 million is related to amortization. Other income and expense should be approximately $450 million as we continued to take gains in our equities portfolio; and we expect this pace to continue until the end of the fiscal year. +Now let me share some additional comments on fiscal '18, given our strong first quarter results, our business momentum and the changing currency landscape. First on FX. For the full year at current rates, we expect FX to increase revenue, COGS and OpEx growth at the company level by 1 point. Therefore, we now expect full year operating expense growth, excluding LinkedIn, to be between 4% and 5%. This is unchanged from our prior outlook except for the updated FX impact. +Second on margins. With our strong Q1 results and the FX impacts I just outlined, we are trending a bit better on both gross and operating margin relative to our original full year outlook of down roughly 1 point each. We now expect operating margin ex LinkedIn, to be up year-over-year even as we increase investment to support long-term top line growth in commercial cloud, AI, mixed reality, quantum, new hardware launches and the continued transformation of our sales team. +Third, tax rate. We're updating our full year tax rate to 22%, plus or minus 2 points, with variability due to the mix of service and license revenue, geographic mix of revenue and timing of equity vest and expect next quarter's tax rate to come in at the midpoint of that full year range. +Chris, let's go to Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. We'll now move to Q&A. Jessie, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Our first question is coming from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- +Satya, a question for you. We've been seeing Intelligent Cloud growing very well for quite some time, Azure sustaining very, very impressive growth rates, but even the server and tools business sustaining growth. When we think about the drivers of that growth, is this just continued share gains by Microsoft enabling you guys to outgrow the market? Or have you started to see stuff like AI and all these additional cognitive services that you bring to the market actually accelerating workload growth within your customers? You're actually like building new market opportunity for yourself with these additional services. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [3] +-------------------------------------------------------------------------------- +Thanks, Keith, for the question. I would say, all of the above. One of the things that we started always, we always believed in distributed computing, and we've built for that -- so when we say hybrid, we never thought of it as some kind of a temporary state, but we always thought the edge and the cloud was going to be where the application pattern was in fact going to get to. In fact, I'm very excited about some of the new workloads. If I look at whether it's IoT or AI, the 2 workloads that are new, both of them require both computation and intelligence on the edge and a very new way to do even computation, which is as event-driven computation. So we feel good about new workload growth. We feel good about this lift, shift, modernize motions that are happening. We feel that we're well positioned for both meeting today's realities of our enterprise customers but most importantly, where on a secular basis, I believe, hybrid computing is going, which is to this architectural pattern of Intelligent Cloud, Intelligent Edge. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +The next question is coming from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [5] +-------------------------------------------------------------------------------- +I had a question related to Azure. You guys mentioned on the call that premium services grew triple digits for the 13th quarter in a row. And I was wondering if you could give us a sense for how to think about the percentage of workloads that are now running premium services as a percentage of the total. And/or is there -- are we at the point now where that's a high enough percentage of the mix that we're at a tipping point here, where what seems like very significant gross margin progression is going to continue at this similar clip? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [6] +-------------------------------------------------------------------------------- +I mean, I can start, and Amy, you can add to this. The premium services, for example, the way we think about them is in everything related to our data is -- and especially the higher level databases. I'm not talking about raw storage, but this is Cosmos DB or Azure DB or any of the data services, our IoT services, our AI services are all the premium services. And there is a path. Every customer sometimes just starts with Infrastructure as a Service and some storage. And then the lift, shift turns into lift, shift and modernize and that's where these premium services get activated. So they definitely are margin accretive for us, but most importantly, they add a tremendous amount of value to the customers. And I'll let Amy add any additional color to that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- +And I think Heather, it gives me good opportunity to talk a little bit about the real drivers of the Azure gross margin improvement. There are really, when you think about it, 3. The first one's just pure revenue scale. We've done such a terrific job, I think, of growing and focusing and the innovation we put in and having our sales teams, through investments we've made for the past couple of years, and competency building land that at customers. The second component and the one you'd asked about is a little bit about that premium services revenue mix. And you're absolutely seeing the impact of that growth as mix show up in the gross margin. In addition to the workload Satya mentioned, I also bring up EMF. EMF continues to be, I think, an incredible value to customers. And I think we've done a very good job of pointing out its competitive advantages, and we're seeing that also benefit margins. And finally, just a strong work on the infrastructure team, both between hardware innovation done at everything from the network, all the way to the [products] and their integration with each other as well as the software innovation being done on top of it. Those things together, with premium being a component of that, are all lending itself to gross margin improvement. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Our next question is coming from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [9] +-------------------------------------------------------------------------------- +I just want to focus in on Office because you've obviously spent a fair amount of time on Azure, the gross margins there. But within Office, you've got several secular trends as well as just mix shift going on there just from a price point perspective as well as the gross margin between the different levels of E1, E3, E5. So wondering if you can give us some color on what we're seeing there because obviously, there is healthy seat growth, revenues outpacing and it seems like margins are as well. So just [rise] more color on sort of what we've been seeing an kind of how you think about that trending going forward. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [10] +-------------------------------------------------------------------------------- +Let me just start at the highest levels because for us, again in this last quarter, some of the innovation that we launched, I think, is also pretty key as you look forward to what it means for Office and Office growth. One of the new suites we have is called F1 and this is about first-line work. So Office is no longer limited just to the knowledge workers. In fact, we see significant opportunity for some of our teamwork, collaboration, communications as well as scheduling software to be very, very relevant for anyone who is on the manufacturing plant or a retail specialist. Some of our social tools like llama are increasingly getting used for broad communications, inclusive of Skype for Teams. So I just wanted to put that in there as well as the -- there is, of course, E3. There is E3 to E5. But there is also F1, which is increasing the overall penetration. And not to mention the small business segment. And of course, all the markets that we participate in with Office 365 where we don't have much of a server business at all. We sold Office on-premise or Office perpetual clients. But now you can have a small business in a country like India buy Office 365 as a subscription service. So those are all the things that are in play. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- +And I do think that's important, Keith, in terms of the innovation and the value. I think sometimes, on this call particularly, we talked about there's installed base growth and there's ARPU increases. Sitting underneath that is this very large $120 million (sic) [120 million] monthly active users in commercial. And they're experiencing frankly the latest innovations that the company has built. So I look and say, seeing growth in that number allows us to actually grow the ARPU, and the new services that Satya mentioned continues to let us grow the installed base. Innovations around Teams, innovations in AI in the actual Office products themselves are now being experienced by our customers. I think when you have that happen, over time, it builds confidence in the product and it builds confidence in end user, confidence in it itself. And then purchasers are happy to continue to add SKUs and add and move up the scale. We -- still, this is primarily the ARPU growth, continues to be some of the early -- earlier transitions we've always talked about, is that E3 transition as well as installed base growth. E5 continues to see encouraging signs, starting to see it enter but that will take a long time as we talked about to actually land in ARPU. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +The next question is coming from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- +This one's for Amy. Amy, just a general sort of corporate-wide question on gross margins. Your revenue and COGS guide, if I ran the math correctly, imply about 60% gross margins for the December quarter. So that's going to be down year-over-year and I suspect below some of the street estimates, but it sounds like your tone is a little bit better for gross margins for the full year. So I just want to make sure I leave the call understanding what's happening here is the conclusion that 2Q is somewhat of a one-off, given the uptick in lower-margin hardware and thereafter will return to a more normal year-over-year pattern on gross margins. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- +Thanks, Karl. Actually, this is really all the gaming Xbox One console launch. It's very specific. And so every other gross margin trend across IC, across PDP and across the rest of the MPC portfolio exhibits the exact same fundamental drivers and improvement. And so really, this is really 100% the Xbox One X impact in Q2 of the launch on the company gross margin and in particular, the MPC gross margin. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Our next question is coming from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [16] +-------------------------------------------------------------------------------- +I think, another question for Amy here. Just looking at the -- trying to figure out the dependency of your Azure growth this year on your -- on the volume of annuity up for renewal. I know last year, you had very, very strong growth in annuity on that renewal cycle, and you're talking about some pressure in the Q2 and then slightly uptrend for the year. But how dependent is Azure growth in customers attaching that to the volume of annuity up? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- +Yes, I would -- I wouldn't call it pressure, Walter, just how I think about it. There is just an expiration base that comes up every quarter and there's volatility to it. So the way to think about it is, over the year, it's up a little, and in Q2, it happens to be just a low quarter of the 12 that come up through the cycle, much like Q4 was quite large in the cycle. And Azure actually falls a couple of patterns. It's not just about EA attach, although it absolutely can be one of the motions. Because it tends to be project-based as well and many of the investments we've made in sales capacity and the reason we did some of the sales transformation was to invest a lot more in that project-led motion, which is a bit disconnected actually from the EA renewal cycles and you've really seen that. The Azure pace is not, if you drew a line, as correlated to EAs as it even was 3 years ago as we both, I think, matured the product and matured our sales cycles. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +The next question is coming from the line of Kirk Materne with Evercore ISI. + +-------------------------------------------------------------------------------- +Stewart Kirk Materne, Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst [19] +-------------------------------------------------------------------------------- +Satya, yesterday, you were down at the GE event and announcing the partnership with them around Predix. And I was wondering, when we think about the opportunities for Azure to be that sort of trusted platform for ISVs, can you just talk about how you think the progress is going on that front because it seems to obviously just expand your overall TAM and the kind of use cases you can address by your bringing partners like GE onto your platform? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [20] +-------------------------------------------------------------------------------- +Yes, thank you for the question. Overall, I think you sort of speak to, I think, one of the big advantages and one of the big value propositions we have on both sides. One is to the enterprise customer, we are a trusted partner. And we support them with their hybrid computing needs and their AI needs. One of the things that we emphasize is it's not about our technology but it's our ability to transfer that capability to our customer because they're increasingly becoming, whether you're in retail or you're in oil and gas or you're in financial services, every one of them is trying to build their own software capability and we're uniquely capable of doing so. The second part is the ISVs. We now, in fact, one of the big areas of investment this year was the co-sell capacity in our field so that ISVs can be successful on our platform. Whether it is GE or Adobe and many others can all now benefit both because of our enterprise partnership and credibility and more importantly, because of the field resources we have put in place. So we are really looking forward to accelerating our business with GE and many others to come. But it's a very important co-sell motion and, more importantly, building trust on both sides of that equation. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +The next question is coming from the line of Mark Moerdler with Bernstein. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [22] +-------------------------------------------------------------------------------- +I'd like to look at Dynamics 365. It's been growing really fast. It was center stage at Envision in almost every presentation and discussion. Can you talk a bit more about how you think about the opportunity and give us a sense of which of the offerings right now within 365, whether it's CRM or talent or ERP or whatever are driving the growth and could be part of the future growth? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [23] +-------------------------------------------------------------------------------- +Thank you, Mark, for that question. The way we designed Dynamics 365 both on the technology front as well as on the business model front was to get away from what I would describe as the old-school suite-based selling or suite-based building of these things, whether it's CRM or ERP or SEM. Because we realized that, for example, you take any IoT project that is starting in Azure, it first translates into an analytics workload that pulls through some Azure high router analytics services. And then immediately after you do something like preventive maintenance, you need field service. And all they need is just a very robust field service module that's cost-effective and efficient. And so we're able to attach that to that project. Similarly, on talent, they want to be able to -- if you start on LinkedIn with hiring, you want to be able to do the onboarding and talent management. That's the module you want. Even on the operations side, we are realizing that even if you keep your financials the same, there is need -- with increasing digitization, there is more operational modules that you need. So that's what we have designed it for. So the growth is actually across the board. It's coming in customer service, it's coming in sales, it's coming in talent, it's coming in operations. And we have some very competitive price points there. The other one is that there is no such thing as a canonical business. There is no such thing as a canonical business in time. That means things are always changing. So customization, customization and composition, especially with Office 365, is very important, and this is where we have some very differentiated offer with Power BI, Power Apps and Flow. And that's another big driver of some of that growth across our enterprise customers. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question is coming from the line of Adam Holt with MoffettNathanson. + +-------------------------------------------------------------------------------- +Adam Hathaway Holt, MoffettNathanson LLC - Partner & Senior Research Analyst [25] +-------------------------------------------------------------------------------- +I'm tempted to ask about the strength in Windows, which I know you don't talk about much and don't get much questions about. But really since we've launched, the question that I get, by far, the most is around the long-term margin potential in Azure. And with the gross margins being as good as they were this quarter, without giving us long-term guidance, is there any reason to believe that the long-term operating margins in Azure couldn't be -- we just saw AWS put up a mid-20s operating margin. Is there anything structural to -- that would lead us to believe that you couldn't do something in that range? Or how should we think about the long-term framework to that business? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [26] +-------------------------------------------------------------------------------- +I'll start, Adam. The one thing I'd say is -- when I think about the long-term margin, I actually think of the long-term margin across our cloud. I mean, when we even make our CapEx decisions, which is one of the drivers of margin, we think of -- first of all, first party equals third party. A lot of what we do even in Windows, most people don't recognize, but one of the most important services we run is Windows Update as a cloud service. And so we have a lot of value that is across-the-board cloud services, whether it's Xbox LIVE, Windows Update, Office 365, Dynamics 365, and of course, all of the Azure services. And we want to build scale across all of them. And so we would not -- in fact, we will be very aggressive in taking margin in one place, which is different as we see a path to margin in a different spot. That's something that we want to make sure we follow more, our opportunity in a customer across the board versus trying to micromanage to certain margins in very specific opportunities because we think that it's the integrated ability for us to deliver value is -- which I think long term, is what customers expect of Microsoft. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- +And I would just add that as we think about that long-term trajectory, our ability to continue to improve margins in our SaaS portfolio and our PaaS portfolio and IaaS portfolio still exist. And our ability to blend them into interesting products that solve customer solutions, which may not even be priced as the component parts is, I think, how we think about, especially in our solution areas that Satya talks about, how we talk about delivering it to a customer. So while I'm confident in our ability to continue to grow the core margin, I do think for us in particular, it really is a portfolio that we believe that we need to manage appropriately. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +The next question is coming from the line of Michael Nemeroff with Crédit Suisse. + +-------------------------------------------------------------------------------- +Michael Barry Nemeroff, Crédit Suisse AG, Research Division - Director [29] +-------------------------------------------------------------------------------- +My question is on the gaming business. Given the even larger focus you're putting on this segment in the near term, how quickly or in what time frame do you think gaming revenue could grow at or above the average gaming industry growth rate of mid- to high single digits? And I know you don't break out segment margins, but could you give us a sense of how you think about gaming from a normalized contribution margin perspective relative to MPC and your overall company-wide margins, excluding the onetime Xbox launch effects? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [30] +-------------------------------------------------------------------------------- +I can start again. I would say, from a gaming perspective, one of the bigger changes that has happened in the last, I would say, couple of years is one, of course, the vibrancy of the Xbox LIVE network across the PC and the console and now increasingly even on the phone because of titles like Minecraft. And once you have the network, you have plenty of different opportunities. In particular, we now have a subscription offer with Game Pass that's off to a very good start, and our goal is to be able to have essentially a Netflix for games so that we can have the game subscriptions that people can use across all of the devices they play in. The other area is streaming. As you know, there is gameplaying and game watching and there is secular growth on both fronts. And we feel very, very good about the engagement increases in a pretty unique value proposition we have in Mixer. So that's another opportunity that we believe will shape in addition to things like e-sports and so on. So it's the totality of that. And one of the numbers that I did put in my script was that 20% growth in what we call software and services, that's perhaps a leading indicator of where we think the opportunity lies. These are early days for us, but that said, that's probably one of the key numbers to watch as we make progress and execute. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [31] +-------------------------------------------------------------------------------- +And because of that, you're actually already seeing that impact in the MPC gross margins. Even this quarter is a great example. There was material improvement in gross margin in that segment, and a lot of that was actually due to the higher margins that we have structurally in that software and services revenue from Xbox. And as I believe the industry that Satya is talking about pivots to be more about the engagement and monetization of that member network, you can expect that margin profile as well of our traditional, more hardware-focused Xbox to evolve, to be a real combination of those 2 things going forward. And structurally, that would, of course, have higher operating margins. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Our next question is coming from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays PLC, Research Division - Director and Analyst [33] +-------------------------------------------------------------------------------- +The conversation we have on around Azure and adoption there seems to be changing with customers, where they seem to be seeking a deeper relationship with you guys now, given that your maturity has increased quite a bit over the last few quarters. Can you talk to that? Is that something that just I picked up or is that what you're seeing in your customer relation -- in your conversations as well? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [34] +-------------------------------------------------------------------------------- +Hopefully, we picked it up a lot earlier than you did. But we have -- so we do have a very different dialogue. If I -- if you think about it, all of the customers that we have worked with, we have always worked with them historically even in our server days. But to your point, Raimo, I think what has happened is the change, even in the financial services, the segments that you all represent, the kinds of workloads now that are moving to the cloud has qualitatively changed. In the past, we participated but a lot of Tier 1 workloads were not on Microsoft stack, whereas now, a lot of Tier 1 workloads are, in fact, increasingly on Microsoft Cloud. And so to me, that represents a qualitative change, and so the type of dialogue we have, whether it's with an auto company or a financial services company or a retail company, is much deeper, much broader. And I would use the word, we are deeply partnering with them. It's no longer just simple vendor relationships because as they are trying to build their own software capability, they need a trusted partner who's more interested in making sure that they build their own technology capability. And that's what we're investing in. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [35] +-------------------------------------------------------------------------------- +And I would say, Raimo, a way to think about this is, we've always had that trusted relationship, which we're incredibly proud of as a company with our enterprise customers. The investments we've made over the past years are about hiring the type of talent that can go and sit with a customer and drive the customer's successful outcomes of the projects they deploy. And that's what we mean. It's about the investment we've made in capability, the evolution of the product and its innovation, and I think using and trying to continue to earn the customer for us to deliver these world-class workloads. So I do think this is really an output of multiple years of concentration on delivering that capability. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Our last question comes from the line of Ross MacMillan with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross Stuart MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [37] +-------------------------------------------------------------------------------- +Satya, I was curious. You've made a number of announcements with Adobe over the last year or so. And it seems like Microsoft's products and Adobe's products are getting more intertwined. And just curious from your perspective, if you could just maybe give us some insights into where you see the big opportunities to work with a vendor like Adobe and what are the go-to-market actions that you're seeing being more successful? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [38] +-------------------------------------------------------------------------------- +Yes, we're very excited about the partnership with Adobe. And as you said, Adobe and Microsoft have partnered, in fact, across our entire histories in many of the areas, but increasingly across of the creative cloud and their Document Cloud as well as their Experience Cloud, we have plenty going on. In fact, we are very excited about what we are doing with our devices and Adobe and with Windows because I think Windows and Windows 10 Creators Update is the ideal platform for all of the creators in the world because of the innovation in Windows and the innovation in devices, both Surface Book as well as our OEM devices. So that's one area that I think you will see. I would love if you're an illustrator or a Photoshop user, you should just check out the dial support that they have in Surface, which just is beautiful. And then you go to Office 365. We have a partnership with them on e-signatures. We have good interoperability between our respective document clouds. That will, in fact, continue. And then on the creative side or on the experience side, in fact, we are adding a lot of data and AI capability, which is obviously key to Adobe as an ISV. So we're looking forward to the -- ultimately the impact all this has with customers in terms of their ability to take advantage of our respective value and for them to be able to benefit from it all. And so these kinds of partnerships, whether it's with Adobe or others, we are very focused on making sure that ISVs and partners have success on our platforms. And that's sort of our core heritage, and that's something that we want to absolutely focus on. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [39] +-------------------------------------------------------------------------------- +Thank you, Ross. So that wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [40] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Non-Independent Director [41] +-------------------------------------------------------------------------------- +Thank you so much. Thank you all. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Thank you. This concludes today's teleconference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2018-Apr-26-MSFT.txt b/Transcripts/MSFT/2018-Apr-26-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..1faf1e1ca323f90358aa0c9e1bcc747b17c40a2e --- /dev/null +++ b/Transcripts/MSFT/2018-Apr-26-MSFT.txt @@ -0,0 +1,477 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Microsoft Corp Earnings Call +APRIL 26, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Ross Stuart MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Michael Barry Nemeroff + Crédit Suisse AG, Research Division - Director + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst + * Kasthuri Gopalan Rangan + BofA Merrill Lynch, Research Division - MD and Head of Software + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Microsoft Fiscal Year 2018 Third Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Mike Spencer, General Manager of Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, - [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Carolyn Frantz, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides reconciliation of differences between the GAAP and non-GAAP financial measures. Unless otherwise specified, we refer to non-GAAP metrics on the call. +The non-GAAP financial measures provided should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance, in addition to the impact that these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call, view the -- and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during the conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. It was another strong quarter, the result of picking the right secular trends, delivering differentiated innovation and focused execution that results in increased engagement and usage. +The intelligent cloud and the intelligent edge era is already upon us. It represents a tremendous opportunity. We took significant steps this quarter to put this at the forefront of everything we do, realigning our entire engineering organization to accelerate innovation and better serve the needs of customers and partners. With that as the backdrop, I want to highlight key areas of innovation and growth across our customer solutions. +Creating a modern workplace where people can do their best work requires the right culture and the right technology. Microsoft 365 helps every organization empower their employees with AI-backed tools that unlock creativity, increase teamwork and fuel innovation, all the while ensuring compliance and protecting data from new cyber threats. +Microsoft is a clear leader in cloud security. Advanced AI [releases] over hundreds of billions of signals each month to identify anomalies, automate detection and help customers respond to cyber threats. Just last week, we announced new value for customers, Microsoft Secure Score, Attack Simulator and Windows Defender ATP automatic detection and remediation capabilities as well as a new open API for the Intelligent Security Graph. +We've also built compliance capability directly into our cloud services. Thousands of organizations are using the recently launched compliance manager with new information protection scanner and built-in classification capability to help prepare for GDPR. Our comprehensive approach and proactive protection are one reason Coca-Cola chose Microsoft Cloud for their digital transformation. +One year in, Teams has rapidly become the hub for teamwork. More than 200,000 organizations in 181 markets use Teams, from Maersk to General Motors. Teams is now enabled for a broad spectrum of calling and meeting room devices. We're also building AI-powered services into Teams. We've integrated Microsoft Stream, our enterprise video service, into Teams for transcription and time coding of recorded meetings. We've added new facial recognition capabilities, which will attribute remarks to specific meeting attendees. And we are adding new Cortana capability to make calls, join a meeting or initiate 3-way calling just using your voice. +All this innovation is driving customer usage. Windows 10 continues to gain traction in the enterprise, with Windows 10 commercial monthly active devices up 79% year-over-year. Office 365 commercial now has more than 135 million monthly active users and Office 365 consumer subscribers increased to 30.6 million. +Now I'll turn to LinkedIn and business applications. From the start, we recognized the opportunity for LinkedIn and Microsoft to combine forces to create economic opportunity for every member of the global workforce and enable professionals to be more productive and successful. A little over 1 year in, we feel great about the value we are delivering for members, customers and shareholders. +Our integration model has enabled LinkedIn to accelerate growth while retaining its member-first ethos. Results are ahead of expectations across all lines of business, with revenue growth of 37% year-over-year. We saw record levels of engagement again this quarter with sessions growth of more than 30% year-over-year, driven by innovation across the platform. This increased engagement is driving strong demand for sponsored content and marketing solutions and record levels of job postings and job visitors again this quarter in Talent Solutions. +Shifting to business applications. Dynamics 365 is gaining traction as our third commercial cloud growth engine, up 65% this quarter. We unleashed a wave of AI innovation in Dynamics with hundreds of new capabilities to transform sales and automate marketing, with Office 365 embedded inside Dynamics for productivity. Relationship analytics for sales and marketing leverage the Microsoft Graph and data from social networks to improve customer relationships, and predictive lead scoring help sellers identify and focus on high-quality leads. +We're investing in our business applications platform capabilities across Power BI, Power Apps, Flow and a Common Data model. Now customers can extend Dynamics 365 and Office 365 and quickly build applications using data from across the organization as well as third-party data with minimal custom code. The new power platform enables customers like Inter Cars, a leading European auto parts company, to go from paper to digitized workflows within days versus months. With the rapid growth of Power BI, we are now the leader in business analytics in the cloud. +Now I'll turn to infrastructure and AI platforms. Our architectural advantage of a consistent stack from the cloud to the edge is resonating with customers, with Azure revenue growth of 93% this quarter. Recent CIO surveys affirm our leadership position in hybrid, developer productivity, trusted security and compliance and new workloads such as IoT and AI at the edge. +We have made the right investment decisions and they're having an impact, increasing our overall share in an expanding market. Our recent data center expansion, including the United Arab Emirates and Switzerland, brings our total number of regions to 50, more than any other cloud provider, and the additional availability zones provide the most comprehensive resiliency in the industry. +We also continue to see strong customer demand for Azure Stack across industries, and it's unlocking new workload scenarios across hybrid and edge. Industrial IoT is transforming the rules of manufacturing, fueling cloud and edge innovation, accelerating the evolution of digital factories and enhancing supply chain performance. +Azure IoT and Azure Stack enable customers and partners to build industrial IoT solutions that run at the edge, so operators on the factory floor can manage devices and analyze data in real-time. And HoloLens is quickly becoming an indispensable tool as we take digital twin technology to the next level. +We're also innovating in silicon to help customers realize the promise of a connected world of devices and things. Our just announced Azure Sphere is a first of its kind, highly secure edge solution that combines chip design and IoT operating system and a cloud service to secure more than 9 billion microcontroller-powered devices entering the market each year. +And we're already seeing rapid customer adoption of IoT scenarios. Toyota Material Handling in Europe is using Azure as well as HoloLens to create a factory of the future. Using AI, drones learn complex processes to automate the flow of a factory, increasing supply chain and warehouse efficiency. And Microsoft and ABB are partnering to push the boundaries of smart manufacturing for industrial automation. +We're investing to make Azure the best cloud for enterprise data estates. In less than a year, Azure Cosmos DB, the first globally distributed multi-model and multi-model database, exceeded $100 million in annualized revenue. Azure database for MySQL and PostgreSQL makes it even easier to bring open source powered applications to Azure, expanding our opportunity in this space. We are seeing a rapid adoption of Azure Databricks for data preparation, advanced analytics and machine learning scenarios. +We continue to innovate to democratize AI. More than 1 million developers have already used cognitive services to quickly and easily create AI applications, and we have more services than any other cloud provider. Our Azure Bot Service has nearly 300,000 developers, up more than 150% year-over-year. +Microsoft Translator brings AI-powered translation to developers where their data is, whether that's in the cloud or on the edge. And just last month, we reached human parity in language translation, a new milestone, in addition to our previous human parity achievements in object recognition, speech recognition and machine reading comprehension. We're also gaining traction in machine learning tools adoption with tens of thousands of customers using Azure ML. +Finally, we are innovating with new GPU and FPGA-based offerings to lead in AI infrastructure for both training and inference. I'm excited to share more about our cloud and AI innovation at our developer conference next month at Build. +Now to gaming. We continue to pursue our expansive opportunity in gaming from the way games are created and distributed to how they are played and viewed. We had one of the best quarters in gaming with strong revenue performance and record levels of engagement. Software and services revenue grew 24% as we continued to attract, retain and deepen user relationships across Xbox Live, Game Pass and Mixer. +Xbox Live monthly active users grew to 59 million, up 13%. Our new first-party game, Sea of Thieves, drove gameplay across Windows 10 and Xbox One, in addition to nearly 10 million hours of viewing on services like Mixer in its very first week. Our results speak to the strength of our platform and services for both first-party and third-party experiences. And we'll continue to invest in our platform, enhancing our cloud services with AI capabilities for developers to quickly build and monetize games across PC, console and mobile. +In closing, intelligent cloud and intelligent edge represents a tremendous opportunity for our customers. It comes with a responsibility to ensure trust in technology. We are working to instill this trust in 3 key areas. The first is privacy. We recognize that privacy is a fundamental human right, and we have consistently acted accordingly. Our success is grounded in our customers' success. We have been working towards the May 25 GDPR implementation date since 2016, with hundreds of engineers across the company working on end-to-end privacy architecture, and we'll ensure that all our products and services are GDPR compliant. +For customers, we will provide robust tools backed by a contractual commitment to help them comply with GDPR. In fact, for most customers, it will be more effective and less costly to host their data in Microsoft's GDPR-compliant cloud than to develop and maintain GDPR compliance tools themselves. +Second, cybersecurity. In response to escalating cyber attacks around the world, we are leading a bold initiative to defend and protect our customers. We recently led a coalition of 34 global technology and security companies in signing the Cybersecurity Tech Accord. The accord is an important first step by the industry to help create a safer and more secure online environment for everyone. +Finally, we recently established the AI in Ethics and Engineering and Research Committee at Microsoft to ensure we always advance AI in an ethical and responsible way to benefit our customers and the broader society. This includes new investments in technology to detect and address bias in AI systems. +Microsoft stands for trust and this will continue to be a differentiating focus for us moving forward. +With that, I'll hand it over to Amy to cover our financial results in more detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $26.8 billion, up 16% and 13% in constant currency, with better-than-expected performance across all segments. +Gross margin increased 16% and 13% in constant currency. Operating income increased 23% and 20% in constant currency. Earnings per share was $0.95, increasing 36% and 31% in constant currency. From a geographic perspective, we saw broad-based strength across markets of all sizes, benefiting from the positive global corporate IT spend environment. +Growth in cloud services increased our commercial annuity mix, up 2 points year-over-year, to 89%. Along with healthy renewals, our sales teams and partners drove a higher volume of new business, leading to commercial bookings growth of 26% and 18% in constant currency. Commercial unearned came in slightly above our expectations due to FX, growing 20% and 17% in constant currency. +Commercial cloud revenue was $6 billion, increasing 58% and 55% in constant currency, highlighted by healthy growth in the U.S., Western Europe and the U.K. We again improved commercial cloud gross margin, now at 57%, up 6 points, with improvement in each cloud service, most notably Azure. +We outperformed our expectation on company gross margin, finishing the quarter at 65%. We are up slightly year-over-year with improvement in our Productivity and Business Processes segment from Office 365 commercial and LinkedIn, offset by a decline in our Intelligent Cloud segment, driven by a greater mix of Azure revenue. +FX positively impacted revenue growth by 1 point more than expected. 3 points of the company and Productivity and Business Processes level and 2 points on both Intelligent Cloud and More Personal Computing. FX added 2 points of growth to COGS and operating expenses, 1 point more than expected. +Operating expenses grew 10% and 8% in constant currency as we continued to invest in commercial sales capacity, cloud engineering and LinkedIn. Even with this accelerated pace of spend, we increased operating margin 2 points year-over-year, a direct result of our focused investments to drive top line growth. +Now to the segment results. Revenue from Productivity and Business Processes was approximately $9 billion, increasing 17% and 14% in constant currency, with better-than-expected results from Office 365 commercial and LinkedIn. +Office commercial revenue grew double digits again this quarter, up 14% and 12% in constant currency, including a couple of points from a greater mix of contracts with higher in-period recognition. +Office 365 commercial revenue grew 42% and 40% in constant currency, with continued installed base growth and ARPU expansion, driven by customer migration to our premium workloads in E3 and E5. Office 365 commercial seats grew 28%, in line with the expected trend, given the increasing size of the installed base. +Office consumer revenue increased 12% and 9% in constant currency, driven by recurring subscription revenue and a growing overall installed base. +Our Dynamics business accelerated this quarter, growing 17% and 14% in constant currency, driven by Dynamics 365 growth of 65%, 62% in constant currency. +LinkedIn revenue grew 37% and 33% in constant currency, with more than $1.3 billion in revenue. We continued to see outperformance across all segments, with record levels of engagement. +Segment gross margin dollars increased 18% and 15% in constant currency. Gross margin percentage increased, with margin improvements in Office 365 commercial and LinkedIn, offsetting the increased mix of cloud revenue. +Operating expenses grew 14% and 12% in constant currency as we continued to strategically invest in LinkedIn, commercial sales capacity and cloud engineering. +Operating income increased 23% and 19% in constant currency. The Intelligent Cloud segment delivered $7.9 billion of revenue, increasing 17% and 15% in constant currency, exceeding expectations due to our on-premises server business. +Server products and cloud services revenue grew 20% and 17% in constant currency to $6.3 billion, driven by continued strong Azure revenue growth of 93%, 89% in constant currency, on a significant revenue base. Our on-premises server business grew 3% and 1% in constant currency, driven by customer demand for hybrid solutions as well as increasing virtualization needs, resulting in the uptake of premium versions. +Enterprise Services revenue increased 8% and 5% in constant currency, with growth in premium support services and Microsoft consulting services more than offsetting the continued decline in custom support agreements for Windows Server 2003. +Segment gross margin dollars grew 16% and 14% in constant currency, and gross margin percentage declined with a growing mix of Azure IaaS and PaaS revenue, mostly offset by another quarter of material improvement in Azure gross margin. +Operating expenses increased 9% and 7% in constant currency, driven by our continued investment in sales capacity and cloud engineering. Operating income increased 24%, up 21% in constant currency. +Now to the results of More Personal Computing. Revenue from the segment was $9.9 billion, up 13% and 11% in constant currency, with significantly better-than-expected results in gaming, Windows commercial and Surface. +Windows OEM revenue increased 4% this quarter. OEM Pro revenue grew 11%, in line with a strong commercial PC market. +We continued to see healthy enterprise demand for Windows 10 benefiting our OEM partners. OEM non-Pro revenue declined this quarter by 8%, below the consumer PC market, driven by a higher mix of lower-priced licenses and continued pressure in the entry-level price category. Inventory levels were within the normal range. +Windows commercial products and cloud services increased 21% and 17% in constant currency from strong double-digit billings as well as a higher mix of in-quarter recognition from multiyear agreements. The fundamentals of this business remained healthy, with installed base growth and adoption of our security solutions. As a reminder, under Accounting Standard 606, the Windows commercial growth rate will have significant variability quarter-to-quarter due to its relatively high mix of on-premises licensing revenue. +Search revenue ex TAC grew 16% and 14% in constant currency, with higher revenue per search and search volume driven by Bing performance in the U.S. and international markets. +Surface revenue grew 32% and 27% in constant currency with better-than-expected performance from Surface Book as we continued to transition to the latest products in our portfolio and against the prior year comparable impacted by product end-of-life cycle dynamics. +Gaming revenue increased 18% and 16% in constant currency due to Xbox software and services revenue growth of 24% and 21% in constant currency. +Momentum in digital distribution as well as record levels of engagement, driven by a third-party title, contributed to better-than-expected software and services revenue. We grew Xbox Live monthly active users by 13% to 59 million, with user expansion across Xbox One, Windows 10 and mobile platforms. +Segment gross margin dollars increased 13% and 11% in constant currency, in line with revenue growth. Segment gross margin percentage was relatively flat year-on-year. +Operating expenses increased 5% and 3% in constant currency from investments in engineering across gaming, search and AI. Operating income grew 24% and 20% in constant currency. +Now back to total company results. In line with our expectations, we increased capital expenditures on a sequential basis, with $3.5 billion invested to support current and future growth of our cloud offerings. Cash paid for property and equipment was $2.9 billion. +Cash flow from operations was up 14%, driven by collections from strong billings growth. Free cash flow of $9.2 billion grew at a slower rate, 3%, due to an increasing cash use for property, plant and equipment. +Other income and expenses was approximately $350 million from net recognized gains on investments and income from dividends and interest, partially offset by interest expense. Our effective tax rate came in at 14% due to a benefit from an R&D tax credit. +We returned $6.3 billion to shareholders through dividends and share repurchases, increasing total shareholder return by 37%. We nearly doubled our year-over-year amount buyback, accelerating our pace from the prior quarter and now have roughly $30 billion remaining of our current $40 billion share repurchase authorization. +Now let's turn to next quarter's outlook. +First on FX. Assuming current rates remain stable, we expect FX to increase revenue growth by 3 points, COGS by 1 point and operating expenses by 1 point. +Second, we again expect strong performance from our commercial business with solid execution in our largest quarter of the year. We expect commercial unearned revenue to be up 38% to 39% sequentially. +Third on CapEx. We expect sequential growth in capital expenditures on an accrual dollar basis as we continued to see strong demand signals globally. +Finally, we expect commercial cloud gross margin to be roughly flat to Q3, representing another quarter of material year-over-year improvement even with increasing Azure revenue mix. +Now to the segments. In Productivity and Business Processes, we expect revenue between $9.55 billion and $9.75 billion. We expect Office commercial growth rates to normalize as we do not expect the same level of in-quarter recognition on multiyear contracts as we saw in Q3. Dynamics should see another quarter of double-digit revenue growth, driven by Dynamics 365 and LinkedIn growth should remain high. +In Intelligent Cloud, we expect revenue between $8.95 billion and $9.15 billion, with another quarter of server products and cloud services revenue growth in the high teens as our hybrid cloud leadership continues to be a differentiator for customers. +We expect the total Azure revenue growth to reflect the balance of our continued strength in infrastructure, data and application services and a moderating growth in our per user base services like EMS. +In More Personal Computing, we expect $10.3 billion to $10.6 billion. Across both OEM Pro and non-Pro, we anticipate trends in Q3 to continue into Q4. +In our devices business, we expect Surface revenue growth in the high teens as we continued to transition to the latest products in our portfolio. Search ex TAC should see another mid-teens revenue growth quarter as it has the entire year. +In gaming, we expect a higher revenue growth rate in Q3 as we continue to benefit from third-party game title performance and user engagement on our platform. +We expect COGS between $9.6 billion and $9.8 billion, including 1 point of growth from FX. We expect operating expenses of $9.8 billion to $9.9 billion, with 1 point of growth from FX. This would place us slightly above the high end of our prior range for the full year operating expense growth due to the impact from FX and incremental revenue-driven expenses that support our continued strong top line growth. +In Q4, we expect other income and expense to be approximately $350 million as we continue to take gains on our equities portfolio and earn dividend and interest income, as we have in prior quarters. We expect our effective tax rate in Q4 to be approximately 16%, with some volatility in the final quarter of our fiscal year. +Finally, I want to offer a few early thoughts on FY '19. Assuming the macro environment remains consistent, many of the key drivers of our business should remain intact. Revenue growth will continue to be driven by the transition to cloud services. And within our commercial business, strong execution and our differentiated hybrid position should drive continued high teens growth in our server product and cloud services revenue KPI. Office 365, Dynamics 365 and LinkedIn should also continue to drive double-digit revenue growth in our Productivity and Business Processes segment. +The gross margin percentage of every commercial cloud service will continue to improve, with more improvement in Azure IaaS and PaaS consumption-based services and less improvement in our per user SaaS services. While we expect continued improvement in the overall commercial cloud gross margin, the revenue mix shift to Azure will moderate the rate of improvement relative to FY '18. +We'll continue to grow our investment in capital expenditures to meet the growing demand for our cloud services. With the business results we delivered and the tremendous opportunities we see ahead, we will continue to see growth in operating expenses in key areas we discussed, including LinkedIn. We expect other income and expenses to be slightly negative in FY '19 as we don't expect to have any significant equity gains. +And lastly, we continue to expect the full year FY '19 effective tax rate to be slightly below the new U.S. corporate tax rate of 21%, with variability across the quarters due to the mix of cloud versus license revenue and the timing of equity vests. +And with that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, - [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question is coming from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [2] +-------------------------------------------------------------------------------- + + Great. You guys are seeing a really nice acceleration in Intelligent Cloud gross profit growth. And with 15 straight quarters now of triple-digit premium services growth in Azure, I know you mentioned some comments directionally about the gross margin ramp. But how do we think about the pace of the ramp in gross margin expansion from here for this -- for Azure, in particular, as you approach what we estimate to be roughly an $8 billion business in annualized revenue? And I guess, what -- the other thing that would be helpful is when you think of the COGS of commercial cloud, can you give us a rough ballpark of what percentage of COGS comes from CapEx depreciation? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + So maybe I'll start and then I'll have you, Amy, go into some of the numbers. One of the things, Heather, that's happening is there is growth in Azure across each of the layers. And I think I've said this before. Sometimes, when you have new workloads and new customers onboard, they start with, in some sense, the IaaS and the data, more at a Blob Storage, but then scale to higher-layer services, like our Cosmos DB or even some of our compute higher-level services like in AI. So that, I think, will continue because we're still in the early innings of the cloud transition. We're investing aggressively, whether it's on the field side or on the CapEx side to attract more customers and more workloads per customer. So they will have that same profile, which is lower-margin services first, higher-margin services over time. That's just inside of Azure. And of course, you combine that with the rest. One of the things that, I think, should be fairly clear is the high correlation between our services in Office 365 as well as Dynamics 365 around data, in particular, with Azure. So that's why we think of this as one cloud play, but that should give you a feel for how the customers are looking at it. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And I think to your specific questions, there were a couple in there, Heather. If you think about the portion of our commercial cloud gross margins that come from depreciation, it's best to think of it as roughly half. And actually, it's been going up as we begin to get scale through these services over time, actually. Some of the fixed costs, frankly, even in COGS, tend to come down as a percentage over time. So that should help you roughly to think about how much depreciation is to that number. Now if you think about sort of the dynamics that we've been going through in the Intelligent Cloud segment, in particular, the way I tend to think about that, as you've seen, our 20% growth this quarter in that server and product services KPI, 17% on a constant currency basis and are sort of confident that you should continue to see that, as I said, into Q4 and then into FY '19 as well. I tend to think about that as we'll have significant revenue growth in that segment. We'll have significant gross margin dollar growth in that segment, and you'll actually continue to see operating margin dollar growth as significant in that segment even as we reinvest into it, given the top line signal. If you think about gross margins, in particular, what you'll see is Azure continuing to be a growing percentage of the total revenue growth. So even with significant improvement again and what Satya was talking about, some of the lower level IaaS and PaaS services within Azure on the gross margin side, you'll see some gross margin percentage pressure in that segment through '19, but with significant dollar growth. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Mark Moerdler with AllianceBernstein. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [6] +-------------------------------------------------------------------------------- + + CapEx increased significantly this quarter, $2.9 billion, you said, in cash and property and equipment. We know that you build out -- you significantly invested in the data center footprint ahead of demand, but you don't build out the equipment itself that far in advance. Is there a large corporate or government requirement or is it the acceleration in new data centers that ended up causing that lift? Or is there something else driving it? And as a follow-up, how should we think about that for the next couple of quarters? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Thanks, Mark. I actually didn't think of it as a significant change in trajectory from what we expected. A year ago, Q3 was actually a little low. So on a year-over-year basis, I think it pops a little bit, Mark, when on really a sequential basis, I actually don't think, to me, it looks out of sorts especially with the type of demand we're seeing not just for Azure but across all of the cloud components. Those growth rates, really at 58% on that total cloud number, it's pretty good demand signal on a global basis. So I hear you on a year-over-year basis, but Q3 was a little funny a year ago on that front. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [8] +-------------------------------------------------------------------------------- + + And we continue to really monitor the actual equipment in that supply chain and what-have-you, and if anything, there's a lot of automation and demand sensing capability we have there. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + And I would say, Mark, while I appreciate your point that it takes -- and we do build data centers in advance, the majority of the cost obviously in a data center is in the equipment inside. And so while this really is -- the majority of this spend is servers. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [11] +-------------------------------------------------------------------------------- + + And really nice quarter across the board. There's really not much to pick on in this quarter. One of the highlights from my perspective was definitely LinkedIn and what seems to be an acceleration in the revenue growth in LinkedIn. So 2-parter here. One, where are we in terms of that acquisition? Is this still just LinkedIn operating better as an independent company? Are we starting to see some of the synergies, specifically revenue synergies, come to bear from maybe broader distribution channel that they get from Microsoft or product integration? So have synergies started to kick in, number one? And number two, given where we are in terms of the M&A process on LinkedIn, what's the appetite for further, like large M&A, for Microsoft on a going-forward basis? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [12] +-------------------------------------------------------------------------------- + + Thanks, Keith, for the question. Let me start and then, Amy, you can add to this. First of all, it is very important for us to ensure that we did everything to enable LinkedIn to keep their product and cultural ethos of putting members first and innovating on their behalf. I mean, that was sort of priority 1, 2 and 3. And that's what you see in their sessions growth, engagement growth, their quality member growth. And obviously, that all translates into the revenue growth as well across all of the marketing solutions, talent solutions and sale solutions. We also, during that 1 year, done integrations. You see it -- I see it every day in my Outlook mobile. I see it in Sales Navigator and Dynamics. And so you will see us -- and with Windows 10. So you'll see us continue to do these integrations that add value again to both the Microsoft 365 and Dynamics users as well as LinkedIn members. And clearly, that's increasing engagement as well. And that obviously then translates into revenue growth of those business solutions we mentioned. So yes, revenue synergies are showing up, but mostly because product synergies are showing up, and that's because of the product ethos of LinkedIn around member-first is what we have maintained throughout this integration. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + And I will also add, Keith, the LinkedIn team has really done a tremendous job. So let me also say, after a year of working with them closely, my appreciation and frankly a lot of inspiration that I think you've seen at our own product development has been their focus on users and how important it is and how focused they are on it. In some of the products, I would urge people to look at the Outlook Mobile experience and how really meaningful the experiences for the user and the member. And I think sometimes it's harder for us to measure exactly what a revenue synergy means. But I think I look at this and say, "At a 37% growth rate plus some of the integrations we've seen and the growth in usage and users of things like Outlook Mobile, I believe that we're probably a little bit on the front end of the revenue synergies you'll see in product over time." When it comes to our appetite for M&A, I think it actually -- it has remained unchanged, which is when things meet our criteria and when we feel like it's in core areas for us, where markets are expanding, where the companies have a unique asset, I think that we -- our ability to both execute on those and see them both execute on their own and execute inside Microsoft, I actually feel quite good that our -- we don't worry about our ability to do them, but I wouldn't say that's new this quarter. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [14] +-------------------------------------------------------------------------------- + + Yes. And I think just to add on that, which is whether it's Minecraft or LinkedIn or many other acquisitions we've done as part of Azure, I think the key thing that we are very, very focused on is how do we make this culturally accretive, management times accretive as well as revenue. And that's where we're building good muscle and we'll continue on that. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [16] +-------------------------------------------------------------------------------- + + And just to start, Satya and team, congrats on getting Microsoft to over 10% organic growth. That's a big achievement for a company at your scale, and it looks like you're expecting the same for the June quarter, so congrats. So I guess, my question is in the spirit of this, to Amy, on the overall growth margin trade-off as you look into fiscal '19. Amy, when I go back to the Analyst Day you had almost a year ago, I left thinking that your messaging was really that you were going to press on revenue growth and not on big margin leverage. So I'm just wondering as we look into fiscal '19, is it correct to assume that, that's a similar framework with the focus on top line growth and not to expect much in the way of overall improvement in gross margins? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Thanks, Karl. Yes, I think that's a fair interpretation of my commentary both last year and this, which really speaks to consistency. I do believe that the market that which we are operating, the set of assets we've picked, the team we've built, the investments we made in our sales force, even to some extent, the acquisitions we've done, these are all showing up as top line revenue growth for us. You see it this quarter. You see it, frankly, in the guide. And I think your interpretation that our focus on being a growth company, even at our scale, is certainly the right interpretation. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [19] +-------------------------------------------------------------------------------- + + I'm wondering, I guess, a combination of Amy and Satya, if you could talk about the forward kind of view of Azure growth and how we should think about the drivers of that as we go into '19. New customers, existing consumption, premium services and we're growing at eye-popping rates right now. We saw that with Office 365 in the early days. How should we expect this business to sort of level out over time as I think it inevitably will as we look to next year? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [20] +-------------------------------------------------------------------------------- + + Yes, and I'll start qualitatively. And it's true that we are, at this point, at scale on Azure and with very, very high growth rates. But as I said, I think the key things that we think about is differentiation of Azure at each level because that's what is super important for us as we compete in this marketplace, and more importantly, double down on areas of differentiation we have. So the first thing is on the infrastructure side itself with the combination of the edge and the cloud, I believe, between Azure Stack and Azure as well as inclusive of our servers, we have the best cloud platform for what is going to be hybrid computing and we'll continue to push on that, so you'll see growth that just got a different margin profile. The layer about that is the place which we are very excited about. You've seen lots of consecutive quarters of growth in our high-level services but we're now seeing some good scale. I, for the first time, talked about Cosmos DB. This was actually a database we just launched last year. I mean, I've been around databases for a long time. I've never seen a product that's gotten to this kind of scale this quickly. And so we're very bullish about what can happen in the higher-level services and we'll continue to build on that piece. But as I said, one of the key things is architecturally, the way we build Azure, the way we build Office 365, the way we build our gaming cloud and the way we build even Dynamics are all pretty much one architecture. And you see that even in the way customers use it. So overall to your specific question on Azure, the growth will moderate as the numbers become big, and they've already become very big. But that said, we see plenty of opportunity for total gross margin growth in terms of dollars just because of the number of markets that we participate in, which we, by the way, never participated in the old server world. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + And Walter, I think the way you see that show up is really in my conversation on FY '19, to Satya's point, really we talked about that server product and KPI being high teens through FY '19. We're really confident in double-digit growth in that PBT segment with the components of Office 365, Dynamics 365 and LinkedIn. So if you think about that as the primary components of our commercial cloud, overall, we're certainly saying that it's a big business growing very fast at $6 billion, not counting LinkedIn. At 58% growth, it certainly speaks to having a big base and a big growth number. On Azure, you're right. It will moderate through next year. But because of the scale at which it's operating, that's why you still see that server KPI remain at that high level even as the base grows. And so you will see also some different dynamics within that Azure revenue number. Satya mentioned the layers of Azure. If you think about the IaaS and PaaS numbers, I would expect to be on the higher end of growth rates. And some of the services that are more per user like, like EMS within the Azure frame, you would expect that growth to moderate somewhat more quickly just because it's a per seat business. You will actually, over time, see us be able to continue to add ARPU and growth in those segments. Think of it almost like an Office business. Internally, we call that component part of our Microsoft 365 value. That's how we sell it externally even. And so hopefully, that helps give a little context to the number as well as our overall ability to continue to grow the sort of hybrid cloud opportunity high teens. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + Satya, you touched on the synergies that you're seeing between applications businesses and LinkedIn helping the 2 out. Wonder if you can talk just sort of high level and strategically about applications and enterprise applications in Azure and how you kind of see the synergy of potentially coming up between those, especially when you think about Azure AI, ML services sort of -- kind of questions is how important or how critical are applications like the growth that we're seeing in Dynamics, et cetera? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + Yes, I mean, one of the things that I talked about in my remarks this time was this power platform. One of the areas of, in fact, real breakout growth in differentiation as being in Power BI, Power Apps and Flow. For the first time, in fact, in our own Microsoft history, we have an extensibility model that is the same for Office 365 and Dynamics 365. This has been a dream of mine for, I don't know, for 15 years probably. And we are finally here and we are executing super well. But the interesting thing is it's not just even for our own SaaS applications. It is the extensibility model for every SaaS application out there, including a common data model. So I think that, that's where the synergies lie because AI starts with having a data estate that can really bring data from all of your applications, silos, in some sense, together so that you can start doing, building an analytical power that you can then visualize and put in the hands of people using Power BI or run an AI model that does some prediction that you can deploy in your system, whether it's forecasting, sales lead scoring, what have you. So that workflow, we have every layer of it. We have the best deployment tools and development tools in Azure. We have this common data model. On top of this, we have the best BI visualization technology. So that's what you're seeing increasingly as the synergy. But most importantly, architectural benefit for customers because by having incoherence around these layers is where you may feel like you're making some great best-of-breed sort of choices in individual layers, but you'll bear that expense in your overall agility as well as your overall management of your data. And that's where I think we will be very differentiated. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Ross MacMillan with RBC Capital Markets. +(technical difficulty) +Okay. We'll move on to the next question, which is coming from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [26] +-------------------------------------------------------------------------------- + + Maybe Amy, quick question. The Windows OEM Pro business has been extraordinarily strong the last few quarters. Can you maybe give us a sense of how penetrated you guys are in the Windows 10 corporate upgrade cycle and the sustainability of that growth? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Thanks, Brad. Let me -- first, I wouldn't say penetration is the word for this. Let me talk about this in 2 or even a couple of components because when you think about Windows 10, what we've seen over the past couple of years is you're right, a very strong enterprise deployment cycle and real pull for that product inside enterprises because of the security value prop of the product itself. When you see that deployment for security reasons, an externality of that is people often choose to upgrade machines in that process. We've seen good demand inside commercial entities for and when they make those upgrades to buy Windows PCs and often Surface devices in that choice. I think it's benefited our OEM partners and us. The portfolio of devices that are available are incredibly compelling. I think our partners have done a terrific job on that as well. The overall economy is certainly also quite good. And the installed base had actually gotten older. And so I think what you're starting to see is a process whereby there's a great product, there's a good macro environment. And you've got customers who really want to move to a modern infrastructure. A modern infrastructure has to both be secure at its very core and that can result, as you're seeing through that confluence of events, in a very strong PC market with very strong Pro performance. And I -- and certainly, the guide for Q4 continues to imply all those factors. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question is coming from the line of Michael Nemeroff with Credit Suisse. + +-------------------------------------------------------------------------------- +Michael Barry Nemeroff, Crédit Suisse AG, Research Division - Director [29] +-------------------------------------------------------------------------------- + + Satya or Amy, can you help us understand the large revenue outperformance and guide for continued strong growth in gaming? And Amy, could you please give us a sense of the margin profile of the areas of gaming that exceeded expectations? And if you could also comment on the strength of the MPC margin in the context of the gaming margin as well, that would be helpful. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [30] +-------------------------------------------------------------------------------- + + Yes, I can start and then (inaudible) even on gaming, very much like how we talk about some of our commercial segments. We've gotten a strategy, which sort of really helps us articulate both the growth opportunity as well as our investments across all of the various layers. So first is the console itself is the highest engagement console out in the marketplace. So anytime a new game, whether it's first-party or third-party releases, the fact that Xbox is where the best engagement is driven, benefits us. So as a platform owner, that's a great growth area for us. But we don't stop there because now we have, whether it's Xbox Live, whether it's Game Pass or Mixer, these are all additional opportunities to really serve the gamer as they play more games or watch games on different platforms. So that's the other big opportunity. But the last one, which I think is new and is something which is already paying its dividends on the Azure growth side, is we've taken all the knowledge of what it means to go to any one of these first-party titles of ours and building it as a PaaS service in Azure for game developers, and the PlayFab acquisition speaks directly to that. So those are all the various levers we have in gaming. And you'll see it in the MPC segment and you'll see it, as I said, increasingly over time even on Azure. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [31] +-------------------------------------------------------------------------------- + + And I think, Michael, if you don't mind, I'm going to expand your question a little bit because I don't think the increase in the MPC guide is simply gaming. So let me talk a bit about the components and which ones, I think, are a bit more sustainable and which ones may have a temporal nature to them. The performance in Q3 and the guidance for Q4 shows actually strong performance in a number of places that we expect to continue. OEM Pro is a terrific example for the reasons I just gave in Brad's question. Windows commercial, which is really the business inside the enterprise of selling much of the security value on a far more annuity like basis. We've seen strong double-digit billings growth there and we expect that to continue into Q4 as well. The next piece that I would say is a part of that sort of uplift in Q4 is our Surface device. The reception to Surface Book 2 as well as Surface Pro with LTE has been quite good. And you see us reflect that again in Q4, even as the comparable gets a little bit more difficult than it was in Q3 for us when you saw a very large growth rate. We're still expecting high teens there. Then you get to that gaming component and specifically what Satya was talking about, the Xbox software and services component is where I would expect to see the impact of the continuation of Q3. Part of that, I want to be very clear, is consistent, even going back a few quarters. That has been a double-digit grower. It will be a double-digit grower. There'll be some volatility in the number like anything else. And third-party hit games will move it higher as they did this quarter and we're expecting in Q4, but there's also a really strong base to that business that is the result of what Satya is talking about in terms of having a vibrant platform with fans that believe in it and come to it with all the value that's been added. So that's how -- okay, great. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question is from the line of Ross MacMillan with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross Stuart MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [33] +-------------------------------------------------------------------------------- + + Hopefully, the line is clear this time. So Satya and Amy, I wanted to ask about server products because striking growth this quarter, given the comp. And Amy, you talked about expected strength into fiscal Q4 and all of that, I guess, is testament to the strength of the kind of hybrid leadership you have. The 2 questions, though, were really, is that strength in server products broad-based across Windows Server, SQL Server, System Center, et cetera? Or is there any sort of bias in the mix, if you will, in terms of what's driving that strength? And then Satya, you mentioned Cosmos DB and that was a striking number to me as well. And I was just curious, do you think, now you have the multi-model database in market, that, that can help you take market share within the data management database space? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + Yes. I mean, I'll take the second one. I think that yes, I mean, Cosmos DB's pretty unique capability, in combination with everything else we do in both the data layer, the AI layer and the infrastructure layer, I think we have a tremendous opportunity because, as I said, the AI era is mostly first data era. And that's where I think the opportunity lies. But to your previous question, even there, there are multiple trends, and Amy referenced it in her remarks, which is, for example, virtualization still continues to be a growth driver of server products. The other growth driver of server products is cybersecurity and the security value in our servers. So that's one. The fact that we now have SQL and, for example, when you think about SQL itself, it's a hybrid product. You can tier SQL databases with the cloud. SQL is an AI product because we are the one database that actually allows you to write Python and R in situ, store procedures right in your database. So for example, when we talk about data and AI close to data because computation will always go wherever data is, and a lot of data shows up in relational databases and we have a growth driver there as well. And then there is the hybrid choices where somebody's building a smart factory, they're now looking and saying, "What is the server I deploy in the factory to manage the millions of sensors that are there across the factory?" And that's where Azure Stack shows up. So multiple drivers of what is essentially the server and cloud number in combination. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + And to your point on the component, the on-prem component even with tough comparable doing well, let me break Satya's comment into sort of 2 drivers that have been actually more sustaining. And it's across both Windows in particular, but also SQL, which are obviously the largest products within our server portfolio. The first, exactly with hybrid demand. We have something called hybrid -- Azure Hybrid Benefits. What it does is really provide confidence to our committed customers, buying on-prem servers that their transition to a hybrid, to cloud over a period of their agreement, is really about their choices, their time lines and their confidence. And so with that right, it lets them easily transition between Windows or SQL to those same benefits in Azure with a small uplift in price. I think that has actually been a core component. The second one was the virtualization drive or data center modernization, another one, do move the premium mix up a bit. So that's -- if you wanted to break it down into 2 more sustaining things, those are the types of things we're seeing in that number. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our final question is coming from the line of Kash Rangan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [37] +-------------------------------------------------------------------------------- + + Last question will be the longest one, really, really long. Question for you, Satya. As you meet with CEOs of large companies, this is a recurring theme that we've been hearing from other software company CEOs, the theme of digitization. Can you help us understand just -- especially given that Microsoft's growth rate is accelerating, whereas the GDP growth rate is the GDP growth rate. So obviously, tech spending or IT spending as a percentage of GDP or revenue, average company revenue is going higher. So can you help us, given your perspective, which is pretty unique, help us understand, what is the baseline of IT that we've been operating in? When it comes to digital business transformation, what are the Phase 1, Phase 2, Phase 3 initiatives like? Where are companies likely to spend more? And what kinds of products and services that are new and upcoming or maybe you sell them today that comprise that incremental swing factor over the baseline of what IT is today versus wherever we're likely to go with the digitization of business processes? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [38] +-------------------------------------------------------------------------------- + + Yes, I mean, I think when we talk to customers and CTOs, CEOs, what have you, we talk about 4 digital transformational outcomes. In fact, everything that we do across our solution areas are all ingredients to helping our customers achieve digital transformation objectives on. For example, how do they engage their customers? When I talked about Cosmos DB growth, Cosmos DB happens to be one of the best database products to be able to capture the signals that you want around your customers from a variety of different sources. That's one example of it. The second piece is, of course, around empowering your employees. I mean, one of the things that now has increasingly become #1 priority for every CEO is to make sure that the right tools, the right products are in front of their own employees so that they can do their very best work and collaborate. So teams grow. That's a great example of how companies are modernizing their workforce with things like Microsoft 365. The third one is operational efficiency. When we see the Dynamics 365 growth or Azure IoT growth, that's -- taking every IoT project, it ends up as a field service project. So that's a classic way somebody says, "Let me sense something, predict something and then actually fix using field service." So that's a transformational outcome that we're very well positioned. And lastly, people are changing their business models. You take somebody like Nalco Water. You could say they're a water company, but now they're pure water service company. In other words, they put sensors that allow them to actually deliver a very differentiated business model to their customers. And so that's the transformational outcomes we see. And we feel we -- at Microsoft, we're well positioned both with the technology but also with our front-line sales capability, service capability and partner capacity to best address the digital transformation needs. + +-------------------------------------------------------------------------------- +Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [39] +-------------------------------------------------------------------------------- + + Wonderful. It seems like CRM, HCM, ERP, IoT, these are the predominant themes that are going to be driving your growth. Very useful, insightful. + +-------------------------------------------------------------------------------- +Michael Spencer, - [40] +-------------------------------------------------------------------------------- + + That wraps up the Q&A portion of today's earnings call. Thank you for joining us, and we look forward to speaking with all of you soon. You can find additional details at the Microsoft Investor Relations website. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [41] +-------------------------------------------------------------------------------- + + Thanks, everyone. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [42] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this does conclude today's teleconference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2018-Jan-31-MSFT.txt b/Transcripts/MSFT/2018-Jan-31-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..614674cdbbeecaf9df38183ccdd29325e3e31175 --- /dev/null +++ b/Transcripts/MSFT/2018-Jan-31-MSFT.txt @@ -0,0 +1,367 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Microsoft Corp Earnings Call +JANUARY 31, 2018 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Chris Suh + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Aleksandr J. Zukin + Piper Jaffray Companies, Research Division - MD and Senior Research Analyst + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Raimo Lenschow + Barclays PLC, Research Division - Director and Analyst + * Gregg Steven Moskowitz + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Michael Barry Nemeroff + Crédit Suisse AG, Research Division - Director + * Kasthuri Gopalan Rangan + BofA Merrill Lynch, Research Division - MD and Head of Software + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Welcome to the Second Quarter Fiscal Year 2018 Microsoft Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the call over to Chris Suh, General Manager of Investor Relations. Chris, please proceed. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- +Thank you, Roya. Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Carolyn Frantz, our new Deputy General Counsel, Corporate Secretary. +On the Microsoft Investor Relations website you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provide the reconciliation of differences between GAAP and non-GAAP financial measures. This quarter, we incurred a tax charge related to the enactment of the Tax Cut and Jobs Act. We have excluded the impact of this tax charge in our non-GAAP net income and earnings per share metrics. These non-GAAP financial metrics should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact that these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. + +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website until January 31, 2019. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during the conference call and in the Risk Factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thank you, Chris, and thanks to everyone on the phone for joining. Our results this quarter speak to us picking the right secular trends and markets and following that up with focused innovation and execution. The intelligent cloud and intelligent edge paradigm is fast becoming a reality. Azure growth accelerated. LinkedIn growth accelerated. Microsoft 365 and Dynamics 365 are driving our growth and transforming the workplace. Xbox is reaching new customers with new offers. +With that as a backdrop, I want to highlight key areas of innovation and growth across our customer solutions. Every CEO I talk to is keen to start their transformation journey by empowering their employees and creating a modern workplace. They want productivity and collaboration tools that deliver continuous innovation and do so securely. Spectre and Meltdown are the latest instances in an increasingly complex threat environment. Our investments to make Windows 10 the most secure, always up-to-date operating system enabled us to move quickly to protect customers in the face of these threats. +Protecting customers will continue to be a top priority. Our continued commitment to operational security and advanced technology is one reason customers like BP, Goodyear, PayPal are choosing Microsoft 365. MasterCard chose Microsoft 365 to empower employees and inspire teamwork with integrated apps like Teams, Yammer and SharePoint. We're infusing AI across Microsoft 365 with the simple goal of helping people do their best work. Insights in Excel is a new service that uses machine learning to detect and highlight patterns. Translator brings 60 languages to Word. We are helping people be more productive on-the-go on any platform with real-time co-authoring in Office apps on iOS, Android and now the Mac. +And just this month, we announced that dictation will be available across multiple apps in Office 365, empowering users to write freely using only their voice. We are making voice a first-class input for productivity. Cortana can help manage your e-mail by pulling up important e-mails, reading them aloud and letting you reply using just your voice. We're also bringing Cortana's intelligence to Outlook mobile app, notifying you when it's time to leave a meeting to get to your next one based on your location and traffic. Mixed Reality empowers employees with new immersive experiences. Enterprise customers like Mercedes-Benz in Germany are using Mixed Reality to transform training, helping maintenance technicians learn everything from guided brake repair to how components in a new diesel engine work. +We are expanding our opportunity with Microsoft 365 for organizations of all types and sizes. Take first-line workers. Leading global telecommunications, retail and hospitality companies, such as BT, Target, Panera Bread and Delta Global Services all chose Office 365 to maximize the impact of their first-line workforce. In education, we are empowering every student with new learning tools natively built into Office 365 to improve reading, writing and comprehension as well as mixed reality experiences for immersive learning. This quarter, we launched Surface LTE and unveiled a new generation of always-on, always-connected Windows 10 PCs from our OEM partners. With up to 20 days of standby power, this new category of PCs deeply integrated with Cortana and with new near-field and far-field capability will fundamentally change productivity. +Now I'll turn to LinkedIn and business applications. As we pass the 1-year mark of Microsoft and LinkedIn uniting the world's leading professional cloud with the world's leading professional network, LinkedIn continues its strong trajectory with accelerating revenue growth and record levels of engagement, the fifth consecutive quarter of more than 20% sessions growth. Appetite for conversations across the platform continues to grow, from sharing in the feed to video to one-on-one messages sent, all up more than 60% year-over-year. This increased engagement across the platform is driving strong growth in demand for sponsored content and marketing solutions and record levels of job postings and job visitors in Talent Solutions. +LinkedIn is continually creating new ways for members to connect and engage with one another, such as this quarter's launch of Career Advice. From the deeper integration of Sales Navigator and Dynamics 365 for Sales and Dynamics for Talent to the launch of Profile Card to bring personalized LinkedIn insights directly into Office 365 to the new Resume Assistant, I'm excited about the many ways in which we are delivering powerful customer and member experiences that leverage both the Microsoft and LinkedIn graphs. +We continue to see good momentum in Dynamics 365 with revenue growth of 67% year-over-year. Our modern and modular business process applications are resonating with customers, driving digital transformation. Park Place Technologies, a global leader in data center support, chose Dynamics 365 along with LinkedIn Sales Navigator integration. And United Technologies and Columbia Sportswear chose Dynamics 365 and Azure for their digital transformation. +Now I'll talk about cloud and AI. As intelligent cloud/intelligent edge becomes more predominant, our architectural advantage is increasingly clear to our customers. You see this reflected in the latest CIO surveys as well as in our 98% Azure revenue growth this quarter. Only Microsoft delivers hybrid consistency, developer productivity, AI capabilities and trusted security and compliance. This architectural advantage helps us address both existing enterprise workloads and new workloads, such as IoT and edge AI. To thrive in this new era, customers need a consistent stack across public cloud and the edge, a model Azure Stack uniquely enables. +Since broad availability just a few months ago, we are seeing incredible customer demand for Azure Stack across a diverse set of industries, including Schlumberger, ABB, Mitsui Knowledge Industry. We're democratizing data science and AI so any organization can convert their data into actionable insights and drive competitive advantage. Azure Cosmos DB is the first globally distributed multimodal database. It is unique in its support for a new class of low-latency, event-based serverless applications. Azure Databricks brings leading Apache Spark-based analytics. Our new SQL Server on Linux is off to a strong start with more than 5 million downloads and will bring more developers to the SQL ecosystem longer term. +To thrive in a world with millions of intelligent endpoints, every company needs an IoT strategy. Microsoft is giving customers comprehensive solutions to help them realize the promise of connected world of devices and things. Azure IoT Central is the first global-scale SaaS offering that enables customers to build intelligent, secure, enterprise-grade IoT app in hours. Azure Event Grid simplifies the creation of event-driven IoT solutions across millions of endpoints. Azure IoT Edge enables customers to run serverless computing and machine learning models at the edge. +Chevron is using Azure IoT to harness massive amounts of data from its oil fields to accelerate deployment of new intelligent solutions for oil exploration and to manage thousands of oil wells worldwide, increasing revenue and improving safety and reliability of their operations. Kohler is building connected, voice-activated products powered by Azure IoT. And Johnson Controls is using large-scale device management capabilities in Azure IoT and Windows IoT for their new smart GLAS thermostat with Cortana voice control. +We reached the human parity milestone in machine reading comprehension using the Stanford Question Answer Dataset benchmark, which is the ability for AI to read a document and answer questions about it. We're using this and other AI advances to address some of society's most stressing challenges by partnering broadly across industries. +In health care, we are partnering with Adaptive Biotechnologies to build a practical solution for mapping the human immune system to detect cancer and other diseases in their earlier stages. We have created a HIPAA-compliant health bot powered by Azure Cognitive Services to assist with questions about health insurance, symptoms and location on nearby doctors. Aurora Health Care, UPMC, Premera Blue Cross have already signed on. +In retail, Kroger is using Azure to power their digital grocery store display solution for real-time pricing and promotions based on customer data to boost sales. Lowe's autonomous in-store robot uses Azure to keep constant tabs on inventory and identify out-of-stock or misplaced items, freeing store employees to focus on their customers. And Publicis Groupe's new AI platform built on Azure and Office 365 will empower their 80,000 employees worldwide. +Now let me turn to gaming. Our new Xbox One X was the top-selling premium console this holiday in the United States, and we saw strong sales of Xbox One S. We will continue to innovate in console to attract high-value gamers who want immersive 4K experiences to build a broader subscription service with Game Pass and to extend our services to all devices in our customers' lives across the console, PC and mobile. Our decision to release exclusive game content on the Xbox Game Pass simultaneously with global release increases the value of the subscription for members and our partners, and we are off to a very good start. We grew gamer engagement again this quarter with 59 million monthly active Xbox LIVE members, record usage of our Xbox LIVE services, record viewers of our new streaming service, Mixer, and record Minecraft users. +Finally, we just acquired PlayFab, which serves more than 700 million gamers with more than 1,200 games from companies like Disney, Rovio and Atari. It's a complete back-end platform for mobile, PC and console game developers to build, launch and scale cloud-connected games, extending our investments in Azure to provide a world-class cloud platform for the gaming industry. +Before I turn over to Amy, I want to reflect on a topic that is at the forefront of every customer conversation that I have. In an era where there is rapid transformation driven by digital technology, customers are looking for a trusted partner, someone with a business model that is aligned with their long-term interests, deep technical innovation and an understanding of the responsibility that goes along with this innovation. This perhaps is one of our key differentiators. Internally, we have a saying, "Microsoft runs on trust," and we strive to earn it every day with all of the constituents we serve. +Now I'll hand it over to Amy, who will cover our financial results in more detail and share our outlook, and I look forward to rejoining you for the questions later. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, Satya, and good afternoon, everyone. Our second quarter revenue was $28.9 billion, up 12% and 11% in constant currency with better-than-expected performance across all segments. Gross margin increased 12%. Operating income increased 10%. This quarter, we incurred a tax charge of $13.8 billion related to the enactment of the Tax Cuts and Jobs Act. Excluding that, earnings per share was $0.96, increasing 20%. We achieved another quarter of double-digit top and bottom line growth as we continued to realize the impact of strategic growth investments along with strong sales execution. +At a company level, LinkedIn contributed approximately 4 points of revenue growth and 5 points of gross margin growth with minimal impact on operating income growth. Excluding the cost of amortization of acquired intangibles, LinkedIn contributed $111 million operating income and continues to be accretive to EPS this fiscal year, ahead of our original expectations. +Across most geographies, our results were in line with overall improving macroeconomic trends. Large markets, including the U.S., Western Europe and France, performed better than expected driven by commercial cloud momentum. Our sales teams and channel partners delivered another quarter of outstanding commercial results, even as we continue to work through our sales reorganization from July. +Our commercial revenue annuity mix improved by 3 points year-over-year to 86% with healthy renewal rates. Commercial bookings increased 7% and 4% in constant currency even with a 20% smaller underlying expirations base. Commercial unearned revenue came in slightly higher-than-expected at more than $20.2 billion from growth in multiyear customer commitments to Azure. Commercial cloud revenue was $5.3 billion, growing 56% year-over-year with broad-based growth across geographic markets and customer segments. Gross margin increased by 7 points to 55%, in line with seasonal trends. We improved gross margin percentage in each cloud service, and Azure again saw the most significant margin improvement this quarter. +Company gross margin was 62% and flat year-over-year. Sales mix of higher-margin products and services, including better-than-expected performance from Windows Server and Windows OEM Pro, combined with improving cloud margins offset the impact of a growing mix of cloud revenue, LinkedIn amortization cost and device launches. +The FX impact on company and segment revenue growth was in line with expectation. The weaker U.S. dollar increased revenue growth by less than 1 point. FX had only 1 point of impact on operating expense growth, less than expected. This quarter, operating expenses grew 14% and 13% in constant currency with 10 points of growth from LinkedIn, including $154 million of amortization expense. We continued to increase investments in cloud engineering, AI and sales capacity to drive future growth. +Now to the segment results. Productivity and Business Processes revenue grew 25% and 24% in constant currency to $9 billion, slightly better than expected, fueled by LinkedIn revenue acceleration. LinkedIn contributed 15 points of growth. Office commercial revenue grew double digits again this quarter, increasing 10% year-over-year. Office 365 commercial revenue increased 41% from an installed base growth across all customer segments and ARPU expansion from continued customer migration to higher-value offers in the E3 and E5 workloads. Office 365 commercial seats grew 30%, in line with the expected trend given the increasing size of the base. +Office consumer revenue increased 12% and 11% in constant currency driven by Office 365 recurring subscription revenue and growth in our subscriber base, now at 29.2 million. Our Dynamics business grew 10% and 9% in constant currency driven by Dynamics 365 revenue growth of 67% and 68% in constant currency. LinkedIn revenue for the quarter was better than expected at $1.3 billion driven by strong sales execution across all LinkedIn services. We saw continued strength in user engagement, customer acquisition, renewals and upsell performance. +Segment gross margin dollars increased 24% and 23% in constant currency with 14 points of contribution from LinkedIn, including the impact of $222 million of amortization expense. Gross margin percentage decreased slightly due to the impact of LinkedIn-related amortization expense and the increased mix of cloud services. +Operating expenses grew 41%, 39% in constant currency with 33 points of contribution from LinkedIn, including $154 million of amortization expense. Excluding LinkedIn, operating expenses increased on cloud engineering and sales capacity investments. Operating income increased 9% and 10% in constant currency with only 2 points of negative impact from LinkedIn. +The Intelligent Cloud segment delivered $7.8 billion of revenue, growing 15% with better-than-expected performance driven by hybrid cloud. Server products and cloud services revenue grew 18% with another quarter of double-digit annuity revenue growth. Azure revenue growth accelerated to 98%, with Azure premium services revenue growing triple digits for the 14th consecutive quarter. Enterprise Services revenue grew 5% and 3% in constant currency as growth in Premier Support services and Microsoft consulting services was partially offset by declines in custom support agreements for Windows Server 2003. +Segment gross margin dollars grew 13%, and gross margin percentage declined slightly as the impact of increasing cloud revenue mix was mostly offset by material improvement in Azure gross margin. Operating expenses grew 3% and 2% in constant currency from ongoing investments in sales capacity and cloud engineering. Operating income increased 24%. +In More Personal Computing, revenue was $12.2 billion, up 2% with better-than-expected results driven by Windows and search. Excluding phone, revenue grew 4%. Our Windows OEM business grew 4% this quarter, better than we expected. OEM Pro revenue reflects a stronger-than-anticipated commercial PC market bolstered by improved macro conditions and continued healthy enterprise Windows 10 deployments. We benefited as well from higher mix of premium licenses and the timing of license purchases. +OEM non-Pro revenue was down 5 points, below the stabilizing consumer PC market. We continued to see growth in the premium category in line with the market, but heightened price competition of entry-level devices contributed to lower volumes. Inventory levels remained in the normal range. +Windows commercial products and cloud services declined 4% and 5% in constant currency mainly due to the impact of a large deal in the prior year. Search revenue ex TAC grew 15% from higher revenue per search driven by continued optimization of our advertising platform and search volume growth in both the U.S. and international markets. +Surface revenue grew 1%, roughly flat in constant currency, as we continue to transition our portfolio towards Surface Laptop, Pro with LTE and the new Surface Book 2. This holiday quarter, gaming revenue grew 8%, mainly driven by hardware revenue growth of 14%, 13% in constant currency from the launch of our premium console, the Xbox One X. Xbox software and services revenue growth was 4% with continued monetization growth partially offset by a prior year first-party AAA title launches. +Segment gross margin dollars were roughly flat year-over-year with the decline in gaming offset by growth in search and Surface. Segment gross margin percentage declined as expected with the console launch. Operating expenses increased 2% and 1% in constant currency from growth in engineering investments in search, AI and gaming that were partially offset by declines in Windows marketing and phone expenses. Operating income declined 2%. As a reminder, Q2 was the last quarter of phone comparability given the sale of feature phone business last year. +Now back to the overall company results. As expected, our capital expenditures, including finance leases, increased sequentially to $3.3 billion due to higher levels of customer demand and usage for our cloud services. Cash paid for property and equipment was $2.6 billion. Free cash flow generation -- free cash flow grew this quarter 23% driven by operating cash flow growth of 25%. Free cash flow increased from higher customer collections following strong billings growth, working capital improvements in the hardware business and contribution from LinkedIn. Other income and expenses was $490 million this quarter, more than planned due to higher interest income. Our non-GAAP effective tax rate this quarter was 18%, lower than anticipated, driven by an audit settlement as well as the normal variability between service and license revenue mix, geographic revenue mix and the timing of equity vest. We returned $5 billion to shareholders in share repurchases and dividends. +Now let's turn to next quarter's outlook. Assuming rates -- assuming current rates remain stable, we expect FX to increase revenue growth by 2 points, COGS by 1 point and operating expenses by 1 point. With positive IT spend signals, a strengthening commercial PC market and growing customer demand for hybrid cloud services, we expect our commercial business to remain strong as we drive annuity growth, expand our installed base and execute well on renewals. We expect commercial unearned revenue to be down approximately 2% to 3% sequentially, in line with historic seasonality. And our Q3 expiry base will return to year-over-year growth, impacting commercial bookings growth. +Third, CapEx. We will increase our capital expenditures to support increasing demand and capacity requirements. On an accrual dollar basis, we expect a sequential dollar increase next quarter. We expect year-over-year improvement in overall commercial cloud gross margin as Azure margin improvement continues to offset an increasing mix of Azure revenue. +In Productivity and Business Processes, we expect revenue between $8.6 billion and $8.8 billion. Both Office commercial and consumer revenue growth will be driven by Office 365 with growth rates for each consistent with Q2. We expect double-digit Dynamics revenue growth from the shift to Dynamics 365. LinkedIn should deliver approximately $1.2 billion, growing more than 20%. +In Intelligent Cloud, we expect revenue between $7.55 billion and $7.75 billion, with strong double-digit revenue growth in server products and cloud services. In Enterprise Services, we expect a revenue growth rate similar to Q2 as growth in Premier Support should offset the decline of Windows 2003 custom support agreements. In More Personal Computing, we expect revenue between $9.1 billion and $9.4 billion. In Windows, we expect OEM revenue to be largely in line with the total PC market. Both OEM Pro revenue and non-Pro revenue should be impacted by similar dynamics seen in Q2. +Now to devices. Surface revenue should grow year-over-year from continued launch momentum from the latest Surface Pro, Book and Laptop, but decline sequentially consistent with holiday seasonality. In search ex TAC, we expect a similar strong rate of revenue growth to Q2. In gaming, we expect revenue growth similar to last quarter but with a revenue mix shift to software and services and continued year-over-year growth of our Xbox LIVE user base. We expect COGS between $9 billion and $9.2 billion, including 1 point of FX headwind. We expect operating expenses of $9.1 billion to $9.2 billion, including 1 point of FX headwind. Given the opportunity ahead of us and our execution to date, we will continue to invest in intelligent cloud, intelligent edge, AI and our sales teams to drive sustainable top line growth. Other income and expense should be approximate $350 million as we continue to take gains in our equities portfolio and earn dividend and interest income. This is lower than we previously expected, reflecting the impact of rising interest rates on our fixed income portfolio. +Now a few comments on the fiscal year. First, given our outperformance in the first half of the year, we are now ahead of our previous expectation for full year gross margin. We are now trending to be roughly flat year-over-year, including LinkedIn. Second, we still expect full year operating expenses, including LinkedIn, between $36.4 billion and $36.7 billion. We are confident in this investment given our significant growth opportunities, consistent execution and strong competitive position. Third, on operating margin. We are again trending ahead of our previous guidance. We now expect company operating margin, including LinkedIn, to be slightly up year-over-year. Excluding LinkedIn, company operating margin should improve by more than 1 point. +Fourth, tax rate. Based on our current understanding of the recently enacted tax law, we now expect our effective tax rate for H2 to be 16%, plus or minus 2 points. For FY '19, we expect our full year effective tax rate to be slightly below the new U.S. corporate rate of 21% due to the impact of tax law provisions effective for us July 1, 2018. We will continue to have quarterly variability based on the mix of service and license revenue, geographic mix of revenue and the timing of equity vests. +Finally, we remain consistent in our ongoing commitment to capital return. As always, we believe the highest shareholder value is created first through organic and inorganic investment to pursue the significant market opportunities ahead and are proud of our resource allocation changes and the results. And we've been focused on capital return through both dividend and share repurchase as a key part of our commitment to total shareholder return for many years. With the recent tax reform, we can continue that commitment without the need to access the capital markets. +Before turning to Q&A, I have one special thank you. Chris Suh is moving to a new role as the senior finance leader of our Azure and Server business. On behalf of the company, thank you for your significant impact on Investor Relations for the past 5 years. And I'd like to welcome Mike Spencer, the former finance leader of our Office 365 business, as the new head of Investor Relations. We look forward to having you lead the team. +Now Chris, let's go to Q&A. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. We'll now move to the Q&A. Roya, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Our first question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- +So relative to your guidance, over half the beat this quarter came in the Intelligent Cloud segment, so I wouldn't mind digging in there a little bit. And it wasn't just the amazing Azure performance. Your on-prem server product business accelerated despite the cautious commentary about a tough comp on the last call. Even Enterprise Services was plus 3 instead of flat, and your guide actually suggests that, that goodness in Intelligent Cloud should continue next quarter despite actually a way tougher comp. So I'm just curious, Amy or Satya, if there are any threads that you can weave through this Intelligent Cloud outperformance, if you saw any broader increase in enterprise spend in the December quarter, any change in behavior. Or is all of this goodness a little bit more Microsoft-specific? Amy, you called out IT spending signals, so I'm guessing maybe a little bit was macro. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thanks, Karl. Let me start and Amy can add. For me, it all comes down to really having an architectural advantage on what is a new secular trend. So when we think about the intelligent cloud and the intelligent edge and then bring that to the Azure business, you can see it at each layer. When it comes to infrastructure, we're the only cloud provider that provides true hybrid cloud computing with Azure and Azure Stack. When it comes to the data tier, we have real uniqueness. Take something like Cosmos DB. It's the only planet-scale database that's multimodal, supports these new programming models of serverless and event-driven programming. Take SQL. What we are seeing in terms of SQL growth, in terms of Azure DB as well as SQL Server and SQL Server on Linux, that's, again, addressing the customer needs. There are new workloads that are being born that require both the cloud and the edge, IoT being a great example of that. And especially when you take that in combination with AI, again, you train on the cloud and you score on the edge. That's a real competitive advantage. We have everything from sort of the life cycle management of how these models get created and deployed and so on. So I think that's what you're seeing. There will be variability quarter-to-quarter. There will be mix differences. But overall, when I look at what is it that we need to get done is innovate on what is a fundamental architectural advantage to where the world is going. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +And I would say, Karl, a couple of things. We've been investing here both in engineering to land the differentiation that Satya just talked about in sales resources and in continuing to invest in technical sales resources that can help our customers be successful in these deployments. I actually think you're continuing to see the impact of those investments growing in time and growing in expertise. And so I feel encouraged both by the technical differentiation but also the return on the investments we've made here that lead us to have a good amount of confidence that you do see in the guide in Q3. And yes, you're right. We do have a tougher comparable particularly on prem in Q3, which is correct. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Our next question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [6] +-------------------------------------------------------------------------------- +Very -- again, a really solid quarter. And Chris, it's been great working with you. Sorry to see you go from this role. As for my questions, one question for Satya, and starting a little bit narrow and maybe running off from there. Gaming in the quarter, seems to have had a good quarter for gaming with the Xbox launch. But more broadly, there's some murmurings out there about Xbox falling behind PlayStation if you look at the sort of the bases of those 2 consoles. There's murmurings about not having enough kind of exclusive games on the console. I know you sort of mixed up the leadership a little bit there. How do you feel about your positioning in gaming from a narrow focus? And then more broadly, how are you guys feeling about your position in the home, if you will? When I go home, I'm talking to Alexa, not talking to Cortana. Is that something that you're comfortable with where we are today? Is that something we should see improving on a going-forward basis? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- +Thanks, Keith. So let me take both of those questions. So on gaming, we feel good about Xbox One X, the premium console launch. We also feel good about the volume we got for Xbox One S because we always wanted that halo effect of the premium console driving even the lower-end console because that creates the sockets for gaming for us. But our real strategy going forward is not only to do great work on the console, but to complement that with the work we're doing on the PC. PC gaming is a growth market. And so therefore, you see us whether it's our subscription offer, whether it's our streaming efforts that are increasingly bringing the console plus PC together and then not stopping there but going to other devices. So for example, mobile. Minecraft on mobile, we just launched, in fact, in the last quarter in China. We are seeing tremendous growth of Minecraft expansion on mobile platform in China. So overall, you will see us do good work on console. We'll compete there. But more importantly, we have a much more broader gaming view in terms of what value we can add with our subscription services, streaming services across all devices. And one other point, I think, I made in my remarks earlier is gaming also is a growth area for Azure. In other words, we have now increasing PaaS services that we are going to reinforce on Azure and attract more game developers. Some of the know-how that we have from Xbox is not just about the Xbox, but it's going to help developers across the board. So that, I think, will also transcend or lead into even media companies. So we are very excited about some of what we can get out of our investments in gaming. So that's our focus on gaming. In terms of Cortana and home, I think it's probably important, although the question I'll ask is -- you asked it narrowly, but my investments are much broader. In other words, I first start by saying let's make sure our best AI capability, whether it's speech, whether it's ultimately even image recognition and dialogue management because right now most assistants are fairly dumb in terms of just doing one-turn dialogue, but where we're going to go is multi-turn dialogue and that requires real natural language understanding. So all of those investments, for example, are available on Azure as Cognitive Services. I even referenced in my remarks how in health care, people are using those to build bots and skills and agents. That's where we will make sure we do our best building blocks and AI work. Of course, it will manifest for us with Cortana as an agent for Microsoft that has some special skills, especially around that crossover between work and life. Most agents and their knowledge of smarts come from the data access they have. In our case, it's going to be about things that are there in Office 365: the people, places, things and how we reason about it and help users whether they're at home or whether they're at work. Lastly, even when it comes to devices, we want to take an approach that brings all assistants. That's why we are working with Alexa. We would welcome it on our devices because we believe in a world where our own assistant should be available everywhere and so should other assistants be available on our devices versus thinking that the end game here is about speaking -- doing one-turn dialogues on one speaker in one home. That's just not our vision. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Moerdler with AB. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [9] +-------------------------------------------------------------------------------- +Chris, congratulations on the new position. I'm sure you'll be greatly successful. Satya, I'd like to ask you a question. Can you give us a sense of what is the adoption of Azure in the U.S. versus international, not just in the revenue point of view, but in terms of the mix of premium workloads, types of workloads, et cetera? How should we think of where we are in that process? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- +I would say the U.S. has been a lead market in general when it comes to the latest technology and architectural paradigm adoption, but let's take something like AI or the higher-level services around data. We clearly see, first, things happening in U.S. and quickly followed by geographies like Germany and the U.K. There are certain workloads, like the IoT workload, where we do see very advanced action in countries like Germany, especially with industrial customers in terms of smart factories, Japan. But I think broadly, I don't see any difference than, say, what we used to see or what we still see on our server or any other technology adoption curves. And they have differences in industry patterns because different industries are strong in different parts of the globe. So and then they represent different use cases in terms of the components of Azure that get used. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [12] +-------------------------------------------------------------------------------- +Two questions. One, Amy, I guess you've been talking about, and so is IR, about the commercial bookings where the expiry base was down over year-over -- on a year-over-year basis. I'm just wondering, if you look ahead to 2019, is there anything you could share with us about the size of the expiry base in that period just so we could think about it? I know you don't give guidance that far out, but just as we start to think about -- thinking about further outgrowth. And then I guess the other question would be, you mentioned better IT spending. But just also given the significant savings companies in the U.S. are going to be seeing due to lower tax bills, is there any early feedback from partners or customers about the rate that this might be reinvested back into IT spending and digitization? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- +Thanks, Heather. In general, FY '19 we'll have a higher base than FY '18 just as you start to think through the impacts on bookings for the next year. And as we talked about, Q3 has that same attribute. It's higher than it was a year ago Q2. The reason we called that out obviously because it was such an outlier. And if you look back 3 years sort of how this EA expiry base works, our performance this quarter was really strong compared to 3 years ago. So I feel great about our sales execution, especially in terms of growing the recapture rate at accounts. To your question on the demand signals we're seeing in the U.S. in particular, I think it is quite early. But as we've said, the U.S. has been a good market for us and a strong market for us for a good period of time, and it was again in Q2 as we noted. And I think we are optimistic as we look to H2 when we see the signals we're seeing in the market, whether it's PCs, server or the cloud demand. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [15] +-------------------------------------------------------------------------------- +Congrats not only just on the income statement, but also obviously the balance sheet where obviously the commercial, it was only down 5% versus your guide of 7%, so congrats there. The -- my focus is actually on the commercial side, but specifically on Office. Office 365 revenue continues to outpace fee growth there. We've talked about that in the past with pricing. But if I just look at also overall Office on the commercial side, up 10%, same as Q1, when you all think about just going forward just the mix of those 2, obviously, the on-prem business is still declining in the high teens and then Office 365 growing rapidly, how do you think about just the blended growth of Office commercial and the puts and takes there? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- +This is one where I tend to -- when I think about that 10% number, it really is the same way I think about Office 365. Our goal and I think the real opportunity that remains with Office 365 and Microsoft 365 going forward is our ability to continue to grow the installed base and to also continue to grow ARPU. The combination of those 2 things and the opportunity we see is the reason in the sales reorg that we did in July, we continue to put resources and sales resources behind collaboration and communication and so many of the important workloads that allow us to give great value to customers. And you even started to see it this quarter, as you're pointing out, Phil. We saw a little bit more impact of E5 this quarter in ARPU than we had been seeing. It's been in the market a while. We're seeing that momentum, the value all up of E5 not just from an Office perspective, but from a Microsoft 365 perspective with security and management as well as some of the newer products that are getting some strong adoption like Teams. I think we feel really good about where we are and the value and our opportunity both from small business up to the large enterprise, from first-line workers to do all of these things and continue to execute well. So the guide certainly implies that continued optimism. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Our next question comes from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays PLC, Research Division - Director and Analyst [18] +-------------------------------------------------------------------------------- +All the best for you, Chris. I just wanted to double click on the productivity gaze you see in the cloud, especially on Azure. Can you talk a little bit about the drivers there? I know one is that your build-out pattern was different than some of your competitors, so you're kind of filling capacity. But also talk a little bit about what you see in terms of how you're delivering the services in Azure and how that's evolving. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [19] +-------------------------------------------------------------------------------- +I mean, overall, we did take an approach that we want to make sure we meet the real-world needs across the globe, and we'll continue to do so. When we look at our CapEx spend, we want to make sure that the data center regions meet the needs of our customers globally across both consumer workloads and enterprise workloads where real data sovereignty requirements and speed-of-light issues are all really relevant. Having said that, the way it fills up is by the value-add that we can do. So that's why the mix of these higher-level services, especially around data and AI, is definitely driving a lot more consumption of our higher-level services. And even something like IoT, they're not just at the consumption meters, but they also got SaaS-like qualities to them. So I feel very, very good about ultimately having innovation that drives both the consumption of more higher-level services and then also making sure that we are available in all parts of the world where the demand is going to spread to because we're in the very, very early innings of, essentially, this new cloud growth. And there's only going to be increasing demand as there's more digitization of every city, every factory, every hospital and so on. So I think we have a long way to go to still fill up. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- +And I would say the way to think about that, and you see it in the gross margin percentages and the improvements we've continued to see, is the Azure premium revenue growth exceeding the overall revenue growth. That actually is a benefit to the gross margin rate. Then again, all the work we have done through the supply chain. So while we have a signal come in, you see a very quick turn from demand signal to us having servers in place and ready to be utilized very quickly. That work continues and the team has done a really nice job. And then as well, software improvements. They continue to go on to increase our ability to run more on less. Those, taken together, continue to show gross margin improvement. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Our next question comes from the line of Gregg Moskowitz with Cowen and Company. + +-------------------------------------------------------------------------------- +Gregg Steven Moskowitz, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [22] +-------------------------------------------------------------------------------- +Amy, I'd like to follow up on Heather's question because it's really difficult to grow commercial bookings by mid-single-digits constant currency in the face of 20% or so declining EA expirations. And so I'm wondering, looking beyond this quarter, if you could expand on how commercial bookings growth ex renewals is trending. And in other words, are you getting more separation, if you will, between reported growth and growth excluding renewal activity? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- +Let me take a shot. The way I think about bookings growth every quarter is you tend to look at a couple of things. And I would say I start with renewals, not just that we renew the contract, but how many new products, new services did we add to that contract. Did we expand our footprint, our percentage of the IT budget at a customer? Did they rely on us for more products and more services? This quarter is a good example of that happening. And if you think about the connection to why that happens, it's not just the terrific engineering work that we've done in product value. It's also the investments that we've made to put resources in some of these larger accounts to continue to add new workloads that are only possible in the cloud, and we've added resources that we're seeing the revenue get recaptured in that way. So that, I think, feels very good from a resource allocation and return perspective. And so then the next component obviously is being able to grow just brand-new accounts. Are we growing customer bases? Are we penetrating segments? And you also saw that in the quarter. So at a high level, you can either sort of add more expand your footprint or you get to add a new customer, and both of those are motions that we focus on. And I feel good about our execution. I think there's -- and you'll see that dynamic. So if the expiry base is a little bigger, you'd expect obviously a number bigger than that on the bookings side and when the expiry raises, there's growth. It's really about the delta between the 2, as you note, and our execution this quarter was quite good. But it's come from sustainable investment and our sales technical resources and in the engineering to deliver a differentiated value at the customer. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from the line of Kash Rangan with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [25] +-------------------------------------------------------------------------------- +Satya, my 9-year-old kid insists that Minecraft is the best thing for his brain development. So whatever it is, congratulations. My serious question is with the cash repatriation, obviously, Microsoft has the ability to bring back a lot of money. I'm wondering what the priorities of the company are with respect to doing a large strategic deal or not so perhaps and perhaps even share repurchases and dividends. Clearly, this is once-in-a-lifetime opportunity, and there's a lot that can be done. Curious how you think about this. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [26] +-------------------------------------------------------------------------------- +I'll actually let Amy take it. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- +Yes, why don't I take this? Number one, I would say we have -- when we have seen an opportunity to invest, we have not really waited for tax reform to do that. Our opportunity, the TAM, really the once-in-a-lifetime opportunity is really the technical transition and digital transformation that's occurring now. And so we've invested to make that happen. We've made acquisitions when they made sense. We have used the capital markets and the debt market to fund those to make sure that we made the right investments to grow our business. And so for us, we also didn't wait when we thought about capital return. Even this quarter, we returned almost all of our free cash flow generation in dividends and share repurchase. And we've been on that path for a number of years. Now that being said, I am pleased, obviously, to be able to access the cash more easily and not have to go through the debt market to be able to make these choices, whether it's investment in ourselves and the returns you've seen in this quarter in revenue growth, whether it's the acquisitions like LinkedIn that are performing better than we expected. And I think today, we would even say it's a more strategic asset than we even maybe thought a year ago in terms of the power of it to add to our graph and our understanding and then be able to return capital. So for me, while I appreciate the spirit behind the question, for us, we have felt a necessity to do that for years as a part of total shareholder return and our commitment to do that. And I think we've done a good job, and I'm proud of what we've done and I'm proud and excited for what we can continue to do. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from the line of Michael Nemeroff with Crédit Suisse. + +-------------------------------------------------------------------------------- +Michael Barry Nemeroff, Crédit Suisse AG, Research Division - Director [29] +-------------------------------------------------------------------------------- +This one's for Amy about the Office 365 commercial. Are there any limitations other than storage-related workloads that would limit Office 365 commercial gross margin from reaching, say, 80% over time? And what are some of the current limitations on that gross margin that you think could be improved upon for that to work higher than 70% over time? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- +Thanks. You're right. In general, workloads like Exchange and increasingly, SharePoint, which we have seen some really great encouraging numbers on usage of SharePoint in our Office 365 consumer -- commercial base, those do have storage requirements. And so you're absolutely right. They are slightly different than many of the very high-level SaaS workloads that you see. But we still do have room, which I think is really the core of the question. We still have some room to improve that Office 365 commercial gross margin from the new workloads we've added, which have even more of those pure SaaS-like workloads. And aside from Office in that same segment is Dynamics who -- or LinkedIn, which both have those SaaS-like margins and can and we see opportunity to both improve those as well. So I don't think there's necessarily a level, but there's certainly room even within these storage-heavy workloads. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- +Yes, I mean, just to add, but not specifically to the gross margin question, but the expansive nature of Microsoft 365 is for we think of it all up in that context. Amy already referenced how small businesses that perhaps never did advanced workloads are now able to do so. Emerging markets that never did are able to do so. So first of all, whether it's -- on first-line workers, we never had any solutions for first-line workers. So there is a market expansion in terms of users and the sophistication of the workloads that they can use or the higher-level services. The other thing is Office by itself, you talked about storage. It's an interesting question to say what is being stored in Office: in meetings going forward, at home office or people calling in, things like Mixed Reality being used in meetings. It's very different. It's not about you sitting in front of Word and entering text. That's not the full limit of Office. Office is about any people collaborating in voice or in -- with even computer vision and many other ways that I think collaboration will happen. So we have a very expansive view, much like Azure for infrastructure and data and AI in terms of human activity that gets digitized at work and at home is something that we are going after with Microsoft 365. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Our last question will come from the line of Alex Zukin with Piper Jaffray. + +-------------------------------------------------------------------------------- +Aleksandr J. Zukin, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [33] +-------------------------------------------------------------------------------- +Satya, I wanted to ask you about Azure Stack adoption. You mentioned it was ahead of your expectations on the call. And I guess, if you think about your early traction with service providers and how you're empowering them to build these Azure-capable data centers globally, maybe longer term, how should we think about the impact of this on Azure hyper growth durability beyond fiscal '18 as you scale? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- +See, our overall vision for how computing evolves is that it's going to be more distributed, not less distributed. Let's just take, for example, what's happening in a factory. In a factory, one thing that is secular is that they're putting lots and lots of more sensors. A lot of these sensors today are, in fact, rendezvousing some of that data straight to the cloud. As you do more of that, what happens is you need to -- and then you start doing sensor fusion, which is your multiple sensors that you want to be able to fuse and take action. The speed of light gets in the way. So they want local compute. And so in order to have that local compute in some of these factories with millions of sensors, you may, in fact, need Azure Stack. So it's not just about old workloads and service providers and essentially hybrid computing as we understand it. When I think about hybrid computing, at least in the fullness of time, it's more the future of distributed computing where there is a cloud, there is an edge and even the edge is not just one single edge, but it's got a typology associated with it going all the way to the sensors, whether it's at home, whether it's in a hospital, whether it's in a factory. So that's where we're going to end up, which is a true distributed computing fabric that the world needs in order to be digitally transformed. How and quarter-to-quarter will there be volatility, shifts, changes, that's all going to be the case. But we see the pattern emerge pretty clearly in terms of where we need to go. + +-------------------------------------------------------------------------------- +Chris Suh, Microsoft Corporation - General Manager of IR [35] +-------------------------------------------------------------------------------- +Thank you, Alex. So that wraps up the Q&A portion of today's earnings call. Thank you for joining us today. We look forward to seeing many of you at the coming months at various investor conferences and events. You can find the details on the Microsoft IR website. Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- +Thank you all. Thanks very much. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- +Thank you, all. Thanks, Chris. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2018-Jul-19-MSFT.txt b/Transcripts/MSFT/2018-Jul-19-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..c2e29a200886bc63d0b84ddf726ebaa4a49a9c15 --- /dev/null +++ b/Transcripts/MSFT/2018-Jul-19-MSFT.txt @@ -0,0 +1,441 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Microsoft Corp Earnings Call +JULY 19, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Keith Frances Bachman + BMO Capital Markets Equity Research - MD & Senior Research Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Gregg Steven Moskowitz + Cowen and Company, LLC, Research Division - MD and Senior Research Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Microsoft Fiscal Year 2018 Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael Spencer, General Manager, Investor Relations. Thank you, sir. You may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, - [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Carolyn Frantz, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides reconciliation of differences between GAAP and non-GAAP financial measures. +Unless otherwise specified, we'll refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance, in addition to the impact these items and events have on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying business performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During the call, we will be making forward-looking statements, which are predictions, projections and -- or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. I'm proud of our strong results this quarter and even more proud of what we have accomplished over the last 12 months. We delivered more than $110 billion in revenue for the full year with double-digit top line and bottom line growth. And our commercial cloud business surpassed more than $23 billion in revenue for the year with gross margin expanding to 57%. +The strength of our results reflects accelerating innovation and the trust customers are placing in us to power their digital transformation. I shared our vision for the intelligent cloud and the intelligent edge a little over a year ago, a vision that is now quickly becoming reality and impacting every customer in every industry. +Everything we have accomplished this year has been about accelerating our lead in this new era and the tremendous opportunity ahead. We focus on the right secular technology trends and growing markets and follow that up with solid road map execution. We've reorganized our engineering teams to break free of the categories of the past and better align with the emerging tech stack, from silicon to AI to experiences, to better serve the needs of our customers today and long into the future. +We reoriented our sales and marketing teams, adding industry and technical expertise to partner more deeply with our customers on their digital transformation journeys. And most importantly, we drove innovation to deliver differentiated value across the cloud and the edge. +Now I'll briefly highlight some of our innovation and momentum. We introduced Microsoft 365 to empower employees in the modern workplace. Microsoft 365 is now a multibillion-dollar business that gives our customers a path to the cloud and broadens our reach with new and underpenetrated markets, including more than 2 billion first-line workers and industry-specific workflows. +Across Microsoft 365, we are helping people be more productive, collaborate and stay secure on any device with AI-infused experiences they use every day, and it's driving usage. We have more than 135 million users of Office 365 commercial. Outlook mobile is being used on more than 100 million iOS and Android devices, and more than 200,000 organizations are using Microsoft Teams as the hub for teamwork. +We invested to make Windows 10 the most modern, secure, always up-to-date operating system. Windows 10 is now active on nearly 700 million devices, and the growth of the enterprise deployments this year exceeded our expectations. +It was a record year for LinkedIn, now with more than 575 million members and revenue growth of 37% in Q4, the fifth consecutive quarter of revenue acceleration. We saw record levels of engagement in job postings again this quarter, with sessions growth up 41% year-over-year. This strong engagement is driven by the quality of the feed, video messaging and acceleration of mobile usage, with mobile sessions up more than 55% year-over-year. We will continually invest to make LinkedIn the essential platform to connect the world's professionals and help them achieve more with experiences powered by LinkedIn and Microsoft Graphs. +Dynamics 365 gives organizations an alternative to monolithic siloed suites of business applications with modular, modern extensible and AI-driven apps that unlock insights across every part of the organization, from sales to HR. It's gaining traction as our third commercial cloud growth engine with revenue up 61% year-over-year. Our investments in Power BI, Power Apps and Flow as the new analytics and application platform are gaining significant momentum with ISVs and enterprise customers. +Azure is the only hyperscale cloud that extends to the edge across identity, data, application, platform security and management. And our differentiated architectural approach drove another strong quarter of growth. We're investing aggressively to build Azure as the world's computer. We expanded our global data center footprint to 54 regions, more than any other cloud provider, and with the most comprehensive compliance coverage in the industry. We added nearly 500 new Azure capabilities in the last year alone, focused on both existing workloads and new workloads such as IoT and AI at the edge. +We introduced Azure Stack and Azure Sphere, 2 first-of-their-kind cloud to edge solutions that are already seeing strong customer demand. We're democratizing data science and AI with Azure Cognitive Services, Azure ML and data services such as Azure Cosmos DB to help organizations of all sizes convert their data into insights and experiences for competitive advantage. The world's leading companies are running on Azure, and I'm especially proud that Walmart chose Azure and Microsoft 365 to accelerate its digital transformation for their associates and customers. +In gaming, we are pursuing our expansive opportunity from the way games are created and distributed to how they're played and viewed, surpassing $10 billion in revenue this year for the first time. We're investing aggressively in content, community and cloud services across every endpoint to expand usage and deepen engagement with gamers. The combination of Xbox Live, Game Pass subscriptions and Mixer are driving record levels of growth and engagement. +Not only are we investing to grow organically but we're also investing inorganically in opportunities that expand our total addressable market and accrue value to our platforms and our customers. +Take LinkedIn, we have united the world's leading professional cloud with the world's leading professional network and proved that we have an integration model that works, enabling LinkedIn to accelerate growth while retaining its member-first ethos. With GitHub, we recognize the increasingly vital role that developers play in value creation and growth in the era of the intelligent cloud and intelligent edge. Our pending acquisition will enable us to bring our tools and services to new audiences while enabling GitHub to grow and retain its independence and develop a first ethos in community. +PlayFab accelerates our vision to build a world-class cloud platform for the gaming industry across mobile, PC and console, and the addition of 5 new gaming studios bolsters our first-party content development to support our fast-growing gaming services. +Microsoft has always been a partner-led company, and partners increasingly see more opportunity on our platforms, inspiring leading companies like SAP, Adobe and GE as well as fast-growing start-ups, like InMobi, to play an even larger role in our vibrant and growing partner ecosystem, an asset that gives us scale in this new era. +In closing, our opportunity has never been greater. We will continue to innovate and invest across our solution areas and serving our customers and their unmet and unarticulated needs. With this tremendous opportunity comes great responsibility. We're relentlessly working to instill trust in technology across everything we do. It's why we will continue to lead the industry dialogue on trust, advocate for customer privacy, drive industry-wide cybersecurity initiatives and champion ethical AI. +Our investments and business model are fundamentally aligned with our customers' long-term interests and success. This opportunity and responsibility grounds us in our mission to empower every person in every organization on the planet to achieve more. I'm proud of our progress, and I'm proud of the more than 100,000 Microsoft employees around the world who are focused on our customers' success in this new era. +Now I'll hand over to Amy, who will cover our financial results in detail and share our outlook, and I look forward to rejoining you for the questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $30.1 billion, up 17% and 15% in constant currency. Gross margin dollars increased 19% and 16% in constant currency. Operating income increased 30% and 24% in constant currency. Earnings per share was $1.13, increasing 7% and 3% in constant currency. As a reminder, FY '17 included a $1.8 billion tax benefit related to previously nondeductible phone losses. +In our largest quarter of the year, our sales teams and partners delivered exceptional commercial results. We saw strong performance in most of our geographic regions against a backdrop of favorable macroeconomic conditions and positive IT spending trends. +Customer commitment to our cloud platform continues to increase. In FY '18, we closed a record number of multimillion-dollar commercial cloud agreements and more than doubled the number of $10 million-plus Azure agreements. Our annuity mix increased 3 points year-over-year to 89%. As a result, commercial bookings increased 18%, even with a strong prior year comparable. Commercial unearned revenue was $29 billion, growing 23% and 21% in constant currency, significantly higher than anticipated due to stronger-than-expected cloud billings. +Our commercial cloud revenue was $6.9 billion, growing 53% and 50% in constant currency, with strong performance across the U.S., Western Europe and the U.K. Commercial cloud gross margin percentage increased 6 points to 58%. In line with our commitment at the beginning of the year, we improved the gross margin percentage in each cloud service, with Azure seeing the most significant improvement. Our company gross margin percentage was 68%, ahead of our expectations, and up 1 point year-over-year from improvement in our More Personal Computing segment, driven by Surface. +FX increased revenue growth by 2 points, 1 point lower than anticipated due to a stronger U.S. dollar. At the segment level, FX had a positive impact of 3 points on Productivity and Business Processes and Intelligent Cloud, and 1 point on More Personal Computing revenue. The FX impact to COGS was immaterial. +This quarter, operating expenses grew 9% and 8% in constant currency, above our expectations, due to revenue-driven expense such as sales compensation, given the strength of the quarter, and severance expense primarily in our sales organizations, offset by FX favorability. Strong revenue growth, improved device gross margin percentage and continued targeted investments in cloud engineering, cloud sales capacity and LinkedIn created operating income leverage. This quarter, operating income increased again, up 3 points year-over-year. +Now to our segment results. Revenue from Productivity and Business Processes was $9.7 billion, increasing 13% and 10% in constant currency, in line with our expectations, even with the headwinds from a stronger dollar and a higher-than-anticipated mix of cloud billings in our Office commercial and Dynamics businesses during the quarter. +As a reminder, under ASC 606, cloud revenue is ratably recognized, while annuity on-premises revenue has a component of upfront recognition. A higher mix of cloud billings is reflected more on earned revenue and less in period recognition in a quarter. +Office commercial revenue increased 10% and 8% in constant currency. Office 365 commercial revenue grew 38% and 35% in constant currency, and Office 365 commercial seats grew 29%. We continued to see healthy installed base growth and ARPU expansion from customer adoption of premium workloads in E3 and E5. Office consumer revenue increased 8% and 6% in constant currency, driven by recurring subscription revenue and growth in the subscriber base, now at 31.4 million. Our Dynamics business grew 11% and 8% in constant currency with double-digit billings growth. Dynamics 365 grew 61% and 56% in constant currency. +LinkedIn revenue grew 37% and 34% in constant currency with strong execution across all businesses. As Satya highlighted, engagement continued to accelerate, and we also saw record levels of job postings, benefiting from a robust U.S. job market. +Segment gross margin dollars grew 13% and 10% in constant currency. Gross margin percentage was relatively unchanged year-over-year even as cloud mix increased, driven by margin expansion in Office 365 and LinkedIn. Operating expenses increased 7% as we continued to invest in LinkedIn, cloud engineering and commercial sales capacity. Operating income increased 20% and 13% in constant currency. +Revenue from the Intelligent Cloud segment was $9.6 billion, increasing 23% and 20% in constant currency, with better-than-expected results in both our on-premises and Azure businesses. Server products and cloud services revenue increased 26% and 24% in constant currency, driven by continued strong Azure revenue growth of 89% and 85% in constant currency. +Azure per user services have performed ahead of expectations, with our Enterprise Mobility installed base growing 55% year-over-year to over 82 million. Our on-premises server business grew 8% and 6% in constant currency, with double-digit growth in premium server products revenue and healthy renewals benefiting from the significant value customers see in our hybrid solutions. +Enterprise Services revenue grew 8% and 7% in constant currency, as growth in premier support services and Microsoft consulting services was partially offset by a decline in custom support agreements for Windows Server 2003. Segment gross margin dollars increased 23% and 20% in constant currency. Gross margin percentage was relatively unchanged as material improvement in the Azure gross margin percentage was offset by a growing mix of Azure IaaS and PaaS revenue. Operating expenses increased 11% with ongoing investments in cloud engineering and sales capacity to support top line growth. Operating income grew 34%, up 30% in constant currency. +Finally, More Personal Computing. Revenue was $10.8 billion, up 17% and 16% in constant currency, with better-than-expected results in Windows commercial, OEM Pro and Surface. In the commercial space, we saw an accelerating pace of Windows 10 enterprise deployments this quarter. Customer demand for modern and secure hardware and stronger-than-expected PC growth in geographies where Pro mix was high contributed to OEM revenue growth of 14%, ahead of the overall commercial market. Windows commercial products and cloud services grew 23% and 19% in constant currency, driven by double-digit billings growth as well as a higher mix of in-quarter recognition from multiyear agreements. +In consumer, OEM non-Pro revenue declined 3%, slightly below the consumer PC market, driven by continued pressure in the entry-level price category, even as we continued to take share in the premium category. Inventory levels were within the normal range. Search revenue ex TAC increased 17% and 16% in constant currency, driven by enhancements to our advertising platform and Bing volume growth across both U.S. and international markets. +Surface revenue increased 25% and 21% in constant currency, driven by strong performance of the latest editions in the portfolio against a low prior year comparable. In gaming, revenue grew 39% and 38% in constant currency. Xbox software and services grew 36% and 35% in constant currency, mainly from a third-party title. Xbox Live monthly active users increased 8% to 57 million. Segment gross margin dollars grew 21% and 18% in constant currency. Gross margin percentage increased, driven by new Surface editions, offset by sales mix to lower-margin businesses. +Operating expenses grew 9% and 8% in constant currency, driven by seasonality, changes in advertising spend versus the prior year and investments in engineering across search and AI. Operating income grew 38% and 32% in constant currency. +Now back to total company results. Capital expenditures, including finance leases, were $4.1 billion and increased on a sequential basis in line with expectations. Cash paid for property, plant and equipment was $4 billion, reflecting investments to support growth in our cloud business as well as a $250 million real estate acquisition. +Free cash flow was $7.4 billion and down 15% year-over-year, reflecting higher capital expenditures in support of our cloud business. Cash flow from operations grew 4% year-over-year and included tax payments related to the adoption of ASC 606 and TCJA as well as an earlier start to the hardware inventory build for holiday than in the prior year. Excluding the impact of these items, operating cash flow grew approximately 13%, driven by strong cloud billings and collections. +Other income and expense was approximately $300 million, lower than expected due to FX remeasurement. Our non-GAAP effective tax rate was 18%, higher than anticipated due to the geographic mix of our revenue. And finally, we returned $5.3 billion to shareholders through dividends and share repurchases, an increase of 16%. Our Q4 share repurchase was $2.1 billion, up 31% year-over-year but down sequentially, given the suspension of share repurchase activity in advance of the announced GitHub acquisition. +Now let's move to the outlook. My commentary for both the full year and next quarter does not include any impact from GitHub, which we still expect to close by the end of the calendar year. Overall, the key drivers and trends of our business for the next fiscal year remain largely unchanged from April and assume a consistent macro environment. +First on FX. Assuming that rates remain stable, we expect no impact to full year revenue growth, with any FX benefits in H1 offset in H2. FX should decrease COGS and operating expense growth by 1 point. +Second, our commercial business. Given corporate IT spend optimism and increasing demand for cloud services, our strong competitive product position and consistent sales execution, we expect another year of strong revenue growth and higher annuity mix across commercial business. As customer commitment to our cloud increases, we are seeing larger and longer-term agreements. As a result, we may see increased quarterly volatility in commercial bookings growth and commercial unearned revenue. +Productivity and Business Processes should continue to grow double digits, driven by Office 365, Dynamics 365 and LinkedIn. Customer demand for our hybrid offerings should drive high teens growth in our server products and cloud services KPI. +And in Azure specifically, we expect an increasing mix of IaaS and PaaS consumption-based revenue. In Windows, we expect strong business fundamentals in our OEM Pro and Windows commercial businesses, though the rates of revenue growth will slow through the year against a strong FY '18 comparable. +Third, commercial cloud gross margin percentage. We expect continued improvement in each commercial cloud service as well as in the overall commercial cloud gross margin percentage. The rate of improvement will moderate relative to FY '18 as revenue mix continues to shift to Azure IaaS and PaaS consumption-based services and we realize less year-over-year improvement in our per user services. We will continue to increase our investments in CapEx to meet growing demand for our cloud services, although, we do expect the growth rate for the year to moderate. +Next, operating expenses. Given our strong execution, we will continue to invest in the trends and growing markets we believe are fundamental to long-term shareholder value creation. Investment in commercial cloud, LinkedIn, gaming and AI should result in operating expense growth of roughly 7%. +Even with these strategic investments and the continued shift to our cloud businesses, we expect operating margin to be up slightly year-over-year. Other income and expense should be slightly negative, in line with prior guidance and with quarterly variability, primarily due to changes in FX remeasurement, interest rates and valuation changes with the adoption of the new accounting rules for financial investments. +And finally, tax rate. We've refined our estimates of the impacts from TCJA, the mix of service versus license revenue and the geographic mix of revenue and now expect our FY '19 effective tax rate to be roughly 17%, with quarterly variability. +Now to the outlook for first quarter. First, FX. Assuming current rates remain stable, we expect FX to increase revenue growth by approximately 1 point and decrease COGS and operating expenses by 1 point. +Second, our commercial business. We expect another healthy quarter with commercial unearned revenue down approximately 10% sequentially, in line with historic seasonality. Commercial cloud gross margin percentage will improve slightly on a sequential basis. +Third, we expect another quarter of sequential growth in capital expenditures as we continue to support growing global customer demand. +Now to the segment guidance. In Productivity and Business Processes, we expect revenue between $9.25 billion and $9.45 billion, driven by double-digit growth in Office commercial and Dynamics. LinkedIn revenue growth should remain high on a stronger prior year comparable. +In Intelligent Cloud, we expect revenue between $8.15 billion and $8.35 billion. Azure revenue growth should reflect a balance of continued strength in our IaaS and PaaS consumption-based services and a moderating growth -- rate of growth in our per user services. In More Personal Computing, we expect revenue between $9.95 billion and $10.25 billion. In OEM Pro, we expect revenue growth in line with the commercial PC market. And in OEM non-Pro, we expect similar dynamics as seen in Q4. +In Surface, we continue to expect strong performance from our latest editions, including the new Surface Go, to drive growth similar to Q1 of the prior year. Search ex TAC should see another quarter of mid-teens growth, with consistent execution against rate and volume growth opportunities. +In gaming, we expect mid-teens revenue growth with continued strong user engagement on our platform. The software and services growth rate will moderate due to strong third-party titles launched a year ago. We expect COGS of $9.5 billion to $9.7 billion and operating expenses of $9.2 billion to $9.3 billion. Other income and expense is expected to be approximately negative $100 million. +And finally, we expect our Q1 effective tax rate to be slightly lower than our full year rate due to the volume of equity vests that take place during our first quarter. Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, - [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question is coming from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + Congratulations on the really nice quarter. I wanted to dig into Azure a little bit. I think growth overall in Azure this quarter is probably ahead of most people's expectations. And it sounds like the type of business that's being done on Azure is becoming more strategic and changing a little bit. So Satya, I was hoping you could talk to us a little bit about the types of workloads, the type of sort of services that are being used on Azure, how that's evolved over the past year. +And Amy, for you, maybe there's a new KPI, I believe, you gave us sort of the growth in the Enterprise Mobility up 55%. Was that in line with your expectations because I know you were sort of tempering our expectations on growth in that part of the business? Is that growing in line with kind of the slowdown you were expecting? Or is that better than you had imagined? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes, so let me -- first of all, thanks, Keith, for the question, and so let me start. Overall, in terms of the workload mix, it's been fairly stable, which is our hybrid value proposition really is -- continued to resonate, so that means there is a bunch of workloads that are migrating to the cloud. People use both Azure Stack plus Azure, so that continues to drive a lot of IaaS growth for us as people are sort of looking basically to lift and shift a lot of their current data center workloads. +Then, on top of it, we even have a modernization of apps that is accelerating, and that drives a lot of the higher-level services, in particular, our data services as well as our AI services when AI services are essentially compute, but what happens is all this compute then requires storage and data, and that's another place where we see increasing acceleration. +The one thing that I would say that I'm increasingly seeing is Tier 1 workloads. In some sense, when we think about some of the commitments being made by some of the biggest brands in the world in terms of what they're doing, one, it's very core to their operation. And two, they're running it in the cloud. And so that's one thing that definitely is a market difference for us. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And to your question on the per user services, specifically Enterprise Mobility, Keith, it was a bit better than I had anticipated in Q4. And really, the driver of these per user services such as EMS actually is the value proposition that Satya refers to and we refer to as Microsoft 365, and we saw strength broadly. And if you think about that, it's the Windows commercial, it's Office 365 commercial and EMS. And really that, I think, what we've heard a lot was the value of the security and management continuing to add more supported endpoints offer really tremendous value to customers, and we did see a bit more strength than I was anticipating in Q4. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + Congrats on a good quarter. Amy, the commercial unearned revenue and bookings were again super strong, and evidently, Microsoft is benefiting from fairly strong EA renewal activity. So when you look out into fiscal '19, how would you compare the degree of renewal activity versus fiscal '18 and fiscal '17? It sounds like you're still constructive, but I'd love to hear some color, whether it feels as good as the fiscal year you just ended. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Thanks, Karl. Let me break up that question a little bit because you actually asked a couple of things that are important. Number one, the unearned strength that we saw at the end of Q4, you're right, was very good execution on renewals on a reasonably large renewal base. But there was also very good execution of adding new workloads, adding new opportunity in Q4, things such as Azure, as an example, or Dynamics 365, as an example. So really, Q4 wasn't just renewal activity, it was also new workloads and new value. +So when you look into '19, I am optimistic on both of those fronts, good execution continuing on renewals as well as adding new value and new opportunity. And the third component of your question was really how did the renewal base correlate to FY '18. The answer is it's a little bigger but it actually has the same amount of volatility quarter-to-quarter. So Q1's renewal base is actually almost equivalent to last year. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [9] +-------------------------------------------------------------------------------- + + I was wondering, Amy or Satya, if you can help us think about how Azure Hybrid Benefit has changed the type of net expansion rate you're experiencing on your ELAs that come up for renewal. And I know you were kind of a little bit touching on that with Karl, but is there any way to help think about how that, in particular, might be helping the expansion rate to those accounts? And can you help us think about how this might be -- how that might be helping drive growth in your existing contracts? +And then, the other question would be, you mentioned that you're moving from per user consumption that you're going to see more growth in consumption-based services versus per user Azure workload growth. And I'm just kind of wondering if you could share with us, is there any gross margin impact there? Does one have higher gross margins than the other? Is there anything that we should be taking from how you're parsing those comments about how we think of Azure's gross margin progression going forward? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- + + Thanks, Heather. So on the first one, I actually think that these hybrid use benefits have been sort of the best kept secrets. So I'm actually hoping that going into this next fiscal year, we do a much better job and customers do a much better job for their own benefit because the advantage Azure has because of the hybrid use benefits across the entire workload are pretty phenomenal. And we had a good set of sessions at our partner meetings this week, just really making sure everybody understands those benefits. So I don't think that that has really played out. If we have seen anything, all the growth we have seen is in spite of that not being broadly really driving growth. +But to your second question, I'll even say the following, which is that I think there is clearly a difference in GM between the per user and consumption. But the key is even the consumption services come in different forms. There is the IaaS services, there is the data services and some of the higher-level services. Some of these IoT services now even have SaaS components to it. So therefore, I think that the mix will be different by quarter by quarter. But increasingly, our strategy is, in many times, to get customers to get going with what is core storage or core compute but then they scale into these higher-level of services. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + And I would say, Heather, on those 2 components, just to add, the Azure hybrid benefits, I think we're starting, as Satya said, we started to see some impact from that, in my opinion, in Q4 in the on-prem KPI. But it really was more in Windows. And the value, as we continue to see in SQL next year, I do think there's some opportunity for customers to realize real value from these hybrid benefits. And so it sort of adds confidence to my high teens KPI growth for the year is that this is a very customer value-oriented offer. +To your question on GM, Satya's obviously correct on that one. And I would say, the way we think about it is actually more -- when you talk about Azure per user, it really does move more with M365 per user. It's almost better to put that in your mind as behaving more and having margin structures more like Office 365 and behave quite similarly. It tends to have good quarters when we do good execution on Office 365. And so my comments were more and continue to be around having people understand that sales motion and that it tends to move in that direction. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + Congratulations on the quarter. So I have 2 related questions. The first is if you look at this quarter at Intelligent Cloud revenue, it grew 23% and the gross margin dollars grew the same 23%. Given the fast-growing lower-margin Azure business, we're not seeing any longer negative margin impact. Have you reached the point where the incremental dollar of Azure revenue is close to the overall Intelligent Cloud gross margin? +And then, a second, I apologize, slightly long question. CapEx spending in the quarter and the full year were both strong. We could argue 2 possibilities, it's driven by all the capacity demand or you're having to spend a lot of it on replacing equipment as they're aging out. How should we think about the mix in CapEx between building demand and replacing what's there? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + Let me take both those. On the first one, in terms of the GM this quarter, you're right. The improvements, particularly in the IaaS and PaaS gross margin of Azure did offset the cloud mix to Azure within the segment. Going forward, continuing to see that. I think we'll see more pressure on gross margin just because the amount of Azure in the mix at the rate it's growing, we're still not at that point where $1 of gross margin in the cloud is equivalent to $1 of on-prem. That being said, we have a lot, as you saw this quarter, room to grow gross margin dollars in that within -- even within that frame going into FY '19. +On your second question in terms of capital spend, if you think about it at a high level, our capital expenditures are growing at a lower rate than our overall cloud revenue is growing. And that's why you're starting to see leverage, right, flow through the P&L. And I think that the rate of CapEx growth, as I said, in FY '19 will moderate. That happens because, of course, we're doing some replacement but we're also adding regions and seeing a lot of global demand. And so, we're actually -- and improving margins. So I think that's -- when I put it at a very high level as you asked the question, I tend to think revenue's growing faster than my capital, you're seeing leverage through the P&L, and we'll see a moderating rate in FY '19 even if Q1 is a big quarter. It's just going to be volatile, as CapEx tends to be, quarter-to-quarter based on both supply chain and demand. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [16] +-------------------------------------------------------------------------------- + + Amy, wondering on the Office product and services on the commercial side, you had, I think, 8% growth. It's the lowest you've seen. I know 606 drives some volatility in that business. Could you help us understand what drove that in the quarter? And I know you're making some changes like to support and so forth as we get into the out years. Is there any impact that you expect to the growth rate in that business as we look forward from those changes? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Thanks, Walter. The entire impact in that KPI, I actually feel very good about that number because, if you think about the $1 billion-plus beat we had to the unearned, it was partially due to the fact that we had very good mix shift to Office 365 in terms of billings in the quarter. Almost very little of that gets recognized in quarter. It almost all goes to the balance sheet. So my confidence for FY '19 in that number being the double digits we talked about in the full year guide only gets raised by seeing that execution. So it is really 606-related is the way to think about it, plus a mix of billings and billings strength. So I don't really think about that as being a negative. And you saw the exact same behavior in Dynamics, so it is a pretty similar in-period, in-quarter impact. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [19] +-------------------------------------------------------------------------------- + + Congrats on a great quarter and a great fiscal year. Amy, a question for you. You commented on the positive spread that you're seeing in the Windows OEM business, both overall but particularly on the commercial side. When you start to think forward over the next, call it, couple of quarters here, obviously, you told us what the positive drivers were. But how do you see those sort of playing out? And can we maintain that positive spread? And if so, why? And if it does maybe narrow, just sort of how do you think about the narrowing? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Sure. Let me frame it first as the things that I and we are seeing really customer-driven, which is, if you start with Windows 10 and the value that customers see and what we are seeing is accelerating enterprise deployment of Windows 10. When that happens, it does create demand for new devices and modern devices that improve security. So that then, in turn, results in a better and stronger overall OEM PC commercial market. +In addition, because the macroeconomic conditions are actually quite good on this front and with some business optimism creating some wind at our back, I also think people look and say, "If security and value are important, this is a great time to invest in modern PCs." And particularly in markets where Pro mix has been strong, I continue to expect to see all of those things happen through the course of next year. +Now what you will see, however, if all those things even do remain true, which I expect them to if the economic environment stays the same, H2, where we've had really strong revenue growth and a really strong market, will, I think, moderate growth-wise just because the base it was coming off of in '17 was just a lot lower. So even if I see all the good things and good trends happening that I feel really create a great opportunity for us to sell Microsoft 365, you will see growth rates moderate in H2. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [22] +-------------------------------------------------------------------------------- + + Amy, can I go back to the server product? You partly answered it with the -- when Heather asked, and I believe hybrid cloud will be a factor here. But the growth was the best we've seen for a long time. Can you just talk about the drivers that kind of were at play here? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- + + Thank you. You're right. The first one was the benefits that we saw from hybrid, in particular, with an outsized impact on Windows Server. The second has been a trend we also have talked about a little bit before. We saw strong double-digit growth in premium. So it was both mix shift as well as, I think, strength in the hybrid benefits as a value prop to customers. Those 2 are the ones I would actually call out as drivers for the quarter. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [24] +-------------------------------------------------------------------------------- + + Good. I mean, they should be relatively sustainable if I listen to them -- to you. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + I believe the one, I think, really important thing for us is continuing to focus on creating customer value. The concept of adding a lot of value by having and giving comfort to a customer that as they make a commitment to the Microsoft platform, that they can move between a commitment to on-prem to the cloud in a high value way, I do believe, is a unique thing that we offer at this time. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Gregg Moskowitz with Cowen and Company. + +-------------------------------------------------------------------------------- +Gregg Steven Moskowitz, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + Satya, this is more of a big picture question but over a longer-term period, I'm curious how large you think edge computing will become relative to centralized cloud computing. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes, I mean, I think, the vision that we have always had is that distributed computing, in some sense, will remain distributed. So we don't split this into there's an edge computing, there's a cloud computing. The need for computing is, on a secular basis, going to increase. And as you need to reason over large amounts of data, you need not only storage and compute to be colocated all over as the world gets embedded with computing. That's what we are building for. +So if you think about our real competitive advantage and differentiation is, we have one programming model, one identity model, security, management so that modern developers as well as IT can use the compute available from Azure Sphere to Azure. And the reality is these modern workloads, in fact, use it all. So it's not like I just build an Azure Sphere application. I build an application that's fundamentally distributed that also happens to run some compute on Azure Sphere. That's, I think, the future, which is distributed computing going back to what needs to be truly distributed, event-driven, server-less even versus this thing about let's just have onetime migration to something new. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question is coming from the line of Keith Bachman with Bank of Montreal. + +-------------------------------------------------------------------------------- +Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [30] +-------------------------------------------------------------------------------- + + Satya, I wanted to direct this to you, if I could. I'd like to understand how you view Dynamics' current positioning compared to the market opportunities? And the context of the question is Dynamics remains a fairly small part of Microsoft revenues. As well, if you look at the market share of where Dynamics serve, it's a fairly small part of the market served. So what do you think Microsoft needs to do to have a larger impact against the market opportunities? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Yes. So overall, we are very committed and very bullish about the opportunity in Dynamics. With Dynamics 365, for example, what you've even just seen in the last fiscal year, which has been the first full fiscal year where we've had this modern modular approach to business applications. I think it's very disruptive in the marketplace because it brings a very different value proposition. It has a price advantage and a value advantage for customers and in what is fundamentally a fragmented market, this is not business applications, never was and never will be a winner-take-all. I know folks think about it that way, but it's not. I mean, it's about one small category in one segment called enterprise. There is a share. High share is considered 20%, 35% or what have you. +So in some sense, this one has always been about being able to serve customers, especially in an increasing digitization world, right, which is the need for more business process automation is increasing. Take an IoT project, it translates into a preventive maintenance in Azure and then ends up as field service in Dynamics. That's been one pattern we've seen a ton of traction with. So to me, us going, in fact, to these new secular growth opportunities while being disruptive to the status quo of anyone who has high margin and very high-priced monolithic products today is basically our strategy going forward. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our final question is coming from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [33] +-------------------------------------------------------------------------------- + + I will add my congrats. So Amy, we keep expecting the Office 365 commercial seat growth to decelerate materially at some point based upon the penetration level. But this quarter, that seat growth actually accelerated about 1 point to 29%. And when we look back on it, the trajectory really isn't too different than where it was even a year ago. So I'm just curious, is there some underlying driver there that would keep that deceleration relatively manageable going forward? Or would you continue to see that slowing in a way that, over time, would exert a little drag on Azure through those per user Azure services? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [34] +-------------------------------------------------------------------------------- + + This is one where, over time, there certainly is going to be a deceleration just because this is a per user business. M365 has that characteristic and Office has it, EMS has it. And so this quarter, actually, what we saw was actually some strength in education which added a good amount of seats this quarter as well as good execution across our other segments. So we did see a bit of growth that we're excited to see, frankly, in a segment where we've been working hard to make additional progress and add value. The team has actually done a nice job in that segment of creating some really modern offers to get that into the hands of that market as well. +But over the long term and as we continue to move aggressively, we will continue to see seat growth dissipate. But I would also say, this is going to take longer than I think maybe people would have thought. There are lots of users as we continue to redefine what Office is that you add to the base, whether that's first-line workers, whether that's an increasing number of small businesses who finally have access and value that we're creating for them across things from scheduling all the way to being able to work through minor business process adjustments like Satya has talked about. +So really, as we continue to redefine what Office means from something that people have always associated with Word, Excel and PowerPoint to things that mean mobile or video with stream or collaboration with Teams, I think we have opportunity to continue to add those new users, new types of users that we haven't had access before and new capabilities even to users we have. + +-------------------------------------------------------------------------------- +Michael Spencer, - [35] +-------------------------------------------------------------------------------- + + Great. Thanks, Mark. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today and we look forward to speaking with all of you soon. You can find additional details at the Microsoft Investor Relations website. Thanks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [38] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2018-Oct-24-MSFT.txt b/Transcripts/MSFT/2018-Oct-24-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..5ec9ac00b97f7048aaabeb4a106ef8867a8ffa64 --- /dev/null +++ b/Transcripts/MSFT/2018-Oct-24-MSFT.txt @@ -0,0 +1,419 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Microsoft Corp Earnings Call +OCTOBER 24, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Ross Stuart MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Jennifer Alexandra Swanson Lowe + UBS Investment Bank, Research Division - Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Brad Alan Zelnick + Crédit Suisse AG, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Microsoft Fiscal Year 2019 First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mike Spencer, General Manager, Investor Relations. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Carolyn Frantz, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides reconciliation of differences between GAAP and non-GAAP financial measures. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing our underlying business performance, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we'll be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. We're off to a very strong start in fiscal '19, delivering record revenue and profit. Every organization today needs tech intensity to compete and grow in an increasingly digital world. +There are 2 aspects to this. Think of it as a simple equation. First, every organization needs to be a fast adopter of best-in-class technology. Second, they'll need to build their own proprietary digital capability. Our cloud platforms and tools enable our customers to build tech intensity while ensuring we're addressing their tough questions around trust, both trust in technology and trust that they have a partner whose business model is aligned to their success. No customer wants to be dependent on a provider that sells them technology on one end and competes with them on the other. Getting this equation right is key to their success going forward. Microsoft is uniquely positioned to help. +Now I'll briefly highlight how we're innovating across our solution areas. A little over a year ago, we introduced Microsoft 365 to help organizations of all sizes empower their employees in the modern workplace. Today, it's a multibillion-dollar business that gives our customers a path to the cloud and broadens our reach with new and underpenetrated markets. Customers from large multinationals like Eli Lilly to Rio Tinto first-line field workers to small businesses are all choosing Microsoft 365. +Cybersecurity is a central challenge. Microsoft security differentiation is based on 2 things: first, our unparalleled operational security posture; second, our comprehensive product suite spanning identity, information, application and device protection. We analyze more than 6.5 trillion signals each day, process 4 -- 50 billion authentications monthly and scan 400 billion e-mails for malware and phishing each month. These massive signals generate insights that fuel security innovations for customers. New capabilities in Microsoft 365 detect, investigate and remediate sophisticated cybersecurity threats across every endpoint, saving IT professionals thousands of hours. +Microsoft Security Score gives organizations a dynamic report card on their security posture. In identity management, Microsoft is already a leader with Azure Active Directory, and we are innovating with new capabilities to eliminate passwords for the hundreds of thousands of Azure AD-connected apps that businesses use every day. +The future of productivity and collaboration will be defined by AI innovation. And new AI-driven features across Microsoft 365 from automated slide design to proactive Cortana reminders to enhanced search experiences and real-time meeting transcription to org analytics are all augmenting human capability, making it easier for people to focus on what matters most. +Another differentiator is Microsoft Teams. Microsoft Teams is the only enterprise-grade solution that brings together messaging, video conferencing, meetings and web-based collab into a single integrated user experience scaffolding. It eliminates the need for discrete single-point solutions that only increase an organization's security and compliance exposure. Customers recognize this value. Teams is now the hub for teamwork for 329,000 organizations, including 87 of the Fortune 100. And we are adding automated translation support for meetings, shift scheduling for first-line workers and new industry-specific offerings, including health care and small business. +Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system, and more than half of our commercial device installed base is now on Windows 10. Surface continues to set the bar for the industry for -- with 5 new category leading Surface devices, including the new Surface Go. Microsoft 365 and Surface are inspiring our OEM ecosystems to innovate, and we have the strongest line of devices going into the holiday season. +Moving to business applications. AI-powered digital feedback loops that connect products, operations, customers and employees to create predictive power, automate workflows and ultimately, improve outcomes are key to all organizations. Dynamics 365 uniquely addresses this need. We expect Dynamics to deliver more than $2.5 billion in revenue this year with half of that total coming from Dynamics 365. And this quarter, we introduced Dynamics 365 AI, a new class of AI applications built for an era where the systems of record and engagement are converted into intelligence. +Dynamics 365 mixed reality digitizes the physical spaces and interactions. Companies like Chevron and ZF Group are already using it to transform training and design for their first-line workers. And H&M, the world's second-largest clothing retailer, is relying on Dynamics 365 to digitize its critical business processes. +These customers and others recognize the advantage of our modular extensible approach over the traditional SaaS model of monolithic suites or siloed apps. And our investments in our analytics and application platform spanning Power BI, Power Apps and Flow are driving momentum with customers and have made us a leader in no-code app building and business analytics in the cloud. +Our open data initiative, a strategic partnership with Adobe and SAP, takes this even further, delivering on our vision of one unified data model to provide unparalleled business insight from behavioral, transactional, financial and operational data. Together, we'll enable data to be exchanged and enriched across systems, making it a renewable resource that enables new intelligent customer experiences. +LinkedIn continues to be an essential platform to connect the world's professionals with sessions growth of 34% year-over-year and record levels of messages sent and content shared. We're innovating with new experiences that leverage the LinkedIn and Microsoft Graphs such as the ability to e-mail LinkedIn connections directly from Microsoft 365. Strong engagement across the platform is fueling demand for sponsored content and marketing solutions and Talent Solutions, which saw record job postings again this quarter. +Talent Insights is a new self-service analytics solution that gives HR professionals competitive intelligence and labor market trends for an increasingly competitive jobs market. And the pending acquisition of Glint brings employee insights alongside LinkedIn's workforce insights to create a powerful solution to help customers attract, retain and develop the best talent. +Now turning to Azure. Customers from multinationals like Volkswagen, Anheuser-Busch InBev, MasterCard to fast-growing startups like Grab are recognizing the architectural advantage of a consistent computing stack from the cloud to the edge. Azure is the only hyperscale cloud that extends to the edge across identity, data, application platform as well as security and management. We introduced 100 new Azure capabilities this quarter alone, focused on both existing workloads like security and new workloads like IoT and edge AI. With Azure Confidential Computing, Azure is now the first cloud to provide a secure platform for protecting the confidentiality and the integrity of data while in use, adding to our existing security protections to encrypt data in transit as well as in rest. +Every company needs a strategy to take advantage of the billions of IoT devices entering the market each year. Azure Sphere, our end-to-end solution for securing microcontroller-powered devices, is now broadly available and seeing strong customer interest. Azure Digital Twins is a new service that models relationships and interactions across people, places and devices. +We're investing to make Azure the best cloud for enterprise data. Our data services spanning SQL Database, Cosmos DB, Data Warehouse and Data Lake provide the most comprehensive data platform needed for enterprise data estates. Azure ML builds on this foundation to further democratize data and AI to unlock insights, helping data scientists build and train AI models faster, then deploy them with the -- through the cloud or to the edge. +Across industries, our customers and partners are using services like these to transform. BMW introduced an agent to redefine how people interact with their cars. Bühler, which processes 65% of the world's grain, is relying on Azure Cognitive Services to improve food safety. Shell is applying AI across its enterprise to optimize deal productivity and keep workers safe. And this week at Sibos Conference, the Microsoft Cloud is front and center, powering financial services transformation for organizations such as SWIFT, which is enabling secure payment transfers on Azure. +Finally, our pending acquisition of GitHub, which we expect to close shortly, recognizes the increasingly vital role developers play in value creation and growth across every industry. I'm excited about the opportunity to bring our tools and services to new audiences while enabling GitHub to grow and retain its developer-first ethos. +Now I'll turn to gaming. We continue to broaden our reach with more than 2 billion gamers worldwide and expand our opportunity from the way games are distributed to how they're played and viewed. We are investing in content, community and cloud services across every endpoint to expand usage and deepen engagement. First-party content is key to our approach, and we now have 11 Game Studios in our portfolio to deliver differentiated content for our fast-growing services like Game Pass. Xbox Live now has 57 million monthly active users, and Mixer usage growth is accelerating. This loyal high-value community is our strongest asset, creating expanding opportunity for monetization of first- and third-party games. Fortnite is a good example of that, and all up, we are seeing record software and services revenue and engagement being driven on our platform. +Earlier this month, we announced Project xCloud, a breakthrough game streaming technology that puts gamers at the center of their gaming experience, enabling them to play games in high fidelity wherever and whenever they want on any device. And it will empower game developers to scale through hundreds of millions of new users across devices. It's early days, but I'm excited about our road map. +Across our businesses, we are accelerating innovation, picking the right secular trends, investing in large growing markets, many of which are still in their infancy. Additionally, every one of our solutions is reinforcing our core intelligent cloud and intelligent edge platform. Not only are we optimistic about the opportunity for us and for our customers, we also recognize our responsibility. +We were one of the first companies in the United States to require suppliers doing substantial business with us to provide paid time-off for their employees. And this quarter, we took a further step to ensure that these suppliers also provide their employees with paid parental leave. We're ensuring that our enterprise-class security innovation not only helps our largest customers but also protects small businesses and consumers who are often the most vulnerable to attacks. +Finally, we are putting AI into the hands of change-makers to address society's most pressing challenges with initiatives like AI for Humanitarian Action, which supports critical disaster recovery efforts around the world and more. This recognition of our broader responsibility, coupled with our bold innovation, makes me incredibly optimistic about our opportunity ahead. +With that, now I'll hand over to Amy, who will cover our financial results in detail and share our outlook, and I look forward to rejoining you after for questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $29.1 billion, up 19% and 18% in constant currency. Gross margin dollars increased 18%. Operating income increased 29% and 28% in constant currency, and earnings per share was $1.14, increasing 36% and 33% in constant currency. Another quarter of double-digit revenue and operating income growth drove a record start to the fiscal year. We saw strength across each of our segments with strong sales execution by our partners and sales teams. Customer demand for our hybrid and cloud offerings drove the quarter, and we continued to benefit from favorable macroeconomic and IT spending trends. +Now to our commercial business. As a reminder, starting this quarter, the commercial portion of LinkedIn is included in these metrics. Our commercial annuity -- our commercial revenue annuity mix increased 1 point year-over-year to 90%. Commercial unearned revenue was $27.3 billion, growing 22% and 21% in constant currency, in line with expectations. +On an expiry base that was roughly flat year-over-year, commercial bookings were better than expected and increased 15% and 16% in constant currency, benefiting from larger long-term Azure contracts, growth in Azure consumption overages and pay-as-you-go contracts and strength in on-premises revenue. These contract types impact bookings, reported revenue and unearned revenue in different ways. Let me explain. +First, under ASC 606, hybrid and on-premises offerings drive bookings growth and more in-period revenue recognition. Therefore, there's less impact on unearned revenue. Second, growth in Azure consumption overages and pay-as-you-go contracts drive bookings growth and in-period revenue but have little impact on unearned revenue. And finally, long-term Azure contracts drive significant bookings growth but have a smaller impact on in-period revenue and unearned revenue. The inclusion of LinkedIn results was immaterial to the growth rates of commercial unearned and commercial bookings. +Commercial cloud revenue was $8.5 billion, growing 47% and 46% in constant currency with strong performance in the U.S., Western Europe and the U.K. Commercial cloud gross margin percentage increased 4 points to 62%, driven again by significant improvement in Azure gross margin. +Company level, gross margin percentage was 66%, down slightly year-over-year with sales mix shift to gaming and commercial cloud. FX increased overall company and Productivity and Business Processes revenue by 1 point, in line with guidance. The impact to Intelligent Cloud and More Personal Computing revenue was immaterial, 1 point less favorable than expected. FX impact was immaterial to COGS and operating expenses, about 1 point less favorable than expected. Even with that headwind, operating expenses grew 8%, in line with expectations. +Our engineering and sales capacity investments in large growing markets continue to deliver differentiated value for our customers while generating material operating income leverage. This quarter, we increased operating margin nearly 3 points year-over-year. +Now to segment results. Revenue from Productivity and Business Processes was $9.8 billion, increasing 19% and 18% in constant currency, ahead of expectations, driven by both the on-premises and cloud businesses. Office commercial revenue grew 17% and 16% in constant currency, driven by continued Office 365 commercial growth and approximately 3 points of growth from increased demand ahead of a price increase with the launch of Office 2019. +Office 365 commercial revenue grew 36% and 35% in constant currency with installed base expansion across all customer segments and ARPU growth as customers shift to E3 and E5 workloads. Office 365 commercial seats grew 29% and, in line with last quarter, benefited from strong performance of our Microsoft 365 academic offers. +Office consumer revenue increased 16% and 17% in constant currency, driven by growth in Office 365 subscription revenue and approximately 5 points of growth from increased channel demand ahead of a price increase with the launch of Office 2019. Office 365 consumer subscribers grew to 32.5 million. +Dynamics revenue grew 20%, including a few points from a greater mix of contracts with higher in-period recognition under ASC 606. Dynamics 365 grew 51% and 49% in constant currency. +LinkedIn revenue increased 33% with strong execution across all businesses. Segment gross margin dollars grew 18% and 17% in constant currency, and gross margin percentage declined slightly year-over-year as cloud mix offset LinkedIn and Office 365 margin expansion. Operating expenses increased 7% and 8% in constant currency with ongoing investments in LinkedIn, cloud engineering and commercial sales capacity to support top line growth. Operating income increased 29% and 27% in constant currency. +Revenue from Intelligent Cloud was $8.6 billion, increasing 24%, better than anticipated driven by demand for our hybrid offerings. Server products and cloud services revenue grew 28%. Azure revenue increased 76%, in line with our expectations with strong growth across both consumption and per user base businesses. Our on-premises server business grew 10% and 9% in constant currency, driven by continued demand for premium versions and hybrid solutions as well as increased demand ahead of Q2 price increases for certain versions of our server products. +Enterprise Services revenue grew 6% as growth in premier support services and Microsoft consulting services was partially offset by a decline in custom support agreements for Windows Server 2003. Segment gross margin dollars increased 28% and 27% in constant currency. Gross margin percentage increased year-over-year as material improvement in Azure gross margin percentage offset the growing mix of Azure IaaS and PaaS revenue. Operating expenses increased 19% and 20% in constant currency, driven by ongoing investments in cloud and AI engineering and commercial sales capacity. Operating income grew 37% and 35% in constant currency. +Now to More Personal Computing. Revenue was $10.7 billion, increasing 15% with significantly better-than-expected results in gaming. Gaming revenue increased 44% and 45% in constant currency with better-than-expected results across both software and services and hardware. +Xbox software and services revenue grew 36% with continued strength from a third-party title. Xbox hardware revenue grew 94% and 96% in constant currency with earlier-than-expected sell-in of holiday hardware bundles. +In Windows, we saw healthy Windows 10 commercial deployments as the OEM ecosystem continued to benefit from customer demand for modern and secure software and hardware. OEM Pro revenue grew 8%, a few points ahead of the commercial PC market from a higher mix of premium licenses. Windows commercial products and cloud services revenue increased 12%. In consumer, OEM non-Pro revenue declined 5%, below the consumer PC market with continued pressure in the entry-level price category. Inventory levels were within the normal range. +Search revenue ex TAC increased 17%, driven by Bing rate growth and increased volume in U.S. and international markets. In Surface, revenue grew 14%, driven by Surface Book 2 and Surface Go. Segment gross margin dollars grew 10%, and gross margin percentage decreased due to sales mix to our lower-margin gaming business. Operating expenses declined 1%. As a result, operating income grew 23%. +Now back to our total company results. As expected, capital expenditures, including finance leases, were up sequentially to $4.3 billion, driven by ongoing investment to meet demand for our cloud services. Cash paid for property, plant and equipment was $3.6 billion. +Free cash flow was $10.1 billion and decreased 2% year-over-year due to higher capital expenditures in support of our cloud business. Cash flow from operations increased 10% year-over-year with strong cloud billings and collections partially offset by our first annual TCJA payment of $1.5 billion. Excluding the TCJA payment, free cash flow grew 12% and operating cash flow grew 22%. +Other income was $266 million, higher than anticipated, due to realized gains and the recording of mark-to-market gains under the new accounting rules for financial investments. Our effective tax rate was 14%. As a reminder, Q1 and Q3 rates are impacted by the volume of equity vests during those quarters. This Q1, the impact was a bit more than expected due to the movement of our share price within the quarter. And finally, in line with our continued commitment, we returned $6.1 billion to shareholders through dividends and share repurchases, an increase of 27% year-over-year. +Now let's turn to our outlook. Given that we expect the GitHub acquisition to close shortly, my commentary includes the full impact of the deal, including purchase accounting, integration and transaction-related expenses based on our current understanding of the purchase price allocation and related deal accounting. We continue to expect the deal to be minimally dilutive to FY '19 and FY '20 EPS on a non-GAAP basis and accretive to FY '20 operating income on a non-GAAP basis. +For Q2, first, FX. Assuming current rates remain stable, we expect no impact to revenue growth. FX should decrease COGS and operating expense growth by approximately 1 point. +Second, our commercial business. We expect another quarter of healthy performance with solid bookings growth. Commercial unearned revenue is expected to grow approximately 19% year-over-year even with the ongoing shift toward the cloud contracts discussed earlier. Commercial cloud gross margin percentage should continue to improve on a year-over-year basis though at a more moderated rate than prior years given the continued mix of revenue toward Azure consumption-based services. Margin improvement will continue to vary on a quarterly basis driven by revenue mix, seasonality and the timing of infrastructure spend. +Third, we expect ongoing year-over-year growth in capital expenditure as we support growing demand. Given infrastructure spend timing, Q2 CapEx should be roughly in line with Q1. +Now to our segment guidance. In Productivity and Business Processes, we expect revenue between $9.95 billion and $10.15 billion. Office commercial and Dynamics should continue to exhibit double-digit growth, driven by strong cloud performance but with some moderation due to the on-premise drivers discussed earlier. Office consumer will see continued momentum in new subscribers but overall revenue growth will be negatively impacted as channel inventories normalize. LinkedIn revenue growth should remain healthy though on a stronger prior year comparable. +For Intelligent Cloud, which includes GitHub, we expect revenue between $9.15 billion and $9.35 billion. In Azure, we expect healthy growth across our consumption and per user base businesses, though per user services growth will moderate given the size of the installed base. +In More Personal Computing, we expect revenue between $12.8 billion and $13.2 billion. OEM Pro revenue growth should be in line with the commercial PC market. As a reminder, prior year comparables strengthened throughout the remainder of the year. In Windows commercial products and cloud services, we expect continued strength as well as the benefit of a low prior year comparable. And for OEM non-Pro, we expect similar dynamics to Q1. +In Surface, revenue growth should accelerate with the impact of recently launched devices, including Surface Pro 6 and Surface Laptop 2. Search ex TAC results should be similar to Q1 with durable growth in rate and volume. +In gaming, we expect revenue growth to moderate due to a prior year comparable that included the launch of Xbox One X. Software and services growth should be similar to Q1 with continued benefit from a third-party title plus overall platform strength. +Now, back to our company results. We expect COGS of $12.2 billion to $12.4 billion and operating expenses of $9.8 billion to $9.9 billion. Other income and expense should be approximately $50 million as interest income and investment gains are partially offset by interest expense. And finally, we expect our Q2 effective tax rate to be slightly above the full year estimate of 17%. +Now a few comments on the fiscal year. First, FX. Assuming current rates remain stable, we expect a 1-point headwind to full year revenue growth with any benefit in H1 offset in H2. FX should decrease COGS and operating expense growth by approximately 1 point. +Second, operating expenses. We remain unchanged in our commitment to invest in strategic priorities that are key to driving long-term value creation. With the addition of GitHub as a strategic priority, we now expect operating expenses to grow roughly 8%. Growth, excluding GitHub, is expected to be in line with our prior guidance of roughly 7%. +Third on operating margin. Even with the full GAAP impact of GitHub purchase accounting now included in our guidance, we continue to expect our operating margin to be up slightly year-over-year. Margin leverage is a direct result of our focused investments in the right technology trends coupled with consistent execution. +For CapEx, we continue to expect the growth rate for the year to moderate, even as we meet demand for our cloud services. Regarding the GitHub acquisition, we remain committed to an incremental share buyback beyond the normal quarterly pace that is expected to fully offset stock consideration issue in the transaction by the end of the fiscal year. And finally, we continue to expect the full year effective tax rate to be roughly 17% with quarterly variability. +And with that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question is coming from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [2] +-------------------------------------------------------------------------------- + + Amy and Satya, if I look at your Intelligent Cloud segment, and in particular the server products and cloud services, those continue to defy gravity a little bit here. And I'm just wondering if you could just give us a sense of how much maybe the pricing changes that went into effect at the beginning of the quarter that you're in now might have helped drive spending last quarter ahead of them going into effect. But also, can you share with us how the Azure Hybrid Benefit message might also be impacting Azure growth rate? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure. Thanks, Heather, for the question. I'll start and then, Amy, you can add. I mean, I think what you're fundamentally seeing in that overall KPI is what I think our 2 major advantages we have. One is an architectural technology advantage around hybrid, right? So we don't think of hybrid as some stopgap as a move to the cloud. We think about it's the coming together of distributed computing, where the cloud and the edge work together for not just the old workloads but most importantly, for new workloads. And that's where we're seeing some very significant good feedback loops and shaping even our future road map. And this is a place where we're leading. The second thing, as you pointed out in your question, is we have a business model advantage. The Azure benefits are things both for Windows Server as well as for SQL, which I think are very, very unique to us, and you see that. So the combination of the technology advantage and the business model advantage is what I see in the results, whether it's the stand-alone Azure growth, which is what we expected, and it's very strong. And the server KPI is even stronger. So I think that's at least how I would answer that question. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And to your specific question, Heather, on the impact of some of the price increases that went into effect in Q2, I'd say it's a couple of points, so I would not sort of over-rotate on that topic. The overall number, even if you take a couple of points off that 28%, is a very good performance, I believe, to Satya's point, is the impact you've seen of the very aligned technology road map on the architecture plus the business model that matches it. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [6] +-------------------------------------------------------------------------------- + + I wanted to dig into capital efficiency here around your cloud assets a little bit. This quarter, you talked about Azure gross margins coming in sort of -- continuing to improve really nicely. CapEx came in, I mean, the growth there is slowing a little bit. Can you talk to us about sort of what's kind of driving that? Is it sort of the move to higher-level services? Do you get like better pricing against the capital? Is this sort of you're just not sort of pouring down as much cement, if you will, in terms of data expansion? Is it like better productivity of the core sort of compute stuff? Like can you help us understand sort of how capital intensity is trending in that -- Azure in particular but more broadly in the cloud businesses? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- + + It's a great question, Keith. I would say the way we think about our capital efficiency and I, in fact, added that even to my commentary this time, which is we're building this intelligent cloud, intelligent edge platform to span everything, not only the Azure business but also the future of game streaming to what we are doing at Microsoft 365 or Dynamics 365. For the first time, what you see across Microsoft is really one platform, which spans all of these businesses and all of the margin structures that are there represented in it. So that's where, if you think about the thing that Amy and I focus a lot on is the capital efficiency end to end in that context versus getting caught up in even the capital efficiency as measured by any one of these individual pieces because we think that's what Microsoft's uniqueness long term lies. But that said on Azure, you're absolutely right. What you are seeing is 2 things: One is things like the Azure Hybrid Benefits as well as the higher-level services that create, I think, both uniqueness as well as good margins long term. I mean, especially on the database side is one place where I would say from a year-over-year worth of progress, whether it's just Azure database by itself, I mean, that service with full compatibility with SQL Server is a fantastic value proposition for our customers who have huge estates, whether it's the Data Warehouse that's become very, very competitive, the Data Lake. And Cosmos DB, I think, is very unique in its capability. So that's one place where -- as you know, any AI project first starts with data, and that's one place where we are seeing good traction. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Philip Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [9] +-------------------------------------------------------------------------------- + + I just wanted to focus in on Office. Obviously, Amy, you called out some of the positives from the price increase that's coming up. But if I look at just Office 365, both commercial and consumer, just continued just strong growth on both those 2 and especially on the commercial side, there's still that gap between seat growth and revenue growth. So if you kind of just think where you are and I guess, in terms of just sort of the life cycle here and obviously, we've got multiple SKUs, maybe just kind of give us an update of how sort of you're thinking about where you stand and especially as you think about the full year here, how you sort of expect these metrics to progress. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + Sure, and I'm actually going to expand my comments a little bit because the sales motion is really broader than Office 365. The sales motion is really about Microsoft 365. And what that encompasses is both the Office 365 value proposition but also our management and security value proposition with EMS as well as Advanced Threat Protection and Windows value that shows up in that Windows commercial services KPI. So the bucket of those together, what we're seeing, is many of the workloads and movement to E3 within Microsoft 365 and to E5 continue to have good pull. There's great customer demand for the value that comes in security and analytics, in meetings, in voice, in collab. And I think when you look at the value, I think we feel good about the opportunity to continue to move these users, including new first-line or frontline users that we've not had access before. We got room on user growth, which as you -- you continue to see that number go up across segments. And we've got room in ARPU, which you've continued to see us have. So in many ways, your question shows itself in Office but the trends are the same if you look at EMS growth or if you were to look at that Windows commercial growth number. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [11] +-------------------------------------------------------------------------------- + + And I'd just add that the seat growth as well as the ARPU growth, one of the things, even in spite of the success we may have achieved in the past, we never were that successful in penetrating with all of our workloads when it comes to small business and definitely across the globe. So that's another dimension that you see play out as well. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [13] +-------------------------------------------------------------------------------- + + Satya, can you focus on gaming for a little bit? With the xCloud, you kind of announced something that the whole industry has kind of been dreaming about as like the Holy Grail where you want to go, eventually have it all in the cloud, deliver from the cloud, and subscription driven. Can you talk a little bit about the innovation that is involved in you being able to -- starting to deliver that now? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [14] +-------------------------------------------------------------------------------- + + Sure. But before I get to streaming, the thing that I'd say is most critical when you think about gaming is having a platform where the gamers are already there. That means you need to have a platform that has a community around it and monetized as well. So when you see some of the KPIs and some of the strength you saw in quarter, that's the foundation of Xbox. Xbox has the key gaming community and the monetization capabilities. Whether it's first-party games or third-party games, we are best in class in that monetization, and that's what's reflected in the results. So given that structural position, we are going to make sure that we keep increasing the strength of the community. You see that already with Minecraft going to all platforms and that increasing the intensity of the community, and you'll see us do more of that. Obviously, bringing Game Pass to even the PC is going to be a big element of that. And then streaming is just a natural sequence of it. And the advantage we have with streaming is we have a massive cloud advantage. And so we're going to bring obviously what we're doing with Azure, Azure networking all to bear in ensuring that Xbox and xCloud is one of the best workloads for it. So that's how I see it. It, of course, will increase our reach, but what I'm most excited about is the core content and community and the platform we have for monetizing that usage. And that, I think, is really what gives us even the permission to think about streaming. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question is coming from the line of Jennifer Lowe with UBS. + +-------------------------------------------------------------------------------- +Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [16] +-------------------------------------------------------------------------------- + + I know you mentioned GitHub's closing soon. It's obviously not closed yet. But given you've got a few months under your belt now since it was announced and an opportunity to solicit some feedback from the developer communities that maybe aren't using Microsoft technologies on a regular basis but are very active with GitHub, do you have a sense yet of what the opportunities might be to do outreach to those developers that might be working closely with competing platforms and how closely you can kind of hug them into the Microsoft ecosystem versus just leaving GitHub as sort of a self-sustaining entity now that you have a little bit more opportunity to discuss that with customers in the field? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [17] +-------------------------------------------------------------------------------- + + Sure. First of all, thank you for the question. We're very excited about GitHub closing, and quite frankly, primarily I'm excited because, for us, is that what we said, GitHub is not a means to some other end. It's an end onto its own, which is we have always cared about developer and developer productivity and especially at a time like this when there are more developers outside of the tech industry as the world goes digital. We think this is perhaps one of the big SaaS opportunities going forward. And so therefore, that's why we want to ensure that everything we do and the #1 priority for Nat and team at GitHub will be all about maintaining that GitHub community, the ethos around developers at the core. That said, I think we will do what is necessary to make sure that our products and services that are on Azure or elsewhere, our tooling, which are already many open source projects on GitHub, we do a good job of earning that developer trust and developer adoption. But we are very grounded in the fact that it has to be earned and not something that we will inherit because of being owners of GitHub. +The second thing I'll also mention is that, to me, the opportunity to win, I would say, new class of developers, we are making progress. In fact, this morning, I was reading a news article in Hacker News, which is a community where we've been working hard to make sure that Azure is growing in popularity, and I was pleasantly surprised to see that we made a lot of progress. In some sense, that at least basically said that we are neck to neck with Amazon when it comes to even elite developers as represented in that community. So we have more work to do, but we are making progress on all dimensions. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Brad Zelnick with Crédit Suisse. + +-------------------------------------------------------------------------------- +Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [19] +-------------------------------------------------------------------------------- + + Amy, in your comments, you cited the continued benefit from a strong IT spending environment, and it's very clear from your results there's a lot of Microsoft-specific success and execution happening here as well. But as you look at your pipelines and all the various signals you see in the market, do you have a view on how long the environment persists? And what are the indicators that give you confidence? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Thanks, Brad, for the question. In general, the way I tend to look at this is the interactions we have with customers and the markets we're in and do we feel like they're expansive. And so when I look at the businesses that we built and the businesses we're investing in and do I feel like this need for tech intensity that Satya talked about that will ultimately drive the desire and need for customers to adopt technology, we're in the right places. And that's the signal actually we hear back from customers, whether that is Microsoft 365, Dynamics 365 and a new worldview on what business processes and business applications look like. Whether it's, frankly, our views on gaming that Satya just discussed, I feel like the signal we're hearing is that we're in the right part of the market with customer-focused value that can deliver a high ROI to them no matter what that IT budget looks like. And so I think as long as we focus on providing that value, we'll feel good about our opportunity to both grow and take share in the market. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [22] +-------------------------------------------------------------------------------- + + Amy, I'm wondering if you could talk about Azure, the outlook for the year. I know growth rate's been a bit volatile. I think you had a pretty strong Q4, including bookings in that business. Maybe you can help us understand relative to growth we're seeing right now how you expect the Azure trajectory to play out for the year? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- + + Sure, let me spend a couple of minutes on that. We actually saw better bookings in Q1 again on Azure, as I mentioned, just like we did in Q4. And so obviously, that's certainly encouraging as we look on a go-forward basis for the rest of the year. But as I think about -- I tend to focus, as you know, on the all-up server and product KPI because the Azure Hybrid Benefits that exist with Windows Server and SQL Server are really valuable to customers if they want to move to Azure on their own terms, it is the single best value proposition to a customer to make a commitment there. And so if we start to focus on one number or the other, I think we're missing the fact that our customer method and go to market is actually through the overall product portfolio. And so I tend to probably, as you might imagine, be more confident than I was in coming out of Q4 with a strong Q1 in that overall hybrid demand and Azure signal plus good Azure bookings when I talked about my confidence in high-teens growth in that KPI for the rest of the year. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question is coming from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [25] +-------------------------------------------------------------------------------- + + Amy, last quarter, you mentioned that you could see increased volatility in time in commercial bookings growth as you were talking about the commitments were increasing to larger and longer-term agreements. But this quarter, the expiry portfolio was flattish, and yet your commercial bookings grew 16%. I think presumably, a very powerful performance with the renewals, the expansions and the new bookings. And I don't think you repeated that comment about bookings volatility in the same way. So I'm just curious, maybe could you help us connect the dots on that performance and also the potential for volatility in either direction going forward? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + Sure, thank you. That's a great question. You will see volatility in the bookings number for the reasons we've laid out before, the changing expiry base but also large contracts and commitments done by Azure. And to your point, we actually saw it this quarter because we again saw quite good performance in some of these larger long-term Azure contracts, which added on a flat expiry base to that 15% bookings growth, which was good. And so what that means is you'll see some volatility in that, and you're also going to see some volatility in commercial unearned, specifically because whenever you see hybrid strength, it won't land as much in unearned. So when we -- as the business gets bigger and we do bigger and larger deals and some of them are on-prem and some of them are in Azure, you're going to see volatility, frankly, in both of those. But what I tried to do is think about the impact of all the key data points, which is how do we do in quarter, how do we do on the unearned revenue on the balance sheet and how do we do in overall bookings. And if I triangulate between all those 3 just like I did in Q4, I feel really good about our commercial performance. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + The next question is coming from the line of Ross MacMillan with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross Stuart MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [28] +-------------------------------------------------------------------------------- + + Maybe 2 for Amy. Just first on that KPI of Azure plus server products, that high teens number was obviously a lot better this quarter. But is that still the framework for the year? +And then actually on Windows, we've seen such elevated strength on the Pro side, I think, because of the corporate Win 10 cycle, and I wondered if you could just -- as we think about the back half of the current fiscal year and we come up against some tougher comps, I wondered if you could just help us sort of think through that and how we should think about the puts and takes on that refresh cycle. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [29] +-------------------------------------------------------------------------------- + + Sure. On the first question on the server and product KPI, obviously, the strong performance this quarter gives me higher confidence in my commitment to high teens growth in that number. But I'll update that generally longer in the quarter and will get me through Q2 before I make a longer commitment. +And then separately on Windows 10 and the strength we've seen in OEM Pro, and I will also say it mirrors -- in some ways, you're also going to see some of that growth and strength in Windows commercial, so let me answer them a bit together. The Windows 10 Pro strength and, I think, commercial strength we've seen, we continue to see good signs on the commercial refresh. Really security, manageability of modern hardware and software together continues to be a good signal for us. We continue to watch the end of support. It's really critical for us, for customers to have a terrific experience as we upgrade them and ask them to move to Windows 10 with a lot of value. That end of support is about 5 quarters away, so we'll continue to expect good signal and good demand in that Pro segment. And it should, to your point, match increasingly the market, and we do get to some slightly bigger comps in H2, which I would agree with. But I don't want to diminish the signal because the signal is demand is very good for Windows 10 and upgrade to modern hardware when they realize the benefits. And so even if you have a tougher comp, I think the demand signal and our opportunity to continue to sell Microsoft 365 in that process and then upgrade to Office 365 as they do deployments is a big opportunity for us to excel. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our final question is coming from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [31] +-------------------------------------------------------------------------------- + + Maybe one for Satya. Satya, as you think about the Dynamics business going forward, how do you weigh the potential need to do a larger acquisition there versus just organic development or small tuck-ins? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [32] +-------------------------------------------------------------------------------- + + Yes. I mean, overall, I feel very good about the opportunity ahead in business applications for us, and I think about the combination of both Dynamics 365 as well as what we're doing on the LinkedIn side. They all represent our participation in business applications. And the thing that I -- what's happening out there in the marketplace is, as things become more digital, there is, in fact, more need for business process automation. At the same time, there is a need for the application suite to be built very differently, and that's where, I think, we have an architectural advantage again with Dynamics 365. It's much more modular. It's modern. It's extensible with this power platform that gives us the ability to do things for customers and serve them in ways that is very differentiated. So that's our primary focus. We'll always look at opportunities outside. But in a time when there is a real fundamental shift in the category when it comes to both business models and technology, we feel we are well positioned to ride that. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [33] +-------------------------------------------------------------------------------- + + Thanks, Brad. That wraps up the Q&A portion for today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon. You can find additional details at the Microsoft Investor Relations website. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + Thank you all. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Thanks all. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference. Again, we thank you for your participation, and you may disconnect your lines at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2019-Apr-24-MSFT.txt b/Transcripts/MSFT/2019-Apr-24-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..a4492141af16b41e6c731a7244fb8b2ab0e0efc0 --- /dev/null +++ b/Transcripts/MSFT/2019-Apr-24-MSFT.txt @@ -0,0 +1,420 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Microsoft Corp Earnings Call +APRIL 24, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Ross Stuart MacMillan + RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Jennifer Alexandra Swanson Lowe + UBS Investment Bank, Research Division - Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + * Brad Alan Zelnick + Crédit Suisse AG, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings. Welcome to the Microsoft Fiscal Year 2019 Third Quarter Earnings Conference Call. (Operator Instructions) Please note, this conference is being recorded. +I will now turn the conference over to your host, Mike Spencer, General Manager of Investor Relations. Mr. Spencer, you may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact that these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we'll refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements, which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. +It was another strong quarter with double-digit top line and bottom line growth, the result of picking the right secular trends, accelerating innovation and most importantly relentlessly focusing on our customers' success. Our trusted extensible cloud platform spanning application infrastructure, data and AI, productivity and collaboration as well as business applications enables every organization to create their own intelligent systems and experiences to compete and grow. +Now I'll briefly highlight key areas of innovation and growth across our business. Microsoft 365 empowers everyone from the largest multinationals to small businesses, from knowledge workers to first-line workers with an integrated, secure, compliant experience on any device. It's the only comprehensive productivity, collaboration and communication solutions that integrates with an organization's business process workflows. +Microsoft Teams brings together everything a team needs: messaging, video conferencing, meetings and collaboration into a single integrated user experience scaffolding, eliminating the need for discrete apps that only increase an organization's security and compliance exposure. 91 of the Fortune 100 use Teams, and more than 150 organizations have over 10,000 active users. And we are expanding Teams to new industries like health care with priority notifications for patient care and the ability to securely access patient records. +Cybersecurity is a central challenge, and Microsoft is the clear leader in cloud security with our unparalleled operational security posture and our growing portfolio of security and compliance solutions spanning identity, device endpoints, e-mail, information, cloud applications as well as infrastructure. +In financial services, National Bank of Canada; BNP Paribas; Refinitiv, a joint venture between Thomson Reuters and BlackRock all chose Microsoft 365 for our advanced security and compliance. We expanded Microsoft Threat Protection to include the Mac and manage vulnerabilities in third-party applications, providing the best defense for customers' heterogeneous environments. And we introduced 2 first-of-their-kind services. Azure Sentinel analyzes security signals at massive scale across an entire organization using AI to detect, investigate and respond rapidly to threats. Microsoft Threat Experts is a new cyber threat hunting service that provides access to our security experts on demand. All this innovation is driving growth. Office 365 Commercial now has 180 million users, our EMS installed base reached 100 million and the Outlook apps on iOS and Android surpassed more than 100 million users for the first time this quarter. +We expanded our Surface family of devices with Surface Hub 2S, which brings together Teams, Windows and our category-creating Surface hardware to power teamwork for organizations like Volvo, Domino's Pizza, Northwestern University and NASA Jet Propulsion Labs. Finally, Windows 10 is now active on more than 800 million devices and continues to gain traction in the enterprise as the most secure and productive operating system. +Moving to business applications. Today, traditional systems of record and engagement are often siloed, limiting the value of an organization's most important asset: its data. Dynamics 365 solves this challenge, connecting all their systems and creating digital feedback loops, enabling any organization to become a true AI-first company. The open data initiative we announced last year with Adobe and SAP delivers on this promise and is already enabling customers like Unilever to unify their business data across all their lines of business applications to unlock new AI-driven insights. +Personalization is increasingly key to every organization's marketing strategy, enabling them to effectively engage customers, tailor their experiences and increase return on investment. Tivoli, one of the world's oldest amusement parks, is using AI and Dynamics 365 to help personalize marketing campaigns and transform how their first-line workers engage with guests, reducing churn and increasing customer loyalty. +And we are not stopping there. We are leading in 2 emerging categories: robotic process automation and mixed reality. Our Power Platform brings together robotic process automation with self-service analytics and no-code/low-code app development. Recent updates enable citizen developers to build higher-quality Power Apps faster and easier and, along with new capabilities in Power BI, empower customers like SNCF, France's national railway, to create a more data-centric culture. +Our new HoloLens 2 is the most advanced intelligent edge device available and, in combination with Dynamics 365 and new Azure Mixed Reality services, enables organizations like PACCAR and Chevron to digitize physical spaces and the interactions to empower their first-line employees with the right information at the right time in the context of their business process work. All this innovation is driving growth. Revenue for our Power Platform grew triple digit year-over-year, and for the first time, more than 50% of our Dynamics revenue was driven by the cloud. +Moving to LinkedIn. LinkedIn again exceeded expectations across all lines of business driven by record levels of engagement in the feed, content shared across the platform, the messages sent this quarter. Marketing solutions was up 46% year-over-year, and customers are relying on our new pages experience and audience-targeting capabilities to connect with LinkedIn's nearly 630 million members. We saw record job postings again this quarter and making -- are making it easier for job seekers to find more relevant and higher-paying jobs and get personalized salary insights. +We have the most comprehensive solution for every organization to manage and engage their most important resource: their talent. New tools in Glint empower managers to quickly analyze and action feedback to have the greatest impact on team performance. And with our combination of LinkedIn Talent Solutions, Talent Insights, LinkedIn Learning and Glint, we are helping employers access data-driven insights to attract, retain and develop the best talent in an increasingly competitive jobs marketplace. +Now let's talk about Azure. From the outset, we took a differentiated approach to the cloud to meet the real-world needs of customers. Our architectural advantage is a clear reason for our success. Azure is the only true hybrid hyperscale cloud that extends to the edge. Operational sovereignty is increasingly critical to customers, and Azure uniquely provides consistency across development environments, operating models and technology stacks whether connected or disconnected to the public cloud. And we are accelerating our innovation. Azure Stack extends our hybrid differentiation, enabling customers like Airbus Defence and Space to build and run cloud applications at the edge. And now with our new Azure Stack HCI, customers can build and run virtualized applications on-premise in a consistent way. +Azure Data Box Edge is a powerful new AI-enabled edge appliance that sits within a customer's environment, in their data center or on a factory floor so that they can use AI to reason over data at the edge. More than 95% of the Fortune 500 run their workloads on our cloud, including TD Bank, and AT&T chose Azure to shape the future of 5G with computing at the edge. +We are building Azure as the world's computer with more global data center regions, and now 2 in South Africa and more compliant certifications than any other cloud provider. And just last week, we announced 2 new Azure government regions to meet the stringent requirements for maintaining the security and integrity of classified U.S. government workloads. +Every organization needs an IoT strategy to manage the 20 billion connected devices coming online by 2020. Our comprehensive Azure IoT platform enables customers to build, manage and secure their connected devices. And our recently announced acquisition of Express Logic furthers our goal, bringing our cloud to more than 6 billion MCU-powered endpoints. BMW Group is partnering with us to speed the adoption of industrial IoT, both in automotive and more broadly in manufacturing. And Renault-Nissan-Mitsubishi Alliance and Volkswagen both chose Azure to fuel their new connected car experiences. +Data and analytics is the foundation for building an organization's AI capability, and we're investing to make Azure the best cloud for data estates from data warehousing to real-time stream analytics. Daimler chose Azure as its new platform for big data and advanced analytics, and third-party analysts affirm our price performance lead in this fast-growing space. And we're investing to make Azure the best place to build AI. This quarter, we introduced new Azure Cognitive Services for fraud detection and image identification. Telefónica is using Azure AI services to create new intelligent experiences for their customers around the world and transform customer engagement. +The developers will play an increasingly vital role in value creation, and we are committed to giving them the tools they need to be productive on any platform. GitHub surpassed 36 million registered users, and free private repositories expanded the opportunities for all developers, with private repo creation more than doubling this quarter. The new Visual Studio 2019 optimizes developer productivity and team collaboration. And I'm excited to share more about how we are empowering developers at our Build Conference in 2 weeks. +Now to gaming. We are investing in content, community and cloud to capture our massive opportunity in gaming, delivering record user engagement again this quarter. Microsoft Game Stack brings together our tools and services to empower game developers from independent creators to the biggest game studios to build, operate and scale cloud-first games across mobile, PC and console. Our Xbox Live community, now 63 million strong, is key to our approach, and we are enabling developers to reach these highly engaged gamers on iOS and Android for the first time. +Our fast-growing gaming subscription service, Game Pass, is expanding our reach bolstered by a growing pipeline of first-party content. And Project xCloud, our new game streaming service, will be in public trials later this year. +In closing, I'm energized by our progress and incredibly optimistic about our opportunity ahead. Across all of our businesses, we are delivering differentiated value for customers and creating new categories of growth that position us well for the future. +With that, I'll now hand it over to Amy who will cover the financial results in detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. +This quarter, revenue was $30.6 billion, up 14% and 16% in constant currency. Gross margin dollars increased 16% and 18% in constant currency. Operating income increased 25% and 27% in constant currency, and earnings per share was $1.14, increasing 20% and 22% in constant currency. Our sales teams and partners delivered strong results across each of our segments, once again resulting in double-digit top and bottom line growth. +From a geographic perspective, most markets performed in line with our expectations. However, results in Japan were much stronger than we anticipated. In our commercial business, cloud services strength drove our annuity mix to 90%, up 1 point year-over-year. Commercial unearned revenue was better than expected at $25.1 billion, up 19% and 20% in constant currency. Commercial bookings growth was strong, increasing 30% and 34% in constant currency. +Bookings growth was driven by healthy renewals on an expiration base that was over 20% larger than a year ago as well as an increase in the number of larger long-term Azure contracts. As a reminder, an increased mix of these larger long-term Azure contracts with low upfront billings will drive more volatility in our commercial bookings and unearned revenue growth. Commercial cloud revenue was $9.6 billion, growing 41% and 43% in constant currency, highlighted by healthy growth in the U.S., Western Europe, the U.K. and Germany. +Commercial cloud gross margin percentage increased 5 points year-over-year to 63% driven again by significant improvement in Azure gross margin. Company gross margin percentage was 67%, ahead of our expectations and up year-over-year, primarily from an increase in margin in our More Personal Computing segment due to sales mix shift. FX reduced revenue growth by 2 points and COGS growth by 1 point in line with expectations. FX reduced operating expense growth by 1 point, less than anticipated. Even with this headwind, operating expenses grew in line with expectations, increasing 9% and 10% in constant currency. Strong revenue growth, improving gross margins and disciplined investment in strategic and high-growth areas resulted in operating margin expansion. +Now to segment results. Revenue from Productivity and Business Processes was $10.2 billion, increasing 14% and 15% in constant currency, ahead of expectations driven by performance in Japan and LinkedIn. Office Commercial revenue grew 12% and 14% in constant currency. Office 365 Commercial revenue grew 30% and 31% in constant currency driven by installed base expansion across all workloads and customer segments as well as ARPU growth from our customers' continued shift to our E3 and E5 offerings. Office 365 Commercial seats grew 27% and benefited from the strong performance of our Microsoft 365 academic offers. +Office Consumer revenue grew 8% and 10% in constant currency, ahead of our expectations, with 4 points of growth from transactional sales in Japan. Office 365 Consumer subscribers grew to 34.2 million. Our Dynamics business grew 13% and 15% in constant currency driven by Dynamics 365 revenue growth of 43% and 44% in constant currency. We saw continued progress in our finance and operations offering with strong growth in customer billings and deployments. +LinkedIn revenue increased 27% and 29% in constant currency with continued strength across all businesses. LinkedIn concessions increased 24% as engagement once again reached record levels. Segment gross margin dollars increased 15% and 17% in constant currency, and gross margin percentage increased 1 point year-over-year as improvements in LinkedIn and Office 365 margins more than offset increased cloud mix. Operating expenses increased 4% and 6% in constant currency driven by continued investment in LinkedIn and cloud engineering. Operating income increased 28% and 30% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $9.7 billion, increasing 22% and 24% in constant currency, ahead of expectations driven by continued customer demand for our differentiated hybrid offerings. Server products and cloud services revenue increased 27% and 29% in constant currency. Azure revenue grew 73% and 75% in constant currency driven by strong growth in our consumption-based business across all customer segments partially offset by tempering growth in our per-user business. Our Enterprise Mobility installed base grew 53% to over 100 million seats. And our on-premises server business grew 7% and 9% in constant currency driven by the continued strength of our hybrid solutions, premium offerings and GitHub as well as increased transactional demand ahead of the end of support of Windows Server and SQL Server 2008. +Enterprise Services revenue increased 4% and 5% in constant currency driven by growth in premier support services. Segment gross margin dollars increased 21% and 23% in constant currency. Gross margin percentage decreased slightly as the growing mix of Azure IaaS and PaaS revenue was partially offset by another quarter of material improvement in Azure gross margin. Operating expenses increased 22% and 23% in constant currency driven by continued investment in cloud and AI engineering, GitHub and commercial sales capacity. Operating income increased 21% and 23% in constant currency. +Now to the More Personal Computing segment. Revenue was $10.7 billion, increasing 8% and 9% in constant currency as better-than-expected performance in Windows was partially offset by lower-than-expected gaming revenue. In Windows, the overall PC market was stronger than we anticipated, driven by improved chip supply that met both unfulfilled Q2 commercial and premium consumer demand as well as better-than-expected Q3 commercial demand. Therefore, OEM Pro revenue grew 15%, and OEM non-Pro revenue declined 1%. Inventory levels were within the normal range. +Windows Commercial products and cloud services revenue grew 18% and 20% in constant currency with continued double-digit billings growth and a higher mix of in-quarter recognition from multi-year agreements. Windows 10 deployments across new and existing devices remains healthy. +In gaming, revenue grew 5% and 7% in constant currency, below expectations, driven by lower-than-expected monetization across third-party titles and console sales. Xbox software and services revenue grew 12% and 15% in constant currency with continued momentum in Xbox Live and Game Pass subscriber growth. Surface revenue grew 21% and 25% in constant currency driven by continued strength across consumer and commercial segments, particularly in Japan. +Surface revenue ex TAC increased 12% and 14% in constant currency primarily driven by Bing rate growth. Segment gross margin dollars increased 13% and 15% in constant currency, and gross margin percentage increased 2 points due to sales mix shift to higher-margin products in Windows and gaming. Operating expenses increased 1% and 2% in constant currency, and operating income increased 25% and 28% in constant currency. +Now back to our total company results. Capital expenditures, including finance leases, were down sequentially to $3.4 billion and lower than initially planned primarily due to normal quarterly spend variability and the timing of cloud infrastructure build-out. Cash paid for property, plant and equipment was $2.6 billion. Cash flow from operations increased 11% year-over-year driven by strong cloud billings and collections. Free cash flow was $11 billion and increased 19% year-over-year, reflecting the timing of lower cash payments for property, plant and equipment. +Other income was $145 million driven by interest income and net gains on derivatives and investments offset partially by debt and finance lease expense. Our effective tax rate came in lower than expected at 16%. And finally, we returned $7.4 billion to shareholders through share repurchases and dividends, an increase of 17%. +Now let's move to next quarter's outlook. First, on FX. Assuming the current rates remain stable, we expect FX to decrease revenue growth by approximately 2 points and COGS operating expenses growth by approximately 1 point. Within the segments, we anticipate about 2 points of negative FX impact on revenue growth in Productivity and Business Processes and Intelligent Cloud, and 1 point in More Personal Computing. Second, we again expect customer demand and solid execution to drive continued strong performance across our commercial business in our largest quarter of the year. +The expiry base will grow in Q4 but at a more moderated rate than in Q3, and we expect commercial unearned revenue to increase 36% to 37% sequentially. Commercial cloud gross margin percentage should continue to improve year-over-year as material improvement in Azure gross margin will be partially offset by the continued mix of revenue toward Azure IaaS and PaaS services. +Third, CapEx. Our full year outlook remains unchanged. Therefore, we expect a sequential dollar increase in capital expenditures in Q4 as we continue to invest to meet growing customer demand. +Now to the segment guidance. In Productivity and Business Processes, we expect revenue between $10.55 billion and $10.75 billion. Office Commercial revenue growth rate will be slightly down sequentially as is normal for Q4 due to the high mix of cloud billings during this quarter. As a reminder, under ASC 606, a higher mix of cloud billing is reflected in more unearned revenue and less in-period revenue recognition. +Dynamics should see another quarter of double-digit revenue growth driven by Dynamics 365. LinkedIn revenue growth should be in the low 20s against a high prior year comparable. In Intelligent Cloud, we expect revenue between 8 -- $10.85 billion and $11.05 billion. In Azure, we expect continued strong growth in our consumption-based business and moderating growth in our per-user business given the increasing in size of the installed base. +In our on-premise server business, demand for our hybrid solutions and premium offerings should remain strong. And we expect continued benefit from the upcoming end of support for Windows Server and SQL Server 2008 though, as a reminder, their prior year comparable will impact the year-over-year growth rate. +In More Personal Computing, we expect revenue between $10.8 billion and $11.1 billion. In Windows, overall OEM growth rates should normalize with revenue growth roughly in line with the PC market. In Surface, we expect low double-digit growth with continued momentum across commercial and consumer segments. In search ex TAC, we expect revenue growth similar to Q3. And in gaming, we expect revenue to decline year-over-year driven by the tough comparable in Xbox software and services and the continuation of the hardware trends from Q3. +Now back to the overall company guidance. We expect COGS of $10.65 billion to $10.85 billion and operating expenses of $10.7 billion to $10.8 billion. Other income and expense should be approximately $50 million as interest income is partially offset by interest and finance lease expense. And finally, we expect our effective tax rate in Q4 to be approximately 17% with some potential volatility given it is the final quarter of our fiscal year. +Now I'd like to provide some closing thoughts as we look forward to FY '20. Overall, we feel very good about the progress we've made thus far in FY '19. Our decision to invest with significant ambition in high-growth areas, coupled with strong execution, has resulted in material revenue growth at scale and a stronger position in many key markets. +As FY '20 approaches, we again see tremendous opportunity to drive sustained long-term growth. We will invest aggressively in strategic areas like cloud through AI and GitHub; business applications through Power Platform and LinkedIn; Microsoft 365 through Teams, Security and Surface as well as gaming. At the same time, we will continue to drive improvement and efficiency as our business scales. This consistent approach of investing in future growth while delivering strong operating performance will result in double-digit revenue and operating income growth in FY '20 with stable operating margins. +With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [2] +-------------------------------------------------------------------------------- + + Amy, if I go back and look through your KPIs, it looks like the year-over-year growth in commercial bookings has never been this high on a constant currency basis; at least I was able to go back through fiscal '13. You mentioned an increase in the number of larger long-term Azure contracts, which obviously is a driver of this. But is there any more color you could share? Is this coming from a handful of customers, I mean, that are just driving all of their -- like outsourcing everything to you guys and shutting down their data centers? Or do you see this as kind of a broad-based trend even in some of the industries that have been slow to move to the cloud where this is really starting to snowball? +And then the follow-up would be just Azure gross margins where you guys have done a remarkable job just continuing to increase efficiency there. How much room is left to go? And how do you think about the percentage of COGS in Azure that are variable versus fixed? And has the ratio been changing? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Great. Heather, let me try to take both of those questions. On your commercial bookings growth question, I find it easiest to think about commercial bookings, before I answer the larger question about onetime, in 2 ways. The first is the expiration base absolutely does matter, and that's why we talked about it. And we had a, actually, very good quarter here in terms of renewals and what I think of as revenue recapture where we're able to grow the revenue in existing contracts. And so that absolutely contributed and has contributed over the past couple of years to what I do believe has been reasonably consistent commercial bookings strength versus the expiration base. +The second component is what I would put in bucket of new business whether that new business comes as what you saw this quarter, 2 ways: there was some on-prem strength this quarter. It does show up in bookings. It doesn't show up in unearned, and it does show up in the P&L. We had a good quarter there. And we did have some large Azure contracts, which tend to be longer-dated and tend to have low billings upfront. That means it shows up in bookings and again not in the unearned balance in the same way. +And so you will see as we go forward, and you're already starting to see it, more volatility in this number not just based on the way we've traditionally talked about it, which is the movement of the expiration base but also in some of these larger, longer-term commitments by what we now think of not just as customers, but these are really now partnership relationships that we have where, to your point, we're co-collaborating to help customers be successful as they build their digital future. And so you will see a little bit of volatility in this number as those contracts and those types of contracts start to land. +On your second question of Azure GM, we have continued to see strong improvement in the core gross margin of Azure. The team has done a nice job on a number of fronts, continue to make progress on both software innovation but also importantly hardware innovation and working with our supply chain to continue to have and see benefits on that side. Also is increasing use of premium services also contributed to Azure gross margin improvement. So while we remain focused on efficiency and the utilization of the hardware and software, it's also important to continue to see premium upsell, premium workload usage, so that customers are getting the most out of their deployments and usage of the Azure platform. +In general, I -- it hasn't changed a ton in terms of that final component about fixed versus, I think, variable base. It's still been in that, I think, low 40% as a range for us in terms of what's depreciation versus what's more variable. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Keith Weiss from Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [5] +-------------------------------------------------------------------------------- + + A very impressive quarter. I'm going to pick a similar question to Heather's but directed at you, Satya, to try to get a higher-level answer. In terms of -- during this quarter, it just sounds to me like I've heard Amy talk more about exceeding expectations than we have in prior quarters and exceeding plan more than we have in prior quarters. This matches up from what we're hearing in our CIO survey as we've been talking to customers. It almost sounds like there's an inflection point going on in the adoption of cloud and digitalization efforts. So the question to you is are you guys seeing that? Are you starting to see an inflection point in terms of these adoption trends and the investment that you guys have made behind this really starting to take hold? +And then perhaps a follow-up for Amy. So operating margins really exceeded our expectations this quarter and I think consensus expectations. Could you talk a little bit about kind of what drove that and kind of why we wouldn't see as much of that on a go-forward basis in terms of operating margin expansion? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Yes. Thanks, Keith, for the question. So let me start. I think overall, what we are seeing is continued momentum. If you think about even -- our overall approach has been to have a view of an architecture that is grounded in our customers' needs. So we always believe that in distribute computing, you need a cloud and an edge. You need hybrid. And guess what? Today, in 2019, hybrid's become much more mainstream, but we were talking about this even 5 years ago. They also sort of said things that will matter in this transition to the cloud will be consistency and productivity. So for example, whether it's developer productivity or IT productivity, it's not any one dimension, you need to bring IT and developers together to drive agility in an organization and the digital capability building. This is again a place where we've had also traditional strength and that's showing up in the marketplace. +And also, if you look at our cloud stack, we have application and infrastructure, data and AI, productivity and collaboration as well as business applications, that's pretty unique again. So that's, I think, what is showing up at scale as competitive differentiation, and that's what you see in our numbers. But most importantly, I think you see it in the customer momentum and what I believe is what is customer success. Digital technology today is not about tech companies doing innovation. It is about the rest of the world doing innovation with technology, and Microsoft's uniquely in position to enable that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + And on your operating margin question, Keith, there's a couple of things I would say that in this quarter in particular, the places where we had a lot of outperformance were especially high-margin areas, and I would point out 3. The first is obviously the OEM and chip supply. The improvement in that in Q3 is obviously very high margin and falls to the bottom. Japan as a geography for us is a high transactional market. And so when Japan is strong, it tends to be a very high margin landing down to the bottom line. And the other one is the on-premises server number, which is very good, in terms of hybrid demand this quarter also is high margin. So when that happens, you do see, because it's a lot of -- almost 100% in-quarter recognition, a lot of help at the operating margin line. +Now the more sustainable conversation, I think, we continue to have on operating margin is our ability to pick the right secular markets and the right secular trends. You see significant revenue growth. We continue to focus on improving the gross margin of each individual product area, which creates leverage over time. And finally, focused investment in operating expense, and that obviously creates leverage. And I think you do see that in general through the year as we've continued to keep that formula. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler from Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + Congratulations on a really strong quarter, everyone. Amy, Satya. Amy, can you delve into the impact of Azure hybrid benefits on Azure revenues, server and tools, renewals? I don't think it's really well understood. Does it have any meaningful impact on Azure's reported revenue growth because of the fact that some of this is appearing in server and tools? And Satya, can you give us some added color on why this specific offering is resonating so well with customers, which is what we're hearing? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- + + Yes. Maybe I can start on the second part and then leads to the first question. I would say, Mark, the main thing that this offering enables is the flexibility with which customers can adopt hybrid computing. And as I've always said that there is -- hybrid computing is important for workloads that are more in the characteristic or can be characterized as lift, shift and modernize. So that's one motion. And then there is new world hybrid as well, which is people are building. In fact, they'll do an AI training job in the cloud but want to deploy the model close to the edge. And in both of these cases, hybrid benefits actually help with -- our business model is basically differentiated in supporting the architectural needs and the flexibility needs. +The one additional thing I'll mention, which is increasingly becoming clear to us, is operational sovereignty will become important. The world and its distributed computing needs is not going to become some homogeneous set of requirements, but it's going to be very heterogeneous, very, in many cases, regulated. And so what we provide in terms of both the technology and the business model, I think, shows up with the maximum flexibility. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + And maybe let me talk a little bit about the question around server products and services and how to think about the hybrid use benefits. In general, today, Mark, almost all of that benefit shows up in what I would say is the on-premise KPI. And so over time though, how you should think about that is it will eventually show up in Azure consumed revenue growth. This is a benefit that's fundamentally about high value and flexibility and meeting customers where they are so that they can make the determination of when to make that choice. And so it tends to be why I keep focusing people back on the all-up KPI because it's the best representation of really customer commitment and usage of our architected-from-the-beginning hybrid cloud. But to your specific question, it shows up today in the on-prem number, it's where you could see most of the strength of that value. And over time, as it gets used and consumed, it will show up more in the Azure ACR number. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead from Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- + + Amy, I'd like to ask you about the big revenue beat in the Intelligent Cloud segment that drove much of the upside and in particular the server product KPI that was just addressed, up 9%. I'm just wondering if you could frame how material the contribution of the version 2008 upgrades were. And assuming that that lift can continue throughout calendar 2019, could it be enough to keep that on-prem KPI, as you described it, flat or even up slightly in the coming 2 quarters despite the tougher comps? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + Thanks, Karl. In -- when I think about the on-prem number, I really divide it into things that have durable value and things that I think of as more onetime. When I think about the durable trends that I expect to see, it's been the hybrid value prop that we really just talked about on Mark's last question and then the premium mix. Those 2, we have seen and continue to see. I do think we saw some benefit of end of support, but I would not say it was the primary benefit this quarter. The primary benefit was the 2 things I just talked about. In the support, obviously we've got SQL in July and then Windows in January. And so I do think we saw some impact particularly in SQL, and I do expect we'll see some of that in Q4. But the Q4 comparable for on-prem is very big. And so even with some of that benefit of the durable trends plus, I think, a more temporal one of end of support, I do expect to see a deceleration in that number in Q4. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jennifer Lowe from UBS. + +-------------------------------------------------------------------------------- +Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [16] +-------------------------------------------------------------------------------- + + Great. I wanted to turn to the Office 365 Commercial business a bit, and that's been a consistent, very strong performer for you all and was again this quarter. But maybe just sort of 2 related questions there. First, if I heard you right, Satya, I think you said there was 180 million users now on Office 365 Commercial, which seems like you're hitting a lot of the customers that you thought might be there a couple of years ago. So I was just curious to get your view on how far along you are in that adoption cycle and if there's still a lot more opportunity in terms of seat expansion in the upcoming year. +And then related, Amy, you mentioned E3 and E5 were both pretty big contributors on the ASP front in the quarter. Are we starting to see a shifting where E5 is sort of increasing in relevance and E3 is played out a bit? Or is this sort of equally balanced? I'm just curious to get sort of the mixing there as well. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [17] +-------------------------------------------------------------------------------- + + Sure. In terms of overall reach of Office 365, we continue to see significant opportunity going forward on multiple dimensions. So for example, we never participated as much in, I would call it, nondeveloped market medium and small businesses with all of the sophisticated workloads. So now that -- with the SaaS approach, you can reach a much broader base of business customers all over the world, is one opportunity. +The second opportunity is if you look at Teams as an example, we are now reaching a lot of first-line workers. So this is whether it's in health care, whether it's in manufacturing, whether it's in retail, just not knowledge workers but where you now have messaging solutions as well as business process workflows integrated. So it's that combination of things where you're going from knowledge workers to first-line, going -- and the ability to reach all sizes of businesses is what's going to continue to help us, I think, have overall feet growth or socket growth. And then of course, there is the other dimension, which is the levels of Office 365 all the way to E5 with significant value. +And the one thing I would mention is having compliance security that spans all of these tools is also proving out to be a very big architectural advantage and a customer value proposition because I think as customers look to use more SaaS applications, they don't want an exponential increase in their security exposure or more compliance burden. And so therefore, Office 365's approach resonates even there. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + And Jen, maybe a little to your question, which is fundamentally about seat growth and ARPU as the drivers of that all-up Office 365 Commercial growth number. This quarter and a little bit last, I actually think some of the ARPU increase has been masked by some of the trends in seat growth. What I mean by that is that 27% seat growth is starting to include some lower ARPU seats that Satya just mentioned, whether that's in academic, in edu, in frontline workers. And that's really important for us to keep having that seat growth even if it's not at the same ARPU level, those are not seats that we ever could reach before at any level, and that's absolutely a new opportunity for us. But it does tend to mask a little some of the ARPU improvement that we've seen. It's still E3 and E5. There's opportunity on both, although we are starting to see the impact of E5 in that ARPU number. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy from JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [20] +-------------------------------------------------------------------------------- + + Satya, we've seen many indications of Azure winning a greater share of enterprise workloads recently. Do you think that you have found the right formula now for Azure to win the majority of workloads in the enterprise IT world? And then Amy, just given the trajectory and the long-term commitments that you mentioned there, do you see a path for Azure to surpass Office 365 Commercial and thus become the largest revenue stream for Microsoft, say, in the next couple, a few years? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Sure. I'll start, Mark. And I mean, having grown up essentially in our infrastructure business in Microsoft, I would say that compared to even the previous eras where we did well in the client/server era in the face of tough competition and in this era again in the face of a different set of competitors, we are doing well. And we are doing well, much better than we did in the previous era because we are seeing these Tier 1 workloads, which we never saw in the past. If you think about it, in the client/server era, we never participated in the core of the digital infrastructure of financial services or in health care or in retail or in manufacturing. And absolutely, when we think about the digital transformational design wins, deployment, consumption, it's kind of like what we would have done with some ISVs of the past, how we worked perhaps with SAP in the '90s when we were coming out with SQL Server and they were coming out with R/3, is what we are now doing with many, many, many businesses as they build out their digital businesses. So that sort of perhaps characterizes for you what's new in terms of Microsoft's own growth in this space. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + And the way that would show up, Mark, is a little bit, I think, where you were leading with the question you asked, which is when we think about the Microsoft commercial cloud at $9.6 billion and growing over 40%, how do you see that evolving? And really, the question is we have quite a bit of per-seat or per-user type businesses. But what Satya just talked about is really about the Azure concept of participating both in an expansionary total addressable market, which I think people have talked about for a long time. But what was different about what Satya just said is our ability frankly to have higher share in the next era than we had in the last era. And so if you look about then our ability to grow and will Azure be larger over any period of time than our per-seat or per-user businesses, it certainly could be. But I don't want that to really diminish the fact that there's a lot of room for us in our per-seat businesses, particularly in business applications across LinkedIn, the Power Platform work we're doing. Satya mentioned security, identity, compliance. There is a lot of room for us to continue to add value and growth in that area as well. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross MacMillan from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Ross Stuart MacMillan, RBC Capital Markets, LLC, Research Division - Co-Head of Software Sector [24] +-------------------------------------------------------------------------------- + + My congratulations as well. We continue to see this really nice progression in the commercial cloud gross margin, and you called out the Azure gross margin improvements. And within that, there's some moving pieces. I think you've got better utilization and efficiency of core Azure. You've got premium services, and then you've got this maybe counter-prevailing force of the different growth in consumption versus user base. +Two questions on this, one for Satya. On the premium services, I'm just curious as to which 1 or 2 or 3 are you seeing maybe break out and become the largest or grow the fastest, which are most meaningful at this point? And then second, for Amy, as we think about this trend, are you convinced that we'll continue to see, not just for fiscal Q4 but into fiscal '20 and beyond, consistent progression and growth in the overall commercial cloud gross margin? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [25] +-------------------------------------------------------------------------------- + + Sure. I mean on the first question, Ross, as far as premium services, just even on the application infrastructure side, for example, in compute, there is increasing need for things like IoT services. Essentially, there is a new business application-like set of services that are getting developed to help people manage their complex IoT application development. IoT Central is a good example of that. When you have many, many connected devices, you need a control plane for many of those devices so that you can tame the complexity of your app deployments, security management. That's one example. +The other one is, of course, data. And the sophistication of the data estate is growing exponentially both in terms of the needs of the databases required, the processing that is required close to data. So that's another place where something like Cosmos DB, which is very unique in its capability in the marketplace, is definitely another service that's got real traction. Even data warehousing, the scale at which -- this is another market, which we never participated in, in the past whereas now we have one of the most competitive products when it comes to benchmarking around data warehousing. So those are all things that I would say are premium services that's just talking about new applications being built on Azure, not counting all of the SaaS applications about that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + And to your overall commercial cloud gross margin question, you're right that the fundamental driver is, when I look forward into the next year, I expect each service, just like it did this year, to really see gross margin improvement, whether that service is LinkedIn or Dynamics or Office 365, Azure per user or Azure IaaS and PaaS. But what you'll see is a revenue mix shift, right, that will offset that to Azure IaaS and PaaS. And so what that generally will do will be a headwind to continued gross amount of the improvement, even though you'll see individual improvement across all of the GM services. And you'll continue to see Azure increase as a percentage of the total revenue. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brad Zelnick from Crédit Suisse. + +-------------------------------------------------------------------------------- +Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [28] +-------------------------------------------------------------------------------- + + And congrats on the strong outperformance. I want to follow up on Karl's question but more generally on database products. With the end of support coming for SQL Server 2008 in July, Satya, can you tell us how that's sparking conversations with customers about database offerings on Azure and moving workloads to the cloud? And Amy, can you perhaps help us contextualize the opportunity to move traditional database workloads onto Azure and what the expansion economics look like? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [29] +-------------------------------------------------------------------------------- + + Yes. A couple of things, Brad. One is overall, the need to get on the latest and greatest database technology just because of what is the increasing need for compute and data at the edge is what's driving a lot of the conversations on SQL Server. Interestingly enough, we have a lot of requirements around edge devices even so that you can have databases with compute, so that you can really have what is needed at the edge. That's sort of one conversation. +The other one is in terms of the cloud migration, there is a variety of different use cases. We see people who are using SQL DB, which is essentially a PaaS service with the complete compatibility of SQL Server. They want managed services around SQL Server, which we have. And so both of those are all happening in parallel. A good example of this is, in fact, even the rewrite of -- complete revamp, I would say, of Dynamics. Dynamics 365 and its architecture, at least in my eyes, is a thing of beauty because it's completely been rewritten for the new database technology, whether it is in the database side or on the data warehouse side, again uses a whole bunch of micro services and functions so that you can do AI close to data. That type of architectural approach is what we see is possible now for every SaaS application when they're out there as well because we think about the number of SaaS -- number of business applications that were built on SQL Server, I feel that, that's an architecture that can support both what they want to do on the edge but as well as in the cloud. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + And on the contextualizing the opportunity, the reason I said it's not the primary driver is because the vast, vast majority of our server business is annuity-based. And so when it's annuity-based, there's really no opportunity to see it as upside in Q4 from an end-of-support frame. For the smaller portion of our business, it's still not annuity per transactional. It does provide, as I talked about earlier, some opportunity, but it's not that large just because the nature of the commitment of our customers now is far more of the annuity type. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Raimo Lenschow from Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [32] +-------------------------------------------------------------------------------- + + Can you talk a little on the Windows OEM side? You mentioned that the chipset situation is kind of easing a little bit. Are we kind of fully done there in terms of what do you see there from the Intel side? And did that create some pent-up demand for the coming quarters as people are thinking about moving over to Windows 10 with the end-of-life coming up? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + Thanks, Raimo. I think we actually, in Q3, as I said, met sort of the unfulfilled Q2 demand and Q3. So I don't think of it as a pent-up situation heading into Q4, and our guide certainly does not indicate that, that is what we believe will happen. What I would say is I think there's -- we feel good about the supply in the commercial segment and the premium consumer segment, which is where the vast majority of our revenue is in OEM. And so I think in those segments, we feel fine for Q4. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [34] +-------------------------------------------------------------------------------- + + Thanks, Raimo. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [35] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [36] +-------------------------------------------------------------------------------- + + Thank you all. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2019-Jan-30-MSFT.txt b/Transcripts/MSFT/2019-Jan-30-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..82711c309c0a3aff6a0405bd0d9423cb44414e97 --- /dev/null +++ b/Transcripts/MSFT/2019-Jan-30-MSFT.txt @@ -0,0 +1,430 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Microsoft Corp Earnings Call +JANUARY 30, 2019 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Aleksandr J. Zukin + Piper Jaffray Companies, Research Division - MD and Senior Research Analyst + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Walter H Pritchard + Citigroup Inc, Research Division - MD and U.S. Software Analyst + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Jennifer Alexandra Swanson Lowe + UBS Investment Bank, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Second Quarter Fiscal Year 2019 Microsoft Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the call over to Mike Spencer, General Manager of Investor Relations. Thank you. Please proceed. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are: Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Carolyn Frantz, Deputy General Counsel and Corporate Secretary. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should (sic) [should not] be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are not included as -- they are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact these items and events have on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone for joining on the phone. We delivered $32.5 billion in revenue this quarter with double-digit top line and bottom line growth driven by strength across all of our commercial cloud. Our commercial cloud revenue grew 48%, anchored by Azure revenue growth of 76%. These results speak to us picking the right secular trends in large and growing markets, many of which are still in their infancy, as well as focused innovation and execution. +Leading companies in every industry are partnering with us to build their own digital capability to compete and grow. This is creating a broad opportunity for everyone, including our ecosystem. As one example, the co-sell program we introduced 18 months ago has already generated $8 billion in contracted partner revenue. +Now I'll briefly highlight our momentum and innovation across our businesses. Microsoft 365 empowers everyone, enterprises, small businesses and then more than 2 billion first-line workers with an integrated secure experience that transcends any 1 device. We are helping every business build out their system of communication and collaboration to drive their productivity as well as their business transformation. Microsoft Teams is the hub for teamwork and a powerful on-ramp for Microsoft 365, and we're seeing increased usage of OneDrive, SharePoint, Yammer and the entire Office Suite of applications. +Teams is the only enterprise-grade solution that brings together messaging, meetings, video conferencing as well as document collaboration. And as of this quarter, enhanced voice capabilities like group call forwarding, delegation, location-based routing are all being brought into Teams. +We are seeing rapid adoption of Teams with more than 420,000 organizations of all sizes and 89 of the Fortune 100 using Teams, including customers like Pfizer, who chose Teams as the collaboration platform for their 115,000 employees, and we are expanding into new and underpenetrated markets. This quarter, we introduced new capabilities to empower first-line workers in the service and task-oriented roles to communicate and collaborate more effectively on the go with mobile schedule management, location sharing as well as the ability to easily record and share secure audio messages. +We're expanding our opportunity in education with Microsoft 365, innovating in hardware and software to improve learning outcomes from the more collaborative classrooms with Teams to personalized learning tools in OneNote, to social learning with Flipgrid, to affordable easy-to-manage Windows 10 devices. +Cybersecurity is a central challenge, and Microsoft is leading the way, helping all organizations operate in what is known in the industry as a zero trust environment. It all starts with Azure AD Active Directory and the deep work we're doing with Microsoft Threat Protection to provide an integrated solution for our customers that extends across identities, device endpoints, e-mail, information, cloud applications and infrastructure. And this quarter, we introduced new advanced capabilities for identity and threat protection and for information protection and compliance. A comprehensive approach to security and compliance is another reason why customers are adopting Microsoft 365. Customers from Neiman Marcus to Brooks Running to global biopharmaceutical leader, Sanofi, all chose our solutions. +Surface had its biggest quarter ever this holiday, delivering strong double-digit growth in both consumer and commercial. We continue to innovate and expand our family of devices, setting the bar for the industry with newest Surface Pro, Surface Laptop and Surface Go. More broadly, Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system. And at CES, our OEM partners showcased always connected Windows 10 PCs that deliver break-through levels of performance to enable powerful new scenarios like immersive gaming. +Moving to business applications and LinkedIn. Dynamics 365 grew 51% this quarter as we win customers with our differentiated approach to systems of record and systems of engagement by making them more modular, extensible and AI-driven. Increasingly, business process automation includes digitizing physical spaces, activities and interactions. Dynamics 365, along with advances in Azure IoT, AI and Mixed Reality are leading the way for organizations to create these new systems of observation and systems of intelligence that drive end-to-end business processes and bridge the online and off-line worlds. +For example, we now have the capability for customers to manage inventory in real-time from the shelf to the warehouse to the farm. But we're not stopping there. Our Power platform spanning Power BI, Power Apps and Flow enables anyone in an organization to start building an intelligent app or workflow where none exists. It is the only solution of its kind in the industry, bringing together no code or low code app development, robotic process automation and self-service analytics into a single comprehensive application platform. And it enables extensibility across Microsoft 365 and Dynamics 365 as well as leading third-party SaaS business applications. +With Power platform, Microsoft is fundamentally demarketizing business processes, empowering everyone to make smarter, faster decisions, and I'm energized about the tremendous opportunity in this space. Already, Centrica is relying on Power BI, Power Apps and Flow along with Dynamics 365 to transform scheduling and dispatch of its first-line workforce in the United Kingdom. Virgin Group is using Power Apps and Dynamics 365 to generate a single view of its passengers' surfacing insights to improve customer service and increase operational efficiency. And in Italy, postal service is using Dynamics 365 to jump start the digital transformation of thousands of the post offices across the country. +Moving to LinkedIn. We continue to generate strong revenue growth across all businesses, with sessions growth of 30% year-over-year fueled by record levels of engagement in the feed and content shared across the platform. We also saw record job postings again this quarter. We introduced new brand and community building tools for marketeers with LinkedIn pages, making it easier for organizations of all sizes to foster strong connections with LinkedIn's 610 million members. +Finally, Glint broadens our market opportunity with its industry leading employee engagement platform. At a time when competing for talent and skill development is a priority for every leader, the combination of LinkedIn Talent Solutions, Talent Insights, LinkedIn Learning and now Glint helps every business attract, retain and develop the best talent in an increasingly competitive jobs marketplace. +Now turning to Azure. Azure is the only hyperscale cloud with a consistent computing stack that extends from the data center to the edge, and customers across every industry recognize this architectural advantage. In retail, Azure was front and center at the NRF. Kroger is partnering with us to redefine customer experience in stalls and provide employees with AI-driven insights, while the Gap chose our cloud to accelerate the digital transformation. And just this week, Albertsons chose Azure as its preferred cloud. +In financial services, MasterCard is partnering with us on a new, more secure way to verify digital identities. BlackRock is applying the power of the Microsoft Cloud to reimagine retirement planning, and UBS is using Azure to increase agility across the organization while meeting the highest bar of compliance and security. +In health care, Walgreens Boots Alliance chose Azure to put people at the center of their health and wellness with digital solutions to improve health care outcomes and lower costs. In addition, they will roll out Microsoft 365 to more than 380,000 employees in stores globally. +We're accelerating our innovation in emerging workloads like IoT and edge AI. At CES, our partners showcased how Azure IoT and Azure AI are enabling them to build new connected devices and experiences that span the cloud and the edge from connected homes to cars to smart cities. Just this month, Starbucks chose Azure Sphere to secure its business-critical edge devices in the stores. +Developers will increasingly drive the influence business -- and influence business processes and functions across every organization. And we are committed to drive at giving developers the tools they need to be productive on any platform. More than 12 million developers around the world use Visual Studio to build applications, and new features enable them to collaborate in real-time and spend more time driving innovation. +We closed our acquisition of GitHub this quarter, enabling us to bring our tools and services to new audiences while enabling GitHub to grow and retain its developer-first ethos. GitHub has more than 31 million developer accounts and recently surpassed 100 million code repositories, a major milestone. Development teams at more than half of the Fortune 50 do their work in GitHub Enterprise. This month, we announced significant updates to make GitHub accessible to even more developers, introducing unlimited private repos as well as new, simpler and unified enterprise offering already available through the Microsoft global sales force, and we're not stopping there. Just last week, we announced our acquisition of Citus Data, the leading provider of PostgreSQL, enhancing our overall data platform differentiation and building on our investments in Azure and making it the most comprehensive cloud for open source and proprietary workloads at any scale. +And now I'll turn to gaming. We continue to pursue our expansive opportunity to transform how games are distributed, played and viewed. Our investments in content community and cloud services across every endpoint drove both record user engagement and record average revenue per user and contributed to our largest gaming revenue quarter ever, driven by software and services. +We acquired 2 new studios this quarter, bringing the total to 13 and more than doubling our first-party content capacity in the past 6 months. Xbox Live monthly active users reached a record 64 million, with the highest number of mobile and PC users to date. Xbox Game Pass subscribers and Mixer engagement also hit new all-time highs. And Minecraft, which continues to be one of the most popular and durable gaming franchises in the industry, delivered record revenue as we expanded into new platforms, geographies and segments like education. PlayFab surpassed 1 billion player accounts this quarter, and xCloud will be public trialed later this year as we make progress on our ambition to build a world-class gaming platform spanning mobile, PC and console. +In closing, our accelerating customer momentum is driven by our deep and growing partnerships with leading companies and differentiated innovation across our portfolio. Every company is becoming a digital company, and they're looking for a trusted partner to help them build tech intensity. Microsoft is that partner. +With that, now I'll hand over to Amy, who will cover our financial results in detail and share our outlook, and I look forward to rejoining you for questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. First, as a reminder, my comments across our results and outlook include the impact from GitHub, inclusive of purchase accounting, integration and transaction-related expenses. +This quarter, revenue was $32.5 billion, up 12% and 13% in constant currency. Gross margin dollars increased 12%. Operating income increased 18%, and earnings per share was $1.10, increasing 15% and 14% in constant currency when adjusting for the net charges related to TCJA. Strong execution and continued customer demand for our hybrid cloud offerings drove another quarter of double-digit top and bottom line growth. We continued to benefit from favorable secular trends and IT spending conditions. From a geographic perspective, our performance was in line with macroeconomic trends with strength across the U.S., Western Europe and the U.K. partially offset by weaker performance in Central and Eastern Europe and the Middle East and Africa. +In our commercial business, annuity mix grew 3 points year-over-year to 89%. Commercial unearned revenue was $25.3 billion, growing 20%, slightly above our expectations. And commercial bookings were strong, growing 18% and 22% in constant currency driven by solid renewal execution and an increase in the number of larger, longer-term Azure contracts. +As a reminder, strong performance in larger long-term Azure contracts, Azure consumption overages and pay-as-you-go contracts will drive bookings growth and in-period revenue but will have a limited impact on unearned revenue. Commercial cloud revenue was $9 billion, growing 48% and 47% in constant currency. Commercial cloud gross margin percentage increased 5 points year-over-year to 62% driven by significant improvement in Azure gross margin. +Our company gross margin percentage was 62%, flat year-over-year as improving cloud margins were offset by sales mix shift to commercial cloud and Surface hardware. The U.S. dollar was a bit stronger than anticipated, which resulted in a slightly greater impact to our results. FX reduced revenue, COGS and operating expense growth by less than 1 point. Operating expenses grew 7%, slightly lower than expectation as some marketing spend shifted to Q3. We again expanded operating margins as a result of focused investment, solid execution and improving gross margins in key product areas. +Now to segment results. Revenue from Productivity and Business Processes was $10.1 billion, increasing 13% driven by Office 365 Commercial, LinkedIn and Dynamics 365. Office Commercial revenue grew 11%. Office 365 Commercial revenue increased 34% and 33% in constant currency driven by seat growth of 27% and ARPU expansion from continued customer migration to higher value E3 and E5 offerings. We saw installed base growth across all workloads and customer segments. +Office Consumer revenue grew 1% and 2% in constant currency, below our expectation. As discussed on our last earnings call, Q2 revenue growth was impacted by channel inventories normalizing after the prelaunch builds in Q1 but was further negatively impacted by a smaller-than-expected consumer PC market and execution challenges through the quarter. Office 365 Consumer subscribers grew to 33.3 million, a sequential slowdown primarily due to changes made in how Office 365 is sold in Japan. Our Dynamics business grew 17% driven by Dynamics 365 revenue growth of 51% and 50% in constant currency. This quarter, more than 9 out of every 10 new Dynamics CRM customers chose our cloud offering. +LinkedIn revenue increased 29% and 30% in constant currency with continued strong execution across all businesses. LinkedIn sessions grew 30% as engagement once again reached record levels. Segment gross margin dollars increased 11%, and gross margin percentage declined slightly year-over-year as increased cloud mix offset the benefit from improvements in LinkedIn and Office 365 margins. Operating expenses increased 3% and 4% in constant currency as we continued to invest in LinkedIn and cloud engineering. Operating income increased 20% and 19% in constant currency. +Next, the Intelligent Cloud segment, which now includes GitHub. Revenue was $9.4 billion, increasing 20% and 21% in constant currency, ahead of expectations, driven by continued strength in our hybrid solutions. Server products and cloud services revenue increased 24%. Azure revenue increased 76% with strong growth from both the consumption and per user base businesses. In our on-premises server business, continued customer demand for flexible hybrid solutions and our premium offerings drove growth of 3% and 4% in constant currency. +Enterprise Services revenue increased 6% and 7% in constant currency, driven by growth in premier support services and Microsoft Consulting Services. Segment gross margin dollars increased 20%. Gross margin percentage was relatively unchanged as revenue mix to Azure IaaS and PaaS was offset by material improvement in the Azure gross margin percentage. Operating expenses increased 26% with continued investment in cloud and AI engineering as well as commercial sales capacity and the addition of GitHub. Operating income grew 16% and 15% in constant currency. +Now to the results for More Personal Computing segment. Revenue was $13 billion, increasing 7%. Results in our Windows OEM business were lower than expected, partially offset by strong Surface results. In Windows, the overall PC market was smaller than we expected primarily due to the timing of chip supply to our OEM partners, which constrained an otherwise healthy PC ecosystem and negatively impacted both OEM Pro and non-Pro revenue growth. Windows OEM Pro revenue declined 2%, roughly in line with the commercial PC market. OEM non-Pro revenue declined 11%, below the market with continued pressure in the entry-level category. +Inventory levels ended the quarter below the normal range. Windows Commercial products and cloud services grew 13% and 14% in constant currency with continued customer adoption of our premium offerings. Windows 10 deployments across new and existing devices remained strong. +Gaming revenue grew 8% and 9% in constant currency. Xbox software and services revenue increased 31% and 32% in constant currency, primarily driven by continued strength from a third-party title. Additionally, strong subscriber growth across Xbox Live and Game Pass helped to offset lower-than-expected performance from other third-party titles on the platform. Xbox hardware performed better than expected but declined year-over-year given the holiday launch of the Xbox One X a year ago. +In Surface, revenue increased 39% and 41% in constant currency to nearly $1.9 billion, ahead of our expectations, driven by strong growth across both our consumer and commercial segments. Search revenue ex TAC increased 14%, driven by Bing rate growth and increased volume in U.S. and international markets. Segment gross margin dollars increased 6% and 7% in constant currency, and gross margin percentage decreased due to sales mix to our lower-margin Surface and gaming businesses. Operating expenses declined 4%. As a result, operating income increased 18% and 19% in constant currency. +Now back to total company results. Capital expenditures, including finance leases, were down sequentially to $3.9 billion, lower than originally planned mainly due to quarter-to-quarter variability and the timing of cloud infrastructure build-out. Cash paid for plant, property and equipment was $3.7 billion. +Cash flow from operations increased 13% year-over-year driven by strong cloud billings and collections. Free cash flow was $5.2 billion and decreased 2% year-over-year, reflecting the timing of higher cash payments for plant, property and equipment. +Other income was $127 million, higher than anticipated, driven by interest income and investment gains partially offset by interest expense and net losses on foreign currency remeasurement. Our non-GAAP effective tax rate was slightly above 17%, in line with expectations. +And finally, we returned $9.6 billion to shareholders through share repurchases and dividends, an increase of 91%. Our Q2 share repurchase was $6.1 billion, higher than our normal quarterly pace and aligned to our commitment of incremental buyback to fully offset stock consideration issued in the GitHub transaction by the end of the fiscal year. +Now let's move to the outlook. For Q3, first, FX. With the stronger U.S. dollar and assuming the current rates remain stable, we now expect FX to decrease revenue and operating expense growth by approximately 2 points and decrease COGS growth by approximately 1 point. With the segments, we anticipate about 2 points of negative FX impact on revenue growth and Productivity and Business Processes and Intelligent Cloud and 1 point in More Personal Computing. +Second, continued strong customer demand, healthy bookings growth and increasing revenue annuity mix should drive another solid quarter in our Commercial business. Commercial unearned revenue is expected to decline approximately 2% to 3%, in line sequentially with historic trends. We expect commercial cloud gross margin percentage to continue to improve year-over-year as material improvement in Azure gross margin will again be partially offset by the mix of revenue toward Azure consumption-based services. +Third, CapEx. We expect a sequential dollar increase in capital expenditures as we continue to invest to support increasing demand. +Now to segment guidance. In Productivity and Business Processes, we expect revenue between $9.9 billion and $10.1 billion, driven by double-digit growth in Office Commercial and Dynamics as well as healthy LinkedIn growth on a strong prior year comparable. We expect Office Consumer revenue growth to continue to be in the low single digits as growth in Office 365 will be partially offset by the continuation of the consumer PC market headwinds. +For Intelligent Cloud, we expect revenue between $9.15 billion and $9.35 billion, with our hybrid demand continuing to drive strong growth in server products and cloud services. Azure growth will continue to reflect the balance between strong growth in our consumption-based businesses and moderating growth in our per-user business. +In More Personal Computing, we expect revenue between $10.35 billion and $10.65 billion, with a shift in revenue mix to our Surface and gaming businesses. +In Windows overall, OEM revenue growth should be in the low single digits as we anticipate continued market demand -- market impact from constrained chip supply in Q3. In Surface, continued momentum from Surface Pro 6, Surface Laptop 2 and Surface Go will drive another strong quarter of over 20% growth for Surface. +In search ex TAC, we expect revenue growth similar to Q2. In gaming, we expect revenue growth to be slightly higher than last quarter. Sales mix will shift to software and services where we expect healthy growth. +Now back to overall company guidance. We expect COGS of $10.35 billion to $10.55 billion and operating expenses of $10.1 billion to $10.2 billion dollars, inclusive of marketing spend that moved from Q2 to Q3. Other income and expense should be approximately $50 million as interest income is partially offset by interest expense. And finally, we expect our Q3 effective tax rate to be in line with the full year rate of 17%. +Now a few comments on our outlook for Q4 and the full fiscal year, which are unchanged from October. First on FX. In Q4, assuming rates remain stable, we expect FX to decrease revenue growth by approximately 2 points and COGS and operating expense growth by approximately 1 point. +Second, in Q4, we expect continued strong performance in our commercial cloud business; but as a reminder, we also have several challenging comparisons from the prior year, specifically in on-premise server, LinkedIn, Windows OEM and the strength of a third-party title in gaming. In terms of operating expenses, we continue to expect full year growth of roughly 8%. We will continue to invest in strategic growth areas like Azure, GitHub, Dynamics, the Power platform, LinkedIn, Teams and gaming content given our significant growth opportunities, competitive advantage and growing momentum. We still expect full year operating margin to be up slightly year-over-year, inclusive of the full GAAP impact of GitHub. +For CapEx, we continue to expect the growth rate for the year to moderate, even as we meet the high demand for our cloud services. We remain committed to an incremental share buyback beyond the normal quarterly pace that will fully offset stock consideration issued in the GitHub transaction by the end of the fiscal year. And finally, we still expect the full year effective tax rate to be roughly 17% with quarterly variability. +With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + A question on Azure, and it's a 2-parter, 1 part for Satya and 1 for Amy. Satya, there's been a lot of press releases of you up on the stage with CEOs from guys like Albertson and Walgreens talking about these large strategic deals that you're doing with these companies. Can you help us understand sort of how do these large strategic deals translate into sort of the services being used on Azure changing? Like is there a mix shift in the type of services that are supporting these large digital transformations that we should be sort of aware of on a going-forward basis? And to Amy, one of the sort of big investor debates is a lot of suppliers into -- on the big cloud vendors like yourself are talking about weaker shipments into the suppliers. But you guys have seen very stable growth. I mean, Azure growth was dead solid from Q1 to Q2. Can you help us understand how the sort of capital intensity of some of these cloud businesses has been changing over time? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure. First of all, thank you, Keith, for the question. It is very true that, at this point, we have seen these very large digital transformational efforts and projects that we are partnered with. And they span, quite frankly, all the industries. I think in the last quarter, you saw in health care, in retail, in financial services. In fact, I sort of internally think of them as what our relationships with our traditional OEM partners in the PC ecosystem were. At this point, some of the partnerships we have with customers are of that same magnitude. And that just speaks to, I think, what's happening in the economy, which is every company is becoming a digital company, and essentially what used to be COGS and operating expense is all going digital. From a mix of services, it starts always with, I would say, infrastructure, so this is the edge and the cloud, the infrastructure being used as compute. In fact, you could say the measure of a company going digital is the amount of compute they use. So that's the base. Then on top of that, of course, all this compute means it's being used with data. So the data estate, one of the largest things that happens is people consolidate the data that they have and so that they can reason over it. And that's where things like AI services all get used. So we definitely see that path of -- where they're adopting the layers of Azure. But it doesn't stop in Azure. In fact, if you take Walgreens Boots Alliance, it was Microsoft 365 as well as Azure. In many cases, it's Dynamics 365. Any IoT project on Azure leads to a Dynamics field service project in most instances. So we're seeing the breadth and depth of our cloud offering, which is what we are really architected to have real synergies in the context of what our customers want to achieve, and that's what we are seeing. And one comment before I throw it over to Amy. Even on that -- our own demand for it, we don't see any change. In fact, it's very healthy and we think that it'll continue to be healthy. And if anything, at our scale, as you can imagine, we are becoming much more efficient in how we use software to utilize the capacity we have. So we have significant gains in utilization across our estate. So with that, I'll turn over to Amy. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And Keith, the thing I would add in addition to Satya's comment about investing and investing materially to make these improvements in performance and utilization, we've always had and seen, as you all have gotten a bit used to, it can be a little bit lumpy quarter-to-quarter, and so we expect a sequential growth into Q3, which is really just a movement that happens from time to time. Our guidance, really, in terms of overall capital spend is unchanged from 90 days ago even if the timing of that can move month-to-month. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + Amy, I just wanted to ask you a question about your March quarter guidance. The total looks terrific. The only area that might decelerate a little bit appears to be the Intelligent Cloud segment, where 17%, I think at the midpoint, it implies still amazing but down from 20-plus percent the last 3 quarters. So I'm wondering if you could just focus on that for a second and help us understand what some of the variables inside that Intelligent Cloud business are that might be impacting next quarter growth. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Thanks, Karl. The first place to start is obviously FX. We've got a 2 point headwind on that range of 16% to 18%, so if you think about that and move your midpoint up to 19%. And then I think within that guidance, there's a reasonable amount of confidence that the server products and services KPI will remain quite healthy. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + I have a question for Satya and then one for Amy if you don't mind. Satya, in the different documents related to the earnings this quarter you have on product launches, et cetera, there's a discussion in there on the Microsoft launch of the Quantum Development Kit. Can you give us a bit of color on how you're thinking about quantum computing today, where the -- how soon the opportunity, where is it in the maturation? And then I have a follow-up for Amy. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [10] +-------------------------------------------------------------------------------- + + Sure. Thanks, Mark. So the way we think about our overall investment, I think of this as a systems investment because at the scale at which we operate, the Intelligent Cloud and the intelligent edge infrastructure, which you all track as Azure, you got to remember it's the core platform that's powering everything from our gaming ambitions to what we are doing with Microsoft 365, to what we are doing with Dynamics 365 and of course, our third-party business in Azure. So that's the core platform. And now when you think about the scale at which we operate, it is very important for us to make sure that every new breakthrough that happens in the system architecture that can improve efficiencies in what is distributed computing is something that we stay on the forefront of it. So that's why we have a very long-term view on Quantum, and the things that we did even in this last quarter is take things like the quantum simulator stuff and bring it to Azure. In fact, we are seeing very good adoption in scientific labs, in universities and some pharma companies and others who are looking at really building their quantum algorithmic promise long before the quantum computer [cloud] is real so that they are ready to be able to take advantage of that computing resource. So that's how we look at it, but you got to remember that before Quantum, there are many byproducts of a quantum effort that have significant implications on how we get more competitive, efficient in terms of providing computing to the world. So that's one of the reasons why you hear us talk about quantum as the long-term goal, but you can fully expect us to take a lot of learnings, advances in that roadmap and bring them to market earlier. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [11] +-------------------------------------------------------------------------------- + + I really appreciate it. Amy, you gave a lot of color this quarter, but in the quarter, there was overall transactional weakness. Can you give us a little more color? Is there something structural driving it, U.S. government, China weakness? Were there just simply less contracts up for renewal? Or is it the cloud? Any additional data would be helpful. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Thanks, Mark, for the question. The only transactional weakness I felt in the quarter at all was what we covered, which was the OEM impact from the chip supply, which was about 1.5 points of growth on MPC, and the Office Consumer impact, which was secondary impact of the PC environment plus some execution challenges we had that I feel really good that we've gotten to the root of and will get handled in H2. Outside of that, our transactional execution was really precisely as we expected. Office Commercial actually had a pretty reasonable quarter given some of the impacts we had in Q1, a couple of points of impact of extra growth that we talked about. And the product and services KPI on prem and server was also quite good when we think about the balance and what that represents for hybrid demand. We continue to see good demand on DC -- sorry, data center modernization as well as some of the premium SKUs. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Just wanted to focus on Windows. Amy, I think you've guided to low single-digit growth in Windows OEM revenue for Q3. And just wondering if you can sort of help us bridge that because you also talked about inventory levels, Windows being low in the OEMs as well as some mix. So maybe kind of help us bridge the gap between your comments about maybe continued storage as a component but -- the revenue growth. And then the other side of Windows, the Commercial, obviously it's been super strong, but we're starting to lap some -- there's some pretty big growth numbers Q3, Q4 last year, and then, obviously, there's some accounting change with 606. Maybe give us some color there. So I guess, one, on the OEM side and then, two, on the commercial side. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Great. Thank you. On the OEM side, the way to think about those comments is we do expect inventory levels to likely remain low as we exit the next quarter as well. So think about there having -- because your -- we do expect chip supply to remain constrained. I don't expect to see any impact from changing inventory levels through the next quarter. So I would sort of remove that as one of the mechanisms you're thinking about on overall OEM demand. I do think what we will see in Q3 is we're expecting a little better performance in the Pro side of the market in terms of seeing growth there, and that's probably helping a little bit. To your second question on Office -- I'm sorry, on Windows Commercial overall, our real investment -- and you're right, we are starting to reach some tougher comparables. But a lot of that comparability, which you referenced, is due a little bit of how it's licensed, which is a lot of this is new and gets recognized more upfront in quarter. That's going to continue to have some lumpiness still as we go over the years. As that business continues to grow, it'll get less of that impact. The primary driver in terms of billings is how I tend to think about that, has been pretty consistent. It's been double-digit consistent growth. It tends to look a lot like our Office 365 motion. It's sold with Microsoft 365. It's about the selling motion of E3 and E5 that we talk about. If you could almost take out that 606 impact in the billings team to almost mirror the Microsoft 365 SKUs we sell. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jennifer Lowe with UBS. + +-------------------------------------------------------------------------------- +Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [17] +-------------------------------------------------------------------------------- + + I appreciate getting the sort of visibility you have into the, as someone earlier alluded to, transactional businesses. It sounds like you feel pretty good or at least stable about the PC outlook for the remainder of this year. But given that Windows is a pretty material driver of profitability at Microsoft, if we do start to see a more protracted decline in PC unit sales and you think about your investments going out through the remainder of this calendar year, are there opportunities to sort of flex down the cost structure at this point to preserve profitability in margins? Or should we assume that much of the investments happening right now are really tied to the commercial cloud and some of the lower margin but higher opportunity businesses and maybe there isn't so much of an offset? Just how should we think about contingency planning if we do see a weaker -- an extended weakening in the global economic climate? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [18] +-------------------------------------------------------------------------------- + + Let me start, and Amy, you can add to it. See, first of all, I'd say the opportunity for our shareholders when they think about Microsoft has never been better. When I look at every business becoming a digital business and then take that opportunity and map that to our capability, we have the broadest platform of anyone in the tech sector to really help every customer in every country become that digital business. And we have the business model that aligns with them and their interests and the trust. And so therefore, from a secular perspective, we are all in on making sure that we invest in our commercial cloud as well as our investments in things like gaming and going after the opportunity that is there in front of us. And as you even think about Microsoft 365, the value proposition of Microsoft 365 transcends Windows and Office on Windows. We think about the relevance of our applications across all device sockets. We think about the security, identity management, information protection and all that value across all device sockets, so therefore, I feel very, very good about the product investments and the go-to-market investments we are making to really help our shareholders realize that growth potential that's available in what is going to be an increasingly digital world. And I'll let Amy answer. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [19] +-------------------------------------------------------------------------------- + + Let me just add a little bit, Jennifer, when it comes to really your question around OEM. We know that the signals we get from especially our commercial customers is that there's a healthy demand for the value that exists in Windows 10. We're seeing it in terms of deployments on new and existing devices and the security and manageability value prop that comes with a modern device and the experiences that employers want their employees to have and be able to take advantage of, along with some of the end-of-support deadlines that we have talked about, there is still an opportunity for us to remain focused on and execute on through this calendar year. And I still feel quite good about that, including the signals we're getting in the market. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [21] +-------------------------------------------------------------------------------- + + I wanted to focus on the data and database side of your business. We saw the acquisition this quarter of the Postgres company. If you think about the ecosystem around the world, a lot of the cloud guys are talking a lot about database. Can you kind of maybe talk a little bit what you see around Cosmos, the whole database offering that you have and what you see in terms of client adoption there? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [22] +-------------------------------------------------------------------------------- + + Yes, we feel very, very good about the data platform and the portfolio we have, whether it's on the relational side with obviously SQL and now Postgres support. And then our Cosmos DB has become the leading multi-model, multi-region database. And so therefore, I feel very, very good, as I said even earlier, whenever these customer digital transformation projects start, they start by really getting their data into shape. And what that means is you bring all the data in its native format. You need the full comprehensive platform and then the ability to able -- to do things like AI and analytics on top of all of this data. So our data platform growth as well as competitiveness is very good and increasing. And we're the only provider still who can do this in a hybrid way. That is the consistency between what happens at the edge to the cloud when it comes to data tier becomes even more important as edge scenarios become very, very real. So therefore, I feel very good about our data story in Citus, which is the company we just bought for the Postgres capability, is something that we are very excited about. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Walter Pritchard with Citi. + +-------------------------------------------------------------------------------- +Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [24] +-------------------------------------------------------------------------------- + + Question on Azure and growth numbers this quarter were very strong. I'm wondering if you can talk about just your visibility into the growth in that business. A lot of that comes from enterprise agreements and commitments customers are making. Some of that's on sort of credits that they have to consume. I'm not sure if you're willing to give us sort of a growth kind of trajectory as you look out forward, but I think there's a lot of investor interest in terms of how much visibility +(technical difficulty) +your perspective. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Maybe I'll start, Satya. In terms of the Azure growth, most of the Azure growth is really driven by consumption. So this is about getting projects started, making those projects successful, making sure customers feel the value and get the value of their investment. And increasingly, that's why we've been talking a bit about the form of these contracts changing, larger commitments being made that are -- that land in bookings but not in unearned, right? So it's a bit different mechanism than you think about having in our standard EA, where it goes to the balance sheet and gets earned off. These are contracts that unless it is used and deployed and a customer gets value from, it does not land into the P&L. And so the part that looks a little bit more EA-like is the part we've talked about on a per-user basis, right? That's something you're going to deploy, whether that's EMS, is the best example. And so those have the characteristic you talk about, which is that it really comes from the EA and the recognition is more predictable. But on the IaaS and PaaS layer, that's about our execution each quarter and especially making an impact. The way that -- the only other way that, that Azure number, to think about it, is when we've talked about the Azure Hybrid Benefits that exist, those show up actually in the on-prem number, right, even if they ultimately get used on the Azure side. So there actually is some Azure Benefit revenue ultimately that shows "is on-prem." + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [27] +-------------------------------------------------------------------------------- + + Satya, in the last couple of quarters, you have announced a number of these large multiyear Azure wins with companies, including Walmart and Albertsons and Walgreens, as Keith mentioned earlier. I'm just curious whether you're sensing an amplified tailwind there due to Amazon's ambitions to actually compete with grocers and retailers and health care providers and other industries. And then, Amy, I am assuming that those wins are captured by this robustness that we're seeing in the commercial bookings growth, which is up 22%. But I guess, I don't understand if they're fully captured, if this is a consumption-based structure. Or are we only seeing a portion of those bookings if we look in the unearned revenue and in the KPI? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Okay, I'll start. I mean, the first thing is to -- we need to have product truth and product competitiveness and capability to, first of all, play, and that's where I'll start. We have a very, very good compelling platform across our commercial cloud. That's what's really leading us to be able to do these types of partnerships that you referenced. It's clear that we also have a fantastic alignment of our business model with the interest of our customers. In other words, we want to make sure that we are, in fact, making our customers fully capable digital companies in their own right, whether they're in retail, whether they're in oil and gas, whether they're in health care because that's really what's in our long-term interest, which is to ensure that they have full digital capability, and then they'd use the subscriptions and the consumption capabilities of our cloud. And of course, that means we have a trusted relationship, which is a competitive advantage in a world where some of our competitors have more complex business models, where in some cases they give them platforms, in other cases where they compete with them or tax them. That's definitely something that I'm sure our customers pay attention to. But we are very focused on making sure that we have the right product that's competitive in the marketplace and then our business model that's long-term aligned with the interest of our customers, and we'll stay focused on it. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [29] +-------------------------------------------------------------------------------- + + And to your second question, most of these larger contracts are showing up in that commercial bookings number, and we referenced that on these -- when we say the longer -- larger, longer-term contracts, that is where they show up. Very little shows up in unearned, and that's the distinction that we're starting to see in many of these Azure contracts. It will, as it gets used, go straight to that Azure revenue growth number on the P&L. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [31] +-------------------------------------------------------------------------------- + + Satya, of late, you talked about Microsoft 365 being the new operating system, and I know you talked a bunch about that today. But as you think about going after the front-line worker, people you could not get to previously, how should we think about the TAM expansion from that from a seat standpoint? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [32] +-------------------------------------------------------------------------------- + + Yes, a good example of the first-line opportunity was something that you could have seen at NRF this January. We launched, for example, Teams for first-line workers, which had things like shift worker capabilities, secure messaging. One of the challenges in retail and in many other industries is what's that messaging tool that has actually got the security framework that they expect of any other enterprise tool as opposed to using one of these consumer messaging tools, which then all the liability is with the enterprise. So that's the opportunity we see, whether it's -- for all front line, whether it's in manufacturing, whether it's in retail, whether it's in healthcare. So that's the TAM expansion. So in other words, it can be -- start with Teams. It can start with some of our devices in the first-line worker. For example, one of the things that we see the most traction for HoloLens is with first-line workers. People in manufacturing and other in field service, where they were never issued a standard laptop or even a phone are being issued a HoloLens as their first computing device, and that's just because of the productivity it drives. So those are the kinds of TAM expansion we see across Microsoft 365. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our final question will come from the line of Alex Zukin with Piper Jaffray. + +-------------------------------------------------------------------------------- +Aleksandr J. Zukin, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [34] +-------------------------------------------------------------------------------- + + Satya, you guys reorganized the sales and customer service organization about 18 months ago quite substantially, and you're now seeing the benefits both around much larger deals and broader deals that we've discussed on this call for your products across the portfolio. I wanted to ask, as the deal complexity increases, are you seeing any impact to your sales cycles as a result? And is there any impact that you're seeing on sales cycles maybe not from that but from kind of the macro volatility that we've seen in the headlines? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [35] +-------------------------------------------------------------------------------- + + I mean, overall, a lot of our transformation, whether it's on the engineering side or on the marketing side or on the sales side, have all been driven by the opportunity we see with the broad platform capabilities we have across all of our commercial clouds, whether it's Azure or Dynamics 365 or Microsoft 365. So it is true that the deals are much broader, deeper. The relationships with the customers that we have now signed up with span a lot more of our capability and also drives a lot more of their own ambition. So for sure, the sales cycles are different. But at the same time, you've got to remember, at Microsoft, we do have a lot of different business that we do with the customers, which may include some things like refreshes of their on-premise infrastructure all the way to some very high-ambition digital transformation projects. So I would say we are well equipped to deal with that complexity and the variability of what our customers want us to be helping them with. And that's where a lot of the transformation we have done internally is helping us accelerate our Cloud business. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [36] +-------------------------------------------------------------------------------- + + And I think the way we've seen this in the field is -- and our sales organization has been not unlike some of these Dynamics transactions or the Power platform transactions that require a fundamental understanding of business process and the changes you're trying to implement. Those do naturally have longer sales cycles. Azure has many of those same attributes at the higher end of the complexity and digital transformation Satya's talking about. And in these very large transactions, many of which we've been signing recently, where you'll see some of that volatility would be in bookings. But I think, in general, the goal is to have -- and continue to build on that business, but certainly, that would be where the "volatility" would show up. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [37] +-------------------------------------------------------------------------------- + + Okay. Well, thanks, Alex. That wraps up the Q&A portion of today's earnings call. Thank you for joining us, and we look forward to speaking with all of you soon. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [38] +-------------------------------------------------------------------------------- + + Thank you all. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [39] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2019-Jul-18-MSFT.txt b/Transcripts/MSFT/2019-Jul-18-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..182bafbb2a7f45a3f26e5fe01dac04bbb9e2dd6e --- /dev/null +++ b/Transcripts/MSFT/2019-Jul-18-MSFT.txt @@ -0,0 +1,413 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Microsoft Corp Earnings Call +JULY 18, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brent Alan Bracelin + KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Jennifer Alexandra Swanson Lowe + UBS Investment Bank, Research Division - Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Microsoft Fiscal Year 2019 Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +I would like to turn the call over to Mike Spencer, General Manager of Investor Relations. Thank you. Please proceed. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we'll refer to growth rate only. +We will post our prepared remarks to the website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we'll be making forward-looking statements which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors sections of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. +It is a strong finish to a record fiscal year. We delivered more than $125 billion in revenue for the full year with double-digit top line and bottom line growth. Our commercial cloud business is the largest in the world, surpassing $38 billion in revenue for the year with gross margin expanding to 63%. I'm proud of what we've accomplished over the last 12 months and I'm energized by the tremendous opportunity ahead. +Every day, we work alongside our customers to help them build their own digital capability, creating new businesses with them, innovating with them and earning their trust. This commitment to our customers' success is resulting in deeper partnerships, larger multi-year cloud agreements and growing momentum across every layer of our differentiated technology stack from application infrastructure to data and AI to business process to productivity and collaboration. +Now I'll briefly highlight our innovation and momentum. In a world where every company is a software company, developers will play an increasingly vital role in value creation across every organization. And GitHub is their home. GitHub is used by more than 36 million developers as well as the largest enterprises, including a majority of the Fortune 50. And we're investing to build the complete toolchain for developers, independent of language, framework and cloud. Visual Studio and Visual Studio Code are the most popular code editing tools in the world. With Azure DevOps, you can build, test and deploy code to any platform. And with Azure PlayFab, we have LiveOps, a complete backend platform to optimize engagement and interaction in real-time. +We are building Azure as the world's computer, addressing customers' real-world operational sovereignty and regulatory needs. We have 54 data center regions, more than any other cloud provider, and we were the first in Middle East and in Africa. Azure is the only cloud that extends to the edge, spanning identity management, security and infrastructure. This year, we introduced new cloud to the edge services and devices from Azure Data Box Edge to Azure Stack HCI to Azure Connect, bringing the full power of Azure to where data is generated. +Azure Sphere is a first-of-a-kind edge solution to secure the more than 9 billion MCU-powered endpoints coming online each year. And now IoT plug-and-play seamlessly connects IoT devices to the cloud without having to write a single line of embedded code. Azure is the most open cloud and this quarter, we expanded our partnerships with Oracle, Red Hat and VMware to make the technologies and tools customers already have first class on Azure. +Azure is the only cloud with limitless data and analytics capabilities across the customers' entire data estate. The variety, velocity and the volume of data is increasing, and we are bringing hyperscale capabilities to relational database services with Azure SQL database. New analytics support in Cosmos DB enables customers to build and manage analytics workloads that run real-time over globally distributed data. And we offer the most comprehensive cloud analytics from Azure Data Factory to Azure SQL Data Warehouse to Power BI. +The quintessential characteristic of any application being built in 2019 and beyond will be AI. We are democratizing AI infrastructure tools and services with Azure Cognitive Services, the most comprehensive portfolio of AI tools so developers can embed the ability to see, hear, respond, translate, reason and more into their applications. And this quarter, we introduced a new speech-to-text, search, vision and decision capabilities. New updates to Azure ML streamlined the building, training and deployment of machine learning models, bringing a no-code approach to machine learning. +Our differentiated approach from developer tools and infrastructure to data and analytics to AI is driving growth. The world's leading companies trust Azure for their mission-critical workloads, including more than 95% of the Fortune 500. And just yesterday, AT&T chose our cloud in one of the largest cloud commitments to date. +Now let's move up the stack to business process. We are redefining business processes with Dynamics 365 and Power Platform with modern, modular, extensible and AI-driven applications. Dynamics 365 uniquely enables any organization to create digital feedback loops and take data from one system and use it to optimize the outcomes of another, enabling any business to become an AI-first business. Our Open Data Initiative with SAP and Adobe builds on this promise, giving customers like Coke, HP, Unilever and Walmart a single 360-view of their customers built on one data model on one data lake, eliminating data silos and driving real-time insights at scale. +This year, we introduced Dynamics 365 AI, a new class of AI applications built for an era where systems of record are converted into systems of engagement and intelligence. The citizen developer movement is here and we are empowering it. 500 new -- 500 million new apps will get created in the next 5 years and more than the total created in the last 40. Businesses will need to empower domain experts with tools to create applications as well as robotic process automation to streamline and customize workflow like service monitoring and time and expense tracking. +Our Power Platform, spanning Power BI, Power Apps and Flow, is the only solution of its kind in the industry. It brings together low-code, no-code app development, robotic process automation and self-service analytics into a single comprehensive platform. Chevron has gone from 80 users of Power Apps to 5,500 in a year and now has over 200 apps in production. +This quarter, we introduced AI Builder, adding AI capabilities like object recognition to any Power App. And with Power BI, we are the leader in business intelligence in the cloud with more than 25 million models hosted on the service and 12 million queries processed each hour. We are enabling our customers to digitize not only their business processes but to bridge the physical and digital worlds with our investments in Mixed Reality cloud. Spanning HoloLens 2, Azure Spatial Anchors and Dynamics 365 applications, we are seeing traction in every industry from manufacturing to retail to gaming. Airbus alone is pursuing more than 300 use cases from training to design to remote assistance. All this innovation is fueling rapid growth with more than 90% of the Fortune 500 using Dynamics 365 or Power Platform. +Now to LinkedIn. People are an organization's most valuable asset. Our strong talent portfolio from Talent Solutions and Talent Insights to employee engagement with Glint to LinkedIn Learning enables every organization to attract, retain and develop the best talent in an increasingly competitive jobs market. New capabilities help job seekers find and land more relevant and higher-paying jobs through alerts, deeper insights and the new suite of interview prep tools, contributing to another quarter of record job postings. +Marketing solutions is now our fastest-growing business with new brand and community-building tools that make it easier for marketeers to connect with LinkedIn's 645 million members. And we are enabling every business to drive a culture of relationship selling and take full advantage of their social networks with the combination of Dynamics 365 and LinkedIn Sales Navigator. All this innovation contributed to another record year for LinkedIn driven by all-time high engagements across the platform. +Now turning to Microsoft 365. Microsoft 365 is the world's productivity cloud. It empowers everyone, including the 2 billion first-line workers around the world with an integrated, secure AI-infused experience on any device. It's the only comprehensive productivity and collaboration communication solution that integrates with an organization's critical business process workflows. +Multinationals from L'Oréal and Walgreens Boots Alliance to the largest chemical producer in the world, BASF, all chose Microsoft 365 this year. And over the last 2 quarters, our premium offerings gained momentum with S&P Global, CenturyLink and KPMG all selecting Microsoft 365 E5. Microsoft Teams has had a breakout year. Teams now has more than 13 million daily active users and 19 million weekly active users. It brings together everything a team needs, chat, voice, meetings, collaboration with the power of Office apps and the business process workflow into a single integrated user experience, scaffolding, eliminating the need for discrete apps that only increase an organization's security and compliance exposure. +And we are broadening our opportunity, bringing Teams to new under-penetrated markets, including health care, hospitality and retail as well as first-line workers. We are empowering them with mobile tools in Teams like shift scheduling and priority notifications. +And we are infusing AI across Microsoft 365 to enable new automation, prediction, translation and insight capabilities. Meetings are now more inclusive in Teams. Presentations are more accessible in PowerPoint. Videos, more searchable in stream; and e-mails, more relevant in Outlook. And with Workplace Analytics and Microsoft Search, we take our relationship schedules and activities and distill insights and knowledge to help people work smarter, not longer. +We are investing in cybersecurity to protect customers in today's zero trust environment. Microsoft is the only company that offers end-to-end security, spanning identity, device endpoints, information, cloud application as well as infrastructure. It starts with Azure Active Directory and builds with 3 new services we introduced this year: Microsoft Threat Protection, Azure Sentinel and Azure Confidential Computing. We expanded our family of category-creating Surface devices this year, including the new Surface Go and Surface Hub 2S. And Windows 10 is active on more than 800 million devices with accelerating adoption in the enterprise as the most secure and productive operating system. +Finally, gaming. We're investing to empower the world's 2 billion gamers to play the games they want with anyone, anywhere on any device with our new game streaming service, Project xCloud, which will enter public trials this fall, Xbox Live monthly active users increased to a record 65 million with the highest number of mobile and PC users to date. We are bringing one of the world's most popular video games to a new generation of mobile gamers with Minecraft Earth and Mixed Reality. And we nearly doubled our first-party game studios this year to deliver differentiated content for our fast-growing subscription services like Xbox Game Pass now available on both console and PC. +In closing, I'm optimistic of what's ahead. We are accelerating our innovation to deliver differentiated value to customers across the cloud and the edge from GitHub to Azure to Dynamics 365 to Microsoft 365 as well as Xbox Game Pass. We're investing in the right secular trends to expand our opportunity, and we are working to earn our customers' trust every day. +With that, I'll hand it over to Amy who'll cover our financial results in detail and share our outlook. I look forward to rejoining you after for questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. +Our fourth quarter revenue was $33.7 billion, up 12% and 14% in constant currency. Gross margin dollars increased 15% and 17% in constant currency. Operating income increased 20% and 24% in constant currency. This quarter, we transferred intangible properties from our foreign subsidiaries to the United States and Ireland which resulted in a net tax benefit of $2.6 billion. When adjusting for this and the net benefit related to the Tax Cuts and Jobs Act from the fourth quarter of FY '18, earnings per share was $1.37, increasing 21% and 24% in constant currency. +In our largest quarter of the year, our sales teams and partners delivered exceptional commercial results, which drove another quarter of double-digit top and bottom line growth. From a geographic perspective, we saw broad-based strength across markets of all sizes. Customer commitment to our cloud platform continues to grow. In FY '19, we closed a record number of multi-million-dollar commercial cloud agreements with material growth in the number of $10 million-plus Azure agreements. +Commercial bookings growth was significantly ahead of expectations, increasing 22% and 25% in constant currency, driven by strong renewal execution and an increase in the number of larger long-term Azure contracts. As a result, our contracted-not-recognized revenue was $91 billion, up 25% year-over-year, reflecting our continued momentum and growing long-term customer commitment. +We expect to recognize approximately 50% of this revenue in the next 12 months. Even with the higher mix of larger long-term Azure contracts with low upfront billings, commercial unearned revenue was in line with expectations at $34.1 billion, up 13% and 16% in constant currency. And this quarter, our annuity mix was again 90%. +Commercial cloud revenue was $11 billion, growing 39% and 42% in constant currency. Commercial cloud gross margin percentage increased 6 points year-over-year to 65%, driven again by significant improvement in Azure gross margin. +The company gross margin percentage was 69%, up 2 points year-over-year and ahead of our expectations, driven by sales mix to commercial licensing and OEM. In line with expectations, foreign exchange reduced revenue growth by 2 points and COGS and operating expenses growth by 1 point. Operating expenses grew slightly ahead of expectations, increasing 9% and 10% in constant currency, driven by continued investment in cloud and AI engineering, LinkedIn and GitHub. Operating margins expanded again this quarter as a result of strong revenue growth, improving gross margin and disciplined decisions we've made over the past 5 years to invest in strategic and high-growth areas. +Now to our segment results. Revenue from Productivity and Business Processes was $11 billion, increasing 14% and 17% in constant currency, ahead of expectations, driven by both our cloud and on-premises businesses. Office commercial revenue grew 14% and 16% in constant currency, including roughly 4 points from a greater mix of contracts with higher in-period recognition that benefited both our cloud and on-premises business. +Office 365 Commercial revenue grew 31% and 34% in constant currency, driven by installed base expansion across all workloads and customer segments as well as ARPU growth from our customers' continued shift to our E3 and E5 offerings. Office 365 Commercial seats grew 23% on a prior year comparable that included the strong performance of our Microsoft 365 academic offers. Office consumer revenue grew 6% and 8% in constant currency with 4 points of growth from transactional sales in Japan. Office 365 Consumer subscriptions grew to 34.8 million. +Our Dynamics business grew 12% and 15% in constant currency, driven by Dynamics 365 growth of 45% and 48% in constant currency. LinkedIn revenue increased 25% and 28% in constant currency with continued strength across all businesses, highlighted by marketing solutions growth of 42%. LinkedIn sessions grew 22% with record levels of engagement and job postings again this quarter. +Segment gross margin dollars increased 16% and 20% in constant currency, and gross margin percentage increased 1 point year-over-year as improvements in LinkedIn and Office 365 margins more than offset increased cloud mix. Operating expenses increased 8% or 9% in constant currency, driven by continued investment in LinkedIn and cloud engineering. Operating income increased 25% and 31% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $11.4 billion, increasing 19% and 21% in constant currency. Our on-premises server business drove our better-than-expected performance. Continued customer demand for our differentiated hybrid solutions drove strong server product and cloud services revenue growth, increasing 22% and 24% in constant currency on a significant revenue base. +Azure revenue increased 64% and 68% in constant currency with another quarter of strong growth in our consumption-based business and continued moderation in our per-user business. And our on-premises server business grew 5% and 7% in constant currency with roughly 4 points from stronger-than-expected demand ahead of the end of support for SQL Windows Server 2008 as well as continued strength across hybrid offerings, premium version and GitHub. +Enterprise Services revenue increased 4% and 6% in constant currency, driven by growth in Premier Support Services. Segment gross margin dollars increased 19% and 21% in constant currency. Gross margin percentage was flat year-over-year as another quarter of material improvement in Azure gross margin offset the growing mix of Azure IaaS and PaaS revenue. +Operating expenses increased 23% and 24% in constant currency driven by ongoing investments in cloud and AI engineering and GitHub as well as revenue-driven expenses given the strength of the quarter. Operating income increased 15% and 19% in constant currency. +Now to the More Personal Computing segment. Revenue was $11.3 billion, increasing 4% and 6% in constant currency, ahead of expectations as better-than-expected performance in Windows more than offset lower-than-expected gaming and search revenue. In Windows, OEM non-Pro revenue declined 8%, below the consumer PC market, with continued pressure in the entry level category. OEM Pro revenue grew 18%, ahead of the commercial PC market, driven by healthy Windows 10 demand, strong momentum in advance of the Windows 7 end of support and roughly 4 points of benefit from increased inventory levels due to uncertainty around tariffs. Therefore, inventory levels ended the quarter above the normal range. +Windows commercial products and cloud services grew 13% and 16% in constant currency with strong double-digit billings growth and a higher mix of in-quarter recognition from multi-year agreements. In Surface, revenue grew 14% and 17% in constant currency driven by strength in our commercial segment, particularly in the U.S., Japan and Canada. +Search revenue ex TAC increased 9% and 10% in constant currency, below expectations driven by lower-than-expected volume. In gaming, revenue declined 10% and 8% in constant currency, below expectations driven by lower console sales and monetization across third-party titles. Xbox software and services revenue declined 3% and 1% in constant currency, with the tough comparable from a third-party title in the prior year offsetting continued momentum in Xbox Live and Game Pass subscriber growth. +Segment gross margin dollars increased 8% and 10% in constant currency, and gross margin percentage increased 2 points due to sales mix shift to our higher-margin Windows businesses. Operating expenses declined 2% and 1% in constant currency. As a result, operating income grew 18% and 22% in constant currency. +Now back to the total company results. As expected, capital expenditures including finance leases were up sequentially to $5.3 billion driven by ongoing investment to meet demand for our cloud services. Cash paid for PP&E was $4.1 billion. Cash flow from operations increased 41% year-over-year driven by strong cloud billings and collections and roughly 8 points benefit from tax payments made in the prior year. Free cash flow was $12 billion and increased 62% year-over-year, reflecting strong operating cash flows and timing of cash payments for PP&E. +For the fiscal year, we generated over $52 billion in operating cash flow and $38 billion in free cash flow driven by improving margins and operating leverage across our businesses as well as operating improvements to better optimize cash flow. +Other income was $191 million, higher than anticipated due to recording of mark-to-market gains. As a reminder, under the recently adopted accounting standards for financial investment, we're required to recognize unrealized gains and losses on our equity portfolio. As a result, we expect increased quarterly volatility in other income and expense. Our non-GAAP effective tax rate came in slightly lower than anticipated at 16%. And finally, this quarter, we returned $7.7 billion to shareholders through share repurchases and dividends, an increase of 45%, bringing our total cash return to shareholders to over $30 billion for the full fiscal year. +Now let's move to the outlook, starting with Q1 where we expect another strong commercial quarter. Assuming current rates remain stable, we expect FX to decrease total company, Productivity and Business Processes and Intelligent Cloud revenue growth by approximately 2 points and More Personal Computing revenue and total company COGS and operating expenses growth by approximately 1 point. In our commercial business, we expect continued customer demand to drive commercial unearned revenue up 11% to 12% year-over-year with volatility based on contract type. Commercial cloud gross margin percentage will be up slightly on a sequential basis, and we expect capital expenditures to be roughly line in with Q4 as we continue to invest to meet growing demand for our cloud services. +Now to segment guidance. In Productivity and Business Processes, we expect revenue between $10.7 billion and $10.9 billion driven by double-digit growth in Office Commercial, Dynamics and LinkedIn. In Intelligent Cloud, we expect revenue between $10.3 billion and $10.5 billion. In Azure, revenue growth will continue to reflect the balance of strong growth in our consumption-based business and moderating growth in our per-user business. Our on-premises server business will be driven by demand for our hybrid solutions and premium offerings as well as the continued benefit from the end of support for SQL Server and Windows Server 2008. +In More Personal Computing, we expect revenue between $10.7 billion and $11 billion. In Windows, overall OEM revenue growth should be slightly ahead of the PC market driven by healthy commercial demand. Surface revenue will decline slightly year-over-year driven by product life cycle transition. Search ex TAC revenue growth should be roughly in line with Q4. And in gaming, we expect revenue to decline year-over-year at a similar rate to Q4 as we move through the end of this console generation and a challenging Xbox software and service comparable from a third-party title in the prior year. +Now back to overall company guidance. We expect COGS of $10.55 billion to $10.75 billion and operating expenses of $10.1 billion to $10.2 billion. In other income and expense, interest income and expenses should offset each other. Next, we expect our Q1 effective tax rate to be slightly lower than our full year expected tax rate of 17% due to the volume of equity vests that take place during our first quarter. +And finally, as a reminder on Q1 cash flow, we will be making a $4.7 billion tax payment related to TCJA transition tax and the Q4 transfer of intangible property. +Now I'd like to share some comments on FY '20. First, FX. Assuming that current rates remain stable, we expect FX to reduce full year revenue and COGS growth by 1 point. FX should have no impact on operating expense growth. Next, revenue. At the company level, we continue to expect double-digit revenue growth with another year of strong performance and continued momentum in our commercial business. As a reminder, our commercial, licensing and OEM Pro businesses in the second half of the year will be impacted by a comparable that benefited from the end of support of SQL Server 2008, Windows Server 2008 and Windows 7 as well as transactional strength in Japan. +We expect revenue in our gaming business to be down slightly year-over-year as double-digit growth in Xbox software and services will be offset by declining console sales. We do expect a stronger H2 than H1 in gaming as we work through a third-party titles comparison. And as a reminder, an increasing number of large long-term Azure contracts will drive more quarterly volatility in our commercial bookings and unearned revenue growth. +Next, commercial cloud gross margin. Revenue mix will continue to shift to our Azure consumption-based services. Even with this headwind, we expect commercial cloud gross margin percentage to be up slightly as we again drive meaningful improvement in Azure gross margin. Capital expenditures will increase to meet the growing demand for our cloud services. +Finally, on operating expenses. We will continue to invest, given our strong execution, our growing competitive position and our significant ambition in high-growth areas. Investment in areas like cloud through AI and GitHub, business applications through Dynamics, Power Platform and LinkedIn, Microsoft 365 through Teams, Security and Surface as well as gaming, should result in operating expense growth of 11% to 12%. Even with these strategic investments, the continued shift to our cloud business and our very strong finish to FY '19, we expect double-digit operating income growth as well as stable operating margins. We are looking forward to FY '20. +With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. (Operator Instructions) Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + And very nice end to a really strong FY '19. I wanted to focus on the Office 365. If I'm looking at this right, I think you guys saw acceleration in the Office 365 Commercial business. And the kind of recipe to get in there seemed to have changed a little bit in that it's more sort of positive pricing versus just the seat growth. Is there a changing dynamic in kind of what's pushing growth there? Because we had seen the F1 SKU and the frontline workers bringing down the price point a little bit. It looks like the pricing actually improved this quarter. How should we think about sort of the dynamics and what's going to be driving growth for Office 365 into FY '20 and beyond? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Keith. Let me walk through a little bit of this because there are some new behaviors that I think are important this quarter. But the fundamentals that you talked about are relatively unchanged. We continue to see and saw again installed base growth across all of our customer segments from the enterprise to small business. That's happening not just because of frontline workers but also continued expansion and continued movement in every segment where we see the opportunity to increase the installed base. +We did see ARPU growth this quarter. It wasn't as much different from past quarters. We continue to see improvement from E3 and E5 transition, saw both again. And I think we were quite encouraged by E5 performance particularly in Q4 as we ended the quarter, which was great to see. What you saw a little bit, and I referred to it, was some more in-quarter recognition, but let me talk about why that's happening because it's got 2 important and positive trends that underlie it. +The first thing is we're seeing longer commitments. When you say longer commitments under 606, you often have more recognition upfront. And so we saw longer commitments and we got a little bit more recognition in the quarter, and so you saw then revenue grow a little faster. The other thing that we saw is increasing focus. As we were having more conversations across organizations around Azure and rethinking their digital transformation plans with us, it opens up a very large conversation around the value Microsoft 365 can bring as people go through and think about those transitions. +And so the fact that we -- then we're often seeing extensions take place of prior commitments on Office 365 to again be longer and include the Azure contracts. When that happens, it's almost like they're adding new product and new value and a lot of that gets recognized faster in-quarter when you see that happen. And so when you have a dynamic where you're seeing longer contracts plus you're able to sell more and new things and I think different conversations around Microsoft 365, it was a good execution by the team and I think a recognition of the value that we continue to put into that what we believe is our hero experience. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + And congratulations not only on the great end to the year but confidence into next quarter and next year in terms of growth, investment, et cetera. We met recently at E3 with your gaming team and heard a lot about the steps that were being taken. Satya, can you give us more color explanation on how you see the gaming business fitting into the overall company's direction over the next few years? Specifically, how does gaming change? How does the synergy between gaming and the rest of the business change? How should we think about that overall mix and that whole morph that's going to occur? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [6] +-------------------------------------------------------------------------------- + + Sure. First, I would say we are in gaming because of what we believe are going to be the secular changes in the gaming addressable market for us. We've always had a gaming position with console as well as the PC. But going forward, we think that any endpoint can in fact be a great endpoint for high-end games, which is where our structural position is. And we now have a business model with Game Pass as well as all the supporting mechanisms for Game Pass like game streaming. We have a social network in Xbox Live that is the best in the business. So I feel we are well positioned to what is going to be a much larger market than what was traditionally gaming in spite of all the success we've had over the years in gaming. +Now the second point is that it builds on the rest of the cloud investment. So if you think about what we are doing with xCloud, it's a hero workload on top of Azure. So when we think about capital allocation, what's happening in the cloud, what's happening in the edge, how we build the network to optimize the streaming, the same infrastructure, for example, is what Sony has decided to use as well and be on Azure as well as use our AI capabilities. So you'll see significant synergies in terms of the architectural platform underneath gaming, Microsoft 365, Dynamics 365, LinkedIn all being the same. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [8] +-------------------------------------------------------------------------------- + + I had a couple of questions for Amy. Just thinking through with the Azure mix becoming an ever bigger portion of IC revenue and when you factor in continued gross margin expansion that you continue to show in Azure, how should we think about the gross margin potential of IC overall? And I guess I also wanted to ask about the build-out of data centers related to the cloud build-out. How do we think about your points of presence today from a coverage perspective, if you will, versus the regional -- the revenue pockets that you're targeting over the next few years? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [9] +-------------------------------------------------------------------------------- + + Great, Heather. Let me -- on gross margin, over any long-term period in Intelligent Cloud, given the expansive TAM and the growth opportunity we see, it will create gross margin pressure over the long term. Now over the next period, especially in H1, we continue to see -- expect to see very good hybrid performance and execution, which helps to offset some of that. +So even as we continue to see Azure gross margin improvement at the IaaS and PaaS layer, just given the TAM and our opportunities, it will create long-term pressure on that gross margin number but of course, a lot of opportunity in terms of gross margin dollar growth and of course, operating margin dollar growth as we move forward. +When it comes to our build-out, Heather, I tend to think it's 2 components. The majority of our capital expenditures is actually in server equipment, it's new capacity. It's not necessarily in the overall geo footprint build-out. We'll, of course, continue to do that where it makes sense and where opportunity presents itself. And we do a very good job in terms of supply chain and being able to be able to get those up and running quite quickly. But the majority of the investment today is continuing to build capacity inside existing incredibly large data centers. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jennifer Lowe with UBS. + +-------------------------------------------------------------------------------- +Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [11] +-------------------------------------------------------------------------------- + + Satya, you mentioned the AT&T deal that was announced, I think, earlier this week. IBM also had an announcement with AT&T. Oracle has been a long-time partner with AT&T in the cloud as well. I don't want to dwell on AT&T in particular, but I do think it's interesting that a few different large-scale cloud players are around the table there. So as you see more of these very large deals out there, and Amy mentioned the increase in $10 million deals, how often are those multi-cloud deals and companies taking that sort of approach versus ones that are committing to Microsoft? And how do you navigate that landscape? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [12] +-------------------------------------------------------------------------------- + + Yes. I mean I think overall, you all, I think, do a good job of tracking what is the public cloud competition and that's the competition we pay most attention to. And in this context, I think we see a mix. There are a few of us who are at scale in public cloud, who are very competitive. And anybody who decides to be multi-cloud, public cloud, those are the winners. When someone thinks of only using one cloud, we are definitely one of the names. And in the case of AT&T, we were the only public cloud in there. And so that's why we highlighted -- they highlighted us and we highlighted that in our quarterly announcement. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + And I would say in general, what we see, especially as contracts get larger, for us, the opportunity under Tier 1 workloads for us to really see TAM growth, it's just expansive. And so Jennifer, listen, I kind of think about this as we have incredibly strong footprint inside existing enterprises today. That footprint, and you could see it in our results, customers are relying on us for not only that footprint but as they continue to expand, they sit under of a Tier 1 opportunity we haven't seen before. And so we, of course, see multi-cloud in a lot of our larger accounts, but this type of significant commitment is an opportunity, I think, you all continue to see us execute well on. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + The next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [15] +-------------------------------------------------------------------------------- + + Amy, I've got a question about the Windows business. A couple of the metrics, 18% Windows OEM Pro and 16% on the volume licensing side were extraordinary. I know you called out a couple of, call it, one-time issues around inventory levels and an uptick in in-quarter revs. But I wanted to ask you 2 questions. How much of a tail do you think we have left on the Win 7 to Win 10 migration? Is it too cautious to say that there's really just 2 quarters of that tailwind left? And secondly, on the volume licensing or commercial and cloud services segment, do you think that can, in fiscal '20, contribute to your overall double-digit growth? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Thanks, Karl. I don't actually combine these because really, there's a fundamental driver that sits underneath this and then we can get to the specifics of end of support. There is, I think, a recognized momentum with Windows 10, its deployment inside of enterprises for its security and management value prop. +We've worked hard and I think Satya mentioned some of the new features as we continue to invest in security for all of our products, one of the places I think that often resonates the most is Windows 10 and inside that value. +The OEM Pro number, as I talked about, was impacted by a number of factors. But what we've seen is over the past 3 or 4 quarters, pretty consistent sort of high single-digit performance once you take out various impacts from chip supply and inventory levels on the tariffs. That performance certainly has some end-of-support impact to it as we talked about before. I think in general, what we've seen in prior releases is it does extend a bit past the deadline, especially in our small and midsize business customers. And it's really important for us to continue to work hard to have the small and medium businesses find a path forward to make sure they can experience the most secure computing environment we have. +And so we'll see some extensions pass the line, we certainly have seen 3 or 4 quarters of that and we certainly expect H1 to remain strong. The more important part around the security and management value prop is in fact I'm going to pivot back again a little bit because it's the same thing we saw in Office. The Microsoft 365 value prop to customers, especially in the second half of the year and particularly in Q4, has 3 components. It has Office 365, it has EMS and it has this Windows 10 commercial component. +The Windows 10 commercial component will look far more like our success in our motions, in overall being able to sell the Microsoft 365 value prop. It was a good quarter for that. We've seen consistent double-digit billings in this segment and it speaks to that. I expect that to continue. Although you'll have volatility because what's interesting about that specific metric is it has a little bit more 606 impact than we've felt, it's an on-prem product. And so there will be volatility in this number but the consistent theme of seeing double-digit billings that really match our strength in Office 365, I think and I do expect to continue. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + And congrats on a great close to a great year. I just want to focus in on M 365 particularly, Satya, your comments on Microsoft Teams. Really kind of 2 components to this question. How do you think about the sort of why customers are adopting Teams, especially the larger ones you highlighted at the Ignite Conference? Is it the fact that it's a single app with those combined features you talked about? Or is it the broader, call it, Office experience? And then I guess a question for Amy off that, when you think about sort of the relevance of Teams on a going-forward basis to keep the migration up, E1, E3, E5 and then plus those add-ons that are associated with Teams like calling, et cetera, how critical is Teams to the long-term, call it, like price migration here at Office and M 365? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [19] +-------------------------------------------------------------------------------- + + Yes. So overall, I think, first, there's no question this last fiscal year has been an absolute breakout year for Teams in terms of both the product innovation and most importantly at-scale deployment and usage that we're seeing. And I think in fact, unlike any other time other than Windows, we've not had this kind of platform effect. Office has obviously had very, very successful individual products that have been deployed broadly. But each of them was a singular tool. Perhaps SharePoint was the last time we had a platform effect of this kind. +But Teams is -- transcends all that. It's the communications tool, it's the collaboration tool. It's the line of business tool for meetings as well as business process. And so the amount of value creation for the customer by deployment is something that we ourselves are sort of really learning a lot each deployment, whether it's on the first-line. +The other point about Teams is just not limited to knowledge workers, which has been really the only place traditionally we play. Even our licenses to the non-knowledge workers were just mostly licenses of the tools we built for knowledge workers whereas now we actually have specific value which is in fact very valuable to those first-line workers. And the thing that we realized is the businesses are in fact looking to spend more for those first-line worker productivity. +So we are in the very early innings of it but we're pretty excited. The one other benefit, to sort of tease off of some of the comments Amy was making, is that security compliance and governance is a huge issue for enterprise customers and commercial customers at scale. And Teams in some sense helps them a lot because it builds on all the rest of the investment they have made already in Office 365. And so we see that benefit even on that front. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + And I think it's an important component of our M 365 value, but it's really not outsized. I mean we have all these components of value. That's really been the secret of what customers look and see. They see Teams that can not only change what Satya talked about but also it's about culture change in terms of employees being able to be involved and collaborate regardless of the org chart. And that is what you're going to see. When you have 500 million new applications built in the next 5 years, you're going to see, and I believe, Teams to be one of the major interfaces through which that experience and business process reinvention will happen. +Teams really span multiple categories. So I wouldn't think of it just as productivity or even just collab or meetings. That is an interface. As you see business process reinvention occur, I do think of this is the surface through which many people will experience it. And so I would ask you to expand your thinking on this one. It's not just Office or needed to be in Office. It's really about having employees fundamentally experience Microsoft in a different way day to day. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Yes, and I would to point to the conference we just finished and some of the demos and I think the customer demos in particular. I would say that will sort of probably give you the best feel for how people look at this in terms of the deployment characteristics. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [23] +-------------------------------------------------------------------------------- + + Amy, you are mentioning large and long-term Azure contracts. I'm wondering as we consider this robust 25% growth in your commercial bookings this quarter, roughly how many points are coming from that -- from any tailwind of the longer-duration types of contracts? And then Satya, I wanted to ask you regarding the recent partnership with AT&T. Some media reports said it was worth over $2 billion. Wondering if there's some hyperbole there in the media. Or is this an example of how Microsoft can play in every line of a company's OpEx budgets today? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + I'll just take the second one and Amy can go. I mean I think it is a very significant deal. I'm not going to comment on any specific dollar terms. It is the largest commercial deal that we have signed of the size and we see -- we have line of sight to many more such deals. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + And when you think about bookings growth, I'm not sure for me, break it down to 2 pieces, which is I think about bookings, which were very good this quarter, has 2 fundamental motions. There's a motion around renewals and there's a motion around new. Both were very good this quarter and it wasn't while certainly long-term Azure contracts had a meaningful component of the new, they weren't alone in being the only component of the new. And renewals, as I mentioned earlier, we saw very good execution not just on renewals in-quarter but really healthy behavior in terms of maybe expirations that we had seen happen earlier in the year getting renewed because of the new value prop and the commitment of the sales team to make sure that we landed a really thoughtful high customer value transaction. So while the long-term large contracts will add volatility to that number, if you look at our -- seen our balance of $91 billion and see that, that also grew 25% year-over-year, you'll get a sense that it certainly wasn't alone in its impact for the year. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [27] +-------------------------------------------------------------------------------- + + And congrats for me as well. I wanted to zone in on Dynamics. There, you obviously like you're playing in applications and we've seen other vendors kind of do SaaS applications. If you look at Dynamics online, you now, on my math, kind of around $2 billion, still growing at a clip that organically not many others have achieved. It's now bigger than your on-premise business. Can you talk a little bit about the drivers there? And is there -- what are the ways to kind of -- how did you achieve that growth at this scale? And what are the drivers going forward? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes. We are very, very excited about the progress again in the last fiscal year around Dynamics 365. Both the traditional business process applications themselves have become much more modular and much more modern. And we have a very disruptive business model as well that goes with it. And so therefore, we're becoming much more competitive with the large customers deploying, whether it's sales or operations. +The other exciting thing is we have this entire new class of applications and I talked about this even in this week's conference, which is these AI-first modules, whether it's for sales, for marketing, for customer service or this customer 360. And these are modules that there isn't an installed base of those anywhere nor competition even exists. So in other words, we can, in fact, have these modules get deployed in commercial customers even on top of existing business applications. And so we feel that we have plenty of opportunity ahead. Again, this is a place where we are a very low-share player. And so the fact that we have become a very competitive supplier of this technology at a time where the world needs more business process automation, we feel good about the opportunity ahead. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our final question will come from the line of Brent Bracelin with KeyBanc. + +-------------------------------------------------------------------------------- +Brent Alan Bracelin, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [30] +-------------------------------------------------------------------------------- + + I wanted to drill down on the commercial cloud gross margins. They were up 200 basis points sequentially, 600 basis points year-over-year to 65%. I guess my question here is how sustainable are the cloud gross margins now that you're at this $40 billion-plus scale. Or were there some kind of onetime benefits we should think about in the quarter that helped you there? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [31] +-------------------------------------------------------------------------------- + + There were not any one-time benefits in this quarter that helped us. This is really about seeing improvement in some of our largest services, the continuous improvement year-over-year in the larger services. What we said for FY '20 and particularly in Q1 is we expect to be up sequentially in Q1. And we'll continue to get some headwind because of the strong Azure IaaS and PaaS growth we expect through the year but we certainly think that Azure fundamental gross margin improvement will help offset that next year. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [32] +-------------------------------------------------------------------------------- + + That wraps up the Q&A portion of today's earnings call. We appreciate you joining us and look forward to speaking with all of you soon. Thanks. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [33] +-------------------------------------------------------------------------------- + + Thanks, everyone. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [34] +-------------------------------------------------------------------------------- + + Thank you all. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2019-Oct-23-MSFT.txt b/Transcripts/MSFT/2019-Oct-23-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..697a22085593c086b66864e22e44a566f1788ccc --- /dev/null +++ b/Transcripts/MSFT/2019-Oct-23-MSFT.txt @@ -0,0 +1,379 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Microsoft Corp Earnings Call +OCTOBER 23, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Jennifer Alexandra Swanson Lowe + UBS Investment Bank, Research Division - Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Microsoft Fiscal Year 2020 First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the call over to Mike Spencer, General Manager of Investor Relations. Thank you. Please proceed. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon. Thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. +On the Microsoft investor relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides reconciliation of differences between GAAP and non-GAAP financial measures. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft investor relations website. +During this call, we will be making forward-looking statements, which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factor sections of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike, and thanks to everyone on the phone for joining. We're off to a strong start in fiscal 2020, delivering $33 billion in revenue this quarter. Our commercial cloud business continues to grow at scale as we work alongside the world's leading companies to help them build their own digital capability. Microsoft provides a differentiated technology stack spanning application infrastructure, data and AI, developer tools and services, security and compliance, business process, productivity and collaboration. For each of these areas -- first, each of these areas represents secular long-term growth opportunity. Second, we are delivering best-in-class innovation and openness in each layer. And third, we offer unparalleled integration and architectural coherence across the entire stack to meet the real-world needs of our customers. +Now I'll briefly highlight how we are accelerating our progress and innovation starting with Azure. Organizations today need a distributed computing fabric to meet their real-world operational sovereignty and regulatory needs. This quarter, we opened a new -- new data center regions in Germany and Switzerland. And in India, we are bringing the power of Microsoft Cloud to millions of small businesses through our partnership with Jio, one of the largest mobile carriers in the country. +Every Fortune 500 customer today is on a cloud migration journey, and we are making it faster and easier. Just this week, we announced an extensive go-to-market partnership with SAP, making Azure the preferred destination for every SAP customer. And our partnerships with VMware and Oracle also bring these ecosystems to our cloud. +We're extending beyond the cloud to the edge, enabling customers to get real-time insights where data is generated while ensuring security and privacy. And we are seeing traction in every industry, from Azure Sphere securely connecting Starbucks coffee machines to Azure Stack enabling scenarios from smart factories and modern compliant banking to mobile health care in remote areas. +We're reimagining customers' data estates for the cloud era with new limitless capabilities. Azure SQL Database brings hyperscale capabilities to relational databases and Azure Cosmos DB, the low-latency, high-availability database for globally distributed applications of any data type. +The quintessential characteristic of every application going forward will be AI, and we have the most comprehensive portfolio of AI tools, infrastructure and services. Azure AI now has more than 20,000 customers, and more than 85% of the Fortune 100 companies are using Azure AI in the last 12 months. +In health care, Novartis chose Azure AI to transform how medicines are discovered, developed and commercialized. Nuance will rely on our cloud to power the patient exam room of the future where clinical documentation writes itself, and Humana is using Azure AI to build personalized health care solutions for its more than 10 million members. +We're also pushing the bounds of how computers and AI can generalize learning beyond narrow domains, collaborating with open AI on a supercomputing platform to train and run AI models. I'm excited about our partnership and our collective pursuit to democratize AI and its benefits for everyone. +Now to developer tools. The rise of digital IP creation in every organization means developers will increasingly drive and influence every business process and function, and GitHub is where they go to learn, share and collaborate. GitHub has grown to more than 40 million developers, up more than 30% since our acquisition a year ago, and more than 2 million organizations use GitHub, including the majority of the Fortune 50. At Ford Motor Company alone, 8,000 employees use GitHub to innovate and collaborate with the vast ecosystem of third-party software developers. Our acquisition of Symantec code analysis engine family this quarter strengthens our security capabilities, enabling developers to more easily find vulnerabilities in large open source code bases. +Now let's turn to our workflow cloud, Power Platform. Automating workflows across every function will be key to productivity gains for every organization. We are building Power Platform as the extensibility framework for both Microsoft 365 inclusive of Microsoft Teams as well as Dynamics 365. It brings together low code, no code app development; robotic process automation; and self-service analytics, enabling everyone in an organization to build an intelligent app or workflow where none exist. Power Platform already has more than 2.5 million monthly active seasoned developers. Power Apps helps domain experts, those closest to the business problem, to design, build and publish custom apps fast, and 84% of the Fortune 500 have already created Power applications. +Now let's talk about security. Rising cyber threats and increasing regulation means security and compliance on a strategic priority for every organization. We have a comprehensive offering across identity, security and compliance spanning people, devices, apps, developer tools, data and infrastructure to protect customers in today's zero-trust environment. It starts with Azure active directory premium used by more than 100,000 organizations for identity, access management and SaaS application security across heterogeneous environments. It builds with information protection and cloud security with Microsoft Defender Advanced Threat Protection and now with risk-based vulnerability management. And it extends to Azure Sentinel, now broadly available. Sentinel is a cloud-first service that analyzes security signal at massive scale across the entire organization using AI to detect, investigate and automatically remediate threats. We'll share more about our expanding opportunity in security at our Ignite conference in the next few weeks. +Now onto business applications. Dynamics 365 is the only AI-powered business cloud that gives customers a 360-degree view of their business from marketing and sales to finance and operations to unify data and unlock insights. It enables every level of organization to move from reactive silo transactional processes to proactive, repeatable and predictable business outcomes. +This quarter, we introduced Dynamics 365 Commerce, a new omni-channel solution to unify back-office, in-store and digital experiences and deliver personalized content wherever shoppers are. Dynamics 365 AI insights app ingest data from any first-party or third-party source, freeing data from systems of record to power modern systems of engagement and intelligence. New Dynamics 365 Product Insights provides organizations like Ecolab real-time view of how customers are using their products to maximize customer lifetime value. And Dynamics 365 Connected Store helps retailers select Marks & Spencer analyze observational data to optimize in-store shopping experience. +We're enabling our customers to bridge the physical and digital business processes with our mixed reality cloud, spanning HoloLens 2, Azure mixed reality services and Dynamics 365 applications. Pharmaceutical company, Patheon, for example, is using Dynamics 365 Guides along with HoloLens 2 to reimagine training for its employees. +Now to LinkedIn. We saw record levels of engagement again this quarter across the platform. Marketing solutions remains our fastest-growing segment, up 44% year-over-year as marketeers leverage our community-based tools to connect with LinkedIn's nearly 660 million members. We continue to innovate across our talent portfolio, including Talent Solutions, Talent Insights, Glint, LinkedIn Learning, to help every organization attract, retain and develop best talent. LinkedIn skills assessment is a new way for members to showcase their proficiencies and become more discoverable to recruiters. +Now turning to Microsoft 365 and Surface. Earlier this month, we unveiled our broadest Surface line up to date, including 2 new dual-screen devices coming next year. We are reimagining every layer with how we infuse AI from silicon up to device form factors and the role of operating systems to help people be more productive and creative in a multi-sense, multi-device world. We will continue to invest across form and function to new create categories that benefit our entire OEM ecosystem. And our expanded partnership with Samsung builds on our promise to help people be more productive on any device anywhere, bringing OneDrive, Outlook and Your Phone and more to new Samsung devices. +Microsoft 365 is the world's productivity cloud and the only comprehensive solution that empowers everyone from the C suite to first-line workers with an integrated secure work -- secure experience on any device. We're infusing AI across Microsoft 365 to help make work more intuitive and natural. New Presenter Coach in PowerPoint makes anyone a better public speaker. New capabilities in Word enable professionals to transcribe or record audio files while staying in the flow. Video is more searchable, shareable and first class within Microsoft 365 with Stream. And new inking capabilities let users create and reply to comments from anywhere using pen or voice. +Microsoft Teams continues to gain traction, bringing together everything a team needs: chat, voice, meetings, collaboration with the power of Office and business process workflow into a single integrated user experience, all with the highest security and compliance. Teams keeps all of your work, conversations and meetings in context, eliminating the need to bounce back and forth between different apps with features like integrated calendaring, one touch to join meetings from your phone. And we are broadening our opportunity with 2 billion first-line workers worldwide, adding priority notifications, role-specific targeted messages and the ability to clock in and cloud out of a shift. Our differentiated offering is driving usage making Teams the category leader. More than 350 organizations now have more than 10,000 users of Teams. +More broadly, all this innovation is fueling growth. Office 365 Commercial monthly active users surpassed 200 million this quarter. The leading organizations like Cerner, Chevron and the LEGO group are choosing our premium Microsoft 365 E5 offerings for their advanced security and productivity experiences. +Finally, gaming. In gaming, we are investing in content, community and cloud services to expand our opportunity with 2 billion gamers worldwide. We saw record Xbox Live monthly active users with strength both on and off console in mobile and PC and continued growth for Game Pass subscriptions. Gears 5 saw more than 3 million players in its first weekend alone. 10 years in, Minecraft is stronger than ever with record revenue and usage, and we are bringing the franchise to new audiences with Minecraft Earth. Finally, just last week, we started trials of Project xCloud, so gamers can play games wherever and whenever they want on any device. +In closing, we are accelerating our innovation across the entire technology stack to deliver new value for customers. We're investing aggressively in large markets with significant growth potential, and it's still early days. +With that, I'll hand over to Amy, who will cover our financial results in detail and share our outlook. And I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $33.1 billion, up 14% and 15% in constant currency. Gross margin dollars increased 18% and 20% in constant currency. Operating income increased 27% and 32% in constant currency. And earnings per share was $1.38, increasing 21% and 25% in constant currency. Consistent execution and strong demand for our hybrid and cloud offerings drove a solid start to the fiscal year with another quarter of double-digit top and bottom line growth. +From a geographic perspective, we saw broad-based strengths across all markets. In our commercial business, we again saw increased customer commitment across our cloud platform. In Azure, we had material growth in the number of $10 million-plus contracts. Additionally, Microsoft 365 drove new customer adoption as well as expansion in our existing customer base given the strong value Office 365, Windows 10 and Enterprise Mobility and Security provide as a secure intelligent solution. As a result, commercial bookings growth was ahead of expectations, increasing 30% and 35% in constant currency with a higher volume of new business and strong renewal execution. +Commercial annuity mix increased to 91%, and commercial unearned revenue was ahead of expectations at $31.1 billion, up 14% and 16% in constant currency. Our commercial remaining performance obligation was $86 billion, up 26% and 27% in constant currency driven by these long-term customer commitments. As a reminder, going forward, we will disclose the commercial remaining performance obligation as a KPI, which better reflects commitments our customers are making across all contract types. +Commercial cloud revenue was $11.6 billion, growing 36% and 39% in constant currency. Commercial cloud gross margin percentage increased 4 points year-over-year to 66%, a significant improvement in Azure gross margin, offset a sales mix shift to Azure. Company gross margin percentage was 69%, up 3 points year-over-year and ahead of our expectations driven by sales mix to higher-margin businesses. +The U.S. dollar was a bit weaker than anticipated, which resulted in slightly less impact to our results. FX reduced revenue growth by less than 2 points and COGS and operating expenses growth by approximately 1 point. Operating expenses grew 8% and 9% in constant currency, slightly lower than expectations, mainly driven by the timing of marketing and project spend. And operating margins expanded this quarter driven by the combination of higher gross margins and operating leverage through effective resource allocation. +Now to our segment results. Revenue from Productivity and Business Processes was $11.1 billion, increasing 13% and 15% in constant currency, ahead of expectations, primarily driven by our on-premises Office Commercial business. Office Commercial revenue grew 13% and 15% in constant currency and benefited approximately 2 points from the transactional strength in Japan. Office 365 Commercial revenue growth of 25% and 28% in constant currency was again driven by installed base growth across all workloads and customer segments as well as higher ARPU. Office 365 Commercial seats increased 21% with a growing mix from our Microsoft 365 suite. +Office Consumer revenue grew 5% and 6% in constant currency with roughly 7 points of benefit from transactional strength in Japan, more than offsetting the strong prior year comparable related to the launch of Office 2019. Office 365 Consumer subscribers grew to 35.6 million. +Dynamics revenue grew 14% and 16% in constant currency driven by Dynamics 365 revenue growth of 41% and 44% in constant currency. LinkedIn revenue increased 25% and 26% in constant currency with continued strength across all businesses. LinkedIn sessions increased 22% as engagement again reached record levels. Segment gross margin dollars increased 16% and 19% in constant currency, and gross margin percentage increased 2 points year-over-year as improvements in LinkedIn and Office 365 margins more than offset an increase in cloud revenue mix. +Operating expenses increased 8% and 9% in constant currency driven by continued investment in LinkedIn and cloud engineering. Operating income increased 23% and 27% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $10.8 billion, increasing 27% and 29% in constant currency, ahead of expectations driven by our on-premises server business. On a significant base, server products and cloud services revenue increased 30% and 33% in constant currency driven by continued demand from our hybrid value. Azure revenue increased 59% and 63% in constant currency with strong growth in our consumption-based business across all customer segments partially offset by further moderation in our per user business. +Our enterprise mobility installed base grew 36% to over 120 million seats, benefiting from the Microsoft 365 suite momentum. And our on-premises server business grew 12% and 14% in constant currency driven by continued strength across our hybrid and premium offerings, GitHub, and roughly 4 points of benefit from the end of support for SQL and Windows Server 2008. +Enterprise services revenue increased 7% and 8% in constant currency driven by growth in premier support services. Segment gross margin dollars increased 27% and 30% in constant currency. Gross margin percentage was up slightly as another quarter of material improvement in Azure gross margin was partially offset by a growing mix if Azure, IaaS and PaaS revenue. +Operating expenses increased 22% driven by ongoing engineering and sales investments in cloud and AI, including GitHub. Operating income grew 33% and 38% in constant currency. +Now to More Personal Computing. Revenue was $11.1 billion, increasing 4% and 5% in constant currency, ahead of expectations as better-than-expected performance in our OEM Pro and Windows Commercial businesses more than offset lower-than-expected monetization across third-party titles within gaming. +In Windows, OEM non-Pro revenue declined 7%, below the consumer PC market with continued pressure in the entry-level category. OEM Pro revenue grew 19%, ahead of the commercial PC market driven by strong Windows 10 demand and momentum in advance of the Windows 7 end of support. Inventory levels ended the quarter in the normal range. +Windows Commercial products and cloud services revenue grew 26% and 29% in constant currency driven by healthy demand for Microsoft 365, which carries higher in-quarter revenue recognition. +Surface revenue declined 4% and 2% in constant currency driven by the timing of product life cycle transitions ahead of the recently announced product launches. Search revenue ex TAC increased 11% and 13% in constant currency driven by Bing rate growth. +In gaming, revenue declined 7% and 6% in constant currency driven by lower console sales. Xbox content and services revenue was relatively unchanged and increased 1% in constant currency with growth from Minecraft, Gears of War 5 and Game Pass subscriptions offset by a strong third-party title in the prior year. +Segment gross margin dollars increased 12% and 13% in constant currency, and gross margin percentage increased 4 points due to higher-margin sales mix. Operating expenses declined 7% and 6% in constant currency as redeployment of engineering resources to higher-growth opportunities was partially offset by investments in gaming. As a result, operating income grew 28% and 31% in constant currency. +Now back to total company results. Capital expenditures, including finance leases, were $4.8 billion, up 12% year-over-year driven by ongoing investment to meet growing demand for our cloud services and slightly below expectations due to normal quarterly spend variability in the timing of our cloud infrastructure build-out. Cash paid for PP&E was $3.4 billion. +Cash flow from operations was $13.8 billion and increased 1% year-over-year as strong cloud billings and collections were partially offset by tax payments related to the Q4 transfer of intangible property. Free cash flow was $10.4 billion and increased 4%. Excluding the impact of these tax payments, cash flow from operations and free cash flow grew 27% and 39%, respectively. +As expected, in other income and expense, interest income was offset by interest expense, foreign currency remeasurement and recognized losses on investments. Our effective tax rate was 16%, in line with expectations. And finally, we returned $7.9 billion to shareholders through share repurchases and dividends, an increase of 28% year-over-year. +Now let's move to our outlook. Assuming current rates remain stable, we expect FX to decrease Intelligent Cloud revenue growth by approximately 2 points; total company, Productivity and Business Processes and More Personal Computing revenue growth by approximately 1 point and have no impact on total company COGS and operating expenses growth. We expect another strong quarter in our commercial business. Demand for our hybrid offerings and cloud services remain strong, and capital expenditures will continue to reflect that. +Given the normal variability and infrastructure spend timing, we expect Q2 CapEx spend to be down slightly on a sequential basis but still growing from the prior year. And commercial cloud gross margin percentage will continue to improve on a year-over-year basis even with the continued mix of revenue toward Azure consumption-based services. +Now to segment guidance. In Productivity and Business Processes, we expect revenue between $11.3 billion and $11.5 billion driven by double-digit growth across Office Commercial, Dynamics and LinkedIn. For Intelligent Cloud, we expect revenue between $11.25 billion and $11.45 billion. In Azure, we expect continued strong growth in our consumption-based business and moderating growth in our per user business given the size of the installed base. +Our on-premises server business will be driven by demand for our hybrid and premium solutions as well as the continued benefit from increased demand ahead of the end of support for Windows Server 2008. In More Personal Computing, we expect revenue between $12.6 billion and $13 billion. In Windows, overall OEM revenue growth should again be ahead of the PC market as we balance healthy Windows 10 demand and the benefit from the upcoming end of support for Windows 7 with the supply chain's ability to meet this demand in Q2. Based on our customer demand signal and prior end-of-support cycles, we expect some continued momentum past January, end-of-support deadline. In Windows Commercial products and cloud services, we expect another strong quarter, benefiting from continued Microsoft 365 momentum. +In Surface, the launch of the latest Surface Pro and Surface laptop devices should drive low double-digit revenue growth on a strong prior year comparable. In Search ex TAC, we expect revenue growth similar to Q1. And in gaming, we expect revenue to decline in the mid-20% range driven by lower console sales as we near the end of this generation as well as the most challenging quarterly comparable and third-party titles from last year. +Now back to overall company guidance. We expect COGS of $12.45 billion to $12.65 billion and operating expenses of $10.8 billion to $10.9 billion. Other income and expense should be approximately $50 million as interest income is partially offset by interest and finance lease expense. And finally, we expect our Q2 effective tax rate to be slightly above the full year rate of 17%. +Now let me share some additional comments on the full year. At the company level, we continue to expect double-digit revenue and operating income growth driven by continued momentum in our commercial business. Given our strong first quarter results and the expected sales mix for the remainder of the year, we now expect operating margins to be up slightly year-over-year even as we continue to invest with significant ambition in high-growth areas. +With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. (Operator Instructions) Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + Very nice quarter. I was hoping to dig in a little bit into the Intelligent Cloud business and what you guys are seeing there from a hybrid perspective. So maybe one question for Satya and one for Amy. For Satya, can you talk to us a little bit about sort of how these hybrid engagements are kind of rolling out with the largest customers, how they're contracting from it? And any sense you can give us in terms of in what way do they engage both kind of the on-premise assets as well as the cloud assets? Because I think that's part of the equation that's really positively surprising a lot of investors in how well server and tools is doing. And maybe for Amy, you could help us understand, sort of when we look at server and tools up 14% in constant currency, which is well ahead of our expectations, how should we think about the durability of that in terms of what comes from sort of the pull forward of demand ahead of some -- like SQL Server and Windows Server expirations and what is going to be more durable over time on the back of those pull forwards. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure, Keith. Thanks for the question. Overall, our approach has always been about this distributed computing fabric or thinking about hybrid as not as some transitory phase but as a long-term vision for how computing will meet the real-world needs because if you think about the long term, compute will migrate to wherever data is getting generated. And increasingly, there'll be data generated in the real world where just -- when you think about the cloud, you have to think about the edge of the cloud as a very first-class construct. And so in that context, the -- what we see is a couple of things that you see even in the results today. One is the hybrid benefit that is increasingly what is getting customers excited about the Azure choice and the fact that they can renew knowing that they have the flexibility of both the cloud and the edge. That's definitely driving growth. +Second is we're also gaining share. When you think about what's happening even in the edge, some of the -- our data center edition products are very competitive in the marketplace. And so you see both of those effects. But architecturally, we feel well placed. In fact, at our Ignite Conference, you'll see us even take the next leap forward even in terms of how we think about the architecture inclusive of the application models, programming models on what distributed computing looks like going forward. So we feel well positioned there. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And Keith, to your question on durability, we tried to call out the 4 points that we felt transactionally was due to the end of support, and that's 4 of the 12 in USD. And so -- but for us, if you step back for a second, the durable trends that Satya just talked about, which is making sure we license in a way that respects this long-term reality of where data and compute will be needed is what we call the hybrid value proposition. And the rights to that, of course, are inherent in how we report this number. And so for us, what you'll see is premium strength, which we saw this quarter in both SQL and Windows because of some of the value proposition of hybrid and of course, broad strength as well when people feel that flexibility to not be constrained by licensing in terms of how they view their estate. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [6] +-------------------------------------------------------------------------------- + + This is a question for Amy. I was just wondering, you've been saying for a while now that you're seeing material improvements in Azure gross margins and that's obviously hugely benefited commercial cloud gross margin. I'm just wondering if you could share with us how much of the improvement is related to the need to maybe expand data centers at a lower clip than you have been. Maybe it's less depreciation and amortization that's coming -- that you're starting to recognize. How much of it is due to just better capacity utilization then? I'm just trying to get a sense of how much longer you're going to be able to say that for I guess. And just have you guys been ratcheting up your target gross margins for Azure over the years to where you think they could be as you look ahead? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [7] +-------------------------------------------------------------------------------- + + Thanks, Heather. Let me start by saying, in general, at the commercial cloud gross margin, what you're seeing is revenue growth that, for the past almost 2 years, has vastly been faster than our capital expenditure growth. So if you start at the top of the frame, what we're seeing is overall gross margin improvement across portfolio and improving -- and that comes from a couple of things, which is where you're getting to on Azure. It comes from structural improvement on sort of cost per unit, but it also comes from mix shift of revenue to premium services, from being able to sell more SaaS-like services and consumption services or even premium data services that really do have both more margin but also are quite consistent in terms of their growth. And you see then that represented as improving targets for us. +But I would say in general, Heather, what the team has done is actually delivered on what I think we felt was a 5-year road map of improving gross margins on a material basis. Now as you continue to see the mix shift to the consumption-based Azure services, the overall cloud gross margin will improve at the same rate. And we've said that, and you'll continue to see that on a go-forward basis as well. But we do continue to expect Azure, especially on the consumption side gross margins, to improve. And they still have room to improve, especially as we start to see some of these premium services both being made available and being utilized at higher rates. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [9] +-------------------------------------------------------------------------------- + + Amy, question for you. When I look at your next quarter guidance by revenue segment, it seems to equate to an overall revenue growth rate assuming the midpoint of about 9% to 10%. So when I combine that with the 14% growth you just put up in Q1, it implies that, in the second half, overall Microsoft revenue growth should remain roughly in the 10% zip code to enable you to get to double-digit growth for the full year despite the fact that you're moving past some fairly key end-of-support milestones. I think some of us were expecting a little bit more of a first half, second half delta. So I just wanted to ask you what are the maybe 1 or 2 or 3 drivers that enable you to sustain that growth rate in the second half and if it's fair to assume that your guidance doesn't really reflect any deterioration in the overall spending environment. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + Yes. I think in general, Karl, a couple of things I would point to or many of the things I talked about in the comments that we prepared, overall, Q1 was a very strong start commercially from a bookings perspective with some very strong trends across the board. Whether it is in both the absolute size and number of the Azure commitments that we're seeing, the consistency we're seeing in the consumption growth rates of Azure, the commitments we're seeing to Microsoft 365, some of the signs we're seeing across our Dynamics, the Power Platform, the workflow cloud that Satya referred to and LinkedIn, it's a good bookings quarter, a good execution quarter on overall contracting value. Renewals were good, recapture rates were good, and new business was good. +So with that confidence, some of those same trends that we had talked about, of course, show up through the year. And we've tried to be consistent in that while end of support will make for points here and there each quarter, the more sustainable trends are the fact that our commercial cloud overall offers significant value and differentiation to customers and are making longer-term commitments and we continue to grow ARPU. So when I think about sort of some of the seasonality that you're talking about, Q2, I felt we were -- I wanted to be clear that that's really a gaming challenge in Q2, and you see that reflected in the margins in Q2 being significantly better than they were last Q2. And if you think about H2, I do expect Surface will have some easier comparables in H2 and a new portfolio to grow from. So I think that's another change you'll see in trajectory in H2 as well. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + Congrats on the quarter. AI is obviously a large focus. It was a large driver of Intelligent Cloud OpEx spending growth this quarter. Satya, can you give us some more color on where you see Microsoft on the AI journey? And Amy, is this investing way ahead of revenue? Or is AI already driving big revenue for Azure? How should we think about it? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [13] +-------------------------------------------------------------------------------- + + Thanks, Mark. It's a great question because we look at what's happening with AI having 2 dimensions to it. One is I would say just our own use of AI as first-party SaaS applications. There's some phenomenal breakthroughs. When you see new transcription features or new computer vision features that come with HoloLens, all of these are being driven by new AI capabilities. They're all, by the way, powered by the same cloud infrastructure. We all build everything at Microsoft with first party equals third party with Azure as the core platform. So what you see us is, in fact, using our own SaaS applications and consumer innovation even to drive the high-end AI capability but then bring the best-in-class tooling for enterprise customers. So for example, like we have innovated even in what does DevOps look like for the machine learning age. That's a unique capability that's there in Azure ML. And those are the types of innovations that are even driving the projects that enterprise customers have on Azure. So you'll see us leverage our overall spend, whether it's CapEx or OpEx across all of what Microsoft does and then surface them in, I think, what is perhaps the best way to get traction in the enterprise market, which is great tooling, compliance, security. And that's a place where we are making good progress. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + And so for me, Mark, it's a little bit hard for me to say, gosh, we invest in AI here and you'll see it specifically here. What I think you heard through Satya's commentary is actually AI woven through every layer and component of the entire tech stack and how important that is, whether you're participating at the Dynamics 365 layer with insights or whether you're using components like some of our customers are maybe for a natural interaction work. And so for me, it is almost fundamental to see that cost and investment because you'll see it in margin and usage and frankly, product differentiation that we can provide versus our competitors. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [16] +-------------------------------------------------------------------------------- + + Amy, there's been a lot of macro concern among tech investors given some of the peers in your group that have seen some weakness. It doesn't seem that you have seen anything, but I'm curious if you could just comment on what you're seeing from a demand perspective. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + Thanks, Brent. What I would say is, for us, it has been so important to remain focused on where growth and opportunity exist and to invest in those areas that are large, expansive and durable TAMs. And I think when you think about where we've spent our time, both building products, investing in marketing, investing in sales capability and technical capability, it has been in many, if not all, of those places. So when I look and say where is our execution or how do I think about our ability to execute in a macro environment, for me, it is about investing in the right places, executing in a great way, remaining focused on the transition our customers need us to help them through to create their own opportunity and their own growth. And I think we've done a nice job of being invested in the right places. Satya mentioned a few of them on the call, but there are really many. If you think about security, compliance, communication, workflow, business process reinvention, the list can go on and on where I feel like we have set up a multiyear journey to be well positioned. And I tend to think of every quarter, every year as an opportunity to continue to differentiate, invest in innovation and execute well to take share. And so that's, I think, how I've approached that. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [18] +-------------------------------------------------------------------------------- + + And I think that's probably the unifying theme, quite frankly, of all the questions so far, which is what's next. What's next for us is in the apps and infra go from perhaps first inning to second innings; for data and AI, to start the first innings. When it comes to security, compliance, we never participated in this. Guess what? We get to participate in a fairly competitive way now. We have built for something that didn't even exist a few years ago, which is the workflow cloud. That's a huge opportunity for us. Biz apps, we are a very competitive and growing footprint. Even when we think about something like Microsoft 365, we never participated in spite of our past success with all the first-line work, and now we get to participate in it. So I see long-term secular growth opportunities, and we want to stay focused on making sure our innovation is competitive in all those layers we talked about. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + Congrats on another really impressive quarter. Satya, I want to focus on the strategic announcements you talked about earlier in the call, Oracle, VMware and obviously, the most recent one with SAP. Wondering if you would just walk us through the sort of the strategic thoughts behind these. And then also especially with VMware and Oracle since those have been out there obviously longer, what's the feedback from customers been? And then I guess to Amy, how do you think about sort of these big strategic [offices] this year actually showing up in the numbers? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Sure, Phil. Thanks. So overall, I think this is again one of those things where, in the past, we participated in the infrastructure business, but we had a fairly narrow footprint, which is we had our own infrastructure that supported primarily our databases and our operating systems. Whereas with the migration to the cloud, customers are looking for us to be a provider of all their infrastructure needs, which is heterogeneous. And that's what has really led us at the infrastructure layer to have partnerships with VMware and Oracle. We, as you know, have first-class support for Windows and Linux, Java and .NET, Postgres and SQL, VMware, Red Hat as well as obviously Windows hypervisor. +So we -- I feel that we now have that ability to be able to take the entire infrastructure estate, the entire data estate and really add value with these partnerships. And SAP represents the same because SAP has got both infrastructure. We now are the preferred cloud, so I think it's a fairly no-brainer for any customer who's an SAP customer who wants to accelerate their migration to the cloud and innovation from SAP and us that they should move to Azure, and that's what this announcement was all about. And so we're really looking forward to essentially executing on that strategy and that customer need that we see very clearly. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + And Phil, to your question on where would we see this, you'd actually see it in a couple of places, not just in Azure, which may, in fact, be the most logical extension. But at the heart of this is making it easier, faster and more reliable for us to help customers move their estate to the cloud and to migrate that with confidence. And so when we do that, it's about becoming a committed partner. And you actually see that in broader Microsoft Cloud results, whether that's helping even through these partnerships to be able and get closer to Tier 1 workloads, business process changes. And so I actually think these are quite important for us to continue to make sure the first goal is customer centric, which is why we continue to move in this direction. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jennifer Lowe with UBS. + +-------------------------------------------------------------------------------- +Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [24] +-------------------------------------------------------------------------------- + + I think this is probably an Amy question. As I sort of parse through the Dynamics within Office 365 and through the discussion around sustainability of double-digit growth within the commercial segment, we've seen seat count decelerate. Also, the uplift on pricing maybe isn't as much this quarter as we saw in the past, which leads me to believe that you are seeing a lot of success in the front-line worker piece and maybe that's a bigger driver of the seat count from here. But can you just -- and at the same time, you're seeing strong uptake of the premium SKUs as well. But as we think about seat count going forward, how much opportunity is there still left on the migration front of commercial licenses versus leaning a bit more on things like front-line worker to sustain outgrowth? And is there a point where potentially the seat growth and things like frontline could start to eat further into your ability to continue to lift ARPU on the base you already have? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Thanks, Jen. Let me break this question apart because you're actually asking important dynamics that I don't always think of as trade-off, and so I want to make that more clear in my answer. First, to your question on seat growth, we have room even beyond just first-line workers. Whether that is our ability in small- and mid-sized businesses, on a global basis with mobile-first workers, this is a very broad opportunity for us to reach people trying to accomplish tasks and do their work on devices of any size. And so there is significant room for us to continue to make progress on that front. +Now could that end up with some ARPU pressure long term? It certainly could, but the important -- for me, I don't think of that as being necessarily a negative. We used to really make no money through these seats that we just talked about. And so every dollar or multiple dollars or many dollars earned on those new seats is all new revenue, new opportunity and new socket for us. Let me separate that from the next dynamic, which is why sort of an average number may not be the best indication, which is our ability to continue to move people to higher-value SKUs, whether that's through the addition of really compelling things in security or compliance or communications or collaboration or knowledge or learning, where we can add value. Whether we call that E5 or E3, we have room in that transition as well and new opportunity in a way that I'm not sure I've seen us. I feel very optimistic about M365 -- I'm sorry, Microsoft 365 and our ability to continue to add value. So hopefully that helps, Jen. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our last question will come from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [27] +-------------------------------------------------------------------------------- + + Quick question on Azure. If I look at the SAP announcements, but you had some other industry announcements out there as well like Humana, et cetera, like how do I have to think about the progress you guys are making here in terms of getting more into the different industries and to kind of create deeper relationships around Azure rather than just doing kind of simple infrastructure outsourcing? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes. It's a very deliberate strategy that we have. In meeting our customers' needs, we need to have the partners they already work with and want to work with also on our platform. So it starts sometimes with the customers, whether it's Humana or Walgreens or Walmart and others. It also starts with partners like Nuance, which is another one that we announced recently. And so the idea is for us to be really ensuring that by every industry we have the right marquee customers as well as the partners and have strong go to markets. +One of the things that everyone, I think, in the marketplace understands is Microsoft, especially from a partner perspective, is a great route to market. We have a platform directly with our sales force as well as our channel that is very attractive to third-party developers to get on Azure and they've realized those benefits. And in fact, our customers rely on that also as a benefit because it helps them get the best value from their partners as well. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [29] +-------------------------------------------------------------------------------- + + That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Thank you all. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2020-Apr-29-MSFT.txt b/Transcripts/MSFT/2020-Apr-29-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..bbab707b08229d1b943293bb749bab0b412d7991 --- /dev/null +++ b/Transcripts/MSFT/2020-Apr-29-MSFT.txt @@ -0,0 +1,375 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2020 Microsoft Corp Earnings Call +APRIL 29, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Aleksandr J. Zukin + RBC Capital Markets, Research Division - MD of Software Equity Research & Analyst + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Greetings, and welcome to the Microsoft Fiscal Year 2020 Third Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +I would now like to turn the conference over to your host, Mr. Mike Spencer, General Manager of Investor Relations for Microsoft. Thank you. You may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- +Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. +On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events have on the financial results. +All growth comparisons we make on the call today relate to the corresponding period last year, unless otherwise noted. We also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we'll refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thank you, Mike. We delivered double-digit top line and bottom line growth once again this quarter, driven by the strength of our commercial cloud. As COVID-19 impacts every aspect of our work and life, we have seen 2 years' worth of digital transformation in 2 months. From remote teamwork and learning to sales and customer service to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. +There is both immediate surge demand and systemic structural changes across all of our solution areas that will define the way we live and work going forward. Our diverse portfolio, durable business models and differentiated technology stack across the cloud and the edge position us well for what's ahead. +And now I'll highlight our innovation and momentum, starting with modern work. We are empowering people and organizations for a world of secure remote work and learning with Microsoft 365 and Teams. As work norms evolve, organizations are realizing they need a comprehensive solution that brings together communications, collaboration and business process, built on a foundation of security and privacy. Microsoft Teams supports multiple communications modalities in a shared work space. It's the only solution with meetings, calls, chat, collaboration and -- with the power of Office and business process workflows in a single integrated user experience, with the highest security as well as compliance. +Teams keeps all your work in communication, conversations, documents, whiteboards and meeting notes in context. It helps people collaborate inside and outside meetings, making them more efficient, effective while reducing fatigue. We're accelerating Teams innovation, adding new capabilities each week and now support meetings of all sizes, meetings that scale from 250 active participants to live events for up to 100,000 attendees to streaming broadcast. +We saw more than 200 million meeting participants in a single day this month, generating more than 4.1 billion meeting minutes. Teams now has more than 75 million daily active users engaging in rich forms of communication and collaboration, and 2/3 of them shared, collaborated or interacted with files on Teams. And number of organizations integrating their third-party and line of business apps with Teams has tripled in the past 2 months. +In health care alone, there were more than 34 million Teams meetings in the past month. New capabilities enable providers like Northwell Health, New York State's largest health provider, to deliver first-class telehealth. And the NHS in the United Kingdom is using Teams to ensure staff have the tools they need to do their vital work. +Now that home offices are doubling as home schools, educational outcomes are at a premium. The combination of Teams and curriculum in OneNote and social learning with Flipgrid give teachers a complete remote learning solution so that they can improve student outcomes. More than 183,000 educational institutions now rely on Teams. In the United Arab Emirates, more than 350,000 students are using Teams. In Italy, the University of Bologna chose Teams to move 90% of their courses for 80,000 students online in just 3 days. +20 organizations with more than 100,000 employees are now using Teams, including Continental AG, Ernst & Young, Pfizer and SAP. Just last week, Accenture became the first organization to surpass 0.5 million users. And we expanded our partnership with NFL to include Teams, which powered their first-ever virtual draft. +More broadly, we continue to see momentum with organizations across Microsoft 365. Office 365 now has 258 million paid seats. Usage of Windows virtual desktop tripled this quarter as organizations deploy virtual desktops and apps on Azure to enable secure remote work. From Interpublic Group and Kohler to Vodafone, the world's leading companies are choosing Microsoft 365 as their productivity cloud. And we continue to see strong demand for our premium offerings from customers like Mastercard, Autodesk, AARP and Coca-Cola, which chose not only Microsoft 365 but Dynamics 365 and Azure in a 5-year multi-cloud agreement. +We're also expanding our opportunity with consumers with Microsoft 365 Personal and Family, which now has more than 39 million subscribers, and we're bringing Teams to consumers for the first time so that they can stay connected with family and friends. +Windows 10 now has more than 1 billion monthly active devices, up 30% year-over-year, and we are seeing demand for Windows 10 PCs from small screens to large screens to dual screens. +Now on to security. Security remains a strategic priority for every organization, and the shift to remote only increases the need for integrated end-to-end zero-trust security architecture that reduces both cost and complexity. Third-party analysts affirm our leadership as the only company that offers comprehensive identity, security and compliance solutions. This quarter, we introduced new capabilities to protect customer data no matter where it resides. Microsoft Defender ATP now supports Linux in addition to Windows and macOS with iOS and Android to come soon. A new insider risk management in Microsoft 365 helps organizations detect and mitigate malicious activity. +The world's largest hedge fund, Bridgewater Associates, is using security services built into Microsoft 365 to protect employees and core services in a zero-trust environment. Retailer ASOS is using Azure Sentinel to detect and mitigate threats. And the need to secure remote identity and access management is increasing demand for Azure Active Directory now at 300 million active users. +Now on to developer tools. We have the most complete developer tool chain, independent of language, framework or cloud from GitHub to the world's most popular code editing tool, Visual Studio Code. And our developer relevance is increasing. For over a decade, developers have come together remotely on GitHub to build the world's software. As of today, we have 50 million developers on GitHub. From Twilio to the U.S. Department of Veterans Affairs to more than 10,000 engineers at Daimler, GitHub is where developers go from idea to code and code to cloud. +Developers are also collaborating on mission-critical projects from tracking the spread of COVID-19 to implementing contact tracing to helping expand access to personal protective equipment. We are bringing GitHub to even more developers, making core features free for the first time for teams of any size. And our acquisition of npm makes GitHub the largest software repository for JavaScript. +Now on to Power Platform. COVID-19 has accelerated the urgent need for every business to create no-code, low-code apps and workflows in hours or days, not weeks or months. Power Platform is already used by more than 3.4 million citizen developers and business decision-makers. If you can create an Excel spreadsheet, you can create an app, build a virtual agent, automate a workflow, analyze data and share insights in real time. In just 2 weeks, Swedish Health Services, the largest nonprofit health provider in the Seattle area, used Power Apps to track critical supplies. Thousands of organizations are relying on new integration between Microsoft Teams and Power Apps to share timely information. And governments around the world are using Power BI to share the latest COVID-19 data with their citizens. Leaders in every industry, from global health care company, GSK, to Coca-Cola to Toyota, are all using Power Platform to accelerate their automation. +Now on to Dynamics 365. Dynamics 365 is helping thousands of organizations accelerate digital transformation as they remote every part of their operations from manufacturing to supply chain management to sales and customer service, inclusive of new scenarios like curbside pickup, contactless shopping, remote customer assistance and operations. Patagonia is using Dynamics 365 Commerce to rapidly move to new, more intelligent distribution and fulfillment models, including contactless shopping. And we are working with card issuers like American Express so merchants who use Dynamics 365 Fraud Protection can reduce fraudulent activity as they process more transactions online. +In field service, the world's largest commercial real estate services firm, CBRE, is using Dynamics 365 Remote Assist to help keep its life sciences tenants' labs fully operational from afar. And enterprise software company, C3.ai, founded by Tom Siebel, shifted its entire sales force to Dynamics 365 Sales in less than 2 weeks. +Now to LinkedIn. Amidst the changing jobs market, LinkedIn's role in creating economic opportunity for every member of the global workforce has never been more acute. LinkedIn is where more than 690 million professionals go to connect, learn new skills and find new opportunities, contributing to record levels of engagement across the platform in Q3. We are helping organizations attract, retain and develop talent with our portfolio of Talent Solutions, Talent Insights, Glint and LinkedIn Learning. +Professionals watched nearly 4 million hours of content on LinkedIn Learning in March, a nearly 50% increase month-over-month. With LinkedIn Live, people and organizations can broadcast video content to their networks in real time. Streams are up 158% since February. And the combination of LinkedIn Sales Navigator and Dynamics 365 gives sales professional tools for more effective remote selling. +Now on to gaming. People everywhere are turning to gaming to sustain human connection while practicing social distancing, and we continue to deliver new, exclusive first- and third-party content to attract and retain gamers. We saw all-time record engagement this quarter, with nearly 19 million active users of Xbox Live, led by the strength on and off-console. Xbox Game Pass has more than 10 million subscribers, and we are seeing increased monetization of in-game content and services. And our Project xCloud gaming service now has hundreds of thousands of users in preview across 7 countries, with 8 more launching in the coming weeks. +Now on to Azure. Now more than ever, organizations are relying on Azure to stay up and running, driving increased usage. We have more data center regions than any other cloud provider. And this quarter, we announced new regions in Mexico as well as in Spain. We are the only cloud that extends to the edge, with consistency across operating models, development environments and infrastructure stack. Now Azure Edge Zones extends Azure to the network edge, connecting directly with the carriers' 5G network to enable immersive real-time experiences that require ultralow latency. And our acquisition of Affirmed Networks will help operators deploy and maintain 5G networks and services cost effectively and securely. +From BlackRock to Coca-Cola to Genesys, leading companies in every industry are choosing Azure. The NBA is using Azure and our AI capabilities to build their own direct-to-consumer experiences, and the world's largest companies like AB InBev and Mars continue to migrate their SAP workloads to our cloud. In AI, customers are applying a comprehensive portfolio of tools and services and infrastructure to address unique challenges, including those created by COVID-19. In health care, we are seeing compute data and AI come together to help speed up response from testing to therapeutics and vaccine development. Health care providers have created more than 1,400 bots using our Healthcare Bot service, helping more than 27 million people access critical health care information. +The Centers for Disease Control is using the Healthcare Bot to help people self-assess for coronavirus symptoms. Adaptive Biotechnologies is using our tools to decode the immune system's response to the virus. And ImmunityBio is using more than 24 petaflops of computing power on our cloud to help researchers build models in days instead of months. +Enterprises are using our speech services to manage a record influx of customer service inquiries, including Poste Italiane, which is using it to automatically respond to nearly 170,000 calls per day. All of 6 million hours of speech were transcribed in March alone. +In closing, we will continue to work and innovate alongside our customers as their digital-first responders today and as their trusted digital transformation partners going forward. +With that, I'll hand it over to Amy, who will cover our financial results in detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, and good afternoon, everyone. +As Satya discussed, the COVID-19 health crisis is changing the way our employees, customers, partners and communities live and work together. In a new environment, our team addressed surging usage and remote business process adjustments well. Therefore, in Q3, revenue was $35 billion, up 15% and 16% in constant currency. Gross margin dollars increased 18% and 20% in constant currency. Operating income increased 25% and 28% in constant currency. Our earnings per share was $1.40, increasing 23% and 27% in constant currency. +Let me take a moment to discuss the impact of COVID-19 on the quarter. In our consumer business, the landscape evolved quickly following our mid-quarter guidance update. The supply chain in China returned to more normal operations at a faster pace than we had anticipated. And we saw increased demand from work, play and learn-from-home scenarios, benefiting Windows OEM, Surface, Office Consumer and Gaming. This was partially offset by a significant reduction in advertising spend, which impacted our Search and LinkedIn businesses. +In our commercial business in March, we saw healthy Azure consumption and, as Satya mentioned, increased usage across Windows Virtual Desktop, Power Platform and Microsoft 365, particularly in Teams and our advanced security solutions. However, we also saw some changes to our sales dynamics, particularly in the industries and segments most impacted by COVID-19. We saw a slowdown in our transactional business across segments but particularly in small and medium businesses. In Enterprise Services, growth rates slowed as consulting projects were delayed. And on annual contracts in LinkedIn's Talent Solutions business, renewals were impacted by the weak job market. +Moving to our overall results. Commercial bookings increased 7% and 12% in constant currency on a relatively small expiration base and strong prior year comparable. Growth was driven by strong renewal execution, consistent with prior quarters, though we saw some impact from the previously mentioned changes in sales dynamics. Commercial remaining performance obligation increased 24% to $89 billion. Approximately 50% will be recognized in revenue in the next 12 months, in line with prior quarter trends. +Our commercial revenue annuity and mix increased 2 points year-over-year to 92%. And commercial cloud revenue was $13.3 billion, growing 39% and 40% in constant currency. Commercial cloud gross margin percentage increased 4 points year-over-year to 67%. Significant improvement in Azure gross margin percentage, including some benefit from short-term utilization gains as we worked through COVID-19-related supply chain constraints more than offset sales mix shift to Azure. +Company gross margin percentage was 69%, up 2 points year-over-year, driven by favorable segment sales mix and improvement across all 3 of our segments. In line with expectations, FX reduced revenue growth by 1 point and had no impact on operating expense growth. The FX impact on COGS growth was slightly more favorable than expected and reduced growth by 1 point. Operating expense grew 10%, slightly below expectations, primarily driven by lower marketing and travel spend in March. And operating expenses expanded this quarter -- excuse me, operating margins expanded this quarter as a result of higher gross margins and disciplined decisions to invest in strategic and high-growth areas. +Now to our segment results. In line with expectations, revenue from Productivity and Business Processes was $11.7 billion, increasing 15% and 16% in constant currency. Office Commercial revenue grew 13% and 15% in constant currency. Office 365 Commercial revenue grew 25% and 27% in constant currency, again driven by installed base growth across all workloads and customer segments as well as higher ARPU with strong upsell to E5. And Office 365 Commercial seats grew 20% to nearly 258 million, with an increasing mix from Microsoft 365. +Office Consumer revenue grew 15% and 17% in constant currency, driven by growth in Office 2019 and Office 365 subscription revenue. Office 365 Consumer subscribers grew to 39.6 million, benefiting from the increased demand noted earlier. Dynamics revenue grew 17% and 20% in constant currency, driven by Dynamics 365 growth of 47% and 49% in constant currency. LinkedIn revenue increased 21% and 22% in constant currency as early quarter momentum was slightly offset by the slowdown in advertising. +Segment gross margin dollars increased 16% and 18% in constant currency, and gross margin percentage increased 1 point year-over-year as improvements in Office 365 and LinkedIn margins more than offset an increase in cloud revenue mix. Operating expense increased 12% and 13% in constant currency, driven by continued investment in LinkedIn and cloud engineering. And operating income increased 20% and 23% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $12.3 billion, increasing 27% and 29% in constant currency, ahead of expectations, driven by continued customer demand for our hybrid offerings. On a significant base, server products and cloud services revenue increased 30% and 32% in constant currency. Azure revenue grew 59% and 61% in constant currency, driven by continued strong growth in our consumption-based business. +In our per user business, our enterprise mobility installed base grew 34% to over 134 million seats, with continued benefit from Microsoft 365. And our on-premises server business grew 11% and 12% in constant currency, driven by the demand for our hybrid and premium solutions and continued benefit from the end of support for Windows Server 2008. Enterprise Services revenue increased 6% and 7% in constant currency as growth in Premier Support Services more than offset the consulting delays. Segment gross margin dollars increased 30% and 32% in constant currency, and gross margin percentage increased 2 points year-over-year as another quarter of significant improvement in Azure gross margins more than offset the growing mix of Azure IaaS and PaaS revenue. Operating expense increased 19%, primarily driven by continued investments in Azure, and operating income grew 42% and 46% in constant currency. +Now to More Personal Computing. Revenue was $11 billion, increasing 3% and 4% in constant currency, ahead of the revised expectations from our mid-quarter guidance update as better-than-expected Windows OEM, Surface and Gaming revenue more than offset lower-than-expected Search revenue. OEM as well as Surface revenue benefited from the improved supply chain in China, increased demand from remote scenarios and continued Windows 7 end-of-support dynamics. In OEM non-Pro, those dynamics were offset by continued pressure in the entry-level category. +Windows Commercial products and cloud services grew 17% and 18% in constant currency, again driven by Microsoft 365 and demand for our advanced security solutions. Search revenue ex TAC increased 1%, below our expectations, driven by significantly reduced advertising spend. And in Gaming, revenue declined 1% and was relatively unchanged in constant currency, driven by higher user engagement than expected. Xbox content and services revenue increased 2% on a high prior year comparable with strong growth in Game Pass subscribers and Minecraft. +Segment gross margin dollars increased 6% and 8% in constant currency, and gross margin percentage increased 2 points year-over-year due to higher-margin sales mix. Operating expense declined 3%, driven by a redeployment of engineering resources to higher growth opportunities. As a result, operating income grew 15% and 17% in constant currency. +Now back to total company results. Capital expenditures, including finance leases, were $3.9 billion, up 15% year-over-year to support growing demand for our cloud services and lower than expected driven by COVID-19-related delays across the supply chain. Cash paid for PP&E was $3.8 billion. Cash flow from operations was $17.5 billion and increased 29% year-over-year, driven by healthy cloud billings and collections. And free cash flow was $13.7 billion, up 25%. Other income and expense was negative $132 million, lower than anticipated due to FX remeasurement and net recognized losses on investments. As a reminder, we are required to recognize unrealized gains or losses on our equity portfolio. Our effective tax rate was slightly above 16%, in line with expectations. And finally, we returned $9.9 billion to shareholders through share repurchases and dividends, an increase of 33% year-over-year. +Now let's move to our outlook, starting with our expectations for COVID-19-related impact. In our consumer business, we expect continued demand across Windows OEM, Surface and Gaming from the shift to remote work, play and learn from home. Our outlook assumes this benefit remains through much of Q4, though growth rates may be impacted as stay-at-home guidelines ease. We assume advertising spend levels from March do not improve in Q4, which will impact Search and LinkedIn. +In our commercial business, our strong position in durable growth markets means we expect consistent execution on a large annuity base, with continued usage and consumption growth across our cloud offerings. However, we expect the sales dynamics from March to continue, including a significant impact in LinkedIn from the weak job market and increased volatility in new longer lead time deal closures. +In commercial bookings, growth from healthy renewal execution on a larger Q4 expiry base will be impacted by some large commitments in the prior year and the previously mentioned sales dynamics. Commercial cloud gross margin percentage will be relatively changed year-over-year as continued improvement in IaaS and PaaS gross margin percentage will be more than offset by revenue mix shift to Azure. And with the supply chain constraints easing, we expect a material sequential increase in our capital expenditures to support growing usage and demand for our cloud services. +Next to FX. We expect a larger impact to our results due to the stronger U.S. dollar. Based on current rates, FX should now decrease total company, Productivity and Business Processes and Intelligent Cloud revenue growth by approximately 2 points and decrease More Personal Computing revenue growth and total company COGS and operating expense growth by approximately 1 point. +Now to segment guidance, which includes wider ranges than normal given the uncertainty in our business with higher in-quarter sales and revenue recognitions. In Productivity and Business Processes, we expect revenue between $11.65 billion and $11.95 billion. Approximately 80% of this revenue comes from the earnout on existing contracts and agreement renewals. The remaining 20% of revenue, primarily from annuity agreements, transactional licensing and LinkedIn, is subject to more volatility in the current environment. +In Office Commercial, revenue growth will continue to be driven by Office 365, with strong upsell opportunity particularly to our advanced security solutions. However, growth will be partially offset by continued transactional weakness, some impact from the previously mentioned sales dynamics and a strong prior year comparable, where 4 points of growth were from a greater mix of contracts with higher in-period recognition. +In Office Consumer, we expect low single-digit revenue growth, down sequentially, as subscription growth is offset by a slowdown in our Office 2019 transactional business. In LinkedIn, we expect continued strong engagement on the platform. However, a material mix of revenue is driven by customer hiring needs and advertising. Therefore, we expect a significant slowdown to mid-single-digit revenue growth. +In Dynamics, we expect low double-digit revenue growth with continued Dynamics 365 momentum, offset slightly by a slowdown in new projects with longer lead times. For Intelligent Cloud, we expect revenue between $12.9 billion and $13.15 billion. Approximately 80% of this revenue comes from the earnout on existing annuity contracts, agreement renewals and consumption from existing Azure workloads. The remaining 20%, which is primarily made up of new annuity agreements, transactional licensing and enterprise services consulting revenue, is subject to more volatility. +In Azure, revenue growth will again be driven by our consumption-based business, with continued strong growth across our customer base, though we expect some moderation in the most impacted industries and segments. And in our per user business, growth will be impacted by the increasing size of the installed base as well as the sales dynamic noted earlier. In our on-premises server business, we expect revenue to decline low single digits on a strong prior year comparable as continued hybrid demand is more than offset by some transactional weakness. And in Enterprise Services, we expect a low single-digit revenue decline, driven by continued delays in our consulting business. +In More Personal Computing, we expect revenue between $11.3 billion and $11.7 billion. Roughly 75% of this revenue across OEM, Surface, Search and Gaming is earned in quarter. In Windows, overall OEM revenue growth should be low to mid-single digits on a strong prior year comparable. In Windows Commercial products and cloud services, we expect mid-single-digit revenue growth with headwinds from our transactional business and the previously mentioned sales dynamics. +In Surface, the continued strong demand should drive revenue growth in the low teens. In Search ex TAC, we expect revenue to decline in the mid-20% range, similar to March. And in Gaming, we expect revenue growth in the high teens with continued strong user engagement across the platform. +Now back to overall company guidance. We expect COGS of $11.55 billion to $11.75 billion and operating expense of $11.8 billion to $11.9 billion. Other income and expense should be negative $100 million as interest expense is expected to more than offset interest income. And finally, we expect our Q4 effective tax rate to be approximately 18%, slightly higher than our full year tax rate of 17% due to the geographic mix of the revenue. +I'd like to close sharing a few thoughts as we look beyond Q4 and into the next fiscal year. Our focus remains on strategically managing the company for the long term, with decisions optimized for delivering greater customer value and long-term financial growth and profitability. With that, we'll continue to provide increased support to our customers and partners as they navigate the uncertain future ahead, deepening our engagement and adding increased value. We will continue to aggressively expand our cloud infrastructure to support not only the usage surges of today but the growing customer demand for our unique and differentiated cloud offerings in the future. +We will continue to make significant investments against the strategic growth opportunities Satya outlined, organically and through strategic acquisitions like that of Affirmed Networks this quarter. And we have the flexibility given our strong financial position and free cash flow generation to do all of this and support our commitment to capital return. Microsoft does well when our customers do well, and we are uniquely positioned to continue to invest and contribute to their future success. +With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- +Thanks, Amy. We'll now move over to Q&A. (Operator Instructions) Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Our first question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- +Very impressive quarter in a difficult time, and I hope all of you and your families are all safe and healthy. Satya, a question for you. You did a really great job of talking to how well the expanded portfolio -- really broad portfolio that Microsoft brings to the market has helped customers during a crisis period and a period that engendered a lot of change within the way organizations were operating. Can you talk to us a little bit about how much of that sort of assistance and how much of that you were able to actually take to revenues, if you will? How much of that is stuff that you could actually monetize today versus, given the customer relationship, given the focus on the long term, you have to sort of let play out over time, and it's about kind of expanding usage and expanding the relationships with customers that you expect to pay out over a longer period? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- +Thank you, Keith, for the question. Overall, the perspective we take, the approach we take is really to be there for our customers at their time of most acute need. So we don't go in there with the mindset of what does it mean for our revenue. I mean this thing that I'd always say which is when our customers do well, we'll do well on a long-term basis, that's at the core of our business model. That's the core of how we approach it. +That said, Keith, I think there are 3 phases here, and there's overlap. For example, the phase we are mostly in right now is that first response space, where from business continuity perspective, people want to be able to work remotely, want to be able to conduct remote operations. That's what's leading to increased demand in Teams or increased demand in remote desktop and security and what have you. So that's sort of, I would say, the phase we are in broadly. And of course, there are certain sectors like the health care sector. There is even education obviously as well as some of the public sector organizations. They all have surge demand or even in some segments of retail, there is surge demand. And so that's something that we are scaling to meet their needs. +Then I believe, as we work out here, so if you think about the next phase of recovery, it's more like a dial. Things will start coming back in terms of economic activity and we'll have to keep adjusting the dial. This hybrid work is going to be there with us for a period of time. That's where some of the sort of architectural product strength of ours will be very useful to our customers. Even just take Teams. It's not -- Teams is not just about having lots and lots of video meetings. Teams is about actually getting work done where meetings and video is one part. So that's, for example, something the utility of it will only increase for our customers as some people come back to work, some people are remote, you have to collaborate without any fatigue. So that's that second phase. +And then the third phase is where there is going to be structural change. There's no turning back, for example, in telemedicine, right? If you look at even what has happened in this first phase with AI bots powering telemedicine triage, that's going to change, I think, what health care outcomes look like. Same thing in education. +Digital twins. This is something I think I talked about maybe in the last earnings even. This is what -- anybody who has a digital twin is able to, first, remote the control plane, is able to automate, is able to simulate. That's huge for anybody who's into manufacturing or is trying to model out and plan their supply chain. So I think that there are ways for us to participate in what ultimately will be productivity growth. But immediate term, we are mostly building out the relationships, adding new customers, adding intensity in usage in existing relationships, which all, in the long term, will play out in terms of economics for us as well. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +And maybe just to add on to that, the way you might think about that, Keith, is the first stage for many of the licensing protocols was to include trial offers for many of our customers who were in need of the specific things we just discussed and, over time, being able to convert that into a monetization engine or, for example, to take some of the usage surge we've seen even across our consumer properties or even in gaming or Office 365, which is now Microsoft 365 for Consumers, I think there's a lot of opportunity here for us to continue to add value. And when you add value, long-term customer value certainly goes up. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [6] +-------------------------------------------------------------------------------- +Congratulations, Satya and Amy, on the quarter and how you've been able to shift the business over many years to position it so well into these difficult times. We understand there are supply chain issues that have been impacting server deliveries in the quarter, and the changes in demand have been massive. During the quarter, there were disruptions in Azure, Xbox Live and Teams, we heard. How is Microsoft coping with these sudden demands from work from home? Do you have enough capacity? How quickly can you add capacity? Can you give us a sense of how you deal with that on the Azure and the overall business side? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- +Yes. Maybe I'll start, and Amy, you can add to this. Overall, first, I think I would say the current cloud architecture, whether it's at the infrastructure level or the SaaS applications with M365 or Azure, have been, I think, very, very helpful in us being able to all as an economy pivot to this new way of working, working from home, remoting all of our operations. If you think about it, like the orders of magnitude increase we've seen in usage, in our own case with our applications such as Teams or virtual desktop, have been tremendous. And that's happening, as I said, in different segments with our customers as they move to remote operations and are dealing, in some cases, with their own surge demand or what you've seen even in gaming and other entertainment categories. +So I would say these architectures withheld well. We did have, as you mentioned, some supply chain issues coming into the quarter, which have largely worked themselves out. But we have a data center architecture and a footprint that really supports our customers' needs for both the elasticity of demand they need but also compliance. So one of the things is data sovereignty and security is not going to go away ever, especially in the geopolitical environment we live in. If anything, it's going to be more important for us to support this need for people to scale while keeping them compliant. And so we feel well positioned for that. +With that, I'll transition to Amy to add further. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- +I think, Mark, in many ways, the way you see that capacity show up is in the Q4 CapEx guide. And so while we spent $3.9 billion in Q3, that was certainly short, in particular, on the server side in terms of getting what we need into the data centers. Things got a lot better in March, and they're continuing to get better. And so I feel good that we'll have a healthy CapEx number in Q4 but more importantly continue to get ahead of the surge demand and also there's the continuing demand growth we're seeing across the properties. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [10] +-------------------------------------------------------------------------------- +I actually had 2 for you. I was wondering if you could share new logo growth in Azure and Office 365 versus net expansions, just that there was -- if there's any color you could give on what happened in the quarter. And also, I guess, Satya, how do you think about the adoption curve of Azure and the workloads in the cloud accelerating over the next few years as a result of the changes that may occur from COVID? And any thoughts on if your 3-year out view of cloud adoption is increasing as a result of what's going on? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [11] +-------------------------------------------------------------------------------- +Yes. Maybe, Amy, I'll take the second one first and then you can take the first one. I would say the -- there is no question that moving to the public cloud even at a time like this is just capital efficient. If you think about for any business, the conversations we're having is even for businesses that are having tough economic cycles, one of the smartest things that anyone can do, and we want to be very helpful in those conversations, is to transition to the efficient frontier as quickly as possible so that they can have more agility, more elasticity and better unit economics coming out of this or even while you're in this crisis. So I think the migration to the cloud is absolutely a secular shift. +But at the same time, the architecture of the cloud itself is going to be -- have the cloud and the edge. So it's not just about migrating off-premise, but it's going to be able to have an architecture that supports the needs, where edge compute is increasingly going to be very important. That's why even what we are doing on our edge compute, what we did with Affirmed Networks, what we did with even the launch of Azure Edge Zones, all speaks to, I think, what is going to be the secular infrastructure architecture going forward. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- +And to your first question on really expanding the customer base versus adding seats or consumption within that customer base, we actually saw both this quarter again, the way you would have seen a little bit of weakness, I guess, in on-premises Office Commercial due to transactional weakness and maybe SMB. But outside of that, Heather, it didn't really show a different pattern than I would have normally expected in terms of a breakdown between those. +The one difference I will say is just because there was so much deployment done in the past 4 weeks, especially around Teams and some of the other workloads, there's certainly a distinction that a lot of that was expanding the footprint as opposed of deployment much faster than I think many enterprises had initially planned to do so. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Our next question comes from the line of Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [14] +-------------------------------------------------------------------------------- +Satya, I was curious if you could share on the next chapter of Teams and what you think it looks like, and maybe speak to the monetization halo that you're seeing with the rest of the product line spinning off of the great adoption, which seems to be doubling every time you give us the stats. Thanks for getting our firm up on Teams basically in a couple of weeks. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [15] +-------------------------------------------------------------------------------- +Thanks, Brent. Overall, the way we've always approached Teams is as a user experience and, I would say, a scaffolding was to sort of incorporate what's a modern way of working. We always felt that we needed to have, in some sense, best-in-class functionality in each of the modalities, right, whether it's meetings or chat, collaboration or business process. But the most important thing is to bring these together so that people can get more done, teams of people and organizations can get more done. And that's what you see play out even in this pandemic, if you look at it. Of course, there's no question, meetings are most important. We do a lot of them. +But at the same time, what is happening in a meeting is the important context that can't get lost. That's what's going to have continuity, whether it's the whiteboard you created, it's the OneNote you shared, it's the document you edited together, it's a business process alert that you are responding to. Thinking that through holistically is the most important thing. And that's where our focus will be. In fact, some of the stats I shared even around some of the number of business process applications that are getting integrated. One of the most exciting things to me that happened even in this COVID response, people were able to use Power Platform to build new applications in hours, put that into Teams and then get their first-line workers to be able to track, say, PPE because there was no ERP system that did that. That ability to digitize at high rates and do it in the context of how people work and collaborate, I think, speaks to the power of the Teams platform. And when Teams does well, all of Microsoft 365 does well. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Our next question comes from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- +And I'm glad to hear that you all are well and I hope the same for your families. Satya, in your prepared remarks, you mentioned how Microsoft continues to broaden its relevancy with developers from GitHub, Visual Studio, Visual Studio Code, dev ops, dev server and most recently, obviously, multi-cloud infrastructures code with Azure Arc. Just 2 questions on this topic. Firstly, Satya, how do you think about how much of that dev ops life cycle Microsoft needs to address directly versus partnering with third parties or maybe open source? +And then secondly, for both Satya and Amy, if COVID-19 is really creating sort of a zeitgeist opportunity for the cloud and digital transformation, how are you seeing your broadening CI/CD pipeline product set impacting Azure's competitive position near and longer term? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [18] +-------------------------------------------------------------------------------- +Yes. First thing, we have always said when we acquired GitHub that we want to be in the developer tools and developer services business as an end, not as a means to some end. And so that's what we're executing on. We care about this. After all, Microsoft was created as a dev tools company first before anything else, and that means a lot to us. And so with GitHub now, we're just really executing on that strategy, which is to start. And that means you have to be true with the developer choices. So this is not about us having anything homogenous from us but to really respect the heterogeneous choices of developers. +All we want to make sure is we bring the very best of our code editing tools to GitHub as the code repository, bring great security capabilities, bring the best of CI/CD and dev ops, bring even live ops, something like Azure PlayFab, all of those tools. But it's not to say that anyone else can't participate. In fact, we have marketplaces on Azure as well as on GitHub. It will be -- it will work across cloud, so we will always ensure that it's an open community that supports all of the developer choices. At the same time, we think of this as -- we're building essentially what we did with Microsoft 365 for knowledge workers and first-line workers. What we are doing with Dynamics 365 for BDMs, we want to do with developers because there are going to be more software developers, and their workflows are going to impact more people outside of software development. So to me, this is a very important SaaS category to be in for its own sake. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Our next question comes from the line of Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [20] +-------------------------------------------------------------------------------- +Hope you guys are staying safe. I wanted to focus on Dynamics. It's obviously not the biggest part of Microsoft, but it's a very important growth one. In this sort of environment where there's a lot of uncertainty, with Dynamics, you're addressing some very fundamental kind of business apps. What do you see there in terms of customer appetite to kind of go for this at this point? Is that kind of an area? Because it's now online compared to on-premise, that is seeing more adoption, fast adoption. Or can you talk a little bit about the trends there? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- +Sure. I think it's actually very important to have the ability in a very agile way as a business to be able to move on your business process needs. So for example, if you're a retailer and you now need to do contactless shopping, that is something that, for example, Dynamics is going to support for you to be able to use even commodity cameras with AI modules, with all of it helping with a data model that supports shopping inside of physical stores or curbside pickup or even remote assistance. These are some of the examples I even used in my script. +So this is what is sort of going to be high priority. So as long as business applications like ours with Dynamics 365 address the immediate pressing needs, these are project starts that will happen because, in some sense, that's the way for economic activity to return. But at the same time, I think business applications that perhaps are -- have longer lead in terms of implementation, people are probably going to take some more time to decide on it. But whereas we think we are well positioned to capture the new scenarios. And Power Apps, because we think about Power Platform and Dynamics as both what we do with business applications, and we feel that between these 2, along with Azure, are well positioned to address what are going to be increasing digitization needs, where people don't have months to deploy or months to implement. And that's where we shine. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- +And I think that you would say that we've seen that in our pipeline and really in the customer demand scenarios. So I think what we've seen is really more of a shift to some of these quick time-to-value deployments and a real change in terms of new, long lead time projects there, and I think that's probably not surprising. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [23] +-------------------------------------------------------------------------------- +And the one thing -- one scenario I should mention is, for anyone who's looking to say, "How do I continue to generate revenue?" Remote sales, for example, is going to be a very critical scenario. And there's no better solution than the combination of Dynamics Sales and LinkedIn Sales Navigator to be able to drive especially B2B sales. So those are the types of solutions that are going to be very relevant in times like this. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [25] +-------------------------------------------------------------------------------- +I'm interested in whether you see the current environment as a net tailwind or a net headwind on Azure growth, just as we try to weigh the idea of the pandemic as a forcing function to adopt cloud a little more rapidly versus, on the other hand, potential economic pressure on IT budgets. How do you think that, that balances out for bookings and for consumption? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [26] +-------------------------------------------------------------------------------- +Let me start, and Amy, you can add to it. There are, as you said, many different ins and outs here. But if you step back and ask yourself, say, 2 years from now, "Is there going to be more being done in the public cloud or hybrid cloud or less?" The answer is more, just because it is more efficient. It is the only way for you to have even the business continuity required in times like this, and your needs going forward of increasing digitization are going to be met with better pricing, better economics at a unit price level for the given business. So that's sort of what we use to forecast out what we commit, both in terms of CapEx, OpEx, innovation and customer engagement. +To your point, ultimately, Microsoft's not immune from what's happening broadly in the world in terms of GDP growth. But at the same time, if there is going to be economic activity, then I would claim that digital as a component of that economic activity is going to increase. And specifically, the full stack we have from infrastructure to our SaaS applications are going to be very competitive in that context. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- +And I think for me, we -- it's so clear. I think we talk about our capital investment or our world view, that it's a tailwind over any long period of time. Satya talked about 2 years or 3 years for sure. And I think the way you're seeing it in something like bookings, for example, would be, maybe you don't make as large of a giant commitment, and you're more willing to do pay as you go as you just think about making that transition when you don't want to have a giant budget conversation with your department but you'd rather move to an easier use and pay in the moment. And I think in some ways, that will be the same thing that we were already seeing is a transition in terms of thinking about that for long term. And so it will have some impact as big deals always did or didn't on bookings. And so I would keep that in mind. But other than that, I think obviously over any longer period of time, it's certainly a tailwind. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our last question comes from the line of Alex Zukin with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Aleksandr J. Zukin, RBC Capital Markets, Research Division - MD of Software Equity Research & Analyst [29] +-------------------------------------------------------------------------------- +And glad to hear you're staying safe. Satya, given the incredible spike you're seeing in Teams and broader Office adoption around remote work, I guess maybe first, given how this crisis has dramatically accelerated some of these adoption curves, how do you think about the longer-term growth and monetization trajectory on Teams and Office maybe versus pre-COVID levels? And then if you think about your competitive positioning, having both the opportunity to solve remote work challenges from a productivity standpoint and infrastructure challenges from an Azure standpoint, how does the combination of those change some of the competitive dynamics in the market right now? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [30] +-------------------------------------------------------------------------------- +Thank you for that question. First of all, as I said a little earlier, Teams and the usage of Teams is something that increases the intensity across all of what's Microsoft 365. And to your point about whether it's -- and usage leads to monetization. Now for example, one of the things that we didn't talk as much at least in the Q&A section is on security. If you look at one of the key considerations, as people go remote work, is to ensure, starting with the identity, to the device endpoint, to the application, to the information in the application and the infrastructure behind the app, you need that zero-trust architecture. So that's, again, built in to and in around Teams itself. +So to me, we have -- and same thing with compliance, right? So it's one thing to have Teams, people working remotely. But information being shared in Teams, that OneNote you share, does it carry the policies that were set for information protection? See, that's the big advantage we have architecturally in terms of all this having been built with one particular set of architectural principles so that they can be enforced throughout all of these applications. And we'll obviously want to monetize these as appropriate at different levels of subscription we have for M365. And so we feel well positioned on that. +And to your second part, we've always said this, which is we don't, for example, even allocate our capital in building out our cloud infrastructure for Azure or Dynamics 365 or Microsoft 365 or even, for that matter, xCloud all as separate. We think of this as all being built on one common platform in Azure. And that's where our fundamental capital efficiency of that architecture comes from. And yes, from a customer end perspective, we absolutely want to win each layer based on its own merits, and we will have openness in each layer. +But there are great benefits. And Coca-Cola and the deal this quarter is a great example of someone who wants to use, in fact, our security across all these 3 clouds and the products across all these 3 clouds. So that's what we will increasingly do, but that also means we want to be competitive in each layer and open in each layer. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [31] +-------------------------------------------------------------------------------- +And maybe to add that I think in some ways speaks in Alex's question goes back to the very beginning of how we feel the value sits in that Microsoft 365. But even more broadly is that while we've seen a surge in Teams now, there was a lot of surging in security and compliance 6 months ago and 6 months before that. We've seen increased usage across multiple products in our line, and that includes Windows and the PC. And so this very holistic and breadth commercial opportunity, but also that extends, in many ways, to consumer opportunities for us as well, is connected. And that breadth, in a moment and a period like this, all the pieces are important to value long term here to a company being able to transition through the phases that Satya talked about, from this initial phase of almost emergency response to a hybrid phase to ultimately what I think we all believe is a very different way and a long-term way of working and collaborating together and driving a digital economy. So I think in some ways, the breadth of this company and where we've invested over the past few years, it's not just Teams but maybe a few products that have served us well and served our customers well. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [32] +-------------------------------------------------------------------------------- +Thanks, Alex. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [33] +-------------------------------------------------------------------------------- +Thank you all. Thank you, and stay safe. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [34] +-------------------------------------------------------------------------------- +Stay safe. Thanks. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2020-Jan-29-MSFT.txt b/Transcripts/MSFT/2020-Jan-29-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..e356827ddf56a1008498efc51666f0cb984c5ba2 --- /dev/null +++ b/Transcripts/MSFT/2020-Jan-29-MSFT.txt @@ -0,0 +1,390 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Microsoft Corp Earnings Call +JANUARY 29, 2020 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Ronald Murphy + JP Morgan Chase & Co, Research Division - MD + * Philip Alan Winslow + Wells Fargo Securities, LLC, Research Division - Senior Analyst + * Karl Emil Keirstead + Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Brad Robert Reback + Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - MD & Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to the Microsoft Fiscal Year 2020 Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to turn the call over to Mike Spencer, General Manager of Investor Relations. Thank you. Please proceed. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. +Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's second quarter performance in addition to the impact these items and events have on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors sections of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike. It was another strong quarter with double-digit top and bottom line growth driven by the strength of our commercial cloud. Stepping back from the quarter and reflecting more broadly on the next decade, the defining secular trend will be the increasing rate of digitization of people, places and things. This malleable power of software will drive productivity growth across all industries, leading to more inclusive economic growth, far beyond the domains of consumer tech today. +Tech spend as a percentage of GDP is projected to double over the next decade. At Microsoft, we are focused on building the most differentiated tech stack to enable every organization in every industry to build their own digital capability and tech intensity, with a business model that is trusted and aligned with their success in this new era. +Now I'll briefly highlight our innovation momentum, starting with Azure. Every customer will need a distributed computing fabric across the cloud and the edge to power their mission-critical workloads and meet regulatory as well as operational sovereignty needs. We have more data center regions than any other cloud provider and will be the first to open in Israel and Qatar, expanding our footprint to 56 in total. Azure is the only cloud that offers consistency across operating models, development environments and infrastructure stack, enabling customers to bring cloud compute and intelligence to any connected or disconnected environment. +This quarter, we expanded our portfolio of edge appliances. Azure Stack Edge brings rapid machine learning inferencing closer to where data is generated. And the new ruggedized Azure Stack form factors provide cloud capabilities in even the harshest of conditions like disaster response. With Azure Arc, we are defining the next generation of hybrid computing. Arc is an industry-first control plane built for a multi-cloud, multi-edge world, helping partners like HPE meet their customers' complex hybrid needs. +Our differentiated approach across the cloud and edge is winning customers. The U.S. Department of Defense chose Azure to support our men and women in uniform at home, abroad and at the tactical edge. And our exclusive partnership with SAP makes Azure the preferred destination for every SAP customer with large migrations in every industry from Accenture to Coca-Cola to Rio Tinto to Walgreens Boots Alliance. +We're also going beyond conventional computing architecture, ushering in a new era with Azure Quantum, a full stack open ecosystem that enables customers like Ford Motor Company to apply the power of quantum computing today. There will be 175 zettabytes of data by 2025, up from 40 zettabytes today. Processing this data in real time will be an operational imperative for every organization. Azure Synapse is our limitless analytics service. It brings together big data analytics and data warehousing with unmatched performance, scale and security. In concert with Power BI, it enables data scientists to generate immediate insights from structured and unstructured data and build custom AI models. Walgreens Boots Alliance is using Synapse to analyze more than 200 million item-store combination, so millions of customers can rely on items always being in stock. +In AI, we are seeing rapid adoption across our comprehensive portfolio of AI tools, infrastructure and services. 6 billion transactions on Azure Cognitive services each month, 7 billion documents processed daily with Azure cognitive search, 2 billion predictions a month using Azure machine learning and 3,500 new conversational agents bots created each week with Azure Bot Service. +Nationwide is using Azure Bot Service to simplify how millions of customers submit claims. And KPMG is using Azure Cognitive Services to transcribe and catalog thousands of hours of calls, reducing compliance costs for its clients by as much as 80%. +Now to security. Cybercrime will cost businesses, governments and individuals $1 trillion this year. We are the only company that offers integrated end-to-end identity, security and compliance solutions to protect people and organizations, spanning identity management, devices, cloud apps, data and infrastructure. Recent CIO surveys affirm our leadership and strong structural position, and customers from Maersk to Vodafone are increasingly turning to us to simplify security integration and speed their responses to issues. 4 months since launch, more than 3,500 customers already rely on Azure Sentinel to detect and mitigate threats. It's early days, and we are accelerating our investments. +Now on to developer tools. From Azure DevOps to Visual Studio to GitHub, we offer the most complete developer tool chain, independent of language, framework or cloud. New capabilities make it easier for any developer to go from idea to code, and from code to cloud. Developers can collaborate on the go with new GitHub mobile app. And GitHub Security Lab addresses the important need to keep open source software secure. More than 10,000 developers at Adobe are using GitHub to collaborate and create software. Stripe is using GitHub to build the online payment platform of choice for millions of customers, and Chipotle is using our dev tools to power their online ordering system. +Now on to Power platform. We are empowering not only professional developers but those closest to the business problem from citizen developers to businesses -- business decision-makers with no-code, low-code tools so they can create apps and intelligent workflows that solve unique needs. Today, 2.6 million citizen developers use Power platform to make better decisions using self-service analytics, building mobile app, automate a business process or even create a virtual agent, all with no coding experience. +We're innovating in robotic process automation. Power Automate enables customers to turn manual tasks into automated workflows and power virtual agents enables anyone to build an intelligent bot with just point and click. TruGreen, the largest lawn care company in the United States is using both these solutions to handle customer inquiries and take action. +Now on to Dynamics 365. The competitiveness of every business going forward will be defined by their ability to harness the full value of their data. Dynamics 365 enables organizations to move from reactive, siloed transactional processes to proactive, repeatable and predictable business outcomes. Dynamics 365 Customer Insights, that's layered and built on Azure Synapse, is the only customer data platform operating at scale today. AEP Energy is using it to unify first- and third-party customer data to increase, upsell and reduce churn. +In retail, Canada Goose is using Dynamics 365 Commerce to unify data across back-office, in-store and call centers to deliver more personalized shopping experiences. And in training, ABB is using Dynamics 365 Guides and Remote Assist to bridge the physical and digital worlds. And Qantas is using HoloLens 2 for immersive new training experiences. +Now on to LinkedIn. LinkedIn continues to create economic opportunity for every member of the global workforce. Every 7 seconds, someone is hired on LinkedIn. We saw record levels of member engagement again this quarter. Marketing solutions remains our fastest-growing business as marketeers leverage the enhanced tools and LinkedIn pages to connect with our nearly 675 million members. New data validation features in LinkedIn Sales Navigator helps sellers use the power of their LinkedIn network to drive more meaningful customer engagement. +We continue to innovate across our Talent portfolio, including Talent Solutions, Talent Insights, Glint and LinkedIn Learning to help organizations attract, retain and develop the best talent. More than 5 million members have already completed LinkedIn skills assessment since the launch last quarter. +Now turning to Microsoft 365. Microsoft 365 is the only solution that empowers everyone with an integrated, secure experience on any device. Everyday AI and Microsoft 365 is helping create, collaborate and convert content into knowledge in a world where computing is abundant, however, attention is scarce. Presentations are more persuasive in PowerPoint, data is more insightful in Excel, videos are more searchable in stream and e-mail more actionable with Cortana. +The new Project Cortex analyzes massive amounts of information to give people precisely the knowledge they need in the context of their work. And the new Microsoft Edge with enterprise-class security protects your privacy online and makes it easier to find information at your work with Microsoft Search. +Microsoft Teams is the leading hub for teamwork, now with more than 20 million daily active users. People are increasingly engaged across the platform in richer forms of communication and collaboration, participating in more than 27 million meetings a month. Integrated calendaring, pop-out chats and one touch to join meetings from your phone keeps work, conversations and meetings in the context, eliminating the need to bounce back and forth between apps. We are reimagining the meeting rooms of the future with Teams integration with Cisco's Webex and new devices from Lenovo. And our partnership with Samsung, along with a new walkie-talkie feature in Teams gives first-line workers the technology they need to be more collaborative, productive and secure on the go. +All this innovation is driving usage. 64,000 employees at L'Oréal are using Teams, more than 70,000 first-line employees at IKEA are moving to Teams for shift management, from Nestlé to Tesco, the world's largest companies are choosing Microsoft 365. And we continue to see increased demand for our premium offerings from customers like AXA, Rockwell Automation, Berkshire Hathaway Specialty Insurance and Duracell. +This holiday, we expanded our family of Surface devices, creating new categories that benefit the entire OEM ecosystem. And at CES, our partners showcased innovative Windows 10 devices from incredibly thin and light laptops to powerful gaming rigs to new dual-screen designs. +Finally, gaming. We continue to invest to reach gamers across every end point, mobile, PC and console. xCloud is off to a very strong start, transforming how games are distributed, played and viewed with hundreds of thousands of people participating in initial trials. We set a new record for Xbox Live monthly active users again this quarter, led by the strength of console. Xbox Game Pass subscribers more than doubled this quarter, and Xbox Series X announced last month will be our most powerful console ever. +In closing, we are expanding our opportunity across all our businesses. Along with this opportunity, we recognize the responsibility we have to ensure the technology we build is always inclusive, trusted and is creating more sustainable world. Our customers see this urgent need and are looking to us in partnership with them to take action. That's why we announced an ambitious new sustainability commitment. Microsoft will be carbon negative by 2030. And by 2050, we will remove all the carbon we have emitted since the company was founded in 1975. And our $1 billion Climate Innovation Fund will accelerate the development of carbon reduction and removal technologies. We will continue to innovate alongside customers with profitable, sustainable solutions that expand our opportunity. +With that, I'll hand it over to Amy, who will cover our financial results in detail and share our outlook. I look forward to rejoining you after for questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $36.9 billion, up 14% and 15% in constant currency. Gross margin dollars increased 22% and 25% in constant currency. Operating income increased 35% and 39% in constant currency, and earnings per share was $1.51, increasing 37% and 41% in constant currency when adjusting for the net charges related to TCJA from the prior year. +Our sales teams and partners again delivered strong commercial results, and we continue to benefit from favorable secular trends. From a geographic perspective, we saw broad-based strength across all markets. In our commercial business, we continued to see strong demand for our differentiated hybrid and cloud offerings, with increased customer commitment to the Azure platform. And the unique value of Microsoft 365, bringing together Office 365, Windows 10 and Enterprise Mobility and Security as a secure intelligent solution, again drove adoption by both new and existing customers. As a result, commercial bookings growth was ahead of expectations, increasing 31% and 30% in constant currency, with a high volume of new business and strong renewal execution. +Our commercial remaining performance obligation was $90 billion, up 30% year-over-year, driven by long-term customer commitments. Commercial cloud revenue was $12.5 billion, growing 39% and 41% in constant currency. Commercial cloud gross margin percentage increased 5 points year-over-year to 67%, driven again by material improvement in Azure gross margin percentage, which more than offset sales mix shift to Azure. +Company gross margin percentage was 67%, up 5 points year-over-year, driven by favorable sales mix and improvement across all 3 of our segments. In the quarter, gross margin percentage benefited from lower console sales, stronger-than-expected software licensing results and improvement in our commercial cloud gross margin percentage. In line with expectations, FX reduced revenue growth by 1 point and had no impact on operating expense growth. FX impact on COGS growth was slightly more favorable than expected and reduced growth by 1 point. +Operating expense grew 9%, slightly below expectations, primarily driven by lower program spend. And operating margins expanded this quarter as a result of higher gross margins and operating leverage through disciplined decisions to invest in strategic and high-growth areas. +Now to our segment results. Revenue from Productivity and Business Processes was $11.8 billion, increasing 17% and 19% in constant currency, ahead of expectations, driven by both our commercial and consumer businesses. Office commercial revenue grew 16% and 18% in constant currency with roughly 3 points of on-premises benefit, primarily from transactional strength in Japan. Office 365 commercial revenue growth of 27% and 30% in constant currency was again driven by installed base growth across all workloads and customer segments as well as higher ARPU. +Office 365 commercial seats grew 21% with an increasing mix from our Microsoft 365 suite. Office consumer revenue grew 19% and 20% in constant currency, driven by growth in Office 365 subscription revenue. This quarter, growth was also impacted by roughly 7 points of benefit from transactional strength in Japan and 5 points of benefit from the low prior year comparable related to the timing of the Office 2019 purchases. +Office 365 consumer subscriptions grew to 37.2 million. Dynamics revenue grew 12% and 15% in constant currency. Dynamics 365 revenue increased 42% and 45% in constant currency, with continued momentum in the number of customers adopting multiple Dynamics 365 workloads. +LinkedIn revenue increased 24% and 26% in constant currency, with continued strength across all businesses, highlighted by marketing solutions growth of 42%. LinkedIn sessions grew 25% with record levels of engagement again this quarter. Segment gross margin dollars increased 21% and 23% in constant currency, and gross margin percentage increased 2 points year-over-year as improvements in Office 365 and LinkedIn margins more than offset an increase in cloud revenue mix. Operating expense increased 12%, driven by continued investment in LinkedIn and cloud engineering. And operating income increased 29% and 33% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $11.9 billion, increasing 27% and 28% in constant currency, ahead of expectations, driven by continued customer demand for our hybrid offerings. On a significant base, server products and cloud services revenue increased 30% and 32% in constant currency. Azure revenue grew 62% and 64% in constant currency, driven by another quarter of strong growth in our consumption-based business across all customer segments. +In our per-user business, our enterprise mobility installed base grew 35% to over 127 million seats, with continued benefit from Microsoft 365 suite momentum. And our on-premises server business grew 10% and 12% in constant currency, with roughly 4 points of benefit from the end of support for Windows Server 2008, in, addition to the continued strength of our hybrid and premium solutions. Nearly 1/3 of our Windows Server and SQL Server enterprise customers are already using our hybrid use benefits to deploy Azure, reflecting the value and flexibility of these offerings. +Enterprise Services revenue increased 6% and 7% in constant currency, driven by growth in Premier Support Services. Segment gross margin dollars increased 28% and 31% in constant currency, and gross margin percentage increased 1 point year-over-year as another quarter of material improvement in Azure gross margin more than offset the growing mix of Azure IaaS and PaaS revenue. Operating expense increased 18%, primarily driven by continued investments in Azure. Operating income grew 38% and 42% in constant currency. +Now to More Personal Computing. Revenue was $13.2 billion, increasing 2% and 3% in constant currency, ahead of expectations as better-than-expected performance across our Windows businesses more than offset lower-than-expected Search and Surface revenue. In Windows, overall PC market growth was stronger than we expected and benefited from the low prior year comparable related to the timing of chip supply to our OEM partners. +OEM Pro revenue, which makes up roughly 40% of total Windows revenue, grew 26%, driven by continued momentum in advance of Windows 7 end of support and strong Windows 10 demand. The benefit from the low prior year comparable drove roughly 11 points of that growth. OEM non-Pro revenue, which makes up roughly 20% of total Windows revenue, increased 4%. This quarter, continued pressure in the entry-level category was more than offset by roughly 7 points of benefit from the low prior year comparable and the timing of license purchases from an OEM partner. Inventory levels ended the quarter in the normal range. +Windows commercial products and cloud services revenue, which makes up roughly 30% of total Windows revenue, grew 25% and 27% in constant currency, again driven by strong demand for Microsoft 365, which carries higher in-quarter revenue recognition. The remainder of the Windows business is made up of our other licensing and services components. +Surface revenue increased 6% and 8% in constant currency, lower than expected, as continued strong momentum in the commercial segment was partially offset by execution challenges in the consumer segment. Search revenue ex TAC increased 6% and 7% in constant currency, below expectations, primarily driven by lower Bing volume. +And in gaming, revenue declined 21% and 20% in constant currency, in line with expectations, driven by lower console sales as we approach the next Xbox launch. Xbox content and services revenue declined 11% and 9% in constant currency as the impact from a strong third-party title in the prior year more than offset continued growth in Game Pass subscribers and Minecraft. Segment gross margin dollars increased 18% and 20% in constant currency, and gross margin percentage increased 7 points year-over-year due to higher margin sales mix. Operating expense declined 5% as redeployment of engineering resources to higher-growth opportunities was partially offset by gaming investments, primarily in first-party content. As a result, operating income grew 41% and 45% in constant currency. +Now back to total company results. In line with expectations, capital expenditures including finance leases were $4.5 billion, up 17% year-over-year, driven by an ongoing investment to meet growing demand for our cloud services. Cash paid for PP&E was $3.5 billion. +Cash flow from operations was $10.7 billion and increased 20% year-over-year, driven by healthy cloud billings and collections. Free cash flow was $7.1 billion and increased 37%, reflecting the timing of cash payments for PP&E. +Other income was $194 million, higher than anticipated, due to the recording of mark-to-market gains in our equity portfolio. Our effective tax rate was slightly above 17%, in line with expectations. And finally, we returned $8.5 billion to shareholders through share repurchases and dividends. +Now let's move to our outlook. Assuming current rates remain stable, we expect FX to decrease revenue at both the company and individual segment level by approximately 1 point and have no impact on total company COGS and operating expense growth. In our commercial business, we expect consistent execution and continued demand for our hybrid solutions to drive another strong quarter. Commercial bookings growth should again be healthy, but will be impacted by a materially lower growth in our Q3 expiry base. +Commercial cloud gross margin percentage will continue to improve year-over-year, although at a lower rate than last quarter, given the growing mix of Azure consumption-based services. And we expect a sequential dollar increase in our capital expenditure as we continue to invest to support growing demand. +Now to segment guidance. In Productivity and Business Processes, we expect revenue between $11.5 billion and $11.7 billion, driven by continued double-digit growth across Office commercial, Dynamics and LinkedIn. For Intelligent Cloud, we expect revenue between $11.85 billion and $12.05 billion. In Azure, revenue growth will continue to reflect the balance of our strong growth in our consumption-based business and moderating growth in our per-user business, given the size of the installed base. +Growth in our on-premise server business should be high single digits, again driven by strong hybrid demand as well as some continued benefit related to the end of support for Windows Server 2008. In Enterprise Services, we expect revenue growth to be slightly higher than last quarter. In More Personal Computing, we expect revenue between $10.75 billion and $11.15 billion. +In Windows, overall, OEM revenue growth should be in the low to mid-single digits and continue to reflect healthy Windows 10 demand, end of support for Windows 7 and the supply chain's ability to meet demand. The wider-than-usual range in More Personal Computing segment reflects uncertainty related to the public health situation in China. +In Windows commercial products and cloud services, we expect another quarter of healthy double-digit revenue growth, driven by continued Microsoft 365 suite momentum and some benefit from Windows 7 extended support agreements. In Surface, we expect revenue growth in the low single digits as we work through the execution challenges in the consumer segment. In search ex TAC, we expect revenue growth similar to Q2. +And in gaming, we expect revenue to decline in the low double-digit range, driven by the continuation of the console trend as we near the launch of Xbox Series X as well as lower transaction volume on a third-party title. +Now back to the overall company guidance. We expect COGS of $11.05 billion to $11.25 billion and operating expense of $11.2 billion to $11.3 billion. In other income and expense, interest income and expense should offset each other. And finally, we expect our Q3 effective tax rate to be slightly below our full year rate of 17% due to the timing of equity vests. +Now let me share some additional comments on the full year. At the company level, we continue to expect double-digit revenue and operating income growth, driven by the continued strength of our commercial business. For operating expense, as a result of lower spend in H1, we now expect full year growth between 10% and 11%. And finally, given our strong H1 results, particularly in high-margin businesses, as well as the expected sales mix for the remainder of the year, we now expect operating margins to be up roughly 2 points year-over-year, even as we invest with significant ambition in strategic and high-growth areas in the second half of this year. With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. (Operator Instructions). Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Mark Moerdler with Bernstein. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [2] +-------------------------------------------------------------------------------- + + Congratulations on a really strong quarter. I'd like to look at Azure. Can you give a little bit of more details on what's driving the Q-over-Q acceleration in the revenue growth? Are we seeing large contracts starting to ramp? Are there other factors that are kicking in that are helping that? And Satya, can you also give us some sense of what you think about the impact, if xCloud is successful on Azure? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Sure. Thanks, Mark, for the question. I think overall, in terms of the Azure momentum, it's sort of the thing that we have seen even in the previous quarters so, which is we have a stack that is -- from infrastructure to the PaaS services that's fairly differentiated. I mean I went through some of the things that we even announced at our Ignite Conference. Take something like Azure Arc. The fact that we have a control plane for hybrid computing that is multi-cloud, multi-edge, that's a pretty differentiated aspect of it. +And the data side, both on the transactions on the OLTP side as well as on the analytics side, we now have cloud-native databases. And Azure Synapse, I think, is a very competitive product. So that's what you see play out in terms of a customer adoption and the growth there. xCloud, I think, is a great workload. I mean we always have the mantra of first party equals third party, whether it is any of the workloads internally really helping us understand the new patterns, which then, of course, third parties can use. And you can see that even in terms of how Sony will use some of the same infrastructure capabilities. So we are excited about what xCloud teaches us but more importantly, we're excited about how others in the ecosystem can use the same capability for their streaming needs. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And Mark, to your question on -- a little bit about the reacceleration in the Azure growth rate, let me divide that into its components. We did have a very good and healthy, broad-based consumption growth, especially in IaaS and PaaS. I think actually, Satya touched on 1 of the important parts that we started to see this quarter was not only good workload migration work, strong growth and the optimization of the workloads already running but also some of these new PaaS workloads like Synapse and Cosmos DB and Arc are really starting to add some momentum in that part of the stack as well, which is important. +The SaaS component or the per user component also tends to be where you'll get some variability as well. We did have a good SaaS component quarter in addition to the healthy base, and that does result in some movement in that number from quarter-to-quarter. And in particular, I think Microsoft 365 suite actually, and the momentum we've got in security and management and mobility is a big contributor to that. +And of course, just the type of contracts that get signed, whether that's for the consumption layer, in particular, can have some impact quarter-to-quarter in a couple of points. So there will be some variability in that number, but the underlying fundamentals across both the consumption and per user were quite good. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [6] +-------------------------------------------------------------------------------- + + Sorry, guys, I was on mute. A very, very nice quarter. Coming out of the Ignite conference, I wanted to sort of get your views on progress with developers broadly, particularly after the GitHub acquisition. Can you talk to us a little bit about how that kind of impacted your traction with stuff like DevOps Studio and your developer tools? And also, how that's kind of changed the dynamic around Azure? Has that become a real competitive differentiation and change at all the competitive dynamic with guys like AWS and GCP out there in the marketplace? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- + + Yes. First of all, thanks, Keith, for the question. We are very excited about what's happening with the developer offering. I mean at some level, I think of what we're doing between Visual Studio and Azure DevOps and GitHub as effectively coming together as a compelling developer SaaS solution in the same class as any other SaaS solution from Microsoft around productivity or communication because 1 of the data points I love to use is the number of developers in the non-tech sector is now more than in the tech sector. This is software engineers and that's going to only increase in the world going forward. So we want to build the best tool chain. After all, that's who we are as a company. We love building tools for developers. +And so -- and by the way, we're not focused only on Azure. For developers who use our tool chain, they can target any cloud, any edge device, and so this is not sort of means to some end. We've always been clear about it. It's an end to itself. But that said, of course, having this tool chain will help us overall, both with essentially what is, by itself, a high-margin tool as a SaaS business as well as, of course, developers who are going to be in our ecosystem. But we want to stay true to that ethos of open source, GitHub and do the best tools. In fact, just this last quarter, you saw even some of the tools being adopted by Facebook engineering, and that's, I think, a testament to the progress that's been made by Microsoft. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + And I would just add to that, Keith, this is an important area for us to continue to invest in. The opportunity Satya talked about is at the developer SaaS level. And so whether you see us investing in GitHub or in the Azure tool chain, this will be a place that we'll continue to see as an opportunity for growth. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Keirstead with Deutsche Bank. + +-------------------------------------------------------------------------------- +Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [10] +-------------------------------------------------------------------------------- + + Amy, I'd love to ask you a gross margin question. Beginning in your third quarter or the current March quarter, we've been bracing for gross margins to trend flat or even down year-over-year, given the sales mix shifts that you and your IR team have long warned us about. Yet when I take your revs guide and your COGS guide, it equates to 3Q gross margins of 68%, which are actually up about 150 bps year-over-year. So I just wanted to understand what's going on. Is it that the higher gross margin businesses are decelerating at a slower-than-expected pace in your second half? Or perhaps the pace of Azure gross margin improvement is greater than you thought? A little color there might be helpful. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + Thanks, Karl. Really, when you see the gross margin changes, it all comes down to sales mix. So at a fundamental level, I feel very good about the execution of each service to their own gross margin goals. We saw improvement across every cloud service, not just Azure in terms of their ability to deliver growing gross margin as they focus not only on cost but also on continuing to see ARPU growth and attach growth. +So -- and I could say that about many of the product lines, right? I focus on them at the -- what can each products line do to be its best and most competitive? What you saw in H1 and what you'll see in H2 is simply mix in Q2. There was a lot of mix into Windows away from, for example, the console, right, since we're heading into the next console cycle. At a company level, if you thought about what gross margins would have looked like without gaming, it's a couple of points of impact. +And as we head to H2, what you'll see is that the mix will shift a little bit. The sort of end of support impacts tail off, whether that's in OEM or on the server side. And the contribution from gaming as well as other components in our hardware portfolio go up a little bit. So that still does result, as you said, in a higher gross margin implication in Q3, and you'll see that continue to have a slightly different impact as we head into Q4, if that helps to give you a little sense. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [13] +-------------------------------------------------------------------------------- + + I just wanted to follow up on a little bit what Karl was just asking relating to gross margins. I was wondering if you could maybe help us think about the mix between PaaS and IaaS and kind of what -- if you can give us a sense of the mix shift or just kind of how that's been trending? But also, I wanted to ask about -- you've been -- it's been unbelievable, every quarter, you're able to call out material gross margin improvements in Azure. And I guess ultimately, what I'm asking is, given the success you've seen there, has your view for -- if you look 2 to 3 years down the road, do you just think Azure is going to be a higher gross margin business than maybe what you would have thought 3 years ago? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + Specifically on Azure, I think the Azure gross margins are trending where we thought they would trend actually on the IaaS and PaaS layer. And they're trending where we thought they would trend on the per-user-like assets. And what you're seeing is continued improvement on that trend line that we expected. But you'll also see as we go forward in time, those improvements will flow at the IaaS and PaaS layer. It will get better but the nature and the sort of rate of improvement will flow. And you'll see that increasing mix toward IaaS and PaaS in a way from the per user just as in terms of the opportunity and the TAM. +So -- and for the long run, Heather, I think my view is unchanged, frankly, about what that should look like. And of course, over the same time period, how it would impact commercial cloud gross margins all up. But what -- I think if you separate this from this gross margin implication, it goes to the fact of just how much revenue opportunity exists in cloud. And so if we can continue to capture the revenue growth, continue to meet customer needs and scenarios, pick and thoughtfully invest in industry-level solutions to grow those things, I worry less about the mechanics of the GM, which can continue to improve by service and more really about our opportunity to grow revenue. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [15] +-------------------------------------------------------------------------------- + + Yes. And I would say when we think about whether it's our R&D and operating leverage there or sales or CapEx for the cloud, we don't sort of separate out these categories of IaaS, PaaS and even SaaS. I mean just to put it practically for you, we might do an infrastructure service around IoT. We then have PaaS services around IoT. We have apps around IoT and Dynamics 365. Similarly, we have the xCloud and Game Pass subscriptions and we have the streaming capability in Azure. So we think about our investments holistically in that sense, and I think that's what's going to define the long-term margin profile of our company is how well we manage all layers and collectively get leverage across the investment. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [17] +-------------------------------------------------------------------------------- + + Amy, you called out the strength of on-premise software. I'm just curious, I know you have the tailwind from the expiration. But maybe talk through some of the other drivers that you're seeing in the business that's causing such great growth even on the on-premise as the cloud continues to grow? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + Thanks, Brent. What we've seen has been relatively consistent is the drivers on the on-prem side have absolutely been the hybrid value prop and also premium. And they're actually related because ultimately, the really things that we've seen that has value for customers is that flexibility. And so the flexibility to deploy where they need it and when they need it. And if that makes sense on the edge, which some people may call on-prem, and whether that makes sense in the cloud, which people may call Azure, were relatively indifferent as long as it meets the customer solution in the way that the solution demands. +And so that hybrid value prop, you start to see that flexibility in the data point I gave, which is that 1/3 of the Windows and SQL Server customers are already starting to use that right, to be able to take advantage of that flexibility for their workload solutions. And so those trends I see is relatively durable. And that's why we talked about, I think, now for a number of years. And I think if we think about the sort of end of support and the tail on that, it was probably 2 points on IC for the quarter as I called out. So I feel very good about the underlying trajectory. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Murphy with JPMorgan. + +-------------------------------------------------------------------------------- +Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [20] +-------------------------------------------------------------------------------- + + Satya, a few quarters ago, you had commented that Teams is the fastest-growing app in the company's history. Wondering if you could clarify if that is a reference to daily active user growth or bookings impact? Or is that a comment on user engagement and the time being spent in Teams or some other criteria? As well, Amy, wondering if you could offer any kind of directional thoughts on just how to model the Windows OEM line post-Windows 7 end of support and going into fiscal year '21. And any high-level thoughts on how you think that could trend versus what happened in the prior cycle. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [21] +-------------------------------------------------------------------------------- + + Yes, thanks for the question, Mark. My comment was mostly around deployment engagement, the depth of engagement. There are very few types of products which have these platform effects. Teams is a scaffolding that is obviously related to messaging, which has significant usage. It's also driving usage of the rest of office because rest of office gets integrated in the usage patterns around channels. It's obviously used in meetings. It's also the place where business process workflows in context of messaging happen and both for knowledge workers and first-line workers. +So when I look at all of that cumulative effect, it's much broader than any other user experience scaffolding and in terms of its ability to drive that type of platform effect and engagement. So we're excited about it. And we continue to see that, and you saw that in my remarks as well. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + And to your question on OEM, I think what's important is if you try to take out, which is challenging, some of the comments we've had on either chip supply constraints or some of the uncertainty related to the public health situation in China, you would say, what we have in terms of what the cycle would look like compared to prior cycle ends, would actually be quite similar. If not, we probably have a little more opportunity in the mid and small business segment to have the tail last a little longer probably than it did the last time. So we feel very good. We'll still need to work through that as we work through both the situations I've talked about, frankly, now for quite a few quarters and then looking forward. So we'll continue to give you guidance on what we see in the market each quarter. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brad Reback with Stifel. + +-------------------------------------------------------------------------------- +Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [24] +-------------------------------------------------------------------------------- + + Great. Amy, you mentioned a couple of times this evening about 1/3 of customers using hybrid rights. Within that customer base, any sense of what percent of workloads that represents for those clients? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Brad, there's not really a good way for me to know that. For me, the way I think about this is a top of funnel. It means that we've got solutions or workloads where all the corporate developers that Satya mentioned are really starting to make that transition and making decisions for themselves about how to use Azure and how to get to experience it. For me, that is a great sign. We've always said a lot of these hybrid use rights were about investing in skilling and learning and teaching the environment and having the adoption happen for the workloads that make the most sense. And then we can continue to partner with customers to help them through this process and continue to have more meaningful workload transition. So for us, I think I tend to start at the top and say, if we've got more going into the funnel, more opportunities to partner with customers, that's a good thing. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our last question will come from the line of Phil Winslow with Wells Fargo. + +-------------------------------------------------------------------------------- +Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Congrats on a great quarter. I just wanted to focus in on Dynamics. I guess a question for Amy and Satya. I mean, Amy, you called out seat growth but also increasing attach to multiple products with the Dynamics driving that growth rate. Wondering if you could help us sort of parse that out. And then to Satya, when you think about just SaaS in general, how important is sort of Dynamics to the overall Microsoft strategy, particularly with what you're trying to do with the AI platform in Azure because, obviously, over the past 12 months, we've seen rollouts of some of those insights, AI products where you have -- you can use the Dynamics' data, but also data from Salesforce, Zendesk, et cetera, but as a sort of a sidecar there. So wondering if you could just sort of walk us through just sort of the, call it, the application strategy and then that in the context of what you're trying to do in the AI world. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [28] +-------------------------------------------------------------------------------- + + Yes. No, great. Thanks, Phil, for the question. Let me start, and then Amy, you can. I mean we are very excited about what's happening with Dynamics 365 in particular because when I look at what the world needs is it needs a business application suite that is more comprehensive. That can turn what is the real currency of this next era, which is data into predictions, insights and automation without boundaries. I mean they take even the Canada Goose example that I had in my remarks, which is actually a pretty fascinating story of how they've been able to take the end-to-end nature of Dynamics 365 and really bring together the manufacturing, wholesale and retail operations to the next level of efficiency. That's, I think, what is needed. And the way we have architected it on top of Azure, it's cloud native in terms of its use of databases. It's, for example, all these insights modules I referenced and you referenced are all built on Azure Synapse. So it's sort of deeply integrated into Azure. It integrates into LinkedIn. It integrates into Microsoft 365, Power platform, the extensibility model for both Microsoft 365 and Dynamics is the same, which is Power platform. And that's a pretty -- no, there's no such thing as a canonical business and no such thing as a canonical business over time, right? The business processes change. The question is how rapidly can people and domain experts keep up with the change. And that's where Dynamics 365 absolutely shine. So we're excited about what's happening there. +You mentioned a point about sidecar. We think that, that's a very legitimate use case. There is a new category, in fact, and a new race starting with CDP, and we are leading. And so I feel excited about that as well. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [29] +-------------------------------------------------------------------------------- + + And to your question on how the Dynamics 365, sort of the excitement we have, when I think about the comment I made around adding workloads, what's so important about what Satya just talked about is how this reaches into new budgets for us, new opportunity for us in terms of being able to tap growth that we had not been able to access before. And the way I tend to think about that is not dissimilar from how I think of most per seat businesses. You add a seat and then you add workloads and the more you can do that in terms of tapping into new budgets, that's a great opportunity for us. So I think that's a frame that I'll start to talk a little bit more about as we learn more about Dynamics 365 and its momentum. This is another place I would call out, where I do think we can sort of focus and continue to make some investments in H2 based on the momentum we have seen in H1. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [30] +-------------------------------------------------------------------------------- + + Thanks, Phil. That wraps up the Q&A portion of today's earnings call. You can find additional details on the Microsoft Investor Relations website. Thanks for joining us today, and we look forward to speaking with you soon. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MSFT/2020-Jul-22-MSFT.txt b/Transcripts/MSFT/2020-Jul-22-MSFT.txt new file mode 100644 index 0000000000000000000000000000000000000000..10971f3f628a2fc90736b25675d3d83130669b39 --- /dev/null +++ b/Transcripts/MSFT/2020-Jul-22-MSFT.txt @@ -0,0 +1,414 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2020 Microsoft Corp Earnings Call +JULY 22, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Satya Nadella + Microsoft Corporation - CEO & Director + * Amy E. Hood + Microsoft Corporation - Executive VP & CFO + * Michael Spencer + Microsoft Corporation - General Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Raimo Lenschow + Barclays Bank PLC, Research Division - MD & Analyst + * Gregg Steven Moskowitz + Mizuho Securities USA LLC, Research Division - MD of Americas Research + * Mark L. Moerdler + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Stewart Kirk Materne + Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst + * Keith Weiss + Morgan Stanley, Research Division - Equity Analyst + * Heather Anne Bellini + Goldman Sachs Group, Inc., Research Division - MD & Analyst + * Brad Alan Zelnick + Crédit Suisse AG, Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings, and welcome to the Microsoft Fiscal Year 2020 Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. +It is now my pleasure to introduce your host, Mike Spencer, General Manager and Investor Relations for Microsoft. Thank you. Sir, you may begin. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [2] +-------------------------------------------------------------------------------- + + Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chief Executive Officer; Amy Hood, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. +On the Microsoft Investor Relations website, you can find our earnings press release and our financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Unless otherwise specified, we will refer to non-GAAP metrics on the call. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events had on the financial results. +All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to growth rate only. +We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. +During this call, we will be making forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the risk factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. +And with that, I'll turn the call over to Satya. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Mike. Good afternoon, everyone. We delivered record results this fiscal year powered by our commercial cloud, which surpassed $50 billion in revenue for the first time, up 36% year-over-year. The last 5 months have made it very clear that digital tech intensity is key to business resilience. Organizations that build their own digital capability will recover faster and emerge from this crisis stronger. We are seeing businesses accelerate the digitization of every part of their operations from manufacturing to sales and customer service, to reimagine how they meet customer needs from curbside pickup and contactless shopping in retail to telemedicine in healthcare. That's why we are building the full modern technology stack powered by cloud and AI, and underpinned by security and compliance, to help every organization digitally transform. +Now I'll highlight our innovation and momentum, starting with Azure. Every organization today needs a distributed computing fabric to run essential workloads. We are building Azure as the world's computer to support them with data center regions -- more data center regions than any other provider, including new regions as of this quarter in Italy, New Zealand and Poland. We have always led in hybrid, and we are accelerating our innovation to meet customers' needs wherever they are. Azure Arc is the first control plane built for a multi-cloud, multi-edge world, and we are taking it further with Azure Arc-enabled Kubernetes. New capabilities in Azure Stack HCI help organizations bring the cloud to their very own data centers. And our acquisitions of Affirmed and Metaswitch, along with Azure Edge Zones, extend Azure to the network edge, expanding our offering to telecom operators as they move to 5G. +Our differentiated approach across cloud and edge is winning new customers in every industry from Land O'Lakes, the National Australia Bank to Johns Hopkins Medicine, as well as leading ISVs including Citrix, Fenestra, SAS and Workday. +At the data layout, Azure is the only cloud with limitless data and analytics capabilities that can deliver a cloud-native data estate for every organization. The combination of SQL Hyperscale, Cosmos DB, Synapse Analytics and the new Synapse Link, which enables live analytics on real-time transactions, differentiate Azure. In AI, we have the most comprehensive portfolio of tools, frameworks and infrastructure. +We're thrilled with the progress our partner, OpenAI, is making. Their new GPT-3 model constitutes a new breakthrough in AI, and we trained -- and was trained on our Azure AI supercomputer. New capabilities in Azure Cognitive Services make it easier to build applications that speak naturally in 49 languages and its variants, and to generate insights from unstructured data including paper-based forms and medical records. Microsoft Bot Framework now includes powerful authoring tools to build sophisticated conversational bots with low code. And with Azure machine learning, organizations can deploy AI more responsibly and safely. +All this innovation is driving usage. In June alone, 13.5 billion transactions were processed in Azure Cognitive Services, 2.5 billion messages sent, 9 million hours of speech transcribed. From Bridgestone to UnitedHealth Group to EY, companies are relying on Azure AI to innovate and better meet customer needs. +Now to developer tools. The role of developers is more important than ever. From emergency response to recovery to reimagining the world, we have the most used and loved developer tools to build any application for any platform. We have seen increased activity across multiple measures, and we are going further with new tools to power secure remote development. With Codespaces, we are bringing together the best of GitHub, Visual Studio and Azure to help developers go from code to cloud in seconds. New advanced security features in GitHub use semantic analysis to scan code for vulnerabilities, and GitHub discussions help software communities collaborate outside of the code base. +More than 3 million organizations, including the majority of the Fortune 50, now use GitHub. The State of California is using GitHub and Azure DevOps to power 90% of its digital COVID-19 response infrastructure. All the 5,000 engineers at Autodesk rely on GitHub to break down silos across the organization. And at Etsy, developers are using GitHub to deploy production -- to production more than 50 times per day. +Now to Power Platform. With Power Platform, anyone in an organization can rapidly create an application, build a virtual agent, automate a workflow or analyze data. Citizen developers and business decision makers at companies like Schlumberger and T-Mobile are using Power Platform to address challenges created by COVID-19. Power BI is the clear leader in business intelligence in the cloud and is growing significantly faster than competition. 96% of the Fortune 500 now use Power BI to find insights in their data. +More broadly across the Power Platform, we are seeing accelerating usage. Power Apps monthly active users increased 170% year-over-year. Power Automate is up 75%, and in just 6 months, Power Virtual Agents have already surpassed 6.7 million sessions. Just yesterday, we launched an end-to-end return-to-workplace solution in Power Platform that will help organizations like CBRE keep employees safe and healthy when they go back to their office. And we continue to invest in robotic process automation. Our acquisition of Softomotive, when coupled with Power Automate, enables customers, including KPMG, to automate manual business processes across both legacy as well as modern applications. +Now to Dynamics 365. Dynamics 365 is helping organizations in every industry digitize their end-to-end business operations from sales and customer service to supply chain management so that they can rapidly adapt to changing market conditions. Customer Insights is the fastest-growing Dynamics 365 application ever, helping organizations like Walgreens Boots Alliance and Chipotle offer more personalized customer experiences. BNY Mellon chose Dynamics 365 this quarter to help investment managers build stronger relations with their customers. +More than 4,500 organizations now use Dynamics 365 commerce, finance and supply chain management, making it one of the fastest-growing SaaS solutions in its category. FedEx, for example, uses Dynamics 365 to drive more precise logistics and inventory management. In retail, Dynamics 365 Connected Store now offers in-store traffic analytics and curbside pickup, prioritizing safety as stores reopen. And we continue to invest in solutions to protect merchants as they process more online transactions. New account protection and loss-prevention features in Dynamics 365 Fraud Protection help protect online revenue, and we are working with financial services firms like Capital One to improve fraud detection and keep customers secure. +Now to LinkedIn. In spite of revenue headwinds due to lower hiring needs, we are seeing record engagement as LinkedIn's more than 706 million professionals turn to the network to connect, learn and plan for the future. Content shared was up nearly 50% year-over-year and LinkedIn Live streams were up 89% since March. People will increasingly need to move beyond current domain expertise to learn new skills, and they're turning to LinkedIn. Professionals watched nearly 4x the amount of LinkedIn Learning content in June than they did a year ago. And we are making it easier for them to access LinkedIn Learning's more than 16,000 online courses directly in the flow of their work. A new learning app in Teams will allow organizations to integrate LinkedIn Learning as well as their own content to create a continuous feedback loop between work, skills and the learning needed for upskilling and reskilling employees. +Now to Microsoft 365 and Teams. When, where and how the world works is fundamentally changing. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working as well as learning. Microsoft Teams is helping people be together even when they are apart. It's the only solution with meetings, call, chat, content, collaboration with Office as well as business process workflows in a secure, integrated user experience. We are reimagining every aspect of the meetings experience with new capabilities like Together Mode and the Dynamic Stage to help people feel more connected and reduce cognitive load. We expanded the gallery view in Teams so that people can see and interact with up to 49 participants at a time, and breakout rooms and live reactions will help people build social capital in a virtual world. +Deeper integration between Teams and Power Platform brings an integrated data platform, Microsoft Dataflex, for easier, faster application creation and deployment, enabling a new category of enterprise grid apps and chatbots in Teams. Teams is rapidly becoming the communications backbone as customers accelerate moving voice to the cloud, and we are expanding Teams beyond the workplace, making it easy to add personal Teams account on mobile so you can stay connected with friends and family across work as well as your life. +Teams users generated more than 5 billion meeting minutes in a single day this quarter, and we are seeing increased usage intensity across the platform as people communicate, collaborate and co-author content in Teams. 69 organizations now have more than 100,000 users of Teams, and over 1,800 organizations have more than 10,000 users of Teams. +We are working alongside educators as they prepare for remote hybrid and in-person scenarios this fall. More than 150 million students and teachers around the world now rely on our tools, including Teams, Stream, OneNote as well as Flipgrid to prioritize student engagement and learning outcomes. Our new Microsoft Cloud for Healthcare is helping providers schedule, manage and conduct virtual visits using Teams and engage with patients using Dynamics 365. In healthcare, there were more than 46 million Teams meetings this past month. The NHS in the U.K. chose Microsoft 365 to empower its 1.2 million employees with the latest productivity and collaboration tools to deliver better patient outcomes. +More broadly, we are seeing increased usage of Microsoft 365 and larger strategic agreements. Alcoa and Telstra are empowering their entire workforce, including first-line employees, with Microsoft 365 and Teams. Across industries, customers like 3M, CenturyLink, GE and Providence are increasingly choosing our Microsoft 365 premium offerings for differentiated security, compliance, voice and analytics value. Our Microsoft 365 E5 user base more than doubled year-over-year. +People are turning to Windows PCs more than ever, with minutes spent in Windows 10 up more than 55% year-over-year. And we expanded our family of Surface devices and accessories to help people work, learn and connect from anywhere as we create new categories that benefit the entire OEM ecosystem. +Now on to security and compliance. Remote everything continues to accelerate the need for a Zero Trust security architecture that protects people, devices, applications and data holistically. And we are the only company with an integrated end-to-end capability informed by more than 8 trillion signals each day. Azure Active Directory now has more than 345 million monthly active users across more than 200,000 organizations, and we are not only securing employee identities but customer and partner identities as well. +General Motors, for example, is using Azure Active Directory to secure interactions between its employees, dealers and customers. Azure Sentinel now has more than 6,500 customers. The accelerating adoption of IoT across industries is creating new security challenges, and our acquisition of CyberX this quarter will help secure customers' IoT deployments. +Finally, we are helping customers protect their more sensitive information. Microsoft Information Protection is enabling companies, such as Siemens AG, to protect sensitive data wherever it exists. And new Microsoft 365 Records Management helps customers govern data and reduce risk. +Now on to gaming. It is simply a breakthrough quarter for gaming. We saw record engagement and monetization led by strength on- and off-console as people everywhere turned to gaming to connect, socialize and play with others. Stepping back, we are expanding our opportunity to empower the world's 2 billion gamers to play wherever and whenever they want on any device. Xbox Game Pass has seen record subscriber growth across both console and PC and now includes content from more than 100 studios. Our xCloud gaming service is already live in 15 countries. And just last week, we announced that we will bring xCloud to Xbox Game Pass so subscribers can stream games to a phone or a tablet and play along with nearly 100 million Xbox live players around the world. +In content, we are delivering differentiated first- and third-party content to attract and retain gamers. Xbox Series X launched this fall with the largest launch lineup for any console ever. And Minecraft reached a new high of nearly 132 million monthly active users during the quarter. +In closing, we are expanding our opportunity and investing across the full modern technology stack. Over the next decade, technology spending as a percentage of GDP is projected to double, and we are well positioned to participate in that growth by innovating and defining the key technologies that empower every person and every organization on the planet to build more of their own tech intensity. +With that, I'll hand it over to Amy who will cover our financial results in detail and share our outlook, and I look forward to rejoining for your questions. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $38 billion, up 13% and 15% in constant currency. Gross margin dollars increased 10% and 12% in constant currency. Operating income increased 8% and 12% in constant currency and earnings per share was $1.46, increasing 7% and 9% in constant currency when adjusting for the net tax benefit related to the transfer of intangible properties from the fourth quarter of fiscal year '19. In our largest quarter of the year, our sales teams and partners again delivered strong results with many similar trends to the end of the third quarter. +In our commercial business, increased usage, consistent execution and continued demand for our differentiated, high-value cloud services drove another strong quarter. And in our consumer business, increased demand from work-, learn- and play-from-home scenarios again benefited our Gaming, Surface and Windows OEM non-Pro businesses. We also saw weakness in small and medium business purchasing, which primarily impacted our transactional Office and Windows OEM Pro businesses, and drove some moderation to our Office 365 Commercial paid seat growth. And in our search business, though rates stabilized through the quarter, we saw a continued reduction in advertising spend on our platform. +Moving to our overall results, customer commitment to our cloud continues to grow. In FY '20, we closed a record number of multimillion-dollar commercial cloud agreements with material growth in the number of $10 million-plus Azure contracts. And on a strong prior-year comparable, commercial bookings growth was ahead of expectations, increasing 12% year-over-year, driven by consistent renewal execution and an increase in the number of large, long-term Azure contracts. As a result, commercial remaining performance obligation increased 23% to $107 billion. +Approximately 50% of this balance will be recognized in revenue in the next 12 months, up 21% year-over-year, reflecting consistent execution across our core annuity sales motions. The remaining 50%, which will be recognized beyond the next 12 months, increased 25% year-over-year, highlighting the growing long-term customer commitment to our cloud platform. And this quarter, our annuity mix increased 4 points year-over-year to 94%. +Commercial cloud revenue grew 30% and 32% in constant currency to $14.3 billion, surpassing $50 billion for the fiscal year. And commercial cloud gross margin percentage expanded 1 point to 66% despite revenue mix shift to Azure and significant customer engagement and usage to support remote work scenarios. In line with expectations, FX reduced revenue growth by approximately 2 points and COGS growth by approximately 1 point. FX had no impact on operating expense growth, slightly less favorable than expected. +Our margins this quarter reflect investments to deliver greater customer value in this challenging environment and, therefore, strengthen our long-term competitive position. We invested in capacity for cloud infrastructure usage, free trial offers for critical remote work scenarios and flexible financing options across the ecosystem. Additionally, we re-envisioned our retail store strategy as we stayed focused on growing our investments in these strategic high-growth opportunities of the future. As a result, company gross margin percentage was down 2 points year-over-year to 68%, with additional impact from lower-margin sales mix. Operating expense grew 13%, including a $450 million charge related to the realignment of our retail store strategy. And operating margins declined 2 points year-over-year to 35%. +Now to our segment results. Revenue from Productivity and Business Processes was $11.8 billion, increasing 6% and 8% in constant currency. Commercial -- Office Commercial revenue grew 5% and 7% in constant currency, impacted by the small and medium business slowdown noted earlier, as well as a strong prior-year comparable where 4 points of growth were from a greater mix of contracts with higher in-period recognition. Office 365 commercial revenue grew 19% and 22% in constant currency, in line with expectations, and was again driven by installed-base growth across all workloads and customer segments as well as higher ARPU. +Demand for our high-value security and voice components drove strong upsell to Office 365 and Microsoft 365 E5. Paid Office 365 commercial seats increased 15% year-over-year, slightly below prior quarter trends. This reflects the strong adoption of free trial offers we made to enable customers to quickly adapt to needed remote work scenarios as well as some growth moderation in first-line worker and small and medium business offerings. +Office Consumer revenue grew 6% and 7% in constant currency as stronger-than-expected growth in Office 365 consumer subscriptions was partially offset by transactional weakness. As a result, we saw a significant quarter-over-quarter increase in Office 365 consumer subscribers, up more than 3 million to 42.7 million. +Dynamics revenue grew 13% and 15% in constant currency driven by Dynamics 365 growth of 38% and 40% in constant currency. This fiscal year, total Dynamics revenue surpassed $3 billion with over 60% from Dynamics 365. +LinkedIn revenue increased 10% and 11% in constant currency as a weak job market materially impacted annual bookings in our Talent Solutions business even as usage remained high. Segment gross margin dollars were relatively unchanged and increased 3% in constant currency, and gross margin percentage decreased 4 points year-over-year. Operating expense increased 10% and 11% in constant currency and operating income decreased 9% and 5% in constant currency. +Next, the Intelligent Cloud segment. Revenue was $13.4 billion, increasing 17% and 19% in constant currency, slightly ahead of expectations, driven by continued customer demand for our differentiated hybrid offerings. On a significant base, server products and cloud services revenue increased 19% and 21% in constant currency. Azure revenue grew 47% and 50% in constant currency, in line with expectations, driven by continued strong growth in our consumption-based business. +In our per-user business, growth continued to moderate given the size of our enterprise mobility installed base, which grew 26% to over 147 million seats. And our on-premise server business was relatively unchanged and grew 1% in constant currency, ahead of expectations, driven by strong renewal execution and continued demand for our hybrid and premium solutions. +Enterprise Services revenue was relatively unchanged and grew 2% in constant currency as growth in premier support services offset consulting delays. Segment gross-margin dollars increased 19% and 21% in constant currency, and gross-margin percentage increased 1 point year-over-year. Operating expense increased 19% and operating income grew 19% and 22% in constant currency. +Now to More Personal Computing. Revenue was $12.9 billion, increasing 14% and 16% in constant currency with better-than-expected performance across all businesses as we continue to benefit from work-, learn- and play-from-home scenarios. +In Windows, overall OEM revenue grew 7%, benefiting from improved supply in April that met unfulfilled Q3 demand. In OEM Pro, this benefit was more than offset by the impact from small and medium businesses in May and June. And in OEM non-Pro, the benefit from work- and learn-from-home scenarios continued but did moderate through the quarter. Inventory levels ended the quarter in a normal range. Windows Commercial products and cloud services revenue grew 9% and 11% in constant currency driven by Microsoft 365 and the continued demand for our advanced security solutions. +In Surface, revenue grew 28% and 30% in constant currency, with strength across consumer and commercial segments. Search revenue ex TAC declined 18% and 17% in constant currency driven by the trends noted earlier. And in Gaming, revenue increased 64% and 66% in constant currency, significantly ahead of expectations, with the continued benefit from play-at-home scenarios driving record levels of engagement and monetization across the platform as well as a significant increase in console sales. +Xbox content and services revenue increased 65% and 68% in constant currency with strong growth in third-party transactions, Game Pass subscribers and Minecraft. Segment gross-margin dollars increased 12% and 15% in constant currency, and gross-margin percentage decreased 1 point year-over-year with the mix shift to Gaming. Operating expense increased 10%, including the retail stores charge, and operating income grew 15% and 19% in constant currency. +Now back to total-company results. In line with expectations, capital expenditures, including finance leases, were $5.8 billion, up 8% year-over-year, to support growing usage and demand for cloud services. Cash paid for PP&E was $4.7 billion. Cash flow from operations was $18.7 billion and increased 16% year-over-year driven by healthy cloud billings and collections. And free cash flow was $13.9 billion, up 16%. For the fiscal year, we generated over $60 billion in operating cash flow and over $45 billion in free cash flow driven by a year of improving margins and operating leverage across our businesses. +In other income and expense, interest income, net gains on derivatives, investments and foreign currency remeasurement were mostly offset by interest expense. Our effective tax rate was slightly below 17%, lower than expected due to the geographic mix of revenue. And finally, we returned $8.9 billion to shareholders through share repurchases and dividends, an increase of 16% year-over-year, bringing our total cash returned to shareholders to over $35 billion for the full fiscal year. +Now before we turn to our outlook, I'd like to update you on a change in accounting estimate to the useful life of server and networking equipment assets in our cloud infrastructure. Effective at the start of fiscal year '21, we are extending the depreciable life for these assets to 4 years, which will apply to the asset balances on our balance sheet as of June 30, 2020, as well as future asset purchases. This change will not impact historical depreciation expense, the total depreciation expense over the life of the asset or cash flow, but it will impact the timing of depreciation expense in the future for these assets. +As a result, based on the outstanding balances as of June 30, we expect fiscal year '21 operating income to be favorably impacted by approximately $900 million in the first quarter and approximately $2.7 billion for the full fiscal year. This has been included in the guidance we'll provide on today's call, and you will find additional details on the mechanics of the change in our earnings materials. +Now let's move to our next-quarter outlook. In our Commercial business, given our differentiated position in growth markets, we expect continued commitment to our cloud platform as well as strong usage and consumption growth. In our Consumer business, we expect some continued benefit from work-, learn- and play-from-home scenarios in Gaming and Surface, though at a more moderated rate, as stay-at-home guidelines ease in many places around the world. However, we expect the small- and medium-business weakness we saw in Q4 to continue, which will impact transactional sales, primarily in Office and Windows OEM. +In commercial bookings, growth should again be healthy, but we will be impacted by the strong prior-year comparable and a low growth in the Q1 expiry base. Commercial cloud gross margin percentage will increase approximately 4 points year-over-year from the accounting estimate change noted earlier. Excluding this impact, continued improvement in Azure IaaS and PaaS gross margin percentage will be mostly offset by revenue mix shift to Azure. And on a dollar basis, we expect capital expenditures to be roughly in line with last quarter to support the growing usage and demand for our cloud services. +Next, to FX. Based on current rates, FX should decrease total company, Productivity and Business Process and Intelligent Cloud revenue growth by approximately 1 point and have no impact on More Personal Computing revenue, total company COGS and operating expense growth. +Now to the segment guidance. In Productivity and Business Processes, we expect revenue between $11.65 billion and $11.9 billion. In Office Commercial, on a strong prior year comparable, revenue growth will again be driven by Office 365 with continued upsell opportunity to E5. However, growth will be impacted by a decline of approximately 30% in our on-premises business driven by the transactional weakness in small and medium businesses noted earlier. In Office Consumer, we expect revenue to be relatively unchanged year-over-year as subscription growth will be offset by a decline in our transactional business. +In LinkedIn, we expect low to mid-single-digit revenue growth, primarily from weak bookings and, therefore, revenue growth in the Talent Solutions business. And in Dynamics, continued Dynamics 365 momentum from our modern and intelligent solutions will drive revenue growth in the low double digits. +For Intelligent Cloud, we expect revenue between $12.55 billion and $12.8 billion. In Azure, revenue growth will again be driven by our consumption-based business. And in our per-user business, we expect continued benefit from Microsoft 365 Suite momentum, though growth will again be impacted by the increasing size of the installed base. In our on-premises server business, on a strong prior year comparable, we expect revenue to be up slightly year-over-year driven by the durable value of our hybrid and premium annuity offerings. In Enterprise Services, we expect revenue to be relatively unchanged year-over-year, similar to last quarter. +In More Personal Computing, we expect revenue between $10.95 billion and $11.35 billion. In our Windows OEM business, we expect revenue to decline in the low teens range, impacted by the strong prior-year comparable that benefited from the end of support for Windows 7 as well as the continued slowdown in small and medium businesses. In Windows Commercial products and cloud services, we expect healthy double-digit growth from continued Microsoft 365 momentum and the value of our advanced security offerings. +In Surface, solid demand against a low prior-year comparable that was impacted by product life cycle transitions should drive growth in the mid-teens. In Search ex TAC, we expect revenue to decline in the low 20% range. And in Gaming, we expect revenue growth in the high teens with continued strong user engagement across the platform. +Now back to overall company guidance. We expect COGS of $10.75 billion to $10.95 billion and operating expense of $10.7 billion to $10.8 billion with continued investment against our significant long-term ambition. Other income and expense should be negative $50 million as interest expense is expected to more than offset interest income. And finally, we expect our Q1 tax rate to be approximately 16%, lower than our expected full-year rate, given the volume of equity vests in our first quarter. +In closing, we are committed to our customers' success in these challenging times and to managing the company for long-term growth and profitability. We will continue to expand our cloud infrastructure to support the growing customer usage and demand across our differentiated cloud offerings. And given our strong execution and growing competitive advantage in high-growth areas, we remain committed to investing against the long-term opportunity ahead of us. +Now before turning to Q&A, I have one special thank you. Frank Brod, our Chief Accounting Officer, will soon be retiring. And on behalf of the entire company, thank you for your significant impact and close partnership over the years. You played a key role in our success. And I'd like to welcome Alice Jolla, who has been working alongside Frank and I for many years, as our new Chief Accounting Officer. Alice, we look forward to having you in this position. With that, Mike, let's go to Q&A. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [5] +-------------------------------------------------------------------------------- + + Thanks, Amy. We'll now move over to Q&A. (Operator Instructions) Operator, can you please repeat your instructions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Keith Weiss with Morgan Stanley. + +-------------------------------------------------------------------------------- +Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + A very nice quarter. Satya, I was hoping you could help us with your view of what the enterprise spending environment looks like through this difficult period. On one side of the equation, we have very good secular trends that are still very well in place. And like you said, digital transformation is accelerating. On the other side though, we do have difficult macro conditions out there, and we're seeing it in places like SMB and the like. Can you help us understand how that's splitting out on the ground in terms of your customers? Are you still able to get those big deals over the line? And how do you see that playing out through the rest of the fiscal year? Like, how should we think about those impacts through FY '21? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Keith, for the question. The thing that at least we have learned, I would say, in the last 5 months is that digital technology is no longer viewed as just new project starts, but it's becoming perhaps the most key for business resilience. Business continuity obviously is a board-level discussion everywhere. But I don't think digital tech as sort of being key to business resilience was the #1 priority whereas now it is. So I think that that's, I think, what -- when I think about digital transformation now, I break it into 2 things. I think about resilience and all of sort of what Microsoft can do to help any business be more resilient, whether it's remote everything, whether it's about their ability to simulate anything, automate everything, those are the things that I think are going to increase. +Then, of course, there is how you readjust to what is going to be an increased e-commerce, contactless, reimagined world, reconfigured supply chain. So in both of those are secular tailwinds, but no one can take away from sort of the fact that GDP is going to be negative. So that's why I think you're going to see lots of ins and outs. But digital technology by -- and digital transformation itself is going to be pretty key. And therefore, we are very focused on sharpening the value proposition of every part of the stack I described and making sure we are there for our customers as they navigate these tough times. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + And Keith, maybe just to add to that a little bit, and I think you saw that in our bookings growth for the quarter and, increasingly, I think people will start to focus as well on the remaining performance obligations. You're starting to see this commitment both in the next 12 months and then in the 12 months past that. And so we are -- obviously, you'll see some volatility in that from the longer-term larger contracts we had talked about. But we did, in Q4, have more of that closed than we anticipated. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group, Inc., Research Division - MD & Analyst [6] +-------------------------------------------------------------------------------- + + I was just wondering, Satya and Amy, just given the success that you guys have in expanding your footprint with customers, is there any sense that you could [fill] with us -- some people talk about net expansion rates, right? Just wondering if you guys have a way of helping investors think about kind of the net expansion rate from your existing customers on an annual basis just given the success you're having with things like Azure hybrid benefits and migrations to the cloud. So any way for us to help think through that would be really helpful. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [7] +-------------------------------------------------------------------------------- + + Amy, maybe I'll start and then you can add. I mean the way at least we think about the core, Heather, as far as how we are architecting what we're doing here, and that's one of the reasons why even I structured my remarks the way I structured them, which is each of these layers is being built obviously to reinforce the other layer. But each layer is independent. It's -- and we recognize that enterprises are very heterogeneous. They're going to choose multiple layers from multiple vendors, and interoperability will be key. +But we have a very differentiated value proposition. I mean even in this quarter, if you think about the number of customers who started with Teams, built a Power application, in fact had Azure, GitHub, Power DevOps on top of that code base and then used Azure Synapse all in one solution. So you can see that power of our stack. So each layer is architected such that it reinforces the other, and we see increasing adoption, including all of these layers. But I think in the numbers, when we talk about each of the numbers and the growth rates for each of the numbers, that in some sense showcases that. But maybe, Amy, you want to add more to that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + Yes. I think the other way to think about it, Heather, and we do, I know, talk about it a little bit every quarter, there are 2 main motions that we focus a lot on here: number one, are we adding new customers; and number two, are we adding workloads within customers. And I think you'll increasingly hear us talk about the number of customers who are purchasing multiple components of the cloud, whether that's Microsoft 365, Azure, the Power Platform Satya just talked about, developer SaaS or GitHub and then numerous cloud opportunities within Dynamics 365. So I think the way I tend to think about it is, is revenue per customer going up? Yes. And are we adding new customers? Yes. And do we feel like we still have room to add additional clouds? I think that will be sort of the language you'll hear us talk through this year. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Moerdler with Bernstein Research. + +-------------------------------------------------------------------------------- +Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [10] +-------------------------------------------------------------------------------- + + Congrats on the quarter. Amy, cash flow from operations has been an area of concern across the software industry, with some companies reporting payment delays, requests for extended payments, et cetera. This quarter, your CFO was a strong standout. What do you think is the reason for the strength? Is this a function of the channel or enterprise exposure or something else? Any data, any information will be appreciated. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- + + Thanks, Mark. We did have, as you saw -- and we have had very consistent performance in our cash flow from operations. And I think a lot of that, as you've noted, has to do with where that strength is coming from, which is, overall it's cloud billings, it's usage, it's consumption-based growth. We do have, as you noted, a lot of exposure to enterprise. That has tended to perform quite well. And we did extend, and I mentioned it in our call in the prepared remarks, a lot of financing options to customers as well. So I feel like we are taking an appropriately balanced approach here and really focusing more on customer enablement. And so we could see some impact, but I think the broad portfolio, Mark, and broad geographic exposure probably has benefited us on CFO. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [12] +-------------------------------------------------------------------------------- + + And broadly, we will be very much optimizing for helping our customers through this period and our own share. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from Kirk Materne with Evercore ISI. + +-------------------------------------------------------------------------------- +Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [15] +-------------------------------------------------------------------------------- + + Amy and Satya, you noticed the strong growth in the E5 SKU around Office 365 over the last year. Can you just talk perhaps a little bit more specifically about how Teams is perhaps changing the discussion around productivity more broadly, how that's maybe raising your profile even more from a strategic perspective as customers start thinking about how sort of collaboration is going to change in this new world, both in the short and the long term? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [16] +-------------------------------------------------------------------------------- + + Sure, Kirk. The approach we took with Teams always was to not just think of this as just a chat application, right? I mean we thought about messaging obviously is important. But we said, okay, we had to reimagine how people communicate using both chat as well as video and then, most importantly, how people collaborate in meetings, outside meetings, before and after. So that's sort of the second element. And third, think about business process and workflows dominating inside of the scaffolding of Teams, and then building it with the same compliance and security base of Microsoft 365. So yes, absolutely. +So first of all, Microsoft 365 has entered many new categories. They're all part of our Microsoft 365 value. And so with that and the architectural coherence of Microsoft 365 because, in some sense, complexity, security risk, management costs, these are all real things for enterprises, especially if you've got to go remote everything. So I feel that we have a great value proposition for customers at a time of most acute need where they want to go remote, they need that flexibility when there is hybrid work and yet, they want the low-cost management and high security and compliance. So I think we have a differentiated offer there. +And I'll turn it to Amy if she wanted to add anything to that as well. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- + + No. I actually think the other component, Satya, that I would mention is really the transition we've seen from just Office 365 E5 to Microsoft 365 E5 with the entirety of the value proposition. This, I think, has been a pivotal year. And again, in Q4, we saw even more transition in the SKU mix to the Microsoft 365 SKU than just simply the Office SKU. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Gregg Moskowitz with Mizuho. + +-------------------------------------------------------------------------------- +Gregg Steven Moskowitz, Mizuho Securities USA LLC, Research Division - MD of Americas Research [19] +-------------------------------------------------------------------------------- + + I have one for Satya. I'm curious how you would assess the net impact of the current environment on Azure, inclusive of potentially lower consumption growth among highly impacted industries and, of course, the per-seat moderation in EMS, offset by some acceleration in digital transformation more broadly among other customers. In addition, I was curious if you're seeing more pay-as-you-go-type arrangements for Azure than you were previously. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [20] +-------------------------------------------------------------------------------- + + Thanks for the question. Overall, as I said, even in industries that have been impacted, say, economically, one of the things is -- getting to the new efficient frontier of cloud economics is one way for them to, in fact, do better as they get into recovery, right? So one of the things that we are seeing, in fact, is some acceleration even of getting rid of the old and getting to the efficient frontier so that then they can recover faster. That doesn't mean that some places where there is absolute real shutdown of economic activity, there isn't a slowdown. But where people are looking to say using even that as an opportunity to come out stronger, we do see that. +For sure, pay-as-you-go on Azure is going to increase and is increasing. And we are fundamentally focused on wherever people want to have those long-term commitments as well as pay-as-you-go customers. So we don't, in some sense, discriminate between the two. What we want to be able to just stay focused on is quarter-over-quarter consumption growth by adding value to customers' digital transformation projects. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [21] +-------------------------------------------------------------------------------- + + And I would add maybe, Gregg, a little context is we have been seeing a transition to pay-as-you-go probably for the majority of this year as opposed to saying it has more recently just emerged as a trend. So I wanted to make sure to decouple those a teeny bit. And I think in general for us, this quarter, the consumption patterns were very, very similar actually to what we expected, to Satya's note, with the pressure to, I think, move to this new frontier being really at the forefront of people's minds, far more so than maybe a discussion on per-user impacts. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Brent Thill with Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [23] +-------------------------------------------------------------------------------- + + You've continued to show great top line double-digit growth and margin improvement. And many are asking, is that same framework in place in this environment, showing this same double-digit growth with margin improvement? Or do things change and you need to invest in new areas that could potentially stall out margins as we go through the cycle? + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [24] +-------------------------------------------------------------------------------- + + Brent, I'll start, and Amy, you can add to this. The way I would say, Brent, is that our focus, especially given that -- what is it, GDP is negative 10% in the world and you pick your timeframe. Right now what I would like us to focus on in the interest of our long-term investors is to say, how can we build this modern tech stack so that it can really capture -- both help customers transform, be resilient and help us get into new categories and build a strong position in those categories. +So my own approach to this would be not to worry as much about short term, whether it's the growth number because when you are growing compared to where GDP is, healthily and competitively, the growth number is high. I'm not trying to match some artificial double-digit growth number, and nor are we trying to sort of think about a margin target because, in some sense, the world needs to do well for us to do well in the long run. And I think the world will come out of this, and we will be stronger if we invest during this phase. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + And I just want to reiterate how important that is. The opportunity that Satya really outlined in his remarks is, I do believe, fundamental. And so you see us continuing to invest. You'll see it in capital expenditure based on demand. You'll see it in the operating expense line. And a lot of the margin movement you're going to see is going to be actually far more sales mix than it is to think about it as margins going down in a particular product. So for me, it's really about in every product are we investing with a strong position, with a clearer view of the future in a way that we can be a more important part of every customer's budget. And so I think we feel very good about the products we've got, the lineup we've got and the execution engine we've got. And so I think we're far more focused in that way than maybe on a short-term number goal. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question is from Brad Zelnick with Crédit Suisse. + +-------------------------------------------------------------------------------- +Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [27] +-------------------------------------------------------------------------------- + + Congrats on the amazing results. Amy, I believe in your prepared remarks you had said Q4 CapEx was in line with expectations, and Q1 should be at a similar level. Can you speak to the evolution in cloud CapEx, productivity and utilization trends, your capacity planning process and lead times to stand up incremental capacity? And ultimately, how should we be thinking about the cadence of CapEx going forward? + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Thanks, Brad. As you saw, we made great progress this quarter, catching up from supply chain challenges that I think we entered the quarter with. And as you can imagine, with the Teams surge and usage along with other workload surges, we look forward to continuing to be able to invest to meet that demand ahead of the curve, in addition to what Satya mentioned, which is continuing to enter new regions where we see opportunities. So for me, the way to think about it is you see the cloud revenue growth continuing, you see strong consumption and usage growth and you should expect cloud CapEx to follow in pretty short order. The lead times there have gotten tighter over time, and so you can generally think they'll be more correlated. But obviously, there's some demand planning that we like to give ourselves ample room. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our last question comes from Raimo Lenschow with Barclays. + +-------------------------------------------------------------------------------- +Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [30] +-------------------------------------------------------------------------------- + + Congrats as well. A quick one for me. Like, can you talk a little bit about gaming? So this quarter was kind of, we saw very, very strong numbers but -- and before, like, it's slightly weaker because of the tougher comps. But like, how do you think about that cycle of growth that you get out of Gaming? And if we should be getting more stable with more recurring revenue? Just talk a little bit about the dynamics there a little bit. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [31] +-------------------------------------------------------------------------------- + + Sure. I'll start. I mean our overall vision that we have sort of been talking about for, quite frankly, multiple years and building out with, in particular, our Game Pass strategy, that's what we are going for. This Gaming TAM is much more expansive than what we participated in, even with all of the success we had with Xbox. So we think going forward Xbox, with the approach we are taking, has much more of an ability to reach the 2-plus billion gamers out there, and we are in the early days of building that out. And so this quarter, of course, will stand out for many of the reasons because of the remote nature of how a lot of the activity happened. But -- and also, we have a new console that's very much part of our strategy. +But we go beyond the console to the PC. We go to mobile and we have the streaming service. So all of these accrue to what we think, in the long run, is going to be a much bigger addressable market. And we have a great structural position. We have a social network in Xbox Live. Obviously, we have a store that monetizes super well as well as we have the Game Pass subscription. +So Amy, if you wanted to add to that. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + Maybe just a few things, which is, when I think about Gaming and where we are at this point, the reason it's so exciting is because I think this quarter reinforces that we have such platform strength built on the view, the support we have of fans of the console. We've extended that and begun to extend it to the PC. We're extending it to mobile. That platform strength will drive this more annuity-like behavior that you're thinking about, which is great. And we saw that in the Game Pass subscription growth again this quarter, building on that base. But then the third-party titles will drive some volatility, but that volatility is just reinforcing of the position we have and I think the long relationship with fans. So I think we're all pretty excited. I think Satya called it pivotal. I think it certainly is, and we're certainly looking forward to the next console release as well. + +-------------------------------------------------------------------------------- +Michael Spencer, Microsoft Corporation - General Manager of IR [33] +-------------------------------------------------------------------------------- + + Great. Thanks, Raimo. That wraps up the Q&A portion of today's earnings call. Thank you for joining us, and we look forward to speaking with all of you soon. Take care. + +-------------------------------------------------------------------------------- +Amy E. Hood, Microsoft Corporation - Executive VP & CFO [34] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Satya Nadella, Microsoft Corporation - CEO & Director [35] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation, and you may disconnect your lines at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2016-Dec-21-MU.txt b/Transcripts/MU/2016-Dec-21-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..44cacf26ada5b7a3c18e7e3a80bbd604ac035478 --- /dev/null +++ b/Transcripts/MU/2016-Dec-21-MU.txt @@ -0,0 +1,792 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Micron Technology Inc Earnings Call +DECEMBER 21, 2016 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark Durcan + Micron Technology Inc. - CEO and Director + * Ernie Maddock + Micron Technology Inc. - CFO + * Ivan Donaldson + Micron Technology Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vijay Rakesh + Mizuho Securities USA - Analyst + * Jagadish Iyer + Summit Redstone Partners - Analyst + * Harlan Sur + JPMorgan - Analyst + * Steven Fox + Cross Research - Analyst + * Ada Menaker + Evercore ISI - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Mark Newman + Bernstein - Analyst + * Chris Danely + Citigroup - Analyst + * John Pitzer + Credit Suisse - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Romit Shah + Nomura Securities - Analyst + * Mark Delaney + Goldman Sachs - Analyst + * Chris Hemmelgarn + Barclays Capital - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Lateef, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Micron Technology's first quarter 2017 financial release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. +(Operator Instructions) +Thank you. It is now my pleasure to turn the floor over to your host, Ivan Donaldson. Sir, you may begin your conference. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- +Thank you, Lateef, and welcome to Micron Technology's first quarter 2017 financial conference call. On the call with me today are Mark Durcan, CEO and Director; and Ernie Maddock, Chief Financial Officer. This conference call, including audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. +In addition, our website contains the earnings press release filed a short while ago and supplemental information including quarterly operational and financial metrics and guidance, GAAP to non-GAAP reconciliations, slides used during today's conference call, and a convertible debt and capped call dilution table. Today's call will be approximately 60 minutes in length. A webcast replay will be available on our website for one year. +We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the Company, including information on the various financial conferences that we will be attending and our 2017 analyst conference which will be held on Thursday, February 2. You can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements based on the environment as we currently see it. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents the Company files with the SEC, specifically our most recent Form 10-Q and 10-K, for a complete discussion of these important factors and other risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. I'll now turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- +Thank you, Ivan. For fiscal Q1 2017, Micron posted total revenue of $3.97 billion with non-GAAP gross margin of 26% and net income of $335 million, or $0.32 per share. Revenue, gross margin, operating income, all exceeded our guidance. Operating cash flow was $1.1 billion. +In the first quarter, we saw an acceleration of the positive market conditions that began this fall. For the industry, supply is slowing, demand is strong in a number of key segments, and inventory is at low levels. Prices have been strengthening on a like-for-like basis across all leading edge DRAM and NAND products and we see this trend continuing into the current quarter. +To give you some perspective on pricing dynamics, after declining for roughly 18 months, PC DRAM ASPs are up 50% to 60% compared to the trough pricing, driven by an improvement in demand, historically low inventory levels and the impact of supply shifts to other segments. In contrast, all other DRAM segments declined substantially less over the same period and are recovering at a slower rate. +Given the duration of the broad supply/demand tightness in the market, we are currently seeing improvements in quarter-over-quarter pricing trends in these non-PC segments. Taking all these variables together, blended DRAM ASPs are essentially flat compared to the same period last year. With this in mind, and as we look at our current quarter, operational execution is driving DRAM sales up more than $1 billion year-over-year, while our cost of goods sold is up only about half this amount, driving substantial improvements in gross margins. +Product mix has a more significant impact on the NAND landscape where we are also experiencing like-for-like pricing increases. However, we are also shifting our product portfolio to 3D and TLC NAND which enables higher density and lower cost products that also have lower ASPs. Taken together, blended NAND ASPs are down approximately 10% year-over-year while gross margins are up meaningfully. +Turning to the industry outlook, we currently expect 2017 DRAM bit supply growth in the 15% to 20% range. This is based on an assumption that suppliers won't add significant wafer capacity to the industry, but will continue to focus on process node migrations to enable cost reductions and natural supply growth. This compares to our long-term bit demand growth forecast of approximately 20% to 25%. We expect favorable supply and demand dynamics to persist in 2017. +For NAND, we estimate 2017 industry bit growth in the high 30% to low 40% range which is in line with 2016. This compares to our long-term bit demand growth forecast of approximately 40% to 45%. 3D conversions continue to be a headwind to industry supply growth. This factor, along with strong demand for storage and mobile solutions, sets up for a well-balanced supply and demand dynamic in 2017. +I'll now provide a high level overview of each of our business units and Ernie will follow with more details on their specific financial performances. In the Compute and Networking business unit, we experienced revenue growth as a result of strengthening or strengthened demand. We executed well to our 20-nanometer shipment plan and achieved key qualifications of 64 gigabyte LRDIMMs at multiple server customers. We also continued our strong performance in the graphic segment where our GDDR5X technology leads competitors. +In our Mobile business unit, the completion of our customer qualifications drove substantial revenue and profit growth this quarter. As noted last quarter, we continue to see the Chinese market driving mobile growth and higher memory content per smartphone. We had strong growth in our LPDRAM and mobile NAND product lines and are focused on new qualification opportunities as we see the mobile market as one of the strongest growth drivers of our business. +Our Embedded business was driven by strong demand across a variety of segments. Our NAND-based MCPs continue in business and machine-to-machine communications modules and our strong portfolio also brought us significant share in several new home automation and action camera platforms this quarter. We expect our new application Optimize SD cards to drive market share gains within both the industrial and connected home segments. +Our Automotive business had another excellent quarter. We're securing an increasing number of automotive design wins on our leading edge, managed NAND and 20-nanometer DRAM products. We also see automotive demand for advanced memory technologies accelerating as more sophisticated ADAS systems come to market in the years ahead. +Our Storage business unit continues to make progress shifting our portfolio to advanced 3D NAND technologies. First, the 1,100 client SSDs we announced last quarter completed qualifications and we commenced volume shipments with several major customers. This complements our crucial MX300 consumer drive which is currently shipping in high volumes. Additionally, we announced our cloud-based 5100 SATA SSD earlier this month offering industry leading performance and 8 terabyte capacities. All three of these SSDs are built with our TLC 3D NAND and illustrate our focused portfolio transition to this high capacity, high performance and cost effective technology. +We continue to provide updates with respect to critical targets related to operational execution originally shared at our Analyst Day in August of 2015. Thus far, these milestones include bit crossover on 20-nanometer DRAM and 3D NAND, and the SSD product release road map have all been achieved on or ahead of schedule. Our two-year bit growth and cost per bit targets remain on track and we continue to be focused on delivering to our commitments. +Our focus in DRAM this year is primarily related to the deployment of our 1X nanometer technology. We're targeting meaningful output on 1X by the latter part of FY17. We expect to generate approximately 20% to 25% cost per bit reductions in FY17. Our cash costs for bit declines will be well above this range. +For NAND, we will continue to focus on ramping our Gen 1 3D, as well as TLC. We have also commenced production on our second generation 64-layer 3D technology and we're targeting meaningful output by the latter part of FY17. The 3D and TLC ramps will deliver 20% to 25% cost per bit improvement in FY17. This cost per bit includes the impact of expanding our SSD, eMCP and managed NAND solutions which carry additional bill of materials and costs, but will also enable a richer ASP mix. +Relative to 3D XPoint technology, we will be shipping our QuantX solutions for revenue in 2017 and continue to believe this innovative technology will be an important contributor to Micron's future success. This month, just after our quarter closed, we finalized the acquisition of Inotera in Taiwan which we expect to continue to provide strategic and financial opportunities for the Company. We are excited to welcome the Inotera team to Micron and look forward to realizing the benefits of the new operating model. Now I'd like to turn it over to Ernie. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [4] +-------------------------------------------------------------------------------- +Thank you, Mark. As we indicated earlier this month, we continue to see positive trends in the overall business environment resulting in fiscal Q1 performance that came in above the high end of the guidance ranges we provided in October. Today I'll first discuss some technology and business unit details followed by an overview of the Company's results for the quarter and guidance for our fiscal second quarter. +DRAM represented 61% of our total revenue with the following segmentation. Mobile represented about 30%, up from 25% the prior quarter. The PC segment was in the mid-20% range and the server business was in the high-teens percent range. Specialty DRAM, which includes networking, graphics, auto and other embedded technologies, was in the mid-20% range, down from the prior quarter. +In our Non-Volatile Memory business, trade revenue represented 32% of total revenue, with the following segmentation. Consumer, which includes memory cards, USB and components, represented 40%, down from the prior quarter. Mobile was in the low-20% range, up from the prior quarter, as we saw the continued impact of our completed customer qualifications. As a reminder, eMCPs are primarily in the Mobile segment. SSDs were in the mid-teens range, up from the prior quarter and the automotive, industrial multi-market, and other embedded applications were in the 20% range. +Turning to performance by business unit, the Compute and Networking business unit reported fiscal Q1 revenue of $1.47 billion, up 18% sequentially, primarily due to stronger demand and higher 20-nanometer shipments and a stronger pricing environment. The non-GAAP operating profit was $204 million or 14% of revenue. +In the Enterprise segment, we executed well in shipping 20-nanometer solutions to the market and qualified several lower cost products at multiple customers. Cloud was CMBU's fastest growing segment and Micron is now qualified on most high volume sockets for the top customers in this segment. Demand is being driven by both our leading edge DDR4 solutions, as well as continuing need for DDR3. +In graphics, we had continued share growth in GDDR with our major graphics customers. New graphics card launches and strong console sales sustained favorable demand for both GDDR5 and GDDR5X. In Networking, we saw shipment and revenue growth, bolstered by the continued transition to 20-nanometer, 4 gigabyte DDR3 and 8 gigabyte DDR4. We continue to see strong interest in our high performance memory portfolio, as well. Finally, within the client segment, ASP strength exceeded our expectations and solid execution on 20-nanometer drove improved shipments and cost reductions. +The mobile business delivered fiscal Q1 revenue of $1.03 billion, up 54% sequentially, driven by completed customer qualifications and strong sales of LPDRAM and mobile NAND products in an improved pricing environment. The non-GAAP operating income was $89 million or 9% of revenue, as we continue to ramp our 20-nanometer products and made substantial progress reducing higher cost early production inventory. The Embedded business unit delivered fiscal Q1 revenue of $578 million, up 13% sequentially. Non-GAAP operating income was $178 million or 31% of revenue. +The results were primarily driven by seasonally strong consumer business and record automotive revenue. Embedded ASP trends tend to be more stable compared to the broader compute and mobile markets, but we are beginning to see the benefit of tightening supply/demand in this business unit, as well. Consumer revenue was up 25% sequentially, driven by home automation and camera application. In addition, our 20-nanometer DDR4 products continue to ramp into some 4K set-top box applications. +The Automotive business performed well with revenue up 7% sequentially and 11% year-over-year. These solid results continue to be driven by strong and increasing demand for both DDR3 and e.MMC solutions for infotainment, instrument cluster and LPDRAM for advanced driver assist systems applications. +The industrial and multi-market business increased 6% sequentially with a strong quarter for our NOR business combined with ramping our NAND solutions into the Japanese amusement market. In addition, we continue to see growing demand for our industrial grade managed NAND solutions. +The Storage business delivered fiscal Q1 revenue of $860 million, up 13% sequentially. The non-GAAP operating loss was $45 million, or 5% of revenue. During the quarter, SBU strengthened both the NAND and SSD product portfolios, having now entered fully ramped production and customer qualification of 3D TLC NAND client and cloud drives. Our ramp of 3D TLC cost competitive products will position us to effectively participate more fully in this growth segment. SBU is also benefiting from a favorable supply/demand balance in the industry with like-for-like pricing improving for many products. Demand drivers look strong for the foreseeable future. +Moving on to overall Company results, revenue for the first fiscal quarter was $3.97 billion, up 23% sequentially, and driven by strong volume shipments for DRAM combined with increasing ASPs. Trade NAND shipments also increased as a result of the successful crossover of 3D production which occurred in the quarter, and we experienced stable blended ASPs with like-for-like ASPs trending up in many cases. +Non-GAAP gross margin for the quarter was 26%, up from 19% in the prior quarter, driven by a strong pricing environment, particularly for DRAM, and solid execution on cost per bit reductions. NAND cost reductions were driven by an ongoing ramp of 3D and the portfolio shifting to higher density TLC enabled solutions. Non-GAAP net income was $335 million, or $0.32 per share. +Turning to results by product line, DRAM revenue increased 24% compared to the prior quarter as a result of an 18% increase in bit shipments and a 5% increase in ASPs. DRAM gross margins for the first quarter increased 8 percentage points sequentially to 28%, primarily driven by the strong pricing environment and continued 20-nanometer ramp. Our Non-Volatile Trade revenue increased 26% compared to the prior quarter, reflecting a 26% increase in bit shipments. ASPs were relatively unchanged from the prior quarter on a blended basis. +Gross margin increased 6 percentage points sequentially to 23% as cost per bit was down 8%, benefiting from the 3D and TLC ramps. Non-GAAP operating expenses for the quarter were $594 million, slightly below the lower end of our guided range, driven by lower prequalification expenses, lower legal costs, and higher expense sharing credits. +The Company generated cash flow of $1.1 billion, an increase of $200 million over last quarter, and we ended the quarter with cash and marketable investments of approximately $4.3 billion. In the first fiscal quarter, capital expenditures net of partner contributions were approximately $1.18 billion. +Moving now to the guidance for the second quarter. On a non-GAAP basis, we expect the following: Consolidated revenue in the range of $4.35 billion to $4.7 billion, gross margin in the range of 31% to 34%, operating expenses between $590 million and $640 million, operating income ranging between $800 million and $900 million, and EPS ranging between $0.58 and $0.68 per share based on 1.123 billion diluted shares. +Please note that as indicated earlier this month, we expect the impact from the Inotera acquisition to be accretive beginning this quarter. Specifically, for fiscal quarter 2, we expect the accretion to positively impact gross margins by low-single-digit percentage and contribute approximately $0.02 to EPS. These impacts have already been included in the guidance I just provided and will not be further distinguished as we provide guidance in future quarters. +From an operational perspective, we remain on track to achieve the bit growth and cost per bit reduction targets that we've previously shared and we look forward to sharing more details on our progress and plans at our analyst conference on February 2. With that, I will turn it back to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- +Thank you, Ernie. To summarize, we're entering our second quarter with a number of positive drivers across the business. The markets for both DRAM and NAND are healthy and improving, and I'm pleased with our operational execution over the past several quarters. We will continue deploying leading edge technology and shifting our product portfolio toward higher value segments and products. Operator, we're now ready to begin the Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you, sir. +(Operator Instructions) +Our first question comes from the line of Blayne Curtis of Barclays. Your line is open. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [2] +-------------------------------------------------------------------------------- +Hi, this is Chris Hemmelgarn on for Blayne. Thanks very much for taking the question, and congrats on the great quarter. First of all, just regarding Inotera, could you help us understand roughly how much you expect consolidating it, fully consolidating operations to add to bit output on the DRAM side in the February quarter? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [3] +-------------------------------------------------------------------------------- +We already had included the benefits of that since we took 100% of the output. So it really represents no material change to anything we've provided previously. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [4] +-------------------------------------------------------------------------------- +No, I just mean in terms of -- obviously, you'd expect the recognized bit output to be up quarter-on-quarter. Any guide in terms of like what percentage of the existing -- . + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- +Obviously, we said all along that as we have full managerial control of the entity we will have increased operational flexibility and the opportunity to potentially fine-tune some of our management practices, et cetera. We expect that over time that will provide some modest benefits to manufacturing efficiency. All of those are baked into our overall projections on a go-forward basis and we don't anticipate breaking out individual fabs for you on a go-forward basis. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [6] +-------------------------------------------------------------------------------- +Okay, that's helpful. And then as a quick follow-up, there's been, obviously, a lot in the news about potential changes to policies with the new presidential administration coming in. As I recall, you guys had a chance to sit down and chat some of that over with them. I was just curious if you had any thoughts about how some of the [river] changes are going to impact your business in the coming years? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [7] +-------------------------------------------------------------------------------- +Micron did not actually participate in the gathering of tech executives that happened recently. Through our activities, our ongoing activities and engagement with government, we continue to stay involved in all sorts of policies that we believe impact our business. But there's really nothing specific that we would have to say about how that transition is going or anything of that nature at this point. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [8] +-------------------------------------------------------------------------------- +Okay. Thanks much, and congrats again on the strong quarter. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Vijay Rakesh of Mizuho. Your line is open. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [10] +-------------------------------------------------------------------------------- +Hi, guys, congrats on a great set of results here. Just on the DRAM side, I know you mentioned that, obviously, great results there, as well. How is 60-nanometer going? How do you see the transition to 60-nanometer as you progress through the year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [11] +-------------------------------------------------------------------------------- +I'm sorry to 1X nanometer? + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [12] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [13] +-------------------------------------------------------------------------------- +On the DRAM front? + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [14] +-------------------------------------------------------------------------------- +That's correct. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [15] +-------------------------------------------------------------------------------- +We're very pleased with the product progress we're making. We have a number -- a broad set of products that are supported by that 1X technology. It's running in Japan, as well as our DRAM fab in Taichung, and we have a number of mobile products, as well as compute and server products, all of which are progressing on schedule and we're quite happy with. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [16] +-------------------------------------------------------------------------------- +Great. And on the 3D NAND side, happy to see you guys start up the second generation 64 layer. Any thoughts on how we should see that progress? Obviously on crossover already, but how do you see the 64 layer ramping through 2017? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [17] +-------------------------------------------------------------------------------- +Yes, just to reiterate, we believe it will be significant late in the fiscal year in terms of the bit output. It's a very significant shrink for us. So we're very excited about the efficiencies that will bring to our operation, but its impact will occur later in the fiscal year. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [18] +-------------------------------------------------------------------------------- +Great, thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Mark Delaney of Goldman Sachs. Your question, please. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- +Hi, yes, good afternoon. Thanks very much for taking the questions. First question, was hoping you could help us understand the sustainability of some of the strong bit growth trends that you reported in the November quarter. I think you've talked about growing above the market in 2017 in both DRAM and in NAND. Can you sustain some of these types of strong sequential bit growth trends as you look into February? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [21] +-------------------------------------------------------------------------------- +Yes, we don't have any bit growth update for you relative to the two-year CAGRs that we had previously forecast. We're still on track to sustain those numbers, and trying to get down quarter-to-quarter, we think, is less productive than continuing to focus on that long-term productivity increase in trend. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [22] +-------------------------------------------------------------------------------- +Got it. Okay. And then for a follow-up question, I was hoping you could help us understand a little bit more on some of the end market trends in PCs and handsets, and if you could elaborate specifically on what you're seeing in terms of demand trends in the China handset market? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [23] +-------------------------------------------------------------------------------- +Yes, so first of all, on PCs, I think you've got the same market data we have there. The PC industry ended up maybe a little stronger than any of us anticipated. Still from a unit perspective, flattish to maybe down a percent, but overall generating about 10% DRAM bit growth going into that segment. +Mobile is interesting. We continue to see pretty good bit growth by system. On average for the mobile market, probably moving to 2.4 gigabytes of DRAM and high 30%s, somewhere in the 35% to 40%, maybe in the middle of that range in terms of gigabytes of NAND. +So if you net that out, that's almost 20% DRAM bit growth per system and maybe a little north of 40% on NAND. So for that market in aggregate, pretty strong, and in particular the value smartphone probably seeing the highest bit growth per system of any of those segments. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [24] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Rajvindra Gill from Needham & Company. Your line is open. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [26] +-------------------------------------------------------------------------------- +Yes, thank you. Congratulations, as well, on excellent results. Housekeeping question first, on the taxes, I think this quarter was about $30 million. Can you give some sense of what the guidance for taxes going forward would be? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [27] +-------------------------------------------------------------------------------- +I think I'd guide you to low-teens millions, which would be low-single-digit tax rate and that will change as the Company's profitability changes. Obviously, when the profitability goes up, the tax rate will sequentially decline a little bit because of where that income is generated and should the Company's profitability decline, the actual rate will creep up just a little bit. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [28] +-------------------------------------------------------------------------------- +Okay. Great. And in the commentary you had mentioned around 15% to 20% bit supply growth in DRAM baring any additional supply from competitors. Can you talk a little about the -- what you're seeing in terms of the transition to 18-nanometer for some of your competitors, and is there risk in your mind in terms of additional supply coming online, any thoughts on that would be helpful? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [29] +-------------------------------------------------------------------------------- +We don't have a great crystal ball as to what our competitors are doing. We read the same reports that you guys read. All of that, plus all the other internal intelligence we can generate, is baked into our ranges and in the data sheet that we provided. +So I think there has been some chatter recently potentially about a few incremental wafers from one of the suppliers. Our view of that is if that were to happen it's a relatively minor adjustment in terms of the overall scope of the bit growth that we're projecting and that would probably not cause us to change that range that we've given you. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [30] +-------------------------------------------------------------------------------- +All right, great. And last question, in terms of on the balance sheet, how do you think about reducing the level of debt going forward now that you're entering into a period of higher free cash flow generation? We're at about $8.5 billion, or close to $10 billion of debt. Any thoughts on the strategy about reducing debt levels over time? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [31] +-------------------------------------------------------------------------------- +Yes, so to be consistent with my prior comments, first thing I want to do is make sure we generate the cash, which we're working on feverishly and expect to make some headway on here with the results we've just shared. And then as we get to that point and look at the credit markets, as well as a number of other factors, we will make a determination about the best way to delever. But delevering for the Company remains an important priority as we have an expectation of increased free cash flow this year. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [32] +-------------------------------------------------------------------------------- +Okay. Great. Thanks again. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Timothy Arcuri of Cowen. Your question, please. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [34] +-------------------------------------------------------------------------------- +Thank you very much. First question, Mark, you made some recent comments about China and about them potentially flooding the market if they do get access to IP, so my question is, can you again remind us of what your mission statement is around the potential of sharing IP or licensing IP into China? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [35] +-------------------------------------------------------------------------------- +So first of all, let me say that comments that I make in the press are sometimes not in the full context of the discussion I had. And I think one of the things to think about in terms of what might or might not happen in China is that these things do take time. Our investment cycles take place over periods of useful life of equipment of five years. We think in the long term, when we think about investing in our business to make sure that we're being good stewards of the shareholders' money, but anything that would happen there is going to play out over many years. And having a crystal ball as to exactly how that will play out is difficult to say. +Relative to what Micron has said about our interests in China, we have a great interest in doing business in China. We have large existing operations there including back end operations, circuit design, product engineering activities, as well as software and firmware activity. We have a lot of activity in China already from an operations perspective and we have a large number of important customers over there. So we stay fully engaged with China and continue to expect to have strong relationships there and grow our business. +Relative to whether we would undertake any expansion or licensing activity in China, what we said is really as it has been, which is our job is to look for opportunities to make Micron a stronger Company. And we will continue to investigate lots of options about ways to generate shareholder value, whether it's in China or any other part of the world. And that's just part of us being effective managers of the Company, and we'll continue to do that and if we can figure out things that make the Company stronger, we'll always consider that in terms of the long-term benefits and act accordingly. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [36] +-------------------------------------------------------------------------------- +Okay. Great. Thank you for that. And then I had a follow-up to a question that was asked about some of the tax law changes coming. +It seems pretty obvious that there's going to be some sort of VAT that gets added to product that's made outside the US and you guys are, obviously, fairly exposed to that. So I'm wondering, is there any like contingency planning happening? And I'm trying to assess the likelihood that maybe CapEx might have to be a little higher as you may have to plan for some of those contingencies. Thanks. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [37] +-------------------------------------------------------------------------------- +So, Tim, really, it's an issue of what you think any such tariffs of whatnot, how they would impact our end market, not necessarily as they directly impact Micron, because typically we manufacture overseas. We sell in many cases overseas, and then it's our customers who would then be subject to any of those importation issues. +I think it's really too soon to tell what the impact of that would be because simultaneously we're reading about a dramatic reduction of the corporate tax rate and also the ability to repatriate billions of dollars of cash. So there's a lot of moving pieces to this, and I think anybody who would portend to be able to specifically predict things is probably guessing a little bit right now. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [38] +-------------------------------------------------------------------------------- +Okay, Ernie. Thank you. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Joe Moore of Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [40] +-------------------------------------------------------------------------------- +Great. Thank you. I wonder if you can just give us some context on why the markets are so good? And in particular, when I look at your shipments have been stronger than I expected, your competitors' shipments have been a bit stronger than I expected, and yet our checks, and everyone's checks show this -- good now and staying good for a while. +Can you give us any context on why the supply/demand balance has shifted so much in a favorable direction when everyone's shipping more bits than the sort of long-term trend line? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [41] +-------------------------------------------------------------------------------- +At the end of the day, Joe, it's got to be adding up all the pieces, right, and having less supply than demand. I will say that as the end markets that we ship into continue to segregate and the product has to find its way into the right -- or the wafers have to find their way into the right product at the right time for the right segment, getting that balance exactly right segment to segment becomes difficult. +And, therefore, I think it provides the opportunity for supply -- for pricing to react to changes in supply and demand in a way that I think is positive from a manufacturer's perspective. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [42] +-------------------------------------------------------------------------------- +Great. That's helpful. Thank you. And then, secondly, in terms of your NAND planning, is there going to continue to be a long tail on the planer NAND business, or do you see the whole business transitioning to 3D over time? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [43] +-------------------------------------------------------------------------------- +There's definitely a tail and it definitely exists for a long time. The question is how significant is that in terms of bits and what eventually will be the pricing in that long tail. I think that the planer bits are going to get squeezed out of a lot of the end market applications as we start to generate more 3D supply as an industry. +However, there will be a long tail that's probably less than 10% of the overall market that sticks around for a long, long time and serves very valuable niches. It's a matter of getting that balance right, making sure you have the product, have the right products in that -- in those lagging nodes so you can address the right market opportunities. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [44] +-------------------------------------------------------------------------------- +That's very helpful. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Steven Fox of Cross Research. Your question, please. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [46] +-------------------------------------------------------------------------------- +Hi. Good afternoon. I was just wondering if you could talk a little bit about some of the higher margin, higher mix products where maybe -- where you mentioned like-for-like pricing also getting better. +For example, in the storage business unit with SSDs, how are you managing your customer expectations for longer design cycles and qualification cycles given that product is tight now and you're saying it could be tight for a while, especially as you ramp 3D NAND and maybe it has some puts and takes along the way? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [47] +-------------------------------------------------------------------------------- +It's always tricky when you have customers with supply expectations, making sure that you are making the right commitments that you can deliver on while not significantly over or under committing. There are lots of those segments that are value-add where you have to have long-term customer relationships where there's a certain amount of trust, and I think from Micron's perspective, that's actually an advantage for us. Our customers like us. They want us to succeed. We have a long-term history of meeting our commitments, and so I think in this kind of environment that actually plays out pretty well for us. +Some of the specific segments that are value-add that are pretty important, things like graphics, we grew our graphics business pretty substantially this year. In many cases, those are sole source relationships, or two sources at most, and a significant piece of the customer's end product and so those types of relationships, I think, are flagships for that kind of thought process. Automobile also, I think, is another one where Micron has very significant market share, deep relationships with the customers and a trust that we're going to be there for them with the right products as markets tighten up. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [48] +-------------------------------------------------------------------------------- +That's really helpful. And then just a quick clarification, so on Inotera I understand you don't want to go too much deeper into the numbers, but in terms of some of the synergies that are potentially ahead of you with Inotera, should we just think of it more as the flexibility to manage bits a little bit more efficiently or should we consider that there could be some meaningful cost savings that could come through to the margins down the road? Thanks. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [49] +-------------------------------------------------------------------------------- +This is Ernie. I think the best way to think about it is what Mark articulated earlier, which is the cost synergies are relatively small. The real opportunity will be as we align the manufacturing capability fully to the best of Micron's fabs, and that will provide more incremental opportunity to us than the cost savings piece. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [50] +-------------------------------------------------------------------------------- +Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Chris Danely of Citigroup. Your line is open. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [52] +-------------------------------------------------------------------------------- +Thanks, guys. Quick question on the mobile end market. You talked about China as being a big driver there. Can you give us any sense of how big China is as far as your mobile demand or how big of the increase it was sequentially? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [53] +-------------------------------------------------------------------------------- +We had pretty good growth, obviously, in all geographies and with a lot of different customers with the mobile business doubling. Some of that was with the market leaders, but a lot of it also was in China. So EMCPs have been a great business for us. A lot of that is in the Chinese value handsets, and I don't think we want to get specific in terms of percentages, but I think it's fair to say that we had strong growth in China, as well as at some of the high end smartphone manufacturers. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [54] +-------------------------------------------------------------------------------- +Great. And then a second question on another end market PCs. Again, we all read the same stuff you do about shortages in DRAM in the PC end market. I would you say that is the end market where supply is tightest, and any estimate of when these lead times could be -- these extending lead times could be relieved? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [55] +-------------------------------------------------------------------------------- +Yes, I'd say it's tight there, but product is moving around, right? The industry is not static, and what tends to happen as the market tightens up like this is people will sacrifice a little bit of short-term margin to move product into segments they believe are longer term, more advantaged. +There's a little bit of that going on right now where perhaps margins might actually be a little higher in PCs, but people may shift production into servers because it's viewed as potentially longer term, more favorable, or mobile because it's maybe a slightly more defendable market share as things change over time. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [56] +-------------------------------------------------------------------------------- +Okay, thanks, guys. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from John Pitzer of Credit Suisse. Your line is open. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [58] +-------------------------------------------------------------------------------- +Yes, good afternoon, guys. Thanks for letting me ask the question. Mark, my first question is just around sort of your DRAM profitability versus peers. Absolutely, clearly, DRAM is getting better, but there's still this gap between the peers. I'm wondering if you can talk about the 1X transition for you? +It seems like there's two vectors where you might be able to close that gap. One, it just seems like a better shrink for you than maybe your peers, and, two, correct me if I'm wrong, but of most of Rexchip, I believe, is still at 25 nanometers. So it might seem to me that as you guys move to 1X you'll have a bigger wafer start base at 1X than you had at 20 nanometers. Am I thinking about that the right way, or how are you thinking about it? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [59] +-------------------------------------------------------------------------------- +First of all, at a high level, we're going to continue to outgrow the market in terms of bits like we talked about, and we're reducing cost at a faster rate than we have over the last three years. So that gap will continue to narrow with the forecast we've given you. Specifically, relative to 110 Series, yes, it's a good shrink. +We have -- as I mentioned, we've got a number of different products coming. Some of them are bigger shrinks than others. We're pretty -- particularly excited about some of the ones that come later in the fiscal year that really drive out a lot of cost and die size, as opposed to some of the ones that come earlier and fill value-added potential segments or specific power or performance attributes that the customers are looking for. +Beyond that, I think it's fair to say that we should get a good bang for the buck on this technology transition, not only because it's a substantial shrink, but also because a chunk of it, a large chunk of it's happening in Taichung, so we're actually transitioning capacity from 25-nanometer all the way down to 1X. So it's as we did with 20-nanometer in Hiroshima and Inotera, and a big chunk of that capacity at Inotera was a double hop from 30 nanometer to 20 nanometer. This will be a double hop from 25 to 1X at the Taichung fab, and so there is a pretty good bang for the buck there. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [60] +-------------------------------------------------------------------------------- +That's helpful. And then, guys, as my follow-up, you're still endorsing the two-year CAGRs for bit growth in NAND and DRAM for you. Ernie, I know you don't want to get into quarter-by-quarter, but I'm curious as how we should think about linearity of that bit growth from here on out for this fiscal year for both DRAM and NAND? +And I ask the question because specifically for DRAM, if it's a linear growth rate, it just seems like the February numbers are still embedding some very conservative assumptions around pricing given how good the environment is. So how do I think about that dynamic? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [61] +-------------------------------------------------------------------------------- +I think you're going to see us make some steady quarter-on-quarter growth, but I don't think in DRAM particularly you're going to see it continue at the levels that you've seen it for the last couple quarters. And I think the best guidance we can provide is that we're going to be roughly year-on-year to get to our targets, we're going to need to be at or slightly above 50% in terms of bit growth year-on-year. We've just given you a pretty big number for Q1. So that math is getting easier and easier to work out. +I would also tell you relative to some of the pricing, you'll note that we widened our revenue guidance range a little bit and that's reflective of a bigger business, and the fact that we realize pricing environment continues to be dynamic. So we did try to reflect our best thinking in the guidance that we've provided to you. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [62] +-------------------------------------------------------------------------------- +Perfect. Thanks, guys. Congratulations on the strong results. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from of Jagadish Iyer of Summit Redstone. Your question, please. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Summit Redstone Partners - Analyst [64] +-------------------------------------------------------------------------------- +Yes, thanks so much for taking my question. First question, Mark or Ernie, how should we think about cost reduction for Gen 2 NAND versus your Gen 1, and when do you think it might become visible for you guys? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [65] +-------------------------------------------------------------------------------- +On full conversion, think of it as roughly doubling the bits per wafer, and think of a cost down in the range of greater than 30%. So it's a big transition, but it's also, as we mentioned, won't start to become significant until later in FY17. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Summit Redstone Partners - Analyst [66] +-------------------------------------------------------------------------------- +Okay. Then on the DRAM front, I just wanted to find out if there is going to be any meaningful wafer capacity additions from Micron in FY17. Is there a fab where you have some additional headroom for you to invest or should you invest in a new greenfield? Thank you. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [67] +-------------------------------------------------------------------------------- +We're very focused on the technology upgrades that we were talking about with John a minute ago. That's where we get the biggest bang for the buck. We do have some clean room space around the network, but we have no plans to add new wafers this year. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Summit Redstone Partners - Analyst [68] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Harlan Sur with JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [70] +-------------------------------------------------------------------------------- +Good afternoon, guys, and solid job on the quarterly execution. And also congrats on the 600-basis-point inflection in NAND gross margins. +If we focus on this, clearly, 3D bit crossover was a big driver going forward, as I think about more cost per bit declines, you still have the benefits of continued higher 3D mix, higher TLC 3D mix on Gen 1. Question here is, when should we expect TLC 3D crossover with 3D MLC? Is that going to be this quarter? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [71] +-------------------------------------------------------------------------------- +It definitely will be this quarter in aggregate. We expect TLC to be greater than 50% of the 3D bits. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [72] +-------------------------------------------------------------------------------- +Great. Thanks for that. And then at the product level, based off of third party estimates, the enterprise SSD market's about a $10 billion market growing at about 25% year-over-year for the next few years. +You guys have low-single-digits market share while you're JV partner has about 35% market share here. High capacity SATA is the biggest portion of this market. You just announced the 5100 Series that's 3D TLC. +Can you guys just give us a sense on when you're going to start shipping this in volume production? Are the large hyper scale guys the lead customers here? And just given what looks to be a step-up in the road maps and maybe some of your customer feedback, do you guys anticipate growing your shares here in the enterprise space in 2017? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [73] +-------------------------------------------------------------------------------- +Yes, we definitely plan to grow our share. As you point out, the fact that our share is relatively small in those segments today means there's a lot of opportunity. We do have what we think is a much better product portfolio now that's got a lot of customer excitement and eagerness, and we think that we're well-positioned with long-term customers who really want to buy from Micron. So, yes. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [74] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Romit Shah of Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [76] +-------------------------------------------------------------------------------- +Yes, thank you. I just wanted to ask a question about gross margin. The guidance is much better than expected. I'm just curious, how would you suggest we think about the gross margin potential of Micron considering your mix, cost road map, and whatever baseline pricing assumptions you're making? Is last cycle's, your peak gross margin a good guidepost for us, or are you thinking about it differently? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [77] +-------------------------------------------------------------------------------- +That's a question that's got a thousand relative comparisons in it. What I would tell you is look, we are a different Company than at the last peak. We have a higher mix of NAND. We have a technology progression that we've tried to share with you. +Certainly, I think we've outlined our cost reductions over the next three quarters or so, if you take the broad guidance we've provided. We've provided bit growth targets. You get to overlay a pricing environment and from that derive a gross margin profile. But I would expect if you have a similar market, you're going to continue to see opportunity for us to expand our gross margins. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [78] +-------------------------------------------------------------------------------- +Okay. Thanks, Ernie. Can I also ask you, what's the net operating -- the NOL balance today, and can you just educate us on restrictions in terms of utilizing that asset against future tax provisions? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [79] +-------------------------------------------------------------------------------- +It's somewhere in the $4 billion plus or minus range, and one of the reasons that -- and we're very focused on protecting that NOL, which is the reason we put our NOL rights plan in place and it's been the proxy now and up for shareholder review, as well. And we intend to do everything we can to continue to preserve our ability to use that because these are exactly the times that we want to have the ability to do that. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [80] +-------------------------------------------------------------------------------- +Does a $4 billion balance mean that whatever the tax rate is, 5%, is the right way to think about your rate over the next several years? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [81] +-------------------------------------------------------------------------------- +No, because that would apply to US income and earnings which are taxed, unfortunately, at a much higher rate than 5%. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [82] +-------------------------------------------------------------------------------- +Okay. So you can only utilize it for US income? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [83] +-------------------------------------------------------------------------------- +That's right. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [84] +-------------------------------------------------------------------------------- +Okay. Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from David Wong of Wells Fargo. Your line is open. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [86] +-------------------------------------------------------------------------------- +Thanks very much. Can you give us some idea of what you expect your debt and cash and equivalents might be at the end of the February quarter following the Inotera payments? And apart from CapEx, are there any significant post-acquisition cash charges for restructuring or anything else to do with Inotera? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [87] +-------------------------------------------------------------------------------- +There are no significant restructuring charges anticipated. We borrowed $2.5 billion relative to Inotera. So we would expect that to be somewhere -- our total debt to be somewhere in the range of $12 billion, high $12 billion, maybe $13 billion, plus or minus. There's a few little moving pieces around. +We're sitting here with cash this quarter at $4.3 billion. There was a cash component to the transaction of about $500 million, and then we'll generate operating cash flow and free cash flow in fiscal Q2, which we don't guide. So the result of that will be where we'll be at cash, but I would expect based on everything I know that it's reasonable to think flat or higher. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [88] +-------------------------------------------------------------------------------- +Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Kevin Cassidy of Stifel. Your question, please. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [90] +-------------------------------------------------------------------------------- +Thank you. On your transition to the 1X DRAM process, will this be any different than past transitions, meaning are you going to be coming out into the PC market first and then mobile, or will these be targeted for certain markets? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [91] +-------------------------------------------------------------------------------- +We've got a -- as I mentioned earlier, Kevin, we've got a broad spectrum of products. We're trying to make sure we get as many of them qualified early in the ramp as possible this time and do a slightly better job than we did at 20-nanometer. So actually we have mobile and compute products coming, and then we have additional cost reduced and broader market applications behind that. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [92] +-------------------------------------------------------------------------------- +Okay. Great. And on your 3D XPoint, you said that you'd have your first revenue in 2017. Can you say what end market that would be? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [93] +-------------------------------------------------------------------------------- +Sorry, can you repeat the question? + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [94] +-------------------------------------------------------------------------------- +3D XPoint, what's your first end markets for that? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [95] +-------------------------------------------------------------------------------- +We're talking to a number of different customers and we probably don't want to say yet. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [96] +-------------------------------------------------------------------------------- +Okay. Congratulations on the great results and guidance. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [97] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Mark Newman of Bernstein. Your line is open. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [99] +-------------------------------------------------------------------------------- +Hi. Thanks, and congrats on a great quarter. Question relating about where we are in the cycle right now. Things look really great on pricing. I wonder -- also you mentioned inventory on the DRAM maintenance level also looks good. +Do you have any comments on the inventory level of the customers? I'm wondering particularly on the Chinese smartphone OEMs have been buying quite a lot of memory through the second half of 2016. And I'm just wondering if you're seeing any double ordering, any excess inventory on the customer side, anything at all that makes you a little bit concerned of excess inventory, either on the chip side or on the finished product side, especially on the handsets? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [100] +-------------------------------------------------------------------------------- +Not really, Mark. We've heard rumors along the lines of those that you're alluding to, I believe, but we can't validate -- I can't validate those for you. Certainly, in most market segments, it's very, very tight, and any time you have that and customers start get nervous about, are they potentially going to go line down, et cetera, you always start to be concerned that people are just trying to get a little bit ahead of it and build some inventory. +I think that's only natural. I think we're doing a pretty good job of trying to allocate this product where it's absolutely most needed, and so I don't think too many people are building up too much inventory. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [101] +-------------------------------------------------------------------------------- +Great. Thanks. And then if you think back to the previous, back in 2014, at the moment, this feels very much like 2014, pricing's strong, demand's good, supply/demand remains pretty tight. Anything different if you compare between now and then because, clearly, what happened in 2015 and 2016 wasn't quite what we were hoping for in terms of supply/demand balance and pricing. +I'm just wondering if you had any comments on what is different between the previous cycle? Clearly, the industry is a lot better than the past, but the question is how much, and I'm just trying to ask if you have any particular thoughts of this time versus 2014 in particular? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [102] +-------------------------------------------------------------------------------- +Well, I think it's -- I think that part of what happened in the last -- latter stage of the last cycle were perhaps a little bit of miscalculation by one of the suppliers. But they probably learned from. So there's that. +The biggest change structurally in the market, though, really is the fact that the products are going into a much broader set of end markets, much more broadly distributed now we're three or four years on from where we were in the last cycle. And I think that does make a difference. On top of that -- + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [103] +-------------------------------------------------------------------------------- +Thanks very much. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [104] +-------------------------------------------------------------------------------- +Mark, I'll add one more piece to that, which is a long-term trend that we've talked about in the past in terms of slowing technology migrations, means that competitors in the marketplace are likely doing math with numbers that are changing less rapidly than they used to be. So both from a demand and a supply perspective, as those numbers get smaller and the slope gets smaller, and the rate of change, it gets a little bit easier to do the math and to keep things in balance. +And then finally, you layer on what's going on with NAND right now from a demand perspective, it's just explosive, I think, is probably the right word in terms of demand and elastic, as well. I think there's maybe some insulation there that wasn't there last time around. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [105] +-------------------------------------------------------------------------------- +Great. Thanks very much. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc. - Senior Director of IR [106] +-------------------------------------------------------------------------------- +Operator, we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- +Yes, sir. Our next question comes from C.J. Muse of Evercore ISI. Your question, please. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [108] +-------------------------------------------------------------------------------- +Hi, this is Ada calling in for C.J. A question, another question on XPoint. Can you talk about whether you see that product impacting DRAM demand down the road? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [109] +-------------------------------------------------------------------------------- +A question on export? Is that what -- + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [110] +-------------------------------------------------------------------------------- +XPoint. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [111] +-------------------------------------------------------------------------------- +Oh, XPoint. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [112] +-------------------------------------------------------------------------------- +XPoint. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [113] +-------------------------------------------------------------------------------- +Not early, no. The question was asked, who are we going to ship to first? We're not going to tell you who we're going to ship to first, but longer term it's storage, it's data center, and it's mobile applications, all of those. I think early on it's pure additive demand in the overall memory market. We get two or three years in and have more substantial ramp going on and cost reduction, yes, I think it will over time cannibalize part of the DRAM business. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [114] +-------------------------------------------------------------------------------- +And second question, in terms of the NAND channel inventory, how's that looking right now? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [115] +-------------------------------------------------------------------------------- +Very tight, very tight. Customers are quite concerned. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [116] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc. - Senior Director of IR [117] +-------------------------------------------------------------------------------- +Thank you, everyone. This now concludes Micron Technology's first quarter 2017 financial release conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2016-Jun-30-MU.txt b/Transcripts/MU/2016-Jun-30-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..c6f317d12688846fc8297bc4b765369a4772a9dc --- /dev/null +++ b/Transcripts/MU/2016-Jun-30-MU.txt @@ -0,0 +1,663 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Micron Technology Inc Earnings Call +JUNE 30, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark Durcan + Micron Technology Inc - CEO & Director + * Ernie Maddock + Micron Technology Inc - CFO + * Ivan Donaldson + Micron Technology Inc - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + SIG - Analyst + * Tristan Gerra + Robert W. Baird & Co. - Analyst + * Harlan Sur + JPMorgan - Analyst + * John Pitzer + Credit Suisse - Analyst + * Chris Hemmelgarn + Barclays Capital - Analyst + * Tim Arcuri + Cowen and Company - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Vijay Rakesh + Mizuho Securities USA - Analyst + * CJ Muse + Evercore ISI - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Romit Shah + Nomura Securities - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +At this time, I would like to welcome everyone to the Micron Technology's third quarter 2016 financial release conference call. +(Operator Instructions) +It is now my pleasure to turn the floor over to your host, Ivan Donaldson. Sir, you may begin your conference. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [2] +-------------------------------------------------------------------------------- +Thank you, Karen, and welcome to Micron Technology's third quarter 2016 financial release conference call. On the call with me today are Mark Durcan, CEO and Director, and Ernie Maddock, Chief Financial Officer. This conference call including audio and slides is also being webcast from our Investor Relations website at investors.Micron.com. +In addition, our website contains the earnings press release filed a short while ago and supplemental information including quarterly operational and financial metrics and guidance, GAAP to non-GAAP reconciliations, slides used during today's conference call and a convertible debt and cap call dilution table. Today's call will be approximately 60 minutes in length. A webcast replay will be available on our website for one year. We encourage you to monitor our website at Micron.com throughout the quarter for the most current information on the Company including information on the various financial conferences that we will be attending. You can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements based on the environment as we currently see it. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents the Company filed with the SEC, specifically our most recent Form 10-K and Form 10-Q for a complete discussion of these important risk factors and other risks that may affect our future results. +Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. I'll now turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [3] +-------------------------------------------------------------------------------- +Thanks, Ivan. For fiscal Q3 2016, Micron posted total revenue of $2.9 billion, with gross margin of 17%, a non-GAAP net loss of $79 million and a non-GAAP loss of $0.08 per share, all within our guided range. Operating cash flow was $389 million. Top line results were primarily impacted by continued weakness in the PC segment and the mobile qualifications we discussed last quarter. With recent data points indicating some improvement in channel pricing, an expectation of finalizing our mobile qualifications and continued progress on our technology and operational milestones, we remain confident about our opportunities. +Today, I'd like to provide a brief overview of our progress in each of the businesses and Ernie will cover other business unit performance details. In our compute and networking business unit, we returned to revenue growth despite pricing pressure in the client segment. This was driven by the ongoing ramp of our 20-nanometer products, which exceeded 25-nanometer shipments on a bit basis for the first time. We enjoy continued 20-nanometer qualifications across all CNB market segments lead by our 8-gigabit DDR4 product in enterprise, cloud and client. +In May, NVIDIA launched the world's fastest consumer graphics card designed with Micron's GDDR5X. We are excited about the prospects for this high performance memory product. In enterprise and cloud, we saw initial customer announcements based on our NVDIMM product offering with high performance persistent memory. +Turning to our mobile business unit, our results continue to be impacted by the timing of product qualifications as we transition customers to 20-nanometer versions of LPDDR4. We have successfully concluded some of the delayed qualifications that we discussed last quarter and we anticipate finalizing the remainder during fiscal Q4. We are ramping the output of these products throughout the quarter and into fiscal Q1 2017. We anticipate continued demand growth in mobile market in the fourth quarter in terms of both NAND and LPDRAM. +In our embedded business unit, the automotive segment delivered record revenue driven by volume increases in DDR3 and increasing density mix in the e.MMC. Design activity remains strong with recent qualifications of automotive consumer and connected home applications. In the consumer MCP business, we saw some recovery that we expect to continue into fiscal Q4, aligning with seasonal demand. +Finally, our storage business unit is in the midst of refreshing its SSD portfolio with a higher capacity 3D NAND memory technology. We also introduced Micron Accelerated Solutions, which are enabled by our enterprise SSDs and advanced DRAM, integrating compute and storage to improve efficiency and performance in a variety of storage applications. And we announced our new 110 SATA client SSDs leveraging triple level cell 3D NAND for class-leading performance and power efficiency. +To summarize, our leading edge technology deployment continues to progress throughout manufacturing for both DRAM and NAND and we are on track with our bit growth and cost reduction targets. We believe the combination of new products with more efficient manufacturing on advanced nodes will drive improvement in our competitive position in the rest of 2016 and beyond. +Turning to the memory industry more generally, we believe that the DRAM industry supply growth will be in the low to mid-20% range in 2016, which is consistent with our prior commentary. If wafer output declines in the latter half of the year as some parties have forecast, we would expect to exit the year on a slower run rate and 2017 bit supply growth could be in the mid to high teens. This compares to our long-term bit demand forecast in the low to mid 20% range. The significant improvements we're seeing in channel pricing are not currently impacting other segments and as a result, we continue to take a conservative view of the market environment. +For NAND, we estimate 2016 industry bit supply growth in the mid-30% to low 40% range, with a similar range in 2017 as early 3D conversions create some temporary supply constraints. Over the last several quarters, we've experienced strong demand coupled with aggressive pricing as suppliers have been driving to increase penetration rates and densities. Similar to DRAM, the current channel pricing environment appears to be improving but is not yet significantly impacted across other segments. Our long-term bit demand forecast is in the low 40% range as lower costs and higher performance 3D NAND solutions enter the market. +From an operations perspective, Micron remains focused on a few key priorities. For DRAM, we successfully achieved our targeted 20-nanometer crossover during fiscal Q3, and also enabled our 1x node in manufacturing. We expect to ramp 1x-nanometer DRAM in volume starting in 2017. +We are still forecasting Micron's FY16 and FY17 DRAM bit growth in the 20% to 30% range, which is likely above the market. We achieved 22% bit growth in fiscal Q3, and expect even stronger bit growth in Q4. In light of current market conditions, we have no plans to add DRAM wafer capacity. As noted above, we are migrating to advanced technology nodes in order to achieve cost reductions and adjust higher density designs for mobile, cloud and enterprise segments. +For NAND, we continue to make great progress on our Gen-1 3D NAND and are reaching maturity yields ahead of expectations. We still expect to achieve 3D bit crossover by this fall, which will allow us to take advantage of the cost benefits that this technology provides. Our second generation 3D product is also on track with initial production this quarter. Equally exciting is that we expect TLC to be the majority of our 3D bit output within the next few quarters. +In aggregate, we are forecasting Micron's FY16 and FY17 NAND bit growth in the 30% to 40% range. We expect to be somewhat below the market in 2016, and somewhat above the market in 2017. TLC enabled 3D NAND technology is a big step forward and a significant driver relative to the progress we expect to make in our NAND business. +This technology progress must be complemented by enabling product solutions for key storage and mobile segments. We've outlined our storage product road map, which includes our recently announced client SSDs, followed by cloud drives later this year and enterprise solutions early next year. We're also evaluating a number of mobile product opportunities for 3D NAND in 2017. Relative to 3D XPoint, we're working with market enablers across a number of market segments and continue to believe this innovative technology will be a strong contributor to Micron's future success with revenue in 2017 and beyond. +Micron has a committed focus on the deployment of advanced technology to drive manufacturing efficiency and enable innovative new products for our customers. While we haven't finalized our FY17 business plan, we are approaching that plan with prudence and conservatism and carefully reviewing our capital investments and projected operating cash flows to ensure the appropriate balance. Now, I'd like to turn it over to Ernie. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Mark. I'll start off by sharing technology and business unit details and circle back to the overall Company results for the quarter, followed by the guidance for the fiscal fourth quarter. +DRAM represented 60% of our total revenue with the following segmentation. Mobile was in the mid-20% range, the PC segment represented about 25%, the server business was in the low 20% range, and specialty DRAM, which includes networking, graphics, auto and other embedded technologies, was in the high 20% range. +In our non-volatile memory business, trade revenue represented 31% of total revenue with the following segmentation. Consumer, which includes memory cards, USB and components, represented about 55%. Mobile and SSDs each represented approximately 13% and as a reminder, eMCPs are accounted for in the mobile segment. The automotive, industrial multi-market and other embedded applications were in the high teens percent range. +Moving on, I'll share a brief operational summary of each of our business units. Micron's compute and networking business unit posted fiscal Q3 revenue of $1.09 billion, up 4% from the previous quarter, primarily driven by our 20-nanometer shipment growth across all segments and partially offset by lower average selling prices. Our non-GAAP operating loss was $63 million or 6% of revenue. +In the enterprise segment, demand for our 20-nanometer 32-gigabit DDR4 RDIMM was driven by the launch of Intel's latest server platform. We also saw solid growth in the cloud segment with continued transition to DDR4. In graphics, we saw strong growth driven by our GDDR5 and GDDR5X products and are approaching a seasonally strong period for graphics applications including virtual reality and expect good performance from this segment for the next quarter. +In networking, our business was somewhat flat, however we made significant progress enabling our 20-nanometer products and also announced our eUSB 3.0 solution. Finally, within the client segment, we continued enablement and volume ramp of our 20-nanometer 4-gigabit DDR3 and 8-gigabit DDR4 solution to all major OEMs. +In Micron's mobile business unit, we posted fiscal Q3 revenue of $561 million, up 12% from the prior quarter as we continued to ramp 20-nanometer LPDDR3 and LPDDR4. While the low density eMCP market is still under pressure, a move to higher density designs in FQ4 and early FY17, should help stabilize and improve this segment. +Our non-GAAP operating loss was $17 million or 3% of revenue. We have successfully concluded some of the delayed qualifications that we discussed last quarter and we anticipate finalizing the remainder during fiscal Q4. This work will allow us to more fully ramp our 20-nanometer mobile products in fiscal Q4 and into next year. Both LPDRAM and NAND content continue to increase in mobile devices, which when combined with even modest unit growth will result in very solid bit consumption. +In our embedded business, we posted fiscal Q3 revenue of $487 million, up 6% from the previous quarter, with a non-GAAP operating income of $107 million, or 22% of revenue. The results were primarily driven by continued strength in the automotive and consumer segments offset by softness in the industrial multi-market segment. +In our automotive segment, we achieved record revenue increasing 6% quarter-over-quarter and 10% year on year. We continue to see increasing demand in both DRAM and eMMC applications that include infotainment, instrument cluster and advanced driver assist systems and continue to see strong demand from our EMEA customers, which is more recently complemented by growth in Korea and demand recovery in North America. Our portfolio of leading edge solutions is enabling major 2018 platform automotive design wins. +Our industrial multi-market business declined 9% quarter-over-quarter, primarily due to global market softness in the manufacturing infrastructure segment. However, we continue to see healthy demand for our NOR and NAND-based MCPs used in machine to machine wireless communication modules. +Our consumer and connected home revenue was up 3% quarter-over-quarter with some softness in the set top box business offset by strong demand for NAND and LPDRAM MCPs to support action camera and home automation applications. As we enter into a seasonally strong period, we expect demand to continue to grow. Customers are also beginning to design in and ramp our 20-nanometer DDR4 products into set top box applications. +Micron storage business unit posted fiscal Q3 revenue of $719 million, down 20% from the previous quarter with a non-GAAP operating loss of $62 million or 9% of revenue. As we transition to lower cost 3D NAND products, we continue to optimize our product mix. +In client and consumer SSD, consecutive quarter bits sold were down 20% as we reduced production of planar NAND-based SSDs while ramping volume production of 3D NAND-based SATA and PCIe client and consumer SSDs. These new products will enable the Company to enhance its competitive position. +In the Enterprise and data center SSD segments, consecutive quarter bits sold were down 10%. As we have previously noted, our 3D NAND solutions will improve our product portfolio in this segment enabling us to participate more significantly in this important growth business for the Company. +Now looking at the Company overall, as Mark noted earlier, revenue for the third quarter was $2.9 billion, which was near the midpoint of our guided range and roughly flat compared to the prior quarter. Fairly significant increases in volume shipments for DRAM were offset by decreases in selling prices, while trade NAND shipments declined as we are in the middle of a significant conversion from planar to 3D NAND. +Gross margin for the quarter was 17%, within our guided range. The non-GAAP net loss for the third quarter was $79 million, or $0.08 per share, slightly better than the midpoint of our guided range. As a reminder, Micron includes both amortization of acquisition intangibles and stock compensation expense in our non-GAAP results. Taken together, these two items represent $0.05 per share for the recently completed quarter. +Now, let's look at results by product line. DRAM revenue increased 9% compared to the second quarter, as a result of a 22% increase in bit shipments partially offset by lower selling prices. As the result of our 20-nanometer ramp and ongoing mobile qualification timeline, DRAM finished goods inventory increased during the quarter. DRAM gross margins for the third quarter decreased approximately 2 percentage points to 18% as decreases in ASPs outpaced significant cost reductions. +Our nonvolatile trade revenue decreased 15% compared to the second quarter, reflecting a 10% decrease in bit shipments combined with a 6% decrease in ASPs. Gross margin decreased a couple of percentage points to 17% as ASP reductions outpaced cost per bit reductions. +Non-GAAP operating expenses for the quarter came in at $523 million, below our guided range due to the reversal of accrued costs for variable compensation plans, which were suspended in the third quarter. The Company generated operating cash flow of $389 million, and we ended the quarter with cash and marketable investments of approximately $5.7 billion. Expenditures for PP&E during the quarter were $1.7 billion, and we continue to expect our FY16 capital expenditures to be in the range of $5 billion to $5.5 billion net of partner contributions. +During the quarter, we received approximately $2 billion from the issuance of secured notes and an additional $114 million in equipment financing. Also, we resolved a long outstanding tax matter, which resulted in a $52 million benefit to the tax line. This benefit was offset by the write-off of a related $30 million receivable that was reflected as non-operating expense. In the third quarter, we also acquired Photronics' interest in our captive mask operations for $93 million, resulting in 100% ownership of the mask operations. +Moving on to our guidance for the fourth quarter, on a non-GAAP basis we expect the following; consolidated revenue in the range of $2.9 billion to $3.2 billion, gross margin in the range of 15.5% to 18%, operating expenses between $580 million and $630 million, and operating loss ranging between $135 million and $55 million, and an EPS loss ranging between $0.24 and $0.16 per share based on 1.036 billion diluted shares. Operationally, we are on track to achieve the bit growth and cost per bit reduction that we have previously shared as we continue to ramp our 20-nanometer DRAM and 3D NAND production. +In recognition of the current business environment and the need to accelerate focus on the Company's key priorities, we plan to implement a cost saving program, which we expect will save the Company approximately $80 million per quarter in FY17. The savings will result from a combination of our more focused set of projects and programs, the permanent closure of a material number of open headcount requisition and a workforce reduction in certain areas of the business, as well as other non-headcount related spending reductions. +About half of these savings will appear in the gross margin line of the Company, while the remainder will be reflected in operating expenses. These savings are baseline against our previously planned 2017 fiscal spend levels. We expect to take reserves approximating $70 million for the cost of this program, the majority of which will occur in fiscal Q4, with the remainder in the early part of FY17. As we complete our FY17 planning process, we are mindful of the need to effectively balance period spending, CapEx and free cash flow and we continue to explore other opportunities to improve the Company's financial performance. +Finally at this time, we don't have any new information to share relative to Inotera. As we stated in our press release, the transaction will not be closing in mid-July, and we expect to provide an update during the latter part of the calendar year. With that, I'll turn it back to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [5] +-------------------------------------------------------------------------------- +Thank you, Ernie. To summarize, we continue to navigate challenging market conditions, but remain confident in the long-term health of the industry and the Company's strategy to improve our relative competitive position. The decision to implement cost reduction initiatives is always difficult and is never made without thoughtful consideration about the short-term and the long-term impacts. +However, to ensure that we can continue to place emphasis on our most important Company priorities, we believe the steps Ernie outlined are prudent and will help deliver the best long-term results for the Company. I'd like to take a moment to thank our customers, partners, shareholders and team members for their continued support. Operator, we're now ready for Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question comes from the line of Vijay Rakesh from Mizuho. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [2] +-------------------------------------------------------------------------------- +Yes, hello, guys. Just a couple of questions here on the DRAM side. Obviously, a good bit growth there. But what's the mix of 20-nanometer that is shipping now and how do you see that as you progress through the August quarter? Do you see further cost reductions there? Thanks. I have one follow-up. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [3] +-------------------------------------------------------------------------------- +20-nanometer is a majority of the bits that we are shipping now and when we talked in our prepared remarks about strong bit growth above Q3 levels, you saw what the relative growth was in Q3 and you can assume that it will be a little bit north of that as we look at fiscal Q4. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [4] +-------------------------------------------------------------------------------- +Got it. And on the 3D NAND, on the NAND side obviously, looks like bit growth was a little light obviously because of the transition. What's your mix of 3D NAND that you're shipping now and when do you see the transition and the bit growth start to open up for you on the NAND side? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [5] +-------------------------------------------------------------------------------- +It's a low double digits today. As we commented, as we get into the back half of the calendar year, we expect a crossover. So that's coming pretty soon. So it's a pretty significant ramp from here over the next couple of quarters. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [6] +-------------------------------------------------------------------------------- +Got it, and obviously, you guys are giving the point estimate to me on the gross margin now which is great. As you look at your mix, the 20-nanometer cost coming down and 3D NAND TLC starting to ship, any thoughts on where you see those margins start to bottom out? Thanks. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [7] +-------------------------------------------------------------------------------- +You know, we typically don't comment on margins because of the function of our pricing environment that's moving around on us every day. And so really, what we have said is that the cost curves that we articulated in our Analyst Day are still legitimate. As you can imagine, when we do 3D crossover and NAND in the fall, that's when you can expect to see the accelerated cost reductions begin to occur there. And on the DRAM side with the bit growth that we delivered in fiscal Q3, as well as what we're forecasting for fiscal Q4, you can get some idea of what the cost reductions would be there. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [8] +-------------------------------------------------------------------------------- +Great, thanks a lot. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of John Pitzer from Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [10] +-------------------------------------------------------------------------------- +Good afternoon, guys. Thanks for letting me ask a question. Ernie, maybe a follow on to that margin question, and I appreciate that margins are a function of pricing which is hard to predict. But you've got a lot of elements moving in the right direction. Revenue is growing sequentially into the fiscal fourth quarter. You've got 20-nanometer mix. You've got more mobile. NAND is starting to turn your way. And yet, you've got gross margins that are likely going to be down sequentially. +Can you help me understand just some of the factors around mix that are in play? And the narrative that we were hoping for is that this quarter, the May quarter, and the August quarter, would start to show some tangible evidence of you closing the relative cost gap to some of your peers. And just given the gross margin guidance, it looks like that's not happening and I'm trying to figure out why. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [11] +-------------------------------------------------------------------------------- +Maybe John, I can take that one instead of Ernie. Again, on the pricing environment as you noted, we're seeing -- there's obviously encouraging things going on in the channel. Before we start baking that into any sort of guidance we would give, we want to actually see that as it moves through other end market segments and out in the contract pricing et cetera. So really this is a question about the tailwinds we have and I think you did a nice job articulating for us. +I think we've done a good job on the 20-nanometer ramp and we'll continue to see some improvement for that as we move through the next quarter. And we articulated pretty strong bit growth moving forward in both DRAM and in particular, maybe a couple of quarters out in NAND as we really see that transition kick in and the 3D TLC part of that transition kick in. So we've got a lot of good tailwinds. We also articulated we're making a lot of good progress on qualifying and resegmenting those more advanced technology nodes in the right market segments. +And we do believe that you'll see progress relative to our competition in terms of how our margins move. We never know exactly what they are going to do and it's tough for us to predict what their results are going to look like given the pricing environment. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [12] +-------------------------------------------------------------------------------- +That's helpful, Mark. I appreciate it. And then, Ernie, maybe as my follow-on just on the OpEx guidance for the fiscal fourth quarter. A little bit higher than we thought. Can you help us understand, are there some period expenses that are coming in? +And then as you talk about the restructuring and the cost savings, given that you have that cost gap and you have a lot of initiatives on your plate for investing, how do we get comfortable that you're taking costs out of the right areas and yet still investing in areas you need to invest? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [13] +-------------------------------------------------------------------------------- +Sure. So to the first part of your question, there are some very significant prequal expenses that we expect to incur in Q4 that are influencing the guidance that we provided for the quarter's OpEx. And then relative to the cost reduction, the only comfort perhaps I would offer you, which I hope is very strong comfort, is that we actually think very carefully about what we're doing here. +And the decisions that we made with respect to the cost savings program were deliberated very thoughtfully debated and at the end, we believe we're at the right balance to both help improve the financial performance of the Company, while at the same time, not jeopardizing any of the Company's potential in terms of revenue opportunities. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [14] +-------------------------------------------------------------------------------- +John, maybe I can add one point there just so everyone on the call is clear. I know you are. The pre-production R&D costs Ernie is referencing are really associated with a lot of new products in qual with the technology nodes that are now ramped. And some of those are costs that flow through the R&D now as opposed to directly on the cost flow and inventory. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [15] +-------------------------------------------------------------------------------- +Perfect. Thanks, guys. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of Romit Shah from Nomura Securities. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [17] +-------------------------------------------------------------------------------- +Yes, thanks. Mark, you mentioned that channel pricing has improved. At what point would you start to see that show up in contract and in some of your other businesses? Because it looks like just based on the guidance for August that you're not expecting the overall pricing environment to (technical difficulties). + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [18] +-------------------------------------------------------------------------------- +Well you know, it's a very dynamic environment. So again, we want to make sure we're giving you what we believe is realistic guidance and guidance that is achievable and we're going to have to see what plays out in the markets overtime. When spot pricing starts moving, that's a great indicator of where the markets might go. But what has to happen obviously, is there has to be enough liquidity in the market that it can carry through into larger volume orders associated with contract market and inventory has to burn off. And we're seeing good indications of those types of things, but we need to make sure the pudding is fully baked before we serve it. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [19] +-------------------------------------------------------------------------------- +Okay, that's helpful. And then just on the prequal expenses that are boosting OpEx this quarter, is that more one-time in nature or do you expect expenses to remain elevated through the course of the year as you ramp these new products? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [20] +-------------------------------------------------------------------------------- +Well certainly, they will occur as there is a concentration of new products. So you shouldn't expect that they are going to occur each quarter. I would tell you that in Q4, they are particularly high relative to what we've seen over the recent history as a reflection of what Mark said. +But it is likely that sometime during the course of 2017, you're also going to see these occur as we release new products. But again, we see a particularly high concentration in FY16 Q4. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities - Analyst [21] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of Tim Arcuri from Cowen and Co. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [23] +-------------------------------------------------------------------------------- +Thanks a lot. I guess I had two questions. First of all, the NAND bits are really moving around a lot, obviously given the planar to the 3D move. So maybe you can hold our hand a little bit, A, on the 3D transition, because it does look like there's been some issues in the 3D transition looking at the bits. And maybe also talk about what the bit outlook is for August in NAND to just give us some comfort that you're getting through this transition. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [24] +-------------------------------------------------------------------------------- +So Tim, relative to -- I'll take the second part of your question first and then we'll circle back around to the first. The stake in the ground is that we've said a few things, which were actually we reiterated today that would be in the opposite direction of thinking there were problems with our 3D NAND transition. We're seeing mature yields occurring at rates that are slightly faster than we anticipated. We had originally probably six months ago, talked about bit crossover for 3D at the end of the year. +Today, we've reiterated again that that was going to occur in the fall. So a pull forward of a couple of months. And so, we're not going to give you bit guidance for the August quarter, but we do think that these data points will hopefully give you comfort that in fact the transition really is occurring slightly more rapidly than we have expected it to occur. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [25] +-------------------------------------------------------------------------------- +The thing I would add to that Tim is keep in mind we've also talked about the fact that we want to deliver more of our NAND bits in actual solutions to the customer. And as we do that, there's a natural tendency to stretch out the supply chain in aggregate and some lengthening of the total manufacturing cycle time as we move through that transition. Part of this I think is also reflective of the fact that we're making some fairly significant progress relative to getting these bits into the types of end products that we want to deliver the customer. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [26] +-------------------------------------------------------------------------------- +I think one final point that may be also contributing to the overall impression is we do see planar bits coming down fairly significantly as we move away from the planar SSD markets that we have sold into in the past. So there are many dynamics at play here relative to what comes out as an aggregate bit number. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [27] +-------------------------------------------------------------------------------- +Got it. And then just as the follow-up to that. Ernie, you talked at the Analyst Day, I think you said that $800 million of the CapEx this year would be for fab shell spending. So that net of the partner contribution you'd be in the $4 billion to $4.5 billion range. So sorry -- net of the partner contribution and also net of the fab shell spend, you'd be in the $4 billion to $4.5 billion range. +So I'm just wondering as you look to next year and I'm not asking for guidance, but I'm just wondering how you think about the maintenance CapEx level of the Company given some of these initiatives you have in DRAM and also in 3D NAND? How do you think about how to balance that? Thanks. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [28] +-------------------------------------------------------------------------------- +Well, you really asked two different questions right? How do we balance and obviously the balance has to come in as we think about the aggregate business of the Company and the cash flow that we plan to generate and a number of other factors. +As we look at maintenance CapEx, we said that we were normalized in that low $4 billion range ex-Inotera, and we wouldn't move away from that in a very substantial way as we're thinking about things today. Bearing in mind that we're still in the midst of a ramp of 3D in the Singapore fab, so it isn't exactly a normalized environment for us. Even taking out the shell, we're still outfitting that shell with productive capacity. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [29] +-------------------------------------------------------------------------------- +Got it. Okay. Thank you so much. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of David Wong from Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [31] +-------------------------------------------------------------------------------- +Thank you very much. For the second generation 3D NAND, when you hit crossover in the fall for 3D NAND, will this all be on second generation technology or will it be first generation? And what's the difference in layer count between first and second generation, please? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [32] +-------------------------------------------------------------------------------- +So David, it will be primarily -- a significant majority of that, in fact almost all of it, will still be gen one. Gen two, we start to see significant output in the second calendar quarter into the summer of 2017. And we haven't said what the layer count does, but we've indicated that it's roughly a 30% cost reduction moving from gen one to gen two and that it's roughly double the bits. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [33] +-------------------------------------------------------------------------------- +Great, thanks. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of Chris Hemmelgarn from Barclays. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [35] +-------------------------------------------------------------------------------- +Thanks very much for taking the question. I guess first of all, building on David's question. As you're seeing 3D ramp across the industry, how do you view your competitive positioning? At your Analyst Day, you laid out some beliefs that you were going to have cost leadership. Is that holding as you're seeing the competition ramp? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [36] +-------------------------------------------------------------------------------- +This is Mark. Yes, absolutely. We are very happy with the way the ramp is going. We're very happy with the technology was delivering and its ability to scale going forward. We think it's the best solution in the industry for almost every end market application. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [37] +-------------------------------------------------------------------------------- +Okay, and I guess to the harder question. What needs to happen for you guys to get back to sustained profitability? I applaud the restructuring efforts, but I look at the savings you've announced and that falls short of the losses you put up the last two quarters and what you guided to the next quarter. Are you confident these changes are going to be enough to get you back to profitability next year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [38] +-------------------------------------------------------------------------------- +Well, we think we're doing all the right things and we think we're making a lot of good progress on our relative competitive position on technology, the products are all coming along nicely now and the qualifications are progressing well. So there's always the wild card around ASPs, but we think we are making very significant progress and we think we'll see that every quarter as we move forward, you'll be able to measure us versus our competition. And hopefully confirm that we're doing all the right things. Exactly when that results in profitability, we can't tell you, but we think it's coming. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- +Thanks, much. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of Kevin Cassidy from Stifel. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [41] +-------------------------------------------------------------------------------- +Thanks for taking my question. On the mobile side, as you start getting more qualification on the LP DDR3 and DDR4, are you expecting that -- I guess what percentage of your revenue will be those products versus EMCP and what is it today? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [42] +-------------------------------------------------------------------------------- +Let me see if I can find those numbers. I don't have them right in front of me. For the mobile DRAM portfolio generally, EMCP probably represents -- + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [43] +-------------------------------------------------------------------------------- +Well, I'll jump in real quick Mark. So the way we break it out Kevin, is mobile DRAM discrete is reported in our DRAM business and that's about mid-20% of our total DRAM. Our EMCPs are reported in our NAND reporting segment and we said mobile was in the mid-teens percent of the NAND business, low to mid-teens. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [44] +-------------------------------------------------------------------------------- +Okay, maybe as you ship more of the LP DDR3 and 4s, are you expecting that your average selling price would increase? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [45] +-------------------------------------------------------------------------------- +Again, it's really challenging to give you a forecast of what's going to happen with the pricing environment. But in terms of aggregate revenues, we would expect it as we move through these qualifications that you're going to see the mobile business maintain or slightly improve in terms of a percentage of its overall revenue to the business. +And as we noted in our comments, as we see EMCP market moving to higher density, we think that will be a starting point for an improvement in that aggregate market, which has been weak actually in the last couple of quarters. And that's a quarter or so off as we roll into calendar 2017. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [46] +-------------------------------------------------------------------------------- +Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +Thank you. And our next question comes from the line of CJ Muse from Evercore ISI. + +-------------------------------------------------------------------------------- +CJ Muse, Evercore ISI - Analyst [48] +-------------------------------------------------------------------------------- +Good afternoon. Thank you for taking my question. First question on the mobility qualification side. How much is the uncertainty around timing there, whether it's the month of August or September/October, impacting your gross margin guide? And then as part of that, how should we think about the incremental gross margins as you start selling down your inventory going forward once we do get the qualified? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [49] +-------------------------------------------------------------------------------- +So CJ, this is Ernie. We're pretty clear on the qualification timeline. There is more uncertainty around the timing of shipments because at the end of the day, that is going to be a function of each of those customers current inventory dynamics with respect to the inventories they have on hand, their success in the marketplace and how they want to position their inventory. +And in addition to that, we are going to have as we already talked about, significant quarter on quarter growth in production. Some of which is directed toward that mobile market because we believe that it's fairly strong. +So mobile in general, has a better gross margin profile than the aggregate business. So as that product flows through, although there will be some early pressure as a result of that inventory having been built at a time when costs weren't fully baked as the result of the volume ramp, eventually it will flow through into the margin profile of the Company. + +-------------------------------------------------------------------------------- +CJ Muse, Evercore ISI - Analyst [50] +-------------------------------------------------------------------------------- +Okay, that's helpful. And I guess as a follow-up, when you think about your 3D NAND cost structure, curious how you would compare that today versus the price leader in planar NAND and when you think you'll crossover? Is that gen one when you're fully ramped at high volume or is that more gen two in the summertime next year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [51] +-------------------------------------------------------------------------------- +Yes, I think that it's probably most closely timed to an increase in our TLC mix, which is probably a couple of quarters out. And then we'll get a second surge in calendar Q2 and Q3 of next year as the gen two kicks in a significant way. But again, we think we'll be -- we think we'll be the leader as we fully implement gen two and TLC. + +-------------------------------------------------------------------------------- +CJ Muse, Evercore ISI - Analyst [52] +-------------------------------------------------------------------------------- +Great. Thanks, Mark. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [54] +-------------------------------------------------------------------------------- +Hello, thank you. I just wanted to clarify when you talk about Q4 DRAM bit growth being better than Q3, that's sequential bit growth north of 20%. And I guess that then implies when you look at revenue not growing very much that ASPs are down similarly. I know you don't want to give a pricing forecast, but I just want to make sure I understand. I'm finding it hard to get to your revenue number with my pricing assumptions. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [55] +-------------------------------------------------------------------------------- +So the first part of your assumption process Joe, is correct. And again, we're not going to comment on ASPs. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [56] +-------------------------------------------------------------------------------- +Okay, and then separately, can you talk about how the Inotera, the new pricing agreement factors into this? Is that a positive or a negative at this point relative to the old pricing agreement? And maybe if you could compare that versus a wholly-owned situation if that deal in fact moves through? Just any context you can give us around that dynamic? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [57] +-------------------------------------------------------------------------------- +Sure, so in the current pricing environment, what we've contemplated as we look forward to Q4, it's pretty much a wash to be honest with you. Either way, the results to Micron would be roughly the same. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [58] +-------------------------------------------------------------------------------- +Got it. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Harlan Sur from JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [60] +-------------------------------------------------------------------------------- +Hello, guys. Thanks for taking my question. I'm still a little bit unclear as to the gross margin decline or the slight gross margin decline in the August quarter, given that we've seen some stabilization in DRAM and NAND prices starting in the month of June. Your 20-nanometer mix and your 3D NAND mix is moving higher, so would assume that your blended costs are coming down nicely. +You mentioned other parts of the market that may not be participating on the pricing stabilization that we're seeing in the PC market, but if I look at the end market demand parameters, data center, networking fundamentals seem to be improving into the second half. Embedded fundamentals seem to be seasonally up. Can you guys just articulate what segments are still showing aggressive pricing declines? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [61] +-------------------------------------------------------------------------------- +Yes, so let me try to characterize that a little bit for you. So it is important to recognize that these data points are really happening in realtime and as we look at how we actually entered this quarter, we were actually starting the quarter below the average of the prior quarter and we're now seeing some upward trends that are causing everyone to have the enthusiasm that we're talking about. But it is important to understand that what we've been reading about in the last two weeks has A, not impacted the entirety of the quarter and B, hasn't reflected itself yet as we look at forward pricing. And as Mark mentioned a couple times, we really are wanting to provide prudent guidance in the context of an environment moving around very significantly. +The other point I would make is it is absolutely true that we are seeing strong bit growth and cost reductions on the DRAM side. Remember that we said the majority of the NAND cost reductions occur as we achieve that bit crossover, which is later in the fall of this year. So we are getting quarter on quarter cost reductions in NAND, but I think you might be perhaps pulling towards that bit crossover comment into the full quarter that we're coming up on and that's just not going to be the case. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [62] +-------------------------------------------------------------------------------- +Okay, appreciate the insights there. Maybe more of a product question for me next. If we include two in ones, SSD and embedded NAND attach rates and notebook PCs are at or slightly above 50% now and continuing to climb. I think you guys had a target of having your 3D NAND base client SSD in the market in calendar Q3. Maybe if you can give us an update there? +And I think you guys also had a target to have your 3D NAND-based SATA solution, your high capacity drives for hyper scale guys, starting in calendar Q4. If you could give us an update there as well? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [63] +-------------------------------------------------------------------------------- +Well, they are both in the market and we're just going to have to see what the demand looks like. But so far, we like the reaction we're seeing. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [64] +-------------------------------------------------------------------------------- +Great, thank you. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Rajvindra Gill from Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [66] +-------------------------------------------------------------------------------- +Yes, thanks for taking my question. On the whole 3D NAND conversion, I just wanted to get a better understanding of in your estimation, what would be more cost effective, the 3D on 32 layer versus the 20-nanometer that's currently on 2D NAND? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [67] +-------------------------------------------------------------------------------- +Definitely the 3D 32 layers is cost advantaged relative to 20-nanometer. Even 16-nanometer planar NAND. And we believe that as we move through time, the market is going to appreciate incremental value in 3D NAND business as well. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [68] +-------------------------------------------------------------------------------- +But can you give us an idea in terms of if your 3D NAND is actually fitted for some of the applications will be available for applications such as mobile or embedded or car? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [69] +-------------------------------------------------------------------------------- +We have a full product portfolio coming for 3D NAND that will address. And I think I mentioned this in my commentary, we have 3D NAND products for consumer, client, data center and enterprise as well as evaluating mobile applications on a go-forward basis. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [70] +-------------------------------------------------------------------------------- +Okay and just last question on the mobile DRAM qualification issues. What specifically can you talk about? Has there been quality issues with respect to your mobile DRAM, which is preventing you from getting qualified at certain customers and as a result losing market share to Samsung and --? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [71] +-------------------------------------------------------------------------------- +You know, I think we've gone through a very significant transition here. In some cases from 30-nanometer to 20-nanometer. In some cases from 25-nanometer to 20-nanometer. And from a timing perspective, in some cases we were later with a particular either density or IO or interface that the customers wanting. +So it's just a matter of working through that process and qualifying those products in the various fabs that we're ramping. So I don't think there's anything untoward or unusual in that process. It's just a matter of a fairly significant ramp across two high volume fabs and taking the time to qualify a full suite of products across all those technologies. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [72] +-------------------------------------------------------------------------------- +And if I can squeeze one more. In terms of competitively as it relates to your other major competitor moving to a smaller process node, and you guys perhaps perpetually playing catch up in terms of the profit node transition. What are some of the lessons you think you guys have understood from the 20-nanometer transition and trying to rectify that when you go to the other process node transition? Just in general, any comments there would be helpful. Thank you very much. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [73] +-------------------------------------------------------------------------------- +So certainly, we think 3D NAND has gone very well for that. For us, that has been really a model where we take technology we've developed in fab four and move it into a consistent equipment set and a historically Micron environment where the equipment all matches and things go very well. +What we experienced in 20-nanometer, is we're matching a disparate set of equipment given the Elpida acquisition. So we have got one tool set in Hiroshima, on tool set in the MMT fab in Taichung, and a separate tool set in the Inotera fab. And that's just more complicated. +And every time we make this transition, we get more and more of those tools aligned and we feel like actually we're in pretty good shape now. And as we move to the 1x node beyond that, it's going to be a lot more seamless and a lot easier to execute on a go-forward basis. So we think we're the leader in 3D and we think we're getting closer in DRAM and 1x is coming along now running at a preproduction levels in both Hiroshima and Taichung. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [74] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Mehdi Hosseini from SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [76] +-------------------------------------------------------------------------------- +Yes, thanks for taking my question. Mark, just looking at your NAND gross margin. It's been below corporate average since mid-2013, and you have all of these new product qualifications coming up. +I'm just wondering is there strategic alternative here to make a more dramatic or to take a more dramatic action? Because there's been more than two years that NAND has been underperforming compared to the corporate average. And in case these product qualifications don't go well, is there an alternative strategy here? And I have a follow-up. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [77] +-------------------------------------------------------------------------------- +We're always open to looking at lots of different ways to optimize the business for the shareholders. Having said that, we like our NAND position. We like the technology, the early feedback from the customers is they like what we're doing. They like not only the 3D technology, but the product portfolio. And we think we're making progress. So we are encouraged with the progress we've been making. +Yes, we have admitted for 18 months now that we completely missed the boat on planar TLC. We think we've taken significant steps to remedy that on a go-forward basis and we intend to do so. So we're going to play it out and as we do that, we'll look at lots of different strategic options for the DRAM business just like we do for the NAND business. Just like we do for the DRAM business and 3D cost point and all of the other interesting new technologies we're developing. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [78] +-------------------------------------------------------------------------------- +Any way you could share with us qualitatively or big picture what those options are? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [79] +-------------------------------------------------------------------------------- +Well I think we'll just keep those to ourselves, Mehdi. But I think the main point I would want to make is we think it's important to have a diversified set of products or technologies to support memory system solutions for our customers. We think we're in a strong position there. +We like the growth profile associated with non-volatile memory business generally and that includes not only NAND, not only the 3D XPoint business that we're currently developing, but also other advanced storage class memories we're working in. And we'll look at lots of different ways of optimizing the value in all those different technologies. And we may find different solutions and different segments, but we're always looking for those opportunities to create value-added partnerships or new relationships. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [80] +-------------------------------------------------------------------------------- +Got it and then quickly for Ernie, how should we think about working capital inventory and accounts receivable? It seems like, at least on an inventory side, it may not come down significantly until February quarter. Is that a fair assumption or not? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [81] +-------------------------------------------------------------------------------- +I think that it's reasonable to think about inventories being within a pretty narrow band for a couple of quarters. I think that's a reasonable thing to think about. And obviously, we pay a lot of attention to working capital and intend to do so on a going forward basis. And my statement about inventories was on a dollar basis, so obviously bits are going to move around as costs move around. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, SIG - Analyst [82] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [83] +-------------------------------------------------------------------------------- +Operator, I think we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- +Certainly, our final question for today comes from the line of Tristan Gerra from Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. - Analyst [85] +-------------------------------------------------------------------------------- +Hello, good afternoon. You've mentioned on the call today that the 3D NAND cost structure is laying to the TLC mix and you've mentioned a two quarter out timeframe for that mix ramp. Is that even on with the fiscal Q4 target in terms of cost improvement in your NAND difference that you provided last quarter? Or is there a little bit of a change in terms of where you expect an inflection point in your cost structure and NAND flash? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [86] +-------------------------------------------------------------------------------- +No, there's no change. I think that we're pretty consistent. The fiscal Q1 is our crossover, is aligned with our crossover in the fall that we talked about today, which is a little earlier than we had originally talked about. The 3D crossover comes a little bit later and that drives a surge in the cost improvement but not necessary to drive the improvements that we've outlined relative to our guidance. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. - Analyst [87] +-------------------------------------------------------------------------------- +Okay, and then just as a quick follow-up, any steps that you can talk about that you're taking to accelerate the node migration at Elpida? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [88] +-------------------------------------------------------------------------------- +The migration of DRAM from 20-nanometer to 1x? + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. - Analyst [89] +-------------------------------------------------------------------------------- +That's right, yes. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [90] +-------------------------------------------------------------------------------- +We're not completely done with 20-nanometer there yet, but as I mentioned a minute ago, we have 1x running there. It's where we've been doing our pilot line activity and we've transitioned or we've transferred then that technology into the Taichung fab and they are progressing with that. We wouldn't expect to see volume starts in either LPO or Taichung until later this year. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. - Analyst [91] +-------------------------------------------------------------------------------- +Great, thank you. + +-------------------------------------------------------------------------------- +Operator [92] +-------------------------------------------------------------------------------- +Thank you and our next question comes from the line of -- I'm sorry, that does conclude our conference for today. And we thank you for your participation. You may now disconnect. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [93] +-------------------------------------------------------------------------------- +Thank you, everyone. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2016-Mar-30-MU.txt b/Transcripts/MU/2016-Mar-30-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..ec3faa46f17f8a482aad35cfc1cdc7eb9e588b66 --- /dev/null +++ b/Transcripts/MU/2016-Mar-30-MU.txt @@ -0,0 +1,866 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Micron Technology Inc Earnings Call +MARCH 30, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark Durcan + Micron Technology Inc - CEO & Director + * Ernie Maddock + Micron Technology Inc - CFO + * Ivan Donaldson + Micron Technology Inc - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vijay Rakesh + Mizuho Securities USA - Analyst + * Jagadish Iyer + Redstone Technology Research - Analyst + * Tim Arcuri + Cowen and Company - Analyst + * Steven Fox + Cross Research - Analyst + * Steven Chin + UBS - Analyst + * Ada Menaker + Evercore ISI - Analyst + * Mehdi Hosseini + Susquehanna International Group - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Romit Shah + Nomura Securities Co., Ltd - Analyst + * Mark Delaney + Goldman Sachs - Analyst + * Farhan Ahmad + Credit Suisse - Analyst + * Justin Li + Robert W. Baird & Co. - Analyst + * Nilay Mehta + KLS - Analyst + * Ian Ing + MKM Partners - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Latif, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Micron Technology's second quarter 2016 financial release conference call. +(Operator Instructions) +Thank you. It is now my pleasure to turn the floor over to your host, Ivan Donaldson. Sir, you may begin your conference. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's second quarter 2016 financial release conference call. On the call today is Mark Durcan, CEO and Director, and Ernie Maddock, Chief Financial Officer. +This conference call including audio and slides is also available on our website at Micron.com. In addition, our website has a file containing the quarterly operational and financial information and guidance, non-GAAP information with reconciliation, slides used during the conference call, and a convertible debt and capped call dilution table. If you have not had an opportunity to review the second quarter 2016 financial press release, it is also available on our website at Micron.com. +Our call will be approximately 60 minutes in length. There will be an audio replay of the call accessed by dialing 404-537-3406, with a confirmation code of 67709190. This replay will run through Thursday, April 7 at 11:30 pm Mountain Time. A webcast replay will be available on the Company's website until March 2017. +We encourage you to monitor our website at Micron.com throughout the quarter for the most current information on the Company, including information on the various financial conferences that we will be attending. You can also follow us on Twitter at MicronTech. +Please note the following Safe Harbor statement. During the course of this meeting, we may make projections or other forward-looking statements regarding future events, or the future financial performance of the Company and the industry. We wish to caution you that such statements are predictions, and that actual events or results may differ materially. We refer you to the documents the Company files on a consolidated basis from time to time with the Securities and Exchange Commission, specifically the Company's most recent Form 10-K and Form 10-Q. +These documents contain and identify important factors that could cause the actual results for the Company on a consolidated basis to differ materially from those contained in our projections or forward-looking statements. These certain factors can be found in the Investor Relations section of Micron's website. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after the date of the presentation to conform these statements to actual results. I'll now turn the call over to Mark Durcan. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Ivan. For our second quarter FY16, Micron posted total revenue of $2.93 billion with gross margin of 20%, non-GAAP net loss of $48 million, and a non-GAAP loss per share of $0.05, all within our guided range. Operating cash flow was $763 million. +Our results were impacted by continued weakness in the PC market, seasonality, and timing of product launches in certain market segments. We are simultaneously ramping, qualifying, and delivering several leading edge products including 20 nanometer DDR4, low-power DDR4, and 3D NAND-based solutions. Our progress has been strong, but is always challenging to precisely align technology conversions and fab output, with customer qualification cycles and market seasonality. +Today, I'd like to provide a high level overview of our progress in each of the business units, and have asked Ernie to cover business unit metrics and financial performance. In our compute and networking business unit, we recently achieved initial customer qualifications of our 20-nanometer 8 gigabit DDR4 products. These are now ramping in volume. In the enterprise, we have qualified an innovative NVDIMM solution at two major OEMs. +In the graphics segment, we are enthusiastic about the early success of our GDDR5X, a discreet solution for increasing data rates above 10 gigabits per second. We have several major design wins, and expect to have the product available by the end of the current fiscal quarter. +In the networking segment, we are seeing early signs of demand recovery in China, where we believe our broad portfolio and strong customer engagements position us well for the future. +Turning to our mobile business units, results have been negatively impacted by the timing of product qualifications, as we transition customers to 20-nanometer versions of LPDDR4 products. We do expect to finalize 20-nanometer low-power DDR4 qualifications with most customers by the end of this quarter. And this, coupled with our expectation that memory demand across the smartphone categories will continue to expand, leaves us confident that our mobile business is well-positioned for substantial growth by the fourth fiscal quarter of this year. +In our embedded business unit, automotive design-in activity remains strong, particularly with 20-nanometer DDR3 and low-power DDR4 products. We are seeing growth with automotive customers in greater Asia, and continuing to build upon success with European and US manufacturers. We are also generating strong design-in activity for our industrial SSDs, and we are delivering a broad portfolio of differentiated non-volatile memory DRAM and MCP solutions for the consumer and connected home segments. +Finally, our storage business unit has been positioning its product portfolio to take advantage of our high performance 3D NAND technology. We are currently sampling Tier 1 OEMs with early versions of our 3D NAND-enabled PCIe NVMe client SSDs. Over the next two quarters, we will be shipping Crucial-branded low cost 3D NAND client SSDs, high performance drives targeting gaming enthusiasts, and a 2 terabyte client OEM drive. +In summary, the leading edge technology deployment is progressing well across manufacturing for both DRAM and NAND, and our bit growth and cost reduction targets are on track. We believe the combination of new products, with more efficient manufacturing on advanced nodes will drive significant improvement in Micron's relative competitive position in the second half of 2016 and beyond. +Turning to the memory industry more generally, we believe that DRAM industry bit supply will decrease to the low to mid 20% range in 2016, and could drop below 20% in 2017. Our estimate is based on slowing technology-driven supply growth, and no incremental wafer supply. Although the current environment remains challenging, we believe -- we continue to believe that longer term DRAM bit demand growth in the low to mid 20% range will result in healthy market fundamentals. +For NAND, we estimate 2016 industry bit supply growth in the mid to high 30% range, as early 3D conversions create some temporary supply constraints. We continue to expect the cost and performance advantages of 3D NAND will drive enhanced adoption rates and densities across key storage markets, and we are confident in Micron's road map in 3D NAND in terms of timing, performance, and relative cost position. +Internally, and from an operations perspective, Micron remains focused on a few key operating priorities. For DRAM, we continue ramping 20-nanometer. This technology node will represent more than 50% of our fab bit output in the current fiscal quarter. +We are enabling 1X DRAM in manufacturing, and recently began transferring this technology to our Taiwan fab in Taichung. We expect to ramp 1X nanometer in volume starting in FY17. We are still forecasting our own FY16 and 2017 DRAM bit growth CAGR in the 20% to 30% range. This is likely above the market. +Our current year bit growth will be weighted to the second half of FY16, with substantial bit production output gains in fiscal Q3 and Q4. We currently have no plans to add DRAM wafer capacity, so any market share growth in DRAM will be the result of technology deployment. +For NAND, we are ramping gen 1 3D NAND in Singapore, and expect to have more than 50% of our NAND bit fab bit output on 3D by the fall of 2016. We are also enabling gen 2 3D in manufacturing, and expect to be in early production starting this summer. +We are forecasting Micron's FY16 and 2017 NAND bit growth CAGR in the 30% to 40% range. We expect to be below the market in 2016, but well above the market in 2017. Most of this growth will be related to 3D and TLC conversions, which will begin to deliver more substantial bit growth and cost reductions, starting late in FY17-- FY16, excuse me. +We are planning for incremental capacity with our Singapore fab expansion, and are beginning tool installations this quarter. As always, we continue to be mindful of market conditions as we contemplate our investment decisions. +Relative to 3D [cross point], we are working with market enablers, and continue to believe this innovative technology will be a strong contributor to Micron's future success. We continue to augment our controller and subsystem capabilities, and have made good progress in aligning this road map with our 3D NAND RAM. We expect to substantially expand our vertically integrated solutions over the next 12 months. Now I would like to turn it over to Ernie. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Mark. Before sharing our normal financial summary, I'll cover more technology and business unit details. DRAM represented 54% of our total revenue with the following segmentation. Mobile was in the low 20% range. The PC segment was in the mid 20% range. The server business was in the low 20% range, and specialty DRAM, which includes networking, graphics, auto and other embedded technologies was in the high 20% range. +In our non-volatile memory business, trade revenue represented [37]% of total revenue, with the following segmentation. Consumer, which includes our memory cards, USB and components, represented more than 50%. Mobile, including MCP, was in the low teens percent range, while SSDs were in the mid teens percent range. Automotive and industrial multi-market segment and other embedded applications were in the mid teens percent range. +Moving on, I'll share a brief operational summary of each of our business units. First, CNBU. The compute and network business unit posted fiscal Q2 revenue of $1.05 billion, down 8% from the previous quarter, impacted by lower average selling prices, and continued softness in demand from the PC segment. Our non-GAAP operating loss was $55 million, or 5%. Our [high] value solutions to enterprise, networking and graphics markets helped to offset some of this weakness. +In the enterprise and cloud segment, we continued to see significant demand for our DDR4 solutions. Specifically within the cloud segment, we had record DDR4 shipments increasing our market share with key hyperscale customers in Asia-Pacific. Within the enterprise segment, demand for our 32 gigabyte DDR4 RDIMM also gained significant traction with key customers. +In graphics, we continued to see demand softness, however, second half demand looks stronger for products such as our 20-nanometer 8-gig GDDR5 solution. In networking, we also saw a slowdown in demand, as a result of lower LTE shipments during the quarter, but we are expecting a recovery in the second half of the year. Finally, within the client segment, we achieved successful enablement and volume ramp of our 20-nanometer 4 gigabit DDR3 solutions. Also, we shipped samples of our 20-nanometer 8-gigabit DDR4 solution to all major OEMs, and began high volume production. +Micron's mobile business unit posted fiscal Q2 revenue of $503 million, down 40% from the prior quarter, due to delayed customer qualifications, and pricing pressure in the eMCP market. Our non-GAAP operating loss was $21 million, or 4% of revenue. We expect some continued challenges during fiscal Q3, as we conclude our customer qualifications, but expect to see improved shipments during our fourth fiscal quarter. +Bit shipments of eMCPs were down approximately 25%, as we redirected bits to higher value homes. We saw strong LPDDR3 demand from China in mid tier phones, and expect this demand will continue into next year. Looking forward, our mobile portfolio continues to position us for growth and success. +While we had some missteps in our mobile qualifications in [F] Q2, we expect this situation to progressively improve during the calendar year. We continue to ramp our LPDDR4 solutions into both the flagship and high end segments, and will be introducing our innovative 3D NAND into flagships, and some higher end phones in the second half of calendar 2016. +The embedded business unit posted fiscal Q2 revenue of $460 million, down 4% from the previous quarter with a non-GAAP operating income of $87 million, or 19% of revenue. The results were primarily impacted by softness in demand from the consumer and industrial multi-market segments, offset by continued strength in the automotive segment. +Looking ahead, we continue to see increasing demand in both DRAM and e.MMC for automotive application that includes infotainment, instrument cluster, and advanced driver assistance systems. In addition, our NOR [XTRMFlash] product introduced last quarter continues to gain adoption with key chipset and system-on-chip venders within the automotive ecosystem. +Our industrial multi-market segment, we are seeing good design-in activity of our M500IT industrial SSDs and specialty DRAM. And in the connected home segment, we are seeing increased DRAM demand from key set-top-box customers in both Asia and North America. +Micron's storage business unit posted fiscal Q2 revenue of $901 million, up 2% from the previous quarter, with a non-GAAP operating loss of $18 million, which represents 2% of revenue. We continue to optimize our product mix to address market challenges, particularly in the client and data center SSD segments. Our trade NAND component bit growth was up 16% quarter-over-quarter, and we see demand increasing, driven by OEM enterprise solution providers and web scale customers who want to leverage the energy savings and performance gain enabled by Micron Flash. +In our client and consumer SSD segment, consecutive quarter bit growth was up 13%, reflecting accelerated SSD adoption in OEM Ultrabook and Ultrathin PCs. In our enterprise SSD segment, we are starting to ship our S600 series SAS drive, Micron's first product produced through our strategic partnership with Seagate. We expect to realize revenue from this new product line in Q3, as we move into volume production. +Finally, the data center SSD market segment saw significant downward pricing pressure, driven by TLC-enabled competitors and aggressive competition for hyperscale business. Micron's participation in this market has been measured, and in the second quarter, we strategically shifted bit supply from this segment to more favorable market -- margin opportunities. +Looking at the Company overall, as Mark noted earlier, revenue for the second quarter was $2.93 billion, which is at the low end of our guided range. Our revenues were impacted by seasonality, timing of product launches, and DRAM and NAND pricing pressure driven primarily by the PC end market. Gross margin for the quarter was 20%, 5 percentage points below the previous quarter, and at the high end of our guidance. +The non-GAAP net loss for the second quarter was $48 million, or $0.05 per share, at the favorable end of our guided range. Gross margin reflects the pricing environment noted earlier, as well as the timing of our leading edge technology migrations. As we've noted before, these migrations will generate more substantial cost per bit reductions, starting in fiscal Q3 for DRAM and fiscal Q4 for NAND. +As a reminder, Micron includes both amortization of acquisition intangibles and stock compensation expense in our non-GAAP reporting. Taken together, these two items represent $0.06 per share for the recently completed quarter. +Looking at results by product line, DRAM revenue decreased 18% compared to the first fiscal quarter, primarily as a result of lower average selling prices, and lower volume shipments. During the second quarter, DRAM bit inventories increased as a result of the 20-nanometer ramp, and the timing of product qualifications with certain mobile customers. +While we currently expect substantial growth in the volume of DRAM sales in Q3, we also expect an additional inventory increase that will become available for incremental revenue during the following quarters. The further market adoption of DDR4 products continued in the second quarter, and represented approximately 26% of total DRAM volume sales. As a result of decreases in average selling prices, DRAM gross margin was lower than in our previous quarter at approximately 20%, while bit costs remain relatively flat. +Our non-volatile trade revenue decreased 6% compared to the first quarter, as a result of the decrease in selling prices, partially offset by higher sales volume. Gross margin decreased a couple of percentage points, as improvement in per bit costs nearly offset the decrease in selling prices. Non-GAAP operating expenses for the quarter came in at $583 million, slightly below the midpoint of our guided range. +The Company generated operating cash flow of $763 million during the second quarter, and we ended the quarter with cash and marketable investments of approximately $5.1 billion. Expenditures for PP&E during the quarter were $1.2 billion, and we continue to expect our FY16 capital expenditures to be in the $5 billion range, net of partner contributions. +During the second quarter, we borrowed approximately $425 million with equipment financing, and also repaid the third installment on the former Elpida creditor debt, bringing the total repayment to approximately half of the total debt. +Moving now to our third fiscal quarter guidance. On the non-GAAP basis, we expect the following: consolidated revenue in the range of $2.8 billion to $3.1 billion, gross margin in the range of 16.5% to 19%, operating expenses between $560 million and $610 million, operating income ranging between a loss of $70 million and income of $10 million and an EPS range between a loss of $0.12 per share and a loss of $0.05 per share based on 1.036 billion shares. +Operationally, we are on track to achieve the bit growth and cost per bit reduction targets outlined in our recent Analyst Day. Along these lines, we expect strong double-digit bit growth and related cost reductions for DRAM in fiscal Q3, as a result of the deployment of our 20-nanometer technology. These trends will continue in future quarters, along with the benefits of expected improvements in seasonality, and further progress on our product qualifications. Our 3D NAND ramp in manufacturing is proceeding well, and we expect to see significant bit growth and cost reductions starting in fiscal Q4. With that, I'll turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Ernie. There is one additional thing I would like to mention, before opening up the call for questions. As you know, Mark Adams resigned for health reasons at the beginning of the year. Rather than directly replacing his role, we have decided to make, and are in the process of implementing some changes to our organizational structure, that we believe will effectively ensure our ongoing competitiveness. +To summarize, we continue to navigate challenging market conditions, and we are working to match the timing of our leading edge output, with the right mix of customers and end markets. We remain confident in the long-term health of the industry, and our strategy to improve our relative competitive position. Operator, we are now ready to begin Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you, sir. Our first question comes from the line of Mark Delaney of Goldman Sachs. Your question, please? + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Yes. Good afternoon, and thanks for taking the question. First question is on the inventory, which I know Ernie, you talked about increasing this quarter, then potentially again next quarter. Can you just talk about how you expect to work down inventory going forward, and if you need to do anything on the utilization front, in order to manage the inventory levels? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [3] +-------------------------------------------------------------------------------- + + No, we don't expect to do anything on the utilization front. And we think the substantial majority of the inventory will be worked through in the fourth fiscal quarter, with maybe a little bit carrying over into Q1, but we don't foresee anything beyond that. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Then for a follow-up on the gross margin outlook for next quarter, can you just help us better understand some of the mechanics that are driving the decline, and if any color between the different segments of how gross margins might trend? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [5] +-------------------------------------------------------------------------------- + + I think, if you accept that the cost reductions are on track with what we articulated in our Analyst Day, really it sort of boils down to what your assumption is relative to the pricing environment. And certainly, we've embedded certain assumptions in our guided range, and really want to make sure that we're communicating that the issue relates to an assumption around the pricing environment, and not the realization of the cost reduction of the Company. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Steven Fox of Cross Research. Your line is open. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks. Good afternoon. I was wondering if you could just provide a little more color on the qualifications on the mobile side? Any issues as to why you missed a window, and why it won't penalize you maybe for more than a couple of quarters? And then secondly, just on the client SSD business, if I look at numbers in terms of pricing in the last three months or so, you're seeing pretty sharp ASP declines on average for client SSDs. And I'm just curious, given I know -- I understand the cost basis is going down, but relative to those cost declines, how close are you to coming to acceptable margins, once you get through the technology transition? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [9] +-------------------------------------------------------------------------------- + + Yes. So first, relative to the qualifications, obviously, when you're ramping multiple new fabs on new technology nodes, and simultaneously transitioning to new densities and new IOs, it's a complicated thing to keep everything completely aligned with all the various customer requirements and customer product rollouts, particularly in a design-in, more sticky environment like we experienced in the mobile segment. So really what we experienced is more of a timing issue, relative to some of those products at some of those customers, and we're very confident that the product meets their needs. +It's just a matter of now getting them queued up, and through the qualification cycle. So I'm very, very confident that, that we have a good handle on the timing. And that's why we continue to build those products, and are confident in holding an amount of inventory to cover that. +Relative to the client SSDs, you're right, there's been significant pressure there. We have talked about strong double-digit growth, in terms of our bit growth on NAND on a go-forward basis, and given that, the significant cost reductions that come with that, as well as the strong ability to ramp TLC as we move late into the year with our 3D NAND. So generally speaking, we feel pretty good about where our NAND business goes, as we move late into this year and into the next year. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [10] +-------------------------------------------------------------------------------- + + Okay. So just to be clear, the costs, you still feel like the cost reductions can -- obviously, those margins aren't going to be above average, but you feel like you can get into an acceptable range and ramp volumes in there, by the fourth fiscal quarter, is that fair to say? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [11] +-------------------------------------------------------------------------------- + + I'm not going to predict anything relative to ASPs or margins, but I do feel very confident that our 3D NAND ramp and TLC ramp are as predicted, with the associated cost gains that you would expect, and that we've previously discussed. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [12] +-------------------------------------------------------------------------------- + + Great. That's very helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Mehdi Hosseini of SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [14] +-------------------------------------------------------------------------------- + + Yes, thanks for taking my question. Mark, as you look into the second half, especially with the mix shift that's shifting more towards mobile and server DRAM, how should we think about the die penalty, and increased DRAM bits that are coming from your migration to 20-nanometer? You do get a better cost decline, but there's also a mix shift that carries a die penalty. And I'm just trying to better understand those dynamics. And I have a follow-up. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [15] +-------------------------------------------------------------------------------- + + Yes. So you're correct, that some of these new IOs have a die size penalty associated with them. It's a mix of anywhere between 0% and 8%, 9%, 10%, depending on the density and the form factor. I would say that the mix shift that we see is, yes, we will continue to see, as we move through the year, some increase in the growth in the mix, relative to these mobile IDs. +Generally speaking, we're also going to see growth in the server segment as well. So generally speaking, we've given you this all-in bit growth guidance of 15% to 25% CAGR over the next couple of years. And that includes the mix effects that we currently anticipate in our business, and I think we're fairly confident in terms of our ability to understand. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [16] +-------------------------------------------------------------------------------- + + Sure. And then, one question for Ernie, as you go through these inventory adjustments, is there any color you can provide on how we should think about the free cash flow? I know you don't want to comment on margin, but your working capital requirement is going up. Should we assume the cash burn is going to decrease or increase from the just reported quarter, or any other color that you can provide? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [17] +-------------------------------------------------------------------------------- + + If you look at the guidance we provided for F Q2, and what we provided for F Q3, they are not too dissimilar to one another. And if you look at the CapEx discussion we just had, where we're saying we're still on track to spend about $5 billion. And clearly, we've reported on the first half of the year in terms of CapEx spend, I think you have all the information you need to understand within a reasonable estimable range, what the cash flow environment will likely look like for the third fiscal quarter. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [18] +-------------------------------------------------------------------------------- + + But you just said that your inventories are going to go higher. I'm just -- would that imply that your operating cash is going to be less, compared to the February quarter? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [19] +-------------------------------------------------------------------------------- + + No, because if you think about the reverse, let's say they weren't going higher. You would have expected those to sell through into the revenue line, which would have effectively increased the cash flow vis-a-vis the prior quarter. So the fact that we -- the guidance does really contemplate, if you follow the guide posts I've just provided to you, they'll get you to a pretty good estimate of what is likely to happen on cash flow for the quarter. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna International Group - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from the line of Kevin Cassidy of Stifel. Your line is open. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [22] +-------------------------------------------------------------------------------- + + Thanks for taking my question. It seems the automotive market has some good growth in it. Can you give us an idea of what content, what DRAM content can be in the automobile over the years? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [23] +-------------------------------------------------------------------------------- + + Well, I'm probably not -- it varies greatly depending on model obviously. You would think in terms of all-in memory growth, and we think it can be up to $90, $100 a car. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [24] +-------------------------------------------------------------------------------- + + Okay. And would this be above corporate average gross margin, or where does it fit in on the gross margin curve? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [25] +-------------------------------------------------------------------------------- + + The automotive business has been pretty strong for us. And it's also, we view it as an attractive business, because the sockets are pretty sticky, the lifetimes of the products are longer. And so, from a total return, it's a very positive market for us. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Rajvindra Gill of Needham & Company. Your line is open. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [28] +-------------------------------------------------------------------------------- + + Yes. Thanks for taking my questions. I'm just trying to get a better understanding of the gross margin guide. I'm trying to reconcile the fact that, as we progress throughout the year, you should be getting higher yields on 20-nanometer, and 20 nanometer should represent a higher percentage of the capacity, yet the margins are coming down 300-odd basis points. And so, if you could maybe help me reconcile that, the gross margin guide, relative to the cost reductions improving as you go throughout the year, that would be helpful? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [29] +-------------------------------------------------------------------------------- + + I think it's very similar to the answer, of one of the earlier questions, which is we are very confident, and provided some pretty clear visibility into what we think is happening with the cost structure. And as I said earlier, we all have an assumption set around what's going to happen in the pricing environment. And so, depending on your assumption about that -- and we certainly have taken a view that suggests that you're going to continue to see some of the pressure that we've seen over the recent quarters. So the, the gross margin guide is very, very centered around an ASP assumption, versus any doubt about our ability to achieve our cost reductions. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [30] +-------------------------------------------------------------------------------- + + So why would you -- in the second half, calendar second half, what makes you optimistic that the pricing is going to -- or the overall DRAM environment is going to get better, and somehow lead to better DRAM pricing? And along those lines, can you talk a little bit about, why has the pricing been so weak the last several quarters, and why would it somehow abate going forward, if that's the case? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [31] +-------------------------------------------------------------------------------- + + I'm not sure I said that I thought it would improve at all. So I don't think I went there. And as a result of that, I think I said we expect to see continued pricing pressure. And certainly, if you think about our discussion around our inventory build, and that being in the mobile business, and the mobile typically being at the upper end of the gross margin continuum, rather than the PC segment, it does help explain some of the thinking that went into our gross margin guide for the quarter. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [32] +-------------------------------------------------------------------------------- + + Just last question, what is the basis of the comment, that you're going to improve your competitive position as you move throughout the second half of 2016? If, as you just acknowledged that the pricing environment, we don't know what is going to happen -- it could get worse, could get better -- why would your competitive positioning improve in the second half? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [33] +-------------------------------------------------------------------------------- + + So there is always a mix piece of the equation that may vary from competitor to competitor. But if you set that aside, I think we've outlined that we think our bit growth and our cost downs, particularly in DRAM starting in Q3, and in NAND later in the quarter, are going to be significant relative to what you would expect for an industry average. And that's really what drives the fundamental equation, relative to relative competitive position, irrespective of what market conditions might look like. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [34] +-------------------------------------------------------------------------------- + + All right. Thank you, sir. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from John Pitzer of Credit Suisse. Your question, please? + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [36] +-------------------------------------------------------------------------------- + + Hi. This is Farhan. I am asking the question on behalf of John. Thanks for taking the question. My first question is regarding the cost reductions that you just reported for DRAM and NAND. It seems like the NAND cost reductions were pretty significant. They came in at 12% quarter-on-quarter, whereas DRAM was somewhat less than what I would have thought, like the cost per bit actually went up. Can you talk about what drove the bit cost reduction in NAND? And also on DRAM, like why are we not seeing any benefit from the 20-nanometer transition yet? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [37] +-------------------------------------------------------------------------------- + + Well, we had significant bit growth in NAND in the quarter, and typically you would expect that cost reduction associated with that. On the DRAM side, while we did, I think, experience a measure of success relative to the progress we made on our 20-nanometer, and the placement of those products with customers, there is a mix impact that is somewhat of a headwind related to the type of memory, and in particular, LPDDR4 and DDR4 versus LPDDR3 and DDR3, that is a headwind relative to bit growth. +We will overwhelm that as we move through the next couple of quarters, as we've talked about, but that has been a little bit of a headwind. And then, when you layer on top of that some of the inventory growth in high margin products -- or what are higher margin products, typically the mobile piece of the business, that was somewhat of a headwind relative to the cost reduction for DRAM in the current quarter. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [38] +-------------------------------------------------------------------------------- + + Got it. And then one question related to your inventories, like you are holding a little bit longer inventory. And given that the mix is such a big factor in, like on the mobile side, it seems like it's very specific to the products that you are designed in. Should we assume like most of the inventory you are holding mostly is going to be in the PC, or can you hold inventory in other segments of the market as well? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [39] +-------------------------------------------------------------------------------- + + No. In particular, the inventory that we're holding has primarily been around timing of product qualifications. And while there is a mix of different types of products in that inventory, I wouldn't direct you to the compute market in particular. In fact, I would say that the mobile is more significant piece of that. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [40] +-------------------------------------------------------------------------------- + + Thank you. That's all I had. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [41] +-------------------------------------------------------------------------------- + + Let me just add -- additionally, it's -- we're not taking what we think is any significant risk here. These are products that we have high confidence are going to sell through, and are pretty fungible among customers. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Tim Arcuri of Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [44] +-------------------------------------------------------------------------------- + + Hi. Thanks a lot. I had a question on gross margin as well. But I guess, I'm just -- I want to make sure I have the right message from what you're saying. It sounds like that you're saying that, look, from the gross margin guidance, that it would appear that maybe you're not getting the cost downs, but in fact you are. It's just that pricing is basically overwhelming the cost downs in the May quarter. Is that the message? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [45] +-------------------------------------------------------------------------------- + + We're not going to forecast the May quarter pricing for you (laughter). We -- no matter how many different ways we go at it, Tim, unfortunately, we can't tell you that. But what we can tell you, we're pretty comfortable with our cost downs and our bit growth, being along the lines of what we previously forecast to you, and we're very comfortable with the way everything's progressing in manufacturing. So yes, you've got to take that last little piece, and plug it in yourself. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [46] +-------------------------------------------------------------------------------- + + Yes, and I'd add to that, Tim, that it's important to remember that we've always looked at NAND cost reduction, as more of a Q4 event with DRAM in Q3. And if you, again, couple that with the color we've provided around inventory, and that being predominantly attributable to one of the higher margin segments, I think you'll find that if you triangulate around all of this, it's pretty easy to understand that what we're saying around cost reduction, is in fact reality. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [47] +-------------------------------------------------------------------------------- + + Got it. Thanks, Ernie. And then, just one more. So can you talk about Inotera? May is the first full quarter of the new agreement. Of course, you're in the process of buying them, but the market dynamics have changed a lot since you last talked about the impact. So can you maybe help us a little bit about handicapping what the impact of the change in the agreement is on the May quarter guidance? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [48] +-------------------------------------------------------------------------------- + + Sure. So obviously, with the change in the market, since the time we've talked about the acquisition, the benefits, whether you assume it's the new arrangement or the full consolidation, are actually more muted. We still believe that they are positive, but significantly more muted than the time when we originally announced things. And we would expect from a handicapping point of view, F Q1 would be the first time you'd see the big uplift, and the impacts that we have previously talked about, relative to margin accretion starting in the third quarter, have obviously changed as a result of the change in the market environment. + +-------------------------------------------------------------------------------- +Tim Arcuri, Cowen and Company - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from C.J. Muse of Evercore ISI. Your question, please? + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [51] +-------------------------------------------------------------------------------- + + Hi. This is [Ada] calling in for C.J. I was wondering if you could talk a little bit about the timing of the 1X nano ramp, and also the required CapEx there? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [52] +-------------------------------------------------------------------------------- + + Yes, not a whole lot to communicate on that yet, other than we have started early silicon in the fab in Taichung. And it's a process that we don't believe will result in any significant volume on 110 -- on what we call 110 series, our 1X nanometer node until we get into 2017. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [53] +-------------------------------------------------------------------------------- + + Thank you. And in terms of the financing for the Inotera acquisition, any updates there? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [54] +-------------------------------------------------------------------------------- + + That's moving along as we expected. So there's no new news from the last time that we shared things publicly. + +-------------------------------------------------------------------------------- +Ada Menaker, Evercore ISI - Analyst [55] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from the line of Joe Moore of Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [57] +-------------------------------------------------------------------------------- + + Great. Thank you. I wanted to clarify one thing. On the slides, it says the capital expenditures is $5.3 billion to $5.8 billion net of the partner contribution. Is it still $5 billion net of partner contribution, is that right? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [58] +-------------------------------------------------------------------------------- + + Yes, it is still $5 billion net of partner contribution. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [59] +-------------------------------------------------------------------------------- + + Okay, great. And then with the mobile issue, is that something that you were able to anticipate? Did you know that three months ago, when you talked about the quarter, when you planned the fab, or did that surprise you over the course of the quarter? And what happened for like-for-like pricing in the mobile space, outside of that issue? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [60] +-------------------------------------------------------------------------------- + + The -- we ended up in a slightly different place, relative to what we sold through relative to mobile. That is fair to say. Relative to mobile pricing, down mid single-digits in the quarter we finished. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [61] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Vijay Rakesh of Mizuho. Your line is open. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [63] +-------------------------------------------------------------------------------- + + Yes, hi, guys. Just looking at the May quarter, the softness in the gross margin side, when you -- as you ramp your 20-nanometer LPDDR4, once it gets qualified, let's say, and 3D NAND, do you expect the margins to improve once they start shipping? Obviously, most of it is (inaudible) in inventory now. Can you give us some color there? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [64] +-------------------------------------------------------------------------------- + + We continue to focus around our costs and our cost competitiveness. We really don't get in the business of forecasting margins, because there's a pricing environment piece of that, which we have very little control over. So we can talk clearly about what we think is going to happen on the cost front. We've done that. I'm happy to reiterate that, but margins is not something we're in the business of doing. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [65] +-------------------------------------------------------------------------------- + + All right. And on the 3D NAND side, I guess, just looking at 3D NAND and LPDDR4, what do you expect the mix -- what is the mix here, and where do you see the mix, let's say, by exiting calendar 2016? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [66] +-------------------------------------------------------------------------------- + + Well, we've talked about being over 50% 3D NAND in the fall. And so, if you want more precision than that, probably not ready to go there yet, other than to say, we continue to be very happy with the way that technology is rolling out in manufacturing. We're very satisfied with the quality, and our ability to apply TLC versions of our 3D NAND, and that will provide an added boost really later in the fall, and into the beginning of 2017. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities USA - Analyst [67] +-------------------------------------------------------------------------------- + + Okay, great. Thanks. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Justin Li of Robert Baird. Your line is open. + +-------------------------------------------------------------------------------- +Justin Li, Robert W. Baird & Co. - Analyst [69] +-------------------------------------------------------------------------------- + + Thanks for taking the question. This is Justin calling on behalf Tristan Gerra. My first question would be, could you share your view on the recent memory investment from China? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [70] +-------------------------------------------------------------------------------- + + Well, it's -- I don't think I've got anything really new to say about that. I think we've said before, that we anticipated that clearly China was interested in being in the memory market, and that they would look for ways to find partners or to grow organically. We've now heard about significant investments in organic growth. But we would remind everyone that we believe that there's significant technology hurdles, and intellectual property requirements in terms of being a major player in the memory space. And we think it's going to be a challenging road for the -- for organic, and it will take some time. + +-------------------------------------------------------------------------------- +Justin Li, Robert W. Baird & Co. - Analyst [71] +-------------------------------------------------------------------------------- + + Okay. Thanks. My next question is regarding the 3D cross point that you will start to sell next year, which customers are you going to sell to? And how much cannibalization do you think it will bring to DRAM and NAND? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [72] +-------------------------------------------------------------------------------- + + Yes. It's -- well, first of all, you're right. This year we're in enablement mode, and we're working with a number of different end market segments. Some customers in -- have significant interest in mobile. Some customers in enterprise for Big Data applications, some in mobile for low-power, some of the low-power benefits. +Early on, as we ramp this technology, we expect cannibalization to be low to zero. Over time, as the technology matures and drives to significantly higher volumes, I would expect some of that volume to come out of what otherwise would have been DRAM, and maybe even eventually what otherwise would have been other types of non-volatile memory. But generally speaking, this is a differentiated technology that will grow the size of the overall memory market at least over the next two, three, four years. + +-------------------------------------------------------------------------------- +Justin Li, Robert W. Baird & Co. - Analyst [73] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Jagadish Iyer of Redstone. Your line is open. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [75] +-------------------------------------------------------------------------------- + + Yes, thanks for taking my question. Two questions, Mark. First, on the -- you heard on the DRAM side, the bit growth was substantially less in the last quarter. And you did say that in the fiscal third quarter, you are going to have a significant [chunk of it]. What gives you the confidence that you're going to be ramping successfully on that, given that the -- historically, that you've had some challenges on that? Can you just elaborate your conviction level, on what kind of step-up on the bit growth are we going to see in the second half, between calendar third quarter and fourth quarter, and then in 2017? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [76] +-------------------------------------------------------------------------------- + + Yes. So we don't give you bit growth projections for either production or sales anymore, since we're now guiding all the financial numbers. But I think that the broader interpretation of your question is, why are we confident we're going to have the bit growth that we're baking into our models? And the answer there is, we're now a month into the quarter. So a significant part of the output is already out, and another significant part of the output is already running in the fab. +We've seen a month of yield data already. And I would just reinforce what we said on our last Analyst Day presentation that the ramp is really -- at that time was, and continues to outperform any previous new technology ramp in terms of yield maturity. And so, we just really like the way it's going. We're seeing strong progress in two fabs in parallel, and we're highly confident that we're going to deliver on the bit growth, and associated cost improvements that we forecast to you previously. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [77] +-------------------------------------------------------------------------------- + + Okay. Just on the cost reduction, how should we be thinking about in terms of, is it going to be -- how -- is there cost reduction for 20-nanometer going to be different from the cost reduction on the 25-nanometer? Can you just elaborate on that part? Or is it going to be similar? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [78] +-------------------------------------------------------------------------------- + + Well, what we've said is that over a -- the CAGR that we provided which is 2016 and 2017, that we are looking at somewhere in the realm of 25% cost downs versus 20-nanometer. That's more of a cash cost down. And that if you take total costs all-in including depreciation, which we will encounter to a higher degree, a 20-nanometer versus what we encountered at 25-nanometer, we're looking at somewhere between 15% and 25%. So it will -- obviously, in the early days, it will be less. But as we get and ramp to mature yields, you'll expect to see somewhere right in the center of that range. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [79] +-------------------------------------------------------------------------------- + + Okay. Thank you so much. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Steven Chin of UBS. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [81] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. Had a couple on NAND flash, if I could. First is, I just wanted to review real quick the cost reduction strategy for SSD products, in particular, as (inaudible) mentioned TLC. I just wanted to make sure, is that TLC 3D NAND, or were you referring to 2D planer TLC as well as part of the lower cost NAND that's going to go into SSD [later] this year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [82] +-------------------------------------------------------------------------------- + + So we have planer TLC NAND in the marketplace today. But I think we commented earlier that the SSD, the client SSD and consumer SSD market has been fairly challenged from a pricing perspective. And so, we've been measured in terms of how we approach that end market. I think the more important thing is that, yes, we believe that as we move to 3D NAND, a very significant percentage of our output will eventually become 3D, and that just drives a significant cost reduction above and beyond the conversion to 3D itself. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [83] +-------------------------------------------------------------------------------- + + Got it. Thanks, Mark. And just as my follow-up, for the gen 2-3D NAND process that you mentioned will be going into -- going through the fabs a little bit later this summer, can you comment on whether the tool set for this gen 2 will be identical to gen 1 that's you're already outfitting in your fabs, or will it require some incremental spending on top of that? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [84] +-------------------------------------------------------------------------------- + + So we actually already have gen 2 in a manufacturing fab. What I commented on, was that we would start early production in the summer. So we have -- we actually have product running through a manufacturing fab today on gen 2, and obviously, like the way that's going as well. As to the equipment set, it's not identical, but it is similar equipment. In some cases, more of it, but very, very similar tools. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [85] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [86] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Romit Shah of Nomura. Your question, please? + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd - Analyst [87] +-------------------------------------------------------------------------------- + + Yes, thanks. Just back to inventories, it just seems from my perspective that unless demand gets a lot better, pricing is going to continue to be weak until Micron and the DRAM industry overall cuts production. So my question is, what will it take for that to happen? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [88] +-------------------------------------------------------------------------------- + + We don't have any plans to cut production today (multiple speakers) you could talk, you could see if others do. I don't know. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd - Analyst [89] +-------------------------------------------------------------------------------- + + Is your point that it's got to come from the market share leader first? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [90] +-------------------------------------------------------------------------------- + + Well, I think -- well, first of all, we're not going to do it unless we see negative cash margins, because we haven't added any incremental capacity. And we think we would be foolish to be the first ones to take capacity off, given that fact set. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [91] +-------------------------------------------------------------------------------- + + Yes. It's important to remember how much of our cost structure is fixed. And so, to Mark's point, as long as we're getting a contribution to that cost structure, that fixed cost structure, it's a really ill-advised move to be unilaterally cutting production. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [92] +-------------------------------------------------------------------------------- + + So the other thing I think, just to temper the assumption in your question, DRAM CapEx is going to be down about 30% this year. So I don't think it's necessarily all doom and gloom. As we look at what we think supply growth is going to be going forward, and what we think demand growth is segment by segment, we already gave you our opinion, which is it's going to take a little bit of time, but we think that this is going to be a healthy environment again. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd - Analyst [93] +-------------------------------------------------------------------------------- + + The prevailing view a year ago, was that all the players in the DRAM industry were focused on maximizing profits. But today, the focus seems to be on market share. Mark, maybe you could just give us your perspective on what you think is happening in terms of competitive dynamics? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [94] +-------------------------------------------------------------------------------- + + Yes, our focus isn't on market share. Our focus is on making sure that we have deployed equivalent advanced technology, at least equivalent advanced technology to our competitors, so we that are not incentivizing others to play for market share. And we think that that's really just a prudent thing to do as managers of our business. That we should make sure that we're putting in place efficient manufacturing production capacity, and that's what we're very, very focused on. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd - Analyst [95] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + Thank you. Our next question comes from Ian Ing of MKM Partners. Your question, please? + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [97] +-------------------------------------------------------------------------------- + + Yes. Thank you. So in your prepared comments, you talked about early signs of a demand recovery in China. Could you talk more about that? I'm assuming it excludes mobile, given some of the qualification issues. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [98] +-------------------------------------------------------------------------------- + + Yes, that comment was really specific to the networking segment of our CNBU business. And we're starting to see a little bit more activity there, maybe early parts of next generation infrastructure roll out. We would expect that to continue for a number of years. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [99] +-------------------------------------------------------------------------------- + + So largely networking then, okay. My follow-up is expectations for DRAM bit growth in FY17, under 20%. Has that thinking changed since the Analyst Day, because you did provide that two-year CAGR, 20% to 30% over two years. Do we go to the low end of the range, or could you go under that? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [100] +-------------------------------------------------------------------------------- + + No. We still think that the range that we provided is accurate over that time frame. The industry, we think will be less than 20%, in terms of industry bit growth. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [101] +-------------------------------------------------------------------------------- + + Thanks for the clarification. So you're implying you could outgrow in FY17, outgrow the industry? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [102] +-------------------------------------------------------------------------------- + + That's as a result of deploying advanced technology, not adding wafers, or targeting some specific market share. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [103] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [104] +-------------------------------------------------------------------------------- + + And, operator, it looks like we've got one more question, then we'll be done. + +-------------------------------------------------------------------------------- +Operator [105] +-------------------------------------------------------------------------------- + + Yes, sir. And that question comes from the line of Nilay Mehta of [KLS]. Your line is open. + +-------------------------------------------------------------------------------- +Nilay Mehta, KLS - Analyst [106] +-------------------------------------------------------------------------------- + + Hey, guys. Thanks for taking the question, a few for me. First, on the end market, it seems like PCs were pretty weak in the first quarter, just from all the data points. It seems like that came through your numbers. Just want to see what you guys are thinking going forward, and what you guys are seeing from customers on the PC side. And also on the mobile side, it sounds like you guys have some inventory build. Just want to get a little bit of color on what caused that inventory build, and how you guys see that playing out? +And then my last question is on the Inotera financing. You say there's no updates. But given where your stock is right now, would you contemplate doing the equity portion in debt given, again, where your stock price is now, and the amount of shares you guys would have to issue to finance that $1 [million] piece? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [107] +-------------------------------------------------------------------------------- + + All right. So I'll take the first two, and then I'll let Ernie come back to the Inotera financing. Relative to PCs, yes, it continues to be weak. We think it maybe down mid single-digits for the year. DRAM content may be up about 10% for the year. We're not expecting any big things out of PC demand, when we give you our view as to the demand growth for the year across all the various segments. +But once you get outside of PCs growing obviously slower than overall market supply for DRAM, and mobile growing maybe right around the market supply for DRAM, you got all of these other segments that we think will outstrip supply growth, servers, automotive, et cetera, et cetera. So generally speaking, we do believe that in aggregate, things are going to take care of themselves. +Relative to mobile inventory, again, it's primarily -- there's a mix of things in inventory. But we did indicate that, yes, a chunk of it is mobile. And a lot of that just revolves around timing and product qualifications that we have high confidence in. We're just building inventory in advance of those qualifications, and so that we're prepared to ship that product out, when the qualifications come through. And Ernie, do you want to take Inotera? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc - CFO [108] +-------------------------------------------------------------------------------- + + Sure. Again, similar to what we said before, we're looking at a wide variety of options for that remaining $1 billion. And as the time to close approaches, we'll be looking at the alternatives that make the most sense to us, given where we are at the time. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc - CEO & Director [109] +-------------------------------------------------------------------------------- + + All right. I want to thank everyone for their participation on the call today, and for their continued interest in Micron. Obviously, I'm still bullish on the memory industry. I like the way we're executing. And with that, I'm going to turn it back over to Ivan to close us up. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc - Senior Director of IR [110] +-------------------------------------------------------------------------------- + + Thanks, Mark. If you'll just bear with me, I have to reread the Safe Harbor language real quickly. I need to -- let's see. During the course of this call, we may have made forward-looking statements regarding the Company and the industry. These particular forward-looking statements, and all other statements that may have been made on the call that are not historical facts, are subject to a number of risks and uncertainties, and actual results may differ materially. For information on the important factors that may cause actual results to differ materially, please refer to our filings with the SEC, including the Company's most recent 10-Q and 10-K. Thank you again. + +-------------------------------------------------------------------------------- +Operator [111] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's Micron Technology's second quarter 2016 financial release conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2016-Oct-04-MU.txt b/Transcripts/MU/2016-Oct-04-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..a2183226a71564ac61a3f5338e61f02d2e324e9a --- /dev/null +++ b/Transcripts/MU/2016-Oct-04-MU.txt @@ -0,0 +1,623 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Micron Technology Inc Earnings Call +OCTOBER 04, 2016 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark Durcan + Micron Technology Inc. - CEO and Director + * Ernie Maddock + Micron Technology Inc. - CFO + * Ivan Donaldson + Micron Technology Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Harlan Sur + JPMorgan - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Steven Fox + Cross Research - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Mehdi Hosseini + Susquehanna Financial Group / SIG - Analyst + * John Pitzer + Credit Suisse - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Mark Delaney + Goldman Sachs - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + * Ian Ing + MKM Partners - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Abigail, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Micron Technology's fourth quarter 2016 financial release conference call. +(Operator Instructions) +Thank you. It is now my pleasure to turn the floor over to your host, Ivan Donaldson. Sir, you may begin your conference. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- +Thank you, and welcome to Micron Technology's fourth quarter and FY16 financial release conference call. On the call today with me are Mark Durcan, CEO and Director, and Ernie Maddock, Chief Financial Officer. This conference call including audio and slides is also being webcast from our Investor Relations website at investors.Micron.com. +In addition, our website contains the earnings press release filed a short while ago, and supplemental information including quarterly operational and financial metrics and guidance, GAAP to non-GAAP reconciliations, slides used during today's conference call, and a convertible debt and capped call dilution table. +Today's call will be approximately 60 minutes in length. A webcast replay will be available on our website for one year. We encourage you to monitor our website at Micron.com throughout the quarter for the most current information on the Company, including information on the various financial conferences that we will be attending. You can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements based on the environment as we currently see it. These forward-looking statements are subject to risks and uncertainty that may cause actual results to differ materially from statements made today. We refer you to the documents the Company files with the SEC, specifically our most recent Form 10-K and Form 10-Q for a complete discussion of these important risk factors and other risks that may affect our future results. +Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's call to conform these statements to actual results. I'll now turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- +Thank you, Ivan. For FY16 Q4, Micron posted total revenue of $3.2 billion, with gross margin of 18%, and a non-GAAP net loss of $56 million or $0.05 per share. Both revenue and gross margin were at the high end of the guidance range, and together generated earnings per share that exceeded guidance. Operating cash flow was $896 million. +On the last call, we reported that -- while we were seeing signs of improvement in selected markets, we were uncertain of the extent and duration of the improvements. During the quarter, we continued to see market conditions improve, driven by both supply and demand fundamentals. Industry inventory appears lean, and the current market outlook for both NAND and DRAM continues to be positive. Currently prices are increasing in a number of segments, stabilizing in others, and we are seeing fewer segments showing residual declines. This environment framed our thinking in the guidance that Ernie will provide a little later on. +We made significant progress on a number of key initiatives in the quarter, including the completion of the mobile product qualifications that we have been discussing, and our early 1X nanometer DRAM deployment. We are also seeing benefits of the 3D NAND yield ramp, which generated stronger than expected NAND bit growth in the quarter. I'm going to provide a high level overview of each of the business units, and Ernie will follow with more details on each business' financial performance. +In our compute and networking business unit, we experienced accelerating revenue growth in the face of moderating pricing environment. Revenue growth was driven by continued increases of 20-nanometer shipments, as well as a significant transition to DDR4 in the cloud and client segments, where shipments exceeded DDR3 for the first time. We saw ongoing strength in graphics, driven by our GDDR5 and 5X products which supported NVIDIA's introduction of the 5X based Titan X, the highest performance consumer graphics card in the market. In the enterprise segment, Micron was recognized at the Flash Memory Summit as the innovation leader in non-volatile DIMMs, an important solution for high performance servers. +Turning to our mobile business unit. China is becoming a more significant growth driver in mobile devices. Most of these devices are differentiated by large amounts of memory, including up to 6 gigabytes of low power DRAM. Additionally, the top of the line Apple and Samsung models now ship with 256 gigabytes of NAND, and we see mid range Chinese handsets heading in the same direction in order to compete. Although there is a moderating pace of smartphone unit growth, significant content increases of both NAND and DRAM will generate strong overall bit growth. +During the quarter, we introduced four new mid to high density mobile 3D NAND products with positive reviews from the press and from our customer base. Mobile DRAM and eMCP price declines moderated in the quarter with more recent signs of stabilization and increases. Revenue growth in our embedded business unit has been driven by a record automotive business, and increased performance in the consumer and connected home segments, as well as a strengthening industrial multi-market business during the quarter. +We have maintained our leadership position in automotive to strong customer support and the introduction of new products that meet the fast-growing memory content requirements for infotainment, ADAS and instrument cluster applications. High temperature DRAM and automotive grade NAND products are enabling a strong design win pipeline. +The introduction of several new industrial solutions has positioned us to grow our share within IMM, and retain our high market share in machine-to-machine communication modules as the industry migrates from 2G to 4G and LTE. We have also been successful in achieving strong market share positions in consumer applications from action cameras and home automation to high volume markets including digital TV and set-top boxes. +Finally our storage business unit is continuing to transition it's product line to our leading edge 3D NAND technology. We've seen positive response from customers this quarter related to our refreshed SSD portfolio, which offers a breadth of solutions to meet diverse application requirements. We're finalizing qualification with eight major OEMs on our 1100 client drive, and are engaging with cloud customers on future designs. +In the enterprise, we're seeing companies begin to retrofit HDD infrastructure with SAS SSDs as they modernize existing investments. Our customers in demanding sectors like financial services and energy are moving storage closer to the server. We've seen significant interest in our PCIe, NVMe drives in these applications due to their ability to deliver very consistent high performance. We are actively expanding TLC 3D NAND across our cloud and enterprise portfolio, and expect to introduce our first TLC 3D SATA drive for these markets later this year, followed by a server-focused version early next year. We expect to see positive supply and demand dynamics in the SSD market for 2017. +Turning to the memory industry more generally, we've seen further evidence that DRAM wafer output is declining as a result of lost throughput related to the 20-nanometer and 1X nanometer conversions. Absent some replacement of these wafers, we could see industry supply growth as low as mid-teens in 2017. If some of the lost wafer output is replaced, industry supply growth could be in the high teens percent range. This compares to our long-term bit demand growth forecast in the low to mid 20% range. +For NAND, we estimate 2017 industry bit growth in the high 30% to low 40% range, which is in line with 2016. This compares to our long-term bit demand growth forecast in the low to mid 40% range. Despite significant investments in 3D conversions across the industry, we believe that 2017 supply growth will be relatively balanced with demand, given the disruption in the fab output related to these conversions. +For our operational priorities for FY17, or our operational priorities for FY17, continue to be targeted at ramping advanced technologies with an added focus on building out a more robust product portfolio, in particular for non-volatile memory products. For DRAM, we begin the 1X nanometer ramp, and expect to have meaningful output by the middle of 2017. At our Winter Analyst day, we shared two year bit growth targets for DRAM, and we are on track to meet these targets. We were slightly below the range in FY17, and expect to be above the range in FY17. +All of the DRAM bit growth will come from technology transitions, and we currently have no plans to add wafer capacity. We expect our FY17 DRAM costs per bit to decline 20% to 25%, as a result of completing the 20-nanometer migration, and initiating the 1X nanometer conversion. Our cash costs per bit declines will be meaningfully higher than this range. +For NAND, we will continue to focus on ramping our Gen 1 3D as well as TLC. As we updated at our last Analyst meeting, 3D bit output will exceed 2D output in the current quarter, ahead of our initial target. We will also be working on deploying second-generation 64-layer 3D technology. +Similar to DRAM, our 2016 NAND bit growth came in below the two year CAGR shared at our Analyst event, and we therefore expect 2017 to be above that range. We are forecasting our FY17 NAND cost per bit to decline 20% to 25%, as a result of the 3D and TLC conversions. This cost per bit includes the impact of our planned build-out of SSDs, eMCPs, and Managed NAND solutions, all of which carry additional bill of materials costs but will also enable a richer ASP mix. On a like-for-like basis, cost per bit will decline more substantially. +Relative to 3D Xpoint technology, we are working with market enablers on adoption of our QuantX solutions, and continue to believe this innovative technology will be an important contributor to Micron's future success, with initial revenue later in 2017. Now I'd like to turn the mic over to Ernie. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [4] +-------------------------------------------------------------------------------- +Thank you, Mark. We had a solid end to our fiscal year, as our continued focus on execution, coupled with a more favorable business environment resulted in improved financial performance. I'll begin my comments today with some technology and business unit details, followed by an overview of the Company's results for the quarter, and guidance for our first quarter of FY17. +DRAM represented 60% of our total revenue with the following segmentation. Mobile represented about 25%, similar to the prior quarter. The PC segment was in the upper 20% range, up slightly from the prior quarter. The server business was in the high teens percent range, down from the prior quarter. And specialty DRAM which includes networking, graphics, auto, and other embedded technologies was in the low 30% range, up from the prior quarter and primarily driven by an increase in graphics which represented more than 10% for the quarter. +In our non-volatile memory business, trade revenue represented 31% of total revenue with the following segmentation. Consumer, which includes memory cards, USB, and components represented about 50%, down slightly from the prior quarter. Mobile was in the high teens percent range, up from 13% in the prior quarter, as we began to see the impact of our completed customer quals. As a reminder, eMCPs are primarily in the mobile segment. SSDs represented 13% similar to last quarter, and the automotive, industrial multi-market and other embedded applications were in the high teens percent range, similar to prior quarter. +Turning to performance by business unit. The compute and networking business unit delivered fiscal Q4 revenue of $1.25 billion, up 14% sequentially primarily driven by 20-nanometer shipment growth, accompanied by strengthening demand, and a moderating pricing environment across all segments. The non-GAAP operating loss was $7 million or less than 1% of revenue. +In the enterprise segment, conversions to DDR4 are now largely complete, and we are focused on enabling our solutions for the next-generation server platform. We are seeing continued interest in both higher density RDIMMs and LRDIMMs, as well as NVDIMM solutions. The cloud component of the enterprise segment is growing quickly, driven by continued growth in density across both DDR3 and DDR4 solutions. +In graphics, we saw growth well above typical seasonality, driven by our GDDR5 and GDDR5X products. There are additional G5X based product announcements from NVIDIA in both the graphics and workstation segments during the quarter. In networking, we enjoyed double-digit revenue growth, with strength across all regions, and growing interest in applying the high bandwidth capabilities of GDDR5 and GDDR5X to the networking segment. Finally, within the client segment, we saw market demand which exceeded our expectations, as well as a continued transition to DDR4 which for the first time represented a majority of client shipments. +The mobile business unit delivered fiscal Q4 revenue of $671 million, up 20% sequentially driven by a strong quarter in our eMCP products. The non-GAAP operating loss was $45 million or 7% of revenue, and was partially impacted by the consumption of higher cost early production inventory accumulated over the last two quarters. We saw significant growth in the recently qualified higher density MCPs, and as smartphone OEMs are positioning their products based on higher memory density specifications, which is helping to accelerate adoption of smartphones with richer memory content. +The embedded business unit delivered fiscal Q4 revenue of $513 million, up 5% sequentially. Non-GAAP operating income was $133 million or 26% of revenue. The results were primarily driven by record automotive and increasing consumer business, combined with some recovery in our industrial multi-market business. +The automotive business delivered solid results with revenue up 6% sequentially, driven by strong and increasing demand for both DRAM and eMMC solutions for infotainment, instrument cluster, and advanced driver systems applications. European, Korean and Japanese customers continue to fuel this growth, and our portfolio of leading edge automotive grade solutions is continuing to enable platform design wins. The industrial and multi-market business increased [16]% sequentially, primarily driven by the ramp of our NAND solutions into the Japanese amusement market. In addition, we continue to see strong demand for our NOR and NAND-based MCPs used in machine-to-machine wireless communication modules. +Consumer and connected home revenue was up 7% sequentially, with solid demand for MCPs used in action cameras and home automation applications. We continue to see this demand pattern continue in the current fiscal quarter which typically sees strong seasonal demand. Our 20-nanometer DDR4 products continue to ramp into set-top boxes and IMM applications. +The storage business delivered fiscal Q4 revenue of $758 million, up 5% sequentially. The non-GAAP operating loss was $69 million or 9% of revenue. +During the quarter, we entered production and OEM qualification of TLC 3D NAND based SSDs in the client and consumer segments, providing customers with a refreshed 3D-based portfolio of storage products that span the demand spectrum in these markets. In the enterprise SSD segments, consecutive quarter bits sold were up 45% based on higher sales of our planar MLC-based cloud drive. We are deploying 3D TLC across the enterprise and cloud portfolio, with several product launches over the next two quarters. +Moving on to overall Company results. Revenue for the fourth fiscal quarter was $3.2 billion at the top end of our guided range, and up 11% sequentially. Fairly significant increases in volume shipments for DRAM were offset by moderating ASP declines, while trade NAND shipments increased as a result of early success of our 3D ramp, and we experienced generally stable ASPs. Gross margin for the quarter was 18%, also at the top end of our guided range. +The non-GAAP net loss for the quarter was $56 million or $0.05 per share, significantly better than our guidance. For the full fiscal year, we achieved non-GAAP profitability, despite our technology transition and memory market pricing pressure, achieving non-GAAP net income of $66 million or $0.06 per share. As a reminder, Micron included both amortization of acquisition-related intangibles and stock compensation expense in our fiscal Q4 non-GAAP results. Taken together, these two items represent $0.04 a share in the fourth fiscal quarter, and $0.20 per share for the full FY16. +Turning to results by product line. DRAM revenue increased 13% compared to the prior quarter, as a result of a 20% increase in bit shipments, partially offset by a 6% decrease in ASPs. DRAM gross margins for the fourth quarter increased 2 percentage points to 20%, primarily driven by strong cost reductions as a result of the continued 20-nanometer ramp. Our non-volatile trade revenue increased 12% compared to the prior quarter, reflecting a 13% increase in bit shipments, partially offset by a 1% decrease in ASPs. +Gross margin decreased a couple of percentage points to 16%, as costs per bit was up related to the 3D ramp, and build-out of higher cost storage and mobile solutions to support future growth. Non-GAAP operating expenses for the quarter were $559 million. This was below our guidance primarily due to continued expense control and the timing of pre-qualification expenses for the fourth quarter, some of which will now occur in fiscal Q1. The Company generated operating cash flow of $896 million, which included a strong quarter for collection activity, and we ended the quarter with cash and marketable investments of approximately $4.8 billion. In the fourth fiscal quarter, capital expenditures net of partner contributions were approximately $1.7 billion. +Before we move on to our guidance for the upcoming quarter, I wanted to share some changes to our reporting. The first of these changes relates to the depreciation schedule for our DRAM capital equipment. Previously, this equipment had been depreciated over five years, however, given the longer intervals between technology transitions, we've changed the depreciable life of our DRAM capital equipment from five years to seven years. This change will reduce depreciation by approximately $100 million per quarter on a going forward basis. +The depreciation schedule for NAND-related equipment remains unchanged. Additionally, and to be consistent with the majority of semiconductor companies who report non-GAAP results, Micron will exclude stock-based compensation and the amortization of acquisition-related intangibles from our non-GAAP reporting. These expenses on average are approximately $50 million per quarter. +Moving on now to our guidance for the first fiscal quarter, which we developed in the context of the market environment that Mark described earlier, on a non-GAAP basis we expect the following. Consolidated revenue in the range of $3.55 billion to $3.85 billion, gross margin in the range of 23% to 25.5%, operating expenses between $600 million and $650 million, due to the resumption of variable compensation expense, and the higher pre-qual expenses that we spoke of earlier. Taken together, these items represent a sequential increase of approximately $80 million, of which $25 million resulted from the timing of pre-qual between fiscal Q4 and fiscal Q1. Operating income in the range of $245 million to $330 million, and EPS ranging between $0.13 and $0.21 per share based on [1.046 billion] diluted shares. +Relative to our capital spending plans for FY17 as we shared last month, we expect to spend between $4.8 billion and $5.2 billion net of partner contributions. Between 40% and 50% of the total will be allocated to DRAM, between 30% and 40% to non-volatile memory, and between 15% and 25% to technology and product enablement. Consistent with our public comments, this level of CapEx allows us to appropriately fund our technology investments, while achieving neutral to positive free cash flow generation in FY17. +Operationally, we are on track to deliver the bit growth and cost per bit reduction targets that we previously shared, as we complete the 20-nanometer DRAM conversion, reach crossover of first-generation 3D NAND this quarter, and commence the ramp of 1X nanometer DRAM and second-generation 3D NAND in 2017. For FY17 specifically, we expect DRAM and NAND cost per bit reductions between 20% and 25%. +Finally, relative to the Inotera transaction, Micron and Inotera have concluded that sufficient progress has been made in Inotera addressing the issues that caused the delay in closing. An Inotera Board meeting has been scheduled for October 11, and the Directors of Inotera are expected to set a Share Swap record date at that meeting. We anticipate that the Share Swap record date will be set for the first half of December of 2016. With that, I'll turn it back to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- +Thank you, Ernie. To summarize, we faced challenging market conditions in FY16, in addition to going through a transition period for our technology migrations. Despite these headwinds, we ended the year with positive non-GAAP EPS. Compared to prior cycles, this represents a material improvement in our performance, and further reinforces our belief in structural industry improvements. +We are now experiencing a more positive and improving environment, and Micron is committed to making even further improvements in our relative performance, with enhanced growth and cost reductions, and expanded capability to deliver value-added products to enable our customers. Okay, operator, we are now ready to begin Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question comes from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- +Yes, good afternoon. Thank you for taking my question. First question, Ernie, for you on the pricing front. I know you don't want to go into specific details, but curious as you think about November, what you're embedding in terms of changes to mix, and perhaps any flow through of lower margin inventory, and any other kind of factors that we should be thinking about as it relates to DRAM ASPs? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [3] +-------------------------------------------------------------------------------- +This is Mark. Maybe I'll take that one, C.J. Certainly relative to the sell-through of inventory, there is an impact there, given some of the inventory we've built up over the last couple of quarters relative to the qualifications we mentioned. Relative to market assumptions, we're not going to get into the detail as always of the embedded margin, because we don't want to forecast the ASPs for you. But I think that it's fair to say that we are seeing early signs of significant price movements. And as we've done in the past, we want to wait before we get ahead of ourselves in predicting what may come as we move further out into the quarter. But I do think that that the trend is positive, and the bias is positive. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [4] +-------------------------------------------------------------------------------- +Mark, that's very helpful. As my follow-up, how do you think about channel inventory today? And this is another DRAM question. And then, as part of that, how do you expect customers to act as you look into 2017, in an environment where bit supply is sub 20%, and demand presumably higher than that? How do you expect changes in behavior there? Thank you. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [5] +-------------------------------------------------------------------------------- +Yes. Well, certainly, if we think about inventory in the marketplace, certainly channel inventory I think is very, very tight, maybe one to two weeks, or less than a week. At the major customers, we have less precision relative to that. But I'd say it's certainly down, and there's a sense of urgency at the large OEM customers as well. In some cases, we may be looking at allocation of certain products in certain markets. And certainly, the customers are beginning to ask for longer term price commitments, which is in my mind always a good thing. And we'll look at those on a case by case basis, and potentially take customers up on that where appropriate, but obviously always keeping the long-term interest of the shareholders in mind. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [6] +-------------------------------------------------------------------------------- +Very helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Romit Shah with Nomura. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [8] +-------------------------------------------------------------------------------- +Yes, I just want to come back to the guidance, because it's something that people are trying to gauge, given that last quarter, at least relative to how you originally guided, you guys came in a lot better. And I know at the time that there was a lot of moving pieces, and you guys wanted to give yourself cushion. So could you talk a little bit about visibility? And at least on the pricing front, if we could get a sense just directionally, how you're thinking about ASPs in the November period? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [9] +-------------------------------------------------------------------------------- +Sure. This is Ernie. So I think it's important to acknowledge, that although we beat our EPS guidance, we actually were well in the ranges of both our revenue and our gross margin guidance. And so we did think about the opportunity that was ahead of ourselves as we were giving the guidance for last quarter, and we've done the same thing in essence this quarter as well. So I think you can look at the range of our guidance, and it generally contemplates the outcomes that we see. And obviously, if things continue on a strong and favorable momentum, it's reasonable to think that you'd end up at the upper end of both pieces of the range, which would generate a result similar to this quarter. +And I think consistent with Mark's prior comments, we are continuing to see positive momentum. I do think it's important to understand that that momentum has existed and has started to strengthen. And so, as a result of its actual impact in our fiscal quarter, with part of it already completed and we're in negotiations for others, I think that the trap we want to avoid is presuming that whatever the latest pricing news is gets retroactively applied across the entire quarter, because that's certainly not the environment that we're living in. But I do think that we were pretty thoughtful about the revenue range. And obviously we're going to work hard and try to do as well as we can. But we put a lot of thought behind the numbers we've just shared with you. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [10] +-------------------------------------------------------------------------------- +Yes, that's helpful. And then Mark, I have a strategic question for you which is, you talk about one of the priorities being to just ramp advanced products in non-volatile memory. But at the same time, implicit in the FY17 free cash flow guidance is that you, at least the way I'm interpreting it, is that you'll continue to burn cash in NAND. And so my question is, at what point do you consider a partnership to lessen the period expense and the CapEx burden associated with running this business? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [11] +-------------------------------------------------------------------------------- +Yes, we're always looking for ways to improve our relative competitive position, and we've used partnerships and strategic relationships extensively in the past. We'll continue to evaluate that, and again, always with the long term in mind. We're -- there's an embedded assumption in there that there are lots of opportunities out there today, and I think I would not try to dissuade you of that view of life. I would just caution you that we're going to be pretty careful and deliberate about making sure we take a long-term view relative to the relationships and the partnerships we engage in. And that we're doing something that really drives a long-term strategic benefit for the Company, as opposed to a short-term fix of more supply in the marketplace. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [12] +-------------------------------------------------------------------------------- +Helpful, thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Mark Delaney with Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- +Yes. Good afternoon, and thanks very much for taking the questions. First question is, I was hoping you could update us on the Inotera transaction, and if that were to close, if you could help us understand the potential accretion or dilution from that transaction? And then related to it, to what extent is Inotera closing already embedded in any of the financial guidance that you gave for FY17? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [15] +-------------------------------------------------------------------------------- +So as we had in our prepared remarks, we do expect the transaction to close at this point in -- some time in the middle of December. We did contemplate that timing in our guidance, so it doesn't really have a dramatic impact on our FQ1 guide at all. And certainly the transaction will continue to be accretive to gross margins. It will continue, and continues to be accretive to free cash flow. And essentially, the EPS accretion is really dependent on how we choose to finance that last $1 billion component, which we don't have to make a decision on until about 30 days or so prior to closing. So as we said before, we have the option of using equity, or a convert, or cash, or a combination of those. And so, the specific EPS accretion will really be dependent upon what we finally decide for those things. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [16] +-------------------------------------------------------------------------------- +That's helpful. And then a clarification on your comment that Micron will be above the CAGR that it provided for DRAM and [N] bit growth in FY17. I just want to clarify, you would expect to be above the high end of your guidance for both DRAM and NAND? So I think it was over 30% in DRAM for FY17, and over 40% in NAND for FY17? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [17] +-------------------------------------------------------------------------------- +Well, what we said Mark was that we had given these two year CAGRs and we were slightly below for both NAND and DRAM in FY16, so it's reasonable to think it would be slightly above the range that we provided in FY17. So that we, over the two year CAGR fulfill the commitment that we made around those bit growth CAGRs. So yes, that's a reasonable thing to assume. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [18] +-------------------------------------------------------------------------------- +That's very helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Timothy Arcuri with Cowen. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [20] +-------------------------------------------------------------------------------- +Thank you, I had two. Ernie, I'm still a little confused on the guidance. If I try to adjust for the changes in the reporting, it sounds like you're excluding about $150 million per quarter now. So on an apples-to-apples basis, the guidance is actually like $0.13 or something like that lower than what the headline number is, or more like $0.04 at the mid point. Am I not thinking about that right? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [21] +-------------------------------------------------------------------------------- +Yes, that's a reasonable way to think about it, sure, Tim. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [22] +-------------------------------------------------------------------------------- +Okay. And then that leads me to the question about OpEx, because it seems like some of that is related to OpEx. If you add the stock comp back and you assume that it's mostly OpEx, you're guiding to like $650 million to $700 million. But it sounds like maybe $80 million of that is really one-time in nature. So maybe the baseline is more like $600 million going into next quarter? Is that -- or sorry, going into the fiscal Q2? Is that the right run rate headed into the January quarter? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [23] +-------------------------------------------------------------------------------- +So let me try to frame that for you a little bit. We had a couple things that are impacting this quarter's OpEx. The first was, that about $25 million give or take of pre-qual expenses that had planned to spend in FQ4 are appearing in FQ1. And then secondly, we have -- we had, even prior to this rollover, the highest point of pre-qual expenses for the entire fiscal year was actually occurring in Q1, plus we have the resumption of variable compensation, given the new pricing environment. And so, what we've try to frame for folks is sequentially, between the variable comp being reinstated, as well as the pre-qual expenses, that's a sequential increase of about $80 million from FQ4 to FQ1. So that predominantly explains the change to the OpEx. +And it certainly, we're hopeful that the variable compensation piece continues, because we're hopeful that the business environment is favorable. And we would expect pre-qual expenses to moderate, such that we should be in that range of $600 million plus or minus, so we'd probably mid point around $600 million a few quarters -- maybe a couple quarters higher, a couple quarters a little bit lower, under the new framework for recording OpEx. So those numbers would still exclude stock-based comp. But you would expect to see a pretty meaningful moderation of OpEx, as we go forward throughout the year as a result of this pre-qual situation being resolved from the rollover. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from Ian Ing with MKM Partners. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [25] +-------------------------------------------------------------------------------- +Yes, thank you. Congrats on the guidance. DRAM question here. You've got favorable contract pricing. You didn't quite get the bit output acceleration in Q4. Just wanted to understand that a bit. And are there any shortages in terms of meeting customer demand at this point? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [26] +-------------------------------------------------------------------------------- +I think part of the explanation of Q4 bit growth being slightly below, I think what we previously talked about was in fact that as we watched the market evolve, we made some choices around where we would like that output to be. And the result is that our Q1, fiscal Q1 bit output would -- is now going to be higher than what we had expected it to be. So obviously, that did play into our thinking as we saw the market evolve. +Relative to specific shortages, I'm not aware of any. I don't know, Mark, if you are, but certainly, all of our customers are being very attentive to making sure that their supply needs are taken care of, and we are seeing certain segments and certain customers where the possibility of allocation is present. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [27] +-------------------------------------------------------------------------------- +Yes, I don't think we want to call those out today on this call, but there's certainly that risk. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [28] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [29] +-------------------------------------------------------------------------------- +Okay. Thanks. And for my follow-up here, server as a percent of DRAM, that is down sequentially, and August is -- what's happening here, perhaps enterprise is offsetting the cloud. And shouldn't this be a pretty attractive market to serve? I think, pricing in server typically attracts PCs, with a little bit of lag? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [30] +-------------------------------------------------------------------------------- +Yes, I think it will reaccelerate relatively quickly. It has been a little bit more of a lumpy business here over the last year or so, but we like the trends there. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [31] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Rajvindra Gill with Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [33] +-------------------------------------------------------------------------------- +Yes. Thanks, and congrats on good execution. Just a question on the inventory increase on a year-over-year basis, relative to the revenue increase year-over-year based on your guidance. So it seems like the -- it seems like that the inventory is increasing at a faster clip than revenue, so just wanted to get a sense in terms of any concerns you see there? (multiple speakers) + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [34] +-------------------------------------------------------------------------------- +Sure -- I'm sorry, go ahead. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [35] +-------------------------------------------------------------------------------- +So with inventory outgrowing revenue on a year-over-year basis? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [36] +-------------------------------------------------------------------------------- +Yes, I think you have a couple things. First, as we talked about in the last quarter or so, as we are ramping on the new technologies, and predominantly because of these delayed mobile quals, we had some inventory built up that is now flowing through. However, we absolutely still continue to get more and more output from the factory, and it's going to be a couple quarters before that inventory actually starts to decline. But we have a very clear view of an ability to decrease inventory meaningfully over the course of FY17. +I'd also remind you that we are also building supply chains for SSDs and MCPs, which take longer in terms of their aggregate end-to-end cycle time than selling components. So we have that effect as well. That will cap out here in the next quarter or so, and then you'll see a normalization and a flow through of that as well. So we're not -- we're cognizant of the inventory position. We like to think that we anticipated that, and shared that with you. And we're equally confident that the inventory will decline nearly every quarter in FY17. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [37] +-------------------------------------------------------------------------------- +Yes, to be honest, we feel pretty good about where we sit, given the trends in the marketplace as well, and we don't feel quite as much urgency as we might under different market conditions. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [38] +-------------------------------------------------------------------------------- +Okay. That was helpful. And just a last question for me on the cash flow. Obviously, you can't talk a little bit about FY17. But if you take your CapEx guidance and your depreciation add back, it does seem like it would still be difficult to generate a meaningful free cash flow next year, assuming a fairly big ramp, and gross margins and revenue -- gross margins maybe, continue to increase above and beyond what you're guiding for November. So I just wanted to get a sense of how you're looking at free cash flow, and the Inotera agreement, how much free cash flow does that add to the Company, if we were to add that back on? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [39] +-------------------------------------------------------------------------------- +On average, the Inotera transaction is going to add somewhere between [$300 million] and $600 million of cash flow on a free cash flow basis. But I'd really stress that that's an average amount which would be the free cash flow net of the incremental depreciation -- I'm sorry, the incremental CapEx. But I think that the best way I could guide your thinking there is that we have prepared pretty conservative plan, and we have a free cash flow neutral position in the context of that conservative plan. +Obviously, Q4 is a little bit stronger. It's fair to say that Q1 was a little bit stronger, as we look at it now versus our conservative plan. And so we would expect to be able to accumulate cash over the course of 2017, if in fact this current market environment continues. Any time we use words like significant, it gets hard to determine what's significant to you or significant to me, but trust me every dollar is significant to us. And so we're being very careful and monitoring that very carefully. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [40] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [42] +-------------------------------------------------------------------------------- +Good afternoon. Thanks for taking my question. NAND cost per bit was actually up slightly in Q4. Was most of this mix related? Maybe you could just tell us what cost per bit declines were on a like-for-like basis? And should we anticipate an acceleration of cost per bit starting here in the first quarter, especially I think as you mentioned you'd get 3D bit crossover over 2D? But it seems like to me, as gross margins for NAND should be inflecting up here in Q1, but I'm just trying to get a sense for that? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [43] +-------------------------------------------------------------------------------- +Yes, a lot of moving pieces, Harlan. I think just to get to the crux of your question, yes, you should anticipate cost per bit, start coming down nicely with the 3D ramp, as we start flushing those wafers through the back end, and out in the marketplace. Costs are coming down nicely this quarter, and [see] a continued road map ahead for that, as we move through the year. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [44] +-------------------------------------------------------------------------------- +Yes, and we provided a cost per bit reduction forecast for the year to you, and I think everything Mark said is absolutely true. And counter balancing that just a bit is the supply chain build up that I talked about, because as MCPs and those SSDs have a higher COGS component theoretically, they are also generating more margin. But if we're only looking at the cost perspective, that will have a tendency to dampen the cost per bit reduction because the mix is changing. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [45] +-------------------------------------------------------------------------------- +Great. Thanks for the insights there. And then, on the 1X DRAM ramp that you highlighted in your slides, when does that ramp actually commence? Is it end of this year, beginning of next calendar year? And you've mentioned also that you'd expect significant output by middle of next year, maybe you can just be more specific on when you expect bit crossover 1X versus 20-nanometer? Thank you. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [46] +-------------------------------------------------------------------------------- +Yes, so we have actually wafers in manufacturing fabs in both Hiroshima and Taiwan that are yielding. The output today is insignificant. We'll continue to run at engineering pilot line lots. And by the time we get to the middle of next year, you should see it be significant in terms of our overall output. I think probably going to wait another quarter before we give you a little bit more precision on what the -- when the bit crossover might be. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [47] +-------------------------------------------------------------------------------- +Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Steven Fox with Cross Research. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [49] +-------------------------------------------------------------------------------- +Thanks. Good afternoon. Just two questions for me. Just following on that prior question regarding NAND cost per bit and all of the mix issues, can you just take that one step forward and talk about maybe how the storage business unit starts to recover in terms of profitability? Is there a path to turning profitable this fiscal year? And then secondly, could you just talk about seasonality this year maybe versus last year in terms of what kind of unit shipments you're seeing versus content shipments from some of your core markets, and whether it's stronger or weaker than a year ago? Thanks. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [50] +-------------------------------------------------------------------------------- +Sure. So let me address the question about the storage business. We are certainly hopeful that we can exit the year at least with a profitable note for the storage business. I think it's dependent on a few things. Obviously, we're in the middle of a very significant portfolio change-out, and we have to execute on those. So far, our record has been good with respect to the client and consumer segments. But we have some big product launches, with respect to both data center and enterprise coming up here toward the end of this calendar year and in early calendar 2017. And those would be really pivotal to us in completing that transition. I think that again, track record has been good. The SSDs have been well reviewed, and we're very optimistic that our subsequent product launches will be equally successful. +I also think it's important to keep in mind that we also are seeing benefit of 3D in the memory -- or I'm sorry, in the mobile business unit as well. We saw that -- we had the mobile percentage of our NAND business this quarter move from the low teens essentially to the high teens, as a result of more and more quals there, and the increasing importance of the MCP portfolio. So we are seeing benefit of that, really across multiple business units. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [51] +-------------------------------------------------------------------------------- +Let me just add to that on the seasonality question. Q4 obviously, typically is a very strong quarter for NAND. Hard to know for sure, but our sense is that the demand picture probably has more staying power than just the typical seasonality that you would see, given the strong growth in the end applications. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [52] +-------------------------------------------------------------------------------- +Thanks very much. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Kevin Cassidy with Stifel. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [54] +-------------------------------------------------------------------------------- +Thank you for taking my question. Your guidance for first quarter is a significant increase over fourth quarter. Can you give us a ranking of the end markets or the end products that are driving the increase? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [55] +-------------------------------------------------------------------------------- +Yes, I'll take that. So obviously, as has been the case, the specialty markets, the embedded markets, whether it's automotive, industrial, medical probably top of the list. Within the computing and networking segment, graphics has been quite strong. Server probably next, and then followed up with mobile and client. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [56] +-------------------------------------------------------------------------------- +Okay. And are you seeing a significant increase with 3D NAND versus the planar NAND? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [57] +-------------------------------------------------------------------------------- +In terms of demand? + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [58] +-------------------------------------------------------------------------------- +Gross (multiple speakers). Sorry, no, gross margin (multiple speakers). + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [59] +-------------------------------------------------------------------------------- +But that -- it's a very quickly moving dynamic right now. So yes, we're seeing that happen real-time as we sell through the early production and move more and more of the products into the TLC format. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [60] +-------------------------------------------------------------------------------- +And certainly more of that opportunity is ahead of us than it is behind us, given that we're just going to hit bit crossover for 3D in this quarter. And as Mark said, we're continuing to transition which adds costs because it suppresses output. But with more significant bit growth ahead, we would expect the cost reduction opportunity to accelerate a little bit here throughout FY17. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [61] +-------------------------------------------------------------------------------- +Okay, great. Congratulations on the good results. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [62] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from John Pitzer with Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [64] +-------------------------------------------------------------------------------- +Yes, good afternoon, guys. Thanks for letting me ask a question. I want to go back to the cost side of the equation, guys. Just given the change in the depreciation schedule for the November quarter, I would have thought your ability to get gross margin to the high 20% range, especially in this pricing environment, would have been fairly easy. +So I'm just curious as to what the offsets are in the November quarter. Is this all about the quals on mobile? And if it is, what do you estimate that to be a hit to gross margins, and when might that be done? And then, Ernie, I know you gave full year cost targets on a per bit basis. Did you give them for the fiscal first quarter? If you did, I missed them. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [65] +-------------------------------------------------------------------------------- +I think, John, actually it's really a little bit more about the lag that you typically see as pricing starts to turn around in some of these things. Yes, there is an inventory effect relative to some of these products that we built up in inventory that were early production on either 20-nanometer or 3D NAND, et cetera. As we sell-through, that's a little bit of a headwind until that's flushed out. +But it's really more around, as ASPs turn around, they don't turn around instantaneously. And they didn't turn around until we were into the quarter last quarter. So remember, we had a pretty significant beat relative to the mid point of our guidance last quarter, which gives you an indication that the pricing was starting to accelerate then. It takes a little while to play out, and to flush through as we see these things happen. So the trends are all in place. And I think we're heading where you think you are, where we ought to be, but it can take a little while to play out through the financials. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [66] +-------------------------------------------------------------------------------- +Yes. And I didn't provide a cost specific cost per bit target for FQ1. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [67] +-------------------------------------------------------------------------------- +Okay. And then as my follow-up, Mark, just on the Inotera acquisition. If you go back and look at what you guys have tried to accomplish over the last seven or eight years, it's actually been to try to mitigate the cyclicality of the industry within your financials by setting up some of these JVs, buying Inotera reverses that. I'm curious, is this purely a financial decision on your part? You mentioned in your prepared comments that this downturn troughed at much higher levels than past downturns. So is that giving you the confidence, or is there actually a fundamental reason to own the asset? Will this allow you to ramp 1X or 1Y or 1Z more quickly owning Inotera? If you could just give a justification that would be great. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [68] +-------------------------------------------------------------------------------- +Yes. Well, there's a lot of components to it. I think you put your finger on a piece of it, which is that the volatility in this business, I think we can conclude is going to be less going forward. This certainly seems to have been borne out as we move through this last cycle. It doesn't mean the cycles are gone, it just means that the volatility is less, and so that is less of a defensive driver so to speak. +An important thing for us in this whole picture is operational flexibility and control. As we think about our ability to drive new technologies, either into manufacturing or to transition technologies with the Inotera assets, having ownership of that asset and the ability to mix and match different technologies, as well as potentially more value-add products and capture that value as significant. +Notwithstanding the fact that we have a good operating relationship with Inotera, we believe that there is more value we can bring as sole owners than as Board members and operational partners. And at the end of the day, it gives us the ability as well to take the cash flow that's going to be generated with Inotera, and deploy it across our network where we find that most useful. So a number of different factors playing into it, all of which, I think, point in the direction that we're moving. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [69] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Mehdi Hosseini with SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group / SIG - Analyst [71] +-------------------------------------------------------------------------------- +Yes, thanks for taking my question. Ernie, just going back to your CapEx for the next fiscal year, it sounds like you're incrementally more confident with the Inotera deal. And in that context, how should we think about the incremental CapEx requirements for Inotera, in the context of your comment that Inotera would help with free cash flow accretion? I'm just trying to reconcile everything, and I have a follow-up. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [72] +-------------------------------------------------------------------------------- +Sure. So when we provided that CapEx guidance of essentially midpoint of $5 billion net of partner contributions, we did say it included contemplated investments from Inotera. So that's an all-in number, as you know, we don't break out specific CapEx by fab, so we don't plan to start doing that now. But that $5 billion midpoint, with [a little] range around it is inclusive of anticipated investments at Inotera. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group / SIG - Analyst [73] +-------------------------------------------------------------------------------- +Got it. Thanks for the clarification. And then with the 3D NAND and a crossover with [300] NAND is, should I assume that all of the 3D NAND, the capacity coming online is TLC, or is there still any MLC left in the mix? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [74] +-------------------------------------------------------------------------------- +No, the first out 3D was MLC, but we very quickly introduced TLC. And as we said in our prepared remarks, most of our client consumer SSDs are now out on TLC, and we're qualifying TLC into mobile applications as well. And we will be a majority TLC by the middle of FY17 here as we go forward. So that's part of the engine of the significant bit growth that we've contemplated and forecast. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group / SIG - Analyst [75] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [77] +-------------------------------------------------------------------------------- +Great. Thank you. Wonder if you could talk about the decision to move to seven year depreciable life on DRAM? That strikes me as a long time, and I look at your CapEx ratio to PP&E as a third. What was the thinking behind seven years, and can you remind us the depreciation life of the NAND equipment? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [78] +-------------------------------------------------------------------------------- +So depreciation life of the NAND equipment is about five years. And really, we conducted quite an extensive study around how long the technology transitions existed, or took in the DRAM world, how long they were contemplated to take on a going forward basis. We looked at the practices of others, both competitors and partners. But really, the substance of the decision was related to what we anticipate and what we've been saying for some time is a slowing of the technology transitions, and therefore, the longer use ability of that equipment as the technology transition times change. +And the reality is, there's a range of answers you come up with when you do a study like that. And much like the midpoint of a guided range, and seven years felt to us like it was not overly aggressive, but not overly conservative either. So you could assume that we could have gone a year or two on either side of that, and we chose a position that we thought was reasonable, given what we know and understand about the pace of technology transition. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [79] +-------------------------------------------------------------------------------- +Okay, great. Thank you for that. And then, as a follow-up, have you given or can you give an absolute number for depreciation for either the quarter or the fiscal year? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [80] +-------------------------------------------------------------------------------- +We -- yes, we expect depreciation to be somewhere in the range of $4 billion for the year, give or take. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [81] +-------------------------------------------------------------------------------- +Great. Thank you very much. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology Inc. - CEO and Director [82] +-------------------------------------------------------------------------------- +And operator, I think we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- +Thank you. Our last question comes from David Wong with Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [84] +-------------------------------------------------------------------------------- +Thanks very much. Ernie, earlier you noted that you might be able to generate cash over, some point over the next few quarters. Can you give us any idea of what you would do with any net cash generated? Would you be able to pay down debt, or are there other uses for cash? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology Inc. - CFO [85] +-------------------------------------------------------------------------------- +Certainly, first thing we're going to be focused on is actually accumulating the cash. So that's my first priority, because I have to have some of it to be able to decide what to do with it. And certainly at that point in time, we would certainly look at the opportunities that were available to delever. And we would look at those in the context of, everything else that's going around. And it's really impossible to say specifically what we would decide to do in the context of a future that's not yet here. But I can tell you that delevering is an important priority. And depending on how much cash we generate, we may choose to deploy a $100 million of that or so back into CapEx, if that's the right decision. But delevering is certainly nearest and dearest to our hearts at the moment. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [86] +-------------------------------------------------------------------------------- +Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- +Thank you. This concludes today's Micron Technology fourth quarter 2016 financial release conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2017-Dec-19-MU.txt b/Transcripts/MU/2017-Dec-19-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..06737a3bb1cd4c235d1a2ed9cd13f4203fcced98 --- /dev/null +++ b/Transcripts/MU/2017-Dec-19-MU.txt @@ -0,0 +1,487 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 Micron Technology Inc Earnings Call +DECEMBER 19, 2017 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Shanye Hudson + - + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Ernest E. Maddock + Micron Technology, Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Steven Bryant Fox + Cross Research LLC - MD + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Jagadish Kalyanam Iyer + Summit Redstone Partners, L.L.C - MD & Senior Analyst + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, ladies and gentlemen, and welcome to Micron's First Quarter 2018 Financial Call. (Operator Instructions) As a reminder, today's conference is being recorded. +I would now like to turn the call over to Ms. Shanye Hudson. Ma'am, you may begin. + +-------------------------------------------------------------------------------- +Shanye Hudson, - [2] +-------------------------------------------------------------------------------- +Thank you, Chelsea, and welcome to Micron Technology's First Fiscal Quarter 2018 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Ernie Maddock, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call, including audio and slides, is being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with a convertible debt and capped call dilution table. +As a reminder, the prepared remarks from this call and webcast replay will also be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we'll be attending. You can follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we file with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a discussion of risks that may affect our future results. +Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We're under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +Lastly, Micron is planning to host its 2018 Analyst and Investor Event on May 21 in New York City. We'll share further details about this event in the coming months. +With that, I'll now turn the call over to you, Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- +Thank you, Shanye. Good afternoon. Micron's record first quarter results demonstrate the company's continued strong execution, a market environment that reflects the strategic importance of memory and flash storage and healthy supply and demand fundamentals. +During the quarter, we continued to enhance our cost competitiveness, achieving these maturity on both 1X DRAM and 64-layer 3D NAND. We improved our mix of high-value solutions, delivering record SSD revenues and further increasing our SSD share. +More recently, we began shipping our first 64-layer NAND consumer SSD. We also introduced the industry's fastest high-density 32-gigabyte NVDIMM-N, which combines Micron's DRAM and NAND to deliver a persistent memory solution that addresses intense data analytics workloads. +We have garnered solid interest from enterprise and cloud customers, and customer qualifications are underway. And we strengthened our talent bench with the recent addition of Manish Bhatia, who leads our global operations. Manish brings extensive experience in managing end-to-end operations, and is focused on driving manufacturing and supply chain efficiencies to reduce costs and improve our agility. +Finally, we improved our financial foundation with the retirement of $2.4 billion of debt. I'm pleased with our accomplishments and believe our focus on speed and execution better position Micron to deliver value to our customers and capture the increasing number of end market opportunities. +I will now discuss trends and results in each of our major markets. Cloud and traditional enterprise data center trends are continuing to drive robust demand for memory and flash storage solutions. Our Q1 SSD revenue to cloud and enterprise customers increased 50% sequentially. We recovered from the flash component issue discussed in our September earnings call that impacted last quarter's SSD sales. +On the compute side, we have solid sequential DRAM revenue growth into data center markets, driven primarily by enterprise sales. DRAM bench shipments to both cloud and enterprise customers were up by more than 50% year-over-year, underscoring the data center's growing need for memory and our strong execution in this market. +Our 1X nanometer designs have been well received by cloud customers, with more than a quarter of our cloud revenue in Q1 coming from our 1X technology. Fast qualification and production ramp by our cloud customers of new technology node products is a significant benefit, as it diversifies and accelerates our customer traction and market reach during early stages of production deployment of these advanced nodes. +The need to access, analyze and store data extends well beyond the cloud. This is perhaps most evident in the mobile market. Smartphone capabilities has surpassed simple communication and web browsing. They help us navigate, monitor and interact with the world around us. New cameras capture precious moments with amazing fidelity, and emerging applications like AR have tremendous promise. This increase in functionality is driving the use of higher capacity memory solutions and increased storage in mobile devices. +These trends, along with our solid execution, drove record mobile revenue in F Q1. We are strengthening our offerings and continue to diversify our portfolio of LPDRAM, MCP and discrete managed storage solutions to meet the growing needs of our customers. +We are accelerating our progress to expand our portfolio of low-power solutions, with the release of new products, such as our 1X LPDRAM designs. We also shipped initial samples of our 64-layer NAND discrete UFS solution to chipset partners and customers with very promising results. +Home automation and edge computing devices continue to drive strong revenues in consumer and industrial market segments, which require a wide variety of memory and managed [storage] products. As more edge devices begin to integrate machine learning and intelligence, we see opportunities to provide higher performance memory and flash storage solutions in these markets. +We have also seen rapidly growing demand for our graphics products. The graphics market continues to be fueled by the ever-growing popularity of gaming and eSports. Although smaller in size, recent interest in cryptocurrency mining has put further pressure on graphics memory supply. Our close customer relationships and leading product portfolio helped drive record graphics revenue, up more than 75% year-over-year. +We sampled industry-leading 16 gigabit per second GDDR6 products to key customers, and are seeing significant interest in automotive and networking applications that meet the high bandwidth this memory provides. We plan to ramp GDDR6 to production in early calendar 2018 for the graphics market, followed by other high-performance applications, such as automotive and networking. +The rapid innovation in automotive technology towards autonomous driving continues to create significant demand for higher memory capacities and greater performance. We secured a key design win in an important autonomous driving platform this quarter and are focused on replicating our success to retain our leading-edge share in that market. +Automotive customers are moving more rapidly to new memory technologies than they have in the past, and our announcement of the fastest 1X LPDDR4 and GDDR6 products for autonomous driving applications will ensure we continue to support this shift to leading-edge technologies. +We also set record revenues supplying the networking applications that serve data centers and edge devices as our reputation for consistency and innovation drives strong ties with networking customers. +These diversified growth drivers and structural market trends are generating tremendous opportunity for Micron. We are uniquely positioned in these markets with a broad portfolio of both DRAM and NAND solutions, excellent quality and comprehensive customer ecosystem engagement. We are focused on developing the right products, deepening our customer relationships and enriching our revenue mix to capitalize on these opportunities. +Turning now to manufacturing and technology. Our ability to execute our technology road map and drive cost competitiveness are foundational to our ongoing success. +In terms of wafer manufacturing plans, we still expect to achieve bit output crossover on 64 layer NAND during the second half of fiscal 2018 and expect to achieve bit output crossover on 1X DRAM by the end of calendar 2018. +We are outfitting our new back-end factory in Taichung, Taiwan to ramp assembly and test capacity and expect meaningful output from the facility before the end of the fiscal year. +Our capital investments are tracking with our deployment plans, and we are seeing good traction in improving the efficiency and cost effectiveness of our operations through these investments. Both 1Y DRAM and third-generation 3D NAND development are progressing well, and we remain on track for initial output of both in the second half of calendar 2018. +We continue to make good progress with our 3D XPoint technology. Historically, Micron's efforts on 3D XPoint have been largely focused on technology development and early manufacturing ramp. But given our increased focus on high-value product solutions, we have recently resourced a product development team to address the opportunity ahead of us. +Simultaneously, we are working with various players in the ecosystem to assess market and enablement opportunities, and we will provide further details of our views regarding these opportunities during our upcoming analyst event. We will also continue to have the opportunity to sell our 3D XPoint output to our partner, as this market develops. +Switching to our industry outlook, our supply and demand projections remain consistent with what we shared last quarter. DRAM industry supply bit growth is expected to be about 20% in calendar 2018, and we expect a healthy market environment driven by the ongoing enterprise data center, cloud and mobile strength, as we just discussed. +We expect the industry bit growth for NAND to approach 50% in calendar 2018 as the industry continues to ramp 64 layer designs into volume production. SSD adoption in client computing and data center applications continues to increase and will expand further as more supply becomes available over time. +Against that backdrop, projections for our own bit growth remain unchanged. We expect our DRAM bit growth to be slightly below the industry, and we expect our NAND bit growth to be somewhat above the industry for fiscal 2018. +During fiscal 2018, we are focusing on technology transitions for both DRAM and NAND without any additions to our total wafer capacity and on improving our mix of high-value solutions to enhance our revenue share. +For fiscal 2019 and beyond, we continue to assess scenarios for the Fab clean room space required to implement technology transitions to future, more advanced DRAM and 3D NAND nodes. +I'll now turn it over to Ernie to provide details on our first quarter results by business unit. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- +Thank you, Sanjay, and thanks to all of you for joining the call today. +We had a very strong start to our fiscal year, exceeding guidance across all financial metrics, driven by strong execution, a continued robust market environment and further progress on our technology migrations. +For fiscal Q1, total company revenue was $6.8 billion, up 11% from the prior quarter and up 71% on a year-over-year basis. Non-GAAP gross margin expanded to 55%, up 4 percentage points from Q4 and 29 percentage points from the first quarter of fiscal 2017. Non-GAAP operating margin was 46%, up from 41% in the prior quarter and up 35 percentage points from the year ago period. +We continue to prudently manage spending with non-GAAP operating expenses totaling $612 million for the quarter, up 2% from Q4, with both SG&A and R&D remaining relatively flat quarter-on-quarter. Non-GAAP net income increased to 44% of revenue and totaled approximately $3 billion or $2.45 per share. This performance compares with $2.4 billion or $2.02 per share in Q4 and $335 million or $0.32 per share from the year ago period. +Turning to performance by business unit. The Compute and Networking Business Unit reported FQ1 revenue of $3.2 billion, up 13% sequentially, and more than double year ago levels. Our record performance was driven by increasing server memory content, which drove higher sales to enterprise customers together with strong demand for graphics processing. Operating income was 60% compared to 56% in F Q4 and 14% in FQ1 2017. +Q1 Storage Business Unit revenues increased 7% sequentially to $1.4 billion, driven by strong growth in SSD sales. On a year-over-year basis, revenues were up 61%, driven by increasing market share in SSDs. In fact, sales of SSDs reached record levels in the quarter with double-digit sequential growth across consumer, client and enterprise and cloud markets. +SBU operating margins increased to 29% from 19% in the prior quarter and negative 5% in fiscal Q1 '17. These results reflect a higher-value product mix and continued market acceptance of our TLC 3D NAND-based products. +The Mobile Business Unit reported $1.4 billion in revenue, up 16% sequentially and up 32% year-over-year. We are seeing strong acceptance of our LPDRAM products and continue to enhance our portfolio of managed NAND offerings. The solid demand environment, combined with the traction we've made with our latest generation products, led to operating income of 37%, up from 31% in FQ4 and 9% in FQ1 2017. +The Embedded Business Unit reported revenue of $830 million in FQ1, in line with the prior quarter and up 44% year-over-year. Operating margin was 41%, essentially flat from the prior quarter, and up 10 percentage points year-over-year. +As Sanjay noted earlier, we continue to see exciting demand trends across each of the underlying embedded markets with evolving end market requirements ranging from high-performance memory for autonomous driving to ultra-high-density storage solutions for edge devices, such as video surveillance cameras. We are focused on building upon our existing leadership position to capture these growth opportunities. +Turning to results by product line. DRAM represented 67% of overall company revenue in fiscal Q1. Demand for client PCs, solid exposure to new flagship smartphones and ongoing strength from servers, particularly in cloud and hyperscale data centers, drove DRAM revenue higher during the quarter, up 13% sequentially and up 88% year-over-year. +Sequentially, shipment quantities increased in the upper single-digit range, while ASPs increased in the mid-single-digit range. +DRAM non-GAAP gross margin was 61.5% in FQ1, up 2 percentage points from the prior quarter and up 33 percentage points from the year ago quarter. +Revenue from trade NAND increased 2% sequentially and represented 27% of overall company revenue in fiscal Q1. Trade NAND revenue was up 47% year-over-year, driven by our strong growth and market share gains in the SSD market and robust demand from the mobile and embedded markets. +On a sequential basis, shipment quantities increased in the mid-single-digit range, while ASPs declined in the low single-digit range. Trade NAND non-GAAP gross margin was 49% in FQ1, up 9 percentage points from the prior quarter and up 26 percentage points from the year ago quarter, reflecting a richer mix of sales into high-value end markets. +As Sanjay noted in his prepared remarks, we are making strong progress on the rollout of our 1X nanometer DRAM and 64 layer 3D NAND deployment. The rollout of these technologies will enable meaningful levels of ongoing cost per bit reduction as we make progress throughout fiscal '18. +For DRAM, our bit output growth will be more heavily weighted to the first half of the fiscal year, while NAND bit output growth will be relatively greater in the second half of the fiscal year. +The company generated operating cash flow of $3.6 billion in fiscal Q1 compared to $1.1 billion in the year ago period. During the quarter, we deployed $1.9 billion for capital expenditures, net of partner contributions. We continue to expect FY '18 CapEx in the range of $7.5 billion, plus or minus 5%, fairly balanced between the first and second halves of the fiscal year. Free cash flow for the quarter was $1.7 billion compared to negative free cash flow in the year ago period. +We continue to pursue our plans to strengthen our balance sheet and lower debt. During fiscal Q1, we raised $1.4 billion from an equity offering and repurchased or converted $2.4 billion in principal amount of our debt. Total face value of debt was $9.3 billion as of the end of FQ1, and we currently expect to exit FY '18 with approximately $8 billion in face value debt. +We expect the interest savings from these deleveraging actions, combined with higher interest income from larger cash balances and the anti-dilutive effects of selling converts for cash, to materially offset the dilutive impacts associated with the equity offering. +Exiting FY '18, we foresee non-GAAP net interest expense of $25 million to $30 million per quarter versus $100 million per quarter in FQ4 of '17. We ended the first quarter with cash, marketable investments and restricted cash of approximately $6.6 billion and continue to see the opportunity to exit FY '18 in a positive net cash position. +Moving on to guidance for fiscal Q2 2018. On a non-GAAP basis, we expect the following: revenue in the range of $6.8 billion to $7.2 billion; gross margin in the range of 54% to 58%; operating expenses between $625 million and $675 million; operating income ranging between $3.25 billion and $3.45 billion; and EPS ranging between $2.51 and $2.65 per share, based on 1,241,000,000 diluted shares. +Finally, a word about tax reform. As drafted, the legislation would have no significant impact to our FY '18 tax rate, which we continue to expect to be in the mid-single-digit range. In FY '19 and beyond, we would expect some impact to our non-GAAP tax rate with an offsetting benefit of more flexibility in deploying our global cash balances. As further clarity around this legislation develops, we will provide appropriate updates. +With that, I will turn it back to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- +Thank you, Ernie. As we close out calendar 2017 and look to 2018, we see increasing opportunities for Micron to play a larger role in the technology trends shaping modern life. We will be hosting an Analyst Conference in May, where we plan to elaborate on our view of these trends and how Micron envisions our technologies shaping the world in the years to come. +We believe that our technologies, capabilities and team talent place us in a unique position in the market. Memory and flash storage are strategic assets that put Micron at the intersection of the biggest growth trends in technology, and we cannot be more excited about our future. +Our customers increasingly view us as an essential partner in early design discussions due to the differentiation our solutions can provide. We are focused on increasing this value, and I look forward to sharing the results of that focus throughout 2018. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) And our first question comes from the line of Srini Pajjuri with Macquarie Securities. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [2] +-------------------------------------------------------------------------------- +A couple of questions on the NAND side. Sanjay, at least among the investor community, there seems to be some concerns that there's going to be a flood of supply coming online into the industry in the first half. I'm just wondering if you have any thoughts about what your view is about the supply/demand balance as we head into the first half. And then, for Ernie, the NAND gross margin improvement is 900 basis points, sequentially. I know you mentioned mix healthy there, but I'm just curious if you could provide some more color as to exactly what's driving that, and how sustainable that is going forward? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- +So in terms of the industry demand supply environment, let me just say that with respect to the industry supply growth in the calendar year 2018, we have said that the industry supply growth would be approaching 50%. While that is more than what the calendar year '17 supply growth is in the range of 35% to 40%, the -- overall, what you have to look at is the demand requirements. In calendar year '17, of course, supply has been tight. There has been pent-up demand, particularly in the areas of client SSDs and the client PC, notebook PC environments. The march toward high-density SSDs in notebook PCs was somewhat slowed down given the overall tightness of supply in calendar year '17. When I look ahead at calendar year '18, I see strong demand trends with respect to attach rate of SSDs and client PCs continue to increase. The applications related to cloud and data centers, enterprise data centers continuing to drive higher average capacities, usage in cloud and data center applications as well. And certainly, in mobile applications also, the average capacities of NAND content continue to increase. And these are all increasing because of the trends, right? I mean, attach rate in notebook PCs in calendar year '17, about 35% going toward over the course of next several years by 2020 time frame, getting to 75% attach rates. So a lot of HDD, that is still to be replaced with SSDs. And same trends are continuing in all markets for NAND. Average capacities are continuing to increase. So the demand trends continues to be very robust. For flash, yes, more supply environment, but we are very focused on continuing to strengthen our product portfolio and increase our share with respect to SSD markets as well as with more managed NAND solutions to address the mobile markets. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- +And relative to the question about margins, I think there are 2 pieces of that. One, we are making progress toward a mix -- a higher value-added mix of solutions, and those typically carry the opportunity for higher margins. Also, we continue to make progress on the cost side with respect to increasing amounts of 3D NAND as well as TLC, and you had a good quarter for cost reduction as well. So it's a combination of both market facing with the higher value-add solutions, and then, a good quarter from an operational perspective relative to cost. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [5] +-------------------------------------------------------------------------------- +And then, maybe just one follow-up, Ernie, on the balance sheet. I think you previously said your gross debt target is about $8 billion, which you said you're going to reach, I guess, next quarter. Given -- assuming that the tax bill will pass, is there any change to that target? And then, if you can talk about, again, assuming that the tax bill will pass, what's your priorities for cash going forward? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- +Yes. I don't think we've said that we'd reach that gross debt target in FQ2. We said, by the end of our fiscal year. And so I wouldn't expect that we would achieve that level end fiscal Q2. The tax bill, as we understand it, would not necessarily change the priorities, which are always to continue to make sure we have the best technology we can in production and to be able to transition that at a time that makes sense for us. And then, for fiscal year '18, certainly, getting the balance sheet in shape relative to these aggregate levels of debt. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +And our next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [8] +-------------------------------------------------------------------------------- +On the DRAM side, you've got Intel ramping Skylake. You've got AMD ramping EPYC on the server CPU side. Cloud and hyperscale CapEx spending looks to grow about 30% next year. Given all of this, do you guys anticipate continued momentum and mix in your server and cloud business in DRAM to continue to move higher next year? And then, from an industry perspective, does the server and cloud segment become a bigger part of the DRAM consumption mix over the next 2 to 3 years overtaking mobile? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [9] +-------------------------------------------------------------------------------- +Yes. Absolutely. Cloud and server, data center enterprise as well as cloud data centers absolutely will continue to be the biggest growth drivers at large volumes for the DRAM industry. And we have very strong penetration in these markets. And actually, we do expect to continue to build momentum in these markets going forward. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [10] +-------------------------------------------------------------------------------- +Great. And Sanjay, you talked about semi and fully autonomous wins in the quarter. All of the major auto OEMs and self-systems guys are focused on this. We talked to one of the leading guys that's focused on sensors and processor technology required for these types of vehicles. They're talking about 25, 30 gigabytes of DRAM and 1 terabyte SSDs per car for level 4 and level 5 fully autonomous. That's a pretty significant step up in DRAM and NAND content. Is that consistent with how you see the content trends in automotive over the next kind of 3 to 5 years? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [11] +-------------------------------------------------------------------------------- +It absolutely is. I mean, when you look at autonomous vehicles, they really are level 5 autonomous vehicles in the future are projected to have about 40 gigabyte of DRAM content in them. And when you think about it, that is very similar to the average capacity that's associated with servers -- in the server workstations, right? So these cars will be really very powerful computers in the future, and they are not only going to be driving tremendous amount of DRAM content usage, but they will also drive NAND Flash usage. They will be generating, using data to make millions of real-time split-second decisions to make sure that the passengers in the autonomous vehicles can be transported effortlessly and safely to their destination. There will be sensors from sonar to camera that will be generating billions of signals, and all of that data will have to be processed, accessed in order to make fast decisions. So you're absolutely right to note that this is really a secular trend here in front of us in terms of driving continued usage of memory and storage. Earlier, we talked about cloud and data center applications. And again, those are growing faster than the rest of the industry. Autonomous vehicles will be another big driver in the future. And Micron is uniquely positioned with a strong portfolio of solutions, both with flash solutions as well as DRAM memory solutions to address these fast-growing market trends. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +And our next question comes from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [13] +-------------------------------------------------------------------------------- +A couple of questions. Maybe on DRAM, can you just go back to -- the servers been a huge driver, and that's really been without Intel's Purley's still the minority. Can you just maybe talk about content per server? How much that increased this year? And then, as you look into next year, how much of a driver is Purley as you look in the second half, and that being more meaningful? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [14] +-------------------------------------------------------------------------------- +So in terms of content for server, I think 2017, if you look at flash, attach rate, it's about average capacity around 2.5 -- 2,500 gigabytes. And when you look at projection over 2018 timeframe going to anywhere above 3,000 gigabyte average capacity continues to march ahead by 2021 timeframe, almost tripling from the 2017 levels, well above 8,000 gigabytes as well. So that is on the SSD side. And similarly, on the DRAM side, average capacities continue to increase nicely there as well. In 2017, timeframe about 145 gigabytes per server average capacity estimated, and industry reports are showing that by 2021 timeframe going to about 350. So very strong solid and year-over-year increases, not just in near term, but again, as I say, these are secular trends here. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [15] +-------------------------------------------------------------------------------- +And then, just on the NAND side, I just want to go back to that prior question. Obviously, you're seeing a crossover at 64. How do you think about the cost trajectory here as you then start to ramp third gen as you look to the fiscal year, is there any sort of -- what's the slope of that cost curve as one is going up, and the other one's going down? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- +As we introduce third-generation 3D NAND, we would continue to expect that, that technology of mature yield have -- or has favorable cost dynamics relative to 64-layer. We don't believe that it will have a significant positive or negative impact in our FY '18 results as we will just be implementing that as we get into the last quarter of the fiscal year. So it won't be material enough either way to change the fundamental dynamic that we're going to see this year, which is largely driven by our 64-layer TLC NAND. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +And our next question comes from the line of Kevin Cassidy with Stifel. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [18] +-------------------------------------------------------------------------------- +You had mentioned when you gave your guidance for CapEx for the year about adding more value-added into your DRAMs and flash. Can you say what percentage right now would you call in a value-added group? And what's the goal for that? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [19] +-------------------------------------------------------------------------------- +Well, in the value-added solution category, we count our SSDs index, and in fiscal Q1, we had really solid increase in our SSD revenues. We gained share in the market as well. In the mobile space, managed NAND solutions are also -- and discrete NAND solutions we consider as value-add as well. Our share in those markets today is relatively low, low single digits, but we see tremendous opportunity as we are continuing to diversify our product portfolio. And as we execute on that product road map in the quarters to come, we expect to be gaining -- making substantial progress. And of course, in the DRAM side, applications such as automotive, such as graphics, high-performance applications as they all contribute towards the value-add solution. We are not providing you any specifics at this point. We'll discuss more details at our Analyst Day in May. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [20] +-------------------------------------------------------------------------------- +Okay. Great. Maybe just as one follow-up because especially a DRAM market had been such a commodity market, are you getting any pushback from your customers that they want you to move more towards a commodity? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- +And let me just point out, in response to your previous question, that while we will provide more detail in May, but on a year-over-year basis, certainly, we are increasing our value-add solution mix substantially and very pleased with the progress that we are making. Regarding your second question on DRAM. DRAM really is a strategic enabler today in diversity of markets and the megatrends we talk about, whether it is data centers, cloud applications, being the fuel for AI engine, helping make decisions for various search algorithms as well as various activities in all verticals that are being pursued, leveraging AI in mobile space as more and more applications go toward augmented reality type of features in mobile requires more DRAM. DRAM is highly strategic. Even in the future, when you look at notebook computers, they will require the form factor and the low-power aspects, even in PCs of LPDRAM in future years to come. So you see -- and of course, we just talked about automotive as well. So now DRAM is addressing diversity of markets. I mean, several large diverse markets. Product portfolio, meeting the needs of these markets is becoming differentiated. And when that happens, that always gives you stronger opportunities to drive profitable growth in that market. And our customers, when we have an engagement with them, when we have dialogues with them, they are talking to us how memory, DRAM memory, is really now helping them solve the bottlenecks in their applications. So DRAM today is very different, as I've said many times before, from the DRAM in the PC-era only or when it was about just PC and mobile. Today, it is about many more applications of DRAM and really providing a very strategic enabling role in creating all these applications that are truly transforming the world right before our eyes. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +And our next question comes from the line of David Wong with Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [23] +-------------------------------------------------------------------------------- +I'm not sure if you said it, but on the November quarter, how much of your total NAND production was 3D NAND? And as you transition to 64-layer in the February and May quarter next year, does your NAND production drop or grow sequentially? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- +So about 80% of our output for the quarter just completed was on 3D. And over the course of the balance of fiscal '18, we'd expect that number to grow to about 95%. We expect that we will have some measure of bit growth, as we said. Each and every quarter, we said it would be, in the prepared remarks, a little more heavily weighted to the back half of the year. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [25] +-------------------------------------------------------------------------------- +But you, nevertheless, will grow in the first half? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- +Yes. Yes. That output for the quarter was up in the low single-digit range. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +And our next question comes from the line of C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [28] +-------------------------------------------------------------------------------- +I guess first question on DRAM. You talked about 20% bit supply for the industry in '18, which would suggest continued tightness throughout the whole year. So curious how customers are reacting to that reality. What kind of visibility are you seeing to pricing as well as extension to contracts? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [29] +-------------------------------------------------------------------------------- +We work very closely with our customers, and we certainly work hard in terms of gaining visibility to their future requirements of DRAM and how their applications are shaping up so that we can make sure that our technology and product road map is addressing their needs. And this varies from customer to customer. Some customers tend to be more on a month by month basis, some more quarter, and some, certainly, longer-term engagements as well. And you're right to note that, yes, I mean, that the industry supply growing about 20% and demand likely to be somewhat higher. We do expect a healthy DRAM industry supply and demand environment and continue to work very closely to drive strategic growth of our revenue mix going forward. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [30] +-------------------------------------------------------------------------------- +Very helpful. And I guess as my follow-up, on the NAND side, you're talking around 50% bit growth or approaching that for the industry. One or 2 of the other players in the market are expecting lower type of bit growth. So it would appear that you're making assumptions around the 64-layer ramp that might be a little bit more robust than your competitors. So curious, how are you thinking about that ramp? And clearly, I think you'd agree the risk is probably lower than 50%, how would you kind of, I guess, put a probability around where you think it truly ends up? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [31] +-------------------------------------------------------------------------------- +So of course, in terms of projecting, our industry bit growth estimates here, we, of course, are taking into consideration our estimate of the ramp of 64-layer technology in the industry and our assumptions around ramp of wafer production as well as yield ramp of that technology. And along with other mix of technologies in the industry as well. But you're right to note that the dominant factor of the supply bit growth in the industry will be with 64 layers here. And we continually look at our estimates and we review it, based on all the intelligence that we may have as well as we may collect from third-party reports, we define our models on an ongoing basis. And if we have any changes on this, we will share them with you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +And our next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [33] +-------------------------------------------------------------------------------- +I wonder, I know you don't want to get too far ahead of yourself on this, but when you get to sort of net cash neutral and you get to investment grade, what's next from a prioritization of free cash flow? And how do you just qualitatively think about cash return versus maintaining cash for more strategic uses? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [34] +-------------------------------------------------------------------------------- +I think that we will continue to prioritize the -- supporting our latest generation technology in production. As we've talked about for fiscal '18, clearly focused on getting aggregate debt down in that $8 billion range. Those things will lead to, we believe, over time, improved ratings. I think how we think about deploying cash is not wholly dependent upon the achievement of any particular ratings grade. We just think these are things that will be worked in parallel. And at the appropriate time, I think we're very open to thinking about broader uses of cash, including shareholder return programs, so those do have a place in the hierarchy of thinking about uses of our cash. But until we get to the point where we have completed or substantively completed our work on this technology deployment and regaining cost competitiveness and also getting our aggregate debt levels to the -- to a level that we are more comfortable with, certainly, those will continue to remain our priority. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [35] +-------------------------------------------------------------------------------- +Great. And then, I wondered, the disparity between the 60% operating margins in your compute business and mobile, which are still quite high, I guess, to me, sort of you can see that PC DRAM still quite a bit more profitable than mobile. How do you think about that going forward in terms of your allocation of mix? Obviously, mobile gives you more stability down the road versus the upside that you can get from PCs. How are you thinking about that balance? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- +Yes. Don't forget that the Compute and Networking Business Unit includes a wide array of products, which includes both client, but also includes data center, mobile -- I'm sorry, not mobile, but networking and other products as well. So it isn't just a statement about the client compute environment. And many of those subsegments within the Compute and Networking Business Unit we would also consider as strategically important. These are relationships where we have the opportunity to deploy both DRAM and NAND. And certainly, mobile continues to be important. So I wouldn't necessarily presume that the margin performance out of our Compute and Networking Business Unit is largely driven by the performance of client. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Our next question comes from the line of Romit Shah with Nomura Instinet. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [38] +-------------------------------------------------------------------------------- +Sanjay, some of your equipment -- semicap equipment suppliers have -- this is like over the last 3 months, have been raising their spending forecast for 2018, driven in part by higher DRAM investments. And my question is, what's the risk that your competitors, perhaps, are going more aggressively for share and that the 20% growth assumption you laid out for next year may actually end up proving conservative? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- +I think, again, our estimates based -- for DRAM as well, are based on all the information from various sources and reports that we gather and we have put that here. I do think that even when you look at estimates by other suppliers, we are all pointing to fairly close, tightly-aligned, industry supply growth estimate here. And -- but this is our estimate. We will, as I said before for NAND, same thing. We routinely look at this very, very closely. And just also remember that the technology transitions in the industry today certainly are becoming increasingly complex, and they have greater capital intensity. As well as with advanced technology nodes, you are actually getting less bits on a per wafer basis even at mature yields compared to prior generation nodes. Again, given the scaling challenges, the increased complexity. So all of these trends are actually increased technology complexity and increased capital intensity have a moderating effect on the supply growth. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [40] +-------------------------------------------------------------------------------- +And then, just on the February quarter, I don't know if you guys look at your individual periods on a seasonal basis, but it seems like the February quarter typically is a down quarter and you're guiding to sequential growth off of a better-than-expected November period. What's driving the better-than-normal seasonality for you? Is it pricing or other factors as well? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [41] +-------------------------------------------------------------------------------- +Yes. I think, Sanjay mentioned earlier the diversification of the DRAM demand stream. And certainly, that is also true on the NAND side. And in the context of that diversified demand stream, for example, automobiles tend to be far less seasonal than client PCs. And if you look at data center deployments among all of the key players, there's certainly a specific pattern per customer. But when you put them all together, there is no macro seasonality pattern that emerges when you look at that. So as we've transitioned to these diversified demand drivers, the concept of seasonality, I think, has been redefined and is perhaps less impactive on a quarter by quarter basis than it may have been in the past. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +And our next question comes from the line of Jagadish Iyer with Summit Redstone. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD & Senior Analyst [43] +-------------------------------------------------------------------------------- +Two questions. First, if NAND ASPs continue to decline from rising supply, do you expect cost reduction to keep pace with the ASP decline as we look at fiscal '18? And then, I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [44] +-------------------------------------------------------------------------------- +I mean, we are certainly not projecting pricing for fiscal year '18 here. But again, what I'll point to you is that if you look at the history of NAND, increase in technology capabilities, technology advances, which leads to cost reductions, ultimately enable opening up of many new market applications and drive the elasticity in many of these markets as well and drive the demand environment. So I consider it as healthy if the cost declines are greater than the price declines in the industry. That's a healthy industry environment. And while we don't get into the projection of pricing, again, when we look at all the demand drivers that are ahead of us, I spoke about it repeatedly in the call today, multitude of demand drivers and in each of these large market segments, again, whether it is about cloud data center, enterprise data center, mobile, smartphones, client notebook, automotive applications, all of these are continuing to drive strong demand trends for NAND Flash application. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [45] +-------------------------------------------------------------------------------- +Yes. I think the one thing I would add to that as well is if you think about our statements around industry bit growth, which are approaching 50%, those would be associated, typically, with fairly healthy levels of cost reduction. We're not going to get into the specifics of what that might be, but it is important to remember that, that bit growth usually would be accompanied by some good cost reduction as well. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD & Senior Analyst [46] +-------------------------------------------------------------------------------- +Okay. Fair enough. Then, on 3D XPoint, I was wondering how much are you earmarking for spending in fiscal '18? And has there been customers who have identified? And how should we think, generally, on a big picture, about pricing there? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [47] +-------------------------------------------------------------------------------- +So this is Ernie. The 3D XPoint CapEx and any associated R&D expenses, the CapEx piece is embedded in our nonvolatile estimates for the year, which we said was between 35% and 45% of our total spending. And as we look at that product, we're going to have to see how the markets develop, as Sanjay mentioned, before we provide any broader perspective on that. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Our next question comes from the line of Steven Fox with Cross Research. + +-------------------------------------------------------------------------------- +Steven Bryant Fox, Cross Research LLC - MD [49] +-------------------------------------------------------------------------------- +Two quick questions for me. First of all, you mentioned the market share gains in SSDs and I assumed some of that was related to fixing the component issue. But can you sort of give us some more color on where you think specifically you had most success in gaining share? And then, secondly, I know you're not going to talk specifically about pricing for the upcoming quarter, but if you could, maybe, qualify some more how you get to your sales guidance in terms of pricing and mix, that would be helpful. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [50] +-------------------------------------------------------------------------------- +In terms of SSD share gain during the quarter, we believe we gained share both in client applications as well as enterprise and cloud data center applications. Really, our products did very well there. And at this point, our offerings are with SATA drive. And next year, we'll bring out our NVMe solution sometime during calendar year '18, and that should help us expand our portfolio and give us opportunities to continue to gain share in this market. And regarding our guidance that we have given you, of course, we have certain assumptions related to total demand. And our pricing assumptions are baked in there as well. But obviously, for competitive reasons, we do not get into discussions of pricing on the call. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- +And our next question comes from the line of John Pitzer with Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [52] +-------------------------------------------------------------------------------- +Ernie, maybe I can ask the gross margin question around NAND a little bit differently. I'm just kind of curious, given that you guys had significant gross margin upside on pricing down low single digits sequentially, under a scenario where pricing continues to decline, let's say, at a low single-digit rate sequentially, is there enough mix and cost opportunity for you to maintain and/or grow gross margins from here? Or how should we think about the parameters that you're able -- being able to maintain or grow gross margins relative to your cost and mix availability from here? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [53] +-------------------------------------------------------------------------------- +Yes. So if we're framing the scenario in the future as we continue to see sort of marginally declining pricing environment, a couple of points per quarter or so, I think there's ample room for gross margin expansion, both as a result of our cost reduction as well as the ongoing transition to high-value solutions, which would include redirecting -- continuing to redirect component sales into higher value-added solutions as well as some of our partner contracts wind down over the course of our fiscal '18 and into 2019. So I think in that pricing scenario that you've set forth, we believe there's reasonable room for gross margin expansion. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [54] +-------------------------------------------------------------------------------- +That's helpful. And a similar question on the DRAM front. You mentioned in your prepared comments that you expect more DRAM bit growth in the first half of your fiscal year than the second half. As we transition into the second half, how much -- how many levers do you have on the mix side in DRAM to be able to progress sort of gross margins higher from here? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [55] +-------------------------------------------------------------------------------- +Yes. I think, again, the same general story with respect to continuing to move towards higher value-add solutions. You heard Sanjay speak to, for example, increasing the breadth of our managed NAND offerings. If you look at server, that's certainly a very, very strong growth pattern here as well as automotive. So I think there are a number of segments where we would continue to expect to be able to optimize our bit output toward that would give us the best gross margin opportunity. And of course, even though our bit output growth is going to be lower in DRAM than NAND, we'd still expect to deliver some meaningful cost reduction there, as I articulated in the prepared remarks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- +And we'll take our final question from the line of Mark Newman with Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [57] +-------------------------------------------------------------------------------- +I had a question on CapEx and capacity. So Micron -- you stepped up the CapEx quite a bit this year from previous years. But still, quite significantly underspending some of the rivals, particularly Samsung. My question, actually, is about how is Micron thinking about the need for fabs longer term. This is more of a kind of longer-term question, because both Samsung and Hynix are building brand-new greenfield fabs as we speak. What is the status right now for Micron in both DRAM and NAND in terms of how much space you have available to you in DRAM and NAND? And I understand your goal is to keep wafer capacity roughly flat and grow gigabytes from technology migration. At what point do you need more fab space to keep that fab capacity roughly flat? Or it is, of course, more layers requires more fab space, and of course, as you shrink DRAM, you also need more fab space as well. So do you have any plans for new fabs? What would be the plan? And how are you thinking about that? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [58] +-------------------------------------------------------------------------------- +So like you noted, in order to realize the technology transitions, you, of course, do need space in your cleanroom to deploy the tools that are required to implement the advanced technology nodes. So our fabs have had space here in terms of deploying the technology transitions, for example, in Singapore going from 32-layer to 64-layer. And in the past, in Singapore fab for NAND, going from planar to 3D nodes as well. And similarly, cleanroom space is something we look at very carefully for DRAMs as well because, as I just said, I mean, more cleanroom space is needed for technology transitions. So as I said in my prepared remarks, I mean, we do continue to assess the scenarios that are needed for future technology transitions, and I continue to assess our cleanroom space requirements. Fiscal year '18, we are not looking at any new wafer capacity additions. We are not looking at any new -- any meaningful new cleanroom space required to implement our technology transition plans in fiscal year '18. And as I said in my remarks, going beyond that, we continue to assess various scenarios to implement the requirements for technology transitions, both in DRAM as well as in NAND. No plans firmed up yet. And as and when we look at it, we will share these things. Remember, any time you build a new cleanroom, it takes several months to build, construct the building. And it takes a few months then to roll in equipment into the new cleanroom and to deploy the equipment, qualify it and build products. So these are things that are to be looked at for the longer-term horizon, and we are evaluating those scenarios. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Thank you. And this concludes today's question-and-answer session. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2017-Jun-29-MU.txt b/Transcripts/MU/2017-Jun-29-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..007e4b98b759d6d2e988cf62eabe9d771cf61ebb --- /dev/null +++ b/Transcripts/MU/2017-Jun-29-MU.txt @@ -0,0 +1,569 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Micron Technology Inc Earnings Call +JUNE 29, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Shanye Hudson + Sr. Director Investor Relations - + * Sanjay Mehrotra + Micron Technology, Inc. - President, CEO & Director + * Ernest E. Maddock + Micron Technology, Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Srinivas Reddy Pajjuri + Macquarie Research - Senior Analyst + * Kevin Edward Cassidy + Stifel, Nicolaus & Company, Incorporated, Research Division - Director + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Mark Trevor Delaney + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * John William Pitzer + Credit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst + * Wayne Loeb + Citigroup - + * Jagadish Kalyanam Iyer + Summit Redstone Partners, L.L.C - MD and Senior Analyst + * David Michael Wong + Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Karen, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to Micron Technology's Third Quarter 2017 Financial Release Conference Call. (Operator Instructions) +It is now my pleasure to turn the floor over to your host, Shanye Hudson. You may begin the conference. + +-------------------------------------------------------------------------------- +Shanye Hudson, Sr. Director Investor Relations - [2] +-------------------------------------------------------------------------------- + + Thank you, Karen, and welcome to Micron Technology's Third Fiscal Quarter 2017 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Ernie Maddock, Chief Financial Officer. +This conference call, including audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release, which was filed a short while ago, and supplemental information including a reconciliation of GAAP to non-GAAP financial measures, slides for today's conference call and a convertible debt and capped call dilution table. The prepared remarks from today's call will also be added to our website later today. +Today's call will be approximately 60 minutes in length. A webcast replay will be available on our website for a year. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we'll be attending. You can also follow us on Twitter, @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements based on the environment as we currently see it. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements being made today. We refer you to the documents that the company files with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a complete discussion of these important risk factors and other risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or other achievements. We're under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +With that, I'll turn the call over to you, Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Shanye. Good afternoon, everyone. I'm pleased to be speaking with you for my first Micron quarterly earnings call, and I'm particularly fortunate to be joining at a time when we are able to report record revenues and non-GAAP EPS. These results reflect healthy industry fundamentals, the strength of Micron's diversified technology and product portfolio and our broad customer reach. Micron also continues to make progress in improving its technology and product competitiveness. +The current industry dynamic and the growing strategic importance of Micron's technologies and capabilities make this an exciting time to join the company. The unprecedented amount of data being created, stored and processed presents tremendous opportunities for Micron. +Applications like autonomous driving, machine learning and big data analytics all promise to make an enormous impact on our lives. Memory and file storage are the critical and increasingly strategic elements in every one of these applications. Market-leading companies from a broad array of industries who provide data center services, automotive applications and mobile solutions, just to name a few, are eager to partner with innovative companies like Micron that can provide leading-edge technology and system solutions. +Micron is uniquely positioned with the right technologies and capabilities to take a leadership position, and I'm delighted to have the opportunity to help the company maximize this potential. +I will now share some details from each of our business units, followed by technology and operational highlights for the quarter. Finally, I'll share our perspective on current industry supply and demand dynamics. +We had record revenues in all business units this quarter, nearly doubling our company level year-over-year revenue performance. In the Compute and Networking Business Unit, all segments posted significant gains from year-ago levels. Revenue from cloud customers was more than 4x higher year-over-year. And we saw increased enterprise demand as analytics workloads are driving more use of in-memory databases and higher server memory content. +We continue to build upon our strong position in graphics and high-performance memory technology, with shipments of our 12 gigabits per second GDDR5X, the industry's fastest discrete DRAM, which we successfully ramped to high volume during the quarter. Most CNBU revenue came from 20-nanometer DRAM products, and we also recognized initial revenue on our next-generation 1x DDR4 products. +Looking forward, we believe that we are well positioned to effectively serve both our traditional OEM customer base as well as evolving opportunities around tailored solutions for large data center customers. +Our Mobile Business Unit revenue increased slightly quarter-over-quarter with significant margin expansion, driven by lower costs associated with the continued shift to 20-nanometer LPDRAM and the favorable pricing environment. We expect increased demand ahead of the anticipated flagship smartphone introductions planned for the fall. Requirements for multicamera systems, augmented reality applications and high-resolution displays now dictate 4- and 6-gigabyte LPDRAM densities for a great user experience. This demand aligns well with our 20-nanometer and 1x offerings, where we plan to introduce nearly 20 new 1x package-on-package variations in the next 12 months. +We are focused on developing and diversifying our MCP and discrete NAND device offerings, which will position us well to address the full range of smartphones, from basic entry-level smartphones to content-rich high-end devices. Many mobile OEM customers prefer MCPs in their design implementation to address their memory and storage requirements, as MCPs provide a single source for DRAM memory and NAND storage, simplifying system design, validation and supply chain considerations. +We continue to sample our 32-layer MLC and TLC 3D NAND MCP, discrete eUFS and eMMC devices to both chipset partners and handset OEMs. Revenue shipments of these products will begin later in the second half of this calendar year following completion of qualifications by customers. +Our Embedded Business Unit recorded a 44% increase in revenue year-over-year, driven by strong demand growth across all segments and a better pricing environment. We achieved record quarterly revenue for each of the automotive, consumer and connected home and industrial segments. We saw continued strength in automotive DRAM and eMMC NAND with infotainment and instrument cluster applications driving this record level. +We continue to maintain our strong market share leadership position in automotive, enabled by our focus on high quality and deep customer relationships and support. Industrial and consumer-connected home revenues were led by increased shipments into rapidly growing applications, such as voice-activated home assistance and set-top boxes. We continue to transition our nonautomotive DRAM portfolio onto 20-nanometer designs. +Our Storage Business Unit delivered record revenues as sales of our SSD products grew 33% quarter-over-quarter. Sales to cloud and enterprise SSD customers grew appreciably on a combined basis and exceeded revenue from client customers for the first time. +The most significant growth came from our cloud customers, where revenue doubled quarter-over-quarter. Our SSD sales in the quarter were driven primarily by our SATA SSD solutions using our 32-layer TLC 3D NAND. +During the quarter, we had first revenue shipments of our 8-terabyte SATA enterprise-class SSD, which is an industry first. Several new OEM and hyperscale customer qualifications are underway for our SATA drives. And in calendar year 2018, we plan to introduce NVMe PCIe offerings using our 64-layer TLC 3D NAND. +On the manufacturing operations front, we continue to make good progress toward achieving meaningful output by the end of our fiscal year on both our 64-layer 3D NAND and our 1X DRAM. Both of these technologies have already begun revenue shipments and are advancing well in their production yield run. We also continue to execute our plans to outfit our assembly operations as part of our DRAM center of excellence in Taiwan. This DRAM center, in addition to our NAND center of excellence in Singapore, will be essential to our ongoing efforts to optimize costs and improve our flexibility and speed to meet customer needs. +On the technology front, we continue to make solid progress on the development of our third-generation 3D NAND and our next-generation 1Y DRAM technologies. Our third-generation 3D NAND will continue to be based on our innovative CMOS Under the Array architecture. This architecture, pioneered by Micron, provides the benefits of smaller die size and lower cost. We expect our 1y DRAM to further improve our competitive position in the industry. +Looking at the industry broadly, Micron continues to see a healthy supply and demand environment that creates opportunities across both memory and storage markets. For calendar 2017, we expect DRAM industry bit supply growth of between 15% and 20%, slightly below our view of demand growth. For NAND, we expect 2017 industry supply growth in the high 30% to low 40% range, constraining what would otherwise be higher demand. We expect healthy industry demand to persist into 2018, supported by continued strong growth in both DRAM and NAND demand, reflecting broader trends in the data center and mobile markets as well as increased adoption of SSDs across enterprise, cloud and client PCs. +Finally, after my first 2 months at Micron, I would like to share some of my priorities. Our execution and competitiveness are my primary focus, particularly accelerating the ramp of new technologies into volume production and introducing new products quickly, both of which are essential to developing innovative solutions at lower costs and strengthening Micron's business fundamentals. +Micron has a tremendous portfolio of technologies and core capabilities. Our goal is to leverage these to provide high-value products and solutions that improve our revenue mix. We will target high-growth opportunities and seek out partnerships with leading companies in the ecosystem to position Micron for long-term success. We are off to a good start. Our execution and the current business climate are creating more flexibility, which we are leveraging to solidify our foundation through technology, product and manufacturing investments while also strengthening our balance sheet. I believe that through focus and solid execution, Micron can capitalize on the world's increasing reliance on memory and storage solutions. +I'll now turn it over to Ernie, who will walk through the specifics of our financial performance this quarter. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sanjay. We had a strong quarter with record revenue, non-GAAP EPS and operating cash flow, driven by the continued positive industry environment, additional bit growth from our current technologies and progress on deploying our next-generation technologies into manufacturing. I will provide an overview of the fiscal Q3 results by technology and business unit, followed by comments on our overall corporate financial performance and guidance for FQ4. +DRAM represented 64% of our total revenue with the following segmentation: Mobile was in the mid-20% range; PC was in the low 20% range, down from the prior quarter; server represented approximately 30%, up from 25% the prior quarter; and specialty DRAM, which includes networking, graphics, automotive and other embedded technologies, was in the mid-20% range. +Our trade NAND revenue represented 31% of total revenue with the following segmentation: consumer, which consists primarily of component sales to partners and customers, was approximately 40%; mobile, which includes managed NAND discrete solutions and the majority of our MCPs, was in the mid-teens percent range; SSDs were in the mid-20% range, up slightly from last quarter; and automotive, industrial and other embedded applications were in the high-teens percent range. +Turning to performance by business unit. The Compute and Networking Business Unit reported fiscal Q3 revenue of $2.4 billion, up 25% sequentially due to increased bit shipments, ongoing success in penetrating growing segments like enterprise, graphics and high-performance memory and cloud and a stronger pricing environment. Non-GAAP operating income was $1.2 billion or 51% of revenue, up from 38% the prior quarter. 20-nanometer products were greater than half of CNBU revenue and were shipped primarily in the enterprise, cloud and client segments. Revenue growth in the enterprise segment was driven by the continued expansion of DRAM content per server. And in the cloud space, we experienced good sequential bit growth. Both segments also benefited from the current pricing environment. We saw ongoing growth of our 20-nanometer DDR4 products, with particular strength coming from the latest industry server platforms. +In networking, we saw shipment and revenue growth bolstered by the continued transition to 20-nanometer 4-gigabit DDR3 and 8-gigabit DDR4 products. We also continue to see strong interest in our high-performance memory portfolio. This strength was primarily evident in data center networking equipment. +Double-digit client revenue growth was driven by a continued firm pricing environment and product mix optimization, resulting in modestly declining bit shipments. Our 1x nanometer revenue was predominantly in this segment. Graphics also saw double-digit revenue growth, driven by strength in the game console market as well as new PC graphics card product launches, including the G5x-based Titan Xp from NVIDIA. +The Mobile Business Unit delivered fiscal Q3 revenue of $1.1 billion, up 4% sequentially, driven primarily by a stronger pricing environment. And our non-GAAP operating income was $304 million or 27% of revenue, up from 16% the prior quarter. +The Embedded Business Unit delivered fiscal Q3 revenue of $700 million, up 19% sequentially. Non-GAAP operating income was $256 million or 37% of revenue, up from 33% the prior quarter. The results were driven by strong bit demand and increased average selling prices of DRAM, combined with record shipments of SLC and MLC NAND in the consumer and connected home segments and record shipments of DRAM and eMMC NAND into the industrial and automotive segments, respectively. +The Storage Business Unit delivered fiscal Q3 revenue of $1.3 billion, up 26% sequentially. Non-GAAP operating income was $276 million or 21% of revenue, up from 7% the prior quarter. The results were primarily driven by strong unit growth of SSDs and a stronger pricing environment +Moving to overall company results. Revenue for the third fiscal quarter was $5.6 billion, up 20% sequentially and driven by, primarily, stronger DRAM ASPs and higher NAND bit volumes. +On a year-over-year basis, revenue increased 92%, primarily due to a stronger DRAM pricing environment, increased bit volumes in both DRAM and NAND and our focus on higher value-add solutions to improve our product mix. Examples of this improved mix includes SSDs where year-on-year revenue tripled, while in DRAM bits embedded in high-value solution for enterprise, cloud and graphics customers, together grew at a rate twice our overall DRAM bit output for the same period. +Non-GAAP gross margin for the quarter was 48%, up from 38.5% in the prior quarter, driven by increased DRAM ASPs and cost per bit reductions in both DRAM and NAND. On a year-over-year basis, non-GAAP gross margin increased 30 percentage points, driven by a stronger DRAM pricing environment, a better product mix and lower cost per bit in both DRAM and NAND. Non-GAAP net income was $1.9 billion or $1.62 per share. +Turning to results by product line. DRAM revenue increased 20% compared to the prior quarter as a result of a 5% increase in bit shipments and a 14% increase in ASPs. DRAM non-GAAP gross margins for the third quarter increased 10 percentage points sequentially to 54%, driven by a 6% cost per bit reduction and better product mix. +As a reminder, we noted last quarter that second half fiscal year 2017 DRAM bit output would be about 10% higher than first half fiscal year 2017. As we look forward into fiscal 2018, the timing of the 1x technology transition is expected to result in our bit growth at or slightly below industry growth rates over the same period. We considered this bit growth pattern when we provided our 2-year bit growth CAGR earlier this year. +Trade NAND revenue increased 21% compared to the prior quarter, reflecting a 17% increase in bit shipments and a 3% increase in ASPs. Non-GAAP gross margin was 41%, up 10 percentage points, driven by a 12% cost per bit reduction and better product mix. +As a reminder, we noted last quarter that second half fiscal year 2017 bit growth would be about 30% above first half fiscal year 2017. Based on the timing of technology transitions, we foresee relatively muted bit growth in the first half of fiscal 2018, followed by stronger growth in the second half. Consistent with DRAM, we considered this bit growth pattern when we provided our 2-year bit growth CAGRs earlier in the year. +Non-GAAP operating expenses for the quarter were $600 million, down $12 million from the prior quarter. +The company generated operating cash flow of $2.4 billion in fiscal Q3 compared to $389 million in the year-ago period. During the quarter, we deployed $1.3 billion for capital expenditures, net of partner contributions. And free cash flow for the quarter was $1.1 billion as we retired approximately $1 billion of debt via a tender offer for certain of our high-yield notes. We currently expect fiscal year 2017 free cash flow of approximately $3 billion and continue to prioritize the deployment of our cash flow toward advancing our production technology capabilities and reducing our debt. +For fiscal year 2017, we are trending to the upper end of our indicated net CapEx range of $4.8 billion to $5.2 billion. We will provide a fiscal year 2018 CapEx perspective later this year. We ended the third quarter with cash, marketable investments and restricted cash of approximately $4.9 billion. +Our guidance for fiscal Q4 is informed by our view of sustained, healthy supply and demand dynamics, our ongoing work around cost reduction and the improvement of our product mix. On a non-GAAP basis, we expect the following: revenue in the range of $5.7 billion to $6.1 billion; gross margin in the range of 47% to 51%; operating expenses between $575 million and $625 million; and operating income ranging between $2.2 billion and $2.4 billion. EPS will range between $1.73 and $1.87 per share, based on 1,179 million diluted shares +At our Analyst Day in February, we outlined how our production technology execution and the result in bit growth and cost reductions have enabled us to significantly strengthen our cash flow and financial performance in any market conditions. We've been reporting our incremental progress each quarter. However, I wanted to share the tremendous progress we've made over the 12-month period ending in fiscal Q3. During that time, our bit output has been above industry average for both DRAM and trade NAND, and our cost per bit has declined approximately 25% and 30% in those technologies, respectively. In addition, we continue to improve our competitiveness by successfully delivering solutions to deliver higher value-add opportunities. Our ability to deliver these results has enhanced our energy and excitement to make further progress, and we look forward to sharing that with you. +With that, I will turn it back to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Ernie. Last week we announced that Sumit Sadana joined Micron as Executive Vice President and Chief Business Officer, a role that unites our 4 business units and our strategy and business development team into a single organization. This structure will better equip us to align our product strategies to market trends and customer demands. Sumit brings nearly 3 decades of industry experience. He's a proven leader in driving strategy and building businesses with a focus on high-value profitable growth. Sumit has a successful track record at multiple large technology companies, and his perspective and expertise make him an ideal fit for Micron. +Earlier this week, we also announced that Jeff VerHeul has joined Micron as Senior Vice President of Non-Volatile Engineering. Jeff has extensive experience in leading the development of advanced semiconductor products, including flash system-level solutions. I look forward to Jeff's contributions in advancing Micron's road map of flash memory technology and value-added products. We welcome both Sumit and Jeff to Micron. +Finally, I would like to express gratitude to my predecessor, Mark Durcan. His dedication and leadership have positioned Micron well for this next chapter of success. As I have toured Micron's facilities and met with leaders and teams throughout the company and have begun to engage with some of our customers, I have been impressed by the strength of our technologies, scale, customer reach and the innovative, hard-working spirit of our global team. My experience since joining Micron has reinforced what I have known for a long time. This company has tremendous potential and can become one of the world's most successful semiconductor companies. I'm proud to be part of this iconic company. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + Sanjay, welcome to the team. First question is for you. At the time that SanDisk was acquired by Western Digital, SanDisk had a #2 position in the global SSD markets, strong #3 position in enterprise SSD. I think you were growing that business about 15% to 20% year-over-year. If I look at the most recent market share stats, Micron is sitting at about a #5 market share position in both total SSD and enterprise SSD market share. So in what areas does the Micron team really have to focus on in order to drive a leadership position in SSD, especially enterprise? Is it systems capability, firmware, controller, OEM and cloud relationships? And more importantly, what are you going to do to start to enable this? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Well, Micron team actually has already been, as we said in our remarks, working on driving our high-value solutions mix to greater levels in its portfolio. The company has made strong progress over a couple of quarters in client SSDs as well as enterprise and cloud SSDs. And if you look at some of the market share numbers, you will see that the market share over last couple of quarters has increased meaningfully. The market share in enterprise cloud stands at sub-10% levels. And in client markets for SSDs, the market share is in high single digits at this point. So all this definitely points to much greater opportunity for the company in the times ahead. And key things that we have to focus on, this is absolutely an area of my priority here, is to increase the mix of system-level solutions in the NAND portfolio of the company. Things that have been going well, continue to build on them, but expand, diversify our capabilities, our product portfolio and deepen our customer engagements. The thing that's really, really powerful for Micron here is that Micron has strong position in DRAM as well as NAND. And basically on the continent, this is the only company that has these strong capabilities, therefore, customers are very much engaged with us in helping us drive the strength in the system-level solutions on the NAND side. In the areas where we have to focus on, to answer your question further, certainly, we continue to strengthen our controller capabilities as well as firmware capabilities. Today, some of them -- most of them are based on external controllers, and we have a road map of both external and internal controllers going ahead. So these will be an important area of focus for the company going forward. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [4] +-------------------------------------------------------------------------------- + + Great. And then, Ernie, for you on the gross margin front, solid job over the team -- by the team over the past few quarters. Going forward, you're looking for about another 100 basis points of improvements. The demand environment is shaping up to be stronger second half over first half. Supply outlook still seems pretty disciplined, and the team is doing a great job on driving the cost curves. So it seems like your gross margin expansion should be greater than the implied 100 basis points you're guiding to. Are there any mix-related impacts in Q4 which is holding back the margin profile? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + I don't think so. I think it's a function of the pattern of our bit growth over the course of this year. So while we will continue to enjoy cost reduction in the final quarter of this fiscal year, it's going to be likely at a bit of a slower rate than you've experienced for the first part of the year. And also as we look at the pricing environment, we continue to view supply and demand in a favorable way. But bear in mind, we've now had several consecutive quarters of nice quarter-over-quarter step-ups. And it isn't always advisable to bank on continued aggressive quarter-on-quarter pricing increases as you think about the business. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Chris Danely from Citi. + +-------------------------------------------------------------------------------- +Wayne Loeb, Citigroup - [7] +-------------------------------------------------------------------------------- + + This is Wayne Loeb on for Chris Danely. Can you talk about any changes you're seeing in server demand trends? Is it possible that we'll see allocation or lead time expansion in this market? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [8] +-------------------------------------------------------------------------------- + + The server demand definitely continues to be strong for DRAM. If you look at the growth for DRAM content combined with the unit server increases, the growth -- bit growth rate that we are looking at for the industry is about 40% on a year-over-year basis. So this is really high-value segment of the market. And certainly as you know, that industry in 2017 is experiencing overall tightness on the DRAM side, driven primarily by the strong growth on markets such as server as well as other markets like mobile continuing to be very strong, where the average capacities of DRAM content is increasing, given all the features that the phones are implementing, and even markets like automobile where DRAM content continues to increase nicely. So the demand trends are being driven by multiple markets. Certainly server is the highest growth trend in the marketplace today, and that's all for the DRAM side of the business. + +-------------------------------------------------------------------------------- +Wayne Loeb, Citigroup - [9] +-------------------------------------------------------------------------------- + + Okay. Can I ask you for a little bit more color on what you're seeing as far as handset demand trends? What has the impact been from China inventory correction? And also, what you anticipate the impact will be of high-end SKUs of a flagship phone being delayed? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [10] +-------------------------------------------------------------------------------- + + So I think when you look at the content of DRAMs in the mobile market, it really continues to increase nicely going in various smartphones from about a little over a gigabyte per phone to about doubling by 2018 time frame, so continued strong growth in terms of average capacity. And the same trend is certainly happening on the high-end phones too, where you are starting to see 4- and 6-gigabyte DRAM content. And certainly on the multichip packages also, we are seeing high-DRAM content as well as high-NAND content being driven in the mobile phone market. So overall, when you look at year-over-year trends in 2017 as well as when you look at the trajectory in 2018, mobile does continue to be a strong market. Certainly, there can be periods where there can be some inventory adjustments in certain parts of the market, but the important thing to focus on is really the long-term trend. And that trend, due to all the features that are being implemented, even in the entry-level smartphones and certainly on the high-end smartphones, are tending to drive higher average content and demand growth for DRAM as well as for NAND. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Mark Delaney from Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [12] +-------------------------------------------------------------------------------- + + First question is on DRAM ASPs. On the last earnings call, the company commented about how some of the contracts that have been in place for a while hadn't caught up with the substantial increase in spot pricing. And I'm wondering to what extent you expect a similar dynamic to play out as you think about the August quarter. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + I think as I mentioned in my earlier remark, we are still seeing some adjustments upward in certain segments of the market, certainly in terms of a frequency and magnitude. Those are a little less than we've experienced in the prior few quarters, Mark. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [14] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then for a follow-up question, the NAND gross margins expanded very significantly, and the company did very well on the cost per bit reduction, down 12% quarter-on-quarter. I know, Ernie, you said, we shouldn't expect cost reductions to come in every quarter at those sorts of rates, but it seems like the company's on track to exceed the 20% to 25% cost target that had guided you for NAND business for this year. And I'm just wondering to what extent you think you have the ability to exceed that prior guidance, given how much you've already accomplished. Or is there maybe other factors like mix that we need to keep in mind for the August quarter on the NAND business on cost? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes, I think it's important to remember that, that cost reduction was a 2-year CAGR. And certainly you'd expect with the kind of bit growth that we've experienced in our fiscal '17, that you would be at the upper end or above the upper end of that range. And if you go back and look at our fiscal '16, we were below. So it's important to blend those 2 years together. But the answer would get you to fairly significant cost reductions this year, commensurate with the type of bit growth that we've spoken of. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And our next question comes from the line of David Wong with Wells Fargo. + +-------------------------------------------------------------------------------- +David Michael Wong, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Technology and Services Analyst [17] +-------------------------------------------------------------------------------- + + Can you give us a bit more detail on 3D NAND, the third generation versus the second generation? You've somewhat answered it in terms of the cost, but just looking specifically at third to second generation, how much cost savings do you get and reduction in cost per bit? And does third generation have more layers or a narrower line width or both? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [18] +-------------------------------------------------------------------------------- + + So regarding the third generation, we will provide you more details as we get closer to production of that technology, obviously for competitive reasons. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Kevin Cassidy with Stifel + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [20] +-------------------------------------------------------------------------------- + + Can you say what's happening with your contract periods? It used to be PC DRAMs were negotiated every 2 weeks. I'm sure that customers are asking for extensions on those contracts. Can you just say, in general, what's your average contract time now? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [21] +-------------------------------------------------------------------------------- + + So there hasn't been a significant change during this period of time. Typically, as you noted, PC DRAM contracts are the shortest. We would actually say maybe a little longer than 2 weeks, but certainly roughly in the realm of a month or so. And then the other technologies tend to go up from there. But we haven't seen any material change in the duration as a result of the current market environment. Although there may be some requests for that, it's typically not something that gets changed very much over the course of a cycle. + +-------------------------------------------------------------------------------- +Kevin Edward Cassidy, Stifel, Nicolaus & Company, Incorporated, Research Division - Director [22] +-------------------------------------------------------------------------------- + + Okay, great. And maybe just if you could give us your views on adding more DRAM wafer capacity, what would stimulate that? Or what would be your decision to ever add wafer capacity on DRAM? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [23] +-------------------------------------------------------------------------------- + + Our focus in DRAM is to continue to advance our technology and to ramp the new technology nodes into production as quickly as we can, keeping in mind our customer requirements. And there, of course, qualification of products built using those technologies. And we always keep an eye on overall demand and supply balance and our own demand and supply balance as well, so basically prudent focus on supply growth management. But the primary focus, the one that provides highest return on investments is around technology transitions. And that's where really all our priorities will be. In terms of any new capacity, I mean, we would certainly have to first make sure that we have captured the maximum potential of our technology transition capability in manufacturing. And then we'll have to certainly see that there is sustained projection or sustained demand growth in the years ahead before we consider adding new capacity. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Srini Pajjuri with Macquarie. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [25] +-------------------------------------------------------------------------------- + + Question on PC segment, Ernie, I think you said PC is down. I just want to make sure it's not down in absolute terms. It doesn't look like it, but just want to make sure. And then if can you comment on what sort of demand trends you are seeing in PC and also the pricing trends last quarter? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Sure. So Sanjay and I may team up for this, but relative to gigs shift or the volume shift into the PC segment, as we said in our prepared remarks, we did have a slight decline in unit volume. It wasn't very significant at all, but that was part of our plan to address higher value-added markets. I don't think it was reflective of a decreased demand environment in any way, shape or form. We don't typically comment on the going-forward pricing environment, other than the general statement that we see fairly good balance between supply and demand. And we're going to continue to monitor that segment quite carefully from a bit growth perspective. I think we're thinking that, that segment would be somewhere in the range of plus low to mid-single digits in aggregate for us in fiscal '17. And I think that, that addresses the 3 points you raised, but if not, please let us know. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Yes, that's great. That's helpful. And then in terms of the cash usage, Ernie, I think in the past, you said it's mostly -- your top priority is to pay off the debt or at least reduce the debt load. And obviously, very strong free cash flow here, and then really given Sanjay's comments about the enterprise SSD focus, et cetera, I'm just curious as to if and where M&A might come in, if I kind of take a longer-term view here. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [28] +-------------------------------------------------------------------------------- + + In terms of driving our growth ahead, of course, we have several tools available to us: our technology and product capabilities, our engagement with customers and our ability on the manufacturing side in terms of implementing the new technologies into production. We would never rule out any M&A. If and when appropriate, we will absolutely consider it, but it would have to be something that does provide ROI. So we just want to make sure that we focus on our priorities. And our priorities at this point are to strengthen our technology and product execution and increase the mix of high-value solutions in our portfolio mix while engaging with customers on defining the future-generation architectures. So again, I don't rule out any M&A, but it, of course, always has to be considered in the context of what value it brings and what ROI it brings. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Romit Shah with Nomura Instinet. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [30] +-------------------------------------------------------------------------------- + + Ernie, just on OpEx that's been coming in lower than anticipated, I think, for a few quarters and in light of kind of your new product strategies and the upcoming fiscal year, can you give us just some advice on how to think about OpEx? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [31] +-------------------------------------------------------------------------------- + + We've mentioned earlier in the year that one of the biggest variables in terms of the quarterly level of OpEx is something we call pre-qual expense. So as we are going through the process of qualifying either new packages or new technologies for customers, those carry with them significant expenses. When we went into this fiscal year, we suggested that it would be more heavily weighted toward the front part of the fiscal year, and you've seen that play out here as our operating expenses have flattened out. As we look forward, we're considering OpEx as part of our fiscal year 2018 planning process, and we're not quite through that. So I think we'll be in a position to share a little bit more color on that with you on the next call. But we are, as always, very mindful of operating expenses and operating expense progression, so we're taking a very close look at that. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [32] +-------------------------------------------------------------------------------- + + Okay, great. And then, Sanjay, when the announcement was made that you were joining, I think some of us, at least the initial reaction was that there was a lot of potential to improve the mix within NAND. And so sort of seeing consumer at 40% of the business, SSDs kind of in the mid-20s, where do you think you can take the mix of business within NAND? And how long would it take for you to get it where you want? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [33] +-------------------------------------------------------------------------------- + + So at this point, we are not prepared to really lay out mix targets for the future. But I can certainly tell you that, indeed, there is great opportunity, over time, to strengthen the mix of the managed NAND solutions. That means SSDs as well as in the mobile space, things like eMMC and UFS and MCP. And again, I would like to point out that there's a large part of mobile market which demands MCP, and Micron is very well positioned with this mix of DRAM and flash. So we will definitely to focus on bringing up solution, more MCP solutions using our eMMC and UFS capabilities in the future. I would like to point out that these kind of transitions do take a period of time. Micron is, I would say, still in the early days of implementing this transition. Over an extended period of time, we definitely will be driving the mix, but it really has excessive focus of the entire leadership team here. And with the hire of Jeff VerHeul, we have certainly doubled down in this area in terms of focusing further on system-level solutions for NAND. As you know, I will also just add that in terms of the component side of things, that includes some of the sales that the company makes to Intel, which as you know, is our partner in terms of development, so that's part of that component mix that you were talking about as well. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [35] +-------------------------------------------------------------------------------- + + Ernie, I just wanted to go back to a prior answer you had. When you look -- obviously, I feel bad asking. Your cash flow obviously has grown hugely over the last couple quarters. I mean, you look at these, the cash in the next fiscal year, it wasn't that long ago people were asking how you're going to pay for CapEx, and now you're flush with cash. So I was just kind of curious your thought process. You pulled in a little in terms of transition, but it's only $200 million. Just kind of if you weigh those options in terms of faster transitions, capacity adds, buybacks as well as the debt retirement, which you did this quarter? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + Sure. So consistent with one of the earlier answers, we are in the middle of our planning process for fiscal '18. And certainly, as we look at some of the priorities of the company, they have always been highly centered around continuing to drive our costs down. So despite the fact that we have been, to some degree, mindful of that in the context of the cash flow of the company in the past, we're going to continue to do the right thing and be prudent and disciplined in that regard. We have ample opportunity to reduce the debt profile of the company. So I appreciate you thinking we're flush with cash. We're still not as flush as I would like to be. So that's going to continue to be a priority of about generating that free cash flow as well as reducing the debt. So consistent with our prepared remarks, those are the 2 things we're focused on. And you will continue to see us be very thoughtful in how we pursue both of those here as we enter our fiscal year 2018. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [37] +-------------------------------------------------------------------------------- + + And then I just want follow up on the computing strength in terms of, the next platform from Intel has more memory. Can you just maybe talk about that as a demand driver, and did that contribute? Did you see anything in terms of the builds ahead of that launch, which is more second half of this calendar year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [38] +-------------------------------------------------------------------------------- + + We certainly do think that, that will -- as it gets launched, it will be driving greater demand, certainly for bits, yes. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Is that more -- did you see any contribution yet? Or is that something that will be more next fiscal year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [40] +-------------------------------------------------------------------------------- + + I would expect it to be increasing over time. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Joe Moore with MS. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [42] +-------------------------------------------------------------------------------- + + Just to follow on, on the last question. In terms of CapEx trajectory, you've talked about a long-term number that sort of, it will be centered around 30% of sales, I believe. And I'm just curious with, Sanjay, maybe changing some of the priorities and things like that, is that still the -- without getting into the '18 plan that's not done yet, is that still the ballpark we should be thinking about long term? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [43] +-------------------------------------------------------------------------------- + + I think it's important to remember that was a long-term target. And that there are years when we've been below. There are other years when we've been above. And so I don't know that, relative to a long-term target, that we would be prepared to be making any changes at this point. But by the same token -- and if we do, certainly, as we did earlier last year, we'll share that with you. But at present time, that target remains the same, bearing in mind that it is a long-term target. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [44] +-------------------------------------------------------------------------------- + + And I would agree with Ernie that the long-term target here is definitely, I think, very appropriately placed. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [45] +-------------------------------------------------------------------------------- + + Great. Okay. And then the growth that you saw in your compute and networking, when you talk about quadrupling year-on-year in cloud, I guess that number surprised me a little bit. And how much of that do you think is sort of Micron improving penetration versus things like memory content going up, just help us understand how that number's so good year-on-year? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [46] +-------------------------------------------------------------------------------- + + I think it's obviously a combination of both. But we've been saying for some time, Joe, that this is a priority of the company to really become stronger in segments where we have the opportunity to develop deeper relationships, offer higher value add, more sustained customer relationships. And I think we've done a great job at executing on that strategy. So while there is absolutely a benefit from pricing, absolutely, we enjoyed the same benefit that others did. From the average content increase, I think we enjoyed a disproportional benefit by executing on our strategy of addressing these markets in ways that allow us to get deeper penetration. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + And our next question comes from the line of John Pitzer with Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Credit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [48] +-------------------------------------------------------------------------------- + + Sanjay, my first question is, when you think about sort of the consensus view on long-term NAND demand, it's fairly bullish, which makes sense given the SSD story. But when you think about the long-term view of DRAM demand, I think it's less sanguine. And I think the view is sort of PC units aren't really growing, handset units probably not growing all that much. I'm just kind of curious, though, when you think about these new applications like data analytics, AI, maybe level 4, level 5 autonomous driving, is there a bottoms-up argument to have a more bullish long-term view on DRAM demand? And then I'd be kind of curious because the consensus is sort of 15% to 20% might be the long-term bit growth, which would be well below sort of the historic level. I'd love to get your view. And if it's greater than 15% to 20%, is that something that's going to require more than just technology transitions to support? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [49] +-------------------------------------------------------------------------------- + + Certainly, we have, I believe, strong opportunities in technology transitions to meet the future growth expectations. As I said in a response to an earlier question as well that we definitely will have to be exploiting that fully before we would ever consider any capacity additions. And you are certainly right that the demand drivers certainly are the AI, the machine learning. There's so much data being generated. And all of that data required to be processed fast to provide a great experience to consumers as well as bring great value to businesses to enable and unleash new applications. Just as all AI in the technology space is just extremely early days and extremely dynamic. And definitely, memory and storage will become, I believe, a key enabler for the capabilities that AI technology will be able to enable in multitude of applications, whether it is autonomous driving or it is cloud computing, a variety of applications here. So yes, I mean, the demand outlook here certainly is very interesting. But again, we just do not want to be getting ahead of ourselves. I think it is important that we stay focused on continuing to drive the business with a focus on prudent supply growth here. + +-------------------------------------------------------------------------------- +John William Pitzer, Credit Suisse AG, Research Division - MD, Global Technology Strategist, Global Technology Sector Head, and Semiconductor/Semiconductor Capital Equipment Analyst [50] +-------------------------------------------------------------------------------- + + That's helpful. And then, Ernie, as my follow-up, I know you don't want give us quarter-by-quarter mix targets, but I'm kind of curious, as you sort of exit the back half of this fiscal year where you're outgrowing industry bits in both NAND and DRAM, and you move into the first half of next year where you'll be undergrowing, can you help us just kind of frame, is there enough sort of mix up opportunity during the first half of '18 where even though you might be losing some bit share, you might not be losing sort of profit share in the industry? Or how do we think about where you are on that mix optimization curve? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [51] +-------------------------------------------------------------------------------- + + Well, I think as we noted, we are making progress every single quarter with penetrating higher value-add solutions. And we would expect, if we are successful in continuing to execute on that, that we would be in a position to have greater revenue from those segments which may, depending on the pricing environment, to some degree, mitigate a little bit the bit growth profile. But bear in mind, John, that we talk about our bit growth in the context of an industry that we're estimating, but we also used the words at or slightly below, not materially below. So I do think it's important to keep that in mind. And on the NAND front, we just simply said would have a little slower growth in the first half of the year versus the second half of the year. I wouldn't expect that we were going to be dramatically different or so underperforming the industry that it would disadvantage the company. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Jagadish Iyer with Summit Redstone. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [53] +-------------------------------------------------------------------------------- + + Two questions, Ernie and Sanjay. First, if you go from 20-nanometer to 18-nanometer in the case of DRAM and as well as 32- to 64-layer in case of 3D NAND, we just want to understand what kind of cost reduction should we be thinking about? And how is the trajectory as we look through calendar '18? And then I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [54] +-------------------------------------------------------------------------------- + + So as you look through calendar '18, we will certainly be continuing to ramp our 1x DRAM technology as well as our 64-layer technology during the course of that time frame, where we are still in early stages, as we said. We'll be achieving meaningful output of both 1x as well as 64-layer this quarter here. But we continue to be ramping it during the course of the next several quarters. In terms of the bit growth, 20-nanometer provided something like, let's say, 40%, slightly greater than that in terms of bit growth compared to the prior node and gave us a cost reduction of more than 20%. And then you look at 1X compared to 20-nanometer, that's also in that same range, although 1X gives us somewhat greater cost reduction than 20-nanometer node gave us over the prior 25-nanometer node. And when we go to 32-layer compared to the planar NAND that we had -- that we have here at Micron, the last generation of planar NAND, 32-layer gave us a bit growth in volume die of about 100% or so and gave us a cost reduction of greater than -- in the range of maybe sub-30%. And going from 32-layer to 64-layer, bits gained is also about 100%. And cost reduction going from 32-layer to 64-layer is also -- at mature yields, comparing mature yield to mature yield and high volume wafer product to high-volume product, 32-layer to 64-layer will also give us about a 30% cost reduction. So Micron has been really well positioned in NAND with the 32-layer technology, which has given it meaningful cost reduction over our last planar node. And 64-layer continues that trend ahead as well. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [55] +-------------------------------------------------------------------------------- + + And, Jagadish, just to add to that, I would refer you back to some of the 2-year cost reduction CAGRs we provided at our Analyst Day, which gives you a view of fiscal '17 and '18 together. So that might be helpful to you as well as you think about that. + +-------------------------------------------------------------------------------- +Jagadish Kalyanam Iyer, Summit Redstone Partners, L.L.C - MD and Senior Analyst [56] +-------------------------------------------------------------------------------- + + Okay. That's very helpful. And finally, I just want to understand your thoughts on the DRAM channel inventory level at this point of time. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [57] +-------------------------------------------------------------------------------- + + We think that channel inventories are well within the range that we would consider to be normal. Certainly, they have improved from a quantity point of view over the first part of this year where they were extremely, extremely short. But in aggregate, I think that -- we think that channel inventory levels are still within healthy ranges. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO & Director [58] +-------------------------------------------------------------------------------- + + And I just want to add a comment to my response before to you. Your question was very specific in terms of cost reductions between technology nodes on high-volume products, essentially. And that -- those numbers should not be confused with year-over-year cost reductions, because year-over-year cost reductions on the overall blend of the business are very much a function of the technology mix that is in production. And as I indicated, these technologies will be gradually ramping up for us in production over the course of next several quarters, while the older technologies will still continue to be in production to meet our overall diversified customer requirements for a diversified mix of technology and product and solutions. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + And we have time for one more question. Our final question for today comes from the line of C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [60] +-------------------------------------------------------------------------------- + + I guess, first question, could you share your initial thoughts on what your outlook is for DRAM supply for the industry in calendar '18? And as part of that for 1x, when do you expect to reach a crossover point? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [61] +-------------------------------------------------------------------------------- + + C.J., we think the industry for calendar '18 could be slightly higher than the range of growth in calendar '17, which was this 15% to 20%. So maybe add a couple of percentage points to either end of the range. And we haven't shared yet a bit crossover for the 1X node. But we've said we'd have meaningful output by the end of the fiscal year. We're clearly on track to do that. And we'll provide more perspective on that as we more fully describe our 2018 plans. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [62] +-------------------------------------------------------------------------------- + + That's helpful. And then, I guess, a quick follow-up on CapEx. You said you're going to spend towards the higher end of the range, so roughly $300 million plus, give or take a million. Is that more DRAM or NAND? Can you share where that spending is? And is that translating into more bits? Or does it relate to rising capital intensity? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [63] +-------------------------------------------------------------------------------- + + So just to make sure we're on the same page, we had given a range this year of $4.8 billion to $5.2 billion. And we said we were trending toward that $5.2 billion range. So it's just a couple of hundred million dollars. And I would say that, really, there is no specific area that I would point you toward. It's just doing what we need to do to make sure we're well set up here as we exit the end of the fiscal year. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's Micron Technology Third Quarter 2017 Financial Release Conference Call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2017-Mar-23-MU.txt b/Transcripts/MU/2017-Mar-23-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..debf7421dde9389acf5c68bfb93584b6d03d1c34 --- /dev/null +++ b/Transcripts/MU/2017-Mar-23-MU.txt @@ -0,0 +1,802 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Micron Technology Inc Earnings Call +MARCH 23, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark Durcan + Micron Technology, Inc. - CEO, Director + * Ernie Maddock + Micron Technology, Inc. - CFO, VP Finance + * Ivan Donaldson + Micron Technology, Inc. - Senior Director IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * David Ryzhik + Susquehanna Financial Group - Analyst + * Tristan Gerra + Robert W. Baird & Company, Inc. - Analyst + * Robert Mertens + Needham & Company - Analyst + * Stephen Chin + UBS - Analyst + * Harlan Sur + JPMorgan - Analyst + * Mark Delaney + Goldman Sachs - Analyst + * Steven Fox + Cross Research - Analyst + * John Pitzer + Credit Suisse - Analyst + * Chris Danely + Citigroup - Analyst + * Timothy Arcuri + Cowen and Company - Analyst + * Jagadish Iyer + Redstone Technology Research - Analyst + * Mark Newman + Bernstein - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Kristen Shak + Nomura Secuties Co., Ltd. - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Latif and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Micron Technology second-quarter 2017 financial release conference call. +All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you. +It is now my pleasure to turn the floor over to your host, Ivan Donaldson. Sir, you may begin your conference. + +-------------------------------------------------------------------------------- +Ivan Donaldson, Micron Technology, Inc. - Senior Director IR [2] +-------------------------------------------------------------------------------- + + Thank you, Latif, and welcome to Micron Technology's second-quarter fiscal 2017 financial conference call. On the call with me today are Mark Durcan, CEO and Director, and Ernie Maddock, Chief Financial Officer. +This conference call, including audio and slides, is also being webcast from our Investor Relations website at investors.Micron.com. In addition, our website contains the earnings press release filed a short while ago and supplemental information, including quarterly operational and financial metrics and guidance, GAAP to non-GAAP reconciliations, slides used during today's conference call, and a convertible debt and cap call dilution table. +Today's call will be approximately 60 minutes in length. A webcast replay will be available on our website for one year. We encourage you to monitor our website at Micron.com through the quarter for the most current information on the Company, including information on the various financial conferences that we will be attending. You can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements based on the environment as we currently see it. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ material from statements made today. We refer you to the documents the Company's files with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a complete discussion of the important risk factors and other risks that may affect our future results. +Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [3] +-------------------------------------------------------------------------------- + + Thanks Ivan. +For fiscal Q2 2017, Micron posted total revenue of $4.65 billion with non-GAAP gross margin of 38.5% and net income of $1.03 billion, or $0.90 per share. Revenue was at the top of our guidance while gross margin, operating income, and earnings per share exceeded projections. Operating cash flow was $1.8 billion. +Last quarter, we provided detailed insight on industry pricing dynamics, explaining how the significant increases over trough pricing for PC DRAM far exceeded what we had seen in other segments, which typically react more slowly. This quarter, we saw continued gains in client DRAM pricing but also benefited from increases in mobile, cloud, and enterprise pricing as well. All of these segments showed meaningful quarter-over-quarter increases. These gains, combined with outstanding progress on cost reductions, led to a significant increase in our DRAM margins. +In NAND, we were able to capitalize on an increasing percentage of low-cost 3D TLC NAND by more fully participating in the SSD market. As a result, while blended ASPs were down slightly due to a higher density product mix, our NAND margins improved substantially over last quarter. +As we noted in our February analyst conference, we continue to see broad industry trends placing increasing value on the memory and storage technologies we develop and the features those product -- those technologies can provide. In the most recent quarter, you can see that reflected in significant increases in cloud and enterprise businesses, both in bits shipped and value of products going to those segments, and in an ongoing preference for SSDs over HDDs in storage platforms. We'll comment more on this when we walk through the specific business details in a moment. +From a supply and demand perspective, we continue to be comfortable with market dynamics given the capacity plans we are aware of today. +I'll now provide a high-level overview of each of the business units, and Ernie will follow on with more details on our financial performance. +In the compute and networking business unit, we experienced continued revenue growth as a result of strength across all market segments with particular strength in cloud and enterprise. We began enablement of our 1X nanometer products and extended our lead in graphics technology with the announcement of our next generation GDDR5X product, which is the fastest discrete memory available. +In our mobile business, as in other segments, broad market tightness has resulted in increased ASPs across all types of mobile memory. Our customers continue to be focused on increased memory and storage density for smartphones, which nicely plays to Micron strategy to focus on MCP markets. We plan to introduce more than 20 new MCP designs over the next 12 months to address the highest growth mobile applications. Customers prefer these solutions because they simplify design, validation and supply chain processes. MCPs also provide Micron with an opportunity to strengthen our relationship with key market enablers, providing a path to increased market share. +Our embedded business grew revenues this quarter through increased DRAM shipments in automotive as well as consumer and connected home applications, and we achieved record automotive revenues for the fourth quarter in a row. Increased NAND shipments to industrial multi-market customers helped offset this quarter's anticipated decline in NOR shipments to Japanese gaming applications. +Design and activity continues to be strong for our 20 nanometer DDR and LP DDR products in automotive, consumer, connected home, and Internet of Things gateway applications. In addition, design-in activity for our latest generation of automotive grade managed NAND continues to increase with new design wins up significantly over the prior quarter. +Our storage business performance this quarter was driven by continued shift to cost-effective 3D NAND TLC products, and increased traction for our SSD portfolio across the OEM cloud and enterprise markets. Wins with OEM customers enabled a record number of SSD shipments during the quarter. +Customer focus on larger capacity and tailored storage solutions led to a dramatic growth in our enterprise and cloud segments, which were our fastest-growing part of our SSD portfolio. The trend toward tailored solution drives greater opportunities for Micron to engage end customers on future IT investment planning. As we pursue these opportunities, our flexible, feature-oriented portfolio has been well received by our customers. +The storage market has broadly adopted 3D TLC products, and we are well-positioned to take advantage of this trend. We are seeing the ongoing demand for high-performance, reliable, power efficient storage driving greater SSD adoption across multiple markets. We anticipate to grow our overall storage bit output as our Fab 10X expansion continues to ramp. +Our technology transitions are on track, and will continue to provide benefit to the Company over the next several quarters. We are driving deployment of 1X DRAM with meaningful output expected by the end of the fiscal year. We expect 1X nanometer DRAM to build on our success with 20 nanometer DRAM, which is deployed throughout our portfolio and rated number one in quality by multiple enterprise OEM customers. +Likewise, we are aggressively proliferating 32 layer 3D NAND through our product lines while also driving the deployment of 64 layer 3D NAND with meaningful output expected by the end of the fiscal year. Micron's unique integration of CMOS circuitry under the array will enable the industry's smallest die size on our 64 layer designs. +As we look toward the end of our fiscal year, we are currently on track to have more than 75% of our NAND bits on 3D. Of course, certain segments require legacy NAND technologies and will transition much more slowly, embedded markets for example. +As we previewed for you at our analyst day, we believe our NAND bit growth in fiscal 2018 will approximate the aggregate market growth. This will take 3D NAND to 90% of our total bit output for fiscal 2018. +We continue to work on developing new memory technologies and are enabling our 3D XPoint technology. We will be shipping 3D XPoint memory for revenue later in 2017. We believe these innovative solutions offer unique value to enterprise customers and will be an important contributor to Micron's future success. +Now, I'll turn it over to Ernie. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [4] +-------------------------------------------------------------------------------- + + Thank you Mark. The business environments in fiscal Q2 continued to be positive with our results favorably impacted by product mix, progress on our cost improvement, and the sustained positive pricing environment. +I'll begin my remarks today with an overview of the fiscal Q2 results by technology and business unit followed by our corporate financial performance and guidance for fiscal Q3. +DRAM represented 64% of our total revenue with the following segmentation: mobile was in the high 20% range; PC represented 25%; server also represented 25%, up from the high teens of the prior quarter; and specialty DRAM, which includes networking, graphics, auto, and other embedded technologies, was in the low 20% range. +In our nonvolatile memory business, trade NAND represented 30% of our revenue with the following segmentation: consumer, which includes memory cards, USB and components, represented approximately 40%; mobile represented 20%; and as a reminder, EMCPs are primarily in the mobile segment. SSDs were in the mid-20% range, up from the mid-teens percent last quarter. And the automotive, industrial multi-market, and other embedded applications were in the high teens percent range. +Turning to performance by business unit, the compute and networking business units reported fiscal Q2 revenue of $1.92 billion, up 30% sequentially due to firm demand in a robust pricing environment. Non-GAAP operating income was $736 million, or 36% of revenue, up from 14% the prior quarter, enhanced by the pricing environment and better performance on costs. +We saw good growth in the cloud and enterprise segments driven by shipments of our first generation 20 nanometer DDR4 products. Additionally, we are beginning shipments of our second generation product optimized for the industry's newest service -- server platform. Graphics saw modest revenue growth despite what is traditionally a seasonally weak period, and we began shipments of our next generation G5X to Nvidia for the new GeForce 1080Ti, further solidifying Micron's technology leadership in the high-performance graphics memory segment. +Networking saw increased shipments and revenue driven by the continued growth of 20 nanometer 4 gigabit DDR3 and 8 gigabit DDR4 products at key OEMs, especially in Asia, and client revenue growth was primarily driven by the continued strong pricing environment. +The mobile business unit delivered fiscal Q2 revenue of $1.08 billion, up 5% sequentially, driven by a stronger pricing environment. Non-GAAP operating income was $170 million, or 16% of revenue, as pricing strength combined with improved costs. +The embedded business unit delivered fiscal Q2 revenue of $590 million, up 2% sequentially. Non-GAAP operating income was $193 million, or 33% of revenue. The results were primarily driven by increased automotive unit shipments and increased average selling prices of DDR3 and NAND on a like-for-like basis in our consumer and connected home segments. +The storage business delivered fiscal Q2 revenue of $1.04 billion, up 21% sequentially. Non-GAAP operating income was $71 million, or 7% of revenue. The results were primarily driven by strong growth in client and cloud SSD shipments and lower costs. Our 5100 cloud drive, which was introduced in December, continues to be well received and is in the process of additional calls on a large number of customer platforms. +Moving on to overall Company results, revenue for the fiscal second quarter was $4.65 billion, up 17% sequentially and driven primarily by DRAM pricing strength and increased NAND volume shipments in a stable to rising pricing environment. +Non-GAAP gross margin for the quarter was 38.5%, up from 26% in the prior quarter, driven by product mix, cost reductions, and the strong pricing environment. Non-GAAP net income was $1.03 billion, or $0.90 per share. +Turning to results by product line, DRAM revenue increased 22% compared to the prior quarter as the result of a 1% increase in bit shipments and a 21% increase in ASPs. DRAM gross margins for the second quarter increased 16 percentage points sequentially to 44% driven primarily by the strong pricing environment and cost declines. As we look at the next couple of quarters, we expect that second-half fiscal year 2017 bits out will exceed first-half fiscal year 2017 bits out by about 10%. +Our nonvolatile trade revenue, NAND revenue, increased 11% compared to the prior quarter, reflecting an 18% increase in bit shipments. ASPs were down 6% from the prior quarter on a blended basis, primarily as a result of a higher density product mix. Gross margin increased 8 percentage points sequentially to 31% as cost per bit was down 15%. We are seeing like-for-like price increases across nearly all segments and, looking forward, we expect that second-half fiscal year 2017 bits out will exceed first-half fiscal year 2017 bits out by about 30%, occurring primarily in FQ3. Non-GAAP operating expenses for the quarter were $612 million, at the midpoint of the guidance range. +The Company generated operating cash flow of $1.77 billion, representing an increase of $628 million over last quarter. +To conform to GAAP reporting relative to the Inotera acquisition, we reflected approximately $350 million of the Inotera purchase price as a reduction to operating cash flows. As a result, our financial statements reflect operating cash flow of $1.41 billion. +We ended the quarter with cash, marketable investments and restricted cash of approximately $4.6 billion. In the second fiscal quarter, capital expenditures net of partner contributions were approximately $1.2 billion. +Moving now to our guidance for the third quarter, on a non-GAAP basis, we expect the following: revenue in the range of $5.2 billion to $5.6 billion; gross margin in the range of 44% to 48%; operating expenses between $560 million and $610 million; operating income ranging between $1.8 billion and $2 billion; and EPS ranging between $1.43 and $1.57 per share based on 1.155 billion diluted shares. +In closing, we remain focused on achieving the technology transition and cost reduction targets we outlined at our analyst day. Currently, we are tracking to deliver free cash flow in excess of the $1.5 billion we shared with you at that event and continue to view delevering as an important priority. +With that, I'll turn it back over to Mark. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [5] +-------------------------------------------------------------------------------- + + Thanks Ernie. +In summary, we are heading into the third quarter with a strong market environment and steady progress on our technology initiatives. I'm preleased with our execution, and we continue to press forward together on technology, operational, and product enablement targets. Our continued progress towards these goals will enable us -- will enable further cost reductions and the opportunity to address higher value-added market segments. +Looking to the market as a whole, we see increasing customer interest in Micron playing a more collaborative role in solving design challenges and plan to use this environment to strengthen our relationships with industry partners and customers. +As you all know, at our analyst conference in February, I announced my retirement. While the board and I work to identify my successor, I remain fully committed and engaged in leading Micron through this exciting and dynamic period. We will provide further updates on our CEO search as appropriate. +Operator, we are now ready to begin Q&A. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you for taking my question, and congratulations on the solid quarterly execution and strong outlook. +Despite the very optimistic and positive pricing environment, there's been some growing concern around the notion of demand destruction given the strong pricing environment and availability of both DRAM and NAND to a point where I think there is a view forming that there's potential for PC and server destocking on the DRAM side, less DRAM per box, on the mobile side, less DRAM per smartphone and on the NAND side, less uptake of SSDs and more uptake of HDDs. I guess the question is do you see this happening, and how does it impact the dynamics of the supply-demand environment going forward? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [3] +-------------------------------------------------------------------------------- + + This is Mark. To date, we've seen no indication of that at all really in any segment. It's true that, in cycles, from time to time, that does happen late in a cycle, but, today, we see continued strong bit growth across almost every end market segment and no real indication of that occurring anywhere, in particular not in specialty, not in mobile, certainly not in the enterprise and server area. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [4] +-------------------------------------------------------------------------------- + + Great, thank you for that. And then solid results in the NAND business with your margins up I think it's 800 basis points in the quarter. As we think about the cost curve on a go-forward basis and the ramp of your 64 layer 3D, can you just give us an idea on how your yields and performance of the products are doing either relative to your internal targets or relative to the same time last year in the ramp of your 32 layer products? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [5] +-------------------------------------------------------------------------------- + + This is Mark. A year ago, Harlan, I can't catch that I even recall where we were on 3D NAND yields, but I will tell you we are very happy with where they are for 32 layer MLC and TLC. And again, TLC is the big piece of that. We are where we thought we ought to be and at very mature yields. 64 layer, as we talked about, is a material piece of our bid output late in the year, and we are very happy with the progress we are making there and the yields we are seeing on that technology as well. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Steven Fox, Cross Research. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks. Good afternoon. Just two questions from me. First of all, if you could talk a little bit more color around this -- I believe you talked about bit growth of about 30% half-over-half. Maybe qualify or quantify as much as you want to the growth drivers, how much from SSDs versus mobile, etc. +And then secondly, can you talk a little bit about the auto growth in the quarter and what's driving that and how that looks into the second half as well and what's the key contributors there? Thank you. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [9] +-------------------------------------------------------------------------------- + + Sure. So relative to bit growth with NAND, that was more statement around what our output profile is going to look like. And of course, we will deploy that output to the end markets that we feel will provide the best opportunity for the Company here as we see the back half of the year unfold. +Relative to automotive, it's very similar to what we've been consistently talking about -- driver assist systems, infotainment, a lot of what is required as we move up that autonomous driving food chain, and as what are today considered to be advanced features in automotive, the automotive business penetrates mid and lower end cars. So that -- there's nothing particularly unique about what continues to drive that. It's the same unfolding story relative to memory deployment in the automotive sector. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [10] +-------------------------------------------------------------------------------- + + I think, if the question is do we participate in all of the various pieces of automotive end demand, the answer is yes. We are in the drivetrain. We are in the ADAS systems. We are in the infotainment systems and continue to maintain strong market share in all those pieces. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [11] +-------------------------------------------------------------------------------- + + Thanks very much for that. Just real quick on the first comments, on the -- just as it applies to cloud SSDs, your own cloud SSDs that you're launching, can you give a little more color on how broadly we should see those deployed maybe during the fall of this year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [12] +-------------------------------------------------------------------------------- + + Yes. I think you're going to see them very broadly deployed. As we noted, the initial uptakes of that SSD was announced in the early part of December of last year. The uptake has been very strong, and we continue to see that growing at a significant rate here as we progress through the calendar year, along with some new features. We have a 5100 SATA drive with PCIE and NVMe coming soon as well, so we think that will help with the proliferation and the expansion of the demand. + +-------------------------------------------------------------------------------- +Steven Fox, Cross Research - Analyst [13] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Timothy Arcuri, Cowen. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [15] +-------------------------------------------------------------------------------- + + Thank you very much. I guess, Mark, I'm just looking at the guidance, and you guys are guiding to a quarterly earnings number that's like 50% higher than you guys did in the last cycle, yet your stock is still $5.00 below where it peaked last time. And I know there are some changes in the cap structure and whatnot. But I guess the question really is what's the concern you hear from investors when you've been out there on the conference circuit this quarter? Are people worried about the sustainability of the cycle, and like what is the big concern from your point of you and is that valid? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [16] +-------------------------------------------------------------------------------- + + It's a good question. I think people are looking at the cycle and wondering are we getting long in the tooth, etc.? We start to read stuff about that. We are not seeing that at all. As mentioned, we are not seeing -- really what's driving this cycle when you think about it is broad-based demand across multiple market segments, and in particular it's content growth in all of those segments as opposed to particularly strong unit growth in one segment or the other. And so as we look at the market today, it looks very robust from an end market demand, and maybe much broader and less unit-driven than we've seen in the past. +We also see that the supply, as best we can tell, seems in control relative to demand. And I think, if you think about this cycle versus last cycle, what you saw -- what you saw last cycle was a big chunk of supply come off with the Hynix fire and the reaction with more supply to replace it, and so maybe a little less stability than we're seeing this time around. So that's all on the DRAM side. +On the NAND side, this HDD replacement cycle is big. We are well into it in client. It's not going to stop in the cloud and enterprise. Mobile storage demand continues to accelerate. And so, again, it's broad-based content growth in all of those end applications, and it's supply on the NAND side that's relatively capital-intensive to put in place with complex technology. And so there, again, that all seems like it's in pretty good shape. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [17] +-------------------------------------------------------------------------------- + + Okay. I guess just to follow onto that, so it looks like, based upon the guidance, that the gross margin in DRAM is going to be in excess of 50%. Usually, that doesn't last very long, and people are obviously worried about Samsung adding a bunch of wafers. Why would that not happen this time? Based upon what you know, why would that not happen? And sort of what's your -- obviously, they have to add some wafers. But what's your base assumption for what the competition will do sort of in terms of bit growth this year? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [18] +-------------------------------------------------------------------------------- + + Again, I think the last cycle was a little different with that instability in supply created by the Hynix fire. I don't know why they would intentionally repeat the mistake from last cycle. They probably are enjoying making good margins. And our view is we just go out and we look at what information is available relative to all the various additions people are making and might be making and what the timeframe that might occur in, and then we give you -- you know, what we think that bit growth looks like. And that looks like it's probably actually -- Samsung is actually probably on the low end over the next couple of years relative to what's going on in the industry as a whole. And the industry as a whole is probably a little bit south of where we think demand growth is. So, could it happen? Yes. Why would it happen? I can't forecast that for you. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [19] +-------------------------------------------------------------------------------- + + This is Ernie. I think the important thing to bear in mind is, in the estimates that we've provided for supply growth this year of 15% to 20%, you would have to add some wafers to get into that range. Absent those wafer additions, you would be below the low end of that range, based on everything that we know. So, it is not a surprise that wafers are being added, given the forecast that we believe exists from the supply side. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [20] +-------------------------------------------------------------------------------- + + And again, the other thing to keep in mind here is there are some natural impediments. The technology is getting more expensive to deploy. It's getting more difficult. And as we look to the future, we do see trends towards new technologies that might come into place out in time, and that may be somewhat of an impediment to people as they think about do I really want to add incremental, significant new wafers to use supply when there may be competing technologies coming. + +-------------------------------------------------------------------------------- +Timothy Arcuri, Cowen and Company - Analyst [21] +-------------------------------------------------------------------------------- + + Agreed, guys. Thank you. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Chris Danely, Citi. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [23] +-------------------------------------------------------------------------------- + + I didn't know I went from Jewish to Italian. Anyway, congrats. It feels like we have stepped into a time machine and got off in 1995. +Can you just go through your price assumptions for the gross margin guide, and then also maybe list the gross margin drivers in order of importance for beyond the May quarter? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [24] +-------------------------------------------------------------------------------- + + This is Ernie. You and I have been around each other long enough to know you're not going to get an answer to your first question. We don't give underlying pricing assumptions to derive our gross margin guidance. Our gross margin guidance stands on its own for what it is. +Relative -- can you repeat the second piece, half, of your question please? + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [25] +-------------------------------------------------------------------------------- + + Sure, just list the gross margin drivers in order of importance for wait for beyond the make order? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [26] +-------------------------------------------------------------------------------- + + Yes. So, to do that would be predicting a pricing curve, which I also think is troublesome business. As we've talked about, right now, the pricing curve is much flatter than you typically see it, and the normal sort of rules of thumb as you look at segments continue to be a little bit inverted as we experience this environment that we are in. +So, we have -- we never predict that things go up and to the right for an infinite period of time. You would expect that we would be thinking cautiously as we do our internal business planning, which we do. We do apply a very consistent methodology to how we look at things, but we aren't in a position to tell you when we think that the pricing curve would return to any sort of more normalized perspective that we would have from historical reference. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [27] +-------------------------------------------------------------------------------- + + That's fine. Since I whiffed on my first question, maybe you'll allow me another follow-up. You talked about delevering now that cash flow is pretty good. Maybe give us any insight into what would be or what would trigger you to start raising capital or restructure the debt? What would be the options out there? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [28] +-------------------------------------------------------------------------------- + + I think we are pretty consistent with what we said at our analyst day. We talked about 50% to 75% of a $1.5 billion number. We are on track for that. We'll do that at a time and a pace of our choosing based upon a wide variety of business circumstances, but we do, as I said in my script, remain committed to this and think that it's an important priority for us. + +-------------------------------------------------------------------------------- +Chris Danely, Citigroup - Analyst [29] +-------------------------------------------------------------------------------- + + Great. Thanks guys. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Mark Delaney, Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [31] +-------------------------------------------------------------------------------- + + Good afternoon. Congratulations on the good results and thanks for taking the questions. +The first question was a follow-up on just the broader pricing environment. I'm not looking for any absolute number, but just hoping you could help us understand if the contract prices that Micron has seen are still below spot prices. Obviously spot prices rallied pretty significantly, but there's some time maybe before contract can catch up. And just, with what you're guiding at, do you think contract pricing is still below spot in your assumptions? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [32] +-------------------------------------------------------------------------------- + + Certainly, that's the case today. And don't forget we've also talked in the past about how some of our other segments have contracts of longer duration, so you would get the impact of a renewal of those contracts and, generally speaking, that those renewal -- that renewal pricing environment would continue to be favorable as well. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [33] +-------------------------------------------------------------------------------- + + That's helpful. And then for a follow-up question, I know the Company talked a bit in the prepared remarks about certain mix shifts that it has been executing on, doing more in areas like SSDs, and moving more towards server DRAM and creation. I was hoping you could help us understand how much more you think you can achieve in those areas through the rest of this fiscal year. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [34] +-------------------------------------------------------------------------------- + + Sure. So, on the SSD side of the house, as we mentioned I think in response to an earlier question, we think we are at the early days of what we're seeing in terms of penetration on our cloud and enterprise SSDs. I think we do have fairly good momentum and traction in clients in OEM. So that is how we are looking at or thinking about what the opportunities are on the SSD side of the house. +And then you also saw an increase in the percentage of the DRAM output that went into the server and cloud segment, and we see those continuing to increase here, or the demand side of it continuing to increase here, with all of the new data center deployments and a pretty strong demand environment for those. + +-------------------------------------------------------------------------------- +Mark Delaney, Goldman Sachs - Analyst [35] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Tristan Gerra, Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Company, Inc. - Analyst [37] +-------------------------------------------------------------------------------- + + Good afternoon. You mentioned that you 3D mix would exceed 75% by year-end in NAND. Could you remind me? Are you decommissioning 2D capacity, or is that 3D capacity all incremental? And what kind of longer-term ratio should we expect between 3D and 2D beyond this year? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [38] +-------------------------------------------------------------------------------- + + It's a transition primarily from planar to 3D. If it were 100% transition, which it's not, that ratio on a square footage basis might be something north of 2-to-1. But we have incremental space as well, so it's not exactly like that. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Company, Inc. - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. And then could you also remind me, as you transition from 2D to 3D, for the same wafer capacity, what type of bit growth do you get with 64 layer? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [40] +-------------------------------------------------------------------------------- + + From a 2D planar NAND, from a planar NAND wafer to a 64 layer 3D NAND wafer? + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Company, Inc. - Analyst [41] +-------------------------------------------------------------------------------- + + Correct, yes. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [42] +-------------------------------------------------------------------------------- + + It might be -- it's north of 300%, closer to 4X. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Company, Inc. - Analyst [43] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Jagadish Iyer, Summit Redstone. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks for taking my question -- two questions. First, in terms of the DRAM bit supply, given that you have had Inotera under your belt, I'm curious why your bit shipments were only in the low single digits. And then I have follow-up. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [46] +-------------------------------------------------------------------------------- + + Inotera has always been part of our output and measured in our bit shipments, so the transaction -- the formal closing of the transaction really did not represent an incremental addition to the Company's bit supply. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, fair enough. Then on the pricing environment for DRAM, what contributed to the 21% increase? Was there any specific subsegment of DRAM that you saw strength? And do you think that this is a one-time event, or how should we think about it? I know you would not give more clarity on pricing going forward, but any color specifically on the 21% increase would be helpful. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [48] +-------------------------------------------------------------------------------- + + We've all been able to read every week about what's happened to DRAM exchange with respect to spot pricing, and certainly that trend as influenced every single other segment. So I think, as Mark mentioned in his script, while last quarter the pricing was more focused around what was happening in the client and OEM markets, this quarter, the impact of that having extended over time and consistent with our earlier comments been subject to some of these contract renewals, are starting to manifest themselves across mobile, across enterprise, and really the full breadth of the DRAM product portfolio. + +-------------------------------------------------------------------------------- +Jagadish Iyer, Redstone Technology Research - Analyst [49] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + John Pitzer, Credit Suisse. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [51] +-------------------------------------------------------------------------------- + + Good afternoon guys. Thanks for letting me ask a question. Congratulations Mark and Ernie. Ernie, I know you're not going to talk about kind of forward pricing assumptions in the May guide, but when you look at the May guide and just how significantly above investor expectations it were, I was wondering if you could help us quantify or qualify a little bit to what extent is this being driven by cyclical leverage, like-for-like pricing, versus things that might have a little bit more longevity like your ability to mix into better end markets or your ability to cost-down or just operational efficiencies. And as you answer the question, I'd be curious just to see your view on whether or not you believe you are starting to close that cost cap with some of your peers out there. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [52] +-------------------------------------------------------------------------------- + + I think, one, to reiterate something we said earlier, but it is very important, we are really consistent quarter to quarter with how we think about our guidance. So there was no dramatic change from a methodology point of view in that. +And I think, John, you actually hit on many of the points that are contributing to that nice uptick in margin. So, first, we do have a broad profile, and that allows us to move between segments and really maximize the opportunity between those segments. And as you saw this quarter, we are tilting more to cloud and enterprise, which we think represents some good, long-term opportunity for the Company. We have system-level solutions that utilize the breadth of the Company's product portfolio in things like MCPs and builds on the capabilities of the Company with things like SSDs. You have a better technology execution, or strong technology execution, in terms of where we have been in the past, so the gap is closing. We've been consistently telling you that we think it will close and we're going to continue to make progress in that regard. +And then you do have leverage that comes from the scale that we have achieved over the course of the last two or three years as we've made these technology transitions. +So, really, I think, to the point you are making, this is not only about pricing. It's about pricing and everything else that we've been working on collectively as a team to deliver broad operational capability into all of our end markets. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [53] +-------------------------------------------------------------------------------- + + That's helpful. Then maybe as my follow-up, Mark, in your prepared comments, you talked about having meaningful 1X volume by the end of this fiscal year. I'm wondering if you could quantify what you mean by meaningful. And I guess, from my perspective, it seems like a little bit earlier than I would have expected. Is that true? And if so, are you just finding it an easier ramp? And can you remind us of sort of the cost-downs you expect to get with the move to 1X? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [54] +-------------------------------------------------------------------------------- + + I don't want to put too much specificity around exactly where we will end up at the end of the year on a bit mix, but I will tell you that you will recall, at the analyst day, we shared with you that we believe we were making very good progress on our 1X nanometer yield ramp at that time, and that continues to go really very smoothly with a good progress in both Taiwan and Japan. So, we are very happy with the way it's going, and we will continue to monitor that and drive it appropriately. +I will say also that there's a pretty good suite of products that penetrate a number of different end market segments, and those qualifications are going well and those products are looking very robust. And I'm happy with the way that's coming along. +From a cost perspective, I think greater than 20% is what we've indicated in the past, and that's probably a good place to leave it for now. At the end of the day, it will depend on mix. We've got a lot of different products going in a lot of different segments. + +-------------------------------------------------------------------------------- +John Pitzer, Credit Suisse - Analyst [55] +-------------------------------------------------------------------------------- + + Great. Thanks guys. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [57] +-------------------------------------------------------------------------------- + + Thank you. I'm wondering if you could touch on the NAND prices being down sequentially. I was little surprised to see that relative to what we are hearing. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [58] +-------------------------------------------------------------------------------- + + It's primarily around mix. We are shipping a lot of high density TLC 3D product versus, previously, we had some lower density products hanging out in some pretty small niches as our volume has gone up and as we've begun to drive more towards some of these higher density cloud type applications. We are doing more those types of products, and all of the pricing is down. They are driving some pretty significant cost improvements for us as well. And so, from a margin perspective, that's definitely where we want to be moving through time here. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [59] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. Thank you. And then your inventory picked up a little bit, and I was surprised to see that because I know how much customers want product. Can you just talk about, that and did that sort of -- is that the ramp in NAND or what are we seeing there? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [60] +-------------------------------------------------------------------------------- + + Consistent with sort of the ambitious plans we have around the SSD market, I would say the majority of that was attributable to that build-up. And in addition to that, if you are doing a quarter-on-quarter compare, Inotera on the DRAM side was not considered part of the inventory in the December quarter -- or sorry, in the prior quarter -- whereas it's currently part of our inventory. So that was really a significant part of the increase on the DRAM side. So, it's those two things. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [61] +-------------------------------------------------------------------------------- + + Makes a lot of sense. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Romit Shah, Nomura. + +-------------------------------------------------------------------------------- +Kristen Shak, Nomura Secuties Co., Ltd. - Analyst [63] +-------------------------------------------------------------------------------- + + This is Kristen [Shak] in for Romit Shah. Thanks for letting me ask a question and congrats on the great quarter, guys. +My first question, you gave some helpful commentary about the bit growth for the second half of fiscal 2017 versus the first half of fiscal 2017. I was just wondering if you could give some color about how we should think about the cost declines for the second half versus the first half. I'm not looking for anything, really concrete numbers, just anything qualitative would be great. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [64] +-------------------------------------------------------------------------------- + + I think the best way I would guide you do there is we have actually provided what we thought was going to be a fiscal year -- a fiscal year cost-down target for both technologies and we've now given you all of the pieces that you need to compute that. So, that's how I would guide you to come up with your estimate of what you think our cost-downs are going to be. + +-------------------------------------------------------------------------------- +Kristen Shak, Nomura Secuties Co., Ltd. - Analyst [65] +-------------------------------------------------------------------------------- + + Okay, great. Thanks. And then we are still seeing a lot of the spec-ing uptrends for Chinese smartphones, especially in DRAM. With the strong pricing that we've seen in DRAM over the past few months, do you see that trend changing, or do you see that trend continuing? Any color there would be great. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [66] +-------------------------------------------------------------------------------- + + Sorry, the question around Chinese phones was content or -- + +-------------------------------------------------------------------------------- +Kristen Shak, Nomura Secuties Co., Ltd. - Analyst [67] +-------------------------------------------------------------------------------- + + Yes, content, mainly in DRAM content. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [68] +-------------------------------------------------------------------------------- + + We continue to see, in the lower-end and midtier phones, we continue to see pretty good content growth. Yes, there is more of a concern at the high end in terms of what eventually will people stop taking densities up there, but even at the high end, I think we anticipate some continued growth with 6 to 8 gigabits at the top. But in the lower-tier and mid-tier smartphones, we still see pretty robust growth, and so, in aggregate, when we look at mobile, we are thinking in terms of 30% bit growth there this year. + +-------------------------------------------------------------------------------- +Kristen Shak, Nomura Secuties Co., Ltd. - Analyst [69] +-------------------------------------------------------------------------------- + + Great. Thanks guys. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Mehdi Hosseini, Susquehanna. + +-------------------------------------------------------------------------------- +David Ryzhik, Susquehanna Financial Group - Analyst [71] +-------------------------------------------------------------------------------- + + Hi, thanks for taking my question. This is David Ryzhik for Mehdi. Just two if I can. Just how can we think about contract discussions with customers? Are you seeing more long-term type of duration negotiations? And I just had a quick follow-up. Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [72] +-------------------------------------------------------------------------------- + + It's very different segment to segment, customer to customer. So, I wouldn't say that there is a huge sea change, although clearly there are some customers in this kind of environment that are interested in lengthier relationships. + +-------------------------------------------------------------------------------- +David Ryzhik, Susquehanna Financial Group - Analyst [73] +-------------------------------------------------------------------------------- + + Great. And for 3D NAND, any update on timing of QLC introduction, and would you introduce it at the 64 layer density? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [74] +-------------------------------------------------------------------------------- + + Yes, we are not going to be too specific yet about our QLC plans, but we will confirm that we are happy with the way that technology is progressing. And that's probably all we've got to say for now. + +-------------------------------------------------------------------------------- +David Ryzhik, Susquehanna Financial Group - Analyst [75] +-------------------------------------------------------------------------------- + + Thanks so much. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Robert Mertens, Needham & Company. + +-------------------------------------------------------------------------------- +Robert Mertens, Needham & Company - Analyst [77] +-------------------------------------------------------------------------------- + + Thank you for taking my question. Just two quick questions on behalf of Raji Gill. You spoke a little bit towards the yields with 3D NAND on the 32 layer. Could you just talk a little bit about your competitive advantage going forward on the 3D NAND side, and then also just give a little bit more color on your gross margin trajectory and how we should think about that throughout the year? Thank you. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [78] +-------------------------------------------------------------------------------- + + We are not going to give you gross margins, as Ernie already indicated unfortunately. We're just not going to go there. But relative to our competitive position on 3D NAND, we feel very good about it. I would direct you back to the comments we made in the slides we showed at the analyst conference a couple of months ago. +We are very happy with our 32 layer yields. We are very happy with how we are progressing on our 64 layer spec. And we think we are in the lead position relative to our cost effectiveness and our density and our ability to deliver products at all the (inaudible). + +-------------------------------------------------------------------------------- +Robert Mertens, Needham & Company - Analyst [79] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + C.J. Muse, Evercore. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [81] +-------------------------------------------------------------------------------- + + Good afternoon. Thank you for taking my question. Can you guys -- first question -- update us on your thoughts in terms of DRAM supply demand for this year? And are we to assume that tightening shortages should continue through the calendar year? And then assuming the wafers that you already have baked into that 15% to 20% supply, if we don't see new wafers next year and we just think about a world that shrinks, how should we think about supply into calendar 2018? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [82] +-------------------------------------------------------------------------------- + + We really don't have an update for you. It's still, in our view, it's 15% to 20% supply growth this year, could actually be less than that if there's less new wafers than we have in our plan. Demand is still 20% plus. Next year, we would be in the teens if we don't get the new wafers. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [83] +-------------------------------------------------------------------------------- + + Great. And as a follow-up, you talked about second-half DRAM bits being 10% higher than first-half. I'm assuming that's production. Can you hit that on a sales basis, or should we assume slightly less, given the timing of 1X? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [84] +-------------------------------------------------------------------------------- + + No, that was representative of what we think will ultimately be reflected in our financial statements. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [85] +-------------------------------------------------------------------------------- + + Excellent. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [86] +-------------------------------------------------------------------------------- + + Stephen Chin, UBS. + +-------------------------------------------------------------------------------- +Stephen Chin, UBS - Analyst [87] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. I had a question on, first of all, for the NAND flash business with mobile being only 20% of the sales there. I was wondering. Just given the relatively low exposure there currently relative to the overall market, is that implying that, for the second half of the year, you are expecting you'll see a lot of seasonality that's helping to drive some of the second-half 30% half-on-half growth? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [88] +-------------------------------------------------------------------------------- + + Again, the 30% was a function of our output, and we would direct that output into the various outlets that we have, whether it be the SSD business, the mobile business, etc. So, we will sort of wait and see how that plays out here as we get to the back half of the year. + +-------------------------------------------------------------------------------- +Stephen Chin, UBS - Analyst [89] +-------------------------------------------------------------------------------- + + Okay, that's fair. As my follow-up, in terms of the gross margin guidance, can you talk a bit about the implied cost reductions on both DRAM and NAND flash for this quarter's guidance? Just given the relatively high output for your 20 nanometer DRAM and also I guess the ramping nature of 32 layer 3D, is there still a lot of cost reduction in the current quarter from both of those technologies? + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [90] +-------------------------------------------------------------------------------- + + Again, I'd kind of refer you back to the full-year guidance that we provided, which was rather specific. We have now completed two quarters of that year, and we've given you a view of the back-half bit growth. So I think we've given you all the building blocks that you need to derive a gross margin profile, and that's not something that we typically share. +And operator, I think we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + Mark Newman, Bernstein. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [92] +-------------------------------------------------------------------------------- + + Hi. Thanks. Congrats on great results. I have a question around your supply growth, given there is such strong pricing out there in the market. So, firstly, can you talk about what the underlying wafer capacity trend is doing for Micron in both DRAM and NAND this year? And related to that, how much flexibility, given how strong pricing is today, how much flexibility does Micron have to add more either this calendar year or next year? I'm not saying that you will. Just how much flexibility do you have to add more if, for whatever economic means reasons, you could make the calculation that it does make sense to add more? Thanks. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [93] +-------------------------------------------------------------------------------- + + I think the best way -- as best as we going to characterize wafers would be to say it's pretty stable. We are very focused on technology transitions. We are not focused on adding more supply, so we are just utilizing the existing capacity and transitioning it through advanced nodes. We do have white space in both our Fab 16 in Taichung as well as Fab 10X, but we are not planning any capacity additions this year. And if we were to decide we wanted to, which I think is unlikely, for us, as for our competitors, there is significant leadtime at the moment for equipment and it would take quite a while to bring that on in the marketplace. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [94] +-------------------------------------------------------------------------------- + + Is it possible to quantify how much it would be in terms of wafers? Again, not saying you're going to add it, but just how much capacity you have the ability -- and how much do you have the ability to add in both DRAM and NAND? + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [95] +-------------------------------------------------------------------------------- + + No, and, again, it's kind of moot. So, thanks for the questions. + +-------------------------------------------------------------------------------- +Mark Newman, Bernstein - Analyst [96] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Ernie Maddock, Micron Technology, Inc. - CFO, VP Finance [97] +-------------------------------------------------------------------------------- + + This is Ernie. Before we close, I wanted to share with everyone that Ivan is going to be transitioning out of his IR role into another role here at Micron, and I wanted to personally express my appreciation to him for his support of the Company during his tenure in IR, including bringing me up to speed, which was quite challenging, I'm sure. We will miss him very, very much. We are in the process of determining how best to fill his shoes, but in the interim, Liz Morali will be the primary IR contact point. And with that, we will say thanks again for your participation and we'll talk to you next quarter. + +-------------------------------------------------------------------------------- +Mark Durcan, Micron Technology, Inc. - CEO, Director [98] +-------------------------------------------------------------------------------- + + Thank you everyone. + +-------------------------------------------------------------------------------- +Operator [99] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's Micron Technology second-quarter 2017 financial release conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2017-Sep-26-MU.txt b/Transcripts/MU/2017-Sep-26-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..fbf0495a55dc5fadd60936befd859447308a8b10 --- /dev/null +++ b/Transcripts/MU/2017-Sep-26-MU.txt @@ -0,0 +1,482 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 Micron Technology Inc Earnings Call +SEPTEMBER 26, 2017 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Shanye Hudson + Micron Technology, Inc. - Sr. Dir. Investor Relations + * Sanjay Mehrotra + Micron Technology, Inc. - President, CEO + * Ernest E. Maddock + Micron Technology, Inc. - Senior VP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Rajvindra S. Gill + Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal, Consumer IC & Multi-Market + * Tristan Gerra + Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Mark Trevor Delaney + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Steven Bryant Fox + Cross Research LLC - MD + * Karl Fredrick Ackerman + Cowen and Company, LLC, Research Division - VP + * John William Pitzer + Credit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Karen, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to Micron Technology's Fourth Quarter 2017 Financial Release Conference Call. (Operator Instructions) +It is now my pleasure to turn the floor over to your host, Shanye Hudson. You may begin your conference. + +-------------------------------------------------------------------------------- +Shanye Hudson, Micron Technology, Inc. - Sr. Dir. Investor Relations [2] +-------------------------------------------------------------------------------- + + Thank you, Karen, and welcome to Micron Technology's Fourth Fiscal Quarter 2017 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Ernie Maddock, Chief Financial Officer. +Today's call will be approximately 60 minutes in length. This call, including audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release which was filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis unless otherwise specified. Comparison to prior year non-GAAP financial results excludes stock-based compensation and the amortization of acquisition-related intangibles. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with the convertible debt and capped call dilution table. +As a reminder, the prepared remarks from this call and webcast replay will be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on various financial conferences that we will be attending. You can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we file with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +And with that, I'll now turn the call over to you, Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Shanye. Good afternoon, everyone. Our fourth quarter results accentuate an unprecedented year for the company. I thank the Micron global team for maintaining intense focus on our key priorities and delivering outstanding results. +Our fourth quarter revenue was $6.14 billion with record gross margin, operating income and free cash flow. Full year revenue, profitability and free cash flow also set company records. Our results were driven by favorable industry fundamentals and solid execution in deploying our next-generation, lower-cost technologies and diversifying our product portfolio toward a richer mix of differentiated, high-value solutions. We are excited about future opportunities as customers increasingly recognize the strategic value of our memory and storage solutions across a range of high growth markets. +Now I will share details from each of our business units, followed by our perspectives on industry dynamics and an outline of our corporate strategy. +In our Compute and Networking Business Unit, we saw robust growth in Q4 revenue and profitability compared with the prior year. Our results were driven by strong demand in cloud and graphics, complemented by a healthy pricing environment. Revenue growth from these 2 segments significantly exceeded overall CNBU growth, which more than doubled compared with the year-ago quarter. Cloud sales are supported by increasing DRAM content per server, which is up nearly 50% versus a year ago. In graphics, we continue to leverage our industry-leading GDDR5 and GDDR5X performance to address strong demand, primarily from gaming. The business unit is also benefiting from the initial ramp of our first-generation 1X 8-gigabit DDR4 product, which was sold primarily into the client and cloud segments. +In fiscal Q1, we anticipate continued growth of our 1X portfolio, coincident with the ramp of our second-generation 1X 8-gigabit DDR4 and GDDR5 products, both of which have already been validated at certain partners and customers. We also received initial customer qualifications on our TSV-stacked DDR4 products, enabling modules with up to 128 gigabyte and the highest speed supported on industry-standard server platforms. These products address the growing demand for analytics and in-memory database sales in both the enterprise and cloud segments. +Fourth quarter revenues in our Mobile Business Unit were driven by a favorable pricing environment and significant growth in our eMCP business. Due to strong execution, sales from our mobile NAND and eMCP solutions nearly doubled year-over-year. We believe that increased DRAM and flash capacities in flagship smartphones will continue, due in part to new applications such as augmented reality in mobile devices. Our roadmap of new LPDRAM, discrete managed NAND and eMCP offerings position us well to address these market requirements. +In fiscal Q4, we achieved our first 1X LPDRAM qualification at a major mobile OEM and have several others underway. Also, our technology capabilities in 1X LPDRAM package-on-package products allow us to offer cost-effective, high-capacity mobile solutions ranging from 3 gigabytes to 8 gigabytes. We expect volume shipments of these new products in fiscal 2018, following successful customer qualifications. +During the fourth quarter, we also qualified our first 3D TLC eMCP and eMMC solutions at a major chipset vendor and now have dozens of high-density products in qualification with several OEMs. We expect production shipments to start later in 2017. Our 64-layer 3D TLC UFS products will also start OEM qualifications later in 2017, enabling us to participate in the mobile market's highest-density designs. +The Storage Business Unit recorded a revenue increase of 71% in Q4 compared with the prior year quarter, supported by a strong demand for our SSD product portfolio. Late in the fourth quarter, we identified and corrected a flash component issue on select TLC 3D NAND products. We paused shipments of affected products, and we worked to implement a solution to the issue, which appeared only under a narrow set of performance conditions. As a result, our SSD revenue declined sequentially during the quarter. Shipments have now restarted, and we expect to resume solid, sequential SSD revenue growth in Q1. +We continued to garner positive momentum with our SSD products across a broad range of customers. Our flagship SATA 5100 SSD has been qualified at enterprise server OEMs, cloud service providers and Fortune 500 companies. Demand for our client SSDs is also strong with Micron shipping solutions to most leading PC OEMs. +We see healthy demand trends for SSDs moving forward. Client SSD attach rates continue to increase. And although storage density growth has slowed temporarily due to a tight pricing environment, we foresee longer-term demands for higher-density SSDs. +We made substantial progress in growing our relationships and our business with cloud and hyperscale customers in fiscal 2017. Cloud data center customers are seeking innovative memory and storage solutions tailored to their workloads. Micron's unique capabilities and expertise in DRAM, 3D NAND and emerging memory technologies make us a compelling partner for these customers. +Our Embedded Business Unit delivered strong performance, growing revenue 39% for the full year. We strengthened our leadership position in automotive in fiscal 2017, with growth driven by increasing connectivity and electronics content in vehicles. Automotive applications continue to require leading-edge performance. As a result, we have seen significant ramp of our 20-nanometer DDR and LPDDR technologies this quarter and began sampling automotive-grade 1X DRAM to meet these needs. +The growth in edge analytics in both industrial and consumer/connected home applications led to record quarterly revenues in both segments. We saw strong growth through the year of our NAND and LPDDR MCP products, driven by form factor and performance needs in applications like machine-to-machine communications, surveillance, drones and home automation. +Turning to Micron's technology progress, our 1X DRAM and our 64-layer NAND production rollout is proceeding on plan, and we expect to achieve mature yields in both technologies before the end of calendar 2017. We are pleased with our 1Y DRAM technology progress and are focused on the late stages of technology and product development. Our third-generation 3D NAND development is also proceeding well, with production expected to commence later in 2018. +This latest-generation technology continues to utilize Micron's industry-leading CMOS Under the Array architecture, which yields smaller die sizes. We have made significant progress in our technology development and volume ramp execution. We see meaningful opportunities to further shorten the cadence of new technology node introductions, accelerate new technologies into volume production, upgrade our fab infrastructure and expand our captive assembly operations. Through successful execution, we expect to narrow our technology cost gap and optimize bit output growth in both DRAM and NAND with a disciplined focus on profitable growth. +Our fiscal year 2018 CapEx plan targets achieving these objectives through technology migrations with no new wafer capacity. Ernie will discuss our CapEx plans in further detail later in the call. Our ability to successfully execute our technology transition plans will be a key enabler of our cost reduction and supply bit growth capability in the foreseeable future. +Moving on to the demand and supply fundamentals, we expect the industry to remain moderately undersupplied for the rest of 2017 for both DRAM and NAND. We see DRAM industry supply bit growth of about 20% in calendar 2017 and expect it to grow at relatively similar levels in calendar 2018. The DRAM industry supply and demand balance is expected to stay healthy throughout calendar 2018, driven in part by ongoing strength in data center and cloud computing trends. We expect Micron's fiscal 2018 DRAM bit output growth to be slightly below the industry growth rate. Our bit growth is supported by our 1X DRAM ramp, which represented mid-teens percent of our DRAM bit output in Q4 and will grow throughout the next several quarters to achieve bit output crossover as we exit calendar year 2018. +We expect industry NAND bit supply growth to finish calendar 2017 in the high-30% range. At these levels, supply remains below demand, which has created a constrained environment. As the industry continues to transition to 64-layer 3D NAND, we estimate industry bit supply growth in calendar 2018 will approach the 50% range, which should better satisfy the current unfulfilled demand. We expect that Micron's ongoing transition to 64-layer 3D NAND in fiscal 2018 will result in bit output growth that is somewhat higher than the industry range. In fiscal Q4, 64-layer NAND represented mid-teens percent of our trade NAND bit output, and we expect to achieve bit output crossover during the second half of our fiscal 2018. +The dynamic industry transition to 3D NAND is taking place in the context of a NAND market that has consistently exhibited demand elasticity. We expect this behavior to continue for the foreseeable future as higher-density SSD solutions increasingly displace HDDs in client computing, cloud data centers and enterprise environments and as average capacities continue to grow with more performance-sensitive, storage-hungry devices and applications in mobile and other end markets. These trends support our view that NAND demand drivers will remain healthy into 2018. +As I begin my first new fiscal year here as CEO, I would like to outline our strategic priorities. First, we are focused on driving our cost competitiveness to best-in-class levels primarily by accelerating the percentage of our output on leading-edge technology in both DRAM and NAND. Second, we will drive execution excellence, delivering solutions to customers quickly, predictably and in line with their product launch windows. Third, we will accelerate our transition to high-value solutions. We intend to lead the industry in deploying disruptive memory and storage solutions. Fourth, we will leverage the full breadth of our capabilities to develop deeper collaboration and partnerships with marquee customers, maximizing our value in the market. And finally, we are strengthening our focus on our teams, investing in the best talent and driving a winning culture. We believe our diligent emphasis on the speed and urgency with which we execute these strategic priorities will have a transformative effect on our market competitiveness and financial performance. +I look forward to sharing the results of our progress with you in the year ahead. I'll now turn it over to Ernie who will walk through the specifics of our financial performance this quarter. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sanjay, and thanks for joining the call today. Our solid operational execution and favorable market dynamics resulted in excellent financial performance in our fourth fiscal quarter and the full year. +For the full fiscal year, we achieved record revenue of $20.3 billion, up 64% from the prior year. We narrowed the technology cost gap with our competitors by successfully executing our technology migration plans. Our efforts resulted in strong levels of DRAM and NAND bit output growth for fiscal year 2017, enhancing our competitiveness while maintaining our wafer output. +I'll now provide some further details on Q4 results, starting with the breakdown by technology and business unit. +DRAM represented 66% of our Q4 revenue with the following segmentation: server held steady at approximately 30%; mobile was 20%; specialty DRAM, which includes networking, graphics, automotive and other embedded technologies, remained in the mid-20% range; and PC was also in the mid-20% range. +Our trade NAND revenue represented 30% of total revenue. The 3 segments comprised of SSDs; mobile, which includes managed NAND discrete solutions and MCPs; and automotive, industrial and other embedded applications, each represented approximately 20% of our quarterly trade NAND revenue. The remaining 40% of our trade NAND was made up primarily of component sales to partners and customers. +Turning to performance by business unit. The Compute and Networking Business Unit reported record FQ4 revenue of $2.8 billion, more than doubling on a year-over-year basis. The growth was supported by strong demand from cloud customers who are architecting data centers and computing capabilities that enable them to execute their specific strategies. Our successful conversion to 20-nanometer DRAM production and the initial ramp of 1X DRAM output boosted Q4 CNBU operating income to $1.6 billion or 56% of revenue, up 31% compared with Q3. +The Mobile Business Unit delivered its highest-ever revenue quarter at $1.2 billion, up 76% from the year-ago quarter. Mobile operating income also set a record at $364 million or 31% of revenue. Our results are due in part to the positive progress we've made in qualifying our mobile NAND solutions, and we expect this momentum to continue in fiscal '18. +The Storage Business Unit reported fiscal Q4 revenue of $1.3 billion, up 71% on a year-over-year basis. Revenue and operating income were slightly lower quarter-over-quarter due to the NAND component issue that Sanjay discussed earlier. With this issue behind us, we are focused on leveraging the progress we've made in penetrating the SSD markets over the past year. We estimate that our global SSD market share nearly doubled in fiscal 2017, enabling record fiscal year revenue for the Storage Business Unit. Our operating income for the first -- fourth quarter was $250 million or 19% of revenue compared with a loss of $57 million in the same period last year. +The Embedded Business Unit also achieved record performance in fiscal Q4 with revenue of $827 million, up 18% sequentially and 61% on a year-over-year basis. Growth in the quarter was driven by solid sales for consumer applications, which include home automation. Automotive also remains a key revenue driver for this business as the shift towards smarter and connected cars is driving increased memory content. These trends bode well for Micron as we continue to capture new design wins and strengthen our leadership position. Operating income for EBU was $348 million in Q4 or 42% of revenue, more than doubling year-over-year. +Moving on to overall company results. Revenue for the fourth fiscal quarter was $6.1 billion, up 10% from last quarter and 91% on a year-over-year basis. Sales of server and SSD solutions each were more than 3x higher than year-ago levels, reflecting our focus toward a higher value-add revenue mix. Non-GAAP gross margin was 51%, up 3 percentage points from Q3 and 33 points from the fourth quarter of fiscal '16. The improvement reflects the successful adoption of products based on our advanced technologies combined with a healthy industry pricing environment. Non-GAAP net income was $2.4 billion or $2.02 per share. For the full fiscal year, we achieved non-GAAP net income of $5.6 billion or $4.96 per share compared with $273 million or $0.26 per share for fiscal 2016. +Turning to results by product line. DRAM revenue more than doubled on a year-over-year basis and increased 13% sequentially. The sequential results reflect a 5% increase in bit shipments. DRAM non-GAAP gross margin for the fourth quarter was 59%, up 39 percentage points from year-ago levels and up 5 points sequentially, benefiting from an 8% increase in ASPs. We are seeing the benefits of execution on our technology migration plans and the continued strong market environment. +Trade NAND revenue increased 81% on a year-over-year basis. Sales were 8% higher quarter-over-quarter, supported by demand from mobile and embedded segments and a 5% increase in ASPs. Trade NAND's non-GAAP gross margins for the quarter was 40%, up 24 percentage points from a year ago and down 1 percentage point sequentially as a result of the NAND-related issues mentioned earlier. NAND bit shipments increased sequentially by 3% during the quarter. Our fiscal year results reflect strong adoption of our 3D TLC NAND products and a strong market environment. +As we continue -- as we consider the ongoing progress of the business as well as the competitive environment, we plan on making a few changes to our disclosures beginning with F Q1 2018. Specifically, we will be eliminating the presentation of changes in cost per bit and market segmentation detail for each technology. The evolution of our business to higher value-add solutions, which often have higher BOM costs and higher margin opportunities, makes cost per bit comparison a less reliable indicator of our progress. Relative to the market segmentation by technology, we will continue to provide qualitative color through our business unit reporting. +Non-GAAP operating expenses for the quarter were $601 million, essentially flat from the prior quarter. The company generated operating cash flow of $3.2 billion in fiscal Q4 compared to $896 million in the year-ago period. During the quarter, we deployed $1.5 billion for capital expenditures net of partner contributions and $5.1 billion for the full fiscal year. DRAM investments were between 40% and 45% of the full year spend, and nonvolatile memory was around 30%. Free cash flow for the quarter was $1.7 billion and, for the full year, was $3.3 billion compared to negative $2.7 billion in fiscal 2016. +In fiscal 2017, we deployed $1.6 billion or approximately 50% of our free cash flow for de-levering activities. The results of these activities represent approximately $0.07 of annualized EPS accretion. We ended the fourth quarter with cash, marketable investments and restricted cash of approximately $6.2 billion. +Turning to more near-term matters as we have been discussing for some time, our 2 key priorities for cash flow are accelerating the company's cost competitiveness and improving our financial foundation through reducing leverage. Our fiscal 2018 plan enables both priorities. +We currently expect our fiscal 2018 CapEx net of partner contributions to be in the range of $7.5 billion, plus or minus 5%. Our investments will be focused on technology transition and product enablement. Generally, we expect that between 35% and 45% of CapEx will be deployed for DRAM, 35% to 45% for nonvolatile memory and the remainder for technology and product enablement. There are no wafer capacity additions planned for fiscal 2018. +We will continue to target our free cash flow generation for the opportunistic retirement of debt. We see the opportunity to reach our interim target of $8 billion to $9 billion of gross debt during fiscal 2018. These actions, together with the progress that we've made in fiscal 2017, would drive annualized EPS improvement of between $0.18 and $0.23. We also see the potential to be net cash positive as we exit fiscal 2018. +Moving on to guidance for fiscal Q1 2018. On a non-GAAP basis, we expect the following: revenue in the range of $6.1 billion to $6.5 billion; gross margin in the range of 50% to 54%; operating expenses between $575 million and $625 million; operating income ranging between $2.65 billion and $2.85 billion; and EPS ranging between $2.09 and $2.23 per share based on 1,191,000,000 diluted shares. +With that, I'll turn it back to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [5] +-------------------------------------------------------------------------------- + + Thank you, Ernie. As part of our strategic planning process, Micron developed a new vision statement that embodies how we see the opportunities in front of us. As we close out one year and look to the next, I would like to now share it with you. Our vision- Transforming how the world uses information to enrich life - captures the tremendous potential Micron possesses. New technologies like artificial intelligence will change the world in ways we can barely imagine today. Fast data access and high-performance data analytics will be at the heart of those transformations, making memory and storage core to the data-centric world that is taking shape in front of our eyes. I believe our strategy to tighten our focus, accelerate our technology and product development and strengthen our presence in critical markets will make Micron an increasingly prominent player in the industry as these revolutionary new technologies take shape. Fiscal 2017 was a record year for us, but I'm confident that the best is yet to come for Micron. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of John Pitzer with Credit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Credit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- + + I guess, Ernie, my first question is just around your CapEx number, $7.5 billion. That doesn't surprise me as much as your sort of guidance around bit growth for DRAM and NAND for the fiscal year just given the significant jump in CapEx. I'm wondering if you can just help me understand, to what extent is this being driven by a back-end-loaded expectation around CapEx? And how do we think about kind of the bit growth exiting next fiscal year? And I guess, at what point do you think you'd begin to start to outgrow bits relative to the industry for both DRAM and NAND? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Yes, so multipart question. Let me try and break it down in an easily understandable way. First, as you pointed out, there is a time lag between the time CapEx is invested and the time that the bit growth is realized. And certainly, if you look at what we did in 2017, that was actually a function of the investments that we made in 2016. And it's also important to remember that the bit growth that we were able to realize from the Inotera investments were not part of Micron's CapEx plan then. So if you add Micron's spend and Inotera's spend, you're probably in the upper $6 billion range. And so that's a good point of comparison as we now look at 2018. So in 2018, we would expect the majority of the bits that are the results of the CapEx to come on towards the latter part of the fiscal year. And you heard Sanjay in his prepared remarks say that we would be at bit crossover on an output basis for our 64-layer NAND around the second or third fiscal quarter of the year. But it was going to be the exit part of the calendar year for DRAM before we hit bit output crossover on 1X. So that gives you some sense of the timing and the impacts of timing on those investments. I would also tell you that our objective over a multiyear period is to grow at about industry levels. And certainly, we think this investment plan, over the course of a multi year horizon, will allow us to do that, obviously being above in 2017 fiscal, as we've just reported, DRAM at the low end, a little above on NAND. So I think looking at snapshot comparisons across our fiscal year is interesting, but really important is the statement that we intend to grow, aligned with industry over the course of these multiyear periods. And I think that's probably the best broad perspective I can provide. Happy to address any specific question. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [4] +-------------------------------------------------------------------------------- + + And of course, our focus also would be on high-value solutions so that our revenue share outperforms our bit share. + +-------------------------------------------------------------------------------- +John William Pitzer, Credit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [5] +-------------------------------------------------------------------------------- + + That's helpful, guys. And then Sanjay, this is my follow-on question. I think clearly, the most significant concern in the investment community is the sustainability of the current environment. So I'd love to kind of get your thoughts on sustainability. And I guess, specifically, to what extent in an environment like this can you move the business from more sort of a transactional, hand-to-mouth business to something that might have more backlog and visibility with your customers, especially as you try to move the mix towards more higher value end solutions? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [6] +-------------------------------------------------------------------------------- + + In terms of the market environment, we are certainly excited about the demand requirements for DRAM as well as for NAND. As I mentioned in my prepared remarks, I mean, a big growth driver for DRAM certainly that's outpacing the average growth of the industry is in the area of server and cloud. And here, we are making great penetration with the hyperscale customers in terms of driving the growth of their DRAM business. So we remain very bullish about the DRAM market environment. Through the 2017, we think it will be undersupplied. And given the demand trends, we think we'll have healthy demand-supply balance in DRAM throughout 2018 time frame as well. And in terms of NAND, it is well known that average capacities are increasing certainly in mobile devices, but even more importantly, SSDs are displacing HDDs at a rapid pace, with attach rate continuing to be projected to be going up over the course of next several quarters. And of course, there is a strong value proposition for SSDs in the cloud and hyperscale data center environment as well, given all the trends of artificial intelligence, machine learning, all of this is driving big data analytics. So all these trends related to artificial intelligence, big growth in data, customers wanting to offer differentiated value to their end customers. All of this is driving need for memory and storage solutions. And overall, we remain pretty bullish about the demand trends. I mean, if you look at DRAM as well as NAND, even in autonomous vehicles, the demand requirements for flash, I mean, data is being generated -- so much data is being generated by autonomous vehicles that it requires fast processing both within the vehicle as well as on the cloud. So I think demand trends for the foreseeable future continue to be strong, and that bodes well for our industry. In terms of your question regarding customers and some of the customers wanting to engage in longer-term requirements, yes, that is absolutely happening, and we do consider that based on various customers. I mean, it depends on the nature of the customer's requirements. We cannot get into the details of that here in this call. But certainly, our business includes customers that are more transactional in nature, that have business more on a monthly transaction basis, some that are more on a quarterly basis, and certainly, certain customers that are also involved in longer-term trends. I think customers are just seeing the increasing value of memory and storage. I mean, this -- DRAM and flash is becoming strategic to our customers. And our customers are seeing Micron as being uniquely positioned with having a strong portfolio of DRAM as well as flash and being the only company in the western hemisphere with those capabilities. And that is definitely making us an attractive and valued partner to our customers. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Rajvindra Gill of Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal, Consumer IC & Multi-Market [8] +-------------------------------------------------------------------------------- + + Question on the NAND bit growth. So the bit growth is increasing to 50% from kind of the high-30s this year. A lot of this, obviously being driven by 3D NAND. Wanted to talk about in terms of how you're seeing the supply-demand balance going into next year and the NAND environment and kind of your thoughts around pricing as we start to have more supply and the impact also to cost per bit. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [9] +-------------------------------------------------------------------------------- + + So in terms of going into 2018, we see healthy industry demand and supply balance for NAND. And you are right to note that the bit growth is going up because of the technology transition in the industry to the 64-layer technology. And when we look at the demand trends, those demand trends continue to be strong, as I just pointed out, related to SSDs as well as increasing average capacities of flash in mobile devices and all kinds of other devices. So demand continues to be strong. We see healthy trends in that regard in 2018 time frame. Regarding pricing, we don't specifically, for competitive reasons, provide comments on pricing on the call. But we'd just like to point out that we believe that the healthy industry environment is one where price decline is less than or equal to cost decline. And we are certainly focused on aggressively reducing our product costs with -- and realizing successfully our technology production ramp of 64-layer. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal, Consumer IC & Multi-Market [10] +-------------------------------------------------------------------------------- + + And just my follow-up, Sanjay. One of the positive trends that has been happening at Micron is the diversification of the end markets for DRAM. And you could just compare this cycle, say, to previous cycles maybe not just too long ago, only about 3 years ago where PCs were a higher percentage of DRAM and now they are mid-20% range today. So can you talk about that phenomenon, and you mentioned it in your prepared remarks, but the diversification of the end markets in DRAM specialty, particularly in graphics and automotive and server, how that is affecting the business model, how that is affecting the customer relationships and engagements going forward? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [11] +-------------------------------------------------------------------------------- + + Certainly, the diversification of the end markets for DRAM absolutely bodes well for the future health of our business. We are enjoying the benefits of that. Calendar year 2017, as you noted, is a great example. And you just pointed out the mix of our DRAM business between PC. What used to be just about PC and mobile is now very much about PC, mobile, server, automotive in multitude of markets. And Micron has really great presence with variety of -- I mean, whole slew of customers and channels. So this really bodes well, plays very well to the strength of Micron. It has really, for a long time, enjoyed a diversified set of global customers and great presence in channels. And that is coming into full play as the demand requirements for DRAM continue to grow nicely and into 2 multiple mega-markets. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Mark Newman with Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + My question is about the technology migration. You talked about the 64-layer second crossover, I believe, second half FY '18. Can you talk about what's next on NAND Flash 96-layer or whatever it is and what the timing is? And will Micron look at transitioning to a charged trap flash alternative at 96-layer or perhaps one after that? And then similarly for DRAM, when -- what is the plan for 1Y and timing for EUV? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [14] +-------------------------------------------------------------------------------- + + With respect to NAND, in terms of our third-generation 3D NAND, we are not yet disclosing the number of layers in that technology. As I said in my prepared remarks, we are continuing to make good progress with that, and we plan to be introducing that technology in the 2018 -- calendar 2018 time frame and continuing to deploy CMOS Under the Array technology that continues to provide Micron a die-size leadership position, which is usually attractive cost point of view. And with respect to DRAM in terms of 1Y node, we will be introducing that node also in calendar 2018 time frame. And beyond that, we are not providing any specific details for our technology related to competitive basis. And your question regarding floating gate, we have a strong road map of future technologies related to floating gate. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [15] +-------------------------------------------------------------------------------- + + And then just as a quick follow-up if I may. When do you think you will narrow the gap or catch up potentially with Samsung in both the NAND, 3D NAND and DRAM? I mean, I think that you have alluded before to closing the gap and narrowing the gap to 0 hopefully eventually. I don't think it's happened yet. Is there an update on your thinking of when that could be? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [16] +-------------------------------------------------------------------------------- + + As we have indicated before that in terms of technology cost position as well as the technology node readiness, in recent times over the course of last couple of years, Micron has lagged the competitors in terms of getting advanced technology ready and at par with them and deploying those technologies into volume production. However, in recent times, Micron has made very good progress in this area, and we are getting the benefit of that as we are ramping those technologies into production. I have said before that these kind of undertakings, driving accelerated deployment of new technology nodes into volume production and continuing to narrow the gap on the cost front is a multiyear phenomenon, and we have made very good progress in this regard. I fully expect us to make -- continue to make good progress in fiscal year 2018 as well. And we will -- we are, of course, very much focused on continuing to accelerate the time line of our future technologies into production and then well positioned to ramp those technologies into volume production as well. And along with this, of course, remain very much focused on driving a greater mix of high-value solutions both in DRAM and NAND as well. So these are really 2 very important pillars of our strategy: driving cost competitiveness and driving greater mix of high-value solutions. And these things don't happen overnight. They will continue to be strong growth opportunities for us going forward over the course of the next few years. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Steven Fox with Cross Research. + +-------------------------------------------------------------------------------- +Steven Bryant Fox, Cross Research LLC - MD [18] +-------------------------------------------------------------------------------- + + Two quick questions for me. First of all, you mentioned that as demand -- your bit growth accelerates for NAND next year, that you expect to capture some of the pent-up demand that the NAND market is seeing. I guess, I was curious if you can talk about what gives you confidence that your -- that pent-up demand hasn't actually turned into demand destruction this year, why it will still be there. And secondly, if I look at CapEx breakdown that you provided, it looks like about $1.5 billion or so is dedicated towards product enablement. And I was just curious how that number compares to maybe a year ago and if there's anything you'd say it's most focused on. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [19] +-------------------------------------------------------------------------------- + + So I will let Ernie comment on the CapEx. But on the demand side, as I pointed out earlier, I mean, it's not that this demand is perishable. I mean, this demand -- in terms of the trend of SSDs replacing HDDs in clients' notebook computers where their attach rate continues to increase in 2017, attach rate of SSDs to PCs is around 35%. That attach rate, over the course of next few years, continues to grow to around 50% in 2018 and, by 2020 time frame, expected to grow to around 75%. So these demand trends are secular in nature. It's the same thing on the enterprise side and on the cloud side that attach rates of SSDs as well as the average capacity requirement on a per-server basis continue to go up as well. So these are really very solid secular trends here that are long term in nature. And of course, the trends of mobile devices adding new rich features such as augmented realities, such as rich displays, all of these are trends that also continue to drive higher average capacities in mobile devices. So I feel very good about the demand trends on the NAND side. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, and just to follow up on the CapEx. If you look year-on-year, we just reported the totality of fiscal '17, and you would get a reasonably similar number within the ranges we provided. So there, we would expect on a hard dollar basis perhaps $100 million to $200 million more in that enablement and technology piece of the business. And that's predominantly related to the centers of excellence that we've been talking about relative to wanting to consolidate a lot of our back-end operations very close to our front-end operations. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [21] +-------------------------------------------------------------------------------- + + Some of the product enablement CapEx is related to back-end captive assembly operations, which will help us improve our cost position going forward. And of course, also, there is CapEx associated with upgrading of the infrastructure that is needed to realize the technology transitions. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Chris Danely with Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [23] +-------------------------------------------------------------------------------- + + Can you just give us a little color on, I guess, the 3 main end markets, server, mobile and PC on tightness or relative tightness and how it trended during the quarter? And any information, either qualitative or quantitative, you have on inventory levels out there with channel or at customers? Just on DRAM. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + Sure, Chris. So I think as has been the case for a few quarters now, there's actually a fair amount of tightness across that -- across those 3 channels that you mentioned. So it would be hard to distinguish one from the other relative to any nuances there. I don't think there's an inventory issue. Certainly, if you actually take a look at inventory levels that are reported, which are typically financial numbers, and adjust those for dollar costs of how pricing has changed over the course of the year, you do get a bit of a different perspective on inventory, as reported by a variety of customers and channel partners in those areas, but the environment continues to be strong. The supply-demand circumstances continue to be fairly tight, and we're working very closely with our customers to make sure that we stay in close sync with them as they think about their plans going forward. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [25] +-------------------------------------------------------------------------------- + + And for my follow-up question for Sanjay. By the way, welcome to the DRAM party. You were not afraid to engage in M&A at your previous shop. Can you talk about the willingness or appetite for M&A at this point for Micron versus the desires to continue to improve the balance sheet? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [26] +-------------------------------------------------------------------------------- + + We do not rule out M&A in the future. Right now, our focus is on the priorities that I mentioned that include cost competitiveness and strengthening the high value mix in our revenue. And of course, if and when we were to engage in M&A, our focus would, of course, be to try to strengthen our future opportunity and make it an opportunity that absolutely provides a strong ROI. Beyond that, I will not speculate in this matter. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Karl Ackerman with Cowen and Company. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - VP [28] +-------------------------------------------------------------------------------- + + Ernie and Sanjay, I wanted to ask more of a strategic question. Two of your competitors in the NAND industry have been at disagreement on the trajectory of their manufacturing partnership. Are you and your existing NAND partner inclined to abstain from future partnerships? And I have a follow-up, please. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + I don't think the experience that, I think, you're referring to, colors our perspective on partnerships, at all partnerships are very individualized, partner-specific set of activities. And so certainly, while we continue to become informed just as you do, our color would be very specific to the circumstances at hand vis-a-vis any potential partnerships or the continuation of any partnerships. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [30] +-------------------------------------------------------------------------------- + + And I think we have a long history of valued partnerships here and knowing how to make the partnerships work well. So I mean, partnerships are important. Absolutely. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - VP [31] +-------------------------------------------------------------------------------- + + Understood. Appreciate the color. I guess, for my final question. This was somewhat addressed earlier in the call. I just want to move back to just some of the content growth that we have been talking about. But our fieldwork during the quarter indicated that DRAM fulfillment rates, at least in the server market, improved from last quarter, but they were still well below 100%. Are you seeing more active engagement today with tier 2 customers for longer-term contract agreements that gives you greater confidence in your capacity planning assumptions? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [32] +-------------------------------------------------------------------------------- + + I mean, we are definitely seeing strong demand trends from the entire spectrum of our customers. Large, what you would call Tier 1 or Tier 2, as you term, although all customers are important to us, and we do engage meaningfully with them and we work closely with them to understand their demand requirements. And we apply our own judgment to their demand requirements as well in terms of assessing the overall industry demand trends. And based on those demand understanding of our -- on behalf of our customers, we project healthy industry demand-supply environment in DRAM and NAND. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Vijay Rakesh with Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [34] +-------------------------------------------------------------------------------- + + Just looking on the DRAM side. You mentioned the crossover of 1X nanometer. When do you expect to see that? And if you can give some color on what the cost structures are as you transition the mix to 1X. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [35] +-------------------------------------------------------------------------------- + + Sure. So we talked about being at bit output crossover for 1X DRAM by -- before the end of calendar year 2018. And then as we have previously shared for the 1X node, we see somewhere roughly 45% increase in bits per wafer versus 20-nanometer and about a 20 -- to slightly more than 20% cost reduction on a cost per bit basis. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [36] +-------------------------------------------------------------------------------- + + Right. Got it. And on the NAND side, obviously, pretty nice numbers on the storage business side, up 71%. But could you parse out how much is enterprise mix for you on NAND? And obviously, you guys have seen some good traction there. Where is the enterprise mix exiting next year, let's say? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [37] +-------------------------------------------------------------------------------- + + So we said that our SSD makes up about 20% of our NAND revenue, and that consists of our sales of client -- to client customers as well as to the hyperscale cloud and enterprise customers. And both are roughly about the same in both of those categories. Beyond that, we don't provide further breakdown. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And our next question comes from the line of Tristan Gerra with Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Looking at your production cost reduction time line. Is it fair to assume that there's going to be some slowdown as you reach crossover for 64-layer in NAND? Meaning that after that, there could be a little bit of a slowdown in terms of your ability to reduce production costs. And then if you could reiterate the production cost reduction targets for NAND and DRAM for 2018? + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + Sure. So I think that in terms of gen 3 NAND, we'll certainly talk more about that as we are able to in terms of what we might expect and whatever is appropriate for that. So it is true, just on a mathematical basis, that as you progress up layer count on an absolute basis, there are less incremental bits, and there is an association between cost reduction and bit growth opportunity. But in terms of providing specifics, it's very, very early to share that with you. And if you look at 64-layer versus the first generation, it's somewhere in the realm, as we've talked about before, of 2x the density and roughly in aggregate of 30% reduction in bit cost. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [41] +-------------------------------------------------------------------------------- + + In general, the technology complexity increases with subsequent technology generations both in DRAM and NAND. And also given the increased technology complexity, gigabytes or gigabits that you gained in NAND as well as DRAM on a per-wafer basis tends to decline with advanced technology nodes. So all of those factors play a role in terms of cost reduction capabilities as well going forward. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [42] +-------------------------------------------------------------------------------- + + Okay, great. And then a quick second question. So you talked about the adoption rate trajectory of SSDs in notebooks. Could you also give us your expectation both now and, say, in a year or 2 in terms of the adoption rate for SSDs in a data center and traditional enterprise server? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [43] +-------------------------------------------------------------------------------- + + Sure, I can do that. And I just want to add a comment to the previous question on cost. My comment was related to cost on a per wafer -- gigabytes-per-wafer basis from one technology node to the next. Of course, cost also depends very much on how you deploy those technologies into volume production, and this is one of our focus areas in terms of deploying advanced technologies faster into production. Now specific to your second question regarding the attach rates in enterprise and server markets, so SSD attach rate is around 50% there in terms of -- on an SSD per-unit basis. And opportunity, there is greater. Average capacities are definitely moving fairly fast. In fact, enterprise and data center is one of the fastest-growth segments for flash in terms of year-over-year bit demand increases that are projected. Average capacities in enterprise and data center for SSDs are over 3 terabytes. That's the average capacity, and that trend continues to increase by some projections, tripling almost to 9 terabytes by 2020 time frame. So as I was saying earlier, I mean, these demand trends for increasing attach rate of SSDs in client and data center cloud computing applications as well as increases in average capacity are secular trends. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Mark Delaney with Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [45] +-------------------------------------------------------------------------------- + + First question is a follow-up on CapEx. I was hoping you could clarify the comment about no new wafer capacity additions. I know you said that explicitly for DRAM, but can you clarify if that also applies to NAND Flash? And on that topic, if you could help us understand to what extent you may need to invest in new cleanroom capacity as part of that CapEx guidance next year, obviously even without adding new wafer capacity that the amount of factory floor space is going up for both 1X nanometer and more so for 3D NAND. I know the company had some available. But just wondering if any of the spending relates to cleanroom capacity due to the floor space requirements. + +-------------------------------------------------------------------------------- +Ernest E. Maddock, Micron Technology, Inc. - Senior VP & CFO [46] +-------------------------------------------------------------------------------- + + Yes, Mark. So certainly, the statement about no new wafer capacity in fiscal year 2018 applies equally to both DRAM and NAND. And relative to your second question, there is not anything material relative to the CapEx guide that we shared that relates to construction costs or whatnot. As you pointed out, there is obviously incremental cleanroom space available or could be available at pretty low cost, but it would not be material in the course of the overall guide that we provided. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [47] +-------------------------------------------------------------------------------- + + Okay. And if I could just follow up specifically on smartphone demand trends. If you could touch on what the company is seeing in terms of end demand for some of the flagship models specifically, but also if you could talk about some of the Chinese domestic OEMs, if you're starting to see any pickup in demand trends for memory from those customers. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - President, CEO [48] +-------------------------------------------------------------------------------- + + I think in the flagship models, to answer your specific question, the demand for DRAM as well as for NAND, average capacities continues to go up. And of course, the mix of these high-end smartphones also, as a part of the total smartphone market, continues to go up. And specifically to DRAM, average capacities of DRAM in high-end smartphones, going from somewhere over 3 gigabyte in 2017, projected to go up to over 5 gigabyte, closer to 6 gigabyte by 2020 time frame. And specifically to NAND, average capacities of NAND in high-end smartphones in 2017 somewhere around 70 gigabytes, let's say, projected to double or more than double by 2020 time frame as well. So again, the average capacity increased trend in smartphones continues to be solid, not only, actually, in high-end smartphones but in value segment of the smartphone market as well. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + And that concludes our question-and-answer session for today. I'd like to turn the floor back over to Micron for any closing comments. + +-------------------------------------------------------------------------------- +Shanye Hudson, Micron Technology, Inc. - Sr. Dir. Investor Relations [50] +-------------------------------------------------------------------------------- + + Thank you. That concludes our call today. We really appreciate your support. And as a reminder, we will be posting the prepared remarks from today's call as well as a webcast replay on our website later this afternoon. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2018-Dec-18-MU.txt b/Transcripts/MU/2018-Dec-18-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..c3ad66c6d13840290b21b0d39c01e9741b57de8e --- /dev/null +++ b/Transcripts/MU/2018-Dec-18-MU.txt @@ -0,0 +1,395 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 Micron Technology Inc Earnings Call +DECEMBER 18, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Brian, I'll be your conference facilitator today. At this time, I would like to welcome everyone to Micron's First Quarter 2019 Financial Release Conference Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Farhan Ahmad, Head of Investor Relations. You may begin your conference. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology First Fiscal Quarter 2019 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call, including audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures can be found on our website, along with the convertible debt and capped call dilution table. As a reminder, the prepared remarks from this call and webcast replay will be available on our website later today. We encourage you to monitor our website at Micron.com throughout the quarter for the most current information on the company, including information on various financial conferences that will -- we will be attending. We can also -- you can also follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we filed with the SEC, specifically, our most recent Form 10-K and Form 10-Q, for a discussion of risks that may affect our future results. Although, we believe that the expectations reflected in the forward-looking statements are reasonable, we can't -- cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon, everyone. In the first quarter, we demonstrated solid execution, further improved our balance sheet and began executing on our $10 billion share buyback program. We delivered strong profitability despite revenue headwinds from the inventory adjustments at several customers, and industry-wide CPU shortages. Our results also reflect our success in further diversifying our business as evidenced by record sales in our mobile, automotive and industrial businesses in the quarter. As we enter calendar 2019, we are seeing weakening demand from our customers. As a result, we are taking decisive actions, including a meaningful reduction in our fiscal 2019 CapEx plan, in both DRAM and NAND that will materially reduce our supply bit growth. I'll provide more details on these items later in the call after first reviewing the highlights of the quarter. I'll start with our execution progress. We are focused on improving our cost structure and increasing the mix of high-value solutions in our portfolio, both of which provide immediate benefits, and strengthen Micron's ability to drive long term profitable growth. Our cost reductions in DRAM and NAND have meaningfully outpaced the industry over the last 3 years. Our progress on advanced technology gives us confidence that we will deliver healthy year-over-year cost declines in DRAM and NAND in fiscal 2019, even after taking into account the supply and CapEx changes, which I referenced earlier. +In the first quarter, we achieved crossover of 1X nanometer DRAM shipments, and started revenue shipments of 1Y nanometer products. Our 1Y year ramp is ahead of schedule, and we remain on track for meaningful production by the fiscal third quarter. We're also making excellent progress on our 1Z technology, which leverages our leadership in advanced materials and cost effective lithography techniques. In NAND, we continue to lead with our QLC product offerings, and have introduced both consumer QLC and VME SSDs and enterprise QLC SATA SSDs. +In the first quarter, we started shipping 96-layer NAND products. Yields on 96-layer are ahead of plan. We remain focused on increasing the mix of high-value solutions in our portfolio, and investing in differentiated products for our customers. In DRAM, we introduced our 1Y nanometer 12-gigabit low-power DRAM, which offers the highest density available for the mobile market. We are seeing strong demand for this product as the market continues to move toward higher densities. +In NAND, high-value solutions now represent over 50% of our NAND bits, which is an important milestone for us. The improving mix of high-value solutions increases our gross profit opportunity and provides better margin stability. The strength of our high-value solutions this quarter, which was driven by managed NAND products, helped us maintain overall NAND gross margins above 45%, despite industry oversupply. We strengthened our number 1 share position in SATA enterprise SSDs, gaining about 3 percentage points of market share sequentially, according to industry reports. In addition to the QLC consumer and VME SSD, mentioned earlier, we also introduced the industry's first one terabyte TLC and VME automotive SSD in the first quarter. We are working to further expand our NVMe [4] product portfolio, and plan to introduce SSDs targeting client, enterprise and cloud markets through the course of calendar 2019. +Looking ahead, we expect the SSD market opportunity will continue to shift from SATA to NVMe. Fiscal 2019 will be a year of transition for our SSD portfolio, and we expect our SSD share gains to resume in fiscal 2020. In the meantime, the growth of our high-value NAND solutions in fiscal 2019 will be driven by our mobile managed NAND products, where we believe we have significant opportunity to increase share. In the first quarter, we shipped multiple high-capacity, high-performance UFS solutions, nearly tripling our bit shipments quarter-over-quarter. +We continue to make good progress in developing high-value solutions using our 3D XPoint technology and plan to introduce differentiated products towards the end of calendar 2019, as previously discussed. Our conviction in the opportunities ahead is reflected in our October announcement that we intend to exercise our option to acquire Intel's interest in the IMFT Facility in Lehi, Utah, early in calendar 2019. +Now turning to end markets. I will start first with mobile, where we set records for revenue, gross margins and operating margins in the first fiscal quarter. In addition to strong seasonal sales, we benefited from major product wins with several customers, which is driving our managed NAND share gains. We are seeing strong demand elasticity in this market, and within our MCP portfolio, our average NAND density was up over 25% sequentially, and over 150% year-on-year. Content growth also continues to do well in mobile DRAM, with more than 25% growth in density per unit shipped on a year-on-year basis. We expect content growth to continue in mobile devices, driven by broader use of artificial intelligence, and the increasing number of cameras in the average smartphone. These elements will become pervasive, while the industry readies for 5G implementation. In data center markets, we saw reduced revenue coming off a record-setting fiscal fourth quarter, due primarily to inventory adjustments at our customers. We expect this headwind will persist for a couple of quarters. We are seeing some cloud customers go through a digestion period following very strong growth over the last 2 years. +We believe we are still in the early innings of cloud growth and long-term end customer demand trends remain strong in this market. Our engagement with our customers continues to be deep, and now includes collaboration on our 3D XPoint product roadmap. Higher density DRAM products are seeing stronger demand across the data center market. Revenue from our high-density 64 gigabyte DRAM modules grew more than 50% quarter-over-quarter. We are focused on the upcoming industry transition from 8 to 16 gigabit DRAM, and expect to start sampling our new 16 gigabit DRAM by our fiscal third quarter. In graphics, we started volume ramp of our high-performance GDDR6 memory, and are working closely with our key customers in this segment. Higher-than-normal inventories in gaming cards and the fall off in crypto-related demand created revenue headwinds, which we expect to continue for a couple more quarters. +Looking ahead, we see broadening interest in high-performance graphics memory for AI enablement in segments like data center and automotive. Our product leadership in GDDR6 is already creating new opportunities in these segments. +Turning to markets requiring our long life cycle products. In the fiscal first quarter, we had record revenue in auto and industrial markets, with a sequential expansion in gross margins. Strength in automotive continues to be driven by increasing demand for in-vehicle infotainment and advanced driver assistance systems. As a result, we see strong demand for our latest generation of automotive products. In November, we announced a collaboration with BMW to define and validate next generation automotive solutions. This is another proof point of Micron's leadership in automotive, and the growing criticality of memory and storage to leading-edge automotive applications. +Turning to our DRAM industry outlook. As I've mentioned previously, DRAM demand weakened through the course of our fiscal first quarter. Since the start of this fiscal second quarter, the weakening demand trend has continued, and our near-term visibility is limited. Due to a lengthy period of rising DRAM prices, we believe some of our customers had decided to carry higher-than-normal inventory levels, and as DRAM supply caught up with demand, these customers are bringing down their inventory levels. Smartphone unit demand is also continuing to weaken, particularly, at a high-end in what is seasonally slow quarter for mobile. +Lastly, we are continuing to see the impact of CPU shortages. While our customers' end market demand in segments like industrial, cloud, enterprise and client compute is healthy, this inventory adjustment period will contribute to weaker demand conditions in DRAM that will likely persist through the first half of calendar 2019. We now expect DRAM bit demand growth for the industry in calendar 2019 at approximately 16%, compared with our prior expectation of approximately 20%. Even after factoring in the recent CapEx cuts publicly announced across the industry, DRAM supply growth is tracking above our view of demand growth in calendar 2019. Given this supply-demand dynamic, we are taking decisive actions to lower our DRAM bit output growth to approximately 15% for calendar 2019, versus our prior plan of around 20% bit growth. These actions include a significant reduction to our capital expenditures in fiscal year 2019. Based on our current demand estimates, our DRAM bit shipments for the fiscal second quarter will decline sequentially, but more importantly, are likely to be flat to down on a year-over-year basis as well, consistent with a weak quarter for the memory industry and significantly below the long-term demand growth rate. This shows that inventory adjustments by our customers are well underway. Barring weaker macroeconomic conditions, we expect our DRAM bit demand to grow sequentially in our fiscal third quarter. +Looking beyond fiscal Q3, as we enter the second half of calendar 2019, we expect a healthier demand environment alongside an improved industry supply picture, which should contribute to improved financial performance. +In NAND, while the inventory levels at customers are in better shape, NAND suppliers appear to have elevated levels of inventory. The transition from planar to 3D NAND in the industry and successful ramp of 64-layer across the NAND manufacturers has resulted in oversupply in the market over the last several quarters. We currently expect calendar 2019 NAND industry bit demand growth to be approximately 35%, with ongoing impacts due to client compute CPU shortages, and weaker high-end smartphone unit demand. Even after taking into account recently publicly announced NAND CapEx reductions for calendar 2019, our assessment is that the NAND industry supply growth will exceed industry demand growth in the coming calendar year. We are, therefore, lowering our 2019 planned NAND bit growth, and further reducing our fiscal 2019 NAND CapEx. We now expect our calendar 2019 NAND supply bit growth to be meaningfully reduced from prior expectations, and expect our bit shipment growth to be in line with the industry demand at approximately 35%. We also expect NAND demand to accelerate in the second half of the calendar year, as demand elasticity kicks in for the mobile, enterprise and client markets. Given our attractive cost structure on leading-edge NAND and DRAM, in this market environment, we will manage pricing and carry inventory as necessary to optimize our profitability. We are taking decisive action on the supply side to manage our business in a prudent fashion, with an eye towards delivering a robust return on our investments. Our actions will significantly reduce our fiscal 2019 CapEx and allow us to continue delivering strong profitability and healthy free cash flow, while investing in our strategic priorities as we position Micron to capitalize on the exciting growth opportunities for the company. +I'll now turn it over to Dave to provide financial details of our fiscal first quarter and guidance for the second quarter. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. Micron delivered strong results in our fiscal first quarter, including double-digit year-over-year growth in revenue, gross profits, and earnings per share. While our near-term outlook has become more challenging, the actions taken to improve our cost structure and increase our mix of high-value solutions, will ensure that our profitability profile remains strong. Moreover, Micron's financial position remains healthy, with an improved net cash position and with total liquidity reaching our target levels. +Total fiscal first quarter revenue was $7.9 billion, up 16% from the prior year, and down 6% from the record fiscal fourth quarter. Revenue was adversely impacted by inventory adjustments at key customers in the cloud, graphics and enterprise markets. Offsetting these headwinds, we delivered record revenue in the mobile, industrial and automotive markets. DRAM represented 68% of total company revenue in the fiscal first quarter. DRAM revenue increased 18% year-over-year and declined 9% from the prior quarter. +On a blended basis, DRAM ASPs declined high single digits percent compared to the prior quarter, while shipment quantities were relatively flat. Trade NAND revenue represented 28% of total company revenue in the fiscal first quarter. Trade NAND revenue increased 17% year-over-year and declined 2% quarter-over-quarter. Our overall NAND ASP declined in the low- to mid-teens percent, and shipment quantities increased in the low to mid-teens percent, compared to the prior quarter. +Now turning to our revenue trends by business unit. Revenue for the Compute and Networking Business Unit was $3.6 billion, up 12% year-on-year and down 17% quarter-on-quarter. The sequential decline was driven by the impact of inventory adjustments at some of our customers in the graphics, enterprise and cloud markets. The Mobile Business Unit delivered a strong quarter, with record revenue of $2.2 billion, revenue increased 62% year-over-year and 17% from the prior quarter. Revenue growth was driven by the continued strength of our low-power DRAM offerings, and share gains in our mobile managed NAND business with several leading handset customers. +Embedded Business Unit revenue of $933 million was up 12% year-on-year, and up 1% quarter-on-quarter. The automotive and industrial business -- businesses had record revenue, driven by strong sales of our DRAM and NOR products. +And finally, turning to the Storage Business Unit, or SBU, fiscal first quarter revenue was $1.1 billion, down 17% year-on-year and 8% quarter-on-quarter. The sequential decline in revenue was driven by weaker pricing and the ongoing transition from SATA to NVMe SSDs. The impact of this transition will continue through calendar 2019. Our strategy to move bits from SBU components to high-value solutions in mobile is also contributing to a decline in revenue for SBU. +The consolidated gross margin for the fiscal first quarter was 59%, up 360 basis points from the prior year, and down approximately 230 basis points from the prior quarter. This includes a 120 basis point impact from 3D XPoint underutilization costs. +During the last few months, we successfully leveraged our global supply chain to mitigate the impact of the China trade tariffs to less than 50 basis points to our consolidated fiscal first quarter gross margin. We expect to be able to mitigate approximately 90% of the impact from tariffs starting in January 2019. We believe that Micron will not be directly impacted by any expansion of trade tariffs to additional product categories. +Operating expenses were $783 million, slightly above our guidance, mainly due to higher-than-expected prequalification expenses associated with new product introductions. +Looking forward, as our joint development work with Intel comes to a conclusion around the end of this fiscal year, the R&D cost-sharing between the companies will naturally reduce and come to an end. In the fiscal first quarter, Intel's share of joint R&D expenses was approximately $30 million. We expect that our R&D expenses will continue to increase in the coming quarters, due to the combination of these declining R&D contributions from Intel, as well as increased investments in future technologies and high-value solutions across our portfolio. We continue to drive strong profitability in the fiscal first quarter, with operating income of $3.9 billion, representing 49% of revenue. This margin is up 3 percentage points year-over-year and down 3 percentage points from the fiscal fourth quarter. +As previously mentioned, the improvements that Micron has made over the prior several years have resulted in structurally higher margins. The tax rate for the fiscal first quarter was 10%, and we expect our fiscal year 2019 tax rate to be around 11%. Non-GAAP earnings per share in the fiscal first quarter totaled $2.97, up from $2.45 in the year ago quarter and down from $3.53 in the prior quarter. We commenced our capital return program in the fiscal first quarter with the repurchase of $1.8 billion of common stock, representing a reduction of approximately 42 million shares or about 3.5% of shares outstanding. We expect to remain active with our stock buybacks in the fiscal second quarter, as we continue to make progress on our $10 billion repurchase program by returning at least 50% of our ongoing free cash flows to shareholders. +Turning to cash flows and capital spending. In the fiscal first quarter, we generated $4.8 billion in cash from operations, representing 61% of revenue. Capital spending, net of third-party contributions, was $2.5 billion, up from $2.1 billion in the prior quarter. In the fiscal first quarter, our free cash flow was approximately $2.3 billion, up about $600 million from the year ago quarter, and down approximately $750 million from the prior quarter. We deployed approximately 80% of the quarter's free cash flow towards our share repurchase program. Even with the substantial outlay for share repurchases, we ended the fiscal quarter in a record net cash position of $3.1 billion, with approximately $7.2 billion in cash, marketable investments and restricted cash, and $4.1 billion in debt. While we largely completed our deleveraging activities in fiscal year 2018, we further reduced our debt balance in the quarter by approximately $500 million through the settlement of outstanding convertible note redemptions of $160 million and other scheduled payments. +Overall, our solid balance sheet, strong cash flow, and robust liquidity put us in an excellent position to execute on our capital returns program. +Prior to issuing our fiscal second quarter guidance, I'd like to provide some context for our outlook. Due to the weaker demand environment, we expect fiscal second quarter sequential bit shipments to be down meaningfully for both NAND and DRAM. Given the weaker near-term outlook, we are lowering our CapEx plans to a range of $9 billion to $9.5 billion for fiscal 2019. At the midpoint, this represents a $1.25 billion reduction from our prior guidance, and our front-end equipment CapEx is now down year-on-year. We'll continue to remain flexible with capital spending to respond to market conditions. +With that in mind, our non-GAAP guidance for the fiscal second quarter is as follows: we expect revenue to be in the range of $5.7 billion to $6.3 billion; and gross margins to be in the range of 50% to 53%; operating expenses are expected to be $800 million, plus or minus $25 million. As we execute on longer-term growth investments, we're actively managing OpEx by implementing expense controls across the company, including tighter controls on headcount, holiday work schedule slowdowns and reductions in discretionary spending. Based on a share count of approximately 1.15 billion fully diluted shares, we expect EPS to be $1.75, plus or minus $0.10. +In closing, Micron continues to deliver solid financial results on a stronger performance foundation. We are making progress on all of our key initiatives, including our high-value solutions product portfolio, our cost profile, capital return program, and financial structure, with a record net cash position, and $9.7 billion of liquidity at the end of the fiscal first quarter. While near-term market conditions are challenging, we are taking appropriate steps to manage production and spending, in order to deliver healthy profitability and cash flows. There is no doubt Micron remains in the strongest financial position in the company's history, as we transition to next-generation technologies and products. +I'll now turn the call over to Sanjay for some concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. While we end calendar 2018 on the heels of unprecedented profitability and revenue for both Micron and the industry, we do believe we are entering a period of weaker market conditions. We are taking prudent actions to adapt our manufacturing plans to the changing demand environment. While we are implementing expense controls, we are also continuing to invest in our technology and cost competitiveness, as well as strengthening our portfolio of high-value solutions. Memory and storage have become essential ingredients to the value created by the data economy, and it is this added value that is driving a virtual cycle of long-term growth and innovation. We continue to believe that the memory industry is structurally stronger, with more diversified demand drivers and moderating supply growth capability. Micron is better positioned than ever before to win in this environment with our strong balance sheet and the structural improvements we have made to our operating model in the past several years. We believe 2019 will be a year of solid profitability, and I look forward to sharing our results over the quarters ahead. We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question will come from Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [2] +-------------------------------------------------------------------------------- + + Thank you, Sanjay, I was wondering if you could help quantify the inventory at your big hyper scale customers? It sounds like in aggregate it's maybe 2 months. So I'm wondering if you can help with that number? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + So inventory at our customers and this is -- customers in various segments of our market, some of those customers are carrying higher levels of inventory, and that inventory level varies from customer to customer, we believe. And our assessment is that inventory adjustments will take couple of quarters for it to be corrected, for it to work through the system entirely and, of course, we continue to work with our customers in the meantime, in terms of understanding their longer-term demand requirements. And, certainly, our customers are indicating optimism towards the demand requirements in the second half of the year, and especially, as inventory adjustments work through the system and as supply cuts, the effect of those come through the industry, as well as second half of the calendar year tends to be seasonally stronger, compared to the first half of the year, we do expect that by the second half of the year, we'll have an environment that will be improved, stronger, compared to the first half of the year. And just keep in mind that the long-term demand trends in our end markets of cloud, client, enterprise, graphics, all of these end markets, the trends continue to be strong, needing more memory and more storage ultimately. We're just going through an air pocket here, related to primarily inventory adjustments, as well as some seasonal, weak mobile demand, including mobile demand on the high-end smartphones that is impacting some of our near-term visibility, as well as the near-term outlook. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [4] +-------------------------------------------------------------------------------- + + And then I guess just as a quick follow-up, Dave. So I think maybe the surprise in the guidance is that the bit shipments are down, I think you said, meaningfully for both NAND and DRAM. I'm wondering, what that means for inventories? Are you going to ship out of inventory? Or are you cutting utilization? Can you sort of walk us through that? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + So we are reducing our production for both DRAM and NAND. As Sanjay indicated, from a DRAM perspective, we're bringing bit supply growth down to 15% approximately in calendar year 2019. For NAND, we're also bringing the production down meaningfully, and we did indicate that we would ship close to demand for NAND, and we think that demand is about 35%. So, obviously, there will be periods of time where we do have inventory increasing for some period of time and then, of course, it will adjust down through the years as we -- as those demand and supply numbers get more aligned. In the first quarter, we had days of inventory up to 107 days, I'm very comfortable with 107 days. This is very low cost product that we're putting on the balance sheet. There is no risk around obsolescence, it's part -- it's very likely that it will go up again next quarter. Again, I'm very comfortable with that. But I think over the long term, we'll have it more aligned with ultimately where we want it to be. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + And our next question will come from the line of John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [7] +-------------------------------------------------------------------------------- + + Dave, just relative to the guidance for OpEx in February quarter of $800 million, plus or minus $25 million, does that now reflect what we should think about as a fully burdened OpEx as you kind of move away from the shared cost with Intel? And relative to the $6 billion of operational efficiency gains you talked about at the Analyst Day this past summer, how does that fit in with this OpEx guide? Because this is about $200 million more OpEx per quarter than we saw at similar revenue levels back in sort of '16, '17, and it's about $300 million above per quarter what we saw kind of in the '15 sort of correction? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [8] +-------------------------------------------------------------------------------- + + Yes, good question. So we did guide $800 million for OpEx in the second quarter, plus or minus $25 million. That's probably -- that's certainly not fully burdened. We had about $30 million of benefit in the first fiscal quarter related to Intel's contribution through R&D expenses. It will be a little bit less in the second quarter, but over the course of the rest of the year, it will kind of phase down. So that certainly will elevate the OpEx in the third and fourth quarter relative to the second quarter. And also, we're not -- while we are certainly managing expenses prudently and we are taking steps in terms of reducing discretionary spending and just monitoring our head count very closely, we still are making the necessary investments on the product side and the non-technology side. This is as Sanjay mentioned, and air pocket, we don't want to in any way, impact our long term strategy for some sort of near-term event. So OpEx will likely go up a little bit. It's a fair point on the OpEx. I would say, if you look at the guidance for the second quarter or even with the revenue guidance we gave relative to what the first quarter was like, if you take the kind of midpoint of the earnings number, and the midpoint of the revenue guidance number, you'll get kind of 38% plus operating margin. So that is a really good number obviously. It's a number of, in my previous company, we were kind of aspirationally trying to get to. So it's a very good operation -- operating margin number. And I think it reflects the fact that we achieved the $6 billion of improvements that we said we would make at the Analyst Day. We still think we have more work to do in terms of driving the mix towards high-value solutions in terms of improving our cost competitiveness, both on the front-end and on the back-end side. So there is more to come, there is another $3 billion that we committed, and we feel very good about that. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [9] +-------------------------------------------------------------------------------- + + And then as my follow-up for Sanjay. Can you just walk us through the strategic puts and takes of building inventory into the February quarter, as opposed to trying to let those bits out into the marketplace and let elasticity sort of take over? Is this sort of intangible reflection of your view that this will be relatively short-lived a couple of quarters? And what would you need to see before you would think that inventory build was too risky? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [10] +-------------------------------------------------------------------------------- + + So I think our inventory, our cost structure is very good, both on DRAM as well as on the NAND side. And so we are definitely prepared that in terms of managing our overall profitability, which is absolutely our primary focus, that we'll manage pricing and manage inventory accordingly, as necessary. If inventor has to be carried over, we will carry it over, because the demand in NAND will kick in with elasticity. In DRAM, the inventory consumption with our customers will occur, supply cuts will be driving return to stronger demand environment, compared to -- in the second half, compared to first half. So we will be using inventory as a lever to ultimately manage for the best profitability of the company. And certainly, be prepared, use that inventory as necessary to also capitalize on the second half opportunities. And our focus really will also remain that in terms of our CAGR, in terms of output growth, to be aligned with the demand CAGR. And we'll, of course, from time-to-time, use inventory as a lever to manage the profitability of our business and, of course, manage our customers' requirements as well. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And our next question will come from C. J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [12] +-------------------------------------------------------------------------------- + + I guess, first question, can you talk about what you're thinking in terms of cost down efforts both for DRAM and NAND, particularly as you move to higher-value solutions, changing mix, including 1Y, 1Z, as well as 96 layers in the '19 time frame? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [13] +-------------------------------------------------------------------------------- + + With respect to the cost structure, we continue to be in very good position, as we said, that for our fiscal year '19, we'll have healthy cost reductions, both for NAND as well as DRAM. And you're, of course, right to note that as we increase the mix of our high-value solutions, for example, over the longer term as we increase our SSD mix or increase our managed NAND solutions, those do tend to incur higher costs. But they also bring higher margins, higher profitability, higher pricing associated with them as well. So cost wise, we are in good shape. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [14] +-------------------------------------------------------------------------------- + + That's helpful. And I guess, as a follow-up, a question for you, Dave. I think in the past you've talked about wanting to have liquidity, including gross cash and revolver, of roughly 1 year CapEx, which would basically put you on the screws here. So the question is, how to think about incremental free cash flow generation? And what percentage of that would be used for buybacks? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes, good question, C.J. So, we contribute -- let's start with the -- we're at about $9.7 billion of liquidity when you count the cash that we have on the balance sheet, plus the $2.5 billion revolver we have. So we're in, as you point out, very good shape relative to where our target at liquidity would be. You saw a pretty healthy return of cash to shareholders in the first quarter. About 80% of our free cash flow went to shareholders in the form of the buyback, and really, the rest went to further deleverage the balance sheet. There's not a ton of deleveraging that will go on through the rest of the year, quite honestly. And so I would expect us to be -- continue to be good buyers of the stock, so to speak, through the next 3 quarters, and contribute a high portion of our free cash flow in the form of a buyback. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And our next question will come from Mark Newman with Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + First question really, I'd like to ask on the supply adjustments you're making, you're taking down the guidance for both DRAM and NAND production. You mentioned about some of that being inventory, but you also mentioned some of that being some reduction adjustments. It would be useful to understand a bit more about that. For example, is that reduction of utilization? Is that a no more capacity additions? Or what is that? Because some of your competitors have been pushing out some of their capacity additions. And so it would be useful to understand what Micron is doing here on the capacity adjustments to get this slightly lower bit growth that you are forecasting for calendar '19? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [18] +-------------------------------------------------------------------------------- + + So, certainly, we are taking actions, a range of actions, and we won't really get into any specifics here in terms of what actions we are taking to reduce our output. You earlier mentioned about inventory. I mean, of course, we will carry inventory as necessary to manage the profitability. But important thing to understand is that we are taking decisive actions in terms of reducing our production output, both in NAND as well as in DRAM. And that's the contributor to the $1.25 billion reduction in CapEx, compared to our prior guidance. And, of course, our intention here is to align our supply output in line with the industry demand trends. And we feel very good about the actions we have taken. In DRAM, we've pointed out that compared to our prior expectations of 20% supply bit growth in calendar 2019, we have taken actions now to reduce our output to provide a 15% supply output growth on a year-over-year basis. And in DRAM as well, we have taken actions to adjust our output so that our shipments will match with our demand that we expect to be around 35% in 2019. And I just wanted to make it very clear here -- and I just want to be very clear as we have always said, that we are not adding any new wafer capacity. We are -- the CapEx that we discussed today, the lowered CapEx that we discussed, which on a wafer equipment basis is a reduction from fiscal year '18 CapEx, is all going towards technology transitions only. And that, of course, is the best way to achieve the ROI on those investments. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + So does that mean slower technology migration? Or does it perhaps mean slightly lower utilization for a temporary period? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [20] +-------------------------------------------------------------------------------- + + So, Mark, I'm not going to get into the specifics. Most important thing is, we have managed our CapEx lower, and we continue to take actions to manage our production output lower to align our supply with our demand expectations. And I think the effect of these actions will in fact, some of these actions will start showing as early as this quarter. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [21] +-------------------------------------------------------------------------------- + + Thanks Sanjay and then... + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + And if you look at our gross margin guidance. Go ahead, sorry Mark. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + All right, go ahead. You go ahead, Dave, first. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + I was just going to say, if you look at our gross margin guidance, it would reflect that we have a very good cost structure for our products. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [25] +-------------------------------------------------------------------------------- + + And the reduction of these output that we are talking about, our cost structure will remain in very good shape, even with that. And in fact, in terms of cost, on a year-over-year basis, we actually, our cost reductions we believe both in DRAM and NAND, will be above the industry. Cost reductions remain above the industry, yes. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + My follow-up question is on the demand. You talked about this a little bit of an inventory correction amongst customers, some of your competitors have talked a bit about that as well. But you seem to be reasonably confident that demand is going to come back second half of calendar '19, which also suggests that the inventory should have been burnt up by then. The customer's inventory should have been used up mostly by then. It would just be helpful, do you have any data points to explain how you get that confidence that demand will come back? Is it perhaps on the NAND side more about demand elasticity? Is it on the DRAM side? Anything about the kind of magnitude of the inventory level the customers have today to give us some kind of sense that -- confidence that, that would've been used up within a couple of quarters, for example? That'll be great, that would be very helpful. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [27] +-------------------------------------------------------------------------------- + + So first of all, I think we should realize that the end market demand trends, by and large, really remain quite healthy and our customers also are absolutely continuing to show to us the optimism around the long-term demand trends. And as we noted in my remarks, that in our fiscal second quarter, the bits for DRAM, let me first talk about DRAM here, the bits for DRAM will be down on a year-over-year basis, and this needs to be compared with the long-term DRAM demand CAGR of 20%, high teens to 20% range. So, when in FQ2, on a year-over-year basis, you reduction and you contrast it with the long-term demand trends of 20% kind of demand growth, then it tells you that during fiscal second quarter, a lot of the inventory adjustments will certainly be occurring. And that's why we say that it will take couple of quarters for inventory adjustments to occur. So again, the point about year-over-year reduction in our DRAM shipments is an important point in understanding that the inventory adjustment by our customers is well underway. And all of this, while the end market demand drivers of cloud, as you see from all the data, is absolutely continuing to be healthy, the end market demand driver in terms of average capacity increases of flash and smartphones, as well as DRAM content and smartphones driven by AI and machine learning, continues to be on the upward trend. And of course, applications like automotive and industrial IoT, with more AI and more machine learning, all of these are continuing to drive the demand trends toward a need for more storage and more memory. And we laid out some of these opportunities at our Investor Day, and all of those opportunities very much stay intact, and at the end market level, continue to be vibrant. So, I think these couple of points that the November quarter itself was, in terms of overall shipment, was below seasonal, as well as the first quarter, on a year-over-year basis, really showing reduction, points to inventory adjustments are well underway. And, of course, you have to look at this in the backdrop that the output in the industry is coming down as well. We have announced our decisive actions here today, and we have provided the outlook in terms of our output growth in calendar year '19, both for NAND as well as DRAM. So these -- and then, as I said before, that second half of the year tends to be a seasonally stronger part in terms of demand compared to the first half. So these all are definitely pointing to our confidence, and built up on inputs from our customers in terms of second half of the year being stronger than the first half of the year in terms of -- in demand trends and the industry fundamentals as well. And let me just point out one more thing here, that when you look at industry, I mean, compared to the past cycles, really the CapEx cuts are happening at much, much earlier level in the cycle. And really, in terms of happening even at much higher levels of profitability than ever in the past. So all this, overall, I believe, bodes well for the long term fundamentals of the industry as well as, certainly, for Micron. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + And our next question will come from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [29] +-------------------------------------------------------------------------------- + + I was wondering if I could build on that last comment, you've talked a lot about your own plans in terms of curtailing your capacity expansion this year. But given that you are in off quarter, off calendar quarter, I'm just curious of how you will characterize maybe the competitive landscape, maybe what you've seen change over the last month and a half or so, relative to some of your competitors in the context of both DRAM and NAND? And I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [30] +-------------------------------------------------------------------------------- + + I think in that regard, you know as much as I do, and over the course of last couple of months, there have been a reduction that have been discussed in the industry, the reductions that you have heard about, that manufacturers have talked about, but also, several analysts have indicated those as well. And of course, the near-term outlook has also, as we said, continued to weaken through the course of our FQ1 time frame and even since our FQ2 has started, those demand weakening trends have continued as well. So I think that this is the information that is out there, is what we're using, but we can only talk about ourselves and we can -- we certainly have taken here decisive actions in terms of managing our output growth in line with our demand expectations. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And then as a quick follow-up, just thinking about your product portfolio, particularly around the enterprise SSD market, I'm curious, it sounds like possibly you're seeing maybe even a quicker ramp towards NVMe than what you previously have seen. I mean, is there a way to kind of quantify how much of maybe the enterprise SSD market is kind of moving away from you until you get your products into the market in the latter part of this calendar year -- or calendar year '19? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [32] +-------------------------------------------------------------------------------- + + Certainly, as we have been speaking for a while, the transition from SATA to NVMe is taking place at a fast pace in enterprise, as well as in cloud applications. And we have been focused on developing our own products. And that's why we have said that in calendar year -- our fiscal year 2019, as we bring out our new NVMe products to the market, our 2019 calendar year ends up being more a year of transition for us. But there is no question that the market certainly is moving from SATA to NVMe applications across-the-board. And we have just introduced some of our early NVMe products for consumer SSDs, and I talked about how we have introduced NVMe product for automotive applications as well. And during the course of calendar 2019, we'll first be bringing out client NVMe products to the market, and then later in the year, we'll bring enterprise and cloud NVMe SSDs. And that's why we look at calendar year 2020 will be the one time frame when we start gaining share again in our SSDs -- SSD market. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And our next question will come from the line of Romit Shah with Nomura. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors [34] +-------------------------------------------------------------------------------- + + Sanjay, I heard you indicate that you expect above average cost declines, but I guess my question is, aren't the actions that you've announced today probably more of a hit to cost per bit in 2020 versus 2019? How do we think about that? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [35] +-------------------------------------------------------------------------------- + + I think what we have shown you today is that we are able to take decisive actions and we are able to take them fast. I mean, just remember that FQ4 was a record year for the company. And FQ1 is when we first saw signs of inventory adjustment. During the course of FQ1, we have been able to react in terms of cutting down our CapEx, as well as manage our output growth. So point is, we can react fast to the changes that are needed in the marketplace, and we remain, this is something we review very, very closely on an ongoing basis, very focused on making sure that we are maximizing the long-term profitability and long-term growth opportunity for Micron. So this is something that in terms of cost, we feel very good about our position for 2019 and beyond -- going beyond that. We of course continue to make very good progress on our technology nodes. As I discussed with you, our technology on 1Z is progressing well. We feel good about that roadmap and continue to make good progress on our NAND roadmap as well. And that will all position us well for 2019 as well as for 2020 time frame. And I just want to point out that our focus also is on shifting our portfolio to high-value solutions, and those will also strengthen our profitability profile. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors [36] +-------------------------------------------------------------------------------- + + I guess as my follow-up, on CapEx, I mean, you are cutting your forecast for the year, but CapEx is still up on a year-on-year basis. I'm curious, if this downturn ends up being longer than any of us sort of anticipate, is there leverage to reduce CapEx even further from current levels? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [37] +-------------------------------------------------------------------------------- + + So, I will just touch on CapEx, on your previous question on cost, I also wanted to point out that on the cost side, we are making tremendous progress on the back-end assembly and test cost reductions, as well as managing, transforming our supply chain operations, which will give us significant cost benefits as well. So, all in all, 2019 and beyond feel very good about our technology roadmap, manufacturing roadmap capability, as well as overall cost capabilities. In terms of, on the CapEx side, just keep in mind that we have said that with the adjustments that we just have made, over wafer equipment CapEx actually is coming down in fiscal year '19 versus fiscal year '18. And as we've discussed before, Micron over the last few years, have significantly underinvested in clean room shell CapEx in the facilities and the buildings that are needed to really implement ongoing future technology transitions and a big part of our CapEx, as we have shared with you the past, actually is going towards buildings and facilities, clean room that will be needed for future technology transitions as well. All of that CapEx does not contribute to bit growth. And similarly, we a have significant increase in our CapEx in fiscal year '19 over fiscal year '18 on back-end test and assembly operations as well. And that is, again, intended to reduce costs, and not -- it doesn't go towards any bit growth. And we have flexibility, as we have shown already, in terms of managing CapEx. We'll continue to look at this carefully. And if any factors require us to change our CapEx outlook again, we will absolutely address it in a timely and prudent fashion. We always continue to evaluate market environment, as well as our own status of technology, transitions, production requirements, and we are making real-time adjustments as needed. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - MD & Senior Analyst of Semiconductors [38] +-------------------------------------------------------------------------------- + + I mean, it seems like the actions you guys are taking are very prudent, but I -- the part that's confusing for me is, if you're slowing your process migration, then there should be some impact to cost per bit. And I'm just, I guess I'm just not quite, I just don't quite understand what that impact is? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Again, in terms of cost per bit, there are a lot of details that have to be looked at. We're not going to get into all of those details here. Key message here is that we are bringing our production output in line with our demand expectations. Second, we feel very good about our technology position and our cost position, and we'll continue to do very well in this regard. Cost position, of course, includes wafer level, die cost position, but also includes the benefits of assembly and test cost improvements that we are making; and third, is we absolutely stay focused on our high-value solutions strategy, and we're executing well in this area. We talked about how in mobile, even in a market environment of significant NAND oversupply, we actually have delivered strong gains in our mobile high-value solutions portfolio as well. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes our question-and-answer session for today. Thank you for your participation in today's conference. This does conclude the program and we may all disconnect. Everybody, have a wonderful day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2018-Mar-22-MU.txt b/Transcripts/MU/2018-Mar-22-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..da189fd103600dadb4ad81ff57c1475b448699f4 --- /dev/null +++ b/Transcripts/MU/2018-Mar-22-MU.txt @@ -0,0 +1,504 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 Micron Technology Inc Earnings Call +MARCH 22, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Shanye Hudson + - + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * David Ryzhik + Susquehanna Financial Group, LLLP, Research Division - Associate + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Rajvindra S. Gill + Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal; Consumer IC & Multi-Market + * Tristan Gerra + Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst + * Unidentified Analyst + - + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Mark Trevor Delaney + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Karl Fredrick Ackerman + Cowen and Company, LLC, Research Division - Director & Senior Research Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jonathan, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Micron Technology Second Quarter 2018 Financial Results Conference Call. (Operator Instructions). +It is now my pleasure to turn the floor over to your host, Shanye Hudson. You may begin your conference. + +-------------------------------------------------------------------------------- +Shanye Hudson, - [2] +-------------------------------------------------------------------------------- + + Thank you, Jonathan, and welcome to Micron Technology's Second Fiscal Quarter 2018 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call, including audio and slides, is being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release which was filed a short while ago. +Today's discussion on financial results will be presented on a non-GAAP financial basis unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with the convertible debt and capped call dilution table. +As a reminder, the prepared remarks from this call and webcast replay will be available on our website later on today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we'll be attending. You can also follow us on Twitter, @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we filed with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We're under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to you, Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Shanye. Good afternoon. During the second quarter, Micron, once again, set company performance records across multiple metrics, including revenue, gross profit, EPS and cash generation. We are consistently delivering results that underscore our relentless focus on execution and solid progress on our strategic priorities. Specifically, we are evolving our product portfolio to a richer mix of high-value solutions, enhancing our financial performance and cultivating deeper relationships with more key customers across multiple mega markets. +Our growing portfolio of managed NAND solutions and low-power DDR4 products boosted our mobile business to record revenue and profitability during the quarter. We also grew our SSD shares in our second quarter with total SSD sales up 80% year-over-year and sales of cloud and enterprise drives more than tripling for that same period. +Continued strong penetration of our highly competitive DDR4 products into cloud applications and our industry-leading high-performance graphics memory portfolio into gaming, graphics and cryptomining applications contributed to a robust 15% sequential growth for our Compute and Networking Business Unit. +Strong demand for our DRAM and NAND products delivered record second quarter revenues for us in the automotive market. We continue to execute well on our goal of introducing new products on our advanced technologies, delivering performance, quality, supply and cost advantages to our customers. +In NAND, we are transitioning from being the components supplier to becoming a solutions provider. We launched and began qualifications of the industry's first cloud and enterprise SATA SSD drive incorporating 64-layer 3D TLC NAND. We also introduced the 3DFS solutions targeted at flagship smartphones. These solutions are also based on our 64-layer 3D TLC NAND, which has 15% higher performance and double the density of the prior technology. We have qualified a family of these products with a major chipset vendor and we expect to complete customer qualification in the coming months. +In DRAM, our focus remains on enhancing our cost competitiveness and accelerating our product execution. We have qualified our 1X nanometer DRAM at 3 of the world's largest hyperscale customers, with other qualifications underway. We also garnered positive feedback on our 1X nanometer LPDRAM solutions and set industry benchmarks for power efficiency, which is particularly critical to our mobile customers. Our comprehensive and expanding portfolio of DRAM, NAND and NOR solutions has enabled us to achieve record design wins for our automotive business in the first half of fiscal 2018. We believe we are well positioned to continue to support our share leadership in this rapidly growing market. These achievements illustrate our focus and the ability to deliver value to both our customers and shareholders. +I'll now discuss some of the trends we are seeing across our end markets, which will continue to expand the significant opportunities for our business in the years ahead. +At Mobile World Congress recently, phone manufacturers featured high-end smartphones with larger 4K displays, multiple high resolution cameras and 4K HDR video recording. Capabilities like these have driven increased memory and storage requirements in recent years. But perhaps, most impressive were the multiple implementations of artificial intelligence and virtual reality. OEMs are bundling new artificial intelligence, augmented reality. OEMs are building new artificial intelligence, augmented reality and lifelike virtual reality capabilities into high-end smartphones, including facial and voice recognition, realtime translation, fast image search and scene detection. +To support these data intensive capabilities, flagship and high-end smartphones are migrating towards 6 gigabytes of LPDRAM, a trend that bodes well for Micron given our leadership in LPDRAM power efficiency, which is essential for optimizing battery life. +Average storage SSDs are also increasing across all smartphone classes with new flagship models using 64 gigabytes of flash memory at a minimum. Micron's portfolio of managed NAND solution is well-suited to address this growing demand, and we are leading the industry in TLC utilization with a portfolio that leverages the strong attributes of our 3D NAND technology. +Of course, the growing adoption of AI is not limited to mobile. At the Consumer Electronics Show, several companies showed AI smart cockpits in new automotive models. These systems integrate the instrument dashboard, infotainment and telematic systems with a centralized compute and storage architecture to create a data center on wheels. Voice and gesture recognition, combined with driver alert monitoring capabilities, are making automobiles more intelligent and much more compute intensive, requiring higher capacity and more powerful memory and storage solutions. +Micron is already working with automotive customers who will benefit from our highest speed automotive-grade, LPDDR4 solutions in the near term and new memory technologies in the future like our high-bandwidth GDDR6 graphics memory. The new features in mobile, automotive and other connected devices require rapid data analysis in storage and enterprise and cloud servers, including machine learning, training and inferencing to complement the compute taking place at the edge. This is driving significant investments in the data center and growing demand for both memory and high-performance storage. Micron's broad technology portfolio and strong innovation engine position us well for these growth trends. We continue to partner with our customers to ensure our technology and engineering roadmaps deliver the critical features for tomorrow's solutions. +Now I will provide an update to near-term industry supply/demand dynamics. The dealer market today is very different from the PC-dominated market of the past. This market now supports a healthy demand environment with several secular demand drivers that I have discussed earlier. More specifically, memory is making possible applications such as AI and VR, and enabling new cloud-based business models which deliver a fundamental value far in excess of a price per bit. Against this healthy demand backdrop, we project DRAM industry bit output to grow in the 20% range for calendar 2018, maintaining favorable industry fundamentals. +For the NAND market, we believe the ongoing transition to 64-layer 3D NAND creates the opportunity for a more balanced industry dynamic in calendar 2018 versus the constrained conditions we saw in 2017. We expect industry bit output growth to be somewhat higher than 45% in calendar 2018, providing incremental supply to address the increasing demand created with the further displacement of HDDs in client, enterprise and cloud applications. +From a Micron perspective, we continue to make significant strides to strengthen our competitive position through technology and cost improvements. In DRAM, we are focused on accelerating our technology transition cadence and ramped our 1X nanometer technology to mature yield faster than any of our previous technology nodes. We remain on track to achieve 1X nanometer bit output crossover relative to our 20-nanometer node by the end of calendar 2018. We now expect Micron's calendar 2018 DRAM bit output growth to be in line with the industry's 20% range. +In NAND, our 64-layer technology continues to ramp very well with yields somewhat ahead of plan. We continue to execute plans to achieve bit output crossover on our 64-layer 3D NAND technology relative to 32-layer in the second half of fiscal 2018. We believe we will be somewhat above industry bit output growth in calendar 2018 for NAND. +We expect to deliver qualification samples to OEM customers of both our 1Y DRAM technology and our third generation 3D NAND technology by the end of fiscal 2018. And we continue to expect to ramp initial volume for each of these new nodes in the second half of calendar 2018. +For some time now, industry participants have pointed out that the cost and complexity of DRAM and NAND scaling is increasing with each subsequent technology node. Additional space and equipment is required to manufacture the increasingly complex architectures of these leading technologies to maintain data capacity and meet market demand. Accordingly, we are executing plans to add clean room space in our NAND and DRAM SAS network. With the support of the Singapore Economic Development Board, we have finalized plans to build additional shelf space in Singapore, adjacent to our existing NAND Center of Excellence. The primary purpose for this new clean room space will be to transition our existing wafer capacity to future 3D NAND nodes. This location will enable us to drive efficiencies of scale. We expect to build out this facility in phases, in line with our manufacturing requirements and market demands. +The first phase of this clean room is expected to be completed by the summer of 2019, with initial wafer output from the facility expected in the fourth quarter of calendar 2019. We are also building out incremental clean room space in our fab in Hiroshima, Japan, which will be available for production at the beginning of calendar year 2019. This clean room space will be used to continue our 1Y nanometer DRAM transition. For fiscal year 2018, we expect our capital expenditures to be in the upper end of our previously guided range of $7.5 billion, plus or minus 5%. Long term, we target capital expenditures as a percentage of revenue to be in the low 30% range. +Before we move to the next section of our call, I would like to address a supplier maintenance issue, disrupting nitrogen supply to 1 of our 5 DRAM SAS which occurred on Tuesday of this week. We expect this event will impact our DRAM production output by 2% to 3% for the quarter. Our teams are working around-the-clock to recover from the situation and we expect to return to full production within the next week. +Lastly, I would like to welcome Dave Zinsner as our CFO. Dave brings years of experience within the semiconductor industry, and we are happy to have him on board. Dave will now provide details on our second quarter results and third quarter outlook. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sanjay. I'm excited to be joining Micron at a time when the company is accelerating its focus on execution, including the delivery of more high-value solutions and the ongoing improvement of cost competitiveness. +During my first few weeks at the company, I've been diving into the details of the business and operations, and I'm more convinced than ever that there's a fantastic opportunity to build an even stronger company while continuing to enhance shareholder value. +For the second fiscal quarter, revenues were $7.35 billion, up 8% from the prior quarter and 58% from the prior year. The overall strength reflects a positive business environment and broad-based demand for our memory and storage solutions, particularly for cloud, enterprise and mobile markets. +Non-GAAP gross margins for the quarter were 58.4%, up 300 basis points from the prior quarter and up from 38.5% in the prior year. Our ability to drive a richer mix of high-value products, strong execution on our cost goals and favorable market conditions contributed to the gross margin expansion. Non-GAAP operating margin was 49%, up from 46% in the prior quarter and 25% in the prior-year period. +Non-GAAP operating expenses were $666 million, up approximately 9% from both the prior quarter and prior-year periods. The sequential increase is primarily attributed to expenses associated with shifting our portfolio to high-value solutions and accelerating our technology and product development. These expenses tend to fluctuate quarter-to-quarter. We're also beginning to incur the impact of solely funding the development of our fourth generation 3D NAND technology. We continue to manage operating expenses tightly and are generally only increasing operating expenses for developing and qualifying new products and technologies. +Turning to performance by business unit. The Compute and Networking Business Unit grew revenue to $3.7 billion in the second quarter, up 15% from the prior quarter and 93% year-over-year. Cloud server revenues were up nearly 30% quarter-over-quarter as hyperscale customers continue to invest in data center infrastructure and broaden their service offerings. We also benefited from strong demand for graphics memory with cryptocurrency mining augmenting sales for gaming applications. +Operating income increased to $2.3 billion or 63% of revenue, and reflects higher sales of our 1X nanometer DRAM solutions, along with tight supply conditions. +The Mobile Business Unit achieved its highest ever revenue and operating income in the second quarter of $1.6 billion and $680 million, respectively. These results compare to $1.1 billion of revenue and $170 million of operating income for the same period last year. Our performance underscores our laser focus to meet customer's needs. +The Embedded Business Unit reported revenue of $829 million in the second quarter, in line with last quarter, and up 41% year-over-year. The automotive business had a record quarter, driven by strong sales of ADAS and in-vehicle experience applications. +We also saw an increase on our industrial business, driven by the growing industrial IoT markets, expanding factory automation, transportation and surveillance applications. +Operating margins were 44% in the fiscal second quarter, expanding by 260 basis points compared with the first quarter. And finally, turning to the Storage Business Unit, revenue was $1.3 billion, up 20% year-over-year, supported by record revenue in SSDs. On a sequential basis, SD revenue declined by 9% with the strong growth in SSDs offset by a reduction in components revenue. The sequential revenue comparison was impacted by a mix shift within our NAND component sales, which I'll elaborate on momentarily. We're continuing to penetrate the SSD market and expand sales across each end-market: consumer, compliant -- client, enterprise and cloud. The growth is most pronounced in the enterprise and cloud SSD portion of the market. Our sales of these end markets were up nearly 30% quarter-over-quarter and more than 230% year-over-year. As we previously noted, product developments for 3D crosspoint solutions is now underway. +During the second quarter, and over the next few quarters, we have incurred, and will likely to continue to incur, costs associated with production capacity underutilization in advance of volume ramp of these new 3D crosspoint products. These charges negatively impacted our SBU operating margins by approximately 500 basis points this quarter. Including these charges, second quarter operating margins were 20% compared with 29% in the fiscal first quarter and 7% in the prior-year period. +Moving to performance by product line. DRAM represented 71% of total company revenue in the fiscal second quarter. DRAM revenue in the quarter was up 14% from the prior quarter and 76% year-over-year. Sequentially, shipment quantities increased in the mid-single-digit percentage range while ASPs increased in the low double-digit percentage range. DRAM non-GAAP gross margin was 66% in the second quarter, up 4 percentage points from the prior quarter and up 22 percentage points from the year-ago quarter. +Revenue from trade NAND represented 25% of overall company revenue in fiscal second quarter. Trade NAND revenue on the quarter was down 3% sequentially and up 28% year-over-year. On a sequential basis, shipment quantities increased in the low double-digit percentage range, while ASPs declined in the mid-teens percentage range. The sequential ASP decline in NAND increased in part due to a meaningful last time purchase of higher price MLC NAND in the fiscal first quarter. This is the mix shift in our SBU NAND components that I have referenced earlier. Trade NAND non-GAAP gross margins were at 47% in the second quarter, down 2 percentage points from the prior quarter but up 16 percentage points from the year-ago quarter. Gross margins for both SSDs and managed NAND solutions increased quarter-over-quarter, offsetting the declines in component margin. This change in mix illustrates the importance of shifting our sales towards high-value solutions. +I'd like to take a moment to update you on the impact of U.S. tax reform on Micron. The onetime impact related to the taxation of accumulated offshore earnings and cash was largely neutral for the company. The impacts of this repatriation transition tax were largely offset by our accumulated tax losses and other tax credits. For the remainder of the year, we expect our non-GAAP tax rate to remain in the low to mid-single-digit percentage since we are not yet subject to certain provisions of the new tax code. For fiscal 2019 and beyond, we expect our non-GAAP tax rate to settle in the low teens percentage range. Going forward, we'll benefit from having greater flexibility to access our worldwide cash deposits. +Our non-GAAP earnings per share were $2.82, up 15% from the prior quarter and up over 200% from the prior year. As a result of our record performance, we generated $4.3 billion in cash from operations, which represented 59% of revenue. This compares to $1.8 billion in the year-ago period. Capital spending, net of third party contributions, was $2.1 billion, resulting in a very strong free cash flow adjusted for the third-party capital contributions of $2.2 billion or 30% of revenue. This compares to free cash flow of approximately $600 million in the year-ago period. +As Sanjay mentioned earlier, we expect capital spending, net of third party contributions, to be at the upper end of our fiscal 2018 guided range of $7.5 billion, plus or minus 5%. +As a result of the strong free cash flow, we ended the quarter with approximately $8.7 billion in cash, marketable investments and restricted cash. The face value of our debt increased approximately $200 million to $9.5 billion. A $300 million reduction in debt due to scheduled debt repayments was offset by a $500 million increase in debt at our MIFT -- IMFT joint venture. Since the first of our 3D crosspoint products are expected to launch in calendar 2019, we chose to defer funding for IMFT. Our partner is contractually able to make the funding on our behalf and designated a debt on IMFT's balance sheet. And that debt is then counted as part of our debt for the purpose of GAAP reporting. We still expect to be in a net cash positive position in the fourth quarter, and possibly sooner, depending on the extent and timing of any future convertible note redemptions. This net cash positive position remains a significant milestone in the ongoing strengthening of our financial foundation. We continue to evaluate additional opportunities to accelerate our deleveraging actions that will provide a high rate of return. This strong financial profile is the result of consistent execution and focus across the entire company. +Now turning to the fiscal third quarter guidance. As Sanjay mentioned, we had a maintenance issue at one of our Taiwan DRAM fabs this week, which is impacting production. We expect this event to decrease our total revenue by approximately 2% in the third quarter, which we've accounted for in our guidance. Having said that, we continue to experience a strong demand environment and we, therefore, expect fiscal third quarter revenue to be in the range of $7.2 billion to $7.6 billion, and non-GAAP gross margins to be in the range of 57% to 60%. We expect to see an increase in operating expenses, again, associated with product and technology qualifications, and the funding of our fourth generation 3D NAND technology, both of which primarily impact R&D. Considering these costs, non-GAAP operating expenses are expected to be $725 million, plus or minus $25 million. We expect non-GAAP operating income to be in the range of $3.6 billion to $3.8 billion. Based on a share count of approximately 1.25 billion shares, these results should drive non-GAAP EPS of $2.83, plus or minus $0.07. +I'll now turn the call over to Sanjay for some concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. Micron will be celebrating our 40th anniversary this fall. Innovation has always been a key cornerstone to our success, ensuring that our technologies and products quickly adapt to serve the world's growing appetite for faster data. As we look ahead, we remain focused on nurturing and fostering an accelerated pace of innovation, and I know our team is fired up and ready for the challenge. The opportunity to create a dramatic impact on the world around us is undeniable and I'm excited to be part of this team shaping that future. +I'm looking forward to speaking with all of you at our analyst and investor event in May. You can expect us to provide more detail on how we see secular market trends, creating new opportunities for memory and high-performance storage, and why we believe Micron is well positioned to win. We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Rajvindra Gill from Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal; Consumer IC & Multi-Market [2] +-------------------------------------------------------------------------------- + + I was wondering, Sanjay, if you could talk a little bit about the changes in the DRAM industry that you've seen over the past year or so. I think in the past, you had mentioned that memory is becoming a strategic differentiator for high-performance computing. I was wondering if you can maybe elaborate on what specific end markets or behavior patterns that have been changing with some of your main customers in terms of how they consume memory. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Certainly. I think we are seeing the fastest growth through our DRAM memory at large-scale, in cloud computing and hyperscale data centers. And this is where high-performance memory is absolutely becoming essential along with fast storage is becoming essential for the trend such as AI, which are really driving new business models. Whether you go from education and training tailored toward the individual levels of coaching or training to the individuals or to millions of transactions processed realtime in the financial sector, to detect fraud or going to diagnosing and treating life-threatening diseases. Bottom line is we are barely starting with AI in cloud computing and data centers. And to realize the full impact of these solutions and to truly provide this new business model and services and applications to consumers and businesses alike, more and more data needs to be processed. It needs to be realtime analytics, and that requires more fast memory and more fast storage, that means flash as well as DRAM. So we are seeing tremendous growth. And if you look at trends, when we project that 2017, about 145 gigabytes per server going to about 350 gigabytes per server by 2021. Similarly, if you look at flash storage, 1.5 terabyte average in 2017 growing to something like 6 terabyte average with each server by 2021 timeframe. So these are massive, secular demand trends in the cloud computing and hyperscale for memory as well as for flash storage. Similarly, going to mobile, I talked about in my script that at Mobile World Congress, several new phone models were introduced that leverage 4K SDR capabilities that leverage AR and VR and even in our processors that are being introduced for mobile application that actually have the AI unit built into it. So just imagine how much data-intensive applications are now being run in order to provide users smooth experience. That then requires high performance and lot of memory. And you're starting to see now 6 gigabyte phones, 6 gigabyte of DRAM in the phone. So mobile is another large driver of DRAM memory. And of course, it is also a large driver with average capacities continuing to increase for flash as well. And then autonomous driving is barely starting. I mean, industry pundits are talking about robo taxis, intercepting the whole autonomous driving trend and maybe being introduced even in 2019-2020 kind of timeframe. And autonomous driving means, as I said in my remarks, data center on wheels. It's requiring more fast memory to again make all realtime decisions providing for the safe and comfortable and efficient driving experience. So these are really massive trends and these are secular in nature and I believe will continue to drive strong demand for DRAM in the years ahead. And of course, there are other ones, continuing average capacity increases in PCs for DRAM, with more gaming features and VR features. And of course, industrial 4.0 initiatives. I mean, these are all multiple mega markets for DRAM. And we are very well positioned with our product portfolio focusing on cost competitiveness, with our technology advancements as well as what I indicated, low-power DRAM solutions which are becoming increasingly important across a multitude of these applications. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst of Microcontrollers, Analog & Mixed Signal; Consumer IC & Multi-Market [4] +-------------------------------------------------------------------------------- + + That's very helpful, Sanjay. As my follow-up, your SSD revenue was up 80% year-over-year. Can you talk a little bit about the attach rate for client SSD specifically? Last year, they were put on a temporary pause because of tightness of supply. I was wondering if you could talk a little about that now that we're about a quarter into this year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + I mean, last year's flash was severely constrained and that did somewhat slow down the cash rate of SSD in client computing as well as slow down the march towards higher capacities of SSDs in notebook computers. And attach rates for SSDs in client computing, around 35% to 40% and maybe 40% in 2018, maybe going towards 50%. Over the next few years, this is expected to continue to go toward by 2020-2021 timeframe to 85%-plus attach rate for SSD. So again, this is a large growth driver for SSDs in client computing applications. And we are focused on, of course, expanding our portfolio of SSDs. We talked about significant progress of our SSDs across-the-board in client, enterprise as well as in the consumer market. And we look at opportunities to gain further share in all of these SSD markets in the future as we continue to execute on our product roadmap. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Chris Danely from Citi. + +-------------------------------------------------------------------------------- +Unidentified Analyst, - [7] +-------------------------------------------------------------------------------- + + This is [Wayne Loeb] on the line for Chris Danely. My question is when you talk about your plans for acquisitions, what would be the criteria that would make you buy something? And how does M&A fit into your plan in the context of Micron wanting to be a NAND solution provider? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [8] +-------------------------------------------------------------------------------- + + We're not going to speculate on M&A matters here but we are very pleased with the portfolio of technologies and the initiatives we have with respect to continuing to advance our product solution. But of course, we do not rule out, in the future, leveraging M&A toward any growth initiatives. And of course, we'll always look for core capabilities to expand the market opportunities for Micron. And of course, we'll be focused on value in terms of any acquisition that we may entertain in the future, again, not speculating on anything at this point. And of course, always looking for ROI kind of opportunities. + +-------------------------------------------------------------------------------- +Unidentified Analyst, - [9] +-------------------------------------------------------------------------------- + + As a follow-up question, can you talk about what Micron's projected cost reductions are for NAND and DRAM this year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [10] +-------------------------------------------------------------------------------- + + So we don't provide specifics on cost reductions but what I can tell you is that we are making very good progress on our technology. As we indicated, I mean, in our 1X DRAM technology, we have achieved the fastest ramp to mature yield in the history of the company. And similarly, our 64-layer technology, it has ramped to mature yields, rather well and we are continuing, of course, to do very well on our 20-nanometer DRAM technology that we use as well. So we are very pleased with our continuing progress on cost at the technology level, and continuing to focus on advancing our next-generation technology nodes and products. And of course, also very much focused nonmemory costs in our products such as SSD nonmemory costs. So making good progress and all of that is baked into our gross margin guidance that we have provided. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Delaney from Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [12] +-------------------------------------------------------------------------------- + + First question, I hope you can detail a little bit more about that nitrogen issue you mentioned. Did you have to scrap wafers or just idle production? And can you help us reconcile the comment about a little bit less DRAM output for next quarter with the now full year guidance about growing in line with the industry compared to last quarter. I think, Micron was going to grow slightly before -- definitely below, excuse me. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [13] +-------------------------------------------------------------------------------- + + So this nitrogen maintenance issue has not caused trapping of vapors. It has idled or slowed down production. As we said, it's impacting 2% to 3% of our this quarter's DRAM production output. And with respect to our expectation of our output growth for calendar year 2018, that remains in line with the industry estimate of 20%, and this effect is already included in that as well. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [14] +-------------------------------------------------------------------------------- + + Is it fair to assume a better 1X nanometer yield? Is that how Micron is now growing in line with the industry for the full year despite this nitrogen issue? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [15] +-------------------------------------------------------------------------------- + + Yes, that is correct that our production output is expected to grow in line with the industry and that is, of course, as a result of our excellent yield on 1X nanometer node as well as the 20-nanometer node. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [16] +-------------------------------------------------------------------------------- + + Okay. And then one other question for me, if I could. Sanjay, you commented about having a CapEx-to-sales target in the low 30% range. I don't want to parse words too closely, I think it was about 30% as of the last Analyst Day. But the strategy for Micron, as I understood it, had been that the company is trying to keep its net DRAM wafer starts flat and there's a lot of costs associated with getting to these new nodes because of all the extra factory space that you need and need for new clean rooms. Just given your comments about CapEx coming in toward the higher end of the range this year and the comments about that ratio, is there any change about the strategy of Micron, how it's thinking about CapEx? And really just enabling -- getting to those next nodes which are getting more expensive? Or is there a change we need to be thinking about in terms of how Micron is thinking about managing its net wafer starts in DRAM? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [17] +-------------------------------------------------------------------------------- + + I think if you look at last few years and you look at Micron's revenue and you look at Micron's CapEx, you will see that Micron's CapEx, over the course of last few years, is in the low 30% range of the revenue over those last few years as well. So what we have said here today is fairly consistent with what actually has been the case at Micron over the course of the last few years. And in fact, if you look at the industry itself and you look at the revenue of the industry players and you look at the CapEx, over the course of last few years, you will see actually that, that average for the industry as well is in that same range also. So in terms of our own strategy for CapEx spend is absolutely focused on accelerating our technology transitions. So our CapEx is geared toward realizing DRAM and NAND technology transition toward more cost-effective advance technology nodes for our products. And it is not about capacity, wafer capacity production increase for us. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Ackerman from Cowen and Company. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [19] +-------------------------------------------------------------------------------- + + Dave, welcome to the team. I have 2 questions, please. My first question is on DRAM demand. We all know that DRAM is more inelastic than NAND but I was curious, what are some signs that you look for to assess if you are beginning to see demand destruction in DRAM demand from higher ASPs, particularly in mobile and PC environments that are more sensitive to price than hyperscale environments? I have a follow-up, please. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [20] +-------------------------------------------------------------------------------- + + So can you clarify the question to me? I didn't totally get the question. I'm sorry. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [21] +-------------------------------------------------------------------------------- + + Yes, I'm just curious how should we assess the potential demand destruction in DRAM demand from higher ASPs in mobile and PC environments over the next few quarters, if there were to be an issue? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [22] +-------------------------------------------------------------------------------- + + So I think what we have to realize is that DRAM absolutely is essential to the experience in the business models that it enables. Whether it is the experience in mobile phones, I talked about all these experiences, AR, VR, 3D gaming, multitude of applications and users absolutely expecting seamless experience that requires -- such data-intensive applications require more DRAM. So it is essential. I mean, it's not like you can offer a model with a less DRAM in it, a high-end model with a less DRAM in it and expect that users will still have the same good experience. So DRAM capacity has really become a key enabler and essential element of mobile. And same, as I talked about earlier, for hyperscale data centers. When they look at what models that they can enable for their end customers, those are all being built on very data-intensive applications. I mean, imagine retailers, and a consumer goes into a retail store and the retailer already knows about what are the needs of their consumer. All of that requires realtime -- for retail, realtime AI applications, which means lot of data that has been processed fast, which means, again, it needs more DRAM memory. So it is actually, when you look at hyperscale data centers, it's not about the cost of DRAM anymore. I think the value that it enables to these cloud applications and hyperscalers is far in excess of any aspect of DRAM price per bit. So DRAM really has become an essential part. This is very different from any time in the past. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + And the best indicator of this is that DRAM pricing is strong and DRAM demand is strong right now. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + That's helpful. As my follow-up, I was hoping you could elaborate on your comments for OpEx as we think about the trajectory of spending for the next few quarters. Specifically, do you plan on reinvesting the savings you expect to achieve from Micron and Elpida coming together for the first time on 1X development? And how should we think about the timing of any planned prequalification expenses for maybe 1X DRAM or QLC 3D NAND deployment when we make assumptions for OpEx for the balance of 2018? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [25] +-------------------------------------------------------------------------------- + + So let me go back to kind of the commentary and make sure it's clear. So in the second quarter, most of the increase we experienced was around qualifications of various technologies that kind of all came together, all in kind of the second quarter. And it kind of continues on into the third quarter. Those expenses kind of vary over time. And so this just happens to be kind of a couple of quarters in which that activity is pretty heavy. And so we're kind of experiencing kind of a lift in expenses, and I would expect that portion of it to kind of settle down. And when the next set of qualifications are required, it will come back up again. The other piece of the expenses really relate to our fourth-generation 3D NAND where, as we announced earlier, we're taking that on ourselves. We had -- about half of that hit us in the second quarter. We'll have the full quarter's effect in the third quarter, and that was about $20 million on a full quarter. So about $10 million lift in the second quarter and $20 million lift in the third quarter. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Tristan Gerra from Baird. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + Given the continued strong demand that you see in data center, how should we look at the initial supply/demand outlook in NAND flash for the second half of calendar '18? Should we expect the pricing to stabilize? Any commentary based on trends that you see currently continuing for the rest of the year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [28] +-------------------------------------------------------------------------------- + + So we are not going to comment on pricing trends in the industry but what I can tell you is that NAND industry does have certain aspect of its end market such as USB flash drive or imaging cards or retail. That tends to be more somewhat seasonal in the first calendar quarter. And as we go forward, that part changes. The most important thing to look at is that as more supply becomes available, it drives deeper penetration of SSDs in client devices as well as in -- gives an even stronger value proposition in enterprise and data center applications. So this is what we expect during the course of the year. And of course, average capacities of NAND in mobile phones, smartphones, continue to increase as well. And we are expanding our portfolio of multichip packages with DRAM and NAND, which is where Micron is uniquely well positioned to expand our opportunities and increase our shares with NAND flash and DRAM-based solutions in multichip packages as well as discrete NAND solutions such as the UFS that I talked about that are in the stages of qualification with our customers. So we look ahead at the year with strong demand drivers for NAND in the industry and growing opportunities for our NAND business for the remainder of the year, calendar year here. And very focused on execution of all our new product introductions and qualifications with our customers because those will ultimately drive our success toward high-value solutions as part of mix of NAND revenue. + +-------------------------------------------------------------------------------- +Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + Okay. That's useful. And then as a quick follow-up, is it fair to assume that the high double-digit growth rate in better demand for NAND in data center is something that is possible again for this calendar year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [30] +-------------------------------------------------------------------------------- + + Yes, for this calendar year, for data center, absolutely, NAND bit consumption in data center is expected to be 50%, in the range of 50% or higher. Basically, a data center is where demand will grow faster than the average of the industry. Keep in mind, same thing for client SSDs as well. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mehdi Hosseini from SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Sanjay, I have a follow-up. You and others in the memory industry have been discussing opportunities in moving up the stack. At the same time, some of your enterprise customers are also trying to navigate their way and move up the stack. And I'm just wondering, what's wrong with keeping the business as is? Your NAND gross margin is in the 45% to 50%; DRAM gross margin is in the 65% to 70%, and assuming that the industry is rational and we can't avoid excess capacity, why not just focus on making the most cost-effective DRAM and bit and capitalize on the margin profile? And I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [33] +-------------------------------------------------------------------------------- + + So let me be clear that we are very excited about the market opportunities for DRAM and NAND. All the things that we have been talking about so far over the course of the last 45 minutes here. And of course, our strategy is to continue to strengthen our competitive -- cost competitiveness as well as increase the mix of high-value solutions in our revenue. And by high-value solutions in our revenue, we mean products such as SSDs as well as managed NAND solution because we have both DRAM and NAND and that gives us a unique opportunity to provide management solutions for today's smartphones that are needing more and more of such solutions. So we are absolutely focused on leveraging our core capabilities to drive cost reductions, catch up on the DRAM cost with the rest of the competition and in the NAND, strengthen our portfolio of these high-value solutions. And I have no doubt that there is -- nobody is taking their eye off the ball and we have relentless focus on strengthening the execution engine of the company and tremendous opportunity ahead in that regards for us. It's already implied through the strong results we have demonstrated so far but there is even greater opportunity ahead of us. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- + + In terms of costs, you recently introduced a QLC 64-layer 3D NAND SATA SSD. Is there any way you can either quantify or qualitatively discuss the cost per gigabyte that this particular product offers you? And how we should think about its ability, due to lowest cost, to penetrate and displace existing technologies? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [35] +-------------------------------------------------------------------------------- + + So what we introduced recently is a 64-layer bit TLC SATA SSD. And as we have said before, QLC is certainly an exciting opportunity for Micron in the years ahead, and QLC is in the development stages. And it is not a 2018 phenomena. I mean, that is something that's more like 2019 opportunity, starting in 2019 timeframe. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + But should we assume that this offers you, perhaps, I'm just going to give you a number, could it still offer a customer less than $0.20 per gigabyte of cost? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [37] +-------------------------------------------------------------------------------- + + We don't get into cost discussions. And our focus, of course, is to develop QLC solutions that will be, in the future, going toward applications that are very read intensive and somewhat balanced in terms of more write applications. And of course, our goal would be to drive these -- build value in these solutions, especially going toward high-capacity aspects of the storage market, build value in these solutions so that we can be selling them in a profitable fashion and bringing strong value to our customers as well. I'm not going to get into pricing or speculate of the pricing for QLC. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Hans Mosesmann from Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Sanjay, if you can just clarify, I think somebody asked the question before but I'll just make it more concise. Are you seeing any despeccing in DRAM or NAND market? And I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [40] +-------------------------------------------------------------------------------- + + We're not seeing any despeccing. If anything, again, given the nature of the application, the average capacity requirements continue to go up in all end markets arena. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [41] +-------------------------------------------------------------------------------- + + Okay. And then a follow-up, more of a longer-term or midterm question. After 1Y in the DRAM world, how many more node transitions or half transitions do you expect you and the industry to have before you hit a wall, if you will? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [42] +-------------------------------------------------------------------------------- + + We have talked about our 1Z technology node in DRAM and our engineers are working on that. And engineers, of course, always continue to look at opportunities for further scaling. And concurrently, we are working on other advanced technologies of the future as well. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + Okay. But there's no letter after 1Z at this point? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [44] +-------------------------------------------------------------------------------- + + There is no letter in the alphabet after Z. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + You can go to 1Zb or you can add a plus, plus or plus, plus, plus. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [46] +-------------------------------------------------------------------------------- + + Thank you. We'll take you up on your suggestion. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Vijay Rakesh from Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [48] +-------------------------------------------------------------------------------- + + Just on the NAND side, I was wondering what percent of your NAND was SSDs? I know you mentioned it grew 80% year-on-year and seeing good traction enterprise. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [49] +-------------------------------------------------------------------------------- + + We don't give that breakdown. + +-------------------------------------------------------------------------------- +David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [50] +-------------------------------------------------------------------------------- + + Got it. And I know you talked about 3D crosspoint. There's a bit drag on the margins. When do you start to see the drag go away? And I was just wondering, as you look at that ramp by the end of -- by year-end, what proportion do you think that would be of your NAND? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [51] +-------------------------------------------------------------------------------- + + So 3D crosspoint products are expected to come out in -- sometime in calendar year 2019. We will have -- sometimes we'll have underloading charges. It's possible that our partner might take some of the -- of those wafers so that would obviously help on the underutilization. Of course, as we start to release those products, about late 2018, we'll start to build some of those wafers and that will help out on the underutilizations as well. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [52] +-------------------------------------------------------------------------------- + + And I just want to comment on your earlier question regarding SSD. Of course, we don't provide the specifics but clearly, SSD is growing fast and it's increasingly large portion of our revenue. And very pleased with the progress that we have made in increasing the mix of SSD in our portfolio. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + This does conclude the question-and-answer session. I'd like to hand the program back to management for any further remarks. + +-------------------------------------------------------------------------------- +Shanye Hudson, - [54] +-------------------------------------------------------------------------------- + + Thanks, Jonathan. As always, we appreciate your interest and support for Micron. I'd remind you that a copy of the prepared remarks as well as a webcast replay can be found on the Investor Relations section of our website later this afternoon. Thank you. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's Micron Technology's second quarter 2018 financial release conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2018-Sep-20-MU.txt b/Transcripts/MU/2018-Sep-20-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4df168e21b19650d4dbd8e42cd7bcaf0d93ca6a --- /dev/null +++ b/Transcripts/MU/2018-Sep-20-MU.txt @@ -0,0 +1,469 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 Micron Technology Inc Earnings Call +SEPTEMBER 20, 2018 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Romit Jitendra Shah + Nomura Securities Co. Ltd., Research Division - Executive Director + * Amit Jawaharlaz Daryanani + RBC Capital Markets, LLC, Research Division - Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Latif, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Micron Technology's Fourth Quarter 2018 Financial Release Conference Call. (Operator Instructions) +It is now my pleasure to turn the floor over to your host, Farhan Ahmad, Head of Investor Relations. You may begin your conference. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Welcome to Micron Technology's Fourth Fiscal Quarter 2018 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. +Today's call will be approximately 60 minutes in length. This call, including audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with the convertible debt and capped call dilution table. +As a reminder, the prepared remarks from this call and webcast replay will be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. You can also follow us on Twitter, @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to documents we file with the SEC, specifically our most recent Form 10-K and Form 10-Q, for a discussion of risks that may affect our future results. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon, everyone. Our fourth quarter results contributed to a year of unprecedented success for the company. With record profitability and revenue over $30 billion, Micron ended fiscal 2018 as the second largest semiconductor company in the U.S. The new Micron is undergoing a fundamental transformation, driven by our 34,000-plus employees around the world, whom I would like to thank for their intense focus on our key priorities. +Our markets are propelled by diversified secular growth trends, our industry is more rational and the Micron team is executing well against the company's strategy. Over the last 12 months, we have sharpened our focus on improving our cost structure and on increasing the mix of high-value solutions in our portfolio, all of which position us well for the future. +Our technology road map and manufacturing execution is driving strong cost reductions for the company. Over the last year, we have increased production DRAM bits per wafer at a higher rate than the industry, reducing the cost gap with competitors. +We are on track to achieve total bit output crossover on 1X nanometer DRAM in the first quarter of fiscal 2019 and have already achieved bit shipment crossover for 1X nanometer in the client and graphics markets in the fourth quarter. +We expect 1Y nanometer sales to commence before the end of calendar 2019, with meaningful production increases beginning in the fiscal third quarter as we recently announced new cleanroom space comes online at our Hiroshima facility. +We are also making good progress on our 1Z nanometer technology development. +In NAND, cost reductions and mix improvements have helped us deliver sequential gross margin expansion even as pricing declined in the industry. At this time last year, our bit output share was meaningfully below our wafer market share. Over the last 12 months, through the strong execution of our 64-layer ramp and a higher mix of TLC, we have reversed this trend and now have our bit share ahead of our wafer share. We remain on track to move 96-layer NAND into production this calendar year and will continue to ramp it next year, which should provide us with solid cost reductions in fiscal 2019. +We have already commercialized CMOS Under the Array, QLC and array stacking on 3D NAND, while most competitors still have these challenges ahead of them. Our technology leadership positions us well for the year ahead, and we are pleased with the headway we are making on our fourth-generation 3D NAND technology, which uses a replacement gate architecture. +We also made excellent progress increasing our mix of higher value-added solutions, delivering record revenue in our SSD and multichip package products this quarter. +Our enterprise and cloud SSD quarterly revenues more than doubled year-over-year as we strengthened our position in SATA SSDs. A third-party research firm recently recognized Micron as the #1 market share leader in enterprise SATA. We achieved well over $2 billion in annual SSD revenue in fiscal 2018. +Our first-generation NVMe SSD is in the final stages of product development. Looking ahead, we are focused on introducing new NVMe SSDs over the course of the next several quarters. Consumer and client NVMe SSDs will come first, and then late in calendar 2019, cloud and enterprise NVMe drives. As the market rapidly shifts to NVMe, 2019 will be a year of transition for us, following solid SSD share gains in 2018, and we expect to start growing SSD share again in 2020 with a fuller product portfolio. +We also look forward to leveraging our market advantage with QLC SSDs in 2019 and beyond. +Fiscal Q4 saw a continuation of our stellar performance in managed NAND growth, with MCP revenues growing 21% sequentially. MCPs are used in the vast majority of smartphones, and we have robust demand from customers for these products. We are focused on growing MCP revenues and are introducing new differentiated products to enhance our portfolio. +In the fourth quarter, our new 128-gigabyte NAND plus 4-gigabyte DRAM MCP ramped revenue faster than any other managed NAND product in our history, demonstrating our strong execution as well as the market demand for high-capacity, high-value MCPs for flagship smartphones. We are pleased with our progress and believe we still have a lot of room to grow in this market over the coming year. +Now turning to highlights by market. More than 1/3 of our total revenues in fiscal 2018 were from data center and graphics. Our annual revenues in these markets have more than doubled year-over-year. We are confident about the long-term demand growth in this market as AI and big data analytics continue to create new value for end customers. Our collaboration with customers in these markets is deep, and we work closely with them to bring new technologies to market. +For example, in Q4, we started shipping a new custom persistent memory solution to a large hyperscale company. In graphics, NVIDIA chose us the lead GDDR6 partner for their GeForce RTX products, and we expect to see strong growth in our GDDR6 shipments in fiscal 2019. +We are also collaborating with customers on 3D XPoint solutions and expect to start sampling products in late calendar 2019. +Markets requiring our long life cycle products make up more than 15% of our revenues. We win in these markets on high-quality, deep partnerships, committed long-term support and the breadth of our DRAM, NAND and NOR product portfolio. These businesses in our portfolio typically show higher stability in revenues, profitability and cash flows and are supported by secular growth drivers such as autonomous driving, networking, IoT and industrial automation. +Our automotive business had record revenues in the quarter. We have a strong design win pipeline for automotive products, with a lifetime value of several billion dollars. To support our long-term growth in these markets, we recently announced a multiyear $3 billion investment to expand our fab in Manassas, Virginia over the next decade. This site will be a world-class center of excellence for developing and manufacturing these long life cycle solutions. +Turning to mobile. The market continues to grow, driven by content increases for DRAM and NAND across all frontiers. We shipped our first high-performance UFS-managed NAND products in the fourth quarter and expect this to be a growth area for us in fiscal 2019. +We delivered record results in mobile, with revenues up 8% sequentially, driven by strength in NAND as we grew NAND bits 80% quarter-on-quarter. DRAM and NAND content will continue to grow in mobile devices in fiscal 2019, driven by customer preferences and the need to support new camera and video features utilizing machine learning. +Looking at the industry broadly, calendar 2018 has been a phenomenal year so far, with a total DRAM and NAND TAM on track to reach record highs and total industry revenues forecasted to grow 29% year-over-year to $168 billion. +As we discussed at our Investor Day event, we expect industry cyclicality to be more dampened than in the past as industry supply growth from nodes transitions slows structurally and supply growth requires higher levels of CapEx. +In addition, we continue to see robust diversified demand drivers and are confident in the long-term outlook for our business. +Turning to bit growth. In DRAM, we see the calendar 2018 industry bit output growth tracking slightly above 20%, with Micron growing in line with the industry. NAND industry bit output growth is tracking close to 45% in calendar 2018, and we expect to grow roughly in line with the industry. +Looking ahead to calendar 2019, we plan to grow DRAM bits in line with estimated industry growth of approximately 20% and plan to grow NAND bits somewhat above our expectation of industry growth of 35% to 40%. +In fiscal 2019, we expect that DRAM profitability will remain strong as the market continues to benefit from long-term structural growth drivers and from structurally slowing supply growth. +Turning to NAND. We have seen an acceleration in supply growth in calendar 2018, driven by the ramp of highly efficient 64-layer 3D NAND across the industry. Looking ahead, we expect a moderation in supply growth beginning in the first half of calendar 2019 as the industry transitions to more challenging 96-layer designs, which provide less benefit node over node. +We also expect higher demand due to elasticity, resulting in higher SSD adoption and increasing average capacities across multiple end markets. In our fiscal first quarter, we see some impact to our client compute customers due to a shortage of CPUs. In addition, there is some limited inventory adjustment underway at a few customers, but their end customer demand remains solid. +Turning to CapEx. Dave will provide more details, but I want to emphasize that our fiscal 2019 CapEx plans are consistent with our strategy to focus on technology transitions while maintaining existing wafer capacity. As we have highlighted previously, future technology transitions in NAND and DRAM require substantially more cleanroom space than prior nodes. As a result, our fiscal 2019 CapEx related to manufacturing facility construction and facility upgrades is increasing by nearly $2 billion year-over-year, primarily due to our previously announced NAND and DRAM cleanroom expansions. This investment will provide us the flexibility to better manage our manufacturing operations and drive the manufacturing ramp of new technologies in a timely manner. +As I reflect on the tremendous progress we have made improving our competitive position this year and the amazing opportunities that drive our industry, I'm very excited about Micron's future. Against this backdrop, we certainly view our stock as being undervalued at current prices and are aggressively implementing our stock buyback program. We will continue to maintain a healthy balance sheet and use strong free cash flow to support over $10 billion buyback and assess opportunities to accelerate the time line for its completion. +With that, I will pass this over to Dave. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Sanjay, and good afternoon, everyone. Micron continues to perform exceptionally well and delivered strong financial results in the fourth quarter. +We set new records for revenue, gross margin, free cash flow and earnings per share. In addition, we continue to strengthen our financial foundation, achieving our highest-ever net cash position. +Total fiscal fourth quarter revenue was $8.4 billion, up 8% from fiscal third quarter and 38% from the prior year. For fiscal 2018, total revenue was $30.4 billion, up 50% from fiscal 2017. +Gross margins for the quarter expanded to a record 61%, up approximately 50 basis points from the prior quarter and up from 51% in the prior year. In the fiscal fourth quarter, we saw the benefit of strong execution on technology transitions for both DRAM and NAND. This strong execution resulted in a significant sequential cost decline, which drove expanded gross margins in both DRAM and NAND. For fiscal 2018, gross margins were 59%, up from 43% in fiscal 2017. +Operating expenses came in at $740 million, approximately flat from fiscal third quarter 2018. As previously communicated, moving forward, we expect to increase our investments in R&D for fiscal 2019 as we add resources to expand our portfolio of new high-value solutions and phase out partner contributions for technology development. +Our record revenue and gross margin performance drove strong profitability in the fiscal fourth quarter, and operating income grew to $4.4 billion, representing 53% of revenue. This compares with operating margins of 52% in fiscal third quarter and 41% in the year-ago period. +Now turning to our revenue trends by business unit. We achieved record revenue for the compute and networking business unit of $4.4 billion in the fiscal fourth quarter, up 9% from the prior quarter and 53% year-over-year. Growth trends were strong in cloud and graphics, which almost doubled year-on-year. +Fiscal fourth quarter operating income in CNBU was up 11% sequentially to $2.9 billion or 67% of revenue. +Revenues for the Mobile Business Unit increased to a record $1.9 billion, up 8% quarter-over-quarter and 60% year-over-year. Sequential growth was primarily led by multichip packages and discrete/managed NAND. Fiscal fourth quarter operating income increased 14% quarter-over-quarter to a record $979 million or 52% of revenue. +The Embedded Business Unit continues to deliver solid results, with record revenue of $923 million, up 3% versus fiscal third quarter and up 12% year-over-year. Sequential growth was driven by the automotive and industrial markets. Fiscal fourth quarter operating income in EBU was $382 million or 41% of revenue. +And finally, turning to the Storage Business Unit. Fourth quarter revenue was $1.2 billion, up 9% sequentially and down 4% year-over-year. We set a record for overall SSD revenues, driven by our continued success in the SATA SSD market. Fiscal fourth quarter operating income in SBU was $157 million or 13% of revenue, which included the impact from the underutilization charges related to 3D XPoint. +And now, moving to performance by product line. DRAM represented 70% of total company revenue in fiscal fourth quarter. DRAM revenue was up 7% from the prior quarter and 47% year-over-year as Micron executed well in a robust market environment. On a blended basis, ASPs were flat to the prior quarter, while shipment quantities were up mid to upper single digits percent. Gross margins for DRAM were 71%, up from 69% in the prior quarter as cost benefited from the ramp of our 1X nanometer technology. +Trade NAND revenue represented 26% of total company revenue in fiscal fourth quarter. Trade NAND revenue was up 15% quarter-over-quarter and 21% year-over-year, driven by strong sequential growth in managed NAND products. Our overall NAND ASP decreased in the mid-teens percentage range, and shipment quantities increased in the mid-30 percentage range compared to the prior quarter. Trade NAND gross margins were 48%, up 50 basis points from the prior quarter and up 720 basis points from the year-ago quarter, driven by robust cost reductions and product mix improvements. +Our solid execution and healthy industry environment led to a record non-GAAP earnings per share of $3.53, up 12% from the prior quarter and 75% from the prior year. +For the full fiscal 2018, we achieved net income of $14.7 billion or $11.95 per share compared with $5.6 billion or $4.96 per share for fiscal 2017. +In the fiscal fourth quarter, we generated a record $5.2 billion in cash from operations, representing 61% of revenue. Micron has historically shown strong cash flows from operations, even in our most difficult years, and our current cash flow levels are now structurally higher as we have made significant improvements on our underlying cost competitiveness and enhanced our product mix. +Capital spending net of third-party contributions was $2.1 billion in the fiscal fourth quarter and $8.2 billion for the fiscal year. While our annual capital spending was well below our CapEx model of low 30s as a percent of revenue in fiscal 2018, we do plan to increase our CapEx as a percent of revenue in fiscal 2019. We currently expect our fiscal 2019 CapEx, net of partner contributions, to be in the range of $10.5 billion, plus or minus 5%. +Our investments will continue to be focused on technology transitions for DRAM and NAND while maintaining flat wafer capacity. We expect that about 25% of our capital spending will be associated with facilities expansions and facilities upgrades needed for successful technology transitions. These expansion and upgrade projects are underway, and as a result, CapEx will be more weighted towards the first half of the fiscal year. Our strategy is to be flexible and disciplined regarding our CapEx, and we will be responsive to market conditions. As an example, we cut back our fab equipment CapEx for NAND in fiscal 2019 compared to fiscal 2018 levels. +In the fourth quarter, our free cash flow was $3.1 billion, up $900 million from the third quarter and up nearly $1.4 billion from the prior year period. Free cash flow for the full fiscal year was $9.2 billion compared to $3.3 billion last fiscal year. +We ended the fiscal year in a record net cash position of $2.7 billion, with approximately $7.4 billion in cash, marketable investments and restricted cash, and $4.6 billion in debt. +During the fiscal year, we used $9.4 billion for the repurchase or prepayment of debt and redemptions of converts and reduced our debt position by $6.5 billion. In the fiscal fourth quarter alone, we reduced our debt position by approximately $2.7 billion, including the repayment of $2 billion of Taiwan secured debt. +Combining the debt and equity components, we spent about $1.3 billion for redeemed convertible notes during the fiscal fourth quarter. Our convert redemption in fiscal third and fourth quarter have lowered the share count in the first quarter by approximately 31 million or 2.5% from what it would have been had the converts not been redeemed. +Prior to turning to our outlook, I wanted to provide some context for our fiscal first quarter guidance. As Sanjay indicated, our markets remain healthy and demand from our customers is strong, but we are seeing some impact of CPU shortages in the client compute market and limited inventory adjustments at select customers. +We expect gross margins to remain very healthy in the fiscal first quarter, although lower than fourth quarter levels, and our gross margins will also be impacted in the near term by the announced 10% tariff on $200 billion of imports from China, which will go into effect on September 24. We are working to gradually mitigate most of the impact from these tariffs over the next 3 to 4 quarters. +Our fiscal 2019 tax rate should increase to approximately 12% versus 2.8% in fiscal 2018, with the new U.S. corporate tax rules enacted this year. +With the revenue, gross margin and tax factors in mind, our non-GAAP guidance for the first fiscal quarter is as follows: we expect revenue to be in the range of $7.9 billion to $8.3 billion; gross margins to be in the range of 57% to 60%; operating expenses are expected to be $750 million, plus or minus $25 million; and based on share count of approximately 1.2 billion fully diluted shares, we expect earnings per share to be $2.95, plus or minus $0.07. +Now let me take a moment to provide an update on our share repurchase program. I'm pleased to report that our buyback has been in effect since the beginning of September. And for the fiscal first quarter, we are committed to spend at least $1.5 billion in programmatic repurchases, with an additional amount allocated for opportunistic repurchases. Beyond the first fiscal quarter, we expect to be active buyers of our stock by repurchasing Micron shares regularly. We are committed to deploying at least 50% of our ongoing free cash flow towards our $10 billion buyback program, and as Sanjay mentioned, we are assessing an accelerated rate of completion of this program. The total buyback program of $10 billion represents approximately 19% of the current equity value. +Before I turn the call back over to Sanjay, I'd like to discuss an update to our disclosures. As we typically do this time of year, we review the financial information we disclose to make sure that we are appropriately balancing the needs of investors to make an informed investment decision with a desire to keep confidential as much proprietary information as possible. In doing so, we also review information disclosed by competitors. As a result, beginning in the fiscal first quarter, we will no longer be disclosing gross margins by our DRAM and NAND product categories. We view this information as sensitive and proprietary. To help investors understand the drivers of our corporate gross margins, we will provide color on factors affecting gross margins. We will continue to provide revenue and operating margin information by segment in our quarterly and annual filings with the SEC. +With that, I'll now turn the call back over to Sanjay for concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. I'm proud of the Micron's teams' execution in fiscal 2018. In October, we will celebrate the 40th anniversary of Micron's founding. Our proven track record in delivering technology and design innovation and building close partnerships with a broad range of customers has laid a solid foundation. We are now driving a culture of agility, efficiency and speed and executing on product level innovations in high-value solutions. This transformation to the new Micron continues to build strong momentum. I'm really excited about our future, and the best is yet to come. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of John Pitzer of Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- + + Dave, I'm wondering if you could just help us understand the magnitude of the impact in the fiscal first quarter to the CPU shortages and just sort of the modest inventory correction we're seeing with some of your customers. And specifically, on the CPU shortages, do you feel like that's something that's limited to the fiscal first quarter? Or are you -- or should we think about that persisting into the fiscal second quarter? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Okay, yes, sure. So let me get -- take the first one. Let's start with -- so on the magnitude side, we're not going to go into necessarily the details, all the details in a granular fashion. Suffice it to say that they both had an impact in terms of the guidance of $7.9 billion to $8.3 billion They're a big driver of obviously why we guided in that direction. I don't know exactly how long the CPU shortage will last. I think on the inventory correction side, it will be a couple of quarters before inventory gets reduced. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [4] +-------------------------------------------------------------------------------- + + And I will just add that [with the CPU] shortages, we expect it to be short term. It's possible that it goes beyond Q1 as well. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [5] +-------------------------------------------------------------------------------- + + That's helpful. And, Sanjay, maybe as a follow-up. In your prepared comments, you talked about 2019 being a year of transition for your SSD business as you bring out NVMe product. I'm wondering if you could help us understand what that means from a financial perspective for your SSD business. Do still expect growth in that business in fiscal year '19? And kind of how do we think about profitability as you transition from SATA to NVMe? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [6] +-------------------------------------------------------------------------------- + + As we said, we have gained substantial shares in SSDs, primarily based on SATA SSDs over the course of 2018, our fiscal 2018. And we are very pleased with the progress we have made there. And, of course, market is shifting towards NVMe SSDs, and that's where the future growth opportunity lies. And we have been working on our NVMe SSD solution. We plan to introduce our first NVMe solutions later this year, and then we will be ramping, as we said, in the client and consumer space, bringing new products into the market in calendar year 2019 and bringing, later on, enterprise and cloud, NVMe SSDs later in the year, in the 2019 year. So our NVMe SSDs will be ramping up gradually over the course of 2019. Of course, we will continue to maintain a solid share position with SATA SSDs. Overall, I expect that our total share in SSDs will continue to be flattish in 2019 time frame, and we expect to resume share growth from [a] 2020 time frame as we complete our NVMe SSD portfolio. And by completing NVMe SSD portfolio, I mean, complete the development of SSDs, get them qualified with our customers and ramp them into production. So we are very confident about the long-term opportunity for us in SSDs, leveraging our low-cost 64 layers NAND as well as our 96-layer NAND solutions over the course of next few quarters. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Romit Shah of Nomura. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [8] +-------------------------------------------------------------------------------- + + [Just in like] your commentary, and certainly, the CapEx paints a fairly positive view of the environment and certainly more positive, Sanjay, than what we've heard from your largest competitor, who appears to be reducing investment and preparing for a protracted downturn. So, I guess, my first question is, how confident are you that the adjustments you're seeing is really just a 1 or 2 quarter issue? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [9] +-------------------------------------------------------------------------------- + + I think most important to understand is the end market demand trends for DRAM as well as NAND continue to be strong. I mean, when you look at data center and cloud applications, AI is in the very, very early innings. And the whole cloud growth is in the very early innings as well. We see the DRAM requirements in enterprise and cloud data center application to be growing much faster than the total average DRAM industry demand growth, CAGR over course of few years of about 30%. Similarly, in mobile applications, DRAM is growing nicely as well, as machine learning kind of features, as facial recognition, et cetera, get implemented in these forms. We are already starting to see 6 to 8 gigabyte, even 10 gigabyte, coming in smart -- high-end smartphones now, and these are not too far -- and then you even see 12 gigabyte in smartphones. And similarly, on the NAND front, when you look at average capacities increasing in smartphones, you are seeing now 512-gigabyte smartphones being offered, and again, days of terabyte smartphones are not far away. And certainly, with elasticity in NAND, average capacities in client computing applications as well as mobile devices will increase as well as attach rate of SSDs will increase. So this is important. When you look at these demand trends, we feel very confident about the long-term trajectory. In 1 or 2 quarters here or there, there can certainly be ebb and flow in terms of demand or supply in the industry, but the long-term trend is positive. And specific to our CapEx, I'll just point out here that we are being very prudent, very disciplined in managing our CapEx, absolutely focused on profitability and ROI. We had mentioned that our CapEx on cleanroom construction and facility upgrades is increasing by $2 billion compared to last year. And Dave mentioned that it represents about 25% of our total CapEx guidance that we provided. And just as an example of our discipline on CapEx management in NAND, in terms of equipment CapEx for 2019, our fiscal year 2019 versus 2018, we have -- we are actually reducing the CapEx fiscal year 2019 versus 2018. So we are extremely focused on technology conversions, technology transitions because they are the best way for us to achieve cost competitiveness as well as ROI on our investments. We are not adding the wafer starts, where some other competitors may have thought about those in the industry. + +-------------------------------------------------------------------------------- +Romit Jitendra Shah, Nomura Securities Co. Ltd., Research Division - Executive Director [10] +-------------------------------------------------------------------------------- + + I think a lot of us certainly believe in the strong secular trends that are driving your business. What's been a little surprising though is just the rate of change in pricing both in NAND and, it seems more recently, DRAM. Can you talk a little bit about that? And you mentioned some customer inventory. I'm curious, which segments do you see that elevated? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [11] +-------------------------------------------------------------------------------- + + So I think with respect to the inventory question that you have, it's very important to understand that we are not talking about debt inventory adjustment in any particular segment. This is with few customers. It is a customer-specific inventory adjustment that we discuss here. And, of course, we cannot call out those customers on this call. And with respect to pricing, of course, we do not forecast pricing. But you look at our F Q4 results, our DRAM pricing was flat, and 71% gross margin, record gross margin, extremely healthy. Industry environment, we see going forward as well for DRAM. As I talked about, the demand drivers are vibrant for DRAM, they are diversified and they are secular in nature, and DRAM solutions are really bringing great value to the AI-driven kind of applications where they're really essential to that trend. And you have to keep in mind that the supply growth is slowing down as well, given the increased technology complexities and greater CapEx that is required to implement the technology transition. So overall, we continue to see healthy DRAM industry fundamentals. On the NAND side, as I mentioned, this year, calendar 2018, we see NAND supply output growth at approximately 45%, and this, as you know, has been there because the industry, over the course of last several months, has gone through a major transition from 2D NAND to 3D NAND with a 64 layer. And the industry at this point is already on 3D transition in terms of total bits on a calendar year basis at about 75% level. So going forward on NAND as well, as you look at transition in the future to 96 layer, that will have the same kind of [consideration] that increase technology complexity and reduced bit gain per wafer from 64- to 96-layer transition. So we see moderation in the industry supply aspect in the first half of 2019. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Amit Daryanani of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [13] +-------------------------------------------------------------------------------- + + I guess, 2 from me as well. First off, could you just maybe help me understand, when I think about the gross margin guide for fiscal Q1, it's down 300 basis points, I think, sequentially. How much of that is due to the tariff issue versus what's going on in memory broadly? And then as you go through fiscal '19, do you think these margins that you can improve throughout the year, especially as you [resolve] some of the tariff issue -- challenges? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [14] +-------------------------------------------------------------------------------- + + Yes. So, first of all, the gross margin guidance was 57% to 60%. So, of course, if we hit the higher end of that range, we will be 140 basis points down. Clearly, tariffs are impacting us, probably to the tune of 50 to 100 basis points. And as we talked about, we're working on steps to mitigate that. That obviously takes some time. We have to do some things operationally to get ourselves in a place where it isn't as impactful. And so it will be a quarter or 2 probably before we start to see some benefit from the improvement there. So that was certainly a factor on the gross margin side. I would say, in general, the market for DRAM is healthy. The market for NAND is well supplied. So we built in various expectations, depending on kind of how things play out from a revenue perspective, and that certainly drives some of the gross margin adjustments as well. But suffice it to say, if we look at this from a year-over-year comparison, gross margins, I think, in the first quarter of 2018 were 55.4%, if I'm not mistaken. So we'll be above, on a year-over-year basis, if we hit within the range of what we expect, anywhere from 160 to 460 basis points. + +-------------------------------------------------------------------------------- +Amit Jawaharlaz Daryanani, RBC Capital Markets, LLC, Research Division - Analyst [15] +-------------------------------------------------------------------------------- + + That's really helpful, Dave. And, I guess, if I could just follow up. On the NAND side very specifically, pricing has degraded for a couple of months, and your data, obviously, [that you put] showed that has declined as well in the quarter. Again, I'm somewhat surprised that you haven't seen demand elasticity kick in with output or your demand, I guess, improving much more dramatically. So I'm curious, what do you attribute perhaps to the fact that demand hasn't stepped up more attractively as pricing has come down? And do you think there's just a time lag for it to get there? Or is there some other reason why we aren't seeing it? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [16] +-------------------------------------------------------------------------------- + + So let me take that. In terms of demand elasticity, we are certainly seeing that. I think in smartphones, you do see a move to higher capacities. I referred to that in my previous comment in response to the previous question. In SSDs, which is currently [limited] to consumer and channels-related SSDs, with the benefit of lower-priced NAND, certainly, you see -- you are starting to see -- there's always some lag. Average capacity increases in those channels as well. So overall, NAND should definitely continue to benefit from price elasticity. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Tim Arcuri of UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [18] +-------------------------------------------------------------------------------- + + I had two. So, Sanjay, first, I wanted to see if you can provide some color sort of in terms of your reduction in cost for DRAM in fiscal 2019 and whether you think it'd be similar to what you reduced cost in DRAM in fiscal 2018? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [19] +-------------------------------------------------------------------------------- + + So we are not going to provide full year guidance on the cost side for fiscal year 2019, but I will tell you that we believe we are in very good position with respect to continuing to execute on our technology and manufacturing road map and realizing cost reduction. Of course, as we have said before, when you go from 1 technology node to the other technology node, you achieve less bits per wafer gain, and that impacts, of course, the cost reduction capability from 1 node to the next node. And again, the laws of physics are the same everywhere, and this is common across the industry, as we discussed at our Investor Day. So 1Y technology in mature years will provide less cost reduction than 1X technology provided over the 20-nanometer. Nonetheless, our position will be good in terms of cost reduction. Things that we discussed at Investor Day, we feel very good about our ongoing march toward strengthening our cost competitiveness. And, of course, in NAND, we are in very good position with the lowest-cost technology in the industry. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [20] +-------------------------------------------------------------------------------- + + Awesome, awesome. And then I had a question on the fiscal 2019 CapEx. So Samsung is pretty significantly -- well, not just them, but both of your peers are pretty significantly reducing DRAM CapEx next year. And it sounds like if I strip out the infrastructure and the building portion, that your equipment spending on DRAM is going to go up next year. So I'm asking about the juxtaposition of you increasing your DRAM CapEx when your peers are pretty heavily cutting DRAM CapEx next year. So I wanted you to talk about that dynamic and, specifically, what it would take for you to cut DRAM CapEx next year. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- + + So let me just point out that in 2018, we were well below the industry in terms of overall CapEx. And overall, we definitely are absolutely focused on technology transitions with respect to our CapEx, and we believe we have, really, a prudent disciplined focus, as I said before, in terms of addressing our CapEx toward equipments, targeting it toward technology transition and bit growth coming from the technology transition. We have mentioned that calendar year '19, we see our supply bit growth in line with the industry on DRAM side, which we expect to be approximately 20%. And in NAND, we have said that we expect our fiscal year 2019 supply output bit growth to be -- industry to be in the range of 35% to 40% and for us to be somewhat higher. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + And I would say, as we talked about in the prepared remarks, we do react to changes in our view, and we did reduce our CapEx plans for NAND in fiscal 2019. So we are able to make adjustments as we see changes. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [23] +-------------------------------------------------------------------------------- + + Yes. And, of course, we retain some flexibility in terms of managing this on an ongoing basis as well. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Aaron Rakers of Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [25] +-------------------------------------------------------------------------------- + + Two, if I can, as well. Kind of building on that last question. As we think about what you've said about 96-layer and less of an incremental capacity increase when compared to that of 64-layer, I'm wondering if you could provide us some framework of how we should think about the next phase of transition to NAND in terms of bit output increases on a per wafer perspective. And then I have a quick follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [26] +-------------------------------------------------------------------------------- + + So at this point, we are not providing specifics on 96-layer and how much you gain per wafer, but I think some of it can be obvious as well. You are going from 64-layer to 96 layers. And future generation beyond 96-layer will tend to have, again, reduced bit gain per wafer. All of that is obviously -- along with the assumptions of industry ramp of 96-layer, is baked into our overall guidance of fiscal year -- calendar year '19 NAND bit growth of 35% to 40%. It's slowing down because, again, 64-layer to 96-layer will give you less gain. So in 2018, you saw a onetime increase in NAND bit growth, given that the industry went from 2D to 3D transition with 64-layer. Going forward, it will revert back to the same curve of less and less bit gain and, of course, more CapEx requirements with each successive technology transition. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Fair enough. As a quick follow-up, I'm curious, you talked a little bit earlier about your NVMe positioning and then the portfolio expansion. You didn't talk much about quad level cell or QLC. So maybe if you can update us of where you see that positioned and when we should expect to see that kind of impacting the SSD business as we look through calendar '19 or into 2020. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [28] +-------------------------------------------------------------------------------- + + So in my prepared remarks, I did mention about QLC, and we have -- we are the first ones to introduce QLC SSDs in the industry, very proud of Micron's ability and execution in that area and very proud of our team to be able to do that. And we have just begun with certain set of limited customers taking that QLC SATA SSD product to the market. This will be a growing revenue for us within SSD next year. Although it will remain relatively small, it will initially be, of course, in the SATA QLC solutions. As in the past, when you went through MLC transitions in the NAND industry or you went through the TLC transitions in the NAND industry, those transitions occurred over the course of few years, and we similarly expect the QLC transition to be happening gradually over the course of next few years, although we will start realizing revenue from QLC SSDs starting now, but -- then continuing to increase it modestly in calendar 2019 as well. And, of course, focusing on it in the SSD space. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + On inventory adjustments, is this primarily client side or data center side? And is this a statement more about just kind of higher accumulated inventories in the first half? Or is this a statement around the overall demand environment coming in less than expected or a combination of both? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [31] +-------------------------------------------------------------------------------- + + So as I said before, this is not limited to any particular segment. It is more specific customer consideration. And given the kind of pricing that had existed in the DRAM market, certain customers have certain inventory levels that -- in a certain inventory strategy that they were pursuing. And those customers have decided to adjust their inventory levels. So that's what we refer to in our remarks. In terms of the end market demand for those customers and end market demand for DRAM application, that continues to be solid. It's just an inventory adjustment approach of some of our customers. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Great. And you guys have done a great job of improving the NAND mix. I mean, your margins actually went up in the quarter. Given the strong cloud spending trends, you obviously have a great mix of enterprise and cloud SATA products. The transition to NVMe is going to be slower than expected, so I would anticipate your SATA products continue to do well. So on a go-forward basis, and given your customer spending trends, do you guys anticipate continued mix-based improvements and benefits in your NAND business from a gross margin perspective? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [33] +-------------------------------------------------------------------------------- + + I mean, absolutely, we will continue to increase our high-value solutions mix, which means SSDs as well as managed NAND solutions for mobile application, including discrete managed NAND solutions as well as multichip packages, where, of course, we have a significant benefit because we have both DRAM and NAND. So absolutely, this is part of our strategy. We will absolutely continue to increase our mix of SSD and managed NAND solutions, high-value solutions. Just want to remind you that we had shared at the Investor Day that in fiscal year '17, we had about 40% of NAND revenue coming from our high-value solution, that means SSDs and managed NAND solutions. And in fiscal year '18, we increased that to a little over 60%. In fact, in fiscal Q4, our managed NAND and SSD mix, the high-value solutions mix in NAND is over 2/3. So this just goes to show you that we are absolutely working toward our goal that we had shared with you at the Investor Day, that by 2021, we will have 80% of our NAND revenue in terms of -- actually, in terms of managed NAND solutions. So this is going really well for us, and it, of course, provides us the benefits in terms of profitability as well. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mehdi Hosseini of SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [35] +-------------------------------------------------------------------------------- + + 2 questions. Sanjay, you have been referencing visibility onto data center. I think it's something that, I think, investment community would really appreciate if you could give us the thought process that gives you the confidence. And what are the key metrics that gives you the visibility? Anything here that could be specific would be really great. And I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [36] +-------------------------------------------------------------------------------- + + So, certainly, I think when you look at the data center, the total CapEx increases particularly in the hyperscale application, a lot of that CapEx, (inaudible) go toward server and memory and storage application. But that certainly is an indication of the continuing year-over-year growth (inaudible) certainly an indication of [keeping] opportunity. But again, I will point out that we are in very early innings there. And this is going to be a multi-year growth opportunity for us. And we are actually focused on working closely with the customers in this space. And through those discussions, we had good visibility from them in terms of our opportunity for the future. So we feel very good about our growth opportunities in this part of the segment here. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [37] +-------------------------------------------------------------------------------- + + Sure. I completely agree with you. And I think your Analyst Day provided a lot of detail and informative information on how the opportunities could be. I think what we are struggling with is how to model this, even if it's not on a quarterly basis, maybe on a 6-month basis, because perhaps, opportunities by 2020, 2021 are enormous. But what happens in 2019? And how should we think about cloud CapEx? In the past, we had PC units and we had content. We had smartphone units and the content. But now the cloud -- either an Internet company or a software company providing cloud services, it's very difficult to model this. And we have to think about how '19 will look like before all of these opportunities would materialize. And I was just wondering if there's anything you can share with us to help us with the thought process. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [38] +-------------------------------------------------------------------------------- + + So I think one of the things I will share with you is that if you look at the DRAM demand growth projections in the cloud and enterprise data center space, you will see that, that CAGR over a few years is 30%, and that is higher than the expected DRAM overall industry supply bit growth of 20%. So this is one of the fastest growth areas where DRAM, along with NAND, really bring a lot of value to those customers. I think at our Investor Day, we had taken you through the details of how AI-driven applications are requiring 6x more DRAM per server and 2x more SSDs per server. So I think you have to look at all of these trends. There is no one particular trend that I can point to. You -- in this regard, of course, you have to look at the cloud CapEx. You have to look at the average capacity increases that are taking place on the DRAM side as well as for the NAND side in cloud applications, the server attach rates. The CPUs that are going into the servers have more memory channels that's enabling more DRAM growth per server content in the data center application. So there are many of these things that all absolutely are pointing to strong demand drivers. And just to end the comment here, I would point out that our end market applications are well diversified in DRAM. Of course, cloud and data center is 1 strong growth area for us, but mobile, automotive, industrial, IoT, all of these are also growth applications. For example, in automotive and industrial, we have #1 market share, and that's a very stable kind of market opportunity. And we are doing very well. Graphics is another example, right? We are very strong positioned in graphics as well and another growth opportunity. So multiple growth drivers and we are well positioned. The message is the industry is structurally different, and Micron -- the new Micron is also structurally different. And we are well positioned to drive the business going forward. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- + + Okay. And if I may just have a quickie one for David. How should we think about your NAND and DRAM aggregate inventory? Are there number of days? Or how has it changed sequentially? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + Well, inventory in total is probably all we are breaking out, which inventory on a days basis right now is in kind of the high 90s. It's been that way for some time now. I would say we're comfortable with our inventory position. Having said that, if you remember in the Analyst Day, Manish, that runs operations talked about some of the things he was doing to improve the efficiency of the manufacturing group and, on top of that, improve, in particular, the back-end and try to make that more streamlined. And there's a whole bunch of things we're doing in terms of system improvement and process improvement that I think will actually have a pretty good effect on inventory going forward. So over time, I think you'll see us carry a lower days of inventory and improved working capital in the process. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our last question for this session comes from C.J. Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [42] +-------------------------------------------------------------------------------- + + If I could ask two. First one, on the call, you talked about moderating NAND supply in the first half of '19. Curious, with the construct of inventory adjustment at a few of your customers, could you kind of walk through how you're seeing DRAM supply/demand, particularly as you also layer in some of the cuts that we've seen from your 2 other competitors in terms of equipment add over the last 6 to 9 months? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [43] +-------------------------------------------------------------------------------- + + So as we mentioned, we see DRAM to be healthy in Q1, and we definitely see healthy demand supply chain for DRAM beyond that as well, given the well-diversified growth drivers for DRAM. So overall, we see DRAM in balance. And regarding the inventory adjustment, I just want to be clear that, that comment is related to DRAM. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [44] +-------------------------------------------------------------------------------- + + Very helpful. And then as my follow-up, on the buybacks, you talked about a $1.5 billion or roughly 3% of the company. I'm curious, given you had the 10b5 program in place September 1, should that be front-end-loaded, thus more material benefit as we go through this quarter and next? And then also, considering you're now, I think, $2.5 billion, plus or minus, net cash position, at these prices, would you consider being even more aggressive? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [45] +-------------------------------------------------------------------------------- + + Good question, C.J. And I do want to thank investors for being patient with us a little bit. We announced this in May at the Analyst Day, and we needed a few more months to get the balance sheet to where we wanted. As you mentioned, now we have a great net cash position, we have debt now below $5 billion, that is 0.3x EBITDA, and we have great liquidity. We're now over $9 billion of liquidity, and we said we wanted to be 30% of sales in liquidity. So we're in a very strong position entering fiscal 2019, which I think is great. Our intention is to be fairly programmatic about the buyback, and so that $1.5 billion does represent more of a programmatic-type approach. Having said that, we did mention that we have layered, on top of that, some opportunistic repurchases, and so that will be somewhat timing-based, based on when the opportunities arise to take advantage of buying back a little bit more. In both Sanjay and my prepared remarks, we did talk about acceleration. And if you look at the $1.5 billion and kind of make some estimations around our free cash flow for the first quarter, you'll probably get a figure that is above the 50% free cash flow number we said we are committed to. So I think it is in the cards for us to be a little bit more aggressive over time, and we obviously think that this is a fantastic price to be buying the stock at. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + And ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2019-Dec-18-MU.txt b/Transcripts/MU/2019-Dec-18-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..a9cd7db8586e80d110d6e39a479500faa176a85f --- /dev/null +++ b/Transcripts/MU/2019-Dec-18-MU.txt @@ -0,0 +1,465 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 Micron Technology Inc Earnings Call +DECEMBER 18, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Srinivas Reddy Pajjuri + SMBC Nikko Securities America, Inc., Research Division - Research Analyst + * Rajvindra S. Gill + Needham & Company, LLC, Research Division - Senior Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Mark Trevor Delaney + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * David Michael Wong + Nomura Securities Co. Ltd., Research Division - MD + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you, ladies and gentlemen, and thank you for standing by. Welcome to Micron Technology's First Quarter 2020 Financial Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) +I would now like to hand the conference over to your host, Head of Investor Relations, Farhan Ahmad. Sir, please go ahead. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's first fiscal quarter 2020 financial conference call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. +Today's call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release and the prepared remarks filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures can be found on our website, along with a convertible debt and capped call dilution table. As a reminder, a webcast replay will be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. You can follow us on Twitter at MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we filed with the SEC, specifically our most recent Form 10-K and 10-Q for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievement. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon. Micron is off to a solid start in our fiscal 2020. Despite a challenging industry environment, we delivered good profitability, maintained positive free cash flow and strengthened our product portfolio. Industry supply-demand balance continues to improve in both DRAM and NAND. Recent trends in our business give us optimism that our fiscal second quarter will mark the bottom for our financial performance, which we expect to start improving in our fiscal third quarter with continued recovery in the second half of calendar 2020. +Our strategy to increase high-value solutions, enhance customer engagement and improve our cost structure is producing results. We have materially improved our competitive position, structurally strengthened our profitability and are poised to drive long-term shareholder value as industry conditions improve. +High-value solutions in fiscal 2019 accounted for approximately 50% of NAND bits. We expect this figure to grow to over 2/3 of our NAND bits sold for fiscal 2020, and we remain on track to drive 80% of our NAND bits into high-value solutions in fiscal 2021. This mix improvement is an important tailwind for us as it improves our profitability and reduces the volatility in our margins. +At our Micron Insight event in October, we articulated a vision for Micron's transformation through greater vertical integration and differentiated products for the new data economy. I will highlight 2 of these and encourage you to view Sumit Sadana's Insight Keynote available on our website for more detail. +First, we announced the acquisition of a small company called FWDNXT. The FWDNXT Deep Learning Accelerator hardware and software technology, when combined with advanced Micron memory, makes it possible to deploy neural network models from any framework into edge devices for inference. FWDNXT's unique technology is an important capability in our portfolio that will help us learn and better address customers' needs in the evolving AI ecosystem. +At Insight, we also launched our first 3D XPoint product, the X100, which is the world's fastest storage device. The Micron X100 SSD is dramatically faster than any other SSD, including those built with NAND or 3D XPoint technology, and we are proud that it was showcased at Microsoft's Ignite conference by their Azure team. +In October, we closed our acquisition of Intel's stake in the IMFT joint venture. We plan on relocating equipment and certain manufacturing employees to other Micron sites as we rightsize the Lehi Fab. Redeploying equipment will also help us optimize Micron's front-end equipment CapEx. As with any innovative technology, it will take time to scale up our 3D XPoint product portfolio, ramp revenues and achieve healthy margins, and we are excited about the long-term potential of 3D XPoint for both memory and storage applications. +As the only company in the world with a portfolio of DRAM, NAND and 3D XPoint technologies, we are in a unique position to develop differentiated products for our customers. +I will now turn to technology and manufacturing operations. +In DRAM, our industry-leading 1Z LP4 DRAM-based uMCP had the fastest revenue ramp of any product in the history of our mobile business. Our production mix on 1Z will increase throughout 2020, and DRAM cost reductions will be skewed toward the second half of fiscal 2020. Our previously announced cleanroom expansion in Taiwan is on track, and we expect output in calendar 2021. This cleanroom expansion is EUV-capable. While we continue to evaluate EUV technology for deployment in DRAM production, our current assessment shows superior economics through 1-gamma node, utilizing advanced immersion technology along with Micron's proprietary multi-patterning technologies. We are encouraged by recent industry progress on EUV productivity and will be prepared to deploy EUV when it becomes cost-effective to do so. +In NAND, we are continuing to make progress on our replacement gate transition and expect to begin production on our 128-layer, first-generation RG node in the second half of fiscal 2020. As a reminder, this node will be deployed for the limited set of products, and we expect minimal NAND cost reduction in fiscal 2020. It will be followed by an introduction of a higher-layer-count, second-generation RG node in fiscal 2021 targeted for a broader implementation, which will begin to provide more robust cost reduction as it ramps. This second-generation RG node will leverage our NAND technology leadership in CMOS under the array as well as QLC. +Now turning to highlights by products and markets. +In SSDs, demand from data center customers was strong in fiscal first quarter. Attach rates and capacities for client and consumer SSDs have continued to increase across our customers. There are supply shortages for SSDs across the industry, and pricing trends are improving. We are making strong progress on our transition to NVMe. As of fiscal second quarter, we will have NVMe SSDs for all market segments, which positions us to gain share in fiscal 2020. NVMe client SSD bit shipments represented almost 3/4 of our client SSD bits in fiscal Q1 versus virtually none a year ago. In the data center market, sales of our previously announced high-performance NVMe SSD nearly tripled quarter-over-quarter, and we announced a 96-layer mainstream data center NVMe SSD. +While growing our presence in NVMe, we continue to maximize our value propositions for the SATA market by ramping 96-layer NAND products. We achieved qualifications with multiple OEMs on our 96-layer SATA data center SSD. +Our QLC technology continues to gain traction. We have QLC SSDs in volume production for SATA SSDs in the data center and consumer markets as well as the NVMe SSDs for the consumer market. We became the first company to ship a 96-layer, second-generation QLC SATA consumer SSD. +In mobile, fiscal first quarter MCP DRAM and NAND bits grew approximately 50% quarter-over-quarter, and our MCP market share increased approximately 50% year-over-year. In fiscal Q1, our leading-edge 1Z LP4 DRAM-based uMCP achieved qualification at multiple OEMs, driving the fastest mobile product revenue ramp I mentioned earlier. We are confident that 5G will be positive for both memory and storage content growth as well as smartphone unit sales and are encouraged to see the launch of affordable 5G phones with price points as low as $300 that feature a minimum of 6 gigabyte of DRAM. The 5G phones launched to date average 8 gigabyte of DRAM and 200 gigabyte of NAND, significantly higher than the average content in smartphones today. Our leadership on DRAM power efficiency continues to drive customer preference for our products, and we remain well positioned in this market. We have the lowest power and the highest bandwidth LP5 product that begins volume production this quarter, which we expect will become more important in 2021 as 5G adoption accelerates. +In data center, strong server DRAM demand in the second half of calendar 2019 is creating an industry-wide shortage of high-quality, high-density modules, for which we are seeing incremental demand from our customers. New CPU architectures supporting higher-density chips and increased number of channels are driving strong DRAM content growth in servers. In fiscal Q1, we saw strong demand growth from enterprise and cloud customers. +In graphics, bit shipments remained stable, with GDDR6 PC graphics cards showing strong growth offset by seasonal weakness in gaming consoles. In fiscal Q1, we began shipments of our new 14-gigabit per second GDDR6 and are well positioned to benefit from the launch of next-generation gaming consoles in calendar 2020. The launch of these new gaming consoles will drive robust multiyear demand in graphics memory, and these consoles will deploy SSDs in place of hard drives for the first time. This continues a trend of SSDs replacing hard drives across more high-volume applications. +In the PC market, bit shipments in the fiscal first quarter continued the growth trend from last quarter. Nevertheless, we are cautious on our near-term outlook for the PC segment due to reported CPU shortages, which seem likely to continue at least into early calendar 2020. +In automotive, despite sluggish worldwide auto sales, we saw quarter-over-quarter revenue growth driven by secular memory and storage content growth. Our leadership in low-power DRAM is also driving growth for us in this market. In the fiscal first quarter, we qualified and shipped the industry's first BGA NVMe SSD for automotive applications, which offers industry-leading performance and capacity in a small form factor and is well suited to service the storage needs of increasing autonomous features. +Now turning to our market outlook. Our base-case assumption on which all our projections are based assumes that there are no perturbations to the demand environment due to macroeconomic conditions or trade-related developments. +In DRAM, there has been a strong recovery in the second half of calendar 2019, and our view of calendar 2019 industry bit demand growth has increased to approximately 20%. This stronger-than-expected demand has resulted in pockets of shortages for us. We continue to exercise price discipline and walk away from price requests that do not meet our objectives. While these actions may impact short-term revenue, improving our business mix will enhance our long-term profitability. We are encouraged by recent DRAM pricing trends and are optimistic about improving supply-demand balance throughout calendar 2020. +As we discussed on our last call, a portion of the strength in demand in the second half of calendar 2019 may be attributable to inventory builds in China, and we expect some of this customer inventory to normalize sometime in calendar 2020. As a result, we expect calendar 2020 industry DRAM bit demand growth to be in the mid-teens percent range year-over-year, which is somewhat lower than our prior outlook due to stronger demand in calendar 2019. +We expect industry bit supply growth for calendar 2020 to be somewhat less than the demand as industry bit supply growth decelerates due to industry CapEx reductions. We continue to target our long-term bit supply growth CAGR to be close to the industry's long-term bit demand growth CAGR of mid- to high teens. In calendar 2019, our bit supply growth will be less than the industry supply growth of mid-teens, and in 2020, our bit supply growth is expected to be slightly above industry bit supply growth. +Turning to NAND. Our industry bit demand growth expectation is in the mid-40s percent range in calendar 2019 and high 20s to low 30s percent range in calendar 2020. We expect calendar 2020 industry bit supply to be lower than industry bit demand as a result of industry CapEx reductions, and consequently, we expect the industry environment to improve through calendar 2020. Micron's NAND bit supply growth in calendar 2019 is likely to be slightly below industry bit demand growth, and in calendar 2020, will be meaningfully below that of the industry. However, we expect our NAND bit shipments growth in calendar 2020 to be close to industry bit demand growth as we ship our inventory during the first generation of our RG transition. As we go through the transition to replacement gate, we expect our multi-year supply growth CAGR to be in line with the industry's demand CAGR of approximately 30%. +Before I turn it over to Dave, I wanted to provide an update on our business with Huawei. +As previously disclosed, we are continuing to ship some products to Huawei that are not subject to Export Administration Regulations and Entity List restrictions. We applied for, and recently received, all requested licenses that enable us to provide support for these products as well as qualify new products for Huawei's mobile and server businesses. Additionally, these licenses allow us to ship previously restricted products that we manufacture in the United States, which represent a very small portion of our sales. However, there are still some products outside of the mobile and server markets that we are unable to sell to Huawei. +Receiving the licenses is a positive development, and we are thankful to the U.S. administration for approving these licenses. +Prior to receiving these licenses, Entity List restrictions severely limited our ability to qualify new products at Huawei. Although we are now able to qualify new products with Huawei's mobile and server businesses, it will take some time before the qualifications are completed and contribute to revenue. Consequently, we do not expect these licenses to have a material impact on our revenue in the next couple of quarters. +I'll now turn it over to Dave to provide our financial results and guidance. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. Micron's FQ1 results were largely consistent with our expectations as market conditions continue to stabilize. During the quarter, DRAM price declines decelerated from recent quarters, and we saw pricing improvements in NAND. Total company revenues grew sequentially, and our total inventory declined in absolute terms. We generated positive free cash flow during the quarter, made progress on our share repurchase program and further strengthened our balance sheet. +The results on today's call reflect our previously announced changes in NAND depreciable life to 7 years from 5 years and the change in reporting from our previous disclosures, which classified all MCP and SSD revenues as NAND revenue to a view now that disaggregates these revenues into DRAM and NAND. The following DRAM and NAND growth figures use restated historical revenues for an apples-to-apples comparison. +Total FQ1 revenue was approximately $5.1 billion. Revenue was up 6% sequentially and down 35% year-over-year. FQ1 DRAM revenue was $3.5 billion, representing 67% of total revenue. DRAM revenue increased 2% sequentially and declined 41% year-on-year. Bit shipments grew approximately 10% sequentially, and on a year-on-year basis, were up in the mid-20% range. ASP declined in the upper single-digit percent range sequentially. DRAM revenues included $435 million of revenues from MCPs and SSDs. +FQ1 NAND revenue was approximately $1.4 billion or 28% of total revenue. Revenue was up 18% sequentially and declined 14% year-on-year. Bit shipments grew in the mid-teen percent range sequentially and in the mid-30% range year-on-year, and ASPs increased in the low single digits sequentially. +Now turning to our revenue trends by business unit. +Revenue for the Compute and Networking business Unit was approximately $2 billion, an increase of 4% sequentially and down 45% year-over-year. The sequential increase was driven by higher volumes and moderating ASP declines. +Revenue for the Mobile Business Unit was $1.5 billion, up 4% sequentially and down 34% year-over-year. MCP revenues grew strongly during the quarter driven by approximately 50% sequential growth in DRAM and NAND bits. +Revenue for the Storage Business Unit in FQ1 was $968 million, an increase of 14% from FQ4 and down 15% year-over-year. Sequential revenue growth was driven by SSD volume growth and ASP increases. +Finally, revenue for the Embedded Business Unit was $734 million, up 4% from FQ4 and down 21% from the prior year. Sequential revenue growth was mostly driven by the automotive market due to content growth. +The consolidated gross margin for FQ1 was 27.3%, slightly above the midpoint of our guidance. FQ1 gross margins included approximately a 240 basis point negative impact or approximately $125 million due to underutilization charges at the Lehi Fab. This came in slightly better than we guided to on last quarter's call, but underutilization charges are expected to ramp higher in FQ2 as production volumes decline. We still expect the underutilization charges to average $150 million per quarter in the first half of fiscal 2020. We have taken action to reduce our spending in the Lehi Fab, which should begin to reduce underutilization charges in fiscal 2021 as these actions are implemented. Ultimately, these charges will be mitigated as our own 3D XPoint products ramp into production over the coming years. +Operating expenses were $811 million as we incurred higher-than-usual R&D expenses to qualify new products. We expect to operate at higher levels of qualification expenses for the remainder of fiscal 2020 as we continue to expand our product portfolio. As a result, we now expect operating expenses to be approximately $3.3 billion for the fiscal year. We continue to prudently control all other operating expenses and remain flexible should business conditions warrant. +FQ1 operating income was $594 million representing 12% of revenue. Operating margin was down 38 percentage points year-over-year and down 3 percentage points from FQ4. +Our FQ1 effective tax rate was 6.9%. We expect our tax rate to be approximately 5% for the remainder of the fiscal year. +Non-GAAP earnings per share in FQ1 were $0.48, down from $0.56 in FQ4 and $2.97 in the year-ago quarter. +Turning to cash flows and capital spending. We generated $2 billion in cash from operations in FQ1, representing 40% of revenue. During the quarter, net capital spending was approximately $1.9 billion, down from approximately $2 billion in the prior quarter. We are continuing to target FY '20 CapEx in the range of $7 billion to $8 billion. +We generated adjusted free cash flow of approximately $80 million in FQ1 compared to $260 million last quarter and approximately $2.3 billion in the year-ago quarter. +In FQ1, we repurchased 1.1 million shares for $50 million. In addition, we deployed approximately $200 million of cash to settle convertible note redemptions in the quarter, removing approximately 3 million shares from our fully diluted share count. +We will continue to target deploying at least 50% of our annual free cash flow towards repurchases. +Days of inventory was 121, down from 131 days in FQ4. Inventory ended the quarter at $4.9 billion, down slightly from $5.1 billion at the end of FQ4. Over the last 2 quarters, our inventory days have declined by approximately 15%. We expect inventory days to increase in fiscal Q2 due to seasonality and then begin to reduce again for the remainder of the year. +We ended the quarter with total cash of $8.3 billion and total liquidity of nearly $11 billion. We deployed approximately $1.3 billion of liquidity in FQ1 to fund the closing of our acquisition of Intel's stake in the IMFT joint venture. +FQ1 ending total debt was $5.7 billion, down slightly from the prior quarter. In addition to the retirement of IMFT's member debt, we used cash on hand to retire approximately $520 million in principal of high-yield debt. This was partially offset by the drawdown of our term-loan facility to fund the IMFT acquisition. +Our balance sheet is very strong, with net cash of $2.7 billion, and we remain committed to maintaining a net cash position. Last month, S&P upgraded Micron's credit rating to investment grade, and now all 3 rating agencies rate Micron's credit as investment grade. +Now turning to our financial outlook. As Sanjay mentioned, our outlook throughout our earnings commentary assumes that the macroeconomic environment and trade-related issues will not impact demand. +Micron's fiscal second quarter is the seasonally weakest quarter for the industry. We continue to exercise pricing discipline and reduce business at customers where pricing does not meet our objectives, and this limits our business opportunity within the quarter. +Additionally, in FQ2, pockets of supply tightness are limiting our bit shipments, Lehi underutilization costs are going to step up, and our cost reductions are likely to remain modest. However, we are encouraged by recent market trends and expect that FQ2 will be the bottom for our gross margins as pricing, increasing mix of high-value solutions and cost reductions drive better gross margins throughout the rest of fiscal and calendar 2020. +We expect a gradual recovery to start in FQ3 and to continue into the seasonally stronger second half of calendar year. +With that in mind, our non-GAAP guidance for fiscal Q2 is as follows: We expect revenue to be in the range of $4.5 billion to $4.8 billion; gross margin to be in the range of 27%, plus or minus 150 basis points; and operating expenses to be approximately $825 million, plus or minus $25 million. Interest and other income is expected to be approximately 0. Based on a share count of approximately 1.14 billion fully diluted shares, we expect EPS to be $0.35, plus or minus $0.06. +As we approach the trough in this cycle, at the midpoint of our guidance, fiscal Q2 revenue will be 60% higher and gross margins 9 percentage points higher than in the prior trough, which occurred in the fiscal third quarter of 2016. Micron's solid financial performance and investment-grade balance sheet demonstrate that the new Micron is indeed structurally stronger with higher lows and better cross-cycle revenue growth and profitability. +I'll now turn the call over to Sanjay for closing remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. Micron is entering 2020 as a fundamentally stronger company in an industry that is structurally transformed. Supply growth is moderating due to rising capital intensity and the slowing down of Moore's Law. Demand drivers are more diversified than ever before, both in end markets and in variety of memory and storage solutions. This change in industry dynamics creates new opportunities for Micron to innovate and provide differentiated value to customers. Nascent applications promise to further accelerate this diversification. Cloud growth continues at a brisk pace driven by new use cases, and 5G networks are just beginning to proliferate and will usher in an age of true machine-to-machine communication with billions of connected devices. And just a little further over the horizon, AI, machine learning and autonomous technologies will expand this potential even more. These trends are transforming every aspect of human life and driving secular growth in memory and storage. Micron's enhanced product portfolio, improved cost structure and talented team put us in an outstanding position to capitalize on the wealth of opportunities ahead and create long-term shareholder value. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Srini Pajjuri of SMBC Nikko. + +-------------------------------------------------------------------------------- +Srinivas Reddy Pajjuri, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + Sanjay, just a couple of questions. I guess, first on the supply shortages that you talked about. Could you please elaborate? Because on one hand, you're talking about some shortages. On the other hand, the inventories are going up as we head into the next quarter. And then I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + So as we said last time as well as in this earnings call that we have certain shortages in DRAM on the leading-edge nodes, and we have brought down our inventory here, overall inventory down fairly fast, as Dave pointed out. And we have seen strong growth in demand in DRAM on high-quality, high-density modules for servers as well as demand trends have continued to be pretty solid. So shortages on the leading-edge nodes on DRAM. +And on the NAND side, we have SSD demand going up substantially. And our 96-layer products, as we expand the portfolio, are being qualified by customers. We are seeing strong demand on our 64-layer node, where we are actually seeing some shortages. And of course, as we mentioned, we experience some back-end constraints as well. We have invested in back-end capacity, assembly and test capacity expansion, and that's -- will -- assembly and test issues impacting some of our multi-die stack on the mobile solutions as well as SSD solutions. The assembly and test constraints will be eliminated largely by the end of fiscal second quarter. +So these are some of the things that are impacting some of the shortages both in DRAM and on the NAND side. And again, the demand trends continue to be solid. Of course, in CQ1, we see seasonality. And yes, some of our inventory may go up at the end of fiscal Q2. But overall, our normal inventory days is around, as we look ahead, is around 110 days and that's really a function of increasing complexity coming from the technology nodes as well as, as we shift toward high-value solutions, more SSDs, more multi-chip packages, they take longer assembly and test times as well. So those are the ones that are contributing to some of the aspects of days of inventory that when we foresee in the future, we look at it as approximately 110 days. +So industry environment, in terms of demand, continues to be solid, pockets of shortages building all across the industry, certainly, we are experiencing that. And pricing trends overall in the industry. As you look ahead at 2020, we are yet optimistic about the improving pricing trends in the industry as well. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our next question comes from the line of John Pitzer of Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [5] +-------------------------------------------------------------------------------- + + Congratulations on the solid results. Sanjay, I wanted to talk a little bit about the CapEx guidance for this fiscal year. I think I understand the strategy around NAND to, kind of, constrain spending on the first generation of replacement gate where cost downs are de minimis and, kind of, weighed to Version 2.0. But I'm kind of curious, as you think about the DRAM strategy, especially given that demand came in much stronger than expected, this year, 20%, and there were some of us that thought at the beginning of the year, we'd be lucky to get to low double-digit growth. How do we think about DRAM CapEx from here and your ability to, kind of, keep up with industry bit growth? And I guess, specifically, my question is, how much circular leeway do you have in moving more of your mix of DRAM towards the leading-edge node as a way to grow bits rather than just shrinking? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [6] +-------------------------------------------------------------------------------- + + Certainly, as we move our DRAM production to leading-edge node, for example, through 1Z that we mentioned that we did very well with ramping 1Z DRAM node in our mobile products during the quarter, so of course, those give us bit growth. It comes with the shrink capability, and technology transitions are the best way to achieve ROI as well. What's important is that we are being extremely disciplined and prudent in terms of managing our supply bit growth, and we want to make sure that it's aligned with our bit demand growth as well, as our long-term objective is to have our supply bit growth CAGR to be aligned with the industry demand growth CAGR. We mentioned that in 2019, our DRAM supply growth somewhat below the industry supply growth. And in fiscal year 2020, we -- in calendar year 2020, we see our supply growth to be somewhat above the industry supply growth. But all in all, our strategy is to have our supply growth CAGR to be aligned with the industry demand growth CAGR. We feel very good about -- when we look ahead at 2020, our supply overall position, and yes, I mean, we are experiencing certain shortages on leading nodes. And we believe that some of these shortages in the industry as well as, for us, will continue in calendar year 2020 time frame. And frankly, that's a good place to be at in terms of running the business because it helps you manage the best mix of the business as well in terms of revenue and profitability. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [8] +-------------------------------------------------------------------------------- + + I guess a question on the DRAM demand side. You're outlining an outlook for 15 -- or sorry, mid-teens growth in 2020. I'm curious, as you think about that number, how much of that, I guess, relates to potential pulling of China demand, potential conservatism on your part? And within that, what kind of assumptions are you making around 5G handsets and continued cloud spending through 2020? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [9] +-------------------------------------------------------------------------------- + + So certainly, 5G will be a growth driver. We expect 5G handsets, smartphones to be more weighted toward the second half of the calendar year. Cloud CapEx, as you have seen the reports from various major cloud providers, cloud CapEx continues to be healthy. A meaningful portion of that cloud CapEx goes into memory and storage and that continues to drive above-average industry -- above-average demand as a percentage versus the average of the total DRAM industry. And 5G phones, I think it's important to note that content continues to grow as we mentioned in our script. I mean, of course, 4G phones content continues to grow, but 5G phones are driving a step-level function increase in the average content of both DRAM as well as NAND. +And our estimation is that in calendar year 2020, approximately $200 million of 5G smartphones to be sold on a global basis. So overall, when we look at the demand -- industry demand of mid-teens that we have projected for calendar year 2020, keep in mind that it's building upon calendar year 2019, where industry demand in the second half came in quite strong. And in fact, we upped our estimate of industry demand growth to approximately 20% for 2019. So you are working off a large demand, larger than previously expected total bit shipments in 2019. And obviously, that has an impact on the percentage that we look at for 2020. But in terms of aggregate of bit demand, that continues to be pretty solid in 2020 as well. And as we said, 2019 was a headwind in terms of demand and supply for the industry. In 2020, we look at demand and supply balance as a tailwind for the industry. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Rakers of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [11] +-------------------------------------------------------------------------------- + + I guess, just on the capital expenditure front. Obviously, you guys have talked about reiterating the CapEx, but you're also, on the Taiwan fab, you're noting that, that fab is capable of EUV. I know you've talked about that you don't need that through the 1-gamma node, but it kind of suggests that you are looking at EUV as potentially something that you're evaluating. Have you pulled in all your thoughts on EUV? And how do we think about that in the context of CapEx, not necessarily this year, but looking out into the subsequent years? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [12] +-------------------------------------------------------------------------------- + + So at this point, we are not providing guidance for any time frame beyond our fiscal year 2020 in terms of CapEx. But as we have always said, we have been evaluating EUV technology. We have carefully evaluated EUV technology in terms of determining our road map for DRAM. And as you noted, through -- we have said that through 1-gamma node, today, we are in production with now 1Z node, starting production with 1Z, and of course, volume production also of 1Y node. So from 1Y to 1Z, as we look ahead at the next few generations through 1-alpha, 1-beta and 1-gamma generations, we see that multi-patterning techniques, along with immersion technology, will serve us well in terms of achieving our cost objective and having a highly cost-competitive road map for us. So we have also said that we continue to evaluate EUV. And when we see it appropriate for deployment in our DRAM production in terms of cost and efficiency of production, we will certainly be deploying it at a future time in that. But at this point, we see our technology road map through 1-gamma node to be in strong position, while we remain encouraged seeing the improvement in EUV productivity tool as well. +But regarding CapEx for future years, we'll obviously always manage it as a function of our supply growth expectations as well as, as a function of technology and cost competitiveness and keeping our supply growth, as I said previously, aligned with demand CAGR. That's how we will manage it, and we'll share those details with you at appropriate time in the future. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Delaney of Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [14] +-------------------------------------------------------------------------------- + + I was hoping to better understand the company's commentary on its own inventory, which -- nice to see that come down in dollars and days in the just-completed quarter. As you think about your inventory, as you move through the year, I understood some of the aggregate commentary, but can you be a bit more specific? Because I think the company had been carrying extra inventory of some of these older DRAM nodes. When do you think that gets used up? And when you talk about 110 days, Sanjay, is that being on a more normal level of inventory, just given because the company is going to be carrying the extra NAND inventory for the replacement gate node? Should we be thinking about inventory running above 110 to allow for that this year? Or is the 110 really a this-year comment as you carry some of that extra replacement gate inventory? And longer term, it's something lower than that? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes. That's a good question. Why don't I try to take a crack at that first? So yes, the comment around 110 days is kind of an optimal level of inventory when we have worked off all of the excess inventory associated with the replacement gate transition and as inventories normalize. Obviously, in the 121 days of inventory that we have today, DRAM is a bit below that. Really what pulls it up to 121 is that NAND is quite a bit higher than that by virtue of the fact that we are executing on this strategy to hold a lot of inventory as we go into our replacement gate transition to augment what won't be a robust bit growth from that first node. As Sanjay mentioned, we do expect days of inventory to go up a bit based on mix and so forth in the second quarter because of seasonality, but we would expect it then to start trending down over the next few quarters, partly as we start to utilize this excess NAND inventory for the replacement gate transition and also as we start to digest and manage through this -- the mix challenges that have created a little bit of excess spill on the DRAM front. So it's just we should be in a pretty healthy place on DRAM within a couple of quarters. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from Ambrish Srivastava of BMO Capital Markets. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [17] +-------------------------------------------------------------------------------- + + Good to see you power through this downturn with positive free cash flow. I just wanted to get back to the comment that, Sanjay, you were making about the fiscal second quarter marking the bottom for fundamentals. And CapEx seems to be a little bit front-end loaded. So is free cash flow going to be positive in the fiscal second quarter as well? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + So I'll take a crack at that one, too. I would say, maybe to start with, that the first priority of the company is to make the appropriate level investments, both in terms of R&D, and which is why we have had a little bit of an increase in operating expenses because we do want to put the right level of investment in new products, particularly high-value solution products that will ultimately be the big factor in terms of our performance over the coming years. And in addition, we obviously want to make the appropriate level in terms of CapEx investments to make sure that we are, as Sanjay mentioned, investing the right level to manage supply growth and to make these node transitions. +Secondarily, of course, our goal is to generate good free cash flow. And ideally, it would be to generate pretty consistent free cash flow over multiple -- or over every quarter. I would say, in the second quarter, what we feel really confident about is that cash flow from operations is going to be very strong. And we will, again, make appropriate level of CapEx investment that could drive the free cash flow to be slightly negative or roughly around 0 or potentially even a little bit more positive, but we're going to make the capital investment be what's appropriate and let free cash flow go where it goes. I would say though, just to put this in perspective, the trough quarter of 2016, in terms of free cash flow, was negative $1.3 billion, I believe. And so if you compare that to whatever we end up doing for the second quarter, this will be massively better in terms of cash flow generation, and of course, that's an indication of -- or an example of how we have structurally improved the business from a cost-competitive perspective and from a cash flow perspective. And indeed, if this does turn out to be the bottom, as Sanjay indicated, it is our expectation, barring any sort of macro event or trade event, we would expect free cash flow to track more positively through the remainder of the fiscal year and into the next fiscal year. So this year will be actually a pretty good year in terms of free cash flow. That will be 4 consecutive years of positive, significantly positive free cash flow for the company, which, of course, has never been done in Micron's history. +So again, ideally, we'd like to have every quarter be positive. That may or may not happen this quarter, but clearly, we're on the right track in terms of generating positive free cash flow for the company. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur of JP Morgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + We've seen a strong reacceleration in cloud and hyperscale spending. Also seeing some near-term strong server builds by the Asia ODMs. And it appears that the excess DRAM channel inventories in this segment have been worked on. But wanted to get your views here. And typically, the cloud spending up-cycle duration is about 3 to 4 quarters. So even in a seasonally weaker period for PCs and smartphones in the first part of next year, do you see the server and data center demand remaining fairly strong? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- + + Yes. As we look ahead, we do see server and data center demand, particularly within cloud, to be strong. We have had, as we mentioned, in our FQ1, strong growth from cloud, and we certainly see that happening through 2020 as well. As we mentioned, high densities are actually in shortage in the industry. And it really is about all the trend of more AI workloads, more need for memory and storage, as EUVs get introduced, that can work with higher-density memory as well as have more channels, which is increasing the attach rate of DRAM content per server and increasing it. So these are all the trends that actually point to continuing higher-than-industry-average level of growth for DRAMs in the cloud and server. +And same thing on the NAND, on the SSD front, average density as well as the average usage of flash in cloud and data center applications continues to increase. And we have always said that this is a long-term demand driver for memory and storage industry. And memory and storage is critical in terms of driving greater value in these cloud applications and in these enterprise applications, and hence, you are seeing continuing strong growth in these end market segments. +And I would just like to point it out that even in 2019, while the demand to the suppliers was weaker in the first half of the year because the customers, particularly in this space, were using up the inventory that they had to meet end consumption, but it's important to understand that the end consumption of DRAM and NAND, even in challenging 2019 periods, continued to be healthy. And as we look ahead, this will be a strong driver of growth in the industry. +But I just want to point out that as we previously discussed, smartphones, content growth there; automotive applications, continuing to drive greater content; graphics, gaming consoles, new gaming consoles are also driving HDD replacement with SSDs as well as greater DRAM content in those applications. So I think the demand drivers and our thesis that has always been there that the industry has strong demand drivers has very much been intact. And we look forward to good environment for our industry in 2020. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from David Wong of Instinet. + +-------------------------------------------------------------------------------- +David Michael Wong, Nomura Securities Co. Ltd., Research Division - MD [23] +-------------------------------------------------------------------------------- + + Could you tell us what proportion of DRAM bits are currently on 1Z technology? And what do you expect will be on 1Z technology by the end of calendar 2020? And what's the differences between cost per bit on 1Z compared to 1Y? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [24] +-------------------------------------------------------------------------------- + + So we don't provide cost details with respect to 1Z versus 1Y or from one node to the other node. But as we have said before that we expect our 1Y plus 1Z combined bit production to cross over our total bit production by summer 2020. That means bit crossover with 1Y and 1Z combined by summer 2020. And as we mentioned, we are doing well with our 1Z. And in fact, in mobile products, as I mentioned in my prepared remarks, we saw the fastest ramp of 1Z node in the history of our mobile presence. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from Joe Moore of Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [26] +-------------------------------------------------------------------------------- + + I wanted to ask a bit more about the China inventory build that you talked about. Can you, kind of, talk about the reasons? Is it concern about ability to procure? Is it tariff related? What's the reason for the pull in? And any way you can help us, kind of, understand the magnitude would be helpful. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [27] +-------------------------------------------------------------------------------- + + As we have mentioned before, we saw some China buying pattern that was above normal compared to the past that we have seen, and we attribute that to some of the U.S.-China trade tensions and perhaps some of the customers in China procuring and shifting to perhaps a longer-term strategy of carrying more inventory because in terms of the U.S.-China trade aspects, while Phase 1 deal is definitely encouraging to see that it's happening, but lack -- there is still ongoing for longer-term lack of clarity. So perhaps some of the China customers have shifted their strategy toward carrying higher levels of inventory. I would say that, that perhaps is an important reason. +There's, of course, Chinese New Year as well that can play a role in the China demand. Chinese New Year is earlier this year compared to the typical years. But there is no question that most important thing is that the underlying demand drivers are strong. And when you look at smartphone content growth that's happening in all smartphones across the globe, including the ones sold by the China manufacturers, the content, both on DRAM and NAND side, continues to increase. And certainly, as we have talked about, 5G is the significant driver. And certainly, 5G phones are planned to be sold, perhaps in the largest quantities, in China first. So all of these underlying demand trends, I think, are the most important thing here as well. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from Blayne Curtis of Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + Maybe, Sanjay, just to follow on Joe's question. Just kind of curious, you said it'd take a couple of quarters for Huawei to get back in the numbers. Are you embedding anything in the calendar '20 outlook you have? And I'm just kind of curious, following on that point, in terms of you're expecting some moderation from China. Have you seen any signs of that yet? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [30] +-------------------------------------------------------------------------------- + + I'm sorry. I didn't quite get the last part of the question. Expecting... + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [31] +-------------------------------------------------------------------------------- + + Following on Joe's question, you're expecting some moderation after an inventory build. Have you seen it yet? Or is that just something you expect will happen at some point? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [32] +-------------------------------------------------------------------------------- + + The -- what we said is that in terms of our estimation of the industry demand growth in calendar year 2020, we have baked in that some of the inventory that we may have seen China customers build, we have baked in that some of that will be consumed, and inventory levels will be lower than what we may be thinking at this point with those customers over the course of calendar year 2020. +And with respect to your first piece of the question on Huawei, we mentioned that now that we have received the licenses, we are able to work with them on new product qualifications. And as you know well, new product qualifications do take a few months, a couple of quarters, before they get qualified into new platforms, and then we can potentially look at additional opportunities. But at this point, I mean, our focus is to resume that product qualification work, both for server as well as mobile applications. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Raji Gill of Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [34] +-------------------------------------------------------------------------------- + + Yes. And congrats as well as you weather through this cycle. Question on mix shift for NAND specifically. Sanjay, you had mentioned that next year, you will be ramping at a higher rate NVMe, SSDs as well as UFS controllers in the China handset market. Could you talk a little bit about the trajectory of those products and how that positive mix shift in NAND will potentially affect overall margins? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [35] +-------------------------------------------------------------------------------- + + I'll have Dave comment on the margin piece of it. But certainly, as we expand our portfolio of NVMe solutions for -- from clients to data center and, of course, certainly on the consumer side as well, we have done well, as we reported for our FQ1, in terms of expanding the portfolio and capitalizing on increased sales of SSDs, and we certainly look at gaining share throughout calendar 2020 as we expand our portfolio there. I think what's important to note is that our share there is today underrepresented. So as we shift toward these higher-value solutions with expanded portfolio, I mean we are basically trying to bring our share in line with what it should be given our share of the total NAND bits, and this is the part of the strategy that we talked about in terms of shifting the mix of our high-value solutions, which now are at about 50% in terms of bits toward higher number in the future. And of course, part of that ongoing shift is toward multi-chip packages as well as discrete, managed NAND solutions for mobile applications, where we pointed out that on a year-over-year basis, we have increased our share by 50%. Yet we remain underrepresented, and therein lies further opportunity for us to be increasing our share in these markets. +So high-value solutions is a very important part of our strategy. It enables us to gain greater stability, greater margin opportunity through the cycles as well as brings us closer to understanding the application landscape with the customer, and I'm very pleased that Micron is executing quite well with respect to achieving our objective in this area. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + So obviously, high-value solutions, the reason -- one of the major reasons we're shifting the strategy to high-value solutions is because they carry higher margins. And I'll just give you a data point. If you look back at fiscal '19 and look at these high-value solutions relative to consumer components, you'll find the margins were about 30 points -- 30 percentage points higher. So significantly higher opportunity to get higher margins. And of course, that obviously helps the overall margins of the company. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our last question comes from the line of Hans Mosesmann of Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [38] +-------------------------------------------------------------------------------- + + Congratulations to the team for the execution. Sanjay, on the server and data center module dynamic where you're seeing a higher mix of quality or higher density, what was the density on average a year ago just to get a reference on how that has improved? And what exactly is driving this move? Is it a new process or architecture? Is it market share gains? That would be helpful. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Yes. In cloud servers as well as enterprise server, average density is around 3 giga -- 300 gigabyte per server average consumption of DRAM, and this trend is expected. When you look at the CAGR over the next few years, expect it to continue to go -- grow in double digit range anywhere, when you look at '19 to '22 kind of CAGR, around 20% CAGR for average content growth in servers, in cloud and enterprise applications. So this is definitely a high-growth area for the market. +And when you look at the new CPUs, like Cascade Lake and other new CPUs starting in 2019, as I mentioned earlier, they support the usage of higher-density chips. That means they support usage of 16-gigabyte chips as well as more channels in the new CPUs, and that is definitely driving greater ability to use more content per server for DRAM. And of course, at the end of the day, it's about the workloads that applications are running and those workloads are requiring -- increasing requirement for speed and that's translating into increasing requirement for memory as more and more real-time data analytics kind of applications and AI applications are being run in enterprise and data center and cloud applications. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [40] +-------------------------------------------------------------------------------- + + Great. And as a quick follow-up, can you give us a commentary regarding 3D XPoint used in main memory? If there is a road map for that this year -- this coming year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [41] +-------------------------------------------------------------------------------- + + So 3D XPoint, certainly, as we said, exciting opportunity for us longer term. It definitely gives us differentiated opportunity with -- as the only company in the world having NAND, DRAM and 3D XPoint. We have just introduced our first storage product with 3D XPoint, the world's fastest SSD. And as you noted, I mean 3D XPoint certainly has opportunities on the memory side of the business as well. And as we look at engaging with the ecosystem, as we look at developing our products, these are the kind of opportunities, both on the memory semantic applications as well as storage side of the applications we'll be addressing over the course of next few years, as we expand our product portfolio in this area. +But certainly, 3D XPoint -- again, these kind of things, breakthrough technologies, take multiple years and require a lot of ecosystem work to get the full use of the technology. And we are well on our way, as we discussed, at Micron Insight. And let me put the plug here again that if you have not watched it, please do watch Sumit's presentation. I think it gives you a pretty good perspective on the capabilities of 3D XPoint technology and our vision of the future with it. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2019-Jun-25-MU.txt b/Transcripts/MU/2019-Jun-25-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..d97fb6b5f4c27b1a33b5417707342ed73addfef8 --- /dev/null +++ b/Transcripts/MU/2019-Jun-25-MU.txt @@ -0,0 +1,509 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 Micron Technology Inc Earnings Call +JUNE 25, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, ladies and gentlemen, and thank you for your patience. You've joined the third fiscal quarter 2019 financial call for Micron Technology. (Operator Instructions) As a reminder, this conference may be recorded. +I would now like to turn the call over to your host, Head of Investor Relations, Farhan Ahmad. Sir, you may begin. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's Third Fiscal Quarter 2019 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. +Today's call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with the convertible debt and capped call dilution table. +As a reminder, the prepared [calls] from this call and the webcast replay will be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. You can follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to documents we filed with the SEC, specifically our most recent 10-K and Form 10-Q for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activities, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I will now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon, everyone. Micron delivered solid fiscal third quarter results despite headwinds from industry oversupply and steeper-than-expected price declines. This financial performance reflects our continued strong execution on technology advancement, further cost reduction and pricing discipline. Our healthy balance sheet structurally improved profitability, and winning team set the foundation for us to emerge even stronger when the industry environment recovers. +We are confident that the long-term demand outlook for memory and storage is compelling, driven by broad secular trends such as AI, autonomous vehicles, 5G and IoT. The new Micron is well-positioned to take advantage of these trends with innovative products, a responsive supply chain and well-established relationships with customers worldwide. +Over the last few months, customer inventory improvements have progressed largely in line with our expectations in most end markets. This reinforces our confidence that bit demand for DRAM will return to healthy year-over-year growth in the second half of calendar 2019. +NAND bit demand is also increasing in most markets as elasticity kicks in, in response to price declines over the last year. Even as customer inventory levels of DRAM and NAND improve across most end markets, producer inventory levels are elevated. Although previously announced CapEx cuts will start to impact industry supply in the second half of the calendar year, our assessment is that further cuts in CapEx and bit supply will be required to return the industry to a healthy supply-demand balance. I will discuss our actions on this front shortly, but first, let me provide an overview of our fiscal third quarter results. +At our 2018 Analyst Day, we discussed our priorities related to technology, cost competitiveness and high-value solutions. Solid execution on these strategies has now yielded over 2,000 basis points of EBITDA margin improvement relative to our peers since 2016. Unlike the last downturn during which Micron's relative profitability declined, in this downturn, our relative profitability has continued to improve. +In DRAM, we are on track to deliver good cost declines in fiscal 2019. We continue to increase the mix of 1Y nanometer and are meeting excellent progress towards ramping 1Z next fiscal year. +In April, we broke ground on our new cleanroom in Taichung, Taiwan. And earlier this month, we announced the opening of a new cleanroom in Hiroshima, Japan. These cleanroom expansions will enable future DRAM node transitions of our existing wafer capacity. +In NAND, we continue to ramp our 96-layer 3D NAND and are on track to achieve healthy cost declines in fiscal 2019. We continue to make progress on our 128-layer 3D NAND, which uses replacement gate technology. +As we discussed on the last call, we expect a partial transition to this node with the full portfolio transition occurring on the second generation replacement gate node. +In addition to these node transitions in DRAM and NAND, we are also improving our cost structure by increasing the percentage of products produced through captive back-end packaging facilities. These facilities now account for more than half of our total assembly requirements. Our captive back-end operations are tightly integrated with our front-end systems, enabling greater product customization, tighter quality control, improved responsiveness to shifts in demand and lower costs. High-value solutions now account for over 2/3 of NAND revenues. +We made further progress in strengthening our SSD portfolio with the launch of our 9300 data center NVMe SSDs for cloud and enterprise markets. We more than doubled revenue shipments of our new NVMe client SSD to large PC OEMs, and more customer qualifications are in progress. As a reminder, this new NVMe drive is built with our own controller technology. +QLC SSD shipments (sic) [bit shipments] increased approximately 75% sequentially, driven by growth of our consumer NVMe SSDs. Overall, the Micron team continues to execute well on cost reductions and on high-value solutions. +While we are operating in a difficult industry environment today, our progress is visible in our reported profitability and increases our confidence in our ability to drive long-term shareholder value. +Now turning to highlights by end markets. Our mobile business was impacted by U.S. trade restrictions, which Dave and I will discuss later in the call. Looking ahead, innovations such as 5G, foldable phones and advanced cameras will drive growth for our products. Our portfolio of mobile DRAM products features best-in-class power consumption. +On low-power DDR5, we are leading the industry and recently started sampling the highest density die in the market. We continue to make good progress on our managed NAND products as well and recently launched our second-generation UFS product with best-in-class endurance. +Within the data center market, cloud customers are turning the corner on inventories and most are approaching normal inventory levels. Our cloud DRAM bit shipments grew sequentially in the fiscal third quarter, exceeding our expectations, and early trends suggest strong sequential growth for the fiscal fourth quarter. Enterprise customer inventories are taking somewhat longer to normalize than we had previously expected. We continue to sample and secure qualifications on 64-gigabyte DDR4 server modules built with our 1Y nanometer DRAM. +In graphics, we saw robust sequential growth as customer inventories normalized. We expanded our customer base for our high-performance GDDR6, which positions us well for strong growth in the second half of calendar 2019. +In the PC market, DRAM bit shipments returned to growth as CPU shortages started to improve. Looking ahead, we expect strong sequential DRAM bit growth in our fiscal fourth quarter as laptop sales improve. +In automotive, while global auto sales are slow, content growth remains strong, driven by innovations in ADAS and infotainment systems. Micron is well-positioned to benefit from the growth opportunity in this market given our leading market share, deep customer relationships and high-quality products. We recently began ramping shipments with an industry-leading OEM for their most advanced autonomous system, which uses 16 gigabytes of our low-power DRAM. +Before talking about the market outlook, I want to provide some comments related to Huawei. As you know, effective May 16, the U.S. Commerce Department's Bureau of Industry and Security, or BIS, added Huawei and 68 of its non-U.S. affiliates to the BIS entity list. To ensure compliance, Micron immediately suspended shipments to Huawei and began a review of Micron products sold to Huawei to determine whether they are subject to the imposed restrictions. +Through this review, we determined that we could lawfully resume shipping a subset of current products because they are not subject to export administration regulations and entity list restrictions. We have started shipping some orders of those products to Huawei in the last 2 weeks. However, there is considerable ongoing uncertainties surrounding the Huawei situation, and we are unable to predict the volumes or time periods over which we will be able to ship products to Huawei. Micron will continue to comply with all government and legal requirements, just as we do in all our operations globally. Of course, we cannot predict whether additional government actions may further impact our ability to ship to Huawei. +Now turning to the market outlook for DRAM. As I mentioned earlier, we have seen early signs of bit demand recovery in most DRAM end markets. Based on our assessment of customer inventory improvement, we anticipate robust bit demand growth for the industry in the second half of the calendar year compared to the weak demand in the first half. Our view of calendar 2019 industry DRAM bit demand growth is in the mid-teens, with industry supply growing mid to high-teens. +Despite early signs of recovery in DRAM bit demand, the excess supply and resulting higher producer inventory levels have created a challenging pricing environment. We expect that the strengthening demand growth will begin to contribute to an improving trend in producer inventory later in calendar 2019. +Turning to our supply. At Micron, our focus continues to be on taking prudent steps to help bring the DRAM market back to stabilization. We are continuing the previously announced wafer start reductions of approximately 5%, which we expect will bring our DRAM bit supply growth for calendar 2019 close to market demand growth. +The overall NAND market remains oversupplied from the accelerated supply growth driven by the industry transition from 2D NAND production to 3D NAND. Our NAND industry bit demand growth expectations for calendar 2019 are unchanged at the mid-30s percent range. We continue to target our bit shipments to be close to the industry demand growth rate. Since our last earnings call, we have taken actions to further adjust wafer starts from the previously announced 5% reduction to now approximately 10%, which will result in lower supply growth in the second half of the calendar year. These reductions are the result of both capital optimizations to reuse more existing equipment for our 96-layer conversion as well as lowering some of our legacy NAND capacity, which we announced previously. +While we still believe the NAND industry supply is growing above demand this year, the market is showing signs of increased elasticity stemming from recent price declines. We are optimistic that the overall NAND market will start to stabilize in the second half of calendar 2019. +With the higher levels of macro uncertainty and the relatively high levels of inventory on our balance sheet, we are taking decisive action to manage our DRAM and NAND bit production. In addition to the wafer start reductions that we discussed, we are also taking action on CapEx. +Earlier this year, we announced a reduction in fiscal 2019 CapEx forecast from $10.5 billion, plus or minus 5% at the start of the year, to approximately $9 billion now. For fiscal 2020, we plan for CapEx to be meaningfully lower than fiscal 2019. While our CapEx plans are still being finalized, we seek to balance our manufacturing investments with our free cash flow objectives. +I'll now turn it over to Dave to provide financial results of our fiscal third quarter and guidance for the fourth quarter. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. Micron's fiscal third quarter results were within the guided revenue range and above the guided EPS range that we provided on our last call. We also generated healthy levels of free cash flow and made further progress on our share repurchase program. +Total fiscal third quarter revenue of approximately $4.8 billion was at the midpoint of our guidance range and was down 39% on a year-over-year basis and down 18% sequentially from the fiscal second quarter. Both DRAM and NAND revenue were negatively impacted by restriction on sales to Huawei, without which we would have reached the high end of our revenue guidance. +DRAM revenue was approximately $3 billion, representing 64% of total revenue. DRAM revenue declined 45% year-over-year and 19% sequentially from the fiscal second quarter. Compared to the prior quarter, the DRAM ASP decline approached 20%, while bit shipments were roughly flat. If not for the impact of Huawei, bit shipments in DRAM would have increased sequentially, as we had guided on our last earnings call. +NAND revenue was approximately $1.5 billion, representing 31% of total revenue. NAND revenue declined 25% relative to fiscal third quarter 2018 and declined 18% sequentially from the fiscal second quarter. Overall, NAND ASPs declined in the mid-teens percent range while shipment quantities declined in the mid-single-digit percent range compared to the prior quarter. Adjusting for the Huawei impact, bit shipments came in better than our expectation due to stronger component sales. +Now turning to our revenue trends by business unit. Revenue for the Compute and Networking Business Unit was $2.1 billion, down 48% year-over-year and 13% from the prior quarter. Lower pricing across major market segments continued to be the leading cause of lower revenue. However, normalized customer inventory levels led to shipment volume growth in the fiscal third quarter, particularly in graphics and client. +Revenue for the Mobile Business Unit was $1.2 billion, down 33% year-over-year and down 27% from the fiscal second quarter, due in part to lower shipments to Huawei. Lower pricing and DRAM volume drove the quarter-over-quarter decline. +Our managed NAND portfolio continued to show strength in the fiscal third quarter, with bit shipments increasing by over 200% year-over-year. +The Embedded Business Unit revenue of $700 million was down 22% from the prior year and down 12% from the fiscal second quarter. Revenue was adversely impacted by broad macroeconomic weakness, weaker pricing and inventory adjustments in the consumer segment. Automotive and industrial, which represented almost 75% of EBU revenue, showed strong margin resilience with gross margins down only 300 basis points from the last fiscal quarter. +And finally, the Storage Business Unit third quarter revenue was $813 million, down 29% year-over-year and down 20% quarter-over-quarter. The sequential decline was driven by competitive pricing and an unfavorable comparison on component volumes coming off a large onetime sale we completed in the prior fiscal quarter. +The consolidated gross margin for the fiscal third quarter was 39% compared to 61% in the prior year and 50% in the fiscal second quarter. Lower pricing in both DRAM and NAND was the primary driver of the lower margin in the fiscal quarter. Gross margins were also negatively impacted by approximately 200 basis points due to underutilization charges related to IMFT. +U.S. tariffs on imports from China were less than 30 basis point impact to gross margins as we have successfully mitigated approximately 90% of the impact from tariffs. Fiscal third quarter NAND gross margins remained above 25%. +Operating expenses of $774 million were well within our guided range. As we've said on prior calls, our goal with OpEx is to remain disciplined with respect to expense control while continuing to invest in future products and technologies throughout the market cycle. Operating expenses also benefited from the strong execution on qualification of our 1Z nanometer mobile DRAM product ahead of our internal schedule. +We delivered solid profitability in the fiscal third quarter with operating income of $1.1 billion, representing 23% of revenue. This margin is down 28 percentage points year-over-year and down 13 percentage points from the fiscal second quarter. +Non-GAAP taxes included $162 million of benefits in the fiscal third quarter due to a favorable state law -- state tax law change and a change in our annual tax rate from 10.5% to 9%. +Non-GAAP earnings per share in the fiscal third quarter was $1.05, down from $3.15 in the year ago quarter and down from $1.71 in the prior quarter. Fiscal third quarter non-GAAP EPS was $0.15 higher due to the $162 million of tax benefits. +Turning to cash flows and capital spending. We generated $2.7 billion in cash from operations in the fiscal third quarter, representing 57% of revenues. Capital spending, net of third-party contributions, was approximately $2.2 billion, down from $2.4 billion in the prior quarter. We still expect fiscal 2019 CapEx at approximately $9 billion. However, we expect meaningfully lower CapEx in fiscal 2020. +In the fiscal third quarter, our adjusted free cash flow, defined as cash flow from operations less net CapEx, was approximately $500 million compared to $2.2 billion in the year ago quarter and $1 billion in the fiscal second quarter. We bought back approximately $157 million of stock in the fiscal third quarter, representing 3.8 million shares. +For the fiscal year-to-date, we've returned $2.7 billion to shareholders in the form of share buybacks, which represents approximately 70% of our year-to-date free cash flow. Combined with the redemptions of outstanding converts, we have reduced outstanding share count by over 8% since fiscal third quarter 2018. +We will continue to prudently manage capital according to our philosophy of maintaining liquidity throughout the cycle, investing in capital assets to enable cost-effective node transitions and back-end cost competitiveness and returning over 50% of free cash flow to shareholders. +Inventory ended the quarter at $4.9 billion, increasing from $4.4 billion at the end of the fiscal second quarter. The fiscal third quarter ended with 151 days of inventory outstanding or 143 days using our average inventory balance for the fiscal third quarter. As we mentioned on the last call, calendar 2020 NAND bit supply will be constrained as we make the transition to replacement gate. To meet expected bit demand growth, we're carrying higher levels of NAND inventory in calendar 2019 and 2020. We also project to carry higher-than-normal levels of DRAM inventory in calendar 2019 as industry supply and demand work toward getting into balance. +Total cash ended the quarter at $7.9 billion, down quarter-over-quarter largely as a result of our $1.4 billion redemption of our Series G convertible notes announced last quarter and completed in the fiscal third quarter. Total liquidity exceeded $10 billion at quarter end while we maintained a healthy balance sheet. +In the quarter, we announced that the close of the IMFT joint venture acquisition will be October 31, which is during our fiscal first quarter of 2020. We expect to pay approximately $1.4 billion for Intel's share of IMFT. A portion of the payment will also be used to repay member debt financing, which at the end of the fiscal third quarter was approximately $860 million. +Now turning to our financial outlook. Both the DRAM and NAND markets remain oversupplied. Having said that, we are starting to see some signs of bit demand improvement. As Sanjay mentioned, we expect strong growth in our DRAM bit shipments for the cloud, graphics and PC markets in fiscal fourth quarter, followed by more normal bit growth in fiscal first quarter. +In NAND, while the industry is benefiting from elasticity kicking in, our bit shipment growth in fiscal fourth quarter will be limited due to the ongoing transition of our SSD portfolio. With that in mind, our non-GAAP guidance for the fiscal fourth quarter is as follows: we expect revenue to be in the range of $4.5 billion, plus or minus $200 million; gross margin to be in the range of 29%, plus or minus 150 basis points; and operating expenses to be approximately $785 million, plus or minus $25 million. Based on a share count of approximately 1.13 billion fully diluted shares, we expect EPS to be $0.45, plus or minus $0.07. +In closing, despite the industry and geopolitical challenges, Micron continues to execute on our key initiatives and remains on strong financial footing. We will continue to draw on our strong relationships with our customers and manage through the cycle with a focus on gross margins and free cash flow. +I'll now turn the call over to Sanjay for some concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. Clearly, fiscal 2019 has been challenging for both Micron and the industry. While we continue to believe that the industry is structurally stronger, the confluence of events that impacted this year was unprecedented. Still, we have fared better due to the tremendous progress we have made on improving our product costs, advancing our technology and increasing the mix of high-value solutions. +Recent industry financial results show that Micron's profitability and balance sheet are best-in-class. Having said that, we are not resting on our recent accomplishments and are continuing to raise the bar for ourselves. Our CapEx and expense controls reflect our focus on profitability and free cash flow. +With the economic and trade challenges facing the industry, the near term continues to be uncertain. But looking beyond these challenges, I'm excited about Micron's future. We are in the early innings of growth in cloud computing, and the value of data in the new economy is going to drive secular growth in numerous memory and storage-intensive applications. AI, autonomous vehicles, 5G and IoT will drive significant improvements in our lives, and we look forward to bringing the value of our innovative, market-leading solutions to our customers. +In April, we issued our fourth annual sustainability report, which details Micron's commitments to enhancing the world we live in through our products and business practices. We achieved perfect scores on industry-standard environmental and social audits of our facilities in 2018 and 2019. Our ongoing focus and improvements in sustainable practices is a competitive differentiator for both our customers and our employees and an important part of the transformation we are driving at Micron. +I'm energized by the potential ahead of us and proud of the culture of innovation and execution that we are building. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of C.J. Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess, first question, I was hoping you could provide a little more granularity on Huawei. You talked about the ability to sell a subset of products. Can you walk through, I guess, where you're allowed, where you're not. They are, I believe, a 13% customer at least last quarter fiscal year. What kind of impact do you expect as we proceed in the coming quarters across both DRAM and NAND? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + So as I said in my prepared remarks, after the Huawei was placed on entity list, we began a review of our products against the export administration regulations. And through that analysis, we determined that certain of our products, a subset of our products that we were previously shipping to Huawei, could continue to ship because it is lawful, it is compliant to those export regulations. +And of course, it had impact, as Dave noted; in our FQ3, it had an impact because we could not ship at that time any product to them, of nearly $200 million. And for FQ4, there would be impact to our revenue. What I would say is that our revenue with Huawei in FQ4 would be less than what had otherwise would have been if Huawei was not on the entity listing. +And of course, as we look ahead beyond FQ4, if Huawei continues to be on the entity list, then in fiscal year '20 as well, we would have an impact compared to what our revenue with Huawei would have been if they were not on the entity listing. Of course, we are a supplier to all customers and all end markets across the globe, and we will -- and our presence with several of those other customers is growing in terms of our penetration there, in terms of our share there. And we will continue to work on addressing those, but we would not be able to make up in fiscal year '20 if this were to continue the full shortfall. And we -- although we plan to make up part of it through other parts of the business. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + That's very helpful. And if I could just follow-up... + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + And it affects both our DRAM as well as the NAND side of the business. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + Great. And if I could follow-up on CapEx. You talked about a meaningful cut. I guess, is meaningful meaning single-type territory? And as part of that, is it more focused on DRAM? NAND? Both? How should we think about the implications there? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [7] +-------------------------------------------------------------------------------- + + So with respect to CapEx, we have said meaningful reduction in CapEx from the fiscal year 2019 levels, and we'll provide more details in the next call as we finalize our plans. Of course, our goal is to have our long-term considerations in mind with respect to technology and product cost capability, but most importantly to have our supply bit growth aligned with our expectations of demand bit growth. +And when we look at supply bit growth, of course, we keep in mind the inventory that we are carrying from fiscal year '19 into fiscal year '20 for both DRAM as well as NAND, which will help us supply some of the demand requirement in fiscal year '20 and enable us to reduce our CapEx requirements in fiscal year '20. And our CapEx management, of course, applies to both NAND as well as DRAM. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Newman of Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + The first question really following on Huawei. Can you give a little bit more quantification on how much the 13-or-so percent revenue you expect you will be able to continue to export to Huawei? And it is -- can you give us some guidance also for your bit growth for this next quarter? I don't think you have mentioned that yet on the earnings -- on the guidance. If you can mention about your expectation for bit growth for the following quarter. And I have a follow-up question. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [10] +-------------------------------------------------------------------------------- + + So with respect to Huawei, as I said before, our revenue expectation in fiscal Q4 is less than what it would have been without Huawei being on the entity list. Beyond that, we don't really get into specifics in terms of revenue as such on a customer-by-customer basis. Of course, our revenue expectation that Huawei is baked into the guidance -- revenue guidance that Dave provided for FQ4 of $4.5 billion, plus or minus $200 million. +And your second question with respect to... + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [11] +-------------------------------------------------------------------------------- + + So on DRAM bit growth, we said it would be up meaningfully in the fourth quarter. NAND will be more modest given the environment. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + Okay. My follow-up question is really taking a step back and looking at the industry. Clearly, it's been a quite challenging year this year with the oversupply. But just looking forward to 2020 with the pretty severe cuts you guys are making on utilization, the CapEx, and we're hearing similar cuts from some of your competitors in Asia, I'm just curious what you think for next year. I guess it very much depends on the economic outlook, which is a little bit unpredictable at the moment. But looking forward to 2020, do you not think that there could be a danger of potential undersupply at some point next year? I'm just curious how you're thinking about that because, to me, at this level of utilization and CapEx, it seems like, inevitably, there will be a period of undersupply coming, just a matter of time. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [13] +-------------------------------------------------------------------------------- + + So as you said, the industry is in oversupply right now, both in DRAM as well as in NAND. And while demand is increasing in the second half, both for NAND and DRAM, the oversupply situation does persist. And we have talked about it in DRAM, a challenging pricing environment. And therefore, it's important that CapEx cuts are made as well as supply bit growth is managed to bring the supply bit growth in line with the demand growth as well as over time to bring inventories in line with expectations as well. So we are not providing a fiscal year '20 guidance at this point, but all of the actions that we are taking here are really targeted to restore the industry demand and supply balance over the course of next few quarters. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer of Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [15] +-------------------------------------------------------------------------------- + + Sanjay, congratulations on the solid execution given the industry conditions. Just going back to the CapEx questions. I would argue, Sanjay, that one of the biggest strategic initiatives you've had has been to try to close a cost gap with your peers. And clearly, CapEx is a pretty important tool in which to do that. You guys are sort of bucking the trend this fiscal year with CapEx actually up slightly versus peers that have actually taken it down. I'm just kind of curious. Help us to get some comfort level that despite the cuts you're talking about for the fiscal year '20, you're still very much on plan relative to closing those cost gaps with your peers. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [16] +-------------------------------------------------------------------------------- + + So certainly, as you noted, we have made tremendous improvement in our cost position and with respect to our peers, and that reflects in our financial performance. As was noted in the prepared remarks, our margin improvement -- relative margin improvement from previous times, has really improved by 2,000 basis points, and that's because of our execution on the cost front as well as on the execution on the high-value solutions front. And of course, we have more room to go with respect to cost competitiveness as well as strengthening our high-value solutions portfolio. +So we are extremely focused on this. And as we look at driving our future opportunities, we -- of course, when we make our CapEx decisions, we make them based on cost competitiveness of our supply in the future and, of course, keeping in mind our free cash flow considerations. And most important is that our total supply available to us coming from our inventory and coming from our supply bit growth, should be matching with our demand expectations going forward over the course of next few quarters and to continue to improve our inventory position. +But on the cost side, we feel very good about the 1Y and 1Z progress on DRAM as well as we feel good about our 96-layer. And overall, even with the CapEx reductions that we are talking about, we'll be in a good position with respect to costs, both in DRAM and NAND next year. +Of course, we have talked about in NAND, our first-generation replacement gate node will be a small node in the sense that it will be deployed across a small set of products. And we will not have any significant cost benefit from that first-generation replacement gate node, but the second generation replacement gate node will give us a meaningful cost benefit compared to the last generations of floating gate node. So we absolutely are on top of the game in terms of managing to our cost objectives. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + I'd just add that Sanjay already mentioned this drive to high value solutions, another way we can improve our gross margins, but also we're -- the node transitions isn't the only way we affect the cost of the product. And so one example is, for example, the back end, we're very acutely focused on the back-end. We are bringing some of that activity that we're doing that was being outsourced internally. We think we can improve our cost structure in that regard, too. So there are many ways we can drive the cost to improve it. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [18] +-------------------------------------------------------------------------------- + + And one thing I would just add is in terms of our overall CapEx that you mentioned, of course, as you know, that in fiscal year '19, we had a meaningful part of our CapEx, around $2 billion that was actually tied to facilities, cleanroom expansions to enable technology transitions. And this facility spend may not be the same from one manufacturer to the other manufacturer. But for us, that was a meaningful part to again, as noted in our remarks before, to prepare us for technology transitions and not targeting any of that cleanroom space for any meaningful capacity, but really for technology transition. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [19] +-------------------------------------------------------------------------------- + + And then, David, just on inventory, it's clearly a key metric that investors are looking at. I'm kind of curious as how we should think about inventory levels exiting the fiscal fourth quarter. And as you answer the question, can you -- clearly, the inventory is somewhat a reflection of where we are in the cycle, but you've got sort of the added burden of wanting to build some NAND inventory as you make this transition to replacement gate. So how do we -- how would inventories look if you sort of normalize for that? +And then, lastly, as part of the question, I apologize, utilization coming down, CapEx coming down is a good way of controlling inventory, so is the potential for write-downs. Can you just talk about how you're thinking about the value of the inventory in this sort of environment? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [20] +-------------------------------------------------------------------------------- + + A 3-part question huh, John? Okay. So yes, the inventories obviously are elevated right now. As you point out, one of the big drivers of our increased inventory level is in NAND, and that is kind of by design for us. We are trying to build up some inventory going into 2020 -- fiscal 2020 for us because we are going to make this transition to replacement gate. Replacement gate doesn't drive very much bit growth for us in the first node in replacement gate, and so we'll need to draw on our inventory in order to meet demand. And that's a -- I don't know the exact number, but that's a decent chunk of the overage in terms of days. +The other aspect of the elevated level of inventory is in DRAM. That was a little bit more a function of a pretty good bit growth in the first couple of quarters of the calendar year of 2019. And of course, we had customers working down their inventories. And so inventory was building up in our balance sheet. +We do expect now that we're in a place -- Sanjay mentioned that we're seeing inventories get to be in a good place in the cloud space, in the graphics' space, in the PC space. And so we would expect to start to see inventories start to come down now. We think we'll be in a relatively good spot by the end of the calendar year, may not be at "optimal levels" but certainly in a healthier place. And then, quickly after that, I would expect DRAM to be in a good place. +From a write-down perspective, we did write-down about $40 million of inventory this quarter specific to Huawei. We have finished goods inventory with Huawei that does not look like that's going to get sold, so we did reserve that. Outside of that, from a kind of an obsolescence perspective, we don't see really any risk with the inventory we're carrying. We think it's very good inventory. It's got a good cost position, very good demand with that inventory, so unlikely to have any issue as it relates to obsolescence. +The other, of course, area you have to concern yourself with is the -- any sort of lower cost to market issue with the inventory. And I think you can kind of guess by the quality of our gross margins that we're not really in danger of having any write-down associated with lower costs to market. So outside of these kind of one-off issues that we deal with from time to time, like we did with Huawei this quarter, I don't really see a big issue with inventory in terms of write-downs or reserves. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- + + So before we get into the next question, I just want to make a small correction. In the prepared comments, I mentioned that QLC shipment were up approximately 75%. I meant to say that QLC bit shipments were up 75% quarter-over-quarter. So I just wanted to make that correction. And now, I think we can move on to the next question. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ambrish Srivastava of BMO Capital. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [23] +-------------------------------------------------------------------------------- + + Sanjay, good to see the discipline here on the CapEx and also with Dave's focus on free cash flow. I was just a little confused and I want to make sure I understood this. If we go -- and I appreciate that you don't want to talk about any specific customer, but if we go back to the reported last 2 quarters and if you triangulate that, if you exclude Huawei, that would mean that bit shipments would be at best up single digit. So the question is, in your CapEx thinking for fiscal '20, how are you handicapping the Huawei impact? Are you expecting this to continue to be on that list, and hence, your CapEx -- lower CapEx includes a certain amount of capacity being taken off-line because of that? What's the right way to think about it? And then I had a quick follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [24] +-------------------------------------------------------------------------------- + + So I think we'll be able to provide you more details related to fiscal year '20 CapEx, et cetera, in our next earnings call. I will just point out that there is obviously considerable uncertainty here. As you can all see from the rather fluid situation with respect to Huawei as well as with respect to U.S., China trade matters. And of course, we are just staying focused on optimizing what we can control and really remaining nimble in our actions. You're seeing that how, over the course of last 1 year, we have, for fiscal year '19, managed our CapEx down from $10.5 billion, plus, minus 5%, to $9 billion now. So we continue to stay vigilant, and we are making decisive actions with respect to meaningful CapEx reductions in fiscal year '20. +With respect to the further details, we will be in a better position to provide you information at the next earnings call. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [25] +-------------------------------------------------------------------------------- + + Okay. And then, just a quick follow-up, and it's not a multipart day for you, what's the AR or DSO target that we should be thinking about as we go through the next couple of quarters? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + Yes. So it got up there and we did kind of work it down this quarter. I think we got it down to about 62 days. I would say, ideally, it should be in the 50s. There was a little bit of a mix challenge this quarter that kind of drove it up a bit and there is a couple of customers that have extended terms and they kind of hit us at that point. But ideally, we'd like to be somewhere in the mid-50s. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Danely of Citi. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [28] +-------------------------------------------------------------------------------- + + You said you've mitigated I think 90% of the tariff so far. Now we're looking at another $300 billion in tariffs. Can you estimate the approximate impact to your business if that goes through? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + I would say that as we -- of course, we don't know for sure what the list looks like. We have a general sense. Based on what we've seen, there's minimal impact from the incremental list. Most of what affects us was contemplated in the first 2, 1A, 1B, and then the second list. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD [30] +-------------------------------------------------------------------------------- + + Got it. And then for my follow-up. Sanjay talked about 5G being a big driver. With the Huawei issue, is that impacting the development of 5G? Have you seen any change in -- like the ongoing development of the standards out there? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [31] +-------------------------------------------------------------------------------- + + So I think it is too soon to tell. And keep in mind that in certain countries, 5G has already started to be deployed such as Korea. And there are, of course, leading suppliers other than Huawei as well for 5G. So it remains to be seen how this deployment occurs over the course of next few quarters in particular here. +But there is no doubt that 5G will bring about greater applications for memory and storage, not only in smartphones but also in machine-to-machine on the IoT front. And all of this will drive greater demand for memory and storage. And we remain absolutely well-prepared, of course, in a flexible fashion to meet the growing demand requirements for the business that 5G we think will provide over the course of next many years. But near term, in terms of exactly what happens with respect to Huawei aspects, I think, really, it is too soon to tell. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [33] +-------------------------------------------------------------------------------- + + In DRAM, given the transition to 1Y and early 1Z move, can you guys just help us understand, qualitatively, your cost reduction profile as you move to the second half of this calendar year? Maybe compare that versus the cost downs in the first half of this year. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [34] +-------------------------------------------------------------------------------- + + With respect to the cost declines, of course, we are continuing to execute well with respect to our node transitions as well as continuing to drive cost declines, the 1Y and 1Z nodes that you talked about. And we are on plan in terms of ramping up these nodes as well. +And as I said before, we don't break out the cost reductions on first half versus second half. Of course, our expectations of cost reductions are baked into for FQ4, the gross margin guidance as well as, of course, that takes into account our price decline assumptions as well for FQ4. So all of that is really baked into it. We don't break it down. But keep in mind that as the new technology nodes advance, the cost reduction coming from new technology nodes is less and less compared to the prior nodes just because, as we have explained several times before, they naturally give you -- given the challenges of scaling, less [pathway] for bit growth capability and less cost reduction capability. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [35] +-------------------------------------------------------------------------------- + + Yes. And then back in April, the team announced its 9300 series NVMe. This is your new cloud and enterprise SSD family. I think you guys have had solid momentum in cloud and enterprise with your SATA family, and that's helped to sustain a better margin profile for the NAND business. So what's the design win momentum been like on the 9300 series? And when do you anticipate your cloud customers to start ramping these new NVMe products? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [36] +-------------------------------------------------------------------------------- + + So as we have discussed in the past that we would be introducing, over the course of our fiscal year 2019, actually during calendar year 2019, our NVMe products. And we started that first with consumer NVMe and later with our OEM NVMe that we talked about today and now also for cloud and enterprise applications NVMe drive. And these will take some period of time over the course of next few months in terms of getting qualified by customers, in terms of gaining traction with customers. And that's why we had mentioned that 2019 will basically be a year of transition for us from SATA to NVMe. +I just want to remind you that a couple of years ago, Micron did not actually have investments in NVMe product development. We did very well and are continuing to do very well in SATA, as you noted. And we began to significantly increase our investments in NVMe product development a couple of years ago, and it takes a while to have these products in the marketplace. So in 2020, as our NVMe solutions get adopted by our customers and as we ramp those into production, we do expect to be gaining share with NVMe all throughout the 2020 time frame. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri of UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [38] +-------------------------------------------------------------------------------- + + (technical difficulty) +that's been asked a couple of times, and I'm just trying to figure out how lower CapEx -- you're going to cut CapEx by a couple of billion and you're certainly cutting wafer starts quite a bit. How that doesn't ultimately have some negative impact on your costs? I think you've been costing down in DRAM maybe low- to mid-teens, and the expectation was that you'd be down somewhere -- that 2020 would be kind of another good year for DRAM cost downs, and you've been down kind of like mid-20s in NAND. So -- yet, it sounds like you're saying that it is not having much of an effect on your costs, so I'm just trying to fit those 2 things. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- + + No, I'm not saying that will not have effect on cost. What I'm saying is that we will be in good position with cost because our technologies -- underlying technologies give us good cost reduction capabilities from one node to the next node. +Overall, from a cost point of view, we'll be in good position. And for NAND, I'll just remind you that our CMOS under the Array technology gives us the smallest die size in the industry, and that has meaningful implications with respect to the cost competitiveness that we have. +So overall, we feel good about the technology and the production mix that we will be driving through the remainder of fiscal year '19 as well as through fiscal year 2020 in terms of meeting our demand expectations as well as remaining cost competitive. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [40] +-------------------------------------------------------------------------------- + + And then, I guess, just related to that, maybe Dave, can you maybe break down CapEx, sort of how much is building versus equipment? It sounds like there's roughly $2 billion that was buildings this year in fiscal '19. Is the cut next year going to be almost all in infrastructure so that WFE is kind of flat to down a smidge year-over-year. Is that kind of how to think about it? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [41] +-------------------------------------------------------------------------------- + + So getting back to the FY '19, just to be clear, what Sanjay said was about $2 billion was kind of construction-related spend. The rest is front-end and back-end. So there is some -- and some miscellaneous capital spend for the R&D group and so forth. So there's more to it than even that. +I'll be honest with you, we have not kind of completely finalized CapEx budget for next year. We have a pretty good sense of directionally where it's going, but all the pieces specifically, we're not quite there yet. And so what we'd like to do is wait and give you more granularity around that in the next quarter's call. But I would anticipate that both areas would have some reduction to them. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And our next question comes from Blayne Curtis of Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [43] +-------------------------------------------------------------------------------- + + I just want to follow up on the Huawei point, just want to make sure I understood what you're saying. Are you able to ship because the IP resides in another country? Just trying to understand how exactly are you able to continue to ship? +And then just kind of curious, as you look out, I'm sure there's going to be some components that go into these phones from other vendors that don't have an ability to ship. So I'm kind of just curious to your thoughts on kind of the downstream impact and whether you've encapsulated all that? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [44] +-------------------------------------------------------------------------------- + + So with respect to what we are able to ship to Huawei, as I said before that what we are able to ship is what is not under the export administration regulations, and that's what we are able to ship. And actually, export administration regulations have various complex aspects and considerations, several criteria that you have to go through. +If you're interested in that, you can certainly go to the BIS site and look for those. And we assess our products versus those. And these considerations are not just limited to any 1 or 2 aspects such as what you mentioned. I mean they have several aspects. And we assess our products that we can ship to Huawei versus those and have made determination of shipments. And as we've said, we began those shipments in last 2 weeks. +And with respect to your question around other components, et cetera, of course, this is a company-by-company decision, and each company has to evaluate its own situation. And obviously, Huawei has to look at its own supply chain. So with respect to the products that we can ship to them, we work closely with them to understand what is their latest demand on those products, and that is what is baked into our FQ4 guidance. +What I would like to point out here is that at the end of the day, since you asked a question about mobile phones, the smartphone demand overall from consumers' point of view is really going to be the same. I mean consumers are going to be buying the phones that they're going to buy based on the features, the new models. All of that will be bought. There may be some share shift that may be occurring between the various suppliers of smartphones. And as you know, we are well-engaged with customers across the smartphone ecosystem as a supplier to them. Of course, we have -- Huawei was our #1 customer. We continue to engage with other customers as well. And we will -- we have had growing presence with those other customers and we'll continue to look for opportunities to best optimize our business while always, of course, continuing to comply with U.S. laws and regulations. And for that matter, we always comply with laws and regulations in all countries that we operate in. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + And then I just want to ask you on the cloud and data center, obviously an important segment and you did have some encouraging comments. Just kind of curious on that pace of recovery maybe versus what you had thought a quarter ago, just kind of the health of the channel and the pace of recovery there. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [46] +-------------------------------------------------------------------------------- + + Pace of recovery? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [47] +-------------------------------------------------------------------------------- + + In cloud and data center. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [48] +-------------------------------------------------------------------------------- + + Oh, for cloud and data center. I mean, as we said, I think cloud customers as well as several other customers had operated with high levels of inventory in the -- starting late last year and through the course of first half of this year, those inventory levels have been largely worked to normal levels, except for in enterprise, as we noted in our prepared remarks. And we look forward to robust growth in fiscal fourth quarter in the area of cloud. And we are, of course, continuing to broaden our product portfolio as well with solutions such as NVMe solutions, and that will bring us bigger opportunities in the future as well. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2019-Mar-20-MU.txt b/Transcripts/MU/2019-Mar-20-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..9138597e6d1fd95d6f66065ef612e12daff5e20c --- /dev/null +++ b/Transcripts/MU/2019-Mar-20-MU.txt @@ -0,0 +1,405 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 Micron Technology Inc Earnings Call +MARCH 20, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Karl Fredrick Ackerman + Cowen and Company, LLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Latif, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Micron's Second Quarter 2019 Financial Release Conference Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Farhan Ahmad, Head of Investor Relations. You may begin your conference. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's Second Fiscal Quarter 2019 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website, along with convertible debt and capped call dilution table. +As a reminder, the prepared remarks from this call and webcast replay will be available on our website later today. We encourage you to monitor our website at Micron.com throughout the quarter for the most current information on the company, including information on various financial conferences that we will be attending. You can follow us on Twitter, @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we filed with the SEC, specifically, our most recent 10-K and Form 10-Q, for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon, everyone. Micron executed well in the second quarter, delivering solid results and healthy levels of profitability and free cash flow despite a challenging industry environment. We continued to strengthen our balance sheet in the quarter by increasing our cash position and total liquidity. Although we expect industry headwinds in the near term, we continue to grow and diversify our product portfolio, improve our cost competitiveness and lay the foundation to emerge stronger, both financially and operationally from this environment. +I would like to start with the review of 2 important pillars of Micron's strategy, improving cost competitiveness and increasing high-value solutions in our portfolio. Our strategy positions us for the tremendous opportunities ahead, while also enabling us to better navigate near-term headwinds. Strong execution against this strategy has improved our annualized profitability by over $6 billion from fiscal 2016 to fiscal 2018. This has improved our EBITDA margin by more than 15 percentage points relative to our competitors over the same period. We expect further progress on cost reduction this fiscal year, including healthy year-over-year cost declines in both DRAM and NAND. +In DRAM, our 1Y nanometer is yielding well, and we expect to increase conversion to 1Y nanometer in the second half of fiscal 2019. We are also making excellent progress on 1Z nanometer and have started sampling products utilizing this technology. +As we have said in the past, future DRAM node transitions required additional process steps and more fab cleanroom space. Consequently, in addition to the previously announced expansion of our Hiroshima facility, we are starting site preparation for the cleanroom expansion at our Taichung facility to enable the transition of existing DRAM wafer capacity to future nodes. We are still finalizing the timing but expect production output some time in calendar 2021. +In NAND, we achieved meaningful production on 96-layer 3D NAND in fiscal Q2 with the fastest yield ramp of any NAND product in our history. We are also making good progress on development of our fourth generation 3D NAND, which uses our replacement gate technology. Given the high initial capital requirements of floating gate to replacement gate conversion, we expect that our first replacement gate node will provide limited cost reduction, and hence, we are planning to deploy this node across select NAND products, with the rest of the portfolio converting later to the second node of replacement gate. This approach will optimize the ROI of our NAND capital investments as we convert our capacity. +As a reminder, our replacement gate architecture will allow us to deliver performance improvements and provide us an efficient path towards scaling multiple future generations of 3D NAND. Given the limited initial deployment at the first node of replacement gate, we expect that our NAND bit supply growth in calendar 2020 will be below industry demand levels, and we plan to utilize our cost-effective floating gate inventory positioned to meet customer requirements. +Turning to high-value solutions. More than 2/3 of NAND revenues in the first half of fiscal 2019 were from high-value solutions, up from 55% in the first half of 2018. This increased mix of high-value solutions, combined with our competitive cost structure, enabled us to deliver fiscal Q2 NAND gross margin in the high 30s despite steep price declines in the industry. +In SSDs, we are making progress on transitioning to NVMe while continuing to improve our cost profile in SATA. In fiscal Q2, we began revenue shipments to a large PC OEM for our first NVMe client SSD, which features our internally designed controller and are in active qualifications with other customers. We intend to introduce cloud and enterprise NVMe SSDs later this calendar year. +In SATA, we introduced consumer and client SSDs based on 96-layer 3D NAND in fiscal Q2. +In the cloud market, our custom persistent memory solution, which combines DRAM and NAND, is now fully ramped and contributed meaningfully to our cloud revenues. 3D XPoint development remains on track with customers' samples planned before calendar year-end. We believe 3D XPoint technology will be a key enabler for numerous new applications, particularly artificial intelligence and data analytics. +As announced previously, in January of this year, we exercised our option to acquire Intel's interest in the IMFT facility in Lehi, Utah. This acquisition provides us with the manufacturing capability and highly skilled talent to drive 3D XPoint to development and innovation. +Now turning to end markets. I'll start with mobile. During fiscal Q2, we grew revenues and expanded gross margins year-over-year despite adverse memory and storage pricing and weakness in high-end smartphone unit sales. Our performance in mobile was propelled by growth in our managed NAND portfolio, where NAND bit shipments grew more than 5x year-over-year. We are also seeing strong demand for our 1Y nanometer LPDRAM due to its industry-leading capacity and best-in-class power consumption. +Memory and storage content growth in smartphones continues, driven by features such as multiple cameras, machine learning, computational photography and 4K video. Last month, Samsung announced its premium Galaxy S10 Plus smartphone, featuring 12 gigabytes of DRAM and 1 terabyte of NAND. At Mobile World Congress, several companies announced exciting new forms featuring 5G connectivity and foldable screens. These next-generation premium smartphones will typically feature 8 to 12 gigabytes of DRAM and 256 to 512 gigabytes of NAND versus 4 to 6 gigabytes of DRAM and 64 to 128 gigabytes of NAND in current-generation premium smartphones. These trends will likely cascade to lower-tier phones as well. We believe that 5G foldable phones and upcoming innovations in augmented and virtual reality will drive sustained content growth for years to come and should reignite smartphone unit sales beginning in calendar 2020. +We are also excited by the opportunity that 5G is likely to create beyond mobile as it will enable true machine-to-machine communication and accelerate data creation and analysis, which are fundamental drivers for our business. We expect 5G adoption to create increased demand for memory and storage in IoT devices, wireless infrastructure and data centers. Our embedded and networking businesses are already starting to see benefit from early 5G infrastructure investments. +In the data center markets, the demand for memory has moderated this year, following exceptional growth in the last 2 years. The slowdown in demand is a result of ongoing customer inventory adjustments as well as software optimizations at some cloud customers. We expect growth to resume in the second half of calendar 2019 as we see improvement in our customers' inventory position. The new server processors that support higher memory densities are expected to be introduced in a few months, which should drive additional demand growth in the second half of calendar 2019. +In fiscal Q2, we shipped high-density 1Y nanometer DDR4 server module samples to customers ahead of plan, which will position us well to benefit from this new CPU platform ramp. +In graphics, we grew sales of our high-performance GDDR6 DRAM and expanded our customer base, which positions us for stronger growth in the second half of calendar 2019. We are seeing steep customer inventory adjustments in GDDR5 and expect them to be largely completed by the middle of this calendar year. +We had delivered strong quarter in automotive, with year-over-year revenue growth driven by increasing demand for ADAS and advanced in-vehicle infotainment systems. In fiscal Q2, we announced several new automotive products, including a collaboration with Qualcomm for next-generation in-vehicle infotainment and 5G communications modules. We also announced a new strategic collaboration with a leading supplier of ADAS platforms using our full portfolio of memory and storage products. Like last year, automobile unit sales are a short-term challenge; however, we see the auto market generating robust growth for Micron over the next decade as memory and storage content continues to increase in autos, driven by advanced infotainment systems and the adoption of autonomous vehicles. +In the industrial and consumer markets, we saw a decline in sales due to seasonal, macroeconomic and pricing weaknesses as well as inventory adjustments. We had important design wins in video surveillance, point-of-sales and factory automation applications. +At Mobile World Congress, we announced the industry's first 1 terabyte microSD card using QLC NAND. +In the PC market, sales declined more than 25% sequentially, driven by weaker pricing and the inventory drawdowns seen in other segments as well as client CPU shortages. We remain focused on our cost competitiveness in this market, and over 2/3 of our PC DRAM bit shipments are now coming from our advanced 1X and 1Y nanometer technology nodes. +Now turning to our DRAM industry outlook. Since our last earnings call, DRAM pricing weakened more than expected. Our demand outlook for calendar 2019 has moderated, led by somewhat greater levels of customer inventory, weakening server demand at several enterprise OEM customers and worse-than-expected CPU shortages. We believe macroeconomic uncertainty is also contributing to hesitation in buying behavior at some customers. +However, as we discussed on our last earnings call, we still expect DRAM bit shipments to begin infusing in our fiscal Q3, with demand growth strengthening in the second half of calendar 2019, as most customer inventories are likely to normalize by midyear. Based on our current view, we now estimate calendar 2019 DRAM bit demand growth from our customers to be in the low- to mid-teens, with their end demand a few points above that. Further, we estimate the industry supply bit growth is tracking to mid- to high teens. +Given the lower DRAM demand outlook from our customers, we have decided to idle approximately 5% of our DRAM wafer starts. This action will bring our production levels close to our view of DRAM industry bit demand growth for calendar 2019. We will continue to monitor the market and take appropriate actions to ensure that our bit supply growth in calendar 2019 remains closely aligned with demand. +Looking beyond our fiscal 2019, we expect bit demand growth to accelerate as mobile and server demand improves. In particular, we expect robust DRAM bit demand growth in fiscal 2020 bouncing back from a weak fiscal 2019. +NAND markets remain oversupplied from the acceleration in bit growth, driven by the industry transition to 64-layered 3D NAND. Although fiscal Q2 pricing came in below our expectations, we are optimistic that demand elasticity and seasonal trends will support improving demand growth in the second half of the calendar year. We expect that calendar 2019 NAND bit demand growth is likely to be in the mid-30s percent range, with industry supply growing in the high 30s, and we are targeting our bit shipments to grow close to the growth rate of industry bit demand. We have been managing our NAND bit supply growth prudently, including adjusting our capital planning and wafer volumes. We are reducing our total NAND wafer starts by approximately 5%, mostly through reductions on our legacy nodes. +Given these changes in DRAM and NAND industry conditions, we have reduced our CapEx for fiscal year '19 and are evaluating our CapEx for fiscal year '20. We are taking prudent actions to address the current market conditions while executing well on our long-term strategic objectives. +I will now turn it over to Dave to provide financial results of our fiscal second quarter and guidance for the third quarter. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. Micron's fiscal second quarter results were within our guidance as we executed well in a period of somewhat weaker-than-expected market conditions. In the quarter, we returned capital to shareholders, continued to improve our cost structure and strengthened our balance sheet through our first issuance of investment-grade debt. Most of the proceeds from this offering were used to redeem a large portion of our outstanding convertible notes, reducing our fully diluted share count. +Total fiscal second quarter revenue was $5.8 billion, down 21% from the prior year and down 26% from the fiscal first quarter. Revenue reflected worse-than-expected pricing trends in DRAM and NAND. +DRAM revenue was down 28% year-over-year and 30% sequentially from the fiscal first quarter and represented 64% of total company revenue in the fiscal second quarter. DRAM ASPs declined in the low-20% range compared to the prior quarter while shipment quantities were down in the low double digits. Year-over-year, DRAM bit shipments were down mid-single digits. +NAND revenue declined 2% year-over-year and 18% from the prior quarter. NAND revenue represented 30% of total company revenue in the fiscal second quarter. Our overall NAND ASP declined in the mid-20% range, while shipment quantities increased in the upper single-digit percentage range compared to the prior quarter. NAND bit shipments came in stronger than our expectation due to timing of demand from a large customer. +Now turning to our revenue trends by business unit. Revenue for the Compute and Networking Business Unit was $2.4 billion, down 35% year-over-year and 34% from the prior quarter. The sequential decline was driven by pricing across major market segments as well as volume reductions, particularly in graphics, cloud and PCs. +Revenue for the Mobile Business Unit, or MBU, was $1.6 billion, up 3% year-over-year and down 27% from the record fiscal first quarter. Lower volume due to weak seasonality and pricing contributed to the quarter-over-quarter revenue decline. Despite the current market conditions, MBU revenue grew year-over-year due to strong growth in our managed NAND products. +The Embedded Business Unit revenue of $800 million was down 4% compared to the prior year and down 14% from the record fiscal first quarter. The automotive business was only down slightly from record fiscal first quarter despite weakness in automobile sales. +Other embedded revenue declined quarter-over-quarter due to weaker pricing and lower DRAM volumes. +Finally, the Storage Business Unit fiscal second quarter revenue was $1 billion, down 19% year-over-year and down 11% quarter-over-quarter. The sequential decline was driven by lower SSD revenue, partially offset by increased component revenue. +The consolidated gross margin for the fiscal second quarter was 50% compared to 58% in the prior year and 59% in the fiscal first quarter. Fiscal second quarter results included ongoing impact from 3D XPoint underutilization cost, which approximated 160 basis points. Pricing came in weaker than expected in both DRAM and NAND, but strong execution on cost reductions resulted in gross margins within our guidance range. +Fiscal second quarter operating expenses of $818 million came in at the high end of our guided range. OpEx included $37 million in onetime tool impairment costs that were not anticipated in our guidance. Excluding this impairment, OpEx would have come in at the low end of our guidance. We remain focused on controlling our expenses while investing in future products and technologies. +We delivered solid profitability in the fiscal second quarter with operating income of $2.1 billion, representing 36% of revenue. This margin is down 13 percentage points year-over-year and also down 13 percentage points from the fiscal first quarter. +The tax rate for the fiscal second quarter was approximately 8.3%, and we now expect our fiscal 2019 tax rate to be approximately 10.5%. +Non-GAAP earnings per share in the fiscal second quarter was $1.71, down from $2.82 in the year-ago quarter and down from $2.97 in the prior quarter. +Turning to cash flows and capital spending. In the fiscal second quarter, we generated $3.4 billion in cash from operations, representing 59% of revenue. Capital spending, net of third-party contributions, was approximately $2.4 billion, relatively flat compared with the prior quarter. We have lowered our CapEx targets for fiscal 2019 to approximately $9 billion from our prior guidance range of $9 billion to $9.5 billion as we manage through the current environment while maintaining investment in our strategic priorities. As we mentioned before, a significant portion of our CapEx this year is going towards cleanroom construction and assembly and test operations, which do not contribute to our bit supply growth. +Fab equipment spend in fiscal 2019 is down from last year and is mostly targeted towards migrating 20-nanometer DRAM and 32-layer 3D NAND to more advanced nodes, with no new wafer capacity additions. The investment in these technology transitions provides compelling cost reduction and a very attractive ROI. As we have demonstrated over the past 2 quarters, we remain nimble on CapEx based on business conditions. +In the fiscal second quarter, our adjusted free cash flow, defined as cash flow from operations less net CapEx, was approximately $1 billion compared to $2.2 billion in the year-ago quarter and $2.3 billion in the fiscal first quarter. We deployed approximately 70% of the quarter's free cash flow towards our share repurchase program. We bought back approximately $700 million of stock in the fiscal second quarter, representing 21 million shares. Through the first half of fiscal 2019, we repurchased 63 million shares for $2.5 billion, utilizing 76% of our free cash flow in fiscal first half. We continue to do share repurchases as an attractive use of capital and remain committed to deploying at least 50% of our free cash flow on an annual basis towards repurchases under our current $10 billion authorization. +In addition to the buybacks, we also eliminated our 2043 converts subsequent to the quarter close, which at current share prices, effectively lowered our fully diluted share count by approximately 9 million shares. Note that the underlying share count for these converts was 35 million shares, which could have resulted in greater dilution with increases in our share price. +Inventory ended the quarter at $4.4 billion, increasing from $3.9 billion at the end of the fiscal first quarter. Our fiscal second quarter days of inventory were 134 days compared to 107 days in the fiscal first quarter. The actions that we have announced today regarding supply reductions, combined with improving customer demand, will begin to address our higher inventory levels. +We ended the fiscal second quarter in a strong liquidity position with net cash of $3 billion and total liquidity of nearly $12 billion. Total cash increased to $9.2 billion, largely as a result of our $1.8 billion debt issuance. Our debt position increased by $2.1 billion to $6.2 billion in the quarter, primarily due do the debt offering and recognition of premium associated with the Series G convertible note redemption. Subsequent to quarter-end, we used $1.4 billion of cash to complete the convertible note redemption, which reduced our outstanding GAAP debt balance by approximately $1.1 billion. +On January 14, we exercised our call option to acquire IMFT, our joint venture with Intel. We expect to close the transaction in either late fiscal 2019 or in the first half of fiscal 2020. This near-$1.5 billion transaction will also retire the $1 billion of joint venture-related debt on Micron's balance sheet. Since we already consolidate IMFT's results in our financial statements, we do not expect a material impact to our near-term results. +Now turning to our market outlook. DRAM and NAND markets are working through supply and demand imbalances. Our visibility remains low, and the near-term environment remains challenging. While there have been CapEx reductions across the industry, they haven't yet impacted output growth due to lead times. We expect our DRAM bit shipments to grow sequentially during the fiscal third quarter and at much higher rates in the fiscal fourth quarter. In NAND, we expect a modest sequential decline in our bit shipments in the fiscal third quarter due to timing of shipments and expect growth to resume in the fiscal fourth quarter. The output reductions that we announced today for DRAM and NAND, plus the $1.5 billion of CapEx reductions that we have announced year-to-date, will also help reduce our supply of DRAM and NAND in the second half of this calendar year. +With that in mind, our non-GAAP guidance for the fiscal third quarter is as follows: We expect revenue to be in the range of $4.8 billion, plus or minus $200 million; gross margin to be in the range of 37% to 40%; and operating expenses at approximately $785 million, plus or minus $25 million. Based on a share count of approximately 1.14 billion fully diluted shares, we expect EPS to be $0.85, plus or minus $0.10. +In closing, Micron continues to execute on our key initiatives, increasing our mix of high-value solutions, improving our cost profile and investing in new and innovative products. Our solid financial footing, strong liquidity and substantially reduced leverage means that we are well positioned to invest in our future despite near-term market conditions. +I'll now turn the call over to Sanjay for some concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. In response to near-term industry conditions, we are taking decisive action to reduce our supply growth to be consistent with industry demand. At the same time, we continue to invest and execute against our strategic priorities to reduce costs and increase the mix of high-value solutions in our portfolio. The long-term demand trends for Micron remain very healthy, with tremendous growth opportunities across multiple markets. We continue to believe that the memory industry is structurally stronger with more diversified demand drivers and moderating supply growth capability. With our strong balance sheet and improved product portfolio and operating model, Micron is better positioned than ever before to win and deliver long-term value for shareholders. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Ambrish Srivastava of BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [2] +-------------------------------------------------------------------------------- + + I just wanted to focus on the inventory situation. Sanjay, you talked about hyperscale inventories a couple of times and that they are tying up also, trying to see what the balance sheet inventory would do. So a, just update on where are we on the -- in terms of weeks of inventory. And then my sort of quick follow-up, Dave, what's the flex CapEx now left that you could moderate down if the conditions were to get worse? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Okay. So I'll take -- first, let me talk about our inventories. So as we noted, our inventories are now at 134 days. A couple of dynamics going on. So in DRAM, as we talked about last quarter, we expected to carry a higher level of inventory in the first half of the calendar year as our customers that have built up inventory start to digest through that. And then on top of that, what we did was we reduced our CapEx. And so the outcome of that reduction in CapEx should start to have an effect in the back half of our calendar year in terms of bit growth, so that will start to help manage inventory as well. And then on top of that, this quarter, we talked about further reductions in CapEx down to the approximately $9 billion, and we talked about taking some underutilization, about 5% of underutilization to kind of further reduce the output. So that should help bring DRAM inventories back more in line. So we would expect that back half of the calendar year, we'd start to see DRAM be in a better place. On the NAND front, obviously, we're at elevated levels of inventory as well. Now that is somewhat by design. As Sanjay noted in his remarks, we do have the transition from floating gate to replacement gate in NAND going on in calendar 2020, and so the bid output is not going to be very robust. And so the idea was to carry higher levels of inventory into 2020 such that, that would help support the end -- the demand from our customers. Having said that, we also -- part of the CapEx reduction does impact NAND as well. And also, we did adjust our wafer output by 5% in NAND as well to also try to manage inventory. So I think the inventory, we'll start to see improve in the back half of the calendar year and then into 2020 as we start to work through the NAND portion of the inventory. As far as CapEx goes, really, the way we're managing this is what we said when we talked about it at the Analyst Day. We're committed to our model of low 30s as a percent of sales for CapEx. Obviously, there will be years where that is above the average, and there'll be years that, that will be below the average. I think the last 2 years, fiscal 2017 and 2018, we were below that low-30s model. So it's not surprising to be a bit above that low-30s level for these couple of years. Plus on top of that, we had a bit of pent-up demand to get some of the cleanroom space staged to be able to manage these node transitions, and so we have a number of different cleanroom build-out initiatives going on this year, which is maybe elevating a little bit from kind of our normal run rate. But over the long term, you would see us be in this low-30s percent level. And as I think Sanjay mentioned in his remarks, I think I mentioned in my remarks, we're flexible on CapEx. We modulate it based on the economic circumstances. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [4] +-------------------------------------------------------------------------------- + + And the hyperscale? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + With respect to hyperscale, as I said in my remarks that we do expect that inventory will work through the system at our customers during the first half of the year. And we certainly are seeing evidence of inventory consumption by our customers. And we do expect that, that will largely be completed by mid this year. And we do expect in DRAM that growth will accelerate both sequentially and year-over-year for the rest of the calendar year. And second half of the calendar year, with respect to demand improvement, we'll be -- demand will improve in the second half of the calendar year compared to the first half of the calendar year. And of course, effect of CPU shortages, those will continue to improve in situation over the course of the year, and we expect that also to contribute toward improvement in demand in the second half of the calendar year compared to first year. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John Pitzer, Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [7] +-------------------------------------------------------------------------------- + + Sanjay, I guess, I just wanted a little bit more detail behind the decision to actually shutter some DRAM capacity in the current quarter. Last quarter, you talked about how a flattening cost curve actually increased the useful life of holding inventory, which seemed to make sense to me. There seems to be a little bit of a reversion from that. And just given that you're not a big enough piece of the DRAM market to, I think, impact overall supply and demand, it really kind of depends upon what the guys in Korea are doing. I'm just kind of curious as to why you came to this decision to shutter some capacity. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [8] +-------------------------------------------------------------------------------- + + So I think as Dave had previously mentioned in one of the earnings calls, that about 150 days of inventory is something that we are comfortable with. And when we really look at our demand at this time and look at our production output, we think it is important for us to bring our supply to be in line with the expected demand for the year. And it provides us obvious benefits in terms of managing our inventories more effectively, managing our cash flow effectively as well and really managing our business in a healthy fashion. Of course, our inventory is at good cost. There is no obsolescence issue with this inventory at all, but we really considered it prudent management of our business to bring our supply growth in line with our demand expectations. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + And I'd just add that the underutilization costs that we'll incur are not going to kind of layer into our cost per units. They would -- they will be taken as period costs within the quarter, and it's implied in our 37% to 40% gross margin guidance for the third fiscal quarter. Sorry, didn't meant to interrupt you, John. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [10] +-------------------------------------------------------------------------------- + + That's okay. So Sanjay, you explained why in fiscal 2020, you will undergrow the industry in NAND bit as you move to fourth generation. I'm wondering if you can help us understand what the cost implication of that is. Will your cost curve in NAND be negatively impacted? Or should you be able to benefit in 2020 from continued mix towards 96-layer on the technology side and just product mix to more manage NAND? How do we think about costs in fiscal year 2020? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [11] +-------------------------------------------------------------------------------- + + Our cost position will be good in fiscal year 2020 because today with our both 64-layer as well as 96-layer technologies, we absolutely have been outperforming the industry in terms of our -- at the die level, the cost on a per gigabyte basis. And that -- and obviously, as you know, we have discussed this many times in the past, those benefits come from CMOS Under the Array architecture, which Micron has pioneered, and we currently are in our third-generation using that. So that gives us a very significant cost advantage, and that will carry over well, giving us competitive mix of NAND production in 2020 in our fiscal year 2020 to meet the market demand. And keep in mind, the fourth generation of our 3D NAND, which will be the first node in replacement gate technology, even with greater number of layers, will actually have greater capital intensity associated with it because of transition from floating gate to replacement gate that requires more tools, more specific unique tools to implement replacement gate. And that's why we are really converting portion of our portfolio to that first-generation replacement gate technology. And remainder of the portfolio will convert from the third-generation floating gate to the second node of replacement gate later on. And obviously, that will provide us a bigger benefit when we do that. The second node of replacement gate will get higher layers later compared to the first node. So that will give us a benefit of cost as well as ROI and it will really be the best way to manage this transition for us. So in summary, even with increasing the number of layers in the current and first generation of replacement gate, we feel very good about the cost competitiveness with the mix of floating gate and replacement gate technologies that we'll be achieving next year. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from the line of CJ Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- + + I guess, a 2-part question. You used the word idling regarding the 5% for DRAM and then reducing your NAND wafer starts by 5%. I guess, 2 questions to that. Are you trying to send us a different signal in terms of what you're doing for both? And then could you provide a little clarity on how we should think about the impact to your cost structure as you slow down wafers? And then when you start to turn back on, how should we think about the impact? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [14] +-------------------------------------------------------------------------------- + + So bottom line is, we are reducing our output of DRAM and NAND. In DRAM, the reduction in supply growth is a result of this idling capacity, idling wafer starts is bigger impact. And in NAND, as we reduce our wafer starts, particularly related to the legacy nodes, the impact on the supply bit growth is smaller because that wafer start reduction that you mentioned is primarily targeted toward legacy nodes. So again, the objective of these is to bring out or to bring down our supply growth towards our estimations of demand, both in DRAM and NAND from the point of view of 2019 as well as 2020 time frame. And with respect to cost, as I said before, we have continued to outperform in terms of cost reduction -- year-over-year cost reduction capability in DRAM, and we feel very good about our ability to manage with this slowdown in DRAM managed in a competitive fashion with our costs over the course of the next few quarters. And in NAND, I just commented on our cost position there. And I'll just add to the previous comments on the cost position that, of course, next year, we will also continue to get the benefit of our 96-layer transition from 64-layer to 96-layer, the ongoing transition during the course of next year, which will also be helping us with cost. So I believe our cost in DRAM as well as NAND will be competitive. And I just want to point out that the benefits of reduction -- an output reduction go beyond just aspects of cost. They, of course include -- those benefits include inventory management and cash flow management. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + So back to a question on inventory. So when you first started seeing your customer demand inventory-related weakness, it always takes time for the actual supply growth output of your manufacturing infrastructure to kind of trend towards your target. So initially, you augment that manufacturing ramp-down with some inventory accumulation. It appears that you executed to that in fiscal Q2. But now that you're moderating output lower again, again, that's going to -- it appears that it's going to take some more time. So do you anticipate inventories actually moving higher here in the mid-quarter before it starts to downshift in the back half of the calendar year? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [17] +-------------------------------------------------------------------------------- + + Yes, I think inventory might be a little bit elevated in the May quarter relative to where we are today. Obviously, as you point out, it does take some time. I mean, most of the CapEx reductions, we took in the first fiscal quarter, so those take a couple of quarters, but we should start experiencing that in the back half of the calendar year. And the underutilization, you get probably a quarter before it starts impacting you. So I think we'll be in pretty good shape on DRAM, as I said as we kind of exit the calendar year. NAND will take a little bit longer because of the reasons we cited about keeping elevated levels of inventory into 2020. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + Great. And then my follow-up question, much of -- Sanjay, much of your industry outlook is based off of a view of second half improvements in virtually all of your target markets, PC client, cloud, mobile, et cetera. Given the value chain and lead time, should we anticipate that your customer second half recovery should start to drive an inflection in your NAND and DRAM business in fiscal Q4? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [19] +-------------------------------------------------------------------------------- + + We are not providing fiscal Q4 guidance here. But as we have said, that second half of this calendar year, we do expect that bit growth in DRAM to continue on a quarter-over-quarter basis, both sequentially as well as on a year-over-year basis. And that is already -- we are guiding to bit growth in DRAM for our F Q3, and that should continue in F Q4 and for the rest of the year as well. And in NAND, there is, of course, seasonality in the second half of the calendar year. And of course, we expect the effect of elasticity also to help improve the demand. And the trends of increasing average capacities in smartphones, both for DRAM and NAND, continues to be intact. When you look at the results that some of the cloud service providers have reported, those results continue to be solid, pointing to the demand and the growth in cloud services. And of course, memory and storage is an essential part of all the computing paradigms of the future that are increasingly being based on the [INML] as well. All of that bodes well for the long-term demand trends as well. But yes, I mean, we do -- in all of our end markets, we do see generally improvement in demand in the second half versus the first half. And of course, all of this is barring macroeconomic uncertainty. In case there is any further deterioration in the macroeconomic climate, then we can have different impact in this outlook. But that's what based on what we know today, that's our assessment of demand expectations. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Timothy Arcuri of UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [21] +-------------------------------------------------------------------------------- + + Sanjay, I wanted to go back just to a question that got asked before. So in DRAM, you're still well above cash cost, yet you're idling capacity. So obviously, demand is a lot worse than you expected. But you sound pretty optimistic that it's going to come back in the back half of the year. So why would you reduce starts now if you're so optimistic about demand coming back in the back of the year? I get that it has to do with inventory, but I'm just trying to reconcile those 2 comments because it seems like you're leaving money on the table. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [22] +-------------------------------------------------------------------------------- + + So demand has been weak so far this year, and we expect demand environment to be weak in the first half as well. So when we talk about our total DRAM demand growth expectation, we are talking about the full year basis, right? So we need to be -- and when we look at our supply growth, of course, we are looking at that, too, on a full year basis. So we want to bring our supply in line with our demand expectations. And we believe that this improving demand environment, second half versus first half that I referred to earlier, we will be able to capture the benefit of that with our supply cutbacks that we have mentioned and also help bring our -- over time continue to drive improvement in our inventory position as well. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [23] +-------------------------------------------------------------------------------- + + Okay. And then just a quick follow-up, Dave. I just wanted to go back to the question on costs. You've been bringing DRAM cost down kind of like low to mid-teens year-over-year and NAND has been kind of in the mid-20s year-over-year. So it seems like some of these actions have to ultimately impact your ability to cost-down vis-à-vis that level. Am I missing something there? Because it sounds like you're saying that there's no impact, so can you just again reconcile those for me? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [24] +-------------------------------------------------------------------------------- + + Yes, good question. We do expect healthy cost declines in both DRAM and NAND this year. We are still making technology transitions next year. And so we would obviously expect, particularly in DRAM, that cost will be good. As we said, replacement gate might not be where we want it to be, in the very first generation. But one of the advantages of carrying the inventory we're carrying, 64-layer and 96-layer inventory in the next year is that it has a very good cost structure, and so we should have a good cost structure in 2020 on NAND as well. The other thing, on utilization, just -- I just want to make sure it's clear what period cost means is we will take that expense kind of as it comes in the quarters in which we take the underutilization. It won't roll up into inventory. It won't be counted as part of the cost. So obviously, it will have an impact on margins. And as I said, it's implied in the guidance of the margins we gave for the fiscal third quarter. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [25] +-------------------------------------------------------------------------------- + + And on NAND, I just want to point out again that 96-layer is still early in our production ramp, and it will continue to ramp during the course of next year as we bring out our first node of replacement gate. So 96-layer will also continue to be a strong driver of our cost reduction capability in 2020. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Karl Ackerman of Cowen and Company. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + I wanted just kind of go back to bit growth. I understand that idling your wafer starts slows your bit supply, but do you expect any shifts in your portfolio mix towards certain end markets or shift toward new technology nodes that should impact your second half bit supply? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [28] +-------------------------------------------------------------------------------- + + So obviously, we pay a lot of attention to this in terms of managing the mix of our production. We do that on an ongoing basis anyhow in production. And when we implement this output cut, both in NAND as well as DRAM, obviously, we make sure that we are not able -- we are not impacting any aspect of our ability to fulfill our demand. So as we said -- I mean, we have high levels of inventory currently, both in NAND and DRAM, and it gives us an opportunity to bring our production to be in line with demand. And when we say that, we mean that we will be able to address the demand in all of our end markets. We are not going to compromise our production cuts so that we run low in terms of meeting our customers' requirements in any of the end market segments. So we believe this is a very prudent way for us to manage our business. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + I appreciate that. I guess, perhaps a clarification on that question then. The cynic would say that NAND demand elasticity has not yet kicked in. So could you just perhaps shed some light on design wins, maybe not just in NAND but also in DRAM that you've seen across your product portfolio that would anchor your view of a second half recovery? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [30] +-------------------------------------------------------------------------------- + + With respect to NAND elasticity, I mean, certainly the average capacities in notebook PCs as well as the attach rates of SSDs to notebooks does continue to go [out], so that is, of course, a price-elastic market as well. And the price -- attractive price points of NAND, of course, provide benefits of greater HDD replacement, both in the data center market as well as in the client market. Mobile definitely continues to be pointing to elasticity with respect to NAND. At Mobile World Congress, you saw smartphones, foldable phones and 5G phones being announced with 512 gigabyte and terabyte of storage capacities in them. And again, applications are also advancing toward features that require more and more storage. For example, 5G will have greater connectivity as well as low latency, will of course, be driving applications that will need more DRAM as well as more NAND. So applications -- end-market applications continue to do very well, and Micron itself, with respect to our product portfolio, we are very much focused on continuing to expand our product offerings. And we have also on the SSD side, we are expanding our portfolio with NVMe solutions. We have just brought our first NVMe client drive into the market, and later this year, we will have NVMe for enterprise and cloud applications as well. So this is -- and we announced that we got a qualification win and just began shipment to a customer with our NVMe -- first-generation NVMe client driver as well. So these are all the things that we are absolutely focused on in terms of a road map toward expanding our opportunities. And of course, we have made a lot of improvement with respect to some of these solutions over the course of last couple of years. And there's a lot of execution that is remaining ahead of us with respect to expanding our SSD opportunities, for example, as well as growing our mobile opportunities on the NAND side, where we have gained meaningful share over the course of last few quarters, but there is a lot more opportunity and a lot more road map execution that is required for us here. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Blayne Curtis of Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [32] +-------------------------------------------------------------------------------- + + I was curious on the customer timing, if you can elaborate. Was that just timing between quarters or was that more of a strategic buy that was multi-quarters in nature? And then I was just curious if you can elaborate on the data center you said back in the second half. It seems like, are you not seeing a pickup in orders yet? And kind of what gives you confidence that you're going to see that start in Q3? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [33] +-------------------------------------------------------------------------------- + + So with respect to the timing of demand in the second quarter, that was, as we mentioned, it was a large customer's timing of specific fulfillment of their demand, and that's what -- and that was related to NAND. And with respect to the second part of your question, as I said before, that we do see evidence of inventory consumption by our customers, and that gives us confidence that this inventory will largely work itself through the system in the first half with improvements in demand in the second half. And we have also, certainly in recent weeks, seen some new orders from certain customers that previously had high inventories. Of course, too soon to use this as any kind of a slope in terms of demand buildup from here on. But bottom line is that ultimately, the end-market demand drivers continue to be strong. The consumption of DRAM by our customers in the end markets, particularly cloud markets, continues to be healthy. It's just that those customers are using up their inventory to meet that demand. And over the course of next few months, by mid this year, that inventory will be returning to normalized levels to a large extent. Then that will provide for opportunities for greater demand in the second half of the year compared to the first half. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Joe Moore of Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [35] +-------------------------------------------------------------------------------- + + Just curious on the inventory side for the May quarter, and sort of Harlan's question, to the extent that you built 27 days of inventory, this last quarter, it seemed like a fair amount of the production went on to the balance sheet. Wouldn't you need to have bits (inaudible) in order to only have inventories be up a little bit? And I guess, I just wanted some confirmation around that. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + We got a little -- most of that. Okay, let me see if I can take a crack at it, Joe. There's some background noise. So yes, as you cite, inventories were up. We do expect DRAM to grow sequentially in the third fiscal quarter. That combined with -- are starting to see some benefit. You might want to put it on mute. So those should be the combination of the reduction utilization and the CapEx activities, our CapEx reductions that we've already put in place, will start to adjust the bit output growth. So we will start to see some benefit from that in the fiscal third quarter. As I've said we do expect inventories to be up again next quarter. But then, as Sanjay cited, a lot of the customers that have built up inventory will start to be back to normal and they'll start to place heavy orders on us again in the third and fourth calendar year. We'll start to see these reductions in the DRAM inventory levels. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + And that does conclude the Q&A session and this call. Ladies and gentlemen, thank you so much for your participation, and have a wonderful day. You may disconnect your lines at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2019-Sep-26-MU.txt b/Transcripts/MU/2019-Sep-26-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..fc19e78b992f40dfa65b77180bfb40d62351020b --- /dev/null +++ b/Transcripts/MU/2019-Sep-26-MU.txt @@ -0,0 +1,444 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 Micron Technology Inc Earnings Call +SEPTEMBER 26, 2019 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Rajvindra S. Gill + Needham & Company, LLC, Research Division - Senior Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Vijay Raghavan Rakesh + Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst + * Mark Trevor Delaney + Goldman Sachs Group Inc., Research Division - Equity Analyst + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Sherry, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Micron's Fourth Quarter 2019 Financial Release Conference Call. (Operator Instructions) Thank you. +It is now my pleasure to turn the floor over to your host, Mr. Farhan Ahmad, Head of Investor Relations. You may begin your conference. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's fourth fiscal quarter 2019 financial conference call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. +Today's call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release and the prepared remarks filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures can be found on our website, along with the convertible debt and capped call dilution table. As a reminder, a webcast replay will be available on our website later today. +We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. You can follow us on Twitter @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we filed with the SEC, specifically our most recent Form 10-K and 10-Q, for a discussion of the risks that may affect our future results. Although we believe that the expectations reflected in forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon. +Fiscal 2019 was another solid year of execution as we continue to transform the New Micron. Despite the challenging industry environment, we achieved the second-best year in our history of revenue, free cash flow and earnings, which underscores the strength of the New Micron. We improved structural profitability by further reducing the technology gap with competitors and by strengthening our product portfolio. We also made progress on our $10 billion share repurchase program by returning $2.7 billion to our shareholders. +In the fiscal fourth quarter, the Micron team's strong execution resulted in financial performance exceeding our guidance ranges. Market trends were broadly consistent with our expectations discussed on the last earnings call. DRAM demand bounced back as the factors that impacted calendar first half demand largely dissipated. NAND elasticity is driving robust demand growth, causing industry inventories to improve rapidly. While the demand recovery in DRAM and NAND is encouraging, we remain mindful of ongoing macroeconomic and trade uncertainties. I will provide more color on our view of the market after the review of progress on our key strategic objectives. +Since 2016, the actions we have taken to reduce our cost structure, increase our mix of high-value solutions and enhance our customer engagement and go-to-market strategy have significantly improved our profitability relative to our peers. +In fiscal 2019, our DRAM cost per bit declines led the industry and exceeded our internal plans despite the headwinds from our announced reduction in wafer starts. In the fiscal fourth quarter, we began mass production and volume shipments of the industry's first 1Z products, giving Micron feature size leadership for DRAM. We are also making good progress migrating more of our production to leading-edge nodes. While we enter fiscal 2019 with more than half of our bit production on 20-nanometer or older nodes, we ended the fiscal year with approximately 3/4 on 1X and beyond, with a meaningful portion on 1Y. As previously announced, we are expanding cleanroom space in our Taichung, Taiwan site to support future node transitions of our existing wafer capacity, and we expect output from this facility in calendar 2021. +In NAND, we continued to outpace industry cost declines during fiscal 2019. 96-layer 3D NAND is continuing to increase as a portion of our mix. Meanwhile, we achieved our first yielding dies using replacement gate or RG for short. This milestone further reduces the risk for our RG transition. As a reminder, our first RG node will be 128 layers and will be used for a select set of products. We don't expect RG to deliver meaningful cost reductions until fiscal 2021 when our second-generation RG node is broadly deployed. Consequently, we are expecting minimal cost reductions in NAND in fiscal 2020. Our RG production deployment approach will optimize the ROI of our NAND capital investments. In addition, we announced the grand opening of our Singapore cleanroom expansion in August. This will enable the transition of our existing NAND wafer capacity to future generations of 3D NAND technology. +We are continuing to make solid progress with our 3D XPoint product development and remain on track to launch our initial products in calendar 2019. +Now turning to highlights by markets. In SSDs, the industry transition from SATA to NVMe in fiscal 2019 continued at a rapid rate. While we have been late to the NVMe market, our progress positions us to gain share starting in fiscal 2020. For OEMs, building on strong growth last quarter, we more than tripled revenue shipments of our NVMe client SSD sequentially with sales penetration in multiple Tier 1 PC OEMs. Our QLC-based NVMe consumer SSD was a best-selling SSD on Amazon Prime Day in North America. Our consumer SSD segment achieved record revenue and unit shipments with bits posting triple digit percentage growth year-over-year driven by our strategy to pursue channel expansion that extends our geographical and customer reach. +Price elasticity is driving an increase in attach rates and capacities, leading to solid demand growth across client and consumer SSDs. We are also making solid progress on advancing our road map of NVMe SSDs for the enterprise and cloud markets. In fiscal 2019, we introduced the high-performance 9300 line of NVMe products targeting high-end data center applications and are looking forward to increasing adoption of this product. +In mobile, our portfolio featuring the industry's lowest-power and highest-density products is enabling our customers to bring differentiated capabilities to the market and helping us deliver outstanding financial performance in a challenging industry environment. In fiscal 2019, we delivered mobile revenue that was down only 3% from 2018's record performance despite a significant drop in market pricing and the impact from the addition of Huawei to the Entity List. Our mobile margins were resilient and our managed NAND bit shipments in fiscal 2019 more than tripled year-on-year driven by growth of MCP and discrete NAND eMMC and UFS products. In the fiscal fourth quarter, we started volume shipments of a new leading-edge UFS-based MCP that uses our 1Z LPDRAM. This new UFS MCP will bring flagship-like performance and densities to mid- and high-end smartphones. We are also leading the industry in power efficient, high-bandwidth LP5 DRAM, which positions us well as 5G begins to accelerate in 2020. +In data center, customer inventories for DRAM have reduced significantly, driving solid sequential demand growth for server solutions in both cloud and enterprise markets. New processor platforms are also creating an uptick in demand for higher-density and higher-performance DRAM modules. +In graphics, we saw strong sequential bit growth with increases for graphics cards and gaming consoles as normal buying resumed following inventory reductions in DRAM. +In the PC market, DRAM module and SSD shipments continued the growth trend from last quarter as CPU shortages further subsided. +In automotive, we continued to increase revenue year-over-year despite weak auto industry unit sales and a challenging DRAM industry environment. Our growth was supported by secular content increases, our superior quality and well-established customer relationships. LP4 shipments in the fiscal fourth quarter were over 5x higher year-over-year as lower-power DRAM becomes increasingly important for new infotainment and ADAS systems. We continue to have leading industry share in automotive. +Before talking about the market outlook, I want to provide an update on our business with Huawei and the ongoing impact of trade uncertainties. As we noted last quarter, we started shipping some products to Huawei that are not subject to Export Administration Regulations and Entity List restrictions. In the fiscal fourth quarter, sales to Huawei declined sequentially and were down meaningfully from the levels we anticipated prior to the addition of Huawei to the Entity List. We have applied for licenses with the Department of Commerce that would allow us to ship additional products, but there have been no decisions on licenses to date. We see ongoing uncertainty surrounding U.S.-China trade negotiations. If the Entity List restrictions against Huawei continue and we are unable to get licenses, we could see a worsening decline in our sales to Huawei over the coming quarters. +Now turning to our market outlook, which assumes that the macroeconomic environment doesn't materially deteriorate from current levels. I'll begin with our industry outlook and then turn to Micron's outlook for DRAM and NAND. The DRAM and NAND industry demand growth in the second half of calendar 2019 compared to the first half is primarily being driven by a normalization of inventories at most customers and secular growth trends in various end markets. In recent months, we have seen increased demand from customers headquartered in Mainland China, some of whom could be making strategic decisions to build higher levels of inventory in the face of increased trade tensions between the U.S. and China as well as Japan and Korea. +Our view of calendar 2019 DRAM industry bit demand growth remains unchanged at mid-teens, with supply exceeding demand due to previously discussed factors that impacted first half calendar 2019 demand. Based on our early view of calendar 2020, we expect the industry to see bit demand growth of high teens to 20%, above supply growth of only mid-teens, which should help normalize supplier inventories and enable a healthy industry environment. We expect the long-term DRAM bit demand growth CAGR to be mid to high teens. +Turning to NAND industry outlook, demand elasticity and industry supply reductions are resulting in improving market conditions and declining industry inventory. On the supply side, CapEx and wafer start cuts across the industry are leading to supply reductions. A power outage at a competitor's fab also reduced industry supply and inventory. We now expect calendar 2019 industry bit demand growth in the low to mid-40% range, which will exceed industry bit supply growth of approximately 30%. Based on our view of calendar 2020, we estimate industry bit demand growth of high 20s to low 30% range, with supply growing somewhat below demand. We believe that NAND industry margins, which are at the lowest levels in the last 10 years, should start increasing for the rest of the year. We expect the long-term NAND bit demand growth CAGR to be in the low 30% range. +Specific to Micron's DRAM outlook, we are seeing solid demand from customers across multiple segments. This is improving our inventory, and we have started to see pockets of tight supply, particularly in leading-edge nodes. However, we still have elevated inventory levels on older nodes. As a result, we are continuing with the previously disclosed DRAM wafer start reductions of 5%. We expect Micron's calendar 2019 bit supply growth to be slightly below industry demand growth of mid-teens and expect our calendar 2020 DRAM bit supply growth to be close to the market demand growth. We also expect our DRAM cost reductions to moderate in fiscal 2020 to high single digits. As we have said before, the increasing complexity of more advanced DRAM nodes is resulting in slower pace of cost declines for the industry. +As our DRAM inventory improves, we are committed to maintaining price discipline. While we are having to respond to some aggressive market pricing, we have started walking away from some transactions as we look to optimize our profitability. +Turning to Micron's NAND outlook, we expect our calendar 2019 bit growth to be slightly above industry supply growth, and in calendar 2020, we expect Micron's bit supply growth to be significantly below the industry demand growth as we transition a limited portion of our wafer starts to our first-generation replacement gate node and use inventory to support customer demand. Supply growth will also be impacted by our previously announced wafer start reductions of approximately 10%. We are seeing some capacity tightness in our back-end manufacturing operations due to significant increases in demand for high-capacity NAND products. This is another data point of elasticity kicking in on high-value NAND solutions. +While NAND and DRAM market conditions are showing some promising signs, in order to bring our supply in line with the market demand, we are targeting our fiscal 2020 front-end equipment CapEx to be reduced by more than 30% from fiscal 2019. Our CapEx decision is also influenced by macroeconomic uncertainty and low industry profitability. Our front-end CapEx outlook reflects our strategy for limited ramp of our first RG node. While we are reducing front-end equipment CapEx, we are spending significantly more on shell space to enable future node transitions and also investing in a new SSD packaging facility in Penang, Malaysia. As always, we will maintain flexibility and discipline while investing appropriately for Micron's long-term success. +I want to emphasize that our goal is to manage our DRAM and NAND bit supply growth CAGR in line with industry demand. As we catch up on the technology and cost gaps to best-in-class competitors in DRAM and transition to RG technology in NAND, our supply growth may fluctuate, but we expect the medium to long-term growth rate of our supply to approximately equal the rate of demand growth across both NAND and DRAM markets. We are also focused on maximizing the ROI of our CapEx investments, and for this reason, we are not emphasizing wafer capacity growth, but instead focusing on bit growth driven by technology transitions. In addition, some of our CapEx is dedicated to increasing our internal capacity for assembly, packaging and test, which helps us drive cost reductions without adding any bit growth and has good ROI. +I'll now turn it over to Dave to provide our financial results and guidance. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. As Sanjay mentioned, Micron delivered resilient performance throughout a challenging year for the industry, highlighted by fiscal Q4 results that exceeded our guided ranges for revenue and earnings. As market conditions evolved during the year, we curtailed our planned operating expenses and capital expenditures, allowing us to preserve margins and generate healthy free cash flow. We achieved our first corporate investment-grade rating, strengthened our balance sheet and meaningfully reduced our share count. All in all, fiscal 2019 was a year of stellar progress that sets Micron up for attractive growth as industry conditions recover. +Turning to our recent financial results. Total fiscal Q4 revenue was approximately $4.9 billion. Revenue was up 2% sequentially and down 42% year-over-year. Revenue exceeded our guidance range largely due to better-than-expected demand. Full fiscal 2019 revenue totaled $23.4 billion, down 23% year-over-year. +Fiscal Q4 DRAM revenue was $3.1 billion, representing 63% of total revenue. DRAM revenue increased 1% sequentially and declined 48% year-on-year. Bit shipments grew approximately 30% sequentially and in the mid-teens percent range year-on-year as customer inventories improved significantly. ASP declined approximately 20% sequentially. For full fiscal 2019, DRAM revenue was $15.2 billion, down 28% from fiscal 2018 as bits grew in the low single digit percent range and ASP declined approximately 30%. +Fiscal Q4 NAND revenue was approximately $1.5 billion or 31% of total revenue. Revenue was up 5% sequentially, but declined 32% year-on-year. Bit shipments grew in the low to mid-teens percent range sequentially. ASP declined in the upper single digit percent range. We're starting to see supply tightness in portions of the NAND market and prices are beginning to increase. +Full fiscal 2019 NAND revenue was $6.9 billion, down 12% from fiscal 2018 as ASP declines of mid-40s percent range more than offset strong bit shipment growth. +Now turning to our revenue trends by business unit. Revenue for the Compute and Networking Business Unit was $1.9 billion in fiscal Q4, a decline of 8% sequentially and down 56% year-over-year. ASP declines across most segments continue to be the leading cause of lower revenue. For the fiscal year, revenue was $10 billion, down 35% year-over-year. +Revenue for the Mobile Business Unit in fiscal Q4 was $1.4 billion, up 20% sequentially and down 26% year-over-year. Both DRAM and NAND bits had strong growth driven by seasonality and continued content growth in smartphones. Our mobile business gained share in the year driven by a stronger product portfolio. For the full fiscal year, MBU revenue was $6.4 billion, down only 3% from fiscal 2018. +Revenue for the Storage Business Unit in fiscal Q4 was $848 million, an increase of 4% from fiscal Q3 and down 32% year-over-year. For the fiscal year, SBU revenue was $3.8 billion, down 24% from fiscal 2018. +And finally, revenue for the Embedded Business Unit was $705 million in fiscal Q4, up 1% from fiscal Q3 and down 24% from the prior year. For the fiscal year, EBU revenue was $3.1 billion, down 10% from fiscal 2018. +The consolidated gross margin for fiscal Q4 was 30.6%, above our guidance range due to our strong execution, improving demand and slightly better pricing. Q4 gross margins included approximately 200 basis point negative impact or approximately $100 million due to the underutilization charges at IMFT. Starting in fiscal Q1 and continuing for the foreseeable future, we expect to incur an underutilization impact of approximately $150 million per quarter, with about half the impact consisting of noncash items. Over time, as our 3D XPoint business ramps, this underutilization impact will be mitigated. But as you can expect, it takes time to commercialize a new breakthrough technology. Meanwhile, we will continue to look for ways to optimize our costs and will provide updates on material progress over time. +With respect to U.S. tariffs on imports from China, with continued mitigation, we were able to contain their impact on our consolidated gross margin in fiscal Q4 to less than 20 basis points. +Operating expenses were $797 million and included some onetime expenses. We continue to control our expenses tightly, and our SG&A as a percent of revenue is meaningfully lower than our competitors. +Fiscal Q4 operating income was $694 million, representing 14% of revenue. Operating margin was down 38 percentage points year-over-year and down 9 percentage points from fiscal Q3. Our full fiscal 2019 operating income was $7.8 billion or 33% of our fiscal year revenue. +Our fiscal Q4 effective tax rate was 8.8%. For the fiscal year, our effective tax rate was approximately 7.3%, which included the tax benefit we recorded in fiscal Q3. Going forward, we expect our tax rate to be mid to high single digits. +Non-GAAP earnings per share in fiscal Q4 were $0.56, down from $1.05 in fiscal Q3 and $3.53 in the year ago quarter. For full fiscal 2019, our non-GAAP earnings per share was $6.35, down from $11.95 in fiscal 2018. +Turning to cash flows and capital spending, we generated $2.2 billion in cash from operations in fiscal Q4, representing 46% of revenue. For full fiscal 2019, cash from operations was $13.2 billion, representing 56% of revenue, down from $17.4 billion or 57% of revenue in fiscal 2018. Cash flow margins remained almost flat due to effective working capital management. +During the quarter, net capital spending was approximately $2 billion, down from $2.2 billion in the prior quarter. For full fiscal 2019, our net CapEx was $9.1 billion, up from $8.2 billion in fiscal 2018, but down meaningfully from the $10 billion to $11 billion plan we originally had entering fiscal 2019. +We expect our fiscal 2020 net CapEx to be in the range of $7 billion to $8 billion, down meaningfully from fiscal 2019. We expect that CapEx for buildings and back-end manufacturing will increase significantly from last year, while the front-end equipment CapEx will decline more than 30% year-on-year. +Looking at cash generation, we generated adjusted free cash flow of approximately $260 million in fiscal Q4 compared to $500 million in fiscal Q3 and $3.1 billion in the year ago quarter. Adjusted free cash flow for fiscal 2019 was $4.1 billion, down from $9.2 billion in fiscal 2018. +We received notice for approximately $180 million of convertible note redemptions in the quarter, which will remove approximately 4 million shares from our ongoing share count in fiscal Q1. For full fiscal 2019, we returned approximately $2.7 billion to shareholders in the form of buybacks, representing 65% of free cash flow, at an average purchase price of $40. Including these share repurchases and our convertible note redemptions, we reduced our average diluted share count by 80 million shares in fiscal 2019, representing 7% of shares outstanding. We remain committed to returning at least 50% of our annual free cash flow to shareholders in the form of share repurchases in the future. +Days of inventory was 131, down from 143 days in fiscal Q3. Inventory ended the quarter at $5.1 billion, increasing from $4.9 billion at the end of fiscal Q3. We will continue to focus on reducing our days of inventory and expect to see further reduction in fiscal Q1. As mentioned before, we are seeing pockets of tight supply in certain parts of our business. Our long-term normalized inventory target has increased over time to above 100 days as a result of greater process complexity and the broadening of our product portfolio to high-value solutions, such as SSDs that require longer assembly and test cycle time. +Total cash ended the quarter at $9.2 billion, up quarter-over-quarter, largely as a result of our $1.75 billion investment-grade debt issuance. Our total debt increased to $5.9 billion. Total liquidity ended fiscal Q4 at $13 billion. We are holding approximately $1.4 billion of liquidity for the acquisition of the IMFT joint venture expected in fiscal Q1 '20. This acquisition will eliminate approximately $700 million of member debt financing and will be funded by drawing down $1.25 billion from our term loan facility secured in fiscal Q4. +Before moving on to guidance, I want to share some expected changes to our upcoming reporting. We continue to evaluate planned technology node transitions, capital spending and reuse rates for NAND equipment. Based on our preliminary assessment, we anticipate changing the depreciable life of our NAND equipment from 5 to 7 years beginning in fiscal Q1 '20. This change will reduce our depreciation expense included in cost of goods sold for Q1 by approximately $80 million and increasing to approximately $100 million to $150 million per quarter for the remainder of fiscal 2020. As a reminder, depreciable life for DRAM equipment is already 7 years. +Also starting in Q1, we expect to change how we report MCP revenue, which we currently include within NAND revenue. We will begin disaggregating MCP revenue into DRAM and NAND, which will reduce our reported NAND revenue and margins in FQ1 while increasing our DRAM revenue. We believe that this change will help improve the transparency of our DRAM and NAND businesses. +Now turning to our financial outlook. As our portfolio strengthens and we improve our share in high-value segments, we're seeing growing demand for both DRAM and NAND and this is creating pockets of supply shortages, particularly in some leading-edge nodes and back-end manufacturing. However, the market remains competitive and industry inventories continue to adjust to economic and geopolitical uncertainties. Notwithstanding these challenges, we expect bit shipments for both DRAM and NAND to grow in fiscal Q1, with NAND increasing more than DRAM. +With that in mind, our non-GAAP guidance for fiscal Q1 is as follows: We expect revenue to be in the range of $5 billion, plus or minus $200 million; gross margin to be in the range of 26.5%, plus or minus 150 basis points; and operating expenses to be approximately $780 million, plus or minus $25 million. Based on a share count of approximately 1.13 billion fully diluted shares, we expect EPS to be $0.46, plus or minus $0.07. +Despite a variety of industry and trade-related challenges in fiscal 2019, Micron delivered strong financial results. At our 2018 Analyst Day, we laid out how we believed Micron was structurally improved and able to weather the storm in even challenging periods for the industry. While we're not out of the woods, we are proud of our execution as we have moved through the current cycle. We are exiting the fiscal year with a stronger product portfolio, deeper customer relationships and our highest liquidity and net cash position to date, and we have also made good progress on our share buyback program. We are well positioned to emerge from the current cycle ready to capitalize on the secular growth trends driving our business. +I'll now turn the call over to Sanjay for concluding remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. Fiscal 2019 has been a solid year of accomplishments for the New Micron, as we continue to focus on structural improvements across a range of functions in the company, to take our performance to new heights. While we have made dramatic progress over the last couple of years, there is significant opportunity ahead of us to further improve our operations, drive product cost reductions, further improve engineering execution, build on our go-to-market strategy and initiatives, deepen customer engagements and enhance the core competitiveness of the company to best-in-class levels. As we look ahead, the long-term opportunities are exciting, and we are extremely enthusiastic about the momentum we have established at the New Micron. +On October 24, we'll be hosting our second annual Micron Insight event, which will bring together leaders from across the industry to discuss how a world activated by data can transform the way we use information to enrich life and how memory and storage are vital to these efforts. We will be webcasting Micron Insight live from San Francisco, and I encourage you all to tune in. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Mark Delaney with Goldman Sachs. + +-------------------------------------------------------------------------------- +Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [2] +-------------------------------------------------------------------------------- + + So then to talk a little bit about your customers' inventory levels. One of the big concerns or debates in the financial community at the moment is whether the pickup in memory volumes that I think Micron has seen, is that mostly being driven by fundamentals or is this just potential inventory stocking because of some of the trade concerns? And Sanjay, I think you maybe talked about a bit of both factors in your prepared comments and some potential inventory stocking but also inventory coming down in some important markets like data center. So maybe you can just kind of level set and put those things together and do you think the pickup in your business, is it primarily being driven by fundamentals or how much of this is maybe some of that inventory stocking because of trade concerns? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + I think certainly the pickup in business is being driven by the industry fundamentals. I would just like to remind you that in the first half of calendar 2019 because of the inventory that the customers have built or had built up the demand to the producers was low yet the end-market demand for all applications continue to be robust. And now as the customers have worked down their inventory to normal levels, the demand is coming back to the producers. And as a result, you saw in our calendar Q, I mean, fiscal Q4 results our strong growth in DRAM bit as well as NAND. And second half is the demand is back, the customer demand is back, and yes, there may be some level of inventory build in China due to the reasons that I've mentioned by certain customers, but I'll tell you that we do not think that, that inventory build is anywhere close to the kind of inventory build that had gone on in the second half of last year. So nowhere materially close to that level. +So overall, the industry environment in terms of demand return is certainly solid. Certainly, in DRAM, there is still some supply, excess supply with the producers, but the inventory is improving fast. We talked about our inventory actually improving faster than what we perhaps anticipated some time ago and overall we even see some shortages in some leading-edge products, particularly on the DRAM side. +So overall, we think that industry inventory at the producers is being consumed at a rapid clip. The demand trends are back to normal levels. And especially when you look at the trends of through next year, 5G, you look at smartphone average capacities continuing to increase, both for NAND and DRAM, and cloud demand drivers continuing to be solid, new platforms, new CPU architectures being used that allow greater use and higher use of DRAM capacities as well as there are applications driving more DRAM and NAND. So the demand trends, when I look at 2020, I believe that the industry demand/supply environment will be in a lot healthier place. Yes, maybe calendar Q1 may have some cyclicality, but the industry fundamentals overall from demand/supply point of view I think in 2020 will be in a much healthier place. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Another way to look at this and kind of back it up mathematically is if you look at the year-over-year bit growth in the fourth quarter. It's only in the kind of 14% kind of range. So that kind of backs up the idea that this is really about industry fundamentals more so than it is about stocking inventory. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [6] +-------------------------------------------------------------------------------- + + Congratulations on the solid results given the macro uncertainty. Sanjay, I just have several questions just around the guided gross margins for the fiscal first quarter. If you look at the incremental hit you keep getting from IMFT that, that's more than offset by kind of the change in depreciation and yet you're still kind of getting sort of a 400 basis point drop sequentially in gross margin on kind of flattish to up revenue. And I know you guys don't comment about future pricing, but can you talk about other puts and takes around mix that might be negatively impacting kind of the gross margin? And I guess given that the incremental cost of IMFT is probably driven by you taking receipt of the whole joint venture in the month of November, why wouldn't that hit get higher as you go into the fiscal second quarter and have it for the full quarter? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Okay. So yes let me kind of walk through a little bit of the puts and takes. Obviously, pricing is a factor in the expectations around gross margins for the first fiscal quarter. And of course, we don't talk necessarily about forward pricing. +But the second piece is cost. And as Sanjay mentioned, our cost declines for fiscal '20 in total will be kind of high single digits. That's lower than the cost declines we got in fiscal 2019 versus fiscal 2018. And so we are seeing a slower rate of cost declines for DRAM and that's, of course, something we've indicated was coming given the complexities that we face and as we migrate nodes. And as we talked about, obviously, on the NAND side, we're going to have very minimal cost declines as we kind of transition to replacement gate. So those are certainly factors in that. And I would tell you that the first quarter cost declines are very minimal. +The third piece is mix. If you look at the mix from just a move to high-value solutions that, of course, is positive, but what is overshadowing that is the mix of NAND and DRAM. And of course, NAND has a lower gross margin than DRAM. And we will see likely a higher mix of NAND next quarter, which will affect gross margins negatively. +And then as you pointed out, there's 2 kind of unusual items, I guess, in the quarter. One is the change in the useful life of NAND equipment. That will be positive, but more than half of that will be offset by underutilization expenses associated with IMFT. So those are kind of all the puts and takes of gross margins. I think it's likely that it will be a little higher from Q1 to Q2 in terms of underutilization expenses, but it was somewhat in the noise. We might be a little bit lower than $150 million of underutilization expense in fiscal Q1 and we might be a little higher than that in fiscal Q2. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question comes from Mitch Steves with RBC. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [9] +-------------------------------------------------------------------------------- + + I just wanted to have a poke again around the gross margin question that was just asked. But one of the bigger questions I have was just your commentary about pricing getting better, but then you're talking about gross margins going down on a higher revenue base. So if you offset that with depreciation as well, I mean, does that imply that November quarter should be the bottom for gross margins or are you guys implying that February can also be down sequentially? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [10] +-------------------------------------------------------------------------------- + + Well, I think clearly we're talking about NAND getting better. And we are seeing the early signs in DRAM of kind of the fundamentals getting better, demand is coming back, inventories on our balance sheet and on the industry's balance sheets are coming down. Of course, that hasn't gotten completely to where it needs to be. And also Sanjay mentioned in his prepared remarks the market continues to be a bit competitive. And so we'll have to see when that, all those things come together and supply kind of aligns with demand to drive a more healthier market for DRAM. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur with JPM. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + On your fiscal '20 DRAM outlook for high single digits cost reductions versus fiscal '19, is that how we should think about your longer-term annualized cost down profile given the higher complexity, capital intensity that you outlined or are there some impacts from the pullback in utilizations, drawdown of your own inventories and/or maybe a slower 1Z transition that's impacting the cost down profile as well? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [13] +-------------------------------------------------------------------------------- + + We definitely have some underutilization expenses in DRAM. Certainly, we have that built into our expectations for the first fiscal quarter. It may last into the second fiscal quarter. And so that certainly is an impact. But I would tell you that over time, as complexity of these nodes goes up and as capital intensity goes up, the cost declines are going to become more challenging. So the high single digit will probably not be something we can routinely do year-to-year. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [14] +-------------------------------------------------------------------------------- + + And I'll just add that we are certainly narrowing the cost gap in terms of DRAM production cost overall. 1Z node is a good example of Micron's leadership, being the first one to introduce the 1Z node with the smallest feature size in the industry and the result of cost improvement that we are making on DRAM as well as, of course, the high-value solutions that are driving higher mix on the NAND side is a major improvement, 2,500-plus basis point improvement in our EBITDA margins versus the competition compared to the past 2016 time frame. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Newman with Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [16] +-------------------------------------------------------------------------------- + + You talk about inventory down quite a bit Q-on-Q. You gave some numbers on that. Do you have an even more break down on how that compares DRAM versus NAND? And then looking forward to next-gen technology, you commented that it's quite difficult transition to replacement gate NAND. Can you give an update on the timing for that, where you are on the 96 layers for your current generation in terms of percentage of the output and give a little bit more detail on the timing for the ramp of replacement gate. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [17] +-------------------------------------------------------------------------------- + + So Dave will comment on your inventory part of the question, but let me just address your question on the 96 layers. As we have said before, 96-layer execution has gone very well with the company. In terms of yield ramp, 96-layer technology has given us the fastest yield ramp of any other NAND technologies in the past. So we are very proud of that accomplishment and 96-layer is continuing to ramp during the course of our fiscal year 2020. In fact, 96-layer will be the major driver of our NAND bit growth in fiscal year 2020. +As I mentioned in my prepared remarks, with respect to replacement gate, we have seen now functionality and yielding dies. We are certainly quite encouraged by that and continue to work on technology and product development. In fiscal year 2020, 64-layer and 96-layer will continue to be the workhorse technologies and our replacement gate technology, of course, will have a small mix in fiscal year '20 and for us as well. +Keep in mind, our first replacement gate node, which will have small production in fiscal year '20, will be a rather limited node because we'll be deploying it across select set of products. It's our second-generation node which will, of course, come in the subsequent fiscal year that will position us well and resume the year-over-year strong cost reductions for us. But basically, the 96-layer will continue to ramp during fiscal year '20 for us. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + Okay. So on the inventory question. So we had 143 days of inventory in the third quarter. That came down to 131 days in the fourth fiscal quarter. If you kind of break that out between DRAM and NAND, DRAM was meaningfully below that and NAND was meaningfully above that. I would say in terms of days. Obviously, in absolute dollars, DRAM has more inventory than NAND. I would say, you've got to remember there are 2 reasons why inventory was building for NAND. It was building as we kind of slowed down our supply, but customers were working down their inventory. Now the adjustments we've made to our supply, both in terms of capital spending reductions and in terms of utilization adjustments, we have brought our inventory down pretty meaningfully this quarter. We expect to bring it down again meaningfully next quarter. +On the NAND side, we have elevated levels of inventory, but that's more strategic. What we're trying to do is have some built up inventory in fiscal '19 that we can use in fiscal '20 to support the RG transition because the replacement gate transition will not drive a lot of bit growth. And so in order to support the increased demand next year, we will have to utilize this inventory for that purpose. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [20] +-------------------------------------------------------------------------------- + + I just wanted to hit on your commentary around DRAM and undergrowing the industry in calendar '19. Within that, is that largely driven by Huawei, perhaps more aggressive competitors in certain markets, change in mix? Would love to hear your thoughts on that. And then as we move into calendar '20, what are your expectations vis-à-vis the market for your market share? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- + + So in terms of overall bits, with respect to DRAM growth in terms of revenue, I mean, it has primarily been impacted by the customer inventories that were built up last year for the first half. And our overall DRAM shipments are in line with overall the industry in this regard. And I think what we said is that the industry demand mid-teens and our overall supply growth during the calendar '19 to be slightly below the industry, of course, as a result some of the underutilization actions that we have taken. And of course, there is an impact of Huawei in terms of our overall business. We have said before that compared to the levels that we anticipated before Huawei's placement on the entity listing, our revenue is lower. And of course, we are very much focused on continuing to diversify our revenue base. But yes, I mean, the Huawei entity listing does have an effect on some of our shipments to the customer. I mean, some of our overall shipments in the market. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Raji Gill with Needham & Co. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + You had mentioned that you did see some elevated inventory levels in the lower process node. I was wondering if you can kind of elaborate on that particular comment. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [24] +-------------------------------------------------------------------------------- + + This is really related to some of our overall production and mix. And some of the older nodes have lower demand compared to our total supply available and therefore, that's where we are primarily running underutilization on the DRAM side. So it really is about the overall demand and this is good inventory that will overall will get consumed over time. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [26] +-------------------------------------------------------------------------------- + + I was wondering if you could help me parse out the CapEx guidance a little bit more in detail. I know last quarter relative to the $9.1 billion you did for the full year, you talked about roughly $2 billion for kind of cleanroom and facility kind of CapEx. Was that the case? And I think on the basis of that, what is that kind of CapEx spend specifically embedded in your fiscal '20 guidance? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes. It was a little bit lower than the $2 billion number, but certainly a meaningful part of our spend. And you could probably parse out from what Sanjay said. We expect that number to increase in fiscal '20 and the opposite is we expect the front-end equipment spend to decrease in fiscal 2020 versus fiscal 2019. We'll obviously make another investment in the back end and we're expecting that to be roughly similar to what we're spending or what we spent in fiscal 2019. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from Vijay Rakesh with Mizuho. + +-------------------------------------------------------------------------------- +Vijay Raghavan Rakesh, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Semiconductor Analyst [29] +-------------------------------------------------------------------------------- + + Just wondering on the same CapEx line, I know you guys talked about equipment CapEx being down 30%. So looks like close to $5 billion for fiscal '20, just wondering what the split would be on NAND and DRAM. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- + + We don't tend to break that out, but I guess I would just tell you that our plan is to reduce front-end equipment spend in both DRAM and NAND next year. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our next question comes from Mehdi Hosseini with SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Two follow-ups. We talked about the demand trends are positive, but I want to get a better assessment of how do you see data centers. There has been some conversation in industry that data center demand is seasonal. Some argue that it is better than seasonal. Sanjay, I want to get your view, how do you see the data center demand for both SSDs and server DRAM is tracking? And in that context, I'm surprised with your NAND bit demand projection for next year. This is well below historical trend of near 40%. What do you attribute this NAND demand trend into 2020 which in my opinion is well below trend line. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [33] +-------------------------------------------------------------------------------- + + So with respect to the NAND demand trend in calendar year 2020, I mean, just keep in mind that in calendar 2018 the industry grew by approximately 45%, in calendar year '19 again by about 45% or so, low 40s to 45%. And that then definitely, I mean, when you look at a multiyear CAGR, I think it does lead to calendar year '20 to be approximately in low 30s or in that range, high 20s to low 30s kind of range in terms of calendar year '20. And I think what you have to realize is that with such aggressive pricing decline that had occurred in NAND over 2018 and 2019 time frame, elasticity definitely has kicked in substantially. And as we said, pricing environment actually has started improving in NAND. And some of the average capacity growth that you perhaps would have seen next year actually has been pulled in faster into this year as a result of some of these aggressive price declines that have occurred and have driven the usage of higher capacities in terms of increasing average capacities of SSDs, increasing the attach rate of SSDs as well as continuing to drive higher average capacities in the smartphone market as well. So these are some of the factors that are absolutely playing an important role in terms of our assessment that for calendar year '20, the year-over-year bit growth will be high 20s to low 30s range. Again, keep in mind that we still are a few months away from next calendar year and we, of course, will continue to assess the overall industry demand trend, but this is our latest projection on that. +Your first question was around cloud and let me just point out that cloud definitely demand grew nicely for us on the DRAM side in FQ4, strong demand increase there. And yes, the cloud demand from time to time can be somewhat lumpy. However, overall, demand growth trends on the cloud side continue to be solid. In fact, we see cloud demand consumption, both for DRAM as well as for SSDs continue to be higher than the average of the respective DRAM and the NAND industries. So overall, cloud, again, new architectures, new CPU platforms that are really enabling more channels as well as usage of higher density of DRAMs as well as again, as I spoke earlier, the trend of AI applications, all of this is driving greater usage of memory and storage in cloud. So cloud, we see as absolutely strong. Cloud customers' inventories have normalized and it's back to normal levels. Other than any aspects perhaps in China, as I talked about, of maybe some element of strategic inventory build by certain customers. But overall, the cloud demand trends are solid. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question will come from Ambrish Srivastava with BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [35] +-------------------------------------------------------------------------------- + + Sorry to get back to NAND for fiscal '20 and I just wanted to reconcile the comments you made and I wanted to make sure I'm walking away with the right take away, is that you have limited cost down. And then you talked about very low gross margin. And you're also selling from already build inventory. So what's the trade-off between all these factors as I compare your profitability in NAND versus competition in fiscal '20? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [36] +-------------------------------------------------------------------------------- + + So I think in fiscal '20, the main focus for us on NAND will be to continue to increase the mix of high-value solutions. I think in mobile, you have seen us increase managed NAND solutions in terms of share gains substantially. And I reported in my prepared remarks on the tremendous progress that we have made with our mobile business. And most of it driven by the progress on the managed NAND side. And we plan to continue to increase that part of the business in fiscal year 2020. +I also spoke about SSDs. SSD was certainly a headwind in terms of share opportunities for us in fiscal year '19. And as we now have expanded our portfolio of NVMe solutions actually have introduced our first NVMe solutions during fiscal year '19 now. We can leverage those solutions to expand our opportunities in fiscal year 2020. And we certainly look forward to resuming gaining share in SSD on fiscal year '20. So I think that those are the important pieces of our strategy of continuing to drive healthier revenue mix of NAND in fiscal year 2020. And of course, we are extremely focused on cost reductions on assembly, test and nonmemory BOM as well which are important factors particularly when it comes to products like SSDs or multichip packages, et cetera. And we are making good progress on cost reductions on nonmemory part of the BOM as well. So these are all opportunities for us in fiscal year '20, but no question that at the die level our cost reduction capabilities will be overall limited in terms of the cost reductions due to the RG transition that we talked about earlier. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + And our final question will come from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [38] +-------------------------------------------------------------------------------- + + Great. Yes. I wonder if you could talk about if your forecasted demand will accelerate next year on the DRAM side. Can you kind of break that down between units and content and just generally what's your expectation for DRAM content for smartphones and servers next year? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- + + I think on the smartphone side, the average DRAM content if you look at it this year, it increased by nearly 25%, slightly above 3 gigabyte was the average capacity. Last year, expected to be in calendar year '19 around 4 and a pretty similar double-digit gains continuing. 5G, if you look at Mobile World Congress, phones that were introduced there were 8-gigabyte and 12-gigabyte DRAM density in those phones. So as 5G phones start selling in the marketplace, some of those phones are already introduced in the market today in some parts of the world and this will continue to build momentum during calendar year '20 and years beyond. Those phones will also require more DRAM. And again, the phones are becoming more and more feature-rich. More AI applications are being built into the smartphones today and rich video and imaging capability and a lot more intelligence behind all those applications. They require more DRAM as well. So looking at next year, we will certainly be seeing continuing average capacity increases next year as well. In fact, in calendar year 2020, if you look at industry projections, average capacity is expected to increase another 20% next year going to something closer to 5-gigabyte per smartphone. +But as I said before, the DRAM is not only about smartphone. It's other applications related to server as well where the average content continues to increase as well as the average content continues to increase in PCs as well with applications such as gaming driving higher need for more DRAM. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now all disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2020-Jun-29-MU.txt b/Transcripts/MU/2020-Jun-29-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..0f493318e95376fb2ce7a64d4f626651f58d91a0 --- /dev/null +++ b/Transcripts/MU/2020-Jun-29-MU.txt @@ -0,0 +1,432 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2020 Micron Technology Inc Earnings Call +JUNE 29, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc., Research Division - MD & Analyst + * Mark C. Newman + Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Karl Fredrick Ackerman + Cowen and Company, LLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JPMorgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to Micron Technologies Third Quarter 2020 Financial Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker, Head of Investor Relations, Farhan Ahmad. Sir, please go ahead. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technology's Fiscal Third Quarter 2020 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. +Today’s call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release, and prepared remarks filed a short while ago. +Today’s discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website. As a reminder, a webcast replay will be available on our website later today. +We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. You can follow us on Twitter at MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we file with the SEC, specifically our most recent Form 10-K and 10-Q, for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after today’s date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon, everyone. I hope that you, your family and your colleagues are safe and healthy. Along with Dave and Farhan, I'm doing this call from Micron’s offices. +Micron’s strong execution in the fiscal third quarter drove solid sequential revenue and EPS growth. We are ramping the industry’s most advanced DRAM node and increasing our mix of high-value NAND. Our strong competitive position and diversified product portfolio put Micron in an outstanding position for the +Many exciting growth opportunities in the memory and storage markets. +I'll start with an update on our operations. Due to the excellent work of Micron's operations team, most of our fab and assembly sites operated at full production throughout the quarter, with our Singapore and Taiwan assembly and test facilities achieving record production. COVID-19's impact to our production early in our third quarter was limited to our back-end assembly and test sites in Muar and Penang, Malaysia, and we quickly offset this impact with production adjustments at our other facilities. All our production facilities are operating normally at this time. We continue to prioritize the health and safety of all team members and contractors and have strong COVID-19 safety measures in place at all our sites worldwide. We are taking a conservative, phased and site-specific approach to returning our team members on-site, prioritizing our manufacturing workforce and engineering teams. +Now turning to the market environment. The pandemic has impacted the cyclical recovery in DRAM and NAND, causing stronger demand in some segments and weaker demand in others. Market segments driven primarily by consumer demand have seen a negative impact. Calendar 2020 analyst estimates for end-unit sales of autos, smartphones and PCs are meaningfully lower than pre-COVID-19 levels, even though estimates for enterprise laptops and Chromebooks have increased. The reduced level of global economic activity has also curtailed near-term demand. The pandemic is driving rapid change in consumer and corporate practices around the world. Consumers are significantly increasing online activity, including e-commerce, gaming and video streaming, all of which drive additional data center capacity requirements. Trends like working-from-home and online learning are likely to drive long-term changes in how we think about workforce flexibility and education. Several governments around the world are considering ways to ensure a level playing field by considering significant programs that provide Chromebooks or tablets to students who cannot afford them, as online learning becomes a necessity in these times. +Additional government fiscal stimulus programs are also supportive of economic activity and will accelerate trends like electric vehicle production. Emerging technologies such as drone-based deliveries and the increased use of robotics across many applications are now being pursued with urgency. Technology solutions are rapidly helping society adapt and manage the temporary and permanent changes stemming from this pandemic. +Clearly, certain trends that would have taken 2 to 4 years to develop have been accelerated into months. It is easy to see how these changes will drive higher consumption of memory and storage in the long term. The faster pace of digital transformation in the economy is here to stay. +Looking ahead to the second half of calendar 2020, let me discuss certain key market trends. First, we expect the data center outlook to remain healthy. Second, we expect smartphone and consumer end-unit sales to continue to improve, accelerating inventory consumption across the supply chain. And third, new gaming consoles will drive stronger DRAM and NAND demand. Despite these trends, our short-term visibility across end markets remains limited due to COVID-19, macro and trade uncertainties, as well as customer inventory changes. +The recent restrictions on Huawei are also impacting our opportunity in the near term. As these risks recede, we expect a resumption of industry growth, with a long-term bit growth CAGR of mid to high-teens for DRAM and approximately 30% for NAND. This growth will be supported by powerful secular technology trends ranging from AI and machine learning, to cloud computing, 5G and the growth in edge computing and the industrial IoT economy. +Turning to industry supply, second-half 2020 supply growth may be somewhat muted compared to pre-COVID-19 expectations. Some suppliers have commented about delays in equipment deliveries, which can result in slower node transitions and lower bit growth. Specific to Micron, we are proactively aligning our bit supply to market demand. Our fiscal year '20 front-end equipment CapEx is down more than 40% from fiscal year '19 and is at its lowest level in the last 5 years. While we expect to increase fiscal year '21 CapEx to support high-ROIC node transition, this CapEx will be meaningfully lower than our pre-COVID-19 plan. We have also made changes to our DRAM utilization to align with the current lower demand in the automotive market. As end market conditions evolve, we will remain flexible to make any needed adjustments to our supply. +Since 2016, Micron has made tremendous progress narrowing the competitive gap on leading-edge technology nodes. In DRAM, we are ramping 1Z technology, which is the industry's most advanced node, and achieving yield improvements that reduce our costs. We have several customer qualifications underway for this technology. Our 1Y and 1Z nodes together now make up more than 50% of our bit production. We continue to make progress on our 1-alpha node, which we expect to introduce in fiscal 2021. We have begun sampling our first high-bandwidth DRAM memory product, which is competitive with the industry's most advanced products and will expand our AI data center opportunity. We are excited about entering this new high-value segment of the DRAM market and look forward to ramping this product after it is qualified with our customers. +In NAND, our 128-layer first generation RG NAND technology entered volume production in FQ3, and we are pleased to announce that we have recently initiated customer shipment. We are also making good progress on our second-generation RG node, which will be deployed broadly across our product portfolio. We remain on track for RG production to make a meaningful portion of our NAND output by the end of calendar 2020. +Micron also continues to make progress with QLC. QLC bits now represents more than 10% of Micron's overall NAND production, contributing to our NAND cost improvement. Fiscal 2020 has been a year of extraordinary gains in the mix of our high-value solutions in NAND, which now make up over 75% of our quarterly NAND bit. We remain on target to increase this to 80% for fiscal 2021. +The new Micron is undergoing a dramatic transformation to combine product leadership with technology, manufacturing and supply chain excellence. Across our entire portfolio of DRAM and NAND products, we will continue to focus on product differentiation and portfolio expansion to grow our share of industry profits while maintaining stable bit share. +Turning to end markets. We had record quarterly revenue in solid-state drives as cloud SSD revenue more than doubled quarter-over-quarter. We continue to introduce new NVMe products in our SSD portfolio while maintaining our leadership in the enterprise SATA market. Customer qualifications are progressing well for our next-generation products for both NVMe and SATA markets. Our client NVMe SSDs have also contributed to our SSD growth. In May, we announced a TLC client SSD and our first QLC client SSD, both using next-generation 96-layer NAND technology. +As the only company with a portfolio of DRAM, NAND and 3D XPoint technologies, Micron is uniquely positioned to benefit from the secular data growth that is driving the cloud, enterprise and networking market. Our cloud DRAM sales grew significantly quarter-over-quarter, with strong demand due to the work from home and e-learning economy and significant increases in e-commerce activity around the world. This quarter, we started early sampling of 1Z DDR5 for enterprise application. Additionally, we also started sampling our higher-frequency DDR4 modules for Intel's Ice Lake server platform, which we expect to drive server DRAM content growth. In networking, our DRAM bit shipments expanded significantly on a sequential basis, driven by rapid work-from-home infrastructure deployment as well as increased 5G deployments, particularly in Asia. +Despite demand headwinds in the smartphone market due to COVID, our mobile business delivered healthy sequential and year-over-year growth due to continuing momentum of our DRAM and NAND solution. The outlook for calendar 2021 is promising, with 5G expected to drive a resumption in smartphone unit sales growth with the multiplier effect of higher memory and storage content. 5G phones will have greater content than 4G phone, and we can see this already in the phones being introduced in calendar 2020. We see the strongest memory and storage content growth in the low- to mid-range part of the smart home market, which is also the largest segment in terms of units. In this part of the market, 5G phones have 6 gigabyte of DRAM and 64 and 128 gigabyte of NAND versus 4G phones with 2 to 4 gigabyte of DRAM and 32 to 64 gigabytes of NAND. We are encouraged to see sub-$250 5G phones, which made 5G accessible to a broader market. This lower price point has been enabled by BOM cost reductions in semiconductor content outside of memory and storage. Micron is well positioned to help our customers win in the 5G era with an industry-leading product portfolio, including low-power DRAM and multichip packages. We continue to achieve design wins for LP4 and LP5 5G platforms, and our most advanced managed NAND products based on UFS 3.1 are now sampling at several major android OEMs. +In PC, our bit shipments declined modestly as we strategically moved supply of compute data to address demand in the data center market. Demand was strong for certain PC subsegments that are supporting increased work from home and remote learning activities, and our PC DRAM revenue was up sequentially as ASPs increased. While certain parts of the PC market has strengthened, overall PC unit shipments are expected to decline this year due to weakness in desktop PCs. In graphics, we have started shipping GDDR6 DRAM for next-generation gaming consoles, and we expect strong demand in the second half of calendar 2020. +In auto, revenue declined significantly from the previous quarter due to broad auto supply chain disruption. Despite auto unit weakness, secular content growth from ADAS and autonomous driving platforms resulted in record LP4 DRAM revenue for our auto business in the fiscal third quarter. As automotive production rates improve around the world, our auto business should return to a growth trajectory. +I'll now turn it over to Dave to provide our financial results and guidance. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. Despite COVID-19, we achieved strong results, thanks to resilient execution from our team members across the globe. Total FQ3 revenue was approximately $5.4 billion, up 13% sequentially and 14% year-over-year. Sequential revenue growth was led by the data center and mobile markets. +FQ3 DRAM revenue was $3.6 billion, representing 66% of total revenue. DRAM revenue increased 16% sequentially and 6% year-over-year. Bit shipments were up by approximately 10% sequentially. ASPs were up sequentially in the mid-single-digit percentage range. FQ3 NAND revenue was approximately $1.7 billion, representing 31% of total revenue. NAND revenue increased 10% sequentially and was up over 50% year-over-year. Bit shipments increased in the lower single-digit percentage range sequentially. ASPs increased sequentially in the upper single-digit percentage range. +Now turning to our revenue trends by business unit. Revenue for the Compute and Networking Business Unit was $2.2 billion, up 13% sequentially and up 7% year-over-year. CNBU's sequential growth was driven by double-digit quarter-over-quarter pricing improvements and stronger demand for data center products. We were supply constrained for certain compute DRAM products, which limited our ability to meet some demand upside from customers. Revenue for the mobile business unit was $1.5 billion, up 21% sequentially and up 30% year-over-year. The sequential growth was primarily driven by strong growth in our LPDRAM bit shipments. MCP revenue remained strong and was up significantly year-over-year. +Revenue for the Storage Business Unit in FQ3 was $1 billion, up 17% from FQ2 and up 25% year-over-year. SBU operating margins increased dramatically to 17%, up from a breakeven level last quarter. This significant sequential improvement in operating margins was driven by improved pricing, stronger data center SSD mix and overall record SSD revenue. And finally, revenue for the Embedded Business Unit was $675 million, down 3% sequentially and down 4% year-over-year, primarily from a reduction in automotive demand. +The consolidated gross margins for FQ3 was 33.2%. Sequential gross margin improvement was driven by pricing improvements in both DRAM and NAND as well as our ongoing improvements in product mix that continue to underpin our financial performance. The impact of underutilization at our Lehi fab was approximately $155 million or 285 basis points in FQ3. We expect underutilization to be approximately $135 million in FQ4 and expect gradual declines in underutilization through fiscal 2021. Operating expenses were $823 million in FQ3. As we said on last quarter's call, we've taken several actions to control our operating expenses, given the increased uncertainty surrounding COVID-19. As a result, we continue to expect favorable underlying OpEx trends to continue into fiscal Q4. +FQ3 operating income was $981 million, resulting in an operating margin of 18% compared to 11% in the prior quarter and 23% in the prior year. +Net interest expense increased to $24 million compared to $6 million of net interest expense in the prior quarter. This increased expense was primarily driven by the drawdown of our revolver and subsequent $1.25 billion investment-grade note issuance in the quarter. We expect net interest expense will be approximately $30 million in FQ4 due to the decline in interest income because of lower interest rates. +Our FQ3 effective tax rate was 3%, which benefited from approximately $19 million of onetime items. We expect our tax rate in the fourth quarter to be approximately 6%. Going forward into fiscal 2021, we expect our tax rate to be in the high single-digit to low double-digit range. +Non-GAAP earnings per share in FQ3 were $0.82, up from $0.45 in FQ2 and down from $1.05 in the year ago quarter. FQ3 non-GAAP EPS was approximately $0.02 higher due to the tax benefits reported in the quarter. +Turning to cash flows and capital spending. We generated $2 billion in cash from operations in FQ3, representing 37% of revenue. During the quarter, net capital spending was approximately $1.9 billion, approximately flat quarter-over-quarter. As we enter the final quarter of FY '20, we are projecting fiscal year 2020 CapEx to be approximately $8 billion. Our FY '20 front end equipment CapEx will still be down more than 40% from last year. However, back-end CapEx and building CapEx, either of which add to bit supply growth, are up from last year. +Free cash flow in the quarter was $101 million compared to $63 million in the prior quarter. This represents the 14th consecutive quarter of positive free cash flow, reflecting the structurally improved profitability and working capital improvements of the new Micron. We repurchased approximately 929,000 shares for $40 million in FQ3 at an average price of $43.54. In the 9 months of FY '20, we've returned $134 million of capital through repurchases and paid $266 million to settle conversion of convertible notes. Combining the convert premiums and share repurchases, we have used $338 million or 135% of FY '20 free cash flow towards reducing the share count. +Ending FQ3 inventory was $5.4 billion or 131 days versus 134 days last quarter. Our overall days of inventory are above our approximately 110-day target level, partly due to elevated NAND inventory as we transition to replacement gate. We are also carrying higher raw material levels as a precaution, given the increased supply chain uncertainty due to the pandemic. +We ended the quarter with total cash of $9.3 billion and total debt of $6.7 billion. Total liquidity was approximately $11.8 billion, up from $10.6 billion at the end of the second quarter. In the quarter, we issued $1.25 billion of investment-grade notes. And those proceeds, together with $1.25 billion of cash on hand, was used to repay the $2.5 billion revolving credit facility we drew at the beginning of the fiscal third quarter. +Prior to providing our outlook and guidance, we'd like to remind everyone that our fiscal Q4 is a 14-week quarter. +Now turning to our outlook. As Sanjay mentioned, while visibility remains limited overall, data center trends are strong, and new gaming consoles will be a tailwind to demand in the second half of the calendar year. While end unit sales of consumer devices such as smartphones have started to recover, we are seeing an impact from the recent restrictions imposed on Huawei. It is also important to remember that we are a lagging indicator relative to the end demand. In addition, the risk of a second wave of COVID-19 infections is continuing to drive greater uncertainty for the economic recovery and our business. Lastly, inventory strategies of our customers are difficult to predict. We continue to closely monitor market conditions and respond to changes in the market environment in a timely and disciplined manner. +With all of these factors in mind, our non-GAAP guidance for FQ4 is as follows: We expect revenue to be $6 billion, plus or minus $250 million; gross margin to be in the range of 35.5%, plus or minus 150 basis points; and operating expenses to be approximately $850 million, plus or minus $25 million. Finally, based on a share count of approximately 1.14 billion fully diluted shares, we expect EPS to be $1.05, plus or minus $0.10. +In closing, we're extremely proud of Micron's performance in this unprecedented period of market uncertainty and operational challenges. The tenacity, creativity and dedication of our team members around the world drove strong results that surpassed our initial expectations. Micron remains on very solid footing with an investment-grade balance sheet, ever strengthening product portfolio and secular industry trends that will continue to drive long-term demand. +I'll now turn the call over to Sanjay for closing remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. The pandemic has impacted our financial performance trajectory, which was shaping up for a robust outcome this calendar year. Nevertheless, we have moved with agility to leverage the new opportunities in the marketplace and have further strengthened our product portfolio. Micron's portfolio is now dramatically better positioned from a competitive perspective, and we have driven a tremendous transformation here over the last 3 years. In the coming quarters and years, we will continue to strengthen our business foundation. And as the industry environment improves, Micron is exceptionally well positioned to take advantage of long-term trends and drive superior returns for our shareholders. +Of course, preparing Micron for a bright future has to be about more than just quarterly business performance. We also have to be leaders in creating positive outcome for all of our stakeholders. In that context, there are 2 topics that I would like to touch upon before we move to Q&A. +First, earlier this month, we issued our fifth annual sustainability report. This year, we set challenging new goals for energy use, emissions, water use and waste generation that aim to dramatically improve the environmental sustainability of our operations worldwide over the years ahead. We also established an aspirational future vision that will drive us to achieve even more. Reaching our goals will require investment, and we plan to devote approximately 2% of annual capital expenditures to environmental sustainability initiatives amounting to about $1 billion over the next 5 to 7 years. These initiatives underpin our commitment to achieve significantly higher standards and help create a better planet. +Second, I would like to address the social unrest and racial division that have gripped our country. The senseless and tragic deaths of people in our black community in the U.S. must be addressed with real and lasting reforms. Hate, racial discrimination, violence and social injustice have no place in our society. Micron is committed to creating a welcoming and safe work environment for everyone, and we are taking concrete actions to increase technical training, career preparedness and opportunities for underserved population. We are also actively engaging and investing in community programs that aim to create a more just and fair society for everyone. +There is much work to do and we look forward to being part of the solution. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of John Pitzer of Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [2] +-------------------------------------------------------------------------------- + + Sanjay, David, congratulations on the solid results. Sanjay, if you think back 90 days ago when you gave guidance for the May quarter, there was a lot of uncertainty around the pandemic, and you guys guided accordingly, in hindsight, extremely conservatively. I think your comment on the call last time was that you're building inventory, so you're assuming that your customers are building inventory. I guess as you look to the August quarter guide, was there a similar methodology used to inform this guide? And I guess, specifically, there's a lot of consternation in the investment community about data center demand, and you seem to be arguing that in your fiscal fourth quarter, it remains strong and you expect it to remain strong in the calendar second half. I'm wondering if you could just share with us why you think that and why you're not as concerned as some perhaps in the investment community about inventory builds? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + So specifically with respect to data center, pre-COVID, we expected 2020 to be a year of strong growth in cloud, again, with all the trends building around AI and that needing more memory and storage. We expected healthy demand for pre-COVID in cloud applications. And of course, with COVID, as we discussed in the last earnings call, certainly, some of the trends got pulled in. Work-from-home economy as well as e-commerce, gaming, video streaming, all of these drove strong surge in demand on the cloud front. +As we look ahead at the second half, of course, given the total COVID environment and uncertainties around COVID around the globe, we basically have limited visibility. Yet, we do believe that cloud demand in the second half of the calendar year will continue to be healthy for us. We work closely with our customers in terms of understanding their inventories. We understand what their demand trends are. And from what we can see, customer inventories with respect to cloud are in a healthy place. And of course, there are other parts of the market such as mobile phone, where there are other considerations such as geopolitical considerations as well as related to COVID as well, where customers may have built up some additional inventory. +And in mobile, in particular, you saw in China that how in April, post-COVID within China, the demand went up, surged up for smartphones. So some of the customers may be preparing for -- as the consumer comes back, given the low point that the world experienced in March, April time frame, customers want to be prepared to supply the smartphone demand to them as well. So overall, it's a mixed picture with respect to the inventory on the customer front, cloud inventories are in decent shape. Mobile, I would say, is somewhat in anticipation of demand as well as managing to the supply chain consolidations due to COVID and some geopolitical considerations as well. +So overall, I would say, when we look at fiscal first quarter, the environment is similar to what we had experienced in FQ3, FQ4. And of course, our best assessment is baked into the guidance that we have provided to you. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [5] +-------------------------------------------------------------------------------- + + I guess a question on gross margins. How should we think about mix, particularly DRAM, as we move into the August quarter? And I guess, would love to hear, as part of that, what implied cost downs will look like? And really just trying to understand the nice step up you're seeing, how much of that is mix versus cost down versus perhaps other? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [6] +-------------------------------------------------------------------------------- + + So well, let me step back to Q3 just for a second. So gross margins obviously expanded in the third quarter as well. As I said in the prepared remarks, I'd say that, that was the pricing environment in both DRAM and NAND combined with just a richer mix of higher-value products, which obviously carry with it better gross margins. From a high-value solution perspective, I think we see that again in the fourth quarter that is helping drive an improved outlook for gross margins for the fourth fiscal quarter. You know, C.J., that we don't telegraph pricing and cost out for future quarters. But suffice it to say, we take both pricing and cost reductions into account. And obviously, the combination of those are pretty favorable. +The other thing I would say is in the third fiscal quarter, we did have some expenses associated with COVID-19, both in terms of just increased spending on our part to manage through some disruptions that we had early on. And then on top of that, we did have to move around the back end production. That did increase our tariff expense in the third quarter. So those things, we wouldn't expect to happen again in the fourth quarter, which is helping also on the gross margin front in the fourth quarter. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Blayne Curtis of Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [8] +-------------------------------------------------------------------------------- + + I'd like to add my congrats. Just on CapEx, seems like this year, there were some concern it that may be lower at $8 billion. I guess when you look at next year, I don't know where your starting point was. But I was wondering if you could walk us through some of your moving pieces. You talked about 5G as being the big tailwind. That makes sense. I'm curious what you would highlight that you're taking in account for next year on the other way. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes. I mean the one thing to keep in mind is, so CapEx spending this year had a fair amount of construction expense. And actually, we drove the front end equipment expense down quite considerably on a year-over-year basis. Sanjay said in the prepared remarks that it was down more than 40% in both DRAM and NAND. So we cut back pretty heavily on the front end equipment side this year. +Next year, we would expect some of that to come back, in particular, we're going through a full rotation into our second-generation replacement gate that certainly will drive some CapEx increases. And offsetting that, we'll have to look at construction and see what directionally we want to do there. I'd say we haven't firmed up the CapEx plans quite honestly for the year. As you know, we've maintained a lot of flexibility around CapEx. We take a hard look at the demand profile of bits over the next few years, and we kind of manage the front end CapEx accordingly to make sure that we're staying aligned with that. So over the next couple of months, we'll continue to refine our outlook over the next year or 2. And I think we'll be able to give you a better picture when we have our fourth quarter earnings announcement. +I would say, when we looked at, coming in pre-COVID levels, on the CapEx front, for front-end equipment, and now that we look at it now, it certainly has been cut back. And our expectation is that will impact kind of our bit supply in the calendar fourth quarter. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan Chase & Co, Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + And congratulations on the solid execution. Last earnings call, the team highlighted the supply production shift in mix from mobile to server DRAM to service the higher demand from your data center customers. Given the outlook for stronger data center demand, are you guys keeping the production mix more heavily weighted towards server DRAM? Or are you already starting to shift part of your DRAM production mix back to mobile? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [12] +-------------------------------------------------------------------------------- + + So we, of course, manage our mix on an ongoing basis. We assess customer demand expectations and make judgments regarding managing that mix. So yes, like you noted, we had shifted some of the supply from mobile toward the server applications. And at this point, we continue to make -- study how trends are evolving. And we think we are in a good position with respect to managing our mix. But if some changes are needed, we'll, of course, revert to making those changes in the future. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Timothy Arcuri of UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [14] +-------------------------------------------------------------------------------- + + Sanjay, you talked about Huawei, I think, twice or maybe 3 times. And I know you've been reshipping under the licenses, and the new restrictions are really on ASICs, not on standard products. So is that comment really more around the fact that this is sort of the last extension of the commerce licenses, and so you won't be able to ship to them in another few months? And can you sort of quantify how much is your Huawei exposure right now? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [15] +-------------------------------------------------------------------------------- + + So thanks for asking that question. Just to be clear, the foundry replacement on entity list, we had applied for licenses, and we secured those licenses for mobile and server shipments. And we do not supply into the networking side of the business. We never sought that license. So the entity list placement that had happened several months ago did impact some of our outlook, but we have been operating under the licenses that we have already received. The comment that I was making today is really related to last month's action by commerce department, which will go into effect sometime next month. And as a result of that action, we are already starting to see an impact in our fiscal Q4 as our customer reacts to the actions by the U.S. And quite frankly, impacts related to Huawei are still unfolding. We expect some of the impact to Huawei, yes, related to the foundries, but it affects their potentially overall considerations on managing their business, managing their supply chain. And we expect some of these impact to continue in FQ1 and beyond as well. +And then this is compounded further by changing inventory strategies at customers as well as market share shifts that happened between the smartphone players. So as far as we are concerned, you know that we have improved our revenue diversity. We have significantly expanded and strengthened our product portfolio. And we have good design and activity with all key players, particularly with new products that we have introduced, such as UFS3.1, LP5, DRAM and multichip packages. So we continue to work with our customer ecosystem to mitigate the effects of this. But the particular comments that you heard us talk about on the Huawei front really relate to the actions from U.S. government that have -- last month that have impacted the customer reaction, the Huawei reaction to those actions and impacting our outlook in FQ4. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [16] +-------------------------------------------------------------------------------- + + And then I guess, just how much of revenue was it maybe in May, Dave? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [17] +-------------------------------------------------------------------------------- + + In the May quarter, the FQ3 quarter, that did not -- the action announced last month did not -- action announced by the commerce department last month did not have an effect in FQ3. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [18] +-------------------------------------------------------------------------------- + + Now suffice it to say that we didn't list them as an over 10% customer, so you can make the assumption that it was below 10%. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Joe Moore of Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [20] +-------------------------------------------------------------------------------- + + I wanted to ask about customer inventory. I want to revisit that. To the extent that customers are wrestling with pretty unprecedented potential supply challenges, do you think they're building up buffer inventory to deal with that? I mean, we've seen single earthquakes in one region caused that behavior in the past. Now we're dealing with rolling outages across multiple continents. Do you think customers may be building inventory? And if so, do you think memory is sort of less or more impacted than other things from that? And I have a follow-up. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [21] +-------------------------------------------------------------------------------- + + So what I can tell you is that Micron itself in our supply chain operations has focused on making sure, given all the considerations around the globe with all the uncertainties around COVID and COVID containment and COVID spread, Micron itself and its supply chain operations is increasing the inventory for raw materials to make sure that we are well prepared to meet our customer demand. So this trend of higher level of inventory, elevated level of inventory is -- it's been talked about, and it's common in the tech supply chain. And with respect to our specific customers for memory and storage, so as I mentioned earlier, so yes, some customers may have built some inventory given their considerations, their concerns around supply -- potential supply chain disruptions that may occur due to all the COVID-related uncertainties. As well as I pointed out, some of the customers in the mobile may have built some inventory, given U.S.-China trade tensions and the regulations. +So the thing is, these are unprecedented times, uncertain times, not just for us or for the memory industry, but for our customer ecosystem as well. And customers' inventory strategies are changing. They are adapting as they themselves see how their market trends are evolving and how they want to best address their own inventory position as well. So this is the changing environment. We continue to work closely with our customers, and we make adjustments as appropriate. And key is to be adaptable and to be agile. And I think we have shown over the course of the first half of this calendar year that we have been really running our operations with tremendous amount of adaptability and agility and continuing to produce healthy results. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [22] +-------------------------------------------------------------------------------- + + Great. And then in terms of the strength that you guys are seeing in cloud in the second half, would you differentiate it all by geography? I think you mentioned China being stronger, but is it any different in China versus the rest of the world in cloud? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [23] +-------------------------------------------------------------------------------- + + We're not going to break it down here between China and rest of the world. But overall, when we look at in totality, we continue to see healthy demand trend in cloud in the second half of the year. And of course, cloud, when you look at long-term trends, I mean, long term, cloud is still actually in early innings, and long-term trends for cloud are strong because AI as well as 5G, 5G driving more intelligent devices at the edge, growing more data opportunities, it's really the virtuous cycle between cloud and intelligent devices at the edge. And then industrial IoT and everything around autonomous and robotics, all of these trends point to growth at the edge as well as in the cloud. So long-term trends continue to be healthy. Will it ever be a little bit lumpy here or there? Certainly, it can be. But the point is that long-term growth drivers are solid and secular in nature for cloud. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Mitch Steves of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [25] +-------------------------------------------------------------------------------- + + So you guys mentioned 2 things on the call that I wanted to double-click on. So the first one is you mentioned that some of the shipments that's semi-capped didn't come in on time. So is this enough, in your opinion, to kind of impact the price of memory? I'm not looking for specific numbers, but was the shipment miss impactful enough that you think it's going to hurt supply enough to move the price? And then secondly, just high level, any comments on the U.S. government kind of incentivizing U.S. manufacturing? So we got TSMC coming to United States. And any impact you guys think it will have on you guys in the future? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [26] +-------------------------------------------------------------------------------- + + So regarding the equipment piece that you asked, let me be very clear that Micron did receive its equipment in time because our equipment deliveries were rather early in fiscal Q3 toward our 1z technology ramp in DRAM and, of course, other aspects on the NAND front as well. So we did not say that equipment deliveries were delayed for us during FQ3. However, it is well-known and has been talked about in the industry that given the various challenges due to COVID, such as logistics and transportation-related challenges as well as supply chain challenges, some of the equipment deliveries have been impacted in the industry. And yes, for us, in the future, it is possible, given the challenges of COVID, that some of our deliveries in the future may get impacted. But in the past, we have been in good shape overall with respect to our receipt of equipment, again, because timing of most of that equipment delivery was such that we were able to actually escape some of the potential challenges in this regard. +So from an industry point of view, if equipment deliveries get impacted, which have been talked about, there have been reports, equipment suppliers have talked about some of that as well, then obviously, that impacts technology transition capabilities, and therefore, it can impact supply, perhaps some with supply growth somewhat lower than pre COVID expectations due to the difficulty in making sure that the equipment are delivered on time as well as equipment install and equipment ramp is happening smoothly, given all the travel considerations involved as well. +So yes, to the extent that affects the supply growth and lessens the supply growth, it obviously impacts the industry supply and demand environment. We have talked about that the demand also due to COVID in certain pockets certainly has been less, particularly those pockets related to COVID. So -- and we don't really comment on the pricing, but obviously, supply has an important role to play on the pricing front. +Your second piece of the question regarding possible U.S. incentives for semiconductor manufacturing, let me first say that we are pleased that the U.S. administration as well as the Congress is considering incentives for U.S. semiconductor industry. This just goes to highlight that U.S. semiconductor industry is extremely important to our economy today. Semiconductor really forms the foundation of the economy of the future and also highlights the recognition of this importance by the officials in Washington, D.C. And really, it's important that U.S. maintains its global competitiveness and innovation capabilities. So from that point of view, we are pleased that there are these consolidations, the bill that is -- that has been put together. Of course, a lot of details still has to be worked out and the bills have to be approved. So we will continue to monitor this. +And from the point of view of memory, I think important thing is that cost and scale in memory are extremely important considerations. Micron, in this regard, actually has a well-diversified footprint of front-end manufacturing across the globe. You know that we have fabs here in the U.S. in Manassas, Virginia, as well as in Utah, and state-of-the-art, best-in-class R&D facility in Boise, Idaho as well. And of course, we have R&D and manufacturing for memory in Asia as well. So we will continue to monitor these trends, but important considerations, our scale, cost and ROI on any investments is important. It's not just about government incentives. It's about managing the business in a healthy fashion, keeping in mind ROI considerations. And above all, it's extremely important that supply growth is managed in a cost-effective fashion but also managed in a fashion to not disrupt the industry, to certainly not disrupt Micron's supply plans and make sure that supply factor is aligned with demand CAGR. So while we welcome these incentives for growth of U.S. semiconductor industry and innovation agenda, we will continue to monitor this in a very disciplined fashion before we make any decisions in this regard. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Daneley of Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc., Research Division - MD & Analyst [28] +-------------------------------------------------------------------------------- + + Just a question. Can you just talk about the linearity of bookings during the quarter? Did they sort of build all quarter? Was there some volatility in there? And then you also mentioned that mobile and data center were the strongest end markets. Were both of those stronger than expected? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [29] +-------------------------------------------------------------------------------- + + So linearity bookings was pretty -- I would call it pretty linear through the quarter. No surprises. And the mix -- of course, as we said, data centers showed good strength through the quarter, and mobile was a bit weaker than perhaps we were thinking coming into it, but just in terms of linearity. But in general, I would say, actually a fairly linear quarter for us. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Mehdi Hosseini of SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [31] +-------------------------------------------------------------------------------- + + Most of the good questions have been asked. I just have a follow-up. I'm just wondering, Sanjay, what would it take for your customers to feel comfortable in signing multiyear -- by quarter, rather, contracts? I remember when supply was tied back in 2016 and '17, the industry was highlighting the longer-term contracts associated with enterprise customer. I think that has changed. And in that context, how do you see (inaudible) coming back and be a more (inaudible) part of the memory industry? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [32] +-------------------------------------------------------------------------------- + + So Mehdi, you were breaking up a little bit. However, your question is a good question. And of course, we -- as you know, our customer base is extremely well diversified from automotive to data center to PC to smartphones and networking and industrial and consumer customers. So customer requirements with respect to discussions around supply and from us, they vary. Some of the customers are managing it on monthly basis, some manage it on quarterly basis. And with some customers, we do have supply agreements that extend for years time frame. Of course, certain pricing discussions, et cetera, I mean, are not part of these contracts. They tend to be around supply, and discussions around pricing tend to be on an ongoing basis. Auto is an example where the contracts can be multiyear contracts, long-term contracts, so it really varies from market to market. And you know that the technology and product mix continues to change as well. So I think we want to be careful in terms of the length of the contracts that we manage with the customers. And we manage, I believe, the diversity of our customers very well. +And our customers value our supply. They are valuing the product portfolio that Micron is delivering. They are recognizing that we are the only company in the world that have NAND, DRAM and 3D XPoint and the ability to bring innovative products and solutions to them with a mix of technologies in them as well. And this really positions us uniquely. So our discussions really regarding longer-term nature of product road maps and supply considerations, we win all of these various aspects and are built around the road maps as well. So things do change in this business. And therefore, multiyear contracts are more in the market that are auto market where more legacy nodes are required to be in production for longer terms. But the parts of the markets where technology and products are moving fast, it's not about multiyear contracts there, but varying length of contracts depending upon the end market customers. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Karl Ackerman of Cowen. + +-------------------------------------------------------------------------------- +Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [34] +-------------------------------------------------------------------------------- + + It's great to see the improvements in your SSD segment, both client and enterprise. First, what sort of percentage could QLC drives represent as a portion of your overall SSD mix next year? Could it be 25% or more? And I'd appreciate hearing your perspective on the development taking place in enterprise SSDs. On one hand, your U.S.-based competitor has been adamant they're going to gain significant share in enterprise SSDs this year. Yet merchant controller manufacturers do enable cloud providers to design their own in-house enterprise SSDs rather than just relying on off-the-shelf SSDs from OEMs. So I was hoping you could just provide the opportunity that you see in enterprise SSD this year versus peers. And how you see that playing out in the next 12 to 24 months, particularly as some of the new technologies that you're introducing and providing, such as PCIe 4.0 becomes more mainstream. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [35] +-------------------------------------------------------------------------------- + + Thank you for asking the question. We are very pleased with our execution in SSDs. As we noted, that record quarter for us in SSDs and really solid sequential growth in SSDs. And this is happening, as we had said before that during calendar year 2020, we will be expanding our portfolio of SSD solutions, introducing NVMe solutions for clients as well as data center markets. And we have said before that as we bring out those new solutions, as we qualify them with those customers, those NVMe solutions, it will give us an opportunity during the course of the year to gain share, and this is what has been happening during the course of this year. With our strong performance in SSDs, we actually have been gaining share, yet, our share is still relatively low. And as we continue to bring out new products in the future, and several are underway and several qualifications are underway as well with our customers, we will have ongoing opportunities through the course of next year as well in terms of driving for profitable share gains in the SSD market. +And regarding QLC that you asked about, we are really pleased with our execution on the QLC front as well. We are shipping QLC SSDs in the consumer markets as well as we have product offerings that will be having -- drive future opportunity for us on the value side of the PC, on the OEM front as well. And QLC SSDs are also being used in read-intensive applications and replacing 10K HDDs as well. So you see there are multiple end market applications and opportunities for our SSDS. And we are already more than 10% of our total NAND consumption with respect to QLC, and this presents a good opportunity for us. And we fully expect our SSD mix to continue to increase as we bring out more new products over the course of next several quarters. So yes, I mean, QLC as a mix of SSD percentage will go up for us going forward. +And let me just add that QLC is obviously an opportunity that instead of 3 bits per cell, it has 4 bits per cell. So obviously, once done right and you really have all the BOM costs taken care of on the product side, it gives you lower cost and, therefore, improved profitability opportunity as well. So we are certainly focused on increasing the mix of QLC. At the same time, TLC will remain vast majority of the market for a considerable period of time. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Mark Newman of Bernstein. + +-------------------------------------------------------------------------------- +Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [37] +-------------------------------------------------------------------------------- + + Congrats on strong numbers today. Just as a follow-up question on the data center segment. There seems to be -- I mean it sounds like everything you said stays very upbeat, quite bullish on data center demand remaining quite strong. There seems to be some worries in the market, particularly around some investors of hyperscalers inventory have been increase slightly. And I think the worry is stemming from what happened in '18 with the cuts in orders in late 2018, which continued too much of 2019. So my question is how has the communication changed with the data center at the hyperscalers? Are you having more frequent and closer communication with them to determine -- trying to get a better idea of what the inventory levels are? Or otherwise, how can you help kind of soothe those fears that data center demand is going to remain stronger for longer, as we hope it will? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [38] +-------------------------------------------------------------------------------- + + So first of all, I would say on the inventory side, pre-COVID, data center customers as well as other customers largely had inventories that had returned to normal levels. And certainly, supplier inventories were at normal level as well pre-COVID. And the COVID environment, work-from-home environment has driven strong surge in demand on the data center front. And as we mentioned, we expect demand trends to continue to be healthy in the second half for data center as well. +In terms of inventories in the data center market, yes, while certain customers may be carrying high levels of inventory, again, for the reasons that I had mentioned earlier, related to their own supply chain considerations as well as changing environment with respect to the demand. But the point is that compared to 2018 or 2019 environment, customer inventories are really at a much better, much healthier levels. This is not like a 2018, 2019 and situation, even if certain customers are carrying some higher levels of inventory, again, given the uncertainties around COVID. +And the other point I would say is that while COVID does give us lower visibility and does bring about uncertainty, not just for us but for our customers as well, cloud is an area where the long-term demand trends, as I mentioned earlier, are secular in nature overall. So memory and storage, given the kind of application that customers -- our data center customers, hyperscalers are working on, those are requiring more memory and more storage. So the longer-term trend continues to be healthy. +In the near term, yes, I mean, COVID does have unprecedented amount of challenges and uncertainty in the entire tech ecosystem, and we are doing our best to continue to work with our customers. Our relationships today, since you were asking about those, are certainly a lot closer than they were in the previous time frame. I would say that even hyperscale customers have become somewhat more sophisticated in terms of understanding the memory dynamics and improving their own supply chain operations. So it's really a 2-way relationship. We do work closely together with them. +Having said all of that, of course, our visibility cannot be perfect in this area. We continue to focus on working closely with the customers, understanding the requirements and planning our supply chain accordingly. And what also helps is that the markets are quite diverse for us. I mean, yes, cloud is a strong driver of growth for the business, but also we are well diversified with strong mobile footprint as well as PC and between DRAM and NAND. And as we talked about, diversified into the gaming side with new gaming consoles coming in, needing more DRAM, twice as much DRAM, the new gaming consoles. So diversity of the business is certainly a helpful factor for us to manage through some of these uncertainties. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/MU/2020-Mar-25-MU.txt b/Transcripts/MU/2020-Mar-25-MU.txt new file mode 100644 index 0000000000000000000000000000000000000000..b8b00267a4cce4b401710f292b189ec60d6bc747 --- /dev/null +++ b/Transcripts/MU/2020-Mar-25-MU.txt @@ -0,0 +1,437 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 Micron Technology Inc Earnings Call +MARCH 25, 2020 / 8:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David A. Zinsner + Micron Technology, Inc. - Senior VP & CFO + * Sanjay Mehrotra + Micron Technology, Inc. - CEO, President & Director + * Farhan Ahmad + Micron Technology, Inc. - Senior Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Brett Danely + Citigroup Inc, Research Division - MD & Analyst + * Mehdi Hosseini + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Rajvindra S. Gill + Needham & Company, LLC, Research Division - Senior Analyst + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Ambrish Srivastava + BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to Micron Technologies Fiscal Second Quarter 2020 Financial Conference Call. (Operator Instructions) Please be advised that today's conference may be recorded. (Operator Instructions) I would now like to hand the conference over to your host, Head of Investor Relations at Micron Technologies, Farhan Ahmad. Sir, please go ahead. + +-------------------------------------------------------------------------------- +Farhan Ahmad, Micron Technology, Inc. - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you, and welcome to Micron Technologies Fiscal Second Quarter 2020 Financial Conference Call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call, including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release and the prepared remarks filed a short while ago. +Today's discussion of financial results will be presented on a non-GAAP financial basis unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures can be found on our website. As a reminder, a webcast replay will be available on our website later today. We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company including information on the various financial conferences that we will be attending. You can follow us on Twitter, @MicronTech. +As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that can cause actual results to differ materially from the statements made today. We refer you to the documents we file with the SEC, specifically our most recent Form 10-K and 10-Q for a discussion of risks that may affect our future results. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. +I'll now turn the call over to Sanjay. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Farhan. Good afternoon. I hope all of you and your families are safe. These are unprecedented times, and I'm calling from home today. +In Micron's fiscal second quarter, we delivered strong results, including revenue at the high end of our guided range even as the COVID-19 crisis began to unfold halfway through our quarter. We have now achieved positive free cash flow for 13 consecutive quarters. This performance represents a marked improvement from historical cycles and is evidence of the strength of the new Micron. +The emergence of the COVID-19 pandemic has created both operational challenges and macroeconomic concerns. Micron has more than 37,000 team members in 18 countries around the world. Since the earliest signs of the outbreak in China, we have taken proactive measures to safeguard our employees. Where possible, Micron employees are working from home, and we have suspended all local and international business travel globally. We implemented health screenings at all Micron locations. We were among the first in the industry to implement physical separation protocols at all our manufacturing sites globally to mitigate the risk of community spread with blue teams and red teams that operate on alternate schedules. We have been requiring self-declaration and self-quarantine measures as this crisis has spread, whereby team members, contractors and their immediate families observe 14 days of work from home after any air or sea travel. +As of yesterday, we have 2 employees who have tested positive for the novel coronavirus and are receiving appropriate medical attention. At the 2 sites where we have confirmed cases, we have used contact tracing to quarantine individuals who were in close contact with either infected team member. We have also implemented more restrictive controls of on-site access, social distancing and service protocols. As a result of stringent preventative measures in place, these events have not impacted our manufacturing operations thus far. +We have also taken measures to protect our raw material supply and increase our supply chain flexibility. First, we have been in close ongoing communication with our suppliers to ensure continuity and identify supply gaps. Second, we have increased our on-hand inventory of raw materials and have begun to store more of that supply on our sites to minimize the impact of any logistics delays. Third, we have increased our focus on multi-sourcing of parts to reduce supplier dependence risk. And fourth, we have added assembly and test capacity at both our captive and contract manufacturing sites to provide redundant manufacturing capability in multiple regions. +As COVID-19 spreads, we are complying with all government orders at our global sites. These orders may result in a temporary or prolonged shutdown of our sites, which could impact our shipments this quarter. For example, on March 16, the Malaysian government issued a restriction of movement order resulting in the closure of borders and most businesses in Malaysia. Subsequently, the Malaysian government added semiconductors to the list of essential services, and we were able to resume operations. Our assembly and test facilities in Muar and Penang, primarily used for packaging high-value NAND, were briefly shut down and have since been able to return to production on a very limited basis in compliance with local regulations. We are using our global supply chain network and increased flexibility to try and mitigate this production impact, and we are working to keep our commitments to our customers. +Turning now to COVID-19's effect on demand. COVID-19 is significantly impacting China's economic growth in the calendar first quarter, reflected in the sharp decline of smartphone and automobile unit sales. Weaker sell-through of consumer electronics and our customers' factory shutdowns in China were headwinds for us late in our fiscal second quarter. In China, lower consumer demand was offset by stronger data center demand due to increased gaming, e-commerce and remote work activity. Looking to the third quarter, as these trends also take shape worldwide, data center demand in all regions look strong and is leading to supply shortages. In addition, we are seeing a recent increase in demand for notebooks used in the commercial and educational segments to support work from home and virtual learning initiatives occurring in many parts of the world. We are also encouraged to see manufacturers in China increasingly returning to full production, and we have recently started to see China smartphone manufacturing volumes recover. Nevertheless, as the world deals with the outbreak of COVID-19, we expect that overall demand for smartphones, consumer electronics and automobiles will be below our prior expectations for the second half of our fiscal 2020. +Once the U.S. and other major economies have demonstrated containment of the virus's spread, we expect a rebound in economic activity. Much depends on potential government stimulus and the rate, pace and effectiveness of containment efforts. We are modeling an improvement in the trajectory of economic activity later into the second half of calendar 2020 with a further rebound in economic momentum into 2021. This is a very fluid situation, and we will learn more about the virus, its spread and its economic impact over the next few weeks and months. +Anticipating changes to our customer demand, we have been moving supply from smartphone to service the strength in data center markets for both DRAM modules as well as SSDs. Just like we have increased our raw materials inventory in these uncertain times, it is possible that certain customers are similarly increasing their inventory of DRAM and NAND products. We will manage our business with prudent and proactive action and continue to work closely with customers to understand their latest demand outlook. We are evaluating our production levels and CapEx plans for calendar 2020 and will adjust to the most recent demand requirements. Once we emerge from this low-visibility environment that is impacted by COVID-19, we expect the industry to resume its long-term growth trajectory with a DRAM demand growth CAGR in the mid- to high teens and NAND in the 30% range. For both DRAM and NAND, we expect our multiyear supply growth CAGR to be in line with the industry's demand growth CAGR. +Focusing on 2020, we returned our DRAM operations to full utilization at the beginning of the calendar year, and our NAND operations continue to run with reduced wafer starts as we deploy capital efficiently through our conversion to replacement gate. While we returned our DRAM utilization to full production, we remain flexible to adjusting these levels depending on the near-term demand environment. Node transitions and industry supply growth in calendar 2020 could be impacted by disruptions to equipment companies' operations including travel restrictions, hindering, field service and engineering support. Recently, some equipment companies have also indicated delays in equipment deliveries due to the impact of various government actions to combat COVID-19. The situation with coronavirus is rapidly evolving, and disruptions could be much larger than we can see today. However, our continued focus on innovation and execution, combined with our rock-solid balance sheet, puts us in an excellent position to navigate this period of uncertainty and capitalize on the long-term opportunities driving our industry once conditions eventually normalize. +Stepping away from the COVID-19 discussion, I want to spend a few minutes talking about the tremendous progress we have made on our technology and products. This progress is contributing to the underlying strength of the new Micron, and this is a source of excitement for us as we look to the future. The new Micron is undergoing a dramatic transformation to combine product leadership with technology, manufacturing and supply chain excellence. Our objective is to have leading process technology so that we can deliver differentiated products to our customers and maintain a competitive cost structure. We are making good progress on this front in both DRAM and NAND. In DRAM, we were the first to introduce 1Z in volume production and expect over half of our bit production to be on 1Y and 1Z by the summer of 2020. We are managing the construction schedule of our new Taiwan cleanroom expansion carefully and currently remain on target for first output in calendar 2021. In the fiscal second quarter, we began sampling 1Z-based DDR5 modules and are on track to introduce high-bandwidth memory in calendar 2020. +We are also making good progress in our 1-alpha node. In NAND, we made significant progress on our replacement gate, or RG, transition and expect to begin volume production in our current quarter with revenue shipments to follow in our fiscal fourth quarter. We expect replacement gate production to be a meaningful portion of our total NAND supply by the end of this calendar year. +Micron continues to lead on QLC NAND, which lowers cost for SSDs and helps us target market segments that are currently served by HDDs. QLC SSD bit shipments rose by 60% sequentially in our fiscal second quarter with a meaningful portion of our consumer SSDs now shipping with our QLC technology. We expect QLC to continue growing in the second half of the fiscal year as market adoption increases. In the fiscal second quarter, we made significant progress on increasing the mix of high-value NAND bits to over 70% of total NAND bits, and we remain on track to drive this figure to around 80% in fiscal 2021. Despite normal seasonal weakness in COVID-19, mobile MCP products had record revenue in the quarter and showed strong sequential growth. SSD revenue also grew approximately 20% sequentially, led by greater than 50% growth in data center SSDs. The resolution of the assembly and test constraints we experienced in the fiscal first quarter, combined with market share gains, drove strong growth in these product lines. This mix improvement increases our profitability and reduces the volatility in our margins. +Now let's turn to 3D XPoint. As the only company in the world with a portfolio of DRAM, NAND and 3D XPoint technologies, Micron is uniquely positioned in the marketplace. We are encouraged by the customer reception of our first 3D XPoint product, the X100, which is the fastest storage device in the world. It is a great start to our portfolio of differentiated 3D XPoint products built in collaboration with our customers. As we mature this X100 solution, we look forward to engaging a broader set of customers this year and delivering the value of 3D XPoint to the data center market. Early in March, we entered into a new 3D XPoint wafer sale agreement with Intel that replaces previous agreements. Intel has been an important partner over the years, and this new agreement ensures a continuation of our close relationship. +Now turning to highlights by products and markets. In SSDs, we had record consumer SSD revenue, assisted by growth of our QLC NVMe consumer SSDs. We expect strong sequential bit growth in our NVMe product portfolio in fiscal third quarter as we continue the transition from SATA to NVMe. In SATA, we achieved several customer qualifications for our newest 96-layer SATA-based data center SSD. In the fiscal second quarter, we became the first company to deliver LP5 mobile DRAM products to customers, including Xiaomi, which is using our LP5 in its 5G-capable Mi 10 smartphones in 8- and 12-gigabyte configurations. More recently, we have begun sampling the world's first LP5 DRAM-based UFS MCPs. These LP5 DRAM products will enable longer smartphone battery life and high-performance image processing. They are great examples of how Micron is innovating for our customers to enhance the end user experience. We are encouraged that LP5 and UFS will become even more important as 5G adoption accelerates, reigniting smartphone unit sales and driving content growth. In just 2 short years, we have gone from trailing the competition in our mobile product portfolio to leading the industry with innovative first-of-a-kind products, consistent with our new Micron strategy. In the data center market, we benefited from strong demand for our products from key cloud and enterprise customers, driven in part by ongoing strength in cloud markets, increased use of online properties, such as e-commerce and the surge and remote work requirements due to COVID-19 containment measures. +In the graphics market, GDDR6 bit shipments increased more than 40% quarter-over-quarter, and we anticipate strong growth with the launch of new gaming consoles that are expected to feature 16 gigabyte of GDDR6. These new consoles also deploy SSDs in place of hard drives for the first time. +In the PC market, DRAM bit shipments and revenue declined sequentially, driven by a slow seasonal demand and continued CPU shortages. Our client SSD sales also declined sequentially. In the automotive market, we delivered record DRAM and NAND revenue despite soft global automobile unit sales as content growth remains strong in this market. +Micron continues to lead the auto market with the industry's highest quality products. Power efficiency is increasingly important in the auto market, creating an opportunity for Micron to leverage our strength in low-power DRAM. LPDRAM now makes up approximately half of our auto DRAM revenue. In the industrial market, we had record bit shipments for both DRAM and NAND. In the longer term, we expect secular growth in the industrial IoT market as 5G rolls out and increases the importance of AI, machine learning and compute at the edge. +I'll now turn it over to Dave to provide our financial results and guidance. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Sanjay. +We executed well in the fiscal second quarter, and our reported financial results largely came in at the high end of our guidance ranges despite the uncertainty and impacts related to COVID-19. Prior to the event of COVID-19, we had outlined our expectations that F Q2 would mark the low point of our financial performance in this cycle, and our business trajectory has been consistent with those expectations. While we still expect improvements in our financial results, these expectations now need to reflect the evolving impacts of COVID-19. As Sanjay said, the situation remains fluid, and we continue to assess our plans and make real-time changes to adapt and optimize our operations. +Total F Q2 revenue was approximately $4.8 billion, the high end of the guidance we provided for the quarter. Revenue was down 7% sequentially and down 18% year-over-year. F Q2 DRAM revenue was $3.1 billion, representing 64% of total revenue. DRAM revenue declined 11% sequentially and 26% year-on-year. Bit shipments were down by approximately 10% sequentially and up more than 20% on a year-on-year basis. ASPs were flat sequentially. F Q2 NAND revenue was approximately $1.5 billion or 32% of total revenue. Revenue increased 6% sequentially and was up 9% year-on-year. Bit shipments declined in the low single-digit percentage range sequentially and increased approximately 20% year-on-year. ASPs increased in the upper single-digit percentage range sequentially. +Now turning to our revenue trends by business unit. Revenue for the compute and networking business unit was approximately $2 billion, down approximately 1% sequentially and down 17% year-over-year. We have now started to include all 3D XPoint revenue in CNBU reporting as the use cases for 3D XPoint technology are more closely aligned with memory expansion, and this business is being managed by CNBU. Excluding 3D XPoint, CNBU revenue would have been down 7% sequentially, primarily driven by weaker sales in the PC market. +Revenue for the mobile business unit was $1.3 billion, down 14% sequentially and down 22% year-over-year. The sequential decline was primarily driven by seasonality in certain products as well as our decision to walk away from some business due to our concerns regarding pricing. +Revenue for the storage business unit in F Q2 was $870 million, down 10% from F Q1 and down 15% year-over-year. Without 3D XPoint, SBU revenue was up 9% sequentially. Operating profit margins for SBU improved sharply in the quarter and were at approximately breakeven levels. And finally, revenue for the embedded business unit was $696 million, down 5% sequentially and down 13% year-over-year. +The consolidated gross margin for F Q2 was 29.1%, exceeding the high end of the guidance range. The quarter-over-quarter margin improvement was driven by portfolio mix improvements and NAND pricing, and approximately $50 million of benefit came from the NAND depreciable life change we made in the prior quarter. The impact of underutilization at our Lehi Fab was approximately $142 million or 295 basis points in F Q2. We expect underutilization to be approximately $160 million in F Q3. We're continuing our efforts to reduce spending in our Lehi Fab, which we expect will begin to materialize in fiscal 2021. +Operating expenses were $856 million in F Q2. Given the increased uncertainty, we have taken additional steps to control our OpEx. These actions include freezing our near-term hiring and cutting back significantly on discretionary spending. As a result, we expect OpEx to decline sequentially in F Q3. For modeling purposes, our F Q4 will be a 14-week quarter. As a result, we expect an uptick in operating expenses for F Q4 that is consistent with the extra week in the quarter. F Q2 operating income was $542 million, representing 11% of revenue. Operating margin was nearly flat compared to the prior quarter. Net interest expense was $6 million compared to $7 million of net interest income in the prior quarter. Since the Federal Reserve has cut short-term interest rates, we anticipate lower interest income on our cash balance for F Q3. With the increased debt from the drawdown of our revolver, we expect net interest expense to be approximately $35 million in F Q3, and it will likely be modestly higher in F Q4, with a full quarter impact of the lower interest income. Our F Q2 effective tax rate was 3.2%. For the remainder of FY '20, we expect our tax rate to be approximately 5%. We expect our long-term tax rate to be in the high single-digit to low double-digit range. +Non-GAAP earnings per share in F Q2 were $0.45, down modestly from $0.48 in F Q1 and $1.71 in the year-ago quarter. +Turning to cash flows and capital spending. We generated $2 billion in cash from operations in F Q2, representing 42% of revenue. During the quarter, net capital spending was approximately $1.9 billion, up slightly quarter-over-quarter. We're continuing to project FY '20 CapEx in the range of $7 billion to $8 billion, including some increases for assembly and test flexibility that Sanjay mentioned. Free cash flow in the quarter was $63 million compared to $86 million in the prior quarter. This marks the 13th consecutive quarter of positive free cash flow. Our ability to generate cash consistently through the cycle is largely the result of the structural improvements made to Micron's profitability, which has led to more than $1.5 billion of operating cash flow improvement and more than 25 percentage points of operating cash flow improvement compared to the trough quarter of the prior cycle. We repurchased approximately 785,000 shares for $44 million in F Q2. In the first half of fiscal 2020, we returned $94 million of capital through repurchases, representing approximately 65% of our free cash flow. +Ending F Q2 inventory was $5.2 billion or 134 days. The increase was expected and largely due to the seasonally weaker demand experienced in F Q2 combined with our strategy of holding more NAND inventory as we approach our transition to replacement gate later in the calendar year. We have also increased our raw material levels as a precaution given increased uncertainty in the supply chain with these materials. As we had outlined on our prior earnings call, we continue to walk away from unfavorably priced business, which also added to our near-term inventory levels. We ended the quarter with total cash of $8.1 billion and total liquidity of approximately $10.6 billion. F Q2 ending total debt was $5.4 billion. To preserve ready access to our liquidity in a period of macroeconomic uncertainty, early this quarter, we drew $2.5 billion from our revolving credit facility. +Now turning to our outlook. Based on our conversations with our customers, the demand for our products remains strong and the pricing trends are favorable. However, it is important to note that we are a lagging indicator relative to end demand, and macro projections have significantly weakened in the near term. It is also currently unclear, the extent to which inventory builds related to COVID supply concerns might be masking weakness in end demand. In addition, we also faced the continued risk of production and logistic disruptions due to government actions, labor and material shortages and to travel and border restrictions. Given these unusual uncertainties, our guidance ranges are wider than usual. However, these wider ranges do not reflect the magnitude of all the risks, and results could vary significantly from these ranges. Our guidance ranges also include expenses for COVID-19 mitigation efforts. +With all these factors in mind, our non-GAAP guidance for F Q3 is as follows: we expect revenue to be in the range of $4.6 billion to $5.2 billion; gross margin to be in the range of 31%, plus or minus 150 basis points; and operating expenses to be approximately $825 million, plus or minus $25 million. Finally, based on a share count of approximately 1.14 billion fully diluted shares, we expect EPS to be $0.55, plus or minus $0.15. +In closing, notwithstanding the near-term uncertainty, we are pleased with Micron's financial execution exiting this cyclical downturn. F Q2 revenue was approximately 65% higher and gross margins 11 percentage points higher than in the prior trough, which occurred in F Q3 of 2016. This revenue growth far outpaced the growth of the overall semiconductor industry in this period. As we assess our cross-cycle performance from the last trough to this trough, we have delivered average returns as follows: gross margins of more than 40%, EBITDA margins of 50%, CapEx to revenue in the 30s and return on invested capital exceeding 20%. While the near-term business environment is uncertain, we believe that long-term demand trends for Micron remain robust. Our focus on execution, our strong product portfolio and our solid balance sheet ensure that Micron is in the best position to capitalize on the secular trends driving our business. +I will now turn the call over to Sanjay for closing remarks. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Thank you, Dave. +I want to close by thanking our extraordinary Micron team around the globe. These recent weeks have placed unforeseen challenges on businesses but, more importantly, on people and families. Micron's team has responded with professionalism and care during this period, and our team members are the reason we can execute our business plan and deliver the strong results we have reported today. +To assist during this period, we are offering U.S. team members earning less than $100,000 per year a special onetime payment of $1,000. These figures are adjusted for market rates worldwide, and 68% of our global team is eligible. In addition, we are establishing an emergency relief fund for employees facing financial hardship. We are also focused on assisting the communities in which we operate through this difficult time. As part of that effort, we are contributing an additional $10 million through the Micron Foundation to address the impact of COVID-19 on top of what we have already donated in China, Italy and the U.S. We are also working with local officials to make space in our facilities available if needed for emergency services as well as providing support through our supply chain operations to help source needed screening and protective equipment. Finally, we are accelerating our payment terms to our small business vendors to help with their liquidity. +I've said many times that the new Micron is stronger than ever, and we are showing that strength today. Micron is leveraging our core expertise to drive leadership in technology, products and manufacturing, delivering differentiated solutions that enrich life for end customers around the world. While the near-term environment creates uncertainty for all of us in our daily lives, the long-term fundamentals of our industry are strengthening, and opportunities are expanding. With these opportunities in front of us, we will continue to execute with tenacity and resilience as we make demonstrable progress towards our vision. +We will now open for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Joe Moore of Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [2] +-------------------------------------------------------------------------------- + + David, in the prepared remarks, you talked about inventory accumulation potentially masking weakness of customers. What -- where specifically might you have that anxiety? It seems like in compute, I think conditions are pretty strong and your customers don't seem to have a lot of this end product inventory. So when you -- is that just a precautionary remark on your side? Or is there anything you're seeing there that creates anxiety? + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [3] +-------------------------------------------------------------------------------- + + Well, we -- I mean clearly, as I said -- oh, sorry. Yes. Sure. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [4] +-------------------------------------------------------------------------------- + + So let me -- I'm sorry. I was just going to say, let me address that first, and then I will definitely have Dave expand on that. +So it is an environment where there can be supply shortages. And of course, underlying demand trends in the markets we are participating continue to be strong. There can be supply shortages given the fluid situation related to the spread of coronavirus in various countries. The rate and pace is different. And ultimately, it will depend upon the rules and regulations that different governments may impose that can potentially impact supply in the industry. +So just like we are accumulating some inventory ourselves to make sure that we don't have supply disruptions, it is legitimate to think that our customers can also be building some inventory to make sure that their supply chain is under control. So I think this is the part that we are just mindful of. Although when you look at work-from-home economy and study-from-home economy for students that are certainly driving greater demand in the enterprise PC side and certainly placing quite a bit of constraints and stress on the infrastructure, so the cloud infrastructure, the enterprise infrastructure definitely is driving increased demand as well. +So in that backdrop, I think we are just being mindful in terms of making those comments. But I will let Dave further elaborate on it. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [5] +-------------------------------------------------------------------------------- + + Yes. I think what you covered, Sanjay, is good. The only thing I'd add is I think we believe the strength in the data center market is real and that the inventory levels are normal in that market. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from Timothy Arcuri of UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [7] +-------------------------------------------------------------------------------- + + I guess, Sanjay, there was some language in the release that -- and you guys have talked about the fact that you're a lagging indicator relative to demand. Can you just help parse through that? I guess it sounds like maybe you're suggesting that the fiscal fourth quarter could be maybe down sequentially, which is typically up. I know that it's very difficult to tell what's going on right now. But maybe can you just help us walk through what the puts and takes look like into Q4? I know you don't want to guide Q4, but it sounds like it's possibly down. So can you just help us think about that? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [8] +-------------------------------------------------------------------------------- + + So certainly, as you noted, we are not guiding to Q4 here. And, of course, the environment is fluid. These are unprecedented times in terms of anybody dealing any business, any verticals or any country dealing with the situation and the spread and containment of coronavirus. But what I would say here is that with respect to our own assessment of the demand trends, I think underlying demand trends definitely continue to be healthy. And when we look at what we supply to our customers, customers build it into the product, if there has to be any macroeconomic weakness, and we know that in the environment of coronavirus pandemic, there will be some impact on some aspects of the consumer demand. The consumer demand, there's a lag between the consumer demand getting impacted to the demand from our customers who are building the product in their supply chains getting impacted. So that's what we mean that sometimes there can be a lag between what we are supplying to our customers versus the impact on the demand in the marketplace. +So we are not guiding to fourth quarter. I think what's important is that it will depend on the spread of the virus, the containment of the virus. Different countries may have their containment at different rates. So while we have seen, for example, last fiscal quarter, our F Q2, demand in China, in the consumer demand and the smartphone demand decline, we have also seen that China has contained this. And, in fact, production is coming back in China, and the demand is being restored in China. Same thing will happen in other parts of the world as well, that while there may be some impact on smartphone demand in different countries, eventually, as the containment happen, the consumer demand will be back, and the long-term trends certainly for our business are strong. The trends of 5G driving greater content in smartphone when we come back on the other side of this pandemic, there will be -- the demand drivers will reassert themselves. +Similarly, cloud demand continues to do well. As I mentioned, the COVID-19 scenario may actually be accelerating some of that demand in cloud that is driving greater demand for memory and storage. The point is, the situation is fluid, and we are really not prepared to guide you to F Q4 at this point. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from John Pitzer of Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [10] +-------------------------------------------------------------------------------- + + I'm just kind of curious, Sanjay and Dave, is it possible to quantify what the impact of COVID was in the February quarter? And more importantly, is there a number in mind for May? It's clear the uncertainty is increasing the range for the May guide, but is it also bringing down the midpoint? Any sort of guidance of how you're thinking through that would be very helpful. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [11] +-------------------------------------------------------------------------------- + + So I'll let Dave address that. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Okay. Yes. Sure. So maybe without throwing out a number because it's difficult to estimate, clearly, we would have been above the high end of the range on revenue if not for COVID-19. And there were some mitigation expenses already in both cost of sales and operating expenses that impacted us a bit in the fiscal second quarter as well. We would have likely been more skewed to a higher growth number for fiscal third quarter if not for COVID-19. And, of course, somewhat unusual for us, we widened the range by a couple of hundred million dollars also to account for the uncertainty as it relates to what might happen, not only from a demand perspective, but from a supply perspective. Either one has some risk to it. +Additionally, we have built in more costs associated with COVID mitigations for us. Sanjay and I already talked about the fact that we're carrying higher levels of inventory of raw materials, but we're also having to flex our supply chain back and have some redundancy that can drive up some expenses on the cost of sales side. In addition, we may see an increased level of tariff expense in an effort to mitigate some supply disruptions that might occur. And also, there's a fair amount of expense associated with just the work-from-home model and allow -- enabling our employees to be able to do all the work they do in the offices now in their homes, and so there are some expenses associated with that. +So our expense likely would have been down even more, particularly with all the actions we've taken to reduce expenses, if not for the fact that we have a bit of this offset or headwind associated with the mitigation expenses in the third quarter. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from C.J. Muse of Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [14] +-------------------------------------------------------------------------------- + + Great to hear that you're safe and well. I guess my question is regarding the supply side, particularly for DRAM. You talked about some issues related to equipment installation and part availability. You've also talked about switching over some of your capacity from mobility to server. So curious, as you think that through, what does bit production look like now, either for you or for the industry here in calendar '20? I think we were all thinking kind of 6% to 8% coming in. Is that still the right number? Or is there a change there? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [15] +-------------------------------------------------------------------------------- + + So I think what we have said before the COVID-19 scenario that in calendar year '20, the DRAM demand growth would be in mid-teens, around mid-teens, and that supply would be somewhat less for the year, supply growth would be somewhat less for the year than the demand growth. And of course, as we look at the scenario of supply growth, technology transitions, the node transitions in the industry perhaps can be impacted by tool deliveries or the engineering or the service support in the industry. +It's too soon to tell this but the point is that there could be some impact to supply and not just related to the wafer output, but there could be some impact to the supply, as I said before, depending upon the rules and regulations and the orders in various countries where the supply chain for memory and storage exists. If those orders impact any production, there could be some supply growth impact there as well. It's hard to tell at this point. And we certainly, when we look at our current supply growth, our current supply growth at this point is intact, but we are mindful of the changes that could occur due to the COVID environment. And of course, we continue to watch the demand as well. And on the supply side, we will take actions. +Today, we have shortages in supply, as we have mentioned, for server DRAM as well as for cloud. Overall, there are shortages for DRAM. And therefore, we are shifting some of the supplies from mobile to the DRAM side. But of course, we'll continue to keep track of what the demand looks like. And as we said, we will evaluate making reductions in our production utilization or in terms of any CapEx aspects to manage the supply growth during the calendar year '20, but it's too soon to really give you any specific projections on that. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from Mehdi Hosseini of SIG. + +-------------------------------------------------------------------------------- +Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + David or Sanjay, can you please tell me how you think of the mix of revenue from China, especially going back to what Sanjay said earlier, China is resuming operation? They're also providing a lot of incentives for 5G adoption. And I'm just curious how China accounted for your revenues in the February quarter and how you see it trending for the remainder of the year. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [18] +-------------------------------------------------------------------------------- + + So I'll let Dave answer that. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes. So I think cumulative revenues, I'll have to go back and look at the exact statistic, but it was somewhere in the kind of 30%, I think it was, China revenue in aggregate. Clearly, as you said, there is a come-back-to-work kind of phenomenon going on in China, and there is economic stimulus. So that certainly will benefit. But we're -- also the customers in the U.S. are -- a lot of them are in the cloud space. And of course, that's a big driver of our business today, given, as Sanjay mentioned, the move to work-from-home and e-commerce and so forth. So I'm not sure that the mix, as we projected, is likely to shift around significantly, geographically. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Ambrish Srivastava of BMO. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [21] +-------------------------------------------------------------------------------- + + I had a question on capacity and cost per bit. What percent of your CapEx is flexible? And I appreciate that things are in such a way that it's very hard for you to tell us how much you're going to -- you would flex. But just as a ballpark, what percentage? And then is the cost down going to change based on what you know as of now versus what you told us last quarter for both NAND and for DRAM? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [22] +-------------------------------------------------------------------------------- + + In terms of CapEx, we -- for our fiscal third quarter, we won't be impacting the CapEx of fiscal third quarter. However, for the rest of the calendar year '20, we certainly will be, as I said before, evaluating our CapEx as well as our production utilization to make sure that our supply stays in line with our demand expectations. Demand expectations, of course, we laid out, working closely with our customers. +So just like in 2019, we made changes to CapEx fairly rapidly, and we reacted fast as well as we manage our production. We will, of course, be doing the same things here. Just keep in mind that the situation with respect to coronavirus escalation across the globe just has really evolved rapidly over the course of last couple of weeks. So we will, of course, keep close tabs with our customer demand expectations. And we will make sure that we make any adjustments to our CapEx, if needed, accordingly. We are absolutely continuing to look at that. +And in terms of cost reductions, of course, cost reductions are a function of technology transitions that are being made in the fabs. And so far, we are on plan with respect to the cost guidance that we had provided to you for our fiscal year '20. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [23] +-------------------------------------------------------------------------------- + + I would add that on the NAND front, as you've seen, we've gotten a fair amount of benefit from the change in depreciation in the first half of fiscal '20. So that, in essence, kind of pulled ahead. As you remember probably, we mentioned that as we transition to replacement gate, FY '20 would show a minimal cost decline. And really FY '21 was where we would see it. But with the depreciation change, in reality, what's happening is we're kind of pulling ahead some of that improvement into fiscal '20. So when you look at the percentages, a bit better in FY '20 and maybe not as good as we had originally kind of telegraphed in FY '21. +And in addition, what -- we continue to drive this mix to the high-value solutions, they generally carry higher costs. And we hope to continue that. Our goal is to get to 80%. So that certainly will also be an impact on the cost side as well. But if you step back and then look at how we do over a multiyear period in terms of NAND improvement, once we're really running on the second-generation replacement gate, in good momentum, we're up to the right yields, it's running through the inventory and showing up in cost of sales, and you see that over a multiyear period, you'll see that our decline in costs over a multiyear period is actually very good, very healthy, very competitive. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [24] +-------------------------------------------------------------------------------- + + And I will just add that due to COVID-19, as we said, that we are enabling greater flexibility in our supply network by adding captive capacity as well as adding capacity on part of our subcontractors to give us the opportunity and resiliency in the supply chain in case there are rules and regulations in various countries that impact our production. So some of those aspects certainly do have headwind on the cost side. But by and large, I think those are being managed well. And overall, our cost targets for fiscal year '20 at this point are on track. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Rakers of Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [26] +-------------------------------------------------------------------------------- + + Congrats on the great execution. I want to go back to the customer inventory dynamics and trying to understand or appreciate how you think about that potential buildup of inventory. Can you help us understand whether you've implemented anything differently or have different lines of visibility into those customers, how you exactly plan on managing or seeing any kind of inventory build, particularly at some of the cloud customers? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [27] +-------------------------------------------------------------------------------- + + I mean we certainly work closely with those customers. Our relationships over time have only deepened with those customers. We have become a more valuable partner to them as well as we have expanded our product offering. For example, on the SSD side, we have brought out NVMe SSDs, those are getting qualified in data center. On the DRAM side, we have been a strong partner with highest quality with those customers. And on the cloud side, still in the very, very early innings of all the growth for memory and storage in cloud. So compared to the last cycle, our relationships with those customers have only expanded, have deepened. We continue to work closely with them in terms of understanding their demand requirements. And this is what -- the best that we can do in terms of working closely with those customers to understand their requirement. +And I would like to once again point out that we are in an environment even before COVID-19 that CapEx investments in cloud were on a strong growth trajectory. A lot of that CapEx going toward the infrastructure for memory and storage requirements. Of course, new CPU architectures with more cores in them as well as more channels giving you greater attach rates for memory and storage and, of course, the workloads that are demanding more DRAM memory for memory-intensive compute applications as well as for faster access driving more SSDs. So those demand trends pre-COVID were already strong. And with COVID, if anything, we are seeing that work-from-home digital economy is driving greater demand on that structure and is accelerating some of that demand. So we, of course, as we work through the memory shortages, we continue to work closely with our customers. And while the smartphone demand may be somewhat down, for example, in China in F Q2, but that demand is coming back in China. And we will continue to monitor these trends in the other parts, and it just requires continuing to work closely with the customers, understanding the requirements and us applying our own judgment and remaining mindful in terms of how we manage overall our supply. +So it's really customer relationship in terms of managing our supply growth and understanding the demand expectations. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + A strong memory demand driver in the second half of this year, as you pointed out, is the new game console refresh. I think there's 35% to 100% more GDDR DRAM memory versus prior generations platforms and the move to SSD storage versus HDD. Given your leadership in graphics DRAM, we know that the Micron team will be participating here on these new consoles. But given your good NVMe client SSD positioning, is the team also participating in the console refresh with either your NAND or your SSD products? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [30] +-------------------------------------------------------------------------------- + + Certainly, as we expand our portfolio of SSDs, yes, previously, we just had SATA. Now we have NVMe SSDs as well, and we are broadening our reach with those NVMe SSDs and to the end market applications as well as with customers. Certainly, it is a growth market opportunity for us, not only in DRAM but also in SSDs. But as you know, these take product qualifications with the customers. And then we are able to realize the benefit of sales and revenue growth in those areas. +I want to highlight here that as we have expanded our product portfolio, both on the SSD side as well as in mobile, on multichip packages, and bringing out discrete UFS products for mobile applications as well, that really has enabled, as I mentioned in the script, opportunity for us to gain share in the marketplace. We have gained share in NAND, managed NAND solutions in mobile. We have gained share in SSDs as well that's enabling us to deliver healthy results in F Q2. And our gain in share and expanding product portfolio also positions us well to navigate through these choppy waters related to COVID-19, and we remain very focused on continuing to expand the product portfolio and broaden our customer relationships in the kind of applications that you just talked about in gaming consoles, both for DRAM and NAND as we look forward to the future long-term secular demand trends and addressing those requirements by our customers. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from Mitch Steves of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [32] +-------------------------------------------------------------------------------- + + So impressive guidance there. One of the questions I did have, though, is just the offset of kind of commercial PCs coming back because obviously more people are working from home, offset by kind of the smartphone unit demand. So how are you guys thinking about that for the rest of the calendar year? Obviously, there's a lot of moving parts, but just how do you guys track kind of the lower expected sales probably from the handset type versus commercial PC upgrade from people working from home? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [33] +-------------------------------------------------------------------------------- + + So yes, that's correct. I think there is near-term surge in demand with respect to commercial PCs. I mean if you look at just Micron itself, Micron itself bought something like 5,000 notebook computers to really provide it to our team members in terms of enabling them to work from home, and we implemented those really very, very fast. So yes, surge in demand related to enterprise PCs, and that bodes well for both SSDs as well as for DRAM. And as we noted, also with respect to virtual learning and students learning from home, that also drives demand in notebook. How long this trend last -- and of course, it is global in nature. But how long does it last, we will have to see. But overall, yes, I mean, we do see that. +While there may be some smartphone -- the weakness outside of China, while China is recovering on the smartphone front, certainly, as I said, enterprise PCs and other PCs for virtual learning, along with greater demand in the data center world, is a tailwind for us. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Raji Gill of Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra S. Gill, Needham & Company, LLC, Research Division - Senior Analyst [35] +-------------------------------------------------------------------------------- + + Just another question on the demand conditions. I think David had mentioned in his prepared remarks that the macro conditions had weakened in the last couple of weeks, and you talked about some of the moving pieces of that. If we try to quantify that, the impact, DRAM is about 70% of your revenue. NAND is 30%. What percentage of DRAM is coming from PCs, hyperscalers, mobile and likewise, on the NAND side? So we can just kind of get a sense of where the potential strengths and weaknesses could be. + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [36] +-------------------------------------------------------------------------------- + + So we don't break it down specifically in terms of percentage, but I think what's important is that we are a very well-diversified supplier, and we have a broad portfolio. And the end market applications are well diversified as well, all the way from data center to PC to smartphone, networking, for DRAM, and Micron is well positioned in these markets. And certainly, some of these markets are seeing some shortages today, such as on the side of data center DRAM requirements. And while others, we are continuing to monitor the overall demand trend. But we don't break it out, but important thing is that the underlying vectors for demand are good. +And as we go through the uncertainties related to COVID-19, when we come out on the other side, I'm very confident that with our broad portfolio and deep customer engagement and the technology and product capabilities, I think we will overall do just fine. +By and large, our mix is fairly similar to the industry in terms of overall mix. If you look at the industry, I think you'll see that tablet is in the 25% to 30% range. The mobile tends to be around 25%. PC is 20%, give or take some. And of course, then is all the others, which we can call like specialty, which includes automotive, includes industrial and other applications. And that, you can -- I think were down around 20%. So I think roughly speaking, I think that's the kind of mix. And you can -- as you can see, it's well diversified across these various end market segments. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Danely of Citigroup. + +-------------------------------------------------------------------------------- +Christopher Brett Danely, Citigroup Inc, Research Division - MD & Analyst [38] +-------------------------------------------------------------------------------- + + I guess just to follow up on some other folks' questions. So you talked about the demand forecast or things changing in the last couple of weeks. Can you just give us a sense of what you've seen in the last couple of weeks? And then also for your -- sort of your forward forecasting, whether it's internal or what you're giving us, are you shaving down what your internal forecast is in anticipation of some more weakness? Or is this kind of like what we see is what we have? + +-------------------------------------------------------------------------------- +Sanjay Mehrotra, Micron Technology, Inc. - CEO, President & Director [39] +-------------------------------------------------------------------------------- + + So I think as Dave mentioned in his prepared remarks that we see strong demand and favorable price trends. But we had also seen that in China, as is well known, that during the time frame of our fiscal second quarter aligned with the COVID-19 spread in China starting from around mid-January kind of time frame, it had impacted smartphone demand in China, while it grew the demand in the cloud infrastructure in China. +So as now, over the last couple of weeks, you see the spread of coronavirus across the globe and various actions being taken in various countries to contain the spread of coronavirus. We do expect that there will be some impact on the consumer demand, but it is really too soon to quantify that. And again, having said that, we also see increasing demand coming from the cloud side as well as from enterprise PC applications. So we are seeing acceleration of demand on that front. So we are continuing to really manage that, and this is all escalating over the last couple of weeks, and we will, of course, continue to work closely with our customers to understand their increases in demand as well as their demand outlook, for example, in the consumer devices and then manage our business accordingly. + +-------------------------------------------------------------------------------- +David A. Zinsner, Micron Technology, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + The only thing I'd add is, in the prepared remarks, leading up to what I did say that pricing and demand trends were favorable, and that included all the way up until today. But of course, there's a higher degree of uncertainty, and that's kind of why we got to the range we did. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + That does end our session. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2016-Aug-11-NVDA.txt b/Transcripts/NVDA/2016-Aug-11-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad302319b6163feb59bac5d7491fcd7f8ab3ef20 --- /dev/null +++ b/Transcripts/NVDA/2016-Aug-11-NVDA.txt @@ -0,0 +1,558 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 NVIDIA Corp Earnings Call +AUGUST 11, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Arnab Chanda + NVIDIA Corporation - VP of IR + * Jen-Hsun Huang + NVIDIA Corporation - President & CEO + * Colette Kress + NVIDIA Corporation - EVP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Vijay Rakesh + Mizuho Securities - Analyst + * Steve Smigie + Raymond James - Analyst + * Harlan Sur + JPMorgan - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Steven Chin + UBS - Analyst + * Craig Ellis + B. Riley & Co. - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Mitch Steves + RBC Capital Markets - Analyst + * Kevin Cassidy + Stifel Nicolaus - Analyst + * Matt Ramsay + Canaccord Genuity - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * Ambrish Srivastava + BMO Capital Markets - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Brian Alger + Raymond James - Analyst + * Toshi Otani + TransLink Capital - Analyst + * Ian Ing + MKM Partners - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Desiree, and I will be your conference Operator today. I would like to welcome you to the NVIDIA financial results Conference Call. All lines have been placed on mute. After the speakers' remarks, there will be a question-and-answer period. +(Operator Instructions) +I will now turn the call over to Arnab Chanda, Vice President of Investor Relations at NVIDIA. You may begin your conference. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. +Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the Second Quarter of FY17. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer, and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that today's call is being Webcast live on NVIDIA's Investor Relations website. +It is also being recorded. You can hear a replay by telephone until the 18th of August, 2016. The Webcast will be available for replay up until next quarter's Conference Call to discuss Q3 financial results. +The content of today's call is NVIDIA's property. It cannot be reproduced or transcribed without our prior written consent. +During the course of this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All of our statements are made as of today, the 11th of August 2016, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find your reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Arnab. +This quarter, we introduced our new family of Pascal-based GPUs, one of our most successful launches ever. We also benefited from both the winding adoption of deep learning and our expanding engagement with hyperscale data centers around the world as they apply deep learning to all the services they provide. +Revenue continued to accelerate, rising 24% to a record $1.43 billion. We saw strong sequential and year-on-year growth across our four platforms. Gaming, professional visualization, data center, and automotive. Our business model based on driving GPU compute platforms into highly targeted markets is clearly succeeding. The GPU business was up 25% to $1.2 billion from a year ago. The Tegra processor business increased 30% to $166 million. +In Q2, our four platforms contributed nearly 89% of revenue, up from 85% a year earlier and 87% in the preceding quarter. They collectively increased 29% year-over-year. +Let's begin with our gaming platform. Gaming revenue increased 18% year on year to $781 million reflecting the success of our latest integration of Pascal-based GPUs. Demand was strong in every geographic region. +The Pascal architecture offers a number of amazing technological advances. It enables unprecedented performance and efficiencies for playing sophisticated AAA gaming titles and driving rich, immersive VR experiences. +In our most successful launch ever, we introduced four major products. They are GeForce GTX1080, 1070, and 1060 for the enthusiast market and the Titan X, the world's fastest consumer GPU for deep learning development, digital content creation, and extreme gaming. +Wired magazine called the GTX 1080 an unprecedented piece of electronic precision, one that performs Herculean feats of computational strength. Forbes called GTX1060, which brings a premium VR experience within reach of many, a fantastic product, and Hardware Canucks describes Titan X as a technological tour de force with frame rates that are simply mind-boggling. The GTX 1080, 1070, 1060, and Titan X are now in full production and available to consumers worldwide. +VR's potential is on vivid display in a new, open source game that we released during the quarter. Available on Steam, NVIDIA VR Funhouse is an open source title created with our GameWorks SDK. It integrates physical simulation into VR along with amazing graphics and precise haptics that you feel like you're actually at a carnival. +Moving to professional visualization, Quadro revenue grew to a record $214 million, up 22% year on year and up 13% sequentially. Growth came from the high end of the market for realtime rendering tools and mobile workstations. The M6000 GPU 24-gig launched earlier this year is drawing strong interest from a broad range of customers. +Digital Domain, a leading special effects studio, is using Quadro to accelerate productivity for its work on films and commercials, which requires especially tight turnaround times. Engineering giant AECOM and the Yale school of architecture are using Quadro to accelerate their design and engineering workflows. +Last month at SIGGRAPH conference, we introduced a series of new products that embed photo-realistic and immersive experience into workflows incorporating Iray a and VR. We launched the Pascal-based Quadro P6000, the most advanced workstation GPU, enabling designers to manipulate complex designs up to twice as fast as before. We demonstrated how deep learning is being brought to the realm of the industrial design to create better products faster. And, we launched eight new and updated software libraries such as VRWorks 360 video SDK which brings panoramic video to VR. +Moving to data center, revenue reached a record $151 million, more than doubling year on year and up 6% sequentially. This impressive performance reflects strong growth in supercomputing, hyperscale data centers, and grid virtualization. Interest in deep learning is surging as industries increasingly seek to harness this revolutionary technology. +Hyperscale companies remain fast adopters of deep learning. Both for training and realtime inference, particularly for natural lingual processing, video, and image analysis. Among them are Facebook, Microsoft, Amazon, Ali Baba, and Bidoo. Major cloud providers are also offering GPU computing for their customers. Microsoft Azure is now using NVIDIA's GPUs to provide computing and graphics virtualizations. +During the quarter, we began shipping Tesla P100, the world's most advanced GPU accelerator based on the Pascal architecture. Designed to accelerate deep learning training, it allows application performance to scale up to 8 GPUs using our NV link interconnect. We also announced a variant of P100 based on PCI express that makes it suitable for a wide range of accelerated servers. +At our GPU Technology Conference in April, we introduced DGX1, the world's first deep learning super computer. Equipped with eight P100s in a single box, it provides deep learning performance that is equivalent to 250 traditional servers. It comes loaded with NVIDIA software and AI application developers. +We are seeing strong interest in DGX1 from AR researchers and developers across academia, government labs, and large enterprises. Two days ago, Jen-Hsun hand-delivered the very first DGX1 production model to the open AI institute. They plan to use the system in part to build autonomous agents like chat box, cars, and robots. Broader deliveries, will commence later this quarter. +We will be talking more about deep learning later this year at regional versions of our GPU technology conference set for eight cities around the world. Among them Beijing, Amsterdam, Tokyo, and Seoul, as well as Washington DC. +Our grid graphics virtualization business more than doubled in the quarter. Adoption is accelerating across a variety of industries, particularly automotive and AEC. Among customers added this quarter was StatOil, a Norwegian Oil & Gas Company. +Finally, in automotive, revenue increased to a record $119 million, up 68% year-over-year and up 5% sequentially, driven by premium infotainment and digital cockpit features in mainstream cars. Our effort to help partners develop self-driving cars continues to accelerate. We have started to ship our drive PX2 automotive super computer to the 80-plus companies using both our hardware and DRI work software to develop autonomous driving technologies. +We remain on track to ship our autopilot solution based on the drive platform. Beyond our four platforms, our OEM and [IPA] business was $163 million, down 6% year on year in line with mainstream PC demands. Now, turning to the rest of the Income Statement, we had a record GAAP gross margins of 57.9% while non-GAAP gross margin was 58.1%. These reflect the strength of our GeForce gaming GPUs, the success of our platform approach, and strong demand for deep learning. GAAP operating expenses were $509 million, down 9% from a year earlier. Non-GAAP operating expenses were $448 million, up 6% from a year earlier. This reflects increased hiring in R&D and Marketing expenses, partially offset by lower legal fees. +GAAP operating income for the Second Quarter was $317 million compared to $76 million a year earlier. Non-GAAP operating income was $382 million, up 65%. Non-GAAP operating margins improved 680 basis points from a year ago to 26.8%. +Now, turning to the outlook for the third quarter of FY17,we expect revenue to be $1.68 billion, plus or minus 2%. Our GAAP and non-GAAP gross margins are expected to be 57.8% and 58%, respectively, plus or minus 50 basis points. +GAAP operating expenses are expected to be approximately $530 million. Non-GAAP operating expenses are expected to be approximately $465 million. GAAP and non-GAAP tax rates for the third quarter of FY17 are both expected to be 21%, plus or minus 1%. Further financial details are included in the CFO commentary and other information available on our IR website. +We will now open the call for questions. Operator, could you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Your first question comes from the line of Mark Lipacis. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [2] +-------------------------------------------------------------------------------- +Hi. Thanks for taking my questions. First question on the data center business. Can you all help us understand to what extent is the demand being driven by the deep learning applications versus the classic computationally intense design applications? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [3] +-------------------------------------------------------------------------------- +Sure, Mark. Data center -- our data center business is comprised of three basic markets as you're alluding to. One of them is high-performance computing, and one could say that or characterize it as a traditional supercomputing market, very computationally intensive. A second market is grid which is our data center virtualization, basically graphics application virtualization. You could stream and serve any PC or any PC application from data center to any client device. And, the third application is deep learning, and this is largely hyperscale data centers applying deep learning to enhance their applications to make them much smarter and much more delightful. The vast majority of the growth comes from deep learning by far, and the reason for that is because high performance computing is a relatively stable business. It's still a growing business, and I expect the high-performance computing to do quite well over the coming years. Grid is a fast-growing business. I think Colette said that it was growing 100% year-over-year, but it's from a much smaller base, and deep learning is not only significant in size, it's also growing quite substantially. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [4] +-------------------------------------------------------------------------------- +That's very helpful, thank you. And then, last question. On the new -- so, you're just starting to ship Pascal now. I guess my understanding is that historically as you're shipping a new product, the yields have opportunity for improvement, and the more volume you ship the more you climb down the yield curve. What classically happens to here on the yield? And, does that positively impact gross margins over the next three or four quarters? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [5] +-------------------------------------------------------------------------------- +Yes, so we've talked extensively about the way we prepare for new process nodes over the last several years. For long-term NVIDIA followers, you might have recalled that 40-nanometer was a very challenging node for us. And, with all of these challenges, it's an opportunity for us to improve our Company. We've implemented a very rigorous process node preparation methodology, and it starts, of course, with some of the world's best process engineers, circuit design engineers, and process readiness teams. We have a fantastic group dedicated to just getting process ready for us. +And, the second part of it is how that process readiness is integrated throughout the entire Company so I'm really proud of the way that the Company executed on Pascal. 16-nanometer finfet is no trivial task, not to mention the speed of the memories that we use. It's the world's first G5x. We also ramped the world's first HBM2 memory and 3D memory stacking. So, the number of technological challenges that we overcame in the ramp of Pascal is quite extraordinary. I'm super-proud of the team. Going forward, we are going to continue to refine yields, and that is absolutely the case. However, we came into 16-nanometer with a great deal of preparedness, and so it's too early to guess what's going to happen to yields and margins long term. But, we'll guide one quarter at a time. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Your next question comes from the line of Toshi Otani. + +-------------------------------------------------------------------------------- +Toshi Otani, TransLink Capital - Analyst [7] +-------------------------------------------------------------------------------- +Hi. Thank you for taking my questions and congrats on a very strong quarter. Your Q3 revenue guide implies further acceleration on a year-over-year basis. Are there one or two end markets where you expect outsized growth? Or, should we expect growth in the quarter to be broad-based? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [8] +-------------------------------------------------------------------------------- +Yes, Toshi. I appreciate it. We are experiencing growth in all of our businesses. Our strategy of focusing on deep learning, self-driving cars, gaming, and virtual reality where markets -- these are markets where GPU makes a very significant difference is really paying off. And, this quarter is really the first quarter where we saw growth across every single one of our businesses, and my expectation is that we're going to see growth across all of our businesses next quarter as well. But, it's driven by the focus on these key markets and away from traditional commodity components businesses. I think one particular dynamic sticks out, and it's a very significant growth driver where we have an extraordinary position in. It's deep learning. Deep learning, you may have heard is a new computing approach. It's a new computing model and requires a new computing architecture, and this is where the parallel approach of GPUs is perfectly suited. And, five years ago we started to invest in deep learning quite substantially, and we made fundamental changes and enhancements for deep learning across our entire stack of technology from the GPU architecture to the GPU design to the systems that GPUs connect into. For example, NVLink to other systems software that has been designed for it like [Kudi] and [N] and digits to all of the deep learning experts that we have now in our Company. The last five years, we've quietly invested in deep learning because we believe that the future of deep learning is so impactful to the entire software industry, the entire computer industry that we, if you will, pushed it all-in. Now, we find ourselves at the epicenter of this very important dynamic, and it is probably -- if there is one particular growth factor that is of great significance that would be deep learning. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Your next question comes from the line of Vivek Arya. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [10] +-------------------------------------------------------------------------------- +Thank you for taking my question, and congratulations on good growth and the execution. Jen-Hsun, the first question is tied to PC gaming, very strong trends. I was curious if you could quantify how much of your base has upgraded to Pascal? And, have you noticed any change in the behavior of gamers in this upgrade cycle? Whether it's the price or what part of the stack they are buying now? And, how quickly they are refreshing versus what you might have seen in the Kepler and the Maxwell cycles? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [11] +-------------------------------------------------------------------------------- +Sure. Thanks a lot, Vivek. Let's see, on PC gaming, there's a few dynamics. Our installed base represents somewhere around 80 million active GeForce users around the world. And, in fact, only about one-third has even upgraded to Maxwell, and we only started shipping Pascal half of this last quarter. And so, that gives you a sense of how much -- and Pascal is unquestionably the biggest leap we've ever made generationally in GPUs ever. It is not only high performance, it is also energy efficient, and it includes some really exciting new graphics technologies for VR and others. I think Pascal is going to be enormously successful for us, and it comes at a time when the PC gaming marketplace is also quite different than the PC gaming market five years ago. +One dynamic that's really quite powerful is that the production quality, the production content is much, much higher in video games today than ever. And, the reason for that -- I've mentioned several times in previous calls -- is that the installed base of capable game platforms that are architecturally compatible, meaning that PlayStation 4 and Xbox 1 and PCs are essentially architecturally compatible. And so, the footprint for developers has grown tremendously over previous generations. This is a dynamic that's relatively new. And so, as a result, the quality of games go up which means that the consumption of GPU capability goes up with it. I think we're absolutely seeing that dynamic. I'm super-excited about the fact that the Next-Generation game console, the big boost, the 2x boost is coming just around the corner. That's going to allow game content providers, game developers to aim even higher, and I think that that's going to support long-term expansion of our gross margins and ASPs of PC gaming. +I would say that there's some other dynamics that are quite powerful as well as you know very well which is eSports is no longer just an interest. E-Sports is a full-force global phenomenon and very powerful in Asia in just about every developing country, and of course, the western world as well. I think that on top of that, not only is VR off to a great start. We're seeing some great content now. But, some of the things that we introduced recently with Pascal, tapping into this grassroots but rather global interest in using video game as an art medium. We introduced project NVIDIA Ansel which is the world's first in-game photography system. It allows you to create virtual reality photographs, and it's just really, really amazing. And so, you could use your video game, capture your amazing moments, share it in VR, or in high resolution with all of your friends. There's a lot of different ways to enjoy games now, and the production value just continues to go up which is great for our platforms. And so, I think just to summarize your initial question, how much of the installed base has upgraded to Pascal -- very, very small, of course, because we just started production ramp. But, even then, only one-third has upgraded to Maxwell, and so there's a pretty large, pretty significant upgrade opportunity ahead of us. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Your next question comes from the line of Steven Chin. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [13] +-------------------------------------------------------------------------------- +Hi, thanks for taking my questions. Jen-Hsun, the first one if I could on the data center competitive landscape. Earlier this week, we saw one of your data center competitors make an acquisition of a smaller private Company, and I was wondering if you could talk a little bit more about how you view your position in the data center market with respect to machine learning AI? And also, how your products are positioned from the high end or low end-type of machine learning application performance? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [14] +-------------------------------------------------------------------------------- +Sure, thanks. Well, as you can imagine, we have a good pulse on the state of the industry, and we've been in this industry since the very beginning. Deep learning was really ignited when pioneering researchers around the world discovered the use of GPUs to accelerate deep learning and made a practical -- made it even practical to use deep learning as an approach for developing software. The GPU was a perfect match because the nature of the GPU is a sea of small processors, not one big processor, but a whole bunch of small processors. And, vitally, they're connected by this connecting tissue. This connecting tissue inside our processor, connecting memory, connecting fabric. That makes it possible for the processors to communicate with each other all simultaneously. That architectural innovation has been the source of our GPU computing initiative some 10 years ago. That invention has really been groundbreaking. And so, the GPU was really quite a perfect match for deep learning where neural nets are communicating neurons essentially -- inspired by neurons communicating with each other all simultaneously. And so, the GPU was really quite a perfect match. +If you look at deep learning today, five years later, I think that it's a foregone conclusion that deep learning is being infused into just about every single Internet service to make them smarter, more intelligent, more delightful to consumers. And so, you could see that the hyperscale adoption of deep learning is not only broad, it's large scale and is completely global. This new computing approach, we realized was going to be quite significant long term and so five years ago we started making quite significant investments across the entire stack of our Company. GPU computing is not just the GPU chip. It's GPU architecture, it's the GPU design. It's the GPU system. All of the algorithms that run on top of it. All of the tools that run on top of it. The frameworks -- our collaborations with researchers all over the world. And so, that collaboration and our investment has improved deep learning on GPUs dramatically in the last two generations when we started this, we were in Kepler. Maxwell was some 10 times better, and Pascal is some 10 times better than Maxwell. So, in just two generations, just five years time, we've improved deep learning by an enormous amount, and the GPU today is very unlike a GPU back in the good old days because of all of the work that we've done to it. +Our strategy -- and this is where we are different not only the focus on the GPU and the expertise in parallel computing, but where we are really different, I would say, is our singular architecture approach to deep learning. We've essentially put all of our investment behind one architecture. We make this architecture available from hyperscale to data centers to workstations to notebooks to PCs, to cars, to embedded computers, to even a brand new, fully integrated, high performance computer in a box we call DGX, the NVIDIA DGX1. So, there's so many different ways to gain access to the NVIDIA architecture, the NVIDIA platform for deep learning. +It's just literally all over the place, all around you. It's available to you in retail stores and E-tail stores from OEMs in the cloud or even universities all over the world just in embedded computer kits. So, our approach is quite singular and quite focused, and my sense is that our lead is quite substantial, and our position is very good. But, we are not sitting on our laurels as you can tell, and for the last five years, we've been investing quite significantly. And so, over the next several years, I think you're going to continue to see quite significant jumps from us as we continue to advance in this area. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Your next question comes from the line of Romit Shah. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [16] +-------------------------------------------------------------------------------- +Yes, thank you. I had a question on automotive. You mentioned that drive PX is now shipping to 80 car companies. Jen-Hsun, I'm curious, are the wins here similar in size and focused more on prototyping? Or, are there opportunities here that could ultimately translate into full production wins and drive the automotive business disproportionately? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [17] +-------------------------------------------------------------------------------- +Well, I appreciate the question. Yes, we've just started this quarter shipping drive PX2. Before I answer your question, let me tell you what drive PX2 is. Drive PX2, of course, is a processor. It's the drive PX2 version with just one single processor with just Parker and our Tegra processor. And, optionally, with discrete GPUs, you could build a car with auto-pilot capability or an AI co-pilot capability all the way to self-driving car capability. And, it was able to do sensor fusion. It was able to do SLAM, which is localization and mapping. Detection, using deep neural nets of the environment. In a surround matter, all of the cameras around the car, all feeding into the processor. And, the drive PX processor doing realtime inferencing of surround cameras. All the way to the actual planning and driving of the car -- all done in this one car computer, this one car AI super computer. +And so, this quarter, we started them shipping to all of our partners and developers so that they can start developing their software and their systems around our computer and on top of our software stack. We have the intentions of shipping in volume production many of these, and it's hard to know exactly what everybody's schedule is. But, it ranges everything from very soon to the next couple of years. And, developing a self-driving car is no -- it's a fairly significant undertaking. Nobody does it for fun surely, and the question is maybe if I could frame the question just slightly differently, do I expect people to be building OEM cars? Or, do we expect them to be building shuttles that are maybe geofenced? Do we expect them to be building trucks? And, you know how many trucks are on the road and how much of the world's economy is built around trucking products all over the world to services of basically taxi as a service. The answer is that we're working with customers and partners across that entire range from cars that are sold to trucks to vans to shuttles to services. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- +Your next question comes from the line of Craig Ellis. + +-------------------------------------------------------------------------------- +Craig Ellis, B. Riley & Co. - Analyst [19] +-------------------------------------------------------------------------------- +Yes, thanks for taking the question. The first is just a follow-up on some of the gaming strength in the quarter with the Company launching the Founders addition availability of gaming products in the quarter. Can you talk about how that went? And, for those products, how gross margins compare to just chip bait sales that would go into a gaming card OEM? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [20] +-------------------------------------------------------------------------------- +Well, first of all Founders edition -- I appreciate you asking that. Founders edition is engineered by NVIDIA, completely built by NVIDIA, and sold directly by NVIDIA and supported by NVIDIA. There's some people that -- some gamers and customers who would prefer to have a direct relationship with our Company. It's availability is limited, and it's engineered just at the highest possible level of quality. And, we limit the production of it. The reason for that is because we have a network of partners who are much, much more able to take the NVIDIA architecture to every corner of the world literally overnight. We have a fair number of partners who blanket every single country on the planet as we know, and they can provide them in different sizes and shapes and styles and different thermal solutions and different configurations and different price points. I think we believe that that diversity is one of the reasons why the NVIDIA GeForce platform is so popular, and it creates a lot of excitement in the marketplace and a lot of interesting and different diversified designs. So, I think those two strategies are harmonious with each other. But, the key point is we built the Founders edition really as a way for some customers to be able to purchase directly and have a relationship directly with us. But, largely, our strategy is to go to the market with a network of partners. As for gross margins, [the margins are the same]. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Your next question comes from the line of Matt Ramsay. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [22] +-------------------------------------------------------------------------------- +Yes, good afternoon. Thank you. Jen-Hsun, I wanted to ask a couple questions again on the data center business. The first being, we've done a little bit of work trying to estimate in our team what the long-term server attach rate for accelerators in general could be and for GPUs within that. So, it would be really interesting to hear your perspectives on that? And then, secondly, is there a market there for an APU-type product in the data center? I know you have project Denver and some other things going on from the CPU perspective, but is there a deep learning integrated CPU/GPU play that might open up more TAM long term for your Company that you are considering pursuing? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [23] +-------------------------------------------------------------------------------- +Sure. Yes, first of all, the type of work loads in the data center has really changed. Back in the good old days, it largely ran database searches, but that has changed so much. It's no longer just about text. It's no longer just about data. The vast majority of what's going through the internet and what's going through data centers today as you know very well are images. They are voice. They are increasingly and probably one of the most important new data formats is live video. +Live video, if you think about it for just a moment, it's live video. So, it doesn't stay in the server, and it doesn't get recorded which means that if you want to enjoy that live video there needs to be a fair amount of artificial intelligence capability in the data center that's running realtime on their live video so that the person that might be interested the video stream that you're streaming knows who to alert and who to invite to come and watch the live video. And so, if you think about data center traffic going forward, my sense is that the workload is going to continue to be increasingly high throughput, increasingly high multimedia content, and increasingly, of course, powered by AI and powered by deep learning. And so, I think that's number one. +The second is that the architecture of the data center is recognizably, understandably changing because the workload is changing. Deep learning is a very different workload than the workload of the past, and so the architecture -- it's a new computing model. It recognized it needs a new computing architecture, and accelerators like GPUs are really well -- a good fit. So, now the other question is how much. It's hard to say. It's hard to say how much. But, my sense is that it going to be alive, and without any predictions, it's going to be a lot more than we currently ship. I think the growth opportunity for deep learning is quite significant. I think every hyperscale data center will be GPU-accelerated. It will be GPU-accelerated for training and GPU-accelerated for inferencing. There may be other approaches, but I think using GPUs is going to be a very large part of that. +And then, lastly, APUs. I guess my sense is for data centers, energy efficiency is such a vital part and although the work load is increasingly AI and increasingly live video and multimedia where GPUs can add a lot of value. There's still a lot of workload that is CPU-centric, and you still want to have an extraordinary CPU. I don't think anybody would argue that Intel makes the world's best CPUs. It's not even close. There's not even a close second, and so I think the artfulness of and the craftsman ship of Intel CPUs is pretty hard to deny. For most data centers, if you have CPU workloads anyway, I think Intel's Xeons are hard to beat, and so that's my opinion anyway. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Your next question comes from the line of Ian Ing. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [25] +-------------------------------------------------------------------------------- +Yes, thank you. Earlier you talked about taping out all of the Pascal products at this point. Are you with three products in the market, are you ceding the sub-$250 price point for cards to competition? Or, is this something you can serve with older Maxwell product or some upcoming product? Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [26] +-------------------------------------------------------------------------------- +Thanks a lot, Ian. We have taped out. We have verified. We have ramped every Pascal GPU. That's right. However, we have not introduced every one. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Your next question comes from the line of Steve Smigie. + +-------------------------------------------------------------------------------- +Steve Smigie, Raymond James - Analyst [28] +-------------------------------------------------------------------------------- +Great, thanks a lot for the question. I just wanted to follow up a little bit on virtual reality. You had talked a little bit about investments there. I was just curious what reception you're getting at this point, and what's going to be in your mind the biggest driver getting that going? Is it more headsets? Or, more developers working on that? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [29] +-------------------------------------------------------------------------------- +Yes, Steve. I think it's all of that. We have to keep pushing VR and get the head mounts out to the world. I think ACC Vive -- they're doing a great job. Oculus is doing a great job. We track very carefully all of the head mounts that are going out there, and it's growing all time. Second, the content is really cool and people are really enjoying it. And so, we've just got to get more content, and developers all over the world are jumping on to VR. It really is a great new experience. But, it's not just games as you know. One of the areas where we have a lot of success, and we see a lot of excitement is in enterprise and industrial design, in medicine, medical imaging, and architectural engineering. +We use it ourselves. We are doing a fair amount of design of our workspace, and we render everything using our photo realistic renderer called Iray, fully accelerated by our GPUs. And then, we render it into VR, and we enjoy it, enjoy it completely in VR. And, it's something else to be inside an environment that's photo-realistic to be rendered and completely enjoying in VR. So, architectural engineering and construction is going to benefit from that. So, we see a lot of broad-based adoption of VR. +Now, one of the things that we did which was really spectacular is the multi-resolution, multi-projection renderings of Pascal. It's the world's first GPU architecture that has the ability to render into multiple projections simultaneously instead of just one, and the reason for that is because the GPU back in the good old days was designed for displaying into one display. You have one keyboard. You have one display. But, that mode of computer graphics has really changed as we moved into the world of virtual reality and all kinds of interesting different display configurations and display types. And so, multi-projection was a revolutionary approach to graphics, and Pascal introduced it. You really benefit in VR. +The second thing that we did was we integrated physics -- real world physics simulation into VR. The benefit is that without the laws of physics, as you know, you can't feel anything. Things don't collide. Things don't bounce. When you pick up something, you don't feel the haptics of it. We made the entire environment physically simulated, and so as a result, you feel the entire environment. When you tip a bottle of water over, it behaves like a bottle of water tipped over. Balls behave the way balls behave, and things don't merge into each other. That integration with haptics has completely revolutionized VR, we believe, and that's physics simulation is another thing. And so, I think our position in VR is really quite great, and I'm super-enthusiastic about the development of VR. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Your next question comes from the line of Vijay Rakesh. + +-------------------------------------------------------------------------------- +Vijay Rakesh, Mizuho Securities - Analyst [31] +-------------------------------------------------------------------------------- +Hi. Just on the data center side. Jen-Hsun, you mentioned three key segments, HBC, grid, and deep learning. What percent of mix are those for the data center? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [32] +-------------------------------------------------------------------------------- +I would say it's about 50% deep learning at the moment, and probably, call it, 35% -- one third is high performance computing. Maybe more than that. And, the rest of it is virtualization. Going forward, which is part of your question, my sense is that deep learning would become a very significant part of that. The other thing to realize is that deep learning is not just for internet Service Providers for voice recognition and image recognition and face recognition and such. Deep learning is a way of using mathematics, using software to discover insight in a huge amount of data. And, the one place where we generate a huge amount of data is high-performance computing. Every single super computing center in the world is going to be moving towards deep learning, and the reason for that is because they generate a huge amount of data that they really have very little ability to comb through -- to sort through. And now, with deep learning, they could discover really, really subtle insights in data that is hyper-dimensional. That's the way to think about deep learning is it's really mathematics. It's a new form of mathematics that is very, very powerful. It's a new approach to software. But, don't think of it as a market. I think every market is going to be a deep learning market. Every application is going to be a deep learning application, and every piece of software will be infused by AI long term. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Your next question comes from the line of Harlan Sur. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [34] +-------------------------------------------------------------------------------- +Good afternoon. Solid job on the quarterly execution. You guys had really good growth in professional visualization, record revenues. I would have thought that most of the growth was being driven by the upcoming release of the Pascal based P5000 and P6000 family. So I was sort pleasantly surprised that most of the demand was driven by your current generation M6000 family, which means obviously that the Pascal demand cycle is still ahead of you. Number one, is that a fair view? And then what's driving the strong adoption of M6000, and if you haven't already released it, when do you expect to launch the Pascal-based 5000 and 6000 family? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [35] +-------------------------------------------------------------------------------- +Yes. Thanks, Harlan. I appreciate the question. The team's been working really hard over the years to really change the way that computer aided design is done. Your observation is absolutely right, and it's coming from several different places. First of all, more and more of design is really about product design, industrial design, where the feeling of the product, the aesthetics of the product is just as important as the mechanical design of the product. And whether you're talking about a building or just a consumer product or a car, we need to be able to simulate the aesthetics of it in a photo realistic way, using real material simulations. The computational load necessary to do that is just really quite extraordinary. And we're now seeing one design package after another, whether it's [DeSo's] leading packages, Solid Work's leading packages, AutoDesk, Adobe the amount of GPU use has really, really increased and it's increasing quite dramatically. +I think partly because, finally for all of the ISVs, of all the developers, not only is the market demand for earlier views of photo realistic designs an important decision criteria. They can also rely on the fact that great GPUs are available in just about every computer. And so the pervasiveness of GPUs allows them to take advantage of the GPUs and to really trust that the software capabilities that they put into their packages, if they rely on GPUs, will have the benefits of GPUs there. +And so I think that's the virtual cycle you're starting to see in design. And so the investment that we made in the photo realistic renderings several years ago, the GPU acceleration of optics, this layer for path tracing that is used by just about every software package in the world, our continued evangelism of GPUs and its general purpose use, from computer graphics all the way to imaging, is something that I think is starting to see benefits. That's number one. +Number two, Maxwell was the most energy efficient GPU ever made, until {Pascal. Maxwell was twice the energy efficiency of Kepler, and the amazing thing is that Pascal is twice the energy efficiency of Maxwell. But Maxwell made it possible for cinema-like designs in laptops and more elegant workstations and the ability to put more horsepower, more capability into any workstation because of power concerns. Maxwell made it possible for the entire industry to uplift the level of GPU that it uses. +And I think that going forward, your last question is going forward, do we see -- how do we see Pascal? Pascal is in the process of ramping into workstations all over the world. And so I think in the coming quarters, we're going to expect to see Pascal out there. And my expectation is that the dynamics that I just described, which is software developers using more photo realistic capabilities, our inventioning of GPU accelerated photo rendering, I-ray and optics and NDL material description language, and then lastly, the energy efficiency of GPUs, those three factors combined is going to be really helpful for workstations, and then last, VR. VR is coming, and in order to really enjoy these type of applications for design, you're going to need a pretty powerful GPU at this point. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Your next question comes from the line of Ross Seymore. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [37] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for letting me ask a question. A couple for you, Jen-Hsun, on the automotive side. I guess the first part would be, we've seen in the recent months some partnerships being formed with some of your competitors and some of your customers, and we've seen some of those partnerships actually dissolve. So how does NVIDIA play in this general ecosystem in forming partnerships or not? And then the second part, if we put even just a rough year on it, when would you think the autonomous driving part of your automotive business would actually exceed the infotainment size of your automotive business? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [38] +-------------------------------------------------------------------------------- +Yes, thanks a lot, Ross. Well, we play in a graceful, friendly and open way. And I mean that rather seriously. We believe this. We believe that building an autonomous self-driving car is a pile of software and it's really complicated software. It's really, really complicated software and it's not like one company is going to do it. And it's also not logical that large, great companies who are refining their algorithms and the capabilities of their self-driving cars over the course of the next two decades can outsource to someone the self-driving car stack. We've always felt that self-driving cars is a software problem and that large companies need to be able to own their own destiny. And that's the reason why PX2 is an open stack. And it's an open platform. So that every car company can build their self-driving car on top of it. Number one. +Number two, the DRIVE PX2 architecture is scalable. And the reason for that is because automatic braking and auto pilot on a highway and a virtual co-pilot and a completely autonomous self-driving car, a self-driving truck, a geofenced autonomous shuttle, all of these, a completely autonomous taxi, all of these platforms cannot be solved by one chip. It's just not even logical. The computation necessary to do it is so diverse. The more digits of accuracy or the more digits of precision towards safety that you would like to have in dealing with all of the unexpected circumstances, the more nines you would like to have, if you will, the more computation you have to do. Just as voice recognition, the amount of computation necessary for voice recognition over the last just four or five years has increased by 100 times. But notice how precise and how accurate voice recognition has become. And image recognition, video circumstance recognition, context recognition, all of that is going to require just an enormous amount of computation. So we believe that scalable platforms is necessary, number two. +And then number three. Detection, computer vision and detection, object detection, is just one tiny sliver of the entire autonomous driving problem. It's just one tiny sliver. And we've always said that autonomous vehicles, self-driving cars, is really a AI computing problem. It's a computing problem because the processors needs not just detection, but also computation, the CPU matters, the GPU matters, the entire system architecture matters, and so the entire computation engine matters. +Number two computation is -- computing is not just a chip problem. It's largely a software problem. And the body of software necessary for the entire system software stack, if you would, the operating system of a self-driving realtime computer, realtime super computer doesn't exist. Most super computers are best effort super computers. They run a job as fast as they can until they're done. But that's not good enough for self-driving cars. This super computer has to run in real time and it has to react at the moment that it sees that there's danger in the way, and best effort doesn't cut it. You need it to be a real time super computer. And the world has never built a real time super computer before and that's what DRIVE PX2 is all about, a real time super computer for some round, autonomous AI. +And so that's the focus that we have. That's the direction that we've taken. And I think what you're seeing is that the market is starting to react to that. That maybe as they go further and further into autonomous driving, that they're discovering that the problems are related to the type of problems that we're seeing and that's the reason why DRIVE PX is a computer, not a smart camera. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +And your next question comes from the line of Joseph Moore. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [40] +-------------------------------------------------------------------------------- +Great. Thank you so much. You talk about deep learning in the hyperscale environment, but it seems like you're getting some traction as well in the enterprise environment. I know at least one IT department that we've talked to has been doing some implementation. Can you talk about your progress there and what does it take for you to build that presence within more traditional enterprises? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [41] +-------------------------------------------------------------------------------- +Well, as you know, deep learning is not just a internet service approach. Deep learning is really machine learning super charged. And deep learning is really about discovering insight in big data, in big unstructured data, in multi-dimensional data. And that's what deep learning, that's what I've called it Thor's hammer that fell from the sky. And it's amazing technology that these researchers discovered. And we were incredibly, incredibly well prepared, because GPUs is naturally parallel. And we put us in a position to really be able to contribute to this new computing revolution. +But when you think about it in the context that it's just, it's software development, it's a new method of doing software and it's a new way of discovering insight from data, what company wouldn't need it? So every medical, every life sciences company needs it. Every health care company needs it. Every energy discovery company needs it. Every E-tail, retail company needs it. Everybody has lots of data. Everybody has lots and lots of data that they own themselves. Every manufacturing company needs it. Every company that cares about security, every company that deals with a massive amount of customer data has the benefit, can benefit from deep learning. And so when you frame it in that context, I think I would say that deep learning's market opportunity is even greater in enterprises than it is in consumer internet services. +And that's exactly the reason why we built the NVIDIA DTX1. Because most of these Enterprises don't have the expertise or simply don't have the willpower to want to build a super computing data center or a high performance computer. They would rather buy an appliance, if you will, with all of the software integrated and the performance incredibly well tuned, and it comes out of a box. And that's essentially what NVIDIA DGX1 is. It's a super computer in a box and it's designed and tuned for high performance computing for deep learning. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Your next question comes from the line of Ambrish Srivastava. + +-------------------------------------------------------------------------------- +Ambrish Srivastava, BMO Capital Markets - Analyst [43] +-------------------------------------------------------------------------------- +Hello. Thank you very much for squeezing me in. I had one question on gross margin, Jen-Hsun. Very big top line guidance, but yet gross margin is guided to flat. What is the reason? And I understand it's not always perfectly correlated, margins should be going up that much, but is it pricing, is it yield? Because the mix also seems to be moving in the right direction, more [Pro Ves], more HPC and less of the OEM business. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [44] +-------------------------------------------------------------------------------- +Well, our guidance is our best estimate. And we'll know how everything turns out next quarter when we talk again. But at some high level, I would agree with you that as we move further and further and more and more into our platform approach of business, where our platform is specialized and rich with software, that increasingly the value of the product that we bring has extraordinary enterprise value, that the benefits of using it is not just measured in frames per second but real TCO for companies and real cost savings as they reduce the number of server clusters, and real increases and real boosts in their productivity. And so I think there's every reason to believe that long term, this platform approach can drive greater value. But as for the next quarter, I think let's just wait and see how it goes. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Your next question comes from the line of Rajvindra Gill. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [46] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [47] +-------------------------------------------------------------------------------- +It's Vindra. How are you? + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [48] +-------------------------------------------------------------------------------- +Exactly. Good. A question, Jen-Hsun, on the DRIVE PX2. So my understanding, as you described it, it's one scalable architecture from the cockpit to ADAS to mapping to autonomous driving. But I'm curious to see how that compares to the approach that some of your competitors are taking with respect to providing different solutions for different levels of the ADAS systems, whether it's level one, level two, level three, specifically with the V2x communication where, for level four autonomous driving, where you're going to need 6 to 20 different radar units, 3 to 6 different cameras, [lidar]. I'm trying to square how your approach is different from some of your competitors in the semiconductor space. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [49] +-------------------------------------------------------------------------------- +Yes, good question. There's no way to square and there's no reason to square, and you aren't going to find one answer. And the reason why you aren't going to find one answer is because nobody knows exactly how to get it done. We all have intuitions and we all have beliefs about how we're going to be able to ultimately solve the long-term fully autonomous vehicle, that wherever I am, the car I step into, the automotive automobile we step into, is completely autonomous, and that it has AI inside and out, and it's just an incredible experience. But we aren't there yet. +And all of these companies have slightly -- not all -- but many companies have slightly different visions of the future. Some people believe that the path to the future is fully autonomous right away in a geofenced area that has been fully mapped in advance. Some people believe that you can use it just for highway auto pilot as a first starting point and work quickly towards fully autonomy, and some people believe the best way to do that is through shuttles and trucks. So you see a lot of different visions out there. And I think all of those visions are coming from smart people doing smart things and they're targeting different aspects of transportation. +I think there's a fallacy that transportation in every single country in every single form is exactly the same. It just doesn't work that way. And so there's technology insight and then there's market insight, and there's a technology vision versus your entry point. And I think that's where all of the squaring doesn't happen. So you're solving for a simple equation that won't happen. However there's one thing that we believe absolutely will happen. We are absolutely certain that AI will be involved in this endeavor, that finally with deep learning and finally with AI that we believe we have the secret sauce necessary to break these puzzles and to solve these puzzles over a period of time. Number one. +Number two. We believe unquestionably that depending on the problem you want to solve, you need a different amount of computational capability. We believe unambiguously this is a software problem, and that for the largest of transportation companies, they need to own their own software in collaboration with you, but they aren't going to let you do it and keep it as a black box. We believe unambiguously that this is a computing problem, that this is a real time super computing problem., that it's not just about a special widget, but computation is necessary, processors, a computer system, systems software, and an enormous amount of operating system capability is necessary to build something like this. +It is a massive software problem. Otherwise, we would have done it already. And so I think you'll see this year the beginnings of a lot of some very visionary and really quite exciting introductions. But in the next year and the year after that, I think you'll see more and more and more. I think this is the beginning and we're working with some really, really amazing people to get this done. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Your next question comes from the line of Mitch Steves. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [51] +-------------------------------------------------------------------------------- +Thanks for taking my question, guys. So just circling back to the data center piece and the deep learning aspect, is there a change in ASPs you guys are seeing when you enter that market? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [52] +-------------------------------------------------------------------------------- +No. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [53] +-------------------------------------------------------------------------------- +So essentially there's going to be no margin change from the data center sales. And I guess the same question in automotive, as well. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [54] +-------------------------------------------------------------------------------- +Oh, automotive ASPs for self-driving cars will be much higher than infotainment. It's a much tougher problem. Every car in the world has infotainment. With the exception of some pioneering work or early, the best, the most leading edge cars today, almost no cars are self-driving. So I think that the technology necessary for self-driving cars is much, much more complicated than lane keeping or adaptive cruise control or first generation, first and second generation ADAS. The problem is much, much more complicated. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +Your next question comes from the line of Brian Alger. + +-------------------------------------------------------------------------------- +Brian Alger, Raymond James - Analyst [56] +-------------------------------------------------------------------------------- +Hi, guys. Thanks for squeezing me in. I think this will be the first, congrats, actually, on a pretty darn good quarter and amazing guidance. I want to come back to the difference of Pascal versus what would be otherwise competition from either Intel or AMD. There's been a fair amount of documentation talking about the power requirements or the power draw differences between Pascal versus Polaris. And one would think that while that's important in gaming and it's gotten a lot of notice, it would actually be more important for these deep learning applications that we've been talking so much about over the past half hour, 45 minutes. Can you maybe talk to that side of the design, not so much the horsepower, but maybe the power efficiency of it and what that means for when you scale it up into really big problems? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [57] +-------------------------------------------------------------------------------- +Brian, thank you very much. First of all, I appreciate your comment. The team worked really, really hard. And over the last several years, the last five years, all of the employees of NVIDIA have been pursuing a strategy that took until today, really, to show people that it really pays off and it's a very unique business model. It's a very unique approach. But I just want to congratulate all of the employees that have worked so hard to get us here. +I appreciate the comment also about energy efficiency. In fact, energy efficiency is the single most important feature of processors today and going forward. And the reason for that is because every single environment that we're in is power constrained, every single environment. Even your PC, with 750 watts or 1,000 watts, is power constrained. Because we could surely put more GPUs in there than 1,000 watts. And so that's power constrained. We're in environments where we only have one or two watts. It might be a drone and we need to be, we're completely power constrained, so energy efficiency is really, really important. We might be in a data center where we're doing deep learning and training we're training neuronets or we're inferencing neuronets. And in this particular case, although the data center has a lot of power to provision, the number of GPUs that they want to use in it is measured in tens, tens and tens of thousands. And so energy efficiency becomes the predominant issue. Energy efficiency, literally, is the most important feature of the processor. +Now from there, from there, there are functionality and architectural features, that the architectural changes that we made in Pascal so that we could stay ahead of the deep learning research work and the deep learning progress, was groundbreaking and people are starting to discover the architectural changes that we put into Pascal and it's going to make a huge difference in the next several years of deep learning. And so that's a feature and an architectural innovation. +And then lastly, of course, there's all of the software that goes on top of the processor base. We call it GPU computing instead of just GPUs, because GPU computing is about computing, it's about software, it's systems, it's about the inner relationship of our GPU with the memories and all of the memories around the system and the networking and the inter connect and storage, and it's a large scale computing problem. It is also the highest throughput computing problem on the planet, which is the reason why we've been called upon by our nation to build the world's next two fastest super computers. High throughput computing is our company's expertise. High throughput computing from fundamental architecture to chip design to system design to system software to algorithms to computational mathematics, and all of the experts in all the various fields of science, that is the great investment that we made in the last five years. And I think the results are really starting to show. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- +Your next question comes from the line of Blayne Curtis. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [59] +-------------------------------------------------------------------------------- +Hey, guys. Thanks for squeezing me in here and great execution on the quarter. Two related questions. One, Colette, just curious your view on the use of capital and buybacks. Obviously, an accelerated one, only $9 million in the last quarter. What's your view going forward? +And then Jen-Hsun, maybe a bigger question in terms of ease of capital, whether you could talk about, you said CPU is not an area that you would want to go into, but obviously GPUs have legs. So just curious, if you look around other areas, maybe in the data center, where you could also add value? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [60] +-------------------------------------------------------------------------------- +Yes, thanks, Blayne. The return of capital continues to be an important part of our shareholder value message But remember, it is still two parts of it. Part of it is still dividends and part of it has been our purchasing of stock. So as we continue to go forward, the dividend is definitely a long term perspective and we'll make sure that we can watch the dividend yield there to stay competitive and also looking at our profitability. Our share repurchase, we'll look at the opportunistic time for those repurchases and making sure that we're also doing that carefully, as well. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [61] +-------------------------------------------------------------------------------- +And long-term use of capital, I would say this, that what NVIDIA is really rich with is we're rich with vision and creativity and the courage to innovate. And that's one of the reasons why we start almost every conversation with anything by gathering our great people around the Company and seeing what kind of future we can invent for ourselves and for the world. And so I think our use of capital is nurturing the employees that we have and providing them the platform to innovate and create the conditions by which they can be successful and do their live's work. And so that's philosophically where we start. +We aren't allergic to acquisitions and purchases, and we look all the time and we have the benefit of working with and partnering with companies large and small all over the world as we move the industry forward. So we're surely open to that. But our natural posture is always to invest in our people and invest in our own company's ability to invent the future. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +Your next question comes from the line of C.J. Muse. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [63] +-------------------------------------------------------------------------------- +Good afternoon. Thank you for squeezing me in. I guess, two quick questions. The first one, thank you for breaking out deep learning as a percentage of the data center. Can you provide what that percentage was for the April quarter? And then the follow-up question is if I look back over the last four quarters and I look at your implied guide, you're looking at roughly 50% incremental operating margin. And curious if that's the right number you would underwrite here, or should we be thinking about improving mix, as well as maturing process and manufacturing at your foundry partners such that that could actually be higher as we look ahead? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [64] +-------------------------------------------------------------------------------- +Yes, deep learning is a software approach, a new computing architecture, a new computing approach that the industry, that researchers have been developing for 20 years. And it was only until five years ago when pioneer work was done on deep learning and on GPUs that really turbo charged it and gave the industry, if you will, a time machine that brought the future to the present. And the power of deep learning is so great that this capability is expanding and people are discovering more ways to use it and more applications and new deep learning architectures, and the networks are getting bigger and deeper and more complicated. And so I think that this area, this area is going to grow quite significantly. It represents a vast majority of our data center revenues recently, and my sense is that it's going to continue to be a significant part of it. +So what was the second question? Did I miss it? I think his question was really about data centers and deep learning, right? What's that? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [65] +-------------------------------------------------------------------------------- +I think your question was regarding deep learning and the percentage of data center and how that has moved. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [66] +-------------------------------------------------------------------------------- +Yes, and it's the vast majority. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- +And your next question comes from the line of Kevin Cassidy. + +-------------------------------------------------------------------------------- +Kevin Cassidy, Stifel Nicolaus - Analyst [68] +-------------------------------------------------------------------------------- +Thanks for taking my question. Maybe I'll go to the other end of the spectrum and speaking of energy efficiency. Are you finding new opportunities for Tegra, aside from the infotainment in automotive? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [69] +-------------------------------------------------------------------------------- +Kevin, I appreciate the question. Tegra is at the core of all of our self-driving car initiatives. And so without Tegra, there would be no self-driving cars. So Tegra is the core of our self-driving car initiative, the computing platform for self-driving cars. And DRIVE PX2 includes Tegra, as well as discrete GPUs of Pascal, but the core of it, the vast majority of the heavy lifting is done by Tegra, and we expect that going forward. And so Tegra is incredibly important to us. +Tegra is also the core of the processor of Jetson. Jetson is a platform that is designed for other embedded autonomous and intelligent machines. And so you could imagine what kind of intelligent machines in the future will benefit from deep learning and AI, but robotics and drones and embedded applications inside buildings and cities. There are all kinds of applications. I'm very, very optimistic about the future of Jetson, but at the core of that is also Tegra. So think of Tegra as our computer on a chip, and it's our AI computer on a chip. +Okay, may I -- I appreciate all the questions. Thank you all for joining us today. Our growth is really driven by several factors. Our focus on deep learning, self-driving cars, gaming, and VR, markets where GPU has been vital, is really starting to pay off. The second factor is that Pascal is the most advanced GPU ever created and we're incredibly excited about it. And we, this last quarter, we ramped it with enormous success. And I'm so proud of the team for all of the preparation and the executions last quarter. And the third is hyper scale adoption of deep learning is now widespread, is large scale and we're seeing it globally. Those are the several growth drivers ahead of us. +As we go forward, we're also looking to sharing our many developments in deep learning AI with you. We're really just in the beginning of seeing the actual growth of deep learning as we scale out into the market. Deep learning adoption is now widespread and is ramping at every hyper scale data center. It's a new computing model that requires a new computing architecture, one that GPU is perfectly suited for. And the thing that we've done that I'm really delighted with is the strategy that started five years ago to optimize our GPU computing platform from end-to-end and optimize it for deep learning, at the processor level, at the architecture level, at the chip design level, systems and software and algorithms and a richness of deep learning experts at the Company, and the collaboration we have all over the world with researchers and developers has made it possible for us to continue to advance this field and this platform. +And as a result of that our deep learning platform improved far more than anybody would have expected. If you just projected it based on semiconductor physics, it would be nowhere near the level of speed up and step up that we got from generation to generation, from Kepler to Maxwell, we got 10x, from Maxwell to Pascal, we got another 10x. And you can surely expect pretty substantial improvements and increases from us over the next several years. +Where we really shine is not only as a fantastic platform for deep learning and the training of the networks, but it's also a fantastic platform to scale out. You can enjoy our platform, whether it's in cloud or in data center or in super computers and workstations and desk side PCs and notebook computers to cars to embedded computers, as I mentioned just now with Jetson. This is a one singular architecture approach, so the thoughtfulness and the care of the investment of the developers and the software programmers and researchers is really our preeminent concern. And as we know, computing is about architecture and computing is about platform, and mostly, computing is about developers. And we've been quite thoughtful about the importance it is to developers. And as a result, developers all over the world, all over the industry, can use this singular architecture and get the benefits of their science and their applications as they scale and deploy their work. +So that's it. We had a great quarter and I look forward to reporting our progress next quarter. Thank you all for joining us. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2016-Feb-17-NVDA.txt b/Transcripts/NVDA/2016-Feb-17-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..8f39386c73fec2711e7ed7982dceaff2567a032b --- /dev/null +++ b/Transcripts/NVDA/2016-Feb-17-NVDA.txt @@ -0,0 +1,560 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 NVIDIA Corp Earnings Call +FEBRUARY 17, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Arnab Chanda + NVIDIA Corporation - VP of IR + * Jen-Hsun Huang + NVIDIA Corporation - President & CEO + * Colette Kress + NVIDIA Corporation - EVP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Deepon Nag + Macquarie Capital - Analyst + * Harlan Sur + JPMorgan - Analyst + * Hans Mosesmann + Raymond James & Associates - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Steven Chin + UBS - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Gabriel Ho + BMO Capital Markets - Analyst + * Matt Ramsay + Canaccord Genuity - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Rajvindra Gill + Needham & Company - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Sanjay Chaurasia + Nomura Securities - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Chris Rolland + FBR & Company - Analyst + * Chris Hemmelgarn + Barclays Capital - Analyst + * Brian Alger + Roth Capital Partners - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Ash, and I will be your conference operator today. I would like to welcome you to the NVIDIA financial results conference call. +(Operator Instructions) +I will now turn the call over to Arnab Chanda, Vice President of Investor Relations at NVIDIA. You may begin your conference. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for fourth quarter of 2016. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that today's call is being webcast live on NVIDIA's Investor Relations website. It is also being recorded. You can hear a replay by telephone until the 24th of February 2016. The webcast will be available for replay up until next quarter's conference call to discuss Q1 financial results. The content of today's call is NVIDIA's property. It cannot be reproduced or transcribed without our prior written consent. +During the course of this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, the 17th of February 2016, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO Commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Arnab. +Revenue reached a record in the fourth quarter, totaling $1.4 billion, up 12% from a year earlier, up 7% sequentially, and above our outlook of $1.3 billion. Our full-year revenue crossed above $5 billion to a record $5.01 billion, which was up 7% from the previous year. Quarterly growth was broad-based, with expansion across each of our four market platforms -- gaming, professional visualization, datacenter and automotive. +Pacing gains were our GTX gaming platform, our datacenter platform, powered by deep learning, growing adoption and automotive. Viewed from a reporting segment perspective, Q4 GP revenue grew 10% to $1.18 billion from a year earlier. Tegra Processor revenue was up 40% to $157 million. NVIDIA's strategy remains sharply focused on creating platforms for our key markets. Our progress stems from our success in creating strong products that are targeted at growth markets. In Q4, our four market platforms contributed more than 85% of revenue, up from 78% a year earlier. Our growth platforms collectively increased 23% year over year. +First let's start with our gaming platform. Gaming revenue grossed 25% year on year to $810 million, with good momentum carrying forward from the previous quarter. Maxwell-based GeForce GTX processors continue to lead our gaming growth, combined with growing anticipation for VR and the launch of holiday blockbuster games. The GeForce GTX 970 GPU stands as the world's most popular graphics card on the Steam gaming platform. And we continue to get strong traction with our GeForce GTX GPUs that power gaming notebooks. That includes the recently launched GTX 980 for notebooks, which has enabled a new category -- enthusiast-class VR-capable gaming notebooks. +Excitement is growing around VR gaming, a key theme of last month's Consumer Electronics Show. We unveiled there our GeForce GTX VR Ready program to help gamers choose the best hardware for an immersive VR experience. And Oculus, which has now opened pre-orders for the Rift headsets, has exclusively certified GeForce GTX systems as being ready for VR. +GeForce sales are driven by the launch of great gaming titles, and that again proved true this past holiday season. Fallout 4 was among the standouts, recording more than $750 million in sales in its first 24 hours. Other major hits were Star Wars Battlefront, Call of Duty: Black Ops 3 and Rainbow Six. We remain pleased with the continued success of GeForce Experience, our gaming platform that automatically optimizes your PC settings for each game and downloads the greatest game-ready drivers. At the end of January, just 2.5 years after its introduction, GeForce Experience subscribers stood at $76 million, up 37% on the year. +Moving to professional visualization. Quadro revenue increased 7%, both sequentially and year over year, to $203 million. The refresh cycle of workstations continued to improve during the quarter, driven in part by new workstation configurations in the market. While VR is often portrayed as a consumer play, we are also excited by its potential in enterprise, particularly in areas such as medicine, architecture, education, and product design. +Audi now has 20 virtual showrooms, with several hundred expected later this year, that lets customers experience new models, customize them in real-time, and take them for a virtual spin. In a very different application, a startup called Surgical Theater uses flight simulator technology and multiple GPUs to allow surgeons to use VR to fly through a patient's anatomy and rehearse complicated procedures before making the first cut. +In datacenter, inclusive of Tesla and GRID, revenue rose 18% sequentially to a record $97 million, up 10% year on year. This reflects the extraordinary rise of deep learning, a field in which we are now engaged with nearly 3,500 companies and organizations, as well as growth in the number of high-performance computing applications that are GPU-accelerated. During the quarter, we launched key products for this market. And a number of the partners provided updates to their own work in this area that underscores the central role of the accelerated GPU platform. +A key development came during November's Supercomputing 2015 Conference, with the release of the latest list of the worlds top 500 fastest supercomputers. It showed that more than 100 of these systems are now using accelerators. Two-thirds of these use NVIDIA accelerators, up 50% on the year. For hyper-scaled datacenters, we announced a platform that lets web services companies accelerate machine learning. It consists of both the NVIDIA Tesla M40, the most powerful accelerator designed for training deep [nolla] networks, and the NVIDIA Tesla M4, a low-power small form-factor accelerator for machine learning inference. +Web services companies have enthusiastically embraced this trend. Shortly after our hyper-scale announcement, Facebook disclosed that it will use the Tesla M40s to power its next-generation computing system for machine learning applications. And earlier this month, AliCloud, Alibaba's cloud computing business, announced it will work with us to promote China's first GPU-accelerated, cloud-based, high-performance computing platform. +They joined other web services giants embracing GPUs for machine learning. During the quarter, Google outsourced its TantraFlow deep learning framework, which can be accelerated on GPUs. Microsoft Computational Network Toolkit was integrated with Azure's GPU Lab, enabling neural nets for speech recognition that are up to 10 times faster than their predecessors. And IBM revealed that its Watson systems are now using GPUs. +Progress continues to be made in our GRID virtualization platform, which enables companies to deliver graphs-rich applications to employees on any device, anywhere. More than 100 companies are participating in an accelerated deployment program. +Turning to automotive. Automotive revenue was a record $93 million, up 18% sequentially, and up 68% year over year. One of the biggest stories at CES was the introduction of our NVIDIA DRIVE PX 2 self-driving car platform, which utilizes artificial intelligence to address the profoundly complex challenge of autonomous driving. As many of you saw, DRIVE PX 2 is a supercomputing platform the size of a lunchbox that processes 24 trillion deep learning operations a second, and delivers 8 teraflops of processing power, equivalent to that of 150 [metso pros]. +It is a flexible platform that automotive developers can scale from one to four processors. And it can utilize passive cooling or integrate seamlessly with the water-cooling systems of self-driving EVs. Capable of fusing data from cameras, lidar, radar and ultrasonic sensors, it creates a full 360-degree understanding of what is happening around the vehicle. It localizes the vehicle on an HD map, and it determines a safe path forward for using deep learning techniques. +Volvo, well-known for its safety and reliability, will be the first to develop DRIVE PX 2, using it as the brain force fleet of 100 self-driving cars to be publicly available next year in its hometown of Gothenburg, Sweden. Just a couple weeks ago, the first autonomous shuttle, the WEpod, incorporating our deep learning platform, took its inaugural trip on public roads in the Netherlands, where it can be summoned with a smart phone app. +The DRIVE PX 2 launch generated enormous interest around the world from car makers, Tier 1 suppliers, and others. We are now collaborating with more than 70 companies that are developing self-driving car technologies. Finally, our OEM and IP business was $198 million, up 3% sequentially, driven by the seasonal demand for notebooks. +Now turning to the rest of the income statement. GAAP quarterly gross margin was 56.5%. Non-GAAP gross margin was a record 57.2%, slightly above our outlook. GAAP and non-GAAP gross margins increased from a year ago. GAAP operating expenses for the fourth quarter were $539 million, inclusive of $34 million of restructuring and other charges. Non-GAAP operating expenses, including litigation charges, were $445 million, in line with our outlook. +For full FY16, our non-GAAP operating expenses were $1.72 billion, including litigation costs. Our focus on rigorous execution and enhancing efficiencies enabled our core operating expenses to remain flat from FY15, as we focused on expanding operating margins. GAAP operating income for the fourth quarter was $252 million. Non-GAAP operating income was $356 million, up 26% from $283 million a year earlier. +GAAP net income was $207 million. GAAP earnings per diluted share were $0.35, including $0.04 of restructuring and other charges. Non-GAAP net income was $297 million. Non-GAAP earnings per diluted share were $0.52, an increase of 21% year over year. +Now turning to some key balance sheet items. At the end of Q4, our cash and marketable securities balance was just over $5 billion. During the quarter, we paid $62 million in cash dividends, and we closed our accelerated repurchasing agreement with an additional 4.3 million shares returned. As a result, we have turned to shareholders an aggregate of $800 million in FY16, meeting our intention we communicated at the start of the fiscal year. Over the past four years, we've returned more than $3 billion to shareholders representing 98% of our free cash flow. As part of our ongoing commitment to deliver shareholder value through capital return, our intention is to return $1 billion in FY17 through quarterly cash dividends and share repurchases. +For FY16, revenue reached a record $5 billion, up 7%. Our growth platforms increased 26% year on year. Non-GAAP gross margin was a record 56.8%, up 100 basis points on the year. Non-GAAP operating income grew 18% to $1.13 billion, with operating margin expansion up more than 200 basis points to 22.5%. Non-GAAP EPS grew 18%. +Now turning to the outlook for the first quarter of FY17. We remain excited about our business prospects. Gaming remains strong and eSports, VR, and new exciting games will lift it further. GP-accelerated datacenters are expanding in both HPC and cloud, driven by the growth of deep learning. And autonomous driving continues to move forward. We have excellent positions in each of these growth markets. +We expect revenue for the first quarter of 2017 to be $1.26 billion, plus or minus 2%. Our GAAP and non-GAAP gross margins are expected to be 57.2% and 57.5%, respectively, plus or minus 50 basis points. GAAP operating expenses are expected be approximately $500 million. Non-GAAP operating expenses are expected to be approximately $445 million. GAAP and non-GAAP tax rates for the first quarter of FY17 are both expected to be 19%, plus or minus 1%. Further financial details, including the CFO Commentary and revenue by market platforms are available on our IR website. +We will now open the call for questions. We ask you that you limit your questions to just two. Ash, would you please poll for questions at this time? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Certainly. Our first question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking my question, and congrats on the very good growth and execution. My first question, Jen-Hsun, is on the gaming segment. For the last two years, it has grown at over 30% a year. I don't know many other multi-billion-dollar businesses and semis that are growing at this pace. The question really is, how sustainable is this growth? +I understand the drivers. But could you help us ballpark that going forward over the next two or three years? Do you think of this as a 10%, 15%, 5% growth opportunity? Any guidance there would be extremely helpful. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [3] +-------------------------------------------------------------------------------- +Yes, thanks a lot, Vivek. First of all, I think you captured the essence of it in your question. GeForce is really not a chip business anymore; it is really a gaming platform business. When you think about it from a gaming platform business, it has to be thought of in the context of the low gaming ecosystem and the gaming industry. It is $100 billion large. When you think about it that way and you drive the business that way and you create value that way, I think the prospects for our growth there is still quite significant. +There are several different ways we can grow the market. First of all, when we introduce new game platforms -- and this last couple of years, we've introduced Maxwell, it's the most successful gaming platform we have ever introduced. The installed base of about 100 million GeForce gamers in the world has an opportunity to upgrade to a new platform. +Another reason why we can grow is because the production value continues to increase, the graphics richness continues to increase. And we do that by inspiring the industry, providing a technology that helps it include our technology in a much easier way. And the way that we do that is called GameWorks. +All the physical simulations, all of the visual simulations, all the lighting simulations and all of the things that makes games beautiful today are easy to include by just supporting GameWorks. It has been an enormous success for us. +And of course, developing companies are still doing incredibly well. There are many countries around the world that are just starting to get into PC gaming. Southeast Asia is growing incredibly. And then not to mention that gaming is no longer just gaming. Gaming is all about sports now. +But we're starting to see a new culture and a new dynamic in gaming even beyond that. It's really becoming a platform by which people could share, and a platform by which they could artistically express themselves. If you look at some of these games today, it's something you enjoy well-beyond just playing the game. You use the game as an editor to tell stories. +And so these games like GTA 5, it's just fantastic for telling stories. And so you can see now that the gaming platform is going beyond games, it's going beyond sports, and now it is a creative platform. So there are just all these wonderful ways that the game industry has continued to be vibrant. And my sense is that we're going to continue to grow with it. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- +Got it. And as a follow-up, Jen-Hsun, on your automotive business, as you move from entertainment systems that are graphics-intensive to more advanced computing systems, do you think it changes the competitive environment? And what I am referring to is, we have seen Qualcomm and others enter the segment, and they are making the case they can integrate a lot of different [piece] parts and tie back to their processor. And I'm trying to draw a parallel with what you had on the smartphone side, where you were specializing in one part, but others could integrate other parts and become more successful. +Is there going to be a similar situation in orders? Or do you think we should read it in a different way as to how your competitive situation can evolve in orders as computing becomes a bigger part of the application? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [5] +-------------------------------------------------------------------------------- +Well, we have to be mindful of competition. And there's a lot of ways to compete, there's a lot of different ways to bring value. And surely what you describe is one way to compete. Those aren't really the segments in a market that we'll address. +The way we think about infotainment is, there are segments of the infotainment market -- surely the parts of the market that we serve incredibly well -- with the richness of the displays, the number of the displays. And how the displays are going to be used in the coming years are going to continue to expand. You know that display costs are coming down, and outlet displays are becoming cheaper. +There are so many different ways to bring visualization into the car, to enhance the driving experience. You can also imagine how artificial intelligence technology can change the way infotainment systems are even used. One of our strategies of course, is to bring artificial intelligence technology to enhance how the driver communicates with the car. So there is all kinds of new technologies that we're going to deploy into the infotainment system, leveraging our expertise in deep learning. +The part of the market that you are starting to talk about is the segment of the market that we really introduced into the marketplace, which is the autonomous driving computer. We started talking about it several years ago -- I think it was like three years ago, at CES, when I introduced the DRIVE PX. Where we imagined that in the future, a car would also have a supercomputer inside that is powered by deep learning, that is powered by artificial intelligence. And that takes in the sensor input continuously from the car, what's surrounding the car. And infer from it the appropriate thing to do. +That vision three years ago seemed a little bit, if you will, outer space. But I think that it is very clear now that the technology that we are bringing to bear, deep learning, is really the best approach for helping car companies go beyond ADAS, which is going to be a commodity in the coming years, as you can imagine. Go beyond ADAS, and move towards assisted driving to full autonomous driving. So I think that we can add a lot of value there. +PX2 was really invented to allow OEMs to scale that entire range, from assisted driving all the way to fully assisted driving. And that is one of the reasons why we can support one chip all the way up to four chips, from passive cooling all the way up to integrating directly into the self-driving EV water-cooling system, that is quite available for most EV cars with liquid cooling. So I think that our strategy there is going to work out quite well. We add a lot of value. It is very algorithm-rich, it's very software-rich. And I think our DRIVE PX platforms is really quite state-of-the-art. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- +Our next question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [7] +-------------------------------------------------------------------------------- +Thank you for taking my questions. The first question, on the TDS business, how -- I'm sorry, the Tegra development services, you noted that, that was an important driver of growth. Can you give us a little bit more color on that business? How big is that? What end markets are you working with? What are you helping customers do? Can you hear me? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [8] +-------------------------------------------------------------------------------- +Actually, I'm just trying to figure out what your question was. Let me see. I guess I'd be reluctant to announce anything today, but there are semi-custom businesses that people need our help on. And we are open for business to help select partners develop proprietary systems that leverages the wealth of technologies that we have, whether it is in visual computing or deep learning or supercomputing. +So we can create systems and products and services that the world has never had before. That's an area that I think is of interest to us. It's an area that we will likely see a lot more success in the future. But there is not much to really announce today. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [9] +-------------------------------------------------------------------------------- +Okay, fair enough. And second question on the gross margins. They've gone over the last three years from the low-50%s, pushing through 57% now. At what point do these [asset tow out]? How should we be thinking about that? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [10] +-------------------------------------------------------------------------------- +I appreciate that question. There are a lot of moving parts in our gross margins. Of course, our enterprise business is richer in gross margins. Our consumer business tends to be lower in gross margins. But at the highest level, the way I would think of our Company's gross margins, it's the nature of our business model is changing. +If you think about our business model, a long time ago, it used to be a chip business, but today we are a differentiated specialty platform business. What I mean by platform business is, it's of course the chips, the systems, but it's largely about the differentiated software that's on top of it. +So increasingly, you're going to find that our business is software-rich, it's services-rich. And if that is the case, one would think that our business model would become increasingly of that nature. And I think you're just seeing the reflection of that. +As our Company continues to move towards our differentiated platforms -- which was, call it, 50% just a few years ago, and is now reaching some 80% now -- as we move into these specialty differentiated platforms, the software content is just much, much higher. And our customers who work with us are not buying chips for their systems, for their commodity systems, but they are looking for a platform to solve a particular problem. And the problems that we would help solve, the solution that we bring to bear, is so high-valued, that I think that increasingly you should expect that -- well, you should hope, and I hope myself, that our gross margins continue to move along with the change in our business model. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Our next question comes from the line of Hans Mosesmann with Raymond James. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates - Analyst [12] +-------------------------------------------------------------------------------- +Great, thanks, and congratulations, guys. Jen-Hsun, can you give us an update on the high-performance compute side of the business? How will Pascal compare to the upcoming other solutions in the market, specifically Intel's Knights Landing? And I have a follow-up. Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [13] +-------------------------------------------------------------------------------- +Yes, Hans, thank you. Our high-performance computing business uses an architecture we call accelerated computing. Accelerated computing is a model of computing that we invented almost 10 years ago. It's a very unique way of computing, and it takes advantage of the strength of the CPU, as well as the advantage of the world's most parallel processor, called the GPU. It is very software-intensive, it is very mathematics-intensive, it's very algorithm-intensive. +It's a problem that, when applied to some verticals, can accelerate computing dramatically. We see accelerations of 5x, 10x, 20x, quite normally, quite regularly. And the way that you translate this benefit to a customer is that it reduces their costs. Instead of building a supercomputer that may cost as much as $500 million, this supercomputer would be the world's best at $100 million. +That's a pretty substantial reduction in expenses. The power-build that they would spend on a regular basis would be dramatically reduced. So datacenters and supercomputing centers save an enormous amount of money. +On the other hand, the researchers see a substantial boost in their application throughput. So that is one of the reasons why accelerated computing is doing really well. We are seeing a couple of different drivers for accelerated computing and high-performance computing. Our datacenter business -- accelerated computing itself for supercomputing applications, whether it is weather simulation or molecular dynamic simulation -- continues to grow. +The killer app that we are starting to see -- and we have been cultivating for several years now, and it's now really turning the corner and going into turbo-charge and growth -- is deep learning. Almost in every field of science, as well as for web services companies, artificial intelligence helps them wade through, comb through just massive mounds and oceans of data to discover insight. So deep learning and using artificial intelligence technology across all fields of science -- I'm super-excited about the work that's going to be done in medicine. It's really going to see some great adoption. +I think we mentioned that in just a couple of years ago, we had 100 companies working with us in the area of deep learning, and now it has ballooned to 3,500. That is quite a large-scale growth. It is in industries all the way from life sciences to supercomputing of course, to web services of course, to even industrial. And the application for industrial would be Internet of Things. All of these sensors all around the world collecting data needs artificial intelligence software, deep learning software, to review insights. +In terms of our positioning relative to the competition, this is an area that we have a real advantage, and we have a real advantage for several reasons. The incremental cost to our Company, the incremental cost of engineering accelerated computing into our normal course of running our GPU business, GeForce business, is incremental. So the system, entire system, the 10,000 people in our Company, can quite easily, if you will, continue this rhythm. And quite a high-velocity rhythm, of bringing out new GPUs that are great for accelerated computing and great for gaming of course, and great for workstations. +And it's a natural course of doing work. This is not an adjunct business to us. This is our core business. At the core, that is our fundamental advantage, that it's a singular motion, singular execution, singular investment, singular architecture, incredibly leveraged, and the execution, as a result, is just absolutely flawless. So I think in the end that, that's our greatest advantage. + +-------------------------------------------------------------------------------- +Hans Mosesmann, Raymond James & Associates - Analyst [14] +-------------------------------------------------------------------------------- +Very helpful, thanks, Jen-Shun. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [15] +-------------------------------------------------------------------------------- +Absolutely. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Our next question comes from the line of Ambrish Srivastava with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- +Hi, this is Gabriel Ho calling in for Ambrish. Thanks for taking my question. I want to follow up on your Tesla business. I think in a recent earnings call, Cray actually reiterated its expectation of over 50% of this $25 million revenue in the fourth quarter of this calendar year. And I think they cited DRIVE as one of three supercomputers that actually use Pascal. So how should we think about the benefit to your Tesla business? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [18] +-------------------------------------------------------------------------------- +Well, Cray is a very important partner of ours. The thing that is really exciting for me, is to see them transition their business -- not transition, but transform their business, from one that is really focused on supercomputing centers to one that is also working on big data. This is an area where we can add a lot of value to them. We have a lot of expertise in this area. +And as they continue to evolve their market footprint beyond supercomputing centers and now into large enterprises, I think they can find a lot of success. They are seeing a lot of this success in this area. Big data analytics is square in their bull's eye, and I'm quite excited for them in the work that they are doing there. They are good customer for us, a great partner of ours and I'm excited to see their ongoing success. +The thing we are all seeing is that big-data analytics, the most powerful weapon for big-data analytics has recently been discovered. Deep learning is just a fantastic new computing model. It is able to discover insight that is provably now superhuman. +Its dimensionality in thinking through data is unrivaled in any approach that we have learned in the past. And that's one of the reasons why industries all over the world, from life sciences to industry to manufacturing to supercomputing, are jumping on the deep learning bandwagon. I think their adoption of Tesla, the NVIDIA GPU, is going to be quite a success for them. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [19] +-------------------------------------------------------------------------------- +Thanks. As a follow-up, [your spend] seems to spend about $90 million in legal expense. How should we think about in FY17? And also, and can you give an update where you are in the case of [Qualcomm] and Samsung? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [20] +-------------------------------------------------------------------------------- +Just as a backdrop, we litigated against Samsung last year. The expenses was what you are referring to. At the core of it, fundamentally, philosophically, we believe that it is inappropriate and it's wrong for Samsung to use NVIDIA's technology -- technology that has cost us billions of dollars to invent and use it without compensating us. At the core, I just think that is just wrong. And we think it's wrong, and that's the reason why we decided to litigate to sue Samsung. + The ITC has passed it's early decisions, and we disagree with them, we are disappointed by them. It's unfortunate that the business courts couldn't see through the obviously complex data associated with the technology. But we are disappointed by it. We have appealed for a review, and hopefully, in the near term, we will discover what the ITC will do. +But I still believe that it was the wrong thing to do, for Samsung to use technology that companies who are specialized in these fields invent, and to use it without compensation. And I'm disappointed with the decision from the ITC, but so be it. +Next year, we have plenty of things to go invest in, and we have plenty of growth drivers. You know that we have four powerful growth drivers in our Company. Gaming is one, VR is another, artificial intelligence and self-driving cars. And we have plenty of growth drivers to go focus our Company on. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Our next question comes from the line of C.J. Muse with Evercore ISI. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [22] +-------------------------------------------------------------------------------- +Good afternoon, thank you for taking my first question. I guess first question, on the auto side. I'm trying to get my arms around how we should think about growth year in calendar 2016 off this 75% growth in 2015. If you could parse between your backlog for infotainment and your outlook there, as well as what kind of ramp you see with product development contracts on the ADAS side? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [23] +-------------------------------------------------------------------------------- +Two questions there. First of all, our pipeline. We've talked about our pipeline several times. We've shipped probably 5 million, 6 million cars. We have another 20 million, 25 million cars to ship in our pipeline. So these are design wins that took quite a few years to have won, and quite a few years of engineering to ramp into production. +So we have a pretty good visibility of the pipeline and the opportunities that are ahead of us. Probably there is some market dynamics that's helpful to some of the design wins, the segments that we serve. Of course, at the time, a long time ago, it's hard to tell. But it's very clear now that the computerization of cars is a highly desirable end-user feature. +The partners that we worked with, the car companies we worked with, to computerize their cars, whether it is Audi or Tesla, whose cars are heavily computerized. Their growth prospects in the coming years are quite good. So I think that's one. We have a clear view of the pipeline, and I think the mega-trends of the computerization of cars is in our favor. +Now you mention -- secondarily, we introduced this platform called DRIVE PX. It is our economist-driving car computer platform. And the recent success of ADAS has really inspired just about every car company in the world to look beyond ADAS and what's beyond ADAS is self-driving cars. + It could be partially assisted, it could be mostly assisted, and it could be completely assisted. And in each one of those levels of autonomy, a different amount of computation would have to be deployed. We've created a scalable architecture that allows car companies to develop cars that are partially assisted, all the way to completely assisted. +We are working with quite a large number of customers now. Car companies, startup companies, companies that are largely cloud-based and have an enormous amount of data that they could transform into an automotive service, transportation-as-a-service. And so we are working with a whole lot of different types of companies, and I think this is going to be an area of quite a significant industrial revolution. And arguably quite a gigantic society good in the long term. So anyways, we are working on a lot of projects there. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Our next question comes from the line of Steven Chin with UBS. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [25] +-------------------------------------------------------------------------------- +Hi, thanks for taking my questions. Jen-Hsun, the first one for you, if I could. In terms of the deep learning, machine learning opportunity, I was wondering if you could help quantify sort of the longer-term silicon TAM for the opportunity, both in datacenter and automotive? And I guess more near term, any thoughts on what kind of development revenues could be generated for these machine learning-type platforms in the near term? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [26] +-------------------------------------------------------------------------------- +Sure, thanks. I think part of the answer is, I'm not sure. Part of the answer is, I'm not sure. So with that as a disclaimer, let me tell you why I'm so enthusiastic about it. There are many problems that computer science has been trying to solve which, algorithmically, is just impossible to solve. There is no known way of a human-described algorithm that completely captures the noisy and long tail of society. +And it could be almost any problem. It can be weather-related-type problems. It could be market-related-type problems. It could be all kinds of purchasing-related challenges, and all kinds of data. It could be life sciences, as we know that the human body is not in a perfect condition all the time, that randomness that plays a role in understanding molecular science. There are so many different types of areas where there is no simple Newtonian physics equation that can describe the nature. +So in that particular case, using an enormous amount of data to train the neural net, to train software, to rewrite the software, if you will, using an enormous amount of computation, is a pretty exciting computation model. I think this is a brand-new computing model, one that is going to augment the traditional model of symbolics and computer programming. This is going to be a data-driven type of computing model. In this particular case, GPU accelerated computing is really quite ideal and the computing model that we invented some ten years ago is really quite ideal. +How big is it? I think that it could be quite significant. And we are starting to see, of course, the type of companies that are jumping on top of the deep learning bandwagon. They are great companies, from Google to Facebook to Vidu to IBM to Alibaba, to just about every hyperscale web services company in the world, is jumping on this. Because they have enormous amounts of data and it has very, very long tails. And traditional segmentation is too contrived of an approach to find great insight. +Now that the companies with a great deal of web-based data, cloud-based data, have already starting to engage in this area, they are starting to implement artificial intelligence into one application after another. I think we already heard them announce that it's very likely they will put artificial intelligence into every single application they have. We are starting to see this sweep across industries. +The automotive industry, of course, has the longest tail, as the world is a very noisy place. And in order to create a car that can navigate through it, the long tail of a very complicated world has to be handled somehow. Writing software programs is just not going to do it. So using an ongoing learning artificial intelligence network could be exactly the solution for it. Life sciences, industries, manufacturing, supercomputing, financial services -- the list goes on and on. And we are seeing a lot of enthusiasm. +Before everybody can use deep learning, they have to train a network. And this is an area where we have a great deal of expertise. This year, as you know, we also announced our first hyperscale inferencing engine. It's our first end-to-end training-to-inferencing -- inferencing is predictions, the application of the network. So from training all the way to inferencing, we now have a complete architecture that is architecturally compatible. +The Tesla M40 is for training, and the Tesla M4 is for inferencing. The M4 is a little, tiny credit card-sized GPU, and very low-power, incredibly energy-efficient. And you can connect it into just about any hyperscale datacenter in the world. And we are sampling customers now. +The results are quite exciting. Customers are very enthusiastic about it. I think we could dramatically reduce the cost of datacenters all over the world, as they start to ramp up artificial intelligence in their everyday workload. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [27] +-------------------------------------------------------------------------------- +Okay, I appreciate that color, Jen-Hsun. And as a quick follow-up, I have one for Colette on the inventory levels. +Colette, just given where inventories ended for the quarter, it's -- on a days and a dollars basis, it's roughly comparable to a number of quarters back, when revenues were about 20% to 30% lower than where it is today. Is this a new level that the Company can continue operating at, just based on supply chain efficiencies? Or is there some -- a seasonal volatility in December or any other kind of average ASP of the [prox] that you are carrying? Thanks. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [28] +-------------------------------------------------------------------------------- +Yes, Steven, thanks so much for the question. Our inventory levels that we are holding here, they are definitely going to swing a bit in terms of the mix, in terms of our platforms. But what we have right now, we do have a very healthy level of inventory. And we have a great team of people managing all of those different pieces, both for the channel, for our partners, and definitely for what we need to ship going forward. +So I don't think we look at a number to exactly optimize in any single one quarter, as we do make sure that we are prepared for the platforms coming down the pipeline, as well as what customers need. But you are correct, it is probably at a fairly healthy low level at this time. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +Our next question comes from the line of Sanjay Chaurasia with Nomura Securities. + +-------------------------------------------------------------------------------- +Sanjay Chaurasia, Nomura Securities - Analyst [30] +-------------------------------------------------------------------------------- +Hi, Jen-Hsun. One question on deep learning. I was wondering if you could talk about relative opportunity sizes in training and inference part of the deep learning? Clearly you have a strong position on the training side. I would love to hear your thoughts of the inference side. My understanding is, a lot of custom chips are being built in the industry on the inferencing side. So I would love to get your color on what competition you're foreseeing on that front? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [31] +-------------------------------------------------------------------------------- +Sure. Here is my guess. I think long term, training will be half of the overall market. And the reason for that is because training is so heavyweight. And in the long term -- well, not long term now -- you're training your network constantly. +You create a network. You want to improve this network as fast as you can, because you have so much valuable data and so much insight that you can go after. And you deploy the network for inferencing, which collects brand-new data. And the world looks completely different to you. +You now collect that data, and you use that data to train your network. I think that network training is going to be continuous basis, and we're seeing that, absolutely. Also there are more types of networks. +The type of networks that are being created, the rate of revolution, the rate of innovation of networks -- network styles, network types, network configurations, network depths. It is happening every single week. I'm actually not exactly sure how you would design a custom chip for it. Which explains why there are only two chips today that are successful in inferencing. One of them is the Intel Xeon, and the other is the Tesla M40 and M4. +So I think the ability to adapt to new algorithms quickly, it's really quite vital as we go through the next several years of this artificial intelligence revolution. There is just so much algorithms being developed, and I think you guys are reading about it constantly -- new breakthroughs in AI, new breakthroughs in network design. At the moment, I just really don't know how someone would settle down and design a custom chip for it. +I happen to believe that long term, artificial intelligence is not a chip. Artificial intelligence is a computing model. And a computing model needs processors. And processors are programmable. And these programmable processors need to have rich software development environments around it, and these platforms need to be available all over the world. +Today the NVIDIA accelerated computing platform is available in a PC, in a work station, in a laptop, in the cloud, in a car, in robots, in embedded environments, and it's all exactly the same architecture. I think that, that's really one of our advantages, that we have the ability to be adaptable, programmable, and yet we are available in literally every single computing platform form-factor you can imagine. And the accessibility of NVIDIA's architecture is literally global, worldwide and within reach for anybody. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Our next question comes from the line of Ross Seymore with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [33] +-------------------------------------------------------------------------------- +Thanks for letting me ask a question. One for either Jen-Hsun or Colette. In your first-quarter guidance, it looks like the down-10% has some seasonality to it. But you also have a lot of businesses that have secular trends behind them. So I was hoping that you could provide a little color on seasonality versus secular? +Or which of the drivers would be better or worse than that 10%? Acknowledging also that you lose a week of business guiding into that April quarter. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [34] +-------------------------------------------------------------------------------- +Yes, first of all, I appreciate your question. I think, first of all, it's just the guidance, and it's our best view today, it's our most prudent view today. And as you know, although there are many things we know, the world is a very uncertain place. +There's a few things that we do know. The gaming market is quite vibrant. It continues to be quite vibrant. We monitor it literally every day, every week. And we monitor it all over the world, and it remains quite vibrant. +In the coming months, there are some really wonderful games that are coming out, that we think are going to be spectacularly successful, whether it is The Division or Tomb Raider or -- the list goes on. So I think the gaming market appears to be quite vibrant. +Our automotive business is vibrant, and the work that we do in self-driving is really gaining traction and capturing the imagination of just about every car company around the world. Our deep learning work and supercomputing work, our high-performance computing work is accelerating. +In a lot of ways, I understand where you're coming from. But we don't want to ignore seasonality. Q1 is Q1, and we recognize that the market is uncertain. We will see how it plays out. At the end of the quarter, we'll come and report it again. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [36] +-------------------------------------------------------------------------------- +Hi, good afternoon, and congratulations on another solid quarter. Jen-Hsun, you talked about the installed base and the upgrade opportunity in gaming, I think, last call. You quantified it as around three-quarters of the installed base that really needs a more updated GTX processor. +Given the 37% growth in the gaming business last year and the success of Maxwell, it actually does appear that you did drive some meaningful upgrade in the installed base. So the question for you is, is there any updates to your views on where the installed base sits at from that upgrade opportunity? And then the second question is, do you get a sense that the cadence of these upgrades will be accelerating, given the advancements you and your gaming engine partners are bringing to the market every year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [37] +-------------------------------------------------------------------------------- +Those are really good questions. We monitor our installed base pretty carefully. Currently in the installed base, we basically have three architectures still in operation. We have the Maxwell architecture, and we have the Kepler architecture, and the Tesla architecture. +All of those -- oh, excuse me, the Fermi architecture. Those architectures are all running in the installed base at the moment. We have managed upgrade about one-third of the installed base. +Meanwhile, it is the case that ASPs of our chief use are going up, because the graphics richness and the graphics production value is going up. The quality of games -- because the market for games is so high, game developers can really create much more beautiful games, and take the risk to do that. + The developing markets are growing. The number of genres, like eSports, of games are growing. So there's a lot of different growing vectors. +Meanwhile, all of that is on top of our desire to upgrade our installed base, so they can enjoy games the way that it ought to be enjoyed. I think there is still a fair amount of growth opportunity ahead of us, and we will monitor it carefully and report it once a quarter. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Our next question comes from the line of Deepon Nag with Macquarie Capital. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Capital - Analyst [39] +-------------------------------------------------------------------------------- +Yes, thanks a lot, guys. So Quadro grew for the first time, I think, in several quarters. Can you describe what drove that growth, and how we should think about the growth profile for the rest of this year? Is it possible that it could grow in the mid-single-digits for all of 2017? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [40] +-------------------------------------------------------------------------------- +Yes, Deepon, thanks for the question. I was delighted myself. I will just put that out there. We worked really hard to improve our Quadro business. The team works incredibly hard. We invented a new technology for rendering called Iray. It's the world's first physically modeled photo-realistic renderer that is accelerated by GPU. The results of it is really quite remarkable, and they continue to add new capabilities to it. +We, this last quarter, also benefited from the enthusiasm and excitement around VR. And we have VR SVKs and collaborations with just about every ISB in the world that is working on VR. So I think there's a lot of good reasons to be enthusiastic about Quadro. +We don't believe for a moment that the design quality and design production value of movies or games or architecture or manufacturing will continue. We believe absolutely that it's going to continue to improve. And visual realism and the productivity of the engineers that are involved, the artists that are involved, needs to continue to increase. +So we think this is going to be a vibrant growth area ahead. I think that what drove recently the uptick on the OEMs refreshing workstation cycle. And I think we should enjoy some of that for the coming quarters. +But I still think long term, the real opportunity, surely the market is there. We know that more and more of design and creativity is done digitally. So at the core, the market is there. The opportunity for us is to bring new forms of rendering, new forms of design. And as you can see, Iray is for rendering, and VR is for interacting with the design. These type of capabilities require just an enormous amount of GPU capability. And I think at the core, that is going to be our long-term growth drivers. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Our next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [42] +-------------------------------------------------------------------------------- +Great, thank you. Can you give us some color on what you are seeing in emerging markets, with a lot of macro concern about some of your end markets, notably China? And you guys keep putting out very good numbers. Can you just sort of talk about that demand by geography, and how you weigh the economic and currency risks over the course of this year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [43] +-------------------------------------------------------------------------------- +Sure. For some reason, I still tend to believe that what drives the gaming market is great games. And I think that there is some evidence that the continued release of great games and great production value games, the vibrancy of eSports, the fact that eSports is really not just for competition, but drives the dynamic of sharing and social. Those kind of factors continue to drive our gaming business. +I'm quite enthusiastic about the developing markets. Southeast Asia, for one, is really starting to adopt PC gaming quite rapidly. It is a market that is extremely underserved. India is a market that is extremely underserved. They are underserved because broadband Internet hasn't been available to those marketplaces until just recently. And there are surely demographics in these markets that would love to jump onto gaming. +Who doesn't need a PC? So almost every market develops around PCs quite rapidly. I think the way of enjoying games is so affordable by adding a GeForce GTX to a PC that you already own, it's the most affordable form of entertainment, if you think about it that way. Most of eSports are free to play anyhow. So much of it is, anyhow. So it is a wonderfully affordable way to enjoy entertainment. So I think the Southeast Asia, India, are really quite exciting developing markets. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Our next question comes from the line of Matt Ramsay with Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [45] +-------------------------------------------------------------------------------- +Thank you very much. Jen-Hsun, there's been a lot of speculation about how the emergence of VR headsets, in particular for gaming, would drive your GPU business. I guess I would like to hear your perspective on a couple of things. One, obviously it requires high-end and high GPU use to support some of these applications. So of the early adopters, maybe a sense of which of those folks might already own those type of GPUs, and which ones might have to upgrade in the near term? +And second, how VR might penetrate the [East Forts] phenomenon over time and drive more of those upgrades into the higher-volume mainstream parts of the gaming market? Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [46] +-------------------------------------------------------------------------------- +Yes. There are really two questions in your question; they are both good. One question is, how do I feel about VR and its impact on gaming? The second part is, how will VR impact our business? +Let me tell you the second part first. We are not forecasting and not assuming any upside in VR. However, there's no way but good that VR will bring to our business. And we will take it a day at a time. +We believe that it's going to be an exciting growth driver. We believe that is going to be helpful to our high-end GPU business. But when the time comes, it will be a nice bonus. +So we're going to run our business as if we don't count on it. However, obviously we care very deeply about it, because we think that the experience of VR is quite amazing. Anybody who has tried it is surprised how immersive it is, how it takes you away from where you are and into another world. You are really suspended in disbelief, and it's as close to a holodeck as we have ever experienced. +So we believe strongly that VR is going to be fantastic for entertainment, it's going to be fantastic for games. We also believe that it's going to be fantastic for all of our pro-business. I wouldn't be surprised if the segment of our business that it helps the earliest may very well be our professional business. +The reason for that is because there are many applications that are mission-critical. Even though the headsets are not free, it's quite affordable. And for people who have power walls and use large displays, VR is actually an incredible cost reduction. +Almost anybody can now have a virtual reality cave, which cost tens of thousands of dollars. Anyone can now have a power wall, which costs tens of thousands of dollars. And now for just a few hundred dollars, have all the benefits of that. +So I think that you could tell that I'm very enthusiastic about it. We are developing a lot of fresh technology and new enabling technology to make it possible. We are working with all the market leaders to develop the market and cultivate the market. And then from a financial perspective, we will just see how it plays out. My sense is that it's going to be a really nice bonus. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +Our next question comes from the line of Chris Hemmelgarn with Barclays. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [48] +-------------------------------------------------------------------------------- +Thanks very much for taking my question, and congrats on the good quarter. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [49] +-------------------------------------------------------------------------------- +Thanks a lot, Chris. + +-------------------------------------------------------------------------------- +Chris Hemmelgarn, Barclays Capital - Analyst [50] +-------------------------------------------------------------------------------- +First of all, we've talked a lot about some of the really exciting businesses that have a lot of great growth prospects for you. I thought we would look at, as well, some that have been a little more stagnant. And I was curious to your take on, for example, the OEM business. + It looks like it may finally be stabilizing after declining. How do you look at that business in the coming fiscal year? Do you think it can even get back to growth, or do you expect continued declines? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [51] +-------------------------------------------------------------------------------- +Well, my sense is that it will stabilize, and let me tell you why. Our OEM business is not about gaming, because it is our gaming business. And the OEMs are not about design, because that's our design business. +But the thing that some OEMs do is, they include our technology to differentiate a mainstream platform from a premium platform. So by adding NVIDIA's technology, you turn a commodity PC into a premium PC. And the experience is better, the performance is better, and everything just works. +So there is a real benefit in using it as a premium multimedia PC, if you will. So we'll probably see continued interest in doing that. And we are delighted by that. We don't count on it, but we're delighted by it. So my sense is that it will likely stabilize. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Our next question comes from the line of Chris Rolland with FBR & Company. + +-------------------------------------------------------------------------------- +Chris Rolland, FBR & Company - Analyst [53] +-------------------------------------------------------------------------------- +Hey, guys, thanks for the question, and great quarter. Speaking about your installed base briefly, can you guys share with us your view on GPU replacement rates? How fast are they or how long are they now, and whether they are shrinking or speeding up here? And also perhaps how they might differ by geography? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [54] +-------------------------------------------------------------------------------- +I don't know if I have the precise granularity by geography, except for just a few countries. But let me address it overall. The installed base takes a couple two or three years to upgrade. And on the lower end, three to four years. On the higher end, one to two years. And so overall I guess, because the lower-end products are higher in volume, it would probably weigh the overall average to call it three-plus years. +But the ASP, of course, if you look at it from an ASP perspective, it's a little bit different -- it would probably drift up. The rate of upgrade appears to be increasing. I might also explain that the ASP of our overall portfolio increasing. I think the reason why it's increasing is because the size of the gaming market has now grown to a level that developers can take a fair amount of risk to add a rich content, rich production value in graphics, which they didn't used to be able to do. +They now have the benefit of a large installed base, a PlayStation an Xbox, a Nintendo and PCs, that they could actually create content that is really, really quite beautiful and technologically rich. Which drives up the adoption of higher-end GPUs, because you need higher-end GPUs to process it. I think that is quite a significant factor. +I think the other factor is that the game consoles, although nowhere near the performance level of our high-end GPUs, on average, is higher in terms of capability than our average installed base. That is actually terrific news for us, because a PC gamer who wants to enjoy games that are adapted from game consoles, which all of them are, now would have to upgrade their GPUs to enjoy at least a game console experience. +So I think that bottom half of our installed base has a real opportunity to enjoy at least a game console experience for just $150. For a $150 graphics card, you can get experience that is superior to a game console. That is quite an amazing value. That, I think, is also another reason to spur adoption. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +Our next question comes from the line of Rajvindra Gill with Needham & Company. + +-------------------------------------------------------------------------------- +Rajvindra Gill, Needham & Company - Analyst [56] +-------------------------------------------------------------------------------- +Thanks, and congrats as well. Just a follow-up question on the virtual reality market and how you are looking at that. +Can you talk a little bit about some of the PC requirements that are going to be necessary to use in Facebook, Oculus Rift headset when it comes out this quarter? And the cost that is going to be needed for the individual user? And contrast that from the business model that Sony is employing, which is basically, based on my knowledge, a bundling strategy with their PlayStation 4, which wouldn't require an upgrade to the graphics card or buying a new desktop? Just wondering how you think about those two different business models? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [57] +-------------------------------------------------------------------------------- +There are two different questions in there. One question is, what is the minimum requirement for VR today? Using today's graphics card as an example, the GTX 970, which is the most popular graphics card in the world, is the min spec for the Oculus Rift. And the reason why, of course, is because Oculus and their PC focus wants to have the best possible experience for the early adopters of VR, and I think that is a really prudent strategy. You want to delight all of your early adopters with the best possible experience. +But the way to think about it long term is that, as the market continues to grow and more content comes and VR moves into the mainstream, there is no question in my mind that our $100 and $150 GeForce GTX cards will, in the future, be able to play VR just perfectly. So this is not a question about the availability of technology or the cost of technology. As we know, technology continues to advance, and whatever experience today will continue to get more affordable long term. +Whatever the Sony PlayStation does, I think is just fantastic either way. What we would like to do is get people excited about VR. +And in the final analysis, there are TV gamers and then there are -- there are console gamers and there are PC gamers. They are different genres, and they are different applications and different styles, and very largely different customers. So I think we are just enthusiastic about VR, period. And over time, the technology will more and more affordable. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- +Our final question comes from the line of Brian Alger with Roth Capital Partners. + +-------------------------------------------------------------------------------- +Brian Alger, Roth Capital Partners - Analyst [59] +-------------------------------------------------------------------------------- +Thanks for squeezing me here at the end. I'll be very brief. The opportunity in automotive obviously continues to grow. And your unveiling at CES was impressive by anyone's standards. However, there seems to be two approaches to the automotive market as we move forward. There is obviously the closed system approach that Mobile [Life] seems to be pursuing, and what appears to be more of an open-architecture approach that you seem to have. +Can you maybe describe how things shape up for you as you look out over the horizon with sensor fusion and the various OEMs, and getting things right from a safety standard space, et cetera? Do we need the control of a closed system, or can we get it done with collaboration with others? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [60] +-------------------------------------------------------------------------------- +Sure. I appreciate the question. It's really a good question. This is really a matter of philosophy. And philosophically, this is how we see the world. We believe the self-driving car is not a solved problem. I say that as a statement of fact. I don't think anybody would dispute it. +I also believe that self-driving cars is a field that's going to require the technological muscle of a very, very large industry, and that no one company with a few hundred employees is going to solve it all by themselves. The idea that a unsolved problem of such incredible daunting levels, that an entire computer industry is in the process of trying to solve, could possibly be a closed system tied around a chip, seems illogical to me. That's number one. +Number two, I believe that long term, our car company, the soul of the car company is the driving experience of that car. The soul of the company is the safety record of that car. The soul of the company is the functionality of that car. In the future, the functionality, the safety, the driving experience of the car is going to be largely software-defined. It's going to be artificial intelligence network-defined. +I just can't imagine great companies like BMW and Mercedes and Audi and all of the world -- Toyota, and the list goes on -- and many great companies that are emerging into this marketplace. I just can't imagine that these companies would somehow outsource the soul of their car to a chip company. That is a second philosophical belief. +So what we have decided to do is to create an automotive autonomous car computing platform and all of the rich software that is necessary to enable this incredibly high-throughput computer to behave in a really energy-efficient way and cost-effective way. And to be able to apply our deep learning expertise, so that these cars can benefit from artificial intelligence to solve these really complicated world problems. And that by partnering with every single car company in the world, that together we might be able to solve this incredibly daunting challenge, and hopefully bring some society good. +So that is our approach as the open platform. And it starts really from a philosophical approach. Now, that philosophical approach results in a very substantial technological difference. +Notice that our platform is completely programmable. We have rich tools. We know that developers all over the world can easily buy themselves a GeForce TITAN and write CUDA applications. And those CUDA applications will tomorrow run on a DRIVE PX just seamlessly. +So I think that is a wonderful way for designers all over the world to be able to develop software -- which is really hard to do right now -- and then quickly deploy it into the car. So our strategy is just very, very different, and that is our approach. And my sense is, at the moment, it appears to be quite a good approach. +Okay, I really appreciate that question. NVIDIA is the world leader in visual and accelerated computing, which is helping to create exciting growth markets like VR, AI, and self-driving cars. Which will transform many industries and positively impact the future of society. Our strategy is to leverage one core investment into four growth markets -- gaming, professional visualization, datacenter and auto. And it's delivering results and gaining momentum. Our goal is to balance investments to capture the enormous opportunity ahead, while maintaining a keen focus on improving near-term financial performance. +I also want to remind everyone that our annual GPU Technology Conference will take place April 4th through the 7th in San Jose. We will be focusing on VR, artificial intelligence and autonomous driving. We will also be holding Analyst Day there, and I look forward to seeing all of you. Thank you. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- +Ladies and gentlemen, that does conclude the call for today. We thank you for your participation, and ask that you please disconnect your lines. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2016-May-12-NVDA.txt b/Transcripts/NVDA/2016-May-12-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..4ff2c02383a611cf39d3c540e42acc801f2d439f --- /dev/null +++ b/Transcripts/NVDA/2016-May-12-NVDA.txt @@ -0,0 +1,620 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 NVIDIA Corp Earnings Call +MAY 12, 2016 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Arnab Chanda + NVIDIA Corporation - VP of IR + * Jen-Hsun Huang + NVIDIA Corporation - President & CEO + * Colette Kress + NVIDIA Corporation - EVP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Deepon Nag + Macquarie Research Equities - Analyst + * Harlan Sur + JPMorgan - Analyst + * Blayne Curtis + Barclays Capital - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Steven Chin + UBS - Analyst + * Craig Ellis + B. Riley & Company - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Gabriel Ho + BMO Capital Markets - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Suji Desilva + Topeka Capital Markets - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Ross Seymore + Deutsche Bank - Analyst + * Romit Shah + Nomura Research - Analyst + * Ian Ing + MKM Partners - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon, my name is Claudine, and I will be your conference coordinator today. I would like to welcome everyone to the NVIDIA financial results conference call. +(Operator Instructions) +This conference is being recorded, Thursday, May 12, 2016. I would now like to turn the call over to Arnab Chanda, Vice President of Investor Relations at NVIDIA. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the first quarter of FY17. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer, and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that today's call is being webcast live on NVIDIA's Investor Relations website. It is also being recorded. You can hear a replay by telephone until May 19, 2016. The webcast will be available for replay up until next quarter's conference call to discuss Q2 financial results. +The content of today's call is NVIDIA's property. It cannot be reproduced or transcribed without our prior written consent. +During the course of this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 12, 2016 based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Arnab. In March, we introduced our newest GPU architecture, Pascal. This extraordinary scalable design built on the16 nanometer finFET process provides massive performance and exceptional power efficiency. It will enable us to extend our leadership across our four specialized platforms, gaming, professional visualization, datacenter and automotive. +Year-on-year revenue growth continued to accelerate, increasing 13% to $1.3 billion. Our GPU business grew 15% to $1.08 billion from a year ago. Tegra processor business was up 10% to $160 million. Growth continued to be broad-based across all four platforms. Record performance in datacenter was driven by the adoption of deep learning across multiple industries. In Q1, our four platforms contributed nearly 87% of revenue, up from 81% a year earlier. They collectively increased 21% year-over-year. +Let's start out with our gaming platform. Gaming revenue increased 17% year-on-year to $687 million, momentum carried forward from the holiday season, helped by the continued strength of Maxwell-based GTX processors. Last weekend at DreamHack Austin, we unveiled GeForce GTX 1080 and GTX 1070, our first Pascal GPUs for gamers. They represent a quantum leap for gaming and immersive VR experiences, delivering the biggest performance gains from the previous generation architect in a decade. +Media reports and gamers have been unanimously enthusiastic. The Verge wrote, what NVIDIA is doing with its new GTX 1000 series is bringing yesteryear's insane high-end into 2016's mainstream. We also extended our VR platform, by adding spatial acoustics to our VRWorks software development kit that helps provided an even greater sense of presence within VR. +We introduced simultaneous multi-projection, enabling accurate efficient projection of the real world to surround monitors, VR headsets, as well as future displays. To showcase these technologies, we created our own amazing open-source game called NVIDIA VR Funhouse available on Steam. In addition, we've announced Dazzle, an in-game photography system which enables gamers to capture high-resolution and VR scenes within their favorite games. +Moving to professional visualization. Quadro grew year-on-year for the second consecutive quarter. Revenue rose 4% to $189 million. Growth came from higher-end products and mobile workstations. +We've launched the M6000 24 gig, and are seeing good success among multiple customers, including Toyota and Pixar. [Roche] is using the M6000 to speed its DNA sequencing pipeline by 8 times, enabling more affordable genetic testing. We see exciting opportunities for our Quadro platform with Virtual Reality, and NVIDIA Iray, a photorealistic rendering tool that enables designers effectively to walk around their creations, and make real-time adjustments. +Moving to datacenter, revenue was a record $143 million, up 63% year-on-year, and up [40%] sequentially, reflecting enormous growth in deep learning. In just a few years, deep learning has moved from academia, and is now being adopted across the hyperscale landscape. We expect growing deployment in the coming year, among large enterprises. +GPUs have become the accelerator of choice for hyperscale datacenters due to their superior programmability, computational performance and power efficiency. Our Tesla M4 is over 50% more power efficient than other programmable accelerators for applications such as real-time image classification for AlexNet, a deep learning framework. Hyperscale companies are the fastest adopters of deep learning, accelerating their growth in our Tesla business. Starting from infancy three years ago, hyperscale revenue is now similar to that from high-performing computing. +NVIDIA GPUs today accelerate every major deep learning framework in the world. We power IBM Watson and Facebook's Big Sur server [through our] AI, and we are in AI platforms at hyperscale giants such as Microsoft, Amazon, AliBaba and Baidu, for both training and real-time imprints. Twitter has recently said, they used NVIDIA GPUs to help users discover the right content among the millions of images and videos shared every day. +During the quarter, we hosted our seventh annual GPU Technology Conference. The event drew record attendance, with 5,500 scientists, engineers, designers and others across a wide range of fields, and featured 600 sessions and 200 exhibitors. At GTC, we unveiled the Tesla P100, the world's advanced GPU accelerator based on the Pascal architecture. The P100 utilizes a combination of technologies including NVLink, a high-speed interconnect [allowing] application performance to scale on multiple GPUs, high memory bandwidth, and multiple hardware features designed to natively accelerate AI applications. The Next Platform, an enterprise IT site, called it a beast, in all of the good sense of that word. +Among the first customers for our Pascal accelerator with the Swiss National Computer Center, which will use it to double its speed of Europe's fastest supercomputer. And GTC, we also announced the DGX-1, the world's first deep learning supercomputer. Loaded with eight P100s in a single box, interconnected with MVLink, it provides the deep learning performance equivalent to 250 traditional servers. DGX-1 comes loaded with a suite of software designed to aid AI and application developers. +Universities, hyperscale vendors and large enterprises developing AI-based applications are showing strong interest in the system. Among the first to get DGX-1, will be the Massachusetts General Hospital. It launched an initiative that applies AI techniques to improve the detection, diagnosis, treatment and management of diseases, drawing on its database of some10 billion medical images. In our GRID graphics virtualization business, we are seeing interest across a variety of industries, ranging from manufacturing, energy, education, government and financial services. +Finally in automotive, revenue continued to grow reaching $113 million, up 47% year-over-year, and up 22% sequentially, reflecting the growing popularity of premium infotainment features in mainstream cars. NVIDIA is working closely with partners to develop self-driving cars, using our end-to-end platform with Tesla in the datacenter, and extends with the deployment with DRIVE PX 2. Since we have unveiled DRIVE PX 2 earlier this year, worldwide interest has continued to grow among car makers, tier 1 suppliers, and others. We are now collaborating with more than 80 companies, using the open architecture of DRIVE PX to develop their own software and driving experiences. +At GTC, we demonstrated the world's first self-driving car, trained using deep learning, and showed its ability to navigate on roads without lane markings, even in bad weather. Additionally, we announced that DRIVE PX 2 will serve as the brain behind the new Roborace initiative in the Formula E racing circuit. The circuit will include 10 teams, racing identical cars, all using DRIVE PX 2. Beyond our four platforms, our OEM IP business was $173 million, down 21% year-on-year, reflecting weak PC demand. +Now turning to the rest of the income statement. We had record GAAP and non-GAAP gross margins for the first quarter, at 57.5% and 58.6%, respectively. Driving these margins was the strength of our Maxwell GPUs, the success of our platform approach, and strong demand for deep learning. +GAAP operating expenses for the first quarter were $506 million, and declined from $539 million in Q4 on lower restructuring charges. Non-GAAP operating expenses were $443 million, flat sequentially and up 4% from a year earlier, reflecting increased hiring for our growth initiatives, and development-related expenses associated with Pascal. GAAP operating income for the first quarter was $245 million, up 39% from a year earlier. +Non-GAAP operating income was $322 million, also up 39%. Non-GAAP operating margins improved more than 470 basis points from a year ago to 24.7%. For the first quarter, GAAP net income was $196 million. Non-GAAP net income was $263 million, up 41% fueled by the strong revenue growth, and improved gross and operating margins. +During the first quarter, we'd entered into a $500 million accelerated share repurchase agreement, and paid $62 million in quarterly cash dividends. Since the restart of our capital return program in the fourth quarter of FY13, we have returned over $3.5 billion to shareholders. This represents over 100% of our cumulative free cash flow for FY13 through this Q1. For FY17, we intend to return approximately $1 billion to shareholders through share repurchases and quarterly cash dividends. +Now turning to the outlook for the second quarter of FY17. We expect revenue to be $1.35 billion, plus or minus 2%. Our GAAP and non-GAAP gross margins are expected to be 57.7% and 58.0%, respectively, plus or minus 50 basis points. +GAAP operating expenses are expected to be approximately $500 million. Non-GAAP operating expenses are expected to be approximately $445 million. GAAP and non-GAAP tax rates for the second quarter FY17 are both expected to be 20%, plus or minus 1%. Further financial details are included in the CFO commentary, and other information available on our IR website. +We will now open the call for questions. Operator, could you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +First question, Vivek Arya, Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you for taking my question, and good job on the results and the guidance. +Maybe as my first one, Jen-Hsun, how do you assess the competitive landscape in PC gaming? AMD recently claimed to be taking a lot of share, and they are launching a Polaris soon. +If you could just walk us through, what does NVIDIA to better than AMD? So that helps you maintain your competitive edge in this market, and what impact does Pascal have in that? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [3] +-------------------------------------------------------------------------------- + + Yes, Vivek, thank you. +Our PC gaming platform, GeForce is strong and getting stronger than ever, and I think the reason for that is several-folds. First of all, our GPU architecture is just superior, and we dedicated an enormous amount of effort to advancing our GPU architecture. I think the engineering of NVIDIA is exquisite, and our craftsmanship is really unrivaled anywhere. +The scale of our company in building GPUs is the highest and the largest of any company in the world. This is what we do, this is the one job that we do. And so, it is not surprising to me that NVIDIA's GPU technology is further ahead than any time in its history. +The second thing, however, it's just so much more than just chips anymore as you know. Over the last 10 years, we've started to evolve our Company to much more of a platform company. And it's about developing all of the algorithms that sit on top of our GPUs. +GPU is a general purpose processor. It's a general-purpose processor that is dedicated to a particular field of computing, such that it is computer graphics here, physics simulation, et cetera. But the thing that's really important all of the algorithms that sit on top of it. And we have a really fantastic team computational of mathematicians that captures our algorithms and our know-how into GameWorks, into the physics engine, and recently the really amazing work that we're doing in VR that we have embodied into VRWorks. +And then, lastly, lastly it is about making sure that the experience always just works. We have a huge investment, in working with game developers all over the world. From the moment that the game is being conceived of, all the way to the point that it is launched. +And we optimize the games on our platform. We make sure that our drivers run perfectly. And even before a gamer downloads or buys into a game, we've already updated their software so that it works perfectly when they install the game. And we call that GFE, GeForce Experience. +And so, Vivek, it's really about a top to bottom approach. And I haven't even started talking about all of the marketing work that we do, in engaging the developers, and engaging the gamers all over the world. This is really a network platform, and all of our platform partners that take our platform to market. And so it's a pretty extensive network, and it's a pretty extensive platform. And it's so much more than chips anymore. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- + + Got it. Thank you, Jen-Hsun. +And as my follow up, so things like data center products were the big upside surprise in Q1, grew over 60% from last year. Could you give us some more color on what drove that upside? Was it the initial Pascal launch? Is that impact still to come? And just broadly, what trends are you seeing there in HPC, versus some of these new AI projects that you're involved with? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [5] +-------------------------------------------------------------------------------- + + Yes, thanks. +You know that I have been rather enthusiastic about high-performance computing for some time. We've been evolving our GPU platforms, so that it's better at general-purpose computing than ever. And almost every single data center in the world, every single server company in the world are working with us, to build servers that are based on GPUs, based on video GPUs and high-performance computing. +One of the most important areas of high-performance computing has been this area called deep learning. And this deep learning -- deep learning as you know, as you are probably starting to hear, is a brand-new computing model that takes advantage of the massively parallel processing capability of the GPU, along with the big data that many companies have, to essentially have software write algorithms by itself. +Deep learning is a very important field of machine learning, and machine learning is now the process of revolutionizing artificial intelligence, making machines more and more intelligent, and using it to discover insights that quite frankly, is impossible otherwise. And so, this particular field was first adopted by hyperscale companies, so that they could find insight, and make recommendations, and make predictions from the billions of customer transactions they have every day. +Now it is in the process of moving into enterprises, but in the meantime hyperscale companies are now the process of deploying our GPUs, and deep learning applications into production. And so, we've been talking about this area for some time, and now we're starting to see the broad deployment in production. So we're quite excited about that. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Next question, Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. +A first question, the growth in the Tesla business is impressive, and in looking back, it seemed like that business actually decelerated in 2015, which was a head-scratcher for me. And I wonder do you think that your customers in that business paused in anticipation of Pascal? Or do you think it is the AI apps and deep learning applications that are just hitting their stride right now? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [8] +-------------------------------------------------------------------------------- + + Well, decelerate, I guess, I'm not sure I recall that. The thing about HPC, about GPU computing is, as you know this is a new computing model, and we've been promoting this computing model for close to seven years. And a new computing model doesn't come along very frequently. In fact, as I know it, I do not know if there's a new computing model that's used anywhere, that has been revolutionary in the last 20 years. +And so, GPU computing took some time to develop. We've been evangelizing it for quite some time. We developed robust tools, so that would make it easier for people to take advantage of our GPUs. We have industry expertise in a large number of industries now. +We have APIs that have been created for each one of the industries. We've been working with the ecosystem in each one of the industries, and developers in each one of the industries. And as of this time, we have quite a large handful, quite a large number of industries that we accelerate applications for. +And so, I think that -- I guess, my recommendation -- my recollection would be is that, that it has taken a long time, in fact, to have made GPU computing into a major, new computing model. But I think at this point, it is pretty clear that it's going mainstream. +It is really one of the best ways to achieve post Moore's law error of computing acceleration, and a lot of (inaudible) competition. And the one that, of course, that is very big deal is deep learning and machine learning. This particular field is a brand-new, new way of doing computing for a large number of companies, and we're seeing traction all over the place. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Next question, Steven Chin, UBS. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [10] +-------------------------------------------------------------------------------- + + Hey, thanks for taking my questions. +Jen-Hsun or Colette, first of all I want to see if you can help provide some color on some of the drivers of growth for fiscal 2Q, whether most of it is coming from Pascal possibly in the gaming market, or in the Tesla products, or if there was also some outgrowth and Tegra automotive as called for fiscal 2Q? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [11] +-------------------------------------------------------------------------------- + + Yes, Stephen, I would expect that all of our businesses grow in Q2. And so, it is across the board. +We are seeing great traction in gaming. Gaming as you know, has multiple growth drivers covers. But partly of the gaming is growing, because the production value of game is growing, partly because the number of people who are playing is growing. E-sports is more popular sport than ever, sports spectatorship is more popular than ever. +And so, gaming is just a larger and larger market, and it's surprising everybody. And the quality of games is going up, which means that the complexity of GPUs has to go up. +High-performance computing has grown, and the killer app is machine learning and deep learning. And that's going to continue to go into production from the hyperscale companies, as we expand our region to enterprises all over the world now. Companies who have a great deal of data that they would like to (inaudible). +Automotive is growing, and we're delighted to see that the enterprise is growing as well. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [12] +-------------------------------------------------------------------------------- + + Great. +As my follow-up, maybe for Colette. On the gross margin side of things, you guys are guiding margins up nicely for the quarter. And just kind wondering looking further across the year, whether you have -- whether or not that the levers that you have available to you currently, if there's further room for expansion, whether it is from product mix, higher ASPs, and or maybe some of the platform-related elements such as software services? +And I was kind wondering, especially on the software side, how much that can continue to help the margins from a platform perspective? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [13] +-------------------------------------------------------------------------------- + + Sure. Thanks, Stephen. +Yes, our gross margins within the quarter for Q1 did hit record levels, just due to very strong mix across our products, on the Maxwell side both from a gaming perspective, as well as what we have in enterprise for pro visualization and data center. As we look to Q2, a good review of where we also see gross margins, and those are looking at a non-GAAP at about 58%. So, again, be a strong component of that. As the launch of Pascal will come out with high-end gaming and with datacenter, and the growth essentially across all of our platforms will help our overall gross margins. +As we go forward, there is still continued work to do. We're here to guide just one quarter out, but we do have a large TAM in front of us on many of these different markets, and the mix will certainly help us. We're in the initial stages of rolling out what we have in software services, our overall systems. So I don't expect it to be a material part of the overall gross margin, but it will definitely be a great value proposition for us, for what we put forth. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Next question, Deepon Nag, Macquarie. + +-------------------------------------------------------------------------------- +Deepon Nag, Macquarie Research Equities - Analyst [15] +-------------------------------------------------------------------------------- + + Yes, thanks, guys, and congratulations on the great quarter. +For Q2, can you kind of talk about how much of a contribution you expect from Pascal? And also maybe give us an update on where you think that yields are progressing right now? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [16] +-------------------------------------------------------------------------------- + + Yes, thanks a lot, Deepon. +We're expecting a lot out of Pascal. Pascal was just announced with 1080 and 1070, and both of those products are in full production. We're in production with Tesla P100. And so, all of our Pascal products that have we've already announced are in full production, so we're expecting a lot. +Yields are good and building these semiconductor devices are always hard, but we're very good at it. And this is now -- a year behind when the first 16 nanometer finFET products went into production at TSMC. They have yields under great control. +TSMC is the world's best manufacturer of semiconductors, and we work very closely with them, to make sure that we are ready for production. And we surely wouldn't have announced it, if we didn't have manufacturing under control. So we're in great shape. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Next question, Ambrish Srivastava, BMO Capital Markets. + +-------------------------------------------------------------------------------- +Gabriel Ho, BMO Capital Markets - Analyst [18] +-------------------------------------------------------------------------------- + + This is Gabriel calling in for Ambrish. Thanks for taking my question. +I think when you recently launched a new GPU products, looks like your pricing, your MSRP appears to be higher than your prior generation. And how should we think about your ASP, and even gross margin trend as you are ramping this product for the rest of the year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [19] +-------------------------------------------------------------------------------- + + Yes, thanks. +The thing that's most important, is that the value is greater than ever. And one of the things that we know is games are becoming richer than ever, production value has become richer than ever. And gamers want to play these games with all of the settings maxed out. They would like to play at a very high resolution, and they want to play it at very high frame rates. +When I announced 1080, I was showing all of the latest, the most demanding games running at twice the resolution of a game console, at twice the frame rate of the game console, and it was barely even breathing hard. And so, I think one of the most important things is for customers of this segment, they want to buy a product that they can count on, and that they can rely on to be ready for the future generation games. And some of the most important future generation games are going to be in VR. +And so, the resolution is going to be even higher, the frame rate expectation is 90 hertz, and the latency has to be incredibly low, so that you feel a sense of presence. And so, I think the net of it all, is that the value proposition we deliver with 1080 and 1070 is just through the roof. And if you look at the early response on the web, and from analysts, they're quite excited about the value proposition that we brought. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Next question, CJ Muse, Evercore. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [21] +-------------------------------------------------------------------------------- + + Yes, good afternoon. Thank you for taking my question. +I guess, two questions around the data center. I guess, first part, how is the visibility here today? And I guess how do you see perhaps the transition from hyperscale to ramp in HPC? +And then, I know you guys are not like to forecast over the next couple of quarters. But looking out over the next 12 to 24 months, this part of your business has grown from 8% to 11% year over year. And curious as you look at one to two years, what do you think this could be as a percentage of your overall company? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [22] +-------------------------------------------------------------------------------- + + Yes, CJ, thanks a lot. +I think a lot -- the answer to a lot of your questions is I don't know. However, there are some things I do know very well. One of the things that we do know is that high-performance computing is an essential approach for one of the most important computing models that we know today, which is machine learning and deep learning. Hyperscale datacenters all over the world is relying on this new model of computing, so that it can harvest, it could study all of the vast amounts of data that we're getting to find insight for individual customers, make the perfect recommendation, predict when somebody would anticipate, would look forward to in terms of news or products or whatever it is. +And so, this approach of using computing is really unprecedented, and this is a new computing model, and the GPU is really ideal for it. And we have been working on this for coming up on a decade. And it explains one of the reasons why we have such a great lead in this particular aspect. +The GPU is really the ideal processor, if you use massively parallel problems. And we've optimized our entire stack of platforms from the architecture, to the design, to the system, to the middleware, to the system software, all the way to the work that we do with developers all over the world, so that we can optimize the entire experience to deliver the best performance. +And so, this is something that has taken a long time to do. I have a great deal of confidence that machine learning is not a fad. I have a great deal of confidence that machine learning is going to be the future computing model for a lot of very large and complicated problems. And I think that all of the stories that you see, whether it's the groundbreaking work that's done at Google, and Google DeepMind on AlphaGo, to self driving cars, to the work that people are talking about, and artificial intelligence recommendation chatbots to -- boy, the list just goes on and on. +And I think that it goes without saying, that this new computing model in the last couple of years has really started to deliver very promising results, and I would characterize results as being superhuman results. And now they're going into production. And we're seeing production deployments, not just in one or two customers, but basically in every single hyperscale data center in the world, in every single country. +And so, I think this is a very big deal. And I don't think it's a short-term phenomenon, and the amount of data that we process is just going to grow. And so, that those are some of the things I do know. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Next question, Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [24] +-------------------------------------------------------------------------------- + + Hi, thanks for cycling me back in for a follow up. +Sometimes in -- when you introduce a new product, and this is broadly for technology, there's kind of a hiccup as the transition happens, where the supply chain blows out the older inventory, and before the new products can ramp in, so people call that an air pocket. So I was wondering is that something that you can manage, how do you try to manage that? Did you account for it, when you think about the outlook for this quarter? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [25] +-------------------------------------------------------------------------------- + + Yes, thanks, Mark. +Well, part of transitions are always tricky, and we take it very seriously, and there's several things that we do know. We have a great deal of visibility to the channel. And so, we know how much inventory is where, and of which kind. +And secondarily, we have perfect visibility into our supply chain, and both of those matters, we've taken into account, when we launch a new product. And so, anything could happen. The fact of the matter is we are in a high tech business, and high tech is hard. The work that we do is hard. +The team is -- doesn't take it for granted and we're not complacent about our work. And so, I think that I can't imagine a better team in the world that is to manage this transition. We manage transitions all the time. And so, we do not take it lightly, however, you're absolutely right. I mean, it requires care, and the only thing I can tell you is that we're very careful. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Next question, Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [27] +-------------------------------------------------------------------------------- + + Great, thank you. +I guess, along the same lines, can you talk a little bit about the founders edition of the new gaming products? And how does that differ from sort of previous reference designs that you've done, and is there any kind of difference in economics to NVIDIA if you sell founders edition? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [28] +-------------------------------------------------------------------------------- + + The founders edition is something we did, as a result of demand from the end-user base. The founders edition is basically designed by -- a wholly designed by NVIDIA product. +A reference design is really not designed to be an end product. It's really designed to be a reference for manufacturers to use as a starting point. But a founders edition is designed so that it could be manufactured, it could be marketed, and customers can continue to buy it from us, for as long as they desire. +Now our strategy -- our strategy is to support our global network of adding card partners, and we're going to continue to do that. And we gave them -- we gave everybody reference designs like we did before. And, in this particular case, we created the founders edition so that people who like to buy directly from us, people who like our industrial design, and people who would like the exquisite design and quality that comes with our products that we can do. +And so, it's designed to be extremely [over clockable]. It's designed with all the best possible components. And if somebody would like to buy products directly from us, they have the ability to do that. +I expect that the vast majority of the add-in cards will continue to be manufactured by our add-in card partners, and that's our expectation, and that's our hope. And I don't expect any dramatic change in the amount of shifting of that. So that's basically it, Founders edition, the most exquisitely engineered add-in card the world has ever seen, directly from NVIDIA. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Next question, Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [30] +-------------------------------------------------------------------------------- + + Good afternoon, and solid job on the execution. +At the recent Analyst Day, I think articulated its exposure to developed and emerging markets and the unit and ASP growth opportunities around EM. Just wondering, what are the current demand dynamics that you're seeing in the emerging markets? Clearly, I think macro-wise, they're still pretty weak, but on the flip side, gaming has shown to be fairly macro-insensitive. Would be great to get your views here. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [31] +-------------------------------------------------------------------------------- + + Well, I think you just said it. Depending on which one of our businesses that you're talking about, gaming is rather macro-insensitive for some reason. People enjoy gaming whether the economy is good or not, whether the oil price is high or not, people seem to enjoy gaming. +Don't forget gaming is not something that people do once a month, like going out to a movie theater or something like that. People game every day, and the gamers that use our products are gaming every day. +It's their way of engaging with their friends, they hang out with their friends that way. It's a platform for chatting. +Don't forget that the number one messaging company in China, is actually a gaming company. And the reason for that is, because while people are gaming, they're hanging out with their friends and they're chatting with their friends. +And so, it is really a medium for all kinds of things, whether it's entertaining, or hanging out, or expressing your artistic capabilities or whatnot. And so, gaming for one, appears to be doing quite well, in all aspects of the market. +The second thing is, enterprise, however, is largely or hyperscale is largely a US dynamic. And the reason for that is, because a US dynamic as well as a China dynamic, because that's where most of the world's hyperscale companies happen to be and so. And then, automotive, most of our automotive success to date has been from the European car companies, and we're seeing robust demand from the premium segments of the marketplace. +However, in the future we're going to see a lot more success with automotive here in the United States, here in Silicon Valley, in China. We're going to see a lot more global penetration because of our self-driving car platform. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Next question, Ian Ing, MKM Partners. + +-------------------------------------------------------------------------------- +Ian Ing, MKM Partners - Analyst [33] +-------------------------------------------------------------------------------- + + Yes, thank you. +So for July, it looks like you've got some operating expense discipline. Given some hiring activity in April, you're down sequentially. Is that related to the timing of some tape out activity? And as Pascal rolls out, what should the shape of tape outs be, do you think of the upcoming quarters? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [34] +-------------------------------------------------------------------------------- + + Well, all of the Pascal chips have been taped out. And so -- but we still have a lot of engineering work to do. The difference -- differences are minor. We're a large company, and we have a lot of things that we're doing. +I wouldn't over-study the small deltas in OpEx. We don't manage things a dollar at a time, and we're trying to invest in the important things. +On the other hand, this Company is really good about not wasting money. And so, we want to make sure that, on the one hand, we invest into opportunities that are very important to our company, but we just have a culture of frugality that permeates our company. +And then lastly, from an operational perspective, we unified everything in our company behind one architecture. And whether you're talking about the cloud or workstations, or datacenters, or PCs, or cars, or embedded systems, or autonomous machines, you name it, everything is exactly one architecture. And the benefit of one architecture is that we can leverage one common stack of software, and that -- a base software, it really streamlines our execution. +And so, it's an incredibly efficient approach for leveraging our one architecture into multiple markets. And so, those three aspects of how we run the company really helps. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Next question, Blayne Curtis, Barclays. + +-------------------------------------------------------------------------------- +Blayne Curtis, Barclays Capital - Analyst [36] +-------------------------------------------------------------------------------- + + Hey, guys, thanks for taking my question, and nice results. +I was just curious, two questions. Jen-Hsun, you talked about the ramp of deep learning, and you talked about that you are going to use GPUs for both learning, as well as applying the inferences. Just curious, what stages, you mentioned all these consumers, what stages are all these customers? Are they actually deploying it in volume, or are they still more of sales for learning? +And then, you said all segments up. Just curious, OEM is finally hitting some easy compares. Is that also going to be up year over year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [37] +-------------------------------------------------------------------------------- + + I think this question I should -- + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [38] +-------------------------------------------------------------------------------- + + I think OEM business, will that be up year over year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [39] +-------------------------------------------------------------------------------- + + I think the OEM business is down year over year, isn't it? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [40] +-------------------------------------------------------------------------------- + + Right. And so, on Q2 we'll probably follow along in Q2, along with the overall PC demand, which is not expected to grow. So we'll look at that as our side product, and probably would not be a growth business in Q2. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [41] +-------------------------------------------------------------------------------- + + Yes. So Blayne, you know that our OEM business is a declining part of our company's overall business. And not to mention that the margins are also significantly low on the corporate average. And so, I would suggest that it's just increasingly a less important part of the way that we go to market. Now what I don't mean by that, is that we don't partner with the world's large OEMs, HP, Dell, IBM, Cisco, Lenovo, all of the world large enterprise companies are our partners. +We partner with them to take our platforms, our differentiated platforms, or specialty platforms to the world's market, and most of them are related to enterprise. We just do less and less volume, high-volume components devices. Generic devices like cell phones that we got out of, generic PCs that we've gotten out of. Largely we tend not to do business like that anymore. We tend to focus on our differentiated platforms. +Now you mentioned some, you mentioned learning and training and inferencing. First of all, training is production. You can't train a network just once, you have to train your network all the time. And every single hyperscale company in the world is in the process of scaling out their training. Because the networks are getting bigger, they want their networks to do even better. The difference between a 95% accurate network, and a 98% accurate network, or a 99% accurate network could mean billions of dollars of differences to internet companies. +And so, this is a very big deal. And so, they want their networks to be larger, they want to deploy their networks across more applications, and they want to train their network with new data all the time. And so, training is a production matter. It is probably the largest HPC, high-performance computing application on the planet that we know of at the moment. And so, we're scaling, we're ramping up training for production for hyperscale companies. +On the other hand, I really appreciate you asking about the inferencing We, recently -- well, this year, several months ago we announced the Tesla M4 that was designed for inferencing. And it's a little tiny graphics card, a little tiny processor, and it's less than 50 watts. It's called the M4. And at GTC, I announced a brand-new compiler called the GPU inference engine, GIE. +And GIE recompiles the network that was trained, so that it can be optimumly inferenced at the lowest possible energy. And so, not only are we already 50 watts, which is low power, we can also now inference at a higher energy efficiency, than any processor that we know today, better than any CPU by a very long shot, better than any FPGA. And so, now hyperscale companies could use our GPUs for both training, and use exactly the same architecture for inferencing, and the energy efficiency is really fantastic. +Now the benefit of using GPU for inferencing, is that you're not just trying to inference only. You're trying to, often times, decode the image, or you could be decoding the video, you inference on it. And you might even want to use it for transcoding, which is to re-encode that video, and stream it to whoever it is, that is -- that wants to share live video with. +And so the [proxy] that you want to do on the images and the video and the data, is more than just inferencing, and the benefit of our GPU is that it's really great for all the other stuff too. And so, we're seeing a lot of success in M4. I expect M4 to be quite a successful product, and hyperscale datacenters, my expectation will start to ramp that into production Q2, Q3, Q4 time frame. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Next question, Ross Seymore, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Seymore, Deutsche Bank - Analyst [43] +-------------------------------------------------------------------------------- + + Hi, thanks for letting me ask a question. +On the automotive side, I just wondered, Colette, in your CFO commentary, you mentioned by product development contracts as part of the reason it was increasing. Can you give us a little bit of an indication what those are? And is the percentage of revenue coming from those increasing? And then maybe finally, is that activity indicative of future growth in any way, that can be meaningful for us to track? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [44] +-------------------------------------------------------------------------------- + + Sure, thanks for the question. +So in our automotive business, there's definitely a process even before we're shipping platforms into the overall cars, that we're working jointly with the auto manufacturers, start ups and others on what may be a future product. Many of those agreements continue, and will likely continue going forward, and that is what you see incorporated in our automotive business. So, yes, you probably will see this continue, and go forward. +It is not necessarily consistent, it's starts in some quarters, are bigger in other quarters. But that's what is incorporated in our automotive. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [45] +-------------------------------------------------------------------------------- + + And Colette, let me just add one thing. +The thing to remember is that we're not selling chips into a car. We're not selling -- you know that DRIVE PX is the world's first autonomous driving car computer that's powered by AI, it's powered by deep learning, and we're seeing a lot of success with DRIVE PX. And as Colette mentioned earlier, there's some 80 companies that we're working with, whether it's tier 1s, or OEMs, or start-up companies all over the world that we're working with, in this area of autonomous vehicles. +And the thing to realize is, you're not selling a chip into that car. You're working with a car company to build an autonomous driving car. And so that process requires a fair amount of engineering. And so, we have a mechanism, we have a development mechanism that allows car companies to work with our engineers to collaborate, to develop these self-driving cars. And that's most of that stuff that Colette was talking about. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Next question, Craig Ellis, B Riley & Company. + +-------------------------------------------------------------------------------- +Craig Ellis, B. Riley & Company - Analyst [47] +-------------------------------------------------------------------------------- + + Thanks for taking the question, and congratulations on the revenue and the margin performance. +Jen-Hsun, I wanted to follow up on one of the comments that you made regarding Pascal. I think you indicated that all Pascal parts had taped out. So the question is, if that is the case, will we see refresh activity across all of the platform groups in FY17, or in fact will some of the refresh activity taking place FY18? So what's the duration of the refresh that we are looking at? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [48] +-------------------------------------------------------------------------------- + + Well first, let's -- thanks for the question, and we don't comment on unannounced products as you know. +I hate to ruin all of the surprises for you, but Pascal is the single most ambitious GPU architecture we have ever undertaken. And this is really the first GPU that was designed from the ground up, for applications that are quite well beyond computer graphics and high-performance computing. It was designed to take into consideration, all of the things that we've learned about deep learning, all of the things that we've learned about VR. +For example, it has a brand-new graphics pipeline that allows Pascal to simultaneously project into multiple surfaces at the same time, with no performance penalty, that otherwise, it would degrade your performance in VR by factor by a factor of 2, just because you have two surfaces you're projecting into. And then, we can do all kinds of amazing things for augmented reality, other types of virtual reality displays, surround displays, curved displays, domed displays, I mean there's all kind of -- holographic displays, all kind of display that are being invented at the moment. And we have the ability to now support those type of displays, with a much more elegant architecture, without degrading performance. +And so, Pascal is, whether it's AI, whether it's gaming, whether it's VR, is really the most ambitious project we have ever undertaken, and it's going to go through all of our markets. The application for self-driving cars is going to be pretty exciting. And so, it's going to go through all of our market. And so, we are in -- of course, we have plenty to announce in the future, but we've announced what we announced. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Next question, Romit Shaw, Nomura Research. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Research - Analyst [50] +-------------------------------------------------------------------------------- + + Yes, thanks very much. +Jen-Hsun, I was hoping you could just share your view today on fully autonomous driving, because your mobilized chairman has said very recently, that the technology basically isn't ready. And that fully autonomous cars won't be available until -- I think he was saying 2019. And I guess, my question is well, one, I'd love your view on that? And two, whether the cars are fully autonomous, or autonomous in certain environments say, one or two years out, does it impact the trajectory of your automotive business? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [51] +-------------------------------------------------------------------------------- + + First of all, to -- working on full autonomy is a great endeavor. And whether we get there 100%, 90%, 92%, 93%, is in my mind completely irrelevant. The endeavor of getting there, and making your car more and more autonomous -- initially, of course, we would like to have a virtual copilot. +Having a virtual copilot is the way I get to work every day. I mean, every single day I drive my Model S. And every single day I put it into autonomous mode, and every single day it brings me joy. And I'm not confessing necessarily, texting a little bit is okay. +And so, I think that the path to full autonomy is going to be paved by amazing capabilities along the way. And so, we're not waiting around for 2019, we'll ship autonomous vehicles by the end of this year. And so I understand that we're three years ahead of other people's schedules. +However, we also know that DRIVE PX 2 is the most advanced autonomous computing car computer in the world today. And it's powered by AI fully. And DRIVE PX 2 will be a DRIVE PX 3, there will be a DRIVE PX 4. And then by 2019, I guess, we'll be shipping DRIVE PX 5. +And so, those -- our road map just like that. That's how we work, as you guys know very well. And so, I think there's a point, there 's a lot of work to be done, which is the exciting part. The thing about a technology company, a thing about any company, unless there's great problems and great challenges that we can help solve, what value do we bring? +And what NVIDIA does for a living, is to do what-- to build computers that no other company in the world can build, whether it's high-performance computers that are used to power a nation's supercomputers, or a deep learning supercomputer so that we can gain insight from data, or self-driving car computers, so that autonomous cars can save people's lives, and make people's lives more convenient. +That's what we do. This is the work that we do. And I am delighted here, that we're three years ahead of the competition. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Next question, Suji Desilva, Topeka Capital Markets. + +-------------------------------------------------------------------------------- +Suji Desilva, Topeka Capital Markets - Analyst [53] +-------------------------------------------------------------------------------- + + Hi, Jen-Hsun, hi, Colette. Congratulations on the impressive results here. +On the data center business, is there an inflection going on, with deep learning, with the software maturity that's driving some at this point? And can you give us any metrics. Jen-Hsun, for how to think about the size of this opportunity before you? And I know it's hard, but things like server attach rates, what percent of servers you could attach? Will it be an M4 in an high end in every box? Or was it -- or maybe the number of GPUs a single deep learning implementation has? Something like that. That would help. Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [54] +-------------------------------------------------------------------------------- + + Yes, the truth is that nobody really knows how big, this deep learning market is going to be. Until a couple of two or three years ago, it was really even hard to imagine how good the results were going to be. +And if it wasn't because the groundbreaking work that was done at Google and Facebook, and in other researchers around the world, how would we have discovered, that it was going to be superhuman? The work that recently was done by Microsoft Research. They've achieved superhuman levels of inferencing that -- of image recognition and voice recognition that's really kind of hard to imagine. And these networks are now huge +The Microsoft Research network, super deep network is 1,000 layers deep. And so, training such a network is quite a chore, it's quite endeavor, and this is a problem that high-performance computing will have to deployed, and this is why our GPUs so sought after. +In terms of how big that's going to be, my sense is that almost no transaction -- my sense is that almost no transaction with the internet will be without deep learning, or some machine learning inference in the future. I just can't imagine that. +There's no recommendation of a movie, no recommendation of a purchase, no search, no image search, no text that won't somehow had passed through some smart chatbot, or smartbot, or some machine learning algorithms, so that they could make the transaction more -- make the inference, or more request, more useful to you. And so, I think this is going to be a very big thing. +And then, on the other hand, the enterprises, we use deep learning all over our Company today. And we're not -- we had the benefit of being early, because we saw the power of this technology early on. But we are seeing deep learning being used now in medical imaging all over the world. We're seeing it being used in manufacturing, it's going to be used for scientific computing. +More data is generated by high-performance computers and supercomputers than just about anything. They generate it through simulation. They generate so much data, that they to throw the vast majority of it away. For example, Hadron Collider, whenever the protons collide, they throw away 99% of the data, and they're barely able to keep up with just that 1%. +And so, by using machine learning, and our GPUs, they could find insight in the rest of the 99%. And so, there's just -- applications go on and on and on. And people are now starting to understand this deep learning. It really puts machine learning and puts artificial intelligence in the hands of engineers, is understandable. And that's one of the reasons why it's growing so fast. +And so, I don't know exactly how big it's going to be. But here's my proposition, and this is going to be the next big computing model, the way that people compute. That in the past, software programmers wrote programs, compiled it. And in the future, we're going to have algorithms write the software for us. +And so, that's a [very good way of computing] and I think it's a very good deal. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Next question, David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks very much. +In automotive, what product are your revenues coming from currently? Is DRIVE PX at all significant, or are your sales primarily DRIVE CX, or something else? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President & CEO [57] +-------------------------------------------------------------------------------- + + The primary parts of our automotive business today comes from infotainment, in the premier infotainment systems. For example, the virtual cockpit that Audi ships. And the vast majority of our development projects today come from DRIVE [PX] on those projects. +We probably have 10 times as many autonomous driving projects, as we have infotainment projects today. And we have a fair number of infotainment projects. And so, that gives you a sense of where we were in the past, and where we're going in the future. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + I'm showing no further questions at this time. Mr. Chanda, please I will turn the call over to you. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [59] +-------------------------------------------------------------------------------- + + We had a great start to the year, with strong revenue growth and profitability. Pascal is a quantum leap in performance for AI, gaming, and VR and is in full production. +Deep learning is spreading across every industry, making datacenter our fastest growing business. With growing worldwide adoption of AI, the arrival of VR, and the rise of self-driving cars, we're really excited about the future. Thanks for tuning in. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, that concludes today's conference call. We thank you for your participation, and we ask that you please disconnect your line. Have a great day, everyone. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2016-Nov-10-NVDA.txt b/Transcripts/NVDA/2016-Nov-10-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..f4fe6734bf341c9dbe19f0b5edaf15e389018766 --- /dev/null +++ b/Transcripts/NVDA/2016-Nov-10-NVDA.txt @@ -0,0 +1,372 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 NVIDIA Corp Earnings Call +NOVEMBER 10, 2016 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Arnab Chanda + NVIDIA Corporation - VP of IR + * Jen-Hsun Huang + NVIDIA Corporation - President and CEO + * Colette Kress + NVIDIA Corporation - EVP and CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Toshiya Hari + Goldman Sachs - Analyst + * Harlan Sur + JPMorgan - Analyst + * David Wong + Wells Fargo Securities, LLC - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Romit Shah + Nomura Securities Co., Ltd. - Analyst + * Steven Chin + UBS - Analyst + * Craig Ellis + B. Riley & Co. - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Atif Malik + Citigroup - Analyst + * Mitch Steves + RBC Capital Markets - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Victoria, and I will be your conference operator today. Welcome to NVIDIA financial results conference call. +(Operator Instructions) +I will now turn the call over to Arnab Chanda, Vice President of Investor Relations. You may begin your conference. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the third quarter of FY2017. With me on the call today from NVIDIA our Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It is also being recorded. You can hear a replay by telephone until the 17th of November 2016. The webcast will be available for replay up until next quarter's conference call to discuss Q4 financial results. The content of today's call is NVIDIA's property. It cannot be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All of our statements are made as of today, the 10th of November 2016, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find your reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary which is posted on our website. With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP and CFO [3] +-------------------------------------------------------------------------------- +Thanks, Arnab. Revenue reached a record in the third quarter exceeding $2 billion for the first time. Driving this was success in our Pascal-based gaming platform and growth in our data center platform reflecting the role of NVIDIA's GPU as the engine of AI computing. Q3 revenue increased 54% from a year earlier to $2 billion and was up 40% from the previous quarter. Strong year-on-year gains were achieved across all four of our platforms. Gaming, professional visualization, data center, and automotive. The GPU business was up 53% to $1.7 billion, and the Tegra processor business increased 87% to $241 million. +Let's start with our gaming platform. Gaming revenue crossed the $1 billion mark and increased 63% year on year to a record $1.24 billion fueled by our Pascal-based GPUs. Demand was strong in every geographic region across desktop and notebook and across the full gaming audience from GTX 1050 to the Titan X. GeForce gaming PC notebooks recorded significant gains. Our continued growth in the GTX gaming GPUs reflects the unprecedented performance and efficiency gains in the Pascal architecture. It delivers seamless play on games and richly immersive VR experiences. +In Q3 for desktops, we launched the GTX 1050 and the 1050 Ti bringing eSports and VR capabilities at great value. For notebooks, we introduced GTX 1080, 1070, and 1060 giving gamers a major leap forward in performance and efficiency in a mobile experience. The fundamentals of the gaming market remain strong. The production value of blockbuster games continues to increase. +Gamers are upgrading to higher-end GPUs to enjoy highly anticipated fall titles like Battlefield 1, Gears of War 3, Call of Duty: Infinite Warfare, and eSports is attracting a new generation of gamers to the PC. League of Legends is played by over 100 million gamers each month. And, there is now a Twitch audience of more than 300 million who follow eSports. VR and AR will redefine entertainment and gaming. A great experience requires a high performance GPU, and we believe we are still in the early innings of these evolving markets. Pascal represents not only the biggest innovation gains we've made in a single GPU generation in a decade, it's also our best executed product rollout. +Moving to professional visualization, Quadro revenue grew 9% from a year ago to $207 million driven by growth in the high end of the markets for Realtime rendering and mobile workstations. We are seeing strong customer interest in the Pascal-based P6000 among digital entertainment leaders like: Pixar, Disney, and ILM, architectural, engineering, and construction companies like Japan's SHIMIZU, and automotive companies like Hyundai. +Next, data center. Revenue nearly tripled from a year ago and was up 59% sequentially to $240 million. Growth was strong across all fronts in AI and supercomputing for hyperscale as well as for GRID virtualization and supercomputing. GPU deep learning is revolutionizing AI and is poised to impact every industry worldwide. Hyperscale companies like Facebook, Microsoft, and Baidu are using it to solve problems for their billions of consumers. +Cloud GPU computing has shown explosive growth. Amazon Web Services, Microsoft Azure, and Ali cloud are deploying NVIDIA GPUs for AI data analytics and HPC. AWS most recently announced its new EC2 P2 Instance which scales up to 16 GPUs to accelerate a wide range of AI applications including image and video recognition, unstructured data analytics, and video transcoding. We saw strong growth in AI training. For AI inference, we announced the Tesla P4 and P40 to serve power-efficient and high performance workloads, respectively. +Shipments began in Q3 for the DGX-1 AI super computer. Early users include major universities like Stanford, UC Berkeley, and NYU, leading research groups such as OpenAI, the German Institute of Artificial Intelligence, and the Swiss Artificial Intelligence Lab as well as multinationals like SAP. So far this year, our GPU technology conference program has reached 18,000 developers and ecosystem partners underscoring the broad enthusiasm for AI. Complementing our major spring event in Silicon Valley, we have organized GPCs in seven cities on four continents. They drew sellout audiences in Beijing, Taipei, Tokyo, and Seoul, as well as Amsterdam, Melbourne, and Washington DC, with Mumbai still to come. Along with 400 sessions and labs, we provided training in AI skills to nearly 2,000 individuals through our Deep Learning Institute construction program. +We also have begun partnering with key global companies to enable the adoption of AI. To implement AI in manufacturing, we announced a collaborative with Japan's FANUC focused on robots and automated factories, and in the transportation sector, more than 80 OEMs, Tier 1s, and startups are using our GPUs for their work on self-driving cars. +Our GRID graphics virtualization business continues to achieve extremely strong growth. Adoption is accelerating across a variety of industries particularly manufacturing, automotive, engineering, and education. Among customers added this quarter were John Hopkins University and GE global India. +And, finally, in automotive, revenue increased to a record $127 million, up 61% year over year and up 7% sequentially from premium infotainment products. NVIDIA is developing an end-to-end AI computing platform for autonomous driving. This allows car makers to collect and label data, train their own deep neural networks on the video GPUs in the data center, and then process them in the car with DRIVE PX 2. +We have also been developing a cloud-to-car HD mapping system with mapping companies all over the world. Two such partnerships were announced this quarter. We are working with Baidu to create a cloud-to-car development platform with HD maps, Level 3 autonomous vehicles, and automated parking. We are also partnering with TomTom to develop an AI-based, cloud-to-car mapping system that enables real-time, in-car localization to mapping. +We've developed an integrated, scalable AI platform with capabilities ranging from automated highway driving to fully autonomous driving operation. We are extending the DRIVE PX2 architecture to scale in performance and power consumption. It will range from DRIVE PX2 auto cruise with a single SSE for self-driving on highways up to multiple DRIVE PX2 computers capable of enabling fully autonomous driving. +We also announced a single-chip AI supercomputer called Xavier with over 7 billion transistors. Xavier incorporates our next GPU architecture, a custom CPU design, and a new computer vision accelerator. Xavier will deliver performance equivalent to today's full DRIVE PX2 board, and its two Parker SoCs and two Pascal GPUs while only consuming a fraction of the energy. +Finally, Tesla motors announced last month that all its factory-produced vehicles: the Model S, the Model X, and upcoming Model 3 feature a new autopilot system powered by the NVIDIA DRIVE PX2 platform and will be capable of fully autonomous operation via future software updates. This system delivers over 40 times the processing power of the previous technology and runs a new, neural network for vision, sonar, and data processing. Beyond our four platforms, our OEM and IP business was $186 million, down 4% year on year. +Now, turning to the rest of the income statement. GAAP gross margin for Q3 was a record 59%, and non-GAAP gross margin was a record 59.2%. These reflect the strength of our GeForce gaming GPUs, the success of our platform approach, and strong demand for Deep Learning. GAAP operating expenses were $544 million including $66 million in stock-based compensation and other charges. +Non-GAAP operating expenses were $478 million, up 11% from one year earlier. This reflects headcount-related costs for our growth initiatives as well as investments in sales and marketing. We intend to continue to invest in Deep Learning to capture this once-in-a-lifetime opportunity. Thus, we would expect the operating expense growth rate to be sustained over the next several quarters. +GAAP operating income was $639 million. Non-GAAP operating income more than doubled to $708 million. Non-GAAP operating margins were over 35% this quarter. For FY18, we intend to return $1.25 billion to shareholders through ongoing quarterly cash dividends and share repurchases. We also announced a 22% increase in our quarterly cash dividend to $0.14 per share. +Now turning to the outlook for the fourth-quarter of FY17, we expect revenue to be $2.1 billion, plus or minus 2%. Our GAAP and non-GAAP gross margin are expected to be 59% and 59.2%, respectively, plus or minus 50 basis points. GAAP operating expenses are expected to be $572 million. Non-GAAP operating expenses are expected to be approximately $500 million. And, GAAP and non-GAAP tax rates for the fourth quarter of FY17 are both expected to be 20%, plus or minus 1%. With that, Operator, I'm going to turn it back to you and see if we can take some questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Mark Lipacis, Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking my questions and congratulations on a great quarter. I think to start out, Jen-Hsun, maybe if you could help us understand -- the data center business tripled year over year. What's going on in that business that's enabling that to happen? if you could maybe talk about if it's on the technology side or the end market side? And, maybe as part of that, you can help us deconstruct the revenues and what's really driving that growth? And, I had a follow-up, too. Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [3] +-------------------------------------------------------------------------------- +A couple things. First of all, GPU computing is more important than ever. There's so many different types of applications that require GPU computing today, and it's permeating all over enterprise. There are several applications that we're really driving. One of them is graphics virtualization, application virtualization. Partnering with VMware and Citrix, we have essentially taken very compute-intensive, very graphics-intensive applications, virtualizing it and putting it into the data center. +The second is computational sciences. Using our GPU for general-purpose scientific computing, and scientific computing, as you know, is not just for scientists. It's running equations and using numerics is a tool that is important to a large number of industries. And then, third, one of the most exciting things that we're doing because of deep learning we've really ignited a wave of AI innovation all over the world. These several applications -- graphics application, virtualization, computational science, and data science has really driven our opportunity in the data center. +The thing that made it possible though -- the thing that really made it possible was really the transformation from our Company from a graphics processor to a general-purpose processor, and then on top of that -- probably the more important part of that is transforming from a chip Company to a platform Company. What makes application and graphics virtualization possible is a complicated stack of software we call GRID, and you have heard me talk about it for several years now. And, second, in the area of numerics and computational sciences, CUDA, our rich library of applications and libraries on top of numerics -- numerical libraries on top of CUDA and all the tools that we have invested in the ecosystem we have worked with all the developers all around the world that now know how to use CUDA to develop applications makes that part of our business possible. +And then, third, our deep learning toolkit, the NVIDIA deep learning toolkit has made it possible for all frameworks in the world to get GPU acceleration. And, with GPU acceleration the benefit is incredible. It's not 20% it's not 50%. It's 20 times, 50 times. That translates to most importantly for researchers the ability to gain access to insight much, much faster. Instead of months, it could be days. It's essentially like having a time machine. And, secondarily, for IT managers it translates to lower energy consumption, and most importantly, it translates to a substantial reduction in data center cost. Whereas you have a rack of servers with GPUs, it replaces an entire basketball court of cluster of off-the-shelf servers. And so, a pretty big deal. A great value proposition. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Vivek Arya, Bank of America Merrill Lynch + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [5] +-------------------------------------------------------------------------------- +Thanks for taking my question and congratulations on the consistent growth and execution. Jen-Hsun, one more on the data center business. It has obviously grown very strongly this year, but in the past, it has been lumpy. For example, when I go back to your FY15, it grew 60% to 70% year on year. Last year, it grew about 7%. This year, it is growing over 100%. How should we think about the diversity of customers and the diversity of applications to help us forecast how the business can grow over the next one or two years? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [6] +-------------------------------------------------------------------------------- +I think embedded in your question, in fact, are many of the variables that influence our business. Especially in the beginning, several years ago when we started working on GPU computing and bringing this capability into data centers. We relied on supercomputing centers in the beginning, and then, we relied on remote workstations, data center workstations, if you will, virtualized workstations. And, then, increasingly we started relying on -- we started seeing demand from hyperscale data centers as they used our GPUs for deep learning and to develop their networks. And now, we're starting to see data centers take advantage of our new GPUs, P40 and P4 to apply to operate, to use the networks for inferencing in a large-scale way. So, I think we are moving, if you will, our data center business in multiple trajectories. +The first trajectory is the number of applications we can run. Our GPU now has the ability with one architecture to run all of those applications that I mentioned from graphics virtualization to scientific computing to AI. Second, we used to be in data centers, but now we're in data centers, supercomputing centers, as well as hyperscale data centers. And then, third, the number of applications -- industries that we effect is growing. It used to start with supercomputing. Now, we have supercomputing. We have automotive. We have oil and gas. We have energy discovery. We have financial services industry. We have, of course, one of the largest industries in the world, consumer Internet Cloud services. And so, we're starting to see applications in all of those different dimensions. +I think the combination of those three things: the number of applications, the number of platforms and locations by which we have success. And then, of course, the number of industries that we affect. The combination of that should give us more upward directory in a consistent way. But, I think really, the mega point though is really the size of the industries we are now able to engage. In no time in the history of our Company have we ever been able to engage industries of this magnitude. And so, that's the exciting part, I think, in the final analysis. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [8] +-------------------------------------------------------------------------------- +Great. Thanks for taking my question and congratulations on a very strong quarter. Jen-Hsun, you've been on the road quite a bit over the past few months, and I'm sure you've had the opportunity to connect with many of your important customers and partners. Can you maybe share with us what you learned from the multiple trips? And, how your view on the Company's long-term growth trajectory changed, if at all? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [9] +-------------------------------------------------------------------------------- +Yes. Thanks a lot, Toshi. First of all, the reason why I've been on the road for almost two months solid is because at the request and the demand, if you will, from developers all over the world for a better understanding of GPU computing and getting access to our platform and learning about all of the various applications that GPUs can now accelerate. The demand is just really great. We no longer could do GTC, which is our developer conference, essentially our developer conference. We can no longer do GTC just here in Silicon Valley, and so we this year decided to take it on the road. And, we went to China, went to Taiwan, went to Japan, went to Korea. We had one in Australia, and also one in India and Washington DC and Amsterdam for Europe. +So, we pretty much covered the world with our first global developer conference. I would say probably the two themes that came out of it, is that GPU acceleration, the GPU has really reached a tipping point. That it is so available everywhere. It's available on PCs. It's available from every computer company in the world. It's in the cloud. It's in the data center. It's in laptops. GPU is no longer a niche component. As they say, it's a large-scale, massively available general-purpose computing platform. So I think people realize now the benefits of GPU and that the incredible speedup or cost reduction -- basically, the opposite sides of a coin that you can get with GPUs. So, GPU computing. +Number two, is AI. Just the incredible enthusiasm around AI, and the reason for that, of course, for everybody who knows already about AI what I'm going to say is pretty clear. But, there's a large number of applications, problems, challenges where a numerical approach is not available. A laws-of-physics-based, equation-based approach is not available. These problems are very complex. Oftentimes, the information is incomplete, and there's no laws of physics around it. For example, what's the laws of physics of what I look like? What's the laws of physics for recommending tonight's movie? So, there's no laws of physics involved. +The question is how do you solve those kind of incomplete problems? There's no laws-of-physics equation that you can program into a car that causes the car to drive and drive properly. These are artificial intelligence problems. Search is an artificial intelligence problem. Recommendations is an artificial intelligence problem. So, now that GPU deep learning has ignited this capability, and it has made it possible for machines to learn from a large amount of data and to determine the features by itself -- to compute the features to recognize. GPU deep learning has really ignited this wave of AI revolution. So, I would say the second thing that is just incredible enthusiasm around the world is learning how to use GPU deep learning. How to use it to solve AI-type problems, and to do so in all of the industries that we know from healthcare to transportation to entertainment to enterprise to you name it. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Atif Malik, Citigroup. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup - Analyst [11] +-------------------------------------------------------------------------------- +Hi. Thanks for taking my question and congratulations. You mentioned that Maxwell upgrade was about 30% of your (technical difficulty) exactly two years. Should we be thinking about a two-year time (inaudible)? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [12] +-------------------------------------------------------------------------------- +Atif, first of all, there were several places where you cut out, and this is one of those artificial intelligence problems. Because what I heard incomplete information, but I'm going to infer from some of the important words that I did hear, and I'm going to apply in this case human intelligence to see if I can predict what it is that you were trying to ask. The baseline, the basis of your question was that Maxwell -- in the past, Maxwell GPU during that generation, we saw an upgrade cycle about every two or three years. And, we had an install base of some 60 million, 80 million gamers during that time and several years have now gone by. The question is what would be the upgrade cycle for Pascal, and what would it look like? +There are several things that have changed that I think it's important to know that could affect the Pascal upgrade. First of all, the increase in adoption, the number of units has grown, and the number of the ASP has grown. And, I think the reason for that is several-fold. I think, one, the number of gamers in the world is growing. Everybody that is effectively born in the last 10, 15 years are likely to be a gamer and so long as they have access to electricity and the Internet, they are very likely a gamer. The quality of games has grown significantly. +One of the factors of production value of games that has been possible is because the PC and the two game consoles, Xbox and PlayStation, and in the future, in the near future, the Nintendo Switch. All of these architectures are common in the sense that they all use modern GPUs. They all use programmable shading, and they all have basically similar features. They have very different design points. They have different capabilities, but they have very similar architectural features. As a result of that, game developers can target a much larger install base with one common code base. As a result, they can increase the production quality, the production value of the games. +The second -- and one of the things that you might have noticed that recently, PlayStation and Xbox both announced 4K versions. Basically, the Pro versions of their game console. That's really exciting for the gaming industry. It's really exciting for us because what's going to happen is the production value of games will amp up, and as a result, it would increase the adoption of higher-end GPUs. I think that that's a very important positive. That's probably the second one. The first one being the number of gamers is growing. Second is game production value continues to grow. +And then the third is gaming is no longer just about gaming. Gaming is part sports, part gaming, and part social. There's a lot of people who play games just so they can hang out with their other friends who are playing games. It's a social phenomenon. And then, of course, because games are -- the quality of games, the complexity of games, and some such as League of Legends, such as StarCraft; the real-time simulation, the real-time strategy component of it, the agility, the hand-eye coordination part of it, the incredible teamwork part of it is so great that it has become a sport. Because there are so many people in gaming, because it's a fun thing to do, and it's hard to do so it's hard to master. And the size of the industry is large. It has become a real sporting event. +And, one of the things that I'll predict is that one of these days, I believe that gaming would likely be the world's largest sport industry. And, the reason for that is because it's the largest industry. There are more people who play games and now enjoy games and watch other people play games than there are people who play football, for example. So, I think it stands to reason that eSports will be the largest sporting industry in the world, and that's just a matter of time before it happens. So, I think all of these factors have been driving both the increase in the size of the market for us as well as the ASP of the GPUs for us. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Steven Chin, UBS. + +-------------------------------------------------------------------------------- +Steven Chin, UBS - Analyst [14] +-------------------------------------------------------------------------------- +Hi, thanks for taking my questions. Jen-Hsun, first question if I could on your comments regarding the GRID systems. You mentioned some accelerating demands in the manufacturing and automotive verticals? Just wondering if you had any thoughts on what inning you are currently in, in terms of seeing a strong ramp-up towards a full run rate for those areas? And, especially for the broader corporate enterprise and market vertical, also? And, as a quick follow-up on the gaming side, was wondering if you had any thoughts on whether or not there is still a big gap between the ramp-up of Pascal supply and the pent-up demand for those new products? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [15] +-------------------------------------------------------------------------------- +Sure. I would say that we're probably in the first at-bat of the first inning of GRID. The reason for that is this. We prepared ourselves. We went to spring training camp. We came up through the farm league or something like that. I'm not really a baseball player, but I heard some people talk about it. So, I think we're probably at the first at-bat of the first inning. The reason why I'm excited about it is because I believe in the future applications are virtualized in the data center or in the cloud. +On first principles, I believe that data applications will be virtualized, and that you will be able to enjoy these applications irrespective of whether you're using a PC, a chrome notebook, a Mac, or a Linux workstation. It simply won't matter. And yet, on the other hand, I believe that in the future applications will become increasingly GPU-accelerated. How do you put something in the cloud that have no GPUs, and how do you GPU-accelerate these applications that are increasingly GPU-accelerated? The answer is, of course, is putting GPUs in the cloud and putting GPUs in data center. That's what GRID is all about. It's about virtualization. It's about putting GPUs in large-scale data centers and be able to virtualize the applications so that we can enjoy it on any computer, on any device, and putting computing closer to the data. +I think we're just in the beginning of that, and that could explain why GRID is finally after a long period of time of building the ecosystem, building the infrastructure, developing all the software, getting the quality of service to be really exquisite, working with the ecosystem partners, it has really taken off. And I could surely expect to see it continue to grow at the rate that we're seeing for some time. +In terms of Pascal, we are still ramping. Production is fully ramped in the sense that all of our products are fully qualified. They are on the market. They have been certified and qualified with OEMs. However, demand is still fairly high so we're going to continue to work hard. Our manufacturing partner, TSMC, is doing a great job for us. The yields are fantastic for 2016 FinFET, and they're just doing a fantastic job supporting us. We're just going to keep running at it. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- +Thank you very much. Great quarter by the way and still amazed how good this is. Can you talk a little bit about the size of the inference opportunity? Obviously, you have done really well in training. I assume penetrating inference is reasonably early on, but can you talk about how you see GPUs competitively versus FPGAs on that side of it, and how big you think that opportunity could become? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [18] +-------------------------------------------------------------------------------- +Sure, I'll start backwards. I'll start backwards and answer the FPGA question first. FPGA is good at a lot of things, and anything that you could do on an FPGA if the market opportunity is large, you could always -- it's always better to develop an ASIC. And, FPGA is what you use when the volume is not large. FPGA is what you use when you are not certain about the functionality you want to put into something. FPGA is largely useful when the volume is not large. Because you could build an ASIC -- you could build a full-custom chip that obviously could deliver more performance. Not 20% more performance but 10 times better performance and better energy efficiency than you could using FPGAs. I think that's a well-known fact. +Our strategy is very different than any of that. Our strategy is really about building a computing platform. Our GPU is not a specific function thing anymore. It's a general-purpose parallel processor. CUDA can do molecular dynamics. It could do fluid dynamics. It could do partial differential equations. It could do linear algebra. It could do artificial intelligence. It could be used for seismic analysis. It could be used for computer graphics, even computer graphics. And so, our GPU is incredibly flexible, and it's really designed for, it's designed specifically for parallel throughput computing. And, by combining it with the CPU, we have created a computing platform that is both good at sequential information, sequential instruction processing as well as very high throughput data processing. And so, we have created a computing architecture that's good at both of those things. +The reason why we believe that's important is because several things. We want to build a computing platform that is useful to a large industry. You could use it for AI. You could use it for search. You could use it for video transcoding. You could use it for energy discovery. You could use it for health. You could use it for finance. You could use it for robotics. You could use it for all these different things. +On the first principles, we're trying to build a computing platform. It's a computing architecture. And, not a dedicated application thingy. Most of the customers that we're calling on, most of the markets that we are addressing, and the areas that we have highlighted are all computer users. They need to use and deploy a computing platform. It has the benefit of being able to rapidly improve their AI networks. +AI is still in the early days. It's the early days of early days, and GPU deep learning is going through innovations at a very fast clip. Our GPU allows people to learn to develop new networks and deploy new networks as quickly as possible. So, I think the way to think about it is think of our GPU as a computing platform. +In terms of the market opportunity, the way I would look at it is this. The way I would look at is there are something along the lines of 5 million to 10 million hyperscale data center nodes. I think, as you have heard me say this before, I think that training is a new set of HPC clusters that have been added into these data centers. And then, the next thing that's going to happen is you're going to see GPUs being added to a lot of these 5 million to 10 million nodes so that you could accelerate every single query that will likely come into the data center will be an AI query in the future. I think GPUs have an opportunity to see a fairly large hyperscale installed base. +But, beyond that there is the enterprise market. Still although, a lot of computing is done in the cloud, a great deal of computing especially the type of computing that we're talking about here that requires a lot of data -- and we're a data throughput machine -- the type of computers that we're talking about tends to be one of being in enterprise. And, I believe a lot of the enterprise market is going to go towards AI; and the type of things that we are looking for in the future is to simplify our business processors using AI, to find business intelligence or insight using AI, to optimize our supply chain using AI, to optimize our forecasting using AI, to optimize the way that we find and surprise and delight customers, digital customers or customers in digital using AI. So, all of these parts of the business operations of large companies, I think AI can really enhance. +And then, the third -- so hyperscale, enterprise computing, and then the third is something very, very new. It's called IoT. IoT -- we're going to have 1 trillion things connected to the Internet over time, and they are going to be measuring things from vibration, to sound, to images, to temperature, to air pressure, to -- you name it. These things are going to be all over the world, and we are going to measure and we are going to be constantly measuring and monitoring their activity. And, using the only thing that we can imagine that can help to add value to that and find insight from that is really AI using deep learning. We could have these new types of computers, and they will likely be on-premise or near the location of the cluster of things that you have. And, monitor all of these devices and keep -- prevent them from failing or adding intelligence to it so that they add more value to what it is that people have them do. So, I think the size of the marketplace that we are addressing is really larger than any time in our history. And, probably the easiest way to think about it is we're now a computing platform Company. We are simply a computing platform Company, and our focus is GPU computing and one of the major applications is AI. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Craig Ellis, B. Riley and Company. + +-------------------------------------------------------------------------------- +Craig Ellis, B. Riley & Co. - Analyst [20] +-------------------------------------------------------------------------------- +Thanks for taking the question and congratulations on the stellar execution. Jen-Hsun, I wanted to go back to the automotive business. In the past, the Company has mentioned that the revenues consist of display and then on the auto-pilot side both consulting and product revenues. But, I think much more intensively on the consulting side for now. But, as we look ahead to Xavier and the announcement that you had made intra-quarter that, that's coming late next year, how should we expect that the revenue mix would evolve? Not just from consulting to product, but from Parker towards Xavier? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [21] +-------------------------------------------------------------------------------- +I don't know that I have really granular breakdowns for you, Craig, partly because I'm just not sure. But, I think the dynamics are that self-driving cars is probably the single-most disruptive event -- the most disruptive dynamic that's happening in the automotive industry. It's almost impossible for me to imagine that in five years time, a reasonably capable car will not have autonomous capability at some level. And, a very significant level at that. I think what Tesla has done by launching and having on the road in the very near future here full autonomous driving capability using AI, that has sent a shockwave through the automotive industry. It's basically five years ahead. +Anybody who's talking about 2021, that's just a non-starter anymore. I think that, that's probably the most significant bit in the automotive industry. Anybody who was talking about autonomous capabilities and 2020 and 2021 is at the moment reevaluating in a very significant way. So, I think that, of course, will change how our business profile will ultimately look. It depends on those factors. Our autonomous vehicle strategy is relatively clear, but let me explain it anyway. +Number one, we believe that autonomous vehicles is not a detection problem, it's an AI computing problem. That it's not just about detecting objects. It's about perception of the environment around you. It's about reasoning about what to do -- what is happening and what to do -- and to take action based on that reasoning. And, to be continuously learning. So, I think that AI computing requires a fair amount of computation, and anybody who thought that it would take only one or two watt -- basically, the amount of energy -- one-third the energy of a cell phone. I think it's unfortunate, and it is not going to happen any time soon. +So, I think people now recognize that AI computing is a very software-rich problem, and it is a supremely exciting AI problem. And, that deep learning and GPUs could add a lot of value, and it is going to happen in 2017, it's not going to happen in 2021. I think number one. Number two, our strategy is to apply, to deploy a one-architecture platform that is open that car companies could work on to leverage our software stack and create their network, their artificial intelligence network. And, that we would address everything from highway cruising, excellent highway cruising, all the way to full autonomous to trucks to shuttles. And, using one computing architecture, we could apply it for radar-based systems, radar plus cameras, radar plus cameras plus Lidars. We could use it for all kinds of sensor fusion environments. So, I think our strategy is really resonating well with the industry as people now realize that we need the computation capability five years earlier. That's not a detection problem, but it's an AI computing problem and that software is really intensive. But, these three observations, I think, has put us in a really good position. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitch Steves, RBC Capital Markets - Analyst [23] +-------------------------------------------------------------------------------- +Hi. Thanks for taking my question. Great quarter across the board. I did want to return to the automotive segment because the data center segment has been talked about at length. With the new Drive PX platform increasing potentially the ASPs, how do we think about the ASPs for automotive going forward? And, if I recall, you had about $30 million in backlog in terms of cars? I'm not sure if it's possible to get an update there as well? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [24] +-------------------------------------------------------------------------------- +Our architecture for Drive PX is scalable. You could start from one Parker SoC, and that allows you to have surround camera. It allows you to use AI for highway cruising. And, if you would like to have even more cameras so that your functionality could be used more frequently in more conditions, you could always add more processors. So, we go from one to four processors. And, if it's a fully autonomous, driverless car -- a driverless taxi, for example, you might need more than even four of our processors. You might need eight processors. You might need 12 processors. And, the reason for that is because you need to reduce the circumstance by which auto-pilot doesn't work, doesn't turn on, excuse me, doesn't engage. And, because you don't have a driver in the car at all. I think that depending on the application that you have, we will have a different configuration, and it's scalable. It ranges from a few hundred dollars to a few thousand dollars so I think it just depends on what configuration people are trying to deploy. Now for a few thousand dollars, the productivity of that vehicle is incredible as you can simply do the math. It's much more available. The cost of operations is reduced. And, a few thousand dollars is surely almost nothing in the context of that use case. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan - Analyst [26] +-------------------------------------------------------------------------------- +Good afternoon. Congratulations on the solid execution and growth. Looking at some of your cloud customers' new services offerings, you mentioned AWS EC2 P2 platform. You have Microsoft Azure's Cloud Services platforms. It's interesting because they are ramping new instances primarily using your K80 accelerator platform which means that the Maxwell base and the recently introduced Pascal-based adoption curves are still way ahead of the team which obviously is a great setup as it relates to the continued strong growth going forward. Can you just help us understand why the long design and cycle times for these accelerators? And, when do you expect the adoption curve for the Maxwell-based accelerators to start to kick in with some of your Cloud customers? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [27] +-------------------------------------------------------------------------------- +Harlan, good question. And, it's exactly the reason why having started almost five years ago in working with all of these large-scale data centers is what it takes. The reason for that is because several things have to happen. Applications have to be developed. They're hyperscale. They are enterprise -- their data center-level software has to accommodate this new computing platform. The neural networks have to be developed and trained and ready for deployment. The GPUs have to be tested against every single data center and every single server configuration that they have, and it takes that type of time to deploy at the scales that we are talking about. So, I think that, that's number one. +The good news is that between Kepler and Maxwell and Pascal, the architecture is identical. Even though the underlying architecture has been improved dramatically and the performance increases dramatically, the software layer is the same. So, the adoption rate of our future generations is going to be much, much faster, and you will see that. It takes that long to integrate our software and our architecture and our GPUs into all of the data centers around the world. It takes a lot of work. It takes a long time. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Romit Shah, Nomura. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Co., Ltd. - Analyst [29] +-------------------------------------------------------------------------------- +Yes, thank you. Jen-Hsun, I just wanted to ask regarding the auto-pilot win. We know that you displaced Mobileye, and I was just curious if you could talk about why Tesla chose your GPU? And, what you can give us in terms of the ramp and timing, and how would a ramp like this affect automotive gross margin? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [30] +-------------------------------------------------------------------------------- +I think there are three things that we offer today. The first thing is that it's not a detection problem, it's an AI computing problem. And, a computer has processors and the architecture is coherent and you can program it. You could write software. You can compile to it. It's an AI computing problem, and our GPU computing architecture has the benefit of 10 years of refinement. In fact, this year is the 10-year anniversary of our first GPGPU, our first CUDA GPU called G8, and we been working on this for 10 years. And so, the number one is autonomous driving, autonomous vehicles is an AI computing problem. It's not a detection problem. +Second, car companies realize that they need to deliver ultimately a service. That the service is a network of cars by which they continuously improve. It's like phones. It's like set-top boxes. You have to maintain and serve that customer because they are interested in the service of autonomous driving. It's not a functionality. Autonomous driving is always being improved with better maps and better driving behavior and better perception capability and better AI, so the software component of it and the ability for car companies to own their own software once they develop it on our platform is a real positive. Real positive to the point where it's enabling, or it's essential for the future of the driving fleets. +And then, the third -- to be able to continue to do OTA on them. And, third, is simply the performance and energy level. I don't believe it's actually possible at this moment in time to deliver an AI computing platform of the performance level that is required to do autonomous driving at an energy efficiency level that is possible in a car and to put all the functionality together in a reasonable way. I believe DRIVE PX2 is the only viable solution on the planet today. So, because Tesla had a great intention to deliver this level of capability to the world five years ahead of anybody else, we were a great partner for them. So, those are probably the three reasons. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [32] +-------------------------------------------------------------------------------- +Thank you very much. Good afternoon. Jen-Hsun, I make an interesting observation about your commentary that your Company has gone from a graphic accelerator Company to a computing platform Company, and I think that's fantastic. One of the things that I wonder as maybe AI and deep learning acceleration standardize on your platform, what you are seeing and hearing in the Valley about startup activity? And, folks that are trying to innovate around the platform that you are bringing up both complementary to what you are doing, and potentially really long-term competitive to what you are doing? Would love to hear your perspectives on that. Thanks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [33] +-------------------------------------------------------------------------------- +Yes, Matthew, I really appreciate that. We see a large number of AI startups around the world. There's a very large number here in the United States, of course. There's quite a significant number in China. There's a very large number in Europe. There's a large number in Canada. It's pretty much a global event. The number of software companies that have now jumped on to using GPU deep learning and taking advantage of the computing platform that we have taken almost seven years to build, and it's really quite amazing. We are tracking about 1,500. +We have a program called Inception, and Inception is our startup support program, if you will. They can get access to our early technology. They can get access to our expertise, our computing platform, and all that we've learned about deep learning we can share with many of these startups. They are trying to use deep learning in industries from cybersecurity to genomics to consumer applications, computational finance, to IoT, robotics, and self-driving cars. The number of startups out there is really quite amazing. +So, our deep learning platform is a really unique advantage for them because it's available in a PC so you can -- almost anybody with even a couple hundred dollars of spending money can get a startup going with a [video] GPU that can do deep learning. It's available from system builders and server OEMs all over the world: HP, Dell, Cisco, IBM, system builders, small system builders, local system builders all over the world. And very importantly, it's available in cloud data centers all over the world so Amazon AWS, Microsoft's Azure cloud has a really fantastic implementation ready to scale out. You have got the IBM cloud. You have got Alibaba cloud. So, if you have a few dollars an hour for computing, you pretty much can get a company started and use the NVIDIA platform in all of these different places. So, it's an incredibly productive platform because of its performance. It works with every framework in the world. It's available basically everywhere, and so as a result of that, we've given artificial intelligence startups anywhere on the planet the ability to jump on and create something. The availability, if you will, the democratization of deep learning -- NVIDIA's GPU deep learning is really quite enabling for startups. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +David Wong, Wells Fargo. + +-------------------------------------------------------------------------------- +David Wong, Wells Fargo Securities, LLC - Analyst [35] +-------------------------------------------------------------------------------- +Thanks very much. It was really impressive that 60% growth in your gaming revenues. So, does this imply that there was a 60% jump in [cards] that are being been sold by [online] retailers and retail stores? Or, does the growth reflect new channels through which NVIDIA gaming products are getting to customers? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [36] +-------------------------------------------------------------------------------- +It's largely the same channels. Our channel has been pretty stable for some time. We have a large network. I appreciate your question. It's one of our great strengths, if you will. We cultivated over two decades a network of partners who take the GeForce platform out to the world. You could access our GPUs. You can access GeForce and be part of the GeForce PC gaming platform from literally anywhere on the planet. So, that's a real advantage, and we're really proud of them. +I guess you could also say that Nintendo contributed a fair amount to that growth, and over the next -- as you know, the Nintendo architecture and the Company tends to stick with an architecture for a very long time so we've worked with them now for almost two years. Several hundred engineering years have gone into the development of this incredible game console. I really believe when everybody sees it and enjoy it, they are going to be amazed by it. It's like nothing they've ever played with before, and of course, the brand -- their franchise and their game content is incredible. I think this is a relationship that will likely last two decades, and I'm super-excited about it. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +We have no more time for questions. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [38] +-------------------------------------------------------------------------------- +Thank you very much for joining us today. I would leave you with several thoughts that, first, we're seeing growth across all of our platforms from gaming to Pro graphics, to cars to data centers. The transformation of our Company from a chip Company to a computing platform Company is really gaining traction, and you can see that you can see the results of our work as a result of things like GameWorks and GFE and Driveworks. All of the AI that goes on top of that. Our graphics virtualization remoting platform called GRID to the NVIDIA GPU deep learning toolkit are just really examples of how we have transformed a Company from a chip to a computing platform Company. +In no time in the history of our Company have we enjoyed and addressed as exciting large market as we have today. Whether it's artificial intelligence, self-driving cars, the gaming market as it continues to grow and evolve, and virtual reality. And, of course, we all know now very well that GPU deep learning has ignited a wave of AI innovation all over the world, and our strategy and the thing that we've been working on for the last seven years is building an end-to-end AI computing platform. An end-to-end AI computing platform. Starting from GPUs that we have optimized and evolved and enhanced for deep learning to system architectures to algorithms for deep learning, to tools necessary for developers to frameworks, and the work that we do with all of the framework developers and AI researchers around the world, to servers to the cloud to data centers to ecosystems and working with ISVs and startups and all the way to evangelizing and teaching people how to use deep learning to revolutionize the software that they build. And, we call that the Deep Learning Institute, the NVIDIA DLI. These are some of the high-level points that I hope that you got, and I look forward to talking to you again next quarter. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2017-Aug-10-NVDA.txt b/Transcripts/NVDA/2017-Aug-10-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..969a8a3235e0a7bf7a0e459d801ef05a1c427990 --- /dev/null +++ b/Transcripts/NVDA/2017-Aug-10-NVDA.txt @@ -0,0 +1,467 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2018 NVIDIA Corp Earnings Call +AUGUST 10, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Shawn Simmons + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Ting Pong Ho + BMO Capital Markets Equity Research - Associate + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Craig Andrew Ellis + B. Riley & Co., LLC, Research Division - Senior MD & Director of Research + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Robert Bruce Mertens + Needham & Company, LLC, Research Division - Research Assoc of Microcontrollers, Analog & Mixed Signal; Consumer IC & Multi-Market & Computing + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * William Shalom Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Victoria, and I will be your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) I will now turn the call over to Shawn Simmons from Investor Relations to begin your conference. + +-------------------------------------------------------------------------------- +Shawn Simmons, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the second quarter of fiscal 2018. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until August 17, 2017. The webcast will be available for replay up until next quarter's conference call to discuss Q3 financial results. +The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. +All our statements are made as of today, August 10, 2017, based on information available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Shawn. NVIDIA continues to fire on all cylinders. We achieved strong revenue in each of our businesses. Data center revenue grew more than 2.5x, reflecting momentum behind artificial intelligence as we expanded our product portfolio and began shipping our new Volta platform. Overall, quarterly revenue reached a record $2.23 billion, up 56% from a year earlier, up 15% sequentially and well above our outlook of $1.95 billion. +From a reporting segment perspective, Q2 GPU revenue increased 59% to $1.9 billion from a year earlier. Tegra Processor revenue doubled to $333 million. OEM revenue reached $251 million, reflecting sales of our cryptocurrency-specific GPUs, partially offset by the lapse in our licensing agreement with Intel. +Let's start with our Gaming platform. Gaming revenue was $1.19 billion, up 52% year-on-year and up 15% from Q1. This reflects the vibrant Gaming ecosystem underpinned by continued excitement over our recent launched GPUs and other technologies, great games and growing interest in eSports. +Gamers continue to love our Pascal-based GPUs, with demand remaining strong for GeForce GTX 10 Series products. Our new Max-Q design approach enabling Gaming notebooks that are thinner, lighter and faster is finding a strong market. Max-Q is being utilized in more than 20 new notebook models from a wide range of OEMs. Quality games continue to drive GPU sales. +At the E3 Gaming expo in L.A., we showed the eagerly anticipated Destiny 2 running on 4K on PCs, which drew rave reviews. Major fall titles in addition to Destiny 2 include the new Call of Duty, World War II, Star Wars: Battlefront 2 and Middle-earth: Shadow of War. We're also seeing the rise of independent titles that will become runaway hits, most notably, a new last-man-standing shooter called PlayerUnknown's Battlegrounds. +Gaming also continues to be driven by the surging popularity of eSports. This week's biggest sporting event isn't playing out at Dodger Stadium or Wrigley Field; it's in Seattle at the International Dota 2 Championships. The $24 million in prize money is more than twice the purse of golf's richest event, the US Open. For the third straight year, GeForce GTX is Dota 2's official graphics platform. +GPU sales were lifted by demand from increasingly mining activity, or +Ethereum. We served a large portion of this specialized market with a dedicated board, as seen in our OEM sales, and some with GeForce GTX boards. Our strategy is to stay alert to this fast-changing market, knowing that GPUs are highly efficient at running the algorithms used to mine cryptocurrencies. +Moving to professional visualization. Quadro revenue grew $235 million, up 10% from a year ago, up 15% sequentially and a demand for high-end, real-time rendering and for more powerful mobile workstations. Demand was especially strong in education, both among universities and large public school districts, as well as in the financial sector and defense industry. And last week, at SIGGRAPH's computer graphics show, we highlighted how AI will augment the process of content creation. This new Optix 5 SDK uses AI to accelerate ray tracing. When running on our DGX rendering appliance, it provides the rendering capability of 150 standard dual-CPU servers. +We also introduced NVIDIA eGPU system solutions. This creates a new category for our platforms using an external chassis to expand access to TITAN Xp and Quadro GPUs for the 25 million content creators using standard notebook PCs. +Next, Datacenter. Revenue of $416 million was up more than 2.5x from a year ago. This growth, shared across AI, deep learning, high-performance computing and GRID, is particularly notable given that we announced and shipped production units of our Volta-based V100 accelerator as we transition from Pascal-generation GPUs. +Looking ahead, we see inferencing and video transcoding as emerging applications that are well suited for our GPUs. V100 was among the most important launches at this quarter's GPU Technology Conference. It provides 10x the deep learning power of its year-old predecessor, widely outpacing Moore's Law. Some of the early V100 production units were given out in recent weeks to leading AI researchers attending the [CBPR] and ICML conferences. +We made available our TensorRT 3 inference optimizer and run time for deep learning applications. It delivers 100x faster inferencing on V100 than the best CPU implementation. And it supports the industry's 2 most common AI frameworks: Google TensorFlow and Facebook's Caffe. +We also entered into a wide range of important partnerships based on AI. Among them, Baidu has aligned with us on Volta. It's bringing this new architecture to its cloud and optimizing the PaddlePaddle open-source deep learning framework for Volta. +Volkswagen is collaborating with us to bring the power of AI across their organization, and we announced a new partner program with Taiwan's top ODMs including Foxconn, Inventec, Quanta, Wistron to provide them with the early access to the HGX reference architecture, GPU computing technology and design guidelines. +Demand remains strong for our DGX AI supercomputer as organizations take on multiple systems to build out AI-enabled applications. Facebook disclosed a system incorporating 128 DGXs. We have shipped systems to more than 300 unique customers, with 1,000 plus in the pipeline. +Our HTC business remained strong. The new Green500 list showed that the world's 13 most efficient supercomputers run on NVIDIA Tesla P100 accelerators. The top position is held by the Tokyo Institute of Technology's TSUBAME 3.0 system. It achieved an extraordinary 14.1 gigaflops per watt, 50% higher efficiency than the previous leader, helping to point the way to [exascale] supercomputing. +Momentum continued in our GRID graphics virtualization business. Among key wins was Amazon Web Services whose G3 instances now run on NVIDIA Tesla GPUs. +In automotive. Revenue grew to $142 million, up 19% year-over-year. We announced important new partnerships based on our DRIVE PX AI platform, which is being used by more than 225 car and truck makers, Tier 1 suppliers, HD-mapping companies, start-ups and research institutions. Additionally, production cars using our technology continue to make their way into the market. +Audi announced last month that the 2019 A8 will be the first car to feature NVIDIA's powered Level 3 autonomous technology. This means that, under certain specific use cases, it will be able to be driven by its own software without monitoring from the driver. +Our DRIVE PX platform is already on the road in Tesla Motors' full line of cars, including the new Model 3, which uses the second-generation Tesla autopilot. +This quarter, we also announced that Toyota selected NVIDIA DRIVE PX for their next-generation autonomous cars. +Volvo, long a byword for safety and value, and Autoliv selected DRIVE PX for self-driving cars targeted to hit the market by 2021. ZF and Hella have selected the NVIDIA DRIVE PX platform for their line of autonomous vehicle products. And Baidu announced that its Project Apollo open-source self-diving platform for the China market will use NVIDIA DRIVE PX. +You'll be hearing more from us in the months ahead at regional GTCs that we will be conducting in Beijing, Munich, Tel Aviv, Taipei, Washington, D.C. and Tokyo. +Now turning to the rest of the Q2 income statement. GAAP and non-GAAP gross margins for the second quarter were 58.4% and 58.6%, respectively, reflecting the decline in in-sell licensing revenue. +Q2 GAAP operating expenses were $614 million; non-GAAP operating expenses were $533 million, up 19% from a year ago, reflecting hiring for our growth initiatives. GAAP operating income was $688 million; non-GAAP operating income was $773 million, doubling from a year-ago. GAAP net income was $583 million; non-GAAP net income, $638 million, also doubling from a year ago, reflecting revenue strength as well as gross margin and operating margin expansion. +For fiscal 2018, we intend to return approximately $1.25 billion to shareholders through stock repurchases and quarterly cash dividends. In the first half of fiscal 2018, we have paid $758 million in share repurchases and $166 million in quarterly cash dividends. +Now turning to the outlook for the third quarter of fiscal 2018. We expect revenue to be $2.35 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 58.6% and 58.8%, respectively, plus or minus 50 basis points. +GAAP operating expenses are expected to be approximately $672 million, non-GAAP operating expenses are expected to be approximately $570 million. GAAP OI&E is expected to be an expense of approximately $2 million, inclusive of additional charges from the early conversions of convertible notes. Non-GAAP OI&E is expected to be nominal. GAAP and non-GAAP tax rates are supposed -- are expected to be 17%, plus or minus 1%, excluding discrete items. +Further financial details are included in the CFO Commentary and other information available on our IR website. We will now open the call for questions. (Operator Instructions) +Operator, will you please poll for the first question? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + Maybe a clarification or a question, and a question after that on the data center. On the clarification side, we have seen several quarters where your Datacenter business grew very strongly on a sequential basis. This time, the growth was somewhat more modest, and I was wondering if there is a little more color around that. And then the bigger question is, Jensen, it seems the data center market is sort of bifurcating between your GPU approach on one side and ASICs on the other side. What are you doing to make sure that the balance sort of stays in your favor as the market matures from here? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes, so first of all, Q2 was a transition quarter for our data center, right? I thought we did great. I thought we did great. We almost tripled year-over-year. And we ramped Volta into volume production. And because Volta was so much better than our last-generation processor, Volta is 100x faster than Kepler. 100x faster than Kepler just 4 years ago, and Kepler was already 10x faster than CPUs. And so Volta was such a giant leap when we announced it in GTC right at the beginning of the quarter. I thought the team did fantastically, transitioning the customer base to Volta, and now Volta is in high-volume production. The application of data center -- you asked a larger question about data center. The data center, data center is a very large market, as you know, and the reason for that is because the vast majority of the world's future computing will be largely done in data centers. And there's a very well-accepted notion now that GPU acceleration for servers delivers extraordinary value proposition. If you have a data-intensive application and the vast majority of the future applications in data centers will be data-intensive, a GPU could reduce the number of servers you require or increase the number of the amount of throughput pretty substantially. Just adding one GPU to a server could reduce several hundred thousand dollars of reduction in the number of servers. And so the value proposition in the cost savings of using GPUs is quite extraordinary. There are several applications in data centers. First of all, there's training and there's high-performance computing; there's cloud virtual PC, as what Amazon AWS G3 announcement was about this last -- this quarter; and then there's also new applications such as inferencing as these models are now going into production and the new applications that are coming online, which is likely to overwhelm the Internet in the near future, which is live video. Consumers taking live video on their phones and sharing with their friends and there's -- there are going to be hundreds of millions of these happening all the time. And each one of these videos will have to be transcoded to a variety of formats to be shared with their friends and also has to be -- you have to perform AI on it instantaneously so that you could avoid inappropriate video from being streamed to large audiences. And so the number of applications where GPUs are valuable, from training to high-performance computing to virtual PCs to new applications like inferencing and transcoding and AI, are starting to emerge. The one area where you're talking about ASICs and TPUs, TPU is basically an ASIC. The way to think about that is this is after 4 generations of evolution of our GPU, NVIDIA GPU is basically a TPU that does a lot more. We could perform deep learning applications, whether it's in training or in inferencing now, starting with the Pascal P4 and the Volta generation. We can inference better than any known ASIC on the market that I've ever seen. And so the new generation of our GPU is essentially a TPU that does a lot more, and we can do all the things that I just mentioned and the vast number of applications that are emerging in the cloud. And so our belief is this. Our belief is that, number one, a GPU has to be versatile to handle the vast array of big data and data-intensive applications that are happening in the cloud, because the cloud is a computer, it's not an appliance. It's not a toaster, it's not a lightbulb, it's not a microphone. The cloud has a large number of applications that are data-intensive. And second, we have to be world-class at deep learning. And so our GPUs have to evolve into something that can be absolutely world-class TPU, but it has to do all of the things that a data center needs to do. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [5] +-------------------------------------------------------------------------------- + + It sounds like things went very well on the cryptocurrency side. And that market has not had a lot of history, but a little history it has had, had some volatility. And I was wondering if you could help us understand how you think about managing that volatility. And a broader question on this topic is, do you consider cryptocurrency or other blockchain applications on par with your other 4 big markets? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [6] +-------------------------------------------------------------------------------- + + Yes, thanks. Cryptocurrency and blockchain is here to stay. The market need for it is going to grow, and over time, it will become quite large. I -- it is very clear that new currencies will come to market. And it's very clear that the GPU is just fantastic at cryptography, and as these new algorithms are being developed, the GPU is really quite ideal for it. And so this is a market that is not likely to go away anytime soon, and the only thing that we can probably expect is that there will be more currencies to come. It will come in a whole lot of different nations. It will be -- it will emerge from time to time, and the GPU's really quite great for it. What we've done, our strategy is to stay very, very close to the market. We understand its dynamics really well. And we offer the coin miners a special coin-mining SKU, and this product is -- this product -- this GPU configuration is optimized for mining. We stay very close to the market. We know its every single move and we know its dynamics. And then the last thing that I can say is that, the larger of a GPU company you are, the greater ability you could absorb the volatility. And so between the combination of the fact that we have GPUs at just about every single price point, we have such incredibly efficient designs, that we're so close to the marketplace and because we have such large volumes, we have the ability to rock and roll with this market as it goes. Okay? But this is an important market that likely will continue to grow over time. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + Yes, great. I have a question on some of the numbers. So Q2 revenue came in roughly about $250 million above your guide. Can you kind of confirm what some of the drivers were to the upside relative to your guidance? Was it all cryptocurrency or was it a combination of multiple things? And related to that, for your Q3 guide, I think you are guiding revenue up about $120 million sequentially. What are the puts and takes here on a sequential basis? Thank you. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- + + Sure. Let's see. First of all, we actually gave a really great guidance last quarter, and we beat it by $250 million. And the $250 million, you could see in our -- what we categorized under the OEM SKUs, basically the cryptocurrency SKUs. And that, if you reverse-engineered it out, I think, is approximately $150 million. And I -- and we serve the vast -- I would say, the large majority of the cryptocurrency demand out of that specialized products. There're still small miners that buy GeForces here and there, and that probably also increased the demand of GeForces. There were a lot of shortages all over the world, and as we go into this quarter, it's -- there's still cryptocurrency mining demand that we know is out there. And based on our analytics and understanding of the marketplace, there will be some amount of demand for the foreseeable future. But I -- it's also the case that there were gamers who -- whose needs and demands were not filled last quarter. And the second quarter, the second quarter is an important part of the year for us. I mean, we -- GeForce is in an incredibly great strategic position. After all of the numerous product launches that we've seen from other players, it's very, very clear that the GeForce product lineup is absolutely the best in the world. And the second half is going to see some very exciting titles. You've got Destiny 2, you have Call of Duty from Activision, you have Star Wars Battlefront from EA. I mean, these are going to be blockbusters, and we're expecting them to do incredibly well. We also know that a game that came out of nowhere -- and this is one of the things that's really great about the video game market, you never know where the next amazing new title's going to come from. PlayersUnknown Battleground (sic) [PlayerUnknown's Battlegrounds], it's really essentially survival -- Survivor meets Hunger Games. How could that not be a fun game? And so they've done incredibly well. And so I think the market dynamic is really, really vibrant for the second half of the year, and we have a really great position. With respect to our guidance. The way to think about our guidance, we gave a good guidance and we're comfortable with our guidance. And we know that the dynamics in our business, our data center position, is quite exciting. We know that our Gaming business is vibrant and our position is excellent. We've -- we saw growth across all of our product segments. And we'll just see how it turns out at the end of the next quarter. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + First, I was wondering if you could tell us how much Volta contributed to the data center revenue in the quarter. And what are your expectations for that ramp trajectory into the second half? And the reason I ask is, when I look at gross margins, they're fine but it doesn't look like the Volta ramp is driving upside to that number. So I'm trying to get some feeling for the trajectory of that ramp. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [12] +-------------------------------------------------------------------------------- + + Well, first of all, it's very difficult to reverse-engineer from the first ramp of Volta any impact on gross margins. And the reason for that is because the first ramps tend to be more costly, and you're still trying to stabilize yield, there's a lot of complexities involved. But what I can tell you is that we shipped a lot of Voltas. We shipped a lot of Voltas. And Volta is fully ramped. Customers are clamoring for it. The leap generationally for deep learning is quite extraordinary. And so we're expecting Volta to be very, very successful. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of CJ Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [14] +-------------------------------------------------------------------------------- + + Yes, I guess, a follow-up question to that on the Volta transition and now that, that is ramping in high-volume manufacturing and considering the pretty large uplift in die size there. Curious how you're thinking about ASP uplift over time, and whether you would expect that to drive a reacceleration in growth in data center looking into the second half of the calendar year. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [15] +-------------------------------------------------------------------------------- + + Yes. So the first way to think about our ASP is to think about the value proposition that our GPUs provide. Whenever you include a Volta in your data center, in your server that is doing data-intensive processing, the number of commodity servers that it replaces and the number of just NICs and cables that it replaces is pretty extraordinary. Every single Volta allows you to save several hundred thousand dollars. And so the price of Volta is driven by the fact that, of course, the manufacturing process is quite extraordinary. I mean, these are expensive things to go and design. The manufacturing cost itself, you guys can estimate, is probably in the several hundred dollars, close to $1,000. However, the software intensity of developing Volta, the architectural intensity of developing Volta, the -- all of the software intensity associated with all the algorithms and optimizing all the algorithms of Volta is really where the value added ultimately ends up. And so I guess, the pricing -- your question really is pricing, we're going to -- we expect pricing to be quite favorable for Volta. And then your second question, I think, is related to acceleration. The growth -- the data center growth opportunity for us is quite significant, as you know. I mean, there are several applications that demand GPUs today. Almost every single data center in the world today recognizes that GPU is the path forward for data-intensive processing. Every single OEM and every single cloud service provider now supports NVIDIA GPUs and offer NVIDIA GPUs, and Volta is going to be the engine that serves them. And so I'm expecting a lot of good things from Volta. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Atif Malik with Citi. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst [17] +-------------------------------------------------------------------------------- + + Congratulations on the strong results. Even if you exclude the [QEM] contribution, you would have beaten The Street expectations. My question is in auto. You've announced a very strong pipeline of auto partnerships this year. Can you just talk about when do you expect acceleration in auto sales? And are there any other ways you can monetize your auto partnerships maybe through licensing of software stacks? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [18] +-------------------------------------------------------------------------------- + + Sure. Thanks a lot, Atif. The road map for auto kind of looks like this. For this year and next, what you should see is development partnerships that we have with a growing number of car companies, and they're reflected in our e-projects, development systems and purchasing of our AI supercomputers like DGX. And so for the next, I would say, this year and the vast majority of next year, that's what you should expect from the autonomous driving perspective. Starting next year, you're going to start to see robot taxis start to come to the road. We're working with a handful, maybe, I guess, about 6 or 7 really exciting robot taxi projects around the world. And you could see them start to go into prototype or beta testing starting now. And then, next year, you'll see a lot more of them. And starting 2019, you'll see them going to real commercial services. And so those are robot taxis, what some in the industry call Level 5s, basically driverless cars. And then the fully autonomous driver cars -- driven cars, branded cars, will start hitting the road around 2020 and 2021, okay? And so the way to think about it is this year and next is really about development. Starting next year and the following year is robot taxis. And then 2021 to -- forward, you're going to see a lot of Level 4s. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [20] +-------------------------------------------------------------------------------- + + Great. I wanted to actually ask about the pro vis business. That business continues to grow faster than I had expected, and you had a really good for quarter there. Can you talk about what's driving that and what the trajectory of that business looks like? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [21] +-------------------------------------------------------------------------------- + + Sure. Our Pro business, call it, roughly nearly $1 billion, it was -- it grew, what, 8% last year. It grew 8% the year before that, maybe a little bit less. And this year, it grow -- it grew about 10%, maybe a little faster. The way to think about that business is it's really a platform for design, and the digital design of all kinds. And it's designing movies, designing cars, designing products, people designing websites. Anybody who's doing digital design could really benefit from our Quadro platform. It's very software-intensive, it's certified with every major computer-aided design package. It's certified by large industrial companies all over the world. You could use Quadro and bring up a database 10 years from now and know that, because of the nature of how we manage our software, the certification process we go through with each one of the major industry partners, we could pull up an entire design that's designed 5 years ago 10 years from now. And so if anything were to happen to a product or a plane or a ship or a building, the level of certainty in your data integrity is going to be complete. And so the software intensity is high, and the -- and our platform is recognized all over the world as the industry standard. The growth opportunity for Quadro are several, and it's starting to kick in. And I have -- I'm rather optimistic about its future growth as well. One of them is photorealistic rendering. We now have the ability to use our artificial intelligence and ray tracing technology in combination, called Optix 5.0 that we just announced at SIGGRAPH, that allows you to visualize photorealistic rendering practically interactively. And it's just an amazing thing to watch. Second, we now have a new system, called the external GPU system, that's a partnership between the work that we did with Intel. And all of our partners in the ecosystem taking advantage of Thunderbolt 3 and the new external GPU-capable Windows system, you can now have an external system connect to Thunderbolt. And basically, our GPU is outside the laptop. And so for some 25 million, 20 million users of thin and light notebooks, you can now have the ability to have the GPU as well and get a boost in your productivity like you've never seen before. And so you can now have thin notebooks and still have the benefit of our GPUs. And so that's a new market for us. We're going to see virtual reality do quite well, and especially in design. And we've partnered with HP recently to do an industrial version of a backpack that allows designers to be able to freely roam within their design space and completely in virtual reality. And so there's a variety of growth drivers in that business that I'm quite excited about. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Craig Ellis with B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley & Co., LLC, Research Division - Senior MD & Director of Research [23] +-------------------------------------------------------------------------------- + + Congratulations on the very good execution and capitalizing on the crypto opportunity. Jensen, I wanted to start, just connecting a few dots, you had mentioned that there was significant upside from that opportunity, and we've seen through checks that we can do via public means that demand was very strong in the quarter. And as I look ahead at the guidance for the fiscal third quarter's up 5%, when I think, normally, it would be up in the low double digits. So can you talk about how comfortable you are with your supply availability here? And if demand was there for double-digit growth, if you'd be able to achieve that? And then, Colette, one for you. The OpEx guidance setup, I think it's $37 million quarter-on-quarter, more than we've seen the last few quarters. Can you just bin out what some of the bigger drivers for that increase are? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [24] +-------------------------------------------------------------------------------- + + Sure. Thanks a lot. So first of all, there's -- to answer that question, I would say there are 3 factors. The first factor is our strategic position. Our competitive lineup is probably the best it's ever been, and better than last year, even, which was incredibly strong, better than a year before that because it was incredibly strong. I think our strategic position and the value of our architecture is more powerful today than ever. And so our -- I think #1 is our strategic position. The second, if the demand were there in the second half with respect to -- from a perspective of Gaming demand, and if there's any residual with crypto demand, we will surely be able to serve it. And then, lastly, the factor is related to our guidance. Our guidance is -- we're comfortable with our guidance. We're happy with our guidance, and we want to have an opportunity to come back and give you an update in Q3. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + And Craig, on your second question regarding the OpEx guidance in Q3. Generally, our guidance and actuals as we move into Q3 is usually a little stronger, and it's consistent with our normal annual compensation increase that happens in Q3. And also keep in mind, we are expected to move into our new headquarter building within Q3. And underlying our overall growth and investments is our hiring and focus in terms of on AI, autonomous driving as well as Gaming. So all of these factors contribute to that with about a 19% year-over-year growth rate in terms of what we're targeting. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [27] +-------------------------------------------------------------------------------- + + Yes, I just wanted to clarify some earlier comments with regard to Volta and data center. Is it correct to interpret your comments to mean that some customers may have tended to delay purchases as you went through the quarter as they're waiting for Volta, given the stronger performance gains for that? And if that's the case, if I've got that right, now that Volta is fully ramped, do you expect that to drive stronger growth rates as you go through the second half? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [28] +-------------------------------------------------------------------------------- + + The first -- the answer to your first question is yes. Volta is -- it was a giant leap. It's kind of 120 teraflops. 120 teraflops. Another way to think about that is 8 of them in 1 node is essentially 1 petaflops, which puts it in the -- among the top 20 fastest supercomputer on the planet. And I -- the entire world's top 500 supercomputers is only 700 petaflops. And with 8 Voltas in 1 box for doing artificial intelligence, it represents one of them. And so that's -- Volta is just a gigantic lead for deep learning, and it's such a gigantic leap for processing that -- and we announced that at GTC, if you recall, which is practically right at the beginning of the quarter. And so the transition was not insignificant, and it was that the team just executed flawlessly. I'm so proud of the team that they executed the most complex processor that's ever been built. And working with our teams, working with our partners at TSMC and Samsung and all of our package partners, Bill, and they just did a great job for us. And so the team did great. Now looking forward, there's a whole bunch of growth drivers for our data center business. Deep learning is -- training is a growth driver. Cloud computing, high-performance computing is a growth driver, and we have new growth drivers with inferencing. And so I'm pretty excited about our prospects going into the age of -- the generation of Volta. In terms of the guidance and what we expect, I think our dynamics are really positive. And so we just got to -- we're happy with the guidance, and let's give you an update at the end of the quarter. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of William Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Shalom Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [30] +-------------------------------------------------------------------------------- + + Great. Jensen, you've had a couple questions already about sort of the pace of growth in data center in the second half from Volta, but I'm thinking a little bit further out. At GTC, you highlighted this $30 billion TAM opportunity by 2020. And when we look at the charts that you've published about your expectation for exaflops -- the number of exaflops required to train an increasing number of deep learning networks through 2020, it looks like your expectation is for that to accelerate over time. But naturally, the Street's contemplating a decelerating growth for data center. People don't expect things to grow 150-plus percent forever. So can you comment as to the growth trajectory beyond maybe the very near term in that business? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Yes. I think, at the highest level, the way to think about that is data-intensive computing. Data-intensive computing, whether it's deep learning or high-performance computing, the GPU is just phenomenal at it. NVIDIA's CUDA GPU was after 12 years of driving this architecture and pioneering this computing approach, it's just a home run. And the value proposition and the money that it saves people, the amount of energy that it saves, is quite extraordinary. One way to think about that is if you speed up an application by a factor of 10, you're basically saying that it takes 10x fewer servers to do the same job or you could do 10x as much work in the same amount of servers. And so the value proposition is really quite great. And the applications that we serve is really diverse now. It used to be just high-performance computing and supercomputing, but the number of applications we serve span Internet service providers, manufacturing, health care, financial services, transportation. The number of data-intensive applications and industries that need them is really growing very fast. And so how fast does that -- what does that imply in terms of long-term growth? It's kind of hard to say. It's kind of hard to say. But first principles would suggest, first principles would suggest that every single data center in the world will be GPU-accelerated someday, and I've always believed that. And I believe that even more today because I believe that, in the future, this new computing model that we all finally call AI is going to be a highly data-intensive business model, and the GPU is the ideal computing model for that. And so I'm not exactly sure if that completely answers your question, and partly because I'm not exactly sure. I just know that the -- on first principles, the computing architecture is ideal. There's every evidence that every single data center and every single OEM and every single Internet service provider is jumping on this architecture and jumping on Volta. And I believe that AI is going to be the future of computing. And so somewhere between those beliefs and executing the business is the truth. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Hans Mosesmann with Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [33] +-------------------------------------------------------------------------------- + + Jensen, can you give us an update in terms of how the new platforms and servers may have impacted the business in the data center, with Purley launching here recently and the upcoming Epyc? And as a follow-on, when can we expect Volta in the consumer gaming markets? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- + + Well, that's a good question, Hans, and it's a good observation. Because Purley, I didn't know if everybody understood that codename, but Purley is a new motherboard, new platform for Intel servers and the CPU, Skylake. And it's an excellent server platform. And obviously, every OEM and every service provider was waiting for the launch of that, and it officially launched in the middle of this quarter. And so did it affect the rollout of new servers based on GPUs? Probably, it did, and surely, it did. But now that it's ramped, it's a successful ramp. Every single cloud provider and every single OEM is now fully geared up to take that server to market, and they all have GPU options. Every single OEM in the world now and every cloud provider in every ODM now has NVIDIA GPU chassis and platforms, whether it's in one GPU in one [U] to 8 GPUs in a supercomputing configuration. And so the number of options of ways to enjoy NVIDIA GPUs is really quite countless now. Volta for Gaming, we haven't announced anything. And all I can say is that our pipeline is filled with some exciting new toys for the gamers. And we have some really exciting new technology to offer them in the pipeline. But for the holiday season, for the foreseeable future, I think Pascal is just unbeatable. It's just the best thing out there. And everybody who's looking forward to playing Call of Duty or Destiny 2, if they don't already have one, should run out and get themselves a Pascal. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mitch Steves with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [36] +-------------------------------------------------------------------------------- + + I just had 2 kind of high-level ones. So first, it's your comments on cryptocurrency and blockchain. So when decentralized applications begin to take off and we see people essentially renting out parallel processing, how are you guys going to essentially be able to tell what products are being used in kind of a [lease] model versus what's being used in Gaming, et cetera? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [37] +-------------------------------------------------------------------------------- + + Well, first of all, it's not really possible because our GPUs are all architecturally compatible, which, at some level, is one of our strengths. There are hundreds of millions of NVIDIA GPUs in the world, and they're all CUDA-compatible and they're all 100% CUDA-compatible. And we're so rigorous and so disciplined about ensuring their compatibility that, for developers, it's really a wonderful platform. However, we are thoughtful about how we configure the GPUs so that they're best for the applications. Some applications would like to have the maximum amount of performance in a few nodes. Some would like to have the maximum amount of performance within 30 watts. Some would like to have the maximum amount of flexibility with all of the I/O pin connectors and all display connectors. Some people like to have multi-GPUs and that they have the ability to configure them together. And so every market has a slightly different need. And we have to understand the market needs and understand what it is that the customers are looking for and configure something that is best for them. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [38] +-------------------------------------------------------------------------------- + + Got it. And then just one small one and a follow-up, do you guys have an estimate on how fast the neural network is growing right now relative to a year ago? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Let's see. A neural net, in terms of complexity, is approximately -- not quite, but approximately doubling every year, and this is one of the exciting things about artificial intelligence. In no time in our -- in my history of looking at computers in the last 35 years have we ever seen a double exponential, where the GPU computing model, our GPUs, are essentially increasing in performance by approximately 3x each year in order to be 100x in just 4 years. We have to increase in performance, overall system performance, by a factor of 3 -- by over a factor of 3 every year. And yet on the other hand, on top of it, the neural network architecture and the algorithms that are being developed are improving in accuracy by about twice each year. And so object recognition and accuracy is improving by twice each year, or the error rate is decreasing by half each year. And speech recognition is improving by a factor of 2 each year. And so you've got these 2 exponentials that are happening, and it's pretty exciting. And it's one of the reasons why AI is moving so fast. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [41] +-------------------------------------------------------------------------------- + + On the data center, it was slightly below The Street number. I know it's not your number, but I think we've gotten used to you surpassing The Street number by a wide margin. Wondering if you could just talk about the July quarter, the 3 subsegments, and if they came in as expected. And as you look to October, if you could talk about what kind of growth or -- you're looking for, for that segment. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [42] +-------------------------------------------------------------------------------- + + I'm not sure I understand the question. Colette, if you understand it, go ahead and answer it. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + So in discussing how we did versus our guidance, again, we overshot our overall guidance for Q2. Part of that was the cryptocurrency. And your question was more around the Datacenter and the Datacenter number. We set out with a good amount of work ahead of us to transition to Volta within the quarter. We're very pleased with that result and the overall year-over-year growth that we accomplished in terms of the Datacenter. We always have different ranges across the organization and across the different businesses. But we don't have specifics in terms of our guidance nor did we provide specific guidance in terms of on the Datacenter. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Raji Gill with Needham & Company. + +-------------------------------------------------------------------------------- +Robert Bruce Mertens, Needham & Company, LLC, Research Division - Research Assoc of Microcontrollers, Analog & Mixed Signal; Consumer IC & Multi-Market & Computing [45] +-------------------------------------------------------------------------------- + + This is Robert Mertens on behalf of Raji. I guess I wanted to get a little more clarity towards your automotive division. I didn't know if you broke out rough percentages about the near-term growth between infotainment and these ADAS or autonomous vehicle systems. And then as a follow-up in the autonomous systems, how you're sort of pricing between the different levels, if that's mainly just the GPUs or if the software is baked in there as well. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [46] +-------------------------------------------------------------------------------- + + Well, our GPUs are useless without software, [surfing the backboard forward]. Our GPUs are useless because -- without software. And the reason for that is because, otherwise, they -- each one of the markets, whether it's playing games or professional visualization or high-performance computing, doing molecular dynamics, computation or doing seismic processing or perceiving the 3-dimensional world around the car and reasoning about where it is and trying to figure out how to drive, all of that software is very, very different. What we do is we -- there's a core in our company, the core architecture is a GPU core. However, the configuration of the products and the chips and the systems are very different from market to market. And so somebody asked me earlier, the gentleman asked me about cryptocurrency. That configuration is very, very different than a Gaming configuration, which is different than a high-performance computing configuration. And it's different from our inferencing configuration, and it's different from our self-driving-car configuration. And so the chips are designed to be different even though they're architecturally identical. And then the systems are designed to be market-specific and application-specific. And the software on top of it is super, super application-specific. And that's one of the reasons why our company is increasingly differentiated from a components company and what we call a platform company. Each one of these platforms that we bring to market are very, very different even though, at its core, this data-intensive parallel computing architecture called CUDA is essential among all of them. We don't break out the automotive from the rest of the Tegra business. The Tegra business consists of basically 3 parts at the moment. One part is -- one major component of it is the Nintendo Switch gaming console, and they're just doing incredibly well. I'm so happy for Nintendo because they're risk-takers, they're innovators, they -- they're -- they don't -- they're not influenced by what other people do, and they're original thinkers and I just love the way they invented the Switch and the way they've taken it to market. I'm so happy for them. And it's doing really well. The second major component is our self-driving car platforms and a lot of it still is the infotainment systems. Our infotainment system is going to evolve into an AI cockpit product line. We're going to -- we initially started with autonomous driving, but you've probably heard me say at GTC that our future infotainment systems will basically turn your cockpit or turn your car into an AI. So your whole car will become an AI. It'll talk to you, it'll know where you are, and knows who's in the cabin. And if there's potential things to be concerned about around the car, it might even just tell you in natural language. And so the entire AI will be -- the entire car will become an AI. We announced at CES a partnership with Daimler, and they talked about the work that we're doing together in the next-generation car, how we're going to bring the AI into the car. And that's our first visible -- highly visible project, and there are others that we're working on. And then the future projects, starting from end of next year with robot taxis, and starting with 2020, the autonomous cars, fully autonomous cars. You're going to see the rest of that come online. And that's a major component of Tegra. And then the last component, the third component, the major component, I would say, is AI at the edge. That's the next major revolution. And I -- we have a new product line. It's -- that we announced about a year ago, and it's called Jetson. Jetson is just -- it's just an amazing little AI computer. And if you want to do deep learning at the edge, whether it's really, really clever cameras for smart and safe cities, to traffic lights that can now monitor traffic, Jetson and AI at the edge is going to be the next growth opportunity for us. And those 3 major segments make up essentially the Tegra business. We haven't split each one of them out separately. But one of these days, we'll consider doing it. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Your final question comes from the line of Ambrish Srivastava from BMO. + +-------------------------------------------------------------------------------- +Ting Pong Ho, BMO Capital Markets Equity Research - Associate [48] +-------------------------------------------------------------------------------- + + This is Gabriel Ho calling in for Ambrish. I think, last year this time, I think you -- on the Datacenter business, you disclosed -- I think, highlighted the growth for your cloud business, your deep learning business was about half, and then for HPC. I was wondering, as you're ramping Volta, how would you -- how should we think about maybe the mix as you're entering the second half of the year between HPC, cloud and maybe the rest of the business for the Datacenter? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [49] +-------------------------------------------------------------------------------- + + Yes, Ambrish (sic) [Gabriel], that's a good question. Partly, I'm not in total control of the answer. But on first principles, let me maybe explain it this way. I believe that there are a few hundred million office workers and information workers whose PCs will be virtualized and just become an application, like Netflix, and it will be virtualized, it'll be streamed from our cloud GPUs called GRID. I believe that every single company in the world, manufacturing, health care, finance, will use computational approaches to analyzing their business. And some of them will use it -- will use AI and some of them will use traditional first-principle, physics-based algorithms. And I -- and it's hard to say exactly what the split's going to be. I -- my guess, however, is that AI will be the larger part of that. But you're going to see hybrid versions of it. Most computations, the reason why we're so bullish about CUDA and our GPU, which is able to do both general purpose computation as well as deep learning, is because most algorithms has the combination of both. Inside the car, we don't just use deep learning, we use CUDA and deep learning. We use CUDA for all kinds of algorithms, computer vision algorithms, including deep learning. And so -- and we're seeing in quantum chemistry, in physics simulations like fluid dynamics, more and more of the algorithms are hybrids of deep learning and numerics. And so I -- that segment of the marketplace is kind of hard to predict. And then there's the -- there's just the consumer Internet service providers and the billions and billions of queries that are going into the cloud. Some of them are text, some of them are speech, and increasingly, some of them are video. But the amount of traffic that's going to be inferenced using deep learning is going to be quite explosive. It's kind of hard to know exactly the pace of each one of these. But I think, on first principles, we would all agree that these are large computation challenges and that the previous model of using just microprocessors to do that computation is not efficient. And that the GPU, with its parallel data processing capability and now our fourth-generation deep learning architecture, you essentially have a TPU that does a whole bunch more. And so I think the approach that we take has great promise, and we're just super enthusiastic about it. But exactly how much it's going to contribute in the near term in percentages is going to be hard to guess. +Okay, that was great. I appreciate all the questions. We had a great quarter. We're seeing exciting growth dynamics driving in each of our businesses. This is the era of artificial intelligence, and NVIDIA has dedicated ourselves to be its brain. Cloud and Internet service providers are going in -- going all in on AI and jumping on to our new Volta GPU. Enterprises and giant industries from transportation to health care to manufacturing to financial services have awakened to the power of AI, and the growing pipeline of the NVIDIA DGX AI supercomputer is a great indicator. The next revolution of AI will be AI at the edge, and the most visible and impactful evidence will be the autonomous vehicle. Our strategy is to build a ground-up, deep learning platform for self-driving cars, and that has put us in pole position to lead the charge. And in Gaming, which is actually the first consumer AI application, we have a great strategic position in this growing market. We have a once-in-a-lifetime opportunity ahead. We can make an amazing impact on the future of the world. +Thanks for joining us today, and we look forward to giving you another update next quarter. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2017-Feb-09-NVDA.txt b/Transcripts/NVDA/2017-Feb-09-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..def971cbbd8ea0c2513b5992aa5eccf839b28c50 --- /dev/null +++ b/Transcripts/NVDA/2017-Feb-09-NVDA.txt @@ -0,0 +1,418 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2017 NVIDIA Corp Earnings Call +FEBRUARY 09, 2017 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Arnab Chanda + NVIDIA Corporation - VP of IR + * Jen-Hsun Huang + NVIDIA Corporation - President and CEO + * Colette Kress + NVIDIA Corporation - EVP & CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Ramsay + Canaccord Genuity - Analyst + * Toshiya Hari + Goldman Sachs - Analyst + * Vivek Arya + BofA Merrill Lynch - Analyst + * Mark Lipacis + Jefferies LLC - Analyst + * Steve Smigie + Raymond James & Associates, Inc. - Analyst + * C.J. Muse + Evercore ISI - Analyst + * Atif Malik + Citigroup - Analyst + * Stephen Chin + UBS - Analyst + * Craig Ellis + B. Riley & Company - Analyst + * Raji Gill + Needham & Company - Analyst + * Joe Moore + Morgan Stanley - Analyst + * Romit Shah + Nomura Securities Company, Ltd. - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon, my name is Victoria, and I'm your conference operator for today. Welcome to NVIDIA's financial results conference call. +(Operator Instructions) +Thank you, I'll now turn the call over to Arnab Chanda, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Arnab Chanda, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the fourth quarter and FY17. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until the 16th of February, 2017. The webcast will be available for replay up until next quarter's conference call to discuss Q1 financial results. The content of today's call is NVIDIA's property. It cannot be replayed, reproduced, or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent forms 10-K, and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. +All our statements are made as of today, the 9th of February, 2017, based on information currently available to us. Except as required by law, we assume no outlook obligation to update any such statements. +During this call, we will discuss non GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Arnab. We had a stellar Q4 and FY17, with records in all of our financial metrics -- revenue, gross margin, operating margins, and EPS. Growth was driven primarily by data center tripling, with a rapid adoption of AI worldwide. Quarterly revenue reached $2.17 billion, up 55% from a year earlier, and up 8% sequentially, and above our outlook of $2.1 billion. +FY17 revenue was just over $6.9 billion, up 38%, and nearly $2 billion more than FY16. Growth for the quarter and fiscal year was broad-based, with record revenue in each of our four platforms -- gaming, professional visualization, data center, and automotive. Our full-year performance demonstrates the success of our GPU platform-based business model. +From a reporting segment perspective, Q4 GPU revenue grew 57% to $1.85 billion from a year earlier. Tegra processor revenue was up 64% to $257 million. +Let's start with our gaming platform. Q4 gaming record revenue was a record $1.35 billion, rising 66% year on year, and up 8% from Q3. Gamers continue to upgrade to our new Pascal-based GPUs. Adding to our gaming lineup, we launched GTX 1050-class GPUs for notebooks, bringing e-sports and VR capabilities to mobile at great value. The GTX 1050 and 1050-TI were featured in more than 30 new models launched at last month's consumer electronics show. +To enhance the gaming experience, we announced G-Sync HDR, a technology that enables displays which are brighter and more vibrant than any other gaming monitor. Our partners have launched more than 60 G-Sync-capable monitors and laptops, enabling smooth play without screen tear artifacts. E-sports too continues to attract new gamers. Major tournaments with multi-million dollar purses are drawing enormous audiences. +This last quarter, Dota 2 held its first major tournament of the season in Boston. Tickets sold out in minutes. The prize pool reached 3 million, and millions of gamers watched online. +Moving to professional visualization, Quadro revenue grew 11% from a year ago to a record $225 million, driven by demand for high-end real time renderings and mobile workstations. We recently launched a family of Pascal-based GPUs designed for mobile workstations, which leading OEMs are embracing. +Earlier this week, we introduced Quadro GP100, which creates a new super-computing workstation. This new type of workstation enables engineers, designers, and artists to take advantage of new technologies of photo-realism, fluid simulation, and deep learning. +Next, data center. Revenue more than tripled from a year ago, and was up 23% sequentially to $296 million. Growth was driven by AI, cloud service providers deploying GPU instances, high-performance computing, grid graphics virtualization, and our DGX AI super-computing appliance. +AI is transforming industries worldwide. The first adopters were hyper-scale companies like Microsoft, Facebook, and Google, which use deep learnings to provide billions to customers with AI services that utilizes image recognition and voice processing. The next area of growth will occur as enterprise in such fields as health care, retail, transportation, and finance embrace deep learning on GPUs. +At November's SC16 super-computing conference, Microsoft announced that its GPU-accelerated Microsoft Cognitive Toolkit is available both in Azure Cloud and on-premesis with our DGX-1 AI super-computer. In a series of related announcements at SC16, we described our plans to join the Cancer Moonshop project, in conjunction with the National Cancer Institute, the US Department of Energy, and several national labs. +To help build predictive models and guide treatment under those projects, we are collaborating on a new AI framework called CANDLE, the Cancer Distributed Learning Environment. To support this work, we unveiled our new own super-computer, the NVIDIA DGX Saturn 5, which joins together 124 DGX-1 systems. It's currently the world's 28th fastest super-computer, and the number one system in energy efficiency. +Our grid graphics virtualization business doubled year on year, driven by strong growth in the education, automotive, and energy sectors. We are excited to be hosting our eighth annual GPU Technology Conference here in Silicon Valley from May 8 to May 11. This will be the year's most important event for AI and accelerating computing, and we expect it to be our largest GTC yet, attended by thousands of application developers, scientists and academics, as well as entrepreneurs and corporate executives. +Finally, in automotive, revenue grew to a record $128 million, up 38% year over year. At Jen-Hsun's CES opening keynote, we demonstrated our leadership position in self-driving vehicles. With a growing list of industry players adopting our AI car platform, we also showcased AI Copilot, a technology that will recognize a driver and their preferences, monitor their alertness, understand natural spoken language, and provide alerts in dangerous situations. +One of the highlights of CES was the demonstration of our own autonomous car, dubbed BB8. More than 500 passengers took rides in the back seat without a driver behind the wheel. We announced a number of new partnerships at the show, among them were collaborations with Bosch, the world's largest automotive supplier, and ZF, Europe's leading supplier for the truck industry. Both center on developing AI car computers with Drive PX2 technology. +We also announced that we're working on cloud-to-car mapping collaborations with HERE, focused on the US and Europe, and Zen Ren, focused on Japan. These complement partnerships announced in Q3 with Europe's TomTom, and China's Baidu. Our mapping partnerships now span to all geographies. +Jen-Hsun was joined on the CES stage by Audi of America's President Scott Keogh. They announced the extension of our decade-long partnership to deliver cars with level four autonomy starting in 2020, powered by Drive PX technology. Audi will deliver level three autonomy in its A-8 luxury sedan later this year through its V-fast system, powered by NVIDIA. We also shared news at CES of our partnership with Mercedes-Benz to collaborate on a car that will be available by year's end. +During the quarter, Tesla began delivering a new autopilot system powered by the NVIDIA Drive PX2 platform in every new Model S and Model X, to be followed by the Model 3. Tesla's cars will be capable of fully autonomous operation via future software updates. +In addition, Volvo started turning over the keys to initial customers of its Drive Me program. Its XC90 SUVs equipped with Drive PX2 are capable of fully autonomous operation on designated roads in Volvo's hometown of Gothenburg, Sweden. With NVIDIA's powering the market's only self-driving cars and partnerships with leading automakers, tier-one suppliers, and mapping companies, we feel very confident in our position as the transportation industry moves to autonomous vehicles. +Next, our OEM and IP business was $176 million, down 11% year on year. +Now turning to the rest of the income statement for Q4. Gross margins were at record levels, with GAAP gross margins at 60% and non-GAAP at 60.2%. These reflect the success of our platform approach, as well as strong demand for G-Force gaming GPUs and deep learning. +GAAP operating expenses were $570 million. Non-GAAP operating expenses were $498 million, up 12% from a year earlier, reflecting head-count-related costs for our AI growth initiatives, as well as investments in sales and marketing. We are investing into huge market opportunities: AI, self-driving cars, cloud computing, and gaming. Thus we expect our operating expense growth rate to be in the high teens over the next several quarters. +GAAP operating income was $733 million, and non GAAP operating income was $809 million. Both more than doubled from a year earlier. Our GAAP tax rate was 10%, and our non-GAAP was 13%. These rates were lower than expected, primarily due to a decrease in the amount of earnings subject to US tax. GAAP EPS was $0.99; non-GAAP EPS was $1.13. +In FY17, we returned $1 billion to shareholders through dividends and share repurchases, in line with our intentions. For FY18, we intend to return $1.25 billion to shareholders through dividends and share repurchases. +Now turning to the outlook for the first quarter of FY18, we expect revenue to be $1.9 billion, plus or minus 2%. At the mid-point, this represents 46% growth over the prior year. We expect data center to grow sequentially. +Our GAAP and non-GAAP gross margins are expected to be 59.5% and 59.7%, respectively, plus or minus 50 basis points. This guidance assumes that our licensing agreement with Intel ends at March, and does not renew. GAAP operating expenses are expected to be approximately $603 million. Non-GAAP operating expenses are expected to be approximately $520 million. +GAAP OI&E is expected to be an expense of approximately $20 million, including additional charges from the early conversions of convertible notes. Non-GAAP OI&E is expected to be an expense of approximately $4 million. GAAP and non-GAAP tax rates for the first quarter of FY18 are both expected to be 17%, plus or minus 1%, excluding any discrete items. +With that I'm going to turn it back for the Operator so we can open up for questions. Please limit your questions to just one. Operator, let's start with the questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Certainly. Your first question comes from the line of C.J. Muse with Evercore. C.J., your line is open. + +-------------------------------------------------------------------------------- +C.J. Muse, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- +Can you here me? Yes, my apologies, stuck on a plane here. Great results. I guess I was hoping to get a little more color on the data center side. Now that we've completed a full FY17, would love to get some clarity on the different moving parts and contributions there, then looking into FY18, how you see the growth unfolding thereafter? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [3] +-------------------------------------------------------------------------------- +Yes, C.J. First of all, thanks a lot. Well, the single biggest mover would have to be data center. When you look back on last year and when you look forward, there's a lot of reasons why data center business overall grew 3X, grew by a factor of three. I would expect that to happen, to continue. +There's several elements of our data center business. There's the high-performance computing part, there's the AI part; there's grid, which is graphics virtualization; there's the cloud computing, which is providing our GPU platform up in the cloud for start-ups and enterprises and all kinds of external customers to be able to access in the cloud, as well as a brand new AI super-computing appliance that we created last year, for anybody who would like to engage deep learning and AI, but don't have the skills or don't have the resources or don't have the desire to build their own high-performance computing cluster. We integrated all of that with all of the complicated software stacks into an appliance that we maintain over the cloud. We call that DGX-1. +These pieces -- AI, high-performance computing, cloud computing, grid, and DGX -- all in contribution contributed to our growth in data center quite substantially. My sense is that as we look forward to next year, we're going to continue to see that major trend. +Of course, gaming was a very large and important factor, and my expectation is that gaming is going to continue to do that. Then longer term, our position in self-driving cars I think is becoming more and more clear to people over time. I expect that self-driving cars will be available on the road starting this year with early movers, and no later than 2020 for level four by the majors, and you might even see some of them pull into 2019. Those are some of the things we're looking forward to. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question is from Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch - Analyst [5] +-------------------------------------------------------------------------------- +Thanks. I actually had one question for Jen-Hsun and one clarification for Colette. Jen-Hsun, where are we in the gaming cycle? It's been very strong the last few years. What proportion of your base do you think has a credit to Pascal? Where does that usually peak before you launch your next-generation products? +Then for Colette, just inventory dollars and base ticked up. If you could give us some comment on that? Then on OpEx activity, you did a very good job last year, but this time you're saying OpEx will go up mid-teens. Do you still think there is operating leverage in the model? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [6] +-------------------------------------------------------------------------------- +Well, let's see. We typically assume that we have an installed base of $200 million G-Force gamers, and we've upgraded about two quarters of them -- as in two operating quarters out of four years. It takes about three to four years to upgrade the entire installed base. We started ramping Pascal, as you know, a few quarters ago. Our data would suggest that the upgrade cycle is going well, and we have plenty to go. + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [7] +-------------------------------------------------------------------------------- +Thanks, Vivek. On your question on inventory, as you know, in many of our businesses we are still carrying significant architectures, and a broad list of different products for those architectures across. We feel comfortable with our level of inventory as we look forward into FY18 and our sales going forward. +Your second question was regarding OpEx, and comparing it to where we finished in 2017 and moving into FY18. We do have some great opportunities, large businesses for us to go capture the overall TAMs for, and we are going to be continuing to invest in the data center, specifically in AI, self-driving cars, as well as gaming. Rather than a focus on what the specific operating margin is, we're going to focus primarily just on growing the overall TAM, and capturing that TAM on the top line. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Your next question comes from the line of Mark Lipacis -- I apologize -- from Jefferies. + +-------------------------------------------------------------------------------- +Mark Lipacis, Jefferies LLC - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking my question. Question back on the data center. The growth was impressive, and I'm wondering you mentioned that the hyper-scale players really have embraced the products first. I'm wondering if you could share with us to the extent that you think that they're embracing it for their own use, or to the extent that they're deploying it for services such as machine learning as a service and enterprises are really tapping into this, also, through the hyper-scale guys. +I'm wondering if you could help -- you mentioned that the enterprise is where you expect to see embracing the technology next in health care, retail, transport, finance. I'm wondering if you could share with us how you feel about that visibility, where you're getting that visibility from? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [10] +-------------------------------------------------------------------------------- +On hyper-scale, you're absolutely right that there's what we call internal use for deep learning, and then there's the hosting GPU in the cloud for external high-performance computing use, which includes deep learning. Inside the hyper-scalers, the early adopters are moving obviously very fast, and -- but everybody has to follow. Deep learning has proven to be too effective. You guys -- everybody knows now that every hyper-scaler in the world is investing very heavily in deep learning. My expectation is that over the next coming years, deep learning and AI would become the essential tool by which they do their computing. +Now when they host it in the cloud, people on the cloud use it for a variety of applications. One of the reasons why the NVIDIA GPU is such a great platform is because of its broad utility. We've been working on GPU computing now for coming up on 12 years, and industry after industry, our GPU computing architecture has been embraced for high-performance computing, for data processing, for deep learning and such. +When somebody hosted up in the cloud -- for example, Amazon putting our GPUs up in the cloud -- that instance has the ability to do molecular dynamics to deep learning training to deep learning inferencing. Companies could use it for off-loading their computation, to start-ups being able to build their Company and build their application, and then host it for hundreds of millions of people to use. I think the hyper-scalers are going to continue to adopt GPU, both for internal consumption and cloud hosting for some time to come. We're just in the beginning of that cycle, and that's one of the reasons why we have a fair amount of enthusiasm around the growth here. +You mentioned enterprise. Enterprise has all woken to the power of AI, and everybody understands that they have a treasure trove of data that they would like to find a way to discover insight from. In the case of real applications that we're engaging now, you could just imagine that in the transportation industry, in car companies creating self-driving cars, one car company after another needs to take all of their road data and start to train their neuro-networks for their future self-driving cars. They use our DGX or Tesla GPUs to train the networks, which is then used to run their cars running on Drive PX. That's one application example. +Another application example, which is quite significant, it's going to be the future of processing all of the HD maps in the world. You guys might have seen that we announced at GTC this API SDK called MapWorks. MapWorks takes video information, video information that is recorded from a car, and reconstructs the three-dimensional terrain information from that live video. +It has to do computer vision, 3-D reconstruction, has to determine and detect where the lanes are, the signs are, the lights are, and even some interesting 3-D features, maybe buildings and curbs and such. It would do that automatically, and we need to process that for the world, for the planet. You could just imagine how much video is being recorded today, and how much data is being generated, and how much inferencing, computer vision, and 3-D reconstruction that has to be done, and our GPUs are really quite perfect for it. +MapWorks runs on top of our GPUs, and we're working with just about every mapping company in the world today to adopt, MapWorks and to do HD processing for their maps. That's another example. +Medical imaging companies all over the world have recognized the importance of deep learning in their ability to detect cancer and retinopathy, and the list of examples goes on and on. All the different modalities have now recognized the importance of deep learning, and you're going to start to see one medical imaging company after another. +The list of examples just keep on going. The fact of the matter is at this point, deep learning and AI has really become how future software development's going to be done for a large number of industries, and that's the enthusiasm we're seeing around the world. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Your next question comes from the line of Atif Malik with Citigroup. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup - Analyst [12] +-------------------------------------------------------------------------------- +Hi, thanks for taking my question, and congratulations to the team on great results and guide. My first question is for Jen-Hsun. Jen-Hsun, on the adoption of VR for gaming, if I look at the price points of the headset and the PC, a little bit high for wider adoption. Could the use of GPU in the cloud like you guys are introducing with G-Force now be a way for the price points on VR to come down? Then I have a follow-up for Colette. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [13] +-------------------------------------------------------------------------------- +The first year of VR has sold several hundred thousand units, and many hundreds of thousands of units. Our VR Works SDK, which allows us to process graphics in very low latency, dealing with all of the computer vision, processing, and whether it's lens warping and such, has been -- has delivered really excellent results. +The early VR is really targeted at early adopters. I think the focus of ensuring an excellent experience that surprises people, that delight people by Oculus and by Valve and by Epic and by Vive, by ourselves, by the industry, has really been a good focus. I think that we've delivered on the promise of a great experience. +The thing that we have to do now is we have to make the headsets easier to use with fewer cables. We have to make it lighter, we have to make it cheaper. Those are all things that the industry's working on. As the applications continue to come on line, you're going to see that they're going to meet themselves and find success. I think the experience is very clear that VR is exciting. +However, remember that we are also in the VR, we also brought VR to computer-aided design, and to professional applications. In this particular area, the cost is just simply not an issue. In fact, many of the applications previously were power walls or caves, VR caves, that cost hundreds of thousands of dollars, and now you could put that same experience if not even better on the desk of designers and creators. +I think that you're going to find that creative use and professional use of VR is going to grow quite rapidly. Just recently we announced a brand new Quadro P5000 with VR, the world's first VR notebook that went to market with HP and Dell, and they're doing terrifically. I would think about VR in the context of both professional applications as well as consumer applications; but I think the first year was absolutely a great success. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Your next question comes from the line of Romit Shah with Nomura. + +-------------------------------------------------------------------------------- +Romit Shah, Nomura Securities Company, Ltd. - Analyst [15] +-------------------------------------------------------------------------------- +Yes, thank you. First of all, congratulations on a strong FY17. If I may, Jen-Hsun, the revenue beat this quarter wasn't as big as we've seen in the last several periods, and most of it came from data center. I totally understand that when your gaming business expands as much as it has it becomes harder to beat expectations by the same margin, but I was wondering if you could just spend some time talking about gaming demand, and how you think it was during the holiday season? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [16] +-------------------------------------------------------------------------------- +Well, the global PC gaming market is still vibrant and growing. The number of e-sports gamers around the world is growing. You guys know that Overwatch is a home run. Activision Blizzard's Overwatch is raging all over Asia, and e-sports fans all over the world are picking it up. It's graphically very intensive, without a 1050 class and above, it's simply a non-starter. To really enjoy it, you need at least a 1060. This last quarter we launched a 1050 and a 1050 TI all over the world, and we're seeing terrific success out of that. +My expectation going into next year is that Overwatch is going to continue to spread all over the world. It really basically just started. It started in the west, and it's now moving into the east, where the largest e-sports markets are. Overwatch is going to be a huge success. League of Legends is going to continue to be a huge success. My expectation is that the e-sports, along with AAA titles that are coming out this year, is going to keep PC gaming continuing to grow. +I quite frankly thought Q4 was pretty terrific. We had a record quarter, we had a record year. I don't remember the last time that a large business the size of ours, and surely the size of a data center business, grew by factor of three. I think we're in a great position going into next year. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Your next question comes from the line of Raji Gill with Needham & Company. + +-------------------------------------------------------------------------------- +Raji Gill, Needham & Company - Analyst [18] +-------------------------------------------------------------------------------- +Yes, thanks. Jen-Hsun, can you talk a little bit about the evolution of artificial intelligence, and make a distinction between artificial intelligence versus machine learning versus deep learning? They're different kind of categorizations and implementations of those different sub-segments, so I wanted to get a sense from you how NVIDIA's end-to-end computing platform dominates machine learning relative to say the competition? Then I have a question on the gross margins, if I could, as well? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [19] +-------------------------------------------------------------------------------- +Yes, first of all, thanks for your question. The way to think about that is deep learning is a breakthrough technique in the category of machine learning, and machine learning is an essential tool to enable AI, to achieve AI. If a computer can't learn, and if you can't learn continuously and adapt with the environment, there's no way to ever achieve artificial intelligence. +Learning, as you know, is a foundational part of intelligence. Deep learning is a breakthrough technique where the software can write software by itself, by learning from a large quantity of data. Prior to deep learning, other techniques like expert systems and role-based systems and hand-engineered features, where engineers would write algorithms to figure out how to detect at cat, and then the - they would figure out how to write another algorithm to detect a car. You could imagine how difficult that is, and how imperfect that is. It basically kind of works, but it doesn't work good enough, well enough, to be useful. Then deep learning came along. +The reason why deep learning took a long time to come along is because it's singular handicap is that it requires an enormous amount of data to train the network, and it requires an enormous amount of computation. That's why a lot of people credit the work that we've done with our programmable GPUs and our GPU computing platform, and the early collaboration with deep learning AI researchers as the Big Bang, if you will -- that catalyst that made modern AI possible. We made it possible to crunch through an enormous amount of data to train these very deep neuro networks. +The reason why deep learning has just swept the world, it started with convolusion neuro networks, but reinforcement networks, and time sequence networks, and all kinds of interesting adversarial networks. The list of the types of networks -- there are 100 networks being created a week. Papers are coming out of everywhere. The reason why is because deep learning has proven to be quite robust. It is incredibly useful, and this tool has at the moment found no boundaries of problems that it's figured out how to solve. +I think that the traditional methods of machine learning are still going to be useful if the absolute precision of the prediction or classification is not necessarily super-important. For example, if you wanted to understand the sentiment of consumers on a particular new product that you sent, whether the sentiment is exactly right, so long as you understand the basic trend and you largely understand the sentiment, I think people would consider that information to be useful. +However, if you're using machine learning for cancer detection, obviously we need to have a level of precision that is quite high. Whether it's in health care or financial services or high-performance computing, and in some areas where for example, ad-supported internet search, small differences in accuracy could make a very large difference in financial results for the advertiser, and for the people hosting the service. In all these cases, deep learning has found a great utility, and that's one of the reasons why we're seeing so much growth. Obviously for self-driving cars, being kind of right is not a good idea, and we like to be exactly right. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Your next question comes from the line of Matt Ramsay with Canaccord. + +-------------------------------------------------------------------------------- +Matt Ramsay, Canaccord Genuity - Analyst [21] +-------------------------------------------------------------------------------- +Thank you very much. Jen-Hsun, you guys obviously have won some business with your automotive super-computer at Tesla in recent periods. I was curious if you could comment on some of the application porting and moving of features from the previous architecture on to your architecture, and how that's gone, and what you guys have learned through that process, and how it might be applied to some of your future partnerships? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [22] +-------------------------------------------------------------------------------- +First of all, you know that we are a full-stack platform. The way we think about all of our platforms is from the application all the way back to the fundamental architecture and the semiconductor device. +In the case of Drive PX, we created the architecture, optimized for neural net, for sensor fusion, for high-speed processing; the semiconductor design, in the case of Drive PX2 called Parker, Tegra Parke; the system software for high-speed +sensor fusion and moving data all the way around the car -- the better you do that, the lower cost the system will be; the neural networks on top of that, that sits on top of our deep learning SDK, called KU DNN and Tensor RT, basically frameworks of AI; then on top of that, the actual algorithms for figuring out how to use that information from perception to localization to action planning. +Then on top of that, we have an API and an SDK that is integrated into map makers. We integrate into every single map, HD map service in the world, from HERE to TomTom to Zen Ren in Japan, to Baidu in China. This entire stack is a ton of software. +But your question specifically has to do with the perception layer, and that perception layer quite frankly is just a small part of the self-driving car problem. The reason for that is because in the final analysis you want to detect lanes. You've got video coming in, you want to detect lanes. You have video coming in, you want to detect a car in front of you. All we have to do -- it's not trivial, but it's also not monumental -- we have to detect and sense the lanes and the cars, and we train our networks to do so. +As you know very well now, the deep neural net has the ability to detect objects far better than any human-engineered computer vision algorithms prior to deep learning. That's one of the reasons why Tesla and others have jumped on top of the deep learning approach, and abandoned traditional hand-featured computer vision approaches. Anyway, the answer to your question is that by working on self-driving cars end to end, we realized that this is much more than computer vision, that the self-driving car platform is a stack of software and algorithms that's quite complex, and now we've had a lot of experience doing so. +Then recently at CES, we announced partnerships with Audi, which we announced that we will have level four self-driving cars on the road by 2020. We announced a partnership with Daimler, we announced a partnership with ZF and Bosch, two of the world's top tier-one suppliers. We also announced partnerships with all of the mapping companies. If you put all that stuff together, we have the processor, we have the tier-one partnerships for the integration of the systems, we have all the software on top of it, the deep learning networks, the car partnerships, of course, and integrated into maps around the world. All that entire stack, when you put them all together, should allow us to have self-driving cars on the road. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joe Moore, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- +Great, thank you for taking the question. I wonder if you could talk a little bit about the entrance market? Where are you in terms of hyper-scale adoption for specialized inference-type solutions, and how big do you think that market counts going to be? Thank you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [25] +-------------------------------------------------------------------------------- +Yes, the inference market is going to be very large. It's -- as you know very well, in the future almost every computing device will have inferencing on it. A thermostat will have inferencing on it, a bicycle lock will have inferencing on it, cameras will have inferencing on it, and self-driving cars would have a large amount of inferencing on it. Robots, vacuum cleaners, you name it, smart microphones, smart speakers, all the way into the data center. I believe that long term there will be a trillion devises that has inferencing connected to edge computing devices near them, connected to cloud computing devices, cloud computing servers. That's basically architecture. +The largest inferencing platform will likely be ARM devises. I think that goes without saying. ARM will likely be running inferencing networks, one bit [ex-nor], eight bit, and even some floating point. It just depends on what level of accuracy do you want to achieve, what level of perception do you want to achieve, and how fast you want to perceive it. The inferencing market is going to be quite large. +We're going to focus in markets where the inferencing precision, the inferencing -- the perception scenario, and the performance by which you have to do it, is mission critical. Of course self-driving cars is a perfect example of that. Robots, manufacturing robots will be another example of that. In the future, you're going to see GTC -- if you had a chance to see that. We're working with AI City partners all over the world for end-to-end video analytics. That requires very high throughput, a lot of computation. The examples go on and on, all the way back into the data center. +In the data center, there's several areas where inferencing is quite vital. I mentioned one earlier, just mapping the earth. Mapping the earth at the street level, mapping the earth in HD in three-dimensional level for self-driving cars, that process is going to require -- just a pile of GPUs running continuously as we continuously update the information that needs to be mapped. +There's an inferencing which is called off-line inferencing where you have to re-train a network after you've deployed it. You would likely re-train and re-categorize, re-classify the data using the same servers that you used for training. Even the training servers will be used for inferencing. Then lastly, all of the nodes in cloud will be inferencing nodes in the future. I've said before that I believe that every single node in the cloud data center will have inferencing capability and accelerated inferencing capability in the future, and I continue to believe that. These are all opportunities for us. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Your next question comes from the line of Charles Wong from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [27] +-------------------------------------------------------------------------------- +Hello, can you hear me? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [28] +-------------------------------------------------------------------------------- +Sure. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs - Analyst [29] +-------------------------------------------------------------------------------- +Hi, this is Toshiya from Goldman. Thanks for taking the question, and congrats on the results. I had a question on gross margins. I think you're guiding Q1 gross margins only mildly below levels you saw in fiscal Q4, despite the royalty stream from Intel rolling over. I'm guessing improvement in mix and data center and parts of gaming are driving this, but A, is that the right way to think about the puts and takes going into Q1? B, if that is indeed the case, should we expect gross margins to edge higher in future quarters and future years as data center becomes a bigger percentage of your business? + +-------------------------------------------------------------------------------- +Colette Kress, NVIDIA Corporation - EVP & CFO [30] +-------------------------------------------------------------------------------- +Yes, this is Colette. Let me see if I can help answer that. You're correct in terms of how to look at that in Q1. The delta from Q4 to Q1 is we only have a partial part of recognition from the Intel, and that stops in the middle of March. As we move forward, as well, going into Q2, we will also have the absence of what we had in Q1 moving to Q2. I'm not here to give guidance on Q2 because we just give guidance out one quarter, but keep that in mind. There's a partial amount of Intel still left in Q1, and then it depletes in Q2. +If you think about our overall model, our overall business model, it has moved to higher-end, value-added platforms, and that's what we're selling. Our goal is absolutely to continue to concentrate on providing those higher-value platforms. That gives us the opportunity for gross margin as we make those investments in terms of an OpEx. We'll see what that kind of mix looks like as we go into Q2, but just to leave you with a understanding of Intel is probably what we can do here, okay? + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Your next question comes from the line of Stephen Chin from UBS. + +-------------------------------------------------------------------------------- +Stephen Chin, UBS - Analyst [32] +-------------------------------------------------------------------------------- +Hi, thanks for taking my questions. First one is on the data center segment. Just given the expected sequential growth in that business here in the April quarter, can you talk about what products are helping to drove that? Is it possibly the DGX-1 computer box, or is it more GPUs for training purposes at the hyper-scale cloud data center? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [33] +-------------------------------------------------------------------------------- +It would have to be Tesla processors using the cloud. There are several SKUs of Tesla processors. There's the Tesla processors used for high-performance computing, and it has FP64, FP32, ECC. It's designed. As Kuda of course and has been optimized for molecular dynamics, astrophysics, quantum chemistry, flow dynamics, the list goes on and on. The vast majority of the world's high-performance super-computing applications, imaging applications, 3-D reconstruction applications, has been ported on to our GPUs over the course of the last decade in sum. That's a very large part of our Tesla business. +Then of course we introduced on top of the architecture our deep learning stack. Our deep learning stack starts with KU DNN, the numerics kernels -- a lot of algorithms inside them to be optimized for numerical processing of all kinds of different precisions. It's integrated into frameworks of different kinds. There's so many different frameworks from Tensor RT to Cafe, to Torch to Tiano to MXNet, to CNTK; the work that we did with Microsoft, which is really excellent -- scaling it up from one GPU to many GPUs across multiple racks. That's our deep learning stack, and that's also very important. +Then the third is grid. Grid is a completely different stack. It's the world's first graphics virtualization stack, fully integrated into Citrix, integrated to VMware. Every single workstation and PC application has been verified, tested, and has the ability to be streamed from a data center. +Then last year, starting -- I think we announced it and we started shipping it in August -- our DGX-1, the world's first AI super-computer appliance, which integrates a whole bunch more software of all different types, and has the ability to -- we introduced our first NVIDIA docker. It containerizes applications. It makes it possible for you to have a whole bunch of users use one DGX. They could all be running different frameworks because most environments are heterogeneous. That's DGX-1, and it's got an exciting pipeline ahead of it. +It's really designed for companies and work groups who don't want to build their own super-computer like the hyper-scalers, and aren't quite ready to move into the cloud because they have too much data to move to the cloud. Everybody basically can easily buy a DGX-1 that's fully integrated, fully supported, and get to work on deep learning right away. +Each one of these are all part of our data center business, but the largest, because it's been around the longest, is our Tesla business; but they're all growing, every single one of them. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Your next question comes from the line of Steve Smigie with Raymond James. + +-------------------------------------------------------------------------------- +Steve Smigie, Raymond James & Associates, Inc. - Analyst [35] +-------------------------------------------------------------------------------- +Great, thanks a lot for the time. Just a quick question in the auto market. At CES, you had some solutions you were demonstrating that showed pretty significant declines in the size of what was being offered. You really shrunk it down a lot, yet still having great performance. If you think out to the level-four solution that you talk about for 2020, how small can you ultimately make that? It seems like you could be relative to the size of the car pretty small. Just curious if you would comment on that, and what impact having the system in the car makes on it? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [36] +-------------------------------------------------------------------------------- +We currently have -- Drive PX today is a one-chip solution for level three. It can have -- and with two chips, two processors, you could achieve level four. With many processors, you could achieve level five today. Some people are using many processors to develop their level five, and some people are using a couple of processors to develop their level four. +Our next generation -- so that's all based on a Pascal generation. Our next generation, the processor's called Xavier. We announced that recently. Xavier basically takes four processors and shrink it into one. We'll be able to achieve level four with one processor. That's the easiest way to think about it. While achieve level three with one processor today, next year we'll achieve level four with one processor, and with several processors, you could achieve level five. +I think that the number of processors is really interesting, because we need to do the processing of sensor fusion, and we've got to do perception, we have to do localization, we have to do driving. There's a lot of functional safety aspects to it, fail over functionality, all kinds of black box recorders, all kinds of different functionality that goes into the processor. I think it's really quite interesting. +In the final analysis, what's really hard -- and this is one of the reasons why our positioning in the autonomous driving market is becoming more and more clear -- is that in the final analysis, it's really a software problem, and it's an end-to-end software problem. It goes all the way from processing in the perception processing in the car, to AI processing to helping you drive, connected to HD clouds for HD map processing all over the world. This end-to-end stack of software is really quite a large undertaking. +I just don't know where anybody else is currently doing that, with the exception of one or two companies. I think that's really where the great complexity is. We have the ability to see and to optimize across the entire range. +Now the other thing that we announced at CS that's worth mentioning is that we believe in the future, level four means that you will have autopilot capability, hands-free autopilot capability in many scenarios; however, it's unlikely to ensure and to guarantee that in every scenario that you can achieve level four. It's just not practical for some time. +However, during those circumstances, we believe that the car should still have an AI, that the car should be monitoring what's happening outside, and it should be monitoring the driver. When it's not driving for you, it's looking out for you. We call that the AI co-pilot. Whereas AI autopilot achieves level four driving, AI co-pilot looks out for you in the event that it doesn't have the confidence to drive on your behalf. +I believe that's a really big breakthrough, and we're just seeing incredible excitement about it around the industry, because I think it just makes a lot of sense. The combination of the two systems allows us to achieve or build a better car. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Your next question comes from the line of Craig Ellis with B. Riley & Company. + +-------------------------------------------------------------------------------- +Craig Ellis, B. Riley & Company - Analyst [38] +-------------------------------------------------------------------------------- +Thanks for sneaking me in, and congratulations on the very good execution. Jen-Hsun, I wanted to come back to the gaming platform. You've now got the business running at a $5 billion annualized run rate, so congratulations on the growth there. I think investors look at that as a business that's been built on the strength of a vibrant enthusiast market, but at CES, you announced the G-Force Now offering, which really allows you to tap into the more casual potential gamer. The question is, what will G-Force now do incrementally for the opportunity that you have with your gaming platform? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [39] +-------------------------------------------------------------------------------- +Yes, appreciate that. I think first of all, the PC gaming market is growing because of a dynamic that nobody ever expected -- a dynamic that nobody ever expected 20 years ago. That's basically how video games went from being a game to becoming a sport. Not only is it a sport, it's a social sport. In order to play some of these modern e-sports games, it's a five on five, so you kind of need four other friends. As a result, in order to enjoy, to be part of this phenomenon that's sweeping the world, that it's rather sticky. +That's one of the reasons why Activision Blizzard's doing so well. That's one of the reasons why Tensen's doing so well. These two companies have benefited from tremendously from the e-sport dynamic, and we're seeing it all over the world. Although it's free to play for some people, of course you need to have a reasonably good computer to run it, and that's one of the reasons why you need G-Force in your PC, so that you can enjoy these sports. +When it's also a sport, nobody likes to lose, and surely nobody likes to blame their equipment when they do lose. Having G-Force allows -- gives you confidence and gives you an edge. For a lot of gamers, it's just a world standard. +I think that number one, e-sport is one of the reasons why gaming continues to grow. I think at this point it's fair to say that even though it's now the second most watched spectator sport on the planet behind Super Bowl, it is also the second highest paid winning sport behind football. It is -- it will soon be the largest sport in the world. I can't imagine too many young people long term not coming into the sport somehow, as this sport continues to expand in genres. That's one of the core reasons. +Now aside for -- you asked the question about G-Force Now, which I really appreciate. The simple way to think about that is this. There are many computers in the world that simply don't have the ability to enjoy video games, whether it's extremely thin and light notebooks, Apple Macs, ChromeBooks, the integrated graphics that don't have very good capabilities. I think that it's the reasonable thing to do is to put the technology in the cloud. It took us some five years to make this possible, to put the technology in the cloud and stream the video game experience with very low latency to the computer, like Netflix does. We're basically turning the PC into a virtualized gaming experience, and putting that in the cloud. +I don't know exactly how big it's going to be yet, but our aspiration is that we would reach the parts of the market where they're casual, or they just want to have another way, another device where they can game, or somebody would like to come into the gaming world and isn't quite ready to invest the time in building a computer or buying into a G-Force PC yet. I'm anxious to learn from it. When I learn more about G-Force Now, I'll be more than happy to share it. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Unfortunately, that is all the time we have for questions. Do you have any closing remarks? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - President and CEO [41] +-------------------------------------------------------------------------------- +I want to thank all of you guys for following us. We had a record year, a record quarter, and most importantly, we're at the beginning of the AI computing revolution. This is a new form of computing, a new way of computing, where parallel data processing is vital to success and GPU computing that we've been nurturing for the last decade in sum is really the perfect computing approach. +We're seeing tremendous growth and exciting growth in the data center market. Data center now represents -- had grew at 3X over year over year, and it's on its way to become a very significant business for us. Gaming is a significant business for us, and longer term, self-driving cars is going to be a really exciting growth opportunity. +The thing that has really changed about our Company, what really defines how our Company goes to market today is really the platform approach, that instead of just building a chip that is industry standard, we created software stacks on top of it to serve vertical markets that we believe will be exciting long term that we can serve. We find ourselves incredibly well-positioned now in gaming, in AI, and in self-driving cars. I want to thank all of you guys for following NVIDIA, and have a great year. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2017-May-09-NVDA.txt b/Transcripts/NVDA/2017-May-09-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..d06e2e9fa38078cda94f00e6b2e99c6b413f573a --- /dev/null +++ b/Transcripts/NVDA/2017-May-09-NVDA.txt @@ -0,0 +1,447 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2018 NVIDIA Corp Earnings Call +MAY 09, 2017 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President and Director + * Colette M. Kress + NVIDIA Corporation - CFO and EVP + * Shawn Simmons + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Craig Andrew Ellis + B. Riley & Co., LLC, Research Division - Senior MD and Director of Research + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. +My name is Victoria, and I will -- and I'm your conference operator for today. Welcome to NVIDIA's Financial Results Conference Call. (Operator Instructions) +I'll now turn the call over to Shawn Simmons from Investor Relations to begin your conference. + +-------------------------------------------------------------------------------- +Shawn Simmons, - [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the first quarter of fiscal 2018. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until May 16, 2017. The webcast will be available for replay up until next quarter's conference call to discuss Q2 financial results. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risk factors and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 9, 2017, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO Commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - CFO and EVP [3] +-------------------------------------------------------------------------------- + + Thanks, Shawn. We had a strong start to the year, highlighting our record first quarter with a near tripling of Datacenter revenue, reflecting surging interest in artificial intelligence. Overall, quarterly revenue reached $1.94 billion, up 48% from a year earlier, down 11% sequentially and above our outlook of $1.9 billion. Growth remained broad-based with year-on-year gains in each of our 4 platforms: Gaming, Professional Visualization, Datacenter and Automotive. +From a reporting segment perspective, Q1 GPU revenue grew 45% to $1.56 billion from the year earlier and Tegra processor revenue more than doubled to $332 million. And we recognized the remaining $43 million in revenue from our Intel agreement. +Let's start with our Gaming platform. Gaming revenue in the first quarter was $1.03 billion, up 49% year-on-year. Gamers continue to show great interest in the Pascal-based GPUs, including gaming notebooks. Our Tegra gaming platforms also did extremely well. Demand remained healthy for our enthusiast class, GeForce GTX 1080 GPU, introduced nearly a year ago. It was complemented this past quarter with GTX 1080 Ti, which runs 35% faster and was launched at the annual Game Developers Conference in San Francisco. GTX 1080 Ti is designed to handle the demand of 4K gaming and high-end VR experiences. Typical of many supportive reviews, Ars Technica, stated, "It is undoubtedly a fantastic piece of engineering, cool, quiet and without rival. Those that demand the absolute very best in cutting-edge graphics need look no further." +We also released the next generation of our Titan class product, the TITAN Xp, designed for enthusiasts and researchers who demand extreme performance. Gaming continues to be driven by the headlong growth in eSports. The newest title, Overwatch, added 30 million gamers in its first year. GeForce was the graphics platform of choice at all of the top eSports tournaments, including the finals of the big 4 international competitions. +With apologies to the start of the baseball season, eSports is now as popular among U.S. male millennials as America's favorite pastime. More people watch gaming than HBO, Netflix, ESPN and Hulu combined. GeForce sales remained underpinned by the steady stream of AAA titles coming onto market, which continue to push for more GPU performance. +In the months ahead, we'll see a series of highly anticipated blockbuster titles. Among them are Destiny 2, coming to the PC for the first time, Star Wars: Battlefront 2, Shadow of War and the next installment of the Call of Duty franchise, World War II. We are excited to be working with Nintendo on its acclaimed Switch gaming system. Great reviews and reports of the system selling out in many geographies are a strong part of this platform. +Moving to Professional Visualization. Quadro revenue grew to $205 million, up 8% from a year ago, amid continued demand for high-end real-time rendering and more powerful mobile workstation. We're seeing significant increase in professional VR solutions driven by Quadro P6000 GPUs. Lockheed Martin is deploying Quadro to create realistic VR walk-throughs of the U.S. Navy's most advanced ships. The Marines utilize VR to train aircrew personnel. And IKEA is rolling out VR to many of its stores, helping consumers configure their kitchens from a huge array of options, which they can visualize in sharp detail. +Next, Datacenter. Record revenue of $409 million was nearly triple that of a year ago. The 38% rise from Q4 marked its seventh consecutive quarter of sequential improvement. Driving growth was demand from cloud service providers and enterprises building training clusters for web services plus strong gains in high-performance computing, GRID graphics visualization and our DGX-1 AI supercomputer. AI has quickly emerged as the single most powerful force in technology. And at the center of AI are NVIDIA GPUs. +All of the world's major Internet and cloud service providers now use NVIDIA Tesla-based GPU accelerators: AWS, Facebook, Google, IBM and Microsoft as well as Alibaba, Baidu and Tencent. We also announced that Microsoft is bringing NVIDIA Tesla P100 and P40 GPUs to its Azure cloud. Organizations are increasingly building out AI-enabled applications using training clusters, evident in part by growing demand for DGX-1. We are seeing a number of significant deals. Among them are Fujitsu's installment of 24 systems integrated into an AI supercomputer for RIKEN, Japan's largest research center, as well as new supercomputers at Oxford University, GE and Audi. +Working with Facebook, we announced the launch of the Caffe2 deep learning framework as well as Big Basin servers with Tesla P100 GPUs. To help meet huge demand for expertise in the field of AI, we announced earlier today plans to train 100 people this year through the NVIDIA Deep Learning Institute, representing a 10x increase from last year. Through on-site training, public events and online courses, DLI provides practical training on the tools of AI to developers, data scientists and researchers. +Our HPC business doubled year-on-year, driven by the adoption of Pascal GPUs into supercomputing centers worldwide. The use of AI and accelerated computing in HPC is driving additional demand in governance intelligence, higher education research and finance. +Our GRID graphic virtualization business more than tripled, driven by growth in business services, education and automotive. Intuit's latest TurboTax release deploys GRID to connect tax filers seeking real-time advice with CPAs. And Honda is using GRID to bring together engineering and design teams based in different countries. +Finally, Automotive. Revenue grew to a record $140 million, up 24% year-over-year and 9% sequentially, primarily from infotainment modules. We are continuing to expand our partnerships with companies using AI to address the complex problem of autonomous driving. Since our DRIVE PX 2 AI car platform began shipping just 1 year ago, more than 225 car and truck makers, suppliers, research organizations and start-ups have begun developing with it. That number has grown by more than 50% in the past quarter alone, the result of the platform's enhanced processing power and the introduction of TensorRT for the in-vehicle AI inferencing. +This quarter, we announced 2 important partnerships: Bosch, world's largest auto supplier, which does business all over the world, carmakers is working to create a new AI self-driving car computer based on our Xavier platform; and Paccar, one of the world's largest truck makers, is developing self-driving solutions for Peterbilt, Kenworth and DAF. +We continue to view AI as the only solution for autonomous driving. The nearly infinite range of road conditions, traffic patterns and unexpected events are impossible to anticipate with hand-coded software or computer vision alone. We expect our DRIVE PX 2 AI platform to be capable of delivering Level 3 autonomy for cars, trucks and shuttles by the end of the year, with Level 4 autonomy moving into production by the end of 2018. +Now turning to the rest of Q1 income statement. GAAP and non-GAAP gross margins for the first quarter were 59.4% and 59.6%, respectively, reflecting the decline in Intel licensing revenue. Q1 GAAP operating expenses were $596 million. Non-GAAP operating expenses were $517 million, up 17% from a year ago, reflecting hiring for our growth initiatives. GAAP operating income was $554 million and non-GAAP operating income was $637 million, nearly doubling from a year ago. For the first quarter, GAAP net income was $507 million, non-GAAP net income was $533 million, more than doubling from a year ago, reflecting revenue strengths as well as gross margin and operating margin expansion. +For fiscal 2018, we intend to return approximately $1.25 billion to shareholders through share repurchases and quarterly cash dividends. In Q1, we issued $82 million in quarterly cash dividends. +Now turning to the outlook for the second quarter of fiscal 2018. We expect revenue to be $1.95 billion plus or minus 2%. Excluding the expiry of the Intel licensing agreement, total revenue is expected to grow 3% sequentially. GAAP and non-GAAP gross margins are expected to be 58.4%, 58.6%, respectively, plus or minus 50 basis points. These reflect approximately a 100 basis points impact from the expiry of the Intel licensing agreement. GAAP operating expenses are expected to be approximately $605 million. Non-GAAP operating expenses are expected to be approximately $530 million. GAAP OI&E is expected to be an expense of approximately $8 million, inclusive of additional charges from early conversions of convertible notes. Non-GAAP OI&E is expected to be an expense of approximately $3 million. GAAP and non-GAAP tax rates for the second quarter of fiscal 2018 are both expected to be 17%, plus or minus 1%, excluding discrete items. +Further financial details are included in the CFO Commentary and other information available on our IR website. +Finally, this week, we are sponsoring our annual GPU Technology Conference here in Silicon Valley. Reflecting the surging importance of accelerating computing, GTC has grown to more than 7,000 attendees from 60 countries, up from 1,000 when we started 8 years ago. Among its highlights, Jen-Hsun will deliver a news-filled keynote tomorrow morning. We have 550-plus talks, more than half on AI. Developers will have access to 70 labs and workshops to learn about deep learning and GPU computing. And we will award a total of $1.5 million to the 6 most promising companies, among the 1,300 in our Inception Program for AI start-ups. We will be hosting our Annual Investor Day tomorrow and hope to see many of you there. +We will now open up the call for questions. (Operator Instructions) Operator, will you please poll for questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Mark Lipacis from Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + On the HPC and Datacenter business, clearly impressive growth. And I'm hoping that you can maybe drill down on the drivers here. I guess on the cloud side, we think of 2 different areas, GPU as a service versus the cloud company's own AI effort. And I'm hoping you could help us understand to the extent where the demand is falling into either one of those buckets. And then on the enterprise side, I think there's a view out there that the enterprise is just -- is going to the cloud. So to hear you talk about training clusters for web services is very interesting. And I was hoping you could provide some more color on that demand driver. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [3] +-------------------------------------------------------------------------------- + + Yes, Mark, thanks for your question. So our GPU computing business for Datacenter is growing very fast and it's growing on multiple dimensions. On the one hand, there's high-performance computing using traditional numerical methods. We call that HPC. That's growing. There is, in enterprise, the virtualization of graphics. There's a whole lot of desktop PCs running around. However, more and more people would like to have thinner laptops or they would like to have a different type of computer and still be able to run Windows. And they would like to virtualize basically their entire PC and put it in the data center. It's easier to manage. The total cost of ownership is lower, and mobile employees could enjoy their work wherever they happen to be. And so the second pillar of that is called GRID and it's basically virtualizing the PC. And as you can tell, virtualization, mobility, better security, those are all driving forces there. And then there's the Internet companies. And the Internet companies, as you mentioned, really has 2 pillars. There's the Internet service provision part where they're using deep learning for their own applications, whether it's photo tagging or product recommendation or recommending a restaurant or something you should buy or personalizing your webpage, helping you with search, provisioning up the right apps, the right advertisement, language translation, speech recognition, so on and so forth. I mean, there's a whole bunch of amazing applications that are made possible by deep learning. And so Internet service providers are using it for internal application development. And then lastly, what you mentioned is cloud service providers. And basically, because of the adoption of GPUs and because of the success of CUDA and so many applications are now able to be accelerated on GPUs, so that we can extend the capabilities in Moore's Law so that we can continue to have the benefits of computing acceleration, which in the cloud means reducing cost. And that's on the serve -- cloud service provider side of the Internet companies. So that would be Amazon Web Services, the Google Compute cloud, Microsoft Azure, the IBM Cloud, Alibaba's Aliyun... +(technical difficulty) +by Microsoft Azure. We're starting to see almost every single cloud service around the world standardizing on the NVIDIA architecture. So we're seeing a lot of growth there as well. And so I think the nut of it all is that we're seeing data center growth in GPU computing across the board. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + And a follow-up, if I may. On the Gaming side, what we have observed over time is that when you launch a new platform, it definitely creates demand and you see 12 months of very good visibility and into growth. And I wonder -- I was wondering, as you see the Datacenter numbers come in quarter after quarter here, to what extent do you think the Datacenter demand that you're seeing is -- I know it's probably only -- you're only able to answer qualitatively. But to what extent do you think the Datacenter is secondary versus you have a new platform and there's just kind of a platform-driven demand? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [5] +-------------------------------------------------------------------------------- + + Well, PC gaming is growing, I mean, there's no question about that. The eSports is growing. The number of players in eSports, the number of people who are enjoying eSports is growing. Mobile is growing. I think it's amazing. It's amazing, the growth of mobile and the latest games. And of course, the first-party titles, the AAA titles are doing great work. Battlefield is doing great and I'm looking forward to the new Battlefield. I'm looking forward to the new Star Wars and I'm looking forward to the first time that Destiny is coming to the PC. As you know, it was a super hit on console. But the first-generation Destiny wasn't available on PCs and Destiny 2 is coming to the PC. So I think the anticipation is pretty great. So I would say that PC gaming continues to grow and it's hard to imagine people... +(technical difficulty) +around in another amazing world. And so I think people are going to be amazed at how long the alternate reality of the video gaming market is going to continue to expand. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question comes from the line of the Vivek Arya from Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [7] +-------------------------------------------------------------------------------- + + Jen-Hsun, for my first one, it's on the competitive landscape in your Datacenter business. There's been more noise around FPGA or CPU or ASIC solutions also chasing the same market. What do you think is NVIDIA's sustainable competitive advantage? And what role is CUDA playing in helping you maintain this lead in this business? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [8] +-------------------------------------------------------------------------------- + + Yes, Vivek, thanks for the question. First of all, it's really important to understand that the data centers, the cloud service providers, the Internet companies, they all get kind of lumped together in one conversation. But obviously, the way they use computers are very different. There are 3 major pillars of computing up in the cloud -- or in large data centers. Hyperscale. The one pillar is just internal use of computing systems for developing, for training, for advancing artificial intelligence. That's a high-performance computing problem. It's a very complicated software problem. The algorithms are changing all the time. They're incredibly complicated. The work that the AI researchers are doing are not trivial, and that's why they're in such great demand. And it's also the reason why computing resources have to be provisioned to them, so that they can be productive. Having a scarce AI researcher waiting around for a computer to finish simulation or training is really quite unacceptable. And so that one -- that first pillar is the market that we -- is a segment of the... +(technical difficulty) +or gets strained, once the network is trained, it is put into production. Like for example, your Alexa speakers has a little tiny network inside. And so obviously, you can do inferencing on Alexa. It does voice recognition on the hot keyword. In the long term, your car will be able to do voice recognition and speech recognition. Are we okay? Are we still on? + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + Yes, I think the call got dropped. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [10] +-------------------------------------------------------------------------------- + + No, no, Vivek, I'm just -- I was wondering whether the phone line was cut or not. So anyways, I -- the second pillar is inferencing. And inferencing, inferencing as it turns out, is far, far less complicated than training. It's 1 trillion times less complicated, 1 billion times -- 1 trillion times less complicated. And so once the network is trained, it can be deployed. And there are thousands of networks that are going to be running inside these hyperscale data centers, thousands of different networks, not one, thousands of different types. And they're detecting all kinds of different kinds of things. They're inferring all kinds of different things, classifying, predicting, all kinds of different things, whether it's photo or voice or videos or searchers or whatnot. And in that particular case, our advantage -- in that particular case, the current incumbent is CPUs. The CPU is really the only processor at the moment that has the ability to basically run every single network. And I think that's a real opportunity for us. And it's a growth opportunity for us. And one would suggest that FPGA is as well. One would suggest that ASICs like TPUs -- TPUs and ASIC is as well. And I would urge you to come to the keynote tomorrow and maybe I'll say a few words about that tomorrow as well. And then the last pillar is cloud service providers, and that's basically the outward public cloud provisioning a computing approach. It's not about provisioning inferencing. It's not about provisioning GPUs. It's really provisioning a computing platform. And that's one of the reasons why the NVIDIA CUDA platform and all of our software stacks that we've created over time, whether it's for deep learning or molecular dynamics or all kinds of high-performance computing codes or linear algebra or computer graphics, all of our different software stacks make our cloud computing platform valuable. And that's why it's become the industry standard for GPU computing. And so those are 3 different pillars of hyperscalers, and it's just important to segment them so that we don't get confused. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [11] +-------------------------------------------------------------------------------- + + Got it. Very helpful. And as my quick follow-up, Jen-Hsun, there is a perception that your gaming business has been driven a lot more by pricing and adoption of more premium products, and hence, there could be some kind of ceiling to how much gamers are willing to pay for these products. Could you address that? Are you seeing the number of gamers and the number of cards grow? And how long can they continue to reach for more premium product? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [12] +-------------------------------------------------------------------------------- + + The average selling price of the NVIDIA GeForce is about 1/3 of a game console. That's the way to think about it. That's the simple math. People are willing to spend $200, $300, $400, $500 for a new game console. And the NVIDIA GeForce GPU, the PC gaming card is, on average, far less. There are people who just absolutely demand the best. And the reason for that is because they're driving a monitor or they're driving multiple monitors at a refresh rate well beyond the TV. And so if you have a 4K or you want to run 120 hertz, or some people are even driving at the 2 and 4 -- 200 hertz, those kind of displays demand a lot more horsepower to drive than an average television, whether it's 1080p or 4K, at 60 frames per second or 30 frames per second. And so the amount of horsepower they need is great. But that's just because they just really love their rig and they're surrounded in it and they just want the best. But the way to think about that is ultimately, that's the opportunity for us. I think GeForce is a game console, and the right way to think about that is at an equivalent ASP of some $200, $300, that's probably potentially the opportunity ahead for GeForce. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [14] +-------------------------------------------------------------------------------- + + I guess first question is around Gaming. And I was hoping you could kind of walk through how you're thinking about seasonality here in calendar '17, particularly as Pascal launch calendarizes and you get both the launch coming, I presume, early '18. I would love to hear your thoughts on how we should think about the trajectory of that business. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [15] +-------------------------------------------------------------------------------- + + Well, first of all, GeForce is sold a unit at a time. And it's sold all over the world and it's a consumer product. It's a product that I -- that is sold both into our installed base as well as growing our installed base. When we think about GeForce, they're -- these are the parameters involved. How much of our installed base has upgraded to Pascal? How much of our installed base is growing? How is Gaming growing overall? How is -- what are the driving dynamics of Gaming, whether it's eSports or mobile or using games for artistic expression? It's related to the AAA titles that are coming out. Some years, the games are just incredible. Some years, the games are less incredible. These days, the production quality of the games have just become systematically so good that we've had years now of blockbuster hits. So these are really good dimensions of it. And then there is -- it's overlaid on top of it with some seasonality because people do buy graphics cards and game consoles for Christmas and the holidays and there are international holidays where people are given money as gifts and they save up the money for a new game console or a new game platform. And so in a lot of ways, our business is driven by games. So it's not unlike the characteristics of the rest of the gaming industry. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [16] +-------------------------------------------------------------------------------- + + Very helpful. I guess as my follow-up, on the inventory side, that grew, I think, 3% sequentially. Can you walk through the moving parts there? What's driving that? And is foundry diversification part of that? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [17] +-------------------------------------------------------------------------------- + + The driving reasons for inventory growth is new products. And I -- that's probably all I had to say for now. I would come to GTC. Come to the keynote tomorrow. I think it will be fun. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Toshiya Hari from Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [19] +-------------------------------------------------------------------------------- + + Jen-Hsun, can you maybe talk a little bit about the breadth of your customer base in Datacenter relative to maybe 12 months ago? Are you seeing kind of the same customer group buying more GPUs? Or is it the growth in your business more a function of the broadening of your customer base? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [20] +-------------------------------------------------------------------------------- + + Thanks, Toshiya. Let me think here. I think 1 year ago, 1 year ago was -- maybe it was 2 years ago, maybe it's somewhere between 18 months ago or so when I think Jeff Dean gave a talk where he said that Google was using a lot of GPUs for deep learning. I think it wasn't much longer ago than that. And really, really, that was the only public customer that we had in the hyperscale data center. Fast forward a couple of years, we now have basically everybody. Every hyperscaler in the world is using NVIDIA for either deep learning, for some announcements that you'll read about in data center deployment, tomorrow hopefully, and then a lot of them have now standardized on provisioning the NVIDIA architecture in the cloud. And so I guess in the course of 1 or 2 years, we went from basically hyperscale being an insignificant part of our overall business to quite a large part of our business, and as you could see also, the fastest-growing part of the business. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [21] +-------------------------------------------------------------------------------- + + Okay. And then as my follow-up, I had a question for Colette. 3 months ago, I think you went out of your way to guide Datacenter up sequentially. And for the July quarter, ex the Intel business going away, you're guiding revenue up 3% sequentially. Can you maybe provide some additional color for the individual segments? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - CFO and EVP [22] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question. We feel good about the guidance that we're providing for Q2. We wanted to make sure those understood the impact of Intel that's incorporated in there. It's still too early given that it's just about the same size as what we just finished in Q1 to make comments specifically exactly where we think each one of those businesses will end up. But again, we do believe Datacenter is a super great opportunity for us. I think you'll hear more about that tomorrow. But we don't have any more additional details on our guidance. But we feel good about the guidance we gave. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Atif Malik from Citigroup. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst [24] +-------------------------------------------------------------------------------- + + Jen-Hsun, can you talk about the adoption of GPU in the cloud? At the CES earlier this year, you guys announced GeForce. Now curious how the adoption of GeForce is going. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [25] +-------------------------------------------------------------------------------- + + Yes, Atif, thanks for the question. GeForce NOW is a really -- it's really an exciting platform. It virtualizes GeForce. It puts it in the cloud, turns it into a gaming PC as a service -- that can be streamed as a service. And we are -- I said at GTC that around this time, that we'll likely open it up for external beta. We've been running internal beta for some time. And we'll shortly go to external beta. And last time I checked, there's many, many, tens of thousands of people who are signed up for external beta trials. And so I'm looking forward to letting people try it. But the important thing to realize about that is I -- that's still years away from really becoming a major gaming service. And that's -- it's still years away from being able to find the right balance between cost and quality of service and the pervasiveness of virtualizing a gaming PC. So we've been working on it for several years and these things take a while. My personal experience is almost every great thing takes about a decade. And if that's so, then we've got a few more years to go. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst [26] +-------------------------------------------------------------------------------- + + Great. As a follow-up, with your win and success in Nintendo Switch, does that open up the console market with other console makers? Is that a business that is of interest to you? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [27] +-------------------------------------------------------------------------------- + + Well, consoles is not really a business to us. It's a business to them. And we're selected to work on these consoles. And if it makes sense and the strategic alignment is great and we're in a position to be able to do it -- because the opportunity cost of building a game console is quite high. The number of engineers who knows how to build computing platforms like this -- and in the case of the Nintendo Switch, I mean, it's just an incredible console that fits in such a small, small form factor. And it could both be a mobile computing -- mobile gaming device as well as a console gaming device. It's just really quite amazing. And they just did an amazing job. Somebody asked me a few months ago before it was launched how I thought it was going to do. And of course, without saying anything about it, I said that it delighted me in a way that no game console has done in the last 10, 15 years. And it's true. I mean, this is a really, really innovative product and really quite a genius. And if you ever have a chance to get it in your hands, it's just really, really delightful. And so in that case -- in that case, the opportunity to work on it was just really, really too enticing. We really wanted to do it. And -- but it always requires deep strategic thought because it took several hundred engineers to work on. And they could be working on something else like all of the major initiatives we have. And so we have to be mindful about the strategic opportunity cost that goes along with these. But in the case of the Nintendo Switch, it's just a home run. I'm so glad I did it. And it was a perfect collaboration for us. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Craig Ellis from B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley & Co., LLC, Research Division - Senior MD and Director of Research [29] +-------------------------------------------------------------------------------- + + I wanted to follow up on some of the prepared comments on Automotive with my first question. And it's this. I think Colette mentioned that there were 225 car and truck development engagements that were underway, up 50% in the last quarter. The question is, as you engage with those partners, what's NVIDIA finding in terms of the time from engagement to revenue generation? And what are you finding with your hit rate in terms of converting those individual engagements into revenues? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [30] +-------------------------------------------------------------------------------- + + I know the second one: easier. Not -- the second one is the revenue contribution is not significant at the time, at this moment. But I expect it to be high. And that's why we're working on it. The 200 developers who are working on the DRIVE PX platform are doing it in a lot of different ways. And at the core, it's because in the future, every aspect of transportation will be autonomous. And if you think through what's going on in the world and one of the most important -- one of the most powerful effects that's happening right now is the Amazon effect. We're grabbing our phone. We're buying something and then we expect it to be delivered to us tomorrow. Well, in -- when you sent up that -- those set of electronic instruction, the next thing that has to happen is a whole bunch of trucks has to move around. And they have to go from trucks to maybe smaller trucks and from smaller trucks to maybe a small van that ultimate delivers it to your house. And so if you will, transportation is the physical Internet, is the atomic Internet, the molecular Internet of society. And without it, everything that we're experiencing today would be able to continue to scale. And so you could imagine everything from autonomous trucks to autonomous cars, surely, and autonomous shuttles and vans and motorcycles and small piece of delivery robots and drones and things like that. And for a long time, it's going to augment truck drivers and delivery professionals who, quite frankly, we just don't have enough of. The world is just growing too fast in an instant delivery, delivered to your home, delivered to you right now phenomenon. And we just don't have enough delivery professionals. And so I think autonomous capability is going to make it possible for us to take pressure off of that system and reduce the amount of accidents and make it possible for that entire infrastructure to be a lot more productive. And so that's one of the reasons why you're seeing so much enthusiasm. It's not just the branded cars. I think the branded cars get a lot of attention and we are excited about our partnerships there. And gosh, I love driving autonomous cars. But in the final analysis, I think the way to think about the autonomous future is every aspect of mobility and transportation and delivery will be -- will have autonomous -- will be augmented by AI. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley & Co., LLC, Research Division - Senior MD and Director of Research [31] +-------------------------------------------------------------------------------- + + That's very helpful color, Jen-Hsun. The follow-up is related to the Datacenter business. And you provided a lot of very useful customer and other information. My question is higher level. Given your very unique position in helping to nurture AI for the last many years and your deep insights into the way the customers are adopting it, as investors try and understand the sustainability of recent growth, can you help us understand where you believe AI adoption is overall? And since Colette threw out a baseball comment earlier, if we thought about AI adoption in reference to a 9-inning game, where are we in that 9-inning game? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [32] +-------------------------------------------------------------------------------- + + Well, let's see here. There's a -- it's a great question and there's a couple of ways to come at it. First of all, AI is going to infuse all of software. AI is going to eat software. Whereas Mark said that software is going to eat the world, AI is going to eat software. And it's going to be in every aspect of software. Every single software developer has to learn deep learning. Every single software developer has to apply machine learning. Every software developer will have to learn AI. Every single company will use AI. AI is the automation of automation. And it's -- will likely be the transmission. We're going to, for the first time, see the transmission of automation, the way we're seeing the transmission and the wireless broadcast of information for the very first time. And I'm going to be able to send you automation, send you a little automation by e-mail. And so the ability for AI to transform industry is well understood now. It's really about automation of everything. And the implications of it is quite large. We've been using now deep learning. We've been in the area of deep learning for about 6 years. And the rest of the world has been focused on deep learning for about somewhere between 1 to 2. And some of them are just learning about it. And almost no companies today use AI in a large way. So on the one hand, we know now that the technology is of extreme value. And we under -- we're getting a better understanding of how to apply it. On the other hand, no industry uses it at the moment. The automotive industry is in the process of being revolutionized because of it. The manufacturing industry will be. Everything in transport will be. Retail, Etail everything will be. And so I think the impact is going to be large and we just -- we're just getting started. We're just getting started. Now that's kind of a first inning thing. The only trouble with the baseball analogy is that in the world of tech, things don't -- every inning is not the same. In the beginning, the first inning feels like -- it feels pretty casual and people are enjoying peanuts. The second inning, for some reason, is shorter. And the third inning is shorter than that and the fourth inning is shorter than that. And the reason for is because of exponential growth. Speed is accelerating. And so from the bystander who are on the outside looking in, by the time third inning comes along, it's going to feel like people are traveling at the speed of light next to you. Now if you happen to be on one of the photons, you're going to be okay. But if you're not on the deep learning train in a couple of 2, 3 innings, it's gone. And so that's kind of the challenge of that analogy because things aren't moving in linear time. Things are moving in exponential time. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Hans Mosesmann with Rosenblatt Securities. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [34] +-------------------------------------------------------------------------------- + + Jen-Hsun, can you give us like a State of the Union on process node and technology road maps you guys see? And tell me a pretty nice exposition of where they are in terms of their transistors and so on? So what's your comfort level as you see your process technology and your road maps for new GPUs? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [35] +-------------------------------------------------------------------------------- + + Yes, Hans. I think there's a couple of ways to think about it. First of all, we know that this is the -- we know that some -- the world causes the end of Moore's Law, but it's really the end of 2 dynamics that has happened. And one dynamic, of course, is the end of processor architecture productive innovation, okay, end of instruction-level parallelism advances. The second is the end of Dennard scaling. And the combination of those 2 things makes it look like it's the end of Moore's Law. The easy way to think about that is -- the easy way to think about that is that we can no longer rely -- if we want to advance computing performance, we can no longer rely on transistor advances alone. That's one of the reasons why NVIDIA has never been obsessed about having the latest transistors. We want the best transistors. There's no question about it. But we don't need it to advance. And the reason for that is because we advance computing on such a multitude of levels all the way from architecture, this architecture we call GPU accelerate computing, to the software stacks on top, to the algorithms on top, to the applications that we work with. We tune it across the top, from the top to bottom, all the way from bottom to top. And so as a result, transistors is just one of the 10 things that we use. And like I said, it's really, really important to us and I want the best. And TSMC provides us the absolute best that we can get. And we push along with them as hard as we can. But in the final analysis, it's one of the tools in the box. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Joe Moore from Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [37] +-------------------------------------------------------------------------------- + + I have attended GTC the last couple of days. I'm really quite impressed by the breadth of presentations and sort of the number of industries you guys are affecting. And I guess just on that note, how do you think about segmenting the sales effort? Do you have a health care vertical, an avionics vertical, financial vertical? Or is it sort of having the best building blocks and you're letting your customers discover stuff? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [38] +-------------------------------------------------------------------------------- + + Yes, thanks a lot. Thanks a lot, Joe. You answered it right there. It's both of those. It's both of those. On the first -- the first thing is that we have to develop platforms that are useful per industry. And so we have a team working with the health care industry. We have a team that's working with the Internet service providers. We have a team that's working with the manufacturing industry. We have a team that's working with the financial services industry. We have a team that's working with media and entertainment and with enterprise, so -- with the automotive industry. And so we have different verticals. We call them verticals and we have teams of business development people, developer relations, computational mathematicians that works with each one of the industries to optimize their software for our GPU computing platform. And so it starts with developing a platform stack. Of course, one of the most famous examples of that is our Gaming business. It's just another vertical for us. And it starts with GameWorks that runs on top of GeForce and then it has its own ecosystem of partners. And so that's for each one of the verticals and each one of the ecosystems. And then the second thing that we do is we have, horizontally, partner management teams that work with our partners, the OEM partners and the go-to-market partners so that we could help them succeed. And then, of course, we rely a great deal on the extended sales force of our partners so they could help to evangelize our computing platform all over the world. And so there's this mixed approach between dedicated vertical market, business development teams as well as a partnership approach to partnering with our OEM partners that has really made our business scale so fast. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [39] +-------------------------------------------------------------------------------- + + Great. That's helpful. And then the other question I had was regarding Colette's comment that HPC had doubled year-on-year. Just wondering if you have any comments on what drove that. And is that an indication of the supercomputer types of businesses? Or are there sort of other dynamics in terms of addressing new workloads with HPC products? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [40] +-------------------------------------------------------------------------------- + + Well, HPC is different than supercomputing. Supercomputing to us is a collection of -- not a collection but is 20 different supercomputing sites around the world. And some of the famous ones, whether it's Oak Ridge or Blue Water at UCSC, you've got TiTech in Japan, there are supercomputing centers that are either national supercomputing centers or they could be public and open supercomputer centers or open science. And so we consider those supercomputing centers. High-performance computing is used by companies who are using simulation approaches to develop products or to, well, to simulate something. It could be scenarios for predicting equity, or, for example, as you guys know, Wall Street is the home of some of the largest supercomputing center -- or high-performance computing centers. The energy industry, Schlumberger, for example, is a great partner of ours and they have a massive, massive high-performance computing infrastructure. And Procter & Gamble uses high-performance computers to simulate their products. And so I think last year, McDonald's was at GTC and I hope they come this year as well. And so I think high-performance computing, another way of thinking about it is that more and more people really have to use simulation approaches for product discovery and product design and product simulation and stuff to stress the products beyond what is possible in a physical way so that they understand the tolerance of the products to make sure they are as reliable as possible. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Blayne Curtis from Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [42] +-------------------------------------------------------------------------------- + + Just curious, Jen-Hsun, we've seen half dozen, dozen private companies going after the (inaudible) silicon Google TPU. I know you felt the comparison to a TPU maybe wasn't fair. But I was just kind of curious to your response to these claims of a 10, 100, 500x performance better than a GPU. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [43] +-------------------------------------------------------------------------------- + + Well, it's not that it's not fair. It's just not right. It's not correct. And so in business, who cares about being fair? And so I wasn't looking for fair. I was just looking for right. And so the data has to be correct. It turns out -- and I said earlier that our hyperscale businesses have 3 different pillars. There's training, which our GPUs are quite good at. There's cloud service provision, which is a GPU computing architecture opportunity where CUDA is really the reason why people are adopting it and all the applications that have been -- that has adopted CUDA over the years. And then there's inferencing. And inferencing is a 0 opportunity for us, a 0 business for us at the moment. I mean, we do 0% of our business in inferencing and it's 100% on CPUs. And in the case of Google, they did a great thing and built a TPU as an ASIC. And they compared the TPU against one of our older GPUs. And so I published a blog. I wrote a blog to clarify some of the comparisons and you could look that up. But the way to think about that is our Pascal is probably approximately twice the performance of the TPU, the first generation TPU. And it's incumbent upon us to continue to drive the performance of inferencing. This is something that's still kind of new for us. And tomorrow, I'm probably going to say a few words about inferencing and maybe introduce a few ideas. But inferencing is new to us. It's -- there are 10 million CPUs in the world in a cloud, and today, many of them are running Hadoop and doing queries and looking up files and things like that. But in the future, the belief is that the vast majority of the world's cloud queries will be inference queries, will be AI queries. Every single query that goes into the cloud will likely have some artificial intelligence network that it processes. And I think that's our opportunity. We have an opportunity to do inferencing better than anybody in the world and it's up to us to prove it. At the moment, I think it's safe to say that the P40, the Tesla P40, is the fastest on the planet, period. And then from here on forward, it's incumbent upon us to continue to lean into that and do a better, better job. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [44] +-------------------------------------------------------------------------------- + + And then just moving to the gaming GPU side. I was just wondering if you could just talk about the competitive landscape, looking back at the last refresh and then looking forward into the back half of this year. I think your competitor's going to have a new platform. Just kind of curious to your thought as to how the share worked out on the previous refresh and then the competitiveness into the second half of this year. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [45] +-------------------------------------------------------------------------------- + + My assessment is that the competitive position is not going to change. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Your last question comes from the line of Mitch Steves from RBC. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [47] +-------------------------------------------------------------------------------- + + I just have one actually on the gaming side. I remember at CES, you had mentioned kind of a leasing model, almost effectively kind of target the low-end consumers of gaming products. So just wondering if that'll be some sort of catalyst the back half. So how do we think about gaming working out in terms of both the leasing model and the year-over-year comparisons getting a bit difficult? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President and Director [48] +-------------------------------------------------------------------------------- + + Mitch, yes, I was just talking about that earlier in one of the questions. It's called GeForce NOW and I announced it at CES. And I said that right around this time of the year, we're going to open it up for external beta. We've been running internal beta and closed beta for some time. And so we're looking forward to opening up the external beta. My expectation is that it's going to be some time as we scale that out. It's going to take several years. I don't think it's something that's going to be an overnight success. And as you know, overnight successes don't happen overnight. However, I'm optimistic about the opportunity to extend the GeForce platform beyond the gamers that we currently have in our installed base. There are several billion gamers on the planet and I believe that every human will be a gamer someday. And every human will have some way to enjoy an alternative universe some way, someday. And we would love to be the company that brings it to everybody. And the only way to really do that on a very, very large-scale basis and reach all those people is over the cloud. And so I think our PC gaming business is going to continue to be quite vibrant. It's going to continue to advance. And then hopefully, we can overlay our cloud reach on top of that over time. +Well, thanks for all the questions today. I really appreciate it. We had another record quarter. We saw growth across our 4 market platforms. AI is expanding. Datacenter nearly tripled. Large ISP, CSP deployments everywhere. PC gaming is still growing; eSports, AAA gaming titles, fueling our growth there. And we have great games on the horizon. Autonomous vehicles, becoming imperative on all sectors of transportation, as we talked about earlier. We have a great position with our DRIVE AI computing platform. And as Moore's Law continues to slow, GPU accelerated computing is becoming more important than ever and NVIDIA is at the center of that. +Don't miss tomorrow's GTC keynote. We'll have exciting news to share, next-generation AI, self-driving cars, exciting partnerships and more. Thanks, everybody. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2017-Nov-09-NVDA.txt b/Transcripts/NVDA/2017-Nov-09-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..d9ac4684dcb1c65b37a9535adee124091b1b0cdd --- /dev/null +++ b/Transcripts/NVDA/2017-Nov-09-NVDA.txt @@ -0,0 +1,316 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2018 Nvidia Corp Earnings Call +NOVEMBER 09, 2017 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Simona Jankowski + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst + * Craig Andrew Ellis + B. Riley & Co., LLC, Research Division - Senior MD & Director of Research + * Matthew D. Ramsay + Canaccord Genuity Limited, Research Division - MD + * Hans Carl Mosesmann + Rosenblatt Securities Inc., Research Division - Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Victoria, and I'm your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, - [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone and welcome to NVIDIA's conference call for the third quarter of fiscal 2018. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It is also being recorded. You can hear a replay by telephone until November 16, 2017. The webcast will be available for replay up until next quarter's conference call to discuss Q4 and full year fiscal 2018 financial results. The contents of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, November 9, 2017, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO Commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Simona. We had an excellent quarter with record revenue in each of our 4 market platforms. And every measure of profit hit record levels, reflecting the leverage of our model. Data center revenue of $501 million more than doubled from a year ago and the strong adoption of our Volta platform and early traction with our inferencing portfolio. +Q3 revenue reached $2.64 billion, up 32% from a year earlier, up 18% sequentially and well above our outlook of $2.35 billion. From a reporting segment perspective, GPU revenue grew 31% from last year to $2.22 billion. Tegra processor revenue rose 74% to $419 million. +Let's start with our gaming business. Gaming revenue was $1.56 billion, up 25% year-on-year and up 32% sequentially. We saw robust demand across all regions and form factors. Our Pascal-based GPUs remained the platform of choice for gamers as evidenced by our strong demand for GeForce GTX 10-Series products. We introduced the GeForce GTX 1070 Ti, which became available last week. It complements our strong holiday lineup ranging from the entry-level GTX 1050 to our flagship GTX 1080 Ti. +A wave of great titles is arriving for the holidays, driving enthusiasm in the market. We collaborated with Activision to bring Destiny 2 to the PC earlier in the month. PlayerUnknown's Battlegrounds, popularly known as PUBG, continues to be one of the year's most successful titles. We are closely aligned with PUBG to ensure that GeForce is the best way to play the game, including bringing shadow play highlights to its 20 million players. Last weekend, Call of Duty: WWII had a strong debut, and Star Wars Battlefront II will be out [soon]. +eSports remains one of the most important secular growth drivers in the gaming market with a fan base that now exceeds 350 million. Last weekend, the League of Legends World Championship was held in Beijing's National Stadium, the Bird's Nest, where the 2008 Olympics games were held. More than 40,000 fans attended live, and online viewers were set to break last year's record of 43 million following in 18 languages. +GPU sales also benefited from continued cryptocurrency mining. We met some of this demand with a dedicated board in our OEM business and a portion with GeForce GTX boards, though it's difficult to quantify. We remain nimble in our approach to the cryptocurrency market. It is volatile, does not and will not distract us from focusing on our core gaming market. Lastly, Nintendo Switch console continues to gain momentum since launching in March and also contributed to growth. +Moving to data center. Our data center business had an outstanding quarter. Revenue of $501 million more than doubled from last year and rose 20% on the quarter amid strong traction of the new Volta architecture. Shipments of the Tesla V100 GPU began in Q2 and ramped significantly in Q3 driven primarily by demand from cloud service providers and high-performance computing. As we have noted before, Volta delivers 10x the deep learning performance of our Pascal architecture, which has been introduced just a year earlier, far outpacing Moore's Law. +The V100 is being broadly adopted with every major server OEM and cloud provider. In China, Alibaba, Baidu and Tencent announced that they are incorporating V100 in their data centers and cloud server service infrastructures. In the U.S., Amazon Web Services announced that V100 inferences are now available in 4 of its regions. Oracle Cloud has just added Tesla P100 GPUs to its infrastructure offerings and plans to expand to the V100 GPUs. We expect support from V100 from other major cloud providers as well. +In addition, all major server OEMs announced support for the V100, Dell EMC, Hewlett Packard Enterprise, IBM and Supermicro are incorporating it in servers. And China's top server OEMs, Huawei, Inspur and Lenovo have adopted our HGX server architecture to build a new generation of accelerated data centers with V100 GPUs. +Our new offerings for the AI inference market are also gaining momentum. The recently launched TensorRT 3 programmable inference acceleration platform opens a new market opportunity for us, improving the performance and reducing the cost of AI inferencing in order -- by orders of magnitude compared with CPUs. It supports every major deep learning framework, every network architecture and any level of network complexity. More than 1,200 companies are already using our inference platform including Amazon, Microsoft, Facebook, Google, Alibaba, Baidu, JD.com, iFLYTEK, Hikvision and Tencent. +During the quarter, we announced that the NVIDIA GPU Cloud container registry, or NGC, is now available through Amazon's cloud and will be supported soon by other cloud platforms. NGC helps developers get started with deep learning development through no-cost access to a comprehensive, easy-to-use, fully optimized deep learning software stack. It enables instant access to the most widely used GPU-accelerated frameworks. +We also continue to see robust growth in our HPC business. Next-generation supercomputers, such as the U.S. Department of Energy's Sierra and Summit systems expected to come online next year, leverage Volta's industry-leading performance, and our pipeline is strong. The past weeks have been exceptionally busy for us. We have hosted 5 major GPU Technology Conferences in Beijing, Munich, Taipei, Tel Aviv and Washington with another next month in Tokyo. In a strong indication of the growing importance of GPU-accelerated computing, more than 22,000 developers, data scientists and others will come this year to our GTCs, including the main event in Silicon Valley. That's up 10x in just 5 years. Other key metrics show similar gains. Over the same period, the number of NVIDIA GPU developers has grown 15x to 645,000, and the number of CUDA downloads this year are up 5x to 1.8 million. +Moving to professional visualization. Third quarter revenue grew to $239 million, up 15% from a year ago and up 2% sequentially driven by demand for high-end real-time rendering, simulation and more powerful mobile workstations. The defense and automotive industries grew strongly as the demand for professional VR solutions driven by Quadro P5000 and P6000 GPUs. Among key customers, Audi and BMW are deploying VR in auto showrooms. And the U.S. Army, Navy and Homeland Security are using VR for mission training. +Last month, we announced early access to NVIDIA Holodeck, the intelligent VR collaboration platform. Holodeck enables designers, developers and their customers to come together virtually from anywhere in the world in a highly realistic, collaborative and physically simulated environment. Future updates will address the growing demand for the development of deep learning techniques in virtual environments. +In automotive, revenue grew to $144 million, up 13% year-over-year and up slightly from last quarter. Among key developments this quarter, we announced DRIVE PX Pegasus, the world's first AI computer for enabling Level 5 driverless vehicles. Pegasus will deliver over 320 trillion operations per second, more than 10x its predecessor. It's powered by 4 high-performance AI processors in a supercomputer that is the size of a license plate. NVIDIA DRIVE is being used by over 25 companies to develop fully autonomous robotaxis, and DRIVE PX Pegasus will become the path to production. It is designed for ASIL D certification, the industry's highest safety level and will be available in the second half of 2018. +We also introduced the DRIVE IX SDK for delivering intelligent experiences inside the vehicle. DRIVE IX provides a platform for car companies to create and always engage AI co-pilot. It uses deep learning networks to track head movement and gaze, and it will have a conversation with the driver using advanced speech recognition, lipreading and natural language understanding. We believe this will set the standard for the next generation of infotainment systems, a market that is just beginning to develop. +Finally, we announced that DHL, the world's largest mail and package delivery service, and ZF, one of the world's leading automotive suppliers, will deploy a test fleet of autonomous delivery trucks next year using the NVIDIA DRIVE PX platform. DHL will outfit electric light trucks with the ZF ProAI self-driving system based on our technology. +Now turning to the rest of the income statement. Q3 GAAP gross margins was 59.5% and non-GAAP was 59.7%, both up sequentially and year-over-year, reflecting continued growth in value-added platforms. GAAP operating expenses were $674 million, and non-GAAP operating expenses were $570 million, consistent with our outlook and up 19% year-on-year. Investing in our key market opportunities is essential to our future, including gaming, AI and self-driving cars. +GAAP operating income was a record $895 million, up 40% from a year ago. Non-GAAP operating income was $1.01 billion, up 42% from a year ago. GAAP net income was a record $838 million, and EPS was $1.33, up 55% and 60%, respectively, from a year earlier. Non-GAAP net income was $833 million, and EPS was $1.33, up 46% and 41%, respectively from a year earlier, reflecting revenue strength as well as gross margin and operating margin expansion. +We have returned $1.16 billion to shareholders so far this fiscal year through a combination of quarterly dividends and share repurchases. We have announced an increase to our quarterly dividend of $0.01 to an annualized $0.60 effective with our Q4 fiscal year '18 dividend. We are also pleased to announce that we intend to return another $1.25 billion to shareholders for fiscal 2019 through quarterly dividends and share repurchases. Our quarterly cash flow from operations reached record levels, surpassing $1 billion for the first time to $1.16 billion. +Now turning to the outlook for the fourth quarter of fiscal 2018. We expect revenue to be $2.65 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 59.7% and 60%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $722 million and $600 million, respectively. GAAP and non-GAAP OI&E are both expected to be nominal. GAAP and non-GAAP tax rates are both expected to be 17.5%, plus or minus 1%, excluding discrete items. Further financial details are included in the CFO Commentary and other information available on our website. +We will now open the call for questions. (Operator Instructions) Operator, we will -- would you please pool for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Your first question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- +Jensen, 3 months ago you described the July quarter as a transition quarter for your data center business. And clearly, you guys have ramped very well into October. But if you can talk a little bit about the outlook for the next couple of quarters in data center and particularly on the inferencing side. I know you guys are really excited about that opportunity. So if you can share customer feedback and what your expectations are into the next year in inferencing, that would be great. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- +Yes, as you know, we started ramping very strongly Volta this last quarter, and we started the ramp the quarter before. And since then, every major cloud provider, from Amazon, Microsoft, Google to Baidu, Alibaba, Tencent and even recently, Oracle, has announced support for Volta and we'll be providing Volta for their internal use of deep learning as well as external public cloud services. We also announced that every major server computer maker in the world has now supported Volta and in the process of taking Volta out to market. HP and Dell and IBM and Cisco and Huawei in China, Inspur in China, Lenovo, have all announced that they will be building servers -- families of servers around the Volta GPU. And so I think we -- this ramp is just the first part of supporting the build out of GPU-accelerated servers from our company for data centers all over the world as well as cloud service providers all over the world. The applications for these GPU servers has now grown to many markets. I've spoken about the primary segments of our Tesla GPUs. There are 5 of them that I talk about regularly. The first one is high-performance computing where the market is $11 billion or so. It is one of the faster-growing parts of the IT industry because more and more people are using high-performance computing for doing their product development or looking for insights or predicting the market or whatever it is. And today, we represent about 15% of the world's top 500 supercomputers. And I've repeatedly said and I believe this completely and I think it's becoming increasingly true that every single supercomputer in the future will be accelerated somehow. So this is a fairly significant growth opportunity for us. The second is deep learning training, which is very, very much like high-performance computing. And you need to do computing at a very large scale. You're performing trillions and trillions of iterations. The models are getting larger and larger. Every single year, the amount of data that we're training with it is increasing. And the difference between a computing platform that's fast versus not could mean the difference between building a $20 million data center or high-performance computing servers for training to $200 million. And so the money that we save and the capability we provide is really, the value is incredible. The third segment, and this is the segment that you just mentioned, has to do with inference, which is when you're done with developing this network, you have to put it down into the hyperscale data centers to support the billions and billions of queries that consumers make to the Internet every day. And this is a brand-new market for us. 100% of the world's inference is done on CPUs today. We announced very recently, this last quarter in fact, that TensorRT 3 inference acceleration platform and in combination with our Tensor Core GPU instruction set architecture, we're able to speed up networks by a factor of 100. Now the way to think about that is imagine whatever amount of workload that you've got, if you could speed up using our platform by a factor of 100, how much you can save. The other way to think about that is because the amount of -- the networks are getting larger and larger, and they're so complex now. And we know that every network on the planet will run on our architecture because they were trained on our architecture today. And so whether it's CNNs or RNNs or GANs or autoencoders or all of the variations of those, irrespective of the precision that you need to support, the size of the network, we have the ability to support them. And so you could either scale out your hyperscale data center to support more traffic or you can reduce your cost tremendously or simultaneously, both. The fourth segment of our data center is providing all of that capability, what I just mentioned, whether it's HPC, training or inference and turning it inside out and making it available in the public cloud. There are thousands of start-ups now that are in -- are started because of AI. Everybody recognizes the importance of this new computing model. And as a result of this new tool, this new capability, all these unsolvable problems in the past are now interestingly solvable. And so you can see start-ups cropping up all over the west, all over the east, and there's just -- there are thousands of them. And these companies don't either -- would rather not use their scarce financial resources to go build high-performance computing centers, or they don't have the skill to be able to build out a high-performance platform the way these Internet companies can. And so these cloud providers, cloud platforms are just a fantastic resource for them because they could rent it by the hour. We created in conjunction with that, and I mentioned all the cloud service providers have taken it to market, in conjunction with that, we created a registry in the cloud that containerizes these really complicated software stacks. Every one of these soft frameworks with the different versions of our GPUs and different acceleration layers and different optimization techniques, we've containerized all of that for every single version and every single type of framework in the marketplace. And we put that up in the registry -- cloud registry called the NVIDIA GPU Cloud. And so all you had to do was download that into the cloud service provider that we've got certified and tested for, and with just one click, you're doing deep learning. And then the last -- and so that's the cloud service providers. If you -- the way to guess that -- estimate that is there are obviously tens of billions of dollars being invested in these AI start-ups. And some large proportion of their investment fund raise will ultimately have to go towards high-performance computing, whether they build it themselves or they rent it in the cloud. And so I think that's a multibillion dollar opportunity for us. And then lastly, this is probably the largest of all the opportunities, which is the vertical industries. Whether it's automotive companies that are developing their supercomputers to get ready for self-driving cars or health care companies that are now taking advantage of artificial intelligence to do better diagnostics of -- diagnosis of disease, to manufacturing companies to -- for in-line inspection, to robotics, large logistics companies. Colette mentioned earlier DHL. But the way to think about that is all of these planning -- all of these companies doing planning to deliver products to you through this large network of delivery systems, it is the world's largest planning problem. And whether it's Uber or Didi or Lyft or Amazon or DHL or UPS or FedEx, they all have high-performance computing problems that are now moving to deep learning. And so those are really exciting opportunities for us. And so the last one is just vertical industries. I mean, all of these segments, we're now in a position to start addressing because we've put our GPUs in the cloud, all of our OEMs are in the process of taking these platforms out to market and we have the ability now to address high-performance computing and deep learning training as well as inference using one common platform. And so I think the -- we've been steadfast with the excitement of accelerated computing for data centers, and I think this is just the beginning of it all. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [5] +-------------------------------------------------------------------------------- +I had a question on your gaming seasonality into Q4. It's usually up a bit. I was wondering, do you see any, I guess, drivers that would drive a lack of normal seasonal trends given how strong it's been sequentially and year-over-year? And I guess as a related question, do you see your Volta volumes in Q4 exceeding Q3? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [6] +-------------------------------------------------------------------------------- +Let's see. There's -- I'll answer the last one first and then work towards the first one. I think the guidance that we provided, we feel comfortable with. But if you think about Volta, it is just in the beginning of the ramp, and it's going to ramp into the market opportunities I talked about. And so my hope is that we continue to grow, and there's every evidence that the markets that we serve, that we're addressing with Volta is -- are very large markets. And so there's a lot of reasons to be hopeful about the future growth opportunities for Volta. We've primed the pump. So cloud service providers are either announce the availability of Volta or they announced the soon availability of Volta. They're all racing to get Volta to their cloud because customers are clamoring for it. The OEMs are -- we've primed the pump with the OEMs, and some of them are sampling now and some of them are racing to get Volta to production in the marketplace. And so I think the foundation, the demand is there. The urgent need for accelerated computing is there because Moore's Law is not scaling anymore, and then we've primed the pump. So the demand is there. There's a need -- the need is there, and the foundations for getting Volta to market is primed. With respect to gaming, what drives our gaming business? Remember, our gaming business is sold one at a time to millions and millions of people. And what drives our gaming business is several things. As you know, eSports is incredibly, incredibly vibrant, and what drives -- the reason why eSports is so unique is because people want to win and having better gear helps. The latency that they expect is incredibly low, and performance drives down latency and they want to be able to react as fast as they can. People want to win, and they want to make sure that the gear that they use is not the reason why they didn't win. The second growth driver for us is content, the quality of content. And boy, if you look at Call of Duty or Destiny 2 or PUBG, the content just looks amazing. The AAA content looks amazing. And one of the things that's really unique about video games is that in order to enjoy the content and the fidelity of the content, the quality of the production value at its fullest, you need the best gear. It's very different than streaming video, it's very different than watching movies where streaming videos, it is what it is. But for video games, of course, it's not. And so when AAA titles comes out in the later part of the year, it helps to drive platform adoption. And then lastly, increasingly, social is becoming a huge part of the growth dynamics of gaming. People are -- they recognize how beautiful these video games are, and so they want to share their brightest moments with people. They want to share the levels they discover. They want to take pictures of the amazing graphics that's inside. And it is one of the primary drivers, the leading driver, in fact, of YouTube and people watching other people play video games, these broadcasters. And now with our Ansel, the world's first in-game virtual reality and surround and digital camera, we have the ability to take pictures and share that with people. And so I think all of these different drivers are helping our gaming business, and I'm optimistic about Q4. It looks like it's going to be a great quarter. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Your next question comes from the line of C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [8] +-------------------------------------------------------------------------------- +I was hoping to sneak in a near-term and a longer-term question. On the near term, you talked about the health on demand side for Volta. Curious if you're seeing any sort of restrictions on the supply side, whether it's wafers or access to high-bandwidth memory, et cetera. And then the longer-term question really revolves around CUDA, and you've talked about that as being a sustainable competitive advantage for you guys entering the year. And now that we've moved beyond HPC and hyperscale training to more into inference and GPU as a service and you've hosted GTC around the world, curious if you could extrapolate on how you're seeing that advantage and how you've seen it evolve over the year and how you're thinking about CUDA as the AI standard. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- +Yes, thanks a lot, C.J. Well, everything that we build is complicated. Volta is the single largest processor that humanity has ever made, 21 billion transistors, 3D packaging, the fastest memories on the planet and all of that in a couple hundred watts, which basically says it's the most energy-efficient form of computing that the world has ever known. And one single Volta replaces hundreds of CPUs. And so it's energy-efficient. It saves an enormous amount of money. And it gets this job done really, really fast, which is one of the reasons why GPU-accelerated computing is so popular now. With respect to the outlook for our architecture, as you know, we are a one-architecture company, and it's so vitally important. And the reason for that is because there are so much software and so much tools created on top of this one architecture. On the inference side -- on the training side, we have a whole stack of software and optimizing compilers and numerics libraries that are completely optimized for one architecture called CUDA. On the inference side, the optimizing compilers that takes these large, huge computational graphs that come out of all of these frameworks, and these computational graphs are getting larger and larger and their numerical precision differs from one type of network to another -- from one type of application to another. Your numerical precision requirements for a self-driving car, where lives are at stake, to detecting where -- counting the number of people crossing the street, counting something versus trying to track -- detect and track something very subtle in all kinds of weather conditions is a very, very different problem. And so numeric -- the type of networks are changing all the time. They're getting larger all the time. The numerical precision is different for different applications. And we have different computing -- computer performance levels as well as energy availability levels that these inference compilers are likely to be some of the most complex software in the world. And so the fact that we have one singular architecture to optimize for, whether it's HPC for numeric -- molecular dynamics and computational chemistry and biology and astrophysics, all the way to training to inference gives us just enormous leverage. And that's the reason why NVIDIA could be an 11,000-people company and arguably, performing at a level that is 10x that. And the reason for that is because we have one singular architecture that's -- that is accruing benefits over time instead of 3, 4, 5 different architectures where your software organization is broken up into all these different small subcritical mass pieces. And so it's a huge advantage for us, and it's a huge advantage for the industry. So people who support CUDA knows that the next-generation architecture will just get a benefit and go for the ride that technology advancement provides them and affords them. Okay. So I think it's an advantage that is growing exponentially, frankly, and I'm excited about it. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Your next question comes from the line of Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [11] +-------------------------------------------------------------------------------- +Congratulations on the strong results and the consistent execution. Jensen, in the last few months, we have seen a lot of announcements from Intel, from Xilinx and others describing other approaches to the AI market. My question is how does a customer make that decision whether to use a GPU or an FPGA or an ASIC, right? What is -- what can remain your competitive differentiator over the longer term? And does your position in the training market also then maybe give you a leg up when they consider solution for the inference part of the problem? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [12] +-------------------------------------------------------------------------------- +Yes, thank you, Vivek. So first of all, we have one architecture and people know that our commitment to our GPUs, our commitment to CUDA, our commitment to all of the software stacks that run on top of our GPUs, every single one of the 500 applications, every numerical solver, every CUDA compiler, every tool chain across every single operating system in every single computing platform, we are completely dedicated to it. We support the software for as long as we shall live, and as a result of that, the benefits to their investment in CUDA just continues to accrue. I -- you have no idea how many people send me notes about how they literally take out their old GPU, put in a new GPU and without lifting a finger, things got 2x, 3x, 4x faster than what they were doing before, incredible value to customers. The fact that we are singularly focused and completely dedicated to this one architecture and in an unwavering way allows everybody to trust us and know that we will support it for as long as we shall live. And that is the benefit of an architectural strategy. When you have 4 or 5 different architectures to support, that you offer to your customers and you ask them to pick the one that they like the best, you're essentially saying that you're not sure which one is the best. And we all know that nobody's going to be able to support 5 architectures forever. And as a result, something has to give, and it would be really unfortunate for a customer to have chosen the wrong one. And if there's 5 architectures, surely, over time, 80% of them will be wrong. And so I think that our advantage is that we're singularly focused. With respect to FPGAs, I think FPGAs have their place, and we use FPGAs here in NVIDIA to prototype things and -- but FPGA is a chip design. It's able to be a chip for -- it's incredibly good at being a flexible substrate to be any chip, and so that's its advantage. Our advantage is that we have a programming environment, and writing software is a lot easier than designing chips. And if it's within the domain that we focus on, like, for example, we're not focused on network packet processing, but we are very focused on deep learning. We're very focused on high performance and parallel numerics analysis. If we're focused on those domains, our platform is really quite unbeatable. And so that's how you think through that. I hope that was helpful. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- +Your next question comes from Atif Malik with Citi. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment and Specialty Semiconductor Analyst [14] +-------------------------------------------------------------------------------- +Colette, on the last call you mentioned crypto was $150 million in the OEM line in the July quarter. Can you quantify how much crypto was in the October quarter and expectations in the January quarter directionally? And just longer term, why should we think that crypto won't impact the gaming demand in the future? If you can just talk about the steps NVIDIA has taken with respect to having a different mode and all that. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [15] +-------------------------------------------------------------------------------- +So in our results, in the OEM results, our specific crypto [boards] equated to about $70 million of revenue, which is the comparable to the $150 million that we saw last quarter. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [16] +-------------------------------------------------------------------------------- +Yes, longer term, Atif -- well, first of all, thank you for that. The -- longer term, the way to think about that is, is crypto is small for us but not 0. And I believe that crypto will be around for some time, kind of like today. There will be new currencies emerging. Existing currencies will grow in value. The interest in mining these new emerging currency crypto algorithms that emerge are going to continue to happen. And so I think for some time, we're going to see that crypto will be a small but not 0, small but not 0 part of our business. The -- when you think about crypto in the context of our company overall, the thing to remember is that we're the largest GPU computing company in the world. And our overall GPU business is really sizable and we have multiple segments. And there's data center and I've already talked about the 5 different segments within data center. There's ProVis and even that has multiple segments within it. Whether it's rendering or computer-aided design or broadcast in a workstation, in a laptop or in a data center, the architectures are rather different. And of course, you know that we have high-performance computing. You know that we have autonomous machine business, self-driving cars and robotics. And you know, of course, that we have gaming. And so these different segments are all quite large and growing. And so my sense is that as -- although crypto will be here to stay, it will remain small but not 0. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [18] +-------------------------------------------------------------------------------- +Just following up on that last question. You mentioned that some of the crypto market had moved to traditional gaming. What drives that? Is there a lack of availability of the specialized crypto product? Or is it just that there's a preference being driven for the gaming-oriented crypto solutions? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [19] +-------------------------------------------------------------------------------- +Yes, Joe, I appreciate you asking that. Here's the reason why. So what happens is, is when a crypto -- when a currency -- digital currency market becomes very large, it entices somebody to build a custom ASIC for it. And of course, Bitcoin is the perfect example of that. Bitcoin is incredibly easy to design as a specialized chip form. But then what happens is a couple of different players starts to monopolize the marketplace and as a result, it chases everybody out of the mining market and it encourages a new currency to evolve -- to emerge. And the new currency, the only way to get people to mine it is if it's hard to mine, it's hard to mine, okay, you got to put some effort into it. However, you want a lot of people to try to mine it. And so therefore, the platform that is perfect for it, the ideal platform for digital -- new emerging digital currencies turns out to be a CUDA GPU. And the reason for that is because there are several hundred million NVIDIA GPUs in the marketplace. If you want to create a new cryptocurrency algorithm, optimizing for our GPUs is really quite ideal. It's hard to do. It's hard to do, therefore, you need a lot of computation to do it. And yet there's enough GPUs in the marketplace, it's such an open platform that the ability for somebody to get in and start mining is very low barriers to entry. And so it's the cycles of these digital currencies, and that's the reason why I say that digital currency crypto usage of GPUs, crypto usage of GPUs will be small but not 0 for some time. And it's small because when it gets big, somebody will go and build a custom ASIC. But if somebody builds a custom ASIC, there will be a new emerging cryptocurrency, so ebbs and flows. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Your next question comes from the line of Craig Ellis with B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley & Co., LLC, Research Division - Senior MD & Director of Research [21] +-------------------------------------------------------------------------------- +Jensen, congratulations on data center annualizing at $2 billion. It's a huge milestone. I wanted to follow up with a question on some of your comments regarding data center partners because as I look back over the last 5 years, I just don't see any precedent for the momentum that you have in the marketplace right now between your server partners, white box partners, hyperscale partners that are deploying it, hosted, et cetera. And so my question is relative to the doubling that we've seen year-on-year in each of the last 2 years, what does that partner expansion mean for data center's growth? And then if I could sneak one more in. 2 new products just announced in the gaming platform, 1070 Ti and a Collector's Edition on TITAN Xp. What do those mean for the gaming platform? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [22] +-------------------------------------------------------------------------------- +Yes, Craig, thanks a lot. Let's see. We have never created a product that is as broadly supported by the industries and has grown 9 consecutive quarters, it has doubled year-over-year and with partnerships of the scale that we're looking at. We have just never created a product like that before, and I think the reason for that is several folds. The first is that it is true that CPU scaling has come to an end. That's just laws of physics. The end of Moore's Law is just laws of physics. And yet the world for software development and the world -- the problems that computing can help solve is growing faster than any time before. Nobody's ever seen a large-scale planning problem like Amazon before. Nobody's ever seen a large-scale planning problem like Didi before. The number of millions of taxi rides per week is just staggering. And so nobody's ever seen large problems like these before, large-scale problems like these before. And so high-performance computing and accelerated computing using GPUs has become recognized as the path forward. And so I think that that's at the highest level of the most important parameter. Second is artificial intelligence and its emergence and applications to solving problems that we historically thought were unsolvable. Solving the unsolvable problems is a real realization. I mean, this is happening across just about every industry we know, whether it's Internet service providers to health care to manufacturing to transportation and logistics, you just name it, financial services. And so I think artificial intelligence is a real tool, deep learning is a real tool that can help solve some of the world's unsolvable problems. And I think that our dedication to high-performance computing and this one singular architecture, our 7-year head start, if you will, in deep learning and our early recognition of the importance of this new computing approach, both the timing of it, the fact that it was naturally a perfect fit for the skills that we have and then the incredibly -- the incredible effectiveness of this approach, I think, has really created the perfect conditions for our architecture. And so I think -- I really appreciate you noticing that, but this is definitely the most successful product line in the history of our company. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Your next question comes from the line of Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [24] +-------------------------------------------------------------------------------- +I have a question on the automotive market and the outlook there. And interestingly, with the other segments growing as quickly as they are, auto is becoming a smaller percentage of revenue now. And certainly, the design traction seems very positive. Can you talk about the ramp in terms of when the auto revenue, when we could see that as getting back to a similar percentage of revenue? Is that growing more quickly? Do you think that is likely to happen over the next year with some of these design wins coming out? Or is that something we should -- we'll be waiting for over several years? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [25] +-------------------------------------------------------------------------------- +I appreciate that, Chris. So the way to think about that is as you know, we've really, really reduced our emphasis on infotainment even though that's the primary part of our revenues, so that we could take, literally, hundreds of engineers and including the processors that we're building now, a couple of 2,000, 3,000 engineers, working on our autonomous machine and artificial intelligence platform for this marketplace to take advantage of the position we have and to go after this amazing revolution that's about to happen. I happen to believe that everything that moves will be autonomous someday, and it could be a bus, a truck, a shuttle, a car. Everything that moves will be autonomous someday. It could be a delivery vehicle. It could be little robots that are moving around warehouses. It could be delivering a pizza to you. And we felt that those -- this was such an incredibly, incredibly great challenge and such a great computing problem that we decided to dedicate ourselves to it. Over the next several years, and if you look at our DRIVE PX platform today, there's over 200 companies that are working on it. 125 start-ups are working on it. And these companies are mapping companies. They're Tier 1s. They're OEMs. They're shuttle companies, car companies, trucking companies, taxi companies. And this last quarter, we announced an extension of our DRIVE PX platform to include DRIVE PX Pegasus, which is now the world's first auto-grade, full ASIL D platform for robotaxis. And so I think our position is really excellent, and the investment has proven to be one of the best ever. And so I think in terms of revenues, my expectation is that this coming year, we'll enjoy revenues as a result of the supercomputers that customers will have to buy for training their networks, for simulating the -- all these autonomous vehicles driving and developing their self-driving cars. And we'll see fairly large quantities of development systems being sold this coming year. The year after that, I think, is the year when you're going to see the robotaxis ramping, and our economics in every robotaxi is several thousand dollars. And then starting, I would say, late 2020 to 2021, you're going to start to see the first fully automatic autonomous cars, what people call Level 4 cars, starting to hit the road. And so that's kind of how I see it. Just next year is simulation environments, development systems, supercomputers, and then the year after that is robotaxis and then a year or 2 after that will be all the self-driving cars. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Your next question comes from the line of Matt Ramsay with Canaccord Genuity. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Canaccord Genuity Limited, Research Division - MD [27] +-------------------------------------------------------------------------------- +I have, I guess, a 2-part question on gross margin. Colette, I remember, I don't know, maybe 3 years ago, 3.5 years ago at an analyst day, you guys were talking about gross margins in the mid-50s and that was inclusive of the Intel payment. And now you're hitting numbers at 60% excluding that. I want -- if you could talk a little bit about how mix of the data center business and some others drives gross margin going forward. And maybe, Jensen, you could talk a little bit about -- you mentioned Volta being such a huge chip in terms of transistor count. How you're thinking about taking costs out of that product as you ramp it into gaming next year and the effects on gross margin. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- +Okay. Thanks, Matt, for the question. Yes, we've been on a steady stream of increasing the gross margins over the years. But this is the evolution of the entire model, the model of the value-added platforms that we sell and inclusive of the entire ecosystem of work that we do, the software that we enable in so many of these platforms that we bring to market. Data center is one of them. Our ProVis, another one and if you think about all of our work that we have in terms of gaming and that overall expansion of the ecosystem. So this has been continuing to increase our gross margin. Mix is more of a statement in terms of each quarter we have a different mix in terms of our products. So some of them have a little bit of seasonality. And depending on when some of those platforms come to market, we can have a mix change within some of those subsets. It's still going to be our focus as we go forward in terms of growing gross margins as best as we can, you can see in terms of our guidance into Q4, which we feel comfortable with that guidance that we will increase it as well. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [29] +-------------------------------------------------------------------------------- +Yes, with respect to yield enhancement, the way to think about that is we do it in several ways. The first thing is I'm just incredibly proud of the technology group that we have in VLSI, and they get us ready for these brand new nodes, whether it's in the process readiness with all the circuit readiness, the packaging, the memory readiness. The readiness is so incredible -- incredibly important for us because these processors that we're creating are really, really hard. They're the largest things in the world. And so we get one shot at it. And so the team does everything they can to essentially prepare us. And by the time that we tape-out a product for real, we know for certain that we can build it. And so the technology team in our company is just world-class, absolutely world-class. There's nothing like it. Then once we go into production, we have the benefit of ramping up the products. And as yields improve, we'll surely benefit from the cost. But that's not really where the focus is. I mean, in the final analysis, the real focus for us is continue to improve the software stack on top of our processors. And the reason for that is each one of our processors carry with it an enormous amount of memory and systems and networking and the whole data center. Most of our data center products, if we can improve the throughput of a data center by another 50% or, in our case, often times we'll improve something from 2x to 4x, the way to think about that is that billion-dollar data center just improved its productivity by a factor of 2. And all of the software work that we do on top of CUDA and the incredible work that we do with optimizing compilers and graph analytics, all of that stuff then all of a sudden translates to value to our customers, not measured by dollars, but measured by hundreds of millions of dollars. And that's really the leverage of accelerated computing. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Your next question comes from the line of Hans Mosesmann with Rosenblatt. + +-------------------------------------------------------------------------------- +Hans Carl Mosesmann, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [31] +-------------------------------------------------------------------------------- +Jensen, can you comment on some of the issues this week regarding Intel and their renewed interest in getting into the graphics space and their relationship at the chip level with AMD? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [32] +-------------------------------------------------------------------------------- +Yes, thanks, Hans. Yes, listen, there's a lot of news out there. I guess some of the things I take away, first of all, Raja leaving AMD is a great loss for AMD. And it's a recognition by Intel probably that the GPU is just incredibly, incredibly important now. And the modern GPU is not a graphics accelerator. The modern GPU, we just left the word G in there -- the letter G in there. But these processors are domain-specific parallel accelerators, and they're enormously complex. They're the most complex processors built by anybody on the planet today. And that's the reason why IBM uses our processors for the world's largest supercomputers. That's the reason why every single cloud, every single -- every major cloud, every major server maker in the world has adopted NVIDIA GPUs: It's just incredibly hard to do. The amount of software engineering that goes on top of it is significant as well. And so if you look at the way we do things, we plan a road map about 5 years out. It takes about 3 years to build a new generation, and we build multiple GPUs at the same time. And on top of that, there are some 5,000 engineers working on systems software and numerics libraries and solvers and compilers and graph analytics and cloud platforms and virtualization stacks in order to make this computing architecture useful to all of the people that we serve. And so when you think about it from that perspective, it's just an enormous undertaking; arguably, the most significant undertaking of any processor in the world today. And that's the reason why we're able to speed up applications by a factor of 100. You don't walk in and have a new widget and a few transistors and all of a sudden speed up applications by a factor of 100 or 50 or 20. That's just something that's inconceivable unless you do the type of innovation that we do. And then lastly, with respect to the chip that they built together, I think it goes without saying now that the energy efficiency of Pascal GeForce and the Max-Q design technology and all of the software that we created has really set a new design point for the industry. It is now possible to build a state-of-the-art gaming notebook with the most leading-edge GeForce processors and be able to deliver gaming experiences that are many times greater than a console in 4K and have that be in a laptop that's 18 millimeters thin. The combination of Pascal and Max-Q has really raised the bar, and I think that that's really the essence of it. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Unfortunately, we have run out of time. Presenters, I'll now turn the call over to you for closing remarks. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- +We had another great quarter. Gaming is one of the fastest-growing entertainment industries, and we are well positioned for the holidays. AI is becoming increasingly widespread in many industries throughout the world, and we're hoping to lead the way with all major cloud providers and computer makers moving to deploy Volta. And we're building the future of autonomous driving. We expect robotaxis, using our technology, to hit the road in just a couple of years. We look forward to seeing many of you at SC17 next week, and thank you for joining us. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2018-Aug-16-NVDA.txt b/Transcripts/NVDA/2018-Aug-16-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..c16cc052b9f35e9e749cbe2d0eff723bea5c01d4 --- /dev/null +++ b/Transcripts/NVDA/2018-Aug-16-NVDA.txt @@ -0,0 +1,420 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2019 NVIDIA Corp Earnings Call +AUGUST 16, 2018 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Kelsey, and I'm your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the Second Quarter of Fiscal 2019. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until August 23, 2018. The webcast will be available for replay until the conference call to discuss our financial results for the third quarter of fiscal 2019. +The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. Forward-looking statements are made as of today, August 16, 2018, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. This is a big week for NVIDIA. We just announced the biggest leap in GPU architecture in over a decade. We can't wait to tell you more about it, but first, let's talk about the quarter. +We had another strong quarter, led by data center and gaming. Q2 revenue reached $3.12 billion, up 40% from a year earlier. Each market platform -- gaming, data center, pro visualization and automotive hit record levels -- with strong growth both sequentially and year-on-year. These platforms collectively grew more than 50% year-on-year. Our revenue outlook had anticipated cryptocurrency-specific products declining to approximately $100 million while actual crypto-specific product revenue was $18 million, and we now expect a negligible contribution going forward. +Gross margins grew nearly 500 basis points year-on-year while both GAAP and non-GAAP net income exceeded $1 billion for the third consecutive quarter. Profit nearly doubled. From a reporting segment perspective, GPU revenue grew 40% from last year to $2.66 billion. Tegra processor revenue grew 40% to $467 million. +Let's start with our gaming business. Revenue of $1.8 billion was up 52% year-on-year and up 5% sequentially. Growth was driven by all segments of the business with desktop, notebook and gaming consoles up all strong double-digit percentages year-on-year. +Notebooks were a standout this quarter, with strong demands for thin and light form factors based on our Max-Q technology. Max-Q enables gaming PC OEMs to pack a high-performance GPU into a slim notebook that is just 20 millimeters thick or less. All major notebook OEMs and ODMs have adopted Max-Q for their top-of-the-line gaming notebooks, just in time for back-to-school. And we expect to see 26 models based on Max-Q in stores for the holidays. +The gaming industry remains vibrant. The eSports audience now approaches 400 million, up 18% over the past year. The unprecedented success of Fortnite and PUBG has popularized this new battle royale genre and expanded the gaming market. In fact, the battle royale mode is coming to games like the much-anticipated Battlefield V. We are thrilled to partner with EA to make GeForce the best PC-gaming platform for the release of Battlefield V in October. +We have also partnered with Square Enix to make GeForce the best platform for its upcoming Shadow of the Tomb Raider. Monster Hunter: World arrived on PCs earlier this month and it was an instant hit. And many more titles are lined up for what promises to be a big holiday season. +It's not just new titles that are building anticipation. The gaming community is excited over the Turing architecture announced earlier this week at SIGGRAPH. Turing is our most important innovation since the invention of the CUDA GPU over a decade ago. The architecture includes new dedicated ray-tracing processors or RT cores and new Tensor Cores for AI inferencing, which together will make real-time ray-tracing possible for the first time. We will enable the cinematic quality gaming, amazing new effects powered by neural networks and fluid interactivity on highly complex models. +Turing will reset the look of video games and open up the 250 billion visual effects industries to GPUs. Turing is the result of more than 10,000 engineering years to -- of effort. It's -- delivers up to 6x performance increase over Pascal for ray-traced graphics and up to 10x boost for peak inference flops. This new architecture will be the foundation of a new portfolio of products across our platforms going forward. +Moving to data center. We had another strong quarter with revenue of $760 million, accelerating to 83% year-on-year growth and up 8% sequentially. This performance was driven by hyperscale demand as Internet services used daily by billions of people increasingly leverage AI. Our GPUs power real-time services such as search, voice recognition, voice synthesis, translation, recommender engines, fraud detection and retail applications. +We also saw a growing adoption of our AI and high-performance computing solutions by vertical industries, representing one of the most fastest areas of growth in our business. Companies in sectors ranging from oil and gas to financial services through transportation are harnessing the power of AI and our accelerating computing platform to turn data into actionable insights. +Our flagship Tensor Core GPU, the Tesla V100, based on Volta architecture, continue to ramp for both AI and high-performance computing applications. Volta has been adopted by every major cloud provider and hyperscale data center operator around the world. Customers have quickly moved to qualify the new version of V100, which doubled the on-chip DRAM to 32 gig to support much larger data sets and neural networks. Major server OEMs, HP Enterprise, IBM, Lenovo, Cray and Supermicro also brought the V100 32-gig to market in the quarter. +We continue to gain traction with AI inference solution, which helped expand our addressable market in the data center. During the quarter, we released our TensorRT 4 AI inference accelerator software for general availability. While prior versions of the TensorRT optimized image and video-related workloads, TensorRT 4 expands the aperture to include more use cases, such as speech recognition, speech synthesis, translation and recommendation systems. This means we can now address a much larger portion of deep learning inference workloads, delivering up to 190x performance speed-up, relative to CPUs. +NVIDIA and Google engineers have integrated TensorRT into the TensorFlow deep learning framework, making it easier to run AI inference on our GPUs. And Google Cloud announced that NVIDIA Tesla P4 GPU, our small form factor GPU for AI inference and graphic virtualization, is available on Google Cloud Platform. +Data center growth was also driven by DGX, our fully optimized AI server, which incorporates V100 GPUs, our proprietary high-speed interconnect and our fully optimized software stack. The annual run rate for DGX is in the hundreds of millions of dollars. DGX-2, announced in March at our GPU Technology Conference, is being qualified by customers and is on track to ramp in the third quarter. +At GTC Taiwan in June, we announced that we are bringing DGX-2 technology to our HGX-2 server platform. We make HGX-2 available to OEM and ODM partners so they can quickly deploy our newest innovations in their own server designs. In recent weeks, we announced partnerships with NetApp and Pure Storage to help customers speed AI deployment from months to days or even hours, with highly integrated optimized solutions that combine DGX with the company's all-flash storage offerings and third-party networking. +At GTC Taiwan, we also revealed that we are -- set 5 speed records for AI training and inference. Key to our strategy is our software stack. From CUDA to our training and inference SDKs as well as our work with our developers to accelerate their applications, it is the reason we can achieve such dramatic performance gains in such a short period of time. +And our developer ecosystem is getting stronger. In fact, we just passed 1 million members in our developer program, up 70% from 1 year ago. One of our proudest moments this quarter was the launch of the Summit AI supercomputer in Oak Ridge National Laboratory. Summit is powered by over 27,000 Volta Tensor Core GPUs and helped the U.S. reclaim the #1 spot on the TOP500 Supercomputer list for the first time in 5 years. +Other NVIDIA power systems joined the TOP500 list were Sierra at Lawrence Livermore National Laboratory in the third spot, and the ABCI, Japan's fastest supercomputer, in the fifth spot. NVIDIA now powers 5 of the world's 7 fastest supercomputers, reflecting the broad shift in supercomputing to GPUs. Indeed, the majority of the computing performance added to the latest TOP500 list comes from NVIDIA GPUs, and more than 550 HPC applications are now GPU accelerated. With our Tensor Core GPUs, supercomputers can now combine simulation with the power of AI to advance many scientific applications from molecular dynamics to seismic processing to genomics and materials science. +Moving to pro visualization. Revenue grew to $281 million, up 20% year-on-year and 12% sequentially, driven by demand for real-time rendering and mobile workstations as well as emerging applications like AI and VR. These emerging applications now represent approximately 35% of pro visualization sales. Strength extended across several key industries, including health care, oil and gas and media and entertainment. Key wins in the quarter include Raytheon, Lockheed, GE, Siemens and Philips Healthcare. +In announcing the Turing architecture at SIGGRAPH, we also introduced the first Turing-based processors, the Quadro RTX 8000, 6000 and 5000 GPUs, bringing interactive ray tracing to the world years before it has been predicted. We also announced that the NVIDIA RTX server, a full ray-tracing global illumination rendering server that will give a giant boost to the world's render farms as Moore's Law ends. +Turing is set to revolutionize the work of 5 -- 50 million designers and artists, enabling them to render photorealistic scenes in real time and add new AI-based capabilities to their work flows. Quadro GPUs based on the Turing will be available in the fourth quarter. Dozens of leading software providers, developers and OEMs have already expressed support for Turing. Our pro viz partners view it as a game-changer for professionals in the media and entertainment, architecture and manufacturing industries. +Finally, turning to automotive. Revenue was a record $161 million, up 13% year-on-year and up 11% sequentially. This reflects growth in our autonomous vehicle production and development engagements around the globe as well as the ramp of next-generation AI-based smart cockpit infotainment solutions. +We continue to make progress on our autonomous vehicle platform with key milestones and partnerships announced this quarter. In July, Daimler and Bosch selected DRIVE Pegasus as the AI brain for their Level 4 and Level 5 autonomous fleets. Pilot testing will begin next year in Silicon Valley. This collaboration brings together NVIDIA's leadership in AI and self-driving platforms, Bosch's hardware and systems expertise as the world's largest Tier 1 automotive supplier and Daimler's vehicle expertise and global brand synonymous with safety and quality. +This quarter, we started shipping development systems for DRIVE Pegasus, an AI supercomputer designed specifically for autonomous vehicles. Pegasus delivers 320 trillion operations per second to handle diverse and redundant algorithms and is architected for safety as well as performance. This automotive-grade functionally safe production solution uses 2 NVIDIA Xavier SoCs and 2 next-generation GPUs designed for AI and visual processing, delivering more than 10x greater performance and 10x higher data bandwidth compared to the previous generation. With co-designed hardware and software, the platform is created to achieve ASIL D ISO 26262, the industry's highest level of automotive functional safety. +We have created a scalable AI car platform that spans the entire range of automated and autonomous driving from traffic jam pilots to Level 5 robo-taxis. More than 370 companies and research institutions are using NVIDIA's automotive platform. With this growing momentum and accelerating revenue growth, we remain excited about the intermediate and long-term opportunities for autonomous driving business. +This quarter, we also introduced our Xavier platform for Jetson for the autonomous machine market. With more than 9 billion transistors, it delivers over 30 trillion operations per second, more processing capability than a powerful workstation while using 1/3 the energy of a lightbulb. Jetson Xavier establishes customers to deliver AI computing at the edge, powering autonomous machines like robots or drones with applications in manufacturing, logistics, retail, agricultural, health care and more. +Lastly, in our OEM segment, revenue declined by 54% year-on-year and 70% sequentially. This was primarily driven by the sharp decline of cryptocurrency revenues to fairly minimal levels. +Moving to the rest of the P&L. Q2 GAAP gross margin was 63.3% and non-GAAP was 63.5%, in line with our outlook. GAAP operating expenses were $818 million. Non-GAAP operating expenses were $692 million, up 30% year-on-year. We can continue to invest in the key platforms driving our long-term growth, including gaming, AI and automotive. +GAAP net income was $1.1 billion and EPS was $1.76, up 89% and 91%, respectively, from a year earlier. Some of the upside was driven by a tax rate near 7% compared to our outlook of 11%. Non-GAAP net income was $1.21 billion and EPS was $1.94, up 90% and 92%, respectively, from a year ago, reflecting revenue strength as well as gross and operating margin expansion and lower taxes. Quarterly cash flow from operations was $913 million. Capital expenditures were $128 million. +With that, let me turn to the outlook for the third quarter of fiscal 2019. We are including no contribution from crypto in our outlook. We expect revenue to be $3.25 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 62.6% and 62.8%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $870 million and $730 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of $20 million. GAAP and non-GAAP tax rates are both expected to be 9%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $125 million to $150 million. +Further financial details are included in the CFO commentary and other information available on our IR website. In closing, I'd like to highlight some of the upcoming events for the financial community. We'll be presenting at the Citi Global Technology Conference on September 6 and meeting with the financial community at our GPU Technology Conferences in Tokyo on September 13 and Munich on October 10. And our next earnings calls to discuss our financial results is in the third quarter of 2019 will take place on November 15. +We will now open the call for questions. (Operator Instructions) And operator, would you please poll for questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + The question's on ray tracing, to what extent is this creating new markets versus enabling greater capabilities in your existing markets? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes, Mark. So first of all, Turing, as you know, is the world's first ray-tracing GPU. And it completes our new computer graphics platform, which is going to reinvent computer graphics altogether. It unites 4 different computing modes: rasterization, accelerated ray tracing, computing with CUDA and artificial intelligence. It uses these 4 basic methods to create imagery for the future. There's 2 different -- 2 major ways that we'll experience the benefits right away. The first is for the markets of visualization today, they require photorealistic images. Whether it's an IKEA catalog or a movie or architectural engineering or product design, car design, all of these types of markets require photorealistic images. And the only way to really achieve that is to use ray tracing with physically based materials and lighting. The technology is rather complicated. It's been computing-intensive for a very long time. And it wasn't until now that we've been able to achieve it in a productive way. And so Turing has the ability to do ray tracing, accelerated ray tracing, and it also has the ability to combine very large frame buffers because these data sets are extremely large. And so that marketplace is quite large and it's never been served by GPUs before until now. All of that has been run on CPU render farms, gigantic render farms in all these movie studios and service centers and so on and so forth. The second area where you're going to see the benefits of ray tracing, we haven't announced. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + If I could have a follow-up on the gaming side. Where do you think the industry is on creating content that leverages that kind of capability? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Yes, Mark, the -- at GTC this last year in March, GDC and GTC, we announced a brand-new platform called NVIDIA RTX. And this platform has those 4 computation methods that I described for generating images. We put that platform out with the support of Microsoft. They call it the Microsoft DirectX Raytracing and the major game engine companies. Epic has implemented real-time raytracing and the RTX into the Epic engine, the Unreal Engine. And at GDC and GTC, we demonstrated, for the very first time, on 4 Volta GPUs, on 4 Volta GPUs, the ability to do that. And it was the intention of -- to get this platform out to all of the game developers. And we've been working with game developers throughout this time. +Thus, this week at SIGGRAPH, we announced Quadro, which is the first -- the Quadro RTX 8000, 6000 and 5000 -- the world's first accelerated ray-tracing GPUs. And I demonstrated one Quadro running the same application that we demonstrated on 4 Volta GPUs running in March. And the performance is really spectacular. And so I think the answer to your question is developers all have access to RTX. It's in Microsoft's DirectX. It's in the most popular game engine in the world, and you're going to start to see developers use it. On the workstation side, on the professional visualization side, all of the major ISPs have jumped on to adopt it. And at SIGGRAPH this year, there you could see a whole bunch of developers demonstrating the NVIDIA RTX with accelerated ray tracing, generating photorealistic images. And so I would say that in no platform in our history has, on day 1 of announcement, had so many developers jump onto it. And stay tuned, we've got a lot more stories to tell you about RTX. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question is from Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [7] +-------------------------------------------------------------------------------- + + Colette, I had a couple of questions about inventory, the first of which is, I understand you've launched a new product set in pro viz, and the data center business is obviously ramping really strongly. But if you look at the balance sheet, I think the inventory level is up by around mid-30s percent sequentially and you're guiding revenue up 3% or so. Maybe you could help us sort of walk through the contribution to that inventory and what it might mean for future products. And secondly, if you could talk a little bit about the gaming channel in terms of inventory, how things are looking in the channel as you guys see it during this period of product transition. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + Sure. Thanks for your question. So when you look at our inventory on the balance sheet, I think it's generally consistent with what you have seen over the last several months in terms of what we will be bringing to market. Turing is an extremely important piece of architecture, and as you know, it will be with us for some time. So I think the inventory balance is getting ready for that. And don't forget our work in terms of data center and what we have for Volta is also a very, very complex computer, in some cases, in terms of what we have also in terms of there. So just those things together, plus our Pascal architecture is still here, makes up almost all of what we have there in terms of inventory. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- + + Matt, on the channel inventory side, we see inventory in the lower ends of our stack. And that inventory is well positioned for back-to-school and the building season that's coming up on Q3. And so I feel pretty good about that. The rest of our product launches and the ramp-up of Turing is going really well. And so I think the rest of the announcements we haven't made, but stay tuned. The RTX family is going to be a real game-changer for us and the reinvention of computer graphics altogether has been embraced by so many developers. We're going to see some really exciting stuff this year. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Next question is from Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [11] +-------------------------------------------------------------------------------- + + Actually, just a clarification and then a question. On the clarification, Colette, if you could also help us understand the gross margin sequencing from Q2 to Q3. And then, Jensen, how would you contrast the Pascal cycle, the Turing cycle? Because I think in your remarks, you mentioned Turing is a very strong advancement over what you had before. But when you launched Pascal, you had guided to very strong Q3s and then Q4s. This time, the Q3 outlook, even though it's good on an absolute basis, on a sequential and a relative basis, it's perhaps not as strong. So if you could just help us contrast the Pascal cycle with what we should expect with the Turing cycle. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure, thanks for that -- for the question. Let me start first with your question regarding gross margins. We have essentially reached, as we move into Q3, a normalization of our gross margins. I believe, over the last several quarters, we have seen the impacts of crypto and what that can do to elevate our overall gross margins. We believe we have reached a normal period as we're looking forward to essentially no cryptocurrency as we go forward. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [13] +-------------------------------------------------------------------------------- + + Let's see, Pascal was really successful. Pascal, relative to Maxwell, was a leap in fact. And it was a really significant upgrade. The architectures were largely the same. They were both programmable shading, they were both at the same generation programmable shading. But Pascal was much, much more energy efficient. I think it was something like 30%, 40% more energy efficient than Maxwell, and that translated to performance benefits to customers. The success of Pascal was fantastic. There's just simply no comparison to Turing. Turing is a reinvention of computer graphics. It is the first ray-tracing GPU in the world. It's the first GPU that will be able to ray trace light in an environment and create photorealistic shadows and reflections and be able to model things like area lights and global illumination and indirect lighting. But the images are going to be so subtle and so beautiful, it -- when you look at it, it just looks like a movie. And yet it's backwards compatible with everything that we've done. +This new hybrid rendering model, which extends what we've built before but added to it 2 new capabilities, artificial intelligence and accelerated ray tracing, is just fantastic. So everything of the past will be brought along and benefits, and it's going to create new visuals that were impossible before. We also did a good job on laying the foundations of the development platform for the developers. We've partnered with Microsoft to create DXR. Vulkan RT is also coming, and we have optics that are used by pro viz renderers and developers all over the world. And so we have the benefit of laying the foundation stack by stack by stack over the years. And as a result, on the day that Turing comes out, we're going to have a richness of applications that gamers will be able to enjoy. +You mentioned guidance. I actually think that on a year-over-year performance, we're doing terrific. And I'm super excited about the ramp of Turing. It is the case that we benefited in the last several quarters from an unusual lift from crypto. In the beginning of the year, we thought and we projected that crypto would be a larger contribution through the rest of the year, but at this time, we consider it to be immaterial for the second half. And so that makes comparisons on a sequential basis on, I guess, a quarterly sequential basis harder. But on a year-to-year basis, I think we're doing terrific. Every single one of our platforms are growing. High-performance computing, of course, data centers is growing. AI, the adoption continues to sweep from one industry to another industry. The automation that's going to be brought about by AI is going to bring productivity gains to industries like nobody's ever seen before. +And now with Turing, we're going to be able to reignite the professional visualization business, open us up to photorealistic rendering for the very first time, render farms and everybody who's designing products that has to visualize it photo realistically, to reinventing and resetting graphics for video games. And so I think we're in a great position, and I'm looking forward to reporting Q3 when the time comes. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Your next question is from Atif Malik with Citi. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [15] +-------------------------------------------------------------------------------- + + Colette, I have a question on data center. In your prepared remarks, you talked about AI and high-performance computing driving new verticals and some of these verticals are fastest growing. Some of your peers have talked about enterprise spending slowing down in the back half of this year and so unit demand, and you guys are not a unit play but more of an AI adoption. Just curious in terms of your thinking about second half data center growth. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + So as you know, we generally give our view on guidance for 1 quarter out. You are correct that our data center results that we see is always a tremendous unique mix every single quarter in terms of what we're seeing. But there's still some underlying points of that, that will likely continue. The growth in terms of use by the hyperscales, continued industry by industry coming on board, essentially just because the needs of accelerated computing for the workloads and for the data that they have is so essential. So we still expect, as we go into Q3, for data center to grow both sequentially and year-over-year. And we'll see probably a mix of both selling our Tesla V100 platforms but also a good contribution from our DGX. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [17] +-------------------------------------------------------------------------------- + + Yes, that's right. Atif, let me just add a little bit more to that. I think the one simple way to think about that is this. In the transportation industry, let's take one particular vertical. There are 2 dynamics that are happening that are very abundantly clear and that will transform that industry. The first, of course, is ride hailing and ride sharing. Those platforms, in order to make the recommendation of which taxi to bring to which passenger, to which customer, is a really large computing problem. It's a machine-learning problem. It's an optimization problem of very, very large scale. And in every -- in each and every one of those instances, you need high-performance computers to use machine learning to figure out how to make that perfect match or the most optimal match. +On the second -- the second is self-driving cars. Every single car company that's working on robot taxis or self-driving cars needs to collect data, label data, train a neural network or train a whole bunch of neural networks and to run those neural networks in cars. And so you just make your list of how many people are actually building self-driving cars. And every single one of them will need even more GPU-accelerated servers. And that's just for developing the model. Then the next stage is to simulate the entire software. Because we know that the industry or the world travels 10 trillion miles per year, and the best we could possibly do is to drive several million normal miles. And what we really want to do is to be able to simulate and stress -- stress-test our software stack and the only way to do that is doing virtual reality. And so that's another supercomputer that you have to build for simulating all your software costs, those billions and billions of virtually created, challenging miles. +And then lastly, before you OTA the software, you're going to have to re-sim and replay against all of the miles that you've collected over the years to make sure that you have no regressions before you OTA the new models into a fleet of cars. And so transportation is going to be a very large industry. Health care is the same way, from medical imaging that is now using AI just about everywhere to genomics that has discovered deep learning and the benefits of artificial intelligence; and in the future, pathology. The list goes on. And so industry after industry after industry, we're discovering the benefits of deep learning and the industries could be really, really revolutionized by it. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question is from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [19] +-------------------------------------------------------------------------------- + + I guess, short term and the long term. So for short term, as you think about your gaming guide, are you embedding any drawdown of channel inventory there? And then longer term, as you think about Turing Tensor Cores, can you talk a bit about differentiation versus Volta V100, particularly as you think about 8-bit integer and the opportunities there for inferencing? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [20] +-------------------------------------------------------------------------------- + + We're expecting the channel inventory to work itself out. We are masters at managing our channel, and we understand the channel very well. As you know, the way that we go to market is through the channels around the world. We're not concerned about the channel inventory. As we ramp Turing, any -- whenever we ramp a new architecture, we ramp it from the top down. And so we have plenty of opportunities as the -- as we go back to the back-to-school and the gaming cycle to manage the inventory, so we feel pretty good about that. As a result, comparing Volta and Turing, CUDA's compatible. That's one of the benefits of CUDA. CUDA -- all of the applications that take advantage of CUDA that are written on top of cuDNN, which is our deep neural network platform, to TensorRT that takes advantage -- that takes the output of the frameworks and optimize it for run time. All of those tools and libraries run on top of Volta and run on top of Turing and run on top of Pascal. +What Turing adds over Pascal is the same Tensor Core that is inside Volta. Of course, Volta is designed for large-scale training. 8 GPUs could be connected together. They have the fastest HBM2 memories, and it's designed for data center applications, has 64-bit double-precision ECC, high-resilience computing and all of the software and system software capability and tools that make Volta the perfect high-performance computing accelerator. In the case of Turing, it's really designed for 3 major applications. The first application is to open up pro visualization, which is a really large market that has historically used render farms and were really unable to use GPUs until we now have the ability to do full path trace, global illumination with very, very large data sets. So that's one market that's brand new as a result of Turing. +The second market is to reinvent computer graphics, real-time computer graphics, for video games and other real-time visualization applications. When you see the images created by Turing, you're going to have a really hard time wanting to see the images of the past. It just looks amazing. And then the third, Turing has a really supercharged Tensor Core. And this Tensor Core is used for image generation. It's also used for high throughput deep learning inferencing for data centers. And so these applications for Turing, which suggests that there are multiple SKUs of Turing, which is one of the reasons why we have such a great engineering team, we could scale one architecture across a whole lot of platforms at one time. And so I hope that answers your question. The Tensor Core inference capability of Turing is going to be off the charts. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Next question is from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [22] +-------------------------------------------------------------------------------- + + I wonder if you could talk about cryptocurrency now that the dust has settled. You guys have done a good job of kind of laying out exactly how much of the OEM business has been driven by that. But there's also been, I think, some sense of -- some of the GeForce business was being driven by crypto. Can you -- looking backwards, can you size that for us? And I guess, I'm trying to understand the impact that crypto would have on the guidance for October, given that it seems like it was very small in the July quarter. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [23] +-------------------------------------------------------------------------------- + + Well, I think -- I mean, the second question is easier to answer, and the reason -- the first one is just -- it's ambiguous and hard to predict anyway. It's hard to estimate no matter what. But the second question, the answer is we're expecting -- we're projecting 0 basically. And for the first question, how much of GeForce could have been used for crypto, a lot of gamers at night, they could -- while they're sleeping, they could do some mining. And so did they buy it for mining or did they buy it for gaming, it's kind of hard to say. And some miners were unable to buy our OEM products, and so they jumped onto the market to buy it from retail. And that probably happened a great deal as well. And that all happened in the last -- the previous several quarters, probably starting from Q -- late Q3, Q4, Q1 and very little last quarter, and we're projecting no crypto mining going forward. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Your next question is from Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [25] +-------------------------------------------------------------------------------- + + I had one for Jensen and one for Colette. Jensen, I was hoping you could remind us how meaningful your inference business is today within data center and how you would expect growth to come about over the next 2 years as you -- as your success at accounts like Google proliferate across a broader set of customers. And then for Colette, if you can give directional guidance for each of your platforms. I know you talked about data center a little bit, but if you can talk about the other segments. And on gaming specifically, if you can talk about whether or not new products are embedded in that guide. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [26] +-------------------------------------------------------------------------------- + + Thanks, Toshiya. Inference is going to be a very large market for us. It is surely material now in our data center business. It's not the largest segment, but I believe it's going to be a very large segment of our data center business. There are 30 million servers around the world, let's kind of estimate, in the cloud, and there are a whole lot more in enterprises. I believe that almost every server in the future will be accelerated. And the reason for that is because artificial intelligence and deep learning software and neural net models are going to -- prediction models, are going to be infused into software everywhere. And acceleration has proven to be the best approach going forward. We've been laying the foundations for inferencing for a couple 2, 3 years. And as we've described at GTCs, inference is really, really complicated. And the reason for that is you have to take the output of these massive, massive networks that are output of the training frameworks and optimize it. This is the -- probably the largest computational graph optimization problem the world's ever seen. And this is brand-new invention territory. +There are so many different network architectures from CNNs to RCNNs to autoencoders to RNNs and LSTMs, there is just so many different species of neural networks these days, and it's continuing to grow. And so the compiler technology is really, really complicated. And this year, we announced 2 things. Earlier this year, we announced that we've been successful in taking the Tesla P4 low-profile, high-energy efficiency inference accelerator into hyperscale data centers. And we announced our fourth generation TensorRT optimizing compiler -- neural network optimizing compiler. And TRT 4 goes well beyond CNNs and image recognition in the beginning. It now allows us to support and optimize for voice recognition or speech recognition, natural language understanding, recommendation systems, translation. And all of these applications are really pervasive from Internet services all over the world. And so now from images to video to voice to recommendation systems, we now have a compiler that can address it. +We are actively working with just about every single Internet service provider in the world to incorporate inference acceleration into their stack. And the reason for that is because they need high throughput and, very importantly, they need low latency. Voice recognition is only useful if it responds in a relatively short period of time. And our platform is just really, really excellent for that. And then this last week -- this week, we announced Turing. And I announced that the inference performance of Turing is 10x the inference performance of Pascal, which is already a couple of hundred times the inference performance of CPUs. And so you take a look at the rate at which we're moving, both in the support of new neural networks, the ever-increasing optimization and performance output of the compilers and the rate at which we're advancing our processors, I think we're raising the bar pretty high, okay? So with that, Colette? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes. So when you look at our overall segments, as you will have seen our results in terms of this last Q2, there was growth across every single one of our platforms from a year-over-year standpoint. We probably possibly see that again in our Q3 guidance, the year-over-year growth across each and every one of those platforms. Of course, our OEM business will be down likely year-over-year, again just due to the absence of cryptocurrency in our forecast. When we think about sequentially, our hopes is absolutely, our data center will grow and we'll likely see the growth of our gaming business as well. It's still early, still we've got many different scenarios and -- on our pro viz and auto. But definitely, our gaming and our data center are expected to grow sequentially. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Your next question is from Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [29] +-------------------------------------------------------------------------------- + + Two on gross margin. Colette, I just want to make sure I understood, July to October gross margins down. I know you've been getting a benefit from crypto, but it's pretty de minimis in July. Just is there any other moving pieces? And then kind of longer picture here, how do you think about the ramp of Turing affecting gross margins? You're obviously enabling a lot of capabilities. You get paid for it, 12-nanometers, fairly stable. Just kind of curious how to think about over the next couple of quarters gross margin with that ramp. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes. So let me take your first part of the question regarding our gross margins and what we had seen from crypto. Although crypto revenue may not be large, it still has a derivative impact on our stock in terms of what we are selling in to both replenish the overall channel and such. So over the last several quarters that we had stabilizing that overall channel, we did get the great effect of selling just about everything, and our margin's really been able to benefit from that. Again, when we look at the overall growth year-over-year for Q2, you have 500 basis points in terms of growth. We're excited about what we have now here for Q3 as well, which is also significant growth year-over-year. Of course, we have our high value-added platforms as we move forward, both those in data center, those in terms of what we expect the effects of Turing in terms of -- on our Quadro piece as well. But that will take some time for that all to partake. So we'll see how that goes. We haven't announced anything further at this time. But yes, we'll see probably over the longer term, the effects of what Turing can do. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Next question is from Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [32] +-------------------------------------------------------------------------------- + + I'm curious as we look at the data center business, if you can help us understand the breakdown of demand between hyperscale, the supercomputing piece of the business and the AIPs. And I guess, on top of that, I'm just curious, one of the metrics that's pretty remarkable over the last couple of quarters is you've seen significant growth in China. I'm curious if that's related to the data center business or what's really driving that as kind of a follow-up question. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [33] +-------------------------------------------------------------------------------- + + Yes, Aaron, I think that if you look at the -- if you start from first principles, here's the simple way to look at it. Demand is continuing to grow at historical levels of 10x computing demand. Computing demand is increasing at historical levels of 10x every 5 years. 10x every 5 years is approximately Moore's Law. And computing demand continues to grow at 10x every 5 years, however, Moore's Law stopped. And so that gap in the world in high-performance computing, in medical imaging, in life sciences computing, in artificial intelligence, that gap -- because those applications demand more computing capability, that gap can only be served in another way. And NVIDIA's GPU accelerated computing that we pioneered really stands to benefit from that. And so at the highest level, whether it's supercomputing -- and this year, you heard Colette say earlier that NVIDIA GPUs represented 56% of all the new performance that came into the world's TOP500. The TOP500 is called the TOP500 because it reflects the future computing. And my expectation is that more and more, from one vertical industry after another -- and I mentioned transportation, I mentioned health care, the vertical industries go on and on -- that as computing demand continues at a factor of 10x every 5 years, developers are rational and logical to have jumped on NVIDIA's GPU computing to boost their demand. I think that's probably the best way to answer it. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question is from Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [35] +-------------------------------------------------------------------------------- + + When we think about cloud and hyperscale, we tend to think about the top guys, right? They're designing their own platform using your Tesla-based products or sometimes even designing their own chips for AI and deep learning. But there's a larger base of medium to smaller cloud and hyperscale customers out there who don't have the R&D scale. And I think that's where your HGX platform seems to be focused on. So Jensen, can you just give us an update on the uptake of your first-generation HGX-1 reference platform and the initial interest on the HGX-2? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + HGX-1 was, I guess, kind of the prototype of HGX-2. HGX-2 is doing incredibly well for all the reasons that you mentioned. It is -- and even the largest hyperscale data centers can't afford to create these really complicated motherboards at the scale that we're talking about. And so we created HGX-2 and it was immediately adopted by several most important hyperscalers in the world. And we were at GTC Taiwan, and we announced basically all of the leading server OEMs and ODMs supporting HGX-2 and are ready to take it to market. So we're in the process of finishing the -- finishing HGX-2 and ramping them into production. And so I think HGX-2 is a huge success for exactly the reasons that you mentioned. We could use it for essentially a standard motherboard like the ATX motherboard for PCs that could be used for hyperscalers, it could be used for HPC, it could be used for data centers. And it's really -- it's a really fantastic design. It just allows people to adopt this really complicated and high performance and really high-speed interconnect motherboard in a really easy way. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question is from Tim Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [38] +-------------------------------------------------------------------------------- + + Actually, I had 2 questions, Jensen, both for you. First, now that crypto has fallen off, I'm curious what you think the potential is that maybe we see a slug of cards that get resold on eBay or some other channel and that could cannibalize new Pascal sales. Is that something that keeps you up at night? Number one. Number two, obviously, the stories about gaming and data center, and I know that you don't typically talk about customers, but since Tesla did talk about you on their call, I'm curious what your comments are about the development for Hardware 3 and their own efforts to move away from your drive platform. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Sure. Well, the crypto mining market is very different today than it was 3 years ago. And even though new cards -- at the current prices, it doesn't make much sense for new cards to be sold into the mining market. The existing capacity is still being used, and you could see that the hash rates continue. And so my sense is that the installed base of miners will continue to use their cards. And then probably the more important factor though is that we're in the process of announcing a brand-new way of doing computer graphics. And with the -- with Turing and the RTX platform, computer graphics will never be the same. And so I think this -- our new generation of new GPUs is really going to do great. +I also think that -- I appreciate Elon's comments about our company, and I also think Tesla makes great cars, and I drive them very happily. And with respect to the next generation, it is the case that when we first started working on autonomous vehicles, they needed our help. And we used the 3-year-old Pascal GPU for the current generation of autopilot computers. And it is very clear now that in order to have a safe autopilot system, we need a lot more computing horsepower. In order to have safe computing -- in order to have safe driving, the algorithms have to be rich, it has to be able to handle corner conditions in a lot of diverse situations. And every time that there's more and more corner conditions or more subtle things that you have to do or you have to drive more smoothly or be able to take turns more quickly, all of those requirements require greater computing capability. And that's exactly the reason why we built Xavier. Xavier is in production now. We're seeing great success, and customers are super excited about Xavier. And that's exactly the reason why we built it. And I think it's super hard to build Xavier and all the software stack on top of it. And if it doesn't turn out -- for whatever reason, it doesn't turn out for them, he can give me a call, and I'd be more than happy to help. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Unfortunately, we have run out of time. I will now turn the call back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [41] +-------------------------------------------------------------------------------- + + We had a great quarter. Our core platforms exceeded expectations even as crypto largely disappeared. Each of our platforms -- AI, gaming, pro viz and self-driving cars -- continue to enjoy great adoption. These markets are -- we are enabling are some of the most impactful to the world today. We launched Turing this week. It was 10 years in the making and completes the NVIDIA RTX platform. And NVIDIA RTX with Turing is the greatest advance since CUDA nearly a decade ago. I'm incredibly proud of our company for tackling this incredible challenge, reinventing the entire graphic stack and giving the industry a surge of excitement as we reinvent computer graphics. Stay tuned as we unfold the exciting RTX story. See you guys next time. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Thank you for joining. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2018-Feb-08-NVDA.txt b/Transcripts/NVDA/2018-Feb-08-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..714f208d8ac794994838a05aebb4865608f2a328 --- /dev/null +++ b/Transcripts/NVDA/2018-Feb-08-NVDA.txt @@ -0,0 +1,479 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2018 NVIDIA Corp Earnings Call +FEBRUARY 08, 2018 / 10:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Simona Jankowski + NVIDIA Corporation - VP, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher Adam Jackson Rolland + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Blayne Peter Curtis + Barclays PLC, Research Division - Director and Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Craig Andrew Ellis + B. Riley FBR, Inc., Research Division - Senior MD & Director of Research + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * William Shalom Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Victoria, and I will be your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP, IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the Fourth Quarter of Fiscal 2018. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until February 16, 2018. The webcast will be available for replay up until next quarter's conference call to discuss our fiscal first quarter financial results. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the report that we may file on Form 8-K with the Securities and Exchange Commission. +All our statements are made as of today, February 8, 2018, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures and our CFO commentary, which is posted on our website. +With that, I will turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. We had an outstanding quarter and fiscal 2018 led by strong growth in our gaming and data center businesses. Q4 revenue reached $2.91 billion, up 34% year-on-year, up 10% sequentially, and above our outlook of $2.65 billion. All measures of profitability set records. They also hit important milestones. For the first time, gross margins strongly exceeded 60%, non-GAAP operating margins exceeded 40% and net income exceeded $1 billion. +Fiscal 2018 revenue was $9.71 billion, up 41% or $2.8 billion above the previous year. Each of our platforms posted record full year revenue, with data center growing triple digits. From a reporting segment perspective, Q4 GPU revenue grew 33% from last year to $2.46 billion. Tegra Processor revenue rose 75% to $450 million. +Let's start with our gaming business. Q4 revenue was $1.74 billion, up 29% year-on-year and up 11% sequentially with growth across all regions. Driving GPU demand were a number of great titles during the holiday season, including Player's Battleground (sic) [PlayerUnknown's Battlegrounds], PUBG, Destiny 2, Call of Duty: WWII, Star Wars Battlefront II. +PUBG continued its remarkable run, reaching almost 30 million players and recording more than 3 million concurrent players. These games deliver stunning visual effects that require strong graphics performance which has driven a shift toward the higher end of our gaming portfolio and adoption of our Pascal architecture. +eSports continues to grow, expanding the overall industry and our business. In one sign of their popularity, Activision's Overwatch League launched in January and reached 10 million viewers globally in its first week. +We had a busy start to the year with a number of announcements at the annual Consumer Electronics Show in Las Vegas. We introduced NVIDIA BFGDs, big-format gaming displays, in a partnership with Acer, ASUS and HP. These high-end 65-inch 4K displays enable ultralow latency gaming and integrate our SHIELD streaming device, offering popular apps such as Netflix, gaming video (sic) [Amazon Video], YouTube and Hulu. The BFGD won 9 Best of Show awards for various publications. +We expanded the free beta of GeForce NOW beyond Macs to Window-based PCs, and we enhanced GeForce Experience with new features, including NVIDIA freestyle for customizing gameplay with various filters. And updated NVIDIA Ansel's photo mode and support for new titles with ShadowPlay highlights for capturing gaming achievements. Additionally, the Nintendo Switch gaming console contributed to our growth as it became the fastest-selling console of all time in the U.S. +Strong demand in the cryptocurrency market exceeded our expectations. We met some of this demand with a dedicated board in our OEM business, and some was met with our gaming GPUs. This contributed to lower than historical channel inventory levels of our gaming GPUs throughout the quarter. While the overall contribution of cryptocurrency to our business remains difficult to quantify, we believe it was a higher percentage of revenue than the prior quarter. That said, our main focus remains on our core gaming market as cryptocurrency trends will likely remain volatile. +Moving to data center. Revenue of $606 million was up 105% year-on-year and up 20% sequentially. This excellent performance reflected strong adoption of Tesla V100 GPUs based on our Volta architecture which began shipping in Q2 and continued to ramp in Q3 and Q4. V100s are available through every major computer maker and have been chosen by every major cloud provider to deliver AI and high-performance computing. Hyperscale and cloud customers adopting the V100 include Alibaba, Amazon Web Services, Baidu, Google, IBM, Microsoft Azure, Oracle and Tencent. +We continued our leadership in AI-trending markets where our GPUs remain the platform of choice for training deep learning networks. During the quarter, Japan's Preferred Networks trained the ResNet-50 neural network for image classification in a record 15 minutes by using 1,024 Tesla P100 GPUs. Our newer-generation V100s delivered even higher performance, with the Volta architecture offering 10x the deep learning performance of Pascal. +We also saw a growing traction in the AI inference market where NVIDIA's platform can improve performance and efficiency by orders of magnitude over CPUs. We continue to view AI inference as a significant new opportunity for our data center GPUs. Hyperscale inference applications that run on GPUs include speech recognition, image and video analytics, recommender systems, translation, search and natural language processing. +The data center business also benefited from strong growth in high-performance computing. The HPC community has increasingly moved to accelerated computing in recent years as Moore's Law has begun to level off. Indeed, more than 500 HPC applications are now GPU-accelerated, including all of the top 15. NVIDIA added a record 34 new GPU-accelerated systems to the latest TOP500 supercomputer list, bringing our total to 87 systems. We increased our total petaflops of list by 28%, and we captured 14 of the top 20 spots on the Green500 list of the world's most energy-efficient supercomputers. +During the quarter, we continued to support the buildout of major next-generation supercomputers. Among them is the U.S. Department of Energy's Summit system, expected to be the world's most powerful supercomputer when it comes online later this year. We also announced new wins such as Japan's fastest AI supercomputer, the ABCI system, which leverages more than 4,000 Tesla V100 GPUs. +Importantly, we are starting to see the convergence of HPC and AI as scientists embrace AI to solve problems faster. Modern supercomputers will need to support multi-precision computation for applying deep learning together with simulation and testing. By combining AI with HPC, supercomputers can deliver increased performance that is orders of magnitudes greater in computations ranging from particle physics to drug discovery to astrophysics. +We are also seeing traction for AI in a growing number of vertical industries, such as transportation, energy, manufacturing, smart cities and health care. We announced engagements with GE Health and Nuance in medical imaging; Baker Hughes, a GE company, in oil and gas; and Japan's Komatsu in construction and mining. +Moving to professional visualization. Fourth quarter revenue grew a record -- to a record $254 million, up 13% from a year ago, up 6% sequentially, driven by demand for real-time rendering as well as emerging applications like AI and VR. These emerging applications now represent approximately 30% of pro visualization sales. We saw strength across several key industries including defense, manufacturing, energy, health care and Internet service providers. Among key customers, high-end Quadro products are being used by GlaxoSmithKline for AI and by Pemex oil and gas for seismic processing and visualization. +Turning to automotive. In automotive, for the fourth quarter, revenue grew 3% year-on-year to $132 million and was down 8% sequentially. The sequential decline reflects our transition from infotainment, which is becoming commoditized, to next-generation AI cockpit systems and complete top-to-bottom self-driving vehicle platforms built on NVIDIA hardware and software. +At CES, we demonstrated our leadership position on autonomous vehicles with several key milestones and new partnerships that point to AI self-driving cars moving from deployment to production. In a standing-room only keynote that drew nearly 8,000 attendees, Jensen announced that DRIVE Xavier, the world's first autonomous machine processor, will be available to customers this quarter. +With more than 9 billion transistors, DRIVE Xavier is the most complex system on a chip ever created. We also announced that NVIDIA DRIVE is the world's first functionally safe AI self-driving platform, enabling automakers to create autonomous vehicles that can operate safely, a necessary ingredient for going to market. +Additionally, we announced a number of collaborations at CES, including with Uber, which has been using NVIDIA technology for the AI computing system in its fleets of self-driving cars and freight trucks. We announced that ZF and Baidu are using NVIDIA DRIVE self-driving technologies to create a production-ready AI autonomous vehicle platform for China, the world's largest automotive market. Production vehicles utilizing this technology, including those from Chery, are expected on the road by 2020. +We also announced a partnership with Aurora, which is working to create a modular, scalable, Level 4 and Level 5 self-driving hardware platform, incorporating the NVIDIA DRIVE Xavier processor. Jensen was joined on stage by Volkswagen CEO, Herbert Diess. They announced the new generation of intelligent VW vehicles will use the NVIDIA DRIVE intelligent experience, or DRIVE IX, platform to create the new AI-infused cockpit experiences and improved safety. +Later at CES, Mercedes Benz announced that MBUX, its new AI-based smart cockpit uses NVIDIA's graphics and AI technologies. The MBUX user experience, which includes beautiful touchscreen displays and a new voice-activated assistant, debuted last week at Mercedes-Benz A-Class compact car and will ship this spring. And earlier this week, we announced a partnership with Continental to build AI self-driving vehicle systems from enhanced Level 2 to Level 5 for production in 2021. +There are now more than 320 companies and research institutions using the NVIDIA DRIVE platform. That's up 50% from a year ago and encompasses virtually every carmaker, truck maker, robotaxi company, mapping company, sensor manufacturer and software startup in the autonomous vehicle ecosystem. With this growing momentum, we remain excited about the intermediate to long-term opportunities for autonomous driving. +Now turning to the rest of the P&L. Q4 GAAP gross margins was 61.9%, and non-GAAP was 62.1%, records that reflect continued growth in our value-added platforms. GAAP operating expenses were $728 million, and non-GAAP operating expenses were $607 million, up 28% and 22% year-on-year, respectively. We continue to invest in the key platforms driving our long-term growth, including gaming, AI and automotive. +GAAP EPS was $1.78, up 80% from a year earlier. Some of the upside was driven by a lower-than-expected tax rate as a result of U.S. tax reform and excess tax benefits related to stock-based compensation. Our fourth quarter GAAP effective tax rate was a benefit of 3.7% compared with our expectation of a tax rate of 17.5%. +Non-GAAP EPS was $1.72, up 52% from a year ago, reflecting a quarterly tax rate of 10.5% compared with our expectation of 17.5%. We returned $1.25 billion to shareholders in the fiscal year through a combination of quarterly dividends and share repurchases. +Our quarterly cash flow from operations reached record levels at $1.36 billion, bringing our fiscal year total to a record $3.5 billion. Capital expenditures were $416 million for the fourth quarter, inclusive of $335 million associated with the purchase of our previously financed Santa Clara campus building. +Let me take a moment to provide a bit more detail on the impact of U.S. corporate tax reform on the quarter and our go-forward financials. In Q4, we recorded a GAAP-only one-time net tax benefit of $133 million or $0.21 per diluted share. This is primarily related to provisional tax amounts for the transition tax on accumulated foreign earnings and remeasurement of certain deferred tax assets and liabilities associated with the Tax Cuts and Jobs Act. We previously accrued for taxes on a portion of forward earnings in excess of the provisional tax amount recorded for the transition tax, hence, the one-time benefit. +For fiscal 2019, we expect our GAAP and non-GAAP tax rates to be around 12%, which is down from approximately 17% previously. This does not take into effect the excess tax benefit from stock-based compensation which, depending on stock price and vesting schedule, could increase or decrease our tax rate and GAAP in a given quarter. +In terms of our capital allocation priorities, we continue to focus first and foremost on investing in our business as we see significant opportunities ahead. Our lower tax rate strengthens our ability to invest in both OpEx, such as adding engineering talent; as well as CapEx, such as investing in supercomputers for internal AI development. In addition, we remain committed to returning cash to shareholders, with our plan remaining at $1.25 billion for fiscal 2019. +With that, let me turn to the outlook for the first quarter of fiscal 2019. We expect revenue to be $2.9 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 62.7% and 63%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $770 million and $645 million, respectively. GAAP and non-GAAP OI&E are both expected to be nominal. GAAP and non-GAAP tax rates are both expected to be 12%, plus or minus 1%, excluding discrete items. +For the full fiscal year 2019, we expect our operating expenses to grow at a similar pace as in Q1. Further financial details are included in the CFO commentary and other information available in our IR website. +In closing, I'd like to highlight a few upcoming events for the financial community. We'll be presenting at the Goldman Sachs Technology & Internet Conference on February 13 and at the Morgan Stanley Technology, Media & Telecom Conference on February 26. We will also be hosting our annual Investor Day on March 27 in San Jose, on the sidelines of our annual GPU Technology Conference, which we are very excited about. +We will now open the call for questions. Operator, will you poll for questions, please? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of C.J. Muse from Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess first question, when I think about normal seasonality for gaming, that would imply data center potentially north of $700 million-plus into the coming quarter. And so curious if I'm thinking about that right or whether crypto is being modeled more conservatively by you guys, and so would love to hear your thoughts there. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Which way is more conservatively, C.J.? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [4] +-------------------------------------------------------------------------------- + + Yes? Sorry. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [5] +-------------------------------------------------------------------------------- + + When you say conservatively, which direction were you saying it was. Are you implying up or down? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + Well, just curious to hear your thoughts there. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [7] +-------------------------------------------------------------------------------- + + We model crypto approximately flat. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And then I guess as part of a larger question, how are you thinking about seasonality for gaming into the ensuing quarter? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- + + Well, there's a lot of dynamics going on in gaming. One dynamic, of course, is that there's a fairly sizable pent-up demand going into this quarter. But I think the larger dynamics that are happening relate to just the really amazing games that are out right now. +PUBG is just -- is doing incredibly well, as you might have known, and it's become a global phenomenon. And whether it's here in the United States or in Europe, or in China, in Asia, PUBG is just doing incredibly well. And we expect other developers to come up with similar genre, like PUBG, that are going to be coming out in the near future. And I'm super excited about these games. +And then, of course, there's Call of Duty, there's Star Wars. There's just so many great games that are out in the marketplace today, Overwatch and League of Legends, still doing well. There's just a countless number of great franchises that are out in the marketplace. And the gaming market is growing, and production value is going up. And that's driving increased unit sales of GPUs as well as ASPs of GPUs. And so I think those are -- that's probably the larger dynamic of gaming. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [11] +-------------------------------------------------------------------------------- + + The first question, the checks we've done indicate that the Tensor Cores you put into Volta give it a huge advantage in neural network applications in the data center. And I'm wondering whether the Tensor Cores might also have a similar kind of utility in the gaming market. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [12] +-------------------------------------------------------------------------------- + + Yes, first of all, I appreciate you asking a Tensor Core question. It is probably the single biggest innovation we had last year in data centers. +Our GPUs, the equivalent performance to one of our GPUs -- one of our Volta GPUs would take something along the lines of 20-plus CPUs or 10-plus nodes. And so 1 GPU alone would do deep learning so fast that it would take 10-plus CPU-powered server nodes to keep up with. +And then Tensor Core comes along last year, and we increased the throughput of deep learning, increased the computational throughput of deep learning by another factor of 8. And so Tensor Core really illustrates the power of GPUs. It's very unlike a CPU where the instruction set remains locked for a long time, and it's hard -- it's difficult to advance. +In the case of our GPUs and with CUDA, that's one of its fundamental advantages, we can continue to -- year in and year out, continue to add new capabilities to it. And so Tensor Core's boost of the original great performance of our GPU has really raised the bar last year. +And as Colette said earlier, our Volta GPU has now been adopted all over the world, whether it's in China with Alibaba, Tencent and Baidu, iFLYTEK, to here in the United States, Amazon and Facebook and Google and Microsoft and IBM and Oracle in Europe, in Japan. The number of cloud service providers that have adopted Volta has been terrific, and I think everybody really appreciates the work that we did with Tensor Core. +And all of the updates that are now coming out from the frameworks, Tensor Core is a new instruction set, it's a new architecture. And the deep learning developers have really jumped on it. And almost every deep learning framework is being optimized to take advantage of Tensor Core. +And on the inference side, and that's where it would play a role in video games, you could use deep learning now to synthesize and to generate new art. And we've been demonstrating some of that at GTC, if you've seen some of that. Whether it's improve the quality of textures, generating artificial characters, animating characters, whether it's facial animation with -- for speech or body animation, the type of work that you can do with deep learning for video games is growing. And that's where Tensor Core could be a real advantage. +If you take a look at the computational capability that we have in Tensor Core, compare that to a nonoptimized GPU or even a CPU, it's now 2-plus orders of magnitude greater computational throughput. And that allows us to do things like synthesize images in real time, synthesize virtual worlds, animate characters, animate faces, bring a new level of virtual reality and artificial intelligence to these video games. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [14] +-------------------------------------------------------------------------------- + + Congratulations on the strong growth and the consistent execution. Jensen, just a near- and longer-term question on the data center. Near term, you had, had a number of strong quarters in data center. How is the utilization of these GPUs? And how do you measure whether you're over or under from a supply perspective? +And then longer term, there seems to be a lot of money going into startups developing silicon for deep learning. Is there any advantage they have in taking a clean-sheet approach? Or is GPU the most optimal answer? Like if you were starting a new company looking at AI today, would you make another GPU? Or would you make another ASIC or some other format? Just any color would be helpful. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [15] +-------------------------------------------------------------------------------- + + Sure. In the near term, the best way to measure customers that are already using our GPUs for deep learning is repeat customers. When they come back another quarter, another quarter, and they continue to buy GPUs, that would suggest that their workload has continued to increase. +The -- with existing customers that already have a very deep penetration, another opportunity for us would be using our GPUs for inference, and that's an untapped growth opportunity for our company that's really, really exciting, and we're seeing traction there. +For companies that are not at the forefront, the absolute forefront, of deep learning, which -- with the exception of 1 or 2 or 3 hyperscalers, almost everybody else I would put in this category, and their deployment, their adoption of deep learning applying deep learning to all of their applications is still ongoing. And so I think the second wave of customers is just showing up. +And then there's the third wave of customers which is -- they're not hyperscalers, they -- they're Internet service applications, Internet applications for consumers. They have enormous customer bases and -- that they could apply artificial intelligence to. But they run their application in hyperscale clouds. That third phase of growth is now really spiking, and I'm excited about that. +And so that's kind of the way to think about it. There's the pioneers, the first phase, are the returning customers. Then there's the second phase that's now ramping. The third phase that's now ramping. And then for everybody, we have an opportunity to apply our GPUs for inference. +If I had all the money in the world and I had, for example, billions and billions of dollars of R&D, I would give it to NVIDIA's GPU team, which is exactly what I do. And the reason for that is because the GPU was already inherently the world's best high-throughput computational processor. +A high-throughput processor is a lot more complicated than linear algebra done that you instantiate from a synopsis tool, it's not quite that easy. The computation throughput, keeping everything moving through your chip with supreme levels of energy efficiency with all of the software that's needed to keep the data flowing, with all of the optimizations that you do with each and every one of the frameworks, the amount of complexity there is just really enormous. +The networks are changing all the time. It started out with just basically CNNs, and then all kinds of versions of CNNs now. It started out with RNNs and simple RNNs, and now there's all kinds of LSTMs and gated RNNs, and all kinds of interesting networks that are growing. It started out with just 8 layers, and now it's 152 layers going to 1,000 layers. It started with mostly recognition, and now it's moving to synthesis with GANs. And there's so many versions of GANs. +And so all of these different types of networks are really, really hard to nail down. And we're still at the beginning of AI. So the ability for our GPUs to be programmable to all of these different architectures and networks is just an enormous advantage. You don't ever have to guess whether NVIDIA GPUs could be used for one particular network or another. And so you could buy our GPUs at will and know that every single GPU that you buy gives you an opportunity to reduce the number of servers in your data center by 22 nodes, by 10 nodes, 22 CPUs. And so the more GPUs you buy, the more money you save. +And so I think that capability is really quite unique. And then if I could just give you one example from last year or from previous year, we introduced 16-bit mix precision, we introduced 8-bit integer, we introduced NVLink the year before this last year. This year -- this last year, we introduced Tensor Core, which increased it by another factor of nearly 10. Meanwhile, our GPUs get more complex, energy-efficient. Efficiency gets better and better every single year, and the software richness gets more amazing. +And so it's a much harder problem than just a multiply accumulator. Artificial intelligence is the single most complex mode of software that the world has ever known. That's the reason why it's taken us so long to get here. And these high-performance supercomputers is an essential ingredient and an essential instrument in advancing AI. And so I don't think it's nearly as simple as linear algebra. But if I had all the money in the world, I would invest it in the team that we have. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question come from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + I have a question for Colette. So if I correct for the Switch revenue growth in the quarter, it means the gaming business [x], which was up, I don't know maybe $140 million, $150 million. In your Q3 commentary, you did not call out crypto as a driver, you are calling it out in Q4. Is it fair to say that like that incremental growth is all crypto? +And I guess going forward, you mentioned pent-up demand. Normally, your seasonality for gaming will be down probably double digits. Do you think that pent-up demand is enough to reverse that normal seasonal pattern -- or normally down? And frankly, do you think gamers can even find GPUs at retail at this point to buy in order to satisfy that pent-up demand? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + So let me comment on the first one. We did talk about our overall crypto business last quarter as well. We indicated how much we had in OEM boards, and we also indicated that there was definitely some also in our GTX business. +Keep in mind, that's very difficult for us to quantify down to the end customer. It is. But yes, there is also some in our Q3, and we did comment on it. So here we are commenting in terms of what we saw in terms of Q4. It's up a bit from what we saw in Q3, and we do again expect probably going forward. I'll let Jensen answer regarding the demand for gamers as we move forward. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [19] +-------------------------------------------------------------------------------- + + Yes. So if you -- one way to think about the pent-up demand is we typically have somewhere between 6 to 8 weeks of inventory in the channel. And I think you would ascertain that globally right now the channel is relatively lean. +We're working really hard to get GPUs down to the marketplace for the gamers, and we're doing everything we can to advise Etailers and system builders to serve the gamers. And so we're doing everything we can. But I think the most important thing is we just got to catch up with supply. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mitch Steves with RBC. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [21] +-------------------------------------------------------------------------------- + + I actually want to circle back on the autos, since I was at CES. So it's still kind of on track for calendar -- towards calendar year '19, at the end of that, where we see the autonomous kind of ASP uplift. And just to clarify, the expected ASP uplift is somewhere around $1,000. Is that about right? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [22] +-------------------------------------------------------------------------------- + + Yes, it just depends on mix. I think the -- for autonomous vehicles that still have drivers, passenger cars, branded cars, ASPs anywhere from $500 to $1,000 make sense. For robot taxis, where they're driverless, they're not autonomous vehicles, they're actually driverless vehicles, the ASP will be several thousand dollars. +And in terms of timing, I think that you're going to see larger and larger deployments starting this year and going through next year for sure, especially with robot taxis. And then with autonomous vehicles, cars that have autonomous driving capability, automatic driving capability starts late 2019. You could see a lot more in 2020. And just almost every premium car by 2022 will have autonomous automatic driving capabilities. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question come from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [24] +-------------------------------------------------------------------------------- + + Great. Jensen, I was hoping to ask a little bit about inferencing. How big was inferencing within data center in Q4 or fiscal '18? And more importantly, how do you expect it to trend over the next 12 to 18 months? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [25] +-------------------------------------------------------------------------------- + + Yes, thanks a lot, Toshi. First of all, just a comment about inference. The way that it works is you take the output of these frameworks. And the output of these frameworks is a really complex, large computational graph. +When you think about these neural networks, and they have millions of parameters, millions of anything is very complex. And these parameters are waves and activation layers and -- activation functions, and there are millions of them. And it's millions of them that composes -- consists of this computational graph. And this computational graph has all kinds of interesting and complicated layers. +And so you take this computational graph that comes out of each one of these frameworks, and they're all different. They're in different formats, they're in different styles, they have different architectures. They're all different. And you take these computational graphs, and you have to find a way to compile it, to optimize this graph, to rationalize all of the things that you could combine and fold, reduce the amount of conflict across all of the resources that are in your GPUs -- or in your processor. +And these conflicts could be on-chip memory and register files and data paths, and it could be the fabric, it could be the frame buffer interface, it could be the amount of memory. I mean you got -- this computer is really complicated across all these different processors and the interconnect between GPUs, the network that connects multiple nodes. And so you've got to figure out what all these different conflicts are, resources are, and compile and optimize to take advantage of it to keep it moving all the time. +And so TensorRT is basically a very sophisticated optimizing graph compilation -- graph compiler. And it targets each one of our processors. The way it targets Xavier is different to the way it targets Volta, the way it targets our inference, the way it targets for low energy, for different precisions. All of that targeting is different. And so first of all, TensorRT, the software of inference, that's really where the magic is. +Then the second thing that we do, we optimize our GPUs for extremely high throughput and to support different precisions because some networks could afford to have 8-bit integer or even less, some really could barely get by with a 16-bit floating point and some, you really would like to keep it at 32-bit floating point so that you don't have to second-guess about any precision that you lost along the way. And so we created an architecture that consists of this optimizing graph, computational graph compiler, to processors that are very high throughput, that are mix precision. Okay, so that's kind of the background. +We start -- we've been sampling our Tesla P4, which is our data center inference processor, and I -- we're seeing just really exciting response. And this quarter, we started shipping. We -- looking outwards, my sense is that the inference market is probably about as large in the data centers as training. And the wonderful thing is everything that you train on our processor will inference wonderfully on our processors as well. +And the data centers are really awakening to the observation that the more GPUs they buy for offloading inference and training, the more money they save. And the amount of money they save is not 20% or 50%, it's factors of 10. The money savings for all of these data centers that are becoming increasingly capital constrained is really quite dramatic. +And then the other inference opportunity for us is autonomous machines, which is self-driving cars. TensorRT also targets Xavier. TensorRT targets our Pegasus robot taxi computer. And they all have to inference incredibly efficiently so that we can sustain real time, keep the energy level low and keep the cost low for car companies, okay? So I think inference is a very important work for us. It is very complicated work, and we're making great progress. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question come from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays PLC, Research Division - Director and Senior Research Analyst [27] +-------------------------------------------------------------------------------- + + Just kind of curious, as you look at the Gaming business -- I've kind of lost track of what seasonality is. You clearly have a big ramp ahead of you. I'm kind of curious, as you think about Pascal versus seasonality ahead of Volta, if you can just kind of extrapolate as you look out into April and maybe July. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [28] +-------------------------------------------------------------------------------- + + I -- well, we haven't announced anything for April or July. And so the best way to think about that is Pascal is the best gaming platform on the planet. It is the most feature-rich, the best software, the most energy-efficient. And from $99 to $1,000, you could buy the world's best GPUs, the most advanced GPUs. And if you buy Pascal, you know you've got the best. +Seasonality is a good question and increasingly because gaming is a global market and because people play games every day. It's just part of their life. There's no -- I don't think there's much seasonality in TV or books or music. People just -- whenever new titles come out, that's when a new season starts. +And so in China, there's iCafes and there's Singles' Day, November 11, there's Back to School in the United States, there's Christmas, there's Chinese New Year. Boy, there are so many seasons that it's kind of hard to imagine what the exact seasonality is anymore. And so hopefully, over time, it becomes less of a matter. But the most important thing is that we expect Pascal to continue to be the world's best gaming platform for the foreseeable future. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + Congratulations on the solid results and the execution. I know somebody asked a question about inferencing for the data center markets. But on inferencing for embedded and Edge applications, on the software and firmware side, you talked about TensorRT framework; on the hardware side, you've got the Jetson TX platform; for embedded and Edge inferencing applications, things like drones and factory automation and transportation. What else is the team doing in the embedded market to capture more of the TAM opportunity there going forward? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Yes, thanks a lot, Harlan. The NVIDIA TensorRT is really the only optimizing inference compiler in the world today, and it targets all of our platforms. And we do inference in the data center that I mentioned earlier. In the embedded world, the first embedded platform we're targeting is self-driving cars. +In order to drive the car, you basically inference or try to predict or perceive what's around you all the time. And that's a very complicated inference matter. It could be extremely easy, like detecting the car in front of you and applying the brakes, or it could be incredibly hard which is trying to figure out whether you should stop at an intersection or not. +If you look at most intersections, you can't just look at the lights to determine where do you stop. There are very few lines. And so using scene understanding and using deep learning, we have the ability to recognize where to stop and whether to stop. +And then for Jetson, we have a platform called Metropolis. And Metropolis is used for very large scale smart cities where cameras are deployed all over to keep cities safe. And we've been very successful with smart cities. Just about every major smart city provider, and what is called intelligent video analysis company, whether -- almost all over the world is using NVIDIA's platform to do inference at the Edge, AI at the Edge. +And then we've announced recently success with FANUC, the largest manufacturing and robotics company in the world; Komatsu, one of the largest construction equipments company in the world to apply AI at the Edge for autonomous machines. Drones, we have several industrial drones that are inspecting pipelines and inspecting power lines, flying over large spans of farms to figure out where to spray insecticides more accurately. There's all kinds of applications. +So you're absolutely right that inference at the Edge or AI at the Edge is a very large market opportunity for us, and that's exactly why TensorRT was created. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question come from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [33] +-------------------------------------------------------------------------------- + + You had mentioned how lean the channel is in terms of gaming cards. There's been an observable increase in prices at retail. And I'm just curious, is that a broad-based phenomenon? And is there any economic ramifications to you? Or is that just sort of retailers bringing prices up in a shortage environment? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- + + We don't set prices at the end of the market. And the best way for us to solve this problem is work on demand -- excuse me, work on supply. The demand is great. And it's very likely the demand will remain great as we look throughout -- through this quarter. +And so we just have to keep working on increasing supply. We have -- our suppliers are the world's best and the largest semiconductor manufacturers in the world, and they're responding incredibly, and I'm really grateful for everything they're doing. We just got to catch up to that demand which is just really great. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Chris Rolland with Susquehanna. + +-------------------------------------------------------------------------------- +Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [36] +-------------------------------------------------------------------------------- + + Great quarter. So just to clarify, Jensen, on pent-up demand. One of your GPU competitors basically said that the constraint was memory. I just want to make sure that, that was correct. +And then in the CFO commentary, you mentioned opportunities for professional vis, like AI and deep learning. Can you talk about that, and what kind of applications you would use, Quadro versus Volta or GeForce? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [37] +-------------------------------------------------------------------------------- + + Sure. We are -- we're just constrained. Obviously, we're 10x larger of a GPU supplier than the competition. And so we have a lot more suppliers supporting us and a lot more distributors taking our products to market and a lot more partners distributing our products all over the world. And so we -- I don't know how to explain it aside from the demand is just really great. And so we've just got to keep our nose to it and catch up to the demand. +With respect to Quadro, Quadro is a workstation processor. The entire software stack is designed for all of the applications that the workstation industry uses. And it's used -- the quality of the rendering is, of course, world-class because of NVIDIA and -- but the entire software stack has been designed so that mission-critical applications or long-life industrial applications and companies that are enormous and gigantic manufacturing and industrial companies in the world could rely on an entire platform which consists of processors and system and software and middleware and all the integrations into all of the CAD tools in the world to know that the supplier is going to be here and can be trusted for the entire life of the use of that product which could be several years, but the data that is generated from it has to be accountable for a couple of decades. +You need to be able to pull up an entire design of a plane or a train or a car a couple decades after it was sent to production to make sure that it's still in compliance, and if there are any questions about it, that it can be pulled up. NVIDIA's entire platform was designed to be professional class, professional grade, long lived. +Now the thing that's really exciting about artificial intelligence is we now can use AI to improve images. Like, for example, you could fix a photograph using AI. You could fill in damaged parts of a photograph or parts of the image that hasn't been rendered yet, you want to use AI to fill in the dots, predict the future, rendering results, which we announced and which we demonstrated at GTC recently. +You could use that to generate designs. You sketch up a few strokes of what you want a car to look like. And based on the inventory, safety, physics, it could -- it has learned how to fill in the rest of it, okay, design the rest of the chassis on your behalf. It's called generative design. We're going to see generative design in product design, in building design and just about everything. +The last, if you will, 90% of the work is after the initial inspiration or the conceptual design is done. That part of it can be highly automated through AI. And so Quadro could be used as a platform that designs as well as generatively designs. And then lastly, a lot of people are using our workstations to also train their neural networks for these generative designs. And so you could train and develop your own networks and then apply it in the applications, okay? +So AI, think of AI really as, in the final analysis, the future way of developing software. It's a brand-new capability where computers can write its own software. And the software that's written is so complex and so capable that no humans could write it ourselves. And so you could teach, you could use the data to teach a software to figure out how to write the software by itself. +And then when you're done developing that software, you could use it to do all kinds of stuff, including design products. And so for workstations, that's how it's used. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question come from the line of Craig Ellis with B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [39] +-------------------------------------------------------------------------------- + + Congratulations on the very good quarterly execution. A lot of near-term items here on gaming. So I'll switch it to longer term. Jensen, at CES, I think you said that there are now 200 million GeForce users globally. And if my math is correct, then that would be up about 2x over the last 3 to 4 years. +So the question is, is there anything that you can see that would preclude that kind of growth over a similar period? And given the recent demand dynamics, I think we've seen that NVIDIA's direct channels have been very good sources for GPUs at the prices that you intend. So as we look ahead, should we expect any change in channel management from the company? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [40] +-------------------------------------------------------------------------------- + + Yes. Thanks a lot, Craig. In the last several years, several dynamics happened at the same time. And all of it were the favorable contributions to today. First of all, gaming became a global market, and China became one of the largest gaming markets in the world. +But second, because the market became so big, developers could invest extraordinary amounts into the production value of a video game. They could invest a few hundred million dollars and know that they're going to get the return on it. Back when the video game industry was quite small or when PC industry -- PC gaming was small, it was too risky for a developer to invest that much. +And so now an investor, a developer could invest hundreds of millions of dollars and create something that is just completely photorealistic and immersive and just beautiful. And so the production -- when a production value goes up, the GPU technology that's needed to run it well goes up. It's very different than music, it's very different than watching movies. Everything in video games is synthesized in real time. And so when the production value goes up, the ASP or the technology has to go up. +And then lastly, the size of the market, people have wondered how big the video game market is going to be. And I've always believed that the video game market is going to be literally everyone. In 10 years' time, 15 years' time, there's going to be another 1 billion people on Earth. And those people are going to be gamers. We're going to see more and more gamers. +And not to mention that, almost every single sport could be a virtual-reality sport. So video games is every sport. So eSport can be any sport and every sport and every type of sport. And so I think when you consider this and put that in your mind, I think the opportunity for video games is going to be quite large, and that's essentially what we are seeing. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question comes from the line of William Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Shalom Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [42] +-------------------------------------------------------------------------------- + + I'm hoping we can touch on automotive a little bit more. In particular, I think, in the past, you've talked about expecting sort of a low revenue growth in this market until roughly the 2020 time frame when autonomous driving kicks in, in a more meaningful way. But of course, you have the AI copilot that seems to be potentially ramping sooner, and you have at least 1 marquee customer that is ramping now, I guess, but volumes aren't quite that large on the autonomous driving side. So any guidance as to when we might see these 2 factors start to accelerate revenue in that end market? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [43] +-------------------------------------------------------------------------------- + + Yes. Thanks a lot, Will. I wish I had more precision for you, but here are some of the dynamics that I believe in. I believe that autonomous capabilities -- autonomous driving, is the single greatest dynamic next to EVs in the automotive industry. And transportation is a $10 trillion industry. Between cars and shuttles and buses, delivery vehicles, I mean, it's just an extraordinary, extraordinary market. And everything that's going to move in the future will be autonomous. That's for sure. And it will be autonomous fully, or it will be autonomous partly. The size of this marketplace is quite large. In the near term, I -- our path to that future, which I believe starts in 2020 -- 2019, 2020, but starts very strongly in 2022, I believe the path to that, in our case, has several elements. The first element is that in order for all these companies, whether they're Tier 1s or startups or OEMs or taxi companies or ride-hailing companies or tractor companies or shuttle companies or pizza delivery shuttles, in order to deliver -- in order to create their autonomous driving capability, the first thing you have to do is train a neural network. And we've created a platform we call the NVIDIA DGX that allows everybody to train their neural networks as quickly as possible. So that's first. The development of the AI requires GPUs, and we benefit first from that. The second is -- which we'll start this year and next year, is development platforms for the cars themselves for the vehicles themselves. And finally, Xavier's here. We have first silicon at Xavier's, the most complex SOC that was ever made. And we're super excited about the state of Xavier, and we're going to be sampling it in Q1. And so now we'll be able to help everybody create development systems. And there'll be thousands and tens of thousands of quite expensive development systems based on Xavier and based on Pegasus that the world is going to need. And so that's the second element. The third element, in the near term, will be development agreements. Each one of these projects are engineering-intensive, and there's a development agreement that goes along with it. And so these 3 elements, these 3 components, are in the near term. And then hopefully, starting from 2019, going forward and very strongly going from 2022 and beyond, the actual car revenues and economics will show up. Appreciate that question. And I think this is our last question, yes? +Well, we had a record quarter, wrapping up a record year. We have a strong -- we had strong momentum in our gaming, AI, data center and self-driving car businesses. It's great to see adoption of NVIDIA's GPU computing platform increasing in so many industries. We accomplished a great deal this last year, and we have big plans for this coming year. Next month, the brightest minds in AI and the scientific world will come together at our GPU Technology Conference in San Jose. GTC has grown tenfold in the last 5 years. This year we expect more than 8,000 attendees. GTC is the place to be if you're an AI researcher or doing any field of science where computing is your essential instrument. There will be over 500 hours of talks of recent breakthroughs and discoveries by leaders in the field, such as Google, Amazon, Facebook, Microsoft and many others. Developers from industries ranging from health care to transportation to manufacturing and entertainment will come together and share state-of-the-art and AI. This is going to be a great GTC. I hope to see all of you there. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. Thank you for your participation. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2018-May-10-NVDA.txt b/Transcripts/NVDA/2018-May-10-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..302af35762702f5531436e60e872ce8b81e5e37d --- /dev/null +++ b/Transcripts/NVDA/2018-May-10-NVDA.txt @@ -0,0 +1,501 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2019 NVIDIA Corp Earnings Call +MAY 10, 2018 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jensen Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Christopher Adam Jackson Rolland + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Craig Andrew Ellis + B. Riley FBR, Inc., Research Division - Senior MD & Director of Research + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * William Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon, my name is Kelsey, and I am your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the First Quarter of Fiscal 2019. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until May 16, 2018. The webcast will be available for replay until the conference call to discuss our financial results for the second quarter of fiscal 2019. +The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Form 10-K, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 10, 2018, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO Commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. We had an excellent quarter, with growth across all our platforms, led by gaming and data center. Q1 revenue reached a record $3.21 billion, up 66% year-on-year, up 10% sequentially, and above our outlook of $2.9 billion. Once again, all measures of profitability set records, with GAAP gross margins at 64.5%, operating margins at 40.4%, and net income at $1.24 billion. From a reporting segment perspective, Q1 GPU revenue grew 77% from last year, to $2.77 billion. Tegra Processor revenue rose 33% to $442 million. +Let's start with our gaming business. Revenue was $1.72 billion, up 68% year-on-year and down 1% sequentially. Demand was strong and broad-based across regions and products. The gaming market remains robust and the popular Battle Royale genre is attracting a new wave of gamers to the GeForce platform. We also continued to see demand from upgrades, with about 35% of our installed base currently on our Pascal architecture. The launch of popular titles, like Far Cry 5 and FANTASY -- FINAL FANTASY XV, continued to drive excitement in the quarter. Gamers are increasingly engaging in social gameplay and gaming is rapidly becoming a spectator sport, while the production value of games continues to increase. This dynamic is fueling a virtuous cycle that expands the universe of gamers and drives a mix shift to higher end GPUs. +At the recent Game Developers Conference, we announced our real-time ray-tracing technology, NVIDIA RTX. Ray tracing is movie-quality rendering technique that delivers lifelike lighting, reflections and shadows. It has long been considered the Holy Grail of graphics and we've been working on it for over 10 years. We look forward to seeing amazing, cinematic games that take advantage of this technology come to the market later this year, with the pipeline building into next year and beyond. And we expect RTX, as well as other new technologies like 4K and virtual reality, to continue driving gamers' requirements for higher GPU performance. +While supply was tight earlier in the quarter, the situation is now easing. As a result, we are pleased to see that channel prices for our GPUs are beginning to normalize, allowing gamers who had been priced out of the market last quarter to get their hands on the new GeForce GTX at a reasonable price. Cryptocurrency demand was again stronger than expected, but we were able to fulfill most of it with crypto-specific GPUs, which are included in our OEM business, at $289 million. As a result, we could protect the vast majority of our limited gaming GPU supply for use by gamers. Looking into Q2, we expect crypto-specific revenue to be about 1/3 of its Q1 level. +Gaming notebooks also grew well, driven by an increasing number of thin and light notebooks based on our Max-Q design. And Nintendo Switch contributed strongly to year-on-year growth, reflecting that platform's continued success. +Moving to data center. We had another phenomenal quarter, with revenue of $701 million, up 71% year-on-year, up 16% sequentially. Demand was strong in all market segments, and customers increasingly embraced our GPUs and CUDA platform for high-performance computing and AI. Adoption of our Volta architecture remained strong across a wide range of verticals and customers. In the public cloud segment, Microsoft Azure announced general availability of Tesla V100 instances, joining Amazon, IBM and Oracle. And Google Cloud announced that the V100 is now publicly available in beta. Many other hyperscale and consumer Internet companies also continued their ramp of Volta, which delivers 5x the deep learning performance of its predecessor, Pascal. Volta has been chosen by every major cloud provider and server maker, reinforcing our leadership in AI deep learning. +In high-performance computing, strength from the broad enterprise vertical more than offset the ramp down of major supercomputing projects such as the U.S. Department of Energy's Summit System. We see a strong pipeline across a number of vertical industries from manufacturing to oil and gas, which has helped sustain the trajectory of high-performance computing next quarter and beyond. +Traction is also increasing in AI inference. Inference GPU shipments to cloud service providers more than doubled from last quarter. And our pipeline is growing into next quarter. We dramatically increased our inference capabilities with the announcement of the TensorRT 4 AI Inference Accelerator Software at our recent GPU Technology Conference in San Jose. TensorRT 4 accelerates deep learning inference up to 190 times faster than CPUs for common applications such as computer vision, neural machine translation, automatic speech recognition, speech synthesis and recommendation systems. It also dramatically expands the use cases prepared with the prior version. With TensorRT 4, NVIDIA's market reach has expanded to approximately 30 million hyperscale servers worldwide. +At GTC, we also announced other major advancements in our deep learning platform. We doubled the memory of Tesla V100 to 32 GB DRAM, which is a key enabler for customers building large neural networks through larger data sets. And we announced a new GPU interconnect fabric called NVIDIA NVSwitch. (inaudible) 16 Pascal V100 GPUs at a speed of 2.4 terabytes per second, or 5x faster than the best PCIe switch. We also announced our DGX-2 system, which leverages these new technologies and its updated, fully-optimized software stack to deliver a 10x performance boost beyond last year's DGX. DGX-2 is the first single server capable of delivering 2 petaflops of computational power. We are seeing strong interest from both hyperscale and (inaudible) customers, and we look forward to bringing this technology to cloud customers later this year. +At our Investor Day in March, we updated our forecast for the data center and the rest of the market. We see the data center opportunity as very large, fueled by growing demand for accelerated computing and applications ranging from AI (inaudible) multiple market segments and vertical industries. We estimate the TAM at $50 billion by 2023, which extends our previous forecast of $30 billion by 2020. We see strong momentum in the adoption of our accelerated computing platform and the expansion of our development ecosystem to serve this rapidly growing market. About 8,500 attendees registered for GTC, up 18% from last year. CUDA downloads have continued to grow, setting a fresh record in the quarter. And our total number of developers is well over 850,000, up 72% from last year. +Moving to pro visualization. Revenue grew to $251 million, up 22% from a year ago and accelerating from last quarter, driven by demand for real-time rendering as well as emerging applications like AI and VR. Strength extended across several key industries, including public sector, health care and retail. Key wins in the quarter included Columbia University, using high-end Quadro GPUs for AI, and Siemens, using them for CT and ultrasound solutions. +At GTC, we announced the Quadro GV100 GPU with NVIDIA RTX technology, capable of delivering real-time ray tracing to the more than 25 million artists and designers throughout the world. RTX makes computational intensive ray tracing possible in real time when running professional design and content creation applications. This allows media and entertainment professionals to see and interact with their creations with correct light and shadows and do complex renders up to 10x faster than a GPU -- a CPU alone. And the NVIDIA OptiX AI denoiser built into RTX delivers almost 100x the performance of CPUs for real-time noise-free rendering. This enabled customers to replace racks of servers in traditional render farms with GPU servers at 1/5 the cost, 1/7 the space, and 1/7 the power. +Lastly, automotive. Revenue grew 4% year-on-year to a record $145 million. This reflects the ongoing transition from our infotainment business to our growing autonomous vehicle development and production opportunities around the globe. +At GTC and Investor Day, we made key product announcements on the advancement of autonomous vehicles and established a total addressable market opportunity of 60 billion by 2035. We believe that every vehicle will be autonomous one day. By 2035, this will encompass 100 million autonomous passenger vehicles and 10 million robo-taxis. +We also introduced NVIDIA DRIVE Constellation, a platform that will help car companies, carmakers, tier 1 suppliers, and others developing autonomous vehicles test and validate their systems in a virtual world across a wide range of scenarios before deploying on the road. Each year, 10 trillion miles are driven around the world. Even if test cars can eventually cover millions of miles, that's an insignificant fraction of all the scenarios that require testing to create a safe and reliable autonomous vehicle. DRIVE Constellation addresses this challenge by (inaudible) cars to safely drive billions of miles in virtual reality. +The platform has 2 different servers. The first is loaded with GPUs and simulates the environment that the car is driving in, as in a hyper-real video game. The second contains the NVIDIA DRIVE Pegasus Autonomous Vehicle Computer, which possesses the simulated data, as if it were coming from the sensors of a car driving on the road. Real-time driving command from the DRIVE Pegasus are fed back to the simulation for true hardware-in-the-loop verification. Constellation will enable autonomous vehicle industry for safety test and validate their AI self-driving systems in ways that are not practical or possible with on-road testing. +We also extended our product roadmap to include our next-generation DRIVE Autonomous Vehicle Computer. We have created a scalable AI car platform that spans the entire range of autonomous driving, from traffic jams, pilots, to level 5 robo-taxis. More than 370 companies and research institutions are now using NVIDIA's automotive platform. With this growing momentum, we remain excited about the intermediate and long-term opportunities for autonomous driving business. +Now moving to the rest of the P&L. Q1 GAAP gross margins were 64.5% and non-GAAP was 64.7%, records that reflect continued growth in our value-added platforms. GAAP operating expenses were $773 million. Non-GAAP operating expenses were $648 million, up 25% year-on-year. We continue to invest in key platforms driving our long-term growth, including gaming, AI and automotive. GAAP net income was a record $1.24 billion and EPS was $1.98, up 145% and 151% respectively from a year earlier. Some of the expenses (inaudible) by a tax rate of 5% compared to our guidance of 12%. Non-GAAP net income was $1.29 billion and EPS was $2.05, both up 141% from a year ago, reflecting the revenue strength as well as gross margins and operating margin expansion on slightly lower tax. Our quarterly cash flow from operations reached record levels at $1.45 billion. Capital expenditures were $118 million. +With that, let me turn to the outlook for the second quarter of fiscal 2019. We expect revenue to be $3.1 billion plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 63.6% and 63.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $810 million and $685 million, respectively. GAAP... +(technical difficulty) +Capital expenditures are expected to be approximately $130 million to $150 million. Further financial details are included in the CFO Commentary and other information available on our IR website. +In closing, I'd like to highlight a few upcoming events for the financial community. We'll be presenting at the JPMorgan Technology Conference next week on May 15, and at the Bank of America Global Technology Conference on June 5. We will also hold our Annual Meeting of Stockholders online on May 16. +We will now open the call for questions. Simona and I are here in Santa Clara and Jensen is dialing in from the road. Operator, would you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question is from Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + First, I had a question on gaming seasonality. It's usually down pretty decently in Q1. It was obviously flat this time as you were trying to fill up the channel. Now that's done. I was just wondering on with the supply dynamics -- supply-demand dynamics as well as like any thoughts on crypto might mean for typical -- the seasonality in the Q2 versus what would be typical or what would usually be down -- or usually be up pretty decently? How are you looking at that? And there's a question for Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Jensen, why don't you start on the question for Stacy, and I'll follow-up afterwards, after you speak. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [4] +-------------------------------------------------------------------------------- + + Okay. Stacy, so let's see. Q1, as you probably know, Fortnite and PUBG are global phenomenons. The success of Fortnite and PUBG are just beyond, beyond comprehension, really. Those 2 games, a combination of Hunger Games and Survivor, has just captured imaginations of gamers all over the world. And we saw the uptick and we saw the demand on our GPUs from all over the world. Surely, there was scarcity as you know. Crypto miners bought a lot of our GPUs during the quarter, and it drove prices up. And I think that a lot of the gamers weren't able to buy into the new GeForces as a result. And so we're starting to see the prices come down. We monitor spot pricing every single day around the world. And the prices are starting to normalize. It's still higher than where they should be. And so obviously, the demand is still quite strong out there. But my sense is that there's a fair amount of pent-up demand still. Fortnite is still growing in popularity. PUBG is doing great. And then, we've had some amazing titles coming out. And so my sense is that the overall gaming market is just really -- is super healthy. And our job is to make sure that we work as hard as we can to get supply out into the marketplace. And hopefully, by doing that, the pricing will normalize and the gamers can buy into their favorite graphics card at a price that we hope they can get it at. And so I think there's a fair -- so I mean, the simple answer to your question is Fortnite and PUBG. And the demand is just really great. They did a great job. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Your next question is from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [6] +-------------------------------------------------------------------------------- + + No wonder -- Colette had talked about the inference doubling in sales quarter-over-quarter with cloud. Can you just talk about where you're seeing the early applications for inference? Is that sort of as-a-service business? Or are you looking at internal cloud workloads? And just any color you can give us on where you guys are sitting in the inference space. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [7] +-------------------------------------------------------------------------------- + + Sure. Joe, so as you know, there are 30 million servers around the world. And they were put in place during the time when the world didn't have deep learning. And now with deep learning and with machine learning approaches, the accuracy of prediction, the accuracy of recommendation has jumped so much that just about every Internet service provider in the world that has a lot of different customers and consumers are jumping onto this new software approach. And in order to take this newer network -- and the software that's written by deep learning, these frameworks, are massive software. The way to think about these deep neural nets is, it has millions and millions and millions of parameters in it, and these networks are getting larger every year. And they're enormously complex. And the output of these neural nets had to be optimized for the computing platform that it targets. How you would optimize the neural network for a CPU or a GPU is very, very different. And how you optimize for different neural networks, whether it's image recognition, speech recognition, natural language translation, recommendation systems, all of these networks have different architectures, and the optimizing compiler that's necessary to make the neural network run smoothly and fast is incredibly complex. And so that's why we created TensorRT. That's what TensorRT is. TensorRT is an optimizing graph neural network compiler. And it optimizes for our -- each one of our platforms. And each -- even each one of our platforms has very different architectures. For example, we invented recently -- reinvented the GPU and it's called the Tensor Core GPU, and the first of its kind is called Volta. And so TensorRT 4.0 now supports, in addition to image recognition, all of the different types of neural network models. The answer to your question is internal consumption. Internal consumption is going to be the first users. Video recognition, detecting for inappropriate video, for example, all over the world, making recommendations from the videos that you search or the images that you're uploading, all of these types of applications are going to require an enormous amount of computation. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Next question is from Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + Jensen, I have 2 questions about the data center. One from a growth, and the second, from a competition perspective. So from the growth side, you guys are doing about, say, $3 billion or so annualized, but you have outlined a market that could be $50 billion. What needs to happen for the next inflection? Is it something in the market that needs to change? Is it something in the product set that needs to? How do you go and address that $50 billion market, right? Because you're only a few percent penetrated today in that large market. So what needs to change for the next inflection point? And then, on the competition side, as you are looking at that big market, how should we think about competition that is coming from some of your cloud customers, like a Google announcing a TPU 3 or perhaps others looking at other competing technologies? So any color on both sort of how you look at growth and competition would be very helpful. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [10] +-------------------------------------------------------------------------------- + + Thanks, Vivek. First of all, at its core, this is something we all know now, that CPU scaling has really slowed. And if you think about the several hundred billion dollars worth of computer equipment that's been installed in the cloud, in data centers all over the world, and as these applications for machine learning and high-performance computing approaches come along, the world needs a solution. CPU scaling has slowed. And so here's the approach that we pioneered 1.5 decades ago called GPU computing. And we've been determined to continue to advance it during this time because we saw this day coming and we really believed that it was going to end. I mean, you can't deny physics. And so we find ourselves in a great position today. And as Colette already mentioned, we have something close to 1 million developers on this platform now. It is incredibly fast, speeding up CPUs by 10, 20, 50, 100x, 200x sometimes, depending on the algorithm. It's everywhere. The software ecosystem is just super rich. And as Colette mentioned, that there is already almost 1 billion -- 1 million developers around the world, that's grown 70% year-over-year. And so I think at the core, it's about the fact that the world needs a computing approach going forward. With respect to the -- our ability to address the TAM, there are 3 major segments. There's more than that, but there's 3 major segments. One is, of course, training for deep learning. The other is inferencing, and TRT 4 is intended to do just that, to expand our ability to address all of the different types of algorithms, machine learning algorithms that are now coming -- that are running in the data centers. The third is high-performance computing, and that's molecular dynamics, to medical imaging, to earth sciences, to energy sciences. The type of algorithms that are being run in supercomputers all over the world is expanding. And we're doing more and more of our product designs in virtual reality. We want to simulate our products and simulate its capabilities in simulation in this computer rather than build it in the beginning. And then, the last category would be graphics virtualization. We've taken with GRID and our Quadro virtual workstation and now with Quadro -- with NVIDIA RTX, we turned the data center into a powerful graphic supercomputer. And so these are the various applications and segments of data center that we see. I think, in the case of training, we're limited by the number of deep learning experts in the world. And that's growing very quickly. The frameworks are making it easier. There's a lot more open source and open documentation on sharing of knowledge. And so the number of AI engineers around the world is growing super fast. The second is inference. And I've already talked about that. It's really limited by our optimizing compilers and how we can target these neural network models to run on our processors. And if we could do so, we're going to save our customers enormous amounts of money. We speed up applications, we speed up these neural network models 50x, 100x, 200x over a CPU. And so the more GPUs they buy, the more they're going to save. And high-performance computing, the way to think about that is, I think, at this point, it's very clear that going forward, supercomputers are going to get built with accelerators in them. And because of our long-term dedication to CUDA and our GPUs for acceleration, of all these codes and the nurturing of the ecosystem, I think that we're going to be -- we're going to do super well in the supercomputing world. And so these are the different verticals. With respect to competition, I think it all starts with the core. And the core is that the CPU scaling has slowed. And so the world needs another approach going forward. And surely, because of our focus on it, we find ourselves in a great position. Google announced GPU 3 and it's still behind our Tensor Core GPU. Our Volta is our first generation of a newly reinvented approach of doing GPUs. It's called Tensor Core GPUs. And we're far ahead of the competition. And -- but more than that, more than that, it's programmable. It's not one function. It's programmable. Not only is it faster, it's also more flexible. And as a result of the flexibility, developers could use it in all kinds of applications, whether it's medical imaging or weather simulations or deep learning or computer graphics. And as a result, our GPUs are available in every cloud and every data center, everywhere on the planet. And which developers need, so that accessibility so that they could develop their software. And so I think that on the one hand, it's too simplistic to compare a GPU to just one of the many features that's in our Tensor Core GPU. But even if you did, we're faster. We support more frameworks. We support all neural networks. And as a result, if you look at GitHub, there are some 60,000 different neural network research papers that are posted that runs on NVIDIA GPUs. And it's just a handful for the second alternative. And so it just kind of gives you a sense of the reach and the capabilities of our GPUs. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Your next question comes from Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [12] +-------------------------------------------------------------------------------- + + Jensen, I had a question regarding your decision to pull the plug on your GeForce partner program. I think most of us read your blog from last Friday, I think it was. So we understand the basic background. But if you can describe what led to this decision, and perhaps talk a little bit about the potential implications, if any, in terms of your ability to compete or gain share, that will be really helpful. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [13] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question, Toshiya. At the core, the program was about making sure that gamers who buy graphics cards knows exactly the GPU brand that's inside. And the reason for that is because we want gamers to -- the gaming experience of a graphics card depends so much on the GPU that is chosen. And we felt that using one gaming brand, a graphics card brand and interchanging the GPU underneath causes it to be less -- causes it to be more opaque and less transparent for gamers to choose the GPU brand that they wanted. And most of the ecosystem loved it. And some of the people really disliked it. And so instead of all that distraction, we're doing so well, and we're going to continue to help the gamers choose the graphics cards like we always have, and things will sort out. And so we decided to pull the plug because the distraction was unnecessary and we had too much good stuff to go do. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Next question is from C.J. Muse with Evercore ISI. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [15] +-------------------------------------------------------------------------------- + + This is (inaudible) calling in for C.J. Muse. So I had a question on HPC. TSMC, on their recent call, raised their accelerator attach rate forecast in HPC to 50% from mid-teens. So I would love to get further details on what exactly NVIDIA is doing to software services, et cetera, that's kind of creating this competitive positioning in HPC and AI, basically. And then, if I could ask a follow-up, basically, in benchmarks. So there's been some news on AI benchmarks, whether it's Stanford's DAWNBench, et cetera. So I would love to get your thoughts on, a, the current state of benchmarks for AI workloads. And b, the relative positioning of ASICs versus GPUs, especially as we move towards newer networks like RNN and GAN, et cetera. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [16] +-------------------------------------------------------------------------------- + + Yes. Thanks for the question. HPC. First of all, at the core, CPU scaling has stalled and it's reached the limits of physics. And the world needs another approach to go forward. We created the GPU computing approach 1.5 decades ago, and I think at this point, with the number of developers jumping on, the number of applications that's emerging, it's really clear that the future of HPC has accelerated. And our GPU approach, because of its flexibility, because of its performance, because of the value that we create, that as a result of the throughput of a data center, we save people so much money just in cables alone. Oftentimes, more than pays for the GPUs that they buy. And the reason for that is because the number of servers is reduced dramatically. And so I think the future of HPC is about acceleration, and the NVIDIA CUDA GPUs are really in a great position to serve this vacuum that's been created. With respect to benchmarks, you might have seen that earlier this week, we released 3 speed records. The fastest single GPU, the fastest single node -- single computer node. A definition of a computer node is something that fits in a box that runs one operating system, one node. And one instance, one cloud instance. We now have the fastest speed record for 1 GPU, 1 node and 1 instance. And so we love benchmarks. Nothing is more joyful than having a benchmark to demonstrate your leadership position. And in the world of deep learning, the number of networks is just growing so fast because the number of different applications that deep learning is able to solve is really huge. And so you need a lot of software capability and you're -- the versatility of your platform needs to be great. We also have a lot of expertise in the company and software. I mean, NVIDIA is really a full-stack computing company. From architecture, to system software, to algorithms, to applications, we have a great deal of expertise across the entire stack. And so we love these complicated benchmarking -- benchmarks that are out there, and I think this is a great way for us to simplify our leadership position. I think long term, the number of networks that are going to emerge will continue to grow. And so the flexibility of ASICs is going to be its greatest downfall. And if someone were to create a general-purpose parallel accelerating processor like ours, and had it designed to be incredibly good at deep learning, like recently what we did with our Tensor Core GPU, which is a reinvented GPU, and Volta is the first one, I -- it's going to be hard. It's going to be expensive, and we've been doing it for a long time. And so I think this is a -- it's a great time for us. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Next question is from Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [18] +-------------------------------------------------------------------------------- + + Jensen, I wanted to ask on the inference side [about edge inference]. And beyond autos, when you look at sizing that TAM, what are the other big areas that you think you can penetrate with GPUs and inference, besides auto? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [19] +-------------------------------------------------------------------------------- + + Yes, Blayne. The largest inference opportunity for us is actually in the cloud and the data center. That's the first great opportunity. The reason for that is there's just an explosion in the number of different types of neural networks that are available. There are image recognition, there's video sequencing, there's video -- there's recommender systems. There's speech recognition, speech synthesis, natural language understanding. There's just so many different types of neural networks that are being created. And creating one ASIC that can be adapted to all of these different types of networks is just a real challenge. And by the time that you create such a thing, it's called a Tensor Core GPU, which is what we created. And so I think the first opportunity for us in -- large-scale opportunity will be in the data center and the cloud. The second will be in vertical markets. The vertical market that you mentioned is self-driving cars. And we see a great opportunity in autonomous vehicles, both in the creation of autonomous vehicles. And I mentioned that before, between now and the time that we ramp our AV computers we call DRIVE, we're going to be selling a whole lot of servers so that the companies could develop their neural network models for their self-driving cars as well as simulating the virtual reality -- in virtual reality, there are various test drives as well as testing their neural network and their self-driving car stack against billions and billions of miles of saved-up prerecorded videos. And so in the vertical markets, we're going to see inference both in the data center for developing the self-driving car stack as well as in the self-driving cars themselves. Now in the self-driving cars, the ASPs for level 2 could be a few hundred dollars to a level 5 self-driving car, taxi or driverless taxi being a few thousand dollars. And I expect that driverless taxis will start going to market about 2019, and self-driving cars probably somewhere between 2020 and 2021. And I think the size of the market is fairly well modeled. And the simple way to think about that is, I believe that every single -- everything that moves someday will be autonomous or have autonomous capabilities. And so the 100 million cars, the countless taxis, all the trucks, all the agriculture equipment, all the pizza delivery vehicles, you name it, everything is going to be autonomous. And the market opportunity is going to be quite large. And that's the reason why we're so determined to go create that market. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Your next question is from Tim Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [21] +-------------------------------------------------------------------------------- + + I actually wanted to go back to the question about seasonality for gaming in June. Normal seasonal sounds like it's up mid-teens for June in gaming. But obviously, the comps are skewed a little bit because of the channel restock and the crypto stuff. So does the guidance for June assume that gaming is better or worse than that mid-teens normal seasonal? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [22] +-------------------------------------------------------------------------------- + + We are expecting the -- we are expecting Q2 to be better than seasonality, if I understand your question. It should be -- we're expecting Q2 to be better than Q1 and we're expecting Q2 to be better than seasonality. Did that answer your question? + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question is from Atif Malik with Citi. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [24] +-------------------------------------------------------------------------------- + + I have a question for Colette. Colette, first thank you for breaking out crypto sales in the OEM line and guide for us. I have a question on your gross margins. Your gross margins have been expanding on product mix, despite component pricing headwinds on the DRAM side. When do you expect component pricing to become a tailwind to your gross margin? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- + + Thanks so much for the question. When you think about our gross margins, just over this last quarter, as you know, we were working on stabilizing the overall supply that was out there in the market for consumer GPUs. We benefited from that with a higher gross margin as we filled and completed that. You've seen us absorb a significant amount of the component pricing changes that we have seen, particularly around the memory. We're not here to be able to forecast, generally, when those pricing of those components will stabilize. But we believe in terms of the value added that our platforms provide, the components are an important part of finishing that. But I think we have a tremendous amount more value that we are adding in terms of the software on top of our platforms, which is enabling our gross margins. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question is from Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [27] +-------------------------------------------------------------------------------- + + My question is the progress on the deployment of Volta into the cloud service providers. You talked in your prepared remarks about 5 deployments, including the Google beta. Can you talk about the -- how soon we can expect to see some of those remaining deployments? And of those already launched, how far are they along? What -- I guess, to say proverbially, what inning are we in, in these deployments? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [28] +-------------------------------------------------------------------------------- + + Yes. So first of all, Volta is a reinvented GPU. Volta is the world's first GPU that has been designed to be incredibly good at deep learning. We call it the Tensor Core GPU. It has still retained all of the flexibilities of all -- everything that CUDA has ever run is backwards compatible with everything that runs on CUDA. But it has new architectures designed to be incredibly good at deep learning. We call it a Tensor Core GPU. And that's the reason why it has all of the benefits of our GPU, but none of the ASICs can catch up to it. And so Volta is really a breakthrough. We're going to be very successful with Volta. Every cloud will have it. The initial deployment is for internal consumption. Volta has been shipping to the cloud service -- cloud providers, the Internet service companies, for the vast majority of last quarter, as you guys know. And they're using it internally. And now they're starting to open up Volta for external consumption, their cloud customers. And they are moving as fast as they can. And my expectation is that you're going to see a lot more coming online this quarter. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [30] +-------------------------------------------------------------------------------- + + I had a question about the DGX family of products. Our own fieldwork is indicating very positive reception for DGX. And I was wondering, Jensen, if can you help us understand, the high-growth we've seen in the data center business, to what extent is that being driven by the DGX? And what, when DGX-2 starts to ramp in the back half of the year, is that -- is it something that kind of layers on top of DGX? Does DGX-2 layer top of DGX? Are they (inaudible) segments, that you're kind of segmenting the market with these different products? Any color on how to think about those 2 products are -- should be -- would be helpful. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Colette, could you give me a brief version of that? It was kind of crackling on my side. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [32] +-------------------------------------------------------------------------------- + + I'm going to ask the operator if they could ask for the question again because it was also, on our side, a little crackly. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Yes. Mark, your line is open. Please restate your question. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [34] +-------------------------------------------------------------------------------- + + Okay. Can you hear me better now? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [35] +-------------------------------------------------------------------------------- + + Yes. Much better, Mark. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Sorry about that. I'm at the airport. So the question was on the DGX family of products. Our own fieldwork indicates very positive reception. I was wondering, Jensen, if you could help us understand the high-growth you've seen in the data center market. How much is DGX contributing to that? And then, when DGX-2 starts to ramp in the second half of the year, how do we think about DGX-1? Does it replace DGX -- the original DGX? Or you're going after different segments? Or do they layer on top of one another? Any color on that would be helpful. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [37] +-------------------------------------------------------------------------------- + + I see. Thank you. DGX-2 and DGX-1 will both be in the market at the same time. And DGX is a few hundred million dollar business. It's -- it was introduced last year. So its growth rate is obviously very high. It's designed for enterprises where they don't -- they need to have their computers on-premise, but they don't want to build a supercomputer and they don't have the expertise to do so. And they would like to pull a supercomputer out of a box, plug it in, and start doing supercomputing. And so DGX is really designed for enterprises. It's designed for car companies. It's designed for health care companies doing life sciences work or medical imaging work. We recently announced a project called Project Clara, which basically takes medical imaging equipment, virtualizes them, containerizes the software, and turns it into a -- and most medical imaging equipment today are computational and they -- a lot of them run on NVIDIA CUDA anyways. And so we put that -- we can put that into the data center, we can virtualize their medical instruments and it gives them the opportunity to upgrade the millions of instruments that are out in the marketplace today. And so DGX is really designed for enterprises and we're seeing great success there. It's really super easy to use and it comes with direct support from HPC and AI researchers at NVIDIA. And the answer to your question at the end is, both of them will be in the marketplace at the same time. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Next question is from Mitch Steves with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [39] +-------------------------------------------------------------------------------- + + I'm actually going to go with a more nitty-gritty question just on the financial side, just to make sure I'm understanding this right. So the OEM beat was pretty material, given a lot of crypto revenue. Is it still the case that OEM is materially lower gross margin than your corporate average at this time? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [40] +-------------------------------------------------------------------------------- + + Sure. I'll take that question. Generally, our OEM business can be a little bit volatile. Because remember, OEM business incorporates our mainstream GPUs as well as our Tegra integrated. So we have development platforms that we sell on some of the Tegra piece of it. But they are slightly below, and I think you can go back and refer to our discussion at Investor Day as there's a slide there that talks about those embedded pieces and them being below. So yes, you're correct. Again, a very small part of our business right now. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question comes from Christopher Rolland with Susquehanna. + +-------------------------------------------------------------------------------- +Christopher Adam Jackson Rolland, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [42] +-------------------------------------------------------------------------------- + + So your competitor thinks that just 10% of their sales were from crypto, or like $150 million, $160 million. And you guys did almost $300 million there. And perhaps I think there could actually be some in gaming as well, which would imply that you guys have 2/3 or more of that market? So I guess, what's going on there? Is there a pricing dynamic that's allowing you to have such share there? Or do you think it's your competitors that don't know what's actually being sold to miners versus gamers? Why such implied share in that market? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [43] +-------------------------------------------------------------------------------- + + Well, we try to as transparently reveal our numbers as we can. And so the thing that we -- our strategy is to create a SKU that allows the crypto miners to fulfill their needs, and we call it CMP, and to the -- as much as possible, fulfill their demand that way. Sometimes it's just not possible because the demand is too great. And -- but we try to do so. And we try to keep the miners on the CMP SKUs as much as we can. And so I'm not exactly sure how other people do it, but that's the way we do it. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question is from Craig Ellis with B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [45] +-------------------------------------------------------------------------------- + + Jensen, I just wanted to come back to an announcement that you made at GTC with ray tracing. Because the technology looked like it was very high fidelity, and I think you noted at that time that it was very computationally intensive. So the question is, as we think about the gaming business and the potential for ray tracing to enter that platform group, what does it mean for dynamics that we've seen in the past, for example, the ability to really push the high end of the market with high-end capability, 1070. Ti launched late last year. It was very successful. Does this give you further flexibility for those types of launches as you bring exciting and very high-end technology to market? + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [46] +-------------------------------------------------------------------------------- + + Yes. I appreciate it. NVIDIA RTX is the biggest computer graphics invention in the last 15 years. It took us 1 decade to do. We literally worked on it continuously for 1 decade. And to put it into perspective, it's basically film rendering, cinematic rendering, except it's in real time. It merges the style of computer graphics, rasterization, and light simulation, what people call ray tracing, as well as deep learning and AI, merged it into one unified framework so that we can achieve cinematic rendering in real time. What it currently takes is a server about a few hours, depending on the scene, it might take as long as a full day, take a few hours to render one frame. So it takes a server, one node of a server, several hours to render one frame. And in order to render 30 frames per second, just imagine the number of servers you need. If it takes several hours per frame, and you need to render 30 frames per second in order to be real-time, it basically takes a high-performance computer, a supercomputer, a render farm, that's why they call it a render farm, it's a full data center designed just for rendering. And now we've created NVIDIA RTX which makes it possible to do in real time. We demonstrated RTX on 4 Quadro GV100s. It takes 4 of our latest generation Volta Tensor Core GPUs to be able to render 30 frames per second, the Star Wars cinematic that people enjoyed. And so the amount that we saved, we basically took an entire data center, reduced it into one node. And we're now doing it in real time. And so the amount of money that we can save people who create movies, people who do commercials, people who use film rendering to create the game content, almost every single game is done that way. There's quite a bit of offline rendering to create the imagery and the textures and the lighting. And then, of course, architectural design and car design, the number of applications, the number of industries that are built on top of modern computer graphics is really quite large. And I'm certain that NVIDIA RTX is going to impact every single one of them. And so that's our starting point, is to dramatically reduce the cost of film rendering, dramatically reduce the time that it takes to do it, and hopefully, more GPU servers will get -- will be purchased. And of course, better content will be created. Long-term, we've also now plotted the path towards doing it in real time. And someday, we will be able to put RTX into a GeForce gaming card and the transformation to the revolution to the gaming industry will be quite extraordinary. So we're super excited about RTX. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Your next question is from Stacy Rasgon with Bernstein. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [48] +-------------------------------------------------------------------------------- + + This is a question for Colette. I want to follow up, again, on the seasonality, understanding the prior comments. Normal seasonal for Q2 for gaming would be up in the double digits. Given your commentary on the crypto declined into Q2, given your commentary on just the general drivers around data center and the Volta ramps, I can't bring that together with the idea of gaming being above seasonal within the guidance -- the context of your guidance envelope. So how should I reconcile those things? How are you actually thinking about seasonality for gaming into Q2 within the context of the scenarios that are currently contemplated in your guidance for next quarter? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [49] +-------------------------------------------------------------------------------- + + Sure, Stacy. Let me see if I can bridge together Jensen and then some comments here. Unfortunately, they are moving quite fast to the next question, so I wasn't able to add on. But let me see if I can add on here and provide a little bit of clarity in terms of the seasonality. Remember, in Q1, we outgrew seasonality significantly. We left Q4 with very low inventory in terms of the channel. We spent Q1 working on establishing a decent amount of inventory available. We wanted to concentrate on our miners separately, and then you can see we did that in terms of Q1 by moving that to OEM and moving that to cryptocurrency-only boards. So we left Q1 at this point with healthy overall channel inventory levels as far as where we stand. So that then takes you now to Q2. But if we overshot in terms of seasonality in terms of Q1, we don't have to do those channel-fill dynamics again as we get into Q2. But we do have demand out there for our gamers that we can now address very carefully with the overall inventory that we now have available. So putting together Q1 and Q2 together, yes, we are within normal seasonality, again, for our guidance. And we'll see how we'll finish in terms of the quarter. But you should be in that range. So yes, from a normal seasonality, at a year-to-date inclusive of Q2, yes, we're on that overall seasonality. Always keep in mind, generally, our H2s are usually higher than our overall H1s, and that's what you should think about our overall guidance. Gaming is still strong. We have to comment that our overall drivers that have taken us to this place over the last 3 to 5 years with phenomenal growth and our ability to grow that overall market is still here and all of those things are together. We've just had a few quarters in terms of making sure that we get the overall channel correct and put our miners separately. I hope that clarifies in terms of where we are, in terms of gaming seasonality. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Your last question comes from Will Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [51] +-------------------------------------------------------------------------------- + + The question relates to the supply chain challenges that you've talked so much about in the gaming end market. I'm wondering if there's something particular to that end market that is making the shortages concentrated there? Or are, in fact, other end markets in particular that the data center end market also somewhat restricted from what growth they might have achieved if there weren't the shortages that are out there? And maybe talk about the pace of recovery of those. That be really helpful. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [52] +-------------------------------------------------------------------------------- + + Let me start off here, and I'll have Jensen finish up on the last part of that question. But overall, our data center business did phenomenal. Volta is doing extremely well. And even now with 32-bit, we're seeing tremendous adoption throughout. Again, remember it's very different than the overall consumer business. You have significant amount of time for qualification, and that is moving extremely fast based on a lot of other industries and their ability to qualify. So no, there is not a supply challenge at all in terms of our data center. And our overall growth in data center, we're extremely pleased with in terms of how the quarter came out. I'll turn it over to you, Jensen, and you can answer the rest of the part of it. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [53] +-------------------------------------------------------------------------------- + + Yes. The reason why miners love GeForce is because miners are everywhere in the world. One of the benefits of cryptocurrency is that it's not any sovereign currency. And it's, in the digital world, it's distributed. And GeForce is the single largest distributed supercomputing infrastructure on the planet. Every gamer has a supercomputer in their PC. And GeForce is so broadly distributed, it's available everywhere. And so GeForce is really a good candidate for any new cryptocurrency or any new cryptography algorithm that comes along. We try the best we can to go directly to the major miners, and the major miners. And they represent the vast majority of the demand. And to the best of our ability, serve their needs directly and we call that CMP, and that's why it's not called GeForce. They're called CMP. And we can serve those miners directly, hopefully, to take some of the demand pressure off of the GeForce market. Because ultimately, what we would like is, we would like the market for GeForce pricing to come down so that the gamers could benefit from the GeForces that we built for them. And the gaming demand is strong. I mean, the bottom line is, Fortnite is a home run. The bottom line is, PUBG is a home run. And the number of gamers that are enjoying these games is really astronomic, as people know very well. And it's a global phenomenon. These 2 games are equally fun in Asia as it is in Europe, as it is in the United States. And because you team up and this is a Battle Royale, you'd rather play with your friends. So it's incredibly social. It's incredibly sticky. And more and more -- more gamers that play, more of their friends join, and more of their friends join, more gamers that play. And so it's this positive feedback system, and the guys at Epic did a fantastic job creating Fortnite, and it's just a wonderful game genre that people are really enjoying. And so I think at the core of it, gaming is strong and we are looking forward to inventory normalizing in the channel so that pricing could normalize in the channel, so that gamers can come back to buy the GeForce cards that has now been in short supply for over a quarter. And so the pent-up demand is quite significant, and I'm expecting the gamers to be able to buy new GeForces pretty soon. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Unfortunately, we have ran out of time. I will now turn it back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [55] +-------------------------------------------------------------------------------- + + Let's see here. Is it my turn again? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [56] +-------------------------------------------------------------------------------- + + It is. + +-------------------------------------------------------------------------------- +Jensen Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [57] +-------------------------------------------------------------------------------- + + Okay. We had another great quarter. Record revenue, record margins, record earnings, growth across every platform. Data center achieved another record, with strong demand for Volta and AI inference. Gaming was strong. We're delighted to see prices normalizing and we can better serve pent-up gamer demand. +At the heart of our opportunity is the incredible growth of computing demand of AI, just as traditional computing has slowed. The GPU computing approach that we've pioneered is ideal for filling this vacuum. And our invention of the Tensor Core GPU has further enhanced our strong position to power the AI era. I look forward to giving you another update next quarter. Thank you. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + This concludes today's conference call. Thank you, guys, for joining. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2018-Nov-15-NVDA.txt b/Transcripts/NVDA/2018-Nov-15-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..e355db6c68a21d065807684f1a6f47897e274d3c --- /dev/null +++ b/Transcripts/NVDA/2018-Nov-15-NVDA.txt @@ -0,0 +1,498 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2019 NVIDIA Corp Earnings Call +NOVEMBER 15, 2018 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * William Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Craig Andrew Ellis + B. Riley FBR, Inc., Research Division - Senior MD & Director of Research + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Kelsey, and I'm your conference operator for today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the third quarter of fiscal 2019. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. It's also being recorded. You can hear a replay by telephone until November 22, 2018. The webcast will be available for replay until the conference call to discuss our financial results for the fourth quarter of fiscal 2019. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, November 15, 2018, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, I'd like to turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. Q3 revenue reached $3.18 billion, up 21% from a year earlier, with all 4 of our market platforms growing double digits. Data center, professional visualization and automotive all hit record levels. However, gaming was short of expectations as post crypto channel inventory took longer than expected to sell through. Gaming card prices, which were elevated following the sharp crypto falloff, took longer than expected to normalize. +Our Q4 outlook for gaming reflects very little shipments in the midrange Pascal segment to allow channel inventory to normalize. In Q4, we also expect minimal sales of Tegra chips for game consoles due to the normal seasonal build cycle. While channel inventory situation presents a near-term headwind, it does not change our long-term fundamentals. Our competitive position is as strong as ever, and we have expanded our addressable market with Turing and our recent software announcements. We remain excited about the growth opportunities in ray-traced gaming, rendering, high-performance computing, AI and self-driving cars. +GAAP gross margins grew 90 basis points year-on-year and non-GAAP gross margins rose 130 basis points. This reflects our continued shift toward higher-value platforms but also included a $57 million charge for prior architecture components and chips following the sharp falloff of crypto mining demand. Both GAAP and non-GAAP net income exceeded $1 million for the fourth consecutive quarter. +From a reporting segment perspective, GPU revenue grew 25% from a year ago to $2.77 billion. Tegra processor revenue was down 3% to $407 million. +Let's continue with our gaming business. Revenue of $1.76 billion was up 13% year-on-year and down 2% sequentially. Year-on-year growth was driven by initial sales of our new Turing-based GPUs as well as strong notebook sales, which more than offset gaming console declines. In mid-September, we began shipping GeForce RTX series, the first gaming GPUs based on our Turing architecture. Turing RTX technology delivers up to 2x the performance of its predecessor, Pascal, and 6x more for ray-traced graphics. These are the biggest generational jumps we have ever delivered in gaming GPUs. +The first 2 GeForce RTX gaming cards to hit the shelves were the 2080 Ti and the 2080, delivering 4K HDR gaming and 60 frames per second on even the most advanced AAA titles, a major milestone for gamers. This is quickly becoming the new performance baseline as 4K displays are now reaching affordable price points. These 2 end -- 2 high-end cards were quickly followed by the rollout of the GeForce [27 D]. NVIDIA RTX technology brings games to life like never before. The highly anticipated Battlefield V launched this week with the first release of RTX ray-tracing, enabling lifelike reflections on GeForce RTX GPUs. With a pipeline of upcoming games supporting NVIDIA RTX features, RTX is well on its way to establishing itself as a game-changing architecture. +Although the cryptocurrency wave has ended, the channel has taken longer than expected to normalize. Pascal high-end cards have largely sold through ahead of RTX. However, on midrange Pascal gaming cards, both channel prices and inventory levels remained higher than expected. Pascal is well positioned as the GPU of choice in the midrange for the holidays, and we expect to work down channel inventories over the next quarter or 2. +Moving to data center. We had another strong quarter with revenue of $792 million, up 58% year-on-year and up 4% sequentially. Demand remains strong for Volta architecture products, including Tesla V100 and VGX systems, and our inference business continued to grow, benefiting from the launch of the Turing T4 Cloud GPU during the quarter. Just 2 months after its launch, the T4 has received the fastest adoption of any server GPU. It is integrated into 57 server designs and it is already on the Google Cloud Platform, its first cloud availability. The T4 delivers world record performance for deep learning inference and accelerates diverse cloud workloads, including high-performance computing, deep learning training and inference, machine learning, data analytics and graphics. +We also announced an updated TensorRT software stack and NVIDIA TensorRT Hyperscale Platform. This new software includes 2 critically important capabilities that can drive deployment of the NVIDIA inference platform at scale in hyperscale data centers. First, it enables multiple models and multiple frameworks to run on the same GPU at the same time. This can drive higher data center utilization, directly translating to significant savings. Second, it integrates with Kubernetes, the leading orchestration layer for hyperscale data centers. +Completing our inference platform, the new T4 GPU delivers 12x the peak inference performance of its T4 predecessor. All told, our inference platform delivers 40x faster performance in CPUs. And with the TensorRT software stack, it is ideally suited for hyperscale data centers. With this launch, NVIDIA is poised to take the data center inference market, targeting every server node in the hyperscale data centers. +Another important launch for the quarter was the NVIDIA RTX Server reference architecture, which incorporates up to 8 Turing-based RTX 8000. With this product, Turing opens a new market to GPOs, photoreal rendering or the creation of computer-generated images that look real. Rendering is instrumental to large industries, such as media and entertainment, retail, product designs, manufacturing and architecture. Yet prior to Turing and its ray-tracing capabilities, GPUs were not able to address this workload. So most rendering at -- up to this point has been done on CPUs. An RTX-accelerated render farm compared with an equivalent performance CPU render farm is 1/4 the cost, 1/10 the space and 1/11 the power. NVIDIA's RTX platform has garnered major industry support, including from key developers such as Adobe, ANSYS, Autodesk, Dassault and many others. +Lastly, NVIDIA announced a GPU acceleration platform for data science and machine learning called RAPIDS, which enables companies to analyze massive amounts of data and make accurate business predictions at unprecedented speed. Up until now, data analytics and machine learning has been the largest high-performance computing applications not to have been accelerated. Virtually all enterprise use data analytics to extract insight from big data for a wide range of use cases, such as predicting credit card fraud, forecasting retail inventory and understanding customer buying behavior. RAPIDS is an open source suite of libraries for GPU-accelerated analytics, machine learning and, soon, data visualization. With RAPIDS, NVIDIA GPUs can now accelerate machine learning, as we have done with deep learning, with performance up to 50x faster than CPUs. The RAPIDS launch opens up a $20 billion server market used for data analytics and machine learning workloads to GPUs, and it's received broad industry support, including from Oracle, IBM, SAP, Dell EMC, Hewlett Packard Enterprise, Microsoft Azure machine learning, Google, Q-Flow as well as the open source community. +With one unified architecture and ecosystem, NVIDIA GPUs can address the redefined high-performance computing market, including scientific computing, deep learning and machine learning. Our GPUs and software stack accelerate a broad and diverse set of workloads, ranging from scale-up software in supercomputers to scale out deployments in hyperscale data centers. Just earlier this week, this capability was on display at Supercomputing Conference in Dallas, where the number of systems on the TOP500 supercomputer list using NVIDIA GPUs jumped 48% from last year, including the #1 and #2 systems in the world. +Moving to pro visualization. Revenue reached a record $305 million, up 28% versus the prior year and up 9% sequentially. Strength extended across the desktop and mobile as well as several key industries, including the public sector, manufacturing and architecture, engineering and construction. +At SIGGRAPH in August, we announced our Quadro RTX 8000, 6000 and 5000 GPUs based on the Turing architecture. And earlier this week, we introduced the Quadro RTX 4000, the most advanced professional GPU priced under $1,000. These GPUs will revolutionize the work of 50 million designers and artists by enabling them to render photorealistic scenes in real-time and leveraging AI in their workflows. The Quadro RTX series started shipping in Q3, with the server-grade, high-end products recognized in data center. We already engaged with a range of customers on RTX, including the major movie studios and game developers, and the reaction has been very positive. +Finally, turning to automotive. Automotive sales in Q3 reached $172 million, up 19% from a year ago and up 7% sequentially. This reflects growth in our autonomous vehicle production and development engagement in addition to the ramp of next-generation, AI-based cockpit infotainment systems. +At GTC Europe, we announced that Volvo Cars selected NVIDIA's DRIVE AGX Xavier next-generation -- for next-generation Volvo Cars. The initial production release slated for the early 2020s will deliver Level 2+ assisted driving features, integrating 360-degree surround perception and a driver monitoring system. This is our first Level 2 mass-market car design win. In addition to Volvo, global automotive suppliers, Continental and Veoneer, announced that they have selected NVIDIA DRIVE AGX for their autonomous driving systems. Lastly, our DRIVE AGX Xavier development kit started shipping in this quarter. This is the world's first autonomous driving platform, and it can run our NVIDIA DRIVE software for autonomous driving, including data collection, 360-degree surround perception, advanced driver monitoring and in-vehicle visualization. With this platform, customers have developed and test their autonomous driving solutions and then easily move into production. We are excited about the AV opportunity as we look into next year and beyond. +Moving to the rest of the P&L and the balance sheet. Q3 gross margins was 60.4% and non-GAAP was 61%, below our outlook due to the $57 million charge for prior architecture components and chips following the sharp falloff in crypto demand. GAAP operating expenses were $863 million and non-GAAP operating expenses were $730 million, up 28% year-on-year. We continue to invest in the key platforms driving our long-term growth, including gaming, data center and automotive. +GAAP net income was $1.23 billion, and EPS was $1.97, up 48% from a year earlier. GAAP net income benefited from the reduction of $138 million in our U.S. tax reform transition tax amount as well as other discrete tax items. Non-GAAP net income was $1.15 billion and EPS was $1.84, up 38% from a year ago, reflecting revenue growth and gross margin expansion as well as lower income tax expense. +Accounts receivable was $2.22 billion compared to $1.66 billion in the prior quarter as Turing's RTX shipments began in the latter part of the quarter. Inventory at the end of the quarter was $1.42 billion compared to $1.09 billion in the prior quarter, reflecting the ramp in production of Turing products. +Quarterly cash flow from operations was $487 million. Capital expenditures were $150 million. This fiscal year, we have returned $1.13 billion to shareholders through the end of Q3. We've announced a $0.01 increase in our quarterly dividend to $0.16 effective in Q4 of fiscal 2019. We are also pleased to announce an increase of $7 billion to our share repurchase authorization and that we intend to return an additional $3 billion to shareholders by the end of fiscal 2020. +With that, let me turn to the outlook for the fourth quarter of fiscal 2019. As noted earlier, our revenue outlook is impacted by the expected work-down of Pascal midrange gaming card inventory in the channel. In addition, we expect a decline in our gaming console revenue given seasonal build patterns. Keep in mind that the midrange desktop portfolio is typically about 1/3 of our gaming business. Our outlook assumes that channel inventory weeks approach normal levels exiting Q4 and that gaming and demand increases in Q4 compared with Q3. +Now in total, we expect revenue to be $2.7 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 62.3% and 62.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $915 million and $755 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of $21 million. GAAP and non-GAAP tax rates are both expected to be 8%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $190 million to $210 million. Further financial details are included in the CFO commentary and other information available on our IR website. +In closing, I'd like to highlight some upcoming events for the financial community. We'll be presenting at the Barclays Global Technology, Media and Telecommunications Conference on December 6, and we will be meeting with the financial community at the Consumer Electronics Show in Las Vegas from January 8 through 11. And our next earnings call to discuss our financial results for the fourth quarter of fiscal 2019 will take place on February 14. +With that, we will now open the call for questions. Operator, will you please poll for questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question is from Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + Within your guidance for the January quarter, is the team anticipating continued sequential growth in your data center business? There seems to be some concern around a near-term slowdown in cloud spending. But on the flip side, we're hearing that the NVIDIA team is actually seeing pretty strong demand, near term, from some of your China cloud customers for your Tesla-based products. So I just wanted to get your views on cloud data center dynamics and the trajectory into the January quarter. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes, we expect to continue to do well in data centers. The -- if you look at the background of what's happening, we know that Moore's Law has ended. And while demand for computing continues to grow and more and more of the data center is running machine learning algorithms, which is computationally really intensive, the only way to increase computational demand -- or computational resource is to buy more computers, buy more CPUs because each one of those CPUs aren't getting much faster. And so as a result of that, the data center CapEx would have to go up. The alternative, which is the alternative that we offer and is one of the reasons why the adoption of NVIDIA's accelerated computing platform is growing so fast, is because the approach that we provide allows for a path forward beyond Moore's Law. There are several things that we have done this last quarter that I think is really fantastic. The first is the introduction of a new computing platform, new accelerated platform called RAPIDS. And as you know very well that the vast majority of the industry today, although are super excited about deep learning, deep learning as a method for artificial intelligence is very data-intensive. And in areas where there's a lot of domain expertise, where there's -- whether it's in retail or whether it's in financial services or health care, logistics, there's a fair amount of domain expertise, and the amount of data that they have to fuse together to train a model is quite high. The approach using traditional machine learning is quite successful. That has never been accelerated before. And we worked with the open source community over the course of the last several years to pull together an entire stack that starts from Apache Arrow, the Dask parallel distributed computing engine, and then all of our CUDA and all of our algorithms that run on top of that. We now have an accelerated machine learning platform. That's a brand-new platform, and the excitement around that is really quite incredible. The second thing is the Turing architecture allows us to do film rendering at a much, much more affordable way than Moore's Law would have allowed. And then the third, which we just announced recently, is our first Turing-based T4 Cloud GPU. And along with all of the software stack that we've put on top of it, Kubernetes, the Docker, the TRT inference engine, our second-generation Tensor Core, AI accelerator, all of that together has created a lot of excitement in data center. So I'm expecting our data center business to be -- to continue to do quite well. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [4] +-------------------------------------------------------------------------------- + + Great. And then just on the high-end Turing products that the team started rolling out in October, early demand actually seems to be quite strong. And I think part of it is just the lineup of AAA-rated games. eSports continue to be strong as well, obviously a big motivator for your enthusiast-class gamers. I know the team is, near term, kind of working down midrange Pascal cards, but do you anticipate your Turing-based RTX product families to drive sequential growth in the January quarter just what appears to be pretty strong demand pull for these products? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Yes, the Turing launch happened towards the end of the quarter, and it's the biggest generational leap we've ever had. It introduced real-time ray-tracing. It's the first GPU to -- gaming GPU to include artificial intelligence. At every single price point it serves, it is substantially higher performance than the last and it's the highest performance GPU in the world. And all the great content are coming. Today, I think it is -- or yesterday, I think it was, the Battlefield V was released with real-time ray-tracing, the world's first application to support real-time ray-tracing. So I -- we expect Turing to do really well. As we go on, surely, we'll bring Turing deeper into the mainstream. And so we don't have anything to announce today, but as usual, we want to bring a brand-new architecture to as many gamers as possible. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question is from Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [7] +-------------------------------------------------------------------------------- + + I had a question on the gaming outlook and as it relates to channel inventory. Colette, you mentioned that typically, the midrange is about 1/3 of gaming. How much was it in the October quarter? And are you effectively assuming close to 0 in the January quarter? And related to that, I think with your game console business, I'm estimating you did something around $200 million to $250 million in October. Again, is that coming down pretty hard into January? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + Yes. So I commented about the overall size of what we have traditionally seen in terms of the midrange over a fairly large period of time because keep in mind, the launches of products quarter-to-quarter have changed that. So it has been about 1/3 consistently over, let's say, about an 8-quarter period of time. And we think that's a good number for you to use as we look at our guidance in terms of Q4. From an overall console perspective, we again have seen about -- in the hundreds and sometimes more than that in prior quarters. What we're seeing is just a normal where they build ahead of the holidays in Q3, and that slows down as we move into Q4 when we're in the middle of the holidays. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [9] +-------------------------------------------------------------------------------- + + Great. And then as a follow-up, you saw nice acceleration in growth in your ProVis business this quarter. Jen-Hsun, I think you've talked extensively about the RTX and the long-term opportunity there. What are your expectations going into 2019 for that segment? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [10] +-------------------------------------------------------------------------------- + + I expect ProVis to grow. The ProVis platform, more -- there's more content ever being created that is digitally created. And most photographs -- what appears to be photographs are rendered in software. Almost every catalog, every video, every movie, every TV show now has a great deal of digital rendering in it. And until now, it's not been possible to do the rendering in an accelerated way. So RTX is the world's first accelerated ray-tracing GPU, and the enthusiasm from the digital content creation market is really, really great. I surely expect that -- and as I was mentioning earlier, that it's been close to a decade that the workstation industry has not had a fundamental platform architecture change. And so RTX is the first one. So I'm expecting ProVis to do really well. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Your next question is from Vivek Arya with Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [12] +-------------------------------------------------------------------------------- + + I'm curious, Jen-Hsun, what needs to happen to work down this midrange Pascal inventory? Is it pricing? Is it something else? Because the thinking was that this could be cleared within the October quarter, but it hasn't. Do you think people were waiting for Turing to come out and maybe that created some kind of pause? And then as part of -- part B of that question, maybe Colette, how should we think about seasonality in the April quarter given that you mentioned it could take 1 or 2 quarters to work down this inventory? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [13] +-------------------------------------------------------------------------------- + + Yes, the -- well, we came into Q3 with excess channel inventory post the crypto hangover. We expected the pricing in the marketplace to decline. It declined slower than we expected and -- but while it was declining, we were expecting sales volume to grow, demand to grow and for pricing to be -- for volume to be elastic with pricing. I think it just took longer than -- the pricing took longer than we expected, and the volume increase took longer than we expected. At this point, most of the pricing has come down to its -- and slightly below its prelaunch levels. And so I'm hoping that -- I'm hopeful that now that pricing has stabilized, that customers will come back and buy. I guess when pricing is volatile in the channel, it probably freezes some people waiting for prices to stabilize, and that took longer than we expected frankly. But now that it's at the right levels, our expectation is that the market will return to normal. 1060 is the #1 selling graphics card in the world, and we decided not to sell any more into the channel for the upcoming quarter to give the channel an opportunity to sell through the inventory it has. And so we'll keep our eyes on it, but our expectation is that inventory levels will come back to normal by the end of the quarter. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + Okay. Vivek, to answer your question also regarding Q1 in terms of what we're going to see in terms of the expectation, as the channel inventory normalizes at the end of Q4, we do believe going into Q1, we will be probably up from where we end in terms of Q4. So we won't follow that normal seasonality between Q1 and Q4. We do expect to be up as we go into Q1. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + You have a question from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [16] +-------------------------------------------------------------------------------- + + I guess, a follow-up question on the channel inventory side. It looks like it's roughly $600 million kind of a drawdown here. And just curious, does that sound right? Number one. Number two, does that fit with what you are hearing from your channel partners in terms of what's excess? And then as part of that, are you drawing down inventory in the current quarter ahead of Turing architecture launch into the mainstream? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [17] +-------------------------------------------------------------------------------- + + The last question, I'm not sure I understand. The -- I think the answer to your first question is yes. You framed it nicely. It's -- the answer is yes. The last question was what again? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [18] +-------------------------------------------------------------------------------- + + The last question was regarding our midrange. Is there any statement about future Turing products that were taken into account? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [19] +-------------------------------------------------------------------------------- + + We -- yes, we haven't announced our future Turing product, but it would be expected for us to create a Turing GPU that serves the mainstream parts of the marketplace. And so we're not announcing anything, but it would be conventional of us to do that. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [20] +-------------------------------------------------------------------------------- + + I guess, the question was whether you were drawing down inventory perhaps below normalized levels in the current quarter. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [21] +-------------------------------------------------------------------------------- + + No, we're really not shipping into the midrange segment of Pascal so that we give the channel an opportunity to sell through the product that has. And we would like to see channel inventory get normalized by the end of Q4, and then we'll get back to doing our work. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Your next question is from Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + My first one is for Colette. I just wanted to be a little more explicit. If I think about your business split into sort of gaming and non-gaming, are you looking for the non-gaming pieces in aggregate to grow sequentially into Q4? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Stacy, yes. I think the answer to that is yes. In aggregate, yes, we do believe the rest of the business will grow sequentially. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + Got it. I guess that fits with the kind of 1/3 you're talking because that implies the gaming down 30%-plus. So that is what your kind of a magnitude that you're thinking about at this point. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Got it. For my second question, I just wanted to -- for the last several quarters, the idea that the channel could be getting full is not necessarily a new worry. And yet the last several quarters, you've been saying, like on this call, that you guys felt like you had a really good handle on the channel, and yet it seems like maybe that wasn't exactly the case. Can you give us a feeling, maybe a better feeling for what changed and when you saw it in the quarter? Was this something that happened kind of like late in the quarter that you realized it? Or did you go into the quarter knowing that the inventories were high and needed to be corrected? Like what happened? Because this tone is a little different from what we've heard over the last few earnings calls from you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [28] +-------------------------------------------------------------------------------- + + Let's see. The -- we were surprised, obviously. I mean, we're surprised by it, as anybody else. The crypto hangover lasted longer than we expected. Prices started to drift down, and we expected to come down much more quickly than it did and -- but -- and when it went down, we expected demand to come up much more quickly than it did. And so I think the channel wanted to protect its price. People were uncertain about crypto, and demand was uncertain about when the price will be stabilized. And so all of that uncertainty, I think, froze the market a little longer than we expected. Pricing is now down to below prelaunch normal levels. And so I am hopeful that we're going to see demand come back and the sell-through will happen through the holidays. And we're seeing that. And so that's -- the first one is that we -- just we didn't expect it either and we didn't realize the magnitude of it until towards the end of the quarter. What was the other question? Was there another question? I think that, that was it. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question is from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [30] +-------------------------------------------------------------------------------- + + With regards to Turing ramp, I guess, how is that going relative to your expectations? It seems like availability is quite a bit better now. And where do you stand with DLSS support? I know you've announced a number of games that will have DLSS support by year-end. Like how many of those are already supporting that technology? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Yes, the ramp is going great, and I think this is the biggest generational leap we've ever had. This is the most substantial new technology that computer graphics has seen in a decade. Real-time ray-tracing is something that everybody had dreamed about for a long time. It's never seen before. And today with Battlefield V, people are enjoying real-time ray-tracing for the very, very first time. And the images are beautiful. So the ramp is great. Of course, Turing ramped into -- towards the end of the quarter and into a much more different situation than any GPU of the past. But nonetheless, the demand on the high-end products are fantastic. The 2080 Tis are largely sold out. I think it's still sold out everywhere. And so I think that the demand is great. I'm expecting it to be just a fantastic new generation. In terms of the content, you saw the first one. FINAL FANTASY is also out. And we have a pipeline, about 30 of them. We're working hard on that. And so when they -- when these games get released, RTX will be enabled. But I will say one last thing, which is content aside, RTX is higher performing at the same price point than any graphics card on the planet. And so at every single graphics -- every single price point, it is the highest performing graphics card. So it is unambiguously the highest performance GPU in the world and then -- and of course, all of these great new features will be coming. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question is from Pierre Ferragu with New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [33] +-------------------------------------------------------------------------------- + + I'm still trying to put my head around the magnitude of this channel inventory drawdown because if you don't ship like the midrange cards for a full quarter, that means your inventory today is more than a quarter, more than 12 weeks of sales. And so my first question would be, am I right thinking that? Are you available a full quarter of sales in inventories? +And then my second question is while you are drawing down this inventories, I would have expected to see, like, the Turing high-end card, the 2080 and the 2080 Ti ramping in Q4. And it looks like, excluding the inventory, the rest of the business -- the rest of the GPU business in gaming would be more like flattish sequentially. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- + + I'm trying to figure out what the first part of the question was. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [35] +-------------------------------------------------------------------------------- + + The first question was whether the midrange of Pascal had more than 12 weeks of inventory, if it's going to take more than a quarter to bring it down. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + I think the channel has more than 12 weeks of inventory between us and the other brand. One of the things that is hard to estimate is how much inventory the other brands have. And our quarter is 1 month later. And so whatever action we take, whatever we see in the channel is 1 month after their end of the quarter. The amount of inventory is not just us. It's also the other brands. And our ability to see the other brand's inventory is just much harder. We try our best to estimate it, but obviously, we didn't estimate it well enough. And so the answer to your question is yes, I think there's about -- from our perspective, about 12 weeks of our inventory to sell through at this point. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question is from Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [38] +-------------------------------------------------------------------------------- + + The -- I was hoping you could contrast this product cycle transition to Turing to the product transition you had to Pascal. And is the only -- or is the main difference the crypto hangover? Or is there something else impacting the transition, do you think? I mean, you've described Turing as the greatest generational leap, and I'm wondering if that larger delta has an impact to the transition as well. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Turing is the highest performance GPU at every single price point. And so it played no role in its transition. It's all about crypto hangover. This is the new experience as we made this transition. If you look at Turing on -- just on the basis of Turing, it had a great launch. We ramped it at the end of the quarter, as we expected. It was back-end loaded, as we expected, and the ramp was great. Everybody did a great job. And the performance is fantastic, and the excitement is great. And so I think Turing's ramp was a big success. It's -- underneath Turing was choppy, as we're talking about. And we really didn't see that until towards the end of the quarter. And as we looked out into this quarter, this coming quarter, we came to the conclusion that the best thing to do is just not to ship any more products into this segment of the marketplace because there's a fair amount of inventory and let the channel sell through the midrange Pascals. And then a quarter's time, we'll get back to business. And so I think -- I knew this is surely a setback, and I wish we had seen it earlier, in the final analysis can't be exactly sure what we would have done different. But between the unexpected, unanticipated slow decline of pricing in the channel and even after the prices came down, it took a little longer than we expected for volume to kick up. And the other brand's inventory in the marketplace, those factors kind of compounded and made it a lot worse than we expected. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + You have a question from Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [41] +-------------------------------------------------------------------------------- + + Maybe I can ask the question a little bit differently on the gaming business. If I look back over the past several quarters, let's say you've been running at roughly a $1.6 billion to $1.8 billion revenue level since the October '17 quarter. Prior to that, you were at $1.1 billion, $1.2 billion. We look like we're now going back to that level. I guess, the question is, do we build off of that level? Do we bring back half of the inventory burn? How do I think about the return of year-over-year growth in that gaming piece of the business as we start to look into fiscal 2020? +And then a quick second question. Over the past few years, you've had really strong seasonal sequential growth in the data center business, in Q4, about 20% sequentially. I'm just curious, how is your guide factoring in the sequential growth in that piece of the business into this current quarter? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [42] +-------------------------------------------------------------------------------- + + Okay. Let me take the second one first. Our data center business is doing great. I mean, the fundamental dynamics of accelerated computing is spot on. And with Moore's Law coming to an end, it's the path forward. Take a look at the number of systems in the TOP500, 127 systems, I think, this year was, a growth of nearly 50% year-over-year. We're the #1 system in United States and the world, in Europe, in Japan. We're 22 out of the top 25 most energy-efficient computers in the world. And then this quarter, we announced 3 new initiatives that's going to expand us into a broader part of the high-performance computing market with machine learning, which is -- as we know, is the largest part of artificial intelligence today, which has not been accelerated and now it is. The second is the ability to do rendering for film, photorealistic rendering for the first time. And then the third is a brand-new cloud GPU, we call T4, that the enthusiasm around it is just incredible. And from the time that we went to production to the time that Google put it in their cloud was literally 30 days. It's just an incredible speed of adoption. And so I expect T4 to do quite well. So I think our data center business dynamics are really quite great. In terms of forecast, we'll just see how it turns out. But I think the fundamental dynamics are great. Back to your question about gaming. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + So the statement came in regarding, you've bumped up the overall gaming somewhere in mid of the year to about a $1.7 billion gaming business, where maybe if you look back 2 years, you were at about $1.1 billion. At this stage, when you come out of the setback that we have here to get through the overall channel inventory, where will you come out after that? And what type of growth could we expect? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [44] +-------------------------------------------------------------------------------- + + Yes, I'm going to let you guys do the modeling, but let me just say this. There's nothing fundamentally different about the gaming market that we know. Cryptocurrency is an extraordinary factor that we all have to just internalize as it is. And we thought we had done a better job managing the cryptocurrency dynamics. But when the prices came down -- started to come down and we hoped the demand would start to reflect the declining price, it just took longer than we expected. And that's what we're experiencing. In terms of the gaming marketplace, if you take a look at some of the dynamics, our notebook gaming, which is not affected by crypto, grew 50% year-over-year in China. And so the gaming market seems quite robust. RTX is going to unquestionably redefine gaming computer graphics. And so I think that the dynamics are good. We have to work through the channel inventories. This quarter, of course, we had the simultaneous decision of not shipping any more midrange products into the channel as well as seasonal -- normal seasonal console build plans. And they tend to build out a quarter before the holiday season. So you have these 2 simultaneous effects. But there's nothing about the gaming marketplace or the gaming business that we see that's fundamentally different. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [45] +-------------------------------------------------------------------------------- + + Yes. To kind of add to that, think about our gaming business in several pieces that we talked about in terms of the tremendous strength that is also continuing. In terms of our success in terms of Turing, our notebooks for gaming are growing extremely strong, and our overall console business is also extremely healthy as well. So to think about all of the different components, we just have a piece of channel inventory at the midrange, but overall, as you can see, gaming is also growing quite well. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Your next question is from Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [47] +-------------------------------------------------------------------------------- + + A question with regard to inferencing and what we can expect from that for both Q4 and going forward. And perhaps I don't know if it's a valid comparison to compare what we might expect from inferencing after the new Quadro launches to what happened in training after the Volta launches. Is there any comparison there in terms of magnitude for how the ramp goes? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [48] +-------------------------------------------------------------------------------- + + The ramp of T4 is completely related to customers porting their model on top of our platform. And the inference model is really complicated. This is one of the things that I've talked about in the past that on the one hand, people think that inference appears to be simple because there are so many ASICs built being talked about. The vast majority of the complexity of inference is actually in the optimizing compiler on top. The TensorRT, fifth-generation optimizing compiler that we announced just recently took 3, 4 years to build. And then on top of that, in order to get it to scale as quickly as what people saw in Google -- Google's cloud requires us to build something called a TRT server, an inference server, that allows multiple models to run on top of Kubernetes in the cloud. That piece of software is also super complicated to write. And so the pieces of technology that we're putting together have come together. And now we're engaged with Internet companies around the world to port their most heavy workload applications on top -- or models on top of T4. And so we're working hard on that. And when that happens, it comes down to their decision of how many they would like to buy, and that tells us about our adoption rate. I think from a high-level perspective, if we step back for a second, the high-level -- the way to look at it is this: that we know for a fact that Moore's Law has come to an end, and at the same time, we also know that more and more data centers are deploying deep learning models and machine learning models into their data center. And it's computationally really intensive. And at this time and as we look out into the horizon, the T4 Cloud GPU is just unquestionably the most effective. It can run models, whether it's an image model or a recommendation model or a speech synthesis model. It is the highest throughput processor in the world at 70 watts, which fits into a hyperscale data center OCP server. It is also the lowest latency of any processor at inferencing in the world at less than 1 millisecond. And so between the architecture, all of the software technology and all of the software capabilities we put in place and the fact that the conditions would suggest that Internet companies need an accelerated path forward, I think T4 is really well positioned. And I look forward to coming back and telling you guys about success. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + You have a question from Will Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [50] +-------------------------------------------------------------------------------- + + First, Jen-Hsun, I appreciate all the details on the T4 for inference in the data center. Could you likewise highlight the current traction you're seeing and the long-term growth expectations for the Jetson product that's designed for really, I think, a different market? It's inference at the edge, right? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [51] +-------------------------------------------------------------------------------- + + Yes, Jetson is designed for edge AI. One version of Jetson, which is a functional save, high-performance with a lot of complicated software, one version of that, you could say, is self-driving cars. And this quarter, we announced winning our first mass-market Level 2. We've been really successful in robot taxis and Level 4s and trucks and shuttles and high-end systems, where the number of processors, the number of sensors, the combination of LiDARs and surround cameras requires a lot of computation and -- but we've never been successful until now with taking the DRIVE platform all the way down to Level 2 mass-market cars. Volvo is our first announcement, our first win in high-volume, early 2020s production ramp. And I'm expecting many more. And I think we've positioned and created a solution that is both highly useful and easy to use as well as could deliver Level 2 capability in a single chip for the very first time. And Xavier is in production. It is the only single-chip, autonomous vehicle processor in production today. Then you take that same platform and you could apply to all kinds of other edge AI devices. It could be manufacturing picking robots. It could be autonomous retail, basically AI retail, and autonomous warehouses. So -- or medical instruments, medical imaging instruments that, in the device itself, recognizes and identifies anomalies. And so all of this type of applications are leaning towards AI, and that's the reason why we built Jetson. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Your next question is from Craig Ellis with B. Riley. + +-------------------------------------------------------------------------------- +Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [53] +-------------------------------------------------------------------------------- + + I'll ask a clarification and then a question. The clarification is just on the inventory issue, and thanks for all the color. But one, are Pascal 1070s and 1080s and in Ti flavors still selling? And if so, could they present any kind of inventory risk either later this year or in early fiscal '20? +And then the question really, Jen-Hsun, is trying to get a better understanding of how you see the intermediate-term growth rate of the data center business. You had spectacular high-performance compute TOP500 accelerator penetration performance up 50-plus percent. That about matches the growth in the data center business. Those may be somewhat coincidental, but can you just talk about where you see penetration across key end markets like HPC, like cloud and hyperscale and like enterprise? Which offer you the best growth from here? And where do you feel like your penetration may be more mature? I'm just trying to get a sense if there's an acceleration coming off of the 50% year-on-year growth that we're seeing now or if, consistent with the recent trend, we might be moderating potentially down into the 40% or 30% range as we go into the next calendar year. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [54] +-------------------------------------------------------------------------------- + + Our high-end Pascal GPUs are largely sold. And we did a fairly good job making sure that -- with that transition before we ramped up the high-end Turing products. The -- our data center business, I would say that Q2 -- or excuse me, Q3, this last quarter, the inventory setback aside, I actually have to say that it's one of the best quarter we've ever experienced. And the reason for that is because our data center position, our accelerated computing position as a company, which is the foundation of this company, the accelerated computing focus of our company expanded in really several ways. For the first part of our journey into accelerated computing, it was really following scientific computing, simulating first principle laws of physics for scientific computing and high-performance computing codes. About 5 years ago, deep learning came into the fore, and we were alert and agile to have invested a great deal and mobilized the company to go help the world put deep learning into software developers' hands all over the world. The area where I'm super excited about right now are the 3 that I've mentioned that we've opened up in this last quarter with the launch of Turing and with the launch of RAPIDS. The first is our film rendering opportunity is -- we think that there's about 10 million CPU nodes around the world that are used for film rendering. They can now benefit from accelerated computing as Moore's Law comes to an end. The second is opening up inference. The hyperscale data center marketplace is something along the lines of 15 million CPUs sold this year. And it was growing -- let's call it, growing at about 15% per year and -- the number of CPUs. And we know for a fact that Moore's Law has come to an end and those servers are going to have to be accelerated going forward. And so I think that T4 is just ideal for that. It was designed from the ground up to deliver computing in a very, very compressed and very condensed and power-sensitive environment, which these hyperscale data centers tend to be. And the software stack from Kubernetes to containers, to a TRT compiler, to the TRT inference server and our NGC cloud with all of the stacks fully accelerated and containerized in the cloud, certifying all of the major cloud providers around the world for our containers, that process took us several years and it's put us in a really great place. So T4 is really fantastic. And so that's -- the second segment of high-performance computing is deep learning. The third and potentially the largest currently is machine learning. This is where Hadoop goes. This is where Spark goes. This is where scikit-learn, Python, pandas. All of the data scientists around the world in retail, in transportation and logistics, in health care, in financial services that are using algorithms like random forest and XGBoost and k-nearest and k-means and PCA and all of these different buzzwords have never had the opportunity to have accelerated computing until now. And this took a couple, 2, 3 years for us to pull together. RAPIDS has been open sourced. You can go into the NGC cloud, download it. IBM is going to integrate it into their machine learning platform. SaaS, SAP, Oracle, the cloud providers are all integrating the RAPIDS open source SDK into their machine learning platform. And so this is a new segment for us. +The answer about our growth rate is, I believe, that our accelerated computing, our data center opportunity has significantly expanded during the quarter. Between the T4 hyperscale cloud GPU and RAPIDS machine learning platform, it has -- and our RTX server film rendering, we surely have expanded our data center opportunity. And so I fully expect us to continue to do well in accelerated computing for data centers. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Unfortunately, we have run out of time. I will now turn the call back over to Jen-Hsun for any closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [56] +-------------------------------------------------------------------------------- + + Thanks, everyone. To sum up, the crypto hangover has left the industry with excess inventory -- excess channel inventory. It will take 1 or 2 quarters to work through it. This is an unexpected near-term setback and doesn't change the fundamental dynamics of our company. The end of Moore's Law has cleared a way for NVIDIA accelerated computing as a great path forward. Turing opens up 3 exciting markets for us with ray-tracing games, film rendering and hyperscale inference. And with our first win in mainstream Level 2 self-driving cars with Volvo, our DRIVE AV platform is gearing up for the mass market, and our competitive position has never been stronger. We look forward to updating you on our progress. Thank you. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Thank you for joining. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2019-Aug-15-NVDA.txt b/Transcripts/NVDA/2019-Aug-15-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b5a0b9d5db96fd67693f1e65d5d08b242d30802 --- /dev/null +++ b/Transcripts/NVDA/2019-Aug-15-NVDA.txt @@ -0,0 +1,381 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2020 NVIDIA Corp Earnings Call +AUGUST 15, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Christina, and I will be your conference operator today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski from Investor Relations to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the Second Quarter of Fiscal 2020. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. +I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the third quarter of fiscal 2020. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Form 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, August 15, 2019, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. Q2 revenue was $2.58 billion, in line with our outlook, down 17% year-on-year and up 16% sequentially. +Starting with our gaming business. Revenue of $1.31 billion was down 27% year-on-year and up 24% sequentially. We are pleased with the strong sequential growth in the quarter when we launched our RTX SUPER lineup for desktop gamers, wrapped up our greatest ever number of gaming laptops and launched our new RTX studio laptops for creators. In July, we unveiled 3 GeForce RTX SUPER GPUs, delivering the best-in-class gaming performance and power efficiency and real-time ray tracing for both current and next-generation games. These GPUs delivered a performance boost of up to 24% from our initial Turing GPUs launched a year earlier. The SUPER lineup strengthens our leadership in the high end of the market, and the response has been great. We look forward to delighting gamers with the best performance in ray tracing as we get into the back to school and holiday shopping seasons. +Ray tracing is taking the gaming industry by storm and have quickly come to define the modern era of computer graphics. A growing number of blockbuster AAA titles have announced support for NVIDIA RTX ray tracing, including Call of Duty: Modern Warfare, Super Punk 2077 (sic) [Cyberpunk 2077], Watch Dogs: Legion and Wolfenstein: Youngblood. Excitement around these titles is tremendous. GameSpot called Cyberpunk one of the most anticipated games of the decade. NVIDIA GeForce RTX are the only graphic cards in the market with hardware support for ray tracing. They deliver a 2 to 3x performance speed up over GPUs without a dedicated ray tracing core. +The laptop business continues to be a standout growth driver as OEMs are ramping a record 100-plus gaming laptop models ahead of the back to school and holiday season. The combination of our energy-efficient Turing architecture and Max-Q technology enables beautifully crafted thin and light form factors that can deliver the performance of high-end gaming desktop or our next-generation console. +At Computex in May, we unveiled NVIDIA RTX Studio laptops, a new design artist platform that extends our reach to the large, underserved market of creators. In the age of YouTube, creators and freelancers are rapidly growing population, but they have traditionally not had access to professional-grade workstations through online and retail channels. RTX Studio laptops are designed to meet their increasing complex workflows such as photorealistic ray tracing, AI image enhancement and ultra high-resolution video. Powered by our RTX GPUs and optimized software, RTX Studio laptops deliver performance that's up to 7x faster than that of the MacBook Pro. A total of 27 RTX Studio models have been announced by major OEMs. +Sequential growth also benefited from the production ramp of the 2 new models of Nintendo Switch gaming console. We are expecting our console business to remain strong in Q3 before the seasonal production slowdown in Q4 when console-related revenue is expected to be fairly minimal, similar to last year. +Moving to data center. Revenue was $655 million, down 14% year-on-year and up 3% sequentially. In the vertical industries portion of the business, expanding AI workload drove sequential and year-over-year growth. In hyperscale portion, we continue to be impacted by relatively weak overall spending at a handful of CPU -- CSPs. Sales of NVIDIA GPUs for use in the cloud were solid. While sales of internal hyperscale use were muted, the engineering focus on AI is growing. +Let me give some color on each of these areas. We are building a broad base of customers across multiple industries as they adopt NVIDIA's platforms to harness the power of AI. Public sectors, higher education and financial services were among the key verticals driving growth this quarter. In addition, we won Lighthouse account deals in important industries that are on the cusp of being transformed by AI. For example, in retail, Walmart is using NVIDIA GPUs to run some of its product demand forecasting models, slashing the time to do so in just 4 hours from several weeks on CPUs. By accelerating its data science workflow, Walmart can improve its algorithms, reduce development cycles and test new features. +Earlier this week, we announced breakthroughs for the fastest training and inference of the state-of-the-art model for natural language process understanding called BERT, or Bidirectional Encoder Representations of -- from Transformers, a breakthrough AI language model that achieves a deeper sense of language, context and meaning. This can enable mere human comprehension in real-time by chat box, intelligent personal assistants and search engines. We are working with Microsoft as an early adopter of these advances. +AI computing leadership is a high priority for NVIDIA. Last month, we set records for training deep learning neural network models on the latest MLPerf benchmarks, particularly in the most demanding areas. In just 7 months, we have achieved up to 80% speed-ups enabled by new algorithms and software optimizations across the full stack while using the same hardware. This is a direct result of the productive programming environment and flexibility of CUDA. +Delivering AI at scale isn't just about silicon. It's about optimizing across the entire high-performance computing system. In fact, the NVIDIA AI platform is getting progressively faster. Every month, we publish new optimization and performance improvements to CUDA-X AI libraries, supporting every AI framework and development environment. All in, our ecosystem of developers is now 1.4 million strong. +In setting these MLPerf records, we leveraged our new DGX SuperPOD AI supercomputer, demonstrating that leadership in AI research demands leadership in computing infrastructure. This system debuted in June at #22 on the TOP500 list of the world's fastest supercomputers at the annual International Supercomputing Conference. Used to meet the massive demand for autonomous vehicle development program, it is powered by more than 1,500 NVIDIA V100 Tensor Core GPUs linked with Mellanox interconnects. We've made DGX SuperPOD available commercially to customers, essentially providing them with the turnkey supercomputer that they can assemble in weeks rather than months. It is roughly 400x smaller in size than other similarly performing TOP500 systems, which are built from thousands of servers. +Also at the conference, we announced that by next year's end, we will make available to the ARM ecosystem NVIDIA's full stack of AI and HPC software, which accelerates more than 600 HPC applications and all AI frameworks. With this announcement, NVIDIA will accelerate all major CPU architectures, including x86, POWER and ARM. +Lastly, regarding our pending acquisition of Mellanox, we have received regulatory approval in the U.S. and are engaged with regulators in Europe and China. The approval process is progressing as expected, and we continue to work toward closing the deal by the end of this calendar year. +Moving to pro visualization. Revenue reached $291 million, up 4% from our prior year and up 9% sequentially. Year-on-year and sequential growth was led by record revenue for mobile workstations with strong demand for new thin and light form factors. We had a great showing at SIGGRAPH, the computer graphics industry's biggest annual conference held in Los Angeles. Our researchers won several Best in Show awards. In just a year since the launch of RTX ray tracing, over 40 design and creative applications with RTX technology had been announced by leading software vendors, including Adobe, Autodesk and Dassault systems and many others. NVIDIA RTX technology has reinvigorated the computer graphics industry by enabling researchers and developers to take a leap in photorealistic rendering, augmented reality and virtual reality. +Finally, turning to automotive. Q2 revenue was $209 million, up 30% from a year ago and up 26% sequentially. This reflects growing adoption of next-generation AI cockpit solutions and autonomous vehicle development projects, including 1 particularly sizable development services transaction that was recognized in the quarter. In addition, in June, we announced a new partnership with the Volvo Group to develop AI and autonomous trucks utilizing NVIDIA's end-to-end AI platform for training, simulation and in-vehicle computing. The strategic partnership will enable Volvo Group to develop a wide range of autonomous driving solutions for freight transport, recycling collection, public transport, construction, mining, forestry and more. This collaboration is a great validation of our long-held position that every vehicle, not just cars but also trucks, shuttles, business, taxis and many others, will have autonomous capability 1 day. +Autonomous features can bring enormous value to the trucking industry, in particular as the demand of online shopping put ever greater stress on the world's transport systems. Expectations for overnight or same-day deliveries create challenges that can only be met by autonomous trucks, which can operate 24 hours a day. To help address these needs, NVIDIA has created an end-to-end platform for autonomous vehicles from AI computing infrastructure to large-scale simulation to in-car computing. Multiple customers from OEMs like Mercedes-Benz, Toyota and Volvo to Tier 1s like Bosch, Continental and ZF are already onboard. We see this as a $30 billion addressable market by 2025. +Moving to the rest of the P&L. Q2 GAAP gross margins was 59.8% and non-GAAP was 60.1%, up sequentially, reflecting higher automotive development services, a favorable mix in gaming and lower component cost. GAAP operating expenses were $970 million, and non-GAAP operating expenses were $749 million, up 19% and 8% year-on-year, respectively. We remain on track for high single-digit OpEx growth in fiscal 2020 while continuing to invest in the key platforms driving our long-term growth, namely graphics, AI and self-driving cars. GAAP EPS was $0.90, down 49% from a year earlier. Non-GAAP EPS was $1.24, down 36% from a year ago. +With that, let me turn to the outlook for the third quarter of fiscal 2020. We expect revenue to be $2.9 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 62% and 62.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $980 million and $765 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of approximately $25 million. GAAP and non-GAAP tax rates are both expected to be 10%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $100 million to $120 million. Further financial details are included in the CFO commentary and other information available on our IR website. +In closing, let me highlight upcoming events for the financial community. We will be at the Jefferies conference, hardware and communications infrastructure summit, on August 27 and at the Citi Global Technology Conference on September 25. +With that, we will now open the call for questions. Operator, would you please poll for the questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And your first question comes from the line of C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2] +-------------------------------------------------------------------------------- + + I guess first question on gaming, how should we think about your outlook into the October quarter vis-à-vis kind of normal seasonality? How are you thinking about Switch within that? And considering now that you have full Turing lineup as well as content truly coming to the forefront here, how do you think about trends beyond the October quarter? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Sure. Colette, why don't you take the Switch question? And then I'll take the rest of the RTX questions. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Sure. From a gaming perspective, the overall Switch or the overall console business definitely is a seasonal business. We usually expect to see production ramping in Q2 and in Q3, with it coming down likely in Q4. So you should see Switch to be a portion definitely of our gaming business in Q3. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Yes. C.J., thanks for the question. RTX, as you know, is -- first of all, RTX is doing great. I think we've put all the pieces in place to bring ray tracing into the future of games. The number of games, the blockbuster games that adopted RTX is really snowballing. We announced several -- 6 games in the last couple of months. There's going to be some exciting announcements next week at gamescom. It's pretty clear now the future of gaming will include ray tracing. The number of software developers that create -- with creative tools that adopted RTX is really quite spectacular. We now have 40 -- over 40 ISV tools that was announced at SIGGRAPH that have accelerated ray tracing and video editing. And some of the applications' amazing AI capabilities for image optimization enhancement support RTX. And so looking forward, this is what I expect. I expect that ray tracing is going to drive a reinvigoration of gaming graphics. I expect that the over 100 laptops that we have RTX designed -- RTX GPUs designed into is going to contribute our growth. Notebook gaming is one of the fastest-growing segments of the gaming platform world. The number of notebooks that are able to game is only a few percent, so it's extremely underexposed. And yet, we know that gamers are -- like the rest of us, they like thin and light notebooks, but they like it to be able to run powerful games. And so this is an area that has grown significantly for us year-over-year, and we're expecting it to grow through the end of the -- through the second half and through next year. +And one of the things that's really exciting is our RTX Studio line that we introduced recently. We observed, and through our discussions with the PC industry, that the creatives are really underexposed and underserved by the latest technologies. And they want notebooks and they want PCs that have powerful graphics. They use it for 3D content creation and high definition video editing and image optimization and things like that. And we introduced a brand-new line of computers that we call RTX Studio. Now the OEMs were so excited about it. And at SIGGRAPH, we now have 27 different laptops shipping and more coming. And so I think RTX is really geared for growth. We have great games coming. We got the SUPER line of GPUs. We have all of our notebooks that were designed into that we're ramping and, of course, the new RTX Studio line. And so I expect this to be a growth market for us. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + Very helpful. If I could follow up on the data center side, perhaps you can speak directly just to the hyperscale side, both internal and cloud, and whether you're seeing any green shoots, any signs of life there and how you're thinking about what that rate of recovery could look like over time. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [7] +-------------------------------------------------------------------------------- + + With the exception of a couple of hyperscalers, C.J., I would -- we're seeing broad-based growth in data centers. In the area of training, the thing that's really exciting everybody, and everybody is racing towards, is training these large gigantic natural language understanding models, language models. The transformer model that was introduced by Google, called BERT, has since been enhanced into XLned and RoBERTa and, gosh, so many different, GP2, and Microsoft's MASS. And there's so many different versions of these language models. And in the AI, NLU, natural language understanding, is one of the most important areas that everybody's racing to go to. And so these models are really, really large. It's over 1,000x larger than image models that we're training just a few years ago, and they're just gigantic models. It's one of the reasons why we built the DGX SuperPOD so that we could train these gigantic models in a reasonable amount of time. The second area -- so that's training in the hyperscalers. +The second area where we're seeing enormous amounts of activity has to do with trying to put these conversational AI models into services so that they could be interactive and in real time. Whereas photo tagging and photo enhancement is something that you could put off-line and you could do that while you have excess capacity when it's off of the most busy time of the day. You can't do that with language and conversational AI. You better to respond to the person in real time. And so the performance that's required is significant. But more importantly, the number of models necessary for conversational AI from speech recognition to language understanding to recommendation systems to text-to-speech to wave synthesis, these 5, 6, 7 models have to be processed in real time -- in series and in real time so that you can have a reasonable conversation with the AI agent. +And so these type of activities is really driving interest and activity at all of the hyperscalers. My expectation is that this is going to continue to be a big growth opportunity for us. But more importantly, in addition to that, we're seeing that AI is -- the wave of AI is going from the cloud to the enterprise to the edge and all the way out to the autonomous systems. The place where we're seeing a lot of excitement, and we talked about that in the past and we're seeing growth there, has to do with the vertical industry enterprises that are starting to adopt AI to create new products, whether it's a delivery robot or some kind of a chat bot or the ability to detect fraud in financial services, these applications in vertical industries are really spreading all over the place. There's some over 4,000 AI start-ups around the world. And the way that we engage them is they use our platform to start developing AI in the cloud. And as you know, we're the only AI platform that's available on-prem and in every single cloud. And so they can use our AI platforms for -- in all the clouds, which is driving our cloud computing, external cloud computing growth. And then they can also use it on-prem if their usage really grows significantly. And that's one of the reasons why our Tesla for OEMs and DGX is growing. And so we're seeing broad-based excitement around AI as they use it for their products and new services. And these 4,000, 4,500 start-ups around the world is really driving consumption of that. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + I actually had 2 as well, one quick one for Colette and one for Jensen. Colette, good to see the gross margin recovery getting into October. Is this 62% to 63% range a more sustainable level and perhaps a level you could grow off of as sales get more normalized levels? And then a bigger question is for Jensen. Again, on the data center side, Jensen, when I look back between -- 2015 to 2018, your data center business essentially grew 10x. And then the last year has been a tough one with the slowdown in cloud CapEx and so forth. When do you think your data center starts to grow back on a year-to-year -- on a year-on-year basis? Can that happen sometime -- later this year? And then just longer term, what is the right way to think about this business? Does it go back to prior levels? Does it go at a different phase? This is the one part of the business that I think is toughest for us to model, so any color would be very helpful. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + Great. So let me start first with your question, Vivek, regarding gross margins. Yes, thanks for recognizing that we are moving towards our expectations that, over time, we'll continue to see our overall volumes improve. Essentially, our business is normalized. We've reached normalized levels through the last couple of quarters. And this quarter, just very similar to what we will see going forward, is mix is the largest driver, what drives our overall gross margins and our gross margin improvements. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [11] +-------------------------------------------------------------------------------- + + Yes, Vivek, if you look at the last several years, there's no question our data center business has grown a lot. And my expectation is that it's going to grow a lot more, and let me explain to you why. Aside from a couple -- a few of uncontrollable circumstances and the exception of a couple of large customers, the overall trend, the broad-based trend, of our data center business is upward, to the right. And it is growing very nicely. There's a couple of different dynamics that's causing that on first principles to grow. And of course, one of them is as AI is well known now to require accelerated computing, our computing architecture is really ideal for it. AI is not just one network. It's thousands of different types of networks, and these networks are getting more and more complex over time, the amount of data you have to process is enormous. And so like all software programs, you can't predict exactly how the software is going to get programmed. And having a programmable architecture like CUDA and yet optimized for AI like Tensor Cores that we've created is really the ideal architecture. +We know also that AI is the most powerful technology force of our time. The ability for machines to learn and write software by itself and write software that no humans can write is pretty extraordinary. And the applications of AI, as you guys are watching yourself, are just spreading in every single industry. And so the way we think about AI is in waves, if you will. The first wave of AI is developing the computer architecture, and that was the first part where -- that's when a lot of people discovered who we are, and we emerged into the world of high-performance computing in AI. The second wave is applying the AI for cloud service providers or hyperscalers. They have a large amount of data. They have a lot of consumer applications. Many of them are not life-critical and so, therefore, the application of an early technology -- early-adoption technology was really viable. And so you saw hyperscalers adopt AI. And the thing that's really exciting for us is beyond recommendations, beyond image enhancement, the area where we believe the most important application for AI is likely conversational AI. Most people talking and asking questions and talking to their mobile devices and looking for something or asking for directions. Instead of having a page of -- a list of options, it responds with an answer that is very likely a good one. +The next phase of AI is what we call vertical industry enterprise AI. And this is where companies are using it not just to accelerate the business process internally, but they're using AI to create new products and services. They could be new medical instruments to IoT-based medical instruments to monitor your health. It could be something related to an application that -- used for financial services for forecasting or for fraud detection. It could be some kind of device that delivers pizza to you, delivery bots. And the combination of IoT and artificial intelligence, for the very first time, you actually have the software capabilities to make use of all of these sensors that you're putting all over the world. And that's the next phase of growth. And it affects companies from large industrials, transportation companies, retailers, you name it. Health care companies, you name it. And so that phase of growth of AI is the phase that we're about to enter into. +And then the longer term is an industry that we all know to be extremely large, but it takes time because it's life-critical, and it has to do with transportation. It's a $100 trillion industry. We know it's going to be automated. We know that everything that moves in the future will be autonomous or have autonomous capabilities. And that's just a matter of time before we realize its full potential. +And so the net of it all is that I believe that AI is the single most powerful technology force of our time, and that's why we're all in on it. And we know that acceleration and accelerated computing is the perfect model for that. And it started in the cloud, but it's going to keep moving out into the edge and through data centers and enterprises and hopefully -- well, eventually, all the way out into autonomous devices and machines in the real world. And so this is a big market, and I'm super enthusiastic about it. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [13] +-------------------------------------------------------------------------------- + + I had 2 as well, one for Jensen and the other for Colette. Jensen, you guys called out inference as a significant contributor to growth in data center last quarter. I think you guys talked about it being a double-digit percentage contributor, curious what you saw from inference in the quarter. And more importantly, if you can talk about the outlook, both near term and long term, as it relates to inference, that'll be helpful. And then secondly, for Colette, just want to double click on the gross margin question. The sequential improvement that you're guiding to is a pretty significant number. So I was just hoping if you can kind of break it down for us in terms of overall volume growth mix dynamics, both between segments and within segments and also to the extent DRAM pricing is impacting that, any color on that will be helpful as well. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [14] +-------------------------------------------------------------------------------- + + Yes, Toshiya, I got to tell you, I'm less good at normal pre -- near-term productions than I am good at thinking about long-term dynamics. But let me talk to you about inference. Our inference business is -- remains robust. It's double digits. It's a large part of our business. And -- but more importantly, the 2 dynamics that I think are near term and that's going to drive growth, number one is interactive conversational AI, interactive conversational AI inference. +If you simply ask a chat bot a simple question, where is the closest pizza and you would -- pizza shop, and you would like to have a conversation with this bot, it would have to do speech recognition, it has to understand what it is that you asked about, it has to look it up in a recommender based on the locations you're at, maybe your preferences of styles of pizza and the price ranges that you're interested and how far you're willing to go, to go get it. It has to recommend a pizza shop for you to go to. It has to then translate that from text-to-speech and then into human -- a human understand a voice. +And those models have to happen in just a few -- ideally, a few hundred milliseconds. Currently, it's not that. And it makes it really hard for these services to be deployed quite broadly and used for all kinds of different applications. And so that's the near-term opportunity, it's interactive conversational AI inference. And you could just imagine every single hyperscaler racing to go make this possible because recently, we had some important breakthroughs in machine learning language models. The BERT model that I mentioned earlier is really, really an important development, and it's caused a large number of derivatives that has improved upon it. And so near-term conversational AI inference. +We're also seeing near term the inference at the edge. There are many types of applications where because of the laws of physics reasons, the speed of light reasons or the economics reasons or data sovereignty reasons, it's not possible to stream the data to the cloud and have the inference done at the cloud. You have to do that at the edge. You need the latency to be low, the amount of data that you're streaming is continuous. And so you don't want to be paying for that line rate the whole time, and maybe the data is of great confidentiality or privacy. And so we're seeing a lot of excitement and a lot of development for edge AI. Smart retail, smart warehouses, smart factories, smart cities, smart airports, you just make a list of those kind of things, basically locations where there is a lot of activity, where safety or cost or large amount of materials is passing through, you could just imagine the applications. All of those really want to be edge computing systems and edge inference systems. And so those are near term -- 2 near-term drivers, and I think it's fair to say that both of them are quite large opportunities. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + So to answer your question regarding gross margin in a little bit more detail, probably our largest area that we expect improvement in terms of our mix is our mix return regarding our overall gaming business. We expect to have a full quarter of our SUPER lineup within the next quarter, including our RTX as well as our notebook becoming a bigger mix as well as it grows. These drivers are one of the largest reasons why we see that growth in our gross margin. We always think about our component cost, our overall cost of manufacturing, so this is always baked in over time, but we'll continue to see improvements on that as well. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + Again, your data center business, many of your peers on the compute and storage side are seeing spending recovery by cloud and hyperscalers in the second half of this year after a similar weak first half of the year. You guys saw some growth in Q2 driven primarily by enterprise. It seems like you had some broadening out of the customer spending this quarter. Inferencing continues to see strong momentum. Would you guys expect that this translates into a double-digit percentage sequential growth in data center in Q3 off of the low base in Q2? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [18] +-------------------------------------------------------------------------------- + + Our hyperscale data center with a few customers don't give us very much -- we don't get very much visibility from a handful of customers in hyperscale. However, we're seeing broad-based growth and excitement in data centers. And the way to think about data center, our data center business consists of hyperscale training, internal training, hyperscale inference, cloud computing -- and that's hyperscale, and that cloud is a public cloud. And then we have vertical industry enterprise, what sometimes we call enterprise, vertical industry enterprise, it could be transportation companies, retailers, telcos, vertical industry adoption of AI either to accelerate their business or to develop new products and services. +And then the -- so when you look at our data center from that perspective and these pieces, although we don't see as much -- we don't get as much visibility as we like in a couple of the large customers, the rest of the hyperscalers, we're seeing broad-based growth. And so we're experiencing the enthusiasm and the energy that maybe the others are. And so we'll keep reporting -- updating you guys as we go. We'll see how it goes. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [20] +-------------------------------------------------------------------------------- + + I had 2. I guess first for Jensen, Volta's been around now for about 2 years. Do you see signs of demand maybe building up ahead of the new set of nanometer products, whenever that comes out? I guess I'm just wondering whether there's some element of this is more around product cadence that gets resolved as you do roll out the product. That's the first question. +And then I guess, the second question, Colette, is of the $300 million growth into October, it sounds like Switch is pretty flat, but I'm wondering if you can give us maybe some qualitative sense of where the growth is coming from, is it maybe like 2/3 gaming and 1/3 data centers, something like that? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [21] +-------------------------------------------------------------------------------- + + Well, Volta -- data center products can churn that fast. We -- gamers could churn products quickly because they're bought and sold one at a time. But data centers -- data center infrastructure really has to be planned properly, and the build-out takes time. And we expect Volta to be successful all the way through next year. And software still continues to be improved on it. We're still improving systems on it. And in fact, just 1 year -- in just 1 year, we improved our AI performance on Volta by almost 2x, 80%. And so you could just imagine the amount of software that's built on top of Volta and all the Tensor Cores and all the GPUs connected with NVLink and the large number of nodes that are connected to build supercomputers. +The software of building these systems, large-scale systems, is really, really hard. And that's one of the reasons why you hear people talk about chips, but they never show up because building the software is just an enormous undertaking. The number of software engineers we have in the company is in the thousands, and we have the benefit of having built on top of this architecture for over 1.5 decades. And so when we're able to deploy into data centers as quickly as we do, I think we kind of lose sight of how hard it is to do that in the first place. The last time a new processor entered into a data center was an x86 Xeon, and you just don't bring processors in the data centers that frequently or that easily. And so I think the way to think about Volta is that it's surely in its prime, and it's going to keep -- continue to do well all the way through next year. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [22] +-------------------------------------------------------------------------------- + + In regard to our guidance on revenue, and we do guide in terms of the total. You have seen, in this last quarter, we executed a sequential increase really focusing on moving to a normalization of our gaming business. And we're now approaching the second half of the year getting ready for the back to school and the holidays. So you should expect also our gaming business to continue to grow to reach that full normalization by the end of Q3. We do expect the rest of our platforms to likely also grow. We have a couple different models on how that will come out. But yes, we do expect our data center business to grow, and then we'll see on the rest of our businesses as well. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [24] +-------------------------------------------------------------------------------- + + A couple of questions. I guess the first one is, Jensen, if you have any, I guess, high-level qualitative commentary on how the new SUPER upgrades of your Turing platform have been received in the market and how you might think about them progressing through the year. And then, I guess, the second question is a bigger one. Intel's talked quite openly about One API. The software stack at Xilinx is progressing with Versal ACAP. I mean you guys get a lot of credit for the decade of work that you've done on CUDA. But I wonder if you might comment on if you've seen any movement in the competitive landscape on the software side for the data center space. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [25] +-------------------------------------------------------------------------------- + + SUPER is off to a great start. Goodness, SUPER is off to a super start. And if you look at -- if you do channel checks all over, even though we've got a lot of products in the channel and we -- last quarter was a transitional quarter for us actually. And we didn't -- we shipped SUPER later in the quarter. But because the entire ecosystem and all of our execution engines are so primed, we were able to ship a fair number through the channel. And so -- and yet, if you do spot checks all around the world, they're sold out almost everywhere. And the pricing in the spot market is drifting higher than MSRP. That just tells you something about demand. And so that's really exciting. SUPER is off to a super start for -- and at this point, it's a foregone conclusion that we're going to buy a new graphics card, and it's going to the last 2, 3, 4 years to not have ray tracing is just crazy. Ray tracing content just keeps coming out. And between the performance of SUPER and the fact that it has ray tracing hardware, it's going to be super well positioned for -- throughout all of next year. +Your question about APIs and software programmability. APIs is just one of the issues. The large issue about processors is how do you program it. The reason why x86s and CPUs are so popular is because they solve the great challenge of software developers: how to program a computer. And how to program a computer and how to compile for that computer is a paramount concern to computer science, and it's an area of tremendous research. Going from single CPU to multi-core CPUs was a great challenge. Going from multi-core CPUs to multi-node multi-core CPUs is an enormous challenge. And yet, when we created CUDA in our GPUs, we went from 1 CPU core or one processor core to a few to now, in the case of large-scale systems, millions of processor cores. And how do you program such a computer across multi-GPU, multi-node? It's a concept that's not easy to grasp. And so I don't really know how one programming approach or a simple API is going to make 7 different type of weird things work together. And I can't make it fit in my head. But programming isn't as simple as a PowerPoint slide, I guess. And I think it's just -- time will tell whether one programming approach could fit 7 different types of processors when no time in history has it ever happened. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [27] +-------------------------------------------------------------------------------- + + I wonder if you could talk about the strength in the automotive business. Looks like the services piece of that is getting to be bigger. What's the outlook for that part of the business? And can you give us a sense of the mix between services and components at this point? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [28] +-------------------------------------------------------------------------------- + + Sure. Thanks, Joe. Our approach to autonomous vehicles comes in basically 2 parts. The first part is a full stack, which is building the architected processor, the system, the system software and all of the driving applications on top, including the deep neural nets. The second part of it, we call that a full stack self-driving car computer. The second part of DRIVE includes an end-to-end AV development system. For those who would like to use our processors, use our system software but create their own applications, we created a system that allows -- basically shares with them our computing infrastructure that we built for ourselves that allows them to do end-to-end development from deep learning development to the application of AV to simulating that application to doing regression testing of that application before they deploy it into a car. And the 2 systems that we use there is called DGX for training and Constellation for simulation and what is called Replay. +And then the third part of our business model is development agreements, otherwise known as NRE. These 3 elements, full stack computer, end-to-end development flow and NRE project development -- product development consists of the overall DRIVE business. And so although the cars will take several years to go into production, we're seeing a lot of interest in working with us to develop self-driving cars using our development systems and entering into development projects. And so we're -- the number of autonomous vehicle projects is quite large around the world as you can imagine. And so my sense is that we're going to continue to do well here. The additional part of autonomous vehicles and where the capability has been derived and is going to seal up more near-term opportunities has to do with things like delivery shuttles, self-driving shuttles and maybe cargo movers inside walled warehouses. Those kind of autonomous machines require basically the same technology, but it's sooner and easier to deploy. And so we are seeing a lot of excitement around that area. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [30] +-------------------------------------------------------------------------------- + + Congratulations on the improved performance. At your Analyst Day back a couple of months ago, you had highlighted the installed base opportunity for RTX. And I think at that point in time, you talked about 50% being Pascal base, 48% being pre-Pascal. You also alluded to the fact that you were seeing a positive mix shift higher in terms of the price points of this RTX cycle. So I'm curious, where do we stand on the current product cycle? And what are you seeing currently as we go through this product cycle on the Turing platforms? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + We launched -- well, first of all, the answer is that RTX adoption is faster than Pascal's adoption if you normalize to time 0 of launch. The reason for that is Pascal launched top to bottom on the same day. And as you guys know, we weren't able to do that for Turing. But if we did that for Turing, the adoption rate is actually faster. And to me, it's a rather sensible. And the reason for that is because Pascal was basically DX12. And Maxwell was DX12. And Turing is the world's first DXR, the first ray tracing GPU, brand-new functionality, brand-new API and a lot more performance. And so I think it's sensible that Turing's adoption is going to be rapid. +The second element of Turing is something that we've never talked about before. We're mentioning it more and more because it's such an exciting book market for us is notebooks. The install base of Pascal has a very, very little notebook in it. And the reason for that is because, in the past, we were never able to put a high performance gaming GPU into a thin and light notebook until we invented Max-Q. And in combination with our energy efficiency, we were able to -- we're now able to put a 2080 into a laptop, and it's still beautiful. And so this is effectively a brand-new growth market for us. And with so few people and so few gamers in the world that are able to game on a laptop, I think this is going to be a nice growth market for us. +And then the new market that we introduced and launched this last quarter is called RTX Studio. And this is an underserved segment of the market where consumers, enthusiasts, they could be artists that are working on small firms, they need powerful computers to do their work. They need powerful computers to do rendering and high-definition video editing. And yet it's underserved by workstations because workstations are really sold on a B2B basis into large enterprises. And so we aligned all of the OEMs and created a whole new line of notebooks called RTX Studio. And the enthusiasm has been great. We've launched 27 different laptops, and I'm looking forward to seeing the results of that. This is tens of millions of people who are creators. Some of them professionals, some of them hobbyists. And they use Adobe suites, they use Autodesk in their suites and some of them use SolidWorks and some of them use all kinds of renders, like blender. And these are 3D artists and video artists, and this digital content creation is the modern way of creativity. And so this is an underserved market that we're excited to go serve with RTX Studio. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And your last question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [33] +-------------------------------------------------------------------------------- + + I have 2 for Colette. My first question is on data center. So I know you say that you have a broad-based growth except for a few hyperscalers. But you only grew at 3% sequentially, about $20 million. That doesn't sound like broad-based growth to me unless like -- did the hyperscalers get worse? Or are they just still so much bigger than like the rest of it? I guess, what's going on in data center? How do I wrap my head around like broad-based growth with relatively minimal growth observed? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [34] +-------------------------------------------------------------------------------- + + So to answer your question here, Stacy, on what we refer to when we're discussing the broad-based growth is the substantial expansion that we have on the types of customers and the industries that we are now approaching. As you know, even a year ago, we had a very, very small base in terms of industry-based hyper -- excuse me, industry-based AI workloads that they were using. Over this last quarter, we're continuing to see strong growth as we roll out all different types of AI solutions, both across the U.S. and worldwide, to these overall customers. Our hyperscalers, again, a couple of them, not necessarily growing. Some of them are flat and some of them are growing depending on whether or not that's for cloud instances or whether or not they're using it for internal use. So we believe that our continued growth with the industries is important for us for the long term to expand the use of AI, and we're just really pleased with what we're seeing in that growth this quarter. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + I'll now turn the call back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + Thanks, everyone. We're happy with our results this quarter and our return to growth across our platforms. Gaming is doing great. It's great to see NVIDIA RTX reinvigorating the industry. GeForce has several growth drivers. Ray traced games continue to gain momentum. A large number of gaming laptops are rolling out, and our new Studio platform is reaching the large underserved community of creators. Outside a few hyperscalers, we're seeing broad-based growth in data centers. AI is the most powerful technology force of our time and a once-in-a-lifetime opportunity. More and more enterprises are using AI to create new products and services while leveraging AI to drive ultra-efficiency and speed in their business. And with hyperscalers racing to harness recent breakthroughs in conversational AI, we see growing engagements in training as well as interactive conversational inference. RTX, CUDA accelerated computing, AI, autonomous vehicles, the work we're doing is important, impactful and incredibly fun. We're just grateful there is so much of it. We look forward to updating you on our progress next quarter. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2019-Feb-14-NVDA.txt b/Transcripts/NVDA/2019-Feb-14-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..ac92970af94e82bb58a22f11fd304c2a43b4e5bc --- /dev/null +++ b/Transcripts/NVDA/2019-Feb-14-NVDA.txt @@ -0,0 +1,526 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2019 NVIDIA Corp Earnings Call +FEBRUARY 14, 2019 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - Senior Equity Research Analyst + * Pierre C. Ferragu + New Street Research LLP - Global Team Head of Technology Infrastructure + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Mitchell Toshiro Steves + RBC Capital Markets, LLC, Research Division - Analyst + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Christina, and I will be your conference operator today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the fourth quarter of fiscal 2019. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the first quarter of fiscal 2020. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Form 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, February 14, 2019, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. As you know, we lowered our fourth quarter guidance on January 28, and our results are in line with our pre-announcement. Q4 revenue was $2.21 billion, down 24% from a year earlier, driven primarily by a 45% year-on-year decline in gaming. Full year revenue was $11.72 billion, up 21% from our previous year. +Starting with our gaming business. Revenue of $954 million was down 45% year-on-year and down 46% sequentially, weaker than our expectations heading into the quarter. Full year revenue was up 13% to $6.25 billion. +Three factors contributed to the Q4 gaming revenue decline. First, post-crypto inventory of GPUs in the channel caused us to reduce shipments in order to allow excess channel inventory to sell through. We expect channel inventories to normalize in Q1, in line with 1- to 2-quarter time line we had outlined on our previous earnings call. Second, deteriorating macroeconomic conditions, particularly in China, impacted consumer demand for our GPUs. And third, sales of certain high-end GPUs using our new Turing architecture, including the GeForce RTX 2080 and 2070, were lower than we expected for the launch of a new architecture. These products deliver a revolutionary leap in performance and innovation with real-time ray tracing and AI, but some customers may have delayed their purchase while waiting for new -- for lower price points or further demonstration of the RTX technology in actual games. The significant volatility in our gaming business over the last few quarters has been challenging to model. Crypto mining demand and its after effects have distorted the quarter-to-quarter trends in the gaming business and obscured its underlying trend line. +Let me try to give you some visibility into what we believe the normalized business looks like. As you know, our gaming business consists of desktop gaming, notebook gaming and gaming console products. To get a sense of the underlying run rate in our gaming business last year, it is helpful to look at desktop gaming revenue across a period that doesn't include crypto demand. Let's look at the 4 quarters starting from Q2 of last year to the current quarter or Q1 this year. +In Q2 and Q3 of last year, with the benefit of hindsight, we shipped a higher amount of desktop gaming products relative to where end demand turned out to be. To allow the channel to work down that excess channel inventory, we shipped a lower amount relative to end demand in Q4, and will do so again in Q1. Therefore, exiting Q1, we expect channel inventories to be at normal levels. On average, our desktop gaming revenue across these 4 quarters is about $900 million. We believe this represents the normalized level of desktop gaming for this period. Notebook gaming and gaming consoles have averaged close to $500 million per quarter over the same 4 quarters. Thus, in total, we believe our normalized quarterly gaming business revenue run rate is approximately $1.4 billion. +As we look past Q1, we expect the channel inventory correction to be behind us and our business to have bottomed. On a full year basis, we expect our gaming business to be down slightly, given the tough first half compares with growth in Turing and notebook gaming. +At CES last month, we launched into the recovery of our gaming business. We announced the GeForce RTX 2060 at the midrange price point of $349. The 2060 delivers a 60% performance improvement over the GTX 1060 while also bringing Turing's real-time ray tracing and AI features to the mass market for the first time. The 2060 has received rave reviews and is off to a great start. +In addition, we announced a record of 40-plus new Turing-based gaming laptops, which became available on January 29. This is more than double the number of GeForce-powered notebooks in the market last year, featuring the energy efficiency of the Turing architecture and the light laptops are able to deliver the performance of desktop gaming PCs. We expect GeForce laptops to continue to be the fastest-growing segment of gaming. +We are also pleased to see growing momentum in the RTX ecosystem as more game developers are creating content to take advantage of the Turing architecture's amazing capabilities. Just this week, DLSS technology is becoming available in 2 blockbuster games, Battlefield V and Metro Exodus and Anthem coming soon. In addition, at CES, Justice and Atomic Heart showed demos featuring ray tracing and DLSS. And a large pipeline of games plan to integrate RTX technology. Pairing DLSS with ray tracing can provide comparable frame rates to traditional rasterization but also much more beautiful cinematic visuals, the best of both worlds. This is the next generation of gaming. While this was a challenging quarter in our gaming business, we look forward to putting the channel inventory correction behind us and building on a solid foundation of our Turing architecture. +Moving to datacenter. Revenue was $679 million, up 12% year-on-year and down 14% sequentially. Full year datacenter revenue was $2.93 billion, up a strong 52%. The Q4 sales decline was broad-based across vertical end markets and geographies. As the quarter progressed, customers around the world became increasingly cautious, due to rising economic uncertainty and a number of deals did not close in January. In addition, hyperscale and cloud purchases declined both sequentially and year-on-year as several customers paused at the end of the year. We believe the pause is temporary. The strength of NVIDIA's accelerated computing platform remains intact. We continue to lead the industry in performance for scientific computing and deep learning. And with CUDA's programmability, we can continue to expand the value of our platform. For example, we recently announced RAPIDS or CUDA acceleration stack for data analytics and machine learning. +In December, the first objective third-party AI benchmark called MLPerf became available, and NVIDIA captured the top spot in the 6 test categories for training deep learning models that we competed in. And in January, Google Cloud announced that NVIDIA T4 Tensor Core GPUs are now available in beta in its datacenters in the U.S., Europe, Brazil, India, Singapore and Tokyo. The T4 is a universal cloud GPU that accelerates a variety of workloads, including high-performance computing, deep learning training and inference, broader machine learning, data analytics and graphics. +Our visibility remains low in the current cautious spending environment, and we don't forecast a meaningful recovery in the data center segment until later in the year. However, we are working closely with hyperscales around the world to integrate NVIDIA TensorRT software and Tensor Core GPUs into their inference production flow. Inference currently drives less than 10% of our data center business, but represents a significant expansion of our addressable market opportunity going forward. +We have also strengthened our product portfolio and go-to-market capabilities to address vertical industries that have an enormous data and analytics requirements, such as automotive, financial services, retail, health care and consumer Internet services. With our RAPIDS software stack, NVIDIA can accelerate data analytics and machine learning, and we have -- as we have done in deep learning. And we made it easier for customers to adopt our technology by partnering with Cisco, IBM, NetApp and Pure Storage to create pre-integrated systems that can be sold through their global IT channels. +Moving to pro visualization. Revenue reached $293 million, up 15% from the prior year and down 4% sequentially. Full year revenue was $1.13 billion, up 21% year-on-year. New applications like data science, AI and VR as well as the need for thin and light mobile workstations remain key growth drivers for the business. +We had key wins in the quarter, including Boeing, Google, LinkedIn and Toyota for applications including AI and robotics. This past week, with our partners, HP, Dell, Lenovo, we announced the availability of Quadro RTX workstations. Quadro RTX is the most significant workstation GPU upgrade in 10 years. It will enable millions of designers and creative architects for the first time to work interactively with super high resolution media and photorealistic 3D rendering, enabling them to be creative with dramatically improved productivity. +Finally, turning to automotive. Q4 revenue was $163 million, up 23% from a year ago and down 5% sequentially. Full year revenue reached $641 million, up 15%. The sequential decline was largely seasonal. The year-on-year growth was driven by the increasingly adoption of next-generation AI cockpit solutions and autonomous vehicle development deals, partially offset by declines in legacy infotainment. +Last month at CES, we announced DRIVE AutoPilot, the world's first commercially available Level 2+ self-driving car computer. The system offers sophisticated automated driving features that far surpass today's ADAS offerings, increasing the vehicle's performance, functionality and road safety while the driver remains in control. We delivered these capabilities. DRIVE AutoPilot uses multiple deep neural networks; surround camera perception, both in and outside of the car; and significant AI processing capability. Systems from our Tier 1 partners, including Bosch, Continental, Veoneer and ZF were all on display on at our booths. +Volvo, as announced back in October, was our first Level 2+ design win with cars slated for production in the early 2020s. Mercedes-Benz has also chosen NVIDIA for its next-generation autonomous vehicle and cockpit computer. This centralized AI computing system replaces dozens of smaller processors inside current cars. DRIVE AutoPilot is a major milestone for NVIDIA and takes our high-functioning, self-driving capabilities into the mass market. This will be an important year for robo-taxi pilots and initial Level 2 design wins. +Moving to the rest of the P&L and balance sheet. Q4 GAAP gross margins was 54.7%. And non-GAAP was 56.0%, down sequentially and year-on-year, primarily due to a $128 million charge for DRAM, boards and other components associated with our lower-than-expected Q4 revenue and current market conditions. +GAAP operating expenses were $913 million, and non-GAAP operating expenses were $755 million, up 25% and 24% year-on-year, respectively. GAAP EPS was $0.92, down 48% from a year earlier. Full year GAAP EPS was $6.63, up 38% from the prior year. Non-GAAP EPS was $0.80, down 53% from a year ago. Full year non-GAAP EPS was $6.64, up 35% from the prior year. +We returned $1.95 billion to shareholders in the fiscal year through a combination of quarterly dividends and share repurchases. As we announced last quarter, we plan to return $3 billion to shareholders through the end of fiscal 2020 in the form of dividends and buybacks. We repurchased $700 million during the fourth quarter of fiscal 2019. +With that, let me turn to the outlook for the first quarter of fiscal 2020. We expect revenue to be $2.2 billion plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 58.8% and 59%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $930 million and $755 million, respectively. GAAP and non-GAAP OI&E are both expected to be an income of $20 million. GAAP and non-GAAP tax rates are both expected to be 10% plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $150 million to $170 million. +For fiscal 2020, we expect Q1 to mark the bottom as we pass the inventory correction in gaming. We expect total revenue for the year to be flat to down slightly with growth in our 4 end markets, compensating for the absence of crypto revenue and the excess selling from last year. We plan to grow OpEx in the high single digits this year, and we continue to invest in our focused growth areas of graphics, AI and self-driving cars. Further financial details are included in the CFO commentary, and other information is available on our IR website. +In closing, I'd like to highlight upcoming events for the financial community. We'll be presenting at the Morgan Stanley Technology, Media and Telecom Conference on February 26. And our next earnings call to discuss our financial results for the quarter of fiscal 2020 will take place on May 15. +We will now open the call for questions. Operator, would you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I had 2 questions. First, Colette, you talked about the weakness you saw in the 2070 and the 2080 in the quarter. I guess this question is more for Jensen. Are you concerned at all about your ability to convince and incentivize gamers to -- as Colette pointed out, it's more of a timing thing? And second question is inventory was up on the balance sheet. Colette, if you can just provide some color there and expectations going forward. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes, Toshiya. When we launched the 2070 and 2080, it was the first time we've ever launched a new generation where the only available SKUs were very high end. And in addition to that, the early boards that came out into the marketplace were the special edition and the overclock versions, and the MSRP versions didn't show up for some short time after, couple of months after. And so the conditions weren't ideal, if you will. Now we weren't able to launch into the mainstream segment with 2060 for all the reasons that I think everybody understands now. And so I think that the situation wasn't ideal. When you take a look at our situation now, every single graphics card had the best performance at its price point, and it remain so today. And I think that right out of the box, it delivered excellent performance. It is true that everybody was hoping to see more games with RTX on day 1. But it's such a new technology with ray tracing and AI for image processing that it's only really possible to make available with new games, which is tied to the schedules of new games. And now they're starting to come out. Battlefield V, Metro Exodus, I think the reviews from this week are just spectacular. People are finally realizing what it is that we were talking about. And that it's possible with RTX technology, the combination of applying ray tracing and AI for us to deliver much more beautiful images without sacrificing performance. And so I think people are starting to understand now the benefits of the RTX technology. And we just needed some time to demonstrate it. And I think the takeaway is simply this. RTX is the best graphics card at every single price point without using ray tracing technology. And for new games that are coming out, each one of the new games that come out in the future will apply ray tracing, and work with developers to apply ray tracing technology. I think everybody agrees that it is surely the next generation. And then probably one of the biggest stories that came out just last week is Unreal Engine and Unity, both of the game engines are going to incorporate RTX and ray tracing technology in the engine itself. And so all future games in the future will be able to take advantage of that. So that's a really big news, and I'm excited about that. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + So Toshiya, to answer your second question regarding our inventory balance. Our inventory balance at the end of Q4 rose just due to the weaker-than-expected finish to Q4. Inventory right now is primarily related to Turing, Volta and DGX. And we don't expect any further write-downs as we have incorporated approximately $128 million of write-downs within the current Q4. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Your next question is from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [6] +-------------------------------------------------------------------------------- + + I guess on the commentary regarding a pause in spending in datacenter and a handful of deals that got delayed, can you give a little bit more color in terms of, I guess what you're seeing across enterprise, cloud, high-performance compute? And I guess within that, how you're seeing the ramp of T4? And I guess if you can kind of then speak to I'm sure embedded in the fiscal '20 guidance is a pretty nice ramp into the second half. What are the key drivers, key milestones that you're looking for to see that business reaccelerate higher as we go through the year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [7] +-------------------------------------------------------------------------------- + + The slowdown is broad-based. We saw it across every vertical, every geography. There was just a level of cautiousness across all of the enterprise customers in the cloud service providers that we've not experienced in a while. And so I think that it has to be temporary. The computing needs of Earth has not certainly been satisfied with what we shipped last quarter. And so I think that the demand will return and customers will return. Our situation in datacenters is dramatically better year-over-year. And if you take a look at where we are, our deep learning solution is unquestionably the best in the world. We introduced T4 with inference capability. It's the world's first universal cloud GPU, and it does everything that NVIDIA does all in one GPU in 75 watts. And so it fits into every hyperscale datacenter. We're engaged with Internet service providers all around the world, optimizing, importing their high-production models, networks, so that we could deploy it into production. So we now have 4 different new growth drivers for our data center in addition to deep learning and scientific computing. We have inference that we're actively working on. We have data analytics that's called RAPIDS. Some people call it big data, but data analytics and machine learning. The third is rendering. And because of the partnerships that we've developed and the excitement that people see around enterprises around the world, we've developed partnerships with large IT companies to pre-configure systems that make it easier for enterprises to be able to adopt our technology. So we have 4 new ways for us to grow our enterprise business. And so we're looking forward to when the pause releases, and now we'll get back to growing. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [9] +-------------------------------------------------------------------------------- + + I just had a clarification and a question. On the clarification, gross margins, Colette, what is the normalized run rate for gross margin that as you get your sales back to normalized levels, how should we think about the trajectory of gross margins? And will there be any impact from the balance sheet inventory? And then on the question, Jensen, can you give us more reassurance that gaming is still a growth business? But I understand that over the last year, there's been a lot of confusion, there's been macro issues. But if you look at the number of gamers and the mix of product that they are buying, so essentially the sell-through to gamers, has that been on an upward trajectory? And as part of that, when do you think we could see Turing exceed the demand you saw for Pascal? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [10] +-------------------------------------------------------------------------------- + + So I'll go first. Thanks for the question. On gross margin, our gross margin, the largest contributor to our absolute gross margin is really just the mix of our products. The mix of our products based on our market platforms but also the mix of our products within data center as well as within gaming. We provided guidance for Q1, which has a good level of confidence from us, and we'll see how it goes from there. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [11] +-------------------------------------------------------------------------------- + + Vivek, the fundamentals of gaming has not changed. There are more gamers than ever. Games are better than ever. There's been a recent shift in the popularity of multiplayer competitive eSports-like games. That's good for hardware. It lowers the barrier to entry because it's free to play with the exception of downloadable content. And so the barriers to entry is lower. But you could see that the excitement around Fortnite and recently with Apex Legend, PUBG is still popular, League of Legends is still popular. And so this genre of games, these genre of games is both competitive, requires great hardware. It attracts a lot more players because it's social, and you want to play with your friends. And it's much stickier because it happens to be social. It happens to be a game where you had to play with a whole bunch of other people. So I think that gaming is vibrant as ever before. If you take the methodology that Colette described earlier and you averaged out our underlying gaming business and you compare that to a year before, surely it grew. If you compare that -- if you compare also the rate of which our gaming notebook is growing, I think that's pretty exciting. I think last year, we had mentioned it before that our gaming notebook business grew 50% year-over-year. And just at CES, the number of new notebook designs that came out with Turing because of an invention that we created called Max-Q and because of the energy efficiency of the Turing architecture, you can now make notebooks that are really wonderful and also high performing at the same time. And so I think the dynamics are the same, and gaming is going to continue to be a growth business. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + And your next question comes from the line of John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [13] +-------------------------------------------------------------------------------- + + Colette, I appreciate all the data you gave us on trying to size normalized demand for gaming. What I have to ask, though, is if you're still going through of the channel inventory worked out in fiscal first quarter, it seems like to hit your full year guide, the expectation is for gaming revenue to accelerate well above that normalized level you talked about. One, am I doing the math right? And if I am, kind of what gives you confidence throughout the year that you can see that kind of gaming growth off of these bottoms? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [14] +-------------------------------------------------------------------------------- + + I'll start, and I'll let Jensen finish that question. So along the lines of Jensen's response in terms of what we do believe are the key drivers of gaming and everything still intact in terms of gaming, both with our Turing architecture, the growth expected with our Turing architecture as well as the growth from the notebook, we do believe will be great drivers as we head into the rest of the year. We'll have to wait and see in terms of how that plays out, but that is really the underlying reason why we think the growth will continue. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [15] +-------------------------------------------------------------------------------- + + Yes. I think your math isn't wrong. The part that you probably didn't consider is notebook. Our GeForce notebook business is quite large. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [16] +-------------------------------------------------------------------------------- + + That's helpful, Jensen. And then maybe just a follow-up, just on the data center side. Clearly, you've talked about new applications that should help grow your TAM inside of datacenter. I'm just kind of curious, the calendar fourth quarter of last year, I think marked the first time that a competitor had some meaningful volumes of GPU in the datacenter. There's always talk about the hyperscale guys are wanting to do their own ASICs. What kind of anecdotal evidence can you give us to help us get more comfortable of what's going on here is more macro and not share loss either to competition and/or architectural differences between GPUs and ASICs? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [17] +-------------------------------------------------------------------------------- + + We don't see them in high-performance computing. And so I haven't found where -- we haven't met them in high-performance computing and deep learning and in the areas that we serve. And so competitively, I can't -- I don't really -- we don't see it. But the bigger picture, I think is this, that the market segments that we serve, whether it's in deep learning, machine learning, data analytics, those segments are really quite large. And I think that it is, unquestionably, the future of high-performance computing is going to be highly data driven, both computational methods, algorithmic methods as well as data-driven methods. And so I think the fundamental trend has not changed. We have 4 new growth drivers, 4 new ways to grow in the datacenter. The first one, of course, is inference. We're making a lot of progress there. T4 is doing great. I think we're going to be quite successful with T4s. You just got to keep saying that. It has second-generation Tensor Core, 75 watts. And you can use that for training. You can use it for inference. You could use it for remote graphics. You could use it for high-performance computing. And it fits literally into any hyperscale data center. The second way is data analytics. This is a brand-new thing for us. You must know that big data and using data to predict dynamics in the marketplace is really important in retail, in e-tail, in health care, in financial services. And there's never been an accelerated approach to solve this problem for people. And because of the flexibility of CUDA and because of the performance of our architecture, over the course of last year, we reengineered the entire data analytics stack, so that we can accelerate it. It's called RAPIDS. That work is really, really important, and I hope to give you guys updates on that on a regular basis. Rendering is a brand-new market for us because of Turing. Finally, we can render photorealistic images in accelerated way. There are millions of servers in the world that are driving render farms, and they're getting upgraded on a regular basis. And then lastly, we've been successful with CSPs because they're easy for us to reach. But the world's enterprises are far and many and they're giant industries. And our companies' sales coverage doesn't allow us to reach every single health care company and every single insurance company and retail company. And that's where our network of partners really come in. We have great partnerships with HP. We have great partnerships with Dell and Cisco and IBM. And now we've developed relationships with the storage vendors, so that -- and the reason for that is because most of these big data problems require a great deal of storage. And they both -- they all see, they see the opportunities that we've created. And we came together to create pre-configured systems that are optimized and tuned, and these high-performance systems that you can just bring into the company, prop up and install. And we're seeing a lot of great success with that. And so we have 4 different ways to grow our datacenter business, and we're enthusiastic about it. I'm optimistic about it. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [19] +-------------------------------------------------------------------------------- + + First I had a clarification, Colette. I just wanted to clarify what the mix is assumed for the fiscal Q1 guidance? Are you kind of assuming that datacenter and gaming are both kind of flat sequentially? And then I guess my question was can you help us sort of shape the revenue through the year? To get to your full year guidance, you have to add roughly maybe $1.3 billion, $1.5 billion from where you are in fiscal Q1. How does that shape through the year? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes. Our guidance for the next quarter is a makeup of many different types of options across our market segment. We feel confident in terms of that roll-up, as we've provided the guidance today. And we'll just have to see how that ends out. With the expectation that we will be flat or slightly down for the full year, you are correct in some case that we're growing to have to build up to that over the course of the several next quarters. Likely, the second half of the year, we'll definitely be stronger than the first half of the year, and that is our expectation at this time. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [21] +-------------------------------------------------------------------------------- + + Yes, Tim, one of the things to keep in mind is that we have 4 growth drivers. We have 4 growth businesses. Our datacenter business is growing. It's unquestionably that our footprint is larger than ever. Our pro viz business is growing. Our workstation business now has 3 ways to grow. One is rendering. The second is data science -- data scientists are now a workstation customer. That has never happened before. And our software stack with Turing, turns a workstation into an ideal data science workstation. And the third is, finally, we're able to make workstations into notebooks. And they're delightfully thin, using all the same technologies that talked about for gaming notebooks. And so workstations is a growth business. And then lastly, our automotive is going to be a growth business. We've been investing, as you know, in self-driving cars. And this year, we announced entry into Level 2+, our first foot into the mainstream marketplace of autonomous vehicles. And the first design win is Volvo, and we have others to announce. And so I think this is going to be a good year for self-driving cars as well. So we have 4 growth businesses. Our 4 core businesses are all growing. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + First, I wanted to get again at the mix. Colette, you -- this is a question for Colette. You have said that mix was going to be the primary driver of your gross margins. And I know that sequentially they're up, but if I correct for the inventory write-down in Q4, the normalized gross margin this quarter was 61.7%. And so you're guiding it to 59%, so it's down 270 basis points sequentially on flat revenues. So do I take from that guidance that that's an indicator of the mix between the businesses, it's the primary driver of that gross margin degradation? Is there something else going on that we should be aware of? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Thanks, Stacy, we'll start with that first question on gross margin. You're correct, mix is still the primary driver of our gross margin every single quarter. You have correctly reduced -- or excuse me, changed our Q4 numbers to remove the overall inventory write-down. So when you look at Q1, there is a mix around our products that we plan on shipping by platforms but also within our gaming business and within our data center business. We also have different gross margins that would influence. This is our best estimate that we have at this time, and we'll see as we move through the year. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + So what do you think the bigger -- between those 2, whether it's intra-business mix or inter-business mix, between the businesses or within the businesses, which one of those is the biggest driver of the gross margin degradation sequentially into Q1? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + I think it's more on the inter business. Now keep in mind, our Q4 has a very low percentage of gaming as a total in terms of there and then a different mix within there as we move to the next quarter as well. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + So you think it's the mix between the businesses within, like you said inter, is that mix between the businesses that you think is the bigger driver then? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + The mix of the intra, both within the segments as well as between the segments. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + Okay. For my follow-up, Jensen, you and Colette, I guess you mentioned the datacenter was growing. But if I got full year revenue sort of flat to down slightly, and I've got gaming revenues down a bit like you said and I have pro viz and auto growing, it's kind of really hard for me within the envelope of that guidance to get datacenter growing much if at all. I mean, it could even be down within that. I mean, how are you thinking about the idea of datacenter growing within the context of the full year guidance that you've given? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [30] +-------------------------------------------------------------------------------- + + Well, in the short term, in near term, we have relatively limited visibility. We don't think it's going to remain this way. And with a little bit of tailwind, I think we could have a fairly good year. And so we'll just see how it turns out. This is our year guidance for now, and we'll update you as we go. The fundamental dynamics doesn't change. The fact of the matter is the world needs more computing. And a lot of that computing is related to machine learning, data analytics, deep learning. It's related to the things that we're working on. And we have 4 new ways to grow our datacenter business. I think our deep learning position is as good as ever. Our scientific computing position is as good as ever. And we have 4 new ways to grow. We have inference, we have data analytics and machine learning. We have rendering. And now we're taking that entire stack to the enterprise. And so I think we have the right strategy. We have the best platform. And the utilization -- the utility of it is really fantastic. And so with a little bit of a tailwind, I think we could have a fairly good year, and we'll just report it as we go. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And your next question comes from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [32] +-------------------------------------------------------------------------------- + + I wanted to ask about again, competition in datacenter. AMD on their call had talked about graphics in their datacenter business being as big as server, which is sort of north of $100 million a quarter, which surprised me. My sense is they're doing quite a bit different applications than you guys are. But maybe if you can just give us some context around what they're doing and how you see the competition coming up from within other graphics vendors. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [33] +-------------------------------------------------------------------------------- + + Our data center business is really focused on computing, and we just don't -- we don't see anybody. Our primary competitor is CPUs. That's really the starting of it and the ending of it. And it's very clear. The vast majority of the world's data center only runs on CPUs today. But the advance of technology has slowed. And it's creeping along at a few percent a year, and unfortunately, that's just not good enough. And so either datacenters are going to continue to increase in CapEx or they're going to have to find a new approach. And I think people are fairly enthusiastic about University, about accelerated computing. And I think our position is really quite good. And so I would say that those are largely the positions. If you think about competitively comparing our GPU to a competitor's latest GPU, I think the expectation was really high, and didn't turn out quite that way. I think our -- we've established that the Turing energy efficiency is much better. I think we've established that NVIDIA's Tensor Core architecture as a result allows our Volta to be 4x the performance of the highest end of the alternative. And the T4 is 1/4 the power at the same performance. And so the benefit of having great architectural advantage is a really rich software stack, and engineering that resulted in the energy efficiency that we've achieved, generation in, generation out, I think those are really great advantages. And then lastly, because of the broad reach of our architecture and OEM or a cloud service provider can adopt our architecture, and the utility of it is going to be greater because there's just a lot more applications. And the best way to reduce cost for any utility is to increase its utility. And I think that that's -- that our position there is really strong as you could imagine. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [35] +-------------------------------------------------------------------------------- + + I have just a couple of questions. The first one, Jensen, it seemed like the Turing platform is delivering some amazing results. But as you talked about relying on some new software features to do it. I wonder if you might talk about any steps you're taking in the road map to really upgrade performance for the installed base of games, given the time that it might take for some of those software features to roll out. And then secondly, you noted in the pre-announcement something about the write-down having to do with DRAM. I mean, obviously, that commodity pricing has been volatile. Colette, is there anything you can talk about, about how big of an effect that might have on the business and on pricing overall? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + Yes, thanks a lot, Matt. First of all, the Turing architecture is the highest-performing architecture at every single price point. And it's a big jump from our last generation in every single way. Without ray tracing, the Turing architecture is the first GPU to do concurrent floating point and integer operations at the same time. The instruction per clock of the Turing processor is so much better than our last generation, so much better than what's available in the marketplace. The cache architecture is a big improvement, and you can just see it in all of the existing games. If you just measure the existing games without touching anything, Turing gives you a big boost. And that's before we talked about ray tracing. And we've already spoken about ray tracing earlier, Matt. And we know that every single game that are coming out, we're working with the developers to incorporate RTX technology. And a very, very big deal, both Epic with Unreal engine and Unity engine are going to incorporate Ray tracing. It is very, very clear that the next generation of computer graphics is ray tracing. And all of the work that we've done with RTX to move the industry forward is well worth it. But remember, that's just the graphics part of Turing. Turing comes with it several new opportunities for growth for us. The first is, of course, advancing games. Advancing games for notebooks, advancing computer graphics, photorealistic rendering for film. All the work that we've done with Tensor Core that we just talked about. It's our second-generation Tensor Core, making it great for training as well as inference, a big leap for us for inference. And then lastly, all of the work that we're doing for data analytics and machine learning, we'll take advantage of all the capabilities of Turing. And so Turing is a big deal for us. And that's one of the reasons why last year was so busy for us as we put Turing into workstations, into data centers, into clouds, into rendering, into video games. And so Turing is really a gigantic leap for us architecturally. We're really excited by it. It's -- I think that the turbulent Q4 kind of overshadowed all of it. But in the final analysis, I think Turing was a home run for us. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + And to also answer your question regarding DRAM prices. Yes, they have definitely been volatile over the historical period. It is great to see them coming down in price. Over the long term, yes, that is beneficial to us from a gross margin perspective. So if we look out to the horizon later, we will probably be able to incorporate that into our gross margins. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [39] +-------------------------------------------------------------------------------- + + Kind of building on the discussion around the Turing platform and particularly to the gaming market, I'm curious, you mentioned in your prepared comments pricing of these new solutions was a bit of an inhibitor. Has the company invoked any changes in their pricing strategy around Turing? And then also, I'd be interested at can you help us frame how important China is to the gaming segment? And whether or not you're assuming that the China market rebounds in your annual assumption? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [40] +-------------------------------------------------------------------------------- + + First of all, on the pricing part, the biggest inhibitor was that we didn't have -- we couldn't launch our midrange segment. The inability to launch 2060 was a big inhibitor for us. But we did so at CES. The launch is a great success. The reviews are fantastic. People loved 2060. The price point is great. And so now we have a great stack from the midrange all the way to enthusiasts. The other part which could have turned out better is at the time of the launch, there were so many special editions and there were so many overclocked versions that the price point appeared high. But now while we have MSRP pricing for all of our segments. And so that's terrific. China is an important market. China is an important market, and it's an important gaming market. And I have every confidence it's going to rebound. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - Senior Equity Research Analyst [42] +-------------------------------------------------------------------------------- + + Could you just -- a clarification, could you repeat what you said you thought the OpEx would grow in this fiscal year? And what is the -- where's the focus of that investment? To what extent is it R&D versus SG&A? And then maybe one layer deeper, where is the focus of the higher OpEx? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [43] +-------------------------------------------------------------------------------- + + Sure, I'll start off. To repeat what we indicated in our transcript, we plan to increase OpEx in the high single digits over where we finished in terms of fiscal year '19. That is related to our opportunities that we see in front of us, gaming, AI as well as self-driving cars. Our focus in terms of investment, we are a very R&D-heavy significant company. But there are investments across the board, both in R&D as well as what we need in terms of go-to-market strategies to obtain these higher markets in front of us. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Mitch Steves with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [45] +-------------------------------------------------------------------------------- + + So I don't want to poke too many holes on the memory side and the downturn in gaming due to the crypto inventory. But if I think about kind of the gross margin profile, you guys almost reached 65%. So if I look out, let's call it a year or even call it 18 months and make it a -- more of a kind of a long-term target, is there any reason why you guys can't get back up to kind of the mid-60s level? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [46] +-------------------------------------------------------------------------------- + + Yes. On your gross margin question, yes, we still have drivers within the mix of our products that allow us to grow our gross margin over the long term. Absolutely. And there is definitely a goal for us to continue doing that. So the focus in terms of what the cost components of what we do but also moving the entire portfolio into the higher value-added platforms that we sell. So over the long term, absolutely, all of those things are still in place and intact that we can do. And we'll look quarter to quarter to give the best guidance that we can to help you see that. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [48] +-------------------------------------------------------------------------------- + + Obviously, a pause in datacenter, particularly the hyperscale, is pretty well documented. I'm just kind of curious to your perspective, particularly being AI still a growth area versus -- or run rate being memory and CPUs. Can you give any perspective as to how widespread it is? Maybe number of customers or geographic perspective. And just kind of curious how AI is affected with this greater slowdown. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [49] +-------------------------------------------------------------------------------- + + Yes. Blayne, the hyperscalers, their pause is probably the most dramatic. We still see a lot of activity in enterprise. It's just a much smaller base for us, but we expect it to be a much larger base in the future. And the reason for that is because most of the enterprises today don't use deep learning, they use an approach called machine learning. They might use things like decision trees or graph analytics or regressions or clustering or things like that, algorithms like that. And they'll run data analytics applications for business intelligence on a large amount of data. And they might be running it on a -- on top of a Spark stack that was created out of Berkeley and open source from Databricks. And so there's a -- if you recognize some of these things, that's what health care companies do and financial services companies do and retail companies do. They use it for fraud detection, predicting inventory, trying to make the best matches between riders and drivers and trying to predict which route to take to deliver food, dinner to you. And so those kinds of applications, most of the developers today use machine learning in large -- and big data analytics. And so we invested in a stack called RAPIDS and built our architecture called T4. And we're in the process of partnering with large IT companies to take the stack and the solution out to the world's enterprise. And so I expect enterprise to be a fairly exciting growth opportunity for us. Meanwhile, the CSPs, their pause will end. The amount of computation they do is increasing. More and more of them are using deep learning. And we have inference opportunity with the work that we did with T4 and TensorRT. And so we've got a lot of exciting opportunities to go. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Pierre Ferragu with New Street Research. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [51] +-------------------------------------------------------------------------------- + + A question for Colette. I'm trying to figure out how your position with cloud data centers evolved last year in financial year 2019. So if I look at the cloud CapEx, they were up about 70%. If I look at the CPU going into the cloud, according to Intel, it was up about 60%. So I was wondering how much you guys have been increasing revenues within your cloud business? Did you grow faster than CPUs? Did you grow faster than the overall CapEx? And then I have a follow-up in 2020. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [52] +-------------------------------------------------------------------------------- + + Sure. Let me start on that piece. As we talked about earlier on the call, our hyperscale and our hyperscales, many of them are also cloud providers, did start to slow down in terms of their purchasing in the latter half of the year. But the overall growth rate, as you can see from our data center business, grew more than 50% for the full year. Now even with that strong growth, we are still a very small percentage of overall CapEx that we see in cloud providers or the overall hyperscales. We are likely one of their top priorities of areas where they need to grow in terms of in their data center as they focus on AI, as they focus on the cloud businesses and the importance of that compute is necessary. But we are still a very, very small percentage of it. So slow down in the second half of the year, full year growth, phenomenal growth of 50%. And we track with the (inaudible). + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [53] +-------------------------------------------------------------------------------- + + But this 50% growth, is that for your overall datacenter business? Is that what like specifically your cloud hyperscale business grew as well? Or did that grow even faster with that? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [54] +-------------------------------------------------------------------------------- + + Yes, depending on the quarter, we will have a mix of what is hyperscale growth or what is cloud. And again, in the core -- in the fourth quarter, that was not a growth opportunity for us. But earlier in the year, definitely it was. + +-------------------------------------------------------------------------------- +Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [55] +-------------------------------------------------------------------------------- + + Great. And then quickly maybe, Jensen, on 2020, so you seem to be very cautious on the datacenter outlook. When we listen to players like Google and Facebook and others, they all seem to be seem like very keen to grow their overall spending this year. And when we listen to other providers around you, they all seem to be -- I mean they all demonstrate a bit of a confidence that in the second half, spending should resume. Is that just because they are being more optimistic than you? Do they see something you don't see? What do you hear from your clients about the second half? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [56] +-------------------------------------------------------------------------------- + + Well, we're enthusiastic about the second half. We're enthusiastic about our position, and we're enthusiastic about the solution we offer. And Pierre, as you know, we've also expanded our application and our market reach. We guided -- I think probably the biggest takeaway is we guided flight to slightly down for the whole year for the whole number. We do have 4 growth drivers. And maybe the best way to think about it is we should just wait and see how it goes. I think we've -- considering where we are, I feel pretty good about our guidance, and -- but I feel even better about our strategic position. And so I look forward to working through the year with you guys. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + And your last question comes from the line of Harlan Sur with JP Morgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [58] +-------------------------------------------------------------------------------- + + On the China gaming weakness, is it the slower economic environment? Or is it sort of government policy related? Because we know that the China government has had a freeze on new gaming approvals, although they've recently started to approve new games. This ban is in place, I think since the first half of last year. So given what you know of the business, how much of the China weakness is coming from the China gaming bans? Or is this just overall slower economic environment? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [59] +-------------------------------------------------------------------------------- + + I don't know that we could tear that apart, tease that apart, Harlan. We just know that China, the consumer market is relatively slow towards the end of the year. But the China economy is in the final analysis of growth economy, and so we're looking forward to it recovering. And gaming is one of the most important pastimes of that culture, and so I'm excited about our prospects there. All of the things that we're seeing in the near term, Colette, has done a really good job describing. And as we leave the bottom and leave this inventory issue behind us, we're super well positioned. We have a full stack of RTX, the Turing architecture is fantastic. It is unquestionably the best in the world. We have the best performance at every single price point. And we have great notebooks that the market can now buy. And so I'm looking forward to reporting our status with you guys as the year goes on. This should be a good year. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + I will now turn the call back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [61] +-------------------------------------------------------------------------------- + + 2018 was a record year, but it was a disappointing finish. This quarter, we expect to put the channel inventory issue behind us and get back on track. As the pioneer of accelerated computing, our position is unique and strong. And the opportunities ahead in graphics, high-performance computing, AI and autonomous machines remain enormous. We are as enthusiastic about these growth opportunities as ever. Thanks, everyone, for joining us today. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + And this concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2019-May-16-NVDA.txt b/Transcripts/NVDA/2019-May-16-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..093bfbae00d7e0107796a07ad8993212cb051f3e --- /dev/null +++ b/Transcripts/NVDA/2019-May-16-NVDA.txt @@ -0,0 +1,469 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2020 NVIDIA Corp Earnings Call +MAY 16, 2019 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Christopher Caso + Raymond James & Associates, Inc., Research Division - Research Analyst + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon, my name is Christina, and I will be your conference operator today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski from Investor Relations to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the First Quarter of Fiscal 2020. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the second quarter of fiscal 2020. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 16, 2019, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. Q1 revenue was $2.2 billion, in line with our outlook and down 31% year-on-year and up 1% sequentially. Starting with our gaming business. Revenue of $1.05 billion was down 39% year-on-year and up 11% sequentially, consistent with our expectations. We are pleased with the initial ramp of Turing and the reduction of inventory in the channel. During the quarter, we filled out our Turing lineup with the launch of midrange GeForce products that enable us to delight gamers with the best performance at every price point starting at $149. New product launches this quarter included the GeForce GTX 1660 Ti, 1660 and 1650, which bring Turing to the high-volume PC gaming segment for both desktop and laptop. These GPUs deliver up to 50% performance improvement over their Pascal-based predecessors, leveraging new share innovations such as concurrent floating point and integer operations, a unified cache and Adaptive Shading, all with the incredibly power-efficient architecture. +We expect continued growth in the gaming laptops this year. GeForce gaming laptops are one of the shining spots of the consumer PC market. This year, OEMs have built a record of nearly 100 GeForce gaming laptops. GeForce laptops start at $799 and all the way up to an amazing GeForce RTX 2080 4K laptops that are more powerful than even next-generation consoles. +The content ecosystem for ray-traced games is gaining significant momentum. At the March Game Developers Conference, ray-tracing sessions were packed. Support for ray tracing was announced by the industry's most important game engines, Microsoft DXR, Epic's Unreal Engine and Unity. Ray tracing will be the standard for next-generation games. +In March, at our GPU Technology Conference, we also announced more details on our cloud gaming strategies through our GeForce NOW service and the newly announced GFN Alliance. GeForce NOW is a GeForce gaming PC in the cloud for the 1 billion PCs that are not game-ready, expanding our reach well beyond today's 200 million GeForce gamers. It's an open platform that allows gamers to play the games they own instantly in the cloud on any PC or Mac anywhere they like. The service currently has 300,000 monthly active users with 1 million more on the waitlist. +To scale out to millions of gamers worldwide, we announced the GeForce NOW Alliance, expanding GFN through partnerships with the global telecom providers. Softbank in Japan and LG Uplus in South Korea will be among the first to launch GFN later this year. NVIDIA will develop the software and manage the service and share the subscription revenue with alliance partners. GFN runs on NVIDIA's edge computing servers. As telcos race to offer the new services for their 5G network, GFN is an ideal new 5G application. +Moving to data center. Revenue was $634 million, down 10% year-on-year and down 7% sequentially, reflecting the pause in hyperscale spending. While demand from some hyperscale customers bounced back nicely, others paused or cut back. Despite the uneven demand drop -- backdrop, the quarter had significant positives consistent with the growth drivers we outlined on our previous earnings call. First, inference revenue was up sharply both year-on-year and sequentially with broad-based adoption across a number of hyperscale and consumer Internet companies. As announced at GTC, Amazon and Alibaba joined other hyperscalers such as Google, Baidu and Tencent in adopting the T4 in their data centers. A growing list of consumer Internet companies is also adapting our GPUs for inference, including LinkedIn, Expedia, Microsoft, PayPal, Pinterest, Snap and Twitter. The contribution of inference to our data center revenue is now well into the double-digit percent. +Second, we expanded our reach in enterprise, teaming up with major OEMs to introduce the T4 enterprise and edge computing servers. These are optimized to run the NVIDIA CUDA-X AI acceleration libraries for AI and data analytics. With an easy-to-deploy software stack from NVIDIA and our ecosystem partners, this wave of NVIDIA edge AI computing systems enables companies in the world's largest industries, transportation, manufacturing, industrial, retail, health care and agricultural, to bring intelligence to the edge where the customers operate. +And third, we made significant progress in data center rendering and graphics. We unveiled a new RTX Server configuration packing 40 GPUs into an 8 use case and up to 32 servers in a pod, providing unparalleled density, efficiency and scalability. With a complete stack, this server design is optimized for 3 data center graphic workloads: rendering, remote workstations and cloud gaming. The rendering opportunity is starting to take shape with early RTX Server deployments at leading studios, including Disney, Pixar and Weta. +In the quarter, we announced our pending acquisition of Mellanox for $125 per share in cash, representing a total enterprise value of approximately $6.9 billion, which we believe will strengthen our strategic position in data center. Once complete, the acquisition will unite 2 of the world's leading companies in high-performance computing. Together, NVIDIA's computing platform and Mellanox's interconnects power over 250 of the world's TOP500 supercomputer and have as customers every major cloud service provider and computer maker. +Data centers in the future will be architected as giant compute engines with tens of thousands of compute nodes designed holistically with their interconnects for optimal performance. With Mellanox, NVIDIA will optimize data center scale workloads across the entire computing, networking and storage stack to achieve higher performance, greater utilization and lower operating cost for customers. Together, we can create better AI computing systems for the cloud to enterprise to the edge. As stated at the time of the announcement, we look forward to closing the acquisition by the end of this calendar year. +Moving to pro visualization. Revenue reached $266 million, up 6% from the prior year and down 9% sequentially. Year-on-year growth was driven by both desktop and mobile workstations, while the sequential decline was largely seasonal. Areas of strength included the public sector, oil and gas and manufacturing. Emerging applications, such as AI, AR, VR, contributed an estimated 38% of pro visualization revenue. +The real-time ray-tracing capabilities of RTX are a game changer for the visual effects industry, and we are seeing tremendous momentum in the ecosystem. At GTC, we announced that the world's top 3D application providers have adopted NVIDIA RTX in their product releases set for later this year, including Adobe, Autodesk, Chaos Group, Dassault and Pixar. With this rich software ecosystem, NVIDIA RTX is transforming the 3D market. For example, Pixar is using NVIDIA RTX ray tracing on its upcoming films. Weta Digital is using it for upcoming Disney projects and Siemens NX ray-traced studios users will be able to generate rendered images up to 4x faster in their product design workloads. We are excited to see the tremendous value that NVIDIA RTX is bringing to the millions of creators and designers served by ecosystem partners. +Finally, turning to automotive. Q1 revenue was $166 million, up 14% from a year ago and up 2% sequentially. Year-on-year growth was driven by growing adoption of next-generation AI cockpit solutions and autonomous vehicle development deals. At GTC, we had major customer and product announcements. Toyota selected NVIDIA's end-to-end platform to develop, train and validate self-driving vehicles. This broad partnership includes advancements in AI computing, infrastructure using NVIDIA GPUs, simulation using NVIDIA DRIVE Constellation platform and in-car AV computers based on the DRIVE AGX Xavier or Pegasus. We also announced the public availability of DRIVE Constellation, which enables millions of miles to be driven in virtual worlds across the broad range of scenarios with greater efficiency, cost effectiveness and safety than what's possible to achieve in the real world. Constellation will be reported in our data center market platform. +And we introduced NVIDIA Safety Force Field, a computational defensive driving framework that shields autonomous vehicles from collisions. Mathematically verified and validated in simulation, Safety Force Field will prevent a vehicle from creating, escalating or contributing to an unsafe driving situation. We continue to believe that every vehicle will have an autonomous capability one day, whether with a driver or driverless. To help make that vision a reality, NVIDIA has created an end-to-end platform for autonomous vehicles from AI computing infrastructure to simulation to in-car computing. And Toyota is our first major win that validates this strategy. We see this as a $30 billion addressable market by 2025. +Moving to the rest of the P&L and balance sheet. Q1 GAAP gross margin was 58.4% and non-GAAP was 59%, down year-on-year to lower gaming margins and mix, up sequentially from Q4, which had $128 million charge from DRAM boards and other components. GAAP operating expenses were $938 million, and non-GAAP operating expenses were $753 million, up 21% and 16% year-on-year, respectively. We remain on track for high single-digit OpEx growth in fiscal 2020 while continuing to invest in the key platforms driving our long-term growth, namely graphics, AI and self-driving cars. +GAAP EPS was $0.64, and non-GAAP EPS was $0.88. We did not make any stock repurchases in the quarter. Following the announcement of the pending Mellanox acquisition, we remain committed to returning $3 billion to shareholders through the end of fiscal 2020 in the form of dividends and repurchases. So far, we have returned $800 million through share repurchases and quarterly cash dividends. +With that, let me turn to the outlook for the second quarter of fiscal 2020. While we anticipate substantial quarter-over-quarter growth, our Q2 outlook is somewhat lower than our expectations earlier in the quarter where our outlook for fiscal 2020 revenue was flat to down slightly from fiscal 2019. The data center spending pause around the world will likely persist in the second quarter, and visibility remains low. In gaming, the CPU shortages while improving will affect the initial ramp of our laptop business. +For Q2, we expect revenue to be $2.55 billion, plus or minus 2%. We expect a stronger second half than the first half, and we are returning to our practice of providing revenue outlook one quarter at a time. Q2 GAAP and non-GAAP gross margins are expected to be 59.2% and 59.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $985 million, $765 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of approximately $27 million. GAAP and non-GAAP tax rates are both expected to be 10%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $120 million to $140 million. Further financial details are included in the CFO commentary and other information available on our IR website. +In closing, let me highlight upcoming events for the financial community. We'll be presenting at the Bank of America Global Technology Conference on June 5, at the RBC Future of Mobility Conference on June 6 and at the NASDAQ investor conference on June 13. Our next earnings call to discuss financial results for the second quarter of fiscal 2020 will take place on August 15. +We will now open the call for questions. Operator, will you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [2] +-------------------------------------------------------------------------------- + + Colette, I was wondering if you could give a little bit more color or discussion around what exactly you've seen in the data center segment and whether or not or what you're looking for in terms of signs that we can kind of return to growth or maybe this pause is behind us. I guess what I'm really asking is kind of what's changed over the last, let's call it, 3 months relative to your prior commentary from a visibility perspective and just demand perspective within that segment. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Sure. Thanks for the question as we start out here. I think when we had discussed our overall data center business 3 months ago, we did indicate that our visibility as we turned into the new calendar year was low. We had a challenge in terms of completing some of the deals at the end of that quarter. As we moved into Q1, I think we felt solid in terms of how we completed. We saw probably a combination of those moving forward continuing with their CapEx expenditures and building out in terms of what they need for the data centers. Some others are still in terms of the pause. +So as we look in terms of with Q2, I think we see a continuation of what we have in terms of the visibility, not the best visibility going forward but still rock-solid to what we think are benefits of what we provide in terms of a platform. Our overall priorities are aligned to what we see with the hyperscalers as well as the enterprises as they think about using AI in so many of their different workloads. But we'll just have to see as we go forward how this turns out. But right now, visibility probably just remains the same about as where we were when we started 3 months ago. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then as a quick follow-up on the gaming side, last quarter, you talked about that being down -- I think it was termed as being down slightly for the full year. Is that still the expectation? Or how has that changed? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [5] +-------------------------------------------------------------------------------- + + So at this time, we don't plan on giving a full year overall guidance. I think our look in terms of gaming, all of the drivers that we thought about earlier in the quarter and we talked about on our Investor Day and we have continued to talk about are still definitely in line. The drivers of our gaming business and Turing RTX for the future are still on track, but we're not providing guidance at this time for the full year. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Harlan Sur of JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [7] +-------------------------------------------------------------------------------- + + On the last earnings call, you'd mentioned China gaming demand as a headwind. At the Analyst Day in mid-March, I think Jensen had mentioned that the team was already starting to see better demand trends out of China maybe given the relaxed stance on gaming bans. Do you anticipate continued China gaming demand on a go-forward basis? And maybe talk about some of the dynamics driving that demand profile in the China geography. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [8] +-------------------------------------------------------------------------------- + + Sure. China looks fine. I think China has stabilized. The gaming market in China is really vibrant, and it continues to be vibrant. Tencent's releasing new games. I think you might have heard that Epic stores now are open in Asia, and games are available from the West. So there are all kinds of positive signs in China. There are some 300 million PC gamers in China, and people are expecting it to grow. We're expecting the total number of gamers to continue to grow from the 1-plus billion PC gamers around the world to something more than that. And so things look fine. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [9] +-------------------------------------------------------------------------------- + + And then as a follow-up, a big part of the demand profile in the second half of the year for the gaming business is always the lineup of AAA-rated games. Obviously, you guys have a very close partnership with all of the game developers. How does the pipeline of new games look? Kind of they get launched October, November time frame, either total number of blockbuster games and also games supporting real-time ray tracing as well as some of your DLSS capabilities. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [10] +-------------------------------------------------------------------------------- + + Yes. Well, it's seasonal. Second half of the year, we expect to see some great games. We won't preannounce anybody else's games for them, but this is a great PC cycle because it's the end of the console cycle, and PCs is just where the action's at these days with battle royale and eSports and so much social going on, the PC gaming ecosystem is just really vibrant. Our strategy with RTX was to take a lead and move the world to ray tracing. And at this point, it's fairly, fairly safe to say that the leadership position that we've taken has turned into a movement that has turned next-generation gaming ray tracing into a standard. Almost every single game platform will have to have ray tracing, and some of them already announced it. +And the partnerships that we've developed are fantastic. Microsoft DXR is supporting ray tracing. Unity is supporting ray tracing. Epic is supporting ray tracing. Leading publishers like EA has adopted RTX and supporting ray tracing. And movie studios, Pixar has adopted -- announced that they're using RTX and will use RTX to accelerate their rendering of films. And so Adobe and Autodesk jumped on top -- jumped onto RTX and will bring ray tracing to their content and their tools. And so I think at this point, it's fair to say that ray tracing is the next generation and is going to be adopted all over the world. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [12] +-------------------------------------------------------------------------------- + + I guess the first question is for Colette. So what went into the decision to pull full year guidance versus just cutting it? Is it really to see around how long it could take for data center to come back? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [13] +-------------------------------------------------------------------------------- + + Yes. I'll start off here and kind of go back to where our thoughts were in Q1 and why we provided full year guidance when we were in Q1. When we looked at Q1 and what we were guiding, we understood that it was certainly an extraordinary quarter, something that we didn't feel was a true representative of our business, and we wanted to get a better view of our trajectory of our business in terms of going forward. +We are still experiencing, I think, the uncertainty as a result of the pause in terms of with the overall hyperscale data centers. And we do believe that's going to extend into Q2. However, we do know and expect that our Q2 -- or excuse me, our H2 will likely be sizably larger than our overall H1, and the core dynamics of our business at every level is exactly what we expected. Just that said though, we're going to return to just quarterly guidance at this time. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [14] +-------------------------------------------------------------------------------- + + Okay. And then just as a follow-up, can you give us some even qualitative, if not quantitative, sense of the $320 million incremental revenue for July, how that breaks out? Is the thinking sort of that data center is going to be flat to maybe up a little bit and pretty much the remainder of the growth comes from gaming? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [15] +-------------------------------------------------------------------------------- + + Yes. So when you think about our growth between Q1 and Q2, yes, we do expect in terms of our gaming to increase. We do expect our Nintendo Switch to start again in sizable amounts once we move into Q2, and we do at this time expect probably our data center business to grow. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [17] +-------------------------------------------------------------------------------- + + Jensen, I had a follow-up on the data center business. I was hoping you could provide some color in terms of what you're seeing not only from your hyperscale customers, which you've talked extensively on, but more on the enterprise and HP side of your business and specifically on the hyperscale side. You guys talked about this pause that you're seeing from your customer base. When you're having conversations with your customers, do they give you a reason as to why they're pausing? Is it too much inventory of GPUs and CPUs and so on and so forth? Or is it optimization giving them extra capacity? Is it caution on their own business going forward? Or is it a combination of all the above? Any color on that would be helpful, too. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [18] +-------------------------------------------------------------------------------- + + Hyperscalers are digesting the capacity they have. They -- at this point, I think it's fairly clear that in the second half of last year, they took on a little bit too much capacity. And so everybody has paused to give themselves a chance to digest. However, our business on inference is doing great, and we're working with CSPs all over the world to accelerate their inference models. +Now the reason why recently the inference activity has gotten just off the charts is because of breakthroughs in what we call conversational AI. In fact, today, I think that -- I just saw it today, but I've known about this work for some time, Harry Shum's group, Microsoft AI research group, today announced their multitask DNN general language understanding model. And it just -- it broke benchmark records all over the place. And basically, what this means is the 3 fundamental components of conversational AI, which is speech recognition; natural language understanding, which does multitask DNN is a breakthrough, and it's based on a piece of work that Google did recently called BERT; and then text-to-speech. All of the major pieces of a conversational AI are now put together. +Of course, it's going to continue to evolve, but these models are gigantic to train. And in the case of Microsoft's network, it was trained Volta GPUs, And these systems require large amounts of memory. The models are enormous. It takes an enormous amount of time to train these systems. And so we're seeing a breakthrough in conversational AI. And across the board, internet companies would like to make their AI much more conversational, so that you can access your phones and smart speakers and be able to engage AI practically everywhere. +The work that we're doing in the industries makes a ton of sense. We're seeing AI adoption in just about all the industries from transportation to health care to retail to logistics, industrials, agriculture. And the reason for that is because they have a vast amount of data that they're collecting. And I heard a statistics just the other day from a talk that Satya gave that some 90% of today's data was created just 2 years ago and is being created by and gathered by these industrial systems all over the world. +And so if you want to put that data to work -- and you could create the models using our systems, our GPUs for training, and then you can extend that all the way out to the edge. This last quarter, we started to talk about our enterprise server based on T4. This inference engine that has been really successful for us at the CSPs is now going out into the edge, and we call them edge servers and enterprise servers. And these edge systems are going to do AI basically instantaneously. It's too much data to move all the way to the cloud. You might have data sovereignty concerns. You want to have very, very low latency. Maybe it needs to have multi-sensor fusion capabilities so it understands the context better. For example, what it sees and what it hears has to be harmonious. And so you need that kind of AI, those kind of sensor computing at the edge. +And so we're seeing a ton of excitement around this area. Some people call it intelligent edge, some people call it edge computing. And now with 5G networks coming, we're seeing a lot of interest around the edge computing servers that we're making. And so those are the activities that we're seeing. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [19] +-------------------------------------------------------------------------------- + + As a quick follow-up on the gaming site, Colette, can you characterize product mix within gaming? You saw in the current quarter -- you cited mix is one of the key reasons why gross margins were down year-over-year, albeit off a high base. Going into Q2 in the back half, would you expect SKU mix within gaming to improve or stay the same? I asked because it's important for gross margins obviously. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, when you look at our sequential gross margin increase, that will be influenced by our larger revenue -- our larger revenue and better mix, which you are correct, is our largest driver of our overall gross margin. However, we will be beginning the Nintendo Switch backup, and that does have lower gross margins than the company average, influencing therefore Q2 gross margin guidance that we had provided. As we look forward towards the rest of the year, we think mix and the higher revenue again will influence and likely rise our overall gross margins for the full year. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [22] +-------------------------------------------------------------------------------- + + You talked quite a bit about GeForce NOW in the prepared remarks and at the Analyst Day. It seems like cloud gaming is going to be a big topic at E3. Is that going to be your preferred way to go to market with cloud gaming? And do you expect to sell GPUs to sort of traditional cloud vendors in non-GeForce NOW fashion? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [23] +-------------------------------------------------------------------------------- + + Yes. Our strategy for cloud gaming is to extend our PC position for GeForce gamers into the cloud, and our strategy for building out our network is partnerships with telcos around the world. And so we'll build out some of it. And on top of the service, we have our entire PC gaming stack. And when we host the service, we'll move to a subscription model. And with our telcos around the world who would like to provision the service at their edge servers, and many of them would like to do so in conjunction with our 5G telco services to offer cloud gaming as a differentiator. And all of these different countries where PC exposure has been relatively low, we have an opportunity to extend our platform out to that billion PC gamers. And so that's our basic strategy. +We also offer our edge server platform to all of the cloud service providers. Google has NVIDIA GPU graphics in the cloud, amazon has NVIDIA GPU graphics in the cloud and Microsoft has NVIDIA GPU graphics in the cloud. And these GPUs will be fantastic also for cloud gaming and workstation graphics and also ray tracing. And so the platform is capable of running all of the things that NVIDIA runs, and we try to put it in every data center, in every cloud from every region that's possible. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [25] +-------------------------------------------------------------------------------- + + I actually had a clarification for Colette and a question for Jensen. Colette, are you now satisfied that the PC gaming business is operating at a normal level when you look at the Q2 guidance? Like are all the issues regarding inventory and other issues, are they over? Or do you think that the second half of the year is more the normalized run rate for your PC gaming business? +And then Jensen, on the data center, NVIDIA has dominated the training market. Inference sounds a lot more fragmented and competitive. There's a lot of talk of software being like more at the framework level. How should we get the confidence that your lead in training will help you maintain a good lead in inference also? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + Thanks for the question. So let's start with your first part of the question regarding how we reach overall normalized gaming levels. When we look at our overall inventory in the channel, we believe that this is relatively behind us and moving forward that it will not be an issue. Going forward, we will probably reach normalized level for gaming somewhere between Q2 and Q3 similar to our discussion that we had back at Analyst Day, at the beginning of the quarter. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [27] +-------------------------------------------------------------------------------- + + NVIDIA's strategy is accelerated computing. It is very different than an accelerator strategy. For example, if you were building a smart microphone, you need an accelerator for speech recognition, ASR. Our company is focused on accelerated computing, and the reason for that is because the world's body of software is really gigantic, and the world's body of software continues to evolve. And AI is nowhere near done. We're probably at the first or a couple of innings of AI at that. And so the amount of the software and the size of the models are going to have to continue to evolve. +Our accelerated computing platform is designed to enable the computer industry to bring forward into the future all the software that exists today, whether it's TensorFlow or Caffe or PyTorch or it could be classical machine learning algorithms like XGBoost, which is actually right now the most popular framework and machine learning overall. And there's so many different types of classical algorithms and not to mention all of the handwritten engineered algorithms by programmers. And those algorithms and those hand-engineered algorithms also would like to be mixed in with all of the deep learning or otherwise classical machine learning algorithms. +This whole body of software doesn't run on a single function accelerator. If you would like that body of software to run on something, it would have to be sufficiently general purpose. And so the balance that we made was we invented this thing called a Tensor Core that allows us to accelerate deep learning to the speed of light. Meanwhile, it has the flexibility of CUDA so that we can bring forward everything in classical machine learning as people have started to see with RAPIDS and is being announced, being integrated into machine learning pipelines, in the cloud and elsewhere, and then also all of the high-performance computing applications or computer vision algorithms, image processing algorithms that don't have deep learning or machine learning alternatives. And so our company is focused on accelerated computing. +And speaking of inference, that's one of the reasons why we're so successful in inference right now. We're seeing really great pickup. And the reason for that is because the type of models that people want to run on one application, and let's just use one application, one very, very exciting one, conversational AI, you would have to do speech recognition. You would have to then do natural language understanding to understand what the speech is. You might have to convert -- you have to translate to another language. Then you have to do something related to maybe making a recommendation or making a search. And then after that, you have to convert that recommendation and search and the intent into speech. While some of it could be 8-bit integers, some of it really wants to be 16-bit floating point. And some of it because of development state of it may want to be in 32-bit floating point. And so the mixed precision nature and the computational algorithm nature or flexibility nature of our approach make it possible for cloud providers and people who are developing AI applications to not have to worry about exactly what model it runs or not. We run every single model. And if it doesn't currently run, we'll help you make it run. +And so the flexibility of our architecture and the incredible performance in deep learning is really a great balance and allows customers to deploy it easily. So our strategy is very different than an accelerator. I think the only accelerators that I really see successful at the moment are the ones that go into smart speakers. And surely, there are a whole bunch being talked about, but I think the real challenge is how to make it run real, real workloads. And we're going to keep cranking along in our current strategy and keep raising the bar as we have in the past. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29] +-------------------------------------------------------------------------------- + + This is a question for Colette. Colette, so you said inference and rendering within data center were both up very strongly. But I guess that has to imply that like the training/acceleration pieces is quite weak, even weaker than the overall. And given those should be adding to efficiency, I'm just surprised it's down that much. I mean is this truly just digestion? I mean is it share? I mean like your competitor is now shipping some parts here. I mean I guess how do we get confidence that just we haven't seen the ceiling on this? I mean do you think given the trajectory, you can exit the year above the prior peaks? I guess you kind of have to given at least the qualitative outlook in the second -- I guess maybe just any color you can give us on any of those trends would be super helpful. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + Sure. As we discussed, Stacy, we are seeing many of the hyperscalers definitely purchasing in terms of the inferencing into the installment that it continues, also in terms of the training instances that they will need for their cloud or for internal use absolutely. But we have some that have paused and are going through those periods. So that -- we do believe this will come back. We do believe as we look out into the future that they will need that overall deep learning for much of their research as well as many of their workloads. So no concern on that, but right now, we do see a pause. I'll turn it over to Jensen to see if he has any additional comments. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Let's see. I think that when it comes down to training, if your infrastructure team tells you not to buy anything, the thing that suffers is time to market and some amount of experimentation that allows you to get better comps and waiting longer. And I think that for computer vision type of algorithms and recommendation type of algorithms, those -- that posture may not be impossible. However, the type of work that everybody is now jumping on top of, which is natural language understanding and conversational AI and the breakthrough that Microsoft just announced, if you want to keep up with that, you're going to have to buy much, much larger machines. And I'm looking forward to that, and I expect that that's going to happen. But in the latter part of last year, Q4 and Q1 of this year, we did see pause from the hyperscalers and -- but I don't expect it to last. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [32] +-------------------------------------------------------------------------------- + + Got it. Just as a quick follow-up, I just wanted to ask about the regulatory around Mellanox in the context of what we're seeing out of China now. How do we sort of gauge the risk of, I guess, potential for the deterioration in relationships sort of spilling over on the regulatory front around that deal? We've seen that obviously with some of the other large deals in the space. What are your thoughts on that? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [33] +-------------------------------------------------------------------------------- + + Well, on first principles, the acquisition is going to enable data centers around the world, whether it's U.S. or elsewhere in China, to be able to advance much, much more quickly. We're going to invest and building infrastructure technology. And as a combined company, we'll be able to do that much better. And so this is good for customers, and it's great for customers in China. The 2 matters, whether it's -- the 2 matters that we're talking about are just -- are different. And one is related to competition in a -- with respect to our acquisition, the competition in the market, and the other one is related to trade. And so the 2 matters are just different. And in our particular case, we bring so much value to the marketplace in China, and I'm confident that the market will see that. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + And your next question comes from the line of C.J. Muse with Evercore ISI. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [35] +-------------------------------------------------------------------------------- + + I guess a question on the noncloud part of your data center business. So if you think about the trends you're seeing in enterprise virtualization, in HPC and all the work you're doing around RAPIDS, rendering, et cetera, can you kind of talk through the visibility you have today for that part of your business? I think that's roughly 50% of the mix. So is that a piece that you feel confident you can grow in 2019? And any color around that would be appreciated. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + We expected to grow in 2019. The -- a lot of our T4 inference work is related to what people call edge computing. And it has to be done at the edge because of the amount of data that otherwise would be transferred to the cloud is just too much. It has to be done at the edge because of data sovereignty issues and data privacy issues. And it has to be done at the edge because the latency requirement is really, really high. It has to respond basically like a reflex and to make a prediction or make a suggestion or stop a piece of machinery instantaneously. And so a lot of that work, a lot of the work that we're doing in T4 inference is partly in the cloud, a lot of it is at the edge. +T4 servers for enterprise were announced, I guess, about halfway through the quarter. And the OEMs are super excited about that because the number of companies in the world who want to do data analytics, predictive analytics is quite large, and the size of the data is growing so significantly. And with Moore's Law ending, it's really hard to power through terabytes of data at a time. And so we've been working on building the software stack from the new memory architectures and storage architectures all the way to the computational middleware, and it's called RAPIDS. And I appreciate you saying that, and that's being put together. And the activity in GitHub is just fantastic. And so you can see all kinds of companies jumping in to make contributions because they would like to be able to take that open-source software and run it in their own data center on our GPUs. And so I expect the enterprise side of our business, both for enterprise big data analytics or for edge computing, to be a really good growth driver for us this year. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [37] +-------------------------------------------------------------------------------- + + And a follow-up real quickly on auto. It's a business that you talked about, more R&D focused, but clearly I think has surprised positively. What's the visibility like there? And how should we think about growth trajectory into the second half of the year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [38] +-------------------------------------------------------------------------------- + + Our automotive strategy has several components. There's the engineering component of it where we -- our engineers and their engineers have to codevelop the autonomous vehicles. And then there's 3 other components. There's the component of AI computing infrastructure we call DGX and/or any of the OEM service that include our GPUs that are used for developing the AIs. The cars are collecting a couple of terabytes per day per test car, and all of that data has to be powered through and crunched through in the data center. And so we have an infrastructure of what we call DGX that people could use, and we're seeing a lot of success there. +We just announced this last quarter, a new infrastructure called Constellation that lets you essentially drive thousands and thousands of test cars in your data center, and they're all going through pseudo-directed random or directed scenarios that allows you to either test untestable scenarios or regress against previous scenarios, and we call that Constellation. And then lastly, after working on a car for several years, we would install the computer inside the car, and we call that DRIVE. +And so these are the 4 components of opportunities that we have in the automotive industry. We're doing great in China. There's a whole bunch of electric vehicles being created. The robotaxis' developments around the world largely use NVIDIA's technology. We recently announced the partnership with Toyota. There's a whole bunch of stuff that we're working on, and I'm anxious to announce them to you. +But this is an area that is the tip of the iceberg of a larger space we call robotics and computing at the edge. But if you think about the basic computational pipeline of a self-driving car, it's no different essentially than a smart retail or the future of computational medical instruments, agriculture, industrial inspection, delivery drones, all basically use essentially the same technique. And so this is the foundational work that we're going to do for a larger space that people call the intelligent edge or computing at the edge. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Chris Caso with Raymond James. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [40] +-------------------------------------------------------------------------------- + + First question is on notebooks and just to clarify what's been different from your expectations this year. Is it simply that the OEMs didn't launch the new models you'd expected given the shortage? Or is it more just about unit volume? And then just following up on that, what's your level of confidence in that coming back to be a driver as you go into the second half of the year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [41] +-------------------------------------------------------------------------------- + + In Q2, we were -- we had to deal with some CPU shortage issues at the OEMs. It's improving, but the initial ramp will be affected. And so the CPU shortage situation has been described fairly broadly, and it affected our initial ramp. We don't expect it to affect our ramp going forward. And the new category of gaming notebooks that we created called Max-Q has made it possible for really amazing gaming performance to fit into a thin and light. And these new generations of notebooks with our Max-Q design and the Turing GPU, which is super energy efficient, in combination, made it possible for OEMs to create notebooks that are both affordable all the way down to $799, thin and really delightful, all the way up to something incredible with RTX 2080 and a 4K display. And these are thin notebooks that are really beautiful that people would love to use. +And this -- the invention of the Max-Q design method and all the software that went into it that we announced last year, we had -- I think last year, we had some 40 notebooks or so, maybe a little bit less than that. And this year, we have some 100 notebooks that are being designed at different price segments by different OEMs across different regions. And so I think this year is going to be quite a successful year for notebooks. And it's also the most successful segment of consumer PCs. It's the fastest-growing segment. It is very largely underpenetrated because until Max-Q came along, it wasn't really possible to design a notebook that is both great in performance and experience and also something that a gamer would like to own. And so finally, we've been able to solve that difficult puzzle and created powerful gaming machines that are inside a notebook that's really wonderful to own and carry around. +And so this is going to be a really -- this is a fast-growing segment, and all the OEMs know it. And that's why they put so much energy into creating all these different types of designs and styles and sizes and shapes. And we have 100 Turing GPU notebooks, gaming PCs ramping right now. + +-------------------------------------------------------------------------------- +Christopher Caso, Raymond James & Associates, Inc., Research Division - Research Analyst [42] +-------------------------------------------------------------------------------- + + That's very helpful. As a follow-up, I just want to follow up on some of the previous questions on the automotive market. And we've been talking about it for a while. Obviously, the design cycles are very long, so you do have some visibility, and I guess the question is when can we expect an acceleration of auto revenue. Is next year the year? And then what will be the driver of that in terms of dollar contribution? I presume some of the Level 2+ things you've been talking about would probably mean most likely they're given the amount of volume there. If you can confirm that and just give some color on expectations for drivers. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [43] +-------------------------------------------------------------------------------- + + Yes. Level 2+, call it 2020, late 2021 or like 2022-ish. So that's Level 2+. I would say 2019, very, very early for robotaxis; next year, substantially more volume for robotaxis; 2021, bigger volumes for robotaxis. The ASP differences, the amount of computation you put into a robotaxi because of sensor resolutions, sensor diversity and redundancy, the computational redundancy and the richness of the algorithm, all of it put together, it's probably an order of magnitude plus in computation. And so the economics would reflect that. And so that robotaxi is kind of like next year, the year after, ramp. And then think of Level 2+ as 2021, 2022. +Overall, remember that our economics come from 4 different parts. And so there's the NRE components of it, there's the AI development infrastructure, computing infrastructure part of it, the simulation part of it called Constellation and then the economics of the car. And so we just announced Constellation. The enthusiasm around it is really great. Nobody should ever ship anything they don't simulate. And my expectation is that billions of miles will get simulated inside a simulator long before they'll ship it. And so that's a great opportunity for Constellation. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And the next question comes from the line of Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [45] +-------------------------------------------------------------------------------- + + I have a few questions, one for Jensen and one for Colette. I guess, Jensen, you've done -- you said in many forums that the move down to the new process node at 7-nanometer across the business was not really sufficient to have a platform approach, and I agree with that. But maybe you could talk a little bit about your product plans at least in general terms around a 7-nanometer franchise in the gaming business and also in your training accelerator program. And I wonder if that might be waiting for some of those products or at least anticipation of those might be the cause of a little bit of a pause here. +And secondly, Colette, maybe you could talk us through your expectations. I understand there's a lack of visibility in certain parts of the business on revenue, but maybe you could talk about OpEx trends through the rest of the year where you might have a little more visibility. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [46] +-------------------------------------------------------------------------------- + + The entire reason for Q4 and Q1 is attributed to oversupply in the channel as a result of cryptocurrency. It has nothing to do with Turing. In fact, Turing is off to a faster start than Pascal was, and it continues to be on a faster pace than Pascal was. And so the pause in gaming is now behind us. We're in a growth trajectory with gaming. RTX has -- took the lead on ray tracing and has now become the standard for next-generation gaming, support from basically every major platform and software provider on the planet. And our notebook growth is going to be really great because of the Max-Q design that we invented. And the last couple of quarters would also intersect it with -- overlap with the seasonal slowdown that -- not sell but build -- the seasonal builds of the Nintendo Switch, and we're going to go back to the normal build cycle. +And as Colette said earlier, somewhere between Q2 and Q3, we'll get back to normal levels for gaming. And so we're off to a great start in Turing, and I'm super excited about that. And in the second half of the year, we would have fully ramped up from top to bottom our Turing architecture, spanning everything from 179 to as high performance as you like. And we have the best price, best performance and best GPU at every single price point. And so I think we're in a pretty good shape. +In terms of process nodes, we tend to design our own process with TSMC. If you look at our process and you measure its energy efficiency, it's off the charts. And in fact, if you take our Turing and you compare it against a 7-nanometer GPU on energy efficiency, it's incomparable. In fact, the world's 7-nanometer GPU already exists. And it's easy to go and pull that and compare the performance and energy efficiency against one of our Turing GPUs. And so the real focus for our engineering team is to engineer a process that makes sense for us and to create an architecture that is energy efficient. And the combination of those 2 things allows us to sustain our leadership position. Otherwise, buying off the shelf process is something that we can surely do, but we want to do much more than that. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [47] +-------------------------------------------------------------------------------- + + Okay. And to discuss your question regarding OpEx trajectory for the rest of the year, we're still on track to our thoughts on leaving the fiscal year with a year-over-year growth and overall OpEx on a non-GAAP basis in the high single digits. We'll see probably an increase sequentially quarter-to-quarter along there, but our year-over-year growth will start to decline as we will not be growing at the speed that we did in this last year. But I do believe we're on track to meet that goal. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + And I'll now turn back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [49] +-------------------------------------------------------------------------------- + + Thanks, everyone. We're glad to be returning to growth. We are focused on driving 3 growth strategies. First, RTX ray tracing. It's now clear that ray tracing is the future of gaming and digital design, and video RTX is leading the way. With the support of Microsoft DXR, Epic, Unity, Adobe and Autodesk, game publishers like EA, movie studios like Pixar, industry support has been fantastic. +Second, accelerated computing and AI computing. The pause in hyperscale spending will pass. Accelerated computing in AI are the greatest forces in computing today, and NVIDIA is leading these movements. Whether cloud or enterprise or AI at the edge for 5G or industries, NVIDIA's one scalable architecture from cloud to edge is the focal point platform for the industry to build AI upon. +Third, robotics. Some call it an embedded AI, some edge AI or autonomous machines. The same computing architecture is used for self-driving cars, pick-and-place robotics arms, delivery drones and smart retail stores. Everything machine -- every machine that moves or machines that watch other things that move, whether with driver or driverless, will have robotics and AI capabilities. Our strategy is to create an end-to-end platform that spans NVIDIA's DGX AI computing infrastructure to NVIDIA Constellation simulation to NVIDIA AGX embedded AI computing. +And finally, we are super excited about the pending acquisition of Mellanox. Together, we can advance cloud and edge architectures for HPC and AI computing. See you next quarter. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + And this concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2019-Nov-14-NVDA.txt b/Transcripts/NVDA/2019-Nov-14-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..33f363cd5a35986bb5b9900c1d8bffb018ccf968 --- /dev/null +++ b/Transcripts/NVDA/2019-Nov-14-NVDA.txt @@ -0,0 +1,403 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2020 NVIDIA Corp Earnings Call +NOVEMBER 14, 2019 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Harsh V. Kumar + Piper Jaffray Companies, Research Division - MD & Senior Research Analyst + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Mitchell Toshiro Steves + RBC Capital Markets, Research Division - Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Christina, and I'm your conference operator for today. Welcome to NVIDIA's Financial Results Conference Call. (Operator Instructions) +I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the third quarter of fiscal 2020. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the fourth quarter of fiscal 2020. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Form 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, November 14, 2019, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. Q3 revenue was $3.01 billion, down 5% year-on-year and up 17% sequentially. +Starting with our gaming business. Revenue of $1.66 billion was down 6% year-on-year and up 26% sequentially. Results exceeded our expectations driven by strength in both desktop and notebook gaming. Our GeForce RTX lineup features the most advanced GPU for every price point and uniquely offers hardware-based ray tracing for cinematic graphics. While ray tracing launched a little more than a year ago, 2 dozen top titles have shipped with it or are on the way. Ray tracing is supported by all the major publishers, including all-star titles and franchise such as Minecraft, Call of Duty, Battlefield, Watch Dogs, Tomb Raider, Doom, Wolfenstein and Cyberpunk. Of note, Call of Duty: Modern Warfare, had a record-breaking launch in late October that came on heels of CONTROL, an action-adventure game with multiple ray trace features. Reviews have praised both for their ray tracing implementation and game-play performance. With last week's PC release of Red Dead Redemption 2 as a strong gaming lineup for the holiday season, our business reflects this growing excitement. RTX GPUs now drive more than 2/3 of our desktop gaming GPU revenue. +Gaming laptops were a standout, driving strong sequential and year-on-year growth. This holiday season, our partners are addressing the growing demand for high-performance laptops for gamers, students and prosumers by bringing more than 130 NVIDIA-powered gaming and studio laptop models to market. This includes many thin and light form factors enabled by our Max-Q technology, triple the number of Max-Q laptops last year. +In late October, we announced the GeForce GTX 1660 Super and the 1650 Super, which refresh our mainstream desktop GPUs with more performance, faster memory and new features. The 1660 Super delivers 50% more performance than our prior-generation Pascal-based 1060, the best-selling gaming GPU of all time. It began shipping on October 29, priced at just $229. PC World called it the best GPU you can buy for 1080p gaming. +We also announced the next generation of our streaming media player with 2 new models, Shield TV and Shield TV Pro, which launched on October 28. These bring AI to the streaming market for the first time with the ability to upscale video real time from high definition to 4K using NVIDIA-trained deep neural networks. Shield TV has been widely recognized as the best streamer on the market. +Finally, we made progress in building out our cloud gaming business. Two global service providers, Taiwan Mobile and Russia's Rostelecom with GFN.ru joined SoftBank and Korea's LG as partners for our GeForce NOW game-streaming service. Additionally, Telefónica will kick off a cloud gaming proof-of-concept in Spain. +Moving to data center. Revenue was $726 million, down 8% year-on-year and up 11% sequentially. Our hyperscale revenue grew both sequentially and year-on-year, and we believe our visibility is improving. Hyperscale activity is being driven by conversational AI, the ability for computers to engage in human-like dialogue, capturing context and providing intelligent responses. Google's breakthrough, introduction of the BERT model, with its superhuman levels of natural language understanding, is driving a way of neural networks for the language understanding. That, in turn, is driving demand for our GPUs on 2 fronts. First, these models are massive and highly complex. They have 10 to 20x, in some cases 100x, more parameters than image-based models. As a result, training these models requires V100-based compute infrastructure that, in orders of magnitude, beyond what is needed in the past. Model complexity is expected to grow significantly from here. +Second, real-time conversational AI requires very low latency and multiple neural networks running in quick succession from de-noising to speech recognition, language understanding, text-to-speech and voice encoding. While conventional approaches fail at these tasks, NVIDIA's GPUs can handle the entire inference chain, in less than 30 milliseconds. This is the first AI application where inference requires acceleration. Conversational AI is a major driver for GPU-accelerated inference. +In addition to this type of internal hyperscale activity, our T4 GPU continue to gain adoption in public clouds. In September, Amazon AWS announced general availability of the T4 globally, following the T4 rollout on Google Cloud platform earlier in the year. We shipped a higher volume of T4 inference GPU this quarter with V100 training GPUs, and both were records. Inference revenue more than doubled from last year and continued a solid double-digit percentage of total data center revenue. +Last week, the results of the first industry benchmark for AI inference, MLPerf inference, were announced. We won. In addition to demonstrating the best performance among commercially available solutions for both data center and edge applications, NVIDIA accelerators were the only ones that completed in all 5 MLPerf benchmarks. This demonstrates the programmability and performance of our computing platform across diverse AI workloads, which is critical for wide-scale data center deployment and is a key differentiator for us. +Several product announcements this quarter helped extend our AI computing platform into new markets, the enterprise edge. At Mobile World Congress, Los Angeles, we announced a software-defined 5G wireless RAN solution accelerated by GPUs in collaboration with Ericsson. This opens up the wireless brand market to NVIDIA GPUs. It enables new AI applications as well as AR, VR and gaming to be more accessible to the telco edge. +We announced the NVIDIA EGX Intelligent Edge Computing Platform. With an ecosystem of more than 100 technology companies worldwide, early adopters include Walmart, BMW, Procter & Gamble, Samsung Electronics, NTT East and the cities of San Francisco and Las Vegas. Additionally, we announced a collaboration with Microsoft on intelligent edge computing. This will help industries better manage and gain insights from the growing flood of data created by retail stores, warehouses, manufacturing facilities and urban infrastructure. +Finally, last week, we held our GPU Technology Conference in Washington, D.C., which was sold out with more than 3,500 registered developers, CIOs and federal employees. At the event, we announced that the U.S. Postal Service, the world's largest delivery service with almost 150 billion pieces of mail delivered annually, is adopting AI technology from NVIDIA, enabling 10x faster processing of package data and with higher accuracy. +Moving to ProVis. Revenue reached a record $324 million, up 6% from the prior year and up 11% sequentially driven primarily by mobile workstations. NVIDIA RTX graphic and Max-Q technology have enabled a new wave of mobile workstations that are powerful enough for design applications yet thin and light enough to carry. We expect this to become a major new category with exciting growth opportunities. +Over 40 top creative design applications are being accelerated with RTX GPUs. Just last week, at the Adobe Max Conference, RTX accelerated capabilities were added to 3 Adobe Creative apps. RTX-accelerated apps are now available to tens of millions of artists and designers, driving demand for our RTX GPUs. We also continue to see growing customer deployment of data science, AI and VR applications. Strong demand this quarter came from manufacturing, public sector, higher education and health care customers. +Finally, turning to automotive. Revenue was $162 million, down 6% from a year ago and down 22% sequentially. The sequential decline was driven by a onetime nonreoccurring development services contract recognized in Q2. Additionally, we saw a roll-off of legacy infotainment revenue and general industry weakness. Our AI cockpit business grew driven by the continued ramp of the Daimler as they deploy their AI-based infotainment systems across their fleet of Mercedes-Benz vehicles. +In August, Optimus Ride launched New York City's first autonomous driving pilot program powered by NVIDIA DRIVE. Urban settings pose unique challenges for autonomous vehicles given the number of density of objects that need to be perceived and comprehended in real time. Our DRIVE computer and software stack allows these shuttles to safely and effectively provide first- and last-mile transit services. We remain excited about the long-term opportunity in auto. Our offering is -- consists of in-car AV computing platforms as well as GPU servers for all AI development and simulation. We believe we are well positioned in the industry with leading end-to-end platform that enables customers to develop, test and safely operate autonomous vehicles, ranging from cars and trucks to shuttles and robo-taxis. +Moving to the rest of the P&L. Q3 GAAP gross margins was 63.6%, and non-GAAP was 64.1%, up sequentially, reflecting a benefit from sales of previously written-off inventory, higher GeForce GPUs average selling prices and lower component costs. GAAP operating expenses were $989 million, and non-GAAP operating expenses were $774 million, up 15% and 6% year-on-year, respectively. GAAP EPS was $1.45, down 26% from a year earlier. Non-GAAP EPS was $1.78, down 3% from a year ago. Cash flow from operations was a record $1.6 billion. +With that, let me turn to the outlook for the fourth quarter of fiscal 2020, which does not include any contribution from the pending acquisition of Mellanox. +We expect revenue to be $2.95 billion, plus or minus 2%. This reflects expectations for strong sequential growth in data center, offset by a seasonal decline in notebook GPUs for gaming and Switch-related revenue. GAAP and non-GAAP gross margins are expected to be 64.1% and 64.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $1.02 billion and $805 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of approximately $25 million. GAAP and non-GAAP tax rates are both expected to be 9%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $130 million to $150 million. Further financial details are included in the CFO commentary and other information available on our IR website. +In closing, let me highlight the upcoming events for the financial community. We will be at the Crédit Suisse Annual Technology Conference on December 3, Deutsche Bank's Auto Tech Conference on December 10 and Barclays Global Technology, Media and Telecommunications Conference on December 11. +We will now open the call for questions. Operator, would you please poll for questions? + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And your first question comes from the line of Vivek Arya with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- + + For my first one, you mentioned that you were seeing strong sequential growth in the data center going into Q4. Jensen, I was wondering if you could give us some color on what's driving that, and just how you think about the sustainability of data center growth going into next year and what markets do you think will drive that. Is it more enterprise, more hyperscale, more HPC? Just some color on near and longer term on data center. And then I have a follow-up for Colette. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes. Thanks a lot, Vivek. We had a strong Q3 in hyperscale data centers. As Colette mentioned earlier, we shipped a record number of V100s and T4s. And for the very first time, we shipped more T4s than V100. And most of the T4s are driven by inference. In fact, our inference business is now a solid double-digit, and it doubled year-over-year. And all -- most -- that is really driven by several factors. The -- as you know, we've been working on deep learning for some time, and people have been developing deep learning models. It started with computer vision. But image recognition doesn't really take that much of the data center capacity. +Over the last couple of years, a couple of very important developments have happened. One development is a breakthrough in using deep learning for recommendation systems. As you know, recommendation systems is the backbone of the Internet. Whenever you do shopping, whenever you're watching movies, looking at news, doing search, all of the personalized web pages, all of just about your entire experience on the Internet is made possible by recommendation systems because there is just so much data out there putting the right data in front of you based on your social profile or your personal use patterns or your interest or your connections. All of that is vitally important. For the very first time, we're seeing recommendation system based on deep learning throughout the world. And so increasingly, you're going to see people roll this out. And the backbone of the Internet is now going to be based on deep learning. +The second part is conversational AI. Conversational AI has been coming together in pieces; at first, speech recognition, which requires some amount of noise processing or beam forming. Then you go into speech recognition. Then it goes to natural language understanding, which then gets connected to a recommendation system, which then gets connected to text-to-speech and a speech encoder. And then that has to be done very, very quickly. Whereas images could be done off-line, conversation has to be done in real time. And without acceleration and without NVIDIA's accelerators, it's really not possible to do it in real time. It takes seconds to process all of the handful of deep learning models, and now we're able to do that all on an accelerator and do it in real time. +And so the combination of these various breakthroughs from deep learning-based recommenders, the speech stack as well as natural language understanding breakthrough in what is called a bidirectional encoded transformer, that breakthrough is really quite significant. And since then, derivative works have come from that approach. And natural language understanding is really, really working incredibly well. And so what we're seeing people do is -- the hyperscalers across the world, we work with just about everybody, this area of work is really complicated. The models are very, very large. There's a whole bunch of models that has to work together, and they're getting larger. And so that's one large category, which is the hyperscalers. +The second, which we introduced this quarter, is really about taking AI out to the edge. And the reason for that is because there are many applications, whether it's based on video or other types of sensors of all kinds where there's a vibration sensor, temperature sensors, barometric sensor. There's all kinds of sensors that are used in industries to monitor the health of equipment, monitor the conditions of various situations. And you want to do the processing at the point of action. This way, you don't have to screen the data, which is continuous back into the cloud, which costs a lot of money. You want to take the action at the point of action because latency matters. Maybe you're controlling gates or vehicles or robots or drones or whatnot. +And then lastly, one major issue is data sovereignty. Maybe your company doesn't own all of the data that you are processing and, therefore, you have to do that processing at the edge, and you can't afford to put that into the cloud. And so these various industries: retail, warehouse, logistics, smart cities, we're just seeing so much enthusiasm there around that. And this -- so we built a platform called the EGX, which basically is a cloud native, completely secure, takes advantage of NVIDIA's full stack of every single model. And it's managed with Kubernetes remotely, and you could deploy these services at the edge in faraway places because IT departments can't afford to go out there to manage them. And we've seen some really great adoption. We announced this last quarter. Walmart is using our platform. BMW is using it for logistics, Procter & Gamble for manufacturing, Samsung Electronics for manufacturing, visual inspection. And then last week, we announced probably the largest logistics operation in the world, the United States Postal Service. +And so those are -- I would say that intelligent edge will likely be the largest AI industry in the world for rather clear reasons. If you just kind of estimated the size of retail, it's nearly $30 trillion. And if retail stores could be made a little bit more convenient, it could save the industry a lot of money: warehouses, logistics, transportation, farming. I think there's like 0.5 million farms in the world, covers 1/3 of the world's land mass. And so there's a lot of places where AI could be put at the edge and could make a big difference. And I think this is going to be the grand adventure that we started this last quarter with the announcement of NVIDIA EGX. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [4] +-------------------------------------------------------------------------------- + + Right. And Jensen, as quick follow-up, on PC gaming, how are you looking at growth going forward in that you had a very good quarter in October? I think in January, you're probably guiding to some seasonal declines, but I imagine a lot more of that is due to console decline. Just how are you looking at PC gaming growth going into October -- into January and then next year as you get competition from 2 new consoles that are also supposed to come out? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [5] +-------------------------------------------------------------------------------- + + Yes. The -- during Q3 -- during Q4 and Q1, we see normal seasonal declines of console builds, and we also see a normal seasonal decline of notebook builds. And the reason for that is because the notebook vendors have to line up all their manufacturing in Q3 so that they could meet the hot selling season in Q4. And so we're seeing -- what we see in the Q4 and Q1 time frame are just normal seasonal declines of these systems. Overall, for PC gaming -- and RTX is doing fantastic. Let me tell you why it's so important. I would say that at this point, I think it's fairly clear that ray tracing is the future and that RTX is a home run. Just about every major game developer has signed on to ray tracing. Even the next-generation consoles had to stutter step and include ray tracing in their next-generation consoles. The effects -- the photorealistic look is just so compelling, it's not possible to really go back anymore. And so I think that it's fairly clear now that RTX ray tracing is the future. And there are several hundred million PC gamers in the world that don't have the benefits of it, and I'm looking forward to upgrading them. +Second, and this is a combination of RTX and Max-Q, we really created a brand-new game platform, notebook PC gaming. Notebook PC gaming really didn't exist until Max-Q came along. And our second-generation Max-Q, this last season, really turbocharged this segment. Over 100 laptops now are available for PC gaming. And my sense is that this is likely going to be the largest gaming platform, new gaming platform that emerges. And we're just in the beginning innings of that. And so the combination of upgrading the entire installed base of PC gamers to RTX and ray tracing and this new gaming segment called notebook PC gaming is really quite exciting, and it's going to drive our continued growth for some time. And so I'm excited about that. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [7] +-------------------------------------------------------------------------------- + + I have a follow-up if I can as well. Just thinking about the trajectory of gross margin here, solid gross margin upside in the quarter, you also noted that you had the benefit of selling through some written-off components. So I guess first question is what was that impact in this most recent reported quarter. And how do we think about the trajectory of gross margin here even beyond the January quarter? What should we be thinking about in terms of that gross margin trend? And again, I have a quick follow-up. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- + + Sure. Thanks for the question. In the current quarter, the net benefit, as we refer to as the net release of our inventory provisions primarily associated with our components, was about 1 percentage point to our overall gross margin. As you know, going forward, mix is still the largest driver of our gross margin over time. Over the long term, we do expect gross margins to improve, and we'll continue to see, outside of the benefit that we received, gross margin improvement for the long term. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- + + Yes. As you know, just to add to that, as you know, NVIDIA's really become a software company. If you take a look at almost all of our products, the GPU -- having the world's best GPU, of course, is the starting point. But almost everything that we do, whether it's in artificial intelligence or data analytics or health care or robotics or self-driving cars, almost all of these platforms: gaming, rendering, cloud graphics, all of these platforms start from a really rich stack of software. And you can't just put a chip in these scenarios and they work. And so most of our businesses are now highly software-rich, and they address verticals that we focus on. And then secondarily, we're a platform company. And so our platform is available from all the OEMs and cloud providers. And as a platform company that has a great deal of software intensity, it's natural that the margins would be higher over time. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [10] +-------------------------------------------------------------------------------- + + Yes. Very helpful. And then you mentioned in your prepared remarks that you've seen hyperscale -- your hyperscale business within data center grow both on a quarter-over-quarter as well as year-over-year basis in this last print. You also mentioned that your visibility is improving. Can you just help us understand what exactly you're seeing in the hyperscale guys because it feels like there's some mixed data points out there? What underpins your improved visibility? Or what are you seeing in that piece of your business? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [11] +-------------------------------------------------------------------------------- + + Yes. We had a strong Q3. We're going to see a much stronger Q4. And the foundation of that is AI, it's deep learning inference. That is -- this deep learning inference is understandably going to be one of the largest computer industry opportunities. And the reason for that is because the computation intensity is so high. And for the very first time, aside from computer graphics, this mode of software is not really practical without accelerators. And so I mentioned earlier about the large-scale movement to deep learning recommendation systems. Those models are really, really hard to train. +I mentioned earlier about conversational AI. Because conversation requires real-time processing, several seconds is really not practical. And so you have to do it in milliseconds, tens of milliseconds. And our accelerator makes that possible. What makes it really complicated and the reason why -- although so many people talk about it, only we demonstrated -- we submitted all 5 results -- all 5 tests for the MLPerf inference benchmark, and we won them. And the reason for that is because it's far more than just a chip. The software stack that sits on top of the chip and the compilers that sits on top of the chip are so complicated. And it's understandably complicated because a supercomputer wrote the software, and this body of software is really, really large. And if you have to make it both accurate as well as performant, it's really quite a great challenge. And it's one of the great computer science challenges. This is one of those problems that hasn't been solved, and we've been working hard at it for the last 6, 7 years now. +And so this is really the great opportunity. We've been talking about inference for some time now. Finally, the workloads and a very large diverse set of workloads are now moving into production. And so I'm hoping -- I'm enthusiastic about the progress and seeing the trends and the visibility that inference should be a large market opportunity for us. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Your next question comes from the line of C.J. Muse with Evercore ISI. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- + + I guess I'd love to follow on, on that last question. So clearly, your commentary, Jensen, here is much more bullish than I've heard you, I think, before on inference, particularly as it relates to this first benchmark. And so I guess can you talk a bit about how you see mix within data center looking out over the next 12, 24 months as you see kind of training versus inference as well as cloud versus enterprise, considering, I would think, inference over time could be -- could grow into a large opportunity there as well? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [14] +-------------------------------------------------------------------------------- + + Yes. C.J., that's really good. Let me break it down. So when we think about hyperscale, there are 3 parts: training, inference and public cloud. +Training, you might have seen the work that was done at open AI recently where they've been measuring and monitoring the amount of computation necessary to train these large models. These large models are now only getting larger. The amount of data necessary, therefore, has to scale as well. The computation is now growing and doubling every 3 months. And the reason for that is because of recent breakthroughs in natural language understanding. And all of a sudden, a whole wave of problems are now able to be solved. And just as AlexNet 7 years ago kind of was the watershed event for a lot of computer vision-oriented AI work, now the transformer-based natural language understanding model and the work that Google did with BERT really is a watershed event also for natural language understanding. This is, of course, a much, much harder problem. And so the scale of the training has grown tremendously. I think what we're going to see this year is a fair number of very sizable installations of GPU systems to do this very thing, training. +The second part is an untapped market for us, and this untapped market is really inference. The reason why I haven't really spoken about it until now is because we've never really been able to validate our intuition that inference is going to be a large market opportunity for us, that it's going to be very complicated. The models are very large. They're very diverse. They require large amount of computation, large amount of memory bandwidth and large amounts of memory and large and significant capabilities of programmability. And so I've talked about this before, but I've never been able to validate it. And of course, with MLPerf and sweeping the benchmarks and, frankly, only -- the only one although so many have attempted, they submitted results and some of them resented it, that this benchmark is just really, really hard. Inference is hard. And then finally, our business results also validated the -- our intuition. And so our engagement now with CSPs are now global. We're working across natural language understanding, recommendation systems, conversational AI, just a whole bunch of really, really interesting problems. +Now the cloud is the third piece. And the reason why cloud is growing so well and represents about half almost of many of our CSPs, particularly the ones with the public cloud, the reason for that is because the number of AI start-ups in the world is still growing so incredibly. I think we're tracking something close to 10,000 and more AI start-ups around the world. In health care, in transportation, in retail, in consumer Internet, in Fintech, the number of AI companies out there is just extraordinary. I think over the last 3 or 4, 5 years, some $20 billion, $30 billion have been invested into start-ups. And these start-ups, of course, use cloud service providers so that they don't have to invest in their own infrastructure because it's fairly complicated. And so we're seeing a lot of growth there. +And so that's just the hyperscalers. The hyperscalers give us 3 points of growth -- 3 areas of growth: training, inference and public cloud. And the public cloud is primarily AI start-ups. Then there's the intelligent edge, which we recently ventured into, and we've been building this platform called EGX for some time. And it's cloud native. It's incredibly secure. You can manage it from afar. It's -- the stack is complicated. It's performant. And we saw some -- we've been working with some early adopters. And this last quarter, we announced some of them: Walmart and BMW and Procter & Gamble and the largest logistics company in the world, USPS. And so this new platform, I think, long term, will likely be the largest opportunity. And the reason for that is because of the industries that it serves. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + There are a lot of concerns around China trade tensions, economic slowdown. But history has shown that gamers tend to be less sensitive to these macro trends and, in fact, also somewhat insensitive to price changes, at least at the enthusiast level. So given that China is such a big part of the gaming segment, can you just discuss the gaming demand trends out of this geography? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [17] +-------------------------------------------------------------------------------- + + Gaming is solid in China, and it is also the fastest adopter of our gaming notebooks. This gaming RTX notebooks or GeForce notebooks is really a brand new category. This category never existed before because we couldn't get the technology in there so that it's both delightful to own as well as powerful to enjoy. And so we saw really great success with RTX notebooks and GeForce notebooks in China, and RTX adoption has been fast. +Your comments make sense because most of the games are free-to-play these days. The primary games that people play are esports, which you want the best gear, but you could -- after you buy the gear, you pretty much enjoy it forever; and mobile, which is largely free-to-play. You invest in some of your own personal outfits. And after that, I think you can enjoy it for quite a long time. And so the gear is really important. One of the areas where we've done really great work, particularly in China, has to do with social. We have this platform called GeForCe Experience. And as an extension of that, there's a new feature called RTX Broadcast Engine. And it basically applies AI to broadcasting your content to share it. You could make movies. You could capture your favorite scenes and turn it into art, applying AI. And one of the coolest features is that you could overlay yourself on top of the game and share it with all the social networks without a green screen behind you. We use AI to stitch you out, basically, to cut you out of the background and irrespective of what noisy background you've got. +And so as you know, China has really a super hyper social community -- communities back there and they have all kinds of really cool social platforms to share games and user-generated content and short videos and all kinds of things like that. And so GeForce has that one additional feature that really makes it successful. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [19] +-------------------------------------------------------------------------------- + + I wanted to ask on automotive. Colette, in your prepared remarks, you talked about your legacy infotainment business being down in the quarter. Just curious, what percentage of automotive revenue at this point is legacy infotainment versus the newer AI/ADAS solutions? And more importantly, Jensen, if you can speak to the growth trajectory in automotive over the next 1.5 years, maybe 2, that would be appreciated. And I do ask the question because it feels like we've heard many, many announcements, customer announcements, collaborative work that you're doing with your customers, yet we haven't quite seen sort of a hockey-stick inflection that some of us were expecting a couple of years ago. So just kind of curious when we should -- how we should set our expectations going forward. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Yes. Toshiya, let me address the first question regarding our legacy infotainment systems for our automotive business. It is still representing maybe about half or more of our overall revenue in the automotive business. We have our AI cockpit continuing to grow and grow quite well, both sequentially as well as year-over-year, as well as our autonomous vehicle solutions that we may be doing, including development services. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [21] +-------------------------------------------------------------------------------- + + Let's see. The -- we're the first -- probably the first AV car that's going to be passenger-owned on the road, and I think we've talked about it before, is Volvo. And we're expecting them to be in the late 2020, early 2021 time frame. And I'm still expecting so. And then there's the 2022, 2023 generations. Most -- I would say most of the passenger-owned vehicle developments are going quite well. The industry, as you know, is under some amount of pressure, and so a lot of them have slipped it out a couple of years or so. And this is something that I think we've already spoken about in the past. +Our focus, our strategy consists of several areas. One area, of course, is passenger-owned vehicles. The second part is robot taxis. We have developments going with just about every major robot taxi company that we know of. And they're here in the states. They're in Europe. They're in China. And when you hear news of them, we're delighted to see their progress. And then the third part has to do with trucks, shuttles and increasingly a large number of vehicles that don't carry people, they carry goods. And so we have a major development with Volvo. That was Volvo Trucks. Volvo Cars and Volvo Trucks, as you know, are 2 different companies. One of them belongs to Geely, Volvo Cars. Volvo Trucks is the heritage Volvo. And we have a major program going with them to automate the delivery of goods. +You also see us during various GTCs, I'll mention companies that we're working with on grocery delivery or goods delivery or within a warehouse product delivery. You're going to see a whole bunch of things like that because the technology is very similar, and it's starting to -- the development -- the technology we develop for passenger-owned vehicles has started to propagate down into logistics vehicles. I continue to believe that everything that moves eventually will have autonomous capability or be fully autonomous. And that, I think, is, at this point, fairly certain. +Now our strategy is both in developing the in-car AV computing system, and it's software-defined, it's scalable, as well as the AI development and simulation systems. And so when somebody's working on AV and they're using AI, and most of them are, there's a great opportunity for us. And when they start ramping up and they're collecting miles of data, it becomes a very large market opportunity for us. And so I'm anxious to see every single car company be as progressive and aggressive in developing AV. And they will be. They will be. This is a foregone conclusion. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Stacy Rasgon with Bernstein. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [23] +-------------------------------------------------------------------------------- + + I have 2 data center questions for Colette. The first question, I want to return to your kind of outlook for strong sequential data center growth in Q4. Now this business grew 11% sequentially in Q3. And you didn't actually call out strong growth as we were going into the quarter. You are calling it out for Q4. Does that suggest to me that you expect sequential growth in Q4 to be stronger than Q3 given you're calling it out in Q4 and you didn't call it out in Q3? Or would you define like what you saw in Q3 as well as already being strong sequential growth? Like how do we think about the wording of that in relation to what we've seen in Q3 and what you expect for Q4? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [24] +-------------------------------------------------------------------------------- + + Sure, Stacy. When we had provided guidance in Q3 and how we finished the quarter in Q3, we had indicated that our growth would stem from both gaming and data center. We completed that. And we also had stronger than expected from guidance from both gaming and data center in our Q3 results. Moving to Q4, Q4 is a sequential decrease in totality versus Q3. We have reminded the teams about our overall seasonality that we sometimes have in gaming associated with our consoles as well as also with our notebooks that seem to be primarily in Q2 and Q3 being our strongest quarters and likely, therefore, a seasonal downtick as it move to Q4. What we wanted to do was, if we have in totality overall decline associated with that, we did want to emphasize what we are expecting in terms of data center with the overall strong growth sequentially. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- + + So I guess to ask the question again, would you define what you saw in Q3 as being strong growth as well? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- + + I would believe our growth of 17% was higher than we expected to Q3. Again, when we get into Q4, we'll see how the quarter ends in terms of data center, but we are expecting strong growth. Thanks, Stacy. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27] +-------------------------------------------------------------------------------- + + Okay. And for my second question, hyperscale you said was up year-over-year. Now -- and that's after, off of last year, where it was the peak. Inference doubled year-over-year. And this suggests to me -- I know you said enterprise was down year-over-year. But this suggests to me that it wasn't just down year-over-year, it was down a lot year-over-year. How do we think about that in the context of like the growth that we've seen very strongly over the last few quarters in enterprise. And going back to your commentary at the Analyst Day, which was almost entirely about the opportunity coming from enterprise growth, what's going on there? What drove that? And what should we expect going forward? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [28] +-------------------------------------------------------------------------------- + + Sure. Our enterprise business has been beginning to ramp from over a year ago at a very, very, very small base. We've continued to see great traction in there with a lot of the things that we've announced throughout. But keep in mind in our year ago quarter, we also had very strong systems and a very large deal associated with our DGX. So when we look from a quarter-over-quarter period or just looking at 1 quarter, we can have a little bit of lumpiness. So that year-over-year impact is really just due to an extremely large deal in the prior year Q3. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mitch Steves with RBC. + +-------------------------------------------------------------------------------- +Mitchell Toshiro Steves, RBC Capital Markets, Research Division - Analyst [30] +-------------------------------------------------------------------------------- + + I apologize for any background noise, but I just have one question, just for Jensen. So in 2018, can you give us a rough update on what the GPU utilization was for deep learning application? What it is today? I'm just wondering how the -- how that's advanced over the last couple of year or 2. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [31] +-------------------------------------------------------------------------------- + + Let's see. I would say 2018, it was nearly all related to training. And this year, we started to see the growth of inference to the point where we now -- we have now sold more -- this last quarter, we sold more T4 GPUs for inference than we sold V100s that's used for training, and both of them were record highs. And so the comment that Colette just made, comparing to year-over-year, we had a large DGX system sale a year ago that we didn't have this year. But if you excluded that, the V100 and the T4 is doing great. They're at record levels. And T4 didn't hardly existed a year ago, now it's selling more than V100s, and both of them are record highs. And so that kind of gives you a feeling for it. I think that's really the major difference that inference is really kicking into gear, and my sense is that it's going to continue to grow quite nicely. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [33] +-------------------------------------------------------------------------------- + + I wonder if you could talk a little bit more about the 5G opportunity that you announced at Mobile World. And I guess you talked a lot about AI and IoT services in a C-RAN environment. But is there -- how big is that opportunity? And can you address kind of the core compute aspect to C-RAN with the GPU? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- + + Yes. If you look at the world of mobile today, there are players that are building DRAMs and their radio heads in the BBU, basically the baseband units. In the data center where people would like to move the software for radio networks, it's really an untapped market. And the reason for that is because the CPU is just not able to support the level of performance that's necessary for 5G. And ASICs are too rigid to be able to put into a data center. And so the data center needs a programmable solution that is data center-ready that can support all of the software richness that goes along with the data center, whether it's a VM environment like VMware. And we -- recently, during the quarter, we announced another partnership with VMware. They recognize that increasingly, our GPUs are becoming a core part of data centers and cloud. We had a partner -- we announced a partnership with Red Hat. They realize the momentum that they're seeing us in, in telcos, and they would like to adapt their entire stack from open stack to OpenShift on top of our GPUs. And so now with VMware, with Red Hat, we're going to have a world-class telco enterprise stack that ranges all the way from hypervisors and virtual machines all the way to Kubernetes. +And so our strategy is to -- our goal is to really create this new world of C-RAN, vRAN centralized data centers and software-defined networking. And the software-defined networking will, of course, include things like in the data center networking as well as firewalls. But the computationally-intensive stuff is really the 5G radio. And so we're going to create a software stack for 5G and basically exactly the same way that we've done for creating a -- excuse me, a software stack for deep learning. And we call it Aerial. Aerial is to 5G essentially what Cuda-NN is for deep learning and essentially what optics is for ray tracing. And this software stack is going to allow us to run the whole software -- run the whole 5G stack in software and deliver the highest performance, the incredible flexibility and scale to as many layers of MIMO as customers need and to be able to put all of it in the data center. +The power of putting it into data center, as you know, is flexibility and fungibility. With the low latency capability of 5G, you could put a data center somewhere in the regional hub. And depending on where the traffic is going, you could shift the traffic computation from 1 data center to another data center, something that you can't do in basebands, in baseband units in the cell towers, but you can do that in the data center. And that helps them reduce the cost. The second benefit is that the telcos would love to be a service provider for a data center's computation at the edge. And the edge applications are things like smart cities and whether it's warehouses or retail stores or whatever it is because they're geographically located and is distributed all over the world. And so to be able to use their data center to also be able to use AI in combination with IoT is really exciting to them. And so I think that that's really -- this is really the future that we're going to see a lot more service providers at the edge. And these edge data centers will have to run the data center, the networking, including the mobile network and software as well as run 5G and IoT -- AI and IoT applications + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And your last question comes from the line of Harsh Kumar with Piper Jaffray. + +-------------------------------------------------------------------------------- +Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [36] +-------------------------------------------------------------------------------- + + I apologize for the background noise. But Colette, maybe you could give us an idea of gaming. In the guidance, it's down. And I was wondering, could you maybe give us the impact of the console business versus the laptop and give us an idea of what might be the bigger driver there? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [37] +-------------------------------------------------------------------------------- + + I would say, for our Q4, both of them are expected to be seasonally down. In the case of the consoles, we do wait for Nintendo to assist in terms of what they need. So we will have to see how the quarter ends on that. But in both cases, in totality, these businesses have ranged, maybe in totality of the 2, of about $500 million a quarter. And we'll see both of them sequentially decline. Thank you. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + I'll now turn the call back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- + + Thanks, everyone. We had a good quarter driven by strong gaming growth and hyperscale demand. We're making great strides in 3 big impact initiatives. The world of computer graphics is moving to ray tracing, and our business reflects that. Some of the biggest blockbuster games this holiday season and beyond are RTX-enabled, including Call of Duty: Modern Warfare; and the best-selling game of all-time, Minecraft. Design applications used by millions of artists and creators are rapidly adopting RTX ray tracing. We're reinventing computer graphics and look forward to upgrading the hundreds of millions of PC gamers to RTX. +Hyperscale demand was strong this quarter, and our visibility continues to improve. The race is on for conversational AI, which will be a powerful catalyst for us in both training and inference. And lastly, we have extended our computing platform beyond the cloud to the edge, where GPU-accelerated 5G, AI and IoT, will revolutionize the world's largest industries. We look forward to updating you on our progress in February. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2020-Aug-19-NVDA.txt b/Transcripts/NVDA/2020-Aug-19-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..6ac3ec6fa78c7964784926c7bc76300af1156981 --- /dev/null +++ b/Transcripts/NVDA/2020-Aug-19-NVDA.txt @@ -0,0 +1,339 @@ + + +Refinitiv StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2021 NVIDIA Corp Earnings Call +AUGUST 19, 2020 / 9:00PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group, Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to NVIDIA's financial results conference call. (Operator Instructions) +Simona Jankowski, you may begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the second quarter of fiscal 2021. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the third quarter of fiscal 2021. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, August 19, 2020, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Simona. Q2 was another extraordinary quarter. The world continued to battle the COVID-19 pandemic, and most of our employees continued to work from home. But through the team's agility and dedication, we successfully combined Mellanox into NVIDIA while also delivering a very strong quarter. revenue was $3.87 billion, up 50% year-on-year, up 26% sequentially and well ahead of our outlook. +Starting with gaming. Revenue was $1.65 billion, was up 26% year-on-year and up 24% sequentially, significantly ahead of our expectations. The upside is broad-based across geographic regions, products and channels. Gaming's growth amid the pandemic highlights the emergence of a leading form of entertainment worldwide. For example, the number of daily gamers on Steam, a leading PC game online distributor is up 25% from pre-pandemic levels. And NPD reported that U.S. consumer spending on video games grew 30% in the second calendar quarter to a record $11 billion. +NVIDIA's PCs and laptops are ideal for the millions of people who are now working, learning and gaming at home. At the outset of the pandemic, many retail outlets were closed, and demand shifted to online channels. As the quarter progressed and the stores reopened, retail demand picked up, iCafes largely reopened and online sales continued to thrive. Gaming laptop demand is very strong as students and professionals turn to GeForce-based systems to improve how they work, learn and game from home. We ramped over 100 new models with our OEM partners, focused on both premium and mainstream price points. +In the premium laptop segment, we delivered unparalleled performance with the GeForce RTX 2080 and the 2070 SUPER GPUs InfiniBand form factors. We also brought ray tracing to gaming laptops for the first time at price points as low as $999 with the GeForce RTX 2060. In the mainstream segment, we brought the GeForce GTX to laptop price points as low as $699. +Momentum continues for our Turing architecture, which enables stunning new visual effects in games and is driving powerful upgrade cycle among gamers. Its RTX technology adds ray tracing and AI to programmable shading and has quickly redefined the new standard for computer graphics. DLSS used the AI capabilities of Turing to boost frame rates by almost 2x while generating crisp image quality. RTX support in blockbuster games continues to grow, including megahit Death Stranding, the high anticipated Cyberpunk 2077 and the upcoming release of Watch Dogs. These games join Minecraft and other major titles that support NVIDIA RTX ray tracing and DLSS. +We're in the midst of a 21-day countdown campaign, promoting a GeForce special event on September 1, with each day highlighting a year in the history of GeForce. We don't want to spoil the surprise, but we encourage you to tune in. We are very pleased with the traction of our GeForce NOW cloud gaming service, now in its second quarter of commercially availability. GFN offers the richest content to any game streaming service through partnerships with leading digital game stores, including Valve Steam, Epic Games and Ubisoft Uplay. GeForce NOW enables users with underpowered PC, Macs or Android devices to access powerful GPUs to play their libraries of PC games in the cloud, expanding the universe of gamers that we can reach with GeForce. +Just yesterday, we announced that GFN is now supported on Chromebooks, further expanding our reach in to tens of millions of users. In addition to NVIDIA's own service, GFN is available or coming soon to a number of telecom partners around the world, including SoftBank and KDDI DION in Japan, Rostelecom and Beeline in Russia, LG U+ in South Korea and Taiwan Mobile. +Moving to Pro Viz. In Q2 was $203 million in revenue, down 30% year-on-year and down 34% sequentially, with declines in both mobile and desktop workstations. Sales were hurt by lower enterprise demand amid the closure of many offices around the world. Industries negatively impact during the quarter include automotive, architectural, engineering and construction, manufacturing, media and entertainment and oil and gas. Initiatives by enterprises to enable remote workers drove demand for virtual and cloud-based graphic solutions. Accordingly, our Q2 vGPU bookings accelerated, increasing 60% year-on-year. +Despite near-term challenges, we are winning new business in areas such as health care, including Siemens, Philips and General Electric, and the public sector. We continue to expand our market opportunity with over 50 leading design and creative applications that are NVIDIA RTX-enabled, including the latest release from Foundry, Chaos Group and Maxon. These applications provide faster ray tracing and accelerated performance, improving creators design workflows. The pandemic will have a lasting impact on how we work. Our revenue mix going forward will likely reflect this evolution in enterprise workforce trends with a greater focus on technologies, such as NVIDIA laptops and virtual workstations, that enable remote work and virtual collaboration. +Moving to automotive. Automotive revenue was $111 million, down 47% year-on-year and down 28% sequentially. This was slightly better than our outlook of a 40% sequential decline as the impact of the pandemic was less pronounced than expected, with auto production volumes starting to recover after bottoming in April. Some of the decline is also due to the roll-off of legacy infotainment revenue, which remained a headwind in future quarters. +In June, we announced a landmark partnership with Mercedes-Benz which, starting in 2024, will launch software-defined intelligent vehicles across an entire fleet in using end-to-end NVIDIA technology. Mercedes will utilize NVIDIA's full technology stack, including the DRIVE AGX computer, DRIVE AV autonomous driving software and NVIDIA's AI infrastructure, spanning from the core to the cloud. Centralizing and unifying computing in the car will make it easier to integrate and upgrade advanced software features as they are developed. With over-the-air updates, vehicles can receive the latest autonomous driving and intelligent cockpit features, increasing value and extending majority of ownership with each software upgrade. This is a transformative announcement for the automotive industry, making the turning point of traditional vehicles becoming high-performance, updatable data centers on wheels. It's also a transformative announcement for NVIDIA's to evolving business model as the software content of our platforms grows, positioning us to build a recurring revenue stream. +Moving to data center. Data center is diverse, consist of cloud service providers, public cloud providers, supercomputing centers, enterprises, telecom and industrial edge. Q2 revenue was a record $1.75 billion, up 167% year-on-year and up 54% sequentially. In Q2, we incorporated a full quarter of contribution from the Mellanox acquisition, which closed on April 27, the first day of our quarter. Non-ops contributed approximately 14% of company revenue and just over 30% of data center revenue. Both compute and networking within data center set a record with accelerating year-on-year growth. +The biggest news in data center this quarter was the launch of our Ampere architecture. We are very proud of the team's execution in launching and ramping this technological marvel, especially amid the pandemic. The A100 is the largest chip ever made with 54 billion transistors. It runs our full software stack for accelerating the most compute-intensive workloads. Our software leases include CUDA 11, the new versions of over 50 CUDA-X libraries and a new application frameworks for major AI workloads, such as Jarvis for conversational AI and Merlin for deep recommender systems. The A100 delivers NVIDIA's greatest generational leap ever, boosting AI performance by 20x over its predecessor. It is also our first universal accelerator, unifying AI training and inference and powering workloads, such as data analytics, scientific computing, genomics, edge video analytics, 5G services and graphics. +The first Ampere GPU, A100, has been widely adopted by all major server vendors and cloud service providers. Google Cloud Platform was the first cloud customer to bring it to market, making it the fastest GPU to come to the cloud in our history. And just this morning, Microsoft Azure announced the availability of massively scalable AI clusters, which are based on the A100, and interconnected with 200 gigabyte per second Mellanox InfiniBand networking. A100 is also getting incorporated into offerings from AWS, Alibaba Cloud, Baidu Cloud and Tencent Cloud. And we announced that the A100 is going to market with more than 50 servers from leading vendors around the world, including Cisco, Dell, Hewlett Packard Enterprise and Lenovo. Adoption of the A100 into leading server makers offerings is faster than any prior launch, with 30 systems expected this summer and over 20 more by the end of the year. +The A100 is already winning industry recognition. In the latest A100 training benchmark, MLPerf 0.7, NVIDIA set 16 records, sweeping all categories for commercially available solutions in both per chip and outscale performance based on the A100. MLPerf offers the industry's first and only objective AI benchmark. Since the benchmark was introduced 2 years ago, NVIDIA has consistently delivered leading results and record performance for both training and inference. NVIDIA also topped the chart in the latest top 500 list of the fastest supercomputers. The ranking, released in June, showed that 8 of the world's top 10 supercomputers use NVIDIA GPUs, NVIDIA networking or both. They include the most powerful systems in the U.S. and Europe. NVIDIA, now combined with Mellanox, powers 2/3 of the top 500 systems on the list compared with just less than a half for the 2 companies in total 2 years ago. +In energy efficiencies, systems using NVIDIA GPUs are pulling away from the pack. On average, they are nearly 2.8x more powerful and efficient than systems without NVIDIA GPUs, measured by gigaflops per watt. The incredible performance and efficiency of the A100 GPU is best amplified by NVIDIA's own new Selene supercomputer, which debuted as #7 on the top 500 list and is the only top 100 systems to cross the 20 gigaflops per watt barrier. Our engineers were able to assemble Selene in less than 4 weeks using NVIDIA's open modular DGX SuperPOD reference architecture instead of the typical build time of months or even years. This is the system that we will use to win the MLPerf benchmarks, and it is a reference design. It's available for our customers to quickly build a world-class supercomputer. +We also brought GPU acceleration to data analytics, one of the largest and fastest-growing enterprise workload. We enabled an acceleration of the entire data analytics workload pipeline for the first time with NVIDIA's GPUs and software stack in the latest version of Apache Spark released in June. Spark is the world's leading data analytics platform used by more than 500,000 data scientists and 16,000 enterprises worldwide. +And we have 2 major milestones to share. We have now shipped a cumulative total of 1 billion CUDA GPUs, and the total number of developers in the NVIDIA ecosystem just reached 2 million. It took over a decade to reach the first million and less than 2 years to reach the second million. Mellanox has fantastic results across the board in its first quarter as part of NVIDIA. Mellanox revenue growth accelerated with strength across Ethernet and InfiniBand products. Our Ethernet shipments reached a new record. Major hyperscale build drove the upside in the quarter as growth in cloud computing and AI is fueling increased demand for high-performance networking. Mellanox networking was a critical part of several of our major new product introductions this quarter. These include the DGX AI system, the DGX SuperPOD clusters for our Selene supercomputer and the EGX Edge AI platform. We also launched the Mellanox ConnectX-6 Ethernet NIC, the 11th generation product of the ConnectX family, and it's designed to meet the needs of modern cloud and hyperscale data centers, where 25, 50 and 100 gigabyte per second is becoming the standard. +We expanded our switch networking capabilities with the addition of Cumulus Networks, a privately held network software company that we purchased in June. Cumulus augments our Mellanox acquisition in building out open modern data center. The combination of NVIDIA accelerated computing, Mellanox networking and Cumulus software enables data centers that are accelerated, disaggregated and software-defined to meet the exponential growth in AI, cloud and high-performance computing. +Moving to the rest of the P&L. Q2 GAAP gross margin was 58.8% and non-GAAP gross margin was 66%. GAAP gross margin declined year-on-year and sequentially due to costs associated with the Mellanox acquisition. Non-GAAP gross margins increased by almost 6 points year-on-year, reflecting a shift in product mix with higher data center sales and lower automotive sales. Q2 GAAP operating expenses were $1.62 billion, and non-GAAP operating expenses were $1.04 billion, up 67% and 38% from a year ago, respectively. Q2 GAAP EPS was $0.99, up 10% from a year earlier. Non-GAAP EPS was $2.18, up 76% from a year ago. Q2 cash flow from operations was $1.57 billion. +With that, let me turn to the outlook for the third quarter of fiscal 2021. We expect revenue to be $4.4 billion, plus or minus 2%. With that, we expect gaming to be up just over 25% sequentially with data center to be up in the low to mid-single digits sequentially. We expect both pro viz and the auto to be at similar levels out in Q2. GAAP and non-GAAP gross margins are expected to be 62.5% and 65.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $1.54 billion and $1.09 billion, respectively. Full year GAAP and non-GAAP OpEx is tracking in line with our outlook of $5.7 billion and $4.1 billion, respectively. GAAP and non-GAAP OI&E are both expected to be expense of approximately $55 million. GAAP and non-GAAP tax rates are both expected to be 8%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $225 million to $250 million. Further financial details are included in the CFO commentary and other information available on our IR website. +In closing, let me highlight upcoming events for the financial community. We will be at the BMO Virtual Technology Summit on August 25, Citi's 2020 Global Technology Conference on September 9, Deutsche Bank's Technology Conference on September 14 and the Evercore's Virtual Memo Forum, The Future of Mobility, on September 21. We will also host a financial analyst Q&A with Jensen on October 5 as part of our next virtual GTC. Our earnings call to discuss our third quarter's results is scheduled for Wednesday, November 18. +We will now open the call for questions. Operator, would you please poll for questions? Thank you. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Your first question comes from the line of Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [2] +-------------------------------------------------------------------------------- +Congratulations on the strong growth and execution. Jensen, I'm wondering how much of the strength that you're seeing in gaming and data center is maybe more temporary because COVID or some customer pull-ins in the data center or so forth? And how much of it is more structural and more secular that can continue even once we get into, hopefully, sooner rather than later, into a more normalized period for the industry? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- +Yes. Vivek, thank you. So first of all, we didn't see pull-ins, and we're in the beginning of our brand-new product cycle with Ampere. And so the vast majority of the data center growth came from that. The gaming industry, they -- with all that's happening around the world, and it's really unfortunate, but it's made gaming the largest entertainment medium in the world. More than ever, people are spending time digitally, spending on time -- spending their time in video games. The thing that people haven't realized about video games is that it's not just the game itself anymore. The variety of different ways that you can play, whether you can hang out with your friends in Fortnite, go to a concert in Fortnite, building virtual worlds in Minecraft, you're spending time with your friends, you're using it to create -- to realize your imaginations. +People are using it for broadcast, for sharing ideas and techniques with other people, and so -- and then of course, it's just an incredibly fun way to spend time even by consumption of the video -- of a video game. And so there's just so much that you could do with video games now. And I think that this way of enjoying entertainment digitally has been accelerated as a result of the pandemic, but I don't think it's going to return. Video game adoption has been going up over time and pretty steadily. PC is now the single largest entertainment platform -- is the largest gaming platform. And GeForce is now the largest gaming platform in the world. And as I mentioned, it's not just about gaming. There's just so many different ways that you could enjoy games. +With data center, the thing that -- the structural change that's happening in data center are a couple of different dynamics that are happening at the same time. The first dynamic, of course, is the movement to the cloud. The way that a cloud data center is built and the way that an enterprise data center or a cluster is built is fundamentally different. And it's really, really beneficial to have the ability to accelerate applications that cloud service providers would like to offer, which is basically everything. And we know that one of the most important applications of today is artificial intelligence. It's a type of software that really wants acceleration, and NVIDIA's GPU acceleration is the perfect medium, perfect platform for it. +And then the last reason about the data center is the architectural change from hosting applications to hosting services that's driving this new type of architecture called disaggregation versus hyper converged. And the original name of hyperscalers is a large data center of a whole bunch of hyperconverged computers. But the computers of today are really disaggregated. A single application service could be running on multiple servers at the same time, which generates a ton of east-west traffic, and a lot of it is artificial intelligence neuro network models. +And so because of this type of architecture, 2 components, 2 types of technologies are really important to the future of cloud. One of them, as I mentioned, was -- is acceleration, and our GPU is ideal for it. And then the other one is high-speed networking. And the reason for that is because the server is now disaggregated, the application is fractionalized and broken up into a bunch of small pieces that are running across the data center. And whenever an application needs to send parts of the answer to another server for the microservice to run, that transmission is called east-west traffic, and the most important thing you could possibly do for yourself is to buy really high-speed, low-latency networking. And that's what Mellanox is fantastic at. +And so we find ourselves really in this perfect condition where the future is going to be more virtual, more digital, and that's one -- that's the reason why GeForce is so successful. And then we find ourselves in a world where the future is going to be more autonomous and more AI-driven, and that's the benefit of our GPUs. +And then lastly, cloud microservice transactions really benefit high-speed networking, and that's where Mellanox comes in. And so I think that this is -- the dynamics that I'm describing are permanent, and it's just been accelerated to the present because of everything that's happening to us. But this is the future, and it's not -- there's no going back, and we just found everything accelerated. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question comes from the line of Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [5] +-------------------------------------------------------------------------------- +Jensen, I guess I had a question on both architecture and also manufacturing. And I think on the manufacturing side, you've been radical now for some time. And when you've been asked in the past about moving to more of a tiled or chiplet approach, you sort of made light of that. But the CPU guys are clearly taking that approach. So I guess the question is, why do you think you won't have to make a similar move? And then on the side of architecture, the theme of Hot Chips this week was really how compute demand is far outstripping computing power? And then we see this talk about you and ARM. So I guess can you talk about whether GPU is the future and maybe the broader opportunity to integrate CPU and GPU? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [6] +-------------------------------------------------------------------------------- +Yes. We push architecture really hard. And the way we push architecture is we start from the system, but we believe that the future computer company is a data center-scale company. The computing unit is no longer a microprocessor or even a server or even a cluster. The computing unit is an entire data center now. And as I was explaining to Vivek just now that a microservice that we're enjoying hundreds of billions of transactions a day, those are broken up into a whole bunch of microservices that are running across the entire data center. +And so the data center is running -- the entire data center is running an application. I mean that's pretty remarkable thing, and that's happened in the last several years. We were ahead of this trend, and we recognized that as a computing company, we have to be a data center-scale company, and we architect from that starting. If you look at our architecture, we were the first in the world to create the concept of an NVLink with 8 processors being fully synchronized across a computing node, and we created the DGX. +We recognize the importance of high-speed networking and low-latency networking, and that's why we bought Mellanox. And the amount of software that we invented along the way to make it possible for low-latency communications, whether it's GPUDirect or recently the invention of GPUDirect Storage, all of that technology was inspired by the idea that you have to think about the data center all-in-one holistic way. +And then in the last -- in this current generation with Ampere, we invented the world's first multi-instance GPU. We invented the world's first multi-instance GPU, which means that our Ampere GPU could simultaneously be 1 GPU or, with NVlink, 8 GPUs combined, working together, so you could think of them as being tiled. So those 8 GPUs are working harmoniously together. Or each one of the GPUs could fractionalize itself, if you don't need that much GPU working on your workload, fractionalize into a multi-GPU instance, we call the MIG, a little tiny instance. And each one of those tiny instances are more powerful and more performant than our entire Volta GPU lap time. And so whether you like to fractionalize the GPU, which happens oftentimes; create a larger GPU using NVLink; or create an even larger GPU, the size of DGX POD, connected together with high-speed, low-latency networking with Mellanox, we could architect it any way you'd like. +You made a comment about -- you asked a question about ARM. We've been a long-term partner of ARM, and we use ARM in a whole bunch of applications. And whether it's autonomous driving or a robotics application, the Nintendo Switch, console business that we're in. And then recently, we brought CUDA to ARM and to bring accelerated computing to ARM. And so we worked with the ARM team very closely. They're really great guys. And one of the specials about the ARM architecture that you know very well is that it's incredibly energy-efficient. And because it's energy-efficient, it has the headroom to scale into very high-performance levels over time. And so anyways, we love working with the ARM guys. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Your next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [8] +-------------------------------------------------------------------------------- +Congratulations on the quarter. Just building on some prior questions. The first one, I was just curious if you could help us appreciate kind of the installed base of the gaming GPU business relative to where we're at the Turing upgrade cycle. What do we see still on prior generations, be it Pascal or before? And then secondly, I was wondering, Colette, could you just give me a kind of updated commentary or views on visibility in the data center business? How has that changed over the last 3 months? What does that look like as you look through the back half of the calendar year? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- +Yes. Thanks a lot, Aaron. We are -- we're still in the ramping of the RTX generation. Turing, Turing the current generation that we're in, is the world's first ray tracing GPU. And it fuses -- the RTX technology fuses 3 fundamental technologies: the programmable shader that we introduced a long time ago that revolutionized computer graphics; and we added 2 new technologies. One technology is a ray tracing acceleration core that makes the tracing of rays and looking for intersections between the ray and the scene -- objects in the scene super, super fast. And that -- it's a complicated problem. It's a super-complicated problem. We want it to be running concurrently to shading so that the ray traversal and the shading of the pixels could be done independently and concurrently. +The second thing is we invented this technology to bring AI, artificial intelligence, using this new type of algorithm called deep learning to computer graphics. And one example of its capability is the algorithm we introduced called DLSS, Deep Learning Super Sampling, which allows us to essentially synthesize by learning from previous examples, essentially learning from previous examples of images and remembering it, remembering what beautiful images look like so that when you take a low-resolution image, and you run it through the deep neural network, it synthesizes a high-resolution image that's really, really beautiful. And people have commented that it's even more beautiful than native rendered images at the native resolution. And the benefit is not only is it beautiful, it's also super fast. We essentially nearly doubled the performance of RTX as a result of doing that. So you can have the benefit of ray tracing as well as very high resolution and very high speed. And so that's called RTX. +And Turing is probably not even close, not even 1/3 of the total installed base of all of our GeForce GPUS, which is, as you know, the single-largest installed base of gaming platforms in the world. And so we support this large installed base, and we're in the process of bringing them to the future with RTX. And now with the new console generation coming, every single game developer on the planet is going to be doing ray tracing, and they're going to be creating much, much richer content. And because of multi-platform, cross-platform play and because of the size of the gaming platform, PC gaming platform, it's really important that these game developers bring the latest generation content to PCs, which is great for us. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [10] +-------------------------------------------------------------------------------- +And then on the data center visibility? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- +Yes. Let me see if I can answer this one for you. Yes, we have been talking about our visibility of data center. And as you've seen in our Q2 results, you can see that our overall adoption of the NVIDIA computing portfolio has accelerated quite nicely. But keep in mind, we're still really early in the product cycle. A100 is ramping. It's ramping very strong into our existing installed bases but also into new markets. Right now, A100 probably represents less than 1/4 of our data center revenues. So we still have a lot to grow. +We have good visibility looking into Q3 with our hyperscales. We have a little bit more of a mixed outlook in terms of our vertical industries, given a lot of the uncertainty in the market and in terms of the overall economy. On-premises are challenged because of the overall COVID. But remember, industries are quickly and continuing to adopt and move to the overall cloud. But overall, we do expect a very strong Q3. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Your next question comes from the line of C.J. Muse with Evercore ISI. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [13] +-------------------------------------------------------------------------------- +I guess 2 questions. If I look at your outstanding inventory purchase obligations, grew, I think, 17% sequentially. Is that as you prepare for the September 1 launch? And can you kind of comment on gaming visibility into the back half of the year? And then the second question, Jensen, I know you're very focused on platforms and driving recurring revenues. Would love to hear if there's any particular platforms over the last 3 months where you've made real headway or get you excited, whether Jarvis, Merlin, Spark or whatever. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [14] +-------------------------------------------------------------------------------- +Yes. Thanks so much, C.J. We're expecting a really strong second half for gaming. I think this may very well be one of the best gaming seasons ever. And the reason for that is because PC gaming has become such a large format. The combination of amazing games like Fortnite and Minecraft and because of the way people game now, their gaming and their e-sporting, even F1 is an e-sport now. They're hanging out with friends. They're using it to create other content. They're using game captures, create art. They're sharing it with the community. It's a broadcast medium. The number of different ways you could game has just really, really exploded. And it works on PCs because all the things that I described require cameras or keyboards or streaming systems or -- and -- but it requires an open system that is multitasking. And so the PC has just become such a large platform for gaming. +And the second thing is that RTX, it's a home run. We really raised the bar with computer graphics, and the games are so beautiful, and it's really, really the next level. It's not been this amazing since we introduced programmable shaders about 15 years ago. And so for the last 15 years, we've been making programmable shaders better and better and better, and it has been getting better. But there's never been a giant leap like this, and RTX brought both artificial intelligence as well as ray tracing to PC gaming. +And then the third factor is the console launch. There's -- people are really -- the game developers are really gearing up for a big leap. And because of the gaming -- because how vibrant the gaming market is right now and how many people around the world is depending on gaming at home. I think it's going to be the most amazing season ever. We're already seeing amazing numbers from our console partner, Nintendo. Switch has -- about to sell more than Super Nintendo, more than all the Famicom, which was one of the best gaming consoles of all time. I mean they're underway to make Switch the most successful gaming platform of all time. And so I'm super excited for them. And so I think it's going to be quite a huge second half of the year. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Your next question comes from the line of Toshiya Hari of Goldman Sachs. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [16] +-------------------------------------------------------------------------------- +Colette, I felt like I didn't -- I missed C.J.'s second question. Can we jump on and answer it? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [17] +-------------------------------------------------------------------------------- +I think the question was regarding our inventory purchases on that piece. Is that the part that you're referring to? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [18] +-------------------------------------------------------------------------------- +Yes. That's the one. Yes. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [19] +-------------------------------------------------------------------------------- +Yes. Keep in mind, C.J., that when you think about the complexity of the products that we are building, we have extremely long lead times, both in terms of what we produce for the data center, our full systems that we need to do as well as what you are seeing now between the sequential growth between Q2 and Q3 for overall gaming. So all of that is in preparation for the second half. Nothing unusual about it other than, yes, we've got to hit those revenue numbers that are in our Q3 guidance. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Your next question comes from the line of Toshiya Hari with Goldman and Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group, Inc., Research Division - MD [21] +-------------------------------------------------------------------------------- +I had one for Jensen and another one for Colette. Jensen, just following up on the data center business. As you probably know, quite a few of your peers have been talking about potential digestion of capacity on the part of your hyperscale customers over the next, call it, 6 to 12 months. Curious, is that something that you think about, worry about in your data center business? Or do you have enough idiosyncratic growth drivers like the A100 ramp? And I guess the breadth that you've built within your data center business across compute and networking, are those enough for you to buck the trend within data center over the next 6 to 12 months? +And then the second one for Colette, just on gross margins. You're guiding October quarter gross margins down 50 basis points sequentially. Based on the color that you provided for the individual segments, it looks like mix remains pretty positive. So just curious what's driving the marginal decline in gross margins in the October quarter? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [22] +-------------------------------------------------------------------------------- +Yes. Thank you. So thanks for the question. The -- our data center trend is really tied to a few factors. One is the proliferation of using deep learning and artificial intelligence and all the services that are in -- by the cloud service providers. And I think it's fair to say that over the last several years, the number of breakthroughs in artificial intelligence has been really terrific. And we're seeing anywhere from 10x, 10x more computational requirement each year to more than that. And so in the last 3 years, we've seen somewhere between 1,000 to 3,000x increase in the size of models, the computational requirement necessary to create these AI models and to deploy these AI models. +And so the #1 trend that we're probably indexed to is the breakthroughs of AI and the usefulness of AI and how people are using it. And one of the -- and I remember C.J.'s question now, and I'll answer this along with that. One of the things that we look for and you should look for is how -- what kind of breakthroughs are based on deep learning and based on AI that these services all demand. +And there are 3 big ones, just gigantic one. Of course, one of them is natural language understanding, the ability to take a very complicated text and use deep learning to create essentially a dimension reduction, it's called deep embedding, dimension reduction on that body of text so that you could use that vector as a way to teach a recommender system, which is the second major breakthrough, the recommender system, how to predict and make a recommendation to somebody. Recommendation on ads and videos, and there are trillions of videos on the web. You need ways to recommend them, both the news and just the amount of information that is going to -- that is in true dynamic form require these recommenders to be instantaneous. +And so the first one is natural language understanding. The second one is the recommender system, gigantic breakthroughs in the last several years. And the third is conversational AI. I mean we're going to have conversational engines that are just super clever, and they can predict what you're about to ask. They're going to predict the right answer for you, make recommendations to you based on the 3 pillars that I just described. +And I haven't even started talking about robotics, the breakthroughs that are happening there with all the factories that need to automate and breakthroughs that we're seeing in self-driving cars, the models there are really improving fast. And so the answer to you, Toshiya, and C.J. are kind of similar, that on the first one, we're indexed to AI. The second, we're indexed to breakthroughs of AI. So that it can continue to consume more and more capability and more technology. +And then the third thing that we're indexed to is the movement of workloads to the cloud. It is now possible to do rendering in the cloud, remote graphics workstations in the cloud. And NVIDIA virtual workstations is in every single cloud. You could do big data analytics in the cloud. And these applications, I've just given you a few applications where you can do scientific computing in the cloud. These applications all have fundamentally different computing architectures. +NVIDIA is the only accelerated architecture that allows you to do microservices for conversational AI and other types of AI applications to scale up applications like high-performance computing, training, big data analytics to virtualize applications like workstations. Our platform is universal, and these 3 facets that I just described are supremely complex, virtualized, microservices-based and scale-up-based. And so these -- bare metal scale-up. And these are complicated, and it's one of the reasons why we bought Mellanox because they're at the core and at the intersection of all of that. The storage, the networking, the security, the virtualization, they're at the intersection of all of that. And I just described 3 dynamics that are very, very powerful and are at the early stages yet. And so those are the things that we're really indexed to. +And then lastly, when somebody adopts -- when we introduce a new platform like Ampere, we're in the beginning of a multiyear product cycle, Ampere is such a gigantic breakthrough. It's the first universal GPU we ever created. It is both able to scale up as well as scale out, scale up as in multi GPUs, scale out is fractionalization, multi-instance GPUs. And it's -- it reduced -- it saves money, tremendous amount of money for people who use it. It speeds up their application. It reduces their TCO. Their TCO value just goes through the roof. And so we're in the beginning of this multiyear cycle and the enthusiasm has been fantastic. This is the fastest ramp we've ever had. And so we're going to keep on racing through the second half. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- +Okay. And Toshiya, you asked a question regarding our guidance going forward regarding gross margin. And within our Q3 guidance, we have just a small decline in our gross margin from Q2. Most of that is really associated with mix but also a little bit in terms of the ramping of our new Ampere architecture products that we have. So keep in mind, our data center will likely be a lower percentage of total revenue, given the strong overall gaming growth that we expect between Q2 and Q3. Within that gaming growth, keep in mind, consoles are also included, which will continue to be below our company totals average gross margin, and that is expected to be up strongly quarter-over-quarter for our overall console shipments. We're going to be ramping those new architectures over time when we have the ability to expand our gross margin as Ampere GPUs mature, too. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Your next question comes from the line of Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25] +-------------------------------------------------------------------------------- +I wanted to dig into data center a little bit. This is a question for Colette. So in the quarter, ex Mellanox, data center was up, core data center, maybe 6%, 7%. The guide looks to be roughly similar to that into Q3. Can you talk to us a little bit about what's driving the trajectory? Are you more demand or more supply limited at this point? What does your supply situation look like? And what are the lead times especially on the A100 products for data center look like at this point? Like if you have more capacity available, do you think you'd have like a stronger trajectory than you have right now? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [26] +-------------------------------------------------------------------------------- +Yes. Stacy, so thanks for the question. Let me first start on our Q3 outlook and what we're seeing. And when we think about our demand and our supply, we're very comfortable with the supply that we have. Keep in mind, our products are quite complex, and a lot of our time is spent in terms of procuring every aspect of that supply over multiple quarters previously. So that's how we work. But we are very confident with the overall supply that we have across the board in data center. Keep in mind that it's not just A100. We are continuing to sell V100 or T4. And we're also bringing new versions of the A100 coming to overall market. So I hope that helps you understand our statements on where are we at in terms of the Q3 guidance. We'll see if Jensen wants to add a little bit more to that. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [27] +-------------------------------------------------------------------------------- +Well, when we're ramping, we sure love to have more and sooner. And -- but this is our plan, and we're executing to the plan. It is a very complicated product, as Colette mentioned. It is the most complicated. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- +Got it. Got it. And just a quick follow-up. Within the data center guidance, how do you think about like the core data center sequential growth versus Mellanox? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [29] +-------------------------------------------------------------------------------- +Yes. So in terms of moving from Q2 to Q3, we believe that most of the actual growth that we will receive in that single -- low single-digit to mid-single-digit growth will likely stem from NVIDIA compute, will be the largest driver of that. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Your next question comes from the line of Joseph Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [31] +-------------------------------------------------------------------------------- +I wonder if I could ask a longer-term question about the -- how you guys see the importance of process technology. There's been a lot of discussion around that in the CPU domain. But you guys haven't really felt the need to be first on 7 nanometer, and you've done very well. Just how important do you think it is to be early in the new process node? And how does that factor into the cycle of innovation at NVIDIA? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [32] +-------------------------------------------------------------------------------- +Yes. First of all, thanks, Joe. The process technology is a lot more complex than a number. I think people have simplified it down to almost a ridiculous level, right? And so process technology, we have a really awesome process engineering team, world-class. Everybody will recognize that it's absolutely world-class. And we work with the foundries, we work with TSMC really closely, to make sure that we engineer transistors that are ideal for us and we engineer metallization systems that's ideal for us. It's a complicated thing, and we do it at high part. +Then the second part of it is where architecture, where the process technology and the rest of the design process, the architecture of the chip, and the final analysis, what NVIDIA paid for, is architecture, not procurement of transistors. We're paid for architecture. And there's a vast difference between our architecture and the second best architecture and the rest of the architectures. The difference is incredible. We are easily twice the energy efficiency all the time, irrespective of the number of the -- in the transistor side. And so it must be more complicated than that. And so we put a lot of energy into that, and then the last thing I would say is that going forward, it's really about data center-scale computing. Going forward, you optimize at the data center scale. And the reason why I know this for a fact is because if you're a software engineer, you would be sitting at home right now, and you will write a piece of software that runs on the entire data center in the cloud. You have no idea what's underneath it, nor do you care. And so what you really want is to make sure that, that data center is as high throughput as possible. There are a lot of code in there. +And so what NVIDIA has decided to do over the years is to take our game to a new level. Of course, we start with building the world's best processors, and we use the world's best foundries, and we partnered them very closely to engineer the best process for us. We partner with the best packaging companies to create the world's best packaging. We're the world's first user of cobots. And whether it's -- I think we're -- I'm pretty sure we're still the highest volume by far of 2.5D and 3D packaging. +And so we start from a great chip. We start from a great chip, but we don't end there. That's just the beginning for us. Now we take this thing all the way through systems, the system software, algorithms, networking, all the way up to the entire data center. And the difference is absolutely shocking. We built our data center, Selene, and it took us 4 weeks. We put up Selene in 4 weeks' time. It is the seventh fastest supercomputer in the world, one of the fastest AI supercomputers in the world. It's the most energy-efficient supercomputer in the world, and it broke every single record in MLPerf, and that kind of shows you something about the scale that we work and the complexity of the work that we do. This is the future. It's for -- the future is about data centers. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +We have no further questions at this time. Jensen Huang, I turn the call back over to you. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- +Thank you. The accelerated computing model we pioneered has clearly passed the tipping point. Adopting of NVIDIA computing is accelerating. On this foundation and leveraging one architecture, we have transformed our company in 3 dimensions. First, NVIDIA is a full stack computing platform company, offering the world's most dynamic industries, the chips systems, software and libraries like NVIDIA AI to tackle their most pressing challenges. NVIDIA -- second, NVIDIA is a data center-scale company with capabilities to architect, build and operate the most advanced data centers. The data center is the new computing unit. With this capability, we can create modern data center architectures that are computer maker partners, and then scale out to the world's industry. Third, NVIDIA is a software-defined company today, with rich software content like GeForce NOW, NVIDIA virtual workstation in the cloud, NVIDIA AI and NVIDIA Drive that will add recurring software revenue to our business model. +In the coming years, AI will revolutionize software. Robotics will automate machines, and the virtual and physical worlds will become increasingly integrated through VR and AR. Industry advancements will accelerate, and NVIDIA accelerated computing will play an important role. +Our next GTC will be coming on October 5, again from my kitchen. Join me. I have some exciting developments to share with you. Thanks, everyone. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2020-Feb-13-NVDA.txt b/Transcripts/NVDA/2020-Feb-13-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..5bddf0ce4e10d1a8d1d22cab8c6e2335e3d841a3 --- /dev/null +++ b/Transcripts/NVDA/2020-Feb-13-NVDA.txt @@ -0,0 +1,430 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2020 NVIDIA Corp Earnings Call +FEBRUARY 13, 2020 / 10:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jensen Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * William Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Blayne Peter Curtis + Barclays Bank PLC, Research Division - Director & Senior Research Analyst + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Atif Malik + Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst + * Harlan Sur + JPMorgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - MD & Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Christina, and I'm your conference operator today. Welcome to NVIDIA's financial results conference call. (Operator Instructions) Thank you. I'll now turn the call over to Simona Jankowski, Vice President of Investor Relations, to begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, everyone, and welcome to NVIDIA's Conference Call for the Fourth Quarter of Fiscal 2020. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the first quarter of fiscal 2021. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, February 13, 2020, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Simona. Q4 revenue was $3.11 billion, up 41% year-on-year and up 3% sequentially, well above our outlook, reflecting upside in our data center and gaming businesses. Full year revenue was $10.9 billion, down 7%. We recovered from the excess channel inventory in gaming and an earlier pause in hyperscale spending and exited the year with great momentum. +Starting with gaming. Revenue of $1.49 billion was up 56% year-on-year and down 10% sequentially. Full year gaming revenue was $5.52 billion, down 12% from our prior year. +We enjoyed strong end demand for our desktop and notebook GPUs. Let me give you some more details. Our gaming lineup was exceptionally well positioned for the holidays with the unique ray tracing capabilities of our RTX GPUs and incredible performance at every price point. From the Singles Day shopping event in China through the Christmas season in the West, channel demand was strong for our entire stack. Fueling this were new blockbuster games like Call of Duty: Modern Warfare, continued eSports momentum and new RTX Super products. With RTX price points as low as $299, ray tracing is now the sweet spot for PC gamers. +Gaming is thriving and gamers prefer GeForce. The global phenomenon of eSports keeps gaming momentum with an audience now exceeding 440 million, up over 30% in just 2 years according to Newzoo. The League of Legends World Championship brought more than 100 million viewers, on par with this month's Super Bowl. +Ray tracing titles continue to come to market, and GeForce RTX GPUs are the only ones that support this important technology. This quarter, Wolfenstein: Young blood and Deliver Us The Moon were the latest titles to support ray tracing as well as NVIDIA's Deep Learning Super Sampling technique, which also uses AI to boost performance. With the proliferation of RTX-enabled games and our best ever top-to-bottom performance, we are solidly into the Turing architecture upgrade cycle. Gamers continue to move to higher-end GPUs, seeking better performance and support for ray tracing. +Gaming laptops posted double-digit year-on-year growth for the eighth consecutive quarter. The category continues to expand, driven by appealing thin and light form factors with fantastic graphics performance. This holiday season, retailers stocked a record 125 gaming laptops based on NVIDIA GPUs, up from 94 last year, with our Max-Q designs up 2x. At CES, we launched the world's first 14-inch GeForce RTX laptop with ASUS. We also continue to expand our Studio lineup of laptops for the fast-growing population of freelance creators, designers and YouTubers with 13 new RTX Studio systems introduced at CES. Powered by Turing GPUs, these systems are optimized for over 55 creative and design applications with RTX accelerated ray tracing and/or AI. +Last week, we launched our GeForce NOW cloud gaming service. Powered by GeForce, GeForce NOW is the first cloud gaming service to deliver ray trace games. It's also the only open platform so gamers can enjoy the games they already have and use their existing store accounts without having to repurchase games. GeForce NOW enables PC games on Macs, Windows, PCs, TVs, Mobile devices and soon, Chromebooks. GFN has a freemium business model that includes 2 membership plans: a free membership with standard access; and a Founders tier with a starting price of $4.99 per month, which gives priority access and RTX ray tracing support. +Our goal with GeForce NOW is to expand GeForce gaming to more gamers. About 80% of GeForce NOW gamers are playing on underpowered PCs or devices with Mac OS or Android. With GeForce NOW, they are able to enjoy PC gaming on a GeForce GPU in the cloud. GeForce now can expand GeForce well beyond the roughly 200 million gamers we reach today. +Separately, we entered into a collaboration with Tencent, the world's largest gaming platform, to bring PC gaming in the cloud to China, the world's largest gaming market. NVIDIA GPU technology will power Tencent's Start cloud gaming service, which is in early testing stages. +Moving to data center. Revenue was a record $968 million, up 43% year-on-year and up 33% sequentially, our strongest ever sequential growth in dollar terms. Full year fiscal year '20 data center revenue was a record $2.98 billion, up 2% from the prior year. Strong growth was fueled by hyperscale and vertical industry end customers. Hyperscale demand was driven by purchases of both our training and inference products in support of key AI workloads, such as natural language understanding, conversational AI and deep recommendators. Hyperscale demand was also driven by cloud computing. AWS now makes the T4 available in every region. This underscores the versatility of the T4, which excels at a wide array of high-performance computing workloads, including AI inference, cloud gaming, rendering and virtual desktop. +Vertical industry growth was driven primarily by consumer Internet companies. Other verticals such as retail, health care and logistics continue to grow from early-stage build-outs with a strong foundation of deep learning engagements, and we see an expanding set of opportunities across high-performance computing, data science and edge computing applications. +T4, our inference platform, had another strong quarter, with shipments up 4x year-on-year, driven by public cloud deployments as well as edge AI video analytics applications. T4 and V100, reflecting strong demand for inference and training, respectfully, set records this quarter for both shipments and revenue. +Even as NVIDIA remains the leading platform for AI model training, NVIDIA's inference platform is getting wide use by some of the world's leading enterprise and consumer Internet companies, including American Express, Microsoft, PayPal, Pinterest, Snap and Twitter. +The industry continues to do groundbreaking AI work for NVIDIA. For example, Microsoft's biggest quality improvements made over the past year in its Bing search engine stem from its use of NVIDIA GPUs and software for training and inference of its natural language understanding models. These DNN transformer models popularized by BERT have computational requirements for training that are in the order of magnitude higher than earlier image-based models. Conversational AI is a major new workload, requiring GPUs for inference to achieve high throughput within the desired low latency. Indeed, Microsoft cited an inference throughput increase of up to 800x on NVIDIA GPUs compared with CPUs, enabling it to serve over 1 million BERT inferences per second worldwide. And just this week, Microsoft researchers announced a new breakthrough in natural language processing with the largest ever publicized model trained on NVIDIA DGX-2. This advances the state of the art for AI assistance in tasks, such as answering questions, summarization and natural language generation. +Recommendators are also an important machine learning model for the Internet, powering billions of queries per second. The industry is moving to deep recommendators such as wide and deep model, which leverage deep learning to enable automatic feature learning and to support unstructured content. Running these models on GPUs can dramatically increase inference throughput and reduce latency compared with CPUs. For example, Alibaba's and Baidu's recommendation engines run on NVIDIA AI, boosting their inference throughput by orders of magnitudes beyond CPUs. Deep recommendators enabled Alibaba to achieve 10% increase in click-through rates. +We also announced the availability of a new GPU-accelerated supercomputer on Microsoft Azure. It enables customers for the first time to rent an entire AI supercomputer on demand from their desk, matching the capabilities of large on-premise supercomputers that can take months to deploy. And in Europe, energy company Eni announced the world's fastest industrial supercomputer based on NVIDIA GPUs. +AI has even come to pizza delivery. At the National Retail Federation's Annual Conference last month, we announced Domino's as a customer deploying our platform for deep learning and data science applications, helping with customer engagement and order accuracy prediction. More broadly in retail, we have seen a significant increase in the adoption of NVIDIA's edge computing offerings by large retailers for powering AI applications that reduce shrinkage, optimize logistics and create operational efficiencies. +At the SC19 Supercomputing conference, we introduced a reference design platform for GPU-accelerated ARM-based servers, along with ecosystem partners, ARM, Ampere Computing, Fujitsu and Marvell. We made available our ARM-compatible software development kit consisting of NVIDIA CUDA-X libraries and development tools for accelerating computing. This opens the floodgates of innovation to support growing new applications from hyperscale cloud to Exascale supercomputing. We also introduced NVIDIA Magnum IO, a suite of software optimized to eliminate storage and input/output bottlenecks. Magnum IO delivers up to 20x faster data processing for multi-server, multi-GPU computing nodes when working with massive data sets to carry out complex financial analysis, climate modeling and other workloads for data scientists, high-performance computing and AI researchers. +Finally, we introduced TensorRT 7, the seventh generation of our inference software development kit, which speeds up components of conversational AI by 10x comparing to running on CPUs. This helps drive latency below the 300 millisecond threshold considered necessary for real-time interactions supporting our growth in conversational AI. +Moving to ProVis. Revenue reached a record $331 million, up 13% year-on-year and up 2% sequentially. Full year revenue was a record $1.21 billion, an increase of 7% from the prior year. ProVis accelerated in Q4 as the rollout of more RTX-enabled applications is driving strong upgrade cycle for our Turing GPUs. RTX is also opening up new market segment opportunities, such as rendering and studio for freelance creatives. +In November, V-ray, Arnold and Blender software renderers began shipping with RTX technology. These joined our leading creative and design applications, including Premier Pro, Dimension, SOLIDWORKS, CATIA and Maya. With RTX, these applications enable enhanced creativity and notable productivity gains. In Blender Cycles, for example, real-time rendering performance is boosted 4x versus a CPU. RTX is now supported by more than 40 leading creative and design applications, reaching a combined user base of over 40 million. +Finally, turning to automotive. Revenue was $163 million, flat from a year ago and up 1% sequentially. Full year revenue reached a record $700 million, up 9% year-on-year. During the quarter, we announced DRIVE AGX Orin, the next-generation platform for autonomous vehicles and robots, powered by our new Orin SoC and delivering nearly 7x the performance of the previous generation Xavier SoC. The platform scales from level 2 plus AI-assisted driving up to level 5 fully driverless operation. Orin is software-defined and compatible with Xavier, allowing developers to leverage their investment across multiple product generations. +Moving to the rest of the P&L. Q4 GAAP gross margins was 64.9% and non-GAAP was 65.4%, up sequentially, largely reflecting a higher contribution of data center products. Q4 GAAP operating expenses were $1.02 billion and non-GAAP operating expenses were $810 million, up 12% and 7% year-on-year, respectively. +Q4 GAAP EPS was $1.53, up 66% from a year earlier. Non-GAAP EPS was $1.89, up 136% from a year ago. Q4 cash from operations was $1.46 billion. Fiscal year '20 cash flow from operations was a record $4.76 billion. +With that, let me turn the outlook for the first quarter of fiscal 2021. The outlook does not include any contribution from the pending acquisition of Mellanox. We are engaged and progressing with China on the regulatory approval and believe the acquisition will likely close in the first part of calendar 2020. +Before we get to the new -- the numbers, let me comment on the impact of the coronavirus. While it is still early and the ultimate effect is difficult to estimate, we have reduced our Q1 revenue outlook by $100 million to account for the potential impact. We expect revenue to be $3 billion, plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 65% and 65.4%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $1.05 billion and $835 million, respectively. GAAP and non-GAAP OI&E are both expected to be income of approximately $25 million. GAAP and non-GAAP tax rates are both expected to be 9%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $150 million to $170 million. Further financial details are included in the CFO commentary and other information available on the IR website. +In closing, let me highlight an upcoming event for the financial community. We will be at the Morgan Stanley Technology, Media and Telecom Conference on March 2 in San Francisco. +With that, we will now open the call for questions. Operator, will you please poll for questions. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +And our first question comes from the line of Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I guess on data center, Colette or Jensen, can you speak to some of the areas that drove the upside in the quarter? You talked about inference and -- both the T4 and the V100 having record quarters but relative to your internal expectations, what were some of the businesses that drove the upside? And if you can also speak to the breadth of your customer profile today relative to a couple of years ago, how that's expanded, that would be helpful as well. + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- + + Yes. Toshiya, thanks a lot for your question. The primary driver for our growth is AI. There are 4 fundamental dynamics. The first is that the AI models that are being created are achieving breakthroughs and quite amazing breakthroughs, in fact, in natural language understanding, in conversational AI, in recommendation systems. And you know this, but for the others in the audience, recommendation systems are essentially the engine of the Internet today. And the reason for that is because there are so many items in the world, whether it's a store or whether it's content or websites or information you are querying, there are hundreds of billions, trillions, and depending on how you count it, hundreds of trillions of items in the world. And there are billions of people, each with their own characteristics and their countless contexts. And between the items, the people, the users and the various contexts that we're in, location and what you're looking for and weather or what's happening in the environment, those kind of contexts affects the search query that -- the answer they provide you. The recommendation system is just foundational now to search. And some people have said this is the end of search and the beginning -- and the era of recommendation systems. Work is being done everywhere around the world in advancing recommendation systems. And very first time over the last year, it's been able to be done in deep learning. +And so the first thing is just the breakthroughs in AI. The second is production AI, which means that whereas we had significant and we continue to have significant opportunities in training because the models are getting larger, and there are more of them, we're seeing a lot of these models going into production, and that business is called inference. Inference, as Colette mentioned, grew 4x year-over-year. It's a substantial part of our business now. But one of the interesting statistics is TensorRT 7, the entire TensorRT download this year was about 500,000, a doubling over a year ago. What most people don't understand about inference is it's an incredibly complex computational problem, but it's an enormously complex software problem. And so the second dynamic is moving from training or growing from training and models going into production called inference. +The third is the growth, not just in hyperscale anymore, but in public cloud and in vertical industries. Public cloud because of thousands of AI start-ups that are now developing AI software in the cloud. And the OpEx model works much better for them as they're younger. When they become larger, they could decide to build their own data center infrastructure on-prem, but the thousands of start-ups start their lives in the cloud. +We're also seeing really great success in verticals. One of the most exciting vertical is logistics. Logistics, retail, warehousing. We announced, I think, this quarter or last -- end of last quarter, USPS, American Express, Walmart, just large companies who have enormous amounts of data that they're trying to do data analytics on and do predictive analytics on. And so the third dynamic is the growth in -- beyond hyperscale and public cloud as well as vertical industries. +And then the last dynamic is being talked about a lot, and this is really, really exciting, and it's called edge AI. We used to call it industries and AI where the action is. But the industry now calls edge AI. We're seeing a lot of excitement there. And the reason for that is you need to have low latency inference. You might not be able to stream the data all the way to the cloud for cost reasons or data sovereignty reasons, and you need the response time. And so those 4 dynamics around AI really drove our growth. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [5] +-------------------------------------------------------------------------------- + + Great. Just following up on that. As you look back at the last 12 months and the deceleration that you saw in your HPC cloud business, now that you have the perspective of seeing what's driving the rebound, any thoughts on what drove it to slow down in the first place? Was it just digestion? Was it sort of a handoff from image recognition to these newer applications that you just talked about? Just help us -- what happened there? And I guess as it pertains to the future, do we think of this as a business that will have that kind of lumpiness to it? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [6] +-------------------------------------------------------------------------------- + + Yes. That's a really good question. In fact, if you look backwards, now we only have the benefit of history. The deep recommendation systems, the natural language understanding breakthroughs, the conversational AI breakthroughs, all happened in this last year. And the velocity by which the industry captured the benefits here and continue to evolve and advance from these what so-called transformer models was really quite incredible. And so all of a sudden, the number of breakthroughs in AI has just grown tremendously, and these models have grown tremendously. Just this last week, Microsoft announced that they've trained a neural net model in collaboration with work that we did, we call Megatron, increased the size of a model from 7.5 billion parameters to 17.5 billion parameters. And the accuracy of their natural language understanding has just -- has really been boosted. +And so the models are -- AI is finding really fantastic breakthroughs, and models are getting bigger and there are more of them. And when you look back and look at when these breakthroughs happened, it essentially happened this last year. +The second, we've been working on inference for some time. And until this last year, very few of those inference models went into production. And now we have deep learning models across all of the hyperscalers in production. And this last year, we saw really great growth in inference. +The third dynamic is public clouds. All these AI startups that are being started all over the world, there's about 6,000 of them, they're starting to develop and be able to put their models into production. And with the scale out of AWS, we now have T4s in every single geography. So the combination of the availability of our GPUs in the cloud, and the startups and vertical industries deploying their AI models into production, the combination of all that just kind of came together. And all of that happened this last year. And as a result, we had record sales of V100s and T4s. And so we're quite excited with the developments, and it's all really powered by AI. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Vivek Arya with Bank of America Securities. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [8] +-------------------------------------------------------------------------------- + + Congratulations on returning the business back to the strong growth. Jensen, I wanted to ask about how you are positioned from a supply perspective for this coming year? Your main foundry is running pretty tight. How will you be able to support the 20% or so growth here that many investors are looking for? If you could just give us some commentary on how you're positioned from a supply perspective, that will be very helpful. + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- + + Well, I think we're in pretty good shape on supply. We surely won't have ample supply. It is true that the industry is tight and the combination of supporting multiple processes, multiple fabs across our partner, TSMC. We've got a lot of different factories and a lot of different -- several different nodes of process qualified. I think we're in good shape. And so we just have to watch it closely. And we're working very closely with all of our customers in forecasting. And of course, that gives us better visibility as well and -- but all of us have to do a better job forecasting, and we're working very closely between our customers and our foundry partners, TSMC. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [11] +-------------------------------------------------------------------------------- + + Colette, I'm wondering if you can give us -- in data center, if you can give us a little idea of what the mix was between industries and hyperscale. I think last quarter, hyperscale was a little bit less than 50%. Can you give us maybe the mix or how much it was up, something like that? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Yes. Tim, thanks for the question. Similar to what we had seen last quarter, with all things growing as we moved into this quarter, growth in terms of the hyperscales, continued expansion in terms of those vertical industries and even in the cloud instances. We're still looking at around the same split of 50-50 between our hyperscales and our vertical industries and maybe a little bit tad below 50 in terms of our total overall hyperscales. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [14] +-------------------------------------------------------------------------------- + + Congratulations on the results. When I look at the numbers, the growth on an absolute basis sequentially in data center was almost 2x or north of 2x, what we've seen in the past as far as the absolute sequential change. Through the course of this quarter, you were pretty clear that you would expect to see an acceleration of growth in the December quarter. I'm just curious of how you think about that going into the April quarter? And how we should think about that growth rate through the course of this year? If you can give us any kind of framework. +And Jensen, just curious, I mean, as you think about the bigger picture, where do you think we stand from an industry perspective today in terms of the amount or the attach rate of GPUs, is it for acceleration in the server market? And where do you think that might be looking out over the next 3 years or so? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [15] +-------------------------------------------------------------------------------- + + Thanks, Aaron. Colette, do you want to go first? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [16] +-------------------------------------------------------------------------------- + + Sure. When we think about going into Q1 and our data center overall growth, we do expect to see continued growth, both going into Q1. We believe our visibility still remains positive quite well, and we're expecting that as we move into it and go forward. + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [17] +-------------------------------------------------------------------------------- + + Yes. Aaron, I believe that every query on the Internet will be accelerated someday. And at the very core of it, most -- almost all queries will have some natural language understanding component to it. Almost all queries will have to sort through and make a recommendation from the trillions of possibilities, filter it down and recommend a handful of recommended answers to your queries. Whether it's shopping or movies or just asking locations or even asking a question, the number of the possibilities of all the answers versus what is best answer is -- needs to be filtered down. And that filtering process is called recommendation. That recommendation system is really complex, and deep learning is going to be involved in all that. That's the first thing. I believe that every query will be accelerated. +The second is, as you know, CPU scaling has really slowed, and there's just no two ways about it. It's not a marketing thing. It's a physics thing. And the ability for CPUs to continue to scale without increasing cost or increasing power has ended. And it's called the end of Dennard scaling. And so there has to be another approach. The combination of the emergence of deep learning and the use of artificial intelligence and the amount of computation that's necessary to -- for every single query but the benefit that comes along with that, and the end of Dennard scaling, suggests that there needs to be another approach, and we believe that approach is acceleration. +Now our approach for acceleration is fundamentally different than an accelerator. Notice, we never say accelerator, we say accelerated computing. And the reason for that is because we believe that a software-defined data center will have all kinds of different AIs. The AIs will continue to evolve, the models will continue to evolve and get larger, and a software-defined data center needs to be programmable. It is one of the reasons why we've been so successful. And if you go back and think about all the questions that have been asked of me over the last 3 or 4 years around this area, the consistency of the answer has to do with the programmability of architecture, the richness of the software, the difficulties of the compilers, the ever-growing size of the models, the diversity of the models and the advances that these models are creating. And so we're seeing the beginning of a new computing era. +And a fixed function accelerator is simply not the right answer. And so we believe that the future is going to be accelerated. It's going to require an accelerated computing platform, and software richness is really vital, so that these data centers could be software defined. And so I think that we're in the early innings, the early innings, very, very early innings of this new future. And I think that accelerated computing is going to become more and more important. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [19] +-------------------------------------------------------------------------------- + + Obviously, congratulations on the data center success. I wanted to ask a little bit, Colette, about the -- you took $100 million out for coronavirus, and I wanted to ask a little bit about how you got to that number. Really 2 pieces. One, if you could remind us maybe in terms of units or revenue, how -- what percentage of your gaming business is within China? And as you look at that $100 million that you pulled out of the guidance, are you thinking about that from a demand disruption perspective? Or are you thinking about it from something in the supply chain that might limit your sales? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [20] +-------------------------------------------------------------------------------- + + Sure. Thanks for the question, Matt. So it's really still quite early in terms of trying to figure out what the impact from the overall coronavirus may be. So we're not necessarily precise in terms of our estimate. Yes, our estimates are split between an impact possibly on gaming and data center and split pretty much equally. The $100 million also reflects what may be supply challenges or may be overall demand. But we're still looking at those to get a better understanding where we think that might be. +In terms of our business and our business makeup, yes, our overall China business for gaming is an important piece. We have about 30% of our overall China gaming as a percentage of our overall gaming business. For data center, it's -- it moves quite a bit. They are a very important market for us, but it moves from quarter-to-quarter just based on the overall end customer mix as well as the system builds that they may choose. So it's a little harder to determine. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JPMorgan Chase & Co, Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + Congratulations on the strong results and guidance. On gaming -- yes, no problem. Good to see the recent launch of your GeForce NOW service. But on the partnership with Tencent on cloud gaming, seems like Tencent should have a smoother transition to the cloud model. They are the largest gaming company in the world, so they own many of the games. They also have their own data center infrastructure already in place. But how is the NVIDIA team going to be supporting this partnership? Is it going to be [deal your] GeForce NOW hardware framework? Or will you just be supporting them with your standalone GPU products? And when do you expect the service to go mainstream? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [23] +-------------------------------------------------------------------------------- + + Let's see. Tencent is the world's largest publisher. China represents about 1/3 of the world's gaming, and transitioning to the cloud is going to be a long-term journey. And the reason for that is because Internet connection is not consistent throughout the entire market. And a lot of application still needs to be onboarded, and we're working very closely with them. We're super enthusiastic about it. If we're successful long term, and we're talking about an extra 1 billion gamers that we might be able to reach. And so I think that this is an exciting opportunity, just a long-term journey. +Now here in the West, we've had a lot more opportunity to refine the connections around the world and working through the data centers, the local hubs as well as people's WiFi routers at home. And so we've been in beta for quite some time, as you know. And here in the West, our platform is open. And we have several hundred games now and we're in the process of onboarding another 1,500 games. We're the only cloud platform that's based on Windows and allows us to be able to bring PC games to the cloud. And so the reach is -- we've had more experience here in the West with reach, and we've had -- we obviously have a lot more games that we can onboard. But I'm super enthusiastic about the partnership we have with Tencent. +Overall, our GeForce NOW -- you guys saw the launch, it's -- the reception has been fantastic, the reviews have been fantastic. Our strategy has 3 components. There's the GeForce NOW service that we provide ourselves. We also have GeForce NOW alliances with telcos around the world to reach the regions around the world that we don't have a presence in. And that is going super well, and I'm excited about that. And then lastly, partnerships with large publishers, for example, like Tencent. And we offer them our platform, of course, and a great deal of software and just a lot of engineering that has to be done in collaboration to refine the service. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Your next question comes from the line of C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [25] +-------------------------------------------------------------------------------- + + I guess a question on the gaming side. If I look at your overall revenue guide, it would seem to suggest that you're looking for typically, I guess, better seasonal trends into April. And I guess can you speak to that? And then how are you seeing desktop gaming demand with ray tracing content becoming more available? How should we think about the growth trajectory through 2020? And then just really as a modeling question as part of gaming, with notebook now 1/3 of the revenues, how should we think about kind of the seasonality going into April and July for that part of your business? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [26] +-------------------------------------------------------------------------------- + + Yes. So C.J., I'm going to go first, and then Colette is going take it home here. So the first part of it is this, our gaming business has at the end -- I'm sorry. Okay. Our gaming business, the end market demand is really terrific. It's really healthy. It's been healthy throughout the whole year. And it's pretty clear that RTX is doing fantastic. And it's very -- it's super clear now that ray tracing is the most important new feature of next-generation graphics. We have 30 -- over 30 games that have been announced, 11 games or so that have been shipped. The pipeline of ray tracing games that are going to be coming out is just really, really exciting. The second factor -- and one more thing about RTX, we finally have taken RTX down to $299. So it's now at the sweet spot of gaming. And so RTX is doing fantastic. The sell-through is fantastic all over the world. +The second part of our business that is changing in gaming is this -- the amount of notebook sales and the success of Nintendo Switch has really changed the profile of our overall gaming business. Our notebook business, as Colette mentioned earlier, has seen double-digit growth for 8 consecutive quarters, and this is unquestionably a new gaming category. Like it's a new game console. This is going to be the largest game console in the world, I believe. And the reason for that is because there are more people with laptops than there are of any other device. And so the fact that we've been able to get RTX into a thin and light notebook, a thin and light notebook, is really a breakthrough. And it's one of the reasons why we're seeing such great success in notebook. Between the notebook business and our Nintendo Switch business, the profile of gaming overall has changed and has become more seasonal. It's more seasonal because devices, systems, like notebooks and Switch, are built largely in 2 quarters, Q2 and Q3. And they build it largely in Q2 and Q3 because it takes a while to build them and ship them and put them into the hubs around the world. And they tend to build it ahead of the holiday season. And so that's one of the reasons why Q3 will tend to be larger and Q4 will tend to be more seasonal and Q1 will tend to be more seasonal than the past. But the end demand is fantastic. RTX is doing great. And part of it is just a result of the success of our notebooks. I'm going to hand it over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [27] +-------------------------------------------------------------------------------- + + Yes. So with that from a background and you think about all those different components that are within gaming, the notebook, the overall Switch, and of course, all of the ray tracing that we have in terms of desktop, our normal seasonality, as we look at Q1 for gaming with all those 3 pieces, is usually sequentially down from Q4, sequentially down Q4 to Q1. This year, the outlook assumes it will probably be a little bit more pronounced due to the coronavirus. So in total, we're probably looking at Q1 to be in the low double-digit sequential decline in gaming. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Atif Malik with Citi. + +-------------------------------------------------------------------------------- +Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [29] +-------------------------------------------------------------------------------- + + Good job on results and guide. On the same topic, coronavirus. Colette, I'm a bit surprised that the guidance -- the range on the guidance is not wider versus historic. Can you just talk about why not widen the range? And what went into that $100 million hit from the coronavirus? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [30] +-------------------------------------------------------------------------------- + + So Atif, thanks for the question. Again, it's still very early regarding the coronavirus. Our thoughts are out with both the employees, the families and others that are in China. So our discussions, both with our supply chain that is very prominent in the overall Asia region as well as our overall AIC makers as well as our customers, is as about as timely as we can be. And that went into our discussion and our thoughts on the overall guidance that we gave into our $100 million. We'll just have to see how the quarter comes through, and we'll discuss more when we get to it. But at this time, that was our best estimate at this time. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Your next question comes from the line of William Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [32] +-------------------------------------------------------------------------------- + + Jensen, I'd love to hear your thoughts as to how you anticipate the inference market playing out. Historically, NVIDIA's had essentially all of the training market and little of the inference market in the last 1.5 years or so. I think that's changed where you've done much better in inference. Now you have the T4 in the cloud, you have EGX at the edge. And you have Jetson, I think, is what it's called at the sort of endpoint device. How do you anticipate that market for inference developing across those various positions? And how are you aligning your portfolio for that growth? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [33] +-------------------------------------------------------------------------------- + + Yes. Thanks a lot, Will. Let's see, I think the -- historically, inference has been a small part of our business because AI was still being developed. Deep learning, AI is not -- historical AI, classical machine learning weren't particularly suited for GPUs and weren't particularly suited for acceleration. It wasn't until deep learning came along that the amount of computation necessary is just extraordinary. And the second factor is the type of AI models that were developed. Eventually, if -- the type of models related to natural language understanding and conversational AI and recommendation systems, these require instantaneous response. The faster the answer, the more likely someone is going to click on the answer. And so you know that latency matters a great deal, and it's measurable. The effect on the business is directly measurable. +And so for conversational AI, for example, we've been able to reduce the latency of the entire pipeline from speech recognition to the language processing to, for example, fix the errors and such, come up with a recommendation to text to speech to the voice synthesis. That entire pipeline could take several seconds. We run it so fast that it's possible now for us to process the entire pipeline within a couple of hundred, 200, 300 milliseconds. That is in the realm of interactive conversation. +Beyond that, it's just simply too slow. And so the combination of AI models that are large and complex that are moving to inference, moving to production. And then secondarily, conversational AI and latency-sensitive models and applications where our GPUs are essential, now moving forward, I think you're going to see a lot more opportunities for us in inference. +The way to think about that long-term is acceleration is essential because of end of Dennard scaling. Process technology is going to demand that we compute in a different way. And the way that AI has evolved and deep learning, it suggests that acceleration on GPUs is just a really phenomenal approach. +Data centers are going to have to be software-defined. And I think as I mentioned, I think I mentioned earlier to another question, I believe that in the future, the data center will all be accelerated. It will be all running AI models, and it will be software-defined and it will be programmable and having an accelerated computing platform is essential. As you move out to the edge, it really depends on whether your platform is software-defined, whether it has to be programmable or whether it's fix functioned. There are many, many devices where the inference work is very specific. It could be something as simple as detecting changes in temperature or changes in sound or detecting motion. Those type of inference models are -- could still be based on deep learning. It's function-specific. You don't have to change it very often and you're running 1 or 2 models at any given point in time. And so those devices are going to be incredibly cost-effective. +I believe, those AI chips, you're going to have AI chips that are $0.50, $1, and you're just going to put it into something and it's going to be doing magical detections. The type of platforms that we're in, such as self-driving cars and robotics, the software is so complicated and there's so much evolution to come yet, and it's going to constantly get better. Those software-defined platforms are really the ideal targets for us. And so we call it AI at the edge, edge computing devices. One of the edge computing devices I'm very excited about is what people call mobile edge or basically 5G telco edge. That data center will be programmable. We recently announced that we partnered with Ericsson and we're going to be accelerating the 5G stack. And so that needs to be a software-defined data center. It runs all kinds of applications, including 5G. And those applications are going to be -- those opportunities are fantastic for us. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [35] +-------------------------------------------------------------------------------- + + Jensen, I guess I had a question about your -- how you think about the sustainability of your market position in the data center? And I guess in my simplistic view, about 12 years ago, you made out a consensus call to invest in CUDA software, distribute it to universities. Neural networking took off and you were the de facto standard, and here we are right now. And for me, what's interesting to hear is that the demand that you're seeing today for your products is from markets that's just developed within the last year. And my question is like, how do you think about your investment, your R&D investment strategy to make sure that you are staying way ahead of the market, of the competition and even your customers who are investing in these markets, too? + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [36] +-------------------------------------------------------------------------------- + + Yes. Thanks, Mark. Our company has to live 10 years ahead of the market. And so we have to imagine where the world is going to be in 10 years' time, in 5 years' time and work our way backwards. Now our company is focused on one singular thing. The simplicity of it is incredible. And that one singular thing is accelerated computing, accelerated computing. And accelerated computing is all about the architecture, of course. It's about the complicated systems that we're in because throughput is high. When our acceleration, we can -- when we can compute 10x, 20x, 50x, 100x faster than the CPU, all of a sudden, everything becomes a bottleneck. Memory's a bottleneck, networking's a bottleneck, storage is a bottleneck, everything is a bottleneck. And so we have to be -- NVIDIA has to be a supremely good system designer. But the complexity of our stack, which is the software stack above it, is really where the investments over the course of the last -- some 29 years now, has really paid off. +NVIDIA, frankly, has been an accelerated computing company since the day it was born. And so we -- our company is constantly trying to expand the number of applications that we can accelerate. Of course, computer graphics was an original one, and we're reinventing it with real-time ray tracing. We have rendering, which is a brand-new application that we're making great progress in. We just talked -- I just mentioned 5G acceleration. Recently, we announced genomics computing. And so those are new applications that are really important to the future of computing. +In the area of artificial intelligence, from image recognition to natural language understanding, to conversation, to recommendation systems, to robotics and animation, the number of applications that we're going to accelerate in the field of AI is really, really broad. And each one of them are making tremendous progress and getting more and more complex. And so the question about the sustainability of our company really comes down to 2 dimensions. Let's assume for the fact -- let's assume for now that accelerated computing is the path forward, and we surely believe so. And there's a lot of evidence from the laws of physics to the laws of computer science that would suggest that accelerated computing is the right path forward. But this really basically comes down to 2 dimensions. One dimension is are we continuing to expand? Are we continuing to expand the number of applications that we can accelerate? Whether it's AI or computer graphics or genomics or 5G, for example. +And then the number -- and then the second is those applications, are they getting more impactful and adopted by the ecosystem, the industry? And are they continuing to be more complex? Those dimensions, the number of applications and the rich -- and the impact of those applications and the evolution, the growth of complexity of those applications, if those dynamics continue to grow, then I think we're going to do a good job. We're going to sustain. And so -- and I think when I spelled it out that way, it's basically the equation of growth of our company. I think it's fairly clear that the opportunities are fairly exciting ahead. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Blayne Curtis with Barclays. + +-------------------------------------------------------------------------------- +Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [38] +-------------------------------------------------------------------------------- + + Jensen, I just wanted to ask you on the auto side. I think at least one of your customers might have slowed out their program. Just kind of curious as you look out the next couple of years, the challenges, if the OEM is moving slower? And then just any perspective on the regulatory side, has anything changed there, would be helpful. + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- + + I think that the automotive industry is struggling, but -- for all of the reasons that everybody knows. However, the enthusiasm to redefine and reinvent their business model has never been greater. Every single one of them, every single one of them would know now and they surely -- they've known for some time, and autonomous capabilities is really the vehicle to do that. They need to be tech companies. Every car company wants to be a tech company. They need to be a tech company. Every car company needs to be software-defined. And the platform by which to do so is an electric vehicle with autonomous autopilot capability. That car has to be software-defined. And this is their future and they're racing to get there. +And so although the automotive industry is struggling in near term, their opportunity has never been better in my opinion. The future of AV is more important than ever. The opportunity is very real. The benefits of autonomous is for whether it's safety, whether it's utility, whether it's cost reduction and productivity, has never been more clear. And so I think that I'm as enthusiastic as ever about the autonomous vehicles and the projects that we're working on are moving ahead. And so the near-term challenges of the automotive industry or whatever sales slowdown in China that they're experiencing, I feel badly about that. But the industry is as clearheaded about the importance of AV as ever. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + I will now turn the call back over to Jensen for any closing remarks. + +-------------------------------------------------------------------------------- +Jensen Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [41] +-------------------------------------------------------------------------------- + + We had an excellent quarter with strong demand for NVIDIA RTX graphics and NVIDIA AI platforms and record data center revenue. NVIDIA RTX is reinventing computer graphics, and the market's response is excellent, driving a powerful upgrade cycle in both gaming and professional graphics, while opening whole new opportunities for us to serve the huge community of independent creative workers and social content creators and new markets in rendering and cloud gaming. Our data center business is enjoying a new wave of growth, powered by 3 key trends in AI, natural language understanding, conversational AI, deep recommenders, are changing the way people interact with the Internet. The public cloud demand for AI is growing rapidly. And as AI shifts from development to production, our inference business is gaining momentum. We'll be talking a lot more about these key trends and much more at next month's GTC Conference in San Jose. Come join me. You won't be disappointed. Thanks, everyone. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/Transcripts/NVDA/2020-May-21-NVDA.txt b/Transcripts/NVDA/2020-May-21-NVDA.txt new file mode 100644 index 0000000000000000000000000000000000000000..5256d45af5cd55425447a02a44f7af05bb3595e9 --- /dev/null +++ b/Transcripts/NVDA/2020-May-21-NVDA.txt @@ -0,0 +1,509 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2021 NVIDIA Corp Earnings Call +MAY 21, 2020 / 9:30PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Colette M. Kress + NVIDIA Corporation - Executive VP & CFO + * Jen-Hsun Huang + NVIDIA Corporation - Co-Founder, CEO, President & Director + * Simona Jankowski + NVIDIA Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Toshiya Hari + Goldman Sachs Group Inc., Research Division - MD + * Vivek Arya + BofA Merrill Lynch, Research Division - Director + * Aaron Christopher Rakers + Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst + * Joseph Lawrence Moore + Morgan Stanley, Research Division - Executive Director + * Stacy Aaron Rasgon + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * William Stein + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Timothy Michael Arcuri + UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment + * Harlan Sur + JP Morgan Chase & Co, Research Division - Senior Analyst + * Mark John Lipacis + Jefferies LLC, Research Division - MD & Senior Equity Research Analyst + * Christopher James Muse + Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst + * John William Pitzer + Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head + * Matthew D. Ramsay + Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst + +================================================================================ +Presentation +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Josh, and I will be your conference operator today. At this time, I would like to welcome everyone to NVIDIA's Financial Results Conference call. (Operator Instructions) Thank you. +Simona Jankowski, you may begin your conference. + +-------------------------------------------------------------------------------- +Simona Jankowski, NVIDIA Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the first quarter of fiscal 2021. With me on the call today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the second quarter of fiscal 2021. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. +During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may vary materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Form 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 21, 2020, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. +During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. +With that, let me turn the call over to Jensen. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [3] +-------------------------------------------------------------------------------- +Thanks, Simona. Before Colette describes our quarterly results, I'd like to thank those who are on the front lines of this crisis, first responders, health care workers, service providers, who inspires every day with their bravery and selflessness. I also want to acknowledge the incredible efforts of our colleagues here at NVIDIA. Despite many challenges, they have barely broken stride during one of the busiest periods in our history. +Our efforts related to the virus are focused in 3 areas. First, we're taking care of our families and communities. We've pooled in raises by 6 months to put more money in our employees' hands, and NVIDIA and our people have donated thus far more than $10 million to those in need. +Second, we're using NVIDIA's unique capabilities to fight the virus. A great deal of science being done on COVID-19 uses NVIDIA technology for acceleration when every second counts. Some of the many examples, including sequencing the virus, analyzing drug candidates, imaging the virus at molecular resolution with cryo-electron microscopy and identifying elevated body temperature with AI cameras. +And third, because COVID-19 won't be the last killer virus, we need to be ready for the next outbreak. NVIDIA technology is essential for the scientific community to develop an end-to-end computational defense system, a system that can detect early, accelerate the development of a vaccine, contain the spread of disease and continuously test and monitor. +We are racing to deploy the NVIDIA Clara computational health care platforms, Clara Parabricks can accelerate genomics analysis from days to minutes. Clara Imaging will continue to partner with leading research institutes to develop state-of-the-art AI models to detect infections, and Clara Guardian will connect AI to cameras and microphones and hospitals to help overloaded staff watch over patients. +We completed the acquisition of Mellanox on April 27. Mellanox is now NVIDIA's networking brand and business unit and will be reported as part of our data center market platform, and Israel is now one of NVIDIA's major technology centers. +The new NVIDIA has a much larger footprint in data center computing, end-to-end and full-stack expertise in data center architectures and tremendous scale to accelerate innovation. NVIDIA Mellanox are a perfect combination and position us for the major forces shaping the IT industry today, data center scale computing and AI. +From micro service cloud applications to machine learning and AI, accelerated computing and high-performance networking are critical to modern data centers. Previously, a CPU compute node was the unit of computing. Going forward, the new unit of computing is an entire data center. The basic computing elements are now storage servers, CPU servers and GPU servers, and are composed and orchestrated by hyperscale applications that are serving millions of users simultaneously. Connecting these computing elements together is the high-performance Mellanox networking. This is the era of data center scale computing. And together, NVIDIA Mellanox can architect end to end. Mellanox is an extraordinary company, and I'm thrilled that we're now one force to invent the future together. +Now let me turn the call over to Colette. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [4] +-------------------------------------------------------------------------------- +Thanks, Jensen. Against the backdrop of the extraordinary events unfolding around the globe, we had a very strong quarter. Q1 revenue was $3.08 billion, up 39% year-on-year, down 1% sequentially and slightly ahead of our outlook, reflecting upside in our data center and gaming platforms. +Starting with gaming. Revenue of $1.34 billion was up 27% year-on-year and down 10% sequentially. We are pleased with these results, which exceeded expectations in the quarter, marked by the unprecedented challenge of the COVID-19. +Let me give you some color. Early in Q1, as the epidemic unfolded, demand in China was impacted with iCafes closing for an extended period. As the virus spread globally, much of the world started working and learning from home, and gameplay surged. Globally, we have seen 50% rise in gaming hours played on our GeForce platform, driven both by more people playing and more gameplay per user. +With many retail outlets closed, demand for our products has shifted quite efficiently to e-tail channels globally. Gaming laptops revenue accelerated to its fastest year-on-year growth in 6 quarters. We are working with our OEMs, channel partners to meet the growing needs of the professionals and students engaged in working, learning and playing at home. In early April, our global OEM partners announced a record new 100 NVIDIA GeForce-powered laptops with availability starting in Q1 and the most to ship in Q2. These laptops are the first to use our high-end GeForce RTX 2080 SUPER and 2070 SUPER GPUs, which have been available for desktop since last summer. +In addition, OEMs are bringing to market laptops based on the RTX 2060 GPU at just $999, a price point that enables a larger audience to take advantage of the power and features of RTX, including its unique ray tracing and AI capabilities. These launches are well-timed as mobile and remote computing needs accelerate. +The global rise in gaming also lifted sales of NVIDIA Nintendo Switch and our console business, driving strong growth both sequentially and year-over-year. We collaborated with Microsoft and Mojang to bring RTX ray tracing to Minecraft, the world's most popular game with over 100 million gamers monthly and over 100 billion total views on YouTube. Minecraft with RTX looks astounding with realistic shadows and reflections. Light that reflects, refracts and scatters through surfaces as naturalistic effects like fog. Reviews for it are off the charts. Ars Technica called it a jaw-dropping stunner, and PC World said it was glorious to behold. +Our RTX technology stands apart, not only with our 2-year lead in ray tracing but with its use of AI to speed up and enhance games using the Tensor Core silicon on our RTX class GPUs. We introduced the next version of our AI algorithm called Deep Learning Super Sampling. In real time, DLSS 2.0 can fill the missing bits from every frame, doubling performance. It represents a major step function from the original, and it can be trained on nongaming-specific images, making it universal and easy to implement. +The value and momentum of our RTX GPUs continue to grow. We have a significant upgrade opportunity over the next year with the rise and tide of RTX-enabled games, including major blockbusters like Minecraft and Cyberpunk. Let me also touch on our game streaming service, GFN, which exited beta this quarter. It gives gamers access to more than 650 games with another 1,500 in line to get onboarded. These include Epic Games, Fortnite, which is the most played game on GFN; and other popular titles such as CONTROL, Destiny 2 and League of Lighting in the fall. Since launching in February, GFN has added 2 million users around the world, with both sign-ups and hours of gameplays boosted by stay-at-home measures. GFN expands our market reach to the billions of gamers with underpowered devices. It is the most publisher-friendly, developer-friendly game streaming service with the greatest number of games and the only one that supports ray tracing. +Moving to Pro Visualization. Revenue was $307 million, up 15% year-on-year and down 7% sequentially. Year-on-year revenue growth accelerated in Q1 driven by laptop workstations and Turing adoption. +We are seeing continued momentum in our ecosystem for RTX ray tracing. We now have RTX support for all major rendering visualization and design software packages, including Autodesk Maya, Dassault's CATIA, Pixar's RenderMan, Chaos Group's V-Ray and many others. Autodesk has announced that the latest release of VRED, its automotive 3D visualization software, supports NVIDIA RTX GPUs. This enables designers to take advantage of RTX to produce more like-life designs in a fraction of the time versus CPU-based systems. Over 45 leading creative and design applications now take advantage of RTX, driving a sustained upgrade opportunity for Quadro-powered systems while also expanding their reach. +We see strong demand in verticals, including health care, media and entertainment and higher education, among others. Higher health care demand was fueled in part by COVID-19 related research at Siemens, Oxford and Caption Health. Caption Health received FDA clearance for an update to its AI-guided ultrasound, making it easier to perform diagnostics-quality cardiac ultrasounds. And in media and entertainment, demand increased as companies like Disney deployed remote workforce initiatives. +Turning to automotive and robotic autonomous machines. Automotive revenue was $155 million, down 7% year-on-year and down 5% sequentially. The automotive industry is seeing a significant impact from the pandemic, and we expect that to affect our revenue in the second quarter as well, likely declining about 40% from Q1. +Despite the near-term challenges, our important work continues. We believe that every machine that moves someday will have autonomous capabilities. During the quarter, Xpeng introduced the P7, an all-electric sports sedan with innovative Level 3 automated driving features, powered by the NVIDIA DRIVE AGX Xavier AI compute platform. Our open, programmable, software-defined platform enables Xpeng to run its proprietary software while also delivering over-the-air updates for new driving features and capabilities. Production deliveries of the P7 with NVIDIA DRIVE begin next month. +Our Ampere architecture will power our next-generation NVIDIA DRIVE platform called Orin, delivering more than 6x the performance of Xavier Solutions and 4x better power efficiency. With Ampere scalability, the DRIVE platform will extend from driverless robotaxis all the way down to in windshield driver assistant systems sipping just a few watts of power. Customers appreciate the top-to-bottom platform all based on a single architecture, letting them build one software-defined platform for every vehicle in their fleet. +Lastly, in the area of robotics, we announced that BMW Group has selected the new NVIDIA as a robotics platforms to automate their factories, utilizing logistic robots built on advanced AI computing and visualization technologies. +Turning to data center. Quarterly revenue was a record $1.14 billion, up 80% year-on-year and up 18% sequentially, crossing the $1 billion mark for the first time. Announced last week, the A100 is the first Ampere architecture GPU. Although just announced, A100 is in full production, contributed meaningful to Q1 revenue and demand is strong. Overall, data center demand was solid throughout the quarter. It was also broad-based across hyperscale and vertical industry customers as well as across workloads, including training, inference and high-performance computing. We continue to have solid visibility into Q2. +The A100 offers the largest leap in performance to date over our 8 generations of GPUs, boosting performance by up to 20x over its predecessor. It is exceptionally versatile, serving as a universal accelerator for the most important high-performance workloads, including AI training and inference as well as data analytics, scientific computing and cloud graphics. +Beyond its leap performance and versatility, the A100 introduces new elastic computing technologies that make it possible to bring rightsized computing power to every job. A multi-instance GPU capability allows each A100 to be partitioned into as many as 7 smaller GPU instances. Conversely, multiple A100 interconnected by our third-generation NVLink can operate as one giant GPU for ever larger training tasks. This makes the A100 ideal for both training and for inference. The A100 will be deployed by the world's leading cloud service providers and system builders, including Alibaba cloud, Amazon Web Services, Baidu Cloud, Dell Technologies, Google Cloud platform, HPE and Microsoft Azure, among others. It is also getting adopted by several supercomputing centers, including the National Energy Research Scientific Computing Center and the Jülich Supercomputing Centre in Germany and Argonne National Laboratory. +We launched and shipped the DGX A100, our third-generation DGX and the most advanced AI system in the world. The DGX A100 is configurable from 1 to 56 independent GPUs to deliver elastic software-defined data center infrastructure for the most demanding workloads from AI training and inference to data analytics. +We announced 2 products for edge AI: the EGX A100 for larger commercial off-the-shelf servers; and the EGX Jetson Xavier NX for micro-edge servers. Supported by full AI optimized cloud, native and secure software, the EGX platform is built for AI computing at the edge. With the EGX, hospitals, retail stores, farms and factories can securely carry out real-time processing of the massive amounts of data streaming from trillions of edge sensors. NVIDIA EGX makes it possible to securely, deploy and manage and update fleets of servers remotely. EGX is also ideal for the massive computational challenge of 5G networks, which we are working on with our partners like Ericsson and Mavenir. +Additionally, we announced CUDA 11 and other important software harnessing the A100's performance and universatility (sic) [universality] to accelerate 3 of the most complex and fast-growing workloads: recommendation systems, conversational AI and data science. +First, NVIDIA Merlin is a deep recommendator (sic) [recommender] application framework that enables developers to quickly build state-of-the-art recommendation systems, leveraging our pretrained models. With billions of users and trillions of items on the Internet, deep recommendators are the critical engine powering virtually every internet service. +Second, NVIDIA Jarvis is a GPU-accelerated application framework that makes it easy for developers to create, deploy and run end-to-end real-time conversational AI applications that understand terminology unique to each company and its customers using both vision and speech. Demand for these applications are surging. Amid the shift to working from home, telemedicine and remote learning. +And third, in the field of data science and data analytics, we announced that we are bringing end-to-end GPU acceleration to Apache Spark, an analytics engine for big data processing that uses more than 500,000 data scientists worldwide. Native GPU acceleration for the entire Spark pipeline, from extracting, transforming and loading the data to training to inference, delivers the performance and the scale needed to finally connect the potential of big data with the power of AI. Adobe has achieved a 7x performance improvement and a 90% cost savings in an initial test using GPU-accelerated data analytics with Spark. +Our accelerated computing platform continues to gain momentum, underscored by the tremendous success of GTC Digital, our annual GPU technology conference, which shifted this spring to an online format. More than 55,000 online developers and AI research registered for the online event, which includes hundreds of hours of free content from AI practitioners and industry experts who leverage NVIDIA's platforms. +Our ecosystem is now 1.8 million developers strong. Times like these truly test a computing platform's metal in the utility it brings to scientist racing for solutions. Researchers around the world are deploying our GPU computing platform in the fight against COVID-19. Scientists are combining AI simulation to detect changes in pneumonia cases, sequence, the virus and seek effective biomolecular compounds for a vaccine or treatment. +The first breakthrough came from researchers at the University of Texas at Austin and National Institute of Health, who used the GPU-accelerated application to create the first 3D atomic scale map of virus using NVIDIA GPUs. This was followed by researchers at Oak Ridge National Laboratory who screened 8,000 compounds to identify 77 promising drug targets using the world's fastest supercomputer, Summit, which is powered by more than 27,000 NVIDIA GPUs. +The V100 GPUs at Oak Ridge are in high demand as they can analyze 17 million compound protein combinations in a day. They'll help understand the virus spread pattern, the University of California, San Diego, researchers ported their microbiomic analysis software to GPUs in the San Diego supercomputing cluster of 500x analysis speed up from what some people are more susceptible to the virus. +Okay. Moving to the rest of the P&L. Q1 GAAP gross margins was 65.1% and non-GAAP was 65.8%, up sequentially and year-on-year, primarily driven by GeForce GPU product mix and higher data center sales. Q1 GAAP operating expenses were $1.03 billion, and non-GAAP operating expenses were $821 million, up 10% and 9% year-on-year, respectively. Q1 GAAP EPS was $1.47, up 130% from a year earlier, and non-GAAP EPS was $1.80, up 105% from a year ago. Q1 cash flow from operations was $909 million. +Before I turn to the outlook, let me make a few comments on our Mellanox acquisition. Beyond the strong strategic and cultural fit that Jensen has discussed, Mellanox has exceptionally strong financial profile. The company reported revenue of $429 million in its March quarter, accelerating to 40% year-on-year growth, with GAAP and non-GAAP gross margins in the mid- to high 60% range. We expect the acquisition to be immediately accretive to non-GAAP gross margins, non-GAAP earnings per share and free cash flow. We aim to retain the full Mellanox team and accelerate investments in our combined road map as we jointly innovate on our shared vision for the future of accelerated computing. +With that, let me turn to the outlook of the second quarter of fiscal 2021, which includes a full quarter contribution from Mellanox. We have assumed in our outlook the potential ongoing impact from COVID-19. We expect our automotive platform sales to be down 40% on a sequential basis and Pro Viz to decline sequentially. In gaming, while we will likely see ongoing impact from the partial operations or closures of iCafes and retail stores, we expect that to be largely offset by a shift to e-tail channels. Overall, the precise magnitude of the impact is difficult to predict, given uncertainties around the reopening of the economy. Overall, we expect second quarter revenue to be $3.65 billion, plus or minus 2%. The contribution of Mellanox revenue is likely to be in the low teens percentage range of our total Q2 revenue. We are providing this breakout to help with comparability between Q1 and Q2. But going forward, it will become an integrated part of our data center market platform. +GAAP and non-GAAP gross margins are expected to be 58.6% and 66%, respectively, plus or minus 50 basis points. The sequential decline in GAAP gross margins primarily reflects an increase in acquisition-related costs, most of which are nonrecurring. +GAAP and non-GAAP operating expenses are expected to be approximately $1.52 billion, and $1.04 billion, respectively. The sequential change in GAAP operating expenses reflects an increase in stock-based compensation and acquisition-related costs. GAAP and non-GAAP operating expenses for the full year are expected to be approximately $5.7 billion and $4.1 billion, respectively. For the full year, stock-based compensation and acquisition-related costs also influence. +GAAP and non-GAAP OI&E are both expected to be an increase of approximately $50 million and $45 million, respectively. GAAP and non-GAAP tax rates are both expected to be 9%, plus or minus 1%, excluding discrete items. Capital expenditures are expected to be approximately $225 million to $250 million. Further financial details are included in the CFO commentary and other information available on our IR website. +New this quarter, we have also posted an investor presentation summarizing our results and key highlights. In closing, let me highlight upcoming events for the financial community. Next Thursday, May 28, we will webcast a presentation and Q&A with Jensen on our recent product announcement moderated by Evercore. We will also be at Cowen's TMT Conference on May 27; Morgan Stanley's Cloud Secular Winners Conference on June 1; BoFa's Technology Conference on June 2; Needham's Fourth Automotive Technology Conference on June 3 and Nasdaq Investor Conference on June 16. +Operator, we will now open for questions. Can you please poll for questions, please. + + +================================================================================ +Questions and Answers +================================================================================ +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Aaron Rakers with Wells Fargo. + +-------------------------------------------------------------------------------- +Aaron Christopher Rakers, Wells Fargo Securities, LLC, Research Division - MD of IT Hardware & Networking Equipment and Senior Analyst [2] +-------------------------------------------------------------------------------- +Congratulations on a solid quarter. Colette, I'm curious of your commentary around visibility in the data center side, that that's comments over the last couple of quarters, how would you characterize your visibility today relative to maybe what it was last quarter? And how do we think about the visibility in the context of trends maybe into the back half of the calendar year. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [3] +-------------------------------------------------------------------------------- +Thanks, Will, for the question. You are correct. We have indicated a couple of quarters ago that we were starting to see improved visibility after we came out of the digestion period in the prior overall fiscal year. As we move into Q2, we still have visibility and solid visibility into our Q2 results for overall data centers. So at this time, I'd say they are relatively about the same of what we had seen going into the Q1 period. And we think that is a true indication of their excitement about our platform and most particularly our excitement regarding A100, and that's launched and its additional products. +Now regarding the second half of the year, as you know, we have seen broad-based growth in both the hyperscale and the vertical industries, both of them in terms of at record levels. In our Q1 results. And we see in terms of inferencing continuing to grow as well, as well as we're also expanding in terms of edge AI. Our strong demand of the A100 products, including the Delta Board, but also in terms of our DGXs, was just starting an initial ramp. However, we do guide only 1 quarter at a time. So it's still a little bit too early for us to give a true certainty in terms of the macro situation that's in front of us. But again, we feel very good about the demand for A100. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question comes from Stacy Rasgon with Bernstein Research. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [5] +-------------------------------------------------------------------------------- +I first wanted to follow-up on your gaming commentary. You sort of mentioned a couple of offsets. COVID potentially still a headwind, e-tail or tailwind and maybe offsetting each other. Were you trying to suggest that those did offset completely and gaming was kind of flattish into Q2? Because I know it has a typical seasonal pattern switches typically up. I guess what were you trying to say with those kind of factors? And what are the kinds of things we should be thinking about when it comes to seasonality, Colette, into Q2 around that business segment? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [6] +-------------------------------------------------------------------------------- +So let me start, and I'll see if Jensen also wants to add on to it. I think you're talking about our sequential between Q1 and Q2. Some of the... + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [7] +-------------------------------------------------------------------------------- +Yes. That's right. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [8] +-------------------------------------------------------------------------------- +Right. Some of the pieces that we had seen related to COVID-19 in Q1 may carry over into Q2. COVID-19, in fact, had an impact in terms of our retail channels as well as our iCafes. However, as we discussed, efficiently, moved to overall e-tail. We have normally been seasonally down in desktop between Q1 and Q2, and that will likely happen. But we do see the strength in terms of laptops and overall consoles as we move for Q1 to Q2. So in summary, we do expect grow sequentially between Q1 and Q2 for our overall gaming business. And I'll turn it over to Jensen to see if he has additional commentary. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [9] +-------------------------------------------------------------------------------- +No, that was great. That was fantastic. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [10] +-------------------------------------------------------------------------------- +Yes. I guess just to follow up on that, though, if it's growing. I mean like in prior years, we've seen it grow like very strong double digits. Obviously, the mix of the business was different back then. But do you think that the kind of -- I mean are we thinking kind of it's up somewhat? You don't -- is there any chance that it could be up like on -- for what we've seen in terms of like typical levels in the past? Like can you give us any sense of magnitude, that would be really helpful? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [11] +-------------------------------------------------------------------------------- +Yes. I think when we think about that sequential growth, we'll probably be in the low -- moving up to probably the mid-single digits in terms of -- that's what our guidance right now, and we'll just have to see how the quarter goes. + +-------------------------------------------------------------------------------- +Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- +Yes. That's very helpful. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [13] +-------------------------------------------------------------------------------- +Stacy, the thing that I would add is this. I would say, I think the guidance is exactly what Colette mentioned. But if you look at the big picture, there's a few dynamics that are working really well in our favor. First, of course, is that RTX and ray tracing is just the home run. Minecraft was phenomenal. We have 33 games in the pipe that has already been announced or shipping. Just about every game developers signed on to RTX and ray tracing, and I think it's a foregone conclusion that this is the next generation. This is the way computer graphics is going to be in the future. And so I think RTX is a home run. +The second, the notebooks that we create is just doing great. We got 100 notebooks in gaming. We have 75 notebooks designed for either mobile workstations or what we call NVIDIA studio for designers and creators. And the timing was just perfect. With everybody needing to stay at home, the ability to have a mobile gaming platform and a mobile workstation, it was just perfect timing. And then, of course, you guys know quite well that our Nintendo Switch is doing fantastic. There are 3 -- the top 3 games in the world. The top games in the world today are Fortnite, Minecraft and Animal Crossing. All 3 games are NVIDIA platforms. And so I think we have all the dynamics working in our favor. And then we just got to see how it turns out. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Your next question comes from Joe Moore with Morgan Stanley. + +-------------------------------------------------------------------------------- +Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [15] +-------------------------------------------------------------------------------- +I wanted to ask about the rollout of Ampere how quickly does that roll in the various segments between hyperscale as well as on the DGX side as well as on the HPC side. And is it a smooth transition? Is there -- I remember when you launched Volta, there was a little bit of a transitional pause. Just can you tell us how you see that ramping up with the different customer segments? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [16] +-------------------------------------------------------------------------------- +Yes. Thanks a lot, Joe. So first of all, taking a step back. Accelerated computing is now common sense in data centers. It wasn't the case when we first launched Volta. If you went back to Volta, Volta was the first generation that the deep learning training in a really serious way, and it was really focused on training. It was focused on training and high-performance computing. We didn't come until later with the inference version called T4. +But over the course of the last 5 years, we've been accelerating workloads that are now diversifying in data centers. If you take a look at most of the hyperscalers, machine learning is now pervasive. Deep learning is now pervasive. The notion of accelerated deep learning and machine learning using our GPUs is now common sense. It didn't used to be. People still saw it as something esoteric. But today, data centers all over the world expect a very significant part of their data center being accelerated with GPUs. The number of workloads that we've accelerated since in the last 5 years have expanded tremendously, whether it's imaging or video or conversational AI or deep recommender systems that probably unquestionably, at this point, the most important machine learning model in the world. And so the number of applications we now accelerate is quite diverse. And so that's really -- that's contributed greatly to the ramp of Ampere. When we came -- when we started to introduce Ampere to the data center, it was very commonsensical to them that they would adopt it. They have a large amount of workload that's already accelerated by NVIDIA GPUs. +And as you know, our GPUs are architecturally compatible from generation to generation. We're forward compatible or backwards compatible. Everything that runs on T4 runs on A100, everything that runs on V100 runs on A100. And so I think the transition is going to be really, really smooth. On the other hand, because V100 and T4 -- which, by the way, V100 and T4 had a great quarter. It was sequentially up. And then on top of that, we grew with the A100 shipment. A100 -- or excuse me, V100 and T4 are now quite broadly adopted in hyperscalers for their AI services, in cloud computing, in a vertical industries, which is almost roughly half of our overall HPC business. All the way out to the edge, which had a great quarter. Much smaller part, of course -- supercomputing is important, but it's a very small part of the high-performance computing. But that's also -- we also shipped A100 to supercomputing centers. And so I think the general sense of it -- the summary of it is that the number of workloads for accelerated computing has continued to grow, the adoption of machine learning and AI and all the cloud and hyperscalers has grown. The common sense of using acceleration is now a foregone conclusion. And so I think we're ramping into a very receptive market with a really fantastic -- with a really fantastic product. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Your next question comes from Vivek Arya with Bank of America. + +-------------------------------------------------------------------------------- +Vivek Arya, BofA Merrill Lynch, Research Division - Director [18] +-------------------------------------------------------------------------------- +Congratulations on the strong growth and execution. Just a quick clarification. Colette, 66% kind of the new baseline for gross margin? And then the question, Jensen, for you, is give us a sense for how much inference as a workload and payer as a product are expected to contribute? I'm just curious where you are in terms of growing in the inference and edge AI market? And where are we kind of in the journey of Ampere penetration? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [19] +-------------------------------------------------------------------------------- +So let me start on the first question regarding the gross margin and our gross margin as we look into Q2. We are guiding Q2 non-GAAP gross margins at 66%. This is -- would be another record gross margin quarter just as we finished an overall record level, even as we are continuing right now to ramp our overall Ampere architecture within that. The Q2 also incorporates Mellanox. Mellanox has a very similar overall margins to our overall data center margins as well. But we see this new baseline as a great transition and likely to see some changes as we go forward. However, it's still a little early to see where these gross margins will go. But we're very pleased with the overall guidance right now at 66% for Q2. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [20] +-------------------------------------------------------------------------------- +Accelerated computing is just at the beginning of its journey. If you look at -- I would characterize it as several segments. First is hyperscaler AI microservices, which is all the services that we enjoy today that has AI. Whenever you shop on the web, it recommends a product. When you're watching a movie, it recommends a movie or it recommends a song. All of those -- or recommends news or recommends a friend or recommends a website, the first 10 websites that they recommend. All of these recommenders that are powering the Internet are all based on machine learning today. It's the reason why they're collecting so much data. The more data they can collect, the more they could predict your preference, and that predicting your preference is the core to a personalized Internet. It used to be largely based on CPU approaches. But going forward, it's all based on deep learning approaches. The results are much more superior and a few percentage change in preference prediction accuracy could result in tens of billions of dollars of economics. +And so this is very, very big deal. And the shift towards deep learning in hyperscale micro services or AI micro services is still ramping. Second is cloud. And as you know, cloud is a $100 billion market segment of it today, growing about 40% into $1 trillion opportunity. This -- cloud computing is the single largest IT industry transformation that we have ever seen. The 2 powers that is really -- the force -- the 2 forces that is really driving our data center business is AI and cloud computing. We're perfectly, perfectly positioned to benefit from these 2 powerful forces. So the second is cloud computing. And that journey is -- has a long ways to go. Then the third is industrial edge. In the future, today -- it's not the case today. But the combination of IoT, 5G, industrial 5G and artificial intelligence, it's going to turn every single industry into a tech industry. And whether it's logistics or warehousing or manufacturing or farming, construction, industrial, every single industry will become a tech industry. And there'll be trillions of sensors, and they'll be connected to little micro data centers. +And those data centers will be in the millions. They'll be distributed all over the edge. And that journey has just barely started. We announced 3 very important partners in 3 domains. And they're the lead partners that we felt that people would know, but we have several hundred partners that are working with us on edge AI. We announced Walmart for smart retail. We announced the U.S. Postal Service, the world's largest mail sorting service and logistics service. And then we announced this last quarter, BMW, who is working with us to transform their factory into a robotics, automated factory of the future. And so these 3 applications are great examples of the next phase of artificial intelligence and where Ampere is going to ramp into. And that is just really at its early stages. And so I think it's fair to say that we're really well positioned in the 2 fundamental forces of IT today, data center scale computing and artificial intelligence. And the segments that it's going to make a real impact are all gigantic markets. Hyperscale AI, cloud and edge AI. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Your next question comes from C.J. Muse with Evercore. + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [22] +-------------------------------------------------------------------------------- +I guess if I could ask 2. Colette, can you help us with what you think the growth rate for Mellanox could look like in calendar '20? And then Jensen, a bigger picture question for you and really not specific to health care, more broad-based. But how do you think about the long-lasting impact of COVID on worldwide demand for AI? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [23] +-------------------------------------------------------------------------------- +C.J., can you help me? You cut out in the middle of your sentence to me. Can you repeat the first part of it for me? + +-------------------------------------------------------------------------------- +Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [24] +-------------------------------------------------------------------------------- +No, sorry about that. I'm curious if you could provide a little handholding on what we should think about for growth for Mellanox in calendar '20? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [25] +-------------------------------------------------------------------------------- +At this time, it's a little early for us. And as you know, we generally just go 1 quarter out, and we're excited to bring the Mellanox team on board so we can start beginning the future of building products together. For the overall margin, their overall performance over the last couple of quarters, they had a great last year. They had a great March quarter as well. And we're just going to have to stay tuned to see equally with them what the second half of the year looks for them. Okay? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [26] +-------------------------------------------------------------------------------- +Yes, C.J., thanks for the question. This pandemic is really quite tragic, and it's reshaping industries and markets. And I think it's going to be structural. I think it's going to remain. And I think your question is really good because now it's a good time to think about where to double down. There's a few areas that I believe are going to be structurally changed. And I think that once I say it, it'll be very sensible. The first is that the world's enterprise digital transformation and moving to the cloud, that is going to accelerate. Every single company can't afford to rely just on on-prem IT. They have to be much more resilient. And having a hybrid cloud computing infrastructure is going to provide them the resilience they need. And so that's one. And when the world moves and accelerates into this $1 trillion IT infrastructure transformation, which is now $100 billion into that journey, it's growing 40% a year, I wouldn't be surprised to see that accelerate. And so cloud computing AI is going to accelerate because of that. The second is the importance of creating a computational defense system. The defense systems of most nations today are based on radar. And yet in the future, our defense systems are going to detect things that are unseeable. It's going to be infectious disease. +And I think every nation and government and scientific lab is now gearing up to think about what does it take to create a national defense system for each country that is based on computational methods? And NVIDIA is an accelerated computing company. We take something that otherwise would take a year in the case of Oak Ridge, and they filter 1 billion compounds in a day. And that's what you need to do. You need to find a way to have an accelerated computational defense system that allows you to find insight, detect early warning ASAP. And then, of course, the computational system has to go through the entire range from mitigation to containment to living within the monitoring. And so scientific labs are going to be gearing up. National labs are going to be gearing up. The third part is AI and robotics. We're going to have to have the ability to be able to do our work remotely. +NVIDIA has a lot of robots that are helping us in our labs. And without those robots helping us in our labs, we'll have a hard time getting our work done. And so we need to have remote autonomous capability for -- to handle all of these -- either dangerous circumstances to disinfect environments, to fumigate environments autonomously, to clean environments, to be able to interact with people where as little as possible in the event of an outbreak. All kinds of robotics applications are being dreamed up right now to help society forward in the case of another outbreak. And then lastly, I think more and more people are going to work permanently from home. There's a strong movement of companies that are going to support a larger percentage of people working from home. And when people work from home, it's going to clearly increase the single best home entertainment, which is video games. I think video games is going to represent a much larger segment of the overall entertainment budget of society. +And so these are some of the trends, I would say. I would say cloud computing, AI. I would say national labs, a computational defense system, robotics and working from home are structural changes that are going to be here to stay. And these dynamics are really good for us. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Your next question comes from Toshiya Hari with Goldman Sachs. + +-------------------------------------------------------------------------------- +Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- +I had one for Colette and then one for Jensen as well, if I may. Colette, I wanted to come back to the gross margin question. You're guiding July essentially flat sequentially, despite what I'm guessing is better mixed with non-ops coming in and automotive guided down 40% sequentially. I guess the question is, what are some of the offsets that are pulling down gross margins in the current quarter? And sort of related to that, how should we be thinking about the cadence and OpEx going forward, given the 6-month pull in that you guys talked about on the compensation side? And then one quick one for Jensen. I was hoping you could comment on the current trade landscape between the U.S. and China. I feel like you guys shouldn't be impacted in a material way directly nor indirectly. But at the same time, given the critical role you play in scientific computing, I can sort of see a scenario where some people may claim that you guys contribute to efforts outside of the U.S. So if you can kind of speak on that -- speak to that, that will be helpful. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [29] +-------------------------------------------------------------------------------- +Thanks, Toshiya, for your question. So regarding our gross margins in the second quarter, our second quarter guide at 66% is up sequentially from even a record level in terms of what we had in terms of Q1. This next record that we hope to achieve with our overall guidance is even with including our overall Ampere architecture. So typically, when we transition to a new architectures, margins can somewhat be a little bit lower on the onset but tend to kind of move up and trend up over time. Additionally, as you articulated, our automotive is lower. But also, we're going to see growth in some of our platforms in gaming such as consoles, which may offset those 2. But overall, there's nothing structural to really highlight other than our mix in business and the ramp of Ampere and its transition. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [30] +-------------------------------------------------------------------------------- +Let's see, the trade tension. We've been living in this environment for some time, Toshiya. And as you know, the trade tension has been in the background for coming up on a year, probably gotten longer. And China's high-performance computing systems are largely based on Chinese electronics anyhow. And so that's -- I think our condition won't materially change going forward. + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [31] +-------------------------------------------------------------------------------- +So Toshiya, let me respond to your second question that you had for me, which was regarding to our OpEx and our decision to pull forward our overall local into Q2. This is something that we've normally done later in the year. We felt it was prudent during the current COVID-19. Although our employees are quite safe. We just wanted to make sure that their family members also were safe and had the opportunity to have cash upfront. It is about a couple of months, about 4 months earlier than normal, and it is incorporated in our guidance for Q2. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Your next question comes from Mark Lipacis with Jefferies. + +-------------------------------------------------------------------------------- +Mark John Lipacis, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [33] +-------------------------------------------------------------------------------- +A question coming back to the A100. I'm trying to understand how this kind of fits into the evolution of your solution set over time and the evolution of the demand for the applications. Is -- and I guess if I think about it going back, you had a solution, which is largely training based. And then you kind of introduced solutions that were targeted more inferencing. And now you have a solution, it sounds to my understanding that it solves both inferencing and training efficiently. And so I guess I'm wondering is 3 years, 5 years, 10 years down the line, is this part of the kind of general purpose computing or acceleration framework that you had talked about in the past, Jensen, where Ampere is kind of like an Ampere-class product? Or is this -- would you still -- should we still expect to see inferencing-specific solutions in the market and then training-specific solutions and then an Ampere solution for a different class application? If you could provide a framework for thinking about Ampere in those context, I think that would be helpful. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [34] +-------------------------------------------------------------------------------- +Yes. Thanks for the call, Mark. Good Question. I think the -- if you take a step back, currently in our data centers, the current setup in data centers, starting from probably all the way back, 6, 7 years ago, but really accelerating in the last 5 years and then really accelerating in the last couple of years, we learned our way into it. There are 3 classes of workloads, and they kind of came into acceleration over time. The first class of workload that we discovered was -- the major workload was deep learning training. Deep learning training. And the ideal setup for that today prior to Ampere or yesterday prior to Ampere is the V100 SXM with NVLink, 8 GPUs on one board, and that architecture is called scale up. It's like a supercomputer architecture. It's like a -- it's like a weather simulation architecture. You're trying to build the largest possible computing node you can for one operating system called scale up. And the second thing that we learned along the way was then cloud computing started to grow because researchers around the world needed to get access to an accelerated platform for developing their machine learning algorithms. And because they have a different degree of budget, and they want to get into it, a little bit more lightly and have the ability to scale up to larger nodes, the perfect model for that was actually a V100 PCI Express, not SXM, but PCI Express that allows you to offer 1 GPU all the way up to many GPUs. +And so that versatility, V100 PCI Express, not as scalable in performance as the V100 SXMs, but it was much more flexible for rentals. Cloud renting was really quite ideal. And then we started to get into inference, and we're on our seventh generation of TensorRT, TensorRT 7.0. Along the way, we've been able to accelerate more and more. And today, we largely accelerate every deep learning inference computational graph that's out there. And the ideal GPU for that was something that has the reduced precision, which is called (inaudible), reduced precision not with electronics that is focused more for inference -- and because inference is a scale-out application, where you have millions of queries, and each one of the queries are quite small versus scale up, where you have 1 training job and that 1 training job is running for a day. +It could be running for days and sometimes even weeks. And so scale-up application is for 1 user that uses it for a long period of time on a very large machine. Scale out, it's for millions of users, each one of them have a very small query and that query could last hundreds of milliseconds and where ideally, you like to get it done in hundreds of milliseconds. And so notice, I've said 3 different architecture in a data center today. Most data centers today has a storage server, has CPU servers, and it has scale-up acceleration service with Voltas has scaled out servers with GeForce and then it has scale cloud computing, flexible servers based on V100. And so the ability to predict workload is so hard, and therefore, the utilization of these systems will be spiky. And so we created an architecture that allows for 3 things. +So things -- the 3 characteristics of Ampere are: number one, it is the greatest generational leap in history. I mean I don't remember a generation where we increased throughput for training and inference by 20x. And it's just a gigantic -- for training and for inference, it is a gigantic leap forward. The second, it's the first architecture that is unified. We could use this to the computational -- the computation engine of Ampere accelerates the moment the data comes into the data center. From data processing, it's called [ETO]; the engine, which many of you probably know, it's the single most important computational engine in the world today for big data. It used to be Hadoop, but now it's Spark. Spark is used all over the world, 16,000 customers. We finally have the ability to accelerate that. +And then it's -- Ampere is also good for training, deep learning, machine learning, extra boost as well as deep learning, all the way out to inference. And so we now have a unified acceleration platform for the entire workload. And then the third thing is it's the first GPU ever, the first acceleration platform ever that's elastic. You could reconfigure it. You could configure it for either scale up or you can configure it for scale out. When you configure it for scale up, you're gaining a whole bunch of GPUs together using NVLink, and it creates this 1 gigantic GPU. When you want to scale it out, that same computation node becomes 56 small GPUs. Each one of those 56 partitions, each 1 is more powerful than Volta. +I mean it's really quite extraordinary. And so Ampere is a breakthrough on all of these fronts for performance for the fact that it unifies the workload, and you can now have 1 acceleration cluster; and then number three, it's elastic. You could use in the cloud, you could use for inference, you could use it for training. And so the versatility of Ampere is the thing that I'm most excited about. And now you could have 1 acceleration cluster that serves all of your needs. That's very helpful. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Your next question comes from Timothy Arcuri with UBS. + +-------------------------------------------------------------------------------- +Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [36] +-------------------------------------------------------------------------------- +Actually I had 2, I guess, Jensen, first for you. Just on the data center business, things have been very strong recently. Obviously, there's always concerns that customers are pulling in CapEx, but it sounds like you have pretty good visibility into July. But I guess last time, most folks also thought that your kind of attrition really was so low that you would be immune into any digestion, but that wasn't the case. So I guess I'm wondering, if things are different now with A100 and whatnot, but my question is how do you handicap your ability to this time, maybe get through any digestion on the CapEx side? And then I guess, second question, Colette, stock comp had been running like 220 a quarter, and the guidance implies that it goes to like 460 a quarter. So it goes up a lot. Is that all executive retention? And is that sort of the right level as you look into 2021? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [37] +-------------------------------------------------------------------------------- +Colette, did you want to handle that first? And then I'll do the... + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [38] +-------------------------------------------------------------------------------- +Sure. So let me help you out on the overall GAAP adjustments, so the delta between our GAAP OpEx and our non-GAAP OpEx. If you look at it for the full year and what we guided, we probably have about $1.55 billion associated with GAAP level expenses. Keep in mind, there is more in there than just our stock-based compensation. We have also incorporated the accounting that we will do for the overall Mellanox, and a really good portion of those costs are associated with the amortization of intangibles and also in terms of acquisition-related costs and deal fees and onetime items. So our stock-based compensation includes what we need for NVIDIA and also the onboarding of Mellanox. There is some retention with the overall onboarding of Mellanox. But for the most part, it is just working them in to the year for 3 quarters, which is influencing the stock-based compensation. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [39] +-------------------------------------------------------------------------------- +Tim, there are several differences between our condition then and our condition today. So the first -- the first difference is the diversity of workload we now accelerate. Back then, we were early in our inference. We were still early in our inference, and most of the data center acceleration was used for deep learning. And so today, the versatility stands from data processing to deep learning and the number of -- the number of different types of AI models that's being trained for deep learning is growing tremendously from detecting, from training video, from training a model to detecting unsafe video. The natural language understanding the conversational AI to now a gigantic movement towards deep recommender systems. And so the number of different models that are being trained is growing. The size of the models are gigantic. Recommendation systems are gigantic. They're training on models that are hundreds. The data sizes, hundreds of terabytes. Terabytes, hundreds of terabytes. And it would take tens of -- hundreds of servers to hold all of the data that is needed to train these recommender systems. And so the diversity of -- from data analytics to training all the different models to the influence of all different models. We didn't inference recurring elements at a time, which is probably the most important model today. Text language models, speech models are all recurrent, Euronet models. And so those models were early for us at the time. So number one is the diversity of workload. The second is the acceleration of -- to cloud computing. I think that accelerated cloud computing is a movement that is going to be a multiyear if not a decade-long transition. From where we are today, it's only $100 billion industry segment of the IT industry. It's going to be $1 trillion someday, and that movement is just starting. We're also much more diversified out of the clouds. At the time, cloud was largely where our acceleration went for deep learning. And today, hyperscale only represents about half. And so we've diversified significantly out of cloud, not out of cloud, but including vertical industries. And a lot of that has to do with edge AI and inference. And as I mentioned earlier, we're working with Walmart and BMW and USPS, and that's just the tip of the iceberg. And so I think the conditions are a little different. And then what I would say lastly is Ampere. I mean we are -- we've ramped a few weeks. Even though it was quite significant, it was a great ramp. The demand is fantastic. It is the best ramp we've ever had. The demand is the strongest we've ever had in data centers. And we're starting to ramp of a multiyear ramp. And so -- those are some of the differences. I think the conditions are very different. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Your next question comes from Harlan Sur with JPMorgan. + +-------------------------------------------------------------------------------- +Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- +Jensen, the team has showed the importance of networking, networking fabric and the Mellanox acquisition, like, for example, when you guys move from Volta DGX-1 to Volta DGX-2, you guys didn't change the GPU chipset. But by adding a custom networking fabric chip and more Mellanox network interface cards, among other things, you guys drove a pretty significant improvement in performance per GPU. But now when we think about scaling out compute acceleration to data center skilled implementation, how does Mellanox' Ethernet switching platforms differ from those provided by other large networking OEMs, some of whom have been your long-term partners? And then how does the Cumulus acquisition fit into the switching and networking strategy as well? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [42] +-------------------------------------------------------------------------------- +Yes. Great. Thanks a lot, Harlan. I appreciate the question. So DGX, you know this is our third-generation DGX and it's really successful. People love it. It's the most advanced AI instrument in the world. If you're a serious AI researcher, this is your instrument. And in the DGX, there are 8 A100s and there are 9 Mellanox NICs, the highest speed NICs they have. And so we have a great appreciation for high-performance networking. High-performance networking and high-performance computing go hand-in-hand. And the reason for that is because the problems we're trying to solve no longer fit in one computer, no matter how big it is. And so it has to be distributed. And when you distribute a computational workload of such intense scale, the communications overhead becomes one of its greatest bottlenecks, which is the reason why Mellanox is so valuable. There's reason why this company is so precious and really a jewel and one of a kind. And so -- and it's not just about the link speed. It's not mostly. +I mean we just have a deep appreciation for software. It's a combination of architecture and software and electronics design, chip design. And in that combination, Mellanox is just world-class. And that's the reason why they're in 60% of the world's supercomputers. That's why they're in 100% of the AI supercomputers. And their understanding of large-scale distributed computing is second to none. Now in the world of -- and I just talked about scale up. And you're absolutely right. +Now the question is why scale out? And the reason for that is this. This is the reason why they're doing so well. The movement towards disaggregated microservice applications where containers, microservice containers are distributed all over the data center and orchestrated so that the workload could be distributed across a very large hyperscale data center. That architecture -- and you probably know the 3 most important application in my estimation in the world today, number one, would be TensorFlow and PyTorch; number two would be Spark; and number three would be Kubernetes. And you could rank it however you desire. +And these 3 applications, in the case of Kubernetes, it's a brand-new type of application where the application is broken up with a small pieces and orchestrated across an entire data center. And because it's broken up into small pieces and orchestrate across the entire data center, the networking between the compute nodes becomes the bottleneck again. And that's the reason why they're doing so well. By increasing the network performance by offloading the communications of the CPUs, you increase the throughput of a data center tremendously. And so it's the reason why they had a record quarter last quarter. It's the reason why they've been growing 27% per year. And their stock was back, their integration into the hyperscale cloud companies, they're low latency, they're incredibly low latency of their link makes them really unique, even whether it's Ethernet or InfiniBand in both cases. +And so they're -- it's a really fantastic stack. And then lastly, Cumulus, we would like to integrate -- we would like to innovate in this world where the world is moving away from just a CPU as a compute node. The new computing unit, a software developer is writing a piece of software that runs on the entire data center. In the future, going forward, the computing, the fundamental computing unit is an entire data center. It's so incredible. It's just utterly incredible. You write an application, 1 human could write an application, and it would literally activate an entire data center. And in that world, we would like to be able to innovate from end to end, from networking storage, security. Everything has to be secured in the future so that we can reduce the attack surface down to practically nothing. +And so networking storage, security are all completely offloaded, all incredibly low latency, all incredibly high performance and all the way to compute, all the way through the switch. And then the second thing is we'd like to be able to innovate across the entire stack. You know that NVIDIA is just supremely obsessed about software stacks. And the reason for that is because software creates markets. You can't create new markets like we're talking about, whether it's computational health care or autonomous driving or robotic or conversational AI or recommender systems or edge AI. All of that requires software stacks. It takes software to create markets. And so our obsession about software and creating open platforms for the ecosystem and all of our developer partners, Cumulus plays perfectly into that. They are -- they pioneered the open networking stack. And they pioneered, in a lot of ways, software-defined data centers. And so we're super, super excited about the team. And now we have the ability to innovate in a data center scale world from end to end and then from top to bottom of the entire stack. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- +Your next question comes from William Stein with SunTrust. + +-------------------------------------------------------------------------------- +William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [44] +-------------------------------------------------------------------------------- +Jensen, I'd like to focus on something you said. I think it was in one of your earlier responses, you said something about a very significant part of data centers are now accelerated with GPUs. I'm sort of curious how to interpret that. If we think about sort of the evolution of compute architecture going from almost entirely, let's say, [REX and REXs] CPUs to some future day where we have many more accelerators and maybe a much smaller number of CPUs relative to those. Maybe you can talk to us about where we are in terms of that architectural shift and where you think it goes sort of longer term, where we are in the position of that? + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [45] +-------------------------------------------------------------------------------- +Yes. I appreciate the question. And this, for computer architecture geeks and people who follow history, you know well that in the entire history of time, there are only 2 computing architectures that has made it so far, which is one of them is x86. The other one's ARM in any reasonable way. And if you get an ARM computer, you get an x86 computer, you can program it. And in fact, there's no such thing as an accelerated computing platform until we came along. +And today, we're the only computing -- accelerated computing platform that you could really largely address. We're in every cloud. We're in every computer company. We're in every country. We have every single size, and we accelerate applications from computer graphics to video games to scientific computing to workstations to machine learning to robotics. This journey took 20-some-odd years. Inside our company, it took 20-some-odd years. And we've been focused on accelerated computing since the beginning of our company. And we made a general purpose. We made a general purpose really starting with an endeavor cost Cg, C for graphics, and then it became CUDA. And we've been working on accelerated computing for quite a long time. +And I think at this point, it's a foregone conclusion that accelerated computing has reached the tipping point and is well beyond it. The number of developers this year that support -- that we supported was almost 2 million developers around the world, and it's growing what appears to be exponentially. And so I think accelerated computing is now well established. NVIDIA-accelerated computing is well established. It's common sense, and people who are designing data centers expect to put accelerated computing in it. The question is how much? How much accelerated computing do you use? And what part of the date in your pipeline do you do it? And the big -- the gigantic breakthrough, of course, we know well now, and NVIDIA is recognized as one of the 3 pillars that ignited the modern AI, the big bang of modern AI. +And the other 2 pillar, of course, is deep learning algorithm and the abundance of data. And so the 3 -- these 3 ingredients came together and was -- people use NVIDIA accelerated computing largely for training. But over time, we expanded training to have a lot more models. And as I mentioned earlier, the single most important model of machine learning today is the recommender system. It's the most important model because it's the only way that you and I could use the Internet in any reasonable way. It's the only way that you and I could use a shopping website or a video web -- a video app or a music app or book or news or anything. And so it is the engine of the Internet from the consumer's perspective. On the company perspective, it is the engine of commerce. Without the recommender system, there's no way they could possibly make money. +And so their accuracy in predicting user preferences is core to everything they do. You just go up and down the list of every company. And that engine is gigantic. It is just a gigantic engine. And from the data processing part of it, which is the reason why we went and spent 3 years on Spark and RAPIDS, which made Spark possible and all the work that we did on NVLink and all that stuff was really focused on big data analytics. The second is all of the training of the deep learning models and the inference. So the number of applications, the footprint, the accelerated computing has grown tremendously, and its importance has grown tremendously because of the applications are the most important applications of these companies. And so I think when I mentioned -- when I said that, that acceleration is still growing, it is. But the major workloads, the most important workloads of the world's most important companies are now -- solidly require acceleration. And so I'm looking forward to a really exciting ramp for Ampere for all the reasons that I just mentioned. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Your next question comes from John Pitzer with Crédit Suisse. + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [47] +-------------------------------------------------------------------------------- +Just 2 quick ones. Colette, I hate to ask something as mundane as OpEx, but just given the full year guide, there's sort of a lot to unpack. And you talked about some of it like the raises. I mean I think you also probably have some COVID plus or minuses in that. I think there's an extra week this year as well. And then, of course, there's Mellanox and how you're thinking about investing in that asset. +I guess I'm just kind of curious, when we look at the full year guide, is there something structural going on OpEx as you try to take advantage of all these opportunities? Or can we use it as sort of a guidepost to how you're thinking about revenue for the back half of the year as well? How do I understand that? And then, Jensen, just a quick one for you. It kind of makes sense to me that COVID is accelerating activity in sort of HPC and hyperscale and maybe even in certain verticals like health care. But in the other verticals, has the sort of shelter in place kind of hurt engagement? And could we actually come out of COVID with some pent-up demand in those vertical markets? + +-------------------------------------------------------------------------------- +Colette M. Kress, NVIDIA Corporation - Executive VP & CFO [48] +-------------------------------------------------------------------------------- +Okay. Thanks, John, for the question. Let's start from the first perspective on the overall OpEx for the year. We've guided the non-GAAP at approximately $4.1 billion for the year. Yes, that incorporates 3 full quarters of Mellanox, Mellanox and its employees. We have about close to 3,000 Mellanox employees coming on board. You are correct. We have a 53rd week in this quarter -- excuse me, not this quarter, this year. +And that is -- has been outlined in SEC filings, and you should expect that as well. We pulled forward a little bit our focal by several months in order to take care of our employees. And then lastly though, we are investing in our business. We see some great opportunities. You've seen some good results from our investment, and there's more to do. We are hiring and investing in those businesses. So there's nothing different structurally, but just this onset of Mellanox and are investing together, I think, we'll produce long-term great results. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [49] +-------------------------------------------------------------------------------- +And as usual, John, you know that we're investing into the IT industry's largest opportunities, cloud computing and AI. And then after these 2 opportunities is edge AI. And so we're looking down the fairway with some pretty extraordinary opportunities. But as usual, we're thoughtful about the rate of investment, and we're well-managed. And NVIDIA's leadership team are excellent managers, and you could count on us to continue to do that. Simona, what was John's question? Could you just give me one hint? I haven't... + +-------------------------------------------------------------------------------- +John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [50] +-------------------------------------------------------------------------------- +Just the idea of engagement levels in verticals, just with shelter in place. Has that hampered... + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [51] +-------------------------------------------------------------------------------- +Oh yes. Right. Yes, right. Yes, right. A few -- some of the industries have been affected. We already mentioned automotive industry. The automotive industry has been grounded to a halt. Manufacturing hasn't largely stopped. And you saw that in our guidance. We expect automotive to be down 40% quarter-to-quarter. It's not going to remain that way. It's going to come back. And nobody knows what level is going to come back to you and how long, but it's going to come back. And there's no question in my mind that the automotive industry, they're hunkered down right now, but they will absolutely invest in the future of autonomous vehicles. +They have to, or they'll be extinct. It's not possible not to have autonomous capability in the future of everything that moves. Not so that it could just completely drive without you. That a nice benefit, too. But mostly because of safety and comfort and just a joy of what seems like the car is reading your mind. And of course, you're still responsible for driving it and -- but it just seems to be coasting down the road, reading your mind and helping you. And so I think the future of autonomous vehicles is a certainty. People recognize the incredible economics that the pioneer, Tesla, is enjoying. And the industry is going to go after it. +The future car companies are going to be software-defined companies and technology companies. And they would love to have an economic that allows them to enjoy the installed base of their fleets. And so they're going to go after it. And so this is -- I'm certain that this is going to come back. And well, I have every confidence is going to come back. And let's see, the energy sectors are -- have been impacted. The retail sector has been impacted. There's -- those aren't large industries for us. The impact in some of the industries is accelerating their focus in robotics. Like, for example, on the one hand, BMW has obviously impacted in manufacturing, which is the reason why they're moving so rapidly towards robotics. They have to figure out a way to get robotics into their factories. So same thing with retail. You're going to see a lot more robotic support in retail, you're going to see a lot more robotic support in warehouses, in logistics. And so during this time, when the market -- when the industry is disrupted and impacted, it allows the market leaders to really lean into investing into the future. And so when they come back, they'll be coming back stronger than ever. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +And your next question comes from Matt Ramsay with Cowen. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [53] +-------------------------------------------------------------------------------- +Two different topics, Jensen. Well, first of all, congrats on Ampere. It's a heck of a product. The first question... + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [54] +-------------------------------------------------------------------------------- +Thank you, Matt. I'm so proud. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [55] +-------------------------------------------------------------------------------- +The first question is it might have been a little bit hard to talk when the deal was pending about this topic, but now that it's closed, maybe you could talk a little bit about opportunities to innovate on and customize the Mellanox stack and the balance of having an industry standard. And the second one is E3 canceled, Computex moved around. At the same time, there's obviously stay-at-home gaming demand. Just how you think about gaming product, launch logistics? And any comments on there would be really helpful. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [56] +-------------------------------------------------------------------------------- +Yes. Thanks a lot, Matt. I appreciate your questions. I'll go backwards because it's kind of cool. On the one hand, I do miss that we can't engage the developers face to face. It's just so much fun. GTC is doing all their work and the hundreds of papers that are presented, I learned so much each time. And frankly, I really enjoyed the analyst meeting that we have. And so there's all kinds of stuff that I missed about the physical GTC, but here's the amazing thing. +We had almost -- the GTC kitchen keynote. I did it from my kitchen just right behind me, and the kitchen keynote has been viewed almost 4 million times. And the video is incredible. And so I think our reach is -- could be quite great. And so I'm not too -- we've got an amazing marketing team, and we just -- we've got great people. They're going to find a way to reach our gamers. And whenever we launch something next, you know that gamers are going to be and our customers are going to be -- our end markets are going to be really excited to see it. And so I'm very confident that we're going to do just fine. Matt, what was the question before? I should never do backwards. + +-------------------------------------------------------------------------------- +Matthew D. Ramsay, Cowen and Company, LLC, Research Division - MD & Senior Technology Analyst [57] +-------------------------------------------------------------------------------- +Just the industry standard versus customization of Mellanox opportunity. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [58] +-------------------------------------------------------------------------------- +I see. Okay. Yes. There's -- we work so closely with Mellanox over the years. And on the day that we announced GTC, you could see the number of products that we have working together. The product synergies are really incredible, and the product synergies include a lot of software development that went in and a lot of architectural development that went in. DGX comes with 9 Mellanox, Matt, as I mentioned. If you look at our data center, we ship -- before we ship DGXs to the customers, we ship it to our own engineers. And the reason for that is because every single product in our company has AI in it. +From Jarvis to Metropolis to Merlin to DRIVE to Clara to Isaac to -- right? All of our products has AI in it, and we're accelerating frameworks for all of the AI industry. And Ampere comes with a brand-new numerical format called Tensor Float 32. And TF32 is just a fantastic [medium medical] format and the performance is incredible. And we had to get it integrated in with the industry standard frameworks. And now Tensor Float comes standard with Tensor Flow -- with TF -- NVIDIA TF32, and PyTorch come standard with TF32. And so we need our own large-scale data center. And so the first customer we ship to was ourselves. And then we started shipping as quickly as we could to all of the customers. You saw that in our data center, in our supercomputer. +We have 170 -- 170 state-of-the-art, brand-new Mellanox switches. And almost 1,500 -- 200 gigabit per second Mellanox mix. And 15 kilometers of cables, fiber optic cables. And that is one of the most powerful supercomputers in the world today, and it's based on Ampere. And so we have a great deal of work that we did there together. We announced our first edge computer between us and Mellanox in this new card, we call it the EGX A100. It integrates Ampere and it integrates Mellanox' CX-6 Dx, which is designed for 5G telcos and edge computing. It's incredible security and has a single route of trust, and it's virtualized. And so basically, we -- this EGX A100, when you put it into a standard center x86 server, turns that server into a cloud computer in a box. +The entire capability of a cloud, of a state-of-the-art cloud, which is cloud native, it's secure, it has incredible AI processing, it's now completely hyperconverged inside 1 box. The technology that made EGX A100 is really quite remarkable. And so you could see all the different product synergies that we have in working together. We could have done Spark acceleration without the collaboration with Mellanox. They worked on this piece of networking software called UCX. We worked on [nickel] together. It made possible the infrastructure for large-scale distributor computing. I mean just the list goes on and on and on. And so we -- the 2 teams have great chemistry. The culture -- it's a great culture fit. I love working with them. And right out of the chute, you saw all of the great product synergies that are made possible because of the combination. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +That is all the time we have for questions. I'll turn the call back to Jensen Huang for closing remarks. + +-------------------------------------------------------------------------------- +Jen-Hsun Huang, NVIDIA Corporation - Co-Founder, CEO, President & Director [60] +-------------------------------------------------------------------------------- +It's coming. Let me just -- thank you. We had a great and busy quarter. With our announcements, we highlighted several initiatives. First, computing is moving to data center scale where computing and networking go hand in hand. The acquisition of Mellanox gives us deep expertise and scale to innovate from end to end. Second, AI is the most powerful technology force of our time. Our Ampere generation offers several breakthroughs. It is the largest ever generational leap 20x in training and inference throughput; the first unified acceleration platform for data analytics, machine learning, deep learning, training and inference; and the first elastic accelerator that can be configured for scale-up applications like training to scale-out applications like inference. +Ampere is fast, it's universal and it's elastic. It's going to re-architect the modern data center. Third, we are opening large new markets with AI software application framework, such as Clara for health care, DRIVE for autonomous vehicles, Isaac for robotics, Jarvis for conversational AI, Metropolis for edge IoT, AERIAL for 5G and Merlin with the very important recommender systems. And then finally, we have built up multiple engines of accelerated computing growth. RTX computer graphics, artificial intelligence, and data center scale computing from cloud to edge. I look forward to updating you on our progress next quarter. Thanks, everybody. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. Although the companies +may indicate and believe that the assumptions underlying the forward-looking +statements are reasonable, any of the assumptions could prove inaccurate or +incorrect and, therefore, there can be no assurance that the results +contemplated in the forward-looking statements will be realized. + +THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION +OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO +PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, +OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. +IN NO WAY DOES THOMSON REUTERS OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER +DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN +ANY EVENT TRANSCRIPT. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/app.py b/app.py new file mode 100644 index 0000000000000000000000000000000000000000..7532a6a4c15edd17fcf7ca81550646310366a4c1 --- /dev/null +++ b/app.py @@ -0,0 +1,261 @@ +import re +import numpy as np +import openai +import streamlit_scrollable_textbox as stx + +import pinecone +import streamlit as st + +st.set_page_config(layout="wide") # isort: split + +from utils import nltkmodules +from utils.entity_extraction import ( + extract_entities_docs, + year_quarter_range, + clean_companies, + ticker_year_quarter_tuples_creator, + extract_entities_keywords, + clean_keywords_all_combs, +) +from utils.models import ( + get_alpaca_model, + get_vicuna_ner_1_model, + get_vicuna_ner_2_model, + get_vicuna_text_gen_model, + get_data, + get_instructor_embedding_model_api, + gpt_turbo_model, + vicuna_text_generate, + save_key, +) +from utils.prompts import ( + generate_prompt_alpaca_style, + generate_multi_doc_context, +) +from utils.retriever import ( + query_pinecone, + sentence_id_combine, + get_indices_bm25, +) +from utils.transcript_retrieval import retrieve_transcript +from utils.vector_index import create_dense_embeddings + +st.title("Question Answering on Earnings Call Transcripts") +st.write( + "The app uses the quarterly earnings call transcripts for 10 companies (Apple, AMD, Amazon, Cisco, Google, Microsoft, Nvidia, ASML, Intel, Micron) for the years 2016 to 2020." +) + +# Caching Resources and Model APIs +data = get_data() +alpaca_model = get_alpaca_model() +vicuna_ner_1_model = get_vicuna_ner_1_model() +vicuna_ner_2_model = get_vicuna_ner_2_model() +vicuna_text_gen_model = get_vicuna_text_gen_model() + +# Sidebar Options + +decoder_models_choice = ["GPT-3.5 Turbo", "Vicuna-7B"] + +with st.sidebar: + st.subheader("Select Options:") + + num_results = int( + st.number_input("Number of Results to query", 1, 15, value=4) + ) + + window = int(st.number_input("Sentence Window Size", 0, 10, value=1)) + + threshold = float( + st.number_input( + label="Similarity Score Threshold", + step=0.05, + format="%.2f", + value=0.6, + ) + ) + + use_bm25 = st.checkbox("Use 2-Stage Retrieval (BM25)") + num_candidates = int( + st.number_input( + "Number of Candidates to Generate after first stage", + 25, + 200, + step=25, + value=50, + ) + ) + decoder_model = st.selectbox( + "Select Text Generation Model", decoder_models_choice + ) + + +col1, col2 = st.columns([3, 3], gap="medium") + +with col1: + query_text = st.text_area( + "Input Query", + value="What was discussed regarding Wearables revenue performance in Q1 2020?", + ) + +# Extracting Document Entities from Question +( + companies, + start_quarter, + start_year, + end_quarter, + end_year, +) = extract_entities_docs(query_text, vicuna_ner_1_model) + +year_quarter_range_list = year_quarter_range( + start_quarter, start_year, end_quarter, end_year +) + +ticker_list = clean_companies(companies) + +ticker_year_quarter_tuples_list = ticker_year_quarter_tuples_creator( + ticker_list, year_quarter_range_list +) + + +# Extract keywords from query +all_keywords = extract_entities_keywords(query_text, vicuna_ner_2_model) +if all_keywords != []: + keywords = clean_keywords_all_combs(all_keywords) +else: + keywords = None + + +# Connect to PineCone Vector Database - Instructor Model + +pinecone.init( + api_key=st.secrets["pinecone_instructor"], + environment="us-west4-gcp-free", +) + +pinecone_index_name = "week13-instructor-xl" +pinecone_index = pinecone.Index(pinecone_index_name) +retriever_model = get_instructor_embedding_model_api() +instruction = ( + "Represent the financial question for retrieving supporting documents:" +) + + +dense_query_embedding = create_dense_embeddings( + query_text, retriever_model, instruction +) + +context_group = [] +if ticker_year_quarter_tuples_list != []: + for ticker, quarter, year in ticker_year_quarter_tuples_list: + if use_bm25 == True: + indices = get_indices_bm25( + data, ticker, quarter, year, num_candidates + ) + else: + indices = None + + query_results = query_pinecone( + dense_query_embedding, + num_results, + pinecone_index, + year, + quarter, + ticker, + keywords, + indices, + threshold, + ) + context = sentence_id_combine(data, query_results, lag=window) + context_group.append((context, year, quarter, ticker)) + + multi_doc_context = generate_multi_doc_context(context_group) + +else: + if use_bm25 == True: + indices = get_indices_bm25(data, None, None, None, num_candidates) + else: + indices = None + + query_results = query_pinecone( + dense_query_embedding, + num_results, + pinecone_index, + None, + None, + None, + keywords, + indices, + threshold, + ) + multi_doc_context = sentence_id_combine(data, query_results, lag=window) + + +prompt = generate_prompt_alpaca_style(query_text, multi_doc_context) + +with col1: + edited_prompt = st.text_area( + label="Model Prompt", value=prompt, height=400 + ) + +if decoder_model == "GPT-3.5 Turbo": + with col1: + with st.form("gpt_form"): + openai_key = st.text_input( + "Enter OpenAI key", + value="", + type="password", + ) + gpt_submitted = st.form_submit_button("Submit") + if gpt_submitted: + api_key = save_key(openai_key) + openai.api_key = api_key + generated_text = gpt_turbo_model(edited_prompt) + +if decoder_model == "Vicuna-7B": + with col2: + st.write("The Vicuna Model is running: ...") + st.write("The model takes 10-15 mins to generate the text.") + generated_text = vicuna_text_generate(prompt, vicuna_text_gen_model) + + +with col2: + st.subheader("Answer:") + regex_pattern_sentences = "(?

  • {answer_text}

    • ", + unsafe_allow_html=True, + ) + + +tab1, tab2 = st.tabs(["Retrieved Text", "Retrieved Documents"]) + + +with tab1: + with st.expander("See Retrieved Text"): + st.subheader("Retrieved Text:") + st.write( + f"

    {multi_doc_context}

    ", + unsafe_allow_html=True, + ) + +with tab2: + + if ticker_year_quarter_tuples_list != []: + for ticker, quarter, year in ticker_year_quarter_tuples_list: + file_text = retrieve_transcript(data, year, quarter, ticker) + with st.expander(f"See Transcript - {quarter} {year}"): + st.subheader("Earnings Call Transcript - {quarter} {year}:") + stx.scrollableTextbox( + file_text, + height=700, + border=False, + fontFamily="Helvetica", + ) + + else: + st.write( + "No specific document chosen. Please mention Ticker and Duration in Question." + ) diff --git a/earnings_calls_cleaned_metadata_keywords_indices.csv b/earnings_calls_cleaned_metadata_keywords_indices.csv new file mode 100644 index 0000000000000000000000000000000000000000..86cb4e749ee562f025e7961fcaa1ccec902e7929 --- /dev/null +++ b/earnings_calls_cleaned_metadata_keywords_indices.csv @@ -0,0 +1,3 @@ +version https://git-lfs.github.com/spec/v1 +oid sha256:52a8350978cb768b90886898edad87b4a9ebb09439e493e0f2897ffc8256fd35 +size 42804336 diff --git a/requirements.txt b/requirements.txt new file mode 100644 index 0000000000000000000000000000000000000000..c69902de0b92fb408714cc83c0996b7dc1259070 --- /dev/null +++ b/requirements.txt @@ -0,0 +1,17 @@ +pandas +nltk +tqdm +pinecone-client +spacy[transformers] == 3.3.0 +https://github.com/explosion/spacy-models/releases/download/en_core_web_trf-3.3.0/en_core_web_trf-3.3.0.tar.gz#egg=en_core_web_trf==3.3.0 +https://github.com/explosion/spacy-models/releases/download/en_core_web_lg-3.3.0/en_core_web_lg-3.3.0.tar.gz#egg=en_core_web_lg==3.3.0 +https://github.com/explosion/spacy-models/releases/download/en_core_web_sm-3.3.0/en_core_web_sm-3.3.0.tar.gz#egg=en_core_web_sm==3.3.0 +torch +git+https://github.com/UKPLab/sentence-transformers.git +transformers +streamlit +streamlit-scrollable-textbox +openai +InstructorEmbedding +gradio_client +rank_bm25 diff --git a/utils/__init__.py b/utils/__init__.py new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/utils/__pycache__/__init__.cpython-38.pyc b/utils/__pycache__/__init__.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..f4dbc3d316d6ba1d34d83b86057ede8858464db6 Binary files /dev/null and b/utils/__pycache__/__init__.cpython-38.pyc differ diff --git a/utils/__pycache__/entity_extraction.cpython-38.pyc b/utils/__pycache__/entity_extraction.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..524317f5a79a9c2e97aba21acdfffd169ceb2431 Binary files /dev/null and b/utils/__pycache__/entity_extraction.cpython-38.pyc differ diff --git a/utils/__pycache__/models.cpython-38.pyc b/utils/__pycache__/models.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..00279c7420b73842c3253270a9fadbbd7daffe25 Binary files /dev/null and b/utils/__pycache__/models.cpython-38.pyc differ diff --git a/utils/__pycache__/prompts.cpython-38.pyc b/utils/__pycache__/prompts.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..f82f178a0855ed831e1ba2b63b8add8155ca758c Binary files /dev/null and b/utils/__pycache__/prompts.cpython-38.pyc differ diff --git a/utils/__pycache__/retriever.cpython-38.pyc b/utils/__pycache__/retriever.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..8d1642e9ef7be05360087a22bee8bd9a82465160 Binary files /dev/null and b/utils/__pycache__/retriever.cpython-38.pyc differ diff --git a/utils/__pycache__/transcript_retrieval.cpython-38.pyc b/utils/__pycache__/transcript_retrieval.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..3287e6cf7c0975159848b415ef9d089c411b6605 Binary files /dev/null and b/utils/__pycache__/transcript_retrieval.cpython-38.pyc differ diff --git a/utils/__pycache__/vector_index.cpython-38.pyc b/utils/__pycache__/vector_index.cpython-38.pyc new file mode 100644 index 0000000000000000000000000000000000000000..8e4b3414d6446fae9e3e2b0a1e02355af61eaeed Binary files /dev/null and b/utils/__pycache__/vector_index.cpython-38.pyc differ diff --git a/utils/entity_extraction.py b/utils/entity_extraction.py new file mode 100644 index 0000000000000000000000000000000000000000..7d941bf43508e122b7bcbd04b0b4f7c459ec97ea --- /dev/null +++ b/utils/entity_extraction.py @@ -0,0 +1,272 @@ +import re +from ast import literal_eval +from nltk.stem import PorterStemmer, WordNetLemmatizer + +# Entity Extraction + + +def generate_ner_docs_prompt(query): + prompt = """USER: Extract the company names and time duration mentioned in the question. The entities should be extracted in the following format: {"companies": list of companies mentioned in the question,"start-duration": ("start-quarter", "start-year"), "end-duration": ("end-quarter", "end-year")}. Return {"companies": None, "start-duration": (None, None), "end-duration": (None, None)} if the entities are not found. +Examples: +What did analysts ask about the Wearables during AAPL's earnings call? +{"companies": ["AAPL"], "start-duration": (None, None), "end-duration": (None, None)} +What is Intel's update on the server chip roadmap and strategy for Q1 2019? +{"companies": ["Intel"], "start-duration": ("Q1", "2019"), "end-duration": ("Q1", "2019")} +What are the opportunities and challenges in the Indian market for Amazon in 2016? +{"companies": ["Amazon"], "start-duration": ("Q1", "2016"), "end-duration": ("Q4", "2016")} +What is the comparative performance analysis between Intel and AMD in key overlapping segments such as PC, Gaming, and Data Centers in Q2 to Q3 2018? +{"companies": ["Intel", "AMD"], "start-duration": ("Q2", "2018"), "end-duration": ("Q3", "2018")} +How did Microsoft and Amazon perform in terms of reliability and scalability of cloud for the years 2016 and 2017? +{"companies": ["Microsoft", "Amazon"], "start-duration": ("Q1", "2016"), "end-duration": ("Q4", "2017")}""" + input_prompt = f"""###Input: {query} +ASSISTANT:""" + final_prompt = prompt + "\n" + input_prompt + return final_prompt + + +def extract_entities_docs(query, model): + """ + Takes input a string which contains a dictionary of entities of the format: + {"companies": list of companies mentioned in the question,"start-duration": ("start-quarter", "start-year"), "end-duration": ("end-quarter", "end-year")} + """ + prompt = generate_ner_docs_prompt(query) + string_of_dict = model.predict(prompt, api_name="/predict") + + entities_dict = literal_eval(string_of_dict) + start_quarter, start_year = entities_dict["start-duration"] + end_quarter, end_year = entities_dict["end-duration"] + companies = entities_dict["companies"] + print((companies, start_quarter, start_year, end_quarter, end_year)) + return companies, start_quarter, start_year, end_quarter, end_year + + +def year_quarter_range(start_quarter, start_year, end_quarter, end_year): + """ + Creates a list of all (year, quarter) pairs that lie in the range including the start and end quarters. + + Example: + year_quarter_range("Q2", "2020", "Q3", "2021") + [('Q2', '2020'), ('Q3', '2020'), ('Q4', '2020'), ('Q1', '2021'), ('Q2', '2021'), ('Q3', '2021')] + """ + if ( + start_quarter is None + or start_year is None + or end_quarter is None + or end_year is None + ): + return [] + else: + quarters = ["Q1", "Q2", "Q3", "Q4"] + start_index = quarters.index(start_quarter) + end_index = quarters.index(end_quarter) + + years = range(int(start_year), int(end_year) + 1) + year_quarter_range_list = [] + + for year in years: + if year == int(start_year): + start = start_index + else: + start = 0 + + if year == int(end_year): + end = end_index + 1 + else: + end = len(quarters) + + for quarter_index in range(start, end): + year_quarter_range_list.append( + (quarters[quarter_index], str(year)) + ) + + return year_quarter_range_list + + +def clean_companies(company_list): + """Returns list of Tickers from list of companies""" + company_ticker_map = { + "apple": "AAPL", + "amd": "AMD", + "amazon": "AMZN", + "cisco": "CSCO", + "google": "GOOGL", + "microsoft": "MSFT", + "nvidia": "NVDA", + "asml": "ASML", + "intel": "INTC", + "micron": "MU", + } + + tickers = [ + "AAPL", + "CSCO", + "MSFT", + "ASML", + "NVDA", + "GOOGL", + "MU", + "INTC", + "AMZN", + "AMD", + "aapl", + "csco", + "msft", + "asml", + "nvda", + "googl", + "mu", + "intc", + "amzn", + "amd", + ] + + ticker_list = [] + for company in company_list: + if company.lower() in company_ticker_map.keys(): + ticker = company_ticker_map[company.lower()] + ticker_list.append(ticker) + elif company.lower() in tickers: + ticker_list.append(company.upper()) + return ticker_list + + +def ticker_year_quarter_tuples_creator(ticker_list, year_quarter_range_list): + ticker_year_quarter_tuples_list = [] + for ticker in ticker_list: + if year_quarter_range_list == []: + return [] + else: + for quarter, year in year_quarter_range_list: + ticker_year_quarter_tuples_list.append((ticker, quarter, year)) + return ticker_year_quarter_tuples_list + + +# Keyword Extraction + + +def generate_ner_keywords_prompt(query): + prompt = """USER: Extract the entities which describe the key theme and topics being asked in the question. Extract the entities in the following format: {"entities":["keywords"]}. +Examples: +What is Intel's update on the server chip roadmap and strategy for Q1 2019? +{"entities":["server"]} +What are the opportunities and challenges in the Indian market for Amazon from Q1 to Q3 in 2016? +{"entities":["indian"]} +What is the comparative performance analysis between Intel and AMD in key overlapping segments such as PC, Gaming, and Data Centers in Q1 2016? +{"entities":["PC","Gaming","Data Centers"]} +What was Google's and Microsoft's capex spend for the last 2 years? +{"entities":["capex"]} +What did analysts ask about the cloud during Microsoft's earnings call in Q1 2018? +{"entities":["cloud"]} +What was the growth in Apple services revenue for 2017 Q3? +{"entities":["services"]}""" + input_prompt = f"""###Input: {query} +ASSISTANT:""" + final_prompt = prompt + "\n" + input_prompt + return final_prompt + + +def extract_entities_keywords(query, model): + """ + Takes input a string which contains a dictionary of entities of the format: + {"entities":["keywords"]} + """ + prompt = generate_ner_keywords_prompt(query) + string_of_dict = model.predict(prompt, api_name="/predict") + + entities_dict = literal_eval(string_of_dict) + keywords_list = entities_dict["entities"] + return keywords_list + + +def expand_list_of_lists(list_of_lists): + """ + Expands a list of lists of strings to a list of strings. + Args: + list_of_lists: A list of lists of strings. + Returns: + A list of strings. + """ + + expanded_list = [] + for inner_list in list_of_lists: + for string in inner_list: + expanded_list.append(string) + return expanded_list + + +def all_keywords_combs(list_of_cleaned_keywords): + # Convert all strings to lowercase. + lower_texts = [text.lower() for text in list_of_cleaned_keywords] + + # Stem the words in each string. + stemmer = PorterStemmer() + stem_texts = [stemmer.stem(text) for text in list_of_cleaned_keywords] + + # Lemmatize the words in each string. + lemmatizer = WordNetLemmatizer() + lemm_texts = [ + lemmatizer.lemmatize(text) for text in list_of_cleaned_keywords + ] + + list_of_cleaned_keywords.extend(lower_texts) + list_of_cleaned_keywords.extend(stem_texts) + list_of_cleaned_keywords.extend(lemm_texts) + + list_of_cleaned_keywords = list(set(list_of_cleaned_keywords)) + + return list_of_cleaned_keywords + + +def create_incorrect_entities_list(): + words_to_remove = [ + "q1", + "q2", + "q3", + "q4", + "2016", + "2017", + "2018", + "2019", + "2020", + "apple", + "amd", + "amazon", + "cisco", + "google", + "microsoft", + "nvidia", + "asml", + "intel", + "micron", + "strategy", + "roadmap", + "impact", + "opportunities", + "challenges", + "growth", + "performance", + "analysis", + "segments", + "comparative", + "overlapping", + "acquisition", + "revenue", + ] + words_to_remove = all_keywords_combs(words_to_remove) + return words_to_remove + + +def clean_keywords_all_combs(keywords_list): + + words_to_remove = create_incorrect_entities_list() + + texts = [text.split(" ") for text in keywords_list] + texts = expand_list_of_lists(texts) + + # Convert all strings to lowercase. + lower_texts = [text.lower() for text in texts] + cleaned_keywords = [ + text for text in lower_texts if text not in words_to_remove + ] + all_cleaned_keywords = all_keywords_combs(cleaned_keywords) + return all_cleaned_keywords diff --git a/utils/models.py b/utils/models.py new file mode 100644 index 0000000000000000000000000000000000000000..1ff82d451f05594f5fb1d8827edca756bcb2701a --- /dev/null +++ b/utils/models.py @@ -0,0 +1,139 @@ +import re + +import openai +import pandas as pd +import streamlit_scrollable_textbox as stx +import torch +from InstructorEmbedding import INSTRUCTOR +from gradio_client import Client +from transformers import ( + AutoModelForMaskedLM, + AutoTokenizer, +) +from rank_bm25 import BM25Okapi, BM25L, BM25Plus +import numpy as np +from nltk.tokenize import word_tokenize +from nltk.corpus import stopwords +from nltk.stem.porter import PorterStemmer +import re +import streamlit as st + + +@st.cache_resource +def get_data(): + data = pd.read_csv("earnings_calls_cleaned_metadata_keywords_indices.csv") + return data + + +# Preprocessing for BM25 + + +def tokenizer( + string, reg="[a-zA-Z'-]+|[0-9]{1,}%|[0-9]{1,}\.[0-9]{1,}%|\d+\.\d+%}" +): + regex = reg + string = string.replace("-", " ") + return " ".join(re.findall(regex, string)) + + +def preprocess_text(text): + # Convert to lowercase + text = text.lower() + # Tokenize the text + tokens = word_tokenize(text) + # Remove stop words + stop_words = set(stopwords.words("english")) + tokens = [token for token in tokens if token not in stop_words] + # Stem the tokens + porter_stemmer = PorterStemmer() + tokens = [porter_stemmer.stem(token) for token in tokens] + # Join the tokens back into a single string + preprocessed_text = " ".join(tokens) + preprocessed_text = tokenizer(preprocessed_text) + + return preprocessed_text + + +# Initialize models from HuggingFace + + +@st.cache_resource +def get_splade_sparse_embedding_model(): + model_sparse = "naver/splade-cocondenser-ensembledistil" + # check device + device = "cuda" if torch.cuda.is_available() else "cpu" + tokenizer = AutoTokenizer.from_pretrained(model_sparse) + model_sparse = AutoModelForMaskedLM.from_pretrained(model_sparse) + # move to gpu if available + model_sparse.to(device) + return model_sparse, tokenizer + + +@st.cache_resource +def get_instructor_embedding_model(): + model = INSTRUCTOR("hkunlp/instructor-xl") + return model + + +@st.cache_resource +def get_instructor_embedding_model_api(): + client = Client("https://awinml-api-instructor-xl-2.hf.space/") + return client + + +@st.cache_resource +def get_alpaca_model(): + client = Client("https://awinml-alpaca-cpp.hf.space") + return client + + +@st.cache_resource +def get_vicuna_ner_1_model(): + client = Client("https://awinml-api-vicuna-openblas-ner-1.hf.space/") + return client + + +@st.cache_resource +def get_vicuna_ner_2_model(): + client = Client("https://awinml-api-vicuna-openblas-ner-2.hf.space/") + return client + + +@st.cache_resource +def get_vicuna_text_gen_model(): + client = Client("https://awinml-api-vicuna-openblas-4.hf.space/") + return client + + +@st.cache_resource +def get_bm25_model(data): + corpus = data.Text.tolist() + corpus_clean = [preprocess_text(x) for x in corpus] + tokenized_corpus = [doc.split(" ") for doc in corpus_clean] + bm25 = BM25Plus(tokenized_corpus) + return corpus, bm25 + + +@st.cache_resource +def save_key(api_key): + return api_key + + +# Text Generation + + +def vicuna_text_generate(prompt, model): + generated_text = model.predict(prompt, api_name="/predict") + return generated_text + + +def gpt_turbo_model(prompt): + response = openai.ChatCompletion.create( + model="gpt-3.5-turbo", + messages=[ + {"role": "user", "content": prompt}, + ], + temperature=0.01, + max_tokens=1024, + ) + return response["choices"][0]["message"]["content"] diff --git a/utils/nltkmodules.py b/utils/nltkmodules.py new file mode 100644 index 0000000000000000000000000000000000000000..c081a95438e01834212f548d955ed04e06d5478d --- /dev/null +++ b/utils/nltkmodules.py @@ -0,0 +1,5 @@ +import nltk + +nltk.download("wordnet") +nltk.download("punkt") +nltk.download("stopwords") diff --git a/utils/prompts.py b/utils/prompts.py new file mode 100644 index 0000000000000000000000000000000000000000..554cc62f67a2c5b7b156144d4a4af68646239d03 --- /dev/null +++ b/utils/prompts.py @@ -0,0 +1,29 @@ +def generate_multi_doc_context(context_group): + multi_doc_text = "" + for context_text, year, quarter, ticker in context_group: + print((context_text, year, quarter, ticker)) + if context_text == "": + break + else: + multi_doc_text = ( + multi_doc_text + + "\n" + + f"Source: {quarter} {ticker} Earnings Call {year}" + + "\n" + + context_text + ) + return multi_doc_text + + +def generate_prompt_alpaca_style(query_text, context): + prompt = f"""Below is an instruction that describes a task, paired with an input that provides further context. Use the following guidelines to write a response that that appropriately completes the request: +### Instruction: +- Write a detailed paragraph consisting of exactly five complete sentences that answer the question based on the provided context. +- Focus on addressing the specific question posed, providing as much relevant information and detail as possible. +- Only use details from the provided context that directly address the question; do not include any additional information that is not explicitly stated. +- Aim to provide a clear and concise summary that fully addresses the question. + +Question: {query_text} +Context: {context} +### Response:""" + return prompt diff --git a/utils/retriever.py b/utils/retriever.py new file mode 100644 index 0000000000000000000000000000000000000000..14f3f6d3ec95344fe6713d595e53b1090469d969 --- /dev/null +++ b/utils/retriever.py @@ -0,0 +1,109 @@ +from utils.models import get_bm25_model, preprocess_text +import numpy as np + +# BM25 Filtering and Retrieval + + +def filter_data_docs(data, ticker, quarter, year): + year_int = int(year) + data_subset = data[ + (data["Year"] == year_int) + & (data["Quarter"] == quarter) + & (data["Ticker"] == ticker) + ] + return data_subset + + +def get_bm25_search_hits(corpus, sparse_scores, top_n=50): + bm25_search = [] + indices = [] + for idx in sparse_scores: + if len(bm25_search) <= top_n: + bm25_search.append(corpus[idx]) + indices.append(idx) + indices = [int(x) for x in indices] + return indices + + +# BM-25 Filtering +def get_indices_bm25( + data, query, ticker=None, quarter=None, year=None, num_candidates=50 +): + if ticker is None or quarter is None or year is None: + corpus, bm25 = get_bm25_model(data) + else: + filtered_data = filter_data_docs(data, ticker, quarter, year) + corpus, bm25 = get_bm25_model(filtered_data) + tokenized_query = preprocess_text(query).split() + sparse_scores = np.argsort(bm25.get_scores(tokenized_query), axis=0)[::-1] + indices_hits = get_bm25_search_hits(corpus, sparse_scores, num_candidates) + return indices_hits + + +def query_pinecone( + dense_vec, + top_k, + index, + year=None, + quarter=None, + ticker=None, + keywords=None, + indices=None, + threshold=0.25, +): + + filter_dict = { + "QA_Flag": {"$eq": "Answer"}, + } + if year is not None: + filter_dict["Year"] = int(year) + if quarter is not None: + filter_dict["Quarter"] = {"$eq": quarter} + if ticker is not None: + filter_dict["Ticker"] = {"$eq": ticker} + if keywords is not None: + filter_dict["Keywords"] = {"$in": keywords} + if indices is not None: + filter_dict["index"] = {"$in": indices} + + xc = index.query( + vector=dense_vec, + top_k=top_k, + filter=filter_dict, + include_metadata=True, + ) + + # filter the context passages based on the score threshold + filtered_matches = [] + for match in xc["matches"]: + if match["score"] >= threshold: + filtered_matches.append(match) + xc["matches"] = filtered_matches + return xc + + +def sentence_id_combine(data, query_results, lag=1): + # Extract sentence IDs from query results + ids = [ + result["metadata"]["Sentence_id"] + for result in query_results["matches"] + ] + # Generate new IDs by adding a lag value to the original IDs + new_ids = [id + i for id in ids for i in range(-lag, lag + 1)] + # Remove duplicates and sort the new IDs + new_ids = sorted(set(new_ids)) + # Create a list of lookup IDs by grouping the new IDs in groups of lag*2+1 + lookup_ids = [ + new_ids[i : i + (lag * 2 + 1)] + for i in range(0, len(new_ids), lag * 2 + 1) + ] + # Create a list of context sentences by joining the sentences + # corresponding to the lookup IDs + context_list = [ + " ".join( + data.loc[data["Sentence_id"].isin(lookup_id), "Text"].to_list() + ) + for lookup_id in lookup_ids + ] + context = " ".join(context_list).strip() + return context diff --git a/utils/transcript_retrieval.py b/utils/transcript_retrieval.py new file mode 100644 index 0000000000000000000000000000000000000000..b255f7e101baa6e875dcdbc072eda635949035ad --- /dev/null +++ b/utils/transcript_retrieval.py @@ -0,0 +1,32 @@ +# Transcript Retrieval + + +def retrieve_transcript(data, year, quarter, ticker): + if year == "All" or quarter == "All": + row = ( + data.loc[ + (data.Ticker == ticker), + ["File_Name"], + ] + .drop_duplicates() + .iloc[0, 0] + ) + else: + row = ( + data.loc[ + (data.Year == int(year)) + & (data.Quarter == quarter) + & (data.Ticker == ticker), + ["File_Name"], + ] + .drop_duplicates() + .iloc[0, 0] + ) + # convert row to a string and join values with "-" + # row_str = "-".join(row.astype(str)) + ".txt" + open_file = open( + f"Transcripts/{ticker}/{row}", + "r", + ) + file_text = open_file.read() + return f"""{file_text}""" diff --git a/utils/vector_index.py b/utils/vector_index.py new file mode 100644 index 0000000000000000000000000000000000000000..df19429c79070430006093f626d39667d7280854 --- /dev/null +++ b/utils/vector_index.py @@ -0,0 +1,21 @@ +import json +import numpy as np + + +def create_dense_embeddings( + query, + model, + instruction="Represent the financial question for retrieving supporting documents:", +): + # Fetching embedding from API for Instructor + json_output_embedding = model.predict( + instruction, + query, + api_name="/predict", + ) + + json_file = open(json_output_embedding, "r") + json_dict = json.load(json_file) + dense_array = np.array(json_dict["data"], dtype=np.float64) + dense_emb = dense_array.tolist() + return dense_emb \ No newline at end of file